UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
| x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarter Ended March 31, 2008. |
| ¨ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from to . |
Commission file number: 001-33598
Encore Bancshares, Inc.
(Exact name of registrant as specified in its charter)
| Texas | 76-0655696 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
| Nine Greenway Plaza, Suite 1000, Houston, Texas | 77046 | |
| (Address of principal executive offices) | (Zip Code) | |
(713) 787-3100 (Registrant’s telephone number, including area code) | ||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ | Accelerated filer ¨ | |||
Non-accelerated filer x (Do not check if a smaller reporting company) | Smaller reporting company ¨ | |||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of April 30, 2008, there were 10.2 million shares of common stock, $1.00 par value, issued and outstanding.
ENCORE BANCSHARES, INC.
2
Part I – Financial Information
| Item 1. | Financial Statements |
Encore Bancshares, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Unaudited, amounts in thousands, except per share amounts)
| March 31, 2008 | December 31, 2007 | |||||||
| ASSETS | ||||||||
Cash and due from banks | $ | 16,608 | $ | 18,817 | ||||
Interest-bearing deposits in banks | 40,328 | 18,581 | ||||||
Federal funds sold and other temporary investments | 58,769 | 41,017 | ||||||
Cash and cash equivalents | 115,705 | 78,415 | ||||||
Securities available-for-sale, at estimated fair value | 12,108 | 12,207 | ||||||
Securities held-to-maturity, at amortized cost | 123,133 | 134,056 | ||||||
Mortgages held-for-sale | 1,928 | 1,396 | ||||||
Loans receivable | 1,156,501 | 1,097,268 | ||||||
Allowance for loan losses | (11,603 | ) | (11,161 | ) | ||||
Net loans receivable | 1,144,898 | 1,086,107 | ||||||
Federal Home Loan Bank of Dallas stock, at cost | 6,987 | 5,880 | ||||||
Investments in real estate | 2,078 | 835 | ||||||
Premises and equipment, net | 16,789 | 16,831 | ||||||
Goodwill | 27,969 | 27,942 | ||||||
Other intangible assets, net | 6,592 | 6,780 | ||||||
Cash surrender value of life insurance policies | 14,256 | 14,091 | ||||||
Accrued interest receivable and other assets | 16,183 | 16,657 | ||||||
| $ | 1,488,626 | $ | 1,401,197 | |||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Deposits: | ||||||||
Noninterest-bearing | $ | 129,983 | $ | 106,382 | ||||
Interest-bearing | 981,164 | 934,992 | ||||||
Total deposits | 1,111,147 | 1,041,374 | ||||||
Borrowings and repurchase agreements | 188,845 | 173,395 | ||||||
Junior subordinated debentures | 20,619 | 20,619 | ||||||
Accrued interest payable and other liabilities | 8,604 | 8,330 | ||||||
Total liabilities | 1,329,215 | 1,243,718 | ||||||
Commitments and contingencies | — | — | ||||||
Shareholders’ equity: | ||||||||
Preferred stock, $1 par value, 20,000 shares authorized; none issued | — | — | ||||||
Common stock, $1 par value, 50,000 shares authorized; 10,158 shares at March 31, 2008 and 10,128 shares at December 31, 2007 issued | 10,158 | 10,128 | ||||||
Additional paid-in capital | 108,813 | 108,173 | ||||||
Retained earnings | 40,933 | 39,763 | ||||||
Common stock in treasury, at cost (4 shares at March 31, 2008 and December 31, 2007) | (69 | ) | (69 | ) | ||||
Accumulated other comprehensive loss | (424 | ) | (516 | ) | ||||
Total shareholders’ equity | 159,411 | 157,479 | ||||||
| $ | 1,488,626 | $ | 1,401,197 | |||||
The accompanying notes are an integral part of these statements.
3
Encore Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited, amounts in thousands, except per share amounts)
| Three Months Ended March 31, | |||||||
| 2008 | 2007 | ||||||
Interest income: | |||||||
Loans, including fees | $ | 18,378 | $ | 15,808 | |||
Mortgages held-for-sale | 32 | 1,121 | |||||
Securities | 1,319 | 2,273 | |||||
Federal funds sold and other | 803 | 278 | |||||
Total interest income | 20,532 | 19,480 | |||||
Interest expense: | |||||||
Deposits | 8,542 | 9,456 | |||||
Borrowings and repurchase agreements | 1,755 | 1,889 | |||||
Junior subordinated debentures | 356 | 455 | |||||
Total interest expense | 10,653 | 11,800 | |||||
Net interest income | 9,879 | 7,680 | |||||
Provision for loan losses | 1,501 | 900 | |||||
Net interest income after provision for loan losses | 8,378 | 6,780 | |||||
Noninterest income: | |||||||
Trust and investment management fees | 4,407 | 4,244 | |||||
Mortgage banking | 54 | 2,192 | |||||
Insurance commissions and fees | 1,727 | 1,713 | |||||
Real estate operations, including net gain on sales | 55 | 18 | |||||
Net loss on sale of available-for-sale securities | — | (149 | ) | ||||
Other | 434 | 437 | |||||
Total noninterest income | 6,677 | 8,455 | |||||
Noninterest expense: | |||||||
Compensation | 8,078 | 7,863 | |||||
Occupancy | 1,438 | 1,399 | |||||
Equipment | 531 | 520 | |||||
Advertising and promotion | 204 | 196 | |||||
Outside data processing | 694 | 808 | |||||
Professional fees | 1,156 | 390 | |||||
Intangible amortization | 187 | 209 | |||||
Other | 989 | 1,077 | |||||
Total noninterest expense | 13,277 | 12,462 | |||||
Net earnings before income taxes | 1,778 | 2,773 | |||||
Income tax expense | 608 | 998 | |||||
NET EARNINGS | $ | 1,170 | $ | 1,775 | |||
Earnings Per Common Share: | |||||||
Basic | $ | 0.12 | $ | 0.23 | |||
Diluted | 0.11 | 0.22 | |||||
Average common shares outstanding | 9,846 | 7,555 | |||||
Diluted average common shares outstanding | 10,714 | 8,131 | |||||
The accompanying notes are an integral part of these statements.
4
Encore Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Three Months Ended March 31, 2008
(Unaudited, amounts in thousands)
Common stock | Additional paid-in capital | Retained earnings | Treasury stock | Accumulated other comprehensive income (loss) | Total shareholders’ equity | |||||||||||||||||||
| Shares | Amount | |||||||||||||||||||||||
Balance at January 1, 2008 | 10,128 | $ | 10,128 | $ | 108,173 | $ | 39,763 | $ | (69 | ) | $ | (516 | ) | $ | 157,479 | |||||||||
Stock-based compensation cost recognized in earnings | — | — | 335 | — | — | — | 335 | |||||||||||||||||
Issuance of common shares for exercise of options | 33 | 33 | 302 | — | — | — | 335 | |||||||||||||||||
Forfeitures of restricted stock | (3 | ) | (3 | ) | 3 | — | — | — | — | |||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||
Net earnings | — | — | — | 1,170 | — | — | 1,170 | |||||||||||||||||
Change in net unrealized loss on securities available-for-sale, net of deferred tax expense of $52 | — | — | — | — | — | 92 | 92 | |||||||||||||||||
Total comprehensive income | 1,262 | |||||||||||||||||||||||
Balance at March 31, 2008 | 10,158 | $ | 10,158 | $ | 108,813 | $ | 40,933 | $ | (69 | ) | $ | (424 | ) | $ | 159,411 | |||||||||
The accompanying notes are an integral part of this statement.
5
Encore Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, amounts in thousands)
| Three Months Ended March 31, | ||||||||
| 2008 | 2007 | |||||||
Cash flows from operating activities: | ||||||||
Net earnings | $ | 1,170 | $ | 1,775 | ||||
Adjustments to reconcile net earnings to net cash provided by operating activities, net of effects of business combinations: | ||||||||
Provision for loan losses | 1,501 | 900 | ||||||
Amortization of premiums and discounts, net | 319 | 423 | ||||||
Stock-based compensation | 335 | 252 | ||||||
Depreciation | 616 | 596 | ||||||
Gain on sale of mortgage loans | (64 | ) | (2,038 | ) | ||||
(Gain) loss on sale of foreclosed real estate | 6 | (13 | ) | |||||
Realized loss on sales of available-for-sale securities, net | — | 149 | ||||||
Increase in mortgage loans held-for-sale | (8,646 | ) | (57,612 | ) | ||||
Proceeds from sale of mortgage loans | 8,178 | 71,465 | ||||||
Federal Home Loan Bank of Dallas stock dividends | (66 | ) | (105 | ) | ||||
Tax effect of stock-based compensation | — | (27 | ) | |||||
Decrease in accrued interest receivable | 527 | 518 | ||||||
Increase in other assets | (271 | ) | (1,140 | ) | ||||
Increase (decrease) in accrued interest payable | (63 | ) | 101 | |||||
Increase in other liabilities | 338 | 1,369 | ||||||
Net cash provided by operating activities | 3,880 | 16,613 | ||||||
Cash flows from investing activities: | ||||||||
Purchases of available-for-sale securities | — | (3,065 | ) | |||||
Principal collected on available-for-sale securities | 187 | 3,329 | ||||||
Proceeds from sales of available-for-sale securities | — | 33,401 | ||||||
Principal collected on held-to-maturity securities | 10,848 | 8,370 | ||||||
Proceeds from sales of held-to-maturity securities | — | 7,414 | ||||||
Proceeds from sales of foreclosed real estate | 53 | 51 | ||||||
Cash paid for acquisition, net of cash acquired | (27 | ) | (25 | ) | ||||
Loan originations and principal collections, net | (61,594 | ) | (25,049 | ) | ||||
Purchases of Federal Home Loan Bank stock | (1,041 | ) | (432 | ) | ||||
Redemption of Federal Home Loan Bank stock | — | 1,645 | ||||||
Purchases of premises and equipment | (574 | ) | (2,138 | ) | ||||
Net cash provided (used) by investing activities | (52,148 | ) | 23,501 | |||||
Cash flows from financing activities: | ||||||||
Net increase (decrease) in deposits | 69,773 | (33,513 | ) | |||||
Increase in short term Federal Home Loan Bank of Dallas borrowings | — | 12,000 | ||||||
Proceeds from long term Federal Home Loan Bank of Dallas borrowings | 30,000 | — | ||||||
Repayment of long term Federal Home Loan Bank of Dallas borrowings | (25,000 | ) | (25,000 | ) | ||||
Increase (decrease) in repurchase agreements | 10,496 | (1,181 | ) | |||||
Payment on notes payable | (46 | ) | (46 | ) | ||||
Tax effect of stock-based compensation | — | 27 | ||||||
Proceeds from issuance of common stock, net | 335 | 425 | ||||||
Net cash provided (used) by financing activities | 85,558 | (47,288 | ) | |||||
Net increase (decrease) in cash and cash equivalents | 37,290 | (7,174 | ) | |||||
Cash and cash equivalents at beginning of period | 78,415 | 39,096 | ||||||
Cash and cash equivalents at end of period | $ | 115,705 | $ | 31,922 | ||||
Supplementary cash flows information: | ||||||||
Interest paid on deposits and borrowed funds | $ | 10,716 | $ | 11,594 | ||||
Income taxes paid | 385 | — | ||||||
Noncash operating, investing and financing activities: | ||||||||
Real estate acquired in satisfaction of loans | 1,302 | 458 | ||||||
The accompanying notes are an integral part of these statements.
6
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008 and 2007
(Unaudited, amounts in thousands, except per share amounts)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Encore Bancshares, Inc. is a holding company that was formed on March 28, 2000 as Guardian Holdings, Inc. and had no operations until it acquired GSF Holding, Inc., now known as Encore Holdings, Inc. (Encore Holdings), and its wholly-owned subsidiary, Guardian Savings and Loan Association effective September 30, 2000. Guardian Savings and Loan Association, a federally chartered savings institution, changed its name to Guardian Savings Bank effective September 28, 2000 and then to Encore Bank (the Bank) effective September 1, 2001. The Bank converted from a federal savings association to a national banking association effective March 30, 2007 and changed its name to Encore Bank, National Association. In connection with the conversion, we became a bank holding company and Encore Holdings was merged into Encore Bancshares, Inc. As part of a corporate reorganization following the conversion of the Bank to a national banking association, as of June 30, 2007, the Bank was merged with and into Encore Trust Company, N.A. (Encore Trust). The resulting bank, which was renamed Encore Bank, National Association (Encore Bank), operates as a national banking association with its main office in Houston, Texas. Since the merger, the business of Encore Trust is being conducted as a division of Encore Bank.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Encore Bancshares, Inc., Encore Bank, and Encore Bank’s wholly-owned subsidiaries, Town & Country Insurance Agency, Inc. (Town & Country), and Linscomb & Williams, Inc. (Linscomb & Williams). We have made all adjustments that, in our opinion, are necessary for a fair presentation of results of the interim periods, and all such adjustments are of a normal recurring nature. All significant intercompany balances and transactions have been eliminated. The unaudited consolidated financial statements should be read in conjunction with our annual audited consolidated financial statements and related notes. The consolidated balance sheet at December 31, 2007 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (US GAAP).
We must make estimates and assumptions that affect amounts reported in our interim consolidated financial statements and in disclosures of contingent assets and liabilities. Ultimate results could differ from those estimates.
These interim consolidated financial statements and the notes thereto should be read in conjunction with our Annual Report on Form 10-K. Operating results for the three months ended March 31, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008 or any other period.
Nature of Operations
We are primarily in the business of attracting deposits and investing these funds in loans and mortgage-backed securities, as well as providing trust and investment management services and property and casualty insurance products.
We provide a variety of financial services through our seventeen private client offices located in the greater Houston area and southwest Florida, our two loan production offices in southwest Florida and five wealth management offices and three insurance offices in Texas. Our product offerings, places of business and service delivery are positioned to best meet the needs of professional firms, privately-owned businesses, investors and affluent individuals.
Adoption of New Accounting Pronouncements
On January 1, 2008, we adopted the following new accounting pronouncements:
SFAS 157 – Statement of Financial Accounting Standards (SFAS) No. 157,Fair Value Measurements;and
SFAS 159 – SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities.
7
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008 and 2007
(Unaudited, amounts in thousands, except per share amounts)
The adoption of SFAS 157 and SFAS 159 did not have any effect on our consolidated financial statements at the date of adoption other than expanded disclosures required by SFAS 157.
Descriptions of our significant accounting policies are included in Note A to our consolidated financial statements as of and for the year ended December 31, 2007 included in our Annual Report on Form 10-K. There have been no significant changes to these policies.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net earnings. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net earnings, are components of comprehensive income.
The changes in the components of other comprehensive income (loss) are as follows:
| Three Months Ended March 31, | ||||||||
| 2008 | 2007 | |||||||
Unrealized holding gains on available-for-sale securities | $ | 144 | $ | 1,615 | ||||
Reclassification adjustment for losses realized in income | — | (149 | ) | |||||
Net unrealized gain | 144 | 1,466 | ||||||
Tax expense | (52 | ) | (528 | ) | ||||
Net-of-tax amount | $ | 92 | $ | 938 | ||||
Recent Accounting Pronouncements
SFAS No. 141(R),Business Combinations (SFAS 141R). Issued by the Financial Accounting Standards Board (FASB) in December 2007, SFAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. SFAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The provisions of SFAS 141R are effective for business combinations for which the acquisition date is within financial statements issued for fiscal years beginning after December 15, 2008, and earlier application is prohibited. We do not expect the adoption of SFAS 141R to have a material effect on our consolidated financial statements; however, the effect is dependent upon whether we make any future acquisitions and the specifics of those acquisitions.
SFAS 160,Noncontrolling Interests in Consolidated Financial Statements – An Amendment of ARB No. 51 (SFAS 160). Issued by the FASB in December 2007, SFAS 160 amends Accounting Research Bulletin No. 51,Consolidated Financial Statements(ARB 51), to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement also amends certain of ARB 51’s consolidation procedures for consistency with the requirements of SFAS 141R. In addition, SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. The provisions of SFAS 160 are effective for fiscal years beginning after December 15, 2008. Earlier adoption is prohibited. We do not expect the adoption of SFAS 160 to have a material effect on our consolidated financial statements.
FASB Staff Position No. 157-2 (FSP 157-2). FSP 157-2 delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The delay is intended to allow the FASB and constituents additional time to consider the effect of various implementation issues that have arisen, or that may arise, from the application of SFAS 157. This FSP defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. We are currently evaluating what impact, if any, this FSP will have on our consolidated financial statements.
8
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008 and 2007
(Unaudited, amounts in thousands, except per share amounts)
NOTE B – SECURITIES AVAILABLE-FOR-SALE AND SECURITIES HELD-TO-MATURITY
The amortized cost and fair values for the major categories of securities available-for-sale and held-to-maturity were as follows:
| March 31, 2008 | December 31, 2007 | |||||||||||
| Amortized cost | Fair value | Amortized cost | Fair value | |||||||||
Available-for-Sale: | ||||||||||||
Mortgage-backed securities | $ | 3,720 | $ | 3,692 | $ | 3,910 | $ | 3,809 | ||||
Other | 4,354 | 4,352 | 4,354 | 4,347 | ||||||||
Total | 8,074 | 8,044 | 8,264 | 8,156 | ||||||||
Marketable equity securities | 4,000 | 4,064 | 4,000 | 4,051 | ||||||||
Total available-for-sale securities | $ | 12,074 | $ | 12,108 | $ | 12,264 | $ | 12,207 | ||||
Held-to-Maturity: | ||||||||||||
Mortgage-backed securities | $ | 123,133 | $ | 124,796 | $ | 134,056 | $ | 133,454 | ||||
NOTE C – LOANS RECEIVABLE
A summary of the major categories of loans outstanding is shown in the following table:
| March 31, 2008 | December 31, 2007 | |||||
Commercial Loans: | ||||||
Commercial | $ | 142,259 | $ | 127,583 | ||
Commercial real estate | 291,543 | 277,047 | ||||
Real estate construction | 97,807 | 100,975 | ||||
Total commercial loans | 531,609 | 505,605 | ||||
Consumer Loans: | ||||||
Residential real estate first lien | 264,445 | 271,346 | ||||
Residential real estate second lien | 234,623 | 195,583 | ||||
Home equity lines | 78,860 | 79,023 | ||||
Consumer installment - indirect | 21,917 | 25,262 | ||||
Consumer other | 25,047 | 20,449 | ||||
Total consumer loans | 624,892 | 591,663 | ||||
Total loans receivable | $ | 1,156,501 | $ | 1,097,268 | ||
Included in loans receivable is $3,092 and $3,117 of net deferred loan origination costs at March 31, 2008 and December 31, 2007.
9
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008 and 2007
(Unaudited, amounts in thousands, except per share amounts)
Changes in the allowance for loan losses were as follows:
| Three Months Ended March 31, | ||||||||
| 2008 | 2007 | |||||||
Balance at beginning of period | $ | 11,161 | $ | 9,056 | ||||
Provision for loan losses | 1,501 | 900 | ||||||
Loans charged-off | (1,108 | ) | (318 | ) | ||||
Recoveries of loans previously charged-off | 49 | 152 | ||||||
Balance at end of period | $ | 11,603 | $ | 9,790 | ||||
The following is a summary of information pertaining to impaired and non-accrual loans:
| March 31, 2008 | December 31, 2007 | |||||
Impaired loans on non-accrual without a valuation allowance | $ | 2,146 | $ | — | ||
Impaired loans on non-accrual with a valuation allowance | 6,748 | 6,901 | ||||
Total impaired loans | $ | 8,894 | $ | 6,901 | ||
Valuation allowance related to impaired loans | $ | 2,433 | $ | 2,581 | ||
Total non-accrual loans | $ | 14,131 | $ | 11,208 | ||
Total loans past due ninety days or more and still accruing | $ | 283 | $ | 2,183 | ||
NOTE D – REGULATORY MATTERS
We and Encore Bank are subject to various regulatory capital adequacy requirements administered by the Board of Governors of the Federal Reserve System (Federal Reserve) and the Office of the Comptroller of the Currency (OCC). Actual and minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as of March 31, 2008 are set forth in the following table:
| Actual | For capital adequacy purposes | To be categorized as well capitalized under prompt corrective action provisions | ||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||
As of March 31, 2008 | ||||||||||||||||||
Tier 1 capital (to average assets) | ||||||||||||||||||
Tier 1 (leverage) | ||||||||||||||||||
Encore Bancshares, Inc. | $ | 145,274 | 10.31 | % | $ | 56,384 | 4.00 | % | N/A | N/A | ||||||||
Encore Bank, N.A. | 111,969 | 7.96 | 56,233 | 4.00 | $ | 70,292 | 5.00 | % | ||||||||||
Tier 1 capital (to risk-based assets) | ||||||||||||||||||
Encore Bancshares, Inc. | $ | 145,274 | 12.91 | % | $ | 45,019 | 4.00 | % | N/A | N/A | ||||||||
Encore Bank, N.A. | 111,969 | 9.96 | 44,956 | 4.00 | $ | 67,434 | 6.00 | % | ||||||||||
Total capital (to risk-based assets) | ||||||||||||||||||
Encore Bancshares, Inc. | $ | 156,877 | 13.94 | % | $ | 90,039 | 8.00 | % | N/A | N/A | ||||||||
Encore Bank, N.A. | 123,572 | 10.99 | 89,912 | 8.00 | $ | 112,391 | 10.00 | % | ||||||||||
10
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008 and 2007
(Unaudited, amounts in thousands, except per share amounts)
As part of Encore Bank’s conversion to a national bank, the OCC required that Encore Bank have a leverage ratio of at least 7.75% as of December 31, 2008.
NOTE E – COMMITMENTS AND CONTINGENCIES
We are involved in an arbitration with the former owner of a company we acquired in 2005. While the final outcome of the arbitration cannot be predicted with certainty, we do not believe that this matter, when finally resolved, will have a material adverse effect on our financial position or cash flows. However, an adverse resolution of this matter in any quarter or fiscal year could have a material adverse effect on our results of operations in that period.
We are a defendant in legal actions arising from transactions conducted in the ordinary course of business. We believe, after consultation with legal counsel, that the ultimate liability, if any, arising from such actions will not have a material adverse effect on our consolidated financial statements.
NOTE F – EARNINGS PER COMMON SHARE
The factors used in the earnings per common share computation follow:
| Three Months Ended March 31, | ||||||
| 2008 | 2007 | |||||
Basic: | ||||||
Net earnings | $ | 1,170 | $ | 1,775 | ||
Average common shares outstanding, net of nonvested restricted stock | 9,846 | 7,555 | ||||
Per Share | $ | 0.12 | $ | 0.23 | ||
Diluted: | ||||||
Average common shares outstanding | 9,846 | 7,555 | ||||
Add: Net effect of nonvested restricted stock and the assumed exercise of stock options | 583 | 451 | ||||
Contingent share-based consideration | 285 | 125 | ||||
Diluted average common shares outstanding | 10,714 | 8,131 | ||||
Per Share | $ | 0.11 | $ | 0.22 | ||
In July 2007, we completed our initial public offering of 1,905 shares of common stock at $21.00 per share. In August, our underwriters exercised their over-allotment option for an additional 286 shares of common stock, also at $21.00 per share. No dividends have been declared on our common stock.
NOTE G – FAIR VALUE OF FINANCIAL INSTRUMENTS
Effective January 1, 2008, we adopted SFAS 157,Fair Value Measurements. In accordance with SFAS 157, we group our financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
| • | Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 also includes U.S. Treasury, other U. S. government and agency mortgage-backed securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. |
| • | Level 2 – Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities. |
11
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008 and 2007
(Unaudited, amounts in thousands, except per share amounts)
| • | Level 3 – Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. |
The table below presents the balances of assets measured at fair value on a recurring basis.
Description | March 31,2008 | Level 1 | ||||
Available-for-sale securities (1) | $ | 6,441 | $ | 6,441 | ||
Total | $ | 6,441 | $ | 6,441 | ||
| (1) | Excludes cost-basis equity securities of $5,667. |
Also, we may be required, from time to time, to measure certain other financial assets at fair value on a non-recurring basis in accordance with US GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. For assets measured at fair value on a non-recurring basis in first quarter 2008 that were still held in the balance sheet at quarter end, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets at quarter end.
Description | March 31,2008 | Level 2 | Losses for Three Months Ended March 31, 2008 | ||||||
Loans (1) | $ | 2,146 | $ | 2,146 | $ | — | |||
Total | $ | 2,146 | $ | 2,146 | $ | — | |||
| (1) | Represents carrying value of loans and related write-downs for which adjustments are based on the appraised value of the collateral. |
We have only partially applied SFAS 157 as allowed by FSP 157-2. The major categories of non-financial assets for which we have not applied the provisions of SFAS 157 are goodwill, other intangible assets and investments in real estate.
NOTE H – SEGMENT INFORMATION
We have three lines of business which are banking, wealth management and insurance, that are delineated by the products and services that each segment offers. The segments are managed separately with different clients, employees, systems, risks and marketing strategies. Banking includes our commercial and private client banking services. Wealth management provides personal wealth management services through Encore Trust, a division of Encore Bank, and Linscomb & Williams, and insurance includes the selling of property and casualty insurance products by Town & Country.
The accounting policies of each line of business are the same as those described in the summary of significant accounting policies included in Note A to our consolidated financial statements as of and for the year ended December 31, 2007 included in our Annual Report on Form 10-K. Revenues, expenses, and assets are recorded by each line of business, and we separately review financial information. In addition to direct expenses, each line of business was allocated certain general corporate expenses such as executive administration, accounting, internal audit, and human resources based on the average asset level of the operating segment. Activities that are not directly attributable to the reportable operating segments, including the elimination of intercompany transactions, are presented under other.
12
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008 and 2007
(Unaudited, amounts in thousands, except per share amounts)
Financial results by operating segment were as follows:
| Banking | Wealth Management | Insurance | Other | Consolidated | |||||||||||||
For the three months ended March 31, 2008 | |||||||||||||||||
Net interest income (expense) | $ | 10,130 | $ | 64 | $ | 41 | $ | (356 | ) | $ | 9,879 | ||||||
Provision for loan losses | 1,501 | — | — | — | 1,501 | ||||||||||||
Noninterest income | 519 | 4,407 | 1,732 | 19 | 6,677 | ||||||||||||
Noninterest expense | 9,103 | 3,070 | 1,104 | — | 13,277 | ||||||||||||
Earnings (loss) before income taxes | 45 | 1,401 | 669 | (337 | ) | 1,778 | |||||||||||
Income tax expense (benefit) | (15 | ) | 504 | 240 | (121 | ) | 608 | ||||||||||
Net earnings (loss) | $ | 60 | $ | 897 | $ | 429 | $ | (216 | ) | $ | 1,170 | ||||||
Total assets at March 31, 2008 | $ | 1,500,462 | $ | 47,444 | $ | 10,143 | $ | (69,423 | ) | $ | 1,488,626 | ||||||
For the three months ended March 31, 2007 | |||||||||||||||||
Net interest income (expense) | $ | 8,035 | $ | 73 | $ | 27 | $ | (455 | ) | $ | 7,680 | ||||||
Provision for loan losses | 900 | — | — | — | 900 | ||||||||||||
Noninterest income | 2,481 | 4,244 | 1,716 | 14 | 8,455 | ||||||||||||
Noninterest expense | 8,453 | 3,027 | 982 | — | 12,462 | ||||||||||||
Earnings (loss) before income taxes | 1,163 | 1,290 | 761 | (441 | ) | 2,773 | |||||||||||
Income tax expense (benefit) | 396 | 467 | 272 | (137 | ) | 998 | |||||||||||
Net earnings (loss) | $ | 767 | $ | 823 | $ | 489 | $ | (304 | ) | $ | 1,775 | ||||||
Total assets at March 31, 2007 | $ | 1,301,562 | $ | 43,935 | $ | 9,278 | $ | (59,788 | ) | $ | 1,294,987 | ||||||
13
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Special Cautionary Notice Regarding Forward-Looking Statements
Statements and financial discussion and analysis contained in this quarterly report on Form 10-Q that are not statements of historical fact constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond our control. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “continue,” “would,” “could,” “hope,” “might,” “assume,” “objective,” “seek,” “plan,” “strive” and similar words, or the negatives of these words, are intended to identify forward-looking statements.
Many possible events or factors could affect our future financial results and performance and could cause our actual results to differ materially from the expectations of future results we express or imply in any forward-looking statements. In addition to the other factors discussed in the “Risk Factors” section of our Annual Report on Form 10-K, factors that could contribute to those differences include, but are not limited to:
| • | general business or economic conditions, either nationally, regionally or in the local markets we serve, may be less favorable than expected, resulting in, among other things, a deterioration of credit quality or a reduced demand for credit or a decline in wealth management fees; |
| • | changes in the interest rate environment, which may reduce our margins or impact the value of changes in market rates and prices may impact the value of securities, loans, deposits and other financial instruments; |
| • | legislative or regulatory developments including changes in laws concerning taxes, banking, securities, investment advisory, trust, insurance and other aspects of the financial services industry; |
| • | the continued service of key management personnel; |
| • | our ability to attract, motivate and retain key employees; |
| • | factors that increase competitive pressure among financial services organizations, including product and pricing pressures; |
| • | our ability to expand and grow our business and operations, including the establishment of additional private client offices and acquisition of additional banks, and our ability to realize the cost savings and revenue enhancements we expect from such activities; and |
| • | fiscal and governmental policies of the United States federal government. |
Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. We believe we have chosen these assumptions or bases in good faith and that they are reasonable. We caution you, however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this Form 10-Q. These statements speak only as of the date of this report (or an earlier date to the extent applicable). We undertake no obligation to update publicly such forward-looking statements in light of new information or future events.
Overview
Encore Bancshares, Inc. is a bank holding company and wealth management organization that provides banking, investment management, financial planning and insurance services to professional firms, privately-owned businesses, investors and affluent individuals. We are headquartered in Houston, Texas and currently manage, through our primary subsidiary, Encore Bank, National Association (Encore Bank), eleven private client offices in the greater Houston market and six private client offices and two loan production offices in southwest Florida. We also operate five wealth management offices and three insurance offices in Texas. As of March 31, 2008, we reported, on a consolidated basis, total assets of $1.5 billion, total loans of $1.2 billion, total deposits of $1.1 billion, shareholders’ equity of $159.4 million and $2.7 billion in assets under management.
Results of Operations
Net earnings for the quarter ended March 31, 2008 were $1.2 million, or $0.11 per diluted share, compared with $1.8 million, or $0.22 per diluted share, for the quarter ended March 31, 2007. Net interest income increased by $2.2 million, however, this increase was offset by a $2.1 million decrease in mortgage banking income, a $601,000 increase in the provision for loan losses and a $815,000 increase in noninterest expense. The change in net earnings was different than earnings per share primarily because of the additional shares issued in the initial public offering in the third quarter of 2007.
14
We posted a return on average common equity of 2.97% and 6.68%, a return on average assets of 0.33% and 0.55%, and an efficiency ratio of 79.06% and 75.25% for the quarters ended March 31, 2008 and 2007. The efficiency ratio is calculated by dividing total noninterest expense (excluding amortization of intangibles) by the sum of net interest income and noninterest income (excluding gains or losses on sales of securities).
Net Interest Income
Our operating results are significantly impacted by net interest income, which represents the amount by which interest income on interest-earning assets, including securities and loans, exceeds interest expense incurred on interest-bearing liabilities, including deposits and other borrowed funds. Net interest income is a key source of our earnings. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income.
Net interest income was $9.9 million for the three months ended March 31, 2008, an increase of $2.2 million, or 28.6%, compared with the first quarter of 2007. The net interest margin expanded 39 basis points to 2.94% for the same comparison period, reflecting an improved asset mix, as we continued to execute our strategy of replacing lower yielding mortgage loans and securities with higher yielding loans. In addition, average earning assets grew $132.1 million, or 10.8%, due primarily to growth in loans. The growth in the net interest margin was due primarily to our ability to reprice more funding liabilities than assets while in a declining rate environment.
Average loans were $1.1 billion for the first quarter of 2008, a $202.9 million, or 22.1%, increase compared with the same quarter of 2007. Consistent with our strategy, this increase in loans was partially offset by a $90.1 million, or 38.8%, decrease in average securities during the same period. As a result of this shift in asset mix, loans accounted for 82.8% of earning assets during the first quarter of 2008, compared with 75.1% of earning assets for the same period of 2007. In addition, noninterest-bearing deposits were $106.9 million for the first quarter of 2008, a $955,000, or 0.9%, increase compared with the same period of 2007.
The following table sets forth for the periods indicated an analysis of net interest income by each major category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest earned or paid on such amounts and the average rate earned or paid. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities and the net interest margin for the same periods. All balances are daily average balances and nonaccrual loans were included in the average loans with a zero yield for the purpose of calculating the rate earned on total loans. We have no tax-exempt securities and an insignificant amount of tax-exempt loans, and no tax equivalent adjustments have been made with respect to these loans.
15
| For the Three Months Ended March 31, | ||||||||||||||||||||
| 2008 | 2007 | |||||||||||||||||||
| Average Outstanding Balance | Interest Earned/ Paid | Average Yield/ Rate | Average Outstanding Balance | Interest Earned/ Paid | Average Yield/ Rate | |||||||||||||||
| (dollars in thousands) | ||||||||||||||||||||
Assets: | ||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||
Loans | $ | 1,119,439 | $ | 18,378 | 6.60 | % | $ | 916,523 | $ | 15,808 | 6.99 | % | ||||||||
Mortgages held-for-sale | 1,465 | 32 | 8.79 | 52,273 | 1,121 | 8.70 | ||||||||||||||
Securities | 142,098 | 1,319 | 3.73 | 232,154 | 2,273 | 3.97 | ||||||||||||||
Federal funds sold and other | 89,419 | 803 | 3.61 | 19,412 | 278 | 5.81 | ||||||||||||||
Total interest-earning assets | 1,352,421 | 20,532 | 6.11 | 1,220,362 | 19,480 | 6.47 | ||||||||||||||
Less: Allowance for loan losses | (11,178 | ) | (9,268 | ) | ||||||||||||||||
Noninterest-earning assets | 102,266 | 102,234 | ||||||||||||||||||
Total assets | $ | 1,443,509 | $ | 1,313,328 | ||||||||||||||||
Liabilities, shareholders’ equity and puttable common stock: | ||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||
Interest checking | $ | 182,483 | $ | 953 | 2.10 | % | $ | 183,335 | $ | 1,301 | 2.88 | % | ||||||||
Money market and savings | 333,241 | 2,380 | 2.87 | 334,971 | 3,619 | 4.38 | ||||||||||||||
Time deposits | 434,597 | 5,209 | 4.82 | 374,389 | 4,536 | 4.91 | ||||||||||||||
Total interest-bearing deposits | 950,321 | 8,542 | 3.62 | 892,695 | 9,456 | 4.30 | ||||||||||||||
Borrowings and repurchase agreements | 193,855 | 1,755 | 3.64 | 172,660 | 1,889 | 4.44 | ||||||||||||||
Junior subordinated debentures | 20,619 | 356 | 6.94 | 20,619 | 455 | 8.95 | ||||||||||||||
Total interest-bearing liabilities | 1,164,795 | 10,653 | 3.68 | 1,085,974 | 11,800 | 4.41 | ||||||||||||||
Noninterest-bearing liabilities: | ||||||||||||||||||||
Noninterest-bearing deposits | 106,905 | 105,950 | ||||||||||||||||||
Other liabilities | 13,313 | 13,685 | ||||||||||||||||||
Total liabilities | 1,285,013 | 1,205,609 | ||||||||||||||||||
Shareholders’ equity and puttable common stock | 158,496 | 107,719 | ||||||||||||||||||
Total liabilities, shareholders’ equity and puttable common stock | $ | 1,443,509 | $ | 1,313,328 | ||||||||||||||||
Net interest income | $ | 9,879 | $ | 7,680 | ||||||||||||||||
Net interest spread | 2.43 | % | 2.06 | % | ||||||||||||||||
Net interest margin | 2.94 | % | 2.55 | % | ||||||||||||||||
Provision for Loan Losses
The provision for loan losses is the amount we determine necessary to be charged against the current period’s earnings to maintain the allowance for loan losses at a level that is considered adequate in relation to the estimated losses inherent in the loan portfolio. The provision was $1.5 million for the three months ended March 31, 2008, increasing $601,000 compared with the same period of 2007. The increase in the provision reflects the amount we consider necessary to fund losses inherent in the loan portfolio primarily as a result of the growth in the loan portfolio and changes in historical loss factors and other qualitative factors.
Noninterest Income
Noninterest income represented 40.33% and 52.40% of total revenue for the three months ended March 31, 2008 and 2007.
Noninterest income decreased $1.8 million, or 21.0%, to $6.7 million for the three months ended March 31, 2008, compared with the same period in 2007. The decrease was due primarily to a $2.1 million decrease in mortgage banking income. The decrease in mortgage banking income was due primarily to the disruption in the mortgage markets and our strategic decision in the third quarter of 2007 to retain originated mortgages. Marginally offsetting the decrease in mortgage banking income was an increase in trust and investment management fees. Trust and investment management fees rose $163,000, or 3.8%, to $4.4 million. The increase was due primarily to a 4.9% increase in assets under management.
16
The following table presents, for the periods indicated, the major categories of noninterest income:
| For the Three Months Ended March 31, | |||||||
| 2008 | 2007 | ||||||
| (dollars in thousands) | |||||||
Trust and investment management fees | $ | 4,407 | $ | 4,244 | |||
Mortgage banking | 54 | 2,192 | |||||
Insurance commissions and fees | 1,727 | 1,713 | |||||
Real estate operations, including net gain on sales | 55 | 18 | |||||
Net loss on sale of available-for-sale securities | — | (149 | ) | ||||
Other | 434 | 437 | |||||
Total noninterest income | $ | 6,677 | $ | 8,455 | |||
Noninterest Expense
Noninterest expense was $13.3 million, an increase of $815,000, or 6.5%, compared with the first quarter of 2007. The increase was due primarily to $415,000 of legal fees related to an arbitration matter and a severance charge (included in compensation) of $635,000. The severance charge was related to a former executive officer of our subsidiary Encore Bank.
The following table presents, for the periods indicated, the major categories of noninterest expense:
| For the Three Months Ended March 31, | ||||||
| 2008 | 2007 | |||||
| (dollars in thousands) | ||||||
Compensation | $ | 8,078 | $ | 7,863 | ||
Non-staff expenses: | ||||||
Occupancy | 1,438 | 1,399 | ||||
Equipment | 531 | 520 | ||||
Advertising and promotion | 204 | 196 | ||||
Outside data processing | 694 | 808 | ||||
Professional fees | 1,156 | 390 | ||||
Intangible amortization | 187 | 209 | ||||
Other | 989 | 1,077 | ||||
Total noninterest expense | $ | 13,277 | $ | 12,462 | ||
Income Tax Expense
The provision for income taxes decreased $390,000, or 39.1%, to $608,000 for the three months ended March 31, 2008, compared with $998,000 for the same three months of 2007. The change in income tax expense primarily reflects the decrease in earnings before income tax expense. The effective tax rate for the three months ended March 31, 2008 and 2007 was 34.2% and 36.0%.
Result of Segment Operations
We manage the company along three operating segments: banking, wealth management and insurance. The column identified as “Other” includes the parent company and the elimination transactions between segments. The accounting policies of the individual operating segments are the same as our accounting policies described in Note A to our consolidated financial statements as of and for the year ended December 31, 2007 included in our Annual Report on Form 10-K.
17
The following table presents the net earnings and total assets for each of our operating segments as of and for the periods indicated:
| Banking | Wealth Management | Insurance | Other | Consolidated | |||||||||||||
| (dollars in thousands) | |||||||||||||||||
For the three months ended March 31, 2008 | |||||||||||||||||
Net interest income (expense) | $ | 10,130 | $ | 64 | $ | 41 | $ | (356 | ) | $ | 9,879 | ||||||
Provision for loan losses | 1,501 | — | — | — | 1,501 | ||||||||||||
Noninterest income | 519 | 4,407 | 1,732 | 19 | 6,677 | ||||||||||||
Noninterest expense | 9,103 | 3,070 | 1,104 | — | 13,277 | ||||||||||||
Earnings (loss) before income taxes | 45 | 1,401 | 669 | (337 | ) | 1,778 | |||||||||||
Income tax expense (benefit) | (15 | ) | 504 | 240 | (121 | ) | 608 | ||||||||||
Net earnings (loss) | $ | 60 | $ | 897 | $ | 429 | $ | (216 | ) | $ | 1,170 | ||||||
Total assets at March 31, 2008 | $ | 1,500,462 | $ | 47,444 | $ | 10,143 | $ | (69,423 | ) | $ | 1,488,626 | ||||||
For the three months ended March 31, 2007 | |||||||||||||||||
Net interest income (expense) | $ | 8,035 | $ | 73 | $ | 27 | $ | (455 | ) | $ | 7,680 | ||||||
Provision for loan losses | 900 | — | — | — | 900 | ||||||||||||
Noninterest income | 2,481 | 4,244 | 1,716 | 14 | 8,455 | ||||||||||||
Noninterest expense | 8,453 | 3,027 | 982 | — | 12,462 | ||||||||||||
Earnings (loss) before income taxes | 1,163 | 1,290 | 761 | (441 | ) | 2,773 | |||||||||||
Income tax expense (benefit) | 396 | 467 | 272 | (137 | ) | 998 | |||||||||||
Net earnings (loss) | $ | 767 | $ | 823 | $ | 489 | $ | (304 | ) | $ | 1,775 | ||||||
Total assets at March 31, 2007 | $ | 1,301,562 | $ | 43,935 | $ | 9,278 | $ | (59,788 | ) | $ | 1,294,987 | ||||||
Banking
Net earnings for the three months ended March 31, 2008 decreased to $60,000, compared with $767,000 in the same period of 2007. Net interest income increased $2.1 million, or 26.1%, but was offset by an increase in the provision for loan losses of $601,000, a decrease in noninterest income of $2.0 million, or 79.1%, and an increase in noninterest expense of $650,000.
Net interest income for the three months ended March 31, 2008 increased $2.1 million, or 26.1%, compared with the same period of 2007. The increase resulted primarily from an improvement in the net interest margin and a higher volume of interest-earning assets. The net interest margin improved as a result of a more optimal mix of earning assets. See the analysis of net interest income included in the section of this report captioned “—Net Interest Income.”
The provision for loan losses for the three months ended March 31, 2008 totaled $1.5 million, compared with $900,000 for the same period of 2007. See analysis of the provision for loan losses included in the section of this report captioned “—Provision for Loan Losses.”
Noninterest income for the three months ended March 31, 2008 decreased $2.0 million, or 79.1%, compared with the same period in 2007. The decrease was due primarily to the decrease in mortgage banking income.
Noninterest expense for the three months ended March 31, 2008 increased $650,000, or 7.7%, compared with the same period in 2007. The increase in noninterest expense was due primarily to a $635,000 severance charge and $415,000 in legal fees related to an arbitration matter. These expense increases were partially offset by the cost reduction initiative that was launched in the fourth quarter of 2007.
Wealth Management
Net earnings for the three months ended March 31, 2008 increased $74,000, or 9.0%, compared with the same period in 2007. The increase in earnings was due primarily to an increase in assets under management. Assets under management were $2.7 billion as of March 31, 2008 compared with $2.6 billion as of March 31, 2007, a 4.9% increase.
Noninterest income for the three months ended March 31, 2008 increased $163,000, or 3.8%, compared with the same period in 2007, due primarily to increased assets under management.
Noninterest expense for the three months ended March 31, 2008 increased $43,000, or 1.4%, compared with the same period in 2007. The increase was due primarily to higher compensation expense due to hiring of additional staff and merit increases.
18
Insurance
Net earnings for the three months ended March 31, 2008 decreased $60,000, or 12.3%, compared with the same period of 2007. Commission revenue was essentially flat due to the soft property and casualty insurance market.
Noninterest income for the three months ended March 31, 2008 increased $16,000, or 0.9%, compared with the same period of 2007. Commission revenue was essentially flat as new customer growth was offset by lower commissions resulting from the soft property and casualty insurance market.
Noninterest expense for the three months ended March 31, 2008 increased $122,000, or 12.4%, compared with the same period of 2007. The increase was due primarily to increased compensation expense related to new business.
Other
“Other” consists primarily of interest expense on our junior subordinated debentures, which is not allocated to the business segments. Interest expense on these borrowings decreased due to a refinance of $15.5 million of the debentures in April 2007.
Financial Condition
Our total assets increased $87.4 million, or 6.2%, to $1.5 billion as of March 31, 2008 compared with total assets of $1.4 billion as of December 31, 2007. Our loan portfolio grew $59.2 million, or 5.4%, to $1.2 billion as of March 31, 2008. Our securities portfolio decreased $11.0 million, or 7.5%, to $135.2 million compared with $146.3 million as of December 31, 2007. Shareholders’ equity increased $1.9 million, or 1.2%, to $159.4 million compared with $157.5 million as of December 31, 2007.
Loan Portfolio
Our primary lending focus is to professional firms, privately-owned businesses, investors and affluent individuals. To these customers, we make commercial, commercial real estate, real estate construction, residential real estate and consumer loans. Total commercial loans, which consist of commercial, commercial real estate and real estate construction loans, accounted for 46.0% of our portfolio as of March 31, 2008. Total consumer loans, which consist of residential real estate, home equity lines of credit, consumer installment-indirect and other consumer loans, made up 54.0% of our loan portfolio as of March 31, 2008.
Total loans were $1.2 billion as of March 31, 2008, an increase of $59.2 million, or 5.4%, compared with loans of $1.1 billion as of December 31, 2007. The majority of loan growth occurred in residential real estate second lien, which increased $39.0 million, or 20.0%, and commercial real estate, which increased $14.5 million, or 5.2%, to $291.5 million. This growth was due primarily to continued strength in our market areas in Texas.
The following table summarizes our loan portfolio by type of loan as of the dates indicated:
| As of March 31, 2008 | As of December 31, 2007 | |||||||||||
| Amount | Percent | Amount | Percent | |||||||||
| (dollars in thousands) | ||||||||||||
Commercial: | ||||||||||||
Commercial | $ | 142,259 | 12.3 | % | $ | 127,583 | 11.6 | % | ||||
Commercial real estate | 291,543 | 25.2 | 277,047 | 25.3 | ||||||||
Real estate construction | 97,807 | 8.5 | 100,975 | 9.2 | ||||||||
Total commercial | 531,609 | 46.0 | 505,605 | 46.1 | ||||||||
Consumer: | ||||||||||||
Residential real estate first lien | 264,445 | 22.9 | 271,346 | 24.7 | ||||||||
Residential real estate second lien | 234,623 | 20.3 | 195,583 | 17.8 | ||||||||
Home equity lines | 78,860 | 6.8 | 79,023 | 7.2 | ||||||||
Consumer installment - indirect | 21,917 | 1.9 | 25,262 | 2.3 | ||||||||
Consumer other | 25,047 | 2.1 | 20,449 | 1.9 | ||||||||
Total consumer | 624,892 | 54.0 | 591,663 | 53.9 | ||||||||
Total loans receivable | $ | 1,156,501 | 100.0 | % | $ | 1,097,268 | 100.0 | % | ||||
19
Nonperforming Assets
The following table presents information regarding nonperforming assets as of the dates indicated:
| As of March 31, 2008 | As of December 31, 2007 | |||||||
| (dollars in thousands) | ||||||||
Nonaccrual loans | $ | 14,131 | $ | 11,208 | ||||
Accruing loans past due 90 days or more | 283 | 2,183 | ||||||
Restructured loans | — | — | ||||||
Total nonperforming loans | 14,414 | 13,391 | ||||||
Investment in real estate | 2,078 | 835 | ||||||
Total nonperforming assets | $ | 16,492 | $ | 14,226 | ||||
Nonperforming assets to total loans and investment in real estate | 1.42 | % | 1.30 | % | ||||
Nonperforming assets were $16.5 million and $14.2 million as of March 31, 2008 and December 31, 2007. Our ratio of nonperforming assets to total loans and investment in real estate was 1.42% and 1.30% as of March 31, 2008 and December 31, 2007. The increase in nonaccrual loans was primarily attributable to two commercial real estate loans totaling $2.7 million. Included in nonaccrual loans was a loan in the amount of $6.3 million to a law firm. Repayment of a major portion of this loan is primarily dependent on a lawsuit which has settled and the proceeds are placed in escrow, but distribution of the attorneys’ fee to our client is pending final court action. Loans 90 days past due or more and still accruing were $283,000 at March 31, 2008, compared with $2.2 million at December 31, 2007. Investment in real estate was $2.1 million at March 31, 2008 compared with $835,000 at December 31, 2007, a $1.2 million increase due primarily to repossession of a residential lot in Houston.
Allowance for Loan Losses
Our allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The allowance for loan losses is maintained at a level which we believe is adequate to absorb all probable losses on loans inherent in the loan portfolio. The amount of the allowance is affected by loan charge-offs, which decrease the allowance; recoveries on loans previously charged off, which increase the allowance; and the provision for loan losses charged to earnings, which increases the allowance. In determining the provision for loan losses, we monitor fluctuations in the allowance resulting from actual charge-offs and recoveries and periodically review the size and composition of the loan portfolio in light of current and anticipated economic conditions. If actual losses exceed the amount of the allowance for loan losses, our earnings could be adversely affected.
The allowance for loan losses represents our estimate of the amount necessary to provide for losses inherent in the loan portfolio in the normal course of business. Due to the uncertainty of risks in the loan portfolio, our judgment of the amount of the allowance necessary to absorb loan losses is approximate. The allowance for loan losses is also subject to regulatory examinations and determination by the regulatory agencies as to its adequacy in comparison with peer institutions.
Net charge-offs for the first quarter of 2008 were $1.1 million, or 0.38% of average total loans on an annualized basis, compared with $166,000, or 0.07% of average total loans on an annualized basis for the first quarter of 2007. Consumer loans, which include our indirect auto and boat portfolio, accounted for a majority of the net charge-offs in the first quarter of 2008. We stopped originating indirect auto and boat loans in the third quarter of 2005.
20
The following table summarizes the activity in our allowance for loan losses as of and for the periods indicated:
| As of and for the Three Months Ended March 31, 2008 | As of and for the Year Ended December 31, 2007 | |||||||
| (dollars in thousands) | ||||||||
Average loans outstanding | $ | 1,119,439 | $ | 972,760 | ||||
Total loans outstanding at end of period | $ | 1,156,501 | $ | 1,097,268 | ||||
Allowance for loan losses at beginning of period | $ | 11,161 | $ | 9,056 | ||||
Charge-offs: | ||||||||
Commercial: | ||||||||
Commercial | (231 | ) | (62 | ) | ||||
Commercial real estate | (80 | ) | — | |||||
Real estate construction | (9 | ) | (79 | ) | ||||
Total commercial | (320 | ) | (141 | ) | ||||
Consumer: | ||||||||
Residential real estate first lien | (43 | ) | (190 | ) | ||||
Residential real estate second lien | (377 | ) | (760 | ) | ||||
Home equity lines | (42 | ) | (334 | ) | ||||
Consumer installment - indirect | (297 | ) | (962 | ) | ||||
Consumer other | (29 | ) | (226 | ) | ||||
Total consumer | (788 | ) | (2,472 | ) | ||||
Total charge-offs | (1,108 | ) | (2,613 | ) | ||||
Recoveries: | ||||||||
Commercial: | ||||||||
Commercial | 11 | 46 | ||||||
Commercial real estate | — | — | ||||||
Real estate construction | — | — | ||||||
Total commercial | 11 | 46 | ||||||
Consumer: | ||||||||
Residential real estate first lien | 1 | 34 | ||||||
Residential real estate second lien | 2 | 178 | ||||||
Home equity lines | 2 | 43 | ||||||
Consumer installment - indirect | 6 | 294 | ||||||
Consumer other | 27 | 94 | ||||||
Total consumer | 38 | 643 | ||||||
Total recoveries | 49 | 689 | ||||||
Net charge-offs | (1,059 | ) | (1,924 | ) | ||||
Provision for loan losses | 1,501 | 4,029 | ||||||
Allowance for loan losses at end of period | $ | 11,603 | $ | 11,161 | ||||
Ratio of net charge-offs to average loans | 0.38 | % | 0.20 | % | ||||
Ratio of allowance for loan losses to period end loans | 1.00 | 1.02 | ||||||
Ratio of allowance for loan losses to nonperforming loans | 80.50 | 83.35 | ||||||
21
Deposits
Our deposits averaged $1.1 billion for the three months ended March 31, 2008 and $1.0 billion for the year ended December 31, 2007. As of March 31, 2008, core deposits (which consist of noninterest-bearing deposits, interest checking, money market and savings and time deposits less than $100,000) were $860.7 million, or 77.5%, of total deposits, while time deposits $100,000 and greater and brokered deposits made up 22.5% of total deposits. As of March 31, 2008, total deposits increased $69.8 million, or 6.7%, to $1.1 billion compared with total deposits of $1.0 billion as of December 31, 2007.
The following table presents the daily average balance and weighted average rates paid on deposits for the periods indicated:
| Three Months Ended March 31, 2008 | Year Ended December 31, 2007 | |||||||||||
| Average Balance | Average Rate | Average Balance | Average Rate | |||||||||
| (dollars in thousands) | ||||||||||||
Noninterest-bearing deposits | $ | 106,905 | — | % | $ | 109,448 | — | % | ||||
Interest checking | 182,483 | 2.10 | 172,701 | 2.97 | ||||||||
Money market and savings | 333,241 | 2.87 | 348,567 | 4.23 | ||||||||
Time deposits less than $100,000 | 199,372 | 4.86 | 175,393 | 4.86 | ||||||||
Core deposits | 822,001 | 2.81 | 806,109 | 3.52 | ||||||||
Time deposits $100,000 and greater | 218,547 | 4.81 | 192,234 | 5.02 | ||||||||
Brokered deposits | 16,678 | 4.43 | 13,220 | 4.54 | ||||||||
Total deposits | $ | 1,057,226 | 3.25 | % | $ | 1,011,563 | 3.82 | % | ||||
Borrowings, Repurchase Agreements and Junior Subordinated Debentures
We utilize borrowings to supplement deposits in funding our lending and investing activities. These borrowings are typically advances from the Federal Home Loan Bank of Dallas (FHLB), which have terms ranging from overnight to several years. All borrowings from the FHLB are collateralized by a blanket lien on Encore Bank’s mortgage-related assets. Additionally, we borrow from other financial institutions using investment securities as collateral and have issued junior subordinated debentures to subsidiary trusts.
Our borrowings and repurchase agreements were $188.8 million as of March 31, 2008. The outstanding balance as of March 31, 2008 includes $125.0 million in long-term advances and $63.6 million in repurchase agreements with clients. Included in the long term advances are $95.0 million of long term advances that have call provisions that are at the discretion of the FHLB which could shorten the maturity of the borrowings. Additionally, we had $201,000 in notes payable related to the acquisition of Town & Country Insurance Agency, Inc.
We increased our borrowings and repurchase agreements $15.5 million, or 8.9%, to $188.8 million as of March 31, 2008 from $173.4 million as of December 31, 2007. The increase was due primarily to the addition of long term FHLB advances to fund the growth in our second mortgage portfolio.
22
The following table summarizes our two issues of junior subordinated debentures outstanding as of March 31, 2008:
Description | Issuance and Call Dates (1) | Trust Preferred Securities Outstanding | Interest Rate as of March 31, 2008 | Fixed/ Adjustable | Interest Rate Basis | Junior Subordinated Debt Owed to Trusts | Final Maturity Date | ||||||||||
| (dollars in thousands) | |||||||||||||||||
Encore Statutory | |||||||||||||||||
Trust II | 9/17/2003 | $ | 5,000 | 5.75 | % | Adjustable quarterly | 3 month | $ | 5,155 | 9/24/2033 | |||||||
| LIBOR + 2.95% | |||||||||||||||||
Encore Capital | |||||||||||||||||
Trust III | 4/19/2007 | 15,000 | 6.85 | % | Fixed rate (2) | 6.85%(2) | 15,464 | 4/19/2037 | |||||||||
| (1) | Each issue of junior subordinated debentures is callable by us after five years from issuance date. |
| (2) | The debentures bear a fixed interest rate until April 19, 2012, when the rate begins to float on a quarterly basis based on the 3 month LIBOR plus 1.75%. |
Liquidity and Funding
Our liquidity represents our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers also affect our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position.
Liquidity needs of a financial institution can be met from either assets or liabilities. On the asset side, our primary sources of liquidity are cash and due from banks, federal funds sold, maturities of securities and scheduled repayments and maturities of loans. On the liability side, our principal sources of liquidity are deposits, borrowed funds and the accessibility to money and capital markets. Client deposits are our largest source of funds. As of March 31, 2008, our average deposits were $1.1 billion, or 73.2% of average total assets.
Shareholders’ Equity
Shareholders’ equity increased $1.9 million, or 1.2%, to $159.4 million as of March 31, 2008 compared with $157.5 million as of December 31, 2007, primarily due to net earnings.
Regulatory Capital
We actively manage our capital. Our potential sources of capital are earnings and common or preferred equity. From time to time, we have issued trust preferred securities through a subsidiary trust either to fund organic growth or to support an acquisition. Trust preferred securities can be eligible for treatment as Tier 1 regulatory capital provided such securities comprise less than 25% of Tier 1 regulatory capital. Any amount above this limit can be eligible for treatment as Tier 2 capital. We currently have the capacity to issue additional trust preferred securities that would be treated as Tier 1 capital.
Each of the federal bank regulatory agencies has established minimum capital adequacy and leverage capital requirements for banking organizations. Encore Bank is subject to the capital adequacy requirements of the Office of the Comptroller of the Currency (OCC) and we, as a bank holding company, are subject to the capital adequacy requirements of the Federal Reserve. As of the most recent notification from the OCC, Encore Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized “well capitalized”, Encore Bank must maintain minimum Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios as set forth in the table below. There are no conditions or events since that notification that we believe have changed Encore Bank’s capital position. We intend that Encore Bank will maintain a capital position that meets or exceeds the “well capitalized” requirements as defined by the OCC.
23
The following table presents capital amounts and ratios for us and Encore Bank as of March 31, 2008:
| Actual | For Capital Adequacy Purposes | To Be Categorized as Well Capitalized Under Prompt Corrective Action Provisions | ||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||
| (dollars in thousands) | ||||||||||||||||||
Encore Bancshares, Inc. | ||||||||||||||||||
Leverage | $ | 145,274 | 10.31 | % | $ | 56,384 | 4.00 | % | N/A | N/A | ||||||||
Tier 1 risk-based | 145,274 | 12.91 | 45,019 | 4.00 | N/A | N/A | ||||||||||||
Total risked-based | 156,877 | 13.94 | 90,039 | 8.00 | N/A | N/A | ||||||||||||
Encore Bank, N.A. | ||||||||||||||||||
Leverage (1) | $ | 111,969 | 7.96 | % | $ | 56,233 | 4.00 | % | $ | 70,292 | 5.00 | % | ||||||
Tier 1 risk-based | 111,969 | 9.96 | 44,956 | 4.00 | 67,434 | 6.00 | ||||||||||||
Total risked-based | 123,572 | 10.99 | 89,912 | 8.00 | 112,391 | 10.00 | ||||||||||||
| (1) | As part of Encore Bank’s conversion to a national bank, the OCC required that Encore Bank have a leverage ratio of at least 7.75% as of December 31, 2008. |
Recent Development
John Lingor was named Executive Vice President and Chief Credit Officer of Encore Bank. Mr. Lingor has over 36 years of banking and credit management experience, most recently as Senior Vice President and Credit Risk Manager at Amegy Bank of Texas.
Critical Accounting Policies
We have made no changes in our methods of application of our critical accounting policies from the information provided in our Annual Report on Form 10-K.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
There have been no material changes in market risk from the information provided in the Asset/Liability Management section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K.
| Item 4. | Controls and Procedures |
(a) Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, an evaluation was carried out by our management, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.
As described in Item 9A of our 2007 Annual Report on Form 10-K, we identified the following material weakness in our internal control over financial reporting as of December 31, 2007. We did not maintain effective controls over cost-basis investments (equity securities without a readily determinable market value). Specifically, we did not have formal documented policies and procedures in place to determine the fair value of this particular type of investment or assess whether such investment was impaired. The lack of this control could potentially result in us not detecting an “other than temporary” impairment in the quarter in which it should be recognized, which could result in a material adjustment to earnings. The fair value of these cost-basis investments should be determined and a formal process performed at least quarterly to ascertain if there is an “other than temporary” impairment. If we determine that any impairment is “other than temporary”, a write-down of these cost-basis investments should be recorded at such time. At March 31, 2008, our cost basis in these assets was approximately $2.0 million.
24
| (b) | Changes in Internal Control over Financial Reporting |
In the first quarter of 2008, to remediate the material weakness discussed above, we implemented controls and procedures to determine the fair value of cost-basis investments. As of March 31, 2008, we performed an impairment analysis and determined there was no “other than temporary” impairment in these cost-basis investments. We evaluated the design and operation of the new controls and procedures and concluded that these controls and procedures were designed and operating effectively as of March 31, 2008. We believe that the changes and enhanced controls and procedures described above remediated the material weakness as of March 31, 2008.
Except for such changes, during the first quarter of 2008, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
| Item 1. | Legal Proceedings |
We are involved in an arbitration with the former owner of a company we acquired in 2005. While the final outcome of the arbitration cannot be predicted with certainty, we do not believe that this matter, when finally resolved, will have a material adverse effect on our financial position or cash flows. However, an adverse resolution of this matter in any quarter or fiscal year could have a material adverse effect on our results of operations in that period.
We are a defendant in legal actions arising from transactions conducted in the ordinary course of business. We believe, after consultation with legal counsel, that the ultimate liability, if any, arising from such actions will not have a material adverse effect on our consolidated financial statements.
| Item 1A. | Risk Factors |
In addition to the information contained in this report, you should consider the factors discussed under the heading “Risk Factors” in our Annual Report on Form 10-K. There have been no material changes in our Risk Factors from those disclosed in our Form 10-K.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Not applicable
| Item 3. | Defaults Upon Senior Securities |
Not applicable
| Item 4. | Submission of Matters to a Vote of Security Holders |
Not applicable
| Item 5. | Other Information |
Not applicable
| Item 6. | Exhibits |
| 3.1 | Amended and Restated Articles of Incorporation of Encore Bancshares, Inc. (incorporated by reference to Exhibit 3.1 to Encore Bancshares, Inc.’s Registration Statement on Form S-1, Registration No. 333-142735 (the “S-1 Registration Statement”)). | |
| 3.2 | Articles of Amendment to Articles of Incorporation of Encore Bancshares, Inc. (incorporated by reference to Exhibit 3.2 to the S-1 Registration Statement). | |
| 3.3 | Amended and Restated Bylaws of Encore Bancshares, Inc. (incorporated by reference to Exhibit 3.3 to the S-1 Registration Statement). | |
| 4.1 | Form of specimen certificate representing shares of Encore Bancshares, Inc. common stock (incorporated by reference to Exhibit 4.1 to the S-1 Registration Statement). | |
25
| 10.1* | Executive Employment Agreement dated April 7, 2008 between William Reed Moraw and Town & Country Insurance Agency, Inc. | |
| 31.1* | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. | |
| 31.2* | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. | |
| 32.1** | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| * | Filed with this Quarterly Report on Form 10-Q |
| ** | Furnished with this Quarterly Report on Form 10-Q |
26
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Encore Bancshares, Inc. | ||||
| (Registrant) | ||||
May 8, 2008 | /s/ James S. D’Agostino, Jr. | |||
| (Date) | James S. D’Agostino, Jr., Chief Executive Officer and President | |||
May 8, 2008 | /s/ L. Anderson Creel | |||
| (Date) | L. Anderson Creel, Chief Financial Officer, Executive Vice President and Treasurer | |||
27
