SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act
- - of 1934
For the quarterly period ended June 30, 2006.
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or
Transition Report under Section 13 or 15(d) of the Securities Exchange Act
- - of 1934
For the transition period from _______________ to ________________.
Commission File No. 0-23980
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Southeastern Bank Financial Corporation
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(Exact name of registrant as specified in its charter)
Georgia 58-2005097
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(State of Incorporation) (I.R.S. Employer Identification No.)
3530 Wheeler Road, Augusta, Georgia 30909
-----------------------------------------
(Address of principal executive offices)
(706) 738-6990
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(Issuer's telephone number, including area code)
Not Applicable
--------------
(Former name, former address and former fiscal year, if changed since last
report)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
--- ---
Check whether the issuer is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of "accelerated filer and
large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act): Yes No X
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date:
5,283,246 shares of common stock, $3.00 par value per share, outstanding as
of July 31, 2006.
SOUTHEASTERN BANK FINANCIAL CORPORATION
FORM 10-Q
INDEX
Page
Part I
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of June 30, 2006 and
December 31, 2005 3
Consolidated Statements of Income for the Three and Six
Months ended June 30, 2006 and 2005 4
Consolidated Statements of Cash Flows for the
Six Months ended June 30, 2006 and 2005 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
Item 4. Controls and Procedures 26
Part II Other Information
Item 1. Legal Proceedings *
Item 1A. Risk Factors 27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 27
Item 3. Defaults Upon Senior Securities *
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information *
Item 6. Exhibits 29
Signature 30
* No information submitted under this caption
1
PART I
FINANCIAL INFORMATION
2
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Balance Sheets
(Unaudited)
ASSETS
June 30, December 31,
2006 2005
------------- --------------
Cash and due from banks $ 19,572,531 $ 18,792,799
Federal funds sold 8,124,000 2,758,000
Interest-bearing deposits in other banks 512,406 1,012,257
------------- --------------
Cash and cash equivalents 28,208,937 22,563,056
Investment securities
Available-for-sale 202,271,023 197,551,996
Held-to-maturity, at cost (fair values of
$3,352,195 and $3,897,341, respectively) 3,275,847 3,776,040
Loans held for sale 20,101,184 22,146,834
Loans 638,618,458 579,087,791
Less allowance for loan losses (9,304,146) (9,124,801)
------------- --------------
Loans, net 629,314,312 569,962,990
Premises and equipment, net 22,038,107 21,376,183
Accrued interest receivable 4,775,293 4,624,023
Bank-owned life insurance 15,666,519 11,863,276
Restricted equity securities 4,936,281 4,287,481
Other assets 7,345,431 6,125,360
------------- --------------
$937,932,934 $ 864,277,239
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Noninterest-bearing $104,373,028 $ 97,083,931
Interest-bearing:
NOW accounts 114,281,798 100,692,388
Savings 254,044,309 265,131,754
Money management accounts 44,951,173 37,719,408
Time deposits over $100,000 153,375,134 122,009,813
Other time deposits 58,612,194 41,017,555
------------- --------------
729,637,636 663,654,849
Federal funds purchased and securities sold
under repurchase agreements 54,404,190 67,013,416
Advances from Federal Home Loan Bank 60,000,000 52,000,000
Other borrowed funds 400,000 1,000,000
Accrued interest payable and other liabilities 7,225,394 7,025,767
Subordinated debentures 20,000,000 10,000,000
------------- --------------
Total liabilities 871,667,220 800,694,032
------------- --------------
Stockholders' equity:
Common stock, $3.00 par value; 10,000,000 shares
authorized; 5,279,549 and 5,279,241 shares issued in
2006 and 2005, respectively; 5,279,440 and 5,263,144
shares outstanding in 2006 and 2005, respectively 15,838,647 15,837,723
Additional paid-in capital 34,311,955 34,138,876
Retained earnings 20,113,703 16,099,414
Treasury stock, at cost; 109 and 16,097 shares in
2006 and 2005, respectively (4,033) (233,898)
Accumulated other comprehensive loss, net (3,994,558) (2,258,908)
------------- --------------
Total stockholders' equity 66,265,714 63,583,207
------------- --------------
$937,932,934 $ 864,277,239
============= ==============
See accompanying notes to consolidated financial statements.
3
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Income
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2006 2005 2006 2005
----------- ------------ ----------- ------------
Interest income:
Loans, including fees $13,018,274 $ 9,271,626 $24,830,362 $17,515,164
Investment securities 2,702,309 1,936,599 5,158,381 3,701,141
Federal funds sold 44,036 95,762 194,629 151,369
Interest-bearing deposits in other banks 5,675 6,766 13,650 9,199
----------- ------------ ----------- ------------
Total interest income 15,770,294 11,310,753 30,197,022 21,376,873
----------- ------------ ----------- ------------
Interest expense:
Deposits 5,547,283 3,244,981 10,465,934 5,890,571
Federal funds purchased and securities sold
under repurchase agreements 724,846 350,430 1,408,754 622,400
Other borrowings 1,058,303 554,263 1,905,291 1,062,090
----------- ------------ ----------- ------------
Total interest expense 7,330,432 4,149,674 13,779,979 7,575,061
----------- ------------ ----------- ------------
Net interest income 8,439,862 7,161,079 16,417,043 13,801,812
Provision for loan losses 456,336 515,269 960,128 986,963
----------- ------------ ----------- ------------
Net interest income after provision
for loan losses 7,983,526 6,645,810 15,456,915 12,814,849
----------- ------------ ----------- ------------
Noninterest income:
Service charges and fees on deposits 1,539,978 1,354,425 2,892,122 2,565,475
Gain on sales of loans 1,270,992 1,298,399 2,525,337 2,340,582
Investment securities gains (losses), net 283,600 (40,051) 283,600 (39,260)
Retail investment income 216,562 121,603 383,973 203,566
Trust service fees 198,367 150,024 390,832 306,936
Increase in cash surrender value of
bank-owned life insurance 149,973 102,157 289,243 184,946
Miscellaneous income 146,770 202,201 296,395 327,303
----------- ------------ ----------- ------------
Total noninterest income 3,806,242 3,188,758 7,061,502 5,889,548
----------- ------------ ----------- ------------
Noninterest expense:
Salaries 3,427,626 3,014,016 6,808,185 5,763,555
Employee benefits 1,077,414 775,925 2,136,835 1,585,369
Occupancy expenses 685,165 682,433 1,433,901 1,355,526
Other operating expenses 2,041,484 1,734,410 4,018,655 3,239,572
----------- ------------ ----------- ------------
Total noninterest expense 7,231,689 6,206,784 14,397,576 11,944,022
----------- ------------ ----------- ------------
Income before income taxes 4,558,079 3,627,784 8,120,841 6,760,375
Income tax expense 1,631,675 1,222,052 2,734,462 2,270,654
----------- ------------ ----------- ------------
Net income $ 2,926,404 $ 2,405,732 $ 5,386,379 $ 4,489,721
=========== ============ =========== ============
Basic net income per share $ 0.55 $ 0.46 $ 1.02 $ 0.85
=========== ============ =========== ============
Diluted net income per share $ 0.55 $ 0.45 $ 1.01 $ 0.84
=========== ============ =========== ============
Weighted average common shares outstanding 5,279,333 5,256,807 5,276,526 5,255,175
=========== ============ =========== ============
Weighted average number of common and
common equivalent shares outstanding 5,331,632 5,343,086 5,329,007 5,337,433
=========== ============ =========== ============
See accompanying notes to consolidated financial statements.
4
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended June 30,
2006 2005
-------------- --------------
Cash flows from operating activities:
Net income $ 5,386,379 $ 4,489,721
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 720,553 719,321
Provision for loan losses 960,128 986,963
Net investment securities (gains) losses (283,600) 39,260
Net (accretion of discount) amortization of premium
on investment securities (167,840) 194,700
Increase in CSV of bank owned life insurance (289,243) (184,946)
Stock options compensation cost 258,890 -
(Gain) loss on disposal of premises and equipment (91,834) 17
Gain on the sale of other real estate - (4,150)
Gain on sales of loans (2,525,337) (2,340,582)
Real estate loans originated for sale (136,105,604) (122,078,283)
Proceeds from sales of real estate loans 140,676,591 120,681,852
Increase in accrued interest receivable (151,270) (525,964)
Increase in other assets (339,948) (12,122)
Increase (decrease) in accrued interest payable and other liabilities 199,627 (198,877)
-------------- --------------
Net cash provided by operating activities 8,247,492 1,766,910
-------------- --------------
Cash flows from investing activities:
Proceeds from sales of available for sale securities 15,729,239 20,164,223
Proceeds from maturities of available for sale securities 22,151,932 10,070,942
Proceeds from maturities of held to maturity securities 500,000 -
Purchase of available for sale securities (44,778,338) (44,546,679)
Purchase of Federal Home Loan Bank stock (873,800) (650,600)
Proceeds from redemption of FHLB stock 225,000 -
Net increase in loans (60,311,450) (54,619,056)
Purchase of Bank-owned life insurance (3,500,000) -
Additions to premises and equipment (3,061,294) (512,396)
Proceeds from sale of other real estate - 57,579
Proceeds from sale of premises and equipment 1,770,651 2,500
-------------- --------------
Net cash used in investing activities (72,148,060) (70,033,487)
-------------- --------------
Cash flows from financing activities:
Net increase in deposits 65,982,787 59,299,848
Net (decrease) increase in federal funds purchased and
securities sold under repurchase agreements (12,609,226) 12,370,388
Advances from Federal Home Loan Bank 19,000,000 11,000,000
Payments of Federal Home Loan Bank advances (11,000,000) (5,000,000)
Proceeds from subordinated debentures 10,000,000 -
Principal payments on other borrowed funds (600,000) -
Purchase of treasury stock (31,146) -
Payment of cash dividends (1,372,090) (1,365,834)
Proceeds from stock options exercised 176,124 -
-------------- --------------
Net cash provided by financing activities 69,546,449 76,304,402
-------------- --------------
Net increase in cash and cash equivalents $ 5,645,881 $ 8,037,825
Cash and cash equivalents at beginning of period 22,563,056 26,024,197
-------------- --------------
Cash and cash equivalents at end of period $ 28,208,937 $ 34,062,022
============== ==============
Supplemental disclosures of cash paid during the period for:
Interest $ 13,165,019 $ 7,401,882
============== ==============
Income taxes $ 3,255,000 $ 2,420,000
============== ==============
See accompanying notes to consolidated financial statements.
5
SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 2006
Note 1 - Basis of Presentation
The accompanying consolidated financial statements include the accounts of
Southeastern Bank Financial Corporation, and its wholly-owned subsidiary,
Georgia Bank & Trust Company (the "Company" or the "Bank"). Significant
intercompany transactions and accounts are eliminated in consolidation.
The financial statements for the three and six months ended June 30, 2006 and
2005 are unaudited and have been prepared pursuant to the rules and regulations
of the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to such rules and regulations. These
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and footnotes included in the Company's annual
report on Form 10-K for the year ended December 31, 2005.
In the opinion of management, all adjustments necessary to present fairly the
financial position and the results of operations and cash flows for the interim
periods have been made. All such adjustments are of a normal recurring nature.
The results of operations for the three and six months ended June 30, 2006 are
not necessarily indicative of the results of operations which the Company may
achieve for the entire year.
Some items in the prior period financial statements were reclassified to conform
to the current presentation.
Note 2 - Comprehensive Income
Other comprehensive income for the Company consists of net unrealized gains and
losses on investment securities available for sale. Total comprehensive income
for the three months ended June 30, 2006 was $806,000 compared to $2,893,000 for
the three months ended June 30, 2005. Total comprehensive income for the six
months ended June 30, 2006 was $3,651,000 compared to $3,688,000 for the six
months ended June 30, 2005.
Note 3 - Stock-based Compensation
During 2000, the Company adopted the 2000 Long-Term Incentive Plan (the 2000
Plan) which allows for stock option awards for up to 253,000 shares of the
Company's common stock to employees, officers, and directors of the Company.
The Company
6
believes that such awards better align the interests of its employees with those
of its shareholders. Under the provisions of the 2000 Plan, the option price is
determined by a committee of the board of directors at the time of grant and may
not be less than 100% of the fair value of the common stock on the date of the
grant of such option. Generally, when granted, these options vest over a
five-year period. However, there were 10,000 options granted in 2005, that vest
based on specific loan growth performance targets. All options must be
exercised within a ten-year period.
During 2006, the Company adopted the 2006 Long-Term Incentive Plan (the 2006
Plan) which allows for stock options awards for up to 250,000 shares of the
Company's common stock to key employees, officers, directors and independent
contractors providing material services to the Bank. The purpose of the Plan is
to enhance stockholder investment by attracting, retaining and motivating key
employees, officers, directors and independent contractors of the Bank, and to
encourage stock ownership by such persons by providing them with a means to
acquire a proprietary interest in the Bank's success, and to align the interests
of management with those of stockholders. Under the provisions of the 2006
Plan, the option price is determined by a committee of the board of directors at
the time of grant and may not be less than 100% of the fair value of the common
stock on the date of the grant of such option. Notwithstanding the foregoing,
in the case of an Incentive Stock Option granted to a Participant who is a Ten
Percent Stockholder, the Option Price shall not be less than one hundred and ten
percent (110%) of the Fair Market Value of the Common Stock on the Date of
Grant. Generally, when granted, these options vest over a five-year period.
All options must be exercised within a ten year period from the date of the
grant; however, options issued to a ten percent stockholder must be exercised
within a five year period from its date of grant. As of June 30, 2006, no
options had been granted under this Plan.
The Company periodically purchases treasury stock and uses it for stock option
exercises, when available. If treasury stock is not available, additional stock
is issued. The Company estimates it will repurchase 25,000 shares or less
during the 2006 year.
The Company will accept as payment for options exercised, at the optionee's
discretion, cash, or shares of the Company's stock at market value, or a
combination of cash and Company stock. For the three months ended June 30,
2006, the Company received $12,000 in cash, and no stock was received. For the
three months ended June 30, 2005, no stock options were exercised. For the six
months ended June 30, 2006, the Company received $176,000 in cash, and stock
with a fair market value of $22,000. For the six months ended June 30, 2005,
the Company received stock with a fair market value of $210,000 and no cash was
received. All options issued are incentive stock options and therefore, no tax
benefit is realized.
Effective January 1, 2006, the Company adopted SFAS No. 123 (Revised 2004),
Accounting for Stock-Based Compensation, which requires the Company to compute
the fair value of options at the date of grant and to recognize such costs as
compensation expense ratably over the vesting period of the options. For the
three and six months ended June 30, 2006, the Company recognized $189,000 and
$259,000, respectively, as compensation expense resulting from all stock
options. This expense includes $138,000
7
related to the accelerated stock option vesting period for two key employees.
The Company accelerated this vesting period to cause expense as to partially
offset a $526,000 gain on sale of equity securities.
The fair value of each option is estimated on the date of grant using the
Black-Scholes valuation model that uses the assumptions noted in the following
table. Expected volatility is the annualized standard deviation of the
continuously compounded rate of return. The method used to calculate historical
average annualized volatility is based on the closing price of the first trade
of each month. Expected dividends are based on the Company's historical pattern
of dividend payments. The Company uses historical data to estimate option
exercise and employee termination within the valuation model. The risk-free rate
is the ten year U.S. Treasury note at the time of grant.
Stock Options with a Specified Vesting Period
- ---------------------------------------------
The following tables provide information for stock options that vest over a five
year period.
Three Months Ended June 30 Six Months Ended June 30
------------------------------- --------------------------------
2006 2005 2006 2005
--------------- -------------- --------------- ---------------
Expected volatility 37.36% - 33.47% - 37.36% 29.87%
Expected dividend yield 2.00% - 2.00% 2.00%
Expected option life 7.92 - 7.92 8.54
Risk-free interest rate 5.14% - 4.36% - 5.14% 4.05%
A summary of activity for stock options that vest over a five year period as of
June 30, 2006 and June 30, 2005, and changes during the six months is presented
in the following table:
8
For the Six Months Ended June 30, 2006 and 2005
-----------------------------------------------------
Weighted
Weighted average
average remaining Aggregate
exercise contractual life Intrinsic
Shares price/share in years Value
-------- ------------- ---------------- ----------
Options outstanding - December 31, 2005 205,434 $ 21.35
Granted in 2006 10,000 38.63
Options exercised in 2006 (17,674) (11.18)
-------- -------------
Options outstanding - June 30, 2006 197,760 $ 23.15 6.94 $2,936,736
======== ============= ================ ==========
Exercisable at June 30, 2006 98,220 $ 17.05 5.93 $2,057,709
======== ============= ================ ==========
Options outstanding - December 31, 2004 188,040 $ 17.05
Granted in 2005 9,000 30.00
Options exercised in 2005 (13,200) (15.90)
-------- -------------
Options outstanding - June 30, 2005 183,840 $ 17.77 7.02 $2,983,723
======== ============= ================ ==========
Exercisable at June 30, 2005 84,872 $ 14.93 6.44 $1,618,509
======== ============= ================ ==========
The weighted average grant-date fair value of the options granted during the
three months ended June 30, 2006 was $14.13. There were no options granted
during the three month period ended June 30, 2005. The weighted average
grant-date fair value of the options granted during the six months ended June
30, 2006 and June 30, 2005 was $14.87 and $10.52, respectively. The total
intrinsic value of options exercised during the three months ended June 30, 2006
was $19,000. There were no options exercised during the three months ended June
30, 2005. The total intrinsic value of options exercised during the six months
ended June 30, 2006 and June 30, 2005 was $475,000 and $219,000, respectively.
A summary of the status of the Company's nonvested shares as of June 30, 2006
and June 30, 2005 is presented in the following table.
9
Weighted
Average
Grant date
Shares Fair value
-------- -----------
Nonvested at December 31, 2005 115,837 $ 17.73
Granted in 2006 10,000 14.87
Vested in 2006 (26,297) 15.98
-------- -----------
Nonvested at June 30, 2006 99,540 $ 17.90
======== ===========
Nonvested at December 31, 2004 115,851 $ 19.57
Granted in 2005 9,000 10.00
Vested in 2005 (25,883) 16.46
-------- -----------
Nonvested at June 30, 2005 98,968 $ 19.52
======== ===========
As of June 30, 2006, there was $532,000 of total unrecognized compensation cost
related to nonvested options that vest over a five year period. That cost is
expected to be recognized over a weighted average period of 3.1 years. The
total fair value of shares vested during the six month periods ended June 30,
2006 and 2005 was $1.0 million and $834,000, respectively.
Performance Stock Options
- ---------------------------
The following tables provide information for stock options that vest based on
specific loan growth performance targets.
For the Six Months Ended June 30, 2005 and 2006
--------------------------------------------------
Weighted
average
remaining Aggregate
Exercise contractual life Intrinsic
Shares price/share in years Value
------ ------------ ---------------- ----------
Options outstanding- December 31, 2005 10,000 $ 34.30
Granted in 2006 - -
Options exercised in 2006 - -
------ ------------
Options outstanding - June 30, 2006 10,000 $ 34.30 9.0 $ 37,000
====== ============ ================ ==========
Exercisable at June 30, 2006 - $ - - $ -
====== ============ ================ ==========
10
There were no options based on performance granted as of June 30, 2005.
Weighted
Average
Grant Date
Shares Fair Value
------ -----------
Nonvested at December 31, 2005 10,000 $ 11.59
------ -----------
Granted in 2006 - -
Vested in 2006 - -
------ -----------
Nonvested at June 30, 2006 10,000 $ 11.59
====== ===========
As of June 30, 2006, there was $60,000 of total unrecognized compensation cost
related to nonvested options granted based on performance. That cost is
expected to be recognized over a weighted average period of 4.0 years.
Pro Forma Earnings Per Share
- ----------------------------
Had compensation cost been determined based upon the fair value of the options
at the grant dates consistent with the method recommended by SFAS No. 123, the
Company's net income and income per share, on a pro forma basis, for the three
and six months ended June 30, 2005 is indicated in the following table.
Three Months Six Months
Ended Ended
June 30, 2005 June 30, 2005
-------------- --------------
Net income $ 2,405,732 $ 4,489,721
Deduct: Total stock-based
Compensation expense determined
Under fair value based method,
net of related tax effect 54,261 108,522
-------------- --------------
Pro Forma, net income $ 2,351,471 $ 4,381,199
============== ==============
Basic net income per share:
As reported $ 0.46 $ 0.85
Pro forma $ 0.45 $ 0.83
Diluted net income per share:
As reported $ 0.45 $ 0.84
Pro forma $ 0.44 $ 0.82
Note 4 - Cash Dividend Declared
On April 18, 2006, the Company declared a quarterly cash dividend of $0.13 per
share on outstanding shares. The dividend was paid on May 19, 2006 to
shareholders of record as of May 4, 2006.
11
On July 19, 2006, the Company declared a quarterly cash dividend of $0.13 per
share on outstanding shares. The dividend is payable on August 15, 2006 to
shareholders of record as of August 4, 2006.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
- --------
The Bank was organized by a group of local citizens and commenced business on
August 28, 1989, with one branch location. Today, the Bank is Augusta's largest
community banking company operating eight full service branches in Richmond and
Columbia counties in Augusta, Martinez, and Evans, Georgia and one branch in
Athens, Georgia. The Bank operates two mortgage origination offices in Augusta,
Georgia, and Savannah, Georgia. The Savannah, Georgia office also offers
construction lending services. Bank and mortgage operations are located in
Augusta, Georgia in two operations campuses located in close proximity to the
main office in Augusta, Georgia. Wealth management and trust services are
located in the main office. The Company received approval from the Office of
Thrift Supervision in July 2006 to open a federally chartered thrift in Aiken,
South Carolina and anticipates that the thrift will open for business in
September 2006.
Richmond and Columbia counties have a diversified economy based primarily on
government, transportation, public utilities, health care, manufacturing,
construction, and wholesale and retail trade. Augusta is one of the leading
medical centers in the Southeast. The 2005 population of the Augusta-Richmond
County, GA-SC metropolitan area was 520,332, the second largest in Georgia. The
Bank expanded into the Athens, Georgia market in December 2005. Athens has a
diversified economy which includes government, retail services, tourism,
manufacturing, other services, and health care, with the largest share of
government jobs in the state. The Athens-Clarke County, GA metropolitan area
ranks sixth in Georgia with a 2005 population of 175,085.
The Bank's services include the origination of residential and commercial real
estate loans, construction and development loans, and commercial and consumer
loans. The Bank also offers a variety of deposit programs, including
noninterest-bearing demand, interest checking, money management, savings, and
time deposits. In the Augusta-Richmond County, GA-SC metropolitan area, the Bank
had 11.25% of all deposits and was the fourth largest depository institution at
June 30, 2005, as cited from the Federal Deposit Insurance Corporation's
website. Securities sold under repurchase agreements are also offered.
Additional services include wealth management, trust, retail investment, and
mortgage. As a matter of practice, most mortgage loans are sold in the secondary
market; however, some mortgage loans are placed in the portfolio based on
asset/liability management strategies. The Bank continues to concentrate on
increasing its market share through various new deposit and loan products and
other financial services and by focusing on the customer relationship management
philosophy. The Bank is committed to building life-long relationships with its
customers, employees, shareholders, and the communities it serves.
The Bank's primary source of income is from its lending activities followed by
interest income from its investment activities, service charges and fees on
deposits, and gain on sales of mortgage loans in the secondary market. Interest
income on loans and
13
investment securities increased during the first six months of 2006 as compared
to the first six months of 2005 due to rising interest rates and increased
volumes. Service charges and fees on deposits increased for the first six
months of 2006 as compared to the same period in 2005 due to increases in NSF
income on retail checking accounts and debit/ATM card income, both the result of
new account growth. Gain on sales of mortgage loans increased due to higher
production levels. Other significant contributors to income are trust services
fees and retail investment income.
The Bank continues to experience steady growth. Over the past four years,
assets grew from $481.5 million at December 31, 2001 to $864.3 million at
December 31, 2005. At June 30, 2006, assets were $937.9 million. From year end
2001 to year end 2005, loans increased $261.6 million, and deposits increased
$294.5 million. From December 31, 2005 to June 30, 2006, loans increased $57.5
million and deposits increased $66.0 million. Also, from 2001 to 2005, return
on average equity increased from 12.19% to 16.15% and return on average assets
increased from 1.02% to 1.27%. For the six months ended June 30 2006,
annualized return on average assets was 1.20% and annualized return on average
equity was 16.47%. Net income for the year ended 2001 was $4.6 million compared
to net income of $10.0 million at year end 2005. Net income for the six months
ended June 30, 2006 was $5.4 million. The Company has reached a level of
maturity evidenced by long-term financial performance and stability that
resulted in cash dividends of $0.13 per share paid for each quarter of 2004 and
2005 and for the first two quarters of 2006.
The Bank meets its liquidity needs by managing cash and due from banks, federal
funds purchased and sold, maturity of investment securities, principal
repayments from mortgage-backed securities, and draws on lines of credit.
Additionally, liquidity can be managed through structuring deposit and loan
maturities. The Bank funds loan and investment growth with core deposits,
securities sold under repurchase agreements and Federal Home Loan Bank advances.
During inflationary periods, interest rates generally increase and operating
expenses generally rise. When interest rates rise, variable rate loans and
investments produce higher earnings; however, deposit and other borrowings
interest expense also rise. The Bank monitors its interest rate risk as it
applies to net income in a ramp up and down annually 200 basis points (2%)
scenario and as it applies to economic value of equity in a shock up and down
200 (2%) basis points scenario. The Bank monitors operating expenses through
responsibility center budgeting.
Forward-Looking Statements
- ---------------------------
Southeastern Bank Financial Corporation (the "Company") may, from time to time,
make written or oral forward-looking statements, including statements contained
in the Company's filings with the Securities and Exchange Commission (the
"Commission") and its reports to shareholders. Statements made in such
documents, other than those concerning historical information, should be
considered forward-looking and subject to various risks and uncertainties. Such
forward-looking statements are made based upon management's belief as well as
assumptions made by, and information currently available to, management pursuant
to "safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. The Company's actual results may differ materially from the
14
results anticipated in forward-looking statements due to a variety of factors,
including unanticipated changes in the Bank's local economy, the national
economy, governmental monetary and fiscal policies, deposit levels, loan demand,
loan collateral values and securities portfolio values; difficulties in interest
rate risk management; the effects of competition in the banking business;
difficulties in expanding the Bank's business into new markets; changes in
governmental regulation relating to the banking industry, including regulations
relating to branching and acquisitions; failure of assumptions underlying the
establishment of reserves for loan losses, including the value of collateral
underlying delinquent loans; and other factors. The Company cautions that such
factors are not exclusive. The Company does not undertake to update any
forward-looking statement that may be made from time to time by, or on behalf
of, the Company.
Critical Accounting Estimates
- -------------------------------
The accounting and financial reporting policies of the Company conform to
accounting principles generally accepted in the United States of America and to
general practices within the banking industry. Of these policies, management has
identified the allowance for loan losses as a critical accounting estimate that
requires difficult, subjective judgment and is important to the presentation of
the financial condition and results of operations of the Company.
The allowance for loan losses is established through a provision for loan losses
charged to expense, which affects the Company's earnings directly. Loans are
charged against the allowance for loan losses when management believes that the
collectibility of the principal is unlikely. Subsequent recoveries are added to
the allowance. The allowance is an amount that management believes will be
adequate to absorb losses on existing loans that become uncollectible, based on
evaluations of the collectibility of loans. The evaluations take into
consideration such factors as changes in the nature and volume of the loan
portfolio, historical loss rates, overall portfolio quality, review of specific
problem loans, and current economic conditions and trends that may affect a
borrower's ability to repay.
The Company segments its allowance for loan losses into the following three
major categories: 1) identified losses for impaired loans; 2) general allocation
for Classified/Watch loans; and 3) general allocation for loans with
satisfactory ratings. Risk ratings are initially assigned in accordance with the
Bank's loan and collection policy. An organizationally independent department
reviews grade assignments on an ongoing basis. Management reviews current
information and events regarding a borrower's financial condition and strengths,
cash flows available for debt repayment, the related collateral supporting the
loan and the effects of known and expected economic conditions. When the
evaluation reflects a greater than normal risk associated with the individual
loan, management classifies the loan accordingly. If the loan is determined to
be impaired, management allocates a portion of the allowance for loan losses for
that loan based upon the present value of future cash flows discounted at the
loan's effective interest rate, or the fair value of the collateral if
collection of the loan is deemed to be dependent upon the collateral. Regulatory
guidance is also considered. Cash receipts for accruing loans are applied to
principal and interest under the contractual terms of the loan
15
agreement; however, cash receipts on impaired and nonaccrual loans for which the
accrual of interest has been discontinued are generally applied first to
principal and then to interest income depending upon the overall risk of
principal loss to the Company. Impaired and Classified/Watch loans are
aggressively monitored. The allocation for loans rated satisfactory is further
subdivided into various types of loans as defined by call report codes. The
Company's management also gives consideration to subjective factors such as,
national and local economic conditions, bankruptcy trends, unemployment trends,
loan concentrations, and competitive factors in the local market. These factors
represent uncertainties in the Bank's business environment and are included in
the various individual components of the allowance for loan losses.
Performance Overview -- Net Income
- ----------------------------------
The Company's net income for the second quarter of 2006 was $2.9 million, which
was an increase of $521,000 (21.6%) compared to net income of $2.4 million for
the second quarter of 2005. Diluted net income per share for the three months
ended June 30, 2006 was $0.55 compared to $0.45 for the three months ended June
30, 2005. Net income for the first six months of 2006 was $5.4 million, an
increase of $897,000 (20.0%) compared with net income of $4.5 million for the
first six months of 2005. The increase in net income for the three and six
months ended June 30, 2006 as compared with the three and six months ended June
30, 2005, was primarily a result of increases in net interest income and
noninterest income, somewhat offset by increases in noninterest expense.
Interest income on both loans and investment securities increased due to
increased volumes and higher interest rates. Interest expense on deposits,
securities sold under repurchase agreements and other borrowings increased as a
result of rising interest rates and higher volumes. Factors contributing to the
increase in noninterest income for the three and six months ended June 30, 2006,
were increases in both service charges and fees on deposits and net investment
securities gains. NSF fees on retail checking accounts and debit/ATM card
income increased due to new account growth, somewhat offset by decreases in
service charges on business checking accounts due to increases in the earnings
credit. Net investment securities gains increased due to a $526,000 gain
recognized on the sale of equity securities, partially offset by losses on the
sale of agency securities. Increases in gain on sales of loans, retail
investment income and increase in cash-surrender value of bank-owned life
insurance also contributed to the increase in non-interest income for the six
months ended June 30, 2006. Noninterest expense increased during the three and
six months ended June 30, 2006 compared to the same periods ended June 30, 2005,
primarily due to increases in salaries and employee benefits related to company
growth and increases in other operating expenses. The increase in noninterest
expense for the six months ended June 30, 2006 included $610,000 in expenses
related to the Company's expansion into new markets. Significant changes in
other operating expenses during the three and six month periods include
increases in processing expenses for retail and business checking products and
retail investment services as well as increases in contributions for a $200,000
donation to Georgia Bank Foundation. Professional fees increased for the
six-month period for Sarbanes-Oxley 404 compliance, legal fees and other
advisory services.
16
Total assets of $937.9 million at June 30, 2006 reflect an increase of $73.7
million (8.5%) from year-end 2005. This increase is primarily attributable to
higher balances for loans, federal funds sold and investment securities since
December 2005. Total loans at June 30, 2006 were $658.7 million which
represented an increase of $57.5 million (9.6%) from December 31, 2005. Since
December 31, 2005, federal funds sold increased $5.4 million (194.6%),
investment securities increased $4.2 million (2.1%), and cash surrender value of
bank-owned life insurance increased $3.8 million (32.1%). These increases were
funded by increases in total deposits of $66.0 million (9.9%), increases in
subordinated debentures of $10.0 million (100.0%) and increases in Federal Home
Loan Bank advances of $8.0 million (15.4%), somewhat offset by decreases in
securities sold under repurchase agreements of $12.6 million (18.8%). Net
income of $5.4 million less dividends paid of $1.4 million also contributed to
the funding.
The annualized return on average assets for the Company was 1.20% for the six
months ended June 30, 2006, compared to 1.21% for the same period last year.
The steady ratio reflects growth of both net income and assets in proportion to
one another during the periods compared. The annualized return on average
stockholders' equity was 16.47% for the six months ended June 30, 2006, compared
to 15.10% for the same period last year. The increase is primarily attributable
to net income growth and increases in accumulated other comprehensive loss.
Net Interest Income
- ---------------------
Table 1 - Net Interest Income
Three Months Ended Six Months Ended
June 30 Variance June 30, Variance
------------------ ------------------ ------------------ ------------------
2006 2005 Amount % 2006 2005 Amount %
-------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Interest income:
Loans, including fees $ 13,018 $ 9,272 $ 3,746 40.4% $ 24,830 $ 17,515 $ 7,315 41.8%
Investment securities 2,702 1,937 765 39.5% 5,158 3,701 1,457 39.4%
Interest expense:
Deposits 5,547 3,245 2,302 70.9% 10,466 5,891 4,575 77.7%
Federal funds purchased
and securities sold under
repurchase agreements 725 350 375 107.1% 1,409 622 787 126.5%
Other borrowings 1,058 554 504 91.0% 1,905 1,062 843 79.4%
Net interest income 8,440 7,161 1,279 17.9% 16,417 13,802 2,615 18.9%
Net interest income increased $1.3 million (17.9%) during the three-month period
and $2.6 million (18.9%) during the six-month period due to an increase in
average earning assets. Interest-earning assets were $893.5 million at June 30,
2006, an increase of $144.0 million (19.2%) over June 30, 2005 and $71.0 million
(8.6%) over December 31, 2005. Loan interest income increased $3.7 million and
$7.3 million in the three and six month periods, respectively, while deposit
interest expense increased $2.3 million and $4.6 million in the three and six
17
month periods, respectively, all the result of rising interest rates and the
continued growth of account balances. The annual average balance for loans was
$626.0 million at June 30, 2006 with an annualized average yield of 7.92%
compared to $513.5 million at June 30, 2005 with an annualized average yield of
6.82%. Deposits had an annual average balance of $600.0 million with an
annualized average rate of 3.52% at June 30, 2006 compared to $498.7 million and
2.38% at June 30, 2005. Other contributing factors during both the three and
six month periods included increases in interest income on investment
securities, increases in interest expense on other borrowings and increases in
interest expense on federal funds purchased and securities sold under repurchase
agreements, all the result of increased volumes and higher interest rates.
The Company's net interest margin for both the three and six months ended June
30, 2006 was 3.84% as compared to 3.95% for the three and six months ended June
30, 2005. The decrease in the net interest margin for both the three and six
month periods is primarily the result of increases in the cost to fund earning
assets due to interest expense on subordinated debentures issued in December
2005 and March 2006. Interest expense on subordinated debentures was $326,000
for the three months ended June 30, 2006 and $518,000 for the six months ended
June 30, 2006.
Noninterest Income
- ------------------
Table 2 - Noninterest Income
Three Months Ended Six Months Ended
June 30, Variance June 30, Variance
------------------- ------------------- ------------------- ------------------
2006 2005 Amount % 2006 2005 Amount %
-------- --------- --------- -------- -------- --------- -------- --------
(Dollars in thousands)
Service charges and fees
on deposits $ 1,540 $ 1,354 $ 186 13.7% $ 2,892 $ 2,565 $ 327 12.7%
Gain on sales of loans 1,271 1,298 (27) (2.1%) 2,525 2,341 184 7.9%
Investment securities
gains (losses), net 284 (40) 324 (810.0%) 284 (39) 323 (828.2%)
Retail investment income 217 122 95 77.9% 384 204 180 88.2%
Increase in cash surrender
value of bank-owned
life insurance 150 102 48 47.1% 289 185 104 56.2%
Noninterest income 3,806 3,189 617 19.3% 7,062 5,890 1,172 19.9%
Noninterest income increased $617,000 (19.3%) during the three-month period and
$1.2 million (19.9%) during the six-month period. The most significant changes
for the three and six month periods were for service charges and fees on
deposits and net investment securities gains. Increases in service charges and
fees on deposits during both the three and six month periods were primarily due
to increases in NSF fees for retail checking accounts and debit/ATM card income,
both the result of new account growth, somewhat
18
offset by decreases in service charges on business checking accounts due to
increases in the earnings credit. Increases in net investment securities gains
for both the three and six month periods were the result of a $526,000 gain
recognized on the sale of equity securities, partially offset by losses on the
sale of agency securities. Other contributing factors to the increase in
noninterest income for the six-month period include increases in gain on sales
of loans due to increased mortgage production, which is primarily the result of
new personnel, increases in retail investment income due to production by new
personnel and increases in the increase in cash-surrender value of bank-owned
life insurance due to an additional purchase of $3.5 million in bank-owned life
insurance in February 2006.
Noninterest Expense
- --------------------
Table 3 - Noninterest Expense
Three Months Ended Six Months Ended
June 30, Variance June 30, Variance
------------------ ------------------ ------------------ ------------------
2006 2005 Amount % 2006 2005 Amount %
-------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Salaries $ 3,428 $ 3,014 $ 414 13.7% $ 6,808 $ 5,763 $ 1,045 18.1%
Employee benefits 1,078 776 302 38.9% 2,137 1,585 552 34.8%
Occupancy expenses 685 683 2 0.3% 1,434 1,356 78 5.8%
Other operating expenses 2,041 1,734 307 17.7% 4,019 3,240 779 24.0%
-------- -------- -------- -------- -------- -------- -------- --------
Total noninterest expense $ 7,232 $ 6,207 $ 1,025 16.5% $ 14,398 $ 11,944 $ 2,454 20.5%
======== ======== ======== ======== ======== ======== ======== ========
Noninterest expense increased $1.0 million (16.5%) during the three-month period
and $2.5 million (20.5%) during the six-month period. Noninterest expense
attributable to the Company's expansion into new markets totaled $279,000 for
the three months ended June 30, 2006 and $610,000 for the six months ended June
30, 2006. Salary expense increased during the three and six month periods
primarily as the result of company growth related to new markets, opening of a
customer care center and expansion of the wealth management area. Increases in
employee benefits during the three and six month periods were for FICA taxes and
medical expenses directly related to salaries and for stock option compensation
expense recognized for the acceleration of the vesting period for two key
employees and to comply with SFAS No. 123 (Revised 2004). Other operating
expenses increased $307,000 (17.7%) for the three-month period and $779,000
(24.0%) for the six-month period. Increases in processing expenses during both
the three and six month periods were attributable to new account growth for both
retail and business checking products and retail investment processing fees
related to increased production. Contributions increased for both the three and
six month periods as the result of a $200,000 donation made to Georgia Bank
Foundation. Professional fees increased for the six-month period for
Sarbanes-Oxley 404 compliance, legal fees and other advisory services.
19
Income Taxes
- -------------
Income tax expense in the second quarter of 2006 totaled $1.6 million, an
increase of $410,000 (33.5%) over the second quarter of 2005. The effective tax
rate for the three months ended June 30, 2006 and 2005 was 35.8% and 33.7%,
respectively. Income tax expense for the six months ended June 30, 2006 totaled
$2.7 million for an effective tax rate of 33.7% compared to 33.6% for the six
months ended June 30, 2005. The increase in the effective tax rate for the
three month period is primarily due to nondeductible stock option expense
related to incentive stock options recorded in the second quarter of 2006. For
the six months ended June 30, 2006 as compared to the six months ended June 30,
2005, the nondeductible stock option expense and the increase in disallowed
state agency and non-Georgia municipal interest income was mostly offset by
increases in federal deductible interest income.
Asset Quality
- --------------
Table 4 which follows shows the current and prior period amounts of
non-performing assets. Non-performing assets were $3.2 million at June 30, 2006,
compared to $4.0 million at December 31, 2005 and June 30, 2005. Significant
changes from December 2005 to June 2006 include a $723,000 decrease in
non-performing assets with balances less than $100,000, a $940,000 decrease for
one customer from a combination of collateral sale and charge-off, and a $1.0
million increase for three customers added to nonaccrual status. The ratio of
non-performing assets to total loans and other real estate was 0.48% at June 30,
2006, compared to 0.67% at December 31, 2005 and 0.72% at June 30, 2005. The
control and monitoring of non-performing assets continues to be a priority of
management.
There were no loans past due 90 days or more and still accruing at June 30, 2006
and June 30, 2005. At December 31, 2005 there were loans past due 90 days or
more and still accruing of $1,000.
Table 4 - Non-Performing Assets
(Dollars in thousands)
June 30, 2006 December 31, 2005 June 30, 2005
-------------- ------------------ --------------
Nonaccrual loans $ 3,185 $ 4,009 $ 3,955
Other real estate owned - - -
-------------- ------------------ --------------
Total non-performing assets $ 3,185 $ 4,009 $ 3,955
============== ================== ==============
Loans past due 90 days or more
and still accruing interest $ - $ 1 $ -
============== ================== ==============
20
Allowance for Loan Losses
- ----------------------------
The allowance for loan losses represents an allocation for probable incurred
loan losses in the loan portfolio. The adequacy of the allowance for loan
losses is evaluated periodically based on a review of all significant loans,
with particular emphasis on impaired, non-accruing, past due, and other loans
that management believes require special attention. The determination of the
allowance for loan losses is considered a critical accounting estimate of the
Company. See "Critical Accounting Estimates."
When reviewing the allowance for loan losses, it is important to understand to
whom the Company lends. The following table sets forth the composition of the
Company's loan portfolio as of June 30, 2006 and December 31, 2005.
Table 5 - Loan Portfolio Composition
June 30, 2006 December 31, 2005
------------------- -------------------
Amount % Amount %
--------- -------- --------- --------
(Dollars in thousands)
Commercial financial and agricultural. $ 75,260 11.43% $ 64,398 10.71%
--------- -------- --------- --------
Real estate
Commercial 187,859 28.52% 171,652 28.55%
Residential 125,034 18.98% 123,960 20.62%
Residential held for sale 20,101 3.05% 22,147 3.68%
Construction and
development 218,131 33.11% 184,826 30.74%
--------- -------- --------- --------
Total real estate 551,125 83.67% 502,585 83.59%
--------- -------- --------- --------
Lease financing 132 0.02% 111 0.02%
Consumer
Direct. 24,591 3.73% 24,343 4.05%
Indirect 7,725 1.17% 9,752 1.62%
Revolving 745 0.11% 656 0.11%
--------- -------- --------- --------
Total consumer 33,061 5.02% 34,751 5.78%
--------- -------- --------- --------
Deferred loan origination fees (858) -0.13% (610) -0.10%
--------- -------- --------- --------
Total $658,720 100.00% $601,235 100.00%
========= ======== ========= ========
At June 30, 2006, the loan portfolio is comprised of 83.67% real estate loans.
Commercial, financial and agricultural loans comprise 11.43%, and consumer loans
comprise 5.02% of the portfolio.
While the Company has 83.67% of its loan portfolio composed of real estate
loans, this percentage is not significantly higher than in previous years.
Commercial real estate comprises 28.52% of the loan portfolio and is primarily
owner occupied properties where the operations of the commercial entity provide
the necessary cash flow to service the debt. For this portion of real estate
loan portfolio, repayment is not dependent upon the sale of the real estate held
as collateral. Construction and development (33.11%) has been an increasingly
important portion of the real estate loan portfolio. The Company carefully
monitors the loans in this category since the repayment of these loans is
generally dependent upon the sale of the real estate in the normal course of
business and can be impacted by national and local economic conditions. The
residential category,
21
18.98% of the portfolio, represents those loans that the Company chooses to
maintain in its portfolio rather than selling into the secondary market for
marketing and competitive reasons and commercial loans secured by residential
real estate. The residential held for sale category, 3.05% of the portfolio,
comprises loans that are in the process of being sold into the secondary market.
In these loans, the credit has been approved by the investor and the interest
rate locked so that the Company minimizes credit and interest rate risk with
respect to these loans.
The Company has no large loan concentrations to individual borrowers. Unsecured
loans at June 30, 2006 were $10.5 million. While management uses available
information to recognize losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
advise additions to the allowance based on their judgments about information
available to them at the time of their examination. Such regulatory guidance is
considered, and the Company may recognize additions to the allowance as a
result.
Additions to the allowance for loan losses are made periodically to maintain the
allowance at an appropriate level based upon management's analysis of potential
risk in the loan portfolio. Loans determined to be uncollectible are charged to
the allowance for loan losses and subsequent recoveries are added to the
allowance. A provision for losses in the amount of $456,000 was charged to
expense for the quarter ended June 30, 2006 compared to $515,000 for the quarter
ended June 30, 2005, and $960,000 for the six months ended June 30, 2006
compared to $987,000 for the six months ended June 30, 2005. The decrease in
provision for loan losses for both the three and six month periods is primarily
due to adjustments in the allowance calculation for economic and market risk
factors related to improvements in local economic conditions within the
Company's market area and decreases in the levels of Classified and Watch-rated
debt. The increase in the allowance for loans losses as of June 30, 2006 as
compared to June 30, 2005 is primarily due to increases in outstanding loan
balances somewhat offset by decreases to the allowance due to lower levels of
Classified and Watch-rated debt and the change in the allowance calculation
related to economic and market risk factors. Charge-offs for the three and six
months ended June 30, 2006 increased primarily as the result of a $423,000
charge-off for one real estate loan.
Table 6 - Allowance for Loan Losses
2006 2005
----------- -----------
Beginning balance, January 1 $ 9,125 $ 7,930
Provision charged to expense 960 987
Recoveries 426 511
Loans charged off (1,207) (750)
----------- -----------
Ending balance, June 30 $ 9,304 $ 8,678
=========== ===========
At June 30, 2006 the ratio of allowance for loan losses to total loans was 1.41%
compared to 1.52% at December 31, 2005 and 1.57% at June 30, 2005. Management
considers the current allowance for loan losses appropriate based upon its
analysis of the
22
potential risk in the portfolio, although there can be no assurance that the
assumptions underlying such analysis will continue to be correct.
Liquidity and Capital Resources
- ----------------------------------
The Company's liquidity remains adequate to meet operating and loan funding
requirements. The loan to deposit ratio at June 30, 2006 was 90.3% compared to
90.6% at December 31, 2005 and 89.6% at June 30, 2005. The steady loan to
deposit ratio from December 31, 2005 to June 30, 2006 reflects growth of both
loans and deposits in proportion to one another during the first six months of
2006. The increase in the loan to deposit ratio from June 30, 2005 to December
31, 2005 reflects loan growth at a higher rate than deposit growth during that
time period. Deposits at June 30, 2006 and December 31, 2005 include $57.7
million and $40.4 million of brokered certificates of deposit, respectively. The
Company has also utilized borrowings from the Federal Home Loan Bank. The
Company maintains a line of credit with the Federal Home Loan Bank approximating
10% of the Bank's total assets. Federal Home Loan Bank advances are
collateralized by eligible first mortgage loans, commercial real estate loans
and investment securities. These borrowings totaled $60.0 million at June 30,
2006. The Company maintains repurchase lines of credit with SunTrust Robinson
Humphrey, Atlanta, Georgia, for advances up to $20.0 million and with The
Bankers Bank, Atlanta, Georgia, for advances up to $10.0 million of which no
amounts were outstanding in either case at June 30, 2006. The Company has a
federal funds purchased accommodation with The Bankers Bank, Atlanta, Georgia,
for advances up to $16.7 million and with SunTrust Bank, Atlanta, Georgia for
advances up to $10.0 million. Additionally, liquidity needs can be satisfied by
the structuring of the maturities of investment securities and the pricing and
maturities on loans and deposits offered to customers. The Company also uses
retail securities sold under repurchase agreements to fund growth. Retail
securities sold under repurchase agreements were $54.4 million at June 30, 2006.
Shareholders' equity to total assets was 7.07% at June 30, 2006 compared to
7.36% at December 31, 2005 and 7.80% at June 30, 2005. The capital of the
Company and the Bank exceeded all required regulatory guidelines at June 30,
2006. The Company's Tier 1 risk-based, total risk-based and leverage capital
ratios were 12.10%, 13.38%, and 9.74%, respectively, at June 30, 2006. The
following table reflects the current regulatory capital levels in more detail,
including comparisons to the regulatory minimums.
23
Table 7 - Regulatory Capital Requirements
June 30, 2006
(Dollars in Thousands)
Required for capital
Actual adequacy purposes Excess
Amount Percent Amount Percent Amount Percent
----------- ----------- ---------- ----------- ---------- -----------
Southeastern Bank Financial
Corporation
Risk-based capital:
Tier 1 capital $ 90,121 12.10% 29,790 4.00% 60,331 8.10%
Total capital 99,664 13.38% 59,579 8.00% 40,085 5.38%
Tier 1 leverage ratio 90,121 9.74% 37,010 4.00% 53,111 5.74%
Georgia Bank & Trust Company
Risk-based capital:
Tier 1 capital $ 67,245 9.11% 29,527 4.00% 37,718 5.11%
Total capital 76,473 10.36% 59,054 8.00% 17,419 2.36%
Tier 1 leverage ratio 67,245 7.43% 36,199 4.00% 31,046 3.43%
Management is not aware of any events or uncertainties that are reasonably
likely to have a material effect on the Company's liquidity, capital resources
or operations.
Commitments and Contractual Obligations
- ------------------------------------------
The Bank is a party to lines of credit with off-balance sheet risk in the normal
course of business to meet the financing needs of its customers. Lines of
credit are unfunded commitments to extend credit. These instruments involve, in
varying degrees, exposure to credit and interest rate risk in excess of the
amounts recognized in the financial statements. The Bank's exposure to credit
loss in the event of nonperformance by the other party to the financial
instrument for unfunded commitments to extend credit and letters of credit is
represented by the contractual amount of those instruments. The Bank evaluates
construction and acquisition and development loans for the percentage completed
before extending additional credit. The Bank follows the same credit policies
in making commitments and contractual obligations as it does for on-balance
sheet instruments.
Unfunded commitments to extend credit where contract amounts represent potential
credit risk totaled $173.6 million at June 30, 2006. These commitments are
primarily at variable interest rates.
The Company's commitments are funded through internal funding sources of
scheduled repayments of loans and sales and maturities of investment securities
available for sale or
24
external funding sources through acceptance of deposits from customers or
borrowings from other financial institutions.
The following table is a summary of the Company's commitments to extend credit,
commitments under contractual leases as well as the Company' contractual
obligations, consisting of deposits, FHLB advances, which are subject to early
termination options, and borrowed funds by contractual maturity date.
Table 8 - Commitments and
Contractual Obligations Less than 1 - 3 3 - 5 More than
($in thousands) 1 Year Years Years 5 Years
- ---------------------------- ---------- ------- ------- ----------
Lines of credit $ 173,633 - - -
Lease agreements 84 42 9 -
Deposits 670,599 49,788 4,772 4,479
Securities sold under
repurchase agreements 54,404 - - -
FHLB advances 5,000 - 30,000 25,000
Other borrowings 400 - - -
---------- ------- ------- ----------
Total commitments and
contractual obligations $ 904,120 $49,830 $34,781 $ 29,479
========== ======= ======= ==========
Although management regularly monitors the balance of outstanding commitments to
fund loans to ensure funding availability should the need arise, management
believes that the risk of all customers fully drawing on all these lines of
credit at the same time is remote.
Effects of Inflation and Changing Prices
- ----------------------------------------
Inflation generally increases the cost of funds and operating overhead, and to
the extent loans and other assets bear variable rates, the yields on such
assets. Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates generally have a more significant impact on the performance of a
financial institution than the effects of general levels of inflation. Although
interest rates do not necessarily move in the same direction and to the same
extent as the prices of goods and services, increases in inflation generally
have resulted in increased interest rates. In addition, inflation can increase
a financial institution's cost of goods and services purchased, the cost of
salaries and benefits, occupancy expense and similar items. Inflation and
related increases in interest rates generally decrease the market value of
investments and loans held and may adversely affect liquidity, earnings, and
stockholders' equity. Mortgage originations and refinancings tend to slow as
interest rates increase, and can reduce the Company's earnings from such
activities and the income from the sale of residential mortgage loans in the
secondary market.
25
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As of June 30, 2006, there were no substantial changes in the interest rate
sensitivity analysis or the sensitivity of market value of portfolio equity for
various changes in interest rates calculated as of December 31, 2005. The
foregoing disclosures related to the market risk of the Company should be read
in conjunction with the Company's audited consolidated financial statements,
related notes and management's discussion and analysis of financial condition
and results of operations for the year ended December 31, 2005 included in the
Company's 2005 Annual Report on Form 10-K.
Item 4. Controls and Procedures
As of the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's President and Chief Executive Officer
(principal executive officer) and its Group Vice President and Chief Financial
Officer (principal financial officer), of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15. Based upon that evaluation, such officers concluded
that the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiaries) that is required to be included in the Company's
periodic filings with the Securities and Exchange Commission. There have been
no changes in the Company's internal controls or, to the Company's knowledge, in
other factors during the quarter covered by this report that have materially
affected, or are reasonably likely to materially affect, the Company's internal
controls over financial reporting.
26
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
There are no material pending legal proceedings to which the
Company or any of its subsidiaries is a party or of which any of
their property is subject.
Item 1a. Risk Factors
In addition to the other information set forth in this report,
you should carefully consider the factors discussed in Part I,
"Item 1A. Risk Factors" in the Company's Annual Report on Form
10-K for the year ended December 31, 2005, which could materially
affect its business, financial condition or future results. The
risks described in the Annual Report on Form 10-K are not the
only risks facing the Company. Additional risks and uncertainties
not currently known to management or that management currently
deems to be immaterial also may materially adversely affect the
Company's business, financial condition and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
The following table sets forth information regarding the
Company's purchases of its common stock on a monthly basis during
the second quarter of 2006.
- ---------------------------------------------------------------------------------
Maximum Number
(or appropriate
Dollar Value) of
Total Number of Shares (or Units)
Total Shares (or Units) that May Yet be
Number of Average Purchased as Part of Purchased Under
Shares Price Paid Publicly Announced the Plans or
Period Purchased Per Share Plans or Programs Programs
- ---------------------------------------------------------------------------------
April 1 through
April 30, 2006 723 $ 37.50 723 99,277
- ---------------------------------------------------------------------------------
May 1 through
May 31, 2006 - - - 100,000
- ---------------------------------------------------------------------------------
June 1 through
June 30, 2006 109 37.00 109 99,891
- ---------------------------------------------------------------------------------
Total 832 37.43 832 99,891
- ---------------------------------------------------------------------------------
27
On April 15, 2004, the Company announced the commencement of
a stock repurchase program, pursuant to which it will, from time
to time, repurchase up to 100,000 shares of its outstanding
stock. The program does not have a stated expiration date. No
stock repurchase programs were terminated during the second
quarter of 2006.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Shareholders was held on April 19, 2006 at
the Company's Cotton Exchange office located at 32 8th Street,
Augusta, Georgia.
(b) The following directors were elected for a term of one year and
until a successor is duly qualified and elected:
William J. Badger
R. Daniel Blanton
Warren Daniel
Edward G. Meybohm
Robert W. Pollard, Jr.
Randolph R. Smith
Ronald L. Thigpen
John W. Trulock, Jr.
(c) The following matters were voted on at the meeting as was
previously identified in the Proxy materials forwarded to each
shareholder:
1. Proposal to elect the eight individuals nominated by
management as Directors.
Votes were cast as follows:
Director For Withhold
- -------- --- --------
William J. Badger 4,817,399 0
R. Daniel Blanton 4,813,899 3,500
Warren Daniel 4,817,237 162
Edward G. Meybohm 4,817,399 0
Robert W. Pollard, Jr. 4,813,737 3,662
Randolph R. Smith, M.D. 4,813,899 3,500
Ronald L. Thigpen 4,813,899 3,500
John W. Trulock, Jr. 4,742,251 75,148
28
2. Proposal to amend the Articles of Incorporation to eliminate
the preemptive rights provision in Article Eight.
Votes were cast as follows:
For Against Abstain
--- ------- -------
3,844,788 101,410 128,336
3. Proposal to approve the 2006 Long-Term Incentive Plan.
Votes were cast as follows:
For Against Abstain
--- ------- -------
3,787,559 145,670 141,305
Item 5. Other Information
None
Item 6. Exhibits
10.1 2006 Long-Term Incentive Plan
10.2 Form of Incentive Stock Option Agreement under the 2006
Long- Term Incentive Plan
10.3 Form of Non-Qualified Stock Option Agreement under the 2006
Long-Term Incentive Plan
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
29
SOUTHEASTERN BANK FINANCIAL CORPORATION
Form 10-Q Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
SOUTHEASTERN BANK FINANCIAL CORPORATION
Date: August 7, 2006 By: /s/ Darrell R. Rains
---------------- --------------------------------
Darrell R. Rains
Group Vice President, Chief
Financial Officer (Duly Authorized
Officer of Registrant and Principal
Financial Officer)
30