First Community Bancshares 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2011
Commission file number 000-19297
FIRST COMMUNITY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
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 smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Class Common Stock, $1.00 Par Value; 17,846,314 shares outstanding as of November 4, 2011
FIRST COMMUNITY BANCSHARES, INC.
For the quarter ended September 30, 2011
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FIRST COMMUNITY BANCSHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements.
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FIRST COMMUNITY BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
See Notes to Consolidated Financial Statements.
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FIRST COMMUNITY BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
See Notes to Consolidated Financial Statements.
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FIRST COMMUNITY BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (Unaudited)
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Note 1. General
Unaudited Consolidated Financial Statements
The accompanying unaudited consolidated financial statements of First Community Bancshares, Inc. and subsidiaries (First Community or the Company) have been prepared in accordance with United States generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments, including normal recurring accruals, necessary for a fair presentation have been made. All significant intercompany balances and transactions have been eliminated in consolidation. These results are not necessarily indicative of the results of consolidated operations that might be expected for the full calendar year.
The consolidated balance sheet as of December 31, 2010, has been derived from the audited consolidated financial statements included in the Companys 2010 Annual Report on Form 10-K (the 2010 Form 10-K). Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with GAAP have been omitted in accordance with standards for the preparation of interim consolidated financial statements. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Companys 2010 Form 10-K.
A more complete and detailed description of First Communitys significant accounting policies is included within Note 1 of Item 8, Financial Statements and Supplementary Data in the Companys 2010 Form 10-K. Further discussion of the Companys application of critical accounting policies is included within the Application of Critical Accounting Policies section of Item 2, Managements Discussion and Analysis of Financial Condition and Results of Operations, included herein.
The Company operates within two business segments community banking and insurance services. Insurance services are comprised of agencies that sell property and casualty and life and health insurance policies and arrangements. All other operations, including commercial and consumer banking, lending activities, and wealth management are included within the banking segment.
Earnings Per Share
Basic earnings per share are determined by dividing net income available to common shareholders by the weighted average number of shares outstanding. Diluted earnings per share are determined by dividing net income by the weighted average shares outstanding, which includes the dilutive effect of stock options, warrants, contingently issuable shares, and convertible preferred shares. Basic and diluted net income per common share calculations follow:
For the three- and nine-month periods ended September 30, 2011, options and warrants to purchase 480,045 and 480,221 shares, respectively, of common stock were outstanding but were not included in the computation of diluted earnings per
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common share because they would have an anti-dilutive effect. Likewise, options and warrants to purchase 491,189 shares of common stock were excluded from the three- and nine-month periods ended September 30, 2010, computation of diluted earnings per common share because their effect would be anti-dilutive.
Series A Preferred Stock
On May 20, 2011, the Company completed a private placement of 18,921 shares of its Series A Preferred Stock. The shares carry a 6% dividend rate and are non-cumulative. Each share is convertible into 69 shares of the Companys common stock at any time and mandatorily convert after five years. The Company may redeem the shares at face value after the third anniversary.
Recent Accounting Pronouncements
Financial Accounting Standards Board (FASB) Accounting Standard Codification (ASC) Topic 310, Receivables. New authoritative accounting guidance under ASC Topic 310 amends prior guidance to provide financial statement users with greater transparency about an entitys allowance for credit losses and the credit quality of its financing receivables by providing additional information to assist financial statement users in assessing an entitys credit risk exposures and evaluating the adequacy of its allowance for credit losses. The Company adopted the provisions of the new authoritative accounting guidance under ASC Topic 310 during the fourth quarter of 2010. Other than the additional disclosures, the adoption of the new guidance had no significant impact on the Companys financial statements.
In April 2011, FASB issued Accounting Standard Update (ASU) 2011-02, A Creditors Determination of Whether a Restructuring is a Troubled Debt Restructuring, which clarifies when creditors should classify loan modifications as troubled debt restructurings. The guidance is effective for interim and annual periods beginning on or after June 15, 2011, and is applied retrospectively to restructurings at the beginning of the year of adoption. The guidance on measuring the impairment of a receivable restructured in a troubled restructuring is effective on a prospective basis. The Company adopted the new guidance during the third quarter of 2011 and the new disclosures are presented in Note 5 to the Consolidated Financial Statements.
In April 2011, FASB issued ASU 2011-03, Reconsideration of Effective Control for Repurchase Agreements, which simplifies the accounting for financial assets transferred under repurchase agreements and similar arrangements by eliminating the transferors ability criteria from the assessment of effective control over those assets as well as the related implementation guidance. The guidance is effective for interim and annual periods beginning on or after December 15, 2011, and is applied on a prospective basis. The Company is currently assessing the impact on its financial statements.
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in the U.S. GAAP and IFRS, which was issued primarily to provide largely identical guidance about fair value measurement and disclosure requirements for International Financial Reporting Standards (IFRS) and U.S. GAAP. The new standards do not extend the use of fair value but rather provide guidance about how fair value should be determined where it already is required or permitted under IFRS or U.S. GAAP. For U.S. GAAP, most of the changes are clarifications of existing guidance or wording changes to align with IFRS. Public companies are required to apply the standard prospectively for interim and annual periods beginning after December 15, 2011. The Company is currently assessing the impact on its financial statements.
In June 2011, FASB issued ASU 2011-05, Presentation of Comprehensive Income, which revises the manner in which entities present comprehensive income in their financial statements. The new guidance removes the presentation options in ASC 220 and requires entities to report components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. The guidance does not change the items that must be reported in other comprehensive income. The guidance is effective for fiscal years and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The Company is currently assessing the impact on its financial statements.
In September 2011, FASB issued ASU 2011-08, Testing Goodwill for Impairment, which simplifies how an entity tests goodwill for impairment. The guidance permits an entity to first assess qualitative factors to determine whether it is necessary to perform additional impairment testing. The guidance is effective for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company is currently assessing the impact on its financial statements.
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Note 2. Divestitures
In July and August 2011, the Company sold three insurance agency offices. The Company recorded net gains of $67 thousand on the sales of the offices and has the potential to recognize an additional $650 thousand over time as earn-out payments are received. Annualized revenue and income before taxes from the three offices approximate $572 thousand and $5 thousand, respectively.
Note 3. Investment Securities
As of September 30, 2011, and December 31, 2010, the amortized cost and estimated fair value of available-for-sale securities were as follows:
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As of September 30, 2011, and December 31, 2010, the amortized cost and estimated fair value of held-to-maturity securities were as follows:
The amortized cost and estimated fair value of available-for-sale securities by contractual maturity at September 30, 2011, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
The amortized cost and estimated fair value of held-to-maturity securities by contractual maturity at September 30, 2011, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
The carrying value of securities pledged to secure public deposits as required by law and for other purposes was $292.32 million and $302.67 million at September 30, 2011, and December 31, 2010, respectively.
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The following table presents the Companys gross gains and gross losses from the sale of securities for the three- and nine-month periods ended September 30, 2011 and 2010.
The following tables reflect those investments, both available-for-sale and held-to-maturity, in a continuous unrealized loss position for less than 12 months and for 12 months or longer at September 30, 2011, and December 31, 2010.
At September 30, 2011, the combined depreciation in value of the 24 individual securities in an unrealized loss position was approximately 5.11% of the combined reported value of the aggregate securities portfolio. At December 31, 2010, the combined depreciation in value of the 214 individual securities in an unrealized loss position was approximately 5.93% of the combined reported value of the aggregate securities portfolio.
The Company reviews its investment portfolio on a quarterly basis for indications of other-than-temporary impairment (OTTI). The analysis differs depending upon the type of investment security being analyzed. For debt securities, the Company has determined that it does not intend to sell securities that are impaired and has asserted that it is not more likely than not that the Company will have to sell impaired securities before recovery of the impairment occurs. This determination is based upon the Companys investment strategy for the particular type of debt security and its cash flow needs, liquidity position, capital adequacy and interest rate risk position.
For non-beneficial interest debt securities, the Company analyzes several qualitative factors such as the severity and duration of the impairment, adverse conditions within the issuing industry, prospects for the issuer, performance of the security,
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changes in rating by rating agencies and other qualitative factors to determine if the impairment will be recovered. Non-beneficial interest debt securities consist of U. S. government agency securities, states and political subdivisions, and single issue trust preferred securities. If it is determined that there is evidence that the impairment will not be recovered, the Company performs a present value calculation to determine the amount of credit related impairment and records any credit related OTTI through earnings and the non-credit related OTTI through other comprehensive income (OCI). During the three- and nine-month periods ended September 30, 2011, the Company incurred no OTTI charges related to non-beneficial interest debt securities. The temporary impairment on these securities is primarily related to changes in interest rates, certain disruptions in the credit markets, destabilization in the Eurozone, and other current economic factors.
For beneficial interest debt securities, the Company reviews cash flow analyses on each applicable security to determine if an adverse change in cash flows expected to be collected has occurred. Beneficial interest debt securities consist of pooled trust preferred securities, corporate FDIC insured, and mortgage-backed securities. An adverse change in cash flows expected to be collected has occurred if the present value of cash flows previously projected is greater than the present value of cash flows projected at the current reporting date and less than the current book value. If an adverse change in cash flows is deemed to have occurred, then an OTTI has occurred. The Company then compares the present value of cash flows using the current yield for the current reporting period to the reference amount, or current net book value, to determine the credit-related OTTI. The credit-related OTTI is then recorded through earnings and the non-credit related OTTI is accounted for in OCI.
During the three- and nine-month periods ended September 30, 2011, the Company incurred credit-related OTTI charges related to beneficial interest debt securities of $210 thousand and $737 thousand, respectively. These charges were related to a non-Agency mortgage-backed security (MBS). During the three-month period ended September 30, 2010, the Company incurred no credit-related OTTI charges related to beneficial interest debt securities. During the nine-month period ended September 30, 2010, the Company incurred credit-related OTTI charges on beneficial interest debt securities of $134 thousand. These charges were related to two pooled trust preferred security holdings and brought the carrying value of those securities to zero.
For the non-Agency, Alt-A residential MBS, the Company models cash flows using the following assumptions: voluntary constant prepayment speed of 5, a customized constant default rate scenario that assumes approximately 23% of the remaining underlying mortgages will default, and a loss severity of 60.
The table below provides a cumulative roll forward of credit losses recognized in earnings for debt securities for which a portion of an OTTI is recognized in OCI:
For equity securities, the Company reviews for OTTI based upon the prospects of the underlying companies, analysts expectations, and certain other qualitative factors to determine if impairment is recoverable over a foreseeable period of time. During the three- and nine-month periods ended September 30, 2011, the Company did not recognize any OTTI charges on equity securities. For the three months ended September 30, 2010, the Company recognized no OTTI charges on its equity securities. For the nine months ended September 30, 2010, the Company recognized OTTI charges on certain of its equity securities of $51 thousand.
As a condition to membership in the Federal Home Loan Bank (FHLB) system, the Company is required to subscribe to a minimum level of stock in the FHLB of Atlanta (FHLBA). The Company believes this ownership position provides access to relatively inexpensive wholesale and overnight funding. The Company accounts for FHLBA and Federal Reserve Bank stock as
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a long-term investment in other assets. At September 30, 2011, and December 31, 2010, the Company owned approximately $11.14 million and $12.24 million, respectively, in FHLBA stock, which is classified as other assets. The Companys policy is to review for impairment of such assets at the end of each reporting period. Based on the Companys review of publicly available information about the FHLBA and its own internal analysis, the Company believes that its FHLBA stock was not impaired as of September 30, 2011.
Note 4. Loans
Loans, net of unearned income, consist of the following:
During the third quarter of 2011, the Company enhanced its loan loss methodology by further segmenting the one-to-four family residential real estate class into owner occupied and non-owner occupied segments. The enhancement in the one-to-four family residential real estate class resulted in the owner occupied portion being reported in the consumer real estate loan segment and the non-owner occupied portion being reported in the commercial loans segment.
Acquired, Impaired Loans
Loans acquired in a business combination are recorded at estimated fair value on their purchase date. Under applicable accounting standards, it is not appropriate to carryover a valuation for allowance for loan losses at the time of acquisition when the acquired loans have evidence of credit deterioration. Evidence of credit quality deterioration as of the purchase date may include measures such as credit scores, decline in collateral value, past due and non-accrual status. For acquired, impaired loans the difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference which is included in the carrying amount of the loans. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or a reversal of the nonaccretable difference with a positive impact on interest income prospectively. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life
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of the loan when there is a reasonable expectation about the amount and timing of such cash flows. Acquired performing loans are recorded at fair value, including a credit component. The fair value adjustment is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for acquired performing loans. A provision for loan losses is recorded for any credit deterioration in these loans subsequent to acquisition.
The following table presents information regarding acquired, impaired loans for the three- and nine-month periods ended September 30, 2011 and 2010. The Company has estimated the cash flows to be collected on the loans and discounted those cash flows at a market rate of interest.
The remaining balance of the accretable difference at September 30, 2011, and December 31, 2010, was $822 thousand and $944 thousand, respectively.
Off-Balance Sheet Financial Instruments
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. These instruments involve, to varying degrees, elements of credit and interest rate risk beyond the amount recognized on the balance sheet. The contractual amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Companys exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is not a violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customers creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on managements credit evaluation of the counterparties. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income producing commercial properties.
Standby letters of credit and written financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. To the extent deemed necessary, collateral of varying types and amounts is held to secure customer performance under certain of those letters of credit outstanding.
Financial instruments whose contract amounts represent credit risk are commitments to extend credit (including availability of lines of credit) of $206.98 million and standby letters of credit and financial guarantees written of $2.90 million at September 30, 2011. Additionally, the Company had gross notional amounts of outstanding commitments to lend related to secondary market mortgage loans of $10.42 million at September 30, 2011.
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Note 5. Allowance for Loan Losses and Credit Quality
The allowance for loan losses is maintained at a level that the Company believes is sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by charges to earnings in the form of provision for loan losses and recoveries of prior loan charge-offs, and decreased by loans charged off. The provision is calculated to bring the allowance to a level which, according to a systematic process of measurement, reflects the amount management estimates is needed to absorb probable losses within the portfolio. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Companys control, including, among other things, the performance of the Companys loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
Management performs quarterly assessments to determine the appropriate level of allowance for loan losses. Differences between actual loan loss experience and estimates are reflected through adjustments that are made by either increasing or decreasing the allowance based upon current measurement criteria. Commercial, consumer real estate, and non-real estate consumer loan portfolios are evaluated separately for purposes of determining the allowance. The specific components of the allowance include allocations to individual commercial credits and allocations to the remaining non-homogeneous and homogeneous pools of loans that have been deemed impaired. Managements general reserve allocations are based on judgment of qualitative and quantitative factors about both macro and micro economic conditions reflected within the portfolio of loans and the economy as a whole. Factors considered in this evaluation include, but are not necessarily limited to, probable losses from loan and other credit arrangements, general economic conditions, changes in credit concentrations or pledged collateral, historical loan loss experience, and trends in portfolio volume, maturities, composition, delinquencies, and non-accruals. The allowance methodology was recently enhanced to further segment the commercial loan portfolio by risk grade. Historical loss rates for each risk grade of commercial loans are adjusted by environmental factors to estimate the amount of reserve needed by segment. While management has allocated the allowance for loan losses to various portfolio segments, the entire allowance is available for use against any type of loan loss deemed appropriate by management.
The Company enhanced its allowance for loan loss methodology during the first quarter of 2011. The enhancement included, among other things, further segmentation of the commercial loan portfolio by risk code and consideration of additional qualitative factors as outlined in the Interagency Policy Statement for Loan and Lease Losses. Under the previous methodology, qualitative adjustments were a multiple of the historical loss rate calculated by the Company for each segment, as compared to the enhanced methodology that utilizes addition to and subtraction from the historical loss rate.
Initially, the qualitative factors for the consumer loan segments under the enhanced methodology were calculated by determining an equivalent rate to the prior method. As part of the continued refinement of the enhanced methodology, the adjustments historically applied to consumer loans were reviewed. As of the third quarter of 2011, it was determined that qualitative adjustments to the consumer loan segments loss rates should be revised downward based upon review and analysis of historical loss experience within the portfolio as the Company is now estimating fewer losses on the consumer portfolio. As a result of the downward revision, the allocation of the allowance to the consumer loan segments is 30%. Historically, net consumer charge-offs comprised 28% of total net charge-offs. The decrease in estimated losses on the consumer portfolio segment was offset by increases in estimated losses on the commercial portfolio segment. The increase is particularly in specific loss estimated on certain impaired loans as a result of new information regarding the values of underlying collateral.
As an additional enhancement to the loan loss methodology in the third quarter of 2011, the Company further segmented the one-to-four family residential real estate class into owner occupied and non-owner occupied segments, which management believes provides better granularity and segmentation of loans with similar risk characteristics. This also contributed to the overall reduction of estimated losses on non-impaired consumer loan segments in the allowance model, as losses on the Companys non-owner occupied residential real estate loans have historically been higher than losses on owner occupied residential real estate loans. The following tables reflect the change of the segmentation in the single family residential loan class for the period ended September 30, 2011.
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The following tables detail the Companys allowance for loan loss activity, by portfolio segment, for the three- and nine-month periods ended September 30, 2011 and 2010.
The Company identifies loans for potential impairment through a variety of means including, but not limited to, ongoing loan review, renewal processes, delinquency data, market communications, and public information. If it is determined that it is probable that the Company will not collect all principal and interest amounts contractually due, the loan is generally deemed to be impaired.
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The following table presents the Companys recorded investment in loans considered to be impaired and related information on those impaired loans for the periods ended September 30, 2011, and December 31, 2010.
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As part of the ongoing monitoring of the credit quality of the Companys loan portfolio, management tracks certain credit quality indicators including trends related to the risk rating of commercial loans, the level of classified commercial loans, net charge-offs, non-performing loans and general economic conditions. The Companys loan review function generally reviews all commercial loan relationships greater than $2.00 million on an annual basis and at various times through the year. Smaller commercial and retail loans are sampled for review throughout the year by our internal loan review department. Through the loan review process, loans are identified for upgrade or downgrade in risk rating and changed to reflect current information as part of the process.
The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. A description of the general characteristics of the risk grades is as follows:
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The following tables present the Companys investment in loans by internal credit grade indicator at September 30, 2011, and December 31, 2010.