Security Bank 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
For the fiscal year ended December 31, 2007
For the transition period from to
Commission File No. 000-23261
SECURITY BANK CORPORATION
(Exact Name of Registrant Specified in Its Charter)
Registrants Telephone Number, Including Area Code
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 whether the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes ¨ 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 ¨ 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 Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers in response 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. ¨
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):
Large accelerated filer ¨ Accelerated filer x
Non-accelerated filer ¨ Smaller reporting company ¨
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act of 1934). Yes ¨ No x
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, 2007: $328,297,601 based on stock price of $20.10 as reported on the Nasdaq Global Select Market.
State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date was 18,918,315 shares of $1.00 par value common stock as of February 29, 2008.
DOCUMENTS INCORPORATED BY REFERENCE
Specifically identified portions of our definitive Proxy Statement for the 2008 Annual Meeting of Shareholders (the Proxy Statement) to be filed pursuant to Rule 14a-6 of the Securities Exchange Act of 1934, as amended, are incorporated by reference into Part III of this Annual Report on Form 10-K.
Table of Contents
Forward Looking Statement Disclosure
This Annual Report on Form 10-K contains or incorporates by reference statements that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act) and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). Forward-looking statements discuss future expectations, describe future plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Forward-looking statements are generally identifiable by the use of forward-looking terminology such as anticipate, assume, believe, continue, could, would, endeavor, estimate, expect, forecast, goal, intend, may, objective, plan, potential, predict, project, seek, should, target, will and other similar words and expressions of future intent.
Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. Factors that could cause actual results and performance to differ from those expressed in our forward-looking statements we make or incorporate by reference in this Annual Report on Form 10-K include, but are not limited to:
The cautionary statements in this Annual Report on Form 10-K also identify important factors and possible events that involve risk and uncertainties that could cause our actual results to differ materially from those contained in the forward-looking statements. These forward-looking statements speak only as of the date on which the statements were made. We do not intend, and undertake no obligation, to update or revise any forward-looking statements contained in this Annual Report on Form 10-K, whether as a result of differences in actual results, changes in assumptions or changes in other factors affecting such statements, except as required by law.
Readers should carefully review all disclosures we file from time to time with the SEC.
Unless indicated otherwise, references in this Annual Report on Form 10-K 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, Security Bank of Jones County, Security Bank of North Metro, Security Bank of North Fulton, Security Bank of Gwinnett County (collectively, the Banks) and CFS Wealth Management, LLC.
Overview. We are a Georgia corporation and a multi-bank holding company headquartered in Macon, Georgia. 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 to the northern metropolitan area of Atlanta, Georgia, and to the southeastern coastal region of Georgia. We provide a wide variety of community banking services through our six banking subsidiaries and 18 mortgage production offices, with a substantial portion of our business being drawn from Bibb, Houston and Jones Counties and in the northern metropolitan area of Atlanta in the State of Georgia. At December 31, 2007, we had total assets of approximately $2.83 billion, total deposits of approximately $2.30 billion and total shareholders equity of approximately $306.7 million.
Our Subsidiary Banks. Substantially all of our business is conducted through our six state-chartered subsidiary banks. The names and total assets at December 31, 2007 of the Banks are as follows:
The Banks each operate as a separate legal entity under the corporate umbrella of Security Bank Corporation. As a result, each bank has its own board of directors and management team comprised of individuals known in the local community in which each bank operates. We provide significant assistance and oversight to the 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. In addition to our traditional banking services, we also operate Fairfield Financial Services, Inc. (Fairfield Financial), a subsidiary of Security Bank of Bibb County. Fairfield Financial is an interim real estate development lender and a traditional residential mortgage originator with a number of production locations throughout Georgia. During 2007, Fairfield Financial closed over $185.0 million in residential mortgages. For the year ended December 31, 2007, Fairfield Financial posted a net loss of approximately $9.2 million. This net loss resulted primarily from a provision for loan losses of $20.8 million and foreclosed property expense of $2.1 million. Approximately 15% of Fairfield Financials 2007 gross revenue was a product of its traditional residential mortgage origination business, with the remaining 85% derived from its interim real estate and real estate development lending activities.
CFS Wealth Management. We acquired CFS Wealth Management, LLC, (CFS Wealth Management) an investment management and financial planning firm based in Macon in February 2007. CFS Wealth Management is a wholly owned subsidiary of Security Bank Corporation and provides investment management and financial planning services in Macon, Georgia.
Correspondent Banking. We formed a Correspondent Banking division in March 2007 to expand lending services to other financial institutions. The division specializes in credit lines for other commercial banks, warehouse lending, loans to directors of other banks and participation loans. For the year ended December 31, 2007, Correspondent Banking recorded loans of $59.6 million.
Our Market Area
We provide a wide variety of community banking services through 45 full service banking and loan production offices. A substantial portion of our business is drawn from the Middle Georgia counties of Bibb, Houston and Jones. We believe we are the market leader among community banks based in Middle Georgia and we expect to gain market share at the expense of our super-regional and national competitors in these core markets.
We believe the continued growth of Atlanta is beneficial to the Middle Georgia market. 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 approximately 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.
Several years ago, we made a strategic decision to expand into other markets in the State of Georgia. 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 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. In addition, we opened a de novo branch on St. Simons Island, Georgia in 2005.
In May 2005, we made our initial entry into the metro Atlanta market by acquiring SouthBank (now Security Bank of North Metro), a community bank located in Woodstock, Georgia. In March and July 2006, we made additional entries into the metro Atlanta market with the acquisitions of Neighbors Bancshares, Inc. (now Security Bank of North Fulton) and Homestead Bank (now Security Bank of Gwinnett County), community banks located in Alpharetta and Suwanee, Georgia, respectively. In addition, due primarily to the operations of Fairfield Financial, we service communities throughout Georgia and in northeastern Florida.
There is significant competition within the financial services industry in general as well as with respect to the particular financial services provided by the Company and the Banks. Within our markets, the Banks compete directly with major banking institutions of comparable or larger size and resources, as well as with various other smaller banking organizations. The Banks also have numerous local and national nonbank competitors, including savings and loan associations, credit unions, mortgage companies, personal and commercial finance companies, investment brokerage and financial advisory firms, and mutual fund companies. Entities that deliver financial services and access to financial products and transactions exclusively through the Internet are another source of competition. Technological advances have also allowed the Banks and other financial institutions to provide electronic and Internet-based services that enhance the value of traditional financial products. Continued consolidation within the financial services industry will most likely change the nature and intensity of competition that we face, but can also create opportunities for us to demonstrate and exploit competitive advantages.
According to Federal Deposit Insurance Corporation (FDIC) deposit data as of June 30, 2007, in the combined markets of Bibb, Jones and Houston Counties, our three core counties of operation, bank and thrift deposits totaled approximately $1.43 billion. Approximately 48% of this deposit base was controlled by super-regional and national institutions, including BB&T, Bank of America, SunTrust Bank, Wachovia 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. As of June 30, 2007, our deposits accounted for 30% 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 developing; however, our market share at June 30, 2007 increased
approximately 51% to 4.8% compared to 3.2% at June 30, 2006. Our presence in metropolitan Atlanta is still in the early stages of development and our market share is not yet meaningful. We anticipate that similar competitive advantages enjoyed by us in our core markets, namely our ability to attract customers away from other community banks and super-regional and national competitors due to level of customer service, will allow us to make substantial headway in gaining market share in Glynn County and in metropolitan Atlanta.
Through the Banks, we offer a range of lending services, including real estate-construction, real estate-mortgage, commercial, financial and agricultural and loans to individuals. Our loans receivable, net of unearned interest, at December 31, 2007 were approximately $2.18 billion, or approximately 87.3% of total earning assets. The interest rates charged on loans vary with the degree of risk, maturity and amount of the loan and are further subject to competitive pressures, money market rates, availability of funds and government regulations.
Types of Loans. We offer the following types of loans (which are based on FDIC 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 loans, we emphasize the use of real estate as collateral. As of December 31, 2007, approximately 90% of our loan portfolio, regardless of type, was secured by real estate. Although the Banks generally lend to clients located in their market areas, our Fairfield Financial subsidiary is more geographically diversified, with approximately 97.2% of its interim real estate development portfolio consisting of loans in areas outside the Middle Georgia market, as illustrated in the following table:
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, however, we do offer investment management and financial planning services through CFS Wealth Management.
Financial Information about Segments
Financial information regarding segments is contained in a separate section of this Annual Report on Form 10-K. See Note 1 of Notes to Consolidated Financial Statements beginning on page F-11 of Exhibit 13 to this Annual Report on Form 10-K.
As of December 31, 2007, we had 523 employees on a full-time equivalent basis. None of the employees are represented by any unions or similar groups, and we have not experienced any type of strike or labor dispute. We consider our relationship with employees to be good.
We do not consider our business to be seasonal in nature.
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 by 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 or 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 or 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 or 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 or bank holding company. A company may be presumed to have control under the BHCA if it acquires 5% or more of any class of voting securities of the bank or 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. In the event of the Companys bankruptcy, any commitment by the Company to a bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority of payment.
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 Deposit 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 restrictions limit the Banks abilities to lend or otherwise supply 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. 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. Finally, Section 23A requires that all of a banks extensions of credit to an affiliate be secured by collateral in amounts ranging from 100% to 130% of the loan amount, depending on the nature of the collateral.
The Banks are also restricted in the loans that they may make to our executive officers, directors, or any owner of 10% or more of its stock or the stock of the Company, and certain entities affiliated with any such person. Amounts of such loans are subject to various limits, depending on the purpose of the loan, and certain Bank board approvals may be necessary.
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 bank regulatory authorities may prevent the payment of a dividend if they determine that the payment would be an unsafe and unsound banking practice. As a rule, the amount of a dividend may not exceed the sum of year-to-date net income and of retained net income in the immediately previous two years. Additionally, the federal agencies have issued policy statements to the effect 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. In 2008, upon receiving a request from the Federal Reserve Bank of Atlanta, our Board of Directors approved a resolution stating that we will not declare or pay any dividends to our shareholders and we will not incur additional debt at the holding company without prior written approval of the Federal Reserve Bank of Atlanta.
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 frequently employ 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: (1) the Total Capital ratio (the total of Tier 1 Capital and Tier 2 Capital measured against risk-adjusted assets), (2) the Tier 1 Capital ratio (Tier 1 Capital measured against risk-adjusted assets) and (3) the leverage ratio (Tier 1 Capital measured against total assets) (i.e., non-risk-weighted).
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.
Except when calculating the leverage ratio, 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.
At December 31, 2007, each of the Banks exceeded the Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios to qualify as well-capitalized under current regulatory capital guidelines. Additionally, as of December 31, 2007, the holding company had Tier 1 Capital and Total Capital of approximately 8.75% and 9.97%, respectively, of risk-weighted assets and a leverage ratio of Tier 1 Capital to total average assets of approximately 8.03%.
The federal bank regulatory authorities adopted two new risk-based capital rules. Popularly known as Basel II, the first rule imposes complex new requirements on the largest U.S. banking organizations, with assets in excess of $250 billion or foreign exposures in excess of $10 billion. Regulators have also proposed Basel IA, which would revise the current risk-based capital rules to which the Company and the Banks are subject in a way intended to provide a measure of equivalence to the Basel II rules. The proposed rules are written so as to take effect in 2009, but we cannot predict whether the final rules in fact will do so. The proposed rules address only risk-based capital requirements. Public statements from the federal bank regulatory authorities indicate that the current leverage ratio requirement will remain in place, as will the prompt corrective action regime discussed immediately below.
FDICIA & Prompt Corrective Action
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) established a prompt corrective action program in which every bank is placed in one of five regulatory categories, depending primarily on its regulatory capital levels. The federal bank regulatory authorities must take prompt corrective action in respect of depository institutions that do not meet minimum capital requirements. The capital categories are: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under these regulations, a bank will be:
The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital. Specifically, a federal bank regulatory agency may, after notice and an opportunity for a hearing, reclassify a well-capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category if the institution is operating in an unsafe or unsound condition or engaging in an unsafe or unsound practice. The FDIC may not, however, reclassify a significantly undercapitalized institution as critically undercapitalized.
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 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.
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.
Under the Federal Deposit Insurance Act (FDIA), an insured depository institution that is under common control with another insured depository institution is generally liable for (1) any loss incurred, or reasonably anticipated to be incurred, by the FDIC in connection with the default of the commonly controlled institution or (2) any assistance provided by the FDIC to any commonly controlled institution that is in danger of default. The term default is defined to mean the appointment of a conservator or receiver for such institution and in danger of default is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. Thus, if applicable, one of our Banks could incur liability to the FDIC pursuant to this statutory provision in the event of the default of another bank or insured depository institution that we own or control. Such liability is subordinated in right of payment to deposit liabilities, secured obligations, any other general or senior liability, and any obligation subordinated to depositors or other general creditors, other than obligations owed to any affiliate of the depository institution (with certain exceptions) and any obligations to shareholders in such capacity. The Company currently controls six banks.
Standards for Safety and Soundness
The FDIA requires the federal bank regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to: (1) internal controls, information systems and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest rate risk exposure; and (5) asset growth. The agencies also must prescribe standards for asset quality, earnings and stock valuation, as well as standards for compensation, fees and benefits. The federal bank regulatory authorities have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness (Safety
and Soundness Guidelines) to implement these required standards. The Safety and Soundness Guidelines set forth the safety and soundness standards that the federal bank regulatory authorities use to identify and address problems at insured depository institutions before capital becomes impaired. Under the regulations, if the FDIC determines that the bank fails to meet any standards prescribed by the Safety and Soundness Guidelines, the agency may require the bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDIC. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.
Deposit 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.
In November 2006, the FDIC adopted final regulations that set the deposit insurance assessment rates that took effect in 2007. The FDIC uses a risk-based assessment system that assigns insured depository institutions to one of four risk categories based on three primary sources of information: (1) supervisory risk ratings for all institutions, (3) capital ratios for most institutions, and (3) long-term debt issuer ratings for large institutions that have such ratings. The new premium rate structure imposes a minimum assessment of from five to seven cents for every $100 of domestic deposits on institutions that are assigned to the lowest risk category. This category is expected to encompass substantially all insured institutions, including the Banks. A one time assessment credit is available to offset up to 100% of the 2007 assessment. Any remaining credit can be used to offset up to 90% of subsequent annual assessments through 2010. For institutions assigned to higher risk categories, the premium that took effect in 2007 ranges from 10 cents to 43 cents per $100 of deposits.
The FDIC also collects a deposit-based assessment from insured financial institutions on behalf of The Financing Corporation (FICO). The funds from these assessments are used to service debt issued by FICO in its capacity as a financial vehicle for the Federal Savings & Loan Insurance Corporation. The FICO assessment rate is set quarterly and in 2007 ranged from 1.14 cents to 1.22 cents per $100 of assessable deposits. For the first quarter of 2008, the FICO assessment rate is 1.14 cents per $100 of assessable deposits.
Mortgage Banking Regulation
Fairfield Financial is regulated as a notificant by the Georgia Department as it is a wholly owned subsidiary of a federally insured bank. 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.
Under amendments to BHCA and Federal Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers. In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that (1) the customer obtain or provide some additional credit, property, or services from or to the bank, the bank holding company or subsidiaries thereof or (2) the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule. A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.
Community Reinvestment Act
The Banks are subject to the provisions of the Community Reinvestment Act of 1977, as amended (the CRA), and the federal bank regulatory 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 the most recent CRA examinations which occurred during 2004 and 2005, each of the Banks received a satisfactory rating.
Privacy and Data Security
The Gramm-Leach-Bliley Act imposed new requirements on financial institutions with respect to consumer privacy. The statute generally prohibits disclosure of consumer information to non-affiliated third parties unless the consumer has been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to consumers annually. Financial institutions, however, will be required to comply with state law if it is more protective of consumer privacy than the Gramm-Leach-Bliley Act. The statute also directed federal regulators, including the Federal Reserve and the FDIC, to prescribe standards for the security of consumer information. The Company and our Banks are subject to such standards, as well as standards for notifying consumers in the event of a security breach.
Activities of the Banks are subject to a variety of statutes and regulations designed to protect consumers, such as including the Fair Credit Reporting Act (FCRA), Equal Credit Opportunity Act (ECOA), and Truth-in-Lending Act (TILA). Interest and other charges collected or contracted for by the Banks are also subject to state usury laws and certain other federal laws concerning interest rates. The Banks loan operations are also subject to federal laws and regulations applicable to credit transactions. Together, these laws and regulations include provisions that:
As a result of the turmoil in the residential real estate and mortgage lending markets, there are several legislative and regulatory initiatives currently under discussion at both the federal and state levels that could, if adopted, alter the terms of existing mortgage loans, impose restrictions on future mortgage loan originations, diminish lenders rights against delinquent borrowers or otherwise change the ways in which lenders make residential mortgage loans. If made final, any or all of these proposals could have a negative effect on our mortgage lending operations, our ability to sell mortgage loans into the secondary market or our ability to proceed against delinquent borrowers.
The deposit operations of the Banks are also subject to laws and regulations that:
Anti-Money Laundering and Anti-Terrorism Legislation
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 customer identification 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, federal agencies have adopted 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.
Commercial Real Estate Lending and Concentrations
On December 12, 2006, the federal bank regulatory agencies released Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices (the Guidance). The Guidance, which was issued in response to the agencies concern that rising commercial real estate (CRE) concentrations might expose
institutions to unanticipated earnings and capital volatility in the event of adverse changes in the commercial real estate market, reinforces existing regulations and guidelines for real estate lending and loan portfolio management.
The Company believes that the Guidance is applicable to it, as it has a concentration in CRE loans. The Company and its Board of Directors have discussed the Guidance and believe that that the Companys underwriting policy, management information systems, independent credit administration process and monthly monitoring of real estate loan concentrations will be sufficient to address the Guidance.
Allowance for Loan and Lease Losses (ALLL)
On December 13, 2006, the federal bank regulatory agencies released Interagency Policy Statement on the Allowance for Loan and Lease Losses, which revises and replaces the banking agencies 1993 policy statement on the ALLL. The revised statement was issued to ensure consistency with generally accepted accounting principles (GAAP) and more recent supervisory guidance.
The Company and its Board of Directors have discussed the revised statement and believe that our ALLL methodology is comprehensive, systematic, and that it is consistently applied across the Company. We believe our management information systems, independent credit administration process, policies and procedures are sufficient to address the guidance.
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 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.
These policies have a direct effect on the amount of our loans and deposits and on the interest rates charged on loans and paid on deposits, with the result that federal policies may have a material effect on our earnings. Policies that are directed toward changing the supply of money and credit and raising or lowering interest rates may have an effect on our earnings. 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 the Company or the Banks.
Sarbanes-Oxley Act of 2002
We are required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as rules and regulations adopted by the SEC, the Public Company Accounting Oversight Board and Nasdaq. In particular, we are required to include management and independent auditor reports on internal controls as part this Annual Report on Form 10-K pursuant to Section 404 of the Sarbanes-Oxley Act. We have evaluated our controls, including compliance with the SEC rules on internal controls, and have and expect to continue to spend significant amounts of time and money on compliance with these rules. Our failure to comply with these internal control rules may materially adversely affect our reputation, ability to obtain the necessary certifications to financial statements, and the values of our securities. The assessments of financial reporting controls as of December 31, 2007 are included elsewhere in Annual Report on Form 10-K with no material weaknesses reported.
Our filings with the SEC, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports, are accessible free of charge at our website at www.securitybank.net as soon as reasonably practicable after filing with the SEC. By making this reference to our website, we do not intend to incorporate into this report any information contained in the website and the website should not be considered part of this report.
Additionally, our corporate governance guidelines, codes of conduct and ethics, charters of our committees of the Board of Directors, as well as information regarding our director nominating process and our procedures for shareholders to communicate with our Board of Directors are available on our website. We will furnish copies of all of the above information free of charge upon request to our Secretary.
The SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers including the Company that file electronically with the SEC.
In addition to the other information contained in or incorporated by reference into this Annual Report on Form 10-K and the exhibits hereto, the following risk factors should be considered carefully in evaluating our business. The risks disclosed below, either alone or in combination, could materially adversely affect our business, financial condition or results of operations. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of us.
Our business is subject to the success of the local economies where we operate.
Our success significantly depends upon the growth in population, income levels, deposits and housing starts in our primary and secondary markets. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. We are currently experiencing adverse economic conditions in some of our market areas, which affect the ability of our customers to repay their loans to us and generally negatively affect our financial condition and results of operations. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies and are thus disproportionately impacted. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas if they do materialize in the future.
The market value of the real estate securing our loans as collateral has been adversely affected by the slowing economy and unfavorable changes in economic conditions in our market areas and may be further adversely affected in the future. As of December 31, 2007, approximately 90% of our loans receivable were secured by real estate. Any sustained period of increased payment delinquencies, foreclosures or losses caused by the adverse market and economic conditions, including the downturn in the real estate market in our markets will adversely affect the value of our assets, our revenues, results of operations and financial condition. Currently, the markets we operate in are experiencing such an economic downturn, and if it continues, our operations will be further adversely affected.
We make and hold in our portfolio a significant number of land acquisition and development and construction loans, which pose more credit risk than other types of loans typically made by financial institutions.
We offer land acquisition and development and construction loans for builders and developers. As of December 31, 2007, approximately $711.2 million of our loan portfolio represented loans for which the related property is neither presold nor preleased. Approximately $243.5 million of these speculative loans are for residential developments and approximately $467.7 million are for commercial developments. These land acquisition and development and construction loans are considered more risky than other types of residential mortgage loans. The primary credit risks associated with land acquisition and development and construction lending are underwriting, project risks and market risks. Project risks include cost overruns, borrower credit risk, project completion risk, general contractor credit risk, and environmental and other hazard risks. Market risks are risks associated with the sale of the completed residential units. They include affordability risk, which means the risk of affordability of financing by borrowers, product design risk, and risks posed by competing projects. While we believe we have established adequate reserves on our financial statements to cover the credit risk of our land acquisition and development and construction loan portfolio, there can be no assurance that losses will not exceed our reserves, which could adversely impact our earnings. Given the current environment and declining real estate values, we expect that in 2008, the nonperforming loans in our land acquisition and development and construction portfolio will increase substantially and these nonperforming loans will result in a material level of charge-offs, which will negatively impact our capital and earnings.
Current and anticipated deterioration in the housing market and the homebuilding industry may lead to increased loss severities and further worsening of delinquencies and nonperforming assets in our loan portfolios. Consequently, our results of operations may be adversely impacted.
There has been substantial industry concern and national publicity over asset quality among financial institutions due in large part to issues related to subprime mortgage lending, declining real estate values and general economic concerns. As of December 31, 2007, our nonperforming assets increased significantly to $79.1 million, or 3.58%, of loans receivable plus other real estate owned. Furthermore, the housing and the residential mortgage markets have experienced, and continue to experience, a variety of difficulties and changed economic conditions. If market conditions continue to deteriorate, which we expect to occur in the near-term, this will lead to additional valuation adjustments on our loan portfolios and real estate owned as we continue to reassess the market value of our loan portfolio, the losses associated with the loans in default and the net realizable value of real estate owned.
The homebuilding industry has experienced a significant and sustained decline in demand for new homes and an oversupply of new and existing homes available for sale in various markets, including the markets in which we lend. Our customers who are builders and developers face greater difficulty in selling their homes in markets where these trends are more pronounced. Consequently, we are facing a sharp increase in delinquencies and nonperforming assets as these builders and developers are forced to default on their loans with us. We do not anticipate that the housing market will improve in the near-term, and accordingly, additional downgrades, significant provisions for loan losses and charge-offs related to our loan portfolio will likely occur.
We occasionally purchase non-recourse loan participations from other banks based on information provided by the selling bank.
From time to time, we purchase loan participations from other banks in the ordinary course of business, usually without recourse to the selling bank. This may occur during times when we are experiencing excess liquidity in an effort to improve our profitability. When we purchase loan participations we apply the same underwriting standards as we would to loans that we directly originate and seek to purchase only loans that would satisfy these standards. We are less likely to be familiar with the borrower, and may rely to some extent on information provided to us by the selling bank and on the selling banks administration of the loan relationship. We therefore have less control over, and may incur more risk with respect to, loan participations that we purchase from selling banks.
Our net interest income could be negatively affected by the Federal Reserves recent interest rate adjustments, as well as by competition in our primary market area.
As a financial institution, our earnings are significantly dependent upon our net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as loans and investment securities, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes resulting from changes in the Federal Reserves fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of the assets and liabilities. As a result, an increase or decrease in market interest rates could have material adverse effects on our net interest margin and results of operations.
In response to the dramatic deterioration of the subprime, mortgage, credit and liquidity markets, the Federal Reserve recently has taken action on five occasions to reduce interest rates by a total of 225 basis points since September 2007, which likely will reduce our net interest for the foreseeable future. This reduction in net interest income likely will be exacerbated by the high level of competition that we face in our markets, which requires us to offer more attractive interest rates to borrowers, both on loans and deposits, and to rely upon out of market funding sources. Any reduction in our net interest income will negatively affect our business, financial condition, liquidity, operating results, cash flows and/or the price of our securities. Additionally, in 2008, we expect to have continued margin pressure given these interest rate reductions, along with elevated levels of nonperforming assets.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.
Our success depends to a significant extent upon the quality of our assets, particularly loans. In originating loans, there is a substantial likelihood that credit losses will be experienced. The risk of loss will vary with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the quality of the collateral for the loan.
Our loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. As a result, 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 that 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 and trends in delinquencies and non-accruals, national and local economic conditions and other pertinent information. 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. Material additions to our allowance would materially decrease our net income. As a result of a difficult real estate market, we have increased our allowance from $22.3 million as of December 31, 2006 to $31.7 million as of December 31, 2007. We expect to continue to increase our allowance in 2008; however, we can make no assurance that our allowance will be adequate to cover future loan losses given current and future market conditions.
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 would have a negative effect on our operating results.
We may need to raise capital in the future in addition to the capital raised in our rights offering, but that capital may not be available when it is needed or may be expensive.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We will likely need to raise additional capital to support our business as a result of our losses. Our ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed on favorable terms. Furthermore, following a recent exam by the Federal Reserve Bank of Atlanta in January 2008, our Board of Directors passed a board resolution that our company will not incur additional indebtedness at the holding company without prior written consent from the Federal Reserve Bank of Atlanta. We can give no assurance that we will receive such consent from the Federal Reserve Bank of Atlanta, which could hinder our ability to raise additional capital through the issuance of debt securities or convertible debt securities. If we cannot raise additional capital when needed, our ability to operate our business could be materially impaired.
We face regulatory risks related to our commercial real estate loan concentrations.
Commercial real estate (CRE) is cyclical and poses risks of possible loss due to concentration levels and similar risks of the asset class. As of December 31, 2007, approximately 78% of our loan portfolio consisted of CRE loans. The banking regulators have begun giving CRE lending greater scrutiny and may require banks with higher levels of CRE loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly requiring higher levels of allowances for possible loan losses and capital levels as a result of CRE lending growth and exposures.
Our loan portfolio has commercial and industrial loans that include risks that may be greater than the risks related to residential loans.
Our commercial and industrial loan portfolio was $161.9 million at December 31, 2007 and comprised 7.4% of loans receivable. Commercial and industrial loans generally carry larger loan balances and involve a greater degree of financial and credit risk than home equity loans or residential mortgage loans. Any significant failure to pay on time by our customers would hurt our earnings. The increased financial and credit risk associated with these types of loans is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans. In addition, when underwriting a commercial or industrial loan, we may take a security interest in commercial real estate, and, in some instances upon a default by the borrower, we may foreclose on and take title to the property, which may lead to potential financial risk for us under applicable environmental laws. If hazardous substances were discovered on any of these properties, we may be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination.
Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate or commercial project. If the cash flow from the project is reduced, a borrowers ability to repay the loan may be impaired. This cash flow shortage may result in the failure to make loan payments. In such cases, we may be compelled to modify the terms of the loan. In addition, the nature of these loans is such that they are generally less predictable and more difficult to evaluate and monitor. As a result, repayment of these loans may, to a greater extent than residential loans, be subject to adverse conditions in the real estate market or economy.
If we are unable to increase our share of deposits in our market, we may accept out of market and brokered deposits, the costs of which may be higher than expected.
We can offer no assurance that we will be able to maintain or increase our market share of deposits in our highly competitive service area. If we are unable to do so, we may be forced to accept increased amounts of out
of market or brokered deposits. As of December 31, 2007, we had approximately $854.4 million in out of market deposits, including brokered deposits, which represented approximately 37% of our total deposits. At times, the cost of out of market and brokered deposits exceeds the cost of deposits in our local market. In addition, the cost of out of market and brokered deposits can be volatile, and if we are unable to access these markets or if our costs related to out of market and brokered deposits increases, our liquidity and ability to support demand for loans could be adversely affected.
We are subject to extensive regulation that could limit or restrict our activities.
We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, incurring debt, 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. In response to an exam by the Federal Reserve Bank of Atlanta in January 2008, our Board of Directors passed a board resolution that we will not incur additional indebtedness at the holding company or declare or pay any dividends to our shareholders without the prior written approval of the Federal Reserve Bank of Atlanta. The Federal Reserve Bank of Atlanta approved our 2008 first quarter dividend. However, we can give no assurance that we will receive such consent for dividends or indebtedness from the Federal Reserve Bank of Atlanta in the future.
Our business also is subject to laws, rules and regulations regarding the disclosure of non-public information about our customers to non-affiliated third parties. Our operations on the Internet are not currently subject to direct regulation by any government agency in the United States beyond regulations applicable to businesses generally. A number of legislative and regulatory proposals currently under consideration by the federal, state and local governmental organizations may lead to laws or regulations concerning various aspects of our business on the Internet, including: user privacy, taxation, content, access charges, liability for third-party activities and jurisdiction. The adoption of new laws or a change in the application of existing laws may decrease the use of the Internet, increase our costs or otherwise adversely affect our business.
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. Additionally, we cannot predict the effect of any legislation that may be passed at the state or federal level in response to the recent deterioration of the subprime, mortgage, credit and liquidity markets. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.
Our financial condition and results of operations are reported in accordance with GAAP. While not impacting economic results, future changes in accounting principles issued by the Financial Accounting Standards Board (FASB) could impact our earnings as reported under GAAP. As a public company, we are also subject to the corporate governance standards set forth in the Sarbanes-Oxley Act of 2002, as well as applicable rules and regulations promulgated by the SEC and the Nasdaq Global Select Market. Complying with these standards, rules and regulations may impose administrative costs and burdens on us.
Additionally, political conditions could impact our earnings. Acts or threats of war or terrorism, as well as actions taken by the United States or other governments in response to such acts or threats, could impact the business and economic conditions in which we operate.
Competition from financial institutions and other financial service providers may adversely affect our profitability.
The banking business is highly competitive and we experience competition in each of our markets from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance
companies, money market funds and other mutual funds, as well as other super-regional, national and international financial institutions that operate offices in our primary market areas and elsewhere.
We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our primary markets, we may face a competitive disadvantage as a result of our smaller size, lack of geographic diversification and inability to spread our marketing costs across a broader market. Although we compete by concentrating our marketing efforts in our primary markets with local advertisements, personal contacts, and greater flexibility and responsiveness in working with local customers, we can give no assurance that this strategy will be successful.
Our directors and executive officers own a significant portion of our common stock.
Our directors and executive officers, as a group, beneficially owned approximately 18.25% of our outstanding common stock as of February 29, 2008. As a result of their ownership, the directors and executive officers have the ability, by voting their shares in concert, to significantly influence the outcome of all matters submitted to our shareholders for approval, including the election of directors.
We may face risks with respect to future expansion and acquisitions or mergers.
We may seek to acquire other financial institutions or parts of those institutions and may engage in de novo branch expansion in the future. We may also consider and enter into new lines of business or offer new products or services. We also may receive future inquiries and have discussions with potential acquirers of us. Acquisitions and mergers involve a number of risks, including:
We may incur substantial costs to expand, and we can give no assurance that such expansion will result in the levels of profits we seek. There can be no assurance that, integration efforts for any future mergers or acquisitions will be successful. Also, we may issue equity securities, including common stock and securities convertible into shares of our common stock in connection with future acquisitions, which could cause ownership and economic dilution to our current shareholders. There is no assurance that, following any future merger or acquisition, our integration efforts will be successful or that our company, after giving effect to the acquisition, will achieve profits comparable to or better than our historical experience.
The Company, through the Banks, owned 20 full-service banking locations as of December 31, 2007. In addition, the Banks lease one limited-service banking location and operations centers in Macon and Perry, Georgia. Fairfield Financial leases a number of mortgage production offices throughout Georgia, each of which management believes to be reasonable and appropriate for the market area. The net book value of all facilities including furniture, fixtures and equipment totaled $43.2 million as of December 31, 2007. Management considers our properties to be well maintained. For additional information regarding our premises and equipment, see Note 8 of Notes to Consolidated Financial Statements beginning on page F-25 of Exhibit 13 to this Annual Report on Form 10-K.
The Company and its subsidiaries may become parties to various legal proceedings arising from the normal course of business. As of December 31, 2007, there are no material pending legal proceedings to which the Company or its subsidiaries are a party or of which any of its property is the subject.
As of February 28, 2008, we had approximately 2,029 shareholders of record plus approximately 4,091 shareholders listed in street name. Our common stock is quoted on the Nasdaq Global Select Market under the symbol SBKC.
The following table sets forth the high and low sale prices and closing prices per share of common stock as reported on the Nasdaq Global Select Market, and the dividends declared per share for the periods indicated.
The Company did not purchase any shares of its common stock during the quarter ended December 31, 2007 and there have been no recent sales of unregistered securities.
Stock Performance Graph
Set forth below is a line graph comparing the percentage change in the cumulative shareholder return on our common stock with the cumulative Nasdaq Total Return Index and the SNL Southeast Bank Index. The graph assumes $100 invested on December 31, 2002 in our common stock and the reinvestment of dividends compared to $100 invested in each of the two indexes.
The following performance graph and related information shall not be deemed soliciting material or to be filed with the SEC, nor shall such information be incorporated by reference into any future filings under the Securities Act or the Exchange Act, except to the extent we specifically incorporate it by reference into such filing.
Our selected consolidated financial data presented below as of and for the years ended December 31, 2003 through December 31, 2007 is derived from our audited consolidated financial statements, which are included elsewhere in this Annual Report on Form 10-K. 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. See Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations for a full discussion of comparability between periods.
The following discussion reviews our financial condition and results of operations and contains forward-looking statements that are subject to known and unknown risks, uncertainties and other factors that may cause the Companys actual results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include those discussed in Item 1A, Risk Factors and elsewhere in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K.
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, as amended, and the bank holding company laws of Georgia. We own six state-chartered subsidiary banksSecurity Bank of Bibb County, Security Bank of Houston County, Security Bank of Jones County, Security Bank of North Metro, Security Bank of North Fulton and Security Bank of Gwinnett County. We also own Fairfield Financial and CFS Wealth Management, which function as operating subsidiaries of Security Bank of Bibb County and Security Bank Corporation, respectively. Our subsidiaries are also subject to various federal and state banking laws and regulations.
In 2007, the community banking industry was significantly impacted by a downturn in the residential housing market. In the broader financial services industry, financial markets were also impacted by the collapse of subprime lending, an interim period of severe illiquidity in credit markets and declines in market value of a broad range of investment products. Furthermore, given concerns about the slowing national economy, we started to see the easing of interest rates by the Federal Reserve in the latter part of 2007, which has continued into 2008. These market conditions had a significant impact on our results, which showed slower loan growth, an increased provision for loan losses due to our growing level of nonperforming loans, primarily residential real estate acquisition and development, and construction, as well as compression in our net interest margin given our asset sensitive balance sheet and the added costs of elevated nonperforming assets.
The following is a summary of our 2007 financial performance:
Given the current changing and challenging operating environment, we have adjusted our strategic objectives. Our strategic objectives include the following:
As a result of the slowing in the residential real estate markets that began in the second quarter of 2007 our community bank business model experienced significant stress in our real estate-oriented loan portfolio. Income generation from our residential real estate-related loans as well as cost containment of related expenses will be challenging for 2008.
For 2008, we believe that the level of nonperforming assets, provisions for loan losses and loan charge-offs will all be significantly higher than the levels we experienced in 2007. As a result, we will experience increased pressure on our earnings, liquidity and regulatory capital. We believe we are taking prudent and appropriate steps to ensure that as the residential real estate market remains unsettled, we focus on controlling costs and on actively managing our exposures in a challenging credit environment. We believe that our strategy of focusing on high growth markets, exemplary customer service, expense discipline, and our commitment to strong credit risk management will continue to create value for shareholders over the long term.
Our outlook for 2008 generally assumes a slowing overall national economy and a steepening yield curve including the effect of declining short-term interest rates. Based on these assumptions, we expect for the year 2008 compared with the year 2007:
Critical Accounting Policies
Our significant accounting policies are described in Note 1 of the consolidated financial statements and are essential in understanding managements discussion and analysis of financial condition and results of operations. Some of our accounting policies require significant judgment to estimate values of either assets or liabilities. In addition, certain accounting principles require significant judgment in applying the complex accounting principles to complicated transactions to determine the most appropriate treatment.
The following is a summary of the more judgmental estimates and complex accounting principles. In many cases, there are numerous alternative judgments that could be used in the process of estimating values of assets or liabilities. Where alternatives exist, we have used the factors that it believes represent the most reasonable value in developing the inputs for the valuation. Actual performance that differs from the Corporations estimates of the key variables could impact net income.
Allowance for Loan and Lease Losses (ALLL)
Our management assesses the adequacy of the ALLL quarterly. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The ALLL consists of two components: (1) a specific amount representative of identified credit exposures that are readily predictable by the current performance of the borrower and underlying collateral; and (2) a general amount based upon historical losses that is then adjusted for various stress factors representative of various economic factors and characteristics of the loan portfolio. Even though the ALLL is composed of two components, the entire ALLL is available to absorb any credit losses.
We establish the specific amount by examining impaired loans. Under generally accepted accounting principles, we may measure the loss either by (1) the observable market price of the loan; or (2) the present value of expected future cash flows discounted at the loans effective interest rate; or (3) the fair value of the collateral if the loan is collateral dependent. Because the majority of our impaired loans are collateral dependent, nearly all of our specific allowances are calculated based on the fair value of the collateral.
We establish the general amount by taking the remaining loan portfolio (excluding those loans discussed above) with allocations based on historical losses in the total portfolio. The calculation of the general amount is then subjected to stress factors that are particularly subjective. The amount due to stress testing attempts to correlate the historical loss rates with current economic factors and current risks in the portfolio. The stress factors consist of: (1) economic factors including such matters as changes in the local or national economy; (2) the depth or experience in the lending staff; (3) any concentrations of credit (such as commercial real estate) in any particular industry group; (4) new banking laws or regulations; (5) the credit grade of the loans in our unsecured consumer loan portfolio; and (6) additional risk resulting from the level of speculative real estate loans in the portfolio. After we assess applicable factors, we evaluate the remaining amount based on managements experience.
Finally, we compare the level of the ALLL with historical trends and peer information as a reasonableness test. Management then evaluates the result of the procedures performed, including the result of our testing, and makes a conclusion regarding the appropriateness of the ALLL in its entirety.
In assessing the adequacy of the ALLL, we also rely on an ongoing independent credit administration 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 credit administration review process includes the judgment of management, the input of our internal loan review function, and reviews that may have been conducted by bank regulatory agencies as part of their usual examination process. The Credit Quality Committee, which is a committee comprised of members of the Boards of Directors of the Company and its subsidiaries, reviews the ALLL process and results.
In accordance with Statement of Financial Accounting Standards (SFAS) No. 123R, Accounting for Stock-Based Compensation, management expenses 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.
Goodwill and Intangible Assets
Goodwill and intangible assets deemed to have indefinite lives are no longer being amortized but will be subject to impairment tests on at least an annual basis. Other intangible assets, primarily core deposits, will continue to be amortized over their estimated useful lives. In 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. 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.
The calculation of our income tax expense requires significant judgment and the use of estimates. We periodically assess tax positions based on current tax developments, including enacted statutory, judicial and regulatory guidance. In analyzing our overall tax position, consideration is given to the amount and timing of recognizing income tax liabilities and benefits. In applying the tax and accounting guidance to the facts and circumstances, income tax balances are adjusted appropriately through the income tax provision. Reserves for income tax uncertainties are maintained at levels we believe are adequate to absorb probable payments. Actual amounts paid, if any, could differ significantly from these estimates.
Results of Operations for the Years Ended December 31, 2007, 2006 and 2005
Our net income was $6.6 million, $23.4 million, and $16.2 million, for the years ended December 31, 2007, 2006, and 2005, respectively. Our 2007 earnings were down 72% compared to 2006, and the 2006 earnings showed a 44% increase over 2005. Diluted earnings per share (EPS) amounted to $0.34 in 2007, $1.33 in 2006 and $1.27 in 2005. The $0.34 EPS in 2007 was down $0.99 per share from 2006 results for a decrease of 74%. The $1.33 EPS in 2006 was up $0.06 per share over 2005 results for an increase of 4.7%. Our return on average equity (ROE) of 2.10% in 2007 is a 718 basis-point decline from our 2006 ROE of 9.28%. The decline in the ROE in 2007 was primarily attributable to the increase in the provision for loan losses from $4.5 million in 2006 to $32.7 million in 2007. Our ROE of 9.28% in 2006 is a 352 basis-point decline from our 2005 ROE of 12.80%. The decline in the ROE in 2006 was primarily attributable to the losses on the sale of securities of $1.6 million, common equity issuances of approximately $67.2 million in connection with our two acquisitions and the public offering of 1,725,000 shares of our common stock.
The following table provides an analysis of the dollar and percentage changes we have experienced in our income statements, balances sheets and key ratios in recent years.
ANALYSIS OF CHANGES IN INCOME STATEMENT & KEY RATIOS
(Dollars in thousands, except per share data)
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 tax-equivalent basis, was 3.88% in 2007, 4.40% in 2006 and 4.46% in 2005. Net interest income before tax equivalency adjustments in 2007 amounted to $90.5 million, up 14% from $79.4 million in 2006. Net interest income before tax equivalency adjustments in 2006 amounted to $79.4 million, up 58% from $50.4 million in 2005.
The following table presents a summary 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
(Dollars in thousands)
2007 compared to 2006
Net Interest Income. Net interest income on a tax-equivalent basis for the year ended December 31, 2007 increased $11.1million to $90.9 million from $79.8 million for the year ended December 31, 2006. The increase in net interest income was attributable to an increase of $44.8 million, or 30%, in interest income while interest expense only increased $33.7 million during 2006. The net interest rate spread (the yield on earning assets minus the cost of interest-bearing liabilities) decreased 51 basis points from 3.87% for the year ended December 31, 2006 to 3.36% for the year ended December 31, 2007, while the net interest margin (net interest income on a tax-equivalent basis divided by average earning assets) decreased from 4.40% to 3.88% during the same period.
The decrease in the net interest rate spread in 2007 was primarily reflective of a 58 basis-point increase in the average cost of interest-bearing liabilities, while the yield on earning assets increased seven basis points. We experienced significant increases in the costs of all deposits except for interest-bearing demand and savings deposits. Our average cost of interest-bearing deposits increased to 4.82% in 2007 from 4.18% in 2006. Meanwhile, the loan portfolio yield remained consistent at 8.62%, primarily due to lost interest income from nonaccrual loans; while the yield on investment securities increased from 4.74% in 2006 to 5.25% in 2007.
Interest Income. Interest income on a tax-equivalent basis was $193.3 million for the year ended December 31, 2007, an increase of $44.8 million from $148.5 million for the year ended December 31, 2006. Interest income on loans and investment securities increased $41.6 million and $3.1 million, respectively, for the year ended December 31, 2007 compared to the year ended December 31, 2006.
The increase in interest income on loans for the year ended December 31, 2007 compared to the year ended December 31, 2006 was primarily attributable to an increase in average balance of $482.2 million resulting from loan growth in our core markets. The average yield on our loan portfolio remained consistent at 8.62%.
Interest income on investment securities increased $3.1 million as a result of an increase of $42.9 million in average balance for the year ended December 31, 2007 compared to the year ended December 31, 2006, and an increase of 51 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 $42.9 million was our effort to maintain a certain level of on-balance sheet liquidity. The average yield on securities increased 51 basis points partly as a result of the restructuring of our bond portfolio in December 2006, during which we sold several low-yield securities. At December 31, 2007, investment securities equaled 10.8% of assets, as compared to 9.2% at December 31, 2006.
Overall, the yield on interest-earning assets increased seven basis points from 8.18% during the year ended December 31, 2006 to 8.25% for the year ended December 31, 2007.
Interest Expense. Interest expense increased $33.7 million, to $102.3 million, for the year ended December 31, 2007, from $68.6 million for the year ended December 31, 2006. The increase in interest expense resulted primarily from an increase of $33.1 million in interest expense on deposits. The average cost of interest-bearing deposits, the largest component of interest expense, increased by 64 basis points and the average balance increased by $496.3 million. Of the $496.3 million increase in average balances, interest-bearing NOW accounts increased $62.9 million, money market accounts increased $18.2 million and savings accounts decreased $3.3 million. The increase in the average balance for interest-bearing NOW accounts reflects the attractive rates paid on the Premium Select Checking account, which have contributed to continued balance growth. Time deposits, the largest category of deposits, increased $418.5 million; primarily due to the increased use of brokered and internet-based certificates of deposit, which continue to provide a quick and cost-effective means of generating deposits to meet our funding needs. The average cost of time deposits increased 66 basis points. The increase is due to the inclusion of a full year of results for Security Bank of North Fulton and Security Bank of Gwinnett County (both acquired in 2006) whose average cost of time deposits is generally higher than that of the Banks in the Middle and Coastal Georgia markets.
The interest expense on borrowed funds in 2007 increased by $0.5 million or 6.8% when compared to 2006. This increase is related to an increase of $5.4 million or 3.9% in the average balance of borrowed funds combined with an increase of 16 basis points to 5.85% in the average costs of borrowings. The increase in the average balance is related to increases in the draws on correspondent bank lines of credit to meet our funding needs.
2006 compared to 2005
Net Interest Income. Net interest income on a tax-equivalent basis for the year ended December 31, 2006 increased $29.1 million to $79.8 million from $50.7 million for the year ended December 31, 2005. The increase in net interest income was attributable to an increase of $70.0 million, or 89%, in interest income while interest expense only increased $40.8 million during 2006. The net interest rate spread (the yield on earning assets minus the cost of interest-bearing liabilities) decreased 20 basis points from 4.07% for the year ended December 31, 2005 to 3.87% for the year ended December 31, 2006, while the net interest margin (net interest income on a tax-equivalent basis divided by average earning assets) decreased from 4.46% to 4.40% during the same period.
The decrease in the net interest rate spread in 2006 was primarily reflective of a 148 basis-point increase in the average cost of interest-bearing liabilities, while the yield on earning assets increased only 128 basis points. We experienced significant increases in the costs of all deposits, except for savings accounts, as our average cost of interest-bearing deposits increased to 4.18% in 2006 from 2.69% in 2005. Meanwhile, the loan portfolio yield increased 135 basis points as higher-yielding fixed rate loans repriced at higher rates and variable rate loans with interest rate floors began to participate fully in rate increases during 2006.
Interest Income. Interest income on a tax-equivalent basis was $148.5 million for the year ended December 31, 2006, an increase of $70 million from $78.5 million for the year ended December 31, 2005. Interest income on loans and investment securities increased $65.5 million and $3.3 million, respectively, for the year ended December 31, 2006 compared to the year ended December 31, 2005.
The increase in interest income on loans for the year ended December 31, 2006 compared to the year ended December 31, 2005 was primarily attributable to an increase in average balance of $602.0 million, of which $189.9 million was attributable to the inclusion of loan balances acquired from Neighbors Bancshares, Inc. and Homestead Bank. Excluding the acquired loan balances, the $412.1 million increase in average loans is attributable to the continued strong loan growth in our core markets.
Interest income on investment securities increased $3.3 million as a result of an increase of $58.2 million in average balance for the year ended December 31, 2006 compared to the year ended December 31, 2005, and an increase of 49 basis points in the average yield on these securities during the same period. Excluding investment securities acquired from Neighbors Bancshares, Inc. and Homestead Bank, the average balance of investment securities increased $39.1 million.
The primary reason for the increase in the average balance of investment securities of $39.1 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, 2006, investment securities equaled 9.2% of assets, as compared to 9.1% at December 31, 2005.
Overall, the yield on interest-earning assets increased 128 basis points from 6.90% during the year ended December 31, 2005 to 8.18% for the year ended December 31, 2006.
Interest Expense. Interest expense increased $40.8 million, to $68.6 million, for the year ended December 31, 2006, from $27.8 million for the year ended December 31, 2005. The increase in interest expense resulted primarily from an increase of $37.1 million in interest expense on deposits. Excluding the expense resulting from our acquisitions, interest expense increased $31.0 million and interest expense on deposits increased $27.7 million. The average cost of interest-bearing deposits, the largest component of interest expense, increased by 149 basis points and the average balance increased by $571.4 million. Of the $571.4 million increase in average balances, interest-bearing NOW accounts increased $152.4 million, money market accounts increased $46.8 million and savings accounts decreased $0.7 million. The increase in the average balance for interest-bearing NOW accounts is primarily due to the increase in the number of customers with the Premium Select Checking account, which offers a competitive interest rate and the benefits of a traditional checking account. Given the advantages and attractive interest rate offered with the Premium Select Checking account, some of our customers transferred their deposits from our traditional money market account to the Premium Select Checking account. Time deposits, the largest category of deposits, increased $372.9 million; primarily due to the increase in brokered and internet-based certificates of deposit to fund loan growth in the Fairfield Financial Interim Lending (Acquisition and Development) division.
The interest expense on borrowed funds in 2006 increased by $3.8 million or 92% when compared to 2005. This increase is related to an increase of $38.8 million or 39% in the average balance of borrowed funds combined with an increase of 158 basis points to 5.69% in the average costs of borrowings. The increase in the average balance is related to an increase in advances with the Federal Home Loan Bank (FHLB) to meet our funding needs.
Interest Rates and Interest Differential
The following tables set forth our average balance sheets, interest and yield information on a tax-equivalent basis for the years ended December 31, 2007, 2006, and 2005.
AVERAGE BALANCE SHEETS, INTEREST AND YIELDS
(Tax-equivalent basis, dollars 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 2007 compared to 2006 and for 2006 compared to 2005.
RATE / VOLUME ANALYSIS
Provision for Loan Losses
The provision for loan losses is a charge to current earnings taken to increase the allowance for loan losses. The general nature of lending results in periodic charge-offs of nonperforming loans, in spite of our continuous loan review process, credit standards and internal controls. We expensed $32.6 million in 2007, $4.5 million in 2006, and $2.8 million in 2005 for loan loss provisions. The increase in the provision for loan losses in 2007 is due primarily to significant declines in residential real estate market values, primarily in the metropolitan Atlanta area, caused by recent disruptions in financial markets. As a result of these adverse market conditions, our net
charge-offs increased to $23.3 million in 2007, compared to $2.4 million in 2006 and $1.2 million in 2005. Our net charge-offs as a percentage of average loans outstanding increased to 1.12% in 2007 compared to 0.15% in 2006 and 0.12% in 2005. The adverse market conditions also resulted in an increase in the allowance for loan losses as a percentage of outstanding net loans receivable to 1.45% at December 31, 2007, up from 1.18% at December 31, 2006 and 1.27% at December 31, 2005. See Risk Elements section on page 41 for further discussion.
2007 compared to 2006
Noninterest income of $19.0 million in 2007 represented an increase of 5.7% or $1.0 million from $18.0 million recorded in 2006. The increase is primarily due to a reduction in the loss on the sale of securities. In 2006, we incurred a $1.6 million loss in connection with the restructuring of our bond portfolio and incurred a minimal loss in 2007. The $1.6 million increase resulting from the lower loss on sale of securities is offset by a decrease in mortgage origination and related fee income of $0.4 million, which is the result of decreased loan volume.
2006 compared to 2005
Noninterest income of $18.0 million in 2006 represented an increase of 8.2% or $1.4 million from $16.6 million recorded in 2005. Service charges on deposit accounts, which constitute 51% of noninterest income, are the largest component of noninterest income, generating $9.2 million for 2006, up from $7.4 million in 2005. Fees generated from our courtesy overdraft protection product accounted for $6.8 million or 74% of service charges on deposits. The increase in fees from our courtesy overdraft product is also attributable to the significant growth in deposits during the year of $323.3 million or 25%, excluding the impact of 2006 acquisitions. The second largest component of noninterest income is mortgage origination and related fee income, which constituted 28% of noninterest income during 2006. Mortgage origination and related fee income increased $0.4 million, from $4.5 million in 2005 to $4.9 million in 2006. The increases in service charges and mortgage origination and related fee income are offset by losses of $1.6 million incurred in connection with the restructuring of our bond portfolio in December 2006.
2007 compared to 2006
Noninterest expense was $67.1 million for 2007, up 20.5% or $11.4 million, from $55.7 million in 2006. Salaries and benefits, the largest component of noninterest expense, constituting 54% of noninterest expense, increased $2.7 million to $35.1 million in 2007 from $32.4 million in 2006. Approximately $2.1 million of the increase in salaries and benefits is due to the inclusion of a full years results for Security Bank of North Fulton and Security Bank of Gwinnett County, which were acquired in March and July 2006, respectively. The remainder of the increase is due to normal salary and benefit increases from merit increases and the hiring of new employees.
All other operating overhead increased by $8.7 million, or 38%, during 2007. Approximately $1.2 million is attributable to increased professional fees. Specifically, audit fees increased by approximately $0.5 million as a result of the additions of Security Bank of North Fulton and Security Bank of Gwinnett County in 2006. Further, legal fees and other expenses increased approximately $0.5 million as a result of the fees incurred in connection with the proposed acquisition of First Commerce Community Bankshares, Inc. which was not consummated.
The increase is also due to a $4.4 million increase in foreclosed property expenses, stemming from the significant increase in nonperforming assets and an increase of $0.4 million in directors fees, resulting from the additional directors at subsidiary banks acquired during 2006. The remainder of the increase is spread across various expense categories.
2006 compared to 2005
Non-interest expense was $55.7 million for the year ended 2006, up 44.1%, or $17.1 million, from $38.6 million in 2005. Salaries and benefits, the largest component of non-interest expense, constituting 58% of non-interest expense, increased $9.6 million to $32.4 million in 2006 from $22.8 million in 2005. Approximately $2.4 million of the increase in salaries and benefits is related to the hiring of employees in connection with the acquisitions of Neighbors Bancshares, Inc. (Security Bank of North Fulton) and Homestead Bank (Security Bank of Gwinnett County). Also contributing to the increase is the hiring of employees in connection with the acquisition of Rivoli BanCorp on December 31, 2005. The remainder of the increase is due to normal salary and benefit increases from merit increases and the hiring of new employees.
All other operating overhead increased by $7.5 million, or 48%, during 2006. Excluding the expenses incurred by the banks acquired during the year, other operating overhead increased approximately $5.8 million or 37%. Approximately $1.4 million is attributable to increased occupancy and equipment expenses resulting from the continued growth of the Banks in our core markets. The increase is also attributable to a $795,000 increase in the amortization of intangibles resulting from the 2005 acquisitions of SouthBank and Rivoli BanCorp. Furthermore, approximately $590,000 of the increase is the result of increased audit and other professional fees. The remaining increase of $3.0 million is related to increases in various service-related expenses including appraisal fees and directors fees resulting from additional directors at subsidiary banks acquired in 2006.
Income Tax Expense
Our consolidated federal and state income tax expense decreased to $3.2 million in 2007, down from $13.9 million in 2006 and $9.3 million in 2005. Our effective tax rate also decreased to 32.6% in 2007, down from 37.2% in 2006 and 36.5% in 2005. 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 our balance sheet.
During 2007, we purchased low income housing tax credits. These credits provide reductions in our state income tax expense over the next 11 years. When added to existing state income tax credits, the 2007 credits resulted in a zero state income tax expense for 2007. See Note 8 to our Consolidated Financial Statements for a detailed analysis of income taxes.
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, 2007 and 2006.
QUARTERLY RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)
Balance Sheet Review
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, 2007 and 2006, loans receivable, net of unearned income, of $2.18 billion and $1.90 billion, respectively, amounted to 77.0% and 76.2% of total assets, and 94.9% and 96.5% of deposits. Loans, including loans held for sale amounted to 87.4% of interest-bearing liabilities at
December 31, 2007 and 89.0% at December 31, 2006. Our loan portfolio grew by 14.8% from December 31, 2006 to December 31, 2007. Loan yields were 8.62% for 2007, compared to 8.62% for 2006 and 7.27% for 2005. Our allowance for loan losses as a percentage of loans receivable amounted to 1.45% at December 31, 2007, compared to 1.18% and 1.27% at December 31, 2006 and 2005, respectively.
The largest components of our loan portfolio are the real estate construction and land development loans and the other mortgages secured by nonfarm, nonresidential properties. Real estate construction and land development loans, which constituted 53.4% of the loans outstanding at December 31, 2007, are loans secured by real estate made to finance land development and residential and commercial construction.
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
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 the loan committee comprised of officers or the loan committee comprised of members of the Board of Directors.
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, 2007, our legal lending limit was approximately $35.2 million (unsecured) plus an additional $23.4 million (secured) for a total of approximately $58.6 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 is limited by the credit grades assigned to those loans. These credit grades are reviewed regularly by management, regulatory authorities and our external loan review vendor for appropriateness and applicability.
Collectively, our chief operating officer, other senior members of corporate management, our Bank presidents and chief lending officers act as the primary lending officers for the Company. These individuals, combined, have over 475 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 believe 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.
Nonperforming assets consist of nonaccrual loans, 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. Nonaccrual loans are those loans on which recognition of interest income has been discontinued. When management believes there is sufficient doubt as to the collectibility of principal or interest on any loan, or generally when loans are 90 days or more past due, the accrual of the applicable interest is discontinued and the loan is designated as nonaccrual, unless the loan is well secured and in the process of collection. Management reviews past due loans on a monthly basis and will place certain loans on nonaccrual status at 60 days past due in some circumstances. Interest payments received on nonaccrual loans are applied against principal. Loans are returned to an accrual status when factors indicating doubtful collectibility on a timely basis no longer exist. 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 if a subsequent decline in value occurs.
Nonperforming assets at December 31, 2007 amounted to approximately $79.1 million, or 3.58% of loans receivable and other real estate. This compares to approximately $37.2 million in nonperforming assets, or 1.95% of loans receivable and other real estate at December 31, 2006. The following table sets forth our nonperforming assets and allowance for loan losses at the end of the past five years.
(Dollars in thousands)
The increase in nonperforming assets is primarily attributable to the significant slowdown in residential real estate sales that began in the summer of 2007. Approximately 15% of the loan portfolio consists of loans made to purchase, develop and build residential real estate. A significant portion of the loan portfolios of our metropolitan Atlanta banks and Fairfield Financial is concentrated in this market. During the summer of 2007, the subprime mortgage market collapsed as loans with adjustable interest rates began resetting and homeowners could not afford the higher payments. The effects of this dilemma rippled throughout the national and international economy as many of these loans had been packaged and sold to financial firms around the world. The home mortgage loan market experienced illiquidity during 2007 that affected prime customers as well. With the significant slowing of home and land sales, the prices of homes and land have begun to decline. Many potential home and land purchasers are not making purchases as they watch the market for further slowing sales and declining prices. Therefore, many of our customers who develop and sell residential real estate cannot service their loans because they are not generating any revenue. Presently, the majority of our loans in this category continue to perform; however, management cannot predict the impact of future economic changes on our nonperforming assets. Management believes that the increase in nonperforming assets during 2007 is indicative of a trend that we currently believe will accelerate at least throughout 2008.
The 10 largest nonaccrual loans comprise $28.3 million or 55.9% of the total. Of these 10 loans, seven are residential development loans and three are commercial real estate loans. We experienced significant activity in nonaccrual loans during 2007 with $92.3 million in new loans moved to nonaccrual status, $23.3 million in nonaccruals being charged-off, $4.1 million in nonaccrual loans being sold and $48.6 million in nonaccrual loans moved into foreclosure.
The 10 largest other real estate owned properties comprise $12.2 million or 43.2% of the total. Nine of these properties are residential in nature and one property is commercial. Of the total other real estate owned balance, the largest component is residential real estate 42.0% followed by single family homes at 25.8%, raw land at 21.8% and commercial property at 9.7%. We incurred significant activity in other real estate owned during 2007 with $48.6 million in newly foreclosed properties, $22.1 million in sales of the properties and $1.2 million in writedowns.
Summary of Loan Loss Experience
The following table summarizes loans charged-off, recoveries of loans previously charged-off and provisions for loan losses for the periods indicated. We have no lease financing or foreign loans.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(Dollars in thousands)
The provision for loan losses represents managements determination of the amount necessary to be transferred to the allowance 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 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 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 the Banks, the primary banking regulators may, from time to time, require additions to the Banks provisions for loan losses and allowances 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 allowance for loan losses, including current economic conditions, loan loss experience, regulatory guidelines and current levels of nonperforming loans. Management believes that the balances of $31.7 million and $22.3 million in the allowance for loan losses at December 31, 2007 and 2006, respectively, 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 or that our allowance for loan losses will be sufficient to absorb such unexpected losses.
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 the specific allocation of the allowance for loan losses. When management considers a loan, or a portion thereof, as uncollectible, it is charged-off against the allowance for loan losses.
A general allocation of the allowance 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 stress factors representative of various economic factors and characteristics of the loan portfolio. The allowance 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 allowance for loan losses based on loan categories. The loan balance in each category is expressed as a percentage of the total loans at the end of the respective periods.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(Dollars in thousands)
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 in previous years, 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 3.12 years as of year end. The investment portfolio also serves to balance interest rate risk and credit risk related to the loan portfolio.
As of December 31, 2007, our portfolio of bonds and equity investments amounted to $305.4 million, or 10.8% of total assets, compared to $229.9 million, or 9.2% of total assets at December 31, 2006.
The average tax-equivalent yield on the portfolio was 5.25% for the year 2007 versus 4.74% in 2006 and 4.25% in 2005. Net losses on the sale of securities were less than $0.1 million, $1.6 million, and less than $0.1 million in 2007, 2006 and 2005, respectively. In December 2006, we restructured our bond portfolio and sold a total of approximately $54.0 million in bonds with lower yielding rates at a loss of approximately $1.3 million to reinvest in higher-yielding bonds.
At December 31, 2007, the major portfolio components included 70.1% in mortgage-backed securities issued by U.S. government agencies; 20.0% in other bonds of U.S. government agencies; 6.6% in state, county and municipal bonds; 2.7% in FHLB stock; and 0.6% in other securities. As of December 31, 2007, the investment portfolio had gross unrealized gains of $2.5 million and gross unrealized losses of $0.9 million for a net unrealized gain of $1.6 million. As of December 31, 2006, the portfolio had a net unrealized loss of $1.0 million. In accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, shareholders equity included net unrealized gains of $1.1 million for December 31, 2007 and net unrealized losses of $0.6 million for December 31, 2006 recorded on the Available for Sale portfolio, net of deferred tax effects. Management identified no value impairment related to credit quality in the portfolio, and we hold no securities that are tied to the subprime home mortgage loans. In addition, management has the intent and ability to hold those securities with unrealized losses until the market-based impairment is recovered; therefore, no value impairment was determined to be other than temporary.
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, 2007, 2006 and 2005. 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.
(Dollars in thousands)
The following table illustrates the contractual maturities and weighted average yields of investment securities Available for Sale held at December 31, 2007. 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 35%. At December 31, 2007, we had $1.0 million carrying value (and fair value) of U.S. Government Agency investment securities classified as Held to Maturity, with an average yield of 5.0% with all securities maturing in the five to 10 year time period.
MATURITIES OF INVESTMENT SECURITIES AND AVERAGE YIELDS
(Dollars in thousands)
As of December 31, 2007 and 2006, we had several holdings of securities of a single issuer in which the aggregate book value and aggregate market value of the securities exceeded 10% of shareholders equity. Our total holdings of these issuers as a percentage of total shareholders equity are as follows:
Deposits are our primary liability and funding source. Total deposits as of December 31, 2007 were $2.29 billion, an increase of 16.6% from $1.97 billion at December 31, 2006. Average deposits in 2007 were $2.11 billion, an increase of $0.5 million from $1.61 billion during 2006. The average cost of deposits, considering non-interest checking accounts, was 4.44% during 2007, up from 3.75% during 2006 and 2.37% for 2005. We seek to set competitive deposit rates in our local markets to retain and grow our market share of deposits in our market area as our principal funding source; however, we have continued to increase our reliance on brokered and internet-based certificates of deposit as sources of funding, given the cost-effectiveness and prompt receipt of funds. On an average basis for the year 2007, 7.8% of our deposits were held in non-interest-bearing checking accounts, 25.3% were in lower yielding interest-bearing transaction, money market and savings accounts, and 66.9% were in time certificates with higher yields. Comparable average deposit mix percentages during 2006 were 10.3%, 28.2% and 61.5%, respectively. We hold no deposit funds from foreign depositors.
The following table reflects average balances of deposit categories for 2007, 2006 and 2005.
(Dollars in thousands)
The following table outlines the maturities of certificates of deposit of $100,000 or more as of December 31, 2007, 2006 and 2005. All of our time deposits as of December 31, 2007 are certificates of deposit.
MATURITY DISTRIBUTION OF CERTIFICATES OF DEPOSIT OF $100,000 OR MORE
(Dollars in thousands)
Our borrowed funds at December 31, 2007 totaled $206.3 million. The major component was $77.2 million in various advances from the FHLB. We have borrowed from the FHLB under a Blanket Agreement for Advances and Security Agreement, under which our Banks have pledged residential first-mortgage loans, commercial real estate loans and investment securities of $467.1 million as collateral to secure available advances. At December 31, 2007, our lendable collateral value, which represents approximately 23.3% of eligible collateral, was $108.8 million, $31.6 million of which was available. These advances have maturities in varying lengths through January 2011 and interest rates ranging from 3.50% to 5.92%. Total outstanding advances from the FHLB averaged $55.0 million during 2007, with an average interest cost of 5.27%. Of the $77.2 million in FHLB advances outstanding at December 31, 2007, $36.0 million, or 46.6%, mature during 2008. Another $31.2 million, or 40.4%, mature in 2009, and another $5.0 million or 6.4% mature in 2010. The remaining $5.0 million, or 6.6%, mature after three years. In 2006, FHLB advances averaged $67.1 million with an average interest cost of 4.84%.
At the request of the Federal Reserve Bank of Atlanta, our Board of Directors passed a resolution stating that we will not incur additional debt at the holding company without the prior approval of the Federal Reserve Bank of Atlanta.
We have a revolving line of credit with Silverton Bank (formerly The Bankers Bank, N.A.) in Atlanta, Georgia totaling $22.0 million. The line is secured with the common stock of Security Bank of Bibb County (and indirectly the stock of Fairfield Financial as its subsidiary), Security Bank of Houston County and Security Bank of Jones County as collateral, and carries a floating interest rate of the Prime Rate minus 100 basis points. We use the revolving line of credit primarily to provide capital injections as necessary to our Banks. At December 31, 2007 and 2006 the outstanding balance on the revolving line of credit was $17.5 million and zero, respectively. Total outstanding advances from the line of credit averaged $4.1 million during 2007, with an average interest cost of 6.56%. We did not borrow under the line of credit during 2006.
The revolving line of credit with Silverton Bank contains several debt covenants that are to be met either by the Company or the individual Banks. The covenants specify minimum amounts with respect to capital ratios, return on average assets, allowance for loan losses as a percentage of loans and classified loans. At December 31, 2007, we failed two of these covenants: (1) minimum return on assets of 0.90% for any fiscal year and (2) total of assets classified as substandard, doubtful or loss should not exceed 45% of Tier 1 capital plus the allowance for loan losses. The Company has a cure period of six months to regain compliance with these covenants. If the Company does not regain compliance at the end of the cure period, the lender has the right to call the line of credit due and payable in full, or we can request a waiver of these covenants.
We also have a line of credit for $2 million with Thomasville National Bank. The line of credit matures on March 21, 2008 and interest is payable quarterly based on the Prime Rate. At December 31, 2007, the outstanding balance under the line of credit was $2.0 million. We received the $2.0 million advance from the line of credit on December 28, 2007; therefore, the average balance and related interest were minimal. For 2006, the average balance was $0.7 million with an average interest cost of 6.95%.
During the fourth quarter of 2002, a subsidiary trust issued $18.0 million in trust preferred securities. To support the trust preferred securities issued by the trust, we issued a like amount of junior subordinated debentures to the trust, which the trust purchased from us using proceeds from its sale of the trust preferred securities. The trust preferred securities and related junior subordinated debentures pay interest at a floating annual rate, reset quarterly, equal to the three-month LIBOR rate plus 3.25%, which equaled 8.11% at December 31, 2007. We used the proceeds from this trust preferred securities offering to retire holding company debt and to fund our acquisition of Security Bank of Jones County.
In December 2005, a subsidiary trust issued $19.0 million in trust preferred securities. To support the trust preferred securities issued by the trust, we issued a like amount of junior subordinated debentures to the trust, which the trust purchased from us using proceeds from its sale of the trust preferred securities. We used the
proceeds from this trust preferred securities offering to pay off our line of credit with The Bankers Bank (currently Silverton Bank) and to fund the acquisition of Rivoli BanCorp. The trust preferred securities issued by the trust in 2005, and the junior subordinated debentures we issued to the trust in connection with that offering, bear a fixed rate of interest equal to 6.46% annually for the first five years and a floating rate of interest, reset quarterly, equal to the three-month LIBOR rate plus 1.40% annually thereafter. In each case, the trust preferred securities and related junior subordinated debentures issued by us have a maturity of 30 years and are redeemable after five years, subject to certain conditions and limitations.
In connection with our acquisition of Rivoli BanCorp, we assumed $3.0 million in junior subordinated debentures issued to a trust subsidiary in connection with an issuance of trust preferred securities. Rivoli BanCorps trust subsidiary issued trust preferred securities in 2002 through a pool sponsored by Wells Fargo Bank. The Rivoli BanCorp trust preferred securities and related junior subordinated debentures have a 30-year maturity and are redeemable after five years, subject to certain conditions and limitations. The Rivoli BanCorp trust preferred securities and related junior subordinated debentures pay interest at a floating annual rate, reset quarterly, equal to the three-month LIBOR rate plus 3.45%, which rate equaled 8.32% at December 31, 2007.
The following table outlines our various sources of borrowed funds during the years 2007, 2006 and 2005, the amounts outstanding at year end, at the maximum point for each component during the three years and on average for each year, and the average interest rate that we paid for each borrowing source. The maximum month-end balance represents the high indebtedness for each component of borrowed funds at any time during each of the calendar years shown.
(Dollars in thousands)