BancTrust Financial Group 10-K 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the fiscal year ended December 31, 2006
For the transition period from to
Commission File No. 0-15423
BANCTRUST FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK $.01 PAR
(Title of class)
Securities registered pursuant to Section 12(g) of the Act:
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15 (d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in rule 12b-2 of the Exchange Act).
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
Aggregate market value of the Common Stock ($.01 Par) held by non-affiliates of the registrant as of February 28, 2007 (assuming that all executive officers, directors and 5% shareholders are affiliates): $214,884,387
Shares of Common Stock ($.01 Par) outstanding at March 09, 2007: 11,184,056
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2007 annual meeting of shareholders are incorporated by reference into Part III.
TABLE OF CONTENTS
Cautionary Note Concerning Forward-Looking Statements
This Annual Report on Form 10-K, other periodic reports filed by us under the Securities Exchange Act of 1934, as amended (the Exchange Act), and any other written or oral statements made by or on behalf of BancTrust may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which reflect our current views with respect to future events and financial performance. These statements can be identified by our use of words like expect, may, could, intend, project, estimate, anticipate, should, will, plan, believe, continue, predict, contemplate and similar expressions. These forward-looking statements reflect our current views, but they are based on assumptions and are subject to risks, uncertainties and other variables that may cause actual results to differ materially from the views, beliefs and projections expressed in such statements, including, in addition to the items discussed under the caption Risk Factors and elsewhere in this Report on Form 10-K, the following:
We caution you not to place undue reliance on our forward-looking statements, which speak only as of the date of this Report on Form 10-K in the case of forward-looking statements contained herein.
We expressly qualify in their entirety all written or oral forward-looking statements attributable to us or any person acting on our behalf by the cautionary statements contained or referred to in this section. We do not intend to update or revise, and we assume no responsibility for updating or revising, any forward-looking statement contained in this Report on Form 10-K, whether as a result of new information, future events or otherwise.
Item 1. Business
BancTrust Financial Group, Inc. is a multi-bank holding company headquartered in Mobile, Alabama. We operate 31 banking offices in the southern half of Alabama and northwest Florida and provide banking and related services in that market area through the following subsidiaries: BankTrust (the Mobile Bank), BankTrust of Alabama (the Eufaula Bank), BankTrust (Florida) (the Florida Bank) and BancTrust Company, Inc. (the Trust Company). We refer to BancTrust Financial Group, Inc. and its subsidiaries as we, us, and our and as BancTrust and the Company throughout this Annual Report on Form 10-K.
We were originally incorporated as a Delaware corporation in 1985 under the name Mobile National Corporation. In 1993, we changed our name to South Alabama Bancorporation, Inc. We operated under that name until May of 2002, when we changed our name to BancTrust Financial Group, Inc. Most of our current executive management team has been in place since 1989. At December 31, 2006, we had total consolidated assets of approximately $1.353 billion, total consolidated deposits of approximately $1.104 billion and total consolidated shareholders equity of approximately $138.5 million.
We formed our Company in 1986 by acquiring all of the stock of the Mobile Bank. In 1993, we acquired the First National Bank, Brewton, Alabama, by means of a merger with that banks holding company. In 1996, we acquired The Monroe County Bank in the same manner. In 1998, we acquired the assets of Peterman State Bank by merging that bank into The Monroe County Bank, and we acquired Commercial National Bank of Demopolis by merger and converted it to an Alabama charter under the name Commercial Bank of Demopolis. We formed the Trust Company in 1998 as a trust corporation under Alabama law. In 1999, we acquired Sweet Water State Bank by means of a merger with that banks holding company. In 2002, we acquired Wewahitchka State Bank by merger with its holding company. In 2003, we acquired the Florida Bank and the Eufaula Bank through a merger with their holding company, CommerceSouth, Inc.
In 2003, we began consolidating the Banks with the merger of BankTrust of Brewton (formerly First National Bank, Brewton) into the Mobile Bank. Continuing this consolidation strategy in 2004, we merged The Monroe County Bank and Commercial Bank of Demopolis into the Mobile Bank, leaving us with five subsidiary banks: the Mobile Bank, the Eufaula Bank, the Florida Bank, Sweet Water State Bank and BankTrust of Florida, formerly Wewahitchka State Bank (the Wewahitchka Bank). On October 15, 2004, we sold the Wewahitchka Bank, including approximately $50.3 million in total assets and approximately $43.4 million in total deposits, for $7.5 million; and on August 1, 2005, we sold Sweet Water State Bank, including approximately $56.0 million in total assets and approximately $50.8 million in total deposits, for $7.0 million, consisting of a $6.5 million purchase price and a $500,000 dividend. We anticipate merging the Eufaula Bank into the Mobile Bank in the second quarter of 2007, but we expect to maintain the Florida Bank as a separate banking subsidiary for the foreseeable future.
Our Banking Subsidiaries
Through our subsidiary banks (the Banks), the Mobile Bank, the Florida Bank and the Eufaula Bank, we offer a wide range of lending services, including real estate, consumer and commercial loans, to individuals, small businesses and other organizations that are located in or conduct a substantial portion of their business in our markets. We also offer a full array of retail and commercial deposit products and fee-based services to support our customers financial needs, including checking accounts, money market accounts, savings accounts and certificates of deposit. For our commercial customers we also offer cash management services such as lock-box, sweep account and repurchase agreements. Other traditional services offered include drive-in banking and night deposit facilities, 24-hour automated teller machines, internet banking, debit and credit card services and telephone banking.
We currently operate 31 bank branches, and we expect to open one additional branch location in 2007, in Fairhope, Alabama.
Our Non-banking Subsidiaries
In addition to our traditional banking services, we also offer our customers a full array of trust services through our subsidiary, the Trust Company. In addition to trust services, we offer our customers certain investment and insurance products through a subsidiary of the Mobile Bank, BancTrust Financial Services, Inc.
The following table sets forth information regarding our holding company and our wholly-owned subsidiaries as of December 31, 2006:
Market Areas and Competition
We offer banking services in our subsidiary Banks market areas of Autauga, Baldwin, Barbour, Escambia, Marengo, Mobile, Monroe and Montgomery Counties in Alabama and in Bay, Okaloosa and Walton Counties in Florida. Trust services are offered throughout Alabama and Florida through our trust subsidiary, BancTrust Company, and investment and certain insurance products are offered to all of our markets through BancTrust Financial Services.
The following table sets forth our Banks total deposits and market share by county as of June 30, 2006:
The banking business is highly competitive, and we experience competition in our market from many other financial institutions. Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the quality and scope of the services rendered, the convenience of banking facilities and, in the case of loans to commercial borrowers, relative lending limits. We compete with commercial banks, credit unions, finance companies, insurance companies, mortgage companies, securities brokerage firms and money market mutual funds, as well as super-regional, national and international financial institutions that operate offices in our market areas. We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and new residents. Many of our competitors are larger financial institutions with substantially greater resources and lending limits such as Regions (which now includes AmSouth), Compass and Wachovia.
We believe our commitment to quality and personalized banking services is a factor, along with our delivery of services, product pricing, convenience and personal and local contacts with our customers, that allows us to compete effectively with these financial institutions.
Overall Business Strategy
Our business strategy is to deliver a full range of bank and banking related products in a responsive and personalized manner. Each subsidiary and its employees are expected to be actively involved in all aspects of the community in which it operates. The members of the boards of directors of each of our subsidiaries are from the local markets which the subsidiary serves. In addition, to further enhance our local knowledge, we maintain local advisory boards in certain of our markets. We are able to compete effectively with larger financial institutions by providing superior customer service with localized decision making capabilities. The holding company provides corporate oversight and efficiencies in certain back office areas such as loan review, marketing and business development, certain personnel matters, accounting, auditing, compliance and information technology.
In early 2004, our Board of Directors adopted a comprehensive Strategic Plan for our consolidated operations. This formal plan provides strategic goals and time-frames for the accomplishments of those goals and provides our executive leadership with guidelines for the operation of our business through the year 2008. Our Strategic Plan focuses on several different operational aspects of our business and includes the following:
Lending Activities and Credit Administration
We originate loans primarily in the categories of commercial, commercial real estate, individual and commercial construction and consumer. We also make available to our customers fixed rate, longer-term real estate mortgage loans in the residential real estate mortgage area. We are able to offer, through third party arrangements, certain mortgage loan products that do not require the longer-term loans to be carried on our
books. These products allow us to gain the benefit of a larger variety of product offerings and have generated a significant amount of fee income for us for the last several years. These fees come from first and second home purchases, as well as from home owners who have elected to refinance their home loans. The loan portfolio mix varies throughout our market areas. Generally speaking, we make loans with relatively short maturities or, in the case of loans with longer maturities, we attempt to issue loans with floating rate arrangements whenever possible. The largest component of our loan portfolio is loans secured by real estate mortgages. We obtain a security interest in real estate, whenever possible, in addition to any other available collateral, in order to increase the likelihood of the ultimate repayment of the loan. These loans will generally fall into one of four categories: (1) commercial, financial and agricultural loans; (2) real estate construction loans; (3) real estate mortgage loans; and (4) installment or consumer loans.
Our loan portfolio at December 31, 2006 was comprised as follows:
DISTRIBUTION OF LOANS BY CATEGORY
Credit Risks and Lending Policies
Certain credit risks are inherent in making loans. These include prepayment risks, risks resulting from uncertainties in the future value of collateral, including real estate values, risks resulting from changes in economic and industry conditions and risks inherent in dealing with individual borrowers. We attempt to mitigate repayment risks by adhering to internal credit policies and procedures.
Our Board of Directors has established and annually reviews our lending policies and procedures. Each of our subsidiary banks have Loan Committees that make credit decisions based on our company-wide lending policies. These policies and procedures include officer and client lending limits, a multi-layered approval process for larger loans, documentation and examination procedures and follow-up procedures for any exceptions to credit policies. Loans above an established limit must be reviewed and approved by the Board of Directors or a Board appointed Loan Committee. There are regulatory restrictions on the dollar amount of loans available for each lending relationship. We adhere to the guidelines established by our regulators and regularly monitor our credit relationships for compliance.
We have a Loan Review Department that is part of the Internal Audit function of our company. Our Loan Review Department reports directly to our Audit Manager. Large credit relationships are reviewed on an on-going basis for continued financial, collateral and guarantor support. New credit offerings are reviewed for adequacy of underwriting and collateral valuation. The Loan Review Department makes periodic on-site visits to each of our subsidiary banks. Typically, during these on-site visits, the loan review officers review 30-35%, by amount, of the subsidiary Banks loan portfolio. All problem loans that are identified are included on an internal watch list. These loans are continually monitored for on-going repayment ability, collateral deterioration and adequacy of any allowance for loan losses.
Deposits and Other Sources of Funding
We consider core deposits to be the main source of funds used to support our assets. We offer a full range of deposit products designed to appeal to both individual and corporate customers, including checking accounts, commercial accounts, savings accounts and other time deposits of various types ranging from daily money market accounts to long-term certificates of deposit. Deposit rates are reviewed regularly by senior management. We believe that the rates we offer are competitive with those offered by other financial institutions in our area. In the fall of 2005 we completed the process of streamlining and standardizing our line of deposit products for each of our subsidiary banks. This new deposit product line allows our employees throughout the Company to offer the same products, regardless of location, and we believe the revised program has helped and will continue to help us attract and retain deposits. In addition, the advertising of our deposit products has become easier and more cost efficient.
Our primary emphasis is placed on attracting and retaining core deposits from customers who will purchase other products and services that we offer. We recognize that it is necessary from time to time to pursue non-core funding sources such as large certificates of deposit from outside of our market area and Federal Home Loan Bank borrowings, especially during periods when loan growth is significantly greater than deposit growth. We view these as secondary sources of funds. Our out-of-market, or brokered, certificates of deposit represented 2.12% of total deposits at December 31, 2006.
Other Banking Services
We offer a full range of other products and services that give our customers convenience and account access. Such products and services include internet and telephone banking, access to funds through ATMs and debit cards, credit cards, safe deposit boxes, travelers checks, direct deposit and customer friendly telephone operators who direct the customer quickly to the appropriate area of the bank. We earn fees for most of these services, including debit and credit card transactions, sales of checks and wire transfers. We receive ATM transaction fees from transactions performed for our customers.
While loans are our primary use of funds, most of our remaining liquid funds, after cash reserves, are invested in short-term securities. We invest primarily in securities issued by U.S. government sponsored enterprises and state and political subdivisions and in mortgage-backed securities. We typically invest any surplus cash in the overnight federal funds market. Interest rate fluctuation, maturity, quality and concentration are all risks associated with the use of funds.
As of December 31, 2006, we had 419 full-time equivalent employees. We are not a party to any collective bargaining agreement, and, in the opinion of Management, we enjoy satisfactory relations with our employees.
Supervision and Regulation
BancTrust and its subsidiaries are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws generally are intended to protect depositors and not shareholders. The following discussion describes the material elements of the regulatory framework that applies to us.
Since we own all of the capital stock of the Banks, we are a bank holding company under the federal Bank Holding Company Act of 1956, as amended (the Bank Holding Company Act). As a result, we are primarily
subject to the supervision, examination and reporting requirements of the Bank Holding Company Act and the regulations of the Federal Reserve Board.
Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserve Boards prior approval before:
Additionally, the Bank Holding Company Act provides that the Federal Reserve Board may not approve any of these transactions if it would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve Board is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve Boards consideration of financial resources generally focuses on capital adequacy, which is discussed below.
Under the Bank Holding Company Act, if we are adequately capitalized and adequately managed, we may purchase banks located either inside or outside of Alabama and Florida. Conversely, an adequately capitalized and adequately managed bank holding company located either inside or outside of Alabama or Florida may purchase a bank located inside Alabama or Florida. In Florida, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits. For example, Florida law prohibits a bank holding company from acquiring control of a financial institution until the target financial institution has been in existence and continually operating as a bank for more than three years.
Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve Board approval prior to any person or company acquiring control of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:
Our common stock is registered under Section 12 of the Securities Exchange Act of 1934. The regulations provide a procedure for challenging any rebuttable presumption of control.
Permitted Activities. A bank holding company is generally permitted under the Bank Holding Company Act to engage in or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in the following activities:
Activities that the Federal Reserve Board has found to be so closely related to banking as to be a proper incident to the business of banking include:
Despite prior approval, the Federal Reserve Board may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding companys continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.
In addition to the permissible bank holding company activities listed above, a bank holding company may qualify and elect to become a financial holding company, permitting the bank holding company to engage in additional activities that are financial in nature or incidental or complementary to financial activity. The Bank Holding Company Act expressly lists the following activities as financial in nature:
To qualify to become a financial holding company, each of our depository institution subsidiaries must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least
satisfactory. Additionally, we must file an election with the Federal Reserve Board to become a financial holding company and must provide the Federal Reserve Board with 30 days written notice prior to engaging in a permitted financial activity. We are not a financial holding company at this time.
Support of Subsidiary Institutions. Under Federal Reserve Board policy, we are expected to act as a source of financial strength for the Banks and to commit resources to support them. This support may be required at times when, without this Federal Reserve Board policy, we might not be inclined to provide it.
Each of our subsidiary Banks is a member of the Federal Deposit Insurance Corporation (the FDIC), and, as such, their respective deposits are insured by the FDIC to the extent provided by law. Each of our subsidiary Banks is also subject to numerous state and federal statutes and regulations that affect its business, activities, and operations, and each is supervised and examined by one or more state or federal bank regulatory agencies. Our subsidiary Banks are state-chartered banks subject to supervision and examination by the state banking authorities of the states in which they are located. The primary state regulator for the Mobile and Eufaula Banks is the Superintendent of the State Banking Department of Alabama. The primary state regulator for the Florida Bank is the Office of Financial Regulation under the Florida Department of Financial Services. The federal banking regulator for each of our Banks, as well as the appropriate state banking authority for each Bank, regularly examines their operations and is given authority to approve or disapprove mergers, consolidations, the establishment of branches and similar corporate actions. The federal and state banking regulators also have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law.
Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) in which all institutions are placed. Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category.
An institution that is categorized as undercapitalized, significantly undercapitalized or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding companys obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiarys assets at the time it became undercapitalized or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.
FDIC Insurance Assessments. The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The system assigns an institution to one of three capital categories: (1) well capitalized; (2) adequately capitalized; and (3) undercapitalized. These three categories are substantially similar to the prompt corrective action categories described above, with the undercapitalized category including institutions that are undercapitalized, significantly undercapitalized and critically undercapitalized for prompt corrective action
purposes. The FDIC also assigns an institution to one of three supervisory subgroups based on a supervisory evaluation that the institutions primary federal regulator provides to the FDIC and information that the FDIC determines to be relevant to the institutions financial condition and the risk posed to the deposit insurance funds. Assessments range from 0 to 27 cents per $100 of deposits, depending on the institutions capital group and supervisory subgroup. In addition, the FDIC imposes assessments to help pay off the $780 million in annual interest payments on the $8 billion Financing Corporation bonds issued in the late 1980s as part of the government rescue of the thrift industry. This assessment rate is adjusted quarterly and is set at 1.3 cents per $100 of deposits for the first quarter of 2007.
The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve Board, the FDIC or the Office of the Comptroller of the Currency, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on our Banks. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.
Other Regulations. Interest and other charges collected or contracted for by our Banks are subject to state usury laws and federal laws concerning interest rates. For example, under the Servicemembers Civil Relief Act, which amended the Soldiers and Sailors Civil Relief Act of 1940, a lender is generally prohibited from charging an annual interest rate in excess of 6% on any obligation for which the borrower is a person on active duty with the United States military.
Our Banks loan operations are also subject to federal laws applicable to credit transactions, such as the:
The deposit operations of our Banks are subject to:
We are required to comply with the capital adequacy standards established by the Federal Reserve Board. The Federal Reserve Board has established a risk-based and a leverage measure of capital adequacy for bank holding companies. The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. Total capital consists of two components, Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generally consists of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 Capital must equal at least 4% of risk-weighted assets. Tier 2 Capital generally consists of subordinated debt, other preferred stock and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital. At December 31, 2006, our ratio of total capital to risk-weighted assets was 12.77% and our ratio of Tier 1 Capital to risk-weighted assets was 11.51%.
In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve Boards risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2006, our leverage ratio was 10.02%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve Board considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.
Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits and certain other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.
Payment of Dividends
BancTrust is a legal entity separate and distinct from our banking and other subsidiaries. Our principal source of cash flow, including cash flow to pay dividends to shareholders, is dividends from our Banks and the Trust Company. There are statutory and regulatory limitations on the payment of dividends by these subsidiaries, and there are statutory and regulatory limitations on our ability to pay dividends to our shareholders.
As to the payment of dividends, each of our state-chartered Banks and the Trust Company are subject to the respective laws and regulations of the state in which it is located and to the regulations of the FDIC. Various federal and state statutory provisions limit the amount of dividends our subsidiary Banks can pay to us without regulatory approval. The approval of the Federal Reserve Board is required for any dividend by a state chartered
bank that is a member of the Federal Reserve System (a state member bank) if the total of all dividends declared by the bank in any calendar year would exceed the total of its net profits (as defined by regulatory agencies) for that year combined with its retained net profits for the preceding two years. In addition, a state member bank may not pay a dividend in an amount greater than its net profits then on hand. State member banks may also be subject to similar restrictions imposed by the laws of the states in which they are chartered. None of our Banks, however, is currently a state member bank.
If, in the opinion of a federal bank regulatory agency, an institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the depository institution, could include the payment of dividends), such agency may require, after notice and hearing, that such institution cease and desist from such practice. The federal banking agencies have indicated that paying dividends that deplete an institutions capital base to an inadequate level would be an unsafe and unsound banking practice. Under current federal law, an insured institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the Federal Reserve Board and the FDIC have issued policy statements which provide that bank holding companies and insured banks should generally pay dividends only out of current operating earnings.
Under Alabama law, a bank may not pay a dividend in excess of 90% of its net earnings until the banks surplus is equal to at least 20% of its capital. An Alabama state bank is also required by Alabama law to obtain the prior approval of the Superintendent of the State Banking Department of Alabama for the payment of dividends if the total of all dividends declared by it in any calendar year will exceed the total of (a) its net earnings (as defined by statute) for that year, plus (b) its retained net earnings for the preceding two years, less any required transfers to surplus. In addition, no dividends may be paid from an Alabama state banks surplus without the prior written approval of the Superintendent.
Under Florida law, the directors of a bank, after charging off bad debts, depreciation, and other worthless assets, if any, and making provision for reasonably anticipated future realized losses on loans and other assets, may quarterly, semiannually or annually declare a dividend of so much of the aggregate of the net profits of that period combined with its retained net profits of the preceding two years as the directors shall judge expedient, and, with the approval of the Florida Office of Financial Regulation, a bank may declare a dividend from retained net profits which accrued prior to the preceding two years, but each bank shall, before the declaration of a dividend on its common stock, carry 20 percent of its net profits for such preceding period as is covered by the dividend to its surplus fund, until the same shall at least equal the amount of its common and preferred stock then issued and outstanding. No bank shall declare any dividend at any such time that its net income from the current year combined with the retained net income from the preceding 2 years is a loss or which would cause the capital accounts of the bank to fall below the minimum amount required by law, regulation, order, or any written agreement with the Florida Office of Financial Regulation or a state or federal regulatory agency.
At December 31, 2006, our subsidiaries were able to pay dividends totaling approximately $18.5 million without the need for regulatory approval.
Restrictions on Transactions with Affiliates
We are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:
The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a banks capital and surplus and, as to all affiliates combined, to 20% of a banks capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Banks must also comply with other provisions designed to avoid the taking of low-quality assets.
We are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.
Consumer Credit Reporting
On December 4, 2003, President Bush signed the Fair and Accurate Credit Transactions Act amending the federal Fair Credit Reporting Act. These amendments to the Fair Credit Reporting Act (the FCRA Amendments) became effective in 2004.
The FCRA Amendments include, among other things:
The FCRA Amendments also prohibit a business that receives consumer information from an affiliate from using that information for marketing purposes unless the consumer is first provided a notice and an opportunity to direct the business not to use the information for such marketing purposes (the opt-out), subject to certain exceptions. We do not share consumer information among our affiliated companies for marketing purposes, except as allowed under exceptions to the notice and opt-out requirements. Because no affiliate of BancTrust is currently sharing consumer information with any other affiliate of BancTrust for marketing purposes, the limitations on sharing of information for marketing purposes do not have a significant impact on us.
Anti-Terrorism and Money Laundering Legislation
The Banks are subject to the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the USA PATRIOT Act), the Bank Secrecy Act and rules and regulations of the Office of Foreign Assets Control (the OFAC). These statutes and related rules and regulations impose requirements and limitations on specific financial transactions and account relationships and are intended to guard against money laundering and terrorism financing. The Banks have each established a customer identification program pursuant to Section 326 of the USA PATRIOT Act and the Bank Secrecy Act, and otherwise have implemented policies and procedures to comply with the foregoing rules.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (SOX) comprehensively revised the laws affecting corporate governance, accounting obligations and corporate reporting for companies, such as BancTrust, with equity or debt securities registered under the Exchange Act. In particular, SOX established: (a) new requirements for audit committees, including independence, expertise, and responsibilities; (b) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (c) new standards for auditors and regulation of audits; (d) increased disclosure and reporting obligations for the reporting company and their directors and executive officers; and (e) new and increased civil and criminal penalties for violations of the securities laws.
Proposed Legislation and Regulatory Action
New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating and doing business in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.
Effect of Governmental Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Boards monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks. The Federal Reserve Board has the power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments of those reports, filed with or furnished to the SEC are available on our website at http://www.banctrustfinancialgroupinc.com. These documents are made available on BancTrusts website as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. You may also request a copy of these filings, at no cost, by writing or telephoning BancTrust at the following address:
BancTrust Financial Group, Inc.
Attn: F. Michael Johnson
100 St. Joseph Street
Mobile, Alabama 36602
Executive Officers of the Registrant
The following table reflects certain information concerning the executive officers of BancTrust. Each such officer holds his office(s) until the first meeting of the Board of Directors following the annual meeting of shareholders each year, or until a successor is chosen, subject to removal at any time by the Board of Directors. Except as otherwise indicated, no family relationships exist among the executive officers and directors of BancTrust, and no such officer holds his office(s) by virtue of any arrangement or understanding between him and any other person except the Board of Directors.
Item 1A. Risk Factors
You should carefully consider the following risk factors and other information included in this Annual Report on Form 10-K. The risks and uncertainties described below are not the only ones we face, and additional risks and uncertainties not presently known to us or that we deem to be less significant may also impair our financial condition and results of operations.
Our business strategy includes significant growth plans. Our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.
We intend to continue pursuing a profitable growth strategy. We cannot assure you that we will be able to expand our market presence in our existing markets or successfully enter new markets or that any such expansion will not adversely affect our results of operations. Failure to manage our growth effectively could have a material adverse effect on our business, future prospects, financial condition or results of operations and could adversely affect our ability to successfully implement our business strategy. Also, if we grow more slowly than anticipated, our operating results could be materially adversely affected.
Our ability to grow successfully will depend on a variety of factors including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and our ability to manage our growth. While we believe we have the management resources and internal systems in place to successfully manage our future growth, there can be no assurance growth opportunities will be available or growth will be successfully managed.
Our business is subject to the vitality of the local economies where we operate, and a downturn in our local economies, including as a result of hurricanes or other adverse weather conditions, could adversely affect our business.
Our success depends in large part upon the growth in population, industry, income levels, deposits and housing starts in our primary and secondary markets. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. Adverse economic conditions in our specific market area could reduce our growth rate, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations. Damage caused by hurricanes and other adverse weather conditions may create economic uncertainty in our market area that could negatively affect our local economies. We cannot predict the long-term effects that hurricanes and other adverse weather conditions may have on our business or results of operations. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.
Any adverse market or economic conditions in Alabama and Northwest Florida may disproportionately increase the risk that our borrowers will be unable to make their loan payments. In addition, the fair value of the real estate we hold as collateral could be adversely affected by unfavorable changes in market and economic conditions. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market, real estate or economic conditions in our market areas, including as a result of Hurricane Katrina and other storms, could adversely affect the value of our assets, our revenues, results of operations and financial condition.
Hurricanes or other adverse weather events could negatively affect our local economies or disrupt our operations, which could have an adverse effect on our business or results of operations.
Our market areas in Alabama and Florida are susceptible to hurricanes. This coastal region experienced major hurricanes in 2004 and 2005. The psychological impact of these storms, the high cost of and, in some cases, lack of property insurance, an over-supply of housing and investment properties along with changing property values and higher taxes over recent years have slowed the economic growth in these areas. Such weather events can disrupt our operations, result in damage to our properties and negatively affect the local economies in which we operate. We cannot predict whether or to what extent damage caused by these hurricanes or damage that may be caused by future hurricanes will affect our operations or the economies in our market areas, but such weather events could result in a decline in loan originations, a decline in the value or destruction of properties securing our loans and an increase in the risk of delinquencies, foreclosures or loan losses. Our business or results of operations may be adversely affected by these and other negative effects of future hurricanes.
We face risks with respect to future expansion.
We may acquire other financial institutions or parts of those institutions in the future and we may engage in de novo branch expansion. We may also consider and enter into new lines of business or offer new products or services. We also may receive future inquiries and have discussions with potential acquirors. Acquisitions and mergers involve a number of expenses and risks, including:
We may incur substantial costs to expand, and we can give no assurance such expansion will result in the levels of profits we seek. There can be no assurance integration efforts for any future mergers or acquisitions will be successful. Also, we may issue equity securities in connection with future acquisitions, which could cause ownership and economic dilution to our shareholders. There is no assurance that, following any future mergers or acquisitions, our integration efforts will be successful or our company, after giving effect to the acquisition, will achieve profits comparable to or better than our historical experience.
If the value of real estate in our core Northern Gulf Coast market were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us.
With a substantial portion of our loans concentrated along the Gulf Coast of South Alabama and Northwest Florida, a decline in local economic conditions could adversely affect the values of our real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse. In particular, we cannot predict whether and to what extent damage caused by hurricanes and other adverse weather in our market areas will cause adverse economic conditions or will disrupt our operations. Any decline in deposits or loan originations, any increase in borrower delinquencies or any decline in the value or condition of mortgaged properties could have a material adverse effect on our business.
In addition to considering the financial strength and cash flow characteristics of our borrowers, the Banks often secure loans with real estate. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower. Real estate values may deteriorate during the time the credit is extended. If we are required to liquidate collateral to satisfy a debt during a period of reduced real estate values, our earnings and capital could be adversely affected.
An inadequate allowance for loan losses would reduce our earnings.
The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, Management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and
provides an allowance for loan losses based upon such assumptions and judgments as well as a percentage of the outstanding balances. If Managements assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb losses, or if the bank regulatory authorities require the Banks to increase the allowance for loan losses as a part of their examination process, the Banks earnings and capital could be significantly and adversely affected.
We may be required to raise additional capital at a time when capital may not be readily available.
We are required by federal and state regulatory authorities, as well as good business practices, to maintain adequate levels of capital to support our operations. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at the time and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.
Changes in interest rates may negatively affect our earnings and the value of our assets.
Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense, our largest recurring expenditure. In a period of rising or declining interest rates, our interest expense could increase or decrease in different amounts and at different rates than the interest that we earn on our assets. Accordingly, changes in interest rates could reduce our net interest income.
Changes in the level of interest rates may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings. A decline in the market value of our assets may limit our ability to borrow additional funds or result in our lenders requiring additional collateral from us under our loan agreements. As a result, we could be required to sell some of our loans and investments under adverse market conditions, upon terms that are not favorable to us, in order to maintain our liquidity. If those sales were made at prices lower than the amortized costs of the investments, we would incur losses.
Competition from financial institutions and other financial service providers may adversely affect our profitability.
The banking business is highly competitive and we experience competition in each of our markets from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as other super-regional, national and international financial institutions that operate offices in our primary market areas and elsewhere.
We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our primary markets, we may face a competitive disadvantage as a result of our smaller size, lack of geographic diversification and inability to spread our marketing costs across a broader market. Although we compete by concentrating our marketing efforts in our primary markets with local advertisements, personal contacts and greater flexibility and responsiveness in working with local customers, we can give no assurance this strategy will continue to be successful.
We are subject to extensive regulation that could limit or restrict our activities.
We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies. Our compliance with these regulations is costly and restricts
certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans, interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capitalization guidelines established by our regulators that require us to maintain adequate capital to support our growth.
The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.
The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission and Nasdaq that are now applicable to us, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. As a result, we have experienced, and may continue to experience, greater compliance costs.
Our directors and executive officers own a significant portion of our common stock.
Our directors and executive officers, as a group, beneficially owned approximately 13.41% of our outstanding common stock as of February 28, 2007. As a result of their ownership, the directors and executive officers will have the ability, by voting their shares in concert, to significantly influence the outcome of all matters submitted to our shareholders for approval, including the election of directors.
We are dependent upon the services of our management team.
Our future success and profitability are substantially dependent upon the management and banking abilities of our senior executives. We believe that our future results will also depend in part upon our attracting and retaining highly skilled and qualified management, sales and marketing personnel. Competition for such personnel is intense, and we cannot assure you that we will be successful in retaining such personnel. We also cannot guarantee that members of our executive management team will remain with us. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition and results of operations.
Item 2. Properties
Our corporate headquarters occupy an approximately 30,000 square foot facility located at 100 St. Joseph Street, in downtown Mobile, Alabama 36602. We lease this entire facility, which also houses the headquarters of the Trust Company and the Mobile Bank. The current term of the lease for this building expires on December 31, 2010. We have an option to extend this lease for one additional term of five years. In addition to our corporate headquarters, we operate 30 office or branch locations in Southern and Central Alabama and Northwest Florida, of which 27 are owned and three are subject to either building or ground leases. In 2005, we purchased a building in downtown Mobile for use as an operations center. We paid annual rents in 2006 of approximately $380 thousand. At December 31, 2006, there were no significant encumbrances on our offices, equipment or other operational facilities.
Item 3. Legal Proceedings
In the ordinary course of operating our business, we may be a party to various legal proceedings from time to time. We do not believe that there are any pending or threatened proceedings against us, which, if determined adversely, would have a material effect on our business, results of operations or financial condition.
Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Prices and Cash Dividends Per Share
BancTrusts common stock trades on The Nasdaq Global Select Market under the symbol BTFG.
At December 31, 2006, the Company had approximately 3,415 shareholders, of record or through registered clearing agents.
The following chart provides the high and low sales price and the cash dividend declared for each quarter in 2006 and 2005.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth certain information at December 31, 2006 with respect to BancTrusts equity compensation plans that provide for the issuance of options, warrants or rights to purchase BancTrusts securities.
On September 28, 2001, the Company announced that it intended to repurchase up to 425 thousand shares of its common stock. Approximately one year before implementation of the stock repurchase plan, the Company purchased 61 thousand of its shares. As of December 31, 2006, the Company had purchased 195 thousand shares under the stock repurchase plan. These purchases were accomplished primarily through private transactions and were accounted for under the cost method. The Company share purchases, including those that predate the repurchase plan, ranged in price from $8.00 per share to $15.33 per share, and the weighted-average price per share paid by the Company was $9.42. The Company has not repurchased any of its shares under this repurchase plan since December 23, 2002.
The following table provides information about purchases by BancTrust during the quarter ended December 31, 2006 of equity securities that are registered by BancTrust pursuant to Section 12 of the Exchange Act.
Item 6. Selected Financial Data
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operation
The following discussion and analysis reviews our results of operations and assesses our financial condition. The purpose of this discussion is to focus on information about us that is not otherwise apparent from the consolidated financial statements and related footnotes appearing elsewhere in this Report on Form 10-K. Reference should be made to those financial statements and the selected financial data presented elsewhere in this Report on Form 10-K for an understanding of the following discussion and analysis. Historical results of operations and any trends which may appear are not necessarily indicative of the results to be expected in future periods.
We are a multi-bank holding company that was originally formed in 1985 as a Delaware corporation under the name Mobile National Corporation. In 1993, we changed our name to South Alabama Bancorporation, Inc. and, in 1996, reincorporated in Alabama. In May 2002, we changed our name to BancTrust Financial Group, Inc.
As a bank holding company, our results of operations are almost entirely dependent on the results of operations of our subsidiary Banks. The following table sets forth our subsidiary Banks and selected data related to each Bank:
Through the Banks, BancTrust Company, Inc., our wholly owned trust company subsidiary, and BancTrust Financial Services, Inc., a wholly owned securities and insurance subsidiary of the Mobile Bank, we offer a broad range of traditional banking services to our customers, including retail banking, trust, insurance and securities services and products.
Like most community banks, we derive the majority of our revenue from the interest we earn on our loans and investments, and our greatest expense is the interest we pay on interest-bearing deposits and borrowings. Consequently, one of the key measures of our success is our net interest income, which is the difference between the revenues we earn on our interest-earning assets, such as loans and investments, and the expenses we pay on our interest-bearing liabilities, such as interest-bearing deposits and borrowings. Another key measure of our success is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread.
There are risks inherent in all loans, so we maintain an allowance for loan losses that we believe is adequate to absorb probable losses inherent in our loan portfolio. We maintain this allowance by charging a provision for loan losses against our operating earnings for each period. We have included a discussion of this process, as well as several tables describing our allowance for loan losses, in the following discussions.
In addition to earning interest on our loans and investments, we earn income through fees and other charges to our customers, including service charges on deposit accounts, mortgage fees, trust fees and fees for investment services. We have also included a discussion of the various components of this non-interest income, as well as of our non-interest expense.
We measure and monitor the following factors as key indicators of our financial performance:
Highlights for the year ended December 31, 2006 include:
The following discussion and analysis also identifies significant factors that have affected our financial condition and results of operations during the periods included in the financial statements contained in this Report on Form 10-K. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in this Report on Form 10-K.
Effect of Economic Trends
During 2002, the United States experienced an economic decline. During this period, the economy was affected by lower returns of the stock markets. Economic data had led the Federal Reserve in 2001 to begin an aggressive program of reducing interest rates that moved the federal funds rate down 11 times during 2001 for a total reduction of 475 basis points. In 2002 and 2003, the federal funds rate was reduced another 100 basis points, bringing the federal funds rate in mid-2003 to its lowest level in 40 years.
Despite sharply lower short-term rates, stimulus to the economy during 2003 was muted and consumer demand and business investment activity remained weak. During 2003 and most of 2004, the financial markets operated under historically low interest rates. As a result of these unusual conditions, Congress passed an economic stimulus plan in 2003. During 2004, many economists believed the economy was beginning to show signs of strengthening, and the Federal Reserve increased the federal funds interest rate by 100 basis points during the second, third and fourth quarters of 2004 and by an additional 200 basis points during 2005. In mid-2006 the Federal Reserve stopped increasing rates, and has made no further interest rate changes as of this report date.
The specific economic and credit risks associated with our loan portfolio, especially the real estate portfolio, include, but are not limited to, a general downturn in the economy which could affect unemployment rates in our market areas, general real estate market deterioration, interest rate fluctuations, deteriorated collateral, title defects, inaccurate appraisals and financial deterioration of borrowers. Construction and development lending can also present other specific risks to the lender such as whether developers can find builders to buy lots for home construction, whether the builders can obtain financing for the construction, whether the builders can sell the home to a buyer and whether the buyer can obtain permanent financing. For several years, real estate values in our metropolitan Montgomery and coastal Alabama and Florida markets have increased, and employment trends in our market areas have been favorable. That improvement continued through mid-2005; however, a slowdown in loan demand was experienced in our coastal markets in the Fall of 2005 and continued through 2006. The most likely reason for the slowdown is the effects the recent hurricanes have had along the Gulf Coast, especially after Hurricane Katrina in August of 2005.
Critical Accounting Policies and Estimates
We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States of America and general practices within the banking industry in the preparation of
our financial statements. Our significant accounting policies are described in the notes to our audited consolidated financial statements as of December 31, 2006, beginning on page 53 of this Report on Form 10-K. Certain accounting policies require Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements. A description of these policies is set forth below.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level considered by Management to be sufficient to absorb losses inherent in the loan portfolio. Loans are charged off against the allowance for loan losses when Management believes that the collection of the principal is unlikely. Subsequent recoveries are added to the allowance. BancTrusts determination of its allowance for loan losses is determined in accordance with Statement of Financial Accounting Standards ("SFAS") Nos. 114 and 5 and other regulatory guidance. The amount of the allowance for loan losses and the amount of the provision charged to expense is based on periodic reviews of the portfolio, past loan loss experience, current economic conditions and such other factors which, in Managements judgment, deserve current recognition in estimating loan losses.
Management has a developed and documented systematic methodology for determining and maintaining an allowance for loan losses. A regular, formal and ongoing loan review is conducted to identify loans with unusual risks and probable loss. Management uses the loan review process to stratify the loan portfolio into risk grades. For higher-risk graded loans in the portfolio, the Banks determine estimated amounts of loss based on several factors, including historical loss experience, Managements judgment of economic conditions and the resulting impact on higher-risk graded loans, the financial capacity of the borrower, secondary sources of repayment including collateral and regulatory guidelines. This determination also considers the balance of impaired loans. Specific allowances for impaired loans are based on comparisons of the recorded carrying values of the loans to the present value of these loans estimated cash flows discounted at each loans effective interest rate, the fair value of the collateral, or the loans observable market price. Recovery of the carrying value of loans is dependent to a great extent on economic, operating and other conditions that may be beyond the Companys control.
In addition to evaluating probable losses on individual loans, Management also determines probable losses for all other loans that are not individually evaluated. The amount of the allowance for loan losses related to all other loans in the portfolio is determined based on historical and current loss experience, portfolio mix by loan type and by collateral type, current economic conditions, the level and trend of loan quality ratios and such other factors that, in Managements judgment, deserve current recognition in estimating inherent loan losses. The methodology and assumptions used to determine the allowance are continually reviewed as to their appropriateness given the most recent losses realized and other factors that influence the estimation process. The model assumptions and resulting allowance level are adjusted accordingly as these factors change.
Average Assets and Liabilities
Average assets in 2006 were $1.298 billion, compared to $1.270 billion in 2005. Excluding the assets associated with discontinued operations, average assets increased $59 million from 2005 to 2006, an increase of 4.8 percent. Average loans, net, in 2006 were $984.2 million or 4.5 percent higher than average loans, net, of $942.0 million in 2005. We experienced a significant increase in loan demand beginning in 2003, and the
demand continued to accelerate in 2004 and into the first half of 2005. Beginning in the third quarter of 2005 we experienced a rapid slowdown in loan demand along our Gulf Coast markets, most likely a reaction to the extreme hurricane season of 2005, especially Hurricane Katrina.
Average deposits of $1.042 billion in 2006 were 4.1 percent higher than average deposits of $1.001 billion in 2005. Short-term and long-term borrowings consist of federal funds purchased, Federal Home Loan Bank (FHLB) borrowings, overnight repurchase agreements, notes payable to our subsidiary statutory trusts issued in connection with trust preferred securities offerings and deposits in the treasury tax and loan account. In December 2006, we issued an additional $15.0 million of trust preferred securities. Part of the funds were used to pay off a bank loan, and the remaining proceeds are to be used for general corporate purposes.
Our average equity as a percent of average total assets in 2006 was 10.5 percent, compared to 10.0 percent in 2005. Average equity in 2006 and 2005 included approximately $45.4 million and $46.1 million, respectively, recorded as intangible assets related to acquisitions accounted for as purchases.
DISTRIBUTION OF AVERAGE ASSETS, LIABILITIES AND SHAREHOLDERS EQUITY
Average loan growth was strong from 2003 to mid-2005 as economic conditions in our markets were good. After the 2005 hurricane season, and especially after Hurricane Katrina, loan demand in our markets directly on the Gulf of Mexico slowed considerably. While our offices are well to the east of the areas most directly affected by Katrina, we believe that the slowdown in loan demand along the Gulf Coast beach markets was brought on by the psychological effects of the storms of 2005 and 2004 as well as severe problems in the property insurance industry. Our average loan-to-deposit ratio was 94.4 percent in 2006 compared to 94.1 percent in 2005 and 86.7 percent in 2004. Our loan-to-deposit ratio at year-end 2006 was 91.0 percent compared to 95.3 percent at year-end 2005 and 91.7 percent at year-end 2004.
Our lending strategy concentrates on originating loans with relatively short maturities or, in the case of loans with longer maturities, with floating rate arrangements when possible. Of our outstanding loans at December 31, 2006, $725.8 million, or 72.2 percent, mature within one year or otherwise reprice within one year. Maintaining high levels of short-term and variable rate loans in our portfolio is a key component of our interest rate risk management strategy and was a key contributor to our improved net interest revenue and net interest margin during the recent rising interest rate environment. Net interest revenue and net interest margin decreased when the interest rate environment stabilized. Net interest revenue and the net interest margin are discussed more fully under Results of Operations.
We offer, through third party arrangements, certain mortgage loan products that we sell to these third parties shortly after origination and that are therefore not retained in our loan portfolio. These products expand our mortgage loan product offerings and have generated significant fee income during the recent periods of lower mortgage rates. These fees have come from first and second home purchases as well as from substantial home refinancing volume. The rise in interest rates beginning in mid-2004, combined with the severe hurricane season of 2005, resulted in a slowdown in mortgage loan refinancing volume along our beach markets; however, first home purchase and refinancing volume in the metropolitan areas of Mobile and Montgomery has remained strong.
Table 2 shows the distribution of our loan portfolio by major category at December 31, 2006, and at year-end for each of the previous four years. Table 3 depicts maturities of selected loan categories and the interest rate structure for such loans maturing after one year.
DISTRIBUTION OF LOANS BY CATEGORY
SELECTED LOANS BY TYPE AND MATURITY
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, requires that securities be classified into one of three categories: held to maturity, available for sale or trading. Securities classified as held to maturity are stated at amortized cost. Securities are classified as held to maturity if Management has the positive intent, and we have the ability, to hold the securities until they mature. Securities classified as available for sale are stated at fair value. Securities are classified as available for sale if they are to be held for indefinite periods of time, such as securities Management intends to use as part of its asset/liability strategy or that may be sold in response to changes in interest rates, changes in prepayment risks, changes in liquidity needs, the need to increase regulatory capital or other similar factors. At December 31, 2006, all of our securities were in the available for sale category. At December 31, 2006, we held no trading securities or securities classified as held to maturity.
The maturities and weighted-average yields of securities available for sale at December 31, 2006, are presented in Table 4 at amortized cost using the average stated contractual maturities. The average stated contractual maturities may differ from the average expected life because of amortized principal payments or because borrowers may have the right to call or prepay obligations. Tax equivalent adjustments, using a 35 percent tax rate, have been made when calculating yields on tax-exempt obligations. Mortgage-backed securities are shown only in the total as these securities have monthly principal payments.
MATURITY DISTRIBUTION OF INVESTMENT SECURITIES
Deposits and Short-Term Borrowings
In 2004 average deposits grew $344.3 million, or 71.1 percent, compared to 2003. The CommerceSouth transaction accounted for $329.4 million, or all but 3.1 percent, of the increase in average deposits in 2004, with the remaining increase resulting from growth in the Gulf Coast markets of Alabama. Average deposits increased at a rapid pace in 2005, growing from $828.7 million in 2004 to $1.0 billion in 2005, an increase of 20.8 percent. Our deposit mix, on average, did not significantly change in 2004 and 2005. In 2006, we saw a decrease in average savings deposits of $27.6 million. Most of the decrease occurred in our Florida market, and appears to be a result of the slowdown which occurred after Hurricane Katrina. Also in 2006 we experienced an increase of $86.5 million in average time deposits. Part of this increase is a result of our efforts to offset the savings deposit decrease in Florida, and the remainder resulted from new account efforts in our other markets. We define core deposits as total deposits less certificates of deposit of $100,000 or more. Core deposits, as a percentage of total deposits, represented 72.4 percent and 75.9 percent at year-end 2006 and 2005 respectively. While our primary deposit taking emphasis focuses on attracting and retaining core deposits from customers who will also use our products and services, Management recognizes that in order to fund loan growth, it is necessary from time to time to pursue non-core funding sources such as large certificates of deposit and other borrowed funds. Access to non-core funding sources is particularly important in periods of very rapid loan growth, such as we experienced during 2004 and 2005. We do not currently need to access our non-core funding sources, as internally generated funds are supplying our liquidity needs; however, we might consider using non-core funding sources during periods when loan growth exceeds core deposit growth.
Table 6 reflects maturities of time deposits of $100,000 or more, including brokered deposits, at December 31, 2006. Deposits of $304.9 million in this category represented 27.6 percent of total deposits at year-end 2006, compared to $251.5 million representing 24.1 percent of total deposits at year-end 2005.
MATURITIES OF TIME DEPOSITS OF $100,000 OR MORE
Short-term borrowings include three items: (1) federal funds purchased; (2) securities sold under agreements to repurchase, which are overnight transactions with large corporate customers, commonly referred to as repos; and (3) other, representing borrowings from the FHLB and a short-term loan from an unrelated bank to BancTrust. We sold federal funds of $26.2 million on average during 2006 while average short-term borrowings
were $9.6 million. During 2004 and 2005, as Table 7 demonstrates, we relied much more than we have historically on short-term borrowings as a funding source to meet rapid loan growth; however, our liquidity position improved in 2006 and we relied less on short-term borrowings as a loan funding source.
FHLB Advances and Long-term Debt
We use FHLB advances occasionally as an alternative to other funding sources with similar maturities. FHLB advances, as a funding source, are flexible and allow us to quickly obtain funding with the mix of maturities and rates that best suits our overall asset/liability management strategy. Our FHLB advances totaled $61.5 million at December 31, 2006, a decrease of $20.0 million from December 31, 2005. We use our long-term FHLB advances primarily to fund loan originations.
Of our outstanding FHLB advances at December 31, 2006, $26.5 million had fixed interest rates, one $20.0 million advance had a variable interest rate that reprices monthly and one $15.0 million advance had a variable interest rate that reprices quarterly. Note 11 to the consolidated financial statements included in this Report on Form 10-K sets forth additional information relating to outstanding balances, scheduled maturities and rates of our FHLB advances.
In 2003, we increased our long-term borrowings by issuing a note payable to our wholly owned statutory trust subsidiary, BancTrust Capital Trust I (the Trust), which the Trust purchased with the proceeds of $18.0 million of trust preferred securities it sold to investors. The note payable matures in December 2033. We pay interest on the note to the Trust, and the Trust pays distributions on trust preferred securities quarterly. The interest rate we and the Trust pay is reset quarterly at Three-Month LIBOR plus 290 basis points. We used the proceeds from the note payable to finance a portion of the purchase price for CommerceSouth, Inc. We do not have the option to repay any amounts of the note payable until December 2008.
In 2006, we again increased our long-term borrowings by issuing a note payable to our wholly owned statutory trust subsidiary, BancTrust Capital Trust II (Trust II), which Trust II purchased with the proceeds of $15.0 million of trust preferred securities it sold to an investor. The note payable matures in 2037. We pay interest on the note to Trust II, and Trust II pays distributions on trust preferred securities quarterly. The interest rate we and Trust II pay is reset quarterly at Three-Month LIBOR plus 164 basis points. We used $7.5 million of the proceeds from the note payable to repay a bank loan. The remainder will be used for general corporate purposes. We do not have the option to repay any amounts of the note payable until 2012.
Other long-term debt as of December 31, 2005 also included a $10 million loan from an unrelated bank to the Company. This loan was incurred in January of 2004 to finance a portion of the purchase price for CommerceSouth, Inc. The loan was secured by a portion of BancTrusts stock in the Mobile Bank. The loan was fully paid in December of 2006.
The purpose of asset/liability management is to maximize return while minimizing risk. Maximizing return means achieving or exceeding our profitability and growth goals. Minimizing risk means managing four key risk factors: (1) liquidity; (2) interest rate sensitivity; (3) capital adequacy; and (4) asset quality. Our asset/liability management involves a comprehensive approach to Statement of Condition management that meets the risk and return criteria established by Management and the Board of Directors. Management has not used derivative financial instruments as part of the asset/liability management process.
Our primary market risk is our exposure to interest rate changes. Interest rate risk management strategies are designed to optimize net interest income while minimizing the effects of changes in market rates of interest on operating results and asset and liability fair values. A key component of our interest rate risk management strategy is to manage and match the maturity and repricing characteristics of our assets and liabilities.
We use modeling techniques to simulate the effects various changes in market rates of interest would have on our interest income and on the fair values of our assets and liabilities. Important elements that affect the risk profile of our Statement of Condition in interest rate risk modeling include the mix of floating versus fixed rate assets and liabilities and the scheduled, as well as expected, repricing and maturing volumes and rates of assets and liabilities. Using the Interest Sensitivity Analysis presented in Table 10, applying a scenario simulating a hypothetical 100 basis point rate increase applied to all interest-earning assets and interest-bearing liabilities, we would expect a net increase in net interest income of $2.6 million for the year following the rate increase. Using a scenario simulating a hypothetical 100 basis point decrease, we would expect a net decrease in net interest income of $3.1 million for the year following the rate decrease. These hypothetical examples are not a precise indicator of future events or of the actual effects such rate increases or decreases would have on our financial condition and operating results. Instead, they are reasonable estimates of the results anticipated if the assumptions used in the modeling techniques were to occur.
Liquidity represents the ability of a bank to meet loan commitments as well as deposit withdrawals. Liquidity is derived from both the asset side and the liability side of the Statement of Condition. On the asset side, liquidity is provided by marketable investment securities, maturing loans, federal funds sold and cash and cash equivalents. On the liability side, liquidity is provided by a stable base of core deposits. In addition to our ability to meet liquidity demands through current assets and liabilities, we have available, if needed, federal funds lines of credit of $81.5 million and FHLB lines of credit $31.3 million. Our Asset/Liability Committee, which is made up of certain members of Management and the Board of Directors, monitors our liquidity position and formulates and implements corrective measures in the event certain liquidity parameters are exceeded.
The Consolidated Statements of Cash Flows provide an analysis of cash from operating, investing, and financing activities for each of the three years in the period ended December 31, 2006. Cash flows are a significant part of liquidity management, contributing significant levels of funds in 2006 and 2005.
Cash flows from operating activities provided $12.6 million in 2006 compared to $20.5 million in 2005 and $19.0 million in 2004. Net cash used in investing activities decreased to $19.1 million in 2006 from $129.0 million in 2005 and $231.0 million in 2004 primarily due to slower growth in loans. Net cash provided by financing activities decrease to $38.2 million in 2006 from $142.6 million in 2005 and $180.7 million in 2004, due primarily to the slow-down in deposit growth. The net increase in cash and cash equivalents was $31.7
million in 2006 and $40.7 million in 2005. Net cash and cash equivalents decreased $24.0 million in 2004 due to a payment of $38.4 million in connection with a business combination in 2003.
Table 8 presents information about our contractual obligations, which by their terms are not short-term, at December 31, 2006.
Off-Balance Sheet Arrangements
The Company, as part of its ongoing operations, issues financial guarantees in the form of financial and performance standby letters of credit. Standby letters of credit are contingent commitments issued by the Company generally to guarantee the performance of a customer to a third party. A financial standby letter of credit is a commitment by the Company to guarantee a customers repayment of an outstanding loan or financial obligations. In a performance standby letter of credit, the Company guarantees a customers performance under a contractual non-financial obligation for which it receives a fee. The Company has recourse against the customer for any amount it is required to pay to a third party under a standby letter of credit. Revenues are recognized over the life of the standby letter of credit. The maximum potential amount of future payments the Company could be required to make under its standby letters of credit at December 31, 2006 was $24.271 million, and that sum represents the Companys maximum credit risk. At December 31, 2006, the Company had $243 thousand of unearned fees associated with standby letter of credit agreements. The Company holds collateral to support standby letters of credit when deemed necessary. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial property.
Table 9 presents information about our off-balance sheet arrangements at December 31, 2006.
OFF-BALANCE SHEET ARRANGEMENTS
Interest Rate Sensitivity
By monitoring our interest rate sensitivity, Management attempts to maintain a desired balance between the growth of net interest revenue and the risks that might result from significant changes in interest rates in the market. One tool for measurement of this risk is gap analysis, whereby the repricing of assets and liabilities is compared within certain time categories. By identifying mismatches in repricing opportunities within a time category, we can identify interest rate risk. The interest sensitivity analysis presented in Table 10 is based on this type of gap analysis, which assumes that rates earned on interest-earning assets and rates paid on interest-bearing liabilities will move simultaneously in the same direction and to the same extent. However, the rates associated with these assets and liabilities typically change at different times and in varying amounts.
Changes in the composition of interest-earning assets and interest-bearing liabilities can increase or decrease net interest revenue without affecting interest rate sensitivity. The interest rate spread between assets and their corresponding liabilities can be significantly changed while the repricing interval for both remains unchanged, thus impacting net interest revenue. Over a period of time, net interest revenue can increase or decrease if one side of the Statement of Condition reprices before the other side. An interest sensitivity ratio of 100 percent (earning assets divided by interest-bearing liabilities), which represents a matched interest rate sensitive position, does not guarantee maximum net interest revenue. Before making adjustments to earning assets, Management must evaluate several factors, including the general direction of interest rates, in order to determine the type of investment and the maturity needed to maximize net interest revenue while minimizing interest rate risk. Management may, from time to time, accept calculated risks associated with interest rate sensitivity in an attempt to maximize net interest revenue. We do not currently use derivative financial instruments to manage interest rate sensitivity, but we may do so in the future.
At December 31, 2006, our three-month gap position (interest-earning assets divided by interest-bearing liabilities) was 126 percent, and our twelve-month cumulative gap position was 91 percent. Both positions were within the range established by Management as acceptable. Our three-month gap position indicates that, in a period of rising interest rates, each $1.26 of earning assets that reprice upward during the three months would be accompanied by $1.00 in interest-bearing liabilities repricing upward during the same period. Thus, under this scenario, net interest revenue could be expected to increase during the three-month period of rising rates, as interest income increases would exceed increases in interest expense. Likewise, our twelve-month gap position indicates that each $.91 of interest-earning assets that reprices upward during such period would be accompanied by upward repricing of $1.00 in interest-bearing liabilities resulting in a decrease in net interest revenue. In a period of falling rates, the opposite effect might occur. While certain categories of liabilities are contractually tied to interest rate movements, most, including deposits, are subject only to competitive pressures and do not necessarily reprice directly with changes in market rates. Management has some flexibility when adjusting rates on these products. Therefore, the repricing of assets and liabilities would not necessarily take place at the same time and in the same amounts.
The following table summarizes our interest-sensitive assets and liabilities from continuing operations as of December 31, 2006. Adjustable rate loans are included in the period in which their interest rates are scheduled to adjust. Fixed rate loans are included in the periods in which they are anticipated to be repaid based on scheduled maturities. Investment securities are included in the period in which they are scheduled to mature. Certificates of deposit are presented according to contractual maturity dates.
INTEREST SENSITIVITY ANALYSIS
Tangible shareholders equity (shareholders equity less goodwill, other intangible assets and accumulated other comprehensive income) was $ 94.4 million at December 31, 2006, compared to $86.3 million at December 31, 2005. At year-end 2006, our Tier 1 capital ratio increased to 11.51 percent from 9.70 percent at year-end 2005. The increase resulted from growth in tangible common shareholders equity of 9.4 percent compared to growth in risk-adjusted assets of 2.9 percent. The issuance of $15 million in trust preferred securities in December of 2006 also increased Tier 1 capital.
In December 2003, we formed a wholly-owned statutory trust subsidiary (the Trust). The Trust issued $18.0 million of trust preferred securities guaranteed by BancTrust on a junior subordinated basis. We obtained the proceeds from the Trusts sale of trust preferred securities by issuing junior subordinated debentures to the Trust, and used the proceeds to partially finance the purchase price of CommerceSouth, Inc. In December 2006, we formed another wholly-owned statutory trust subsidiary (Trust II). Trust II issued $15.0 million of trust preferred securities guaranteed by BancTrust on a junior subordinated basis. We obtained the proceeds from Trust IIs sale of trust preferred securities by issuing junior subordinated debentures to Trust II, and used the proceeds to repay $7.5 million of long term debt and for general corporate purposes. Under revised Interpretation No. 46 (FIN 46R) promulgated by Financial Accounting Standards Board (FASB), both the Trust and Trust II must be deconsolidated with us for accounting purposes. As a result of this accounting pronouncement, the Federal Reserve Board adopted changes to its capital rules with respect to the regulatory capital treatment afforded to trust preferred securities. The Federal Reserve Boards rules permit qualified trust preferred securities and other restricted capital elements to be included as Tier 1 capital up to 25% of core capital. We believe that our trust preferred securities qualify under these revised regulatory capital rules and expect that we will continue to treat our $33.0 million of trust preferred securities as Tier 1 capital. For regulatory purposes, the trust preferred securities are added to our tangible common shareholders equity to calculate Tier 1 capital.
Our leverage ratio, defined as tangible shareholders equity divided by quarterly average assets, was 10.02 percent at year-end 2006 compared to 8.40 percent at December 31, 2005. The Federal Reserve and the FDIC require bank holding companies and banks to maintain certain minimum levels of capital as defined by risk-based capital guidelines. These guidelines consider risk factors associated with various components of assets, both on and off the Statement of Condition. Under these guidelines, capital is measured in two tiers, and these capital tiers are used in conjunction with risk-based assets in determining risk-based capital ratios. Our capital ratios expressed as a percentage of total risk-adjusted assets, for Tier 1 and Total Capital were 11.51 percent and 12.77 percent, respectively, at December 31, 2006. We exceeded the minimum risk-based capital guidelines at December 31, 2006, 2005, and 2004. The minimum guidelines are shown on Table 11. (See Managements Discussion and AnalysisCapital Adequacy, and Note 15 of Notes to Consolidated Financial Statements).
Results of Operations
Net Interest Revenue
Net interest revenue, the difference between amounts earned on interest-earning assets and the amounts paid on interest-bearing liabilities, is the most significant component of earnings for a financial institution. Changes in interest rates, changes in the volume of assets and liabilities and changes in the asset/liability mix are the major factors that influence net interest revenue. Presented in Table 12 is an analysis of net interest revenue, weighted-average yields on interest-earning assets and weighted-average rates paid on interest- bearing liabilities for the past three years.
Net yield on interest-earning assets is net interest revenue, on a tax equivalent basis, divided by total interest-earning assets. This ratio is a measure of our effectiveness in pricing interest-earning assets and funding them with both interest-bearing and non-interest-bearing liabilities. Our net yield in 2006, on a tax equivalent basis, decreased 19 basis points to 4.61 percent compared to 4.80 percent in 2005. After a period of stable rates in 2003, interest rates began to rise in mid-2004, and net yield also began to increase. Added to the positive effect of rising rates of interest on our net interest margin was a large increase in our loan volume. This trend continued until The Federal Reserve stopped increasing rates in mid-2006. The Federal Reserves monetary policy, combined with slower loan growth in 2006, resulted in margin compression. In 2006 several loans were placed on non-accrual, and this added to the reduced net interest margin. Our liquidity position improved in 2006, and, if our liquidity continues to improve or remains stable in 2007, we may be less aggressive in pricing deposits, resulting in a more stable net interest margin.
NET INTEREST REVENUE
Table 13 reflects the changes in our sources of taxable-equivalent interest income and expense between 2006 and 2005 and between 2005 and 2004. The variances resulting from changes in interest rates and the variances resulting from changes in volume are shown.
Tax-equivalent net interest revenue in 2006 was approximately the same as in 2005. Total interest revenue increased by $15.2 million, while total interest expense increased by $15.1 million. The increases in both total interest revenue and total interest expense were primarily caused by rising interest rates in the economy. Volume had a much smaller influence in 2006 than it did in 2005.
Tax-equivalent net interest revenue in 2005 was $12.9 million higher than in 2004. Total interest revenue increased $21.8 million, while total interest expense increased $8.9 million. Tax-equivalent net interest revenue increased $9.9 million due to volume and $3.0 million due to rate, primarily a result of the growth we experienced during 2005, especially in loan volume, combined with the increase in the prime lending rate of 200 basis points during the year.
ANALYSIS OF TAXABLE-EQUIVALENT INTEREST INCREASES (DECREASES)
Provision for Loan Losses and Allowance for Loan Losses
The provision for loan losses is the charge to earnings that is added to the allowance for loan losses in order to maintain the allowance at a level that is adequate to absorb inherent losses in our loan portfolio. Management reviews the adequacy of the allowance for loan losses on a continuous basis by assessing the quality of the loan portfolio and adjusting the allowance when appropriate. Risk management procedures are in place to ensure that potential problem loans are identified.
Managements evaluation of each loan includes a review of the financial condition and capacity of the borrower, the value of the collateral, current economic trends, historical losses, work-out and collection arrangements and possible concentrations of credit. The loan review process also includes an evaluation of credit quality within the mortgage and installment loan portfolios. In establishing the allowance, loss percentages are applied to groups of loans with similar risk characteristics. These loss percentages are determined by historical experience, portfolio mix, economic factors and other risk factors. Each quarter this review is quantified in a report prepared by loan review officers and delivered to Management, which uses the report to determine whether any adjustments to the allowance for loan losses are appropriate. Management submits these quarterly reports to BancTrusts Board of Directors. The amount of the allowance is affected by: (i) loan charge-offs, which decrease the allowance; (ii) recoveries on loans previously charged-off, which increase the allowance; and (iii) the provisions for loan losses charged to income, which increase the allowance.
Table 14 sets forth certain information with respect to our average loans, allowance for loan losses, charge-offs and recoveries for the five years ended December 31, 2006.
SUMMARY OF LOAN LOSS EXPERIENCE
Net charge-offs were $2.3 million in 2006 compared to $1.3 million in 2005 and $2.1 million in 2004. The allowance for loan losses as a percentage of loans was 1.63 percent at December 31, 2006, 1.41 percent at December 31, 2005, and 1.11 percent at December 31, 2004.
Management believes the increase in our ratio of allowance for loan losses to total loans from 2005 to 2006 is warranted due to the increase in the ratio of non-performing loans to loans (see Table 16) and the decrease in the ratio of the allowance for loan losses to non-performing loans (see Table 14). Loan charge-offs, changes in risk grades and adjustments to allocations on individual loans also affected the allocation of the allowance for loan losses. The changes in the allocation of the allowance for loan losses (see table 15) from 2005 to 2006 are primarily attributable to the increase in non-performing loans secured by real estate (see table 2). Loan charge-offs, changes in risk grades and adjustments to allocations on individual loans also affected the allocation of the allowance for loan losses.
Management reviews the adequacy of the allowance for loan losses on a continuous basis by assessing the quality of the loan portfolio, including non-performing loans, and adjusts the allowance when appropriate. Management believes the current methodology used to determine the required level of reserves is adequate, and Management considered the allowance adequate at December 31, 2006.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
Non-performing assets include accruing loans 90 days or more past due, loans on non-accrual, renegotiated loans and other real estate owned. Commercial, business and installment loans are classified as non-accrual by Management upon the earlier of: (i) a determination that collection of interest is doubtful; or (ii) the time at which such loans become 90 days past due unless collateral or other circumstances reasonably assure full collection of principal and interest.
Table 16 sets forth certain information with respect to accruing loans 90 days or more past due, loans on non-accrual, renegotiated loans and other real estate owned, all with respect to continuing operations. Non-performing loans were $16.2 million at year-end 2006 compared to $6.8 million at year-end 2005. Loans on non-accrual increased to $15.3 million at December 31, 2006 from $5.3 million at year-end 2005, primarily as a result of the loans of four borrowers being placed on non-accrual. Management anticipates foreclosing on the collateral securing the loans to these borrowers and has reserved an amount in the allowance for loan losses to cover the anticipated losses on these loans. These anticipated losses were considered in Managements evaluation of the allowance for loan losses. The allowance for loan losses as a percentage of loans increased to 1.63% at December 31, 2006 from 1.41% at year-end 2005 (see Table 14). As of December 31, 2006, renegotiated loans consisted of a single large loan that is performing as scheduled. Management anticipates returning the renegotiated loan to market terms during the first quarter of 2007, at which time the loan will no longer be reported as renegotiated.
Total non-performing assets as a percentage of loans and other real estate owned of continuing operations at year-end 2006 was 1.74 percent compared to 0.72 percent at year-end 2005 and 0.42 percent at year-end 2004.
SUMMARY OF NON-PERFORMING ASSETS OF CONTINUING OPERATIONS
Details of Non-Accrual Loans
The impact of non-accrual loans on interest income over the past five years is shown in Table 17. Not included in the table are potential problem loans totaling $5.3 million at December 31, 2006. Potential problem loans are loans as to which Management had serious doubts as to the ability of the borrowers to comply with present repayment terms. These loans do not meet the standards for, and are therefore not included in, non-performing assets. Management, however, classifies potential problem loans as either doubtful or substandard. These loans were considered in determining the adequacy of the allowance for loan losses and are closely and regularly monitored to protect BancTrusts interests.
DETAILS OF NON-ACCRUAL LOANS
Non-Interest Revenue and Non-Interest Expense
Non-interest revenue was $11.6 million in 2006, compared to $11.0 million in 2005, an increase of 5.8 percent. Excluding securities gains (losses), net, non-interest revenue in 2006 increased $802 thousand, or 7.4 percent. Service charges on deposit accounts increased 6.2%, primarily a result of an increase in volume. Trust revenue increased 27.9%, reflecting the addition of a significant number of accounts in that area in 2006. The category other income, charges and fees included a gain on the sale of bank property of $323 thousand in 2006. Mortgage fee income, the largest source of non-interest revenue, decreased $275 thousand in 2006 compared to 2005. Second home purchase volume has slowed considerably in our coastal markets, a result, we believe, of the severe storms in 2004 and 2005.
One measure of performance in the banking industry is the efficiency ratio, calculated as non-interest expense divided by net interest revenue (tax adjusted) plus non-interest revenue. A lower efficiency ratio indicates a more efficient company. The ratio can be lowered by increasing revenue or by decreasing expenses. Our efficiency ratio in 2006 was 61.4 percent compared to 58.3 percent in 2005, and the decrease in the net interest margin in 2006 was the primary contributor to the decrease. Included in the efficiency ratio calculation in 2006 and 2005 was $749 thousand in intangible amortization expense.
Non-interest expense increased 6.5 percent in 2006 compared to 2005. Most of this increase is attributable to increased salary and benefit expense, increased advertising expenditures and increased accounting fees, including Sarbanes-Oxley work and audit work. The salary and benefit expense increase represents over half of the total non-interest expense increase and resulted primarily from our strategic decision to hire, in mid-2006, 13 experienced and well-regarded local bankers in our Mobile/Baldwin County market. These new bankers, by year-end 2006, have already contributed to strong loan and deposit growth in that market. Part of the increase in non-interest expense in 2006 was attributable to an advertising campaign designed to capitalize on market disruption following recently announced large bank mergers affecting some of our markets. We plan to invest considerable resources in 2007 in areas where we feel we can capitalize on the market disruptions expected to occur as a result of these mergers.
Income tax expense from continuing operations was $6.3 million in 2006, compared to $6.8 million in 2005, and $3.9 million in 2004. Our effective combined tax rate from continuing operations was 32.2 percent in 2006, compared to 33.8 percent in 2005 and 28.2 percent in 2004. The change in the effective combined tax rate from 2005 to 2006 is attributable in part to the reversal in 2006 of a valuation allowance established in 2005. Income tax expense from discontinued operations was $1.1 million in 2005, compared to $1.8 million in 2004.
Inflation and Other Issues
Because our assets and liabilities are primarily monetary in nature, the effect of inflation on our assets is less significant compared to most commercial and industrial companies. However, inflation does have an impact on the growth of total assets in the banking industry and the resulting need to increase capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Inflation also has a significant effect on other expenses, which tend to rise during periods of general inflation. Notwithstanding these effects of inflation, Management believes our financial results are influenced more by Managements ability to react to changes in interest rates than by inflation.
Except as discussed in this Managements Discussion and Analysis, Management is not aware of trends, events or uncertainties that will have or that are reasonably likely to have a material adverse effect on the liquidity, capital resources or operations of the Company. Management is not aware of any current recommendations by regulatory authorities which, if they were implemented, would have such an effect.
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)