GB&T Bancshares 10-K 2008
Documents found in this filing:
UNITED STATES SECURITIES AND
WASHINGTON, D.C. 20549
x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2007
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 000-24203
GB&T Bancshares, Inc.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (770) 532-1212
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
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):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The aggregate market value of the registrants common stock held by nonaffiliates as of June 30, 2007 was approximately $218,098,009 based on the closing price of the common stock on the Nasdaq Global Select Market of $16.70 per share on that date. For this purpose, directors and executive officers have been assumed to be affiliates.
As of February 28, 2008, the Company had issued and outstanding 14,230,796 shares of the 20,000,000 authorized shares of its no par value common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of this Annual Report on Form 10-K, to be filed in connection with the 2008 Annual Meeting of Shareholders or as an amendment to this Form 10-K, are incorporated by reference into Part III of this report.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements contained or incorporated by reference in this Report, including, without limitation, matters discussed under the caption Managements Discussion and Analysis of Financial Condition and Results of Operation, of GB&T Bancshares, Inc. (the Company) are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements about the competitiveness of the banking industry, potential regulatory obligations, our entrance and expansion into other markets, our ability to recover on the impaired loans, our other business strategies and other statements that are not historical facts. Forward-looking statements are not guarantees of performance or results. When we use words like may, plan, contemplate, anticipate, believe, intend, continue, expect, project, predict, estimate, could, should, would, will, and similar expressions, you should consider them as identifying forward-looking statements, although we may use other phrasing. These forward-looking statements involve risks and uncertainties and are based on our beliefs and assumptions, and on the information available to us at the time that these disclosures were prepared. Factors that may cause actual results to differ materially from those expressed or implied by such forward-looking statements include, among others, the following possibilities: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) changes in the interest rate environment may reduce margins; (3) general economic conditions may be less favorable than expected (both generally and in our markets), resulting in, among other things, a deterioration in credit quality and/or a reduction in demand for credit; (4) declines in local real estate values; (5) economic, governmental or other factors may prevent the projected population and commercial growth in the counties in which we operate; (6) legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses in which we are engaged; (7) costs or difficulties related to the integration of our acquired businesses may be greater than expected; (8) deposit attrition, customer loss or revenue loss following acquisitions may be greater than expected; (9) competitors may have greater financial resources and develop products that enable such competitors to compete more successfully than we can; (10) adverse changes may occur in the equity markets; and (11) our transaction with SunTrust Banks, Inc. may not be consummated or may be significantly delayed. You should refer to the risks detailed below under the heading Risk Factors and throughout this Report and in our periodic and current reports filed with the Securities and Exchange Commission for specific factors which could cause our actual results to be materially different from those expressed or implied by these forward-looking statements. Many of these factors are beyond our ability to control or predict, and readers are cautioned not to put undue reliance on such forward-looking statements. We do not intend to, and assume no responsibility for updating or revising any forward-looking statements contained in this Report, whether as a result of new information, future events or otherwise.
ITEM 1. BUSINESS
GB&T Bancshares was formed in 1998 as a bank holding company existing under the laws of the State of Georgia. On April 24, 1998, we completed a reorganization of Gainesville Bank & Trust to the current holding company structure by acquiring all of the outstanding common stock of Gainesville Bank & Trust in exchange for 1,676,160 shares of GB&T Bancshares common stock. The acquisition was accounted for as a pooling of interests. We operate as a multi-bank holding company. All of our business activities are conducted through our subsidiaries. At December 31, 2007, we had seven wholly owned bank subsidiaries, Gainesville Bank & Trust, (GBT), United Bank & Trust, (UBT), Community Trust Bank, (CTB), HomeTown Bank of Villa Rica, (HTB), First National Bank of the South, (FNBS), First National Bank of Gwinnett, (FNBG), Mountain State Bank (MSB) and one mortgage company which is a subsidiary of GBT.
Through our subsidiary banks, we offer a wide range of lending services, including real estate, consumer and commercial loans to individuals, small businesses and other organizations that are located in or conduct a substantial portion of their business in our markets. We complement our lending operations with a full array of retail deposit products and fee-based services to support our clients including checking accounts, money market accounts, savings accounts and certificates of deposit. We also offer a variety of other traditional banking services to our customers, including drive-up and night depository facilities, 24-hour automated teller machines, internet banking, telephone banking and limited trust services.
Market Areas and Competition
We currently conduct business through 35 branches in our subsidiary banks market areas of Hall, Polk, Paulding, Cobb, Carroll, Baldwin, Bartow, Putnam, Houston, Clarke, Gwinnett, Dawson, Forsyth, Fulton and Lumpkin Counties, Georgia. These market areas geographically surround metropolitan Atlanta.
As a whole, the banking industry in Georgia is highly competitive. Our subsidiary banks compete with local as well as with national and regional financial institutions in our markets. In addition, our banks compete with credit unions, brokerage firms and money market funds. We compete with institutions which may have much greater financial resources than our subsidiary banks, and which may be able to offer more services to customers. In recent years, intense market demands, economic pressures, and increased customer awareness of products and services, and the availability of electronic services have forced banks to diversify their services and become more cost-effective. Our subsidiary banks face strong competition in attracting and retaining deposits and loans.
Direct competition for deposits comes from other commercial banks, savings institutions, credit unions and issuers of securities, such as shares in money market funds. Interest rates on deposit accounts, convenience of banking facilities, products and services, and marketing are all significant factors in the competition for deposits.
Competition for loans comes from other commercial banks, savings institutions, insurance companies, consumer finance companies, credit unions, mortgage banking firms and other institutional lenders. We compete for loan originations through interest rates charged on loans, loan fees, our efficiency in closing and handling of loans, and the overall quality of service. Competition is affected by the availability of lendable funds, general and local economic conditions, interest rates, and other factors that are not readily predictable.
Management expects that competition will continue in the future due to statewide branching laws and the entry of additional bank and nonbank competitors to our markets.
On November 2, 2007, we entered into a definitive merger agreement with SunTrust Banks, Inc. (SunTrust), pursuant to which SunTrust will acquire GB&T. At the effective time of the merger, by virtue of the merger and without any action on the part of the holders of any capital stock of GB&T, each share of common stock of GB&T issued and outstanding immediately prior to the effective time (excluding shares owned by GB&T or SunTrust) will be converted into the right to receive 0.1562 shares of SunTrust common stock (the Exchange Ratio). Cash will be paid in lieu of fractional shares. The Agreement also provides that each issued and outstanding option to purchase shares of GB&T common stock will be converted into an option to purchase the number of whole shares of SunTrust common stock equal to the number of shares of GB&T common stock subject to the stock option multiplied by the Exchange Ratio (rounded down to the nearest whole share). The exercise price per share of the SunTrust stock option will equal the exercise price for the GB&T stock option divided by the Exchange Ratio.
The merger has been approved by the Boards of Directors of both companies. The completion of the merger is subject to various closing conditions, including obtaining the approval of GB&T shareholders, and is expected to be completed in the second quarter of 2008. GB&T and SunTrust will continue to operate separately until the transaction closes. SunTrust has filed a registration statement on Form S-4 in connection with the proposed merger, which includes additional information related to the proposed merger and GB&Ts proxy statement and SunTrusts prospectus for the proposed transaction.
We intend to achieve our primary goal of maximizing shareholder value by focusing on the following objectives:
· Improve our earnings through efficient management of our infrastructure, capital base and other resources;
· Continue to build market share in high growth markets in Georgia where we believe we have a competitive advantage and an opportunity for growth;
· Continue our primary focus on commercial and retail customers in our market areas with the goal of providing superior, personal customer service and building strong asset quality;
· Maintain local authority and accountability at our subsidiary banks;
· Expand our financial products and services to meet the needs of our customers and to increase our fee income; and
· Ensure managements interests are aligned with shareholders.
Community Banking. We believe that, in our market areas, customers are attracted and retained primarily through personal customer service and a local, community-oriented atmosphere in which they can feel comfortable and trust the bank personnel with whom they are dealing. In order to maintain this atmosphere, as we have acquired new banks and grown internally, we generally maintain the management team of each separate bank, allowing it to retain its local entrepreneurial identity, autonomy and decision making. By keeping with this community banking strategy, we feel that our employees and customers will forge long-term, mutually beneficial relationships. By keeping management local and accessible to customers, we believe our banks can respond more quickly to our customers needs than other, larger banks. Although we intend to maintain the relatively autonomous community bank atmosphere, due to the growth our company has experienced in the past several years, we focused our attention on maintaining asset and credit quality at all of our bank subsidiaries from a centralized, holding company level. To further this effort, in 2006 we appointed Sid J. Sims, a twenty-eight year banking veteran, to the newly created position of Executive Vice President and Chief Credit Officer. Mr. Sims is responsible for managing asset and credit quality throughout our company. With the current economy, this role has grown rapidly, and quickly evolved into a more centralized asset quality function.
Growth Strategy. Our strategy is to continue pursuing expansion into attractive, high growth markets around the metropolitan Atlanta area through selective acquisitions of community banks as market conditions permit, and the establishment of de novo branch offices. Since February 2000, we have integrated eight bank acquisitions through mergers with their holding companies or merging the banks into Gainesville Bank & Trust. We focus our acquisition strategy on high-quality community banks with proven management teams that view combining with us as forging a partnership rather than as an exit strategy. Our goal is to maintain the management team of each acquired bank, allowing it to retain its local entrepreneurial identity, autonomy and decision making, while simultaneously increasing efficiency by consolidating administrative and back office operations. While selective acquisitions will remain a part of our long-term strategy, we believe that current economic and market conditions are not conducive to active acquisition activities.
We intend to continue to expand internally where possible by growing our existing banks in their respective market areas and nearby attractive markets. We believe that our decentralized community banking strategy allows our banks to effectively compete with our larger competitors by providing superior, personalized customer service, leveraging local decision making capabilities, and staying attuned to community matters.
Trust Preferred Securities
In 2002, our holding company formed a wholly owned grantor trust and issued $15.5 million in aggregate principal amount of trust preferred securities in a private placement offering. The grantor trust has invested the proceeds of the trust preferred securities in subordinated debentures of our holding company. The trust preferred securities can be redeemed, in whole or in part, from time to time, prior to maturity at our option on or after October 30, 2007. The sole assets of the grantor trust are the subordinated debentures of GB&T Bancshares. The debentures have the same variable interest rate as the trust preferred securities. We have the right to defer interest payments on the debentures for up to 20 consecutive quarterly periods (five years), so long as we are not in default under the debentures.
On July 22, 2004, we issued an additional $10.3 million in aggregate principal amount of trust preferred securities through a wholly owned grantor trust in a private placement. The grantor trust has invested the proceeds of the trust preferred securities in subordinated debentures of our holding company. The trust preferred securities can be redeemed, in whole or in part, from time to time, prior to maturity at our option on or after September 30, 2009. The sole assets of the grantor trust are the subordinated debentures of GB&T Bancshares.
In addition, in connection with the acquisition of Southern Heritage Bank, which now operates as a division of GBT, we assumed $4.1 million in aggregate principal amount of trust preferred securities which have substantially the same terms as our other trust preferred securities except that they have a fixed rate of interest and may be redeemed at our option on or after June 26, 2008. As of December 31, 2007, we had $29.9 million in aggregate principal amount of trust preferred securities outstanding. See the notes to the consolidated financial statements for further information on our trust preferred securities.
We originate loans primarily secured by single and multi-family real estate, residential construction, and owner-occupied commercial buildings. In addition, we make loans to small and medium-sized commercial businesses, as well as to consumers for a variety of purposes. We also lend to residential contractors and developers in our market areas. We attempt to obtain a security interest in real estate whenever possible. As of December 31, 2007, approximately 90% of our loan portfolio was secured by real estate.
We also provide commercial and consumer installment loans to our customers that are secured by real estate and other collateral. Such loans are typically of multiple-year duration and, if not variable rate, bear interest at a rate tied to our cost of funds of equivalent maturity.
Our loan portfolio at December 31, 2007 was comprised as follows:
Real Estate-Mortgage. We make commercial mortgage loans to finance the purchase of real property as well as loans to smaller business ventures, credit lines for working capital and short-term seasonal or inventory financing, including letters of credit, that are also secured by real estate. Commercial mortgage lending typically involves higher loan principal amounts, and the repayment of loans is dependent, in large part, on sufficient income from the properties collateralizing the loans to cover operating expenses and debt service. As a general practice, we require our commercial mortgage loans to be collateralized by income producing property having either actual or projected income to service the debt with adequate margins and to be guaranteed by responsible parties. In addition, a substantial percentage of our commercial mortgage loan portfolio is secured by owner-occupied commercial buildings. We look for opportunities where cash flow from the collateral provides adequate debt service coverage and the guarantors net worth is centered on assets other than the project we are financing. Our commercial mortgage loans are generally collateralized by first liens on real estate, have fixed or floating interest rates and amortize over a 15 to 25-year period with balloon payments due at the end of one to nine years. Payments on loans collateralized by such properties are often dependent on the successful operation or management of the properties. Accordingly, repayment of these loans may by subject to adverse conditions in the real estate market.
In underwriting commercial mortgage loans, we seek to minimize our risks in a variety of ways, including giving careful consideration to the propertys operating history, future operating projections, current and projected occupancy, location and physical condition. Our underwriting analysis also includes credit checks, reviews of appraisals and environmental hazards or EPA reports and a review of the financial condition of the borrower. We attempt to limit our risk by analyzing our borrowers cash flow and collateral value on an ongoing basis.
Our residential mortgage loans consist of originating residential loans for the purchase of residential property to individuals for other third-party lenders. Residential loans to individuals held in our loan portfolio primarily consist of home equity loans and lines of credit. These loans are generally made on the basis of the borrowers ability to repay the loan from his or her employment and other income and are secured by residential real estate, the value of which is reasonably ascertainable. We expect that these loan-to-value ratios will be sufficient to compensate for fluctuations in real estate market value and to minimize losses that could result from a downturn in the residential real estate market. Other than originating residential mortgage loans for other lenders, we infrequently make consumer residential real estate loans consisting primarily of first and second mortgage loans for residential properties. We generally do not retain long term, fixed rate residential real estate loans in our portfolio due to interest rate and collateral risks and low levels of profitability.
Real Estate-Construction. We also make construction and development loans to residential and, to a lesser extent, commercial contractors and developers located within our market areas. Construction loans generally are secured by first liens on real estate and have floating interest rates. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of a project under construction, and the value of the project is dependent on its successful completion. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, upon the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If we are forced to foreclose on a project prior to completion, there is no assurance that we will be able to recover all of the unpaid portion of the loan. In addition, we may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time. While we
have underwriting procedures designed to identify what we believe to be acceptable levels of risks in construction lending, no assurance can be given that these procedures will prevent losses from the risks described above.
Commercial Lending. Our commercial loan portfolio includes loans to smaller business ventures, credit lines for working capital and short-term seasonal or inventory financing, as well as letters of credit that are generally secured by collateral other than real estate. Commercial borrowers typically secure their loans with assets of the business, personal guaranties of their principals, and sometimes mortgages on the principals personal residences. Our commercial loans are primarily made within our market areas and are underwritten on the basis of the commercial borrowers ability to service the debt from income. The risk in commercial loans is the expectation that the loans generally will be serviced from the operations of the business, and those operations may not be successful. Additionally, commercial loans may be secured by more specialized collateral which can result in lower levels of recovery.
Consumer Loans. We make a variety of loans to individuals for personal, family and household purposes, including secured and unsecured installment and term loans. Consumer loans entail greater risk than other loans, particularly in the case of consumer loans that are unsecured or secured by depreciating assets such as automobiles. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan balance. In addition, consumer loan collections are dependent on the borrowers continuing financial stability, and thus are more likely to be affected by job loss, divorce, illness or personal bankruptcy.
Credit Risks. The principal economic risk associated with each category of the loans that we make is the creditworthiness of the borrower and the ability of the borrower to repay the loan. General economic conditions and the strength of the services and retail market segments affect borrower creditworthiness. General factors affecting a commercial borrowers ability to repay include interest rates, inflation and the demand for the commercial borrowers products and services, as well as other factors affecting a borrowers customers, suppliers and employees.
Risks associated with real estate loans also include fluctuations in the value of real estate, new job creation trends, tenant vacancy rates and, in the case of commercial borrowers, the quality of the borrowers management. Consumer loan repayments depend upon the borrowers financial stability and are more likely to be adversely affected by divorce, job loss, illness and personal bankruptcy or other hardships.
Lending Policies. The boards of directors of our subsidiary banks establish and periodically review the subsidiary banks lending policies and procedures. Our board of directors adopted a company-wide lending policy in 2004. Despite our centralized policy, we may grant our subsidiary banks the flexibility to adapt our lending policy to conditions in their specific market areas. However, in order to properly recognize the benefits of that flexibility within the parameters of our lending policy, in late 2006 we appointed Sid J. Sims as our Chief Credit Officer to oversee the lending practices of all our subsidiary banks. There are also regulatory restrictions on the dollar amount of loans available for each lending relationship. State banking regulations provide that no secured loan relationship may exceed 25% of the subsidiary banks statutory capital or net assets, as defined, and no unsecured loan relationship may exceed 15% of statutory capital, except in limited circumstances. National banking regulations provide that no loan relationship may exceed 15% of the subsidiary banks Tier 1 capital. Our subsidiary banks occasionally sell participation interests in loans to other lenders, including our other subsidiary banks, primarily when a loan exceeds the subsidiary banks legal lending limits.
Our principal source of funds for loans and investing in securities is core deposits. We offer a wide range of deposit services, including checking, savings, money market accounts, and certificates of deposit. We obtain most of our deposits from individuals and businesses in our market areas. We believe that the rates we offer for core deposits are competitive with those offered by other financial institutions in our market areas. A secondary source of funding is through advances from the Federal Home Loan Bank of Atlanta, subordinated debt and other borrowings which enable us to borrow funds at rates and terms, which at times, are more beneficial to us.
Other Banking Services
We offer a range of products and services, including 24-hour internet banking, trust services, direct deposit, travelers checks, safe deposit boxes, United States savings bonds and automatic account transfers. We earn fees for most of these services. We also receive ATM transaction fees from transactions performed by our customers participating in a shared network of automated teller machines and a debit card system that our customers can use throughout Georgia and in other states.
After establishing necessary cash reserves and funding loans, we invest our remaining liquid assets in securities allowed under banking laws and regulations. We invest primarily in obligations of the United States or obligations guaranteed as to principal and interest by the United States, other taxable securities and in certain obligations of states and municipalities. We also invest excess funds in federal funds with our correspondent banks and primarily act as a net seller of such funds. The sale of federal funds represents a short-term loan from us to another bank. Risks associated with securities include, but are not limited to, interest rate fluctuation, maturity, and concentration.
It is our objective to manage our assets and liabilities to provide a satisfactory and consistent level of profitability within the framework of established cash, loan, securities, borrowing and capital policies. Our overall philosophy is to support asset growth primarily through the growth of core deposits, which include deposits of all categories from individuals and businesses. Management seeks to invest the largest portion of our assets in loans.
Our asset-liability mix is monitored on a periodic basis with a report reflecting interest-sensitive assets and interest-sensitive liabilities being prepared and presented to the Investment Committee of the holding companys board of directors on a quarterly basis. The objective of this policy is to manage interest-sensitive assets and liabilities so as to minimize the impact of substantial movements in interest rates on our earnings.
As of December 31, 2007, we had 476 full-time equivalent employees, of which 142 were employed by Gainesville Bank & Trust, 27 were employed by GB&T Mortgage, Inc., a subsidiary of GBT, 26 were employed by United Bank & Trust, 60 were employed by Community Trust Bank, 34 were employed by HomeTown Bank of Villa Rica, 44 were employed by First National Bank of the South, 22 were employed by First National Bank of Gwinnett, 42 were employed by Mountain State Bank and 79 were employed by the holding company. We are not a party to any collective bargaining agreement and, in the opinion of management, we enjoy satisfactory relations with our employees.
Supervision and Regulation
We, like the rest of the banking industry, are subject to extensive state and federal banking laws and regulations that impose specific requirements or restrictions on and provide for general regulatory oversight of virtually all aspects of our operations. These laws and regulations are generally intended to protect depositors, not shareholders.
Legislation and regulations authorized by legislation influence, among other things:
· How, when and where we may expand geographically;
· What product or service market we may enter;
· How we must manage our assets; and
· Under what circumstances money may or must flow between the parent bank holding company and the subsidiary bank.
Set forth below is an explanation of the major pieces of legislation affecting our industry and how that legislation affects our actions. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects, and legislative
changes and the policies of various regulatory authorities may significantly affect our operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation may have on our business and earnings in the future.
General. The Company is a bank holding company registered with the Board of Governors of the Federal Reserve System (the Federal Reserve) and the Georgia Department of Banking and Finance (the Georgia Department) under the Bank Holding Company Act of 1956, as amended (the BHC Act) and the Financial Institutions Code of Georgia (the FICG), respectively.
GBT, UBT, CTB, HTB and MSB are state banks incorporated under the laws of Georgia and are subject to examination by the Georgia Department and the Federal Deposit Insurance Corporation (FDIC). FNBS and FNBG are nationally chartered banks incorporated under the laws of the United States and are subject to examination by the FDIC and the Office of the Comptroller of the Currency (OCC). All of our banks deposits are insured by the FDIC to the maximum extent provided by law. The FDIC, OCC, the Federal Reserve and the Georgia Department regularly examine our operations and have the authority to approve or disapprove mergers, consolidations, the establishment of branches, and similar corporate actions. The agencies also have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law.
On November 26, 2007, HTB executed and entered into a Stipulation and Consent Agreement with the FDIC and the Georgia Department agreeing to the issuance of a Cease and Desist Order (the Order). The Order became effective on December 6, 2007 and addressed the supervision and education of HTBs board of directors, management team, equity capital and reserves in relation to the volume and quality of assets held, level of poor quality loans, allowance for loan and lease losses, lending and collection practices, routine and internal controls policies, and alleged violations of certain laws, regulations and FDIC statements of policy. Under the terms of the Order, HTB has agreed to take a number of affirmative steps, many of which have been implemented over the past few months.
Acquisitions. The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before: (i) it may acquire direct or indirect ownership or control of any voting shares of any bank if, after such acquisition, the bank holding company will directly or indirectly own or control more than 5% of the voting shares of the bank; (ii) it or any of its subsidiaries, other than a bank, may acquire all or substantially all of the assets of any bank; or (iii) it may merge or consolidate 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 communities 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 involved and the convenience and needs of the communities to be served. Consideration of financial resources generally focuses on capital adequacy, and consideration of convenience and needs issues generally focuses on the parties performance under the Community Reinvestment Act of 1977.
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act, the restrictions on interstate acquisitions of banks by bank holding companies were repealed. As a result, the Company, and any other bank holding company located in Georgia, is able to acquire a bank located in any other state, and a bank holding company located outside of Georgia can acquire any Georgia-based bank, in either case subject to certain deposit percentage and other restrictions. The legislation provides that unless an individual state has elected to prohibit out-of-state banks from operating interstate branches within its territory, adequately capitalized and managed bank holding companies are able to consolidate their multistate banking operations into a single bank subsidiary and to branch interstate through acquisitions. De novo branching by an out-of-state bank is permitted only if it is expressly permitted by the laws of the host state. Georgia does not permit de novo branching by an out-of-state bank. Therefore, the only method by which an out-of-state bank or bank holding company may enter Georgia is through an acquisition. Georgia has adopted an interstate banking statute that removed restrictions on the ability of banks to branch interstate through mergers, consolidations and acquisitions.
However, Georgia law prohibits a bank holding company from acquiring control of a financial institution until the target financial institution has been incorporated for three years.
Restrictions on Transactions with Affiliates. We and our subsidiary banks are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on: the amount of a banks loans or extensions of credit to affiliates; a banks investment in affiliates; assets a bank may purchase from affiliates, except for real and personal property exemption by the Federal Reserve; the amount of loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and a banks guarantee, acceptance or letter of credit issued on behalf of an affiliate.
The total amount of the above transactions is limited in amount, as to any one affiliate, to 10.0% of a banks capital and surplus and, as to all affiliates combined, to 20.0% of a banks capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid the taking of low-quality assets.
We and our subsidiary banks are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
We are also subject to restrictions on extensions of credit to our executive officers, directors, principal shareholders and their related interests. These extensions of credit must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and must not involve more than the normal risk of repayment or present other unfavorable features.
Activities. The BHC Act has generally prohibited 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 determined by the Federal Reserve to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Act (the GLB Act), discussed below, have expanded the permissible activities of a bank holding company that qualifies as a financial holding company. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity can be reasonably expected to produce benefits to the public, such as a 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.
Gramm-Leach-Bliley Act. The GLB Act implemented major changes to the statutory framework for providing banking and other financial services in the United States. The GLB Act, among other things, eliminated many of the restrictions on affiliations among banks and securities firms, insurance firms, and other financial service providers. A bank holding company that qualifies as a financial holding company will be permitted to engage in activities that are financial in nature or incidental or complimentary to a financial activity. The GLB Act specifies certain activities that are deemed to be financial in nature, including underwriting and selling insurance, providing financial and investment advisory services, underwriting, dealing in, or making a market in securities, limited merchant banking activities, and any activity currently permitted for bank holding companies under Section 4(c)(8) of the BHC Act.
To become eligible for these expanded activities, a bank holding company must qualify as a financial holding company. To qualify as a financial holding company, each insured depository institution controlled by the bank holding company must be well-capitalized, well-managed, and have at least a satisfactory rating under the Community Reinvestment Act. In addition, the bank holding company must file a declaration with the Federal Reserve of its intention to become a financial holding company. The Company has not filed an application to become a financial holding company.
The GLB Act designates the Federal Reserve as the overall umbrella supervisor of the new financial services holding companies. The GLB Act adopts a system of functional regulation where the primary regulator is determined by the nature of activity rather than the type of institution. Under this principle, securities activities are regulated by the Securities and Exchange Commission (the SEC) and other securities regulators, insurance activities by the state insurance authorities, and banking activities by the appropriate banking regulator. As a result, to the extent that we engage in non-banking activities permitted under the GLB Act, we will be subject to the regulatory authority of the SEC or state insurance authority, as applicable.
Payment of Dividends. The Company is a legal entity separate and distinct from its subsidiaries. Its principal source of cash flow is dividends from its subsidiary banks. There are statutory and regulatory limitations on the payment of dividends by the subsidiary banks to the Company, as well as by the Company to its shareholders.
If, in the opinion of the federal banking agencies, a depository institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the depository institution, could include the payment of dividends), such authority may require, after notice and hearing, that such institution cease and desist from such practice. The federal banking agencies have indicated that paying dividends that deplete a depository institutions capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. See Prompt Corrective Action. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally pay dividends only out of current operating earnings.
During 2007, the Company paid a total of $0.38 per share to its shareholders. At December 31, 2007, the Company could declare approximately $9.1 million in dividends without further regulatory approval.
Capital Adequacy. We are required to comply with the capital adequacy standards established by the federal banking agencies. There are two basic measures of capital adequacy for bank holding companies that have been promulgated by the Federal Reserve: a risk-based measure and a leverage measure. All applicable capital standards must be satisfied for a bank holding company to be considered in compliance.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.
The minimum guideline for the ratio of Total Capital to risk-weighted assets (including certain off-balance-sheet items, such as standby letters of credit) is 8.0%. Total Capital consists of Tier 1 Capital, which is comprised of common stock, undivided profits, minority interests in the equity accounts of consolidated subsidiaries and noncumulative perpetual preferred stock, less goodwill and certain other intangible assets, and Tier 2 Capital, which consists of subordinated debt, other preferred stock, and a limited amount of loan loss reserves. At December 31, 2007, our consolidated Total Capital Ratio and our Tier 1 Capital Ratio were 11.44% and 10.18%, respectively.
In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio (the Leverage Ratio) of Tier 1 Capital to average assets, less goodwill and certain other intangible assets, of 3.0% for bank holding companies that meet certain specified criteria, including those having the highest regulatory rating. All other bank holding companies generally are required to maintain a Leverage Ratio of at least 3.0%, plus an additional cushion of 1.0% to 2.0%. Our Leverage Ratio at December 31, 2007 was 8.66%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the Federal Reserve has indicated that it will consider a tangible Tier 1 Capital Leverage Ratio (deducting all intangibles) and other indicators of capital strength in evaluating proposals for expansion or new activities.
The Banks are subject to risk-based and leverage capital requirements adopted by its federal banking regulators, which are substantially similar to those adopted by the Federal Reserve for bank holding companies.
Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on the taking of brokered deposits, and certain other restrictions on its business. As described below, substantial additional restrictions can be imposed upon FDIC-insured depository institutions that fail to meet applicable capital requirements. See Prompt Corrective Action.
The federal bank agencies continue to indicate their desire to raise capital requirements applicable to banking organizations beyond their current levels. In this regard, the Federal Reserve and the FDIC have, pursuant to FDICIA, recently adopted final regulations requiring regulators to consider interest rate risk (when the interest rate sensitivity of an institutions assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of a banks capital adequacy. The bank regulatory agencies have concurrently proposed a methodology for evaluating interest rate risk that would require banks with excessive interest rate risk exposure to hold additional amounts of capital against such exposures.
Support of Subsidiary Institutions. Under Federal Reserve policy, we are expected to act as a source of financial strength for, and to commit resources to support, our subsidiary banks. This support may be required at times when, absent such Federal Reserve policy, we may not be inclined to provide such support. In addition, any capital loans by a bank holding company to any of its banking subsidiaries are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding companys bankruptcy, any commitment by a bank holding company to a federal bank regulatory agency to maintain the capital of a banking subsidiary will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Prompt Corrective Action. FDICIA established a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized), and are required to take certain mandatory supervisory actions, and are authorized to take other discretionary actions, with respect to institutions in the three undercapitalized categories. The severity of the action will depend upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category.
An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to certain limitations. The controlling holding companys obligation to fund a capital restoration plan is limited to the lesser of 5.0% of an undercapitalized subsidiarys assets or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. In addition, the appropriate federal banking agency may treat an undercapitalized institution in the same manner as it treats a significantly undercapitalized institution if it determines that those actions are necessary.
At December 31, 2007, all of our banks had the requisite capital level to qualify as well capitalized under the regulatory framework for prompt corrective action.
FDIC Insurance Assessments. The FDIC establishes rates for the payment of premiums by federally insured banks and thrifts for deposit insurance. Member institutions pay deposit insurance assessments to the Deposit Insurance Fund, or the DIF. The FDIC previously maintained the Savings Association Insurance Fund and the Bank Insurance Fund, which primarily insured the deposits of banks and state chartered savings banks. These two funds were merged into the DIF effective March 31, 2006.
The FDIC recently amended its risk-based assessment system for 2007 to implement authority that the FDIC was granted under the Federal Deposit Insurance Reform Act of 2005, or the Reform Act. Under the revised system,
insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and other factors. The new regulation allows the FDIC to more closely tie each financial institutions deposit insurance premiums to the risk it poses to the DIF. The assessment rate of an institution depends upon the category to which it is assigned. Risk Category I, which contains the least risky depository institutions, is expected to include more than 90 percent of all institutions. Risk Category I, unlike the other risk categories, contains further risk differentiation based on the FDICs analysis of financial ratios, examination components and other information. The new assessment rates for nearly all financial institutions (Risk Category I) are expected to vary between five and seven basis points, or five to seven cents for every $100 of domestic deposits. The riskiest institutions (Risk Category IV) may be assessed up to 43 basis points. The FDIC may adjust rates uniformly from one quarter to the next, except that no single adjustment can exceed three basis points.
In addition to the assessments for deposit insurance, institutions are required to make payments on bonds which were issued in the late 1980s by the Financing Corporation in order to recapitalize the predecessor to the Savings Association Insurance Fund. During 2007, Financing Corporation payments for Savings Association Insurance Fund members approximated 1.14 basis points of assessable deposits. These assessments, which are adjusted quarterly, will continue until the Financing Corporation bonds mature in 2017.
The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Safety and Soundness Standards. The FDIA, as amended by the FDICIA and the Riegle Community Development and Regulatory Improvement Act of 1994, requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. The federal bank regulatory agencies have adopted a set of guidelines prescribing safety and soundness standards pursuant to FDICIA, as amended. The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation and fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal shareholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the prompt corrective action provisions of FDICIA. See Prompt Corrective Action. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties. The federal regulatory agencies also proposed guidelines for asset quality and earnings standards.
Community Reinvestment Act. Under the Community Reinvestment Act (CRA), our subsidiary banks, as FDIC insured institutions, have a continuing and affirmative obligation to help meet the credit needs of the entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices. The CRA requires the appropriate federal regulator, in connection with its examination of an insured institution, to assess the institutions record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as applications for a merger or the establishment of a branch. An unsatisfactory rating may be used as the basis for the denial of an application by the federal banking regulator. The Banks have received satisfactory ratings in their CRA examinations.
Effect of Governmental Monetary Policies. The earnings of our subsidiary banks are affected by domestic and foreign conditions, particularly by the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve has had, and will continue to have, an important impact on the operating results of commercial banks through its power to implement monetary policy in order, among other things, to mitigate recessionary and inflationary pressures by regulating the national money supply. The techniques used by the Federal Reserve include setting the reserve requirements of member banks and establishing the discount rate on member bank borrowings. The Federal Reserve also conducts open market transactions in United States government securities.
USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 (the Patriot Act) was enacted in response to the terrorist attacks in New York, Pennsylvania, and Washington, D.C. that occurred on September 11, 2001. The Patriot Act impacts financial institutions in particular through its anti-money laundering and financial transparency laws. The Patriot Act amended the Bank Secrecy Act and the rules and regulations of the Office of Foreign Assets Control to establish regulations which, among others, set standards for identifying customers who open an account and promoting cooperation with law enforcement agencies and regulators in order to effectively identify parties that may be associated with, or involved in, terrorist activities or money laundering.
On March 2, 2006, Congress passed the USA Patriot Act Improvement and Reauthorization Act of 2005. This act reauthorized all provisions of the Patriot Act that would otherwise have expired, made 14 of the 16 sunsetting provisions permanent, and extended the sunset period of the remaining two for an additional four years.
Proposed Legislation and Regulatory Action. New regulations and statutes are regularly proposed that contain certain wide-ranging proposals for altering the structures, regulations, and competitive relationships of the nations financial institutions. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.
The Company files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission. These filings are available to the public at the SECs website at http://www.sec.gov. The Company also has a website at http://www.gbtbancshares.com. On the website, the Company provides hyperlinks to copies of the annual, quarterly and current reports that the Company files with the SEC, any amendments to those reports and press releases, as well as the Companys code of ethics policy.
ITEM 1A. RISK FACTORS
Our business is subject to certain risks, including those described below. Readers of this Annual Report on Form 10-K should take such risks into account in evaluating any investment decision involving our common stock. The risks below do not describe all risks applicable to our business and are intended only as a summary of certain material factors that affect our operations in the industries in which we operate. More detailed information concerning these and other risks is contained in other sections of this Annual Report on Form 10-K, including Business and Managements Discussion and Analysis of Financial Condition and Results of Operations.
Our proposed merger with SunTrust may not be consummated or may be delayed, which may adversely affect our anticipated results of operations and financial condition, or both.
In November 2007, we announced that we had signed a definitive merger agreement with SunTrust pursuant to which SunTrust would acquire GB&T. The merger is expected to close in the second quarter of 2008, subject to the satisfaction of customary closing conditions, including the receipt of regulatory and GB&T shareholder approvals to the merger. There can be no assurance that all of these conditions will be satisfied. If these conditions are not satisfied or waived, we may be unable to complete the merger.
Upon completion of the merger, each share of common stock of GB&T issued and outstanding immediately prior to the effective time (excluding shares owned by GB&T or SunTrust) will be converted into the right to receive 0.1562 shares of SunTrust common stock. Cash will be paid in lieu of fractional shares. The Agreement also provides that each issued and outstanding option to purchase shares of GB&T common stock will be converted into an option to purchase the number of whole shares of SunTrust common stock equal to the number of shares of GB&T common stock subject to the stock option multiplied by 0.1562 (rounded down to the nearest whole share). The exercise price per share of the SunTrust stock option will equal the exercise price for the GB&T stock option divided by the 0.1562. Accordingly, if the price of SunTrust common stock declines prior to the completion of the merger, the value of the stock to be received by GB&T stockholders in the merger will decrease as compared to the value on the date the merger was announced.
As is typical with change of control transactions, GB&T employees may experience uncertainty about their future role with the combined company. These employees may leave GB&T prior to or after the closing of the merger. This may adversely affect GB&Ts ability to attract and retain key management, sales, marketing, technical and other personnel, pending the closing of the merger. Similarly, GB&Ts customers may, in response to the announcement of the merger, delay or defer purchasing decisions. Any delay or deferral in purchasing decisions by GB&Ts customers could harm the business of GB&T in the short-term, and the combined company in the long-term.
If the merger is not completed, the price of GB&T common stock may decline to the extent that the current market price of GB&T reflects a market assumption that the merger will be completed. The management team would have been distracted from running the business and GB&T will incur significant costs related to the merger, such as legal, accounting and some of the fees and expenses of their financial advisors, some of which costs must be paid even if the merger is not completed.
We have recently experienced significant growth through acquisitions, including the acquisitions of Lumpkin County Bank and Southern Heritage Bank in August 2004, the acquisition of First National Bank of Gwinnett in March 2005 and the acquisition of Mountain State Bank in May 2006. These acquisitions could place a strain on our resources, systems, operations and cash flow. Our ability to manage these acquisitions will depend on our ability to monitor operations and control costs, maintain effective quality controls, expand our internal management and technical and accounting systems and otherwise successfully integrate acquired businesses into our company. If we fail to do so, our business, financial condition and operating results will be negatively impacted.
Our loan customers may not repay their loans according to the terms of the loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. We may experience significant loan losses which could have a material adverse effect on our operating results. Management makes various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses in an attempt to cover any loan losses which may occur. In determining the size of the allowance, we rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume, delinquencies and non-accruals, national and local economic conditions and other pertinent information.
As we expand into new markets, our determination of the size of the allowance could be understated due to our lack of familiarity with market-specific factors. If our assumptions are wrong, our current allowance may not be sufficient to cover future loan losses, and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Additions to our allowance would significantly decrease our net income.
In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory agencies could have a negative effect on our operating results.
Deteriorating credit quality, particularly in real estate loans, has adversely impacted us and may continue to adversely impact us, leading to higher loan charge-offs or an increase in the our provision for loan losses.
The second half of 2007 was highlighted by volatility in the financial markets associated with subprime mortgages, including adverse impacts on credit quality and liquidity within the financial markets. The volatility has been exacerbated by a general decline in the real estate and housing market along with significant mortgage loan related losses reported by many other financial institutions. The market areas surrounding metropolitan Atlanta in which our subsidiary banks operate have been significantly impacted by the decline in the real estate and housing market. Loan defaults result in a decrease in interest income and may require the establishment of or an increase in loan loss reserves. Furthermore, the decrease in interest income resulting from a loan default or defaults may be for a prolonged period of time as we seek to recover, primarily through legal proceedings, the outstanding principal balance, accrued interest and default interest due on a defaulted loan plus the legal costs incurred in pursuing our legal remedies. No assurance can be given that these conditions will not result in our need to increase loan loss reserves or charge-off a higher percentage of loans, thereby reducing net income. Furthermore, because our subsidiary banks rely more heavily on loans secured by real estate, a decrease in real estate values could cause higher loan losses and require higher loan loss provisions.
Our success significantly depends upon the growth in population, income levels, deposits and housing starts in our market areas. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may be negatively impacted. In addition, the economies of the communities in which we operate are substantially dependent on the growth of the economy in metropolitan Atlanta. To the extent that economic conditions in metropolitan Atlanta are unfavorable or do not continue to grow as projected, the economies in our market areas would be adversely affected. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our market areas if they do occur.
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 90% of our total loans were secured by real estate. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in our market areas could adversely affect the value of our assets, our revenues, results of operations and financial condition.
Conditions such as inflation, recession, unemployment, high interest rates, short money supply, scarce natural resources, international disorders, terrorism and other factors beyond our control may adversely affect our profitability. Because the majority of our borrowers are individuals and businesses located and doing business in Hall, Polk, Paulding, Cobb, Carroll, Bartow, Baldwin, Putnam, Houston, Clarke, Gwinnett, Dawson, Forsyth, Fulton and Lumpkin Counties, Georgia, our success will depend significantly upon the economic conditions in those and the surrounding counties. Unfavorable economic conditions in those and the surrounding counties may result in, among other things, a deterioration in credit quality or a reduced demand for credit and may harm the financial stability of our customers. Due to our limited market areas, these negative conditions may have a more noticeable effect on us than would be experienced by a larger institution more able to spread these risks of unfavorable local economic conditions across a large number of diversified economies.
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 rapid growth over the past few years, including our growth through acquisitions, may distort some of our historical financial ratios and statistics. Our strong performance during this time period was, in part, the result of an extremely favorable residential mortgage refinancing market and our successful integration of acquisitions which occurred during that period. In the future, we may not have the benefit of a favorable interest rate environment, a strong residential mortgage market, or the ability to find suitable candidates for acquisition. 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 success has been and continues to be largely dependent upon the services of Richard A. Hunt, our President and Chief Executive Officer, other members of our senior management team, including our senior loan officers, and our board of directors, many of whom have significant relationships with our customers. Our continued success will depend, to a significant extent, on the continued service of these key personnel. The prolonged unavailability or the unexpected loss of any of them could have an adverse effect on our financial condition and results of operations. We cannot be assured of the continued service of our senior management team or our board of directors with us.
The banking business is highly competitive, and we experience competition in each of our market areas 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 such as Bank of America, BB&T, Regions Bank, SunTrust, Synovus and Wachovia that operate offices in our 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 market areas, 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 attempt to compete by concentrating our marketing efforts in our market areas with local advertisements, personal contacts, and greater flexibility and responsiveness in working with local customers, we can give no assurance that this strategy will be successful.
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. Many of these regulations are intended to protect depositors, the public and the FDIC rather than shareholders.
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 earnings. In addition, the Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission and Nasdaq that are applicable to us, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices, including the costs of completing our audit and maintaining our internal controls.
We face risks arising from any supervisory actions taken by our regulators, and HomeTown Bank of Villa Rica is currently operating under a Cease and Desist Order from the FDIC.
On November 26, 2007, our subsidiary bank HomeTown Bank of Villa Rica executed and entered into a Stipulation and Consent Agreement with the FDIC and the Georgia Department of Banking and Finance agreeing to the issuance of a Cease and Desist Order (the Order). The Order became effective on December 6, 2007 and addressed the supervision and education of HTBs board of directors, management team, equity capital and reserves in relation to the volume and quality of assets held, level of poor quality loans, allowance for loan and lease losses, lending and collection practices, routine and internal controls policies, and alleged violations of certain laws, regulations and FDIC statements of
policy. Under the terms of the Order, HTB has agreed to take a number of affirmative steps, including, among other things, increasing the participation of the board of directors in its affairs; assessing the qualifications and experience of management to comply with the requirements of the Order; achieving and maintaining a Tier 1 Capital ratio equal to or exceeding 7.0% of HTBs total assets; in addition to a fully funded loan reserve, developing a plan to meet the minimum risk-based capital requirements as described in the FDIC Statement of Policy on Risk-Based Capital; eliminating certain assets classified as loss, doubtful or substandard; performing a risk segmentation analysis and reducing concentrations in the loan portfolio; establishing effective systems for loan review and grading, loan documentation, and allowance for loan and lease losses; and establishing a written strategic business plan.
Over the past few months, HTB has begun the implementation of many of the items contained in the Order, and many of the conditions imposed by the Order are extensions of these actions, but we may not be able to cause HTB to adequately comply with the order. Failure by us to comply with the terms of this order or other applicable laws and regulations could have a material adverse effect on our business, financial condition or operating results. In addition, other of our subsidiary banks may be subject to possible regulatory action in the future.
Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital. The ability of our bank subsidiaries to pay dividends to us is limited by their obligations to maintain sufficient capital and by other general restrictions on their dividends that are applicable to our regulated bank subsidiaries. If these regulatory requirements are not met, our subsidiary banks will not be able to pay dividends to us, and we may be unable to pay dividends on our common stock.
We have reported that our internal control over financial reporting is not effective, and any unidentified material weaknesses could cause us to fail to meet our SEC and other reporting requirements.
In connection with an evaluation of the effectiveness of our internal control over financial reporting for the year ended December 31, 2007, management determined the Companys internal control over financial reporting was not effective, as demonstrated by a material weakness in the controls over loan approval procedures related to loan proceeds disbursement on construction and development loans, and problem loan identification and reporting. We can provide no assurances that these material weaknesses have been fully corrected or that additional material weaknesses or significant deficiencies in our internal control over financial reporting will not be discovered in the future. If we fail to remediate any such material weaknesses, our operating results or client relationships could be adversely affected or we may fail to meet our SEC reporting requirements or our financial statements may contain a material misstatement.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives or of preventing fraud due to its inherent limitations, regardless of how well designed or implemented. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Because of these limitations, there is a risk that material misstatements or instances of fraud may not be prevented or detected on a timely basis by our internal control over financial reporting.
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
The Companys corporate headquarters are located at 500 Jesse Jewell Parkway, S.E., Gainesville, Georgia, in the main office of the lead bank, Gainesville Bank & Trust. The building is jointly owned by Gainesville Bank & Trust and a related party. The Company also has an operations center located at 1480 Jesse Jewell Parkway, Gainesville, Georgia. Data Processing, Deposit Operations, Human Resources, Accounting and Audit are located in this facility. The Companys seven subsidiary banks conduct business from facilities the majority of which are owned by the respective banks, all of which are in good state of repair and appropriately designed for use as banking facilities. The subsidiaries provide services from 35 locations, of which 21 locations are owned and 14 are leased. In the opinion of management, all properties including improvements and furnishings are adequately insured.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to, nor is any of our property the subject of, any material pending legal proceedings, other than ordinary routine proceedings incidental to our business, nor to the knowledge of the management are any such proceedings contemplated or threatened against us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
(a) Our common stock is quoted on the Nasdaq Global Select Market under the symbol GBTB. The following table sets forth the high and low closing prices for our common stock as reported by the Nasdaq Global Select Market and the cash dividends declared per share of our common stock for the indicated periods.
(b) As of February 22, 2008, there were approximately 3,789 holders of record of our common stock.
(c) Dividends are paid at the discretion of our board of directors. We have historically paid dividends on a quarterly basis as set forth in the table above. We intend to continue paying cash dividends, but the amount and frequency of cash dividends, if any, will be determined by our board of directors after consideration of earnings, capital requirements and our financial condition and will depend on cash dividends paid to us by our subsidiary banks. Dividends from our subsidiary banks are our primary source of funds for the payment of dividends to our shareholders, and there are various legal and regulatory limits on the extent to which our subsidiary banks may pay dividends or otherwise supply funds to us. See Supervision and Regulation section discussed earlier in this Report. In addition, federal and state agencies have the authority to prevent us from paying a dividend to our shareholders. Thus, while we intend to continue paying dividends, we can make no assurances that we will continue to pay dividends or that we will not reduce the amount of dividends paid in the future.
(d) During the fourth quarter of 2007, the Company did not repurchase any of its equity securities.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected historical consolidated financial information for us and our subsidiaries and is derived from the consolidated financial statements and related notes included in this Annual Report on Form 10-K. This information is only a summary and should be read in conjunction with our historical financial statements and related notes. The year ended December 31, 2006 includes the acquisition of Mountain Bancshares, Inc. which was completed on May 1, 2006 and accounted for as a purchase. See Managements Discussion and Analysis of Financial Condition and Results of Operations for further discussion on this and our prior acquisitions.
(1) Net loans include the outstanding principal balances of loans less unearned income, net deferred fees and the allowance for loan losses.
(2) Earning assets include interest-bearing deposits in banks, federal funds sold, securities available for sale, restricted equity securities, loans net of unearned income, less unrealized gains (losses) on securities and nonaccrual loans.
(3) The increase in stockholders equity for the years ended December 31, 2006 and 2005 related to business combinations was 15% and 12%, respectively. Net income less dividends declared represented 2% and 4% of the total increase for the same periods, respectively. The net loss plus dividends declared represented 8% of the total decrease for the year ended December 31, 2007.
(4) Nonperforming loans include nonaccrual loans, other impaired loans and loans past due 90 days or more and still accruing interest.
(5) Nonperforming assets include nonperforming loans and foreclosed assets.
GAAP Reconciliation and Management Explanation for Non-GAAP Financial Measures
Certain financial information included in selected consolidated financial data above is determined by methods other than in accordance with GAAP. These non-GAAP financial measures are tangible book value per share, tangible equity to tangible assets, return on average tangible equity, return on average tangible assets, average tangible equity to average tangible assets and earning assets. Our management uses these non-GAAP measures in its analysis of our performance.
· Tangible book value per share is defined as total equity reduced by recorded intangible assets divided by total common shares outstanding. This measure is important to investors interested in changes from period to period in book value per share exclusive of changes in intangible assets. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing total book value while not increasing the tangible assets of the company. For companies such as ours that have engaged in multiple business combinations, purchase accounting can result in the recording of significant amounts of goodwill related to such transactions.
· Tangible equity to tangible assets is defined as total equity reduced by recorded intangible assets divided by total assets reduced by recorded intangible assets. This measure is important to investors interested in the equity to assets ratio exclusive of the effect of changes in intangible assets on equity and total assets.
· Return on average tangible equity is defined as annualized earnings for the period divided by average equity reduced by average goodwill and other intangible assets. Return on average tangible assets is defined as annualized earnings for the period divided by average assets reduced by average goodwill and other intangible assets. We believe these measures are important when measuring the companys performance exclusive of the effects of goodwill and other intangibles recorded in recent acquisitions, and these measures are used by many investors as part of their analysis of the companys performance.
· Average tangible equity to average tangible assets is defined as average total equity reduced by recorded average intangible assets divided by average total assets reduced by recorded average intangible assets. This measure is important to many investors that are interested in the equity to asset ratio exclusive of the effect of changes in average intangible assets on average equity and average total assets.
· Earning assets is defined as total assets plus the allowance for loan losses less cash and due from banks, premises and equipment, goodwill and intangible assets, other assets, unrealized gains (losses) on securities and nonaccrual loans. This measure is important to many investors because for financial institutions, their net interest income is directly related to their level of earning assets.
These disclosures should not be viewed as a substitute for results determined in accordance with GAAP, and are not necessarily comparable to non-GAAP performance measures which may be presented by other companies. The following reconciliation table provides a more detailed analysis of these non-GAAP performance measures.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion reviews our results of operations and assesses our financial condition. The purpose of this discussion is to focus on information about our financial condition and results of operations which is not otherwise apparent from the consolidated financial statements included or incorporated by reference in this Report. Reference should be made to those statements and the selected financial data presented elsewhere or incorporated by reference in this Report for an understanding of the following discussion and analysis. Historical results of operations and any trends which may appear are not necessarily indicative of the results to be expected in future years.
The Company, headquartered in Gainesville, Georgia, consists of a network of community banks in growth areas of Georgia with approximately $1.9 billion in total consolidated assets as of December 31, 2007. We believe that maintaining autonomy within our subsidiary banks serves the unique needs of each community we serve. We focus on strong asset quality and sound management teams and use economies of scale to enhance our profitability. Our results reflect a combination of internal and acquisition growth. Prior to 2006, we had completed seven acquisitions. On May 1, 2006, we completed the acquisition of Mountain Bancshares, Inc. and its banking subsidiary Mountain State Bank. We continue to build infrastructure to support our growth.
As a bank holding company, our results of operations are almost entirely dependent on the results of operations of our subsidiary banks. The following table sets forth our subsidiary banks and selected data related to each bank as of December 31, 2007:
We derive the majority of our income from interest received on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Approximately 91% of our total deposits are interest-bearing. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread.
There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We maintain this allowance by charging a provision for loan losses against our operating earnings for each period. We have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses. The financial performance for the year ended December 31, 2007 was impacted by the additional loan loss provisions taken in the fourth quarter of 2007 as well as the goodwill impairment at one of our affiliates. Please see Results of Operations Asset Quality for further discussion concerning the additional loan loss provision and goodwill impairment.
In addition to earning interest on our loans and investments, we earn income through fees and other charges to our clients. We have also included a discussion of the various components of this noninterest income, as well as of our noninterest expense.
The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the financial statements accompanying or incorporated by reference in this report. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included and incorporated by reference in this report.
We measure and monitor the following factors as key indicators of our financial performance:
· Net income
· Earnings per share
· Loan and deposit growth
· Credit quality
Below is a summary of the performance of these key indicators for the year ended December 31, 2007 as compared to the year ended December 31, 2006:
· Net loss of $12.5 million compared to net income of $9.5 million
· Diluted earnings per share of $(0.87) compared to $0.68
· Net interest margin of 3.75% compared to 4.34%
· Loan growth of $3.0 million or 2.0%
· Deposit growth of $15.3 million or 1.0%
· Return on average assets of (0.64)% compared to 0.54%
· Return on average equity of (5.32)% compared to 4.27%
· Nonperfoming assets ratio of 8.34% compared to 1.59%
· Net charge-off ratio of 1.38% compared to 0.36%
Effect of Economic Trends
During the three years ended December 31, 2004, our rates on both short-term or variable rate interest-earning assets and short-term or variable rate interest-bearing liabilities declined primarily as a result of the actions taken by the Federal Reserve, however during 2005 and continuing through 2006, both these rates increased. Then during 2007, these rates began to decline again due to actions taken by the Federal Reserve.
During most of 2001 and during 2002, the United States experienced an economic decline. During this period, the economy was affected by lower returns of the stock markets. Economic data led the Federal Reserve to begin an aggressive program of reducing rates that moved the federal funds rate down 11 times during 2001 for a total reduction of 475 basis points. During the fourth quarter of 2002 and the first quarter of 2003, the Federal Reserve reduced the federal funds rate down an additional 75 basis points, bringing the federal funds rate to its lowest level in 40 years.
Despite sharply lower short-term rates, stimulus to the economy during 2003 was muted and consumer demand and business investment activity remained weak. During all of 2003 and substantially all of 2004, the financial markets operated under historically low interest rates. As a result of these unusual conditions, Congress passed an economic stimulus plan in 2003. During 2004, many economists believed the economy began to show signs of strengthening, and the Federal Reserve increased the short-term interest rate by 100 basis points during the second, third and fourth quarters of 2004 and by 200 basis points during 2005. In 2006, the short-term interest rate continued to increase by 50 basis points during the first quarter and another 50 basis points during the second quarter of 2006. In late 2007, due to concerns relating to the overall economy, the Federal Reserve decreased rates in the third quarter by 50 basis points and an additional 50 basis points in the fourth quarter. The Federal Reserve decreased the short-term interest rate by 125 basis points in January 2008. Many economists believe the Federal Reserve will continue to lower rates during 2008. No assurance can be given that the Federal Reserve will actually lower interest rates or that the results we anticipate will actually occur.
The specific economic and credit risks associated with our loan portfolio, especially the real estate portfolio, include, but are not limited to, a general downturn in the economy which could affect unemployment rates in our market areas, general real estate market deterioration, interest rate fluctuations, deteriorated collateral, title defects, inaccurate appraisals, and financial deterioration of borrowers. Construction and development lending can also present other specific risks to the lender such as whether developers can find builders to buy lots for home construction, whether the builders can obtain financing for the construction, whether the builders can sell the home to a buyer, and whether the buyer can obtain permanent financing. Currently, real estate values and employment trends in our market areas have shown signs of weakness due to the decline in the residential housing market. The general economy and loan demand declined slightly during 2001 and continued to decline throughout 2002. In 2003, the economy began to show signs of improvement which continued through 2004, 2005 and 2006. However during 2007, there was significant deterioration in the residential real estate market, which significantly impacted our loan growth and credit quality.
Critical Accounting Policies
We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are reviewed and discussed periodically by our Audit Committee and are described in the notes to our consolidated financial statements as of December 31, 2007 included in this report. Certain accounting policies require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.
Allowance for Loan Losses. We believe that our determination of the allowance for loan losses is our most significant judgment and estimate used in the preparation of our consolidated financial statements. The allowance for loan losses is an amount that management believes will be adequate to absorb estimated losses in the loan portfolio. The calculation is an estimate of the amount of loss in the loan portfolios of our subsidiary banks. The allowance for loan losses is evaluated on a regular basis by management and is based upon managements periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. In addition, regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses, and may require us to make additions to the allowance based on their judgment about information available to them at the time of their examinations.
The company uses an 8 point rating system for its loans. Ratings of 1 to 4 are considered pass ratings, 5 is special mention, 6 is substandard, 7 is doubtful, and 8 is loss. The originating loan officer rates all loans based on this system, and the ratings are adjusted as needed to reflect the current status of the loan. The loan officers are trained to rate loans in a timely and accurate manner based on current information. These ratings are reviewed regularly by the loan committee of the respective bank subsidiary, an outside independent loan review firm and by the applicable regulator for accuracy.
A specific allowance will be maintained for all loans rated 1- 5 and for all homogeneous loan pools such as consumer, credit card and residential mortgage. Management will develop a range of expected losses for each risk grade and for each loan pool. This range of losses will be managements best estimate based on actual loss experience, industry loss experience, loan portfolio trends and characteristics of the markets it serves. On a quarterly basis management will evaluate each of the loan categories and determine the expected loss levels from the higher of the range previously established or the historical loss history calculation. The range of expected losses shown below will be used until management determines changes are needed.
All loans rated 6, 7 and 8 as well as any other impaired loan of a significant amount will be individually analyzed and a specific reserve assigned. This analysis will include information from the Problem Asset Review Committee, a subcommittee of the Companys Loan Committee, which meets quarterly and reviews credit relationships of one million and above and rated 5-8. Management, considering current information and events regarding a borrowers ability to repay its obligations, considers a loan to be impaired when the ultimate collection of all amounts due, according to the contractual terms of the loan agreement, is in doubt. When a loan is considered to be impaired, the amount of the impairment is measured based on the present value of expected future cash flows discounted at the loans effective interest rate. If the loan is collateral dependent, the fair value of the collateral less estimated selling costs is used to determine the amount of impairment. Impairment losses are included in the allowance for loan losses through a charge to the provision for loan losses. Traditionally, a majority of our impaired loans have been collateral dependent. The allowance for loan losses on these loans is determined based on fair value estimates (net of selling costs) of the respective collateral. The actual losses on these loans could differ significantly if the fair value of the collateral is different from the estimates used in determining the allocated allowance. Traditionally most of our collateral dependent impaired loans have been secured by real estate. The fair value of these real estate properties is generally determined based on appraisals performed by a certified or licensed appraiser. Management also considers other factors or recent developments which could result in adjustments to the collateral value estimates indicated in the appraisals. These estimates will be made in accordance with FASB 114.
The remainder of the balance in the reserve for loan losses is unallocated. The unallocated reserve represents managements current estimate of the probable losses inherent in the loan portfolio that have not been fully provided for through the specific reserve calculations. Factors considered in determining the unallocated reserve are overall economic conditions, the rapid rise of real estate prices over the past three years in our markets, the recent slowdown in real estate activity, the number of new and relatively inexperienced banks and bankers entering our markets and offering aggressive terms and pricing, our concentration in commercial and consumer real estate and the experience and historic performance of our lenders.
Goodwill. Our growth over the past several years has been enhanced significantly by mergers and acquisitions. Prior to July 2001, all of our acquisitions were accounted for using the pooling-of-interests business combination method of accounting. Effective July 1, 2001, we adopted SFAS No. 141, Business Combinations, which allows only the use of the purchase method of accounting. For purchase acquisitions, we are required to record the assets acquired, including identified intangible assets, and liabilities assumed at their fair value, which in many instances involves estimates based
on third party valuations, such as appraisals, or 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 net assets acquired compared to the carrying value of goodwill. In July 2007, the required impairment testing of goodwill was performed and no impairment existed as of the valuation date, as the fair value of our net assets exceeded their carrying value. Due to the deterioration in the residential real estate market, an additional impairment test was performed as of December 31, 2007 and it was determined there was impairment in the carrying value of our goodwill balances at one of our affiliates and we recorded a charge to our earnings.
Effect of Recent Business Acquisitions
On May 1, 2006, the Company completed the acquisition of Mountain Bancshares, Inc. the parent company of Mountain State Bank, which is headquartered in Dawsonville, Dawson County, Georgia, and has branches in Dawson, Forsyth, Fulton and Lumpkin Counties. Mountain State Bank became a wholly owned subsidiary of the Company. The Company issued 1,088,924 shares of its capital stock and approximately $10.3 million in cash in exchange for all of the issued and outstanding common shares of Mountain Bancshares, Inc. The acquisition was accounted for as a purchase resulting in estimated goodwill of approximately $26.0 million. Mountain State Banks results of operations from May 1, 2006 are included in the consolidated results of operations for the year ended December 31, 2006. The results of operations for the years ended December 31, 2005 and 2004 do not include the results of operations of Mountain Bancshares, Inc.
On March 1, 2005, the Company completed the acquisition of FNBG Bancshares, Inc. the parent company of First National Bank of Gwinnett in Duluth, Gwinnett County, Georgia, which resulted in First National Bank of Gwinnett becoming a wholly owned subsidiary of the Company. The Company issued 845,128 shares of its capital stock and approximately $3.8 million in cash in exchange for all of the issued and outstanding common shares of FNBG Bancshares, Inc. The acquisition was accounted for as a purchase resulting in estimated goodwill of approximately $16.4 million. First National Bank of Gwinnetts results of operations from March 1, 2005, are included in the consolidated results of operations for the year ended December 31, 2005. The results of operations for the year ended December 31, 2004 does not include the results of operations of FNBG Bancshares, Inc.
Total Assets. Our total assets increased $38.6 million or 2.0% during 2007 compared to $316.3 million or 20.0% during 2006. The increase in 2007 consists primarily of an increase in total loans of $3.0 million or 2.0%, and an increase in other real estate and repossessions of $35.7 million. Asset growth and credit quality were negatively impacted by the decline in the residential real estate market. For the year ended December 31, 2006 as compared with the year ended December 31, 2005, the acquisition of Mountain Bancshares, Inc. accounted for approximately $165.5 million of the increase in total assets. The competition for deposits plays an important role in our overall growth.
Total Loans. Our primary focus is to maximize earnings through lending activities. Any excess funds are invested according to our investment policy. Total loans increased 2.0% or $3.0 million for the year ended December 31, 2007. This increase is compared to an increase of $266.3 million or 21.6% during 2006. Exclusive of the acquisition of Mountain Bancshares, Inc., which represented $107.5 million of the increase in 2006, total loans increased $158.8 million or 12.9%. As of December 31, 2007 and 2006, our loan-to-deposit ratio was 100.4% and 101.2%, respectively. At December 31, 2007 and 2006, we had total outstanding borrowings of $209.6 million and $168.4 million, respectively. These funds have been used to fund loan growth. The utilization of borrowings to fund loan growth enables us to maintain a higher loan to deposit ratio and maintain an adequate liquidity ratio. Our loan-to-funds ratio was 88.0% and 90.8% at December 31, 2007 and 2006, respectively.
Total Deposits. During 2007, total deposits grew by $15.3 million or 1.0% compared to an increase of $283.1 million or 23.7% in 2006, including the acquisition of Mountain Bancshares, Inc., which accounted for $124.0 million of this increase.
Results of OperationsFor the Years Ended December 31, 2007, 2006 and 2005
Net Interest Income and Earning Assets. During 2007 and 2006, we continued to experience moderate internal growth in interest-earning and total assets which was funded by increases in deposits and the retention of net profits. During 2006, we experienced additional growth through the acquisition of Mountain Bancshares, Inc. as explained above. We recorded a net loss of $12.5 million for the year ended December 31, 2007 and net income of $9.5 million and $12.0 million for the years ended December 31, 2006 and 2005, respectively.
Our profitability is determined by our ability to effectively manage interest income and expense, to minimize loan and security losses, to generate noninterest income, and to control operating expenses. Because interest rates are determined by market forces and economic conditions beyond our control, our ability to generate net interest income depends upon our ability to obtain an adequate net interest spread between the rate earned on interest-earning assets and the rate paid on interest-bearing liabilities. The net yield on average interest-earning assets decreased to 3.75% for the year ended December 31, 2007 from 4.34% for the year ended December 31, 2006. This decrease is primarily attributable to decreases in interest rates by the Federal Reserve in 2007. In 2007, the average yield on interest-earning assets increased to 7.95% from 7.93% in 2006 and the average yield on interest-bearing liabilities increased to 4.68% in 2007 from 4.20% in 2006. The overall change in the interest rate spread from 2006 to 2007 was a decrease of 46 basis points. The decrease in the net interest spread is a result of increases in time deposit volume at an average rate 60 basis points above the average in 2006, increases in interest-bearing demand and savings volume at an average rate 21 basis points above the 2006 average as well as increases in borrowings volume at an average rate 22 basis points above the average in 2006. Total average interest-earning assets increased by $133.9 million, to $1,732.6 million at December 31, 2007 as compared to 2006 and average interest-bearing liabilities increased by $183.5 million, to $1,551.2 million for the same period. We continue to experience slight growth in our portfolios while maintaining our competitive pricing.
The net yield on average interest-earning assets increased by 8 basis points to 4.34% from 4.26% for the year ended December 31, 2006 as compared to 2005. The increased net yield in 2006 was primarily attributable to increases in loan volume in addition to increases in interest rates.
Net interest income decreased by $4.7 million to $64.5 million in 2007, compared to an increase of $12.2 million in 2006. The decrease in 2007 reflects the increased level of nonaccrual loans as well as the increase in interest-bearing liabilities along with increased rates, which was only partially offset by the increase in interest-earning assets with no increase in rates from the prior year. The increase in 2006 reflects the increase in interest-earning assets during 2006 as compared to 2005. The change in net interest income is primarily the result of minimal increases in net volume versus increased changes in net interest rates. These variances include the impact of the acquisition of Mountain Bancshares, Inc. in 2006.
Other Income. Other income increased during 2007 by $851,000 compared to a decrease of $1.1 million in 2006. For the year ended December 31, 2007, service charges on deposit accounts increased by $1,041,000. This increase was partially offset by a decrease in mortgage origination fees of $347,000. For the year ended December 31, 2006, service charges on deposit accounts decreased by $135,000, other service charges and fees decreased by $151,000 and securities transactions, net decreased by $569,000. These decreases were partially offset by an increase in mortgage origination fees of $398,000.
Other Expense. Other expense increased $17.9 million for the year ended December 31, 2007. Increases in other operating expenses represented the most significant portion of the increase for 2007, which increased by $15.0 million. This increase is primarily related to the impairment of goodwill and core deposit intangible as of December 31, 2007 of $10.0 million. Also included in this category is the provision for other real estate losses taken in 2007 of $1.7 million. Salaries and employee benefits increased for 2007 as compared to 2006 by $2.4 million partially due to the inclusion of Mountain Bancshares, Inc. for a full year in 2007 compared to eight months in 2006, along with increases in profit sharing contributions, health insurance costs, incentive compensation and normal salary increases.
Other expense increased $5.3 million for the year ended December 31, 2006. Increases in salaries and employee benefits represent the most significant portion of this increase, which increased by $3.7 million. The number of full-time equivalent employees increased by 34 employees in May 2006 due to the acquisition of Mountain Bancshares, Inc. Other operating expenses increased by $882,000 for the year ended December 31, 2006. The increase in other operating expenses included increases in marketing and public relations of $124,000, ATM and data processing expense of $82,000, supplies, postage and telephone expense of $68,000 and a loss of $306,000 recorded in the fourth quarter of 2005 on the sale of Community Loan Company.
Income Tax Expense. Income tax expense decreased by $7.7 million to a tax benefit of $3.4 million in 2007 from tax expense of $4.3 million in 2006. The decrease in 2007 was attributable to decreased profits primarily related to additional loan loss provisions taken in 2007 along with provisions taken for other real estate losses as discussed below. The effective tax rate for year ended December 31, 2007 was 21.6%, compared to 31.0% for 2006.
Income tax expense decreased by $1.6 million to $4.3 million in 2006 from $5.9 million in 2005. The decrease in 2006 was attributable to decreased profits primarily related to the additional loan loss provision taken in the fourth quarter of 2006. The effective tax rate for the year ended December 31, 2006 was 31.0%, compared to 32.9% for 2005.
Net Income. Net income decreased by $22.0 million for the year ended December 31, 2007 when compared to 2006. This decrease is primarily related to the expense recorded for the impairment in the goodwill and core deposit intangible carrying balances as of December 31, 2007 in addition to increased loan loss provisions taken in 2007 along with provisions taken for other real estate losses as discussed below. The decrease in net income for the year ended December 31, 2006 was $2.5 million when compared to 2005. This decrease is primarily related to the additional loan loss provision taken in the fourth quarter of 2006.
Asset Quality. The provision for loan losses was $23.7 million during 2007, compared to $15.7 million in 2006. This increase was due to additional loan loss provisions needed because of deterioration in the real estate market during the last half of 2007. The increased provision reflects the decline in the residential real estate market and the elevated level of chargeoffs we experienced during 2007. The provision for loan losses is the charge to operations which management believes is necessary to fund the allowance for loan losses. This provision is based on managements periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any underlying collateral and prevailing economic conditions. Our evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. In addition, regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses, and may require us to make additions to the allowance based on their judgment about information available to them at the time of their examinations. Loans acquired in business acquisitions were acquired at their estimated fair value, including an adequate allowance for loan losses. See also our discussion of the loan loss allowance in the Critical Accounting Policies section included in this report.
The following table presents details of the provision for loan losses, nonaccrual loans and related categories. The increase in nonaccrual loans is related to our exposure to the declining residential real estate market that has affected all of the markets in which we operate. As shown in Summary of Loan Loss Experience below, the consumer related charge-offs consist of many smaller balance loans while the real estate related charge-offs consist of several larger balance loans. Real estate loans are normally secured by one to four family residences or other real estate with values exceeding the original loan balance, however, due to the downturn in the residential real estate market and the corresponding decline in real estate values, we experienced substantial net chargeoffs in the latter half of 2007. Consumer loans, however, may be secured by consumer goods and automobiles, or may be unsecured, and therefore subject to greater loss in the event of charge-off. During a recession, losses are more likely and the risk of loss is greater in the consumer portfolio. The allowance for loan losses as a percentage of nonperforming loans at December 31, 2007 was 22.56%, which was down from 96.50% at December 31, 2006. This decrease is due to nonaccrual loans increasing to $70.6 million at December 31, 2007 from $14.8 million at December 31, 2006 as well as the increase in the provision for loan losses in 2007 to $23.7 million compared to $15.7 million for 2006. Based on managements evaluations, management believes the allowance for loan losses is adequate to absorb potential losses on existing loans.
Effects of Inflation
The impact of inflation on banks differs from its impact on non-financial institutions. Banks, as financial intermediaries, have assets which are primarily monetary in nature and which tend to fluctuate in concert with inflation. A bank can reduce the impact of inflation if it can manage its interest rate sensitivity gap. This gap represents the difference between rate sensitive assets and rate sensitive liabilities. Through the Investment Committee of our holding companys board of directors, we attempt to structure the assets and liabilities and manage the rate sensitivity gap of each subsidiary bank, thereby seeking to minimize the potential effects of inflation. For information on the management of our interest rate sensitive assets and liabilities, see Asset/Liability Management above.
Off-Balance Sheet Arrangements
Our financial statements do not reflect various commitments and contingent liabilities that arise in the normal course of business. These off-balance sheet financial instruments include commitments to extend credit, standby letters of credit and credit card commitments. Such financial instruments are included in the financial statements when funds are distributed or the instruments become payable. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and credit card commitments is represented by the contractual amount of those instruments. We use the same credit policies in making such commitments as we do for on-balance sheet instruments. Although these amounts do not necessarily represent future cash requirements, a summary of our commitments as of December 31, 2007 and December 31, 2006 are as follows:
Liquidity and Capital Resources
Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. We seek to meet liquidity requirements primarily through management of short-term investments, monthly amortizing loans, maturing single payment loans, and maturities of securities and prepayments. Also, we maintain relationships with correspondent banks which could provide funds on short notice. As of December 31, 2007, we had amounts borrowed under federal funds purchase lines and securities sold under repurchase agreements of $62.4 million compared to $41.1 million as of December 31, 2006. These borrowings typically mature within one to four business days.
The following table sets forth certain information about contractual cash obligations as of December 31, 2007.
Our operating leases represent obligations with maturities of five years or less, with the exception of one lease entered into in 2005 which has a maturity of 25 years. Many of the operating leases have thirty-day cancellation provisions.
Our liquidity and capital resources are monitored on a periodic basis by management and state and federal regulatory authorities. At December 31, 2007, our liquidity ratio was 11.05%. Our liquidity ratio is measured by the ratio of net cash, federal funds sold and securities to net deposits and short-term liabilities. In the event our subsidiary banks need to generate additional liquidity, funding plans would be implemented as outlined in the liquidity policy of the banks. Our banks have lines of credit available to meet any unforeseen liquidity needs. Also, our banks have relationships with the Federal Home Loan Bank of Atlanta, which provides funding for loan growth on an as needed basis. Management reviews liquidity on a periodic basis to monitor and adjust liquidity as necessary. Management has the ability to adjust liquidity by
selling securities available for sale, selling participations in loans and accessing available funds through various borrowing arrangements. At December 31, 2007, we had available borrowing capacity totaling approximately $230.9 million through various borrowing arrangements and available lines of credit. We believe our short-term investments and available borrowing arrangements are adequate to cover any reasonably anticipated immediate need for funds.
As of December 31, 2007, the Company and its subsidiary banks were considered to be well-capitalized as defined in the FDICIA and based on regulatory minimum capital requirements. The Company and its subsidiary banks capital ratios as of December 31, 2007 are presented in the following table:
Management is not aware of any known trends, events or uncertainties, other than those discussed above, that will have or are reasonably likely to have a material effect on our liquidity, capital resources, or operations. Management is also not aware of any current recommendations by the regulatory authorities which, if they were implemented, would have such an effect.
Our subsidiary banks are subject to certain restrictions on the amount of dividends that may be declared without prior regulatory approval. At December 31, 2007, approximately $9.1 million of retained earnings at our subsidiary banks were available for dividend declaration without regulatory approval.
Selected Financial Information and Statistical Data
The tables and schedules on the following pages set forth certain financial information and statistical data with respect to: the distribution of assets, liabilities and stockholders equity; interest rates and interest differentials; interest rate sensitivity gap ratios; our securities portfolio; our loan portfolio, including types of loans, maturities and sensitivities to changes in interest rates and information on nonperforming loans; summary of the loan loss experience and allowance for loan losses; types of deposits; and the return on equity and assets.
Distribution of Assets, Liabilities and Stockholders Equity; Interest Rates and Interest Differentials
The following table sets forth the amount of our interest income or interest expense for each category of interest-earning assets and interest-bearing liabilities and the average interest yield/rate for total interest-earning assets and total interest-bearing liabilities, net interest spread and net yield on average interest-earning assets.