BG FINANCIAL GROUP, INC. AND SUBSIDIARY
Greeneville, Tennessee
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Summary of Significant Accounting Policies
Nature of Business:
BG Financial Group, Inc. (the “Company”) is a bank holding company whose business is conducted by its wholly-owned subsidiary, Bank of Greeneville (the “Bank”). Bank of Greeneville is engaged in the business of originating loans primarily within its lending area, Greeneville and Greene County in Tennessee. The Bank obtains deposits both inside and outside of its primary lending area. The Company was organized in October 2003. The Company had minimal assets, liabilities or operations until January, 2004, when it acquired the Bank in a Plan of Share Exchange whereby the stockholders exchanged their shares of ownership in the Bank for shares of ownership in the Company on a one-for-one basis. As a part of the Plan of Share Exchange, the Bank became a wholly owned subsidiary of the Company.
The following is a description of the significant policies used in the preparation of the accompanying consolidated financial statements.
Basis of Presentation:
These consolidated financial statements include the accounts of the BG Financial Group, Inc. and its wholly owned subsidiary Bank of Greeneville. Significant intercompany transactions and accounts are eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Operating results for the three months ended March 31, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. Certain amounts from prior period financial statements have been reclassified to conform to current period’s presentation.
Use of Estimates:
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant management accounting estimate is the appropriate level for the allowance for loan losses. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
7
Note 2. Stock Options and Awards
On July 1, 2005, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”). This statement supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), which the Company had followed until the adoption of SFAS No. 123R. The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of income. In anticipation of adopting SFAS No. 123R, on May 17, 2005 the Board of Directors approved that all non-vested employee stock options granted to become fully vested and exercisable as of that date in order to avoid recognition of compensation costs in the consolidated statement of income in future periods. Any stock options granted after May 17, 2005 are fully exercisable on the date granted. Accordingly, no compensation cost was recognized prior to the adoption of SFAS No. 123R on July 1, 2005. No additional options were granted during the period ended March 31, 2007, therefore, no compensation cost is recognized in the consolidated statement of income for the period ended March 31, 2007. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123R to stock-based employee compensation for comparative periods ended March 31.
| | Three-Month Period | |
| | Ended March 31 | |
| | (Unaudited) | |
| | 2007 | | 2006 | |
Net income, as reported | | $ | 101,091 | | $ | 165,344 | |
| | | | | |
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects | | — | | — | |
| | | | | |
Pro forma net income | | $ | 101,091 | | $ | 165,344 | |
| | | | | |
Earnings per share | | | | | |
Basic – as reported | | $ | .04 | | $ | .07 | |
| | | | | |
Basic – pro forma | | $ | .04 | | $ | .07 | |
| | | | | |
Diluted – as reported | | $ | .04 | | $ | .07 | |
| | | | | |
Diluted – pro forma | | $ | .04 | | $ | .07 | |
8
Note 3. Earnings Per Share of Common Stock
Basic earnings per share (EPS) of common stock is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share of common stock is computed by dividing net income by the weighted average number of common shares and potential dilutive common shares outstanding during the period. Stock options are regarded as potential common shares. Potential common shares are computed using the treasury stock method. For the three months ended March 31, 2007, 19,000 options are excluded from the effect of dilutive securities because they are anti-dilutive; 85,344 options are similarly excluded from the effect of dilutive securities for the three months ended March 31, 2006.
The following is a reconciliation of the numerators and denominators used in the basic and diluted earnings per share computations for the three months ended March 31, 2007 and 2006:
| | Three Months Ended September 30, | |
| | 2007 | | 2006 | |
| | Income | | Shares | | Income | | Shares | |
| | (Numerator) | | (Denominator) | | (Numerator) | | (Denominator) | |
| | | | | | | | | |
Basic EPS | | | | | | | | | |
Income available to common stockholders | | $ | 101,091 | | 2,310,771 | | $ | 165,344 | | 2,310,771 | |
| | | | | | | | | |
Effect of dilutive securities Stock options outstanding | | — | | 119,621 | | — | | 157,285 | |
| | | | | | | | | |
Diluted EPS | | | | | | | | | |
Income available to common shareholders plus assumed conversions | | $ | 101,091 | | 2,430,392 | | $ | 165,344 | | 2,468,056 | |
9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Impact of Inflation
The consolidated financial statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States and practices within the banking industry that require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.
Critical Accounting Estimates
The Company follows generally accepted accounting principles that are recognized in the United States, along with general practices within the banking industry. In connection with the application of those principles and practices, we have made judgments and estimates which, in the case of our allowance for loan and lease losses (ALLL), are material to the determination of our financial position and results of operation. Other estimates relate to the valuation of assets acquired in connection with foreclosures or in satisfaction of loans, and realization of deferred tax assets.
Recent Accounting Pronouncements
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of this standard is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is effective as of the beginning of fiscal years beginning after November 15, 2007, with early adoption permitted under certain circumstances. The Company did not choose to early adopt this standard.
In March 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 156, Accounting for Servicing of Financial Assets, an Amendment of FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, (“SFAS 140”) which requires that all separately recognized servicing assets and liabilities be initially measured at fair value, if practicable, and requires entities to elect either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of Statement 140 for subsequent measurement. SFAS 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company plans to adopt SFAS 156 on January 1, 2007. The adoption of SFAS 156 did not have any material impact on the Company’s consolidated financial condition or results of operations.
In July 2006, FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (“FIN 48”). FIN 48 is effective for fiscal years beginning after December 15, 2006. FIN 48 applies to all income tax positions subject to FASB Statement No. 109, Accounting for Income Tax (“SFAS 109”), including tax positions considered to be routine and those with a high degree of uncertainty. FIN 48 did not have a material impact on the Company’s consolidated financial statements.
10
In September, 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 will be applied prospectively and is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. SFAS 157 is not expected to have a material impact on the Company’s consolidated financial statements.
In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”), which revised SFAS No. 123, Accounting for Stock-Based Compensation. This statement supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of income. The revised statement was effective as of the first interim or annual period beginning after September 15, 2005. In anticipation of adopting SFAS No. 123R, the Company elected to immediately vest all remaining stock options during 2005 to avoid the recognition of compensation costs in the consolidated statement of income in future periods.
Forward-Looking Statements
Management’s discussion of the Company and management’s analysis of the Company’s operations and prospects, and other matters, may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other provisions of federal and state securities laws. Although the Company believes that the assumptions underlying such forward-looking statements contained in this Report are reasonable, any of the assumptions could be inaccurate and, accordingly, there can be no assurance that the forward-looking statements included herein will prove to be accurate. The use of such words as “expect,” “anticipate,” “forecast,” and comparable terms should be understood by the reader to indicate that the statement is “forward-looking” and thus subject to change in a manner that can be unpredictable. Factors that could cause actual results to differ from the results anticipated, but not guaranteed, in this Report, include (without limitation) economic and social conditions, competition for loans, mortgages, and other financial services and products, changes in interest rates, unforeseen changes in liquidity, results of operations, and financial conditions affecting the Company’s customers, and other risks that cannot be accurately quantified or completely identified. Many factors affecting the Company’s financial condition and profitability, including changes in economic conditions, the volatility of interest rates, political events and competition from other providers of financial services simply cannot be predicted. Because these factors are unpredictable and beyond the Company’s control, earnings may fluctuate from period to period. The purpose of this type of information is to provide readers with information relevant to understanding and assessing the financial condition and results of operations of the Company, and not to predict the future or to guarantee results. The Company is unable to predict the types of circumstances, conditions and factors that can cause anticipated results to change. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of changed or unanticipated events, circumstances or results.
General
On January 23, 2004, BG Financial Group, Inc. (“Company”), a bank holding company, acquired all of the outstanding shares of Bank of Greeneville (“Bank”) in a one for one stock exchange. The Bank is a Tennessee-chartered, FDIC-insured, non-Member commercial bank offering a wide range of banking services, including checking, savings, and money market deposit accounts, certificates of deposit and loans for consumers, commercial and real estate purposes, and is the principal business of the Company. The main office of the Corporation is located at 3095 East Andrew Johnson Highway, Greeneville, Greene County, Tennessee, which is also the main office of the Bank. This location is a 2.66 acre lot, on which there is a fully operational modular bank unit. Other full service branch banking offices of the Bank are located at 506 Asheville Highway and 208 West Summer Street, Greeneville, Greene County, Tennessee. Recently the Bank purchased property in Maryville, Tennessee at 710 South Foothills Plaza Drive. This location is a 1.17 acre lot, on which there is a 3,272 square foot fully operational brick bank building with drive through facilities. These locations are centrally located and in high traffic/exposure areas. Automatic teller machines and overnight “deposit drops” are positioned to serve the Bank’s clients. Additional branches may be established as market opportunities surface.
11
Liquidity
At March 31, 2007, the Company had liquid assets of approximately $14.6 million in the form of cash and federal funds sold compared to approximately $15.5 million on December 31, 2006. Management believes that the liquid assets are adequate at March 31, 2007. Additional liquidity should be provided by the growth in deposit accounts and loan repayments. The Company also has the ability to purchase federal funds and is a member of the Federal Home Loan Bank of Cincinnati that will provide a credit line if necessary. Management is not aware of any trends, events or uncertainties that are reasonably likely to have a material impact on the Company’s short term or long term liquidity.
Results of Operations
The Company had net income of $101,091 or $.04 per share for the quarter ended March 31, 2007 compared to net income of $165,344 or $.07 per share for the quarter ended March 31, 2006. During the quarter ended March 31, 2007, the Company made a provision for loan losses of $104,364, while recording a benefit from loan losses of $(50,497) for the same period in 2006 (See additional discussion at Provision for / Benefit from Loan Losses).
Net Interest Income/Margin
Net interest income represents the amount by which interest earned on various assets exceeds interest paid on deposits and other interest-bearing liabilities and is the most significant component of the Company’s earnings. Interest income for the quarter ended March 31, 2007 was $1,831,756 compared to $1,646,387 for the same period in 2006. Total interest expense was $845,349 in 2007 compared to $628,997 in 2006 for the same period. The Company pursues local deposits aggressively with attractive interest rates, which has resulted in compression of net interest margin. The Company benefited from a “catch up” interest payment of $136,267 received from a large loan previously in non accrual status during the three months ended March 31, 2006. Based on the Company’s mix of interest earning assets and interest bearing liabilities, management believes that net interest margin should remain stable or begin to increase slightly for the remainder of the year. This assumption is based on a continued rising interest rate environment. If interest rates remain stable or begin to decline, net interest margin could decline due to competitive pricing of both loans and interest bearing deposits.
Provision for / Benefit from Loan Losses
The provision for (benefit from) loan losses represents a charge (or recovery) to operations necessary to establish an allowance for possible loan losses, which in management’s evaluation, is adequate to provide coverage for estimated losses on outstanding loans and to provide for uncertainties in the economy. The provision for (benefit from) loan losses during the three-month period ended March 31, 2007 was $104,364 as compared to $(50,497) for the same three-month period ended March 31, 2006. During the three months ended March 31, 2007, loan charge-offs were $25,694. The recoveries for the three-month period ended March 31, 2007 were $7,965. The allowance for loan losses was $704,591 at March 31, 2007 as compared to $617,956 at December 31, 2006, an increase of 14.0%. The 14.0% increase is due to an increase in the loan portfolio and a higher percentage of past due loans at March 31, 2007. The allowance was .88% of loans at March 31, 2007. Management believes the allowance for loan losses at March 31, 2007 to be adequate.
12
Provision for Income Taxes
The Company’s provision for income tax expense for the three months ended March 31, 2007 was $60,947, compared to $106,485, for the same period in 2006. The provisions represent 37.6% and 37.8% of the Company’s pretax income respectively. Management believes the provision for income taxes for the period ended March 31, 2007 to be adequate.
Noninterest Income
The Company’s noninterest income consists of service charges on deposit accounts and other fees and commissions. Total noninterest income for the three months ended March 31, 2007 was $169,360, compared to $125,889 for the same period in 2006. The main reason for the increase was a sharp increase in service charges on deposit accounts due to a revenue generating program called “Bounce Protection” that began late in the year 2006. Fees from origination of mortgage loans also increased due to more aggressive marketing efforts by Company personnel. These increases were offset by a decrease in investment sales commissions. Management projects that noninterest income will improve during the remainder of 2007 due to more aggressive collection of fees and renewed marketing efforts.
Noninterest Expense
Noninterest expenses totaled $893,165 for the three months ended March 31, 2007 as compared to $925,414 for the three months ended March 31, 2006 and consisted of employee costs, occupancy expense and other operating expenses. Salaries and employee benefits increased from $461,095 for the three months ended March 31, 2006 when compared to $462,991 for the three months ended March 31, 2007. Legal and professional fees decreased $34,286 to $81,525 for the three month ended March 31, 2006 from $115,811 for the same period in 2006. Management continues to strengthen all departments of the Company to meet the new demands of regulatory requirements and strategic plan development. Other operating expenses decreased $17,601 to $146,452 for the three months ended March 31, 2007 from $164,053 for the same period in 2006. Most of the other noninterest expense can be accounted for by an increase in occupancy expenses.
Financial Condition
Total assets at March 31, 2007, were $100,821,615, an increase of $3,068,934 or 3.1% compared to 2006 year-end assets of $97,752,681. Deposits increased to $87,353,776 at March 31, 2007, an increase of $4,850,724 or 5.9% from $82,503,052 at December 31, 2006. The increase in deposits was mainly due to management’s aggressive efforts to obtain local deposits. Premises and equipment increased to $5,317,635 at March 31, 2007 an increase of $1,518,116 or 40.0% from $3,799,519 at December 31, 2006. The purchase of a new branch located at 710 South Foothills Plaza Drive, Maryville, Tennessee, accounted for $1,483,258 of the increase in Premises and equipment. Federal Home Loan Bank Stock was $262,600 at March 31, 2007 compared to $258,800 at December 31, 2006.
13
The Company places an emphasis on an integrated approach to its balance sheet management. Significant balance sheet components of loans and sources of funds are managed in an integrated manner with the management of interest rate risk, liquidity, and capital. These components are discussed below.
Loans
Net loans outstanding totaled $79,367,037 at March 31, 2007 compared to $77,059,828 at December 31, 2006. Commercial and real estate loan growth accounted for almost all of the approximately $2.3 million increase for the first quarter of 2007.
Management feels the overall quality of loans remains solid. In the event that a loan is 90 days or more past due the accrual of income is generally discontinued when the full collection of principal or interest is in doubt unless the obligations are both well secured and in the process of collection. At March 31, 2007, there were no loans 90 days or more past due and still accruing interest, while total loans 90 days or more past due and in non-accrual status were $1,415,179. At December 31, 2006, there we no loans 90 days or more past due and still accruing interest, while total loans 90 days or more past due and in non-accrual status were $1,531,621.
Restricted Equity Investments
Federal Home Loan Bank (FHLB) stock at March 31, 2007 had an amortized cost of $262,600 as compared to an amortized cost of $258,800 at December 31, 2006. As a member of the FHLB, the Company is required to maintain stock in an amount equal to .15% of total assets and 4% of outstanding FHLB advances. Federal Home Loan Bank stock is carried at cost under the available-for-sale category. Federal Home Loan Bank stock is maintained by the Company at par value of one hundred dollars per share.
Deposits
Total deposits, which are the principal source of funds for the Company, were $87,353,776 at March 31, 2007, compared to $82,503,052 at December 31, 2006 representing an increase of 5.9%. The Company has targeted local consumers, professional and commercial businesses as its central clientele, therefore, deposit instruments in the form of demand deposits, savings accounts, money market demand accounts, NOW accounts, certificates of deposit and individual retirement accounts are offered to customers. The Company established a line of credit with the Federal Home Loan Bank secured by a blanket-pledge of 1-4 family residential mortgage loans. At March 31, 2007 the Company had outstanding advances of $2,090,419 at the Federal Home Loan Bank.
Capital
Equity capital at March 31, 2007 was $8,937,619, an increase of $101,091 from $8,836,528 at December 31, 2006, due to a net profit of $101,091 for the first three months of 2007.
At March 31, 2007, both the Company’s and Bank’s capital ratios were in excess of the regulatory minimums. Those ratios are as follows:
| | Required
Minimum Ratio | | To be Well
Capitalized | | Bank | | Company | |
Tier 1 Leverage ratio | | 4.00 | % | 5.00 | % | 9.31 | % | 9.32 | % |
Tier 1 risk-based capital ratio | | 4.00 | % | 6.00 | % | 10.82 | % | 10.83 | % |
Total risk-based capital ratio | | 8.00 | % | 10.00 | % | 11.68 | % | 11.69 | % |
14
Liability and Asset Management
The Company’s Asset/Liability Committee (“ALCO”) actively measures and manages interest rate risk using a process developed by the Company. The ALCO is also responsible for implementing the Company’s asset/liability management policies, overseeing the formulation and implementation of strategies to improve balance sheet positioning and earnings, and reviewing the Company’s interest rate sensitivity position.
The primary tool that management uses to measure short-term interest rate risk is a net interest income simulation model prepared by an independent correspondent institution. These simulations estimate the impact that various changes in the overall level of interest rates over one- and two-year time horizons would have on net interest income. The results help the Company develop strategies for managing exposures to interest rate risk.
Like any forecasting technique, interest rate simulation modeling is based on a large number of assumptions. In this case, the assumptions relate primarily to loan and deposit growth, asset and liability prepayments, interest rates and balance sheet management strategies. Management believes that both individually and in the aggregate the assumptions are reasonable. Nevertheless, the simulation modeling process produces only a sophisticated estimate, not a precise calculation of exposure.
At March 31, 2007, approximately 63% of the institution’s gross loans had adjustable rates. Based on the asset/liability modeling, management believes that these loans reprice at a faster pace than liabilities held at the institution. Because the majority of the institution’s liabilities are 12 months and under and the gap in repricing is asset sensitive, management believes that a rising rate environment would have a positive impact on the Company’s net interest margin. Floors in the majority of the institution’s adjustable rate assets also mitigate interest rate sensitivity in a decreasing rate environment.
Off-Balance Sheet Arrangements
The Company, at March 31, 2007, had outstanding unused lines of credit and standby letters of credit that totaled approximately $16,460,265. These commitments have fixed maturity dates and many will mature without being drawn upon, meaning that the total commitment does not necessarily represent the future cash requirements. The Company has the ability to liquidate Federal funds sold or, on a short-term basis, to purchase Federal funds from other banks and to borrow from the Federal Home Loan Bank. At March 31, 2007, the Company had established with correspondent banks the ability to purchase Federal funds if needed.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The information set forth on pages 10 through 15 of Item 2, “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS is incorporated herein by reference.
15
Item 4. Controls and Procedures
a) Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer. The Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and 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 Chief Financial Officer concluded that the Company’s disclosure control and procedures were effective.
b) Changes in Internal Controls and Procedures
There were no changes in our internal controls over financial reporting during the quarter ended March 31, 2007, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 4T. Controls and Procedures
Not applicable.
16
