ITEM 1. BUSINESS.
First Pulaski National Corporation, (the "Corporation" or the "registrant") is a financial corporation engaged in general commercial and retail banking business through its subsidiary bank First National Bank of Pulaski ("First National" or the "Bank").
During the third quarter of 2001, First National's wholly-owned subsidiary, First Pulaski Reinsurance Company ("FPRC") received its insurance license. FPRC is engaged in the business of reinsuring credit insurance written by the Corporation's subsidiaries.
The Corporation was organized under the laws of the state of Tennessee in 1981 and its only significant asset is the common stock of First National, headquartered in Pulaski, Tennessee.
The Corporation, through its subsidiaries, offers a diversified range of financial services to its customers. These include activities related to general banking business with complete services in the commercial, corporate and retail banking fields.
The Bank offers a wide range of banking services, including checking, savings, and money market deposit accounts, certificates of deposit and loans for consumer, commercial and real estate purposes. The Bank does not have a concentration of deposits obtained from a single person or entity or a small group of persons or entities, the loss of which would have a material adverse effect on the business of the Bank.
The Corporation owns all of the common stock of the Bank. At December 31, 2010, the Corporation and its subsidiaries had combined total assets of $601,140,219.
At December 31, 2010, the Bank had long-term indebtedness of approximately $7.55 million in the form of advances payable to the Federal Home Loan Bank of Cincinnati. Note 9 to the Corporation's Consolidated Financial Statements includes a detailed analysis of this debt. The Corporation derives its primary source of funds from deposits acquired through the Bank. The Bank is the largest financial institution in Giles County, Tennessee, measured by county deposits. It has two branches in Lincoln County, Tennessee, where it is also the largest financial institution, measured by county deposits. The Bank is the fifth largest financial institution in Marshall County, Tennessee, the fifth largest financial institution in Limestone County, Alabama, and the twenty-first largest financial institution in Madison County, Alabama, measured by county deposits.
As of February 28, 2011, First National had 174 employees, 11 of whom were part-time. The Corporation has no employees other than those employed by First National and its subsidiaries.
COMPETITION
First National operates principally in three counties in Tennessee, Giles County, Lincoln County, and Marshall County, and two counties in Alabama, Limestone County and Madison County. The following discussion of market areas contains the most recent information available from reports filed with the FDIC and the Office of Thrift Supervision.
Giles County, Tennessee. First National competes in Giles County with five (5) commercial banking organizations. Four (4) of the five (5) commercial banking competitors are small community banking organizations. The other commercial banking competitor is owned by a large regional bank holding company. From June 30, 2008 to June 30, 2010, total deposits for all commercial banks in the Giles County market decreased 5.1% from $627.6 million to $595.8 million. First National has five (5) offices in Giles County, and approximately 52% of its deposits are located there. As of June 30, 2010, First National had the largest market share of banks in Giles County with a 46.5% share of the bank deposits.
Giles County is located in southern Middle Tennessee, approximately 70 miles from Nashville, Tennessee. Pulaski is the largest city in Giles County. Giles County had an estimated population of 29,082 in 2009 and an estimated median household income of $38,046 in 2009, the latest available data.
Lincoln County, Tennessee. First National competes in Lincoln County with six (6) commercial banking organizations. Two (2) of the commercial banking competitors are owned by regional or national multi-bank holding companies. The other four (4) commercial banking competitors are small community banking organizations. From June 30, 2008 to June 30, 2010, total deposits for all commercial banks in Lincoln County decreased 1.3% from $515.1 million to $508.5 million. First National has
two (2) branch offices located in this market, and approximately 25% of its deposits are located there. As of June 30, 2010, First National had a 26.8% share of the Lincoln County bank deposit market, the largest market share in the county.
Lincoln County is also located in southern Middle Tennessee, approximately 80 miles from Nashville, Tennessee. The largest city in Lincoln County is Fayetteville. Lincoln County had an estimated population of 33,374 in 2009, and an estimated median household income of $40,108 in 2009, the latest available data.
Marshall County, Tennessee. First National competes in Marshall County with five (5) commercial banking organizations. Four (4) of the five (5) commercial banking competitors are small community banking organizations. The other commercial banking competitor is owned by a national bank holding company. From June 30, 2008 to June 30, 2010, total deposits for all commercial banks in the Marshall County market decreased 0.7% from $430.3 million to $427.1 million. First National has two (2) offices in Marshall County and approximately 7% of its deposits are located there. As of June 30, 2010, First National had the fifth largest market share of banks in Marshall County with a 9.0% share of the bank deposits.
Marshall County is located in southern Middle Tennessee, approximately 50 miles from Nashville, Tennessee. Lewisburg is the largest city in Marshall County. Marshall County had an estimated population of 30,279 in 2009 and an estimated median household income of $41,681 in 2009, the latest available data.
Madison County, Alabama. In January 2008, the Bank opened a branch in a leased facility in Huntsville, located in Madison County, Alabama. Madison County, Alabama is the first urban market in which the Bank opened a branch and the first branch located outside the state of Tennessee. Madison County had an estimated population of 327,744 in 2009 and an estimated median household income of $57,327 in 2009, the latest available data. First National has one (1) office in Madison County and competes with twenty-three (23) commercial banking organizations in the county. Approximately 2% of the Bank's deposits are located there. As of June 30, 2010, First National had the twenty-first largest market share of banks in Madison County with a 0.15% share of the bank deposits. Total deposits for all commercial banks in the Madison County market was $6.458 billion as of June 30, 2010.
Limestone County, Alabama. In April 2008, the Bank opened a branch in Athens, located in Limestone County, Alabama. Limestone County had an estimated population of 78,572 in 2009 and an estimated median household income of $46,610 in 2009, the latest available data. First National has one (1) office in Limestone County and competes with eight (8) commercial banking organizations in the county. Approximately 14% of the Bank's deposits are located there. As of June 30, 2010, First National had the fifth largest market share of banks in Limestone County with an 11.4% share of the bank deposits. Total deposits for all commercial banks in the Limestone County market was $749.8 million as of June 30, 2010.
The Bank has substantial competition in attracting and retaining deposits and in lending funds. The primary factors in competing for deposits are the range and quality of financial services offered, the ability to offer attractive rates and availability of convenient office locations as well as convenient on-line banking capabilities. Direct competition for deposits comes from other commercial banks (as well as from credit unions and savings institutions in neighboring counties). Additional significant competition for savings deposits may come from other investment alternatives, such as money market mutual funds and corporate and government securities. The primary factors in competing for loans are the range and quality of the lending services offered, interest rates and loan origination fees. Competition for the origination of loans normally comes from other savings and financial institutions, commercial banks, credit unions, insurance companies and other financial service companies. The Corporation believes that its strategy in relationship banking and local autonomy in the communities it serves allows flexibility in rates and products offered in response to local needs. The Corporation believes this is its most effective method of competing with both the larger regional bank holding companies and the smaller community banks.
The Corporation does not maintain an internet website. As such, the Corporation does not make available on a website free of charge its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports. The Corporation will, however, provide paper copies of such filings free of charge upon request. To request any of these documents please write to First Pulaski National Corporation, Attention: Corporate Secretary, 206 South First Street, Pulaski, Tennessee 38478.
SUPERVISION AND REGULATION
Both the Corporation and First National are subject to extensive state and federal banking laws and regulations that impose restrictions on and provide for general regulatory oversight of the Corporation's and First National's operations. These laws and regulations are generally intended to protect depositors and borrowers, not shareholders. In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") was signed into law, incorporating numerous financial institution regulatory reforms. Many of these reforms will be implemented over the course of 2011 through
regulations to be adopted by various federal banking and securities regulations. The following summary of applicable statutes and regulations does not purport to be complete and is qualified in its entirety by reference to such statutes and regulations.
First Pulaski National Corporation
The Corporation is a bank holding company under the federal Bank Holding Company Act of 1956. As a result, it is subject to the supervision, examination and reporting requirements of the Bank Holding Company Act and the regulations of the Federal Reserve.
The Dodd-Frank Wall Street Reform and Consumer Protection Act. In July 2010, the Dodd-Frank Act was signed into law, incorporating numerous financial institution regulatory reforms. Many of these reforms will be implemented over the course of 2011 through regulations to be adopted by various federal banking and securities regulations. The following discussion describes the material elements of the regulatory framework that currently apply. The Dodd-Frank Act implements far-reaching reforms of major elements of the financial landscape, particularly for larger financial institutions. Many of its most far-reaching provisions do not directly impact community-based institutions like the Corporation. For instance, provisions that regulate derivative transactions and limit derivatives trading activity of federally-insured institutions, enhance supervision of "systemically significant" institutions, impose new regulatory authority over hedge funds, limit proprietary trading by banks, and phase-out the eligibility of trust preferred securities for Tier 1 capital are among the provisions that do not directly impact the Corporation either because of exemptions for institutions below a certain asset size or because of the nature of the Corporation's operations. Other provisions that will impact the Corporation will:
Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminate the ceiling and increase the size of the floor of the Deposit Insurance Fund, and offset the impact of the increase in the minimum floor on institutions with less than $10 billion in assets.
Make permanent the $250,000 limit for federal deposit insurance, increase the cash limit of Securities Investor Protection Corporation protection to $250,000 and provide unlimited federal deposit insurance until December 31, 2012 for non-interest-bearing demand transaction accounts at all insured depository institutions.
Repeal the federal prohibition on payment of interest on demand deposits, thereby permitting depositing institutions to pay interest on business transaction and other accounts.
Centralize responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing federal consumer protection laws, although banks below $10 billion in assets will continue to be examined and supervised for compliance with these laws by their federal bank regulator.
Restrict the preemption of state law by federal law and disallow national bank subsidiaries from availing themselves of such preemption.
Impose new requirements for mortgage lending, including new minimum underwriting standards, prohibitions on certain yield-spread compensation to mortgage originators, special consumer protections for mortgage loans that do not meet certain provision qualifications, prohibitions and limitations on certain mortgage terms and various new mandated disclosures to mortgage borrowers.
Apply the same leverage and risk based capital requirements that apply to insured depository institutions to holding companies.
Permit national and state banks to establish de novo interstate branches at any location where a bank based in that state could establish a branch, and require that bank holding companies and banks be well-capitalized and well managed in order to acquire banks located outside their home state.
Impose new limits on affiliated transactions and cause derivative transactions to be subject to lending limits.
Implement corporate governance revisions, including with regard to executive compensation and proxy access to shareholders that apply to all public companies not just financial institutions.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, and their impact on the Corporation or the financial industry is difficult to predict before such regulations are adopted.
Acquisition of Banks. The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserve's prior approval before:
Acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank's voting shares;
Acquiring all or substantially all of the assets of any bank; or
Merging or consolidating with any other bank holding company.
Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would substantially lessen competition or otherwise function as a restraint of trade, or result in or tend to create a monopoly, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the communities to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the communities to be served. The Federal Reserve's consideration of financial resources generally focuses on capital adequacy, which is discussed below.
Under the Bank Holding Company Act, as amended by the Dodd-Frank Act, if well capitalized and well managed, the Corporation or any other bank holding company located in Tennessee may purchase a bank located outside of Tennessee. Conversely, a well capitalized and well managed bank holding company located outside of Tennessee may purchase a bank located inside Tennessee. In each case, however, state law restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits. For example, Tennessee law currently prohibits a bank holding company from acquiring control of a Tennessee-based financial institution until the target financial institution has been in operation for three years
.
Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Federal Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring "control" of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:
The bank holding company has registered securities under Section 12 of the Securities Exchange Act of 1934; or
No other person owns a greater percentage of that class of voting securities immediately after the transaction.
The Corporation's common stock is registered under Section 12 of the Securities Exchange Act of 1934. The regulations provide a procedure for challenge of the rebuttable control presumption.
Permitted Activities. Under the Bank Holding Company Act, a bank holding company, which has not qualified or elected to become a financial holding company, is generally prohibited from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in nonbanking activities unless, prior to the enactment of the Gramm-Leach-Bliley Act, the Federal Reserve found those activities to be so closely related to banking as to be a proper incident to the business of banking. Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include: (i) factoring accounts receivable; (ii) acquiring or servicing loans; (iii) leasing personal property; (iv) conducting discount securities brokerage activities; (v) performing selected data processing services; (vi) acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and (vii) performing selected insurance underwriting activities.
Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company's continued ownership, activity or control constitutes a serious risk to the financial safety, soundness, or stability of any of its bank subsidiaries.
Support of Subsidiary Institutions. Under the Dodd-Frank Act, and previously under Federal Reserve policy, the Corporation is expected to act as a source of financial strength for First National and to commit resources to support First National. This support may be required at times when it would not be in the best interests of the Corporation's shareholders and creditors to provide it. If First National's capital levels were to fall below minimum regulatory guidelines, First National would need to develop a capital plan to increase its capital levels and the Corporation would be required to guarantee First National's
compliance with the capital plan in order for such plan to be accepted by the federal regulatory authority. In the unlikely event of the Corporation's bankruptcy, any commitment by it to a federal bank regulatory agency to maintain the capital of First National would be assumed by the bankruptcy trustee and entitled to a priority of payment.
First National
First National is a national bank chartered under the Federal National Bank Act. As a result, it is subject to the supervision, examination and reporting requirements of the Federal National Bank Act and the regulations of the Office of the Comptroller of the Currency (the "OCC"). The OCC regularly examines First National's operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The OCC also has the power, in connection with its examinations, to identify matters necessary to improve a bank's operations in accordance with principles of safety and soundness. Any matters identified in such examinations are required to be appropriately addressed by the bank. Additionally, First National's deposits are insured by the FDIC to the maximum extent provided by law. First National also is subject to numerous state and federal statutes and regulations that will affect its business, activities and operations.
Branching. While the OCC has authority to approve branch applications, national banks are required by the Federal National Bank Act to adhere to branching laws applicable to state-chartered banks in the states in which they are located. With prior regulatory approval, Tennessee law permits banks based in the state to either establish new or acquire existing branch offices throughout Tennessee. As a result of the Dodd-Frank Act, First National and any other national or state-chartered bank generally may branch across state lines to the same extent as banks chartered in the state of the branch if allowed by the applicable states' laws. Tennessee law, with limited exceptions, currently permits branching across state lines either through interstate merger or branch acquisition. Tennessee, however, only permits an out-of-state bank, short of an interstate merger, to branch into Tennessee through branch acquisition if the state of the out-of-state bank permits Tennessee-based banks to acquire branches there.
FDIC Insurance. The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. Under the Dodd-Frank Act, the FDIC was required to adopt regulations that would base deposit insurance assessments on total assets less capital rather than deposit liabilities and to include off-balance sheet liabilities of institutions and their affiliates in risk-based assessments.
The Emergency Economic Stabilization Act of 2008 ("EESA") provided for a temporary increase in the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. This increased level of basic deposit insurance was made permanent by the Dodd-Frank Act. In addition, on October 14, 2008, the FDIC instituted temporary unlimited FDIC coverage of non-interest bearing deposit transaction accounts. Following passage of the Dodd-Frank Act, an institution can provide full coverage on non-interest bearing transaction accounts until December 31, 2012. The Dodd-Frank Act also repealed the prohibition on paying interest on demand transaction accounts, but did not extend unlimited insurance protection for these accounts.
The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Capital Adequacy
The Corporation and First National are required to comply with the capital adequacy standards established by the Federal Reserve, in the Corporation's case, and the OCC, in the case of First National. The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for bank holding companies. First National is also subject to risk-based and leverage capital requirements adopted by the OCC, which are substantially similar to those adopted by the Federal Reserve for bank holding companies. In addition, the OCC may require national banks to maintain capital at levels higher than those required by general regulatory requirements.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.
In late 2010, the Basel Committee on Banking Supervision issued Basel III, a new capital framework for banks and bank holding companies. If implemented in the United States, Basel III will impose a stricter definition of capital, with more focus on common equity. At this time, we do not know whether Basel III will be implemented in the United States, and if so
implemented whether it will be applicable to the Corporation and First National, because by its terms it is applicable only to internationally active banks. But, if Basel III is implemented in the United States and becomes applicable to us, the Corporation and First National would likely be subject to higher minimum capital ratios than those to which the Corporation and First National are currently subject.
Failure to meet capital guidelines set out in OCC regulations or separately imposed on a bank holding company or a bank by the bank holding company's or bank's regulators could subject a bank holding company or bank a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits or paying in excess of a certain percentage of interest on deposits and other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements. For a more detailed discussion of capital requirements and the Corporation's and the Bank's capital levels see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources, Capital and Dividends" and Note 15 to the Notes to Consolidated Financial Statements.
Prompt Corrective Action
The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) into one of which all institutions are placed. Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category.
An institution that is categorized as undercapitalized, significantly undercapitalized or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company's obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiary's assets or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution and a lower capital category based on supervisory factors other than capital. As of December 31, 2010, First National met the conditions necessary to be considered "well capitalized" by its primary regulator.
The Dodd-Frank Act contains a number of provisions dealing with capital adequacy of insured depository institutions and their holding companies, and for the most part will result in insured depository institutions and their holding companies being subject to more stringent capital requirements. Under the so-called Collins Amendment to the Dodd-Frank Act, federal regulators were directed to establish minimum leverage and risk-based capital requirements for, among other entities, banks and bank holding companies on a consolidated basis. These minimum requirements can't be less than the generally applicable leverage and risk-based capital requirements established for insured depository institutions nor quantitatively lower than the leverage and risk-based capital requirements established for insured depository institutions that were in effect as of the date that the Dodd-Frank Act was enacted. These requirements in effect create capital level floors for bank holding companies similar to those in place currently for insured depository institutions.
Payment of Dividends
The Corporation is a legal entity separate and distinct from First National. The principal sources of the Corporation's cash flow, including cash flow to pay dividends to its shareholders, are dividends that First National pays to it as its sole shareholder. Statutory and regulatory limitations apply to First National's payment of dividends to the Corporation as well as to the Corporation's payment of dividends to its shareholders.
Under Tennessee law, the Corporation is not permitted to pay dividends if, after giving effect to such payment, it would not be able to pay its debts as they become due in the usual course of business or its total assets would be less than the sum of its total liabilities plus any amounts needed to satisfy any preferential rights if the Corporation were dissolving. In addition, in deciding whether or not to declare a dividend of any particular size, the Corporation's board of directors must consider the Corporation's and First National's current and prospective capital, liquidity, and other needs.
Statutory and regulatory limitations also apply to First National's payment of dividends to the Corporation. First National is required by federal law to obtain the prior approval of the OCC for payments of dividends if the total of all dividends declared by its board of directors in any year will exceed (1) the total of First National's net profits for that year, plus (2) First National's retained net profits of the preceding two years, less any required transfers to surplus. During 2011, the Bank could, without prior approval, declare dividends of approximately $3,370,000 plus any 2011 net profits retained to the date of the dividend declaration.
The payment of dividends by the Corporation and First National may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines or more restrictive requirements imposed on the Corporation or First National by regulators or themselves. If, in the opinion of the OCC, First National was engaged in or about to engage in an unsafe or unsound practice, the OCC could require, after notice and a hearing, that First National stop or refrain from engaging in the practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution's capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. See "Prompt Corrective Action" above.
Restrictions on Transactions with Affiliates
Both the Corporation and First National are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:
A bank's loans or extensions of credit, including purchases of assets subject to an agreement to repurchase, to affiliates;
A bank's investment in affiliates;
Assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;
The amount of loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates;
Transactions involving the borrowing or lending of securities and any derivative transaction that results in credit exposure to an affiliate; and
A bank's guarantee, acceptance or letter of credit issued on behalf of an affiliate.
The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank's capital and surplus and, as to all affiliates combined, to 20% of a bank's capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. First National must also comply with other provisions designed to avoid the taking of low-quality assets.
The Corporation and First National are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibits an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
First National is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.
Community Reinvestment
The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve, the OCC or the FDIC shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low- and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on First National. Additionally, banks are required to publicly
disclose the terms of various Community Reinvestment Act-related agreements. First National has received a "satisfactory" CRA rating from the OCC.
Privacy
Under the Gramm-Leach-Bliley Act, financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing personal financial information with nonaffiliated third parties except for third parties that market the institutions' own products and services. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing through electronic mail to consumers. First National has established a privacy policy to ensure compliance with federal requirements.
Other Consumer Laws and Regulations
Interest and other charges collected or contracted for by First National are subject to state usury laws and federal laws concerning interest rates. For example, under the Soldiers' and Sailors' Civil Relief Act of 1940, a lender is generally prohibited from charging an annual interest rate in excess of 6% on any obligations for which the borrower is a person on active duty with the United States military. First National's loan operations are also subject to federal laws applicable to credit transactions, such as the:
Federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;
Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
Bank Secrecy Act, governing how banks and other firms report certain currency transactions and maintain appropriate safeguards against "money laundering" activities;
Soldiers' and Sailors' Civil Relief Act of 1940, governing the repayment terms of, and property rights underlying, secured obligations of persons in active military service; and
Rules and regulations of the various federal agencies charged with the responsibility of implementing the federal laws.
First National's deposit operations are subject to the:
Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities (including with respect to the permissibility of overdraft charges) arising from the use of automated teller machines and other electronic banking services.
Anti-Terrorism Legislation
On October 26, 2001, the President of the United States signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and "know your customer" standards in their dealings with foreign financial institutions and foreign customers.
In addition, the USA PATRIOT Act authorizes the U.S. Secretary of the Treasury to adopt rules increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to have violated the privacy provisions of the Gramm-Leach-Bliley Act, as discussed above. First National currently has policies and procedures in place designed to comply with the USA PATRIOT Act.
Recent and Proposed Legislation and Regulatory Action
New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of the nation's financial institutions. In 2010, the U.S. Congress passed the Dodd-Frank Act, which includes significant consumer protection provisions related to residential mortgage loans that is likely to increase the Corporation's regulatory compliance costs. The Corporation cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which its business may be affected by any new regulation or statute. With the enactments of EESA, AARA and the Dodd-Frank Act and the significant amount of regulations that are to come from the passage of that legislation, the nature and extent of the future legislative and regulatory changes affecting financial institutions and the resulting impact on those institutions is very unpredictable at this time. The Dodd-Frank Act, in particular, will require that a significant number of new regulations be adopted by various financial regulatory agencies over 2011 and 2012.
Effect of Governmental Monetary Policies
The Corporation's earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve's monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through the Federal Reserve's statutory power to implement national monetary policy in order to, among other things, curb inflation or combat a recession. The Federal Reserve, through its monetary and fiscal policies, affects the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. The Corporation cannot predict the nature or impact of future changes in monetary and fiscal policies.
ITEM 1A.
ITEM 1A. RISK FACTORS.
Investing in our common stock involves various risks which are particular to our corporation, our industry and our market area. Several risk factors regarding investing in our common stock are discussed below. This listing should not be considered as all-inclusive. If any of the following risks were to occur, we may not be able to conduct our business as currently planned and our financial condition or operating results could be negatively impacted. These matters could cause the trading price of our common stock to decline in future periods.
Negative developments in the U.S. and local economy and in local real estate markets have adversely impacted the Corporation's results and may continue to adversely impact the Corporation's results in the future.
Economic conditions in the markets in which the Corporation operates deteriorated significantly between early 2008 and the middle of 2010. As a result, the Corporation has experienced a significant reduction in its earnings when compared to historical levels. These challenges result from provisions for loan losses related to declining collateral values in the Corporation's real estate construction and development loan portfolio. Although economic conditions began to stabilize in the Corporation's markets in the second half of 2010, management of the Corporation believes that it will continue to experience a challenging economic environment in 2011. Accordingly, management expects that its results of operations will continue to be negatively impacted in 2011. There can be no assurance that the economic conditions that have adversely affected the financial services industry, and the capital, credit and real estate markets, generally, or the Corporation in particular, will improve materially, or at all, in the near future, or thereafter, in which case the Corporation could continue to experience reduced earnings and write-downs of assets, and could face capital and liquidity constraints or other business challenges.
The Corporation could sustain losses if its asset quality declines.
The Corporation's earnings are significantly affected by its ability to properly originate, underwrite and service loans. The Corporation could sustain losses if it incorrectly assesses the creditworthiness of its borrowers or fails to detect or respond to deterioration in asset quality in a timely manner. Problems with asset quality could cause the Corporation's interest income and net interest margin to decrease and its provisions for loan losses to increase, which could adversely affect its results of operations and financial condition. Further increases to non-performing loans would reduce net interest income below levels that would exist if those loans were performing.
An inadequate allowance for loan losses would reduce the Corporation's earnings.
The risk of credit losses on loans varies 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 value and marketability of the collateral for the loan. Management maintains an allowance for loan losses based upon, among other things, historical experience, internal loan classifications, trends in classifications, an evaluation of national and local economic conditions and volumes and trends in delinquencies, nonaccruals and charge-offs, loss experience of various loan categories and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectability of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and takes a charge against earnings with respect to specific loans when their ultimate collectability is considered questionable. If management's assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb losses, or if the bank regulatory authorities require First National to increase the allowance for loan losses as a part of their examination process, First National's and the Corporation's earnings and capital could be significantly and adversely affected. In addition, federal and state regulators periodically review First National's loan portfolio and may require it to increase its allowance for loan losses or recognize loan charge-offs. Their conclusions about the quality of a particular borrower or First National's entire loan portfolio may be different than the conclusions reached by First National. Any increase in First National's allowance for loan losses or loan charge-offs as required by these regulatory agencies could have a negative effect on the Corporation's operating results. Moreover, additions to the allowance may be necessary based on changes in economic and real estate market conditions, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of First National's management's control. These additions may require increased provision expense which would negatively impact the Corporation's results of operations.
Negative developments in the financial services industry and U.S. and global credit markets may adversely impact the Corporation's operations and results.
Negative developments in the latter half of 2007 and throughout 2008, 2009 and 2010 in the capital markets have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing at least into 2011. Loan portfolio performances have deteriorated at many institutions resulting from, amongst other factors, a weak economy and a decline in the value of the collateral supporting their loans. The competition for the Corporation's deposits has increased significantly due to liquidity concerns at many of these same institutions. Stock prices of bank holding companies, like the Corporation, have been negatively affected by the current condition of the financial markets, as has the Corporation's ability, if needed, to raise capital or borrow in the debt markets compared to recent years.
Liquidity needs could adversely affect the Corporation's results of operations and financial condition.
The Corporation relies on dividends from First National as its primary source of funds. The primary sources of First National are customer deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters and international instability. Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions. Accordingly, the Corporation may be required from time to time to rely on secondary sources of liquidity, which in some cases may be more costly, to meet withdrawal demands or otherwise fund operations. Such sources include Federal Home Loan Bank advances, brokered certificates of deposit and federal funds lines of credit from correspondent banks. The availability of these noncore funding sources are subject to broad economic conditions and, as such, the pricing on these sources may fluctuate significantly and/or be restricted at any point in time, thus impacting the Corporation's net interest income, its immediate liquidity and/or its access to additional liquidity. While the Corporation believes that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands.
As the Corporation has expanded its operations into more urban areas in Alabama, it has significantly increased its real estate construction and development loans, which loans have a greater credit risk than residential mortgage loans.
The percentage of construction and land development loans in First National's portfolios to total loans was approximately 9.2% of total loans at December 31, 2010 down from 11.0% of total loans at December 31, 2009 and 13.9% at December 31, 2008 but higher than the 6.8% at December 31, 2007. This type of lending is generally considered to have more complex credit risks than traditional single-family residential lending because the principal is concentrated in a limited number of loans with repayment dependent on the successful completion and operation of the related real estate project. Consequently, the credit quality of many of these loans has deteriorated as a result of the current adverse conditions in the real estate market. These loans are generally less predictable and more difficult to evaluate and monitor and collateral may be difficult to dispose of in a
market decline. A continued reduction in residential real estate market prices and demand could result in further price reductions in home and land values adversely affecting the value of collateral securing the construction and development loans that First National holds. These adverse economic and real estate market conditions may lead to further increases in non-performing loans and other real estate owned, increased losses and expenses from the management and disposition of non-performing assets, increases in provision for loan losses, and increases in operating expenses as a result of the allocation of management time and resources to the collection and work out of loans, all of which would negatively impact the Corporation's financial condition and results of operations.
The Corporation is geographically concentrated in Giles, Lincoln and Marshall Counties, Tennessee, and Limestone and Madison Counties, Alabama and changes in local economic conditions impact its profitability.
The Corporation operates primarily in Giles, Lincoln and Marshall Counties in Tennessee and Limestone and Madison Counties in Alabama, and substantially all of its loan customers and most of its deposit and other customers live or have operations in this same geographic area. Accordingly, the Corporation's success significantly depends upon the growth in population, income levels, deposits and housing starts in these areas, along with the continued attraction of business ventures to the area, and its profitability is impacted by the changes in general economic conditions in these markets. Economic conditions in the Corporation's market areas weakened during 2009 and 2010, negatively affecting the Corporation's operations, particularly the real estate construction and development segment of its loan portfolio. Additionally, unemployment levels continued at elevated levels in the Corporation's markets in 2010. The Corporation cannot assure you that economic conditions in its markets will improve during 2011 or thereafter, and continued weak economic conditions in its markets could cause the Corporation to continue to reduce the Corporation's asset size or constrict it's growth, affect the ability of its customers to repay their loans and generally affect the Corporation's financial condition and results of operations. The Corporation is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies.
The Corporation has increased levels of other real estate owned, primarily as a result of foreclosures, and the Corporation anticipates higher levels of foreclosed real estate expense.
As the Corporation continues to resolve non-performing real estate loans, foreclosed properties have remained at elevated levels, primarily those acquired from builders and from residential land developers. Foreclosed real estate expense consists of three types of charges: maintenance costs, valuation adjustments to appraisal values and gains or losses on disposition. As levels of other real estate owned increase and also as local real estate values decline, these charges will increase, negatively impacting the Corporation's results of operations.
Environmental liability associated with commercial lending could result in losses.
In the course of business, First National may acquire, through foreclosure, properties securing loans it has originated or purchased which are in default. Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties. In this event, the Corporation, or First National, might be required to remove these substances from the affected properties at the Corporation's sole cost and expense. The cost of this removal could substantially exceed the value of affected properties. The Corporation may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have a material adverse effect on the Corporation's business, results of operations and financial condition.
Implementation of the various provisions of the Dodd-Frank Act may increase the Corporation's operating costs or otherwise have a material affect on the Corporation's business, financial condition or results of operations.
On July 21, 2010, President Obama signed the Dodd-Frank Act. This landmark legislation includes, among other things, (i) the creation of a Financial Services Oversight Counsel to identify emerging systemic risks and improve interagency cooperation; (ii) the elimination of the Office of Thrift Supervision and the transfer of oversight of federally chartered thrift institutions and their holding companies to the Office of the Comptroller of the Currency and the Federal Reserve; (iii) the creation of a Consumer Financial Protection Agency authorized to promulgate and enforce consumer protection regulations relating to financial products that would affect banks and non-bank finance companies; (iv) the establishment of new capital and prudential standards for banks and bank holding companies; (v) the termination of investments by the U.S. Treasury under TARP; (vi) enhanced regulation of financial markets, including the derivatives, securitization and mortgage origination markets; (vii) the elimination of certain proprietary trading and private equity investment activities by banks; (viii) the elimination of barriers to de novo interstate branching by banks; (ix) a permanent increase of the previously implemented temporary increase of FDIC deposit insurance to $250,000; (x) the authorization of interest-bearing transaction accounts; and (xi) changes in how the FDIC deposit insurance assessments will be calculated and an increase in the minimum designated reserve ratio for the Deposit Insurance Fund.
Certain provisions of the legislation are not immediately effective or are subject to required studies and implementing regulations. Further, community banks with less than $10 billion in assets (like the Corporation) are exempt from certain provisions of the legislation. The Corporation cannot predict how this significant new legislation may be interpreted and enforced or how implementing regulations and supervisory policies may affect the Corporation. There can be no assurance that these or future reforms will not significantly increase the Corporation's compliance or operating costs or otherwise have a significant impact on the Corporation's business, financial condition and results of operations.
National or state legislation or regulation may increase the Corporation's expenses and reduce earnings.
Federal bank regulators are increasing regulatory scrutiny, and additional restrictions, including those originating from the Dodd-Frank Act, on financial institutions have been proposed or adopted by regulators and by Congress. Changes in tax law, federal legislation, regulation or policies, such as bankruptcy laws, deposit insurance, consumer protection laws, and capital requirements, among others, can result in significant increases in the Corporation's expenses and/or charge-offs, which may adversely affect its earnings. Changes in state or federal tax laws or regulations can have a similar impact. Furthermore, financial institution regulatory agencies are expected to continue to be very aggressive in responding to concerns and trends identified in examinations, including the continued issuance of additional formal or informal enforcement or supervisory actions. These actions, whether formal or informal, could result in the Corporation's agreeing to limitations or to take actions that limit its operational flexibility, restrict its growth or increase its capital or liquidity levels. Failure to comply with any formal or informal regulatory restrictions, including informal supervisory actions, could lead to further regulatory enforcement actions. Negative developments in the financial services industry and the impact of recently enacted or new legislation in response to those developments could negatively impact the Corporation's operations by restricting its business operations, including its ability to originate or sell loans, and adversely impact its financial performance. In addition, industry, legislative or regulatory developments may cause the Corporation to materially change its existing strategic direction, capital strategies, compensation or operating plans.
Fluctuations in interest rates could reduce our profitability.
The absolute level of interest rates as well as changes in interest rates may affect the Corporation's level of interest income, the primary component of its gross revenue, as well as the level of its interest expense. Interest rate fluctuations are caused by many factors which, for the most part, are not under the Corporation's direct control. For example, national monetary policy plays a significant role in the determination of interest rates. Additionally, competitor pricing and the resulting negotiations that occur with the Corporation's customers also impact the rates the Corporation collects on loans and the rates it pays on deposits.
As interest rates change, the Corporation expects that it will periodically experience "gaps" in the interest rate sensitivities of its assets and liabilities, meaning that either its interest-bearing liabilities (usually deposits and borrowings) will be more sensitive to changes in market interest rates than its interest-earning assets (usually loans and investment securities), or vice versa. In either event, if market interest rates should move contrary to the Corporation's position, this "gap" may work against the Corporation, and its earnings may be negatively affected.
Changes in the level of interest rates also may negatively affect the Corporation's ability to originate real estate loans, the value of its assets and its ability to realize gains from the sale of its assets, all of which ultimately affect the Corporation's earnings. A decline in the market value of the Corporation's assets may limit the Corporation's ability to borrow additional funds. As a result, the Corporation could be required to sell some of its loans and investments under adverse market conditions, upon terms that are not favorable to the Corporation, in order to maintain its liquidity. If those sales are made at prices lower than the amortized costs of the investments, the Corporation will incur losses.
Competition from financial institutions and other financial service providers may adversely affect the Corporation's profitability.
The banking business is highly competitive, and the Corporation experiences competition in each of its markets from many other financial institutions. The Corporation competes 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 community banks and super-regional and national financial institutions that operate offices in the Corporations' primary market areas and elsewhere. Some of the Corporation's competitors are well-established, larger financial institutions that have greater resources and lending limits and a lower cost of funds than the Corporation has.
Additionally, the Corporation faces competition from de novo community banks, including those with senior management who were previously affiliated with other local or regional banks or those controlled by investor groups with strong local business and community ties. These de novo community banks may offer higher deposit rates or lower cost loans in an effort to attract the Corporation's customers and may attempt to hire the Corporation's management and employees.
The Corporation competes with these other financial institutions both in attracting deposits and in making loans. In addition, the Corporation has to attract its customer base from other existing financial institutions and from new residents. This competition has made it more difficult for the Corporation to make new loans and at times has forced the Corporation to offer higher deposit rates. Price competition for loans and deposits might result in the Corporation earning less interest on its loans and paying more interest on its deposits, which reduces the Corporation's net interest income. The Corporation's profitability depends upon its continued ability to successfully compete with an array of financial institutions in its market areas.
Loss of the Corporation's senior executive officers or other key employees could impair its relationship with its customers and adversely affect its business.
The Corporation has assembled a senior management team which has a substantial background and experience in banking and financial services in the Corporation's market areas. Loss of these key personnel could negatively impact the Corporation's earnings because of their skills, customer relationships and/or the potential difficulty of promptly replacing them.
The Corporation, as well as First National, operate in a highly regulated environment and are supervised and examined by various federal and state regulatory agencies which may adversely affect the Corporation's ability to conduct business.
The Office of the Comptroller of the Currency and the Board of Governors of the Federal Reserve supervise and examine First National and the Corporation, respectively. Because First National's deposits are federally insured, the FDIC also regulates its activities. These and other regulatory agencies impose certain regulations and restrictions on the Corporation and First National, including:
explicit standards as to capital and financial condition;
limitations on the permissible types, amounts and extensions of credit and investments;
restrictions on permissible non-banking activities; and
restrictions on dividend payments.
Federal and state regulatory agencies have extensive discretion and power to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies. As a result, the Corporation and First National each must expend significant time and expense to assure that it is in compliance with regulatory requirements and agency practices.
New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of the nation's financial institutions. The Corporation cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which the Corporation's business may be affected by any new regulation or statute.
The Corporation, as well as First National, also undergoes periodic examinations by one or more regulatory agencies. Following such examinations, the Corporation or First National may be required, among other things, to make additional provisions to its allowance for loan losses, maintain higher levels of capital than as required under general regulatory guidelines or to restrict its operations. These actions would result from the regulators' judgments based on information available to them at the time of their examination. First National's operations are also governed by a wide variety of state and federal consumer protection laws and regulations. These federal and state regulatory restrictions limit the manner in which the Corporation and First National may conduct business and obtain financing. These laws and regulations can and do change significantly from time to time, and any such change could adversely affect the Corporation's results of operations.
The Corporation's common stock is thinly traded, and recent prices may not reflect the prices at which the stock would trade in an active trading market.
The Corporation's common stock is not traded through an organized exchange, but rather is traded in individually-arranged transactions between buyers and sellers. Therefore, recent prices may not necessarily reflect the actual value of the Corporation's common stock. A shareholder's ability to sell the shares of common stock in the Corporation in a timely manner may be substantially limited by the lack of a trading market for the common stock.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable
ITEM 2.
ITEM 2. PROPERTIES.
The Corporation and the Bank are headquartered at 206 South First Street, Pulaski, Tennessee. The banking facility housing the headquarters was completed in 1966 and has undergone several major renovation and expansion projects over the years. The most recent expansion at this main office facility was completed in early 1995 and renovations to the facility were completed in 2009. An expansion and renovation of the Bank's Industrial Park Road office, which is owned by the Bank and is on the western edge of Pulaski, was completed in early 1996. The Minor Hill Road office, in the southern part of Pulaski, operates in a facility that is owned by the Bank and was completed in 1985. Other banking facilities operated by the Bank include owned offices at Ardmore in the southeastern corner of Giles County and in Fayetteville and Park City in adjacent Lincoln County, Tennessee. The Ardmore office, in existence since 1963, has also undergone several major expansions, with the most recent being completed in early 1993. In 2001, the Bank built a new facility that is owned by the Bank in Fayetteville. Construction of the Park City branch was completed in 1997. A facility on Flower Street near the main office in Pulaski, already owned by the Corporation and previously used for storage, was renovated and completed in 1998 primarily for the purpose of housing the Bank's mortgage lending operations. During 2009, the Bank moved its mortgage lending operations to the main office and is currently using the facility on Flower Street to house certain of the loan operations of the Bank. The Belfast office, which is owned by the Bank, was acquired by the Bank during the merger with the Bank of Belfast in 2002 and was last renovated in 1980. The Bank also assumed a leased facility in Lewisburg, Tennessee during the Bank of Belfast merger. In 2005, the Bank purchased land in Lewisburg for the construction of a new banking office that would replace the leased facility in that town. Construction was completed and the Bank moved into the new facility in Lewisburg in February, 2007. Also, in October 2005, the Bank opened an office in Lynnville, Tennessee in a renovated facility. In January 2008, the Bank opened its Huntsville Office in a leased facility. The Bank opened a temporary branch in Athens, Alabama in the April 2008 and constructed a new facility on the property adjacent to the temporary facility that was completed and opened April 2010.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Corporation and its subsidiary are involved, from time to time, in ordinary routine litigation incidental to the banking business. Neither the Corporation nor its subsidiary is currently involved in any material pending legal proceedings.
ITEM 4.
ITEM 4. (REMOVED AND RESERVED).
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Common stock of First Pulaski National Corporation is not traded through an organized exchange but is traded between local individuals. As such, price quotations are not available on Nasdaq or any other quotation service. The following trading prices for 2010 and 2009 represent trades of which the Corporation was aware and do not necessarily include all trading transactions for the period and may not necessarily reflect actual stock values.
Trading Prices
Dividends Paid
1st Quarter, 2010
$50.00 - 55.00
$0.25
2nd Quarter, 2010
$48.00 - 55.00
$0.25
3rd Quarter, 2010
$48.00 - 50.00
$0.25
4th Quarter, 2010
$45.00 - 55.00
$0.25
Total Annual Dividend, 2010
$1.00
1st Quarter, 2009
$50.00 - 55.00
$0.45
2nd Quarter, 2009
$50.00 - 55.00
$0.45
3rd Quarter, 2009
$50.00 - 55.00
$0.45
4th Quarter, 2009
$55.00 - 55.00
$0.25
Total Annual Dividend, 2009
$1.60
There were approximately 1,587 shareholders of record of the Corporation's common stock as of February 28, 2011.
The Corporation reviews its dividend policy at least annually. The amount of the dividend, while in the Corporation's sole discretion, depends in part upon the performance of First National. The Corporation's ability to pay dividends is restricted by federal laws and regulations applicable to bank holding companies and by Tennessee laws relating to the payment of dividends by Tennessee corporations. Because substantially all operations are conducted through its subsidiaries, the Corporation's ability to pay dividends also depends on the ability of the subsidiaries to pay dividends to the Corporation. The ability of First National to pay cash dividends to the Corporation is restricted by applicable regulations of the OCC and the FDIC. For a more detailed discussion of these limitations see "Item 1. Business - Supervision and Regulation - Payment of Dividends" and Note 15 to the Notes to Consolidated Financial Statements.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
The table below contains selected financial data for the Corporation for the last five years
. Note 18 to the Consolidated Financial Statements which follows shows figures for basic earnings per share and gives effect to dilutive stock options in determining diluted earnings per share. Total average equity and total average assets exclude unrealized gains or losses on investment securities.
(1) Total average equity and total average assets above excludes the unrealized gain or loss on investment securities.
The basic earnings per share data and the diluted earnings per share data in the above table are based on the following weighted average number of shares outstanding:
ITEM 7:
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The Corporation is a one-bank holding company with its only direct subsidiary being First National in Pulaski, Tennessee. During the third quarter of 2001, First National's wholly-owned subsidiary, FPRC, received its insurance license. FPRC is engaged in the business of reinsuring credit insurance written by the Corporation's subsidiary.
The following analysis should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report.
FORWARD-LOOKING STATEMENTS
Certain of the statements in this discussion may constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, (the "Exchange Act"), as amended. The words "expect," "anticipate," "intend," "should," "may," "could," "plan," "believe," "likely," "seek," "estimate" and similar expressions are intended to identify such forward-looking statements, but other statements not based on historical information may also be considered forward-looking. All forward-looking statements are subject to risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Corporation to differ materially from any results expressed or implied by such forward-looking statements. Such factors include those identified in "Item 1A. Risk Factors" above and, without limitation, (i) deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses, (ii) continuation of the historically low short-term interest rate environment, (iii) increased competition with other financial institutions, (iv) deterioration or lack of sustained growth in the economy in the Corporation's market areas, (vi) rapid fluctuations in interest rates, (vi) significant downturns in the businesses of one or more large customers, (vii) risks inherent in originating loans, including prepayment risks, (viii) the fluctuations in collateral values, the rate of loan charge-offs and the level of the provision for losses on loans, (ix) results of regulatory examinations, (x) any activity in the capital markets that would cause the Corporation to conclude that there was impairment of any asset including intangible assets, and (xi) changes in state and Federal legislation, regulations or policies applicable to banks and other financial services providers, including regulatory or legislative developments arising out of current unsettled conditions in the economy, including implementation of the Dodd-Frank Act enacted by Congress in July 2010 and (xii) loss of key personnel. Many of such factors are beyond the Corporation's ability to control or predict, and readers are cautioned not to put undue reliance on such forward-looking statements. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Corporation cautions investors that future financial and operating results may differ materially from those projected in forward-looking statements made by, or on behalf of, the Corporation. The Corporation disclaims any obligation to update or revise any forward-looking statements contained in this discussion, whether as a result of new information, future events or otherwise.
OVERVIEW
Total assets of the Corporation declined $8.3 million, or 1.4%, from December 31, 2009 to December 31, 2010. Loans net of unearned income declined $28.1 million from year-end 2009 to year-end 2010 due to decreased loan demand and more robust lending standards as well as foreclosures of certain problem loans that resulted in the collateral becoming other real estate owned. Other real estate owned remained at elevated levels in 2010 as weak economic conditions continued, leading to $12.7 million in other real estate owned at year-end 2010 as compared to $12.6 million in other real estate owned at year-end 2009. Concerted efforts are being made to dispose of other real estate owned while striving to ensure that fair market value is received for other real estate owned and excessive discounts are not taken.
Other real estate owned is likely to continue at elevated levels in 2011. The decline in loans contributed to a $39.3 million increase in securities at year-end 2010 as compared to year-end 2009, as funds that had been used for loans were used to buy securities. A decline of $19.7 million in cash and due from banks from year-end 2009 to year-end 2010 also contributed to the increase in securities as these funds were invested in higher yielding securities. Deposits decreased $9.7 million from year-end 2009 to year-end 2010. The decrease in deposits was primarily due to a decrease of $8.9 million in interest bearing deposits at December 31, 2010 as compared to December 31, 2009. Total shareholders' equity increased $714,000 during 2010 and regulatory Tier I capital increased $2.7 million bolstering the Corporation's capital position and regulatory capital ratios at December 31, 2010.
Net income in 2010 was $4.03 million, an increase of $1.80 million compared to 2009. Net interest income increased $869,000 in 2010 as compared to 2009 primarily due to an increase in the net interest margin to 4.09% in 2010 from 3.96% in 2009. Gains on the sale of securities of $1.07 million occurred in 2010 as compared to $82,000 in 2009. Also, non-interest income increased in 2010 as compared to 2009 primarily due to increased debit card interchange fees, increased mortgage banking income, and increased rental income received on certain properties taken into other real estate owned. The provision
for loan losses totaled $4.75 million in 2010, a decrease of $578,000 from the provision for loan losses in 2009. Weak economic conditions continue to place stress on some of the registrant's borrowers, leading to a continued elevated provision for loan losses in 2010. Provision for loans losses is expected to remain at elevated levels in 2011 as compared to years prior to 2009. FDIC insurance assessments decreased $253,000 in 2010 as compared to 2009, primarily reflecting the Bank's share of the FDIC's special assessment imposed on all financial institutions on June 30, 2009, which amounted to $276,000. Foreclosed asset expense remained at elevated levels in 2010, showing an increase of $28,000 in 2010 as compared to 2009. Foreclosed asset expense is expected to remain at elevated levels in 2011. Net charged-off loans totaled $3.84 million in 2010, resulting in charge-off ratio (net loans charged-off divided by average loans) of 1.07% as compared to net charge-offs of approximately $3.46 million in 2009, resulting in an annualized charge-off ratio of 0.89%. Nonaccrual loans also increased to $13.25 million at December 31, 2010 as compared to $7.55 million at December 31, 2009 as weak economic conditions negatively impacted many loan customers, particularly construction and land development loans, 1-4 family real estate loans and commercial real estate loans.
CRITICAL ACCOUNTING POLICIES
The accounting principles we follow and our methods of applying these principles conform to accounting principles generally accepted in the United States and with general practices within the banking industry. In connection with the application of those principles to the determination of our allowance for loan losses, we have made judgments and estimates which have significantly impacted our financial position and results of operations.
The allowance for loan losses is maintained at a level that is considered to be adequate to reflect estimated credit losses for specifically identified loans as well as estimated probable credit losses inherent in the remainder of the loan portfolio at the balance sheet date. The allowance is increased by the provision for loan losses, which is charged against current period operating results and decreased by the amount of charge-offs, net of recoveries. A formal review of the allowance for loan losses is prepared quarterly to assess the risk in the portfolio and to determine the adequacy of the allowance for loan losses. Our methodology of assessing the appropriateness of the allowance consists of several elements, which include the historical allowance and specific allowances as described below.
The historical allowance is calculated by applying loss factors to outstanding loans. For purposes of the quarterly review, the loan portfolio is separated by loan type, and each type is treated as a homogeneous pool. Each loan is assigned a risk rating by loan officers using established credit policy guidelines. These risk ratings are periodically reviewed, and all risk ratings are subject to review by an independent Credit Review Department. Each risk rating is assigned an allocation percentage which, when multiplied by the dollar value of loans in that risk category, results in the amount of the allowance for loan losses allocated to these loans. Allocation percentages are based on our historical loss experience and may be adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the evaluation date such as past loan loss experience, trends in net charge-offs, trends in delinquencies and nonaccrual loans, trends in unemployment, trends in classified and criticized loans, loan growth and composition of the loan portfolio, review of specific problem loans, results of regulatory examinations, results of updated appraisals, the relationship of the allowance for credit losses to outstanding loans and current economic conditions that may affect the borrower's ability to repay.
Specific allowances are established in cases where management has determined a loan is impaired. A loan is impaired when full payment under the loan terms is not probable. Every substandard or worse loan in excess of $250,000 and all loans criticized as "Other Assets Especially Mentioned" over $400,000 are reviewed quarterly by the Executive and Loan Committee of the Bank's Board of Directors. Impaired loans in excess of $250,000 are reviewed quarterly to determine any specific allowances that are necessary.
RESULTS OF OPERATIONS
OVERVIEW
Net income for 2010 was approximately $4.03 million, or $2.58 per diluted share, compared with approximately $2.23 million, or $1.43 per diluted share, in 2009 and approximately $3.47 million, or $2.24 per diluted share, in 2008. Return on average assets was 0.66% in 2010, 0.37% in 2009 and 0.62% in 2008. The return on average equity was 7.80%, 4.42% and 6.92% for 2010, 2009 and 2008, respectively. Net income for 2010 was positively impacted by an increase in the net interest margin, a sizeable gain on the sale of investment securities and a reduction in the provision for loan losses as compared to 2009. Net income for 2009 was negatively impacted by continuing deterioration in the local and national economy reflected in increased provision expense and increased FDIC insurance expenses. Net income for 2008 was negatively impacted by a non-cash impairment charge of approximately $1,953,000 related to the write-down of the Corporation's investment in Fannie Mae
preferred stock securities, increased noninterest expense associated with the Corporation's expansion into Alabama and continuing deterioration in the local and national economy.
NET INTEREST INCOME
Net interest income is the difference between interest and fees earned on loans, securities and other interest-earning assets (interest income) and interest paid on deposits, repurchase agreements, and borrowed funds (interest expense). In 2010, net interest income increased by 4.1% to $21.82 million from $20.95 million in 2009. Total assets of the Corporation decreased approximately $8.3 million from December 31, 2009 to December 31, 2010. Loans net of unearned income decreased approximately $28.1 million over the same period. Deposits decreased approximately $9.7 million over the same period. The higher decrease in loans as compared to deposits contributed to an approximately $39.3 million increase in investments as the Corporation invested excess funds from deposits in investment securities over the same period. Also, cash and due from banks decreased approximately $19.7 million from December 31, 2009 to December 31, 2010, primarily due to a reduction in excess interest-earning balances held at the Federal Reserve Bank.
In 2009, net interest income increased by 11.3% to $20.95 million from $18.83 million in 2008, following an increase of 11.9% in 2008 from $16.83 million in 2007. Total assets of the Corporation increased approximately $17.1 million from December 31, 2008 to December 31, 2009. Loans net of unearned income decreased approximately $26.3 million from December 31, 2008 to December 31, 2009. Deposits increased approximately $12.5 million over the same period. The growth in deposits and the decrease in loans contributed to an approximately $15.2 million increase in investments. Also, federal funds sold decreased approximately $9.3 million from December 31, 2008 to December 31, 2009 and cash and due from banks increased approximately $22.6 million over the same period as excess funds were held at the Federal Reserve. The Federal Reserve began paying interest on excess balances above reserve requirements in the fourth quarter of 2008, leading to the increase in the Corporation's funds held at the Federal Reserve.
Net interest income is a function of the average balances of interest-earning assets and interest-bearing liabilities and the yields earned and rates paid on those balances. Management strives to maintain an acceptable spread between the yields earned on interest-earning assets and rates paid on interest-bearing liabilities to maintain an adequate net interest margin.
Net interest income on a fully taxable equivalent basis increased $746,000 from 2009 to 2010. This increase resulted from a $2,265,000 increase due to changes in interest rates that was partially offset by a $1,519,000 decrease due to changes in volumes of the components comprising taxable-equivalent net interest income. The decrease in interest income in 2010 as compared to 2009 was primarily due to a decrease in average loan volumes that was partially offset by an increase in the interest rates earned on those loans. A decrease in the interest rates earned on investment securities also contributed to the decrease in interest income in 2010 as compared to 2009. The decrease in interest expense in 2010 as compared to 2009 was primarily due to a decrease in interest rates paid on interest-bearing liabilities. Net interest income on a fully taxable equivalent basis increased $2,094,000 from 2008 to 2009. This increase resulted from a $1,733,000 increase due to increased volumes and a $361,000 increase due to changes in interest rates. The decrease in interest income in 2009 as compared to 2008 was due to a decrease in the interest rates earned on interest-earning assets, together with a shift in the mix of earning assets to more investment securities, which was partially offset by an increase in the average volumes of interest-earning assets. The decrease in interest expense in 2009 as compared to 2008 was primarily due to a decrease in rates paid on interest-bearing liabilities that was slightly offset by an increase in the volumes of interest-bearing liabilities.
The following tables summarize the changes in interest earned and interest paid for the given time periods and indicate the factors affecting these changes. The first table presents, by major categories of assets and liabilities, the average balances, the components of the taxable equivalent net interest earnings/spread, and the yield or rate for the years 2010, 2009 and 2008.
Note: The taxable equivalent adjustment has been computed based on a 34% federal income tax rate and has given effect to the disallowance of interest expense, for federal income tax purposes, related to certain tax-free assets. Loans include nonaccrual loans for all years presented. Interest on loans includes loan fees. Loan fees included above amounted to $1,072,000 for 2010, $1,120,000 for 2009 and $1,266,000 for 2008.
The following table shows the change from year to year for each component of the taxable equivalent net interest margin separated into the amount generated by volume changes and the amount generated by changes in the yields earned or rates paid.
The change in interest due to volume has been determined by applying the rate from the earlier year to the change in average balances outstanding from one year to the next. The change in interest due to rate has been determined by applying the change in rate from one year to the next to the average balances outstanding in the later year. The change in interest due to both volume and rate that cannot be segregated has been included in the change due to rate. The computation of the taxable equivalent adjustment has given effect to the disallowance of interest expense, for federal income tax purposes, related to certain tax-free assets.
The net interest margin improved in 2010 to 4.09% from 3.96% in 2009. This increase in net interest margin was primarily due to decreased interest expense on deposits due to lower interest rates paid in 2010 as compared to 2009. The average interest rate paid on deposits was 1.56% in 2010 as compared to 2.16% in 2009. This lower interest expense was partially offset by lower earnings on interest-bearing assets, primarily due to a decline in average loan volumes in 2010 as compared to 2009. Average loans decreased $33.2 million in 2010 as compared to 2009 reflecting weakened loan demand. Also, the decrease in interest expense on deposits was partially offset to a lesser degree by a decrease in the average yield on investment securities from 3.84% in 2009 to 2.97% in 2010.
The net interest margin improved in 2009 to 3.96% from 3.80% in 2008. This increase in net interest margin was primarily due to the growth in average loans in 2009 as compared to 2008 as well as a decline in the interest expense due to interest-bearing liabilities over the same periods offset in part by the negative impact of increased levels of nonaccrual loans. Average loans increased $33.5 million to $390.6 million in 2009 as compared to $357.1 million in 2008. Loans are generally higher yielding assets than investment securities and federal funds sold, thus the growth in average loans in 2009 contributed to the increased net interest margin in 2009 as compared to 2008. While average loans increased in 2009 when compared to 2008, loan balances at December 31, 2009 were 6.7% less than loan balance at December 31, 2008, reflecting reduced loan demand and the Corporation's decision to increase liquidity. The Corporation's decision to slow loan growth and invest available cash from increased deposits in lower yielding investment securities and more liquid assets in the second half of 2009, together with the increased levels of nonaccrual loans and other real estate owned, negatively impacted net interest.
NON-INTEREST INCOME
The Corporation's non-interest income is composed of several components, some of which vary significantly between quarterly periods. Service charges on deposit accounts and other non-interest income generally reflect the Corporation's growth, while fees for origination of mortgage loans and security gains fluctuate more widely from period to period.
Non-interest income totaled $5,911,000 in 2010, an increase of $1,635,000, or 38.2%, from 2009. Most of the increase is attributable to a $991,000 increase in net security gains in 2010 as compared to 2009. Other service charges increased $348,000 in 2010 as compared to 2009 due to increased debit card interchange fees. Mortgage banking income increased $261,000 in 2010 as compared to 2009 primarily as a result of increased mortgage refinancing activity. Other income increased $183,000 in 2010 as compared to 2009 primarily as a result of rental income received on certain properties taken into other real estate owned in 2009 and 2010. These increases were partially offset by a $94,000 decrease in service charges on deposit accounts primarily due to overall decreased levels of overdrafts by the Bank's customers as well as a $45,000 reduction in commissions and fees primarily due to reduced commissions on sales of credit insurance.
Non-interest income totaled $4,276,000 in 2009, a decrease of $125,000, or 2.8%, from 2008. The decrease is primarily attributable to a $285,000 decrease in service charges on deposit accounts primarily due to a decrease in overdraft fees in 2009 as compared to 2008 as customers overdrafted their accounts less often in 2009 than in 2008. Smaller decreases of $47,000 and $30,000 occurred in other income and commissions and fees, respectively, in 2009 as compared to 2008. These decreases were partially offset by a $112,000 increase in income on company-owned life insurance, a $57,000 increase in security gains, a $50,000 increase in other service charges and fees and an $18,000 increase in mortgage banking income in 2009 as compared to 2008.
NON-INTEREST EXPENSE
Non-interest expense in 2010 was $17,642,000, a decrease of $60,000, or 0.3%, from 2009. The largest decrease in non-interest-expense was a $253,000 decrease in FDIC insurance premiums. The decrease in FDIC insurance expense was primarily due to the absence of an FDIC imposed 5 basis point emergency assessment on insured depository institutions paid on September 30, 2009, based on total assets less Tier I capital at June 30, 2009. The Corporation incurred approximately
$276,000 in special assessments from the FDIC in the second quarter of 2009. No such special assessment was incurred in 2010, however FDIC insurance premiums are expected to remain at elevated levels in 2011 but thereafter should begin to drop as a result of the changes mandated by the Dodd-Frank Act. The impairment on available for sale securities and other equity investments decreased $105,000 in 2010 as compared to 2009. Other smaller decreases included a $37,000 decrease in furniture and equipment expense and a $34,000 decrease in other operating expenses in 2010 as compared to 2009. These decreases were partially offset by increases in salaries and employee benefits, occupancy expenses and foreclosed asset expenses. Salaries and employee benefits increased $236,000, or 2.6% in 2010 as compared to 2009. Occupancy expenses increased $119,000 in 2010 as compared to 2009 primarily due to increased depreciation expense related to the opening of the Athens, Alabama office in April 2010. Expenses related to foreclosed assets saw a small increase of $28,000 in 2010 as compared to 2009 and is expected to remain at elevated levels in 2011. Foreclosed asset expense is composed of three types of charges: maintenance costs, valuation adjustments based on new appraisal values and gains or losses on disposition. Note 4 of the Consolidated Financial Statements gives more information on foreclosed asset expense. Non-interest expense in 2009 was $17,703,000, an increase of $450,000, or 2.6%, from 2008. This increase is primarily attributable to a $1,274,000 increase in other expenses and a $922,000 increase in foreclosed asset expenses 2009 as compared to 2008. The increase in other expenses was primarily due to a $947,000 increase in FDIC insurance expense and a $256,000 increase in directors' fees and expenses in 2009 as compared to 2008. The increase in FDIC insurance expense was due to increased regular assessments in 2009 as compared to 2008 as well as a special assessment on June 30, 2009. The increase in directors' fees was primarily due to a reduction in the discount rate used to calculate the Corporation's accrued liability for directors' deferred compensation due to a lower interest rate environment in 2009 as compared to 2008, leading to $243,000 in additional expense in 2009. The increase in foreclosure expense was due to the increased levels of other real estate owned in 2009 as compared to 2008 and the related expenses necessitated by these properties. Foreclosed real estate expense was $964,000 for 2009 compared to $42,000 for 2008 and a net gain of $14,000 for 2007. The increase in foreclosed asset expenses in 2009 was related to the continued deterioration of local real estate values, particularly with respect to foreclosed properties acquired from builders and residential land developers. At December 31, 2009, the Corporation had $12.6 million in other real estate owned compared to $247,000 at December 31, 2008. Salaries and employee benefits increased $185,000 and occupancy expenses increased $185,000 in 2009 as compared to 2008. The increase in salaries and employee benefits expenses reflect the increased expenses associated with opening and staffing new offices in Huntsville and Athens, Alabama in the first four months of 2008. These new offices also contributed to the increase in occupancy expenses, as well as the completion of the main office renovation in Pulaski in 2009. Impairment on available for sale securities and other equity investments decreased
$1,808,000 in 2009 as compared to 2008, primarily due to a $1,953,000 write-down on investments related to FNMA preferred securities in 2008 and a $144,000 write-down of the Corporation's investment in Silverton Financial Services, Inc. ("Silverton") common stock in 2009, discussed in more detail below. Advertising and public relations expenses and furniture and fixture expenses declined $261,000 and $47,000 respectively in 2009 as compared to 2008.
A capital loss of $144,000 was incurred in the second quarter of 2009 relating to the Corporation's investment in common stock of Silverton that was classified as an other asset on the Corporation's balance sheet at December 31, 2008. On May, 1, 2009, the Office of the Comptroller of the Currency closed Silverton's subsidiary, Silverton Bank, N.A. The Corporation recorded a capital loss of $144,000 to write-down its investment in Silverton to $0 in the second quarter of 2009 due to the closing of Silverton Bank, N.A. The Company has sufficient capital gains to offset the capital loss for federal income tax purposes.
As an FDIC-insured institution, the Bank is required to pay deposit insurance premiums to the FDIC. Because the FDIC's deposit insurance fund fell below prescribed levels in 2008, the FDIC announced in 2009 increased premiums for all insured depository institutions, including the Bank, in order to begin recapitalizing the fund. Insurance assessments ranged from 0.12 percent to 0.50 percent of total deposits for the first calendar quarter 2009 assessment. Effective April 1, 2009 through the end of 2010, insurance assessments ranged from 0.07% to 0.78%, depending on an institution's risk classification and other factors.
In addition, the FDIC imposed a 5 basis point emergency assessment on insured depository institutions to be paid on September 30, 2009, based on total assets less Tier I capital at June 30, 2009. The Corporation incurred approximately
$276,000 in special assessments from the FDIC in the second quarter of 2009. In November 2009, the FDIC issued a rule that required all insured depository institutions, with limited exceptions, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The FDIC also adopted a uniform three-basis point increase in assessment rates effective on January 1, 2011. In December 2009, the Bank paid $3.39 million in prepaid risk-based assessments, which included $216,000 related to the fourth quarter of 2009 that would have otherwise been payable in the first quarter of 2010. This amount was included in deposit insurance expense for 2009. As of December 31, 2010, $2.32 million of the prepaid FDIC insurance assessment remained to be expensed in future periods.
PROVISION FOR LOAN LOSSES
The provision for loan losses is the charge to earnings which management feels is necessary to maintain the allowance for loan losses at a level considered adequate to absorb probable incurred losses on loans. The adequacy of the allowance for loan losses is determined by a continuous evaluation of the loan portfolio. The Bank utilizes an independent loan review function which considers past loan experience, collateral value and possible effects of prevailing economic conditions. Findings are presented regularly to management, where other factors such as actual loan loss experience relative to the size and characteristics of the loan portfolio, deterioration in concentrations of credit, trends in portfolio volumes, delinquencies and non-performing loans and, when applicable, reports of the regulatory agencies are considered. Management performs calculations for the minimum allowance level needed and a final evaluation is made.
The provision for loan losses was $4,750,000 in 2010 compared to $5,328,000 in 2009 and $2,033,000 in 2008. The size of the provision for loan losses in 2010 and 2009 primarily reflected the effects of weaker local and national economic conditions and the resulting deterioration in the loan portfolio, particularly within the real estate segment of the portfolio and primarily real estate construction and development loans. Increases in nonperforming loans, net charge-offs and an overall increase in the Corporation's allowance for loan losses in relation to loan balances during 2010 and 2009 were the primary reasons for the elevated levels in the provision for 2010 and 2009 when compared to 2008. The Bank's collateral, for substantially all construction and development loans, is its primary source of repayment and as the value of the collateral deteriorates, ultimate repayment by the borrower becomes increasingly difficult. As a result, the Corporation has increased its allowance for loan losses which has led to increased provision expense in 2010 and 2009 as compared to 2008. Although non-performing loans increased in 2010 as compared to 2009, provision for loan losses declined in 2010 as compared to 2009 primarily as a result of the $27.9 million decrease in loans in 2010, leading to an increased ratio of allowance for loan losses to loans net of unearned income of 2.33% at December 31, 2010 as compared to 1.91% at December 31, 2009. The provision for loan losses is likely to continue at elevated levels in 2011 due to continuing challenging economic conditions, negatively impacting the Corporation's net income. The provision for possible loan losses is based on past loan experience and other factors that, in management's judgment, deserve current recognition in estimating possible credit losses. Such factors include past loan loss experience, trends in net charge-offs, trends in delinquencies and nonaccrual loans, trends in unemployment, trends in classified and criticized loans, loan growth and composition of the loan portfolio, review of specific problem loans, results of regulatory examinations, results of updated appraisals, the relationship of the allowance for credit losses to outstanding loans and current economic conditions that may affect the borrower's ability to repay.
INCOME TAXES
Income tax expense includes federal and state taxes on taxable earnings. Income taxes were $1,313,000 in 2010. There was a $33,000 income tax benefit in 2009. Income taxes were $475,000 in 2008. The effective tax rates were 24.6%, -1.5%, and 12.0% in 2010, 2009 and 2008, respectively. The decline in the effective tax rates for 2009 and 2008 was primarily a result of reduced income before taxes while tax free income was proportionally higher as compared to 2010.
The Corporation had net deferred tax assets of $5,439,000 at December 31, 2010, as compared to a net deferred tax asset of $3,102,000 at December 31, 2009. The deferred tax asset resulting from the allowance for loan losses was the largest component of the deferred tax asset in both periods. The Corporation has sufficient refundable taxes paid in available carryback years to fully realize its recorded deferred tax assets. Accordingly, no valuation has been recorded.
FINANCIAL CONDITION
LOANS
Management's historical focus has been to promote loan growth in the Corporation's target markets, emphasizing the expansion of business in the Corporation's trade areas. Efforts are taken to maintain a diversified portfolio without significant concentration of risk. In 2010 and 2009, however, the Corporation's total loans shrank as loan demand softened and economic conditions, particularly in real estate construction and development, impaired potential borrower creditworthiness. Total loans net of unearned fees decreased $27.9 million from December 31, 2009 to December 31, 2010. All major categories of loans showed a decrease in 2010. The categories of loans showing the largest decrease included construction and land development loans with a decrease of $9.2 million, nonresidential nonfarm real estate loans with a decrease of $4.9 million, residential real estate loans with a decrease of $4.6 million and consumer loans with a decrease of $2.1 million.
Over the last three years, average total loans decreased by $33.2 million, or 8.5%, in 2010, increased by $33.5 million, or 9.4%, in 2009 and increased by $57.0 million, or 19.0%, in 2008, in each case over the prior year. The growth in deposits, together with a liquidation of available for sale securities in 2008, was the primary funding source for this increase in average loan demand in 2009 and 2008. The decrease in average loans outstanding in 2010 as compared to 2009 led to an increase of $22.2 million in average investment securities in 2010 over 2009 as the funds previously used for loan fundings were placed in the investment portfolio.
LOAN QUALITY
Credit risk represents the maximum accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted and any collateral or security proved to be of no value. Concentrations of credit risk or types of collateral arising from financial instruments exist in relation to certain groups of customers. A group concentration arises when a number of counterparties have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The Corporation does not have a significant concentration to any individual customer or counterparty. The major concentrations of credit risk for the Corporation arise by collateral type in relation to loans and credit commitments. The most significant concentration that exists is in loans secured by real estate, primarily commercial real estate loans (36% of the total loans) and 1-4 family residential loans (25% of total loans). Commercial loans, both those secured by real estate and those not secured by real estate, are further classified by their appropriate North American Industry Classification System ("NAICS") code. Of those loans classified by NAICS code, the Corporation has concentrations of credit, defined as 25% or more of total risk-based capital, of loans to lessors of residential buildings and dwellings (37% of total risk-based capital), loans secured by subdivision land (34% of total risk-based capital), loans to religious organizations (29% of total risk-based capital), loans secured by hotel and motel properties (27% of total risk-based capital) and loans to gasoline stations with convenience stores (26% of total risk-based capital). Although the Corporation has a loan portfolio diversified by type of risk, the ability of its customers to honor their contracts is to some extent dependent upon economic conditions in the regions where our customers operate, particularly conditions impacting residential and commercial real estate, which continued to experience deterioration throughout 2010. A geographic concentration arises because the Corporation grants commercial, real estate and consumer loans primarily to customers in Giles, Marshall and Lincoln Counties, Tennessee and Limestone and Madison Counties, Alabama. In order to mitigate the impact of credit risk, management strives to identify loans experiencing difficulty early enough to correct the problems and to maintain an allowance for loan losses at a level management believes is adequate to absorb probable incurred losses in the loan portfolio.
The amounts of loans outstanding, excluding deferred loan fees, at the indicated dates are shown in the following table according to type of loan.
(1) Includes student loans, non-taxable loans, overdrafts, and all other loans not included in any of the designated categories.
The following table presents the maturity distribution of selected loan categories at December 31, 2010 (excluding residential mortgage, home equity and installment-individual loans).
The table below summarizes the percentages of the loans selected for use in the preceding table falling into each of the indicated maturity ranges and the sensitivity of such loans to interest rate changes for those with maturities greater than one year, all as of December 31, 2010.
Due in one year
or less
Due after one
year but before
five years
Due after
five years
Total
Percent of total selected loans
49.17%
45.23%
5.60%
100.00%
Cumulative percent of total
49.17%
94.40%
100.00%
Sensitivity of loans to changes in interest rates-loans due after one year
Fixed rate loans
$97,344
$3,040
$100,384
Variable rate loans
5,860
9,743
15,603
Total
$103,204
$12,783
$115,987
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SUMMARY OF LOAN LOSS EXPERIENCE
The following table summarizes loan balances at the end of each period and average loans outstanding, changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off, and provisions for loan losses which have been charged to expense.
As seen in the above table, net loans charged-off increased significantly in 2010 and 2009 to $3,838,000 and $3,463,000, respectively, from $280,000 in 2008. Net charged-off loans remained at elevated levels in 2010 as weak economic conditions continued. Net loans charged-off in 2010 consisted of net losses on construction and land development loans of $1,572,000, net losses on real estate loans of $1,860,000, net losses on commercial and industrial loans of $144,000, net losses on loans to individuals of $262,000, net losses on agricultural loans of $1,000 and net recoveries on other loans of $1,000. This compared to net loans charged-off in 2009 which consisted of net losses on construction and land development loans of $1,974,000, net losses on real estate loans of $1,238,000, net losses on commercial and industrial loans of $143,000, net losses on loans to individuals of $119,000 and net recoveries on agricultural loans of $8,000. The allowance for loan losses at the end of 2010 was $7,997,000, or 2.33% of outstanding loans, net of unearned income, as compared to $7,085,000, or 1.91% of outstanding loans, net of unearned income, and $5,220,000, or 1.32% of outstanding loans, net of unearned income in 2009 and 2008,
respectively. Net loans charged-off amounted to 1.07% of average total loans outstanding in 2010, 0.89% in 2009 and 0.08% in 2008.
The allowance for loan losses was 0.6 times the balance of nonaccrual loans at the end of 2010 compared to 0.9 times in 2009 and 1.7 times in 2008
. Nonaccrual loans increased $5,698,000 to $13,253,000 at December 31, 2010 from $7,555,000 at December 31, 2009 primarily due to an increase in residential real estate loans, commercial real estate loans and construction and land development loans classified as nonaccrual. Much of the increase in nonaccrual loans at December 31, 2010 was due to 3 larger relationships that were placed on nonaccrual during 2010. Nonaccrual loans increased $4,526,000 to $7,555,000 at December 31, 2009 from $3,029,000 at December 31, 2008, primarily due to an increase in residential real estate loans and construction and land development loans classified as nonaccrual. Management believes that the allowance for loan losses as of December 31, 2010 is adequate, but if economic conditions deteriorate beyond management's expectations and additional charge-offs are incurred, the allowance for loan losses may require an increase through significant additional provision for loan losses. Charge-offs are expected to remain at elevated levels in 2011 resulting in elevated provision for loan losses in 2011 as compared to years prior to 2009.
The following table sets out respectively the allocation of the Allowance for Loan Losses and the percentage of loans by category to total loans outstanding at the end of each of the years indicated.
The Corporation monitors changes in the credit quality, terms and loan concentrations in its loan portfolio. Construction and land development loans decreased $9.2 million, or 22.4%, at year-end 2010, following a decrease of $14.6 million, or 26.3%, at year-end 2009 as compared to year-end 2008. However, these decreases followed a significant increase of $33.7 million, or 154.2%, at year-end 2008 as compared to year-end 2007, primarily due to increases in loans secured by subdivision land, reflecting the Corporation's expansion into more growth-oriented urban areas in Alabama. All major loan categories declined at year-end 2010 as compared to year-end 2009. The Corporation evaluates its exposure level to loan concentrations periodically to determine any amount of additional allowance allocations that is necessary based on these concentrations.
NON-PERFORMING ASSETS
Non-performing assets include nonaccrual loans, loans restructured because of a debtor's financial difficulties, other real estate owned and loans past due ninety days or more as to interest or principal payment.
Nonaccrual loans are those loans for which management has discontinued accrual of interest because there exists significant uncertainty as to the full and timely collection of either principal or interest or such loans have become contractually past due 90 days or more with respect to principal or interest, unless such loans are well secured and in the process of collection
. From December 31, 2009 to December 31, 2010, nonaccruing loans increased to $13,253,000 from $7,555,000 following an increase from $3,029,000 at year-end 2008. The changes in each year were primarily a result of weak economic conditions negatively impacting many loan customers, particularly construction and land development loans, 1-4 family real estate loans and commercial real estate loans. There were $2,742,000 in restructured loans as of December 31, 2010, all of which were commercial real estate loans as compared to $7,307,000 in restructured loans as of December 31, 2009, which included $2,787,000 in commercial real estate loans, $2,335,000 in 1-4 family real estate loans, $2,105,000 in construction and land development loans and $80,000 in commercial and land development loans. Since no loans classified as troubled debt restructurings included interest rate reductions as part of the modification, and modifications only changed the timing of cash flows as the loans were placed on interest-only payments for a period of time, the Company has not allocated any specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2010.
Other real estate owned, consisting of properties acquired through foreclosures or deeds in lieu thereof, totaled $12,704,000 at December 31, 2010, an increase of $154,000 from $12,550,000 at December 31, 2009. The continued weak economic conditions lead to the elevated levels other real estate owned in 2010 and 2009 as compared to earlier periods. Other real estate owned is likely to remain at elevated levels throughout 2011 as are the related foreclosure/repossession expenses. All major credit lines and troubled loans are reviewed regularly by a committee of the Board of Directors. Management believes that the Bank's non-performing loans have been accounted for in the methodology for calculating the allowance for loan losses. The following table summarizes the Corporation's nonaccrual loans, loans past due 90 days or more but accruing interest, restructured loans and other real estate owned.
The amount of interest income actually recognized on nonaccrual loans during 2010, 2009 and 2008 was $121,000, $95,000 and $35,000, respectively. The additional amount of interest income that would have been recorded during 2010, 2009 and 2008, if the above nonaccrual loans had been current in accordance with their original terms, was $818,000, $595,000 and $38,000, respectively. No interest was foregone on troubled debt restructurings in 2010, 2009 and 2008.
Loans that are classified as "substandard" by the Bank represent loans to which management has doubts about the borrowers' ability to comply with the present loan repayment terms. At December 31, 2010, there were approximately $12,003,000 in loans that were classified as "substandard" and accruing interest. This compares to approximately $19,677,000 in loans that were classified as "substandard" and accruing interest at December 31, 2009. At December 31, 2010, management was not aware of any specifically identified loans, other than those classified as "substandard" that represent significant potential problems or that management has doubts as to the borrower's ability to comply with the present repayment terms. The Corporation believes that it and the Bank have appropriate internal controls and although the Corporation and the Bank conduct regular and thorough loan reviews, the risk inherent in the lending business results in periodic charge-offs of loans. The Corporation maintains an allowance for loan losses that it believes to be adequate to absorb probable incurred losses in the loan portfolio. Management evaluates, on a quarterly basis, the risk in the portfolio to determine an adequate allowance for loan losses. The evaluation includes analyses of historical performance, the level of nonperforming and rated loans, specific analyses of problem loans, loan activity since the previous quarter, loan review reports, consideration of current economic conditions and other pertinent information. The evaluation is reviewed by the Audit Committee of the Board of Directors of the Bank. Also, as a matter of policy, internal classifications of loans are performed on a routine and continuing basis. See "Critical Accounting Policies" for more information pertaining to the Corporation's allowance for loan losses.
SECURITIES
The securities portfolio consists primarily of U.S. government agency securities, U.S. government-sponsored agency securities, marketable bonds of states, counties and municipalities, and corporate bonds. Management uses investment securities to assist in maintaining proper interest rate sensitivity in the balance sheet, to provide securities to pledge as collateral for certain public funds and repurchase agreements and to provide an alternative investment for available funds.
The following table sets forth the carrying amount of investment and other securities at the dates indicated:
The following table sets forth the maturities of securities at December 31, 2010 and the average yields of such securities. Actual maturities may differ from contractual maturities of mortgage-backed securities because the mortgages underlying the securities may be called or prepaid with or without penalty. Therefore, these securities are not included in the maturity categories noted below as of December 31, 2010. Also, the securities labeled "Other securities" in the table above are equity securities of a government-sponsored agency authorized to make loans and loan guarantees and have no maturity date. Therefore they are not included in the maturity categories below as of December 31, 2010.
The above table shows yields on the tax-exempt obligations to be computed on a taxable equivalent basis.
Total average securities increased by $22.2 million, or 15.5%, to $165.3 million during 2010 as compared to $143.0 million for 2009. Average non-taxable securities decreased by $13.3 million, or 25.2%, in 2010 while average taxable securities increased
by $35.5 million, or 39.3%, to account for the overall increase in average investments. The increase in total average securities during 2010 was primarily a result of lower average loan balances in 2010 that led to excess funds being placed in the investment portfolio. Total average securities decreased by $6.9 million, or 4.6%, to $143.0 million during 2009 as compared to $149.9 million for 2008. Average non-taxable securities decreased by $19.6 million, or 27.0%, in 2009 while average taxable securities increased by $12.7 million, or 16.4%, to account for the overall decrease in average investments. The decrease in total average securities during 2009 was primarily a result of higher average federal funds sold and funds held overnight at the Federal Reserve as more funds were held in overnight balances for additional liquidity during the economic turmoil occurring throughout 2009.
The Corporation saw a decline in the market value of its investment securities portfolio at December 31, 2010 as compared to December 31, 2009. There was an unrealized loss on securities, net of tax, of $293,000 at December 31, 2010 as compared to an unrealized gain on securities, net of tax, of $1,734,000 at December 31, 2009. The primary cause for unrealized gains and losses within the portfolio at each year-end is the impact movements in market rates have had in comparison to the underlying yields on these securities. Market interest rates moved higher in the last quarter of 2010, causing the investments held by the Corporation to decrease in market value at December 31, 2010 as compared to December 31, 2009.
DEPOSITS
The Corporation's primary source of funds is customer deposits, including certificates of deposits in excess of $100,000. Average deposits increased by $8.6 million, or 1.6%, to $542.9 million in 2010, by $35.9 million, or 7.2%, to $534.3 million in 2009, and by $53.4 million, or 11.9%, to $498.4 million in 2008.
The average amount of deposits for the periods indicated is summarized in the following table:
Remaining maturities of time certificates of deposits of $100,000 or more outstanding at December 31, 2010 are summarized as follows (in thousands of dollars):
3 months or less
$30,540
Over 3 months through 6 months
37,359
Over 6 months through 12 months
39,439
Over 1 year
32,611
Total
$139,949
==========
Other funds were invested in other earning assets such as federal funds at minimum levels necessary for operating needs and to maintain adequate liquidity. A significant amount of the Corporation's deposits are time deposits greater than $100,000. A significant percentage of these time deposits mature within one year. If the Corporation is unable to retain these deposits at their maturity it may be required to find alternate sources of funds to fund any future loan growth, which may be more costly than these deposits and may as such negatively affect the Corporation's net interest margin
. The Corporation does not currently expect that a material amount of these deposits will be withdrawn at maturity.
The Corporation began using reciprocal brokered deposits in 2009 and had $1.0 million and $9.1 million of such deposits at December 31, 2010 and 2009, respectively. These are customer deposits which the bank has swapped for deposits of other banks so that the entire customer deposit with the Bank is spread among other banks and the Bank's customer is able to acquire FDIC insurance coverage for the full amount of his/her deposit. The Corporation has not traditionally used brokered deposits as a funding source and had no brokered deposits at year-end 2010 and 2009 other than the reciprocal brokered deposits above.
OFF BALANCE SHEET ARRANGEMENTS
Neither the Corporation nor the Bank have historically incurred off-balance sheet obligations through the use of, or investment in, off-balance sheet derivative financial instruments of structured finance or special purpose entities organized as corporations, partnerships or limited liability companies or trusts. However, the Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. The following table summarizes the Bank's involvement in financial instruments with off-balance-sheet risk as of December 31:
LIQUIDITY AND INTEREST RATE SENSITIVITY MANAGEMENT
The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest sensitive earning assets and interest bearing liabilities. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates.
Marketable securities, particularly those of shorter maturities, are the principal source of asset liquidity. Securities maturing in one year or less amounted to $9.0 million at December 31, 2010, representing 4.7% of the investment securities portfolio as compared to $8.8 million at December 31, 2009, representing 5.8% of the investment securities portfolio. Monthly principal paydowns received on mortgage-backed securities also provide additional liquidity. Management believes that the investment securities portfolio, along with additional sources of liquidity, including cash and cash equivalents, federal funds sold and maturing loans, provides the Corporation with adequate liquidity to meet its funding needs.
The Bank also has federal funds lines with some of its correspondent banks. These lines may be drawn upon if the Bank has short-term liquidity needs. As of December 31, 2010, the Bank had $20.0 million available under these lines. At December 31, 2010, the Bank had no federal funds purchased from these lines. The average daily federal funds purchased for 2010 equaled $16,000 at an average interest rate of 1.22%. For 2009 the average daily federal funds purchased equaled $29,000 at an average interest rate of 0.98%. For 2008 the average daily federal funds purchased equaled $193,000 at an average interest rate of 2.70%.
In addition to the federal funds lines, the Bank also has the capacity to borrow additional funds from the Federal Home Loan Bank of Cincinnati that may be drawn upon for short-term or longer-term liquidity needs. At December 31, 2010, the Bank had total borrowings of $7,545,000 and had approximately $23,078,000 of available additional borrowing capacity from the Federal Home Loan Bank of Cincinnati.
On August 21, 2007, the Board of Directors approved a plan authorizing the management of the Corporation to repurchase up to $5,000,000 of the Corporation's common stock from shareholders desiring to liquidate their shares in either the open market or through privately negotiated transactions. This repurchase plan was in addition to a 2004 stock repurchase plan that expired in 2008. This stock repurchase plan does not have an expiration date and unless terminated earlier by resolution of the Corporation's Board of Directors, will expire when the Corporation has repurchased shares having a value equal to $5,000,000. The Corporation's Board of Directors suspended this stock repurchase plan in the third quarter of 2008. As of December 31,
2010, $4,738,585 remained available for repurchase under this plan. The Corporation has no other programs to repurchase common stock at this time. Management does not anticipate that this plan will reduce liquidity to unacceptable levels.
Interest rate sensitivity varies with different types of interest earning assets and interest bearing liabilities. Overnight federal funds, on which rates change daily, and loans which are tied to the prime rate differ considerably from long term securities and fixed rate loans. Similarly, time deposits, especially those $100,000 and over, are much more interest-sensitive than are savings accounts. At December 31, 2010, the Corporation had a total of $106.2 million in certificates of $100,000 or more which would mature in one year or less. In addition, consumer certificates of deposits of smaller amounts mature generally in two years or less, while money market deposit accounts mature on demand.
The Corporation has certain contractual obligations at December 31, 2010 as summarized in the table below.
CAPITAL RESOURCES, CAPITAL AND DIVIDENDS
Regulatory requirements place certain constraints on the Corporation's capital. In order to maintain appropriate ratios of equity to total assets, a corresponding level of capital growth must be achieved. Growth in total average assets was 2.0% in 2010 and 7.1% in 2009. Average shareholder's equity increased 2.2% in 2010 and 2.7% in 2009. The Corporation's equity capital was $52,664,000 at December 31, 2010 as compared to $51,951,000 at December 31, 2009. The Corporation's equity capital was negatively impacted at year-end 2010 by an unrealized loss on available-for-sale securities, net of tax, of $293,000 as compared to an unrealized gain on available-for-sale securities, net of tax, of $1,734,000 at year-end 2009. These unrealized gains and losses are excluded from capital in the Bank's and Corporation's calculation of regulatory capital. The Corporations Tier I capital increased 5.5% from year-end 2009 to year-end 2010.
The Corporation's average equity-to-average asset ratio (excluding unrealized gain/loss on investment securities) was 8.5% in 2010 and 2009. The increase in the Corporation's average assets declined in 2010 as compared to earlier periods to help maintain its capital position. Management expects the Corporation to maintain a slower growth rate in 2011 as it seeks to sustain and improve its capital position. The Corporation expects to maintain a capital to asset ratio that reflects financial strength and conforms to current regulatory guidelines. Federal Reserve Board guidelines generally state that dividends should be reduced if they exceed net income for the prior four quarters, of if prospective earnings retention is not adequate for a holding company's capital needs or overall current financial condition. The ratio of dividends to net income was 38.8% in 2010, 111.6% in 2009 and 80.4% in 2008.
As of December 31, 2010, the authorized number of common shares was 10 million shares, with 1,564,350 shares issued and outstanding.
The Federal Reserve, the OCC and the FDIC have issued risk-based capital guidelines for U.S. banking organizations. These guidelines provide a uniform capital framework that is sensitive to differences in risk profiles among banking companies. Under these guidelines, total capital consists of Tier I capital (core capital, primarily shareholders' equity) and Tier II capital (supplementary capital, including certain qualifying debt instruments and the loan loss reserve). Assets are assigned risk weights ranging from 0% to 100% depending on the level of credit risk normally associated with such assets. Off-balance sheet items (such as commitments to make loans) are also included in assets through the use of conversion factors established by the regulators and are assigned risk weights in the same manner as on-balance sheet items. Banking institutions are expected to achieve a Tier I capital to risk-weighted assets ratio of at least 4.00%, a total capital (Tier I plus Tier II) to risk-weighted assets ratio of at least 8.00%, and a Tier I capital to total assets ratio (leverage ratio) of at least 4.00%. The Dodd-Frank Act
imposes minimum capital requirements at the holding company level that are at least as high as those at the Bank level. As of December 31, 2010, the Corporation and the Bank, had ratios exceeding the regulatory requirements to be classified as "well capitalized," the highest regulatory capital rating. The Corporation's and the Bank's ratios are illustrated below.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Adoption of New Accounting Standards:
In July 2010, the FASB issued ASU No. 2010-20, "Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses." The ASU expands the disclosures about the credit quality of financing receivables and the related allowance for credit losses. The ASU also requires disaggregation of existing disclosures by portfolio segment. The amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. The adoption of this guidance expanded the Company's disclosures surrounding credit quality of financing receivables and the related allowance for credit losses.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Corporation's primary place of exposure to market risk is interest rate volatility of its loan portfolio, investment portfolio and interest-bearing deposit liabilities. Fluctuations in interest rates ultimately impact both the level of income and expense recorded on a large portion of the Corporation's assets and liabilities, and the market value of interest-earning assets and interest-bearing liabilities, other than those which possess a short term to maturity.
Simulation modeling is used to evaluate both the level of interest rate sensitivity as well as potential balance sheet strategies. Important elements in this modeling process include the mix of floating rate versus fixed rate assets and liabilities, the repricing/maturing volumes and rates of the existing balance sheet, and assumptions regarding future volumes, maturity patterns and pricing under varying interest rate scenarios. The Bank's Asset/Liability policy strives to limit the decrease in net interest income over a +/-200 basis point rate shock to no more than 9.0 percent over the next twelve months as compared to the base scenario of no changes in interest rates and to limit the decrease in the current present value of the Bank's equity to no more than 18 percent over the same +/-200 basis point rate shock. As of December 31, 2010, the -200 basis point rate shock
was estimated to decrease the current present value of the Bank's equity by 0.1% and a +200 basis point rate shock was estimated to decrease the current present value of the Bank's equity by 4.7%, both well within the policy guidelines. A -200 basis point rate shock was estimated to decrease net interest income approximately $2,009,000, or 9.3 percent, over the next twelve months, as compared to the base scenario. A +200 basis point rate shock was projected to decrease net interest income approximately $1,038,000, or 4.8 percent, over the next twelve months as compared to the base scenario. The decrease in net interest income in the next twelve months in the -200 basis point rate shock is slightly outside the Bank's limit of -9.0%; however, the longer-term interest rate risk seems to be mitigated as shown by the very small change in the current present value of the Bank's equity in the -200 basis point rate shock scenario as compared to rates remaining stable. Although interest rates are currently very low, the Bank believes a -200 basis point rate shock is an effective and realistic test since interest rates on many of the Bank's loans still have the ability to decline 200 basis points. For those loans that have floors above the -200 basis point rate shock, the interest rate would be the floor rate. All deposit account rates would likely fall to their floors under the -200 basis point rate shock as well. This simulation analysis assumes that NOW and savings accounts have a lower correlation to changes in market interest rates than do loans, investment securities and time deposits. The simulation analysis takes into account the call features of certain investment securities based upon the rate shock, as well as estimated prepayments on loans. The simulation analysis assumes no change in the Bank's asset/liability composition due to the inherent uncertainties of specific conditions and corresponding actions of management. Actual results would vary due to changing market conditions and management's response to those conditions.
More about market risk is included in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Interest Rate Sensitivity Management." All market risk sensitive instruments described within that section have been entered into by the Corporation for purposes other than trading. The Corporation does not hold market risk sensitive instruments for trading purposes. The Corporation is not subject to any foreign currency exchange or commodity price risk.
The following table provides information about the Corporation's financial instruments that are sensitive to changes in interest rates as of December 31, 2010. Non-maturity deposits such as NOW accounts, money market accounts and savings accounts are not included in the following table.
U.S. Government agency and U.S. government-sponsored entity securities in the above table with call features are shown as maturing on the call date if they are likely to be called in the current interest rate environment
.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated financial statements appear on the following pages for First Pulaski National Corporation and its subsidiary
.
Report of Management on the Company's
Internal Control over Financial Reporting
March 16, 2011
Management of First Pulaski National Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records, that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are made only in accordance with authorizations of management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of change in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
Management of First Pulaski National Corporation, including the Chief Executive Officer and the Chief Financial Officer, has assessed the Company's internal control over financial reporting as of December 31, 2010, based on criteria for effective internal control over financial reporting described in "Internal Control - Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that the Company's internal control over financial reporting was effective as of December 31, 2010, based on the specified criteria.
Crowe Horwath LLP, an independent registered public accounting firm, has audited the effectiveness of the Company's internal controls over financial reporting as stated in their report which is included herein.
/s/Mark A. Hayes /s/Tracy Porterfield
Mark A. Hayes 						Tracy Porterfield
Chairman of the Board & Chief Executive Officer 		Chief Financial Officer
Report of Independent Registered Public Accounting Firm
Audit Committee
First Pulaski National Corporation
Pulaski, Tennessee
We have audited the accompanying consolidated balance sheets of First Pulaski National Corporation and subsidiary ("Company") as of December 31, 2010 and 2009 and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2010. We also have audited the Company's internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on the Company's Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Pulaski National Corporation and subsidiary as of December 31, 2010 and 2009 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
/s/Crowe Horwath LLP
Crowe Horwath LLP
Brentwood, Tennessee
March 16, 2011
Note 1 - Summary of Significant Accounting Policies
Nature of Operations and Principles of Consolidation: The consolidated financial statements include First Pulaski National Corporation (the "Corporation") and its wholly owned subsidiary, First National Bank of Pulaski (the "Bank"), as well as the Bank's wholly owned subsidiary First Pulaski Reinsurance Company ("FPRC"), together referred to as the "Company." Intercompany transactions and balances are eliminated in consolidation.
The Company provides financial services through its offices in Giles, Lincoln and Marshall Counties in Tennessee and Limestone and Madison Counties in Alabama. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. There are no significant concentrations of loans to any one industry or customer. However, the customers' ability to repay their loans is dependent on the real estate and general economic conditions in the area.
Use of Estimates: To prepare financial statements in conformity with U.S. generally accepted accounting principles management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses and fair values of financial instruments are particularly subject to change.
Cash Flows: Cash and cash equivalents includes cash, deposits with other financial institutions with maturities under 90 days, and federal funds sold. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions, and federal funds purchased and repurchase agreements.
Interest-Bearing Deposits in Other Financial Institutions: Interest-bearing deposits in other financial institutions mature within one year and are carried at cost.
Securities: Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method. Prepayments are anticipated in the amortization of premiums and discounts for mortgage backed securities. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Management evaluates securities for other-than-temporary impairment ("OTTI") at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
Note 1 - Summary of Significant Accounting Policies - (Continued)
Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using a method to approximate the level-yield method.
Interest income on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans that are not performing. A loan is moved to non-accrual status in accordance with the Company's policy, typically after 90 days of non-payment.
All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Concentration of Credit Risk: Most of the Company's business activity is with customers located within Giles, Lincoln and Marshall Counties in Tennessee and Limestone and Madison Counties in Alabama. Therefore, the Company's exposure to credit risk is significantly affected by changes in the economy in these areas.
Mortgage Banking: The Company originates first-lien mortgage loans for the purpose of selling them in the secondary market. Mortgage loans held for sale are recorded at cost, which approximates fair value. Gains and losses realized from the sale of these assets are included in mortgage banking income. Servicing rights related to the mortgages sold are not retained.
Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors.
Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
Note 1 - Summary of Significant Accounting Policies - (Continued)
Commercial and commercial real estate loans over $250,000 are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loan's effective rate at inception. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent 3 years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified:
Commercial loans include loans for commercial or industrial purposes to business enterprises that are not secured by real estate. Commercial loans are typically are made on the basis of the borrower's ability to repay from the cash flow of the borrower's business. Commercial loans are generally secured by accounts receivable, inventory and equipment. The collateral securing loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. The Company seeks to minimize these risks through its underwriting standards.
Commercial and Agricultural Real Estate loans include loans secured by non-residential real estate, including farmland and improvements thereon. Often these loans are made to single borrowers or groups of related borrowers, and the repayment of these loans largely depends on the results of operations and management of these properties. Adverse economic conditions may affect the repayment ability of these loans.
Construction and Land Development loans include loans to finance the process of improving land preparatory to erecting new structures or the on-site construction of industrial, commercial, residential or farm buildings. Construction and land development loans also include loans secured by vacant land, except land known to be used or usable for agricultural purposes. Construction loans generally are made for relatively short terms. They generally are more vulnerable to changes in economic conditions. Further, the nature of these loans is such that they are more difficult to evaluate and monitor. The risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value upon completion of the project and the estimated cost (including interest) of the project. Periodic site inspections are made on construction loans.
Residential Real Estate loans include loans secured by residential real estate, including single-family and multi-family dwellings. Mortgage title insurance and hazard insurance are normally required. Adverse economic conditions in the Company's market area may reduce borrowers' ability to repay these loans and may reduce the collateral securing these loans.
Note 1 - Summary of Significant Accounting Policies - (Continued)
Consumer loans include loans to individuals for household, family and other personal expenditures that are not secured by real estate. Consumer loans are generally secured by vehicles and other household goods. The collateral securing consumer loans may depreciate over time. The Company seeks to minimize these risks through its underwriting standards.
Other loans include loans to finance agricultural production and other loans to farmers that are not secured by real estate. Other loans also include loans to states and political subdivisions in the U.S. Loans to farmers are subject to the inherent risks in farming, such as unpredictable weather and market prices for goods produced from farming operations. Loans to states and political subdivisions are generally subject to the risk that the borrowing municipality or political subdivision may lose a significant portion of its tax base or that the project for which the loan was made may produce inadequate revenue.
Transfers of Financial Assets: Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line and accelerated methods with useful lives ranging from 5 to 39 years. Furniture, fixtures and equipment are depreciated using the straight-line and accelerated method with useful lives ranging from 3 to 7 years.
Federal Home Loan Bank (FHLB) Stock: The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Company Owned Life Insurance: The Company has purchased life insurance policies on certain directors and key executives. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Long-Term Assets: Premises and equipment, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Stock-Based Compensation: Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Corporation's common
Note 1 - Summary of Significant Accounting Policies - (Continued)
stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
Retirement Plans: Employee profit sharing plan expense is the amount contributed by the Company. Deferred compensation and supplemental retirement plan expense allocates the benefits over years of service. The present value of future benefits to be paid is being accrued over the period from the effective date of the agreements until the full eligibility date.
Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. All outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options.
Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity.
Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank was required to meet regulatory reserve and clearing requirements.
Dividend Restriction: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Corporation or by the Corporation to its shareholders.
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Operating Segments: While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Operating segments are aggregated into one as operating results for all segments are similar. Accordingly,
Note 1 - Summary of Significant Accounting Policies - (Continued)
all of the financial service operations are considered by management to be aggregated in one reportable operating segment.
Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no affect on prior year net income or shareholders' equity.
Adoption of New Accounting Standards:
In July 2010, the FASB issued ASU No. 2010-20, "Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses." The ASU expands the disclosures about the credit quality of financing receivables and the related allowance for credit losses. The ASU also requires disaggregation of existing disclosures by portfolio segment. The amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. The adoption of this guidance expanded the Company's disclosures surrounding credit quality of financing receivables and the related allowance for credit losses.
Note 2 - Securities
The amortized cost and fair value of the available for sale securities portfolio at December 31, 2010 and 2009 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
Note 2 - Securities - (Continued)
Sales of available for sale securities were as follows:
The tax provision related to these net realized gains and losses was $(410,638), $(31,227) and $(9,224), respectively.
The amortized cost and fair value of debt securities at year end 2010 are shown below by contractual maturity. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.
Securities pledged at year-end 2010 and 2009 had a carrying amount of $87,602,230 and $115,726,152, respectively, and were pledged to secure public deposits and repurchase agreements.
At year-end 2010 and 2009, there were no holdings of securities of any one issuer, other than U.S. government agencies and U.S. government-sponsored entities, in an amount greater than 10% of shareholders' equity.
Note 2 - Securities (Continued)
The following table summarizes the investment securities with unrealized losses at December 31, 2010 and December 31, 2009 aggregated by major security type and length of time in a continuous unrealized loss position:
In determining OTTI for debt securities, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.
When OTTI occurs the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment's amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.
Note 2 - Securities (Continued)
As of December 31, 2010, the Company's security portfolio consisted of 332 securities, 125 of which were in an unrealized loss position. The majority of unrealized losses are related to the Company's obligations of U.S. government-sponsored entities and obligations of state and political subdivisions. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2010.
The Company's equity securities consist of floating rate preferred stock issued by Federal National Mortgage Association ("Fannie Mae"). For the year ended December 31, 2008, the Company recognized a $1,952,721 pre-tax charge for the other-than-temporary decline in fair value. As required by accounting guidance, when a decline in fair value below cost for an equity security is deemed to be other-than-temporary, the unrealized loss must be recognized as a charge to earnings. On September 7, 2008, the United States Department of the Treasury, the Federal Reserve and the Federal Housing Finance Agency ("FHFA") announced that the FHFA was placing Fannie Mae and the Federal Home Loan Mortgage Corporation ("Freddie Mac") under conservatorship, eliminating dividend payments on Fannie Mae and Freddie Mac common and preferred stock and giving management control over Fannie Mae and Freddie Mac to FHFA. Subsequent to the announcement of the actions described above, the market value of the perpetual preferred securities of Fannie Mae owned by the Company declined significantly, leading to the charge to earnings for other-than-temporary impairment. A $39,200 pre-tax charge was recognized for the other-than-temporary decline in fair value on these Fannie Mae securities in 2010 as the fair value of these securities declined further.
The Company held common stock in Silverton Financial Services, Inc. ("Silverton") in the amount of $144,408 that was classified as an other asset on the Company's balance sheet. On May, 1, 2009, the Office of the Comptroller of the Currency closed Silverton's subsidiary, Silverton Bank, N.A. The Company recorded a capital loss of $144,408 in the second quarter of 2009 due to the closing of Silverton Bank, N.A. The Company had sufficient capital gains to offset the capital loss for federal income tax purposes.
Note 3 - Loans
Loans at year end were as follows:
Activity in the allowance for loan losses was as follows:
Beginning balance
$7,085,316
$5,219,956
$3,467,019
Provision for loan losses
4,750,000
5,327,702
2,032,719
Loans charged-off
(3,943,873)
(3,605,212)
(475,001)
Recoveries
105,518
142,870
195,219
Ending balance
$7,996,961
$7,085,316
$5,219,956
=========
=========
=========
The loan balances in the following tables related credit quality do not include approximately $2,225,000 in accrued interest receivable and $229,000 in deferred loan fees. Accrued interest receivable is a component of the Company's recorded investment in loans.
The following table presents the balances in the allowance for loan losses and loans by portfolio segment and based on impairment method as of December 31, 2010:
Note 3 - Loans (Continued)
Individually impaired loans were as follows:
Average of individually impaired loans during the year
$12,907,114
$8,824,125
$546,887
Interest income recognized during impairment
326,397
170,568
35,296
Cash-basis interest income recognized
120,617
95,183
25,776
The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2010:
Nonaccrual loans and loans past due 90 days still on accrual were as follows:
Loans past due over 90 days still on accrual
$-
$7,980
Nonaccrual loans
13,252,562
7,554,750
Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans that are not performing.
Note 3 - Loans (Continued)
The following table presents nonaccrual and loans past due 90 days still on accrual by class of loans as of December 31, 2010:
The following table presents the aging of past due loans as of December 31, 2010 by class of loans:
The above table of past due loans includes nonaccrual loans of $4,648,327 in the loans not past due category, $2,919,099 in the 30-89 days past due category and $5,685,136 in the 90 days and greater past due category.
Troubled Debt Restructurings
Since no loans classified as troubled debt restructurings included interest rate reductions as part of the modification, and modifications only changed the timing of cash flows as the loans were placed on interest-only payments for a period of time, the Company has not allocated any specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2010. The Company has not committed to lend any funds to customers whose loans are classified as a troubled debt restructuring as of December 31, 2010. The Company had committed to lend $390,000 to customers whose loans are classified as troubled debt restructurings as of December 31, 2009.
Note 3 - Loans (Continued)
Credit Quality Indicators
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. The Company uses the following definitions for risk ratings, which are updated annually:
Special Mention.
Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. Loans listed as not rated are typically loans held for sale and overdrafts. As of December 31, 2010, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
Note 4 - Real Estate Owned
Expenses related to foreclosed assets include:
Net loss (gain) on sales
$(170,039)
$39,991
$558
Direct write-downs
496,461
352,500
-
Operating expenses
665,825
571,478
41,381
Total expenses
$992,247
$963,969
$41,939
=========
=========
=========
Note 5 - Fair Value
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:
Investment securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).
Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
Other Real Estate Owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below:
Note 5 - Fair Value (Continued)
There were no significant transfers between Level 1 and Level 2 during 2010.
Assets and Liabilities Measured on a Non-Recurring Basis
Assets measured at fair value on a non-recurring basis are summarized below:
Note 5 - Fair Value (Continued)
There were $4,547,700 in impaired loans measured for impairment using the fair value of the collateral at December 31, 2010, resulting in an additional provision for loan losses of $1,558,966 for the year ended December 31, 2010. At December 31, 2009 impaired loans, had a carrying amount of $4,297,943, with a valuation allowance of $446,776, resulting in an additional provision for loan losses of $193,058 for the year ended December 31, 2009.
Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $12,703,579 for the year ended December 31, 2010. Included in this amount were properties that were written down to fair value totaling $4,056,100 resulting in additional foreclosed asset expense of $496,461for the year ended December 31, 2010. Other real estate owned had a net had a carrying amount of $12,550,296 for the year ended December 31, 2009. Included in this amount were properties that were written down to fair value totaling $1,057,500 resulting in additional foreclosed asset expense of $352,000.
Carrying amount and estimated fair values of financial instruments at year end were as follows:
The methods and assumptions, not previously presented, used to estimate fair value are described as follows:
Carrying amount is the estimated fair value for cash and cash equivalents, interest bearing deposits, accrued interest receivable and payable, demand deposits, and variable rate loans or deposits that reprice frequently and fully. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values of debt are based on current rates for similar financing. It was not practicable to determine the fair value of Federal Home Loan Bank stock due to restrictions placed on its transferability. The fair value of off-balance-sheet items and loans held for sale are not considered material.
Note 6 - Premises and Equipment
Year-end premises and equipment were as follows:
Land
$6,438,371
$6,186,529
Buildings
19,606,904
17,049,006
Furniture and equipment
7,020,988
6,986,604
Leasehold improvements
152,603
152,603
Construction in progress
-
1,555,270
$33,218,866
$31,930,012
Less: Accumulated depreciation
$(13,862,368)
$(13,054,000)
$19,356,498
$18,876,012
==========
==========
Operating Leases: The Company leases certain branch properties and equipment under operating leases. Rent expense was $169,850, $217,180 and $124,578 for 2010, 2009, and 2008, respectively. Rent commitments, before considering renewal options that generally are present, were as follows:
104,267
106,873
Total
$211,140
========
Note 7 - Deposits
Time deposits of $100,000 or more were $139,949,423 and $172,423,904 at year-end 2010 and 2009.
Scheduled maturities of time deposits for the next five years were as follows:
$225,296,761
33,420,776
5,223,735
8,910,427
7,935,384
Overdrafts in the amounts of $854,989 and $635,446 were reclassified as loans as of December 31, 2010 and 2009, respectively.
Note 8 - Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase are secured by U.S. government-sponsored entity securities with a carrying amount of $3,176,133 and $3,085,400 at year-end 2010 and 2009, respectively.
Securities sold under agreements to repurchase are financing arrangements that mature daily. At maturity, the securities underlying the agreements are returned to the Company. Information concerning securities sold under agreements to repurchase is summarized as follows:
Note 8 - Securities Sold Under Agreements to Repurchase (Continued)
Average daily balance during the year
1,909,560
1,683,477
1,566,862
Average interest rate during the year
1.59%
1.59%
2.53%
Maximum month-end balance during the year
2,133,165
1,959,144
1,824,772
Weighted average interest rate at year-end
1.59%
1.59%
1.59%
Note 9 - Other Borrowed Funds
At year end, advances from the Federal Home Loan Bank were as follows:
Each advance is payable at its maturity date, with a prepayment penalty for fixed rate advances. The advances were collateralized by $57,257,335 and $60,566,513 of first mortgage loans under a blanket lien arrangement at year-end 2010 and 2009, respectively. Based on this collateral and the Company's holdings of FHLB stock, the Company is eligible to borrow up to $23,078,000 at year-end 2010.
Payment Information
Required payments over the next five years are:
237,006
1,122,944
1,077,212
5,035,770
37,964
Thereafter
34,455
$7,545,351
=========
Note 10 - Income Taxes
Income tax expense (benefit) was as follows:
Effective tax rates differ from the federal statutory rate of 34% applied to income before taxes due to the following:
Note 10 - Income Taxes (Continued)
Year-end deferred tax assets and liabilities were due to the following:
The Company has sufficient refundable taxes paid in available carryback years to fully realize its recorded deferred tax assets. Accordingly, no valuation has been recorded.
Unrecognized Tax Benefits
The amount of unrecognized tax benefits was $22,081 and $25,825 at December 31, 2010 and 2009, respectively. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next 12 months.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense. The Company did not have any material amount accrued for interest and penalties for the years ended December 31, 2010 and 2009.
The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of the states of Tennessee and Alabama. The Company filed income tax returns in Alabama in 2005, 2006, 2007, 2008 and 2009. These returns are subject to examination. The Company is no longer subject to examination by U.S. federal and Tennessee taxing authorities for years before 2007.
Note 11 - Benefit Plans
Profit Sharing Plan: The Bank has a non-contributory trusteed profit sharing retirement plan covering all officers and employees who have completed a year of service and are over the age of 21. According to the plan, the Bank's contribution will not exceed 15% of the total salary of all the participants. The plan expense was $478,220, $458,766 and $742,463 in 2010, 2009 and 2008, respectively.
Note 11 - Benefit Plans (Continued)
Deferred Compensation Plan: A deferred compensation plan covers all directors. Under the plan, the Company pays each participant, or their beneficiary, the amount of director fees deferred plus interest over 15 years, beginning with the individual's retirement, death or disability. A liability is accrued for the obligation under this plan. The expense incurred for the deferred compensation for each of the last three years was $441,559, $532,429 and $262,711 resulting in a deferred compensation liability of $2,353,580, $1,973,732 and $1,503,023, respectively.
Employee Stock Purchase Plan: The 1994 Employee Stock Purchase Plan (the "1994 Employee Plan") permits the granting of rights to eligible employees of the Company to acquire stock. A total of 150,000 shares were reserved under this plan. The Company has agreed to pay 3% of the interest rate cost, up to a maximum of $18,000 per year for all participants, if the employee chooses to purchase shares under the 1994 Employee Plan and borrows the funds to purchase the shares from the Company. The employee may also choose to purchase the shares with cash. The Company generally issues new shares to satisfy these purchases. The Board has established the following guidelines as to the number of shares employees are allowed to purchase generally on July 1, each year:
The expense related to the 1994 Employee Plan was not material in 2010, 2009 or 2008.
Note 12 - Other Operating Expenses
The following table summarizes the components of other operating expenses for the years ended December 31:
Directors' fees and expense
$579,834
$679,679
$423,461
Stationery and supplies
190,238
185,419
223,983
Collection and professional fees
517,745
418,512
453,536
Postage
166,531
196,256
175,074
Data processing expense
535,385
484,561
333,003
Educational expense
62,683
123,419
195,957
Telecommunication expense
213,467
239,151
185,976
Other
1,054,612
1,027,941
1,036,982
$3,320,495
$3,354,938
$3,027,972
===========
===========
===========
Note 13 - Related Party Transactions
The following table summarizes loans to principal officers, directors and their affiliates for 2010:
Beginning balance
$2,215,740
New loans
1,679,898
Repayments
(1,780,028)
Balance at end of year
$2,115,610
===========
Deposits from principal officers, directors, and their affiliates at year-end 2010 and 2009 were $9,789,000 and $9,091,000, respectively.
Note 14 - Stock-based Compensation
Bank employees (and in prior years, non-employee directors) may be granted options or rights to purchase shares of the Corporation's common stock under the Corporation's stock option and employee stock purchase plans.
The 1997 Stock Option Plan (the "1997 Plan") permitted the Board of Directors to grant options to key employees. A total of 100,000 shares were reserved under the plan of which 27,500 were granted. These options expire generally 10 years from the date of grant. The 1997 Plan expired in the second quarter of 2007.
The 2007 Equity Incentive Plan (the "2007 Plan") also permits the Board of Directors to grant restricted share awards to key employees. A total of 100,000 shares were reserved under the 2007 Plan, of which the Company has awarded 12,250 shares of restricted stock to certain employees of the Company. The forfeiture restrictions with respect to these awards lapse on the one year anniversary of the date of grant. Compensation expense associated with these restricted share awards is recognized over the time period that the restrictions associated with the awards lapse.
The 1994 Outside Directors' Stock Option Plan (the "1994 Directors' Plan") permitted the granting of stock options to non-employee directors. A total of 150,000 shares were reserved under this plan. An option to purchase 500 shares was granted annually upon becoming a member of the Board of Directors, of which 250 shares were immediately exercisable and the remaining 250 shares were exercisable upon the first annual meeting of shareholders following the date of grant provided the optionee was still serving as an outside director. In addition, each outside director upon first becoming a board member received an immediately exercisable option to purchase 2,500 shares, less the number of shares of stock previously beneficially owned. These options expired ten years from the date of grant. During 2003, the Board terminated this Plan. At the time of termination, options to purchase 66,160 shares under the plan had not been granted.
A summary of the stock option activity in the 2007 Plan, the 1997 Plan and the 1994 Directors' Plan for 2010 follows:
Weighted
Weighted
Average
Average
Remaining
Aggregate
Number
Exercise
Contractual
Intrinsic
of Options
Price
Term
Value
Outstanding at January 1, 2010
9,000
$46.00
Granted
-
-
Exercised
(500)
34.00
Forfeited or expired
(500)
49.00
Outstanding December 31, 2010
8,000
$46.56
2.4
$(12,500)
==========
==========
==========
=========
Fully vested
8,000
46.56
2.4
(12,500)
Exercisable at December 31, 2010
8,000
$46.56
2.4
$(12,500)
==========
==========
==========
=========
Note 14 - Stock-based Compensation (Continued)
Information related to stock option activity in the 2007 Plan, the 1997 Plan and the 1994 Directors' Plan during each year follows:
Intrinsic value of options exercised
$10,500
$15,400
$168,154
Cash received from option exercises
17,000
24,475
110,256
Tax benefit realized from option exercises
4,020
5,896
12,159
Weighted average fair value of options granted
-
-
-
As of December 31, 2010, there were no nonvested stock options; therefore there was no unrecognized compensation cost related to nonvested stock options granted under the plans. No compensation cost has been charged against income for these plans related to stock options for 2010, 2009 and 2008. The Company has a policy to issue new shares to satisfy the exercise of share options.
The 2007 Plan provides for the issuance of restricted shares to employees, directors and contractors of the Company. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at issue date. The fair value of the stock was determined using the price, of which the Company is aware, at which the Company's Common Stock was traded on a date closest to the award date. These restricted shares vest at the rate of twenty percent on each anniversary of the grant date. Compensation expense of $134,750, $134,750 and $125,813 has been charged against income for these shares in 2010, 2009 and 2008, respectively, related to the grants of restricted shares. Total shares issuable under the 2007 Plan are 87,750 at year end 2010, with 12,250 restricted shares granted that vest and are issued at the rate of twenty percent on each anniversary of the grant date.
A summary of changes in the Company's nonvested shares for the year follows:
As of December 31, 2010, there was $249,677 of total unrecognized compensation cost related to nonvested restricted shares granted under the 2007 Plan. The cost is expected to be recognized over a weighted-average period of 1.9 years. The total fair value of shares vested during the years ended December 31, 2010, 2009 and 2008 was $134,750, $134,750, and $90,750, respectively.
Note 15 - Regulatory Capital Matters
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Management believes as of December 31, 2010, the Corporation and the Bank meet all capital adequacy requirements to which it is subject.
Note 15 - Regulatory Capital Matters (Continued)
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits or to pay interest on deposits above certain rates. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2010 and 2009, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution's category.
Actual and required capital amounts (in thousands) and ratios are presented below at year end.
Dividend Restrictions - The Company's principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year's net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. During 2011, the Bank could, without prior approval, declare dividends of approximately $3,370,000 plus any 2011 net profits retained to the date of the dividend declaration.
Note 16 - Loan Commitments and Other Related Activities
Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance-sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.
The contractual amounts of financial instruments with off-balance-sheet risk at year end were as follows:
Commitments to make loans are generally made for periods of 60 days or less. The fixed rate loan commitments have interest rates ranging from 5.50% to 8.00% and maturities ranging from 6 months to 3 years.
Note 17 - Parent Company Only Condensed Financial Information
Condensed financial information of First Pulaski National Corporation follows:
Note 17 - Parent Company Only Condensed Financial Information (Continued)
Note 18 - Earnings Per Share
The factors used in the earnings per share computation follow:
All stock options were considered in computing diluted earnings per share since none were anti-dilutive.
Unvested restricted shares that include non-forfeitable rights to dividends are classified as participating securities and included in average outstanding shares for calculating basic earnings per share. As of December 31, 2010, there were 3,250 shares of unvested restricted stock that were not classified as participating securities.
Note 19 - Other Comprehensive Income (Loss)
Other comprehensive income (loss) components and related tax effects were as follows:
Note 19 - Other Comprehensive Income (Loss) (Continued)
The following is a summary of the accumulated other comprehensive balances, net of tax:
Note 20 - Quarterly Financial Data (Unaudited)
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
.		
None.
Item 9A.
Item 9A. CONTROLS AND PROCEDURES.
The Corporation maintains disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (the "Exchange Act"), that are designed to ensure that information required to be disclosed by the Corporation in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. The Corporation carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and the Chief Financial Officer concluded that the Corporation's disclosure controls and procedures were effective.
The report of the Corporation's management on the Corporation's internal control over financial reporting is set forth on page 38 of this Annual Report on Form 10-K. The report of the Corporation's independent registered public accounting firm on the Corporation's internal control over financial reporting is set forth on page 39 of this Annual Report on Form 10-K.
There were no changes in the Corporation's internal controls over financial reporting during the Corporation's fiscal quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, the Corporation's internal control over financial reporting.
Item 9B.
Item 9B. OTHER INFORMATION.
None
PART III
Item 10.
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information required by this item with respect to directors is incorporated herein by reference to the section titled "Proposal No. 1 - Election of Directors" in the Corporation's definitive proxy material to be filed in connection with the Corporation's 2011 Annual Meeting of Shareholders. The information required by this item with respect to executive officers that are not also directors is set forth below:
Mr. Cox retired as Chairman on the Board of Directors of the Corporation and the Bank on April 24, 2008. He was appointed the Corporation's and Bank's Chief Executive Officer and Chairman of the Board on March 16, 1999 and served as the Corporation's and Bank's Chief Executive Officer until April 24, 2003. He was appointed the Bank's Senior Executive Officer on April 24, 2008.
Mr. Porterfield began employment with the Bank on December 14, 1992 in the Accounting Department. He has been employed by the Bank in various accounting positions and was named the Cashier on June 13, 2000, Chief Financial Officer on April 24, 2003 and Secretary/Treasurer on January 1, 2004.
Mr. Nesbitt began employment with the Bank on February 11, 2002 as Loan Review Officer. Prior to his employment with the Bank, Mr. Nesbitt was employed as a bank examiner with the Office of the Comptroller of the Currency. Mr. Nesbitt was named the Senior Credit Officer on January 20, 2004.
All officers serve at the pleasure of the Board of Directors. No officers are involved in any legal proceedings which are material to an evaluation of their ability and integrity.
The information required by this section with respect to transactions in the Corporation's common stock is incorporated herein by reference to the section titled "Section 16(a) Beneficial Ownership Reporting Compliance" in the Corporation's definitive proxy material to be filed in connection with the Corporation's 2011 Annual Meeting of Shareholders.
The information required by this item with respect to the Corporation's audit committee is incorporated herein by reference to the section entitled "Description of the Board and Committees" in the Corporation's definitive proxy material to be filed in connection with the Corporation's 2011 Annual Meeting of Shareholders.
The information required by this item with respect to the Corporation's audit committee financial expert is incorporated herein by reference to the section entitled "Description of the Board and Committees" in the Corporation's definitive proxy material to be filed in connection with the Corporation's 2011 Annual Meeting of Shareholders.
The information required by this item with respect to the Corporation's code of conduct is incorporated herein by reference to the section titled "Proposal No. 1 - Election of Directors - Code of Conduct" in the Corporation's definitive proxy materials to be filed in connection with the Corporation's 2011 Annual Meeting of Shareholders.
Item 11.
Item 11. EXECUTIVE COMPENSATION
. Information required by this item is contained under the captions "Executive Compensation", "Director Compensation" and "Compensation Committee Interlocks and Insider Participation" in the Corporation's definitive proxy materials to be filed in connection with the Corporation's 2011 Annual Meeting of Shareholders and is incorporated herein by reference.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
Information required by this item is contained under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Corporation's definitive proxy materials to be filed in connection with the Corporation's 2011 Annual Meeting of Shareholders and is incorporated herein by reference.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.
Information required by this item is contained under the caption "Proposal No. 1 Election of Directors - Director Independence" and "Certain Relationships and Related Transactions" in the Corporation's definitive proxy materials
to be filed in connection with the Corporation's 2011 Annual Meeting of Shareholders and is incorporated herein by reference.
Item 14.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
. The information required by this item with respect to the fees paid to, and services provided by, the Corporation's principal accountant is incorporated herein by reference to the section titled "Independent Registered Public Accounting Firm - Fees Incurred by the Corporation from its Independent Registered Accounting Firm During 2010 and 2009" in the Corporation's definitive proxy material to be filed in connection with the Corporation's 2011 Annual Meeting of Shareholders.
PART IV
Item 15.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a)(1) Financial Statements. See Item 8
(a)(2) Financial Statement Schedules. See Item 8
(a)(3) Exhibits. See Index to Exhibits
SIGNATURES
	 	Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
						FIRST PULASKI NATIONAL CORPORATION
						 By:/s/Mark A. Hayes
						Mark A. Hayes
March 16, 2011 Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
Signature
Title
Date
/s/Mark A. Hayes
Mark A. Hayes
Chairman of the Board & CEO, and Director (Principal Executive Officer)
March 16, 2011
/s/Tracy Porterfield
Tracy Porterfield
Chief Financial Officer, Secretary/Treasurer (Principal Financial Officer and Accounting Officer)
March 16, 2011
/s/David E. Bagley
David E. Bagley
Director
March 16, 2011
/s/James K. Blackburn, IV
James K. Blackburn, IV
Director
March 16, 2011
/s/Wade Boggs
Wade Boggs
Director
March 16, 2011
/s/James H. Butler
James H. Butler
Director
March 16, 2011
/s/William Lyman Cox
Director
March 16, 2011
William Lyman Cox
/s/Greg. G. Dugger, DDS
Greg G. Dugger, DDS
Director
March 16, 2011
/s/Charles D. Haney
Charles D. Haney, MD
Director
March 16, 2011
/s/Donald A. Haney
Donald A. Haney
Director
March 16, 2011
/s/Larry K. Stewart
Director
March 16, 2011
Larry K. Stewart
/s/Linda Lee Rogers
Linda Lee Rogers
Director
March 16, 2011
/s/R. Whitney Stevens, Jr.
R. Whitney Stevens, Jr.
Director
March 16, 2011
/s/Bill Yancey
Bill Yancey
Director
March 16, 2011
INDEX TO EXHIBITS
EXHIBIT NUMBER
3.1 	Charter of the First Pulaski National Corporation (1)
3.2 	Amended Bylaws of First Pulaski National Corporation (Restated Electronically for SEC filing purposes (2).
10.1 	Form of First Pulaski National Corporation Incentive Stock Option Agreement. +(3)
10.2 	Directors and Named Executive Officer Compensation Summary.+*
10.3 	Directors' Deferred Compensation Plan.+(4)
10.4 	Form of Adoption Agreement.+(4)
10.5 	Form of Amendment No. 1 to Adoption Agreement. +(4)
10.6 	Form of Amendment No. 2 to Adoption Agreement.+(4)
10.7 	First Pulaski National Corporation 2007 Equity Incentive Plan.+(5)
10.8 	Amended and Restated Directors' Deferred Compensation Plan. + (6)
10.9 	Amended and Restated Form of Adoption Agreement. + (6)
10.10 	First Amendment to the Amended and Restated Directors' Deferred Compensation Plan.+ (7)
10.11 	First Amendment to the Amended and Restated Form of Adoption Agreement.+ (7)
10.12 Form of Restricted Stock Agreement.+ (8)
10.13 	1994 Employee Stock Purchase Plan.+ (9)
10.14 	Employment Agreement by and between First National Bank of Pulaski and Mark Hayes dated December 22, 2010.+ (10)
10.15 	Employment Agreement by and between First National Bank of Pulaski and Tracy Porterfield dated December 22, 2010.+ (10)
10.16 	Employment Agreement by and between First National Bank of Pulaski and Don Haney dated December 22, 2010.+ (10)
10.17 	Employment Agreement by and between First National Bank of Pulaski and William Lyman Cox dated December 22, 2010.+ (10)
10.18 	First Amendment to the First National Bank of Pulaski Amended and Restated Director's Deferred Compensation Plan Participation Agreement
for James Blackburn.+ (7)
21.1 	List of Subsidiaries.*
23.1 	Consent of Crowe Horwath LLP.*
31.1 	Certification of Mark A. Hayes, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2 	Certification of Tracy Porterfield, pursuant to Section 302 of the Sarbanes- Oxley Act of 2002.*
32.1 	Certification of Mark A. Hayes, pursuant to 18 U.S.C. Section 1350 - the Sarbanes-Oxley Act of 2002.*
32.2 	Certification of Tracy Porterfield, pursuant to 18 U.S.C. Section 1350 - the Sarbanes-Oxley Act of 2002.*
* Filed herewith
+ Management contract or compensatory plan or arrangement
(1) 	Incorporated herein by reference to the Corporation's Amendment No. 1 to Registration Statement on Form 8-A/A (Registration No. 000-10974).
(2) 	Incorporated herein by reference to the Corporation's Registration Statement on Form S-4 (Registration No. 333-68448).
(3) 	Incorporated herein by reference to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 (Registration No. 000-10974).
(4) 	Incorporated herein by reference to the Corporation's Current Report on Form 8-K as filed with the Securities and Exchange Commission on April 24, 2006 (Registration No. 000-10974).
(5) Incorporated herein by reference to the Corporation's Current Report on Form 8-K filed with the Securities and Exchange Commission on April 30, 2007 (Registration No. 000-10974).
(6) Incorporated herein by reference to the Corporation's Annual Report on Form 10-K as filed with the Securities and Exchange Commission on April 2, 2007 (Registration No. 000-10974).
(7) Incorporated by reference to the Corporation's Current Report on Form 8-K as filed with the Securities and Exchange Commission on June 21, 2010 (Registration No. 000-10974).
(8) Incorporated by reference to the Corporation's Current Report on Form 8-K as filed with the Securities and Exchange Commission on September 7, 2007 (Registration No. 000-10974).
(9) Incorporated by reference to the Corporation's Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 16, 2010 (Registration No. 000-10974).
(10) Incorporated by reference to the Corporation's Current Report on Form 8-K as filed with the Securities and Exchange Commission on December 28, 2010 (Registration No. 000-10974).