Security Bank 10-K 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2004
For the transition period from to
Commission File No. 000-23261
SECURITY BANK CORPORATION
(Exact Name of Registrant Specified in Its Charter)
Issuers Telephone Number, Including Area Code
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $1.00 PAR VALUE
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 past 90 days. Yes x No ¨
Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K in this form, and no disclosure will 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. ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 126-2). Yes x No ¨
State the aggregate market value of the voting stock held by nonaffiliates computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of June 30, 2004: $169,269,418 based on stock price of $34.60.
State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date: 5,820,343 shares of $1.00 par value common stock as of February 10, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the information required by Part III of this Annual Report are incorporated by reference from the Registrants definitive Proxy Statement to be filed with Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Annual Report.
Unless indicated otherwise, reference to we, us, our, SBKC or the Company refer to Security Bank Corporation and its consolidated subsidiaries, Security Bank of Bibb County, Security Bank of Houston County and Security Bank of Jones County (collectively, the Banks).
Overview. We are a multi-bank holding company headquartered in Macon, the third largest city in Georgia outside of metropolitan Atlanta. Since our formation on February 10, 1994, we have made several strategic acquisitions and have expanded our market presence throughout Middle Georgia, as well as toward the southeastern coastal region of Georgia. In June 2003, we changed our name from SNB Bancshares, Inc. to Security Bank Corporation and changed our stock symbol on the Nasdaq National Market to SBKC. We changed our name to Security Bank Corporation to leverage our Security Bank branding, which is well-recognized in our core markets.
We provide a wide variety of community banking services through 24 banking and mortgage production offices, with a substantial portion of our business being drawn from Bibb, Houston and Jones Counties in the State of Georgia. At December 31, 2004, we had total assets of $1.06 billion, total deposits of $842.6 million and total shareholders equity of $106.7 million.
Our Subsidiary Banks. Substantially all of our business is conducted through our three subsidiary banks:
Our subsidiary banks each operate autonomously under the corporate umbrella of Security Bank Corporation. As a result, each bank has its own board of directors and management comprised of persons known in the local community in which each bank operates. We provide significant assistance and oversight, however, to our subsidiary banks in areas such as budgeting, marketing, human resource management, credit administration, operations and funding. This allows us to maintain efficient centralized reporting and policies while maintaining local decision-making capabilities.
Fairfield Financial Services, Inc. We also operate Fairfield Financial Services, Inc., a subsidiary of Security Bank of Bibb County. Fairfield Financial is a traditional residential mortgage originator and interim real estate development lender with a number of production locations throughout Georgia, including offices in Macon, Butler, Columbus, Gray, Warner Robins, Richmond Hill, Rincon, Fayetteville and St. Simons Island.
Our 2000 acquisition of Fairfield has created tremendous synergies for our core banking business, due primarily to our ability to efficiently expand Fairfield Financials presence into new market areas and build on its reputation and name recognition throughout the State of Georgia. During 2004, Fairfield Financial closed over $197.4 million in residential mortgages, making it one of the largest residential mortgage originators in Middle Georgia. For the year ended December 31, 2004, Fairfield Financial posted approximately $2.8 million in net income. Approximately 31% of Fairfield Financials 2004 gross revenue was a product of its traditional residential mortgage origination business, with the remaining 69% being derived from its interim real estate and real estate development lending activities. See Managements Discussion and Analysis of Financial Condition and Results of Operations.
Our Market Area and Competitive Position
Our primary market area is located in the geographic center of the State of Georgia approximately 75 miles south of Atlanta and is primarily comprised of Bibb, Houston and Jones Counties. We refer to this market area as Middle Georgia, and we are the largest independent, publicly traded bank holding company based in our primary market. Within this three-county area, we operate 13 of our 14 commercial banking offices. As a result, a majority of our revenue is derived from our business activities in and around these counties.
We believe our existing markets are attractive and have stable demographic trends. Our core markets are home to a diverse pool of businesses and industries, as well as an established consumer base. Large employers in Middle Georgia, such as GEICO General Insurance Company, YKK USA, Inc., GE Card Services, The Medical Center of Central Georgia, Mercer University and Robins Air Force Base, make Middle Georgia a desirable market for financial institutions. As the largest independent bank holding company based in Middle Georgia, we believe we are well positioned to take advantage of strategic opportunities in our marketplace to grow our core business.
Another factor that we believe is beneficial to the Middle Georgia market is the continued growth of Atlanta. Specifically, the increasing congestion of the Atlanta metropolitan area is a factor that we believe will provide new customers for the Middle Georgia market. Because we are less than one hours drive south from Atlanta, the metropolitan area of Macon, Georgia is beginning to become attractive to people working in Atlanta who do not want to live in Atlantas big city atmosphere. We expect this dynamic to continue as Atlantas urban sprawl increases.
In January 2003, we expanded our market presence by opening a de novo banking office in the city of Brunswick, which is located on the southeastern coast of Georgia in Glynn County. This new banking office provides diversification outside of our Middle Georgia market and allows us to take advantage of opportunities presented by the Glynn County area, which is situated midway between Savannah, Georgia and Jacksonville, Florida. We expect to open a second de novo branch in the Glynn County area within the next 12 months.
In addition, due primarily to the operations of Fairfield Financial Services, we service communities throughout Georgia and in northeastern Florida.
The deposit base for our core markets continues to expand. According to the FDIC, bank and thrift deposits in these markets grew from approximately $3.7 billion in June 2000 to more than $4.9 billion in June 2004, representing a 32.4% increase during that period. At June 30, 2004, we controlled, through our subsidiary banks, approximately $801 million, or 16.2%, of this $4.9 billion deposit base; and, except for the Glynn County market, our subsidiary banks ranked first in market share when compared against other independent community banks with branch locations in these designated markets. As a result, we believe we are the market leader among community banks based in Middle Georgia and continue to gain market share at the expense of our super-regional and national competitors.
We understand that our ultimate success depends upon our ability to consistently execute our core banking business better than our competitors. As a result, our guiding objective is to be the bank of choice for all of our customers banking needs. To accomplish this objective, we strive to deliver unparalleled customer service as we anticipate and respond to the diverse banking needs of our customers. By doing so, we believe we can win repeat business because we emphasize strong commitment to our customers and expect high performance from all of our employees. This corporate culture, which is fostered from the top down, is the foundation for our successful execution of our operating and growth strategies, which aim to maximize long-term shareholder value.
Positioning Ourselves as the Bank of Choice. As a community banking organization operating autonomous community banks with consolidated assets of $1.06 billion, we believe we are well-positioned to continue to draw business from smaller community bank competitors and from super-regional and national banking conglomerates that compete in our primary markets. Because of our size and autonomous operations, we attract customers from other community banks that lack either the ability to adequately satisfy customer demand for banking convenience and product sophistication or the necessary capital levels needed to meet the significant borrowing needs of their customers. We also attract customers from larger institutions due to our focus on customer service and our localized decision-making capabilities.
Operating Strategies. To carry out our guiding objective, our specific operating strategies have been and continue to be:
Our commitment to current technology has also allowed us to consistently lead our competition in offering new products and services to our retail and small business customers. We were the first bank in Middle Georgia to offer imaged statements, and we have continued that leadership position with the first true free checking program and the first overdraft protection program in Middle Georgia. We have recently extended these products into the small business segment and partnered them with an innovative unsecured small business line of credit. Additionally, our internet banking site is more extensive and user-friendly than many of our competitors sites, allowing customers not only to access their account information and pay bills, but also to print copies of checks or other transaction documents from their personal computers at home. These products and services, combined with our 14 branches across our primary market area, provide an impressive combination of service and convenience in Middle Georgia. This combination has accelerated growth in our market share, as evidenced by the increase in our customer base (net of the Security Bank of Jones County acquisition) of over 16.6% in 2004.
Growth Strategies. Our experienced management team, competitive position and focus on relationship banking have enabled us to maintain solid, consistent growth over the last several years. We have achieved compounded annual growth rates in total assets, loans and deposits in excess of 27% from December 31, 1998 to December 31, 2004. We have achieved this growth by expanding existing relationships, by increasing our market share and through expanding our market presence by de novo branching and strategic acquisition. Specifically, our growth strategies are and continue to be:
We believe competition in our market area is based on several factors, including price, convenience, breadth of product lines and customer service. Although our larger competitors may enjoy a competitive advantage in terms of price and offer a wide variety of products and services, we believe our focus on responsive, quality
service to our customers and our ability to offer a sophisticated array of products to customers provides us with a competitive advantage. We compete to a lesser extent with small community banks on the terms described above, but believe our larger capital base and higher lending limits enable us to serve customers seeking to combine the personalized service typical of a community bank with the lending capacity and product offerings typical of a larger bank.
According to FDIC deposit data as of June 30, 2004, in the combined markets of Bibb, Jones and Houston Counties, our three core counties of operation, bank and thrift deposits totaled approximately $3.8 billion. Approximately 63.2% of this deposit base was controlled by super-regional and national institutions, including BB&T, Bank of America, SunTrust Bank, Colonial Bank and CB&T Bank of Middle Georgia (Synovus). Despite the considerable resources that these competitors possess, we have achieved a significant market share in each of these counties. Specifically, as of June 30, 2004, we controlled 20.8% of the combined deposit base for these three counties, which ranked us first in overall market share and first in market share and asset base of any community bank based in these counties. Our expanded banking presence in Glynn County is still in its initial stages of development. Nevertheless, we anticipate that similar competitive advantages enjoyed by us in our core markets, namely our ability to attract customers away from small community banks and super-regional and national competitors due to our overall borrowing capacity and level of customer service, will allow us to make substantial headway in gaining market share in Glynn County. See GeneralOur Subsidiary Banks for additional information regarding our market share and Our StrategiesGrowth Strategies for additional information regarding our efforts to increase market share.
Types of Loans. We offer the following types of loans (which are based on Call Report classifications):
We originate loans with a variety of terms, including fixed and floating or variable rates, and a variety of maturities. Although we offer a variety of types of loans, we emphasize the use of real estate as collateral. As of December 31, 2004, approximately 85% of our loan portfolio, regardless of type, were secured by real estate. Although our banks generally lend to clients located in their market areas, our Fairfield Financial subsidiary is more geographically diversified, with approximately 90% of its portfolio consisting of loans in areas of Georgia outside the Middle Georgia market and in northeastern Florida. This provides us with some diversification of risk, but may also increase our risk since these loans are being made outside of our local market and local relationships.
Our loan portfolio constitutes our largest interest-earning asset. To analyze prospective loans, management reviews our credit quality and interest rate pricing guidelines to determine whether to extend a loan and the appropriate rate of interest for each loan. At December 31, 2003 and 2004, loans and loans held for sale, net of unearned income, of $709.1 million and $853.3 million, respectively, amounted to 77.8% and 80.2% of total assets, and 95.5% and 101.3% of deposits. Loans amounted to 89.9% of all funding sources from interest-bearing liabilities at December 31, 2004 and 85.6% at December 31, 2003. Our loan portfolio grew by 20.3% from December 31, 2003 to December 31, 2004. Loan yields were 6.36% for 2004, compared to 6.61% for 2003 and 7.11% for 2002. Our reserve for loan losses as a percentage of outstanding loans and loans held for sale amounted to 1.28% at December 31, 2004, compared to 1.33% and 1.16% at December 31, 2003 and 2002.
The following table presents the amount of loans outstanding by category, both in dollars and in percentages of the total portfolio, at the end of each of the past five years.
LOANS BY TYPE
The largest components of our loan portfolio are the real estate construction loans and the other mortgages secured by nonfarm, nonresidential properties. Real estate construction loans, which constituted 41.0% of the loans outstanding at December 31, 2004, are loans secured by real estate made to finance land development and residential and commercial construction.
Lending Limits. When the amount of a loan or loans to a single borrower or relationship exceeds an individual officers lending authority, the lending decision must be approved by a more senior officer with the requisite loan authority, or the lending decision will be made by either the officers or directors loan committee.
Lending limits vary based on the type of loan and nature of the borrower. In general, however, we are able to loan to any one borrower a maximum amount equal to either 15% of total risk-based capital, or 25% of total risk-based capital if the amount that exceeds 15% is fully secured. As of December 31, 2004, our combined legal lending limit was approximately $13.4 million (unsecured) plus an additional $22.3 million (secured), or a total of approximately $89.3 million, for loans that meet federal and/or state collateral guidelines. Regardless of the legal lending limit, our internal guidelines limit the amount available to be loaned to any one borrowing relationship. We adjust the maximum amount available to any one borrower or relationship in accordance with an assigned credit grade. Every loan of material size is assigned a credit grade either by our credit administration department or by the appropriate approval committee, with grades denoting more credit risk receiving a lower in-house maximum. As a result, our exposure to loans with more risk should be limited by the credit grades assigned to those loans. These credit grades are reviewed regularly by bank management, regulatory authorities and our external loan review vendor for appropriateness and applicability.
Underwriting. Collectively, our chief operating officer and our subsidiary bank presidents, who also act as our primary local lending officers, have over 120 years of lending experience. This experienced loan team has developed stringent credit underwriting and monitoring guidelines/policies while simultaneously delivering strong growth in our loan portfolio. We stress individual accountability to our loan officers, basing a portion of their compensation on the performance of the loans they approve. We employ a prudent credit approval process and have developed a comprehensive risk-management system for monitoring and measuring the adequacy of our allowance for loan losses and anticipating net charge-offs.
Other Products and Services
We provide a full range of additional retail and commercial banking products and services, including checking, savings and money market accounts; certificates of deposit; credit cards; individual retirement accounts; safe-deposit boxes; money orders; electronic funds transfer services; travelers checks and automatic teller machine access. We do not currently offer trust or fiduciary services.
We are committed to modifying existing, or developing new, products and services that are responsive to the banking demands of our customers. For example, under a possible changing interest rate environment, we anticipate that the market demand for mortgage refinancing will likely be lower in 2005. We also project, however, that Fairfield Financials interim lending division will experience increased activity. Accordingly, we are addressing necessary changes in, or additions to, Fairfield Financials mortgage origination and interim lending products and services in order to continue to position ourselves appropriately to respond to potential shifts in the marketplace.
As of December 31, 2004, the Company had 311 employees on a full-time equivalent basis. SBKC considers its relationship with its employees to be excellent.
Supervision and Regulation
Bank Holding Company Regulation
We are a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (BHCA). As a bank holding company registered with the Federal Reserve under the BHCA and the Georgia Department of Banking and Finance (the Georgia Department) under the Financial Institutions Code of Georgia, we are subject to supervision, examination, and reporting by the Federal Reserve and the Georgia Department. Our activities are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries, or engaging in any other activity that the Federal Reserve determines to be so closely related to banking, or managing or controlling banks, as to be a proper incident to these activities.
We are required to file with the Federal Reserve and the Georgia Department periodic reports and any additional information as they may require. The Federal Reserve and Georgia Department will also regularly examine us and may examine our bank or other subsidiaries.
The BHCA requires prior Federal Reserve approval for, among other things:
Similar requirements are imposed by the Georgia Department.
A bank holding company may acquire direct or indirect ownership or control of voting shares of any company that is engaged directly or indirectly in banking or managing or controlling banks or performing services for its authorized subsidiaries. A bank holding company may also engage in or acquire an interest in a company that engages in activities that the Federal Reserve has determined by regulation or order to be so closely related to banking as to be a proper incident to these activities. The Federal Reserve normally requires some form of notice or application to engage in or acquire companies engaged in such activities. Under the BHCA, we will generally be prohibited from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in activities other than those referred to above.
The BHCA permits a bank holding company located in one state to lawfully acquire a bank located in any other state, subject to deposit-percentage, aging requirements, and other restrictions. The Riegle-Neal Interstate Banking and Branching Efficiency Act also generally provides that national and state-chartered banks may, subject to applicable state law, branch interstate through acquisitions of banks in other states.
In November 1999, Congress enacted the Gramm-Leach-Bliley Act, which made substantial revisions to the statutory restrictions separating banking activities from other financial activities. Under the Gramm-Leach-Bliley Act, bank holding companies that are well-capitalized and well-managed and meet other conditions can elect to become financial holding companies. As financial holding companies, they and their subsidiaries are permitted to acquire or engage in activities that were not previously allowed bank holding companies such as insurance underwriting, securities underwriting and distribution, travel agency activities, broad insurance agency activities, merchant banking, and other activities that the Federal Reserve determines to be financial in nature or complementary to these activities. Financial holding companies continue to be subject to the overall oversight and supervision of the Federal Reserve, but the Gramm-Leach-Bliley Act applies the concept of functional regulation to the activities conducted by subsidiaries. For example, insurance activities would be subject to supervision and regulation by state insurance authorities. While we have not elected to become a financial holding company in order to exercise the broader activity powers provided by the Gramm-Leach-Bliley Act, we may elect to do so in the future.
Limitations on Acquisitions of Bank Holding Companies
As a general proposition, other companies seeking to acquire control of a bank holding company would require the approval of the Federal Reserve under the BHCA. In addition, individuals or groups of individuals seeking to acquire control of a bank holding company would need to file a prior notice with the Federal Reserve (which the Federal Reserve may disapprove under certain circumstances) under the Change in Bank Control Act. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control may exist under the Change in Bank Control Act if the individual or company acquires 10% or more of any class of voting securities of the bank holding company.
Source of Financial Strength
Federal Reserve policy requires a bank holding company to act as a source of financial strength and to take measures to preserve and protect bank subsidiaries in situations where additional investments in a troubled bank may not otherwise be warranted. In addition, if a bank holding company has more than one bank or thrift subsidiary, each of the bank holding companys subsidiary depository institutions are responsible for any losses to the FDIC as a result of an affiliated depository institutions failure. As a result, a bank holding company may be required to loan money to its subsidiaries in the form of capital notes or other instruments that qualify as capital of the subsidiary bank under regulatory rules. However, any loans from the bank holding company to those subsidiary banks will likely be unsecured and subordinated to that banks depositors and perhaps to other creditors of that bank.
The Banks are commercial banks chartered under the laws of the State of Georgia, and as such are subject to supervision, regulation and examination by the Georgia Department. The Banks are members of the FDIC, and their deposits are insured by the FDICs Bank Insurance Fund up to the amount permitted by law. The FDIC and the Georgia Department routinely examine the Banks and monitor and regulate all of the Banks operations, including such things as the adequacy of reserves, the quality and documentation of loans, the payments of dividends, the capital adequacy, the adequacy of systems and controls, credit underwriting and asset liability management, compliance with laws and the establishment of branches. Interest and other charges collected or contracted for by the Banks are subject to state usury laws and certain federal laws concerning interest rates. The Banks file periodic reports with the FDIC and Georgia Department.
Transactions With Affiliates and Insiders
The Company is a legal entity separate and distinct from the Banks. Various legal limitations restrict the Banks from lending or otherwise supplying funds to the Company and other non-bank subsidiaries of the Company, all of which are deemed to be affiliates of the Banks for the purposes of these restrictions. The Company and the Banks are subject to Section 23A of the Federal Reserve Act. Section 23A defines covered transactions, which include extensions of credit, and limits a banks covered transactions with any affiliate to 10% of such banks capital and surplus and with all affiliates to 20% of such banks capital and surplus. All covered and exempt transactions between a bank and its affiliates must be on terms and conditions consistent with safe and sound banking practices, and banks and their subsidiaries are prohibited from purchasing low-quality assets from the banks affiliates. Finally, Section 23A requires that all of a banks extensions of credit to an affiliate be appropriately secured by acceptable collateral, generally United States government or agency securities. The Company and the Banks are also subject to Section 23B of the Federal Reserve Act, which generally limits covered and other transactions between a bank and its affiliates to terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the bank as prevailing at the time for transactions with unaffiliated companies.
The Company is a legal entity separate and distinct from the Banks. The principal source of the Companys cash flow, including cash flow to pay dividends to its shareholders, is dividends that the Banks pay to it. Statutory and regulatory limitations apply to the Banks payment of dividends to the Company as well as to the Companys payment of dividends to its shareholders.
A variety of federal and state laws and regulations affect the ability of the Bank and the Company to pay dividends. A depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. The federal banking agencies may prevent the payment of a dividend if they determine that the payment would be an unsafe and unsound banking practice. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. In addition, regulations promulgated by the Georgia Department limit the Banks payment of dividends.
Mortgage Banking Regulation
Fairfield is licensed and regulated as a mortgage banker by the Georgia Department. It is also qualified as a Fannie Mae and Freddie Mac seller/servicer and must meet the requirements of such corporations and of the various private parties with which it conducts business, including warehouse lenders and those private entities to which it sells mortgage loans.
Enforcement Policies and Actions
Federal law gives the Federal Reserve and FDIC substantial powers to enforce compliance with laws, rules and regulations. Banks or individuals may be ordered to cease and desist from violations of law or other unsafe or unsound practices. The agencies have the power to impose civil money penalties against individuals or institutions of up to $1 million per day for certain egregious violations. Persons who are affiliated with depository institutions can be removed from any office held in that institution and banned from participating in the affairs of any financial institution. The banking regulators have not hesitated to use the enforcement authorities provided in federal law.
The federal bank regulatory authorities have adopted capital guidelines for banks and bank holding companies. In general, the authorities measure the amount of capital an institution holds against its assets. There are three major capital tests: (i) the Total Capital ratio (the total of Tier 1 Capital and Tier 2 Capital measured against risk-adjusted assets), (ii) the Tier 1 Capital ratio (Tier 1 Capital measured against risk-adjusted assets), and (iii) the leverage ratio (Tier One Capital measured against total (i.e., non-risk-weighted) assets).
Tier 1 Capital consists of common equity, retained earnings and a limited amount of qualifying preferred stock, less goodwill and certain core deposit intangibles. Tier 2 Capital consists of non-qualifying preferred stock, qualifying subordinated, perpetual, and/or mandatory convertible debt, term subordinated debt and intermediate term preferred stock and up to 45% of the pretax unrealized holding gains on available-for-sale equity securities with readily determinable market values that are prudently valued, and a limited amount of any loan loss allowance.
In measuring the adequacy of capital, assets are generally weighted for risk. Certain assets, such as cash and U.S. government securities, have a zero risk weighting. Others, such as commercial and consumer loans, have a 100% risk weighting. Risk weightings are also assigned for off-balance sheet items such as loan commitments. The various items are multiplied by the appropriate risk-weighting to determine risk-adjusted assets for the capital calculations. For the leverage ratio mentioned above, assets are not risk-weighted.
The federal banking agencies must take prompt corrective action in respect of depository institutions that do not meet minimum capital requirements. There are five capital tiers for financial institutions: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under these regulations, a bank will be:
Federal law generally prohibits a depository institution from making any capital distribution, including the payment of a dividend or paying any management fee to its holding company if the depository institution would be undercapitalized as a result. Undercapitalized depository institutions are may not accept brokered deposits absent a waiver from the FDIC, are subject to growth limitations and are required to submit a capital restoration plan for approval. For a capital restoration plan to be acceptable, the depository institutions parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of 5% of the depository institutions total assets at the time it became undercapitalized, and the amount necessary to bring the institution into compliance with applicable capital standards. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. If the controlling holding company fails to fulfill its obligations under this law and files, or has filed against it, a petition under the federal Bankruptcy Code, the FDIC claim related to the holding companys obligations would be entitled to a priority in such bankruptcy proceeding over third party creditors of the bank holding company.
Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator.
At December 31, 2004, the Company exceeded the minimum Tier 1, risk-based and leverage ratios and qualified as well-capitalized under current Federal Reserve Board criteria. As of December 31, 2004, we had Tier 1 Capital and Total Capital of approximately 10.27% and 11.40%, respectively, of risk-weighted assets. As of December 31, 2004, we had a leverage ratio of Tier 1 Capital to total average assets of approximately 9.58%.
The guidelines also provide that institutions 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. Higher capital may be required in individual cases, depending upon a bank or bank holding companys risk profile. All bank holding companies and banks are expected to hold capital commensurate with the level and nature of their risks, including the volume and severity of their problem loans. Lastly, the Federal Reserves guidelines indicate that the Federal Reserve will continue to consider a Tangible Tier 1 Leverage Ratio, calculated by deducting all intangibles, in evaluating proposals for expansion or new activity.
FDIC Insurance Assessments
The Banks deposits are insured by the FDIC and thus the Banks are subject to FDIC deposit insurance assessments. The FDIC utilizes a risk-based deposit insurance premium scheme to determine the assessment rates for insured depository institutions. Each financial institution is assigned to one of three capital groups, well capitalized, adequately capitalized, or undercapitalized.
Each financial institution is further assigned to one of three subgroups within a capital group, on the basis of supervisory evaluations by the institutions primary federal and, if applicable, state regulators and other information relevant to the institutions financial condition and the risk posed to the insurance fund. The actual assessment rate applicable to a particular institution will, therefore, depend in part upon the risk assessment classification assigned to the institution by the FDIC. The FDIC is presently considering whether to charge deposit insurance premiums based upon management weaknesses and whether the banks underwriting practices, concentrations of risk, and growth are undisciplined or outside industry norms.
The deposit insurance assessment rates currently range from zero basis points on deposits (for a financial institution in the highest category) to 27 basis points on deposits (for an institution in the lowest category), but may rate as high as 31 basis points. In addition, the FDIC collects The Financing Corporation (FICO) deposit assessments on assessable deposits at the same rate. FICO assessments are set quarterly, and in 2004 ranged from 1.46 to 1.54 basis points. The FICO assessment rate for the Banks for the first quarter of 2005 is 1.44 basis points of assessable deposits.
Community Reinvestment Act
The Banks are subject to the provisions of the Community Reinvestment Act of 1977, as amended (the CRA), and the federal banking agencies related regulations. Under the CRA, all banks and thrifts have a continuing and affirmative obligation, consistent with safe and sound operation, to help meet the credit needs for their entire communities, including low- and moderate-income neighborhoods. The CRA requires a depository institutions primary federal regulator, in connection with its examination of the institution or its evaluation of certain regulatory applications, to assess the institutions record in assessing and meeting the credit needs of the community served by that institution, including low- and moderate-income neighborhoods. The regulatory agencys assessment of the institutions record is made available to the public.
Current CRA regulations rate institutions based on their actual performance in meeting community credit needs. Following its most recent CRA examination on August 1, 2001, the Bank received a satisfactory rating.
Interest and other charges collected or contracted for by the Banks are subject to state usury laws and certain federal laws concerning interest rates. The Banks loan operations are also subject to federal laws and regulations applicable to credit transactions, such as those:
The deposit operations of the Banks are also subject to laws and regulations that:
Fiscal and Monetary Policy
Banking is a business that depends on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings, constitutes the major portion of a banks earnings. Thus, our earnings and growth and that of the Bank will be subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of money through various means, including open market dealings in United States government securities, the discount rate at which banks may borrow from the Federal Reserve, and the reserve requirements on deposits.
The monetary policies of the Federal Reserve historically have had a significant effect on the operating results of commercial banks and mortgage banking operations and will continue to do so in the future. We cannot predict the conditions in the national and international economies and money markets, the actions and changes in policy by monetary and fiscal authorities, or their effect on us or the Banks.
In the wake of the tragic events of September 11th, on October 26, 2001, the President signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and know your customer standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps:
The USA PATRIOT Act requires financial institutions to establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum standards for these programs, including:
In addition, the USA PATRIOT Act authorizes the Secretary of the Treasury to adopt rules increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to have violated the privacy provisions of the Gramm-Leach-Bliley Act, as discussed above.
The Banks (or Our subsidiary banks) owned fourteen full-service banking locations and one limited-service banking location, one stand alone ATM machine and night depository and Security Bank of Bibb Countys operations center, which houses its in-house data processing facility and operational support functions as of December 31, 2004. Fairfield Financial Services, Inc., a subsidiary of Security Bank of Bibb County, leases a number of mortgage production offices throughout Georgia and the Southeast. The net book value of all facilities including furniture, fixtures and equipment totaled $19,105,286 as of December 31, 2004. Management considers that its properties are well maintained.
The Company and its subsidiaries may become parties to various legal proceedings arising from the normal course of business. As of December 31, 2004, there are no material pending legal proceedings to which SBKC or its subsidiaries are a party or of which any of its property is the subject.
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.
Our common stock is quoted on the NASDAQ Stock Market under the symbol SBKC. Prior to December 1, 1997, our common stock was not traded on any public market or exchange, although certain brokerage firms made a market for the common stock. The following table sets forth the high, low and close sale prices per share of the common stock as reported on the NASDAQ Stock Market, and the dividends declared per share for the periods indicated.
As of February 10, 2005 the Company had approximately 721 shareholders of record plus approximately 978 shareholders listed in street name.
For a discussion on dividend restrictions, refer to Item 1, BusinessSupervision and Bank Regulation - General.
Our selected consolidated financial data presented below as of and for the years ended December 31, 1999 through December 31, 2004 is derived from our audited consolidated financial statements, which are included elsewhere in this report. In the opinion of management, all adjustments (consisting only of normal recurring accruals) that are necessary for a fair presentation for such periods or dates have been made.
The following discussion reviews our results of operations and assesses our financial condition. You should read the following discussion and analysis of our financial condition and results of operations in conjunction with Selected Financial Data and our Consolidated Financial Statements and the related notes included elsewhere in this report.
Security Bank Corporation was incorporated on February 10, 1994 for the purpose of becoming a bank holding company. We are subject to extensive federal and state banking laws and regulations, including the Bank Holding Company Act of 1956 and the bank holding company laws of Georgia. We own three subsidiary banksSecurity Bank of Bibb County, Security Bank of Houston County and Security Bank of Jones County. We also own Fairfield Financial Services, Inc., an operating subsidiary of Security Bank of Bibb County. Our subsidiaries are also subject to various federal and state banking laws and regulations.
Like most financial institutions, our profitability depends largely upon net interest income, which is the difference between the interest received on earning assets, such as loans and investment securities, and the interest paid on interest-bearing liabilities, principally deposits and borrowings. Our results of operations are also affected by our provision for loan losses; non-interest expenses, such as salaries, employee benefits, and occupancy expenses; and non-interest income, such as mortgage loan fees and service charges on deposit accounts.
Economic conditions, competition and federal monetary and fiscal policies also affect financial institutions. For example, 2004 was characterized by several increases in the Federal Reserves target federal funds rate in the second half of the year to reduce inflationary pressures and, therefore, sustain the pace of economic growth. Lending activities are also influenced by regional and local economic factors, such as housing supply and demand, competition among lenders, customer preferences and levels of personal income and savings in our primary market area.
Our balanced growth continued during 2004, with increases in assets, deposits, shareholders equity, earnings per share and returns on average assets and equity. The following chart shows our growth in these areas from December 31, 2003 to December 31, 2004:
An increase in loan volume of $144.2 million in loans as a result of strong loan demand in a low interest rate environment was the primary contributor to an increase in net income to $12.3 million for 2004.
The increase in deposits of $99.3 million resulted from marketing efforts aimed at increasing local low-cost deposits and funding requirements driven by our loan growth. We sometimes met these funding needs with out- of-market deposits, which often carried a lower cost than local market deposits as a result of competitive pricing within our markets.
Our investment portfolio increased $8.6 million during 2004, primarily in order to provide on-balance sheet liquidity in support of strong loan demand. The overall level of investment securities declined to 10.5% of assets at the end of 2004, as compared to 11.3% of assets at the end of 2003.
Fairfield Financial closed over $197 million in residential mortgage loans during 2004 and posted approximately $2.8 million in net income. Approximately 31% of its 2004 gross revenue was a product of its traditional residential mortgage origination business, with the remaining 69% being derived from its interim real estate and real estate development lending activities.
The following table illustrates our selected key financial data for each of the past five years.
SELECTED FIVE YEAR FINANCIAL DATA
(Dollars in thousands, except per share data and number of shares)
Critical Accounting Policies
The accounting principles we follow and our methods of applying these principles conform with accounting principles generally accepted in the United States and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses (ALL), goodwill and stock-based compensation have been critical to the determination of our financial position and results of operations.
Allowance for Loan Losses (ALL)
Our management assesses the adequacy of the ALL prior to the end of each calendar quarter. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The ALL consists of two portions: (1) an allocated amount representative of specifically identified credit exposure and exposures that are readily predictable by historical or comparative experience; and, (2) an unallocated amount representative of inherent loss that is not readily identifiable. Even though the ALL is composed of two components, the entire ALL is available to absorb any credit losses.
We establish the allocated amount separately for three tiers:
We base the allocation for unique loans primarily on risk rating grades assigned to each of these loans as a result of our loan management and review processes. We then assign each risk-rating grade a loss ratio, which is determined based on the experience of management, discussions with banking regulators and our independent loan review process.
The unallocated amount is particularly subjective and does not lend itself to exact mathematical calculation. The unallocated amount represents estimated inherent credit losses which may exist, but have not yet been identified, as of the balance sheet date. In estimating the unallocated amount, we apply two stress factors. The first stress factor consists of economic factors including such matters as changes in the local or national economy, the depth or experience in the lending staff, any concentrations of credit in any particular industry group, and new banking laws or regulations. The second stress factor is based on the credit grade of the loans in our unsecured loan portfolio. After we assess applicable factors, we evaluate the aggregate unallocated amount based on our managements experience.
We then test the resulting ALL balance by comparing the balance in the ALL with historical trends and peer information. Our management then evaluates the result of the procedures performed, including the result of our testing, and makes a conclusion regarding the appropriateness of the balance of the ALL in its entirety. The directors loan committee reviews the assessments prior to the filing of quarterly and annual financial information.
In assessing the adequacy of the ALL, we also rely on an ongoing independent loan review process. We undertake this process both to ascertain whether there are loans in the portfolio whose credit quality has weakened over time and to assist in our overall evaluation of the risk characteristics of the entire loan portfolio. Our loan review process includes the judgment of management, the input of our independent loan reviewer, who is not an employee of ours, and reviews that may have been conducted by bank regulatory agencies as part of their usual examination process.
In accordance with SFAS No. 148, Accounting for Stock-Based Compensation, management has elected to expense the fair value of stock options. We utilize the Black-Scholes model in determining the fair value of the stock options. The model takes into account certain estimated factors such as the expected life of the stock option and the volatility of the stock. The expected life of the stock option is a function of the vesting period of the grant, the average length of time similar grants have remained outstanding, and the expected volatility of the underlying stock. Volatility is a measure of the amount by which a price has fluctuated or is expected to fluctuate during a period.
Effective January 1, 2002, the Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets was adopted. In accordance with this statement, goodwill and intangible assets deemed to have indefinite lives no longer are being amortized but will be subject to impairment tests in accordance with the pronouncement. Other intangible assets, primarily core deposits, will continue to be amortized over their estimated useful lives. In 2002, 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. If for any future period we determine that there has been impairment in the carrying value of our goodwill balances, we will record a charge to our earnings, which could have a material adverse effect on our net income.
Results of Operations For The Years Ended December 31, 2004, 2003 and 2002
Our net income was $12.3 million, $8.6 million, and $5.3 million, for the years 2004, 2003, and 2002, respectively. Our 2004 earnings were up by 42% over 2003, and the 2003 earnings showed a 64% increase over 2002. Diluted earnings per share (EPS) amounted to $2.15 in 2004, $1.92 in 2003 and $1.52 in 2002. The $2.15 EPS in 2004 was up $0.23 per share over 2003 results for an increase of 12.0%. The $1.92 EPS in 2003 was up $0.40 per share over 2002 results for an increase of 26.3%. Our return on average equity (ROE) of 13.04% in 2004 is a 123 basis-point decline over our 2003 ROE of 14.27%. The decline in the ROE in 2004 was primarily attributable to our common equity offering of approximately $19 million in May 2004. The ROE for 2003 of 14.27% was a 16 basis point improvement over the ROE of 14.11% for 2002.
The following tables provide recaps of the dollar and percentage changes we have experienced in our income statements, balances sheets and key ratios in recent years.
RECAP OF CHANGES IN INCOME STATEMENT & KEY RATIOS
(Dollars in thousands, except per share data and number of shares)
Net Interest Income
Net interest income (the difference between the interest earned on assets and the interest paid on deposits and liabilities) is the principal source of our earnings. Our average net interest rate margin, on a taxable equivalent basis, was 4.45% in 2004, 4.40% in 2003, and 4.38% in 2002. Net interest income before tax equivalency adjustments in 2004 amounted to $39.6 million, up 32% from $30.0 million in 2003. The 2003 net interest income was up 44% from $20.8 million posted in 2002.
The following table presents a recap of interest income, adjusted to a tax-equivalent basis, interest expense and the resulting average net interest rate margins for the past three years.
NET INTEREST INCOME
2004 compared to 2003:
Net Interest Income. Net interest income on a tax-equivalent basis for the year ended December 31, 2004 increased $9.6 million to $39.9 million from $30.3 million for the year ended December 31, 2003. The increase in net interest income was attributable to an increase of $11.1 million, or 26%, in interest income for the year ended December 31, 2004 compared to the year ended December 31, 2003. The net interest rate spread (the yield on earning assets minus the cost of interest-bearing liabilities) increased 6 basis points from 4.12% for the year ended December 31, 2003 to 4.18% for the year ended December 31, 2004, while the net interest margin (net interest income on a tax equivalent basis divided by average earning assets) increased 5 basis points from 4.40% to 4.45% during the same period.
The increase in both the net interest rate spread and net interest rate margin in 2004 was primarily reflective of a 27 basis-point decline in the average cost of interest-bearing liabilities, while the yield on earning assets declined 21 basis points. Although the average cost of interest-bearing demand deposits and money market accounts was virtually unchanged, we were able to significantly reduce the costs of time deposits as longer-term, higher rate time deposits matured in a lower rate environment and we were able to reprice the renewals at lower rates. New time deposit money raised in the lower rate environment also reduced the weighted average cost of the total time deposit portfolio. Meanwhile, the loan portfolio yield declined 25 basis points as higher-yielding fixed rate loans repriced at lower rates and variable rate loans with interest-rate floors did not participate fully in rate increases in the second half of 2004.
Interest Income. Interest income on a tax-equivalent basis was $54.3 million for the year ended December 31, 2004, an increase of $11.1 million from $43.2 million for the year ended December 31, 2003. Interest income on loans and investment securities increased $9.8 million and $1.2 million, respectively, for the year ended December 31, 2004 compared to the year ended December 31, 2003.
The increase in interest income on loans for the year ended December 31, 2004 compared to the year ended December 31, 2003 was primarily attributable to an increase in average balance of $178.0 million, of which $21.1 million was attributable to including in 2004 a full year of loan balances acquired from Security Bank of Jones County in May 2003. 2003 included 7 months of these balances.
Interest income on investment securities increased $1.2 million as a result of an increase of $26.2 million in average balance for the year ended December 31, 2004 compared to the year ended December 31, 2003, and an increase of 18 basis points in the average yield on these securities during the same period.
The primary reason for the increase in the average balance of investment securities of $26.2 million was to maintain the level of investment securities as a percent of total assets, so that on-balance sheet liquidity would keep pace with loan growth. At December 31, 2004, investment securities equaled 10.5% of assets, as compared to 11.3% at December 31, 2003.
Overall, the yield on interest-earning assets declined 21 basis points from 6.27% during the year ended December 31, 2003 to 6.06% for the year ended December 31, 2003.
Interest Expense. Interest expense increased $1.5 million, to $14.4 million, for the year ended December 31, 2004, from $12.9 million for the year ended December 31, 2003. The increase in interest expense resulted primarily from an increase of $1.4 million in interest expense on deposits. The average cost of interest-bearing deposits, the largest component of interest expense, declined by 31 basis points and the average balance increased by $169.3 million. Of the $169.3 million increase in average balances, interest-bearing accounts increased $22.9 million, money market accounts increased $14.1 million and savings accounts increased $5.1 million, primarily as a result of our increased marketing efforts to bring in low cost deposits. Time deposits, the largest category of deposits, increased $127.2 million, primarily due to the increase in brokered and internet-based CDs to fund loan growth in the Fairfield Interim Lending (Acquisition and Development) division.
The interest expense on borrowed funds in 2004 was relatively unchanged when compared to 2003. A decline in the average balance in borrowed funds of $4.2 million was offset by an increase in the average cost of borrowed funds of 20 basis points, which resulted in a net increase in the cost of other borrowings of $62,000 when comparing 2004 to 2003.
2003 compared to 2002:
Net Interest Income. Net interest income on a tax-equivalent basis for the year ended December 31, 2003 increased $9.2 million to $30.2 million from $21.0 million during the year ended December 31, 2002. This increase was attributable to the increase of $10.1 million in interest income during the year ended December 31, 2003 compared to the year ended December 31, 2002. The net interest rate spread increased 16 basis points from 3.96% for the year ended December 31, 2002 to 4.12% for the year ended December 31, 2003, and the net interest rate margin increased 2 basis points from 4.38% to 4.40% during the same period.
The increase in both the net interest rate spread and net interest rate margin reflected an 80 basis-point decline in the average cost of interest-bearing liabilities as a result of a shift in the composition of interest-bearing liabilities. The shift occurred between borrowings, local CDs or wholesale CDs depending on the interest rate at the time of funding needs. Additionally, as a result of the strategy we used to price borrowings, borrowing costs declined during the year ended December 31, 2003 compared to the year ended December 31, 2002 due to the average cost of borrowed funds declining 28 basis points during the period. During the year ended December 31, 2003 compared to the year ended December 31, 2002, the average balance of deposits, including non-interest-bearing checking accounts, increased a total of $189.6 million. Of this increase, $67.5 million was attributable to ongoing deposit marketing promotions to bring in low cost deposits, and $122.1 million was attributable to our acquisition of Security Bank of Jones County.
Excluding the impact of our acquisition of Security Bank of Jones County, net interest income for the year ended December 31, 2003 increased $3.3 million. This increase was attributable to a decline of $1.4 million in interest expense that was offset by an increase of $1.9 million in interest income during the year ended December 31, 2003 compared to the year ended December 31, 2002. The net interest rate spread increased 11 basis points from 3.96% for the year ended December 31, 2002 to 4.07% for the year ended December 31, 2003.
Interest Income. Interest income on a tax-equivalent basis was $43.2 million during the year ended December 31, 2003, an increase of $10.1 million from $33.1 million during the year ended December 31, 2002. Interest income on loans and investment securities increased $9.4 million and $700,000, respectively, during the year ended December 31, 2003 compared to the year ended December 31, 2002.
The increase in interest income on loans during the year ended December 31, 2003 compared to the year ended December 31, 2002 was primarily attributable to an increase in average balance of $174.8 million, of which $86.4 million was attributable to our acquisition of Security Bank of Jones County. Excluding the impact of the additional loans from Security Bank of Jones County, the existing loan portfolio declined 66 basis points in average yield during the year ended December 31, 2003 as compared to the year ended December 31, 2002.
Interest income on investment securities increased $700,000 as a result of an increase of $34.0 million in average balance during the year ended December 31, 2003 compared to the year ended December 31, 2002, which was partially offset by a reduction of 155 basis points in the average yield on these securities during the same period.
Excluding the impact of our acquisition of Security Bank of Jones County, the investment securities decreased $5.8 million in average balance during 2003. This decline was due to our general policy to emphasize growth in loans as its primary interest-earning asset, and de-emphasize its investment portfolios, while loan origination demand is strong. The decline in average balance also reflects maturity and call activity experienced on these securities as a result of the lower interest rate environment during 2003. The decline in average yield reflects the decline in interest rates during 2003, as higher coupon securities were called from the portfolio.
Overall, the yield on interest-earning assets declined 64 basis points from 6.91% during the year ended December 31, 2002 to 6.27% during the year ended December 31, 2003.
Interest Expense. Interest expense increased $0.8 million, to $12.9 million, during the year ended December 31, 2003, from $12.1 million during the year ended December 31, 2002. The increase in interest expense resulted primarily from an increase of $338,000 in interest expense on deposits. The average cost of interest-bearing deposits, the largest component of interest expense, declined by 91 basis points and the average balance increased by $171.7 million, resulting in an increase in interest expense of $464,000 during the year ended December 31, 2003 compared to the year ended December 31, 2002. Excluding the impact of the interest-bearing deposits resulting from our acquisition of Security Bank of Jones County, average balances increased $59.4 million and average yield declined 89 basis points resulting in a decrease of interest expense of $1.8 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. Of the $59.4 million increase in average balances, interest bearing accounts increased $10.8 million, money market accounts increased $11.8 million and savings accounts increased $1.6 million, all as a result of our increased marketing efforts to bring in low cost deposits. Brokered CDs increased $18.2 million, wholesale CDs increased $84.6 million, and traditional CDs decreased $68.5 million, which resulted from our shift to low cost, out of market deposits.
The increase in interest expense also resulted from a $500,000 increase in borrowed funds, which further resulted from increases of $19.0 million in the average balance of borrowed funds and 24 basis points in the average cost of borrowed funds during the year ended December 31, 2003 compared to the year ended December 31, 2002. The increase in borrowed funds consists primarily of $18.6 million in subordinated debentures relating to our offering of trust preferred securities.
Interest Rates and Interest Differential
The following tables set forth our average balance sheets, interest and yield information on a taxable equivalent basis for the years ended December 31, 2004, 2003, and 2002.
AVERAGE BALANCE SHEETS, INTEREST AND YIELDS
(Tax equivalent basis, in thousands)
The following table provides a detailed analysis of the changes in interest income and interest expense due to changes in rate and volume for the year 2004 compared to the year 2003 and for the year 2003 compared to the year 2002.
RATE / VOLUME ANALYSIS
Provision for Loan Losses
The general nature of lending results in periodic charge-offs, in spite of our continuous loan review process, credit standards, and internal controls. During 2004 and 2003, we factored into our provision for loan losses a subjective assessment of the economic downturns effect on the cash flow of some of our borrowers. We expensed $2.82 million in 2004, $2.86 in 2003, and $2.60 million in 2002 for loan loss provisions. The slight decrease in 2004s provision for loan losses was primarily due to a low level of net charge-offs as compared to the Companys five year average of net charge-offs. Our net charge-offs as a percentage of average loans outstanding were 0.17% in 2004, 0.32% in 2003, and 0.28% in 2002. 2004s level of net charge-offs to average loans of 0.17% was low compared to the five-year average of 0.25%. Amounts of net loans charged off during recent years are reasonable by industry standards and are below peer group institutions of similar asset size. We incurred net charge-offs of $1.32 million in 2004, compared to $1.82 million during 2003, and $1.22 million during 2002. The reserve for loan losses on December 31, 2004 stood at 1.28% of outstanding net loans and loans held for sale, down from 1.33% at December 31, 2003 and up from 1.16% at December 31, 2002.
Non-interest income of $14.8 million in 2004 represented a 14.5% decrease, or $2.5 million from $17.3 million recorded in 2003. Service charges on deposit accounts, which constitute 43.5% of non-interest income, are the largest component of non-interest income, generating $6.5 million for 2004, up from $5.0 million in 2003. Service charges on deposit accounts, which are primarily fees generated from our courtesy overdraft protection product, accounted for $5.5 million, or 85.5% of all service charges. The courtesy overdraft product completed its third full year in 2004, but its growth was enhanced by the success of the high-performance checking program. The second largest component of non-interest income is mortgage loan fees, which constituted 33.2% of non-interest income during 2004. During 2004, mortgage loans fees decreased $4.3 million from $9.2 million to $4.9 million. The decrease in mortgage loan fees is attributable to the slow down in the refinance market due to increasing interest rates. This decline was offset by commissions and fees generated by Fairfield Financials interim lending division. Commissions and fees increased 32.3% to $2.2 million over amounts reported in 2003.
Non-interest expense was $32.3 million for the year ended 2004, up 4.8% or $1.5 million, from $30.8 million in 2003. Salaries and benefits, the largest component of non-interest expense constituting 57.7% of non-interest expense, increased $0.5 million to $18.6 million from $18.1 million in 2003. The overall increase is due to normal salary and benefit increases from merit increases and from new hires. This increase was offset by a decline in mortgage commissions paid in 2004 of $2.3 million, due to a lower level of associated mortgage revenues from the less favorable refinance market seen in 2004.
All other operating overhead increased by $1.1 million or 13.3%. The primary increases were due to increases in directors fees and audit and accounting fees primarily attributable to compliance with Sarbanes-Oxley Section 404.
Income Tax Expense
Our consolidated federal and state income tax expense increased to $6.9 million in 2004, up from $4.9 in 2003 and $3.1 million in 2001. The effective tax rate was 36.0%, 36.4%, and 36.8% in 2004, 2003 and 2002, respectively. Our effective tax rate has historically been at or just below the maximum corporate federal and state income tax rates due to the relatively small percentage of tax-free investments carried on the balance sheet. See Note 7 to our Consolidated Financial Statements for a detailed analysis of income taxes. With the addition of
Security Bank of Jones County in 2003, which had a lower effective tax rate, the blended effect reduced our overall effective tax rate.
Quarterly Results of Operations
The following table provides income statement recaps and earnings per share data for each of the four quarters for the years ended December 31, 2004 and 2003.
QUARTERLY RESULTS OF OPERATIONS
TABLE 20 Continued
QUARTERLY RESULTS OF OPERATIONS
Distribution of Assets, Liabilities & Shareholders Equity
The following table presents condensed average balance sheets for the periods indicated, and the percentages of each of these categories to total average assets for each period.
AVERAGE BALANCE SHEETS
(Amounts in 1000s)
As of December 31, 2004, total assets were $1.063 billion, an increase of $152.2 million, or 16.7% over year-end 2003s level. Total loans and loans held for sale, increased by $144.2 million, or 20.3%, in 2004. The increase in loans was the primary driver of asset growth during 2004. To fund our loan and asset growth, we increased deposits by $99.2 million, borrowed funds by $21.5 million and stockholders equity by $30.9 million. Of the total increase in stockholders equity, $19.0 was attributable to the proceeds of our common stock offering of 676,200 shares in May 2004.
As of December 31, 2003, total assets were $911.3 million, an increase of 56.9% over year-end 2002 levels. Our total loans and loans held for sale, before deducting the reserve for loan losses, grew by $234.7 million to $709.1 million at year-end, an increase of 49.5% over year-end 2002, driven by strong growth in our construction and land development lending portfolio and our acquisition of Security Bank of Jones County. Excluding Security Bank of Jones County, total assets were $705.3 million, an increase of 21.4% over year-end 2002 levels. Total deposits grew $302.7 million, or 68.5%, to $743.3 million, with balanced growth across both transaction and time deposit categories. On an average basis, total assets grew from $513.4 million in 2002 to $746.6 million in 2003 for an increase of 45.4%. Average gross loans grew from $429.5 million in 2002 to $604.2 million in 2003, an increase of 40.7%. Average deposits grew from $396.6 million in 2002 to $586.1 million in 2003, a 47.8% increase.
Risk ElementsLoan Quality
Nonperforming assets consist of nonaccrual loans, loans restructured due to debtors financial difficulties, loans past due 90 days or more as to interest or principal and still accruing, and other real estate owned, which is real estate acquired through foreclosure and repossession. Nonaccrual loans are those loans on which recognition of interest income has been discontinued. Restructured loans generally allow for an extension of the original repayment period or a reduction or deferral of interest or principal because of deterioration in the financial position of the borrower. Loans, whether secured or unsecured, are generally placed on nonaccrual status when principal and/or interest is 60 days or more past due, or sooner if it is known or expected that the collection of all principal and/or interest is unlikely. Other real estate owned is initially recorded at the lower of cost or estimated market value at the date of acquisition. A provision for estimated losses is recorded when a subsequent decline in value occurs.
Nonperforming assets at December 31, 2004, amounted to $8.2 million, which is essentially unchanged from the level of nonperforming assets at December 31, 2003. However, the level of nonperforming assets as a percent of loans and other real estate at December 31, 2004 was down to 0.96% from 1.15% at December 31, 2003.
Nonperforming assets at December 31, 2003 amounted to approximately $8.2 million, or 1.15% of total loans and other real estate. This compares to approximately $6.3 million in nonperforming assets, or 1.31% of total loans and other real estate, at December 31, 2002. We acquired $1.6 million of nonperforming assets from Security Bank of Jones County in May 2003, of which $1.4 million remained at December 31, 2003. Excluding these assets, nonperforming assets increased $500,000, or 8.4%, versus December 31, 2002.
The following table sets forth our nonaccrual, restructured and past-due loans, along with other real estate owned at the end of the past five years, and the amount of interest foregone in 2003 on our nonperforming assets.
At December 31, 2004 and December 31, 2003, there were no other loans classified for regulatory purposes as loss or doubtful that are not included in the table above, but there were other loans classified for regulatory purposes as substandard or special mention that are not included in the table above. However, management is aware of no such substandard or special mention loans not included above which (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (ii) represent material credits about which any information causes management to have serious doubts as to the ability of the borrowers to comply with the loan repayment terms. We have no loans in our portfolio to borrowers in foreign countries.
Loan concentrations exist when large amounts of money are loaned to multiple borrowers who would be similarly impacted by economic or other conditions. The loan portfolio is concentrated in various commercial, real estate and consumer loans to individuals and entities located in Middle Georgia and in other Georgia markets
where Fairfield Financial operates loan offices. Accordingly, the ultimate collectibility of the loans is largely dependent upon economic conditions in these Georgia markets. Other than our geographic concentrations due to our physical location and the loan type concentrations as shown in the above table, we have no other concentrations of loans that exceed 10% of our total loan portfolio as of December 31, 2004.
We have no other interest-bearing assets that would be required to be disclosed as nonperforming assets if they were loans.
Summary of Loan Loss Experience
The following table summarizes loans charged off, recoveries of loans previously charged off and additions to the reserve that have been charged to operating expense for the periods indicated. We have no lease financing or foreign loans.
RESERVE FOR LOAN LOSSES
The reserve for loan losses decreased to 1.29% at December 31, 2004 from 1.35% at December 31, 2003. The reasons for the decrease in the reserve level were two-fold: a lower level of net charge-offs and one loan relationship of $266,000 was identified as a loss as of December 31, 2003 and was provided for, but the loss was charged-off in January 2004 (which would have lowered the reserve level to 1.31% at December 31, 2003, had the loan been charged-off on or before year-end 2003).
The provision for loan losses represents managements determination of the amount necessary to be transferred to the reserve for loan losses to maintain a level that it considers adequate in relation to the risk of future losses inherent in the loan portfolio. It is the policy of our subsidiary banks to provide for exposure to losses principally through an ongoing loan review process. This review process is undertaken to ascertain any probable losses that must be charged off and to assess the risk characteristics of individually significant loans and of the portfolio in the aggregate. This review takes into consideration the judgments of the responsible lending officers and the loan committees of our subsidiary banks boards of directors, and also those of the regulatory agencies that review the loans as part of their regular examination process. During routine examinations of banks, the primary banking regulators may, from time to time, require additions to banks provisions for loan losses and reserves for loan losses if the regulators credit evaluations differ from those of management.
In addition to ongoing internal loan reviews and risk assessment, management uses other factors to judge the adequacy of the reserve, including current economic conditions, loan loss experience, regulatory guidelines and
current levels of non-performing loans. Management believes that the balance of $10.9 million in the reserve for loan losses at December 31, 2004 and the balance of $9.4 million in the reserve for loan losses at December 31, 2003 were adequate to absorb known risks in the loan portfolio at those dates. No assurance can be given, however, that adverse economic conditions or other circumstances will not result in increased losses in our loan portfolio.
In accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures, management, considering current information and events regarding the borrowers ability to repay their obligations, considers a loan to be impaired when the ultimate collectibility of all amounts due, according to the contractual terms of the loan agreement, is in doubt. When a loan becomes impaired, management calculates the impairment 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 is used to measure the amount of impairment. The amount of impairment and any subsequent changes are recorded, through a charge to earnings, as an adjustment to the loan loss reserve. When management considers a loan, or a portion thereof, as uncollectible, it is charged against the reserve for loan losses.
An allocation of the reserve for loan losses has been made to provide for the possibility of incurred losses within the various loan categories. The allocation is based primarily on previous charge-off experience adjusted for risk characteristic changes among each category. Additional reserve amounts are allocated by evaluating the loss potential of individual loans that management has considered impaired. The reserve for loan loss allocation is based on subjective judgment and estimates, and therefore is not necessarily indicative of the specific amounts or loan categories in which charge-offs may ultimately occur. The following table shows a five-year comparison of the allocation of the reserve for loan losses.
ALLOCATION OF RESERVE FOR LOAN LOSSES
The investment securities portfolio is another major interest-earning asset and consists of debt and equity securities categorized as either Available for Sale or Held to Maturity. Given our strong loan demand, the investment portfolio is viewed primarily as a source of liquidity, with yield as a secondary consideration. Because the investment portfolio is primarily for liquidity purposes, the investment portfolio has a relatively short effective duration of 2.3 years. The investment portfolio also serves to balance interest rate risk and credit risk related to the loan portfolio.
As of December 31, 2004, our portfolio of bonds and equity investments amounted to $111.4 million, or 10.5% of total assets, compared to $102.9 million, or 11.3% of assets at December 31, 2003.
The average tax-equivalent yield on the portfolio was 4.24% for the year 2004 versus 4.06% in 2003 and 5.61% in 2002. The increase in the average tax-equivalent yield is reflective of the rising market interest rate environment during 2004. During 2004, net gains on the sale of securities were $12,703, compared to $55,484 for 2003 and $135,802 for 2002.
At December 31, 2004, the major portfolio components, based on amortized or accreted cost, included 56.5% in bonds of mortgage-backed U.S. government agencies; 23.4% in bonds of other U.S. agency obligations; 14.4% in state, county and municipal bonds; 4.4% in stock of the Federal Home Loan Bank; 0.7% in U.S. Treasury securities; and 0.6% in Marketable Equity Securities. As of December 31, 2004, the investment portfolio had gross unrealized gains of $1,190,434 and gross unrealized losses of $633,209, for a net unrealized gain of $557,225. As of December 31, 2003, the portfolio had a net unrealized gain of $1,425,230. In accordance with SFAS No. 115, shareholders equity included net unrealized gains of $352,801 for December 31, 2004 and net unrealized gains of $886,864 for December 31, 2003 recorded on the Available for Sale portfolio, net of deferred tax effects. No trading account has been established by us and none is anticipated.
The following table summarizes the Available for Sale and Held to Maturity investment securities portfolios as of December 31, 2004, 2003, and 2002. Available for Sale securities are shown at fair value, while Held to Maturity securities are shown at amortized or accreted cost. Unrealized gains and losses on securities Available for Sale are excluded from earnings and are reported, net of deferred taxes, in accumulated other comprehensive income, a component of shareholders equity.
The following table illustrates the contractual maturities and weighted average yields of investment securities Available for Sale held at December 31, 2004. Expected maturities will differ from contractual maturities because certain issuers have the right to call or prepay obligations with or without call or prepayment penalties. No prepayment assumptions have been estimated in the table. The weighted average yields are calculated on the basis of the amortized cost and effective yields of each security weighted for the scheduled maturity of each security. The yield on state, county and municipal securities is computed on a tax equivalent basis using a statutory federal income tax rate of 34%. At December 31, 2004, the Company had $1,385,485 carrying value ($1,405,596 of fair value) of State County and Municipal investment securities classified as held to maturity, with an average yield of 7.34% with all securities maturing in the 1-5 year time period. In addition, there was $998,500 carrying value ($998,444 of fair value) of other U.S. agency obligations classified as held to maturity, with an average yield of 2.03% and maturities in the less than 1 year time frame.
MATURITIES OF INVESTMENT SECURITIES AND AVERAGE YIELDS