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Other

First Financial Holdings 10-Q 2010

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. 10-Q
  6. 10-Q
Unassociated Document
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period endedJune 30, 2010
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                 to

Commission File Number:  0-17122

FIRST FINANCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
57-0866076
(State or other jurisdiction of incorporation or organization)
  
(I.R.S. Employer Identification No.)

2440 Mall Dr., Charleston, South Carolina
 
29406
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code
 
(843) 529-5933
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES x NO ¨

Indicate by check mark 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 (section 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).
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” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨         Accelerated filer x        Non-accelerated filer ¨        Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
YES ¨ NO x

APPLICABLE ONLY TO CORPORATE ISSUERS:  Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class
Outstanding Shares at
Common Stock
July 30, 2010
$.01 Par Value
16,526,752

 
 

 

FIRST FINANCIAL HOLDINGS, INC.
INDEX

 
PAGE NO.
   
PART I – FINANCIAL INFORMATION 
       
Item
 
 
1.
Condensed Consolidated Financial Statements (Unaudited)
 
   
3
       
   
4
       
   
5
       
   
6
       
   
7 – 8
       
   
9 – 32
       
 
33 – 55
       
 
56
       
 
56
   
 
       
Item
 
 
57
 
57 – 60
 
60
 
60
 
60
 
60
 
61 – 62
       
63
   
EXHIBIT 31 – CERTIFICATIONS
 
   
EXHIBIT 32 – CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND
CHIEF FINANCIAL OFFICER
 

SCHEDULES OMITTED
All schedules other than those indicated above are omitted because of the absence of the conditions under which they are required or because the information is included in the Condensed Consolidated Financial Statements and related notes.

 
2

 
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except share data)

   
(Unaudited)
   
(Audited)
 
   
June 30,
   
September 30,
 
   
2010
   
2009
 
ASSETS
           
Cash and cash equivalents
  $ 62,008     $ 78,070  
Investments available for sale, at fair value
    12,844       13,756  
Investments held to maturity
    22,512       22,401  
Investment in capital stock of FHLB
    46,141       46,141  
Mortgage-backed securities available for sale, at fair value
    400,774       478,980  
Loans receivable, net of allowance of $86,945 and $68,473
    2,503,874       2,593,269  
Loans held for sale
    15,030       25,603  
Accrued interest receivable
    10,333       12,058  
Office properties and equipment, net
    83,529       81,021  
Real estate and other assets acquired in settlement of loans
    12,543       22,002  
Goodwill
    28,260       29,278  
Intangible assets
    9,997       8,683  
Residential mortgage servicing rights, at fair value
    10,593       11,166  
FDIC indemnification recievable, net
    66,794       62,754  
Other assets
    39,112       25,105  
Total assets
  $ 3,324,344     $ 3,510,287  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Liabilities:
               
Deposit accounts
               
Noninterest-bearing
  $ 207,196     $ 190,159  
Interest-bearing
    2,240,599       2,113,452  
Total deposits
    2,447,795       2,303,611  
Advances from FHLB
    478,364       492,751  
Other short-term borrowings
    813       258,813  
Long-term debt
    46,392       46,392  
Advances by borrowers for taxes and insurance
    4,857       5,193  
Outstanding checks
    11,005       10,729  
Accounts payable and other liabilities
    11,321       41,149  
Total liabilities
    3,000,547       3,158,638  
                 
Stockholders' equity:
               
Series A preferred stock, $.01 par value, authorized 3,000,000 shares, issued and outstanding 65,000 shares at June 30, 2010 and September 30, 2009 (Redemption value $65,000)
    1       1  
Common stock, $.01 par value, authorized 24,000,000 shares; 21,465,163 and 20,835,381 shares issued at June 30, 2010 and September 30, 2009, respectively; 16,526,752 and 15,896,970 shares outstanding at June 30, 2010, and September 30, 2009, respectively
    215       208  
Additional paid-in capital
    195,175       185,249  
Retained income, substantially restricted
    224,871       265,821  
Accumulated other comprehensive income, net of income taxes
    7,098       3,933  
Treasury stock at cost, 4,938,411 shares at June 30, 2010 and September 30, 2009
    (103,563 )     (103,563 )
Total stockholders' equity
    323,797       351,649  
Total liabilities and stockholders' equity
  $ 3,324,344     $ 3,510,287  

See accompanying notes to condensed consolidated financial statements.

 
3

 

FIRST FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data) (Unaudited)

   
Three Months Ended
 
   
June 30,
 
   
2010
   
2009
 
INTEREST INCOME
           
Interest and fees on loans
  $ 37,485     $ 42,092  
Interest on mortgage-backed securities
    5,434       8,317  
Interest and dividends on investments
    458       848  
Other
    904       9  
Total interest income
    44,281       51,266  
INTEREST EXPENSE
               
Interest on deposits
    8,189       9,457  
Interest on borrowed money
    4,863       6,270  
Total interest expense
    13,052       15,727  
NET INTEREST INCOME
    31,229       35,539  
Provision for loan losses
    36,373       12,367  
Net interest (loss) income after provision for loan losses
    (5,144 )     23,172  
NON-INTEREST INCOME
               
Total other-than-temporary impairment losses
    (1,138 )     (1,046 )
Portion of (loss) gain recognized in other comprehensive income before taxes
    (827 )     669  
Net impairment losses recognized in earnings
    (311 )     (377 )
Brokerage fees
    644       383  
Insurance revenues
    6,292       6,535  
Service charges and fees on deposit accounts
    6,109       5,688  
Mortgage banking income
    2,437       986  
Gains on disposition of assets
    33       37  
Other
    2,039       (280 )
Total non-interest income
    17,243       12,972  
NON-INTEREST EXPENSE
               
Salaries and employee benefits
    19,060       15,640  
Occupancy costs
    2,306       2,215  
Marketing
    528       479  
Furniture and equipment expense
    2,256       2,202  
Amortization of intangibles
    231       202  
Other
    7,260       7,409  
Total non-interest expense
    31,641       28,147  
(Loss) income before income taxes
    (19,542 )     7,997  
Income tax (benefit) expense
    (7,513 )     2,842  
(Loss) income before extraordinary item
    (12,029 )     5,155  
EXTRAORDINARY ITEM
               
Gain on acquisition, net of income tax of $18,833
    -       28,857  
NET  (LOSS) INCOME
    (12,029 )     34,012  
Preferred stock dividends
    813       813  
Accretion on preferred stock discount
    140       132  
NET (LOSS) INCOME AVAILABLE TO COMMON SHAREHOLDERS
  $ (12,982 )   $ 33,067  
                 
Net (loss) income per Common Share before Extraordinary Item - Basic
  $ (0.73 )   $ 0.44  
Net (loss) income per Common Share before Extraordinary Item - Diluted
  $ (0.73 )   $ 0.44  
Net (loss) income per Common Share - Basic
  $ (0.73 )   $ 2.91  
Net (loss) income per Common Share - Diluted
  $ (0.73 )   $ 2.91  
Net (loss) income per Common Share Available to Common Shareholders - Basic
  $ (0.79 )   $ 2.83  
Net (loss) income per Common Share Available to Common Shareholders - Diluted
  $ (0.79 )   $ 2.83  

See accompanying notes to condensed consolidated financial statements.

 
4

 
 
FIRST FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data) (Unaudited)

   
Nine Months Ended
 
   
June 30,
 
   
2010
   
2009
 
INTEREST INCOME
           
Interest and fees on loans
  $ 115,770     $ 115,733  
Interest on mortgage-backed securities
    17,894       21,748  
Interest and dividends on investments
    1,105       1,472  
Other
    3,028       28  
Total interest income
    137,797       138,981  
INTEREST EXPENSE
               
Interest on deposits
    24,742       31,486  
Interest on borrowed money
    17,442       19,864  
Total interest expense
    42,184       51,350  
NET INTEREST INCOME
    95,613       87,631  
Provision for loan losses
    107,615       45,602  
Net interest (loss) income after provision for loan losses
    (12,002 )     42,029  
NON-INTEREST INCOME
               
Total other-than-temporary impairment losses
    (2,124 )     (7,132 )
Portion of (loss) gain recognized in other comprehensive income before taxes
    (499 )     3,753  
Net impairment losses recognized in earnings
    (2,623 )     (3,379 )
Brokerage fees
    1,690       1,496  
Insurance revenues
    19,217       18,747  
Service charges and fees on deposit accounts
    17,634       16,636  
Mortgage banking income
    6,916       5,398  
Gains on disposition of assets
    1,354       125  
Other
    2,122       (152 )
Total non-interest income
    46,310       38,871  
NON-INTEREST EXPENSE
               
Salaries and employee benefits
    56,077       46,439  
Occupancy costs
    7,189       6,489  
Marketing
    1,655       1,551  
Furniture and equipment expense
    6,447       5,269  
Amortization of intangibles
    717       608  
Other
    21,013       18,231  
Total non-interest expense
    93,098       78,587  
(Loss) income before income taxes
    (58,790 )     2,313  
Income tax (benefit) expense
    (23,173 )     584  
(Loss) income before extraordinary item
    (35,617 )     1,729  
EXTRAORDINARY ITEM
               
Gain on acquisition, net of income tax of $18,833
    -       28,857  
NET (LOSS) INCOME
    (35,617 )     30,586  
Preferred stock dividends
    2,440       1,851  
Accretion on preferred stock discount
    413       297  
NET (LOSS) INCOME AVAILABLE TO COMMON SHAREHOLDERS
  $ (38,470 )   $ 28,438  
                 
Net (loss) income per Common Share before Extraordinary Item - Basic
  $ (2.16 )   $ 0.15  
Net (loss) income per Common Share before Extraordinary Item - Diluted
  $ (2.16 )   $ 0.15  
Net (loss) income per Common Share - Basic
  $ (2.16 )   $ 2.61  
Net (loss) income per Common Share - Diluted
  $ (2.16 )   $ 2.61  
Net (loss) income per Common Share Available to Common Shareholders - Basic
  $ (2.33 )   $ 2.43  
Net (loss) income per Common Share Available to Common Shareholders - Diluted
  $ (2.33 )   $ 2.43  
See accompanying notes to condensed consolidated financial statements.

 
5

 

FIRST FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except per share data)  (Unaudited)

   
Common
Stock
   
Preferred
Stock
   
Additional
Paid-in
Capital
   
Retained
Income
   
Accumulated
Other
Comprehensive
Loss
   
Treasury
Stock
   
Total
 
Balance at September 30, 2008
  $ 166     $ -     $ 58,338     $ 244,327     $ (15,966 )   $ (103,387 )   $ 183,478  
Net income
                            30,586                       30,586  
Other comprehensive income:
                                                       
Unrealized net gain on securities available for sale, net of reclassification adjustment and tax of $7,769
                                    18,347               18,347  
Total comprehensive income
                                                    48,933  
Common stock issued pursuant to:
                                                       
Stock option and employee benefit plans
                    612                               612  
Stock option tax benefit
                    5                               5  
Issuance of preferred stock/warrants
            1       64,999                               65,000  
Accretion of preferred stock/warrants
                    298       (298 )                     -  
Cash dividends:
                                                       
Common stock ($.355 per share)
                            (4,151 )                     (4,151 )
Preferred stock ($28.46 per share)
                            (1,850 )                     (1,850 )
Cumulative effect of adoption of FASB ASC 320-10-65
                            1,178                       1,178  
Treasury stock purchased
                                            (176 )     (176 )
Balance at June 30, 2009
  $ 166     $ 1     $ 124,252     $ 269,792     $ 2,381     $ (103,563 )   $ 293,029  

   
Common
Stock
   
Preferred
Stock
   
Additional
Paid-in
Capital
   
Retained
Income
   
Accumulated
Other
Comprehensive
Income
   
Treasury
Stock
   
Total
 
Balance at September 30, 2009
  $ 208     $ 1     $ 185,249     $ 265,821     $ 3,933     $ (103,563 )   $ 351,649  
Net loss
                            (35,617 )                     (35,617 )
Other comprehensive loss:
                                                       
Unrealized net gain on securities available for sale, net of reclassification adjustment and tax of  $2,101
                                    3,165               3,165  
Total comprehensive loss
                                                    (32,452 )
Common stock issued pursuant to:
                                                       
Public offering
    7               9,183                               9,190  
Stock option and employee benefit plans
                    329                               329  
Accretion of preferred stock/warrants
                    414       (414 )                     -  
Cash dividends:
                                                       
Common stock ($.15 per share)
                            (2,479 )                     (2,479 )
Preferred stock ($37.50 per share)
                            (2,440 )                     (2,440 )
Balance at June 30, 2010
  $ 215     $ 1     $ 195,175     $ 224,871     $ 7,098     $ (103,563 )   $ 323,797  

See accompanying notes to condensed consolidated financial statements.

 
6

 

FIRST FINANCIAL HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) (Unaudited)

   
Nine Months Ended
 
   
June 30,
 
   
2010
   
2009
 
Cash Flows from Operating Activities
     
Net (loss) income
  $ (35,617 )   $ 30,586  
Adjustments to reconcile net (loss) income to net cash provided by operating activities
               
Depreciation
    4,663       4,500  
Amortization of acquisition discounts
    (376 )     -  
Amortization of intangibles
    717       608  
Loss (gain) on sale of loans, net
    547       (1,234 )
Gain on sale of loan securitizations, net
    (2,772 )     -  
Gain on disposition of property and equipment, net
    (1,354 )     (125 )
Loss on sale of real estate owned, net
    1,873       935  
Stock option compensation expense
    317       336  
Excess tax benefit resulting from stock options
    -       5  
(Accretion) amortization of discounts/premiums on investments, net
    (2,654 )     4,992  
(Decrease) increase in deferred loan fees and discounts
    (3,836 )     306  
Net impairment losses recognized in earnings
    2,623       3,379  
Net other comprehensive loss
    (2,012 )     -  
Cumulative effect of adoption of  FASB ASC 320-10-65
    -       1,178  
(Increase) decrease in receivables and other assets
    (13,079 )     1,142  
Provision for loan losses
    107,615       45,602  
Write-down of real estate and other assets acquired in settlement of loans
    2,968       2,733  
Proceeds from sales of loans held for sale
    186,865       275,092  
Deferred income taxes
    (28,277 )     (24,999 )
Capitalized mortgage servicing rights
    (2,374 )     (3,441 )
Decrease in fair value of mortgage servicing rights
    2,947       5,288  
Increase in FDIC Indemnification asset
    (4,039 )     (61,541 )
Origination of loans held for sale
    (174,067 )     (328,437 )
(Decrease) increase in accounts payable and other liabilities
    (1,275 )     27,843  
Net cash provided by (used in) operating activities
    39,403       (15,252 )
                 
Cash Flows from Investing Activities
               
Proceeds from maturity of investments available for sales
    208       92  
Proceeds from sales of investment securities available for sale
    -       3,000  
Purchases of investment securities held to maturity
    -       (19,994 )
Purchases of investment securities available for sale
    (261 )     (3,150 )
Purchase of FHLB stock
    -       (4,261 )
Proceeds from sales of mortgage-backed securities available for sale
    21       13,670  
Repayments on mortgage-backed securities available for sale
    117,582       98,528  
Purchase of mortgage-backed securities available for sale
    (33,316 )     (261,528 )
Increase in investment in subsidiaries
    (236 )     -  
Increase in loans, net
    (26,738 )     (349,962 )
Proceeds from the sales of real estate owned and other repossessed assets
    17,348       6,781  
Reclassification of goodwill to intangibles
    -       (104 )
Net purchase of office properties and equipment
    (5,817 )     (6,773 )
Net cash provided by (used in) investing activities
    68,791       (523,701 )
 
 
7

 

FIRST FINANCIAL HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(in thousands) (Unaudited)

   
Nine Months Ended
 
   
June 30,
 
   
2010
   
2009
 
Cash Flows from Financing Activities
           
Net increase in checking, savings and money market accounts
  $ 76,580     $ 80,888  
Net increase in certificates of deposit
    67,604       409,065  
Net repayments of FHLB advances
    (14,387 )     (325,120 )
Issuance of common stock
    9,190       -  
Issuance of preferred stock
    -       62,019  
Issuance of stock warrants
    -       2,981  
Net (decrease) increase in other borrowings
    (258,000 )     344,999  
Decrease in advances by borrowers for taxes and insurance
    (336 )     (836 )
Proceeds from the exercise of stock options
    12       277  
Excess tax benefit resulting from stock options
    -       5  
Preferred stock dividends paid
    (2,440 )     (4,151 )
Common stock dividends paid
    (2,479 )     (1,850 )
Treasury stock purchased
    -       (176 )
Net cash (used in) provided by financing activities
    (124,256 )     568,101  
                 
Net (decrease) increase in cash and cash equivalents
    (16,062 )     29,148  
                 
Cash and cash equivalents at beginning of period
    78,070       62,949  
                 
Cash and cash equivalents at end of period
  $ 62,008     $ 92,097  
                 
Supplemental disclosures:
               
Cash paid during the period for:
               
Interest
  $ 43,627     $ 50,499  
Income taxes
  $ 5,473     $ 13,288  
Noncash investing and financing activities during the period:
               
Loans foreclosed
  $ 12,354     $ 19,093  
Unrealized gain on securities available for sale, net of tax
  $ 3,165     $ 18,347  

See accompanying notes to condensed consolidated financial statements

 
8

 

FIRST FINANCIAL HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

NOTE 1.  Basis of Presentation

The consolidated financial statements presented in this quarterly report included the accounts of First Financial Holdings, Inc. (the “Company” or which may be referred to as “First Financial”, “we”, “us” or “our”) and its wholly-owned subsidiaries, the principal one being First Federal Savings and Loan Association of Charleston (“First Federal” or “the Association”), a federally-chartered stock savings and loan association.  The financial statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and are unaudited.  The significant accounting policies followed by the Company for interim financial reporting are consistent with the accounting policies followed for annual financial reporting of the Company.  The Condensed Consolidated Statements of Financial Condition as of June 30, 2010 and September 30, 2009, which has been derived from audited financial statements, unaudited condensed consolidated financial statements and accompanying notes are presented in accordance with the instructions for Form 10-Q.  In the opinion of management, all adjustments necessary to fairly present the condensed consolidated financial position and condensed consolidated results of operations have been made.  All such adjustments are of a normal, recurring nature.  The results of operations for the three and nine months ended June 30, 2010, are not necessarily indicative of the results of operations that may be expected in future periods.

These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended September 30, 2009 (“2009 Form 10-K”).

NOTE 2.  Critical Accounting Estimates and Related Accounting Policies

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods.  Actual results could differ significantly from these estimates and assumptions.

Management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements.  These policies relate to the determination of the allowance for loan losses, including the evaluation of impaired loans and the associated provision for loan losses, loans acquired with deteriorated credit quality, the Federal Deposit Insurance Corporation (“FDIC”) indemnification asset, valuation of real estate owned (“REO”), valuation of investment securities, goodwill and intangible assets, residential mortgage servicing rights, and deferred income taxes as well as the associated income tax expense.

Allowance for Loan Losses

Management recognizes that losses may occur over the life of a loan and that the allowance for loan losses must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio.  Management assesses the allowance for loan losses on at least a quarterly basis by analyzing several factors including charge-off rates, delinquency rates and the changing risk profile of our loan portfolio, as well as local economic conditions such as unemployment rates, bankruptcies, real estate values, and vacancy rates of business and residential properties.

The Company believes that the accounting estimate related to the allowance for loan losses is a critical accounting estimate because it is highly susceptible to change from period to period, requiring management to make assumptions about probable incurred losses inherent in the loan portfolio at the balance sheet date.  The impact of an unexpected large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.

The Company’s methodology for analyzing the allowance for loan losses consists of specific allocations on significant individual credits and a general allowance amount, including a range of loss estimates.  The specific allowance component is determined when management believes that the collectability of an individually reviewed loan has been impaired and a loss is probable.  The general allowance component takes into consideration probable, incurred losses that are inherent within the loan portfolio but have not been specifically identified.  The general allowance is determined by applying a historical loss percentage to various types of loans with similar characteristics and classified loans that are not analyzed specifically.

 
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As a result of the imprecision in calculating inherent and probable losses, and in order to provide an allowance for loan losses that is adequate to cover losses that may arise as a result of changing economic conditions, qualitative adjustments are made to historical loss percentages to reflect current economic and internal environmental factors such as changes in underwriting standards and unemployment rates that may increase or decrease those historical loss factors.

The allowance is increased by the provision for loan losses, which is charged against current period operating results and decreased by the amount of actual charge-offs, net of recoveries.

Loans Acquired with Deteriorated Credit Quality

Accounting Standards Codification Topic (“ASC”) 310-30 applies to a loan with evidence of deterioration of credit quality since origination, and for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable.  For loans accounted for under ASC 310-30, management determines the value of the loan portfolio based, in part, on work provided by an appraiser.  Factors considered in the valuation are projected cash flows for the loans, type of loan and related collateral, classification status and current discount rates.  Loans are grouped together according to similar characteristics and are treated in the aggregate when applying various valuation techniques.  Management also estimates the amount of credit losses that are expected to be realized for the loan portfolio primarily by estimating the liquidation value of collateral securing loans on nonaccrual status or classified as substandard or doubtful.  Certain amounts related to these loans were estimates and highly subjective.

Adjustments to loan values in future periods may occur based on management’s expectation of future cash flows to be collected over the lives of the loans.  If based on the review, it is probable that a significant increase in cash flows previously expected to be collected or if actual cash flows are significantly greater than cash flows previously expected, the remaining valuation allowance established for the loans is reduced for the increase in the present value of cash flows expected to be collected and the accretable yield is increased and is recognized over the remaining life of the loan.  If based on the review, it is probable that a significant decrease in cash flows previously expected to be collected or if actual cash flows are significantly less than cash flows previously expected, the allowance for loan losses is increased for the decrease in the present value of the cash flows expected to be collected.  The accretable yield for the loans is recalculated based on the decrease of the revised cash flows expected and is recognized over the remaining life of the loan.

For assets covered under the FDIC Indemnification Agreement, loans are considered in the calculation of the allowance for loan losses as previously discussed.  Loans determined to be impaired and related credit losses incurred subsequent to the initial measurement of the loan valuation and FDIC Indemnification Agreement appropriately affect the provision for loan losses and the allowance in that period.  Related changes to the FDIC Indemnification Agreement will be presented net in the provision for loan losses.

FDIC Indemnification Asset

On April 10, 2009, First Federal entered into a purchase and assumption agreement (“the agreement”) with loss share with the FDIC to acquire certain assets and assume certain liabilities of a failed financial institution.  The loans and REO purchased under the agreement are covered by a loss share agreement between the FDIC and First Federal, which affords the Association significant protection.  This agreement covers realized losses on loans and foreclosed real estate purchased from the FDIC.  Realized losses covered by the loss sharing agreement include loan contractual balances (and related unfunded commitments that were acquired), accrued interest on loans for up to 90 days, the book value of foreclosed real estate acquired, and certain direct costs, less cash or other consideration received by the Association.  This agreement extends for 10 years for one-to-four family real estate loans and for five years for other loans. First Federal cannot submit claims of loss until certain events occur, as defined under the agreement.

The determination of the initial fair value of loans and REO acquired, and the initial fair value of the related FDIC indemnification asset involve a high degree of judgment and complexity.  The amount that First Federal realizes on these assets could differ materially from the carrying value reflected in these financial statements, based upon the timing and amount of collections on the acquired loans in future periods.  Because of the loss sharing agreement with the FDIC on these assets and that First Federal considered its share of losses in estimating fair values of assets acquired, First Federal should not incur any significant losses.  To the extent the actual values realized for the acquired loans are different from the estimate; the indemnification asset will generally be affected in an offsetting manner due to the loss sharing support from the FDIC.  As such, the indemnification asset is subject to a high degree of uncertainty and estimation as to the timing of the losses and subsequent recovery of a portion of those losses under the loss sharing agreement.

 
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Real Estate Owned

Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at the fair value at the date of foreclosure minus estimated costs to sell.  Any valuation adjustments required at the time of foreclosure are charged to the allowance for loan losses.  After foreclosure, the properties are carried at the lower of carrying value or fair value less estimated costs to sell.  Any subsequent valuation adjustments, operating expenses or income, and gains and losses on disposition of such properties are recognized in current operations.

Valuation of Investment Securities

Fair values of investment securities may be based on quoted market prices in an active market when available, or through a combination of prices determined by an income valuation technique using fair value models and quoted prices.  When market observable data is not available, which generally occurs due to the lack of liquidity for certain investment securities, the valuation of the security is subjective and may involve substantial judgment.

To determine which individual securities are at risk for other-than-temporary impairment (“OTTI”), the Company also considers various characteristics of each security including, but not limited to, the credit rating, the duration and amount of the unrealized loss and any credit enhancements.  The relative importance of this information varies based on the facts and circumstances surrounding each security, as well as the economic environment at the time of assessment.  For securities identified as at risk for OTTI, additional evaluation techniques are applied, include estimating projected cash flows based on the structure of the security and certain assumptions such as prepayments, default rates, and loss severity to determine whether the Company expects to receive all of the contractual cash flows as scheduled.  The Company recognizes an OTTI credit loss when the present value of the investment security’s cash flows expected to be collected are less than the amortized cost basis. OTTI attributed to credit is recorded as a charge against current earnings, while OTTI attributed to noncredit factors is recorded as a charge against Other Comprehensive Income.  The detail of the components of OTTI is presented in Note 5.

Goodwill and Intangible Assets

Accounting standards require that we account for acquisitions using the purchase method of accounting.  Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of its net assets, the excess is carried on the acquirer’s balance sheet as goodwill.  In accordance with U.S. GAAP, our goodwill is evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists.  Such evaluation is based on a variety of factors, including the quoted price of our common stock, market prices of common stock of other banking organizations, common stock trading multiples, discounted cash flows and data from comparable acquisitions.

An intangible asset is recognized as an asset apart from goodwill if it arises from contractual or other legal rights or if it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged.  Intangible assets with finite useful lives are amortized over those lives.  To determine useful lives of intangible assets various guidelines exist and require subjectivity and judgment.

Residential Mortgage Servicing Rights

The methodology used to determine the fair value of mortgage servicing rights (“MSRs”) is subjective and requires the development of a number of assumptions.  We determine fair value by estimating the present value of the asset’s future cash flows utilizing market-based prepayment rates, discount rates, and other assumptions validated through comparison to trade information, industry surveys, and with the use of independent third party appraisals.  Risks inherent in the MSRs valuation include higher than expected prepayment rates and/or delayed receipt of cash flows.  The value of MSRs is significantly affected by mortgage interest rates available in the marketplace, which influence mortgage loan prepayment speeds.

Income Taxes

The Company computes its interim period tax expense based upon projections of pretax income adjusted for income or expense that has different tax treatment and projected tax credits.  Various estimates included but not limited to, tax rates in multiple state tax jurisdictions, exempt income earned in the interim period and projections for the remainder of the fiscal year are used in determining the interim period tax provision.  The Company also incorporates the impact of taxable income or loss for each period and the projections in determining the effective rate.  The Company reviews the actual period results and estimates the tax expense, determines the effective rate for the period and compares this to the projected effective rate for the year.  The Company uses the actual results for the period to determine the tax expense, unless there is a material difference in the actual rate of tax for the period versus the projected effective rate for the fiscal year.

 
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Deferred income taxes are reported for temporary differences between items of income or expense reported in the financial statements and those reported for income tax purposes.  Deferred taxes are computed using the asset and liability approach as prescribed in ASC 740, “Income Taxes.”  Under this method, a deferred tax asset or liability is determined based on the currently enacted tax rates applicable to the period in which the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company’s income tax returns.  The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.

NOTE 3.  Recent Accounting Pronouncements

Business Combinations

In December 2007, the Financial Accounting Standards Board (“FASB”) issued ASC 805, Business Combinations which significantly changes the accounting for business combinations and will impact financial statements both on the acquisition date and in subsequent periods.  Under ASC 805, an acquiring entity will be required to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree to be measured at their fair values as of the acquisition date, with limited exceptions.  ASC 805 also includes a substantial number of new disclosure requirements.  ASC 805 was adopted by the Company on October 1, 2009, and its provisions will apply to any future business combinations entered into by the Company.

Accounting for Transfers of Financial Assets

In June 2009, the FASB issued ASC 860, Accounting for Transfers of Financial Assets, which removes the concept of a qualifying special-purpose entity and requires consolidation of variable interest entities that are qualifying special-purpose entities.  ASC 860 limits the circumstances in which a transferor derecognizes a portion or component of a financial asset and establishes conditions for reporting a transfer of a portion(s) of a financial asset as a sale.  This statement is effective as of the beginning of each entity’s first annual reporting period that begins after November 15, 2009.  Early application is not permitted.  The Company is evaluating the impact of ASC 860 on its consolidated financial condition, results of operation and cash flows.

Consolidations (Topic 810) – Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities

In December 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-17, Consolidations (Topic 810) – Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities, which changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated.  ASU 2009-17 also requires a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement and how the Company’s involvement with the variable interest entity affects the Company’s financial statements.  ASU 2009-17 is effective at the start of a reporting entity’s fiscal year beginning after November 15, 2009.  Early application is not permitted.  The Company is evaluating the impact on its consolidated financial condition, results of operation and cash flows.

Fair Value (Topic 820) – Improving Disclosures about Fair Value Measurement

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. Pursuant to ASU 2010-06, a reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and, in the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.

In addition, ASU 2010-06 clarifies the requirements of the existing disclosures that a reporting entity should provide about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.  ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early application is permitted.  The Company does not expect any material impact on its consolidated financial condition or results of operations.

Receivables (Topic 310) – Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses

In July 2010, the FASB issued ASU No. 2010-20, Receivables (Topic 310) – Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. Pursuant to ASU 2010-20, a reporting entity should disclose the nature of credit risk inherent in the entity’s portfolio of financing receivables; how that risk is analyzed and assessed in arriving at the allowance for credit losses; and, the changes and reasons for those changes in the allowance for credit losses.

 
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In addition, ASU 2010-20 changes existing disclosure requirements about financing receivables to provide disclosure on a disaggregated basis on two defined levels; (1) portfolio segment; and (2) class of financing receivable. Additional disclosure is required concerning credit quality indicators of financing receive; an aging of past due financing receivables at the end of the reporting period; and, the nature and extent of troubled debt restructuring that occurred during the period by class of  financing receivable and the effect on the allowance for loan loses. ASU 2010-20 is effective for interim and annual reporting periods ending on or after December 15, 2010.  The disclosures about activity during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.  The Company does not expect any material impact on its consolidated financial condition or results of operations.

NOTE 4.  Acquisition

On April 10, 2009, First Federal entered into an agreement with the FDIC and acquired certain assets and assumed certain liabilities of Cape Fear Bank, a full service community bank that was formerly headquartered in Wilmington, North Carolina.  First Federal assumed approximately $306 million of deposits (which excluded nearly all brokered deposits), $59 million of FHLB advances and $474 thousand of other liabilities of Cape Fear Bank.  Additionally, First Federal purchased approximately $274.5 million in loans, $7.5 million in real estate and other repossessed assets, and $70.8 million of other assets.  Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded.  The transaction resulted in a pre-tax gain of $47.7 million, which is included as an extraordinary item in First Financial’s fiscal 2009 Consolidated Statement of Operations.  Due to the difference in tax bases of the assets acquired and liabilities assumed, First Federal recorded a deferred tax liability of $18.8 million, resulting in an after-tax gain of $28.9 million.

In addition to the assets purchased and liabilities assumed, First Federal entered into a loss sharing agreement with the FDIC which affords First Federal significant protection.  Under the loss sharing agreement, First Federal will share in the losses on assets covered under the agreement (referred to as “covered assets”).  On losses up to $110.0 million, First Federal will assume the first $31.5 million and the FDIC has agreed to reimburse First Federal for 80% of the losses between $31.5 million and $110.0 million.  On losses exceeding $110.0 million, the FDIC has agreed to reimburse First Federal for 95% of the losses.  Reimbursement for losses on single family one-to-four family residential mortgage loans are to be made quarterly until the end of the quarter in which the tenth anniversary of the closing of the acquisition occurs, and reimbursement for losses on non-one-to-four family residential mortgage loans are to be made quarterly until the end of the quarter in which the fifth anniversary of the closing of the acquisition occurs.  The reimbursable losses from the FDIC are based on the Cape Fear’s book value of the relevant loans and foreclosed assets as determined by the FDIC as of the date of the acquisition, April 10, 2009.  The loss sharing agreement is subject to the servicing procedures as specified in the agreement with the FDIC.  The expected reimbursements under the loss sharing agreement were recorded as an indemnification asset at their estimated fair value of $60.4 million on the acquisition date.  The cumulative losses realized and reported to the FDIC as of June 30, 2010 were $31.1 million which did not exceed our first loss tranche.

On the acquisition date, the preliminary estimate of the contractually required payments receivable for all loans acquired with deteriorated credit quality and accounted for in accordance with ASC 310-30 was $170.6 million.  The estimated fair value of the loans was $74.6 million, net of an accretable yield of $10.7 million, which represents the difference between the value of the loans on our balance sheet and the cash flows they are expected to produce.  At April 10, 2009, a majority of these loans were valued based on the liquidation value of the underlying collateral because the future cash flows are primarily based on the liquidation of underlying collateral.  There was no allowance for credit losses established related to these loans at acquisition based on the provision of ASC 310-30.

On the acquisition date, the estimate of the contractually required payments receivable for all ASC 310-30 loans acquired in the acquisition was $216.2 million and the estimated fair value of the loans totaled $204.1 million.  First Federal determined an allowance for credit losses totaling approximately $4.1 million that was applied to the acquired loans, which was derived using First Federal’s allowance methodology.

 
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Note 5.  Investment Securities

The amortized cost, gross unrealized gains, gross unrealized losses and fair value of investment securities available for sale, mortgage-backed securities (“MBS”) available for sale, and held to maturity securities are as follows (in thousands):

   
As of June 30, 2010
 
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Estimated Fair
Value
 
Securities available for sale:
                       
                         
Obligations of U.S. gov't agencies and corporations
  $ 2,061     $ 27     $ -     $ 2,088  
State and municipal obligations
    450       6       -       456  
Corporate debt securities
    13,719       1,038       4,457       10,300  
      16,230       1,071       4,457       12,844  
Mortgage-backed securities:
                               
FHLMC
    29,672       1,565       68       31,169  
FNMA
    26,242       1,145       -       27,387  
GNMA
    32,047       993       -       33,040  
CMOs
    296,968       13,442       1,232       309,178  
      384,929       17,145       1,300       400,774  
Total
  $ 401,159     $ 18,216     $ 5,757     $ 413,618  
                                 
Securities held to maturity:
                               
                                 
State and municipal obligations
  $ 21,605     $ 1,816     $ 13     $ 23,408  
Certificates of deposit and other
    907       -       -       907  
Total
  $ 22,512     $ 1,816     $ 13     $ 24,315  

   
As of September 30, 2009
 
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Estimated Fair
Value
 
Securities available for sale:
                       
                         
Obligations of U.S. gov't agencies and corporations
  $ 2,173     $ 14     $ 2     $ 2,185  
State and municipal obligations
    450       24       -       474  
Corporate debt securities
    16,078       142       5,123       11,097  
      18,701       180       5,125       13,756  
Mortgage-backed securities:
                               
FHLMC
    39,184       1,363       297       40,250  
FNMA
    33,374       874       64       34,184  
GNMA
    41,906       948       -       42,854  
CMOs
    352,292       13,413       4,013       361,692  
      466,756       16,598       4,374       478,980  
Total
  $ 485,457     $ 16,778     $ 9,499     $ 492,736  
                                 
Securities held to maturity:
                               
                                 
State and municipal obligations
  $ 21,495     $ 2,784     $ -     $ 24,279  
Certificates of deposit
    906       -       -       906  
Total
  $ 22,401     $ 2,784     $ -     $ 25,185  
 
 
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As of June 30, 2010
 
   
Amortized Cost
   
Fair Value
 
Securities available for sale:
           
Due within one year
  $ 1,485     $ 1,487  
Due after one year through five years
    -       -  
Due after five years through ten years
    1,582       1,635  
Due after ten years
    13,163       9,722  
      16,230       12,844  
Mortgage-backed securities
     384,929       400,774  
Total securities available for sale
  $ 401,159     $ 413,618  
                 
Securities held to maturity:
               
Due within one year
  $ 400     $ 400  
Due after one year through five years
    507       507  
Due after five years through ten years
    -       -  
Due after ten years
    21,605