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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
Amendment No. 1
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 2010 Commission File Number 0-13823
FNB UNITED CORP.
(Exact name of Registrant as specified in its Charter)
| North Carolina | 56-1456589 | |||||
| (State of Incorporation) | (I.R.S. Employer Identification No.) | |||||
| 150 South Fayetteville Street | ||||||
| Asheboro, North Carolina | 27203 | |||||
| (Address of principal executive offices) | (Zip Code) | |||||
(336) 626-8300
(Registrant’s telephone number, including area code)
Securities Registered Pursuant to Section 12(g) of the Securities Exchange Act of 1934:
Title of each class
Common Stock, $2.50 par value
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes¨ Nox
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes¨ Nox
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. Yesx No¨
Indicate by check mark whether the registrant (1) has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes¨ No¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference to Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check one)
| Large accelerated filer ¨ | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company x | |||
| (Do not check if a 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¨ Nox
The aggregate market value of the Registrant’s common stock held by nonaffiliates of the Registrant, assuming, without admission, that all directors and officers of the Registrant may be deemed affiliates, was approximately $8.3 million as of June 30, 2010, the last business day of the Registrant’s most recently completed second fiscal quarter. As of March 10, 2011 (the most recent practicable date), the Registrant had outstanding 11,424,390 shares of Common Stock.
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on July 19, 2011, are incorporated by reference in Part III of this report.
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Explanatory Statement to Form 10-K Amendment
This Amendment No. 1 to Form 10-K/A (“Amendment”) amends the Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (“Original Filing”), as filed on March 14, 2011, by FNB United Corp. (“FNB United”). On May 23, 2011, FNB United filed its Current Report on Form 8-K with the Securities and Exchange Commission (“SEC”) in which it announced that it was restating previously reported financial statements set forth in the Original Filing to reflect the correction of the recorded amounts of valuation allowances for impaired loans and valuation write-downs for other real estate owned (OREO) as of December 31, 2010. As more fully described in Note 2 of the financial statements, FNB United has determined that the misstatement relates to the failure to reflect all events or transactions available prior to its making the Original Filing that related to the valuation of impaired loans and OREO and that provided additional evidence about conditions that existed as of December 31, 2010.
Except as required to reflect the effects of the restatement for the item above and to revise Exhibits 99.10 and 99.11 to reflect and include the certifications filed by FNB United with the United States Department of the Treasury, and to complete a date inadvertently left blank in Part I, Item 1A, no additional modifications or updates in this Amendment have been made to the Original Filing on Form 10-K. Information not affected by the restatement remains unchanged and reflects the disclosures made at the time of the Original Filing. This amendment does not describe other events occurring after the original filing, including exhibits, or modify or update those disclosures affected by subsequent events. This Amendment should be read in conjunction with FNB United’s filings made with the SEC subsequent to the filing of the Original Filing, as information in such reports and documents may update or supersede certain information contained in this Amendment. Accordingly, this Amendment only amends and restates Item 1A of Part I, Items 6, 7, 8, and 9A of Part II, and Item 15 of Part IV of the Original Filing, in each case, solely as a result of, and to reflect, the restatement, and, with the exception as noted above of revised Exhibits 99.10 and 99.11 (certifications pursuant to section 111 of the Emergency Economic Stabilization Act of 2008, as amended), no other information in the Original Filing is amended hereby. Pursuant to the rules of the SEC, Item 15 of Part IV of the Original Filing has been amended to contain currently dated certifications of the Chief Executive Officer and Chief Financial Officer. As required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002, the certifications of FNB United’s Chief Executive Officer and Chief Financial Officer are attached to this Amendment as Exhibits 31.10, 31.11 and 32.
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Form 10-K/A
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Cautionary Statement Regarding Forward-Looking Statements
The statements contained in this Annual Report on Form 10-K/A of FNB United Corp. (“FNB United”) that are not historical facts are forward-looking statements, as such term is defined in the Private Securities Litigation Reform Act of 1995. These statements can be identified by the use of forward-looking terminology, such as “believes,” “expects,” “plans,” “projects,” “goals,” “estimates,” “may,” “should,” “could,” “would,” “intends,” “outlook” or “anticipates,” or the negative of such terms, variations of these and similar words, or by discussions of strategy that involve risks and uncertainties. In addition, from time to time FNB United or its representatives have made or may make forward-looking statements, orally or in writing. Such forward-looking statements may be included in, but are not limited to, various filings made by FNB United with the Securities and Exchange Commission, or press releases or oral statements made by or with the approval of an authorized officer of FNB United. Forward-looking statements are based on management’s current views and assumptions and involve risks and uncertainties that could significantly affect expected results.
FNB United wishes to caution the reader that factors, such as those listed below, in some cases have affected and could affect FNB United’s actual results, causing actual results to differ materially from those in any forward-looking statement. These factors include, without limitation: (i) competitive pressures in the banking industry or in FNB United’s markets may increase significantly; (ii) inflation, interest rate, market and monetary fluctuations; (iii) general economic conditions, either nationally or regionally, may be less favorable than expected, resulting in, among other things, credit quality deterioration or a reduced demand for credit or other services; (iv) the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (v) adverse changes in the securities markets; (vi) changes may occur in banking and other applicable legislation and regulation; (vii) changes in accounting principles and standards; (viii) adverse changes in financial performance or condition of FNB United’s borrowers, which could affect repayment of such borrowers’ outstanding loans; (ix) changes in general business conditions; (x) competitors of FNB United may have greater financial resources and develop products that enable them to compete more successfully than FNB United; (xi) unpredictable natural and other disasters could have an adverse effect on FNB United in that such events could materially disrupt its operations or the ability or willingness of its customers to access the financial services offered by FNB United; (xii) local, state or federal taxing authorities may take tax positions that are adverse to FNB United; (xiii) FNB United’s success at managing the risks involved in the foregoing, and (xiv) regulatory actions and developments, including the potential impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act; (xv) fluctuations in our stock price; (xvi) the effect of any mergers, acquisitions or other transactions to which we or our subsidiary may from time to time be a party; and (xvii) FNB United’s failure of assumptions underlying the establishment of our allowance for loan losses. FNB United cautions that this list of factors is not exclusive. Our forward-looking statements may also be subject to other risks and uncertainties, including those discussed elsewhere in this report, such as in Item 1A, “Risk Factors,” and in the Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” or in our other filings with the Securities and Exchange Commission.
All forward-looking statements speak only as of the date on which such statements are made, and FNB United undertakes no obligation to update any statement, whether written or oral, to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.
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| Item 1. | BUSINESS |
General
FNB United Corp. (“FNB United”) is a bank holding company incorporated under the laws of the State of North Carolina in 1984. On July 2, 1985, through an exchange of stock, FNB United acquired a wholly owned bank subsidiary, CommunityONE Bank, National Association (the “Bank”), a national banking association founded in 1907 and formerly known as First National Bank and Trust Company. The Bank has two operating subsidiaries, Dover Mortgage Company (“Dover”) and First National Investor Services, Inc.; and an inactive subsidiary, Premier Investment Services, Inc. FNB United is also parent to FNB United Statutory Trust I, FNB United Statutory Trust II, and Catawba Valley Capital Trust II, which were formed to facilitate the issuance of trust preferred securities. FNB United and its subsidiaries are collectively referred to as the “Company.”
The Bank, which is a full-service bank, currently conducts all of its operations in Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties in North Carolina. The Bank has forty-five offices, including the headquarters office in the City of Asheboro. Some of the major banking services offered include regular checking accounts, interest checking accounts (including package account versions that offer a variety of products and services), money market accounts, savings accounts, certificates of deposit, individual retirement accounts, debit cards, credit cards (offered through an agent relationship), and loans — both secured and unsecured — for business, agricultural and personal use. Other services offered include home mortgages, online and mobile banking, cash management, investment management and trust services. The Bank also has automated teller machines and is a member of Plus, a national automated teller machine network, and Star, a regional network.
Dover, acquired by FNB United in 2003, originates, underwrites and closes mortgage loans for sale into the secondary market. Dover has a retail origination network based in Charlotte, North Carolina, originating loans for properties located in North Carolina. Dover previously engaged in the wholesale mortgage origination business and conducted retail mortgage origination business outside of North Carolina. These operations were closed in February 2011.
First National Investor Services, Inc., which does business as Marketplace Finance, is engaged in servicing loans purchased by the Bank from automobile dealers.
Competition
The banking industry within the Bank’s marketing area is extremely competitive. The Bank faces direct competition in the counties in which it maintains offices from approximately 112 different financial institutions, including commercial banks, savings institutions and credit unions. Although no one of these entities is dominant, the Bank considers itself to be one of the significant financial institutions in the area in terms of total assets and deposits. Further competition is provided by banks located in adjoining counties, as well as other types of financial institutions, such as insurance companies, finance companies, pension funds and brokerage houses and other money funds. The principal methods of competing in the commercial banking industry are improving customer service through the quality and range of services provided, improving cost efficiencies and pricing services competitively.
Dover faces competition within its market area from other mortgage banking companies and from all types of financial institutions engaged in the mortgage loan business. The principal methods of competing in the mortgage banking business are offering competitively priced mortgage loan products and providing prompt and efficient customer service.
Regulation and Supervision
The following discussion sets forth material elements of the regulatory framework applicable to bank holding companies and their subsidiaries. It also provides certain specific information relevant to FNB United. This regulatory framework is intended primarily for the protection of customers and depositors and the deposit insurance funds that insure deposits of banks and savings institutions, and not for the protection of security holders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. A change in the statutes, regulations or regulatory policies applicable to FNB United or its subsidiaries may have a material effect on the business of the Company. Additional information related to regulatory matters is contained in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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General
As a bank holding company, FNB United is subject to regulation under the Bank Holding Company Act of 1956, as amended, and to inspection, examination and supervision by the Federal Reserve Board. Under the Bank Holding Company Act, bank holding companies, such as FNB United, that have not elected to become financial holding companies under the Gramm-Leach-Bliley Act generally may not acquire ownership or control of more than 5% of the voting shares or substantially all the assets of any company, including a bank, without the Federal Reserve Board’s prior approval. With limited exceptions, bank holding companies may engage only in the business of banking or managing or controlling banks or furnishing services to or performing services for their subsidiary banks. A significant exception is that a bank holding company may own shares in a company whose activities the Federal Reserve Board has determined to be closely related to banking or managing or controlling banks.
As a national banking association, the Bank is subject to regulation and examination primarily by the Office of the Comptroller of the Currency (“OCC”). It is also regulated by the Federal Deposit Insurance Corporation (“FDIC”) and the Federal Reserve Board. The Bank’s deposits are insured by the FDIC through the Deposit Insurance Fund. The OCC and the FDIC impose various requirements and restrictions on the Bank, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged on loans, limitations on the types of investments that may be made and the types of services that may be offered, and requirements governing capital adequacy, liquidity, earnings, dividends, management practices and branching. As a member of the Federal Reserve System, the Bank is subject to the applicable provisions of the Federal Reserve Act, which imposes restrictions on loans by subsidiary banks to a holding company and its other subsidiaries and on the use of stock or securities as collateral security for loans.
Dover, as an operating subsidiary of the Bank, is regulated by the OCC. Because Dover underwrites mortgages guaranteed by the government, it is subject to other audits and examinations as required by the government agencies or the investors who purchase the mortgages.
Various consumer laws and regulations also affect the operations of the Company. In addition to the impact of regulation, financial institutions may be significantly affected by legislation, which can change the statutes affecting them in substantial and unpredictable ways and by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability to influence the economy. The instruments of monetary policy used by the Federal Reserve Board include its open market operations in U.S. Government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements on member bank deposits. The actions of the Federal Reserve Board influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans or paid on deposits.
In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Company.
Liability for Bank Subsidiaries
Under current Federal Reserve Board policy, a bank holding company is expected to act as a source of financial and managerial strength to its subsidiary banks and to maintain resources adequate to support each subsidiary bank. This support may be required at times when the bank holding company may not have the resources to provide it. Similarly, the cross-guaranty provisions of the Federal Deposit Insurance Act provide that if the FDIC suffers or anticipates a loss as a result of a default by a banking subsidiary or by providing assistance to a subsidiary in danger of default, then any other bank subsidiaries may be assessed for the FDIC’s loss. Federal law authorizes the OCC to order an assessment of FNB United if the capital of the Bank were to become impaired. If the assessment were not paid within three months, the OCC could order the sale of FNB United’s stock in the Bank to cover the deficiency.
Any capital loans by a bank holding company to any of its bank subsidiaries are subordinate in right of payment to deposits and to certain other indebtedness of such bank subsidiaries. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Transactions with Affiliates
There are certain restrictions on the ability of FNB United and certain of its nonbank affiliates to borrow from, and engage in other transactions with, its bank subsidiary and on the ability of its bank subsidiary to pay dividends to FNB United. In general, these restrictions require that any extensions of credit must be secured by designated amounts of specified collateral and are limited, as to any one of FNB United or a nonbank affiliate, to 10% of the lending bank’s capital stock and surplus, and, as to FNB United and all such nonbank affiliates in the aggregate, to
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20% of such lending bank’s capital stock and surplus. These restrictions, other than the 10% of capital limit on covered transactions with any one affiliate, are also applied to transactions between national banks and their financial subsidiaries. In addition, certain transactions with affiliates must be on terms and conditions, including credit standards, that are substantially the same, or at least as favorable to the institution, as those prevailing at the time for comparable transactions involving other nonaffiliated companies or, in the absence of comparable transactions, on terms and conditions, including credit standards, that in good faith would be offered to, or would apply to, nonaffiliated companies.
Unsafe and Unsound Practices
The OCC has authority under the Financial Institutions Advisory Act to prohibit national banks from engaging in any activity that, in the OCC’s opinion, constitutes an unsafe or unsound practice in conducting their businesses. The Federal Reserve Board has similar authority with respect to FNB United.
Regulatory Actions
Consent Order
Due to the Bank’s condition, on July 22, 2010, pursuant to a Stipulation and Consent to the Issuance of a Consent Order, the Bank consented and agreed to the issuance of a Consent Order (“Order”) by the OCC. In the Order, the Bank and the OCC agreed as to areas of the bank’s operations that warrant improvement and a plan for making those improvements. The Order includes a capital directive, which requires the Bank to achieve and maintain minimum regulatory capital levels in excess of the statutory minimums to be well-capitalized, and a directive to develop a liquidity risk management and contingency funding plan, in connection with which the Bank could be subject to limitations on the maximum interest rates it can pay on deposit accounts. The Order also contains restrictions on future extensions of credit and requires the development of various programs and procedures to improve the Bank’s asset quality as well as routine reporting on the Bank’s progress toward compliance with the Order to the Board of Directors and the OCC. Specifically, the Order imposed the following requirements on the Bank:
| • | to appoint a Compliance Committee to monitor and coordinate the Bank’s adherence to the Order. |
| • | to develop and submit to the OCC for review a written strategic plan covering at least a three-year period. |
| • | to achieve within 90 days and thereafter maintain total capital at least equal to 12% of risk-weighted assets and Tier 1 capital at least equal to 9% of adjusted total assets. |
| • | to submit to the OCC within 60 days a written capital plan for the Bank covering at least a three-year period. |
| • | to develop, implement and ensure the Bank’s compliance with written programs to improve the Bank’s loan portfolio management and to reduce the high level of credit risk in the Bank. |
| • | to adopt and ensure implementation and adherence to an enhanced written commercial real estate concentration management program consistent with OCC guidelines. |
| • | to obtain current and complete credit information on all loans and ensure proper collateral documentation is maintained on all loans. |
| • | to develop and implement an independent review and analysis process to ensure that appraisals conform to appraisal standards and regulations. |
| • | to implement and adhere to a written program for the maintenance of an adequate allowance for loan losses, providing for review of the allowance by the Board of Directors at least quarterly. |
| • | to increase the Bank’s liquidity to a level sufficient to sustain the Bank’s current operations and to withstand any anticipated or extraordinary demand against its funding base. |
| • | to implement and maintain a comprehensive liquidity risk management program, assessing on an ongoing basis the Bank’s current and projected funding needs and ensuring that sufficient funds or access to funds exists to meet those needs. |
| • | to develop and implement a written program to strengthen internal controls over accounting and financial reporting. |
The Order permits the OCC to extend the time periods under the Order upon written request. Any material failure to comply with the Order could result in further enforcement actions by the OCC. In addition, if the OCC does not accept the capital plan or the Bank fails to achieve and maintain the minimum capital levels, the OCC may require the Bank to sell, merge or liquidate the Bank.
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The Bank has submitted all required materials and plans requested to the OCC within the given time periods. The Board of Directors submitted written strategic plans and capital plans to the OCC covering the requisite three-year period. Upon receipt of the OCC’s written determination of no supervisory objection, the Bank will adopt and implement the plans. The Bank can give no assurance as to whether or when the OCC will provide such written determination. In the meantime, the Bank is working diligently to comply with the terms of the Order and within the parameters of its proposed plans.
Written Agreement
On October 21, 2010, FNB United entered into a written agreement with the Federal Reserve Bank of Richmond (“FRBR”). Pursuant to the agreement, FNB United’s Board of Directors is to take appropriate steps to utilize fully FNB United’s financial and managerial resources to serve as a source of strength to the Bank, including causing the Bank to comply with the Order it entered into with the OCC on July 22, 2010.
In the agreement, FNB United agreed that it would not declare or pay any dividends without prior written approval of the FRBR and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System (the “Director”). It further agreed that it would not take dividends or any other form of payment representing a reduction in capital from the Bank without the FRBR’s prior written approval. The agreement also provides that neither FNB United nor any of its nonbank subsidiaries will make any distributions of interest, principal or other amounts on subordinated debentures or trust preferred securities without the prior written approval of the FRBR and the Director.
The agreement further provides that neither FNB United nor any of its subsidiaries shall incur, increase or guarantee any debt without FRBR approval. In addition, FNB United must obtain the prior approval of the FRBR for the repurchase or redemption of its shares of stock.
Within 60 days from the date of the agreement, FNB United submitted to the FRBR a written plan to maintain sufficient capital at FNB United on a consolidated basis. Within 30 days of the agreement, FNB United submitted to the FRBR a statement of its planned sources and uses of cash for operating expenses and other purposes for 2011. FNB United is to submit such a cash flow projection for each subsequent calendar year by December of the preceding year.
The agreement permits the FRBR to grant written extensions of time for FNB United to comply with its provisions.
FNB United is to report to the FRBR monthly regarding its progress in complying with the agreement. The provisions of the agreement will remain effective and enforceable until they are stayed, modified, terminated, or suspended in writing by the FRBR.
Capital Requirements
FNB United and the Bank are required to comply with federal regulations on capital adequacy. There are two measures of capital adequacy: a risk-based measure and a leverage measure. All capital standards must be satisfied for an institution to be considered in compliance. The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. For additional information, see “Capital Adequacy” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Prompt Corrective Action
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) established a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized), and are required to take certain mandatory supervisory actions, and are authorized to take other discretionary actions, with respect to institutions in the three undercapitalized categories. The severity of the action will depend upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.
The federal banking agencies have specified by regulation the relevant capital level for each category as follows: (1) “Well capitalized,” consisting of institutions with a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater and a leverage ratio of 5.0% or greater and which are not operating under
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an order, written agreement, capital directive or prompt corrective action directive; (2) “Adequately capitalized,” consisting of institutions with a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital of 4.0% or greater and a leverage ratio of 4.0% or greater and which do not meet the definition of a “well capitalized” institution; (3) “Undercapitalized,” consisting of institutions with a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or a leverage ratio of less than 4.0%; (4) “Significantly undercapitalized,” consisting of institutions with a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%; and (5) “Critically undercapitalized,” consisting of institutions with a ratio of tangible equity to total assets that is equal to or less than 2.0%.
An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to certain limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5.0% of an undercapitalized subsidiary’s assets or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. In addition, the appropriate federal banking agency may treat an undercapitalized institution in the same manner as it treats a significantly undercapitalized institution if it determines that those actions are necessary.
Not later than 90 days after an institution becomes critically undercapitalized, the institution’s primary federal bank regulatory agency must appoint a receiver or a conservator, unless the agency, with the concurrence of the FDIC, determines that the purposes of the prompt corrective action provisions would be better served by another course of action. Any alternative determination must be documented by the agency and reassessed on a periodic basis. Notwithstanding the foregoing, a receiver must be appointed after 270 days unless the FDIC determines that the institution has positive net worth, is in compliance with a capital plan, is profitable or has a sustainable upward trend in earnings, and is reducing its ratio of non-performing loans to total loans, and unless the head of the appropriate federal banking agency and the chairperson of the FDIC certify that the institution is viable and not expected to fail.
Dividend Restrictions
FNB United is a legal entity separate and distinct from its bank and other subsidiaries. Because the principal source of FNB United’s revenues is dividends from the subsidiary bank, the ability of FNB United to pay dividends to its shareholders and to pay service on its own debt depends largely upon the amount of dividends its subsidiaries may pay to FNB United. There are statutory and regulatory limitations on the payment of dividends by the Bank to FNB United, as well as by FNB United to its shareholders.
Generally, the Bank must obtain the prior approval of the OCC to pay dividends if the total of all dividends declared by the Bank in any calendar year will exceed the sum of its net income for that year and its retained net income for the preceding two calendar years, less any transfers required by the OCC or to be made to retire any preferred stock. Currently, any dividend declaration by the Bank would require OCC approval under this requirement. Federal law also prohibits the Bank from paying dividends that in the aggregate would be greater than its undivided profits after deducting statutory bad debts in excess of its loan loss allowance.
FNB United and the Bank are also subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. If, in the opinion of the appropriate federal regulatory authority, a bank under its jurisdiction is engaged in or is about to be engaged in an unsafe or unsound practice, the authority may require that the bank cease and desist from such practice. The Federal Reserve Board, the OCC and the FDIC have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), an insured bank may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Further, the Federal Reserve Board, OCC and FDIC have each indicated that banking institutions should generally pay dividends only out of current operating earnings.
The Consent Order with the OCC and the written agreement with the FRBR described above prohibit the payment of dividends by either the Bank or FNB United without written regulatory approval. The FDICIA prohibits dividend payments by the Bank because it is significantly undercapitalized.
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FDIC Insurance
The deposits of the Bank are insured by the Deposit Insurance Fund (“DIF”) of the FDIC up to the limits set forth under applicable law and are subject to the deposit insurance premium assessments of the DIF. The FDIC imposes a risk-based deposit premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”) and further amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category, the FDIC further determines its assessment rate based on certain specified financial ratios or, if applicable, its long-term debt ratings. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. Under the current system, premiums are assessed quarterly. The FDIC has published guidelines under the Reform Act on the adjustment of assessment rates for certain institutions. In addition, insured depository institutions have been required to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation (FICO) to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation.
On October 16, 2008, in response to the problems facing the financial markets and the economy, the Federal Deposit Insurance Corporation published a restoration plan (Restoration Plan) designed to replenish the Deposit Insurance Fund (DIF) such that the reserve ratio would return to 1.15% within five years. On December 16, 2008, the FDIC adopted a final rule increasing risk-based assessment rates uniformly by seven basis points, on an annual basis, for the first quarter 2009.
On February 27, 2009, the FDIC concluded that the problems facing the financial services sector and the economy at large constituted extraordinary circumstances and amended the Restoration Plan and extended the time within which the reserve ratio would return to 1.15% from five to seven years (Amended Restoration Plan). In May 2009, Congress amended the statutory provision governing establishment and implementation of a Restoration Plan to allow the FDIC eight years to bring the reserve ratio back to 1.15%, absent extraordinary circumstances.
On May 22, 2009, the FDIC adopted a final rule imposing a five basis point special assessment on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009. The special assessment was collected on September 30, 2009.
In a final rule issued on September 29, 2009, the FDIC amended the Amended Restoration Plan as follows:
| • | The period of the Amended Restoration Plan was extended from seven to eight years. |
| • | The FDIC announced that it will not impose any further special assessments under the final rule it adopted in May 2009. |
| • | The FDIC announced plans to maintain assessment rates at their current levels through the end of 2010. The FDIC also immediately adopted a uniform three basis point increase in assessment rates effective January 1, 2011 to ensure that the DIF returns to 1.15 percent within the Amended Restoration Plan period of eight years. |
| • | The FDIC announced that, at least semi-annually following the adoption of the Amended Restoration Plan, it will update its loss and income projections for the DIF. The FDIC also announced that it may, if necessary, adopt a new rule prior to the end of the eight-year period to increase assessment rates in order to return the reserve ratio to 1.15 percent. |
On November 12, 2009, the FDIC adopted a final rule requiring insured institutions to prepay their quarterly risk-based deposit insurance assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012, on December 30, 2009, to replenish the depleted insurance fund.
The Dodd-Frank Act makes permanent the $250,000 deposit insurance limit for insured deposits and provides for full insurance of noninterest bearing transaction accounts beginning December 31, 2010, for two years. It also revises the assessment base against which an insured depository institution’s deposit insurance premiums paid to the DIF will be calculated. Under the amendments, the FDIC assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average equity. The Dodd-Frank Act also changes the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits by September 30, 2020, and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds. The FDIC is required to offset the effect of the increased minimum reserve ratio for banks with assets of less than $10 billion.
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On November 21, 2008, the FDIC Board of Directors adopted a final rule implementing the Temporary Liquidity Guarantee Program (“TLGP”). The TLGP consists of two basic components: a guarantee of newly issued senior unsecured debt of banks, thrifts, and certain holding companies (the debt guarantee program) and full guarantee of non-interest bearing deposit transaction accounts, such as business payroll accounts, regardless of dollar amount (the transaction account guarantee program). The purpose of the guarantee of transaction accounts and the debt guarantee was to reduce funding costs and allow banks and thrifts to increase lending to consumers and businesses. All insured depository institutions were automatically enrolled in both programs unless they elected to opt out by a specified date.
As originally adopted, the transaction account guarantee program was to terminate on December 31, 2009, although the FDIC subsequently extended the program through December 31, 2010. The Dodd-Frank Act, which was adopted on July 21, 2010, included a provision that effectively replaced the transaction account guarantee program and extended the unlimited FDIC guarantee of noninterest bearing transaction accounts through December 31, 2012 for all insured depository institutions, not just those that elect to participate. Also, the Dodd-Frank Act provision, unlike the transaction account guarantee program, does not include low-interest NOW accounts within the definition of noninterest-bearing transaction accounts, and such accounts are therefore not covered by unlimited deposit insurance coverage. A subsequent amendment to the Dodd-Frank Act that became effective on December 31, 2010 extended unlimited deposit insurance coverage for “Interest on Lawyers Trust Accounts” through December 31, 2012.
Under the Federal Deposit Insurance Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by a bank’s federal regulatory agency.
Community Reinvestment Act
The Bank is subject to the provisions of the Community Reinvestment Act of 1977, as amended (“CRA”). Under the CRA, all financial institutions have a continuing and affirmative obligation consistent with their safe and sound operation to help meet the credit needs for their entire communities, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA.
The CRA requires the appropriate federal bank regulatory agency, in connection with its examination of the bank, to assess the bank’s record in meeting the credit needs of the community served by the bank, including low- and moderate-income neighborhoods. The regulatory agency’s assessment of the bank’s record is made available to the public. Should the Company fail to serve the community adequately, potential penalties are regulatory denials to expand branches, relocate, add subsidiaries and affiliates, expand into new financial activities and merge with or purchase other financial institutions.
Interstate Banking and Branching
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Interstate Banking Act”) permits interstate acquisitions of banks by bank holding companies. FNB United and any other bank holding company located in North Carolina may acquire a bank located in any other state, and any bank holding company located outside North Carolina may lawfully acquire any North Carolina-based bank, regardless of state law to the contrary, in either case subject to certain deposit-percentage limitations, aging requirements and other restrictions. The Interstate Banking Act, as amended by the Dodd-Frank Act, also generally provides that a national or state-chartered bank may establish de novo branches in another state if the law of the state where the branch is to be located would permit a state bank chartered by that state to open the branch. The Interstate Banking Act and the Dodd-Frank Act may have the effect of increasing competition within the markets in which FNB United operates.
Depositor Preference Statute
Under federal law, depositors and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the “liquidation or other resolution” of such an institution by any receiver.
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Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act allows bank holding companies to engage in a wider range of nonbanking activities, including greater authority to engage in the securities and insurance businesses. Under the Gramm-Leach-Bliley Act, a bank holding company that elects to become a financial holding company may engage in any activity that is financial in nature, is incidental to financial activity or complements financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Activities cited by the law as being “financial in nature” include securities underwriting, dealing in securities and market making, insurance underwriting and agency, providing financial, investment or economic advisory services, and activities that the Federal Reserve Board has determined to be closely related to banking. FNB United has not elected to become a financial holding company.
Subject to certain limitations on investment, a national bank or its financial subsidiary may also engage in activities that are financial in nature, other than insurance underwriting, insurance company portfolio investment, real estate development and real estate investment, so long as the bank is well-capitalized, well-managed and has at least a satisfactory CRA rating. Subsidiary banks of a financial holding company or national banks with financial subsidiaries must continue to be well-capitalized and well-managed to continue to engage in activities that are financial in nature. In addition, a financial holding company or a bank may not acquire a company that is engaged in activities that are financial in nature unless each of the subsidiary banks of the financial holding company or the bank has at least a satisfactory CRA rating.
Privacy and Consumer Protection Laws
The Gramm-Leach-Bliley Act also modified other financial laws, including laws related to financial privacy. Under the act, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The Fair Credit Reporting Act restricts information sharing among affiliates and was amended in December 2003 to restrict further affiliate sharing of information for marketing purposes.
In connection with their lending activities, the Bank and Dover are subject to a number of federal laws designed to protect borrowers. These laws include the Equal Credit Opportunity Act, the Trust in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act.
International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001
The USA Patriot Act of 2001 contains the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the “IMLAFA”). The IMLAFA substantially broadens existing anti-money laundering legislation and the extraterritorial jurisdiction of the United States, imposes compliance and due diligence obligations, creates crimes and penalties, compels the production of documents located both inside and outside the United States, including those of foreign institutions that have a correspondent relationship in the United States, and clarifies the safe harbor from civil liability to customers. The U.S. Treasury Department has issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to financial institutions such as the Bank. The regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. The obligations of financial institutions under the USA Patriot Act have increased and may continue to increase. This increase has resulted in greater costs for the Bank, which may continue to rise and also may subject the Bank to greater liability.
Pursuant to the IMLAFA, the Company established anti-money laundering compliance and due diligence programs.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation and enhanced and timely disclosure of corporate information. The act is intended to allow shareholders to monitor more easily and efficiently the performance of public companies and their directors.
Emergency Economic Stabilization Act of 2008
In response to recent unprecedented market turmoil, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008. EESA established the Troubled Asset Relief Program (“TARP”), which authorizes the Secretary of the Treasury to purchase or guarantee up to $700 billion in troubled assets from financial
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institutions. Pursuant to authority granted under EESA and as part of the TARP, the Secretary created the Capital Purchase Program (“CPP”) under which the Treasury Department would invest up to $250 billion in senior preferred stock of U.S. banks and savings associations or their holding companies. Qualifying financial institutions may issue senior preferred stock with a value equal to not less than 1% of risk-weighted assets and not more than the lesser of $25 billion or 3% of risk-weighted assets.
Institutions participating in the TARP or CPP are required to issue warrants for common or preferred stock or senior debt to the Secretary. If an institution participates in the CPP or if the Secretary acquires a meaningful equity or debt position in the institution as a result of TARP participation, the institution is required to meet certain standards for executive compensation and corporate governance, including a prohibition against incentives to take unnecessary and excessive risks, recovery of bonuses paid to senior executives based on materially inaccurate earnings or other statements and prohibition against the payment of golden parachutes. Additional and modified standards with respect to executive compensation and corporate governance for institutions that have participated or will participate in the TARP (including the CPP) were enacted as part of the American Recovery and Reinvestment Act of 2009 (“ARRA”), described below.
CPP Participation
On February 13, 2009, FNB United entered into a Letter Agreement (the “Purchase Agreement”) with the Treasury Department under the CPP, pursuant to which FNB United agreed to issue 51,500 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Preferred Stock”), having a liquidation amount per share equal to $1,000, for a total price of $51.5 million. The Preferred Stock is to pay cumulative dividends at a rate of 5% per year for the first five years and thereafter at a rate of 9% per year. FNB United may not redeem the Preferred Stock during the first three years except with the proceeds from a “qualified equity offering” (as defined in FNB United’s articles of incorporation). However, under the ARRA, FNB United may redeem the Preferred Stock without a “qualified equity offering,” subject to the approval of its primary federal regulator. After three years, FNB United may, at its option, redeem the Preferred Stock at par value plus accrued and unpaid dividends. The Preferred Stock is generally non-voting, but does have the right to vote as a class on the issuance of any preferred stock ranking senior, any change in its terms or any merger, exchange or similar transaction that would adversely affect its rights. The holder(s) of Preferred Stock also have the right to elect two directors if dividends have not been paid for six periods.
As part of its purchase of the Preferred Stock, the Treasury Department received a warrant (the “Warrant”) to purchase 2,207,143 shares of FNB United’s common stock at an initial per share exercise price of $3.50. The Warrant provides for the adjustment of the exercise price and the number of shares of FNB United’s common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of FNB United’s common stock, and upon certain issuances of FNB United’s common stock at or below a specified price relative to the initial exercise price. The Warrant expires ten years from the issuance date. Pursuant to the Purchase Agreement, the Treasury Department has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant. Under the ARRA, the Warrant would be liquidated upon the redemption by FNB United of the Preferred Stock.
Both the Preferred Stock and the Warrant are accounted for as components of Tier 1 capital.
Prior to February 13, 2012, unless FNB United has redeemed the Preferred Stock or the Treasury Department has transferred the Preferred Stock to a third party, the consent of the Treasury Department will be required for FNB United to (1) declare or pay any dividend or make any distribution on its common stock (other than regular quarterly cash dividends of not more than $0.10 per share of common stock) or (2) redeem, purchase or acquire any shares of its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.
American Recovery and Reinvestment Act of 2009
The ARRA was enacted on February 17, 2009. The ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, the ARRA amends the EESA and imposes certain new executive compensation and corporate governance obligations on all current and future TARP recipients, including FNB United, until the institution has redeemed the preferred stock, which TARP recipients are now permitted to do under the ARRA without regard to the three-year holding period and without the need to raise new capital, subject to approval of its primary federal regulator. The executive compensation restrictions under the ARRA (described below) are more stringent than those currently in effect under the CPP.
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The ARRA amended Section 111 of the EESA to require the Secretary to adopt additional standards with respect to executive compensation and corporate governance for TARP recipients (including FNB United). The standards required to be established by the Secretary include, in part, (1) prohibitions on making golden parachute payments to senior executive officers and the next five most highly compensated employees during such time as any obligation arising from financial assistance provided under the TARP remains outstanding (the “Restricted Period”), (2) prohibitions on paying or accruing bonuses or other incentive awards for certain senior executive officers and employees, except for awards of long-term restricted stock with a value equal to no greater than one-third of the subject employee’s annual compensation that do not fully vest during the Restricted Period or unless such compensation is pursuant to a valid written employment contract prior to February 11, 2009, (3) requirements that TARP CPP participants provide for the recovery of any bonus or incentive compensation paid to senior executive officers and the next 20 most highly-compensated employees based on statements of earnings, revenues, gains or other criteria later found to be materially inaccurate, with the Secretary having authority to negotiate for reimbursement, and (4) a review by the Secretary of all bonuses and other compensation paid by TARP participants to senior executive employees and the next 20 most highly-compensated employees before the date of enactment of the ARRA to determine whether such payments were inconsistent with the purposes of the Act.
The ARRA also sets forth additional corporate governance obligations for TARP recipients, including requirements for the Secretary to establish standards that provide for semi-annual meetings of compensation committees of the board of directors to discuss and evaluate employee compensation plans in light of an assessment of any risk posed from such compensation plans. TARP recipients are further required by the ARRA to have in place company-wide policies regarding excessive or luxury expenditures and to include non-binding shareholder “say-on-pay” proposals in proxy materials. The chief executive officer and chief financial officer are required to provide written certifications with respect to compliance. The Secretary promulgated regulations to implement the executive compensation and certain corporate governance provisions detailed in the ARRA, which became effective June 15, 2009.
Dodd-Frank Wall Street Reform and Consumer Protection Act
On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act is extensive, complicated and comprehensive legislation that affects practically all aspects of a banking organization and represents a significant overhaul of many aspects of the regulation of the financial services industry. It is intended to affect a fundamental restructuring of federal banking regulation. Among other things, the Dodd-Frank Act creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. The Dodd-Frank Act also provides for the creation of a new independent federal regulator to administer federal consumer protection laws.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate its overall financial impact on the Company, its customers or the financial industry more generally. Provisions in the legislation that affect deposit insurance assessments, payment of interest on demand deposits and interchange fees could increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate. Among the provisions that are likely to affect the Company are the following:
Holding Company Capital Requirements - The Dodd-Frank Act requires the Federal Reserve to apply consolidated capital requirements to depository institution holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness.
Corporate Governance - The Dodd-Frank Act will require publicly traded companies to give shareholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. The new legislation also authorizes the Securities and Exchange Commission (“SEC”) to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials. Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is
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publicly traded or not. The Dodd-Frank Act gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.
Prohibition Against Charter Conversions of Troubled Institutions - Effective one year after enactment, the Dodd-Frank Act prohibits a depository institution from converting from a state to federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matter. The converting institution must also file a copy of the conversion application with its current federal regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating hereto.
Interstate Branching - The Dodd-Frank Act authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted to branch. Previously, banks could establish branches in other states only if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely.
Transactions with Affiliates and Insiders - Effective one year from the date of enactment, the Dodd-Frank Act expands the definition of affiliate for purposes of quantitative and qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository institution or its affiliates. The Dodd-Frank Act will apply Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transaction that create credit exposure to an affiliate or an insider. Any such transactions with affiliates must be fully secured. The current exemption from Section 23A for transactions with financial subsidiaries will be eliminated. The Dodd-Frank Act will additionally prohibit an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by the disinterested directors.
Consumer Financial Protection Bureau - The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage,” as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
Future Legislation
Changes to the laws and regulations in the United States and North Carolina can affect the Company’s operating environment in substantial and unpredictable ways. FNB United cannot predict whether those changes in laws and regulations will occur, and, if those changes occur, the ultimate effect they would have upon the financial condition or results of operations of the Company. The nature and extent of future legislative, regulatory or other changes affecting financial institutions is highly unpredictable at this time. Due to the current economic environment and issues facing the financial services industry in particular, new legislative and regulatory initiatives may be anticipated over the next several years, including those focused specifically on banking and mortgage lending.
Employees
As of December 31, 2010, FNB United had four officers, all of whom were also officers of the Bank. On that same date, the Bank had 426 full-time employees and 40 part-time employees and Dover had 56 full-time employees and no part-time employees. The Bank and Dover each considers its relationship with its employees to be excellent.
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The Company provides employee benefit programs, including a matching retirement/savings (“401(k)”) plan, group life, health and dental insurance, paid vacations and sick leave.
The Company’s employee benefit programs formerly included a noncontributory defined benefit pension plan and healthcare and life insurance benefits for retired employees. In September 2006, the Board of Directors of FNB United approved a modified freeze to the pension plan. Effective December 31, 2006, no new employees were eligible to enter the plan. Participants who were at least age 40, had earned 10 years of vesting service as an employee of FNB United and remain an active employee as of December 31, 2006 qualified for continued benefits under a grandfathering provision. Under that provision, the grandfathered participant will continue to accrue benefits under the plan through December 31, 2011. All other eligible participants in the plan had their retirement benefit frozen as of December 31, 2006. Effective January 1, 2007, the 401(k) plan became the primary retirement benefit plan. However, in November 2010, the Board of Directors of the Company approved an additional amendment to the plan which ceases participant benefit accruals as of December 31, 2010.
The Company has a noncontributory, nonqualified supplemental executive retirement plan (the “SERP”) covering certain executive employees. Annual benefits payable under the SERP are based on factors similar to those for the pension plan, with offsets related to amounts payable under the pension plan and social security benefits. SERP costs, which are actuarially determined using the projected unit credit method and recorded on an unfunded basis, are charged to current operations and credited to a liability account on the consolidated balance sheet. In 2010, the Board of Directors approved an amendment to the plan which stops additional benefit accrual under the SERP after December 31, 2010. This action does not impact a participant’s vested or accrued benefit in the plan.
In conjunction with the modified freeze of the pension plan, the postretirement medical and life insurance plan was also amended. Effective December 31, 2006, no new employees were eligible to enter the plan. Participants who were at least age 40, had earned 10 years of vesting service as an employee of the Company and remained an active employee as of December 31, 2006 qualified under a grandfathering provision. Under the grandfathering provision, the participant was eligible to continue to accrue benefits under the plan through December 31, 2011. However, in November 2010, the Board of Directors of the Company approved an additional amendment to the plan which ceases participant benefit accruals as of December 31, 2010.
Available Information
The Company makes its annual report on Form 10-K/A, quarterly reports on Form 10-Q, and current reports on Form 8-K, and amendments to those reports, available free of charge on its internet website atwww.MyYesBank.com, as soon as reasonably practicable after the reports are electronically filed or furnished with the Securities and Exchange Commission. Any materials that the Company files with the SEC may be read or copied or both at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. These filings are also accessible on the SEC’s website atwww.sec.gov. FNB United will provide without charge a copy of its annual report on Form 10-K/A to any shareholder by mail. Requests should be sent to FNB United Corp., Attention: Secretary, 150 South Fayetteville Street (27203), P.O. Box 1328, Asheboro, North Carolina 27204.
Additionally, the Company’s corporate governance policies, including the charters of the Audit, Compensation, and Corporate Governance and Nominating Committees; and the Company’s Code of Business Ethics may also be found through the “Investor Relations” link on the Company’s website.
| Item 1A. | RISK FACTORS |
The Company is subject to certain risks and an investment in the Company’s securities may involve risks due to the nature of the Company’s business and activities related to that business. In addition to the factors discussed below, please see the discussion under “Item 7A. Quantitative and Qualitative Disclosure about Market Risk.” These factors, along with the other information in this Annual Report on Form 10-K/A, should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements.
Failure to Comply with Regulatory Orders Could Result in Adverse Actions and Restrictions.
The Company is operating under a Consent Order issued by the OCC, the Bank’s primary regulator, on July 22, 2010, and a written agreement with the Federal Reserve Bank of Richmond, entered into on October 21, 2010. In the Consent Order, the Bank and the OCC agreed as to the areas of the Bank’s operations that warrant improvement and a plan for making those improvements. The Consent Order required the Bank to develop and submit written strategic and capital plans covering at least a three-year period. The Bank is required to review and revise various policies and procedures, including those associated with concentration management, the allowance for loan losses,
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liquidity management, criticized asset, loan review and credit. The written agreement with the Federal Reserve Bank obligates FNB United to cause the Bank to comply with the OCC Consent Order and requires, among other things, that FNB United submit to it an acceptable written capital plan for the Company, cash flow projections for 2011 and thereafter on an annual basis, and quarterly progress reports as to its compliance with the agreement.
Any material failure to comply with the provisions of the Consent Order could result in further enforcement actions by the OCC or the Federal Reserve Bank. In addition, if the OCC does not accept the capital plan or the Bank fails to achieve the minimum capital levels, the OCC may require that the Bank develop a plan to sell, merge or liquidate the Bank. While the Company intends to take such actions as may be necessary to enable it to comply with the requirements of the Consent Order and the written agreement, there can be no assurance that the Bank will be able to comply fully with the provisions of the Consent Order, or that efforts to comply with the Consent Order and written agreement, particularly the limitations on interest rates offered by the Bank, will not have adverse effects on the operations and financial condition of the Company and the Bank.
There Is Substantial Doubt about FNB United’s Ability to Continue as a Going Concern.
As discussed above, the Bank is subject to a Consent Order issued by the OCC and FNB United is under a written agreement with the Federal Reserve Bank of Richmond that require the Company to increase its leverage and total risk-based capital ratios and, at December 31, 2010, the Company was significantly below the required levels. Failure to increase the Company’s capital ratios or further declines in the capital ratios exposes the Company to additional restrictions and regulatory actions, including potential regulatory receivership. This uncertainty as to the Company’s ability to meet existing or future regulatory requirements raises substantial doubt about its ability to continue as a going concern. Unless the Company is able to raise sufficient levels of capital in the very near future, it will be unable to meet the capital ratio requirement. The Company’s audited financial statements were prepared under the assumption that it will continue its operations on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business. The Company’s financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. If the Company cannot continue as a going concern, the FNB United shareholders will lose some or all of their investment in the Company. In addition, the Bank’s customers, employees, vendors, correspondent institutions, and others with whom the Bank does business may react negatively to the substantial doubt about our ability to continue as a going concern. This negative reaction may lead to heightened concerns regarding the Company’s financial condition that could result in a significant loss in deposits and customer relationships, key employees, vendor relationships and our ability to do business with correspondent institutions upon which we rely.
The Bank Is Significantly Undercapitalized; A Further Decline in FNB United’s Capital Position, and the Unavailability of Additional Regulatory Capital, Could Adversely Its Financial Condition and Operations.
At December 31, 2010, the Bank was classified as “significantly undercapitalized” for regulatory capital purposes. Being significantly undercapitalized subjects the Bank to prompt corrective action restrictions on its activities, including, without limitation, limitations on its asset growth and possible required reductions in assets, restrictions on interest rates payable on deposits, prohibitions on accepting, renewing or rolling over brokered deposits, additional restrictions on transactions with affiliates, a prohibition on the Bank’s accepting employee benefit plan deposits and the required alteration or termination of any activity that the OCC determines poses excessive risks to the Bank. If the Bank were to become classified as “critically undercapitalized,” the Bank may be subject to being placed in regulatory receivership.
FNB United’s ability to increase and maintain capital levels, sources of funding and liquidity could be adversely affected by changes in the capital markets in which the Company operates. Loan loss provisions of $132.8 million during 2010 contributed to the decrease in total capital to risk-adjusted assets at both FNB United and the Bank. FNB United’s ability to raise additional capital will depend on conditions in the capital markets, which are outside the Company’s control, and on FNB United’s financial performance and its ability to obtain resolution of nonperforming assets. Additional significant increases in the Bank’s allowance for loan losses, significant write-downs of foreclosed real estate and other assets, or other operating losses would decrease the Company’s capital levels further.
FNB United Is Vulnerable to the Economic Conditions within the Relatively Small Region in Which It Operates
FNB United’s overall success is dependent on the general economic conditions within its market area, which extends from the central and southern Piedmont and Sandhills of North Carolina to the foothills and mountains of western North Carolina. The economic downturn in this fairly small geographic region has negatively affected FNB United’s customers and has adversely affected FNB United. For example, high levels of unemployment and
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depressed real estate values have weakened the economy of the region and depressed the Company’s earnings and financial condition.
Overall, during 2009 and 2010, the North Carolina business environment has been adverse for many households and businesses and continues to deteriorate. There can be no assurance that these conditions will improve in the near term. The continuation of these conditions could further adversely affect the credit quality of the Company’s loans, the value of collateral securing loans to borrowers, the value of the Company’s investment securities and its overall results of operation and financial condition. Until the economic conditions within FNB United’s footprint improve, the Company expects that its business, financial condition and results of operations to be adversely affected.
Weaknesses in the Markets for Residential or Commercial Real Estate Could Reduce FNB United’s Net Income and Profitability
Real estate lending (including commercial, construction, land development, and residential) is a large portion of the Bank’s loan portfolio. These categories constitute $1.2 billion, or approximately 89.4%, of the Bank’s total loan portfolio. These categories are generally affected by changes in economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax and other laws and acts of nature. Further downturns in the real estate markets in which the Company originates, purchases, and services mortgage and other loans could hurt its business because these loans are secured by real estate. The softening of the real estate market through 2009 and 2010 has adversely affected the Company’s net income. If there are further declines in the market, they will adversely affect the Company’s future earnings.
FNB United Faces Significant Operational Risk
FNB United is exposed to many types of operational risk, including reputational risk, legal and compliance risk. Operational risk includes the risk of fraud or theft by employees or persons outside FNB United, unauthorized transactions by employees or operational errors, including clerical or recordkeeping errors or those resulting from faulty or disabled computer or telecommunications systems, and breaches of the internal control system and compliance requirements. Negative public opinion can result from FNB United’s actual or alleged conduct in a variety of areas, including lending practices, corporate governance and acquisitions and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect FNB United’s ability to attract and retain customers and can expose it to litigation and regulatory action. Operational risk also includes potential legal actions that could arise from an operational deficiency or as a result of noncompliance with applicable regulatory standards.
Because the nature of the banking business involves a high volume of transactions, certain errors may be repeated or compounded before they are found and corrected. FNB United’s necessary reliance upon automated systems to record and process its transactions may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. FNB United may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (e.g., computer viruses or electrical or telecommunications outages), which may give rise to disruption of service to customers and to financial loss or liability. The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their employees as is FNB United) and to the risk that the Company’s (or its vendors’) business continuity and data security systems prove to be inadequate.
FNB United’s Decisions Regarding Credit Risk Could Be Inaccurate and Its Allowance for Loan Losses May Be Inadequate, Which May Adversely Affect FNB United’s Financial Condition and Results of Operations
The Company’s largest source of revenue is payments on loans made to the Bank’s customers. Borrowers may not repay their loans according to the terms of those loans, and the collateral securing the payment of the loans may not be sufficient to assure repayment. The Company may experience significant loan losses, which could have a material adverse effect on FNB United’s operating results. Management makes various assumptions and judgments about the collectability of the loan portfolio, including the creditworthiness of the borrowers and the value of the real estate, which is obtained from independent appraisers, and other assets serving as collateral for the repayment of the loans.
FNB United maintains an allowance for loan losses that it considers adequate to absorb losses inherent in the loan portfolio based on its assessment of all available information. In determining the size of the allowance, FNB United relies on an analysis of the loan portfolio based on, among other things, historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and nonaccruals, and general economic
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conditions, both local and national. If management’s assumptions are wrong, the loan loss allowance may not be sufficient to cover loan losses, and adjustments may be necessary to allow for different economic conditions or adverse developments in the loan portfolio. Material additions to the allowance would materially decrease FNB United’s net income. Banking regulators periodically review the Company’s allowance for loan losses and may require FNB United to increase the allowance or recognize further loan charge-offs based on judgments different from those of management. Any increase in the allowance for loan losses or loan charge-offs required by regulatory authorities could have a negative effect on FNB United’s operating results.
Increases in FDIC Insurance Premiums May Adversely Affect FNB United’s Net Income and Profitability.
FNB United is generally unable to control the amount of premiums that the Company is required to pay for FDIC insurance. During 2008 and continuing in 2010, higher levels of bank failures have dramatically increased resolution costs of the FDIC and depleted the deposit insurance fund. In addition, the FDIC instituted two temporary programs to further insure customer deposits at FDIC insured banks: deposit accounts are now insured up to $250,000 per customer (up from $100,000) and noninterest-bearing transactional accounts are currently fully insured (unlimited coverage). These programs have placed additional stress on the deposit insurance fund. To maintain a strong funding position and restore reserve ratios of the deposit insurance fund, the FDIC has increased assessment rates of insured institutions. On November 12, 2009, the FDIC adopted a rule requiring banks to prepay three years worth of estimated deposit insurance premiums by December 31, 2009. The Dodd-Frank Act also imposes additional assessments and costs with respect to deposits, requiring the FDIC to impose deposit insurance assessments based on total assets rather than total deposits, as well as making permanent the increase of deposit insurance to $250,000 and providing for full insurance of non-interest bearing transaction accounts beginning December 31, 2010, for two years. These announced increases, legislative and regulatory changes and any future increases or required prepayments of FDIC insurance premiums may adversely affect FNB United’s earnings and financial condition. If there are additional bank or financial institution failures, or the cost of resolving prior failures exceeds expectations, the Company may be required to pay even higher FDIC premiums than the recently increased levels.
FNB United’s Liquidity Could Be Impaired by an Inability to Access the Capital Markets or an Unforeseen Outflow of Cash.
Liquidity is essential to FNB United’s businesses and FNB United has a significant base of core deposits, which historically has been stable. Due to circumstances that FNB United may be unable to control, however, such as a general market disruption or an operational problem that affects third parties or FNB United, the Company’s liquidity could be impaired by an inability to access the capital markets or an unforeseen outflow of cash.
The Capital and Credit Markets Have Experienced Unprecedented Levels of Volatility.
During the economic downturn, the capital and credit markets experienced extended volatility and disruption. In some cases, the markets produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength. If these levels of market disruption and volatility continue, worsen or abate and then arise at a later date, the Company’s ability to access capital could be materially impaired. FNB United’s inability to access the capital markets could constrain the Company’s ability to comply with the terms of the Consent Order with the OCC and the written agreement with the Federal Reserve Bank of Richmond, to make new loans, and to meet the Company’s existing lending commitments and, ultimately jeopardize the Company’s overall liquidity and capitalization.
FNB United May Experience Significant Competition in its Market Area, Which May Adversely Affect its Business
The commercial banking industry within FNB United’s market area is extremely competitive. In addition, FNB United competes with other providers of financial services, such as savings and loan associations, credit unions, insurance companies, consumer finance companies, brokerage firms, the mutual funds industry, and commercial finance and leasing companies, some of which are subject to less extensive regulations than is the Company with respect to the products and services they provide. Some of FNB United’s larger competitors include several large interstate financial holding companies that are among the largest in the nation and are headquartered in North Carolina. These companies have a significant presence in FNB United’s market area, have greater resources than FNB United, may have higher lending limits and may offer products and services not offered by FNB United. These institutions may be able to offer the same products and services at more competitive rates and prices.
FNB United also experiences competition from a variety of institutions outside of the Company’s market area. Some of these institutions conduct business primarily over the Internet and may thus be able to realize certain cost savings and offer products and services at more favorable rates and with greater convenience to the customer who
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can pay bills and transfer funds directly without going through a bank. This “disintermediation” could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect FNB United’s operations, and the Company may be unable to timely develop competitive new products and services in response to these changes.
Changes in Interest Rates May Have an Adverse Effect on FNB United’s Profitability
FNB United’s earnings and financial condition are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of the margin between interest rates earned on loans and investments and the interest rates paid on deposits and borrowings could adversely affect FNB United’s earnings and financial condition. FNB United can neither predict with certainty nor control changes in interest rates. These changes can occur at any time and are affected by many factors, including national, regional and local economic conditions, competitive pressures, and monetary policies of the Federal Reserve Board. FNB United has ongoing policies and procedures designed to manage the risks associated with changes in market interest rates. Notwithstanding these policies and procedures, changes in interest rates may have an adverse effect on FNB United’s financial results. For example, high interest rates could adversely affect FNB United’s mortgage banking business because higher interest rates could cause customers to apply for fewer mortgages or mortgage refinancings.
FNB United’s Ability to Pay Dividends Is Limited and the Payment of Any Dividend Has Been Restricted by Law and Regulatory Order, Leaving Appreciation in the Value of the Company’s Common Stock as the Sole Opportunity for Returns on Investments Made in FNB United Common Stock.
The holders of FNB common stock are entitled to receive dividends when and if declared by the board of directors out of funds legally available for the payment of dividends. Because the principal source of FNB United’s revenues is dividends from the Bank, the ability of FNB United to pay dividends to its shareholders is dependent upon the amount of dividends the Bank may pay to FNB United. There are statutory and regulatory limitations on the payment of dividends by the Bank to FNB United, as well as by FNB United to its shareholders.
The Federal Deposit Insurance Corporation Improvement Act prohibits the Bank’s paying any dividend because of its being “significantly undercapitalized.” In addition, under the terms of the Consent Order with the OCC, the Bank is prohibited from paying any dividends or making any capital distributions until such time as it is compliance with the capital plan required by the Consent Order and it receives the prior written approval of the OCC. In addition, the Bank must obtain the prior approval of the OCC to pay dividends if the total of all dividends declared by the Bank in any calendar year will exceed the sum of its net income for that year and its retained net income for the preceding calendar years, less certain transfers. The written agreement between FNB United and the Federal Reserve Bank of Richmond prohibits FNB United from declaring or paying any dividends without the prior written approval of the Federal Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. The written agreement further prohibits FNB United from taking any dividends or any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank.
The Treasury Department’s Investment in FNB United Imposes Restrictions and Obligations Limiting FNB United’s Ability to Increase Dividends, Repurchase Common Stock or Preferred Stock and Access the Equity Capital Markets
In February 2009, FNB United issued preferred stock and a warrant to purchase common stock to the Treasury Department under the CPP. Prior to February 13, 2012, unless FNB United has redeemed all of the preferred stock, or the Treasury Department has transferred all of the preferred stock to a third party, the consent of the Treasury Department will be required for FNB United to, among other things, increase quarterly common stock dividends beyond $0.10 per share or effect repurchases of common stock or other equity or capital securities (with certain exceptions, including the repurchase of FNB United Corp. common stock to offset share dilution from equity-based employee compensation awards). FNB United’s ability to declare or pay dividends or repurchase its common stock or other equity or capital securities is also subject to restrictions in the event that FNB United fails to declare and pay full dividends (or declare and set aside a sum sufficient for payment thereof) on the preferred stock held by the Treasury Department.
The Company’s Decision to Defer Interest on Its Trust Preferred Securities Will Likely Restrict Its Access to the Trust Preferred Securities Market until Such Time as It Is Current on Interest Payments, Which Will Limit Its Sources of Liquidity.
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On April 22, 2010, the Board of Directors elected to defer further interest payments on each of the series of junior subordinated debt securities relating to the trust preferred securities of FNB United Statutory Trust I, FNB United Statutory Trust II, and Catawba Valley Capital Trust II. The Company has the right under each indenture for the junior subordinated debt securities to defer interest payments for up to 20 consecutive calendar quarters. The deferral provisions for these securities were intended to provide the Company with a measure of financial flexibility during times of financial stress due to market conditions, such as the current state of the financial and real estate markets.
As a result of the Company’s election to exercise its contractual right to defer interest payments on its junior subordinated debt securities, it is likely that the Company will not have access to the trust preferred securities market until the Company becomes current on those obligations. This may also adversely affect the Company’s ability in the market to obtain debt financing. Therefore, the Company is likely to have greater difficulty in obtaining financing and, thus, will have fewer sources to enhance its capital and liquidity position. In addition, the Company will be unable to pay dividends on its common stock until such time as the Company is current on interest payments on its junior subordinated debt securities. Currently there is no market for trust preferred securities.
FNB United’s Stock Price Can Be Volatile.
FNB United’s stock price can fluctuate widely in response to a variety of factors including actual or anticipated variations in quarterly operating results, recommendations by securities analysts, operating and stock price performance of other companies that investors deem comparable to FNB United, news reports relating to trends, concerns and other issues in the financial services industry, changes in government regulations, and geopolitical conditions such as acts or threats of terrorism or military conflicts.
FNB United’s Business Could Suffer If It Fails to Attract and Retain Skilled People
FNB United’s success depends, in large part, on its ability to attract and retain competent, experienced people. As a result of FNB United’s participation in the CPP, the Company is required to meet certain standards for executive compensation as set forth under the EESA, and related regulations. The Company’s financial condition and results of operations have caused the board of directors of FNB United to freeze salaries and members of management generally have not seen increases in their salaries since 2008. The imposition of compensation limits resulting from the Treasury Department’s investment in FNB United and the salary freeze, in addition to other competitive pressures, may have an adverse effect on the ability of FNB United to attract and retain skilled personnel, resulting in FNB United’s not being able to hire or retain the best people. The loss of key personnel could have an adverse effect on the Bank and the Company’s future results of operations.
Changes in Laws and Regulations and the Regulatory Environment Could Have a Material Adverse Effect on FNB United
FNB United is extensively regulated under federal and state banking laws and regulations that are intended primarily for the protection of depositors, federal deposit insurance funds and the banking system as a whole. In addition, the Company is subject to changes in federal and state laws as well as changes in banking and credit regulations, and governmental economic and monetary policies. FNB United cannot predict whether any of these changes may adversely and materially affect the Company. The current regulatory environment for financial institutions entails significant potential increases in compliance requirements and associated costs, including those related to consumer credit, with a focus on mortgage lending. For example, the enactment of the Dodd-Frank Act represents a significant overhaul of many aspects of the regulation of the financial services industry, which could result in higher compliance costs and otherwise materially adversely affect FNB United’s business, financial condition or results of operations.
Federal and state banking regulators possess broad powers to take supervisory actions as they deem appropriate. These actions may result in higher capital requirements, higher insurance premiums and limitations on FNB United’s activities that could have a material adverse effect on the Company’s business and profitability.
The Passage of the Dodd-Frank Act May Result in Lower Revenues and Higher Costs.
On July 21, 2010, the President signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law. The law includes, among other things: the creation of a Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation; the creation of a Bureau of Consumer Financial Protection (“CFPB”) authorized to promulgate and enforce consumer protection regulations relating to financial products, which would affect both banks and non-bank finance companies; the establishment of strengthened capital and prudential standards for banks and bank holding companies; enhanced regulation of financial markets, including
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derivatives and securitization markets; the elimination of certain trading activities from banks; and a permanent increase of the previously implemented temporary increase of FDIC deposit insurance to $250,000.
While the bill has been signed into law, a number of provisions of the law remain to be implemented through the rulemaking process at various regulatory agencies. FNB United is unable to predict what the final form of these rules will be when implemented by the respective agencies, but management believes that certain aspects of the new legislation, including, without limitation, the additional cost of higher deposit insurance and the costs of compliance with disclosure and reporting requirements and examinations by the CFPB, could have a significant impact on the Company’s business, financial condition and results of operations. Additionally, FNB United cannot predict whether there will be additional proposed laws or reforms that would affect the U.S. financial system or financial institutions, whether or when such changes may be adopted, how such changes may be interpreted and enforced or how such changes may affect the Company.
The Provisions of the Dodd-Frank Act Restricting Bank Interchange Fees May Negatively Affect FNB United’s Revenues and Earnings.
Under the Dodd-Frank Act, the Federal Reserve must adopt rules regarding the interchange fees that may be charged with respect to electronic debit transactions, to take effect one year after enactment. The limits to be placed on debit interchange fees may significantly reduce the Bank’s debit card interchange revenues. Interchange fees, or “swipe” fees, are charges that merchants pay to the Bank and other credit card companies and card-issuing banks for processing electronic payment transactions. The Dodd-Frank Act provides the Federal Reserve with authority over interchange fees received or charged by a card issuer and requires that fees must be “reasonable and proportional” to the costs of processing such transactions. Although final rules have not yet been adopted, this provision of the Dodd-Frank Act and the applicable rules ultimately issued under the Act are expected to cause significant reductions in future card-fee revenues generated by the Bank, while also creating meaningful compliance costs.
Recently Enacted Consumer Protection Regulations Related to Automated Overdraft Payment Programs Could Adversely Affect FNB United’s Business Operations, Net Income and Profitability.
The Federal Reserve and the FDIC recently enacted consumer protection regulations related to automated overdraft payment programs offered by financial institutions. The Bank has implemented, and is in the process further implementing, changes to its business practices relating to overdraft payment programs to comply with these regulations.
For the years ended December 31, 2010 and December 31, 2009, the Bank’s overdraft and insufficient funds fees have represented a significant amount of non-interest fees collected by it. Implementing the changes required by these regulations will decrease the amount of fees the Bank receives for automated overdraft payment services and adversely affect the Bank’s non-interest income. Complying with these regulations results in increased operational costs for the Bank, which may continue to rise. The actual impact of these regulations in future periods could vary due to a variety of factors, including changes in customer behavior, economic conditions and other factors, which could adversely affect FNB United’s business operation, net income and profitability.”
Differences in Interpretation of Tax Laws and Regulations May Adversely Affect FNB United’s Financial Statements.
Local, state or federal tax authorities may interpret tax laws and regulations differently than FNB United and challenge tax positions that FNB United has taken on its tax returns. This may result in the disallowance of deductions or credits, differences in the timing of deductions and the payment of additional taxes, interest or penalties that could have a material adverse effect on FNB United’s performance.
Significant Litigation Could Have a Material Adverse Effect on FNB United.
FNB United faces legal risks in its business, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high. Substantial legal liability or significant regulatory action against FNB United may have material adverse financial effects or cause significant reputational harm to FNB United, which in turn could seriously harm FNB United’s business prospects.
Maintaining or Increasing FNB United’s Market Share May Depend on Lowering Prices and Market Acceptance of New Products and Services.
FNB United’s success depends, in part, on its ability to adapt its products and services to evolving industry standards. There is increasing pressure to provide products and services at lower prices. Lower prices can reduce FNB United’s net interest margin and revenues from its fee-based products and services. In addition, the widespread
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adoption of new technologies, including internet services, could require the Company to make substantial expenditures to modify or adapt its existing products and services. Also, these and other capital investments in FNB United’s business may not produce expected growth in earnings anticipated at the time of the expenditure. The Company may not be successful in introducing new products and services, achieving market acceptance of its products and services, or developing and maintaining loyal customers.
Market Developments May Adversely Affect FNB United’s Industry, Business and Results of Operations.
Significant declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by many financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. During this time FNB United has experienced significant challenges, its credit quality has deteriorated and its net income and results of operations have been adversely affected. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers including other financial institutions. FNB United is part of the financial system and a systemic lack of available credit, a lack of confidence in the financial sector, increased volatility in the financial markets and/or reduced business activity could materially adversely affect the Company’s business, financial condition and results of operations.
The Soundness of Other Financial Institutions Could Adversely Affect FNB United.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. FNB United has exposure to many different industries and counterparties, and FNB United routinely executes transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose the Company to credit risk in the event of default of its counterparty or client. In addition, the Company’s credit risk may be exacerbated when collateral is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due FNB United. These types of losses could materially and adversely affect the Company’s results of operations or financial condition.
FNB United Faces Systems Failure Risks as Well as Security Risks, Including “Hacking” and “Identity Theft”
The computer systems and network infrastructure used by FNB United and others could be vulnerable to unforeseen problems. These problems may arise in the Company’s internally developed systems or the systems of its third-party vendors or both. The Company’s operations are dependent upon its ability to protect computer equipment against damage from fire, power loss, or telecommunications failure. Any damage or failure that causes an interruption in the Company’s operations could adversely affect FNB United’s business and financial results. In addition, the Company’s computer systems and network infrastructure present security risks, and could be susceptible to hacking or identity theft.
FNB United’s Reported Financial Results Depend on Management’s Selection of Accounting Methods and Certain Assumptions and Estimates.
FNB United’s accounting policies and methods are fundamental to the methods by which the Company records and reports its financial condition and results of operations. The Company’s management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report FNB United’s financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in the Company reporting materially different results than would have been reported under a different alternative.
Certain accounting policies are critical to presenting FNB United’s financial condition and results. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These critical accounting policies include: the allowance for credit losses; the determination of fair value for financial instruments; the valuation of goodwill and other intangible assets; the accounting for pension and postretirement benefits and the accounting for income taxes. Because of the uncertainty of estimates involved in these matters, the Company may be required to do one or more of the following: significantly increase the allowance for credit losses or sustain credit losses that are significantly higher than the reserve provided or both; recognize significant
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impairment on its financial instruments and other intangible asset balances; or significantly increase its liabilities for taxes or pension and post retirement benefits.
Management Has Identified Two Material Weaknesses in FNB United’s Internal Control over Financial Reporting, Which If Not Remediated Could Result in Material Misstatements in FNB United’s Future Interim and Annual Financial Statements and Have a Material Adverse Effect on FNB United’s Business, Financial Condition and Results of Operations and the Price of FNB United Common Stock.
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles.
As further described in Item 9A “Controls and Procedures,” management has two identified a material weaknesses in the Company’s internal control over financial reporting. A material weakness, as defined in the standards established by the Public Company Accounting Oversight Board (PCAOB), is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a corporation’s annual or interim financial statements will not be prevented or detected on a timely basis. The Company identified the material weaknesses in its internal control over financial reporting as of December 31, 2010, based upon there being ineffective controls with respect to the timely recognition and measurement of impairment of other real estate owned and the identification and recognition of subsequent events affecting the valuation of other real estate owned and impaired loans.
Although the Company is in the process of implementing initiatives aimed at addressing the material weaknesses and preventing additional material weaknesses from occurring, these initiatives may not remediate the material weaknesses or prevent additional material weaknesses from occurring. Failure to achieve and maintain effective internal control over financial reporting could result in FNB United’s not being able to report accurately its financial results, prevent or detect fraud or provide timely and reliable financial information pursuant to FNB United’s reporting obligations as a public company, which could have a material adverse effect on the Company’s business, financial condition and results of operations. It also could cause FNB United’s investors to lose confidence in the financial information reported by the Company, adversely affecting the price of FNB United common stock.
Changes in Accounting Standards Could Materially Affect FNB United’s Financial Statements.
From time to time accounting standards setters change the financial accounting and reporting standards that govern the preparation of FNB United’s financial statements. These changes can be hard to predict and can materially affect how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to retained earnings.
FNB United Relies on Other Companies to Provide Key Components of Its Business Infrastructure.
Third party vendors provide key components of FNB United’s business infrastructure such as internet connections and network access. While FNB United has selected these third party vendors carefully, it does not control their actions. Any problems caused by these third parties, including those which result from their failure to provide services for any reason or their poor performance of services, could adversely affect FNB United’s ability to deliver products and services to its customers and otherwise to conduct its business. Replacing these third party vendors could also entail significant delay and expense.
There Is a Limited Market for FNB United Common Stock
Although FNB United common stock is traded on The Nasdaq Capital Market, the volume of trading has historically been limited, averaging 27,291shares per day. Therefore, there can be no assurance that a holder of FNB United common stock who wishes to sell his or her shares would be able to do so immediately or at an acceptable price.
The Price of the Company’s Common Stock and FNB United’s Shareholders’ Equity May Not Reach Levels Necessary to Maintain Listing on Nasdaq, Resulting in Further Limitations in the Market for FNB United Common Stock.
FNB United’s common stock is currently listed on The Nasdaq Capital Market. On August 2, 2010, FNB United received a written notice from The Nasdaq Stock Market indicating that FNB United was not in compliance with Rule 5450(a)(1), the bid price rule, because the closing bid price per share of its common stock had been below $1.00 per share for 30 consecutive business days. In accordance with the rules of The Nasdaq Stock Market, FNB
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United was afforded a 180-day grace period to achieve compliance with the bid price rule. As of January 31, 2011, FNB United had not achieved compliance and submitted an application to The Nasdaq Stock Market to transfer the listing of its common stock to The Nasdaq Capital Market from The Nasdaq Global Select Market, where it had been listed. The application was granted effective February 3, 2011, and FNB United became eligible for an additional 180 calendar day period, or until August 1, 2011, to achieve compliance with the bid price rule. Approval to transfer to The Nasdaq Capital Market was conditioned upon FNB United’s agreeing to effect a reverse stock split during the additional 180-day period should it become necessary to do so to meet the minimum $1.00 bid price per share requirement. There can be no assurance that the bid price rule will be satisfied during the additional grace period.
The continued listing standards of The Nasdaq Capital Market provide that FNB United must meet certain other minimum levels, among them minimum shareholders’ equity. At December 31, 2010, FNB United did not meet any of the standards for continued listing and anticipates receiving a notice of deficiency from The Nasdaq Stock Market. Upon receiving that notice, FNB United expects to submit a written plan of compliance, which will include plans to increase its shareholders’ equity to satisfy the minimum requirement. The Nasdaq Stock Market may in its discretion grant up to 180 days for FNB United to increase its shareholders’ equity. There can be no assurance that The Nasdaq Stock Market will accept such a plan and grant a sufficient period of time for the plan to be accomplished or that FNB United will successfully the implement the plan.
The perception or possibility that FNB United’s common stock could be delisted in the future could negatively affect its liquidity and price. Delisting would have an adverse effect on the liquidity of the common shares and, as a result, the market price for the common stock might become more volatile. Delisting could also make it more difficult for the Company to raise additional capital. Although the Company expects that quotes for its common stock would continue to be available on the OTC Bulletin Board or on the “Pink Sheets,” such alternatives are generally considered to be less efficient markets, and the stock price, as well as the liquidity of the common stock, may be adversely affected as a result.
Also, in the future FNB United could fall out of compliance with other minimum criteria for continued listing. A failure to meet any of these other continued listing requirements could result in delisting of FNB United common stock.
Certain Provisions of FNB United’s Articles of Incorporation and Bylaws May Discourage Takeovers
FNB United’s articles of incorporation and bylaws contain certain anti-takeover provisions that may discourage or may make more difficult or expensive a tender offer, change in control or takeover attempt that is opposed by FNB United’s board of directors. In particular, FNB United’s articles of incorporation and bylaws:
| • | classify its board of directors into three classes, so that shareholders elect only one-third of its board of directors each year. |
| • | permit FNB United’s board of directors to issue, without shareholder approval unless otherwise required by law, voting preferred stock with such terms as the board may determine, and |
| • | require the affirmative vote of the holders of at least 75% of FNB United’s voting shares to approve major corporate transactions unless the transaction is approved by three-fourths of FNB United’s “disinterested” directors. |
These provisions of FNB United’s articles of incorporation and bylaws could discourage potential acquisition proposals and could delay or prevent a change in control, even though a majority of FNB United’s shareholders may consider such proposal desirable. Such provisions could also make it more difficult for third parties to remove and replace the members of FNB United’s board of directors. They may also inhibit increases in the trading price of FNB United’s common stock that could result from takeover attempts.
Acts or Threats of Terrorism and Political or Military Actions Taken by the United States or Other Governments Could Adversely Affect General Economic or Industry Conditions.
Geopolitical conditions may affect FNB United’s earnings. Acts or threats of terrorism and political or military actions taken by the United States or other governments in response to terrorism, or similar activity, could adversely affect general economic or industry conditions.
Unpredictable Catastrophic Events Could Have a Material Adverse Effect on FNB United.
The occurrence of catastrophic events such as hurricanes, tropical storms, earthquakes, pandemic disease, windstorms, floods, severe winter weather (including snow, freezing water, ice storms and blizzards), fires and other
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catastrophes could adversely affect FNB United’s consolidated financial condition or results of operations. Unpredictable natural and other disasters could have an adverse effect on the Company in that such events could materially disrupt its operations or the ability or willingness of its customers to access the financial services offered by FNB United. The Company’s property and casualty insurance operations also expose it to claims arising out of catastrophes. The incidence and severity of catastrophes are inherently unpredictable. Although the Company carries insurance to mitigate its exposure to certain catastrophic events, these events could nevertheless reduce FNB United’s earnings and cause volatility in its financial results for any fiscal quarter or year and have a material adverse effect on FNB United’s financial condition or results of operations or both.
Other Risks
There are risks and uncertainties relating to an investment in FNB United common stock or to economic conditions and regulatory matters generally that should affect other financial institutions in similar ways. These aspects are discussed under “Cautionary Statement Regarding Forward-Looking Statements” and “Regulation and Supervision” elsewhere in this Annual Report on Form 10-K/A.
| Item 1B. | UNRESOLVED STAFF COMMENTS |
Not Applicable
| Item 2. | PROPERTIES |
The principal executive and administrative offices of FNB United and the Bank are located in an office building at 150 South Fayetteville Street, Asheboro, North Carolina. The Bank also has six other facilities in Asheboro containing three community banking operations and various administrative and operational functions. The Bank has other community banking offices in Archdale, Belmont, Biscoe, Boone, Burlington, China Grove, Cornelius, Dallas, Ellerbe, Gastonia, Graham, Greensboro (two offices), Hickory (three offices), Hillsborough, Jamestown, Kannapolis, Laurinburg, Millers Creek, Mooresville, Mt. Holly, Newton, Pinehurst, Ramseur, Randleman, Rockingham (two offices), Salisbury (two offices), Seagrove, Siler City, Seven Lakes, Southern Pines, Stanley, Statesville, Taylorsville, Trinity, West Jefferson, and Wilkesboro (two offices), North Carolina. Ten of the community banking offices are leased facilities, and four such offices are situated on land that is leased. Two of the facilities housing operational functions in Asheboro are leased.
Dover operates out of a leased office located in Charlotte, North Carolina.
| Item 3. | LEGAL PROCEEDINGS |
In the ordinary course of operations, the Company is party to various legal proceedings. The Company is not involved in, nor has it terminated during the fourth quarter of 2010, any pending legal proceedings other than routine, nonmaterial proceedings occurring in the ordinary course of business.
| Item 4. | RESERVED |
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| Item 5. | MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERSAND ISSUER PURCHASESOF EQUITY SECURITIES |
Market Prices and Dividend Policies
FNB United’s common stock is traded on The Nasdaq Capital Market under the symbol “FNBN.”
On August 2, 2010, FNB United received written notice from Nasdaq indicating that FNB United was not in compliance with Rule 5450(a)(1), the bid price rule, because the closing price per share of its common stock had been below $1.00 per share for 30 consecutive business days. In accordance with the rules of The Nasdaq Stock Market, FNB United was afforded a 180-day grace period to achieve compliance with the bid price rule. As of January 31, 2011, FNB United had not achieved compliance and submitted an application to The Nasdaq Stock Market to transfer the listing of its common stock to The Nasdaq Capital Market from The Nasdaq Global Select Market, where it had been listed. The application was granted effective February 3, 2011, and FNB United became eligible for an additional 180 calendar day period, or until August 1, 2011, to achieve compliance with the bid price rule. Approval to transfer to The Nasdaq Capital Market was conditioned upon FNB United’s agreeing to effect a reverse stock split during the additional 180-day period should it become necessary to do so to meet the minimum $1.00 bid price per share requirement.
On December 20, 2010, FNB United received a second written notice from The Nasdaq Stock Market indicating that FNB United was not in compliance with Rule 5450(b)(1)(C), the market value rule, because the market value of its publicly held shares was below $5.0 million for the 30 consecutive business days ended December 17, 2010. By transferring the listing of its common stock to the Nasdaq Capital Market, FNB United became subject to the continued listing requirements of the market, which provide that the market value of FNB United’s publically held shares must exceed $1.0 million. FNB United satisfies this requirement.
The following table shows the high and low sale prices of FNB United common stock on The Nasdaq Global Select Market, based on published financial sources, for each of the last two fiscal years. The table also reflects the per share amount of cash dividends paid for each share during the fiscal quarter for each of the last two fiscal years.
Calendar Period | High | Low | Dividends Declared | |||||||||
Quarter ended March 31, 2009 | $ | 4.50 | $ | 1.61 | $ | 0.025 | ||||||
Quarter ended June 30, 2009 | 3.39 | 1.85 | 0.025 | |||||||||
Quarter ended September 30, 2009 | 2.88 | 1.77 | - | |||||||||
Quarter ended December 31, 2009 | 2.65 | 1.10 | - | |||||||||
Quarter ended March 31, 2010 | $ | 1.70 | $ | 1.03 | $ | - | ||||||
Quarter ended June 30, 2010 | 2.42 | 0.67 | - | |||||||||
Quarter ended September 30, 2010 | 0.93 | 0.45 | - | |||||||||
Quarter ended December 31, 2010 | 0.74 | 0.27 | - | |||||||||
As March 10, 2011, there were approximately 6,275 beneficial holders of FNB United’s common stock. For a discussion as to any restrictions on or the ability of FNB United or the Bank to pay dividends, see Item 1 - Regulation and Supervision. See also Note 3 -Regulatory Matters in the notes to the financial statements set forth in Item 8.
Recent Sales of Unregistered Securities
Except for the issuance and sale to the Treasury Department of 51,500 shares of its Fixed Rate Cumulative Perpetual Stock, Series A and a warrant to purchase 2,207,143 shares of its common stock on February 13, 2009 pursuant to the Capital Purchase Program, FNB United did not sell any of its securities in the three fiscal years ended December 31, 2010, which were not registered under the Securities Act of 1933, as amended.
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FIVE-YEAR STOCK PERFORMANCE TABLE
Performance Graph
The following graph and table are furnished with this Annual Report on Form 10-K/A and compare the cumulative total shareholder return of FNB United common stock for the five-year period ended December 31, 2010 with the SNL Southeast Bank Index and the Russell 3000 Stock Index, assuming an investment of $100 at the beginning of the period and the reinvestment of dividends.
FNB United Corp.
| Period Ending | ||||||||||||||||||||||||
Index | 12/31/05 | 12/31/06 | 12/31/07 | 12/31/08 | 12/31/09 | 12/31/10 | ||||||||||||||||||
FNB United Corp. | 100.00 | 99.76 | 68.85 | 19.01 | 8.02 | 2.01 | ||||||||||||||||||
SNL Southeast Bank | 100.00 | 117.26 | 88.33 | 35.76 | 35.90 | 34.86 | ||||||||||||||||||
Russell 3000 | 100.00 | 115.71 | 121.66 | 76.27 | 97.89 | 114.46 | ||||||||||||||||||
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| Item 6. | SELECTED FINANCIAL DATA |
The annual selected historical financial data presented in the accompanying table is derived from the audited consolidated financial statements for FNB United Corp. and Subsidiary. As this information is only a summary, you should read it in conjunction with the historical financial statements (and related notes) of the Company and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere herein.
| (dollars in thousands, except per share data) | As of and for the Year Ended December 31, | |||||||||||||||||||
| 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
| (RESTATED) | ||||||||||||||||||||
Income Statement Data | ||||||||||||||||||||
Net interest income | $ | 52,202 | $ | 62,196 | $ | 60,017 | $ | 63,612 | $ | 56,214 | ||||||||||
Provision for loan losses | 132,755 | 61,741 | 27,759 | 5,514 | 2,526 | |||||||||||||||
Noninterest income | 30,987 | 21,753 | 22,918 | 21,593 | 19,215 | |||||||||||||||
Noninterest expense | 81,002 | 119,912 | 118,103 | 61,044 | 53,441 | |||||||||||||||
Net (loss)/income before goodwill impairment charges | (131,827 | ) | (49,301 | ) | (2,009 | ) | 12,719 | 13,812 | ||||||||||||
Net (loss)/income | (131,827 | ) | (101,696 | ) | (59,809 | ) | 12,361 | 12,187 | ||||||||||||
Preferred stock dividends | (3,294 | ) | (2,871 | ) | - | - | - | |||||||||||||
Net (loss)/income to common shareholders | (135,121 | ) | (104,567 | ) | (59,809 | ) | 12,361 | 12,187 | ||||||||||||
Period End Balances | ||||||||||||||||||||
Assets | $ | 1,902,369 | $ | 2,101,296 | $ | 2,044,434 | $ | 1,906,506 | $ | 1,814,905 | ||||||||||
Loans held for sale | 37,079 | 58,219 | 36,138 | 17,586 | 20,862 | |||||||||||||||
Loans held for investment(1) | 1,303,975 | 1,563,021 | 1,585,195 | 1,446,116 | 1,301,840 | |||||||||||||||
Allowance for loan losses | 93,687 | 49,461 | 34,720 | 17,381 | 15,943 | |||||||||||||||
Goodwill | - | - | 52,395 | 110,195 | 110,956 | |||||||||||||||
Deposits | 1,696,390 | 1,722,128 | 1,514,747 | 1,441,042 | 1,421,013 | |||||||||||||||
Borrowings | 218,315 | 261,459 | 365,757 | 231,125 | 167,018 | |||||||||||||||
Shareholders’ equity | (28,837 | ) | 98,359 | 147,917 | 216,256 | 207,668 | ||||||||||||||
Average Balances | ||||||||||||||||||||
Assets | $ | 2,036,603 | $ | 2,158,123 | $ | 2,040,204 | $ | 1,862,602 | $ | 1,575,307 | ||||||||||
Loans held for sale | 36,345 | 57,007 | 21,925 | 19,627 | 18,229 | |||||||||||||||
Loans held for investment(1) | 1,494,959 | 1,583,213 | 1,555,113 | 1,357,256 | 1,124,121 | |||||||||||||||
Allowance for loan losses | 63,057 | 38,283 | 20,493 | 15,882 | 14,213 | |||||||||||||||
Goodwill | - | 39,045 | 109,193 | 110,724 | 85,956 | |||||||||||||||
Deposits | 1,725,019 | 1,639,830 | 1,483,749 | 1,440,604 | 1,218,071 | |||||||||||||||
Borrowings | 226,660 | 334,332 | 322,643 | 188,790 | 166,507 | |||||||||||||||
Shareholders’ equity | 68,190 | 172,217 | 215,571 | 212,841 | 174,135 | |||||||||||||||
Per Common Share Data | ||||||||||||||||||||
Net (loss)/income before goodwill impairment charges | $ | (11.83 | ) | $ | (4.57 | ) | $ | (0.18 | ) | $ | 1.12 | $ | 1.44 | |||||||
Net (loss)/income per common share: | ||||||||||||||||||||
Basic | (11.83 | ) | (9.16 | ) | (5.24 | ) | 1.09 | 1.27 | ||||||||||||
Diluted | (11.83 | ) | (9.16 | ) | (5.24 | ) | 1.09 | 1.25 | ||||||||||||
Cash dividends declared | - | 0.05 | 0.45 | 0.60 | 0.62 | |||||||||||||||
Book value | (7.80 | ) | 4.05 | 12.94 | 18.93 | 18.39 | ||||||||||||||
Tangible book value | (8.17 | ) | 3.61 | 7.85 | 8.71 | 8.56 | ||||||||||||||
Performance Ratios | ||||||||||||||||||||
Return on average assets before goodwill impairment charges | (6.47 | )% | (2.28 | )% | (0.10 | )% | 0.68 | % | 0.88 | % | ||||||||||
Return on average assets | (6.47 | ) | (4.71 | ) | (2.93 | ) | 0.66 | 0.77 | ||||||||||||
Return on average tangible assets(2) | (6.49 | ) | (4.81 | ) | (3.11 | ) | 0.71 | 0.82 | ||||||||||||
Return on average equity before goodwill impairment charges(3) | (193.32 | ) | (28.63 | ) | (0.93 | ) | 5.98 | 7.93 | ||||||||||||
Return on average equity (3) | (193.32 | ) | (59.05 | ) | (27.74 | ) | 5.81 | 7.00 | ||||||||||||
Return on average tangible equity(2) | (207.30 | ) | (79.59 | ) | (59.78 | ) | 12.99 | 14.75 | ||||||||||||
Net interest margin (tax equivalent) | 2.81 | 3.11 | 3.40 | 4.01 | 4.18 | |||||||||||||||
Dividend payout on common shares(4) | N/M | N/M | N/M | 55.21 | 51.17 | |||||||||||||||
Asset Quality Ratios | ||||||||||||||||||||
Allowance for loan losses to period end loans held for investment | 7.18 | % | 3.16 | % | 2.19 | % | 1.20 | % | 1.22 | % | ||||||||||
Nonperforming loans to period end allowance for loan losses | 352.12 | 352.63 | 276.57 | 107.63 | 69.84 | |||||||||||||||
Net chargeoffs (annualized) to average loans held for investment | 5.92 | 2.97 | 0.67 | 0.27 | 0.17 | |||||||||||||||
Nonperforming assets to period end loans held for investment and foreclosed property(5) | 28.71 | 13.12 | 6.45 | 1.50 | 1.13 | |||||||||||||||
Capital and Liquidity Ratios | ||||||||||||||||||||
Average equity to average assets | 3.35 | % | 7.98 | % | 10.57 | % | 11.43 | % | 11.05 | % | ||||||||||
Total risk-based capital | (2.56 | ) | 10.29 | 10.39 | 10.43 | 11.53 | ||||||||||||||
Tier 1 risk-based capital | (2.56 | ) | 6.86 | 6.94 | 8.03 | 8.36 | ||||||||||||||
Leverage capital | (1.86 | ) | 5.68 | 6.11 | 7.54 | 7.16 | ||||||||||||||
Average loans to average deposits | 86.66 | 96.55 | 106.29 | 95.58 | 93.79 | |||||||||||||||
Average loans to average deposits and borrowings | 76.60 | 80.20 | 87.30 | 84.82 | 82.51 | |||||||||||||||
| (1) | Loans held for investment, net of unearned income, before allowance for loan losses. |
| (2) | Refer to the “Non-GAAP Measures” section in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
| (3) | Net loss to common shareholders, which excludes preferred stock dividends, divided by average realized common equity which excludes accumulated other comprehensive loss. |
| (4) | Not meaningful due to net loss. |
| (5) | Nonperforming loans and nonperforming assets include loans past due 90 days or more that are still accruing interest. |
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| Item 7. | MANAGEMENT’S DISCUSSIONAND ANALYSISOF FINANCIAL CONDITIONAND RESULTSOF OPERATIONS |
This Amendment No. 1 to Form 10-K (Amendment No. 1) is being filed by FNB United Corp. (the Company) to amend and restate its Annual Report on Form 10-K for the year ended December 31, 2010 filed with the United States Securities and Exchange Commission on March 14, 2011 (the Initial Form 10-K). For purposes of this Annual Report on Form 10-K/A, and in accordance with Rule 12b-15 under the Securities Exchange Act of 1934 (Exchange Act), the Company’s Initial Form 10-K has been amended and restated in its entirety.
In preparing financial information for the first quarter of 2011 the Corporation determined there were events or transactions that occurred or became known in the first quarter of 2011 that related to the valuation of impaired loans and other real estate owned (OREO) and provided additional evidence about conditions that existed as of December 31, 2010. The information related to certain of these events or transactions was available prior to the filing of the Corporation’s annual report on Form 10-K and should have been considered in determining reported amounts or valuation allowances of impaired loans and OREO. The Corporation is restating its 2010 financial statements to reflect the correction of the recorded amounts or valuation allowances for impaired loans and OREO related to:
| • | $8.6 million in charge-offs in the first quarter of 2011 for impaired loans that existed at December 31, 2010 that should have had specific reserves in the December 31, 2010 allowance for loan losses. |
| • | $8.9 million in specific reserves for impaired loans recorded during the three-month period ended March 31, 2011 that should have been included as specific reserves in the December 31, 2010 allowance for loan losses due to updated appraisals received in the first quarter of 2011. |
| • | $1.4 million in write-downs of OREO in the first quarter of 2011 that should have been recorded during the year ended December 31, 2010. |
The Company has corrected these errors and in consultation with the Audit Committee of the Board of Directors, determined that the amounts of the allowance for loan losses should be increased by an aggregate of $17.5 million for the year ended December 31, 2010 and that write-downs of OREO should be increased by $1.4 million for the year ended December 31, 2010. In this Annual Report on Form 10-K/A, the Company is restating its consolidated balance sheet, statement of loss, statement of shareholders’ equity and comprehensive loss, and statement of cash flows as of and for the year ended December 31, 2010.
The Company is not required to and it has not updated any forward-looking statements previously included in the Initial Form 10-K filed on March 14, 2010. The Company has not amended, and does not intend to amend, any of its other previously filed reports for the periods affected by the restatement. The Company’s previously issued consolidated financial statements included in those reports should no longer be relied upon. Accordingly, this Annual Report on Form 10-K/A should be read in conjunction with the Company’s filings with the Securities and Exchange Commission subsequent to the Initial Form 10-K.
The following presents management’s discussion and analysis of the financial condition and results of operations of FNB United and should be read in conjunction with the financial statements and related notes included elsewhere in this Annual Report on Form 10-K/A. This discussion may contain forward-looking statements that involve risks and uncertainties. Actual results could differ significantly from those anticipated in forward-looking statements as a result of various factors. The following discussion is intended to assist in understanding the financial condition and results of operations of FNB United.
Executive Overview
Description of Operations
FNB United is a bank holding company with a full-service subsidiary bank, CommunityONE Bank, National Association, which offers a complete line of consumer, mortgage and business banking services, including loan, deposit, cash management, investment management and trust services, to individual and business customers. The Bank has offices in Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties in North Carolina.
The Bank has a mortgage banking subsidiary, Dover Mortgage Company, that originates, underwrites and closes loans for sale into the secondary market. Dover has a retail origination network based in Charlotte, North Carolina, originating loans for properties located in North Carolina. Dover previously engaged in the wholesale mortgage origination business and conducted retail mortgage origination business outside of North Carolina. These operations were closed in February 2011.
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Management’s Plans and Intentions
The Company incurred significant net losses in 2009, which have continued in 2010, primarily from the higher provisions for loan losses due to the significant level of nonperforming assets and the write-off of goodwill. The Bank consented and agreed to the issuance of the Consent Order (“Order”) by the OCC in July 2010 and FNB United entered into a written agreement with the FRB in October 2010. The Company’s independent registered public accounting firm issued a report with respect to the Company’s audited financial statements for the fiscal years ended December 31, 2010 and 2009, which contained an explanatory paragraph indicating that there is substantial doubt about the Company’s ability to continue as a going concern. The following strategies have been or are being implemented:
Held-to-Maturity Investment Securities Reclassification –As part of the Bank’s contingency funding plan, the Bank’s Board of Directors approved in April 2010 the reclassification of the entire held-to-maturity investment securities portfolio to available-for-sale investment securities. The conversion of the portfolio occurred on May 3, 2010 and provides additional liquidity to the Bank. The transfer resulted in the unrealized holding gains of $2.1 million, net of tax, at the date of transfer being recognized in other comprehensive income. The corresponding deferred tax on the unrealized holding gain allowed the Bank to realize a one-time reduction in deferred tax valuation allowance of $1.4 million in the second quarter of 2010.
Deferring Preferred Stock and Trust Preferred Securities Payments –The Company began deferring the payment of cash dividends on its outstanding Fixed Rate Cumulative Perpetual Preferred Stock, Series A, beginning in the second quarter 2010, as well as the payment of interest on the outstanding junior subordinated notes related to its trust preferred securities to enhance the Company’s liquidity. The expense associated with trust preferred securities continues to accrue and is reflected in the Company’s Consolidated Statements of Loss. The dividends on preferred stock are shown as an increase to net loss to derive net loss to common shareholders in the Consolidated Statements of Loss.
Balance Sheet Reductions –Management is implementing strategies to improve capital ratios through the reduction of assets and off-balance sheet commitments. At December 31, 2010, risk-weighted assets have been reduced by $332.1 million since December 31, 2009. Reductions occurred primarily in reductions in the commercial loan portfolio. On December 30, 2010, the Bank sold $32.9 million of mortgage loans held for investment and recognized a net gain of $383,000, including transaction costs. Management expects future reductions in risk-weighted assets to be moderate and occur primarily in the loan portfolio. To offset the majority of asset reductions, liabilities declined primarily through reductions in deposits by $25.7 million. Because asset reductions exceeded liability reductions in the twelve months ending December 31, 2010, cash balances increased by $132.9 million. Future liability reductions are expected to occur primarily in deposits, primarily public unit deposits and high-rate NOW accounts and certificates of deposits.
Earnings –On June 22, 2010, the Bank retired $33.0 million in Federal Home Loan Bank (“FHLB”) advances and paid an early redemption penalty of $1.0 million to the FHLB for the retirement of these advances. The penalty is included in other noninterest expenses. On July 2, 2010, the Bank purchased $30.0 million in brokered certificates of deposit to replace these funds. The advances had a remaining average life of 1.0 years and an average interest rate of 3.93%. The brokered certificates of deposit have maturities ranging from 30 months to 42 months with interest rates ranging from 1.75% to 2.20%. As a result of this transaction, the interest expense savings during the first year is estimated at an annualized rate of 1.94% on the $30.0 million restructured.
Stimulus Loan Program –The Bank implemented in 2009 a stimulus loan program to facilitate the sale of residential real estate held as collateral for some of the Bank’s nonperforming and performing loans and certain Bank-owned properties. The purpose of the program is to reduce the Bank’s credit concentrations and nonperforming assets by providing attractive terms that both fill the mortgage lending void created by the ongoing recession and incent potential buyers to purchase real estate. The Bank offered a reduced interest rate to qualified new borrowers to encourage them to purchase properties in this program. New borrowers are qualified according to the Bank’s normal consumer and mortgage underwriting standards. The Bank records these loans at fair value at time of issue. Existing unimpaired development loans that become part of the program are considered impaired upon inclusion in the stimulus loan program. The Bank discontinued the program in the first quarter of 2011. The Bank currently has $41.1 million in loans under the stimulus loan program, and has recognized an initial fair value adjustment of $172,200. As of December 31, 2010, the fair value adjustment was reduced to $114,100 due to the accretion of the adjustment to interest income. The fair value adjustment is recorded as a reduction of the outstanding loan balance on the balance sheet and accreted into interest income over the contractual life of the loan.
Additional Capital –The Company has engaged two investment banking firms to assist the Company in identifying strategic alternatives and in raising capital. Currently, the Company is working diligently to raise additional capital
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in the next few months and is actively seeking to secure potential investors; however, there are no assurances that an offering will be completed or that the Company will succeed in this endeavor. In addition, a transaction would likely involve equity financing, resulting in substantial dilution to current shareholders and an adverse effect on the price of the Company’s common stock. The Bank’s ability to raise capital is contingent on the current capital markets and on its financial performance. Available capital markets are not currently favorable, and the Bank cannot be certain of its ability to raise capital on any terms.
Liquidity
The Company has a 45-office system of community offices, commonly referred to as branches, that has provided a significant and stable source of local funding. In addition, the Company has a contingency funding plan pursuant to which FNB United and the Bank review each quarter or more frequently liquidity needs based on a number of potential stress conditions. These conditions include, but are not limited to, deposit outflow and reductions in wholesale borrowing lines, including brokered deposits. Liquidity sources are stressed to determine if sufficient liquidity is available to meet potential funding needs. In all scenarios determined plausible by management, the Bank is able to meet liquidity needs through remaining borrowing lines, reducing loan originations, sales of assets, and scheduled cash flow that is not redeployed. The Bank is active in maximizing borrowing lines that can be drawn against under all financial conditions, as well as managing asset and liability cash flows to maintain adequate liquidity levels.
Both FNB United and the Bank actively manage liquidity. FNB United suspended its dividend to shareholders until such time as the Bank returns to profitability and either receives or is not required to receive regulatory approval for the payment of dividends. FNB United began deferring the payment of cash dividends on its outstanding Fixed Rate Cumulative Perpetual Preferred Stock, Series A, beginning in the second quarter 2010, as well as the payment of interest on the outstanding junior subordinated notes related to its trust preferred securities to enhance the Company’s liquidity. The expense associated with trust preferred securities continues to accrue and is reflected in the Company’s Consolidated Statements of Loss. The dividends on preferred stock are shown as an increase to net loss to derive net loss to common shareholders in the Consolidated Statements of Loss.
At December 31, 2010, FNB United had approximately $180,000 of cash held in deposits with the Bank. Based on current and expected liquidity needs and sources, management expects the Bank to be able to meet its obligations at least through December 31, 2011. Cash and cash equivalents at the Bank at December 31, 2010 were approximately $160.6 million. Liquidity at the Bank is dependent upon deposits, which fund 88% of the Company’s assets. Despite reported negative earnings performance during 2010, the Bank’s deposits decreased from December 31, 2009 to December 31, 2010 by only $25.7 million. The Company is reducing its assets to improve capital ratios. The Bank’s loan portfolio does not have features that could rapidly draw additional funds, which would cause an elevated need for additional liquidity at the Bank.
Access to brokered deposits as a contingency funding source for the Bank has been eliminated since the Bank is deemed not well-capitalized.
As a result of its efforts to control the level of assets, management expects reductions in deposits through the end of 2011 as part of a planned deleveraging of the balance sheet. Stress testing of potential severe deposit outflow demonstrates that the Bank is well positioned to respond to withdrawals. Additional sales and maturities of investment securities could provide further liquidity if needed. The Bank reclassified the entire held-to-maturity investment securities portfolio to available-for-sale investment securities to further enhance the Bank’s liquidity. The reclassification of these securities was completed in the second quarter of 2010.
On December 30, 2010 and February 28, 2011, the Bank entered into and consummated conversion agreements with SunTrust Bank, pursuant to which $12.5 million of the outstanding principal amount of the $15.0 million subordinated term loan from SunTrust to the Bank issued on June 30, 2008 was converted into 12.5 million shares of nonvoting, nonconvertible, nonredeemable cumulative preferred stock, par value $1.00 per share, of the Bank. The Bank amended its articles of association to authorize the preferred stock issued to SunTrust in the conversions. The preferred stock carries an 8.0% dividend rate.
Capital
The Bank has increased minimum capital requirements from the OCC. The Company has begun to take steps to increase capital. The Company plans to control asset growth, which should help reduce its risk profile and improve capital ratios through reductions in the amount of outstanding loans, particularly loans with higher risk weights, and a corresponding reduction of liabilities. Outstanding loans will be reduced by slowing loan originations and through normal principal amortization. The Company may also seek commercial note sales arrangements with other lenders
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or private equity sources. Based on its forecasts and projections, management expects the Bank to remain below well-capitalized, according to current regulatory guidelines, through December 31, 2011, unless current capital improvement efforts are successful.
As a result of the Order, the Board of Directors of the Bank has formed a compliance committee of some of its members to oversee management’s response to all sections of the Order. The committee will monitor compliance with the Order, including adherence to deadlines for submission to the OCC of any information required under the Order.
The Company has engaged legal counsel, regulatory experts and various consultants to assist it with compliance with the Order. They are advising the Company on additional action plans and strategies to reduce the level of nonperforming assets and to increase capital. These advisors work directly with the Board of Directors and Bank management to assure that all opportunities for improvement are considered. The Company’s ability to raise capital is contingent on the current capital markets and on its financial performance. Available capital markets are not currently favorable, and the Company cannot be certain of its ability to raise capital on any terms.
Credit Quality
The Company has taken proactive steps to resolve its nonperforming loans, including negotiating repayment restructuring plans, forbearances, loan modifications and loan extensions with borrowers when appropriate. The Bank also has a separate special assets department to monitor and attempt to reduce exposure to further deterioration in asset quality, to manage OREO properties, and to liquidate property in the most cost-effective manner. The Bank is applying more conservative underwriting practices to new loans, including, among other things, increasing the amount of required collateral or equity requirements, reducing loan-to-value ratios, and increasing interest rates.
To improve its results of operations, the Company’s primary focus is to reduce significantly the amount of its nonperforming assets. Nonperforming assets decrease profitability because they reduce the balance of earning assets, may require additional loan loss provisions or write-downs, and require significant devotion of staff time and financial resources to resolve. The level of nonperforming assets (loans not accruing interest, restructured loans, loans past due 90 days or more and still accruing interest, and other real estate owned) increased to $392.3 million as of December 31, 2010, as compared to $209.7 million as of December 31, 2009. The Company believes that the increase in the level of nonperforming assets occurred largely as a result of the severe housing downturn and deterioration in the residential real estate market, as many of the Bank’s commercial loans are for residential real estate projects.
The Company has moved aggressively to address the credit quality issues by increasing its reserves for losses and directing the efforts of a team of experienced workout specialists solely to manage the resolution of nonperforming assets. This group allows the remainder of the Bank’s credit administration and banking personnel to focus on managing the performing loan portfolio, while enhancing objectivity in problem loan resolution by removing from that process the originating or managing lender.
With the assistance of a third-party loan review firm, the Bank conducted a thorough review of the loan portfolio during 2010, including both nonperforming loans and performing loans. The Company believes that the reserves recorded in its allowance for loan losses as of December 31, 2010 are adequate to cover losses inherent in the portfolio as of that date.
It is the Company’s goal to remove the majority of the nonperforming assets from its balance sheet while still obtaining reasonable value for these assets. Given the current conditions in the real estate market, accomplishing this goal is a tremendous undertaking, requiring both time and the considerable effort of staff. The Company is committed to continuing to devote significant resources to these efforts. Sales of real estate in the current market could result in losses.
Continued Expense Control
The Company has made it a priority to identify cost savings opportunities throughout all phases of operations. In 2008, the Bank engaged a third party to review and recommend a cost savings strategy for the Bank. The Bank continues to follow those recommendations and continues to see improvements in expense control. The Company is committed to maintaining these cost control measures and believes that this effort will play a major role in improving its performance. The Company also believes that its technology allows it to be efficient in its back-office operations. In addition, as the level of nonperforming assets is reduced, the operating costs associated with carrying those assets, such as maintenance, insurance and taxes will decrease.
The Company is focused on its collection of core deposits. Core deposit balances, generated from customers throughout the Bank’s branch network, are generally a stable source of funds similar to long-term funding, but core
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deposits such as checking and savings accounts are typically less costly than alternative fixed-rate funding. The Company believes that this cost advantage makes core deposits a superior funding source, in addition to providing cross-selling opportunities and fee income possibilities. To the extent the Bank grows its core deposits, the cost of funds should decrease, thereby increasing the Bank’s net interest margin.
Conclusion
Management projections for 2011 reflect continued stress on the bank’s loan portfolio followed by significant earnings improvement in 2012 primarily as a result of lower levels of loan loss provisions and some recoveries of previously recognized loan losses. In the current interest rate environment, earnings will at most be only minimally affected by further declines in interest rates. Any increase in interest rates is expected to have a positive impact on the earnings of the Bank, with the extent of that impact dependent on the amount of increase. Management’s current projections and forecasts for 2011 include an insignificant increase in interest rates, notwithstanding increasing evidence of economic recovery.
The Company is evaluating and pursuing the feasibility of various strategic options, including capital raising alternatives and the sale of selective assets. While the Company plans to focus on the above actions and to pursue strategic alternatives, the Company can give no assurance that efforts to raise additional capital in the current economic environment will be successful and result in the Company’s desired capital position. The Bank’s ability to decrease its levels of nonperforming assets is also subject to market conditions as some of its borrowers rely on an active real estate market as a source of repayment, and the sale of real estate in this market is difficult. If the real estate market does not improve, the Bank’s level of nonperforming assets may continue to increase.
While the Company believes that it is taking appropriate steps to respond to these economic risks and regulatory actions, continuation as a going concern is subject to raising additional capital. Accordingly, the Company is taking steps that would raise capital above required regulatory levels and levels at which the Bank could profitably operate; however, no assurances that additional capital will be raised can be made.
Primary Financial Data for 2010
FNB United experienced a loss of $135.1 million in 2010, an 29% increase from the net loss of $104.6 million in 2009. Basic and diluted (loss) per share increased 29% from $(9.16) in 2009 to $(11.83) in 2010. Total assets were $1.9 billion at December 31, 2010, down 10% from year-end 2009. Loans amounted to $1.3 billion at December 31, 2010, decreasing 17% from the prior year. Total deposits decreased $25.7 million, to $1.7 billion in 2010.
Significant Factors Affecting Earnings
2010 presented challenges for FNB United as well as for the entire banking industry. The strains in the local and national financial and housing markets presented a challenging environment during 2010. This difficult environment required a significant increase in FNB United’s loan loss provision, which depressed operating results but was a necessary response to increased non-performing loans. FNB United has not originated any subprime real estate loans.
The provision for loan losses was $132.8 million in 2010, compared to $61.7 million in 2009, an increase of 115%. This increase resulted primarily from continued deterioration in credit performance of the residential real estate development and construction sectors of the Bank’s commercial loan portfolio, resulting in loan charge-offs and increased impairment identified in loans determined to be impaired during the year. Nonperforming assets increased 87%, to $392.3 million during 2010 from $209.7 million at the close of 2009. Net loan charge-offs increased to $88.5 million in 2010, compared to $47.0 million in 2009. Loans held for investment decreased by $259.0 million during 2010. The allowance for loan losses was increased to 7.18% of loans held for investment at December 31, 2010. The allowance was 3.16% at December 31, 2009.
The provision for loan losses was $61.7 million in 2009, compared to $27.8 million in 2008, an increase of 122%. Nonperforming assets increased 104%, to $209.7 million during 2009 from $102.6 million at the end of 2008.
The Bank has fully reserved for its deferred tax assets that are dependent upon future taxable income for realization with a valuation allowance. In assessing whether deferred tax assets will be realized, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. In evaluating the positive and negative evidence to support the realization of the asset under current guidance, there is insufficient positive evidence to support a conclusion that it is more likely than not this asset will be realized in the
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foreseeable future. The Bank has fully reserved for its deferred tax assets that are dependent upon future taxable income for realization with a valuation allowance.
Noninterest income increased 42.4% to $31.0 million, compared to $21.8 million in 2009. Of this increase, $5.0 million was attributable to an other-than-temporary impairment (“OTTI”) charge in 2009 on an investment security owned by the Bank for which the Bank deemed it would be unlikely to recover its investment. Mortgage loan income decreased $4.4 million resulting from a reduction in production of 35% and the reduction in value of derivative loan commitments as the pipeline contracted. Other service charges, commissions and fees ended 2010 at $1.0 million compared to $1.1 million for 2009. Net securities gains of $10.6 million were recognized in 2010 compared to $1.0 million in 2009. Noninterest income, excluding the 2009 OTTI charge, was $31.0 million for 2010 compared to $26.7 million in 2009 thus representing a 15.9% increase.
In 2009, noninterest income was $21.8 million, representing a 5.1% decrease when compared to $22.9 million in 2008. Of this decrease, $5.0 million was attributable to an other-than-temporary impairment (“OTTI”) charge in 2009 on an investment security owned by the Bank that the Bank deemed would be unlikely to recover its investment. Mortgage loan income increased $3.5 million resulting from mortgage loan sale activity exceeding $692.6 million in 2009 versus $317.1 million in 2008. Noninterest income, excluding the OTTI charge, improved to $26.7 million for the year compared to $22.9 million in 2008 thus representing a 16.7% increase.
Noninterest expense decreased from $119.9 million in 2009 to $81.0 million in 2010, representing a 32.4% decrease. Contributing to this decrease was a goodwill impairment charge taken in 2009 for $52.4 million, when the Company’s remaining goodwill was written off. Excluding the goodwill impairment charges, noninterest expense was $67.5 million in 2009, compared to $81.0 million in 2010, an increase of $13.5 million or 20.0%. FDIC insurance for 2010 was $5.9 million compared to $4.2 million for 2009, a 40.4% increase year over year. OREO-related expenses increased 318.5% to $14.5 million for 2010 compared to $3.5 million in 2009 due to valuation adjustments required on OREO properties because of continued weakness in the economy and the effect that the current economic environment is having on the valuation of real estate within the Company’s loan portfolio.
Noninterest expense was significantly affected in 2009 and 2008 by goodwill impairment charges of $52.4 million and $57.8 million, respectively. Excluding the goodwill impairment charges, noninterest expense was $67.5 million, compared to $60.3 million in 2008, an increase of $7.2 million or 12.0%. FDIC insurance for 2009 was $4.2 million compared to $0.9 million for 2008, a 366.4% increase year over year. OREO-related expenses increased 469.2% to $3.5 million for 2009 compared to $0.6 million in 2008 due to valuation adjustments required on OREO properties because of continued weakness in the economy and the effect that the current economic recovery is having on the valuation of real estate within the Company’s banking footprint.
FDIC Insurance Assessment
On May 22, 2009, the FDIC adopted a final rule imposing a five basis point special assessment on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009. The special assessment was collected on September 30, 2009.
In a final rule issued on September 29, 2009, the FDIC amended the Amended Restoration Plan as follows:
| • | The period of the Amended Restoration Plan was extended from seven to eight years. |
| • | The FDIC announced that it will not impose any further special assessments under the final rule it adopted in May 2009. |
| • | The FDIC announced plans to maintain assessment rates at their current levels through the end of 2010. The FDIC also immediately adopted a uniform three basis point increase in assessment rates effective January 1, 2011 to ensure that the DIF returns to 1.15 percent within the Amended Restoration Plan period of eight years. |
| • | The FDIC announced that, at least semi-annually following the adoption of the Amended Restoration Plan, it will update its loss and income projections for the DIF. The FDIC also announced that it may, if necessary, adopt a new rule prior to the end of the eight-year period to increase assessment rates in order to return the reserve ratio to 1.15 percent. |
On November 12, 2009, the FDIC adopted a final rule to require insured institutions to prepay their quarterly risk-based deposit insurance assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012, on December 30, 2009.
The Dodd-Frank Act makes permanent the $250,000 deposit insurance limit for insured deposits and provides full insurance of noninterest bearing transaction accounts beginning December 31, 2010, for two years. It also revises the assessment base against which the insured depository institution’s deposit insurance premiums paid to the DIF
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will be calculated. Under the amendments, the FDIC assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average equity. The Dodd-Frank Act also changes the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits by September 30, 2020, and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds. The FDIC is required to offset the effect of the increased minimum reserve ratio for banks with assets of less than $10 billion.
Recent Legislation Affecting the Financial Services Industry
On July 21, 2010, sweeping financial regulatory reform legislation entitled the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including provisions that, among other things, will:
| • | Centralize responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing, examining and enforcing compliance with federal consumer financial laws. |
| • | Restrict the preemption of state law by federal law and disallow subsidiaries and affiliates of national banks from availing themselves of such preemption. |
| • | Apply the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies, which, among other things, will require the Company to deduct, over three years beginning January 1, 2013, all trust preferred securities from the Company’s Tier 1capital. This restriction does not apply to the CPP preferred stock, which will continue to be included in Tier 1 capital. |
| • | Require the Office of the Comptroller of the Currency to seek to make its capital requirements for national banks countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction. |
| • | Require financial holding companies to be well-capitalized and well-managed as of July 21, 2011. Bank holding companies, including FNB United, and banks must also be both well-capitalized and well-managed in order to acquire banks located outside their home state. |
| • | Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminate the ceiling on the size of the Deposit Insurance Fund (“DIF”) and increase the floor of the size of the DIF, which generally will require an increase in the level of assessments for institutions with assets in excess of $10 billion. |
| • | Impose comprehensive regulation of the over-the-counter derivatives market, which would include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institution itself. |
| • | Implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, that apply to all public companies, not just financial institutions. |
| • | Make permanent the $250,000 limit for federal deposit insurance and increase the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000 and provide unlimited federal deposit insurance until January 1, 2013 for noninterest-bearing demand transaction accounts at all insured depository institutions. |
| • | Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts. |
| • | Amend the Electronic Fund Transfer Act (“EFTA”) to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. |
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate its overall financial impact on the Company, its customers or the financial industry more generally. Provisions in the legislation that affect deposit insurance assessments, payment of interest on demand deposits and interchange fees could increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate.
Transaction Account Guarantee Program
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On November 21, 2008, the FDIC Board of Directors adopted a final rule implementing the Temporary Liquidity Guarantee Program (“TLGP”). The TLGP consists of two basic components: a guarantee of newly issued senior unsecured debt of banks, thrifts, and certain holding companies (the debt guarantee program) and full guarantee of non-interest bearing deposit transaction accounts, such as business payroll accounts, regardless of dollar amount (the transaction account guarantee program). The purpose of the guarantee of transaction accounts and the debt guarantee was to reduce funding costs and allow banks and thrifts to increase lending to consumers and businesses. All insured depository institutions were automatically enrolled in both programs unless they elected to opt out by a specified date.
As originally adopted, the transaction account guarantee program was to terminate on December 31, 2009, although the FDIC subsequently extended the program through December 31, 2010. The Dodd-Frank Act included a provision that effectively replaced the transaction account guarantee program and extended the unlimited FDIC guarantee of noninterest bearing transaction accounts through December 31, 2012 for all insured depository institutions, not just those that elected to participate. Also, the Dodd-Frank Act provision, unlike the transaction account guarantee program, does not include low-interest NOW accounts within the definition of noninterest-bearing transaction accounts, and such accounts are therefore not covered by unlimited deposit insurance coverage. A subsequent amendment to the Dodd-Frank Act that became effective on December 31, 2010 extended unlimited deposit insurance coverage for “Interest on Lawyers Trust Accounts” through December 31, 2012.
Earnings Review
FNB United’s net loss of $135.1 million in 2010, primarily the result of an increased provision for loan losses of $71.0 million, compared to the net loss of $104.6 million in 2009, primarily a result of goodwill impairment charges of $52.4 million. Certain factors specifically affecting the elements of income and expense and the comparability of operating results on a year-to-date basis between 2010 and 2009 are discussed in “Significant Factors Affecting Earnings.”
FNB United’s net loss in 2009 was $104.6 million compared to net loss of $59.8 million in 2008. Earnings were negatively impacted in 2009 and 2008 by a goodwill charge of $52.4 million and $57.8 million, respectively. An increase of 122.4%, or $34.0 million in provision for loan losses was recognized in 2009 when compared to 2008. Also affecting 2009 was a $5.0 million OTTI charge compared to no OTTI charge in 2008.
Return on average assets was (6.47)% in 2010, compared to (4.71)% in 2009 and (2.93)% in 2008. Return on average shareholders’ equity decreased from (27.74)% in 2008 to (59.05)% in 2009 and (193.32)% in 2010. In 2010, return on average tangible assets and average tangible equity (calculated by deducting average goodwill and core deposit premiums from average assets and from average equity) amounted to (6.49)% and (207.30)%, respectively, compared to (4.81)% and (79.59)% in 2009 and (3.11)% and (59.78)% in 2008.
Net Interest Income
Net interest income is the difference between interest income, principally from loans and investments, and interest expense, principally on customer deposits. Changes in net interest income result from changes in interest rates and in the volume, or average dollar level, and mix of earning assets and interest-bearing liabilities.
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Table 1
Average Balance Sheet and Net Interest/Dividend Income Analysis
Fully Taxable Equivalent Basis
| Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | 2010 | 2009 | 2008 | |||||||||||||||||||||||||||||||||||||||||
| Average Balance (3) | Income / Expense | Average Yield / Rate | Average Balance (3) | Income / Expense | Average Yield / Rate | Average Balance (3) | Income / Expense | Average Yield / Rate | ||||||||||||||||||||||||||||||||||||
Interest earning assets: | ||||||||||||||||||||||||||||||||||||||||||||
Loans (1)(2) | $ | 1,531,304 | $ | 69,121 | 4.51 | % | $ | 1,640,220 | $ | 84,322 | 5.14 | % | $ | 1,577,038 | $ | 103,567 | 6.57 | % | ||||||||||||||||||||||||||
Taxable investment securities | 255,629 | 11,976 | 4.68 | 281,047 | 16,256 | 5.78 | 152,436 | 7,820 | 5.13 | |||||||||||||||||||||||||||||||||||
Tax-exempt investment securities (1) | 33,169 | 1,551 | 4.68 | 49,884 | 2,256 | 4.52 | 52,454 | 3,138 | 5.98 | |||||||||||||||||||||||||||||||||||
Overnight Federal funds sold | 1,585 | 3 | 0.19 | 10,851 | 21 | 0.19 | 1,316 | 25 | 1.90 | |||||||||||||||||||||||||||||||||||
Other earning assets | 48,702 | 500 | 1.03 | 19,326 | 377 | 1.95 | 19,728 | 785 | 3.98 | |||||||||||||||||||||||||||||||||||
Total earning assets | 1,870,389 | $ | 83,151 | 4.45 | 2,001,328 | $ | 103,232 | 5.16 | 1,802,972 | $ | 115,335 | 6.40 | ||||||||||||||||||||||||||||||||
Non-earning assets: | ||||||||||||||||||||||||||||||||||||||||||||
Cash and due from banks | 66,854 | 27,502 | 29,121 | |||||||||||||||||||||||||||||||||||||||||
Goodwill and core deposit premium | 4,598 | 44,438 | 115,520 | |||||||||||||||||||||||||||||||||||||||||
Other assets, net | 94,762 | 84,855 | 92,591 | |||||||||||||||||||||||||||||||||||||||||
Total assets | $ | 2,036,603 | $ | 2,158,123 | $ | 2,040,204 | ||||||||||||||||||||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||||||||||
Interest-bearing demand deposits | $ | 228,054 | $ | 2,277 | 1.00 | % | $ | 198,343 | $ | 2,250 | 1.13 | % | $ | 168,395 | $ | 2,007 | 1.19 | % | ||||||||||||||||||||||||||
Savings deposits | 43,224 | 112 | 0.26 | 40,301 | 106 | 0.26 | 40,803 | 113 | 0.28 | |||||||||||||||||||||||||||||||||||
Money market deposits | 321,180 | 3,129 | 0.97 | 308,690 | 4,381 | 1.42 | 274,818 | 6,389 | 2.32 | |||||||||||||||||||||||||||||||||||
Time deposits | 974,192 | 19,393 | 1.99 | 940,138 | 25,753 | 2.74 | 841,741 | 33,702 | 4.00 | |||||||||||||||||||||||||||||||||||
Retail repurchase agreements | 13,355 | 98 | 0.73 | 18,737 | 127 | 0.68 | 29,954 | 651 | 2.17 | |||||||||||||||||||||||||||||||||||
Federal Home Loan Bank advances | 140,078 | 3,517 | 2.51 | 185,284 | 5,795 | 3.13 | 204,877 | 7,223 | 3.53 | |||||||||||||||||||||||||||||||||||
Federal funds purchased | 1,537 | 4 | 0.26 | 58,609 | 156 | 0.27 | 21,310 | 501 | 2.35 | |||||||||||||||||||||||||||||||||||
Other borrowed funds | 71,690 | 2,105 | 2.94 | 71,702 | 2,407 | 3.36 | 66,502 | 3,432 | 5.16 | |||||||||||||||||||||||||||||||||||
Total interest-bearing liabilities | 1,793,310 | 30,635 | 1.71 | 1,821,804 | 40,975 | 2.25 | 1,648,400 | 54,018 | 3.28 | |||||||||||||||||||||||||||||||||||
Noninterest-bearing liabilities and shareholders’ equity: |
| |||||||||||||||||||||||||||||||||||||||||||
Noninterest-bearing demand deposits | 158,369 | 152,358 | 157,992 | |||||||||||||||||||||||||||||||||||||||||
Other liabilities | 16,734 | 11,744 | 18,241 | |||||||||||||||||||||||||||||||||||||||||
Shareholders’ equity | 68,190 | 172,217 | 215,571 | |||||||||||||||||||||||||||||||||||||||||
Total liabilities and equity | $ | 2,036,603 | $ | 2,158,123 | $ | 2,040,204 | ||||||||||||||||||||||||||||||||||||||
Net interest income and net yield on earning assets (4) | $ | 52,516 | 2.81 | % | $ | 62,257 | 3.11 | % | $ | 61,317 | 3.40 | % | ||||||||||||||||||||||||||||||||
Interest rate spread (5) | 2.74 | % | 2.91 | % | 3.12 | % | ||||||||||||||||||||||||||||||||||||||
| (1) | The fully tax equivalent basis is computed using a federal tax rate of 35%. |
| (2) | The average loan balances include nonaccruing loans and loans held for sale. |
| (3) | The average balances for all years include market adjustments to fair value for securities and loans held for sale. |
| (4) | Net yield on earning assets is computed by dividing net interest income by average earning assets. |
| (5) | Earning asset yield minus interest bearing liabilities rate. |
Table 1 sets forth for the periods indicated information with respect to FNB United’s average balances of assets and liabilities, as well as the total dollar amounts of interest income (taxable equivalent basis) from earning assets and interest expense on interest-bearing liabilities, resultant rates earned or paid, net interest income, net interest spread and net yield on earning assets. Net interest spread refers to the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. Net yield on earning assets, or net interest margin, refers to net interest income divided by average earning assets and is influenced by the level and relative mix of earning assets and interest-bearing liabilities.
Net interest income according to the Consolidated Statements of Loss was $52.2 million in 2010, compared to $62.2 million in 2009. This decrease of $10.0 million, or 16.1%, resulted primarily from a 6.5% decrease in the level of average earning assets accompanied by a decline in the net yield on earning assets, or net interest margin, from 3.11% in 2009 to 2.81% in 2010. In 2009, the increase of $2.2 million, or 3.6%, resulted primarily from an 11% increase in the level of average earning assets partially offset by a decline in the net yield on earning assets, or net interest margin, from 3.40% in 2008 to 3.11% in 2009. On a taxable equivalent basis, the changes in net interest income were a $9.7 million decrease in 2010 and an increase of $0.9 million for 2009, reflecting changes in the relative mix of taxable and non-taxable earning assets in each year.
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In 2010, the net interest spread decreased by 17 basis points from 2.91% in 2009, to 2.74% in 2010, reflecting the net effect of decreases in both the average total yield on earning assets and the average rate paid on interest-bearing liabilities, or cost of funds. The yield on earning assets decreased by 71 basis points, from 5.16% in 2009 to 4.45% in 2010, while the cost of funds also decreased by 54 basis points, from 2.25% to 1.71%. In 2009, the 21 basis points decrease in net interest spread resulted from a 124 basis points decrease in the yield on earning assets, which was partially offset by a 103 basis points decrease in the cost of funds.
Changes in the net interest margin and net interest spread tend to correlate with movements in the prime rate of interest. There are variations, however, in the degree and timing of rate changes, compared to prime, for the different types of earning assets and interest-bearing liabilities.
Table 2 analyzes net interest income on a taxable equivalent basis, as measured by volume and rate variances. The table reflects the extent to which changes in the interest income and interest expense are attributable to changes in volume (changes in volume multiplied by prior year rate) and changes in rate (changes in rate multiplied by prior year volume).
Table 2
Volume and Rate Variance Analysis
| (dollars in thousands) | 2010 vs 2009 | 2009 vs 2008 | ||||||||||||||||||||||||
| Volume Variance | Rate Variance | Total Variance | Volume Variance | Rate Variance | Total Variance | |||||||||||||||||||||
Interest income: | ||||||||||||||||||||||||||
Loans, net | $ (5,599) | $ | (9,602 | ) | $ | (15,201 | ) | $ | 4,149 | $ | (23,394 | ) | $ | (19,245) | ||||||||||||
Taxable investment securities | (1,470 | ) | (2,810 | ) | (4,280 | ) | 6,598 | 1,838 | 8,436 | |||||||||||||||||
Tax exempt investment securities | (756 | ) | 51 | (705 | ) | (154 | ) | (728 | ) | (882 | ) | |||||||||||||||
Overnight Federal funds sold | (18 | ) | 0 | (18 | ) | 181 | (185 | ) | (4 | ) | ||||||||||||||||
Other earning assets | 573 | (450 | ) | 123 | (16 | ) | (392 | ) | (408 | ) | ||||||||||||||||
Total interest income | (7,270 | ) | (12,811 | ) | (20,081 | ) | 10,758 | (22,861 | ) | (12,103 | ) | |||||||||||||||
Interest expense: | ||||||||||||||||||||||||||
Interest-bearing demand deposits | 337 | (310 | ) | 27 | 357 | (114 | ) | 243 | ||||||||||||||||||
Savings deposits | 8 | (2 | ) | 6 | (1 | ) | (6 | ) | (7 | ) | ||||||||||||||||
Money market deposits | 177 | (1,429 | ) | (1,252 | ) | 787 | (2,795 | ) | (2,008 | ) | ||||||||||||||||
Time deposits | 933 | (7,293 | ) | (6,360 | ) | 3,940 | (11,889 | ) | (7,949 | ) | ||||||||||||||||
Retail repurchase agreements | (36 | ) | 7 | (29 | ) | (244 | ) | (280 | ) | (524 | ) | |||||||||||||||
Federal Home Loan Bank advances | (1,414 | ) | (864 | ) | (2,278 | ) | (691 | ) | (737 | ) | (1,428 | ) | ||||||||||||||
Federal funds purchased | (152 | ) | 0 | (152 | ) | 877 | (1,222 | ) | (345 | ) | ||||||||||||||||
Other borrowed funds | 0 | (302 | ) | (302 | ) | 268 | (1,293 | ) | �� | (1,025 | ) | |||||||||||||||
Total interest expense | (147 | ) | (10,193 | ) | (10,340 | ) | 5,293 | (18,336 | ) | (13,043 | ) | |||||||||||||||
Increase (decrease) in net interest income | $ (7,123) | $ | (2,618 | ) | $ | (9,741 | ) | $ | 5,465 | $ | (4,525 | ) | $ | 940 | ||||||||||||
Regular cuts to the target federal funds rate continued through 2008 with year-end rates at 0.25% and remained at this level for all of 2009 and 2010.
Provision for Loan Losses
This provision is the charge against earnings to provide an allowance for probable losses inherent in the loan portfolio. The amount of each year’s charge is affected by several considerations, including management’s evaluation of various risk factors in determining the adequacy of the allowance (see “Asset Quality” below), actual loan loss experience and loan portfolio growth. The provision for loan losses was $132.8 million in 2010, $61.7 million in 2009 and $27.8 million in 2008. This increase in the level of the provision for loan losses is discussed and analyzed in detail as part of the discussions in the “Significant Factors Affecting Earnings” and “Asset Quality” sections.
Noninterest Income
Noninterest income increased $9.2 million, or 42.4%, in 2010, due primarily to a $10.6 million gain on sale of securities in order to take advantage of market opportunities. Additional information concerning factors that specifically affected noninterest income in 2010 is discussed in “Significant Factors Affecting Earnings” section.
Noninterest income decreased $1.2 million, or 5.1%, in 2009, due primarily to a $5.0 million OTTI charge on an investment security owned by the Bank for which the Bank deemed it would be unlikely to recover its investment.
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| (dollars in thousands) | December 31, | |||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Service charges on deposit accounts | $ | 7,358 | $ | 8,956 | $ | 9,167 | ||||||
Mortgage loan income | 5,510 | 9,888 | 6,340 | |||||||||
Cardholder and merchant services income | 3,000 | 2,514 | 2,395 | |||||||||
Trust and investment services | 1,946 | 1,741 | 1,827 | |||||||||
Bank owned life insurance | 988 | 1,068 | 983 | |||||||||
Other service charges, commissions and fees | 1,030 | 1,158 | 796 | |||||||||
Securities gains, net | 10,647 | 989 | 646 | |||||||||
Gain on fair value swap | 273 | 66 | - | |||||||||
Total other-than-temporary impairment loss | - | (4,985) | - | |||||||||
Portion of loss recognized in other comprehensive income | - | - | - | |||||||||
Net impairment loss recognized in earnings | - | (4,985) | - | |||||||||
Other income | 235 | 358 | 764 | |||||||||
Total noninterest income | $ | 30,987 | $ | 21,753 | $ | 22,918 | ||||||
In 2009, the Federal Reserve adopted amendments to its Regulation E that restricted the Bank’s ability to charge customers overdraft fees beginning in July 2010. Pursuant to the adopted regulation, customers were given the option to opt-in to an overdraft service for the Bank to collect overdraft fees. Additional legislation is being considered in Congress that would further restrict the Bank from collecting overdraft fees or limit the amount of overdraft fees that may be collected. These changes had a minimal impact on the Bank’s noninterest income.
Noninterest Expense
Noninterest expense was $38.9 million, or 32.4%, lower in 2010 mainly due to a goodwill impairment charge of $52.4 million for 2009, which significantly impacted noninterest expense in that year. OREO related expenses increased 318.5% to $14.5 million for 2010 compared to $3.5 million in 2009. Excluding the goodwill impairment charges of $52.4 million in 2009, noninterest expense was $13.5 million higher in 2010 than in 2009. FDIC insurance for 2010 was $5.9 million compared to $4.2 million for 2009, a 40.4% increase year over year. Noninterest expense was $1.8 million, or 1.5%, higher in 2009 compared to 2008. In 2008, noninterest expense was $118.1 million. The major component of the increase from 2008 to 2009 was a $2.9 million increase in OREO related expenses.
On November 12, 2009, the FDIC adopted a final rule imposing a 13-quarter prepayment of FDIC premiums to replenish the depleted insurance fund. This regulation required insured depository institutions to prepay their estimated quarterly regular risk-based assessments for the fourth quarter of 2009, through the fourth quarter of 2012 on December 30, 2009, at the same time that institutions paid their regular quarterly deposit insurance assessments for the third quarter of 2009. The estimated prepayment amount will be used to offset future FDIC premiums beginning on March 30, 2010, which represents payment of the regular insurance assessment for the 2009 fourth quarter. As of December 31, 2010, the Bank has $4.0 million remaining in the FDIC prepaid assessment.
| (dollars in thousands) | December 31, | |||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Personnel expense | $ | 30,360 | $ | 32,932 | $ | 33,081 | ||||||
Net occupancy expense | 5,031 | 5,522 | 5,343 | |||||||||
Furniture, equipment and data processing expense | 7,056 | 7,121 | 6,705 | |||||||||
Professional fees | 3,908 | 2,070 | 2,552 | |||||||||
Stationery, printing and supplies | 526 | 703 | 1,174 | |||||||||
Advertising and marketing | 1,634 | 2,056 | 1,371 | |||||||||
Other real estate owned expense | 14,532 | 3,472 | 610 | |||||||||
Credit/debit card expense | 1,715 | 1,672 | 1,716 | |||||||||
FDIC insurance | 5,856 | 4,170 | 894 | |||||||||
Goodwill impairment | - | 52,395 | 57,800 | |||||||||
Mortgage servicing rights impairment | 2,995 | - | - | |||||||||
Other expense | 7,389 | 7,799 | 6,857 | |||||||||
Total noninterest expense | $ | 81,002 | $ | 119,912 | $ | 118,103 | ||||||
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Provision for Income Taxes
The effective income tax rate increased from (4.1)% in 2009 to (1.0)% in 2010 due principally to the impact of deferred tax assets and valuation allowance on losses in 2010. Nondeductible expenses included a goodwill impairment charge of $52.4 million in 2009. The effective income tax rate decreased from 5.0% in 2008 to (4.1)% in 2009 due principally to lower net interest income and the higher level of nondeductible expenses in 2009.
During 2009, the deferred tax asset had to be evaluated and to the extent that it was determined that recovery was not likely, a valuation allowance was established. Although a valuation allowance was required for deferred tax assets at year end, there is no guarantee that an additional valuation allowance will not be required in the future. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense. The Bank maintained a full valuation allowance for deferred tax asset less unrealized losses on investment securities at December 31, 2010.
Liquidity
Liquidity for the Bank refers to its continuing ability to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve requirements, pay operating expenses and provide funds to FNB United for payment of dividends, debt service and other operational requirements. Liquidity is immediately available from three major sources: (a) cash on hand and on deposit at other banks, (b) the outstanding balance of federal funds sold, and (c) the investment securities portfolio.
A stable deposit base, supplemented by Federal Home Loan Bank (“FHLB”) advances and a modest amount of brokered time deposits, has been sufficient to meet the Bank’s loan demand. Additionally, the Bank’s investment securities portfolio provides a source of readily available liquidity.
Liquidity for Dover refers to its continuing ability to fund mortgage loan commitments and pay operating expenses. Liquidity is principally available from a line of credit with the Bank, established in 2007. Prior to that date, the line of credit was with a large national bank.
Contractual Obligations
Under existing contractual obligations, FNB United will be required to make payments in future periods. Table 3 presents aggregated information about the payments due under such contractual obligations at December 31, 2010. Transaction deposit accounts with indeterminate maturities have been classified as having payments according to an expected decay rate. Benefit plan payments cover estimated amounts due through 2020.
Table 3
Contractual Obligations
| (dollars in thousands) | Payments Due by Period at December 31, 2010 | |||||||||||||||||||
| One Year or Less | One to Three Years | Three to Five Years | Over Five Years | Total | ||||||||||||||||
Deposits | $ | 607,963 | $ | 499,550 | $ | 185,139 | $ | 403,738 | $ | 1,696,390 | ||||||||||
Retail repurchase agreements | 9,628 | - | - | - | 9,628 | |||||||||||||||
Federal Home Loan Bank advances | 25,000 | 50,624 | 18,452 | 50,409 | 144,485 | |||||||||||||||
Subordinated debt | - | - | - | 7,500 | 7,500 | |||||||||||||||
Trust preferred securities | - | - | - | 56,702 | 56,702 | |||||||||||||||
Lease obligations | 1,419 | 2,134 | 1,903 | 10,100 | 15,556 | |||||||||||||||
Estimated benefit plan payments: | ||||||||||||||||||||
Pension | 612 | 1,235 | 1,384 | 4,014 | 7,245 | |||||||||||||||
Other | 140 | 366 | 380 | 1,014 | 1,900 | |||||||||||||||
Total contractual cash obligations | $ 644,762 | $553,909 | $207,258 | $533,477 | $1,939,406 | |||||||||||||||
Commitments, Contingencies and Off-Balance Sheet Risk
Information about FNB United’s off-balance sheet risk exposure is presented in Note 20 to the accompanying consolidated financial statements.
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Asset/Liability Management and Interest Rate Sensitivity
One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings risk associated with changes in interest rates. One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps; however, this method addresses only the magnitude of timing differences and does not address earnings or market value. Therefore, management uses an earnings simulation model to prepare, on a monthly basis, earnings projections based on a range of interest rate scenarios in order to more accurately measure interest rate risk. For additional information, see Item 7A, “Quantitative and Qualitative Disclosure about Market Risk.”
Table 4 presents information about the periods in which the interest-sensitive assets and liabilities at December 31, 2010 will mature, prepay, or be subject to repricing in accordance with market rates, and the resulting interest-sensitivity gaps. This table shows the sensitivity of the balance sheet at one point in time and is not necessarily indicative of what the sensitivity will be on other dates. As a simplifying assumption concerning repricing behavior, 50% of the interest-bearing demand, savings and money market deposits are assumed to reprice immediately and 50% are assumed to reprice beyond one year.
Table 4
Interest Rate Sensitivity Analysis
| December 31, 2010 | ||||||||||||||||||||
| (dollars in thousands) | Rate Maturity in Days | |||||||||||||||||||
| 1-90 | 91-180 | 181-365 | Beyond One Year | Total | ||||||||||||||||
Earning Assets | ||||||||||||||||||||
Investment securities (1) | $ | 48,757 | $ | 1,035 | $ | 5,023 | $ | 251,378 | $ | 306,193 | ||||||||||
Loans | 633,365 | 92,121 | 264,488 | 314,001 | 1,303,975 | |||||||||||||||
Loans held for sale | 37,079 | - | - | - | 37,079 | |||||||||||||||
Interest-bearing bank balances | 139,543 | - | - | - | 139,543 | |||||||||||||||
Other earning assets | 11,501 | 3,761 | - | - | 15,262 | |||||||||||||||
Total interest-earning assets | 870,245 | 96,917 | 269,511 | 565,379 | 1,802,052 | |||||||||||||||
Interest-Bearing Liabilities | ||||||||||||||||||||
Interest-bearing deposits: | ||||||||||||||||||||
Demand deposits | 115,042 | - | - | 115,042 | 230,084 | |||||||||||||||
Savings deposits | 21,862 | - | - | 21,862 | 43,724 | |||||||||||||||
Money market deposits | 156,004 | - | - | 156,003 | 312,007 | |||||||||||||||
Time deposits of $100,000 or more | 70,393 | 85,559 | 140,941 | 247,839 | 544,732 | |||||||||||||||
Other time deposits | 67,325 | 63,865 | 115,937 | 169,783 | 416,910 | |||||||||||||||
Retail repurchase agreements | 9,628 | - | - | - | 9,628 | |||||||||||||||
Federal Home Loan Bank advances | - | - | 25,000 | 119,485 | 144,485 | |||||||||||||||
Subordinated debt | - | - | - | 7,500 | 7,500 | |||||||||||||||
Trust preferred securities | 56,702 | - | - | - | 56,702 | |||||||||||||||
Total interest-bearing liabilities | 496,956 | 149,424 | 281,878 | 837,514 | 1,765,772 | |||||||||||||||
Interest Sensitivity Gap | $ | 373,289 | $ | (52,507) | $ | (12,367) | $ | (272,135) | $ | 36,280 | ||||||||||
Cumulative gap | $ | 373,289 | $ | 320,782 | $ | 308,415 | $ | 36,280 | $ | 36,280 | ||||||||||
Ratio of interest-sensitive assets to interest-sensitive liabilities | 175% | 65% | 96% | 68% | 102% | |||||||||||||||
| (1) | Securities are based on amortized cost. |
FNB United’s balance sheet was asset-sensitive at December 31, 2010. An asset sensitive position means that in a declining rate environment, FNB United’s assets will reprice down faster than liabilities, resulting in a reduction in net interest income. Conversely, when interest rates rise, FNB United’s earnings position should improve. Included in interest-bearing liabilities subject to rate changes within 90 days is a portion of the interest-bearing demand, savings and money market deposits. These types of deposits historically have not repriced coincidentally with or in the same proportion as general market indicators.
Market Risk
Market risk is the possible chance of loss from unfavorable changes in market prices and rates. These changes may result in a reduction of current and future period net interest income, which is the favorable spread earned from the excess of interest income on interest-earning assets, over interest expense on interest-bearing liabilities.
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FNB United’s market risk arises primarily from interest rate risk inherent in its lending and deposit-taking activities. The structure of FNB United’s loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. FNB United does not maintain a trading account nor is FNB United subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of FNB United’s asset/liability management function, which is discussed in “Asset/Liability Management and Interest Rate Sensitivity” above. The use of interest rate swaps in conjunction with asset/liability management objectives is discussed in Note 1 to the accompanying consolidated financial statements.
Table 5 presents information about the contractual maturities, average interest rates and estimated values at current rates of financial instruments considered market risk sensitive at December 31, 2010.
Table 5
Market Risk Analysis of Financial Instruments
| (dollars in thousands) | Contractual Maturities at December 31, 2010 | |||||||||||||||||||||||||||||||||||
| 2011 | 2012 | 2013 | 2014 | 2015 | Beyond Five Years | Total | Average Interest Rate (1) | Estimated Value at Current Rates | ||||||||||||||||||||||||||||
Financial Assets | ||||||||||||||||||||||||||||||||||||
Debt securities (2): | ||||||||||||||||||||||||||||||||||||
Fixed rate | $ | 6,323 | $ | 1,021 | $ | 2,688 | $ | 317 | $ | 101 | $ | 247,251 | $ | 257,701 | 2.90 | % | $ | 257,252 | ||||||||||||||||||
Variable rate | - | - | - | - | - | 48,492 | 48,492 | 0.76 | % | 48,079 | ||||||||||||||||||||||||||
Loans (3): | ||||||||||||||||||||||||||||||||||||
Fixed rate | 105,537 | 56,303 | 51,311 | 66,499 | 26,910 | 173,086 | 479,646 | 6.02 | % | 480,500 | ||||||||||||||||||||||||||
Variable rate | 360,891 | 59,542 | 43,406 | 31,484 | 13,113 | 315,893 | 824,329 | 3.17 | % | 773,350 | ||||||||||||||||||||||||||
Held for sale | 37,079 | - | - | - | - | - | 37,079 | 3.61 | % | 37,079 | ||||||||||||||||||||||||||
Interest-bearing bank balances | 139,543 | - | - | - | - | - | 139,543 | 0.60 | % | 139,543 | ||||||||||||||||||||||||||
Other earning assets | 15,262 | - | - | - | - | - | 15,262 | 1.82 | % | 15,262 | ||||||||||||||||||||||||||
Total | $ | 664,635 | $ | 116,866 | $ | 97,405 | $ | 98,300 | $ | 40,124 | $ | 784,722 | $ | 1,802,052 | 3.62 | % | $ | 1,751,065 | ||||||||||||||||||
Financial Liabilities | ||||||||||||||||||||||||||||||||||||
Interest-bearing demand deposits | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 230,084 | $ | 230,084 | 1.00 | % | $ | 209,439 | ||||||||||||||||||
Savings deposits | - | - | - | - | - | 43,724 | 43,724 | 0.26 | % | 44,723 | ||||||||||||||||||||||||||
Money market deposits | - | - | - | - | - | 312,007 | 312,007 | 0.97 | % | 307,299 | ||||||||||||||||||||||||||
Time deposits: | ||||||||||||||||||||||||||||||||||||
Fixed rate | 533,760 | 243,865 | 118,890 | 24,033 | 27,440 | 66 | 948,054 | 1.68 | % | 958,570 | ||||||||||||||||||||||||||
Variable rate | 10,259 | 3,119 | 110 | 100 | - | - | 13,588 | 5.14 | % | 13,740 | ||||||||||||||||||||||||||
Retail repurchase agreements | - | - | - | - | - | - | 9,628 | 0.78 | % | 9,628 | ||||||||||||||||||||||||||
Federal Home Loan Bank advances Fixed rate | 25,000 | 15,000 | 20,320 | 15,304 | 18,452 | 50,409 | 144,485 | 2.55 | % | 150,466 | ||||||||||||||||||||||||||
Subordinated debt | - | - | - | - | - | - | 7,500 | 3.90 | % | 7,500 | ||||||||||||||||||||||||||
Trust preferred securities | - | - | - | - | - | - | 56,702 | 2.65 | % | 41,681 | ||||||||||||||||||||||||||
Total | $ | 569,019 | $ | 261,984 | $ | 139,320 | $ | 39,437 | $ | 45,892 | $ | 636,290 | $ | 1,765,772 | 1.56 | % | $ | 1,743,046 | ||||||||||||||||||
| (1) | The average interest rate related to debt securities is stated on a fully taxable equivalent basis, assuming a 35% federal income tax rate. |
| (2) | Contractual maturities of debt and equity securities are based on amortized cost. |
| (3) | Nonaccrual loans are included in the balance of loans. The allowance for loan losses is excluded. |
For a further discussion on market risk and how FNB United addresses this risk, see Item 7A of this Annual Report on Form 10-K/A.
Capital Adequacy
Under guidelines established by the Board of Governors of the Federal Reserve System, capital adequacy is currently measured for regulatory purposes by certain risk-based capital ratios, supplemented by a leverage capital ratio. The risk-based capital ratios are determined by expressing allowable capital amounts, defined in terms of Tier 1 and Tier 2, as a percentage of risk-weighted assets, which are computed by measuring the relative credit risk of both the asset categories on the balance sheet and various off-balance sheet exposures. Tier 1 capital consists primarily of common shareholders’ equity and qualifying perpetual preferred stock and qualifying trust preferred securities, net of goodwill and other disallowed intangible assets. Tier 2 capital, which is limited to the total of Tier 1 capital, includes allowable amounts of subordinated debt, mandatory convertible debt, preferred stock, trust preferred securities and the allowance for loan losses. Total capital, for risk-based purposes, consists of the sum of Tier 1 and Tier 2 capital. Under current requirements, the minimum total risk based capital ratio is 8.0% and the minimum Tier 1 capital ratio is 4.0%. The Company is subject to increased minimum capital requirements as part of
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the Consent Order with the Comptroller of the Currency. Under the requirements of the Consent Order the Bank must maintain total capital at least equal to 12% of risk-weighted assets and Tier 1 capital at least equal to 9% of adjusted total assets. At December 31, 2010, FNB United and the Bank had total risk based capital ratios of (2.56)% and 2.36%, respectively, and Tier 1 risk based capital ratios of (2.56)% and 1.18%, respectively. The leverage capital ratio, which serves as a minimum capital standard, considers Tier 1 capital only and is expressed as a percentage of average total assets for the most recent quarter, after reduction of those assets for goodwill and other disallowed intangible assets at the measurement date. As currently required, the minimum leverage capital ratio is 4.0%. At December 31, 2010, FNB United and the Bank had leverage capital ratios of (1.86)% and .86%, respectively. For further discussion on capital strategies, refer to “Management’s Plans and Intentions” above.
Table 6
Regulatory Capital
| (dollars in thousands) | For year ended December 31, | |||||||||||||||||||||||
| 2010 | 2009 | 2008 | ||||||||||||||||||||||
Total risk-based capital | ||||||||||||||||||||||||
Consolidated | $ | (36,818 | ) | (2.6) % | $ | 181,990 | 10.3 % | $ | 185,312 | 10.4 % | ||||||||||||||
Subsidiary Bank | 33,812 | 2.4 | 178,023 | 10.1 | 182,084 | 10.2 | ||||||||||||||||||
Tier 1 risk-based capital | ||||||||||||||||||||||||
Consolidated | (36,818 | ) | (2.6) | 121,207 | 6.9 | 123,796 | 6.9 | |||||||||||||||||
Subsidiary Bank | 16,906 | 1.2 | 140,604 | 8.0 | 144,654 | 8.1 | ||||||||||||||||||
Leverage capital | ||||||||||||||||||||||||
Consolidated | (36,818 | ) | (1.9) | 121,207 | 5.7 | 123,796 | 6.1 | |||||||||||||||||
Subsidiary Bank | 16,906 | 0.9 | 140,604 | 6.6 | 144,654 | 7.2 | ||||||||||||||||||
The Bank is also required to comply with prompt corrective action provisions established by the Federal Deposit Insurance Corporation Improvement Act. The Order, as set forth above, requires the Bank to achieve and maintain Tier 1 capital of not less than 9% and total risk-based capital of not less than 12% for the life of the Order. The Bank has not achieved the required capital levels by the deadline imposed under the Order but is continuing to work to comply with the capital directive. As of December 31, 2010, the Bank was designated as “significantly undercapitalized” under the regulatory framework for prompt corrective action.
Balance Sheet Review
Total assets decreased $198.9 million, or 10%, in 2010 and $56.9 million, or 3%, in 2009. By similar comparison, deposits decreased $25.7 million to $1.7 million, or 2% in 2010 and increased $207.4 million, or 14% in 2009. The level of total assets was also affected in 2010 by a net decrease of $259.0 million of loan outstandings as a direct result of management’s decision to deleverage the balance sheet. Average assets decreased by 6% in 2010 compared to a growth of 6% in 2009. The corresponding average deposit growth rate was 5% in 2010 compared to a growth of 11% in 2009. In addition, the Company recorded $52.5 million in deferred tax valuation allowance for 2010.
Investment Securities
Investments are carried on the consolidated balance sheet at estimated fair value for available-for-sale securities and at amortized cost for held-to-maturity securities. Table 7 presents information, on the basis of selected maturities, about the composition of the investment securities portfolio for each of the last two years.
Table 7
Investment Securities Portfolio Analysis
The following table presents the amortized costs, fair value and weighted-average yield of securities by contractual maturity at December 31, 2010. The average yields are based on the amortized cost. In some cases, the issuers may have the right to call or prepay obligations without call or prepayment penalties prior to the contractual maturity date. Rates are calculated on a fully tax-equivalent basis using a 35% federal income tax rate.
On May 3, 2010, the Company reclassified the entire held-to-maturity investment securities portfolio to available-for-sale investment securities to provide additional liquidity to the Bank. At the time of reclassification, the held-to-maturity investment securities were carried at amortized cost of $83.2 million with an unrealized net gain of $3.5 million.
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Available-for-Sale
| (dollars in thousands) | Within 1 Year | 1 to 5 Years | 5 to 10 Years | Over 10 Years | Total | |||||||||||||||
Amortized Cost | ||||||||||||||||||||
Obligations of: | ||||||||||||||||||||
U.S. Treasury and government agencies | $ | 20 | $ | - | $ | - | $ | - | $ | 20 | ||||||||||
U.S. government sponsored agencies | 5,003 | - | 18,487 | - | 23,490 | |||||||||||||||
States and political subdivisions | 1,300 | 4,127 | 4,261 | 14,179 | 23,867 | |||||||||||||||
Residential mortgage-backed securities | - | - | 8,566 | 250,250 | 258,816 | |||||||||||||||
Total available-for-sale securities | $ | 6,323 | $ | 4,127 | $ | 31,314 | $ | 264,429 | $ | 306,193 | ||||||||||
Fair Value | ||||||||||||||||||||
Obligations of: | ||||||||||||||||||||
U.S. Treasury and government agencies | $ | 21 | $ | - | $ | - | $ | - | $ | 21 | ||||||||||
U.S. government sponsored agencies | 5,161 | - | 18,355 | - | 23,516 | |||||||||||||||
States and political subdivisions | 1,309 | 4,104 | 4,172 | 14,873 | 24,458 | |||||||||||||||
Residential mortgage-backed securities | - | - | 8,568 | 248,768 | 257,336 | |||||||||||||||
Total available-for-sale securities | $ | 6,491 | $ | 4,104 | $ | 31,095 | $ | 263,641 | $ | 305,331 | ||||||||||
Total average yield | 4.64% | 3.32% | 2.46% | 2.52% | 2.56% | |||||||||||||||
| The following table presents the amortized costs, fair value and weighted-average yield of securities by contractual maturity at December 31, 2009. The average yields are based on the amortized cost. In some cases, the issuers may have the right to call or prepay obligations without call or prepayment penalties prior to the contractual maturity date. Rates are calculated on a fully tax-equivalent basis using a 35% federal income tax rate. | ||||||||||||||||||||
Available-for-Sale |
| |||||||||||||||||||
| (dollars in thousands) | Within 1 Year | 1 to 5 Years | 5 to 10 Years | Over 10 Years | Total | |||||||||||||||
Amortized Cost | ||||||||||||||||||||
Obligations of: | ||||||||||||||||||||
U.S. Treasury and government agencies | $ | - | $ | 61 | $ | - | $ | - | $ | 61 | ||||||||||
U.S. government sponsored agencies | - | 32,395 | 33,031 | 6,270 | 71,696 | |||||||||||||||
States and political subdivisions | 4,043 | 6,833 | 15,806 | 18,582 | 45,264 | |||||||||||||||
Residential mortgage-backed securities | - | - | - | 99,307 | 99,307 | |||||||||||||||
Equity securities | - | - | - | 2,667 | 2,667 | |||||||||||||||
Corporate notes | 7,971 | 5,939 | - | - | 13,910 | |||||||||||||||
Total available-for-sale securities | $ | 12,014 | $ | 45,228 | $ | 48,837 | $ | 126,826 | $ | 232,905 | ||||||||||
Fair Value | ||||||||||||||||||||
Obligations of: | ||||||||||||||||||||
U.S. Treasury and government agencies | $ | - | $ | 63 | $ | - | $ | - | $ | 63 | ||||||||||
U.S. government sponsored agencies | - | 33,278 | 33,406 | 6,283 | 72,967 | |||||||||||||||
States and political subdivisions | 4,057 | 6,989 | 15,763 | 19,619 | 46,428 | |||||||||||||||
Residential mortgage-backed securities | - | - | - | 101,613 | 101,613 | |||||||||||||||
Collateralized debt obligations | - | - | - | 45 | 45 | |||||||||||||||
Equity securities | - | - | - | 2,168 | 2,168 | |||||||||||||||
Corporate notes | 8,081 | 6,265 | - | - | 14,346 | |||||||||||||||
Total available-for-sale securities | $ | 12,138 | $ | 46,595 | $ | 49,169 | $ | 129,728 | $ | 237,630 | ||||||||||
Total average yield | 4.91% | 4.42% | 4.55% | 4.46% | 4.49% | |||||||||||||||
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Held-to-Maturity
| (dollars in thousands) | Within 1 Year | 1 to 5 Years | 5 to 10 Years | Over 10 Years | Total | |||||||||||||||
Amortized Cost | ||||||||||||||||||||
Obligations of: | ||||||||||||||||||||
States and political subdivisions | $ | 1,555 | $ | 4,678 | $ | 5,906 | $ | 1,779 | $ | 13,918 | ||||||||||
Residential mortgage-backed securities | - | - | - | 52,127 | 52,127 | |||||||||||||||
Commercial mortgage-backed securities | - | - | - | 21,513 | 21,513 | |||||||||||||||
Corporate notes | - | 1,001 | - | - | 1,001 | |||||||||||||||
Total held-to-maturity securities | $ | 1,555 | $ | 5,679 | $ | 5,906 | $ | 75,419 | $ | 88,559 | ||||||||||
Fair Value | ||||||||||||||||||||
Obligations of: | ||||||||||||||||||||
States and political subdivisions | $ | 1,566 | $ | 4,884 | $ | 6,136 | $ | 1,818 | $ | 14,404 | ||||||||||
Residential mortgage-backed securities | - | - | - | 53,022 | 53,022 | |||||||||||||||
Commercial mortgage-backed securities | - | - | - | 23,232 | 23,232 | |||||||||||||||
Corporate notes | - | 863 | - | - | 863 | |||||||||||||||
Total held-to-maturity securities | $ | 1,566 | $ | 5,747 | $ | 6,136 | $ | 78,072 | $ | 91,521 | ||||||||||
Total average yield | 2.67% | 3.39% | 3.75% | 8.80% | 8.01% | |||||||||||||||
Additions to the investment securities portfolio depend to a large extent on the availability of funds that are not otherwise needed to satisfy loan demand.
Loans
FNB United’s primary source of revenue and largest component of earning assets is the loan portfolio. In 2010, loans decreased $259.0 million, or 17%, due to the Bank’s decision to reduce outstanding loans because of its current financial condition. In 2009, loans decreased $22.2 million, or 1%, due to reduction in loan demand stemming from ongoing uncertainty in the general economy and the market. In 2008, loans increased $139.1 million, or 10%, due entirely to internal loan generation.
Table 8 sets forth the major categories of loans for each of the last five years.
Table 8
Loan Portfolio Composition
| (dollars in thousands) | December 31, | |||||||||||||||||||||||||||||||||||||||
| 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||||||||||||||||||||||
Loans held for sale | $ | 37,079 | $ | 58,219 | $ | 17,586 | $ | 20,862 | $ | 17,615 | ||||||||||||||||||||||||||||||
Loans held for investment: | ||||||||||||||||||||||||||||||||||||||||
Commercial and agricultural | $ | 93,747 | 7.2 | % | $ | 194,134 | 12.4 | % | $ | 184,909 | 11.7 | % | $ | 182,713 | 12.6 | % | $ | 315,184 | 24.2 | % | ||||||||||||||||||||
Real estate-construction | 276,976 | 21.2 | 394,427 | 25.2 | 453,668 | 28.6 | 373,401 | 25.8 | 278,124 | 21.4 | ||||||||||||||||||||||||||||||
Real estate-mortgage: | ||||||||||||||||||||||||||||||||||||||||
1-4 family residential | 388,859 | 29.8 | 398,134 | 25.5 | 369,948 | 23.3 | 331,194 | 22.9 | 319,182 | 24.5 | ||||||||||||||||||||||||||||||
Commercial | 494,861 | 38.0 | 529,822 | 33.9 | 540,192 | 34.1 | 522,737 | 36.2 | 350,261 | 26.9 | ||||||||||||||||||||||||||||||
Consumer | 49,532 | 3.8 | 46,504 | 3.0 | 36,478 | 2.3 | 36,071 | 2.5 | 39,089 | 3.0 | ||||||||||||||||||||||||||||||
Total | $ | 1,303,975 | 100.0 | % | $ | 1,563,021 | 100.0 | % | $ | 1,585,195 | 100.0 | % | $ | 1,446,116 | 100.0 | % | $ | 1,301,840 | 100.0 | % | ||||||||||||||||||||
In 2010, loans held for sale decreased over 36%. This decrease is a result of the discontinuation of a wholesale purchasing agreement with Fannie Mae as well as lower production in 2010. Held-for-sale loans do not include any reclassifications from the held-for-investment portfolio. The held-for-investment portfolio experienced composition changes with a 5.2% decrease in commercial and agricultural loans and a 4.0% decrease in real estate construction loans, both offset by a 4.3% increase in 1-4 family residential mortgages, a 4.1% increase in commercial real estate mortgages and a 0.8% increase in consumer loans. In 2009 the held-for-investment portfolio experienced small composition changes primarily with a 3.4% decrease in real estate construction loans partially offset by a 2.2% increase in 1-4 family residential mortgages and a 0.7% increase in consumer loans.
The maturity distribution and interest rate sensitivity of selected loan categories at December 31, 2010 are presented in Table 9.
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Table 9
Selected Loan Maturities
(dollars in thousands) | December 31, 2010 | |||||||||||||||
| One Year or Less | One to Five Years | Over Five Years | Total | |||||||||||||
Commercial and agricultural | $ | 53,964 | $ | 27,684 | $ | 12,099 | $ | 93,747 | ||||||||
Real estate-construction | 217,770 | 45,229 | 13,977 | 276,976 | ||||||||||||
Total | $ | 271,734 | $ | 72,913 | $ | 26,076 | $ | 370,723 | ||||||||
Sensitivity to rate changes: | ||||||||||||||||
Fixed interest rates | $ | 27,695 | $ | 31,875 | $ | 18,006 | $ | 77,576 | ||||||||
Variable interest rates | 244,039 | 41,038 | 8,070 | 293,147 | ||||||||||||
Total | $ | 271,734 | $ | 72,913 | $ | 26,076 | $ | 370,723 | ||||||||
Asset Quality
Management considers the asset quality of the Bank to be of primary importance. A formal loan review function, independent of loan origination, is used to identify and monitor problem loans. As part of the loan review function, a third-party assessment group has been employed to review the underwriting documentation and risk grading analysis.
In June 2010, an external loan review of the Bank’s loan portfolio (as of April 30, 2010) was conducted, covering 49% of the total outstanding portfolio balance. The external loan review resulted in 9.3% of loans reviewed being downgraded from pass to non-pass. All risk downgrades identified during this review were included as factors in the computation of the allowance for loan losses as of June 30, 2010. Since December 31, 2009 the Company increased its allowance for loan losses to $93.7 million or 7.18% of gross loans.
Nonperforming assets
Nonperforming assets are comprised of nonaccrual loans, accruing loans past due 90 days or more, repossessed assets and other real estate owned (“OREO”). Nonperforming loans are loans placed in nonaccrual status when, in management’s opinion, the collection of all or a portion of interest becomes doubtful. Loans are returned to accrual status when the factors indicating doubtful collectability cease to exist and the loan has performed in accordance with its terms for a demonstrated period of time. OREO represents real estate acquired through foreclosure or deed in lieu of foreclosure and is generally carried at fair value, less estimated costs to sell.
The level of nonperforming loans increased significantly from $174.4 million, or 11.2% of loans held for investment at December 31, 2009, to $329.9 million, or 25.3% of loans held for investment at December 31, 2010. OREO was $62.2 million at December 31, 2010, compared to $35.2 million at December 31, 2009. General downward economic trends, increased unemployment and the depressed housing market in particular have negatively affected the credit performance of the residential real estate development and construction sectors of the Bank’s commercial portfolio in particular, and consumer credit more generally, resulting in additional delinquencies and loans placed on nonaccrual.
The continued softening of the real estate market through 2010 has adversely affected the Company’s net income. Real estate lending (including commercial, construction, land development, and residential) is a large portion of the Bank’s loan portfolio. These categories constitute $1.2 billion, or approximately 89.4%, of the Bank’s total loan portfolio. These categories are generally affected by changes in economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax and other laws and acts of nature. The downturn in the real estate markets in which the Company originates, purchases, and services mortgage and other loans hurts its business because these loans are secured by real estate. Further declines will adversely affect the Company’s future earnings.
Allowance for Loan Losses
In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to a review of individual loans, historical loan loss experience, the value and adequacy of collateral, and economic conditions in the Bank’s
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market area. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans, that may be susceptible to significant change. In addition, the Office of the Comptroller of the Currency (“OCC”), a federal regulatory agency, as an integral part of its examination process, periodically reviews the Bank’s allowance for loan losses. The OCC may require the Bank to recognize changes to the allowance based on its judgments about information available to it at the time of its examinations. Loans are charged off when, in the opinion of management, they are deemed to be uncollectible. Recognized losses are charged against the allowance, and subsequent recoveries are added to the allowance.
The allowance for loan losses, as a percentage of loans held for investment, amounted to 7.18% at December 31, 2010 compared to 3.16% at December 31, 2009. Net charge-offs also significantly increased in 2010. A substantial portion of 2010 charge-offs were related to impaired loans, and consisted of loans considered wholly impaired and loans with partial impairment. During 2010, net charge-offs totaled $88.5 million, which exceeded the combined net charge-offs for the prior seven years. The provision for loan losses recorded in 2010 also exceeded the combined provision recorded in the prior seven years. As discussed above, the increased levels of nonperforming assets and charge-offs resulted largely from loan quality issues driven by worsening economic conditions, including strains in housing and real estate markets. Management continually performs thorough analyses of the loan portfolio. As a result of these analyses, certain loans have migrated to higher, more adverse risk grades and an aggressive posture towards the timely charge-off of identified impairment has also continued. Actual past due loans and loan charge-offs have remained at manageable levels and management continues to diligently work to improve asset quality. Management believes the allowance for loan losses of $93.7 million at December 31, 2010 is adequate to cover probable losses inherent in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires considerable judgment.
Troubled debt restructurings generally occur when a borrower is experiencing, or is expected to experience, financial difficulties in the near-term. As a result, the Bank will work with the borrower to prevent further difficulties, and ultimately to improve the likelihood of recovery on the loan. To facilitate this process, a concessionary modification that would not otherwise be considered may be granted resulting in classification as a troubled debt restructuring. The Bank considers all troubled debt restructurings to be impaired loans. Troubled debt restructurings can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accruing status, depending on the individual facts and circumstances of the borrower. Generally, a nonaccrual loan that is restructured remains on nonaccrual for a period of six months to demonstrate the borrower can meet the restructured terms. However, performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status after a shorter performance period. If the borrower’s ability to meet the revised payment schedule is not reasonably assured, the loan remains in a nonaccrual status.
The majority of the Bank’s loan modifications relates to commercial lending and involves extending the term of the loan. In these cases, the Bank does not typically lower the interest rate or forgive principal or interest as part of the loan modification. In addition, it is common for the Bank to seek additional collateral or guarantor support when modifying a loan. The amount of loan restructurings increased during 2010, as the Bank continues to work with borrowers who are experiencing financial difficulties. As a result of continued economic stress, the Bank anticipates that it will have further increases in loan restructurings during 2011.
The Bank’s criteria for nonperforming status, impaired status and troubled debt restructures have been described earlier. The following table presents the Bank’s level and composition of nonperforming loans as of December 31:
(dollars in thousands)
| 2010 | 2009 | ||||||
Current, nonaccrual | $ | 76,216 | $ | 62,469 | ||||
Delinquent 30-89 days, nonaccrual | 53,440 | 17,626 | ||||||
Delinquent 90+ days, nonaccrual | 195,412 | 87,411 | ||||||
Delinquent 90+ days, accruing | 4,818 | 6,908 | ||||||
Total nonperforming loans | $ | 329,886 | $ | 174,414 | ||||
Nonperforming loans and impaired loans are overlapping sets of loans. Impaired loans are problem loans that may, or may not, have been placed into nonaccrual status. The complete repayment of principal and interest is considered probable for those impaired loans that have not been placed into a nonaccrual status, but not within contracted terms.
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The differential between the amount of nonperforming impaired loans and total impaired loans noted above arises from two loans totaling $5.0 million, which were in the process of being refinanced at other institutions. Neither had been previously impaired. The refinancing process exceeded 90 days in both cases, however, which resulted in the loans being placed in nonaccrual.
The following table presents the level, composition and the reserves associated with those loan balances:
| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||||||||||
| Balance | Associated Reserves | Balance | Associated Reserves | |||||||||||||
Impaired loans, not individually reviewed for impairment | $ | 717 | $ | - | $ | 5,660 | $ | 38 | ||||||||
Impaired loans, individually reviewed, with no impairment | 132,435 | - | 84,928 | - | ||||||||||||
Impaired loans, individually reviewed, with impairment | 208,040 | 70,888 | 98,010 | 28,868 | ||||||||||||
Total impaired loans * | $ | 341,192 | $ | 70,888 | $ | 188,598 | $ | 28,906 | ||||||||
* Included at December 31, 2010 and December 31, 2009 were $6.5 million and $24.7 million, respectively, in restructured and performing loans.
At December 31, 2010, the bank had 86 impaired loans exceeding $1.0 million each, with total impairment of $54.0 million, comprised of 59 borrowing relationships. The average carrying value of impaired loans was $355.1 million in 2010 and $147.2 million in 2009.
Troubled debt restructures are a subset of impaired loans. The following table presents the level, accrual status and the reserves associated with these loan balances:
| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||||||||||||||||||
| Troubled Debt Restructures: | Balance | Nonaccrual | Associated Reserves | Balance | Nonaccrual | Associated Reserves | ||||||||||||||||||
TDRs with no impairment | $ | 66,919 | $ | 60,345 | $ | - | $ | 58,897 | $ | 34,334 | $ | - | ||||||||||||
TDRs with impairment | 79,573 | 79,573 | 18,908 | 36,784 | 36,604 | 5,859 | ||||||||||||||||||
Total Troubled Debt Restructures | $ | 146,492 | $ | 139,918 | $ | 18,908 | $ | 95,681 | $ | 70,938 | $ | 5,859 | ||||||||||||
| The following table presents the composition of impaired loans across loan types, along with the accrual status and the associated reserves, by type: | ||||||||||||||||||||||||
| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||||||||||||||||||
| Impaired | Nonaccrual | Associated Reserves | Impaired | Nonaccrual | Associated Reserves | |||||||||||||||||||
Impaired Loans (composition across loan types): | ||||||||||||||||||||||||
Commercial and agricultural | $ | 21,788 | $ | 20,550 | $ | 7,451 | $ | 5,061 | $ | 4,930 | $ | 849 | ||||||||||||
Real estate - construction | 152,593 | 144,403 | 35,281 | 100,459 | 99,583 | 17,840 | ||||||||||||||||||
Real estate - mortgage: | ||||||||||||||||||||||||
1 - 4 family residential | 41,815 | 36,272 | 5,448 | 22,495 | 22,283 | 3,339 | ||||||||||||||||||
Commercial | 124,788 | 123,681 | 22,708 | 60,300 | 36,750 | 6,877 | ||||||||||||||||||
Consumer | 208 | 162 | - | 283 | 24 | 1 | ||||||||||||||||||
Total Impaired Loans | $ | 341,192 | $ | 325,068 | $ | 70,888 | $ | 188,598 | $ | 163,570 | $ | 28,906 | ||||||||||||
The Bank designates loans as “Special Mention” when the borrower’s financial condition or performance indicates that the loan may potentially become a problem loan. These loans are not classified as problem loans, nor are they impaired, and they have not been modified under conditions that require designation as troubled debt restructurings. At December 31, 2010, the Bank had designated $130.8 million as Special Mention loans, of which 15.5% were delinquent more than 30 days. 33 Special Mention loans had balances over $1.0 million and comprised approximately 66.9% of the total. Approximately 33.6% of the total Special Mention loans were categorized as land acquisition, development, and construction loans, with non-owner occupied commercial rental properties approximating another 15.2% of that total. These categories are generally affected by changes in economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax and other laws and acts of nature. In particular, a continuing trend of adverse economic conditions in the residential real estate market may result in Special Mention loans being individually reclassified as problem loans in the future.
Table 10
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Summary of Allowance for Loan Losses
Table 10 presents an analysis of the changes in the allowance for loan losses and of the level of nonperforming assets for each of the last five years as of December 31.
| (dollars in thousands) | 2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||||
Balance, beginning of year | $ | 49,461 | $ | 34,720 | $ | 17,381 | $ | 15,943 | $ | 9,945 | ||||||||||
Chargeoffs: | ||||||||||||||||||||
Commercial and agricultural | 9,824 | 3,417 | 6,479 | 1,262 | 1,817 | |||||||||||||||
Real estate - construction | 53,374 | 32,737 | 2,000 | 459 | 499 | |||||||||||||||
Real estate - mortgage | 24,478 | 9,789 | 414 | 941 | 210 | |||||||||||||||
Consumer | 3,574 | 3,442 | 3,532 | 2,831 | 2,104 | |||||||||||||||
Total chargeoffs | 91,250 | 49,385 | 12,425 | 5,493 | 4,630 | |||||||||||||||
Recoveries: | ||||||||||||||||||||
Commercial and agricultural | 581 | 70 | 292 | 415 | 1,123 | |||||||||||||||
Real estate - construction | 52 | 544 | - | 42 | 120 | |||||||||||||||
Real estate - mortgage | 449 | 264 | 197 | 171 | 268 | |||||||||||||||
Consumer | 1,639 | 1,507 | 1,516 | 1,091 | 1,231 | |||||||||||||||
Leases | - | - | - | - | 3 | |||||||||||||||
Total recoveries | 2,721 | 2,385 | 2,005 | 1,719 | 2,745 | |||||||||||||||
Net chargeoffs | 88,529 | 47,000 | 10,420 | 3,774 | 1,885 | |||||||||||||||
Provision charged to operations | 132,755 | 61,741 | 27,759 | 5,514 | 2,526 | |||||||||||||||
Purchase accounting acquisition | - | - | - | - | 6,038 | |||||||||||||||
Adjustment for reserve for unfunded commitments | - | - | - | - | (677) | |||||||||||||||
Allowance adjustment for loans sold | - | - | - | (302) | (4) | |||||||||||||||
Balance, end of year | $ | 93,687 | $ | 49,461 | $ | 34,720 | $ | 17,381 | $ | 15,943 | ||||||||||
Nonperforming assets: | ||||||||||||||||||||
Nonaccrual loans | $ | 325,068 | $ | 167,506 | $ | 95,173 | $ | 16,022 | $ | 8,282 | ||||||||||
Past due 90 days or more and still accruing interest | 4,818 | 6,908 | 853 | 2,686 | 2,852 | |||||||||||||||
Total nonperforming loans | 329,886 | 174,414 | 96,026 | 18,708 | 11,134 | |||||||||||||||
Other real estate owned | 62,226 | 35,170 | 6,509 | 2,862 | 3,361 | |||||||||||||||
Foreclosed assets | 138 | 68 | 92 | 181 | 196 | |||||||||||||||
Total nonperforming assets | $ | 392,250 | $ | 209,652 | $ | 102,627 | $ | 21,751 | $ | 14,691 | ||||||||||
Asset quality ratios: | ||||||||||||||||||||
Net loan chargeoffs to average loans | 5.92 | % | 2.97 | % | 0.67 | % | 0.27 | % | 0.16 | % | ||||||||||
Net loan chargeoffs to allowance for loan losses | 94.49 | 95.02 | 30.01 | 21.71 | 11.82 | |||||||||||||||
Allowance for loan losses to loans held for investment | 7.18 | 3.16 | 2.19 | 1.20 | 1.22 | |||||||||||||||
Total nonperforming loans to loans held for investment | 25.30 | 11.16 | 6.06 | 1.29 | 0.86 | |||||||||||||||
Management’s judgments are based on numerous assumptions about current events which it believes to be reasonable, but which may or may not be valid. Thus there can be no assurance that loan losses in future periods will not exceed the current allowance or that future increases in the allowance will not be required. No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of FNB United.
Information about management’s allocation of the allowance for loan losses by loan category is presented in the following table.
Table 11
Allocations of Allowance for Loan Losses
| (dollars in thousands) | December 31, | |||||||||||||||||||
| 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
Commercial and agricultural | $ | 11,144 | $ | 3,543 | $ | 4,146 | $ | 2,777 | $ | 4,474 | ||||||||||
Real estate - construction | 46,792 | 23,932 | 15,238 | 5,254 | 3,829 | |||||||||||||||
Real estate - mortgage | 34,593 | 21,040 | 8,853 | 6,599 | 5,745 | |||||||||||||||
Consumer | 1,133 | 627 | 3,474 | 2,751 | 1,895 | |||||||||||||||
Unallocated | 25 | 319 | 3,009 | - | - | |||||||||||||||
Total allowance for loan losses | $ | 93,687 | $ | 49,461 | $ | 34,720 | $ | 17,381 | $ | 15,943 | ||||||||||
Deposits
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The level and mix of deposits is affected by various factors, including general economic conditions, the particular circumstances of local markets and the specific deposit strategies employed. In general, broad interest rate declines tend to encourage customers to consider alternative investments such as mutual funds and tax-deferred annuity products, while interest rate increases tend to have the opposite effect.
In 2010, deposits decreased $25.7 million, or 1.5%. Noninterest-bearing demand deposits decreased slightly while there were net decreases in all types of interest-bearing accounts (demand, savings, money-market, and time deposits). Certificates of deposit decreased 1.4% to $961.6 million, from $975.2 million in 2009 while other deposits decreased 1.6% to $734.7 million compared to $746.9 million in 2009. Brokered certificates of deposit were $140.2 million, or 8.3% of total deposits, of which $7.5 million were in the Promontory Interfinancial Network, LLC CDARS program.
In 2009, deposits increased by $207.4 million, or 13.7%. Noninterest-bearing demand deposits increased slightly while there were increases in all types of interest-bearing accounts (demand, savings, money-market, and time deposits). Certificates of deposit increased 10.2% to $975.2 million, from $885.3 million in 2008 while other deposits increased 18.7% to $746.9 million compared to $629.5 million in 2008. Brokered certificates of deposit were $112.3 million, or 6.52% of total deposits, of which $90.5 million were in the Promontory Interfinancial Network, LLC CDARS program.
Table 12 shows the year-end and average deposit balances for the years 2010, 2009 and 2008 and the changes in 2010 and 2009.
Table 12
Analysis of Deposits
| 2010 | 2009 | 2008 | ||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Change from Prior Year | Change from Prior Year | ||||||||||||||||||||||||||||||||||
| Balance | Amount | % | Balance | Amount | % | Balance | ||||||||||||||||||||||||||||||
Year End Balances | ||||||||||||||||||||||||||||||||||||
Interest-bearing deposits: | ||||||||||||||||||||||||||||||||||||
Demand deposits | $ | 230,084 | $ | 3,388 | 1.5 | $ | 226,696 | $ | 53,082 | 30.6 | $ | 173,614 | ||||||||||||||||||||||||
Savings deposits | 43,724 | 3,001 | 7.4 | 40,723 | 2,610 | 6.8 | 38,113 | |||||||||||||||||||||||||||||
Money market deposits | 312,007 | (14,951) | (4.6 | ) | 326,958 | 59,462 | 22.2 | 267,496 | ||||||||||||||||||||||||||||
Total | 585,815 | (8,562) | (1.4 | ) | 594,377 | 115,154 | 24.0 | 479,223 | ||||||||||||||||||||||||||||
Time deposits | 961,642 | (13,587) | (1.4 | ) | 975,229 | 89,978 | 10.2 | 885,251 | ||||||||||||||||||||||||||||
Total interest-bearing deposits | 1,547,457 | (22,149) | (1.4 | ) | 1,569,606 | 205,132 | 15.0 | 1,364,474 | ||||||||||||||||||||||||||||
Noninterest-bearing demand deposits | 148,933 | (3,589) | (2.4 | ) | 152,522 | 2,249 | 1.5 | 150,273 | ||||||||||||||||||||||||||||
Total deposits | $ | 1,696,390 | $ | (25,738) | (1.5 | ) | $ | 1,722,128 | $ | 207,381 | 13.7 | $ | 1,514,747 | |||||||||||||||||||||||
Average Balances | ||||||||||||||||||||||||||||||||||||
Interest-bearing deposits: | ||||||||||||||||||||||||||||||||||||
Demand deposits | $ | 228,054 | $ | 29,711 | 15.0 | $ | 198,343 | $ | 30,451 | 18.1 | $ | 167,892 | ||||||||||||||||||||||||
Savings deposits | 43,224 | 2,923 | 7.3 | 40,301 | (502) | (1.2 | ) | 40,803 | ||||||||||||||||||||||||||||
Money market deposits | 321,180 | 12,490 | 4.0 | 308,690 | 33,872 | 12.3 | 274,818 | |||||||||||||||||||||||||||||
Total | 592,458 | 45,124 | 8.2 | 547,334 | 63,821 | 13.2 | 483,513 | |||||||||||||||||||||||||||||
Time deposits | 974,192 | 34,054 | 3.6 | 940,138 | 97,894 | 11.6 | 842,244 | |||||||||||||||||||||||||||||
Total interest-bearing deposits | 1,566,650 | 79,178 | 5.3 | 1,487,472 | 161,715 | 12.2 | 1,325,757 | |||||||||||||||||||||||||||||
Noninterest-bearing demand deposits | 158,369 | 6,011 | 3.9 | 152,358 | (5,634) | (3.6 | ) | 157,992 | ||||||||||||||||||||||||||||
Total deposits | $ | 1,725,019 | $ | 85,189 | 5.2 | $ | 1,639,830 | $ | 156,081 | 10.5 | $ | 1,483,749 | ||||||||||||||||||||||||
Capital Adequacy and Resources
Under guidelines established by the Board of Governors of the Federal Reserve System, capital adequacy is currently measured for regulatory purposes by certain risk-based capital ratios, supplemented by a leverage capital ratio. The risk-based capital ratios are determined by expressing allowable capital amounts, defined in terms of Tier 1 and Tier 2, as a percentage of risk-weighted assets, which are computed by measuring the relative credit risk of both the asset categories on the balance sheet and various off-balance sheet exposures. Tier 1 capital consists primarily of common shareholders’ equity and qualifying perpetual preferred stock and qualifying trust preferred securities, net of goodwill and other disallowed intangible assets. Tier 2 capital, which is limited to the total of Tier 1 capital, includes allowable amounts of subordinated debt, mandatory convertible debt, preferred stock, trust preferred securities and the allowance for loan losses. Total capital, for risk-based purposes, consists of the sum of
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Tier 1 and Tier 2 capital. Under the requirements of the Consent Order, the minimum total capital ratio is 12.00% and the minimum Tier 1 capital ratio is 9.00% for the Bank. At December 31, 2010, FNB United and the Bank had total risk-based capital ratios of (2.56)% and 2.36%, respectively, and Tier 1 capital ratios of (2.56)% and 1.18%, respectively. The leverage capital ratio, which serves as a minimum capital standard, considers Tier 1 capital only and is expressed as a percentage of average total assets for the most recent quarter, after reduction of those assets for goodwill and other disallowed intangible assets at the measurement date. As currently required, the minimum leverage capital ratio is 4.0%. At December 31, 2010, FNB United and the Bank had leverage capital ratios of (1.86)% and .86%, respectively. The Bank is subject to increased minimum capital requirements as part of the Order with the Comptroller of the Currency.
As shown in the accompanying table, FNB United and its wholly owned banking subsidiary have capital levels below the minimum levels for “adequately capitalized” bank holding companies and banks as of December 31, 2010.
| Minimum Regulatory Requirement | ||||||||||||||||||||
| Consolidated | Bank | Adequately Capitalized | Well- Capitalized | Pursuant to Order | ||||||||||||||||
Total risk-based capital ratio | (2.56 | ) % | 2.36 | % | 8.00 | % | 10.00 | % | 12.00 | % | ||||||||||
Tier 1 risk-based capital ratio | (2.56 | ) % | 1.18 | % | 4.00 | % | 6.00 | % | 9.00 | % | ||||||||||
Leverage capital ratio | (1.86 | ) % | 0.86 | % | 4.00 | % | 5.00 | % | 9.00 | % | ||||||||||
On February 13, 2009, the Company entered into a Letter Agreement and Securities Purchase Agreement (the “Purchase Agreement”) with the U.S. Treasury Department (“Treasury”) under the TARP Capital Purchase Program (the “CPP”) discussed below, pursuant to which the Company sold (i) 51,500 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) for $51,500,000 and (ii) a warrant (the “Warrant”) to purchase 2,207,143 shares of the Company’s common stock for an exercise price of $3.50 per share, or $7.7 million in the aggregate, in cash.
The warrant is immediately exercisable and expires 10 years from the date of issuance. Proceeds from this sale of the preferred stock are expected to be used for general corporate purposes, including supporting the capital needs of the Company. The CPP preferred stock is generally non-voting, other than having class voting rights on certain matters, and pays cumulative dividends quarterly at a rate of 5% per annum for the first five years and 9% thereafter. The preferred shares are redeemable at the option of the Company, subject to the approval of its primary federal regulator.
Pursuant to the terms of the Purchase Agreement, the ability of the Company to declare or pay dividends or distributions on its common stock is subject to restrictions, including a restriction against increasing dividends from the last quarterly cash dividend per share ($.10) declared on the common stock prior to October 14, 2008, as adjusted for subsequent stock dividends and other similar actions. In addition, as long as Series A Preferred Stock is outstanding, dividend payments are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions.
The proceeds from the offering of the Series A Preferred Stock and related Warrant were allocated between the Series A Preferred Stock and Warrant based on their relative fair values. The Warrant was assigned a fair value of $1.76 per share, or $3.9 million in the aggregate. As a result, $3.9 million was recorded as the discount on the preferred stock obtained and will be accreted as a reduction in net income available for common shareholders over the next five years at approximately $0.1 million to $0.9 million per year. For purposes of these calculations, the fair value of the shares subject to the Warrant was estimated using the Black-Scholes option pricing model.
On December 30, 2010 and February 28, 2011, the Bank entered into and consummated conversion agreements with SunTrust Bank, pursuant to which $12.5 million of the outstanding principal amount of the $15.0 million subordinated term loan from SunTrust to the Bank issued on June 30, 2008 was converted into 12.5 million shares of nonvoting, nonconvertible, nonredeemable cumulative preferred stock, par value $1.00 per share, of the Bank. The Bank amended its articles of association to authorize the preferred stock issued to SunTrust in the conversions. The preferred stock carries an 8.0% dividend rate.
Recent Accounting and Reporting Developments
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See Note 1 of the Consolidated Financial Statements for a discussion of recently issued or proposed accounting pronouncements.
Effects of Inflation
Inflation affects financial institutions in ways that are different from most commercial and industrial companies, which have significant investments in fixed assets and inventories. The effect of inflation on interest rates can materially impact bank operations, which rely on net interest margins as a major source of earnings. Noninterest expense, such as salaries and wages, occupancy and equipment cost, are also negatively affected by inflation.
Non-GAAP Measures
This Annual Report on Form 10-K/A contains financial information determined by methods other than in accordance with generally accepted accounting principles (“GAAP”). FNB United’s management uses these non-GAAP measures in their analysis of FNB United’s performance. These non-GAAP measures exclude goodwill and core deposit premiums from the calculations of return on average assets and return on average equity. Management believes presentations of financial measures excluding the impact of goodwill and core deposit premiums provide useful supplemental information that is essential to a proper understanding of the operating results of FNB United’s core businesses. In addition, certain designated net interest income amounts are presented on a taxable equivalent basis. Management believes that the presentation of net interest income on a taxable equivalent basis aids in the comparability of net interest income arising from taxable and tax-exempt sources.
These non-GAAP financial measures are “net income (loss) per share assuming dilution adjusted for goodwill impairment charge,” “common shareholders’ equity,” “tangible common shareholders’ equity,” “tangible shareholders’ equity,” “tangible assets” and “tangible common book value per share.” The Company’s management, the entire financial services sector, bank stock analysts, and bank regulators use these non-GAAP measures in their analysis of the Company’s performance.
| • | “Common shareholders’ equity” is shareholders’ equity less preferred stock. |
| • | “Tangible common shareholders’ equity” is shareholders’ equity less goodwill, other intangible assets and preferred stock. |
| • | “Tangible shareholders’ equity” is shareholders’ equity less goodwill and other intangible assets. |
| • | “Tangible assets” are total assets less goodwill and other intangible assets. |
| • | “Tangible book value per common share” is defined as total equity reduced by recorded goodwill, other intangible assets and preferred stock divided by total common shares outstanding. This measure discloses changes from period-to-period in book value per share exclusive of changes in intangible assets and preferred stock. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing total book value while not increasing the tangible assets of a company. Companies utilizing purchase accounting in a business combination, as required by GAAP, must record goodwill related to such transactions. |
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These disclosures should not be viewed as a substitute for results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. The following reconciliation table provides a more detailed analysis of these non-GAAP measures:
| At and for the Year Ended December 31, | ||||||||||||||||||||
| 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
Total shareholders’ equity | $ | (28,837) | $ | 98,359 | $ | 147,917 | $ | 216,256 | $ | 207,668 | ||||||||||
Less: Preferred stock | (56,424) | (48,205) | - | - | - | |||||||||||||||
Less: Common stock warrant | (3,891) | (3,891) | - | - | - | |||||||||||||||
Common shareholders’ equity | $ | (89,152) | $ | 46,263 | $ | 147,917 | $ | 216,256 | $ | 207,668 | ||||||||||
Total shareholders’ equity | $ | (28,837) | $ | 98,359 | $ | 147,917 | $ | 216,256 | $ | 207,668 | ||||||||||
Less: | ||||||||||||||||||||
Goodwill | - | - | (52,395) | (110,195) | (110,956) | |||||||||||||||
Core deposit and other intangibles | (4,173) | (4,968) | (5,762) | (6,564) | (7,378) | |||||||||||||||
Preferred stock | (56,424) | (48,205) | - | - | - | |||||||||||||||
Common stock warrant | (3,891) | (3,891) | - | - | - | |||||||||||||||
Tangible common shareholders’ equity | $ | (93,325) | $ | 41,295 | $ | 89,760 | $ | 99,497 | $ | 89,334 | ||||||||||
Total shareholders’ equity | $ | (28,837) | $ | 98,359 | $ | 147,917 | $ | 216,256 | $ | 207,668 | ||||||||||
Less: | ||||||||||||||||||||
Goodwill | - | - | (52,395) | (110,195) | (110,956) | |||||||||||||||
Core deposit and other intangibles | (4,173) | (4,968) | (5,762) | (6,564) | (7,378) | |||||||||||||||
Tangible shareholders’ equity | $ | (33,010) | $ | 93,391 | $ | 89,760 | $ | 99,497 | $ | 89,334 | ||||||||||
Total assets | $ | 1,902,369 | $ | 2,101,296 | $ | 2,044,434 | $ | 1,906,506 | $ | 1,815,582 | ||||||||||
Less: | ||||||||||||||||||||
Goodwill | - | - | (52,395) | (110,195) | (110,956) | |||||||||||||||
Core deposit and other intangibles | (4,173) | (4,968) | (5,762) | (6,564) | (7,378) | |||||||||||||||
Tangible assets | $ | 1,898,196 | $ | 2,096,328 | $ | 1,986,277 | $ | 1,789,747 | $ | 1,697,248 | ||||||||||
Book value per common share | $ | (7.80) | $ | 4.05 | $ | 12.94 | $ | 18.93 | $ | 18.39 | ||||||||||
Effect of intangible assets | $ | (0.36) | $ | (0.44) | $ | (5.09) | $ | (10.22) | $ | (9.83) | ||||||||||
Tangible book value per common share | $ | (8.17) | $ | 3.61 | $ | 7.85 | $ | 8.71 | $ | 8.56 | ||||||||||
Application of Critical Accounting Policies
FNB United’s accounting policies are in accordance with accounting principles generally accepted in the United States and with general practice within the banking industry and are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. FNB United’s significant accounting policies are discussed in detail in Note 1 of the consolidated financial statements.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of other real estate owned, the valuation of securities and the treatment of deferred tax assets. Actual results could differ from those estimates.
Allowance for Loan Losses
The allowance for loan losses, which is utilized to absorb actual losses in the loan portfolio, is maintained at a level consistent with management’s best estimate of probable loan losses incurred as of the balance sheet date. FNB United’s allowance for loan losses is also assessed monthly by management. This assessment includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk. The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group. The Company has grouped its loans into pools according to the loan segmentation regime employed on schedule RC-C of the FFIEC’s Consolidated Report of Condition and Income (the “Call Report”). Major loan portfolio subgroups include: risk graded commercial loans, mortgage loans, home equity loans, retail loans and retail credit lines. Management also analyzes the loan portfolio on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly. The Company recently implemented a new
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loan loss software program as a modeling tool to assist in the determination of an adequate level of reserves to cover loan losses. While management uses the best information available to make evaluations, future adjustments may be necessary, if economic or other conditions differ substantially from the assumptions used. See additional discussion under “Asset Quality.”
Valuation of Other Real Estate Owned
Other real estate represents properties acquired through foreclosure or deed in lieu thereof. The property is initially carried at fair value based on recent appraisals, less estimated costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral.
Carrying Value of Securities
Securities designated as available-for-sale are carried at fair value. However, the unrealized difference between amortized cost and fair value of securities available-for-sale is excluded from net income unless there is an other than temporary impairment and is reported, net of deferred taxes, as a component of stockholders’ equity as accumulated other comprehensive income (loss). Securities held-to-maturity are carried at amortized cost, as the Bank has the ability, and management has the positive intent, to hold these securities to maturity. Premiums and discounts on securities are amortized and accreted according to the interest method.
Treatment of Deferred Tax Assets
Management’s determination of the realization of deferred tax assets is based upon its judgment of various future events and uncertainties, including the timing and amount of future income earned by certain subsidiaries and the implementation of various tax plans to maximize realization of the deferred tax assets. In evaluating the positive and negative evidence to support the realization of the asset under current guidance, given the current credit crisis and economic conditions, there is insufficient positive evidence to support a conclusion that it is more likely than not this asset will be realized in the foreseeable future. Examinations of the income tax returns or changes in tax law may impact the Company’s tax liabilities and resulting provisions for income taxes.
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In making such judgments, significant weight is given to evidence that can be objectively verified. As a result of the increased credit losses, the Bank continues to be in a three-year cumulative pre-tax loss position as of December 31, 2010. A cumulative loss position is considered significant negative evidence in assessing the realizability of a deferred tax asset, which is difficult to overcome. The Bank’s estimate of the realization of its deferred tax assets was based on the scheduled reversal of deferred tax liabilities and taxable income available in prior carry back years and estimated unrealized losses in the available-for-sale investment portfolio. The Bank did not consider future taxable income in determining the realizability of its deferred tax assets. The Bank expects its income tax expense (benefit) will be negligible for the next several quarters until profitability has been restored for a reasonable time and such profitability is considered sustainable. At that time, the valuation allowance would be reversed. Reversal of the valuation allowance requires a great deal of judgment and will be based on the circumstances that exist as of that future date. If future events differ significantly from the Bank’s current forecasts, the Bank may need to increase this valuation allowance, which could have a material adverse effect on the results of operations and financial condition.
Summary
Management believes the accounting estimates related to the allowance for loan losses, the carrying value of securities and the valuation allowance for deferred tax assets are “critical accounting estimates” because: (1) the estimates are highly susceptible to change from period to period as they require management to make assumptions concerning the changes in the types and volumes of the portfolios and anticipated economic conditions, and (2) the impact of recognizing an impairment or loan loss could have a material effect on the Company’s assets reported on the balance sheet as well as its net earnings.
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| Item 7A. | QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The objective of the Bank’s asset/liability management function is to maintain consistent growth in net interest income within Bank guidelines. This objective is accomplished through management of the Bank’s balance sheet composition, liquidity, and interest rate risk exposures arising from changing economic conditions, interest rates and customer preferences.
The goal of liquidity management is to provide adequate funds to meet changes in loan demand or unexpected deposit withdrawals. This is accomplished by maintaining liquid assets in the form of investment securities, maintaining sufficient unused borrowing capacity and achieving consistent growth in core deposits.
Management considers interest rate risk the Bank’s most significant market risk. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates. Consistency of the Bank’s net interest income is largely dependent upon the effective management of interest rate risk.
To identify and manage its interest rate risk, the Bank employs an earnings simulation model to analyze net interest income sensitivity to changing interest rates. The model is based on contractual cash flows and repricing characteristics and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities. The model also includes management projections for activity levels in each of the product lines offered by the Bank. Assumptions are inherently uncertain and the measurement of net interest income or the impact of rate fluctuations on net interest income cannot be precisely predicted. Actual results may differ from simulated results due to timing, magnitude, and frequency of interest changes as well as changes in market conditions and management strategies.
The Bank’s Asset/Liability Management Committee (“ALCO”), which includes senior management representatives and reports to the Bank’s Board of Directors, monitors and manages interest rate risk. The Bank’s current interest rate risk position is determined by measuring the anticipated change in net interest income over a 24-month horizon assuming a ramped increase or decrease in all interest rates equally over the 24 month time horizon.
The following table shows the Bank’s estimated net interest income profile for the 12-month period beginning December 31, 2010:
Changes in Interest Rates (basis points) | Percentage Change in Net Interest Income – 12 Months | |
+200 | +2.40% | |
+100 | +0.91% | |
-100 | -0.37% | |
-200 | -1.90% |
ALCO also monitors the sensitivity of the Bank’s economic value of equity (“EVE”) due to sudden and sustained changes in market rates. The EVE ratio, measured on a static basis at the current period end, is calculated by dividing the economic value of equity by the economic value of total assets. ALCO monitors the change in EVE on a percentage change basis.
The following table estimates changes in EVE for given changes in interest rates as of December 31, 2010:
Change in Interest Rates (basis points) | Percentage Change in EVE | |
+200 | +12.15% | |
+100 | +8.56% | |
-100 | - 8.35% | |
-200 | -22.25% |
The Bank is in compliance with its internal policy on changes in net interest income but not in changes to EVE as of December 31, 2010. The Bank is currently working on strategies to get changes in EVE within acceptable guidelines. However, due to the current low level of market interest rates, ALCO believes the Bank is not subject to any appreciable level of interest rate risk and is well positioned to take advantage of higher interest rates.
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| Item 8. | FINANCIAL STATEMENTSAND SUPPLEMENTARY DATA |
QUARTERLY FINANCIAL INFORMATION
The following table sets forth, for the periods indicated, certain of our consolidated quarterly financial information. This information is derived from our unaudited financial statements, which include, in the opinion of management, all normal recurring adjustments which management considers necessary for a fair presentation of the results for such periods. This information should be read in conjunction with our consolidated financial statements included elsewhere in this report. The results for any quarter are not necessarily indicative of results for any future period.
| (dollars in thousands, except per share data) | ||||||||||||||||
| 2010 | ||||||||||||||||
| 4th Qtr | 3rd Qtr | 2nd Qtr | 1st Qtr | |||||||||||||
| (RESTATED) | ||||||||||||||||
Interest income | $ | 17,951 | $ | 19,376 | $ | 21,759 | $ | 23,751 | ||||||||
Interest expense | 7,018 | 7,818 | 7,749 | 8,050 | ||||||||||||
Net interest income | 10,933 | 11,558 | 14,010 | 15,701 | ||||||||||||
Provision for loan losses | 39,944 | 55,892 | 27,429 | 9,490 | ||||||||||||
Net interest (loss)/income after provision for loan losses | (29,011) | (44,334) | (13,419) | 6,211 | ||||||||||||
Noninterest income | 12,883 | 6,541 | 5,937 | 5,626 | ||||||||||||
Noninterest expense | 28,776 | 17,127 | 20,271 | 14,828 | ||||||||||||
Loss before income taxes | (44,904) | (54,920) | (27,753) | (2,991) | ||||||||||||
Income taxes expense/(benefit) | 3,575 | (74) | (2,828) | 586 | ||||||||||||
Net loss | (48,479) | (54,846) | (24,925) | (3,577) | ||||||||||||
Preferred stock dividends | (828) | (825) | (822) | (819) | ||||||||||||
Net loss to common shareholders | $ | (49,307) | $ | (55,671) | $ | (25,747) | $ | (4,396) | ||||||||
Net loss per common share: | ||||||||||||||||
Basic | $ | (4.33) | $ | (4.87) | $ | (2.25) | $ | (0.38) | ||||||||
Diluted | $ | (4.33) | $ | (4.87) | $ | (2.25) | $ | (0.38) | ||||||||
| 2009 | ||||||||||||||||
| 4th Qtr | 3rd Qtr | 2nd Qtr | 1st Qtr | |||||||||||||
Interest income | $ | 25,274 | $ | 26,498 | $ | 26,053 | $ | 25,346 | ||||||||
Interest expense | 8,873 | 10,081 | 10,807 | 11,214 | ||||||||||||
Net interest income | 16,401 | 16,417 | 15,246 | 14,132 | ||||||||||||
Provision for loan losses | 24,657 | 17,500 | 5,525 | 14,059 | ||||||||||||
Net interest (loss)/income after provision for loan losses | (8,256) | (1,083) | 9,721 | 73 | ||||||||||||
Noninterest income | 5,421 | 4,960 | 5,490 | 5,882 | ||||||||||||
Noninterest expense | 16,157 | 71,553 | 16,356 | 15,846 | ||||||||||||
Loss before income taxes | (18,992) | (67,676) | (1,145) | (9,891) | ||||||||||||
Income taxes expense/(benefit) | 9,043 | (185) | (742) | (4,124) | ||||||||||||
Net loss | (28,035) | (67,491) | (403) | (5,767) | ||||||||||||
Preferred stock dividends | (818) | (813) | (809) | (431) | ||||||||||||
Net loss to common shareholders | $ | (28,853) | $ | (68,304) | $ | (1,212) | $ | (6,198) | ||||||||
Net loss per common share: | ||||||||||||||||
Basic | $ | (2.53) | $ | (5.98) | $ | (0.11) | $ | (0.54) | ||||||||
Diluted | $ | (2.53) | $ | (5.98) | $ | (0.11) | $ | (0.54) | ||||||||
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors
FNB United Corp. and Subsidiary
Asheboro, North Carolina
We have audited the accompanying consolidated balance sheets of FNB United Corp. and Subsidiary (the “Corporation”) as of December 31, 2010 and 2009, and the related consolidated statements of loss, shareholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FNB United Corp. and Subsidiary at December 31, 2010 and 2009 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, the consolidated financial statements for 2010 have been restated for the correction of an error.
The accompanying consolidated financial statements have been prepared assuming that the Corporation will continue as a going concern. The Corporation continued to incur significant net losses in 2010, primarily from the higher provisions for loan losses due to the significant level of non-performing assets. The Corporation has insufficient capital per regulatory guidelines and has failed to reach capital levels required in the Consent Order issued by the Office of the Comptroller of the Currency (the “OCC”) in 2010. These matters raise substantial doubt about the Corporation’s ability to continue as a going concern. Management’s plans in regard to these matters are described in Note 4 of the consolidated financial statements. The 2010 consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), FNB United Corp. and Subsidiary’s internal control over financial reporting as of December 31, 2010, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 14, 2011 (May 23, 2011 as to the effects of the second material weakness described in Management’s Report on Internal Control over Financial Reporting) expressed an adverse opinion on the effectiveness of the Corporation’s internal control over financial reporting.
/s/ Dixon Hughes Goodman LLP
(formerly Dixon Hughes PLLC)
Charlotte, North Carolina
March 14, 2011 (May 23, 2011 as to the effects of the restatement as described in Note 2)
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors
FNB United Corp. and Subsidiary
Asheboro, North Carolina
We have audited FNB United Corp. and Subsidiary (the “Corporation”)’s internal control over financial reporting as of December 31, 2010, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Corporation’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A corporation’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the corporation’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our report dated March 14, 2011, we expressed an adverse opinion on internal control over financial reporting due to the identification of a material weakness related to the valuation of other real estate owned. As described below, another material weakness was identified as a result of the restatement of the previously issued financial statements. Although the identification of the additional material weakness does not change the assessment of the ineffectiveness of internal control over financial reporting, management’s report on internal control over financial reporting and our report on internal control over financial reporting have been revised to disclose the additional material weakness identified.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Corporation’s annual or interim financial statements will not be prevented or detected on a timely basis. Material weaknesses related to the valuation of other
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real estate owned and evaluation of subsequent events on the valuation of impaired loans and other real estate owned have been identified and included in management’s assessment. The material weakness related to evaluation of subsequent events has resulted in the restatement of the Corporation’s 2010 consolidated financial statements.
In our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, FNB United Corp. and Subsidiary has not maintained effective internal control over financial reporting as of December 31, 2010, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of FNB United Corp. and Subsidiary as of December, 31, 2010 and 2009 and for each of the three years in the period ended December 31, 2010 and our report on those consolidated financial statements dated March 14, 2011 (May 23, 2011 as to the effects of the restatement as described in Note 2), expressed an unqualified opinion thereon and included explanatory paragraphs relating to the existence of substantial doubt about the Corporation’s ability to continue as a going concern, and the restatement described in Note 2. The aforementioned material weaknesses were considered in assessing the nature, timing and extent of audit tests applied in our audit of the consolidated financial statements of the Corporation. These material weaknesses do not affect our report on those consolidated financial statements.
We do not express an opinion or any other form of assurance on management’s statement referring to compliance with designated laws and regulations related to safety and soundness.
/s/ Dixon Hughes Goodman LLP
(formerly Dixon Hughes PLLC)
Charlotte, North Carolina
March 14, 2011 (May 23, 2011 as to the effect of the second material weakness described in Management’s Report on Internal Control over Financial Reporting)
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FNB United Corp. and Subsidiary
Consolidated Balance Sheets
| (dollars in thousands, except share and per share data) | December 31, | December 31, | ||||||
| 2010 | 2009 | |||||||
| (RESTATED) | ||||||||
Assets | ||||||||
Cash and due from banks | $ | 21,051 | $ | 27,600 | ||||
Interest-bearing bank balances | 139,543 | 98 | ||||||
Investment securities: | ||||||||
Available-for-sale, at estimated fair value (amortized cost of $306,193 in 2010 and $232,905 in 2009) | 305,331 | 237,630 | ||||||
Held-to-maturity (estimated fair value of $91,521 in 2009) | - | 88,559 | ||||||
Loans held for sale | 37,079 | 58,219 | ||||||
Loans held for investment | 1,303,975 | 1,563,021 | ||||||
Less: Allowance for loan losses | (93,687) | (49,461) | ||||||
Net loans held for investment | 1,210,288 | 1,513,560 | ||||||
Premises and equipment, net | 45,098 | 48,115 | ||||||
Other real estate owned | 62,226 | 35,170 | ||||||
Core deposit premiums | 4,173 | 4,968 | ||||||
Bank-owned life insurance | 31,968 | 30,883 | ||||||
Other assets | 45,612 | 56,494 | ||||||
Total Assets | $ | 1,902,369 | $ | 2,101,296 | ||||
Liabilities | ||||||||
Deposits: | ||||||||
Noninterest-bearing demand deposits | $ | 148,933 | $ | 152,522 | ||||
Interest-bearing deposits: | ||||||||
Demand, savings and money market deposits | 585,815 | 594,377 | ||||||
Time deposits of $100,000 or more | 544,732 | 503,393 | ||||||
Other time deposits | 416,910 | 471,836 | ||||||
Total deposits | 1,696,390 | 1,722,128 | ||||||
Retail repurchase agreements | 9,628 | 13,592 | ||||||
Federal Home Loan Bank advances | 144,485 | 166,165 | ||||||
Federal funds purchased | - | 10,000 | ||||||
Subordinated debt | 7,500 | 15,000 | ||||||
Junior subordinated debentures | 56,702 | 56,702 | ||||||
Other liabilities | 16,501 | 19,350 | ||||||
Total Liabilities | 1,931,206 | 2,002,937 | ||||||
Shareholders’ Equity | ||||||||
Preferred stock Series A, $10.00 par value; authorized 200,000 shares, 51,500 shares issued and outstanding at $1,000 stated value | 48,924 | 48,205 | ||||||
Preferred stock, $1.00 par value, authorized 15,000,000 shares, 7,500,000 shares issued and outstanding | 7,500 | - | ||||||
Common stock warrant | 3,891 | 3,891 | ||||||
Common stock, $2.50 par value; authorized 50,000,000 shares, issued 11,424,390 shares in 2010 and 11,426,413 shares in 2009 | 28,561 | 28,566 | ||||||
Surplus | 115,073 | 115,039 | ||||||
Accumulated deficit | (229,095) | (96,234) | ||||||
Accumulated other comprehensive loss | (3,691) | (1,108) | ||||||
Total Shareholders’ Equity | (28,837) | 98,359 | ||||||
Total Liabilities and Shareholders’ Equity | $ | 1,902,369 | $ | 2,101,296 | ||||
See accompanying notes to consolidated financial statements.
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FNB United Corp. and Subsidiary
Consolidated Statements of Loss
| (dollars in thousands, except share and per share data) | Years Ended December 31, | |||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| (RESTATED) | ||||||||||||
Interest Income | ||||||||||||
Interest and fees on loans | $ | 68,807 | $ | 84,261 | $ | 103,365 | ||||||
Interest and dividends on investment securities: | ||||||||||||
Taxable income | 11,976 | 16,256 | 7,820 | |||||||||
Non-taxable income | 1,551 | 2,256 | 2,040 | |||||||||
Other interest income | 503 | 398 | 810 | |||||||||
Total interest income | 82,837 | 103,171 | 114,035 | |||||||||
Interest Expense | ||||||||||||
Deposits | 24,911 | 32,490 | 42,211 | |||||||||
Retail repurchase agreements | 98 | 127 | 651 | |||||||||
Federal Home Loan Bank advances | 3,517 | 5,795 | 7,223 | |||||||||
Federal funds purchased | 4 | 156 | 501 | |||||||||
Other borrowed funds | 2,105 | 2,407 | 3,432 | |||||||||
Total interest expense | 30,635 | 40,975 | 54,018 | |||||||||
Net Interest Income before Provision for Loan Losses | 52,202 | 62,196 | 60,017 | |||||||||
Provision for loan losses | 132,755 | 61,741 | 27,759 | |||||||||
Net Interest (Loss)/Income after Provision for Loan Losses | (80,553) | 455 | 32,258 | |||||||||
Noninterest Income | ||||||||||||
Service charges on deposit accounts | 7,358 | 8,956 | 9,167 | |||||||||
Mortgage loan income | 5,510 | 9,888 | 6,340 | |||||||||
Cardholder and merchant services income | 3,000 | 2,514 | 2,395 | |||||||||
Trust and investment services | 1,946 | 1,741 | 1,827 | |||||||||
Bank owned life insurance | 988 | 1,068 | 983 | |||||||||
Other service charges, commissions and fees | 1,030 | 1,158 | 796 | |||||||||
Securities gains, net | 10,647 | 989 | 646 | |||||||||
Net gain on fair value swap | 273 | 66 | - | |||||||||
Total other-than-temporary impairment loss | - | (4,985) | - | |||||||||
Portion of loss recognized in other comprehensive income | - | - | - | |||||||||
Net impairment loss recognized in earnings | - | (4,985) | - | |||||||||
Other income | 235 | 358 | 764 | |||||||||
Total noninterest income | 30,987 | 21,753 | 22,918 | |||||||||
Noninterest Expense | ||||||||||||
Personnel expense | 30,360 | 32,932 | 33,081 | |||||||||
Net occupancy expense | 5,031 | 5,522 | 5,343 | |||||||||
Furniture, equipment and data processing expense | 7,056 | 7,121 | 6,705 | |||||||||
Professional fees | 3,908 | 2,070 | 2,552 | |||||||||
Stationery, printing and supplies | 526 | 703 | 1,174 | |||||||||
Advertising and marketing | 1,634 | 2,056 | 1,371 | |||||||||
Other real estate owned expense | 14,532 | 3,472 | 610 | |||||||||
Credit/debit card expense | 1,715 | 1,672 | 1,716 | |||||||||
FDIC insurance | 5,856 | 4,170 | 894 | |||||||||
Goodwill impairment | - | 52,395 | 57,800 | |||||||||
Mortgage servicing rights impairment | 2,995 | - | - | |||||||||
Other expense | 7,389 | 7,799 | 6,857 | |||||||||
Total noninterest expense | 81,002 | 119,912 | 118,103 | |||||||||
Loss before income taxes | (130,568) | (97,704) | (62,927) | |||||||||
Income tax benefit/(expense) | 1,259 | 3,992 | (3,118) | |||||||||
Net Loss | (131,827) | (101,696) | (59,809) | |||||||||
Preferred stock dividends | (3,294) | (2,871) | - | |||||||||
Net Loss to Common Shareholders | $ | (135,121) | $ | (104,567) | $ | (59,809) | ||||||
Net loss per common share: | ||||||||||||
Basic | $ | (11.83) | $ | (9.16) | $ | (5.24) | ||||||
Diluted | $ | (11.83) | $ | (9.16) | $ | (5.24) | ||||||
Weighted average number of common shares outstanding: | ||||||||||||
Basic | 11,423,967 | 11,416,977 | 11,407,616 | |||||||||
Diluted | 11,423,967 | 11,416,977 | 11,407,616 | |||||||||
See accompanying notes to consolidated financial statements.
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FNB United Corp. and Subsidiary
Consolidated Statements of Shareholders’ Equity and Comprehensive Loss
| (in thousands, except share and per share data) | Preferred Stock | Common Stock | Common Stock Warrant | Surplus | Retained Earnings/ (Accumulated Deficit) | Accumulated Other Comprehensive Loss | Total | |||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | |||||||||||||||||||||||||||||||||
Balance, December 31, 2007 | - | $ | - | 11,426,902 | $ | 28,567 | $ | - | $ | 114,119 | $ | 74,199 | $ | (629 | ) | $ | 216,256 | |||||||||||||||||||
Cumulative effect of a change in accounting principle - record postretirement benefit related to split-dollar insurance | - | - | - | - | - | - | (344 | ) | - | - | ||||||||||||||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||||||||||||||
Net loss | - | - | - | - | - | - | (59,809 | ) | - | (59,809 | ) | |||||||||||||||||||||||||
Other comprehensive income, net of taxes: | ||||||||||||||||||||||||||||||||||||
Unrealized holding losses arising during the period on securities available-for-sale, net of tax | - | - | - | - | - | - | - | (781 | ) | (781 | ) | |||||||||||||||||||||||||
Reclassification adjustment for losses on securities available-for-sale included in net income, net of tax | - | - | - | - | - | - | - | (139 | ) | (139 | ) | |||||||||||||||||||||||||
Change in unrealized losses on securities, net of tax | - | - | - | - | - | - | - | (920 | ) | (920 | ) | |||||||||||||||||||||||||
Interest rate swap, net of tax | - | - | - | - | - | - | - | (300 | ) | (300 | ) | |||||||||||||||||||||||||
Pension and post-retirement liability, net of tax | - | - | - | - | - | - | - | (2,480 | ) | (2,480 | ) | |||||||||||||||||||||||||
Total comprehensive loss | (63,509 | ) | ||||||||||||||||||||||||||||||||||
Cash dividends declared on common stock, $.45 per share | - | - | - | - | - | - | (5,142 | ) | - | (5,142 | ) | |||||||||||||||||||||||||
Stock options: | ||||||||||||||||||||||||||||||||||||
Proceeds from options exercised | - | - | 150 | 1 | - | 1 | - | - | 2 | |||||||||||||||||||||||||||
Compensation expense recognized | - | - | - | - | - | 429 | - | - | 429 | |||||||||||||||||||||||||||
Restricted stock: | ||||||||||||||||||||||||||||||||||||
Shares issued/terminated, subject to restriction | - | - | 951 | 2 | - | (75 | ) | - | - | (73 | ) | |||||||||||||||||||||||||
Compensation expense recognized | - | - | - | - | - | 298 | - | - | 298 | |||||||||||||||||||||||||||
Balance, December 31, 2008 | - | $ | - | 11,428,003 | $ | 28,570 | $ | - | $ | 114,772 | $ | 8,904 | $ | (4,329 | ) | $ | 147,917 | |||||||||||||||||||
Comprehensive loss: | ||||||||||||||||||||||||||||||||||||
Net loss | - | - | - | - | - | - | (101,696 | ) | - | (101,696 | ) | |||||||||||||||||||||||||
Other comprehensive income, net of tax: | ||||||||||||||||||||||||||||||||||||
Unrealized holding gains arising during the period on securities available-for-sale, net of tax | - | - | - | - | - | - | - | 3,767 | 3,767 | |||||||||||||||||||||||||||
Reclassification adjustment for losses on securities available-for-sale included in net income, net of tax | - | - | - | - | - | - | - | (3,548 | ) | (3,548 | ) | |||||||||||||||||||||||||
Unrealized holding gains on securities for which credit-related portion was recognized in net realized investment gains/(losses), net of tax | - | - | - | - | - | - | - | 3,016 | 3,016 | |||||||||||||||||||||||||||
Change in unrealized gains on securities, net of tax | - | - | - | - | - | - | - | 3,235 | 3,235 | |||||||||||||||||||||||||||
Interest rate swap, net of tax | 51 | 51 | ||||||||||||||||||||||||||||||||||
Pension and post-retirement liability, net of tax | - | - | - | - | - | - | - | (65 | ) | (65 | ) | |||||||||||||||||||||||||
Total comprehensive loss | (98,475 | ) | ||||||||||||||||||||||||||||||||||
Issuance of preferred stock, series A | 51,500 | 47,609 | - | - | 3,891 | - | - | - | 51,500 | |||||||||||||||||||||||||||
Accretion of discount on preferred stock | - | 596 | - | - | - | - | (596 | ) | - | - | ||||||||||||||||||||||||||
Cash dividends declared on common stock, $.05 per share | - | - | - | - | - | - | (574 | ) | - | (574 | ) | |||||||||||||||||||||||||
Cash dividends declared on Series A preferred stock, $12.50 per share | - | - | - | - | - | - | (2,272 | ) | - | (2,272 | ) | |||||||||||||||||||||||||
Stock options: | ||||||||||||||||||||||||||||||||||||
Compensation expense recognized | - | - | - | - | - | 211 | - | - | 211 | |||||||||||||||||||||||||||
Restricted stock: | ||||||||||||||||||||||||||||||||||||
Shares issued/terminated, subject to restriction | - | - | (1,590 | ) | (4 | ) | - | (138 | ) | - | - | (142 | ) | |||||||||||||||||||||||
Compensation expense recognized | - | - | - | - | - | 194 | - | - | 194 | |||||||||||||||||||||||||||
Balance, December 31, 2009 | 51,500 | $ | 48,205 | 11,426,413 | $ | 28,566 | $ | 3,891 | $ | 115,039 | $ | (96,234 | ) | $ | (1,108 | ) | $ | 98,359 | ||||||||||||||||||
Comprehensive loss: | ||||||||||||||||||||||||||||||||||||
Net loss (RESTATED) | - | - | - | - | - | - | (131,827 | ) | - | (131,827 | ) | |||||||||||||||||||||||||
Other comprehensive income, net of taxes: | ||||||||||||||||||||||||||||||||||||
Unrealized holding gains arising during the period on securities available-for-sale, net of tax | - | - | - | - | - | - | - | 946 | 946 | |||||||||||||||||||||||||||
Unrealized holding gains arising during the period on reclassifying held-to-maturity securities to available-to-sale securities, net of tax | - | - | - | - | - | - | - | 2,105 | 2,105 | |||||||||||||||||||||||||||
Reclassification adjustment for gains on securities available-for-sale included in net income, net of tax | - | - | - | - | - | - | - | (6,441 | ) | (6,441 | ) | |||||||||||||||||||||||||
Unrealized gains on securities for which credit-related portion was recognized in net realized investment gains (losses) | - | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||
Change in unrealized gains on securities, net of tax | - | - | - | - | - | - | - | (3,390 | ) | (3,390 | ) | |||||||||||||||||||||||||
Interest rate swap, net of tax | - | - | - | - | - | - | - | 249 | 249 | |||||||||||||||||||||||||||
Pension and post-retirement liability, net of tax | - | - | - | - | - | - | - | 558 | 558 | |||||||||||||||||||||||||||
Total comprehensive loss (RESTATED) | (134,410 | ) | ||||||||||||||||||||||||||||||||||
Issuance of preferred stock | 7,500,000 | 7,500 | - | - | - | - | - | - | 7,500 | |||||||||||||||||||||||||||
Accretion of discount on preferred stock | - | 719 | - | - | - | - | (719 | ) | - | - | ||||||||||||||||||||||||||
Cash dividends declared on common stock, $0.05 per share | - | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||
Cash dividends declared on Series A preferred stock, $12.50 per share | - | - | - | - | - | - | (315 | ) | - | (315 | ) | |||||||||||||||||||||||||
Stock options: | ||||||||||||||||||||||||||||||||||||
Proceeds from options exercised | - | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||
Compensation expense recognized | - | - | - | - | - | 32 | - | - | 32 | |||||||||||||||||||||||||||
Restricted stock: | ||||||||||||||||||||||||||||||||||||
Shares issued/terminated, subject to restriction | - | - | (2,023 | ) | (5 | ) | - | (16 | ) | - | - | (21 | ) | |||||||||||||||||||||||
Compensation expense recognized | - | - | - | - | - | 18 | - | - | 18 | |||||||||||||||||||||||||||
Balance, December 31, 2010 (RESTATED) | 7,551,500 | $ | 56,424 | 11,424,390 | $ | 28,561 | $ | 3,891 | $ | 115,073 | $ | (229,095 | ) | $ | (3,691 | ) | $ | (28,837 | ) | |||||||||||||||||
See accompanying notes to consolidated financial statements.
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FNB United Corp. and Subsidiary
Consolidated Statements of Cash Flows
| (dollars in thousands) | Year Ended December 31, | |||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| (RESTATED) | ||||||||||||
Operating Activities | ||||||||||||
Net loss | $ | (131,827 | ) | $ | (101,696 | ) | $ | (59,809 | ) | |||
Adjustments to reconcile net loss to cash (used in) provided by operatings activities: | ||||||||||||
Depreciation and amortization of premises and equipment | 3,665 | 3,700 | 3,453 | |||||||||
Provision for loan losses | 132,755 | 61,741 | 27,759 | |||||||||
Deferred income taxes | 1,307 | 9,854 | (5,056 | ) | ||||||||
Deferred loan fees and costs, net | (314 | ) | (2,060 | ) | (503 | ) | ||||||
Premium amortization and discount accretion of investment securities, net | (3,814 | ) | (1,689 | ) | (422 | ) | ||||||
Gain on sale of investment securities | (10,647 | ) | (989 | ) | (646 | ) | ||||||
Other-than-temporary impairment charge | - | 4,985 | - | |||||||||
Amortization of core deposit premiums | 795 | 794 | 802 | |||||||||
Stock compensation expense | 50 | 405 | 727 | |||||||||
Increase in cash surrender value of bank-owned life insurance | (1,085 | ) | (1,187 | ) | (1,045 | ) | ||||||
Mortgage loans held for sale: | ||||||||||||
Origination of mortgage loans held for sale | (465,581 | ) | (762,087 | ) | (260,964 | ) | ||||||
Proceeds from sale of mortgage loans held for sale | 491,561 | 748,598 | 248,330 | |||||||||
Gain on mortgage loan sales | (5,510 | ) | (9,888 | ) | (6,340 | ) | ||||||
Mortgage servicing rights capitalized | (1,340 | ) | (1,642 | ) | (1,182 | ) | ||||||
Mortgage servicing rights amortization and impairment | 3,748 | 829 | 38 | |||||||||
Goodwill impairment | - | 52,395 | 57,800 | |||||||||
Net loss on other real estate owned | 9,939 | 1,771 | 531 | |||||||||
Changes in assets and liabilities: | ||||||||||||
Decrease/(increase) in interest receivable | 2,097 | (1,254 | ) | 2,435 | ||||||||
(Increase)/decrease in other assets | 3,007 | (15,726 | ) | (2,289 | ) | |||||||
Increase in accrued interest and other liabilities | 3,383 | 2,478 | 364 | |||||||||
Net cash provided by/(used in) operating activities | 32,189 | (10,668 | ) | 3,983 | ||||||||
Investing Activities | ||||||||||||
Available-for-sale securities: | ||||||||||||
Proceeds from sales | 214,181 | 40,789 | 28,165 | |||||||||
Proceeds from maturities and calls | 100,694 | 85,959 | 105,382 | |||||||||
Purchases | (291,341 | ) | (158,398 | ) | (197,395 | ) | ||||||
Held-to-maturity securities: | ||||||||||||
Proceeds from maturities and calls | 6,184 | 20,367 | 12,285 | |||||||||
Purchases | - | (78,548 | ) | (4,487 | ) | |||||||
Net decrease/(increase) in loans held for investment | 90,998 | (55,591 | ) | (154,105 | ) | |||||||
Proceeds from sales of loans | 33,505 | - | - | |||||||||
Proceeds from sale of other real estate owned | 10,981 | 4,954 | 2,757 | |||||||||
Improvements to other real estate owned | (363 | ) | (439 | ) | - | |||||||
Proceeds from settlement of bank-owned life insurance | - | 205 | - | |||||||||
Purchases of premises and equipment | (750 | ) | (1,040 | ) | (8,751 | ) | ||||||
Purchases of SBIC investments | - | (100 | ) | (75 | ) | |||||||
Net cash provided by/(used in) investing activities | 164,089 | (141,842 | ) | (216,224 | ) | |||||||
Financing Activities | ||||||||||||
Net (decrease)/increase in deposits | (25,738 | ) | 207,381 | 73,705 | ||||||||
Decrease in retail repurchase agreements | (3,964 | ) | (4,553 | ) | (10,988 | ) | ||||||
(Decrease)/increase in Federal Home Loan Bank advances | (23,036 | ) | (72,813 | ) | 106,970 | |||||||
(Decrease)/increase in Federal funds purchased | (10,000 | ) | (27,000 | ) | 23,500 | |||||||
(Decrease)/increase in other borrowings | - | - | 15,000 | |||||||||
Proceeds from exercise of stock options | - | - | 2 | |||||||||
Proceeds from issuance of Series A preferred stock and common stock warrant | - | 51,500 | - | |||||||||
Cash dividends paid on common stock | - | (1,714 | ) | (5,712 | ) | |||||||
Cash dividends paid on Series A preferred stock | (644 | ) | (1,946 | ) | - | |||||||
Net cash (used in)/provided by financing activities | (63,382 | ) | 150,855 | 202,477 | ||||||||
Net Increase/(Decrease) in Cash and Cash Equivalents | 132,896 | (1,655 | ) | (9,764 | ) | |||||||
Cash and Cash Equivalents at Beginning of Period | 27,698 | 29,353 | 39,117 | |||||||||
Cash and Cash Equivalents at End of Period | $ | 160,594 | $ | 27,698 | $ | 29,353 | ||||||
Supplemental disclosure of cash flow information | ||||||||||||
Cash paid during the period for: | ||||||||||||
Interest | $ | 30,516 | $ | 42,580 | $ | 54,564 | ||||||
Income taxes, net of refunds | 645 | 700 | 2,352 | |||||||||
Noncash transactions: | ||||||||||||
Foreclosed loans transferred to other real estate | (47,976 | ) | 35,089 | 6,934 | ||||||||
Unrealized securities (losses)/gains, net of income taxes (benefit)/expense | (3,390 | ) | 3,235 | (939 | ) | |||||||
Issuance of preferred stock from debt conversion | 7,500 | - | - | |||||||||
Conversion of debt to preferred stock | (7,500 | ) | - | - | ||||||||
Employee benefit plan costs, net of income taxes | 558 | (65 | ) | (2,480 | ) | |||||||
Unrealized gains/(losses) on interest rate swaps | 249 | 51 | (300 | ) | ||||||||
Record postretirement benefit related to split-dollar insurance | - | - | (344 | ) | ||||||||
See accompanying notes to consolidated financial statements.
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FNB United Corp. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Note 1 – Summary of Significant Accounting Policies and Nature of Operations
Nature of Operations/Consolidation
FNB United Corp. (“FNB United”), formerly known as FNB Corp., is a bank holding company whose wholly owned subsidiary is CommunityONE Bank, National Association (“the Bank”). The Bank has three wholly owned subsidiaries, Dover Mortgage Company (“Dover”), First National Investor Services, Inc., and Premier Investment Services, Inc (inactive). Through its subsidiaries, FNB United offers a complete line of consumer, mortgage and business banking services, including loan, deposit, cash management, investment management and trust services, to individual and business customers. The Bank has offices in Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties in North Carolina. During 2010, Dover had a retail origination network based in Charlotte, North Carolina with retail offices in New Hampshire, North Carolina, South Carolina, Tennessee and Virginia. The wholesale origination network, also based in Charlotte, North Carolina, originated loans for properties located in North Carolina. See Note 26“Subsequent Events”for discussion on changes at Dover.
The consolidated financial statements include the accounts of FNB United and its subsidiaries (collectively, the “Company”). All significant intercompany balances and transactions have been eliminated.
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Business Segments
The Company reports business segments in accordance with regulatory guidelines. Business segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. The guidelines require that a public enterprise report a measure of segment profit or loss, certain specific revenue and expense items, segment assets, information about the way that the business segments were determined and other items. The Company only has one business segment.
Recent Accounting Pronouncements
Allowance for Loan Losses.In July 2010, new guidance regarding the disclosures associated with credit quality and the allowance for loan losses was issued. This standard requires additional disclosures related to the allowance for loan loss with the objective of providing financial statement users with greater transparency about an entity’s loan loss reserves and overall credit quality. Additional disclosures include showing on a disaggregated basis the aging of receivables, credit quality indicators, and troubled debt restructures with their effect on the allowance for loan loss. For public entities, the disclosures as of the end of a reporting period are effective for the first interim or annual reporting period ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for the first interim or annual reporting period beginning on or after December 15, 2010. The Company has adopted the period-end disclosure requirements as of December 31, 2010. The adoption of these requirements did not have a material impact on the Company’s financial position and results of operations. It did, however, increase the amount of disclosures in the notes to the consolidated financial statements.
Modifications of Purchased Loans.In June 2010, an accounting standards update was issued, which clarifies guidance for accounting for certain purchased loans and improves comparability between reporting companies by eliminating diversity in practice. Modifications of purchased impaired loans that are accounted for within a pool do not result in the removal of these loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. This update is effective for interim or annual periods ending on or after July 15, 2010. The adoption of this accounting standard update did not have a material impact on the Company’s consolidated financial statements.
Disclosures about Fair Value.In January 2010, additional guidance was issued to the fair value measurements and disclosures standards and requires disclosures of significant transfers in and out of Levels 1 and 2 fair value measurements and the reasons for the transfers. Additionally, for fiscal years beginning after December 15, 2010,
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activity in Level 3 fair value measurements must also be disclosed and includes purchases, sales, issuances and settlements. The Company does not expect the adoption of the new accounting standard update to materially affect its financial statements other than the additional disclosures for Level 3 activities beginning in the first quarter of 2011.
Recognition and Presentation of Other-Than-Temporary Impairments. A new model for evaluating other-than-temporary impairment (“OTTI”) on debt securities was created. If an entity intends to sell an impaired debt security, or cannot assert it is more likely than not that it will not have to sell the security before recovery, OTTI must be taken. If the entity does not intend to sell the debt security, but the entity does not expect to, or is not more likely than not to be required to sell, then OTTI must be taken, but the amount of impairment is to be bifurcated between impairment due to credit (which is recorded through earnings) and noncredit impairment (which becomes a component of other comprehensive income (“OCI”) for both available-for-sale (“AFS”) and held-to-maturity securities (“HTM”)). For HTM securities, the amount in OCI will be amortized prospectively over the security’s remaining life. Upon adoption, a cumulative effect adjustment must be made to opening retained earnings in the period adopted that reclassifies the noncredit portion of previously taken OTTI from retained earnings to accumulated OCI. The Company is required to present annual disclosures in interim financial statements, and new disclosures are also required. The Company’s adoption required new disclosures that were included in this report on Form 10-K/A. See Note 6 for additional disclosures.
Accounting for Transfers of Financial Assets. This requirement eliminates the concept of a qualifying special purpose entity (QSPE), changes the requirements for derecognizing financial assets, and requires additional disclosures, including information about continuing exposure to risks related to transferred financial assets. It is effective for financial asset transfers occurring after the beginning of fiscal years beginning after November 15, 2009. The disclosure requirements must be applied to transfers that occurred before and after the effective date. The adoption of this accounting guidance had no effect on financial position or results of operations.
Special Purpose Entities. The requirement created new criteria for determining the primary beneficiary, eliminates the exception to consolidating QSPEs, requires continual reconsideration of conclusions reached in determining the primary beneficiary, and requires additional disclosures. It is effective as of the beginning of fiscal years beginning after November 15, 2009 and is applied using a cumulative effect adjustment to retained earnings for any carrying amount adjustments (e.g., for newly-consolidated variable interest entities). The Company does not have any Special Purpose Entities as of December 31, 2010. The adoption of this accounting guidance did not affect the Company’s financial position or results of operation.
Fair Value Measurements and Disclosures.In February 2010, the FASB issued new guidance impactingFair Value Measurements and Disclosures. The new guidance requires a gross presentation of purchases and sales of Level 3 activities and adds a new requirement to disclose transfers in and out of Level 1 and Level 2 measurements. The guidance related to the transfers between level 1 and level 2 measurements is effective on January 1, 2010. The guidance that requires increased disaggregation of the level 3 activities is effective on January 1, 2011.
From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include the balance sheet captions: cash and due from banks, interest-bearing bank balances and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
Investment Securities
Investment securities are categorized and accounted for as follows:
| • | Available-for-sale securities - Debt and equity securities not classified as either held-to-maturity securities or trading securities are reported at fair value, with unrealized gains and losses, net of related tax effect, included as an item of accumulated other comprehensive income and reported as a separate component of shareholders’ equity. |
| • | Held-to-maturity securities - Debt securities that the Company has the positive intent and ability to hold to maturity are reported at amortized cost. |
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The Company intends to hold its securities classified as available-for-sale securities for an indefinite period of time but may sell them prior to maturity. All other securities, which the Company has the positive intent and ability to hold to maturity, are classified as held-to-maturity securities. The Bank reclassified the held-to-maturity securities portfolio to available-for-sale on May 3, 2010 in order to provide additional liquidity to the Bank. At December 31, 2010, the Bank no longer had securities in the held-to-maturity portfolio.
A decline, which is deemed to be other than temporary, in the market value of any available-for-sale or held-to-maturity equity security to a level below cost results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established.
The Company’s policy regarding other than temporary impairment (“OTTI”) of investment securities requires continuous monitoring of those securities. The evaluation includes an assessment of both qualitative and quantitative measures to determine whether, in management’s judgment, the investment is likely to recover its original value. If the evaluation concludes that the investment is not likely to recover its original value, the unrealized loss is reported as an OTTI, and the loss is recorded as a securities transaction on the Consolidated Statement of Loss.
For debt securities, an impairment loss is recognized in earnings only when (1) the Company intends to sell the debt security; (2) it is more likely than not that the Company will be required to see the security before recovery of its amortized cost basis or (3) the Company does not expect to recover the entire amortized cost basis of the security. In situations where the Company intends to sell or when it is more likely than not that the Company will be required to sell the security, the entire impairment loss must be recognized in earnings. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in shareholders’ equity as a component of other comprehensive loss, net of deferred taxes.
Interest income on debt securities is adjusted using the level yield method for the amortization of premiums and accretion of discounts. The adjusted cost of the specific security is used to compute gains or losses on the disposition of securities on a trade date basis.
Loans Held-for-Sale
The Company originates loans under various loan programs and other secondary market conventional products which are sold in the secondary market. Additionally, the Company has residential mortgage loans held for sale that were originated through the retail and wholesale mortgage segment. The majority of loans held for sale are carried at the lower of cost or market. The remaining portion is hedged to protect the Company from changes in interest rates during the period of time a loan is held. The Company irrevocably opted to elect the fair value option for the loans that are hedged, which are recorded at market value in accordance with current guidance. The sold loans are beyond the reach of the Company in all respects and the purchasing investor has all rights of ownership, including the ability to pledge or exchange the loans. Most of loans sold are without recourse. Gains or losses on loan sales are recognized at the time of sale, are determined by the difference between net sales proceeds and the carrying value of the loan sold, and are included in mortgage loan income. In accordance with instructions from Federal National Mortgage Association (“FNMA”), the bank entered into an agreement on December 29, 2010 to sell mortgage servicing rights on approximately $492.9 million of FNMA loans and recognized a loss of $3.0 million, including transaction costs. The Bank continued to service these loans until January 31, 2011.
Loans
Classes are generally disaggregations of a portfolio segment. The Company’s portfolio segments are: Commercial and agricultural, Real estate - construction, Real estate - residential, and other consumer loans. The classes within the Commercial and agricultural portfolio are: owner occupied and non-owner occupied. The classes within the Real estate - construction portfolio are: Retail properties, Multi-family, Industrial and Warehouse, and Other commercial real estate. The classes within the Real estate - residential portfolio are: first-lien and second-lien loans and home equity lines of credit. The other consumer loan portfolios are not further segregated into classes.
Interest income on loans is generally calculated by using the interest method based on the daily outstanding balance. The recognition of interest income is discontinued when, in management’s opinion, the collection of all or a portion of interest becomes doubtful. Loans are returned to accrual status when the factors indicating doubtful collectibility cease to exist and the loan has performed in accordance with its terms for a demonstrated period of time. The past due status of loans is based on the contractual payment terms.
Loan fees and the incremental direct costs associated with making loans are deferred and subsequently recognized over the life of the loan as an adjustment of interest income. The premium or discount on purchased loans is amortized over the expected life of the loans and is included in interest and fees on loans.
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The majority of residential mortgage loans held for sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements, calculated on the aggregate loan basis. A portion of loans held for sale are hedged to take advantage of interest rate locks and changes in the market. These loans are carried at fair value.
Nonaccrual and Past Due Loans – All loan classes are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date. When the Bank cannot reasonably expect full and timely repayment of its loan, the loan is placed on nonaccrual. The bank may calculate forgone interest on a monthly basis, but does not recognize the income. At the time of non-accrual, past due or accrued interest is charged-off unless it is determined that collection of accrued-to-date interest is likely.
All loan classes on which principal or interest is in default for 90 days or more should be put on nonaccrual status, unless there is sufficient documentation to conclude that the loan is well secured and in the process of collection. A debt is “well-secured” if collateralized by liens on or pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt in full; or by the guarantee of a financially responsible party. A debt is “in process of collection” if collection is proceeding in due course either through legal action, including judgment enforcement procedures, or, in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or its restoration to a current status.
Loans that are less delinquent may also be placed on nonaccrual if approved due to deterioration in the financial condition of the borrower that increases the possibility of less than full repayment.
For all loan classes a nonaccrual loan may be returned to accrual status when the Bank can reasonably expect continued timely payments until payment in full. All prior arrearage does not have to be eliminated, nor do all previously charged-off amounts need to have been recovered, but the loan can still be returned to accrual status if the following conditions are met: (1) all principal and interest amounts contractually due (including arrearage) are reasonably assured of repayment within a reasonable period; and (2) there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms involving payments of cash or cash equivalents.
At the time a loan is placed on non-accrual, all accrued, unpaid interest is charged-off, unless it is documented that repayment of all principal and presently accrued but unpaid interest is probable. Charge-offs of accrued and unpaid interest must be against the current year’s interest income. It cannot be charged to the current Allowance for Loan Losses.
For all classes within all loan portfolios, cash receipts received on non-accrual loans are applied entirely against principal until the loan or lease has been collected in full, after which time any additional cash receipts are recognized as interest income.
Charge-off of Uncollectable Loans - For all loan classes, as soon as any loan becomes uncollectable, the loan will be charged down or charged off as follows:
| • | If unsecured, the loan must be charged off in full. |
| • | If secured, the outstanding principal balance of the loan should be charged down to the net liquidation value of the collateral. |
Loans should be considered uncollectable when:
| • | No regularly scheduled payment has been made within four months, or |
| • | The loan is unsecured, the borrower files for bankruptcy protection and there is no other (guarantor, etc.) support from an entity outside of the bankruptcy proceedings. |
Based on a variety of credit, collateral and documentation issues, loans with lesser degrees of delinquency or obvious loss may also be deemed uncollectable.
Impaired Loans - An impaired loan is one for which the Bank will not be repaid all principal and interest due per the terms of the original contract or within reasonably modified contracted terms. If the loan has been modified to provide relief to the borrower, the loan is deemed to be impaired if all principal and interest will not be repaid according to the original contract. All loans meeting the definition of Doubtful should be considered impaired.
When a loan in any class has been determined to be impaired, the amount of the impairment is measured using the present value of expected future cash flows discounted at the loan’s or lease’s effective interest rate or, as a practical expedient, the observable market price of the loan or lease, or the fair value of the collateral if the loan or lease is
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collateral dependent. When the present value of expected future cash flows is used, the effective interest rate is the original contractual interest rate of the loan adjusted for any premium or discount. When the contractual interest rate is variable, the effective interest rate of the loan changes over time. A specific reserve is established as a component of the Allowance for Loan Losses when a loan has been determined to be impaired. Subsequent to the initial measurement of impairment, if there is a significant change to the impaired loan’s expected future cash flows, or if actual cash flows are significantly different from the cash flows previously estimated, the Bank recalculates the impairment and appropriately adjusts the specific reserve. Similarly, if the Bank measures impairment based on the observable market price of an impaired loan or the fair value of the collateral of an impaired collateral-dependent loan, the Bank will adjust the specific reserve if there is a significant change in either of those bases.
When a loan within any class is impaired, interest income is recognized unless the receipt of principal and interest is in doubt when contractually due. If receipt of principal and interest is in doubt when contractually due, interest income is not recognized. Cash receipts received on non-accruing impaired loans within any class are generally applied entirely against principal until the loan or lease has been collected in full, after which time any additional cash receipts are recognized as interest income. Cash receipts received on accruing impaired loans within any class are applied in the same manner as accruing loans that are not considered impaired.
Allowance for Loan Losses (“ALLL”)
The allowance for loan losses, which is utilized to absorb actual losses in the loan portfolio, is maintained at a level consistent with management’s best estimate of probable loan losses incurred as of the balance sheet date. FNB United’s allowance for loan losses is also assessed quarterly by management. This assessment includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk. The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group. The Company has grouped its loans into pools according to the loan segmentation regime employed on schedule RC-C of the FFIEC’s Consolidated Report of Condition and Income. Major loan portfolio subgroups include: risk graded commercial loans, mortgage loans, home equity loans, retail loans and retail credit lines. Management also analyzes the loan portfolio on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly. While management uses the best information available to make evaluations, future adjustments may be necessary, if economic or other conditions differ substantially from the assumptions used.
For all loan classes management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows:
| • | identification of specific impaired loans by loan category; |
| • | specific loans that could have potential loss; |
| • | calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence; |
| • | determination of homogenous pools by loan category and risk grade, reduced by the impaired loans; |
| • | application of historical loss percentages to pools to determine the allowance allocation; and |
| • | application of Q&E factor adjustment percentages to historical losses for trends or changes in the loan portfolio. |
The reserve for unfunded commitments is calculated by determining the type of commitment and the remaining unfunded commitment for each loan. Based on the type of commitment, an expected usage percentage to the remaining unfunded balance is applied. The expected usage percentage is multiplied by the historical losses and Q&E factors for each loans pool as defined in regular Allowance for Loan Loss calculation to determine the appropriate level of reserve. The expected usage percentages for each commitment type are as follows:
| • | Construction draws – 100% |
| • | Equity lines of credit – 50% |
| • | Letters of Credit – 10% |
Historical Loss Rates: Historical loss data has been catalogued by the Company for each pool. The risk-graded pool to which the loss is assigned is the risk-grade assigned to the loan at the quarter end, four quarters earlier. Historical loss recoveries are similarly entered, if significant and applied against the non-classified pools according
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to the Call Report designations of the loans originally charged. Historical loss data is also used to estimate the loss horizon for each pool.
Q&E Loss Factors: The methodology incorporates various internal and external qualitative and environmental factors as described in the Interagency Policy Statement on the Allowance for Loan and Lease Losses dated December 2006. Input for these factors is determined on the basis of management observation, judgment, and experience. The factors utilized by the Company for all loan classes are as follows:
| a) | Standard – Accounts for inherent uncertainty in using the past as a predictor of the future. Uniform across all segments. |
| b) | Volume – Accounts for historical growth characteristics of the portfolio over the loss recognition period. |
| c) | Terms –Measures risk derived from granting terms outside of policy and underwriting guidelines. |
| d) | Staff – Reflects staff competence in various types of lending. |
| e) | Delinquency – Reflects increased risk deriving from higher delinquency rates. |
| f) | Nonaccrual – Reflects increased risk of loans with characteristics that merit nonaccrual status. |
| g) | Migration – Accounts for the changing level of risk inherent in loans as they migrate into, or away from, more adverse risk grades. |
| h) | Concentration – Measures increased risk derived from concentration of credit exposure in particular industry segments within the portfolio. |
| i) | Production – Measures impact of anticipated growth and potential risk derived from new loan production. |
| j) | Process – Measures increased risk derived from more demanding processing requirements directed towards risk mitigation. |
| k) | Economic – Impact of general and local economic factors are the largest single factor affecting portfolio risk and effect is felt uniformly across pools. |
| l) | Competition – Measures risk associated with bank’s potential response to competitors’ relaxed credit requirements. |
| m) | Regulatory and Legal – Measures risk from exposure to regulations, legislation, and legal code that result in increased risk of loss. |
Each pool is assigned an “additional” potential loss percentage by assessing its characteristics against each of the factors listed above.
Calculation and Summary: A general reserve amount for each loan pool is calculated by adding the historical loss rate to the total Q&E factors, and applying the combined percentage to the pool loan balances.
Reserves are generally divided into three allocation segments:
| 1. | Individual Reserves. These are calculated against loans evaluated individually and deemed most likely to be impaired. Management will determine which loans will be considered for potential impairment review. This does not mean that an individual reserve will necessarily be calculated for each loan considered for impairment, only for those noted during this process as likely to be potentially impaired. Loans to be considered will generally include: |
| • | All commercial loans classified substandard or worse |
| • | Any other loan in a non-accrual status |
| • | Any loan, consumer or commercial, which have already been modified such that they meet the definition of Troubled Debt Restructure (“TDR”) |
The individual reserve must be verified at least quarterly, and recalculated whenever additional relevant information becomes available. All information related to the calculation of the individual reserve, including internal or external collateral valuations, assumptions, calculations, etc. must be documented. Assigning an individual reserve based on rough estimates or unsupported conclusions is not permitted.
Individual reserve amounts may not be carried indefinitely.
| • | When the amount of the actual loss becomes reasonably quantifiable the amount of the loss should be charged off against the ALLL, whether or not all liquidation and recovery efforts have been completed. |
| • | If the total amount of the individual reserve that will eventually be charged off cannot yet be determined, but some portion of the individual reserve can be viewed as an imminent loss, that smaller portion should be charged off against the ALLL and the individual reserve reduced by a corresponding |
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amount. It is acceptable to retain an estimate of remaining loss as a “special reserve” only when said estimate is not reasonably quantifiable. |
| 2. | Formula Reserves. These are held against loans evaluated collectively. Loans are grouped by type or by risk grade, or some combination of the two. Loss estimates are based on historical loss rates for each respective loan group, adjusted for appropriate environmental factors established by the Bank. These factors should include: |
| • | Levels and trends in delinquencies and impaired loans |
| • | Estimated effects of changes to underwriting standards, lending policies, etc. |
| • | Experience, depth and ability of lending management and other relevant staff |
| • | National and local economic trends and conditions |
| • | Effects of changes in credit concentrations |
Formula reserves represent the Bank’s best estimate of losses that may be inherent, or embedded, within that group of loans, even if it is not apparent at this time which loans within any group or pool represent those embedded losses.
| 3. | Unallocated Reserves. If individual reserves represent estimated losses tied to any specific loan, and Formula Reserves represent estimated losses tied to a pool of loans but not yet to any specific loan, then Unallocated Reserves represent an estimate of losses that are expected, but are not yet tied to any loan or group of loans. Unallocated Reserves are generally the smallest of the three overall reserve segments and are set based on qualitative factors. |
All information related to the calculation of the three segments including data analysis, assumptions, calculations, etc. are documented. Assigning specific Individual Reserve amounts, Formula Reserve factors, or Unallocated amounts based on unsupported assumptions or conclusions is not permitted.
In addition, the Office of the Comptroller of the Currency (“OCC”), a federal regulatory agency, as an integral part of its examination process, periodically reviews the Bank’s allowance for loan losses. The OCC may require the Bank to recognize adjustments to the allowance based on its judgment about information available to it at the time of its examination.
Other Real Estate
Other real estate represents properties acquired through foreclosure or deed in lieu thereof. The property is classified as held for sale. The property is initially carried at fair value based on recent appraisals, less estimated costs to sell. Declines in the fair value of properties included in other real estate below carrying value are recognized by a charge to income.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets as follows: buildings and improvements, 10 to 50 years, and furniture and equipment, 3 to 10 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the estimated life of the improvement or the term of the lease.
Intangible Assets
Intangible assets include core deposit premiums resulting from acquisitions. Core deposit premiums are amortized primarily on a straight-line basis over a ten-year life based upon historical studies of core deposits.
Mortgage Servicing Rights (MSRs)
The rights to service mortgage loans for others are included in other assets on the consolidated balance sheet. MSRs are recorded at fair value on an ongoing basis, with changes in fair value recorded in the results of operations. A fair value analysis of MSRs is performed on a quarterly basis.
Income Taxes
Income tax expense includes both a current provision based on the amounts computed for income tax return purposes and a deferred provision that results from application of the asset and liability method of accounting for deferred taxes. Under the asset and liability method, deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities
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at enacted tax rates expected to be in effect when such amounts are realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Management’s determination of the realization of deferred tax assets is based upon its judgment of various future events and uncertainties, including the timing and amount of future income earned by certain subsidiaries and the implementation of various tax plans to maximize realization of the deferred tax assets. In evaluating the positive and negative evidence to support the realization of the asset under current guidance, given the current credit crisis and economic conditions, there is insufficient positive evidence to support a conclusion that it is more likely than not this asset will be realized in the foreseeable future. Examinations of the income tax returns or changes in tax law may impact the Company’s tax liabilities and resulting provisions for income taxes.
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In making such judgments, significant weight is given to evidence that can be objectively verified. As a result of the increased credit losses, the Bank continues to be in a three-year cumulative pre-tax loss position as of December 31, 2010. A cumulative loss position is considered significant negative evidence in assessing the realizability of a deferred tax asset, which is difficult to overcome. The Bank’s estimate of the realization of its deferred tax assets was based on the scheduled reversal of deferred tax liabilities and taxable income available in prior carry back years and estimated unrealized losses in the available-for-sale investment portfolio. The Bank did not consider future taxable income in determining the realizability of its deferred tax assets. The Bank expects its income tax expense (benefit) will be negligible for the next several quarters until profitability has been restored for a reasonable time and such profitability is considered sustainable. At that time, the valuation allowance would be reversed. Reversal of the valuation allowance requires a great deal of judgment and will be based on the circumstances that exist as of that future date. If future events differ significantly from the Bank’s current forecasts, the Bank may need to increase this valuation allowance, which could have a material adverse effect on the results of operations and financial condition.
Earnings per Share (EPS)
As required for entities with complex capital structures, a dual presentation of basic and diluted EPS is included on the face of the income statement, and a reconciliation is provided in a footnote of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation.
Comprehensive Income
Comprehensive income is defined as the change in equity of an enterprise during a period from transactions and other events and circumstances from nonowner sources and, accordingly, includes both net income and amounts referred to as other comprehensive income. The items of other comprehensive income are included in the consolidated statement of shareholders’ equity and comprehensive loss. The accumulated balance of other comprehensive loss is included in the shareholders’ equity section of the consolidated balance sheet. The Company’s components of accumulated other comprehensive loss at December 31, 2010 include unrealized gains (losses) on investment securities classified as available-for-sale, the effect of the defined benefit pension and other postretirement plans for employees, and the changes in the value of the interest rate swap designated as a cash flow hedge on one issue of trust preferred securities.
For the twelve months ended December 31, 2010 and 2009, total comprehensive loss was $(134.4) million and $(98.5) million, respectively. The deferred income tax benefit/(liability) related to the components of other comprehensive loss amounted to $1.7 million and $2.1 million, respectively, for the same periods as previously mentioned.
The accumulated balances related to each component of other comprehensive loss are as follows:
| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||||||||||
| Pretax | After-tax | Pretax | After-tax | |||||||||||||
Net unrealized securities (losses)/gains | $ | (862) | $ | (526) | $ | 4,725 | $ | 2,864 | ||||||||
Net unrealized losses on cash flow derivatives | - | - | (408) | (249) | ||||||||||||
Pension, other postretirement and postemployment benefit plan adjustments | (5,187) | (3,165) | (6,103) | (3,723) | ||||||||||||
Accumulated other comprehensive loss | $ | (6,049) | $ | (3,691) | $ | (1,786) | $ | (1,108) | ||||||||
Employee Benefit Plans
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The Company has a defined benefit pension plan covering substantially all full-time employees. Pension costs, which are actuarially determined using the projected unit credit method, are charged to current operations. Pension costs of $0.6 million were recognized as of December 31, 2010 and December 31, 2009. Annual funding contributions are made up to the maximum amounts allowable for Federal income tax purposes. See Note 16“Employee Benefit Plans” for additional information on all benefit plans described below.
In September 2006, the Board of Directors of FNB United approved a modified freeze to the pension plan. Effective December 31, 2006, no new employees are eligible to enter the plan. Participants who were at least age 40, had earned 10 years of vesting service as an employee of FNB United and remained an active employee as of December 31, 2006 qualified for a grandfathering provision. Under the grandfathering provision, the participant will continue to accrue benefits under the plan through December 31, 2011. However, in November 2010, the Board of Directors of the Company approved an additional amendment to the plan which ceases participant benefit accruals as of December 31, 2010.
The Company has a noncontributory, nonqualified supplemental executive retirement plan (the “SERP”) covering certain executive employees. Annual benefits payable under the SERP are based on factors similar to those for the pension plan, with offsets related to amounts payable under the pension plan and social security benefits. SERP costs, which are actuarially determined using the projected unit credit method and recorded on an unfunded basis, are charged to current operations and credited to a liability account on the consolidated balance sheet. In 2010, the Board of Directors approved an amendment to the plan which stops additional benefit accrual under the SERP after December 31, 2010. This action does not impact a participant’s vested or accrued benefit in the plan.
Medical and life insurance benefits are provided by the Company on a postretirement basis under defined benefit plans covering substantially all full-time employees. Postretirement benefit costs, which are actuarially determined using the attribution method and recorded on an unfunded basis, are charged to current operations and credited to a liability account on the consolidated balance sheet.
In conjunction with the modified freeze of the pension plan, the postretirement medical and life insurance plan was also amended. Effective December 31, 2006, no new employees are eligible to enter the postretirement medical and life insurance plan. Participants who were at least age 40, had earned 10 years of vesting service as an employee of the Company and remained an active employee as of December 31, 2006 qualified for a grandfathering provision. Under the grandfathering provision, the participant was to continue to accrue benefits under the plan through December 31, 2011. However, in November 2010, the Board of Directors of the Company approved an additional amendment to the plan which ceases participant benefit accruals as of December 31, 2010.
Derivatives and Financial Instruments
A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. The Company uses derivatives primarily to manage interest rate risk related to mortgage servicing rights, and long-term debt. The fair value of derivatives in a gain or loss position is included in other assets or liabilities, respectively, on the Consolidated Balance Sheets.
The Company classifies its derivative financial instruments as either a hedge of an exposure to changes in the fair value of a recorded asset or liability (“fair value hedge”) or a hedge of an exposure to changes in the cash flows of a recognized asset, liability or forecasted transaction (“cash flow hedge”). The Company has master netting agreements with the derivatives dealers with which it does business, but reflects gross gains and losses on the Consolidated Balance Sheets.
The Company uses the long-haul method to assess hedge effectiveness. The Company documents, both at inception and over the life of the hedge, at least quarterly, its analysis of actual and expected hedge effectiveness. This analysis includes techniques such as regression analysis and hypothetical derivatives to demonstrate that the hedge has been, and is expected to be, highly effective in off-setting corresponding changes in the fair value or cash flows of the hedged item. For a qualifying fair value hedge, changes in the value of the derivatives that have been highly effective as hedges are recognized in current period earnings along with the corresponding changes in the fair value of the designated hedged item attributable to the risk being hedged. For a qualifying cash flow hedge, the portion of changes in the fair value of the derivatives that have been highly effective are recognized in other comprehensive income until the related cash flows from the hedged item are recognized in earnings.
For either fair value hedges or cash flow hedges, ineffectiveness may be recognized in noninterest income to the extent that changes in the value of the derivative instruments do not perfectly offset changes in the value of the hedged items attributable to the risk being hedged. If the hedge ceases to be highly effective, the Company discontinues hedge accounting and recognizes the changes in fair value in current period earnings. If a derivative that qualifies as a fair value or cash flow hedge is terminated or the designation removed, the realized or then
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unrealized gain or loss is recognized into income over the original hedge period (fair value hedge) or period in which the hedged item affects earnings (cash flow hedge). Immediate recognition in earnings is required upon sale or extinguishment of the hedged item (fair value hedge) or if it is probable that the hedged cash flows will not occur (cash flow hedge).
See Note 21 for additional information related to derivatives and financial instruments.
Reclassification
Certain items for 2009 and 2008 have been reclassified to conform to the 2010 presentation. Such reclassifications had no effect on net loss or shareholders’ equity as previously reported.
Note 2 – Restatement of Consolidated Financial Statements
In preparing financial information for the first quarter of 2011 the Corporation determined there were events or transactions that occurred or became known in the first quarter of 2011 that related to the valuation of impaired loans and other real estate owned (OREO) and provided additional evidence about conditions that existed as of December 31, 2010. The information related to certain of these events or transactions was available prior to the filing of the Corporation’s annual report on Form 10-K and should have been considered in determining reported amounts or valuation allowances of impaired loans and OREO. The Corporation is restating its 2010 financial statements to reflect the correction of the recorded amounts or valuation allowances for impaired loans and OREO related to:
| • | $8.6 million in charge-offs in the first quarter of 2011 for impaired loans that existed at December 31, 2010 that should have had specific reserves in the December 31, 2010 allowance for loan losses. |
| • | $8.9 million in specific reserves for impaired loans recorded during the three-month period ended March 31, 2011 that should have been included as specific reserves in the December 31, 2010 allowance for loan losses due to updated appraisals received in the first quarter of 2011. |
| • | $1.4 million in write-downs of OREO in the first quarter of 2011 that should have been recorded during the year ended December 31, 2010. |
The Company has corrected these errors and in consultation with the Audit Committee of the Board of Directors, determined that the amounts of the allowance for loan losses should be increased by an aggregate of $17.5 million for the year ended December 31, 2010 and that write-downs of OREO should be increased by $1.4 million for the year ended December 31, 2010. In this Annual Report on Form 10-K/A, the Company is restating its consolidated balance sheet, statement of loss, statement of shareholders’ equity and comprehensive loss, and statement of cash flows as of and for the year ended December 31, 2010.
The effects of the restatement by line item for the periods presented in this Annual Report on Form10-K/A follow:
Impact on Consolidated Balance Sheets
| December 31, 2010 | ||||||||||||
| (dollars in thousands) | As Previously Reported | As Restated | Effect of Change | |||||||||
Allowance for Loan Losses | $ | 76,180 | $ | 93,687 | $ | 17,507 | ||||||
Net Loans Held for Investment | 1,227,795 | 1,210,288 | (17,507 | ) | ||||||||
Other Real Estate Owned | 63,627 | 62,226 | (1,401 | ) | ||||||||
Total Assets | 1,921,277 | 1,902,369 | (18,908 | ) | ||||||||
Accumulated Deficit | 210,187 | 229,095 | 18,908 | |||||||||
Total Shareholders’ Equity/(Deficit) | (9,929 | ) | (28,837 | ) | (18,908 | ) | ||||||
Impact on Consolidated Statements of Loss
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| December 31, 2010 | ||||||||||||
| (dollars in thousands) | As Previously Reported | As Restated | Effect of Change | |||||||||
Provision for Loan Losses | $ | 115,248 | $ | 132,755 | $ | 17,507 | ||||||
Net Interest (Loss)/Income after Provision for Loan Losses | (63,046) | (80,553) | (17,507) | |||||||||
Other Real Estate Owned Expense | 13,131 | 14,532 | 1,401 | |||||||||
Loss Before Income Taxes | 111,660 | 130,568 | 18,908 | |||||||||
Income Tax Expense/(Benefit) | 1,259 | 1,259 | - | |||||||||
Net Loss | 112,919 | 131,827 | 18,908 | |||||||||
Net Loss to Common Shareholders | 116,213 | 135,121 | 18,908 | |||||||||
Net Loss Per Common Share: | ||||||||||||
Basic | $ | (10.17) | $ | (11.83) | $ | (1.66) | ||||||
Diluted | $ | (10.17) | $ | (11.83) | $ | (1.66) | ||||||
Impact on Consolidated Statements of Shareholders’ Equity and Comprehensive Loss
| December 31, 2010 | ||||||||||||
| (dollars in thousands) | As Previously Reported | As Restated | Effect of Change | |||||||||
Net Loss | $ | 112,919 | $ | 131,827 | $ | 18,908 | ||||||
Total Comprehensive Loss | $ | (115,502) | $ | (134,410) | $ | (18,908) | ||||||
Total Accumulated Deficit | 210,187 | 229,095 | 18,908 | |||||||||
Total Shareholders’ Equity/(Deficit) | (9,929) | (28,837) | (18,908) | |||||||||
Impact on Consolidated Statements of Cash Flows
| December 31, 2010 | ||||||||||||
| (dollars in thousands) | As Previously Reported | As Restated | Effect of Change | |||||||||
Operating Activities: | ||||||||||||
Net Loss | $ | 112,919 | $ | 131,827 | $ | 18,908 | ||||||
Provision for Loan Losses | 115,248 | 132,755 | 17,507 | |||||||||
Net Loss on Other Real Estate Owned | 8,538 | 9,939 | 1,401 | |||||||||
Note 3 – Regulatory Matters
Regulatory Actions
Consent Order
Due to the Bank’s condition, on July 22, 2010, pursuant to a Stipulation and Consent to the Issuance of a Consent Order, the Bank consented and agreed to the issuance of a Consent Order (“Order”) by the OCC. In the Order, the Bank and the OCC agreed as to areas of the bank’s operations that warrant improvement and a plan for making those improvements. The Order includes a capital directive, which requires the Bank to achieve and maintain minimum regulatory capital levels in excess of the statutory minimums to be well-capitalized, and a directive to develop a liquidity risk management and contingency funding plan, in connection with which the Bank could be subject to limitations on the maximum interest rates it can pay on deposit accounts. The Order also contains restrictions on future extensions of credit and requires the development of various programs and procedures to improve the Bank’s asset quality as well as routine reporting on the Bank’s progress toward compliance with the Order to the Board of Directors and the OCC. Specifically, the Order imposed the following requirements on the Bank:
| • | to appoint a Compliance Committee to monitor and coordinate the Bank’s adherence to the Order. |
| • | to develop and submit to the OCC for review a written strategic plan covering at least a three-year period. |
| • | to achieve within 90 days and thereafter maintain total capital at least equal to 12% of risk-weighted assets and Tier 1 capital at least equal to 9% of adjusted total assets. |
| • | to submit to the OCC within 60 days a written capital plan for the Bank covering at least a three-year period. |
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| • | to develop, implement and ensure the Bank’s compliance with written programs to improve the Bank’s loan portfolio management and to reduce the high level of credit risk in the Bank. |
| • | to adopt and ensure implementation and adherence to an enhanced written commercial real estate concentration management program consistent with OCC guidelines. |
| • | to obtain current and complete credit information on all loans and ensure proper collateral documentation is maintained on all loans. |
| • | to develop and implement an independent review and analysis process to ensure that appraisals conform to appraisal standards and regulations. |
| • | to implement and adhere to a written program for the maintenance of an adequate allowance for loan losses, providing for review of the allowance by the Board of Directors at least quarterly. |
| • | to increase the Bank’s liquidity to a level sufficient to sustain the Bank’s current operations and to withstand any anticipated or extraordinary demand against its funding base. |
| • | to implement and maintain a comprehensive liquidity risk management program, assessing on an ongoing basis the Bank’s current and projected funding needs and ensuring that sufficient funds or access to funds exists to meet those needs. |
| • | to develop and implement a written program to strengthen internal controls over accounting and financial reporting. |
The Order permits the OCC to extend the time periods under the Order upon written request. Any material failure to comply with the Order could result in further enforcement actions by the OCC. In addition, if the OCC does not accept the capital plan or the Bank fails to achieve and maintain the minimum capital levels, the OCC may require the Bank to sell, merge or liquidate the Bank.
The Bank has submitted all required materials and plans requested to the OCC within the given time periods. The Board of Directors submitted written strategic plans and capital plans to the OCC covering the requisite three-year period.
Written Agreement
On October 21, 2010, FNB United entered into a written agreement with the Federal Reserve Bank of Richmond (“FRBR”). Pursuant to the agreement, FNB United’s Board of Directors is to take appropriate steps to utilize fully FNB United’s financial and managerial resources to serve as a source of strength to the Bank, including causing the Bank to comply with the Order it entered into with the OCC on July 22, 2010.
In the agreement, FNB United agreed that it would not declare or pay any dividends without prior written approval of the FRBR and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System (the “Director”). It further agreed that it would not take dividends or any other form of payment representing a reduction in capital from the Bank without the FRBR’s prior written approval. The agreement also provides that neither FNB United nor any of its nonbank subsidiaries will make any distributions of interest, principal or other amounts on subordinated debentures or trust preferred securities without the prior written approval of the FRBR and the Director.
The agreement further provides that neither FNB United nor any of its subsidiaries shall incur, increase or guarantee any debt without FRBR approval. In addition, FNB United must obtain the prior approval of the FRBR for the repurchase or redemption of its shares of stock.
Within 60 days from the date of the agreement, FNB United submitted to the FRBR a written plan to maintain sufficient capital at FNB United on a consolidated basis. Within 30 days of the agreement, FNB United submitted to the FRBR a statement of its planned sources and uses of cash for operating expenses and other purposes for 2011. FNB United is to submit such a cash flow projection for each subsequent calendar year by December of the preceding year.
The agreement permits the FRBR to grant written extensions of time for FNB United to comply with its provisions.
FNB United is to report to the FRBR monthly regarding its progress in complying with the agreement. The provisions of the agreement will remain effective and enforceable until they are stayed, modified, terminated, or suspended in writing by the FRBR.
Capital Matters
The Order, described above, requires the Bank to achieve and maintain Tier 1 capital of not less than 9% and total risk-based capital of not less than 12% for the life of the Order. The Bank has not achieved the required capital
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levels by the deadline imposed under the Order but is continuing to work to comply with the capital directive. The Bank is not “well-capitalized” for capital adequacy purposes under the terms of the Order and may not be deemed so in the future, even if the Bank exceeds the levels of capital required under the Order.
The minimum capital requirements to be characterized as “well-capitalized” and “adequately capitalized,” as defined by regulatory guidelines, the capital requirements pursuant to the Order, and the Company’s actual capital ratios on a consolidated and Bank-only basis were as follows as of December 31, 2010:
| Minimum Regulatory Requirement | ||||||||||
| Consolidated | Bank | Adequately Capitalized | Well- Capitalized | Pursuant to Order | ||||||
Total risk-based capital ratio | (2.56) % | 2.36 % | 8.00 % | 10.00 % | 12.00 % | |||||
Tier 1 risk-based capital ratio | (2.56) % | 1.18 % | 4.00 % | 6.00 % | 9.00 % | |||||
Leverage capital ratio | (1.86) % | 0.86 % | 4.00 % | 5.00 % | 9.00 % | |||||
As of December 31, 2010, the Company was designated “significantly undercapitalized” for total risk-based capital, Tier 1 risk-based capital and leverage capital under regulatory guidelines.
Note 4 – Going Concern Considerations and Management’s Plans and Intentions
Going Concern Considerations
The going concern assumption is a fundamental principle in the preparation of financial statements. It is the responsibility of management to assess the Company’s ability to continue as a going concern. In making this assessment, the Company has taken into account all available information about the future, which is at least, but is not limited to, twelve months from the balance sheet date of December 31, 2010. The Company has had a history of profitable operations and sufficient sources of liquidity to meet its short-term and long-term funding needs. However, the Bank’s financial condition has suffered during 2009 as well as 2010 in what may ultimately be the worst economic downturn since the Great Depression.
The effects of the current economic environment are being felt across many industries, with financial services and real estate being particularly hard-hit, and have been particularly severe during the last 24 months. The Bank, with a loan portfolio consisting of a concentration in commercial real estate loans, including residential construction and development loans, has seen a decline in the value of the collateral securing its portfolio as well as rapid deterioration in its borrowers’ cash flow and ability to repay their outstanding loans to the Bank. As a result, the Bank’s level of nonperforming assets has increased substantially during 2009 and 2010. For the years ended December 31, 2010 and 2009, the Bank recorded provisions of $132.8 million and $61.7 million, respectively, to increase the allowance for loan losses to a level that, in management’s best judgment, adequately reflected the increased risk inherent in the loan portfolio as of the respective year-ends.
FNB United and the Bank operate in a highly regulated industry and must plan for the liquidity needs of each entity separately. A variety of sources of liquidity are available to the Bank to meet its short-term and long-term funding needs. Although a number of these sources are limited following execution of the Order with the OCC discussed in Note 3 above, management has prepared forecasts of the Bank’s sources of funds and projected uses of funds for a three-year period in an effort to ensure that the sources available are sufficient to meet the Bank’s projected liquidity needs.
FNB United is a legal entity separate and distinct from the Bank and relies on dividends from the Bank as its primary source of liquidity. Various legal limitations, including the FDICIA and the Order, restrict or prohibit the Bank from lending or otherwise supplying funds to FNB United to meet its obligations, including paying dividends. The regulatory restrictions that restrict cash payments between the Bank and FNB United may cause FNB United to be unable to meets its financial obligations in the normal course of business.
The Company must raise additional capital to increase capital levels to meet the standards set forth by the OCC. As a result of the recent downturn in the financial markets, the availability of many sources of capital (principally to financial services companies) has become significantly restricted or has become increasingly costly as compared to market rates prevailing prior to the downturn. Management cannot predict when or if the capital markets will return to more favorable conditions. Management is actively evaluating a number of capital sources, asset reductions and other balance sheet management strategies to ensure that the Bank’s projected level of regulatory capital can support its balance sheet.
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There can be no assurances that the Company will be successful in its efforts to raise additional capital during 2011. An equity financing transaction sufficient to restore the Bank’s capital to required levels would result in substantial dilution to the Company’s current shareholders and could adversely affect the market price of the Company’s common stock. It is difficult to predict if capital-raising efforts will be successful, either on a short-term or long-term basis. The Company’s failure to raise capital and increase its capital ratios to levels required by the Order may result in the sale, merger or liquidation of the Bank and further deterioration of the Bank’s capital may result in its being placed in regulatory receivership. This uncertainty as to the Company’s ability to meet existing or future regulatory requirements and the continued deterioration in the Bank’s asset quality raise substantial doubt about the Company’s ability to continue as a going concern.
The perception or possibility that FNB United’s common stock could be delisted from the Nasdaq in the future could negatively affect its liquidity and price. Delisting would have an adverse effect on the liquidity of the common shares and, as a result, the market price for the common stock might become more volatile. Delisting could also make it more difficult for the Company to raise additional capital.
The accompanying consolidated financial statements for the Company have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and does not include any adjustments to reflect the possible future effects on the recoverability or classification of assets.
Management’s Plans and Intentions
The Company incurred significant net losses in 2009, which have continued in 2010, primarily from the higher provisions for loan losses due to the significant level of nonperforming assets and the write-off of goodwill. The Bank consented and agreed to the issuance of the Order by the OCC in July 2010. FNB United entered into a written agreement with the FRB in October 2010. The Company’s independent registered public accounting firm issued a report with respect to the Company’s audited financial statements for the fiscal year ended December 31, 2010, which contained an explanatory paragraph indicating that there is substantial doubt about the Company’s ability to continue as a going concern. The following strategies to improve the Company’s financial condition have been or are being implemented:
Held-to-Maturity Investment Securities Reclassification –As part of the Bank’s contingency funding plan, the Bank reclassified and transferred on May 3, 2010 the entire held-to-maturity investment securities portfolio to available-for-sale investment securities. Though there are no immediate plans for the sale of these securities, the transfer gives the Bank additional latitude in managing liquidity and the investment portfolio. The transfer resulted in the unrealized holding gains of $2.1 million, net of tax, at the date of transfer being recognized in other comprehensive income. The corresponding deferred tax on the unrealized holding gain allowed the Bank to realize a one-time reduction in deferred tax valuation allowance of $1.4 million in the second quarter of 2010.
Deferring Preferred Stock and Trust Preferred Securities Payments –The Company began deferring the payment of cash dividends on its outstanding Fixed Rate Cumulative Perpetual Preferred Stock, Series A, beginning in the second quarter 2010, as well as the payment of interest on the outstanding junior subordinated notes related to its trust preferred securities to enhance the Company’s liquidity. The expense associated with trust preferred securities continues to accrue and is reflected in the Company’s Consolidated Statements of Loss. The dividends on preferred stock are shown as an increase to net loss to derive net loss to common shareholders in the Consolidated Statements of Loss.
Balance Sheet Reduction –Management currently is implementing strategies to improve capital ratios through the reduction of assets and off-balance sheet commitments. At December 31, 2010, risk-weighted assets had been reduced by $332.1 million since December 31, 2009. Reductions occurred primarily in reductions in the commercial loan portfolio. Management expects future reductions in risk-weighted assets to be moderate and occur primarily in the loan portfolio. To offset the majority of asset reductions, liabilities declined primarily through reductions in deposits by $25.7 million. Because asset reductions exceeded liability reductions in the twelve months ending December 31, 2010, cash balances increased by $132.9 million. Future liability reductions are expected to occur primarily in deposits, primarily public unit deposits and high-rate NOW accounts and certificates of deposits.
On December 29, 2010, the Bank entered into an agreement to sell mortgage servicing rights on approximately $492.9 million of FNMA (Federal National Mortgage Association) loans and recognized a loss of $3.0 million, including transaction costs.
Earnings –On June 22, 2010, the Bank retired $33.0 million in Federal Home Loan Bank (“FHLB”) advances and paid an early redemption penalty of $1.0 million to the FHLB for the retirement of these advances, of which the penalty is in other noninterest expenses. On July 2, 2010, the Bank purchased $30.0 million in brokered certificates
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of deposit to replace these funds. The advances had a remaining average life of 1.0 years and an average interest rate of 3.93%. The brokered certificates of deposit have maturities ranging from 30 months to 42 months with interest rates ranging from 1.75% to 2.20%. As a result of this transaction, the interest expense savings during the first year is estimated at an annualized rate of 1.94% on the $30.0 million restructured.
Stimulus Loan Program –The Bank implemented in 2009 a stimulus loan program to facilitate the sale of residential real estate held as collateral for some of the Bank’s nonperforming and performing loans and certain Bank-owned properties. The purpose of the program is to reduce the Bank’s credit concentrations and nonperforming assets by providing attractive terms that both fill the mortgage lending void created by the ongoing recession and incent potential buyers to purchase real estate. The Bank offered a reduced interest rate to qualified new borrowers to encourage them to purchase properties in this program. New borrowers are qualified according to the Bank’s normal consumer and mortgage underwriting standards. The Bank records these loans at fair value at time of issue. Existing unimpaired development loans that become part of the program are considered impaired upon inclusion in the stimulus loan program. The Bank discontinued the program in the first quarter of 2011. The Bank currently has $41.1 million in loans under the stimulus loan program, and has recognized an initial fair value adjustment of $172,200. As of December 31, 2010, the fair value adjustment was reduced to $114,100 due to the accretion of the adjustment to interest income. The fair value adjustment is recorded as a reduction of the outstanding loan balance on the balance sheet and accreted into interest income over the contractual life of the loan.
Additional Capital –The Company has engaged investment banking firms and is working to secure investors in a capital raise plan that may include issuing common stock, preferred stock or a combination of both, debt, or other financing alternatives that may be treated as capital for capital adequacy ratio purposes. Currently, the Company is working diligently to raise additional capital in the next few months; however, there are no assurances that an offering will be completed or that the Company will succeed in this endeavor. In addition, a transaction would more likely than not involve equity financing, resulting in substantial dilution to current shareholders and an adverse affect on the price of the Company’s common stock. The Company’s ability to raise capital is contingent on the current capital markets and on its financial performance. Available capital markets are not currently favorable, and the Company cannot be certain of its ability to raise capital on any terms.
Note 5 – Intangible Assets
Business Combinations
For intangible assets related to business combinations, the following is a summary of the gross carrying amount and accumulated amortization of amortized intangible assets and the carrying amount of unamortized intangible assets:
| (dollars in thousands) | December 31, | |||||||
| 2010 | 2009 | |||||||
Amortized intangible assets: | ||||||||
Core deposit premium related to whole bank acquisitions: | ||||||||
Carrying amount | $ | 8,202 | $ | 8,202 | ||||
Accumulated amortization | 4,029 | 3,234 | ||||||
Net core deposit premium | $ | 4,173 | $ | 4,968 | ||||
Amortization of intangibles totaled approximately $795,000 for core deposit premiums in 2010, $794,000 in 2009 and $802,000 in 2008. The estimated amortization expense for core deposit premiums is approximately $795,000 per year for years ending December 31, 2011 through 2015.
Mortgage Servicing Rights
Mortgage loans serviced for others are not included in the consolidated balance sheet. The unpaid principal balance of mortgage loans serviced for others amounted to $493.7 million, $453.3 million and $353.9 million at December 31, 2010, 2009 and 2008, respectively.
In accordance with instructions from Federal National Mortgage Association (“FNMA”), the bank entered into an agreement on December 29, 2010 to sell mortgage servicing rights on approximately $492.9 million of FNMA loans and recognized a loss of $3.0 million, including transaction costs. The Bank continued to service these loans until January 31, 2011. The Bank did not sell any mortgage servicing rights in 2009 or 2008.
The following is an analysis of mortgage servicing rights included in other assets on the consolidated balance sheet:
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| (dollars in thousands) | Years Ended December 31, | |||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Balance at beginning of year | $ | 4,857 | $ | 4,043 | $ | 2,900 | ||||||
Servicing rights capitalized | 1,340 | 1,642 | 1,182 | |||||||||
Amortization expense | (853 | ) | (1,019 | ) | (616 | ) | ||||||
Change in valuation allowance | (312 | ) | 191 | 577 | ||||||||
Impairment write-down | (2,673 | ) | - | - | ||||||||
Balance at end of year | $ | 2,359 | $ | 4,857 | $ | 4,043 | ||||||
Note 6 – Investment Securities
The primary objective of the Company’s management of the investment portfolio is to maintain a portfolio of high quality, highly liquid investments yielding competitive returns. The Company is required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. The Company maintains investment balances based on a continuing assessment of cash flows, the level of loan production, current interest rate risk strategies and the assessment of the potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risk.
On May 3, 2010, the Company reclassified the entire held-to-maturity investment securities portfolio to available-for-sale investment securities to provide additional liquidity to the Bank. At the time of reclassification, the held-to-maturity investment securities were carried at amortized cost of $83.2 million with an unrealized net gain of $3.5 million. The Company recorded $2.8 million to Other Comprehensive Income and a federal income tax benefit of $0.7 million to reduce its deferred tax valuation allowance established on previously recorded deferred tax assets.
During the fourth quarter of 2010, the Bank sold 145 investment securities with a face value of $172.7 million and purchased 20 securities with a face value of $158.5 million. These transactions resulted in a net gain on the sale of investment securities of $8.8 million.
The following table summarizes the amortized cost and estimated fair value of available-for-sale investment securities and the related gross unrealized gains and losses are presented below:
| (dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | ||||||||||||
December 31, 2010 | ||||||||||||||||
Obligations of: | ||||||||||||||||
U.S. Treasury and government agencies | $ | 20 | $ | 1 | $ | - | $ | 21 | ||||||||
U.S. government sponsored agencies | 23,490 | 158 | 132 | 23,516 | ||||||||||||
States and political subdivisions | 23,867 | 885 | 294 | 24,458 | ||||||||||||
Residential mortgage-backed securities | 258,816 | 427 | 1,907 | 257,336 | ||||||||||||
Total | $ | 306,193 | $ | 1,471 | $ | 2,333 | $ | 305,331 | ||||||||
December 31, 2009 | ||||||||||||||||
Obligations of: | ||||||||||||||||
U.S. Treasury and government agencies | $ | 61 | $ | 2 | $ | - | $ | 63 | ||||||||
U.S. government sponsored agencies | 71,696 | 1,460 | 189 | 72,967 | ||||||||||||
States and political subdivisions | 45,264 | 1,494 | 330 | 46,428 | ||||||||||||
Residential mortgage-backed securities | 99,307 | 2,427 | 121 | 101,613 | ||||||||||||
Collateralized debt obligations | - | 45 | - | 45 | ||||||||||||
Equity securities | 2,667 | - | 499 | 2,168 | ||||||||||||
Corporate notes | 13,910 | 436 | - | 14,346 | ||||||||||||
Total | $ | 232,905 | $ | 5,864 | $ | 1,139 | $ | 237,630 | ||||||||
The following table summarizes the amortized cost and estimated fair value of held-to-maturity investment securities and the related gross unrealized gains and losses are presented below:
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| (dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | ||||||||||||
December 31, 2009 | ||||||||||||||||
Obligations of: | ||||||||||||||||
States and political subdivisions | $ | 13,918 | $ | 486 | $ | - | $ | 14,404 | ||||||||
Residential mortgage-backed securities | 52,127 | 1,155 | 260 | 53,022 | ||||||||||||
Commercial mortgage-backed securities | 21,513 | 1,719 | - | 23,232 | ||||||||||||
Corporate notes | 1,001 | - | 138 | 863 | ||||||||||||
Total | $ | 88,559 | $ | 3,360 | $ | 398 | $ | 91,521 | ||||||||
The amortized cost and estimated fair value of investment securities at December 31, 2010, by contractual maturity, are shown in the accompanying table. Actual maturities may differ from contractual maturities because issuers may have the right to prepay obligations with or without prepayment penalties.
| Available-for-Sale | ||||||||
| (dollars in thousands) | Amortized Cost | Estimated Fair Value | ||||||
Due in one year or less | $ | 6,323 | $ | 6,491 | ||||
Due after one one year through five years | 4,127 | 4,104 | ||||||
Due after five years through 10 years | 22,748 | 22,527 | ||||||
Due after 10 years | 14,179 | 14,873 | ||||||
Total | 47,377 | 47,995 | ||||||
Mortgage-backed securities | 258,816 | 257,336 | ||||||
Total | $ | 306,193 | $ | 305,331 | ||||
At December 31, 2010, $168.1 million of the investment securities portfolio was pledged to secure public deposits, including retail repurchase agreements, $27.6 million was pledged to the Federal Reserve Bank (the “FRB”) of Richmond and $7.5 million was pledged to others, leaving $102.2 million available as lendable collateral.
At December 31, 2009, $116.5 million of the investment securities portfolio was pledged to secure public deposits, including retail repurchase agreements, $40.4 million was pledged to the FRB of Richmond, $71.0 million was pledged to the FHLB and $0.7 million was pledged to others, leaving $97.6 million available as lendable collateral.
Gross gains and losses recognized (by specific identification) on the sale of securities are summarized as follows:
| (dollars in thousands) | Years ended December 31, | |||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Gains on sales of investment securities available-for-sale | $ | 10,722 | $ | 1,136 | $ | 664 | ||||||
Losses on sales of investment securities available-for-sale | (75 | ) | (147 | ) | (18 | ) | ||||||
Total securities gains | $ | 10,647 | $ | 989 | $ | 646 | ||||||
The Bank, as a member of the FHLB of Atlanta, is required to own capital stock in the FHLB of Atlanta based generally upon the balances of total assets and FHLB advances. FHLB capital stock is pledged to secure FHLB advances. This investment is carried at cost since no ready market exists for FHLB stock and there is no quoted market value. However, redemption of this stock has historically been at par value. At December 31, 2010 and 2009, the Bank owned a total of $11.5 million and $12.9 million, respectively, of FHLB stock. Due to the redemption provisions of FHLB stock, the Company estimated that fair value approximated cost and that this investment was not impaired at December 31, 2009. FHLB stock is included in other assets at its original cost basis.
The Bank, as a member bank of the FRB of Richmond, is required to own capital stock of the FRB of Richmond based upon a percentage of the Bank’s common stock and surplus. This investment is carried at cost since no ready market exists for FRB stock and there is no quoted market value. At December 31, 2010 and 2009, the Bank owned a total of $3.8 million and $5.4 million, respectively of FRB stock. Due to the nature of this investment in an entity of the U.S. Government, the Company estimated that fair value approximated the cost and that this investment was not impaired at December 31, 2010. FRB stock is included in other assets at its original cost basis.
Other investments are recorded at cost and are composed of the following:
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| (dollars in thousands) | December 31, | |||||||
| 2010 | 2009 | |||||||
Federal Home Loan Bank stock | $ | 11,496 | $ | 12,867 | ||||
Federal Reserve Bank stock | 3,761 | 5,358 | ||||||
Other investments | 6 | 10 | ||||||
Total other investments | $ | 15,263 | $ | 18,235 | ||||
The following table presents a summary of available-for-sale investment securities that had an unrealized loss at December 31:
| Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| (dollars in thousands) | Estimated Fair Value | Gross Unrealized Losses | Estimated Fair Value | Gross Unrealized Losses | Estimated Fair Value | Gross Unrealized Losses | ||||||||||||||||||
December 31, 2010 | ||||||||||||||||||||||||
Obligations of: | ||||||||||||||||||||||||
U.S. government sponsored agencies | $ | 11,855 | $ | 132 | $ | - | $ | - | $ | 11,855 | $ | 132 | ||||||||||||
States and political subdivisions | 8,873 | 294 | - | - | 8,873 | 294 | ||||||||||||||||||
Residential mortgage-backed securities | 151,154 | 1,907 | - | - | 151,154 | 1,907 | ||||||||||||||||||
Total | $ | 171,882 | $ | 2,333 | $ | - | $ | - | $ | 171,882 | $ | 2,333 | ||||||||||||
December 31, 2009 | ||||||||||||||||||||||||
Obligations of: | ||||||||||||||||||||||||
U.S. government sponsored agencies | $ | 11,289 | $ | 189 | $ | - | $ | - | $ | 11,289 | $ | 189 | ||||||||||||
States and political subdivisions | 15,077 | 263 | 799 | 67 | 15,876 | 330 | ||||||||||||||||||
Residential mortgage-backed securities | 4,334 | 121 | - | - | 4,334 | 121 | ||||||||||||||||||
Equity securities | - | - | 2,667 | 499 | 2,667 | 499 | ||||||||||||||||||
Total | $ | 30,700 | $ | 573 | $ | 3,466 | $ | 566 | $ | 34,166 | $ | 1,139 | ||||||||||||
| The following table presents a summary of held-to-maturity investment securities that had an unrealized loss at December 31: | ||||||||||||||||||||||||
| Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| (dollars in thousands) | Estimated Fair Value | Gross Unrealized Losses | Estimated Fair Value | Gross Unrealized Losses | Estimated Fair Value | Gross Unrealized Losses | ||||||||||||||||||
December 31, 2009 | ||||||||||||||||||||||||
Residential mortgage-backed securities | $ | 8,788 | $ | 260 | $ | - | $ | - | $ | 8,788 | $ | 260 | ||||||||||||
Corporate notes | - | - | 863 | 138 | 863 | 138 | ||||||||||||||||||
Total | $ | 8,788 | $ | 260 | $ | 863 | $ | 138 | $ | 9,651 | $ | 398 | ||||||||||||
At December 31, 2010 there were no investment securities that had continuous unrealized losses for more than twelve months. Investment securities with an aggregate fair value of $4.3 million have had continuous unrealized losses of $0.7 million for more than twelve months as of December 31, 2009. These securities include county and municipal securities and corporate securities. The unrealized losses relate to fixed-rate debt securities that have incurred fair value reductions due to higher market interest rates and for certain securities, increased credit risk since the respective purchase date. The unrealized losses are not likely to reverse unless and until market interest rates and credit risk decline to the levels that existed when the securities were purchased. Since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, and the Company has determined that it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, none of the securities are deemed to be other than temporarily impaired.
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Unrealized losses for all investment securities are reviewed to determine whether the losses are OTTI. Investment securities are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value below amortized cost is other-than-temporary. In conducting this assessment, the Company evaluates a number of factors including, but not limited to:
| • | How much fair value has declined below amortized cost; |
| • | How long the decline in fair value has existed; |
| • | The financial condition of the issuer; |
| • | Contractual or estimated cash flows of the security; |
| • | Underlying supporting collateral; |
| • | Past events, current conditions, forecasts; |
| • | Significant rating agency changes on the issuer; and |
| • | The Company’s intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. |
The Company analyzed its securities portfolio at December 31, 2010, paying particular attention to its municipal bonds. After considering ratings, fair value, cash flows and other factors, the Company does not believe securities to be OTTI.
During 2009, the Bank identified one security with a principal amount of $5.0 million where expected cash flows were less than contractual cash flows. This security is backed by a pool of issuers of trust preferred securities. As of this date, issuers within the pool were either deferring or had defaulted on approximately 30% of the outstanding pool balance. The security owned by the Bank is in a subordinated position to other securities backed by the trust preferred pool and was not paying dividends since the second quarter; the Company does not expect to receive any further dividend.
The Bank performed two separate impairment tests assuming that current issuers in default would have no recovery, that a substantial amount of issuers currently deferring would default with a lower severity rate and that additional issuers would default. As a result of the impairment tests, the entire book value was considered impaired with the full amount written off. Though the Bank does not know what the ultimate default and severity rates will be, management determined that this evaluation represented the best estimate of expected loss under a severe stress scenario.
Note 7 – Loans
Loans are stated at the principal amounts outstanding adjusted for purchase premiums/discounts, deferred net loan fees and costs, and unearned income.
The following summary sets forth the major categories of loans:
| (dollars in thousands) | 2011 | 2009 | ||||||
Loans held for sale | $ | 37,079 | $ | 58,219 | ||||
Loans held for investment: | ||||||||
Commercial and agricultural | $ | 93,747 | $ | 194,134 | ||||
Real estate - construction | 276,976 | 394,427 | ||||||
Real estate - mortgage: | ||||||||
1-4 family residential | 388,859 | 398,134 | ||||||
Commercial and other | 494,861 | 529,822 | ||||||
Consumer | 49,532 | 46,504 | ||||||
Gross loans held for investment | 1,303,975 | 1,563,021 | ||||||
Less: allowance for loan losses | (93,687 | ) | (49,461 | ) | ||||
Loans held for investment, net of allowance | $ | 1,210,288 | $ | 1,513,560 | ||||
Loans as presented are reduced by net deferred loan fees of $26,000 and $385,000 at December 31, 2010 and 2009, respectively. Accruing loans past due 90 days or more amounted to $4.8 million at December 31, 2010 and $6.9 million at December 31, 2009. Nonaccrual loans amounted to $325.1 million at December 31, 2010 and $167.5 million at December 31, 2009. Interest income that would have been recorded on nonaccrual loans for the years
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ended December 31, 2010, 2009 and 2008, had they performed in accordance with their original terms, amounted to approximately $12.3 million, $6.9 million and $6.0 million, respectively. Interest income on nonaccrual loans included in the results of operations amounted to approximately $10.7 million in 2010, $5.1 million in 2009 and $4.4 million in 2008. Interest income on nonperforming loans is recorded when cash is actually received.
On December 30, 2010, the Bank sold $32.9 million of mortgage loans held for investment and recognized a net gain of $383,000, including transaction costs, which is reported as mortgage loan income in the Consolidated Statements of Loss. The Bank did not sell any loans held for investment in 2009 or 2008.
The Bank had loans outstanding to executive officers and directors and their affiliated companies during each of the past three years. Such loans were made substantially on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other borrowers and do not involve more than the normal risks of collectability.
The following table summarizes the transactions for the past two years.
| (dollars in thousands) | 2010 | 2009 | ||||||
Balance at beginning of year |
$ |
15,036 |
| $ | 10,556 | |||
Advances during year | 23,790 | 25,333 | ||||||
Repayments during year | (24,754) | (20,853) | ||||||
Balance at end of year | $ | 14,072 | $ | 15,036 | ||||
To borrow from the FHLB, members must pledge collateral to secure advances and letters of credit. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. Gross loans of $468.4 million and $608.9 million were pledged to collateralize FHLB advances and letters of credit at December 31, 2010 and December 31, 2009, respectively, of which $0 and $174.7 million, respectively, was available as additional borrowing capacity. At December 31, 2010, no loans were pledged for borrowings from the Federal Reserve Discount Window.
The Bank implemented in 2009 a stimulus loan program to facilitate the sale of residential real estate held as collateral for some of the Bank’s nonperforming and performing loans and certain Bank-owned properties. The purpose of the program is to reduce the Bank’s credit concentrations and nonperforming assets by providing attractive terms that both fill the mortgage lending void created by the ongoing recession and incent potential buyers to purchase real estate. The Bank offered a reduced interest rate to qualified new borrowers to encourage them to purchase properties in this program. New borrowers are qualified according to the Bank’s normal consumer and mortgage underwriting standards. The Bank records these loans at fair value at time of issue. Existing unimpaired development loans that become part of the program are considered impaired upon inclusion in the stimulus loan program. The Bank discontinued the program in the first quarter of 2011. The Bank currently has $41.1 million in loans under the stimulus loan program, and has recognized an initial fair value adjustment of $172,200. As of December 31, 2010, the fair value adjustment was reduced to $114,100 due to the accretion of the adjustment to interest income. The fair value adjustment is recorded as a reduction of the outstanding loan balance on the balance sheet and accreted into interest income over the contractual life of the loan.
At December 31, 2010 and December 31, 2009, the Bank had certain impaired loans of $325.1 million and $167.5 million, respectively, which were on nonaccruing interest status.
The following is a summary of nonperforming assets for the periods ended as presented.
| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||
Loans on nonaccrual status |
$ |
325,068 |
| $ | 167,506 | |||
Loans more than 90 days delinquent, still on accrual | 4,818 | 6,908 | ||||||
Real estate owned/repossessed assets | 62,364 | 35,238 | ||||||
Total Nonperforming Assets | $ | 392,250 | $ | 209,652 | ||||
The following table summarizes information relative to impaired loans at the dates and for the periods indicated.
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| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||||||||||
| Balance | Associated Reserves | Balance | Associated Reserves | |||||||||||||
Impaired loans, not individually reviewed for impairment | $ | 717 | $ | - | $ | 5,660 | $ | 38 | ||||||||
Impaired loans, individually reviewed, with no impairment | 132,435 | - | 84,928 | - | ||||||||||||
Impaired loans, individually reviewed, with impairment | 208,040 | 70,888 | 98,010 | 28,868 | ||||||||||||
Total impaired loans * | $ | 341,192 | $ | 70,888 | $ | 188,598 | $ | 28,906 | ||||||||
* Included at December 31, 2010 and December 31, 2009 were $6.5 million and $24.7 million, respectively, in restructured and performing loans.
Impaired loans also include loans for which the Bank may elect to grant a concession, providing terms more favorable than those prevalent in the market (e.g., rate, amortization term), and formally restructure due to the weakening credit status of a borrower. Restructuring is designed to facilitate a repayment plan that minimizes the potential losses that the Bank otherwise may have to incur. If these impaired loans are on nonaccruing status as of the date of restructuring, the loans are included in nonperforming loans. Nonperforming restructured loans will remain as nonperforming until the borrower can demonstrate adherence to the restructured terms for a period of no less than six months or when it is otherwise determined that continued adherence is reasonably assured. Some restructured loans continue as accruing loans after restructuring due to the borrower not being past due, adequate collateral valuations supporting the restructured loans or the cash flows of the underlying business appearing adequate to support the restructured debt service. Not included in nonperforming loans are loans that have been restructured that were performing as of the restructure date. At December 31, 2010, there was $146.5 million in restructured loans, of which loans amounting to $6.5 million were accruing and in a performing status. At December 31, 2009, there was $95.7 million in restructured loans, of which loans amounting to $24.7 million were accruing and in a performing status.
Potential problem loans which are not included in nonperforming assets are classified separately within the Bank’s portfolio as Special Mention and carry a risk grade rating of “6”. These loans are defined as those with potential weaknesses which may affect repayment capacity, but do not pose sufficient risk as to require an adverse classification. As of December 31, 2010, the balance of such loans was $130.8 million compared with a balance of $244.3 million as of December 31, 2009.
The average carrying value of impaired loans was $355.1 million in 2010 and $147.2 million in 2009. Interest income recognized on impaired loans, exclusive of nonaccrual loans, amounted to approximately $0.3 million in 2010, $1.7 million in 2009 and $1.3 million in 2008.
Loans with outstanding balances of $47.6 million in 2010 and $34.7 million in 2009 were transferred from loans to other real estate acquired through foreclosure. Other real estate acquired through loan foreclosures amounted to $62.3 million at December 31, 2010 and $35.2 million at December 31, 2009.
Loans held for investment are primarily made in the region of North Carolina that includes Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties. The real estate loan portfolio can be affected by the condition of the local real estate markets.
Note 8 – Allowance for Loan Losses
The allowance for loan losses (“ALLL”) is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectability of principal is unlikely. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses represents management’s best estimate of probable credit losses that are inherent in the loan portfolio at the balance sheet date and is determined by management through quarterly evaluations of the loan portfolio.
The Bank lends primarily in North Carolina. As of December 31, 2010, a substantial majority of the principal amount of the loans held for investment in its portfolio was to businesses and individuals in North Carolina. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. The risks created by this concentration have been considered by management in the determination of the adequacy of the allowance for loan losses. Management believes the allowance for loan losses is adequate to cover estimated losses on loans at each balance sheet date.
Changes in the allowance for loan losses for the years ended December 31 were as follows:
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| (dollars in thousands) | 2010 | 2009 | 2008 | |||||||||
Balance at beginning of year |
$ |
49,461 |
| $ | 34,720 | $ | 17,381 | |||||
Provision for losses charged to operations | 132,755 | 61,741 | 27,759 | |||||||||
Loans charged off | (91,250) | (49,385) | (12,425) | |||||||||
Recoveries on loans previously charged off | 2,721 | 2,385 | 2,005 | |||||||||
Balance at end of year | $ | 93,687 | $ | 49,461 | $ | 34,720 | ||||||
The allowance for loan losses, as a percentage of loans held for investment, amounted to 7.18% at December 31, 2010 compared to 3.16% at December 31, 2009.
The credit quality indicator presented for all classes within the loan portfolio is a widely-used and standard system representing the degree of risk of nonpayment. The risk-grade categories presented in the following table are:
Pass - Loans categorized as Pass are higher quality loans that have adequate sources of repayment and little risk of collection.
Special Mention - A Special Mention loan has potential weaknesses that deserve managements 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 loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard - A Substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified 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. Loss potential, while existing in the aggregate amount of Substandard loans, does not have to exist in individual assets classified Substandard.
Doubtful - An loan classified as 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. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors, which may work to the advantage of strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.
Loans categorized as Special Mention are considered Criticized. Loans categorized as Substandard or Doubtful are considered Classified.
The following table presents loan and lease balances by credit quality indicator as of December 31, 2010:
| (dollars in thousands) | Nonclassified/ Pass (Ratings 1-5) | Special Mention (Rating 6) | Substandard (Rating 7) | Doubtful (Rating 8) | Total | |||||||||||||||
Commercial and agricultural | $ | 71,325 | $ | 6,375 | $ | 10,882 | $ | 5,165 | $ | 93,747 | ||||||||||
Real estate - construction | 76,317 | 46,596 | 111,365 | 42,698 | 276,976 | |||||||||||||||
Real estate - mortgage: | ||||||||||||||||||||
1-4 family residential | 324,369 | 18,398 | 34,662 | 11,430 | 388,859 | |||||||||||||||
Commercial | 283,557 | 59,439 | 84,666 | 67,199 | 494,861 | |||||||||||||||
Consumer | 48,620 | - | 609 | 303 | 49,532 | |||||||||||||||
Total | $ | 804,188 | $ | 130,808 | $ | 242,184 | $ | 126,795 | $ | 1,303,975 | ||||||||||
The following table presents ALLL activity by portfolio segment for the year ended December 31, 2010:
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| Real Estate - Mortgage | ||||||||||||||||||||||||
| (dollars in thousands) | Commercial and Agriculture | Real Estate - Construction | 1-4 Family Residential | Commercial | Consumer | Total | ||||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||||||
Beginning balance at January 1, 2010 | $ | 3,543 | $ | 23,932 | $ | 8,311 | $ | 12,729 | $ | 946 | $ | 49,461 | ||||||||||||
Charge-offs | (9,832) | (53,374) | (9,060) | (15,418) | (3,566) | (91,250) | ||||||||||||||||||
Recoveries | 585 | 52 | 178 | 271 | 1,635 | 2,721 | ||||||||||||||||||
Provision | 16,848 | 76,182 | 8,313 | 29,269 | 2,143 | 132,755 | ||||||||||||||||||
Ending balance at December 31, 2010 | $ | 11,144 | $ | 46,792 | $ | 7,742 | $ | 26,851 | $ | 1,158 | $ | 93,687 | ||||||||||||
Portion of ending balance: | ||||||||||||||||||||||||
Individually evaluated for impairment | $ | 7,451 | $ | 35,280 | $ | 5,448 | $ | 22,709 | $ | - | $ | 70,888 | ||||||||||||
Collectively evaluated for impairment | 3,693 | 11,512 | 2,294 | 4,142 | 1,158 | 22,799 | ||||||||||||||||||
Total ALLL evaluated for impairment | $ | 11,144 | $ | 46,792 | $ | 7,742 | $ | 26,851 | $ | 1,158 | $ | 93,687 | ||||||||||||
Loans held for investment: | ||||||||||||||||||||||||
Ending balance at December 31, 2010 | $ | 93,747 | $ | 276,976 | $ | 388,859 | $ | 494,861 | $ | 49,532 | $ | 1,303,975 | ||||||||||||
Portion of ending balance: | ||||||||||||||||||||||||
Individually evaluated for impairment | $ | 14,176 | $ | 152,465 | $ | 41,109 | $ | 132,537 | $ | 188 | $ | 340,475 | ||||||||||||
Collectively evaluated for impairment | 79,571 | 124,511 | 347,750 | 362,324 | 49,344 | 963,500 | ||||||||||||||||||
Total loans evaluated for impairment | $ | 93,747 | $ | 276,976 | $ | 388,859 | $ | 494,861 | $ | 49,532 | $ | 1,303,975 | ||||||||||||
The following table presents loans and leases on nonaccrual status by loan class at December 31, 2010:
| (dollars in thousands) | ||||
Commercial and agricultural | $ | 13,274 | ||
Real estate - construction | 144,605 | |||
Real estate - mortgage: | ||||
1-4 family residential | 34,994 | |||
Commercial | 131,866 | |||
Consumer | 329 | |||
Total | $ | 325,068 | ||
The following table presents an aging analysis of loans and leases as of December 31, 2010:
| 90 or More Days Past Due and Accruing | ||||||||||||||||||||||||||||
| (dollars in thousands) | Past Due | |||||||||||||||||||||||||||
| 30-59 Days | 60-89 Days | 90 or More Days | Total | Current | Total Loans | |||||||||||||||||||||||
Commercial and agricultural | $ | 1,610 | $ | 3,622 | $ | 5,186 | $ | 10,418 | $ | 83,329 | $ | 93,747 | $ | 48 | ||||||||||||||
Real estate - construction | 21,687 | 10,532 | 98,099 | 130,318 | 146,658 | 276,976 | 212 | |||||||||||||||||||||
Real estate - mortgage: | ||||||||||||||||||||||||||||
1-4 family residential | 11,199 | 7,016 | 22,505 | 40,720 | 348,139 | 388,859 | 4,167 | |||||||||||||||||||||
Commercial | 9,798 | 12,430 | 74,271 | 96,499 | 398,362 | 494,861 | 380 | |||||||||||||||||||||
Consumer | 199 | 44 | 160 | 403 | 49,129 | 49,532 | 11 | |||||||||||||||||||||
Total | $ | 44,493 | $ | 33,644 | $ | 200,221 | $ | 278,358 | $ | 1,025,617 | $ | 1,303,975 | $ | 4,818 | ||||||||||||||
The following table presents impaired loan information as of December 31, 2010:
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(dollars in thousands)
| Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | ||||||||||||
With no related allowance recorded: | ||||||||||||||||
Commercial and agricultural | $ | 4,530 | $ | 6,108 | $ | - | $ | 5,970 | ||||||||
Real estate - construction | 56,638 | 73,579 | - | 74,440 | ||||||||||||
Real estate - mortgage: | ||||||||||||||||
1-4 family residential | 26,737 | 29,173 | - | 29,720 | ||||||||||||
Commercial | 45,042 | 52,565 | - | 54,674 | ||||||||||||
Consumer | 205 | 207 | - | 192 | ||||||||||||
With an allowance recorded: | ||||||||||||||||
Commercial and agricultural | $ | 9,707 | $ | 11,054 | $ | 7,451 | $ | 8,228 | ||||||||
Real estate - construction | 95,890 | 112,858 | 35,281 | 86,329 | ||||||||||||
Real estate - mortgage: | ||||||||||||||||
1-4 family residential | 14,727 | 15,855 | 5,448 | 11,563 | ||||||||||||
Commercial | 87,716 | 96,436 | 22,708 | 84,015 | ||||||||||||
Consumer | - | - | - | - | ||||||||||||
Total: | ||||||||||||||||
Commercial and agricultural | $ | 14,237 | $ | 17,162 | $ | 7,451 | $ | 14,198 | ||||||||
Real estate - construction | 152,528 | 186,437 | 35,281 | 160,769 | ||||||||||||
Real estate - mortgage: | ||||||||||||||||
1-4 family residential | 41,464 | 45,028 | 5,448 | 41,283 | ||||||||||||
Commercial | 132,758 | 149,001 | 22,708 | 138,689 | ||||||||||||
Consumer | 205 | 207 | - | 192 | ||||||||||||
Interest income recognized after the above loans became impaired was immaterial as of December 31, 2010.
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Note 9 – Premises and Equipment
Premises and equipment at December 31 is summarized as follows:
| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||
Land | $ | 11,675 | $ | 11,675 | ||||
Building and improvements | 37,572 | 37,476 | ||||||
Furniture and equipment | 31,342 | 31,247 | ||||||
Leasehold improvements | 1,655 | 1,655 | ||||||
Premises and equipment, gross | 82,244 | 82,053 | ||||||
Accumulated depreciation and amortization | (37,146) | (33,938) | ||||||
Premises and equipment, net | $ | 45,098 | $ | 48,115 | ||||
Depreciation and amortization expense totaled $3.7 million, $3.7 million, and $3.5 million for the years ended December 31, 2010, 2009 and 2008, respectively.
Note 10 – Other Real Estate Owned and Property Acquired in Settlement of Loans
The following table summarizes real estate acquired in settlement of loans and personal property acquired in settlement of loans, the latter of which is included within the other assets financial statement line item on the Consolidated Balance Sheet at the dates indicated.
| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||
Real estate acquired in settlement of loans | $ | 62,226 | $ | 35,170 | ||||
Personal property acquired in settlement of loans | 138 | 68 | ||||||
Total property acquired in settlement of loans | $ | 62,364 | $ | 35,238 | ||||
The following table summarizes the changes in real estate acquired in settlement of loans at the dates and for the periods indicated.
| (dollars in thousands) | For Years Ended December 31, | |||||||
| 2010 | 2009 | |||||||
Real estate acquired in settlement of loans, beginning of period | $ | 35,170 | $ | 6,806 | ||||
Plus: New real estate acquired in settlement of loans | 47,976 | 35,089 | ||||||
Less: Sales of real estate acquired in settlement of loans | (10,981) | (4,954) | ||||||
Less: Write-downs and net loss on sales charged to expense | (9,939) | (1,771) | ||||||
Real estate acquired in settlement of loans, end of period | $ | 62,226 | $ | 35,170 | ||||
During 2010, the Bank received proceeds of $11.0 million in total sales of property acquired in settlement of loans. This compares to prior year sales for the same period in the amount of $5.0 million. At December 31, 2010, four assets with a net carrying amount of $840,000 were under contract for sale and are expected to close in the first quarter of 2011.
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Note 11 – Other Assets and Other Liabilities
Other assets and other liabilities at December 31 are summarized as follows:
| 00000000 | 00000000 | |||||||
| (dollars in thousands) | December 31, | |||||||
| 2010 | 2009 | |||||||
Other Assets: | ||||||||
Interest receivable | $ | 5,747 | $ | 8,071 | ||||
Accounts receivable | 6,855 | 514 | ||||||
Prepaid FDIC assessment | 3,973 | 9,654 | ||||||
Prepaid expenses | 3,369 | 1,349 | ||||||
Small Business Investments (SBIC) | 2,485 | 2,485 | ||||||
Mortgage servicing rights | 2,359 | 4,856 | ||||||
Deferred taxes | 1,113 | 8,481 | ||||||
Other earning assets | 15,262 | 18,235 | ||||||
Other assets | 4,449 | 2,849 | ||||||
Total other assets | $ | 45,612 | $ | 56,494 | ||||
Other Liabilities: | ||||||||
Interest payable | $ | 2,592 | $ | 2,474 | ||||
Accrued expenses | 10,923 | 11,906 | ||||||
Other liabilities | 2,986 | 4,970 | ||||||
Total other liabilities | $ | 16,501 | $ | 19,350 | ||||
Note 12 – Commitments
In the ordinary course of operations, the Company and the Bank are party to various legal proceedings. Neither the Company nor the Bank is involved in, nor have they terminated during 2010, any pending legal proceedings other than routine, nonmaterial proceedings occurring in the ordinary course of business.
The Company leases certain facilities and equipment for use in its business. The lease for facilities generally runs for periods of 10 to 20 years with various renewal options, while leases for equipment generally have terms not in excess of 5 years. The majority of the leases for facilities contain rental escalation clauses tied to changes in price indices. Certain real property leases contain purchase options. Management expects that most leases will be renewed or replaced with new leases in the normal course of business.
Future obligations at December 31, 2010 for minimum rentals under non-cancelable operating lease commitments, primarily relating to premises, are as follows:
| 0000000 | ||||
| (dollars in thousands) | ||||
| Year ending December 31, | ||||
2011 | $ | 1,419 | ||
2012 | 1,090 | |||
2013 | 1,044 | |||
2014 | 988 | |||
2015 | 915 | |||
Thereafter | 10,100 | |||
Total lease commitments | $ | 15,556 | ||
Net rental expense for all operating leases amounted to $1,665,000, $1,612,000, and $1,530,000 for the years ended December 31, 2010, 2009 and 2008, respectively.
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Note 13 – Income Taxes
The components of income tax expense for the years ended December 31 are as follows:
| 000000 | 000000 | 000000 | ||||||||||
| (dollars in thousands) | 2010 | 2009 | 2008 | |||||||||
Current: | ||||||||||||
Federal | $ | 65 | $ | (6,067) | $ | 1,695 | ||||||
State | - | 32 | 243 | |||||||||
Total current taxes | 65 | (6,035) | 1,938 | |||||||||
Deferred | ||||||||||||
Federal | (43,326) | (9,366) | (4,160) | |||||||||
State | (8,870) | (2,952) | (896) | |||||||||
Total deferred taxes | (52,196) | (12,318) | (5,056) | |||||||||
Increase in valuation allowance | 53,390 | 22,345 | - | |||||||||
Total income taxes | $ | 1,259 | $ | 3,992 | $ | (3,118) | ||||||
A reconciliation of income tax expense computed at the statutory federal income tax rate to actual income tax expense is presented in the following table as of December 31:
| 000000 | 000000 | 000000 | ||||||||||
| (dollars in thousands) | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Amount of tax computed using Federal statutory tax rate of 35% in 2010, 2009 and 2008 | $ | (45,698) | $ | (34,196) | $ | (22,024) | ||||||
Increases/(decreases) resulting from effects of: | ||||||||||||
Non-taxable income | (481) | (648) | (740) | |||||||||
State income taxes, net of federal benefit | (5,766) | (1,927) | (425) | |||||||||
Goodwill impairment | - | 18,338 | 20,230 | |||||||||
Valuation allowance on deferred tax assets | 53,390 | 22,345 | - | |||||||||
Other | (186) | 80 | (159) | |||||||||
Total income tax (benefit)/expense | $ | 1,259 | $ | 3,992 | $ | (3,118) | ||||||
Deferred taxes are provided using the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Excluding unrealized losses on available-for-sale securities, the Company has recorded a 100% deferred tax valuation allowance related to various temporary differences, principally consisting of the provision for loan losses and its net operating loss carryforwards.
As of December 31, 2010 and December 31, 2009, net deferred income tax assets totaling $0.9 million and $0.4 million, respectively, are recorded on the Company’s balance sheet. No valuation allowance is recorded for unrealized losses on investment securities because it is not more likely than not that the Company will have to sell these securities at a loss.
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The components of deferred tax assets and liabilities and the tax effect of each are as follows:
| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||
Deferred tax assets: | ||||||||
Allowance for loan losses | $ | 37,388 | $ | 19,833 | ||||
Net operating loss | 36,902 | 7,316 | ||||||
Compensation and benefit plans | 2,102 | 2,192 | ||||||
Fair value basis of loans | - | 356 | ||||||
Pension and other post-retirement benefits | 1,451 | 1,878 | ||||||
Interest rate swap | - | 134 | ||||||
Other real estate owned | 3,815 | - | ||||||
Net unrealized securities losses | 343 | - | ||||||
Other | 701 | 877 | ||||||
Subtotal deferred tax assets | 82,702 | 32,586 | ||||||
Less: Valuation allowance | (75,735) | (22,345) | ||||||
Total deferred tax assets | 6,967 | 10,241 | ||||||
Deferred tax liabilities: | ||||||||
Core deposit intangible | 1,648 | 1,962 | ||||||
Mortgage servicing rights | 931 | 1,918 | ||||||
Depreciable basis of premises and equipment | 1,251 | 1,490 | ||||||
Net deferred loan fees and costs | 898 | 969 | ||||||
Net unrealized securities gains | - | 1,869 | ||||||
SAB 109 valuation | 265 | 512 | ||||||
Other | 1,049 | 1,074 | ||||||
Total deferred tax liabilities | 6,042 | 9,794 | ||||||
Net deferred tax assets | $ | 925 | $ | 447 | ||||
Changes in net deferred tax asset were as follows:
| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||
Balance at beginning of year | $ | 447 | $ | 12,597 | ||||
Income tax effect from change in unrealized gains on available-for-sale securities | 2,212 | (2,299) | ||||||
Employee benefit plan | (427) | 43 | ||||||
Deferred income tax benefit on continuing operations | 52,083 | 12,451 | ||||||
Valuation allowance on deferred tax assets | (53,390) | (22,345) | ||||||
Balance at end of period | $ | 925 | $ | 447 | ||||
Under accounting principles generally accepted in the United States of America, the Company is not required to provide a deferred tax liability for the tax effect of additions to the tax bad debt reserve through 1987, the base year. Retained earnings at December 31, 2010 include approximately $2.7 million for which no provision for federal income tax has been made. These amounts represent allocations of income to bad debt deductions for tax purposes only. Reductions of such amounts for purposes other than bad debt losses could create income for tax purposes in certain remote instances, which would then be subject to the then current corporate income tax rate.
Note 14 – Deposits
Traditional deposit accounts have historically been the primary source of funds for the Company and a competitive strength of the Company. Traditional deposit accounts also provide a customer base for the sale of additional financial products and services and fee income through service charges. The Company sets targets for growth in deposit accounts annually in an effort to increase the number of products per banking relationship. Deposits are attractive sources of funding because of their stability and generally low cost as compared with other funding sources.
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The following table summarizes deposit composition at the dates indicated.
| (dollars in thousands) | December 31, 2010 | December 31, 2009 | ||||||
Noninterest-bearing demand deposits | $ | 148,933 | $ | 152,522 | ||||
Interest-bearing demand deposits | 230,084 | 226,696 | ||||||
Savings deposits | 43,724 | 40,723 | ||||||
Money market deposits | 312,007 | 326,958 | ||||||
Brokered deposits | 140,151 | 112,340 | ||||||
Time deposits less than $100,000 | 416,098 | 437,031 | ||||||
Time deposits $100,000 or more | 405,393 | 425,858 | ||||||
Total deposits | $ | 1,696,390 | $ | 1,722,128 | ||||
The aggregate amount of jumbo certificates of deposit, which include brokered deposits and have minimum denominations of $100,000, was approximately $544.7 million and $503.4 million in 2010 and 2009, respectively.
At December 31, 2010, $0.3 million of overdrawn transaction deposit accounts were reclassified to loans, compared with $0.3 million at December 31, 2009.
The accompanying table presents the scheduled maturities of time deposits at December 31, 2010.
| (dollars in thousands) | ||||
Year ending December 31, | ||||
2011 | $ | 544,019 | ||
2012 | 246,984 | |||
2013 | 119,000 | |||
2014 | 24,133 | |||
2015 | 27,440 | |||
Thereafter | 66 | |||
Total time deposits | $ | 961,642 | ||
Interest expense on time deposits of $100,000 or more amounted to $9.5 million in 2010, $11.3 million in 2009 and $15.5 million in 2008.
As a result of being “significantly undercapitalized” at December 31, 2010, under the capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank’s capital levels do not allow the Bank to increase or renew brokered deposits balances, including all Certificate of Deposit Account Registry Service (“CDARS”), without prior approval from regulators. Regulatory limitations on the ability to accept brokered deposits will also limit the Company’s deposit funding options. Based on its existing capital ratios, the Bank could be subject to limitations on the maximum interest rates it can pay on deposit accounts and certain restrictions on brokered deposits. However, on August 2, 2010 the Bank was notified by the FDIC that the geographic areas in which the Bank operates are considered high-rate areas. Accordingly, the Bank is able to offer interest rates on deposits up to 75 basis points over the prevailing interest rates in its geographic areas.
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Note 15 – Short-Term Borrowings and Long-Term Debt
The following table stratifies the Company’s borrowings as short-term and long-term as of December 31, 2010 and 2009:
| December 31, | ||||||||||||||||
| (dollars in thousands) | 2010 | 2009 | ||||||||||||||
| Balance | Rate | Balance | Rate | |||||||||||||
SHORT-TERM DEBT | ||||||||||||||||
Retail customer repurchase agreements | $ | 9,628 | 0.78 | % | $ | 13,592 | 0.70 | % | ||||||||
Federal funds purchased | - | - | 10,000 | 0.25 | ||||||||||||
Total short-term borrowings | $ | 9,628 | $ | 23,592 | ||||||||||||
LONG-TERM DEBT | ||||||||||||||||
Federal Home Loan Bank advances | $ | 144,485 | 2.56 | % | $ | 166,165 | 3.19 | % | ||||||||
Subordinated debt | 7,500 | 3.79 | 15,000 | 3.75 | ||||||||||||
Junior subordinated debt | 56,702 | 1.83 | 56,702 | 1.77 | ||||||||||||
Total long-term debt | $ | 208,687 | $ | 237,867 | ||||||||||||
Retail Repurchase Agreements and Federal Funds Purchased
Funds are borrowed on an overnight basis through retail repurchase agreements with bank customers and federal funds purchased from other financial institutions. Retail repurchase agreement borrowings are collateralized by securities of the U.S. Treasury and U.S. Government agencies and corporations.
At December 31, 2010, the Bank had no line of credit at the Federal Reserve Bank.
Information concerning retail repurchase agreements and federal funds purchased is as follows:
| (dollars in thousands) | 2010 | 2009 | 2008 | |||||||||||||||||||||
| Retail Repurchase Agreements | Federal Funds Purchased | Retail Repurchase Agreements | Federal Funds Purchased | Retail Repurchase Agreements | Federal Funds Purchased | |||||||||||||||||||
Balance at December 31 | $ | 9,628 | $ | - | $ | 13,592 | $ | 10,000 | $ | 18,145 | $ | 37,000 | ||||||||||||
Average balance during the year | 13,355 | 1,537 | 18,737 | 58,609 | 29,954 | 21,310 | ||||||||||||||||||
Maximum month end balance | 16,424 | 15,000 | 22,693 | 90,000 | 35,815 | 62,400 | ||||||||||||||||||
Weighted average interest rate: | ||||||||||||||||||||||||
At December 31 | 0.78 | % | - | % | 0.70 | % | 0.25 | % | 0.63 | % | 0.47 | % | ||||||||||||
During the year | 0.73 | 0.26 | 0.68 | 0.27 | 2.17 | 2.35 | ||||||||||||||||||
Federal Home Loan Bank (“FHLB”) Advances
The Bank had no line of credit with the FHLB at December 31, 2010. However, at December 31, 2010, current outstanding FHLB advances under the discontinued line amounted to $144.5 million and were at interest rates ranging from 0.27% to 6.15%. These borrowings were secured by delivered collateral on qualifying mortgage loans and, as required, by other qualifying collateral. At December 31, 2009, FHLB advances amounted to $166.2 million and were at interest rates ranging from 0.36% to 6.15%.
At December 31, 2010, the scheduled maturities of FHLB advances payable over the next five years and thereafter, certain of which are callable at the option of the FHLB before scheduled maturity, are as follows:
| (dollars in thousands) | ||||
| Year ending December 31, | ||||
2011 | $ | 25,000 | ||
2012 | 15,000 | |||
2013 | 20,320 | |||
2014 | 15,304 | |||
2015 | 18,452 | |||
2016 and thereafter | 50,409 | |||
Total FHLB advances | $ | 144,485 | ||
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Long-term debt at December 31, 2010 and 2009 consisted of the following advances from the FHLB:
| (dollars in thousands) | ||||||||||
| December 31, | ||||||||||
| Maturity | Interest Rate | 2010 | 2009 | |||||||
August 23, 2011 | 0.2700 % | $ | 25,000 | $ | - | |||||
September 4, 2012 | 3.2600 % | 15,000 | 15,000 | |||||||
January 7, 2013 | 3.9000 % | 10,000 | 10,000 | |||||||
January 7, 2013 | 2.3250 % | 224 | - | |||||||
March 4, 2013 | 3.4275 % | 10,000 | 10,000 | |||||||
March 4, 2013 | 1.7484 % | 96 | (50) | |||||||
March 17, 2014 | 2.9850 % | 10,000 | 10,000 | |||||||
March 17, 2014 | 0.8919 % | 304 | (63) | |||||||
December 29, 2014 | 3.3125 % | 5,000 | 5,000 | |||||||
January 22, 2015 | 3.7810 % | 15,000 | 15,000 | |||||||
January 22, 2015 | 1.3184 % | 452 | (167) | |||||||
September 8, 2015 | 3.7100 % | 3,000 | 3,000 | |||||||
March 19, 2018 | 2.8100 % | 10,000 | 10,000 | |||||||
July 16, 2018 | 2.4300 % | 20,000 | 20,000 | |||||||
July 18, 2018 | 2.3300 % | 20,000 | 20,000 | |||||||
August 27, 2018 | 6.1500 % | 409 | 445 | |||||||
Advances repaid in 2010 | - | - | 48,000 | |||||||
| $ | 144,485 | $ | 166,165 | |||||||
Subordinated Debt
On December 30, 2010, the Bank entered into and consummated a conversion agreement with SunTrust Bank, pursuant to which $7.5 million of the outstanding principal amount of the $15.0 million subordinated term loan from SunTrust to the Bank issued on June 30, 2008 was converted into 7.5 million shares of nonvoting, nonconvertible, nonredeemable cumulative preferred stock, par value $1.00 per share, of the Bank. The Bank amended its articles of association to authorize the preferred stock issued to SunTrust in the conversion. The preferred stock carries an 8.0% dividend rate and is includable in the Bank’s Tier 2 capital for regulatory capital purposes.
The remaining $7.5 million of subordinated debt owed by the Bank to SunTrust was ratified and confirmed but the interest rate was changed from LIBOR plus 3.5% to a fixed rate of 8.0% per annum, commencing January 1, 2011. Immediately prior to the conversion, the Bank paid the interest accrued and unpaid to December 30, 2010 on the subordinated debt. See Note 26“Subsequent Events” for further discussion of the SunTrust agreement.
Junior Subordinated Deferrable Interest Debentures
FNB United has Junior Subordinated Deferrable Interest Debentures (“Junior Subordinated Debentures”) outstanding. Two issues of Junior Subordinated Debentures resulted from funds invested from the sale of trust preferred securities by FNB United Statutory Trust I (“FNB Trust I”) and by FNB United Statutory Trust II (“FNB Trust II”), which are owned by FNB United. Two additional issues of Junior Subordinated Debentures were acquired on April 28, 2006 as a result of the merger with Integrity Financial Corporation. These acquired issues resulted from funds invested from the sale of trust preferred securities by Catawba Valley Capital Trust I (“Catawba Trust I”) and by Catawba Valley Capital Trust II (“Catawba Trust II”), which were owned by Integrity and acquired by FNB United in the merger. FNB United initiated the redemption of the securities issued by Catawba Valley Trust I as of December 30, 2007 and that trust was subsequently dissolved.
FNB United fully and unconditionally guarantees the preferred securities issued by each trust through the combined operation of the debentures and other related documents. Obligations under these guarantees are unsecured and subordinate to senior and subordinated indebtedness of the Company. The preferred securities qualify as Tier 1 and Tier 2 capital for regulatory capital purposes.
During the second quarter of 2010, the Company suspended payment of interest on junior subordinated debt for liquidity purposes. The associated interest expense on junior subordinated debt has been fully accrued and is included in the Consolidated Statements of Loss.
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Information concerning the Junior Subordinated Debentures at December 31, 2010 and 2009 is as follows:
| (dollars in thousands) | Commencement | |||||||||||||||||||
| Stated | of Early | Principal Amount | ||||||||||||||||||
| Maturity | Redemption | As of December 31, | ||||||||||||||||||
| Issuer | Date | Period | 2010 | 2009 | Interest Rate | |||||||||||||||
FNB Trust I | 12/15/35 | 12/15/10 | $ | 20,619 | $ | 20,619 | 3 month LIBOR + 1.37% = 1.671560% at 12/31/10 | |||||||||||||
FNB Trust II | 06/30/36 | 06/30/11 | 30,928 | 30,928 | 3 month LIBOR + 1.32% = 1.622810% at 12/31/10 | |||||||||||||||
Catawba Trust II | 12/30/32 | 12/30/07
|
| 5,155
|
|
| 5,155
|
| 3 month LIBOR + 3.35% = 3.652810% at 12/31/10
| |||||||||||
Total Junior Subordinated Debentures | $ | 56,702 | $ | 56,702 | ||||||||||||||||
Note 16 – Employee Benefit Plans
Pension Plan
The Company has a noncontributory defined benefit pension plan covering substantially all full-time employees who qualify as to age and length of service. Benefits are based on the employee’s compensation, years of service and age at retirement. The Company’s funding policy is to contribute annually to the plan an amount which is not less than the minimum amount required by the Employee Retirement Income Security Act of 1974 and not more than the maximum amount deductible for income tax purposes.
In September 2006, the Board of Directors of the Company approved a modified freeze to the pension plan. Effective December 31, 2006, no new employees are eligible to enter the plan. Participants who were at least age 40, had earned 10 years of vesting service as an employee of the Company and remained an active employee as of December 31, 2006 qualified for a grandfathering provision. Under the grandfathering provision, the participant will continue to accrue benefits under the plan through December 31, 2011. However, in November 2010, the Board of Directors of the Company approved an additional amendment to the plan which ceases participant benefit accruals as of December 31, 2010.
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The following table sets forth the plan’s change in benefit obligation, plan assets and the funded status of the pension plan, using a December 31 measurement date, and amounts recognized in the consolidated statements as of December 31:
| (dollars in thousands) | ||||||||
| 2010 | 2009 | |||||||
Change in Benefit Obligation | ||||||||
Benefit obligation at beginning of year | $ | 11,700 | $ | 10,868 | ||||
Service cost | 181 | 199 | ||||||
Interest cost | 687 | 675 | ||||||
Net actuarial loss | 495 | 470 | ||||||
Benefits paid | (534) | (512) | ||||||
Benefit obligation at end of year | $ | 12,529 | $ | 11,700 | ||||
Change in Plan Assets | ||||||||
Fair value of plan assets at beginning of year | $ | 7,445 | $ | 7,168 | ||||
Actual return on plan assets | 985 | 157 | ||||||
Employer contributions | 800 | 632 | ||||||
Benefits paid | (534) | (512) | ||||||
Fair value of plan assets at December 31 | $ | 8,696 | $ | 7,445 | ||||
Funded Status at End of Year | $ | (3,833) | $ | (4,255) | ||||
Amounts Recognized in the Consolidated Balance Sheets | ||||||||
Other Assets | $ | - | $ | - | ||||
Other Liabilities | (3,833) | (4,255) | ||||||
Total liabilities recognized in consolidated balance sheets | $ | (3,833) | $ | (4,255) | ||||
Amounts Recognized in Accumulated Other Comprehensive Income | ||||||||
Net actuarial loss | $ | 5,392 | $ | 5,654 | ||||
Prior service credit | - | 1 | ||||||
Net amount recognized | $ | 5,392 | $ | 5,655 | ||||
Weighted-Average Allocation of Plan Assets at End of Year | ||||||||
Equity securities | 62 | % | 48 | % | ||||
Debt securities | 35 | 47 | ||||||
Cash and cash equivalents | 1 | 3 | ||||||
Fixed income funds | 2 | 2 | ||||||
Total | 100 | % | 100 | % | ||||
Weighted-Average Plan Assumptions at End of Year | ||||||||
Discount rate | 5.60 | % | 6.00 | % | ||||
Expected long-term rate of return on plan assets | 8.00 | % | 8.00 | % | ||||
Rate of increase in compensation levels | 5.50 | % | 5.50 | % | ||||
The expected long-term rate of return on plan assets considers the portfolio as a whole and not on the sum of the returns on individual asset categories. The return is based exclusively on historical returns, without adjustments.
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Components of net periodic pension cost/(income) and other amounts recognized in other comprehensive income are as follows:
| (dollars in thousands) | 2010 | 2009 | 2008 | |||||||||
Net Periodic Pension Cost/(Income) | ||||||||||||
Service cost | $ | 181 | $ | 199 | $ | 212 | ||||||
Interest cost | 687 | 675 | 665 | |||||||||
Expected return on plan assets | (595) | (553) | (838) | |||||||||
Amortization of prior service cost | 1 | 4 | 4 | |||||||||
Amortization of net actuarial loss | 367 | 307 | 11 | |||||||||
Total pension cost | $ | 641 | $ | 632 | $ | 54 | ||||||
Other Changes in Plan Assets and Benefit Obligations | ||||||||||||
Recognized in Other Comprehensive Income: | ||||||||||||
Net actuarial (gain)/loss | $ | (262) | $ | 558 | $ | 3,910 | ||||||
Amortization of prior service credit | (1) | (4) | (4) | |||||||||
Total recognized in other comprehensive loss | (263) | 554 | 3,906 | |||||||||
Total Recognized in Net Periodic Pension Cost and Other Comprehensive Loss | $ | 378 | $ | 1,186 | $ | 3,960 | ||||||
The estimated net loss and prior service cost that will be amortized from accumulated other comprehensive loss into net periodic pension cost over the next year are approximately $340,000 and $0 respectively.
The Company’s investment policies and strategies for the pension plan use a target allocation of 50% to 60% for equity securities and 40% to 50% for debt securities. The investment goals attempt to maximize returns while remaining within specific risk management policies. While the risk management policies permit investment in specific debt and equity securities, a significant percentage of total plan assets is maintained in mutual funds, approximately 14.6% at December 31, 2010, to assist in investment diversification. Generally the investments are readily marketable and can be sold to fund benefit payment obligations as they become payable.
The following table provides the fair values of investments held in the pension plan by major asset category:
| December 31, 2010 | Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | |||||||||
(dollars in thousands)
| ||||||||||||
Equity securities | $ | 5,378 | $ | 5,378 | $ | - | ||||||
Debt securities | 3,239 | - | 3,239 | |||||||||
Other | 79 | - | 79 | |||||||||
Total fair value of pension assets | $ | 8,696 | $ | 5,378 | $ | 3,318 | ||||||
| December 31, 2009 | Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | |||||||||
(dollars in thousands)
| ||||||||||||
Equity securities | $ | 3,559 | $ | 3,559 | $ | - | ||||||
Debt securities | 3,643 | - | 3,643 | |||||||||
Other | 243 | - | 243 | |||||||||
Total fair value of pension assets | $ | 7,445 | $ | 3,559 | $ | 3,886 | ||||||
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The equity securities measured at fair value consist primarily of stock mutual funds (Level 1 inputs) and common and collective trust funds (Level 2 inputs). Debt securities include corporate bonds and bond mutual funds (Level 1 inputs), U.S. government and agency securities and obligations of state and political subdivisions (Level 2 inputs). Other investments consist of cash, money market deposits and certificates of deposit (Level 2 inputs). For further information regarding levels of input used to measure fair value, refer to Note 22.
In 2010, the Company contributed $800,000 to its pension plan. The Company expects to contribute $750,000 to its pension plan in 2011. However, the assets of the FNB United Corp. Employees Pension Plan are less in value than the present value of the accrued benefits (vested and unvested) of the participants in the Pension Plan on a termination and projected benefit obligation basis.
The estimated benefit payments for each year ending December 31 from 2011 through 2015 are as follows: $612,000 in 2011, $606,000 in 2012, $629,000 in 2013, $689,000 in 2014 and $695,000 in 2015. The estimated benefit payments to be paid in the aggregate for the five year period from 2016 through 2020 are $4,014,000. The estimated benefit payments are based on the same assumptions used to measure the benefit obligation at December 31, 2010 and include estimated future employee service.
Supplemental Executive Retirement Plan
The Company has a noncontributory, nonqualified supplemental executive retirement plan (the “SERP”) covering certain executive employees. Annual benefits payable under the SERP are based on factors similar to those for the pension plan, with offsets related to amounts payable under the pension plan and social security benefits. In 2010, the Board of Directors approved an amendment to the plan which stops additional benefit accrual under the SERP after December 31, 2010. This action does not impact a participant’s vested or accrued benefit in the plan.
The following table sets forth the plan’s change in benefit obligation, plan assets and the funded status of the SERP plan, using a December 31 measurement date, and amounts recognized in the consolidated statements as of December 31:
| (dollars in thousands) | ||||||||
| 2010 | 2009 | |||||||
Change in Benefit Obligation | ||||||||
Benefit obligation at beginning of year | $ | 2,909 | $ | 3,129 | ||||
Service cost | 189 | 226 | ||||||
Interest cost | 120 | 150 | ||||||
Amendments to plan | - | - | ||||||
Net actuarial gain | (658) | (466) | ||||||
Benefits paid | (503) | (130) | ||||||
Benefit obligation at end of year | $ | 2,057 | $ | 2,909 | ||||
Change in Plan Assets | ||||||||
Fair value of plan assets at beginning of year | $ | - | $ | - | ||||
Actual return on plan assets | - | - | ||||||
Employer contributions | 503 | 130 | ||||||
Benefits paid | (503) | (130) | ||||||
Fair value of plan assets at end of year | $ | - | $ | - | ||||
Funded Status at December 31 | $ | (2,057) | $ | (2,909) | ||||
Amounts Recognized in the Consolidated Balance Sheets Other Liabilities | $ | 2,057 | $ | 2,909 | ||||
Amounts Recognized in Accumulated Other Comprehensive Loss | ||||||||
Net actuarial gain | $ | (761) | $ | (140) | ||||
Prior service cost | 234 | 283 | ||||||
Net amount recognized | $ | (527) | $ | 143 | ||||
Weighted-Average Plan Assumption at End of Year: | ||||||||
Discount rate | 5.60 | % | 6.00 | % | ||||
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Components of net periodic SERP cost and other amounts recognized in other comprehensive loss are as follows:
| 0000000222 | 0000000222 | 0000000222 | ||||||||||
| (dollars in thousands) | 2010 | 2009 | 2008 | |||||||||
Net Periodic SERP Cost | ||||||||||||
Service cost | $ | 189 | $ | 226 | $ | 259 | ||||||
Interest cost | 120 | 150 | 150 | |||||||||
Expected return on plan assets | - | - | - | |||||||||
Amortization of prior service cost | 48 | 47 | 78 | |||||||||
Amortization of net actuarial (gain)/ loss | (37) | (7) | 8 | |||||||||
Net periodic SERP cost | $ | 320 | $ | 416 | $ | 495 | ||||||
Other Changes in Plan Assets and Benefit Obligations | ||||||||||||
Recognized in Other Comprehensive Income | ||||||||||||
Net actuarial (gain)/loss | $ | (621) | $ | (458) | $ | 63 | ||||||
Prior service cost | - | - | - | |||||||||
Amortization of prior service credit | (48) | (47) | (78) | |||||||||
Total recognized in other comprehensive loss | (669) | (505) | (15) | |||||||||
Total Recognized in Net Periodic SERP (Income)/Cost and | ||||||||||||
Other Comprehensive (Loss)/Income | $ | (349) | $ | (89) | $ | 480 | ||||||
The estimated net loss and prior service cost that will be amortized from accumulated other comprehensive income into net periodic SERP cost over the next year are approximately $0 and $48,000 respectively.
The SERP is an unfunded plan. Consequently, there are no plan assets or cash contribution requirements other than for the direct payment of benefits.
The estimated benefit payments for each year ending December 31 from 2011 through 2015 are as follows: $141,000 in 2011, $175,000 in 2012, $173,000 in 2013, $172,000 in 2014 and $172,000 in 2015. The estimated benefit payments to be paid in the aggregate for the five-year period from 2016 through 2020 are $510,000. The estimated benefit payments are based on the same assumptions used to measure the benefit obligation at December 31, 2010 and include estimated future employee service.
As a result of the acquisition of Integrity Financial Corporation in 2006, the Bank assumed the obligations of a non-qualifying deferred compensation plan for the former president of Integrity. Under the plan provisions, benefit payments began in 2006 and are payable for 10 years. During 2010, 2009 and 2008 provisions of $26,000, $43,000 and $2,000, respectively, were expensed for future benefits to be provided under this plan. The total liability under this plan was $392,000 at December 31, 2010 and is included in other liabilities in the accompanying consolidated balance sheets. Payments amounting to $70,000 in 2010, $60,000 in 2009 and $57,000 in 2008 were made under the provisions of the plan.
Other Postretirement Defined Benefit Plans
The Company has postretirement medical and life insurance plans covering substantially all full-time employees who qualify as to age and length of service. The medical plan is contributory, with retiree contributions adjusted whenever medical insurance rates change. The life insurance plan is noncontributory.
In conjunction with the modified freeze of the pension plan, the postretirement medical and life insurance plan was also amended. Effective December 31, 2006, no new employees are eligible to enter the plan. Participants who were at least age 40, had earned 10 years of vesting service as an employee of the Company and remained an active employee as of December 31, 2006 qualified for a grandfathering provision. Under the grandfathering provision, the participant will continue to accrue benefits under the plan through December 31, 2011. However, in November 2010, the Board of Directors of the Company approved an additional amendment to the plan which ceases participant benefit accruals as of December 31, 2010.
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The following table sets forth the plans change in benefit obligation, plan assets and the funded status of the postretirement plans, using a December 31 measurement date, and amounts recognized in the consolidated statements as of December 31:
| (dollars in thousands) | 2010 | 2009 | ||||||
Change in Benefit Obligation | ||||||||
Benefit obligation at beginning of year | $ | 1,587 | $ | 1,435 | ||||
Service cost | 18 | 22 | ||||||
Interest cost | 90 | 91 | ||||||
Net actuarial loss | 28 | 74 | ||||||
Plan participant contributions | 87 | 59 | ||||||
Benefits paid | (140) | (94) | ||||||
Benefit obligation at end of year | $ | 1,670 | $ | 1,587 | ||||
Change in Plan Assets | ||||||||
Fair value of plan assets at beginning of year | $ | - | $ | - | ||||
Actual return on plan assets | - | - | ||||||
Employer contributions | 53 | 35 | ||||||
Plan participant contributions | 87 | 59 | ||||||
Benefits paid | (140) | (94) | ||||||
Fair value of plan assets at end of year | $ | - | $ | - | ||||
Funded Status at December 31 | $ | (1,670) | $ | (1,587) | ||||
Amounts Recognized in the Consolidated Balance Sheets Other Liabilities | $ | 1,670 | $ | 1,587 | ||||
Amounts Recognized in Accumulated Other Comprehensive Loss | ||||||||
Net actuarial loss | $ | 393 | $ | 387 | ||||
Prior service credit | (29) | (33) | ||||||
Net amount recognized | $ | 364 | $ | 354 | ||||
Weighted-Average Plan Assumption at End of Year: | ||||||||
Discount rate | 5.60 | % | 6.00 | % | ||||
Increasing or decreasing the assumed medical cost trend rate by one percentage point would not have a significant effect on either the postretirement benefit obligation at December 31, 2010 or the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 2010.
Components of net postretirement benefit cost and other amounts recognized in other comprehensive income are as follows:
| (dollars in thousands) | 2010 | 2009 | 2008 | |||||||||
Net Periodic Postretirement Benefit Cost | ||||||||||||
Service cost | $ | 18 | $ | 22 | $ | 23 | ||||||
Interest cost | 90 | 91 | 86 | |||||||||
Expected return on plan assets | - | - | - | |||||||||
Amortization of prior service credit | (4) | (4) | (4) | |||||||||
Amortization of transition obligation | - | - | - | |||||||||
Amortization of net actuarial loss | 22 | 19 | 23 | |||||||||
Net periodic postretirement benefit cost | $ | 126 | $ | 128 | $ | 128 | ||||||
Other Changes in Plan Assets and Benefit Obligations | ||||||||||||
Recognized in Other Comprehensive Income | ||||||||||||
Net actuarial (gain)/loss | $ | 6 | $ | 55 | $ | 202 | ||||||
Prior service cost | - | - | - | |||||||||
Amortization of prior service cost | 4 | 4 | 4 | |||||||||
Total recognized in other comprehensive loss | 10 | 59 | 206 | |||||||||
Total Recognized in Net Periodic Postretirement Benefit | ||||||||||||
Cost and Other Comprehensive Loss | $ | 136 | $ | 187 | $ | 334 | ||||||
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The estimated net loss and prior service credit that will be amortized from accumulated other comprehensive loss into net periodic postretirement benefit cost over the next year are approximately $29,000 and $(4,000), respectively.
The postretirement medical and life insurance plans are unfunded plans. Consequently, there are no plan assets or cash contribution requirements other than for the direct payment of benefits.
The estimated benefit payments for each year ending December 31 from 2011 through 2015 are as follows: $69,000 in 2011, $76,000 in 2012, $82,000 in 2013, $86,000 in 2014 and $90,000 in 2015. The estimated benefit payments to be paid in the aggregate for the five year period from 2016 through 2020 are $504,000. The estimated benefit payments are based on the same assumptions used to measure the benefit obligation at December 31, 2010 and include estimated future employee service.
Matching Retirement/Savings Plan
The Company has a matching retirement/savings plan which permits eligible employees to make contributions to the plan up to a specified percentage of compensation as defined by the plan. A portion of the employee contributions are matched by the Company based on the plan formula. Additionally, commencing in 2007, the Company on a discretionary basis may make an annual contribution up to a specified percentage of compensation as defined by the plan to the account of each eligible employee. The Company did not make a discretionary contribution in 2009 or 2010. During 2009, the Company lowered its matching contribution from 6% to 3%. The matching and discretionary contributions amounted to $485,000 in 2010, $701,000 in 2009, and $1,161,000 in 2008.
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Note 17 – FNB United Corp. (Parent Company)
The parent company’s principal asset is its investment in its bank subsidiary, CommunityONE Bank. The principal source of income of the parent company is dividends received from the Bank.
The condensed financial position as of December 31, 2010 and 2009, and the condensed results of operations and cash flows for each of the years in the three-year period ended December 31, 2010 of FNB United Corp., parent company only, are presented below.
| (dollars in thousands) | ||||||||||||
| Condensed Balance Sheets | ||||||||||||
| 2010 | 2009 | |||||||||||
Assets: | ||||||||||||
Cash | $ | 180 | $ | 4,106 | ||||||||
Investment in wholly-owned subsidiary, the Bank | 24,755 | 149,421 | ||||||||||
Other assets | 3,361 | 2,157 | ||||||||||
Total Assets | $ | 28,296 | $ | 155,684 | ||||||||
Liabilities and shareholders’ equity: | ||||||||||||
Accrued liabilities | $ | 431 | $ | 623 | ||||||||
Borrowed funds | 56,702 | 56,702 | ||||||||||
Shareholders’ equity | (28,837) | 98,359 | ||||||||||
Total Shareholders’ Equity and Liabilities | $ | 28,296 | $ | 155,684 | ||||||||
Condensed Statements of Income | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Dividends from subsidiary | $ | - | $ | 1,200 | $ | 9,525 | ||||||
Noninterest income | 33 | 42 | 86 | |||||||||
Interest expense | (1,521) | (1,741) | (2,903) | |||||||||
Noninterest expense | (343) | (406) | (160) | |||||||||
Income before tax (benefit)/expense | (1,831) | (905) | 6,548 | |||||||||
Income tax benefit | - | (744) | (1,049) | |||||||||
(Loss)/income before equity in undistributed net income of subsidiary | (1,831) | (161) | 7,597 | |||||||||
Equity in undistributed net (loss)/income of subsidiary | (129,996) | (101,535) | (67,406) | |||||||||
Net loss | (131,827) | (101,696) | (59,809) | |||||||||
Preferred stock dividends | (3,294) | (2,871) | - | |||||||||
Net Loss to Common Shareholders | $ | (135,121) | $ | (104,567) | $ | (59,809) | ||||||
Condensed Statements of Cash Flows | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Cash flows from operating activities | ||||||||||||
Net (loss)/income | $ | (131,827) | $ | (101,696) | $ | (59,809) | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Equity in undistributed net loss/(income) of subsidiary | 129,996 | 101,535 | 67,406 | |||||||||
Other, net | (451) | 215 | (1,236) | |||||||||
Net cash (used)in/provided by operating activities | (2,282) | 54 | 6,361 | |||||||||
Cash flows from investing activities | ||||||||||||
Downstream cash investment in subsidiary | (1,000) | - | - | |||||||||
Net cash (used in) investing activities | (1,000) | - | - | |||||||||
Cash flows from financing activities | ||||||||||||
Increase in borrowed funds | - | 4,000 | - | |||||||||
Common stock issued | - | - | 2 | |||||||||
Cash dividends paid | (644) | (3,660) | (5,712) | |||||||||
Net cash provided by (used in) financing activities | (644) | 340 | (5,710) | |||||||||
Net (decrease)/increase in cash | (3,926) | 394 | 651 | |||||||||
Cash at beginning of period | 4,106 | 3,712 | 3,061 | |||||||||
Cash at end of period | $ | 180 | $ | 4,106 | $ | 3,712 | ||||||
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Note 18 – Regulatory Matters
FNB United and the Bank are required to comply with capital adequacy standards established by the Board of Governors of the Federal Reserve System. In addition, the Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory – and possible additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the accompanying table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). As of December 31, 2010, neither the Company nor the Bank meets the capital adequacy requirements to which they are subject.
As of December 31, 2010, the Bank was designated “significantly undercapitalized” under the prompt corrective action provisions established by the Federal Deposit Insurance Corporation Improvement Act. To be categorized as well-capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the accompanying table.
| Minimum Regulatory Requirement | ||||||||||||||||||||||||||||
| To Be Well Capitalized | ||||||||||||||||||||||||||||
| (dollars in thousands) | Actual | For Capital Adequacy Purposes | Under Prompt Corrective Action Provisions | Pursuant to Order | ||||||||||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | Ratio | ||||||||||||||||||||||
December 31, 2010 | ||||||||||||||||||||||||||||
Total Capital (to Risk Weighted Assets) | ||||||||||||||||||||||||||||
Consolidated | $ | (36,818) | (2.56) % | $ | 114,884 | >8.00 % | $ | N/A | ||||||||||||||||||||
Bank | 33,812 | 2.36 | 114,608 | >8.00 | 143,260 | >10.00 % | 12.00 % | |||||||||||||||||||||
Tier 1 Capital (to Risk Weighted Assets) | ||||||||||||||||||||||||||||
Consolidated | (36,818) | (2.56) | 57,442 | >4.00 | N/A | |||||||||||||||||||||||
Bank | 16,906 | 1.18 | 57,304 | >4.00 | 85,956 | >6.00 % | 9.00 % | |||||||||||||||||||||
Tier 1 Capital (to Average Assets) | ||||||||||||||||||||||||||||
Consolidated | (36,818) | (1.86) | 78,992 | >4.00 | N/A | |||||||||||||||||||||||
Bank | 16,906 | 0.86 | 78,951 | >4.00 | 98,688 | >5.00 % | 9.00 % | |||||||||||||||||||||
December 31, 2009 | ||||||||||||||||||||||||||||
Total Capital (to Risk Weighted Assets) | ||||||||||||||||||||||||||||
Consolidated | $ | 181,990 | 10.30 % | $ | 141,452 | >8.00 % | $ | N/A | ||||||||||||||||||||
Bank | 178,023 | 10.10 | 141,265 | >8.00 | 176,582 | >10.00 % | ||||||||||||||||||||||
Tier 1 Capital (to Risk Weighted Assets) | ||||||||||||||||||||||||||||
Consolidated | 121,207 | 6.90 | 70,726 | >4.00 | N/A | |||||||||||||||||||||||
Bank | 140,604 | 8.00 | 70,633 | >4.00 | 105,949 | >6.00 % | ||||||||||||||||||||||
Tier 1 Capital (to Average Assets) | ||||||||||||||||||||||||||||
Consolidated | 121,207 | 5.70 | 85,283 | >4.00 | N/A | |||||||||||||||||||||||
Bank | 140,604 | 6.60 | 85,164 | >4.00 | 106,455 | >5.00 % | ||||||||||||||||||||||
Certain regulatory requirements restrict the lending of funds by the Bank to FNB United and the amount of dividends which can be paid to FNB United. Since 2009, these regulatory requirements have prohibited the Bank from declaring dividends payable to FNB United without the approval of the OCC. The Order, described in Note 3“Regulatory Matters”further prohibits the Bank from paying dividends or making distributions to FNB United.
The Bank is required to maintain average reserve balances with the Federal Reserve Bank based on a percentage of deposits. For the reserve maintenance period in effect at December 31, 2010, the reserve requirement was $250,000.
Nasdaq
On August 2, 2010, FNB United received written notice from Nasdaq indicating that FNB United was not in compliance with Rule 5450(a)(1), the bid price rule, because the closing price per share of its common stock had been below $1.00 per share for 30 consecutive business days. In accordance with the rules of The Nasdaq Stock Market, FNB United was afforded a 180-day grace period to achieve compliance with the bid price rule. As of January 31, 2011, FNB United had not achieved compliance and submitted an application to The Nasdaq Stock
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Market to transfer the listing of its common stock to The Nasdaq Capital Market from The Nasdaq Global Select Market, where it had been listed. The application was granted effective February 3, 2011, and FNB United became eligible for an additional 180 calendar day period, or until August 1, 2011, to achieve compliance with the bid price rule. Approval to transfer to The Nasdaq Capital Market was conditioned upon FNB United’s agreeing to effect a reverse stock split during the additional 180-day period should it become necessary to do so to meet the minimum $1.00 bid price per share requirement.
Note 19 – Shareholders’ Equity
Earnings per Share (“EPS”)
Basic net loss per share, or basic earnings/(loss) per share (“EPS”), is computed by dividing net loss to common shareholders by the weighted average number of common shares outstanding for the period. For the twelve months of 2010, the Company had paid dividends of approximately $0.3 million on Series A preferred stock, in addition to the $0.7 million accretion of the discount on the preferred stock. At December 31, 2010, the Company had $2.3 million of unpaid cumulative dividends. For the twelve months of 2009, the Company has accrued or paid dividends of approximately $2.3 million on Series A preferred stock, which combined with the $0.6 million accretion of the discount on the preferred stock, increased the net loss to common shareholders by $2.9 million.
Diluted EPS reflects the potential dilution that could occur if the Company’s potential common stock, which consists of dilutive stock options and a common stock warrant, were issued. As required for entities with complex capital structures, a dual presentation of basic and diluted EPS is included on the face of the income statement, and a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation is provided in this note.
A reconciliation of the denominators of the basic and diluted EPS computations is as follows:
| For the year ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Basic: | ||||||||||||
Net loss to common shareholders | $ | (135,121,000) | $ | (104,567,000) | $ | (59,809,000) | ||||||
Weighted average shares outstanding | 11,423,967 | 11,416,977 | 11,407,616 | |||||||||
Net loss per share, basic | $ | (11.83) | $ | (9.16) | $ | (5.24) | ||||||
Diluted: | ||||||||||||
Net loss to common shareholders | $ | (135,121,000) | $ | (104,567,000) | $ | (59,809,000) | ||||||
Weighted average shares outstanding | 11,423,967 | 11,416,977 | 11,407,616 | |||||||||
Effect of dilutive equity-based awards | - | - | - | |||||||||
Weighted average shares outstanding and dilutive potential shares outstanding | 11,423,967 | 11,416,977 | 11,407,616 | |||||||||
Net loss per share, diluted | $ | (11.83) | $ | (9.16) | $ | (5.24) | ||||||
Due to a net loss for the twelve month periods ended December 31, 2010, 2009 and 2008, all stock options and the common stock warrant were considered antidilutive and thus are not included in this calculation. Additionally, for the periods ended December 31, 2010 and December 31, 2009, there were 2,705,088 and 2,554,639 antidilutive shares, respectively. Of the antidilutive shares, the number of shares relating to stock options were 497,945 at December 31, 2010 and 607,515 at December 31, 2009. Average antidilutive shares relating to the common stock warrant were 2,207,143 for December 31, 2010 and 1,947,123 for December 31, 2009. Because the exercise price exceeded the average market price for the periods discussed and because of the net loss, the stock options and common stock warrant were omitted from the calculation of diluted earnings per share for their respective periods. The Company did not have any common stock warrants in 2008.
Net loss for common shareholders was increased for the period ending December 31, 2010 by $3.3 million, for preferred stock dividends and $2.9 million, for the same period of 2009. Accretion on the preferred stock discount associated with the preferred stock of $719,000 and $596,000, for the periods ended December 31, 2010 and 2009, respectively. The Company did not have any preferred stock in 2008.
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Stock Based Compensation
For the years ended December 31, 2010, 2009 and 2008, the Company had five share-based compensation plans in effect. The compensation expense charged against income for those plans was $50,400, $404,700 and $726,800 respectively, and the related income tax benefit was $7,100, $85,000 and $140,000, respectively.
The Company adopted stock compensation plans in 1993 and 2003 that allow for the granting of incentive and nonqualified stock options to key employees and directors. The 2003 stock compensation plan also allows for the granting of restricted stock. Under terms of both the 1993 and 2003 plans, options are granted at prices equal to the fair market value of the common stock on the date of grant. Options become exercisable after one year in equal, cumulative installments over a five-year period. No option shall expire later than ten years from the date of grant. No further grants can be made under the 1993 stock compensation plan after March 10, 2003. Based on the stock options outstanding at December 31, 2010, a maximum of 103,320 shares of common stock has been reserved for issuance under the 1993 stock compensation plan. A maximum of 1,098,534 shares of common stock has been reserved for issuance under the 2003 stock compensation plan. At December 31 2010, there were 869,534 shares available under the 2003 plan for the granting of additional options or stock awards.
The Company assumed three stock compensation plans in its acquisition of Integrity Financial Corporation in 2006. Qualified and nonqualified stock options are outstanding under these plans for grants issued from 1997 to 2004 to key employees and directors at a price equal to fair market value on the date of grant. No additional grants will be made under these plans. Based on the stock options outstanding at December 31, 2010, a maximum of 33,422 shares of common stock has been reserved for issuance under these stock compensation plans.
The fair market value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based on a U.S. Treasury instrument with a life that is similar to the expected life of the option grant. Expected volatility is based on the historical volatility of the Company’s common stock over approximately the previous 6 years. The expected life of the options has historically been considered to be approximately 6 years. The expected dividend yield is based upon the current yield in effect at the date of grant. Forfeitures are estimated at a 3.00% rate, adjusted to 1.75% for 5-year vesting.
The weighted-average fair value per share of options granted amounted to $0.00 for 2010 and 2009, respectively, since there were no grants issued in those years and $1.48 for 2008. Fair values were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
| 2010 | 2009 | 2008 | ||||||||||
Risk-free interest rate | - | % | - | % | 3.47 | % | ||||||
Dividend yield | - | - | 4.16 | |||||||||
Volatility | - | - | 24.00 | |||||||||
Expected life | - | - | 6 years | |||||||||
The following is a summary of stock option activity:
| For the year ended December 31, | ||||||||||||||||||||||||
| 2010 | 2009 | 2008 | ||||||||||||||||||||||
| | Weighted Average Exercise | | | Weighted Average Exercise | | | Weighted Average Exercise | | ||||||||||||||||
| Shares | Price | Shares | Price | Shares | Price | |||||||||||||||||||
Outstanding at beginning of year | 535,232 | $ | 17.01 | 662,612 | $ | 16.56 | 698,848 | $ | 16.11 | |||||||||||||||
Granted | - | - | - | - | 1,000 | 8.78 | ||||||||||||||||||
Exercised | - | - | - | - | (150) | 11.75 | ||||||||||||||||||
Forfeited/expired | (169,490) | 13.63 | (127,380) | 15.15 | (37,086) | 15.63 | ||||||||||||||||||
Outstanding at end of year | 365,742 | 18.57 | 535,232 | 17.01 | 662,612 | 16.65 | ||||||||||||||||||
Options exercisable at end of year | 359,542 | 18.63 | 525,432 | 17.05 | 615,703 | 16.56 | ||||||||||||||||||
Aggregate intrinsic value at end of year (in thousands): | ||||||||||||||||||||||||
Options outstanding | - | - | - | |||||||||||||||||||||
Options exercisable | - | - | - | |||||||||||||||||||||
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At December 31, 2010, information concerning stock options outstanding and exercisable is as follows:
| Options Outstanding | Options Exercisable | |||||||||||||||||
| Range of Exercise Prices | Shares | Weighted Average Remaining Contractual Life (Years) | Weighted Average Exercise Price | Number Exercisable | Weighted Average Exercise Price | |||||||||||||
| $7.51-$10.00 | 10,308 | 0.48 | $ | 9.49 | 10,308 | $ | 9.49 | |||||||||||
| $10.01-$15.00 | 27,614 | 3.73 | 13.87 | 26,314 | 13.95 | |||||||||||||
| $15.01-$20.00 | 219,820 | 2.87 | 17.92 | 214,920 | 17.96 | |||||||||||||
| $20.01-$25.00 | 107,000 | 2.84 | 21.93 | 107,000 | 21.93 | |||||||||||||
| $25.01-$26.03 | 1,000 | 2.64 | 26.03 | 1,000 | 26.03 | |||||||||||||
In 2010, 2009 and 2008 there was no intrinsic value of options exercised. The 2010, 2009 and 2008 grant-date fair value of options vested was $11,200, $171,000 and $380,000, respectively. There were no options exercised in 2010.
The following is a summary of non-vested restricted stock activity:
| For the year ended December 31, | ||||||||||||||||
| 2010 | 2009 | |||||||||||||||
| Shares | Weighted Average Grant Date Fair Value | Shares | Weighted Average Grant Date Fair Value | |||||||||||||
Non-vested at beginning of year | 10,200 | $ | 11.44 | 30,223 | $ | 16.60 | ||||||||||
Granted | - | - | 1,200 | 2.60 | ||||||||||||
Vested | (9,400) | 12.19 | (21,223 | ) | 18.29 | |||||||||||
Forfeited/Expired | - | - | - | - | ||||||||||||
Non-vested at end of year | 800 | $ | 2.60 | 10,200 | $ | 11.44 | ||||||||||
The fair value of restricted stock vested in 2010, 2009 and 2008 were $114,600, $388,000 and $238,000, respectively.
As of December 31, 2010, there was $25,600 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under all of the Company’s stock benefit plans. That cost is expected to be recognized over a weighted-average period of 1.28 years.
The Company funds the option shares and restricted stock from authorized but unissued shares. The Company does not typically purchase shares to fulfill the obligations of the stock benefit plans. Company policy does allow option holders under certain plans to exercise options with seasoned shares.
Note 20 – Off-Balance Sheet Arrangements
In the normal course of business, various commitments are outstanding that are not reflected in the consolidated financial statements. Significant commitments at December 31, 2010 are discussed below.
Commitments by the Bank to extend credit and undisbursed advances on customer lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. At December 31, 2010, total commitments to extend credit and undisbursed advances on customer lines of credit amounted to $202.7 million. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments expire without being fully drawn, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, upon extension of credit is based on the credit evaluation of the borrower.
The Bank issues standby letters of credit whereby it guarantees the performance of a customer to a third party if a specified triggering event or condition occurs. The guarantees generally expire within one year and may be automatically renewed depending on the terms of the guarantee. All standby letters of credit provide for recourse against the customer on whose behalf the letter of credit was issued, and this recourse may be further secured by a
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pledge of assets. The maximum potential amount of undiscounted future payments related to standby letters of credit was $1.9 million at December 31, 2010 and $14.9 million at December 31, 2009.
Dover originates certain residential mortgage loans with the intention of selling these loans. Between the time that Dover enters into an interest rate lock or a commitment to originate a residential mortgage loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in market prices related to these commitments. The Company believes that it is prudent to limit the variability of expected proceeds from the future sales of these loans by entering into forward sales commitments and commitments to deliver loans into a mortgage-backed security. The commitments to originate residential mortgage loans and the forward sales commitments are freestanding derivative instruments. They do not qualify for hedge accounting treatment so their fair value adjustments are recorded through the income statement in income from mortgage loan sales. The commitments to originate residential mortgage loans totaled $18.6 million at December 31, 2010, and the related forward sales commitments totaled $12.1 million with fair values of $18.8 million and $12.3 million, respectively. Loans held for sale by Dover totaled $37.1 million at December 31, 2010 of which $10.0 million was valued at lower of cost or market and $27.1 million valued at fair market due to the adoption of the fair value option. The related forward sales commitments on loans held for sale totaled $37.1 million with a fair value of $37.1 million.
The Bank had no loans held for sale at December 31, 2010. At December 31, 2009, the Bank had loans held for sale of $4.6 million and binding commitments for the origination of mortgage loans intended to be held for sale of $7.0 million with related forward sales commitments also totaling $4.6 million.
The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The fair value of these commitments was not considered material.
The Company does not have any special purpose entities or other similar forms of off-balance sheet financing.
Note 21 – Derivatives and Financial Instruments
A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. These instruments include interest rate swaps, caps, floors, collars, options or other financial instruments designed to hedge exposures to interest rate risk or for speculative purposes.
Accounting guidance requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet, and measure those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting.
During the fourth quarter 2009 and first quarter 2010, the Bank entered into four interest rate swaps totaling $45.0 million, using a receive-fixed swap to mitigate the exposure to changes in the fair value attributable to the benchmark interest rate (3-month LIBOR) of the hedged items (FHLB advances) from the effective date to the maturity date of the hedged instruments. As structured, the pay-variable, receive-fixed swaps are evaluated as fair value hedges and are considered highly effective. As highly effective hedges, all fair value designated hedges and the underlying hedged instrument are recorded on the balance sheet at fair value with the periodic changes of the fair value reported in the income statement.
For the twelve months ended December 31, 2009, the interest rate swaps designated as a fair value hedge resulted in decreased interest expense of $138,090 on FHLB advances than would otherwise have been reported for the liability. The fair value of the swaps at December 31, 2009 was recorded on the consolidated balance sheet as a liability in the amount of $(214,000).
For the twelve months ended December 31, 2010, the interest rate swaps designated as a fair value hedge resulted in a net increase of interest expense of $884,000 on FHLB advances than would otherwise have been reported for the liability. The fair value of the swaps at December 31, 2010 was recorded on the consolidated balance sheet as a asset in the amount of $1.4 million.
Net gains recognized on the fair value swaps were $273,000 at December 31, 2010, $66,000 at December 31, 2009 and $0 at December 31, 2008.
On March 14, 2008, FNB United entered into an interest rate swap to convert the floating rate cash flows on a $20 million trust preferred security to a fixed rate cash flow. As structured, the pay-fixed, receive-floating swap is evaluated, using the long-haul method, as being a cash flow hedge in which the ineffectiveness would be determined
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by any difference in valuation of the fair value of the derivative and the underlying hedged item. Consequently, the difference in cash flows in each period between the fixed rate interest payments that the Company makes and the variable interest payments received is currently reported in earnings while gains and losses on the value of the swap instrument are recorded in shareholders’ equity.
For the twelve months ended December 31, 2010, the interest rate swap resulted in a net increase of $446,000 in the interest expense on FNB United Statutory Trust I than would otherwise have been reported. There is no fair value of the swap recorded at December 31, 2010 since it matured on December 15, 2010.
For the twelve months ended December 31, 2009, the interest rate swap resulted in a net increase of $335,884 in the interest expense on FNB United Statutory Trust I that would otherwise have been reported. The fair value of the swap at December 31, 2009 was recorded on the consolidated balance sheet as a liability in the amount of $383,075 offset by other comprehensive loss of $248,999, net of $134,076 deferred taxes.
The Company has also identified the following derivative instruments that were recorded on the consolidated balance sheet at December 31, 2010: commitments to originate residential mortgage loans and forward sales commitments.
Mortgage banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts (“forward contracts”) and rate lock loan commitments. The fair value of the Company’s derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants.
The table below provides data about the carrying values of derivative instruments:
| As of December 31, 2010 | As of December 31, 2009 | |||||||||||||||||||||||
| (dollars in thousands) | Assets | (Liabilities) | Assets | (Liabilities) | ||||||||||||||||||||
| Carrying Value | Carrying Value | Derivative Net Carrying Value | Carrying Value | Carrying Value | Derivative Net Carrying Value | |||||||||||||||||||
Derivatives designated as hedging instruments: | ||||||||||||||||||||||||
Interest rate swap contracts - trust preferred (1) | $ | - | $ | - | $ | - | $ | - | $ | (383) | $ | (383) | ||||||||||||
Interest rate swap contracts - FHLB advances (2) | 1,415 | - | 1,415 | 280 | - | 280 | ||||||||||||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||||||||||
Mortgage loan rate lock commitments (1) | $ | - | $ | (55) | $ | (55) | $ | - | $ | (83) | $ | (83) | ||||||||||||
Mortgage loan forward sales and MBS (3) | 44 | - | 44 | 251 | - | 251 | ||||||||||||||||||
(1) Included in “Other liabilities” on the Company’s consolidated balance sheets.
(2) Included in “Other Assets” on the Company’s consolidated balance sheets.
(3) Included in “Other assets” on the Company’s consolidated balance sheets.
The table below provides data about the amount of gains and losses related to derivative instruments designated as hedges included in the “Accumulated other comprehensive loss” section of “Shareholders’ Equity” on the Company’s Consolidated Balance Sheets, and in “Other income” in the Company’s Consolidated Statements of Income:
| (dollars in thousands) | Loss, Net of Tax Recognized in Accumulated Other Comprehensive Loss (Effective Portion) | |||||||
| As of December 31, 2010 | As of December 31, 2009 | |||||||
Derivatives designated as hedging instruments: | ||||||||
Interest rate swap contracts - trust preferred | $ | - | $ | (249) | ||||
| (dollars in thousands) | Gain Net of Tax Recognized in Income | |||||||
| As of December 31, 2010 | As of December 31, 2009 | |||||||
Derivatives designated as hedging instruments: | ||||||||
Interest rate swap contracts - FHLB advances | $ | 165 | $ | 40 | ||||
On April 7, 2009, Dover irrevocably opted to elect the fair value option for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. This election allowed Dover to enter into a hedging arrangement for the purpose of limiting risk inherent in the closed but unlocked mortgage loan pipeline and loans held for sale portfolio. These loans have interest rate locks but have not yet settled.
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The table below provides data about the amount of gains and losses recognized in income on derivative instruments not designated as hedging instruments:
| (dollars in thousands) | Gain/(Loss) During Twelve Months Ended | |||||||
| December 31, 2010 | December 31, 2009 | |||||||
Derivatives not designated as hedging instruments: | ||||||||
Mortgage loan rate lock commitments (1) | $ | 28 | $ | (83 | ) | |||
Mortgage loan forward sales and MBS (1) | (207 | ) | 251 | |||||
Total | $ | (179 | ) | $ | 168 | |||
(1) Recognized in “Mortgage loan sales” in the Company’s consolidated statements of loss.
Dover originates certain residential mortgage loans with the intention of selling these loans. Between the time that Dover enters into an interest rate lock or a commitment to originate a residential mortgage loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in market prices related to these commitments. The Company believes that it is prudent to limit the variability of expected proceeds from the future sales of these loans by entering into forward sales commitments and commitments to deliver loans into a mortgage-backed security. The commitments to originate residential mortgage loans and the forward sales commitments are freestanding derivative instruments. They do not qualify for hedge accounting treatment so their fair value adjustments are recorded through the income statement in income from mortgage loan sales.
Note 22 – Fair Value of Assets and Liabilities
The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale, certain loans held for sale at Dover, derivatives and mortgage servicing rights 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 and liabilities on a non-recurring basis, such as loans held for sale, loans held for investment and certain other assets and liabilities. These non-recurring fair value adjustments typically involve application of lower or cost or market accounting or write-downs of individuals’ assets or liabilities.
Fair Value Hierarchy
The Company groups assets and liabilities 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: Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3: Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
Investments Securities Available-for-Sale
Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 may include asset-backed securities in less liquid markets.
Loans Held for Sale
The Company originates loans under various loan programs and other secondary market conventional products which are sold in the secondary market. Additionally, the Company has residential mortgage loans held for sale which were originated through the retail and wholesale mortgage segment. The majority of loans held for sale are carried at the lower of cost or market. The remaining portion is hedged to protect the Company from changes in
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interest rates during the period of time a loan is held. The loans that are hedged are accounted for as fair value hedges and are recorded at market value in accordance with current guidance. The sold loans are beyond the reach of the Bank in all respects and the purchasing investor has all rights of ownership, including the ability to pledge or exchange the loans. Most of loans sold are without recourse. Gains or losses on loan sales are recognized at the time of sale, are determined by the difference between net sales proceeds and the carrying value of the loan sold, and are included in mortgage loan income.
Since loans held for sale are carried at the lower of cost or market value, the market value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subjected to nonrecurring fair value adjustments as Level 2.
Loans
The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and the related impairment is charged against the allowance or a specific allowance is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment. The fair value of impaired loans is estimated using one of several methods, including collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investments in such loans. At December 31, 2010 and December 31, 2009, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loans as nonrecurring Level 3.
Other Real Estate Owned
Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the OREO as nonrecurring Level 3.
Derivative Assets and Liabilities
Substantially all derivative instruments held or issued by the Company for risk management or customer-initiated activities are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company measures fair value using models that use primarily market observable inputs, such as yield curves and option volatilities, and include the value associated with counterparty credit risk. The Company classifies derivatives instruments held or issued for risk management or customer-initiated activities as Level 2.
Mortgage Servicing Rights
Mortgage servicing rights are recorded at fair value on a recurring basis, with changes in fair value recorded as a component of mortgage loan sales. A valuation model, which utilizes a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and a discount rate, is used to determine fair value. Loan servicing rights are adjusted to fair value through a valuation allowance as determined by the model. As such, the Company classifies mortgage servicing rights as Level 3.
Federal Home Loan Bank Advances (“FHLB”)
Four FHLB Advances totaling $45.0 million have been hedged through fair value hedges whereby the change in fair value of the advances is effectively offset by the change in fair value of the interest rate swaps. For those derivatives, the Company measures fair value using models that use primarily market observable inputs, such as yield curves and option volatilities, and include the value associated with counterparty credit risk. The Company classifies derivatives instruments held or issued for risk management or customer-initiated activities as Level 2. Fair value of derivatives are primarily estimated by discounting estimated cash flows using interest rates approximating the current market rate for similar terms and credit risk.
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Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The following tables present the recorded amount of assets and liabilities measured at fair value on a recurring basis:
December 31, 2010
| (dollars in thousands) | Total | Level 1 | Level 2 | Level 3 | ||||||||||||
Assets: | ||||||||||||||||
Available-for-sale debt securities: | ||||||||||||||||
U.S. Treasury and government agencies | $ | 21 | $ | - | $ | 21 | $ | - | ||||||||
U.S. government sponsored agencies | 23,516 | - | 23,516 | - | ||||||||||||
States and political subdivisions | 24,458 | - | 24,458 | - | ||||||||||||
Residential mortgage-backed securities | 257,336 | - | 257,336 | - | ||||||||||||
Total available-for-sale debt securities | 305,331 | - | 305,331 | - | ||||||||||||
Total available-for-sale securities | 305,331 | - | 305,331 | - | ||||||||||||
Loans held for sale | 16,119 | - | 16,119 | - | ||||||||||||
Mortgage servicing rights | 2,359 | - | - | 2,359 | ||||||||||||
Fair value of interest rate swaps | 1,415 | - | 1,415 | - | ||||||||||||
Derivative assets - Dover | 44 | - | 44 | - | ||||||||||||
Total assets at fair value | $ | 325,268 | $ | - | $ | 322,909 | $ | 2,359 | ||||||||
Liabilities: | ||||||||||||||||
FHLB advances - fair value hedge | $ | 1,076 | $ | - | $ | 1,076 | $ | - | ||||||||
Derivative liabilities - Dover | 55 | - | 55 | - | ||||||||||||
Total liabilities at fair value | $ | 1,131 | $ | - | $ | 1,131 | $ | - | ||||||||
December 31, 2009 | ||||||||||||||||
| (dollars in thousands) | Total | Level 1 | Level 2 | Level 3 | ||||||||||||
Assets: | ||||||||||||||||
Available-for-sale equity securities | $ | 2,168 | $ | 2,168 | $ | - | $ | - | ||||||||
Available-for-sale debt securities: | ||||||||||||||||
U.S. Treasury and government agencies | 63 | - | 63 | - | ||||||||||||
U.S. government sponsored agencies | 72,967 | - | 72,967 | - | ||||||||||||
States and political subdivisions | 46,428 | - | 46,428 | - | ||||||||||||
Residential mortgage-backed securities | 101,613 | - | 101,613 | - | ||||||||||||
Collaterialized debt obligations | 45 | - | 45 | - | ||||||||||||
Corporate notes | 14,346 | - | 14,346 | - | ||||||||||||
Total available-for-sale debt securities | 235,462 | - | 235,462 | - | ||||||||||||
Total available-for-sale securities | 237,630 | 2,168 | 235,462 | - | ||||||||||||
FHLB advances - fair value hedge | 280 | - | 280 | - | ||||||||||||
Derivative assets - Dover | 251 | - | 251 | - | ||||||||||||
Loans held for sale | 26,135 | - | 26,135 | - | ||||||||||||
Mortgage servicing rights | 4,857 | - | - | 4,857 | ||||||||||||
Total assets at fair value | $ | 269,153 | $ | 2,168 | $ | 262,128 | $ | 4,857 | ||||||||
Liabilities: | ||||||||||||||||
Derivative liabilities - FNB United | $ | 383 | $ | - | $ | 383 | $ | - | ||||||||
Fair value of interest rate swaps | 214 | - | 214 | - | ||||||||||||
Derivative liabilities - Dover | 83 | - | 83 | - | ||||||||||||
Total liabilities at fair value | $ | 680 | $ | - | $ | 680 | $ | - | ||||||||
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The following are reconciliations of the beginning and ending balances for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of December 31, 2010 and December 31, 2009, respectively:
| Fair Value Measurements Using Significant Unobservable Inputs (Level 3) | ||||||||||
| (dollars in thousands) | Mortgage Rights | |||||||||
Beginning balance at January 1, 2010 | $ 4,857 | |||||||||
Total gains or losses (realized/unrealized): | ||||||||||
Included in earnings | (1,165) | |||||||||
Purchases, issuances and settlements | 1,340 | |||||||||
Impairment write-down | (2,673) | |||||||||
Ending balance at December 31, 2010 | $ 2,359 | |||||||||
| Fair Value Measurements Using Significant Unobservable Inputs (Level 3) | ||||||||||
| (dollars in thousands) | Mortgage Rights | |||||||||
Beginning balance at January 1, 2009 | $ 4,043 | |||||||||
Total gains or losses (realized/unrealized): | ||||||||||
Included in earnings | (828) | |||||||||
Purchases, issuances and settlements | 1,642 | |||||||||
Ending balance at December 31, 2009 | $ 4,857 | |||||||||
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the following tables.
December 31, 2010
| (dollars in thousands) | ||||||||||||||||
| Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Impaired loans | $ | 137,152 | $ | - | $ | 70,827 | $ | 66,325 | ||||||||
Other real estate owned | 19,173 | - | 7,948 | 11,225 | ||||||||||||
Total assets at fair value | $ | 156,325 | $ | - | $ | 78,775 | $ | 77,550 | ||||||||
| December 31, 2009 | ||||||||||||||||
| (dollars in thousands) | ||||||||||||||||
| Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Impaired loans | $ | 69,142 | $ | - | $ | 8,297 | $ | 60,845 | ||||||||
Other real estate owned | 2,836 | - | 278 | 2,558 | ||||||||||||
Total assets at fair value | $ | 71,978 | $ | - | $ | 8,575 | $ | 63,403 | ||||||||
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value for each class of the Company’s financial instruments.
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Cash and cash equivalents.The carrying amounts for cash and due from banks approximate fair value because of the short maturities of those instruments.
Investment securities. The fair value of investment securities is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. The fair value of equity investments in the restricted stock of the Federal Reserve Bank and Federal Home Loan Bank equals the carrying value.
Loans.The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Substantially all residential mortgage loans held for sale are pre-sold and their carrying value approximates fair value. The fair value of variable rate loans with frequent repricing and negligible credit risk approximates book value. There was no illiquidity adjustment used to determine fair value.
Investment in bank-owned life insurance.The carrying value of bank-owned life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.
Deposits. The fair value of noninterest-bearing demand deposits and NOW, savings, and money market deposits are the amounts payable on demand at the reporting date. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.
Borrowed funds. The carrying value of retail repurchase agreements and federal funds purchased is considered to be a reasonable estimate of fair value. The fair value of Federal Home Loan Bank advances and other borrowed funds is estimated using the rates currently offered for advances of similar remaining maturities.
Accrued interest. The carrying amounts of accrued interest approximate fair value.
Financial instruments with off-balance sheet risk. The fair value of financial instruments with off-balance sheet risk is considered to approximate carrying value, since the large majority of these future financing commitments would result in loans that have variable rates and/or relatively short terms to maturity. For other commitments, generally of a short-term nature, the carrying value is considered to be a reasonable estimate of fair value. The various financial instruments were disclosed in Note 20.
The estimated fair values of financial instruments at December 31 are as follows:
| (dollars in thousands) | As of December 31, 2010 | As of December 31, 2009 | ||||||||||||||
| Carrying Value | Estimated Fair Value | Carrying Value | Estimated Fair Value | |||||||||||||
Financial Assets | ||||||||||||||||
Cash and cash equivalents | $ | 160,594 | $ | 160,594 | $ | 27,698 | $ | 27,698 | ||||||||
Investment securities: | ||||||||||||||||
Available-for-sale | 305,331 | 305,331 | 237,630 | 237,630 | ||||||||||||
Held-to-maturity | - | - | 88,559 | 91,521 | ||||||||||||
Loans held for sale | 37,079 | 37,079 | 58,219 | 58,219 | ||||||||||||
Loans, net | 1,210,288 | 1,160,163 | 1,513,560 | 1,442,115 | ||||||||||||
Accrued interest receivable | 5,747 | 5,747 | 8,071 | 8,071 | ||||||||||||
Bank-owned life insurance | 31,968 | 31,968 | 30,883 | 30,883 | ||||||||||||
Financial Liabilities | ||||||||||||||||
Deposits | $ | 1,696,390 | $ | 1,682,704 | $ | 1,722,128 | $ | 1,687,945 | ||||||||
Retail repurchase agreements | 9,628 | 9,628 | 13,592 | 13,592 | ||||||||||||
Federal Home Loan Bank advances | 144,485 | 150,466 | 166,165 | 171,529 | ||||||||||||
Federal funds purchased | - | - | 10,000 | 10,000 | ||||||||||||
Subordinated debt | 7,500 | 7,500 | 15,000 | 15,000 | ||||||||||||
Junior subordinated debentures | 56,702 | 41,681 | 56,702 | 43,257 | ||||||||||||
Accrued interest payable | 2,592 | 2,592 | 2,581 | 2,581 | ||||||||||||
The fair value estimates are made at a specific point in time based on relevant market and other information about the financial instruments. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on current economic conditions, risk characteristics of various financial instruments, and such other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could
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significantly affect the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
Note 23 – FDIC Insurance Assessment
On May 22, 2009, the FDIC adopted a final rule imposing a five basis point special assessment on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009. The special assessment was collected on September 30, 2009.
On November 12, 2009, the FDIC adopted a final rule to require insured institutions to prepay their quarterly risk-based deposit insurance assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012, on December 30, 2009. The prepaid FDIC assessment balances was $3.97 million and $9.65 million at December 31, 2010 and 2009, respectively. Due to increased assessment rates, the Bank’s prepaid assessment amount is expected to be utilized in full prior to December 31, 2012. At the point that the prepaid assessment is fully utilized, the Bank will return to making quarterly cash payments to the FDIC for assessments.
The Dodd-Frank Act also provides the FDIC with discretion to determine whether to pay rebates to insured depository institutions when its deposit insurance reserves exceed certain thresholds. Previously, the FDIC was required to give rebates to depository institutions equal to the excess once the reserve ratio exceeded 1.50%, and was required to rebate 50% of the excess over 1.35% but not more than 1.5% of insured deposits. The FDIC adopted a final rule on February 7, 2011 that implements these provisions of the Dodd-Frank Act.
Note 24 – Common Dividends
The holders of FNB United common stock are entitled to receive dividends, when and if declared by the FNB United’s Board of Directors, out of funds legally available for such dividends. FNB United is a legal entity separate and distinct from the Bank and depends on the payment of dividends from the Bank to make dividend payments to its shareholders. FNB United and the Bank are subject to regulatory policies and requirements relating to the payment of dividends. As a result of being deemed “significantly undercapitalized” for regulatory purposes, FNB United is restricted from declaring and paying a dividend on common stock without prior notification and approval from the regulators.
The Bank must obtain the prior approval of the Office of the Comptroller of the Currency (the “OCC”) to pay dividends if the total of all dividends declared by the Bank in any calendar year will exceed the sum of its net income for that year and its retained net income for the preceding two calendar years, less any transfers required by the OCC or to be made to retire any preferred stock. Currently, any dividend declaration by the Bank would require the Bank’s compliance with the above requirement and the written approval of the OCC under the Order. Federal law also prohibits the Bank from paying dividends that in the aggregate would be greater than its undivided profits after deducting statutory bad debts in excess of its loan loss allowance. The Company did not declare any dividends on common shares in 2010.
Note 25 – Change in Executive Officer
On April 23, 2010, the Company announced the retirement effective April 22, 2010 of Michael C. Miller, president and chief executive officer of FNB United and the Bank. Mr. Miller also resigned from the Boards of Directors of FNB United and the Bank effective April 22, 2010. Also effective April 22, 2010, R. Larry Campbell, executive vice president and chief operating officer, was appointed by the boards of directors of FNB United and the Bank to succeed Mr. Miller as president and chief executive officer on an interim basis while a search for a replacement is undertaken. The OCC has approved Mr. Campbell’s serving in the capacity through June 30, 2011.
Note 26 – Subsequent Events
On February 1, 2011, FNB United Corp. received a written notice from The Nasdaq Stock Market indicating that FNB United’s application to transfer the listing of its common stock to The Nasdaq Capital Market was approved. The transfer was effective at the opening of business on February 3, 2011.
In February 2011, Dover Mortgage made the decision to refocus its business plan and limit operations to the current footprint of the Bank. Dover has ceased doing business outside of the North Carolina.
On February 28, 2011, the Bank signed a conversion agreement with SunTrust Bank, converting $5.0 million of the outstanding $7.5 million subordinated term loan due to SunTrust from the Bank into 5,000,000 shares of nonvoting, nonconvertible, nonredeemable cumulative preferred stock of the Bank. The preferred stock carries an 8% dividend rate. For the remaining $2.5 million of subordinated debt, interest will be payable monthly rather than quarterly beginning on March 31, 2011. Prior to the conversion, the Bank paid the interest due through February 28, 2011. It will be an event of default under the SunTrust subordinated note if FNB United does not raise at least $300 million through the issuance of equity securities by July 31, 2011.
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| Item 9. | CHANGESINAND DISAGREEMENTSWITH ACCOUNTANTSON ACCOUNTINGAND FINANCIAL DISCLOSURE |
None
| Item 9A. | CONTROLSAND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
FNB United Corp.’s management, with the participation of its Chief Executive Officer and its Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of December 31, 2010. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2010.
Management’s Report on Internal Control over Financial Reporting
Management of FNB United Corp. and Subsidiary (the “Corporation”) is responsible for preparing the Corporation’s annual consolidated financial statements and for establishing and maintaining adequate internal control over financial reporting for the Corporation. Management has evaluated the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2010 based on criteria established inInternal Control— Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Corporation’s annual or interim financial statements will not be prevented or detected on a timely basis. As a result of management’s evaluation of the Corporation’s internal control over financial reporting, management identified a material weakness related to the timely recognition and measurement of impairment of other real estate owned. The Corporation’s process to review appraisals, determine any adjustments to the valuation of other real estate owned and communicate such adjustments to those preparing financial statements was not effective to ensure timely and accurate valuation of other real estate owned. Based on this assessment, management concluded that as of December 31, 2010 the Corporation’s internal control over financial reporting was not effective. As result of the identification of matters that caused the restatement described in Note 2 of the Notes to Consolidated Financial Statements, management identified a second material weakness related to the identification and recognition of subsequent events affecting the valuation of other real estate owned and impaired loans. The Corporation’s process to review events or transactions that occurred or became known subsequent to year-end but prior to the filing of the Corporation’s Annual Report on Form 10-K was not effective to ensure timely and accurate valuation of other real estate owned and impaired loans. Because of these material weaknesses, management has concluded that the Corporation did not maintain effective internal control over financial reporting as of December 31, 2010 based on criteria established inInternal Control—Integrated Framework issued by the COSO.
As a result of this amended report of management on internal control over financial reporting, the Corporation’s registered public accounting firm that audited the Corporation’s consolidated financial statements included in this annual report has issued an updated attestation report on the effectiveness of the Corporation’s internal control over financial reporting.
Management is also responsible for compliance with laws and regulations relating to safety and soundness which are designated by the FDIC and the appropriate federal banking agency. Management assessed its compliance with these designated laws and regulations relating to safety and soundness and believes that the Corporation complied, in all significant respects, with such laws and during the year ended December 31, 2010.
Changes in Internal Control over Financial Reporting
The Company assesses the adequacy of its internal control over financial reporting quarterly and enhances its control in response to internal control assessments and internal and external audit and regulatory recommendations. No such control enhancements during the quarter ended December 31, 2010 have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
| Item 9B. | OTHER INFORMATION |
None
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| Item 10. | DIRECTORS, EXECUTIVE OFFICERS,AND CORPORATE GOVERNANCE |
The information set forth in FNB United’s proxy statement for the Annual Meeting of Shareholders to be held on July 19, 2011 (the “Proxy Statement”) under the headings “Election of Directors,” “Executive Officers,” “Report of the Audit Committee,” and “Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.
| Item 11. | EXECUTIVE COMPENSATION |
The information set forth in the Proxy Statement under the headings “Compensation Discussion and Analysis,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation,” and “Report of the Compensation Committee on the Compensation Discussion and Analysis” is incorporated herein by reference.
| Item 12. | SECURITY OWNERSHIPOF CERTAIN BENEFICIAL OWNERSAND MANAGEMENTAND RELATED SHAREHOLDER MATTERS |
The information set forth in the Proxy Statement under the headings “Voting Securities Outstanding and Principal Shareholders,” “Security Ownership of Management,” and “Equity Compensation Plan Information” is incorporated herein by reference.
| Item 13. | CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONSAND DIRECTOR INDEPENDENCE |
The information set forth in the Proxy Statement under the headings “Business Relationships and Related Person Transactions” and “Election of Directions” is incorporated herein by reference.
| Item 14. | PRINCIPAL ACCOUNTANT FEESAND SERVICES |
The information set forth in the Proxy Statement under the heading “Independent Registered Public Accounting Firm” is incorporated herein by reference.
| Item 15. | EXHIBITSAND FINANCIAL STATEMENT SCHEDULES |
(a)(1) Financial Statements. The following financial statements and supplementary data are included in Item 8 of this report.
(a)(2) Financial Statement Schedules. All applicable financial statement schedules required under Regulation S-X have been included in the Notes to the Consolidated Financial Statements.
(a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed below.
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INDEX TO EXHIBITS
Exhibit No. | Description of Exhibit | |
3.10 | Articles of Incorporation of the Registrant, incorporated herein by reference to Exhibit 3.1 to the Registrant’s Form S-14 Registration Statement (No. 2-96498) filed March 16, 1985. | |
3.11 | Articles of Amendment to Articles of Incorporation of the Registrant, adopted May 10, 1988, incorporated herein by reference to Exhibit 19.10 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 1988. | |
3.12 | Articles of Amendment to Articles of Incorporation of the Registrant, adopted May 12, 1998, incorporated herein by reference to Exhibit 3.12 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 1998. | |
3.13 | Articles of Amendment to Articles of Incorporation of the Registrant, adopted May 23, 2003, incorporated herein by reference to Exhibit 3.13 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 2003. | |
3.14 | Articles of Amendment to Articles of Incorporation of the Registrant, adopted March 15, 2006, incorporated herein by reference to Exhibit 3.14 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended March 31, 2006. | |
3.15 | Articles of Merger, setting forth amendment to Articles of Incorporation of the Registrant, effective April 28, 2006, incorporated herein by reference to Exhibit 3.15 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended March 31, 2006. | |
3.16 | Articles of Amendment to Articles of Incorporation, adopted January 23, 2009, incorporated herein by reference to Exhibit 3.1 to the Registrant’s Form 8-K Current Report filed January 23, 2009. | |
3.17 | Articles of Amendment to Articles of Incorporation, adopted February 11, 2009, incorporated herein by reference to Exhibit 3.1 to the Registrant’s Form 8-K Current Report filed February 13, 2009. | |
3.20 | Amended and Restated Bylaws of the Registrant, adopted February 11, 2009, incorporated herein by reference to Exhibit 3.2 to the Registrant’s Form 8-K Current Report filed February 13, 2009. | |
4.10 | Specimen of Registrant’s Common Stock Certificate, incorporated herein by reference to Exhibit 4 to Amendment No. 1 to the Registrant’s Form S-14 Registration Statement (No. 2-96498) filed April 19, 1985. | |
4.11 | Specimen of Registrant’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, Stock Certificate, incorporated herein by reference to Exhibit 4.1 to the Registrant’s Form 8-K Current Report filed February 13, 2009. | |
4.20 | Indenture dated as of November 4, 2005, between FNB Corp. and U.S. Bank, National Association, as trustee, incorporated herein by reference to Exhibit 4.1 to the Registrant’s Form 8- K Current Report filed November 8, 2005. | |
4.21 | Amended and Restated Declaration of Trust of FNB United Statutory Trust I dated as of November 4, 2005, among FNB Corp., as sponsor, U.S. Bank, National Association, as institutional trustee, and Michael C. Miller and Jerry A. Little, as administrators, incorporated herein by reference to Exhibit 4.2 to the Registrant’s Form 8-K Current Report dated November 4, 2005. | |
4.30 | Amended and Restated Declaration of Trust of FNB United Statutory Trust I dated as of November 4, 2005, among FNB Corp., as sponsor, U.S. Bank, National Association, as institutional trustee, and Michael C. Miller and Jerry A. Little, as administrators, incorporated herein by reference to Exhibit 4.2 to the Registrant’s Form 8-K Current Report filed November 8, 2005. | |
4.31 | Amended and Restated Trust Agreement of FNB United Statutory Trust II dated as of April 27, 2006, among FNB Corp., as sponsor, Wilmington Trust Company, as institutional trustee, and Michael C. Miller and Jerry A. Little, as administrators, incorporated herein by reference to | |
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| Exhibit 4.2 to the Registrant’s Form 8-K Current Report dated April 27, 2006 and filed April 28, 2006. | ||
| 4.40 | Warrant to purchase up to 2,207,143 shares of Common Stock used to the United States Department of the Treasury, incorporated herein by reference to Exhibit 4.2 to the Registrant’s Form 8-K Current Report filed February 13, 2009. | |
| 10.10* | Stock Compensation Plan as amended effective May 12, 1998, incorporated herein by reference to Exhibit 10.30 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 1998. | |
| 10.11* | Form of Incentive Stock Option Agreement between FNB Corp. and certain of its key employees, pursuant to the Registrant’s Stock Compensation Plan, incorporated herein by reference to Exhibit 10.31 to the Registrant’s Form 10-KSB Annual Report for the fiscal year ended December 31, 1994. | |
| 10.12* | Form of Nonqualified Stock Option Agreement between FNB Corp. and certain of its directors, pursuant to the Registrant’s Stock Compensation Plan, incorporated herein by reference to Exhibit 10.32 to the Registrant’s Form 10-KSB Annual Report for the fiscal year ended December 31, 1994. | |
| 10.13* | FNB United Corp. 2003 Stock Incentive Plan, as amended and restated as of December 31, 2008, incorporated herein by reference to Exhibit 10.23 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008. | |
| 10.14* | Form of Incentive Stock Option Agreement between FNB Corp. and certain of its key employees, pursuant to the Registrant’s 2003 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.24 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended September 30, 2003. | |
| 10.15* | Form of Nonqualified Stock Option Agreement between FNB Corp. and certain of its directors, pursuant to the Registrant’s 2003 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.25 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2003. | |
| 10.16* | Form of Restricted Stock Agreement between FNB United Corp. and certain of its key employees and non-employee directors, pursuant to the Registrant’s 2003 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.26 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 2006. | |
| 10.20* | Amended and Restated Employment Agreement dated as of December 31, 2008 among FNB United Corp., CommunityONE Bank, National Association and Michael C. Miller, incorporated herein by reference to Exhibit 10.30 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008. | |
| 10.21* | Carolina Fincorp, Inc. Stock Option Plan (assumed by the Registrant on April 10, 2000), incorporated herein by reference to Exhibit 99.1 to the Registrant’s Registration Statement on Form S-8 (File No. 333-54702). | |
| 10.22* | Amended and Restated Employment Agreement dated as of December 31, 2008 between CommunityONE Bank, National Association and R. Larry Campbell, incorporated herein by reference to Exhibit 10.32 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008. | |
| 10.23* | Nonqualified Supplemental Retirement Plan with R. Larry Campbell, incorporated herein by reference to Exhibit 10(c) to the Annual Report on Form 10-KSB of Carolina Fincorp, Inc. for the fiscal year ended June 30, 1997. | |
| 10.24* | Amendment to Executive Income Deferred Compensation Agreement dated as of December 31, 2008 between CommunityONE Bank, National Association and R. Larry Campbell, incorporated herein by reference to Exhibit 10.34 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008. | |
| 10.25* | Amended and Restated Change of Control Agreement dated as of December 31, 2008 among FNB United Corp., CommunityONE Bank, National Association, and R. Mark Hensley, incorporated herein by reference to Exhibit 10.35 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008. | |
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| 10.26* | Amended and Restated Change of Control Agreement dated as of December 31, 2008 among FNB United Corp., CommunityONE Bank, National Association, and Mark A. Severson, incorporated herein by reference to Exhibit 10.36 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008. | |
| 10.27* | Form of Change of Control Agreement among FNB United Corp., CommunityONE Bank, National Association and certain key officers and employees, incorporated herein by reference to Exhibit 10.37 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2008. | |
| 10.28* | Form of Letter Agreement between FNB United Corp. and senior executive officers incorporated herein by reference to the Registrant’s Form 8-K Current Report dated and filed December 1, 2009. | |
| 10.30 | Guarantee Agreement dated as of November 4, 2005, by FNB Corp. for the benefit of the holders of trust preferred securities, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report dated November 4, 2005 and filed November 5, 2005. | |
| 10.31 | Guarantee Agreement dated as of April 27, 2006 between FNB Corp. and Wilmington Trust Company, as guarantee trustee, for the benefit of the holders of trust preferred securities, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report dated April 27, 2006 and filed April 28, 2006. | |
| 10.32 | Subordinated Debt Loan Agreement dated as of June 30, 2008, between CommunityONE Bank, National Association and SunTrust Bank, incorporated herein by reference to Exhibit 10.43 to the Registrant’s Form 10-Q Quarterly Report for the quarter ended June 30, 2008. | |
| 10.33 | Conversion Agreement, dated as of December 30, 2010, among SunTrust Bank, CommunityONE Bank, National Association, and, for purposes of Sections 9 and 10 only, FNB United Corp., incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report dated December 30, 2010 and filed January 4, 2011. | |
| 10.34 | Conversion Agreement, dated as of February 28, 2011, among SunTrust Bank, CommunityONE Bank, National Association, and, for purposes of Sections 9 and 10 only, FNB United Corp., incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report dated February 28, 2011 and filed March 3, 2011. | |
| 10.40 | Letter Agreement between the Registrant and the United States Department of the Treasury, dated February 13, 2009, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report filed February 13, 2009. | |
| 10.41 | Written agreement, effective October 21, 2010, between FNB United Corp. and the Federal Reserve Bank of Richmond, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report dated October 21, 2010 and filed October 26, 2010. | |
| 10.42 | Consent Order issued by the Comptroller of the Currency in the matter of CommunityONE Bank, National Association, and related Stipulation and Consent to the Issuance of a Consent Order, between the Comptroller of the Currency and Community ONE Bank, National Association, each effective July 22, 2010, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report dated July 22, 2010 and filed on July 28, 2010. | |
| 14 | Code of Ethics for Senior Financial Officers, incorporated herein by reference to Exhibit 14 to the Registrant’s Form 10-K Annual Report for the fiscal year ended December 31, 2003. | |
| 21 | Subsidiaries of the Registrant. | |
| 23.10 | Consent of Independent Registered Public Accounting Firm – Dixon Hughes Goodman LLP | |
| 31.10 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.11 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32 | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
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| 99.10 | Certification of Principal Executive Officer Pursuant to Section 111 of the Emergency Economic Stabilization Act of 2008, as amended. | |
| 99.11 | Certification of Principal Financial Officer Pursuant to Section 111 of the Emergency Economic Stabilization Act of 2008, as amended. | |
* Management contract, or compensatory plan or arrangement.
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Pursuant to the requirements of Section 13 or 15(d) 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, as of May 23, 2011.
| FNB United Corp. | ||
| (Registrant) | ||
By: | /s/ R. LARRY CAMPBELL | |
| R. Larry Campbell | ||
Interim President and Chief Executive Officer | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated, as of May 23, 2011.
| Signature | Title | |||
/s/ R. LARRY CAMPBELL | Interim President and Chief Executive Officer | |||
| R. Larry Campbell | (Principal Executive Officer) | |||
/s/ MARK A. SEVERSON | Executive Vice President and Treasurer | |||
| Mark A. Severson | (Principal Financial and Accounting Officer) | |||
/s/ JACOB F. ALEXANDER III | Director | |||
| Jacob F. Alexander III | ||||
/s/ LARRY E. BROOKS | Director | |||
| Larry E. Brooks | ||||
/s/ JAMES M. CAMPBELL, JR. | Director | |||
| James M. Campbell, Jr. | ||||
/s/ R. LARRY CAMPBELL | Director | |||
| R. Larry Campbell | ||||
/s/ DARRELL L. FRYE | Director | |||
| Darrell L. Frye | ||||
/s/ HAL F. HUFFMAN, JR. | Director | |||
| Hal F. Huffman, Jr. | ||||
/s/ THOMAS A. JORDAN | Director | |||
| Thomas A. Jordan | ||||
/s/ LYNN S. LLOYD | Director | |||
| Lynn S. Lloyd | ||||
/s/ RAY H. MCKENNEY, JR. | Director | |||
| Ray H. McKenney, Jr. | ||||
/s/ EUGENE B. MCLAURIN, II | Director | |||
| Eugene B. McLaurin, II | ||||
/s/ R. REYNOLDS NEELY, JR. | Director | |||
| R. Reynolds Neely, Jr. | ||||
/s/ CARL G. YALE | Director | |||
| Carl G. Yale | ||||
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