Centerstate Banks of Florida 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the Fiscal Year Ended December 31, 2007
Commission File Number 333-95087
CENTERSTATE BANKS OF FLORIDA, INC.
(Name of registrant as specified in its charter)
Issuers telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01 per share
Securities registered pursuant to Section 12(g) of the Act:
The registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ¨ NO x
The registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ NO x
Check whether the issuer has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the issuer was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation SK contained in this form, and no disclosure will be contained, to the best of issuers knowledge, in 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, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
(Do not check if a smaller reporting company)
The registrant is a shell company, as defined in Rule 12b-2 of the Exchange Act. YES ¨ NO x
The aggregate market value of the Common Stock of the issuer held by non-affiliates of the issuer (8,881,834 shares) on June 30, 2007, was approximately $160,672,000. The aggregate market value was computed by reference the last sale of the Common Stock of the issuer at $18.09 per share on June 29, 2007. For the purposes of this response, directors, executive officers and holders of 5% or more of the issuers Common Stock are considered the affiliates of the issuer at that date.
As of March 5, 2008 there were outstanding 12,444,407 shares of the issuers Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on April 29, 2008 to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days of the issuers fiscal year end are incorporated by reference into Part III, of this Annual Report on Form 10-K.
TABLE OF CONTENTS
CenterState Banks of Florida, Inc. (We, CenterState or the Company) was incorporated under the laws of the State of Florida on September 20, 1999. CenterState is a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the BHC Act) and owns all the outstanding shares of CenterState Bank Central Florida (Central), CenterState Bank National Association (CSNA), CenterState Bank of Florida (CSB), and Valrico State Bank (VSB) (collectively, the Banks).
In April 2007, we closed the acquisition of Valrico Bancorp, Inc. and its wholly owned subsidiary bank, VSB. VSB operates in Hillsborough County, which is contiguous to Pasco and Polk Counties, where we currently have banking locations.
On November 30, 2007, CSNA purchased all of the assets and assumed all of the liabilities of CenterState Bank Mid Florida, a bank we acquired on March 31, 2006. Following the acquisition by CSNA of CenterState Bank Mid Florida, the shell of CenterState Bank Mid Florida was merged with and into Atlantic Southern Bank, a wholly owned subsidiary of Atlantic Southern Financial Group, Inc., for a payment by Atlantic Southern Bank to CenterState of $1.0 million. The transaction allowed us to consolidate our two subsidiary banks, and facilitated Atlantic Southern Banks expansion into Florida.
Central and CSNA commenced operations in 1989. CSB commenced operations in 1992. Centrals operations are conducted from its main office located in Kissimmee, Florida, and branch offices located in St. Cloud, Poinciana, Ocoee and Orlando, Florida. CSNA operations are conducted from its main office located in Zephyrhills, Florida, and branch offices located in Zephyrhills, Bushnell, Wildwood, Dade City, Inverness, Spring Hill, Crystal River, Brooksville, Leesburg, Clermont, Groveland, and Eustis, Florida. CSB operates through twelve banking locations all within Polk County, Florida. These cities within Polk County include Winter Haven, Haines City, Davenport, Lake Alfred, Auburndale, Lakeland and Lake Wales. VSB conducts business from its main office located in Valrico, Florida and branch offices located in Brandon, Lithia, Plant City and Riverview, Florida. Our three national bank subsidiaries are subject to the supervision of the Office of the Comptroller of the Currency and our state bank subsidiary (VSB) is under the supervision of the Florida Office of Financial Regulation and the FDIC. As of December 31, 2007, we operated through our four wholly owned subsidiary banks, with 37 banking locations located in nine counties in central Florida.
Our Company provides a range of consumer and commercial banking services to individuals, businesses and industries. The basic services we offer include: demand interest-bearing and noninterest-bearing accounts, money market deposit accounts, time deposits, safe deposit services, cash management, direct deposits, notary services, money orders, night depository, travelers checks, cashiers checks, domestic collections, savings bonds, bank drafts, automated teller services, drive-in tellers, and banking by mail and by internet. In addition, we make secured and unsecured commercial and real estate loans and issue stand-by letters of credit. Our Company provides automated teller machine (ATM) cards, thereby permitting customers to utilize the convenience of larger ATM networks. We also offer internet banking services to our customers. In addition to the foregoing services, our offices provide customers with extended banking hours. We do not have a trust department, however, trust services are available to customers through a business relationship with another bank. We also offer other financial products to our customers, including mutual funds, annuities and other products, through a relationship with Infinex Investment, Inc.
The revenue of our Company is primarily derived from interest on, and fees received in connection with, real estate and other loans, and from interest and dividends from investment securities and short-term investments. The principal sources of funds for our lending activities are customer deposits, repayment of loans, and the sale and maturity of investment securities. Our principal expenses are interest paid on deposits, and operating and general administrative expenses.
As is the case with banking institutions generally, our Companys operations are materially and significantly influenced by general economic conditions and by related monetary and fiscal policies of financial institution regulatory agencies, including the Board of Governors of the Federal Reserve System (the Federal Reserve). Deposit flows and costs of funds are influenced by interest rates on competing investments and general market rates of interest. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn is affected by the interest rates at which such financing may be offered and other factors affecting local demand and availability of funds. We face strong competition in the attraction of deposits (our primary source of lendable funds) and in the origination of loans. See Competition.
C.S. Processing, Inc. (CSP) is a wholly owned subsidiary of our Companys subsidiary banks. CSP processes checks and renders statements (i.e. item processing center) and provides certain information technology services for our subsidiary banks.
At December 31, 2007, our Companys primary assets were our ownership of stock of each of our four Banks. At December 31, 2007, we had total consolidated assets of $1,217,430,000, total consolidated deposits of $972,620,000, and total consolidated stockholders equity of $148,282,000.
Note about Forward-Looking Statements
This Form 10-K contains forward-looking statements, such as statements relating to our financial condition, results of operations, plans, objectives, future performance and business operations. These statements relate to expectations concerning matters that are not historical facts. These forward-looking statements reflect our current views and expectations based largely upon the information currently available to us and are subject to inherent risks and uncertainties. Although we believe our expectations are based on reasonable assumptions, they are not guarantees of future performance and there are a number of important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. By making these forward-looking statements, we do not undertake to update them in any manner except as may be required by our disclosure obligations in filings we make with the Securities and Exchange Commission under the Federal securities laws. Our actual results may differ materially from our forward-looking statements.
We offer a range of lending services, including real estate, consumer and commercial loans, to individuals and small businesses and other organizations that are located in or conduct a substantial portion of their business in our market area. The Companys consolidated loans at December 31, 2007 and 2006 were $841,405,000, or 69% and $657,963,000 or 61%, respectively, of total consolidated assets. The interest rates charged on loans vary with the degree of risk, maturity, and amount of the loan, and are further subject to competitive pressures, money market rates, availability of funds, and government regulations. We have no foreign loans or loans for highly leveraged transactions.
Our loans are concentrated in three major areas: commercial loans, real estate loans, and consumer loans. A majority of our loans are made on a secured basis. As of December 31, 2007, approximately 84% of our consolidated loan portfolio consisted of loans secured by mortgages on real estate and 9% of the loan portfolio consisted of commercial loans (not secured by real estate). At the same date, 7% of our loan portfolio consisted of consumer and other loans.
Our commercial loan portfolio includes loans to individuals and small-to-medium sized businesses located primarily in Polk, Osceola, Pasco, Hernando, Hillsborough, Citrus, Sumter, Lake and Orange counties for working capital, equipment purchases, and various other business purposes. A majority of commercial loans are secured by equipment or similar assets, but these loans may also be made on an unsecured basis. Commercial loans may be made at variable or fixed rates of interest. Commercial lines of credit are typically granted on a one-year basis, with loan covenants and monetary thresholds. Other commercial loans with terms or amortization
schedules of longer than one year will normally carry interest rates which vary with the prime lending rate and will become payable in full and are generally refinanced in three to five years. Commercial and agricultural loans not secured by real estate amounted to approximately 9% of our Companys total loan portfolio as of December 31, 2007, compared to 10% at December 31, 2006.
Our real estate loans are secured by mortgages and consist primarily of loans to individuals and businesses for the purchase, improvement of or investment in real estate, for the construction of single-family residential and commercial units, and for the development of single-family residential building lots. These real estate loans may be made at fixed or variable interest rates. Generally, we do not make fixed-rate commercial real estate loans for terms exceeding five years. Loans in excess of five years are generally adjustable. Our residential real estate loans generally are repayable in monthly installments based on up to a 15-year or a 30-year amortization schedule with variable or fixed interest rates.
Our consumer loan portfolio consists primarily of loans to individuals for various consumer purposes, but includes some business purpose loans which are payable on an installment basis. The majority of these loans are for terms of less than five years and are secured by liens on various personal assets of the borrowers, but consumer loans may also be made on an unsecured basis. Consumer loans are made at fixed and variable interest rates, and are often based on up to a five-year amortization schedule.
For additional information regarding the Companys loan portfolio, see Managements Discussion and Analysis of Financial Condition and Results of Operations.
Loan originations are derived from a number of sources. Loan originations can be attributed to direct solicitation by our loan officers, existing customers and borrowers, advertising, walk-in customers and, in some instances, referrals from brokers.
Certain credit risks are inherent in making loans. These include prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers. In particular, longer maturities increase the risk that economic conditions will change and adversely affect collectibility. We attempt to minimize credit losses through various means. In particular, on larger credits, we generally rely on the cash flow of a debtor as the source of repayment and secondarily on the value of the underlying collateral.
In addition, we attempt to utilize shorter loan terms in order to reduce the risk of a decline in the value of such collateral.
Deposits are the major source of our funds for lending and other investment activities. We consider the majority of our regular savings, demand, NOW and money market deposit accounts to be core deposits. These accounts comprised approximately 45% and 54% of our consolidated total deposits at December 31, 2007 and 2006, respectively. Approximately 55% of our consolidated deposits at December 31, 2007, were certificates of deposit compared to 46% at December 31, 2006. Generally, we attempt to maintain the rates paid on our deposits at a competitive level. Time deposits of $100,000 and over made up approximately 31% of consolidated total deposits at December 31, 2007 and 25% at December 31, 2006. The majority of the deposits are generated from Polk, Osceola, Orange, Pasco, Hernando, Hillsborough, Sumter, Lake and Citrus counties. Generally, we do not accept brokered deposits and we do not solicit deposits on a national level. We obtain all of our deposits from customers in our local markets. For additional information regarding the Companys deposit accounts, see Managements Discussion and Analysis of Financial Condition and Results of OperationsDeposits.
A portion of our assets are invested in U.S. Treasury securities, obligations of U.S. government agencies, municipal securities, mortgage backed securities and federal funds sold. Our investments are managed in relation to loan demand and deposit growth, and are generally used to provide for the investment of excess funds at minimal risks while providing liquidity to fund increases in loan demand or to offset fluctuations in deposits.
With respect to our investment portfolio, we invest in U.S. Treasury securities, obligations of U.S. government agencies, mortgage backed securities and municipal securities, because such securities generally represent a minimal investment risk. Occasionally, we may purchase certificates of deposits of national and state banks. These investments may exceed $100,000 in any one institution (the limit of FDIC insurance for deposit accounts). Federal funds sold and money market accounts represent the excess cash we have available over and above daily cash needs. This money is invested on an overnight basis with approved correspondent banks.
We monitor changes in financial markets. In addition to investments for our portfolio, we monitor daily cash positions to ensure that all available funds earn interest at the earliest possible date. A portion of the investment account is invested in liquid securities that can be readily converted to cash with minimum risk of market loss. These investments usually consist of U.S. Treasury securities, obligations of U.S. government agencies, mortgage backed securities and federal funds. The remainder of the investment account may be placed in investment securities of different type and/or longer maturity. Daily surplus funds are sold in the federal funds market for one business day. We attempt to stagger the maturities of our securities so as to produce a steady cash-flow in the event cash is needed, or economic conditions change.
Correspondent banking involves one bank providing services to another bank which cannot provide that service for itself from an economic or practical standpoint. We purchase correspondent services offered by larger banks, including check collections, purchase of federal funds, security safekeeping, investment services, coin and currency supplies, overline and liquidity loan participations and sales of loans to or participation with correspondent banks.
We have established correspondent relationships with Federal Home Loan Bank, Independent Bankers Bank of Florida, First American Bank and SunTrust Banks. The Company pays for such services.
Each of our subsidiary banks use the same third party core data processing service bureau which provides an automated general ledger system, deposit accounting, and commercial, mortgage and installment lending data processing. The output of each of these comprehensive systems is then consolidated at the holding company level.
Our banks wholly owned subsidiary, CSP, provides item processing services and certain information technology (IT) services for our subsidiary banks. These services include; sorting, encoding, processing, and imaging checks and rendering checking and other deposit statements to commercial and retail customers, as well provide IT services for each subsidiary bank and the Company overall. The total cost of providing these services are charged to each subsidiary bank based on usage.
Effect of Governmental Policies
The earnings and business of our Company are and will be affected by the policies of various regulatory authorities of the United States, especially the Federal Reserve. The Federal Reserve, among other things, regulates the supply of credit and deals with general economic conditions within the United States. The instruments of monetary policy employed by the Federal Reserve for these purposes influence in various ways
the overall level of investments, loans, other extensions of credit and deposits, and the interest rates paid on liabilities and received on assets.
Interest and Usury
Our Company is subject to numerous state and federal statutes that affect the interest rates that may be charged on loans. These laws do not, under present market conditions, deter us from continuing the process of originating loans.
Supervision and Regulation
Banks and their holding companies, and many of their affiliates, are extensively regulated under both federal and state law. The following is a brief summary of certain statutes, rules, and regulations affecting our Company, and our subsidiary Banks. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and is not intended to be an exhaustive description of the statutes or regulations applicable to the business of our Company and subsidiary Banks. Supervision, regulation, and examination of banks by regulatory agencies are intended primarily for the protection of depositors, rather than shareholders.
Bank Holding Company Regulation. Our Company is a bank holding company, registered with the Federal Reserve under the BHC Act. As such, we are subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the Federal Reserve. The BHC Act requires that a bank holding company obtain the prior approval of the Federal Reserve before (i) acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, (ii) taking any action that causes a bank to become a subsidiary of the bank holding company, or (iii) merging or consolidating with any other bank holding company.
The BHC Act further provides that the Federal Reserve may not approve any transaction that would result in a monopoly or would be in furtherance of any combination or conspiracy to monopolize or attempt to monopolize the business of banking in any section of the United States, or the effect of which may be substantially to lessen competition or to tend to create a monopoly in any section of the country, or that in any other manner would be in restraint of trade, unless the anticompetitive 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 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. Consideration of financial resources generally focuses on capital adequacy and consideration of convenience and needs issues includes the parties performance under the Community Reinvestment Act of 1977 (the CRA), both of which are discussed below.
Banks are subject to the provisions of the CRA. Under the terms of the CRA, the appropriate federal bank regulatory agency is required, in connection with its examination of a bank, to assess such banks record in meeting the credit needs of the community served by that bank, including low- and moderate-income neighborhoods. The regulatory agencys assessment of the banks record is made available to the public. Further, such assessment is required of any bank which has applied to:
In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the record of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application.
The BHC Act generally prohibits a bank holding company from engaging in activities other than banking, or managing or controlling banks or other permissible subsidiaries, and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those activities determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices. For example, factoring accounts receivable, acquiring or servicing loans, leasing personal property, conducting securities brokerage activities, performing certain data processing services, acting as agent or broker in selling credit life insurance and certain other types of insurance in connection with credit transactions, and certain insurance underwriting activities have all been determined by regulations of the Federal Reserve to be permissible activities of bank holding companies. Despite prior approval, the Federal Reserve has the power to order a holding company or its subsidiaries to terminate any activity or terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that continuation of such activity or such ownership or
control constitutes a serious risk to the financial safety, soundness, or stability of any bank subsidiary of that bank holding company.
Gramm-Leach-Bliley Act. Enacted in 1999, the Gramm-Leach-Bliley Act permits the creation of new financial services holding companies that can offer a full range of financial products under a regulatory structure based on the principle of functional regulation. The law eliminated the legal barriers to affiliations among banks and securities firms, insurance companies, and other financial services companies. The law also provides financial organizations with the opportunity to structure these new financial affiliations through a holding company structure or a financial subsidiary. The law reserves the role of the Federal Reserve Board as the supervisor for bank holding companies. At the same time, the law also provides a system of functional regulation which is designed to utilize the various existing federal and state regulatory bodies. The law also sets up a process for coordination between the Federal Reserve Board and the Secretary of the Treasury regarding the approval of new financial activities for both bank holding companies and national bank financial subsidiaries.
Bank Regulation. CenterState/Osceola, CenterState Bank and CSNA are chartered under the national banking laws. Valrico State Bank is a State chartered Bank. Each of the deposits of the Banks is insured by the FDIC to the extent provided by law. The Banks are subject to comprehensive regulation, examination and supervision by the OCC. The Banks also are subject to other laws and regulations applicable to banks. Such regulations include limitations on loans to a single borrower and to its directors, officers and employees; restrictions on the opening and closing of branch offices; the maintenance of required capital and liquidity ratios; the granting of credit under equal and fair conditions; and the disclosure of the costs and terms of such credit. The Banks are examined periodically by the OCC. The Banks submit to their examining agencies periodic reports regarding their financial condition and other matters. The bank regulatory agencies have a broad range of powers to enforce regulations under their jurisdiction, and to take discretionary actions determined to be for the protection and safety and soundness of banks, including the institution of cease and desist orders and the removal of directors and officers. The bank regulatory agencies also have the authority to approve or disapprove mergers, consolidations, and similar corporate actions.
There are various statutory limitations on the ability of our Company to pay dividends. The bank regulatory agencies also have the general authority to limit the dividend payment by banks if such payment may be deemed to constitute an unsafe and unsound practice. For information on the restrictions on the right of our Banks to pay dividends to our Company, see Part IIItem 5 Market for the Registrants Common Equity, Related Stockholder Matters and Purchases of Equity Securities.
Under federal law, federally insured banks are subject, with certain exceptions, to certain restrictions on any extension of credit to their parent holding companies or other affiliates, on investment in the stock or other securities of affiliates, and on the taking of such stock or securities as collateral from any borrower. In addition, banks are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or the providing of any property or service.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) imposed major regulatory reforms, stronger capital standards for savings and loan associations and stronger civil and criminal enforcement provisions. FIRREA also provides that a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with:
The FDIC Improvement Act of 1993 (FDICIA) made a number of reforms addressing the safety and soundness of deposit insurance funds, supervision, accounting, and prompt regulatory action, and also implemented other regulatory improvements. Periodic full-scope, on-site examinations are required of all insured depository institutions. The cost for conducting an examination of an institution may be assessed to that institution, with special consideration given to affiliates and any penalties imposed for failure to provide information requested. Insured state banks also are precluded from engaging as principal in any type of activity that is impermissible for a national bank, including activities relating to insurance and equity investments. The Act also recodified restrictions on extensions of credit to insiders under the Federal Reserve Act.
Capital Requirements. The Federal Reserve Board and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the risk-based standard, capital is classified into two tiers. Tier 1 capital consists of common shareholders equity (excluding the unrealized gain (loss) on available-for-sale securities), trust preferred securities subject to certain limitations, and minus certain intangible assets. Tier 2 capital consists of the general allowance for credit losses except for certain limitations. An institutions qualifying capital base for purposes of its risk-based capital ratio consists of the sum
of its Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 and 8% for total risk-based capital. At December 31, 2007, our Tier 1 and total risk-based capital ratios were 13.8% and 15.0%, respectively.
Bank holding companies and banks are also required to maintain capital at a minimum level based on total assets, which is known as the leverage ratio. The minimum requirement for the leverage ratio is 3%, but all but the highest rated institutions are required to maintain ratios 100 to 200 basis points above the minimum. At December 31, 2007, our leverage ratio was 10.8%.
FDICIA contains prompt corrective action provisions pursuant to which banks are to be classified into one of five categories based upon capital adequacy, ranging from well capitalized to critically undercapitalized and which require (subject to certain exceptions) the appropriate federal banking agency to take prompt corrective action with respect to an institution which becomes significantly undercapitalized or critically undercapitalized.
The OCC and the FDIC have issued regulations to implement the prompt corrective action provisions of FDICIA. In general, the regulations define the five capital categories as follows:
The OCC and the FDIC, after an opportunity for a hearing, have authority to downgrade an institution from well capitalized to adequately capitalized or to subject an adequately capitalized or undercapitalized institution to the supervisory actions applicable to the next lower category, for supervisory concerns.
Generally, FDICIA requires that an undercapitalized institution must submit an acceptable capital restoration plan to the appropriate federal banking agency within 45 days after the institution becomes undercapitalized and the agency must take action on the plan within 60 days. The appropriate federal banking agency may not accept a capital restoration plan unless, among other requirements, each company having control of the institution has guaranteed that the institution will comply with the plan until the institution has been adequately capitalized on average during each of the three consecutive calendar quarters and has provided adequate assurances of performance. The aggregate liability under this provision of all companies having control of an institution is limited to the lesser of:
An undercapitalized institution may not acquire an interest in any company or any other insured depository institution, establish or acquire additional branch offices or engage in any new business unless the
appropriate federal banking agency has accepted its capital restoration plan, the institution is implementing the plan, and the agency determines that the proposed action is consistent with and will further the achievement of the plan, or the appropriate Federal banking agency determines the proposed action will further the purpose of the prompt corrective action sections of FDICIA.
If an institution is critically undercapitalized, it must comply with the restrictions described above. In addition, the appropriate Federal banking agency is authorized to restrict the activities of any critically undercapitalized institution and to prohibit such an institution, without the appropriate Federal banking agencys prior written approval, from:
The prompt corrective action provisions of FDICIA also provide that in general no institution may make a capital distribution if it would cause the institution to become undercapitalized. Capital distributions include cash (but not stock) dividends, stock purchases, redemptions, and other distributions of capital to the owners of an institution.
Additionally, FDICIA requires, among other things, that:
FDICIA also contains a number of consumer banking provisions, including disclosure requirements and substantive contractual limitations with respect to deposit accounts.
As of December 31, 2007, each of our subsidiary Banks met the capital requirements of a well capitalized institution.
Enforcement Powers. Congress has provided the federal bank regulatory agencies with an array of powers to enforce laws, rules, regulations and orders. Among other things, the agencies may require that institutions cease and desist from certain activities, may preclude persons from participating in the affairs of insured depository institutions, may suspend or remove deposit insurance, and may impose civil money penalties against institution-affiliated parties for certain violations.
Maximum Legal Interest Rates. Like the laws of many states, Florida law contains provisions on interest rates that may be charged by banks and other lenders on certain types of loans. Numerous exceptions exist to the general interest limitations imposed by Florida law. The relative importance of these interest limitation laws to the financial operations of the Banks will vary from time to time, depending on a number of factors, including conditions in the money markets, the costs and availability of funds, and prevailing interest rates.
Branch Banking. Banks in Florida are permitted to branch state wide. Such branch banking, however, is subject to prior approval by the bank regulatory agencies. Any such approval would take into consideration
several factors, including the banks level of capital, the prospects and economics of the proposed branch office, and other conditions deemed relevant by the bank regulatory agencies for purposes of determining whether approval should be granted to open a branch office.
Change of Control. Federal law restricts the amount of voting stock of a bank holding company and a bank that a person may acquire without the prior approval of banking regulators. The overall effect of such laws is to make it more difficult to acquire a bank holding company and a bank by tender offer or similar means than it might be to acquire control of another type of corporation. Consequently, shareholders of the Company may be less likely to benefit from the rapid increases in stock prices that may result from tender offers or similar efforts to acquire control of other companies. Federal law also imposes restrictions on acquisitions of stock in a bank holding company and a state bank. Under the federal Change in Bank Control Act and the regulations thereunder, a person or group must give advance notice to the Federal Reserve before acquiring control of any bank holding company, the OCC before acquiring control of any national bank and the FDIC and the Florida Department before acquiring control of a state bank. Upon receipt of such notice, the bank regulatory agencies may approve or disapprove the acquisition. The Change in Bank Control Act creates a rebuttable presumption of control if a member or group acquires a certain percentage or more of a bank holding companys or state banks voting stock, or if one or more other control factors set forth in the Act are present.
Interstate Banking. Federal law provides for nationwide interstate banking and branching. Under the law, interstate acquisitions of banks or bank holding companies in any state by bank holding companies in any other state are permissible subject to certain limitations. Florida has a law that allows out-of-state bank holding companies (located in states that allow Florida bank holding companies to acquire banks and bank holding companies in that state) to acquire Florida banks and Florida bank holding companies. The law essentially provides for out-of-state entry by acquisition only (and not by interstate branching) and requires the acquired Florida bank to have been in existence for at least three years.
Effect of Governmental Policies. Our earnings and businesses are affected by the policies of various regulatory authorities of the United States, especially the Federal Reserve. The Federal Reserve, among other things, regulates the supply of credit and deals with general economic conditions within the United States. The instruments of monetary policy employed by the Federal Reserve for those purposes influence in various ways the overall level of investments, loans, other extensions of credit, and deposits, and the interest rates paid on liabilities and received on assets.
Sarbanes-Oxley Act. In 2002, the Sarbanes-Oxley Act was enacted which imposes a myriad of corporate governance and accounting measures designed that shareholders are treated and have full and accurate information about the public companies in which they invest. All public companies are affected by the Act. Some of the principal provisions of the Act include:
USA Patriot Act. In 2001, the USA Patriot Act was enacted. The Act requires financial institutions to help prevent, detect and prosecute international money laundering and financing of terrorism. The effectiveness of a financial institution in combating money laundering activities is a factor to be considered in any application submitted by the financial institution with the bank regulatory agencies. Our Banks have adopted systems and procedures designed to comply with the USA Patriot Act and regulations adopted thereunder by the Secretary of the Treasury.
We encounter strong competition both in making loans and in attracting deposits. The deregulation of the banking industry and the widespread enactment of state laws which permit multi-bank holding companies as well as an increasing level of interstate banking have created a highly competitive environment for commercial banking. In one or more aspects of its business, our Company competes with other commercial banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries. Most of these competitors, some of which are affiliated with bank holding companies, have substantially greater resources and lending limits, and may offer certain services that we do not currently provide. In addition, many of our non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks. Recent federal and state legislation has heightened the competitive environment in which financial institutions must conduct their business, and the potential for competition among financial institutions of all types has increased significantly.
To compete, we rely upon specialized services, responsive handling of customer needs, and personal contacts by its officers, directors, and staff. Large multi-branch banking competitors tend to compete primarily by rate and the number and location of branches while smaller, independent financial institutions tend to compete primarily by rate and personal service.
As of December 31, 2007, we had a total of approximately 371 full-time equivalent employees. The employees are not represented by a collective bargaining unit. We consider relations with employees to be good.
Statistical Profile and Other Financial Data
Reference is hereby made to the statistical and financial data contained in the section captioned Managements Discussion and Analysis of Financial Condition and Results of Operations, for statistical and financial data providing a review of our Companys business activities.
Availability of Reports furnished or filed with the Securities and Exchange Commission (SEC)
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available on our internet website at www.csflbanks.com.
We have identified risk factors described below, which should be viewed in conjunction with the other information contained in this document and information incorporated by reference, including our consolidated financial statements and related notes. If any of the following risks or other risks which have not been identified or which we may believe are immaterial or unlikely, actually occur, our business, financial condition and results of operations could be harmed. As noted previously, this report contains forward-looking statements that involve risks and uncertainties, including statements about our future plans, objectives, intentions and expectations. Many factors, including those described below, could cause actual results to differ materially from those discussed in forward-looking statements.
Our business strategy includes the continuation of significant growth plans, and 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 significant growth strategy for our business. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in significant growth stages of development. There is no assurance 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 our growth occurs more slowly than anticipated or declines, our operating results could be materially adversely affected.
Our ability to successfully grow 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 success of the local economies where we operate
Our success significantly depends upon the growth in population, 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. 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.
We may 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 additional 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 of us. Acquisitions and mergers involve a number of 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, including common stock and securities convertible into shares of our common stock in connection with future acquisitions, which could cause ownership and economic dilution to our current shareholders. There is no assurance that, following any future mergers or acquisition, 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 Florida market were to decline further, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us
Any adverse market or economic conditions in Central Florida may disproportionately increase the risk our borrowers will be unable to make their loan payments. In addition, the market value of the real estate securing loans as collateral could be adversely affected by unfavorable changes in market and economic conditions. As of December 31, 2007, approximately 84% of our loans held for investment were secured by real estate. Of this amount, approximately 55% were commercial real estate loans, 30% were residential real estate loans and 15% were construction, development and land loans. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in Central Florida could adversely affect the value of our assets, our revenues, results of operations and financial condition.
With most of our loans concentrated in Central 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 geographically diverse.
In addition to the financial strength and cash flow characteristics of the borrower in each case, the Banks often secure loans with real estate collateral. At December 31, 2007, approximately 84% of our loans have real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If we are required to liquidate the collateral securing a loan to satisfy the 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. We maintain 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 a percentage of the outstanding balances and for specific loans when their ultimate collectibility is considered questionable. 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, our earnings and capital could be significantly and adversely affected.
The building of market share through our de novo branching strategy could cause our expenses to increase faster than revenues
We intend to continue to build market share in Central Florida through our de novo branching strategy. There are considerable costs involved in opening branches and new branches generally do not generate sufficient revenues to offset their costs until they have been in operation for at least a year or more. Accordingly, our new branches can be expected to negatively impact our earnings for some period of time until the branches reach certain economies of scale. Our expenses could be further increased if we encounter delays in the opening of any of our new branches. Finally, we have no assurance our new branches will be successful even after they have been established.
Our recent results may not be indicative of our future results
We may not be able to sustain our historical rate of growth or may not even be able to grow our business at all. In addition, our recent and rapid growth may distort some of our historical financial ratios and statistics. In the future, we may not have the benefit of several recently favorable factors, such as a generally favorable interest rate environment or the ability to find suitable expansion opportunities. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or prohibit our ability to expand our market presence. If we experience a significant decrease in our historical rate of growth, our results of operations and financial condition may be adversely affected due to a high percentage of our operating costs being fixed expenses.
Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate our capital resources following this offering will satisfy our capital requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our continued growth.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, 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 interest rates, our interest expense could increase in different amounts and at different rates while the interest that we earn on our assets may not change in the same amounts or at the same rates. Accordingly, increases in interest rates could decrease our net interest income.
Changes in the level of interest rates also 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 are made at prices lower than the amortized costs of the investments, we will 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 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 and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capitalization guidelines established by our regulators, which 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.
We are dependent upon the services of our management team
Our future success and profitability is 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 and 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.
Our Holding Company owns no real property. We occupy office space in the main office building of CenterState Bank, one of our subsidiary Banks, which is located at 1101 First Street South, Suite 202, Winter Haven, Florida 33880. Our Company, through our Banks, currently operates a total of 37 banking offices. Of these offices there are two mini offices in active adult communities. These offices are leased for nominal amounts, and generally consist of a room that is set aside for us in the community club house or community center. These offices are opened for abbreviated periods and cater to the residents of the gated community. Of the
35 full service offices, we lease six, two of these six we built the building but are leasing the land. Also, we are operating three offices in temporary locations during the construction of their permanent sites (Crystal River, Deer Creek and Eustis), and all the remaining offices (26) we own without encumbrances. See Note 4 to the Consolidated Financial Statements of our Company included in this Annual Report on Form 10-K beginning at page 67 for additional information regarding our premises and equipment.
Our Banks are periodically parties to or otherwise involved in legal proceedings arising in the normal course of business, such as claims to enforce liens, claims involving the making and servicing of real property loans, and other issues incident to their respective businesses. We do not believe that there is any pending or threatened proceeding against the Banks which would have a material adverse effect on our consolidated financial position.
No matters were submitted to a vote of our Company security holders during the fourth quarter of the year ended December 31, 2007.
The shares of our Common Stock are traded on the Nasdaq National Market System. The following sets forth the high and low trading prices for trades of our Common Stock that occurred during 2007 and 2006. Historical per share data has been adjusted to reflect our May 2006 two for one stock split.
As of December 31, 2007, there are 12,436,407 shares of common stock outstanding. There were approximately 1,054 registered shareholders as of that date, as reported by our transfer agent, Continental Stock Transfer & Trust Company.
We have historically paid cash dividends on a quarterly basis, on the last business day of the calendar quarter. The following sets forth per share cash dividends paid during 2007 and 2006. Historical per share data has been adjusted to reflect our May 2006 two for one stock split.
The payment of dividends is a decision of our Board of Directors based upon then-existing circumstances, including our rate of growth, profitability, financial condition, existing and anticipated capital requirements, the amount of funds legally available for the payment of cash dividends, regulatory constraints and such other factors as the Board determines relevant. The source of funds for payment of dividends by our Holding Company is dividends received from our Banks, or excess cash available at the Holding Company level. Payments by our subsidiary Banks to our Holding Company are limited by law and regulations of the bank regulatory authorities. There are various statutory and contractual limitations on the ability of our Banks to pay dividends to our Holding Company. The bank regulatory agencies also have the general authority to limit the dividends paid by banks if such payment may be deemed to constitute an unsafe and unsound practice. Our subsidiaries may not pay dividends from their paid-in surplus. All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts. In addition, a national bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital, unless there has been transferred to surplus no less than one/tenth of the banks net profits of the preceding two consecutive half-year periods (in the case of an annual dividend). The approval of the OCC is required if the total of all dividends declared by a national bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus. As to a state bank, no dividends may be paid at a time when the Banks net income from the preceding two 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 Department or a Federal regulatory agency.
We did not repurchase any shares of our common stock during 2007.
With respect to information regarding our securities authorized for issuance under equity incentive plans, the information contained in the section entitled Equity Compensation Plan Information in our Definitive Proxy Statement for the 2008 Annual Meeting of Shareholders is incorporated herein by reference.
Shares of our common stock are traded on the NASDAQ National Market System. The following graph compares the yearly percentage change in cumulative shareholder return on the Companys common stock, with the cumulative total return of the SNL Southeast Bank Index and the NASDAQ Bank Index, since December 31, 2002 (assuming a $100 investment on December 31, 2002 and reinvestment of all dividends).
The selected consolidated financial data presented below should be read in conjunction with managements discussion and analysis of financial condition and results of operations, and the consolidated financial statements and footnotes thereto, of the Company at December 31, 2007 and 2006, and the three year period ended December 31, 2007, presented elsewhere herein.
Selected Consolidated Financial Data
For the twelve month period ending or as of December 31
Selected Consolidated Financial Datacontinued
For the twelve month period ending or as of December 31
Quarterly Financial Information
The following table sets forth, for the periods indicated, certain consolidated quarterly financial information. This information is derived from our unaudited financial statements which include, in the opinion of management, all normal recurring adjustments which management considers necessary for a fair presentation of the results for such periods. The sum of the four quarters of earnings per share may not equal the total earnings per share for the full year due to rounding. This information should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this document. The results for any quarter are not necessarily indicative of results for future periods. Historical earnings per share data have been adjusted to reflect our May 2006 two for one stock split.
Selected Quarterly Data
(Dollars are in thousands)
Some of the statements in this report constitute forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995 and the Securities Exchange Act of 1934. These statements related to future events, other future financial performance or business strategies, and include statements containing terminology such as may, will, should, expects, scheduled, plans, intends, anticipates, believes, estimates, potential, or continue or the negative of such terms or other comparable terminology. Actual events or results may differ materially from the results anticipated in these forward looking statements, due to a variety of factors, including, without limitation: the effects of future economic conditions; governmental monetary and fiscal policies, as well as legislative and regulatory changes; the risks of changes in interest rates and the level and composition of deposits, loan demand, and the values of loan collateral; and the effects of competition from other commercial banks, thrifts, consumer finance companies, and other financial institutions operating in our market area and elsewhere. All forward looking statements attributable to our Company are expressly qualified in their entirety by these cautionary statements. We disclaim any intent or obligation to update these forward looking statements, whether as a result of new information, future events or otherwise. There is no assurance that future results, levels of activity, performance or goals will be achieved.
Our discussion and analysis of earnings and related financial data are presented herein to assist
investors in understanding the financial condition of our Company at December 31, 2007 and 2006, and the results of operations for the years ended December 31, 2007, 2006 and 2005. This discussion should be read in conjunction with the consolidated financial statements and related footnotes of our Company presented elsewhere herein. Historical per share data has been adjusted to reflect our May 2006 two for one stock split.
Our consolidated financial statements include the accounts of CenterState Banks of Florida, Inc. (the Parent Company, Company, CenterState or CSFL), and our four wholly owned subsidiary banks, and their wholly owned subsidiary, C.S. Processing, Inc.
Our subsidiary banks operate through 37 locations in nine counties throughout Central Florida, providing traditional deposit and lending products and services to its commercial and retail customers. C.S. Processing is a wholly owned subsidiary of our subsidiary Banks, which provides item processing services and certain information technology services for these subsidiary Banks.
On April 2, 2007, we closed on our acquisition of Valrico Bancorp, Inc. (VBI) and its wholly owned subsidiary Valrico State Bank (VSB). The $36,100,000 purchase price was a combination of 65% stock and 35% cash. Other costs including change of control payments, accelerated deferred compensation arrangements and other transaction costs approximated $3,200,000. The total cost of the transaction was approximately $39,300,000. VSB opened for business in 1989 and operated through four banking locations in Hillsborough County, Florida. A fifth location, also in Hillsborough County, opened in May 2007. VSB is operating as a separate wholly owned subsidiary, similar to our other subsidiary banks. This acquisition resulted in additional goodwill and core deposit intangible (CDI) of approximately $18,256,000 and $2,484,000, respectively. Refer to Note 21 in the Companys current year consolidated financial statements for additional information.
We opened several new branch offices during 2007. During February, we opened a new location in Osceola County (St. Cloud, Florida), during August we opened one in Hernando County (Brooksville, Florida), and as discussed above, we opened a new VSB location in Hillsborough County during May. We have three branch offices still operating out of temporary locations while their permanent facilities are being constructed. The construction of two of these branch offices are very near completion, the other one has barely begun construction.
On November 30th of this year we closed a set of related transactions that effectively resulted in combining two of our subsidiary Banks into one and selling the shell of the other. The two Banks that we combined were CenterState Bank West Florida, N.A. (CSWFL) and CenterState Bank Mid Florida (Mid FL). CSWFL was the surviving bank and its name was subsequently changed to CenterState Bank, N.A. We effectively sold the shell of our Mid FL Bank to an out of state bank for $1,000,000. The expenses related to this transaction were approximately $100,000.
With the acquisition of VSB, we were operating through five wholly owned subsidiary Banks. Subsequent to combining CSWFL and Mid FL we are back to four. At December 31, 2007, our four subsidiary Banks are operating an aggregate of 37 banking locations in nine Counties in central Florida as summarized in the table below:
Our Companys principal asset is its ownership of the Banks. Accordingly, our consolidated results of operations are primarily dependent upon the results of operations of the Banks. Through our subsidiary Banks, we conduct commercial banking business consisting of attracting deposits from the general public and applying those funds to the origination of commercial, consumer and real estate loans (including commercial loans collateralized by real estate). Our profitability depends primarily on net interest income, which is the difference between interest income generated from interest-earning assets (i.e. loans and investments) less the interest expense incurred on interest-bearing liabilities (i.e. customer deposits and borrowed funds). Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities, and the interest rate earned and paid on these balances. Net interest income is dependent upon the interest rate spread which is the difference between the average yield earned on our interest-earning assets and the average rate paid on our interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income. The interest rate spread is impacted by interest
rates, deposit flows, and loan demand. Additionally, and to a lesser extent, our profitability is affected by such factors as the level of non-interest income and expenses, the provision for credit losses, and the effective tax rate. Non-interest income consists primarily of service fees on deposit accounts and related services, and to a lesser extent commission earned on brokering single family home loans, and commissions earned on the sale of mutual funds, annuities and other non traditional and non insured investments. Non-interest expense consists of compensation, employee benefits, occupancy and equipment expenses, and other operating expenses.
Critical Accounting Policies
Our accounting policies are integral to understanding the results reported. Accounting policies are described in detail in Note 1 of the notes to the consolidated financial statements. The critical accounting policies require managements judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. We have established policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies involving significant management valuation judgments.
Allowance for Loan Losses
The allowance for loan losses represents our estimate of probable incurred losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. The allowance for loan losses is determined based on our assessment of several factors: reviews and evaluation of individual loans, changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on specific borrowers and industry concentrations, historical loan loss experiences and the level of classified and nonperforming loans.
Changes in the financial condition of individual borrowers, in economic conditions, in historical loss experience and in the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for loan losses and the associated provision for loan losses.
A standardized loan grading system is utilized at each of our subsidiary Banks. The grading system is integral to our risk assessment function related to lending. Loan officers of each Bank assign a loan grade to their newly originated loans in accordance with the standard loan grades. Throughout the lending relationship, the loan officer is responsible for periodic reviews, and if warranted he/she will downgrade or upgrade a particular loan based on specific events and/or analyses. We use a loan grading system of 1 through 7. Grade 1 is excellent and grade 7 is doubtful. Loans graded 5 or higher are placed on a watch list each month end and reported to that particular Banks board of directors. The Companys loan review officer, who is independent of the lending function and is not an employee of any subsidiary bank, periodically reviews each Banks loan portfolio and lending relationships. He may disagree with a particular Banks grade on a particular loan and subsequently downgrade or upgrade such loan(s) based on his risk analysis. As such, our lending process is decentralized, but our credit review process is centralized.
We maintain an allowance for loan losses that we believe is adequate to absorb probable losses inherent in our loan portfolio. The allowance consists of two components. The first component consists of amounts specifically reserved (specific allowance) for specific loans identified as impaired, as defined by Statement of Financial Accounting Standard No. 114 (SFAS 114). Impaired loans are those loans that management has estimated will not repay as agreed upon. Each of these loans is required to have a written analysis supporting the amount of specific reserve allocated to the particular loan, if any. That is to say, a loan may be impaired (i.e. not expected to repay as agreed), but may be sufficiently collateralized such that we expect to recover all principle and interest eventually, and therefore no specific reserve is warranted.
The second component, which we refer to as Statement of Financial Accounting Standard No. 5 (SFAS 5) loans, is a general reserve (general allowance) on all of the Companys loans other than those identified as impaired. We group these loans into categories with similar characteristics and then apply a loss factor to each group which is derived from our historical loss factor for that category adjusted for current internal and external environmental factors, as well as for certain loan grading factors. The aggregate of these two components results in our total allowance for loan losses.
Goodwill and Intangible Assets
Goodwill represents the excess of cost over fair value of assets of business acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values. We acquired CenterState Bank of Florida, in Winter Haven, Florida, on December 31, 2002, CenterState Bank Mid Florida on March 31, 2006 and Valrico State Bank on April 2, 2007. Consequently, we were required to record the assets acquired, including identified intangible assets, and liabilities assumed at their fair value, which involves estimates based on third party valuations, such as appraisals, internal valuations based on discounted cash flow analyses or other valuation techniques. The determination of the useful lives of intangible assets is subjective, as is the appropriate amortization period for such intangible assets. In addition, purchase acquisitions typically result in recording goodwill, which is subject to ongoing periodic impairment tests based on the fair value of the reporting unit compared to its carrying amount, including goodwill. As of November 30, 2007, the required annual impairment test of goodwill was performed and no impairment existed as of the valuation date. If for any future period we determine that there has been impairment in the carrying value of our goodwill balances, we will record a charge to our earnings, which could have a material adverse effect on our net income. Goodwill and intangible assets are described further in Note 5 of the notes to the consolidated financial statements.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2007 AND DECEMBER 31, 2006.
Our net income for the year ended December 31, 2007 was $7,799,000 or $0.64 per share (basic) and $0.63 per share (diluted), compared to $8,459,000 or $0.77 per share (basic) and $0.75 per share (diluted) for the year ended December 31, 2006.
Our return on average assets (ROA) and return on average equity (ROE) for the year ended December 31, 2007 were 0.66% and 5.63%, as compared to the ROA and ROE of 0.86% and 7.70%, for the year ended December 31, 2006.
The significant items contributing to our 2007 net income compared to 2006 are discussed below.
Net Interest Income/Margin
Net interest income consists of interest income generated by earning assets, less interest expense.
Net interest income increased $5,245,000 or 14% to $42,348,000 during the year ended December 31, 2007 compared to $37,103,000 for the same period in 2006. The increase was the result of a $16,060,000 increase in interest income less a $10,815,000 increase in interest expense.
Interest earning assets averaged $1,068,591,000 during the year ended December 31, 2007 as compared to $894,286,000 for the same period in 2006, an increase of $174,305,000, or 19%. The yield on average interest earning assets increased 42 basis points (bps) to 7.03% (46bps to 7.09% tax equivalent basis) during the year
ended December 31, 2007, compared to 6.61% (6.63% tax equivalent basis) for the same period in 2006. The combined net effects of the $174,305,000 increase in average interest earning assets and the 42bps (46bps tax equivalent basis) increase in yield on average interest earning assets resulted in the $16,060,000 ($16,392,000 tax equivalent basis) increase in interest income between the two years.
Interest bearing liabilities averaged $854,251,000 during the year ended December 31, 2007 as compared to $670,562,000 for the same period in 2006, an increase of $183,689,000, or 27%. The cost of average interest bearing liabilities increased 56bps to 3.84% during the year ended December 31, 2007, compared to 3.28% for the same period in 2006. The combined net effects of the $183,689,000 increase in average interest bearing liabilities and the 56bps increase in cost of average interest bearing liabilities resulted in the $10,815,000 increase in interest expense between the two years.
See the tables Average BalancesYields & Rates, and Analysis Of Changes In Interest Income And Expenses below.
Average BalancesYields & Rates
(Dollars are in thousands)
Analysis of Changes in Interest Income and Expenses
(Dollars are in thousands)
The table above details the components of the changes in net interest income for the last two years. For each major category of interest earning assets and interest bearing liabilities, information is provided with respect to changes due to average volume and changes due to rates, with the changes in both volumes and rates allocated to these two categories based on the proportionate absolute changes in each category.
Provision for Loan Losses
The provision for loan losses (expense) increased $2,075,000, to $2,792,000 during the year ending December 31, 2007 compared to $717,000 for the comparable period in 2006. Our policy is to maintain the allowance for loan losses at a level sufficient to absorb probable incurred losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses, which is a charge to current period earnings, and is decreased by charge-offs, net of recoveries on prior loan charge-offs. Therefore, the provision for loan losses
(Income Statement effect) is a residual of managements determination of allowance for loan losses (Balance Sheet approach). In determining the adequacy of the allowance for loan losses, we consider those levels maintained by conditions of individual borrowers, the historical loan loss experience, the general economic environment, the overall portfolio composition, and other information. As these factors change, the level of loan loss provision changes. See credit quality and allowance for loan losses regarding the allowance for loan losses for additional information.
Non-interest income for the year ended December 31, 2007 was $8,332,000 compared to $6,136,000 for the comparable period in 2006. This increase was the result of the following components listed in the table below (Amounts listed are in thousands of dollars).
As previously reported, the Company and two of its subsidiary banks, (CenterState Bank West Florida, N.A. (CSWFL) and CenterState Bank Mid Florida (Mid FL)), Atlantic Southern Financial Group, Inc. (a Georgia Corporation) and its wholly owned subsidiary, Atlantic Southern Bank (collectively referred to as Atlantic Southern) entered into several related agreements (the Transaction) which closed on November 30, 2007. In summary, a description of the Transaction is as follows: CSWFL effectively purchased substantially all the assets and assumed the liabilities of Mid FL, except for the Mid FL main office (a leased office) and a minimum amount of deposits and capital required by banking laws. Atlantic Southern then acquired Mid FL, through a merger. Atlantic Southern paid to the Company an amount equal to the remaining amount of capital of Mid FL (after the sale (transfer) by Mid FL of its assets and liabilities to CSWFL) plus an additional amount of $1,000,000. Atlantic Southern then transferred Mid FLs main office to CSWFL. The Company recognized a gain on the sale of $1,000,000 (included in non interest income) less transaction expenses of approximately $100,000. Transaction expenses are included in non interest expense. The Company continues to operate the same locations operated by CSWFL and Mid FL, except we are now operating these locations under one charter instead of two. All customer loan and deposit accounts/relationships have been retained by the Company. Following the Transaction, CSWFL changed its name to CenterState Bank, N.A.
Excluding the sale of the Mid FL bank shell, our remaining non-interest income increased by $1,196,000 or 19.5% in 2007 compared to 2006. We acquired Mid FL on March 31, 2006, and, as such, we recognized nine months of non interest income generated by Mid FL in 2006, compared to twelve months in 2007. In addition, we acquired VSB on April 2, 2007, and, as such, in this case, we recognized nine months of non interest income generated by VSB in 2007 compared to nothing in 2006. When removing these two subsidiaries from the above non-interest income table, the remaining difference between the two years decreases from $1,196,000, or 19.5% to approximately $439,000, or 7.4%. This remaining increase is primarily due to our general business growth.
Commissions from mortgage broker activities is dependent on market place forces including supply and demand of single family residential property in our local markets, and the interest rate environment which primarily effects refinancing activity. As the residential real estate market in Florida deteriorated, activity decreased, resulting in decreased commissions earned in 2007 compared to 2006.
Sales of mutual funds and annuities are somewhat dependent on market place forces, but primarily dependent on the successful efforts of our investment sales representatives.
Non-interest expense for the year ended December 31, 2007 increased $6,988,000, or 23.9%, to $36,192,000, compared to $29,204,000 for 2006. The table below breaks down the individual components. Amounts are in thousands of dollars.
From a macro viewpoint, the most significant components when comparing current year non-interest expense to prior year are the acquisitions of Mid FL and VSB. We acquired Mid FL on March 31, 2006, and, as such, we recognized nine months of non-interest expense generated by Mid FL during 2006, compared to twelve months in 2007. We acquired VSB on April 2, 2007, and, as such, we recognized nine months of non-interest expense generated by VSB in 2007, compared to nothing in 2006. When removing these two subsidiaries from the above non-interest expense table, the remaining difference between the two years decreases from $6,988,000, or 23.9% to approximately $1,793,000, or 6.7%. This remaining increase is primarily due to our general business growth. The narrative below discusses changes in selected line items year to year.
Our largest non-interest expense is employee and employee related expenses. Total salaries, wages and employee benefits for 2007 accounted for 55% of our total non-interest expense, compared to 58% for 2006. Looking at the table above, employee salaries and wages increased by$2,762,000, or 22.9% to $14,825,000 for 2007, compared to $12,063,000 for 2006. Removing the Mid FL component (approximately $1,200,000 in 2007 and $799,000 in 2006) and the VSB component ($1,641,000 in 2007 and nothing in 2006), reduces the net
increase from $2,762,000, or 22.9%, to $720,000, or 6.4%. This remaining increase of $720,000 was due to a combination of increase in average FTEs (full time equivalent employees) year to year (289 FTEs versus 283 FTEs, excluding Mid FL and VSB) and salary increases commensurate with our market environment.
We use a combination of performance incentive/bonus guidelines to motivate our employees to perform. These are primarily all tied to earnings performance metrics. As our net income increases and our assets grow, our employee incentive/bonus compensation also increases. Although our total assets grew (primarily due to the VSB acquisition), our net income decreased by 7.8% year to year. Although we have more employees in 2007 versus 2006, primarily due to the 60 FTEs we acquired with the VSB transaction, which would increase our incentive/bonus expense, our actual incentive/bonus compensation decreased by $560,000, or 27.2% year to year, which is directionally consistent with the philosophy of our incentive/bonus guidelines.
Employee health insurance expense increased by $506,000, or 28.8% year to year as listed in the table above. Removing VSB employee health insurance expense (approximately $175,000VSB was not included in our 2006 expense) results in an adjusted increase of approximately $331,000, or 18.8%. A small part of this increase is related to the increase in FTEs (exclusive of VSB FTEs), but the largest portion is reflective of the increasing costs occurring in the health insurance industry. We have been proactive in this area during 2007. Effective October 1, 2007, we changed insurance company and third party administrators, and effective January 1, 2008, we initiated a Health Savings Account plan (HSA), as well as other consumer driven initiatives. We dont necessarily expect a decrease in employee health insurance expense in 2008, but we do expect very little, if any, increase in this expense from our 2007 levels.
The acquisitions of Mid FL and VSB, as discussed above, significantly influenced our increase in overall operating expenses. In addition, but to a lesser extent, our branching activity also had an increasing effect on operating expenses. Below is a list of our branching activity during 2006 and 2007.
As shown in the non-interest expense table above, marketing expenses increased by $511,000, or 87.4% year to year. VSBs marketing expense represents $104,000 of this $511,000 increase. The remaining increase in this item relates to the checking account marketing campaign currently in place at one of our banks. This campaign started during the fourth quarter of 2006.
Legal, auditing and other professional fees increased by $428,000. The increase was a result of legal fees of approximately $90,000 related to the sale of bank shell, $141,000 related to VSB and the remaining amount is due to the continuing increase in bank regulation and requirements.
The CDI amortization increase between the two years is due to the April 2, 2007 acquisition of VSB and a full year of amortization versus nine months in 2006 for the March 31, 2006 acquisition of Mid FL.
Income Tax Provision
The income tax provision for the year ended December 31, 2007, was $3,897,000, an effective tax rate of 33.3%, as compared to $4,859,000 for the year ended December 31, 2006, an effective tax rate of 36.5%. This year we had more tax exempt interest income from tax exempt securities than last year, which is a decreasing effect on our effective tax rate. We also had more Bank Owned Life Insurance (BOLI) income this year than last year, which is also tax exempt and also results in a decreasing effect on our effect tax rate. In addition, we also had less stock option expense this year relating to incentive stock options which are not tax deductible expenses, resulting in a decreasing effect on our effective tax rate. Income taxes are described and discussed further in Note 10 of our notes to our consolidated financial statements.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2006 AND DECEMBER 31, 2005.
Our net income for the year ended December 31, 2006 was $8,459,000 or $0.77 per share (basic) and $0.75 per share (diluted), compared to $6,330,000 or $0.675 per share (basic) and $0.655 per share (diluted) for the year ended December 31, 2005.
Our return on average assets (ROA) and return on average equity (ROE) for the year ended December 31, 2006 were 0.86% and 7.70%, as compared to the ROA and ROE of 0.78% and 8.11%, for the year ended December 31, 2005.
Net income increased approximately $2,129,000 or 34% to $8,459,000 for the year ended December 31, 2006, compared to $6,330,000 for the same period during 2005. Earnings per share (basic) increased by $0.095, or 14% during this same period. We acquired the Mid FL bank on March 31, 2006. Therefore, nine months of Mid FL net income (approximately $496,000) was included in our 2006 consolidated net income amount. Average shares outstanding during 2006 issued pursuant to the Mid FL transaction was approximately 416,000. Basic earnings per share, $0.77, would be reduced to approximately $0.75 without Mid FL. Mid FL appears to have been accretive to our basic earnings per share in 2006 by approximately $0.02. All remaining growth in net income and earnings per share resulted from the continuing growth of our business, helped out by expansion in our net interest margin in 2006 compared to 2005 (4.15% versus 3.84%). The significant line items contributing to our 2006 net income compared to 2005 are discussed below.
Net Interest Income/Margin
Net interest income consists of interest income generated by earning assets, less interest expense.
Net interest income increased $8,559,000 or 30% to $37,103,000 during the year ended December 31, 2006 compared to $28,544,000 for the year ended December 31, 2005. The $8,559,000 increase was a combination of an $18,847,000 increase in interest income offset by a $10,288,000 increase in interest expense.
Average interest earning assets increased $149,988,000 to $894,286,000 during the year ended December 31, 2006, compared to $744,298,000 for the year ended December 31, 2005. The yield on average interest earning assets increased 120bps to 6.61% (121bps to 6.63% tax equivalent basis) during the year ended December 31, 2006, compared to 5.41% (5.42% tax equivalent basis) for the same period in 2005. The combined net effects of the $149,988,000 increase in average interest earning assets and the 120bps (121bps tax equivalent basis) increase in yield on average interest earning assets resulted in the $18,847,000 ($18,986,000 tax equivalent basis) increase in interest income between the two years.
Interest bearing liabilities averaged $670,562,000 during the year ended December 31, 2006 as compared to $544,663,000 for the same period in 2005, an increase of $125,899,000, or 23%. The cost of average interest bearing liabilities increased 113bps to 3.28% during the year ended December 31, 2006, compared to 2.15% for the same period in 2005. The combined net effects of the $125,899,000 increase in average interest bearing liabilities and the 113bps increase in cost of average interest bearing liabilities resulted in the $10,288,000 increase in interest expense between the two years.
See the tables Average BalancesYields & Rates, and Analysis Of Changes In Interest Income And Expenses below.
Average BalancesYields & Rates
(Dollars are in thousands)
Analysis of Changes in Interest Income and Expenses
(Dollars are in thousands)
The table above details the components of the changes in net interest income for the last two years. For each major category of interest earning assets and interest bearing liabilities, information is provided with respect to changes due to average volume and changes due to rates, with the changes in both volumes and rates allocated to these two categories based on the proportionate absolute changes in each category.
Provision for Loan Losses
The provision for loan losses is charged to earnings to bring the total loan loss allowance to a level deemed appropriate by management and is based upon historical experience, the volume and type of lending conducted by us, the amount of nonperforming loans, general economic conditions, particularly as they relate to our market areas, and other environmental factors related to the collectibility of our loan portfolio. As these factors change, the level of loan loss allowance changes. As such, the provision for loan loss (income statement) is the difference
between the loan loss allowance (balance sheet) at the beginning and end of the period, net of current period loan charge-offs and recoveries of previously charged off loans. The provision was $717,000 for the year ending December 31, 2006 compared to $1,065,000 for the same period in 2005, a decrease of $348,000. There were several factors effecting the provision period to period (e.g. net differences in net charge-offs and recoveries), however, the primary reason for the decrease in the provision between the periods was due to a decrease in specific reserves on impaired loans of $645,000. The specific reserve on impaired loans at December 31, 2006 was $372,000 compared to $1,017,000 at December 31, 2005.
Non-interest income for the year ended December 31, 2006 was $6,136,000 compared to $5,380,000 for the comparable period in 2005. This increase was the result of the following components listed in the table below (Amounts listed are in thousands of dollars).
Our general business growth helped increase fee income in general. Mid FLs non-interest income is included in 2006 income, but not 2005. Mid Floridas total non interest income contribution for 2006 was approximately $214,000, of which about $117,000 relates to service charges on deposit accounts. Partially off-setting these increasing effects on our deposit account service charges were rising interest rates and the related effect on the earnings credit on our commercial (business) checking accounts. That is, as interest rates rise, the earnings credit on checking accounts has increased thereby reducing checking account service fees, producing a decreasing effect in service charges on deposit accounts. Another off-setting decreasing effect on deposit account service charges was the merger of two of our subsidiary banks in January 2006. One of the banks had been charging customers for checking accounts (i.e. non-business checking accounts). Subsequent to the merger, that product has been changed to free checking, which produced a decreasing effect on service charges on deposit accounts. The reason we changed to free checking was to conform to our other banks and to better align ourselves to the local competition.
We purchased the majority of our BOLI on October 31, 2005. As such, we only had two months of income in 2005, compared to twelve months of earnings in 2006. BOLI is single premium life insurance placed on certain Bank officers. BOLI income is recognized as the cash surrender value of the insurance policies grow. BOLI income is generally tax deferred indefinitely.
Commissions from mortgage broker activities is dependent on market place forces including supply and demand of single family residential property in our local markets, and the interest rate environment which primarily effects refinancing activity.
Sales of mutual funds and annuities are also dependent on market place forces including the successful efforts of our investment sales representatives.
Non-interest expense for the year ended December 31, 2006 increased $6,399,000, or 28%, to $29,204,000, compared to $22,805,000 for 2005. The table below breaks down the individual components. Amounts are in thousands of dollars.
The most significant component when comparing current year non interest expense to prior year is the March 31, 2006 acquisition of Mid FL. Mid FL non interest expense is included in the current year but not in 2005. Mid FLs total 2006 non interest expense was approximately $2,292,000. Excluding Mid FL, our net increase would adjust from $6,399,000, or 28.1%, to $4,107,000, or 18.0% ($6,399,000 minus $2,292,000).
Our largest non-interest expense is employee and employee related expenses. Total salaries, wages and employee benefits for 2006 accounted for 58% of our total non-interest expense (57% excluding stock option expense), compared to 55% for 2005. Effective January 1, 2006, we were required to expense employee stock options pursuant to Statement of Financial Accounting Standard No. 123(R). Prior to 2006, we were not required to record an estimated expense for stock options in our financial statements. We recorded an expense of $594,000 in 2006, which was approximately 2% of our total non interest expense.
Looking at the table above, employee salaries and wages increased by 20.6% to $12,063,000 for 2006, compared to $10,006,000 for 2005. To analyze this $2,057,000 increase, removing the Mid FL component of salary expense (approximately $799,000), results in an adjusted increase of $1,258,000, or 12.6%. This increase is a result of an increase in average FTEs, exclusive of Mid FL (291 in 2006 compared to 266 in 2005), as well as salary increases commensurate with our market environment.
We use a combination of performance incentive / bonus guidelines to motivate our employees to perform. These are primarily all tied to earnings performance metrics. As our net income increases, our employee incentive/bonus compensation also increases.
Employee health insurance expense increased by $580,000, or 49.2% year to year as listed in the table above. Removing Mid FL employee health insurance expense (approximately $121,000Mid FL was not included in our 2005 expense) results in an adjusted increase of approximately $459,000, or 38.9%. Part of this increase is related to the increase in FTEs (exclusive of Mid FL FTEs), and the remaining amount is reflective of the increasing costs occurring in the health insurance industry.
Incremental direct cost of loan origination, represents direct incremental cost of originating loans for our portfolio (successful efforts) that are required to be capitalized and amortized to interest income over the life of the related loan pursuant to Statement of Financial Accounting Standard No. 91. The amount that we capitalize is dependent on not just the cost, but the volume of loans successfully originated.
We added one new branch in October 2005 (Crystal River), which is still operating out of a temporary location until we complete the construction of a new permanent facility. The new facility is expected to be ready during the first half of 2008. We opened a new office in September 2006 (Eustis) and one in October 2006 (Deer Creek), both in temporary facilities until we construct permanent facilities. The Deer Creek facility was recently completed in January 2008. The Eustis facility just began construction during January 2008. We also opened a new branch in a newly constructed permanent facility in October 2006. This accounts for some of the additional FTEs year to year, the rest is due to the continual growth of our business. The increase in the remainder of our non-interest expense was primarily due to the continual growth of our business.
Income Tax Provision
The income tax provision for the year ended December 31, 2006, was $4,859,000, an effective tax rate of 36.5%, as compared to $3,724,000 for the year ended December 31, 2005, an effective tax rate of 37.0%. This year we had more tax exempt interest income from tax exempt securities than last year, which is a decreasing effect on our effective tax rate. We also had more BOLI income this year than last year, which is also tax exempt and also results in a decreasing effect on our effect tax rate. In the other direction, we had stock option expense this year relating to incentive stock options which are not tax deductible expenses, resulting in an increasing effect on our effective tax rate. This year we also crossed into a higher federal tax bracket, which is an increasing effect on our effective tax rate. Income taxes are described and discussed further in Note 10 of our notes to our consolidated financial statements.
COMPARISON OF BALANCE SHEETS AT DECEMBER 31, 2007 AND DECEMBER 31, 2006
Our total assets grew by $140,328,000, or 13%, from $1,077,102,000 at December 31, 2006 to $1,217,430,000 at December 31, 2007. The growth was due to the acquisition of VSB on April 2, 2007, as previously discussed. At the time of the transaction, VSBs total assets at acquisition were approximately $184,090,000. Excluding the VSB acquisition, total assets decreased by approximately $43,762,000, or 4%.
We account for our investments at fair value and classify them as available for sale. Unrealized holding gains and losses are included as a separate component of shareholders equity, net of the effect of deferred income taxes.
A decline in the market value of any available-for-sale security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether an impairment is other-than-temporary, we consider whether we have the ability and intent to hold the investment until a market price recovery and consider whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to year end, and forecasted performance of the security.
If a security has a decline in fair value below its amortized cost that is other than temporary, then the security will be written down to its new cost basis by recording a loss in the statement of operations. We do not engage in trading activities as defined in Statement of Financial Accounting Standard Number 115.
Our available for sale portfolio totaled $199,434,000 at December 31, 2007 and $235,350,000 at December 31, 2006, or 16% and 22%, respectively, of total assets. See the tables below for a summary of security type, maturity and average yield distributions.
We use our security portfolio primarily as a source of liquidity and a base from which to pledge assets for repurchase agreements and public deposits. When our liquidity position exceeds expected loan demand, other investments are considered as a secondary earnings alternative. Typically, we remain short-term in our decision to invest in certain securities. As these investments mature, they will be used to meet cash needs or will be reinvested to maintain a desired liquidity position. We have designated all of our securities as available for sale to provide flexibility, in case an immediate need for liquidity arises. We believe the composition of the portfolio offers flexibility in managing our liquidity position and interest rate sensitivity, without adversely impacting our regulatory capital levels. The available for sale portfolio is carried at fair market value and had a net unrealized gain of approximately $1,135,000 at December 31, 2007, compared to a net unrealized loss of approximately $1,052,000 at December 31, 2006.
We invest primarily in direct obligations of the United States, obligations guaranteed as to the principal and interest by the United States, mortgage backed securities, Municipal securities and obligations of agencies of the United States. In addition, we enter into federal funds transactions with our principal correspondent banks, and act as a net seller of such funds. The Federal Reserve Bank and the Federal Home Loan Bank also require equity investments to be maintained by us, which are shown separately in our consolidated balance sheet.
The tables below summarize the maturity distribution of securities, weighted average yield by range of maturities, and distribution of securities for the periods provided (dollars are in thousands).
Distribution of Investment Securities
(Dollars are in thousands)
Lending-related income is the most important component of our net interest income and is a major contributor to profitability. The loan portfolio is the largest component of earning assets, and it therefore generates the largest portion of revenues. The absolute volume of loans and the volume of loans as a percentage of earning assets is an important determinant of net interest margin as loans are expected to produce higher yields than securities and other earning assets. Average loans during the year ended December 31, 2007, were $791,886,000, or 74% of average earning assets, as compared to $605,236,000, or 68% of average earning assets, for the year ending December 31, 2006. Total loans, net of unearned fees and cost, at December 31, 2007 and 2006 were $841,405,000 and $657,963,000, respectively, an increase of $183,442,000, or 28%. This represents a loan to total asset ratio of 69% and 61% and a loan to deposit ratio of 87% and 74%, at December 31, 2007 and 2006, respectively. The increase in loans during this period was partially attributable to our acquisition of VSB (approximately $121,842,000) and the remaining amount was normal business growth.
Total residential real estate loans totaled $209,186,000 and total commercial real estate loans totaled $385,669,000, making up approximately 25% and 46% (combined total of approximately 71%) of the loan portfolio as of December 31, 2007, respectively. Construction, development, land loans totaled $108,615,000, or 13% of the loan portfolio. Commercial loans totaled $78,231,000, or 9% of the loan portfolio. Consumer and all other loans totaled $60,687,000, or 7% of the loan portfolio.
Loan concentrations are considered to exist where there are amounts loaned to multiple borrowers engaged in similar activities, which collectively could be similarly impacted by economic or other conditions and when the total of such amounts would exceed 25% of total capital. Due to the lack of diversified industry and the relative proximity of markets served, the Company has concentrations in geographic as well as in types of loans funded.
The tables below provide a summary of the loan portfolio composition and maturities for the periods provided below.
Loan Portfolio Composition
(Dollars are in thousands)
Types of Loans
The repayment of loans is a source of additional liquidity for the Company. The following table sets forth the loans maturing within specific intervals at December 31, 2007.
Loan Maturity Schedule
(Dollars are in thousands)
The information presented in the above table is based upon the contractual maturities of the individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon their maturity. Consequently, management believes this treatment presents fairly the maturity structure of the loan portfolio. See Liquidity and Market Risk Management for a discussion regarding the repricing structure of the loan portfolio.
Credit Quality and Allowance for Loan Losses
We maintain an allowance for loan losses that we believe is adequate to absorb probable losses inherent in our loan portfolio. The allowance is increased by the provision for loan losses, which is a charge to current period earnings and decreased by loan charge-offs net of recoveries of prior period loan charge-offs. Loans are charged against the allowance when management believes collection of the principal is unlikely.
The allowance consists of two components. The first component consists of amounts reserved for impaired loans, as defined by Statement of Financial Accounting Standard No. 114. Impaired loans are those loans that management has estimated will not repay as agreed upon. Each of these loans is required to have a written analysis supporting the amount of specific reserve allocated to the particular loan, if any. That is to say, a loan may be impaired (i.e. not expected to repay as agreed), but may be sufficiently collateralized such that we expect to recover all principle and interest eventually, and therefore no specific reserve is warranted.
The second component is a general reserve on all of the Companys loans other than those identified as impaired. We group these loans into five general categories with similar characteristics as listed below:
Residential real estate loans
Commercial real estate loans
Construction, development, land loans
Commercial loans (not collateralized by real estate)
Consumer and all other loans (not collateralized by real estate)
We then apply an adjusted loss factor to each group of loans to determine the total amount of this second component of our allowance for loan losses. The adjusted loss factor for each category of loans is a derivative of our historical loss factor for that category, adjusted for current internal and external environmental factors, as well as for certain loan grading factors. The environmental factors that we consider are listed below.
We consider changes in the levels of and trends in past due loans, non-accrual loans and impaired loans, and the volume and severity of adversely classified or graded loans. Also, we consider changes in the value of underlying collateral for collateral-dependent loans.
We consider levels of and trends in charge-offs and recoveries.
We consider changes in the nature and volume of the portfolio and in the terms of loans.
We consider changes in lending policies, procedures and practices, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses. We also consider changes in the quality of our loan review system.
We consider changes in the experience, ability, and depth of our lending management and other relevant staff.
We consider changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments (national and local economic trends and conditions).
We consider the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in our existing portfolio (industry conditions).
We consider the existence and effect of any concentrations of credit, and changes in the level of such concentrations.
In the table below we have shown the two components, as discussed above, of our allowance for loan losses at December 31, 2007 and 2006.
During 2007, we observed increasing trends in our loan delinquencies and non-accrual loans. We also observed a degradation of real estate values nationally in general, and within Florida specifically. We believe the changes in these trends differ significantly enough from historical trends such that we have added additional risk factors to specific loan categories.
As shown in the table above, our allowance for loan losses (ALLL) as a percentage of total loans outstanding was 1.29% at December 31, 2007 and 1.12% at December 31, 2006. Our ALLL increased by $3,473,000 during this twelve month period. Of this amount, $3,033,000 relates to an increase in our Component 2, or general allowance, of which $1,617,000 relates to the acquisition of VSB and $1,416,000 is due to changes in this components risk factors, as discussed above, and the growth in the loan portfolio.
The remaining $440,000 increase is due to an increase in our Component 1, or specific allowance. This Component is the result of specific allowance analyses prepared for each of our impaired loans.
We are committed to the early recognition of problems and to maintaining a sufficient allowance. We believe our allowance for loan losses at December 31, 2007 was adequate. The table below sets forth the activity in the allowance for loan losses for the periods presented.
Activity in Allowance for Loan Losses
(Dollars are in thousands)
Non-performing loans consist of non-accrual loans and loans past due 90 days or more and still accruing interest. Non-performing assets consist of non-performing loans plus other real estate owned (OREO) and repossessed assets other than real estate. We place loans on non-accrual status when they are past due 90 days and management believes the borrowers financial condition, after giving consideration to economic conditions and collection efforts, is such that collection of interest is doubtful. When we place a loan on non-accrual status, interest accruals cease and uncollected interest is reversed and charged against current income. Subsequent collections reduce the principal balance of the loan until the loan is returned to accrual status.
At December 31, 2007 we had 35 non-accrual loans with a total aggregate balance of $3,797,000. The largest loan in the group is $1,170,000 and is secured by a combination of commercial and residential real estate. The average size loan in this group is approximately $109,000. In terms of dollars, approximately 52% of our non-accrual loans are commercial and commercial real estate, 34% is secured by residential real estate, 4% is secured by land and the remaining 10% are consumer and other loans. Only one loan with a balance of less than $10,000 is unsecured. At December 31, 2007, loans past due 90 or more days and still accruing interest totaled $277,000.
Other real estate owned (OREO) is real estate that the Company has obtained ownership through foreclosure or other repossession process. At December 31, 2007, the Company had four properties in OREO consisting of two single family homes ($304,000 combined), one mobile home with land ($46,000) and one commercial real estate property with building ($233,000).
At December 31, 2007 repossessed assets other than real estate consisted of three mobile homes with an aggregate balance of $170,000.
Total non-performing assets as of December 31, 2007, increased $4,182,000 or 648% to $4,827,000, compared to $645,000 as of December 31, 2006. Non-performing assets, as a percentage of total assets at December 31, 2007 and December 31, 2006, were 0.40% and 0.06%, respectively.
Non-performing loans as of December 31, 2007, increased $3,464,000 or 568% to $4,074,000, compared to $610,000 as of December 31, 2006. Non-performing loans, as a percentage of total loans at December 31, 2007 and December 31, 2006, were 0.48% and 0.09%, respectively.
Interest income not recognized on non-accrual loans was approximately $78,000, $16,000 and $35,000 for the years ended December 31, 2007, 2006 and 2005, respectively. Interest income recognized on impaired loans was approximately $642,000, $363,000 and $18,000 for the years ended December 31, 2007, 2006 and 2005, respectively. The average recorded investment in impaired loans during 2007, 2006 and 2005 were $8,315,000, $5,032,000 and $987,000, respectively. The table below summarizes non-performing assets for the periods provided.
(Dollars are in thousands)
We are continually analyzing our loan portfolio in an effort to recognize and resolve our problem assets as quickly and efficiently as possible. While we believe we use the best information available at the time to make a determination with respect to the allowance for loan losses, we recognize that many factors can adversely impact various segments of our markets, and subsequent adjustments in the allowance may be necessary if future economic indications or other factors differ from the assumptions used in making the initial determination or if regulatory policies change. We continuously focus our attention on promptly identifying and providing for potential problem loans, as they arise. Although the total allowance for loan losses is available to absorb losses from all loans, management allocates the reserve among loan portfolio categories for informational and regulatory reporting purposes. Regulatory examiners may require us to recognize additions to the allowance based upon the regulators judgments about the information available to them at the time of their examination, which may differ from our judgments about the allowance for loan losses.
While no portion of the allowance is in any way restricted to any individual loan or group of loans, and the entire allowance is available to absorb losses from any and all loans, the following table summarizes our allocation of allowance for loan losses by loan category and loans in each category as a percentage of total loans, for the periods presented. Dollar amounts are in thousands.
Bank Premises and Equipment
Bank premises and equipment was $55,458,000 at December 31, 2007 compared to $39,879,000 at December 31, 2006, an increase of $15,579,000 or 39%. Of this amount, $9,289,000 represents the purchase of premises and equipment pursuant to the April 2, 2007 acquisition of VSB as discussed previously. The remaining amount of the increase ($6,290,000) is the result of purchases and construction costs totaling $8,595,000 less $2,305,000 of depreciation expense. Most of these costs relate to the construction of the two branch offices completed in the first half of 2007 (Ashton in Osceola County and FishHawk in Hillsborough County) and two branch offices currently under construction (Deer Creek in Polk County and Crystal River in Citrus County).
We operate from 37 banking locations in nine central Florida Counties. Three of these locations are operating out of temporary facilities while their permanent offices are under construction. The construction is almost complete on two, and the other one just began construction. Excluding these temporary facilities, which are rented, we lease seven of our banking offices and own the remainder. See Note 4 to our consolidated financial statements for additional information.
Total deposits increased $79,814,000, or 9%, to $972,620,000 as of December 31, 2007, compared to $892,806,000 at December 31, 2006. The increase in deposits during this period was attributable to our acquisition of VSB (approximately $130,614,000). Excluding the deposits acquired pursuant to the VSB
transaction, the Companys deposits decreased by $50,800,000, or 5.7%. Deposit growth, especially in core deposits (i.e. non time deposit accounts) continues to be a challenge. Our subsidiary Presidents have initiated various incentive programs throughout their Banks as well as other marketing efforts targeted at deposit growth. We believe there are several forces causing this slow down in deposit growth, including the interest rate environment which may have enticed customers to shift from lower yielding accounts to higher yielding time deposits and the slow down in real estate activity in Florida, which translates into less transactions which equates to lower balances held in title company accounts and other real estate related accounts.
The generation of deposits within our market area serves as our primary source of funds for investment principally in loans. The tables below summarize selected deposit information for the periods indicated.
Average deposit balance by type and average interest rates
(Dollars are in thousands)
Maturity of time deposits of $100,000 or more
(Dollars are in thousands)
We enter into borrowing arrangements with retail business customers by agreements to repurchase (repurchase agreements) under which we pledge investment securities owned and under our control as collateral against the one-day borrowing arrangement. These arrangements are not transactions with investment bankers or brokerage firms, but rather, with several of our larger commercial customers who periodically have excess cash balances and do not want to keep those balances in non interest bearing checking accounts. Because our Banks are not permitted to pay interest on commercial checking accounts, we offer an arrangement via a repurchase agreement whereby balances are transferred from their checking account into a repurchase agreement arrangement which we will pay a daily adjustable interest rate of the federal fund rate minus an amount that generally ranges between 0.35% and 0.75%.
The daily average balance of these short-term borrowing agreements for the years ended December 31, 2007, 2006 and 2005, was approximately $58,329,000, $49,830,000 and $38,210,000, respectively. Interest expense for the same periods was approximately $2,582,000, $2,156,000 and $1,013,000, respectively, resulting in an average rate paid of 4.43%, 4.33% and 2.65% for the years ended December 31, 2007, 2006, and 2005, respectively. The table below summarizes our repurchase agreements for the periods presented.
Schedule of short-term borrowing (1)
(Dollars are in thousands)
Other borrowed funds
From time to time we borrow on a short-term basis, usually over-night, either through Federal Home Loan Bank advances or Federal Funds Purchased. The table below summarizes our repurchase agreements for the periods presented.
Schedule of short-term borrowing (1)
(Dollars are in thousands)
We formed CenterState Banks of Florida Statutory Trust I (the Trust) for the purpose of issuing trust preferred securities. On September 22, 2003, we issued a floating rate corporate debenture in the amount of $10,000,000. The Trust used the proceeds from the issuance of a trust preferred security to acquire the corporate debenture of the Company. The trust preferred security essentially mirrors the corporate debenture, carrying a cumulative preferred dividend at a variable rate equal to the interest rate on the corporate debenture (three month LIBOR plus 305 basis points). The rate is subject to change quarterly. The rate in effect during the quarter ended December 31, 2007 was 8.28%. The corporate debenture and the trust preferred security each have 30-year lives. The trust preferred security and the corporate debenture are callable by the Company or the Trust, at their respective option after five years, and sooner in specific events, subject to prior approval by the Federal Reserve Board, if then required. Related debt issuance costs of $188,000 were capitalized and are being amortized to
interest expense over a five year period. The Company has treated the trust preferred security as Tier 1 capital up to the maximum amount allowed under the Federal Reserve guidelines for federal regulatory purposes.
In September 2004, Valrico Bancorp Inc. (VBI) formed Valrico Capital Statutory Trust (Valrico Trust) for the purpose of issuing trust preferred securities. On September 9, 2004, VBI issued a floating rate corporate debenture in the amount of $2,500,000. The Trust used the proceeds from the issuance of a trust preferred security to acquire the corporate debenture. The trust preferred security essentially mirrors the corporate debenture, carrying a cumulative preferred dividend at a variable rate equal to the interest rate on the corporate debenture (three month LIBOR plus 270 basis points). The rate is subject to change quarterly. The rate in effect during the quarter that included December 31, 2007 was 7.82%. The corporate debenture and the trust preferred security each have 30-year lives. The trust preferred security and the corporate debenture are callable by VBI or the Valrico Trust, at their respective option after five years, and sooner in specific events, subject to prior approval by the Federal Reserve, if then required. On April 2, 2007, the Company acquired all the assets and assumed all the liabilities of VBI pursuant to the merger agreement, including VBIs corporate debenture and related trust preferred security discussed above. The Company has treated the trust preferred security as Tier 1 capital up to the maximum amount allowed under the Federal Reserve guidelines for federal regulatory purposes.
Liquidity and Market Risk Management
Market and public confidence in our financial strength and financial institutions in general will largely determine our access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital reserves.
Liquidity is defined as the ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis. We measure our liquidity position by giving consideration to both on- and off-balance sheet sources of and demands for funds on a daily and weekly basis.
Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liabilities, as well as the risk of not being able to meet unexpected cash needs. Liquidity planning and management are necessary to ensure the ability to fund operations cost-effectively and to meet current and future potential obligations such as loan commitments, lease obligations, and unexpected deposit outflows. In this process, we focus on both assets and liabilities and on the manner in which they combine to provide adequate liquidity to meet our needs.
Interest rate sensitivity refers to the responsiveness of interest-earning assets and interest-bearing liabilities to changes in market interest rates. The rate sensitive position, or gap, is the difference in the volume of rate-sensitive assets and liabilities, at a given time interval, including both floating rate instruments and instruments which are approaching maturity. The measurement of our interest rate sensitivity, or gap, is one of the principal techniques we use in our asset/liability management effort. Each of our Banks, generally attempts to maintain a range, set by policy, between rate-sensitive assets and liabilities by repricing periods. Each of our Banks set their own range, approved by their board of directors. If any of our Banks fall outside their pre-approved range, it requires board action and board approval, by that particular Banks board of directors. The asset mix of our balance sheet is evaluated continually in terms of several variables: yield, credit quality, and appropriate funding sources and liquidity. Management of the liability mix of the balance sheet focuses on expanding the various funding sources.
Our gap and liquidity positions are reviewed periodically to determine whether or not changes in policies and procedures are necessary to achieve financial goals. At December 31, 2007, approximately 41% of total gross loans were adjustable rate. Approximately 59% of our investment securities ($117,716,000 fair value) are invested in U.S. Government Agency mortgage backed securities. Although most of these have maturities in excess of five years, these are amortizing instruments that generate cash flows each month. The duration (average life of expected cash flows) of our securities at December 31, 2007 was approximately 3.4 years. Deposit
liabilities, at that date, consisted of approximately $135,442,000 (14%) in NOW accounts, $142,203,000 (15%) in money market accounts and savings, $535,886,000 (55%) in time deposits and $159,089,000 (16%) in non-interest bearing demand accounts.
The table below presents the market risk associated with our financial instruments. In the Rate Sensitivity Analysis table, rate sensitive assets and liabilities are shown by repricing periods. The estimated fair value of each instrument category is also shown in the table. While these estimates of fair value are based on our judgment of the most appropriate factors, there is no assurance that, if we had to dispose of such instruments at December 31, 2007, the estimated fair values would necessarily have been achieved at that date, since market values may differ depending on various circumstances. The estimated fair values at December 31, 2007, should not necessarily be considered to apply at subsequent dates.
RATE SENSITIVITY ANALYSIS
December 31, 2007
(Dollars are in thousands)