UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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| þ | | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2006
OR
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| o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT FOR THE TRANSITION PERIOD |
For the transition period from to
Commission File Number 000-49966
COMMUNITY FIRST, INC.
(Exact Name of Registrant as Specified in its Charter)
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| Tennessee | | 04-3687717 |
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| (State or other jurisdiction of incorporation | | (I.R.S. Employer Identification No.) |
| or organization) | | |
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| 501 S. James Campbell Blvd. | | |
| Columbia, Tennessee | | 38401 |
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| (Address of principal executive offices) | | (Zip Code) |
(931) 380-2265
(Registrant’s Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b)of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yeso Noþ
Indicate by check mark whether the Registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act. Yeso Noþ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or15(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. Yesþ Noo
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K.o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filero Accelerated filero Non-accelerated filerþ
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ
The aggregate market value of the Registrant’s outstanding Common Stock held by nonaffiliates of the Registrant on June 30, 2006 was approximately $70,410,057. There were 3,147,433 shares of Common Stock outstanding on March 23, 2007.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for its 2007 Annual Meeting of Shareholders currently scheduled to be held on April 24, 2007, are incorporated by reference into Part III of this Annual Report on Form 10-K.
COMMUNITY FIRST, INC.
Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 2006
Table of Contents
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SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the statements made herein, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning and subject to the protections of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “project,” “could,” “intend,” “target,” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation those described under Item 1A, “Risk Factors”, in this document and the following:
| | • | | the effects of future economic or business conditions nationally and in our local market; |
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| | • | | our potential growth, including our entrance or expansion into new markets, and the need for sufficient capital to support that growth; |
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| | • | | governmental monetary and fiscal policies, as well as legislative and regulatory changes, including changes in banking, securities and tax laws and regulations; |
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| | • | | the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values of loan collateral, securities, and interest sensitive assets and liabilities; |
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| | • | | credit risks of borrowers; |
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| | • | | the effects of competition from a wide variety of local, regional, national and other providers of financial, investment, and insurance services; |
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| | • | | the failure of assumptions underlying the establishment of reserves for possible loan losses and other estimates; |
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| | • | | changes in accounting policies, rules and practices; |
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| | • | | changes in technology or products that may be more difficult, or costly, or less effective, than anticipated; |
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| | • | | the effects of war or other conflict, acts of terrorism or other catastrophic events that may affect general economic conditions; and |
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| | • | | other circumstances, many of which may be beyond our control. |
All written or oral forward-looking statements that are made by or are attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update,
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revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made.
PART I
ITEM 1. BUSINESS
(Dollar amounts in thousands, except per share data)
General
Community First, Inc., (the “Company”) is a registered bank holding company under the Bank Holding Company Act of 1956, as amended, and became so upon the acquisition of all the voting shares of Community First Bank & Trust (the “Bank”) on August 30, 2002. An application for the bank holding company was approved by the Federal Reserve Bank of Atlanta (the “FRB”) on August 6, 2002. The Company was incorporated under the laws of the State of Tennessee as a Tennessee corporation on April 9, 2002. The Company conducts substantially all of its activities through and derives substantially all of its income from its wholly-owned subsidiary, the Bank.
The Bank commenced business on May 18, 1999, as a Tennessee-chartered commercial bank whose deposits are insured by the Federal Deposit Insurance Corporation’s (the “FDIC”) Bank Insurance Fund (the “BIF”). The Bank is regulated by the Tennessee Department of Financial Institutions (the “Department”) and the FDIC. The Bank’s sole subsidiary is Community First Title, Inc., a Tennessee chartered and regulated title insurance company. CFBT Investments, Inc., a Nevada corporation, is a wholly-owned subsidiary of Community First Title, Inc., and is the parent of Community First Properties, Inc., a Maryland corporation, which was established as a real estate investment trust pursuant to Internal Revenue Service regulations. The Bank’s principal business is to accept demand and saving deposits from the general public and to make residential mortgage, commercial, and consumer loans.
We conduct our banking activities from our main office and two branch offices in Columbia, Tennessee, one branch office in Mount Pleasant, Tennessee, one branch office in Franklin, Tennessee and one branch office in Murfreesboro, Tennessee. The bank also operates ten automated teller machines in Maury County, Tennessee, two automated teller machines in Williamson County, and one automated teller machine in Rutherford County, Tennessee.
The Company’s assets consist primarily of its investment in the Bank. Its primary activities are conducted through the Bank. At December 31, 2006, the Company’s consolidated total assets were $421,393, its consolidated net loans, including loans held for sale, were $348,695, its total deposits were $366,766, and its total shareholders’ equity was $30,657. At December 31, 2005, consolidated total assets were $328,806, consolidated net loans, including loans held for sale, were $258,040, total deposits were $286,243, and total shareholders’ equity was $24,017.
Loans
The Bank makes secured loans and unsecured loans to individuals, partnerships, corporations, and other business entities within the Middle Tennessee area. Our loan portfolio consists of commercial, financial and agricultural loans, residential and commercial mortgage loans, and consumer loans. Our legal lending limits under applicable regulations (based upon the legal lending limits of 25% of capital and surplus) are currently $9,328.
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Commercial loans are made primarily to small- and medium-sized businesses. These loans are secured and unsecured and are made available for general operating inventory and accounts receivables as well as any other purposes considered appropriate. We will generally look to a borrower’s business operations as the principal source of repayment, but will also receive, when appropriate, a security interest in personal property and/or personal guarantees. In addition, the majority of commercial loans that are not mortgage loans are secured by a lien on equipment, inventory, and/or other assets of the commercial borrower.
Commercial lending (including commercial real estate lending) involves more risk than residential real estate lending because loan balances are greater and repayment is dependent up on the borrower’s operations. We attempt to minimize the risks associated with these transactions by generally limiting our exposure to owner-operated properties of customers with an established profitable history. In many cases, risk can be further reduced by limiting the amount of credit to any one borrower to an amount less than our legal lending limit and avoiding types of commercial real estate financing considered risky.
We originate residential mortgage loans with either fixed or variable interest rates. Our general policy is to sell most fixed rate loans in the secondary market. This policy is subject to review by management and may be revised as a result of changing market and economic conditions and other factors. We do not retain servicing rights with respect to secondary market residential mortgage loans that we originate. Typically, all of our residential real estate loans are secured by a first lien on the real estate. Also, we offer home equity loans, which are secured by prior liens on the subject residence.
We make personal loans and lines of credit available to consumers for various purposes, such as the purchase of automobiles, boats and other recreational vehicles, and the making of home improvements and personal investments. All such loans are retained by us.
Consumer loans generally have shorter terms and higher interest rates than residential mortgage loans and usually involve more credit risk than mortgage loans because of the type and nature of the collateral. Consumer lending collections are dependent on a borrower’s continuing financial stability and are thus likely to be adversely affected by job loss, illness, or personal bankruptcy. In many cases, repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation of the underlying collateral. We underwrite our loans carefully, with a strong emphasis on the amount of the down payment, credit quality and history, employment stability, and monthly income. These loans are generally expected to be repaid on a monthly repayment schedule with the payment amount tied to the borrower’s periodic income. We believe that the generally higher yields earned on consumer loans help compensate for the increased credit risk associated with such loans and that consumer loans are important to our efforts to serve the credit needs of our customer base.
Although we take a progressive and competitive approach to lending, we stress high quality in our loans. We are subject to written loan policies that contain general lending guidelines and are subject to periodic review and revision by our board of directors’ Loan Policy Committee. These policies concern loan administration, documentation, approval, and reporting requirements for various types of loans.
Lending Policy of the Bank
While the ultimate authority to approve loans rests with the Board of Directors (the “Directors”) of the Bank, lending authority is delegated by the Directors to the loan officers and loan committee of the Bank. Loan officers, each of whom is limited as to the amount of secured and unsecured loans that he or she can make to a single borrower or related group of borrowers, report to the Bank’s Chief Lending Officer, Roger Stewart. Marc Lively, President and Chief Executive Officer, chairs the Bank’s loan committee. The Bank’s Chief Credit Officer, Carl Campbell, serves as Vice Chairman of the Bank’s loan committee. Lending limits of individual officers are documented in the Bank’s Loan Policy and Procedures and are approved by the
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Directors. Loan officers discuss with the Senior Lending Officer or Chief Credit Officer any loan request that exceeds their individual lending limit. The loan must have the approval from the Senior Lending Officer, Chief Credit Officer or the loan committee as required by Loan Policy and Procedures. The President and Chief Executive Officer, Marc R. Lively, Chief Credit Officer, Carl Campbell, and the Senior Lending Officer, Roger Stewart, have lending authority on secured and unsecured loans up to $500,000.
The Bank’s Loan Policy provides written guidelines for lending activities and is reviewed at least annually by the Bank’s directors. The directors recognize that, from time to time, it is in the best interests of the Bank to deviate from the established, written credit policy and have established guidelines for granting exceptions to the policy. Situations in which such exceptions might be granted include the waiving of requirements for independent audited financial statements when a comfort level with respect to the financial statements of the borrower can be otherwise obtained and when it is deemed desirable to meet the terms offered by a competitor.
The Bank seeks to maintain a diversified loan portfolio, including secured and unsecured consumer loans, secured loans to individuals for business purposes, secured commercial loans, secured agricultural production loans, and secured real estate loans. The Bank’s primary trade area lies in the counties of Middle Tennessee, with the primary focus in Maury, Williamson and Rutherford Counties. The loan committee must approve all out-of-trade area loans.
As a general rule, the Bank seeks to maintain loan-to-collateral value ratios in conformity with industry and regulatory guidelines. The following standards, established by inter-agency guidelines by the federal bank regulators, including the FDIC, went into effect on March 19, 1993:
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| | | Maximum Allowable |
| Loan Category | | Loan-to-Value Ratio |
| Land | | | 65 | % |
| Land development | | | 75 | % |
| Construction | | | | |
| Commercial, multifamily (1) and other nonresidential | | | 80 | % |
| 1-4 family residential | | | 85 | % |
| Improved property | | | 85 | % |
| Owner-occupied 1-4 family and home equity (2) | | | 85 | % |
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| (1) | | Multifamily construction includes condominiums and cooperatives. |
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| (2) | | A loan-to-value limit has not been established for permanent mortgage or home equity loans or owner-occupied, 1-4 family residential property. However, for any such loan with a loan-to-value ratio that equals or exceeds 90% at origination, appropriate credit enhancement in the form of either mortgage insurance or readily marketable collateral is required. Home equity lines of credit (HELOC) loan-to-value may be up to 100% of the collateral appraisal value. |
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Loan Review and Nonperforming Assets
The Bank has an internal loan review system to determine deficiencies and corrective action to be taken. Loans are graded as follows:
Class 1: High. Loans in this category are to persons or entities of unquestioned financial strength and a highly liquid financial position, with collateral that is liquid and well-margined. These borrowers have performed without question on past obligations, and the Bank expects their performance to continue. Internally generated cash flow covers current maturities of long-term debt by a substantial margin. Loans secured by Bank certificates of deposit and savings accounts, with appropriate holds placed on the accounts, are to be rated in this category.
Class 2: Good. These loans are to persons or entities with strong financial condition and above-average liquidity who have previously satisfactorily handled their obligations with the Bank. Collateral securing the Bank’s debt is margined in accordance with policy guidelines. Internally generated cash flow covers current maturities of long-term debt more than adequately. Unsecured loans to individuals supported by strong financial statements and on which repayment is satisfactory may be included in this classification.
Class 3: Acceptable. Loans to persons or entities with an average financial condition, adequate collateral margins, adequate cash flow to service long-term debt, and net worth comprised mainly of fixed assets are included in this category. These entities are minimally profitable now, with projections indicating continued profitability into the foreseeable future. Closely held corporations or businesses where a majority of the profits are withdrawn by the owners or paid in dividends are included in this rating category. Overall, these loans are basically sound.
Class 4: Watch. These loans are characterized by borrowers who have marginal cash flow, marginal profitability, or have experienced an unprofitable year and a declining financial condition. The borrower has in the past satisfactorily handled debts with the Bank, but in recent months has either been late, delinquent in making payments, or made sporadic payments. While the Bank continues to be adequately secured, margins have decreased or are decreasing, despite the borrower’s continued satisfactory condition. Other characteristics of borrowers in this class include inadequate credit information, weakness of financial statement and repayment capacity, and collateral that appears to limit exposure. This classification includes loans to established borrowers that are reasonably margined by collateral but where potential for improvement in financial condition appears limited.
Class 5: Other Loans Especially Mentioned (OLEM). Loans in this category have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deteriorating prospects for the asset or in the Bank’s credit position at some future date. OLEMs are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. The Bank does not use an OLEM classification as a compromise between a loan rated 4 or higher and “substandard”.
Class 6: Substandard. A loan classified as “substandard” is inadequately protected by the sound worth and paying capacity of the borrower or the collateral pledged. Loss potential, while existing in the aggregate amount of the substandard loan, does not have to exist in individual assets.
Class 7: Doubtful. A loan classified as “doubtful” has all the weaknesses inherent in a loan classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and
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improbable. These are poor quality loans in which neither the collateral, if any, nor the financial condition of the borrower presently ensure collectibility in full in a reasonable period of time; in fact, there is permanent impairment in the collateral securing the Bank’s loan. These loans are in a work-out status and have a defined work-out strategy.
Class 8: Loss. Loans classified as “loss” are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. The Bank takes losses in the period in which they become uncollectible.
Loans graded “4”, “5”, “6”, “7”, or “8” are referred to management for inclusion on the Bank’s “watch list”. Loans graded “4” and “5” are not considered adversely classified.
Nonperforming loans are placed on the non-accrual basis of accounting if: (i) there is deterioration in the financial condition of the borrower; (ii) payment in full of principal or interest is not expected; or (iii) principal or interest has been in default for 90 days or more, unless the obligation is well secured and in the process of collection. The three categories of nonperforming loans are non-accrual status loans, renegotiated debt, and loans in Chapter 13 bankruptcy unless a repayment schedule is adopted that pays out the loan.
Asset/Liability Management
A committee composed of officers and directors of the Bank is responsible for managing the assets and liabilities of the Bank. The chairperson of the committee is Chief Financial Officer Dianne Scroggins. The committee attempts to manage asset growth, liquidity and capital in order to maximize income and reduce interest rate risk. The committee directs the Bank’s overall acquisition and allocation of funds. The committee reviews and discusses the Bank’s assets and liability funds budget in relation to the actual flow of funds. The committee also reviews and discusses peer group comparisons; the ratio of the amount of rate-sensitive assets to the amount of rate-sensitive liabilities; the ratio of allowance for loan losses to outstanding and nonperforming loans; and other variables, such as expected loan demand, investment opportunities, core deposit growth within specific categories, regulatory changes, monetary policy adjustments, and the overall state of the local and national economies.
Investment Policy
The Bank’s investment portfolio policy is designed to provide guidelines by which the funds not otherwise needed to meet loan demand of the Bank’s market area can best be invested to meet fluctuations in the loan demand and deposit structure. The Bank’s Chief Financial Officer, Dianne Scroggins, also serves as its Investment Officer. The Bank seeks to balance the market and credit risk against the potential investment return, make investments compatible with the pledging requirements of the Bank’s deposits of public funds, maintain compliance with regulatory investment requirements, and assist the various local public entities with their financing needs. The Bank’s investment policy is reviewed annually by the Investment Committee, chaired by Director Randy Maxwell, and by the Board of Directors.
Customers
In the opinion of management, there is no single customer or affiliated group of customers whose deposits, if withdrawn, would have a material adverse effect on the Bank’s business. As of December 31, 2006, the Bank had a total of 161 lending relationships that represent exposure to the Bank of at least $500,000. The Bank believes that the loss of one of these relationships or an affiliated group of relationships, while significant, would not materially impact the performance of the Bank.
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Competition
The banking business is highly competitive. The Bank’s primary market area consists of Maury, Williamson and Rutherford Counties in Tennessee. The Bank competes with numerous commercial banks and savings institutions with offices in the Bank’s market area. In addition to these competitors, the bank competes for loans with insurance companies, regulated small loan companies, credit unions, and certain government agencies. The Bank also competes with numerous companies and financial institutions engaged in similar lines of business, such as mortgage banking companies, brokerage companies, investment banking firms and lending companies. These competitors have up to $1.11 billion in deposits in the Maury County market area, up to $4.25 billion in deposits in the Williamson County market area, and up to $2.46 billion in the Rutherford County market as reported by the FDIC as of June 30, 2006. At December 31, 2006, the Bank had deposits of approximately $367 million. The Company does not experience significant seasonal trends in its operations.
Employees
As of December 31, 2006, the Company had 96 full-time equivalent employees and 104 total employees. The Company plans to continue to hire additional employees to meet growth demands. Neither the Company nor any of its subsidiaries is a party to any collective bargaining agreement, and the Company believes that its employee relations are in good standing.
Supervision and Regulation
General
As a registered bank holding company and a Tennessee-chartered, federally insured commercial bank, the Company and the Bank are subject to extensive regulation. Lending activities and other investments must comply with various statutory and regulatory requirements, including prescribed minimum capital standards. The Bank is regularly examined by the FDIC and the Department and files periodic reports concerning its activities and financial condition with its regulators. The Bank’s relationships with depositors and borrowers are also regulated to a great extent by both federal law and the laws of the State of Tennessee, especially in such matters as the ownership of accounts and the form and content of mortgage documents.
Federal and state banking laws and regulations govern all areas of the operation of the Company and the Bank, including reserves, loans, mortgages, capital, issuance of securities, payment of dividends, and establishment of branches. Federal and state bank regulatory agencies also have the general authority to limit the dividends paid by insured banks if such payments should be deemed to constitute an unsafe and unsound practice. Both the Department and the FDIC have the authority to impose penalties, initiate civil and administrative actions and take other steps intended to prevent banks from engaging in unsafe or unsound practices.
The following summaries of statutes and regulations affecting banks do not purport to be complete. Such summaries are qualified in their entirety by reference to the statutes and regulations described.
Bank Holding Company Act of 1956
The Company is a bank holding company registered under the provisions of the federal Bank Holding Company Act of 1956, as amended (the “BHC Act”), and consequently is subject to examination by the Board of Governors of the Federal Reserve System (the “FRS”).
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A bank holding company is required to file, with the Federal Reserve Bank of Atlanta (the “FRB”), annual reports and other information regarding its business operations and those of its subsidiaries. It is also subject to examination by the FRB and is required to obtain FRB approval prior to acquiring, directly or indirectly, ownership or control of any voting shares of any bank, if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting stock of such bank unless it already owns a majority of the voting stock of such bank. Furthermore, a bank holding company is, with limited exceptions, prohibited from acquiring direct or indirect ownership or control of any voting stock of any company which is not a bank or a bank holding company, and must engage only in the business of banking or managing or controlling banks or furnishing services to or performing services for its subsidiary banks. One of the exceptions to this prohibition is the ownership of shares of a company, the activities of which the Federal Reserve Board has determined to be so closely related to banking or management or controlling banks as to be properly incident thereto.
A bank holding company and its subsidiaries are also prohibited from engaging in certain tying arrangements in connection with the extension of credit or provision of any property or service. Thus, an affiliate of a bank holding company may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer must obtain or provide some additional credit, property, or services from or to the bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. The FRB has adopted significant amendments to its anti-tying rules that: (1) removed FRB-imposed anti-tying restrictions on bank holding companies and their non-bank subsidiaries; (2) allow banks greater flexibility to package products with their affiliates; and (3) establish a safe harbor from the tying restrictions for certain foreign transactions. These amendments were designed to enhance competition in banking and non-banking products and to allow banks and their affiliates to provide more efficient, lower cost service to their customers.
In approving acquisitions by bank holding companies of banks and companies engaged in banking-related activities, the Federal Reserve considers a number of factors, including expected benefits to the public such as greater convenience, increased competition, or gains in efficiency, as weighed against the risks of possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices. The Federal Reserve is also empowered to differentiate between new activities and activities commenced through the acquisition of a going concern.
The Change in Bank Control Act of 1978, as amended, requires a person (or group of persons acting in concert) acquiring “control” of a bank holding company to provided the FRB with 60 days’ prior written notice of the proposed acquisition. Following receipt of this notice, the FRB has 60 days within which to issue a notice disapproving the proposed acquisition, but the FRB may extend this time period for up to another 30 days. An acquisition may be completed before expiration of the disapproval period if the FRB issues written notice of its intent not to disapprove the transaction. In addition, any “company” must obtain the FRB’s approval before acquiring 25% (5% if the “company” is a bank holding company) or more of the outstanding shares or otherwise obtaining control over the company.
The Attorney General of the United States may, within 15 days after approval by the FRB of an acquisition, bring an action challenging such acquisition under the federal antitrust laws, in which case the effectiveness of such approval is stayed pending a final ruling by the courts. Failure of the Attorney General to challenge an acquisition does not, however, exempt the holding company from complying with both state and federal antitrust laws after the acquisition is consummated or immunize the acquisition from future challenge under the anti-monopolization provisions of the Sherman Act.
Bank holding companies are not permitted to engage in “unsafe and unsound” banking practices. The FRS’s Regulation Y, for example, generally requires a bank holding company to give the FRS prior notice of any
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redemption or repurchase of its own equity securities, if the consideration to be paid, together with consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the bank holding company’s consolidated net worth. The FRS may oppose the transaction if it believes that the transaction would constitute an unsafe and unsound practice or would violate any law or regulation. Depending upon the circumstances, the FRS could take the position that paying a dividend would constitute an unsafe and unsound banking practice.
The FRS has broad authority to prohibit activities of bank holding companies and their non-bank subsidiaries which represent unsafe and unsound banking practices or which constitute knowing or reckless violations of laws or regulations, if those activities caused a substantial loss to a depository institution. These penalties can be as high as one million dollars for each day the activity continues.
Securities Registration and Reporting
The Common Stock of the Company is registered as a class with the SEC under the1934 Act and thus is subject to the periodic reporting and proxy solicitation requirements and the insider-trading restrictions of the Act. In addition, the securities issued by the Company are subject to the registration requirements of the 1933 Act and applicable state securities laws unless exemptions are available. The periodic reports, proxy statements, and other information filed by the Company with the SEC are available at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company is an electronic filer with the SEC and the Company’s filings may also be obtained at the SEC website (http://www.sec.gov).
Tennessee Supervision and Regulation
As a Tennessee-chartered commercial bank, the Bank is subject to various state laws and regulations which limit the amount that can be loaned to a single borrower, the type of permissible investments, and geographic expansion, among other things. The Bank must submit an application and receive the approval of the Department before opening a new branch office or merging with another financial institution. The Commissioner of the Department has the authority to enforce state laws and regulations by ordering a director, officer or employee of the Bank to cease and desist from violating a law or regulation and from engaging in unsafe or unsound banking practices. The Bank will be required to file annual reports and such other additional information as Tennessee law requires.
Tennessee law contains limitations on the interest rates that may be charged on various types of loans and restrictions on the nature and amount of loans that may be granted and on the type of investments which may be made. The operations of banks are also affected by various consumer laws and regulations, including those relating to equal credit opportunity and regulation of consumer lending practices. All Tennessee banks, including the Bank, must become and remain insured under the Federal Deposit Insurance Act.
The Company is a legal entity separate and distinct from the Bank. The principal source of the Company’s revenues however, is from dividends declared by the Bank. Under Tennessee law, the Bank can only pay dividends in an amount equal to or less than the total amount of its net income for that year combined with retained net income of the preceding two (2) years. Payment of dividends in excess of this amount requires prior approval by the commissioner of the Department. The Bank’s ability to pay dividends also may depend on its ability to meet minimum capital levels established from time to time by the FDIC. Under such regulations, FDIC-insured state banks are prohibited from paying dividends, making other distributions or paying any management fee to a parent if, after such payment, the bank would fail to have a risk-based Tier 1 capital ratio of 4%, a risk-based total capital ratio of 8% and a Tier 1 leverage capital ratio of 4%.
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Under Tennessee law, the Company may pay common stock dividends if, after giving effect to the dividends, the Company can pay its debts as they become due in the ordinary course of business and the Company’s total assets exceed its total liabilities. The payment of dividends by the Company also may be affected or limited by certain factors, such as the requirements to maintain adequate capital above regulatory guidelines. In addition, if, in the opinion of the applicable regulatory authority, a bank holding company or a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), such authority may take various supervisory actions to prevent such action, including a cease and desist order prohibiting such practice. See “Dividends.”
State banks are subject to regulation by the Department with regard to capital requirements. Tennessee has adopted the provisions of Federal Reserve Regulation O with respect to restrictions on loans and other extensions of credit to bank “insiders.” Further, under Tennessee law, state banks are prohibited from lending to any one person, firm or corporation amounts more than fifteen percent (15%) of its equity capital accounts, except (i) in the case of certain loans secured by negotiable title documents covering readily marketable nonperishable staples, or (ii) with the prior approval of the state bank’s board of directors or finance committee (however titled), the state bank may make a loan to any person, firm or corporation of up to twenty-five percent (25%) of its equity capital accounts.
Federal Supervision and Regulation
Deposit Insurance—The Bank’s deposit accounts are insured by the FDIC up to applicable limits by the BIF. The BIF was designated as an insurance fund pursuant to the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”). FIRREA provides that a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in connection with (i) the default of a commonly controlled FDIC insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC insured depository institution in danger of default. FIRREA provides that certain types of persons affiliated with financial institutions can be fined by the federal regulatory agency having jurisdiction over a depository institution with federal deposit insurance (such as the Bank) could be fined up to $1 million per day for each violation of certain regulations related (primarily) to lending to and transactions with executive officers, directors, and principal shareholders, including the interests of these individuals. Other violations may result in civil money penalties of $5,000 to $25,000 per day or in criminal fines and penalties. In addition, the FDIC has been granted enhanced authority to withdraw or to suspend deposit insurance in certain cases.
As an insurer, the FDIC issues regulations, conducts examinations, requires the filing of reports and generally supervises and regulates the operations of state-chartered banks that are not members of the Federal Reserve System. FDIC approval is required prior to any merger or consolidation involving state, nonmember banks, or the establishment or relocation of an office facility thereof. FDIC supervision and regulation is intended primarily for the protection of depositors and the FDIC insurance funds.
Pursuant to the Federal Deposit Insurance Act (“FDIA”), as amended by FIRREA, all BIF-insured banks were required to pay semiannual insurance assessments to recapitalize the BIF to a 1.25% of insured deposits ratio. In August 1995, the FDIC substantially reduced deposit insurance premiums for well-capitalized, well-managed BIF-insured institutions to the lowest assessment rate of 4 basis points per $100 of assessable deposits. The BIF premium reduction became effective in September 1995. Any insured bank which does not operate in accordance with or conform to FDIC regulations, policies and directives may be sanctioned for non-compliance. For example, proceedings may be instituted against any insured bank or any director, officer or employee of such bank who engages in unsafe and unsound practices, including the violation of applicable laws and regulations. The FDIC has the authority to terminate deposit insurance pursuant to procedures established for that purpose.
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At December 31, 2005, the Bank’s deposit base for purposes of FDIC premiums was $309,258. The Bank paid FDIC insurance premiums of $37 in 2006.
FDICIA & Prompt Corrective Action –The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), which was enacted on December 19, 1991, substantially revised the depository institution regulatory and funding provisions of the FDIA and revised several other banking statutes. The additional supervisory powers and regulations mandated by FDICIA include a “prompt corrective action” program based upon five regulatory zones for banks, in which all banks are placed, largely based on their capital positions. Regulators are permitted to take increasingly harsh action as a bank’s financial condition declines. Regulators are also empowered to place in receivership or require the sale of a bank to another depository institution when a bank’s capital leverage ratio reaches two percent. Better capitalized institutions are generally subject to less onerous regulation and supervision than banks with lesser amounts of capital. Each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The FDIC has adopted regulations implementing the prompt corrective action provisions of the FDICIA, which place financial institutions in the following five categories based upon capital ratios: (i) a “well capitalized” institution if it has a total risk-based capital ratio of 10.0%, a Tier 1 risk-based ratio of at least 6% and a leverage ratio of at least 5%; (ii) an “adequately capitalized” institution has a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4%, and a leverage ratio of 4%; (iii) an “undercapitalized” institution has a total risk-based capital ratio of under 8%, a Tier 1 risk-based capital ratio of under 4% or a leverage ratio of under 4%; (iv) a “significantly undercapitalized” institution has a total risk-based capital ratio of under 6%, a Tier 1 risk-based ratio of under 3% or a leverage ratio of under 3%; and (v) a “critically undercapitalized” institution has a leverage ratio of 2% or less.
The regulations also establish procedures for “downgrading” an institution to a lower capital category based on supervisory factors other than capital. Specifically, Section 38 of the FDIA and the implementing regulations provide that a federal banking agency may, after notice and an opportunity for a hearing, reclassify a well-capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as it were in the next lower category if the institution is in an unsafe or unsound condition or engaging in an unsafe or unsound practice. (The FDIC may not, however, reclassify a significantly undercapitalized institution as critically undercapitalized).
FDICIA generally prohibits an FDIC-insured depository institution from making any capital distribution (including payment of dividends) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. A depository institution’s holding company must guarantee the capital plan, up to an amount equal to the lesser of 5% of the depository institution’s assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.
Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator.
FDICIA contains numerous other provisions, including accounting, audit and reporting requirements, beginning in 1995 termination of the “too big to fail” doctrine except in special cases, limitations on the
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FDIC’s payment of deposits at foreign branches, new regulatory standards in such areas as asset quality, earnings and compensation and revised regulatory standards for, among other things, powers of state banks, real estate lending and capital adequacy. FDICIA also requires that a depository institution provide 90 days prior notice of the closing of any branches.
Various other legislation, including proposals to revise the bank regulatory system and to limit or expand the investments that a depository institution may make with insured funds, is from time to time introduced in Congress. The Department and the FRB examine the Bank periodically for compliance with various regulatory requirements. Such examinations, however, are for the protection of the BIF and depositors and not for the protection of investors and shareholders.
As of December 31, 2006, under the regulations promulgated under FDICIA, the Bank would have been deemed to be a “well-capitalized” institution if solely viewed on the basis of capital ratios.
Standards for Safety and Soundness—The FDIA requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; and (vi) compensation, fees and benefits. The federal banking agencies have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness (the “Guidelines”) to implement safety and soundness standards required by the FDIA. The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The agencies also adopted asset quality and earnings standards which are part of the Guidelines. Under the regulations, if the FDIC determines that the Bank fails to meet any standards prescribed by the Guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDIA. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.
Capital Requirements—The FDIC’s minimum capital standards applicable to FDIC-regulated banks and savings banks require the most highly-rated institutions to meet a “Tier 1” leverage capital ratio of at least 3.0% of total assets. Tier 1 (or “core capital”) consists of common stockholders’ equity, noncumulative perpetual preferred stock, and minority interests in consolidated subsidiaries minus all intangible assets other than limited amounts of purchased mortgage servicing rights and certain other accounting adjustments. All other banks must have a Tier 1 leverage ratio of at least 100-200 basis points above the 3% minimum. The FDIC capital regulations establish a minimum leverage ratio of not less than 4% for banks that are not highly rated or are anticipating or experiencing significant growth. Tier 2 capital is an amount equal to the sum of (i) the allowance for possible loan losses in an amount up to 1.25% of risk-weighted assets; (ii) cumulative perpetual preferred stock with an original maturity of 20 years or more and related surplus; (iii) hybrid capital instruments (instruments with characteristics of both debt and equity), perpetual debt and mandatory convertible debt securities; and (iv) in an amount up to 50% of Tier I capital, eligible term subordinated debt and intermediate-term preferred stock with an original maturity of five years or more, including related surplus. The inclusion of the foregoing elements of Tier 2 capital is subject to certain requirements and limitations of the FDIC.
FDIC capital regulations require higher capital levels for banks which exhibit more than a moderate degree of risk or exhibit other characteristics which necessitate that higher than minimum levels of capital be maintained. Any insured bank with a Tier 1 capital to total assets ratio of less than 2% is deemed to be operating in an unsafe and unsound condition pursuant to Section 8(a) of the FDIA unless the insured bank enters into a written agreement, to which the FDIC is a party, to correct its capital deficiency. Insured banks operating with Tier 1 capital levels below 2% (and which have not entered into a written agreement) are subject to an insurance removal action. Insured banks operating with lower than the prescribed minimum
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capital levels generally will not receive approval of applications submitted to the FDIC. Also, inadequately capitalized state nonmember banks will be subject to such administrative action as the FDIC deems necessary.
FDIC regulations also require that banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of total capital (which is defined as Tier 1 capital and Tier 2 or supplementary capital) to risk weighted assets of 8% and Tier 1 capital to risk-weighted assets of 4%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item. The components of Tier 1 capital are equivalent to those discussed above under the 3% leverage requirement. The components of mandatory convertible securities, term subordinated debt, intermediate-term preferred stock and allowance for possible loan losses. Allowance for possible loan losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of capital counted toward supplementary capital cannot exceed 100% of Tier 1 capital. The FDIC includes in its evaluation of a bank’s capital adequacy an assessment of risk-based capital focusing principally on broad categories of credit risk. No measurement framework for assessing the level of a bank’s interest rate risk exposure has been codified but, effective board and senior management oversight of the banks tolerance for interest rate risk is required.
The FDIC has adopted the Federal Financial Institutions Examination Council’s recommendation regarding the adoption of Statement of Financial Accounting Standard No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Specifically, the FDIC determined that net unrealized holding gains or losses on available for sale debt and equity securities should not be included when calculating core and risk-based capital ratios.
FDIC capital requirements are designated as the minimum acceptable standards for banks whose overall financial condition is fundamentally sound, which are well-managed and have no material or significant financial weakness. The FDIC capital regulations state that, where the FDIC determines that the financial history or condition, including off-balance sheet risk, managerial resources and/or the future earnings prospects of a bank are not adequate and/or a bank has a significant volume of assets classified substandard, doubtful or loss or otherwise criticized, the FDIC may determine that the minimum adequate amount of capital for that bank is greater than the minimum standards established in the regulation.
The Bank believes that, under the current regulations, the Bank has sufficient capital to meet its minimum capital requirements. However, events beyond the control of the Bank, such as a downturn in the economy in areas where the Bank has most of its loans, could adversely affect future earnings and, consequently, the ability of the Bank to meet its capital requirements.
Activities and Investments of Insured State-Chartered Banks—Section 24 of the FDIA, as amended by the FDICIA, generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. Under regulations dealing with equity investments, an insured state bank generally may not directly or indirectly acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. An insured state bank is not prohibited from, among other things, (i) acquiring or retaining a majority interest in a subsidiary, (ii) investing as a limited partner in a partnership, the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investment may not exceed 2% of the bank’s total assets, (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors’, trustees’ and officers’ liability insurance coverage or bankers’ blanket bond group insurance coverage for insured depository institutions, and (iv) acquiring or retaining the voting shares of a depository institution if certain requirements are met.
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In addition, an insured state bank (i) that is located in a state which authorized as of September 30, 1991 investment in common or preferred stock listed on a national securities exchange (“listed stock”) or shares of a registered investment company (“registered shares”), and (ii) which during the period beginning September 30, 1990 through November 26, 1991 (the “measurement period”) made or maintained investments in listed stocks and registered shares, may retain whatever shares that were lawfully acquired or held prior to December 19, 1991 and continue to acquire listed stock and registered shares, provided that the bank does not convert its charter to another form or undergo a change in control. In order to acquire or retain any listed stock or registered shares, however, the bank must file a one-time notice with the FDIC which meets specified requirements and which sets forth the Bank’s intention to acquire and retain stocks or shares, and the FDIC must determine that acquiring or retaining the listed stocks or registered shares will not pose a significant risk to the deposit insurance fund of which the bank is a member.
FDIC regulations implementing Section 24 of the FDIA provide that an insured state-chartered bank may not, directly, or indirectly through a subsidiary, engage as “principal” in any activity that is not permissible for a national bank unless the FDIC has determined that such activities would pose no risk to the insurance fund of which it is a member, and the bank is in compliance with applicable regulatory capital requirements. Any insured state-chartered bank or savings bank directly or indirectly engaged in any activity that is not permitted for a national bank must cease the impermissible activity.
Loans-to-One-Borrower—The aggregate amount of loans that the Bank is permitted to make under applicable regulations to any one borrower, including related entities, is the greater of 25% of unimpaired capital and surplus or $500,000. Based on the Bank’s capitalization of $37,314 at December 31, 2006, the Bank’s loans-to-one borrower limit is approximately $9,328. The Bank’s house limits loans-to-one borrower is equal to the loan to one borrower limit.
Federal Reserve System—In 1980 Congress enacted legislation which imposed Federal Reserve requirements (under “Regulation D”) on all depository institutions that maintain transaction accounts or non-personal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank. NOW accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any non-personal time deposits at a bank.
Community Reinvestment Act—The Company is also subject to the provisions of the Community Reinvestment Act of 1977, which requires the appropriate federal bank regulatory agency, in connection with its regular examination of a bank, to assess the bank’s record in meeting the credit needs of the community serviced by the bank, including low and moderate income neighborhoods. The regulatory agency’s assessment of the Company’s record is made available to the public. Further, such assessment is required of any bank which has applied, among other things, to establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. As a component of its Community Reinvestment Act outreach, the Company has instituted an affordable home loan program for first-time home buyers and low to moderate income borrowers.
Interstate Banking—The Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Interstate Act”), which was enacted on September 29, 1994, among other things and subject to certain conditions and exceptions, (i) permits bank holding company acquisitions of banks of a minimum age of up to five years as established by state law in any state, (ii) mergers of national and state banks after May 31, 1997 across state lines unless the home state of either bank has opted out of the interstate bank merger provision, (iii) branching de novo by national and state banks into others states if the state has elected this provision of the Interstate Act, and (iv) certain interstate bank agency activities after one year after enactment.
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Gramm-Leach Bliley Act—The Gramm-Leach-Bliley Act of 1999 (the “Act”) represented a pivotal point in the history of financial services regulation in the United States. The Act removes large parts of a regulatory structure that had its roots in the 1930’s and creates new opportunities for banks, other depository institutions, insurance companies and securities firms to enter into combinations. The Act also provides new flexibility to design financial products and services that better serve the banking consumer. The Act, among other provisions, (i) substantially eliminates the prohibition under the Bank Holding Company Act which existed previously on affiliations between banks and insurance companies; (ii) repeals Section 20 of the Glass-Steagall Act which prohibited banks from affiliating with securities firms; (iii) sets forth procedures for such affiliations; (iv) provides for the formation of Financial Holding Companies; and (v) eliminates the blanket exclusion of banks from the definitions of the terms “broker” and “dealer” under the Securities Exchange Act of 1934 (the “Exchange Act”), while permitting banks to continue to conduct certain limited brokerage and dealer activities without registration under the 1934 Act as a broker-dealer.
In addition to expanding the activities in which banks and bank holding companies may engage, the Gramm-Leach-Bliley Act also imposed new requirements on financial institutions with respect to customer privacy. The Gramm-Leach-Bliley Act generally prohibits disclosure of customer information to non-affiliated third parties unless the customer has been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to customers annually. Financial institutions, however, will be required to comply with state law if it is more protective of customer privacy than the Gramm-Leach-Bliley Act.
The USA Patriot Act of 2001—The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”) was enacted in October 2001. The USA Patriot Act is intended to strengthen U.S. law enforcement’s and the intelligence communities’ ability to work cohesively to combat terrorism on a variety of fronts. The potential impact of the USA Patriot Act on financial institutions of all kinds is significant and wide ranging. The USA Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including: (i) due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons; (ii) standards for verifying customer identification at account opening; (iii) rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iv) reports by non-financial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (v) filing of suspicious activities reports involving securities by brokers and dealers if they believe a customer may be violating U.S. laws and regulations.
Change in Control Restrictions
Statutory Provisions
The Change in Bank Control Act requires the written consent of the FDIC be obtained prior to any person or company acquiring “control” of a state-chartered bank. Tennessee law also requires the prior written consent of the Department to acquire control of a Tennessee-chartered bank. Upon acquiring control, a company will be deemed to be a bank holding company and must register with the Federal Reserve Board. Conclusive control is presumed to exist if, among other things, an individual or company acquires more than 25% of any class of voting stock of the Bank. Rebuttable control is presumed to exist if, among other things, a person acquires more than 10% of any class of voting stock and the issuer’s securities are registered under Section 12 of the Exchange Act (the Common Stock is not expected to be so registered) or the person would be the single largest stockholder. Restrictions applicable to the operations of a bank holding company and conditions that may be imposed by the Federal Reserve Board in connection with its approval of a company to become a bank holding company may deter companies from seeking to obtain control of the Bank.
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Other
While not directly restricting efforts to acquire control of the Company, certain other characteristics of the Bank’s organization may discourage attempts to acquire control of the Company. The Company’s Charter provides that approximately one-third of its Board of Directors are elected each year (see “MANAGEMENT — Classification of Directors”), thereby making it more difficult for a potential acquirer of control of the Company to replace the members of the Board of Directors than it would be if directors were elected at more frequent intervals or if a greater percentage of directors were elected at any one time.
As a result of all of the foregoing restrictions on acquisitions, the Company is a less attractive target for a “takeover” attempt than other less-highly regulated companies generally. Accordingly, these restrictions might deter offers to purchase the Company which stockholders may consider to be in their best interests, and may make it more difficult to remove incumbent management.
Dividends
The principal source of the Company’s cash revenues is dividends received from the Bank. The payment of dividends is subject to government regulation, in that regulatory authorities may prohibit banks and bank holding companies from paying dividends, which would constitute an unsafe or unsound banking practice. In addition, a bank may not pay cash dividends if that payment could reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. Other than the laws and regulations noted above, which apply to all banks and bank holding companies, neither the Company nor Bank are currently subject to any regulatory restrictions on its dividends.
Tennessee law requires that dividends be paid only from retained earnings (or undivided profits), except that dividends may be paid from capital surplus with the prior, written consent of the Department. Tennessee laws regulating banks require certain charges against and transfers from an institution’s undivided profits account before undivided profits can be made available for the payment of dividends.
Monetary Policy
The Bank, like other depository institutions, is affected by the monetary policies implemented by the Board of Governors of the FRS. The FRS has the power to restrict or expand the money supply through open market operations, including the purchase and sale of government securities and the adjustment of reserve requirements. These actions may result in significant fluctuations in market interest rates, which could adversely affect the operations of the Bank, such as its ability to make loans and attract deposits, as well as market demand for loans. See “Supervision and Regulation.”
Capital Adequacy
See Supervision and Regulation —Capital Requirementsfor a discussion of bank regulatory agencies’ capital adequacy requirements.
Future Legislation
Any future banking legislation proposed by the United States Congress and the Tennessee General Assembly may have an effect on the structure, regulation and competitive relationships of the nation’s financial institutions.
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ITEM 1A. RISK FACTORS
We are geographically concentrated in the Middle Tennessee area and changes in local economic conditions could impact our profitability.
Our primary market area consists of Maury County, Tennessee. Earlier in 2006, we opened a new branch in Franklin, Tennessee, in Williamson County and, in October 2006, we opened a branch in Murfreesboro, Tennessee, in Rutherford County. Substantially all of our loan customers and most of our deposit and other customers live or have operations in this same geographic area. Accordingly, our success significantly depends upon the growth in population, income levels, and deposits in these areas, along with the continued attraction of business ventures to the area, and our profitability is impacted by the changes in general economic conditions in this market. In addition, unfavorable local or national economic conditions could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies.
Our business strategy includes the continuation of growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.
We intend to opportunistically pursue our growth strategy through continued de novo branching. We may also grow through the acquisition of branches or entire financial institutions. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in growth stages of development, including the following:
Management of Growth.We may be unable to successfully:
| | • | | maintain loan quality in the context of significant loan growth; |
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| | • | | maintain adequate management personnel and systems to oversee such growth; |
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| | • | | maintain adequate internal audit, loan review and compliance functions; and |
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| | • | | implement additional policies, procedures and operating systems required to support such growth. |
Operating Results. There is no assurance that existing offices or future offices will maintain or achieve deposit levels, loan balances or other operating results necessary to avoid losses or produce profitability. Our growth and de novo branching strategy necessarily entails growth in overhead as we add new offices and staff. Our historical results may not be indicative of future results or results that may be achieved as we continue to increase the number and concentration of our branch offices. Should any new location be unprofitable or marginally profitable, or should any existing location experience a decline in profitability or incur losses, the adverse effect on our results of operations and financial condition could be more significant than would be the case for a larger company.
Development of Offices. There are considerable costs involved in opening branches and new branches generally do not generate sufficient revenues to offset their costs until they have been in operation for at least a year or more. Accordingly, our new branches can be expected to negatively impact our earnings for some period of time until the branches reach certain economies of scale. Our expenses could be further increased if we encounter delays in the opening of any of our new branches. We may be unable to accomplish future expansion plans due to lack of available satisfactory sites, difficulties in acquiring such sites, increased expenses or loss of potential sites due to complexities associated with the zoning and permitting processes,
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higher than anticipated acquisition costs or other factors. Finally, we have no assurance our new branches will be successful even after they have been established.
Expansion into New Markets. Much of our recent and projected growth has been, and will continue to be, focused in the highly competitive Williamson County and Rutherford County, Tennessee markets. In these markets, we will initially have a smaller share of the deposits than our competitors, which include a wide array of financial institutions, including much larger, well-established financial institutions. Our expansion into these new markets may be unsuccessful if we are unable to meet customer demands or compete effectively with the financial institutions operating in these markets that currently maintain a greater percentage of market share than do we.
Regulatory and Economic Factors. Our growth and expansion plans may be adversely affected by a number of regulatory and economic developments or other events. Failure to obtain required regulatory approvals, failure to maintain appropriate capital or asset quality, changes in laws and regulations or other regulatory developments and changes in prevailing economic conditions or other unanticipated events may prevent or adversely affect our continued growth and expansion. Such factors may cause us to alter our growth and expansion plans or slow or halt the growth and expansion process, which may prevent us from entering certain target markets or allow competitors to gain or retain market share in our existing or expected markets.
Failure to successfully address the above issues could have a material adverse effect on our business, future prospects, financial condition or results of operations, and could adversely affect our ability to successfully implement our business strategy. Also, if our growth occurs more slowly than anticipated or declines, our operating results could be materially adversely affected.
We could sustain losses if our asset quality declines.
Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. A significant portion of our loans are real estate based or made to real estate based borrowers, and the credit quality of such loans could deteriorate if real estate market conditions decline nationally or in our market areas. We could sustain losses if we incorrectly assess the creditworthiness of our borrowers or fail to detect or respond to deterioration in asset quality in a timely manner. Problems with asset quality could cause our interest income and net interest margin to decrease and our provisions for loan losses to increase, which could adversely affect our results of operations and financial condition.
An inadequate allowance for loan losses would reduce our earnings.
The risk of credit losses on loans varies with, among other things, general economic conditions, real estate market conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan.
Management maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and provides an allowance for loan losses based upon its estimate of probable incurred credit losses, using past loan experience, nature and value of the portfolio, specific borrower and collateral value information, economic conditions and other factors. A charge against earnings with respect to the provision is made quarterly to maintain the allowance at appropriate levels after loan charge offs less recoveries. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb losses, or if the bank regulatory authorities require us to increase the allowance
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for loan losses as a part of their examination process, our earnings and capital could be significantly and adversely affected.
Liquidity needs could adversely affect our results of operations and financial condition.
We rely on dividends from the bank as our primary source of funds, and the bank relies on customer deposits and loan repayments as its primary source of funds. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters, and international instability. Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, returns available to customers on alternative investments, and general economic conditions. We rely to a significant degree on national time deposits and brokered deposits, which may be more volatile and expensive than local time deposits. Accordingly, we may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Such sources include Federal Home Loan Bank advances and federal funds lines of credit from correspondent banks. To utilize brokered deposits and national market time deposits without additional regulatory approvals, we must remain well capitalized. While we believe that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands.
Competition from financial institutions and other financial service providers may adversely affect our profitability.
The banking business is highly competitive and we experience competition in each of our markets, particularly our Williamson and Rutherford County, Tennessee markets, where we have a small market share. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as other community banks, super-regional and national financial institutions that operate offices in our primary market areas and elsewhere. Many of our competitors are well-established, larger financial institutions that have greater resources and lending limits and a lower cost of funds than we have.
Our business is subject to local real estate market and other local economic conditions.
Any adverse market or economic conditions in the State of Tennessee may disproportionately increase the risk our borrowers will be unable to timely make their loan payments. In addition, the market value of the real estate securing loans as collateral could be adversely affected by unfavorable changes in market and economic conditions. As of December 31, 2006, approximately 81.1% of our loans held for investment were secured by real estate. Of this amount, approximately 31.8% were commercial real estate loans, 34.0% were residential real estate loans and 33.1% were construction and development loans and 1.1% other real estate. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in the markets we serve or in the State of Tennessee could adversely affect the value of our assets, our revenues, results of operations and financial condition. In addition, construction and development lending is generally considered to have more complex credit risks than traditional single-family residential lending because the principal is concentrated in a limited number of loans with repayment dependent on the successful operation of the related real estate project. Consequently, these loans are more sensitive to adverse conditions in the real estate market or the general economy. These loans are generally less predictable and more difficult to evaluate and monitor and collateral may be difficult to dispose of in a market decline. If we experiences significant construction loan loss because the cost and value of a construction loan project is inaccurately estimated or because of a general economic downturn, our results of operations could
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be adversely impacted and our net book value could be reduced
Changes in interest rates could adversely affect our results of operations and financial condition.
Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense, our largest recurring expenditure. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory authorities. In a period of rising interest rates, our interest expense, particularly deposit costs, could increase in different amounts and at different rates, while the interest that we earn on our assets may not change in the same amounts or at the same rates. Accordingly, increases in interest rates could decrease our net interest income. Changes in the level of interest rates also may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings.
Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate our capital resources following this offering will satisfy our capital requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our continued growth.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.
Our key management personnel may leave at any time.
Our success depends in large part on the ability and experience of our senior management. The loss of services of one or more key employees could adversely affect our business and operating results. We have an employment contract with Marc Lively, our president and chief executive officer.
Events beyond our control may disrupt operations and harm operating results.
We may be adversely affected by a war, terrorist attack, third party acts, natural disaster or other catastrophe. A catastrophic event could have a direct negative impact on us, our customers, the financial markets or the overall economy. It is impossible to fully anticipate and protect against all potential catastrophes. A security breach, criminal act, military action, power or communication failure, flood, hurricane, severe storm or the like could lead to service interruptions, data losses for customers, disruptions to our operations, or damage to our facilities. Any of these could have a material adverse effect on our business and financial results. In addition, we may incur costs in repairing any damage beyond our applicable insurance coverage.
We operate in a highly regulated environment and are supervised and examined by various federal and state regulatory agencies who may adversely affect our ability to conduct business.
The Company is a bank holding company regulated by the Board of Governors of the Federal Reserve System. The Bank is a state chartered bank and comes under the supervision of the Tennessee Department of Financial Institutions and the FDIC. The Bank is also governed by the laws of the State of Tennessee and
20
federal banking laws under the FDIC and the Federal Reserve Act. The Bank is also regulated by other agencies including, but not limited to, the Internal Revenue Service, OSHA, and the Department of Labor. These and other regulatory agencies impose certain regulations and restrictions on the bank, including:
| | • | | explicit standards as to capital and financial condition; |
| |
| | • | | limitations on the permissible types, amounts and extensions of credit and investments; |
| |
| | • | | requirements for brokered deposits; |
| |
| | • | | restrictions on permissible non-banking activities; and |
| |
| | • | | restrictions on dividend payments. |
Federal and state regulatory agencies have extensive discretion and power to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies. As a result, we must expend significant time and expense to assure that we are in compliance with regulatory requirements and agency practices.
We also undergo periodic examinations by one or more regulatory agencies. Following such examinations, we may be required, among other things, to make additional provisions to our allowance for loan loss or to restrict our operations. These actions would result from the regulators’ judgments based on information available to them at the time of their examination. Our operations are also governed by a wide variety of state and federal consumer protection laws and regulations. These federal and state regulatory restrictions limit the manner in which we may conduct business and obtain financing. These laws and regulations can and do change significantly from time to time and any such change could adversely affect our results of operations.
We may be unable to satisfy regulatory requirements relating to our internal control over financial reporting.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to perform an evaluation of our internal control over financial reporting for the year ended December 31, 2007. Although we have prepared an internal plan of action for compliance, we have not completed the evaluation as of the date of this filing. Compliance with these requirements is expected to be expensive and time-consuming and may negatively impact our results of operations. Further, we may not meet the required deadlines. If we fail to timely complete this evaluation, we may be subject to regulatory scrutiny and a loss of public confidence in our internal control over financial reporting.
An established public market for our common stock does not currently exist.
While our common stock is freely transferable by most shareholders, there is not an established public market for trading in our common stock and we cannot be sure when an active or established trading market will develop for our common stock, or, if one develops, that it will continue. Our common stock is traded locally among individuals and is not currently listed on The NASDAQ Global Market, the NASDAQ Capital Market or any other securities market.
21
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2. PROPERTIES
The Company’s principal office building is located at 501 South James M. Campbell Boulevard, Columbia, Tennessee 38401. The Bank constructed the building and owns the building and the property. Prior to the completion of construction in November, 2000, the Bank’s main office was located in a modular building at this location.
In December, 2000, the Bank moved the modular building previously located at the principal office to 601 North Garden Street, Columbia, Tennessee. In June, 2006, the modular building was moved to a temporary site located at 607 North Main Street, Columbia, Tennessee. The Bank operates a branch at this location and the Bank owns the modular building and the property. The Bank is currently constructing a new permanent building at 601 North Garden Street, Columbia, Tennessee where the Bank leases the property, but will own the building. We expect this location to open in the third quarter of 2007.
The Bank operates a branch office at 105 Public Square, Mount Pleasant, Tennessee. The Bank owns the building and the property at this location.
The Bank operates a branch office in the Wal-Mart store at 2200 Brookmeade Drive in Columbia. The Bank leases the space occupied by the branch at this location.
The Bank has an operations building located at 501 South James Campbell Boulevard, Columbia, Tennessee, 38401. The Bank owns the building and property.
The Bank operates a branch office at 9045 Carothers Parkway, Franklin, Tennessee in Williamson County. The Bank owns the building and the property at this location pursuant to the terms of a lease that expires in April 1, 2012.
The Bank operates a branch office at 1950 Old Fort Parkway, Murfreesboro, Tennessee in Rutherford County. The Bank currently leases the building and property at this location pursuant to the terms of a lease that expires in August 1, 2008.
The Bank operates a branch office at Neely’s Mill, 1412 Trotwood Avenue, Columbia, Tennessee. The Bank owns the building and leases the property.
At December 31, 2006, the cost of office properties and equipment (less allowances for depreciation and amortization) owned by the Bank was $10,880.
ITEM 3. LEGAL PROCEEDINGS
The Bank is a co-defendant in a suit in Maury County Circuit Court,Holloway et al. v. Evers. Et al, filed May 31, 2005, in which the plaintiff alleges that a bank loan officer disclosed the plaintiff’s loan history at the bank to plaintiff’s two partners in a real estate development, who subsequently forced plaintiff to sell his interest to them. Plaintiff alleges causes of action for tortious interference with contract, breach of common law fiduciary duty, and violation of the Financial Records Privacy Act. Plaintiff seeks $5,000,000 in compensatory damages and $5,000,000 in punitive damages, jointly and severally, from the bank and his two partners. The Company believes the claim is without merit, intends to vigorously defend the suit, and does not believe the ultimate disposition of the suit will have a material adverse effect on its financial condition or
22
results of operation. In the second quarter of 2006, the trial court granted the co-defendants summary judgment. If this judgment is upheld on appeal, the Bank anticipates that plaintiffs will voluntarily dismiss the case as to the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders of the Company during the fourth quarter of the Company’s fiscal year ended December 31, 2006.
23
PART II
| | |
| ITEM 5. | | MARKET FOR THE COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
From November 1998 through April 1999, the Bank sold and issued 572,753 shares of common stock in connection with its initial unregistered offering. Effective July 31, 2002, each share of the Bank’s common stock was exchanged for one share of the Company’s Common Stock pursuant to the plan of reorganization and share exchange that provided for the reorganization of the Bank into a holding company structure. Also effective on August 1, 2002, the Bank became a wholly-owned subsidiary of the Company. Upon closing of the reorganization, the Company had 572,753 shares of Common Stock outstanding.
No public market exists for the Company’s Common Stock, and there can be no assurance that a public trading market for the Company’s Common Stock will develop. As of March 23, 2007, there were 2,029 holders of record of Company Common Stock and 3,147,433 shares outstanding, excluding vested options. As of March 23 2007, there were 172,339 vested options outstanding to purchase shares of common stock.
While there is no public market for the Company’s Common Stock, the most recent trade of the Company’s Common Stock known to the Company occurred on March 23, 2007 at a price of $30.00 per share. These sales are isolated transactions and, given the small volume of trading in the Company’s Common Stock, may not be indicative of its present value. Below is a table which sets forth Community First’s high and low prices of which the Company is aware for the relevant quarters during the three fiscal year ended December 31:
| | | | | | | | | |
| 2006 | | High | | Low |
| First quarter | | $ | 35.00 | | | $ | 20.71 | |
| Second quarter | | $ | 30.00 | | | $ | 27.00 | |
| Third quarter | | $ | 32.50 | | | $ | 29.00 | |
| Fourth quarter | | $ | 30.00 | | | $ | 30.00 | |
| | | | | | | | | |
| 2005 | | High | | Low |
| First quarter | | $ | 19.00 | | | $ | 13.00 | |
| Second quarter | | $ | 24.00 | | | $ | 19.00 | |
| Third quarter | | $ | 26.00 | | | $ | 22.00 | |
| Fourth quarter | | $ | 29.00 | | | $ | 25.00 | |
The above prices have been adjusted to reflect a 2-for-1 stock split which occurred on May 9, 2005.
For a foreseeable period of time, the principal source of cash revenues to the Company will be dividends paid by the Bank with respect to its capital stock. There are certain restrictions on the payment of these dividends imposed by federal banking laws, regulations and authorities. Further, the dividend policy of the Bank is subject to the discretion of the board of directors of the Bank and will depend upon such factors as future earnings, financial conditions, cash needs, capital adequacy and general business conditions. The Company paid cash dividends totaling $575 to shareholders in the second quarter of 2006 and there were no dividends paid in 2005. Tennessee law requires that dividends be paid by the Bank only from retained earnings (or undivided profits), except that dividends may be paid from capital surplus with the prior, written consent of the Department. Tennessee laws regulating banks require certain charges against and transfers from an institution’s undivided profits account before undivided profits can be made available for the payment of dividends.
24
In the future, the declaration and payment of dividends on the Company’s Common Stock will depend upon the Company’s earnings and financial condition, liquidity and capital requirements, the general economic and regulatory climate, the Company’s ability to service any equity or debt obligations senior to the Common Stock, and other factors deemed relevant by the Board of Directors. As of December 31, 2006, an aggregate of approximately $6,524 was available for the payment of dividends by the Bank to the Company under applicable restrictions, without regulatory approval. Regulatory authorities could impose administratively stricter limitations on the ability of the Bank to pay dividends to the Company if such limits were deemed appropriate to preserve certain capital adequacy requirements.
25
ITEM 6. SELECTED FINANCIAL DATA(Dollars in thousands, except per share data)
The following selected financial data for the five years ended December 31, 2006, was derived from our consolidated financial statements and the related notes thereto. This data should be read in conjunction with our audited consolidated financial statements, including the related notes, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
| | | | | | | | | | | | | | | | | | | | | |
| | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 |
INCOME STATEMENT DATA: | | | | | | | | | | | | | | | | | | | | |
| Interest income | | $ | 25,789 | | | $ | 17,305 | | | $ | 12,593 | | | $ | 10,000 | | | $ | 8,957 | |
| Interest expense | | | 13,528 | | | | 7,006 | | | | 4,272 | | | | 3,819 | | | | 3,837 | |
| Net interest income | | | 12,261 | | | | 10,299 | | | | 8,321 | | | | 6,181 | | | | 5,120 | |
| Provision for loan losses | | | 1,018 | | | | 683 | | | | 720 | | | | 614 | | | | 683 | |
| Non-interest income | | | 3,125 | | | | 2,356 | | | | 2,107 | | | | 1,936 | | | | 1,399 | |
| Non-interest expense | | | 10,453 | | | | 8,146 | | | | 6,329 | | | | 5,451 | | | | 4,600 | |
| Net income | | | 2,802 | | | | 2,565 | | | | 2,132 | | | | 1,264 | | | | 750 | |
| | | | | | | | | | | | | | | | | | | | | |
BALANCE SHEET DATA: | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 421,393 | | | $ | 328,806 | | | $ | 257,342 | | | $ | 217,368 | | | $ | 173,955 | |
| Total securities | | | 37,576 | | | | 30,330 | | | | 27,867 | | | | 29,181 | | | | 18,563 | |
| Total loans, net | | | 344,714 | | | | 256,150 | | | | 208,087 | | | | 169,803 | | | | 131,433 | |
| Allowance for loan losses | | | (4,259 | ) | | | (3,268 | ) | | | (2,740 | ) | | | (2,249 | ) | | | (1,773 | ) |
| Total deposits | | | 366,766 | | | | 286,243 | | | | 223,778 | | | | 195,239 | | | | 151,848 | |
| FHLB advances | | | 13,000 | | | | 8,000 | | | | 8,000 | | | | 5,000 | | | | 6,000 | |
| Subordinated debentures | | | 8,000 | | | | 8,000 | | | | 3,000 | | | | 3,000 | | | | 3,000 | |
| Total shareholders’ equity | | | 30,657 | | | | 24,017 | | | | 21,452 | | | | 13,445 | | | | 12,152 | |
| | | | | | | | | | | | | | | | | | | | | |
PER SHARE DATA: | | | | | | | | | | | | | | | | | | | | |
| Earnings per share — basic | | $ | 0.97 | | | $ | 0.89 | | | $ | 0.78 | | | $ | 0.55 | | | $ | 0.33 | |
| Earnings per share diluted | | | 0.94 | | | | 0.86 | | | | 0.75 | | | | 0.52 | | | | 0.31 | |
| Cash dividend declared and paid | | | 0.20 | | | | — | | | | — | | | | — | | | | — | |
| Book value | | | 10.17 | | | | 8.36 | | | | 7.49 | | | | 5.82 | | | | 5.29 | |
| | | | | | | | | | | | | | | | | | | | | |
PERFORMANCE RATIOS: | | | | | | | | | | | | | | | | | | | | |
| Return on average assets | | | 0.76 | % | | | 0.90 | % | | | 0.90 | % | | | 0.67 | % | | | 0.51 | % |
| Return on average equity | | | 11.14 | | | | 11.38 | | | | 11.37 | | | | 10.10 | | | | 5.89 | |
| Net interest margin (1) | | | 3.52 | | | | 3.81 | | | | 3.64 | | | | 3.43 | | | | 3.71 | |
| | | | | | | | | | | | | | | | | | | | | |
ASSET QUALITY RATIOS: | | | | | | | | | | | | | | | | | | | | |
| Nonperforming assets to total loans | | | 0.30 | % | | | 0.20 | % | | | 0.45 | % | | | 0.49 | % | | | 0.33 | % |
| Net loan charge-offs to average loans | | | 0.01 | | | | 0.07 | | | | 0.12 | | | | 0.09 | | | | 0.21 | |
| Allowance for loan losses to total loans | | | 1.22 | | | | 1.26 | | | | 1.30 | | | | 1.31 | | | | 1.33 | |
| | | | | | | | | | | | | | | | | | | | | |
CAPITAL RATIOS: | | | | | | | | | | | | | | | | | | | | |
| Leverage ratio (2) | | | 9.45 | % | | | 10.25 | % | | | 9.63 | % | | | 7.81 | % | | | 9.04 | % |
| Tier 1 risk-based capital ratio | | | 10.14 | | | | 11.59 | | | | 11.33 | | | | 9.70 | | | | 11.11 | |
| Total risk-based capital ratio | | | 11.25 | | | | 12.77 | | | | 12.52 | | | | 10.95 | | | | 12.36 | |
| | |
| (1) | | Net interest margin is the result of net interest income for the period divided by average interest earning assets. |
| |
| (2) | | Leverage ratio is defined as Tier 1 capital (pursuant to risk-based capital guidelines) as a percentage of adjusted average |
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
OVERVIEW
(Dollars in thousands, except per share data)
The following is a discussion of our financial condition at December 31, 2006 and December 31, 2005, and our results of operations for the each of the three years in the period ended December 31, 2006. The purpose of this discussion is to focus on information about our financial condition and results of operations which is not otherwise apparent from the annual audited consolidated financial statements. You should read the following discussion and analysis along with our consolidated financial statements and the related notes included elsewhere herein.
General
Community First, Inc., is a registered bank holding company under the Bank Holding Company Act of 1956, as amended, and became so upon the acquisition of all the voting shares of Community First Bank & Trust on August 30, 2002. We were incorporated under the laws of the State of Tennessee as a Tennessee corporation on April 9, 2002, and conduct substantially all of our activities through and derive substantially all of our income from our wholly-owned bank subsidiary.
The Bank commenced business on May 18, 1999, as a Tennessee-chartered commercial bank whose deposits are insured by the Federal Deposit Insurance Corporation’s Bank Insurance Fund. The Bank is regulated by the Tennessee Department of Financial Institutions and the FDIC. The Bank’s sole subsidiary is Community First Title, Inc.; a Tennessee chartered and regulated title insurance company. CFBT Investments, Inc., is a wholly-owned subsidiary of Community First Title, Inc., and is the parent of Community First Properties, Inc., which was established as a Real Estate Investment Trust pursuant to Internal Revenue Service regulations.
We conduct our banking activities from our main office and two branch offices in Columbia, Tennessee, one branch office in Mount Pleasant, Tennessee, one branch office in Franklin, Tennessee, and one branch office in Murfreesboro, Tennessee. The Bank also operates ten automated teller machines in Maury County, two automated teller machines in Williamson County, and one automated teller machine in Rutherford County, Tennessee.
The Bank’s principal business is to accept demand and savings deposits from the general public and to make residential mortgage, commercial, construction, and consumer loans. The Company’s results of operations depend primarily on net interest income, which is the difference between the interest income from earning assets, such as loans and investments, and the interest expense incurred on interest bearing liabilities, such as deposits, subordinated debentures, and other borrowings. The Company also generates non-interest income, including service charges on deposit accounts, mortgage lending income, investment service income, bank owned life insurance (“BOLI”) income, and other charges and fees. The Company’s non-interest expense consists primarily of employee compensation and benefits, net occupancy and equipment expense, and other operating expenses. The Company’s results of operations are significantly affected by its provision for loan losses and its provision for income taxes. The following discussion provides a summary of the Company’s operations for the past three years and should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in the report.
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Critical Accounting Policies
The accounting principles we follow and our methods of applying these principles conform with accounting principles generally accepted in the United States and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses (ALL), have been critical to the determination of our financial position, results of operations and cash flows.
Allowance for Loan Losses.Our management assesses the adequacy of the ALL prior to the end of each calendar quarter. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The ALL consists of two portions: (1) an amount representative of specifically identified credit exposure and exposures; and (2) an amount representative of incurred loss, which is based in part on the consideration of historic loss histories which management believes is representative of the probable loss. Even though the allowance for loan losses has two components, the entire allowance is available to absorb any credit losses. We base the amount for unique loans primarily on risk rating grades assigned to each of these loans as a result of our loan management and review processes. We then assign each risk-rating grade a loss ratio, which is determined based on the experience of management, discussions with banking regulators, and our independent loan review process. We estimate losses on impaired loans based on estimated cash flows discounted at the loan’s original effective interest rate or based on the underlying collateral value. We also assign loss ratios to our homogeneous loan groups; however, we base the loss ratios for these homogeneous loans on the category of consumer credit (e.g., automobile, residential mortgage, home equity, etc).
We review the reasonableness of the ALL balance by comparing the balance in the allowance account to historical trends and peer information. Our management then evaluates the result of the procedures performed, including the results of our testing, and concludes on the appropriateness of the balance of the allowance for loan losses in its entirety. The audit committee of our board of directors reviews the assessment prior to the filing of quarterly financial information.
In assessing the adequacy of the allowance for loan losses, we also rely on an ongoing independent loan review process. We undertake this process both to ascertain whether there are loans in the portfolio whose credit quality has weakened over time and to assist in our overall evaluation of the risk characteristics of the entire loan portfolio.
ANALYSIS OF RESULTS OF OPERATION
Net income for Community First, Inc., was $2,802 for the year ended December 31, 2006, a 9.2% increase over net income of $2,565 for 2005. Net income in 2004 was $2,132. Pretax income grew from $3,826 in 2005 to $3,915 in 2006. Pretax income in 2004 was $3,379. The increase in pretax income in 2006 and 2005 was primarily due to continued growth in the Bank’s assets, specifically in loans and the associated interest income. Growth in interest income in 2006 and 2005 was offset in part by the increase in interest expense and noninterest expense as a result of an increase in the Bank’s cost of funds and as a result of the Company’s expansion efforts, respectively. In 2006, noninterest expense increased by 28.3% while net interest income only increased 19.1% over 2005. The increase in noninterest expense was due to start up costs associated with expanding in Williamson and Rutherford Counties. In 2005, noninterest expense increased by 28.7% while net interest income increased 23.8% over 2004 due to expanding into Williamson County. Basic and diluted earnings per share were $0.97 and $0.94 for 2006 compared to $0.89 and $0.86 in 2005. Basic and diluted earnings per share in 2004 were $0.78 and $0.75.
28
Net Interest Income
Net interest income represents the amount by which interest earned on various earning assets exceeds interest paid on deposits and other interest-bearing liabilities and is the most significant component of the Company’s earnings.
2006 compared to 2005
Net interest income before the provision for loan losses for 2006 increased $1,962, or 19.1% to $12,261 compared to $10,299 in 2005. The increase was due primarily to continued growth in the Bank’s loan portfolio, which was funded primarily by deposit growth.
Interest and fee income on loans in 2006 was $24,023, an increase of $7,834, or 48.4%, over 2005. The increase in interest income is due to the increase in interest rates and higher average balances on loans. During 2006, approximately 48% of our loan portfolio was tied to a variable rate.
Interest income for tax exempt and taxable securities was $1,534, an increase of $574, or 59.8%, over 2005. The increase in interest income was the result of higher average balances on the investment portfolio and opportunities to reinvest in higher-yield bonds provided by the short term maturity structure of the investment portfolio.
Although net interest income increased, the Company’s net interest margin continued to compress throughout 2006, declining to 3.52% from 3.81% in 2005, a decrease of 29 basis points (“bps”). The yield curve between short-term and long-term interest rates was essentially flat or inverted throughout 2006, contributing to the decline in the Company’s net interest margin in 2006. This situation, along with challenging competitive conditions and continued competitive pricing pressures experienced by the Company, contributed to the decline in the Company’s net interest margin. Management anticipates that the net interest margin will continue to decrease or remain flat during 2007 due to the forecasted changes in the fed funds rate by the Federal Reserve Bank.
Interest expense totaled $13,528 as of December 31 2006, compared to $7,006 in 2005, an increase of $6,522 or 93.1%. The increase in interest expense was due to deposit growth in higher cost deposits as well as an increase in higher costing brokered deposits and interest wholesale deposits. Interest expense on time deposits over $100,000 increased $2,313 in 2006. The increase was due equally to higher volume and interest rates.
The yield on interest earning assets increased 99 bps to 7.40% in 2006, compared to 6.41% in 2005. This increase was primarily due to the Bank’s continued growth in the loan portfolio and variable rate loans that repriced as interest rates rose in the first half of 2006. Loan yields increased 99 bps and investment yields also benefited from the rise in interest rates as yields increased 91 bps over 2005. The cost of interest bearing deposits and other liabilities has followed the same trend, increasing 140 bps to 4.36% in 2006, up from 2.96% in 2005.
2005 compared to 2004
Net interest income before the provision for loan losses for 2005 was $10,299, compared with $8,321 in 2004. The increase of $1,978 was due primarily to continued growth in the Bank’s loan portfolio, which was funded primarily by deposit growth. The net interest margin during 2005 was 3.81% compared to 3.64% in 2004. Loan yields increased 73 bps versus 81 bps on deposits between January 1, 2005, and December 31, 2005. Part of this increase in net interest margin was due to the growth in average loan balances of $44,022
29
compared to growth in average deposit balances of $36,470. Therefore, average balances in loans grew more rapidly compared to deposit growth in an upward rate environment, which caused an increase in net interest margin. The yield on interest earning assets, including loan fees, increased to 6.41% in 2005, compared to 5.51% in 2004. The cost of interest bearing liabilities followed the same trend, increasing 80 bps to 2.96% in 2005, up from 2.16% in 2004.
Interest and fee income on loans in 2005 was $16,189, an increase of $4,416, or 37.5%, over 2004. The increase was due to higher average balances, interest rates increases, and 49.1% of the loan portfolio being tied to a variable rate. The yield on loans was 6.81% in 2005, compared to 6.08% in 2004.
Interest income from taxable and tax exempt securities in 2005 increased to $960, compared to $736 in 2004. The increase in interest rates and the short maturity structure of the investment portfolio provided opportunities to reinvest in higher yield bonds, which resulted in the increase in income. The yield on investments was 3.42% in 2005, compared to 2.48% in 2004. Short-term funds income increased also due to significantly higher interest rates in 2005.
Interest expense as of December 31, 2005, totaled $7,006, compared to $4,272 in 2004. The increase of $2,734 or 64.0% was due to deposit growth and higher yield on deposits as interest rates increased in 2005. The yield on interest bearing deposits increased from 2.06% in 2004 to 2.87% in 2005.
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Average Balance Sheets, Net Interest Revenue
Changes in Interest Income and Interest Expense
The following table shows the average daily balances of each principal category of assets, liabilities and stockholders’ equity of the Company, an analysis of net interest revenue, and the change in interest income and interest expense segregated into amounts attributable to changes in volume and changes in rates for the three years ended December 31.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| | | Average | | | Interest | | | Revenue/ | | | Average | | | Interest | | | Revenue/ | | | Average | | | Interest | | | Revenue/ | |
| | | Balance | | | Rate | | | Expense | | | Balance | | | Rate | | | Expense | | | Balance | | | Rate | | | Expense | |
| | | |
| Gross loans (1 and 2) | | $ | 308,039 | | | | 7.80 | % | | $ | 24,023 | | | $ | 237,643 | | | | 6.81 | % | | $ | 16,189 | | | $ | 193,621 | | | | 6.08 | % | | $ | 11,773 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Securities available for sale (3) | | | 35,465 | | | | 4.33 | % | | | 1,534 | | | | 28,102 | | | | 3.42 | % | | | 960 | | | | 29,682 | | | | 2.48 | % | | | 736 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal funds sold and other | | | 4,824 | | | | 4.81 | % | | | 232 | | | | 4,260 | | | | 3.66 | % | | | 156 | | | | 5,445 | | | | 1.54 | % | | | 84 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-earning assets | | | 348,328 | | | | 7.40 | % | | | 25,789 | | | | 270,005 | | | | 6.41 | % | | | 17,305 | | | | 228,748 | | | | 5.51 | % | | | 12,593 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Cash and due from banks | | | 7,547 | | | | | | | | | | | | 6,091 | | | | | | | | | | | | 4,865 | | | | | | | | | |
| Other nonearning assets | | | 15,696 | | | | | | | | | | | | 12,686 | | | | | | | | | | | | 6,496 | | | | | | | | | |
| Allowance for loan losses | | | (3,745 | ) | | | | | | | | | | | (2,991 | ) | | | | | | | | | | | (2,468 | ) | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 367,826 | | | | | | | | | | | $ | 285,791 | | | | | | | | | | | $ | 237,641 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW & money market investments | | $ | 47,022 | | | | 2.24 | % | | $ | 1,053 | | | $ | 49,096 | | | | 1.53 | % | | $ | 751 | | | $ | 53,606 | | | | 1.12 | % | | $ | 602 | |
| Savings | | | 8,872 | | | | 1.33 | % | | | 118 | | | | 9,436 | | | | 1.20 | % | | | 113 | | | | 8,858 | | | | 1.03 | % | | | 91 | |
| Time deposits $100,000 and over | | | 94,416 | | | | 5.18 | % | | | 4,895 | | | | 65,003 | | | | 3.97 | % | | | 2,582 | | | | 55,142 | | | | 2.52 | % | | | 1,392 | |
| Other time deposits | | | 137,488 | | | | 4.50 | % | | | 6,189 | | | | 99,988 | | | | 2.96 | % | | | 2,963 | | | | 69,447 | | | | 2.53 | % | | | 1,760 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing deposits | | | 287,798 | | | | 4.26 | % | | | 12,255 | | | | 223,523 | | | | 2.87 | % | | | 6,409 | | | | 187,053 | | | | 2.06 | % | | | 3,845 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Other borrowings | | | 22,698 | | | | 5.61 | % | | | 1,273 | | | | 13,322 | | | | 4.48 | % | | | 597 | | | | 10,602 | | | | 4.03 | % | | | 427 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing liabilities | | | 310,496 | | | | 4.36 | % | | | 13,528 | | | | 236,845 | | | | 2.96 | % | | | 7,006 | | | | 197,655 | | | | 2.16 | % | | | 4,272 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing liabilities | | | 32,173 | | | | — | | | | — | | | | 26,399 | | | | — | | | | — | | | | 21,234 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total liabilities | | | 342,669 | | | | | | | | | | | | 263,244 | | | | | | | | | | | | 218,889 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Shareholders’ equity | | | 25,157 | | | | | | | | | | | | 22,547 | | | | | | | | | | | | 18,752 | | | | | | | | | |
| �� | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total liabilities and shareholders’ equity | | $ | 367,826 | | | | | | | | | | | $ | 285,791 | | | | | | | | | | | $ | 237,641 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income | | | | | | | | | | $ | 12,261 | | | | | | | | | | | $ | 10,299 | | | | | | | | | | | $ | 8,321 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest margin (4) | | | | | | | 3.52 | % | | | | | | | | | | | 3.81 | % | | | | | | | | | | | 3.64 | % | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | |
| 1 | | Interest income includes fees on loans of $1,131, $648 in 2006, 2005 and $622 in 2004. |
| |
| 2 | | Nonaccrual loans are included in average loan balances and the associated income (recognized on a cash basis) is included in interest. |
| |
| 3 | | Amortization cost is included in the calculation of yields on securities available for sale. |
| |
| 4 | | Net interest income to average interest-earning assets. |
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The following table reflects how changes in the volume of interest earning assets and interest bearing liabilities and changes in interest rates have affected the Company’s interest income, interest expense, and net interest income for the periods indicated. Information is provided in each category with respect to changes attributable to (1) changes in volume (changes in volume multiplied by prior rate); (2) changes in rate (changes in rate multiplied by prior volume); and (3) changes in rate/volume (changes in rate multiplied by change in volume). The changes attributable to the combined impact of volume and rate have all been allocated to the changes due to volume.
Analysis of Changes in Net Interest Income
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | 2006 to 2005 | | | 2005 to 2004 | |
| | | Due to | | | Due to | | | | | | | Due to | | | Due to | | | | |
| | | Volume (1) | | | Rate (2) | | | Total | | | Volume (1) | | | Rate (2) | | | Total | |
| | | |
| Interest Income: | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross loans (2 and 3) | | $ | 4,796 | | | $ | 3,038 | | | $ | 7,834 | | | $ | 2,677 | | | $ | 1,739 | | | $ | 4,416 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Securities available for sale | | | 252 | | | | 322 | | | | 574 | | | | (39 | ) | | | 263 | | | | 224 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal funds sold and other | | | 21 | | | | 55 | | | | 76 | | | | (18 | ) | | | 90 | | | | 72 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-earning assets | | | 5,069 | | | | 3,415 | | | | 8,484 | | | | 2,620 | | | | 2,092 | | | | 4,712 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Expense: | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW & money market investments | | $ | (32 | ) | | $ | 334 | | | $ | 302 | | | $ | (51 | ) | | $ | 200 | | | $ | 149 | |
| Savings | | | (7 | ) | | | 12 | | | | 5 | | | | 6 | | | | 16 | | | | 22 | |
| Time deposits $100,000 and over | | | 1,168 | | | | 1,145 | | | | 2,313 | | | | 249 | | | | 941 | | | | 1,190 | |
| Other time deposits | | | 1,111 | | | | 2,115 | | | | 3,226 | | | | 774 | | | | 429 | | | | 1,203 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing deposits | | | 2,240 | | | | 3,606 | | | | 5,846 | | | | 978 | | | | 1,586 | | | | 2,564 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Other borrowings | | | 420 | | | | 256 | | | | 676 | | | | 110 | | | | 60 | | | | 170 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing liabilities | | | 2,660 | | | | 3,862 | | | | 6,522 | | | | 1,088 | | | | 1,646 | | | | 2,734 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income | | $ | 2,409 | | | $ | (447 | ) | | $ | 1,962 | | | $ | 1,532 | | | $ | 446 | | | $ | 1,978 | |
| | | | | | | | | | | | | | | | | | | |
| | |
| 1 | | Changes in interest income and expense not due solely to balance or rate changes are included in the rate category. |
| |
| 2 | | Interest income includes fees on loans of $1,131, $648 in 2006, 2005 and $622 in 2004. |
| |
| 3 | | Nonaccrual loans are included in average loan balances and the associated income (recognized on a cash basis) is included in interest. |
Noninterest Income
The Company’s noninterest income consists of service charges on deposit accounts, mortgage banking activities, investment service income, and other noninterest income.
2006 compared to 2005
Noninterest income for the year ended December 31, 2006 increased 32.6% to $3,125 compared to $2,356 in 2005. Service charges on deposit accounts are the Company’s largest source of noninterest income and decreased 2.6% to $1,520 in 2006 compared to $1,561 in 2005. The decrease in service charge income was due to higher average balances on transaction deposit accounts, which allowed customers to avoid service charges. The largest component of service charges on deposits is the Bank’s overdraft courtesy product, which generated $1,037 for 2006 compared to $1,112 in 2005. The Bank originates and sells long-term fixed rate mortgages and the related servicing. Mortgage loans originated and sold generated $666 in gains for 2006, an increase of $197, or 42.0%, compared to $469 in 2005. In 2005, the Bank sold property in Williamson County, Tennessee, which created a deferred gain of $390 due to the Bank’s financing of the loan
32
for this property. During 2006 the Bank subsequently sold this loan to another financial institution and recognized the $390 gain into other noninterest income. Other noninterest income increased $223, or 68.4%, to $549 in 2006 from $326 in 2005. The increase in other noninterest income was due primarily from the Bank offering new investment service products and an increase in BOLI cash surrender value. Management expects that noninterest income will continue in 2007 to increase as the Bank expands its mortgage origination division and investment services and as the Bank increases in size.
2005 compared to 2004
Total noninterest income increased $249 or 11.8% to $2,356 in 2005, compared with $2,107 in 2004. Mortgage loans originated and sold generated $469 of income in 2005, versus $378 in 2004. Service charges on deposit accounts, the largest component of noninterest income, totaled $1,561 in 2005, compared to $1,564 in 2004. Service charge income remained about the same for 2005 and 2004 due to the execution of a new free checking account campaign and higher average balances on transaction deposit accounts. A large component of service charges on deposits was the Bank’s overdraft courtesy product, which generated income of $1,112 for 2005, compared to $1,154 for the same period in 2004.
The table below shows noninterest income for each of three years ended December 31.
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Service charges on deposit accounts | | $ | 1,520 | | | $ | 1,561 | | | $ | 1,564 | |
| Mortgage banking activities | | | 666 | | | | 469 | | | | 378 | |
| Gain on sale of land | | | 390 | | | | — | | | | — | |
| Other: | | | | | | | | | | | | |
| Investment service income | | | 228 | | | | 22 | | | | — | |
| Check printing income | | | 24 | | | | 25 | | | | 24 | |
| Safe deposit rental | | | 12 | | | | 12 | | | | 10 | |
| Credit life insurance commissions | | | 14 | | | | 19 | | | | 18 | |
| BOLI income | | | 138 | | | | 60 | | | | — | |
| ATM income | | | 74 | | | | 70 | | | | 60 | |
| Other | | | 59 | | | | 118 | | | | 53 | |
| | | | | | | | | | |
| Total noninterest income | | $ | 3,125 | | | $ | 2,356 | | | $ | 2,107 | |
| | | | | | | | | | |
Noninterest Expense
Noninterest expense consists of salaries and employee benefits, net occupancy, furniture and equipment, data processing, advertising and public relations, and other operating expenses.
2006 compared to 2005
Noninterest expense for the year ended December 31, 2006 increased 28.3% to $10,453 compared with $8,146 in 2005. During 2006 and 2005, noninterest expenses have increased as the Bank has grown. The growth in noninterest expenses throughout 2006 and 2005 was attributable primarily to salaries and other operating expenses associated with growth of the Bank and expansion into Williamson and Rutherford Counties. The increase of $777 was associated to operating expenses including data processing, advertising, audit and accounting, and other expenses. Salaries and employee benefits increased $1,522, or 38.7% to $5,451 in 2006 compared to $3,929 in 2005. The Company’s staff increased from 76 full time equivalent employees in 2005 to 96 in 2006. Also included in salaries and employee benefits expense for 2006 is $302 in additional expenses due to changes in accounting rules, which now require compensation expense related to stock options to be expensed. Management expects that noninterest expenses will continue to increase
33
moderately during 2007 in conjunction with the growth of the Bank, but should decline as a percentage of average assets as the Bank continues to experience operating efficiencies as its growth continues.
2005 compared to 2004
During 2005 and 2004, noninterest expenses increased as the Bank grew. Total noninterest expense was $8,146 in 2005, an increase of $1,817, or 28.7%, over $6,329 in 2004. As a percentage of average assets, noninterest expense in 2005 was 2.9% as compared to 2.7% in 2004. The growth in noninterest expenses throughout 2004 and 2005 was attributable primarily to salaries and other operating expenses associated with growth of the Bank and expanding into Williamson County, including data processing, legal, and accounting expense. Salaries increased $1,136, or 40.7%, in 2005 when compared with 2004 and data processing expense increased $75, or 15.0%, over 2004. Occupancy expense was $453 in 2005, an increase of $159, or 54.1% over the expense of $294 in 2004.
The table below shows noninterest expense for each of three years ending December 31.
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Salaries and employee benefits | | $ | 5,451 | | | $ | 3,929 | | | $ | 2,793 | |
| Occupancy | | | 550 | | | | 453 | | | | 294 | |
| Furniture and equipment | | | 545 | | | | 518 | | | | 436 | |
| Data processing fees | | | 684 | | | | 575 | | | | 500 | |
| Advertising and public relations | | | 509 | | | | 340 | | | | 302 | |
| Other: | | | | | | | | | | | | |
| Loan expense | | | 146 | | | | 152 | | | | 134 | |
| Legal | | | 63 | | | | 119 | | | | 165 | |
| Audit and accounting fees | | | 214 | | | | 290 | | | | 151 | |
| Directors expense | | | 152 | | | | 97 | | | | 103 | |
| Postage and freight | | | 268 | | | | 220 | | | | 194 | |
| Operational expense | | | 476 | | | | 289 | | | | 236 | |
| Regulatory and compliance | | | 107 | | | | 111 | | | | 83 | |
| ATM expense | | | 222 | | | | 147 | | | | 133 | |
| Other | | | 1,066 | | | | 906 | | | | 805 | |
| | | | | | | | | | |
| Total noninterest expense | | $ | 10,453 | | | $ | 8,146 | | | $ | 6,329 | |
| | | | | | | | | | |
Provisions for Loan Losses
During 2006, the Bank recorded a provision for loan losses of $1,018, an increase of $335, or 49.0%, over $683 in 2005. Our loan growth for 2006 contributed to the increase in the provisions for loan losses in 2006. Gross loans increased $89,555 or 34.5% during the year ended December 31, 2006. In 2005, the Bank recorded a provision for loan losses of $683 compared to $720 for 2004.
Management’s determination of the appropriate level of the provision for loan losses and the adequacy of the allowance for loan losses is based, in part, on an evaluation of specific loans, as well as the consideration of historical loss experience, which management believes is representative of the probable loss. Other factors considered by management include the composition of the loan portfolio, current and anticipated economic conditions, and the creditworthiness of the Bank’s borrowers and other related factors. The provision for loan losses has been most directly impacted by the rapid loan growth experienced by the Bank as well as the effect of a decrease in net charge-offs in 2006.
34
Income Taxes
The effective income tax rates were 28.4%, 33.0%, and 36.9%, respectively, for 2006, 2005, and 2004. The change in the effective tax rate for 2006 and 2005 was largely due to state net operating losses (NOLs) created in 2005 and 2006 and the Bank’s investment in a project that qualifies for the New Markets Tax Credits program in 2006.
Analysis of Financial Condition
Total assets at December 31, 2006, were $421,393, an increase of $92,587 or 28.2%, over 2005 year-end assets of $328,806. Average assets for 2006 were $367,826, an increase of $82,035, or 28.7%, over average assets for 2005.
The primary reason for the increase in total assets was strong loan demand, which resulted in significant loan growth throughout 2006. The increase in total assets was funded primarily by the continued growth of new deposit accounts as well as obtaining national market time deposits, brokered deposits, and public fund deposits. Net loans of $344,714 (excluding mortgage loans held for sale) increased by $88,564 or 34.6% in 2006, from $256,150 in 2005. At year end 2006, securities totaled $37,576, an increase of $7,246, or 23.9%, over year end 2005. At December 31, 2006, cash and cash equivalents were $15,073, a decrease of $10,653 over year end 2005. The decrease in cash and cash equivalents resulted from funding loan growth.
Loans
Gross loans (excludes mortgage loans held for sale) grew from $259,418 at December 31, 2005, to $348,973 at December 31, 2006, an increase of $89,555, or 34.5%. Mortgage loans held for sale at December 31, 2006, were $3,981 compared to $1,890 at December 31, 2005, an increase of $2,091. Most of the net loan growth in 2006 was in 1-4 family residential real estate, construction and commercial (non-real estate) loans. Loans secured by 1-4 family real estate increased $16,675, while commercial (non-real estate) loans increased by $20,598. Construction loans secured by real estate increased $32,174, or 52.3% over 2005. The construction loan increase was due to expanding into the Williamson and Rutherford County markets.
Of the total loans of $348,973 in the portfolio as of year-end 2006, $168,276, or 48.2% were variable rate loans and $180,697 were fixed rate loans.
On December 31, 2006, the Company’s loan to deposit ratio (including mortgage loans held for sale) was 96.2%, compared to 91.3% in 2005. The loan to asset ratio (including mortgage loans held for sale) was 83.8% for 2006, compared to 79.5% in 2005. Management expects loan demand to remain strong, especially in commercial and construction loans.
| | | | | | | | | | | | | | | | | |
| | | December 31, 2006 | | | December 31, 2005 | |
| | | Amount | | | % of Total | | | Amount | | | % of Total | |
| Real estate | | | | | | | | | | | | | | | | |
| Construction | | $ | 93,704 | | | | 26.9 | % | | $ | 61,530 | | | | 23.7 | % |
| 1-4 family residential | | | 96,309 | | | | 27.6 | % | | | 79,634 | | | | 30.7 | % |
| Commercial | | | 90,147 | | | | 25.8 | % | | | 69,549 | | | | 26.8 | % |
| Other | | | 3,009 | | | | 0.9 | % | | | 894 | | | | 0.3 | % |
| Commercial, financial and agricultural | | | 46,942 | | | | 13.4 | % | | | 36,601 | | | | 14.1 | % |
| Consumer | | | 11,560 | | | | 3.3 | % | | | 10,803 | | | | 4.2 | % |
| Other | | | 7,302 | | | | 2.1 | % | | | 407 | | | | 0.2 | % |
| | | | | | | | | | | | | |
| Total (1) | | $ | 348,973 | | | | 100.0 | % | | $ | 259,418 | | | | 100.0 | % |
| | | | | | | | | | | | | |
| | |
| (1) | | Does not include mortgage loans held for sale at December 31, 2006 and December 31, 2005. |
35
The following table presents various categories of loans contained in the Bank’s loan portfolio for the periods indicated and the total amount of all loans for such period:
| | | | | | | | | | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | | | 2003 | | | 2002 | |
| Real estate | | | | | | | | | | | | | | | | | | | | |
| Construction | | $ | 93,704 | | | $ | 61,530 | | | $ | 36,241 | | | $ | 23,977 | | | $ | 28,897 | |
| 1-4 family residential | | | 96,309 | | | | 79,634 | | | | 67,844 | | | | 52,073 | | | | 39,067 | |
| Commercial | | | 90,147 | | | | 69,549 | | | | 66,319 | | | | 63,513 | | | | 36,315 | |
| Other | | | 3,009 | | | | 894 | | | | 288 | | | | 486 | | | | 376 | |
| Commercial, financial and agricultural | | | 46,942 | | | | 36,601 | | | | 30,068 | | | | 21,765 | | | | 18,918 | |
| | | | | | | | | | | | | | | | | | | | | |
| Consumer | | | 11,560 | | | | 10,803 | | | | 9,597 | | | | 9,778 | | | | 9,262 | |
| Other | | | 7,302 | | | | 407 | | | | 470 | | | | 460 | | | | 371 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total loans | | $ | 348,973 | | | | 259,418 | | | | 210,827 | | | | 172,052 | | | | 133,206 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Allowance for possible loan losses | | | (4,259 | ) | | | (3,268 | ) | | | (2,740 | ) | | | (2,249 | ) | | | (1,773 | ) |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total (net of allowance) | | $ | 344,714 | | | $ | 256,150 | | | $ | 208,087 | | | $ | 169,803 | | | $ | 131,433 | |
| | | | | | | | | | | | | | | | |
The following is a presentation of an analysis of maturities of loans as of December 31, 2006:
| | | | | | | | | | | | | | | | | |
| | | Due in 1 | | | Due in 1 | | | Due after | | | | |
| Type of Loan | | year or less | | | to 5 years | | | 5 Years | | | Total | |
| Commercial, financial and agricultural and commercial real estate | | $ | 30,222 | | | $ | 88,412 | | | $ | 18,455 | | | $ | 137,089 | |
| Real estate-construction | | | 57,227 | | | | 34,210 | | | | 2,267 | | | | 93,704 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 87,449 | | | $ | 122,622 | | | $ | 20,722 | | | $ | 230,793 | |
| | | | | | | | | | | | | |
The following is a presentation of an analysis of sensitivities of loans to changes in interest rates as of December 31, 2006 for the loan types mentioned above:
| | | | | |
| Loans due after 1 year with predetermined interest rates | | $ | 97,972 | |
| Loans due after 1 year with floating interest rates | | $ | 45,372 | |
36
Asset Quality
The following table presents information regarding nonaccrual, past due and restructured loans at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | |
| | | December 31, |
| | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 |
| Loans accounted for on a non-accrual basis: | | | | | | | | | | | | | | | | | | | | |
| Number | | | 27 | | | | 12 | | | | 10 | | | | 7 | | | | 3 | |
| Amount | | $ | 1,059 | | | $ | 508 | | | $ | 905 | | | $ | 533 | | | $ | 28 | |
| | | | | | | | | | | | | | | | | | | | | |
| Accruing loans (including consumer loans) which are contractually past due 90 days or more as to principal and interest payments: | | | | | | | | | | | | | | | | | | | | |
| Number | | | — | | | | — | | | | — | | | | 9 | | | | 7 | |
| Amount | | $ | — | | | $ | — | | | $ | — | | | $ | 307 | | | $ | 407 | |
| | | | | | | | | | | | | | | | | | | | | |
| Loans defined as “troubled debt restructurings” | | | | | | | | | | | | | | | | | | | | |
| Number | | | — | | | | — | | | | — | | | | — | | | | — | |
| Amount | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
As of December 31, 2006, there were no loans classified by management as doubtful or substandard that have not been disclosed in the above table, which (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.
Accrual of interest is discontinued on a loan when management of the Bank determines upon consideration of economic and business factors affecting collection efforts that collection of interest is doubtful.
There are no other loans which are not disclosed above, but where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms.
Nonperforming loans are defined as non-accrual loans, loans accruing but past due 90 days or more, and restructured loans. We had nonperforming loans totaling $1,059 at December 31, 2006, compared to $508 at December 31, 2005. The nonperforming loans at December 31, 2006 consisted of 27 loans of which $772 were consumer loans and $287 were commercial loans. Of that, $747 were real estate secured commercial loans, $36 were secured by residential real estate and $446 were guaranteed by the U.S. Government Small Business Administration. We had nonperforming loans totaling $508 at December 31, 2005, compared to $905 at December 31, 2004. The nonperforming loans at December 31, 2005, consisted of 12 loans of which two loans, totaling $118, belonged to a single customer. The nonperforming loans at December 31, 2004, were comprised of 10 loans of which 4 loans totaling $392 belonged to one customer. The nonperforming loans in 2003 were small consumer loans. The nonperforming loan total at year-end 2002 consisted of one loan, secured by residential real estate, which was placed on non-accrual status during the third quarter of 2002. For the years ended December 31, 2006, 2005, 2004, 2003 and 2002, the accrued interest that would have been collected on non-accrual loans was not material to the financial condition or results of operations of the Company.
37
Management classifies commercial and commercial real estate loans as non-accrual loans when principal or interest is past due 90 days or more and the loan is not adequately collateralized. Also loans are classified as non-accrual when they are in the process of collection, or when, in the opinion of management, principal or interest is not likely to be paid in accordance with the terms of the obligation. Non-accrual loans are not reclassified as accruing until principal and interest payments are brought current and future payments appear reasonably certain. Loans are categorized as restructured if the original interest rate, repayment terms, or both were restructured due to deterioration in the financial condition of the borrower. However, restructured loans that demonstrate performance under the restructured terms and that yield a market rate of interest may be removed from restructured status in the year following the restructure.
Summary of Loan Loss Experience
An analysis of the Bank’s loss experience is furnished in the following table for the periods indicated, as well as a breakdown of the allowance for possible loan losses:
| | | | | | | | | | | | | | | | | | | | | |
| | | December 31, | |
| | | 2006 | | | 2005 | | | 2004 | | | 2003 | | | 2002 | |
| Balance at beginning of period | | $ | 3,268 | | | $ | 2,740 | | | $ | 2,249 | | | $ | 1,773 | | | $ | 1,328 | |
| | | | | | | | | | | | | | | | | | | | | |
| Charge-offs: | | | | | | | | | | | | | | | | | | | | |
| Commercial, financial and agricultural | | | (8 | ) | | | (98 | ) | | | (66 | ) | | | — | | | | (55 | ) |
| Real Estate-construction | | | — | | | | — | | | | — | | | | — | | | | — | |
| Real Estate-1 to 4 family residential | | | — | | | | (14 | ) | | | (7 | ) | | | (30 | ) | | | (144 | ) |
| Real Estate-commercial | | | — | | | | — | | | | — | | | | — | | | | — | |
| Real Estate-other | | | — | | | | — | | | | — | | | | — | | | | — | |
| Consumer and other loans | | | (42 | ) | | | (121 | ) | | | (179 | ) | | | (130 | ) | | | (72 | ) |
| | | | | | | | | | | | | | | | |
| | | | (50 | ) | | | (233 | ) | | | (252 | ) | | | (160 | ) | | | (271 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Recoveries: | | | | | | | | | | | | | | | | | | | | |
| Commercials, financials and agriculture | | | — | | | | — | | | | — | | | | 2 | | | | 7 | |
| Real Estate-construction | | | — | | | | — | | | | — | | | | — | | | | — | |
| Real Estate-1 to 4 family residential | | | 1 | | | | 25 | | | | 6 | | | | 1 | | | | — | |
| Real Estate-commercial | | | — | | | | — | | | | — | | | | — | | | | — | |
| Real Estate-other | | | — | | | | — | | | | — | | | | — | | | | — | |
| Consumer and other loans | | | 22 | | | | 53 | | | | 17 | | | | 19 | | | | 26 | |
| | | | | | | | | | | | | | | | |
| | | | 23 | | | | 78 | | | | 23 | | | | 22 | | | | 33 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net Charge-offs | | | (27 | ) | | | (155 | ) | | | (229 | ) | | | (138 | ) | | | (238 | ) |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | 1,018 | | | | 683 | | | | 720 | | | | 614 | | | | 683 | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at end of period | | $ | 4,259 | | | $ | 3,268 | | | $ | 2,740 | | | $ | 2,249 | | | $ | 1,773 | |
| | | | | | | | | | | | | | | | |
| Ratio of net charge-offs during the period to average loans outstanding during the period | | | 0.01 | % | | | 0.07 | % | | | 0.12 | % | | | 0.09 | % | | | 0.21 | % |
| | | | | | | | | | | | | | | | |
38
At December 31, 2006 and 2005, the allowance was allocated as follows:
| | | | | | | | | | | | | | | | | |
| | | 2006 | | | 2005 | |
| | | | | | | Percentage of | | | | | | | Percentage of | |
| | | | | | | loans in each | | | | | | | loans in each | |
| | | | | | | category to | | | | | | | category to | |
| | | Amount | | | total loans | | | Amount | | | total loans | |
| Commercial, financial and agricultural | | $ | 547 | | | | 13 | % | | $ | 458 | | | | 14 | % |
| Real estate-construction | | | 1,053 | | | | 27 | % | | | 772 | | | | 24 | % |
| Real estate-1 to 4 family residential | | | 1,266 | | | | 28 | % | | | 1,038 | | | | 31 | % |
| Real estate-commercial | | | 1,110 | | | | 26 | % | | | 871 | | | | 27 | % |
| Real estate-other | | | — | | | | — | | | | — | | | | — | |
| Consumer and other loans | | | 283 | | | | 6 | % | | | 129 | | | | 4 | % |
| | | | | | | | | | | | | |
| Total | | $ | 4,259 | | | | 100 | % | | $ | 3,268 | | | | 100 | % |
| | | | | | | | | | | | | |
At December 31, 2004 and 2003, the allowance was allocated as follows:
| | | | | | | | | | | | | | | | | |
| | | 2004 | | | 2003 | |
| | | | | | | Percentage of | | | | | | | Percentage of | |
| | | | | | | loans in each | | | | | | | loans in each | |
| | | | | | | category to | | | | | | | category to | |
| | | Amount | | | total loans | | | Amount | | | total loans | |
| Commercial, financial and agricultural | | $ | 379 | | | | 14 | % | | $ | 275 | | | | 13 | % |
| Real estate-construction | | | 494 | | | | 17 | % | | | 354 | | | | 14 | % |
| Real estate-1 to 4 family residential | | | 818 | | | | 32 | % | | | 604 | | | | 30 | % |
| Real estate-commercial | | | 925 | | | | 32 | % | | | 892 | | | | 37 | % |
| Real estate-other | | | — | | | | — | | | | — | | | | — | |
| Consumer and other loans | | | 124 | | | | 5 | % | | | 124 | | | | 6 | % |
| | | | | | | | | | | | | |
| Total | | $ | 2,740 | | | | 100 | % | | $ | 2,249 | | | | 100 | % |
| | | | | | | | | | | | | |
At December 31, 2002, the allowance was allocated as follows:
| | | | | | | | | |
| | | 2002 | |
| | | | | | | Percentage of | |
| | | | | | | loans in each | |
| | | | | | | category to | |
| | | Amount | | | total loans | |
| Commercial, financial and agricultural | | $ | 355 | | | | 14 | % |
| Real estate-construction | | | 177 | | | | 22 | % |
| Real estate-1 to 4 family residential | | | 266 | | | | 29 | % |
| Real estate-commercial | | | 354 | | | | 27 | % |
| Real estate-other | | | — | | | | — | |
| Consumer and other loans | | | 621 | | | | 8 | % |
| | | | | | | |
| Total | | $ | 1,773 | | | | 100 | % |
| | | | | | | |
39
Allowance for Loan Losses
In considering the adequacy of the Bank’s allowance for loan losses, management has focused on the fact that as of December 31, 2006, 81% of outstanding loans are secured by real estate. The Bank’s consumer loan portfolio is also well secured and, as such, does not, in management’s opinion, involve more than normal credit risk.
Although the Bank’s loan portfolio is concentrated in Middle Tennessee, management does not believe this geographic concentration presents an abnormally high risk. At December 31, 2006 there were no loan concentrations that exceeded 10% of total loans other than as included in the preceding table of types of loans. Loan concentrations are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other conditions.
Securities
At December 31, 2006, the Company owned $35,576 in securities, compared to $30,330 at year-end 2005. Total securities increased in 2006 by $5,246. The net unrealized losses on securities for 2006 were $102. The investment portfolio was 8.4% of total assets at December 31, 2006, and 9.2% of total assets at December 31, 2005. All of the Company’s securities are classified as available for sale. The Company’s investment portfolio is used to provide interest income and liquidity and for pledging purposes to secure public fund deposits.
| | | | | | | | | | | | | | | | | |
| | | December 31, 2006 | | | December 31, 2005 | |
| | | Amount | | | % of Total | | | Amount | | | % of Total | |
| U.S. Government sponsored entities | | $ | 19,776 | | | | 55.6 | % | | $ | 18,887 | | | | 62.3 | % |
| Mortgage-backed securities | | | 7,857 | | | | 22.1 | % | | | 3,089 | | | | 10.2 | % |
| State and municipals | | | 6,092 | | | | 17.1 | % | | | 5,487 | | | | 18.1 | % |
| Other debt securities | | | 1,486 | | | | 4.2 | % | | | 2,502 | | | | 8.2 | % |
| Equity securities | | | 365 | | | | 1.0 | % | | | 365 | | | | 1.2 | % |
| | | | | | | | | | | | | |
| Total | | $ | 35,576 | | | | 100.0 | % | | $ | 30,330 | | | | 100.0 | % |
| | | | | | | | | | | | | |
The carrying value of securities at December 31 is summarized as follows:
| | | | | | | | | | | | | |
| Category | | December 31 | |
| Available for sale: | | 2006 | | | 2005 | | | 2004 | |
| U.S. Government sponsored entities | | $ | 19,776 | | | $ | 18,887 | | | $ | 16,932 | |
| Mortgage-backed securities | | | 7,857 | | | | 3,089 | | | | 4,416 | |
| State and municipals | | | 6,092 | | | | 5,487 | | | | 3,138 | |
| Other debt securities | | | 1,486 | | | | 2,502 | | | | 3,061 | |
| Equity securities | | | 365 | | | | 365 | | | | 320 | |
| | | | | | | | | | |
| Total | | $ | 35,576 | | | $ | 30,330 | | | $ | 27,867 | |
| | | | | | | | | | |
40
The following table presents the carrying value by maturity distribution of the investment portfolio, along with weighted average yields thereon, as of December 31, 2006:
| | | | | | | | | | | | | | | | | | | | | |
| | | Within | | | 1-5 | | | 5-10 | | | Beyond | | | | |
| | | 1 Year | | | Years | | | Years | | | 10 Years | | | Total | |
| U.S. Government sponsored entities | | $ | 12,932 | | | $ | 6,844 | | | $ | — | | | $ | — | | | $ | 19,776 | |
| State and municipals | | | — | | | | 340 | | | | 2,456 | | | | 3,296 | | | | 6,092 | |
| Other debt securities | | | — | | | | — | | | | 981 | | | | 504 | | | | 1,485 | |
| | | | | | | | | | | | | | | | |
| Total debt securities | | $ | 12,932 | | | $ | 7,184 | | | $ | 3,437 | | | $ | 3,800 | | | $ | 27,353 | |
| | | | | | | | | | | | | | | | |
| Weighted average yield(tax equivalent) | | | 4.48 | % | | | 5.08 | % | | | 4.94 | % | | | 4.89 | % | | | 4.75 | % |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Mortgage-backed and equity securities | | | | | | | | | | | | | | | | | | $ | 7,857 | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Weighted average yield | | | | | | | | | | | | | | | | | | | 4.70 | % |
| | | | | | | | | | | | | | | | | | | | |
Premises and Equipment
In 2006, fixed assets, net of depreciation, increased $3,579. The largest component of the increase in fixed assets consisted of $3,609 in completion of the Bank’s new Carothers Parkway branch in Williamson County. A partial build out of the second floor in the operations building in Maury County and remodeling at our new Rutherford County branch were other increases to fixed assets.
Construction began on a new downtown branch in Columbia, Tennessee in 2006. Construction in process for the downtown branch in 2006 totaled $247. The total expected cost of the branch is $2,466. The branch is projected to be completed in the third quarter of 2007.
Rent expense was $162 in 2006, compared to $126 in 2005. The increase was due to leasing a new bank building in Rutherford County, a new lease on the land for the new downtown building, and the increase in the number of ATMs.
Deposits
The Bank relies on having a growing deposit base to fund loan and other asset growth. Total deposits were $366,766 at December 31, 2006, compared to $286,243 at December 31, 2005. The following table sets forth the composition of the deposits at December 31.
| | | | | | | | | | | | | | | | | |
| | | 2006 | | | 2005 | |
| | | Amount | | | % of Total | | | Amount | | | % of Total | |
| Noninterest-bearing demand accounts | | $ | 34,001 | | | | 9.3 | % | | $ | 32,499 | | | | 11.4 | % |
| Interest-bearing demand accounts | | | 46,530 | | | | 12.7 | % | | | 45,804 | | | | 16.0 | % |
| Savings accounts | | | 8,921 | | | | 2.4 | % | | | 9,570 | | | | 3.3 | % |
| Time deposits greater than $100,000 | | | 114,480 | | | | 31.2 | % | | | 82,079 | | | | 28.7 | % |
| Other time deposits | | | 162,834 | | | | 44.4 | % | | | 16,291 | | | | 40.6 | % |
| | | | | | | | | | | | | |
| Total | | $ | 366,766 | | | | 100.0 | % | | $ | 286,243 | | | | 100.0 | % |
| | | | | | | | | | | | | |
41
The majority of the deposits continue to be in time deposits. Time deposits (certificate of deposits and IRAs) totaled $277,314, or 75.6% of total deposits. Time deposits greater than $100,000 were $114,480 at December 31, 2006. Time deposits less than $100,000 were $162,834 at December 31, 2006, which is an increase of $46,543 from 2005. The increase in time deposits less than $100,000 was from national market and personal time deposits. The Bank had a promotion in 2006 that increased personal time deposits. Personal time deposits under $100,000 increased from $34,372 in 2005 to $50,899 in 2006. The weighted yield for 2006 on personal time deposits under $100,000 was 4.92%. At December 31, 2006, national market time deposits totaled $74,875, with a weighted average rate of 5.47%. Total brokered time deposits were $19,601 at December 31, 2006 with a weighted average rate of 4.95%. The variable rate time deposit interest rate can change one time over the term of the deposit. Total variable rate time deposits were $23,426 at December 31, 2006, with a weighted average rate of 5.26%. Total variable rate time deposits were $12,284 at year end 2005 with a weighted average rate of 4.36%. The Bank has $273,238 in time deposits maturing within two years, of which $18,512 were brokered deposits. Time deposits maturing within one year were $236,155, or 85.2% of total time deposits. The weighted average cost of all deposit accounts was 3.87% in 2006 compared to 2.58% in 2005. The weighted average rate on time deposits was 4.78% in 2006, compared to 3.36% in 2005. Management expects to seek short-term time deposit funding to match variable rate loans. These efforts, if successful, are expected to reduce interest rate risk. The Bank has introduced a free checking account product and has expanded into Williamson and Rutherford Counties to access lower cost business accounts. Due to competitive pricing pressures in the Bank’s new and existing markets, the Bank is being forced to pursue additional funding at a slightly higher interest rate in national and brokered deposit markets.
The following tables present, for the periods indicated, the average amount of and average rate paid on each of the following deposit categories:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2006 | | 2005 | | 2004 |
| | | | | | | Average | | Average | | Average | | | | |
| | | Average | | Rate | | Average | | Rate | | Average | | Rate |
| | | Amount | | Paid | | Amount | | Paid | | Amount | | Paid |
| Noninterest-bearing demand deposits | | $ | 29,272 | | | na | | $ | 24,927 | | | na | | $ | 20,518 | | | na |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing demand accounts | | | 47,022 | | | | 2.24 | % | | | 49,096 | | | | 1.53 | % | | | 53,606 | | | | 1.12 | % |
| Savings deposits | | | 8,872 | | | | 1.33 | % | | | 9,436 | | | | 1.20 | % | | | 8,858 | | | | 1.03 | % |
| Time deposits | | | 231,904 | | | | 4.78 | % | | | 164,991 | | | | 3.36 | % | | | 124,589 | | | | 2.53 | % |
The following table indicates the amount outstanding of time certificates of deposit of $100,000 or more and other time deposits of $100,000 or more and respective maturities as of December 31, 2006:
| | | | | |
| 3 months or less | | $ | 22,277 | |
| 3-12 months | | | 77,509 | |
| Over 12 months | | | 14,694 | |
| | | | |
| Total | | $ | 114,480 | |
| | | | |
42
Contractual Obligations
The Company has the following contractual obligations as of December 31, 2006:
| | | | | | | | | | | | | | | | | | | | | |
| | | Less than | | | 1 - 3 | | | 3 - 5 | | | More than | | | | |
| | | 1 year | | | years | | | years | | | 5 years | | | Total | |
| Long-term debt obligations | | $ | 2,000 | | | $ | 11,000 | | | $ | — | | | $ | 8,000 | | | $ | 21,000 | |
| Operating leases | | | 227 | | | | 440 | | | | 129 | | | | 1,212 | | | | 2,008 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 2,227 | | | $ | 11,440 | | | $ | 129 | | | $ | 9,212 | | | $ | 23,008 | |
| | | | | | | | | | | | | | | | |
Long-term debt obligations consist of advances from the Federal Home Loan Bank and subordinated debentures. The Bank has entered into operating lease agreements for certain branch properties and equipment. Future minimum rental payments under the terms of these noncancellable leases, including renewal options, are included in the operating lease obligations.
Short-Term Borrowings
The table below includes certain information related to borrowed funds with original maturities of less than one year. The short-term borrowings are made up of federal funds sold.
| | | | | | | | | | | | | |
| | | 2006 | | 2005 | | 2004 |
| Balance at year-end | | | — | | | | — | | | | — | |
| Weighted average interest rate at year-end | | | — | | | | — | | | | — | |
| Maximum outstanding at any month-end during the year | | | 8,000 | | | | 7,400 | | | | 2,433 | |
| Average amount outstanding | | | 1,910 | | | | 843 | | | | 204 | |
| Weighted average rates during the year | | | 5.45 | % | | | 4.10 | % | | | 1.97 | % |
Subordinated Debentures
The Company established a Trust that issued a $3,000 floating rate trust preferred security as a part of a private offering in 2002. The Trust can redeem the securities any time after September 30, 2007. The interest is paid and the interest rate resets quarterly. The interest rate is the New York Prime plus 50 basis points. The trust preferred security maturity date is December 31, 2032. The issued subordinated debentures count as Tier 1 capital for regulatory purposes. The proceeds from this offering were utilized to increase the Bank’s capital by $3,000.
In 2005, the Company established a second Trust that issued $5,000 floating rate obligated mandatory redeemable securities through a special purpose entity as a part of pool offering. The interest is paid and the interest rate resets quarterly. These securities mature on September 15, 2035; however, the maturity may be shortened to a date not earlier than September 15, 2010. The Company issued $5,000 of subordinated debentures to the Trust, which counts as Tier 1 capital for regulatory purposes.
43
Liquidity
Community First’s liquidity, primarily represented by cash and cash equivalents, is a result of its operating, investing, and financing activities. These activities are summarized below for the three years ended December 31:
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Net income | | $ | 2,802 | | | $ | 2,565 | | | $ | 2,132 | |
| Adjusted to reconcile net income to net cash from operating activities | | | (1,375 | ) | | | 2,102 | | | | 1,216 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Net cash from operating activities | | | 1,427 | | | | 4,667 | | | | 3,348 | |
| Net cash from investing activities | | | (100,910 | ) | | | (55,702 | ) | | | (42,941 | ) |
| Net cash from financing activities | | | 88,830 | | | | 67,521 | | | | 37,220 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Net change in cash and cash equivalents | | | (10,653 | ) | | | 16,486 | | | | (2,373 | ) |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Cash and cash equivalents at beginning of period | | | 25,726 | | | | 9,240 | | | | 11,613 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Cash and cash equivalents at end of period | | $ | 15,073 | | | $ | 25,726 | | | $ | 9,240 | |
| | | | | | | | | | |
The adjustments to reconcile net income to net cash from operating activities consist of mortgage banking activities, gain on sale of land, purchase of a bank owned life insurance policy and provisions for loan losses. Significant components of investing activities during 2006 were net loan originations of $89,704 and purchases of securities available for sale of $21,173, offset by the proceeds from the maturities and redemptions of securities available for sale of $14,062. Significant components of investing activities during 2005 were net loan originations of $49,950 and purchases of securities available for sale of $14,428, offset by the proceeds from the maturities and redemptions of securities available for sale of $11,745. Significant components of investing activities during 2004 were net loan originations of $39,416 and purchases of securities available for sale of $17,598, offset by the proceeds from the maturities and redemptions of securities available for sale of $18,478.
Financing activities during 2006 included net deposit inflows of $80,523, proceeds from issuance of common stock of $3,761, and net proceeds from Federal Home Loan Bank advances of $5,000. Cash flows from financing activities during 2005 included net deposit inflows of $62,465 and issuance of $5,000 of subordinate debentures. Financing activities during 2004 included net deposit inflows of $28,539, proceeds from issuance of common stock of $5,681, and proceeds from Federal Home Loan Bank advances of $3,000.
Liquidity refers to the Company’s ability to fund loan demand, meet deposit customers’ withdrawal needs and provide for operating expenses. As summarized in the Statement of Cash Flows, the Company’s main sources of cash flow are receipts of deposits from its customers and, to a lesser extent, repayment of loan principal and interest income on loans and securities.
The primary uses of cash are lending to Community First’s borrowers and investing in securities and short-term interest-earning assets. In 2006, deposit growth kept pace with loan demand. The Bank had $15,000 in surety bonds and $7,000 in FHLB letters of credit to secure public deposits. Surety bonds and FHLB letters of credit were used to keep the Bank’s security portfolio available for liquidity purposes. Other potential sources of liquidity include the sale of securities available for sale from the Bank’s securities portfolio, the sale of loans held for sale, Federal Home Loan Bank advances, acquisition of national market time deposits or broker time deposits, the purchase of federal funds, or repurchase agreements.
44
Community First considers its liquidity sufficient to meet its outstanding short and long-term needs. Community First expects to be able to fund or refinance, on a timely basis, its material commitments and long-term liabilities.
Off-Balance Sheet Arrangements
At December 31, 2006, the Company had unfunded loan commitments outstanding of $69,563 and unfunded letters of credit of $4,160. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Company’s bank subsidiary has the ability to liquidate Federal funds sold or securities available-for-sale or on a short-term basis to borrow and purchase Federal funds from other financial institutions. Additionally, the Company’s bank subsidiary could sell participations in these or other loans to correspondent banks.
Capital Resources
The Company’s total shareholders’ equity at December 31, 2006, was $30,657 compared to $24,017 at December 31, 2005, and $21,452 at December 31, 2004. The increase in shareholder’s equity in 2006 of $6,640 was the result of net income of $2,802 and the issuance of 16,566 shares of common stock under the stock option plan of $121, $5 in restricted stock awards, and a tax benefit of $142 arising from exercising stock options. Net proceeds of $3,761 from the issuance of 125,460 shares of common stock from a stock offering also positively impacted shareholders’ equity. Offsetting these increases was a cash dividend paid to shareholders in the total amount of $575. The change also included stock-based compensation expense of $302 and an increase in the fair value of available-for–sale securities, net of tax, of $82.
As of December 31, 2006, and December 31, 2005, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. The total capital to risk-weighted assets ratios for year end 2006 and 2005 for the Company were 11.25% and 12.77%. Tier 1 to risk weighted assets ratios for the Company were 10.14% and 11.59% at year end 2006 and 2005. Also, Tier 1 to average assets ratios for the Company were 9.45% and 10.25%. The subordinated debentures, issued in 2002 and 2005 increased Tier 1 capital, giving the Bank the opportunity to continue its asset growth.
The Company began a stock offering on December 6, 2006, to provide additional capital of $10,500. The Company, as of December 31, 2006, had sold 125,460 shares of common stock for net proceeds after expenses of $3,761. The proceeds of the offering will be used to strengthen the Company’s capital base and position it to continue to help meet the company’s goal of remaining “well capitalized,’’ which should allow for future growth.
Return on Equity and Assets
Returns on average consolidated assets and average consolidated equity and the ratio of average equity to average assets and the dividend payout ratio for the periods indicated are as follows:
| | | | | | | | | | | | | |
| | | 2006 | | 2005 | | 2004 |
| Return on average assets | | | .76 | % | | | .90 | % | | | .90 | % |
| Return on average equity | | | 11.14 | % | | | 11.38 | % | | | 11.37 | % |
| Average equity to average assets ratio | | | 6.84 | % | | | 7.89 | % | | | 7.89 | % |
| Dividend payout ratio | | | 20.61 | % | | | — | | | | — | |
45
ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity
Management uses a gap simulation model that takes cash flows into consideration. These include mortgage-backed securities, loan prepayments, and expected calls on securities. Non-maturing balances such as money markets, savings, and NOW accounts have no contractual or stated maturities. A challenge in the rate risk analysis is to determine the impact of the non-maturing balances on the net interest margin as the interest rates change. Because these balances do not “mature” it is difficult to know how they will reprice as rates change. It is possible to glean some understanding by reviewing the Bank’s pricing history on these categories relative to interest rates. Using the interest rate history from the Asset Liability Management software database spanning up to 20 quarters of data, we can derive the relationship between interest rates changes and the offering rates themselves. The analysis uses the T-Bill rate as an indicator of rate changes. The gap analysis uses beta factors to spread balances to reflect repricing speed. In the gap analysis the model considers deposit rate movements to determine what percentage of interest bearing deposits that is actually repriceable within a year. Our cumulative one year gap position at December 31, 2006, was 2.63% of total assets. Our policy states that our one-year cumulative gap should not exceed 15% of total assets.
At year-end 2006, $272,727 of $389,523 of interest earning assets will reprice or mature within one year. Loans maturing or repricing within one year totaled $255,633, or 72.4% of total loans. The Bank had $7,999 loans maturing or repricing after five years. As of December 31, 2006, the Bank had $236,155 in time deposits maturing or repricing within one year.
Gap analysis only shows the dollar volume of assets and liabilities that mature or reprice. It does not provide information on how frequently they will reprice. To more accurately capture the Company’s interest rate risk, we measure the actual effects repricing opportunities have on earnings through income simulation models such as rate shocks of economic value of equity and rate shock interest income simulations.
To evaluate the impact of rate change on income, the rate shock simulation of interest income is the best technique because variables are changed for the various rate conditions. Each category of earning assets and liabilities interest change is calculated as rates move up and down. In addition the prepayment speeds and repricing speeds are changed. Rate shock is a method for stress testing the net interest margin over the next four quarters under several rate change levels. These levels span four 100bp increments up and down from the current interest rate. Our policy guideline is that the maximum percentage change for net interest income cannot exceed plus or minus 10% on 100 bp change and 15% on 200bp change. The following illustrates the effects on net interest income of shifts in market interest rates from the rate shock simulation model.
December 31, 2006
| | | | | | | | | | | | | | | | | |
| Basis Point Change | | +200 bp | | +100bp | | -100bp | | -200bp |
| Increase (decrease in net interest income) | | | 8.17 | % | | | 4.11 | % | | | (3.22 | %) | | | (6.50 | %) |
December 31, 2005
| | | | | | | | | | | | | | | | | |
| Basis Point Change | | +200 bp | | +100bp | | -100bp | | -200bp |
| Increase (decrease in net interest income) | | | 8.15 | % | | | 4.06 | % | | | (4.08 | %) | | | (8.23 | %) |
There are less dollars at risk in income in 2006 if rates go down, compared to 2005. There was no significant impact on income in the rate shock simulation of interest income when rates were rising between 2005 and 2006.
Our Economic Value of Equity simulation measures our long-term interest rate risk. The economic value is
46
the difference between the market value of the assets and the liabilities and, technically, it is the liquidation of the Bank. The technique is to apply rate changes and compute the value. The slope of the change between shock levels is a measure of the volatility of value risk. The slope is called duration. The greater the slope, the greater the impact or rate change on the Bank’s long-term performance. Our policy guideline is that the maximum percentage change on economic value of equity cannot exceed plus or minus 10% on 100bp change and 20% on 200bp change. The following illustrates our equity at risk in the economic value of equity model.
December 31, 2006
| | | | | | | | | | | | | | | | | |
| | | +200 bp | | +100bp | | -100bp | | -200bp |
Basis Point Change | | | | | | | | | | | | | | | | |
| Increase (decrease in equity at risk) | | | (4.00 | %) | | | (1.90 | %) | | | 1.60 | % | | | 2.80 | % |
December 31, 2005
| | | | | | | | | | | | | | | | | |
| | | +200 bp | | +100bp | | -100bp | | -200bp |
Basis Point Change | | | | | | | | | | | | | | | | |
| Increase (decrease in equity at risk) | | | (2.50 | %) | | | (1.40 | %) | | | 1.10 | % | | | 1.90 | % |
There was no significant impact on equity at risk in the economic value of equity simulation between 2006 and 2005.
One of management’s objectives in managing the Bank’s balance sheet for interest rate sensitivity is to reduce volatility in the net interest margin by matching, as closely as possible, the timing of the repricing of its interest rate sensitive assets with interest rate sensitive liabilities.
Impact of Inflation
The consolidated financial statements and related notes presented elsewhere in the report have been prepared in accordance with accounting principles generally accepted in the United States. This requires the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements of the Company, together with the Notes thereto and the Report of Independent Registered Public Accounting Firm thereon, are included on pages F-1 to F-30 of this Annual Report on Form 10-K and are incorporated herein by reference:
| | • | | Balance Sheets as of December 31, 2006 and 2005 |
| |
| | • | | Statements of Operations for the three years ended December 31, 2006 |
| |
| | • | | Statements of Changes in Shareholders’ Equity for the three years ended December 31, 2006 |
| |
| | • | | Statements of Cash Flows for the three years ended December 31, 2006 |
47
| | • | | Notes to Consolidated Financial Statements. |
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. Based on their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
There were no changes in the Company’s internal control over financial reporting that occurred during the company’s fiscal quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
48
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The information required by this Item 10 will appear in, and is hereby incorporated by reference to, the information under the headings “Proposal I: Election of Directors,” “Executive Officers,” “Meetings and Committees of the Board of Directors,” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement for the 2007 annual meeting of shareholders.
The Company has adopted a code of conduct for its senior executive and financial officers (the “Code of Conduct”), a copy of which is available under the “Disclosures” section on the Company’s website atwww.cfbk.com. The Company will make any legally required disclosures regarding amendments to or waivers of, provisions of its Code of Conduct on its website at www.cfbk.com.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 will appear in, and is hereby incorporated by reference to, the information under the headings “Executive and Director Compensation” and “Compensation Committee Iinterlocks and Insider Participation” in our definitive proxy statement for the 2007 annual meeting of shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Certain of the information required by this Item 12 will appear in, and is hereby incorporated by referenced from, the information under the heading “Security Ownership of Certain Beneficial Owners and Management” in our definitive proxy statement for the 2007 annual meeting of shareholders.
Equity Compensation Plan Information
| | | | | | | | | | | | | |
| | | | | | | | | | | Number of securities |
| | | | | | | | | | | remaining available for |
| | | Number of securities to be | | Weighted average | | future issuance under |
| | | issued upon exercise of | | exercise price of | | equity compensation plans |
| | | outstanding options, warrant and | | outstanding options, | | (excluding securities |
| | | rights | | warrants and rights | | reflected in (a)) |
| | | (a) | | (b) | | (c) |
| Equity compensation plans approved by security holders | | | 246,644 | | | $ | 14.79 | | | | 305,942 | |
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item 13 will appear in, and is hereby incorporated by reference to, the information under the headings “Certain Relationships and Related Transactions” and “Director nomination Procedure and Director Independence“in our definitive proxy statement for the 2007 annual meeting of shareholders.
49
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item 14 will appear in, and is hereby incorporated by reference to, the information under the heading “Relationship with Independent Auditors” in our definitive proxy statement for the 2007 annual meeting of shareholders.
50
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) Financial Statements. See Item 8.
(a) (2) Financial Statement Schedule. Not applicable.
(a) (3) Exhibits. See Exhibit Index following the signature pages.
51
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | | | |
| | COMMUNITY FIRST, INC.
| |
| Date: March 29, 2007 | By: | /s/ Marc R. Lively | |
| | | Marc R. Lively | |
| | | President and Chief Executive Officer | |
| |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated and on the dates indicated.
| | | | | |
| Signature | | Title | | Date |
| | | | | |
| /s/ Eslick E. Daniel, M.D. | | Chairman of the Board | | March 29, 2007 |
| | | | |
| | | | | |
| /s/ Marc R. Lively | | President and Chief Executive Officer and Director | | March 29, 2007 |
| | (Principal Executive Officer) | | |
| | | | | |
| /s/ Dianne Scroggins | | Chief Financial Officer | | March 29, 2007 |
| | (Principal Financial and Accounting Officer) | | |
| | | | | |
| /s/ Fred C. White | | Director | | March 29, 2007 |
| | | | |
| | | | | |
| /s/ Roger Witherow | | Director | | March 29, 2007 |
| | | | |
| | | | | |
| /s/ Bernard Childress | | Director | | March 29, 2007 |
| | | | |
| | | | | |
| Signature | | Title | | Date |
| | | | | |
| /s/ Stephen Walker | | Director | | March 29, 2007 |
| | | | |
| | | | | |
| /s/ Randy Maxwell | | Director | | March 29, 2007 |
| | | | |
| | | | | |
| /s/ H. Allen Pressnell, Jr. | | Director | | March 29, 2007 |
| | | | |
| | | | | |
| /s/ Dinah C. Vire | | Director | | March 29, 2007 |
| | | | |
| | | | | |
| /s/ Vasant Hari | | Director | | March 29, 2007 |
| | | | |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Community First, Inc.
Columbia, Tennessee
We have audited the consolidated balance sheets of Community First, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Community First, Inc. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006 in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R),Share-Based Payment,using the modified prospective transition method as of January 1, 2006 and accordingly has recorded stock-based employee compensation cost using the fair value method.
| | | |
| | | /s/ Crowe Chizek and Company LLC |
Brentwood, Tennessee
March 22, 2007
F-1
COMMUNITY FIRST, INC.
CONSOLIDATED BALANCE SHEETS
December 31
(Dollar amounts in thousands, except per share data)
| | | | | | | | | |
| | | 2006 | | | 2005 | |
ASSETS | | | | | | | | |
| Cash and due from banks | | $ | 13,886 | | | $ | 12,643 | |
| Federal funds sold | | | 1,187 | | | | 13,083 | |
| | | | | | | |
| Cash and cash equivalents | | | 15,073 | | | | 25,726 | |
| Securities available for sale | | | 35,576 | | | | 30,330 | |
| Loans held for sale | | | 3,981 | | | | 1,890 | |
| Loans | | | 348,973 | | | | 259,418 | |
| Allowance for loan losses | | | (4,259 | ) | | | (3,268 | ) |
| | | | | | | |
| Net loans | | | 344,714 | | | | 256,150 | |
| | | | | | | | | |
| Federal Home Loan Bank stock | | | 905 | | | | 663 | |
| Premises and equipment | | | 10,880 | | | | 7,301 | |
| Accrued interest receivable | | | 2,376 | | | | 1,464 | |
| Other assets | | | 7,888 | | | | 5,282 | |
| | | | | | | |
| | | | | | | | | |
| Total assets | | $ | 421,393 | | | $ | 328,806 | |
| | | | | | | |
| | | | | | | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | |
| Deposits | | | | | | | | |
| Noninterest-bearing | | $ | 34,001 | | | $ | 32,499 | |
| Interest-bearing | | | 332,765 | | | | 253,744 | |
| | | | | | | |
| Total deposits | | | 366,766 | | | | 286,243 | |
| | | | | | | | | |
| Federal Home Loan Bank advances | | | 13,000 | | | | 8,000 | |
| Subordinated debentures | | | 8,000 | | | | 8,000 | |
| Accrued interest payable | | | 2,176 | | | | 1,063 | |
| Other liabilities | | | 794 | | | | 1,483 | |
| | | | | | | |
| Total liabilities | | | 390,736 | | | | 304,789 | |
| | | | | | | | | |
| Commitments and contingent liabilities (Note 11) | | | | | | | | |
| |
| Shareholders’ equity | | | | | | | | |
| Common stock, no par value, authorized 5,000,000 shares; 3,015,886 shares issued 2006, 2,873,514 shares issued in 2005 | | | 21,989 | | | | 17,658 | |
| Retained earnings | | | 8,730 | | | | 6,503 | |
| Accumulated other comprehensive loss | | | (62 | ) | | | (144 | ) |
| | | | | | | |
| Total shareholders’ equity | | | 30,657 | | | | 24,017 | |
| | | | | | | |
| |
| Total liabilities and shareholders’ equity | | $ | 421,393 | | | $ | 328,806 | |
| | | | | | | |
See accompanying notes to consolidated financial statements.
F-2
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Interest income | | | | | | | | | | | | |
| Loans, including fees | | $ | 24,023 | | | $ | 16,189 | | | $ | 11,773 | |
| Taxable securities | | | 1,325 | | | | 785 | | | | 674 | |
| Tax exempt securities | | | 209 | | | | 175 | | | | 62 | |
| Federal funds sold and other | | | 232 | | | | 156 | | | | 84 | |
| | | | | | | | | | |
| Total interest income | | | 25,789 | | | | 17,305 | | | | 12,593 | |
| | | | | | | | | | | | | |
| Interest expense | | | | | | | | | | | | |
| Deposits | | | 12,255 | | | | 6,409 | | | | 3,845 | |
| Federal Home Loan Bank advances | | | 673 | | | | 326 | | | | 282 | |
| Subordinated debentures | | | 600 | | | | 271 | | | | 145 | |
| | | | | | | | | | |
| Total interest expense | | | 13,528 | | | | 7,006 | | | | 4,272 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
Net interest income | | | 12,261 | | | | 10,299 | | | | 8,321 | |
| Provision for loan losses | | | 1,018 | | | | 683 | | | | 720 | |
| | | | | | | | | | |
Net interest income after provision for loan losses | | | 11,243 | | | | 9,616 | | | | 7,601 | |
| | | | | | | | | | | | | |
| Noninterest income | | | | | | | | | | | | |
| Service charges on deposit accounts | | | 1,520 | | | | 1,561 | | | | 1,564 | |
| Mortgage banking activities | | | 666 | | | | 469 | | | | 378 | |
| Gain on sale of land | | | 390 | | | | — | | | | — | |
| Other | | | 549 | | | | 326 | | | | 165 | |
| | | | | | | | | | |
| Total other income | | | 3,125 | | | | 2,356 | | | | 2,107 | |
| | | | | | | | | | | | | |
| Noninterest expenses | | | | | | | | | | | | |
| Salaries and employee benefits | | | 5,451 | | | | 3,929 | | | | 2,793 | |
| Occupancy | | | 550 | | | | 453 | | | | 294 | |
| Furniture and equipment | | | 545 | | | | 518 | | | | 436 | |
| Data processing fees | | | 684 | | | | 575 | | | | 500 | |
| Advertising and public relations | | | 509 | | | | 340 | | | | 302 | |
| Other | | | 2,714 | | | | 2,331 | | | | 2,004 | |
| | | | | | | | | | |
| Total other expenses | | | 10,453 | | | | 8,146 | | | | 6,329 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
Income before income taxes | | | 3,915 | | | | 3,826 | | | | 3,379 | |
| Income taxes | | | 1,113 | | | | 1,261 | | | | 1,247 | |
| | | | | | | | | | |
Net income | | $ | 2,802 | | | $ | 2,565 | | | $ | 2,132 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Earnings per share | | | | | | | | | | | | |
| Basic | | $ | 0.97 | | | $ | 0.89 | | | $ | 0.78 | |
| Diluted | | | 0.94 | | | | 0.86 | | | | 0.75 | |
See accompanying notes to consolidated financial statements.
F-3
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years Ended December 31
(Dollar amounts in thousands, except per share data)
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | Accumulated | | | | |
| | | | | | | | | | | | | | | Other | | | Total | |
| | | | | | | Common | | | Retained | | | Comprehensive | | | Shareholders’ | |
| | | Shares | | | Stock | | | Earnings | | | Income (Loss) | | | Equity | |
| Balance at January 1, 2004 | | | 2,309,812 | | | $ | 11,579 | | | $ | 1,806 | | | $ | 60 | | | $ | 13,445 | |
| | | | | | | | | | | | | | | | | | | | | |
| Stock offering, net of issuance costs | | | 360,000 | | | | 4,448 | | | | | | | | | | | | 4,448 | |
| Exercise of stock options | | | 196,036 | | | | 1,233 | | | | — | | | | — | | | | 1,233 | |
| Tax benefit arising from the exercised stock options | | | — | | | | 303 | | | | — | | | | — | | | | 303 | |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | |
| Net income | | | — | | | | — | | | | 2,132 | | | | — | | | | 2,132 | |
| Other comprehensive income | | | | | | | | | | | | | | | | | | | | |
| Change in unrealized gain (loss) on securities available for sale, net | | | — | | | | — | | | | — | | | | (109 | ) | | | (109 | ) |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income | | | — | | | | — | | | | — | | | | — | | | | 2,023 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2004 | | | 2,865,848 | | | | 17,563 | | | | 3,938 | | | | (49 | ) | | | 21,452 | |
| | | | | | | | | | | | | | | | | | | | | |
| Exercise of stock options | | | 7,666 | | | | 56 | | | | — | | | | — | | | | 56 | |
| Tax benefit arising from the exercised stock options | | | — | | | | 39 | | | | — | | | | — | | | | 39 | |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | |
| Net income | | | — | | | | — | | | | 2,565 | | | | — | | | | 2,565 | |
| Other comprehensive income | | | | | | | | | | | | | | | | | | | | |
| Change in unrealized gain (loss) on securities available for sale, net | | | — | | | | — | | | | — | | | | (95 | ) | | | (95 | ) |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income | | | | | | | | | | | | | | | | | | | 2,470 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2005 | | | 2,873,514 | | | | 17,658 | | | | 6,503 | | | $ | (144 | ) | | | 24,017 | |
| | | | | | | | | | | | | | | | | | | | | |
| Stock offering, net of issuance costs | | | 125,460 | | | | 3,761 | | | | — | | | | — | | | | 3,761 | |
| Exercise of stock options | | | 16,566 | | | | 121 | | | | — | | | | — | | | | 121 | |
| Tax benefit arising from the exercised stock options | | | — | | | | 142 | | | | — | | | | — | | | | 142 | |
| Stock based compensation | | | | | | | | | | | | | | | | | | | | |
| Restricted stock grants | | | 346 | | | | 5 | | | | — | | | | — | | | | 5 | |
| Stock options | | | — | | | | 302 | | | | — | | | | — | | | | 302 | |
| Cash dividend declared ( $.20 per share) | | | — | | | | — | | | | (575 | ) | | | — | | | | (575 | ) |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | |
| Net income | | | — | | | | — | | | | 2,802 | | | | — | | | | 2,802 | |
| Other comprehensive income | | | | | | | | | | | | | | | | | | | | |
| Change in unrealized gain (loss) on securities available for sale, net | | | — | | | | — | | | | — | | | | 82 | | | | 82 | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income | | | | | | | | | | | | | | | | | | | 2,884 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2006 | | | 3,015,886 | | | $ | 21,989 | | | $ | 8,730 | | | $ | (62 | ) | | $ | 30,657 | |
| | | | | | | | | | | | | | | | |
See accompanying notes to consolidated financial statements.
F-4
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
Cash flows from operating activities | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Net income | | $ | 2,802 | | | $ | 2,565 | | | $ | 2,132 | |
| Adjustments to reconcile net income to net cash provided by operating activities | | | | | | | | | | | | |
| Depreciation | | | 505 | | | | 481 | | | | 346 | |
| Amortization | | | (3 | ) | | | 68 | | | | 257 | |
| Provision for loan losses | | | 1,018 | | | | 683 | | | | 720 | |
| Deferred income tax (benefits) | | | (429 | ) | | | (204 | ) | | | 39 | |
| Mortgage loans originated for sale | | | (46,084 | ) | | | (25,007 | ) | | | (17,814 | ) |
| Proceeds from sale of mortgage loans | | | 44,659 | | | | 25,094 | | | | 17,761 | |
| Gain on sale of loans | | | (666 | ) | | | (469 | ) | | | (378 | ) |
| Loss (gain) on sale of other real estate owned | | | 25 | | | | 27 | | | | (23 | ) |
| Federal Home Loan Bank stock dividends | | | (43 | ) | | | (28 | ) | | | (18 | ) |
| Increase in accrued interest receivable | | | (912 | ) | | | (523 | ) | | | (114 | ) |
| Increase in accrued interest payable | | | 1,113 | | | | 448 | | | | 212 | |
| Gain on sale of land | | | (390 | ) | | | — | | | | — | |
| Compensation expense under stock based compensation | | | 307 | | | | — | | | | — | |
| Tax benefit on exercise of stock options | | | (142 | ) | | | (39 | ) | | | (303 | ) |
| Other, net | | | (475 | ) | | | 1,532 | | | | 228 | |
| | | | | | | | | | |
| Net cash from operating activities | | | 1,285 | | | | 4,628 | | | | 3,045 | |
| | | | | | | | | | | | | |
Cash flows from investing activities | | | | | | | | | | | | |
| Available for sale securities | | | | | | | | | | | | |
| Purchases: | | | | | | | | | | | | |
| Mortgage-backed securities | | | (5,792 | ) | | | — | | | | — | |
| Other | | | (15,381 | ) | | | (14,428 | ) | | | (17,598 | ) |
| Maturities, prepayments, and calls: | | | | | | | | | | | | |
| Mortgage-backed securities | | | 1,061 | | | | 1,245 | | | | 1,478 | |
| Other | | | 13,001 | | | | 10,500 | | | | 17,000 | |
| Purchase of Federal Home Loan Bank stock | | | (199 | ) | | | (54 | ) | | | (171 | ) |
| Net increase in loans | | | (89,704 | ) | | | (49,950 | ) | | | (39,416 | ) |
| Proceeds from sale of other real estate owned | | | 188 | | | | 319 | | | | 420 | |
| Disposal of premises and equipment | | | — | | | | 1,591 | | | | 110 | |
| Additions to premises and equipment | | | (4,084 | ) | | | (1,425 | ) | | | (4,764 | ) |
| Purchase of life insurance policies | | | — | | | | (3,500 | ) | | | — | |
| | | | | | | | | | |
| Net cash from investing activities | | | (100,910 | ) | | | (55,702 | ) | | | (42,941 | ) |
| | | | | | | | | | | | | |
Cash flows from financing activities | | | | | | | | | | | | |
| Increase in deposits | | | 80,523 | | | | 62,465 | | | | 28,539 | |
| Proceeds from Federal Home Loan Bank advances | | | 9,000 | | | | — | | | | 3,000 | |
| Payment on Federal Home Loan Bank advances | | | (4,000 | ) | | | — | | | | — | |
| Proceeds from issuance of subordinated debentures | | | — | | | | 5,000 | | | | — | |
| Proceeds from issuance of common stock | | | 3,761 | | | | — | | | | 4,448 | |
| Proceeds from stock option exercises | | | 121 | | | | 56 | | | | 1,233 | |
| Tax benefit on exercise of stock options | | | 142 | | | | 39 | | | | 303 | |
| Cash paid for dividends | | | (575 | ) | | | — | | | | — | |
| | | | | | | | | | |
| Net cash from financing activities | | | 88,972 | | | | 67,560 | | | | 37,523 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Net change in cash and cash equivalents | | | (10,653 | ) | | | 16,486 | | | | (2,373 | ) |
| | | | | | | | | | | | | |
| Cash and cash equivalents at beginning of period | | | 25,726 | | | | 9,240 | | | | 11,613 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
Cash and cash equivalents at end of period | | $ | 15,073 | | | $ | 25,726 | | | $ | 9,240 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Supplemental disclosures of cash flow information | | | | | | | | | | | | |
| Cash paid during year for: | | | | | | | | | | | | |
| Interest | | $ | 12,415 | | | $ | 6,558 | | | $ | 4,060 | |
| Income taxes | | | 1,470 | | | | 1,388 | | | | 1,099 | |
| Supplemental noncash disclosures | | | | | | | | | | | | |
| Transfer from loans to repossessed assets | | | 61 | | | | 602 | | | | 412 | |
See accompanying notes to consolidated financial statements.
F-5
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation: The consolidated financial statements include Community First, Inc. and its wholly-owned subsidiary, Community First Bank & Trust, together referred to as “the Company”. Intercompany transactions and balances are eliminated in consolidation.
The Company provides financial services through its offices in Maury, Williamson and Rutherford Counties. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. There are no significant concentrations of loans to any one industry or customer. The customers’ ability to repay their loans is dependent, however, on the real estate and general economic conditions in the area. Other financial instruments, which potentially represent concentrations of credit risk, include deposit accounts in other financial institutions and federal funds sold.
Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses and fair values of financial instruments are particularly subject to change.
Cash Flows: Cash and cash equivalents include cash, deposits with other financial institutions under 90 days, and federal funds sold. Net cash flows are reported for customer loan and deposit transactions.
Interest-bearing Deposits in Other Financial Institutions: Interest-bearing deposits in other financial institutions mature within one year and are carried at cost.
Securities: Debt securities are classified as available for sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities classified available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
(Continued)
F-6
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
Declines in the fair value of securities below their amortized cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers the length of time and extent that fair value has been less than amortized cost, the financial condition and near term prospects of the issuer, and the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.
Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.
Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest and an allowance for loan losses. Interest income is accrued on the unpaid principal balance.
Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loan is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Loss: The allowance for loan losses is a valuation allowance for probable incurred losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations, and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.
(Continued)
F-7
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
The allowance for loan losses is maintained at a level management believes will be adequate to absorb losses on existing loans that may become uncollectible. Provision to and adequacy of the allowance for loan losses are based on the evaluation of the loan portfolio utilizing objective and subjective criteria. The objective criteria primarily includes an internal grading system and specific allocation for impaired loans. The Company also utilizes a peer group analysis and a historical analysis to validate the overall adequacy of the allowance for loan losses. The subjective criteria take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, review of specific problem loans, and business conditions that may affect the borrowers’ ability to pay, the value of the property securing the loans, and other relevant factors. Changes in any of these criteria or the availability of new information could require adjustments of the allowance for loan losses in future periods. No portion of the Company’s allowance for loan losses is restricted to any individual loan or group of loans, and the entire allowance for loan losses is available to absorb losses from any and all loans.
A loan is impaired when full payment under the loan terms is not expected. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.
The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they come due. When interest is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received.
Foreclosed Assets/Assets Held For Resale: Real estate and personal property acquired through or in lieu of loan foreclosure and repossession are to be resold and are initially recorded at the lesser of current principal investment or fair market value less estimated cost to sell at the date of foreclosure. Valuation of these assets is periodically reviewed by management with such assets adjusted to the then fair market value net of estimated selling cost, if lower, until disposition.
Gains and losses from the sale of foreclosed asset, and real estate are recorded in non-interest income, and expenses used to maintain the properties are included in non-interest expense. If the fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense.
(Continued)
F-8
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 39 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 5 to 7 years.
Federal Home Loan Bank (FHLB) Stock: The bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Bank Owned Life Insurance: The Company has purchased life insurance policies on certain key employees. Bank owned life insurance is recorded at its cash surrender value (or the amount that can be realized).
Long-Term Assets: Premises and equipment, core deposit and other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Stock-Based Compensation: Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No.123(R),Share-Based Payment, using the modified prospective transition method. Accordingly, the Company has recorded stock-based employee compensation cost using the fair value method starting in 2006. For 2006, adopting this standard resulted in a reduction of income before income tax of $302, a reduction in net income of $297, a decrease in basic and diluted earnings per share $0.11 and $0.10 respectively. Prior to January 1, 2006, employee compensation expense under stock options was reported using the intrinsic value method; therefore, no stock-based compensation cost is reflected in net income for the years ending December 31, 2005 and 2004, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant.
(Continued)
F-9
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation, for the years ending December 31.
| | | | | | | | | |
| | | 2005 | | | 2004 | |
| Net income as reported | | $ | 2,565 | | | $ | 2,132 | |
| Deduct: Stock-based compensation expense determined under fair value based method | | | 173 | | | | 249 | |
| | | | | | | |
| Pro forma net income | | $ | 2,392 | | | $ | 1,883 | |
| | | | | | | |
| | | | | | | | | |
| Basic earnings per share | | | | | | | | |
| As reported | | $ | 0.89 | | | $ | 0.78 | |
| Pro forma | | | 0.83 | | | | 0.69 | |
| | | | | | | | | |
| Diluted earnings per share | | | | | | | | |
| As reported | | | 0.86 | | | | 0.75 | |
| Pro forma | | | 0.80 | | | | 0.67 | |
Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
Retirement Plans: Employee 401(k) expense is the amount of matching contributions. The Bank matches up to 3% of wages for all periods presented. The Bank contributed $89 in 2006, $64 in 2005, and $57 in 2004. Deferred compensation and supplemental retirement plan (“SERP”) expense allocates the benefits over years of service. The Bank approved the SERP in 2005. The SERP will provide certain Company officers with benefits upon retirement, death, or disability in certain prescribed circumstances. SERP expense was $79 in 2006 and $28 in 2005.
Earnings per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issue of the financial statements.
Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, which are also recognized as a separate component of equity.
(Continued)
F-10
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank was required to meet regulatory reserve and clearing requirements. These balances do not earn interest.
Stock Dividends: A two-for one stock split to shareholders in the form of a 100% stock dividend was distributed in May 2005, resulting in the issuance of 1,433,424 shares of common stock. Share data has been adjusted to reflect the stock dividend.
Dividend Restriction: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the bank to the holding company or by the holding company to shareholders.
Fair Value of Financial Instruments: Fair value of financial instruments is estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Operating Segments: While the chief decision-makers monitor the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.
Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation.
Adoption of New Accounting Standards: Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (R), Share-Based Payment. See “Stock-Based Compensation” above for further discussion of the effect of adopting this standard.
SAB 108: In September 2006, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin No. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), which is effective for fiscal years ending on or after November 15, 2006. SAB 108 provides guidance on how the effects of prior-year uncorrected financial statement misstatements should be considered in quantifying a current year misstatement. SAB 108 requires public companies to quantify misstatements using both an income statement (rollover) and balance sheet (iron curtain) approach and results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and relevant facts and circumstances were considered. Adjustments considered immaterial in prior years under the method previously used, but now considered material under the dual approach required
(Continued)
F-11
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
by SAB 108, are to be recorded upon initial adoption of SAB 108. The amount so recorded is shown as a cumulative effect adjustment and is recorded in opening retained earnings as of January 1, 2006. The adoption of SAB 108 had no effect on the Company’s financial statements for the year ending December 31, 2006.
Effect of Newly Issued But Not Yet Effective Accounting Standards:
In February 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 155,Accounting for Certain Hybrid Financial Instruments-an amendment to FASB Statements No. 133 and 140.This Statement permits fair value re-measurement for any hybrid financial instruments, clarifies which instruments are subject to the requirements of Statement No. 133, and establishes a requirement to evaluate interests in securitized financial assets and other items. The new standard is effective for financial assets acquired or issued after the beginning of the entity’s first fiscal year that begins after September 15, 2006. Management does not expect the adoption of this Statement to have a material impact on its consolidated financial position or results of operations.
In July 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48), which prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest, and penalties, accounting for interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has determined that the adoption of FIN 48 is not expected to have a material effect on the financial statements.
In September 2006, the FASB issued Statement No. 157,Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The standard is effective for fiscal years beginning after November 15, 2007. The Company has not completed its evaluation of the impact of the adoption of this standard.
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4,Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This Issue is effective for fiscal years beginning after December 15, 2007. The Company has not completed its evaluation of the impact of adoption of EITF 06-4.
(Continued)
F-12
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5,Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life Insurance). This issue requires that a policyholder consider contractual terms of a life insurance policy in determining the amount that could be realized under the insurance contract. It also requires that if the contract provides for a greater surrender value if all individual policies in a group are surrendered at the same time, that the surrender value be determined based on the assumption that policies will be surrendered on an individual basis. Lastly, the issue discusses whether the cash surrender value should be discounted when the policyholder is contractually limited in its ability to surrender a policy. This Issue is effective for fiscal years beginning after December 15, 2006. The Company does not believe the adoption of this Issue will have a material impact on the financial statements.
NOTE 2 — SECURITIES AVAILABLE FOR SALE
The fair value of securities available for sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
| | | | | | | | | | | | | |
| | | | | | | Gross | | | Gross | |
| | | Fair | | | Unrealized | | | Unrealized | |
| | | Value | | | Gains | | | Losses | |
| 2006 | | | | | | | | | | | | |
| U.S. Government sponsored entities | | $ | 19,776 | | | $ | 14 | | | $ | (45 | ) |
| Mortgage-backed securities | | | 7,857 | | | | 17 | | | | (76 | ) |
| State and municipals | | | 6,092 | | | | 47 | | | | (44 | ) |
| Other debt securities | | | 1,486 | | | | 4 | | | | (19 | ) |
| | | | | | | | | | |
| Total debt securities | | | 35,211 | | | | 82 | | | | (184 | ) |
| Equity securities | | | 365 | | | | — | | | | — | |
| | | | | | | | | | |
| Total | | $ | 35,576 | | | $ | 82 | | | $ | (184 | ) |
| | | | | | | | | | |
| 2005 | | | | | | | | | | | | |
| U.S. Government sponsored entities | | $ | 18,887 | | | $ | — | | | $ | (95 | ) |
| Mortgage-backed securities | | | 3,089 | | | | 1 | | | | (105 | ) |
| State and municipals | | | 5,487 | | | | 24 | | | | (59 | ) |
| Other debt securities | | | 2,502 | | | | 2 | | | | — | |
| | | | | | | | | | |
| Total debt securities | | | 29,965 | | | | 27 | | | | (259 | ) |
| Equity securities | | | 365 | | | | — | | | | — | |
| | | | | | | | | | |
| Total | | $ | 30,330 | | | $ | 27 | | | $ | (259 | ) |
| | | | | | | | | | |
The fair value of debt securities at December 31, 2006, by contractual maturity is set forth below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. There were no gains in 2006, 2005, and 2004 recognized from sale of securities available for sale.
(Continued)
F-13
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 2 — SECURITIES AVAILABLE FOR SALE(Continued)
| | | | | |
| | | Fair Value | |
| Due in one year or less | | $ | 12,933 | |
| Due after one through five years | | | 7,184 | |
| Due after five through ten years | | | 4,461 | |
| Due after ten years | | | 2,776 | |
| Mortgage-backed securities | | | 7,857 | |
| Equity securities | | | 365 | |
| | | | |
| Total | | $ | 35,576 | |
| | | | |
Securities carried at $21,170 and $18,399 at December 31, 2006 and 2005, were pledged to secure deposits and for other purposes as required or permitted by law. At year end 2006 and 2005, there were no holding of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders’ equity.
The following table shows securities with unrealized losses and their fair value, aggregated by investment category and length of time that individual securities had been in a continuous unrealized loss position as of December 31, 2006 and 2005.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Less than 12 Months | | | 12 Months or More | | | Total | |
| 2006 | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
| Description of Securities | | Value | | | Loss | | | Value | | | Loss | | | Value | | | Loss | |
| US Government sponsored entities | | $ | 2,392 | | | $ | (2 | ) | | $ | 12,938 | | | $ | (43 | ) | | $ | 15,330 | | | $ | (45 | ) |
| Mortgage-backed securities | | | 2,990 | | | | — | | | | 3,436 | | | | (76 | ) | | | 6,426 | | | | (76 | ) |
| State and municipals | | | 494 | | | | (8 | ) | | | 2,592 | | | | (36 | ) | | | 3,086 | | | | (44 | ) |
| Other debt securities | | | — | | | | — | | | | 981 | | | | (19 | ) | | | 981 | | | | (19 | ) |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total temporarily impaired | | $ | 5,876 | | | $ | (10 | ) | | $ | 19,947 | | | $ | (174 | ) | | $ | 25,823 | | | $ | (184 | ) |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Less than 12 Months | | | 12 Months or More | | | Total | |
| 2005 | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
| Description of Securities | | Value | | | Loss | | | Value | | | Loss | | | Value | | | Loss | |
| US Government sponsored entities | | $ | 11,926 | | | $ | (55 | ) | | $ | 6,961 | | | $ | (40 | ) | | $ | 18,887 | | | $ | (95 | ) |
| Mortgage-backed securities | | | 241 | | | | (7 | ) | | | 2,626 | | | | (98 | ) | | | 2,867 | | | | (105 | ) |
| State and municipals | | | 2,791 | | | | (40 | ) | | | 691 | | | | (19 | ) | | | 3,482 | | | | (59 | ) |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total temporarily impaired | | $ | 14,958 | | | $ | (102 | ) | | $ | 10,278 | | | $ | (157 | ) | | $ | 25,236 | | | $ | (259 | ) |
| | | | | | | | | | | | | | | | | | | |
Unrealized losses on securities have not been recognized into income because the securities are of high credit quality, management has the intent and ability to hold until maturity or until forecasted recovery, and the decline in fair value is largely due to increases in market interest rates. The fair value is expected to recover as the securities approach their maturity date and/or market rates decline.
Management evaluates securities for other-than-temporary impairment on at least a semi-annual basis and the investment committee makes such an evaluation on an annual basis. These evaluations are made more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term
(Continued)
F-14
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 2 — SECURITIES AVAILABLE FOR SALE(Continued)
prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.
NOTE 3 — LOANS
A summary of loans outstanding by category at December 31, 2006 and 2005, follows:
| | | | | | | | | |
| | | 2006 | | | 2005 | |
| Real estate | | | | | | | | |
| Construction | | $ | 93,704 | | | $ | 61,530 | |
| 1-4 family residential | | | 96,309 | | | | 79,634 | |
| Commercial | | | 90,147 | | | | 69,549 | |
| Other | | | 3,009 | | | | 894 | |
| Commercial, financial and agricultural | | | 46,942 | | | | 36,601 | |
| Consumer | | | 11,560 | | | | 10,803 | |
| Other | | | 7,302 | | | | 407 | |
| | | | | | | |
| | | $ | 348,973 | | | $ | 259,418 | |
| | | | | | | |
Changes in the allowance for loan losses were as follows:
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Balance at beginning of year | | $ | 3,268 | | | $ | 2,740 | | | $ | 2,249 | |
| Provision for loan losses | | | 1,018 | | | | 683 | | | | 720 | |
| Loans charged off | | | (50 | ) | | | (233 | ) | | | (252 | ) |
| Recoveries | | | 23 | | | | 78 | | | | 23 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Balance of end of year | | $ | 4,259 | | | $ | 3,268 | | | $ | 2,740 | |
| | | | | | | | | | |
Impaired loans were as follows:
| | | | | | | | | |
| | | 2006 | | | 2005 | |
| Year-end loans with no allocated allowance for loan losses | | $ | — | | | $ | — | |
| Year-end loans with allocated allowance for loan losses | | | 732 | | | | 117 | |
| | | | | | | |
| | | | | | | | | |
| Total | | $ | 732 | | | $ | 117 | |
| | | | | | | |
| | | | | | | | | |
| Amount of the allowance for loan losses allocated | | $ | 149 | | | $ | 36 | |
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Average of impaired loans during the year | | $ | 224 | | | $ | 176 | | | $ | 265 | |
| Interest income recognized during impairment | | | — | | | | — | | | | — | |
| Cash-basis interest income recognized | | | — | | | | — | | | | — | |
(Continued)
F-15
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
Nonperforming loans were as follows:
| | | | | | | | | |
| | | 2006 | | | 2005 | |
| Loans past due over 90 days still on accrual | | $ | — | | | $ | — | |
| Nonaccrual loans | | | 1,059 | | | | 508 | |
Nonperforming loans includes both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
NOTE 4 — PREMISES AND EQUIPMENT
The following is a summary of premises and equipment as of December 31, 2006 and 2005:
| | | | | | | | | |
| | | 2006 | | | 2005 | |
| Land | | $ | 2,617 | | | $ | 2,566 | |
| Buildings and improvements | | | 5,861 | | | | 2,697 | |
| Furniture and equipment | | | 4,147 | | | | 3,066 | |
| Construction in process | | | 619 | | | | 831 | |
| | | | | | | |
| | | | 13,244 | | | | 9,160 | |
| Less: Allowance for depreciation | | | (2,364 | ) | | | (1,859 | ) |
| | | | | | | |
| | | | | | | | | |
| | | $ | 10,880 | | | $ | 7,301 | |
| | | | | | | |
Depreciation expense for the years ended 2006, 2005, and 2004 was $505, $481, and $346, respectively.
The Bank purchased 6.45 acres of land totaling $2,759 in Williamson County in 2004. The Bank built a branch on 1.89 acres of the land on Carothers Parkway and sold the remaining 4.56 acres of the property in 2005. The $390 gain related to the sale of the property was deferred in 2005 due to the Bank’s financing of the loan for this property. During the second quarter of 2006 the Bank subsequently sold this loan to another financial institution and recognized the $390 gain into noninterest income.
During 2006, construction began on a new downtown Columbia branch in Maury County. Total expenditures for the downtown branch building are expected to be approximately $2,466 with completion scheduled for third quarter 2007.
The Bank leases certain branch properties and equipment under operating leases. Rent expense for 2006, 2005, and 2004 was $162, $126, and $99, respectively. Rent commitments under noncancelable operating leases including renewal options were as follows:
| | | | | |
| 2007 | | $ | 227 | |
| 2008 | | | 155 | |
| 2009 | | | 146 | |
| 2010 | | | 139 | |
| 2011 | | | 129 | |
| Thereafter | | | 1,212 | |
| | | | |
| | | | | |
| | | $ | 2,008 | |
| | | | |
(Continued)
F-16
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 5 — DEPOSITS
Deposits at December 31, 2006 and 2005 are summarized as follows:
| | | | | | | | | |
| | | 2006 | | | 2005 | |
| Noninterest-bearing demand accounts | | $ | 34,001 | | | $ | 32,499 | |
| Interest-bearing demand accounts | | | 46,530 | | | | 45,804 | |
| Savings accounts | | | 8,921 | | | | 9,570 | |
| Time deposits greater than $100,000 | | | 114,480 | | | | 82,079 | |
| Other time deposits | | | 162,834 | | | | 116,291 | |
| | | | | | | |
| | | | | | | | | |
| | | $ | 366,766 | | | $ | 286,243 | |
| | | | | | | |
At December 31, 2006 scheduled maturities of time deposits are as follows:
| | | | | |
| 2007 | | $ | 236,144 | |
| 2008 | | | 37,158 | |
| 2009 | | | 2,651 | |
| 2010 | | | 1,152 | |
| 2011 | | | 209 | |
| | | | |
| | | | | |
| | | $ | 277,314 | |
| | | | |
Included in other time deposits above are brokered time deposits of $19,601 at December 31, 2006, with a weighted rate of 4.95% and $15,319 with a weighted rate of 4.15% at December 31, 2005. These deposits represent funds which the Bank obtained, directly, or indirectly, through a deposit broker. A deposit broker places deposits from third parties with insured depository institutions or places deposits with an institution for the purpose of selling interest in those deposit to third parties.
As of December 31, 2006 the Bank had $10,389 of brokered deposits that were scheduled to mature in 2007, $8,123 scheduled to mature in 2008 and $1,089 scheduled to mature in 2009. In addition, the Bank had $74,875 in national market deposits, which are purchased by customers through a third-party internet site. Of these national market time deposits, $72,797 were scheduled to mature in 2007 and $2,078 in 2008. Due to competitive pricing pressures in the Bank’s new and existing markets, the Bank is being forced to pursue additional funding at a slightly higher interest rate in national and brokered deposits markets.
NOTE 6 — FEDERAL HOME LOAN BANK ADVANCES
The Bank has established a line of credit with the Federal Home Loan Bank (FHLB), which is secured by a blanket pledge of 1-4 family residential mortgage loans, commercial real estate loans, and open end home equity loans. The extent of the line is dependent, in part, on available collateral. The arrangement is structured so that the carrying value of the loans pledged amounts to 125% on residential 1-4 family loans, 300% on commercial real estate, and 400% of open end home equity loans of the principal balance of the advances from the FHLB. To participate in this program, the Bank is required to be a member of the FHLB and own stock in the FHLB. The Bank had $905 of such stock at December 31, 2006, to satisfy this requirement.
(Continued)
F-17
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 6 — FEDERAL HOME LOAN BANK ADVANCES(Continued)
At December 31, 2006 and 2005, advances from the FHLB totaled $13,000 and $8,000. The fixed interest rates on these advances range from 3.36% to 5.67% at December 31, 2006 and 2.74% to 4.67% at December 31, 2005. The weighted average rates at December 31, 2006 and 2005 were 4.99% and 3.65%. The FHLB advance maturities ranged from April 2007 to June 2009 at December 31, 2006 and April 2006 to January 2008 at December 31, 2005. Each FHLB advance is payable at its maturity, with a prepayment penalty for all fixed rate advances. At December 31, 2006 and 2005, undrawn standby letters of credit with the FHLB totaled $13,000 and $7,000. The letter of credit is used as a pledge to the State of Tennessee Bank Collateral Pool. Qualifying loans totaling $25,000 were pledged as security under a blanket pledge agreement with the FHLB at December 31, 2006, compared to $18,750 at December 31, 2005.
Maturities of the advances from the FHLB are as follows:
| | | | | |
| 2007 | | $ | 2,000 | |
| 2008 | | | 8,000 | |
| 2009 | | | 3,000 | |
| | | | |
| | | $ | 13,000 | |
| | | | |
NOTE 7 — SUBORDINATED DEBENTURES
In 2002, the Company borrowed $3,000 of 4.75% floating rate mandatory redeemable securities through a special purpose entity as part of a private offering. The securities mature on December 31, 2032; however, the maturity may be shortened to a date not earlier than September 30, 2007. They are presented in liabilities on the balance sheet and count as Tier 1 capital for regulatory capital purposes. Debt issuance costs of $74,000 have been capitalized and are being amortized over the term of the securities. Principal officers, directors, and their affiliates at year end 2006 and 2005 owned $700 of the $3,000 subordinated debentures.
In 2005, the Company borrowed $5,000 of 5.33% floating rate mandatory redeemable securities through a special purpose entity as part of a pool offering. These securities mature on September 15, 2035, however, the maturity may be shortened to a date not earlier than September 15, 2010. They are presented in liabilities on the balance sheet and count as Tier 1 capital for regulatory purposes. There was no debt issuance cost in obtaining the subordinated debenture.
(Continued)
F-18
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 8 — INCOME TAXES
The components of income tax expense (benefit) are summarized as follows:
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Current | | | | | | | | | | | | |
| Federal | | $ | 1,542 | | | $ | 1,426 | | | $ | 993 | |
| State | | | — | | | | 39 | | | | 215 | |
| | | | | | | | | | |
| Total current taxes | | | 1,542 | | | | 1,465 | | | | 1,208 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Deferred | | | | | | | | | | | | |
| Federal | | $ | (232 | ) | | $ | (181 | ) | | $ | 32 | |
| State | | | (146 | ) | | | (23 | ) | | | 7 | |
| | | | | | | | | | |
| Total deferred taxes | | | (378 | ) | | | (204 | ) | | | 39 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Change in valuation allowance | | | (51 | ) | | | — | | | | — | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Income tax expense | | $ | 1,113 | | | $ | 1,261 | | | $ | 1,247 | |
| | | | | | | | | | |
A reconciliation of actual income tax expense in the financial statements to the expected tax benefit (computed by applying the statutory Federal income tax rate of 34% to income before income taxes) is as follows:
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Federal statutory rate times financial statement income | | $ | 1,331 | | | $ | 1,301 | | | $ | 1,149 | |
| Effect of: | | | | | | | | | | | | |
| Bank owned life insurance | | | (71 | ) | | | (20 | ) | | | (5 | ) |
| Tax-exempt income | | | (48 | ) | | | (19 | ) | | | (22 | ) |
| State income taxes, net of federal income effect | | | (96 | ) | | | 11 | | | | 146 | |
| Expenses not deductible for U.S. income taxes | | | 35 | | | | 16 | | | | 10 | |
| Compensation expense related to SFAS 123R | | | 98 | | | | — | | | | — | |
| General business credit | | | (66 | ) | | | — | | | | — | |
| Change in valuation allowance | | | (51 | ) | | | — | | | | — | |
| Other, net | | | (19 | ) | | | (28 | ) | | | (31 | ) |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Income tax expense | | $ | 1,113 | | | $ | 1,261 | | | $ | 1,247 | |
| | | | | | | | | | |
(Continued)
F-19
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 8 — INCOME TAXES(Continued)
The tax effect of each type of temporary difference that gives rise to net deferred tax assets and liabilities is as follows:
| | | | | | | | | |
| | | 2006 | | | 2005 | |
| Deferred tax assets: | | | | | | | | |
| Allowance for loan losses | | $ | 1,528 | | | $ | 1,168 | |
| Net operating loss carry forward | | | 167 | | | | 51 | |
| Unrealized loss on securities | | | 46 | | | | 85 | |
| Other | | | 55 | | | | 27 | |
| | | | | | | |
| | | $ | 1,796 | | | $ | 1,331 | |
| | | | | | | |
| | | | | | | | | |
| Deferred tax liabilities: | | | | | | | | |
| Prepaids | | $ | (150 | ) | | $ | (103 | ) |
| Depreciation | | | (348 | ) | | | (338 | ) |
| Federal Home Loan Bank stock | | | (56 | ) | | | (39 | ) |
| Other | | | (59 | ) | | | (7 | ) |
| | | | | | | |
| | | $ | (613 | ) | | $ | (487 | ) |
| | | | | | | |
| | | | | | | | | |
| Valuation allowance | | | — | | | | (51 | ) |
| | | | | | | | | |
| Balance at end of year | | $ | 1,183 | | | $ | 793 | |
| | | | | | | |
At year-end 2006, the Company has a net operating loss carryforward for state tax purposes of approximately $.8 million expiring in 2020 and $1.8 million expiring in 2021.
NOTE 9 — RELATED PARTY TRANSACTIONS
Loans to principal officers, directors, and their affiliates in 2006 were as follows:
| | | | | |
| Beginning balance | | $ | 5,120 | |
| New loans | | | 2,310 | |
| Effect of changes in related parties | | | (710 | ) |
| Repayments | | | (1,988 | ) |
| | | | |
| | | | | |
| Ending balance | | $ | 4,732 | |
| | | | |
Deposits from principal officers, directors, and their affiliates at year-end 2006 and 2005 were $2,885 and $3,733.
Principal officers, directors, and their affiliates at year end 2006 and 2005 owned $700 of the $3,000 subordinated debentures due December 31, 2032. At December 31, 2006 the approved available unused lines of credit on related parties were $946.
(Continued)
F-20
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 10 – STOCK BASED COMPENSATION
Prior to the Company’s bank holding company reorganization, the Bank had in place the Community First Bank & Trust Stock Option Plan for organizers of the Bank and certain members of management and employees. In connection with the bank holding company reorganization, this plan was amended and replaced in its entirety by the Community First, Inc. Stock Option Plan in October, 2002. Additionally, the Community First, Inc. 2005 Stock Incentive Plan was approved April 26, 2005, at the stockholders meeting. The plans allow for the grant of options and other equity securities to key employees and directors. Exercise price is the market price at the date of grant. The organizer options vested ratably over three years and other non-qualified options vest ratably over four years. The employee options vest ratably from two to four years and the management options vest ratably over six years. All options expire within ten years from the date of grant. The Company has 305,942 authorized shares available for grant as of December 31, 2006.
During 2004, the Financial Accounting Standards Board revised Statement No. 123, “Accounting for Stock-Based Compensation” (SFAS 123R) which established accounting requirements for share-based compensation to employees and carries forward prior guidance on accounting for awards to non-employees. The provisions of this statement became effective for fiscal years beginning after June 15, 2005, for all equity awards granted or modified after the effective date and for the subsequent vesting of previously granted awards. SFAS 123R requires an entity to recognize compensation expense based on an estimate of the fair value and number of awards expected to actually vest. On January 1, 2006, the Company adopted SFAS 123R and began recognizing compensation expense for stock options. The Company recognized $302 as compensation resulting from stock options and $5 for restricted stock awards. The total income tax benefit was $5 and $2. The Company elected to use the modified prospective transition method; therefore, prior period results were not restated. Previously the Company accounted for stock options granted to employees according to the provisions of APB Opinion No. 25, whereby compensation expense was recorded based upon the intrinsic value method.
The fair value of each option is estimated as of the date of grant using the Black-Scholes Option Pricing Model. This model requires the input of subjective assumptions that will usually have a significant impact on the fair value estimate. The assumptions for grants are set forth in the chart below and are based on SFAS 123R and SEC guidance contained in Staff Accounting Bulletin (SAB) No. 107 “Share-Based Payment.” Options to purchase 34,000 and 48,300 shares were granted in 2006 and 2005. Expected volatilities are based on historical volatilities of the Company’s common stock. Employee and management options are tracked separately. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.
(Continued)
F-21
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 10 — STOCK BASED COMPENSATION(Continued)
The fair value of options granted was determined using the following weighted average assumptions at grant date.
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Risk-free interest rate | | | 5.07 | % | | | 4.46 | % | | | 3.22 | % |
| Expected option life | | 7 years | | 7 years | | 7 years |
| Expected stock price volatility | | | 16.06 | % | | | 18.66 | % | | | 20.94 | % |
| Dividend yield | | | 1.00 | % | | | 0.00 | % | | | 0.00 | % |
SFAS 123R requires the recognition of stock-based compensation for the number of awards that are ultimately expected to vest. As a result, for most awards, recognized stock compensation expense was reduced for estimated forfeitures prior to vesting based on historical forfeiture rates. Estimated forfeitures will be reassessed in subsequent periods and may change based on new facts and circumstances. Prior to January 1, 2006, actual forfeitures were accounted for as they occurred for purposes of required pro forma stock compensation disclosures.
A summary of option activity under the Company’s stock option incentive plans for 2006 is presented in the following table:
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | Weighted | | | | |
| | | | | | | | | | | Average | | | | |
| | | | | | | Weighted | | | Remaining | | | | |
| | | | | | | Average | | | Contractual | | | Aggregate | |
| | | | | | | Exercise | | | Life in | | | Intrinsic | |
| | | Shares | | | Price/Share | | | Years | | | Value | |
| Options outstanding January 1, 2006 | | | 229,810 | | | $ | 12.02 | | | | | | | | | |
| Granted | | | 34,000 | | | | 30.00 | | | | | | | | | |
| Options exercised | | | (16,566 | ) | | | 7.29 | | | | | | | | | |
| Forfeited or expired | | | (600 | ) | | | 25.00 | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Options outstanding December 31, 2006 | | | 246,644 | | | | 14.79 | | | | 5.43 | | | $ | 3,758 | |
| | | | | | | | | | | | | |
| Exercisable at December 31, 2006 | | | 172,489 | | | | 10.07 | | | | 3.93 | | | $ | 3,438 | |
| | | | | | | | | | | | | |
(Continued)
F-22
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 10 — STOCK BASED COMPENSATION(Continued)
Information related to the stock option incentive plans during each year is as follows:
($ amount in thousands except weighted average fair value of options granted)
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Intrinsic value of options exercised | | $ | 370 | | | $ | 128 | | | $ | 1,401 | |
| Cash received from option exercises | | | 121 | | | | 56 | | | | 1,233 | |
| Tax benefit realized from option exercises | | | 142 | | | | 39 | | | | 303 | |
| Weighted average fair value of options granted | | $ | 8.46 | | | $ | 8.06 | | | $ | 3.65 | |
As of December 31, 2006, there was $495 of total unrecognized compensation cost related to nonvested stock options granted under the Plans. The cost is expected to be recognized over a weighted average period of 2.5 years.
The following table is a summary of changes in the Company’s nonvested shares from the issuance of restricted stock.
| | | | | | | | | |
| | | | | | | Weighted Average | |
| | | | | | | Grant-Date | |
| | | Shares | | | Fair Value | |
| Nonvested at January 1, 2006 | | | — | | | $ | 0.00 | |
| Granted | | | 346 | | | | 28.00 | |
| Vested | | | — | | | | 0.00 | |
| Forfeited | | | — | | | | 0.00 | |
| | | | | | | | |
| Nonvested at December 31, 2006 | | | 346 | | | $ | 28.00 | |
In first quarter of 2006, 346 shares of restricted stock were awarded at the market price of $28.00 per share. This award vests over a two year period. Unrecognized compensation costs related to this award, as of December 31, 2006, was $5.
(Continued)
F-23
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 11 – LOAN COMMITMENTS AND OTHER RELATED ACTIVITIES
Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance-sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.
The contractual amount of financial instruments with off-balance sheet risk was as follows at year-end.
| | | | | | | | | | | | | | | | | |
| | | 2006 | | 2005 |
| | | Fixed | | Variable | | Fixed | | Variable |
| | | Rate | | Rate | | Rate | | Rate |
| Unused lines of credit | | $ | 4,505 | | | $ | 58,858 | | | $ | 6,335 | | | $ | 35,693 | |
| Letters of credit | | | — | | | | 4,160 | | | | — | | | | 3,515 | |
| Commitments to make loans | | | — | | | | 6,200 | | | | — | | | | — | |
These commitments are generally made for periods of one year or less. The fixed rate loan commitments have interest rates ranging from 5.50% to 10.75% and maturities ranging from 1 to 20 years.
NOTE 12 — REGULATORY MATTERS
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank and the Company are required to meet specific capital adequacy guidelines that involve quantitative measures of a bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material effect on the Bank’s financial condition.
The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The risk-based guidelines are based on the assignment of risk weights to assets and off-balance sheet items depending on the level of credit risk associated with them. In addition to minimum capital requirements, under the regulatory framework for prompt corrective action, regulatory agencies have specified certain ratios an institution must maintain to be considered “undercapitalized”, “adequately capitalized”, and “well capitalized”. As of December 31, 2006, the most recent notification from the Bank’s regulatory authority categorized the Bank as “well capitalized”. There are no conditions or events since that notification that management believes have changed the Bank’s category.
(Continued)
F-24
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 12 — REGULATORY MATTERS(Continued)
The Bank’s and the Company’s capital amounts and ratios at December 31, 2006 and 2005, are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | To Be Well |
| | | | | | | | | | | | | | | | | | | Capitalized Under |
| | | | | | | | | | | For Capital | | Prompt Corrective |
| | | Actual | | Adequacy Purposes | | Action Provisions |
| | | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio |
| 2006 | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Capital to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Bank | | $ | 41,635 | | | | 10.91 | % | | $ | 30,526 | | | | 8.00 | % | | $ | 38,158 | | | | 10.00 | % |
| Consolidated | | | 42,978 | | | | 11.25 | % | | | 30,560 | | | | 8.00 | % | | | 38,200 | | | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Bank | | $ | 37,376 | | | | 9.80 | % | | $ | 15,263 | | | | 4.00 | % | | $ | 22,895 | | | | 6.00 | % |
| Consolidated | | | 38,719 | | | | 10.14 | % | | | 15,280 | | | | 4.00 | % | | | 22,920 | | | | 6.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 to average assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Bank | | $ | 37,376 | | | | 9.16 | % | | $ | 16,320 | | | | 4.00 | % | | $ | 20,400 | | | | 5.00 | % |
| Consolidated | | | 38,719 | | | | 9.45 | % | | | 16,384 | | | | 4.00 | % | | | 20,481 | | | | 5.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| 2005 | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Capital to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Bank | | $ | 34,283 | | | | 12.37 | % | | $ | 22,166 | | | | 8.00 | % | | $ | 27,708 | | | | 10.00 | % |
| Consolidated | | | 35,429 | | | | 12.77 | % | | | 22,200 | | | | 8.00 | % | | | 27,749 | | | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Bank | | $ | 31,015 | | | | 11.19 | % | | $ | 11,083 | | | | 4.00 | % | | $ | 16,625 | | | | 6.00 | % |
| Consolidated | | | 32,161 | | | | 11.59 | % | | | 11,100 | | | | 4.00 | % | | | 16,650 | | | | 6.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 to average assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Bank | | $ | 31,015 | | | | 9.91 | % | | $ | 12,523 | | | | 4.00 | % | | $ | 15,653 | | | | 5.00 | % |
| Consolidated | | | 32,161 | | | | 10.25 | % | | | 12,555 | | | | 4.00 | % | | | 15,693 | | | | 5.00 | % |
The Company’s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. During 2007, the Bank could, without prior approval, declare dividends of approximately $6,524 plus any 2007 net profits retained to the date of the dividend declaration.
(Continued)
F-25
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 13 — FAIR VALUE OF FINANCIAL INSTRUMENTS
The methods and assumptions used to estimate fair value are described as follows:
Carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank stock, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of loans held for sale is based on market quotes. Fair value of debt is based on current rates for similar financing. The fair value of off-balance-sheet items is not considered material (or is based on the current fees or cost that would be charged to enter into or terminate such arrangements).
Carrying amount and estimated fair values of significant financial instruments at year end were as follows:
| | | | | | | | | | | | | | | | | |
| | | 2006 | | 2005 |
| | | Carrying | | Fair | | Carrying | | Fair |
| | | Amount | | Value | | Amount | | Value |
| Financial assets | | | | | | | | | | | | | | | | |
| Securities available for sale | | $ | 37,576 | | | $ | 37,576 | | | $ | 30,330 | | | $ | 30,330 | |
| Loans held for sale | | | 3,981 | | | | 3,981 | | | | 1,890 | | | | 1,890 | |
| | | | | | | | | | | | | | | | | |
| Loans, net of allowance | | | 344,714 | | | | 345,259 | | | | 256,150 | | | | 256,559 | |
| Financial liabilities | | | | | | | | | | | | | | | | |
| Deposits with defined maturities | | $ | 277,314 | | | $ | 277,314 | | | $ | 198,370 | | | $ | 198,371 | |
| Federal Home Loan Bank advances | | | 13,000 | | | | 13,000 | | | | 8,000 | | | | 8,000 | |
| Subordinated debentures | | | 8,000 | | | | 8,000 | | | | 8,000 | | | | 8,000 | |
(Continued)
F-26
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 14 — PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial information of Community First, Inc. follows:
CONDENSED BALANCE SHEET
| | | | | | | | | |
| | | 2006 | | | 2005 | |
Assets | | | | | | | | |
| Cash and cash equivalents | | $ | 1,183 | | | $ | 1,153 | |
| Investment in banking subsidiary | | | 37,562 | | | | 31,119 | |
| Other assets | | | 281 | | | | 149 | |
| | | | | | | |
| | | | | | | | | |
| Total assets | | $ | 39,026 | | | $ | 32,421 | |
| | | | | | | |
| | | | | | | | | |
Liabilities and shareholders’ equity | | | | | | | | |
| Subordinated debentures | | $ | 8,000 | | | $ | 8,000 | |
| Other liabilities | | | 369 | | | | 404 | |
| | | | | | | |
| Total liabilities | | | 8,369 | | | | 8,404 | |
| Shareholders’ equity | | | 30,657 | | | | 24,017 | |
| | | | | | | |
| | | | | | | | | |
| Total liabilities and shareholders’ equity | | $ | 39,026 | | | $ | 32,421 | |
| | | | | | | |
CONDENSED STATEMENTS OF INCOME
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Interest income | | $ | 18 | | | $ | 8 | | | $ | 4 | |
| Dividends from subsidiaries | | | 875 | | | | 100 | | | | — | |
| | | | | | | | | | |
| Total income | | | 893 | | | | 108 | | | | 4 | |
| | | | | | | | | | | | | |
| Interest expense | | | 600 | | | | 270 | | | | 203 | |
| Other expense | | | 510 | | | | 257 | | | | 145 | |
| | | | | | | | | | |
| Total expenses | | | 1,110 | | | | 527 | | | | 348 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Income (loss) before income tax and undistributed subsidiary income | | | (217 | ) | | | (419 | ) | | | (344 | ) |
| Income tax benefit | | | 419 | | | | 151 | | | | 132 | |
| Equity in undistributed subsidiary income | | | 2,600 | | | | 2,833 | | | | 2,344 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Net income | | $ | 2,802 | | | $ | 2,565 | | | $ | 2,132 | |
| | | | | | | | | | |
(Continued)
F-27
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 14 — PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION(Continued)
CONDENSED STATEMENTS OF CASH FLOWS
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Cash flows from operating activities | | | | | | | | | | | | |
| Net income | | $ | 2,802 | | | $ | 2,565 | | | $ | 2,132 | |
| Adjustments to reconcile net income to net cash from operating activities: | | | | | | | | | | | | |
| Equity in undistributed subsidiary income | | | (2,600 | ) | | | (2,833 | ) | | | (2,344 | ) |
| Compensation expense under stock based compensation | | | 307 | | | | — | | | | — | |
| Tax benefit on exercise of stock options | | | (142 | ) | | | (39 | ) | | | (303 | ) |
| Change in other, net | | | (24 | ) | | | (35 | ) | | | 442 | |
| | | | | | | | | | |
| Net cash from operating activities | | | 343 | | | | (342 | ) | | | (73 | ) |
| | | | | | | | | | | | | |
| Cash flows from investing activities | | | | | | | | | | | | |
| Investments in and advances to bank subsidiary | | | (3,762 | ) | | | (4,500 | ) | | | (5,140 | ) |
| | | | | | | | | | |
| Net cash from investing activities | | | (3,762 | ) | | | (4,500 | ) | | | (5,140 | ) |
| | | | | | | | | | | | | |
| Cash flows from financing activities | | | | | | | | | | | | |
| Proceeds from issuance of stock | | | 3,761 | | | | — | | | | 4,448 | |
| Proceeds from stock option exercises | | | 121 | | | | 56 | | | | 1,233 | |
| Tax benefit on exercise of stock options | | | 142 | | | | 39 | | | | 303 | |
| Cash paid for dividends | | | (575 | ) | | | — | | | | — | |
| Proceeds from issuance of subordinated debentures | | | — | | | | 5,000 | | | | — | |
| | | | | | | | | | |
| Net cash from financing activities | | | 3,449 | | | | 5,095 | | | | 5,984 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Net change in cash and cash equivalents | | | 30 | | | | 253 | | | | 771 | |
| | | | | | | | | | | | | |
| Beginning cash and cash equivalents | | | 1,153 | | | | 900 | | | | 129 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Ending cash and cash equivalents | | $ | 1,183 | | | $ | 1,153 | | | $ | 900 | |
| | | | | | | | | | |
(Continued)
F-28
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 15 — EARNINGS PER SHARE
The factors used in the earnings per share computation follows:
| | | | | | | | | | | | | |
| | | 2006 | | | 2005 | | | 2004 | |
| Basic | | | | | | | | | | | | |
| Net income | | $ | 2,802 | | | $ | 2,565 | | | $ | 2,132 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Weighted average common shares outstanding | | | 2,882,041 | | | | 2,868,780 | | | | 2,738,156 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Basic earnings per common share | | $ | 0.97 | | | $ | 0.89 | | | $ | 0.78 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Diluted | | | | | | | | | | | | |
| Net income | | $ | 2,802 | | | $ | 2,565 | | | $ | 2,132 | |
| | | | | | | | | | |
| Weighted average common shares outstanding for basic earnings per common share | | | 2,882,041 | | | | 2,868,780 | | | | 2,738,156 | |
| Add: Dilutive effects of assumed exercise of stock options | | | 99,039 | | | | 105,331 | | | | 98,490 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Average shares and dilutive potential common shares | | | 2,981,080 | | | | 2,974,111 | | | | 2,836,646 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Diluted earnings per common share | | $ | 0.94 | | | $ | 0.86 | | | $ | 0.75 | |
| | | | | | | | | | |
No options were antidilutive for 2006, 2005 or 2004.
NOTE 16—QUARTERLY FINANCIAL DATA (UNAUDITED)
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | Earnings Per Share |
| | | Interest | | Net Interest | | | | | | |
| | | Income | | Income | | Net Income | | Basic | | Diluted |
| 2006 | | | | | | | | | | | | | | | | | | | | |
| First quarter | | $ | 5,510 | | | $ | 2,905 | | | $ | 621 | | | $ | .22 | | | $ | .21 | |
| Second quarter | | | 6,131 | | | | 3,073 | | | | 932 | | | $ | .32 | | | $ | .31 | |
| Third quarter | | | 6,765 | | | | 3,128 | | | | 645 | | | $ | .22 | | | $ | .22 | |
| Fourth quarter | | | 7,383 | | | | 3,155 | | | | 604 | | | $ | .21 | | | $ | .20 | |
| | | | | | | | | | | | | | | | | | | | | |
| 2005 | | | | | | | | | | | | | | | | | | | | |
| First quarter | | $ | 3,603 | | | $ | 2,262 | | | $ | 586 | | | $ | .20 | | | $ | .20 | |
| Second quarter | | | 4,056 | | | | 2,512 | | | | 658 | | | | .23 | | | | .22 | |
| Third quarter | | | 4,627 | | | | 2,753 | | | | 574 | | | | .20 | | | | .19 | |
| Fourth quarter | | | 5,019 | | | | 2,772 | | | | 747 | | | | .26 | | | | .25 | |
The increase in the second quarter net income was related to a gain on the sale of property that was deferred in 2005 due to the Bank’s financing of the loan for this property. During the second quarter of 2006 the Bank subsequently sold this loan to another financial institution and recognized the $390 gain into noninterest income.
(Continued)
F-29
COMMUNITY FIRST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except per share data)
NOTE 17—LEGAL PROCEEDINGS
The Company’s bank subsidiary is a co-defendant in a suit in Maury County Circuit Court,Holloway et al. v. Evers. Et al, filed May 31, 2005, in which the plaintiff alleges that a bank loan officer disclosed the plaintiff’s loan history at the bank to plaintiff’s two partners in a real estate development, who subsequently forced plaintiff to sell his interest to them. Plaintiff alleges causes of action for tortious interference with contract, breach of common law fiduciary duty, and violation of the Financial Records Privacy Act. Plaintiff seeks $5,000,000 in compensatory damages and $5,000,000 in punitive damages, jointly and severally, from the bank and his two partners. The Company believes the claim is without merit, intends to vigorously defend the suit, and does not believe the ultimate disposition of the suit will have a material adverse effect on its financial condition or results of operation. In the second quarter of 2006, the trial court granted the co-defendants summary judgment. If this judgment is upheld on appeal, the Bank anticipates that Plaintiffs will voluntarily dismiss the case as to the Bank.
NOTE 18—STOCK OFFERING
On December 6, 2006, the Company began a stock offering to raise additional capital of up to $10,500. The additional capital will be used to continue growth and to help meet the Company’s goal of remaining “well capitalized”. As of December 31, 2006, the Company had sold 125,460 shares of common stock at $30 per share resulting in proceeds to the company, net of offering expenses, of $3,761. As of March 23, 2007, the Company sold an additional 131,397 shares of common stock for net proceeds of $3,911. Of the $10.5 million the Company planned to raise, 256,857 shares have been sold for net proceeds of $7,673 as of March 23, 2007.
F-30
EXHIBIT INDEX
The following exhibits are filed as a part of or incorporated by reference in this report:
| | | |
| Exhibit No. | | Description |
| | | |
| 3.1 | | Amended and Restated Charter of the Company (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed with the SEC on April 29, 2005. |
| | | |
| 3.2 | | Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the SEC on March 21, 2005. |
| | | |
| 10.1 | | The Community First, Inc. Stock Option Plan. *+ |
| | | |
| 10.2 | | Form of Management Stock Option Agreement pursuant to the Community First, Inc. Stock Option Plan. * + |
| | | |
| 10.3 | | Form of Organizers Stock Option Agreement pursuant to the Community First, Inc. Stock Option Plan. * + |
| | | |
| 10.4 | | Form of Employee Stock Option Agreement pursuant to the Community First, Inc. Stock Option Plan. *+ |
| | | |
| 10.5 | | The Community First, Inc. 2005 Stock Incentive Plan (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on April 29, 2005).+ |
| | | |
| 10.6 | | Form of Non-Qualified Stock Option Agreement for Directors (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on July 20, 2006).+ |
| | | |
| 10.7 | | Form of Non-Qualified Stock Option Agreement pursuant to the Community First, Inc. 2005 Stock Incentive Plan (incorporated by reference to the Company’s Quarterly Report on Form 10-QSB filed with the SEC on March 31, 2005).+ |
| | | |
| 10.8 | | Form of Incentive Stock Option Agreement pursuant to the Community First, Inc. 2005 Stock Incentive Plan (incorporated by reference to the Company’s Quarterly Report on Form 10-QSB filed with the SEC on March 31, 2005).+ |
| | | |
| 10.9 | | Form of Restricted Stock Agreement under the Community First, Inc. 2005 Stock Incentive Plan (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on January 23, 2006).+ |
| | | |
| 10.10 | | Employment Agreement between Marc Lively and the Company (incorporated herein by reference to the Company’s current report on Form 8-K filed with the SEC on September 23, 2004).+ |
| | | |
| 10.11 | | Amendment No. 1 to the Employment Agreement with Marc Lively (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on August 22, 2005).+ |
| | | |
| | | |
| Exhibit No. | | Description |
| | | |
| 10.12 | | Community First Bank & Trust Supplemental Executive Retirement Plan (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on August 22, 2005).+ |
| |
| 10.13 | | Participation Agreement, dated August 16, 2005, with Marc Lively pursuant to the Community First Bank & Trust Supplemental Executive Retirement Plan (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on August 22, 2005).+ |
| | | |
| 10.14 | | Participation Agreement, dated August 16, 2005, with Mike Saporito pursuant to the Community First Bank & Trust Supplemental Executive Retirement Plan. |
| | | |
| 10.15 | | Participation Agreement, dated August 16, 2005, with Carl Campbell pursuant to the Community First Bank & Trust Supplemental Executive Retirement Plan. |
| | | |
| 10.16 | | Participation Agreement, dated August 16, 2005, with Dianne Scroggins pursuant to the Community First Bank & Trust Supplemental Executive Retirement Plan. |
| | | |
| 21.1 | | List of Subsidiaries |
| | | |
| 23.1 | | Consent of Crowe Chizek and Company, LLC |
| | | |
| 31.1 | | Certification of CEO Pursuant to Securities and Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 31.2 | | Certification of CFO Pursuant to Securities and Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 32.1 | | Certification of CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 32.2 | | Certification of CFO pursuant to 18 U.S.C. Section 1350 , as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
| * | | Incorporated herein by reference to the Company’s Form 10-KSB for the year ended December 31, 2003. |
| |
| + | | Management compensatory plan or arrangement |
