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, 2012. |
¨ | 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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 | | x |
| | | |
Non-accelerated filer | | ¨ (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, 2012, there were 11.9 million shares of common stock, $1.00 par value, issued and outstanding.
ENCORE BANCSHARES, INC.
TABLE OF CONTENTS
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, 2012 | | | December 31, 2011 | |
ASSETS | | | | | | | | |
Cash and due from banks | | $ | 16,135 | | | $ | 13,397 | |
Interest-bearing deposits in banks | | | 150,053 | | | | 114,403 | |
Federal funds sold and other temporary investments | | | 1,382 | | | | 1,269 | |
| | | | | | | | |
Cash and cash equivalents | | | 167,570 | | | | 129,069 | |
Securities available-for-sale, at fair value | | | 181,107 | | | | 170,801 | |
Securities held-to-maturity, at amortized cost | | | 97,400 | | | | 99,630 | |
Loans held-for-sale, at lower of cost or fair value | | | 1,350 | | | | 1,778 | |
Loans receivable | | | 1,046,168 | | | | 1,023,486 | |
Allowance for loan losses | | | (17,977 | ) | | | (17,968 | ) |
| | | | | | | | |
Net loans receivable | | | 1,028,191 | | | | 1,005,518 | |
Federal Home Loan Bank of Dallas stock, at cost | | | 9,838 | | | | 9,829 | |
Other real estate owned | | | 3,954 | | | | 2,090 | |
Premises and equipment, net | | | 8,876 | | | | 6,537 | |
Cash surrender value of life insurance policies | | | 16,654 | | | | 16,508 | |
Goodwill | | | 35,799 | | | | 35,799 | |
Other intangible assets, net | | | 5,321 | | | | 4,533 | |
Other assets | | | 35,303 | | | | 40,491 | |
| | | | | | | | |
Total assets | | $ | 1,591,363 | | | $ | 1,522,583 | |
| | | | | | | | |
| | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | |
Deposits: | | | | | | | | |
Noninterest-bearing | | $ | 379,184 | | | $ | 334,859 | |
Interest-bearing | | | 784,483 | | | | 765,378 | |
| | | | | | | | |
Total deposits | | | 1,163,667 | | | | 1,100,237 | |
Borrowings and repurchase agreements | | | 220,971 | | | | 218,702 | |
Junior subordinated debentures | | | 20,619 | | | | 20,619 | |
Other liabilities | | | 7,351 | | | | 9,636 | |
| | | | | | | | |
Total liabilities | | | 1,412,608 | | | | 1,349,194 | |
Commitments and contingencies | | | | | | | | |
Shareholders’ equity: | | | | | | | | |
Preferred stock, $1 par value, 20,000 shares authorized; 33 shares issued at March 31, 2012 and December 31, 2011; aggregate liquidation preference of $32,996 and $33,093 | | | 32,914 | | | | 32,914 | |
Common stock, $1 par value, 50,000 shares authorized; 11,995 shares at March 31, 2012 and 11,739 shares at December 31, 2011 issued | | | 11,995 | | | | 11,739 | |
Additional paid-in capital | | | 126,475 | | | | 124,762 | |
Retained earnings | | | 9,062 | | | | 5,950 | |
Common stock in treasury, at cost (96 shares at March 31, 2012 and 81 shares at December 31, 2011) | | | (1,116 | ) | | | (854 | ) |
Accumulated other comprehensive loss | | | (575 | ) | | | (1,122 | ) |
| | | | | | | | |
Total shareholders’ equity | | | 178,755 | | | | 173,389 | |
| | | | | | | | |
Total liabilities and shareholders’ equity | | $ | 1,591,363 | | | $ | 1,522,583 | |
| | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
3
Encore Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, amounts in thousands, except per share amounts)
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2012 | | | 2011 | |
Interest income: | | | | | | | | |
Loans, including fees | | $ | 14,455 | | | $ | 13,442 | |
Securities | | | 1,626 | | | | 2,305 | |
Federal funds sold and other temporary investments | | | 76 | | | | 30 | |
| | | | | | | | |
Total interest income | | | 16,157 | | | | 15,777 | |
Interest expense: | | | | | | | | |
Deposits | | | 1,627 | | | | 2,340 | |
Borrowings and repurchase agreements | | | 2,120 | | | | 2,106 | |
Junior subordinated debentures | | | 301 | | | | 298 | |
| | | | | | | | |
Total interest expense | | | 4,048 | | | | 4,744 | |
| | | | | | | | |
Net interest income | | | 12,109 | | | | 11,033 | |
Provision for loan losses | | | 733 | | | | 2,170 | |
| | | | | | | | |
Net interest income after provision for loan losses | | | 11,376 | | | | 8,863 | |
Noninterest income: | | | | | | | | |
Trust and investment management fees | | | 5,239 | | | | 5,072 | |
Insurance commissions and fees | | | 1,597 | | | | 1,440 | |
Net loss on sale of available-for-sale securities | | | — | | | | (31 | ) |
Other | | | 809 | | | | 647 | |
| | | | | | | | |
Total noninterest income | | | 7,645 | | | | 7,128 | |
Noninterest expense: | | | | | | | | |
Compensation | | | 8,918 | | | | 8,706 | |
Occupancy | | | 1,198 | | | | 1,287 | |
Equipment | | | 250 | | | | 241 | |
Advertising and promotion | | | 149 | | | | 156 | |
Outside data processing | | | 818 | | | | 783 | |
Professional fees | | | 1,515 | | | | 1,134 | |
Intangible amortization | | | 170 | | | | 140 | |
FDIC assessment | | | 193 | | | | 798 | |
Other real estate owned expenses, net | | | 252 | | | | 83 | |
Write down of assets held-for-sale | | | — | | | | 21 | |
Other | | | 737 | | | | 1,006 | |
| | | | | | | | |
Total noninterest expense | | | 14,200 | | | | 14,355 | |
| | | | | | | | |
Net income before income taxes | | | 4,821 | | | | 1,636 | |
Income tax expense | | | 1,627 | | | | 484 | |
| | | | | | | | |
Net income | | $ | 3,194 | | | $ | 1,152 | |
| | | | | | | | |
Income available to common shareholders | | $ | 3,112 | | | $ | 594 | |
| | | | | | | | |
Income per common share: | | | | | | | | |
Basic | | $ | 0.26 | | | $ | 0.05 | |
Diluted | | | 0.26 | | | | 0.05 | |
Average common shares outstanding | | | 11,751 | | | | 11,491 | |
Diluted average common shares outstanding | | | 11,917 | | | | 11,575 | |
The accompanying notes are an integral part of these consolidated financial statements.
4
Encore Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited, amounts in thousands)
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2012 | | | 2011 | |
Net income | | $ | 3,194 | | | $ | 1,152 | |
| | |
Other comprehensive income, before tax: | | | | | | | | |
| | |
Unrealized holding gains (losses) on available-for-sale securities arising during period | | | 842 | | | | (230 | ) |
Less: reclassification adjustment for gains (losses) included in income | | | — | | | | (31 | ) |
| | | | | | | | |
Other comprehensive income (loss), before tax | | | 842 | | | | (261 | ) |
Income tax (expense) benefit related to items of other comprehensive income | | | (295 | ) | | | 74 | |
| | | | | | | | |
Other comprehensive income (loss), net of tax | | | 547 | | | | (187 | ) |
| | | | | | | | |
Comprehensive income | | $ | 3,741 | | | $ | 965 | |
| | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
5
Encore Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
Three Months Ended March 31, 2012
(Unaudited, amounts in thousands)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Preferred Stock | | | Common Stock | | | Additional Paid-in Capital | | | Retained Earnings | | | Common Stock in Treasury | | | Accumulated Other Comprehensive Income (Loss) | | | Total Shareholders’ Equity | |
| | | Shares | | | Amount | | | | | | |
Balance at January 1, 2012 | | $ | 32,914 | | | | 11,739 | | | $ | 11,739 | | | $ | 124,762 | | | $ | 5,950 | | | $ | (854 | ) | | $ | (1,122 | ) | | $ | 173,389 | |
Stock-based compensation cost recognized in earnings | | | — | | | | — | | | | — | | | | 399 | | | | — | | | | — | | | | — | | | | 399 | |
Issuance of common stock | | | — | | | | 258 | | | | 258 | | | | 900 | | | | — | | | | — | | | | — | | | | 1,158 | |
Forfeiture of restricted stock | | | — | | | | (2 | ) | | | (2 | ) | | | 2 | | | | — | | | | — | | | | — | | | | — | |
Purchase of treasury stock (15 shares) | | | — | | | | — | | | | — | | | | — | | | | — | | | | (262 | ) | | | — | | | | (262 | ) |
Excess tax benefit from stock-based compensation | | | — | | | | — | | | | — | | | | 412 | | | | — | | | | — | | | | — | | | | 412 | |
Comprehensive income | | | — | | | | — | | | | — | | | | — | | | | 3,194 | | | | — | | | | 547 | | | | 3,741 | |
Dividend on preferred stock | | | — | | | | — | | | | — | | | | — | | | | (82 | ) | | | — | | | | — | �� | | | (82 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at March 31, 2012 | | $ | 32,914 | | | | 11,995 | | | $ | 11,995 | | | $ | 126,475 | | | $ | 9,062 | | | $ | (1,116 | ) | | $ | (575 | ) | | $ | 178,755 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of this consolidated financial statement.
6
Encore Bancshares, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, amounts in thousands)
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2012 | | | 2011 | |
Cash flows from operating activities: | | | | | | | | |
Net income | | $ | 3,194 | | | $ | 1,152 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | |
Provision for loan losses | | | 733 | | | | 2,170 | |
Write down of assets held-for-sale and other real estate owned | | | 12 | | | | 34 | |
Depreciation and amortization, net | | | 886 | | | | 715 | |
Stock-based compensation | | | 399 | | | | 306 | |
Loss on sale of available-for-sale securities and other assets, net | | | 25 | | | | 15 | |
Loans originated for sale in the secondary market | | | (3,858 | ) | | | (5,715 | ) |
Proceeds from sale of mortgage loans | | | 4,365 | | | | 7,901 | |
Other assets, net | | | 4,738 | | | | 3,836 | |
Other liabilities, net | | | (2,629 | ) | | | (1,742 | ) |
| | | | | | | | |
Net cash provided by operating activities | | | 7,865 | | | | 8,672 | |
| | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Purchases of available-for-sale securities | | | (32,780 | ) | | | (14,591 | ) |
Principal collected on available-for-sale securities | | | 13,056 | | | | 9,636 | |
Proceeds from sales of available-for-sale securities | | | 10,000 | | | | 14,945 | |
Proceeds from prepayments and maturities of held-to-maturity securities | | | 2,204 | | | | 6,379 | |
Proceeds from sales of other real estate owned | | | 855 | | | | 1,974 | |
Cash paid for acquisition | | | (517 | ) | | | — | |
Net increase in loans | | | (26,241 | ) | | | (14,068 | ) |
Purchase of Federal Home Loan Bank stock, net of redemption | | | — | | | | (587 | ) |
Purchases of premises and equipment | | | (2,624 | ) | | | (34 | ) |
| | | | | | | | |
Net cash provided (used) by investing activities | | | (36,047 | ) | | | 3,654 | |
| | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Net increase (decrease) in deposits | | | 63,430 | | | | (9,652 | ) |
Repayment of long term Federal Home Loan Bank of Dallas borrowings | | | (14 | ) | | | (13 | ) |
Increase in repurchase agreements | | | 2,138 | | | | 1,680 | |
Proceeds from issuance of common stock, net of purchase of treasury stock | | | 896 | | | | 407 | |
Preferred dividend paid | | | (179 | ) | | | (425 | ) |
Other, net | | | 412 | | | | 20 | |
| | | | | | | | |
Net cash provided (used) by financing activities | | | 66,683 | | | | (7,983 | ) |
| | | | | | | | |
Net increase in cash and cash equivalents | | | 38,501 | | | | 4,343 | |
Cash and cash equivalents at beginning of period | | | 129,069 | | | | 64,099 | |
| | | | | | | | |
Cash and cash equivalents at end of period | | $ | 167,570 | | | $ | 68,442 | |
| | | | | | | | |
Supplementary cash flows information: | | | | | | | | |
Interest paid on deposits and borrowed funds | | $ | 4,165 | | | $ | 4,864 | |
Income taxes paid | | | — | | | | — | |
Noncash investing and financing activities: | | | | | | | | |
Real estate acquired in satisfaction of loans | | | 2,835 | | | | 98 | |
Transfer of loans held-for-sale to loans receivable | | | — | | | | 7,327 | |
The accompanying notes are an integral part of these consolidated financial statements.
7
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE A—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Encore Bancshares, Inc. (Bancshares, and on a consolidated basis, referred to as the Company) headquartered in Houston, Texas, is a financial holding company. The Company’s business segments are Banking, Wealth Management and Insurance. For further discussion of each business segment, refer to Note H. The Company’s principal subsidiary is Encore Bank, National Association (Encore Bank), which operates as a national banking association. The Company provides wealth management services through Linscomb & Williams, Inc. (Linscomb & Williams), a subsidiary of Encore Bank, and the Trust Division of Encore Bank (Encore Trust). The Company provides property and casualty insurance products through its subsidiary Town & Country Insurance Agency, Inc. (Town & Country).
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Encore Bancshares, Inc., Encore Bank, Linscomb & Williams and Town & Country. The Company has made all adjustments that, in its opinion, are necessary for a fair presentation of results of the interim periods, and all such adjustments are of a normal recurring nature. All intercompany balances and transactions have been eliminated. These unaudited consolidated financial statements and the notes thereto should be read in conjunction with the Annual Report on Form 10-K for the year ended December 31, 2011. The consolidated balance sheet at December 31, 2011 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).
The Company must make estimates and assumptions that affect amounts reported in these interim consolidated financial statements and in disclosures of contingent assets and liabilities. Ultimate results could differ from those estimates.
Operating results for the three months ended March 31, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012, or any other period.
Nature of Operations
The Company is primarily in the business of attracting deposits and investing these funds in loans and securities, as well as providing trust and investment management services and property and casualty insurance products.
The Company provides a variety of financial services through twelve private client offices located in the greater Houston area, and five wealth management offices and four insurance offices in Texas. The Company’s product offerings, places of business and service delivery are positioned to best meet the needs of privately-owned businesses, professional firms, investors and affluent individuals.
Adoption of Updates to the FASB Codification
On January 1, 2012, we adopted the following updates to the Financial Accounting Standards Board (FASB) Codification:
FASB Accounting Standards Updates (ASU) No. 2011-03,“Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.”The amendments in ASU 2011-03 remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. The adoption of ASU 2011-03 did not have a significant impact on the Company’s financial statements.
FASB ASU No. 2011-04,“Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRSs.”The amendments in ASU 2011-04 generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with US GAAP and IFRSs. ASU 2011-04 was effective for the Company on January 1, 2012 and is reflected in Note G.
8
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FASB ASU No. 2011-05,“Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” Under ASU 2011-05, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity. ASU 2011-05 does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 was effective for the Company on January 1, 2012 and is reflected in the Consolidated Statements of Comprehensive Income.
FASB ASU No. 2011-08,“Testing Goodwill for Impairment”, amends the guidance in FASB ASC 350-20. Under the revised guidance, entities testing goodwill for impairment have the option of performing a qualitative assessment before calculating the fair value of the reporting unit (i.e., step 1 of the goodwill impairment test). If entities determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required. The adoption of ASU 2011-08 did not have a significant impact on the Company’s financial statements.
Descriptions of significant accounting policies are included in Note A to the consolidated financial statements as of and for the year ended December 31, 2011 included in the Annual Report on Form 10-K. There have been no significant changes to these policies.
Pending Merger
As previously announced, on March 5, 2012, Bancshares, Cadence Bancorp, LLC (Cadence) and EMS Sub I, Inc. (EMS Sub) entered into an Agreement and Plan of Merger (the Merger Agreement), pursuant to which EMS Sub, a wholly-owned subsidiary of Cadence, will be merged with and into Bancshares, with Bancshares continuing thereafter as a wholly-owned subsidiary of Cadence, and each share of Bancshares common stock will be converted into the right to receive $20.62 in cash, without interest (the Merger). Completion of the Merger is subject to certain customary conditions, including (1) approval of the Merger Agreement by Bancshares’ shareholders, (2) receipt of required regulatory approvals and (3) the absence of any law or order prohibiting the completion of the Merger. Each party’s obligation to complete the Merger also is subject to certain additional customary conditions, including (1) subject to certain exceptions, the accuracy of the representations and warranties of the other party and (2) the performance in all material respects by the other party of its obligations under the Merger Agreement.
Bancshares and the members of its board of directors have been named as defendants in a putative class and derivative action filed on behalf of Bancshares shareholders on April 16, 2012 in the Supreme Court of the State of New York for the County of New York. The lawsuit challenged the fairness of the Merger and alleged that the director defendants breached their fiduciary duties to Bancshares. The lawsuit generally sought an injunction barring defendants from consummating the Merger, a declaratory judgment that the defendants breached their fiduciary duties to Bancshares and an award of compensatory damages, interest, attorney’s fees and costs. On May 1, 2012, following settlement discussions, the defendants entered into a memorandum of understanding with the plaintiffs regarding the settlement of the lawsuit. In connection with the settlement contemplated by the memorandum of understanding, in consideration for the full settlement and release of all claims, Bancshares agreed to make certain additional disclosures related to the proposed Merger. The memorandum of understanding contemplates that the parties will negotiate in good faith and use their reasonable best efforts to enter into a stipulation of settlement. The stipulation of settlement will be subject to customary conditions, including court approval following notice to shareholders of Bancshares. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the court will approve the settlement even if the parties were to enter into such stipulation.
Other Intangible Assets
In the first quarter of 2012, Town & Country purchased certain assets, including the customer base of Whittington Insurance Agency, Inc. The purchase price consideration is estimated to be $1.0 million and consists of a $0.5 million cash payment that was made at closing and an estimated contingent earn-out totaling $0.5 million. The earn-out was calculated as a percentage of the estimated renewal commissions over a three-year period and was recorded at fair value on the date of acquisition. The full purchase price of $1.0 million was allocated to customer intangibles and will be amortized over fifteen years.
9
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Reclassifications
In 2012, the Company reclassified income earned on certain assets from interest income to other noninterest income for all periods presented. These reclassifications had no impact on financial condition, results of operations or equity in any of the reported periods.
NOTE B – SECURITIES AVAILABLE-FOR-SALE AND SECURITIES HELD-TO-MATURITY
Securities available-for-sale and held-to-maturity were as follows (dollars in thousands):
| | | | | | | | | | | | | | | | |
| | Amortized Cost | | | Gross Unrealized Gains | | | Gross Unrealized Losses | | | Fair Value | |
March 31, 2012 | | | | | | | | | | | | | | | | |
Available-for-sale: | | | | | | | | | | | | | | | | |
U.S. Government securities | | $ | 92,317 | | | $ | 207 | | | $ | — | | | $ | 92,524 | |
Securities of U.S. states and political subdivisions | | | 2,093 | | | | 97 | | | | — | | | | 2,190 | |
Mortgage-backed securities | | | 66,717 | | | | 720 | | | | (291 | ) | | | 67,146 | |
Corporate debt securities | | | 13,968 | | | | — | | | | (2,029 | ) | | | 11,939 | |
Other securities | | | 4,238 | | | | 134 | | | | — | | | | 4,372 | |
| | | | | | | | | | | | | | | | |
Total | | | 179,333 | | | | 1,158 | | | | (2,320 | ) | | | 178,171 | |
Marketable equity securities | | | 2,596 | | | | 340 | | | | — | | | | 2,936 | |
| | | | | | | | | | | | | | | | |
Total available-for-sale securities | | $ | 181,929 | | | $ | 1,498 | | | $ | (2,320 | ) | | $ | 181,107 | |
| | | | | | | | | | | | | | | | |
Held-to-maturity: | | | | | | | | | | | | | | | | |
U.S. Government securities | | $ | 5,000 | | | $ | 40 | | | | — | | | $ | 5,040 | |
Securities of U.S. states and political subdivisions | | | 21,945 | | | | 2,053 | | | | — | | | | 23,998 | |
Mortgage-backed securities | | | 48,611 | | | | 1,385 | | | | (5 | ) | | | 49,991 | |
Corporate debt securities | | | 12,358 | | | | 1,662 | | | | — | | | | 14,020 | |
Other securities | | | 9,486 | | | | 177 | | | | — | | | | 9,663 | |
| | | | | | | | | | | | | | | | |
Total held-to-maturity securities | | $ | 97,400 | | | $ | 5,317 | | | $ | (5 | ) | | $ | 102,712 | |
| | | | | | | | | | | | | | | | |
December 31, 2011 | | | | | | | | | | | | | | | | |
Available-for-sale: | | | | | | | | | | | | | | | | |
U.S. Government securities | | $ | 107,665 | | | $ | 355 | | | $ | — | | | $ | 108,020 | |
Securities of U.S. states and political subdivisions | | | 2,096 | | | | 87 | | | | — | | | | 2,183 | |
Mortgage-backed securities | | | 41,664 | | | | 533 | | | | (18 | ) | | | 42,179 | |
Corporate debt securities | | | 13,967 | | | | — | | | | (3,029 | ) | | | 10,938 | |
Other securities | | | 4,481 | | | | 140 | | | | — | | | | 4,621 | |
| | | | | | | | | | | | | | | | |
Total | | | 169,873 | | | | 1,115 | | | | (3,047 | ) | | | 167,941 | |
Marketable equity securities | | | 2,592 | | | | 268 | | | | — | | | | 2,860 | |
| | | | | | | | | | | | | | | | |
Total available-for-sale securities | | $ | 172,465 | | | $ | 1,383 | | | $ | (3,047 | ) | | $ | 170,801 | |
| | | | | | | | | | | | | | | | |
Held-to-maturity: | | | | | | | | | | | | | | | | |
U.S. Government securities | | $ | 5,000 | | | $ | 44 | | | $ | — | | | $ | 5,044 | |
Securities of U.S. states and political subdivisions | | | 21,955 | | | | 2,258 | | | | (6 | ) | | | 24,207 | |
Mortgage-backed securities | | | 50,642 | | | | 1,388 | | | | (5 | ) | | | 52,025 | |
Corporate debt securities | | | 12,330 | | | | 950 | | | | — | | | | 13,280 | |
Other securities | | | 9,703 | | | | 198 | | | | — | | | | 9,901 | |
| | | | | | | | | | | | | | | | |
Total held-to-maturity securities | | $ | 99,630 | | | $ | 4,838 | | | $ | (11 | ) | | $ | 104,457 | |
| | | | | | | | | | | | | | | | |
10
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company owned certain debt securities with unrealized losses as of March 31, 2012 and December 31, 2011. These securities, with unrealized losses segregated by length of impairment at period end, were as follows (dollars in thousands):
| | | | | | | | |
Description of Securities | | Fair Value | | | Unrealized Losses | |
March 31, 2012 | | | | | | | | |
Less than 12 months | | | | | | | | |
Available-for-sale: | | | | | | | | |
Mortgage-backed securities | | $ | 22,049 | | | $ | (278 | ) |
Corporate debt securities | | | 4,225 | | | | (752 | ) |
| | | | | | | | |
Total available-for-sale securities | | $ | 26,274 | | | $ | (1,030 | ) |
| | | | | | | | |
More than 12 months | | | | | | | | |
Available-for-sale: | | | | | | | | |
Mortgage-backed securities | | $ | 2,060 | | | $ | (13 | ) |
Corporate debt securities | | | 7,714 | | | | (1,277 | ) |
| | | | | | | | |
Total available-for-sale securities | | $ | 9,774 | | | $ | (1,290 | ) |
| | | | | | | | |
Held-to-maturity: | | | | | | | | |
Mortgage-backed securities | | $ | 785 | | | $ | (5 | ) |
| | | | | | | | |
December 31, 2011 | | | | | | | | |
Less than 12 months | | | | | | | | |
Available-for-sale: | | | | | | | | |
Corporate debt securities | | $ | 5,555 | | | $ | (1,412 | ) |
| | | | | | | | |
Held-to-maturity: | | | | | | | | |
Securities of U.S. states and political subdivisions | | $ | 1,009 | | | $ | (6 | ) |
| | | | | | | | |
More than 12 months | | | | | | | | |
Available-for-sale: | | | | | | | | |
Mortgage-backed securities | | $ | 2,170 | | | $ | (18 | ) |
Corporate debt securities | | | 5,383 | | | | (1,617 | ) |
| | | | | | | | |
Total available-for-sale securities | | $ | 7,553 | | | $ | (1,635 | ) |
| | | | | | | | |
Held-to-maturity: | | | | | | | | |
Mortgage-backed securities | | $ | 791 | | | $ | (5 | ) |
| | | | | | | | |
At March 31, 2012, the Company had three corporate debt securities that had been in an unrealized loss position for greater than 12 months. As of March 31, 2012, the Company’s corporate debt securities were all rated BBB or better. Unrealized losses on debt securities were primarily due to changes in market interest rates and not due to credit quality. The Company expects to recover the entire amortized cost of these securities since it does not intend to sell the securities. Additionally, it is not more likely than not that the Company will be required to sell these securities before recovery of its cost basis. Accordingly, as of March 31, 2012 and December 31, 2011, the Company believes the impairments detailed in the table are temporary and no impairment loss has been recorded in the accompanying consolidated statements of operations.
11
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table (dollars in thousands) shows the amortized cost and estimated fair value of securities by contractual maturity at March 31, 2012. Contractual maturities may differ from expected maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment schedules. Mortgage-backed securities and equity securities are shown separately since they are not due at a single maturity date.
| | | | | | | | | | | | | | | | |
| | Available-for-Sale Securities | | | Held-to-Maturity Securities | |
| | Amortized Cost | | | Fair Value | | | Amortized Cost | | | Fair Value | |
Within one year | | $ | 75,180 | | | $ | 75,305 | | | $ | 326 | | | $ | 334 | |
Over one year through five years | | | 15,000 | | | | 15,018 | | | | 12,031 | | | | 13,685 | |
After five years through ten years | | | 13,968 | | | | 11,939 | | | | 10,047 | | | | 10,183 | |
Over ten years | | | 8,222 | | | | 8,509 | | | | 26,385 | | | | 28,519 | |
| | | | | | | | | | | | | | | | |
Total | | | 112,370 | | | | 110,771 | | | | 48,789 | | | | 52,721 | |
Mortgage-backed, marketable equity and other securities | | | 69,559 | | | | 70,336 | | | | 48,611 | | | | 49,991 | |
| | | | | | | | | | | | | | | | |
Total securities | | $ | 181,929 | | | $ | 181,107 | | | $ | 97,400 | | | $ | 102,712 | |
| | | | | | | | | | | | | | | | |
At March 31, 2012 and December 31, 2011, securities with a carrying value of $89.8 million and $74.5 million were pledged as collateral for repurchase agreements, public funds, trust deposits, and for other purposes, as required or permitted by law.
Gross realized gains were $26 thousand and gross realized losses were $57 thousand on sales of available-for-sale securities for the three months ended March 31, 2011. There were no realized gains or losses during the three month period ended March 31, 2012.
NOTE C – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans consisted of the following (dollars in thousands):
| | | | | | | | |
| | March 31, 2012 | | | December 31, 2011 | |
Commercial: | | | | | | | | |
Commercial | | $ | 234,760 | | | $ | 214,575 | |
Commercial real estate | | | 224,479 | | | | 210,437 | |
Real estate construction | | | 56,322 | | | | 59,589 | |
| | | | | | | | |
Total commercial | | | 515,561 | | | | 484,601 | |
| | |
Consumer: | | | | | | | | |
Residential real estate first lien | | | 203,122 | | | | 202,968 | |
Residential real estate second lien | | | 241,849 | | | | 252,825 | |
Home equity lines | | | 55,044 | | | | 55,191 | |
Consumer other | | | 30,592 | | | | 27,901 | |
| | | | | | | | |
Total consumer | | | 530,607 | | | | 538,885 | |
| | | | | | | | |
Loans receivable | | | 1,046,168 | | | | 1,023,486 | |
Loans held-for-sale | | | 1,350 | | | | 1,778 | |
| | | | | | | | |
Total loans | | $ | 1,047,518 | | | $ | 1,025,264 | |
| | | | | | | | |
Included in loans receivable was $1.8 million and $1.9 million of net deferred loan origination costs and unamortized premium and discount at March 31, 2012 and December 31, 2011, respectively. Accrued interest receivable on loans was $3.5 million and $3.7 million at March 31, 2012 and December 31, 2011. Consumer other loans include client overdrafts of $0.1 million and $0.3 million as of March 31, 2012 and December 31, 2011.
12
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The loan portfolio consists of various types of loans with approximately 87.4% outstanding to borrowers located in Texas.
As of March 31, 2012, there were no concentrations of loans to any one type of industry exceeding 10% of total loans.
The allowance for loan losses is a valuation allowance for losses incurred on loans. The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses and is reduced by net charge-offs. All losses are charged to the allowance when the loss actually occurs or when a determination is made that a loss is probable. Consumer loans are generally charged off when the loan principal and interest is deemed not collectible and no later than 120 days past due unless the loan is well secured and in the process of collection. Recoveries are credited to the allowance at the time of recovery. The Company’s allowance for loan losses consists of two components including a specific reserve on individual loans that are considered impaired and a general component based upon probable but unidentified losses inherent in the loan portfolio.
The Company considers a loan impaired when, based on current information and events, it is probable that it will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The Company generally considers a period of delay in payment to include delinquency up to 90 days. The identification of commercial loans that may be impaired is based on a loan review process whereby the Company maintains an internally classified loan list. Loans on this listing are classified as substandard, doubtful or loss based on probability of repayment, collateral valuation and related collectability. The Company individually assesses and evaluates for impairment certain commercial loans over $100,000 and commercial loans collateralized by real estate over $250,000 as well as certain consumer loans collateralized by real estate. Additionally, loans restructured in a troubled debt restructuring are considered impaired. If an individually evaluated loan is considered impaired, a specific valuation allowance is allocated through an increase to the allowance for loan losses, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of the collateral. Impaired loans or portions thereof, are charged-off when deemed uncollectible.
The general component of the reserve is based on, among other things, the historical loan loss experience for each loan type, the growth, composition and diversification of the loan portfolio, delinquency and loan classification trends, estimated value of the underlying collateral, and the results of recent regulatory examinations. Also, new credit products and policies, economic conditions, concentrations of credit risk, and the experience and abilities of lending personnel are also taken into consideration. In analyzing the adequacy of the allowance for loan losses, the Company utilizes a loan grading system for commercial loans, which include commercial, commercial real estate and real estate construction loans, to determine the risk potential in the portfolio and also consider the results of independent internal credit reviews. Consumer loans, which include residential real estate first and second lien, home equity lines and consumer other loans, are evaluated periodically based on their repayment status.
As a final step to the evaluation process, the Company performs an additional review of the adequacy of the allowance based on the loan portfolio in its entirety. This enables the Company to mitigate, but not eliminate, the imprecision inherent in loan- and segment-level estimates of expected loan losses. This review of the allowance includes judgmental consideration of any adjustments necessary for subjective factors such as economic uncertainties and concentration risks.
There are numerous factors that enter into the evaluation of the allowance for loan losses. Some are quantitative while others require qualitative judgments. Although the Company believes that the processes for determining an appropriate level for the allowance adequately address the various factors that could potentially result in loan losses, the processes and their elements include features that may be susceptible to significant change. Any unfavorable differences between the actual outcome of credit-related events and the Company’s estimates and projections could require an additional provision for loan losses, which would negatively impact results of operations in future periods. Management believes that, given the procedures followed in estimating incurred losses in the loan portfolio, the various components used in the current estimation processes are appropriate.
13
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The allowance for loan losses and recorded investment in loans by loan type is as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial | | | Commercial Real Estate | | | Real Estate Construction | | | Residential Real Estate First Lien | | | Residential Real Estate Second Lien | | | Home Equity Lines | | | Consumer Other | | | Total | |
Allowance for Loan Losses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance January 1, 2011 | | $ | 4,150 | | | $ | 2,808 | | | $ | 1,486 | | | $ | 3,355 | | | $ | 4,713 | | | $ | 1,835 | | | $ | 292 | | | $ | 18,639 | |
Charge-offs | | | (196 | ) | | | (465 | ) | | | (4 | ) | | | (222 | ) | | | (1,059 | ) | | | (296 | ) | | | (36 | ) | | | (2,278 | ) |
Recoveries | | | 3 | | | | 12 | | | | 131 | | | | 223 | | | | 71 | | | | 19 | | | | 18 | | | | 477 | |
Provision | | | 404 | | | | 519 | | | | 140 | | | | 79 | | | | 676 | | | | 370 | | | | (18 | ) | | | 2,170 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance March 31, 2011 | | $ | 4,361 | | | $ | 2,874 | | | $ | 1,753 | | | $ | 3,435 | | | $ | 4,401 | | | $ | 1,928 | | | $ | 256 | | | $ | 19,008 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance January 1, 2012 | | $ | 2,888 | | | $ | 3,553 | | | $ | 1,919 | | | $ | 3,335 | | | $ | 4,284 | | | $ | 1,772 | | | $ | 217 | | | $ | 17,968 | |
Charge-offs | | | — | | | | (194 | ) | | | — | | | | (366 | ) | | | (403 | ) | | | (249 | ) | | | (24 | ) | | | (1,236 | ) |
Recoveries | | | 420 | | | | — | | | | 3 | | | | 23 | | | | 31 | | | | 21 | | | | 14 | | | | 512 | |
Provision | | | (498 | ) | | | 339 | | | | (36 | ) | | | 481 | | | | 191 | | | | 269 | | | | (13 | ) | | | 733 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance March 31, 2012 | | $ | 2,810 | | | $ | 3,698 | | | $ | 1,886 | | | $ | 3,473 | | | $ | 4,103 | | | $ | 1,813 | | | $ | 194 | | | $ | 17,977 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance individually evaluated for impairment: March 31, 2011 | | $ | 110 | | | $ | — | | | $ | 43 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 153 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
March 31, 2012 | | $ | 6 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 6 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans (1): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
March 31, 2011 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Individually evaluated for impairment | | $ | 2,097 | | | $ | 10,282 | | | $ | 3,294 | | | $ | 6,477 | | | $ | — | | | $ | — | | | $ | — | | | $ | 22,150 | |
Collectively evaluated for impairment | | | 161,956 | | | | 158,611 | | | | 48,812 | | | | 198,535 | | | | 263,286 | | | | 59,832 | | | | 22,854 | | | | 913,886 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total loans evaluated for impairment | | $ | 164,053 | | | $ | 168,893 | | | $ | 52,106 | | | $ | 205,012 | | | $ | 263,286 | | | $ | 59,832 | | | $ | 22,854 | | | $ | 936,036 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
March 31, 2012 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Individually evaluated for impairment | | $ | 3,781 | | | $ | 1,258 | | | $ | — | | | $ | 1,923 | | | $ | — | | | $ | — | | | $ | — | | | $ | 6,962 | |
Collectively evaluated for impairment | | | 230,979 | | | | 223,221 | | | | 56,322 | | | | 201,199 | | | | 241,849 | | | | 55,044 | | | | 30,592 | | | | 1,039,206 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total loans evaluated for impairment | | $ | 234,760 | | | $ | 224,479 | | | $ | 56,322 | | | $ | 203,122 | | | $ | 241,849 | | | $ | 55,044 | | | $ | 30,592 | | | $ | 1,046,168 | |
| | | �� | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(1) | Excludes loans held-for-sale. |
14
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. When the interest accrual is discontinued, all unpaid interest is charged off against interest income. Subsequently, the Company recognizes income only to the extent cash payments are received until, in its judgment, the borrower’s ability to make periodic interest and principal payments are reasonably assured, in which case the loan is returned to accrual status.
The following is a summary of information pertaining to impaired, nonaccrual and restructured loans (dollars in thousands):
| | | | | | | | |
| | March 31, 2012 | | | December 31, 2011 | |
Impaired loans on nonaccrual without a valuation allowance | | $ | 3,600 | | | $ | 3,980 | |
Impaired loans on nonaccrual with a valuation allowance | | | — | | | | 3,804 | |
Impaired loans still accruing with a valuation allowance | | | 3,362 | | | | 3,405 | |
| | | | | | | | |
Total impaired loans (1) | | $ | 6,962 | | | $ | 11,189 | |
| | | | | | | | |
Valuation allowance related to impaired loans | | $ | 6 | | | $ | 209 | |
| | | | | | | | |
Total nonaccrual loans | | $ | 6,636 | | | $ | 10,789 | |
| | | | | | | | |
Total accruing loans past due 90 days or more | | $ | — | | | $ | — | |
| | | | | | | | |
Restructured loans still accruing | | $ | 2,628 | | | $ | 4,122 | |
| | | | | | | | |
(1) | Does not include nonaccrual loans which are not evaluated separately for impairment and loans held-for-sale. |
The average investment in impaired loans was $9.1 million and $22.1 million for the three months ended March 31, 2012 and 2011. The age analysis of past due loans is as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Loans Past Due and Still Accruing | | | | | | | | | | |
March 31, 2012 | | 30-59 Days | | | 60-89 Days | | | 90 Days or More | | | Total | | | Nonaccrual Loans (1) | | | Current Loans | | | Total Loans (1) | |
Commercial | | $ | 1,998 | | | $ | 3 | | | $ | — | | | $ | 2,001 | | | $ | 419 | | | $ | 232,340 | | | $ | 234,760 | |
Commercial real estate | | | 90 | | | | — | | | | — | | | | 90 | | | | 1,258 | | | | 223,131 | | | | 224,479 | |
Real estate construction | | | 301 | | | | — | | | | — | | | | 301 | | | | — | | | | 56,021 | | | | 56,322 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total commercial | | | 2,389 | | | | 3 | | | | — | | | | 2,392 | | | | 1,677 | | | | 511,492 | | | | 515,561 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Residential real estate first lien | | | 890 | | | | 56 | | | | — | | | | 946 | | | | 4,813 | | | | 197,363 | | | | 203,122 | |
Residential real estate second lien | | | 308 | | | | 100 | | | | — | | | | 408 | | | | 146 | | | | 241,295 | | | | 241,849 | |
Home equity lines | | | — | | | | — | | | | — | | | | — | | | | — | | | | 55,044 | | | | 55,044 | |
Consumer other | | | 176 | | | | 18 | | | | — | | | | 194 | | | | — | | | | 30,398 | | | | 30,592 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total consumer | | | 1,374 | | | | 174 | | | | — | | | | 1,548 | | | | 4,959 | | | | 524,100 | | | | 530,607 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 3,763 | | | $ | 177 | | | $ | — | | | $ | 3,940 | | | $ | 6,636 | | | $ | 1,035,592 | | | $ | 1,046,168 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
15
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Loans Past Due and Still Accruing | | | | | | | | | | |
December 31, 2011 | | 30-59 Days | | | 60-89 Days | | | 90 Days or More | | | Total | | | Nonaccrual Loans (1) | | | Current Loans | | | Total Loans (1) | |
Commercial | | $ | 35 | | | $ | 11 | | | $ | — | | | $ | 46 | | | $ | 774 | | | $ | 213,755 | | | $ | 214,575 | |
Commercial real estate | | | — | | | | — | | | | — | | | | — | | | | 2,223 | | | | 208,214 | | | | 210,437 | |
Real estate construction | | | — | | | | — | | | | — | | | | — | | | | 2,839 | | | | 56,750 | | | | 59,589 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total commercial | | | 35 | | | | 11 | | | | — | | | | 46 | | | | 5,836 | | | | 478,719 | | | | 484,601 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Residential real estate first lien | | | — | | | | 736 | | | | — | | | | 736 | | | | 4,778 | | | | 197,454 | | | | 202,968 | |
Residential real estate second lien | | | 818 | | | | 105 | | | | — | | | | 923 | | | | 175 | | | | 251,727 | | | | 252,825 | |
Home equity lines | | | 301 | | | | — | | | | — | | | | 301 | | | | — | | | | 54,890 | | | | 55,191 | |
Consumer other | | | 103 | | | | 60 | | | | — | | | | 163 | | | | — | | | | 27,738 | | | | 27,901 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total consumer | | | 1,222 | | | | 901 | | | | — | | | | 2,123 | | | | 4,953 | | | | 531,809 | | | | 538,885 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 1,257 | | | $ | 912 | | | $ | — | | | $ | 2,169 | | | $ | 10,789 | | | $ | 1,010,528 | | | $ | 1,023,486 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(1) | Excludes loans held-for-sale. |
The following table presents additional information regarding individually evaluated impaired loans (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2012 | | | December 31, 2011 | |
| | | | | Unpaid | | | | | | | | | Unpaid | | | | |
| | Recorded | | | Principal | | | Related | | | Recorded | | | Principal | | | Related | |
| | Investment | | | Balance | | | Allowance | | | Investment | | | Balance | | | Allowance | |
With no related allowance recorded: | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 419 | | | $ | 494 | | | $ | — | | | $ | 773 | | | $ | 838 | | | $ | — | |
Commercial real estate | | | 1,258 | | | | 1,523 | | | | — | | | | 1,258 | | | | 1,523 | | | | — | |
Residential real estate first lien | | | 1,923 | | | | 1,928 | | | | — | | | | 1,949 | | | | 3,935 | | | | — | |
| | | | | | |
With an allowance recorded: | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 3,362 | | | $ | 3,362 | | | $ | 6 | | | $ | 3,405 | | | $ | 3,405 | | | $ | 5 | |
Commercial real estate | | | — | | | | — | | | | — | | | | 965 | | | | 1,244 | | | | 161 | |
Real estate construction | | | — | | | | — | | | | — | | | | 2,839 | | | | 4,861 | | | | 43 | |
| | | | | | |
Total: | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | 5,039 | | | $ | 5,379 | | | $ | 6 | | | $ | 9,240 | | | $ | 11,871 | | | $ | 209 | |
Consumer | | | 1,923 | | | | 1,928 | | | | — | | | | 1,949 | | | | 3,935 | | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | $ | 6,962 | | | $ | 7,307 | | | $ | 6 | | | $ | 11,189 | | | $ | 15,806 | | | $ | 209 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
16
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Internally assigned risk grades for commercial loans are as follows:
Pass
While there is no formal regulatory definition for Pass credits, credits not otherwise rated Watch, Special Mention, Substandard, Doubtful or Loss are considered to be Pass credits. The Company utilizes a granular approach in assigning Pass risk grades to account for, among other things, the financial strength and capacity of the borrower and/or guarantors, and the nature, quality, liquidity and quantity of the collateral held.
Watch
Watch is not a recognized regulatory category, but it is extensively used by banks in their credit risk rating activities. An example of a Watch credit would be an asset in which all of the financial trends and indicators of the borrower, and the historical and projected financial performance, is acceptable, but the borrower may be in an industry or a geographical locale that is under some degree of stress. A Watch credit is reviewed more closely than a Pass credit, but is otherwise treated similarly to a Pass credit.
Special Mention
A Special Mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard
A Substandard asset is inadequately protected by the current sound worth and capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. Substandard loans are placed on nonaccrual when management doubts a borrower’s ability to meet payment obligations, which typically occurs when principal or interest payments are more than 90 days past due.
Doubtful
An asset classified Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.
Loss
Assets classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future.
17
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The credit risk profile of our commercial loans aggregated by internally assigned grade was as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2012 | | | December 31, 2011 | |
| | Commercial | | | Commercial Real Estate | | | Real Estate Construction | | | Commercial | | | Commercial Real Estate | | | Real Estate Construction | |
Grade: | | | | | | | | | | | | | | | | | | | | | | | | |
Pass | | $ | 218,728 | | | $ | 204,989 | | | $ | 51,893 | | | $ | 202,161 | | | $ | 188,448 | | | $ | 52,151 | |
Watch | | | 5,908 | | | | 6,670 | | | | 35 | | | | 4,656 | | | | 10,514 | | | | 732 | |
Special mention | | | 4,425 | | | | 8,797 | | | | 2,402 | | | | 821 | | | | 4,851 | | | | 1,282 | |
Substandard accruing | | | 5,280 | | | | 2,765 | | | | 1,992 | | | | 6,163 | | | | 4,401 | | | | 2,585 | |
Substandard nonaccrual | | | 419 | | | | 1,258 | | | | — | | | | 774 | | | | 2,223 | | | | 2,839 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 234,760 | | | $ | 224,479 | | | $ | 56,322 | | | $ | 214,575 | | | $ | 210,437 | | | $ | 59,589 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
The credit risk profile of our consumer loans based on payment activity is as follows (dollars in thousands):
| | | | | | | | | | | | | | | | |
| | Residential Real Estate First Lien | | | Residential Real Estate Second Lien | | | Home Equity Lines | | | Consumer Other | |
March 31, 2012 | | | | | | | | | | | | | | | | |
Performing | | $ | 198,309 | | | $ | 241,703 | | | $ | 55,044 | | | $ | 30,592 | |
Nonaccrual | | | 4,813 | | | | 146 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | |
Total | | $ | 203,122 | | | $ | 241,849 | | | $ | 55,044 | | | $ | 30,592 | |
| | | | | | | | | | | | | | | | |
December 31, 2011 | | | | | | | | | | | | | | | | |
Performing | | $ | 198,190 | | | $ | 252,650 | | | $ | 55,191 | | | $ | 27,901 | |
Nonaccrual | | | 4,778 | | | | 175 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | |
Total | | $ | 202,968 | | | $ | 252,825 | | | $ | 55,191 | | | $ | 27,901 | |
| | | | | | | | | | | | | | | | |
Troubled Debt Restructurings
For the three months ended March 31, 2012, troubled debt restructurings consisted of one residential real estate first lien loan of $0.1 million. This restructuring was the result of lowering the interest rate on the loan. The Company did not forgive any principal or interest on this loan. The loan was accruing at the time of the modification and at March 31, 2012. This modification did not have any significant impact on the Company’s determination of the allowance for loan losses. As of March 31, 2012, there have been no defaults on any loans that were modified as troubled debt restructurings during the preceding twelve months.
18
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE D – REGULATORY MATTERS
The Company 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, 2012 are set forth in the following table (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Actual | | | For Capital Adequacy Purposes | | | To Be Categorized as Well Capitalized Under Prompt Corrective Action Provisions | |
| | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
March 31, 2012 | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 capital (to average assets) | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 (leverage) | | | | | | | | | | | | | | | | | | | | | | | | |
Encore Bancshares, Inc. | | $ | 146,547 | | | | 9.99 | % | | $ | 58,698 | | | | 4.00 | % | | | N/A | | | | N/A | |
Encore Bank, N.A. | | | 138,571 | | | | 9.44 | | | | 58,725 | | | | 4.00 | | | $ | 73,406 | | | | 5.00 | % |
Tier 1 capital (to risk-based assets) | | | | | | | | | | | | | | | | | | | | | | | | |
Encore Bancshares, Inc. | | $ | 146,547 | | | | 13.72 | % | | $ | 42,723 | | | | 4.00 | % | | | N/A | | | | N/A | |
Encore Bank, N.A | | | 138,571 | | | | 13.01 | | | | 42,593 | | | | 4.00 | | | $ | 63,889 | | | | 6.00 | % |
Total capital (to risk-based assets) | | | | | | | | | | | | | | | | | | | | | | | | |
Encore Bancshares, Inc. | | $ | 159,963 | | | | 14.98 | % | | $ | 85,446 | | | | 8.00 | % | | | N/A | | | | N/A | |
Encore Bank, N.A. | | | 151,956 | | | | 14.27 | | | | 85,186 | | | | 8.00 | | | $ | 106,482 | | | | 10.00 | % |
NOTE E – COMMITMENTS AND CONTINGENCIES
The Company is a defendant in legal actions arising from transactions conducted in the ordinary course of business. The Company believes, after consultation with legal counsel, that the ultimate liability, if any, arising from such actions will not have a material effect on its consolidated financial statements.
In the normal course of business, the Company enters into various credit related financial instruments with off-balance sheet risk to meet the financing needs of clients. These financial instruments principally include commitments to extend credit and letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the accompanying consolidated balance sheets.
Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit written is represented by the contractual notional amount of those instruments. The Company follows the same credit policies in making commitments and conditional obligations as for on-balance sheet instruments. The credit risk involved and collateral required in issuing letters of credit are essentially the same as those involved in extending loan facilities to clients.
Commitments to extend credit were $196 million at March 31, 2012 and $175 million at December 31, 2011. Standby letters of credit were $4.3 million at March 31, 2012 and $4.4 million at December 31, 2011.
19
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE F – INCOME PER COMMON SHARE
The factors used in the income per common share computation follow (dollars in thousands, except per share data):
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2012 | | | 2011 | |
Basic: | | | | | | | | |
Income available to common shareholders | | $ | 3,112 | | | $ | 594 | |
Average common shares outstanding, including nonvested restricted stock | | | 11,751 | | | | 11,491 | |
Per Share | | $ | 0.26 | | | $ | 0.05 | |
Diluted: | | | | | | | | |
Average common shares outstanding | | | 11,751 | | | | 11,491 | |
Add: Net effect of the assumed exercise of stock options and warrants | | | 166 | | | | 84 | |
| | | | | | | | |
Diluted average common shares outstanding | | | 11,917 | | | | 11,575 | |
Per Share | | $ | 0.26 | | | $ | 0.05 | |
Anti-dilutive stock options and warrants not included in treasury stock method computation | | | 10 | | | | 715 | |
Preferred dividends deducted from net income | | | 82 | | | | 558 | |
No dividends have been declared on our common stock.
NOTE G – FAIR VALUE OF ASSETS AND LIABILITIES
The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis such as certain loans, goodwill and other intangible assets and other real estate owned. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write downs of individual assets.
The Company groups 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—Inputs that utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 1 assets and liabilities include debt and equity securities that are traded in an active exchange market, as well as certain U.S. Treasury securities that are highly liquid and are actively traded in over-the-counter markets.
Level 2—Inputs other than those quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3—Inputs that are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
20
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The tables below present the balances of assets measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011 (dollars in thousands):
| | | | | | | | | | | | |
| | March 31, 2012 | |
Description | | Total | | | Level 1 | | | Level 2 | |
U.S. Government securities | | $ | 92,524 | | | $ | 85,327 | | | $ | 7,197 | |
Securities of U.S. states and political subdivisions | | | 2,190 | | | | — | | | | 2,190 | |
Mortgage-backed securities | | | 67,146 | | | | — | | | | 67,146 | |
Corporate debt securities | | | 11,939 | | | | — | | | | 11,939 | |
Other securities | | | 7,308 | | | | 3,190 | | | | 4,118 | |
| | | | | | | | | | | | |
Total available-for-sale securities | | $ | 181,107 | | | $ | 88,517 | | | $ | 92,590 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | December 31, 2011 | |
Description | | Total | | | Level 1 | | | Level 2 | |
U.S. Government securities | | $ | 108,020 | | | $ | 100,558 | | | $ | 7,462 | |
Securities of U.S. states and political subdivisions | | | 2,183 | | | | — | | | | 2,183 | |
Mortgage-backed securities | | | 42,179 | | | | — | | | | 42,179 | |
Corporate debt securities | | | 10,938 | | | | — | | | | 10,938 | |
Other securities | | | 7,481 | | | | 3,109 | | | | 4,372 | |
| | | | | | | | | | | | |
Total available-for-sale securities | | $ | 170,801 | | | $ | 103,667 | | | $ | 67,134 | |
| | | | | | | | | | | | |
Certain assets are measured at fair value on a nonrecurring basis; that is, they are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Fair value is used on a nonrecurring basis to measure certain assets when applying lower of cost or market accounting or when adjusting carrying values. Assets measured on a nonrecurring basis include held-to-maturity debt securities, impaired loans, other real estate owned and loans held-for-sale.
Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral or at the present value of the estimated cash flows. Collateral values are estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria. The Company did not have any impaired loans that were remeasured during the three-month period ended March 31, 2012. During the three-month period ended March 31, 2011, the Company wrote down $6.1 million of impaired loans resulting in an impairment charge of $0.7 million through the allowance for loan losses. These loans were remeasured using Level 3 assumptions.
The fair value of other real estate owned, upon initial recognition, is remeasured and reported at fair value through a charge-off to the allowance for loan losses and subsequent to their initial recognition, are remeasured at fair value through a write-down included in noninterest expense. The fair value of a foreclosed asset is estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria. During the reported periods, all fair value measurements for foreclosed assets utilized Level 3 inputs. There was no other real estate owned remeasured during the three-month period ended March 31, 2012. During the three-month period ended March 31, 2011, the Company wrote down certain foreclosed real estate properties resulting in an impairment charge of $13 thousand which was included in noninterest expense.
Fair value measurements where there exists limited or no observable market data and, therefore, are based primarily upon the Company’s estimates, are often calculated based on current pricing policy, the economic and competitive environment, the characteristics of the asset or liability and other such factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, that could significantly affect the results of current or future values.
21
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table summarizes the carrying values and estimated fair values of certain financial instruments not recorded at fair value on a regular basis as of March 31, 2012 and December 31, 2011 (dollars in thousands):
| | | | | | | | | | | | | | | | |
| | March 31, 2012 | | | December 31, 2011 | |
| | Carrying Amount | | | Estimated Fair Value | | | Carrying Amount | | | Estimated Fair Value | |
Financial assets: | | | | | | | | | | | | | | | | |
Level 2 inputs: | | | | | | | | | | | | | | | | |
Securities held-to-maturity | | $ | 97,400 | | | $ | 102,712 | | | $ | 99,630 | | | $ | 104,457 | |
Accrued interest receivable | | | 4,826 | | | | 4,826 | | | | 5,133 | | | | 5,133 | |
Level 3 inputs: | | | | | | | | | | | | | | | | |
Loans receivable, net | | | 1,028,191 | | | | 1,065,428 | | | | 1,005,518 | | | | 1,043,714 | |
| | | | |
Financial liabilities: | | | | | | | | | | | | | | | | |
Level 2 inputs: | | | | | | | | | | | | | | | | |
Time deposits | | $ | 339,147 | | | $ | 339,976 | | | $ | 343,460 | | | $ | 344,461 | |
Borrowings and repurchase agreements | | | 220,971 | | | | 239,644 | | | | 218,702 | | | | 237,856 | |
Accrued interest payable | | | 1,014 | | | | 1,014 | | | | 1,131 | | | | 1,131 | |
Junior subordinated debentures | | | 20,619 | | | | 20,635 | | | | 20,619 | | | | 20,807 | |
The summary above excludes financial assets and liabilities for which the carrying amount approximates estimated fair value. For financial assets, these include cash and cash equivalents, loans held-for-sale and Federal Home Loan Bank of Dallas stock. For financial liabilities, these include noninterest-bearing, interest checking and money market and savings deposits. Entities may choose to measure eligible financial instruments at fair value at specified election dates. The fair value measurement option (i) may be applied instrument by instrument, with certain exceptions, (ii) is generally irrevocable and (iii) is applied only to entire instruments and not to portions of instruments. Unrealized gains and losses on items for which the fair value measurement option has been elected must be reported in earnings at each subsequent reporting date. During the reported periods, the Company had no financial instruments measured at fair value under the fair value measurement option.
The following is a description of valuation methodologies used for assets and liabilities recorded at fair value, non-financial assets and non-financial liabilities, and for estimating fair value for financial instruments not recorded at fair value.
Cash and Cash Equivalents
The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents approximate those assets’ fair values. Cash and cash equivalents fair values are classified as Level 1.
Securities
Fair value measurements based upon quoted prices are considered Level 1 inputs. Level 1 securities consist of U.S. Treasury securities and certain equity securities which are included in the available-for-sale portfolio. For all other available-for-sale and held-to-maturity securities, if quoted prices are not available, fair values are measured using Level 2 inputs. For these securities, the Company generally obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. The Company reviews the prices supplied by the independent pricing service, as well as their underlying pricing methodologies, for reasonableness.
Securities available-for-sale are recorded at fair value on a recurring basis.
Loans Receivable
The Company does not record loans at fair value on a recurring basis. As such, valuation techniques discussed herein for loans are primarily for estimating fair value disclosures. However, from time to time, the Company records nonrecurring fair value adjustments to loans to reflect (1) partial write downs that are based on the observable market price or
22
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
current appraised value of the collateral, or (2) the full charge-off of the loan carrying value. The fair value estimates differentiate loans based on their financial characteristics, such as product classification, loan category, pricing features and remaining maturity. All loan receivable fair values are determined using Level 3 inputs.
The fair value of commercial and commercial real estate loans is calculated by discounting contractual cash flows using discount rates that reflect current pricing for loans with similar characteristics and remaining maturity.
For real estate 1-4 family first and second lien mortgages, fair value is calculated by discounting contractual cash flows, adjusted for prepayment estimates, using discount rates based on current industry pricing or estimates of an appropriate risk-adjusted discount rate for loans of similar size, type, credit quality, remaining maturity and repricing characteristics.
For all other consumer loans, the fair value is generally calculated by discounting the contractual cash flows, adjusted for prepayment estimates, based on the current rates that are offered for loans with similar characteristics.
The fair value of significant nonaccrual loans is based on recent external appraisals. Where appraisals are not available, estimated cash flows are discounted using a rate commensurate with the credit risk associated with those cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information.
Loans Held-for-Sale
Loans held-for-sale are carried at the lower of cost or estimated fair value. Fair value of commercial loans held-for-sale is primarily based on third party valuations. Fair value for consumer mortgages held-for-sale is based on commitments on hand from investors or prevailing market prices. As such, the Company classifies loans subjected to nonrecurring fair value adjustments as Level 3.
Federal Home Loan Bank of Dallas Stock
The fair value of FHLB stock is estimated to be equal to its carrying amount as reported in the accompanying Consolidated Balance Sheets, given it is not a publicly traded equity security, it has an adjustable dividend rate, and all transactions in the stock are executed at the stated par value. FHLB stock is considered a Level 2 fair value.
Other Real Estate Owned
Other real estate owned is primarily foreclosed properties securing residential loans and commercial real estate. Foreclosed assets are adjusted to fair value less estimated costs to sell upon transfer of the loans to other real estate owned. Subsequently, these assets are carried at the lower of carrying value or fair value less estimated costs to sell. Fair value is generally based upon independent market prices or appraised values of the property and, accordingly, the Company classifies foreclosed assets as Level 3.
Deposits
The fair value of deposits with no stated maturity, such as noninterest-bearing checking accounts and money market accounts, is equal to the amount payable upon demand. The fair value of certificates of deposit is based on the lower of redemption or discounted value of contractual cash flows. Discount rates for certificates of deposit are estimated using current market rates. Deposits fair value measurements utilize Level 2 inputs.
Borrowings and Repurchase Agreements
The fair values of borrowings and repurchase agreements are estimated using discounted cash flow analyses based on current incremental borrowing rates for similar types of borrowing arrangements and are measured utilizing Level 2 inputs.
Fair value of FHLB advances is estimated using the rates currently being offered for advances with similar remaining maturities.
23
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Junior Subordinated Debentures
The fair values of junior subordinated debentures with floating interest rates are estimated to be equal to their carrying value reported in the consolidated balance sheets since these instruments reprice periodically according to prevailing market interest rates. The discounted cash flow method is used to estimate the fair value of fixed rate debentures. Contractual cash flows are discounted using rates currently offered for new debentures with similar remaining maturities. Junior subordinated debentures fair value measurements utilize Level 2 inputs.
Accrued Interest
The carrying amounts of accrued interest are considered to approximate their fair values due to their short-term nature. Accrued interest fair value measurements utilize Level 2 inputs.
Unrecognized Financial Instruments
The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreement and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.
The Company has reviewed the unfunded portion of commitments to extend credit as well as standby and other letters of credit, and has determined that the fair value of such financial instruments is not material. The Company classifies the estimated fair value of credit-related financial instruments as Level 3.
Nonfinancial Instruments
The Company has not considered the value of long term relationships with depositors, commonly known as core deposit intangibles, when estimating the fair value of deposit liabilities. These intangibles are considered to be separate intangible assets that are not financial instruments. Nonetheless, financial institutions’ core deposits have typically traded at premiums to their book values under both historical and current market conditions.
NOTE H – SEGMENT INFORMATION
The Company has 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 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.
Revenues, expenses, and assets are recorded by each line of business, and the Company separately reviews 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”.
24
Encore Bancshares, Inc. and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Financial results by operating segment were as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | |
| | Banking | | | Wealth Management | | | Insurance | | | Other | | | Consolidated | |
Three months ended March 31, 2012 | | | | | | | | | | | | | | | | | | | | |
| | | | | |
Net interest income (expense) | | $ | 12,400 | | | $ | 9 | | | $ | 1 | | | $ | (301 | ) | | $ | 12,109 | |
Provision for loan losses | | | 733 | | | | — | | | | — | | | | — | | | | 733 | |
Noninterest income | | | 791 | | | | 5,239 | | | | 1,615 | | | | — | | | | 7,645 | |
Noninterest expense | | | 9,132 | | | | 3,845 | | | | 1,223 | | | | — | | | | 14,200 | |
| | | | | | | | | | | | | | | | | | | | |
Income (loss) before income taxes | | | 3,326 | | | | 1,403 | | | | 393 | | | | (301 | ) | | | 4,821 | |
Income tax expense (benefit) | | | 1,096 | | | | 497 | | | | 139 | | | | (105 | ) | | | 1,627 | |
| | | | | | | | | | | | | | | | | | | | |
Net income (loss) | | $ | 2,230 | | | $ | 906 | | | $ | 254 | | | $ | (196 | ) | | $ | 3,194 | |
| | | | | | | | | | | | | | | | | | | | |
Total assets at March 31, 2012 | | $ | 1,602,540 | | | $ | 57,869 | | | $ | 8,706 | | | $ | (77,752 | ) | | $ | 1,591,363 | |
| | | | | |
Three months ended March 31, 2011 | | | | | | | | | | | | | | | | | | | | |
Net interest income (expense) | | $ | 11,305 | | | $ | 24 | | | $ | 2 | | | $ | (298 | ) | | $ | 11,033 | |
Provision for loan losses | | | 2,170 | | | | — | | | | — | | | | — | | | | 2,170 | |
Noninterest income | | | 591 | | | | 5,089 | | | | 1,448 | | | | — | | | | 7,128 | |
Noninterest expense | | | 9,563 | | | | 3,643 | | | | 1,149 | | | | — | | | | 14,355 | |
| | | | | | | | | | | | | | | | | | | | |
Income (loss) before income taxes | | | 163 | | | | 1,470 | | | | 301 | | | | (298 | ) | | | 1,636 | |
Income tax expense (benefit) | | | (34 | ) | | | 516 | | | | 106 | | | | (104 | ) | | | 484 | |
| | | | | | | | | | | | | | | | | | | | |
Net income (loss) | | $ | 197 | | | $ | 954 | | | $ | 195 | | | $ | (194 | ) | | $ | 1,152 | |
| | | | | | | | | | | | | | | | | | | | |
Total assets at March 31, 2011 | | $ | 1,467,887 | | | $ | 64,157 | | | $ | 6,827 | | | $ | (80,690 | ) | | $ | 1,458,181 | |
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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,” “forecast,” “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 for the year ended December 31, 2011, factors that could contribute to those differences include, but are not limited to:
| • | changes in the strength of general business or economic conditions, either nationally, regionally or in the local markets we serve, may result in, among other things, a deterioration of credit quality or a reduced demand for credit or a decline in wealth management fees; |
| • | volatility and disruption in national and international financial markets; |
| • | changes in the interest rate environment, which may reduce our margins or impact the value of changes in market rates and prices and may impact the value of securities, loans, deposits and other financial instruments; |
| • | increased credit risk in our assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio; |
| • | our ability to raise capital when needed or on terms favorable to us; |
| • | the concentration of our loan portfolio in loans collateralized by real estate; |
| • | our level of commercial real estate and commercial loans; |
| • | incorrect assumptions underlying the establishment of and provisions made to the allowance for loan losses; |
| • | increased asset levels and changes in the composition of assets and the resulting impact on our capital levels and regulatory capital ratios; |
| • | our ability to continue to originate loans and grow core deposits; |
| • | legislative or regulatory developments including changes in laws concerning taxes, banking, securities, investment advisory, trust, insurance and other aspects of the financial services industry; |
| • | increased FDIC assessments or the imposition of special assessments; |
| • | our ability to fully realize our net deferred tax asset; |
| • | government intervention in the U.S. financial system; |
| • | the continued service of key management personnel; |
| • | our ability to attract, motivate and retain key employees; |
| • | changes in the availability of funds resulting in increased costs or reduced liquidity; |
| • | factors that increase competitive pressure among financial services organizations, including product and pricing pressures; |
| • | the potential payment of interest on demand deposit accounts to effectively compete for clients; |
| • | risks associated with our investment in Linscomb & Williams; |
| • | the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations; |
| • | regulatory restrictions on Encore Bank’s ability to pay dividends to us and on our ability to make payments on our obligations; |
| • | potential environmental liability risk associated with lending activities; |
| • | 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; |
26
| • | fiscal and governmental policies of the United States federal government; and |
| • | the actual results of the pending merger with Cadence could vary materially as a result of a number of factors, including the possibility that third parties could make competing offers to acquire Bancshares; various closing conditions for the transaction may not be satisfied or waived; and the Merger Agreement could be terminated under certain circumstances. |
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. (Bancshares) is a financial 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. Bancshares and its subsidiaries (we, the Company or our) are headquartered in Houston, Texas and currently manage, through our primary subsidiary, Encore Bank, National Association (Encore Bank), twelve private client offices in the greater Houston market. We also operate five wealth management offices and four insurance offices in Texas. As of March 31, 2012, we reported, on a consolidated basis, total assets of $1.6 billion, total loans of $1.0 billion, total deposits of $1.2 billion, shareholders’ equity of $179 million and $3.0 billion in assets under management.
Pending Merger
As previously announced, on March 5, 2012, Bancshares, Cadence Bancorp, LLC (Cadence) and EMS Sub I, Inc. (EMS Sub) entered into an Agreement and Plan of Merger (the Merger Agreement), pursuant to which EMS Sub, a wholly-owned subsidiary of Cadence, will be merged with and into Bancshares, with Bancshares continuing thereafter as a wholly-owned subsidiary of Cadence, and each share of Bancshares common stock will be converted into the right to receive $20.62 in cash, without interest (the Merger). Completion of the Merger is subject to certain customary conditions, including (1) approval of the Merger Agreement by Bancshares’ shareholders, (2) receipt of required regulatory approvals and (3) the absence of any law or order prohibiting the completion of the Merger. Each party’s obligation to complete the Merger also is subject to certain additional customary conditions, including (1) subject to certain exceptions, the accuracy of the representations and warranties of the other party and (2) the performance in all material respects by the other party of its obligations under the Merger Agreement.
Critical Accounting Policies
We have made no changes in our methods of application of our critical accounting policies from the information previously disclosed in the Critical Accounting Policies and Estimates section of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011.
Non-GAAP Financial Measures
This report contains certain financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (US GAAP). These measures include net interest income, net interest spread and net interest margin on a taxable-equivalent basis, which is common practice in the banking industry. We have included in this report information related to these non-GAAP financial measures for the applicable periods presented. We believe these non-GAAP financial measures provide information useful to investors in understanding our financial results and believe that its presentation, together with the accompanying reconciliation, provides a complete understanding of factors and trends affecting our business and allows investors to view performance in a manner similar to management, the entire financial services sector, bank stock analysts and bank regulators. These non-GAAP measures should not be considered a substitute for operating results determined in accordance with GAAP and we strongly encourage investors to review our consolidated financial statements in their entirety and not to rely on any single financial measure. Because non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies’ non-GAAP financial measures having the same or similar names.
27
Reclassifications
In 2012, the Company reclassified income earned on certain assets from interest income to other noninterest income for all periods presented. These reclassifications had no impact on financial condition, results of operations or equity in any of the reported periods.
Results of Operations
Net income for the quarter ended March 31, 2012, was $3.2 million, or $0.26 per diluted common share, compared with $1.2 million, or $0.05 per diluted common share, for the quarter ended March 31, 2011. The increase in net income was due to an overall increase in revenues including an increase in net interest income of $1.1 million or 9.8% and higher noninterest income of $0.5 million or 7.3%. The increase in net interest income was due primarily to average loan growth of $99.3 million or 10.6% for the first quarter of 2012 compared to the same quarter in 2011. Noninterest income was higher primarily due to an increase in trust and investment management fees and higher insurance commissions and fees.
We posted a return on average common equity of 8.79% and 1.75%, a return on average assets of 0.85% and 0.32%, and an efficiency ratio of 71.02% and 78.02% for the quarters ended March 31, 2012 and 2011, respectively. The efficiency ratio is calculated by dividing total noninterest expense (excluding amortization of intangibles and write down of assets held-for-sale) 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 on a fully taxable-equivalent basis (TE) was $12.2 million for the quarter ended March 31, 2012, an increase of $1.1 million or 9.5%, compared with the first quarter of 2011. Average earning assets increased $73.5 million, or 5.5%, due primarily to loan growth. Net interest margin (TE) increased 10 basis points to 3.48% for the same comparison period, due in part to a decrease in rate paid on interest-bearing liabilities. The decrease in rate paid was due to lower deposit pricing and a change in the deposit mix. Average noninterest-bearing deposits were $321 million for the first quarter of 2012, a $110 million, or 52.1%, increase compared with the same period of 2011.
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. To give effect to our tax-exempt securities and loans, taxable-equivalent adjustments have been made with respect to these assets and their yields are presented on a non-GAAP TE basis.
28
Taxable-Equivalent Yield Analysis
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | |
| | 2012 | | | 2011 | |
| | Average Outstanding Balance | | | Interest Income/ Expense | | | Average Yield/ Rate | | | Average Outstanding Balance | | | Interest Income/ Expense | | | Average Yield/ Rate | |
| | (dollars in thousands) | |
Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Loans – TE yield (1) | | $ | 1,032,628 | | | $ | 14,492 | | | | 5.64 | % | | $ | 933,361 | | | $ | 13,495 | | | | 5.86 | % |
Securities – TE yield (1) | | | 275,511 | | | | 1,689 | | | | 2.47 | | | | 354,250 | | | | 2,369 | | | | 2.71 | |
Federal funds sold and other | | | 102,876 | | | | 76 | | | | 0.30 | | | | 49,926 | | | | 30 | | | | 0.24 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets – TE yield (1) | | | 1,411,015 | | | | 16,257 | | | | 4.63 | | | | 1,337,537 | | | | 15,894 | | | | 4.82 | |
Less: Allowance for loan losses | | | (18,463 | ) | | | | | | | | | | | (18,604 | ) | | | | | | | | |
Noninterest-earning assets | | | 127,671 | | | | | | | | | | | | 141,341 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 1,520,223 | | | | | | | | | | | $ | 1,460,274 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities and shareholders’ equity: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest checking | | $ | 185,283 | | | $ | 41 | | | | 0.09 | % | | $ | 162,577 | | | $ | 91 | | | | 0.23 | % |
Money market and savings | | | 252,138 | | | | 121 | | | | 0.19 | | | | 287,029 | | | | 309 | | | | 0.44 | |
Time deposits | | | 338,025 | | | | 1,465 | | | | 1.74 | | | | 379,142 | | | | 1,940 | | | | 2.08 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing deposits | | | 775,446 | | | | 1,627 | | | | 0.84 | | | | 828,748 | | | | 2,340 | | | | 1.15 | |
Borrowings and repurchase agreements | | | 219,646 | | | | 2,120 | | | | 3.88 | | | | 224,792 | | | | 2,106 | | | | 3.80 | |
Junior subordinated debentures | | | 20,619 | | | | 301 | | | | 5.87 | | | | 20,619 | | | | 298 | | | | 5.86 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities | | | 1,015,711 | | | | 4,048 | | | | 1.60 | | | | 1,074,159 | | | | 4,744 | | | | 1.79 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Noninterest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Noninterest-bearing deposits | | | 320,764 | | | | | | | | | | | | 210,885 | | | | | | | | | |
Other liabilities | | | 8,513 | | | | | | | | | | | | 8,344 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | | 1,344,988 | | | | | | | | | | | | 1,293,388 | | | | | | | | | |
Shareholders’ equity | | | 175,235 | | | | | | | | | | | | 166,886 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities and shareholders’ equity | | $ | 1,520,223 | | | | | | | | | | | $ | 1,460,274 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income TE (1) | | | | | | $ | 12,209 | | | | | | | | | | | $ | 11,150 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net interest spread TE (1) | | | | | | | | | | | 3.03 | % | | | | | | | | | | | 3.03 | % |
Net interest margin TE (1) | | | | | | | | | | | 3.48 | % | | | | | | | | | | | 3.38 | % |
Net interest income (GAAP) | | | | | | $ | 12,109 | | | | | | | | | | | $ | 11,033 | | | | | |
Taxable-equivalent adjustment | | | | | | | 100 | | | | | | | | | | | | 117 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income on taxable-equivalent basis (1) | | | | | | $ | 12,209 | | | | | | | | | | | $ | 11,150 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
(1) | Non-GAAP measure. On taxable-equivalent basis to consistently reflect income from taxable and tax-exempt loans and securities based on a 35% federal tax rate for the three months ended March 31, 2012 and a 34% federal tax rate for the three months ended March 31, 2011. |
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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 $0.7 million for the three months ended March 31, 2012, compared with $2.2 million for 2011. The change in the provision primarily reflects the amount we considered necessary to absorb estimated losses incurred in the loan portfolio. The decrease in the provision for loan losses was due in part to a decrease in net charge-offs of $1.1 million for the first quarter of 2012 compared to the same quarter of 2011 and an overall improvement in credit quality.
Noninterest Income
Noninterest income represented 38.70% and 39.25% of total revenue for the three months ended March 31, 2012 and 2011.
Noninterest income increased $0.5 million, or 7.3%, to $7.6 million for the three months ended March 31, 2012, compared with the same period in 2011. This increase was primarily due to trust and investment management fees, which rose $0.2 million, or 3.3%, to $5.2 million and an increase in insurance commissions and fees of $0.2 million or 10.9%. The increase in trust and investment management fees was due primarily to a 4.3% increase in assets under management. Assets under management at March 31, 2012, were $3.0 billion.
The following table presents, for the periods indicated, the major categories of noninterest income:
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2012 | | | 2011 | |
| | (dollars in thousands) | |
Trust and investment management fees | | $ | 5,239 | | | $ | 5,072 | |
Insurance commissions and fees | | | 1,597 | | | | 1,440 | |
Net loss on sale of available-for-sale securities | | | — | | | | (31 | ) |
Other | | | 809 | | | | 647 | |
| | | | | | | | |
Total noninterest income | | $ | 7,645 | | | $ | 7,128 | |
| | | | | | | | |
Noninterest Expense
Noninterest expense was $14.2 million for the three-month period ended March 31, 2012, a decrease of $0.2 million, compared with the same period of 2011. The decrease in noninterest expense was due primarily to lower FDIC assessments of $0.6 million or 75.8% and a decrease in other noninterest expense of $0.3 million or 26.7%. FDIC assessments were positively impacted by a change in the assessment base from adjusted domestic deposits to consolidated total assets minus average tangible equity (defined as average month-end Tier 1 capital) and lower assessment rates. Lower other noninterest expense was primarily the result of a reduction in the reserve for losses on unfunded loan commitments which is recorded in other liabilities in the Consolidated Balance Sheets included in the Interim Consolidated Financial Statements. These decreases were offset by higher compensation expense of $0.2 million, an increase in professional fees of $0.4 million and increased foreclosed real estate expenses for the first three months of 2012 compared to the same period in 2011. The increase in professional fees was primarily due to merger-related consulting fees paid during the first quarter of 2012. Foreclosed real estate expenses were $0.3 million during the first quarter of 2012 due primarily to net losses on the sale of other real estate owned.
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The following table presents, for the periods indicated, the major categories of noninterest expense:
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2012 | | | 2011 | |
| | (dollars in thousands) | |
Compensation | | $ | 8,918 | | | $ | 8,706 | |
Non-staff expenses: | | | | | | | | |
Occupancy | | | 1,198 | | | | 1,287 | |
Equipment | | | 250 | | | | 241 | |
Advertising and promotion | | | 149 | | | | 156 | |
Outside data processing | | | 818 | | | | 783 | |
Professional fees | | | 1,515 | | | | 1,134 | |
Intangible amortization | | | 170 | | | | 140 | |
FDIC assessment | | | 193 | | | | 798 | |
Other real estate owned expenses, net | | | 252 | | | | 83 | |
Write down of assets held-for-sale | | | — | | | | 21 | |
Other | | | 737 | | | | 1,006 | |
| | | | | | | | |
Total noninterest expense | | $ | 14,200 | | | $ | 14,355 | |
| | | | | | | | |
Income Tax Expense
Income tax expense was $1.6 million for the three months ended March 31, 2012, compared with $0.5 million for the same three months of 2011. The effective tax rate for the three months ended March 31, 2012 and 2011 was 33.7% and 29.6%, respectively. The amount of income tax expense and corresponding effective tax rate are influenced by the amount of taxable income as well as nontaxable income and expense. The increase in effective tax rate for the 2012 period was due to higher overall taxable income in relation to nontaxable items.
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, 2011, included in our Annual Report on Form 10-K.
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The following table presents the net earnings (loss) 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) | |
Three months ended March 31, 2012 | | | | | | | | | | | | | | | | | | | | |
Net interest income (expense) | | $ | 12,400 | | | $ | 9 | | | $ | 1 | | | $ | (301 | ) | | $ | 12,109 | |
Provision for loan losses | | | 733 | | | | — | | | | — | | | | — | | | | 733 | |
Noninterest income | | | 791 | | | | 5,239 | | | | 1,615 | | | | — | | �� | | 7,645 | |
Noninterest expense | | | 9,132 | | | | 3,845 | | | | 1,223 | | | | — | | | | 14,200 | |
| | | | | | | | | | | | | | | | | | | | |
Income (loss) before income taxes | | | 3,326 | | | | 1,403 | | | | 393 | | | | (301 | ) | | | 4,821 | |
Income tax expense (benefit) | | | 1,096 | | | | 497 | | | | 139 | | | | (105 | ) | | | 1,627 | |
| | | | | | | | | | | | | | | | | | | | |
Net income (loss) | | $ | 2,230 | | | $ | 906 | | | $ | 254 | | | $ | (196 | ) | | $ | 3,194 | |
| | | | | | | | | | | | | | | | | | | | |
Total assets at March 31, 2012 | | $ | 1,602,540 | | | $ | 57,869 | | | $ | 8,706 | | | $ | (77,752 | ) | | $ | 1,591,363 | |
| | | | | |
Three months ended March 31, 2011 | | | | | | | | | | | | | | | | | | | | |
Net interest income (expense) | | $ | 11,305 | | | $ | 24 | | | $ | 2 | | | $ | (298 | ) | | $ | 11,033 | |
Provision for loan losses | | | 2,170 | | | | — | | | | — | | | | — | | | | 2,170 | |
Noninterest income | | | 591 | | | | 5,089 | | | | 1,448 | | | | — | | | | 7,128 | |
Noninterest expense | | | 9,563 | | | | 3,643 | | | | 1,149 | | | | — | | | | 14,355 | |
| | | | | | | | | | | | | | | | | | | | |
Income (loss) before income taxes | | | 163 | | | | 1,470 | | | | 301 | | | | (298 | ) | | | 1,636 | |
Income tax expense (benefit) | | | (34 | ) | | | 516 | | | | 106 | | | | (104 | ) | | | 484 | |
| | | | | | | | | | | | | | | | | | | | |
Net income (loss) | | $ | 197 | | | $ | 954 | | | $ | 195 | | | $ | (194 | ) | | $ | 1,152 | |
| | | | | | | | | | | | | | | | | | | | |
Total assets at March 31, 2011 | | $ | 1,467,887 | | | $ | 64,157 | | | $ | 6,827 | | | $ | (80,690 | ) | | $ | 1,458,181 | |
Banking
Net income for the three months ended March 31, 2012, was $2.2 million, compared with a $0.2 million in the same period of 2011.
Net interest income for the three months ended March 31, 2012, increased $1.1 million, or 9.7%, compared with the same period of 2011. 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, 2012, totaled $0.7 million compared with $2.2 million in 2011. 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, 2012, increased $0.2 million compared with the same period in 2011, which was due primarily to additional fees on certain deposit products.
Noninterest expense for the three months ended March 31, 2012, decreased $0.4 million compared with the same period in 2011 primarily due to the reduction of the allowance for unfunded loan losses which is recorded in other liabilities in the Consolidated Balance Sheets included in the Interim Consolidated Financial Statements.
Wealth Management
Net income for the three months ended March 31, 2012, was $0.9 million, flat compared with the same period in 2011.
Noninterest income for the three months ended March 31, 2012, increased $0.2 million, or 2.9%, compared with the same period in 2011, due primarily to an increase in assets under management. Assets under management were $3.0 billion as of March 31, 2012, compared with $2.9 billion as of March 31, 2011, a 4.3% increase.
Noninterest expense for the three months ended March 31, 2012, increased $0.2 million, or 5.5%, compared with the same period in 2011 primarily due to incentive compensation.
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Insurance
Net income for the three months ended March 31, 2012 was $0.3 million, higher when compared with the same period of 2011 due to increased commission revenue. Commission revenue increased $0.2 million due to increased commissions.
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 was unchanged.
Financial Condition
Our total assets increased $68.8 million, or 4.5%, to $1.6 billion as of March 31, 2012, compared with December 31, 2011. Our loan portfolio increased $22.3 million, or 2.2%, to $1.0 billion as of March 31, 2012. Our securities portfolio increased $8.1 million, or 3.0%, to $279 million at March 31, 2012, compared with $270 million as of December 31, 2011. Shareholders’ equity increased $5.4 million, or 3.1%, to $179 million at March 31, 2012, compared with $173 million as of December 31, 2011.
Loan Portfolio
Our primary lending focus is to privately-owned businesses, investors, professional firms, 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 49.2% of our portfolio as of March 31, 2012. Total consumer loans, which consist of residential real estate, home equity lines of credit and other consumer loans, made up 50.7% of our loan portfolio as of March 31, 2012. Loans held-for-sale composed 0.1% of our portfolio.
Total loans were $1.0 billion as of March 31, 2012, an increase of $22.3 million, or 2.2%, compared with December 31, 2011.
The following table summarizes our loan portfolio by type of loan as of the dates indicated:
| | | | | | | | | | | | | | | | |
| | March 31, 2012 | | | December 31, 2011 | |
| | Amount | | | Percent | | | Amount | | | Percent | |
| | (dollars in thousands) | |
Commercial: | | | | | | | | | | | | | | | | |
Commercial | | $ | 234,760 | | | | 22.4 | % | | $ | 214,575 | | | | 21.0 | % |
Commercial real estate | | | 224,479 | | | | 21.4 | | | | 210,437 | | | | 20.5 | |
Real estate construction | | | 56,322 | | | | 5.4 | | | | 59,589 | | | | 5.8 | |
| | | | | | | | | | | | | | | | |
Total commercial | | | 515,561 | | | | 49.2 | | | | 484,601 | | | | 47.3 | |
| | | | |
Consumer: | | | | | | | | | | | | | | | | |
Residential real estate first lien | | | 203,122 | | | | 19.4 | | | | 202,968 | | | | 19.8 | |
Residential real estate second lien | | | 241,849 | | | | 23.1 | | | | 252,825 | | | | 24.6 | |
Home equity lines | | | 55,044 | | | | 5.3 | | | | 55,191 | | | | 5.4 | |
Consumer other | | | 30,592 | | | | 2.9 | | | | 27,901 | | | | 2.7 | |
| | | | | | | | | | | | | | | | |
Total consumer | | | 530,607 | | | | 50.7 | | | | 538,885 | | | | 52.5 | |
| | | | | | | | | | | | | | | | |
Loans receivable | | | 1,046,168 | | | | 99.9 | | | | 1,023,486 | | | | 99.8 | |
Loans held-for-sale | | | 1,350 | | | | 0.1 | | | | 1,778 | | | | 0.2 | |
| | | | | | | | | | | | | | | | |
Total loans | | $ | 1,047,518 | | | | 100.0 | % | | $ | 1,025,264 | | | | 100.0 | % |
| | | | | | | | | | | | | | | | |
33
Asset Quality
Loans are generally placed on nonaccrual status when management determines that full collection of principal or interest is unlikely or when principal or interest payments are 90 days past due, unless the loan is fully collateralized and in the process of collection. Residential mortgage and home equity loans are generally charged off to current appraised values, less costs to sell, no later than 180 days past due. Other consumer loans are generally charged off at no later than 120 days past due, earlier if deemed uncollectible. We sometimes revise the interest rate or repayment terms resulting in a troubled debt restructuring. All troubled debt restructurings are included in nonperforming assets unless interest is still being accrued.
We generally obtain updated appraisals on collateral secured loans categorized as nonaccrual loans and potential problem loans on an annual basis. In instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible write downs or appropriate additions to the allowance for loan losses. We record real estate acquired through foreclosure at fair value at the time of acquisition, less estimated costs to sell the property, establishing a new cost basis.
The following table presents information regarding nonperforming assets, accruing loans past due 90 days or more and restructured loans still accruing as of the dates indicated:
| | | | | | | | |
| | March 31, 2012 | | | December 31, 2011 | |
| | (dollars in thousands) | |
Nonaccrual loans (1) | | $ | 6,636 | | | $ | 10,789 | |
Other real estate owned | | | 3,954 | | | | 2,090 | |
| | | | | | | | |
Total nonperforming assets | | $ | 10,590 | | | $ | 12,879 | |
| | | | | | | | |
Accruing loans past due 90 days or more | | $ | — | | | $ | — | |
| | | | | | | | |
Restructured loans still accruing | | $ | 2,628 | | | $ | 4,122 | |
| | | | | | | | |
Nonperforming assets to total loans and other real estate owned | | | 1.01 | % | | | 1.25 | % |
(1) | Nonaccrual troubled debt restructurings are included in nonaccrual loans. |
Nonperforming assets were $10.6 million and $12.9 million as of March 31, 2012 and December 31, 2011, respectively. The ratio of nonperforming assets to total loans and other real estate owned was 1.01% and 1.25% as of March 31, 2012 and December 31, 2011. At March 31, 2012, nonaccrual loans were $6.6 million, compared with $10.8 million at December 31, 2011, a decrease of $4.2 million, or 38.5%. The decrease in nonaccrual loans was due in part to the transfer of a commercial real estate relationship located in Houston to other real estate owned. Other real estate owned was $4.0 million at March 31, 2012, compared with $2.1 million at December 31, 2011, an increase of $1.9 million, or 89.2%. Restructured loans still accruing were $2.6 million as of March 31, 2012, compared with $4.1 million as of December 31, 2011.
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The following table presents information regarding nonaccrual loans and the associated specific reserves within the allowance for loan losses for each loan category:
| | | | | | | | | | | | | | | | |
| | March 31, 2012 | | | December 31, 2011 | |
| | Outstanding Balance | | | Specific Allocation of Allowance | | | Outstanding Balance | | | Specific Allocation of Allowance | |
| | (dollars in thousands) | |
Commercial: | | | | | | | | | | | | | | | | |
Commercial | | $ | 419 | | | $ | — | | | $ | 774 | | | $ | 5 | |
Commercial real estate | | | 1,258 | | | | — | | | | 2,223 | | | | 161 | |
Real estate construction | | | — | | | | — | | | | 2,839 | | | | 43 | |
| | | | | | | | | | | | | | | | |
Total commercial | | | 1,677 | | | | — | | | | 5,836 | | | | 209 | |
Consumer: | | | | | | | | | | | | | | | | |
Residential real estate first lien (1) | | | 4,813 | | | | — | | | | 4,778 | | | | — | |
Residential real estate second lien and home equity lines | | | 146 | | | | — | | | | 175 | | | | — | |
Consumer other | | | — | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | | |
Total consumer | | | 4,959 | | | | — | | | | 4,953 | | | | — | |
| | | | | | | | | | | | | | | | |
Total nonaccrual loans | | $ | 6,636 | | | $ | — | | | $ | 10,789 | | | $ | 209 | |
| | | | | | | | | | | | | | | | |
(1) | Written down to fair value of collateral after becoming 180 days past due. |
When management’s measured value of an impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. The specific reserves are determined on an individual loan basis based on our current evaluation of loss exposure for each credit, given the payment status, financial condition of the borrower and value of any underlying collateral. The amount of specific reserves can change from period to period as a result of changes in the circumstances of individual loans such as charge-offs, pay-offs, changes in collateral values or other factors. Notwithstanding the specific allocations of the allowance for loan losses, the total allowance is available to absorb losses from any segment of loans.
Allowance for Loan Losses
Our allowance for loan losses is 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.
The allowance for loan losses is comprised of two components: specific reserves and general reserves. Generally, all loans that have been identified as impaired are reviewed on a quarterly basis in order to determine whether a specific reserve is required. A loan is considered impaired when, based on current information, it is probable that we will not receive all amounts due in accordance with the contractual terms of the loan agreement. Once a loan has been identified as impaired, we measure the amount of impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s observable market price, or based on the fair value of the collateral if the loan is collateral-
35
dependent. When management’s measured value of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on our current evaluation of our loss exposure for each credit, given the payment status, financial condition of the borrower and value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general reserve described below. Changes in specific reserves from period to period are the result of changes in the circumstances of individual loans such as charge-offs, pay-offs, changes in collateral values or other factors.
We also maintain a general reserve for each loan type in the loan portfolio. In determining the amount of the general reserve portion of our allowance for loan losses, we consider factors such as our historical loan loss experience, the experience, ability and effectiveness of our lending management and staff, the effectiveness of our loan policies, procedures and internal controls, strategic initiatives, the composition and concentrations of credit, changes in underlying collateral values, nonaccrual and loan classification trends, the effectiveness of the internal loan review function and general economic conditions. Based on these factors, we apply estimated percentages to the various categories of loans, not including any loan that has a specific reserve allocated to it, based on our historical experience, portfolio trends and economic and industry trends. We use this information to estimate the general reserve portion of the allowance for loan losses at a level that reflects our estimate of incurred losses.
Based on an evaluation of the loan portfolio, we present a quarterly review of the allowance for loan losses to Encore Bank’s asset classification committee and our board of directors, indicating any change in the allowance for loan losses since the last review and any recommendations as to adjustments in the allowance for loan losses. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as events change. The allowance for loan losses was $18.0 million or 1.72% of total loans, excluding loans held-for-sale, at March 31, 2012, compared to $18.0 million, or 1.76% of total loans, excluding loans held-for-sale, as of December 31, 2011. The decrease in allowance for loan losses as a percentage of total loans was due primarily to improvements in credit quality during the first quarter of 2012 and a decrease in net charge-offs. Net charge-offs for the first quarter of 2012 were $0.7 million, or 0.28% of average loans on an annualized basis, compared with $1.8 million, or 0.78% of average total loans on an annualized basis for the first quarter of 2011. The decrease in net charge-offs for this time period was due to lower charge-offs of $1.0 million and higher recoveries including a $0.4 million recovery of a previously charged-off commercial loan.
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The following table summarizes the activity in our allowance for loan losses as of and for the periods indicated:
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2012 | | | 2011 | |
| | (dollars in thousands) | |
Average total loans outstanding | | $ | 1,032,628 | | | $ | 933,361 | |
| | | | | | | | |
Loans receivable at end of period (excluding loans held-for-sale) | | $ | 1,046,168 | | | $ | 936,036 | |
| | | | | | | | |
Allowance for loan losses at beginning of period | | $ | 17,968 | | | $ | 18,639 | |
Charge-offs: | | | | | | | | |
Commercial: | | | | | | | | |
Commercial | | | — | | | | (196 | ) |
Commercial real estate | | | (194 | ) | | | (465 | ) |
Real estate construction | | | — | | | | (4 | ) |
| | | | | | | | |
Total commercial | | | (194 | ) | | | (665 | ) |
| | | | | | | | |
Consumer: | | | | | | | | |
Residential real estate first lien | | | (366 | ) | | | (222 | ) |
Residential real estate second lien | | | (403 | ) | | | (1,059 | ) |
Home equity lines | | | (249 | ) | | | (296 | ) |
Consumer other | | | (24 | ) | | | (36 | ) |
| | | | | | | | |
Total consumer | | | (1,042 | ) | | | (1,613 | ) |
| | | | | | | | |
Total charge-offs | | | (1,236 | ) | | | (2,278 | ) |
| | | | | | | | |
Recoveries: | | | | | | | | |
Commercial: | | | | | | | | |
Commercial | | | 420 | | | | 3 | |
Commercial real estate | | | — | | | | 12 | |
Real estate construction | | | 3 | | | | 131 | |
| | | | | | | | |
Total commercial | | | 423 | | | | 146 | |
| | | | | | | | |
Consumer: | | | | | | | | |
Residential real estate first lien | | | 23 | | | | 223 | |
Residential real estate second lien | | | 31 | | | | 71 | |
Home equity lines | | | 21 | | | | 19 | |
Consumer other | | | 14 | | | | 18 | |
| | | | | | | | |
Total consumer | | | 89 | | | | 331 | |
| | | | | | | | |
Total recoveries | | | 512 | | | | 477 | |
| | | | | | | | |
Net charge-offs | | | (724 | ) | | | (1,801 | ) |
| | | | | | | | |
Provision for loan losses | | | 733 | | | | 2,170 | |
| | | | | | | | |
Allowance for loan losses at end of period | | $ | 17,977 | | | $ | 19,008 | |
| | | | | | | | |
Ratio of net charge-offs to average total loans | | | 0.28 | % | | | 0.78 | % |
Ratio of allowance for loan losses to period end loans (excluding loans held-for-sale) | | | 1.72 | | | | 2.03 | |
Ratio of allowance for loan losses to nonaccrual loans (excluding loans held-for-sale) | | | 270.90 | | | | 74.72 | |
Securities
Total securities were $279 million as of March 31, 2012, an increase of $8.1 million, or 3.0%, compared with $270 million as of December 31, 2011. We increased securities during the first quarter of 2012 to further diversify our interest-earning asset portfolio and further utilize excess liquidity.
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Net unrealized losses on the available-for-sale securities were $0.8 million at March 31, 2012, as compared to $1.7 million at December 31, 2011.
We review investment securities on an ongoing basis for the presence of other-than-temporary impairment (OTTI) with formal reviews performed quarterly. Net OTTI losses on individual investment securities are recognized as a realized loss through earnings when it is more likely than not that we will not collect all of the contractual cash flows or we are unable to hold the securities to recovery.
For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we separate OTTI into the amount that is credit-related and the amount that is due to all other factors. The credit loss component is recognized in earnings and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. The amount due to all other factors is recognized in other comprehensive income.
Deposits
Our deposits averaged $1.1 billion for the three months ended March 31, 2012, an increase of $56.6 million, or 5.4%, over average deposits for the three months ended March 31, 2011. For the three months ended March 31, 2012, average core deposits (which consist of noninterest-bearing deposits, interest checking, money market and savings and time deposits less than $100,000) were $858 million, or 78.3%, of average total deposits, while time deposits $100,000 and greater and brokered deposits made up 21.7% of average total deposits. As of March 31, 2012, total deposits increased $63.4 million, or 5.8%, to $1.2 billion compared with total deposits as of December 31, 2011.
The following table presents the daily average balance and weighted average rates paid on deposits for the periods indicated:
| | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, 2012 | | | Three Months Ended March 31, 2011 | |
| | Average Balance | | | Average Rate | | | Average Balance | | | Average Rate | |
| | (dollars in thousands) | |
Noninterest-bearing deposits . | | $ | 320,764 | | | | — | % | | $ | 210,885 | | | | — | % |
Interest checking | | | 185,283 | | | | 0.09 | | | | 162,577 | | | | 0.23 | |
Money market and savings | | | 252,138 | | | | 0.19 | | | | 287,029 | | | | 0.44 | |
Time deposits less than $100,000 | | | 99,704 | | | | 1.83 | | | | 105,669 | | | | 2.24 | |
| | | | | | | | | | | | | | | | |
Core deposits | | | 857,889 | | | | 0.29 | | | | 766,160 | | | | 0.52 | |
| | | | | | | | | | | | | | | | |
Time deposits $100,000 and greater | | | 222,943 | | | | 1.64 | | | | 249,834 | | | | 1.98 | |
Brokered deposits | | | 15,378 | | | | 2.70 | | | | 23,639 | | | | 2.35 | |
| | | | | | | | | | | | | | | | |
Total deposits | | $ | 1,096,210 | | | | 0.60 | % | | $ | 1,039,633 | | | | 0.91 | % |
| | | | | | | | | | | | | | | | |
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 $221 million as of March 31, 2012. The outstanding balance as of March 31, 2012 includes $208 million in long term advances from FHLB and $12.6 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.
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The following table summarizes our two issues of junior subordinated debentures outstanding as of March 31, 2012:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Description | | Issuance and Call Dates (1) | | | Trust Preferred Securities Outstanding | | | Interest Rate as of March 31, 2012 | | | 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 | | | | 3.42 | % | | | Adjustable quarterly | | | | 3 month LIBOR + 2.95 | % | | $ | 5,155 | | | | 9/24/2033 | |
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 on the first interest payment date after five years from issuance date. |
(2) | The debentures bear a fixed interest rate until July 1, 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 management involves forecasting funding requirements and maintaining sufficient capacity to meet the needs and accommodate fluctuations in asset and liability levels due to changes in our business operations or unanticipated events.
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. For the three months ended March 31, 2012, our average deposits were $1.1 billion, or 72.1% of average total assets.
Shareholders’ Equity
Shareholders’ equity increased $5.4 million, or 3.1%, to $179 million as of March 31, 2012 compared with $173 million as of December 31, 2011, primarily due to net earnings and exercises of employee incentive stock options.
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 issued by us prior to May 19, 2010, can be eligible for treatment as Tier 1 regulatory capital provided such securities comprise less than 25% of core capital elements. Any amount above this limit or any amount issued on or after May 19, 2010, can be eligible for treatment as Tier 2 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 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.
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The following table presents capital amounts and ratios for us and Encore Bank as of March 31, 2012:
| | | | | | | | | | | | | | | | | | | | | | | | |
| | 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 | | $ | 146,547 | | | | 9.99 | % | | $ | 58,698 | | | | 4.00 | % | | | N/A | | | | N/A | |
Tier 1 risk-based | | | 146,547 | | | | 13.72 | | | | 42,723 | | | | 4.00 | | | | N/A | | | | N/A | |
Total risk-based | | | 159,963 | | | | 14.98 | | | | 85,446 | | | | 8.00 | | | | N/A | | | | N/A | |
| | | | | | |
Encore Bank, N.A. | | | | | | | | | | | | | | | | | | | | | | | | |
Leverage | | $ | 138,571 | | | | 9.44 | % | | $ | 58,725 | | | | 4.00 | % | | $ | 73,406 | | | | 5.00 | % |
Tier 1 risk-based | | | 138,571 | | | | 13.01 | | | | 42,593 | | | | 4.00 | | | | 63,889 | | | | 6.00 | |
Total risk-based | | | 151,956 | | | | 14.27 | | | | 85,186 | | | | 8.00 | | | | 106,482 | | | | 10.00 | |
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 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011.
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 Rules 13a-15(e) and 15d-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.
(b) Changes in Internal Control over Financial Reporting
During the first quarter of 2012, 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.
Part II – Other Information
Item 1. Legal Proceedings
Bancshares and the members of its board of directors have been named as defendants in a putative class and derivative action filed on behalf of Bancshares shareholders on April 16, 2012 in the Supreme Court of the State of New York for the County of New York. The lawsuit challenged the fairness of the Merger and alleged that the director defendants breached their fiduciary duties to Bancshares. The lawsuit generally sought an injunction barring defendants from consummating the Merger, a declaratory judgment that the defendants breached their fiduciary duties to Bancshares and an award of compensatory damages, interest, attorney’s fees and costs. On May 1, 2012, following settlement discussions, the defendants entered into a memorandum of understanding with the plaintiffs regarding the settlement of the lawsuit. In connection with the settlement contemplated by the memorandum of understanding, in consideration for the full settlement and release of all claims, Bancshares agreed to make certain additional disclosures related to the proposed Merger. The memorandum of understanding contemplates that the parties will negotiate in good faith and use their reasonable best efforts to enter into a stipulation of settlement. The stipulation of settlement will be subject to customary conditions, including court approval following notice to shareholders of Bancshares. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the court will approve the settlement even if the parties were to enter into such stipulation.
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In addition, 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 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 for the year ended December 31, 2011. 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
The following table presents information with respect to repurchases of common stock made by us during the three months ended March 31, 2012:
ISSUER PURCHASES OF EQUITY SECURITIES
| | | | | | | | | | | | | | | | |
Month in 2012 | | Total Number of Shares Purchased (1) | | | Average Price Paid per Share | | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2) | | | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (2) | |
January | | | — | | | $ | — | | | | — | | | | — | |
February | | | 1,765 | | | | 13.89 | | | | — | | | | — | |
March | | | 8,500 | | | | 20.37 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | |
Total | | | 10,265 | | | $ | 19.26 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | |
(1) | All shares of common stock reported in the table above were repurchased by us at the fair market value of our common stock in connection with the satisfaction of tax withholding obligations under restricted stock agreements between us and certain of our key employees and directors. |
(2) | We have no publicly announced plans or programs. |
Item | 3. Defaults Upon Senior Securities |
Not applicable
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits
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3.1 | | Amended and Restated Articles of Incorporation of Encore Bancshares, Inc. (incorporated herein 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)). |
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3.2 | | Articles of Amendment to Articles of Incorporation of Encore Bancshares, Inc. (incorporated herein by reference to Exhibit 3.2 to the S-1 Registration Statement). |
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3.3 | | Statement of Designations establishing the terms of the Series A Preferred Stock of Encore Bancshares, Inc. (incorporated herein by reference to Exhibit 3.1 to Encore Bancshares, Inc.’s Current Report on Form 8-K filed on December 8, 2008). |
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3.4 | | Statement of Designations establishing the terms of the Series B Preferred Stock of Encore Bancshares, Inc. (incorporated herein by reference to Exhibit 3.1 to Encore Bancshares, Inc.’s Current Report on Form 8-K filed on September 29, 2011). |
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3.5 | | Amended and Restated Bylaws of Encore Bancshares, Inc. (incorporated herein by reference to Exhibit 3.3 to the S-1 Registration Statement). |
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4.1 | | Form of specimen certificate representing shares of Encore Bancshares, Inc. common stock (incorporated herein by reference to Exhibit 4.1 to the S-1 Registration Statement). |
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4.2 | | Form of Series B Preferred Stock Certificate (incorporated herein by reference to Exhibit 4.1 to Encore Bancshares, Inc.’s Current Report on Form 8-K filed on September 29, 2011). |
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4.3 | | Warrant, dated December 5, 2008, to purchase 364,026 shares of Encore Bancshares, Inc. common stock (incorporated herein by reference to Exhibit 4.1 to Encore Bancshares, Inc.’s Current Report on Form 8-K filed on December 8, 2008). |
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31.1* | | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. |
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31.2* | | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. |
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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. |
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101* | | Interactive Data File. |
* | Filed with this Quarterly Report on Form 10-Q |
** | Furnished with this Quarterly Report on Form 10-Q |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | | |
| | | | Encore Bancshares, Inc. |
| | | | (Registrant) |
| | |
May 4, 2012 | | | | /s/ James S. D’Agostino, Jr. |
(Date) | | | | James S. D’Agostino, Jr., Chief Executive Officer |
| | |
May 4, 2012 | | | | /s/ Patrick T. Oakes |
(Date) | | | | Patrick T. Oakes, Executive Vice President and Chief Financial Officer |
| | |
May 4, 2012 | | | | /s/ Stephanie Pollock |
(Date) | | | | Stephanie Pollock, Controller and Chief Accounting Officer |
43