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, 2008
OR
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| o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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
or organization) | | (I.R.S. Employer Identification No.) |
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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. Yes o No þ
Indicate by check mark whether the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
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 this Form 10-K. o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer o | Accelerated filer þ |
Non-accelerated filer o
(Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the Registrant’s outstanding Common Stock held by nonaffiliates of the Registrant on June 30, 2008 was approximately $80,640,917. There were 3,211,019 of Common Stock outstanding on March 16, 2009.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive Proxy Statement for its 2009 Annual Meeting of Shareholders, currently scheduled to be held on April 21, 2009, 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, 2008
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 (the “Securities Act”) 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
Unless this Form 10-K indicates otherwise or the context otherwise requires, the terms “we,” “our,” “us,” “the Company” or “Community First” as used herein refer to Community First, Inc. and its subsidiaries, including Community First Bank & Trust, which we sometimes refer to as “the Bank” or “our Bank”.
(Dollar amounts in thousands, except per share data)
General
Community First 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 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 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 primarily 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.
The Company completed its acquisition of 100% of the outstanding shares of common stock of The First National Bank of Centerville, a national banking association (“First National”) on October 26, 2007 pursuant to the terms of an Agreement and Plan of Reorganization and Share Exchange, dated as of August 1, 2007, by and between the Company and First National. First National operated under a National Bank Charter and provides full banking services. As a national bank, First National was subject regulation by the Office of the Comptroller of the Currency and the FDIC. On January 31, 2008, First National was merged with and into the Bank, with the Bank continuing as the surviving entity.
The Company conducts banking activities from the main office and three branch offices in Columbia, Tennessee, one branch office in Mount Pleasant, Tennessee, one branch office in Franklin, Tennessee, one branch office in Murfreesboro, Tennessee, one branch office in Centerville, Tennessee, one branch office in Lyles, Tennessee and one branch office in Thompson’s Station, Tennessee. The Company also operates eleven automated teller machines in Maury County, four automated teller machines in Williamson County, Tennessee, one automated teller machine in Rutherford County, Tennessee and two automated teller machines in Hickman 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, 2008, the Company’s consolidated total assets were $715,326, its consolidated net loans, including loans held for sale, were $567,239, its total deposits were $599,318, and its
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total shareholders’ equity was $36,035. At December 31, 2007, consolidated total assets were $636,062, its consolidated net loans, including loans held for sale, were $490,232, its total deposits were $559,303, and its total shareholders’ equity was $37,173. At December 31, 2006, consolidated total assets were $421,393, consolidated net loans, including loans held for sale, were $348,695, total deposits were $366,766, and total shareholders’ equity was $30,657.
Loans
We make 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 $15,326.
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 for real estate construction and development 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, or in the case of real estate construction and development loans, the underlying real estate property.
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
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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 Policies of the Company
While the ultimate authority to approve loans rests with the Board of Directors (the “Directors”) of the Company, lending authority is delegated by the Directors to the loan officers and Loan Committee. 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 Senior Lending Officer, Charles Isaacs. Marc Lively, President and Chief Executive Officer, chairs the Loan Committee. The Chief Credit Officer, Carl Campbell, serves as Vice Chairman of the Loan Committee. Lending limits of individual officers are documented in the Company’s Loan Policy and Procedures and are approved by the 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, and the Chief Credit Officer, Carl Campbell, have lending authority on secured and unsecured loans up to $500,000. The Senior Lending Officer, Charles Isaacs and the Chief Retail Officer, Louis Holloway have lending authority on secured and unsecured loans up to $500,000.
Our policies provide written guidelines for lending activities and are reviewed at least annually by the Directors. The Directors recognize that, from time to time, it is in the best interests of the Company 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.
We seek 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. Our primary trade area lies in the counties of Middle Tennessee, with the primary focus in Maury, Williamson, Hickman and Rutherford Counties. The Loan Committee must approve all out-of-trade area loans.
As a general rule, we seek 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 |
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| 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. |
Loan Review and Nonperforming Assets
We have 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 we expect 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 us. 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 us, but in recent months has either been late, delinquent in making payments, or made sporadic payments. While we continue 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. We do not use an OLEM classification as a compromise between a loan rated 4 or higher and “substandard”.
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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 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 our 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. We take the losses in the period in which they become uncollectible.
Loans graded “4”, “5”, “6”, “7”, or “8” are referred to management for inclusion on our “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 certain officers and directors of the Company is responsible for managing the assets and liabilities. The chairperson of the committee is the 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 our overall acquisition and allocation of funds. The committee reviews and discusses our 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
Our investment portfolio policy is designed to provide guidelines by which the funds not otherwise needed to meet loan demand of our market area can best be invested to meet fluctuations in the loan demand and deposit structure. The Chief Financial Officer, Dianne Scroggins, also serves as Investment Officer. We seek to balance the market and credit risk against the potential investment return, make investments compatible with the pledging requirements of our deposits of public funds, maintain compliance with regulatory investment requirements, and assist the various local public entities with their financing needs. Our investment policy is reviewed annually by the Investment Committee, chaired by Director Randy Maxwell, and by the Directors.
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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 our business. As of December 31, 2008, we had a total of 215 ending relationships that represent exposure to us of at least $500,000. We believe that the loss of one of these relationships or an affiliated group of relationships, while significant, would not materially impact the performance of the Company.
Competition and Seasonality
The banking business is highly competitive. Our primary market area consists of Maury, Williamson, Hickman, and Rutherford Counties in Tennessee. We compete with numerous commercial banks and savings institutions with offices in these market areas. In addition to these competitors, we compete for loans with insurance companies, regulated small loan companies, credit unions, and certain government agencies. We also compete 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 $901 million in deposits in the Maury County market area, up to $5.03 billion in deposits in the Williamson County market area, up to $2.79 billion in the Rutherford County market area and up to $110 million in the Hickman County market area, as reported by the FDIC as of June 30, 2008. At December 31, 2008, the Bank had deposits of approximately $550 million. The Company does not experience significant seasonal trends in its operations.
Employees
As of December 31, 2008, the Company had 153 full-time equivalent employees and 160 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.
Participation in the United States Department of the Treasury’s Capital Purchase Program
On February 27, 2009, as part of the Capital Purchase Program (the “CPP”) established by the U.S. Department of the Treasury (the “U.S. Treasury”) under the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009 (the “ARRA”) (the “EESA”), the Company issued and sold to the U.S. Treasury (i) 17,806 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share (the “Series A Preferred Stock”), and (ii) a ten-year warrant to purchase 890.00890 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, having a liquidation preference of $1,000 per share (the “Series B Preferred Stock” and, together with the Series A Preferred Stock, the “Preferred Stock”), at an initial exercise price of $0.01 per share (the “Warrant”), for an aggregate purchase price of $17,806,000 in cash. On February 27, 2009, the U.S. Treasury exercised the Warrant to purchase 890 shares (after net settlement without cash payment) of Series B Preferred Stock.
The Preferred Stock will qualify as Tier 1 capital and will pay cumulative dividends (i) with respect to the Series A Preferred Stock, at a rate of 5% per annum for the first five years following issuance and 9% per annum thereafter, and (ii) with respect to the Series B Preferred Stock, at a rate of 9% per annum. Dividends are payable on the Preferred Stock quarterly and are payable on February 15, May 15, August 15 and November 15 of each year. If the Company fails to pay a total of six dividend payments on either the Series A Preferred Stock or the Series B Preferred Stock, whether or not consecutive, holders of the series of Preferred Stock on which such dividends have not been paid shall be entitled, voting together with the other series of Preferred Stock and any other series of voting parity stock, to elect two directors to the Company’s Board of
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Directors until the Company has paid all such dividends that it had failed to pay.
The Series A Preferred Stock has no maturity date and ranks senior to the Company’s common stock, no par value per share (the “Common Stock”), with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. The Series B Preferred Stock has no maturity date and ranks senior to the Common Stock, and pari passu with the Series A Preferred Stock, with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. The Preferred Stock is generally non-voting.
Under the ARRA, the Preferred Stock may be redeemed by the Company at any time. Any redemption of the Preferred Stock is subject to consultation by the U.S. Treasury with the FRS. No shares of Series B Preferred Stock may be redeemed prior to the Company’s redemption, repurchase or other acquisition of all outstanding shares of Series A Preferred Stock.
Supervision and Regulation
General
As a registered bank holding company and 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”).
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
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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 FRS 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 FRS has adopted significant amendments to its anti-tying rules that: (1) removed FRS-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 FRB 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 FRB 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 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.
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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 the Exchange 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 Securities 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 be obtained free of charge at the SEC website (http://www.sec.gov). The Company also makes available on its website (http://www.cfbk.com), free of charge, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after the Company files such material with, or furnishes such material to, the SEC.
Participation in the Capital Purchase Program of the Troubled Asset Relief Program
As a result of the Company’s participation in the CPP, the Company is required to comply with certain limits and restrictions concerning executive compensation throughout the time that the U.S. Treasury holds any equity or debt securities acquired from the Company pursuant to the CPP, including a requirement that any bonus or incentive compensation paid to the Company’s executive officers during the period that the U.S. Treasury holds any equity or debt securities issued by the Company in the CPP be subject to “clawback” or recovery if the payment was based on materially inaccurate financial statements or other materially inaccurate performance metrics and a prohibition on making any “golden parachute” payment (as defined in Section 111 of the EESA, as amended by the ARRA as well as all rules, regulations, guidance or other requirements issued thereunder) during that same period to any senior executive officer. The prohibition on “golden parachute” payments has been expanded under the ARRA to prohibit any payment to a senior executive officer for departure from a company for any reason, except for payments for services performed or benefits accrued, although the U.S. Treasury has yet to issue regulations regarding this expansion of the prohibition on making “golden parachute” payments.
As of March 16, 2009, it is unclear how these executive compensation standards imposed under ARRA will relate to the similar standards announced by the U.S. Treasury in its guidelines on February 4, 2009, or whether the standards will be considered effective immediately or only after implementing regulations are issued by the U.S. Treasury. The new standards applicable to the Company include (but are not limited to) (i) prohibitions on bonuses, retention awards and other incentive compensation to the Company’s chief executive officer, other than restricted stock grants which do not fully vest during the period that the U.S. Treasury owns any debt or equity securities of the Company and which do not exceed one-third of the chief executive officer’s total annual compensation, (ii) prohibitions on any payments to senior executives (other than payments for services performed or benefits accrued) for departure for any reason from the Company, (iii) an expanded clawback of bonuses, retention awards, and incentive compensation if payment is based on materially inaccurate statements of earnings, revenues, gains or other criteria, (iv) prohibition on compensation plans that encourage manipulation of reported earnings, (v) retroactive review of bonuses, retention awards and other compensation previously provided by the Company if found by the U.S. Treasury to be inconsistent with the purposes of TARP or otherwise contrary to public interest, (vi) required establishment of a company-wide policy regarding “excessive or luxury expenditures,” and (vii) inclusion in
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the Company’s proxy statements for annual shareholder meetings of a nonbinding “say on pay” shareholder vote on the compensation of the Company’s executives. The Company is reviewing these legislative and regulatory matters to determine what impact they will have on the Company’s executive compensation program for 2009 and beyond.
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.
Dividends
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%.
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.
In addition to the limitations on the Company’s ability to pay dividends under Tennessee law, the Company’s ability to pay dividends on its Common Stock is also limited by the Company’s participation in the CPP and by certain statutory or regulatory limitations.
Prior to February 27, 2012, unless the Company has redeemed the Senior Preferred and Warrant Preferred shares sold to the U.S. Treasury in connection with the CPP, or the U.S. Treasury has transferred the Senior Preferred and Warrant Preferred shares to a third party, the consent of the U.S. Treasury will be required for the Company to (1) declare or pay any dividend or make any distribution on the Common Stock (other than
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regular quarterly cash dividends of not more than $0.10 per share of Common Stock) or (2) redeem, purchase or acquire any shares of Common Stock or other equity or capital securities, including trust preferred securities, other than in connection with benefit plans consistent with past practice, and certain other limited circumstances
From February 28, 2012 until February 27, 2019, unless the U.S. Treasury has transferred the Senior Preferred and Warrant Preferred shares to third parties or the Senior Preferred and Warrant Preferred shares have been redeemed in total, the Company may increase the dividends paid to holders of the Common Stock by up to 3% in the aggregate per year over the amount paid in the prior year without the U.S. Treasury’s consent; provided that no increase in common dividends may be made as a result of any dividend paid in common shares, any stock split or any similar transactions. From February 28, 2019 until the Senior Preferred and Warrant Preferred shares held by the U.S. Treasury have been redeemed in whole or the U.S. Treasury has transferred all of the Senior Preferred and Warrant Preferred shares to third parties, the Company may not declare or pay any dividend or make any distribution on any capital stock or other equity securities of the Company other than regular dividends on shares of Senior Preferred and Warrant Preferred shares in accordance with the terms thereof and which are permitted by the terms of the Senior Preferred and Warrant Preferred shares, or dividends or distributions by any wholly-owned subsidiary of the Company. Further, during such period the Company may not redeem, purchase or acquire any shares of Common Stock or other capital stock or other equity securities of any kind of the Company, including any trust preferred securities, other than the Senior Preferred and Warrant Preferred shares.
State banks are subject to regulation by the Department with regard to capital requirements. Tennessee has adopted the provisions of FRS 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.
Deposit Insurance—Our 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 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.
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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.
EESA provides for a temporary increase in the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. This legislation provides that the basic deposit insurance limit will return to $100,000 on December 31, 2009. In addition, on October 14, 2008, the FDIC instituted a Temporary Liquidity Guarantee Program that provided for FDIC guarantees of unsecured debt of depository institutions and certain holding companies and for temporary unlimited FDIC coverage of non-interest bearing deposit transaction accounts. Institutions were automatically covered, without cost, under these programs for 30 days (later extended until December 5, 2008); however, after the specified deadline (December 5, 2008), institutions were required to opt-out of these programs if they did not wish to participate and incur fees thereunder. The Company has elected to participate in the transaction account guarantee program, which expires on December 31, 2009, and the temporary debt guarantee program. Under the transaction account guarantee program, an institution can provide full coverage on non-interest bearing transaction accounts for an annual assessment of 10 basis points of any deposit amounts exceeding the $250,000 deposit insurance limit, in addition to the normal risk-based assessment. Under the terms of the temporary debt guarantee program, the Company is eligible to issue prior to June 30, 2009 up to $12,544 of senior unsecured debt guaranteed by the FDIC until the earlier of the maturity of such debt or June 30, 2012. Such guaranteed debt would be subject to an annual assessment amount ranging from 50 to 100 basis points depending on its maturity date.
At December 31, 2008, the Bank’s deposit base for purposes of FDIC premiums was $553,029 and its deposit base under the transaction account guarantee program under the Temporary Liquidity Guarantee Program was $1,691. The Bank paid FDIC insurance premiums of $311 in 2008.
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
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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 if 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 FRS. 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 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 examines us 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, 2008, under the regulations promulgated under FDICIA, each of the Bank and First National 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
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“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. The preferred stock that the Company sold to the U.S. Treasury in connection with the CPP qualifies as Tier 1 Capital. 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 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.
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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 Company believes that, under the current regulations, it 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 Company has most of its loans, could adversely affect future earnings and, consequently, the ability of the Company 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.
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 our 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.
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Loans-to-One-Borrower—The aggregate amount of loans that we are 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 $53,564 at December 31, 2008, our loans-to-one borrower limit is approximately $13,391. Our house limit on 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.
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 BHC 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 Exchange Act, while permitting banks to continue to conduct certain limited brokerage and dealer activities without registration under the Exchange Act as a broker-dealer.
In addition to expanding the activities in which banks and bank holding companies may engage, the Act also imposed new requirements on financial institutions with respect to customer privacy. The 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 Act.
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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 community’s 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.
Proposed Legislation and Regulatory Action— New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of the nation’s financial institutions. The Company cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which the Company may be affected by any new regulation or statute. With the recent enactments of EESA and ARRA, the nature and extent of future legislative and regulatory changes affecting financial institutions is very unpredictable at this time.
Effect of Governmental Monetary Policies— The Company’s earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through the Federal Reserve’s statutory power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The Federal Reserve, through its monetary and fiscal policies, affects the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. The Company cannot predict the nature or impact of future changes in monetary and fiscal policies.
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 FRB. 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 FRB 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 our organization may discourage attempts to acquire control of the Company. The Company’s Charter provides that approximately one-third of its 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 shareholders may consider to be in their best interests, and may make it more difficult to remove incumbent management.
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 Requirements” for a discussion of bank regulatory agencies’ capital adequacy requirements.
Recent negative developments in the financial services industry and U.S. and global credit markets may adversely impact our operations and results.
Negative developments in the latter half of 2007 and throughout 2008 in the capital markets have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing into 2009. Loan portfolio performances have deteriorated at many institutions resulting from, amongst other factors, a weak economy and a decline in the value of the collateral supporting their loans. The competition for our deposits has increased significantly due to liquidity concerns at many of these same institutions. Stock prices of bank holding companies, like ours, have been negatively affected by the current condition of the financial markets, as has our ability, if needed, to raise capital or borrow in the debt markets compared to recent years. As a result, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and financial institution regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement actions. Negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance. In addition, industry, legislative or regulatory developments may cause us to materially change our existing strategic direction, capital strategies, compensation or operating plans.
Our continued growth or significant deterioration in our asset quality metrics may require the need for
19
additional capital and further regulatory approvals which, if not obtained, could adversely impact our profitability and implementation of our current business plan.
To continue to grow, we will need to provide sufficient capital to the Bank through earnings generation, additional equity or trust preferred offerings, if the market for these types of offerings develops again, or borrowed funds or any combination of these sources of funds. We may also require additional capital if we experience significant deterioration in asset quality. For certain amounts or types of indebtedness, we may be required to obtain certain regulatory approvals beforehand. We recently received a $17,806 preferred stock investment from the U.S. Treasury under the CPP. The terms of this investment provide incentives for us to replace this capital as soon as practicable; however, 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 and grow our operations could be materially impaired. Should we not be able to obtain such approvals or otherwise not be able to grow our asset base, our ability to attain our long-term profitability goals will be more difficult.
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. We also have operations in Rutherford and Williamson Counties in Tennessee and in late 2007 we acquired First National Bank of Centerville with branches in Centerville and Lyles, Tennessee in Hickman 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 the stability of the housing market, and our profitability is impacted by the changes in general economic conditions in this market. In addition, unfavorable local or national economic conditions, including deterioration in the housing market like those that we are currently experiencing, 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.
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 has deteriorated and could deteriorate further if real estate market conditions continue to decline or fail to stabilize nationally or, more importantly, 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.
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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 for loan losses as a part of their examination process, our earnings and capital could be significantly and adversely affected.
Our business is subject to local real estate market and other local economic conditions.
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, 2008, approximately 84.8% of our loans held for investment were secured by real estate. Of this amount, approximately 28.5% were commercial real estate loans, 28.6% were residential real estate loans, 26.8% were construction and development loans and 0.9% were other real estate loans. 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, like those we are currently experiencing, 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 experience 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 be adversely impacted and our net book value could be reduced.
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.
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The enactment of the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009 may not be able to stabilize the U.S. financial system or the economy and may significantly affect the Company’s financial condition, results of operation or liquidity.
On October 3, 2008, President Bush signed into law the EESA. The legislation was the result of a proposal by Treasury Secretary Henry Paulson to the U.S. Congress on September 20, 2008 in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. On February 17, 2009, President Obama signed the ARRA in an effort to stimulate the economy and provide for broad infrastructure, energy, health, and education needs. The U.S. Treasury and banking regulators are implementing a number of programs under this legislation to address capital and liquidity issues in the banking system. There can be no assurance, however, as to the actual impact that EESA or ARRA will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of EESA or ARRA to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially affect the Company’s business, financial condition, results of operations, access to credit or the trading price of the Common Stock.
There have been numerous actions undertaken in connection with or following EESA and ARRA by the FRS, Congress, the U.S. Treasury, the FDIC, the SEC and others in efforts to address the current liquidity and credit crisis in the financial industry that followed the sub-prime mortgage market meltdown which began in late 2007. These measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. The purpose of these legislative and regulatory actions is to help stabilize the U.S. banking system. EESA, ARRA and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, the Company’s business, financial condition and results of operations could be materially and adversely affected.
Noncore funding represents a large component of our funding base.
In addition to the traditional core deposits, such as demand deposit accounts, interest checking, money market savings and certificates of deposits, we utilize several noncore funding sources, such as brokered certificates of deposit, Federal Home Loan Bank of Cincinnati advances, Federal funds purchased and other sources. We utilize these noncore funding sources to fund the ongoing operations and growth of the Bank. The availability of these noncore funding sources are subject to broad economic conditions and, as such, the pricing on these sources may fluctuate significantly and/or be restricted at any point in time, thus impacting our net interest income, our immediate liquidity and/or our access to additional liquidity.
Brokered certificates of deposit have received scrutiny from regulators in recent months. We impose upon ourselves limitations as to the absolute level of brokered deposits we may have on our balance sheet at any point in time. The pricing of these deposits are subject to the broader wholesale funding market and may fluctuate significantly in a very short period of time. Additionally, the availability of these deposits is impacted by overall market conditions as investors determine whether to invest in the less risky certificates of deposit or in the more risky debt and equity markets. As money flows between these various investment instruments, market conditions will impact the pricing and availability of brokered funds.
In recent months, the financial media has disclosed that the nation’s Federal Home Loan Bank (“FHLB”) system may be under stress due to deterioration in the financial markets, particularly in relation to valuation
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of mortgage securities. Several FHLB institutions have announced impairment charges of these and other assets and as such their capital positions have deteriorated to the point that they may suspend dividend payments to their members. We are a member of the FHLB-Cincinnati which continues to pay dividends. However, should financial conditions continue to weaken, the FHLB system (including FHLB-Cincinnati) in the future may have to, not only suspend dividend payments, but also curtail advances to member institutions like us. Should the FHLB system deteriorate to the point of not being able to fund future advances to banks, including the Bank, this would place increased pressure on other wholesale funding sources, which may negatively impact our net interest margin and results of operations.
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.
While our primary focus in 2009 will be on monitoring credit quality and focusing on the sound operation of our core business, over the longer term 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; |
| |
| | • | | maintain adequate internal audit, loan review and compliance functions; and |
| |
| | • | | 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, 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
23
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, like those now being experienced, 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.
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.
If the federal funds rate remains at current extremely low levels, our net interest margin, and consequently our net earnings, may continue to be negatively impacted.
Because of significant competitive deposit pricing pressures in our market and the negative impact of these pressures on our cost of funds, coupled with the fact that a significant portion of our loan portfolio has variable rate pricing that moves in concert with changes to the FRS’s federal funds rate (which is at an extremely low rate as a result of the current recession), we have experienced net interest margin compression throughout 2008. Because of these competitive pressures, we are unable to lower the rate that we pay on interest-bearing liabilities to the same extent and as quickly as the yields we charge on interest-earning assets. As a result, our net interest margin, and consequently our profitability, has been negatively impacted. If the federal funds rate remains at extremely low levels, our higher funding costs may negatively impact our net interest margin and results of operations.
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
24
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 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 FRS. The Bank is a state chartered bank and comes under the supervision of the Department and the FDIC. The Bank is also governed by the laws of the State of Tennessee and 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; |
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| | • | | limitations on the permissible types, amounts and extensions of credit and investments; |
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| | • | | requirements for brokered deposits; |
| |
| | • | | restrictions on permissible non-banking activities; and |
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| | • | | 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
25
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.
The Preferred Stock that we have issued to the U.S. Treasury impacts net income available to our common shareholders and our earnings per share.
As long as shares of the Preferred Stock are outstanding, no dividends may be paid on our Common Stock unless all dividends on the Preferred Stock have been paid in full. Additionally, for so long as the U.S. Treasury owns shares of the Preferred Stock, we are subject to certain restrictions on our ability to pay dividends on the Common Stock even if we are current in the payment of dividends on the Preferred Stock.See “Supervision and Regulation — Dividends” above. The dividends declared on shares of the Preferred Stock along with the accretion of the discount upon issuance, will reduce the net income available to common shareholders and our earnings per common share.
Holders of the Preferred Stock that we have issued to the U.S. Treasury have rights that are senior to those of our common shareholders.
The Preferred Stock that we have issued to the U.S. Treasury is senior to our shares of Common Stock and holders of the Preferred Stock have certain rights and preferences that are senior to holders of our Common Stock.
Both the Series A Preferred Stock and the Series B Preferred Stock rank senior to our Common Stock and all other equity securities of ours designated as ranking junior to the Preferred Stock. So long as any shares of the Preferred Stock remain outstanding, unless all accrued and unpaid dividends for all prior dividend periods have been paid or are contemporaneously declared and paid in full on the Preferred Stock, no dividend whatsoever shall be paid or declared on our Common Stock or other junior stock, other than, during the first ten years that the Preferred Stock is issued and outstanding, a dividend payable solely in shares of our Common Stock. Furthermore, both the Series A Preferred Stock and the Series B Preferred Stock are entitled to a liquidation preference over shares of our Common Stock in the event of our liquidation, dissolution or winding up.
Holders of the Preferred Stock that we have issued to the U.S. Treasury may, under certain circumstances, have the right to elect two directors to our Board of Directors.
In the event that we fail to pay dividends on either series of the Preferred Stock for an aggregate of six quarterly dividend periods or more (whether or not consecutive), the authorized number of directors then constituting our Board of Directors will be increased by two. Holders of the series of Preferred Stock for which we have failed to pay dividends, together with the holders of any outstanding parity stock with like voting rights, including in the case of the Series A Preferred Stock, the Series B Preferred Stock, and in the case of the Series B Preferred Stock, the Series A Preferred Stock, voting as a single class, will be entitled to elect the two additional Directors, referred to as the preferred stock directors, at the next annual meeting (or at a special meeting called for the purpose of electing the preferred stock directors prior to the next annual meeting) and at each subsequent annual meeting until all accrued and unpaid dividends for all past dividend periods have been paid in full.
Holders of the Preferred Stock that we issued to the U.S. Treasury have limited voting rights.
Except as otherwise required by law and in connection with the election of directors to our Board of Directors in the event that we fail to pay dividends on either series of the Preferred Stock for an aggregate of at least six
26
quarterly dividend periods (whether or not consecutive), holders of the Preferred Stock have limited voting rights. So long as shares of the Preferred Stock are outstanding, in addition to any other vote or consent of shareholders required by law or our amended and restated charter, the vote or consent of holders owning at least 66 2/3% of the shares of Series A Preferred Stock or Series B Preferred Stock, as the case may be, outstanding is required for (1) any authorization or issuance of shares ranking senior to the Series A Preferred Stock or Series B Preferred Stock, as the case may be; (2) any amendment to the rights of the Series A Preferred Stock or Series B Preferred Stock, as the case may be, so as to adversely affect the rights, preferences, privileges or voting power of the Series A Preferred Stock or Series B Preferred Stock, as the case may be; or (3) consummation of any merger, share exchange or similar transaction unless the shares of Series A Preferred Stock or Series B Preferred Stock, as the case may be, remain outstanding, or if we are not the surviving entity in such transaction, are converted into or exchanged for preference securities of the surviving entity and the shares of Series A Preferred Stock or Series B Preferred Stock, as the case may be, remaining outstanding or such preference securities have such rights, preferences, privileges and voting power as are not materially less favorable to the holders than the rights, preferences, privileges and voting power of the shares of Series A Preferred Stock or Series B Preferred Stock, as the case may be.
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.
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.
The Bank operates a branch office at 601 North Garden Street, Columbia, Tennessee. The Bank owns the building and leases the property at this location pursuant to the terms of a lease that expires on December 1, 2026.
In October 2007, the Company acquired First National with branches in Centerville and Lyles, Tennessee. As a result of the acquisition, the Company now owns the building and the property at both locations. In addition, the Company owns a storage facility located at Hackberry Street East in Centerville, Tennessee.
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, Tennessee. 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.
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The Bank operates a branch office at 9045 Carothers Parkway, Franklin, Tennessee in Williamson County. The Bank owns the building and leases 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.
In the fourth quarter of 2008, the Bank opened a new branch office at 4809 Columbia Pike, Thompson’s Station, Tennessee. The Bank owns the building and leases the property.
At December 31, 2008, the cost of office properties and equipment (less allowances for depreciation and amortization) owned by us was $18,253.
ITEM 3. LEGAL PROCEEDINGS
The Company and the Bank are party to certain routine claims and litigation that is incidental to the business and occurs in the normal course of operations. In the opinion of management, none of these matters, when resolved, will have a material effect on the financial position of the Company, the Bank or their respective future operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A special meeting of the Company’s shareholders was held on December 30, 2008 at Community First Bank & Trust Operations Center to vote on the approval of the amendment of the Company’s Amended and Restated Charter to authorize a class of blank check preferred stock, consisting of two million five hundred thousand (2,500,000) authorized shares, which may be issued in one or more series, with such rights, preferences, privileges and restrictions as shall be fixed by the Company’s Board of Directors. The results of the vote for approval of the amendment of the Company’s Amended and Restated Charter were as follows:
| | | | | | | | | | | | | | | | | |
| Shares | | | | | | | | | | | | | | Broker |
| Voting | | For | | Against | | Abstain | | Non-Votes |
| 1,814,879 | | | 1,748,291 | | | | 37,126 | | | | 29,462 | | | | - | |
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PART II
| ITEM 5. | | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
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 13, 2009 there were 2,144 holders of record of the Company’s Common Stock and 3,209,255 shares outstanding, excluding vested options. As of March 13, 2008, there were 187,706 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 5, 2009 at a price of $20.00 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 Company’s high and low prices of which the Company is aware for the relevant quarters during the three fiscal years ended December 31:
| | | | | | | | | |
| 2008 | | High | | Low |
| First quarter | | $ | 30.00 | | | $ | 30.00 | |
| Second quarter | | $ | 30.00 | | | $ | 30.00 | |
| Third quarter | | $ | 30.00 | | | $ | 24.00 | |
| Fourth quarter | | $ | 25.00 | | | $ | 17.00 | |
| | | | | | | | | |
| 2007 | | High | | Low |
| First quarter | | $ | 30.00 | | | $ | 30.00 | |
| Second quarter | | $ | 30.00 | | | $ | 30.00 | |
| Third quarter | | $ | 30.00 | | | $ | 25.00 | |
| Fourth quarter | | $ | 30.00 | | | $ | 25.00 | |
| | | | | | | | | |
| 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 | |
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 $320 in cash dividends and $467 in stock dividends to shareholders in the second quarter of 2008 and $696 in cash dividends to shareholders in the second quarter of 2007. Tennessee law provides that without the approval of the Commissioner of the Tennessee Department of Financial Institutions dividends may be paid by the Bank in an amount equal to net income in the calendar year the dividend is declared plus retained earnings for the prior two years. 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.
In addition to the limitations on the Company’s ability to pay dividends under Tennessee law, the Company’s ability to pay dividends on its Common Stock is also limited by the Company’s participation in the CPP and by certain statutory or regulatory limitations.
Prior to February 27, 2012, unless the Company has redeemed the Senior Preferred and Warrant Preferred
29
shares sold to the U.S. Treasury in connection with the CPP, or the U.S. Treasury has transferred the Senior Preferred and Warrant Preferred shares to a third party, the consent of the U.S. Treasury will be required for the Company to (1) declare or pay any dividend or make any distribution on the Common Stock (other than regular quarterly cash dividends of not more than $0.10 per share of Common Stock) or (2) redeem, purchase or acquire any shares of Common Stock or other equity or capital securities, including trust preferred securities, other than in connection with benefit plans consistent with past practice, and certain other limited circumstances
From February 28, 2012 until February 27, 2019, unless the U.S. Treasury has transferred the Senior Preferred and Warrant Preferred shares to third parties or the Senior Preferred and Warrant Preferred shares have been redeemed in total, the Company may increase the dividends paid to holders of the Common Stock by up to 3% in the aggregate per year over the amount paid in the prior year without the U.S. Treasury’s consent; provided that no increase in common dividends may be made as a result of any dividend paid in common shares, any stock split or any similar transactions. From February 28, 2019 until the Senior Preferred and Warrant Preferred shares held by the U.S. Treasury have been redeemed in whole or the U.S. Treasury has transferred all of the Senior Preferred and Warrant Preferred shares to third parties, the Company may not declare or pay any dividend or make any distribution on any capital stock or other equity securities of the Company other than regular dividends on shares of preferred stock in accordance with the terms thereof and which are permitted by the terms of the Senior Preferred and Warrant Preferred shares, or dividends or distributions by any wholly-owned subsidiary of the Company. Further, during such period the Company may not redeem, purchase or acquire any shares of Common Stock or other capital stock or other equity securities of any kind of the Company, including any trust preferred securities, other than the Senior Preferred and Warrant Preferred shares.
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, including the Senior Preferred and Warrant Preferred shares, and other factors deemed relevant by the Board of Directors. As of December 31, 2008, the Bank could, without prior approval of the Commissioner of the Tennessee Department of Financial Institutions, declare dividends of approximately $3,577 to the Company under applicable restrictions, without regulatory approval. The Bank does not believe that it is at risk of falling into a capital classification lower than “well capitalized” if it pays the entire $3,577 to the Company during 2009 due to the additional capital provided by participation in the CPP, but additional provision expense in excess of that anticipated by the Bank’s management may limit the Bank’s ability to pay dividends to the Company equal to the entire amount. As described above, the Company is also limited in the types and amounts of dividends that can be paid by it due to the provisions of the CPP.
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ITEM 6. SELECTED FINANCIAL DATA(Dollars in thousands, except per share data)
The following selected financial data for the five years ended December 31, 2008, 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.”
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| | | 2008 | | | 2007 (1) | | | 2006 | | | 2005 | | | 2004 | |
INCOME STATEMENT DATA: | | | | | | | | | | | | | | | | | | | | |
| Interest income | | $ | 38,251 | | | $ | 35,369 | | | $ | 25,789 | | | $ | 17,305 | | | | 12,593 | |
| Interest expense | | | 20,976 | | | | 20,606 | | | | 13,528 | | | | 7,006 | | | | 4,272 | |
| Net interest income | | | 17,275 | | | | 14,763 | | | | 12,261 | | | | 10,299 | | | | 8,321 | |
| Provision for loan losses | | | 5,528 | | | | 1,259 | | | | 1,018 | | | | 683 | | | | 720 | |
| Noninterest income | | | 4,503 | | | | 3,697 | | | | 3,125 | | | | 2,356 | | | | 2,107 | |
| Noninterest expense | | | 19,023 | | | | 13,997 | | | | 10,453 | | | | 8,146 | | | | 6,329 | |
| Net income (loss) | | | (1,290 | ) | | | 2,380 | | | | 2,802 | | | | 2,565 | | | | 2,132 | |
| | | | | | | | | | | | | | | | | | | | | |
BALANCE SHEET DATA: | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 715,326 | | | $ | 636,062 | | | $ | 421,393 | | | $ | 328,806 | | | $ | 257,342 | |
| Total securities | | | 76,497 | | | | 80,933 | | | | 35,211 | | | | 29,965 | | | | 27,867 | |
| Total loans, net | | | 561,132 | | | | 484,522 | | | | 344714 | | | | 256,150 | | | | 208,087 | |
| Allowance for loan losses | | | (8,981 | ) | | | (6,086 | ) | | | (4,259 | ) | | | (3,268 | ) | | | (2,740 | ) |
| Total deposits | | | 599,318 | | | | 559,303 | | | | 366,766 | | | | 286,243 | | | | 223,778 | |
| FHLB advances | | | 32,000 | | | | 11,000 | | | | 13,000 | | | | 8,000 | | | | 8,000 | |
| Subordinated debentures | | | 23,000 | | | | 23,000 | | | | 8,000 | | | | 8,000 | | | | 3,000 | |
| Total shareholders’ equity | | | 36,035 | | | | 37,173 | | | | 30,657 | | | | 24,017 | | | | 21,452 | |
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PER SHARE DATA: | | | | | | | | | | | | | | | | | | | | |
| Earnings per share - basic | | $ | (0.40 | ) | | $ | 0.76 | | | $ | 0.97 | | | $ | 0.89 | | | $ | 0.78 | |
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| Earnings (loss) per share - diluted | | | (0.40 | ) | | | 0.73 | | | | 0.94 | | | | 0.86 | | | | 0.75 | |
| Cash dividend declared and paid | | | .10 | | | | 0.22 | | | | 0.20 | | | | - | | | | | |
| Book value | | | 11.23 | | | | 11.72 | | | | 10.17 | | | | 8.36 | | | | 7.49 | |
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PERFORMANCE RATIOS: | | | | | | | | | | | | | | | | | | | | |
| Return on average assets | | | (0.20 | %) | | | 0.47 | % | | | 0.76 | % | | | 0.90 | % | | | 0.90 | % |
| Return on average equity | | | (3.45 | %) | | | 6.77 | | | | 11.14 | | | | 11.38 | | | | 11.37 | |
| Net interest margin (2) | | | 2.81 | % | | | 3.14 | | | | 3.52 | | | | 3.81 | | | | 3.64 | |
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ASSET QUALITY RATIOS: | | | | | | | | | | | | | | | | | | | | |
| Nonperforming loans to total loans | | | 0.59 | % | | | 0.56 | % | | | 0.30 | % | | | 0.20 | % | | | 0.45 | % |
| Net loan charge offs to average loans | | | 0.49 | | | | 0.04 | | | | 0.01 | | | | 0.07 | | | | 0.12 | |
| Allowance for loan losses to total loans | | | 1.58 | | | | 1.24 | | | | 1.22 | | | | 1.26 | | | | 1.30 | |
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CAPITAL RATIOS: | | | | | | | | | | | | | | | | | | | | |
| Leverage ratio (3) | | | 6.00 | % | | | 6.76 | % | | | 9.45 | % | | | 10.25 | % | | | 9.63 | % |
| Tier 1 risk-based capital ratio | | | 6.72 | | | | 7.87 | | | | 10.14 | | | | 11.59 | | | | 11.33 | |
| Total risk-based capital ratio | | | 9.81 | | | | 10.97 | | | | 11.25 | | | | 12.77 | | | | 12.52 | |
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| (1) | | Includes the operations of First National from October 27, 2007, the date the Company acquired all of the outstanding common stock of that bank. |
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| (2) | | Net interest margin is the result of net interest income for the period divided by average interest earning assets. |
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| (3) | | Leverage ratio is defined as Tier 1 capital (pursuant to risk-based capital guidelines) as a percentage of adjusted average assets. |
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)
The following is a discussion of our financial condition at December 31, 2008 and December 31, 2007, and our results of operations for each of the three years in the period ended December 31, 2008. 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.
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 in our Annual Report on Form 10-K and the following:
| | • | | the effects of future economic or business conditions nationally and in our local markets; |
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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, 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.
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 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, Community First Bank & Trust, a Tennessee chartered bank (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 Bank Insurance Fund. The Bank is regulated by the Tennessee Department of Financial Institutions and the Federal Deposit Insurance Corporation (“FDIC”). This report has not been reviewed, or confirmed for accuracy or relevance, by 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.
The Company completed its acquisition of 100% of the outstanding shares of common stock of The First National Bank of Centerville, a national banking association (“First National”) on October 26, 2007 pursuant to the terms of an Agreement and Plan of Reorganization and Share Exchange, dated as of August 1, 2007, by and between the Company and First National. The Company paid $22.8 million to acquire all of the outstanding shares of common stock of First National which it financed through the issuance of $15 million of subordinated debentures and a $8 million distribution from First National.
As a national bank, First National was subject regulation by the Office of the Comptroller of the Currency (OCC) and the FDIC. On January 31, 2008, First National was merged with and into the Bank, with the Bank continuing as the surviving entity.
The Company conducts banking activities from the main office and three branch offices in Columbia, Tennessee, one branch office in Mount Pleasant, Tennessee, one branch office in Franklin, Tennessee, one branch office in Thompson’s Station, Tennessee, one branch office in Murfreesboro, Tennessee, one branch office in Centerville, Tennessee and one branch office in Lyles, Tennessee. The Company also operates eleven automated teller machines in Maury County, four automated teller machines in Williamson County, one automated teller machine in Rutherford County, Tennessee and two automated teller machines in Hickman County, Tennessee.
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The Company’s and its subsidiaries’ 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 noninterest income, including service charges on deposit accounts, mortgage lending income, investment service income, earnings on bank owned life insurance (“BOLI”), and other charges, and fees. The Company’s noninterest 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 this report.
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 of America 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.
Unrealized Losses on Securities Available for Sale.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.
Allowance for Loan Losses.The allowance for loan losses is a valuation allowance for probable incurred losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using the nature and volume of the portfolio, information about specific borrower situations, and estimated collateral values, economic conditions, and other factors in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 114,Accounting by Creditors for Impairments of a loanand Statement of Financial Accounting Standards (“SFAS”) No. 5,Accounting for Contingencies. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loans that, in management’s judgment, should be charged off.
The allowance for loan losses is maintained at a level that management believes will be adequate to absorb probable incurred losses on existing loans at the balance sheet date. Provision to and adequacy of the allowance for loan losses are based on the evaluation of the loan portfolio utilizing objective and subjective criteria, in accordance with SFAS 114 and SFAS 5. The objective criteria primarily include an internal grading system and specific allocations for impaired loans. The Company utilizes a historical analysis to validate the overall adequacy of the allowance for loan losses in accordance with SFAS 5. The subjective criteria take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, and business conditions that may affect the borrowers’ ability to pay, 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
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absorb losses for any and all loans.
Under SFAS 114, a loan is impaired when it is probable that the Company will be unable to collect all amounts due (including both interest and principal) according to the contractual terms of the loan agreement. Generally, a loan is impaired for purposes of SFAS 114 if it exhibits the same level of weaknesses and probability of loss as loans (or portions of loans) classified special mention, substandard, doubtful or loss. Commercial and commercial real estate loans are individually evaluated for impairment. Consumer and residential real estate loans are also 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, net of selling costs, if repayment is expected solely from the collateral.
The Bank automatically places loans on non-accrual when they become 90 days past due, however; when in management’s opinion the borrower may be unable to meet payments the loan may be placed on non-accrual at that time even if not then 90 days past due. Loans may not be placed on nonaccrual if they are well collateralized and in process of collection. When interest is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received.
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. In February 2008, the FASB issued Staff Position (FSP) 157-2,Effective Date of FASB Statement No. 157. This FSP, delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The impact of adoption was not material. In October 2008, the FASB issued FSP 157-3,Determining the Fair Value of a Financial Asset when the Market for That Asset Is Not Active. This FSP clarifies the application of FAS 157 in a market that is not active. The impact of adoption was not material.
In February 2007, the FASB issued Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilities.The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The new standard was effective for the Company on January 1, 2008. The Company did not elect the fair value option for any financial assets or financial liabilities as of January 1, 2008.
ANALYSIS OF RESULTS OF OPERATION
We had a net loss of $1,290 for the year ended December 31, 2008, a decrease of 154.2% over net income of $2,380 for 2007. Net income in 2006 was $2,802. Pretax income declined from $3,204 in 2007 to a loss of $2,773 in 2008. Pretax income in 2006 was $3,915. The decrease in pretax income in 2008 was primarily the result of additional allowance for loan losses recorded through provision expense due to effects of the deteriorating economy in the Company’s market areas on the overall asset quality of the Bank’s loan portfolio, particularly within the real estate construction and development segment of the portfolio. Growth in interest income in 2008 and 2007 was offset in part by the increase in interest expense. The increase in interest expense in 2008 was primarily due to the $15,000 in subordinated debt that was issued in the fourth quarter of 2007. The increase in interest expense in 2007 was due to increases in interest bearing deposits and
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other borrowings and noninterest expenses. Noninterest expenses increased primarily as a result of an increase in salaries, occupancy, and furniture and equipment expenses, most of which is attributable to the First National acquisition and opening of one additional branch location in Williamson County. In 2008, noninterest expense increased by 35.9% while net interest income only increased 17.0% over 2007. In 2007, noninterest expense increased by 33.9% (while net interest income increased 20.4%) over 2006 primarily due to salaries and other operating expenses associated with growth of the Company including adding additional branches in Maury County and expanding in Williamson, Rutherford, and into Hickman Counties. Basic and diluted earnings (loss) per share were both ($0.40) for 2008 compared to $0.76 and $0.73 in 2007. Basic and diluted earnings per share in 2006 were $0.97 and $0.94.
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.
2008 compared to 2007
Net interest income before the provision for loan losses for 2008 increased $2,512, or 17.0%, to $17,275 compared to $14,763 in 2007. The increase was due primarily to continued growth in the Company’s loan portfolio, which was funded primarily by deposit growth and other borrowings. The increase in volume for loans and deposits was significantly offset by declines in interest rates during 2008.
Interest and fee income on loans in 2008 was $34,713, an increase of $2,056, or 6.3%, over 2007. The increase in interest income is due to growth and higher average balances on loans. The increase in loan interest income was offset by significant declines in market interest rates during 2008 as the federal funds rate dropped 400 basis points in 2008. Average gross loans increased 31.3% while loan interest income increased only 6.3% during 2008 compared to an increase of 34.1% in average loans and a 35.9% increase in loan interest income during 2007. During 2008, approximately 36.5% of our loan portfolio was tied to a variable rate.
Interest income for tax exempt and taxable securities was $3,217, an increase of $978, or 43.7%, over 2007. The increase in interest income was the result of securities acquired through the purchase of First National in October 2007 and purchase of approximately $16,000 in additional securities during the fourth quarter of 2008 as replacement collateral for public funds previously collateralized by surety bonds no longer issued by the insurance company.
Although net interest income increased, our net interest margin continued to experience compression throughout 2008, declining to 2.81% from 3.14% in 2007, a decrease of 33 basis points (“bps”). The decline in net interest margin was primarily due to the decrease in market rates during 2008.As a result of competitive pricing pressures our loans tend to reprice more quickly than our deposits and other funding liabilities.
The yield on interest earning assets decreased 130 bps to 6.23% in 2008, compared to 7.53% in 2007. This decrease was primarily due to the decline in market rates during 2008. The decrease in loan yield was somewhat offset by modest increases in securities yields. Interest and fee income on loans increased $2,056 over 2007. That increase is comprised of a $10,217 increase due to volume offset by $8,161 decrease due to rates. Investment yields increased 56 bps to 5.18% in 2008, compared to 4.62% in 2007. The increase of $978 in investment income in 2008 was attributed primarily to the increase in volume of $624. The remainder of the increase was due to the change in yield of $354.
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Interest expense totaled $20,976 for the year ended 2008, compared to $20,606 in 2007, an increase of $370, or 1.8%. The increase in interest expense was due to $15,000 in subordinated debt that was issued in the third quarter of 2007 bearing a full year’s expense in 2008. Interest expense on deposits decreased $323, or 1.7%, during 2008 due to the effects of exceptionally low fed funds and market rates during the year. Interest expense on time deposits over $100,000 decreased $356 in 2008. The decrease of $356 was due to an increase of $3,950 in volume offset by a decrease of $4,306 due to interest rates. During 2007, the Bank became more dependent upon broker deposits and national market CDs which were only available at rates that were higher than our cost of funds for core deposits. In 2008, the cost of broker deposits and national market CDs dropped below our cost of funds for core deposits due to competitive pricing in the local market for other core deposits. As a result, we were able to replace the higher rate deposits with lower rate deposits during 2008 and acquire additional funding through those sources. Broker deposits increased $28,625 and national market CDs increased $7,056 during 2008.
2007 compared to 2006
Net interest income before the provision for loan losses for 2007 increased $2,502, or 20.4%, to $14,763 compared to $12,261 in 2006. The increase was due primarily to continued growth in the Company’s loan portfolio, which was funded primarily by deposit growth, as well as the Company’s acquisition of First National in the fourth quarter of 2007. The addition of First National increased net interest income $708 in 2007.
Interest and fee income on loans in 2007 was $32,657, an increase of $8,634, or 35.9%, over 2006. The increase in interest income is due to growth and higher average balances on loans. During 2007, approximately 49% of our loan portfolio was tied to a variable rate.
Interest income for tax exempt and taxable securities was $2,239, an increase of $723, or 47.7%, over 2006. The increase in interest income was the result of the acquisition of First National in October 2007 with First National’s investment securities totaling $54,385 at acquisition. Interest income also increased due to higher average balances as well as opportunities to reinvest in higher-yield bonds provided by the short term maturity structure of the investment portfolio. First National had $41,228 in its investment portfolio at year end 2007 which generated $380 of interest income after the acquisition date.
Although net interest income increased, our net interest margin continued to experience compression throughout 2007, declining to 3.14% from 3.52% in 2006, a decrease of 38 bps. We experienced challenging competitive conditions and continued competitive pricing pressures throughout 2007, which contributed to the decline in net interest margin. The Bank’s increased costs of funding resulting from competitive deposit pricing pressure in the Bank’s primary market area and its reliance on brokered and national market deposits contributed to the decline in our net interest margin in 2007.
The yield on interest earning assets increased 13 bps to 7.53% in 2007, compared to 7.40% in 2006. This increase was primarily due to continued growth in the loan portfolio and the growth in the investment portfolio. Interest and fee income on loans increased $8,634 over 2006, with $8,200 of the increase due to the increase in the volume of loans. Loan yields increased only 10 bps over 2006 due to the Federal Reserve Bank cutting rates in the fourth quarter of 2007, which negatively impacted 49% of our portfolio that were variable rate loans. Investment yields increased 35 bps to 4.62% in 2007, compared to 4.27% in 2006. The increase of $723 in investment income was attributed primarily to the increase in volume of $557.
Interest expense totaled $20,606 for the year ended 2007, compared to $13,528 in 2006, an increase of $7,078, or 52.3%. The increase in interest expense was due to deposit growth in higher costing deposits, consisting primarily of time deposits, as well as an increase in higher costing brokered deposits and national market deposits. Interest expense on time deposits over $100,000 increased $1,787 in 2007. The increase of
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$1,787 was due to $188 in volume and $1,599 due to interest rates. However, an increase in interest expense of $3,848 in other time deposits was attributed primarily to the increase in volume. The increase in interest expense was also due to additional interest expense of $318 associated with the $15,000 of subordinated debentures issued by us in the third quarter of 2007 to finance a portion of the purchase price for the acquisition of First National. The cost of interest bearing deposits and other liabilities followed the same trend, increasing 51 bps to 4.87% in 2007, up from 4.36% in 2006.
Average Balance Sheets, Net Interest Income
Changes in Interest Income and Interest Expense
The following table shows the average daily balances of each principal category of our assets, liabilities and stockholders’ equity and an analysis of net interest income for the three years ended December 31.
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| | | Average | | | Interest | | | Revenue/ | | | Average | | | Interest | | | Revenue/ | | | Average | | | Interest | | | Revenue/ | |
| | | Balance | | | Rate | | | Expense | | | Balance | | | Rate | | | Expense | | | Balance | | | Rate | | | Expense | |
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| Gross loans (1 and 2) | | $ | 542,456 | | | | 6.40 | % | | $ | 34,713 | | | $ | 413,185 | | | | 7.90 | % | | $ | 32,657 | | | $ | 308,039 | | | | 7.80 | % | | $ | 24,023 | |
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| Securities available for sale (3) | | | 62,121 | | | | 5.18 | % | | | 3,217 | | | | 48,490 | | | | 4.62 | % | | | 2,239 | | | | 35,465 | | | | 4.27 | % | | | 1,516 | |
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| Federal funds sold and other | | | 9,248 | | | | 3.47 | % | | | 321 | | | | 8,079 | | | | 5.85 | % | | | 473 | | | | 4,824 | | | | 5.18 | % | | | 250 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest earning assets | | | 613,825 | | | | 6.23 | % | | | 38,251 | | | | 469,754 | | | | 7.53 | % | | | 35,369 | | | | 348,328 | | | | 7.40 | % | | | 25,789 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Cash and due from banks | | | 9,454 | | | | | | | | | | | | 8,847 | | | | | | | | | | | | 7,547 | | | | | | | | | |
| Other nonearning assets | | | 39,182 | | | | | | | | | | | | 26,120 | | | | | | | | | | | | 15,696 | | | | | | | | | |
| Allowance for loan losses | | | (6,681 | ) | | | | | | | | | | | (4,879 | ) | | | | | | | | | | | (3,745 | ) | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 655,780 | | | | | | | | | | | $ | 499,842 | | | | | | | | | | | $ | 367,826 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW & money market investments | | $ | 88,167 | | | | 1.55 | % | | $ | 1,368 | | | $ | 61,043 | | | | 2.75 | % | | $ | 1,679 | | | $ | 47,022 | | | | 2.24 | % | | $ | 1,053 | |
| Savings | | | 20,717 | | | | 0.61 | % | | | 126 | | | | 12,550 | | | | 1.17 | % | | | 147 | | | | 8,872 | | | | 1.33 | % | | | 118 | |
| Time deposits $100,000 and over | | | 156,005 | | | | 4.05 | % | | | 6,326 | | | | 98,047 | | | | 6.82 | % | | | 6,682 | | | | 94,416 | | | | 5.18 | % | | | 4,895 | |
| Other time deposits | | | 244,100 | | | | 4.26 | % | | | 10,402 | | | | 218,509 | | | | 4.59 | % | | | 10,037 | | | | 137,488 | | | | 4.50 | % | | | 6,189 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing deposits | | | 508,989 | | | | 3.58 | % | | | 18,222 | | | | 390,149 | | | | 4.75 | % | | | 18,545 | | | | 287,798 | | | | 4.26 | % | | | 12,255 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Other borrowings | | | 56,150 | | | | 4.90 | % | | | 2,754 | | | | 32,882 | | | | 6.27 | % | | | 2,061 | | | | 22,698 | | | | 5.61 | % | | | 1,273 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing liabilities | | | 565,139 | | | | 3.71 | % | | | 20,976 | | | | 423,031 | | | | 4.87 | % | | | 20,606 | | | | 310,496 | | | | 4.36 | % | | | 13,528 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing liabilities | | | 53,234 | | | | | | | | | | | | 41,635 | | | | | | | | | | | | 32,173 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total liabilities | | | 618,373 | | | | | | | | | | | | 464,666 | | | | | | | | | | | | 342,669 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Shareholders’ equity | | | 37,407 | | | | | | | | | | | | 35,176 | | | | | | | | | | | | 25,157 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total liabilities and shareholders’ equity | | $ | 655,780 | | | | | | | | | | | $ | 499,842 | | | | | | | | | | | $ | 367,826 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income | | | | | | | | | | $ | 17,275 | | | | | | | | | | | $ | 14,763 | | | | | | | | | | | $ | 12,261 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest margin (4) | | | | | | | 2.81 | % | | | | | | | | | | | 3.14 | % | | | | | | | | | | | 3.52 | % | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | |
| 1 | | Interest income includes fees on loans of $1,039, $1,267 and $1,131 in 2008, 2007 and 2006. |
| |
| 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 our 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
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | |
| | | 2008 to 2007 | | | 2007 to 2006 | |
| | | Due to | | | Due to | | | | | | | Due to | | | Due to | | | | |
| | | Volume (1) | | | Rate (2) (3) | | | Total | | | Volume (1) | | | Rate (2) (3) | | | Total | |
| | | |
| Interest Income: | | | | | | | | | | | | | | | | | | | | | | | | |
| | | |
| Gross loans (a and b) | | $ | 10,212 | | | $ | (8,156 | ) | | $ | 2,056 | | | $ | 8,201 | | | $ | 433 | | | $ | 8,634 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Securities available for sale | | | 630 | | | | 348 | | | | 978 | | | | 556 | | | | 167 | | | | 723 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal funds sold and other | | | 68 | | | | (220 | ) | | | (152 | ) | | | 169 | | | | 54 | | | | 223 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest earning assets | | | 10,910 | | | | (8,028 | ) | | | 2,882 | | | | 8,926 | | | | 654 | | | | 9,580 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Expense: | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW & money market investments | | $ | 746 | | | $ | (1,057 | ) | | $ | (311 | ) | | $ | 314 | | | $ | 312 | | | $ | 626 | |
| Savings | | | 96 | | | | (117 | ) | | | (21 | ) | | | 49 | | | | (20 | ) | | | 29 | |
| Time deposits $100,000 and over | | | 3,953 | | | | (4,309 | ) | | | (356 | ) | | | 188 | | | | 1,599 | | | | 1,787 | |
| Other time deposits | | | 1,175 | | | | (810 | ) | | | 365 | | | | 3,646 | | | | 202 | | | | 3,848 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing deposits | | | 5,970 | | | | (6,293 | ) | | | (323 | ) | | | 4,197 | | | | 2,093 | | | | 6,290 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Other borrowings | | | 1,459 | | | | (766 | ) | | | 693 | | | | 571 | | | | 217 | | | | 788 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing liabilities | | | 7,429 | | | | (7,059 | ) | | | 370 | | | | 4,768 | | | | 2,310 | | | | 7,078 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income | | $ | 3,481 | | | $ | (969 | ) | | $ | 2,512 | | | $ | 4,158 | | | $ | (1,656) | | | $ | 2,502 | |
| | | | | | | | | | | | | | | | | | | |
| | |
| a | | Interest income includes fees on loans of $1,039, $1,267 and $1,131 in 2008, 2007 and 2006. |
| |
| b | | 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, earnings on bank owned life insurance policies (BOLI), and other noninterest income.
2008 compared to 2007
Noninterest income for the year ended December 31, 2008 increased 21.8% to $4,503 compared to $3,697 in 2007. Service charges on deposit accounts are our largest source of noninterest income and increased $486, or 29.6%, to $2,130 in 2008 compared to $1,644 in 2007. The largest component of the increase in service charge income was from accounts acquired at First National during October 2007. New accounts opened through our new Thompson’s Station branch and regular growth in existing markets also contributed to the increase. The largest component of service charges on deposits is the Bank’s overdraft courtesy product, which generated $1,000 for 2008 compared to $863 in 2007.
The Bank originates and sells long-term fixed rate mortgages and the related servicing. Mortgage loans originated and sold generated $1,025 in gains for 2008, a decrease of $187, or 15.4%, compared to $1,212 in
39
2007. Income from mortgage loans originated and sold was impacted negatively in 2008 by conditions in the economy, particularly in the housing market, which reduced demand for mortgage loans.
Gain on sale of securities available for sale increased $239 to $258 in 2008 compared to $19 in 2007. The increase is due to the Company selling certain securities acquired through the purchase of First National, resulting in the reported gain. The securities were sold in order to fund loan growth during 2008. Investment services income increased $144 to $456 in 2008 compared to $312 in 2007. The increase is due to increasing staff and expanding investment services into Hickman County. Earnings on bank owned life insurance policies (BOLI) increased 58.0% or $87 to $237 in 2008 compared to $150 in 2007. The increase is due to the Company purchasing an additional $4,000 in policies during 2008. Increases in ATM income, and other customer fees are due to continued growth of the Bank’s customer base.
The decrease in other service charges, commissions and fees is due primarily due to a decrease in income from our investment in the Appalachian Fund for Growth II, LLC, an unconsolidated corporation which qualifies as a “Community Development Entity” and provides loans to low-income communities.
Management expects that noninterest income will continue to increase in 2009 as low interest rates have increased market demand for mortgage loan originations and continued expansion of our investment services. Service charges on deposit accounts, ATM income, and other customer fees are expected to increase due to regular growth of the Bank through its existing markets.
2007 compared to 2006
Noninterest income for the year ended December 31, 2007 increased 18.3% to $3,697 compared to $3,125 in 2006. Service charges on deposit accounts were our largest source of noninterest income and increased $124, or 8.2%, to $1,644 in 2007 compared to $1,520 in 2006. The largest component of the increase in service charge income was $71 from accounts at First National. First National was acquired by the Company in the fourth quarter of 2007. The Bank’s overdraft courtesy product generated $863 for 2007 compared to $1,037 in 2006. Mortgage loans originated and sold generated $1,212 in gains for 2007, an increase of $546, or 82.0%, compared to $666 in 2006. Income from mortgage loans originated and sold was impacted positively in 2007 by increasing our mortgage origination staff from 4 in 2006 to 9 in 2007 and expanding into Williamson and Rutherford Counties. 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 for this property. During 2006 the Bank sold this loan to another financial institution and recognized the $390 gain into other noninterest income. First National sold investments during the fourth quarter of 2007 with a gain of $19. Other noninterest income increased $107, or 152.9%, to $177 in 2007 from $70 in 2006. The increase in other noninterest income was primarily due to the Appalachian Fund for Growth II, LLC and an increase in BOLI cash surrender value.
40
The table below shows noninterest income for each of the three years ended December 31:
| | | | | | | | | | | | | | | | | | | | | | | |
| |
| | | | | | | | 2008 | | | 2007 | | | 2006 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | Service charges on deposit accounts | | | | | | | | $ | 2,130 | | | | $ | 1,644 | | | | $ | 1,520 | | |
| | Mortgage banking activities | | | | | | | | | 1,025 | | | | | 1,212 | | | | | 666 | | |
| | Net gains on sale of securities | | | | | | | | | 258 | | | | | 19 | | | | | - | | |
| | Gain on sale of land | | | | | | | | | - | | | | | - | | | | | 390 | | |
| | Investment services income | | | | | | | | | 456 | | | | | 312 | | | | | 228 | | |
| | Earnings on bank owned life insurance policies | | | | | | | | | 237 | | | | | 150 | | | | | 138 | | |
| | ATM income | | | | | | | | | 135 | | | | | 119 | | | | | 74 | | |
| | Other customer fees | | | | | | | | | 121 | | | | | 64 | | | | | 39 | | |
| | Other: | | | | | | | | | | | | | | | | | | | | | |
| | Other equity investment income | | | | | | | | | 14 | | | | | 9 | | | | | 15 | | |
| | Other service charges, commissions, and fees | | | | | | | | | 95 | | | | | 135 | | | | | 5 | | |
| | Check printer income | | | | | | | | | 22 | | | | | 22 | | | | | 24 | | |
| | Credit life insurance commissions | | | | | | | | | 10 | | | | | 11 | | | | | 26 | | |
| | Total noninterest income | | | | | | | | $ | 4,503 | | | | $ | 3,697 | | | | $ | 3,125 | | |
| |
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.
2008 compared to 2007
Noninterest expense for the year ended December 31, 2008 increased 35.9% to $19,023 compared with $13,997 in 2007. During 2008 and 2007, noninterest expenses have increased as a result of the Bank’s expansion. The growth in noninterest expenses throughout 2008 was attributable primarily to salaries and other operating expenses associated with our growth and expansion into Hickman County through our acquisition of First National in the fourth quarter of 2007 and the addition of the new Thompson’s Station branch in Williamson County. Salaries and employee benefits increased $1,953, or 27.5%, to $9,049 in 2008 compared to $7,096 in 2007. The Company’s staff increased from 142 full time equivalent employees in 2007 to 153 in 2008, an increase of 11 employees. Total salaries expense in 2008 was also impacted by the impact of a full year’s salary of 32 employees acquired from First National. Also, included in salaries and employee benefits expense is stock based compensation expense of $226 for 2008 and $253 in 2007. The remaining increase of $3,073 was associated with operating expenses including occupancy expense, furniture, equipment and auto expense, data processing, advertising, audit and accounting, and other expenses. See the table below for details of changes in noninterest expenses for 2008 and 2007. Management expects that noninterest expenses in total will continue to increase moderately during 2009 but should decline as a percentage of average assets as we continue to experience operating efficiencies as our growth continues. We also anticipate a significant increase in FDIC assessments during 2009 as a result of an increase in assessment rates as a result of depletion of the FDIC reserve funds due to an increase in bank failures during 2008 and additional increases in rates related to the Temporary Liquidity Guarantee Program.
41
2007 compared to 2006
Noninterest expense for the year ended December 31, 2007 increased 33.9% to $13,997 compared with $10,453 in 2006. During 2007 and 2006, noninterest expenses have increased as we have expanded our operations. The growth in noninterest expenses throughout 2007 and 2006 was attributable primarily to salaries and other operating expenses associated with our growth and expansion into Williamson and Rutherford Counties and into Hickman County through our acquisition of First National in the fourth quarter of 2007. Salaries and employee benefits increased $1,645, or 30.2%, to $7,096 in 2007 compared to $5,451 in 2006. The Company’s staff increased from 96 full time equivalent employees in 2006 to 142 in 2007, an increase of 46 employees. During the fourth quarter of 2007, we acquired First National and 32 employees were added to our staff. Also, included in salaries and employee benefits expense is stock based compensation expense of $253 for 2007 and $307 in 2006. The remaining increase of $1,899 was associated with operating expenses including data processing, advertising, audit and accounting, and other expenses.
The table below shows noninterest expense for each of the three years ended December 31:
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| | | | | | | | | | | | | |
| Salaries and employee benefits | | $ | 9,049 | | | $ | 7,096 | | | $ | 5,451 | |
| Occupancy expense | | | 1,459 | | | | 864 | | | | 550 | |
| Furniture and equipment expense | | | 1,013 | | | | 721 | | | | 545 | |
| Data processing | | | 954 | | | | 873 | | | | 684 | |
| Advertising and public relations | | | 812 | | | | 719 | | | | 509 | |
| Audit, accounting and legal | | | 481 | | | | 368 | | | | 277 | |
| Operational expense | | | 902 | | | | 763 | | | | 476 | |
| Regulatory and compliance expense | | | 445 | | | | 254 | | | | 107 | |
| ATM expense | | | 463 | | | | 331 | | | | 222 | |
| Amortization of intangible asset | | | 429 | | | | - | | | | - | |
| Other: | | | | | | | | | | | | |
| Holding losses on loans held for sale | | | 93 | | | | - | | | | - | |
| Other insurance expense | | | 201 | | | | 150 | | | | 88 | |
| Printing | | | 133 | | | | 25 | | | | 19 | |
| Other employee expenses | | | 306 | | | | 235 | | | | 210 | |
| Dues and memberships | | | 105 | | | | 81 | | | | 69 | |
| Other real estate expense | | | 260 | | | | 156 | | | | 25 | |
| Loan expense | | | 133 | | | | 139 | | | | 146 | |
| Directors expense | | | 210 | | | | 174 | | | | 152 | |
| Postage and freight | | | 365 | | | | 324 | | | | 268 | |
| Miscellaneous chargeoffs | | | 209 | | | | 70 | | | | 93 | |
| Miscellaneous taxes and fees | | | 231 | | | | 100 | | | | 140 | |
| Federal Reserve and other bank charges | | | 122 | | | | 78 | | | | 63 | |
| Other | | | 648 | | | | 476 | | | | 359 | |
| | | | | | | | | | |
| Total noninterest expense | | $ | 19,023 | | | $ | 13,997 | | | $ | 10,453 | |
| | | | | | | | | | |
Provisions for Loan Losses
During 2008, we provided $5,528 for loan losses, a substantial increase of $4,269, or 339.1%, over $1,259 in 2007. The increase in provision was primarily due to higher net charge offs reflecting the negative effects of the local and national economy on the Bank’s customer’s ability to meet scheduled loan payments, increasing delinquency and default rates for the Bank. The customer credit problem was further impacted by declining market values for real estate collateral securing loans due to decreases in property values. The increase in the provision was also partially due to regular growth of the Bank’s loan portfolio. Gross loans increased 16.2% or $79,505 in 2008.
42
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 probable loan losses. Other factors considered by management include the composition of the loan portfolio, current and anticipated economic conditions, and the creditworthiness of our borrowers and other related factors. See the further discussion under “Critical Account Policies — Allowance for Loan Losses.”
Income Taxes
The effective income tax rates were (53.5%), 25.7%, and 28.4%, for 2008, 2007 and 2006, respectively. The change in the effective tax rate for 2008 as compared to 2007 was primarily because items that reduce taxable income or tax credits have the effect of increasing the effective tax benefit rate when applied to a pre tax loss; whereas, these items decrease the effective tax rate when applied to pretax income.
Analysis of Financial Condition
Total assets at December 31, 2008 were $715,326, an increase of $79,264, or 12.5%, over 2007 year end assets of $636,062. Average assets for 2008 were $655,780, an increase of $155,938 or 31.2% over average assets for 2007.
The primary reason for the increase in total assets was growth in the loan portfolio, offset by decreases in cash and cash equivalents, securities, and an increase in the allowance for loan losses. The increase in total assets was funded primarily through growth in deposits, additional borrowings, and the reduction in securities. Changes for each major class of assets and liabilities are discussed below.
Loans
Gross loans (excluding mortgage loans held for sale) grew from $490,608 at December 31, 2007, to $570,113 at December 31, 2008, an increase of $79,505, or 16.2%. Mortgage loans held for sale at December 31, 2008, were $6,107 compared to $5,710 at December 31, 2007, an increase of $397. The majority of the loan growth is attributable to real estate loans. 58.0% of the loan growth in 2008 is attributable to commercial real estate loans, 15.1% is attributable to construction loans secured by real estate, and 14.8% is attributable to 1-4 family loans.
Of the total loans of $570,113 in the portfolio as of year end 2008, $208,027, or 36.5% were variable rate loans and $362,086 were fixed rate loans.
On December 31, 2008, the Company’s loan to deposit ratio (including mortgage loans held for sale) was 96.1%, compared to 88.7% in 2007. The loan to asset ratio (including mortgage loans held for sale) was 80.6% for 2008, compared to 78.0% in 2007. Management expects loan demand to slow substantially in 2009, particularly in commercial real estate, residential construction, and residential development loans which represent a significant portion of the Company’s loan portfolio, as a result of economic conditions.
43
The following table presents various categories of loans contained in our loan portfolio for the periods indicated and the total amount of all loans for such period:
| | | | | | | | | | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| Real estate | | | | | | | | | | | | | | | | | | | | |
| Construction | | $ | 152,937 | | | $ | 140,905 | | | $ | 93,704 | | | $ | 61,530 | | | $ | 36,241 | |
| 1-4 family residential | | | 163,211 | | | | 151,478 | | | | 96,309 | | | | 79,634 | | | | 67,844 | |
| Commercial | | | 162,475 | | | | 116,327 | | | | 90,147 | | | | 69,549 | | | | 66,319 | |
| Other | | | 4,779 | | | | 4,567 | | | | 3,009 | | | | 894 | | | | 288 | |
| Commercial, financial and agricultural | | | 62,674 | | | | 50,240 | | | | 46,942 | | | | 36,601 | | | | 30,068 | |
| Tax exempt | | | 354 | | | | - | | | | - | | | | - | | | | - | |
| Consumer | | | 13,965 | | | | 14,969 | | | | 11,560 | | | | 10,803 | | | | 9,597 | |
| Other | | | 9,718 | | | | 12,122 | | | | 7,302 | | | | 407 | | | | 470 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total loans | | $ | 570,113 | | | | 490,608 | | | | 348,973 | | | | 259,418 | | | | 210,827 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses | | | (8,981 | ) | | | (6,086 | ) | | | (4,259 | ) | | | (3,268 | ) | | | (2,740 | ) |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Total loans (net of allowance) | | | 561,132 | | | $ | 484,522 | | | $ | 344,714 | | | $ | 256,150 | | | $ | 208,087 | |
| | | | | | | | | | | | | | | | |
The following is a presentation of an analysis of maturities of loans as of December 31, 2008:
| | | | | | | | | | | | | | | | | |
| | | Due in 1 | | Due in 1 | | Due after | | |
| Type of Loan | | year or less | | to 5 years | | 5 Years | | Total |
| | | | | | | | | | | | | | | | | |
| Commercial, financial and agricultural | | | 31,127 | | | | 28,060 | | | | 3,487 | | | | 62,674 | |
| Commercial real estate | | | 44,330 | | | | 111,230 | | | | 6,915 | | | | 162,475 | |
| Real estate-construction | | | 126,104 | | | | 26,198 | | | | 635 | | | | 152,937 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Total | | | 201,561 | | | | 165,488 | | | | 11,037 | | | | 378,086 | |
| | | | | | | | | | | | | | | | | |
The following is a presentation of an analysis of sensitivities of loans to changes in interest rates as of December 31, 2008 for the loan types mentioned above:
| | | | | |
| Loans due after 1 year with predetermined interest rates | | $ | 173,055 | |
| Loans due after 1 year with floating, or adjustable, interest rates | | | 3,470 | |
| | | | |
| | | $ | 176,525 | |
| | | | |
44
Asset Quality
The following table presents information regarding impaired, nonaccrual, past due and restructured loans at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | |
| | | December 31, |
| | | 2008 | | 2007 | | 2006 | | 2005 | | 2004 |
| Loans considered by management as impaired: | | | | | | | | | | | | | | | | | | | | |
| Number | | | 67 | | | | 67 | | | | 38 | | | | 20 | | | | 10 | |
| Amount | | $ | 4,201 | | | $ | 3,945 | | | $ | 1,416 | | | $ | 117 | | | $ | 905 | |
| | | | | | | | | | | | | | | | | | | | | |
| Loans accounted for on nonaccrual basis: | | | | | | | | | | | | | | | | | | | | |
| Number | | | 59 | | | | 63 | | | | 27 | | | | 12 | | | | 10 | |
| Amount | | $ | 3,357 | | | $ | 2,764 | | | $ | 1,059 | | | $ | 508 | | | $ | 905 | |
| | | | | | | | | | | | | | | | | | | | | |
| Accruing loans (including consumer loans) which are contractually past due 90 days or more as to principal and interest payments: | | | | | | | | | | | | | | | | | | | | |
| Number | | | 5 | | | | - | | | | - | | | | - | | | | - | |
| Amount | | $ | 7 | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Loans defined as “troubled debt restructurings” | | | | | | | | | | | | | | | | | | | | |
| Number | | | - | | | | - | | | | - | | | | - | | | | - | |
| Amount | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Other classified loans not included above | | $ | 16,787 | | | $ | 4,882 | | | $ | - | | | $ | - | | | $ | - | |
As of December 31, 2008, there were $16,787 in loans classified by management as doubtful or substandard that are not on nonaccrual, 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 not 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.
Interest income on 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; however, these loans have not reached a point where management considers them to be nonperforming or impaired.
There are no other loans which are not disclosed above 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.
The following table presents information regarding loans included as nonaccrual and the gross income that would have been recorded in the period if the loans had been current.
| | | | | | | | | | | | | | | | | | | | | |
| | | 2008 | | 2007 | | 2006 | | 2005 | | 2004 |
| Nonaccrual interest | | $ | 567 | | | $ | 355 | | | $ | 144 | | | $ | 30 | | | $ | 45 | |
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The commercial real estate market has declined significantly as a result of local and national economic recession during 2008. Real estate related loans, including commercial real estate loans, residential construction and residential development and 1-4 family residential loans, comprised almost 85% of the Company’s loan portfolio at December 31, 2008. Market conditions for residential development and residential construction have seen substantial declines due to the effects of the recession on individual developers, contractors and builders. In the short term, the Company anticipates the market conditions for residential development and residential construction to remain depressed, and loan growth in the residential loan portfolio is expected to lag historical growth levels. Credit quality will also continue to decline. The Company has identified specific credit issues within the residential development and residential construction loan portfolio. These issues are primarily the result of the decline in demand for residential properties. Management and the Board seek to monitor market conditions and risks identified within the loan portfolio, particularly within these key areas. The increase in risk associated with the loan portfolio as a result of economic conditions and specifically identified credit issues contributed to the increase in the Company’s allowance for loan losses, net charge offs and provision for in loan losses in 2008.
Nonperforming loans are defined as nonaccrual loans, loans still accruing but past due 90 days or more, and restructured loans. The following table presents information regarding nonperforming loans at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| Loans secured by real estate | | $ | 2,868 | | | $ | 2,301 | | | $ | 843 | | | $ | 436 | | | $ | 867 | |
| | | | | | | | | | | | | | | | | | | | | |
| Commercial and Industrial | | | 300 | | | | 194 | | | | 191 | | | | 34 | | | | - | |
| Consumer | | | 187 | | | | 256 | | | | 25 | | | | - | | | | 38 | |
| Other | | | 2 | | | | 13 | | | | - | | | | 38 | | | | - | |
| | | | | | | | | | | | | | | | |
| Total | | $ | 3,357 | | | $ | 2,764 | | | $ | 1,059 | | | $ | 508 | | | $ | 905 | |
| | | | | | | | | | | | | | | | |
Management classifies commercial and commercial real estate loans as nonaccrual loans when principal or interest is past due 90 days or more and the loan is not adequately collateralized. Also loans are classified as nonaccrual when, in the opinion of management, principal or interest is not likely to be paid in accordance with the terms of the obligation and the loan is not in the process of collection. Nonaccrual 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 good 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.
Other real estate owned increased $7,343 to $8,041 at December 31, 2008 compared to $698 at December 31, 2007. The increase in other real estate is due to the effects of the recession during 2008 on individual borrowers, resulting in an increase in foreclosures. Included in the balance at year end 2008 are loans totaling $2,269 that were originated to facilitate the sale of other real estate. Under current accounting rules, loans of this nature must be reported as other real estate owned until the loan to value ratio is below a certain level, depending on the type of loan. $428 of the reclassified loans are performing in accordance with the loan agreement. Interest income from those loans is included in loan interest income. At December 31, 2007, loans reclassified as other real estate owned totaled $104. Management is working to sell the properties that are owned in order to recover the Bank’s investment in the loans that ultimately resulted in foreclosure. It is possible that the balance of other real estate owned could increase during 2009 due to the continuing economic recession potentially leading to additional foreclosures and low demand for both residential and commercial properties could require the Bank to hold the properties for a longer period of time. The Company makes every effort to avoid foreclosure, particularly for owner occupied residential properties. We anticipate being able to work with the Treasury and other government agencies as new legislation and
46
initiatives are introduced to help slow the rate of foreclosure during the current economic downturn. The increase in other real estate owned during 2008 will likely result in a decrease in interest income in 2009 due to other real estate being considered a non-earning asset and an increase in noninterest expense due to expenses associated with maintaining the properties that are owned.
Summary of Loan Loss Experience
An analysis of our loss experience is furnished in the following table for the periods indicated, as well as a breakdown of the allowance for loan losses:
| | | | | | | | | | | | | | | | | | | | | |
| | | December 31, | |
| | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| Balance at beginning of period | | $ | 6,086 | | | $ | 4,259 | | | $ | 3,268 | | | $ | 2,740 | | | $ | 2,249 | |
| Increase due to acquisition of First National | | | - | | | | 730 | | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Charge offs: | | | | | | | | | | | | | | | | | | | | |
| Commercial, financial and agricultural | | | (449 | ) | | | (86 | ) | | | (8 | ) | | | (98 | ) | | | (66 | ) |
| Real Estate-construction | | | (1,621 | ) | | | - | | | | - | | | | - | | | | - | |
| Real Estate-1 to 4 family residential | | | (410 | ) | | | (47 | ) | | | - | | | | (14 | ) | | | (7 | ) |
| Real Estate-commercial | | | - | | | | (2 | ) | | | - | | | | - | | | | - | |
| Real Estate-other | | | - | | | | - | | | | - | | | | - | | | | - | |
| Consumer and other loans | | | (273 | ) | | | (77 | ) | | | (42 | ) | | | (121 | ) | | | (179 | ) |
| | | | | | | | | | | | | | | | |
| | | | (2,753 | ) | | | (212 | ) | | | (50 | ) | | | (233 | ) | | | (252 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Recoveries: | | | | | | | | | | | | | | | | | | | | |
| Commercials, financials and agriculture | | | 3 | | | | 27 | | | | - | | | | - | | | | - | |
| Real Estate-construction | | | 7 | | | | - | | | | - | | | | - | | | | - | |
| Real Estate-1 to 4 family residential | | | 47 | | | | - | | | | 1 | | | | 25 | | | | 6 | |
| Real Estate-commercial | | | - | | | | - | | | | - | | | | - | | | | - | |
| Real Estate-other | | | - | | | | - | | | | - | | | | - | | | | - | |
| Consumer and other loans | | | 63 | | | | 23 | | | | 22 | | | | 53 | | | | 17 | |
| | | | | | | | | | | | | | | | |
| | | | 120 | | | | 50 | | | | 23 | | | | 78 | | | | 23 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net Charge offs | | | (2,633 | ) | | | (162 | ) | | | (27 | ) | | | (155 | ) | | | (229 | ) |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | 5,528 | | | | 1,259 | | | | 1,018 | | | | 683 | | | | 720 | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at end of period | | $ | 8,981 | | | $ | 6,086 | | | $ | 4,259 | | | $ | 3,268 | | | $ | 2,740 | |
| | | | | | | | | | | | | | | | |
| Ratio of net charge offs during the period to average loans outstanding during the period | | | 0.49 | % | | | 0.04 | % | | | 0.01 | % | | | 0.07 | % | | | 0.12 | % |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of nonperforming loans to total loans | | | 0.59 | % | | | 0.56 | % | | | 0.30 | % | | | 0.20 | % | | | 0.45 | % |
| Ratio of impaired loans to total loans | | | 0.74 | % | | | 0.80 | % | | | 0.41 | % | | | 0.05 | % | | | 0.43 | % |
| Ratio of allowance for loan losses to total loans | | | 1.58 | % | | | 1.24 | % | | | 1.22 | % | | | 1.26 | % | | | 1.30 | % |
47
At December 31, of each period presented below, the allowance was allocated as follows:
| | | | | | | | | | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| Commercial, financial and agricultural | | $ | 1,015 | | | $ | 596 | | | $ | 547 | | | $ | 458 | | | $ | 379 | |
| Real-estate construction | | | 3,031 | | | | 1,611 | | | | 1,053 | | | | 772 | | | | 494 | |
| Real-estate 1-4 family | | | 3,045 | | | | 2,089 | | | | 1,266 | | | | 1,038 | | | | 818 | |
| Real-estate commercial | | | 1,218 | | | | 1,342 | | | | 1,110 | | | | 871 | | | | 925 | |
| Consumer and other loans | | | 672 | | | | 448 | | | | 283 | | | | 129 | | | | 124 | |
| | | | | | | | | | | | | | | | |
| Total | | $ | 8,981 | | | $ | 6,086 | | | $ | 4,259 | | | $ | 3,268 | | | $ | 2,740 | |
| | | | | | | | | | | | | | | | |
At December 31, of each period presented below, loan balances by category as a percentage of gross loans were as follows:
| | | | | | | | | | | | | | | | | | | | | |
| | | 2008 | | 2007 | | 2006 | | 2005 | | 2004 |
| Commercial, financial and agricultural | | | 11.0 | % | | | 10.2 | % | | | 13.5 | % | | | 14.1 | % | | | 14.3 | % |
| Real-estate construction | | | 26.8 | % | | | 28.7 | % | | | 26.9 | % | | | 23.7 | % | | | 17.2 | % |
| Real-estate 1-4 family | | | 28.6 | % | | | 30.9 | % | | | 27.6 | % | | | 30.7 | % | | | 32.2 | % |
| Real-estate commercial | | | 28.5 | % | | | 23.7 | % | | | 25.8 | % | | | 26.8 | % | | | 31.5 | % |
| Consumer and other loans | | | 5.1 | % | | | 6.5 | % | | | 6.2 | % | | | 4.7 | % | | | 4.8 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Total (1) | | | 100.00 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | |
| (1) | | Does not include mortgage loans held for sale |
Allowance for Loan Losses
The allowance for loan losses increased $2,895 or 47.6% to $8,981 at December 31, 2008 compared to $6,086 at December 31, 2007. The increase in the allowance was based on the factors discussed in the Asset Quality section above. In considering the adequacy of our allowance for loan losses, management has focused on changes in the economy at local and national levels that can bear an impact on the overall risk associated with our loan portfolio as well as increases in specific credit risks identified in our loan portfolio as a result of the changes in market conditions.
Although our loan portfolio is concentrated in Middle Tennessee, management does not believe this geographic concentration presents an abnormally high risk. At December 31, 2008 the following loan concentrations exceeded 10% of total loans: commercial real estate loans, 1-4 family residential loans, construction loans, and commercial, financial, and agricultural loans. Management does not believe that this concentration presents abnormally high risk. 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, 2008, we owned $76,497 in securities, compared to $80,933 at year end 2007. The $4,436 decrease in total securities in 2008 was primarily a result of the Company liquidating a portion of the security portfolio to reinvest in higher yield loans. The unrealized gains on securities at year end 2008 were $152, net of tax. The investment portfolio was 10.7% of total assets at December 31, 2008, and 12.7% of total assets at December 31, 2007. 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.
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 recovery, and the decline in fair
48
value is largely due to changes in market interest rates. The fair value is expected to recover as the securities approach their maturity date and/or normal liquidity returns to the marketplace.
Management evaluates securities for other-than-temporary impairment on at least a quarterly 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 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.
At year end 2008, 16.7% of the Company’s securities available for sale were reported at an unrealized loss. In the event that securities were to be sold for liquidity purposes, there are sufficient holdings not in an unrealized loss position that could be sold, so that the Company would not be forced to sell the securities reporting an unrealized loss. The Company is further limited in the amount of securities that can be sold due to pledging requirements for Bank liabilities. Management considers security holdings in excess of our pledging requirement to be available for liquidity purposes. Sale of such holdings would not impair our ability to hold the securities reporting an unrealized loss until the loss is recovered or until maturity.
At year end 2008, the Company held $5,000 in trust preferred securities issued by Tennessee Commerce Statutory Trust. Other than this investment, the Company did not hold securities of any one issuer, other than U.S. Government sponsored entities, in an amount greater than 10% of shareholders’ equity as of December 31, 2008 or 2007.
The carrying value of securities at December 31 is summarized as follows:
| | | | | | | | | | | | | | | | | |
| | | December 31, 2008 | | | December 31, 2007 | |
| | | Amount | | | % of Total | | | Amount | | | % of Total | |
| |
| U.S. Government sponsored entities | | $ | 4,496 | | | | 5.9 | % | | $ | 15,919 | | | | 19.6 | % |
| Mortgage-backed securities | | | 54,783 | | | | 71.6 | % | | | 54,119 | | | | 66.9 | % |
| State and municipals | | | 8,457 | | | | 11.0 | % | | | 6,233 | | | | 7.7 | % |
| Other debt securities | | | 8,761 | | | | 11.5 | % | | | 4,662 | | | | 5.8 | % |
| | | | | | | | | | | | | |
| Total | | $ | 76,497 | | | | 100.0 | % | | $ | 80,933 | | | | 100.0 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | December 31, 2006 | | | | | | | | | |
| | | Amount | | | % of Total | | | | | | | | | |
| | | | | | | | | |
| U.S. Government sponsored entities | | $ | 19,776 | | | | 56.2 | % | | | | | | | | |
| Mortgage-backed securities | | | 7,857 | | | | 22.3 | % | | | | | | | | |
| State and municipals | | | 6,092 | | | | 17.3 | % | | | | | | | | |
| Other debt securities | | | 1,486 | | | | 4.2 | % | | | | | | | | |
| | | | | | | | | | | | | | | |
| Total | | $ | 35,211 | | | | 100.0 | % | | | | | | | | |
| | | | | | | | | | | | | | | |
49
The following table presents the carrying value by maturity distribution of the investment portfolio, along with weighted average yields thereon, as of December 31, 2008:
| | | | | | | | | | | | | | | | | | | | | |
| | | Within | | | 1-5 | | | 5-10 | | | Beyond | | | | |
| | | 1 Year | | | Years | | | Years | | | 10 Years | | | Total | |
| U.S. Government sponsored entities | | $ | - | | | $ | 4,496 | | | $ | - | | | $ | - | | | $ | 4,496 | |
| State and municipals | | | - | | | | - | | | | 3,619 | | | | 4,838 | | | | 8,457 | |
| Other debt securities | | | - | | | | 5,000 | | | | 982 | | | | 2,779 | | | | 8,761 | |
| | | | | | | | | | | | | | | | |
| Total debt securities | | $ | - | | | $ | 9,496 | | | $ | 4,601 | | | $ | 7,617 | | | $ | 21,714 | |
| | | | | | | | | | | | | | | | |
| |
| Weighted average yield(tax equivalent) | | | - | | | | 5.20 | % | | | 5.56 | % | | | 5.80 | % | | | 5.49 | % |
| | | | | | | | | | | | | | | | |
| |
| Mortgage-backed securities | | | | | | | | | | | | | | | | | | $ | 54,783 | |
| | | | | | | | | | | | | | | | | | | | |
| |
| Weighted average yield | | | | | | | | | | | | | | | | | | | 5.37 | % |
| | | | | | | | | | | | | | | | | | | | |
Premises and Equipment
In 2008, fixed assets, net of depreciation, increased $997. The largest component of the increase in fixed assets consisted of $1,274 due to the completion of the Bank’s new Thompson’s Station branch located in Williamson County.
Rent expense was $409 in 2008, compared to $288 in 2007. The increase was due to the new lease on the land for the new branch in Thompson’s Station, Tennessee, and the increase in the number of ATMs.
Deposits
We rely on having a growing deposit base to fund loan and other asset growth. Total deposits were $599,318 at December 31, 2008, compared to $559,303 at December 31, 2007. The following table sets forth the composition of the deposits at December 31:
| | | | | | | | | | | | | | | | | |
| | | 2008 | | | 2007 | |
| | | Amount | | | % of Total | | | Amount | | | % of Total | |
| |
| Noninterest-bearing demand accounts | | $ | 45,848 | | | | 7.7 | % | | $ | 52,272 | | | | 9.3 | % |
| Interest-bearing demand accounts | | | 88,426 | | | | 14.7 | % | | | 81,637 | | | | 14.6 | % |
| Savings accounts | | | 18,508 | | | | 3.1 | % | | | 21,065 | | | | 3.8 | % |
| Time deposits greater than $100,000 | | | 167,708 | | | | 28.0 | % | | | 145,735 | | | | 26.1 | % |
| Other time deposits | | | 278,828 | | | | 46.5 | % | | | 258,594 | | | | 46.2 | % |
| | | | | | | | | | | | | | |
| Total | | $ | 599,318 | | | | 100.0 | % | | $ | 559,303 | | | | 100.0 | % |
| | | | | | | | | | | | | | |
The majority of deposits continue to be in time deposits. Time deposits (certificate of deposits and IRAs) totaled $446,536, or 74.5% of total deposits. Time deposits less than $100 were $278,828 at December 31, 2008, which is an increase of $20,234 from year end 2007. The majority of the increase in time deposits less than $100 was from broker deposits. Total brokered time deposits were $52,038 at December 31, 2008 with a weighted average rate of 3.04% compared to $23,413 in 2007, with a weighted rate of 5.06%. Management chose to increase broker deposits due to a favorable rate environment compared to national market time deposits and core customer deposits, particularly late in the year, and due to the loss of the surety bond insurance policy described below.
Prior to September 11, 2008 the Bank had surety bond insurance policies through The Kansas Bankers Surety Company (“Kansas”) pledged as collateral for State of Tennessee Collateral Pool public funds deposits. On that date, the Bank was notified that Kansas would exit out of the bank deposit guaranty bond business for all banks. Under Tennessee law, surety bonds pledged to the Tennessee Collateral Pool must be issued by
50
carriers who have the highest claims paying ability rating offered by two nationally recognized ratings services and must be approved by the State Funding Board. As of year end 2008, there were no other insurance companies that had been approved under the Tennessee law. As a result, the Bank is required to pledge other bank securities to secure public funds deposits with the Tennessee Collateral Pool. Additional securities were purchased in order to meet the pledging requirement. The Bank obtained $15,164 in broker deposits in the third quarter of 2008 for the purpose of purchasing the needed securities for pledging, contributing to the significant increase in 2008 broker deposits over 2007.
Personal CDs were $104,757 at December 31, 2008 with a weighted average rate of 3.44%. Personal time deposits decreased $20,557 over 2007. The decrease in personal CDs is primarily due to the 2007 balance being unusually high as a result of a variable rate product that was offered during 2007 that allowed the rate for the CD to change once during its term, at the customer’s discretion. Due to the falling rate environment during 2008, this product was not attractive to customers and the Bank discontinued the product. Due to competitive pricing pressures in the Bank’s new and existing markets, the Bank historically pursued additional funding at a slightly higher interest rate in national market deposits. During 2008, the lower rates available for broker deposits resulted in less growth for national market CDs. At December 31, 2008, 64.6% of total deposits were considered local or core deposits (deposits other than broker CDs, national market CDs, and state, county, and municipal CDs), compared to 63.7% at year end 2007. Broker deposits increased from 4.1% to 8.7% of total deposits during 2008. National market CDs decreased from 6.6% to 6.4% during 2008. At December 31, 2008, national market time deposits totaled $121,572, with a weighted average rate of 4.13%. At December 31, 2008, we had $443,153 in time deposits maturing within two years, of which $52,038 were brokered deposits. Time deposits maturing within one year of December 31, 2008 were $416,610, or 93.3% of total time deposits. If we are not able to retain these deposits at maturity, or attract additional deposits at comparable rates, we may be required to seek higher costing deposits to replace these deposits which could negatively impact our net interest margin. The weighted average cost of all deposit accounts was 3.27% in 2008 compared to 4.33% in 2007. The weighted average rate on time deposits was 4.18% in 2008, compared to 5.28% in 2007. 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 and expand our net interest margin.
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, |
| | | 2008 | | 2007 | | 2006 |
| | | | | | | Average | | | | | | Average | | | | | | Average |
| | | Average | | Rate | | Average | | Rate | | Average | | Rate |
| | | Amount | | Paid | | Amount | | Paid | | Amount | | Paid |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing demand deposits | | $ | 48,964 | | | | n/a | | | $ | 38,112 | | | | n/a | | | $ | 29,272 | | | | n/a | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing demand accounts | | | 88,167 | | | | 1.55 | % | | | 61,043 | | | | 2.75 | % | | | 47,022 | | | | 2.24 | % |
| Savings deposits | | | 20,717 | | | | 0.61 | % | | | 12,550 | | | | 1.17 | % | | | 8,872 | | | | 1.33 | % |
| Time deposits | | | 400,105 | | | | 4.18 | % | | | 316,556 | | | | 5.28 | % | | | 231,904 | | | | 4.78 | % |
51
The following table indicates the amount outstanding of time deposits of $100,000 or more and other time deposits of $100,000 or more, and respective maturities as of December 31, 2008:
| | | | | |
| 3 months or less | | $ | 58,497 | |
| 3 months-6 months | | | 36,582 | |
| 6 months-12 months | | | 62,882 | |
| Over 12 months | | | 9,747 | |
| | | | |
| Total | | $ | 167,708 | |
| | | | |
Contractual Obligations
The Company has the following contractual obligations as of December 31, 2008:
| | | | | | | | | | | | | | | | | | | | | |
| | | Less than | | | 1 — 3 | | | 3 — 5 | | | More than | | | | |
| | | 1 year | | | years | | | years | | | 5 years | | | Total | |
| Operating leases | | $ | 268 | | | $ | 516 | | | $ | 409 | | | $ | 2,932 | | | $ | 4,125 | |
| Time deposits | | | 416,610 | | | | 28,316 | | | | 1,610 | | | | - | | | | 446,536 | |
| Short term borrowings | | | 21,000 | | | | - | | | | - | | | | - | | | | 21,000 | |
| Long term borrowings | | | 10,835 | | | | 6,000 | | | | 8,000 | | | | 23,000 | | | | 47,835 | |
| Repurchase agreements | | | - | | | | - | | | | 7,000 | | | | - | | | | 7,000 | |
| Preferred stock dividends (1) | | | 809 | | | | 1,940 | | | | 1,940 | | | | 1,546 | | | | 6,235 | |
| | | | | | | | | | | | | | | | |
| |
| Total | | $ | 449,522 | | | $ | 36,772 | | | $ | 18,959 | | | $ | 27,478 | | | $ | 532,731 | |
| | | | | | | | | | | | | | | | |
| | |
| (1) | | Reflects payments due on shares issued through the CPP on February 27, 2009. Amounts presented assume that the preferred stock will be fully redeemed on February 26, 2014. |
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 purchased, a cash management line, and a short-term fixed maturity borrowing.
| | | | | | | | | | | | | |
| | | 2008 | | 2007 | | 2006 |
| Balance at year-end | | $ | 21,000 | | | | - | | | | - | |
| Weighted average interest rate at year-end | | | 1.17 | % | | | - | | | | - | |
| Maximum outstanding at any month-end during the year | | $ | 25,594 | | | $ | 14,199 | | | $ | 8,000 | |
| Average amount outstanding | | $ | 10,537 | | | $ | 4,699 | | | $ | 1,910 | |
| Weighted average rates during the year | | | 1.92 | % | | | 5.52 | % | | | 5.45 | % |
Long-Term Borrowings
The Company has a secured line of credit of $4,000 to assist with funding the Company’s acquisition of all of the outstanding capital stock of First National. The line of credit is secured by 100% of the Bank stock owned by the Company. At year end 2008, the balance on the line of credit was $2,835. The interest rate on the line of credit is based on the prime rate as designated in the Money Rates sections of the Wall Street Journal minus 50 bps with a floor rate of 3.75%. The rate being charged to the line as of December 31, 2008 was 3.75%. The line of credit will mature in the fourth quarter of 2009.
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Subordinated Debentures
We 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 currently redeem the securities at any time. The interest rate varies quarterly with interest only payments also due quarterly. The interest rate is New York Prime plus 50 basis points. The interest rate on the securities as of December 31, 2008 was 5.50%. The trust preferred security maturity date is December 31, 2032. We issued $3,000 in floating rate subordinated debentures to the Trust. The issued subordinated debentures count as Tier 1 capital for regulatory purposes. Debt issuance costs of $74 have been capitalized and are being amortized over the term of the securities. Principal officers, directors, and their affiliates at year end 2008 and 2007 owned $700 of the $3,000 subordinated debenture. The proceeds from this offering were utilized to increase the Bank’s capital by $3,000.
In 2005, we 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. The interest rate is the three month LIBOR plus 150 basis points. The interest rate on the securities as of December 31, 2008 was 3.50%. These securities mature on September 15, 2035; however, the maturity may be shortened to a date not earlier than September 15, 2010. We issued $5,000 of subordinated debentures to the Trust, which counts as Tier 1 capital for regulatory purposes. There was no debt issuance cost in obtaining the subordinated debenture. The proceeds from the pool offering were used to increase the Bank’s capital.
In 2007, the Company established a third Trust that issued $15,000 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. The interest rates are 7.96% fixed for five years, and subsequently resets to the 3 month LIBOR plus 300 basis points. These securities mature on September 27, 2037; however, the maturity may be shortened to a date not earlier than December 15, 2012. They are presented in liabilities on the balance sheet and $7,482count as Tier 1 capital and the remaining $7,518 is considered as Tier II capital for regulatory purposes. The proceeds from this offering were used to finance a portion of the cash purchase price paid in connection with the acquisition of First National.
Liquidity
Our liquidity, primarily represented by cash and cash equivalents, is a result of our operating, investing and financing activities. These activities are summarized below for the three years ended December 31:
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| | | | | | | | | | | | | |
| Net income (loss) | | $ | (1,290 | ) | | $ | 2,380 | | | $ | 2,802 | |
| Adjusted to reconcile net income (loss) to net cash provided by (used in) operating activities | | | (911 | ) | | | 1,490 | | | | (1,517 | ) |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Net cash provided by (used in) operating activities | | | (2,201 | ) | | | 3,870 | | | | 1,285 | |
| Net cash from investing activities | | | (86,451 | ) | | | (116,771 | ) | | | (100,910 | ) |
| Net cash from financing activities | | | 81,178 | | | | 125,113 | | | | 88,972 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Net change in cash and cash equivalents | | | (7,474 | ) | | | 12,212 | | | | (10,653 | ) |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Cash and cash equivalents at beginning of period | | | 27,285 | | | | 15,073 | | | | 25,726 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Cash and cash equivalents at end of period | | $ | 19,811 | | | $ | 27,285 | | | $ | 15,073 | |
| | | | | | | | | | |
The adjustments to reconcile net loss to net cash from operating activities in 2008 primarily consist of mortgage banking activities, gain on sale of securities, deferred income tax benefit and provisions for loan
53
losses. The significant components of operating activities for 2008 were a $258 gain on sale of securities, $68,024 of mortgage loans originated for sales and proceeds from the sale of mortgage loans of $63,354 which resulted in a gain of $1,025, provisions for loan loss of $5,528, and deferred income tax benefit of $1,590. The adjustments to reconcile net income to net cash from operating activities in 2007 primarily consist of mortgage banking activities and provisions for loan losses. The significant components of operating activities for 2007 were $82,697 of mortgage loans originated for sales and proceeds from the sale of mortgage loans of $82,180 which resulted in a gain of $1,212, and provisions for loan loss of $1,259.
Significant components of investing activities during 2008 were net loan originations of $86,407 and purchases of securities available for sale of $34,634, offset by the proceeds from the maturities and redemptions of securities available for sale of $17,277 and sales of $22,194 of investment securities. Significant components of investing activities during 2007 were net loan originations of $102,243, purchases of securities available for sale of $31,820, offset by the proceeds from the maturities and redemptions of securities available for sale of $20,453 and sales of $20,289 of investment securities. Net assets acquired from purchase of First National of $18,460 also contributed to cash from investing activities.
Significant financing activities during 2008 included net increase in deposits of $40,015, net proceeds from Federal Home Loan Bank advances of $21,000, net proceeds from federal funds purchased of $9,000, proceeds of $4,325 in other borrowed money, and $7,000 in proceeds from a repurchase agreement. Financing activities during 2007 included the issuance of $15,000 in trust preferred securities, net increase in deposits of $107,846, and proceeds from issuance of common stock of $4,380.
Liquidity refers to our ability to fund loan demand, meet deposit customers’ withdrawal needs and provide for operating expenses. As summarized in the statement of cash flows, our main sources of cash flow are receipts of deposits from our 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 Company’s borrowers and investing in securities and short-term interest earning assets. In 2008, deposit growth was less than loan demand, which necessitated additional borrowings. At December 31, 2008, we had $10,000 in FHLB letters of credit to secure public deposits. FHLB letters of credit were used to keep our security portfolio available for liquidity purposes. Other potential sources of liquidity include 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, repurchase agreements or, to a lesser extent, the sale of securities available for sale from the Bank’s securities portfolio. See Note 2 for discussion of securities availability for liquidity purposes.
We consider our liquidity sufficient to meet our outstanding short and long-term needs. We expect to be able to fund or refinance, on a timely basis, our material commitments and long-term liabilities.
Off-Balance Sheet Arrangements
At December 31, 2008, we had unfunded loan commitments outstanding of $57,281 and unfunded letters of credit of $13,732. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, we have the ability to liquidate federal funds sold or securities available for sale or on a short-term basis to borrow and purchase federal funds from other financial institutions. Additionally, we could sell participations in these or other loans to correspondent banks.
54
Capital Resources
Our total shareholders’ equity at December 31, 2008, was $36,035 compared to $37,173 at December 31, 2007, and $30,657 at December 31, 2006. The factors that changed shareholder’s equity in 2008 were the issuance of 22,600 shares of common stock under the stock option plan providing $152 in additional capital, $226 in stock based compensation, $66 in additional shares issued through the dividend reinvestment plan, and an increase in the fair value of available for sale securities, net of tax, of $88. Offsetting these increases in shareholders’ equity was a net operating loss of $1,290 and a cash dividend of $320 and repurchase of shares of common stock of $124.
As of December 31, 2008, and December 31, 2007, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. Our consolidated total capital to risk-weighted assets ratios for year end 2008 and 2007 were 9.81% and 10.97%. Our consolidated Tier 1 to risk weighted assets ratios were 6.72% and 7.87% at year end 2008 and 2007. Also, our Tier 1 to average assets ratios were 6.00% and 6.76% at year end 2008 and 2007. The subordinated debentures, issued in 2002, 2005 and 2007 increased Tier 1 capital, giving the Bank the opportunity to continue its asset growth.
On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 (EESA), which provides the U. S. secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. One of the provisions resulting from the Act is the Treasury Capital Purchase Program (CPP), which provides direct equity investment of perpetual preferred stock by the Treasury in qualified financial institutions. The program is voluntary and requires an institution to comply with a number of restrictions and provisions, including limits on executive compensation, stock redemptions and declaration of dividends.
The Company applied to participate in the program during the fourth quarter of 2008 and received notification of approval for the program in the first quarter of 2009. Under the terms of the program, Treasury purchased $17,806 in Senior Preferred shares of the Company on February 27, 2009. The Senior Preferred shares have a cumulative dividend rate of 5% per year, until the fifth anniversary of the Treasury investment, and a dividend rate of 9% thereafter. In addition, under the terms of the agreement, the Company issued warrants to Treasury to purchase additional preferred shares equal to 5% of the investment in Senior Preferred shares at a discounted exercise price. Treasury exercised the warrant immediately upon investment in the Senior Preferred shares. The Warrant Preferred shares have a cumulative dividend rate of 9% per year until redeemed. Dividends on both Senior Preferred and Warrant Preferred shares are required to be paid quarterly.
Dividend requirement for the preferred shares in 2009 is $809; years 2010 through 2013 are $970; 2014, $1,564; 2015 through redemption of the shares $1,683 per year. The increase in 2014 is due to the increase in the dividend rate on the Senior Preferred shares. The Company is able to redeem all or a portion of the Senior Preferred shares at any time but may not redeem the Warrant Preferred shares unless all of the Senior Preferred shares have been redeemed. The required dividends in future periods would be reduced for any redemptions.
55
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:
| | | | | | | | | | | | | |
| | | 2008 | | 2007 | | 2006 |
| | | | | | | | | | | | | |
| Return on average assets | | | (.20 | %) | | | 0.47 | % | | | 0.76 | % |
| Return on average equity | | | (3.45 | %) | | | 6.77 | % | | | 11.14 | % |
| Average equity to average assets ratio | | | 5.70 | % | | | 7.04 | % | | | 6.84 | % |
| Dividend payout ratio | | | n/m | | | | 29.24 | % | | | 20.52 | % |
| | |
| 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 our 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, 2008, was -6.0% of total assets. Our policy states that our one-year cumulative gap should not exceed 15% of total assets.
At year end 2008, $417,270 of $661,039 of interest earning assets will reprice or mature within one year. Loans maturing or repricing within one year totaled $390,867, or 68.6% of total loans at December 31, 2008. We had $30,895 loans maturing or repricing after five years. As of December 31, 2008, we had $416,610 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 our 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 100bps 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 bps change and 15% on 200bps change.
56
The following illustrates the effects on net interest income of shifts in market interest rates from the rate shock simulation model.
| | | | | | | | | | | | | | | | | |
| December 31, 2008 | | | | | | | | | | | | | | | | |
| Basis Point Change | | +200 bp | | +100bp | | -100bp | | -200bp |
| | | | | | | | | | |
| Increase (decrease) in net interest income | | | 5.97 | % | | | 3.05 | % | | | (3.45 | %) | | | (7.66 | %) |
| | | | | | | | | | | | | | | | | |
| December 31, 2007 | | | | | | | | | | | | | | | | |
| Basis Point Change | | +200 bp | | +100bp | | -100bp | | -200bp |
| | | | | | | | | | |
| Increase (decrease) in net interest income | | | 7.07 | % | | | 3.55 | % | | | (3.60 | %) | | | (7.36 | %) |
There are more dollars at risk in income in 2008 if rates go down 200 bps, compared to 2007. There are fewer dollars at risk in income in the rate shock simulation when rates rise compared to 2008 and 2007.
Our Economic Value of Equity simulation measures our long-term interest rate risk. The economic value is the difference between the market value of the assets and the liabilities and, technically, it is our liquidation. 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 our 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, 2008 | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Basis Point Change | | +200 bp | | +100bp | | -100bp | | -200bp |
| | | | | | | | | | |
| Increase (decrease) in equity at risk | | | (8.30 | %) | | | (3.50 | ) | | | 1.10 | % | | | (0.50 | %) |
| | | | | | | | | | | | | | | | | |
| December 31, 2007 | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Basis Point Change | | +200 bp | | +100bp | | -100bp | | -200bp |
| | | | | | | | | | |
| Increase (decrease) in equity at risk | | | (15.63 | %) | | | (6.77 | %) | | | 3.23 | % | | | 4.62 | % |
There was less impact on equity at risk in the economic value of equity simulation between 2008 and 2007.
One of management’s objectives in managing our 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.
57
| | |
| ITEM 8. | | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
The following consolidated financial statements of the Company, together with the Notes thereto and the Management Report on Internal Control over Financial Reporting and Reports of Independent Registered Public Accounting Firm thereon, are included on pages F-1 to F-40 of this Annual Report on Form 10-K and are incorporated herein by reference:
| | • | | Balance Sheets as of December 31, 2008 and 2007 |
| |
| | • | | Statements of Operations for the three years ended December 31, 2008 |
| |
| | • | | Statements of Changes in Shareholders’ Equity for the three years ended December 31, 2008 |
| |
| | • | | Statements of Cash Flows for the three years ended December 31, 2008 |
| |
| | • | | Notes to Consolidated Financial Statements. |
| | |
| ITEM 9. | | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
| | |
| ITEM 9A. | | CONTROLS AND PROCEDURES |
The Company maintains disclosure controls and procedures, as defined in Rules 13a-15(e)and 15d-15(d) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. The Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.
The report of the Company’s management on the Company’s internal control over financial reporting is set forth on page F-1 of this Annual Report on Form 10-K.
There were no changes in the Company’s internal controls over financial reporting during the Company’s fiscal quarter ended December 31, 2008 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.
| | |
| ITEM 9B. | | OTHER INFORMATION |
None.
58
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 2009 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 Interlocks and Insider Participation” in our definitive proxy statement for the 2009 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 2009 annual meeting of shareholders.
Equity Compensation Plan Information
The following table set forth certain information as of December 31, 2008 regarding compensation plans under which our equity securities are available for issuance.
| | | | | | | | | | | | | |
| | | | | | | | | | | 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, warrants and | | outstanding options, | | (excluding securities |
| | | rights | | warrants and rights | | reflected in (a)) |
| | | (a) | | (b) | | (c) |
| | | |
| Equity compensation plans approved by security holders | | | 248,127 | | | $ | 17.98 | | | | 271,479 | |
| Equity compensation plans not approved by stockholders | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | |
| | | | 248,127 | | | $ | 17.98 | | | | 271,479 | |
59
| | |
| 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 2008 annual meeting of shareholders.
| | |
| ITEM 14. | | PRINCIPAL ACCOUNTING 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 2008 annual meeting of shareholders.
60
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. |
61
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 16, 2009 | 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 16, 2009 |
| | | | | |
| Eslick E. Daniel, M.D. | | | | |
| | | | | |
| /s/ Marc R. Lively | | President and Chief Executive Officer and Director | | March 16, 2009 |
| | | | | |
| Marc R. Lively | | (Principal Executive Officer) | | |
| | | | | |
| /s/ Dianne Scroggins | | Chief Financial Officer | | March 16, 2009 |
| | | | | |
| Dianne Scroggins | | (Principal Financial and Accounting Officer) | | |
| | | | | |
| /s/ Fred C. White | | Director | | March 16, 2009 |
| | | | | |
| Fred C. White | | | | |
| | | | | |
| /s/ Roger Witherow | | Director | | March 16, 2009 |
| | | | | |
| Roger Witherow | | | | |
| | | | | |
| /s/ Bernard Childress | | Director | | March 16, 2009 |
| | | | | |
| Bernard Childress | | | | |
| | | | | |
| | | | | |
| /s/ Stephen Walker | | Director | | March 16, 2009 |
| | | | | |
| Stephen Walker | | | | |
| | | | | |
| /s/ Randy Maxwell | | Director | | March 16, 2009 |
| | | | | |
| Randy Maxwell | | | | |
| | | | | |
| /s/ H. Allen Pressnell, Jr. | | Director | | March 16, 2009 |
| | | | | |
| H. Allen Pressnell, Jr. | | | | |
| | | | | |
| /s/ Dinah C. Vire | | Director | | March 16, 2009 |
| | | | | |
| Dinah C. Vire | | | | |
| | | | | |
| /s/ Vasant Hari | | Director | | March 16, 2009 |
| | | | | |
| Vasant Hari | | | | |
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Community First, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Community First, Inc.’s internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Community First, Inc.’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on our assessment we believe that, as of December 31, 2008, the Company’s internal control over financial reporting is effective based on those criteria. Community First, Inc.’s independent registered public accounting firm has issued an audit report on Community First, Inc.’s internal control over financial reporting.
| | | |
| March 16, 2009 | | /s/ Marc R. Lively |
| | | |
| (Date) | | Marc R. Lively, |
| | | President and Chief Executive Officer |
| | | |
| March 16, 2009 | | /s/ Dianne Scroggins |
| | | |
| (Date) | | Dianne Scroggins,
Chief Financial Officer |
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Community First, Inc.
We have audited Community First, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control— Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Community First, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Community First, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control— Integrated Framework. Issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM(Continued)
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Community First, Inc. as of December 31 2008 and 2007 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, 2008, and our report dated March 16, 2009, expressed an unqualified opinion thereon.
/s/ Crowe Horwath LLP
Brentwood, Tennessee
March 16, 2009
F-3
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Community First, Inc.
We have audited the accompanying consolidated balance sheets of Community First, Inc. (the “Company”) as of December 31, 2008 and 2007 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, 2008. 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. at December 31, 2008 and 2007 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Community First, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 16, 2009, expressed an unqualified opinion thereon.
/s/ Crowe Horwath LLP
Brentwood, Tennessee
March 16, 2009
F-4
COMMUNITY FIRST, INC.
CONSOLIDATED BALANCE SHEETS
December 31
(Dollar amounts in thousands, except per share data)
| | | | | | | | | |
| | | 2008 | | | 2007 | |
ASSETS | | | | | | | | |
| Cash and due from financial institutions | | $ | 11,489 | | | $ | 11,913 | |
| Federal funds sold | | | 8,322 | | | | 15,372 | |
| | | | | | | |
| Cash and cash equivalents | | | 19,811 | | | | 27,285 | |
| Securities available for sale | | | 76,497 | | | | 80,933 | |
| Loans held for sale | | | 6,107 | | | | 5,710 | |
| Loans | | | 570,113 | | | | 490,608 | |
| Allowance for loan losses | | | (8,981 | ) | | | (6,086 | ) |
| | | | | | | |
| Net loans | | | 561,132 | | | | 484,522 | |
| | | | | | | | | |
| Restricted equity securities | | | 2,111 | | | | 1,440 | |
| Premises and equipment | | | 18,253 | | | | 17,256 | |
| Goodwill | | | 5,204 | | | | 4,622 | |
| Core deposit and customer relationship intangibles | | | 2,383 | | | | 2,812 | |
| Accrued interest receivable | | | 2,632 | | | | 3,382 | |
| Bank owned life insurance | | | 8,085 | | | | 3,848 | |
| Other real estate owned | | | 8,041 | | | | 698 | |
| Other assets | | | 5,070 | | | | 3,554 | |
| | | | | | | |
| | | | | | | | | |
| Total assets | | $ | 715,326 | | | $ | 636,062 | |
| | | | | | | |
| | | | | | | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | |
| Deposits | | | | | | | | |
| Noninterest-bearing | | $ | 45,848 | | | $ | 52,272 | |
| Interest-bearing | | | 553,470 | | | | 507,031 | |
| | | | | | | |
| Total deposits | | | 599,318 | | | | 559,303 | |
| | | | | | | | | |
| Federal Home Loan Bank advances | | | 32,000 | | | | 11,000 | |
| Subordinated debentures | | | 23,000 | | | | 23,000 | |
| Other borrowed money | | | 4,835 | | | | 510 | |
| Accrued interest payable | | | 3,165 | | | | 4,040 | |
| Repurchase agreements | | | 7,000 | | | | - | |
| Federal funds purchased | | | 9,000 | | | | - | |
| Other liabilities | | | 973 | | | | 1,036 | |
| | | | | | | |
| Total liabilities | | | 679,291 | | | | 598,889 | |
| | | | | | | | | |
| Commitments and contingent liabilities (Note 14) | | | | | | | | |
| | | | | | | | | |
| Shareholders’ equity | | | | | | | | |
| Common stock, no par value; 5,000,000 shares authorized; 3,208,321 shares issued 2008; 3,168,960 shares issued 2007 | | | 27,546 | | | | 26,695 | |
| Preferred stock, 2,500,000 authorized, 0 shares issued 2008 | | | - | | | | - | |
| Retained earnings | | | 8,337 | | | | 10,414 | |
| Accumulated other comprehensive income (loss) | | | 152 | | | | 64 | |
| | | | | | | |
| | | | | | | | | |
| Total shareholders’ equity | | | 36,035 | | | | 37,173 | |
| | | | | | | |
| Total liabilities and shareholders’ equity | | $ | 715,326 | | | $ | 636,062 | |
| | | | | | | |
See accompanying notes to consolidated financial statements.
F-5
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| Interest income | | | | | | | | | | | | |
| Loans, including fees | | $ | 34,713 | | | $ | 32,657 | | | $ | 24,023 | |
| Taxable securities | | | 2,891 | | | | 2,004 | | | | 1,307 | |
| Tax exempt securities | | | 326 | | | | 235 | | | | 209 | |
| Federal funds sold and other | | | 321 | | | | 473 | | | | 250 | |
| | | | | | | | | | |
| Total interest income | | | 38,251 | | | | 35,369 | | | | 25,789 | |
| | | | | | | | | | | | | |
| Interest expense | | | | | | | | | | | | |
| Deposits | | | 18,222 | | | | 18,545 | | | | 12,255 | |
| Federal Home Loan Bank advances and federal funds purchased | | | 886 | | | | 1,082 | | | | 673 | |
| Subordinated debentures and other | | | 1,868 | | | | 979 | | | | 600 | |
| | | | | | | | | | |
| Total interest expense | | | 20,976 | | | | 20,606 | | | | 13,528 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
Net interest income | | | 17,275 | | | | 14,763 | | | | 12,261 | |
| Provision for loan losses | | | 5,528 | | | | 1,259 | | | | 1,018 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
Net interest income after provision for loan losses | | | 11,747 | | | | 13,504 | | | | 11,243 | |
| | | | | | | | | | | | | |
| Noninterest income | | | | | | | | | | | | |
| Service charges on deposit accounts | | | 2,130 | | | | 1,644 | | | | 1,520 | |
| Mortgage banking activities | | | 1,025 | | | | 1,212 | | | | 666 | |
| Net gains on sale of securities | | | 258 | | | | 19 | | | | - | |
| Gain on sale of land | | | - | | | | - | | | | 390 | |
| Investment services income | | | 456 | | | | 312 | | | | 228 | |
| Earnings on bank owned life insurance policies | | | 237 | | | | 150 | | | | 138 | |
| ATM income | | | 135 | | | | 119 | | | | 74 | |
| Other customer fees | | | 121 | | | | 64 | | | | 39 | |
| Other | | | 141 | | | | 177 | | | | 70 | |
| | | | | | | | | | |
| Total noninterest income | | | 4,503 | | | | 3,697 | | | | 3,125 | |
| | | | | | | | | | | | | |
| Noninterest expenses | | | | | | | | | | | | |
| Salaries and employee benefits | | | 9,049 | | | | 7,096 | | | | 5,451 | |
| Occupancy expense | | | 1,459 | | | | 864 | | | | 550 | |
| Furniture and equipment expense | | | 1,013 | | | | 721 | | | | 545 | |
| Data processing | | | 954 | | | | 873 | | | | 684 | |
| Advertising and public relations | | | 812 | | | | 719 | | | | 509 | |
| Audit, accounting and legal | | | 481 | | | | 368 | | | | 277 | |
| Operational expenses | | | 902 | | | | 763 | | | | 476 | |
| Regulatory and compliance expenses | | | 445 | | | | 254 | | | | 107 | |
| ATM expense | | | 463 | | | | 331 | | | | 222 | |
| Amortization of intangible asset | | | 429 | | | | - | | | | - | |
| Other | | | 3,016 | | | | 2,008 | | | | 1,632 | |
| | | | | | | | | | |
| Total noninterest expenses | | | 19,023 | | | | 13,997 | | | | 10,453 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
Income (loss) before income taxes | | | (2,773 | ) | | | 3,204 | | | | 3,915 | |
| Income tax (benefits) expense | | | (1,483 | ) | | | 824 | | | | 1,113 | |
| | | | | | | | | | |
Net income (loss) | | $ | (1,290 | ) | | $ | 2,380 | | | $ | 2,802 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Earnings (loss) per share | | | | | | | | | | | | |
| Basic | | $ | (0.40 | ) | | $ | 0.76 | | | $ | 0.97 | |
| Diluted | | | (0.40 | ) | | | 0.73 | | | | 0.94 | |
See accompanying notes to consolidated financial statements.
F-6
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 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 expense | | | | | | | | | | | | | | | | | | | | |
| Restricted stock grants | | | - | | | | 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 of tax effects | | | - | | | | - | | | | - | | | | 82 | | | | 82 | |
| | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income | | | | | | | | | | | | | | | | | | | 2,884 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2006 | | | 3,015,540 | | | $ | 21,989 | | | $ | 8,730 | | | $ | (62 | ) | | $ | 30,657 | |
| | | | | | | | | | | | | | | | | | | | | |
| Stock offering, net of issuance costs | | | 147,630 | | | | 4,380 | | | | - | | | | - | | | | 4,380 | |
| Exercise of stock options | | | 5,617 | | | | 61 | | | | - | | | | - | | | | 61 | |
| Tax benefit arising from the exercised stock options | | | - | | | | 12 | | | | - | | | | - | | | | 12 | |
| Stock based compensation expense | | | | | | | | | | | | | | | | | | | | |
| Restricted stock grants | | | 173 | | | | 22 | | | | - | | | | - | | | | 22 | |
| Stock options | | | - | | | | 231 | | | | - | | | | - | | | | 231 | |
| Cash dividend declared ($.22 per share) | | | - | | | | - | | | | (696 | ) | | | - | | | | (696 | ) |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | |
| Net income | | | - | | | | - | | | | 2,380 | | | | - | | | | 2,380 | |
| Other comprehensive income | | | | | | | | | | | | | | | | | | | | |
| Change in unrealized gain (loss) on securities available for sale, net of tax effects | | | - | | | | - | | | | - | | | | 126 | | | | 126 | |
| | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income | | | | | | | | | | | | | | | | | | | 2,506 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2007 | | | 3,168,960 | | | $ | 26,695 | | | $ | 10,414 | | | $ | 64 | | | $ | 37,173 | |
| | | | | | | | | | | | | | | | |
See accompanying notes to consolidated financial statements.
(Continued)
F-7
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 December 31, 2007 | | | 3,168,960 | | | $ | 26,695 | | | $ | 10,414 | | | $ | 64 | | | $ | 37,173 | |
| | | | | | | | | | | | | | | | | | | | | |
| Exercise of stock options | | | 22,600 | | | | 152 | | | | - | | | | - | | | | 152 | |
| Stock based compensation expense | | | | | | | | | | | | | | | | | | | | |
| Restricted stock grants | | | 939 | | | | 30 | | | | - | | | | - | | | | 30 | |
| Stock options | | | - | | | | 196 | | | | - | | | | - | | | | 196 | |
| Issuance of shares of common stock through dividend reinvestment | | | 2,198 | | | | 66 | | | | - | | | | - | | | | 66 | |
| Retirement of shares of common stock | | | (4,133 | ) | | | (124 | ) | | | - | | | | - | | | | (124 | ) |
| Sale of shares of common stock | | | 2,199 | | | | 64 | | | | - | | | | - | | | | 64 | |
| Stock dividends declared ($0.15 per share) | | | 15,558 | | | | 467 | | | | (467 | ) | | | - | | | | - | |
| Cash dividend ($0.10 per share) | | | - | | | | - | | | | (320 | ) | | | - | | | | (320 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) | | | - | | | | - | | | | (1,290 | ) | | | - | | | | (1,290 | ) |
| Other comprehensive income | | | | | | | | | | | | | | | | | | | | |
| Change in unrealized gain on securities available for sale, net of tax effects | | | - | | | | - | | | | - | | | | 88 | | | | 88 | |
| | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income (loss) | | | | | | | | | | | | | | | | | | | (1,202 | ) |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2008 | | | 3,208,321 | | | $ | 27,546 | | | $ | 8,337 | | | $ | 152 | | | $ | 36,035 | |
| | | | | | | | | | | | | | | | |
See accompanying notes to consolidated financial statements.
F-8
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
Cash flows from operating activities | | | | | | | | | | | | |
| Net income (loss) | | $ | (1,290 | ) | | $ | 2,380 | | | $ | 2,802 | |
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities | | | | | | | | | | | | |
| Depreciation of premises and equipment | | | 1,256 | | | | 800 | | | | 505 | |
| Amortization and accretion on securities | | | 9 | | | | (35 | ) | | | (3 | ) |
| Amortization of core deposit and customer relationship intangibles | | | 429 | | | | - | | | | - | |
| Provision for loan losses | | | 5,528 | | | | 1,259 | | | | 1,018 | |
| Deferred income tax benefits | | | (1,590 | ) | | | (348 | ) | | | (429 | ) |
| Mortgage loans originated for sale | | | (68,024 | ) | | | (82,697 | ) | | | (46,084 | ) |
| Proceeds from sale of mortgage loans | | | 63,354 | | | | 82,180 | | | | 44,659 | |
| Gain on sale of loans | | | (1,025 | ) | | | (1,212 | ) | | | (666 | ) |
| Gain on sale of securities | | | (258 | ) | | | (19 | ) | | | - | |
| Loss on sale of other real estate owned | | | 12 | | | | 29 | | | | 25 | |
| Other real estate chargeoff | | | 122 | | | | - | | | | - | |
| Federal Home Loan Bank stock dividends | | | (46 | ) | | | (14 | ) | | | (43 | ) |
| Holding losses on loans held for sale | | | 93 | | | | - | | | | - | |
| Decrease (increase) in accrued interest receivable | | | 750 | | | | (243 | ) | | | (912 | ) |
| (Decrease) increase in accrued interest payable | | | (875 | ) | | | 1,421 | | | | 1,113 | |
| Gain on sale of land | | | - | | | | - | | | | (390 | ) |
| Compensation expense under stock based compensation | | | 226 | | | | 253 | | | | 307 | |
| Earnings on bank owned life insurance policies | | | (237 | ) | | | (150 | ) | | | (138 | ) |
| Tax benefit on exercise of stock options | | | - | | | | (12 | ) | | | (142 | ) |
| Other, net | | | (635 | ) | | | 278 | | | | (337 | ) |
| | | | | | | | | | |
| Net cash provided by (used in) operating activities | | | (2,201 | ) | | | 3,870 | | | | 1,285 | |
| | | | | | | | | | | | | |
Cash flows from investing activities | | | | | | | | | | | | |
| Available for sale securities: | | | | | | | | | | | | |
| Sale of securities : | | | | | | | | | | | | |
| Mortgage-backed securities | | | 20,202 | | | | - | | | | - | |
| Other | | | 1,992 | | | | 20,289 | | | | - | |
| Purchases: | | | | | | | | | | | | |
| Mortgage-backed securities | | | (25,893 | ) | | | (16,514 | ) | | | (5,792 | ) |
| Other | | | (8,741 | ) | | | (15,306 | ) | | | (15,381 | ) |
| Maturities, prepayments, and calls: | | | | | | | | | | | | |
| Mortgage-backed securities | | | 6,461 | | | | 3,473 | | | | 1,061 | |
| Other | | | 10,816 | | | | 16,980 | | | | 13,001 | |
| Purchase of restricted equity securities | | | (655 | ) | | | (139 | ) | | | (199 | ) |
| Redemption of restricted equity securities | | | 30 | | | | - | | | | - | |
| Purchase of bank, net of cash acquired (Note 18) | | | - | | | | (18,460 | ) | | | - | |
| Net increase in loans | | | (86,407 | ) | | | (102,243 | ) | | | (89,704 | ) |
| Proceeds from sale of other real estate owned | | | 1,997 | | | | 81 | | | | 188 | |
| Additions to premises and equipment, net | | | (2,253 | ) | | | (4,932 | ) | | | (4,084 | ) |
| Purchase of bank owned life insurance policies | | | (4,000 | ) | | | - | | | | - | |
| | | | | | | | | | |
| Net cash from investing activities | | | (86,451 | ) | | | (116,771 | ) | | | (100,910 | ) |
See accompanying notes to consolidated financial statements.
F-9
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
Cash flows from financing activities | | | | | | | | | | | | |
| Increase in deposits | | | 40,015 | | | | 107,846 | | | | 80,523 | |
| Proceeds from Federal Home Loan Bank advances | | | 29,000 | | | | 17,500 | | | | 9,000 | |
| Payment on Federal Home Loan Bank advances | | | (8,000 | ) | | | (19,500 | ) | | | (4,000 | ) |
| Proceeds from issuance of subordinated debentures | | | - | | | | 15,000 | | | | - | |
| Proceeds from other borrowed money | | | 4,325 | | | | 8,310 | | | | - | |
| Proceeds from federal funds purchased | | | 9,000 | | | | - | | | | - | |
| Proceeds from repurchase agreements | | | 7,000 | | | | - | | | | - | |
| Payments on other borrowed money | | | - | | | | (7,800 | ) | | | - | |
| Proceeds from issuance of common stock | | | 64 | | | | 4,380 | | | | 3,761 | |
| Proceeds from stock option exercises | | | 152 | | | | 61 | | | | 121 | |
| Repurchase of common stock | | | (124 | ) | | | - | | | | - | |
| Tax benefit on exercise of stock options | | | - | | | | 12 | | | | 142 | |
| Cash paid for dividends | | | (254 | ) | | | (696 | ) | | | (575 | ) |
| | | | | | | | | | |
| Net cash from financing activities | | | 81,178 | | | | 125,113 | | | | 88,972 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Net change in cash and cash equivalents | | | (7,474 | ) | | | 12,212 | | | | (10,653 | ) |
| | | | | | | | | | | | | |
| Cash and cash equivalents at beginning of period | | | 27,285 | | | | 15,073 | | | | 25,726 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
Cash and cash equivalents at end of period | | $ | 19,811 | | | $ | 27,285 | | | $ | 15,073 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Supplemental disclosures of cash flow information: | | | | | | | | | | | | |
| Cash paid during year for: | | | | | | | | | | | | |
| Interest | | $ | 21,851 | | | $ | 19,178 | | | $ | 12,415 | |
| Income taxes | | | 830 | | | | 1,130 | | | | 1,470 | |
| Supplemental noncash disclosures | | | | | | | | | | | | |
| Transfer from loans to other real estate owned | | | 9,474 | | | | 703 | | | | 61 | |
| Transfer from loans held for sale to portfolio loans | | | 5,298 | | | | - | | | | - | |
| Issuance of common stock through dividend reinvestment | | | 66 | | | | - | | | | - | |
See accompanying notes to consolidated financial statements.
F-10
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(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 as of December 31, 2008, Community First Bank & Trust (the “Bank”), which together are referred to as the “Company”. During 2007, Community First, Inc. acquired First National Bank of Centerville (“First National”) in a cash purchase transaction. On January 31, 2008, First National was merged with and into the Bank, with the Bank as the surviving entity. Intercompany transactions and balances are eliminated in consolidation
The Company provides financial services through its offices in Maury, Williamson, Rutherford and Hickman Counties, in Tennessee. 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. The significant loan concentrations that exceed 10% of total loans are as follows: commercial real estate loans, 1-4 family residential loans, construction loans, and commercial, financial, and agricultural loans. The customers’ ability to repay their loans is dependent, however, on the real estate and general economic conditions in the Company’s market areas. 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 and federal funds sold. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions, and federal funds purchased and repurchase agreements.
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 as 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. 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.
(Continued)
F-11
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at cost, which approximates market value. Loans held for sale are considered short term with the time frame being less than 90 days from when the Company funds the loan held for sale until the loan is purchased by a third party investor. Under normal course of business, at the time of funding of the loan held for sale by the Company there is a commitment from a third party investor to purchase the loan held for sale. The Company recognizes revenue upon purchase of the loan held for sale by the third party investor with the Company receiving a service release premium from the third party investor.
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 an allowance for loan losses. Interest income is accrued on the unpaid principal balance.
Interest income on 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 loans 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.
Loans originated to facilitate the sale of other real estate owned that exceed a loan balance to collateral value ratio of more than a certain percentage, depending on the loan type, are reclassified as other real estate owned on the balance sheet. When the loan balance to collateral value becomes less than 80%, the loans are reported with other loans.
Purchased Loans: In 2007, the Company purchased a group of loans in a business combination. Purchased loans that showed evidence of credit deterioration since origination were recorded at the allocated fair value in a purchase business combination, such that there was no carryover of the seller’s allowance for loan losses. The purchased loans are included in the Bank’s loan portfolio and evaluated for any additional deterioration in credit quality under the Bank’s credit review processes for other loans. Additional losses identified, if any, are recorded through the Bank’s provision for loan losses. The excess of expected cash flows over allocated fair value of the loans is amortized into interest income over the remaining life of the loans.
Allowance for Loan Loss: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using the nature and volume of the portfolio, information about specific borrower situations, and estimated collateral values, economic conditions, and other factors in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 114,Accounting by Creditors for Impairments of a loanand SFAS 5,Accounting for Contingencies. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loans that, in management’s judgment, should be charged off.
F-12
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(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 probable incurred losses on existing loans at the balance sheet date. Provision to and adequacy of the allowance for loan losses are based on the evaluation of the loan portfolio utilizing objective and subjective criteria, in accordance with SFAS 114 and SFAS 5. The objective criteria primarily include an internal grading system and specific allocations for impaired loans. The Company utilizes a historical analysis to validate the overall adequacy of the allowance for loan losses in accordance with SFAS 5. The subjective criteria take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, and business conditions that may affect the borrowers’ ability to pay, 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.
Under SFAS 114, a loan is impaired when it is probable that the Bank will be unable to collect all amounts due (including both interest and principal) according to the contractual terms of the loan agreement. Generally, a loan is impaired for purposes of SFAS 114 if it exhibits the same level of weaknesses and probability of loss as loans (or portions of loans) classified substandard, doubtful or loss. Commercial and commercial real estate loans are individually evaluated for impairment. Consumer and residential real estate loans are also 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, net of selling costs, if repayment is expected solely from the collateral.
The Bank automatically places loans on non-accrual when they become 90 days past due, however; when in management’s opinion the borrower may be unable to meet payments the loan may be placed on non-accrual at that time even if not then 90 days past due. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the Company may be unable to collect all outstanding principal and accrued interest, unless the loan is well secured and in process of collection. 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 assets and real estate are recorded in other noninterest income, and expenses used to maintain the properties are included in other noninterest expense. If the fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense.
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 3 to 7 years.
F-13
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
Restricted Equity Securities: These securities consist primarily of Federal Home Loan Bank (“FHLB”) and Silverton Financial Services, Inc (“Silverton”) stock. The Bank is a member of the FHLB system. Members of the FHLB are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. These securities are carried at cost, classified as restricted securities, 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 Bank has purchased life insurance policies on certain key executives. In accordance with EITF 06-05, bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Goodwill and Other Intangible Assets: Goodwill results from a business acquisition and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified.
Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from a bank acquisition. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, which was determined to be 15 years.
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: Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period.
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. Deferred tax assets are recognized for net operating loss carryforwards for state purposes that expire primarily in 2023 because the benefit is more likely than not to be realized.
F-14
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
The Company adopted FASB Interpretation 48,Accounting for Uncertainty in Income Taxes(“FIN 48”), as of January 1, 2007. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company’s adoption of FIN 48 had no affect on the Company’s financial statements.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
Retirement Plans: Supplemental employee retirement plan (“SERP”) expense is the net of service and interest cost, return on plan assets and amortization of gains and losses not immediately recognized. Employee 401(k) and profit sharing plan expense is the amount of matching contributions. The Company will match 100% of the first 4% the employee contributes to their 401(k) annually.
Employee Stock Purchase Plan: During 2008, the Company approved the Community First, Inc. Employee Stock Purchase Plan (the “Plan”). Under the Plan, eligible employees may elect for the Company to withhold a portion of their periodic compensation and purchase common shares of the Company at a purchase price equal to 95% of the closing market price of the shares of common stock on the last day of the three-month trading period. Expenses for the plan consist of administrative fees from the Company’s transfer agent and are immaterial.
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 and unvested stock awards. 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.
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 stock dividend of 15,558 shares was issued in the second quarter of 2008. All references to common shares and earnings and dividends per share have been restated to reflect the stock dividend as of the beginning of the earliest period presented.
Dividend Restriction: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to shareholders.
F-15
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
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, operations are managed and financial performance is evaluated on a Company-wide basis. Operating segments are aggregated into one as operating results for all segments are similar. 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:
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. In February 2008, the FASB issued Staff Position (FSP) 157-2,Effective Date of FASB Statement No. 157. This FSP, delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The impact of adoption was not material. In October 2008, the FASB issued FSP 157-3,Determining the Fair Value of a Financial Asset when the Market for That Asset Is Not Active. This FSP clarifies the application of FAS 157 in a market that is not active. The impact of adoption was not material.
In February 2007, the FASB issued Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilities.The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The new standard was effective for the Company on January 1, 2008. The Company did not elect the fair value option for any financial assets or financial liabilities as of January 1, 2008.
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 was effective for fiscal years beginning after December 15, 2007. The impact of adoption had no impact on the Company’s consolidated financial statements.
F-16
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)
On November 5, 2007, the SEC issued Staff Accounting Bulletin No. 109,Written Loan Commitments Recorded at Fair Value through Earnings(“SAB 109”). Previously, SAB 105,Application of Accounting Principles to Loan Commitments, stated that in measuring the fair value of a derivative loan commitment, a company should not incorporate the expected net future cash flows related to the associated servicing of the loan. SAB 109 supersedes SAB 105 and indicates that the expected net future cash flows related to the associated servicing of the loan should be included in measuring fair value for all written loan commitments that are accounted for at fair value through earnings. SAB 105 also indicated that internally-developed intangible assets should not be recorded as part of the fair value of a derivative loan commitment, and SAB 109 retains that view. SAB 109 was effective for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The impact of adoption was not material.
In December 2007, the SEC issued SAB No. 110, which expresses the views of the SEC regarding the use of a “simplified” method, as discussed in SAB No. 107, in developing an estimate of expected term of “plain vanilla” share options in accordance with SFAS No. 123(R),Share-Based Payment.The SEC concluded that a company could, under certain circumstances, continue to use the simplified method for share option grants after December 31, 2007. The Company does not use the simplified method for share options and therefore SAB No. 110 has not impact on the Company’s consolidated financial statements.
Effect of Newly Issued But Not Yet Effective Accounting Standards:
In December 2007, the FASB issued FAS No. 141 (revised 2007), Business Combinations (“FAS 141(R)”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. FAS No. 141(R) is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position during 2009.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133”. FAS No. 161 amends and expands the disclosure requirements of SFAS No. 133 for derivative instruments and hedging activities. FAS No. 161 requires qualitative disclosure about objectives and strategies for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements. FAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of this standard did not have a material effect on the Corporation’s results of operations or financial position during 2009.
F-17
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
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) for 2008 and 2007 were as follows:
| | | | | | | | | | | | | |
| | | | | | | Gross | | | Gross | |
| | | Fair | | | Unrealized | | | Unrealized | |
| | | Value | | | Gains | | | Losses | |
2008 | | | | | | | | | | | | |
| U.S. government sponsored entities | | $ | 4,496 | | | $ | 96 | | | $ | - | |
| Mortgage-backed | | | 54,783 | | | | 1,200 | | | | (19 | ) |
| State and municipals | | | 8,457 | | | | 69 | | | | (211 | ) |
| Other | | | 8,761 | | | | - | | | | (880 | ) |
| | | | | | | | | | |
| Total | | $ | 76,497 | | | $ | 1,365 | | | $ | (1,110 | ) |
| | | | | | | | | | |
| |
2007 | | | | | | | | | | | | |
| U.S. Government sponsored entities | | $ | 15,919 | | | $ | 52 | | | $ | - | |
| Mortgage-backed | | | 54,119 | | | | 178 | | | | (163 | ) |
| State and municipals | | | 6,233 | | | | 49 | | | | (26 | ) |
| Other | | | 4,662 | | | | 14 | | | | - | |
| | | | | | | | | | |
| Total | | $ | 80,933 | | | $ | 293 | | | $ | (189 | ) |
| | | | | | | | | | |
Sales of available for sale securities were as follows:
| | | | | | | | | |
| | | 2008 | | 2007 |
| Proceeds | | $ | 22,194 | | | $ | 20,289 | |
| Gross gains | | | 258 | | | | 28 | |
| Gross losses | | | - | | | | (9 | ) |
Tax provision related to the net realized gains for 2008 and 2007 was $99 and $7, respectively.
The fair value of debt securities at December 31, 2008 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.
| | | | | |
| | | Fair Value | |
| Due in one year or less | | $ | - | |
| Due after one through five years | | | 9,496 | |
| Due after five through ten years | | | 4,601 | |
| Due after ten years | | | 7,617 | |
| Mortgage-backed | | | 54,783 | |
| | | | |
| Total | | $ | 76,497 | |
| | | | |
Securities carried at $51,350 and $38,890 at December 31, 2008 and 2007, were pledged to secure deposits and for other purposes as required or permitted by law.
F-18
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 2 — SECURITIES AVAILABLE FOR SALE(Continued)
At year end 2008, the Company held $5,000 in trust preferred securities issued by Tennessee Commerce Statutory Trust. Other than this investment, the Company did not hold securities of any one issuer, other than the U.S. Government sponsored entities, in an amount greater than 10% of shareholders’ equity as of December 31, 2008 or 2007.
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, 2008 and 2007.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Less than 12 Months | | | 12 Months or More | | | Total | |
| 2008 | | | | | | | | | | | | | | | | | | |
| | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
| Description of Securities | | Value | | | Loss | | | Value | | | Loss | | | Value | | | Loss | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage-backed | | $ | 2,857 | | | $ | (11 | ) | | $ | 993 | | | $ | (8 | ) | | $ | 3,850 | | | $ | (19 | ) |
| State and municipals | | | 4,734 | | | | (204 | ) | | | 443 | | | | (7 | ) | | | 5,177 | | | | (211 | ) |
| Other | | | 3,761 | | | | (880 | ) | | | - | | | | - | | | | 3,761 | | | | (880 | ) |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total temporarily impaired | | $ | 11,352 | | | $ | (1,095 | ) | | $ | 1,436 | | | $ | (15 | ) | | $ | 12,788 | | | $ | (1,110 | ) |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Less than 12 Months | | | 12 Months or More | | | Total | |
| 2007 | | | | | | | | | | | | | | | | | | |
| | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
| Description of Securities | | Value | | | Loss | | | Value | | | Loss | | | Value | | | Loss | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage-backed securities | | $ | 11,510 | | | $ | (123 | ) | | $ | 4,323 | | | $ | (40 | ) | | $ | 15,833 | | | $ | (163 | ) |
| State and municipals | | | - | | | | - | | | | 2,244 | | | | (26 | ) | | | 2,244 | | | | (26 | ) |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total temporarily impaired | | $ | 11,510 | | | $ | (123 | ) | | $ | 6,567 | | | $ | (66 | ) | | $ | 18,077 | | | $ | (189 | ) |
| | | | | | | | | | | | | | | | | | | |
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 recovery, and the decline in fair value is largely due to changes in market interest rates. The fair value is expected to recover as the securities approach their maturity date and/or normal liquidity returns to the marketplace.
Management evaluates securities for other-than-temporary impairment on at least a quarterly 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 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.
F-19
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 2 — SECURITIES AVAILABLE FOR SALE(Continued)
At year end 2008, 16.7% of the Company’s securities available for sale were reported at an unrealized loss. In the event that securities were to be sold for liquidity purposes, there are sufficient holdings not in an unrealized loss position that could be sold, so that the Company would not be forced to sell the securities reporting an unrealized loss. The Company is further limited in the amount of securities that can be sold due to pledging requirements for Bank liabilities. Management considers security holdings in excess of our pledging requirement to be available for liquidity purposes. Sale of such holdings would not impair our ability to hold the securities reporting an unrealized loss until the loss is recovered or until maturity.
NOTE 3 — LOANS
Loans outstanding by category at December 31, 2008 and 2007, were as follows:
| | | | | | | | | |
| | | 2008 | | | 2007 | |
| Real estate | | | | | | | | |
| Construction | | $ | 152,937 | | | $ | 140,905 | |
| 1-4 family residential | | | 163,211 | | | | 151,478 | |
| Commercial | | | 162,475 | | | | 116,327 | |
| Other | | | 4,779 | | | | 4,567 | |
| Commercial, financial and agricultural | | | 62,674 | | | | 50,240 | |
| Consumer | | | 13,965 | | | | 14,969 | |
| Tax exempt | | | 354 | | | | - | |
| Other | | | 9,718 | | | | 12,122 | |
| | | | | | | |
| | | $ | 570,113 | | | $ | 490,608 | |
| | | | | | | |
During 2008, the Bank originated $5,391 of residential mortgage loans intended to be sold to secondary market investors that were not subsequently sold. As a result, the Bank transferred these loans at fair value to the Bank’s regular loan portfolio. The fair value adjustment resulted in a loss of $93. The principal balance and carrying value of loans reclassified from held for sale to portfolio loans was $5,027 and $4,935 at December 31, 2008.
Changes in the allowance for loan losses were as follows:
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| Balance at beginning of year | | $ | 6,086 | | | $ | 4,259 | | | $ | 3,268 | |
| Increase due to acquisition of First National | | | - | | | | 730 | | | | - | |
| Provision for loan losses | | | 5,528 | | | | 1,259 | | | | 1,018 | |
| Loans charged off | | | (2,753 | ) | | | (212 | ) | | | (50 | ) |
| Recoveries | | | 120 | | | | 50 | | | | 23 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Balance at end of year | | $ | 8,981 | | | $ | 6,086 | | | $ | 4,259 | |
| | | | | | | | | | |
F-20
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 3 — LOANS(Continued)
Individually impaired loans were as follows:
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| Year-end loans with no allocated allowance for loan losses | | $ | 51 | | | $ | 1,439 | | | $ | - | |
| Year-end loans with allocated allowance for loan losses | | | 4,150 | | | | 2,506 | | | | 1,416 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Total | | $ | 4,201 | | | $ | 3,945 | | | $ | 1,416 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Amount of the allowance for loan losses allocated | | $ | 1,503 | | | $ | 599 | | | $ | 149 | |
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| Average of impaired loans during the year | | $ | 3,884 | | | $ | 1,736 | | | $ | 361 | |
| Interest income recognized during impairment | | | 314 | | | | 145 | | | | 12 | |
| Cash-basis interest income recognized | | | 211 | | | | 149 | | | | 12 | |
Nonperforming loans were as follows:
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| Loans past due over 90 days still on accrual | | $ | 7 | | | $ | - | | | $ | - | |
| Nonaccrual loans | | | 3,357 | | | | 2,764 | | | | 1,059 | |
Nonperforming loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
As a result of the First National acquisition in 2007, the Company has acquired loans, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. A summary of these loans is as follows:
| | | | | | | | | |
| | | Contractually Required | | | Basis in Acquired Loans at | |
| | | Payments at Acquisition | | | Acquisition | |
| |
| Real Estate | | $ | 119 | | | $ | 37 | |
| Consumer | | | 74 | | | | 33 | |
| | | | | | | |
| Outstanding balance at acquisition | | | 193 | | | | 70 | |
| | | | | | | |
Carrying amount, net of allowance of $57 and $98 at December 31, 2008 and 2007 was $22 and $67, respectively.
At the acquisition date, the company could not reasonably estimate the cash flows expected to be collected. Therefore, an accretable yield has not been established and income is not recognized on these loans except to the extent that cash collected exceeds the carrying value.
During 2008 and 2007, the Company collected cash in excess of the carrying value in the amount of $18 and $1, and this amount was recognized as interest income.
F-21
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 4 — PREMISES AND EQUIPMENT
Year end premises and equipment were as follows:
| | | | | | | | | |
| | | 2008 | | | 2007 | |
| | | | | | | | | |
| Land | | $ | 2,948 | | | $ | 2,743 | |
| Buildings and improvements | | | 13,180 | | | | 11,725 | |
| Furniture and equipment | | | 6,317 | | | | 5,800 | |
| Construction in process | | | - | | | | 81 | |
| | | | | | | |
| | | | 22,445 | | | | 20,349 | |
| Less: Accumulated depreciation | | | (4,192 | ) | | | (3,093 | ) |
| | | | | | | |
| | | | | | | | | |
| | | $ | 18,253 | | | $ | 17,256 | |
| | | | | | | |
Depreciation expense for the years ended 2008, 2007, and 2006 was $1,256, $800, and $505, respectively.
The Bank leases certain branch properties and equipment under operating leases. Rent expense for 2008, 2007, and 2006 was $409, $288, and $162, respectively. Rent commitments under noncancelable operating leases including renewal options were as follows:
| | | | | |
| 2009 | | $ | 268 | |
| 2010 | | | 259 | |
| 2011 | | | 257 | |
| 2012 | | | 212 | |
| 2013 | | | 197 | |
| Thereafter | | | 2,932 | |
| | | | |
| | | $ | 4,125 | |
| | | | |
NOTE 5 — GOODWILL AND INTANGIBLE ASSETS
Goodwill
The change in balance for goodwill during the year is as follows:
| | | | | | | | | |
| | | 2008 | | | 2007 | |
| | | | | | | | | |
| Beginning of year | | $ | 4,622 | | | $ | - | |
| Acquired goodwill | | | - | | | | 4,622 | |
| Adjustment of purchase price allocation | | | 582 | | | | - | |
| | | | | | | |
| End of year | | $ | 5,204 | | | $ | 4,622 | |
| | | | | | | |
Adjustments to purchase price allocation were primarily due to deferred tax assets related to changes in fair value estimation of assets and liabilities acquired.
F-22
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 5 — GOODWILL AND INTANGIBLE ASSETS(Continued)
Acquired Intangible Assets
Acquired intangible assets resulting from the Company’s acquisition of First National were as follows at year end:
| | | | | | | | | | | | | | | | | |
| | | 2008 | | | 2007 | |
| | | Gross | | | | | | | Gross | | | | | |
| | | Carrying | | | Accumulated | | | Carrying | | | Accumulated | |
| | | Amount | | | Amortization | | | Amount | | | Amortization | |
| Amortized intangible assets: | | | | | | | | | | | | | | | | |
| Core deposit and customer relationship intangibles | | $ | 2,812 | | | $ | (429 | ) | | $ | 2,812 | | | $ | - | |
Amortization expense of $429 and $0 were recognized in 2008 and 2007, respectively.
Estimated amortization expense for each of the next five years is as follows:
| | | | | |
| 2009 | | $ | 318 | |
| 2010 | | | 275 | |
| 2011 | | | 239 | |
| 2012 | | | 199 | |
| 2013 | | | 137 | |
NOTE 6 — DEPOSITS
Deposits at December 31, 2008 and 2007, are summarized as follows:
| | | | | | | | | |
| | | 2008 | | | 2007 | |
| | | | | | | | | |
| Noninterest-bearing demand accounts | | $ | 45,848 | | | $ | 52,272 | |
| Interest-bearing demand accounts | | | 88,426 | | | | 81,637 | |
| Savings accounts | | | 18,508 | | | | 21,065 | |
| Time deposits greater than $100,000 | | | 167,708 | | | | 145,735 | |
| Other time deposits | | | 278,828 | | | | 258,594 | |
| | | | | | | |
| | | | | | | | | |
| | | $ | 599,318 | | | $ | 559,303 | |
| | | | | | | |
At December 31, 2008, scheduled maturities of time deposits are as follows:
| | | | | |
| 2009 | | $ | 416,610 | |
| 2010 | | | 26,543 | |
| 2011 | | | 1,773 | |
| 2012 | | | 985 | |
| 2013 | | | 625 | |
| | | | |
| | | $ | 446,536 | |
| | | | |
F-23
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 6 — DEPOSITS(Continued)
Included in other time deposits above are brokered time deposits of $52,038 at December 31, 2008, with a weighted rate of 3.04% and $23,413 with a weighted rate of 5.06% at December 31, 2007. 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 deposits to third parties. As of December 31, 2008 the Bank has $42,027 of brokered deposits that are scheduled to mature in 2009 and $10,011 scheduled to mature in 2010.
In addition, the Bank has $121,572 in national market deposits which are purchased by customers through a third-party internet site. Of these national market time deposits, $114,739 are scheduled to mature in 2009, $5,645 in 2010 and $1,188 in 2011.
NOTE 7 — OTHER BORROWINGS
The Company has a secured line of credit of $4,000 to assist with funding the Company’s acquisition of all of the outstanding capital stock of First National. The line of credit is secured by 100% of the Bank stock owned by the Company. At year end 2008, the balance on the line of credit was $2,835. The interest rate on the line of credit is based on the prime rate as designated in the Money Rates sections of the Wall Street Journal minus 50 bps with a floor rate of 3.75%. The rate being charged to the line as of December 31, 2008 was 3.75%. The line of credit will mature in the fourth quarter of 2009.
On December 30, 2008, the Company obtained an unsecured loan of $2,000 to provide liquidity and additional capital for the Bank. The balance of the loan, including accrued interest is due June 30, 2009. Interest rate on the loan is a variable rate equal to the prime rate as designated in the Money Rates sections of the Wall Street Journal, with a floor rate of 5.00%. The rate being charged to the loan as of December 31, 2008 was 5.00%.
NOTE 8 — 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 $1,449 of such stock at December 31, 2008, to satisfy this requirement.
At December 31, 2008 and 2007, advances from the FHLB totaled $22,000 and $11,000. The fixed interest rates on these advances range from 2.71% to 5.60% at December 31, 2008 and 3.81% to 5.67% at December 31, 2007. The weighted average rates at December 31, 2008 and 2007 were 3.50% and 5.28%. The FHLB advance maturities ranged from June 2009 to May 2013 at December 31, 2008. Each FHLB advance is payable at its maturity, with a prepayment penalty for all fixed rate advances. At December 31, 2008 and 2007, undrawn standby letters of credit with the FHLB totaled $10,000. The standby letter of credit matured in January 2009 and in January 2009, was renewed for an additional one year term. The letter of credit is used as a pledge to the State of Tennessee Bank Collateral Pool. Qualifying loans totaling $304,614 were pledged as
F-24
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 8 — FEDERAL HOME LOAN BANK ADVANCES(Continued)
security under a blanket pledge agreement with the FHLB at December 31, 2008.
Maturities of the advances from the FHLB are as follows:
| | | | | |
| 2009 | | $ | 8,000 | |
| 2010 | | | - | |
| 2013 | | | 8,000 | |
| | | | |
| | | $ | 22,000 | |
| | | | |
The Company also has a cash management line of credit with the FHLB totaling $10,000 that will mature July 2009. At December 31, 2008, the line was fully drawn. The interest rate on the line varies daily based on the federal funds rate. The rate for the line of credit was 0.62% at December 31, 2008.
NOTE 9 — SUBORDINATED DEBENTURES
In 2002, the Company borrowed $3,000 of 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 Company can currently repay the securities at any time without penalty. The interest rate on the securities as of December 31, 2008 was 5.50%. The securities bear interest at a floating rate equal to the New York Prime rate plus .50 basis points. They are presented in liabilities on the balance sheet and count as Tier 1 capital for regulatory capital purposes. Debt issuance costs of $74 have been capitalized and are being amortized over the term of the securities. Principal officers, directors, and their affiliates at year end 2008 and 2007 owned $700 of the $3,000 subordinated debentures. The proceeds from this offering were utilized to increase the Bank’s capital by $3,000.
In 2005, the Company borrowed $5,000 of 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. The interest rate on the securities as of December 31, 2008 was 3.50%. The securities bear interest at a floating rate equal to the 3-Month LIBOR plus 1.50%. 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. The proceeds from the pool offering was used to increase the Bank’s capital.
In 2007, the Company borrowed $15,000 of redeemable securities through a special purpose entity as part of a pool offering. These securities mature in 2037, however, the maturity may be shortened to a date not earlier than December 15, 2012. The interest rate on the securities is 7.96% until December 15, 2012, and thereafter the securities bear interest at a floating rate equal to the 3-month LIBOR plus 3.0%. They are presented in liabilities on the balance sheet and $7,482 count as Tier 1 capital and the remaining $7,518 is considered as Tier II capital for regulatory purposes. There was no debt issuance cost in obtaining the subordinated debenture. The proceeds were used to help fund the acquisition of First National.
F-25
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 10 — OTHER BENEFIT PLANS
401(k) Plan: A 401(k) benefit plan allows employee contributions up to 15% of their compensation, of which the Company will match 100% of the first 4% the employee contributes to their 401(k) annually for all periods presented. Expense for 2008, 2007, and of 2006 was $199, $172 and $89, respectively.
Deferred Compensation and Supplemental Retirement Plans: Deferred compensation and supplemental retirement plan (“SERP”) expense allocates the benefits over years of service. The Bank approved the SERP in 2006. The SERP will provide certain Company officers with benefits upon retirement, death, or disability in certain prescribed circumstances. SERP expense was $135 in 2008, $240 in 2007 and $79 in 2006, resulting in a deferred compensation liability for the last three years of $483, $348 and $107.
NOTE 11 — INCOME TAXES
The components of income tax expense (benefit) are summarized as follows:
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| | | | | | | | | | | | | |
| Current | | | | | | | | | | | | |
| Federal | | $ | 107 | | | $ | 1,172 | | | $ | 1,542 | |
| State | | | - | | | | - | | | | - | |
| | | | | | | | | | |
| Total current taxes | | | 107 | | | | 1,172 | | | | 1,542 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Deferred | | | | | | | | | | | | |
| Federal | | | (1,014 | ) | | | (126 | ) | | | (232 | ) |
| State | | | (576 | ) | | | (222 | ) | | | (146 | ) |
| | | | | | | | | | |
| Total deferred taxes | | | (1,590 | ) | | | (348 | ) | | | (378 | ) |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Change in valuation allowance | | | - | | | | - | | | | (51 | ) |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Income tax expense (benefit) | | $ | (1,483 | ) | | $ | 824 | | | $ | 1,113 | |
| | | | | | | | | | |
A reconciliation of actual income tax expense (benefit) 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:
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| Federal statutory rate times financial statement income (loss) | | $ | (943 | ) | | $ | 1,089 | | | $ | 1,331 | |
| Effect of: | | | | | | | | | | | | |
| Bank owned life insurance | | | (81 | ) | | | (51 | ) | | | (71 | ) |
| Tax-exempt income | | | (120 | ) | | | (84 | ) | | | (48 | ) |
| State income taxes, net of federal income effect | | | (380 | ) | | | (147 | ) | | | (96 | ) |
| Expenses not deductible for U.S. income taxes | | | 45 | | | | 40 | | | | 35 | |
| Compensation expense related to SFAS 123R | | | 58 | | | | 70 | | | | 98 | |
| General business credit | | | (66 | ) | | | (66 | ) | | | (66 | ) |
| Change in valuation allowance | | | - | | | | - | | | | (51 | ) |
| Other expense (benefit), net | | | 4 | | | | (27 | ) | | | (19 | ) |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Income tax expense (benefit) | | $ | (1,483 | ) | | $ | 824 | | | $ | 1,113 | |
| | | | | | | | | | |
F-26
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 11 — 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:
| | | | | | | | | |
| | | 2008 | | | 2007 | |
| Deferred tax assets: | | | | | | | | |
| Allowance for loan losses | | $ | 3,279 | | | $ | 2,145 | |
| Net operating loss carry forward | | | 458 | | | | 207 | |
| Deferred compensation | | | 185 | | | | 133 | |
| Tax credit carryforwards | | | 307 | | | | - | |
| Other | | | 161 | | | | 94 | |
| | | | | | | |
| | | $ | 4,390 | | | $ | 2,579 | |
| | | | | | | |
| | | | | | | | | |
| Deferred tax liabilities: | | | | | | | | |
| Prepaids | | $ | (261 | ) | | $ | (186 | ) |
| Depreciation | | | (1,383 | ) | | | (501 | ) |
| Federal Home Loan Bank stock | | | (79 | ) | | | (61 | ) |
| Core deposit intangible | | | (912 | ) | | | (1,077 | ) |
| Intercompany dividend | | | (214 | ) | | | (215 | ) |
| Unrealized gain on securities | | | (104 | ) | | | (40 | ) |
| Other | | | (198 | ) | | | (84 | ) |
| | | | | | | |
| | | $ | (3,151 | ) | | $ | (2,164 | ) |
| | | | | | | |
| | | | | | | | | |
| Balance at end of year | | $ | 1,239 | | | $ | 415 | |
| | | | | | | |
At year end 2008, the Company had net operating loss carryforwards for state tax purposes of approximately $10,700, which begin to expire in 2021. The Company has evaluated this deferred tax asset and believes it is more likely than not that the net operating loss will be utilized prior to its expiration.
The Company currently has no unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods. The Company does not expect any unrecognized tax benefits to significantly increase or decrease in the next twelve months. It is the Company’s policy to recognize any interest accrued related to unrecognized tax benefits in interest expense, with any penalties recognized as operating expenses.
The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of the state of Tennessee. The Company is no longer subject to examination by taxing authorities for tax years before 2006.
NOTE 12 — RELATED PARTY TRANSACTIONS
Loans to principal officers, directors, and their affiliates in 2008 were as follows:
| | | | | |
| Beginning balance | | $ | 4,159 | |
| New loans | | | 1,559 | |
| Repayments | | | (1,517 | ) |
| | | | |
| | | | | |
| Ending balance | | $ | 4,201 | |
| | | | |
F-27
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 12 — RELATED PARTY TRANSACTIONS(Continued)
Deposits from principal officers, directors, and their affiliates at year-end 2008 and 2007 were $5,169 and $3,407, respectively. Principal officers, directors, and their affiliates at year end 2008 and 2007 owned $700 of the $3,000 subordinated debentures due December 31, 2032. At December 31, 2008, the approved available unused lines of credit on related party loans were $1,505.
NOTE 13 — 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. There were 342,000 shares authorized by the Stock Option Plan in 2002. Additionally, the Community First, Inc. 2005 Stock Incentive Plan was approved at the stockholders meeting on April 26, 2005 authorizing shares of 450,000. 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 271,479 authorized shares available for grant as of December 31, 2008. The Company recognized $196, $231, and $302 as compensation expense resulting from stock options and $30, $22, and $5 as compensation expense resulting from restricted stock awards in 2008, 2007, and 2006 respectively. The total income tax benefit from non-qualified stock options was $0 in 2008, $12 in 2007 and $142 in 2006.
The fair value of each option is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical volatilities of the Company’s common stock. 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.
The fair value of options granted was determined using the following weighted average assumptions at grant date.
| | | | | | | | | | | | | |
| | | 2008 | | 2007 | | 2006 |
| Risk-free interest rate | | | 3.88 | % | | | 5.04 | % | | | 5.07 | % |
| Expected option life | | 7 years | | 7 years | | 7 years |
| Expected stock price volatility | | | 12.64 | % | | | 14.00 | % | | | 16.06 | % |
| Dividend yield | | | 0.73 | % | | | 0.74 | % | | | 1.00 | % |
F-28
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 13 — STOCK BASED COMPENSATION(Continued)
A summary of option activity under the Company’s stock incentive plans for 2008 is presented in the following table:
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | Weighted | | | | |
| | | | | | | | | | | Average | | | | |
| | | | | | | Weighted | | | Remaining | | | | |
| | | | | | | Average | | | Contractual | | | Aggregate | |
| | | | | | | Exercise | | | Term in | | | Intrinsic | |
| | | Shares | | | Price/Share | | | Years | | | Value | |
| Options outstanding January 1, 2008 | | | 257,877 | | | $ | 16.15 | | | | | | | | | |
| Granted | | | 39,300 | | | | 30.00 | | | | | | | | | |
| Options exercised | | | (22,600 | ) | | | 6.70 | | | | | | | | | |
| Forfeited or expired | | | (26,450 | ) | | | 27.62 | | | | | | | | | |
| | | | | | | | | | | | | | | |
| Options outstanding December 31, 2008 | | | 248,127 | | | $ | 17.98 | | | | 4.62 | | | $ | 1,487 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Vested or expected to vest | | | 248,127 | | | $ | 17.98 | | | | 4.62 | | | $ | 1,487 | |
| | | | | | | | | | | | | | | | | |
| Exercisable at December 31, 2008 | | | 188,039 | | | $ | 14.20 | | | | 3.28 | | | $ | 2,500 | |
| | | | | | | | | | | | | |
Information related to the stock incentive plans during each year is as follows:
| | | | | | | | | | | | | |
| | | 2008 | | 2007 | | 2006 |
| Intrinsic value of options exercised | | $ | 527 | | | $ | 108 | | | $ | 370 | |
| Cash received from option exercises | | | 152 | | | | 61 | | | | 121 | |
| Tax benefit realized from option exercises | | | - | | | | 12 | | | | 142 | |
| Weighted average fair value of options granted | | | 6.94 | | | | 8.46 | | | | 8.46 | |
As of December 31, 2008, there was $405 of total unrecognized compensation cost related to nonvested stock options granted under the Company’s stock incentive plans. The cost is expected to be recognized over a weighted average period of 2.4 years.
Restricted stock is issued to certain officers on a discretionary basis. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at issue date. The fair value of the stock was determined using the market price on the day of issuance. Restricted stock vests over a 2-3 year period. Vesting occurs ratably on the anniversary day of the issuance.
F-29
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 13 — STOCK BASED COMPENSATION(Continued)
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, 2008 | | | 2,470 | | | $ | 29.86 | |
| Granted | | | 466 | | | | 30.00 | |
| Vested | | | (939 | ) | | | 29.63 | |
| Forfeited | | | - | | | | - | |
| | | | | | | |
| | | | | | | | | |
| Nonvested at December 31, 2008 | | | 1,997 | | | $ | 30.00 | |
| | | | | | | |
Non-fully vested grants of restricted stock as of December 31, 2008 were as follows:
| | | | | |
| Date of Grant | | Shares | |
| First Quarter 2007 | | | 1,531 | |
| First Quarter 2008 | | | 466 | |
| | | | |
| | | | | |
| | | | 1,997 | |
| | | | |
Unrecognized compensation cost related to these awards, as of December 31, 2008 was $36. The unrecognized compensation cost is expected to be recognized over a weighted-average period of 1.20 years.
NOTE 14— 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 2008 and 2007:
| | | | | | | | | | | | | | | | | |
| | | 2008 | | 2007 |
| | | Fixed | | Variable | | Fixed | | Variable |
| | | Rate | | Rate | | Rate | | Rate |
| Unused lines of credit | | $ | 3,719 | | | $ | 53,292 | | | $ | 3,084 | | | $ | 71,946 | |
| Letters of credit | | | - | | | | 13,732 | | | | - | | | | 4,409 | |
| Commitments to make loans | | | 270 | | | | - | | | | - | | | | 7,990 | |
| Loans sold with recourse | | | 27,704 | | | | - | | | | 37,154 | | | | - | |
These commitments are generally made for periods of one year or less. The fixed rate unused lines of credit have interest rates ranging from 4.50% to 10.00% and maturities ranging from 1 to 19 years.
F-30
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 15 — REGULATORY MATTERS
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Management believes as of December 31, 2008, the Company and the Bank met all capital adequacy requirements to which they were subject.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year end 2008 and 2007, the most recent regulatory notifications categorized the Bank and First National (merged into Bank during the first quarter of 2008) as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institutions’ category.
The Company’s and its subsidiary banks’ capital amounts and ratios at December 31, 2008 and 2007, were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | To Be Well |
| | | | | | | | | | | | | | | | | | | Capitalized Under |
| | | | | | | | | | | For Capital | | Prompt Corrective |
| | | Actual | | Adequacy Purposes | | Action Provisions |
| 2008 | | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio |
| Total Capital to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Community First Bank & Trust | | $ | 61,070 | | | | 10.19 | % | | $ | 47,923 | | | | 8.00 | % | | $ | 59,903 | | | | 10.00 | % |
| Consolidated | | | 58,910 | | | | 9.81 | % | | | 48,029 | | | | 8.00 | % | | | N/A | | | | N/A | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Community First Bank & Trust | | $ | 53,564 | | | | 8.94 | % | | $ | 23,961 | | | | 4.00 | % | | $ | 35,942 | | | | 6.00 | % |
| Consolidated | | | 40,373 | | | | 6.72 | % | | | 24,015 | | | | 4.00 | % | | | N/A | | | | N/A | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 to average assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Community First Bank & Trust | | $ | 53,564 | | | | 7.99 | % | | $ | 26,829 | | | | 4.00 | % | | $ | 33,536 | | | | 5.00 | % |
| Consolidated | | | 40,373 | | | | 6.00 | % | | | 26,935 | | | | 4.00 | % | | | N/A | | | | N/A | |
F-31
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 15 — REGULATORY MATTERS(Continued)
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | To Be Well |
| | | | | | | | | | | | | | | | | | | Capitalized Under |
| | | | | | | | | | | For Capital | | Prompt Corrective |
| | | Actual | | Adequacy Purposes | | Action Provisions |
| | | Ratio | | Amount | | Ratio | | Amount | | Ratio | | | | |
2007 | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Capital to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Community First Bank & Trust | | $ | 48,800 | | | | 10.07 | % | | $ | 38,750 | | | | 8.00 | % | | $ | 48,438 | | | | 10.00 | % |
| First National Bank of Centerville | | | 8,652 | | | | 17.61 | % | | | 3,930 | | | | 8.00 | % | | | 4,912 | | | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 58,676 | | | | 10.97 | % | | | 42,773 | | | | 8.00 | % | | | N/A | | | | N/A | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Community First Bank & Trust | | $ | 43,313 | | | | 8.96 | % | | $ | 19,375 | | | | 4.00 | % | | $ | 29,063 | | | | 6.00 | % |
| First National Bank of Centerville | | | 8,037 | | | | 16.36 | % | | | 1,965 | | | | 4.00 | % | | | 2,947 | | | | 6.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 42,064 | | | | 7.87 | % | | | 21,387 | | | | 4.00 | % | | | N/A | | | | N/A | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 to average assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Community First Bank & Trust | | $ | 43,413 | | | | 8.35 | % | | $ | 20,792 | | | | 4.00 | % | | $ | 25,990 | | | | 5.00 | % |
| First National Bank of Centerville | | | 8,037 | | | | 8.27 | % | | | 3,889 | | | | 4.00 | % | | | 4,861 | | | | 5.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 42,064 | | | | 6.76 | % | | | 24,889 | | | | 4.00 | % | | | N/A | | | | N/A | |
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 2009, the Bank could, without prior approval, declare dividends of approximately $3,577 plus any 2009 net profits retained to the date of the dividend declaration. The Bank is not at risk of falling into a capital classification lower than “well capitalized” if it pays the entire $3,577 to the holding company during 2009 due to the additional capital provided by participation in the U.S. Treasury’s Capital Purchase Program described in Note 16. The Company will also be restricted in the types and amounts of dividends that can be paid due to the provisions of the program.
NOTE 16 — SUBSEQUENT EVENT
On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 (EESA), which provides the U. S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. One of the provisions resulting from the Act is the Treasury Capital Purchase Program (CPP), which provides direct equity investment of perpetual preferred stock by the Treasury in qualified financial institutions. The program is voluntary and requires an institution to comply with a number of restrictions and provisions, including limits on executive compensation, stock redemptions and declaration of dividends. Base compensation for top executives of the Company is limited based on the executive’s position with the Company. Bonus payments and other compensation agreements that meet Treasury’s definition of a “golden parachute” are prohibited. Dividends to common shareholders may only be paid if required dividends for preferred shares have been satisfied as of the date of the dividend declaration. Common dividends cannot exceed historical levels unless approved by Treasury and there are no preferred dividends in arrears.
F-32
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 16 — SUBSEQUENT EVENT (Continued)
The Company applied to participate in the program during the fourth quarter of 2008 and received notification of approval for the program in the first quarter of 2009. Under the terms of the program, Treasury purchased $17,806 in Senior Preferred shares of the Company. The Senior Preferred shares have a cumulative dividend rate of 5% per year, until the fifth anniversary of the Treasury investment, and a dividend rate of 9% thereafter. In addition, under the terms of the agreement, the Company issued warrants to Treasury to purchase additional preferred shares equal to 5% of the investment in Senior Preferred shares at a discounted exercise price. Treasury exercised the options immediately upon investment in the Senior Preferred shares. The Warrant Preferred shares have a cumulative dividend rate of 9% per year until redeemed. Dividends on both Senior Preferred and Warrant Preferred shares are required to be paid quarterly. Total required annual dividends for preferred shares are as follows: 2009: $809; 2010 — 2013: $970; 2014: $1,564; 2015 and thereafter $1,683. The Company is able to redeem all or a portion of the preferred shares at any time but may not redeem the Warrant Preferred shares until all of the Senior Preferred shares have been redeemed. Dividend payments on the preferred shares would be reduced for any redemptions.
In order to participate in the CPP, it was necessary for the company to create a class of preferred shares to offer to Treasury. The Company’s shareholders voted on December 30, 2008 to authorize a class of blank check preferred stock, consisting of 2,500,000 authorized shares, which may be issued in one or more series, with such rights, preferences, privileges and restrictions as shall be fixed by the Company’s Board of Directors.
The proceeds from the preferred shares will impact the capital ratios included in Note 15 by increasing the consolidated Tier 1 capital by $17,806. The Company invested $9,000 of this $17,806 in the Bank, which will increase the Tier 1 capital above for the Bank by that amount.
NOTE 17 — FAIR VALUE
Statement 157 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The fair values of trading securities and securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).
F-33
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 17 — FAIR VALUE(Continued)
Trust Preferred Securities which are issued by financial institutions and insurance companies were historically priced using Level 2 inputs, but the decline in the level of observable inputs and market activity in this class of investments during 2008 has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely. The once active market has become comparatively inactive. As such, these investments are now priced using Level 3 inputs.
The Company has developed an internal model for pricing these securities. Information such as historical and current performance of the underlying collateral, deferral/default rates, collateral coverage ratios, break in yield calculations, cash flow projections, liquidity and credit premiums required by a market participant, and financial trend analysis with respect to the individual issuing financial institutions and insurance companies, are utilized in determining individual security valuations. Due to current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.
The fair value of loans held for sale is based upon binding quotes from 3rd party investors. (Level 2 inputs) The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below:
| | | | | | | | | | | | | |
| |
| | | | | Fair Value Measurements at December 31, 2008 using | |
| | | | | Significant Other Observable | | | Significant | |
| | | | | Inputs | | | Unobservable Inputs | |
| | | | | (Level 2) | | | (Level 3) | |
| | Assets: | | | | | | | | | | | |
| | Available for sale securities | | | $ | 76,497 | | | | $ | — | | |
| | Trust preferred securities | | | | — | | | | | 4,645 | | |
| |
Assets and Liabilities Measured on a Non-recurring Basis
Assets and liabilities measured at fair value on a non recurring basis are summarized below:
| | | | | | | | | | | | | |
| |
| | | | | Fair Value Measurements at December 31, 2008 using: | |
| | | | | Significant Other Observable | | | Other significant | |
| | | | | Inputs | | | Unobservable Inputs | |
| | | | | (Level 2) | | | (Level 3) | |
| | Assets: | | | | | | | | | | | |
| | Impaired Loans | | | | — | | | | $ | 2,647 | | |
| |
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral
F-34
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 17 — FAIR VALUE(Continued)
dependent loans, had a current balance of $4,201, with a valuation allowance of $1,503, resulting in an additional provision for loan losses of $1,396 for the period.
Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. It was not practicable to determine the fair value of restricted equity securities due to restrictions placed on their transferability. 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 value of debt is based on current rates for similar financing. The fair value of off-balance-sheet items is not considered material.
Carrying amount and estimated fair values of significant financial instruments at year end 2008 and 2007 were as follows:
| | | | | | | | | | | | | | | | | |
| | | 2008 | | 2007 |
| | | Carrying | | Fair | | Carrying | | Fair |
| | | Amount | | Value | | Amount | | Value |
| Financial assets | | | | | | | | | | | | | | | | |
| Securities available for sale | | $ | 76,497 | | | $ | 76,497 | | | $ | 80,933 | | | $ | 80,933 | |
| Loans held for sale | | | 6,107 | | | | 6,107 | | | | 5,710 | | | | 5,710 | |
| Loans, net of allowance | | | 561,132 | | | | 579,736 | | | | 484,522 | | | | 485,906 | |
| Bank owned life insurance | | | 8,085 | | | | 8,085 | | | | 3,848 | | | | 3,848 | |
| Financial liabilities | | | | | | | | | | | | | | | | |
| Deposits with defined maturities | | $ | 446,536 | | | $ | 448,254 | | | $ | 404,329 | | | $ | 407,249 | |
| Federal Home Loan Bank advances | | | 32,000 | | | | 32,594 | | | | 11,000 | | | | 11,131 | |
| Subordinated debentures | | | 23,000 | | | | 22,009 | | | | 23,000 | | | | 22,947 | |
NOTE 18 — LEASE REVENUE
The Bank built a branch at Carothers Parkway, located in Franklin, Tennessee, that was completed in 2006 at cost of $2,370. The Bank’s principal leasing activities consist of 1,650 square feet of office space on the second floor of the Carothers Parkway Branch under an operating lease. The lessee rents approximately 8% of the branch. The lease term is for five years beginning October 2007 with a renewal term of 36 months upon written notice of 120 days prior to the expiration of the original term. Lessee has five such renewal options. The five year lease will produce $175 in total revenue, of which, $44 and $7 was recognized in 2008 and 2007, respectively.
Approximate minimum rental for the noncancelable lease as of December 31, 2008 was:
| | | | | |
| 2009 | | | 34 | |
| 2010 | | | 35 | |
| 2011 | | | 36 | |
| 2012 | | | 30 | |
| | | | |
| | | $ | 135 | |
| | | | |
F-35
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 19 — BUSINESS COMBINATIONS
On October 26, 2007, the Company acquired 100% of the outstanding shares of First National. Operating results of First National are included in the consolidated financial statements since the date of the acquisition. On January 31, 2008, First National was merged with and into Community First Bank & Trust, with Community First Bank & Trust surviving. As a result of this acquisition, the Company expects to further solidify its market share in the Hickman County market, expand its customer base to enhance deposit fee income, provide an opportunity to market additional products and services to new customers, and reduce operating costs through economies of scale.
The aggregate purchase price was $22,800 in cash. The purchase price resulted in approximately $4,622 in goodwill, and $2,812 in core deposit and customer relationship intangible. The intangible assets will be amortized over 15 years, using an accelerated method. Goodwill will not be amortized but instead evaluated periodically for impairment.
The following table summarizes the estimated fair value of assets acquired and liabilities assumed.
| | | | | |
| Securities available for sale | | $ | 54,385 | |
| Loans, net | | | 39,527 | |
| Premises and equipment | | | 2,244 | |
| Goodwill | | | 4,622 | |
| Core deposit and customer relationship intangibles | | | 2,812 | |
| Other assets | | | 1,178 | |
| | | | |
| Total assets acquired | | | 104,768 | |
| | | | | |
| Deposits | | | (84,691 | ) |
| Other liabilities | | | (1,617 | ) |
| | | | |
| Total liabilities assumed | | | (86,308 | ) |
| | | | |
| | | | | |
| Purchase price net of cash acquired of $4,340 | | $ | 18,460 | |
| | | | |
See Note 5 for final adjustments to goodwill as a result of purchase accounting adjustments during 2008.
F-36
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 19 — BUSINESS COMBINATIONS(Continued)
The following table presents pro forma information as if the acquisition had occurred at the beginning of 2007 and 2006. The pro forma information includes adjustments for interest income on loans and securities acquired, amortization of intangibles arising from the transaction, depreciation expense on property acquired, interest expense on deposits acquired, and the related income tax effects. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transactions been effected on the assumed dates.
| | | | | | | | | |
| | | (Unaudited) | |
| | | 2007 | | | 2006 | |
| | | | | | | | | |
| Net interest income | | $ | 17,453 | | | $ | 14,578 | |
| | | | | | | |
| Net income | | $ | 3,161 | | | $ | 3,293 | |
| | | | | | | |
| Basic earnings per share | | $ | 1.00 | | | $ | 1.15 | |
| | | | | | | |
| Diluted earnings per share | | $ | 0.97 | | | $ | 1.11 | |
| | | | | | | |
NOTE 20 — PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial information of Community First, Inc. follows:
CONDENSED BALANCE SHEET
December 31
| | | | | | | | | |
| | | 2008 | | | 2007 | |
Assets | | | | | | | | |
| Cash and cash equivalents | | $ | 2,362 | | | $ | 1,449 | |
| Investment in banking subsidiaries | | | 62,015 | | | | 59,659 | |
| Other assets | | | 491 | | | | 529 | |
| | | | | | | |
| | | | | | | | | |
| Total assets | | $ | 64,868 | | | $ | 61,637 | |
| | | | | | | |
| | | | | | | | | |
Liabilities and shareholders’ equity | | | | | | | | |
| Subordinated debentures | | $ | 23,000 | | | $ | 23,000 | |
| Other borrowed money | | | 4,835 | | | | 510 | |
| Other liabilities | | | 998 | | | | 954 | |
| | | | | | | |
| Total liabilities | | | 28,833 | | | | 24,464 | |
| Shareholders’ equity | | | 36,035 | | | | 37,173 | |
| | | | | | | |
| | | | | | | | | |
| Total liabilities and shareholders’ equity | | $ | 64,868 | | | $ | 61,637 | |
| | | | | | | |
F-37
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 20 — PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION(Continued)
CONDENSED STATEMENTS OF INCOME
Years Ended December 31
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| Interest income | | $ | 50 | | | $ | 90 | | | $ | 18 | |
| Dividends from subsidiaries | | | - | | | | - | | | | 875 | |
| | | | | | | | | | |
| Total income | | | 50 | | | | 90 | | | | 893 | |
| | | | | | | | | | | | | |
| Interest expense | | | 1,729 | | | | 979 | | | | 600 | |
| Other expense | | | 740 | | | | 610 | | | | 510 | |
| | | | | | | | | | |
| Total expenses | | | 2,469 | | | | 1,589 | | | | 1,110 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Losses before income tax and undistributed subsidiaries income | | | (2,419 | ) | | | (1,499 | ) | | | (217 | ) |
| Income tax benefit | | | 861 | | | | 495 | | | | 419 | |
| Equity in undistributed income of subsidiaries | | | 268 | | | | 3,384 | | | | 2,600 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Net income (loss) | | $ | (1,290 | ) | | $ | 2,380 | | | $ | 2,802 | |
| | | | | | | | | | |
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| Cash flows from operating activities | | | | | | | | | | | | |
| Net income (loss) | | $ | (1,290 | ) | | $ | 2,380 | | | $ | 2,802 | |
| Adjustments to reconcile net income to net cash from operating activities: | | | | | | | | | | | | |
| Equity in undistributed income of subsidiaries | | | (268 | ) | | | (3,384 | ) | | | (2,600 | ) |
| Compensation expense under stock based compensation | | | 226 | | | | 253 | | | | 307 | |
| Tax benefit on exercise of stock options | | | - | | | | (12 | ) | | | (142 | ) |
| Change in other, net | | | 82 | | | | (115 | ) | | | (24 | ) |
| | | | | | | | | | |
| Net cash provided by (used in) operating activities | | | (1,250 | ) | | | (878 | ) | | | 343 | |
| Cash flows from investing activities | | | | | | | | | | | | |
| Investments in and advances to bank subsidiaries | | | (2,000 | ) | | | (18,123 | ) | | | (3,762 | ) |
| | | | | | | | | | |
| Net cash from investing activities | | | (2,000 | ) | | | (18,123 | ) | | | (3,762 | ) |
| Cash flows from financing activities Proceeds from issuance of stock | | $ | 64 | | | $ | 4,380 | | | $ | 3,761 | |
| Proceeds from stock option exercises | | | 152 | | | | 61 | | | | 121 | |
| Tax benefit on exercise of stock options | | | - | | | | 12 | | | | 142 | |
| Repurchase of common stock | | | (124 | ) | | | - | | | | - | |
| Cash paid for dividends | | | (254 | ) | | | (696 | ) | | | (575 | ) |
| Proceeds other borrowed money | | | 4,325 | | | | 8,310 | | | | - | |
| Repayment other borrowed money | | | - | | | | (7,800 | ) | | | - | |
| Proceeds from issuance of subordinated debentures | | | - | | | | 15,000 | | | | - | |
| Net cash from financing activities | | | 4,163 | | | | 19,267 | | | | 3,449 | |
| Net change in cash and cash equivalents | | | 913 | | | | 266 | | | | 30 | |
| Beginning cash and cash equivalents | | | 1,449 | | | | 1,183 | | | | 1,153 | |
| Ending cash and cash equivalents | | $ | 2,362 | | | $ | 1,449 | | | $ | 1,183 | |
| Supplemental noncash disclosures: | | | | | | | | | | | | |
| Issuance of common stock through dividend reinvestment | | $ | 66 | | | $ | - | | | $ | - | |
F-38
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 21 — EARNINGS PER SHARE
The factors used in the earnings per share computation follows:
| | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| Basic | | | | | | | | | | | | |
| Net income (loss) | | $ | (1,290 | ) | | $ | 2,380 | | | $ | 2,802 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Weighted average common shares outstanding | | | 3,202,904 | | | | 3,144,835 | | | | 2,881,715 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Basic earnings (loss) per common share | | $ | (0.40 | ) | | $ | 0.76 | | | $ | 0.97 | |
| | | | | | | | | | |
| Diluted | | | | | | | | | | | | |
| Net income (loss) | | $ | (1,290 | ) | | $ | 2,380 | | | $ | 2,802 | |
| | | | | | | | | | |
| Weighted average common shares outstanding for basic earnings per common share | | | 3,202,904 | | | | 3,144,835 | | | | 2,881,715 | |
| Add: Dilutive effects of assumed exercise of stock options | | | - | | | | 105,071 | | | | 99,385 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Average shares and dilutive potential common shares | | | 3,202,904 | | | | 3,249,906 | | | | 2,981,100 | |
| | | | | | | | | | |
| | | | | | | | | | | | | |
| Diluted earnings (loss) per common share | | $ | (0.40 | ) | | $ | 0.73 | | | $ | 0.94 | |
| | | | | | | | | | |
At year end 2008 and 2007 there were 188,039 and 69,100 antidilutive stock options, respectively. No options were antidilutive for 2006. Due to the net loss for the period ended December 31, 2008, all outstanding stock options are antidilutive and are excluded from the diluted earnings (loss) per common share calculation.
NOTE 22—QUARTERLY FINANCIAL DATA (UNAUDITED)
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | Earnings (loss) | |
| | | | | | | | | | | | | | | Per Share | |
| | | Interest | | | Net Interest | | | Net Income | | | | | | | |
| | | Income | | | Income | | | (loss) | | | Basic | | | Diluted | |
2008 | | | | | | | | | | | | | | | | | | | | |
| First quarter | | | 10,163 | | | | 4,112 | | | | 321 | | | $ | 0.10 | | | $ | 0.10 | |
| Second quarter | | | 9,384 | | | | 4,252 | | | | 231 | | | | 0.07 | | | | 0.07 | |
| Third quarter | | | 9,624 | | | | 4,774 | | | | 374 | | | | 0.12 | | | | 0.11 | |
| Fourth quarter | | | 9,080 | | | | 4,137 | | | | (2,216 | ) | | | (0.69 | ) | | | (0.69 | ) |
| | | | | | | | | | | | | | | | | | | | | |
2007 | | | | | | | | | | | | | | | | | | | | |
| First quarter | | $ | 7,704 | | | $ | 3,314 | | | $ | 512 | | | $ | 0.17 | | | $ | 0.16 | |
| Second quarter | | | 8,299 | | | | 3,620 | | | | 778 | | | | 0.25 | | | | 0.24 | |
| Third quarter | | | 8,968 | | | | 3,824 | | | | 743 | | | | 0.23 | | | | 0.23 | |
| Fourth quarter | | | 10,398 | | | | 4,005 | | | | 347 | | | | 0.11 | | | | 0.10 | |
The 2008 fourth quarter net loss was related to additional provision for loan losses recorded due to an increase in loan charge offs.
F-39
COMMUNITY FIRST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
(Dollar amounts in thousands, except per share data)
NOTE 23—STOCK OFFERING
The Company conducted a stock offering during the fourth quarter of 2006 and the first quarter of 2007 in order to provide the Bank with additional capital. As a result of this offering, the Company sold 273,090 shares of common stock for total net proceeds of $8,141.
F-40
EXHIBIT INDEX
The following exhibits are filed as a part of or incorporated by reference in this report:
| | | |
| Exhibit No. | | Description |
| | | |
| 2.1 | | Agreement and Plan of Reorganization and Share Exchange, dated as of July 31, 2007, by and between Community First, Inc. and The First National Bank of Centerville (Pursuant to Item 601(b)(2) of Regulation S-K, the schedules of this agreement are omitted, but a supplemental copy will be furnished to the Securities and Exchange Commission upon request.) (Incorporated by reference herein to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed with the SEC on August 1, 2007. |
| | | |
| 3.1 | | Amended and Restated Charter of the Company (restated for SEC filing purposes only). |
| | | |
| 3.2 | | Amended and Restated Bylaws of the Company.** |
| | | |
| 4.1. | | See Exhibits 3.1 and 3.2 for provisions defining the rights of holders of Common Stock. |
| | | |
| 4.2 | | Series A Preferred Stock Certificate.** |
| | | |
| 4.3 | | Series B Preferred Stock Certificate. ** |
| | | |
| 4.4 | | Warrant for Purchase of Shares of Series B Preferred Stock dated February 27, 2009. ** |
| | | |
| 10.1 | | The Community First, Inc. Stock Option Plan (incorporated by reference to the Company’s Form 10-KSB for the year ended December 31, 2003).+ |
| | | |
| 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 | | Amendment to 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 4, 2008).+ |
| | | |
| 10.7 | | Form of Incentive Stock Option Agreement (incorporated by reference to the |
| | | |
| Exhibit No. | | Description |
| | | |
| | | Company’s Current Report on Form 8-K filed with the SEC on January 4, 2008).+ |
| | | |
| 10.8 | | 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).+ |
| | | |
| 10.9 | | 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 May 13, 2005).+ |
| | | |
| 10.10 | | 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 May 13, 2005).+ |
| | | |
| 10.11 | | 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).+ |
| | | |
| 10.12 | | Amended and Restated 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 July 7, 2008).+ |
| | | |
| 10.13 | | 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 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).+ |
| | | |
| 10.15 | | Participation Agreement, dated August 16, 2005, with Mike Saporito pursuant to the Community First Bank & Trust Supplemental Executive Retirement Plan (incorporated by reference to the Company’s Form 10-K for the year ended December 31, 2006). |
| | | |
| 10.16 | | Participation Agreement, dated August 16, 2005, with Carl Campbell pursuant to the Community First Bank & Trust Supplemental Executive Retirement Plan (incorporated by reference to the Company’s Form 10-K for the year ended December 31, 2006). |
| | | |
| 10.17 | | Participation Agreement, dated August 16, 2005, with Dianne Scroggins pursuant to the Community First Bank & Trust Supplemental Executive Retirement Plan (incorporated by reference to the Company’s Form 10-K for the year ended December 31, 2006). |
| | | |
| 10.18 | | Community First, Inc. Employee Stock Purchase Plan (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on April 30, 2008).+ |
| | | |
| 10.19 | | Resignation Agreement and General Release, dated as of July 7, 2008, with Roger D. Stewart (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on July 18, 2008).+ |
| | | |
| Exhibit No. | | Description |
| | | |
| 10.20 | | Change in Control Agreement, dated as of July 18, 2008, with Dianne Scroggins (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on July 18, 2008).+ |
| | | |
| 10.21 | | Change in Control Agreement, dated as of July 18, 2008, with Michael J. Saporito (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on July 18, 2008).+ |
| | | |
| 10.22 | | Change in Control Agreement, dated as of July 18, 2008, with Carl B. Campbell (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on July 18, 2008).+ |
| | | |
| 10.23 | | Loan Agreement by and between Community First, Inc. and Tennessee Commerce Bank, dated December 30, 2008 (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on January 6, 2009). |
| | | |
| 10.24 | | Promissory Note of Community First, Inc. dated December 30, 2008 (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on January 6, 2009). |
| | | |
| 10.25 | | First Amendment to Community First Bank and Trust Supplemental Executive Retirement Plan (incorporated by reference to the Company’s Current Report on Form 8-K filed with the SEC on January 6, 2009).+ |
| | | |
| 10.26 | | Amended and Restated Community First Bank and Trust Management Compensation Plan.+ |
| | | |
| 10.27 | | Letter Agreement, dated February 27, 2009, between Community First, Inc. and the United States Department of the Treasury (including Securities Purchase Agreement-Standard Terms).** |
| | | |
| 10.28 | | Letter Agreement, dated February 27, 2009, between Community First, Inc. and the United States Department of the Treasury.** |
| | | |
| 10.29 | | Letter Agreement, dated February 27, 2009, between Community First, Inc. and the United States Department of the Treasury.** |
| | | |
| 10.30 | | Senior Executive Officer Letter Agreement by and between Community First, Inc. and Marc R. Lively dated February 27, 2009.**+ |
| | | |
| 10.31 | | Senior Executive Officer Letter Agreement by and between Community First, Inc. and Dianne Scroggins dated February 27, 2009.**+ |
| | | |
| 10.32 | | Senior Executive Officer Letter Agreement by and between Community First, Inc. and Michael J. Saporito dated February 27, 2009.**+ |
| | | |
| 10.33 | | Senior Executive Officer Letter Agreement by and between Community First, Inc. and Carl B. Campbell dated February 27, 2009.**+ |
| | | |
| Exhibit No. | | Description |
| | | |
| 10.34 | | Senior Executive Officer Letter Agreement by and between Community First, Inc. and Louis F. Holloway dated February 27, 2009.**+ |
| | | |
| 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, 2002. |
| |
| ** | | Incorporated herein by reference to the Company’s Current Report on Form 8-K filed on March 5, 2009. |
| |
| + | | Management compensatory plan or arrangement. |
