Item 1. Business
General. We, or the Company, are a registered bank holding company incorporated in Missouri in 1978 and headquartered in St. Louis, Missouri. We operate through our wholly owned subsidiary bank holding company, The San Francisco Company, or SFC, headquartered in St. Louis, Missouri, and SFC’s wholly owned subsidiary bank, First Bank, also headquartered in St. Louis, Missouri. First Bank’s subsidiaries at December 31, 2010 are as follows:
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First Bank Business Capital, Inc., or FBBC;
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FB Holdings, LLC, or FB Holdings;
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Small Business Loan Source LLC, or SBLS LLC;
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ILSIS, Inc.;
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FBIN, Inc.;
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SBRHC, Inc.;
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HVIIHC, Inc.;
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FBSA Missouri, Inc.;
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FBSA California, Inc.;
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NT Resolution Corporation; and
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LC Resolution Corporation.
First Bank’s subsidiaries are wholly owned, except for FB Holdings, which was 53.23% owned by First Bank and 46.77% owned by First Capital America, Inc., or FCA, a corporation owned and operated by the Company’s Chairman of the Board and members of his immediate family, as of December 31, 2010, as further described in Note 19 to the consolidated financial statements. On April 30, 2009, First Bank and FCA entered into and consummated a Purchase Agreement providing for FCA to sell its 17.45% ownership interest in SBLS LLC to First Bank, as further described in Note 19 to our consolidated financial statements. As such, effective April 30, 2009, First Bank owned 100% of SBLS LLC.
First Bank currently operates 153 branch offices in California, Florida, Illinois and Missouri, with 187 automated teller machines, or ATMs, across the four states. At December 31, 2010, we had assets of $7.38 billion, loans, net of unearned discount, of $4.49 billion, deposits of $6.46 billion and stockholders’ equity of $307.3 million.
Through First Bank, we offer a broad range of financial services, including commercial and personal deposit products, commercial and consumer lending, and many other financial products and services. Commercial and personal deposit products include demand, savings, money market and time deposit accounts. In addition, we market combined basic services for various customer groups, including packaged accounts for more affluent customers, and sweep accounts, lock-box deposits and cash management products for commercial customers. Commercial lending includes commercial, financial and agricultural loans, real estate construction and development loans, commercial real estate loans, small business lending and trade financing. Consumer lending includes residential real estate, home equity and installment lending. Other financial services include mortgage banking, debit cards, brokerage services, internet banking, remote deposit, ATMs, telephone banking, safe deposit boxes, and trust and private banking services. The revenues generated by First Bank and its subsidiaries consist primarily of interest income generated from our loan and investment security portfolios, service charges and fees generated from deposit products and services, and fees and commissions generated by our mortgage banking and trust and private banking business units. Our extensive line of products and services are offered to customers primarily within our geographic areas, which include eastern Missouri, Illinois, southern and northern California, and Florida, including Bradenton and the greater Tampa metropolitan area. Certain loan products are available nationwide.
Primary responsibility for managing our banking units rests with the officers and directors of each unit, but we centralize many of our overall corporate policies, procedures and administrative functions and provide centralized operational support functions for our subsidiaries. This practice allows us to achieve various operating efficiencies while allowing our banking units to focus on customer service.
Ownership Structure. Various trusts, established by and administered by and for the benefit of Mr. James F. Dierberg and members of his immediate family, own all of our voting stock. Mr. Dierberg and his family, therefore, control our management and policies.
We have formed numerous affiliated Delaware or Connecticut business or statutory trusts. These trusts operate as financing entities and were created for the sole purpose of issuing trust preferred securities, and the sole assets of the trusts are our junior subordinated debentures. In conjunction with the formation of our financing entities and their issuance of the trust preferred securities, we issued junior subordinated debentures to each of our financing entities in amounts equivalent to the respective trust preferred securities plus the amount of the common securities of the individual trusts, as more fully described in Note 12 to our consolidated financial statements. Prior to August 10, 2009, we paid interest on our junior subordinated debentures to our respective financing entities. In turn, our financing entities paid distributions to the holders of the trust preferred securities. The interest payable on our junior subordinated debentures is included in interest expense in our consolidated statements of operations. On August 10, 2009, we announced the deferral of our regularly scheduled interest payments on our outstanding junior subordinated debentures relating to our $345.0 million of trust preferred securities beginning with the regularly scheduled quarterly interest payments that would otherwise have been made in September and October 2009.
The trust preferred securities issued by First Preferred Capital Trust IV are publicly held and traded on the New York Stock Exchange, or NYSE. The remaining trust preferred securities were issued in private placements. The trust preferred securities have no voting rights except in certain limited circumstances.
On December 31, 2008, the Company entered into a Letter Agreement, including a Securities Purchase Agreement - Standard Terms, or Purchase Agreement, with the United States Department of the Treasury, or the U.S. Treasury, pursuant to the Troubled Asset Relief Program’s Capital Purchase Program, or CPP. Under the terms of the Purchase Agreement, on December 31, 2008 we issued to the U.S. Treasury, 295,400 shares of senior preferred stock, or Class C Preferred Stock, and a warrant, or Warrant, to acquire up to 14,784.78478 shares of a separate series of senior preferred stock, or Class D Preferred Stock (at an exercise price of $1.00 per share), for an aggregate purchase price of $295.4 million, pursuant to the standard CPP terms and conditions for non-public companies as described and set forth in the Purchase Agreement and the Warrant. Pursuant to the terms of the Warrant, the U.S. Treasury exercised the Warrant on December 31, 2008 and paid the exercise price by having us withhold, from the shares of Class D Preferred Stock that would otherwise be delivered to the U.S. Treasury upon such exercise, shares of Class D Preferred Stock issuable upon exercise of the Warrant with an aggregate liquidation amount equal in value to the aggregate exercise price of $14,784.78. The senior preferred stock and the Warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. The Purchase Agreement contains limitations on certain actions of the Company, including, but not limited to, payment of dividends, redemptions and acquisitions of the Company’s equity securities, and compensation of senior executive officers. In addition, the U.S. Treasury has certain supervisory and oversight duties and responsibilities under the CPP and, pursuant to the terms of the Purchase Agreement, the U.S. Treasury is empowered to unilaterally amend any provision of the Purchase Agreement with the Company to the extent required to comply with any changes in applicable federal statutes. Furthermore, in the event the Company does not pay dividends on the preferred stock issued to the U.S. Treasury for an aggregate of six quarters, the U.S. Treasury shall have the right to elect two directors to our Board. On August 10, 2009, we announced the deferral of the payment of cash dividends on our outstanding Class C Preferred Stock and Class D Preferred Stock beginning with the regularly scheduled quarterly dividend payments that would otherwise have been made in August 2009, however we continue to record the declaration of such dividends and the related additional cumulative dividends on our deferred dividend payments in our consolidated financial statements. As a result of our deferral of dividends to the U.S. Treasury for six quarters, the U.S. Treasury has the right to elect two directors to our Board but has not elected to do so as of March 25, 2011. See Note 18 to our accompanying consolidated financial statements for further discussion regarding our Class C Preferred Stock and Class D Preferred Stock.
Recent Developments.
Successful Completion of Consent Solicitation. We, the holder of 100% of the outstanding common stock of First Preferred Capital Trust IV, or the Trust, announced that we were soliciting consents from the holders of the 8.15% cumulative trust preferred securities of the Trust, or the Trust Preferred Securities. We solicited consents to amend: (a) the Indenture, dated April 1, 2003, or the Indenture, relating to the 8.15% Subordinated Debentures due 2033 issued by the Company to the Trust, or the Debentures; (b) the Amended and Restated Trust Agreement, dated April 1, 2003, relating to the Trust, or the Trust Agreement; and (c) the Preferred Securities Guarantee, dated April 1, 2003, or the Guarantee Agreement, relating to the Trust Preferred Securities. The action was subject to approval of the holders of record (as of October 12, 2010) of a majority in aggregate liquidation amount of the outstanding Trust Preferred Securities.
We solicited the consents to the Indenture, Trust Agreement and Guarantee Agreement in order to increase our capital planning flexibility under the terms of those documents and the provisions of the indentures, guarantee agreements and trust agreements relating to our other tranches of trust preferred securities. The proposed amendments would provide an opportunity for the Company to seek to improve its capital position and decrease its level of indebtedness during a period in which it is deferring interest payments in accordance with the terms of the Indenture.
On January 25, 2011, we obtained the requisite consents from the holders of the Trust Preferred Securities approving the proposed amendments. The consent solicitation terminated on January 26, 2011 after receipt by us and the Trustee of validly executed consents from the holders of a majority in aggregate liquidation amount of the outstanding Trust Preferred Securities.
On January 26, 2011, we entered into the amendments that were approved in the consent solicitation, which consist of: (i) the First Supplemental Indenture, dated as of January 26, 2011, or the Supplemental Indenture, between the Company, as Issuer, and The Bank of New York Mellon Trust Company, N.A., as Trustee; (ii) the First Amendment to the Trust Agreement, dated January 26, 2011, or the Trust Amendment, among the Company, The Bank of New York Mellon Trust Company, N.A., as Property Trustee, Wilmington Trust Company, as Delaware Trustee, and the Administrative Trustees named therein; and (iii) the First Amendment to Preferred Securities Guarantee Agreement, dated as of January 26, 2011, or the Guarantee Amendment, between the Company, as Guarantor, and The Bank of New York Mellon Trust Company, N.A., as Guarantee Trustee.
The Supplemental Indenture amended Sections 4.3 and 5.6 of the Indenture, both of which set forth various restrictions on the Company’s activities during a Deferral Period (as defined in the Indenture), to: (i) allow the Company or a subsidiary or affiliate of the Company to issue its capital stock in exchange for or upon conversion of outstanding capital stock of the Company or any subsidiary or affiliate or for outstanding indebtedness of the Company ranking pari passu with or junior to the Debentures (as defined in the Indenture)(which would include any tranche of junior subordinated debentures relating to trust preferred securities) during a Deferral Period; (ii) permit the Company to exchange any of the Trust Preferred Securities that it beneficially owns for an equal principal amount of corresponding junior subordinated debentures and then cancel such indebtedness during a Deferral Period; and (iii) permit the Company to acquire less than all of any outstanding Debentures or any of the Trust Preferred Securities during a Deferral Period.
The Trust Amendment added a new Section 8.20 to the Trust Agreement to direct the Property Trustee to cancel any Trust Preferred Securities held and surrendered to it by the Company, which would then permit the Trustee under the Indenture to cancel the corresponding indebtedness.
The Guarantee Amendment amended Section 6.1 of the Guarantee Agreement, which sets forth the same restrictions on the Company’s activities during a Deferral Period as are listed in Sections 4.3 and 5.6 of the Indenture, to conform to the amendments effected by the Supplemental Indenture.
As a result of the successful completion of the consent solicitation, the Company believes it is better positioned to consider certain potential capital planning strategies to improve the regulatory capital ratios of First Banks, Inc. and further strengthen the Company’s overall financial position.
Capital Plan. We have been working since the beginning of 2008 to strengthen our capital ratios and improve our financial performance. Additionally, on August 10, 2009, we announced the adoption of our Capital Optimization Plan, or Capital Plan, designed to improve our capital ratios and financial performance through certain divestiture activities, asset reductions and expense reductions. We adopted our Capital Plan in order to, among other things, preserve our risk-based capital. We have completed, or are in the process of completing, a number of initiatives associated with our Capital Plan, including:
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The sale of certain assets and the transfer of certain liabilities of our branch banking office located in Edwardsville, Illinois, or the Edwardsville Branch, to National Bank, under a Branch Purchase and Assumption Agreement dated January 28, 2011. Under the terms of the agreement, National Bank is to assume approximately $13.7 million of deposits associated with our Edwardsville Branch, including certain commercial deposit relationships, for a premium of $130,000. National Bank is also expected to purchase approximately $794,000 of loans associated with our Edwardsville Branch at a premium of 0.5%, or approximately $4,000, and premises and equipment associated with our Edwardsville Branch at a premium of approximately $600,000. The transaction, which is subject to regulatory approvals and certain closing conditions, is expected to be completed during the second quarter of 2011.
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The sale of certain assets and the transfer of certain liabilities of our three retail branches in Pittsfield, Roodhouse and Winchester, Illinois to United Community Bank, or United Community, under a Branch Purchase and Assumption Agreement dated December 21, 2010. Under the terms of the agreement, United Community is to assume approximately $94.1 million of deposits associated with these branches, including certain commercial deposit relationships, for a weighted average premium of approximately 2.4%. United Community is also expected to purchase approximately $40.3 million of loans as well as certain other assets at par value, including premises and equipment, associated with these branches. The transaction, which is subject to regulatory approvals and certain closing conditions, is expected to be completed during the second quarter of 2011.
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The sale of certain assets and the transfer of certain liabilities of our branch banking office located in San Jose, California, or the San Jose Branch, to City National Bank, or City National, under a Branch Purchase and Assumption Agreement dated November 9, 2010. Under the terms of the agreement, City National assumed $8.4 million of deposits associated with our San Jose Branch, including certain commercial deposit relationships, for a premium of 5.85%, or $371,000. City National also purchased certain other assets at par value, including premises and equipment, associated with our San Jose Branch. We completed the transaction on February 11, 2011 which resulted in a loss of $334,000 during the first quarter of 2011, as further described in Note 25 to our consolidated financial statements.
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The sale of certain assets and the transfer of certain liabilities of our branch banking office located in Jacksonville, Illinois, or the Jacksonville Branch, to Bank of Springfield, under a Branch Purchase and Assumption Agreement dated June 7, 2010. We completed the transaction with Bank of Springfield on September 24, 2010. Under the terms of the agreement, Bank of Springfield assumed $28.9 million of deposits associated with our Jacksonville Branch, including certain commercial deposit relationships, for a premium of 4.00%. Bank of Springfield also purchased $2.2 million of loans as well as certain other assets at par value, including premises and equipment, associated with our Jacksonville Branch.
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The sale of certain assets and the transfer of certain liabilities of 10 of our retail branches in Peoria, Galesburg, Quincy, Bartonville, Knoxville and Bloomington, Illinois to First Mid-Illinois Bank & Trust, N.A., or First Mid-Illinois, under a Branch Purchase and Assumption Agreement dated May 7, 2010. We completed the transaction with First Mid-Illinois on September 10, 2010. Under the terms of the agreement, First Mid-Illinois assumed $336.0 million of deposits associated with these branches, including certain commercial deposit relationships, for a premium of 4.77%. First Mid-Illinois also purchased $135.2 million of loans as well as certain other assets at par value, including premises and equipment, associated with these branches.
The 14 branches in the transactions with United Community, Bank of Springfield and First Mid-Illinois are collectively defined as the Northern Illinois Region. We recognized a gain on sale related to the transactions with Bank of Springfield and First Mid-Illinois of $6.4 million during the third quarter of 2010 after the write-off of goodwill and intangible assets allocated to these transactions of $9.7 million. In addition, the completed transactions reduced our risk-weighted assets by $141.8 million.
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The sale of certain assets and the transfer of certain liabilities of our Texas franchise, or Texas Region, to Prosperity Bank, or Prosperity, under a Purchase and Assumption Agreement dated February 8, 2010. We completed the transaction with Prosperity on April 30, 2010. Under the terms of the agreement, Prosperity assumed $492.2 million of deposits associated with our 19 Texas retail branches, including certain commercial deposit relationships, for a premium of 5.5%, or $26.9 million. Prosperity also purchased $96.7 million of loans as well as certain other assets at par value, including premises and equipment, associated with our Texas Region. We recognized a gain on sale related to this transaction of $5.0 million during the second quarter of 2010 after the write-off of goodwill and intangible assets allocated to the Texas Region of $20.0 million. In addition, this transaction reduced our risk-weighted assets by $116.3 million.
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The sale of Missouri Valley Partners, Inc., or MVP, to Stifel Financial Corp., or Stifel, under a Stock Purchase Letter Agreement dated March 5, 2010. Under the terms of the agreement, Stifel purchased all of the capital stock of MVP for a purchase price of $515,000. We completed the sale of MVP on April 15, 2010 and recorded a loss of $156,000 during the second quarter of 2010.
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The sale of certain assets and the transfer of certain liabilities of our Chicago franchise, or Chicago Region, to FirstMerit Bank, N.A., or FirstMerit, under a Purchase and Assumption Agreement, dated November 11, 2009. We completed the transaction with FirstMerit on February 19, 2010. Under the terms of the agreement, FirstMerit assumed substantially all of the deposits associated with our 24 Chicago retail branches, including certain commercial deposit relationships, which totaled $1.20 billion, for a premium of 3.50%, or $42.1 million. FirstMerit also purchased $301.2 million in loans as well as certain other assets at par value, including premises and equipment, associated with our Chicago Region. We recognized a gain on sale related to this transaction of $8.4 million during the first quarter of 2010 after the write-off of goodwill and intangible assets allocated to the Chicago Region of $26.3 million. In addition, this transaction reduced our risk-weighted assets by $342.6 million.
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The sale of certain assets and the transfer of certain liabilities of our branch banking office located in Lawrenceville, Illinois, or the Lawrenceville Branch, to The Peoples State Bank of Newton, or Peoples, under a Branch Purchase and Assumption Agreement dated August 27, 2009. Under the terms of the agreement, Peoples assumed $23.7 million of deposits for a premium of 5.0% as well as certain other liabilities, and purchased $13.5 million of loans as well as certain other assets, including premises and equipment, at par value. We completed this transaction on January 22, 2010 and recorded a gain of $168,000 during the first quarter of 2010 after the write-off of goodwill allocated to the sale of $1.0 million.
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The sale of $141.3 million of loans associated with our premium financing subsidiary, WIUS, Inc., and its wholly owned subsidiary, WIUS of California, Inc., collectively WIUS (formerly Universal Premium Acceptance Corporation and UPAC of California, Inc., respectively, or collectively, UPAC), to PFS Holding Company, Inc., Premium Financing Specialists, Inc., Premium Financing Specialists of California, Inc. and Premium Financing Specialists of the South, Inc., under a Purchase and Sale Agreement, dated December 3, 2009. We completed the sale on December 31, 2009. We recognized a loss on sale of $13.1 million during the fourth quarter of 2009 after the write-off of goodwill and intangible assets allocated to the sale of $20.0 million. This transaction reduced our risk-weighted assets by $146.7 million. On August 31, 2010, First Bank sold all of the capital stock of WIUS to an unrelated third party for a purchase price of $100,000, which resulted in a loss on sale of $29,000.
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The sale of $64.4 million of restaurant franchise loans during the fourth quarter of 2009 to another financial institution at a small discount. We completed the sale of these loans on December 30, 2009 which resulted in a loss of $1.1 million during the fourth quarter of 2009. In addition, this transaction reduced our risk-weighted assets by $64.4 million.
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The sale of certain asset-based lending loans to FirstMerit in conjunction with the Chicago Region transaction. On November 11, 2009, FBBC, First Bank’s wholly owned asset based lending subsidiary, entered into a Loan Purchase Agreement that provided for the sale of certain loans to FirstMerit. Under the terms of the agreement, FirstMerit purchased $101.5 million of loans at a discount of 8.5%. In conjunction with this transaction, which we completed on December 16, 2009, we recorded a loss on the sale of loans of $6.1 million during the fourth quarter of 2009 and reduced our risk-weighted assets by $119.3 million.
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The sale of certain assets and the transfer of certain liabilities of our branch banking office located in Springfield, Illinois, or the Springfield Branch, to First Bankers Trust Company, National Association, a subsidiary of First Bankers Trustshares, Inc., or First Bankers, under a Branch Purchase and Assumption Agreement dated August 31, 2009. Under the terms of the agreement, First Bankers assumed $20.1 million of deposits for a premium of 5.01% as well as certain other liabilities, and purchased $887,000 of loans as well as certain other assets, including premises and equipment, at par value. We completed the transaction on November 19, 2009 and recorded a gain of $309,000 during the fourth quarter of 2009 after the write-off of goodwill allocated to the sale of $1.0 million.
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The sale of Adrian N. Baker & Company, or ANB, to AHM Corporation Holdings, Inc., or AHM, under a Stock Purchase Agreement, dated September 18, 2009. Under the terms of the agreement, AHM purchased all of the capital stock of ANB for a purchase price of $14.3 million. We completed the sale of ANB on September 30, 2009 which resulted in a gain of $120,000 during 2009 after the write-off of goodwill and intangible assets allocated to ANB of $13.0 million.
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The reduction of our net risk-weighted assets to $4.85 billion at December 31, 2010, representing decreases of $2.72 billion from $7.56 billion at December 31, 2009, $4.64 billion from $9.48 billion at December 31, 2008 and $5.40 billion from $10.25 billion at December 31, 2007. The decline in our net risk-weighted assets primarily resulted from our planned divestures and a shift in the mix of our assets during these periods, particularly reduced loan balances and increased investment securities balances, as further described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations -Financial Condition and Average Balances.”
A summary of the primary initiatives completed with respect to our Capital Plan in 2009 and 2010 is as follows:
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(1)
Calculated as the sum of the gain (loss) on sale plus the reduction in intangible assets plus 8.75% of the reduction in risk-weighted assets.
In addition to the action items identified above with respect to our Capital Plan, we are also focused on the following actions which, if consummated, would further improve our regulatory capital ratios and/or result in a reduction of our risk-weighted assets:
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Reduction of our concentration in real estate lending and further diversification of our loan portfolio from real estate lending to commercial and industrial lending;
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Reduction in the overall level of our nonperforming assets and potential problem loans;
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Reduction of our unfunded loan commitments with an original maturity greater than one year;
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Sale, merger or closure of individual branches or selected branch groupings;
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Sale and/or aggressive reduction of the retained assets and liabilities associated with our Chicago, Texas and Northern Illinois Regions; and
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Exploration of possible capital planning strategies to increase the overall level of Tier 1 risk-based capital at our holding company permitted by the successful consent solicitation.
We believe the successful completion of our Capital Plan would substantially improve our capital position. However, no assurance can be made that we will be able to successfully complete all, or any portion of, our Capital Plan, or that our Capital Plan will not be materially modified in the future. Our decision to implement the Capital Plan reflects the adverse effect that the severe downturn in the commercial and residential real estate markets has had on our financial condition and results of operations. If we are not able to successfully complete substantially all of our Capital Plan, our business, financial condition and results of operations may be materially and adversely affected and our ability to withstand continued adverse economic uncertainty could be threatened.
Discontinued Operations. We have applied discontinued operations accounting in accordance with Accounting Standards CodificationTM, or ASC, Topic 205-20, “Presentation of Financial Statements - Discontinued Operations,” to the assets and liabilities being sold related to our Northern Illinois Region as of December 31, 2010, to the assets and liabilities being sold related to our Chicago Region, Texas Region and WIUS as of December 31, 2009, and to the operations of our Northern Illinois, Chicago and Texas Regions, in addition to the operations of WIUS, ANB and MVP, for the years ended December 31, 2010, 2009, 2008, 2007 and 2006, as applicable. All financial information in this Annual Report on Form 10-K is reported on a continuing operations basis, unless otherwise noted. See Note 2 and Note 25 to our accompanying consolidated financial statements for further discussion regarding discontinued operations and subsequent events associated with discontinued operations.
Strategy. Our strategy emphasizes deposit and noninterest income growth within our market areas, aggressive management of asset quality, liquidity and risk, and preservation and enhancement of risk-based capital in the current economic environment. Strategies developed to achieve earnings, growth and asset quality targets include i) expanding our deposit base; ii) improving our net interest margin; iii) increasing noninterest income; iv) further diversifying our loan portfolio; v) substantially improving asset quality; vi) controlling noninterest expenses; and vii) closely monitoring and managing our overall liquidity position. We have developed several plans around these actions, including the previously discussed Capital Plan, a Profit Improvement Plan, a Liquidity Plan and an Asset Quality Improvement Plan.
Our Profit Improvement Plan contains several actions around net interest margin and noninterest income enhancement and continued reduction of noninterest expenses including the following:
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Accelerating the reduction of special mention, substandard and nonaccrual loans and other real estate to reduce future provisions for loan losses, increase our net interest margin and reduce noninterest expenses associated with these assets;
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Developing new loan growth strategies within our commercial and industrial, owner-occupied commercial real estate and residential mortgage segments;
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Re-pricing certain segments of our loan portfolio upward for market risk, including the implementation of interest rate floors on both commercial and consumer loans;
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Re-pricing our deposits to current market interest rates while maintaining appropriate deposit portfolio diversification;
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Utilizing low-yielding short-term investments to complete our pending divestitures, as previously discussed in the Capital Plan section above, and increase our investment securities portfolio;
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Pursuing opportunities to generate noninterest income through sales of other real estate properties, branch offices and other assets;
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Increasing the volume of loans sold in the secondary market in our mortgage division;
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Evaluating opportunities to reduce noninterest expenses as a result of our smaller asset base and lower deposit volumes;
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Continuing to reduce certain controllable expense categories such as marketing and business development, travel and entertainment and data processing fees; and
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Evaluating opportunities to minimize expenses related to the high level of nonperforming assets, including legal fees related to foreclosure matters and other real estate expenses related to property preservation, taxes, insurance and other items.
Our Liquidity Plan includes the following actions;
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Maintaining and continuing to generate core deposits, including non-interest bearing demand, interest-checking, money market and savings deposits;
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Diversifying our loan portfolio, as previously discussed, including strategies surrounding potential sales or aggressive reductions of our retained Chicago, Texas and Northern Illinois loan portfolios;
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Increasing our investment securities portfolio and maintaining appropriate levels of unpledged investment securities; and
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Continuing to maximize potential borrowing relationships with the FHLB and FRB in the event further utilization of these additional alternative funding sources become necessary in the future.
Our Asset Quality Improvement Plan includes the following actions intended to reduce the level of our nonperforming assets and loan charge-offs:
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Developing written action plans for all credit relationships over $3.0 million with approval by the Regional President and Regional Credit Officer;
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Actively pursuing troubled debt restructurings to position credits to return to performing status with sustained operating performance;
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Eliminating or significantly reducing the potential exposure to our largest nonperforming credit relationships;
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Pursuing opportunities to generate significant recoveries on previously charged-off loans;
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Modifying one-to-four family residential real estate loans under the Home Affordable Modification Program, or HAMP, where deemed economically advantageous to our borrowers and us;
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Assessing our commercial real estate portfolio for early risk recognition and identification of potential areas for deteriorating commercial real estate loans, with increased emphasis on non-owner occupied loans;
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Transferring certain nonperforming and potential problem credits to our special asset groups for further review, evaluation and development of appropriate strategies for exiting these relationships or significantly reducing our potential exposure; and
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Further developing additional reporting mechanisms regarding asset quality related matters to assist management in further evaluating and assessing ongoing performance measurements and trends.
We believe the successful completion of the various components of these plans would substantially improve our financial performance and regulatory capital ratios. If we are not able to successfully complete a substantial portion of the action items contained within these plans, our business, financial condition, including our regulatory capital ratios, and results of operations may be materially and adversely affected and our ability to withstand continued adverse economic uncertainty could be threatened.
Lending Activities. As further discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations ¾Loans and Allowance for Loan Losses,” our business development efforts have historically been focused on the origination of the following general loan types: commercial, financial and agricultural loans; real estate construction and land development loans; commercial real estate mortgage loans; and to a lesser extent, residential real estate mortgage loans. Our lending strategy emphasizes quality and diversification. Throughout our organization, we employ a common credit underwriting policy. In addition to underwriting based on estimates and projection of financial strength, collateral values and future cash flows, most loans to borrowing entities other than individuals require the guarantee of the parent company or entity sponsor, or in the case of smaller entities, the personal guarantees of the principals.
Commercial, Financial and Agricultural. Our commercial, financial and agricultural loan portfolio was $1.05 billion, or 23.5% of total loans, at December 31, 2010, compared to $1.69 billion, or 25.8% of total loans, at December 31, 2009. Throughout the last three years, we have attempted to further diversify our loan portfolio by increasing our commercial, financial and agricultural lending opportunities. However, as further discussed under “Recent Developments -Capital Plan,” our loan sale transactions and reclassifications of loans to discontinued operations have reduced the percentage of commercial, financial and agricultural loans as a percentage of total loans. The primary component of commercial, financial and agricultural loans is commercial loans, which are made based on the borrowers’ general credit strength and ability to generate cash flows for repayment from income sources. Most of these loans are made on a secured basis, generally involving the use of company equipment, inventory and/or accounts receivable, and, from time to time, real estate, as collateral. Regardless of collateral, substantial emphasis is placed on the borrowers’ ability to generate cash flow sufficient to operate the business and provide coverage of debt servicing requirements. Commercial loans are frequently renewable annually, although some terms may be as long as five years. These loans typically require the borrower to maintain certain operating covenants appropriate for the specific business, such as profitability, debt service coverage and current asset and leverage ratios, which are generally reported and monitored on a quarterly basis and subject to more detailed annual reviews. Commercial loans are made to customers primarily located in First Bank’s geographic trade areas of California, Florida, Illinois and Missouri that are engaged in manufacturing, retailing, wholesaling and service businesses. This portfolio is not concentrated in large specific industry segments that are characterized by sufficient homogeneity that would result in significant concentrations of credit exposure. Rather, it is a highly diversified portfolio that encompasses many industry segments. Within both our real estate and commercial lending portfolios, we strive for the highest degree of diversity that is practicable. We also emphasize the development of other service relationships, particularly deposit accounts, with our commercial borrowers.
Real Estate Construction and Development. Our real estate construction and land development loan portfolio was $490.8 million, or 11.1% of total loans, at December 31, 2010, compared to $1.05 billion, or 16.0% of total loans, at December 31, 2009. Real estate construction and land development loans include commitments for construction of both residential and commercial properties. Commercial real estate projects often require commitments for permanent financing from other lenders upon completion of the project and, more typically, may include a short-term amortizing component of the initial financing. Commitments for construction of multi-tenant commercial and retail projects generally require lease commitments from a substantial primary tenant or tenants prior to commencement of construction. We typically engage in multi-phase, multi-tenant projects, as opposed to large vertical projects, that allow us to complete the financing for the projects in phases and limit the number of tenant building starts based upon successful lease and/or sale of the tenant units. We finance some projects for borrowers whose home office is located within our trade area but the particular project may be outside our normal trade area. Although we generally do not engage in developing commercial and residential construction lending business outside of our trade area, certain loans acquired in acquisitions from time to time have been related to projects outside of our trade area. Residential real estate construction and development loans are made based on the cost of land acquisition and development, as well as the construction of the residential units. Although we finance the cost of display units and units held for sale, a substantial portion of the loans for individual residential units have purchase commitments prior to funding. Residential condominium projects are funded as the building construction progresses, but funding of unit finishing is generally based on firm sales contracts.
Commercial Real Estate. Our commercial real estate loan portfolio was $1.64 billion, or 37.0% of total loans, at December 31, 2010, compared to $2.27 billion, or 34.6% of total loans, at December 31, 2009. Commercial real estate loans include loans for which the intended source of repayment is rental and other income from the real estate. This includes commercial real estate developed for lease to third parties as well as the owner’s occupancy. The underwriting of owner-occupied commercial real estate loans generally follows the procedures for commercial lending described above, except that the collateral is real estate, and the loan term may be longer. The primary emphasis in underwriting loans for which the source of repayment is the performance of the collateral is the projected cash flow from the real estate and its adequacy to cover the operating costs of the project and the debt service requirements. Secondary emphasis is placed on the appraised value of the real estate, with the requirement that the appraised liquidation value of the collateral must be adequate to repay the debt and related interest in the event the cash flow becomes insufficient to service the debt. Generally, underwriting terms require the loan principal not to exceed 80% of the appraised value of the collateral and the loan maturity not to exceed ten years. Commercial real estate loans are made for commercial office space, retail properties, industrial and warehouse facilities and recreational properties. We typically only finance commercial real estate or rental properties that have lease commitments for a majority of the rentable space.
Residential Real Estate Mortgage. Our residential real estate mortgage loan portfolio was $1.05 billion, or 23.7% of total loans, at December 31, 2010, compared to $1.28 billion, or 19.5% of total loans, at December 31, 2009. Residential real estate mortgage loans are primarily loans secured by single-family, owner-occupied properties. These loans include both adjustable rate and fixed rate mortgage loans. We typically originate residential real estate mortgage loans for sale in the secondary mortgage market in the form of a mortgage-backed security or to various private third-party investors, although from time-to-time, we retain certain residential mortgage loans, including home equity loans, in our loan portfolio as directed by management’s business strategies. Our residential real estate mortgage loans are primarily generated through our branch office network and are underwritten in accordance with conforming terms that allow the loans to be sold into the secondary market. We discontinued the origination of Alt A and Sub-prime mortgage loan products in 2007 and do not presently offer these loan products. Servicing rights may either be retained or released with respect to conventional, FHA and VA conforming fixed-rate and conventional adjustable rate residential mortgage loans.
Market Areas. As of December 31, 2010, First Bank’s 154 banking facilities were located in California, Florida, Illinois and Missouri. First Bank presently operates in the St. Louis metropolitan area, in eastern Missouri and throughout Central and Southern Illinois. First Bank also operates in southern California, including San Diego and the greater Los Angeles metropolitan area, including Ventura County, Riverside County and Orange County; in Santa Barbara County; in northern California, including the greater San Francisco, San Jose and Sacramento metropolitan areas; and in Florida, including Bradenton and the greater Tampa metropolitan area.
The following table lists the geographic market areas in which First Bank operates, total deposits, deposits as a percentage of total deposits and the number of locations as of December 31, 2010:
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(1)
Includes deposits of approximately $9.7 million associated with the announced sale of our San Jose Branch, which was completed on February 11, 2011. See Note 2 and Note 25 to our consolidated financial statements for further discussion of assets and liabilities held for sale.
(2)
Includes deposits of approximately $13.7 million associated with the announced sale of our Edwardsville Branch, which is expected to be completed in the second quarter of 2011. See Note 2 and Note 25 to our consolidated financial statements for further discussion of assets and liabilities held for sale.
(3)
Includes deposits of approximately $94.1 million associated with the announced sale of three of our Northern Illinois Branches, which is expected to be completed in the second quarter of 2011. See Note 2 to our consolidated financial statements for further discussion of discontinued operations.
Competition and Branch Banking. The activities in which First Bank engages are highly competitive. Those activities and the geographic markets served primarily involve competition with other banks, some of which are affiliated with large regional or national holding companies, and other financial services companies. Financial institutions compete based upon interest rates offered on deposit accounts and other credit and service charges, the types of products and quality of services rendered, the convenience of branch facilities, interest rates charged on loans and, in the case of loans to large commercial borrowers, relative lending limits.
Our principal competitors include other commercial banks, savings banks, savings and loan associations, and finance companies, including trust companies, credit unions, mortgage companies, leasing companies, private issuers of debt obligations and suppliers of other investment alternatives, such as securities firms and financial holding companies. Many of our non-bank competitors are not subject to the same degree of regulation as that imposed on bank holding companies, federally insured banks and national or state chartered banks. As a result, such non-bank competitors have advantages over us in providing certain services. We also compete with major multi-bank holding companies, which are significantly larger than us and have greater access to capital and other resources.
Employees
As of March 25, 2011, we employed approximately 1,380 full-time equivalent employees. None of the employees are subject to a collective bargaining agreement. We consider our relationships with our employees to be good.
Supervision and Regulation.
General. Along with First Bank, we are extensively regulated by federal and state laws and regulations which are designed to protect depositors of First Bank and the safety and soundness of the U.S. banking system, not our debt holders or stockholders. To the extent this discussion refers to statutory or regulatory provisions, it is not intended to summarize all such provisions and is qualified in its entirety by reference to the relevant statutory and regulatory provisions. Changes in applicable laws, regulations or regulatory policies may have a material effect on our business and prospects. We are unable to predict the nature or extent of the effects on our business and earnings that new federal and state legislation or regulation may have. The enactment of the legislation described below has significantly affected the banking industry generally and is likely to have ongoing effects on First Bank and us in the future.
As a registered bank holding company under the Bank Holding Company Act of 1956, as amended, we are subject to regulation and supervision of the Board of Governors of the Federal Reserve System, or Federal Reserve. We file annual reports with the Federal Reserve and provide to the Federal Reserve additional information as it may require.
Many of our nonbank subsidiaries are also subject to the laws and regulations of both the federal government and the various states in which they conduct business. As an originator of small business loans, we are also regulated by the U.S. Small Business Administration, or SBA.
Regulatory Agreements. On March 24, 2010, the Company, SFC and First Bank entered into a Written Agreement, or Agreement, with the Federal Reserve Bank of St. Louis, or the FRB, requiring the Company and First Bank to take certain steps intended to improve their overall financial condition. Pursuant to the Agreement, the Company prepared and filed with the FRB a number of specific plans designed to strengthen and/or address the following matters: (i) board oversight over the management and operations of the Company and First Bank; (ii) credit risk management practices; (iii) lending and credit administration policies and procedures; (iv) asset improvement; (v) capital; (vi) earnings and overall financial condition; and (vii) liquidity and funds management.
The Agreement requires, among other things, that the Company and First Bank obtain prior approval from the FRB in order to pay dividends. In addition, the Company must obtain prior approval from the FRB to: (i) take any other form of payment from First Bank representing a reduction in capital of First Bank; (ii) make any distributions of interest, principal or other sums on junior subordinated debentures or trust preferred securities; (iii) incur, increase or guarantee any debt; or (iv) purchase or redeem any shares of the Company’s stock. Pursuant to the terms of the Agreement, the Company and First Bank submitted a written plan to the FRB to maintain sufficient capital at the Company, on a consolidated basis, and at First Bank, on a standalone basis. In addition, the Agreement also provides that the Company and First Bank must notify the FRB if the risk-based capital ratios of either entity fall below those set forth in the capital plans that were accepted by the FRB, and specifically if First Bank falls below the criteria for being well capitalized under the regulatory framework for prompt corrective action. The Company must also notify the FRB before appointing any new directors or senior executive officers or changing the responsibilities of any senior executive officer position. The Agreement also requires the Company and First Bank to comply with certain restrictions regarding indemnification and severance payments. The Agreement is specifically enforceable by the FRB in court.
The Company and First Bank must furnish periodic progress reports to the FRB regarding compliance with the Agreement. As of the date of this filing, the Company and First Bank have provided progress reports and other reports, as required under the Agreement. It is likely that the Company and First Bank may receive additional requests from the FRB regarding compliance with the Agreement. Management intends to respond promptly to any such requests. The Agreement will remain in effect until stayed, modified, terminated or suspended by the FRB.
Prior to entering into the Agreement on March 24, 2010, the Company and First Bank had entered into a memorandum of understanding and an informal agreement, respectively, with the FRB and the State of Missouri Division of Finance, or the MDOF. Each of the agreements were characterized by regulatory authorities as informal actions that were neither published nor made publicly available by the agencies and are used when circumstances warrant a milder form of action than a formal supervisory action, such as a written agreement or cease and desist order. The informal agreement with the MDOF is still in place and there have not been any modifications thereto since its inception in September 2008.
Under the terms of the prior memorandum of understanding with the FRB, the Company agreed, among other things, to provide certain information to the FRB including, but not limited to, financial performance updates, notice of plans to materially change its fundamental business and notice to issue trust preferred securities or raise additional equity capital. In addition, the Company agreed not to pay any dividends on its common or preferred stock or make any distributions of interest or other sums on its trust preferred securities without the prior approval of the FRB.
First Bank, under its informal agreement with the MDOF and the FRB, agreed to, among other things, prepare and submit plans and reports to the agencies regarding certain matters including, but not limited to, the performance of First Bank’s loan portfolio. In addition, First Bank agreed not to declare or pay any dividends or make certain other payments without the prior consent of the MDOF and the FRB and to maintain a Tier 1 capital to total assets ratio of no less than 7.00%. As further described in Note 21 to the consolidated financial statements, First Bank’s Tier 1 capital to total assets ratio was 7.68% at December 31, 2010.
While the Company and First Bank intend to take such actions as may be necessary to comply with the requirements of the Agreement with the FRB and informal agreement with the MDOF, there can be no assurance that the Company and First Bank will be able to comply fully with the requirements of the Agreement or that First Bank will be able to comply fully with the provisions of the informal agreement, that compliance with the Agreement and the informal agreement will not be more time consuming or more expensive than anticipated, that compliance with the Agreement and the informal agreement will enable the Company and First Bank to resume profitable operations, or that efforts to comply with the Agreement and the informal agreement will not have adverse effects on the operations and financial condition of the Company or First Bank. If the Company or First Bank is unable to comply with the terms of the Agreement or the informal agreement, respectively the Company and First Bank could become subject to various requirements limiting the ability to develop new business lines, mandating additional capital, and/or requiring the sale of certain assets and liabilities. Failure of the Company and First Bank to meet these conditions could lead to further enforcement action by the regulatory agencies. The terms of any such additional regulatory actions, orders or agreements could have a materially adverse effect on our business, financial condition or results of operations.
Bank Holding Company Regulation. The activities of bank holding companies are generally limited to the business of banking, managing or controlling banks, and other activities that the Federal Reserve has determined to be so closely related to banking or managing or controlling banks as to the proper incident thereto. In addition, under the Gramm-Leach-Bliley Act, or GLB Act, which was enacted in November 1999 and is further discussed below, a bank holding company, whose control depository institutions are “well-capitalized” and “well-managed” (as defined in Federal Banking Regulations), and which obtains “satisfactory” Community Reinvestment Act (discussed briefly below) ratings, may declare itself to be a “financial holding company” and engage in a broader range of activities. As of this date, we are not a “financial holding company.”
We are also subject to capital requirements applied on a consolidated basis, which are substantially similar to those required of First Bank (briefly summarized below). The Bank Holding Company Act also requires a bank holding company to obtain approval from the Federal Reserve before:
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Acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls a majority of such shares);
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Acquiring all or substantially all of the assets of another bank or bank holding company; or
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Merging or consolidating with another bank holding company.
The Federal Reserve will not approve any acquisition, merger or consolidation that would have a substantially anti-competitive result, unless the anti-competitive effects of the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial factors in reviewing acquisitions and mergers.
Safety and Soundness and Similar Regulations. We are subject to various regulations and regulatory policies directed at the financial soundness of First Bank. These include, but are not limited to, the Federal Reserve’s source of strength policy, which obligates a bank holding company such as us to provide financial and managerial strength to its subsidiary banks; restrictions on the nature and size of certain affiliate transactions between a bank holding company and its subsidiary depository institutions and restrictions on extensions of credit by its subsidiary banks to executive officers, directors, principal stockholders and the related interests of such persons.
Regulatory Capital Standards. The federal bank regulatory agencies have adopted substantially similar risk-based and leverage capital guidelines for banking organizations. Risk-based capital ratios are determined by classifying assets and specified off-balance sheet obligations and financial instruments into weighted categories, with higher levels of capital being required for categories deemed to represent greater risk. Federal Reserve policy also provides that banking organizations generally, and particularly those that are experiencing internal growth or actively making acquisitions, are expected to maintain capital positions that are substantially above the minimum supervisory levels, without significant reliance on intangible assets.
Under the risk-based capital standard, the minimum consolidated ratio of total capital to risk-adjusted assets required for bank holding companies is 8% and the minimum consolidated ratio of Tier I capital (as described below) to risk-adjusted assets required for bank holding companies is 4%. At least one-half of the total capital must be composed of common equity, retained earnings, qualifying noncumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock and noncontrolling interests in the equity accounts of consolidated subsidiaries, less certain items such as goodwill and certain other intangible assets, which amount is referred to as “Tier I capital.” The remainder may consist of qualifying hybrid capital instruments, perpetual debt, mandatory convertible debt securities, a limited amount of subordinated debt, preferred stock that does not qualify as Tier I capital and a limited amount of loan and lease loss reserves, which amount, together with Tier I capital, is referred to as “Total Risk-Based Capital.”
In addition to the risk-based standard, we are subject to minimum requirements with respect to the ratio of our Tier I capital to our average assets less goodwill and certain other intangible assets, or the Leverage Ratio. Applicable requirements provide for a minimum Leverage Ratio of 3% for bank holding companies that have the highest supervisory rating, while all other bank holding companies must maintain a minimum Leverage Ratio of at least 4% to 5%. The Office of the Comptroller of the Currency and the FDIC have established capital requirements for banks under their respective jurisdictions that are consistent with those imposed by the Federal Reserve on bank holding companies.
As further described in Note 21 to our consolidated financial statements, First Bank was categorized as well capitalized at December 31, 2010 and 2009 under the prompt corrective action provisions of the regulatory capital standards. The Company did not meet the minimum regulatory capital standards established for bank holding companies by the Federal Reserve at December 31, 2010 and 2009.
In March 2005, the Federal Reserve adopted a final rule, Risk-Based Capital Standards: Trust Preferred Securities and the Definition of Capital, which allows for the continued limited inclusion of trust preferred securities in Tier 1 capital. The Federal Reserve’s final rule limits restricted core capital elements to 25% of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability. Amounts of restricted core capital elements in excess of these limits may generally be included in Tier 2 capital. Specifically, amounts of qualifying trust preferred securities and cumulative perpetual preferred stock in excess of the 25% limit may be included in Tier 2 capital, but will be limited, together with subordinated debt and limited-life preferred stock, to 50% of Tier 1 capital. In addition, the final rule provides that in the last five years before the maturity of the underlying subordinated note, the outstanding amount of the associated trust preferred securities is to be excluded from Tier 1 capital and included in Tier 2 capital, subject to one-fifth amortization per year. The final rule provided for a five-year transition period, ending March 31, 2009, for the application of the quantitative limits. In March 2009, the Federal Reserve adopted a final rule that delays the effective date for the application of the quantitative limits to March 31, 2011. Until March 31, 2011, the aggregate amount of qualifying cumulative perpetual preferred stock and qualifying trust preferred securities that may be included in Tier 1 capital is limited to 25% of the sum of the following core capital elements: qualifying common stockholders’ equity, qualifying noncumulative and cumulative perpetual preferred stock, qualifying noncontrolling interest in the equity accounts of consolidated subsidiaries and qualifying trust preferred securities. We have determined that the Federal Reserve’s final rules that will be effective in March 2011, if implemented as of December 31, 2010, would reduce the Company’s total capital (to risk-weighted assets), Tier 1 capital (to risk-weighted assets) and Tier 1 capital (to average assets) to 4.53%, 2.27% and 1.44%, respectively. Therefore, upon implementation of the Federal Reserve’s final rule, the Company would remain below the minimum regulatory capital standards established for bank holding companies and could be subject to additional actions by regulators that could have a direct material effect on the operations and financial condition of the Company and First Bank. The final rules that will be effective in March 2011, if implemented as of December 31, 2010, would not have an impact on First Bank’s regulatory capital ratios.
The federal regulatory authorities’ risk-based capital guidelines are based upon the 1988 capital accord (Basel I) of the Basel Committee on Banking Supervision, or the Basel Committee. The Basel Committee is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines for use by each country’s supervisors in determining the supervisory policies and regulations to which they apply. Actions of the Basel Committee have no direct effect on banks in participating countries. In 2004, the Basel Committee published a new capital accord (Basel II) to replace Basel I. Basel II provides two approaches for setting capital standards for credit risk - an internal ratings-based approach tailored to individual institutions’ circumstances and a standardized approach that bases risk weightings on external credit assessments to a much greater extent than permitted in existing risk-based capital guidelines. Basel II also would set capital requirements for operational risk and refine the existing capital requirements for market risk exposures.
A final rule implementing the advanced approaches of Basel II in the United States would apply only to certain large or internationally active banking organizations, or “core banks,” defined as those with consolidated total assets of $250 billion or more or consolidated on-balance sheet foreign exposures of $10 billion or more, became effective as of April 1, 2008. Certain other U.S. banking organizations would have the option to adopt the requirements of this rule. The Company is not required to comply with the advanced approaches of Basel II.
In July 2008, the agencies issued a proposed rule that would give banking organizations that do not use the advanced approaches the option to implement a new risk-based capital framework that generally parallels the relevant approaches under Basel II, but recognizes that United States markets have unique characteristics and risk profiles, most notably with respect to risk weighting residential mortgage exposures. To date, no final rule has been adopted.
In 2009, the U.S. Treasury issued a policy statement, or the Treasury Policy Statement, entitled “Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms,” which contemplates changes to the existing regulatory capital regime involving substantial revisions to major parts of the Basel I and Basel II capital frameworks and affecting all regulated banking organizations and other systemically important institutions. The Treasury Policy Statement calls for, among other things, higher and stronger capital requirements for all banking firms, with changes to the regulatory capital framework to be phased in over a period of several years.
On December 17, 2009, the Basel Committee issued a set of proposals, or the 2009 Capital Proposals, that would significantly revise the definitions of Tier 1 capital and Tier 2 capital. Among other things, the 2009 Capital Proposals would re-emphasize that common equity is the predominant component of Tier 1 capital. Concurrently with the release of the 2009 Capital Proposals, the Basel Committee also released a set of proposals related to liquidity risk exposure, or the 2009 Liquidity Proposals. The 2009 Liquidity Proposals include the implementation of (i) a liquidity coverage ratio, or LCR, designed to ensure that a bank maintains an adequate level of unencumbered, high-quality assets sufficient to meet the bank’s liquidity needs over a 30-day time horizon under an acute liquidity stress scenario and (ii) a net stable funding ratio, or NSFR, designed to promote more medium and long-term funding of the assets and activities of banks over a one-year time horizon.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or Dodd-Frank Act, includes certain provisions concerning the capital regulations of the United States banking regulators, which are often referred to as the “Collins Amendment.” These provisions are intended to subject bank holding companies to the same capital requirements as their bank subsidiaries and to eliminate or significantly reduce the use of hybrid capital instruments, especially trust preferred securities, as regulatory capital. Under the Collins Amendment, trust preferred securities issued by a company with total consolidated assets of less than $15 billion before May 19, 2010 and treated as regulatory capital are grandfathered, but any such securities issued later are not eligible as regulatory capital. The banking regulators must develop regulations setting minimum risk-based and leverage capital requirements for holding companies and banks on a consolidated basis that are no less stringent than the generally applicable requirements in effect for depository institutions under the prompt corrective action regulations discussed below. The banking regulators also must seek to make capital standards countercyclical so that the required levels of capital increase in times of economic expansion and decrease in times of economic contraction. The Dodd-Frank Act requires these new capital regulations to be adopted by the Federal Reserve in final form 18 months after the date of enactment of the Dodd-Frank Act, which was July 21, 2010. To date, no proposed regulations have been issued.
In December 2010 and January 2011, the Basel Committee published the final texts of reforms on capital and liquidity generally referred to as Basel III. Although Basel III is intended to be implemented by participating countries for large, internationally active banks, its provisions are likely to be considered by United States banking regulators in developing new regulations applicable to other banks in the United States, including First Bank.
For banks in the United States, among the most significant provisions of Basel III concerning capital are the following:
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A minimum ratio of common equity to risk-weighted assets reaching 4.5%, plus an additional 2.5% as a capital conservation buffer, by 2019 after a phase-in period;
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A minimum ratio of Tier 1 capital to risk-weighted assets reaching 6.0% by 2019 after a phase-in period;
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A minimum ratio of total capital to risk-weighted assets, plus the additional 2.5% capital conservation buffer, reaching 10.5% by 2019 after a phase-in period;
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An additional countercyclical capital buffer to be imposed by applicable national banking regulators periodically at their discretion, with advance notice;
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Restrictions on capital distributions and discretionary bonuses applicable when capital ratios fall within the buffer zone;
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Deduction from common equity of deferred tax assets that depend on future profitability to be realized;
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Increased capital requirements for counterparty credit risk relating to over-the-counter derivatives, repurchase agreements and securities financing activities; and
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For capital instruments issued on or after January 13, 2013 (other than common equity), a loss-absorbency requirement such that the instrument must be written off or converted to common equity if a trigger event occurs, either pursuant to applicable law or at the direction of the banking regulator. A trigger event is an event under which the banking entity would become nonviable without the write-off or conversion, or without an injection of capital from the public sector. The issuer must maintain authorization to issue the requisite shares of common equity if conversion were required.
The Basel III provisions on liquidity include complex criteria establishing the LCR and NSFR. The purpose of the LCR is to ensure that a bank maintains adequate unencumbered, high quality liquid assets to meet its liquidity needs for 30 days under a severe liquidity stress scenario. The purpose of the NSFR is to promote more medium and long-term funding of assets and activities, using a one-year horizon. Although Basel III is described as a “final text,” it is subject to the resolution of certain issues and to further guidance and modification, as well as to adoption by United States banking regulators, including decisions as to whether and to what extent it will apply to United States banks that are not large, internationally active banks.
Prompt Corrective Action. The FDIC Improvement Act requires the federal bank regulatory agencies to take prompt corrective action in respect to depository institutions that do not meet minimum capital requirements. A depository institution’s status under the prompt corrective action provisions depends upon how its capital levels compare to various relevant capital measures and other factors as established by regulation.
The federal regulatory agencies have adopted regulations establishing relevant capital measures and relevant capital levels. Under the regulations, a bank will be:
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“Well capitalized” if it has a total risk-based capital ratio of 10% or greater, a Tier I capital ratio of 6% or greater and a Leverage Ratio of 5% or greater and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure;
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“Adequately capitalized” if it has a total risk-based capital ratio of 8% or greater, a Tier I capital ratio of 4% or greater and a Leverage Ratio of 4% or greater (3% in certain circumstances);
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“Undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier I capital ratio of less than 4% or a Leverage Ratio of less than 4% (3% in certain circumstances);
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“Significantly undercapitalized” if it has a total risk-based capital ratio of less than 6%, a Tier I capital ratio of less than 3% or a Leverage Ratio of less than 3%; and
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“Critically undercapitalized” if its tangible equity is equal to or less than 2% of its average quarterly tangible assets.
Under certain circumstances, a depository institution’s primary federal regulatory agency may use its authority to lower the institution’s capital category. The banking agencies are permitted to establish individual minimum capital requirements exceeding the general requirements described above. See further discussion above under “-Regulatory Agreements.” Generally, failing to maintain the status of “well capitalized” or “adequately capitalized” subjects a bank to restrictions and limitations on its business that become progressively more severe as the capital levels decrease.
A bank is prohibited from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the bank would thereafter be “undercapitalized.” Limitations exist for “undercapitalized” depository institutions regarding, among other things, asset growth, acquisitions, branching, new lines of business, acceptance of brokered deposits and borrowings from the Federal Reserve System. These institutions are also required to submit a capital restoration plan that includes a guarantee from the institution’s holding company. “Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. The appointment of a receiver or conservator may be required for “critically undercapitalized” institutions.
Dividends. Our primary source of funds in the future is the dividends, if any, paid by First Bank. The ability of First Bank to pay dividends is limited by federal laws, by regulations promulgated by the bank regulatory agencies and by principles of prudent bank management. The dividend limitations are further described in Note 22 to our consolidated financial statements appearing elsewhere in this report. In addition, First Bank has agreed that it will not declare or pay any dividends or make certain other payments to us without the prior consent of the MDOF and the FRB, as previously discussed under “-Regulatory Agreements.”
Federal Deposit Insurance Reform. The FDIC currently maintains the Deposit Insurance Fund (the “DIF”), which was created in 2006 in the merger of the Bank Insurance Fund and the Savings Association Insurance Fund. The deposit accounts of First Bank are insured by the DIF to the maximum amount provided by law. This insurance is backed by the full faith and credit of the United States Government.
As insurer, the FDIC is authorized to conduct examinations of and to require reporting by DIF-insured institutions. It also may prohibit any DIF-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the DIF. The FDIC also has the authority to take enforcement actions against insured institutions.
Under its current regulations, the FDIC imposes assessments for deposit insurance on an insured institution quarterly according to its ranking in one of four risk categories based upon supervisory and capital evaluations. The assessment rate for an individual institution is determined according to a formula based on a weighted average of the institution’s individual CAMELS component ratings plus either six financial ratios or, in the case of an institution with assets of $10.0 billion or more, the average ratings of its long-term debt. Well-capitalized institutions (generally those with CAMELS composite ratings of 1 or 2) are grouped in Risk Category I and their initial base assessment rate for deposit insurance is set at an annual rate of between 12 and 16 basis points. The initial base assessment rate for institutions in Risk Categories II, III and IV is set at annual rates of 22, 32 and 50 basis points, respectively. These initial base assessment rates are adjusted to determine an institution’s final assessment rate based on its brokered deposits, secured liabilities and unsecured debt. The adjustments include higher premiums for institutions that rely significantly on excessive amounts of brokered deposits, including CDARS, higher premiums for excessive use of secured liabilities, including Federal Home Loan Bank advances, and adding financial ratios and debt issuer ratings to the premium calculations for banks with over $10 billion in assets, while providing a reduction for all institutions for their unsecured debt. Total base assessment rates after adjustments range from 7 to 24 basis points for Risk Category I, 17 to 43 basis points for Risk Category II, 27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for Risk Category IV.
In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize a predecessor to the DIF. These assessments will continue until the Financing Corporation bonds mature in 2019. Furthermore, on May 22, 2009, the FDIC board agreed to impose an emergency special assessment of five basis points on each FDIC-insured financial institution’s assets minus its Tier 1 capital as of June 30, 2009. The special assessment was payable on September 30, 2009. We recorded an emergency special assessment of $4.8 million in the second quarter of 2009.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged or is engaging 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 or written agreement entered into with the FDIC. We do not know of any practice, condition or violation that might lead to termination of deposit insurance.
On November 17, 2009, the FDIC adopted regulations that required certain insured depository institutions to prepay, on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and all of 2010, 2011 and 2012, along with their quarterly risk-based assessment for the fourth quarter of 2009. The FDIC exempted First Bank from the prepayment requirement. This action does not impact our regularly scheduled quarterly assessments, which will continue to be payable quarterly.
Pursuant to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio, or DRR, that is, the ratio of the DIF to insured deposits. The FDIC has adopted a plan under which it will meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by the Dodd-Frank Act. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%. The FDIC has not yet announced how it will implement this offset or how larger institutions will be affected by it.
The Dodd-Frank Act requires the FDIC to establish rules setting insurance premium assessments based on an institution's total assets minus its tangible equity instead of its deposits. These rules were finalized on February 7, 2011 and set base assessment rates for institutions in Risk Categories II, III and IV at annual rates of 14, 23 and 35 basis points, respectively. The base assessment rate for a Risk Category I institution was set at a range of five to nine basis points. These initial base assessment rates are adjusted to determine an institution’s final assessment rate based on its brokered deposits and unsecured debt. Total base assessment rates after adjustments range from 2.5 to 9 basis points for Risk Category I, 9 to 24 basis points for Risk Category II, 18 to 33 basis points for Risk Category III, and 30 to 45 basis points for Risk Category IV. The FDIC has adopted regulations under which, effective for assessments for the second quarter of 2011 and payable at the end of September 2011, a bank that has had total assets of $10 billion or more for four consecutive quarters will be assessed quarterly for deposit insurance under a scorecard method. The scorecard method uses a performance score and a loss severity score, which are combined and converted into an initial base assessment rate. The performance score is based on measures of the bank's ability to withstand asset-related stress and funding-related stress and weighted CAMELS rating. The loss severity score is a measure of potential losses to the FDIC in the event of the bank's failure. Under a formula, the performance score and loss severity score are combined and converted to a total score that determines the bank's initial base assessment rate. The FDIC has the discretion to alter the total score based on factors not captured by the scorecard. The resulting initial base assessment rate would be subject to adjustments downward based on long term unsecured debt issued by the bank, to adjustment upward based on long term unsecured debt held by the bank that is issued by other FDIC-insured institutions, and to further adjustment upward if the bank's brokered deposits exceed 10% of its domestic deposits. Modifications to the scorecard method may apply to certain "highly complex institutions." First Bank will not be regarded as a "highly complex institution."
On November 9, 2010 and January 18, 2011, the FDIC, as mandated by Section 343 of the Dodd-Frank Act, as described below, adopted rules providing for unlimited deposit insurance for traditional noninterest-bearing transaction accounts and IOLTA accounts for two years beginning on December 31, 2010. This coverage applies to all insured deposit institutions, and there is no separate FDIC assessment for the insurance. Furthermore, this unlimited coverage is separate from, and in addition to, the coverage provided to depositors with respect to other accounts held at an insured depository institution.
Customer Protection. First Bank is also subject to consumer laws and regulations intended to protect consumers in transactions with depository institutions, as well as other laws or regulations affecting customers of financial institutions generally. These laws and regulations mandate various disclosure requirements and substantively regulate the manner in which financial institutions must deal with their customers. First Bank must comply with numerous regulations in this regard and is subject to periodic examinations with respect to its compliance with the requirements.
Community Reinvestment Act. The Community Reinvestment Act of 1977 requires that, in connection with examinations of financial institutions within their jurisdiction, the federal banking regulators evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those financial institutions. These factors are also considered in evaluating mergers, acquisitions and other applications to expand.
The Gramm-Leach-Bliley Act. The GLB Act, enacted in 1999, amended and repealed portions of the Glass-Steagall Act and other federal laws restricting the ability of bank holding companies, securities firms and insurance companies to affiliate with each other and to enter new lines of business. The GLB Act established a comprehensive framework to permit financial companies to expand their activities, including through such affiliations, and to modify the federal regulatory structure governing some financial services activities. The GLB Act also adopted consumer privacy safeguards requiring financial services providers to disclose their policies regarding the privacy of customer information to their customers and, subject to some exceptions, allowing customers to “opt out” of policies permitting such companies to disclose confidential financial information to non-affiliated third parties.
The Sarbanes-Oxley Act. In July 2002, the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, was enacted. Sarbanes-Oxley imposes a myriad of corporate governance and accounting measures designed to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of disclosures under securities laws. All public companies that file periodic reports with the SEC are affected by Sarbanes-Oxley.
Sarbanes-Oxley addresses, among other matters: (i) the creation of an independent accounting oversight board to oversee the audit of public companies and auditors who perform such audits; (ii) auditor independence provisions which restrict non-audit services that independent accountants may provide to their audit clients; (iii) additional corporate governance and responsibility measures which require the chief executive officer and chief financial officer to certify financial statements, to forfeit salary and bonuses in certain situations, and protect whistleblowers and informants; (iv) expansion of the audit committee’s authority and responsibility by requiring that the audit committee have direct control of the outside auditor, be able to hire and fire the auditor, and approve all non-audit services; (v) requirements that audit committee members be independent; (vi) disclosure of a code of ethics; and (vii) enhanced penalties for fraud and other violations. The provisions of Sarbanes-Oxley also require that management assess the effectiveness of internal control over financial reporting and that the independent auditor issue an attestation report on management’s report on internal control over financial reporting. As we are a non-accelerated filer, management’s report on internal control over financial reporting was not subject to attestation by the Company’s Independent Registered Public Accounting Firm as of December 31, 2010, as further discussed under “Item 9A ¾ Controls and Procedures.”
The USA Patriot Act. The USA Patriot Act, or Patriot Act, was enacted in October 2001 in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. that occurred on September 11, 2001. The Patriot Act is intended to strengthen the ability of U.S. law enforcement agencies and the intelligence communities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.
Reserve Requirements; Federal Reserve System and Federal Home Loan Bank System. First Bank is a member of the Federal Reserve System and the Federal Home Loan Bank System. As a member, First Bank is required to hold investments in those systems. First Bank was in compliance with these requirements at December 31, 2010, with investments of $19.9 million in stock of the FRB and $10.0 million in stock of the Federal Home Loan Bank of Des Moines. First Bank also holds an investment of $238,000 in stock of the Federal Home Loan Bank of San Francisco, as a nonmember, to collateralize certain FHLB advances assumed in conjunction with certain acquisition transactions.
The Federal Reserve requires all depository institutions to maintain reserves against their transaction accounts and non-personal time deposits. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements.
First Bank has established a borrowing relationship with the FRB, which is primarily secured by commercial loans, and provides an additional liquidity facility that may be utilized for contingency purposes. Advances drawn on First Bank’s established borrowing relationship require prior approval of the FRB, and First Bank did not have any FRB borrowings outstanding at December 31, 2010. First Bank also has established a borrowing relationship with the FHLB of Des Moines. The borrowing relationship is secured by one-to-four family residential, multi-family residential and commercial real estate loans. First Bank requests advances and/or repays advances from the FHLB based on its current and future projected liquidity needs. Advances from the FHLB require prior approval of the FHLB. First Bank’s borrowing capacity with the FHLB was approximately $475.1 million at December 31, 2010, and First Bank did not have any FHLB advances outstanding at December 31, 2010.
Monetary Policy and Economic Control. The commercial banking business is affected by legislation, regulatory policies and general economic conditions as well as the monetary policies of the Federal Reserve. The instruments of monetary policy available to the Federal Reserve include the following: (i) changes in the discount rate on member bank borrowings and the targeted federal funds rate; (ii) the availability of credit at the discount window; (iii) open market operations; (iv) the imposition of changes in reserve requirements against deposits of domestic banks; (v) the imposition of changes in reserve requirements against deposits and assets of foreign branches; and (vi) the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates.
These monetary policies are used in varying combinations to influence overall growth and distributions of bank loans, investments and deposits, and this use may affect interest rates charged on loans or paid on liabilities. The monetary policies of the Federal Reserve have had a significant effect on the operating results of commercial banks and are expected to do so in the future. Such policies are influenced by various factors, including inflation, unemployment, and short-term and long-term changes in the international trade balance and in the fiscal policies of the U.S. Government. We cannot predict the effect that changes in monetary policy or in the discount rate on member bank borrowings will have on our future business and earnings or those of First Bank.
United States Securities and Exchange Commission. We are also under the jurisdiction of the SEC and certain state securities commissions for matters relating to the offering and sale of our securities. We are subject to disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. The securities issued by one of our affiliated trusts are registered under the Securities Exchange Act of 1934 and are listed on the NYSE under the trading symbol “FBSPrA,” and therefore, we are subject to certain rules and regulations of the NYSE.
United States Department of the Treasury. As further described above under “Item 1 -Business - Ownership Structure,” on December 31, 2008, we completed the sale to the U.S. Treasury of $295.4 million of newly-issued non-voting preferred stock as part of the CPP. The U.S. Treasury has certain supervisory and oversight duties and responsibilities under the CPP and, pursuant to the terms of the Purchase Agreement, the U.S. Treasury is empowered to unilaterally amend any provision of the Purchase Agreement with us to the extent required to comply with any changes in applicable federal statutes. In addition, as a result of our deferral of dividends to the U.S. Treasury for an aggregate of six quarters, the U.S. Treasury has the right to elect two directors to our Board but has not elected to do so as of March 25, 2011.
SIGTARP. The Special Inspector General for the Troubled Asset Relief Program, or SIGTARP, was established pursuant to Section 121 of the Emergency Economic Stabilization Act of 2008, or EESA, and has the duty, among other things, to conduct, supervise, and coordinate audits and investigations of the purchase, management and sale of assets by the U.S. Treasury under the CPP, including the shares of non-voting preferred shares purchased from us.
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. In addition to the previous discussion above, the Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including provisions that, among other things:
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Directs the Federal Reserve to issue rules which are expected to limit debit-card interchange fees;
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After a three-year phase-in period which begins January 1, 2013, removes trust preferred securities as a permitted component of a holding company’s Tier 1 capital for holding companies with more than $15 billion of assets, and restricts new issuances of trust preferred securities from being included as Tier 1 capital for all holding companies;
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Provides for an increase in the FDIC assessment for depository institutions with assets of $10 billion or more, increases in the minimum reserve ratio for the deposit insurance fund from 1.15% to 1.35% and changes in the basis for determining FDIC premiums from deposits to assets less tangible capital;
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Creates a new consumer financial protection bureau that will have rulemaking authority for a wide range of consumer protection laws that would apply to all banks and would have broad powers to supervise and enforce consumer protection laws;
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Provides for new disclosure and other requirements relating to executive compensation and corporate governance;
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Changes standards for federal preemption of state laws related to federally chartered institutions and their subsidiaries;
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Provides mortgage reform provisions regarding a customer’s ability to repay, restricting variable-rate lending by requiring the ability to repay to be determined for variable-rate loans by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions;
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Creates a financial stability oversight council that will recommend to the Federal Reserve increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity;
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Permanently increases the deposit insurance coverage to $250,000;
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Repeals the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts;
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Requires publicly-traded bank holding companies with assets of $10 billion or more to establish a risk committee responsible for enterprise-wide risk management practices;
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Increases the authority of the Federal Reserve in its regular examinations;
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Requires all bank holding companies to serve as a source of financial strength to their depository institution subsidiaries in the event such subsidiaries suffer from financial distress; and
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Restricts proprietary trading by banks, bank holding companies and others, and their acquisition and retention of ownership interests in and sponsorship of hedge funds and private equity funds.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall impact on the operations and financial condition of the Company. Provisions in the legislation that affect deposit insurance assessments and payment of interest on demand deposits could increase the cost associated with deposits. Provisions in the legislation that require revisions to the capital requirements of the Company and First Bank could require the Company and First Bank to seek additional sources of capital in the future.
CPP Related Compensation and Corporate Governance Requirements. The EESA was signed into law on October 3, 2008 and authorized the U.S. Treasury to provide funds to be used to restore liquidity and stability to the U.S. financial system pursuant to the CPP. Under the authority of EESA, the U.S. Treasury instituted the TARP Capital Purchase Program to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy. As noted above, on December 31, 2008, we participated in this program by issuing 295,400 shares of the Company’s Class C Preferred Stock to the U.S. Treasury for a purchase price of $295.4 million in cash and a Warrant to acquire up to 14,784.78478 shares of Class D Preferred Stock at an exercise price of $1.00 per share.
In addition to the restrictions on the Company’s ability to pay dividends on and repurchase its stock, participation in the CPP also includes certain requirements and restrictions regarding compensation that were expanded significantly by the American Recovery and Reinvestment Act of 2009, or ARRA, as implemented by U.S. Treasury’s Interim Final Rule on TARP Standards for Compensation and Corporate Governance. These requirements and restrictions include, among others, the following: (i) a prohibition on paying or accruing bonuses, retention awards and incentive compensation, other than qualifying long-term restricted stock or pursuant to certain preexisting employment contracts, to the Company’s five most highly-compensated employees; (ii) a general prohibition on providing severance benefits, or other benefits due to a change in control of the Company, to the Company’s senior executive officers (“SEOs”) and next five most highly compensated employees; (iii) a requirement to make subject to clawback any bonus, retention award, or incentive compensation paid to any of the SEOs and any of the next twenty most highly compensated employees if such compensation was based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria; (iv) a requirement to establish a policy on luxury or excessive expenditures; (v) a requirement to annually provide shareholders with a non-binding advisory “say on pay” vote on executive compensation; (vi) a prohibition on deducting more than $500,000 in annual compensation, including performance-based compensation, to the executives covered under Internal Revenue Code Section 162(m); (vii) a requirement that the compensation committee of the board of directors evaluate and review on a semi-annual basis the risks involved in employee compensation plans; and (viii) a prohibition on providing tax “gross-ups” to the Company’s SEOs and the next 20 most highly compensated employees. These requirements and restrictions will remain applicable to the Company until it has redeemed the Class C Preferred Stock and Class D Preferred Stock in full.
Incentive Compensation. On October 22, 2009, the Federal Reserve issued a comprehensive proposal on incentive compensation policies, or the Incentive Compensation Proposal, intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The Incentive Compensation Proposal, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.
The scope and content of the U.S. banking regulators’ policies on executive compensation are continuing to develop and are likely to continue evolving in the near future. It cannot be determined at this time whether compliance with such policies will adversely affect our ability to hire, retain and motivate our key employees. See further discussion under Item 11 ¾ Executive Compensation.
Other Future Legislation and Changes in Regulations. In addition to the specific proposals described above, from time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company. A change in statutes, regulations or regulatory policies applicable to us or any of our subsidiaries could have a material effect on the business, financial condition or results of operations of the Company.
Item 1A.
Item 1A. Risk Factors
Readers of our Annual Report on Form 10-K should consider the risk factors described below in conjunction with the other information included in this Annual Report on Form 10-K, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, our Selected Financial Data, our consolidated financial statements and the related notes thereto, and the financial and other data contained elsewhere in this report. See also “Special Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results” appearing at the beginning of this report. The order of the risk factors described below is not indicative of likelihood or significance.
Our results of operations, financial condition and business may be materially, adversely affected if we fail to successfully implement our Capital Plan. Our Capital Plan contemplates a number of different strategies intended to reduce our costs, increase our risk-based capital ratios and enable us to withstand and better respond to continuing adverse market conditions. There can be no assurance, however, that we will be able to successfully implement each or every component of our Capital Plan in a timely manner or at all, and a number of events and conditions must occur in order for the plan to achieve its intended effect. If we are not able to successfully complete our Capital Plan, we could be adversely impacted and our ability to withstand continued adverse economic conditions could be threatened.
We could be compelled to seek additional capital in the future, but capital may not be available when it is needed. Our holding company, First Banks, did not meet the minimum regulatory capital standards established for bank holdings companies by the Federal Reserve at December 31, 2010. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. A number of financial institutions have recently raised considerable amounts of capital as a result of deterioration in their results of operations and financial condition arising from the turmoil in the mortgage loan market, deteriorating economic conditions, declines in real estate values and other factors, which may diminish our ability to raise additional capital. Our previously announced Capital Plan also contemplates raising additional capital in an effort to improve our capital position.
Our ability to raise additional capital, as part of our Capital Plan or otherwise, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside of our control (including the response to any offers to current holders of the Company’s securities), and on our financial performance. Accordingly, we cannot be assured of our ability to raise additional capital, as part of our Capital Plan or otherwise, or on terms acceptable to us. If we are unable to raise additional capital, as part of our Capital Plan or otherwise on terms satisfactory to us, our financial condition, results of operations, business prospects and our regulatory capital ratios and those of First Bank may be materially and adversely affected. If we are unable to raise additional capital, as part of our Capital Plan or otherwise, we may also be subjected to increased regulatory supervision, which could result in the imposition of additional regulatory restrictions on our operations and/or regulatory enforcement actions and could also potentially limit our future growth opportunities. These restrictions could negatively impact our ability to manage or expand our operations in a manner that we may deem beneficial to our stockholders and debt holders and could result in significant increases in our operating expenses or decreases in our revenues.
The Company, SFC and First Bank entered into an Agreement with the Federal Reserve Bank of St. Louis. As further described under “-Supervision and Regulation - Regulatory Agreements,” the Company, SFC and First Bank entered into an Agreement with the FRB. Although we cannot predict the ramifications that would result from the failure to comply with each of the provisions of the Agreement, the failure to comply could have a material adverse effect on our business, financial condition, results of operations and cash flows. Furthermore, under the Agreement, the Company, SFC and First Bank must receive approval from the FRB prior to paying any dividends on its capital stock or making any interest payments on the Company’s outstanding junior subordinated debentures, which represent the source of distributions to holders of trust preferred securities.
Recently enacted financial reform legislation will, among other things, tighten capital standards, create a new Consumer Financial Protection Bureau and result in new regulations that are expected to increase our costs of operations. On July 21, 2010, the Dodd-Frank Act was signed into law. This new law will significantly change the current bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.
Among the many requirements in the Dodd-Frank Act for new banking regulations is a requirement for new capital regulations to be adopted within 18 months. These regulations must be at least as stringent as, and may call for higher levels of capital than, current regulations. Generally, trust preferred securities will no longer be eligible as Tier 1 capital, but the Company’s currently outstanding trust preferred securities will be grandfathered and its currently outstanding CPP preferred securities will continue to qualify as Tier 1 capital.
Certain provisions of the Dodd-Frank Act are expected to have a near term impact on us. For example, one year after the date of its enactment, the Dodd-Frank Act eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on our interest expense.
The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts and IOLTA accounts have unlimited deposit insurance through December 31, 2013.
In addition, the Dodd-Frank Act increased the authority of the Federal Reserve Board to examine the Company and its non-bank subsidiaries and gave the Federal Reserve Board the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. The Federal Reserve Board recently proposed capping such fees at seven to 12 cents, subject to adjustment for fraud prevention costs. The Dodd-Frank Act also will restrict proprietary trading by banks, bank holding companies and others, and their acquisition and retention of ownership interests in and sponsorship of hedge funds and private equity funds, subject to an exception allowing a bank to organize and offer hedge funds and private equity funds to customers if certain conditions are met, including, among others, a requirement that the bank limit its ownership interest in any single fund to 3% and its aggregate investment in all funds to 3% of Tier 1 capital, with no director or employee of the bank holding company having an ownership interest in the fund unless he or she provides services directly to the fund.
The Dodd-Frank Act creates a new Bureau of Consumer Financial Protection with broad powers to supervise and enforce consumer protection laws. The Bureau will have broad rule-making authority for a wide range of consumer protection laws that apply to all banks, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Bureau will have examination and enforcement authority over all banks with more than $10 billion in assets.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company. However, compliance with this new law and its implementing regulations will result in additional operating costs that could have a material adverse effect on our financial condition and results of operations.
Changes in economic conditions could negatively and materially impact our business. Our business is directly affected by factors such as economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government monetary and fiscal policies and inflation, all of which are beyond our control. A continued deterioration in economic conditions or lack of improvement in economic conditions may result in the following consequences, any of which could negatively and materially impact or continue to negatively and materially impact our business:
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Loan delinquencies may continue to increase or remain at elevated levels;
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Problem assets and foreclosures may continue to increase or remain at elevated levels;
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High unemployment may continue;
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Demand for our products and services may decline;
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Low cost or noninterest bearing deposits may decrease; and
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Collateral pledged to us by our customers for loans made by us, especially residential and commercial real estate property, may decline or continue to decline in value, in turn reducing our customers’ borrowing power, and thereby reducing the value of the underlying assets and collateral associated with our existing loans.
Our emphasis on commercial real estate lending and real estate construction and development lending has increased our credit risk. A substantial portion of our loans are secured by commercial real estate. Commercial real estate and real estate construction and development loans were $1.64 billion and $490.8 million, respectively, at December 31, 2010, representing 37.0% and 11.1%, respectively, of our loan portfolio. As discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations -Loans and Allowance for Loan Losses,” we have experienced increasing amounts of nonperforming loans within our real estate construction and development portfolio and commercial real estate portfolio, reflective of declining market conditions surrounding land acquisition and development loans as a result of increased developer inventories, slower lot and home sales, and declining market values. Adverse developments affecting real estate in one or more of our markets could further increase the credit risk associated with our loan portfolio.
Weakness in the real estate market has adversely affected us and may continue to do so. As discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations -Loans and Allowance for Loan Losses,” we have experienced deterioration within our residential real estate mortgage loan portfolio throughout the previous three years, primarily in our Alt A and sub-prime loan portfolios. Our residential real estate mortgage loans were $1.05 billion at December 31, 2010, representing 23.7% of our loan portfolio. The effects of ongoing mortgage market challenges, as well as the ongoing correction in residential real estate market prices and reduced levels of home sales could result in further price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held, mortgage loan originations and gains recognized on the sale of mortgage loans. In the event our allowance for loan losses is insufficient to cover such losses, our financial condition and results of operations may be adversely affected.
Our allowance for loan losses may not be sufficient to cover our actual loan losses, which could adversely affect our results of operations or financial condition. As a lender, we are exposed to the risk that our loan customers may not repay their loans according to their contractual terms and that the collateral securing the payment of these loans may be insufficient to assure repayment in full. We have experienced, and may continue to experience, significant loan losses, which could continue to have a material adverse effect on our results of operations. Management makes various assumptions and judgments about the collectability of our loan portfolio, which are based in part on:
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Current economic conditions and their estimated effects on specific borrowers;
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An evaluation of the existing relationships among loans, potential loan losses and the present level of the allowance for loan losses;
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Management’s internal review of the loan portfolio, including existing compliance with established policies and procedures; and
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Results of examinations of our loan portfolio by regulatory agencies.
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management’s best estimate of probable incurred loan losses inherent in our loan portfolio. Additional loan losses will likely continue to occur in the future and may occur at a rate greater than we have experienced historically. In determining the amount of the allowance for loan losses, we rely on an analysis of our loan portfolio, experience, and evaluation of general economic, political and regulatory conditions, industry and geographic concentrations, and certain other factors. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and judgment and requires us to make significant estimates of current credit risk and future trends, all of which may undergo material changes. If our assumptions and analysis prove to be incorrect, our current allowance for loan losses may not be sufficient. In addition, adjustments may be necessary to allow for unexpected volatility or deterioration in the local or national economy or other factors such as changes in interest rates that may be beyond our control. In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of management. Any increase in our allowance for loan losses or loan charge-offs could have a material adverse effect on our results of operations.
Our nonperforming loans also impact the sufficiency of our allowance for loan losses. Nonperforming loans totaled $398.9 million as of December 31, 2010. In addition to those loans currently identified and classified as nonperforming loans, management is aware that other possible credit problems may exist with certain borrowers. These include loans that are migrating from grades with lower risks of loss probabilities into grades with higher risks of loss probabilities as performance and potential repayment issues surface. We monitor these loans and adjust the loss rates in our allowance for loan losses accordingly. The most severe of these loans are credits that are classified as substandard loans due to either less than satisfactory performance history, lack of borrower’s paying capacity, or potentially inadequate collateral. Substandard, or potential problem loans, totaled $373.1 million at December 31, 2010, representing an increase of $27.5 million, or 8.0%, from $345.6 million at December 31, 2009.
We are subject to credit quality risks and our credit policies may not be sufficient to avoid losses. We are subject to the risk of losses resulting from the failure of borrowers, guarantors and related parties to pay interest and principal amounts on their loans. Our credit policies and credit underwriting and monitoring and collection procedures may not prevent losses, particularly during periods in which the local, regional or national economy suffers a general decline. If borrowers fail to repay their loans according to the contractual terms of the loans, our financial condition and results of operations will be adversely affected.
The overall level of our nonperforming assets and potential problem loans has increased our noninterest expense levels. We have incurred, and expect to incur for the foreseeable future, significant expenses associated with collection and foreclosure related matters on loans and taxes, insurance, property preservation and other collection matters on other real estate properties. In addition, we recorded write-downs on other real estate properties of $34.7 million and $37.4 million for the years ended December 31, 2010 and 2009, respectively. If the overall level of our nonperforming assets does not decrease, these expense levels will continue to have a material adverse affect on our financial condition and results of operations.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition. Liquidity is essential to our business. An inability to raise funds through traditional deposits, brokered deposits, borrowings, the sale of securities or loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities and on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.
We rely on commercial and retail deposits, advances from the FHLB of Des Moines and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits and advances as necessary, we might not be able to replace such funds in the future if, among other things, our results of operations or financial condition or the results of operations or financial condition of the FHLB of Des Moines or market conditions were to change.
There can be no assurance these sources of funds will be adequate for our liquidity needs and we may be compelled to seek additional sources of financing in the future. Likewise, we may seek additional debt in the future to achieve our business objectives. There can be no assurance additional borrowings, if sought, would be available to us or, if available, would be on terms acceptable to us. The ability of banks and holding companies to raise capital or borrow in the debt markets has been negatively affected by recent adverse economic trends. If additional financing sources are unavailable or not available on reasonable terms, our financial condition, results of operations and future prospects could be materially adversely affected.
We actively monitor the depository institutions that hold our cash operating account balances. It is possible that access to our cash equivalents will be impacted by adverse conditions in the financial markets. Our emphasis is primarily on safety of principal and we seek to diversify our cash balances among counterparties to minimize exposure to any one of these entities. The financial statements and other relevant data of the counterparties are routinely reviewed as part of our asset/liability management process. Balances in our accounts with financial institutions in the U.S. may exceed the FDIC insurance limits. While we monitor and adjust the balances in our accounts as appropriate, these balances could be impacted if the financial institutions fail and could be subject to other adverse conditions in the financial markets. At December 31, 2010, our cash and cash equivalents totaled $995.8 million, of which $895.4 million was maintained in our cash operating account at the FRB.
First Banks, Inc. is a separate and distinct legal entity from its subsidiaries. The Company’s liquidity position is affected by dividends received from our subsidiaries, the amount of cash and other liquid assets on hand, payment of interest and dividends on debt and equity instruments issued by the Company (all of which are presently suspended or deferred), capital contributions the Company makes into its subsidiaries, any redemption of debt for cash issued by the Company, and proceeds we raise through the issuance of debt and/or equity instruments through the Company, if any. The Company’s unrestricted cash totaled $3.6 million at December 31, 2010. The Company’s future liquidity position may be adversely affected if a combination of the following events occurs:
Ø
First Bank continues to experience net losses and, accordingly, is unable or prohibited by its regulators to pay a dividend to the Company sufficient to satisfy the Company’s operating cash flow needs;
Ø
We deem it advisable, or are required by the FRB, to use cash maintained by the Company to support the capital position of First Bank;
Ø
First Bank fails to remain “well-capitalized” and, accordingly, First Bank is required to pledge additional collateral against its borrowings and is unable to do so; or
Ø
The Company has difficulty raising cash through the future issuance of debt or equity instruments or by accessing additional sources of credit.
The Company’s financial flexibility may be severely constrained if we are unable to maintain our access to funding or if adequate financing on terms acceptable to us is not available in the marketplace. If we are required to rely more heavily on more expensive funding sources to support our business, our revenues may not increase proportionately to cover our costs. In this case, our operating margins could be materially adversely affected. A lack of liquidity and/or cost-effective funding alternatives could materially adversely affect our business, financial condition and results of operations.
We rely on dividends from our subsidiaries for most of our revenue. The Company is a separate and distinct legal entity from its subsidiaries. We receive substantially all of our revenue from dividends from our subsidiaries. These dividends are the principal source of funds to pay dividends on our preferred stock and interest and principal on our debt. Various federal and/or state laws and regulations limit the amount of dividends that First Bank and certain nonbank subsidiaries may pay to the Company. In the event First Bank is unable to pay dividends, we may not be able to service our debt (including our junior subordinated debentures issued in connection with the issuance of our outstanding trust preferred securities), pay obligations or pay dividends on our preferred stock, including the preferred stock we issued to the U.S. Treasury. The inability to receive dividends from First Bank could have a material adverse effect on our business, financial condition and results of operations. As further described under “Item 1. Business ¾Supervision and Regulation,” First Bank has agreed not to declare or pay any dividends without the prior consent of the MDOF and the FRB. First Bank did not make any dividend payments during the year ended December 31, 2010.
Our ability to repay our junior subordinated debentures, and our Class C Preferred Stock and Class D Preferred Stock issued under the CPP, could be hindered by the completed and pending divestiture initiatives associated with our Capital Plan. As further described under “Item 1. Recent Developments ¾Capital Plan,” we have completed, or are in the process of completing, a number of initiatives associated with our Capital Plan, including sales of branch offices, sales of certain loans, sales of nonbank subsidiaries and reductions in our risk-weighted assets. While these transactions were considered necessary by the Company to improve our regulatory capital ratios and preserve our risk-based capital in the short-term, these transactions have also decreased our sources of revenue and could hinder the probability and timing of future repayment of these obligations.
Concern of customers over deposit insurance may cause a decrease in deposits. With ongoing increased concerns about bank failures, customers increasingly are concerned about the extent to which their deposits are insured by the FDIC. Customers may withdraw deposits in an effort to ensure that the amount they have on deposit with their bank is fully insured. Decreases in deposits may adversely affect our liquidity position, funding costs and results of operations.
The Company may be adversely affected by the soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse affect on our financial condition and results of operations.
Markets have experienced, and may continue to experience, periods of high volatility accompanied by reduced liquidity. Financial markets are susceptible to severe events evidenced by rapid depreciation in asset values accompanied by a reduction in asset liquidity. Under these extreme conditions, hedging and other risk management strategies may not be as effective at mitigating losses as they would be under more normal market conditions. Moreover, under these conditions, market participants are particularly exposed to trading strategies employed by many market participants simultaneously and on a large scale, such as crowded trades. Our risk management and monitoring processes seek to quantify and mitigate risk to more extreme market moves. Severe market events have historically been difficult to predict, however, and we could realize significant losses if unprecedented extreme market events were to occur, such as the recent conditions in the global financial markets and global economy.
Because of our participation in the CPP under the EESA, we are subject to several restrictions, including restrictions on our ability to declare or pay dividends and repurchase capital stock and trust preferred securities, as well as restrictions on compensation paid to our executive officers. Pursuant to the terms of the Purchase Agreement, our ability to declare or pay dividends on any of our shares is limited. Specifically, we are unable to make any distributions on our trust preferred securities or dividends on pari passu preferred shares if we are in arrears on the payment of dividends on our Class C Preferred Stock and Class D Preferred Stock. In addition, we are not permitted to increase dividends on our common shares above the amount of the last quarterly cash dividend per share declared without the U.S. Treasury’s approval unless all of the Class C Preferred Stock and Class D Preferred Stock has been redeemed or transferred by the U.S. Treasury to unaffiliated third parties. Further, our trust preferred securities and pari passu preferred shares may not be repurchased if we are in arrears on the payment of Class C Preferred Stock and Class D Preferred Stock dividends. The terms of the Purchase Agreement allow the U.S. Treasury to impose additional restrictions, including those on dividends and including unilateral amendments required to comply with changes in applicable federal law. We are unable to predict the potential impact of any such amendments. As a result of our deferral of dividends to the U.S. Treasury for an aggregate of six quarters, the U.S. Treasury has the right to elect two directors to our Board. We expect the U.S. Treasury, our bank regulators and other agencies of the U.S. Government to continue to monitor our use of the CPP proceeds. Our failure to comply with the terms and conditions of the program or the Purchase Agreement may subject us to a regulatory enforcement action or legal proceedings brought by the U.S. Government.
In addition, pursuant to the terms of the Purchase Agreement, we adopted the U.S. Treasury’s current standards for executive compensation and corporate governance for the period during which the U.S. Treasury holds our equity securities issued pursuant to the Purchase Agreement. These standards generally apply to our executive officers identified in the Summary Compensation Table on page 85 and the 20 next most highly compensated employees. The impact of the executive compensation standards, as described under Item 11 ¾Executive Compensation, may result in the loss of current members of our management team and could adversely affect our ability to compete for talent in the industry.
Negative perception could adversely affect our business, impacting our financial condition, results of operations and cash flows. Risk of negative perception or publicity is inherent in any business. Although the Company takes steps to minimize reputation risk in dealing with customers and other constituencies, the Company is inherently exposed to the risk of negative perception by the public and our customers as a result of, but not limited to, our participation in the CPP under the EESA and as a result of actions imposed by our regulators. The risk of negative perception by the public and our customers may adversely affect the Company’s ability to maintain and attract customers and employees.
We could be required to further write down goodwill and other intangible assets. When we acquire a business, a portion of the purchase price of the acquisition is allocated to goodwill and other identifiable intangible assets. The amount of the purchase price that is allocated to goodwill and other intangible assets is determined by the excess of the purchase price over the net identifiable assets acquired. At December 31, 2010, our goodwill and other identifiable intangible assets were $129.1 million. Under current accounting standards, if we determine goodwill or intangible assets are impaired, we are required to write down the carrying value of these assets. We conduct a review at least annually to determine whether goodwill and other identifiable intangible assets are impaired. We completed such an impairment analysis during the fourth quarter of 2010 and determined our goodwill and other intangible assets were not impaired, as further described in Note 8 to our consolidated financial statements. We cannot provide assurance, however, that we will not be required to record an impairment charge in the future. Any additional impairment charge would have an adverse effect on our financial condition and results of operations.
Our controls and procedures may fail or be circumvented. Our management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurance that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, financial condition and results of operations.
The Company’s deposit insurance premiums could be substantially higher in the future, which could have a material adverse effect on our future earnings. The Dodd-Frank Act established 1.35% as the minimum DRR. The FDIC has determined that the DRR should be 2.0% and has adopted a plan under which it will meet the statutory minimum DRR of 1.35% by the statutory deadline of September 30, 2020. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%. The FDIC has not announced how it will implement this offset or how larger institutions will be affected by it. The Dodd-Frank Act also requires the FDIC to base insurance premiums on an institution’s total assets minus its tangible equity instead of its deposits. It is possible that our insurance premiums will increase in the future as a result of these final regulations and/or an increase in our risk assessment rating.
Significant legal actions could subject us to substantial liabilities. We are from time to time subject to claims related to our operations. These claims and legal actions, including supervisory actions by our regulators, could involve monetary claims and significant defense costs. As a result, we may be exposed to substantial liabilities, which could affect our results of operations and financial condition.
The value of securities in the Company’s investment securities portfolio may be negatively affected by continued disruptions in securities markets. The market for some of the investment securities held in our investment portfolio has become extremely volatile over the past two years. Volatile market conditions may detrimentally affect the value of these securities, such as through reduced valuations due to the perception of heightened credit and liquidity risks. There can be no assurance that the declines in market value associated with these disruptions will not result in other-than-temporary impairments of these assets, which could lead to write-downs of the carrying value of these assets that could have a material adverse effect on our net income and capital levels.
Geographic distance between our operations increases operating costs and makes efforts to standardize operations more difficult. We operate banking offices in California, Florida, Illinois and Missouri. The noncontiguous nature of many of our geographic markets increases operating costs and makes it more difficult for us to standardize our business practices and procedures. As a result of our geographic dispersion, we face the following challenges, among others: (a) familiarizing personnel with our business environment, banking practices and customer requirements at geographically dispersed locations; (b) providing administrative support, including accounting, human resources, credit administration, loan servicing, internal audit and credit review at significant distances; and (c) establishing and monitoring compliance with our corporate policies and procedures in different areas.
Decreases in interest rates could have a negative impact on our profitability. Our earnings are principally dependent on our ability to generate net interest income. Net interest income is affected by many factors that are partly or completely beyond our control, including competition, general economic conditions and the policies of regulatory authorities, including the monetary policies of the Federal Reserve. Under our current interest rate risk profile, our net interest income has been and could be negatively affected by a further decline in interest rates, as further discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations ¾Interest Rate Risk Management.”
Our interest rate risk hedging activities may not effectively reduce volatility in earnings. To offset the risks associated with the effects of changes in market interest rates, we periodically enter into transactions designed to hedge our interest rate risk. The accounting for such hedging activities under U.S. generally accepted accounting principles, or GAAP, requires our hedging instruments to be recorded at fair value. The effect of certain of our hedging strategies may result in volatility in our quarterly and annual earnings as interest rates change or as the volatility in the underlying derivatives markets increases or decreases. The volatility in earnings is primarily a result of marking to market certain of our hedging instruments and/or modifying our overall hedge position, as further discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations ¾Interest Rate Risk Management.”
The financial services business is highly competitive, and we face competitive disadvantages because of our size and the nature of banking regulation. We encounter strong direct competition for deposits, loans and other financial services in all of our market areas. Our larger competitors, which have significantly greater resources, may have advantages over us in providing certain services. Our principal competitors include other commercial banks, savings banks, savings and loan associations, mutual funds, finance companies, trust companies, insurance companies, leasing companies, credit unions, mortgage companies, private issuers of debt obligations and suppliers of other investment alternatives, such as securities firms and financial holding companies. Many of our non-bank competitors are not subject to the same degree of regulation as that imposed on bank holding companies, federally insured banks and national or state chartered banks. As a result, such non-bank competitors may have advantages over us in providing certain services.
Non-compliance with the USA Patriot Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions. The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. Although we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.
We provide treasury management services to money services businesses, which include: check cashers, issuers/sellers of traveler’s checks, money orders and stored value cards, and money transmitters. Money services businesses pose risk of compliance with regulatory guidance. We provide treasury management services to the check cashing industry, offering: check clearing, monetary instrument, depository, and credit services. We also provide treasury management services to money transmitters. Financial institutions that open and maintain accounts for money services businesses are expected to apply the requirements of the USA Patriot Act and Bank Secrecy Act, as they do with all accountholders, on a risk-assessed basis. As with any category of accountholder, there will be money services businesses that pose little risk of money laundering or lack of compliance with other laws and regulations and those that pose a significant risk. Providing treasury management services to money services businesses represents a significant compliance and regulatory risk, and failure to comply with all statutory and regulatory requirements could result in fines or sanctions.
We may not be able to implement technological change as effectively as our competitors. The financial services industry has undergone in the past and continues to undergo rapid technological change related to delivery and availability of products and services and operating efficiencies. In many instances technological improvements require significant capital expenditures, and many of our larger competitors have significantly greater resources to absorb such capital expenditures than we may have available. As such, we may be at a competitive disadvantage in our ability to retain existing customers and compete for new customers in the marketplace.
Our information systems could suffer an interruption or breach in security. Our operations are heavily reliant upon our communication and information systems. A failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposits, loan and other systems. While we have policies and procedures designed to prevent or limit the impact of any such failure, interruption or security breach, there can be no assurance that any such failure, interruption or security breach will not occur. Any such failure, interruption or security breach could adversely affect our operations and financial condition including a resulting loss in customer business, damage to our reputation, and possible exposure to regulatory scrutiny and litigation, any of which could have a material adverse affect on our business, financial condition and results of operations.
Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business. Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue, and/or cause us to incur additional expenses. Changing climate conditions may increase the frequency of natural disasters such as hurricanes, windstorms and other severe weather conditions. Although we have established policies and procedures addressing these types of events, the occurrence of any such event could have a material adverse effect on our business, financial condition and results of operations.
The Company is subject to claims and litigation pertaining to fiduciary responsibility. From time to time, customers make claims and take legal action pertaining to the performance of our fiduciary responsibilities. Whether customer claims and legal action related to the performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact customer demand for our products and services. Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition, results of operations and cash flows.
The Company is exposed to risk of environmental liabilities with respect to properties to which we take title. In the course of our business, we may own or foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law or contractual claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, cash flows, liquidity and results of operations could be materially and adversely affected.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
We own our office building, which houses our principal place of business, located at 135 North Meramec, Clayton, Missouri 63105. The property is in good condition and consists of approximately 60,353 square feet, of which approximately 3,712 square feet is currently leased to others. Of our other 153 offices and four operations and administrative facilities at December 31, 2010, 84 are located in buildings that we own and 73 are located in buildings that we lease.
We consider the properties at which we do business to be in good condition generally and suitable for our business conducted at each location. To the extent our properties or those acquired in connection with our acquisition of other entities provide space in excess of that effectively utilized in the operations of First Bank, we seek to lease or sub-lease any excess space to third parties. Additional information regarding the premises and equipment utilized by First Bank appears in Note 7 to our consolidated financial statements appearing elsewhere in this report.
Item 3.
Item 3. Legal Proceedings
The information required by this item is set forth in Item 8 under Note 24, Contingent Liabilities, to our consolidated financial statements appearing elsewhere in this report and is incorporated herein by reference.
In the ordinary course of business, we and our subsidiaries become involved in legal proceedings, including litigation arising out of our efforts to collect outstanding loans. It is not uncommon for collection efforts to lead to so-called “lender liability” suits in which borrowers may assert various claims against us. Our management believes the ultimate resolution of these existing proceedings is not reasonably likely to have a material adverse effect on our business, financial condition or results of operations.
The Company and First Bank entered into agreements with the FRB and MDOF, as further described under “Item 1. Business -Supervision and Regulation - Regulatory Agreements” and in Note 1 to our consolidated financial statements.
Item 4.
Item 4. (Reserved)
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information. There is no established public trading market for our common stock. Various trusts, which were established by and are administered by and for the benefit of Mr. James F. Dierberg, our Chairman of the Board, and members of his immediate family, own all of our voting stock.
Dividends. We have not paid any dividends on our Common Stock.
On August 10, 2009, we announced the suspension of the payment of cash dividends on our outstanding Class A Convertible Adjustable Rate Preferred Stock and our Class B Non-Convertible Adjustable Rate Preferred Stock beginning with the scheduled dividend payments that would have otherwise been made in September 2009. Prior to this time, we have paid minimal dividends on our Class A Convertible Adjustable Rate Preferred Stock and our Class B Non-Convertible Adjustable Rate Preferred Stock.
On August 10, 2009, we also announced the deferral of dividend payments on our Class C Preferred Stock and Class D Preferred Stock beginning with the regularly scheduled quarterly dividend payments that would otherwise have been made in August 2009, however, we continue to record the declaration of such dividends and the related additional cumulative dividends on our deferred dividend payments in our consolidated financial statements. In February 2009 and May 2009, we paid the regularly scheduled quarterly dividends on our Class C Preferred Stock and Class D Preferred Stock, which were pre-approved and authorized for payment by the FRB.
Our ability to pay dividends is limited by regulatory requirements and by the receipt of dividend payments from First Bank, which is also subject to regulatory requirements. First Bank has agreed not to declare or pay any dividends or make certain other payments to us without the prior consent of the MDOF and the FRB, as previously discussed under “Item 1. Business -Supervision and Regulation - Regulatory Agreements.” The dividend limitations are further described in Note 18 and Note 22 to our consolidated financial statements appearing elsewhere in this report.
Item 6.
Item 6. Selected Financial Data. The selected consolidated financial data set forth below are derived from our consolidated financial statements. This information is qualified by reference to our consolidated financial statements appearing elsewhere in this report. This information should be read in conjunction with such consolidated financial statements, the related notes thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors.”
Selected Financial Data (continued):
_____________________________
(1)
The comparability of the selected data, presented on a continuing basis, is affected by the acquisitions of banks and/or branch offices during the five-year period ended December 31, 2010. The selected data includes the financial position and results of operations of each acquired entity only for the periods subsequent to its respective date of acquisition.
(2)
Net interest margin is the ratio of net interest income (expressed on a tax-equivalent basis) to average interest-earning assets.
(3)
Tangible noninterest expense to average assets is the ratio of noninterest expense (excluding goodwill impairment and amortization of intangible assets) to average assets.
(4)
Efficiency ratio is the ratio of noninterest expense to the sum of net interest income and noninterest income. Tangible efficiency ratio is the ratio of noninterest expense (excluding goodwill impairment and amortization of intangible assets) to the sum of net interest income and noninterest income.
(5)
Nonperforming assets consist of nonaccrual loans, other real estate and repossessed assets.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following presents management’s discussion and analysis of our financial condition and results of operations as of the dates and for the periods indicated. This discussion should be read in conjunction with our “Selected Financial Data,” our consolidated financial statements and the related notes thereto, and the other financial data appearing elsewhere in this report. This discussion set forth in Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements with respect to our financial condition, results of operations and business. These forward-looking statements are subject to certain risks and uncertainties, not all of which can be predicted or anticipated. Various factors may cause our actual results to differ materially from those contemplated by the forward-looking statements herein. We do not have a duty to and do not undertake any obligation to update these forward-looking statements. Readers of our Annual Report on Form 10-K should therefore consider these risks and uncertainties in evaluating forward-looking statements and should not place undue reliance on forward-looking statements. See “Special Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results” appearing at the beginning of this report and “Item 1A ─ Risk Factors,” appearing elsewhere in this report.
RESULTS OF OPERATIONS
Overview
All financial information in this Annual Report on Form 10-K is reported on a continuing operations basis, unless otherwise noted. See Note 2 to our accompanying consolidated financial statements appearing elsewhere in this report for further discussion regarding our discontinued operations.
We recorded a net loss, including discontinued operations, of $191.7 million, $427.6 million and $287.2 million for the years ended December 31, 2010, 2009 and 2008, respectively. Our results of operations levels reflect the following:
Ø
A provision for loan losses of $214.0 million for the year ended December 31, 2010, compared to $390.0 million in 2009 and $368.0 million in 2008;
Ø
Net interest income of $233.5 million for the year ended December 31, 2010, compared to $281.0 million in 2009 and $352.2 million in 2008, which contributed to a decline in our net interest margin to 2.93% for the year ended December 31, 2010, compared to 3.12% in 2009 and 3.88% in 2008;
Ø
Noninterest income of $78.5 million for the year ended December 31, 2010, compared to $70.7 million in 2009 and $62.3 million in 2008;
Ø
Noninterest expense of $304.4 million for the year ended December 31, 2010, compared to $356.2 million in 2009 and $258.3 million in 2008;
Ø
A provision for income taxes of $4.1 million for the year ended December 31, 2010, compared to $2.4 million in 2009 and $18.3 million in 2008;
Ø
Income from discontinued operations, net of tax, of $12.2 million for the year ended December 31, 2010, compared to losses from discontinued operations, net of tax, of $52.0 million in 2009 and $58.2 million in 2008; and
Ø
Net losses attributable to noncontrolling interest in subsidiaries of $6.5 million for the year ended December 31, 2010, compared to $21.3 million in 2009 and $1.2 million in 2008.
The decrease in the provision for loan losses in 2010 was primarily driven by the significant decrease in the overall level of our loans, net of unearned discount, a decrease in net loan charge-offs and less severe asset migration to classified asset categories than the migration levels experienced during 2009, as further discussed under “-Provision for Loan Losses” and “-Loans and Allowance for Loan Losses.” The increase in the provision for loan losses in 2009 was primarily driven by increased net loan charge-offs and declining asset quality trends throughout our loan portfolio primarily resulting from continued weak economic conditions and significant declines in real estate values in virtually all market segments.
The decline in our net interest income and our net interest margin in 2010 was primarily attributable to higher average balances of lower-yielding short-term investments and investment securities, a substantially lower average balance of loans and a decrease in the yield on our investment securities portfolio, partially offset by an increase in the yield on our loan portfolio and a significant decrease in our deposit and borrowing costs, as further discussed under “-Net Interest Income” and “-Financial Condition and Average Balances.” The decline in our net interest income and net interest margin in 2009 was primarily attributable to a higher average balance of lower-yielding short-term investments, increases in nonaccrual loans and a decrease in the prime lending rate and the London Interbank Offered Rate, or LIBOR, to historically low levels, partially offset by a decrease in deposit and other interest-bearing liability costs.
The increase in our noninterest income in 2010, as compared to 2009, primarily resulted from increased gains on loans sold and held for sale, an increase in net gains on investment securities, lower net losses on derivative financial instruments, increased other income primarily driven by the receipt of a litigation settlement of $2.6 million and increased gains on sales of other real estate; partially offset by higher declines in the fair value of servicing rights, reduced service charges on deposit accounts and customer service fees and decreased bank-owned life insurance, or BOLI, investment income, as further discussed under “-Noninterest Income.” The increase in our noninterest income in 2009, as compared to 2008, was primarily attributable to an increase in net gains on investment securities, higher gains on the sale of mortgage loans, lower declines in the fair value of servicing rights and higher service charges on deposit accounts and customer service fees; partially offset by losses incurred on the sale of certain asset based lending and restaurant franchise loans in the fourth quarter of 2009, decreased BOLI investment income, increased net losses on derivative financial instruments and a gain on the extinguishment of a term repurchase agreement in 2008.
The overall decrease in the level of noninterest expense in 2010, as compared to 2009, primarily reflects a goodwill impairment charge of $75.0 million in 2009 as compared to zero in 2010 and reductions in other expense categories such as salaries and employee benefits, furniture and equipment, postage, printing and supplies, information technology fees, amortization of intangible assets, advertising and business development and write-downs and expenses on other real estate; partially offset by a $13.6 million operating loss resulting from suspected fraud involving a customer relationship in 2010, prepayment penalties of $10.6 million associated with the early termination of our outstanding FHLB advances and our term repurchase agreement, and increased occupancy expenses, legal, examination and professional fees and FDIC insurance assessment premiums, as further discussed under “¾Noninterest Expense.” The increase in our noninterest expense in 2009, as compared to 2008, primarily resulted from a goodwill impairment charge of $75.0 million, an increase in FDIC insurance assessment premiums and an increase in write-downs and expenses on other real estate properties partially offset by reductions in salaries and employee benefits expense, occupancy and furniture and equipment expenses, information technology fees, advertising and business development and other expenses.
The provision for income taxes for 2010 and 2009 primarily reflects our ongoing deferred tax asset valuation allowance. In addition, our provision for income taxes for 2010 reflects the reclassification of $6.8 million of accumulated other comprehensive income to provision for income taxes related to the expiration of the amortization period of the unrealized gain on certain of our interest rate swap agreements in September 2010, as further discussed under “¾Provision for Income Taxes” and in Note 13 to our consolidated financial statements. The provision for income taxes in 2008 reflects the recognition of a net deferred tax asset valuation allowance of $136.8 million against our deferred tax assets during 2008, which had the effect of increasing our provision for income taxes by $123.2 million during 2008.
Income from discontinued operations, net of tax, in 2010 reflects an aggregate gain on sale of discontinued operations of $19.6 million, including an $8.4 million gain recognized on the sale of our Chicago Region during the first quarter of 2010, a $5.0 million gain recognized on the sale of our Texas Region during the second quarter of 2010 and a $6.4 million gain recognized on the sale of a portion of our Northern Illinois Region during the third quarter of 2010, as further discussed under “¾Income (Loss) from Discontinued Operations, Net of Tax.” The loss from discontinued operations, net of tax, in 2009 reflects an aggregate loss on sale of discontinued operations of $13.0 million, including a loss on the sale of assets of WIUS of $13.1 million in the fourth quarter of 2009, partially offset by a small gain on the sale of ANB in the third quarter of 2009. See Note 2 to our consolidated financial statements for further discussion of discontinued operations.
The decrease in the net loss attributable to noncontrolling interest in subsidiaries in 2010, as compared to 2009, primarily reflects reduced losses associated with FB Holdings related to lower balances of nonaccrual loans and other real estate in addition to increased gains recognized on the sale of certain other real estate properties, as further discussed under “¾Net Loss Attributable to Noncontrolling Interest in Subsidiaries.” The increase in the net loss attributable to noncontrolling interest in subsidiaries in 2009, as compared to 2008, is primarily attributable to increased write-downs and expenses on other real estate properties associated with FB Holdings.
Financial Condition and Average Balances
Our average total assets were $8.70 billion for the year ended December 31, 2010, compared to $10.59 billion and $10.81 billion for the years ended December 31, 2009 and 2008, respectively. Our total assets were $7.38 billion at December 31, 2010, compared to $10.58 billion at December 31, 2009. We attribute the decrease in our total assets in 2010 to decreases in cash and short-term investments, loans, FHLB and FRB stock, bank premises and equipment, goodwill and other intangible assets, BOLI, deferred income taxes, other assets, assets held for sale and assets of discontinued operations, partially offset by increases in investment securities and other real estate. We attribute the decrease in our total assets in 2009 to decreases in our loan portfolio, goodwill and other intangible assets, bank premises and equipment, BOLI and other assets, partially offset by increases in cash and cash equivalents, other real estate, assets held for sale and assets of discontinued operations.
Our interest-earning assets averaged $7.99 billion for the year ended December 31, 2010, compared to $9.02 billion and $9.12 billion for the years ended December 31, 2009 and 2008, respectively. Our interest-bearing liabilities averaged $6.29 billion for the year ended December 31, 2010, compared to $6.32 billion and $6.55 billion for the years ended December 31, 2009 and 2008, respectively. Funds available from decreased average loan balances and increased average deposit balances were primarily utilized to fund our divestitures in 2010 which resulted in significant cash outlays, increases in average investment securities and short-term investments and a reduction in our average other borrowings. Funds available from decreased average loan balances, as well as maturities, calls and sales of investment securities were primarily utilized to fund increases in average short-term investments in 2009 in anticipation of divestitures completed in 2010.
Loans, net of unearned discount, averaged $5.52 billion, $7.33 billion and $8.24 billion for the years ended December 31, 2010, 2009 and 2008, respectively. Loans, net of unearned discount, decreased $2.12 billion to $4.49 billion at December 31, 2010, from $6.61 billion at December 31, 2009. The decreases in 2010 reflect the reclassification of $40.3 million of certain of our Northern Illinois Region loans to assets of discontinued operations at December 31, 2010, the sale of $137.4 million of loans associated with the sale of a portion of our Northern Illinois Region in September 2010, loan charge-offs of $331.2 million, aggregate sales of other commercial loans of $108.0 million, transfers to other real estate of $158.9 million and other reductions in our loan portfolio totaling $1.36 billion, including significant principal repayments and overall reduced loan demand within our markets, as further discussed under “-Loans and Allowance for Loan Losses.” The decrease in average loans in 2009 primarily reflects a decrease in internal loan growth, loan charge-offs of $352.7 million, transfers of loans to other real estate of $143.6 million and sales of $101.5 million, $64.4 million and $141.3 million of asset based lending loans, restaurant franchise loans and premium finance loans, respectively, in December 2009.
Investment securities averaged $1.01 billion for the year ended December 31, 2010, compared to $637.2 million and $743.1 million for the years ended December 31, 2009 and 2008, respectively. Our investment securities increased $952.8 million to $1.49 billion at December 31, 2010, from $541.6 million at December 31, 2009. The increase in our investment securities during 2010 reflects the utilization of excess cash and short-term investments to fund gradual and planned increases in our investment securities portfolio in an effort maximize our net interest income and net interest margin while maintaining appropriate liquidity levels. The reduction in our average investment securities during 2009 reflects the utilization of funds provided by maturities and sales of investment securities to increase our average short-term investments.
FHLB and FRB stock averaged $49.7 million for the year ended December 31, 2010, compared to $57.5 million and $51.5 million for the years ended December 31, 2009 and 2008, respectively. FHLB and FRB stock decreased $35.0 million to $30.1 million at December 31, 2010, from $65.1 million at December 31, 2009. The decrease during 2010 reflects the redemption of $27.3 million of FHLB stock associated with the prepayment of $600.0 million of FHLB advances, as further discussed below, and the redemption of $7.8 million of FRB stock associated with the reduction in our total assets during 2010. The increase during 2009 was primarily attributable to additional investments in FHLB stock commensurate with our increased FHLB borrowing levels during 2009.
Average short-term investments were $1.40 billion for the year ended December 31, 2010, compared to $995.2 million and $83.2 million in 2009 and 2008, respectively. The increase in our average short-term investments during 2010 was primarily due to a higher level of liquidity resulting from the significant decrease in average loans and an increase in average deposits, partially offset by the utilization of such funds to increase our investment securities portfolio and fund our divestitures completed in 2010, as further discussed below. The increase in our average short-term investments during 2009 was primarily due to a higher level of liquidity resulting from the decrease in average loans, partially offset by a decrease in average deposits. We increased our overall liquidity position during 2009 and 2010 in anticipation of significant cash outflows associated with the completion and expected completion of certain transactions associated with our Capital Plan, including the sale of our Chicago Region on February 19, 2010, the sale of our Texas Region on April 30, 2010, the sale of a portion of our Northern Illinois Region in September 2010 and the anticipated sale of the remaining branch offices in our Northern Illinois Region in the second quarter of 2011. The majority of funds in our short-term investments during 2010 and 2009 were maintained in our correspondent bank account with the FRB. The high level of short-term investments, while necessary to complete certain transactions associated with our Capital Plan and maintain significant liquidity in light of the recent economic environment, has negatively impacted our net interest margin. See further discussion under “-Liquidity.”
Our short-term investments decreased $1.45 billion to $924.8 million at December 31, 2010, from $2.37 billion at December 31, 2009. The decrease in our short-term investments of $1.45 billion was primarily attributable to the following:
Ø
The sale of our Chicago Region on February 19, 2010, resulting in a cash outflow of $832.5 million;
Ø
The sale of our Texas Region on April 30, 2010, resulting in a cash outflow of $352.9 million;
Ø
The sale of 11 branch offices in our Northern Illinois Region in September 2010, resulting in a cash outflow of $203.5 million;
Ø
The sale of our Lawrenceville Branch on January 22, 2010, resulting in a cash outflow of $8.3 million;
Ø
A net increase in our investment securities portfolio of $952.8 million during 2010;
Ø
A decrease in our deposit balances of approximately $150.1 million, excluding the impact of the divestitures of the Chicago, Texas and Northern Illinois Regions, and the Lawrenceville Branch;
Ø
The prepayment of $600.0 million of FHLB advances during 2010. In March 2010, funds available from short-term investments were utilized to prepay two $100.0 million FHLB advances that were scheduled to mature in April 2010 and July 2010, resulting in prepayment penalties of $281,000, in aggregate. During the third quarter of 2010, we prepaid an additional two $100.0 million FHLB advances that were scheduled to mature in April 2011 and July 2011, resulting in prepayment penalties of $1.9 million. During the fourth quarter of 2010, we prepaid an additional two $100.0 million FHLB advances that were scheduled to mature in August 2012 and September 2016, resulting in prepayment penalties of $3.2 million; and
Ø
The prepayment of our $120.0 million term repurchase agreement during the fourth quarter of 2010 that was scheduled to mature in April 2012, resulting in an early termination fee of $5.5 million.
These decreases in cash and cash equivalents were partially offset by:
Ø
A decrease in loans of $1.47 billion, exclusive of net loan charge-offs, transfers to other real estate and the impact of the divestitures of the Chicago, Texas and Northern Illinois Regions, and the Lawrenceville Branch;
Ø
The termination of our remaining BOLI policies during 2010, resulting in the receipt of cash proceeds from the surrender of the policies of approximately $25.9 million;
Ø
Sales of other real estate properties resulting in the receipt of cash proceeds from these sales of approximately $108.3 million; and
Ø
The redemption of $7.8 million of FRB stock associated with the reduction in our total assets and $27.3 million of FHLB stock associated with the prepayment of $600.0 million of FHLB advances during 2010.
Nonearning assets averaged $445.7 million, $599.4 million and $799.7 million for the years ended December 31, 2010, 2009 and 2008, respectively. The decreases during 2010 and 2009 were attributable to decreases in: average bank premises and equipment attributable to reduced expenditures associated with certain of our profit improvement initiatives; average BOLI policies resulting from the termination of several BOLI policies; average deferred income and refundable income taxes, including a refund of $62.0 million of federal income taxes received in mid-2009 as a result of the filing of amended federal income tax returns to recover income taxes paid in previous years through the application of the loss carryback rules and regulations; average intangible assets, including the recognition of goodwill impairment of $75.0 million in December 2009; and average fair value of certain of our derivative financial instruments during the periods; partially offset by increases in average other real estate attributable to higher foreclosure activity.
Bank premises and equipment, net of depreciation and amortization, decreased $16.9 million to $161.4 million at December 31, 2010, compared to $178.3 million at December 31, 2009. The decrease is attributable to the sale and reclassification of bank premises and equipment associated with our Northern Illinois Region to assets of discontinued operations of $5.5 million and $850,000, respectively; the reclassification of $790,000 of bank premises and equipment related to our San Jose and Edwardsville Branches to assets held for sale at December 31, 2010; and depreciation and amortization expense; partially offset by purchases of equipment.
Goodwill and other intangible assets decreased $15.4 million to $129.1 million at December 31, 2010, compared to $144.4 million at December 31, 2009. The decrease is due to (a) the reclassification of $1.6 million of goodwill and other intangible assets to assets of discontinued operations at December 31, 2010; (b) the reclassification of $500,000 of goodwill to assets held for sale at December 31, 2010; (c) the allocation of $9.7 million of goodwill and other intangible assets associated with the sale of a portion of our Northern Illinois Region in September 2010; and (d) amortization of $3.3 million.
BOLI decreased $26.4 million to zero at December 31, 2010, compared to $26.4 million at December 31, 2009. In January 2010, we terminated a BOLI policy with a carrying value of $19.8 million and received an initial cash payment of $19.2 million from the liquidation of the underlying assets associated with the terminated BOLI policy. In the third quarter of 2010, we surrendered our remaining BOLI policies and received a total cash payment of $6.7 million associated with the liquidation of these policies.
Other real estate increased $15.4 million to $140.6 million at December 31, 2010, compared to $125.2 million at December 31, 2009, primarily reflecting foreclosures of real estate construction and development, commercial real estate and one-to-four family residential real estate loans aggregating $158.9 million, partially offset by the sale of other real estate properties with a carrying value of $105.5 million and write-downs of other real estate of $34.7 million attributable to declining real estate values on certain properties.
Other assets decreased $11.4 million to $71.8 million at December 31, 2010 from $83.2 million at December 31, 2009, primarily reflecting decreases in accrued interest receivable, servicing rights and other miscellaneous assets.
Assets held for sale decreased $14.7 million to $2.3 million at December 31, 2010, compared to $17.0 million at December 31, 2009, reflecting the completion of the sale of our Lawrenceville Branch on January 22, 2010 and the sale of SBLS LLC’s SBA Lending Authority on April 6, 2010, partially offset by the reclassification of $2.3 million of assets held for sale associated with our San Jose and Edwardsville Branches to assets held for sale at December 31, 2010. See Note 2 to our consolidated financial statements for further discussion of assets held for sale.
Assets of discontinued operations averaged $269.3 million, $964.7 million and $889.3 million for the years ended December 31, 2010, 2009 and 2008, respectively. Assets of discontinued operations were $43.5 million and $518.1 million at December 31, 2010 and 2009, respectively, reflecting the completion of the sales of our Chicago Region and Texas Region during 2010, partially offset by the reclassification of $43.5 million of assets in our Northern Illinois Region to assets of discontinued operations at December 31, 2010. See Note 2 to our consolidated financial statements for further discussion of discontinued operations.
Deposits averaged $6.57 billion, $6.50 billion and $6.60 billion for the years ended December 31, 2010, 2009 and 2008, respectively. The increase in average deposits in 2010 was attributable to organic growth through deposit development programs, including marketing campaigns and enhanced product and service offerings, partially offset by anticipated reductions of higher rate certificates of deposit. The mix of our deposit portfolio volumes during 2010 primarily reflects a shift from time deposits and savings and money market deposits to noninterest-bearing and interest-bearing demand deposits. The decrease in average deposits in 2009 was primarily attributable to anticipated reductions of higher rate certificates of deposit, partially offset by organic growth. Average interest-bearing demand deposits were $909.0 million, $824.9 million and $820.2 million for the years ended December 31, 2010, 2009 and 2008, respectively. Average savings and money market deposits were $2.18 billion, $2.20 billion and $2.18 billion for the years ended December 31, 2010, 2009 and 2008, respectively. Average time deposits were $2.33 billion, $2.38 billion and $2.61 billion for the years ended December 31, 2010, 2009 and 2008, respectively. Our total deposits were $6.46 billion and $7.06 billion at December 31, 2010 and 2009, respectively, reflecting a decrease of $605.6 million. The decrease in deposits in 2010 reflects the sale and reclassification of deposits associated with our Northern Illinois Region to liabilities of discontinued operations at December 31, 2010 of $364.9 million and $94.1 million, respectively, and the reclassification of $23.4 million of deposits associated with our San Jose and Edwardsville Branches to liabilities held for sale at December 31, 2010, as further discussed in Note 2 to our consolidated financial statements. Exclusive of these transactions, total deposits decreased $123.2 million, primarily reflective of the aforementioned anticipated reduction of higher rate certificates of deposit.
Other borrowings, generally comprised of daily and term repurchase agreements, FHLB advances, FRB borrowings and federal funds purchased, averaged $514.7 million, $561.3 million and $567.8 million for the years ended December 31, 2010, 2009 and 2008, respectively. The decrease in average other borrowings in 2010 reflects the prepayment of $600.0 million of our outstanding FHLB advances, the early termination of our $120.0 million term repurchase agreement, and reductions in daily repurchase agreements (in connection with cash management activities of our commercial deposit customers). The decrease in average other borrowings in 2009 reflects reductions in FRB borrowings, federal funds purchased and daily repurchase agreements, partially offset by an increase in FHLB advances in anticipation of the expected completion of certain transactions associated with our Capital Plan, as further described in Note 2 to our consolidated financial statements. Other borrowings decreased $735.7 million to $31.8 million at December 31, 2010, compared to $767.5 million at December 31, 2009, reflecting the repayment of $600.0 million of FHLB advances, the termination of our $120.0 million term repurchase agreement and a decrease in daily repurchase agreements of $15.7 million. See further discussion regarding activity in other borrowings in Note 10 to our consolidated financial statements and under “-Liquidity.”
Our notes payable averaged zero for the years ended December 31, 2010 and 2009, compared to $21.6 million for the year ended December 31, 2008. During the second quarter of 2008, we borrowed $30.0 million under a new secured revolving line of credit with an affiliated entity and utilized the proceeds of the advance to terminate and repay in full all of the obligations under our former secured credit facility with a group of unaffiliated financial institutions. During the third quarter of 2008, we repaid in full the outstanding balance on our new secured revolving line of credit. Subsequent to that time, we did not borrow any additional funds on the new secured line of credit, which matured on June 30, 2009, as further discussed in Note 11 to our consolidated financial statements. In March 2011, we entered into a new secured revolving line of credit with an affiliated entity, as further described in Note 25 to our consolidated financial statements.
Subordinated debentures issued to our affiliated statutory and business trusts averaged $353.9 million, $353.9 million and $353.8 million for the years ended December 31, 2010, 2009, and 2008. Our junior subordinated debentures were $354.0 million and $353.9 million at December 31, 2010 and 2009, respectively, and are further discussed in Note 12 to our consolidated financial statements.
Noninterest-bearing liabilities averaged $1.26 billion, $1.19 billion and $1.07 billion for the years ended December 31, 2010, 2009 and 2008, respectively. Average demand deposits were $1.15 billion, $1.09 billion and $990.9 million for the years ended December 31, 2010, 2009 and 2008, respectively, and average other liabilities were $108.8 million, $98.3 million and $74.3 million for the years ended December 31, 2010, 2009 and 2008, respectively. Noninterest-bearing demand deposits were $1.17 billion and $1.27 billion at December 31, 2010 and 2009, respectively, reflecting a decrease in commercial deposit relationships primarily as a result of the corresponding decrease in the overall level of commercial loans. Our accrued expenses and other liabilities were $83.9 million at December 31, 2010, compared to $87.0 million at December 31, 2009. The decrease in accrued expenses and other liabilities is primarily attributable to a reduction in our other liabilities of $25.9 million due to the purchase of an investment security that settled on December 31, 2009 but for which the cash was not transferred until January 4, 2010, partially offset by an increase in dividends payable on our Class C Preferred Stock and Class D Preferred Stock and accrued interest payable on our junior subordinated debentures of $17.0 million and $12.9 million, respectively.
Liabilities held for sale were $23.4 million and $24.4 million at December 31, 2010 and 2009, respectively, reflecting the completion of the sale of our Lawrenceville Branch on January 22, 2010, partially offset by the reclassification of $23.4 million of liabilities held for sale associated with our San Jose and Edwardsville Branches to liabilities held for sale at December 31, 2010. See Note 2 to our consolidated financial statements for further discussion of liabilities held for sale.
Liabilities of discontinued operations averaged $700.4 million, $2.25 billion and $2.32 billion for the years ended December 31, 2010, 2009 and 2008, respectively. Liabilities of discontinued operations were $94.2 million and $1.73 billion at December 31, 2010 and 2009, respectively, reflecting the completion of the sales of our Chicago Region and Texas Region during 2010, partially offset by the reclassification of $94.2 million of liabilities in our Northern Illinois Region to liabilities of discontinued operations at December 31, 2010. See Note 2 to our consolidated financial statements for further discussion of discontinued operations.
Stockholders’ equity, including noncontrolling interest in subsidiaries, averaged $452.6 million, $825.2 million and $875.9 million for the years ended December 31, 2010, 2009 and 2008, respectively. Our stockholders’ equity was $307.3 million and $522.4 million at December 31, 2010 and 2009, respectively. The decrease for 2010 reflects:
Ø
A net loss, including discontinued operations, of $191.7 million;
Ø
Dividends declared of $17.0 million on our Class C Preferred Stock and Class D Preferred Stock; and
Ø
A decrease in noncontrolling interest in subsidiaries of $6.5 million associated with net losses in FB Holdings; partially offset by
Ø
A decrease of $146,000 in accumulated other comprehensive loss attributable to changes in unrealized gains and losses on derivative financial instruments and available-for-sale investment securities.
The decrease for 2009 reflects:
Ø
A net loss, including discontinued operations, of $427.6 million;
Ø
Dividends declared of $328,000 on our Class A and Class B preferred stock;
Ø
Dividends declared of $14.2 million on our Class C Preferred Stock and Class D Preferred Stock;
Ø
A decrease of $8.7 million in accumulated other comprehensive income primarily due to changes in unrealized gains and losses on derivative financial instruments and available-for-sale investment securities; and
Ø
A decrease in noncontrolling interest in subsidiaries of $26.0 million, reflecting a decrease of $21.3 million associated with net losses in FB Holdings and SBLS LLC, in addition to a decrease of $4.7 million associated with First Bank’s purchase of FCA’s noncontrolling interest in SBLS LLC; partially offset by
Ø
An increase of $2.8 million in additional paid-in capital as a result of First Bank’s purchase of FCA’s noncontrolling interest in SBLS LLC, as further described in Note 1 and Note 19 to our consolidated financial statements.
The following table sets forth, on a tax-equivalent basis, certain information on a continuing basis relating to our average balance sheets, and reflects the average yield earned on our interest-earning assets, the average cost of our interest-bearing liabilities and the resulting net interest income for the years ended December 31, 2010, 2009 and 2008.
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(1)
For purposes of these computations, nonaccrual loans are included in the average loan amounts.
(2)
Interest income on loans includes loan fees.
(3)
Interest income and interest expense include the effects of interest rate swap agreements.
(4)
Information is presented on a tax-equivalent basis assuming a tax rate of 35%. The tax-equivalent adjustments were approximately $496,000, $866,000 and $1.3 million for the years ended December 31, 2010, 2009 and 2008, respectively.
(5)
Interest expense on our notes payable reflects commitment fees for the year ended December 31, 2009. Interest expense on our notes payable reflects commitment, arrangement and renewal fees for the year ended December 31, 2008. Exclusive of these fees, the interest rate paid was 4.42% for the year ended December 31, 2008.
(6)
Net interest margin is the ratio of net interest income (expressed on a tax-equivalent basis) to average interest-earning assets.
The following table indicates, on a tax-equivalent basis, the changes in interest income and interest expense on a continuing basis that are attributable to changes in average volume and changes in average rates, in comparison with the preceding year. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the dollar amounts of the change in each.
________________________
(1)
For purposes of these computations, nonaccrual loans are included in the average loan amounts.
(2)
Interest income on loans includes loan fees.
(3)
Interest income and interest expense include the effects of interest rate swap agreements.
(4)
Information is presented on a tax-equivalent basis assuming a tax rate of 35%.
(5)
Interest expense on our notes payable reflects commitment fees of $37,000 for the year ended December 31, 2009.
Net Interest Income
The primary source of our income is net interest income. Net interest income is the difference between the interest earned on our interest-earning assets, such as loans and investment securities, and the interest paid on our interest-bearing liabilities, such as deposits and borrowings. Net interest income is affected by the level and composition of assets, liabilities and stockholders’ equity, as well as the general level of interest rates and changes in interest rates. Interest income on a tax-equivalent basis includes the additional amount of interest income that would have been earned if our investment in certain tax-exempt interest-earning assets had been made in assets subject to federal, state and local income taxes yielding the same after-tax income. Net interest margin is determined by dividing net interest income on a tax-equivalent basis by average interest-earning assets. The interest rate spread is the difference between the average equivalent yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
Net interest income, expressed on a tax-equivalent basis, was $234.0 million for the year ended December 31, 2010, compared to $281.9 million and $353.5 million for the years ended December 31, 2009 and 2008, respectively. Our net interest margin was 2.93% for the year ended December 31, 2010, compared to 3.12% and 3.88% for the years ended December 31, 2009 and 2008, respectively. We attribute the decline in our net interest margin and net interest income in 2010 and 2009 to a higher average balance of short-term investments that are currently yielding 25 basis points, a decrease in the average balance of loans and a decrease in the yield on our investment securities portfolio, partially offset by a decrease in our deposit and borrowing costs. The average yield earned on our interest-earning assets decreased 53 and 145 basis points to 3.92% and 4.45% for the years ended December 31, 2010 and 2009, respectively, compared to 5.90% in 2008, while the average rate paid on our interest-bearing liabilities decreased 63 and 93 basis points to 1.26% and 1.89% for the years ended December 31, 2010 and 2009, respectively, compared to 2.82% in 2008.
Our balance sheet is presently asset sensitive, and as such, our net interest margin has been negatively impacted by the low interest rate environment as our loan portfolio re-prices on an immediate basis; whereas we are unable to immediately re-price our deposit portfolio to current market interest rates, thereby resulting in a compression of our net interest margin. Our asset-sensitive position, coupled with the level of our nonperforming assets, the increased level of average lower-yielding short-term investments and investment securities, the lower level of average loans and the expiration of the amortization period of the unrealized gain on certain terminated interest rate swap agreements in September 2010, as further discussed below, has negatively impacted our net interest income and is expected to continue to impact the level of our net interest income in the near future.
Derivative financial instruments that were previously entered into in conjunction with our interest rate risk management program to mitigate the effects of decreasing interest rates increased our net interest income by $5.7 million, $12.5 million and $11.5 million in 2010, 2009 and 2008, respectively. The earnings on our interest rate swap agreements increased our net interest margin by approximately seven basis points, 14 basis points and 13 basis points in 2010, 2009 and 2008, respectively. In December 2008, we terminated certain of our interest rate swap agreements designated as cash flow hedges on certain of our loans, as further discussed under “-Interest Rate Risk Management” and in Note 5 to our consolidated financial statements. At the date of termination, these interest rate swap agreements had a fair value of $20.8 million, which was being amortized from other comprehensive income to interest and fees on loans over the remaining terms of the interest rate swap agreements, which concluded in September 2010, as further discussed below.
Interest income on our loan portfolio, expressed on a tax-equivalent basis, was $281.8 million, $371.0 million and $497.4 million for the years ended December 31, 2010, 2009 and 2008, respectively. The yield on our loan portfolio was 5.10%, 5.06% and 6.04% for the years ended December 31, 2010, 2009 and 2008, respectively. The yield on our loan portfolio increased four basis points during 2010, as compared to 2009, and decreased 98 basis points during 2009, as compared to 2008. The yield on our loan portfolio continues to be adversely impacted by the historically low prime and LIBOR interest rates, as a significant portion of our loan portfolio is priced to these indices. Furthermore, the yield on our loan portfolio continues to be adversely impacted by the higher levels of average nonaccrual loans, as further discussed under “-Loans and Allowance for Loan Losses.” Our nonaccrual loans decreased our average yield on loans by approximately 64 basis points, 49 basis points and 30 basis points in 2010, 2009 and 2008, respectively. Interest income on our loan portfolio was positively impacted by income associated with our interest rate swap agreements of $5.7 million, $13.7 million and $11.7 million in 2010, 2009 and 2008, respectively. This income ceased during the third quarter of 2010 with the expiration of the amortization period of the unrealized pre-tax gain associated with the termination of our interest rate swap agreements designated as cash flow hedges, as previously discussed. We have been re-pricing our loan portfolio, in particular our commercial real estate and real estate construction and development loans, over the last several quarters to be more reflective of current market conditions by implementing interest rate floors and increasing margins to prime lending and LIBOR rates in accordance with the respective borrower’s credit risk profile. However, competitive conditions within our market areas may impact our ongoing ability to improve pricing in certain sectors.
Interest income on our investment securities, expressed on a tax-equivalent basis, was $25.9 million, $25.2 million and $36.2 million for the years ended December 31, 2010, 2009 and 2008, respectively. The yield on our investment securities was 2.55%, 3.96% and 4.87% for the years ended December 31, 2010, 2009 and 2008, respectively, reflecting the higher average balance of investment securities during 2010 as previously discussed, the decline in short-term interest rates during the periods as well as the sale of higher-yielding available-for-sale investment securities to reposition our investment securities portfolio from securities that carried relatively high risk-weightings for regulatory capital purposes to lower risk-weighted investment securities.
Dividends on our FHLB and FRB stock were $2.1 million, $2.2 million and $2.5 million for the years ended December 31, 2010, 2009 and 2008, respectively. The yield earned on our FHLB and FRB stock was 4.15%, 3.75% and 4.87% for the years ended December 31, 2010, 2009 and 2008, respectively, and reflects short-term interest rates during these periods.
Interest income on our short-term investments was $3.5 million, $2.8 million and $1.8 million for the years ended December 31, 2010, 2009 and 2008, respectively. The yield on our short-term investments was 0.25%, 0.28% and 2.21% for the years ended December 31, 2010, 2009 and 2008, respectively, reflecting the significant decline in short-term interest rates, most significantly the federal funds rate, that began in the latter half of 2007 and continued throughout 2008 and 2009 to historically low levels. The majority of funds in our short-term investments during 2009 and 2010 were maintained in our correspondent bank account with the FRB, which currently earns 0.25%. As further discussed above, the high level of short-term investments, while necessary to complete certain transactions associated with our Capital Plan and maintain significant liquidity in light of economic conditions, has negatively impacted our net interest margin.
Interest expense on interest-bearing deposits was $58.5 million, $93.8 million and $148.1 million for the years ended December 31, 2010, 2009 and 2008, respectively. For the years ended December 31, 2010, 2009 and 2008, the aggregate weighted average rate paid on our interest-bearing deposit portfolio was 1.08%, 1.74% and 2.64%, respectively. The decreases in interest expense and the weighted average rate paid on our deposit portfolio in 2010 and 2009 is primarily reflective of the re-pricing of certificates of deposits to current market interest rates upon maturity and our efforts to reduce deposit costs across our deposit portfolio. The weighted average rate paid on our time deposit portfolio declined to 1.80% in 2010 from 2.89% in 2009 and 3.76% in 2008; the weighted average rate paid on our savings and money market deposit portfolio declined to 0.69% in 2010 from 1.06% in 2009 and 2.08% in 2008; and the weighted average rate paid on our interest-bearing demand deposits declined to 0.16% in 2010 from 0.19% in 2009 and 0.55% in 2008. Assuming that the prevailing interest rate environment remains relatively stable, we anticipate continued reductions in our deposit costs as certain of our certificates of deposit continue to re-price to current market interest rates upon maturity, as money market accounts re-price from promotional rates to current market interest rates and as we implement certain product modifications designed to enhance overall product offerings to our customer base.
Interest expense on our other borrowings was $7.8 million, $10.0 million and $13.9 million for the years ended December 31, 2010, 2009 and 2008, respectively. The aggregate weighted average rate paid on our other borrowings was 1.52% for the year ended December 31, 2010, compared to 1.79% and 2.45% for the years ended December 31, 2009 and 2008, respectively, reflecting the reduction in short-term interest rates during the periods.
We did not incur any interest expense on notes payable in 2010. Interest expense on our notes payable was $37,000 for the year ended December 31, 2009, consisting entirely of commitment fees as we did not have any balances outstanding under our notes payable during 2009. Interest expense on our notes payable was $1.3 million for the year ended December 31, 2008. The aggregate weighted average rate paid on our notes payable was 6.15% for the year ended December 31, 2008, and reflects changing market interest rates during the period, and unused commitment, arrangement and renewal fees paid in conjunction with the respective financing arrangement. Exclusive of these fees, the aggregate weighted average rate paid on our notes payable was 4.42% for the year ended December 31, 2008.
Interest expense on our junior subordinated debentures was $13.0 million, $15.5 million and $21.1 million for the years ended December 31, 2010, 2009 and 2008, respectively. The aggregate weighted average rate paid on our junior subordinated debentures was 3.68%, 4.38% and 5.95% for the years ended December 31, 2010, 2009 and 2008, respectively. The aggregate weighted average rates and the level of interest expense reflect the reduction in LIBOR rates and the impact to the related spreads to LIBOR during the periods, as $282.5 million, or 79.4%, of our junior subordinated debentures are variable rate, and the entrance into four interest rate swap agreements with an aggregate notional amount of $125.0 million during March 2008 that effectively converted the interest payments on certain of our junior subordinated debentures from a variable rate to a fixed rate. In August 2009, we discontinued hedge accounting on these interest rate swap agreements due to the deferral of interest payments on our junior subordinated debentures, and as such, the net interest recorded on the interest rate swap agreements was recorded as noninterest income effective August 2009, as further described under “-Interest Rate Risk Management” and in Note 5 and Note 12 to our consolidated financial statements. Interest expense on our junior subordinated debentures for the years ended December 31, 2009 and 2008 includes interest expense of $1.3 million and $124,000, respectively, of interest expense associated with these interest rate swap agreements.
Comparison of Results of Operations for 2010 and 2009
Net Income. We recorded a net loss, including discontinued operations, of $191.7 million and $427.6 million for the years ended December 31, 2010 and 2009, respectively. Our results of operations levels reflect the following:
Ø
A provision for loan losses of $214.0 million for the year ended December 31, 2010, compared to $390.0 million in 2009;
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Net interest income of $233.5 million for the year ended December 31, 2010, compared to $281.0 million in 2009, which contributed to a decline in our net interest margin to 2.93% for the year ended December 31, 2010, compared to 3.12% in 2009;
Ø
Noninterest income of $78.5 million for the year ended December 31, 2010, compared to $70.7 million in 2009;
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Noninterest expense of $304.4 million for the year ended December 31, 2010, compared to $356.2 million in 2009;
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A provision for income taxes of $4.1 million for the year ended December 31, 2010, compared to $2.4 million in 2009;
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Income from discontinued operations, net of tax, of $12.2 million for the year ended December 31, 2010, compared to a loss from discontinued operations, net of tax, of $52.0 million in 2009; and
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Net losses attributable to noncontrolling interest in subsidiaries of $6.5 million for the year ended December 31, 2010, compared to $21.3 million in 2009.
The decrease in the provision for loan losses in 2010 was primarily driven by the significant decrease in the overall level of our loans, net of unearned discount, a decrease in nonaccrual loans, a decrease in net loan charge-offs and less severe asset migration to classified asset categories than the migration levels experienced during 2009, as further discussed under “-Provision for Loan Losses” and “-Loans and Allowance for Loan Losses.”
The decline in our net interest income and our net interest margin in 2010 was primarily attributable to higher average balances of lower-yielding short-term investments and investment securities, a substantially lower average balance of loans and a decrease in the yield on our investment securities portfolio, partially offset by an increase in the yield on our loan portfolio and a significant decrease in our deposit and borrowing costs, as further discussed under “-Net Interest Income” and under “-Financial Condition and Average Balances.”
The increase in our noninterest income in 2010, as compared to 2009, primarily resulted from increased gains on loans sold and held for sale, an increase in net gains on investment securities, lower net losses on derivative financial instruments, increased other income primarily driven by the receipt of a litigation settlement of $2.6 million and increased gains on sales of other real estate; partially offset by higher declines in the fair value of servicing rights, reduced service charges on deposit accounts and customer service fees and decreased BOLI investment income, as further discussed under “-Noninterest Income.”
The overall decrease in the level of noninterest expense in 2010, as compared to 2009, primarily reflects a goodwill impairment charge of $75.0 million in 2009 as compared to zero in 2010 and reductions in other expense categories such as salaries and employee benefits, furniture and equipment, postage, printing and supplies, information technology fees, amortization of intangible assets, advertising and business development and write-downs and expenses on other real estate, partially offset by a $13.6 million operating loss resulting from suspected fraud involving a customer relationship in 2010, prepayment penalties of $10.6 million associated with the early termination of our outstanding FHLB advances and our term repurchase agreement, and increased occupancy expenses, legal, examination and professional fees and FDIC insurance assessment premiums, as further discussed under “¾Noninterest Expense.”
The provision for income taxes for 2010 and 2009 primarily reflects our ongoing deferred tax asset valuation allowance. In addition, our provision for income taxes for 2010 reflects the reclassification of $6.8 million of accumulated other comprehensive income to provision for income taxes related to the expiration of the amortization period of the unrealized gain on certain of our interest rate swap agreements in September 2010, as further discussed under “¾Provision for Income Taxes” and in Note 13 to our consolidated financial statements.
Income from discontinued operations, net of tax, in 2010 reflects an aggregate gain on sale of discontinued operations of $19.6 million, including an $8.4 million gain recognized on the sale of our Chicago Region during the first quarter of 2010, a $5.0 million gain recognized on the sale of our Texas Region during the second quarter of 2010 and a $6.4 million gain recognized on the sale of a portion of our Northern Illinois Region during the third quarter of 2010, as further discussed under “¾Income (Loss) from Discontinued Operations, Net of Tax.” The loss from discontinued operations, net of tax, in 2009 reflects an aggregate loss on sale of discontinued operations of $13.0 million, including a loss on the sale of assets of WIUS of $13.1 million in the fourth quarter of 2009 partially offset by a small gain on the sale of ANB in the third quarter of 2009. See Note 2 to our consolidated financial statements for further discussion of discontinued operations.
The decrease in the net loss attributable to noncontrolling interest in subsidiaries in 2010, as compared to 2009, primarily reflects reduced losses associated with FB Holdings related to lower balances of nonaccrual loans and other real estate in addition to increased gains recognized on the sale of certain other real estate properties, as further discussed under “¾Net Loss Attributable to Noncontrolling Interest in Subsidiaries.”
Provision for Loan Losses. We recorded a provision for loan losses of $214.0 million for the year ended December 31, 2010, compared to $390.0 million for the year ended December 31, 2009. We recorded a provision for loan losses of $52.0 million for the three months ended December 31, 2010, compared to $63.0 million for the comparable period in 2009. The decrease in the provision for loan losses for the three months and year ended December 31, 2010, as compared to the same periods in 2009, was primarily driven by the significant decrease in loans, net of unearned discount, during 2010 as compared to 2009, lower net loan charge-offs, a decrease in the average level of nonaccrual loans and less severe asset migration to classified asset categories during 2010 than the migration levels experienced during 2009, as further discussed under “-Loans and Allowance for Loan Losses.”
Our nonaccrual loans were $398.9 million at December 31, 2010, compared to $471.8 million at September 30, 2010 and $691.1 million at December 31, 2009. The decrease in the overall level of nonaccrual loans during 2010 was primarily driven by gross loan charge-offs and transfers to other real estate exceeding net additions to nonaccrual loans, as further discussed under “-Loans and Allowance for Loan Losses.”
Our net loan charge-offs decreased to $279.1 million for the year ended December 31, 2010, compared to $339.0 million for the year ended December 31, 2009. Our net loans charge-offs were 5.06% of average loans in 2010, compared to 4.62% of average loans in 2009. Loan charge-offs were $331.2 million for 2010, compared to $352.7 million in 2009, and loan recoveries were $52.1 million for 2010, compared to $13.7 million in 2009.
Tables summarizing nonperforming assets, past due loans and charge-off and recovery experience are presented under “-Loans and Allowance for Loan Losses.”
Noninterest Income and Expense. The following table summarizes noninterest income and noninterest expense for the years ended December 31, 2010 and 2009:
Noninterest Income. Noninterest income was $78.5 million for the year ended December 31, 2010, in comparison to $70.7 million for 2009. Noninterest income consists primarily of service charges on deposit accounts and customer service fees, mortgage-banking revenues, net gains (losses) on investment securities and derivative instruments, changes in the fair value of servicing rights, loan servicing fees and other income.
Service charges on deposit accounts and customer service fees were $42.8 million and $43.3 million for the years ended December 31, 2010 and 2009, respectively, primarily reflecting reduced non-sufficient funds and returned check fee income on retail and commercial accounts coupled with changes in the deposit mix and certain product modifications designed to enhance overall product offerings to our customer base during the periods.
The gain on loans sold and held for sale increased $5.4 million, to $9.5 million for the year ended December 31, 2010, in comparison to $4.1 million for 2009. The increase in the gain on loans sold and held for sale in 2010, as compared to 2009, reflects an increase in the gain on the sale of mortgage loans to $9.5 million during 2010, as compared to $9.4 million during 2009. For the years ended December 31, 2010 and 2009, we originated residential mortgage loans held for sale and held for portfolio totaling $398.9 million and $541.0 million, respectively, and sold residential mortgage loans totaling $376.2 million and $522.6 million, respectively. The increase in 2010 also reflects losses on the sale of certain asset based lending loans and restaurant franchise loans of $6.1 million and $1.1 million, respectively, during the fourth quarter of 2009 and a decrease in the gain on sale of SBA loans of $1.8 million to $230,000 during 2010, compared to $2.1 million during 2009 due to lower origination volumes within this segment.
We recorded net gains on investment securities of $8.3 million and $7.7 million for the years ended December 31, 2010 and 2009, respectively. During 2010, in particular the fourth quarter of 2010, we sold investment securities to provide funding to payoff our remaining term secured borrowings, including our FHLB advances and our $120.0 million term repurchase agreement. These investment securities were sold at net gains. Throughout 2009, we sold available-for-sale investment securities that carried relatively high risk-weightings for regulatory capital purposes and repositioned a portion of our investment securities portfolio to lower risk-weighted investments. The net gains from these sales were partially offset by other-than-temporary impairment of $4,000 and $1.2 million recorded during the years ended December 31, 2010 and 2009, respectively. We recorded other-than-temporary impairment of $1.2 million during the fourth quarter of 2009 on equity investments in the common stock of two companies in the financial services industry, which management considered to have been primarily caused by economic events impacting the financial services industry as a whole. These equity investments were sold in the fourth quarter of 2010, resulting in a loss of $31,000.
BOLI investment income was $120,000 and $733,000 for the years ended December 31, 2010 and 2009, respectively. The decrease in BOLI investment income reflects a decline in the average balance of BOLI between the periods. In June 2009, we terminated our largest BOLI policy resulting in a reduction in the carrying value of our BOLI investment of $93.1 million. In January 2010, we terminated an additional BOLI policy which had a carrying value of $19.8 million, and in the third quarter of 2010, we liquidated our remaining BOLI policies which had an aggregate carrying value of $6.7 million.
We recorded net losses on derivative instruments of $2.9 million for the year ended December 31, 2010, primarily attributable to changes in fair value and the net interest differential on our interest rate swap agreements previously designated as cash flow hedges on our junior subordinated debentures, as further discussed under “-Interest Rate Risk Management” and in Note 5 to our consolidated financial statements. We recorded net losses of $4.9 million for the year ended December 31, 2009, primarily attributable to a cumulative fair value adjustment of $4.6 million on our interest rate swap agreements designated as cash flow hedges on our junior subordinated debentures that was reclassified from accumulated other comprehensive loss to loss on derivative instruments as a result of the discontinuation of hedge accounting treatment following the announcement of the deferral of interest payments on the underlying trust preferred securities in August 2009. In conjunction with the discontinuation of hedge accounting, the net interest differential on these interest rate swap agreements was recorded as a reduction of noninterest income effective August 2009. These losses were partially offset by income of $711,000 generated from the issuance of customer interest rate swap agreements in 2009.
We recorded net losses from changes in the fair value of mortgage and SBA servicing rights of $5.6 million and $2.9 million for the years ended December 31, 2010 and 2009, respectively. The changes in the fair value of mortgage and SBA servicing rights during the periods reflect changes in mortgage interest rates and the related changes in estimated prepayment speeds, as well as changes in cash flow assumptions underlying SBA loans in the serviced portfolio. The increase in net losses in 2010 is primarily attributable to the decline in mortgage interest rates to historically low levels during the third and fourth quarters of 2010.
Loan servicing fees were $8.8 million for the years ended December 31, 2010 and 2009, and are primarily attributable to fee income generated for the servicing of real estate mortgage loans owned by investors and originated by our mortgage banking division, as well as SBA loans to small business concerns. The level of fees is primarily impacted by the balance of loans serviced and interest shortfall on serviced residential mortgage loans. Interest shortfall represents the difference between the interest collected from a loan servicing customer upon prepayment of the loan and the full month of interest that is required to be remitted to the security owner.
Other income was $17.5 million and $13.8 million for the years ended December 31, 2010 and 2009, respectively. We primarily attribute the increase in other income to:
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The receipt of a litigation settlement of $2.6 million recognized in the second quarter of 2010;
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A gain of $168,000 recognized in the first quarter of 2010 on the sale of our Lawrenceville Branch, as further described in Note 2 to our consolidated financial statements; and
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Net gains on sales of other real estate of $3.5 million for the year ended December 31, 2010, compared to net losses on sales of other real estate of $17,000 for the comparable period in 2009; partially offset by
Ø
A gain of $309,000 recognized in the fourth quarter of 2009 on the sale of our Springfield Branch, as further described in Note 2 to our consolidated financial statements.
Noninterest Expense. Noninterest expense decreased $51.9 million, or 14.6%, to $304.4 million for the year ended December 31, 2010, in comparison to $356.2 million in 2009.
Salaries and employee benefits expense decreased $2.9 million, or 3.2%, to $86.4 million for the year ended December 31, 2010, in comparison to $89.3 million in 2009. The overall decrease in salaries and employee benefits expense in 2010, as compared to 2009, is primarily attributable to the completion of certain staff reductions in 2009 and 2010 intended to improve efficiency in conjunction with our restructuring to a smaller footprint, in addition to a decline in incentive compensation expense commensurate with our earnings performance. Our total full-time equivalent employees (FTEs), excluding discontinued operations, decreased to 1,393 at December 31, 2010, from 1,584 at December 31, 2009, representing a decrease of approximately 12.1%. The decrease in salaries and employee benefits expense is also reflective of a decline in other benefits expenses, including our 401(k) matching contribution, which was eliminated in April 2009, and compensation expense associated with the performance of the underlying investments in our nonqualified deferred compensation program, partially offset by an increase in severance expense as a result of certain profit improvement initiatives.
Occupancy, net of rental income, and furniture and equipment expense was $42.9 million for the year ended December 31, 2010, in comparison to $42.8 million in 2009. The expense levels reflect occupancy expense associated with depreciation expense and standard rental increases pursuant to existing lease obligations at several of our branch and operations facilities, coupled with furniture, fixtures and technology equipment expenditures associated with prior expansion and branch renovation activities and certain branch closures in conjunction with profit improvement initiatives.
Postage, printing and supplies expense decreased $881,000, or 20.6%, to $3.4 million for the year ended December 31, 2010, in comparison to $4.3 million in 2009, primarily resulting from decreases in office supplies expenses as a result of profit improvement initiatives.
Information technology fees decreased $3.2 million, or 10.3%, to $27.7 million for the year ended December 31, 2010, in comparison to $30.9 million in 2009. The decrease in information technology fees is primarily due to the implementation of certain profit improvement initiatives and negotiated fee reductions with First Services, L.P. As more fully described in Note 19 to our consolidated financial statements, First Services, L.P., a limited partnership indirectly owned by our Chairman and members of his immediate family, provides information technology and various operational support services to our subsidiaries and us. Information technology fees also include fees paid to outside servicers associated with our mortgage lending, trust and small business lending divisions.
Legal, examination and professional fees increased $1.9 million, or 16.2%, to $13.8 million for the year ended December 31, 2010, in comparison to $11.9 million in 2009. The increase in legal, examination and professional fees primarily reflects higher legal expenses associated with our divestiture activities, in addition to our collection and foreclosure efforts associated with the significant level of average nonperforming assets, ongoing litigation matters and expenses associated with our consent solicitation, as further discussed under “Item 1. Business -Recent Developments - Successful Completion of Consent Solicitation.” We anticipate legal, examination and professional fees to remain at higher than historical levels during 2011, primarily as a result of higher legal and professional fees associated with ongoing foreclosure efforts on problem loans, other collection efforts, ongoing litigation matters and ongoing matters associated with the completion of our Capital Plan, as further described under “Item 1. Business -Recent Developments - Capital Plan.”
We recorded a goodwill impairment charge of $75.0 million in the fourth quarter of 2009. As further described in Note 8 to our consolidated financial statements, the goodwill impairment charge was necessitated by a decline in the fair value of our single reporting unit, First Bank. The goodwill impairment charge was a direct result of continued deterioration in the real estate markets and economic conditions which decreased the fair value of First Bank. The primary factor contributing to the impairment recognition was further deterioration in the actual and projected financial performance of First Bank, as evidenced by the increases in the provision for loan losses, net loan charge-offs and nonperforming loans and the decline in the net interest margin and net interest income, as further described in Note 8 to our consolidated financial statements.
Amortization of intangible assets decreased $1.1 million, or 24.3%, to $3.3 million for the year ended December 31, 2010, in comparison to $4.4 million in 2009, reflecting a decrease in the amortization of core deposit intangibles associated with prior acquisitions.
Advertising and business development expense decreased $344,000, or 18.8%, to $1.5 million for the year ended December 31, 2010, in comparison to $1.8 million in 2009, reflecting the implementation of certain profit improvement initiatives and management’s efforts to reduce these expenditures.
FDIC insurance expense increased $2.2 million, or 10.9%, to $22.3 million for the year ended December 31, 2010, in comparison to $20.1 million in 2009. The increase in FDIC insurance expense was primarily attributable to the increase in premiums related to our increased risk assessment rating, partially offset by a special assessment of $4.8 million recorded in the second quarter of 2009 and paid on September 30, 2009 in conjunction with a special assessment of five basis points on each FDIC-insured depository institution’s assets minus its Tier 1 capital as of June 30, 2009. See “Item 1. Business -Supervision and Regulation - Federal Deposit Insurance Reform” for further discussion of FDIC insurance.
Write-downs and expenses on other real estate decreased $3.8 million, or 7.9%, to $44.7 million for the year ended December 31, 2010, in comparison to $48.5 million in 2009, and include write-downs related to the revaluation of certain properties of $34.7 million in 2010 pursuant to our valuation procedures as further described below, as compared to $37.4 million in 2009. During the first quarter of 2010, we recorded a write-down of $3.0 million related to a decrease in the fair value of a single property located in Northern California. During the second quarter of 2010, we recorded a write-down of $2.8 million related to a decrease in the fair value of a single property located in Southern California and a write-down of $1.4 million on a single property located in Florida. During the third quarter of 2010, we recorded a write-down of $9.0 million on a single property located in Southern California. During the fourth quarter of 2010, we recorded a write-down of $4.5 million related to a decrease in the fair value of a single property located in Northern California. During the fourth quarter of 2009, we obtained new appraisals on several other real estate properties whereby the prior appraisal had been completed within the last 12 to 18 months and recorded write-downs to the extent the current market value less applicable selling costs was less than the carrying value. Other real estate expenses, exclusive of write-downs, such as taxes and repairs and maintenance, were $10.0 million in 2010 as compared to $11.1 million in 2009. The overall higher than historical level of expenses on other real estate is primarily due to expenses associated with increased foreclosure activity, including current and delinquent real estate taxes paid on other real estate properties, as well as other property preservation related expenses. The balance of our other real estate properties increased to $140.6 million at December 31, 2010, from $125.2 million at December 31, 2009, primarily driven by foreclosures of real estate construction and development, commercial real estate and one-to-four family residential real estate loans, partially offset by the sale of other real estate properties and write-downs of other real estate. We expect the level of write-downs and expenses on our other real estate properties to remain at elevated levels in the near term as a result of the high level of our other real estate balances and the expected future transfer of certain of our nonaccrual loans into our other real estate portfolio.
Other expense increased $31.1 million to $58.3 million for the year ended December 31, 2010, in comparison to $27.2 million in 2009. Other expense encompasses numerous general and administrative expenses including communications, insurance, freight and courier services, correspondent bank charges, loan expenses, miscellaneous losses and recoveries, memberships and subscriptions, transfer agent fees, sales taxes, travel, meals and entertainment, overdraft losses and other nonrecurring expenses. The increase in other expense reflects the following:
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An operating loss of $13.6 million during the third quarter of 2010 resulting from suspected fraud involving a customer relationship;
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Prepayment penalties of $5.1 million associated with the prepayment of FHLB advances during the third and fourth quarters of 2010;
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A fee of $5.5 million paid during the fourth quarter of 2010 associated with the early termination of our $120.0 million term repurchase agreement;
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Payments and accruals related to litigation matters of $5.5 million in 2010 as compared to zero in 2009; and
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The establishment of a specific reserve on an unfunded letter of credit of $2.4 million in the fourth quarter of 2010; partially offset by
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A decrease in loan expenses associated with collection efforts related to asset quality matters to $5.2 million in 2010 as compared to $5.4 million in 2009;
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A decrease in overdraft losses, net of recoveries, to $1.6 million in 2010 as compared to $1.9 million in 2009; and
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Profit improvement initiatives and management’s efforts to reduce overall expense levels.
Provision for Income Taxes. The provision for income taxes was $4.1 million for the year ended December 31, 2010, compared to $2.4 million for the year ended December 31, 2009. The provision for income taxes during 2010 and 2009 reflects the establishment of a full deferred tax asset valuation allowance during 2008 and the resulting inability to record tax benefits on our net loss due to existing federal and state net operating loss carryforwards on which the realization of the related tax benefits is not “more likely than not,” as further described in Note 13 to our consolidated financial statements. The deferred tax asset valuation allowance was primarily established as a result of our three-year cumulative operating loss for the years ended December 31, 2008, 2007 and 2006, after considering all available objective evidence and potential tax planning strategies related to the amount of the deferred tax assets that are “more likely than not” to be realized.
The provision for income taxes for 2010 also reflects a provision for income taxes of $6.8 million related to the establishment of a deferred tax asset valuation allowance regarding the unrealized gain on certain interest rate swap agreements that were designated as cash flow hedges on certain of our loans. These interest rate swap agreements were terminated in December 2008, and as a result, the unrealized gain at the date of termination of $20.8 million was being amortized as an increase to interest and fees on loans in the consolidated statements of operations over the remaining terms of the respective interest rate swap agreements, which had contractual maturity dates through September 2010. During the third quarter of 2010, we recorded a provision for income taxes of $6.8 million related to the expiration of the amortization period of the unrealized gain on the interest rate swap agreements with a corresponding increase to accumulated other comprehensive income. The provision for income taxes also reflects a $2.1 million benefit related to the expiration of the statute of limitations, and the related reversal of certain reserves on a number of uncertain tax positions, and expense of $240,000 related to the termination of our remaining BOLI policies.
The level of our provision for income taxes and the deferred tax asset valuation allowance are more fully described in Note 13 to our consolidated financial statements.
Income (Loss) from Discontinued Operations, Net of Tax. We recorded income from discontinued operations, net of tax, of $12.2 million for the year ended December 31, 2010, compared to a loss from discontinued operations, net of tax, of $52.0 million in 2009. The net income (loss) from discontinued operations, net of tax, for 2010 and 2009 is primarily reflective of the following:
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Net income from discontinued operations attributable to our Chicago Region of $5.3 million for 2010, including a gain of $8.4 million recorded during the first quarter of 2010 associated with the sale of our Chicago Region on February 19, 2010 after the write-off of goodwill and intangible assets allocated to the Chicago Region of $26.3 million, compared to a net loss from discontinued operations attributable to our Chicago Region of $27.4 million in 2009;
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Net income from discontinued operations attributable to our Texas Region of $569,000 for 2010, including a gain of $5.0 million recorded during the second quarter of 2010 associated with the sale of our Texas Region on April 30, 2010 after the write-off of goodwill and intangible assets allocated to the Texas Region of $20.0 million, compared to a net loss from discontinued operations attributable to our Texas Region of $17.3 million in 2009;
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Net income from discontinued operations attributable to our Northern Illinois Region of $6.7 million for 2010, including a gain of $6.4 million recorded during the third quarter of 2010 associated with the sale of a portion of our Northern Illinois Region in September 2010 after the write-off of goodwill and intangible assets allocated to the portion of the Northern Illinois Region sold of $9.7 million, compared to a net loss from discontinued operations attributable to our Northern Illinois Region of $2.0 million in 2009;
Ø
A loss of $156,000 during the second quarter of 2010 associated with the sale of MVP on April 15, 2010; and
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A loss of $13.1 million during the fourth quarter of 2009 associated with the sale of assets of WIUS on December 31, 2009.
See Note 2 to our consolidated financial statements for further discussion of discontinued operations.
Net Loss Attributable to Noncontrolling Interest in Subsidiaries. We recorded a net loss attributable to noncontrolling interest in subsidiaries of $6.5 million for the year ended December 31, 2010, compared to a net loss of $21.3 million in 2009, associated with the noncontrolling interest in the net losses in FB Holdings and SBLS LLC. The noncontrolling interest in the net losses in FB Holdings was $6.5 million for the year ended December 31, 2010, compared to $20.9 million for the comparable period in 2009. The decrease is reflective of lower balances of nonaccrual loans and other real estate in FB Holdings during 2010 as compared to 2009. The noncontrolling interest in the net losses in SBLS LLC was $448,000 for the year ended December 31, 2009. Noncontrolling interest in our subsidiaries is more fully described in Note 19 to our consolidated financial statements.
Comparison of Results of Operations for 2009 and 2008
Net Income. We recorded a net loss, including discontinued operations, of $427.6 million for the year ended December 31, 2009, compared to net loss of $287.2 million for 2008. Our results of operations reflect the following:
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An increase in the provision for loan losses to $390.0 million for the year ended December 31, 2009, compared to $368.0 million in 2008;
Ø
A decline in net interest income to $281.0 million for the year ended December 31, 2009, compared to $352.2 million in 2008, which contributed to a decline in our net interest margin to 3.12% for the year ended December 31, 2009, compared to 3.88% in 2008;
Ø
An increase in our noninterest income to $70.7 million for the year ended December 31, 2009, compared to $62.3 million in 2008;
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An increase in our noninterest expense to $356.2 million for the year ended December 31, 2009, compared to $258.3 million in 2008;
Ø
A provision for income taxes of $2.4 million for the year ended December 31, 2009, compared to $18.3 million in 2008;
Ø
A loss from discontinued operations, net of tax, of $52.0 million for the year ended December 31, 2009, compared to a loss of $58.2 million in 2008; and
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Net losses attributable to noncontrolling interest in subsidiaries of $21.3 million for the year ended December 31, 2009, compared to $1.2 million in 2008.
The increase in the provision for loan losses was primarily driven by increased net loan charge-offs and declining asset quality trends throughout certain segments of our loan portfolio resulting from continued weak economic conditions and significant declines in real estate values, as further discussed under “-Provision for Loan Losses” and “-Loans and Allowance for Loan Losses.”
The decline in our net interest income and our net interest margin was primarily attributable to a significant increase in nonaccrual loans during 2009 and a 400 basis point decrease, in aggregate, in the prime lending rate in 2008 coupled with a significant decline in LIBOR rates during 2008 and 2009, and a higher average balance of lower-yielding short-term investments, partially offset by a decrease in deposit and other interest-bearing liability costs, as further discussed under “-Net Interest Income.”
The increase in our noninterest income in 2009, as compared to 2008, was primarily attributable to an increase in net gains on investment securities, higher gains on the sale of mortgage loans, lower declines in the fair value of servicing rights and higher service charges on deposit accounts and customer service fees, partially offset by losses incurred on the sale of certain asset based lending and restaurant franchise loans in the fourth quarter of 2009, decreased BOLI investment income, increased net losses on derivative financial instruments and a gain on the extinguishment of a term repurchase agreement in 2008, as further discussed under “-Noninterest Income.”
The increase in our noninterest expense in 2009, as compared to 2008, was primarily attributable to a goodwill impairment charge of $75.0 million, an increase in FDIC insurance premium assessments and an increase in write-downs and expenses on other real estate properties, partially offset by reductions in salaries and employee benefits expense, occupancy and furniture and equipment expenses, information technology fees, advertising and business development and other expenses, as further discussed under “¾Noninterest Expense.”
The provision for income taxes in 2009 primarily reflects the consolidated net operating loss due to existing federal and state net operating loss carryforwards on which the realization of the related tax benefits is not “more likely than not,” as further discussed under “¾Provision for Income Taxes” and in Note 13 to our consolidated financial statements. The provision for income taxes in 2008 reflects the recognition of a net deferred tax asset valuation allowance of approximately $136.8 million against our deferred tax assets during 2008, which had the effect of increasing our provision for income taxes by $123.2 million during 2008.
The decrease in net losses from discontinued operations, net of tax, primarily reflects declines in the net loss attributable to our Chicago and Texas Regions, partially offset by a loss of $13.1 million on the sale of assets of WIUS in December 2009. See note 2 to our consolidated financial statements for further discussion of discontinued operations.
The increase in the net loss attributable to noncontrolling interest in subsidiaries reflects increased write-downs and expenses on other real estate properties in FB Holdings related to higher balances of nonaccrual loans and other real estate during 2009 as compared to 2008.
Provision for Loan Losses. We recorded a provision for loan losses of $390.0 million for the year ended December 31, 2009, compared to $368.0 million for the year ended December 31, 2008. The increase in the provision for loan losses was primarily driven by increased net loan charge-offs and declining asset quality trends throughout certain segments of our loan portfolio resulting from continued weak economic conditions and significant declines in real estate values during the periods, as further discussed under “-Loans and Allowance for Loan Losses.”
Our nonaccrual loans were $691.1 million at December 31, 2009, compared to $417.8 million at December 31, 2008. The increase in the overall level of nonaccrual loans during 2009 was primarily driven by increases in nonaccrual loans in our real estate construction and development, one-to-four family residential mortgage and commercial real estate loan portfolios, as further discussed under “-Loans and Allowance for Loan Losses.”
Our net loan charge-offs increased to $339.0 million for the year ended December 31, 2009, compared to $316.2 million for the year ended December 31, 2008. Our net loan charge-offs for 2009 were 4.62% of average loans, compared to 3.84% in 2008. Loan charge-offs were $352.7 million for 2009, compared to $331.0 million in 2008, and loan recoveries were $13.7 million for 2009, compared to $14.8 million in 2008.
Tables summarizing nonperforming assets, past due loans and charge-off and recovery experience are presented under “-Loans and Allowance for Loan Losses.”
Noninterest Income and Expense. The following table summarizes noninterest income and noninterest expense for the years ended December 31, 2009 and 2008:
Noninterest Income. Noninterest income was $70.7 million for the year ended December 31, 2009, in comparison to $62.3 million for 2008. Noninterest income consists primarily of service charges on deposit accounts and customer service fees, mortgage-banking revenues, net gains (losses) on investment securities and derivative instruments, changes in the fair value of servicing rights, loan servicing fees and other income.
Service charges on deposit accounts and customer service fees increased $1.5 million, or 3.5%, to $43.3 million from $41.8 million for the years ended December 31, 2009 and 2008, respectively. The increase in service charges and customer service fees is primarily attributable to an increase of $1.4 million, or 16.9%, in commercial service charges to $9.4 million in 2009 compared to $8.1 million in 2008, primarily resulting from our efforts to control fee waivers and a decrease in the earnings credit rate due to the decline in short-term interest rates throughout 2008 and 2009.
We recorded gains on loans sold and held for sale of $4.1 million and $4.4 million for the years ended December 31, 2009 and 2008, respectively. The decrease in gains on loans sold and held for sale in 2009 as compared to 2008 reflects the following:
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Net losses on the sale of certain asset based lending loans and restaurant franchise loans of $6.1 million and $1.1 million, respectively, during the fourth quarter of 2009, as further discussed under “-Loans and Allowance for Loan Losses;” and
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A decrease in the gain on sale of SBA loans of $227,000 to $2.1 million during 2009 as compared to $2.3 million during 2008, primarily due to lower sales volumes; partially offset by
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An increase in the gain on the sale of mortgage loans of $7.6 million to $9.4 million during 2009 as compared to $1.8 million during 2008, due primarily to an increase in the volume of mortgage loans originated and subsequently sold in the secondary market resulting from increased levels of refinancing of one-to-four family residential real estate loans in light of declining mortgage interest rates experienced during 2009. For the years ended December 31, 2009 and 2008, we originated residential mortgage loans held for sale and held for portfolio totaling $541.0 million and $221.8 million, respectively, and sold residential mortgage loans totaling $522.6 million and $210.6 million, respectively.
We recorded net gains on investment securities of $7.7 million for the year ended December 31, 2009, compared to net losses on investment securities of $8.8 million for the year ended December 31, 2008. During 2009, we sold $521.8 million of available-for-sale investment securities that carried relatively high risk-weightings for regulatory capital purposes and repositioned a portion of our investment securities portfolio to lower risk-weighted investments. The net gains from these sales were partially offset by other-than-temporary impairment of $1.2 million recorded during the fourth quarter of 2009 on equity investments in the common stock of two companies in the financial services industry, as previously discussed. The net loss for 2008 was primarily attributable to the recognition of other-than-temporary impairment of $10.4 million on these same two equity investments, which were carried at fair value at December 31, 2009 and 2008. We also recognized other-than-temporary impairment of $1.0 million on the full amount of a preferred stock investment during 2008, necessitated by bankruptcy proceedings of the underlying financial services company. The aggregate other-than-temporary impairment in 2008 of $11.4 million was partially offset by a gain of approximately $867,000 recognized on the sale of $81.5 million of available-for-sale investment securities in March 2008 and a gain of approximately $1.0 million recognized on the sale of $64.7 million of available-for-sale investment securities in December 2008.
BOLI investment income was $733,000 and $2.8 million for the years ended December 31, 2009 and 2008, respectively. The decrease reflects the performance of the underlying investments associated with the insurance contracts, which is directly correlated to the portfolio mix of investments, the crediting rate associated with the embedded stable value protection program and overall market conditions. Furthermore, in June 2009, we terminated our largest BOLI policy resulting in a reduction in the carrying value of our BOLI investment of approximately $93.1 million, as previously discussed.
We recorded net losses on derivative instruments of $4.9 million for the year ended December 31, 2009, compared to net gains on derivative instruments of $1.7 million in 2008. The net losses in 2009 were primarily attributable to a cumulative fair value adjustment of $4.6 million on our interest rate swap agreements designated as cash flow hedges on our junior subordinated debentures that was reclassified from accumulated other comprehensive loss to loss on derivative instruments as a result of the discontinuation of hedge accounting treatment following the announcement of the deferral of interest payments on the underlying trust preferred securities in August 2009. In conjunction with the discontinuation of hedge accounting, the net interest differential on these interest rate swap agreements was recorded as a reduction of noninterest income effective August 2009. The net loss on derivative instruments in 2009 was partially offset by income generated from the issuance of customer interest rate swap agreements of $711,000. The net gains in 2008 were primarily attributable to the net increase in the fair value of our interest rate floor agreements as a result of the decline in forward rates resulting from the Federal Reserve interest rate cuts. In May 2008, we terminated our $300.0 million interest rate floor agreements to modify our overall hedge position in accordance with our interest rate risk management program. We did not incur any gains or losses in conjunction with the termination of our interest rate floor agreements.
We recorded net losses from changes in the fair value of mortgage and SBA servicing rights of $2.9 million and $11.8 million for the years ended December 31, 2009 and 2008, respectively. The changes in the fair value of mortgage and SBA servicing rights during the periods reflect changes in mortgage interest rates and the related changes in estimated prepayment speeds. The change also reflects changes in cash flow assumptions on the underlying SBA loans in the serviced portfolio.
Loan servicing fees were $8.8 million for the years ended December 31, 2009 and 2008, and are primarily attributable to fee income generated for the servicing of real estate mortgage loans owned by investors and originated by our mortgage banking division, as well as SBA loans to small business concerns. The level of fees is primarily impacted by the balance of loans serviced and interest shortfall on serviced residential mortgage loans. The $66,000 increase in loan servicing fees in 2009 was primarily due to a higher average balance of mortgage loans serviced for others, partially offset by a higher level of interest shortfall as a result of the refinance environment.
In March 2008, we restructured our $100.0 million term repurchase agreement, which included the following primary modifications: (a) increased the borrowing amount to $120.0 million; (b) extended the maturity date from October 12, 2010 to April 12, 2012; (c) converted the interest rate from a variable rate to a fixed rate of 3.36%; and (d) terminated the embedded interest rate floor agreements contained within the term repurchase agreement. These modifications resulted in the recognition of a gain of $5.0 million on the extinguishment of our term repurchase agreement in the first quarter of 2008, as further discussed in Note 10 to our consolidated financial statements.
Other income was $13.8 million and $18.4 million for the years ended December 31, 2009 and 2008, respectively. We primarily attribute the decline in other income to:
Ø
A decrease in recoveries of certain loan principal balances that had been previously charged off by the financial institutions prior to their acquisition by First Bank of $1.6 million to $173,000 for 2009, compared to $1.7 million in 2008;
Ø
Income of $1.8 million recognized on the sale of various state tax credits in the second quarter of 2008; and
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A gain recognized in the first quarter of 2008 on the Visa, Inc., or Visa, initial public offering, or IPO, of $743,000, representing the cash payment received in exchange for a portion of our membership interest in Visa as a result of Visa’s IPO; partially offset by
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A gain of $309,000 recognized in the fourth quarter of 2009 on the sale of our Springfield Branch, as further described in Note 2 to our consolidated financial statements.
Noninterest Expense. Noninterest expense was $356.2 million for the year ended December 31, 2009, in comparison to $258.3 million for 2008. The increase in noninterest expense was primarily attributable to a goodwill impairment charge of $75.0 million and an increase in write-downs and expenses on other real estate and FDIC insurance expenses, partially offset by certain profit improvement initiatives that we implemented throughout 2008 and 2009.
Salaries and employee benefits expense decreased $15.7 million, or 15.0%, to $89.3 million for the year ended December 31, 2009, in comparison to $105.0 million in 2008. The overall decrease in salaries and employee benefits expense is primarily attributable to the completion of certain staff reductions in 2008 and 2009. Our total FTEs, excluding discontinued operations, decreased to 1,584 at December 31, 2009, from 1,681 at December 31, 2008, representing a decrease of approximately 5.8%. The decrease in salaries and employee benefits expense is also reflective of reduced incentive compensation expense commensurate with our earnings performance and a decline in other benefits expenses, including medical and prescription expenses and our 401(k) matching contribution, which we eliminated in April 2009. The decrease was partially offset by increased employee benefit expense associated with our nonqualified deferred compensation program resulting from market value increases in the employee investment accounts underlying this program.
Occupancy, net of rental income, and furniture and equipment expense decreased $2.5 million, or 5.6%, to $42.8 million for the year ended December 31, 2009, in comparison to $45.3 million in 2008. The decrease in 2009 reflects reduced furniture, fixtures and technology equipment expenditures associated with prior expansion and branch renovation activities and certain branch closures in conjunction with profit improvement initiatives.
Postage, printing and supplies expense decreased $1.0 million, or 19.4%, to $4.3 million for the year ended December 31, 2009, in comparison to $5.3 million in 2008, reflecting a decrease in office supplies and check printing expenses as a result of profit improvement initiatives.
Information technology fees decreased $4.5 million, or 12.8%, to $30.9 million for the year ended December 31, 2009, in comparison to $35.4 million in 2008. The decrease in information technology fees is primarily due to the implementation of certain profit improvement initiatives and negotiated fee reductions with First Services, L.P.
Legal, examination and professional fees increased $695,000, or 6.2%, to $11.9 million for the year ended December 31, 2009, in comparison to $11.2 million in 2008. The increase in legal, examination and professional fees primarily reflects higher legal expenses associated with our divestiture activities and related to collection and foreclosure efforts associated with the significant increase in nonperforming assets, partially offset by expenses incurred in 2008 related to internal investigations, including the investigation commissioned by our Audit Committee regarding certain matters associated with the mortgage banking division and the resulting restatement of our consolidated financial statements, and ongoing litigation matters, including those assumed through the acquisition of a Florida bank in late 2007.
We recorded a goodwill impairment charge of $75.0 million in the fourth quarter of 2009, as previously discussed, and as further described in Note 8 to our consolidated financial statements.
Amortization of intangible assets decreased $1.4 million, or 23.6%, to $4.4 million for the year ended December 31, 2009, in comparison to $5.7 million in 2008, attributable to the completion of the amortization period of certain core deposit and other intangible assets, as well as the reduction of our intangible asset levels associated with our discontinued operations.
Advertising and business development expense decreased $2.8 million, or 60.8%, to $1.8 million for the year ended December 31, 2009, in comparison to $4.7 million in 2008. The decrease in 2009 reflects certain profit improvement initiatives and management’s efforts to reduce these expenditures in light of the recent economic environment.
FDIC insurance expense increased $14.6 million to $20.1 million for the year ended December 31, 2009, in comparison to $5.5 million in 2008. We had built up several million dollars of credits through previous acquisitions that were utilized to offset FDIC insurance premiums and were depleted in 2008. Furthermore, our premium rates increased significantly during 2009 based on our risk assessment rating in addition to developments within the banking industry, including the failure of other financial institutions. We also recorded additional FDIC insurance expense of $4.8 million in the second quarter of 2009 related to a special assessment paid on September 30, 2009 of five basis points on each FDIC-insured depository institution’s assets minus its Tier 1 capital as of June 30, 2009.
Write-downs and expenses on other real estate increased $40.2 million to $48.5 million for the year ended December 31, 2009, in comparison to $8.2 million in 2008. The increase in other real estate expenses is primarily attributable to an increase in write-downs of $34.6 million related to the revaluation of certain properties, as previously discussed, which increased to $37.4 million in 2009 as compared to $2.8 million in 2008. The increase is also attributable to an increase in expenses associated with increased foreclosure activity, including current and delinquent real estate taxes paid on other real estate properties as well as other property preservation related expenses. The balance of our other real estate properties increased to $125.2 million at December 31, 2009, from $91.5 million at December 31, 2008, primarily driven by foreclosures of real estate construction and development loans throughout 2009.
Other expense decreased $4.6 million, or 14.5%, to $27.2 million for the year ended December 31, 2009, in comparison to $31.9 million in 2008. Other expense encompasses numerous general and administrative expenses including communications, insurance, freight and courier services, correspondent bank charges, loan expenses, miscellaneous losses and recoveries, memberships and subscriptions, transfer agent fees, sales taxes and travel, meals and entertainment, and overdraft losses. The decrease in other expense was primarily attributable to:
Ø
Profit improvement initiatives and management’s efforts to reduce overall expense levels;
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A decrease in overdraft losses, net of recoveries, of $66,000 to $1.9 million for the year ended December 31, 2009, from $2.0 million in 2008; and
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A litigation settlement of $750,000 during the third quarter of 2008 pertaining to a matter initially brought against a former bank holding company prior to our acquisition in late 2007; partially offset by
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An increase in loan expenses of $140,000 to $5.4 million for the year ended December 31, 2009, from $5.3 million in 2008, attributable to collection efforts related to asset quality matters.
Provision for Income Taxes. The provision for income taxes was $2.4 million for the year ended December 31, 2009, compared to $18.3 million for the year ended December 31, 2008. The provision for income taxes during 2009 reflects the establishment of a full deferred tax asset valuation allowance during 2008 and the resulting inability to record tax benefits on our net loss due to existing federal and state net operating loss carryforwards on which the realization of the related tax benefits is not “more likely than not,” as previously discussed. The provision for income taxes during 2008 reflects the recognition of a deferred tax asset valuation allowance of $158.9 million against our deferred tax assets during the fourth quarter of 2008, which had the effect of increasing our provision for income taxes by $144.8 million during the fourth quarter of 2008, as previously discussed.
Loss from Discontinued Operations, Net of Tax. We recorded a net loss from discontinued operations, net of tax, of $52.0 million for the year ended December 31, 2009, compared to a net loss of $58.2 million in 2008. The decrease in the net loss from discontinued operations in 2009 primarily reflects declines in the net loss attributable to our Chicago Region and our Texas Region of $16.1 million and $5.8 million, respectively, partially offset by a loss of $13.1 million on the sale of assets of WIUS in December 2009. See Note 2 to our consolidated financial statements for further discussion of discontinued operations.
Net Loss Attributable to Noncontrolling Interest in Subsidiaries. We recorded a net loss attributable to noncontrolling interest in subsidiaries of $21.3 million and $1.2 million for the years ended December 31, 2009 and 2008, respectively, associated with the noncontrolling interest in the net losses in FB Holdings and SBLS LLC. The increase in the net loss attributable to noncontrolling interest in subsidiaries during 2009 was primarily attributable to increased write-downs and expenses on other real estate properties in FB Holdings related to higher balances of nonaccrual loans and other real estate during 2009 as compared to 2008. Noncontrolling interest in our subsidiaries is more fully described in Note 1 and Note 19 to our consolidated financial statements.
Interest Rate Risk Management
The maintenance of a satisfactory level of net interest income is a primary factor in our ability to achieve acceptable income levels. However, the maturity and repricing characteristics of our loan and investment portfolios may differ significantly from those within our deposit structure. The nature of the loan and deposit markets within which we operate, and our objectives for business development within those markets at any point in time, influence these characteristics. In addition, the ability of borrowers to repay loans and the possibility of depositors withdrawing funds prior to stated maturity dates introduces divergent option characteristics that fluctuate as interest rates change. These factors cause various elements of our balance sheet to react in different manners and at different times relative to changes in interest rates, potentially leading to increases or decreases in net interest income over time. Depending upon the direction and magnitude of interest rate movements and their effect on the specific components of our balance sheet, the effects on net interest income can be substantial. Consequently, it is critical that we establish effective control over our exposure to changes in interest rates. We strive to manage our interest rate risk by:
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Maintaining an Asset Liability Committee, or ALCO, responsible to our Board of Directors and Executive Management, to review the overall interest rate risk management activity and approve actions taken to reduce risk;
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Employing a financial simulation model to determine our exposure to changes in interest rates;
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Coordinating the lending, investing and deposit-generating functions to control the assumption of interest rate risk; and
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Utilizing various financial instruments, including derivatives, to offset inherent interest rate risk should it become excessive.
The objective of these procedures is to limit the adverse impact that changes in interest rates may have on our net interest income.
The ALCO has overall responsibility for the effective management of interest rate risk and the approval of policy guidelines. The ALCO includes our President and Chief Executive Officer, Chief Financial Officer, Chief Investment Officer, Executive Vice President of Retail Banking, Director of Risk Management and Audit, and certain other senior officers. The Asset Liability Management Group, which monitors interest rate risk, supports the ALCO, prepares analyses for review by the ALCO and implements actions that are either specifically directed by the ALCO or established by policy guidelines.
In managing sensitivity, we strive to reduce the adverse impact on earnings by managing interest rate risk within internal policy constraints. Our policy is to manage exposure to potential risks associated with changing interest rates by maintaining a balance sheet posture in which annual net interest income is not significantly impacted by reasonably possible near-term changes in interest rates. To measure the effect of interest rate changes, we project our net income over a two-year horizon on a pro forma basis. The analysis assumes various scenarios for increases and decreases in interest rates including both instantaneous and gradual, and parallel and non-parallel shifts in the yield curve, in varying amounts. For purposes of arriving at reasonably possible near-term changes in interest rates, we include scenarios based on actual changes in interest rates, which have occurred over a two-year period, simulating both a declining and rising interest rate scenario.
We are “asset-sensitive,” indicating that our assets would generally reprice with changes in interest rates more rapidly than our liabilities, and our simulation model indicates a loss of projected net interest income should interest rates decline. While a decline in interest rates of less than 50 basis points was projected to have a relatively minimal impact on our net interest income, an instantaneous parallel decline in the interest yield curve of 50 basis points indicates a pre-tax projected loss of approximately 4.8% of net interest income, based on assets and liabilities at December 31, 2010. At December 31, 2010, we remain in an asset-sensitive position and thus, remain subject to a higher level of risk in a declining interest rate environment. Although we do not anticipate that instantaneous shifts in the yield curve as projected in our simulation model are likely, these are indications of the effects that changes in interest rates would have over time. Our asset-sensitive position, coupled with the effect of significant declines in interest rates that began in late 2007 and continued throughout 2008 and 2009 to historically low levels, and the overall level of our nonperforming assets, has negatively impacted our net interest income and is expected to continue to impact the level of our net interest income throughout the near future.
We also prepare and review a more traditional interest rate sensitivity position in conjunction with the results of our simulation model. The following table presents the projected maturities and periods to repricing of our rate sensitive assets and liabilities as of December 31, 2010, adjusted to account for anticipated prepayments:
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(1) Loans are presented net of unearned discount.
Management made certain assumptions in preparing the foregoing table. These assumptions included:
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Loans will repay at projected repayment rates;
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Mortgage-backed securities, included in investment securities, will repay at projected repayment rates;
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Interest-bearing demand accounts and savings deposits will behave in a projected manner with regard to their interest rate sensitivity; and
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Fixed maturity deposits will not be withdrawn prior to maturity.
A significant variance in actual results from one or more of these assumptions could materially affect the results reflected in the foregoing table.
We were in an overall asset-sensitive position of $1.26 billion, or 17.1% of our total assets, and $2.67 billion, or 25.3% of our total assets, at December 31, 2010 and 2009, respectively. We were in an overall liability-sensitive position on a cumulative basis through the twelve-month time horizon of $21.0 million, or 0.3% of our total assets at December 31, 2010, compared to an overall asset-sensitive position of $2.61 billion, or 24.7% of our total assets, at December 31, 2009.
The interest-sensitivity position is one of several measurements of the impact of interest rate changes on net interest income. Its usefulness in assessing the effect of potential changes in net interest income varies with the constant change in the composition of our assets and liabilities and changes in interest rates. For this reason, we place greater emphasis on our simulation model for monitoring our interest rate risk exposure.
As previously discussed, we utilize derivative financial instruments to assist in our management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities. We also sell interest rate swap agreement contracts to certain customers who wish to modify their interest rate sensitivity. We offset the interest rate risk of these swap agreements by simultaneously purchasing matching interest rate swap agreement contracts with offsetting pay/receive rates from other financial institutions. Because of the matching terms of the offsetting contracts, the net effect of the changes in the fair value of the paired swaps is minimal.
The derivative financial instruments that we held as of December 31, 2010 and 2009 are summarized as follows:
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(1)
In August 2009, we discontinued hedge accounting following the announcement of the deferral of interest payments on the underlying trust preferred securities associated with our junior subordinated debentures.
(2)
On December 8, 2010, we terminated our $50.0 million notional amount interest rate swap agreement, scheduled to mature on December 15, 2011.
The notional amounts of our derivative financial instruments do not represent amounts exchanged by the parties and, therefore, are not a measure of our credit exposure through our use of these instruments. The credit exposure represents the loss we would incur in the event the counterparties failed completely to perform according to the terms of the derivative financial instruments and the collateral held to support the credit exposure was of no value.
The earnings associated with our derivative financial instruments reflect the interest rate environment during these periods as well as the overall level of our derivative instruments throughout these periods. For the years ended December 31, 2010, 2009 and 2008, we realized net interest income of $5.7 million, $12.5 million and $11.5 million, respectively, on our derivative financial instruments. In December 2008, we terminated certain of our interest rate swap agreements that were designated as cash flow hedges on certain of our loans, and recorded a gain of $20.8 million, in aggregate, which was being amortized as an increase to interest and fees on loans in the consolidated statements of operations over the remaining terms of the respective interest rate swap agreements, which had contractual maturity dates of September 2009 and September 2010. Consequently, the conclusion of the amortization period associated with the aggregate gain in September 2010 resulted in a negative impact to our fourth quarter 2010 and future net interest income and net interest margin. Net interest income on our derivative financial instruments included $5.7 million, $13.7 million and $1.3 million of such amortized gain for the years ended December 31, 2010, 2009 and 2008, respectively.
We recorded net losses on derivative instruments, which are included in noninterest income in the consolidated statements of operations, of $2.9 million and $4.9 million for the years ended December 31, 2010 and 2009, respectively, in comparison to net gains on derivative instruments of $1.7 million for the year ended December 31, 2008. The net loss on derivative instruments in 2010 is solely attributable to changes in the fair value and the net interest differential on our interest rate swap agreements previously designated as cash flow hedges on our junior subordinated debentures. The net loss on derivative instruments in 2009 is primarily attributable to a cumulative fair value adjustment of $4.6 million on our interest rate swap agreements designated as cash flow hedges on our junior subordinated debentures that was reclassified from accumulated other comprehensive loss to net loss on derivative instruments as a result of the discontinuation of hedge accounting treatment following the announcement of the deferral of interest payments on the underlying trust preferred securities in August 2009. In conjunction with the discontinuation of hedge accounting, the net interest differential on these interest rate swap agreements, which was recorded as interest expense on junior subordinated debentures in the consolidated statements of operations, was recorded as a net reduction of noninterest income effective August 2009. The net loss on derivative instruments in 2009 was partially offset by income generated from the issuance of our customer interest rate swap agreements of $711,000. The net gain on derivative instruments in 2008 primarily reflects changes in the value of our $300.0 million notional interest rate floor agreements, which we terminated in May 2008 to modify our overall hedge position in accordance with our interest rate risk management program.
Our derivative financial instruments are more fully described in Note 5 to our consolidated financial statements.
Investment Securities
We classify the securities within our investment portfolio as available for sale or held to maturity. Our investment securities portfolio consists primarily of securities designated as available for sale. Our investment securities increased to $1.49 billion at December 31, 2010, from $541.6 million and $575.1 million at December 31, 2009 and 2008, respectively.
The increase in our investment securities portfolio in 2010 was primarily attributable to the utilization of a portion of our cash and cash equivalents to fund gradual and planned increases in our investment securities portfolio in an effort to maintain appropriate liquidity levels while maximizing our net interest income and net interest margin. Funds available from cash and cash equivalents, in addition to the reinvestment of funds available from maturities and/or calls of investment securities of $192.3 million and sales of investment securities of $249.2 million, were utilized to purchase investment securities of $1.42 billion during 2010.
The decrease in our investment securities portfolio in 2009 was primarily attributable to maturities and/or calls of investment securities of $671.5 million and sales of investment securities of $521.8 million, partially offset by the purchase of investment securities of $1.13 billion. Consistent with our Capital and Profit Improvement Plans, we sold certain higher-yielding available-for-sale investment securities throughout 2009 to reposition certain of our investment securities that carried relatively high risk-weightings for regulatory capital purposes to lower risk-weighted investments. We reinvested funds available from the maturities and sales of investment securities in other available-for-sale investment securities and the remaining funds were primarily utilized to increase our short-term investments in anticipation of expected significant cash outflows, primarily associated with the sale of our Chicago Region and our Texas Region.
Additional information regarding our investment securities portfolio is more fully described in Note 3 to our consolidated financial statements.
Loans and Allowance for Loan Losses
Loan Portfolio Composition. Loans, net of unearned discount, represented 60.9% of our assets as of December 31, 2010, compared to 62.4% of our assets at December 31, 2009. Loans, net of unearned discount, decreased $2.12 billion to $4.49 billion at December 31, 2010 from $6.61 billion at December 31, 2009. The following table summarizes the composition of our loan portfolio by portfolio segment and the percent of each portfolio segment to the total portfolio as of the dates presented:
The following table summarizes the composition of our loan portfolio by geographic region and/or business segment at December 31, 2010 and 2009:
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(1)
The decrease during 2010 reflects the sale and reclassification to discontinued operations of $137.4 million and $40.3 million, respectively, of our Northern Illinois Region loans, and the reclassification of $794,000 of our Edwardsville Branch loans to assets held for sale at December 31, 2010, as further described below and in Note 2 to our consolidated financial statements.
We attribute the net decrease in our loan portfolio in 2010 primarily to:
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A decrease of $647.1 million in our commercial, financial and agricultural portfolio, reflecting gross loan charge-offs of $52.1 million, the sale and reclassification to assets of discontinued operations of $18.1 million and $6.9 million of such loans in our Northern Illinois Region, respectively, and portfolio runoff associated with a decline in internal production and reduced loan demand within our markets;
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A decrease of $562.2 million in our real estate construction and development portfolio, primarily attributable to gross loan charge-offs of $143.4 million, transfers to other real estate of $112.5 million and other loan activity. The following table summarizes the composition of our real estate construction and development portfolio by region as of December 31, 2010 and 2009:
We have experienced significant asset quality deterioration within all geographic areas of our real estate construction and development portfolio. As a result of the asset quality deterioration, we focused on reducing our exposure to this portfolio segment and decreased the portfolio balance by $1.65 billion, or 77.1%, from $2.14 billion at December 31, 2007 to $490.8 million at December 31, 2010. Of the remaining portfolio balance of $490.8 million, $134.2 million, or 27.4%, of these loans were on nonaccrual status as of December 31, 2010 and $128.2 million, or 26.1%, of loans were considered potential problem loans, as further discussed below;
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A decrease of $228.3 million in our one-to-four family residential real estate loan portfolio primarily attributable to gross loan charge-offs of $62.2 million, transfers to other real estate of $22.3 million, the sale and reclassification to assets of discontinued operations of $18.1 million and $14.0 million of such loans in our Northern Illinois Region, respectively, and principal payments. The following table summarizes the composition of our one-to-four family residential real estate loan portfolio as of December 31, 2010 and 2009:
Our Bank portfolio consists of prime mortgage loans originated to customers from our retail branch banking network. As of December 31, 2010, approximately $14.5 million, or 6.0%, of this portfolio is on nonaccrual status. The decrease in this portfolio of $93.3 million, or 28.0%, during 2010 is primarily attributable to prepayments associated with the mortgage refinance environment throughout 2010 and the sale and reclassification to assets of discontinued operations of $10.7 million and $12.1 million of such loans in our Northern Illinois Region, respectively.
Our Mortgage Division portfolio, excluding Florida, consists of both prime mortgage loans and Alt A and sub-prime mortgage loans that were originated prior to our discontinuation of these loan products in 2007. This portfolio of one-to-four family residential real estate loans has decreased $207.6 million, or 42.0%, from $494.2 million at December 31, 2007. We continue to experience significant distress within this portfolio of loans and recorded net loan charge-offs of $15.1 million on this portfolio during 2010. As of December 31, 2010, approximately $102.9 million, or 35.9%, of this portfolio is considered impaired, consisting of performing troubled debt restructurings of $78.9 million, including those loans modified in HAMP of $59.7 million, and nonaccrual loans of $24.0 million.
Our Florida Mortgage Division portfolio consists primarily of prime and Alt A mortgage loans. This portfolio of one-to-four family residential real estate loans has decreased $134.7 million, or 51.8%, from $260.1 million at December 31, 2007. We continue to experience significant distress within this portfolio of loans and recorded net loan charge-offs of $27.8 million on this portfolio in 2010. As of December 31, 2010, approximately $21.9 million, or 17.4%, of this portfolio is considered impaired, consisting of performing troubled debt restructurings of $12.5 million, including those loans modified in HAMP of $3.7 million, and nonaccrual loans of $9.4 million. Our Mortgage Division portfolio, excluding Florida and our Florida Mortgage Division portfolio are collectively defined as our Mortgage Division portfolio unless otherwise noted.
Our home equity portfolio consists of prime loans originated to customers from our retail branch banking network. As of December 31, 2010, approximately $7.1 million, or 1.8%, of this portfolio is on nonaccrual status. The decrease in this portfolio of $26.7 million, or 6.3%, during 2010 is primarily attributable to gross loan charge-offs of $9.4 million and the sale and reclassification to assets of discontinued operations of $7.4 million and $1.8 million of such loans in our Northern Illinois Region, respectively, in addition to overall ordinary and seasonal fluctuations experienced on this loan product type;
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A decrease of $44.8 million in our multi-family residential real estate portfolio primarily attributable to gross loan charge-offs of $9.3 million, the sale of $8.3 million of such loans in our Northern Illinois Region and portfolio runoff associated with a decline in internal production and reduced loan demand within our markets;
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A decrease of $626.5 million in our commercial real estate portfolio primarily attributable to gross loan charge-offs of $63.3 million, transfers to other real estate of $24.9 million, the sale and reclassification to assets of discontinued operations of $83.5 million and $17.3 million, respectively, of such loans in our Northern Illinois Region, and our efforts to reduce our exposure to commercial real estate in the current economic environment. The following table summarizes the composition of our commercial real estate portfolio by loan type as of December 31, 2010 and 2009:
Within our commercial real estate portfolio, we have experienced the most distress in our non-owner occupied portfolio. As of December 31, 2010, approximately $97.9 million, or 12.1%, of this segment of our commercial real estate portfolio is considered impaired, consisting of performing troubled debt restructurings of $17.3 million and nonaccrual loans of $80.6 million. The following table summarizes the composition of our non-owner occupied loan portfolio by region as of December 31, 2010 and 2009:
Our Southern California region accounts for $43.8 million, or 54.3%, of the total nonaccrual loans in this portfolio segment at December 31, 2010, and includes a single credit relationship in the amount of $31.1 million. We recorded a loan charge-off of $7.3 million on this credit relationship in the fourth quarter of 2010; and
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A decrease of $19.1 million in our consumer and installment portfolio, net of unearned discount, reflecting a decrease in unearned discount of $3.3 million, the sale and reclassification to assets of discontinued operations of $1.5 million and $2.0 million of such loans in our Northern Illinois Region, respectively, gross loan charge-offs of $1.0 million, and portfolio runoff associated with a decline in internal production and reduced loan demand within our markets.
These decreases were partially offset by:
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An increase of $11.8 million in our loans held for sale portfolio primarily resulting from the timing of loan originations and subsequent sales in the secondary mortgage and small business markets.
We attribute the net decrease in our loan portfolio in 2009 primarily to:
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A decrease of $882.6 million in our commercial, financial and agricultural portfolio, reflecting the reclassification of $77.6 million and $57.1 million of certain of our Chicago Region and Texas Region loans, respectively, to assets of discontinued operations at December 31, 2009; sales of $141.3 million, $101.5 million and $64.4 million of loans in our premium finance subsidiary, asset based lending subsidiary and restaurant franchise loans, respectively, during the fourth quarter of 2009; gross loan charge-offs of $104.6 million; and portfolio runoff associated with a decline in internal production and reduced loan demand within our markets;
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A decrease of $519.3 million in our real estate construction and development portfolio primarily attributable to gross loan charge-offs of $122.3 million, transfers to other real estate and other loan activity, including transfers of loans from real estate construction and development to commercial and multi-family residential real estate upon completion of the construction of the underlying projects related to such loans;
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A decrease of $274.2 million in our one-to-four family residential real estate loan portfolio primarily attributable to gross loan charge-offs of $83.6 million, the reclassification of $6.8 million and $3.8 million of certain of our Chicago Region and Texas Region loans, respectively, to assets of discontinued operations at December 31, 2009, transfers to other real estate and principal payments;
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A decrease of $293.2 million in our commercial real estate portfolio primarily attributable to the reclassification of $189.0 million and $36.0 million of certain of our Chicago Region and Texas Region loans, respectively, to assets of discontinued operations at December 31, 2009, gross loan charge-offs of $40.3 million and our efforts to reduce our exposure to commercial real estate in the current economic environment, partially offset by transfers of loans from real estate construction and development to commercial real estate upon completion of the construction and development and to multi-family residential real estate upon completion of the construction of the underlying projects related to such loans; and
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A decrease of $22.0 million in our consumer and installment portfolio, net of unearned discount, reflecting the reclassification of $2.7 million and $615,000 of certain of our Chicago Region and Texas Region loans, respectively, to assets of discontinued operations at December 31, 2009, gross loan charge-offs of $1.4 million, and portfolio runoff associated with a decline in internal production and reduced loan demand within our markets.
These decreases were partially offset by:
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An increase of $2.6 million in our multi-family residential real estate portfolio primarily attributable to transfers of loans from real estate construction and development to multi-family residential real estate upon completion of the construction of the underlying projects related to such loans, partially offset by the reclassification of $5.5 million and $1.1 million of certain of our Chicago Region and Texas Region loans, respectively, to assets of discontinued operations at December 31, 2009; and
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An increase of $4.0 million in our loans held for sale portfolio primarily resulting from the timing of loan originations and subsequent sales in the secondary mortgage and small business markets.
Loans at December 31, 2010 mature as follows:
The following table summarizes the components of changes in our loan portfolio, net of unearned discount, for the five years ended December 31, 2010:
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(1)
Loans and leases sold for 2010 include loans associated with our Northern Illinois Region of $137.4 million, as further described in Note 2 to our consolidated financial statements, and other commercial loan sales of $108.0 million. Loans and leases sold for 2009 include loans associated with WIUS, our asset based lending subsidiary and restaurant franchise loans of $141.3 million, $101.5 million and $64.4 million, respectively, in addition to loans associated with our Springfield Branch of $887,000, as further described in Note 2 to our consolidated financial statements.
(2)
Loans transferred to discontinued operations for 2010 include loans associated with our Northern Illinois Region of $40.3 million, as further described in Note 2 to our consolidated financial statements. Loans transferred to discontinued operations for 2009 include loans associated with our Chicago Region, Texas Region and WIUS of $311.3 million, $103.4 million and $1.5 million, respectively.
Nonperforming Assets. Nonperforming assets include nonaccrual loans, restructured loans and other real estate. The following table presents the categories of nonperforming assets and certain ratios as of the dates presented:
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(1)
During the first quarter of 2010, the Company modified its definition of nonperforming assets to exclude performing troubled debt restructurings because these loans were performing in accordance with the current or modified terms. Prior periods have been adjusted for this reclassification.
Our nonperforming assets, consisting of nonaccrual loans, other real estate and repossessed assets, were $539.6 million, $818.0 million and $510.0 million at December 31, 2010, 2009 and 2008, respectively. Our nonperforming assets at December 31, 2010 included $20.1 million, comprised of $7.5 million of nonaccrual loans and $12.6 million of other real estate, held by FB Holdings, a subsidiary of First Bank which is 46.77% owned by FCA, an entity owned by our Chairman of the Board and members of his immediate family.
We attribute the $292.2 million net decrease in our nonaccrual loans during the year ended December 31, 2010 to the following:
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An increase in nonaccrual loans of $26.0 million in our commercial, financial and agricultural portfolio. The increase during 2010 is partially due to a single shared national credit of $12.0 million being placed on nonaccrual status. At December 31, 2010, approximately 6.4% of this portfolio is on nonaccrual status as compared to 2.4% at December 31, 2009;
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A decrease in nonaccrual loans of $272.8 million in our real estate construction and development loan portfolio driven by gross charge-offs of $143.4 million, transfers to other real estate of $112.5 million and other activity, including the receipt of cash and other consideration of $89.1 million on our former largest nonaccrual loan relationship during the second quarter of 2010, partially offset by additions to nonaccrual loans during the year. Nonaccrual loans at December 31, 2010 include a $23.3 million loan to a St. Louis, Missouri home developer and a $20.6 million commercial construction loan in Northern California. Although the pace of deterioration in this portfolio is slowing due in part to the decline in the total portfolio balance, as previously discussed, we continue to experience deterioration as a result of weak economic conditions and significant declines in real estate values and we expect these trends to continue until market conditions stabilize, both on a nationwide basis and in our primary market areas;
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A decrease in nonaccrual loans of $61.0 million in our one-to-four family residential real estate Mortgage Division loan portfolio primarily driven by gross charge-offs of $47.5 million, transfers to other real estate and other activity, including modifications of certain nonaccrual loans, partially offset by additions to nonaccrual loans during the year ended December 31, 2010 driven by market conditions and the overall deterioration of Alt A and subprime residential mortgage loan products experienced throughout the mortgage banking industry. As further described under “Business -Strategy,” we are participating in HAMP where deemed economically advantageous to our borrowers and us; and
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An increase in nonaccrual loans of $13.9 million in our commercial real estate portfolio primarily driven by new additions during the year ended December 31, 2010 resulting from continued weak economic conditions and significant declines in real estate values, partially offset by gross loan charge-offs of $63.3 million and transfers to other real estate of $24.9 million. There is a single $31.1 million nonaccrual credit relationship in our Southern California region at December 31, 2010, which comprises 24.1% of our total commercial real estate nonaccrual loans.
The increase in other real estate of $15.4 million during 2010 was primarily driven by foreclosures of real estate construction and development, commercial real estate and one-to-four family residential real estate loans aggregating $160.7 million, including a single $50.0 million property in Southern California which was subsequently written down $9.0 million to $41.0 million during the third quarter of 2010, partially offset by the sale of properties with a carrying value of $105.5 million at a net gain of $3.5 million, and write-downs of other real estate of $34.7 million, including the $9.0 million write-down as described above, attributable to declining real estate values on certain properties. At December 31, 2010, our other real estate consisted of properties with the most recent appraisal date being in 2010, 2009, 2008 and prior to 2008 of $51.2 million, $73.8 million, $10.4 million and $3.1 million, respectively. Other real estate with an appraisal date in 2009 includes the $41.0 million property in Southern California as described above. Other real estate at December 31, 2010 also consisted of properties with values determined by management or by broker’s price opinions of $2.1 million.
We attribute the $308.0 million net increase in our nonperforming assets during the year ended December 31, 2009 to the following:
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An increase in nonaccrual loans of $761,000 in our commercial, financial and agricultural portfolio. At December 31, 2009, approximately 2.4% of this portfolio is on nonaccrual status;
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An increase in commercial, financial and agricultural restructured loans to $18.9 million at December 31, 2009 due to a single credit relationship in our FBBC subsidiary that was considered a troubled debt restructuring. There were no restructured loans in this portfolio as of December 31, 2008;
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An increase in nonaccrual loans of $136.6 million in our real estate construction and development loan portfolio driven by asset quality deterioration within this portfolio, including loans with an aggregate balance of $116.9 million to a single borrower in addition to a single loan of $63.8 million to a separate borrower being placed on nonaccrual status in our Southern California region during 2009, partially offset by gross charge-offs of $122.3 million and transfers to other real estate;
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An increase in nonaccrual loans of $25.3 million in our one-to-four family residential real estate Mortgage Division loan portfolio primarily driven by current market conditions and the overall deterioration of Alt A and sub-prime residential mortgage loan products experienced throughout the mortgage banking industry;
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An increase in nonaccrual loans of $14.2 million in our multi-family residential loan portfolio primarily driven by continued weak economic conditions and significant declines in real estate values. At December 31, 2009, approximately 6.6% of this portfolio is on nonaccrual status;
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An increase in nonaccrual loans of $92.3 million in our commercial real estate portfolio primarily driven by continued weak economic conditions and significant declines in real estate values. At December 31, 2009, approximately 5.1% of this portfolio is on nonaccrual status. Our commercial real estate portfolio of $2.27 billion is approximately 50.5% owner occupied and 49.5% non-owner occupied at December 31, 2009, and approximately 3.9% and 6.5% of our owner occupied and non-owner occupied commercial real estate portfolio, respectively, is on nonaccrual status at December 31, 2009; and
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An increase in other real estate of $33.7 million primarily driven by foreclosures of real estate construction and development loans throughout 2009, partially offset by write-downs of other real estate of $37.4 million during 2009 attributable to declining real estate values and sales of other real estate properties of $66.7 million.
We expect the declining and unstable market conditions associated with our one-to-four family residential mortgage portfolio, our real estate construction and development portfolio and our commercial real estate portfolio to continue, which will likely continue to impact the overall level of our nonperforming loans, loan charge-offs and provision for loan losses and other real estate balances associated with these segments of our loan portfolio.
The following table summarizes the composition of our nonperforming assets by region / business segment at December 31, 2010 and 2009:
The decrease in the Mortgage Division is primarily attributable to the aforementioned $61.0 million decline in one-to-four family residential real estate nonaccrual loans in the Mortgage Division resulting from gross loan charge-offs, transfers to other real estate and modifications of certain nonaccrual loans. The decrease in the Southern California region was attributable to gross loan charge-offs of $92.8 million and the receipt of cash and other consideration of $89.1 million on our former largest nonaccrual loan relationship during the second quarter of 2010, partially offset by additions to nonaccrual loans. The decreases in Florida, Chicago, Missouri and Texas were primarily attributable to the aforementioned decline in the overall level of nonaccrual real estate construction and development loans due to gross charge-offs, transfers and subsequent sales of other real estate and other activity, including payments.
Troubled Debt Restructurings. In the ordinary course of business, we modify loan terms across loan types, including both consumer and commercial loans, for a variety of reasons. Modifications to consumer loans may include, but are not limited to, changes in interest rate, maturity, amortization and financial covenants. In the original underwriting, loan terms are established that represent the then current and projected financial condition of the borrower. Over any period of time, modifications to these loan terms may be required due to changes in the original underwriting assumptions. These changes may include the financial requirements of the borrower as well as our underwriting standards. If the modified terms are consistent with competitive market conditions and representative of terms the borrower could otherwise obtain in the open market, the modified loan is not categorized as a troubled debt restructuring, or TDR.
For a loan modification to be classified as a TDR, all of the following conditions must be present: (1) the borrower is experiencing financial difficulty, (2) we make a concession to the original contractual loan terms and (3) the concessions are for economic or legal reasons related to the borrower’s financial difficulty that we would not otherwise consider. Modifications of loan terms to borrowers experiencing financial difficulty are made in an attempt to protect as much of our investment in the loan as possible. These modifications are generally made to either prevent a loan from becoming nonaccrual or to return a nonaccrual loan to performing status based on the expectations that the borrower can adequately perform in accordance with the modified terms.
The determination of whether a modification should be classified as a TDR requires significant judgment after taking into consideration all facts and circumstances surrounding the transaction. No single characteristic or factor, taken alone, is determinative of whether a modification should be classified as a TDR. The fact that a single characteristic is present is not considered sufficient to overcome the preponderance of contrary evidence. Assuming all of the TDR criteria are met, we consider one or more of the following concessions to the loan terms to represent a TDR: (1) a reduction of the stated interest rate, (2) an extension of the maturity date or dates at a stated interest rate lower than the current market rate for a new loan with similar terms or (3) forgiveness of principal or accrued interest.
Loans renegotiated at a rate equal to or greater than that of a new loan with comparable risk at the time the contract is modified are excluded from TDR classification in the calendar years subsequent to the renegotiation if the loan is in compliance with the modified terms for at least six months. Approximately $18.4 million of our TDRs were restructured at market interest rates and are eligible to be transferred out of TDR status during the first quarter of 2011 if their performance remains in accordance with all of the restructured terms.
We refer to our TDRs that are accruing interest as performing TDRs. The following table presents the categories of performing TDRs as of December 31, 2010 and 2009:
As of December 31, 2010 and 2009, $26.2 million and $13.8 million, respectively, of loans were identified by management as TDRs, were on nonaccrual status and were classified as nonperforming loans.
The decrease in commercial, financial and agricultural performing troubled debt restructurings during 2010 was primarily attributable to an $18.9 million credit relationship in our FBBC subsidiary being removed from TDR status as a result of compliance with the contractual terms of the modified loan agreement. The increase in real estate construction and development TDRs was attributable to the modification of the contractual terms of three credit relationships during 2010. The increase in one-to-four family residential performing TDRs was primarily attributable to our participation in HAMP. Performing TDRs under HAMP were $63.4 million at December 31, 2010. One-to-four family residential loans restructured under HAMP will be considered TDRs for the life of the respective loans or modifications periods as they are being restructured at interest rates lower than current market rates. There were no performing TDRs under HAMP at December 31, 2009. The increase in commercial real estate TDRs was attributable to the modification of the contractual terms of three credit relationships during 2010.
Potential Problem Loans. As of December 31, 2010 and 2009, $373.1 million and $345.6 million, respectively, of loans not included in the nonperforming assets and performing TDR tables above were identified by management as having potential credit problems, or potential problem loans. These loans are generally defined as loans having an internally assigned grade of substandard and loans in the Mortgage Division which are 30-89 days delinquent. The following table presents the categories of potential problem loans as of December 31, 2010 and 2009:
The increase in potential problem loans of $27.5 million during 2010 reflects continued weak economic conditions in the nationwide housing markets, high unemployment rates, weakened tenancy factors in our non-owner occupied commercial real estate portfolio and ongoing significant declines in real estate values in all of our markets.
The following table summarizes the composition of our potential problem loans by region / business segment at December 31, 2010 and 2009:
Our credit risk management policies and procedures, as further described under “-Allowance for Loan Losses,” focus on identifying potential problem loans. Potential problem loans may be identified by the assigned lender, the credit administration department or the internal credit review department. Specifically, the originating loan officers have primary responsibility for monitoring and overseeing their respective credit relationships, including, but not limited to: (a) periodic reviews of financial statements; (b) periodic site visits to inspect and evaluate loan collateral; (c) ongoing communication with primary borrower representatives; and (d) appropriately monitoring and adjusting the risk rating of the respective credit relationships should ongoing conditions or circumstances associated with the relationship warrant such adjustments. In addition, in the current severely weakened economic environment, our credit administration department and our internal credit review department are reviewing all loans with credit exposure over certain thresholds in loan portfolio segments in which we, or other financial institutions, have experienced significant loan charge-offs, such as real estate construction and development and one-to-four family residential real estate loans, and on loan portfolio segments that appear to be most likely to generate additional loan charge-offs in the future, such as commercial real estate. We include adversely rated credits, including potential problem loans, on our monthly loan watch list. Loans on our watch list require regular detailed loan status reports prepared by the responsible officer which are discussed in formal meetings with internal credit review and credit administration staff members that are generally conducted on a quarterly basis. The primary purpose of these meetings is to closely monitor these loan relationships and further develop, modify and oversee appropriate action plans with respect to the ultimate and timely resolution of the individual loan relationships.
Each loan is assigned an FDIC collateral code at the time of origination which provides management with information regarding the nature and type of the underlying collateral supporting all individual loans, including potential problem loans. Upon identification of a potential problem loan, management makes a determination of the value of the underlying collateral via a third party appraisal and/or an assessment of value from our internal appraisal review department. The estimated value of the underlying collateral is a significant factor in the risk rating and allowance for loan losses allocation assigned to potential problem loans.
Potential problem loans are regularly evaluated for impaired loan status by lenders, the credit administration department and the internal credit review department. When management makes the determination that a loan should be considered impaired, an initial specific reserve is allocated to the impaired loan, if necessary, until the loan is charged down to the appraised value of the underlying collateral, typically within 30 to 90 days of becoming impaired. In the current economic environment, management typically utilizes appraisals performed no earlier than 180 days prior to the charge-off, and in most cases, appraisals utilized are dated within 60 days of the charge-off. As such, management typically addresses collateral shortfalls through charge-offs as opposed to recording specific reserves on individual loans. Once a loan is charged down to the appraised value of the underlying collateral, management regularly monitors the carrying value of the loan for any additional deterioration and records additional reserves or charge-offs as necessary. As a general guideline, management orders new appraisals on any impaired loan or other real estate property in which the most recent appraisal is more than 18 months old; however, management also orders new appraisals on impaired loans or other real estate properties in the event circumstances, change, such as a rapid change in market conditions in a particular region.
We continue our efforts to reduce nonperforming and potential problem loans and re-define our overall strategy and business plans with respect to our loan portfolio as deemed necessary in light of ongoing and dramatic changes in market conditions in the markets in which we operate.
Allowance for Loan Losses. Our allowance for loan losses as a percentage of loans, net of unearned discount, was 4.48%, 4.03% and 2.56% at December 31, 2010, 2009 and 2008, respectively. Our allowance for loan losses as a percentage of nonperforming loans was 50.40%, 38.55% and 52.71% at December 31, 2010, 2009 and 2008, respectively. Our allowance for loan losses decreased to $201.0 million at December 31, 2010, compared to $266.4 million and $220.2 million at December 31, 2009 and 2008, respectively.
The decrease in our allowance for loan losses of $65.4 million during 2010 was primarily attributable to the decrease in nonaccrual loans of $292.2 million in addition to the $2.12 billion decrease in the overall level of our loan portfolio, partially offset by the increase in potential problem loans of $27.5 million and certain other economic factors. The increase in the allowance for loan losses as a percentage of loans, net of unearned discount, during 2010 was primarily attributable to the following:
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The downward migration of performing loans to more severe risk ratings that carry a higher reserve allocation, including the risk rating for potential problem loans;
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An increase in historical loss ratios used to determine estimated credit losses by loan type as a result of an increase in recent charge-off experience;
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The increase in our potential problem loans, which generally resulted in a higher allowance for loan losses being applied to these loans; and
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Significant payoffs of higher credit quality loans during 2010 which carried lower allowance for loan loss allocations; partially offset by
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The decrease in our nonaccrual loans during 2010.
Our allowance for loan losses as a percentage of nonperforming loans increased during 2010 primarily due to the decrease in nonperforming loans.
The following table is a summary of the changes in the allowance for loan losses for the five years ended December 31, 2010:
Our net loan charge-offs were $279.1 million, $339.0 million and $316.2 million for the years ended December 31, 2010, 2009 and 2008, respectively. Our net loan charge-offs as a percentage of average loans were 5.06%, 4.62% and 3.84% for the years ended December 31, 2010, 2009 and 2008, respectively.
We attribute the net decrease in our net loan charge-offs in 2010 to the following:
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A decrease in net loan charge-offs of $88.4 million associated with our commercial, financial and agricultural portfolio to $14.3 million in 2010, compared to $102.7 million in 2009. Specifically in this portfolio, during the third quarter of 2010, we recorded a $5.2 million charge-off on a loan relationship with a related operating loss of $13.6 million as further discussed under “-Noninterest Expense.” In 2009, we recorded $18.5 million in aggregate loan charge-offs on a single credit in our FBBC subsidiary, as well as a $10.7 million loan charge-off on a single credit in our Northern California region that went on nonaccrual status during 2009, and $30.0 million in aggregate loan charge-offs on a single credit in our Southern California region that went on nonaccrual status during 2009. During 2010, we recorded a $25.0 million recovery on the credit in our Southern California region on which we recorded $30.0 million in aggregate loan charge-offs in 2009.
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An increase in net loan charge-offs of $17.9 million associated with our real estate construction and development portfolio to $138.1 million in 2010, compared to $120.2 million in 2009. Net loan charge-offs for 2010 include charge-offs of $24.5 million, $11.5 million and $7.5 million on three credit relationships in our Southern California region and a $9.7 million charge-off on a credit relationship in our St. Louis region. Net loan charge-offs for 2009 include a $12.1 million loan charge-off on a credit relationship in our Southern California region and a $9.0 million charge-off on a credit relationship in our St. Louis region. We continue to experience significant distress and unstable market conditions throughout our market areas, resulting in increased developer inventories, slower lot and home sales and declining real estate values.
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A decrease in net loan charge-offs of $23.1 million associated with our one-to-four family residential loan portfolio to $57.0 million in 2010, compared to $80.1 million in 2009. These net loan charge-offs primarily consist of $42.9 million associated with our Mortgage Division one-to-four family residential mortgage portfolio in 2010, compared to $68.6 million in 2009. The decrease in net loan charge-offs in our Mortgage Division in 2010 is reflective of the declining portfolio balance and the substantial decrease in nonaccrual loans during 2010, in addition to improving delinquency trends.
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An increase in net loan charge-offs of $8.7 million associated with our multi-family residential loan portfolio to $9.3 million in 2010, compared to $503,000 in 2009. During 2010, we recorded loan charge-offs of $2.8 million and $1.4 million on two credit relationships in our St. Louis region and a $2.0 million charge-off on a credit relationship in our Chicago region. There were no significant charge-offs in this portfolio in 2009.
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An increase in net loan charge-offs of $25.5 million associated with our commercial real estate portfolio to $59.9 million in 2010, compared to $34.4 million in 2009, reflecting declining market conditions in commercial real estate, in particular our non-owner occupied commercial real estate portfolio. During 2010, we recorded loan charge-offs of $7.3 million and $2.8 million on two credit relationships in our Southern California region. During 2009, we recorded a $7.9 million loan charge-off on a credit relationship in our Chicago region and a $3.5 million charge-off on a credit relationship in our St. Louis region.
The following table summarizes the composition of our net loan charge-offs (recoveries) by region / business segment for the years ended December 31, 2010 and 2009:
We continue to closely monitor our loan portfolio and address the ongoing challenges posed by the severely weakened economic environment that has directly impacted and continues to impact many of our market segments. Specifically, we continue to focus on loan portfolio segments in which we have experienced significant loan charge-offs, such as real estate construction and development and one-to-four family residential, and on loan portfolio segments that could generate additional loan charge-offs in the future, such as commercial real estate and commercial and industrial. We consider these factors in our overall assessment of the adequacy of our allowance for loan losses.
Each month, the credit administration department provides management with detailed lists of loans on the watch list and summaries of the entire loan portfolio by risk rating. These are coupled with analyses of changes in the risk profile of the portfolio, changes in past-due and nonperforming loans and changes in watch list and classified loans over time. In this manner, we continually monitor the overall increases or decreases in the level of risk in our loan portfolio. Factors are applied to the loan portfolio for each category of loan risk to determine acceptable levels of allowance for loan losses. Furthermore, management has implemented additional procedures to analyze concentrations in our real estate portfolio in light of current economic and market conditions. These procedures include enhanced reporting to track land, lot, construction and finished inventory levels within our real estate construction and development portfolio. In addition, a quarterly evaluation of each lending unit is performed based on certain factors, such as lending personnel experience, recent credit reviews, loan concentrations and other factors. Based on this evaluation, changes to the allowance for loan losses may be required due to the perceived risk of particular portfolios. In addition, management exercises a certain degree of judgment in its analysis of the overall adequacy of the allowance for loan losses. In its analysis, management considers the changes in the portfolio, including growth, composition, the ratio of net loans to total assets, and the economic conditions of the regions in which we operate. Based on this quantitative and qualitative analysis, adjustments are made to the allowance for loan losses. Such adjustments are reflected in our consolidated statements of operations.
We record charge-offs on nonperforming loans typically within 30 to 90 days of the credit relationship reaching nonperforming loan status. We measure impairment and the resulting charge-off amount based primarily on third party appraisals. As such, rather than carrying specific reserves on nonperforming loans, we generally recognize a loan loss through a charge to the allowance for loan losses once the credit relationship reaches nonperforming loan status.
The allocation of the allowance for loan losses by loan category is a result of the application of our risk rating system augmented by historical loss data by loan type and other qualitative analysis. Consequently, the distribution of the allowance for loan losses will change from period to period due to the following factors:
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Changes in the aggregate loan balances by loan category;
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Changes in the identified risk in individual loans in our loan portfolio over time, excluding those homogeneous categories of loans such as consumer and installment loans and residential real estate mortgage loans for which risk ratings are changed based on payment performance;
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Changes in historical loss data as a result of recent charge-off experience by loan type; and
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Changes in qualitative factors such as changes in economic conditions, the volume of nonaccrual and potential problem loans by loan category and geographical location and changes in the value of the underlying collateral for collateral-dependent loans.
The following table is a summary of the allocation of the allowance for loan losses for the five years ended December 31, 2010:
A summary of the allowance for loan losses to loans by category as of December 31, 2010 and 2009 is as follows:
As demonstrated in the above table, the allowance for loan losses as a percentage of loans by category increased for commercial, financial and agricultural, real estate construction and development, multi-family residential, commercial real estate and consumer and installment. The increase in the allocation percentages for these loan categories is primarily reflective of increases in historical loss data as a result of recent charge-off experience and changes in qualitative factors such as changes in economic conditions, the volume of nonaccrual and potential problem loans and changes in the value of the underlying collateral for collateral-dependent loans. The allowance for loan losses as a percentage of loans by category decreased for one-to-four family residential. The decrease in this loan category is reflective of the significant decrease in nonaccrual loans and other factors, including delinquency trends.
Deposits
Deposits are the primary source of funds for First Bank. Our deposits consist principally of core deposits from our local market areas, including individual and corporate customers.
The following table sets forth the distribution of our average deposit accounts for the years ended December 31, 2010, 2009 and 2008, and the weighted average interest rates on each category of deposits:
Capital and Dividends
On December 31, 2008, the Company issued: (a) 295,400 shares of Class C Fixed Rate Cumulative Perpetual Preferred Stock, par value $1.00 per share, and liquidation preference of $1,000.00 per share; and (b) 14,770 shares of Class D Fixed Rate Cumulative Perpetual Preferred Stock, par value $1.00 per share, and liquidation preference of $1,000.00 per share, to the U.S. Treasury pursuant to the Company’s participation in the CPP program, as further described in “Item 1 -Business - Ownership Structure” and in Note 18 to our consolidated financial statements. The Class C and Class D cumulative perpetual preferred stock qualify as Tier 1 capital. Dividends on our Class C and Class D cumulative perpetual preferred stock, which currently carry annual dividend rates of 5.00% and 9.00%, respectively, were payable quarterly, beginning in February 2009.
The redemption of any of our preferred stock requires the prior approval of the Federal Reserve. As previously discussed under “Item 1 -Supervision and Regulation - Regulatory Agreements,” under the terms of the Agreement with the FRB, we have agreed, among other things, not to declare and pay any dividends on our common or preferred stock or to make any distributions of interest, or other sums, on our trust preferred securities without the prior approval of the FRB.
On August 10, 2009, we announced the deferral of our regularly scheduled interest payments on our outstanding junior subordinated debentures relating to the Company’s $345.0 million of trust preferred securities beginning with the regularly scheduled quarterly interest payments that would otherwise have been made in September and October 2009, as further described in Note 18 to the consolidated financial statements. During the deferral period, we may not, among other things and with limited exceptions, pay cash dividends on or repurchase our common stock or preferred stock nor make any payment on outstanding debt obligations that rank equally with or junior to the junior subordinated debentures. Accordingly, we also suspended the payment of cash dividends on our outstanding common stock and preferred stock beginning with the regularly scheduled quarterly dividend payments on the preferred stock that would otherwise have been made in August and September 2009.
Prior to August 10, 2009, we declared and paid $6.0 million of dividend payments on our Class C and Class D Preferred Stock. We subsequently declared and deferred an additional $16.1 million and $8.0 million of regularly scheduled dividend payments on our Class C and Class D Preferred Stock for the years ended December 31, 2010 and 2009, respectively, and, in conjunction with these deferred dividend payments, we also declared and accrued an additional $881,000 and $109,000 of cumulative dividends on our deferred dividend payments for the years ended December 31, 2010 and 2009, respectively.
Effective August 10, 2009, we also suspended the declaration of dividends on our Class A Convertible, Adjustable Rate Preferred Stock and our Class B Adjustable Rate Preferred Stock. Prior to that time, we declared and paid relatively small dividends on our Class A and Class B preferred stock, totaling $328,000 for the year ended December 31, 2009.
The Company’s and First Bank’s capital ratios at December 31, 2010 and 2009 were as follows:
First Bank was categorized as well capitalized at December 31, 2010 and 2009 under the prompt corrective action provisions of the regulatory capital standards. The Company did not meet the minimum regulatory capital standards established for bank holding companies by the Federal Reserve at December 31, 2010 and 2009. First Bank’s and our actual and required capital ratios are further described in Note 21 to our consolidated financial statements. First Bank’s Tier 1 capital ratio to total assets ratio of 7.68% at December 31, 2010 exceeded the 7.00% minimum level required under the terms of the informal agreement with the MDOF. As previously discussed under “Item 1 -Business - Recent Developments - Successful Completion of Consent Solicitation and Capital Plan,” we believe the successful completion of our Capital Plan, which was initiated in 2008 to, among other things, preserve our risk-based capital, would substantially improve our capital position; however, the successful completion of all or any portion of our Capital Plan is not assured, and no assurance can be made that we will be able to successfully complete all or any portion of our Capital Plan, or that our Capital Plan will not be materially modified in the future.
As of December 31, 2010, we had 13 affiliated Delaware or Connecticut statutory and business trusts that were created for the sole purpose of issuing trust preferred securities. As further described in Note 12 to our consolidated financial statements, the sole assets of the statutory and business trusts are our junior subordinated debentures.
A summary of the outstanding trust preferred securities issued by our affiliated statutory and business trusts, and our related junior subordinated debentures issued to the respective trusts in conjunction with the trust preferred securities offerings as of December 31, 2010, is as follows:
For regulatory reporting purposes, the trust preferred securities are eligible for inclusion, subject to certain limitations, in our Tier 1 and Tier 2 capital. Because of these limitations, as of December 31, 2010, $274.1 million of trust preferred securities were not eligible for inclusion in our Tier 1 capital. Of the $274.1 million not eligible for inclusion in our Tier 1 capital, $90.2 million was eligible for inclusion in our Tier 2 capital and $183.9 million was not eligible for inclusion in our Tier 2 capital. Effective March 31, 2011, the aggregate amount of qualifying cumulative perpetual preferred stock and qualifying trust preferred securities that may be included in Tier 1 capital is limited to 25% of specified core capital elements, as further described in Note 21 to our consolidated financial statements. We have determined that the Federal Reserve’s final rules that will be effective in March 2011, if implemented as of December 31, 2010, would reduce our total capital (to risk-weighted assets), Tier 1 capital (to risk-weighted assets) and Tier 1 capital (to average assets) to 4.53%, 2.27% and 1.44%, respectively, and as such, $316.8 million and $261.8 million of our trust preferred securities would not be eligible for inclusion in our Tier 1 capital and Tier 2 capital, respectively. Therefore, upon implementation of the Federal Reserve’s final rule, we would remain below the minimum regulatory capital standards established for bank holding companies and could be subject to additional actions by regulators that could have a direct material effect on the operations and financial condition of the Company and First Bank. The final rules that will be effective in March 2011, if implemented as of December 31, 2010, would not have an impact on First Bank’s regulatory capital ratios. In addition, the Dodd-Frank Act removes trust preferred securities as a permitted component of a holding company’s Tier 1 capital for holding companies with more than $15 billion of assets after a three-year phase-in period beginning January 1, 2013 and restricts new issuances of trust preferred securities from being included as Tier 1 capital for all holding companies.
Liquidity
First Bank. Our liquidity is the ability to maintain a cash flow that is adequate to fund operations, service debt obligations and meet obligations and other commitments on a timely basis. First Bank receives funds for liquidity from customer deposits, loan payments, maturities of loans and investments, sales of investments and earnings before provision for loan losses. In addition, we may avail ourselves of other sources of funds by issuing certificates of deposit in denominations of $100,000 or more (including certificates issued through the CDARS program), selling securities under agreements to repurchase, and utilizing borrowings from the FHLB, the FRB and other borrowings.
As a financial intermediary, we are subject to liquidity risk. We closely monitor our liquidity position and continue to implement actions deemed necessary to maintain an appropriate level of liquidity in light of unstable market conditions, changes in loan funding needs, operating and debt service requirements, current deposit trends and events that may occur in conjunction with our Capital Plan. We continue to seek opportunities to improve our overall liquidity position, and have established a Liquidity Management Committee and an expanded and more efficient collateral management process. In conjunction with our liquidity management process, we analyze and manage short-term and long-term liquidity through an ongoing review of internal funding sources, projected cash flows from loans, securities and customer deposits, internal and competitor deposit pricing structures and maturity profiles of current borrowing sources. We utilize planning, management reporting and adverse stress scenarios to monitor sources and uses of funds on a daily basis to assess cash levels to ensure adequate funds are available to meet normal business operating requirements and to supplement liquidity needs to meet unusual demands for funds that may result from an unexpected change in customer deposit levels or potential planned or unexpected liquidity events that may arise from time to time.
First Bank has built a significant amount of available balance sheet liquidity throughout 2009 and 2010 in anticipation of the expected completion of certain transactions associated with our Capital Plan, as further described under “-Business - Recent Developments - Capital Plan,” including the sale of our Lawrenceville Branch on January 22, 2010, the sale of our Chicago Region on February 19, 2010, the sale of our Texas Region on April 30, 2010, and the sale of 11 branch offices in our Northern Illinois Region in September 2010. These transactions resulted in an aggregate cash outlay of approximately $1.40 billion during 2010. The announced sales of our remaining three branch offices in our Northern Illinois Region, our Edwardsville Branch and our San Jose Branch, which was completed on February 11, 2011, are expected to result in cash outlays of approximately $50.7 million, $12.1 million and $9.0 million, respectively. As such, approximately $71.8 million of our short-term investments of $924.8 million at December 31, 2010 are expected to be utilized in conjunction with the completion of these pending sale transactions during the first and second quarters of 2011.
Our cash and cash equivalents were $995.8 million and $2.52 billion at December 31, 2010 and 2009, respectively. The majority of funds were maintained in our correspondent bank account with the FRB. The decrease in our cash and cash equivalents of $1.52 billion was primarily attributable to the following:
Ø
The sale of our Chicago Region on February 19, 2010, resulting in a cash outflow of $832.5 million;
Ø
The sale of our Texas Region on April 30, 2010, resulting in a cash outflow of $352.9 million;
Ø
The sale of 11 branch offices in our Northern Illinois Region in September 2010, resulting in a cash outflow of $203.5 million;
Ø
The sale of our Lawrenceville Branch on January 22, 2010, resulting in a cash outflow of $8.3 million;
Ø
A net increase in our investment securities portfolio of $952.8 million during 2010;
Ø
A decrease in our deposit balances of approximately $150.1 million, excluding the impact of the divestitures of the Chicago, Texas and Northern Illinois Regions, and the Lawrenceville Branch;
Ø
The prepayment of $600.0 million of FHLB advances during 2010. In March 2010, funds available from short-term investments were utilized to prepay two $100.0 million FHLB advances that were scheduled to mature in April 2010 and July 2010, resulting in prepayment penalties of $281,000, in aggregate. During the third quarter of 2010, we prepaid an additional two $100.0 million FHLB advances that were scheduled to mature in April 2011 and July 2011, resulting in prepayment penalties of $1.9 million. During the fourth quarter of 2010, we prepaid an additional two $100.0 million FHLB advances that were scheduled to mature in August 2012 and September 2016, resulting in prepayment penalties of $3.2 million; and
Ø
The prepayment of our $120.0 million term repurchase agreement during the fourth quarter of 2010 that was scheduled to mature in April 2012, resulting in an early termination fee of $5.5 million.
These decreases in cash and cash equivalents were partially offset by:
Ø
A decrease in loans of $1.47 billion, exclusive of net loan charge-offs, transfers to other real estate and the impact of the divestitures of the Chicago, Texas and Northern Illinois Regions, and the Lawrenceville Branch;
Ø
The termination of our remaining BOLI policies during 2010, resulting in the receipt of cash proceeds from the surrender of the policies of approximately $25.9 million;
Ø
Sales of other real estate properties resulting in the receipt of cash proceeds from these sales of approximately $108.3 million; and
Ø
The redemption of $7.8 million of FRB stock associated with the reduction in our total assets and $27.3 million of FHLB stock associated with the prepayment of $600.0 million of FHLB advances during 2010.
We are actively increasing our unpledged investment securities portfolio in an effort to improve our net interest income and increase our available liquidity. Our unpledged investment securities increased $1.09 billion to $1.22 billion at December 31, 2010, compared to $136.5 million at December 31, 2009, and are mostly comprised of highly liquid and readily marketable available-for-sale securities. The combined level of cash and cash equivalents and unpledged investment securities provided us with total available liquidity in excess of $2.22 billion and $2.65 billion at December 31, 2010 and 2009, respectively. As such, despite a cumulative cash outflow of $1.40 billion to support transactions associated with our Capital Plan and the prepayment of $720.0 million of secured term borrowings, we have maintained available liquidity in excess of $2.22 billion at December 31, 2010. Our ability to maintain strong liquidity was achieved by a substantial shift in our balance sheet from loans to short-term investments and investment securities while maintaining our deposit levels, exclusive of transactions resulting from our Capital Plan. Our loan-to-deposit ratio decreased to 69.6% at December 31, 2010 from 93.5% at December 31, 2009, while the ratio of our cash and cash equivalents and investment securities to total assets increased to 33.7% at December 31, 2010 from 28.9% at December 31, 2009.
During 2010, we reduced the aggregate funds acquired from other sources of funds by $838.2 million to $860.4 million at December 31, 2010, from $1.70 billion at December 31, 2009. These other sources of funds include certificates of deposit of $100,000 or more, and other borrowings, which are comprised of daily and term securities sold under agreements to repurchase and FHLB advances, as further described in Note 11 to our the consolidated financial statements. The decrease is primarily attributable to a reduction in our secured term borrowings of $735.7 million, including the prepayment of $600.0 million of FHLB advances (including $200.0 million of FHLB advances during the fourth quarter of 2010) and the repayment of our $120.0 million term repurchase agreement during the fourth quarter of 2010. The decrease is also attributable to a reduction in certificates of deposit of $100,000 or more of $102.5 million. The following table presents the maturity structure of these other sources of funds at December 31, 2010:
In addition to these sources of funds, First Bank has established a borrowing relationship with the FRB. This borrowing relationship, which is secured primarily by commercial loans, provides an additional liquidity facility that may be utilized for contingency liquidity purposes. Advances drawn on First Bank’s established borrowing relationship require the prior approval of the FRB. First Bank did not have any FRB borrowings outstanding at December 31, 2010 or 2009.
In addition, First Bank’s borrowing capacity through its relationship with the FHLB was approximately $475.1 million and $353.1 million at December 31, 2010 and 2009, respectively. The borrowing relationship is secured by one-to-four family residential, multi-family residential and commercial real estate loans. First Bank requests advances and/or repays advances from the FHLB based on its current and future projected liquidity needs. All borrowing requests require approval from the FHLB. First Bank had FHLB advances outstanding of $600.0 million at December 31, 2009, all of which were repaid during 2010, resulting in no FHLB advances outstanding at December 31, 2010. As a means of further contingency funding, First Bank may use broker dealers to acquire deposits to fund both short-term and long-term funding needs, including brokered money market accounts, and has available funding, subject to certain limits, through the CDARS program.
We believe First Bank has sufficient liquidity to meet its current and future near-term liquidity needs; however, no assurance can be made that First Bank’s liquidity position will not be materially, adversely affected in the future.
First Banks, Inc. First Banks, Inc. is a separate and distinct legal entity from its subsidiaries. The Company’s liquidity position is affected by the amount of cash and other liquid assets on hand, payment of interest and dividends on debt and equity instruments issued by the Company (all of which are presently suspended or deferred), capital contributions the Company makes into its subsidiaries, any redemption of debt for cash issued by the Company, proceeds we raise through the issuance of debt and/or equity instruments through the Company, if any, and dividends received from our subsidiaries. The Company’s unrestricted cash totaled $3.6 million and $7.4 million at December 31, 2010 and 2009, respectively.
On March 24, 2011, the Company entered into a Revolving Credit Note and a Stock Pledge Agreement with Investors of America Limited Partnership, or Investors of America, LP, as further described in Note 25 to our consolidated financial statements. The agreement provides for a $5.0 million secured revolving line of credit to be utilized for general working capital needs. This borrowing arrangement, which has a maturity date of December 31, 2012 and an interest rate of LIBOR plus 300 basis points, is intended to supplement, if necessary, the parent company’s overall level of unrestricted cash to cover the parent company’s projected operating expenses for the foreseeable future. We cannot be assured of our ability to access future liquidity through debt markets. As further described under “Item 1A ─ Risk Factors,” the Company’s ability to access debt markets on terms satisfactory to us will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside of our control, and on our financial performance.
Additional long-term funding is provided by our junior subordinated debentures, as further described in Note 12 to our consolidated financial statements. As of December 31, 2010, we had 13 affiliated Delaware or Connecticut statutory and business trusts that were created for the sole purpose of issuing trust preferred securities. The sole assets of the statutory and business trusts are our junior subordinated debentures.
We agreed, among other things, not to pay any dividends on our common or preferred stock or make any distributions of interest or other sums on our trust preferred securities without the prior approval of the FRB, as previously discussed under “-Supervision and Regulation - Regulatory Agreements.”
On August 10, 2009, we announced the deferral of our regularly scheduled interest payments on our outstanding junior subordinated debentures relating to our $345.0 million of trust preferred securities beginning with the regularly scheduled quarterly interest payments that would otherwise have been made in September and October 2009. The terms of the junior subordinated debentures and the related trust indentures allow us to defer such payments of interest for up to 20 consecutive quarterly periods without default or penalty. During the deferral period, we may not, among other things and with limited exceptions, pay cash dividends on or repurchase our common stock or preferred stock nor make any payment on outstanding debt obligations that rank equally with or junior to our junior subordinated debentures. Accordingly, we also suspended the payment of cash dividends on our outstanding common stock and preferred stock beginning with the regularly scheduled quarterly dividend payments on our preferred stock that would otherwise have been made in August and September 2009, as further described under “-Capital and Dividends,” and in Note 18 to our consolidated financial statements.
The Company’s future liquidity position may be adversely affected if any of the following events occurs:
Ø
First Bank continues to experience net losses and, accordingly, is unable or prohibited by its regulators to pay a dividend to the Company sufficient to satisfy the Company’s operating cash flow needs. The Company’s ability to receive future dividends from First Bank to assist the Company in meeting its operating requirements, both on a short-term and long-term basis, is currently subject to regulatory approval, as further described above and under “-Supervision and Regulation - Regulatory Agreements;”
Ø
We deem it advisable, or are required by the FRB, to use cash maintained by the Company to support the capital position of First Bank;
Ø
First Bank fails to remain “well-capitalized” and, accordingly, First Bank is required to pledge additional collateral against its borrowings and is unable to do so. As discussed above and more fully described in Note 10 to the consolidated financial statements, First Bank prepaid all of its $600.0 million FHLB advances outstanding during 2010; or
Ø
The Company has difficulty raising cash through the future issuance of debt or equity instruments or by accessing additional sources of credit.
The Company’s financial flexibility may be severely constrained if we are unable to maintain our access to funding or if adequate financing on terms acceptable to us is not available in the marketplace. If we are required to rely more heavily on more expensive funding sources to support our business, our revenues may not increase proportionately to cover our costs. In this case, our operating margins could be materially adversely affected. A lack of liquidity and/or cost-effective funding alternatives could materially adversely affect our business, financial condition and results of operations.
Other Commitments and Contractual Obligations. We have entered into long-term leasing arrangements and other commitments and contractual obligations in conjunction with our ongoing operating activities. The required payments under such leasing arrangements, other commitments and contractual obligations at December 31, 2010 were as follows:
_________________________
(1)
Amounts exclude ASC Topic 740 unrecognized tax liabilities of $1.3 million and related accrued interest expense of $180,000 for which the timing of payment of such liabilities cannot be reasonably estimated as of December 31, 2010.
(2)
Amounts exclude operating leases associated with discontinued operations of $129,000, $282,000, $282,000 and $129,000 for less than 1 year, 1-3 years, 3-5 years and over 5 years, respectively, or a total of $822,000.
(3)
Amounts exclude the related accrued interest expense on certificates of deposit and other borrowings of $2.0 million and zero, respectively, as of December 31, 2010.
(4)
Amounts exclude the accrued interest expense on junior subordinated debentures and the accrued dividends declared on preferred stock issued under the CPP of $19.6 million and $25.1 million, respectively, as of December 31, 2010. As further described under “¾Supervision and Review - Regulatory Agreements,” we currently may not make any distributions of interest or other sums on our junior subordinated debentures and related underlying trust preferred securities without the prior approval of the FRB.
(5)
Represents amounts payable upon redemption of the Class C Preferred Stock and Class D Preferred Stock issued under the CPP of $295.4 million and $14.8 million, respectively.
Critical Accounting Policies
Our financial condition and results of operations presented in our consolidated financial statements, accompanying notes to our consolidated financial statements, selected consolidated and other financial data appearing elsewhere in this report, and management’s discussion and analysis of financial condition and results of operations are, to a large degree, dependent upon our accounting policies. The selection and application of our accounting policies involve judgments, estimates and uncertainties that are susceptible to change.
We have identified the following accounting policies that we believe are the most critical to the understanding of our financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could be a reasonable likelihood. The impact and any associated risks related to our critical accounting policies on our business operations is discussed throughout “¾Management’s Discussion and Analysis of Financial Condition and Results of Operations,” where such policies affect our reported and expected financial results. A detailed discussion on the application of these and other accounting policies is summarized in Note 1 to our consolidated financial statements appearing elsewhere in this report.
Allowance for Loan Losses. We maintain an allowance for loan losses at a level we consider adequate to provide for probable losses in our loan portfolio. The determination of our allowance for loan losses requires management to make significant judgments and estimates based upon a periodic analysis of our loans held for portfolio and held for sale considering, among other factors, current economic conditions, loan portfolio composition, past loan loss experience, independent appraisals, the fair value of underlying loan collateral, our customers’ ability to repay their loans and selected key financial ratios. If actual events prove the estimates and assumptions we used in determining our allowance for loan losses were incorrect, we may need to make additional provisions for loan losses. Any increases in our allowance for loan losses will result in a decrease in net income and capital, and may have a material adverse effect on our financial condition and results of operations. For further discussion, refer to “¾Loans and Allowance for Loan Losses,” “Item 1A ─ Risk Factors” and Note 4 to our consolidated financial statements appearing elsewhere in this report.
Derivative Financial Instruments. We utilize derivative financial instruments to assist in our management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities. The judgments and assumptions that are most critical to the application of this critical accounting policy are those affecting the estimation of fair value and hedge effectiveness. Fair value is based on quoted market prices where available. If quoted market prices are unavailable, fair value is based on quoted market prices of comparable derivative instruments. Factors that affect hedge effectiveness include the initial selection of the derivative that will be used as a hedge and how well changes in its cash flow or fair value have correlated and are expected to correlate with changes in the cash flow or fair value of the underlying hedged asset or liability. Past correlation is easy to demonstrate, but expected correlation depends upon projections and trends that may not always hold true within acceptable limits. Changes in assumptions and conditions could result in greater than expected inefficiencies that, if large enough, could reduce or eliminate the economic benefits anticipated when the hedges were established and/or invalidate continuation of hedge accounting. Greater inefficiency and/or discontinuation of hedge accounting are likely to result in increased volatility in our reported earnings. For cash flow hedges, this would result as more or all of the change in the fair value of the affected derivative being reported in noninterest income. For fair value hedges, there may be some impact on our reported earnings as the change in the fair value of the affected derivative may not be offset by changes in the fair value of the underlying hedged asset or liability. For further discussion, refer to “¾Interest Rate Risk Management” and Note 5 to our consolidated financial statements appearing elsewhere in this report.
Deferred Tax Assets. We recognize deferred tax assets for the estimated future tax effects of temporary differences, net operating loss carryforwards and tax credits. We recognize deferred tax assets subject to management’s judgment based upon available evidence that realization is more likely than not. Our deferred tax assets are reduced, if necessary, by a deferred tax asset valuation allowance. In the event that we determine we would not be able to realize all or part of our deferred tax assets in the future, we would need to adjust the recorded value of our deferred tax assets, which would result in a direct charge to our provision for income taxes in the period in which such determination is made. For further discussion, refer to “¾Comparison of Results of Operations for 2010 and 2009 - Provision for Income Taxes,” “¾Comparison of Results of Operations for 2009 and 2008 - Provision for Income Taxes,” and Note 1 and Note 13 to our consolidated financial statements appearing elsewhere in this report.
Goodwill and Other Intangible Assets / Business Combinations. The determination of the fair value of the assets and liabilities acquired, as well as the returns on investment that may be achieved, requires management to make significant judgments and estimates based upon detailed analyses of the existing and future economic value of such assets and liabilities and/or the related income streams, including the resulting intangible assets. If actual events prove the estimates and assumptions we used in determining the fair values of the acquired assets and liabilities or the projected income streams were incorrect, we may need to make additional adjustments to the recorded values of such assets and liabilities, which could result in increased volatility in our reported earnings. In addition, we may need to make additional adjustments to the recorded value of our intangible assets, which may impact our reported earnings and directly impacts our regulatory capital levels. For further discussion, refer to Note 2, Note 8 and Note 21 to our consolidated financial statements appearing elsewhere in this report.
Our annual impairment testing date for goodwill and other intangible assets is December 31. In addition, a goodwill impairment assessment is performed if an event occurs or circumstances change that would make it more likely than not that the fair value of our single reporting unit is below its carrying value. The goodwill impairment test is a two-step process which requires us to make assumptions regarding fair value. Our policy allows management to make the determination of fair value using internal cash flow models or by engaging independent third parties. The first step consists of estimating the fair value of the reporting unit using a number of factors, including projected future operating results and business plans, economic projections, anticipated future cash flows, discount rates, and comparable marketplace fair value data from within a comparable industry grouping. We compare the estimated fair value of our reporting unit to the carrying value, which includes allocated goodwill. If the estimated fair value is less than the carrying value, the second step is completed to compute the impairment amount by determining the “implied fair value” of goodwill. This determination requires the allocation of the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any remaining unallocated fair value represents the “implied fair value” of goodwill, which is compared to the corresponding carrying value to compute the goodwill impairment amount, if any. Although we believe our estimates of fair value are reasonable, many of the factors used in assessing fair value and the allocation of estimated fair value to the assets and liabilities of our reporting unit are outside the control of management, and it is reasonably likely that assumptions and estimates may change in future periods. These changes may result in future impairment that may materially affect the carrying value of our assets and our results of operations.
Due to the ongoing uncertainty regarding market conditions, which may continue to negatively impact the performance of our reporting unit, management will continue to monitor the goodwill impairment indicators and evaluate the carrying amount of our goodwill, if necessary. Events and circumstances that could trigger the need for interim impairment testing include:
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A significant change in legal factors or in the business climate;
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An adverse action or assessment by a regulator;
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Unanticipated competition;
Ø
A loss of key personnel;
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A more-likely-than-not expectation that our reporting unit or a significant portion of our reporting unit will be sold or otherwise disposed of; and
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The testing for recoverability of a significant asset group within a reporting unit.
For further discussion, refer to “Item 1A ─ Risk Factors,” “¾Comparison of Results of Operations for 2010 and 2009 - Noninterest Expense,” and Note 1 and Note 8 to our consolidated financial statements appearing elsewhere in this report.
Effects of New Accounting Standards
In June 2009, the FASB issued SFAS No. 166 - Accounting for Transfers of Financial Assets, an Amendment of SFAS No. 140 - Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which was subsequently incorporated into ASC Topic 860, “Transfers and Servicing.” ASC Topic 860 requires more information about transfers of financial assets, including securitization transactions and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets and requires additional disclosures. The guidance is effective for the annual period beginning after November 15, 2009 and for interim periods within the first annual reporting period, and must be applied to transfers occurring on or after the effective date. We adopted the requirements of ASC Topic 860 on January 1, 2010, which did not have a material impact on our consolidated financial statements or the disclosures presented in our consolidated financial statements.
In June 2009, the FASB issued SFAS No. 167 - Amendments to FASB Interpretation No. 46(R). SFAS No. 167 amends FIN 46(R) - Consolidation of Variable Interest Entities, which was subsequently incorporated into ASC Topic 810, “Consolidation,” to change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated, and requires additional disclosures about involvement with variable interest entities, any significant changes in risk exposure due to that involvement and how that involvement affects the company’s financial statements. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. The guidance is effective for the annual period beginning after November 15, 2009 and for interim periods within the first annual reporting period. We adopted the requirements of ASC Topic 810 on January 1, 2010, which did not have a material impact on our consolidated financial statements or the disclosures presented in our consolidated financial statements.
In January 2010, the FASB issued ASU No. 2010-06 - Fair Value Measurements and Disclosures (ASC Topic 820) - Improving Disclosures about Fair Value Measurements. This ASU amends certain disclosure requirements of Subtopic 820-10, providing additional disclosures for transfers in and out of Levels I and II and for activity in Level III and clarifies certain other existing disclosure requirements including the level of disaggregation and disclosures around inputs and valuation techniques. The final amendments of this ASU will be effective for annual or interim periods beginning after December 15, 2009, except for the requirement to provide the Level 3 activity for purchases, sales, issuances, and settlements on a gross basis. This requirement will be effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early adoption is permitted. The amended ASU does not require disclosures for earlier periods presented for comparative purposes at initial adoption. We implemented the disclosure requirements under this ASU on January 1, 2010, except for the requirement to provide the Level 3 activity for purchases, sales, issuances, and settlements on a gross basis, which are reported in Note 15 to our consolidated financial statements. The implementation of the new disclosure requirements did not have a material impact on our consolidated financial statements or the disclosures presented in our consolidated financial statements.
In July 2010, the FASB issued ASU No. 2010-20 - Receivables (ASC Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This ASU requires expanded credit risk disclosures intended to provide investors with greater transparency regarding the allowance for credit losses and the credit quality of financing receivables. Under this ASU, companies will be required to provide more information about the credit quality of their financing receivables in the disclosures to financial statements, such as aging information, credit quality indicators, changes in the allowance for credit losses, and the nature and extent of troubled debt restructurings and their effect on the allowance for credit losses. Both new and existing disclosures must be disaggregated by portfolio segment or class based on the level of disaggregation that management uses when assessing its allowance for credit losses and managing its credit exposure. The disclosures as of the end of a reporting period were effective for interim and annual periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period will be effective for interim and annual reporting periods beginning on or after December 15, 2010. We implemented the disclosure requirements under this ASU for the reporting period ending December 31, 2010, except for the requirement to provide disclosures about activity that occurs during a reporting period. The implementation of the new disclosure requirements did not have a material impact on our consolidated financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The quantitative and qualitative disclosures about market risk are included under “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Risk Management” appearing on pages 52 through 54 of this report.
Effects of Inflation
Inflation affects financial institutions less than other types of companies. Financial institutions make relatively few significant asset acquisitions that are directly affected by changing prices. Instead, the assets and liabilities are primarily monetary in nature. Consequently, interest rates are more significant to the performance of financial institutions than the effect of general inflation levels. While a relationship exists between the inflation rate and interest rates, we believe this is generally manageable through our asset-liability management program.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The financial statements and supplementary data appear on pages 92 through 155 of this report.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
The Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this report. Based on such evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective as of December 31, 2010 to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the President and Chief Executive Officer and the Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Our internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of our assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP and that receipts and expenditures are being made only in accordance with authorizations of management and our directors, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our 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 circumstances or that the degree of compliance with the policies and procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. Based on that assessment, management concluded that, as of December 31, 2010, the Company’s internal control over financial reporting is effective based on the criteria established in COSO’s Internal Control - Integrated Framework.
This annual report does not include an attestation report of the Company’s Independent Registered Public Accounting Firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s Independent Registered Public Accounting Firm.
Item 9B.
Item 9B. Other Information
On March 24, 2011, the Company entered into a Revolving Credit Note and a Stock Pledge Agreement with Investors of America, LP, a limited partnership that was created by and for the benefit of the Company’s Chairman and members of his immediate family. The agreement provides for a $5.0 million secured revolving line of credit to be utilized for general working capital needs, as further described in Note 11 and Note 25 to our consolidated financial statements, which descriptions are incorporated herein by reference to Exhibit 10.12 and Exhibit 10.13 of this report.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Board of Directors and Committees of the Board
Our Board of Directors consists of six members. The Board determined that Messrs. Blake, Cooper, Steward and Yaeger are independent. Each of our directors identified in the following table was elected to serve a one-year term and until his successor has been duly qualified for office.
(Continued)
__________________________________
(1)
Member of the Audit Committee.
(2)
Member of the Compensation Committee.
(3)
Mr. James A. Cooper serves as Chairman of the Compensation Committee.
(4)
Mr. Douglas H. Yaeger serves as Chairman of the Audit Committee and the Audit Committee financial expert.
Committees and Meetings of the Board of Directors
Four members of our Board of Directors currently serve on the Audit Committee, all of whom the Board of Directors determined to be independent. The Audit Committee assists the Board of Directors in fulfilling the Board’s oversight responsibilities with respect to the quality and integrity of the consolidated financial statements, financial reporting process and systems of internal controls. The Audit Committee also assists the Board of Directors in monitoring the independence and performance of the independent auditors, the internal audit department and the operation of ethics programs. The Audit Committee operates under a written charter adopted by the Board of Directors.
The members of the Audit Committee as of March 25, 2011 were Mr. Allen H. Blake, Mr. James A. Cooper, Mr. David L. Steward, and Mr. Douglas H. Yaeger, who serves as the Chairman of the Audit Committee and the Audit Committee Financial Expert.
In accordance with the requirements of the EESA, as amended by the ARRA, the Board of Directors maintains a Compensation Committee comprised solely of directors determined to be independent. The Compensation Committee, governed by a written charter adopted by the Board of Directors, is comprised of Messrs. Cooper, Steward and Yaeger. Mr. Cooper serves as the Chairman of the Compensation Committee. The Compensation Committee oversees the compensation of the executive officers of the Company and reviews compensation and benefit packages and programs for the Company’s employees generally.
Audit Committee Report
The Audit Committee is responsible for oversight of our financial reporting process on behalf of the Board of Directors. Management has primary responsibility for our financial statements and financial reporting, including internal controls, subject to the oversight of the Audit Committee and the Board of Directors. In fulfilling its responsibilities, the Audit Committee reviewed the audited consolidated financial statements with management and discussed the acceptability of the accounting principles used, the reasonableness of significant judgments made and the clarity of the disclosures.
The Audit Committee reviewed with the Independent Registered Public Accounting Firm, who is responsible for planning and carrying out a proper audit and expressing an opinion on the conformity of our audited consolidated financial statements with U.S. generally accepted accounting principles, their judgments as to the acceptability of the accounting principles we use, and such other matters as are required to be discussed with the Audit Committee by Statement on Auditing Standards No. 61, Communications with Audit Committees. In addition, the Audit Committee discussed with the Independent Registered Public Accounting Firm its independence from management and the Company, including the matters required by Public Company Accounting Oversight Board, or PCAOB, Rule 3526, Communication with Audit Committees Concerning Independence, and the Audit Committee considered the compatibility of non-audit services provided by the Independent Registered Public Accounting Firm with the firm’s independence. KPMG LLP has provided the Audit Committee with the written disclosures and letter required by Standard No. 1 of the Independence Standards Board.
The Audit Committee discussed with our Internal Audit Department and Independent Registered Public Accounting Firm the overall scope and plans for their respective audits. The Audit Committee met with the Internal Audit Department and Independent Registered Public Accounting Firm with and without management present to discuss the results of their examinations, their evaluations of our internal controls and the overall quality of our financial reporting.
In reliance on the reviews and discussions referred to above, the Audit Committee recommended to the Board of Directors that the audited consolidated financial statements be included in the Annual Report on Form 10-K as of and for the year ended December 31, 2010 for filing with the SEC.
Audit Committee
Douglas H. Yaeger, Chairman of the Audit Committee
Allen H. Blake
James A. Cooper
David L. Steward
Code of Ethics for Principal Executive Officer and Financial Professionals
The Board of Directors has approved a Code of Ethics for Principal Executive Officer and Financial Professionals that covers the Principal Executive Officer, the Chief Financial Officer, the Chief Credit Officer, the Chief Investment Officer, the Senior Vice President - Controller, the Senior Vice President - Director of Taxes, and all professionals serving in a Corporate Finance, Accounting, Treasury, Tax or Investor Relations role. These individuals are also subject to the policies and procedures adopted by the Company that govern the conduct of all of its employees. The Code of Ethics for Principal Executive Officer and Financial Professionals is included as an exhibit to this Annual Report on Form 10-K. The Company intends to post on its website at www.firstbanks.com any amendment to or waiver from any provision in the Code of Ethics for Principal Executive Officers and Financial Professionals that applies to the Chief Executive Officer, Chief Financial Officer, Controller or other person performing similar functions and that relate to any element of the standards enumerated in the SEC rules.
Code of Conduct for Employees, Officers and Directors
The Board of Directors has approved a Code of Conduct applicable to all employees, officers and directors of the Company that addresses conflicts of interest, honesty and fair dealing, accounting and auditing matters, political activities and application and enforcement of the Code of Conduct. The Code of Conduct is available on the Company’s website, www.firstbanks.com, under “About us.”
Executive Officers
Our executive officers, each of whom was elected to the office(s) indicated by the Board of Directors, as of March 25, 2011, were as follows:
Item 11.
Item 11. Executive Compensation
Compensation Discussion and Analysis. The compensation program of the Company and its affiliates (collectively referred to only in this Item 11 as the “Company”) is reflective of its ownership structure and its participation in the CPP under the EESA. As outlined in the stock ownership table included in “Item 12
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth, as of March 25, 2011, certain information with respect to the beneficial ownership of all classes of our capital stock by each person known to us to be the beneficial owner of more than five percent of the outstanding shares of the respective classes of our stock:
____________________
*
Represents less than 1.0%.
(1)
Each of the above-named trustees and beneficial owners are United States citizens, and the business address for each such individual is 135 North Meramec, Clayton, Missouri 63105. Mr. James F. Dierberg, our Chairman of the Board, and Mrs. Mary W. Dierberg, are husband and wife, and Messrs. James F. Dierberg II and Michael J. Dierberg and Ms. Ellen C. Dierberg are their adult children.
(2)
Due to the relationship between Mr. James F. Dierberg, his wife and their children, Mr. Dierberg is deemed to share voting and investment power over these shares.
(3)
Due to the relationship between Mr. James F. Dierberg, his wife and First Bank, Mr. Dierberg is deemed to share voting and investment power over these shares.
(4)
Convertible into common stock, based on the appraised value of the common stock at the date of conversion.
(5)
Sole voting and investment power.
(6)
Shares were issued to the U.S. Treasury on December 31, 2008 pursuant to the CPP. The holders of the Class C Preferred Stock and the Class D Preferred Stock have no voting rights except in certain limited circumstances. Due to the fact that we have deferred dividends on the preferred stock issued to the U.S. Treasury for an aggregate of six quarters, the U.S. Treasury presently has the right to elect two directors to our Board but has not elected to do so as of March 25, 2011. The address of the U.S. Treasury is 1500 Pennsylvania Avenue, NW, Room 2312, Washington, D.C. 20220.
The following table sets forth, as of March 25, 2011, certain information with respect to the beneficial ownership of all classes of the capital securities of our subsidiary, FB Holdings, by each of our directors and named executive officers:
____________________
(1)
See further discussion of the membership interests of FB Holdings in Note 19 to our consolidated financial statements.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Review and Approval of Related Person Transactions. We review all relationships and transactions in which we and our directors and executive officers and their immediate family members and entities in which such persons have a significant interest are participants to determine whether such persons have a direct or indirect material interest. Our management collects information from the executive officers and the directors regarding the related person transactions and determines whether we or a related person has a direct or indirect material interest in the transaction. If we determine that a transaction is directly or indirectly material to us or a related person, then the transaction is disclosed in accordance with applicable requirements. In addition, the Audit Committee of our Board of Directors reviews and approves or ratifies any related person transaction that is required to be so disclosed. In the event that a member of the Audit Committee is a related person to such a transaction, such member may not participate in the discussion or vote regarding approval or ratification of the transaction.
Related Person Transactions. Outside of normal customer relationships, no directors, executive officers or shareholders holding over 5% of our voting securities, and no corporations or firms with which such persons or entities are associated, currently maintain or have maintained since the beginning of the last full fiscal year, any significant business or personal relationship with our subsidiaries or us, other than that which arises by virtue of such position or ownership interest in our subsidiaries or us, except as set forth in “Item 11 - Executive Compensation - Compensation of Directors,” or as described in the following paragraphs.
First Bank has had in the past, and may have in the future, loan transactions and related banking services in the ordinary course of business with our directors and/or their affiliates. These loan transactions have been made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated persons and did not involve more than the normal risk of collectability or present other unfavorable features. First Bank does not extend credit to our officers or to officers of First Bank, except extensions of credit secured by mortgages on personal residences, loans to purchase automobiles and personal credit card accounts.
Certain of our shareholders, directors and officers and their respective affiliates have deposit accounts and related banking services with First Bank. It is First Bank’s policy not to permit any of its officers or directors or their affiliates to overdraw their respective deposit accounts. Deposit account overdraft protection may be approved for persons or entities under a plan whereby a credit limit has been established in accordance with First Bank’s standard credit criteria.
Transactions with related parties, including transactions with affiliated persons and entities, are described in Note 19 to our consolidated financial statements on pages 148 through 150 of this report, which descriptions are incorporated by reference herein, and in Note 11 and Note 25 to our consolidated financial statements.
Director Independence. Our Board of Directors has determined that Messrs. Allen H. Blake, James A. Cooper, David L. Steward and Douglas H. Yaeger have no material relationship with us and each is independent. Our Audit Committee of the Board of Directors and our Compensation Committee are composed only of independent directors. In order to be considered independent, our Board of Directors must determine that a director does not have any direct or indirect material relationship with us as provided under the rules of the NYSE. In making such a determination, the Board of Directors considers all relationships between us, or any of our subsidiaries, and the director, or any of his immediate family members, or any entity with which the director or any of his immediate family members is affiliated by reason of being a partner, officer or significant shareholder thereof. In assessing the independence of our directors, the Board of Directors considered all relationships between us and our directors based primarily upon responses of the directors to questions posed through a directors’ and officers’ questionnaire. The Board of Directors considered each of the related person transaction discussed above in making its independence determination.
The Company has preferred securities of only one of its capital trusts listed on the NYSE and, pursuant to the General Application section of NYSE Rule 303A, is not subject to NYSE Rule 303A.01 requiring a majority of independent directors. Messrs. Dierberg and McCarthy are not independent because they are each current or former executive officers of the Company.
Item 14.
Item 14. Principal Accounting Fees and Services
Fees of Independent Registered Public Accounting Firm
During 2010 and 2009, KPMG LLP served as our Independent Registered Public Accounting Firm and provided services to our affiliates and us. The following table sets forth fees for professional audit services rendered by KPMG LLP for the audit of our consolidated financial statements and other audit services in 2010 and 2009:
________________________
(1)
For 2010 and 2009, audit fees include the audit of the consolidated financial statements of the Company, as well as services provided for reporting requirements under FDICIA and mortgage banking activities, which are included in the audit fees of the Company, as these services are closely related to the audit of the Company’s consolidated financial statements. Audit fees also include other accounting and reporting consultations. On an accrual basis, audit fees for 2010 and 2009 were $567,500 and $579,000, respectively.
(2)
For 2010 and 2009, tax fees consist of tax filing, compliance and other advisory services.
Policy Regarding the Approval of Independent Auditor Provision of Audit and Non-Audit Services
Consistent with the SEC requirements regarding auditor independence, the Audit Committee recognizes the importance of maintaining the independence, in fact and appearance, of our independent auditors. As such, the Audit Committee has adopted a policy for pre-approval of all audit and permissible non-audit services provided by our independent auditors. Under the policy, the Audit Committee, or its designated member, must pre-approve services prior to commencement of the specified service. The requests for pre-approval are submitted to the Audit Committee or its designated member by the Director of Audit with a statement as to whether in his/her view the request is consistent with the SEC’s rules on auditor independence. The Audit Committee reviews the pre-approval requests and the fees paid for such services at their regularly scheduled quarterly meetings or at special meetings.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)
1.
Financial Statements and Supplementary Data - The financial statements and supplementary data filed as part of this Report are included in Item 8.
2.
Financial Statement Schedules - These schedules are omitted for the reason they are not required or are not applicable.
3.
Exhibits - The exhibits are listed in the index of exhibits required by Item 601 of Regulation S-K at Item (b) below and are incorporated herein by reference.
(b)
The index of required exhibits is included beginning on page 159 of this Report.
(c)
Not Applicable.
First Banks, Inc.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
First Banks, Inc.:
We have audited the accompanying consolidated balance sheets of First Banks, Inc. and subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Banks, Inc. and subsidiaries 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 U.S. generally accepted accounting principles.
/s/ KPMG LLP
St. Louis, Missouri
March 25, 2011
First Banks, Inc.
Consolidated Balance Sheets
(dollars expressed in thousands, except share and per share data)
The accompanying notes are an integral part of the consolidated financial statements.
First Banks, Inc.
Consolidated Statements of Operations
(dollars expressed in thousands, except share and per share data)
The accompanying notes are an integral part of the consolidated financial statements.
First Banks, Inc.
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss)
Three Years Ended December 31, 2010
(dollars expressed in thousands, except per share data)
The accompanying notes are an integral part of the consolidated financial statements.
First Banks, Inc.
Consolidated Statements of Cash Flows
(dollars expressed in thousands)
First Banks, Inc.
Consolidated Statements of Cash Flows (Continued)
(dollars expressed in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
First Banks, Inc.
Notes to Consolidated Financial Statements
Note 1 - Summary of Significant Accounting Policies
The following is a summary of the significant accounting policies followed by First Banks, Inc. and subsidiaries (the Company):
Basis of Presentation. The accompanying consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and conform to predominant practices within the banking industry. Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare the consolidated financial statements in conformity with GAAP. Actual results could differ from those estimates.
Principles of Consolidation. The consolidated financial statements include the accounts of the parent company and its subsidiaries, giving effect to the noncontrolling interest in subsidiaries, as more fully described below and in Note 19 to the consolidated financial statements. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications of 2009 and 2008 amounts have been made to conform to the 2010 presentation.
All financial information is reported on a continuing operations basis, unless otherwise noted. See Note 2 to the consolidated financial statements for a discussion regarding discontinued operations and certain assets and liabilities held for sale at December 31, 2010.
The Company operates through its wholly owned subsidiary bank holding company, The San Francisco Company (SFC), headquartered in St. Louis, Missouri, and SFC’s wholly owned subsidiary bank, First Bank, also headquartered in St. Louis, Missouri.
First Bank operates through its branch banking offices and subsidiaries: First Bank Business Capital, Inc.; FB Holdings, LLC (FB Holdings); Small Business Loan Source LLC (SBLS LLC); ILSIS, Inc.; FBIN, Inc.; SBRHC, Inc.; HVIIHC, Inc.; FBSA Missouri, Inc.; FBSA California, Inc.; NT Resolution Corporation; and LC Resolution Corporation. All of the subsidiaries are wholly owned as of December 31, 2010, except: (a) FB Holdings, which is 53.23% owned by First Bank and 46.77% owned by First Capital America, Inc. (FCA), a corporation owned and operated by the Company’s Chairman of the Board and members of his immediate family, as further described in Note 19 to the consolidated financial statements. On April 30, 2009, First Bank and FCA entered into a Purchase Agreement providing for FCA to sell its 17.45% ownership interest in SBLS LLC to First Bank. As such, effective April 30, 2009, First Bank owned 100.0% of SBLS LLC, as further described in Note 19 to the consolidated financial statements. FB Holdings and SBLS LLC (prior to its acquisition by First Bank on April 30, 2009, as discussed above) are included in the consolidated financial statements with the noncontrolling ownership interest reported as a component of stockholders’ equity in the consolidated balance sheets as “noncontrolling interest in subsidiaries” and the earnings or loss, net of tax, attributable to the noncontrolling ownership interest, reported as “net loss attributable to noncontrolling interest in subsidiaries” in the consolidated statements of operations.
Regulatory Agreements. As further described under Item 1 -Supervision and Regulation - Regulatory Agreements,” on March 24, 2010, the Company, SFC and First Bank entered into a Written Agreement (Agreement) with the Federal Reserve Bank of St. Louis (FRB) requiring the Company and First Bank to take certain steps intended to improve their overall financial condition. Pursuant to the Agreement, the Company prepared and filed with the FRB a number of specific plans designed to strengthen and/or address the following matters: (i) board oversight over the management and operations of the Company and First Bank; (ii) credit risk management practices; (iii) lending and credit administration policies and procedures; (iv) asset improvement; (v) capital; (vi) earnings and overall financial condition; and (vii) liquidity and funds management.
The Agreement requires, among other things, that the Company and First Bank obtain prior approval from the FRB in order to pay dividends. In addition, the Company must obtain prior approval from the FRB to: (i) take any other form of payment from First Bank representing a reduction in capital of First Bank; (ii) make any distributions of interest, principal or other sums on junior subordinated debentures or trust preferred securities; (iii) incur, increase or guarantee any debt; or (iv) purchase or redeem any shares of the Company’s stock. Pursuant to the terms of the Agreement, the Company and First Bank submitted a written plan to the FRB to maintain sufficient capital at the Company, on a consolidated basis, and at First Bank, on a standalone basis. In addition, the Agreement also provides that the Company and First Bank must notify the FRB if the risk-based capital ratios of either entity fall below those set forth in the capital plans that were accepted by the FRB, and specifically if First Bank falls below the criteria for being well capitalized under the regulatory framework for prompt corrective action. The Company must also notify the FRB before appointing any new directors or senior executive officers or changing the responsibilities of any senior executive officer position. The Agreement also requires the Company and First Bank to comply with certain restrictions regarding indemnification and severance payments. The Agreement is specifically enforceable by the FRB in court.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The Company and First Bank must furnish periodic progress reports to the FRB regarding compliance with the Agreement. As of the date of this filing, the Company and First Bank have provided progress reports and other reports, as required under the Agreement. It is likely that the Company and First Bank may receive additional requests from the FRB regarding compliance with the Agreement. Management intends to respond promptly to any such requests. The Agreement will remain in effect until stayed, modified, terminated or suspended by the FRB.
The description of the Agreement above represents a summary and is qualified in its entirety by the full text of the Agreement which is incorporated herein by reference to Exhibit 10.19 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the United States Securities and Exchange Commission (SEC) on March 25, 2010.
Prior to entering into the Agreement on March 24, 2010, the Company and First Bank had entered into a memorandum of understanding and an informal agreement, respectively, with the FRB and the State of Missouri Division of Finance (MDOF). Each of the agreements were characterized by regulatory authorities as informal actions that were neither published nor made publicly available by the agencies and are used when circumstances warrant a milder form of action than a formal supervisory action, such as a written agreement or cease and desist order. The informal agreement with the MDOF is still in place and there have not been any modifications thereto since its inception in September 2008.
Under the terms of the prior memorandum of understanding with the FRB, the Company agreed, among other things, to provide certain information to the FRB including, but not limited to, financial performance updates, notice of plans to materially change its fundamental business and notice to issue trust preferred securities or raise additional equity capital. In addition, the Company agreed not to pay any dividends on its common or preferred stock or make any distributions of interest or other sums on its trust preferred securities without the prior approval of the FRB.
First Bank, under its informal agreement with the MDOF and the FRB, agreed to, among other things, prepare and submit plans and reports to the agencies regarding certain matters including, but not limited to, the performance of First Bank’s loan portfolio. In addition, First Bank agreed not to declare or pay any dividends or make certain other payments without the prior consent of the MDOF and the FRB and to maintain a Tier 1 capital to total assets ratio of no less than 7.00%. As further described in Note 21 to the consolidated financial statements, First Bank’s Tier 1 capital to total assets ratio was 7.68% at December 31, 2010.
While the Company and First Bank intend to take such actions as may be necessary to comply with the requirements of the Agreement with the FRB and informal agreement with the MDOF, there can be no assurance that the Company and First Bank will be able to comply fully with the requirements of the Agreement or that First Bank will be able to comply fully with the provisions of the informal agreement, that compliance with the Agreement and the informal agreement will not be more time consuming or more expensive than anticipated, that compliance with the Agreement and the informal agreement will enable the Company and First Bank to resume profitable operations, or that efforts to comply with the Agreement and the informal agreement will not have adverse effects on the operations and financial condition of the Company or First Bank.
Capital Plan. As further described in Note 2 to the consolidated financial statements and under Item 1 -Business - Recent Developments,” on August 10, 2009, the Company announced the adoption of a Capital Optimization Plan (Capital Plan) designed to improve its regulatory capital ratios and financial performance through certain divestiture activities, asset reductions and expense reductions. The Capital Plan was adopted in order to, among other things, preserve and enhance the Company’s risk-based capital in the recent economic downturn.
The successful completion of all or any portion of the Capital Plan is not assured, and no assurance can be made that the Capital Plan will not be materially modified in the future. The decision to implement the Capital Plan reflects the adverse affect that the severe downturn in the commercial and residential real estate markets has had on the Company’s financial condition and results of operations. If the Company is not able to complete substantially all of the Capital Plan, its business, financial condition, including regulatory capital ratios, and results of operations may be materially and adversely affected and its ability to withstand continued adverse economic conditions could be threatened.
Successful Completion of Consent Solicitation. The Company, the holder of 100% of the outstanding common stock of First Preferred Capital Trust IV (Trust), announced that it was soliciting consents from the holders of the 8.15% cumulative trust preferred securities of the Trust (Trust Preferred Securities). The Company solicited consents to amend: (a) the Indenture, dated April 1, 2003 (Indenture) relating to the 8.15% Subordinated Debentures due 2033 issued by the Company to the Trust (Debentures); (b) the Amended and Restated Trust Agreement, dated April 1, 2003, relating to the Trust (the Trust Agreement); and (c) the Preferred Securities Guarantee, dated April 1, 2003 (Guarantee Agreement) relating to the Trust Preferred Securities. The action was subject to approval of the holders of record (as of October 12, 2010) of a majority in aggregate liquidation amount of the outstanding Trust Preferred Securities.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The Company solicited the consents to the Indenture, Trust Agreement and Guarantee Agreement in order to increase capital planning flexibility under the terms of those documents and the provisions of the indentures, guarantee agreements and trust agreements relating to other tranches of trust preferred securities. The proposed amendments would provide an opportunity for the Company to improve its capital position and decrease its level of indebtedness during a period in which it is deferring interest payments in accordance with the terms of the Indenture.
On January 25, 2011, the Company obtained the requisite consents from the holders of the Trust Preferred Securities approving the proposed amendments. The consent solicitation terminated on January 26, 2011 after receipt by the Company and the Trustee of validly executed consents from the holders of a majority in aggregate liquidation amount of the outstanding Trust Preferred Securities.
On January 26, 2011, the Company entered into the amendments that were approved in the consent solicitation, which consist of: (i) the First Supplemental Indenture, dated as of January 26, 2011 (Supplemental Indenture) between the Company, as Issuer, and The Bank of New York Mellon Trust Company, N.A., as Trustee; (ii) the First Amendment to the Trust Agreement, dated January 26, 2011 (Trust Amendment), among the Company, The Bank of New York Mellon Trust Company, N.A., as Property Trustee, Wilmington Trust Company, as Delaware Trustee, and the Administrative Trustees named therein; and (iii) the First Amendment to Preferred Securities Guarantee Agreement, dated as of January 26, 2011 (Guarantee Amendment) between the Company, as Guarantor, and The Bank of New York Mellon Trust Company, N.A., as Guarantee Trustee.
Significant Accounting Changes. On January 1, 2009, the Company implemented Statement of Financial Accounting Standards No. 160 - Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB 51, which was subsequently incorporated into Accounting Standards CodificationTM (ASC) Topic 810, “Consolidation.” ASC Topic 810 establishes new accounting and reporting standards for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. ASC Topic 810 requires entities to classify noncontrolling interests as a component of stockholders’ equity and requires subsequent changes in ownership interests in a subsidiary to be accounted for as an equity transaction. Additionally, ASC Topic 810 requires entities to recognize a gain or loss upon the loss of control of a subsidiary and to remeasure any ownership interest retained at fair value on that date. ASC Topic 810 also requires expanded disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. ASC Topic 810 was effective on a prospective basis for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, except for the presentation and disclosure requirements, which are required to be applied retrospectively. The implementation of ASC Topic 810 on January 1, 2009 resulted in the noncontrolling interest in subsidiaries of $129.4 million being reclassified from a liability to a component of stockholders’ equity in the consolidated balance sheets.
Significant Accounting Policies
Cash and Cash Equivalents. Cash, due from banks and short-term investments, which include federal funds sold and interest-bearing deposits, are considered to be cash and cash equivalents for purposes of the consolidated statements of cash flows. Interest-bearing deposits were $924.8 million and $2.37 billion at December 31, 2010 and 2009, respectively, and federal funds sold were zero and $120,000 at December 31, 2010 and 2009, respectively.
First Bank is required to maintain certain daily reserve balances on hand in accordance with regulatory requirements. These reserve balances maintained in accordance with such requirements were $14.4 million and $14.9 million at December 31, 2010 and 2009, respectively.
Federal Reserve Bank and Federal Home Loan Bank Stock. First Bank is a member of the FRB system and the Federal Home Loan Bank (FHLB) system and maintains investments in FRB and FHLB stock. These investments are recorded at cost, which represents redemption value. The investment in FRB stock is maintained at a minimum of 6% of First Bank’s capital stock and capital surplus. The investment in FHLB of Des Moines stock is maintained at an amount equal to 0.12% of First Bank’s total assets, up to a maximum of $10.0 million, plus 4.45% of advances.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
First Bank also holds an investment in stock of the FHLB of San Francisco as a nonmember. Investments in FRB, FHLB of Des Moines and FHLB of San Francisco stock were $19.9 million, $10.0 million and $238,000, respectively, at December 31, 2010, and $27.6 million, $36.7 million and $791,000, respectively, at December 31, 2009.
Investment Securities. The classification of investment securities as available for sale or held to maturity is determined at the date of purchase. Investment securities designated as available for sale, which represent any security that the Company has no immediate plan to sell but which may be sold in the future under different circumstances, are stated at fair value. Realized gains and losses are included in noninterest income, based on the amortized cost of the individual security sold. Unrealized gains and losses, net of related income tax effects, are recorded in accumulated other comprehensive income (loss). All previous fair value adjustments included in the separate component of accumulated other comprehensive income (loss) are reversed upon sale. Premiums and discounts incurred relative to the par value of securities purchased are amortized or accreted, respectively, on the level-yield method taking into consideration the level of current and anticipated prepayments. Investment securities designated as held to maturity, which represent any security that the Company has the positive intent and ability to hold to maturity, are stated at cost, net of amortization of premiums and accretion of discounts computed on the level-yield method taking into consideration the level of current and anticipated prepayments. A decline in the fair value of any available-for-sale or held-to-maturity investment security below its carrying value that is deemed to be other than temporary results in a reduction in the cost basis of the carrying value to fair value. The other-than-temporary impairment is charged to noninterest income and a new cost basis is established. When determining other-than-temporary impairment, consideration is given as to whether the Company has the ability and intent to hold the investment security until a market price recovery and whether evidence indicating the carrying value of the investment security is recoverable outweighs evidence to the contrary.
Loans Held for Portfolio. Loans held for portfolio are carried at cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Interest and fees on loans are recognized as income using the interest method. Loan origination fees and costs are deferred and accreted to interest income over the estimated life of the loans using the interest method. Loans held for portfolio are stated at cost as the Company has the ability and it is management’s intention to hold them to maturity.
The accrual of interest on loans is discon­tinued when it appears that interest or principal may not be paid in a timely manner in the normal course of business or once principal or interest payments become 90 days past due under the contractual terms of the loan agreement. Generally, payments received on nonaccrual and impaired loans are recorded as principal reductions. Interest income is recognized after all delinquent principal has been repaid or an improvement in the condition of the loan has occurred that warrants resumption of interest accruals.
A loan is considered impaired when it is probable that the Company will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the loan agreement. Loans on nonaccrual status and restructured loans are considered to be impaired loans. When measuring impairment, the expected future cash flows of an impaired loan are discounted at the loan’s effective interest rate. Alternatively, impairment is measured by reference to an observable market price, if one exists, or the fair value of the collateral for a collateral-dependent loan. Regardless of the historical measurement method used, the Company measures impairment based on the fair value of the collateral when foreclosure is probable.
A loan is classified as a troubled debt restructuring when a borrower is experiencing financial difficulties that leads to a restructuring of the loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. These concessions may include rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses. A loan that is modified at a market rate of interest may no longer be classified as troubled debt restructuring in the calendar year subsequent to the restructuring if it is in compliance with the modified terms. Performance prior to the restructuring is considered when assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual at the time of the restructuring or after a shorter performance period.
Acquired impaired loans are classified as nonaccrual loans and are initially measured at fair value with no allocated allowance for loan losses. An allowance for loan losses is recorded to the extent there is further credit deterioration subsequent to the acquisition date.
Loans Held for Sale. Loans held for sale are comprised of residential mortgage loans held for sale in the secondary mortgage market, frequently in the form of a mortgage-backed security, U.S. Small Business Administration (SBA) loans awaiting sale of the guaranteed portion to the SBA, and commercial real estate loans which may be identified for sale to specific buyers to achieve credit or loan concentration objectives. One-to-four family residential mortgage loans held for sale are carried at fair value on a recurring basis. The determination of fair value is based on quoted market prices of comparable instruments obtained from independent pricing vendors based on recent trading activity and other relevant information. Other loans held for sale, primarily SBA loans, are carried at the lower of cost or market value, which is determined on an individual loan basis. The amount by which cost exceeds market value is recorded in a valuation allowance as a reduction of loans held for sale. Changes in the valuation allowance are reflected as part of the gain on loans sold and held for sale in the consolidated statements of operations in the periods in which the changes occur. Gains or losses on the sale of loans held for sale are determined on a specific identification basis and reflect the difference between the value received upon sale and the carrying value of the loans held for sale, including any recourse reserve established for potential repurchase obligations. Loans held for sale transferred to loans held for portfolio or available-for-sale investment securities are transferred at fair value.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Loan Servicing Income. Loan servicing income is included in noninterest income and represents fees earned for servicing real estate mortgage loans owned by investors and originated by First Bank’s mortgage banking operation, as well as SBA loans to small business concerns. These fees are net of federal agency guarantee fees and interest shortfall. Such fees are generally calculated on the outstanding principal balance of the loans serviced and are recorded as income when earned.
Allowance for Loan Losses. The allowance for loan losses is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio, and is based on quarterly evaluations of the collectability and historical loss experience of loans. Actual credit losses, net of recoveries, are deducted from the allowance for loan losses. A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in management’s judgment, is appropriate to absorb probable losses in the loan portfolio.
The allocation methodology applied by the Company, designed to assess the appropriateness of the allowance for loan losses, includes an allocation methodology, as well as management’s ongoing review and grading of the loan portfolio into criticized loan categories (defined as specific loans warranting either specific allocation, or a criticized status of special mention, substandard, doubtful or loss). The allocation methodology focuses on evaluation of several factors, including but not limited to: evaluation of facts and circumstances related to specific loans, management’s ongoing review and grading of the loan portfolio, consideration of historical loan loss and delinquency experience on each portfolio category, trends in past due and nonaccrual loans, the level of potential problem loans, the risk characteristics of the various classifications of loans, changes in the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect potential credit losses. Because each of the criteria used is subject to change, the allocation of the allowance for loan losses is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance for loan losses is available to absorb losses from any segment of the loan portfolio.
When an individual loan is determined to be impaired, the allowance for loan losses attributable to the loan is allocated based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flows, as well as evaluation of legal options available to the Company. The amount of impairment is measured based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the fair value of the underlying collateral less applicable selling costs, or the observable market price of the loan. If foreclosure is probable or the loan is collateral dependent, impairment is measured using the fair value of the loan’s collateral, less costs to sell. Large groups of homogeneous loans, such as residential mortgage, home equity and installment loans, are aggregated and collectively evaluated for impairment.
Management believes that the level of the allowance for loan losses is appropriate. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions.
In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require the Company to modify its allowance for loan losses based on their judgment about information available to them at the time of their examination.
Derivative Instruments and Hedging Activities. The Company utilizes derivative instruments and hedging strategies to assist in the management of interest rate sensitivity and to modify the repricing, maturity and option characteristics of certain assets and liabilities. The Company uses such derivative instruments solely to reduce its interest rate risk exposure. First Bank also offers interest rate swap agreement contracts to certain customers who wish to modify their interest rate sensitivity positions. First Bank offsets the interest rate risk of these swap agreements by simultaneously purchasing matching interest rate swap agreement contracts with offsetting pay/receive rates from other financial institutions.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Derivative instruments are recorded in the consolidated balance sheets and measured at fair value. At inception of a non-customer derivative transaction, the Company designates the derivative instrument as either a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedges) or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedges). For all hedging relationships, the Company documents the hedging relationship and its risk-management objectives and strategy for entering into the hedging relationship including the hedging instrument, the hedged item(s), the nature of the risk being hedged, how the hedging instrument’s effectiveness in offsetting the hedged risk will be assessed and a description of the method the Company will utilize to measure hedge ineffectiveness. This process also includes linking all derivative instruments that are designated as fair value hedges or cash flow hedges to the underlying assets and liabilities or to specific firm commitments or forecasted transactions. The Company also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of the hedged item(s). The Company discontinues hedge accounting prospectively when it is determined that the derivative instrument is no longer effective in offsetting changes in the fair value or cash flows of the hedged item(s), the derivative instrument expires or is sold, terminated, or exercised, the derivative instrument is de-designated as a hedging instrument because it is unlikely that a forecasted transaction will occur, a hedged firm commitment no longer meets the definition of a firm commitment, or management determines that designation of the derivative instrument as a hedging transaction is no longer appropriate.
A summary of the Company’s accounting policies for its derivative instruments and hedging activities is as follows:
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Interest Rate Swap Agreements - Cash Flow Hedges. Interest rate swap agreements designated as cash flow hedges are accounted for at fair value. The effective portion of the change in the cash flow hedge’s gain or loss is initially reported as a component of other comprehensive income (loss) and subsequently reclassified into interest income or interest expense when the underlying transaction affects earnings. The ineffective portion of the change in the cash flow hedge’s gain or loss is recorded in noninterest income on each monthly measurement date. The net interest differential is recognized as an adjustment to interest income or interest expense of the related asset or liability being hedged. In the event of early termination or ineffectiveness, the gain or loss on the cash flow hedge would continue to be reported as a component of other comprehensive income (loss) until the underlying transaction affects earnings.
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Interest Rate Swap Agreements - Fair Value Hedges. Interest rate swap agreements designated as fair value hedges are accounted for at fair value. Changes in the fair value of the swap agreements are recognized currently in noninterest income. The change in the fair value of the underlying hedged item is recognized as an adjustment to the carrying amount of the underlying hedged item and is also reflected currently in noninterest income. All changes in fair value are measured on a monthly basis. The net interest differential is recognized as an adjustment to interest income or interest expense of the related asset or liability being hedged. In the event of early termination or ineffectiveness, the net proceeds received or paid on the interest rate swap agreements are recognized immediately in noninterest income and the future net interest differential, if any, is recognized prospectively in noninterest income. The cumulative change in the fair value of the underlying hedged item is deferred and amortized or accreted to interest income or interest expense over the weighted average life of the related asset or liability. If, however, the underlying hedged item is repaid, the cumulative change in the fair value of the underlying hedged item is recognized immediately in noninterest income.
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Customer Interest Rate Swap Agreement Contracts. Derivative instruments are offered to customers to assist in hedging their risks of adverse changes in interest rates. First Bank serves as an intermediary between its customers and the financial markets. Each contract between First Bank and its customers is offset by a contract between First Bank and various counterparties. These contracts do not qualify for hedge accounting. Customer interest rate swap agreement contracts are carried at fair value. Changes in the fair value are recognized in noninterest income on a monthly basis. Each customer contract is paired with an offsetting contract, and as such, there is no significant impact to net income (loss).
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
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Interest Rate Cap and Floor Agreements. Interest rate cap and floor agreements are accounted for at fair value. Changes in the fair value of interest rate cap and floor agreements are recognized in noninterest income on each monthly measurement date.
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Interest Rate Lock Commitments. Commitments to originate loans for subsequent sale in the secondary market (interest rate lock commitments), which primarily consist of commitments to originate fixed rate residential mortgage loans, are recorded at fair value. Fair values are based upon quoted market prices. The value of loan servicing rights is also incorporated into fair value measurements for mortgage loan commitments. Changes in the fair value are recognized in noninterest income on a monthly basis.
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Forward Commitments to Sell Mortgage-Backed Securities. Forward commitments to sell mortgage-backed securities are recorded at fair value. Changes in the fair value of forward commitments to sell mortgage-backed securities are recognized in noninterest income on a monthly basis.
Bank Premises and Equipment, Net. Bank premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Amortization of leasehold improvements is calculated using the straight-line method over the shorter of the useful life of the related asset or the term of the lease. Bank premises and improvements are depreciated over five to 40 years and equipment is depreciated over three to seven years.
Goodwill and Other Intangible Assets. Goodwill and other intangible assets primarily consist of goodwill, core deposit intangibles and customer list intangibles. Goodwill and intangible assets with indefinite useful lives are not amortized, but instead tested at least annually for impairment. Intangible assets with definite useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment. The Company amortizes, on a straight-line basis, its core deposit intangibles, customer list intangibles and other intangibles. Core deposit intangibles and customer list intangibles are amortized over the estimated periods to be benefited, which have been estimated at five to seven years, and seven to 16 years, respectively.
The goodwill impairment test is a two-step process which requires the Company to make assumptions regarding fair value. The Company’s policy allows management to make the determination of fair value using internal cash flow models or by engaging independent third parties. The first step consists of estimating the fair value of the reporting unit using a number of factors, including projected future operating results and business plans, economic projections, anticipated future cash flows, discount rates, and comparable marketplace fair value data from within a comparable industry grouping. The Company compares the estimated fair value of its reporting unit to the carrying value, which includes allocated goodwill. If the estimated fair value is less than the carrying value, the second step is completed to compute the impairment amount by determining the “implied fair value” of goodwill. This determination requires the allocation of the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any remaining unallocated fair value represents the “implied fair value” of goodwill, which is compared to the corresponding carrying value to compute the goodwill impairment amount, if any. First Bank did not record any goodwill impairment in 2010. Based on the results of the goodwill impairment analyses performed in 2009, First Bank recorded goodwill impairment of $75.0 million. Adverse changes in the economic environment, operations of the reporting unit, or other factors could result in a decline in the implied fair value of goodwill which could result in future goodwill impairment.
Servicing Rights. The Company has mortgage servicing rights and SBA servicing rights. Changes in the fair value of mortgage and SBA servicing rights are recognized in earnings in the period in which the change occurs and such changes are reflected in the change in fair value of servicing rights in other noninterest income in the consolidated statements of operations. Servicing rights are valued based on valuation models that utilize assumptions based on the predominant risk characteristics of the underlying loans, including size, interest rate, weighted average life, cost to service and estimated prepayment speeds. The valuation models estimate the present value of estimated future net servicing income.
Mortgage and SBA servicing rights are capitalized upon the sale of the underlying loan at estimated fair value. Prior to January 1, 2008, mortgage and SBA servicing rights were capitalized by allocating the cost of the loans to servicing rights and the loans (without the servicing rights) based on the relative fair values of the two components. The fair value of mortgage and SBA servicing rights fluctuates based on changes in interest rates and certain other assumptions utilized to value the mortgage and SBA servicing rights. The value is adversely affected when interest rates decline which normally causes loan prepayments to increase. The determination of the fair value of the mortgage and SBA servicing rights is performed monthly based upon an independent third party valuation. The valuation analysis is prepared using stratifications of the mortgage and SBA servicing rights based on the predominant risk characteristics of the underlying loans, including size, interest rate, weighted average original term, weighted average remaining term and estimated prepayment speeds.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Other Real Estate. Other real estate, consisting of real estate acquired through foreclosure or deed in lieu of foreclosure, is stated at the lower of cost or fair value less applicable selling costs. The excess of cost over fair value of the property at the date of acquisition is charged to the allowance for loan losses. Subsequent reductions in carrying value, to reflect current fair value or costs incurred in maintaining the properties, are charged to noninterest expense as incurred.
Income Taxes. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in the tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are then recorded to reduce deferred tax assets to the amounts management concludes are more-likely-than-not to be realized. The Company and its eligible subsidiaries file a consolidated federal income tax return and unitary or consolidated state income tax returns in all applicable states.
In accordance with ASC Topic 740, the Company’s policy is to separately disclose any interest or penalties arising from the application of federal or state income taxes. Interest related to unrecognized tax benefits is included in interest expense and penalties related to unrecognized tax benefits are included in noninterest expense. The Company did not recognize any penalties during the years ended December 31, 2010, 2009 and 2008.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states. Management of the Company believes the accrual for tax liabilities is adequate for all open audit years based on its assessment of many factors, including past experience and interpretations of tax law applied to the facts of each matter. This assessment relies on estimates and assumptions.
Noncontributory Defined Benefit Pension Plan. The Company has a noncontributory defined benefit pension plan covering certain former employees of a bank holding company acquired by the Company in 1994 (the Plan) and subsequently merged with and into the Company on December 31, 2002. The Company discontinued the accumulation of benefits under the Plan in 1994, and as such, there is no longer any service cost being accrued by Plan participants. The Company records annual amounts relating to the Plan based on calculations that incorporate various actuarial and other assumptions including discount rates, mortality rates, and assumed rates of return. The Company reviews these assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends when deemed appropriate. The funded status of the Plan is recognized as a net asset or liability and changes in the Plan’s funded status are recognized through other comprehensive income to the extent those changes are not included in the net periodic cost.
Financial Instruments With Off-Balance Sheet Risk. A financial instrument is defined as cash, evidence of an ownership interest in an entity, or a contract that conveys or imposes on an entity the contractual right or obligation to either receive or deliver cash or another financial instrument. The Company utilizes financial instruments to reduce the interest rate risk arising from its financial assets and liabilities. These instruments involve, in varying degrees, elements of interest rate risk and credit risk in excess of the amount recognized in the consolidated balance sheets. “Interest rate risk” is defined as the possibility that interest rates may move unfavorably from the perspective of the Company due to maturity and/or interest rate adjustment timing differences between interest-earning assets and interest-bearing liabilities. The risk that a counterparty to an agreement entered into by the Company may default is defined as “credit risk.”
The Company is a party to commitments to extend credit and commercial and standby letters of credit in the normal course of business to meet the financing needs of its customers. These commitments involve, in varying degrees, elements of interest rate risk and credit risk in excess of the amount reflected in the consolidated balance sheets.
Earnings (Loss) Per Common Share. Basic earnings (loss) per common share (EPS) are computed by dividing the income (loss) available to common stockholders (the numerator) by the weighted average number of shares of common stock outstanding (the denominator) during the year. The computation of dilutive EPS is similar except the denominator is increased to include the number of additional shares of common stock that would have been outstanding if the dilutive potential shares had been issued. In addition, in computing the dilutive effect of convertible securities, the numerator is adjusted to add back any convertible preferred dividends.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 2 -
Discontinued Operations, Assets and Liabilities Held for Sale and Other Corporate Transactions
Discontinued Operations. Northern Illinois Region. During the year ended December 31, 2010, First Bank entered into three Branch Purchase and Assumption Agreements that provided for the sale of certain assets and the transfer of certain liabilities associated with 14 of First Bank’s branch banking offices in Northern Illinois, as further described below.
On December 21, 2010, First Bank entered into a Branch Purchase and Assumption Agreement with United Community Bank (United Community) that provided for the sale of certain assets and the transfer of certain liabilities associated with First Bank’s three retail branches in Pittsfield, Roodhouse and Winchester, Illinois to United Community. Under the terms of the agreement, United Community is to assume approximately $94.1 million of deposits associated with these branches, including certain commercial deposit relationships, for a weighted average premium of approximately 2.4%. United Community is also expected to purchase approximately $40.3 million of loans as well as certain other assets at par value, including premises and equipment, associated with these branches. The assets and liabilities being sold in this transaction are reflected in assets and liabilities of discontinued operations in the consolidated balance sheets as of December 31, 2010. The transaction, which is subject to regulatory approvals and certain closing conditions, is expected to be completed during the second quarter of 2011.
On June 7, 2010, First Bank entered into a Branch Purchase and Assumption Agreement with Bank of Springfield that provided for the sale of certain assets and the transfer of certain liabilities of First Bank’s branch banking office located in Jacksonville, Illinois (Jacksonville Branch) to Bank of Springfield. The transaction was completed on September 24, 2010. Under the terms of the agreement, Bank of Springfield assumed $28.9 million of deposits associated with the Jacksonville Branch, including certain commercial deposit relationships, for a premium of approximately 4.00%, or $1.2 million. Bank of Springfield also purchased $2.2 million of loans as well as certain other assets at par value, including premises and equipment, associated with the Jacksonville Branch.
On May 7, 2010, First Bank entered into a Branch Purchase and Assumption Agreement with First Mid-Illinois Bank & Trust, N.A. (First Mid-Illinois) that provided for the sale of certain assets and the transfer of certain liabilities associated with 10 of First Bank’s retail branches in Peoria, Galesburg, Quincy, Bartonville, Knoxville and Bloomington, Illinois to First Mid-Illinois. The transaction was completed on September 10, 2010. Under the terms of the agreement, First Mid-Illinois assumed $336.0 million of deposits, including certain commercial deposit relationships, for a premium of 4.77%, or $15.6 million. First Mid-Illinois also purchased approximately $135.2 million of loans as well as certain other assets at par value, including premises and equipment, associated with these branches.
The 14 branches in the transactions with United Community, Bank of Springfield and First Mid-Illinois are collectively defined as the Northern Illinois Region (Northern Illinois Region). The Bank of Springfield and First Mid-Illinois transactions, in the aggregate, resulted in a gain of $6.4 million, net of a reduction in goodwill and intangible assets of $9.7 million allocated to the Northern Illinois Region, during the third quarter of 2010. The Company allocated goodwill and intangible assets of $1.6 million to the transaction with United Community, as further described in Note 8 to the consolidated financial statements.
The Company applied discontinued operations accounting in accordance with ASC Topic 205-20, “Presentation of Financial Statements - Discontinued Operations,” to the assets and liabilities being sold in the Northern Illinois Region as of December 31, 2010 and for the years ended December 31, 2010, 2009 and 2008. These assets and liabilities, which were previously reported in the First Bank segment, were sold or are being sold as part of the Company’s Capital Plan to preserve risk-based capital. See further discussion of the Company’s Capital Plan under “Item 1 -Business - Capital Plan.”
Missouri Valley Partners, Inc. On March 5, 2010, First Bank entered into a Stock Purchase Letter Agreement that provided for the sale of First Bank’s subsidiary, Missouri Valley Partners, Inc. (MVP) to Stifel Financial Corp. The transaction was completed on April 15, 2010. Under the terms of the agreement, First Bank sold all of the capital stock of MVP for a purchase price of $515,000. The transaction resulted in a loss of $156,000 during the second quarter of 2010. The Company applied discontinued operations accounting to MVP as of December 31, 2009 and for the years ended December 31, 2010, 2009 and 2008. MVP was previously reported in the First Bank segment and was sold as part of the Company’s Capital Plan.
Texas Region. On February 8, 2010, First Bank entered into a Purchase and Assumption Agreement with Prosperity Bank (Prosperity), headquartered in Houston, Texas, that provided for the sale of certain assets and the transfer of certain liabilities of First Bank’s Texas franchise (Texas Region) to Prosperity. The transaction was completed on April 30, 2010. Under the terms of the agreement, Prosperity assumed substantially all of the deposits associated with First Bank’s 19 Texas retail branches, including certain commercial deposit relationships, which totaled $492.2 million, for a premium of 5.50%, or $26.9 million. Prosperity also purchased $96.7 million of loans as well as certain other assets, including premises and equipment, associated with First Bank’s Texas Region. The transaction resulted in a gain of $5.0 million, net of a reduction in goodwill and intangible assets of $20.0 million allocated to the Texas Region, during the second quarter of 2010. The Company applied discontinued operations accounting to the assets and liabilities being sold in the Texas Region as of December 31, 2009 and for the years ended December 31, 2010, 2009 and 2008. These assets and liabilities, which were previously reported in the First Bank segment, were sold as part of the Company’s Capital Plan.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
WIUS, Inc. and WIUS of California, Inc. On December 3, 2009, First Bank and Universal Premium Acceptance Corporation, predecessor to WIUS, Inc. and its wholly owned subsidiary, WIUS of California, Inc. (collectively, WIUS), entered into a Purchase and Sale Agreement that provided for the sale of certain assets and the transfer of certain liabilities of WIUS to PFS Holding Company, Inc., Premium Financing Specialists, Inc., Premium Financing Specialists of California, Inc. and Premium Financing Specialists of the South, Inc. (collectively, PFS). Under the terms of the agreement, PFS purchased $141.3 million of loans as well as certain other assets, including premises and equipment, associated with WIUS. PFS also assumed certain other liabilities associated with WIUS. With the exception of the subsequent sale of $1.5 million of additional loans to PFS on February 26, 2010, the transaction was completed on December 31, 2009, and resulted in a loss of $13.1 million, net of a reduction in goodwill and intangible assets of $20.0 million allocated to WIUS, during the fourth quarter of 2009. On August 31, 2010, First Bank sold all of the capital stock of WIUS to an unrelated third party for a purchase price of approximately $100,000, which resulted in a loss of approximately $29,000. The Company applied discontinued operations accounting to WIUS as of December 31, 2009 and for the years ended December 31, 2010, 2009 and 2008. WIUS, which was previously reported in the First Bank segment, was sold as part of the Company’s Capital Plan.
Chicago Region. On November 11, 2009, First Bank entered into a Purchase and Assumption Agreement that provided for the sale of certain assets and the transfer of certain liabilities of First Bank’s Chicago franchise (Chicago Region) to FirstMerit Bank, N.A. (FirstMerit). The transaction was completed on February 19, 2010. Under the terms of the agreement, FirstMerit assumed substantially all of the deposits associated with First Bank’s 24 Chicago retail branches, including certain commercial deposit relationships, which totaled $1.20 billion, for a premium of 3.50%, or $42.1 million. FirstMerit also purchased $301.2 million of loans as well as certain other assets, including premises and equipment, associated with First Bank’s Chicago Region. The transaction resulted in a gain of $8.4 million, net of a reduction in goodwill and intangible assets of $26.3 million allocated to the Chicago Region, during the first quarter of 2010. The Company applied discontinued operations accounting to the assets and liabilities being sold in the Chicago Region as of December 31, 2009, and for the years ended December 31, 2010, 2009 and 2008. These assets and liabilities, which were previously reported in the First Bank segment, were sold as part of the Company’s Capital Plan.
Adrian N. Baker & Company. On September 18, 2009, First Bank and Adrian N. Baker & Company signed a Stock Purchase Agreement that provided for the sale of First Bank’s subsidiary, ANB, to AHM Corporation Holdings, Inc. (AHM). Under the terms of the agreement, AHM purchased all of the capital stock of ANB for a purchase price of $14.3 million. The sale of ANB was completed on September 30, 2009 and resulted in a gain of $120,000 during 2009, net of a reduction in goodwill and intangible assets of $13.0 million allocated to ANB. The Company applied discontinued operations accounting to ANB for the years ended December 31, 2009 and 2008. ANB, which was previously reported in the First Bank segment, was sold as part of the Company’s Capital Plan.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Assets and liabilities of discontinued operations at December 31, 2010 were as follows:
Assets and liabilities of discontinued operations at December 31, 2009 were as follows:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Income from discontinued operations, net of tax, for the year ended December 31, 2010 was as follows:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Loss from discontinued operations, net of tax, for the year ended December 31, 2009 was as follows:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Loss from discontinued operations, net of tax, for the year ended December 31, 2008 was as follows:
The Company did not allocate any consolidated interest that is not directly attributable to or related to discontinued operations.
All financial information in the consolidated financial statements and notes to the consolidated financial statements reflects continuing operations, unless otherwise noted.
Assets Held for Sale and Liabilities Held for Sale. On January 28, 2011, First bank entered into a Branch Purchase and Assumption Agreement that provided for the sale of First Bank’s Edwardsville, Illinois branch office (Edwardsville Branch) to National Bank, as further described in Note 25 to the consolidated financial statements. Under the terms of the agreement, National Bank is to assume approximately $13.7 million of deposits associated with the Edwardsville Branch, including certain commercial deposit relationships, for a premium of $130,000. National Bank is also expected to purchase approximately $794,000 of loans associated with the Edwardsville Branch at a premium of 0.5%, or approximately $4,000, and premises and equipment associated with the Edwardsville Branch at a premium of approximately $600,000. The transaction, which is subject to regulatory approvals and certain closing conditions, is expected to be completed during the second quarter of 2011. The assets and liabilities associated with the Edwardsville Branch were reflected in assets held for sale and liabilities held for sale in the consolidated balance sheet as of December 31, 2010.
On November 9, 2010, First bank entered into a Branch Purchase and Assumption Agreement that provided for the sale of First Bank’s San Jose, California branch office (San Jose Branch) to City National Bank (City National). The transaction was completed on February 11, 2011, and resulted in a loss of $334,000 during the first quarter of 2011, as further described in Note 25 to the consolidated financial statements. Under the terms of the agreement, City National assumed $8.4 million of deposits for a premium of 5.85%, or $371,000. City National also purchased certain other assets at par value, including premises and equipment. The assets and liabilities associated with the San Jose Branch were reflected in assets held for sale and liabilities held for sale in the consolidated balance sheet as of December 31, 2010.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
On January 22, 2010, First Bank completed the sale of its banking office located in Lawrenceville, Illinois (Lawrenceville Branch) to The Peoples State Bank of Newton (Peoples). The transaction resulted in a gain of $168,000, net of a reduction in goodwill of $1.0 million allocated to the Lawrenceville Branch, during the first quarter of 2010. In conjunction with the transaction, Peoples assumed $23.7 million of deposits for a premium of 5.0%, or approximately $1.2 million, as well as certain other liabilities, and purchased $13.5 million of loans at par value as well as certain other assets, including premises and equipment. The assets and liabilities associated with the Lawrenceville Branch were reflected in assets held for sale and liabilities held for sale in the consolidated balance sheet as of December 31, 2009.
The Edwardsville, San Jose and Lawrenceville Branch sales were not included in discontinued operations as the Company will have continuing involvement in the respective regions.
On December 14, 2009, SBLS LLC entered into an agreement providing for the transfer of SBLS LLC’s SBA Lending Authority (SBA License) to a third party institution for cash of $750,000. The transaction was completed on April 6, 2010 and resulted in a gain of $13,000 during the second quarter of 2010. The carrying value of SBLS LLC’s SBA License of $737,000 was reflected in assets held for sale in the consolidated balance sheet as of December 31, 2009.
Branch Sales. On November 23, 2009, First Bank completed the sale of its banking office located in Springfield, Illinois (Springfield Branch) to First Bankers Trust Company, National Association, a subsidiary of First Bankers Trustshares, Inc., resulting in a gain of $309,000, net of a reduction in goodwill of $1.0 million allocated to the Springfield Branch. At the time of the transaction, the Springfield Branch had loans, net of unearned discount, of $887,000 and deposits of $20.1 million.
De Novo Branch Offices. During the three years ended December 31, 2010, First Bank opened the following de novo branch offices:
_________________
(1)
Branch office is associated with discontinued operations, as further described above in the “Discontinued Operations” section of this footnote.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 3 - Investments in Debt and Equity Securities
Securities Available for Sale. The amortized cost, contractual maturity, gross unrealized gains and losses and fair value of investment securities available for sale at December 31, 2010 and 2009 were as follows:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Securities Held to Maturity. The amortized cost, contractual maturity, gross unrealized gains and losses and fair value of investment securities held to maturity at December 31, 2010 and 2009 were as follows:
Proceeds from sales of available-for-sale investment securities were $249.2 million, $521.8 million and $417.4 million for the years ended December 31, 2010, 2009 and 2008, respectively. Proceeds from calls of investment securities were $2.4 million, $2.9 million and $24.5 million for the years ended December 31, 2010, 2009 and 2008, respectively. Gross realized gains and gross realized losses on investment securities for the years ended December 31, 2010, 2009 and 2008 were as follows:
The Company recorded other-than-temporary impairment of $1.2 million and $10.4 million for the years ended December 31, 2009 and 2008, respectively, on equity investments in the common stock of two companies in the financial services industry, which management considers to have been primarily caused by economic events impacting the financial services industry as a whole. The Company sold these equity investments during the year ended December 31, 2010. The Company also recorded other-than-temporary impairment of $1.0 million for the year ended December 31, 2008 on a preferred stock investment necessitated by bankruptcy proceedings of the underlying financial services company. The impairment recorded in 2010, 2009 and 2008 represented the difference between the cost basis and fair value of the equity securities as of the respective impairment recognition dates.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Investment securities with a carrying value of approximately $234.9 million and $369.3 million at December 31, 2010 and 2009, respectively, were pledged in connection with deposits of public and trust funds, securities sold under agreements to repurchase and for other purposes as required by law.
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2010 and 2009, were as follows:
U.S. Treasury and U.S. Government sponsored agency securities - The unrealized losses on investments in U.S. Treasury and U.S. Government sponsored agency securities were caused by fluctuations in interest rates. The contractual terms of these securities are guaranteed by government-sponsored enterprises. It is expected that the securities would not be settled at a price less than the amortized cost. Because the decline in fair value is attributable to changes in interest rates and not credit loss, and because the Company does not intend to sell these investments and it is more likely than not that First Bank will not be required to sell these securities before the anticipated recovery of the remaining amortized cost basis or maturity, these investments are not considered other-than-temporarily impaired.
Mortgage-backed securities - The unrealized losses on investments in mortgage-backed securities were caused by fluctuations in interest rates. The contractual terms of these securities are guaranteed by government-sponsored enterprises. It is expected that the securities would not be settled at a price less than the amortized cost. Because the decline in fair value is attributable to changes in interest rates and not credit loss, and because the Company does not intend to sell these investments and it is more likely than not that First Bank will not be required to sell these securities before the anticipated recovery of the remaining amortized cost basis or maturity, these investments are not considered other-than-temporarily impaired. At December 31, 2010 and 2009, the unrealized losses for residential mortgage-backed securities for 12 months or more included nine securities and 14 securities, respectively. At December 31, 2009, the unrealized losses for commercial mortgage-backed securities for 12 months or more included one security.
State and political subdivisions - The unrealized losses on investments in state and political subdivisions were caused by fluctuations in interest rates. It is expected that the securities would not be settled at a price less than the amortized cost. Because the decline in fair value is attributable to changes in interest rates and not credit loss, and because the Company does not intend to sell these investments and it is more likely than not that First Bank will not be required to sell these securities before the anticipated recovery of the remaining amortized cost or maturity, these investments are not considered other-than-temporarily impaired. At December 31, 2009, the unrealized losses for state and political subdivisions for 12 months or more included one security.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 4 - Loans and Allowance for Loan Losses
The following table summarizes the composition of the loan portfolio at December 31, 2010 and 2009:
The Company’s primary market areas are the states of California, Florida, Illinois and Missouri. At December 31, 2010 and 2009, approximately 94% of the total loan portfolio, and 86% and 88% of the commercial, financial and agricultural loan portfolio, respectively, were made to borrowers within these states.
Real estate lending constitutes the only significant concentration of credit risk. Real estate loans comprised approximately 76% and 74% of the loan portfolio at December 31, 2010 and 2009, respectively, of which 32% and 27%, respectively, were made to consumers in the form of residential real estate mortgages and home equity lines of credit. First Bank also offers residential real estate mortgage loans with terms that require interest only payments. At December 31, 2010, the balance of such loans, all of which were held for portfolio, was approximately $59.1 million, of which approximately 24.2% were delinquent. At December 31, 2009, the balance of such loans, all of which were held for portfolio, was approximately $129.6 million, of which approximately 31.8% were delinquent.
In general, the Company is a secured lender. At December 31, 2010 and 2009, 99% of the loan portfolio was collateralized. Collateral is required in accordance with the normal credit evaluation process based upon the creditworthiness of the customer and the credit risk associated with the particular transaction.
First Bank originates certain one-to-four family residential mortgage loans for sale in the secondary market. First Bank has a repurchase obligation on these loans in the event of fraud or, on certain loans, early payment default. The early payment default provisions generally range from four months to one year after sale of the loan in the secondary market.
Loans to directors, their affiliates and executive officers of the Company were approximately $9.1 million and $37.2 million at December 31, 2010 and 2009, respectively, as further described in Note 19 to the consolidated financial statements.
Loans with a carrying value of approximately $2.06 billion and $3.00 billion at December 31, 2010 and 2009, respectively, were pledged as collateral under borrowing arrangements with the FRB and the FHLB. At December 31, 2010 and 2009, First Bank had aggregate outstanding advances of zero and $600.0 million, respectively, under these borrowing arrangements, as further described in Note 10 to the consolidated financial statements.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The following table presents the aging of loans by loan classification at December 31, 2010:
Under the Company’s loan policy, loans are placed on nonaccrual status once principal or interest payments become 90 days past due. However, individual loan officers may submit written requests for approval to continue the accrual of interest on loans that become 90 days past due. These requests may be submitted for approval consistent with the authority levels provided in the Company’s credit approval policies, and they are only granted if an expected near term future event, such as a pending renewal or expected payoff, exists at the time the loan becomes 90 days past due. If the expected near term future event does not occur as anticipated, the loan is then placed on nonaccrual status. At December 31, 2010 and 2009, the Company had $5.5 million and $3.8 million, respectively, of loans past due 90 days or more and still accruing interest.
The Company’s credit management policies and procedures focus on identifying, measuring and controlling credit exposure. These procedures employ a lender-initiated system of rating credits, which is ratified in the loan approval process and subsequently tested in internal credit reviews, external audits and regulatory bank examinations. The system requires the rating of all loans at the time they are originated or acquired, except for homogeneous categories of loans, such as residential real estate mortgage loans and consumer loans. These homogeneous loans are assigned an initial rating based on the Company’s experience with each type of loan. The Company adjusts the ratings of the homogeneous loans based on payment experience subsequent to their origination.
The Company includes adversely rated credits, including loans requiring close monitoring that would not normally be considered classified credits by the Company’s regulators, on its monthly loan watch list. Loans may be added to the Company’s watch list for reasons that are temporary and correctable, such as the absence of current financial statements of the borrower or a deficiency in loan documentation. Loans may also be added to the Company’s watch list whenever any adverse circumstance is detected which might affect the borrower’s ability to comply with the contractual terms of the loan. The delinquency of a scheduled loan payment, deterioration in the borrower’s financial condition identified in a review of periodic financial statements, a decrease in the value of the collateral securing the loan, or a change in the economic environment within which the borrower operates could initiate the addition of a loan to the Company’s watch list. Loans on the Company’s watch list require periodic detailed loan status reports prepared by the responsible officer which are discussed in formal meetings with credit review and credit administration staff members. Upgrades and downgrades of loan risk ratings may be initiated by the responsible loan officer. However, upgrades of risk ratings associated with significant credit relationships and/or problem credit relationships may only be made with the concurrence of appropriate regional or senior regional credit officers.
Under the Company’s risk rating system, special mention loans are those loans that do not currently expose the Company to sufficient risk to warrant classification as substandard, troubled debt restructuring (TDR) or nonaccrual, but possess weaknesses that deserve management’s close attention. Substandard loans include those loans characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. A loan is classified as a TDR when a borrower is experiencing financial difficulties that leads to the restructuring of a loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. Loans classified as nonaccrual have all the weaknesses inherent in those loans classified as substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of the 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.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The following table presents the credit exposure of the commercial loan portfolio by internally assigned credit grade as of December 31, 2010:
The following table presents the credit exposure of the one-to-four family residential mortgage Bank portfolio and home equity portfolio by internally assigned credit grade as of December 31, 2010:
The following table presents the credit exposure of the one-to-four family residential Mortgage Division portfolio and consumer and installment portfolio by payment activity as of December 31, 2010:
Loans deemed to be impaired include TDRs and nonaccrual loans. Impaired loans with outstanding balances equal to or greater than $500,000 are evaluated individually for impairment. For these loans, the Company measures the level of impairment based on the present value of the estimated projected cash flows or the estimated value of the collateral. If the current valuation is lower than the current book balance of the loan, the negative difference is evaluated for possible charge-off. In instances where management determines that a charge-off is not appropriate, a specific reserve is established for the individual loan in question. This specific reserve is included as a part of the overall allowance for loan losses.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The following table presents the recorded investment, unpaid principal balance, related allowance for loan losses, average recorded investment and interest income recognized while on impaired status for impaired loans without a related allowance for loan losses and for impaired loans with a related allowance for loan losses by loan classification at December 31, 2010:
Recorded investment represents the Company’s investment in its impaired loans reduced by any charge-offs recorded against the allowance for loan losses on these same loans. At December 31, 2010, the Company had recorded charge-offs of $187.9 million on its impaired loans, representing the difference between the unpaid principal balance and the recorded investment reflected in the table above. The unpaid principal balance represents the principal amount contractually owed to the Company by the borrowers on the impaired loans.
The aggregate allocation of the allowance for loan losses related to impaired loans was approximately $50.9 million and $83.4 million at December 31, 2010 and 2009, respectively.
The Company had $511.8 million and $745.4 million of impaired loans, consisting of loans on nonaccrual status and restructured loans, at December 31, 2010 and 2009, respectively. Interest on impaired loans at December 31, 2010, 2009 and 2008, respectively, that would have been recorded under the original terms of the loans was $46.3 million, $64.1 million and $38.0 million for the years ended December 31, 2010, 2009 and 2008, respectively. Of these amounts, $14.2 million, $23.0 million and $19.0 million was recorded as interest income on such loans in 2010, 2009 and 2008, respectively. The average recorded investment in impaired loans was $619.4 million, $565.9 million and $351.5 million for the years ended December 31, 2010, 2009 and 2008, respectively. The amount of interest income recognized using a cash basis method of accounting during the time these loans were impaired was $5.9 million, $4.7 million and $987,000 in 2010, 2009 and 2008, respectively.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The outstanding balance and carrying amount of impaired loans acquired in acquisitions was $1.4 million and $314,000, respectively, at December 31, 2010, and $5.9 million and $1.9 million, respectively, at December 31, 2009. Changes in the carrying amount of impaired loans acquired in acquisitions for the years ended December 31, 2010 and 2009 were as follows:
As these loans were classified as nonaccrual loans, there was no accretable yield related to these loans at December 31, 2010 and 2009. There were no impaired loans acquired during the years ended December 31, 2010 and 2009.
Changes in the allowance for loan losses for the years ended December 31, 2010, 2009 and 2008 were as follows:
The following table represents a summary of changes in the allowance for loan losses by portfolio segment for the year ended December 31, 2010 in addition to the impairment method used by loan category at December 31, 2010:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 5 - Derivative Instruments
The Company utilizes derivative financial instruments to assist in the management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities. Derivative financial instruments held by the Company at December 31, 2010 and 2009 are summarized as follows:
_________________
(1)
In August 2009, the Company discontinued hedge accounting following the announcement of the deferral of interest payments on the underlying trust preferred securities associated with its junior subordinated debentures.
(2)
In December 2010, the Company terminated its $50.0 million notional amount interest rate swap agreement, scheduled to mature on December 15, 2011.
The notional amounts of derivative financial instruments do not represent amounts exchanged by the parties and, therefore, are not a measure of the Company’s credit exposure through its use of these instruments. The credit exposure represents the loss the Company would incur in the event the counterparties failed completely to perform according to the terms of the derivative financial instruments and the collateral held to support the credit exposure was of no value. The Company’s credit exposure on interest rate swaps is limited to the net fair value and related accrued interest receivable reduced by the amount of collateral pledged by the counterparty. At December 31, 2010 and 2009, the Company had pledged cash of $1.1 million and $3.9 million, respectively, as collateral in connection with its interest rate swap agreements on junior subordinated debentures. Collateral requirements are monitored on a daily basis and adjusted as necessary.
For the years ended December 31, 2010, 2009 and 2008, the Company realized net interest income of $5.7 million, $12.5 million and $11.5 million, respectively, on its derivative financial instruments. The Company also recorded net losses on derivative financial instruments, which are included in noninterest income in the statements of operations, of $2.9 million and $4.9 million for the years ended December 31, 2010 and 2009, respectively, in comparison to net gains on derivative financial instruments of $1.7 million for the year ended December 31, 2008.
Cash Flow Hedges - Subordinated Debentures. The Company entered into four interest rate swap agreements, which were designated as cash flow hedges prior to August 2009, with the objective of stabilizing the long-term cost of capital and cash flow, and accordingly, net interest expense on junior subordinated debentures to the respective call dates of certain junior subordinated debentures. These swap agreements provided for the Company to receive an adjustable rate of interest equivalent to the three-month London Interbank Offered Rate (LIBOR) plus 1.65%, 1.85%, 1.61% and 2.25%, and pay a fixed rate of interest. The terms of the swap agreements provide for the Company to pay and receive interest on a quarterly basis. In December 2010, the Company terminated its $50.0 million notional interest rate swap agreement that provided for the Company to receive an adjustable rate of interest equivalent to the three-month LIBOR plus 1.85%, and pay a fixed rate of interest.
The amount receivable by the Company under these swap agreements was $149,000 and $197,000 at December 31, 2010 and 2009, respectively, and the amount payable by the Company under these swap agreements was $335,000 and $451,000 at December 31, 2010 and 2009, respectively.
In August 2009, the Company reclassified a cumulative fair value adjustment of $4.6 million on its interest rate swap agreements designated as cash flow hedges on its junior subordinated debentures from accumulated other comprehensive income to loss on derivative instruments as a result of the discontinuation of hedge accounting following the announcement of the deferral of interest payments on the underlying trust preferred securities. In conjunction with the discontinuation of hedge accounting, the net interest differential on these interest rate swap agreements was recorded as a reduction of noninterest income effective August 2009.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The maturity dates, notional amounts, interest rates paid and received and fair value of the Company’s interest rate swap agreements designated as cash flow hedges on certain junior subordinated debentures as of December 31, 2010 and 2009 were as follows:
Cash Flow Hedges - Loans. The Company entered into the following interest rate swap agreements, which were designated as cash flow hedges, to effectively lengthen the repricing characteristics of certain loans to correspond more closely with their funding source with the objective of stabilizing cash flow, and accordingly, net interest income over time:
Ø
In September 2006, the Company entered into a $200.0 million notional amount three-year interest rate swap agreement and a $200.0 million notional amount four-year interest rate swap agreement. The underlying hedged assets were certain variable rate loans within the Company’s commercial loan portfolio. The swap agreements provided for the Company to receive a fixed rate of interest and pay an adjustable rate of interest equivalent to the weighted average prime lending rate minus 2.86%. The terms of the swap agreements provided for the Company to pay and receive interest on a quarterly basis. In December 2008, the Company terminated these swap agreements. The pre-tax gain of $20.8 million, in aggregate, was amortized as an increase to interest and fees on loans in the consolidated statements of operations over the remaining terms of the respective interest rate swap agreements, which had contractual maturity dates of September 18, 2009 and September 20, 2010.
For interest rate swap agreements designated as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income (loss) and reclassified into interest income or interest expense in the same period the hedged transaction affects earnings. The ineffective portion of the change in the cash flow hedge’s gain or loss is recorded in noninterest income on each monthly measurement date. The Company did not recognize any ineffectiveness related to interest rate swap agreements that were designated as cash flow hedges on junior subordinated debentures in the consolidated statements of operations from January 1, 2009 through the discontinuation of hedge accounting in August 2009. The net cash flows on the interest rate swap agreements on junior subordinated debentures were recorded as an adjustment to interest expense on junior subordinated debentures until the discontinuation of hedge accounting in August 2009. The Company also did not recognize any ineffectiveness related to interest rate swap agreements designated as cash flow hedges on loans in the consolidated statements of operations for the years ended December 31, 2010, 2009 and 2008. The net cash flows on the interest rate swap agreements on loans were recorded as an adjustment to interest income on loans.
Customer Interest Rate Swap Agreements. First Bank offers interest rate swap agreements to certain customers to assist in hedging their risks of adverse changes in interest rates. First Bank serves as an intermediary between its customers and the financial markets. Each interest rate swap agreement between First Bank and its customers is offset by an interest rate swap agreement between First Bank and various counterparties. These interest rate swap agreements do not qualify for hedge accounting treatment. Changes in the fair value are recognized in noninterest income on a monthly basis. Each customer contract is paired with an offsetting contract, and as such, there is no significant impact to net income (loss). The notional amount of these interest rate swap agreement contracts at December 31, 2010 and 2009 was $53.7 million and $80.2 million, respectively.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Interest Rate Floor Agreements. In September 2005, First Bank entered into a $100.0 million notional amount three-year interest rate floor agreement in conjunction with its interest rate risk management program. The interest rate floor agreement provided for First Bank to receive a quarterly fixed rate of interest of 5.00% should the three-month LIBOR equal or fall below the strike price of 2.00%. In August 2006, First Bank entered into a $200.0 million notional amount three-year interest rate floor agreement in conjunction with the restructuring of one of First Bank’s $100.0 million term repurchase agreements, as further described below, to further stabilize net interest income in the event of a declining rate scenario. The interest rate floor agreement provided for First Bank to receive a quarterly adjustable rate of interest equivalent to the differential between the strike price of 4.00% and the three-month LIBOR should the three-month LIBOR equal or fall below the strike price. In May 2008, First Bank terminated its interest rate floor agreements to modify its overall hedge position in accordance with its interest rate risk management program, and did not incur any gains or losses in conjunction with the termination of these interest rate floor agreements. Changes in the fair value of interest rate floor agreements are recognized in noninterest income.
Interest Rate Floor Agreements Embedded in Term Repurchase Agreements. Prior to December 2010, First Bank had a term repurchase agreement under a master repurchase agreement with an unaffiliated third party, as further described in Note 10 to the consolidated financial statements. The underlying securities associated with the term repurchase agreement were agency collateralized mortgage obligation securities and were held by other financial institutions under safekeeping agreements. The term repurchase agreement was entered into with the objective of stabilizing net interest income over time, further protecting the net interest margin against changes in interest rates and providing funding for security purchases. The original term repurchase agreement had a borrowing amount of $100.0 million, a maturity date of October 12, 2010, and contained an embedded interest rate floor agreement which was terminated in 2008. The interest rate floor agreement included within the original term repurchase agreement represented an embedded derivative instrument which, in accordance with existing accounting literature governing derivative instruments, was not required to be separated from the term repurchase agreement and accounted for separately as a derivative financial instrument. In March 2008, First Bank restructured its original $100.0 million term repurchase agreement. The primary modifications were to: (a) increase the borrowing amount from $100.0 million to $120.0 million; (b) extend the maturity date from October 12, 2010 to April 12, 2012; (c) convert the interest rate from a variable rate tied to LIBOR to a fixed rate of 3.36%; and (d) terminate the embedded interest rate floor agreement contained within the original term repurchase agreement. These modifications resulted in a gain of $5.0 million, which is reflected in noninterest income in the consolidated statements of operations. In November 2010, First Bank terminated its modified repurchase agreement due to mature on April 12, 2012, resulting in an early termination fee of $5.5 million, which is reflected in noninterest expense in the consolidated statements of operations.
Interest Rate Lock Commitments / Forward Commitments to Sell Mortgage-Backed Securities. Derivative financial instruments issued by the Company consist of interest rate lock commitments to originate fixed-rate loans to be sold. Commitments to originate fixed-rate loans consist primarily of residential real estate loans. These net loan commitments and loans held for sale are hedged with forward contracts to sell mortgage-backed securities, which expire in March 2011. The fair value of the interest rate lock commitments, which is included in other assets in the consolidated balance sheets, was an unrealized gain of $276,000 and $369,000 at December 31, 2010 and 2009, respectively. The fair value of the forward contracts to sell mortgage-backed securities, which is included in other assets in the consolidated balance sheets, was an unrealized gain of $1.5 million and $647,000 at December 31, 2010 and 2009, respectively. Changes in the fair value of interest rate lock commitments and forward commitments to sell mortgage-backed securities are recognized in noninterest income on a monthly basis.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The following table summarizes derivative financial instruments held by the Company, their estimated fair values and their location in the consolidated balance sheets at December 31, 2010 and 2009:
The following table summarizes amounts included in the consolidated statements of operations and in accumulated other comprehensive income (loss) in the consolidated balance sheets as of and for the years ended December 31, 2010, 2009 and 2008 related to interest rate swap agreements designated as cash flow hedges:
_________________
(1)
In August 2009, the Company discontinued hedge accounting following the announcement of the deferral of interest payments on the underlying trust preferred securities associated with its junior subordinated debentures.
The unamortized gain related to the fair value of the cash flow hedges on loans terminated in December 2008 in accumulated other comprehensive loss was $5.7 million, on a gross basis, and $3.7 million, net of tax, at December 31, 2009, and was fully amortized in September 2010, as previously discussed.
In August 2009, the Company reclassified a cumulative fair value adjustment of $4.6 million on its interest rate swap agreements designated as cash flow hedges on its junior subordinated debentures from accumulated other comprehensive loss to net loss on derivative instruments as a result of the discontinuation of hedge accounting following the announcement of the deferral of interest payments on the underlying trust preferred securities in August 2009, as further described in Note 12 to the consolidated financial statements.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The following table summarizes amounts included in the consolidated statements of operations for the years December 31, 2010, 2009 and 2008 related to non-hedging derivative instruments:
Note 6 - Servicing Rights
Mortgage Banking Activities. At December 31, 2010 and 2009, the Company serviced mortgage loans for others totaling $1.27 billion and $1.26 billion, respectively. Borrowers’ escrow balances held by the Company on such loans were $7.5 million and $7.7 million at December 31, 2010 and 2009, respectively. Changes in mortgage servicing rights for the years ended December 31, 2010 and 2009 were as follows:
_________________
(1)
The change in fair value resulting from changes in valuation inputs or assumptions used in valuation model primarily reflects the change in discount rates and prepayment speed assumptions, primarily due to changes in interest rates.
(2)
Other changes in fair value reflect changes due to the collection/realization of expected cash flows over time.
Other Servicing Activities. At December 31, 2010 and 2009, the Company serviced SBA loans for others totaling $200.4 million and $231.3 million, respectively. Changes in SBA servicing rights for the years ended December 31, 2010 and 2009 were as follows:
_________________
(1)
The change in fair value resulting from changes in valuation inputs or assumptions used in valuation model primarily reflects the change in discount rates and prepayment speed assumptions, primarily due to changes in interest rates.
(2)
Other changes in fair value reflect changes due to the collection/realization of expected cash flows over time.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 7 - Bank Premises and Equipment, Net
Bank premises and equipment, net of accumulated depreciation and amortization, were comprised of the following at December 31, 2010 and 2009:
The Company capitalized interest cost of $42,000, $282,000 and $400,000 during the years ended December 31, 2010, 2009 and 2008, respectively.
Depreciation and amortization expense for the years ended December 31, 2010, 2009 and 2008 was $17.3 million, $18.3 million and $20.2 million, respectively.
The Company leases land, office properties and equipment under operating leases. Certain of the leases contain renewal options and escalation clauses. Total rent expense was $15.6 million, $15.9 million and $16.0 million for the years ended December 31, 2010, 2009 and 2008, respectively. Future minimum lease payments under non-cancellable operating leases extend through 2084 as follows:
_________________
(1)
Amounts exclude future minimum lease payments under non-cancellable operating leases associated with assets and liabilities held for sale of $129,000, $141,000, $141,000, $141,000 and $141,000 for the years ended December 31, 2011, 2012, 2013, 2014 and 2015, respectively, and $129,000 thereafter, or a total of $822,000.
The Company also leases to unrelated parties a portion of its banking facilities. Rental income associated with these leases was $5.3 million, $5.9 million and $5.7 million for the years ended December 31, 2010, 2009 and 2008, respectively.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 8 - Goodwill and Other Intangible Assets
Goodwill and other intangible assets, net of amortization, were comprised of the following at December 31, 2010 and 2009:
_________________
(1)
The gross carrying amount and accumulated amortization for core deposit intangibles at December 31, 2010 have been reduced by $617,000 and $559,000, respectively, or a net of $58,000, related to discontinued operations, as further described in Note 2 to the consolidated financial statements. The gross carrying amount and accumulated amortization for core deposit intangibles at December 31, 2009 have been reduced by $17.8 million and $11.6 million, respectively, or a net of $6.2 million, related to discontinued operations.
(2)
Goodwill at December 31, 2010 and 2009 has been reduced by $2.0 million and $41.0 million, respectively, related to discontinued operations and assets held for sale, as further described below and in Note 2 to the consolidated financial statements.
The Company allocated goodwill related to the sales of the Chicago Region, the Texas Region, the branches sold in the Northern Illinois Region, and the Lawrenceville Branch of $24.0 million, $16.0 million, $9.0 million and $1.0 million, respectively, based on the relative fair values of the businesses and operations disposed of during 2010 and the portion of the First Bank segment that will be retained. The allocation of goodwill to the Chicago Region, the Texas Region and the branches sold in the Northern Illinois Region reduced the gain on sale of discontinued operations during the year ended December 31, 2010. The allocation of goodwill to the Lawrenceville Branch reduced other income during the year ended December 31, 2010. The Company did not allocate any goodwill to MVP.
The Company allocated goodwill related to the remaining branches to be sold in the Northern Illinois Region of $1.5 million, which is included in assets of discontinued operations at December 31, 2010. The Company allocated goodwill related to the sale of the Edwardsville Branch of $500,000, which is included in assets held for sale at December 31, 2010. The Company did not allocate any goodwill to the sale of the San Jose Branch. The goodwill allocated to the sales of the Chicago Region and the Texas Region of $24.0 million and $16.0 million, respectively, or $40.0 million in aggregate, is included in assets of discontinued operations at December 31, 2009. The goodwill allocated to the sale of the Lawrenceville Branch of $1.0 million is included in assets held for sale at December 31, 2009.
The Company allocated goodwill related to the sales of ANB, certain assets and liabilities of WIUS and the Springfield Branch of $10.0 million, $5.0 million and $1.0 million, respectively, based on the relative fair values of the businesses and operations disposed of during 2009 and the portion of the First Bank segment that will be retained. The allocation of goodwill to the sales of ANB and certain assets and liabilities of WIUS reduced the gain on sale of discontinued operations during the year ended December 31, 2009. The allocation of goodwill to the Springfield Branch reduced other income during the year ended December 31, 2009.
Core deposit intangibles of $683,000 related to the branches sold in the Northern Illinois region reduced the gain on sale of discontinued operations during the year ended December 31, 2010. Core deposit intangibles of $58,000 related to the remaining branches to be sold in the Northern Illinois Region were included in assets of discontinued operations at December 31, 2010. Core deposit intangibles of $2.3 million and $4.0 million related to the Chicago Region and the Texas Region, respectively, were included in assets of discontinued operations at December 31, 2009, and reduced the gain on sale of discontinued operations during the year ended December 31, 2010. A customer list intangible of $3.0 million related to ANB was recorded as a reduction of gain on sale of discontinued operations upon the sale of ANB in September 2009. A customer list intangible of $15.0 million related to WIUS was recorded as an increase in the loss on sale of discontinued operations upon the sale of certain assets and liabilities of WIUS in December 2009.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
First Bank did not record goodwill impairment for the year ended December 31, 2010. First Bank recorded goodwill impairment of $75.0 million for the year ended December 31, 2009, as further discussed below.
Amortization of intangible assets was $3.3 million, $4.4 million and $5.7 million for the years ended December 31, 2010, 2009 and 2008, respectively. As of December 31, 2010, the remaining estimated life of the amortization periods for core deposit intangibles was two years. Amortization of core deposit intangibles has been estimated in the following table.
Changes in the carrying amount of goodwill for the years ended December 31, 2010 and 2009 were as follows:
_________________
(1)
Goodwill acquired during 2009 pertains to additional earn-out consideration associated with the acquisition of ANB in March 2006.
(2)
Goodwill allocated to sale transactions during 2010 pertains to the sale of a portion of the Northern Illinois Region in September 2010, as previously described above. Goodwill allocated to sale transactions during 2009 pertains to the sale of ANB in September 2009, the sale of certain assets and liabilities of WIUS in December 2009 and the sale of the Springfield Branch in November 2009, as further described above and in Note 2 to the consolidated financial statements.
(3)
Goodwill allocated to discontinued operations and assets held for sale during 2010 pertain to the Northern Illinois Region and the Edwardsville Branch. Goodwill allocated to discontinued operations and assets held for sale during 2009 pertains to the Chicago Region, the Texas Region and the Lawrenceville Branch, as further described above and in Note 2 to the consolidated financial statements.
The Company’s annual measurement date for its goodwill impairment test is December 31. The Company engaged an independent valuation firm to assist in computing the fair value estimate for the impairment assessment by utilizing two separate valuation methodologies and applying a weighted average to each methodology in order to determine fair value for its single reporting unit, First Bank. The valuation methodologies utilized a comparison of the average price to book value of comparable businesses and a discounted cash flow valuation technique. Taking into account this independent third party valuation, the Company concluded that the carrying value of its single reporting unit exceeded its estimated fair value at December 31, 2010 and 2009.
Because the carrying value of the Company’s reporting unit exceeded the estimated fair value at December 31, 2010 and 2009, the Company engaged the same independent valuation firm to assist in computing the fair value of First Bank’s assets and liabilities in order to determine the implied fair value of First Bank’s goodwill at December 31, 2010 and 2009. Management compared the implied fair value of First Bank’s goodwill, as determined by the independent valuation firm, with its carrying value. Taking into account the results of the goodwill impairment analysis performed for the year ended December 31, 2010, First Bank did not record goodwill impairment. Taking into account the goodwill impairment analysis performed for the year ended December 31, 2009, First Bank recorded goodwill impairment of $75.0 million, which is reflected in the consolidated statements of operations. The goodwill impairment charge for the year ended December 31, 2009 was a direct result of continued deterioration in the real estate markets and economic conditions which decreased the fair value of First Bank. The primary factor contributing to the impairment recognition was further deterioration in the actual and projected financial performance of First Bank, as evidenced by the increase in the provision for loan losses, net charge-offs and nonperforming loans and the decline in the net interest margin and net interest income during 2009.
The Company believes the estimates and assumptions utilized in the goodwill impairment test are reasonable. However, further deterioration in the outlook for credit quality or other factors could impact the estimated fair value of the single reporting unit as determined under Step 1 of the goodwill impairment test. A decrease in the estimated fair value of the reporting unit would decrease the implied fair value of goodwill as further determined under Step 2 of the goodwill impairment test. Step 2 of the goodwill impairment test compared the implied fair value of goodwill with the carrying value of goodwill. The implied fair value of goodwill is determined in the same manner as the determination of the amount of goodwill recognized in a business combination. The fair value of a reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The fair value allocated to all of the assets and liabilities of the reporting unit requires significant judgment, especially for those assets and liabilities that are not measured on a recurring basis such as certain types of loans. The excess of the estimated fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The estimated fair value assigned to loans significantly affected the determination of the implied fair value of First Bank’s goodwill at December 31, 2010 and 2009. The implied fair value of a reporting unit’s goodwill will generally increase if the estimated fair value of the reporting unit’s loans is less than the carrying value of the reporting unit’s loans. The estimated fair value of the reporting unit’s loans was derived from discounted cash flow analyses. Loans were grouped into loan pools based on similar characteristics such as maturity, payment type and payment frequency, and rate type and underlying index. These cash flow calculations include assumptions for prepayment estimates over the loan’s remaining life, considerations for the current interest rate environment compared to the weighted average rate of the loan portfolio, a credit risk component based on the historical and expected performance of each loan portfolio stratum and a liquidity adjustment related to the current market environment. To the extent any of these assumptions change in the future, the implied fair value of the reporting unit’s goodwill could change materially. A decrease in the discount rate utilized in deriving the estimated fair value of the reporting unit’s loans would decrease the implied fair value of goodwill.
The estimated fair value assigned to the core deposit intangible, or First Bank’s deposit base, also significantly affected the determination of the implied fair value of First Bank’s goodwill at December 31, 2010 and 2009. The implied fair value of a reporting unit’s goodwill will generally decrease by the estimated fair value assigned to the reporting unit’s core deposit intangible. The estimated fair value of the core deposit intangible was derived from discounted cash flow analyses with considerations for estimated deposit runoff, cost of the deposit base, interest costs, net maintenance costs and the cost of alternative funds. The resulting estimate of the fair value of the core deposit intangible represents the present value of the difference in cash flows between maintaining the existing deposits and obtaining alternative funds over the life of the deposit base. To the extent any of these assumptions used to determine the estimated fair value of the core deposit intangible change in the future, the implied fair value of the reporting unit’s goodwill could change materially.
Due to the recent economic environment and the uncertainties regarding the impact on First Bank, there can be no assurance that the Company’s estimates and assumptions made for the purposes of the goodwill impairment testing will prove to be accurate predictions in the future. Adverse changes in the economic environment, First Bank’s operations, or other factors could result in a decline in the implied fair value of First Bank, which could result in the recognition of future goodwill impairment that may materially affect the carrying value of First Bank’s assets and its related operating results.
Note 9 - Maturities of Time Deposits
A summary of maturities of time deposits of $100,000 or more and other time deposits as of December 31, 2010 is as follows:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 10 - Other Borrowings
Other borrowings were comprised of the following at December 31, 2010 and 2009:
________________________
(1)
In the fourth quarter of 2010, First Bank prepaid its $120.0 million term repurchase agreement and incurred an early termination fee of $5.5 million.
(2)
In the first quarter of 2010, First Bank prepaid two $100.0 million FHLB advances and incurred prepayment penalties of $281,000, in aggregate. In the third quarter of 2010, First Bank prepaid an additional two $100.0 million FHLB advances and incurred prepayment penalties of $1.9 million, in aggregate. In the fourth quarter of 2010, First Bank prepaid its remaining two $100.0 FHLB advances and incurred prepayment penalties of $3.2 million, in aggregate.
First Bank had no outstanding term repurchase agreements at December 31, 2010. The maturity date, par amount, and interest rate on First Bank’s term repurchase agreement as of December 31, 2009 was as follows:
________________________
(1)
First Bank prepaid this term repurchase agreement on November 8, 2010 and incurred an early termination fee of $5.5 million, which was recorded as noninterest expense in the consolidated statements of operations.
(2)
On March 31, 2008, First Bank restructured its previous $100.0 million term repurchase agreement. The primary modifications were to: (a) increase the borrowing amount to $120.0 million; (b) extend the maturity date from October 12, 2010 to April 12, 2012; (c) convert the interest rate from a variable rate to a fixed rate of 3.36%, with interest to be paid quarterly beginning on April 12, 2008; and (d) terminate the embedded interest rate floor agreements contained within the term repurchase agreement. These modifications resulted in a gain of $5.0 million, which was recorded as noninterest income in the consolidated statements of operations.
First Bank had no outstanding FHLB advances at December 31, 2010. The maturity date, par amount and interest rate on First Bank’s FHLB advances as of December 31, 2009 were as follows:
________________________
(1)
On March 29, 2010, First Bank prepaid this FHLB advance and incurred a prepayment penalty of $104,000.
(2)
On March 29, 2010, First Bank prepaid this FHLB advance and incurred a prepayment penalty of $177,000.
(3)
On August 24, 2010, First Bank prepaid this FHLB advance and incurred a prepayment penalty of $941,000.
(4)
On September 27, 2010, First Bank prepaid this FHLB advance and incurred a prepayment penalty of $966,000.
(5)
On November 5, 2010, First Bank prepaid this FHLB advance and incurred a prepayment penalty of $3.2 million.
(6)
On December 23, 2010, First Bank prepaid this FHLB advance and did not incur a prepayment penalty.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The average balance of other borrowings was $514.7 million and $561.3 million, and the maximum month-end balance of other borrowings was $778.5 million and $824.2 million for the years ended December 31, 2010 and 2009, respectively. The average rates paid on other borrowings during the years ended December 31, 2010, 2009 and 2008 were 1.52%, 1.79% and 2.45%, respectively. Interest expense on securities sold under agreements to repurchase was $3.6 million, $4.3 million and $6.5 million for the years ended December 31, 2010, 2009 and 2008, respectively. Interest expense on FHLB advances was $5.4 million, $5.8 million and $7.7 million for the years ended December 31, 2010, 2009 and 2008, respectively. Interest expense on federal funds purchased was zero for the years ended December 31, 2010 and 2009, and $417,000 for the year ended December 31, 2008. Interest expense on FRB borrowings was zero, $64,000 and $88,000 for the years ended December 31, 2010, 2009 and 2008, respectively.
Note 11 - Notes Payable
In May 2008, the Company entered into a Revolving Credit Note and a Stock Pledge Agreement with Investors of America Limited Partnership (Investors of America, LP), a Nevada limited partnership created by and for the benefit of the Company’s Chairman and members of his immediate family, (the Original Credit Agreement), and on August 11, 2008, the Company entered into a First Amended Revolving Credit Note (the Amended Credit Agreement) with Investors of America, LP (collectively, the Credit Agreement), which modified the Original Credit Agreement to provide that the Company receive the prior written consent of Investors of America, LP for any advance that would cause the aggregate outstanding principal amount to exceed $10.0 million. The Credit Agreement provided for a $30.0 million secured revolving line of credit to be utilized for general working capital needs and capital investments in subsidiaries. Advances outstanding under the Credit Agreement bore interest at the three-month LIBOR plus 300 basis points. Interest was payable on outstanding advances on the first day of each month (in arrears) and the aggregate principal balance of all outstanding advances and any accrued interest thereon was due and payable in full on June 30, 2009, the maturity date of the Credit Agreement. The Credit Agreement was secured by the Company’s ownership interest in all of the capital stock of both SFC and CFHI (which was subsequently merged with and into SFC on December 31, 2009).
The Company received an advance of the entire $30.0 million under the Credit Agreement in May 2008 and utilized the proceeds of the advance to terminate and repay in full all of the obligations under its then existing secured credit agreement with a group of unaffiliated financial institutions. In July 2008, First Bank repaid in full its outstanding balance under the Credit Agreement in the aggregate amount of $30.0 million, including the accrued interest thereon. The Credit Agreement matured on June 30, 2009. There were no balances outstanding with respect to notes payable as of and for the year ended December 31, 2010 and 2009.
Interest expense recognized on notes payable for the year ended December 31, 2009 was comprised solely of commitment fees. Interest expense recognized on notes payable for the year ended December 31, 2008 includes commitment, arrangement and renewal fees. The average rate paid on notes payable during the year ended December 31, 2008 was 6.15%. Exclusive of these fees, the average rate paid on notes payable during the year ended December 31, 2008 was 4.42%.
On March 24, 2011, the Company entered into a Revolving Credit Note and a Stock Pledge Agreement with Investors of America, LP, that provides for a $5.0 million secured revolving line of credit to be utilized for general working capital needs, as further described in Note 25 to the consolidated financial statements.
Note 12 - Subordinated Debentures
The Company has formed or assumed various affiliated Delaware or Connecticut statutory and business trusts (collectively, the Trusts) that were created for the sole purpose of issuing trust preferred securities. The trust preferred securities were issued in private placements, with the exception of First Preferred Capital Trust IV, which was issued in a publicly underwritten offering. The Company owns all of the common securities of the Trusts. The gross proceeds of the offerings were used by the Trusts to purchase variable rate or fixed rate junior subordinated debentures from the Company. The junior subordinated debentures are the sole asset of the Trusts. In connection with the issuance of the trust preferred securities, the Company made certain guarantees and commitments that, in the aggregate, constitute a full and unconditional guarantee by the Company of the obligations of the Trusts under the trust preferred securities. The Company’s distributions accrued on the junior subordinated debentures were $12.9 million, $14.1 million and $20.9 million for the years ended December 31, 2010, 2009 and 2008, respectively, and are included in interest expense in the consolidated statements of operations. Deferred issuance costs associated with the Company’s junior subordinated debentures are included as a reduction of junior subordinated debentures in the consolidated balance sheets and are amortized on a straight-line basis to the maturity date of the respective junior subordinated debentures. The structure of the trust preferred securities currently satisfies the regulatory requirements for inclusion, subject to certain limitations, in the Company’s capital base, as further described in Note 21 to the consolidated financial statements.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
A summary of the junior subordinated debentures issued to the Trusts in conjunction with the trust preferred securities offerings at December 31, 2010 and 2009 were as follows:
________________________
(1)
The junior subordinated debentures are callable at the option of the Company on the call date shown at 100% of the principal amount plus accrued and unpaid interest.
(2)
The interest rates paid on the trust preferred securities are based on either a variable rate or a fixed rate. The variable rate is based on the three-month LIBOR plus the basis point spread shown.
(3)
In March 2008, the Company entered into four interest rate swap agreements, which were designated as cash flow hedges prior to August 10, 2009, to effectively convert the interest payments on these junior subordinated debentures from variable rate to fixed rate to the respective call dates as follows:
(a)
$25.0 million notional amount with a maturity date of July 7, 2011 that converts the interest rate from a variable rate of LIBOR plus 165 basis points to a fixed rate of 4.40%;
(b)
$50.0 million notional amount with a maturity date of December 15, 2011 that converts the interest rate from a variable rate of LIBOR plus 185 basis points to a fixed rate of 4.905%;
(c)
$25.0 million notional amount with a maturity date of March 30, 2012 that converts the interest rate from a variable rate of LIBOR plus 161 basis points to a fixed rate of 4.71%; and
(d)
$25.0 million notional amount with a maturity date of December 15, 2012 that converts the interest rate from a variable rate of LIBOR plus 225 basis points to a fixed rate of 5.565%.
(4)
In December 2010, the Company terminated this interest rate swap agreement.
On August 10, 2009, the Company announced the deferral of its regularly scheduled interest payments on its outstanding junior subordinated debentures relating to its $345.0 million of trust preferred securities beginning with the regularly scheduled quarterly interest payments that would otherwise have been made in September and October 2009. The terms of the junior subordinated debentures and the related trust indentures allow the Company to defer such payments of interest for up to 20 consecutive quarterly periods without default or penalty. During the deferral period, the respective trusts will suspend the declaration and payment of dividends on the trust preferred securities. During the deferral period, the Company may not, among other things and with limited exceptions, pay cash dividends on or repurchase its common stock or preferred stock nor make any payment on outstanding debt obligations that rank equally with or junior to the junior subordinated debentures. The Company has deferred $18.8 million and $6.4 million of its regularly scheduled interest payments as of December 31, 2010 and 2009, respectively. In addition, the Company has accrued additional interest expense of $621,000 and $44,000 as of December 31, 2010 and 2009, respectively, on the regularly scheduled deferred interest payments based on the interest rate in effect for each junior subordinated note issuance in accordance with the respective terms of the underlying agreements.
The announcement of the deferral of interest payments on the underlying trust preferred securities in August 2009 resulted in the discontinuation of hedge accounting on the Company’s interest rate swap agreements designated as cash flow hedges on its junior subordinated debentures. Accordingly, the Company reclassified a cumulative fair value adjustment of $4.6 million on its interest rate swap agreements designated as cash flow hedges from accumulated other comprehensive loss to net (loss) gain on derivative instruments. In conjunction with the discontinuation of hedge accounting, the net interest differential on these interest rate swap agreements was recorded as a reduction of noninterest income rather than an increase to interest expense on junior subordinated debentures effective August 2009.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Under its agreement with the FRB, the Company agreed, among other things, to provide certain information to the FRB, including, but not limited to, prior notice regarding the issuance of additional trust preferred securities. The Company also agreed not to make any distributions of interest or other sums on its outstanding trust preferred securities without the prior approval of the FRB, as further described in Note 1 to the consolidated financial statements.
As further described in Notes 1 and 25 to the consolidated financial statements, the Company successfully completed a consent solicitation and amended certain provisions of the Indenture and related Guarantee and Trust Agreements associated with the trust preferred securities of First Preferred Capital Trust IV.
Note 13 - Income Taxes
The provision (benefit) for income taxes from continuing operations for the years ended December 31, 2010, 2009 and 2008 consists of the following:
The effective rates of federal income taxes for the years ended December 31, 2010, 2009 and 2008 differ from the federal statutory rates of taxation as follows:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2010 and 2009 were as follows:
The realization of the Company’s net deferred tax assets is based on the expectation of future taxable income and the utilization of tax planning strategies. The Company has a full valuation allowance against its net deferred tax assets at December 31, 2010 and 2009. The deferred tax asset valuation allowance was recorded in accordance with ASC Topic 740, “Income Taxes.” Under ASC Topic 740, the Company is required to assess whether it is “more likely than not” that some portion or all of its deferred tax assets will not be realized. Pursuant to ASC Topic 740, concluding that a deferred tax asset valuation allowance is not required is difficult when there is significant evidence which is objective and verifiable, such as the lack of recoverable taxes, excess of reversing deductible differences over reversing taxable differences and cumulative losses in recent years. If, in the future, the Company generates taxable income on a sustained basis, management may conclude the deferred tax asset valuation allowance is no longer required, which would result in the reversal of a portion or all of the deferred tax asset valuation allowance, which would be reflected as a benefit for income taxes in the consolidated statements of income.
Changes in the deferred tax asset valuation allowance for the years ended December 31, 2010, 2009 and 2008 were as follows:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
On September 30, 2008, the Internal Revenue Service (IRS) issued Notice 2008-83. In accordance with Notice 2008-83, any deduction properly allowed after an ownership change to a bank with respect to losses on loans or bad debts (including any deduction for a reasonable addition to a reserve for bad debts) shall not be treated as a built-in loss. As a result of Notice 2008-83, certain loan charge-offs and additions to First Bank’s allowance for loan losses are no longer considered to be built-in losses. Consequently, on September 30, 2008, the Company concluded that $1.8 million and $21.0 million of the deferred tax asset valuation allowances related to CIB Bank and CFHI, respectively, were no longer required and recorded a reversal of the deferred tax asset valuation allowances in the amount of $22.9 million, of which $21.6 million resulted in an increase to the benefit for income taxes for the three months ended September 30, 2008, and a corresponding reduction of the provision for income taxes for the year ended December 31, 2008.
In the fourth quarter of 2008, First Bank recorded a deferred tax asset valuation allowance of $158.9 million, which resulted in increases to the provision for income taxes and accumulated other comprehensive loss of $144.8 million and $1.7 million, respectively. As described above, the deferred tax asset valuation allowance was primarily established as a result of the Company’s three-year cumulative operating loss for the years ended December 31, 2008, 2007 and 2006, after considering all available objective and verifiable evidence and potential tax planning strategies related to the amount of the deferred tax assets that are more likely than not to be realized.
At December 31, 2010 and 2009, the Company had unrecognized tax benefits for uncertain tax positions, excluding interest and penalties, of $1.3 million and $3.4 million, respectively. A reconciliation of the beginning and ending balance of these unrecognized tax benefits for the years ended December 31, 2010 and 2009 is as follows:
At December 31, 2010 and 2009, the total amount of unrecognized tax benefits that would affect the effective income tax rate was $837,000 and $1.6 million, respectively. It is the Company’s policy to separately disclose any interest or penalties arising from the application of federal or state income taxes. Interest related to unrecognized tax benefits is included in interest expense and penalties related to unrecognized tax benefits are included in noninterest expense. The Company recorded interest income of $1.0 million and $412,000 related to unrecognized tax benefits during the years ended December 31, 2010 and 2008, respectively, whereas the Company recorded interest expense of $211,000 related to unrecognized tax benefits during the year ended December 31, 2009. At December 31, 2010 and 2009, interest accrued for uncertain tax positions was $180,000 and $1.2 million, respectively. There were no penalties for uncertain tax positions accrued at December 31, 2010 and 2009, nor did the Company recognize any expense for penalties during 2010, 2009 and 2008.
As previously described, Notice 2008-83 was issued on September 30, 2008. When applying Notice 2008-83 to the acquisition of CIB Bank, a contingency reserve on the loan charge-offs would not have been required to be established under ASC Topic 740. Consequently, the full amount of the contingency reserve of $4.5 million, net of the federal benefit, and the related interest reserve of $904,000 that had been established in accordance with ASC Topic 740 were reversed during 2008.
The Company continually evaluates the unrecognized tax benefits associated with its uncertain tax positions. It is reasonably possible that the total unrecognized tax benefits as of December 31, 2010 could decrease by approximately $305,000 by December 31, 2011, as a result of the lapse of statutes of limitations or potential settlements with the federal and state taxing authorities, of which the impact to the effective income tax rate is estimated to be approximately $198,000. It is also reasonably possible that this decrease could be substantially offset by new matters arising during the same period.
The Company files consolidated and separate income tax returns in the U.S. federal jurisdiction and in various state jurisdictions. Management of the Company believes the accrual for tax liabilities is adequate for all open audit years based on its assessment of many factors, including past experience and interpretations of tax law applied to the facts of each matter. This assessment relies on estimates and assumptions. The Company’s federal income tax returns through 2008 have been examined by the IRS. Years subsequent to 2008 contain matters that could be subject to differing interpretations of applicable tax laws and regulations as they relate to the amount, timing or inclusion of revenue and expenses. The Company has recorded a tax benefit only for those positions that meet the “more likely than not” standard. The Company’s current estimate of the resolution of various state examinations, none of which are in process, is reflected in accrued income taxes; however, final settlement of the examinations or changes in the Company’s estimate may result in future income tax expense or benefit.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The Company is no longer subject to U.S. federal, Florida, Illinois and Missouri income tax examination by the tax authorities for the years prior to 2007, and prior to 2006 for California and Texas. The Company had a federal tax examination for tax years through 2008, which was closed during 2010, and a California tax examination for the 2004 and 2005 tax years, which was closed during 2008.
At December 31, 2010 and 2009, the accumulation of prior years’ earnings representing tax bad debt deductions was approximately $29.8 million. If these tax bad debt reserves were charged for losses other than bad debt losses, the Company would be required to recognize taxable income in the amount of the charge. It is not contemplated that such tax-restricted retained earnings will be used in a manner that would create federal income tax liabilities.
At December 31, 2010, the Company’s Federal net operating loss carryforwards expire as follows:
At December 31, 2010, the Company has state net operating loss carryforwards of $567.3 million and a related deferred tax asset of $43.7 million. The state net operating loss carryforwards are primarily from California, Florida, Illinois and Missouri and expire from 2019 to 2030.
The Company had an accumulated other comprehensive loss of $6.8 million related to the establishment of a deferred tax asset valuation allowance regarding the unrealized gain on certain interest rate swap agreements that were designated as cash flow hedges on certain loans. These interest rate swap agreements were terminated in December 2008, and as a result, the unrealized gain at the date of termination of $20.8 million was being amortized as an increase to interest and fees on loans in the consolidated statements of operations over the remaining terms of the respective interest rate swap agreements, which had contractual maturity dates through September 2010. In the third quarter of 2010, the Company recorded a provision for incomes taxes of $6.8 million related to the expiration of the amortization period of the unrealized gain on the interest rate swap agreements with a corresponding increase to accumulated other comprehensive income.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 14 - Earnings (Loss) Per Common Share
The following is a reconciliation of basic and diluted (loss) income per share for the years ended December 31, 2010, 2009 and 2008:
Note 15 - Credit Commitments
The Company is a party to commitments to extend credit and commercial and standby letters of credit in the normal course of business to meet the financing needs of its customers. These instruments involve, in varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The interest rate risk associated with these credit commitments relates primarily to the commitments to originate fixed-rate loans. As more fully described in Note 5 to the consolidated financial statements, the interest rate risk of the commitments to originate fixed-rate loans has been hedged with forward commitments to sell mortgage-backed securities. The credit risk amounts are equal to the contractual amounts, assuming the amounts are fully advanced and the collateral or other security is of no value. The Company uses the same credit policies in granting commitments and conditional obligations as it does for on-balance sheet items.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Commitments to extend fixed and variable rate credit, and commercial and standby letters of credit at December 31, 2010 and 2009 were as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, equipment, income-producing commercial properties or single family residential properties. In the event of nonperformance, the Company may obtain and liquidate the collateral to recover amounts paid under its guarantees on these financial instruments.
Commercial and standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Most letters of credit extend for less than one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Upon issuance of the commitments, the Company typically holds marketable securities, certificates of deposit, inventory, real property or other assets as collateral supporting those commitments for which collateral is deemed necessary. The standby letters of credit at December 31, 2010 expire, at various dates, within seven years.
Standby letters of credit issued by the FHLB on First Bank’s behalf were $50.9 million and $81.1 million at December 31, 2010 and 2009, respectively.
Note 16 - Fair Value Disclosures
In accordance with ASC Topic 820, “Fair Value Measurements and Disclosures,” financial assets and financial liabilities that are measured at fair value subsequent to initial recognition are grouped into three levels of inputs or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the reliability of assumptions used to determine fair value. The three input levels of the valuation hierarchy are as follows:
Level 1 Inputs
-
Valuation is based on quoted prices in active markets for identical instruments in active markets.
Level 2 Inputs
-
Valuation is based on quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 Inputs
-
Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
The following describes valuation methodologies used to measure financial assets and financial liabilities at fair value, as well as the general classification of such financial instruments pursuant to the valuation hierarchy:
Available-for-sale investment securities. Available-for-sale investment securities are recorded at fair value on a recurring basis. Available-for-sale investment securities included in Level 1 are valued using quoted market prices. Where quoted market prices are unavailable, the fair value included in Level 2 is based on quoted market prices of comparable instruments obtained from independent pricing vendors based on recent trading activity and other relevant information.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Loans held for sale. Mortgage loans held for sale are carried at fair value on a recurring basis. The determination of fair value is based on quoted market prices of comparable instruments obtained from independent pricing vendors based on recent trading activity and other relevant information. Other loans held for sale are carried at the lower of cost or market value, which is determined on an individual loan basis. The fair value is based on the prices secondary markets are offering for portfolios with similar characteristics. The Company classifies mortgage loans held for sale subjected to recurring fair value adjustments as recurring Level 2. The Company classifies other loans held for sale subjected to nonrecurring fair value adjustments as nonrecurring Level 2.
Loans. The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans are considered impaired when, in the judgment of management based on current information and events, it is probable that payment of all amounts due under the contractual terms of the loan agreement will not be collected. Acquired impaired loans are classified as nonaccrual loans and are initially measured at fair value with no allocated allowance for loan losses. An allowance for loan losses is recorded to the extent there is further credit deterioration subsequent to acquisition date. In accordance with ASC Topic 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. Once a loan is identified as impaired, management measures the impairment in accordance with ASC Topic 310-10-35, “Receivables.” Impairment is measured by reference to an observable market price, if one exists, the expected future cash flows of an impaired loan discounted at the loan’s effective interest rate, or the fair value of the collateral for a collateral-dependent loan. In most cases, the Company measures fair value based on the value of the collateral securing the loan. Collateral may be in the form of real estate or personal property, including equipment and inventory. The vast majority of the collateral is real estate. The value of the collateral is determined based on third party appraisals as well as internal estimates. These measurements are classified as Level 3.
Derivative instruments. Substantially all derivative instruments utilized by the Company are traded in over-the-counter markets where quoted market prices are not readily available. Derivative instruments utilized by the Company include interest rate swap agreements, interest rate floor and cap agreements, interest rate lock commitments and forward commitments to sell mortgage-backed securities. For these derivative instruments, fair value is based on market observable inputs utilizing pricing systems and valuation models, and where applicable, the values are compared to the market values calculated independently by the respective counterparties. The Company classifies its derivative instruments as Level 2.
Servicing rights. Servicing rights are valued based on valuation models that utilize assumptions based on the predominant risk characteristics of the underlying loans, including principal balance, interest rate, weighted average life, cost to service and estimated prepayment speeds. The valuation models estimate the present value of estimated future net servicing income. The Company classifies its servicing rights as Level 3.
Nonqualified Deferred Compensation Plan. The Company’s nonqualified deferred compensation plan is recorded at fair value on a recurring basis. The unfunded plan allows participants to hypothetically invest in various specified investment options such as equity funds, international stock funds, capital appreciation funds, money market funds, bond funds, mid-cap value funds and growth funds. The nonqualified deferred compensation plan liability is valued based on quoted market prices of the underlying investments. The Company classifies its nonqualified deferred compensation plan liability as Level 1.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Items Measured on a Recurring Basis. Assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 and 2009 are reflected in the following tables:
There were no transfers between Levels 1 and 2 of the fair value hierarchy for the year ended December 31, 2010.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The following table presents the changes in Level 3 assets measured on a recurring basis for the years ended December 31, 2010 and 2009:
_____________________________
(1)
Gains or losses (realized/unrealized) are included in noninterest income in the consolidated statements of operations.
Items Measured on a Nonrecurring Basis. From time to time, the Company measures certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis as of December 31, 2010 and 2009 are reflected in the following table:
Non-Financial Assets and Non-Financial Liabilities. Certain non-financial assets measured at fair value on a non-recurring basis include other real estate (upon initial recognition or subsequent impairment), non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment. Methods utilized for determining fair value of non-financial assets and liabilities are further discussed in Note 1 and Note 8 to our consolidated financial statements.
Certain other real estate, upon initial recognition, was re-measured and reported at fair value through a charge-off to the allowance for loan losses based upon the estimated fair value of the other real estate. The fair value of other real estate, upon initial recognition, is estimated using Level 3 inputs based on third-party appraisals, and where applicable, discounted based on management’s judgment taking into account current market conditions, distressed or forced sale price comparisons and other factors in effect at the time of valuation. Other real estate measured at fair value upon initial recognition totaled $158.9 million, $143.6 million and $109.3 million during the years ended December 31, 2010, 2009 and 2008, respectively. In addition to other real estate measured at fair value upon initial recognition, the Company recorded write-downs to the balance of other real estate of $34.7 million, $37.4 million and $2.8 million to noninterest expense for the years ended December 31, 2010, 2009 and 2008, respectively. Other real estate was $140.6 million at December 31, 2010, compared to $125.2 million at December 31, 2009.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Fair Value of Financial Instruments.
The fair value of financial instruments is management’s estimate of the values at which the instruments could be exchanged in a transaction between willing parties. These estimates are subjective and may vary significantly from amounts that would be realized in actual transactions. In addition, other significant assets are not considered financial assets including servicing assets, deferred income tax assets, bank premises and equipment and goodwill and other intangible assets. Furthermore, the income taxes that would be incurred if the Company were to realize any of the unrealized gains or unrealized losses indicated between the estimated fair values and corresponding carrying values could have a significant effect on the fair value estimates and have not been considered in any of the estimates.
The following summarizes the methods and assumptions used in estimating the fair value of all other financial instruments:
Cash and cash equivalents and accrued interest receivable: The carrying values reported in the consolidated balance sheets approximate fair value.
Held-to-maturity investment securities: The fair value of held-to-maturity investment securities is based on quoted market prices where available. If quoted market prices are not available, the fair value is based on quoted market prices of comparable instruments.
Loans: The fair value of loans held for portfolio uses an exit price concept and reflects discounts the Company believes are consistent with liquidity discounts in the market place. Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial and industrial, real estate construction and development, commercial real estate, one-to-four family residential real estate, home equity and consumer and installment. The fair value of loans is estimated by discounting the future cash flows, utilizing assumptions for prepayment estimates over the loans’ remaining life and considerations for the current interest rate environment compared to the weighted average rate of the loan portfolio. The fair value analysis also included other assumptions to estimate fair value, intended to approximate those factors a market participant would use in an orderly transaction, with adjustments for discount rates, interest rates, liquidity, and credit spreads, as appropriate.
Loans held for sale: The fair value of loans held for sale, which is the amount reported in the consolidated balance sheets, is based on quoted market prices where available. If quoted market prices are not available, the fair value is based on quoted market prices of comparable instruments.
Bank-owned life insurance: The fair value of bank-owned life insurance is based on quoted market prices where available. If quoted market prices are not available, the fair value is based on quoted market prices of comparable instruments.
Deposits: The fair value of deposits generally payable on demand (i.e., noninterest-bearing and interest-bearing demand, and savings and money market accounts) is considered equal to their respective carrying amounts as reported in the consolidated balance sheets. The fair value of demand deposits does not include the benefit that results from the low-cost funding provided by deposit liabilities compared to the cost of borrowing funds in the market. The fair value disclosed for time deposits was estimated utilizing a discounted cash flow calculation that applied interest rates currently being offered on similar deposits to a schedule of aggregated monthly maturities of time deposits. If the estimated fair value is lower than the carrying value, the carrying value is reported as the fair value of time deposits.
Other borrowings and accrued interest payable: The carrying values reported in the consolidated balance sheets for variable rate borrowings approximate fair value. The fair value of fixed rate borrowings is based on quoted market prices where available. If quoted market prices are not available, the fair value is based on discounting contractual maturities using an estimate of current market rates for similar instruments.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Subordinated debentures: The fair value of subordinated debentures is based on quoted market prices of comparable instruments.
Off-Balance Sheet Financial Instruments: The fair value of commitments to extend credit, standby letters of credit and financial guarantees is based on estimated probable credit losses.
The estimated fair value of the Company’s financial instruments at December 31, 2010 and 2009 were as follows:
Note 17 - Employee Benefits
401(k) Plan. The Company’s 401(k) plan is a self-administered savings and incentive plan covering substantially all employees. Employer match contributions are determined annually under the plan by the Company’s Board of Directors. Employee contributions were limited to $16,500 of gross compensation for 2010. Total employer contributions under the plan were zero, $932,000 and $4.0 million for the years ended December 31, 2010, 2009 and 2008, respectively. The plan assets are held and managed under a trust agreement with First Bank’s trust department.
Nonqualified Deferred Compensation Plan. The Company’s nonqualified deferred compensation plan (the NQDC Plan), which covers a select group of employees, is administered by an independent third party. The NQDC Plan is exempt from the participation, vesting, funding and fiduciary requirements of the Employee Retirement Income Security Act of 1974. Prior to January 1, 2010, participants could contribute from 1% to 25% of their salary and up to 100% of their bonuses on a pre-tax basis. Balances outstanding under the NQDC Plan, which are reflected in accrued and other liabilities in the consolidated balance sheets, were $7.8 million and $9.0 million at December 31, 2010 and 2009, respectively. The Company recognized salaries and employee benefits expense related to the NQDC Plan of $685,000 and $1.3 million for the years ended December 31, 2010 and 2009, respectively, resulting from net earnings incurred by participants on the underlying investments in the plan. The Company recognized a decrease in salaries and employee benefits expense related to the NQDC Plan of $2.0 million for the year ended December 31, 2008 resulting from net losses incurred by participants on the underlying investments in the plan.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Noncontributory Defined Benefit Pension Plan. The Company has a noncontributory defined benefit pension plan covering certain current and former employees of a bank holding company acquired by the Company in 1994 and subsequently merged with and into the Company on December 31, 2002. The Company discontinued the accumulation of benefits under the Plan in 1994, and as such, there is no longer any service cost being accrued by Plan participants.
A summary of the Plan’s change in the projected benefit obligation and change in the fair value of Plan assets for the years ended December 31, 2010 and 2009 and amounts recognized in the Company’s consolidated balance sheets as of December 31, 2010 and 2009 is as follows:
The Company’s accrued pension liability of $3.1 million at December 31, 2010 and 2009 represents the difference between the fair value of the Plan assets and the projected benefit obligation of the Plan, and is reflected in accrued expenses and other liabilities in the consolidated balance sheets.
The following table reflects the weighted average assumptions used to determine the net periodic benefit cost for the years ended December 31, 2010 and 2009:
The discount rate used to determine benefit obligations was 4.93% and 5.36% for the years ended December 31, 2010 and 2009, respectively.
A summary of the components of net periodic benefit cost for the years ended December 31, 2010 and 2009 is as follows:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Amounts recognized in accumulated other comprehensive loss consist of:
The Plan’s investment strategy is focused on maximizing asset returns. The target allocations for Plan assets are 50% equity securities and 50% fixed income. Asset allocations can fluctuate between acceptable ranges commensurate with market volatility. Equity securities primarily include investments in large capitalization companies located in the United States. Debt securities include U.S. Treasuries, investment-grade corporate bonds of companies from diversified industries and mortgage-backed securities.
The fair value of Plan assets at December 31, 2010 and 2009 was comprised of the following:
Equity and debt securities included in Level 1 are valued using quoted market prices. Where quoted market prices are unavailable, the fair value of equity and debt securities included in Level 2 is based on quoted market prices of comparable instruments obtained from independent pricing vendors based on recent trading activity and other relevant information.
The Company expects to contribute $288,000 to the Plan in 2011. Pension benefit payments are expected to be paid to Plan participants by the Plan as follows:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 18 - Stockholders’ Equity
There is no established public trading market for the Company’s common stock. Various trusts, which were established by and are administered by and for the benefit of the Company’s Chairman of the Board and members of his immediate family, own all of the voting stock of the Company.
The Company has four classes of preferred stock outstanding. The Class A preferred stock is convertible into shares of common stock at a rate based on the ratio of the par value of the preferred stock to the current market value of the common stock at the date of conversion, to be determined by independent appraisal at the time of conversion. Shares of Class A preferred stock may be redeemed by the Company at any time at 105.0% of par value. The Class B preferred stock may not be redeemed or converted. The holders of the Class A and Class B preferred stock have full voting rights. Dividends on the Class A and Class B preferred stock are adjustable quarterly based on the highest of the Treasury Bill Rate or the Ten Year Constant Maturity Rate for the two-week period immediately preceding the beginning of the quarter. This rate shall not be less than 6.0% nor more than 12.0% on the Class A preferred stock, or less than 7.0% nor more than 15.0% on the Class B preferred stock. Effective August 10, 2009, the Company suspended the declaration of dividends on its Class A and Class B preferred stock.
On December 31, 2008, the Company issued 295,400 shares of Class C Fixed Rate Cumulative Perpetual Preferred Stock (Class C Preferred Stock) and 14,770 shares of Class D Fixed Rate Cumulative Perpetual Preferred Stock (Class D Preferred Stock) to the United States Department of the Treasury (U.S. Treasury) in conjunction with the U.S. Treasury’s Troubled Asset Relief Program’s Capital Purchase Program (CPP). The Class C Preferred Stock has a par value of $1.00 per share and a liquidation preference of $1,000 per share. The holders of the Class C Preferred Stock have no voting rights except in certain limited circumstances. The Class C Preferred Stock carries an annual dividend rate equal to 5% for the first five years and the annual dividend rate increases to 9% thereafter, payable quarterly in arrears beginning February 15, 2009. The Class D Preferred Stock has a par value of $1.00 per share and a liquidation preference of $1,000 per share. The holders of the Class D Preferred Stock have no voting rights except in certain limited circumstances. The Class D Preferred Stock carries an annual dividend rate equal to 9%, payable quarterly in arrears beginning February 15, 2009. The Class C Preferred Stock and the Class D Preferred Stock qualify as Tier 1 capital. Effective February 17, 2009, the Class C Preferred Stock and the Class D Preferred Stock may be redeemed at any time without penalty and without the need to raise new capital, subject to the U.S. Treasury’s consultation with the Company’s primary regulatory agency. The Class D Preferred Stock may not be redeemed until all of the outstanding shares of the Class C Preferred Stock have been redeemed. In addition, the U.S. Treasury has certain supervisory and oversight duties and responsibilities under the CPP and, pursuant to the terms of the agreement governing the issuance of the Class C Preferred Stock and the Class D Preferred Stock to the U.S. Treasury (Purchase Agreement), the U.S. Treasury is empowered to unilaterally amend any provision of the Purchase Agreement with the Company to the extent required to comply with any changes in applicable federal statutes. As a result of the Company’s deferral of dividends to the U.S. Treasury for an aggregate of six quarters, the U.S. Treasury has the right to elect two directors to the Company’s Board.
The Company allocated the total proceeds received under the CPP of $295.4 million to the Class C Preferred Stock and the Class D Preferred Stock based on the relative fair values of the respective classes of preferred stock at the time of issuance. The discount on the Class C Preferred Stock of $17.3 million is being accreted to retained earnings on a level-yield basis over five years. Accretion of the discount on the Class C Preferred Stock was $3.4 million and $3.3 million for the years ended December 31, 2010 and 2009, respectively.
The redemption of any issue of preferred stock requires the prior approval of the Federal Reserve. Furthermore, the agreement that the Company entered into with the U.S. Treasury associated with the issuance of the Class C Preferred Stock and the Class D Preferred Stock contains limitations on certain actions of the Company, including, but not limited to, payment of dividends and redemptions and acquisitions of the Company’s equity securities. In addition, the Company, under its agreement with the FRB, has agreed, among other things, to provide certain information to the FRB including, but not limited to, notice of plans to materially change its fundamental business and notice to raise additional equity capital. Furthermore, the Company agreed not to pay any dividends on its common or preferred stock without the prior approval of the FRB, as further described in Note 1 to the consolidated financial statements.
On August 10, 2009, the Company announced the deferral of its regularly scheduled interest payments on its outstanding junior subordinated debentures relating to its $345.0 million of trust preferred securities beginning with the regularly scheduled quarterly interest payments that would otherwise have been made in September and October 2009, as further described in Note 12 to the consolidated financial statements. During the deferral period, the Company may not, among other things and with limited exceptions, pay cash dividends on or repurchase its common stock or preferred stock nor make any payment on outstanding debt obligations that rank equally with or junior to the junior subordinated debentures. Accordingly, the Company also suspended the payment of cash dividends on its outstanding common stock and preferred stock beginning with the regularly scheduled quarterly dividend payments on the preferred stock that would otherwise have been made in August and September 2009. The Company has declared and deferred $24.1 million and $8.0 million of its regularly scheduled dividend payments on its Class C Preferred Stock and Class D Preferred Stock, and has declared and accrued an additional $990,000 and $109,000 of cumulative dividends on such deferred dividend payments at December 31, 2010 and 2009, respectively.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
The following table presents the transactions affecting accumulated other comprehensive income (loss) included in stockholders’ equity for the years ended December 31, 2010, 2009 and 2008:
_____________________
(1)
In the third quarter of 2009, the Company reclassified a cumulative fair value adjustment of $4.6 million on its interest rate swap agreements designated as cash flow hedges on its junior subordinated debentures from accumulated other comprehensive income to loss on derivative instruments as a result of the discontinuation of hedge accounting following the announcement of the deferral of interest payments on the underlying trust preferred securities in August 2009, as further described in Note 5 and Note 12 to the consolidated financial statements.
(2)
In the third quarter of 2010, the Company reclassified an accumulated other comprehensive loss of $6.8 million related to the establishment of a deferred tax asset valuation allowance to its provision for income taxes related to the expiration of the amortization period of the unrealized gain on certain terminated interest rate swap agreements that had been designated as cash flow hedges on certain loans, as further described in Note 5 and Note 13 to the consolidated financial statements.
Other comprehensive income (loss) of $146,000, $(8.7) million and $11.1 million, as presented in the consolidated statements of changes in stockholders’ equity and comprehensive income (loss), is reflected net of income tax (benefit) expense of $(2.3) million, $(3.0) million and $6.9 million for the years ended December 31, 2010, 2009 and 2008, respectively.
On January 1, 2009, the Company implemented new guidance under ASC Topic 810, “Consolidation,” which resulted in the reclassification of noncontrolling interest in subsidiaries of $129.4 million from a liability to a component of stockholders’ equity in the consolidated balance sheets, as further described in Note 1 to the consolidated financial statements.
As a result of First Bank’s purchase of FCA’s noncontrolling interest in SBLS LLC, as further described in Note 19 to the consolidated financial statements, the Company recorded an increase in additional paid-in-capital of $2.8 million and a decrease in noncontrolling interest in subsidiaries of $4.7 million during the second quarter of 2009.
On January 1, 2008, the Company elected to measure servicing rights at fair value as permitted by ASC Topic 860. The election of this option resulted in the recognition of a cumulative effect of change in accounting principle of $6.3 million, net of tax, which was recorded as an increase to retained earnings.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 19 - Transactions With Related Parties
Outside of normal customer relationships, no directors or officers of the Company, no shareholders holding over 5% of the Company’s voting securities and no corporations or firms with which such persons or entities are associated currently maintain or have maintained, since the beginning of the last full fiscal year, any significant business or personal relationships with the Company or its subsidiaries, other than that which arises by virtue of such position or ownership interest in the Company or its subsidiaries, except as described in the following paragraphs.
First Services, L.P. First Services, L.P. (First Services), a limited partnership indirectly owned by the Company’s Chairman and members of his immediate family, provides information technology, item processing and various related services to the Company and First Bank. Fees paid under agreements with First Services were $26.2 million, $29.4 million and $33.6 million for the years ended December 31, 2010, 2009 and 2008, respectively. First Services leases information technology and other equipment from First Bank. First Services paid First Bank rental fees for the use of such equipment of $2.5 million, $3.1 million and $3.8 million during the years ended December 31, 2010, 2009 and 2008, respectively. In addition, First Services paid approximately $1.9 million for the years ended December 31, 2010, 2009 and 2008, in rental payments to First Bank for occupancy of certain First Bank premises from which business is conducted.
Effective January 1, 2009, First Services entered into an Affiliate Services Agreement with the Company and First Bank. The Affiliate Services Agreement relates to various services provided to First Services, including certain human resources, payroll, employee benefit and training services, insurance services and vendor payment processing services. Fees accrued under the Affiliate Services Agreement by First Services were $157,000 and $231,000 for the years ended December 31, 2010 and 2009, respectively.
First Brokerage America, L.L.C. First Brokerage America, L.L.C. (First Brokerage), a limited liability company indirectly owned by the Company’s Chairman and members of his immediate family, received approximately $5.0 million, $5.7 million and $6.2 million for the years ended December 31, 2010, 2009 and 2008, respectively, in gross commissions paid by unaffiliated third-party companies. The commissions received primarily resulted from sales of annuities, securities and other insurance products to customers of First Bank. First Brokerage paid approximately $312,000, $227,000 and $216,000 for the years ended December 31, 2010, 2009 and 2008, respectively, to First Bank in rental payments for occupancy of certain First Bank premises from which brokerage business is conducted.
Dierberg Vineyards / Wineries. The Company periodically purchases various products from Hermannhof, Inc. and Dierberg Star Lane Vineyards, entities that are owned and operated by the Company’s Chairman and members of his immediate family. The Company utilizes these products primarily for customer and employee events and promotions, and business development functions. During the years ended December 31, 2010, 2009 and 2008, the Company purchased products aggregating approximately $112,000, $133,000 and $258,000, respectively, from these entities.
Dierbergs Markets, Inc. First Bank leases certain of its in-store branch offices and automated teller machine (ATM) sites from Dierbergs Markets, Inc., a grocery store chain headquartered in St. Louis, Missouri that is owned and operated by the brother of the Company’s Chairman and members of his immediate family. Total rent expense incurred by First Bank under the lease obligation contracts was $462,000, $437,000 and $419,000 for the years ended December 31, 2010, 2009 and 2008, respectively.
First Capital America, Inc. / Small Business Loan Source LLC. SBLS LLC, which is presently an inactive subsidiary of First Bank, was previously headquartered in Houston, Texas, and was engaged in the business of originating, selling and servicing business and commercial real estate, equipment and general purpose loans which are generally guaranteed in part by the SBA. In June 2005, FCA, a corporation owned by the Company’s Chairman and members of his immediate family, became a 49.0% owner of SBLS LLC in exchange for $7.4 million pursuant to a written option agreement with First Bank. In 2007, First Bank contributed $11.8 million to SBLS LLC in the form of additional capital contributions, thereby increasing First Bank’s ownership of SBLS LLC to 76.0% and decreasing FCA’s ownership to 24.0%. In March 2009, First Bank contributed $5.0 million to SBLS LLC in the form of an additional capital contribution, thereby increasing First Bank’s ownership of SBLS LLC to 82.55% and decreasing FCA’s ownership to 17.45%.
In April 2009, First Bank and FCA entered into a Purchase Agreement providing for FCA to sell its 17.45% ownership interest in SBLS LLC to First Bank for a purchase price of $1.9 million, the fair value of FCA’s ownership interest in SBLS LLC as of April 30, 2009 as determined by an independent third party appraisal. As such, effective April 30, 2009, First Bank owned 100% of SBLS LLC. As a result of the purchase of FCA’s noncontrolling interest in SBLS LLC, the Company recorded an increase in additional paid-in-capital with a corresponding decrease in noncontrolling interest in subsidiaries of $2.8 million during the second quarter of 2009.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
In September 2008, SBLS LLC renewed its then existing Promissory Note between SBLS LLC and First Bank that provided a $75.0 million unsecured revolving line of credit with a new maturity date of September 30, 2009. Interest was payable monthly in arrears on the outstanding loan balances at a current rate equal to the 30-day LIBOR plus 40 basis points. In January 2009, SBLS LLC executed an Amended Promissory Note with First Bank, which modified the interest payable monthly in arrears on the outstanding loan balance to a current rate equal to the First Bank internal Commercial Cost of Funds Rate, which averaged 3.63% for the nine months ended September 30, 2009. In September 2009, First Bank purchased all of the loans and certain other assets and assumed all of the liabilities of SBLS LLC, and in conjunction with this transaction, SBLS LLC paid off in full the outstanding loan balance. Interest expense recorded by SBLS LLC under the respective agreements was $1.8 million and $2.0 million for the years ended December 31, 2009 and 2008, respectively. The balance of the advances and the related interest expense recognized by SBLS LLC were eliminated for purposes of the consolidated financial statements.
First Capital America, Inc. / FB Holdings, LLC. In May 2008, the Company formed FB Holdings, a limited liability company organized in the state of Missouri. FB Holdings operates as a majority-owned subsidiary of First Bank and was formed for the primary purpose of holding and managing certain nonperforming loans and assets to allow the liquidation of such assets at a time that is more economically advantageous to First Bank and to permit an efficient vehicle for the investment of additional capital by the Company’s sole owner of its Class A and Class B preferred stock. During 2008, First Bank contributed cash of $9.0 million and nonperforming loans and assets with a fair value of approximately $133.3 million and FCA contributed cash of $125.0 million to FB Holdings. As a result, First Bank owned 53.23% and FCA owned the remaining 46.77% of FB Holdings as of December 31, 2010. The contribution of cash by FCA is reflected as a component of stockholders’ equity in the consolidated balance sheets and, consequently, increased the Company’s and First Bank’s total risk-based capital ratios under existing regulatory guidelines, subject to certain limitations.
FB Holdings entered into a Services Agreement with the Company and First Bank effective May 2008. The Services Agreement relates to various services provided to FB Holdings by the Company and First Bank, including loan servicing and special assets services as well as various other financial, legal, human resources and property management services. Fees paid under the Services Agreement by FB Holdings were $321,000, $570,000 and $428,000 for the years ended December 31, 2010, 2009 and 2008, respectively.
Investors of America Limited Partnership. In May 2008, the Company entered into a Credit Agreement with Investors of America, LP, and in August 2008, the Company entered into an Amended Credit Agreement with Investors of America, LP, as further described in Note 11 to the consolidated financial statements. Investors of America, LP is a Nevada limited partnership that was created by and for the benefit of the Company’s Chairman and members of his immediate family. The Credit Agreement matured on June 30, 2009. There were no advances outstanding under the Credit Agreement at the maturity date. Interest expense, comprised of commitment fees, recorded by the Company under the Credit Agreement was $37,000 for the year ended December 31, 2009. Interest expense, including commitment fees, recorded by the Company under the Credit Agreement was $303,000 for the year ended December 31, 2008.
On March 24, 2011, the Company entered into a Revolving Credit Note and a Stock Pledge Agreement with Investors of America, LP, as further described in Note 25 to the consolidated financial statements.
Steven F. Schepman. Mr. Steven F. Schepman, the former son-in-law of the Company’s Chairman, and former Director and Executive Vice President of the Company, received salary and bonus compensation of $157,000 and $204,000 for the years ended December 31, 2009 and 2008, respectively.
Loans to Directors and/or their Affiliates. First Bank has had in the past, and may have in the future, loan transactions in the ordinary course of business with its directors and/or their affiliates. These loan transactions have been made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated persons and did not involve more than the normal risk of collectability or present other unfavorable features. Loans to directors, their affiliates and executive officers of the Company were approximately $9.1 million and $37.2 million at December 31, 2010 and 2009, respectively. First Bank does not extend credit to its officers or to officers of the Company, except extensions of credit secured by mortgages on personal residences, loans to purchase automobiles, personal credit card accounts and deposit account overdraft protection under a plan whereby a credit limit has been established in accordance with First Bank’s standard credit criteria.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Depositary Accounts of Directors and/or their Affiliates. Certain directors and/or their affiliates maintain funds on deposit with First Bank in the ordinary course of business. These deposit transactions include demand, savings and time accounts, and have been established on the same terms, including interest rates, as those prevailing at the time for comparable transactions with unaffiliated persons.
Note 20 - Business Segment Results
The Company’s business segment is First Bank. The reportable business segment is consistent with the management structure of the Company, First Bank and the internal reporting system that monitors performance. First Bank provides similar products and services in its defined geographic areas through its branch network. The products and services offered include a broad range of commercial and personal deposit products, including demand, savings, money market and time deposit accounts. In addition, First Bank markets combined basic services for various customer groups, including packaged accounts for more affluent customers, and sweep accounts, lock-box deposits and cash management products for commercial customers. First Bank also offers consumer and commercial loans. Consumer lending includes residential real estate, home equity and installment lending. Commercial lending includes commercial, financial and agricultural loans, real estate construction and development loans, commercial real estate loans, small business lending and trade financing. Other financial services include mortgage banking, debit cards, brokerage services, internet banking, remote deposit, ATMs, telephone banking, safe deposit boxes, and trust and private banking services. The revenues generated by First Bank and its subsidiaries consist primarily of interest income, generated from the loan and investment security portfolios, service charges and fees generated from deposit products and services, and fees generated by the Company’s mortgage banking and trust and private banking business units. The Company’s products and services are offered to customers primarily within its geographic areas, which include eastern Missouri, Illinois, southern and northern California, and Florida’s Manatee, Pinellas, Hillsborough and Pasco counties. Certain loan products are available nationwide.
The business segment results are consistent with the Company’s internal reporting system and, in all material respects, with GAAP and practices predominant in the banking industry. Such principles and practices are summarized in Note 1 to the consolidated financial statements. The business segment results are summarized as follows:
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 21 - Regulatory Capital
The Company and First Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the operations and financial condition of the Company and First Bank. Under these capital requirements, the Company and First Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and First Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets.
The Company did not meet the minimum regulatory capital standards established for bank holding companies by the Federal Reserve at December 31, 2010 and 2009. The Company must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below in order to meet the minimum capital adequacy standards.
First Bank was categorized as well capitalized at December 31, 2010 and 2009 under the prompt corrective action provisions of the regulatory capital standards. First Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below in order to be categorized as well capitalized. In addition, First Bank is currently required to maintain its Tier 1 capital to total assets ratio at no less than 7.00% in accordance with the provisions of its informal agreement entered into with the MDOF, as further described in Note 1 to the consolidated financial statements. At December 31, 2010 and 2009, First Bank’s Tier 1 capital to total assets ratio was 7.68% and 6.53%, respectively. First Bank’s Tier 1 capital to total assets ratio was greater than the minimum requirement at December 31, 2010 and less than the minimum requirement at December 31, 2009. First Bank completed certain actions associated with its Capital Plan during the year ended December 31, 2010 to reestablish compliance with the minimum Tier 1 capital to total assets ratio requirement.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
As further described in Note 1 to the consolidated financial statements, on August 10, 2009, the Company announced the adoption of its Capital Plan, in order to, among other things, preserve the Company’s risk-based capital levels.
The successful completion of all or any portion of the Capital Plan is not assured, and no assurance can be made that the Capital Plan will not be materially modified in the future. If the Company is not able to complete substantially all of the Capital Plan, its regulatory capital ratios may be materially and adversely affected and its ability to withstand continued adverse economic conditions could be threatened.
At December 31, 2010 and 2009, the Company’s and First Bank’s required and actual capital ratios were as follows:
In March 2005, the Federal Reserve adopted a final rule, Risk-Based Capital Standards: Trust Preferred Securities and the Definition of Capital, which allows for the continued limited inclusion of trust preferred securities in Tier 1 capital. The Federal Reserve’s final rule limits restricted core capital elements to 25% of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability. Amounts of restricted core capital elements in excess of these limits may generally be included in Tier 2 capital. Specifically, amounts of qualifying trust preferred securities and cumulative perpetual preferred stock in excess of the 25% limit may be included in Tier 2 capital, but will be limited, together with subordinated debt and limited-life preferred stock, to 50% of Tier 1 capital. In addition, the final rule provides that in the last five years before the maturity of the underlying subordinated note, the outstanding amount of the associated trust preferred securities is to be excluded from Tier 1 capital and included in Tier 2 capital, subject to one-fifth amortization per year. The final rule provided for a five-year transition period, ending March 31, 2009, for the application of the quantitative limits. In March 2009, the Federal Reserve adopted a final rule that delays the effective date for the application of the quantitative limits to March 31, 2011. Until March 31, 2011, the aggregate amount of qualifying cumulative perpetual preferred stock and qualifying trust preferred securities that may be included in Tier 1 capital is limited to 25% of the sum of the following core capital elements: qualifying common stockholders’ equity, qualifying noncumulative and cumulative perpetual preferred stock, qualifying noncontrolling interest in the equity accounts of consolidated subsidiaries and qualifying trust preferred securities. The Company has determined that the Federal Reserve’s final rules that will be effective in March 2011, if implemented as of December 31, 2010, would reduce the Company’s total capital (to risk-weighted assets), Tier 1 capital (to risk-weighted assets) and Tier 1 capital (to average assets) to 4.53%, 2.27% and 1.44%, respectively. Therefore, upon implementation of the Federal Reserve’s final rule, the Company would remain below the minimum regulatory capital standards established for bank holding companies and, as noted above, could be subject to additional actions by regulators that could have a direct material effect on the operations and financial condition of the Company and First Bank. The final rules that will be effective in March 2011, if implemented as of December 31, 2010, would not have an impact on First Bank’s regulatory capital ratios. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 removes trust preferred securities as a permitted component of a holding company’s Tier 1 capital for holding companies with more than $15 billion of assets after a three-year phase-in period beginning January 1, 2013, and restricts new issuances of trust preferred securities from being included as Tier 1 capital for all holding companies.
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 22 - Distribution of Earnings of First Bank
First Bank is restricted by various state and federal regulations as to the amount of dividends that are available for payment to the Company. Under the most restrictive of these requirements, the payment of dividends is limited in any calendar year to the net profit of the current year combined with the retained net profits of the preceding two years. Permission must be obtained for dividends exceeding these amounts. Based on the current level of earnings, permission must be obtained for any payment of dividends from First Bank to the Company. Furthermore, First Bank, under its agreement with the MDOF and the FRB, has agreed, among other things, not to declare or pay any dividends or make certain other payments without the prior consent of the MDOF and the FRB, as further described in Note 1 to the consolidated financial statements.
Note 23 - Parent Company Only Financial Information
Following are condensed balance sheets of First Banks, Inc. as of December 31, 2010 and 2009, and condensed statements of operations and cash flows for the years ended December 31, 2010, 2009 and 2008:
CONDENSED BALANCE SHEETS
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
CONDENSED STATEMENTS OF OPERATIONS
CONDENSED STATEMENTS OF CASH FLOWS
First Banks, Inc.
Notes to Consolidated Financial Statements (Continued)
Note 24 - Contingent Liabilities
In the ordinary course of business, the Company and its subsidiaries become involved in legal proceedings, including litigation arising out of the Company’s efforts to collect outstanding loans. It is not uncommon for collection efforts to lead to so-called “lender liability” suits in which borrowers may assert various claims against the Company. Management believes the ultimate resolution of these existing proceedings is not reasonably likely to have a material adverse effect on the business, financial condition or results of operations of the Company and/or its subsidiaries.
The Company and First Bank have entered into agreements with the FRB and MDOF, as further described in Note 1 to the consolidated financial statements.
Note 25 - Subsequent events
As further described in Note 1 to the consolidated financial statements, on January 25, 2011, the Company obtained the requisite consents from the holders of the trust preferred securities of First Preferred Capital Trust IV to approve certain amendments to the Indenture, Trust Agreement and Guarantee Agreement. The consent solicitation terminated on January 26, 2011 after receipt by the Company and the Trustee of validly executed consents from the holders of a majority in aggregate liquidation amount of the outstanding trust preferred securities. As a result of the successful completion of the consent solicitation, the Company believes it is better positioned to consider certain potential capital planning strategies to improve the First Banks, Inc. regulatory capital ratios and further strengthen the Company’s overall financial position.
On January 28, 2011, First Bank entered into a Branch Purchase and Assumption Agreement with National Bank that provides for the sale of certain assets and the transfer of certain liabilities of First Bank’s Edwardsville Branch, as further described in Note 2 to the consolidated financial statements. Under the terms of the agreement, National Bank is to assume approximately $13.7 million of deposits associated with First Bank’s Edwardsville Branch, including certain commercial deposit relationships, for a premium of $130,000. National Bank is also expected to purchase approximately $794,000 of loans associated with First Bank’s Edwardsville Branch at a premium of 0.5%, or approximately $4,000, and premises and equipment associated with First Bank’s Edwardsville Branch at a premium of approximately $600,000. The transaction, which is subject to regulatory approvals and certain closing conditions, is expected to be completed during the second quarter of 2011.
On February 11, 2011, First Bank completed the sale of its San Jose Branch to City National, which resulted in a loss of $334,000, as further described in Note 2 to the consolidated financial statements. In conjunction with the transaction, City National assumed $8.4 million of deposits, including certain commercial deposit relationships, for a premium of 5.85%, or $371,000, as well as certain other liabilities, and purchased certain other assets at par value, including premises and equipment, associated with First Bank’s San Jose Branch.
On March 24, 2011, the Company entered into a Revolving Credit Note and a Stock Pledge Agreement with Investors of America, LP. The agreement provides for a $5.0 million secured revolving line of credit to be utilized for general working capital needs. This borrowing arrangement, which has a maturity date of December 31, 2012 and an interest rate of LIBOR plus 300 basis points, is intended to supplement, if necessary, the parent company’s overall level of unrestricted cash to cover the parent company’s projected operating expenses for the foreseeable future. As further described in Note 23 to the consolidated financial statements, the parent company’s unrestricted cash was $3.6 million at December 31, 2010.
First Banks, Inc.
Quarterly Condensed Financial Data ¾ Unaudited
First Banks, Inc.
Investor Information
First Banks, Inc. Preferred Securities
The preferred securities of First Preferred Capital Trust IV are traded on the New York Stock Exchange with the ticker symbol “FBSPrA.” The preferred securities of First Preferred Capital Trust IV are represented by a global security that has been deposited with and registered in the name of The Depository Trust Company, New York, New York (DTC). The beneficial ownership interests of these preferred securities are recorded through the DTC book-entry system. The high and low preferred securities prices and the dividends declared for 2010 and 2009 are summarized as follows:
First Preferred Capital Trust IV (Issue Date - April 2003) - FBSPrA
_________________________
(1)
Amounts exclude the additional dividends on any cumulative unpaid dividends following the announcement of the deferral of payments in August 2009.
For Information Concerning First Banks, Please Contact:
Terrance M. McCarthy
Lisa K. Vansickle
President and
Chief Executive Officer
Executive Vice President
and Chief Financial Officer
135 North Meramec
135 North Meramec
Mail Code - M1-821-014
Mail Code - M1-821-014
Clayton, Missouri 63105
Clayton, Missouri 63105
Telephone - (314) 854-4600
Telephone - (314) 854-4600
www.firstbanks.com
www.firstbanks.com
Transfer Agent:
Computershare Investor Services, LLC
2 North LaSalle Street
Chicago, Illinois 60602
Telephone - (312) 588-4990
www.computershare.com
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.
Date:
March 25, 2011
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
Signatures
Title
Date
/s/
James F. Dierberg
Director
March 25, 2011
James F. Dierberg
/s/
Terrance M. McCarthy
Director and President
March 25, 2011
Terrance M. McCarthy
and Chief Executive Officer
(Principal Executive Officer)
/s/
Allen H. Blake
Director
March 25, 2011
Allen H. Blake
/s/
James A. Cooper
Director
March 25, 2011
James A. Cooper
/s/
David L. Steward
Director
March 25, 2011
David L. Steward
/s/
Douglas H. Yaeger
Director
March 25, 2011
Douglas H. Yaeger
/s/
Lisa K. Vansickle
Executive Vice President
March 25, 2011
Lisa K. Vansickle
and Chief Financial Officer
(Principal Financial and Accounting Officer)
INDEX TO EXHIBITS