NOTE 14: CERTAIN TRANSACTIONS From time to time, the Company and its subsidiaries have made loans and other extensions of credit to directors, officers, their associates and members of their immediate families. From time to time, directors, officers and their associates and members of their immediate families have placed deposits with the Company’s subsidiary banks. Such loans, other extensions of credit and deposits were made in the ordinary course of business, on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons and did not involve more than normal risk of collectibility or present other unfavorable features. NOTE 15: COMMITMENTS AND CREDIT RISK The seven affiliate banks of the Company grant agribusiness, commercial, consumer, and residential loans to their customers throughout Arkansas. Included in the Company’s diversified loan portfolio is unsecured debt in the form of credit card receivables that comprised approximately 12.2% and 14.4% of the portfolio, as of September 30, 2003 and December 31, 2002, respectively. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate. 18
At September 30, 2003, the Company had outstanding commitments to extend credit aggregating approximately $212,273,000 and $330,324,000 for credit card commitments and other loan commitments, respectively. At December 31, 2002, the Company had outstanding commitments to extend credit aggregating approximately $216,167,000 and $289,389,000 for credit card commitments and other loan commitments, respectively. Letters of credit are conditional commitments issued by the bank subsidiaries of the Company, to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company had total outstanding letters of credit amounting to $14,816,000 and $2,474,000 at September 30, 2003 and December 31, 2002, respectively, with terms ranging from 90 days to three years. At September 30, 2003, the Company’s deferred revenue under standby letter of credit agreements of approximately $207,000. At December 31, 2002, the Company’s deferred revenue under standby letter of credit agreements was not material. NOTE 16: SUBSEQUENT EVENTS On October 8, 2003, the Company announced the execution of a definitive agreement under the terms of which, Alliance Bancorporation, Inc. will be merged into Simmons First National Corporation. Alliance Bancorporation, Inc. owns Alliance Bank of Hot Springs, Hot Springs, Arkansas with consolidated assets of approximately $140 million. The proposed transaction is subject to the approval of State and Federal regulatory agencies along with the approval of Alliance stockholders who collectively will receive $11,440,000 in cash and 545,000 shares of Simmons First common stock. The regulatory applications are expected to be filed within 30 days and the approval of the Alliance shareholders will be sought in the first quarter of 2004. The transaction is expected to close during the first quarter of 2004. After the merger, Alliance will continue to operate as a separate community bank with the same board of directors, management and staff. On October 1, 2003, an action in Pulaski County Circuit Court was filed by Thomas F. Carter, Tena P. Carter and certain related entities against Simmons First Bank of South Arkansas and Simmons First National Bank alleging wrongful conduct by the banks in the collection of certain loans. The plaintiffs are seeking $2,000,000 in compensatory damages and $10,000,000 in punitive damages. Management is currently conducting an internal review of the facts and circumstances surrounding this matter. At this time, no basis for any material liability has been identified. The banks plan to vigorously defend the claims asserted in the suit. 19
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONSOVERVIEW Simmons First National Corporation achieved record third quarter earnings of $6,611,000, or $0.46 diluted earnings per share for the quarter ended September 30, 2003. These earnings reflect an increase of $842,000, or $0.06 per share over the September 30, 2002, earnings of $5,769,000, or $0.40 diluted earnings per share (stock split adjusted). Annualized return on average assets and annualized return on average stockholders’ equity for the three-month period ended September 30, 2003, was 1.31% and 12.65%, compared to 1.18% and 11.87%, respectively, for the same period in 2002. The quarterly increase in earnings over the same quarter last year is primarily attributable to the increased volume of the Company’s mortgage banking operation, growth in the loan portfolio and a lower provision for loan losses, which correlates to the improved asset quality ratios. Earnings for the nine-month period ended September 30, 2003, were $18,472,000, or $1.28 per diluted share. These earnings reflect an increase of $2,057,000, or $0.14 per share, when compared to the nine-month period ended September 30, 2002, earnings of $16,415,000, or $1.14 per diluted share. Annualized return on average assets and annualized return on average stockholders’ equity for the nine-month period ended September 30, 2003, was 1.24% and 12.10%, compared to 1.12% and 11.62%, respectively, for the same period in 2002. The year-to-date increase in earnings is primarily attributable to the increased volume of the Company’s mortgage loan production units and investment banking operation, growth in the loan portfolio, improved asset quality ratios as reflected in the provision for loan losses, and the nonrecurring gain on sale of mortgage servicing. Refer to the Sale of Mortgage Servicing discussion for additional information regarding the Company’s nonrecurring gain. Total assets for the Company at September 30, 2003, were $2.016 billion, an increase of $38.1 million from the same figure at December 31, 2002. Average quarter to date total assets for the Company during the third quarter of 2003 was $2.002 billion, an increase of $60.2 million over the average for the third quarter of 2002. Stockholders’ equity at the end of the third quarter of 2003 was $207.2 million, a $9.6 million, or 4.9%, increase from December 31, 2002. The allowance for loan losses as a percent of total loans equaled 1.72% and 1.75% as of September 30, 2003 and December 31, 2002, respectively. As of September 30, 2003, non-performing loans equaled 0.93% of total loans compared to 0.97% as of year-end 2002. As of September 30, 2003, the allowance for loan losses equaled 184% of non-performing loans compared to 179% at year-end 2002. Simmons First National Corporation is an Arkansas based, Arkansas committed, financial holding company, with community banks in Pine Bluff, Jonesboro, Lake Village, Rogers, Russellville, Searcy and El Dorado, Arkansas. The Company’s seven banks conduct financial operations from 64 offices, of which 62 are financial centers, in 34 communities throughout Arkansas. 20
CRITICAL ACCOUNTING POLICIESOverview Management has reviewed its various accounting policies. Based on this review, management believes the policies most critical to the Company are the policies associated with its lending practices including the accounting for the allowance for loan losses, treatment of goodwill, recognition of fee income, estimates of income taxes, and employee benefit plan as it relates to stock options. Loans Loans the Company has the intent and ability to hold for the foreseeable future or until maturity or pay-offs are reported at their outstanding principal adjusted for any loans charged off and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the estimated life of the loan. Generally, loans are placed on non-accrual status at ninety days past due and interest is considered a loss, unless the loan is well secured and in the process of collection. Discounts and premiums on purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method. Allowance for Loan Losses The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance is maintained at a level considered adequate to provide for potential loan losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio that have been incurred as of period end. This estimate is based on management’s evaluation of the loan portfolio, as well as on prevailing and anticipated economic conditions and historical losses by loan category. General reserves have been established, based upon the aforementioned factors and allocated to the individual loan categories. Allowances are accrued on specific loans evaluated for impairment for which the basis of each loan, including accrued interest, exceeds the discounted amount of expected future collections of interest and principal or, alternatively, the fair value of loan collateral. The unallocated reserve generally serves to compensate for the uncertainty in estimating loan losses, including the possibility of changes in risk ratings and specific reserve allocations in the loan portfolio as a result of the Company’s ongoing risk management system. 21
A loan is considered impaired when it is probable that the Company will not receive all amounts due according to the contractual terms of the loan. This includes loans that are delinquent 90 days or more, nonaccrual loans and certain other loans identified by management. Certain other loans identified by management consist of performing loans with specific allocations of the allowance for loan losses. Specific allocations are applied when quantifiable factors are present requiring a greater allocation than that established using the classified asset approach, as defined by the Office of the Comptroller of the Currency. Accrual of interest is discontinued and interest accrued and unpaid is removed at the time such amounts are delinquent 90 days, unless management is aware of circumstances which warrant continuing the interest accrual. Interest is recognized for nonaccrual loans only upon receipt and only after all principal amounts are current according to the terms of the contract. Goodwill Goodwill represents the excess of cost over the fair value of net assets of acquired subsidiaries and branches. Financial Accounting Standards Board Statement No. 142 and No. 147 eliminated the amortization for these assets as of January 1, 2002. Although goodwill is not being amortized, it is tested annually for impairment. Fee Income Periodic bankcard fees, net of direct origination costs, are recognized as revenue on a straight-line basis over the period the fee entitles the cardholder to use the card. Origination fees and costs for other loans are being amortized over the estimated life of the loan. Income Taxes Deferred tax assets and liabilities are recognized for the tax effects of differences between the financial statement and tax bases of assets and liabilities. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized. Employee Benefit Plans The Company has a stock-based employee compensation plan. The Company accounts for this plan under recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date. ACQUISITIONS On July 19, 2002, the Company expanded its coverage in South Arkansas with the purchase of the Monticello location from HEARTLAND Community Bank. Simmons First Bank of South Arkansas, a wholly owned subsidiary of the Company, acquired the Monticello office. As of July 19, 2002, the new location had total loans of $8 million and total deposits of $13 million. As a result of this transaction, the Company recorded additional goodwill and core deposits of $1,058,000 and $217,000, respectively. 22
On September 8, 2003, the Company announced the execution of a definitive agreement to purchase nine branch banking locations from Union Planters Bank, N.A. Six locations in North Central Arkansas include Clinton, Marshall, Mountain View, Fairfield Bay, Leslie and Bee Branch. Three locations in Northeast Arkansas communities include Hardy, Cherokee Village and Mammoth Spring. The nine locations have combined deposits of $140 million with estimated acquired assets of $126 million including selected loans, premises, cash and other assets. The transaction is subject to regulatory approval and is expected to close during the fourth quarter of 2003. SALE OF MORTGAGE SERVICING During the second quarter 2003, the Company recorded a nonrecurring $0.03 addition to earnings per share. On June 30, 1998, the Company sold its $1.2 billion residential mortgage-servicing portfolio. As a result of this sale, the Company established a reserve for potential liabilities due to certain representations and warranties made on the sale date. The time period for making claims under the terms of the mortgage servicing sale’s representations and warranties expired on June 30, 2003. Thus, the Company reversed this remaining reserve in the second quarter of 2003, which is reflected in the $771,000 pre-tax gain on sale of mortgage servicing. Excluding this nonrecurring gain, the Company would have reported $1.25 diluted earnings per share for the nine-months ended September 30, 2003. NET INTEREST INCOMEOverview Net interest income, the Company’s principal source of earnings, is the difference between the interest income generated by earning assets and the total interest cost of the deposits and borrowings obtained to fund those assets. Factors that determine the level of net interest income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, the level of non-performing loans and the amount of non-interest bearing liabilities supporting earning assets. Net interest income is analyzed in the discussion and tables below on a fully taxable equivalent basis. The adjustment to convert certain income to a fully taxable equivalent basis consists of dividing tax-exempt income by one minus the combined federal and state income tax rate (37.50% for September 30, 2003 and 2002). Throughout 2001, the Federal Reserve Bank steadily decreased the Federal Funds rate by a total of 475 basis points to 1.75% in an effort to stimulate economic growth. In 2002, the Federal Reserve continued to decrease the Federal Funds rate from 1.75% at the end of 2001 to 1.25% at the end of 2002. This decline has continued in 2003, with another 25 basis point decrease during the second quarter, bringing the Federal Funds rate to 1.00% at September 30, 2003. This declining rate environment contributed to the decline in interest income. This decline was more than offset by a decline in interest expense, driven by the declining interest rate environment, which resulted in growth in net interest income. The Company’s practice is to limit exposure to interest rate movements by maintaining a significant portion of earning assets and interest bearing liabilities in short-term repricing. Historically, approximately 70% of the Company’s loan portfolio and approximately 85% of the Company’s time deposits have repriced in one year or less. These historical amounts are consistent with current repricing.
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Third Quarter Analysis For the three-month period ended September 30, 2003, net interest income on a fully taxable equivalent basis was $20.6 million, an increase of $399,000 or 2.0%, from the same period in 2002. The increase in net interest income was the result of a $2.3 million decrease in interest income and a $2.7 million decrease in interest expense. The net interest margin declined slightly by 7 basis points to 4.43% for the three-month period ended September 30, 2003, when compared to 4.50% for the same period in 2002. This decline reflects a change in the Company’s overall mix of earning assets. The $2.3 million decrease in interest income for the three-month period ended September 30, 2003, primarily is the result of a 71 basis point decrease in the yield earned on earning assets associated with the lower interest rate environment. The lower interest rates resulted in a $3.4 million decrease in interest income. However, this decrease was offset by an increase in earning asset volume, which resulted in a $1.1 million increase in interest income. More specifically, $2.5 million of the decrease is associated with the repricing of the Company’s loan portfolio that resulted from loans that matured during the period or were tied to a rate that fluctuated with changes in market rates. As a result, the average rate earned on the loan portfolio decreased 75 basis points from 7.49% to 6.74%. The $2.7 million decrease in interest expense for the three-month period ended September 30, 2003, primarily is the result of a 75 basis point decrease in cost of funds, due to repricing opportunities during the lower interest rate environment last year. The lower interest rates resulted in $2.9 million decrease in interest expense. More specifically, $1.8 million of the decrease is associated with management’s ability to reprice the Company’s time deposits that resulted from time deposits maturing during the period or were tied to a rate that fluctuated with changes in market rates. As a result, the average rate paid on time deposits decreased 90 basis points from 3.23% to 2.33%. Year-to-Date Analysis For the nine-month period ended September 20, 2003, net interest income on a fully taxable equivalent basis was $60.3 million, an increase of $1.3 million, or 2.2%, from the same period in 2002. The increase in net interest income was the result of a $7.4 million decrease in interest income and a $8.7 million decrease in interest expense. As a result, the net interest margin improved 5 basis points to 4.41% for the nine-month period ended September 30, 2003, when compared to 4.36% for the same period in 2002. The $7.4 million decrease in interest income for the nine-month period ended September 30, 2003 primarily is the result of a 61 basis point decrease in the yield earned on earning assets associated with the lower interest rates environment. The lower interest rates resulted in a $9.0 million decrease in interest income. More specifically, $6.4 million of the decrease is associated with the repricing of the Company’s loan portfolio that resulted from loans that matured during the period or were tied to a rate that fluctuated with changes in market rates. As a result, the average rate earned on the loan portfolio decreased 68 basis points from 7.71% to 7.03%. The $8.7 million decrease in interest expense for the nine-month period ended September 30, 2003, primarily is the result of a 74 basis point decrease in cost of funds, due to repricing opportunities during the lower interest rate environment. The lower interest rates accounted for $8.5 million or 98.0% of the decrease in interest expense. More specifically, $6.2 million of the decrease is associated with management’s ability to reprice the Company’s time deposits that resulted from time deposits maturing during the period or were tied to a rate that fluctuated with changes in market rates. As a result, the average rate paid on time deposits decreased 102 basis points from 3.57% to 2.55%. 24
Net Interest Income Tables Table 1 and 2 reflect an analysis of net interest income on a fully taxable equivalent basis for the three-month and nine-month periods ended September 30, 2003 and 2002, respectively, as well as changes in fully taxable equivalent net interest margin for the three-month and nine-month periods ended September 30, 2003 versus September 30, 2002. Table 1: Analysis of Net Interest Income
(FTE =Fully Taxable Equivalent) |
