Item 1B.
Unresolved Staff Comments
None
Bancorp and the Bank’s executive offices are located at 1501 Highwoods Boulevard in Greensboro, NC. The Bank’s principal support and operational functions are located at 38 West First Avenue, Lexington, NC and 202 South Main Street in Reidsville, NC. On December 31, 2010, the Bank operated 31 branch offices, two commercial loan production offices and two mortgage loan production offices in its three markets: the Piedmont Triad Region and Coastal Region of NC and the Shenandoah Valley Region of VA. In addition, the Bank operated two mortgage loan production offices outside its markets. The locations of the Bank’s executive and banking offices, their form of occupancy, deposits as of December 31, 2010, and year opened, are provided in the accompanying table:
(1)
Executive offices of Bancorp and the Bank since July 2007 and November 2007, respectively.
(2)
Former headquarters of LSB and LSB Bank. Serves as a full service branch as well as an operations center for the Bank.
(3)
Former headquarters of FNB Southeast. Serves as a full service branch as well as an operations center for the Bank.
(4)
This location is an express drive through facility that only processes transactions and does not open customer accounts.
(5)
On December 21, 2010, the Bank announced it had entered into an agreement to sell its Harrisonburg, VA operation.
Peoples Finance operates from a leased 3,200 square foot, one-story building located at 126 Forest Hill Road, Lexington, NC.
The Bank operates commercial loan production offices in leased premises in Burlington and Greensboro, NC. The Bank also operates mortgage loan production offices in leased premises in Charlotte, Lake Norman, Raleigh and Winston-Salem, NC.
In addition, as of December 31, 2010, the Bank also operated 14 offsite ATM machines in various locations throughout its markets.
In the ordinary course of operations, Bancorp and its subsidiaries are often involved in legal proceedings. In the opinion of management, neither Bancorp nor its subsidiaries is a party to, nor is their property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to their business, nor has any such proceeding been terminated during the fourth quarter of Bancorp’s fiscal year ended December 31, 2010.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Prices and Dividend Policies
Bancorp’s common stock is traded on the Global Select Market of the NASDAQ Stock Market (“NASDAQ GSM”) under the symbol “NBBC”. The following table shows the high, low and closing sales prices of Bancorp’s common stock on the NASDAQ GSM, based on published financial sources, for each quarter within the last two fiscal years.
As of March 15, 2011, there were approximately 6,900 beneficial owners, including 3,253 holders of record, of Bancorp’s common stock.
Holders of Bancorp’s common stock are entitled to receive ratably such dividends as may be declared by Bancorp’s Board of Directors out of legally available funds. No cash dividends have been declared for Bancorp’s common stock since 2008. The ability of Bancorp’s Board of Directors to declare and pay dividends on its common stock is subject to the terms of applicable North Carolina law and banking regulations. Further, except with the U.S. Treasury’s approval, until such time as Bancorp has redeemed all of the Series A Preferred Stock or the U.S. Treasury has transferred all of the Series A Preferred Stock to a third party, prior to December 12, 2011, the payment of dividends on its common stock is limited to a maximum quarterly dividend of $0.05 per share. Also, Bancorp may not pay dividends on its capital stock if it is in default or has elected to defer payments of interest under its junior subordinated debentures. The declaration and payment of future dividends to holders of Bancorp’s common stock will also depend upon Bancorp’s earnings and financial condition, the capital requirements of Bancorp’s subsidiaries, regulatory conditions and other factors as Bancorp’s Board of Directors may deem relevant. For a further discussion as to restrictions on Bancorp and the Bank’s ability to pay dividends, please refer to “Item 1 - Supervision and Regulation”.
The following table sets forth certain information regarding outstanding options and shares available for future issuance under equity compensation plans as of December 31, 2010. Individual equity compensation arrangements are aggregated and included within this table. This table excludes any plan, contract or arrangement that provides for the issuance of options, warrants or other rights that are given to Bancorp’s shareholders on a pro rata basis and any employee benefit plan that is intended to meet the qualification requirements of Section 401(a) of the Code.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Bancorp did not repurchase any of its equity securities during 2010.
Recent Sales of Unregistered Securities
Bancorp did not sell any of its equity securities in the last fiscal year which were not registered under the Securities Act of 1933, as amended.
FIVE-YEAR STOCK PERFORMANCE TABLE
The following table illustrates the cumulative total shareholder return on Bancorp’s common stock over the five-year period ended December 31, 2010 and the cumulative total return over the same period of the S&P 500 Index (U.S.) and The Carson Medlin Company’s Independent Bank Index of 23 independent community banks located in eight southeastern states. The table assumes $100 originally invested on December 31, 2005 and that all subsequent dividends were reinvested in additional shares.
NEWBRIDGE BANCORP
Comparison of Cumulative Total Shareholder Return
Years Ended December 31
The Carson Medlin Company’s Independent Bank Index is the compilation of the total return to shareholders over the past five years of a group of 23 independent community banks located in the southeastern states of Alabama, Florida, Georgia, North Carolina, South Carolina, Tennessee, Virginia and West Virginia. The total five year return was calculated for each of the banks in the peer group taking into consideration changes in stock price, cash dividends, stock dividends and stock splits since December 31, 2005. The individual results were then weighted by the market capitalization of each bank relative to the entire peer group. The total return approach and the weighting based upon market capitalization are consistent with the preparation of the S&P 500 total return index.
The following table should be read in conjunction with “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 the Company’s financial condition and results of operations and should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in forward-looking statements as a result of various factors. The following discussion is intended to assist in understanding the financial condition and results of operations of the Company.
Executive Overview
The Company is in its fourth year of operations following the merger of equals of FNB and LSB in July 2007 and the subsequent merger of the two $1 billion legacy banks, FNB Southeast and LSB Bank, in late 2007. Due primarily to the severe economic recession that followed, the Company lost $6.6 million (not including goodwill impairment) in 2008 and $15.1 million in 2009. The Company did not defer credit costs, but instead aggressively charged-off and wrote down credits in an effort to rapidly restore profitability. In 2010, earnings dramatically improved by $18.5 million. Today, we believe the Company is well positioned to take advantage of a disrupted market.
In July 2008, Pressley A. Ridgill was named CEO of the Company, having become President of the Company, and CEO and President of the Bank in 2007. One year earlier, Mr. Ridgill had been appointed CEO of FNB and FNB Southeast. Through the combination, the Bank became the largest community bank in the North Central region of North Carolina, known as the Piedmont Triad. While a number of challenges emerged during the recession, the newly appointed CEO began bringing together his executive management team. The management team members were selected for their talents, experience and commitment to the Company’s Guiding Principles, which are founded on the concept that “Financial Success Begins with Integrity”. By early 2009, the executive management team was in place, and the credit deterioration in the loan portfolio had peaked. Having implemented a re-defined community bank strategy, the Company focused on returning to profitability. Under Mr. Ridgill’s guidance, management’s implementation of the redefined community bank strategy has yielded dramatically improved operating results and positive trends, including:
As we evaluate our 2010 results, we are satisfied with robust improvements in lowering operating and credit-related costs, increasing net interest income and building a stable capital position well above the regulatory levels required to be “well capitalized”. From 2007 through 2010 the Company charged-off more than $115 million of loans and other real estate owned, or 7.1% of the highest/peak level of loan balances of June 2008. As we have previously discussed, our desire was to put this adverse credit cycle behind us as quickly as possible, through early recognition of credit losses. We believe we have been largely successful in doing so. Looking forward to 2011, we believe credit costs will remain high for many months to come, but core earnings should continue to exceed credit costs and preferred dividends, resulting in a rising level of capital generation. In the recovery period of this recession, we believe the Company has emerged more disciplined and efficient with a greater opportunity for long-term success than what would have otherwise been realized.
Our Community Bank Strategy and Operating Plan
As a community bank, we believe our opportunity to achieve exceptional returns for our shareholders is through consistent delivery of superior customer service to small- and mid-size business and consumer customers in a manner that the large national and super regional banks are unable or unwilling to emulate. The Piedmont Triad has approximately $40 billion of deposits and just 3% of those balances are held at our Bank. The market is dominated by large national and regional banks, with 80% of the market’s deposits residing in banks with more than $10 billion of assets. Consequently, even relatively small growth in our market share could potentially result in extraordinary gains for the Company. We believe the economic downturn affected many of the competing North Carolina banks later in the credit cycle, which is resulting in less effective competition for quality customers, enhancing our opportunity to grow our market share.
To ensure the achievement of our strategic plan, management rewrote our operating plans following the bank merger to include basic measurable items that communicate throughout the organization the steps needed to improve the financial results of the organization. The operating plan objectives include:
•
Manage the net interest margin (NIM), including growing and expanding profitable customer relationships
•
Improve asset quality
•
Increase non-interest income
•
Implement a disciplined cost management culture
•
Position the Company to fulfill its Vision and Mission.
Manage Net Interest Margin
Net interest income is the difference between interest income and interest expense and is the Bank’s primary source of revenue. In order to manage our net interest income effectively, management must manage our net interest margin, which is the net yield on earning assets less the cost of interest bearing liabilities.
In the strategic and operating plans, management defined several steps to improve our control of the net interest margin, including:
•
Identifying and growing profitable relationships, by focusing our efforts and incentives on growing these relationships. Our performance-based sales culture identifies specific methodologies and tools to use in cross-selling to existing clients and introducing the Bank to new prospects. The Bank looks to take advantage of the current turbulent financial environment to grow market share throughout our markets.
•
Enhancing our interest rate risk management tools. Early in 2009, management engaged a prominent consulting firm to improve management’s interest rate risk management tools and practices. This firm works with more than 300 banks across the country and has been a leader in the asset liability management field since the 1980s.
•
Reducing the Company’s dependence on high cost time deposits in favor of lower cost core accounts, including DDA, NOW checking, money market and savings accounts.
•
Pricing loans consistently while considering relationship pricing for deposit and other relationships. Management is also seeking to develop more consistency on loan pricing relative to the various durations of fixed rate loans.
•
Implementing a more disciplined and accountable budget process to include monitoring loan, investment and deposit yields, rates and balances so that variances are questioned and controllable items are controlled.
Management implemented many of these operating changes over the last three years, which had a pronounced impact on the Company’s operating results in 2009 and 2010.
Net interest income increased $10.1 million in 2010 to $69.5 million compared to $59.3 million in 2009. The increased net interest income was due primarily to a 82 basis point rise in the Company’s net interest margin to
4.00% for the twelve months ended December 31, 2010 compared to the same period a year ago. The margin improved due to growth in core deposits and lower dependence on high cost time deposits. The weighted average deposit costs fell 106 basis points to 1.10% for the year ending December 31, 2010 compared to 2.16% for the year ending December 31, 2009. In 2008, the Company faced irrational time deposit pricing pressure from financial institutions in-market. The impact caused intense margin compression during late 2008 and the first two quarters of 2009. As management shifted liability strategies, high cost time deposits left the Bank for higher rates elsewhere and were replaced with lower cost core deposit accounts. NOW checking accounts became the featured product in marketing ads and internal sales incentives, which resulted in a sizable shift in the deposit mix. At December 31, 2010, DDA, money market, NOW and savings accounts totaled 66%, or $957.4 million, of the Company’s $1.45 billion of deposits. The percentage of core deposits has increased significantly, from 55%, or $824.9 million, at December 31, 2009 and 46%, or $763.3 million at December 31, 2008.
Improve Asset Quality
Our primary objective is to put the adverse affects of the recession behind us as quickly as possible through early recognition of credit losses. We believe we have been largely successful in identifying and taking appropriate aggressive action with our problem credits. Since 2007, the Company has charged off more than $115 million of problem loans and other real estate owned. Asset quality has steadily improved since nonperforming loans peaked in June of 2009 at $64.0 million. At December 31, 2010, nonperforming loans totaled $50.6 million, or 4.01% of total loans, and nonperforming assets totaled $77.3 million, or 4.28% of total assets. The Company’s highest risk and most closely monitored nonperforming assets are nonaccruing loans excluding troubled debt restructured loans. These loans totaled $32.0 million at December 31, 2010, down $19.6 million, or 38% since December 31, 2009 and down $27.3 million, or 47%, since June 30, 2009. OREO balances continue to cycle through the balance sheet, helping control the level of nonperforming assets over time. At December 31, 2010, OREO balances totaled $26.7 million, down from $27.3 million at December 31, 2009. During 2010, $20.7 million of loans were transferred into OREO, $3.8 million of OREO was written down, and $17.5 million was sold.
At December 31, 2010, the allowance for credit losses totaled $28.8 million, or 2.28% of loans held for investment and 56.8% of nonperforming loans. Provision for credit losses declined $14.5 million for the year to $21.3 million compared to $35.7 million for the year ending December 31, 2009. The Company’s coverage percentage may not be comparable with other banking institutions due to its practice of charging off specific estimated losses on loans at the time they become measurable. Consequently, the Company’s allowance for credit losses consists primarily of general reserves, with 95% being general and 5% specific. Substantially all estimated losses from the Company’s $50.6 million of non-performing loans have been recognized through charge-offs.
Increase Non-interest Income
Non interest income increased $330,000 in 2010 to $19.5 million compared to $19.2 million for 2009. Gain on sale of investments boosted 2010 non-interest income by $3.2 million compared to the prior year. Excluding the gain on sale of investments, non-interest income declined due primarily to lower deposit fee income resulting from changes in banking regulation combined with industry wide trends in consumer behavior that we believe are favorable to consumers as the banking industry implements improved consumer protection processes and policies on consumer overdraft activates. The Company also took steps to expand mortgage banking fees in 2010 through the acquisition of Bradford Mortgage, a quality community mortgage origination company operating principally in the Piedmont Triad area. Mortgage revenue totaled $2.4 million in 2010 compared to $674,000 in 2009. Investment services income also contributed strong growth, increasing $403,000 to $1.6 million for the year. With our sights set on continued growth in fee income businesses outside of retail banking, we believe non-interest income sources will remain a favorable contributor to our future earnings.
Implement a Disciplined Cost Management Culture
Core to the execution of management’s operating plan is the implementation of a disciplined cost management culture where “that which is within our control is controlled.” While certain items such as FDIC insurance costs have proven to be outside our control, the vast majority of non-interest related expenses are controllable.
A key element to changing the culture was the implementation of a line-item accountable budget process. The budget was built around a philosophy we termed as the “CAST” philosophy, which is an acronym for:
•
Conservative in forecasts and expectations
•
Accountable on an account by account basis
•
Specific to each individual in the organization so goals and budgets are understood
•
Timely so that continued monitoring and adjustments can be made
Since the merger, the Bank has implemented several major cost reduction initiatives focused on eliminating excess costs and non-core or unprofitable activities. These initiatives include an ongoing franchise validation plan, which carefully reviews each of our branch locations and targets the elimination of waste, inefficiency and duplication throughout our franchise. Management developed a methodology that evaluates each location’s pre-tax contribution, age and state of the facility, ease of closure, market demographics and overall fit within our strategic vision. Execution of the franchise validation plan and other expense reduction initiatives has resulted in a net reduction of 12 bank locations and 199 full time equivalent employees since merger. In 2009 and 2010, the validation planning led to the closing of seven low performing locations, the addition of two locations and the planned sale of the last remaining Virginia location. Following the sale, the Company will have 30 full service bank locations and 481 full time equivalent employees. The reduction in the number of branch locations and other expense reductions resulted in an improvement in our core efficiency from a high of 90% to an average of 67% in 2010.
For the second consecutive year, the Company has experienced meaningful gains by lowering operating costs. In 2009, recurring operating expenses declined $8.9 million excluding $3.5 million in one-time items such as losses on disposal of branch locations. In 2010, recurring operating expenses fell an additional $4.6 million. The improved efficiency is due in large part to management’s ability to focus attention on eliminating excess costs and inefficient products, services and delivery channels from legacy operations. As we look into 2011, we anticipate that the improved cost management culture will continue to improve the organization’s financial performance. While noninterest expense has declined significantly in recent years, the goal remains to continue to improve efficiencies to a level that surpasses our peers. That objective has not yet been achieved, but remains a focus through continued discipline in a time that has the potential to generate meaningful growth in our Company.
Position the Company to fulfill its Vision and Mission
The Company is located primarily in the Piedmont Triad area which is the third largest metropolitan area in North Carolina. The Company is headquartered in proximity to the largest two markets in North Carolina; Charlotte and Raleigh/Durham, both within a 90 minute drive. Due to the weakened financial conditions among many North Carolina financial institutions, consolidation of institutions is beginning to occur. While the Company may consider an in-market acquisition of a troubled institution, it is more certain the Company will look to acquire valuable customer relationships, which is likely to occur through the addition of key bankers. The opportunity for growth is significant. The Company is carefully considering the growth and design of our franchise. Late in 2010, the Company decided to sell the last remaining Virginia banking location, further clarifying the strategic plan as a North Carolina bank. Consequently, growth will focus on expansion in the existing and adjacent market locations.
Finally capital planning has remained paramount in this environment. Despite several challenging years following the merger, the Company’s capital levels remain well above the “well capitalized levels” as defined by regulatory guidelines. At December 31, 2010 the Company’s total risk based capital was 13.13% compared to the minimum “well capitalized” level of 10.00%. The Company continues to have no near-term plans to raise capital for the purpose of repaying TARP funds; however, the Small Business Lending Fund capital program may be a viable alternative to replacing TARP funds. The Company is very attentive to the ramifications of near
and long term dilution caused by a capital raise. Therefore, while many opportunities seem to be emerging and will be evaluated, the decision to acquire another in market institution will be evaluated with a high regard to risk and dilution. Organic growth and talent acquisition may prove to be the more prudent growth strategy over time. The Company anticipates modest loan growth in 2011.
Financial Condition at December 31, 2010 and 2009
Bancorp’s consolidated assets of $1.81 billion at year end 2010 reflect a decrease of 7.2% from year end 2009, following a decrease of 6.4% during the previous year. The decreases in both years are primarily a result of a decline in Bancorp’s loan portfolio. Total average assets decreased 7.1% from $2.05 billion in 2009, to $1.91 billion in 2010, while average earning assets decreased 8.2%, from $1.93 billion in 2009, to $1.77 billion in 2010. The decreases in total average assets and average earning assets were also primarily the result of a decrease in loans outstanding.
Gross loans (including loans held for sale) decreased $125.5 million during 2010, or 8.6%, compared to a decrease of 8.8% in 2009. The decrease in loans is due primarily to principal repayment on existing loans, loan chargeoffs, and foreclosures, coupled with soft loan demand from qualified borrowers. Loans secured by real estate totaled $1.07 billion in 2010 and represented 84.8% of total loans (excluding loans held for sale), compared with 83.4% at year end 2009. Within this category, residential real estate loans decreased 9.0% to $544.4 million and construction loans decreased 21.5% to $139.1 million. Commercial loans totaled $516.0 million at year end 2010, a decrease of 13.0% from the end of 2009. Consumer loans decreased 30.0% during 2010, ending the year at $53.0 million. Management believes the Bank is not dependent on any single customer or group of customers concentrated in a particular industry, the loss of whose deposits or whose insolvency would have a material adverse effect on operations.
Investment securities (at amortized cost) totaled $321.3 million at year end 2010, a 1.1% increase from $317.9 million at year end 2009. U.S. Government agency securities totaled $109.3 million, or 34.0% of the portfolio at year end 2010, compared to $49.0 million, or 15.4% of the portfolio one year earlier. Management believes that the additional risk of owning agency securities over U.S. Treasury securities is negligible and has capitalized on the favorable spreads available on the former. Mortgage backed securities totaled $56.0 million, or 17.4% of the portfolio, at December 31, 2010, compared to $77.4 million, or 24.4% of the portfolio at the previous year end. State and municipal obligations amounted to $17.4 million at year end 2010, and comprised 5.4% of the portfolio, compared to $105.2 million, or 33.1% of the portfolio a year earlier. Investment securities with a book value of $82.1 million were sold during 2010 to reposition the investment portfolio and reduce the Company’s exposure to municipalities. A portion of the securities that were identified for sale had been classified as held to maturity and, accordingly, all held to maturity securities were designated as available for sale. During 2009, the Company began investing in corporate bonds and collateralized mortgage obligations (CMOs). Corporate bonds totaled $82.8 million, or 25.8% of the portfolio at December 31, 2010, of which $46.1 million were covered bonds, compared to total corporate bonds of $34.0 million, or 10.7% of the portfolio at December 31, 2009, of which $29.1 million were covered bonds. CMOs totaled $39.7 million, or 12.3% of the portfolio at year end 2010, compared to $35.1 million, or 11.0% of the portfolio at the end of the previous year. The Company’s investment strategy is to achieve acceptable total returns through investments in securities with varying maturity dates, cash flows and yield characteristics. U.S. Government agency securities are generally purchased for liquidity and collateral purposes, mortgage backed securities are purchased for yield and cash flow purposes, corporate bonds are purchased for yield and longer maturity municipal bonds are purchased for yield and income tax advantage. The table, “Investment Securities,” on page 52, presents the composition of the securities portfolio for the last three years, as well as information about cost, fair value and weighted average yield.
The competition for deposits within the Bank’s market areas increased significantly during the liquidity crisis of 2008 as larger national and regional banks increased their rates in an effort to attract deposits and maintain adequate liquidity. The Bank, which historically has relied on appropriate pricing and high quality customer service to retain and increase its retail deposit base, was forced to compete with higher rates offered by the larger national and regional banks in order to satisfy its deposit requirements. During 2009 and throughout 2010, the
Company shifted its liability strategy, reducing its dependence on high cost time deposits in favor of lower cost core accounts, including DDA, NOW checking, money market and savings accounts.
Total deposits decreased $46.3 million to $1.45 billion at December 31, 2010, a 3.1% decrease from a total of $1.50 billion one year earlier. This change was primarily the result of a $178.8 million reduction in time deposits, as the interest rates offered by the Bank declined substantially during the year. This decrease was partially offset by a $169.0 million increase in NOW account deposits, as the Bank’s new “FastForward Checking” product, introduced in the third quarter of 2009, grew to $212.0 million at December 31, 2010.
In order to attract additional deposits when necessary, the Bank uses several different sources such as membership in an electronic deposit gathering network that allows it to post interest rates and attract deposits from across the U.S. (bulletin board deposits), brokered certificates of deposit secured through broker/dealer partnerships and deposits obtained through the Promontory InterFinancial Network, also known as CDARS. The Bank’s reliance on these out-of-market deposits has continued to decrease during 2010. CDARS decreased $30.9 million, from $58.0 million at year end 2009 to $27.1 million at year end 2010, while brokered deposits increased $15.1 million, from $15.0 million at year end 2009 to $30.1 million at year end 2010.
The Bank also has a credit facility available with the FHLB of Atlanta. The Bank utilized a portion of the approximately $361.0 million credit line with the FHLB of Atlanta to fund earning assets. FHLB borrowings totaled $112.7 million at year end 2010. In addition to the credit line at the FHLB, the Bank has borrowing capacity at the Federal Reserve Bank totaling $30.0 million, of which there were no borrowings outstanding at December 31, 2010. Management believes these credit lines are a cost effective and prudent alternative to deposit balances, since particular amounts, terms and structures may be selected to meet changing needs.
Financial Condition at December 31, 2009 and 2008
Bancorp’s consolidated assets of $1.95 billion at year end 2009 reflect a decrease of 6.4% over year end 2008. The decrease from year end 2008 to year end 2009 is primarily a result of the decline in Bancorp’s loan portfolio. Total average assets decreased 1.8% from $2.09 billion in 2008, to $2.05 billion in 2009, while average earning assets increased 0.9%, from $1.91 billion in 2008, to $1.93 billion in 2009. The decrease in total average assets was also primarily the result of a decrease in loans outstanding, while the slight increase in average earning assets was driven by an increase in interest bearing bank balances.
Gross loans decreased $141.4 million during 2009, or 8.8%, compared to increases of 7.7% in 2008 and 96.1% in 2007. The decrease in loans was due primarily to principal repayment on existing loans, loan chargeoffs, and foreclosures, coupled with soft loan demand from qualified borrowers. Loans secured by real estate totaled $1.22 billion in 2009 and represented 83.4% of total loans, compared with 82.3% at year end 2008. Within this category, residential real estate loans decreased 4.4% to $605.0 million and construction loans decreased 19.0% to $177.3 million. Commercial loans totaled $593.4 million at year end 2009, a decrease of 3.9% from the end of 2008. Consumer loans decreased 38.3% during 2009, ending the year at $75.5 million.
Investment securities (at amortized cost) totaled $317.9 million at year end 2009, a 12.0% increase from $283.7 million at year end 2008. U.S. Government agency securities totaled $49.0 million, or 15.4% of the portfolio at year end 2009, compared to $56.6 million, or 20.0% of the portfolio one year earlier. Mortgage backed securities totaled $77.4 million, or 24.4% of the portfolio, at December 31, 2009, compared to $97.8 million, or 34.5% of the portfolio at the previous year end. State and municipal obligations amounted to $105.2 million at year end 2009, and comprised 33.1% of the portfolio, compared to $115.6 million, or 40.8% of the portfolio a year earlier. During 2009, the Company also began investing in corporate bonds and CMOs. Corporate bonds totaled $34.0 million, or 10.7% of the portfolio, of which $29.1 million were covered bonds, while CMOs totaled $35.1 million, or 11.0% of the portfolio.
Total deposits decreased $164.2 million to $1.50 billion at December 31, 2009, a 9.9% decrease from a total of $1.66 billion one year earlier. This change was primarily the result of a $225.8 million reduction in time deposits, as the interest rates offered by the Bank declined substantially during the year. This decrease was
partially offset by increases in NOW and money market deposits, as the Bank’s new “FastForward Checking” product, introduced in the third quarter of 2009, grew to $79.7 million at December 31, 2009.
Net Interest Income
Like most financial institutions, the primary component of the Company’s earnings is net interest income. Net interest income is the difference between interest income, principally from loans and investments, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume and changes in interest rates earned and paid. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Spread and margin are influenced by the levels and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of noninterest-bearing liabilities.
Average Balances and Net Interest Income Analysis. The accompanying table sets forth, for the years 2008 through 2010, information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant yields or rates, net interest income, net interest spread, net interest margin and ratio of average interest-earning assets to average interest-bearing liabilities. Average loans include nonaccruing loans, the effect of which is to lower the average yield.
Average Balances and Net Interest Income Analysis
Fully taxable equivalent basis(1) (Dollars in thousands)
Volume and Rate Variance Analysis
The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table identifies (i) changes attributable to volume (changes in volume multiplied by the prior period’s rate), (ii) changes attributable to rate (changes in rate multiplied by the prior period’s volume), and (iii) net change (the sum of the previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) have been allocated, based on the absolute value, between changes attributable to volume and changes attributable to rate.
Volume and Rate Variance Analysis
Fully taxable-equivalent basis(1) (in thousands)
(1)
Income related to securities exempt from federal income taxes is stated on a fully taxable-equivalent basis, assuming a federal income tax rate of 35% and is then reduced by the non-deductible portion of interest expense.
(2)
The volume/rate variance for each category has been allocated on a consistent basis between rate and volume variances, based on the percentage of rate, or volume, variance to the sum of the two absolute variances.
Results of Operations -Years Ended December 31, 2010 and 2009
Net Income. Net income available to common shareholders for 2010 was $461,000, representing net income per diluted share of $0.03, compared to net loss to common shareholders of ($18.1) million, or ($1.15) per diluted share the prior year. The improvement to net income in 2010 from net loss for 2009 is mostly attributed to a reduction in the provision for credit losses, improved net interest income and continued reductions in noninterest expense. Net interest income for 2010 after provision for credit losses increased by $24.6 million, or 104.3%, as compared to 2009. The taxable equivalent net interest margin increased 82 basis points for 2010, to 4.00%, from 3.18% for 2009. Noninterest income increased $0.3 million, or 1.7%, in 2010, while noninterest expense for 2010 decreased $5.0 million, or 7.1%. The provision for loan losses in 2010 was $21.3 million, down $14.4 million, or 40.6% from $35.7 million in 2009. Return on average assets for 2010 was 0.18% compared to (0.74)% for 2009. Return on average shareholders’ equity for 2010 was 2.03% compared to (8.87)% in 2009.
Net Interest Income. Net interest income represents the gross profit from the lending and investment activities of a banking organization and is the most significant factor affecting the earnings of the Company. Net interest income is influenced by changes in interest rates, volume and the mix of these various components. Net interest income for 2010, on a taxable-equivalent basis, increased $9.6 million, or 15.7%, compared to 2009. This was primarily due to an increase in net interest margin, which increased 82 basis points over the same period. Average earning assets in 2010 decreased $158.4 million, or 8.2%, to $1.77 billion, compared to $1.93 billion in
2009. Average interest-bearing liabilities for 2010 decreased $145.5 million, or 8.5%, to $1.56 billion, compared to $1.70 billion for 2009.
The taxable-equivalent net interest margin for 2010 increased to 4.00%, compared to 3.18% for 2009, an improvement of 82 basis points. During 2010, the Bank substantially reduced its dependence on high cost time deposits, and, as a result, net interest income and the net interest margin improved steadily throughout 2010. In 2010, the average yield on earning assets decreased by five basis points while the average rate on interest-bearing liabilities decreased by 99 basis points, which resulted in an increase in the interest rate spread in 2010 of 94 basis points compared to the prior year.
The table, “Average Balances and Net Interest Income Analysis,” on page 37 summarizes net interest income and average yields earned, and rates paid for the years indicated, on a taxable-equivalent basis. The table, “Volume and Rate Variance Analysis” on page 38 presents the changes in interest income and interest expense attributable to volume and rate changes between the years indicated.
Provision for Credit Losses and Allowance for Credit Losses. The Company recorded a $21.3 million provision for credit losses during the year ended December 31, 2010, compared to a $35.7 million provision during the previous year. The decrease in 2010 is primarily a result of a lower level of chargeoffs in 2010 than in 2009, following the Company’s decision in 2009 to more quickly take appropriate aggressive action with its problem credits. During the fourth quarter of 2010, the Company charged off $6.2 million of a $10.0 million loan which represents subordinated debt to a financial institution. The Company does not have any other loans to financial institutions. The Company’s allowance for credit losses decreased 19.8% from the prior year end and was $28.8 million at December 31, 2010. The allowance for credit losses expressed as a percentage of total loans (including loans held for sale) decreased from 2.45% at December 31, 2009 to 2.15% at December 31, 2010.
Noninterest Income. In 2010, noninterest income increased $330,000 to $19.5 million. Pre-tax gains on sale of investment securities totaled $3.6 million in 2010 compared to $389,000 in 2009. The Company sold substantially all of its municipal securities to reduce exposure to municipalities, many of which are experiencing challenging budgetary issues. These gains were partially offset by losses on sale of OREO of $1.8 million in 2010 and $591,000 in 2009 and other writedowns on land and fixed assets of $418,000 in 2010. For 2010, growth in mortgage revenue and investment services income exceeded declines in deposit service income. Mortgage revenue increased $1.8 million, or 262%, for the year due primarily to the Company’s acquisition of the assets of Bradford Mortgage Company a year ago. Investment services revenue increased $403,000 for the year to $1.6 million from $1.2 million in 2009. Deposit service charge revenue declined 13% for the year, or $1.1 million, due primarily to ongoing regulatory changes in the industry and changes in consumer behavior. Merchant processing income decreased by $1.6 million as a result of the Company’s sale of its merchant card servicing operation in 2009. For the detailed change in other operating income please see the table “Other Operating Income and Expenses” in Note 13 of the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Noninterest Expense. In 2010, noninterest expense declined $5.0 million, or 7%, compared to 2009. The Company recorded a $3.5 million increase in OREO-related costs in 2010 compared to 2009. The results in 2009 were affected by $3.8 million of one time expenses related to restructuring branch operations, terminating certain retired data processing systems and termination of non-executive employment agreements totaling $2.9 million pre-tax, as well as a special industry-wide FDIC assessment expense of $970,000. Excluding the one-time items and the increased costs on OREO, operating costs have declined $4.6 million for the year on lower data processing costs, legal and professional expenses, merchant processing costs and various other operating expense reductions. For the detailed change in other operating income please see the table “Other Operating Income and Expenses” in Note 13 of the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Provision for Income Taxes. Bancorp recorded a tax benefit of $0.2 million in 2010, compared to a tax benefit totaling $11.6 million in 2009. The tax benefits in both years are primarily attributable to the provisions for credit losses and asset writedowns recorded during those years. Bancorp’s effective tax rate was (7.9)% in 2010
and (43.5)% in 2009. In both 2010 and 2009, the difference between the effective tax rate and the statutory rate was principally due to tax exempt interest income.
Results of Operations -Years Ended December 31, 2009 and 2008
Net Income. Net loss available to common shareholders for 2009 was $18.1 million, representing a net loss per diluted share of $1.15, compared to net loss to common shareholders of $57.1 million, or $3.64 per diluted share the prior year. Excluding the goodwill impairment, the net loss available to common shareholders for 2008 was $6.6 million, representing a net loss per diluted share of $0.42. The decrease in net loss for 2009 is mostly attributed to the write off of $50.4 million of goodwill during 2008, partially offset by an increase in the provision for credit losses as a result of the continued weakness in the national and regional economies. Net interest income after provision for credit losses decreased by $14.6 million, or 38.2%, as compared to 2008. The taxable equivalent net interest margin decreased 23 basis points during 2009, to 3.18%, from 3.41% for 2008. Noninterest income decreased $1.5 million, or 7.0%, in 2009, while noninterest expense for 2009 decreased $53.1 million, or 43.3%. The provision for loan losses in 2009 was $35.7 million, up $10.5 million, or 41.5% from $25.3 million in 2008. Return on average assets for 2009 was (0.98)% compared to (2.72)% for 2008. Return on average shareholders’ equity for 2009 was (11.75)% compared to (29.38)% in 2008.
Net Interest Income. Net interest income represents the gross profit from the lending and investment activities of a banking organization and is the most significant factor affecting the earnings of the Company. Net interest income is influenced by changes in interest rates, volume and the mix of these various components. Net interest income for 2009, on a taxable-equivalent basis, decreased $3.9 million, or 5.9%, compared to 2008. This was primarily due to a decline in net interest margin, which decreased 23 basis points. Average earning assets in 2009 increased $18.2 million, or 0.9%, to $1.93 billion, compared to $1.91 billion in 2008. Average interest-bearing liabilities for 2009 decreased $15.2 million, or 0.9%, to $1.70 billion, compared to $1.72 billion for 2008.
The taxable-equivalent net interest margin for 2009 decreased to 3.18%, compared to 3.41% for 2008, a decline of 23 basis points. In mid-2009, the Bank began reducing its dependence on high cost time deposits, and, as a result, net interest income and the net interest margin improved steadily in the second half of 2009, although this improvement was insufficient to overcome the effect of higher deposit costs in the first half of the year. In 2009, the average yield on earning assets decreased by 102 basis points while the average rate on interest-bearing liabilities decreased by 83 basis points, which resulted in a decrease in the interest rate spread in 2009 of 19 basis points compared to the prior year.
The table, “Average Balances and Net Interest Income Analysis,” summarizes net interest income and average yields earned, and rates paid for the years indicated, on a taxable-equivalent basis. The table, “Volume and Rate Variance Analysis” presents the changes in interest income and interest expense attributable to volume and rate changes between the years indicated.
Provision for Credit Losses and Allowance for Credit Losses. The Company recorded a $35.7 million provision for credit losses during the year ended December 31, 2009, compared to a $25.3 million provision during the previous year. The increase in 2009 is primarily a result of continued weakness in asset and credit quality caused by the downturn in the real estate market, disruption and volatility in the financial markets, and the overall decline in the local and national economies. In addition, during 2009, the Company improved its process for identifying and taking appropriate aggressive action with its problem credits. The Company’s allowance for credit losses remained essentially unchanged from the prior year end and was $35.8 million at December 31, 2009. The allowance for credit losses expressed as a percentage of total loans (including loans held for sale) increased from 2.23% at December 31, 2008 to 2.45% at December 31, 2009.
Noninterest Income. In 2009, noninterest income decreased $1.5 million, or 7.0%, and totaled $19.2 million compared to $20.6 million in 2008. Fee income from service charges on deposit accounts for 2009 decreased $0.8 million, or 8.6%, compared to 2008. Noninterest income for 2009 includes $0.4 million in gains from the sales of investment securities, compared to $2.5 million of such gains during the previous year. These declines were partially offset by growth in mortgage banking revenue and investment services income, which increased 51.8%
and 35.7%, respectively from the previous year. Other income for 2009 includes a $1.1 million gain from the sale of merchant card services, and also includes $0.6 million of income on an investment in bank-owned life insurance, compared to $1.1 million of income from bank-owned life insurance in 2008. For the detailed change in other operating income please see the table “Other Operating Income and Expenses” in Note 13 of the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Noninterest Expense. In 2009, noninterest expense was $69.5 million, representing a decrease of $53.1 million, or 43.3%, from 2008. The decrease was primarily the result of the write off of $50.4 million of goodwill in 2008. Excluding one time costs, such as the impairment of goodwill, losses on disposal of branch locations, and a $3.5 million increase in the cost of FDIC insurance, non-interest expense declined $8.9 million for the twelve months ending December 31, 2009 compared to the same period in 2008. Personnel expense, consisting of employee salaries and benefits, decreased $4.3 million, or 12.2%, primarily as a result of headcount reductions taken during the year. For the detailed changes in other operating expenses, please see the table “Other Operating Income and Expense” in Note 13 of the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Provision for Income Taxes. Bancorp recorded a tax benefit of $11.6 million in 2009, compared to a tax benefit totaling $6.9 million in 2008. The tax benefits in both years are primarily attributable to the provisions for credit losses and asset writedowns recorded during those years. Bancorp’s effective tax rates were (43.5)% in 2009 and (10.8)% in 2008. Excluding the goodwill impairment in 2008, the effective rate for 2008 was (51.7)%. In 2009, the difference between the effective tax rate and the statutory rate was principally due to tax exempt interest income. In 2008, the difference between the effective rate and the statutory rate was primarily the result of the write off of goodwill.
Liquidity and Cash Flow
Market and public confidence in our financial strength and in the strength of financial institutions in general will largely determine our access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital resources. Liquidity management refers to the policies and practices that ensure the Bank has the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of the Bank’s customers. Management measures our liquidity position by giving consideration to both on- and off-balance sheet sources of, and demands for, funds on a daily and other periodic bases. Deposit withdrawals, loan funding and general corporate activity create the primary needs for liquidity for the Bank. Sources of liquidity include cash and cash equivalents, net of federal requirements to maintain reserves against deposit liabilities, investments available for sale, loan repayments, loan sales, increases in deposits, and increases in borrowings from the FHLB secured with pledged loans and securities, and from correspondent banks under overnight federal funds credit lines and securities sold under repurchase agreements.
Bancorp, the bank holding company, has sufficient cash and cash equivalents on hand at December 31, 2010 to provide for Bancorp’s obligations and service its debt for approximately two years.
The investment portfolio at December 31, 2010 included securities with a par value of approximately $126.3 million with call features, whereby the issuers of such securities have the option to repay the security before the contractual maturity date. Bancorp anticipates that a number of these debt instruments may be called by their issuers during 2011, due to the current volatility in the interest markets for long term debt issuances.
The Bank has the ability to manage, within competitive and cost of funds constraints, increases in deposits within its market areas. The Bank is a member of an electronic network that allows it to post interest rates and attract certificates of deposit nationally. It also utilizes CDARS and brokered deposits to supplement in-market deposit growth.
The Bank has established wholesale repurchase agreements with regional brokerage firms. The Bank can access this additional source of liquidity by pledging investment securities with the brokerage firms.
Liquidity is further enhanced by a line of credit with the FHLB, amounting to approximately $361.0 million, collateralized by FHLB stock, investment securities, qualifying 1 to 4 family residential mortgage loans, and qualifying commercial real estate loans. Based upon collateral pledged, as of December 31, 2010, the borrowing capacity under this line was $276.9 million, with $114.2 million available to be borrowed. The Bank provides various reports to the FHLB on a regular basis to maintain the availability of the credit line. Each borrowing request to the FHLB is initiated through an advance application that is subject to approval by the FHLB before funds are advanced under the line of credit. In addition to the credit line at the FHLB, the Bank has borrowing capacity at the Federal Reserve Bank totaling $30.0 million, of which none was outstanding at December 31, 2010.
As presented in the Consolidated Statement of Cash Flows, the Company generated $42.9 million in operating cash flow during 2010, compared to $14.7 million in 2009 and $22.1 million in 2008. The increase from 2009 to 2010 was primarily the result of the Company’s net income in 2010, compared to a net loss in 2009. The decrease from 2008 to 2009 was primarily a result of an increase in loans held for sale during 2009 compared to a decrease in loans held for sale during 2008, offset by a number of other changes.
Cash provided by investing activities was $80.5 million in 2010, compared to cash provided by investing activities of $102.3 million in 2009 and cash used for investing activities of $115.6 million in 2008. Cash flows for 2010 and 2009 included inflows of $73.6 million and $83.9 million, respectively, related to a decrease in the loan portfolio, compared to a cash outflow of $156.3 million in 2008 as the loan portfolio increased.
Cash used by financing activities was $139.2 million in 2010, compared to cash used by financing activities of $118.0 million in 2009 and cash provided by financing activities of $80.7 million in 2008. Cash flows for 2010 and 2009 included outflows of $178.8 million and $225.8 million, respectively related to decreases in time deposits, while 2008 included cash inflows of $85.9 million from an increase in time deposits. During 2010, the Company had a cash inflow of $132.5 million related to increase in core deposits, partially offset by cash outflows of $90.3 million used to reduce outstanding borrowings. In 2009, the Company had cash inflows of $61.6 million as a result of increased core deposits and an inflow of $48.7 million as a result of increased borrowings.
Contractual Obligations and Commitments
In the normal course of business there are various outstanding contractual obligations of Bancorp that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit, which may or may not require future cash outflows. Payments for borrowings do not include interest. Payments related to leases are based on actual payments specified in the underlying contracts. The following table reflects the material contractual obligations of Bancorp outstanding as of December 31, 2010.
Contractual Obligations
(in thousands)
Capital Resources
Banks, bank holding companies, and financial holding companies, as regulated institutions, must meet required levels of capital. The Federal Reserve and the FDIC have minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are required to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines. On August 26, 2005, FNB completed a private placement of trust preferred securities in the amount of $25.0 million, and contributed $24.0 million of the proceeds to its bank subsidiary as capital to support the bank’s growth. See Note 8 of the Notes to the Consolidated Financial Statements for a discussion of FNB’s issuance of the trust preferred securities. On December 12, 2008, the Company sold Series A Preferred Stock and a Warrant to the U.S. Treasury for $52.4 million as part of the CPP. As shown in Note 19 of the Notes to the Consolidated Financial Statements, the Company and the Bank both maintained capital levels exceeding the minimum levels required to be categorized as “well capitalized” for each of the three years presented.
The Company’s stock repurchase program expired on May 31, 2009. The Company did not repurchase any shares during 2009 or 2010.
Lending Activities
General. The Bank offers a broad array of lending services, including construction, real estate, commercial and consumer loans, to individuals and small to medium-sized businesses and retail clients that are located in or conduct a substantial portion of their business in the Bank’s market areas. The Bank’s total loans (excluding loans held for sale) at December 31, 2010 were $1.26 billion, or 69.8% of total assets. At December 31, 2010, the Bank had no large loan concentrations (exceeding 10% of its portfolio) in any particular industry, other than real estate. The Bank’s legal lending limit at December 31, 2010 was $31.6 million and the largest credit relationship was approximately $13.9 million.
Loan Composition. The following table summarizes, at the dates indicated, the composition of the Bank’s loan portfolio and the related percentage composition (excluding loans held for sale). A substantial portion of the increases from 2006 to 2007 are as a result of the Merger.
Summary of Loan Portfolio
(in thousands; excluding loans held for sale)
The Company has no foreign loan activity.
Real Estate Loans. Loans secured by real estate totaled $1.07 billion, or 84.8% of total loans (excluding loans held for sale) at December 31, 2010. At year end 2010, the Bank had real estate loan relationships of various sizes ranging up to $13.5 million and commitments up to $13.9 million, secured by office buildings, retail establishments, residential development and construction, warehouses, motels, restaurants and other types of property. Loan terms are typically limited to five years, with payments through the date of maturity generally based on a 15-20 year (15-30 year for owner-occupied single and multi-family properties) amortization schedule. Interest rates may be fixed or adjustable, based on market conditions, and the Bank generally charges an origination fee. Management has attempted to reduce credit risk in the real estate portfolio by emphasizing loans on owner-occupied office, multi-family and retail buildings where the loan to value ratio, established by independent appraisals, does not exceed 70% to 80%, and net projected cash flow available for debt service amounts to at least 120% to 135% of the debt service requirement. The Bank also generally requires personal guarantees and personal financial statements from the principal owners in such cases.
Real Estate - Mortgage. The Bank originates fixed and adjustable rate mortgages as well as FHA, VA and USDA Government supported loans for resale into the secondary market. The Bank provides bank-held mortgage products to accommodate qualified borrowers who do not meet all the standards for a conventional secondary market mortgage. During 2010 the Bank originated $228.7 million of loans in these various categories. Also included in real estate mortgage loans are home equity revolving lines of credit, with $219.6 million outstanding as of December 31, 2010.
Real Estate - Construction Loans. The Bank’s current lending strategy is to reduce exposure in this portfolio segment. The Bank expects that the majority of its new construction and development loans on commercial and residential projects will be in the range of $300,000 to $5.0 million. At December 31, 2010 and 2009, the Bank held $139.1 million and $177.3 million, respectively of such loans. To reduce credit risk associated with such loans, the Bank emphasizes small commercial centers that are substantially preleased, or residential projects that
are substantially presold and built in strong, proven markets. The leases on commercial projects must generally result in a loan to appraised value of 75% to 80% or less and a net cash flow to debt service of no less than 120% to 135%. The Bank typically requires a personal guarantee from the developer or builder. Loan terms are generally 12-15 months, although the Bank will make a “mini-permanent” loan for purposes of construction and development of up to a five year term. Rates can be either fixed or variable, and the Bank usually charges an origination fee. The Bank experienced net chargeoffs from real estate - construction loans of $5.3 million in 2010, $11.6 million in 2009, and $7.2 million in 2008.
Commercial Loans. The Bank makes loans for commercial purposes to various types of businesses. At December 31, 2010, the Bank held $516.0 million of commercial loans, or 40.9% of its total loan portfolio. Equipment loans are typically made on terms up to five years at fixed or variable rates, with the financed equipment pledged as collateral to the Bank. The Bank attempts to reduce its credit risk on these loans by limiting the loan to value percentage to 80%. Working capital loans are made on terms typically not exceeding one year. These loans may be secured or unsecured, but the Bank attempts to limit its credit risk by requiring the borrower to demonstrate its capacity to produce net cash flow available for debt service equal to 120% to 150% of its debt service requirements. The Bank experienced net chargeoffs from commercial loans of $7.7 million in 2010, $10.6 million in 2009, and $4.1 million in 2008.
Consumer Loans. Using a centralized underwriting process, the Bank makes a variety of loans to individuals for personal and household purposes, including (i) secured and unsecured installment and term loans originated directly by the Bank; (ii) unsecured revolving lines of credit, and (iii) amortizing secured lot loans. Certain of the direct loans are secured by the borrowers’ residences. At December 31, 2010, the Bank held $53.0 million of consumer loans. During 2010, 2009, and 2008, the Bank experienced net consumer chargeoffs of $2.2 million, $3.9 million, and $3.7 million, respectively.
Loan Approval and Review. When the aggregate outstanding loans to a single borrower or related entities exceed an individual officer’s lending authority, the loan request must be considered and approved by an officer with a higher lending limit. All consumer purpose loan decisions are made by the Bank’s Central Underwriting Support Group. Area executives can generally approve commercial relationships up to $750,000. If the lending request exceeds the area executive’s lending limit, the loan must be submitted to and approved by a senior credit officer. A senior credit officer has authority to approve commercial relationships up to $2,500,000 on a secured basis. All loan relationships between $2,500,000 and $4,000,000 must be approved by the Chief Commercial Credit Officer (“CCCO”). All loans between $4,000,000 and $7,500,000 must be approved by the Chief Credit Officer (“CCO”). Loan relationships exceeding $7,500,000 up to $10,000,000 must be unanimously approved by a committee of the CCCO, the CCO, and the Bank’s Chief Executive Officer (“CEO”). Loan relationships over $10,000,000 must be approved by the Credit Management Committee of the Bank’s Board of Directors.
The Bank’s Loan Review Program is headed by the Loan Review Manager, who reports directly to the Credit Management Committee of the Bank’s Board of Directors. The Program includes the Annual Loan Review Coverage Plan which is approved by the Credit Management Committee and which stipulates a certain number of loan reviews to be completed by the Loan Review Manager and employees under his or her guidance, and an additional number of loan reviews to be completed by independent loan review consulting firms. In addition, all loan officers are charged with the responsibility of reviewing their portfolios and making adjustments to the risk ratings as needed. The “Watch Loan Committee”, which includes the CCO, the CCCO, the Special Assets Manager and the Special Assets Officers, reviews all commercial loans graded special mention, substandard, doubtful and loss on a monthly basis, and provides a summary to the Credit Management Committee, also on a monthly basis.
The Bank’s credit review system supplements its loan rating system, pursuant to which the Bank may place a loan on its criticized asset list or may classify a loan in one of various other classification categories. A specified minimum percentage of loans in each adverse asset classification category, based on the probability of default and on the historical loss experience of the Bank in each such category, are used to determine the adequacy of the Bank’s allowance for credit losses monthly. These loans are also individually reviewed by the Watch Loan Committee of the Bank to determine whether a greater allowance allocation is justified due to the facts and circumstances of a particular adversely classified loan.
The Bank’s loan portfolio is analyzed on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly. The Bank’s allowance for credit losses is also analyzed monthly by management. This analysis includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk. The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group. Major loan portfolio subgroups include: risk graded commercial loans, mortgage loans, home equity loans, retail loans and retail credit lines. The provisions of ASC 310-10-35 “Loans that Are Identified for Evaluation or that Are Individually Considered Impaired” are applied to individually significant loans. Finally, individual reserves may be recorded based on a review of loans on the watch list. See also Note 5 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Loan Portfolio - Maturities and Interest Rate Sensitivities
(in thousands, including loans held for sale)
Asset Quality
The Bank considers asset quality to be of primary importance, and employs a formal internal loan review process to ensure adherence to its lending policy as approved by the Bank’s Board of Directors. See “Lending Activities - Loan Approval and Review”. It is the responsibility of each commercial lending officer to assign an appropriate risk grade to every loan they originate. Credit Administration, through the loan review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality improves or deteriorates, it is the lending officer’s responsibility to recommend appropriate changes in the borrower’s risk grade.
Currently, the grading process utilized by the Bank is segmented by product type. This methodology does not provide a direct correlation with groupings utilized in the other tables presenting loan information.
The following table summarizes, by internally assigned risk grade, the risk grade for loans for which the bank has assigned a risk grade.
Risk Profile by Internally Assigned Risk Grade
(in thousands)
The Bank’s loan portfolio consists of loans made for a variety of commercial and consumer purposes. Because commercial loans are made based to a great extent on the Bank’s assessment of a borrower’s income, cash flow, character and ability to repay, such loans are generally viewed as involving a higher degree of credit risk than is the case with residential mortgage loans or consumer loans. To manage this risk, the Bank’s commercial loan portfolio is managed under a defined process which includes underwriting standards and risk assessment, procedures for loan approvals, loan grading, ongoing identification and management of credit deterioration and portfolio reviews to assess loss exposure and to ascertain compliance with the Bank’s credit policies and procedures.
Allocation of Allowance for Credit Losses
(in thousands)
The allowance for credit losses has been allocated on an approximate basis. The entire amount of the allowance is available to absorb losses occurring in any category. The allocation is not necessarily indicative of future losses.
In general, consumer loans (including mortgage and home equity) have a lower risk profile than commercial loans. Commercial loans (including commercial real estate, commercial non real estate and construction loans) are generally larger in size and more complex than consumer loans. Commercial real estate loans are deemed less risky than commercial non real estate and construction loans, because the collateral value of real estate generally maintains its value better than non real estate or construction collateral. The Bank has little or no exposure to subprime lending. Consumer loans, which are smaller in size and more geographically diverse across the Bank’s entire primary market areas, provide risk diversity across the portfolio. Because mortgage loans are secured by first liens on the consumer’s residential real estate, they are the Bank’s lowest risk profile loan type. Home equity loans are deemed less risky than unsecured consumer loans because home equity loans and lines are secured by first or second deeds of trust on the borrower’s residential real estate. A centralized decision-making process is in place to control the risk of the consumer, home equity and mortgage loan portfolio. The consumer real estate appraisal process is also centralized relative to appraisal engagement, appraisal review, and appraiser quality assessment. These processes are detailed in the underwriting guidelines, which cover each retail loan product type from underwriting, servicing, compliance issues and closing procedures.
Management follows a loan review program designed to evaluate the credit risk in its loan portfolio. Through this loan review process, the Bank maintains an internally classified watch list that helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for credit losses. In establishing the
appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower’s ability to repay, the borrower’s payment history and the current delinquent status. As a result of this process, certain loans are categorized as special mention, substandard, doubtful or loss and reserves are allocated based on management’s judgment and historical experience.
The function of determining the allowance for credit losses is fundamentally driven by the risk grade system. The allowance for credit losses represents management’s estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio. In determining the allowance for credit losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to a review of individual loans, historical loan loss experience, the value and adequacy of collateral and economic conditions in the Bank’s market areas. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for credit losses. Such agencies may require the Bank to recognize changes to the allowance based on their judgments about information available to them at the time of their examinations. Loans are charged off when in the opinion of management, they are deemed to be uncollectible. Recognized losses are charged against the allowance, and subsequent recoveries are added to the allowance.
Management believes the allowance for credit losses of $28.8 million at December 31, 2010 is adequate to cover probable losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires continuous evaluation and considerable judgment. Management’s judgments are based on numerous assumptions about current events which it believes to be reasonable, but which may or may not be valid. Thus, there can be no assurance that credit losses in future periods will not exceed the current allowance or that future increases in the allowance will not be required. No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting future operating results of the Bank.
The following table presents an analysis of the changes in the allowance for credit losses.
Analysis of Allowance for Credit Losses
(in thousands, except ratios)
Commercial loans. All commercial loans within the portfolio are risk graded among nine risk grades based on management’s evaluation of the overall credit quality of the loan, including the payment history, the financial position of the borrower, the underlying collateral value, an internal credit risk assessment and examination results. There is an increased reserve percentage for each successively higher risk grade. As a result, the allowance is adjusted upon any migration of a loan to a higher risk grade within the commercial loan portfolio. The reserve percentages utilized have been determined by management to be appropriate based on historical loan loss levels and the risk for each corresponding risk grade.
Mortgage, home equity, and credit lines. Reserves are calculated on mortgage, home equity, and credit lines based on historical loss experience. The average rolling eight quarter net loss percentage is calculated for each of these loan categories, and is multiplied by the dollar balance of loans in each of these categories to determine the required reserve.
Retail loans. The retail loans are pooled together to determine the reserve requirement. The average rolling eight quarter net loss percentage is calculated for this loan category, and is multiplied by the dollar balance of retail loans to determine a required reserve. An additional reserve, equal to 25.0% of all retail loans past due 90 days or more, is added to the above.
Specific impairment. Management evaluates significant loans graded substandard, doubtful and loss on an individual basis for impairment. The specific allowance is calculated based upon a review of these loans and the estimated losses at the balance sheet date. At December 31, 2010 and 2009, the recorded investment in significant loans considered impaired was approximately $38.3 million and $46.1 million, respectively and the specific allowance for credit losses associated with those loans was approximately $1.9 million and $2.7 million, respectively. The decrease in the amount of significant impaired loans held by the Bank and the associated allowance for credit losses resulted, primary, from the Bank’s decision to take appropriate aggressive action with our problem credits through chargeoffs and foreclosure.
Other potential problem loans. Loans graded substandard, doubtful and loss which do not fit the criteria to be considered significant are not evaluated on an individual basis for impairment. However, the Bank closely monitors such loans as a result of their elevated risk profile. As a result of the Bank’s disciplined and conservative loan classification methodology and the prolonged negative credit cycle, the balance of these other potential problem loans increased to $110.9 million at December 31, 2010 from $66.7 million at December 31, 2009. The loans that make up this category trended as management had projected and reached a peak level in the third quarter of 2010. These loans, while exhibiting signs of weakness, continue to perform pursuant to stated terms and conditions and therefore do not have identified expected losses. Approximately 70% of the loans in this category are identified as commercial and industrial or income producing commercial real estate, which management assigns a lower probability of default and/or loss given default. The allowance for credit losses associated with such loans was $5.2 million at December 31, 2010, which was based on a model that uses probability of default, and expected loss in the event of default, to determine expected losses within a given group of loans.
Provision for credit losses. The 2010 provision for credit losses totaled $21.3 million, compared to $35.7 million in 2009. As of December 31, 2010, nonperforming assets totaled $77.3 million, comprised of $50.6 million in nonperforming loans and $26.7 million in other real estate owned. Those figures compare to $58.2 million in nonperforming loans and $27.4 million in other real estate owned at the end of 2009, totaling $85.6 million in nonperforming assets. Net chargeoffs decreased in 2010 to $28.3 million, or 2.01% of average loans outstanding, compared with $35.7 million, or 2.32% of average loans outstanding in the prior year. During the fourth quarter of 2010, the Company charged off $6.2 million of a $10.0 million loan which represents subordinated debt to a financial institution. The Company does not have any other loans to financial institutions. At December 31, 2010 and 2009 the allowance for credit losses as a percentage of year end loans (including loans held for sale) was 2.15% and 2.45%, respectively. The 2010 and 2009 results have been impacted by the continued weakness in the regional and national economies.
Nonperforming Assets
(in thousands, except ratios)
Nonperforming assets include nonaccrual loans, accruing loans contractually past due 90 days or more, restructured loans, and real estate acquired in settlement of loans. Loans are placed on nonaccrual status when: (i) management has concerns relating to the ability to collect the loan principal and interest and (ii) generally when such loans are 90 days or more past due. No assurance can be given, however, that economic conditions will not adversely affect borrowers and result in increased credit losses.
Investment Activities
Our investment portfolio plays a primary role in the management of liquidity and interest rate sensitivity and, therefore, is managed in the context of the overall balance sheet. In 2010, the securities portfolio generated a substantial percentage of our interest income and served as a necessary source of liquidity.
Management attempts to deploy investable funds into instruments that are expected to increase the overall return of the portfolio given the current assessment of economic and financial conditions, while maintaining acceptable levels of credit, interest rate and liquidity risk, as well as capital usage and risk.
The following tables present the carrying values, fair values, and weighted average yields of our investment portfolio at December 31, 2010, 2009 and 2008 and the interval of maturities or repricings at December 31, 2010.
Investment Securities
(in thousands)
Investment Securities Portfolio Maturity Schedule
(dollars in thousands)
(1)
The yield related to securities exempt from federal income taxes is stated on a fully taxable-equivalent basis, assuming a federal income tax rate of 35%.
See also Note 4 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Off-Balance Sheet Arrangements
Information about the Company’s off-balance sheet risk exposure is presented in Note 17 in the Notes to the Consolidated Financial Statements.
Market Risk
Market risk is the risk of loss arising from adverse changes in the fair values of financial instruments or other assets caused by changes in interest rates, currency exchange rates, or equity prices. Interest rate risk is the Company’s primary market risk and results from timing differences in the repricing of assets and liabilities, changes in relationships between rate indices, and the potential exercise of explicit or embedded options.
For a complete discussion on market risk and how the Company addresses this risk, see Item 7A
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company’s primary market risk is considered to be the Bank’s interest rate risk which could potentially have the greatest impact on operating earnings. The Bank is not subject to other types of market risk, such as foreign currency exchange rate risk, commodity or equity price risk. Interest rate risk on our balance sheet arises from the maturity mismatch of interest-earning assets versus interest-bearing liabilities, as well as the potential for maturities to shorten or lengthen our interest-earning assets and interest-bearing liabilities. In addition, market risk is the possible chance of loss from unfavorable changes in market prices and rates. These changes may result in a reduction of current and future period net interest income, which is the favorable spread earned from the excess of interest income on interest-earning assets, over interest expense on interest-bearing liabilities.
The Company uses several interest rate risk measurement tools provided by a national asset liability management consultant to help manage this risk. The Bank’s Asset/Liability policy provides guidance for acceptable levels of interest rate risk and potential remediations. Management provides the consultant with key assumptions, which are used as inputs into the measurement tools. Following is a summary of two different tools management uses on a quarterly basis to monitor and manage interest rate risk.
Earnings Simulation Modeling. Net income is affected by changes in the level of interest rates, the shape of the yield curve and the general market pressures affecting current market interest rates at the time of simulation. Many interest rate indices do not move uniformly, creating certain disunities between them. For example, the spread between a 30 day, prime-based asset and a 30 day, FHLB advance may not be uniform over time. The earnings simulation model projects changes in net interest income caused by the effect of changes in interest rates on interest-earning assets and interest-bearing liabilities. Simulation results are measured as a percentage change in net interest income compared to the static-rate or “base case” scenario. The model uses the Company’s current balance sheet, but considers decreases in asset and liability volumes based on prepayment assumptions as well as rate changes. Rate changes are modeled gradually over a 12 month period, referred to as a “rate ramp.” The model projects only changes in interest income and expense and does not project changes in non-interest income, non-interest expense, provision for loan losses or the impact of changing tax rates. At December 31, 2010, net interest income simulation showed a negative 1.92% change from the base case in a 200 basis point ramped rising rate environment and a positive 0.15% change from the base case in a 100 basis point ramped declining rate environment. The projected decrease in net interest income is within the Asset/Liability Committee’s guidelines in a 200 basis point increasing or 100 basis point decreasing interest rate environment. However, management continually monitors signs of elevated risks and takes certain actions to limit these risks.
The following table summarizes the results of the Company’s income simulation model as of December 31, 2010.
Net Portfolio Value Analysis. Net portfolio value (“NPV”) represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 200 basis point increase or decrease in market interest rates with no effect given to any actions management might take to counter the effect of that interest rate movement. The following is a summary of the results of the report compiled by the Company’s outside consultant using data and assumptions management provided as of December 31, 2010.
The preceding table indicates that, at December 31, 2010, in the event of a 200 basis point increase in prevailing market interest rates, NPV would be expected to decrease by $10.3 million, or 4.6% of the base case scenario value of $223.8 million. In the event of a decrease in prevailing market rates of 100 basis points, NPV would be expected to decline by $12.6 million, or 5.6% of the base case scenario value. The projected decrease in NPV is within the Asset/Liability Committee’s guidelines in a 200 basis point increasing or 100 basis point decreasing interest rate environment. However, management continually monitors signs of elevated risks and takes certain actions to limit these risks.
Interest rate risk management is a part of the Bank’s overall asset/liability management process. The primary oversight of asset/liability management rests with the Bank’s Asset and Liability Committee, which is comprised of the Bank’s CEO, Chief Financial Officer (“CFO”) and other senior executives. The Committee meets on a monthly basis to review the asset/liability management activities of the Bank and monitor compliance with established policies. Activities of the Asset and Liability Committee are reported to the Audit and Risk Management Committee of the Company’s Board of Directors.
A primary objective of interest rate sensitivity management is to ensure the stability and quality of the Bank’s primary earnings component, net interest income. This process involves monitoring the Bank’s balance sheet in order to determine the potential impact that changes in the interest rate environment may have on net interest income. Rate sensitive assets and liabilities have interest rates that are subject to change within a specific time period, due to either maturity or to contractual agreements which allow the instruments to reprice prior to maturity. Interest rate sensitivity management seeks to ensure that both assets and liabilities react to changes in interest rates within a similar time period, thereby minimizing the risk to net interest income.
Interest Sensitivity Analysis
At December 31, 2010
(in thousands, except ratios)
The measurement of the Bank’s interest rate sensitivity, or “gap”, is a technique traditionally used in asset/liability management. The interest sensitivity gap is the difference between repricing assets and repricing liabilities for a particular time period. The table, "Interest Sensitivity Analysis,” indicates a ratio of rate sensitive assets to rate sensitive liabilities within one year at December 31, 2010, to be 0.58X. This ratio indicates that a larger balance of liabilities, compared to assets, could potentially reprice during the upcoming 12 month period. Included in rate sensitive liabilities are certain deposit accounts (NOW, MMI, and savings) that are subject to immediate withdrawal and repricing. These balances are presented in the category that management believes best identifies their actual repricing patterns. The overall risk to net interest income is also influenced by the Bank’s level of variable rate loans. These are loans with a contractual interest rate tied to an interest rate index, such as the prime rate. A portion of these loans may reprice on multiple occasions during a one-year period due to changes in the underlying interest rate index. Approximately 45.8% of the total loan portfolio has a variable interest rate and reprices in accordance with the underlying rate index subject to terms of individual note agreements.
The table, “Market Sensitive Financial Instruments Maturities,” presents the Company’s financial instruments that are considered to be sensitive to changes in interest rates, categorized by contractual maturities, average interest rates and estimated fair values as of December 31, 2010.
Market Sensitive Financial Instruments Maturities
(Dollars in thousands)
Market Sensitive Financial Instruments Maturities (continued)
(Dollars in thousands)
Item 8.
Item 8. Financial Statements and Supplementary Data
QUARTERLY FINANCIAL INFORMATION
The following table sets forth, for the periods indicated, certain of Bancorp’s consolidated quarterly financial information. This information is derived from Bancorp’s unaudited financial statements, which include all normal recurring adjustments which management considers necessary for a fair presentation of the results for such periods. This information should be read in conjunction with Bancorp’s consolidated financial statements included elsewhere in this report. The results for any quarter are not necessarily indicative of results for any future period.
Quarterly Financial Data
(Dollars in thousands, except per share data)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
NewBridge Bancorp
We have audited the accompanying consolidated balance sheets of NewBridge Bancorp and Subsidiary as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in shareholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these 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 NewBridge Bancorp and Subsidiary as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), NewBridge Bancorp’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 24, 2011, expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Raleigh, North Carolina
March 24, 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
NewBridge Bancorp
We have audited NewBridge Bancorp’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). NewBridge Bancorp’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management’s report on internal control over financial reporting. Our responsibility is to express an opinion on NewBridge Bancorp’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, NewBridge Bancorp maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of NewBridge Bancorp and Subsidiary as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2010, and our report dated March 24, 2011, expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Raleigh, North Carolina
March 24, 2011
NewBridge Bancorp and Subsidiary
Consolidated Balance Sheets
December 31, 2010 and 2009
(Dollars in thousands, except per share data)
See notes to consolidated financial statements
NewBridge Bancorp and Subsidiary
Consolidated Statements of Income
Years ended December 31, 2010, 2009 and 2008
(Dollars in thousands, except per share data)
See notes to consolidated financial statements
NewBridge Bancorp and Subsidiary
Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income
Years ended December 31, 2010, 2009 and 2008
(Dollars in thousands, except share data)
See notes to consolidated financial statements
NewBridge Bancorp and Subsidiary
Consolidated Statements of Cash Flows
Years ended December 31, 2010, 2009 and 2008
(Dollars in thousands)
See notes to consolidated financial statements
NewBridge Bancorp and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2010, 2009, and 2008
Note 1 - Summary of significant accounting policies
Principles of consolidation
The accompanying consolidated financial statements include the accounts of NewBridge Bancorp (“Bancorp” or the “Company”) and its wholly owned subsidiary NewBridge Bank (the “Bank”). All significant intercompany balances and transactions have been eliminated in consolidation.
Nature of operations
The Bank provides a variety of financial services to individual and corporate customers in North Carolina (“NC”) and Virginia (“VA”). As of December 31, 2010, the Bank operated 30 branches in the Piedmont Triad Region and Coastal Region of NC and one branch in the Shenandoah Valley Region of VA. The majority of the Bank’s NC clients are located in Davidson, Rockingham, Guilford, Forsyth and New Hanover Counties. The majority of the Bank’s VA customers are located in Rockingham County. The Bank’s primary deposit products are noninterest-bearing checking accounts, interest-bearing checking accounts, money market accounts, certificates of deposit and individual retirement accounts. Its primary lending products are commercial, real estate and consumer loans.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for credit losses. A majority of the Bank’s loan portfolio consists of loans in the geographic areas cited above. The local economies of these areas depend heavily on the industrial, agricultural and service sectors. Accordingly, the ultimate collectibility of a large portion of the Bank’s loan portfolio would be affected by changes in local economic conditions.
Cash and cash equivalents
Cash and cash equivalents include cash and due from banks and interest-bearing bank deposits. Cash and cash equivalents are defined as cash and short-term investments with maturities of three months or less at the time of acquisition.
Investment securities
The Bank classifies its investment securities at the time of purchase into three categories as follows:
•
Held to Maturity - reported at amortized cost,
•
Trading - reported at fair value with unrealized gains and losses included in earnings, or
•
Available for Sale - reported at fair value with unrealized gains and losses reported in other comprehensive income.
The Bank is required to maintain certain levels of Federal Home Loan Bank (“FHLB”) of Atlanta stock based on various criteria established by the issuer. Gains and losses on sales of securities are recognized when realized on a specific identification basis. Premiums and discounts are amortized into interest income using methods that approximate the level yield method.
Other Than Temporary Impairment of Investment Securities
Bancorp’s policy regarding other than temporary impairment of investment securities requires continuous monitoring. Individual investment securities with a fair market value that is less than 80% of original cost over a continuous period of two quarters are evaluated for impairment during the subsequent quarter. The evaluation includes an assessment of both qualitative and quantitative measures to determine whether, in management’s judgment, the investment is likely to recover its original value. If the evaluation concludes that the investment is not likely to recover its original value, the unrealized loss is reported as an “other than temporary impairment”, and the loss is recorded as a securities transaction on the Consolidated Statement of Income.
Loans
Interest on loans is accrued and credited to income based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Loans are placed on nonaccrual status when: (i) management has concerns relating to the ability to collect the loan principal and interest and (ii) generally when such loans are 90 days or more past due. Interest income is subsequently recognized only to the extent payments are received and the loan is well secured. Loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance (generally a minimum of six months) of interest and principal by the borrower in accordance with the contractual terms. Loans held for sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements, calculated on the aggregate loan basis.
Loan origination fees and costs
Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan.
Impaired loans
A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Generally, a loan will be considered impaired if it exhibits the same level of underlying weakness and probability of loss as loans classified doubtful or loss.
The impairment evaluation compares the recorded book value of the loan, or loan relationship, to the present value of the expected future principal, interest and collateral value (if applicable) cash flows. The expected cash flows are discounted at the contractual interest rate for the individual note. A specific reserve is established if the present value of expected future cash flows is less than the recorded book value of the loan.
Allowance for credit losses
The Bank’s allowance for credit losses is based on management’s best estimate of probable loan losses incurred as of the balance sheet date. Factors impacting estimated probable loan losses include credit quality trends, past loan loss experience, current economic conditions, and loan volume among loan categories.
While management uses the best available information to establish the allowance for credit losses, future additions to the allowance may be necessary based on the factors cited above. In addition, the allowance is reviewed by regulatory agencies as an integral part of their examination processes. Such agencies may require the Company to recognize changes to the allowance based on their judgments about information available to them at the time of their examination.
Real estate acquired in settlement of loans
Real estate acquired in settlement of loans, through partial or total satisfaction of loans, is initially recorded at fair market value, less estimated costs to sell, which becomes the property’s new basis. At the date of acquisition, losses are charged to the allowance for credit losses. Subsequent write-downs are charged to expense in the period they are incurred.
Premises and equipment
Premises and equipment are stated at cost (or at fair value for premises and equipment acquired in business combinations) less accumulated depreciation and amortization. The provision for depreciation and amortization is computed principally by the straight-line method over the estimated useful lives of the assets. Useful lives are estimated at 20 to 40 years for buildings and three to ten years for equipment. Leasehold improvements are amortized over the expected terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Expenditures for maintenance and repairs are charged to operations, and expenditures for major replacements and betterments are added to the premises and equipment accounts. The cost and accumulated depreciation of premises and equipment retired or sold are eliminated from the appropriate asset accounts at the time of retirement or sale and the resulting gain or loss is reflected in current operations.
Income taxes
Provisions for income taxes are based on taxes payable or refundable, for the current year (after exclusion of non-taxable income such as interest on state and municipal securities and bank owned life insurance and non-deductible expenses) and deferred taxes on temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Per share data
Basic net income per share of common stock is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during each year. Diluted net income per share of common stock is computed by dividing net income available to common shareholders plus any adjustments to net income related to the issuance of dilutive potential common shares, comprised of outstanding options and/or warrants to purchase shares of common stock and restricted stock grants, by the weighted average number of shares of common stock outstanding during each year plus the number of dilutive potential common shares.
Sales of loans
Gains and losses on the sales of loans are accounted for by imputing gain or loss on those sales where a yield rate guaranteed to the buyer is more or less than the contract interest rate being collected. Such gains or losses are recognized in the financial statements at the time of the sale. Loans held for sale are recorded at the lower of cost or fair value, on an aggregate basis.
Off-balance sheet arrangements
In the ordinary course of business, the Bank enters into off-balance sheet financial instruments consisting of commitments to extend credit, commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
Segment information
Operating segments are components of an enterprise with separate financial information available for use by the chief operating decision maker to allocate resources and to assess performance. The Company has determined that it has one significant operating segment, providing financial services through the Bank, including banking, mortgage, and investment services, to customers located principally in Davidson, Rockingham, Guilford, Forsyth and New Hanover Counties in NC, and in Rockingham County VA, and in the surrounding communities. The various products are those generally offered by community banks, and the allocation of resources is based on the overall performance of the Bank, rather than the individual branches or products.
There are no differences between the measurements used in reporting segment information and those used in the Company’s general-purpose financial statements.
Recent accounting pronouncements
In July 2010, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2010-20, Receivables (ASC 310) - “Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” This ASU requires new disclosures and clarifies existing disclosure requirements about the nature of credit risk inherent in an entity’s loan portfolio; how that risk is analyzed and assessed in arriving at the allowance for loan losses; and the changes and reasons for those changes in the allowance for loan losses. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting, as well as clarify the requirements for existing disclosures. ASU 2010-20 is effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. In January 2011, the FASB delayed the effective date of the portion of ASU 2010-20 related to troubled debt restructurings to June 2011. The Company adopted the required portions of ASU-2010-20 as of December 31, 2010, which only impacted disclosures. The Company does not expect the adoption of the remainder of ASU 2010-20 to have a material impact on its financial condition or results of operations.
Reclassification
Certain items for 2009 and 2008 have been reclassified to conform to the 2010 presentation. Such reclassifications had no effect on net income, total assets or shareholders’ equity as previously reported.
Note 2 - Merger of Equals
The Company is a bank holding company incorporated under the laws of the state of North Carolina (“NC”) and registered under the Bank Holding Company Act of 1956, as amended (the “BHCA”). Bancorp is the successor entity to LSB Bancshares, Inc. (“LSB”), which was incorporated on December 8, 1982. On July 31, 2007, FNB Financial Services Corporation (“FNB”), a bank holding company, also incorporated in NC and registered under the BHCA, merged with and into LSB in a merger of equals (the “Merger”). LSB’s name was then changed to “NewBridge Bancorp”.
The Merger was accounted for under the purchase method of accounting and was structured to qualify as a tax-free reorganization under Section 368(a) of the Internal Revenue Code. The Merger initially resulted in $49.9 million of goodwill and $6.6 million of core deposit intangibles. The goodwill was not tax deductible. The core deposit intangible was determined by an independent valuation and is being amortized over the estimated life of 10 years, based on undiscounted cash flows.
As of December 31, 2008, the Company wrote off $50.4 million of goodwill. At December 31, 2010, the carrying value of other intangibles was $4.5 million.
Note 3 - Restriction on cash and due from banks
The Bank maintains required reserve balances with the Federal Reserve Bank of Richmond. The amounts of these reserve balances at December 31, 2010 and 2009 were $25,000 and $15,831,000, respectively.
Note 4 - Investment securities
Investment securities at December 31 consist of the following (in thousands):
The aggregate cost of the Company’s investment in Federal Home Loan Bank (“FHLB”) stock totaled $10,399,000 at December 31, 2010. Because of the redemption provisions of this stock, and the financial condition of the FHLB of Atlanta, the Company estimates that the fair value equals the cost of this investment and that it is not impaired.
The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2010 and 2009. The unrealized losses relate to debt securities that have incurred fair value reductions due to higher market interest rates since the securities were purchased. The unrealized losses are not likely to reverse unless and until market interest rates decline to the levels that existed when the securities were purchased. Since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, and the Company has the intent and ability to hold until recovery, none of the securities are deemed to be other than temporarily impaired.
The amortized cost and estimated market value of debt securities at December 31, 2010, by contractual maturities, are shown in the accompanying schedule. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands).
A recap of the maturities of held to maturity securities follows (in thousands):
A recap of the maturities and sales of available for sale securities follows (in thousands):
Investment securities with a book value of $82,148,000 were sold during 2010 to reposition the investment portfolio and reduce the Company’s exposure to municipalities. A portion of the securities that were identified for sale had been classified as held to maturity and, accordingly, all held to maturity securities were designated as available for sale.
During 2010, the Company determined that investment securities with amortized costs of approximately $98,111,000 and $154,352,000 and market values of approximately $99,223,000 and $158,450,000 as of December 31, 2010 and 2009, respectively, were pledged to secure public deposits and for other purposes. The Bank has obtained $50,000,000 in letters of credit, which are used in lieu of securities to pledge against public deposits.
Note 5 - Loans
Loans are summarized as follows (in thousands):
As of December 31, 2010 and December 31, 2009, loans totaling approximately $569,896,000 and $575,108,000, respectively, were pledged to secure the line of credit with the FHLB and Federal Reserve Bank.
Nonperforming assets are summarized as follows (in thousands):
Impaired loans and related information are summarized in the following tables (in thousands):
The following table summarizes, by internally assigned risk grade, the risk grade for loans for which the bank has assigned a risk grade (in thousands).
An analysis of the changes in the allowance for credit losses follows (in thousands):
The Bank’s policy for impaired loan accounting subjects all loans to impairment recognition except for large groups of smaller balance homogeneous loans such as credit card, residential mortgage and consumer loans. The Bank generally considers loans 90 days or more past due and all nonaccrual loans to be impaired.
Note 6 - Premises and equipment
The following is a summary of premises and equipment (in thousands):
Depreciation and amortization expense amounting to $3,792,000, $4,630,000 and $4,737,000, for the years ended December 31, 2010, 2009, and 2008, respectively, is included in occupancy expense and furniture and equipment expense in the consolidated statements of income.
Note 7 - Deposits
The aggregate amount of certificates of deposit of $100,000 or more was approximately $247,154,000 and $239,057,000 at December 31, 2010 and 2009, respectively. The accompanying table presents the scheduled maturities of total time deposits at December 31, 2010 (in thousands).
Note 8 - Short-term borrowings and long-term debt
The following is a schedule of short-term borrowings and long-term debt (in thousands, except percentages):
At December 31, 2010, the Bank had a $361,032,000 line of credit with the FHLB under which $162,700,000 was used. The amounts used consist of $112,700,000 in regular FHLB advances and a $50,000,000 letter of credit which the Bank uses as collateral securing deposits from municipalities. This line of credit is secured with FHLB stock, certain pledged securities and a blanket floating lien on qualifying 1 to 4 family residential mortgage loans, home equity loans and commercial real estate. Based upon collateral pledged, as of December 31, 2010, the borrowing capacity under this line was $276,922,000, with $114,222,000 available to be borrowed. In addition to the credit line at the FHLB, the Bank has borrowing capacity at the Federal Reserve Bank totaling $29,988,000, of which there were no borrowings outstanding at December 31, 2010.
Federal funds purchased represent unsecured overnight borrowings from other financial institutions by the Bank. Retail repurchase agreements represent short-term borrowings by the Bank, with overnight maturities collateralized by securities issued by the United States Government or its agencies.
FNB Southeast, the banking subsidiary of FNB, sold securities under an agreement to repurchase (a “wholesale repurchase agreement”) on December 8, 2006. This $21,000,000 transaction has a maturity date of December 8, 2016, became callable after one year, and has quarterly calls thereafter at a fixed rate of 4.03%. FNB Southeast also entered into a wholesale repurchase agreement on June 28, 2007. The $15,000,000 transaction has a maturity date of June 28, 2011, became callable after one year, and has quarterly calls thereafter. The transaction has a fixed rate of 4.42%. The investment securities serving as collateral for these two borrowings had a market value of approximately $45,528,000 at December 31, 2010.
FNB and FNB Financial Services Capital Trust I, a Delaware statutory trust (the “Trust,” now wholly owned by the Company), issued and sold in a private placement, on August 26, 2005, $25,000,000 of the Trust’s floating rate preferred securities, with a liquidation amount of $1,000 per preferred security, bearing a variable rate of interest per annum, reset quarterly, equal to 3 month LIBOR plus 1.46% (the “Preferred Securities”) and a maturity date of September 30, 2035. The Preferred Securities become callable after five years. Interest payment dates are March 30, June 30, September 30 and December 30 of each year. The Preferred Securities are fully and unconditionally guaranteed on a subordinated basis by the Company with respect to distributions and amounts payable upon liquidation, redemption or repayment. The entire proceeds from the sale by the Trust to the holders of the Preferred Securities was combined with the entire proceeds from the sale by the Trust to the Company of its common securities (the “Common Securities”), and was used by the Trust to purchase $25,774,000 in principal amount of the Floating Rate Junior Subordinated Notes (the “Junior Subordinated Notes”) of the Company. The Company has not included the Trust in the consolidated financial statements. FNB contributed $24,000,000 of the proceeds from the sale of the Junior Subordinated Notes to FNB Southeast as Tier I Capital to support FNB Southeast’s growth. Currently, regulatory capital rules allow trust preferred securities to be included as a component of regulatory capital for the Company.
The following is a schedule of the components of other borrowings (in thousands):
Note 9 - Other assets and other liabilities
The components of other assets and liabilities for the years ended December 31 are as follows (in thousands):
Note 10 - Income taxes
The components of income tax expense (benefit) for the years ended December 31 are as follows (in thousands):
The significant components of deferred tax assets at December 31 are as follows (in thousands):
Management has evaluated the realizability of the recorded deferred tax assets at December 31, 2010. This evaluation included a review of recent improving trends and expected near term levels in the net interest margin, non performing assets, operating expenses and other factors. It also included a current forecast of performance for 2011 as well as projections for several years based on management’s expectations of performance, adjusted to assume a continuation of credit quality issues and future net interest margin erosion. It further included the consideration of the items that have given rise to the deferred tax assets, as well as tax planning strategies. Management has concluded that, with the exception of contribution and tax credit carryforwards which begin expiring in two years, it is more likely than not that the deferred taxes will be realized and therefore, no valuation allowance is necessary, except for those contribution and tax credit carryforwards.
The provision for income taxes differs from that computed by applying the federal statutory rate of 35% as indicated in the following analysis (in thousands, except percentages):
Note 11 - Lease commitments
The minimum annual lease commitments under noncancelable operating leases in effect at December 31, 2010, are as follows (in thousands):
Payments under these leases amounted to approximately $1,863,000, $2,671,000 and $2,452,000 for the years ended December 31, 2010, 2009, and 2008, respectively.
Note 12 - Related party transactions
The Bank had loans outstanding to principal officers and directors and their affiliated entities during each of the past two years. Such loans were made substantially on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other borrowers, and, at the time that they were made, did not involve more than the normal risks of collectibility. The following table summarizes the transactions for the past two years (in thousands):
Note 13 - Other operating income and expenses
The components of other operating income and other operating expense for the years ended December 31, 2010, 2009 and 2008 are as follows (in thousands):
Note 14 - Stock based compensation
The Company recorded $80,000, or less than $0.01 per diluted share, of total stock-based compensation expense during 2010, compared to $117,000, or less than $0.01 per diluted share, in 2009. The stock-based compensation expense is calculated on a ratable basis over the vesting periods of the related stock options or restricted stock units. This expense had no impact on the Company’s reported cash flows. The stock-based compensation expense is reported under personnel expense in the consolidated statements of income.
To determine the amounts recorded in the financial statements, the fair value of each stock option is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
There were no stock options granted during 2009 or 2010.
For restricted stock units, the fair value is considered to be the market price on the date the restricted stock unit is granted.
As of December 31, 2010, there was $90,000 of total unrecognized compensation expense related to stock options and restricted stock units granted under the NewBridge Bancorp Amended and Restated Comprehensive Equity Compensation Plan (formerly the LSB Bancshares Inc. Comprehensive Equity Compensation Plan for Directors and Employees) (the “Comprehensive Benefit Plan”). This expense will be fully amortized by March of 2013.
As of December 31, 2010, 31,000 restricted stock units granted to certain executive officers were outstanding. The weighted average fair value of these restricted stock units is $6.58, which was the weighted average closing price of the Company’s common stock on the dates they were granted. The restricted stock units vest based on certain
performance criteria that the Company did not meet during 2009, and partially met during 2010. The stock-based compensation expense for these awards was immaterial for the period ended December 31, 2010.
As of December 31, 2010, the Company’s Compensation Committee administered the Company’s five stock-based compensation plans, including two stock-based compensation plans assumed by the Company pursuant to the Merger.
The Company’s Compensation Committee administers the following legacy LSB plans to the extent that awards remain outstanding and unexercised: (a) the 1994 Director Stock Option Plan; and (b) the 1996 Omnibus Stock Incentive Plan (collectively, the “Previous Benefit Plans”). Each of the Previous Benefit Plans has expired and no additional awards may be granted thereunder.
At their 2004 annual meeting, LSB’s shareholders approved the Comprehensive Benefit Plan. Under the Comprehensive Benefit Plan, 750,000 shares of common stock are available for issuance to plan participants in the form of stock options, restricted stock, restricted stock units, performance units and other stock-based awards.
At their 1996 annual meeting, FNB shareholders approved the FNB Omnibus Equity Compensation Plan (the “1996 FNB Omnibus Plan”). The 1996 FNB Omnibus Plan authorizes the Board of Directors to grant stock options to directors, executives and key employees. Options granted under the 1996 FNB Omnibus Plan have a term of up to ten years and generally vest over a four-year period beginning on the date of the grant. Options under the 1996 FNB Omnibus Plan were granted at a price not less than the fair market value at the date of grant. The 1996 FNB Omnibus Plan expired in 2006 and no more options may be granted thereunder.
The FNB Long Term Stock Incentive Plan (the “2006 FNB Omnibus Plan”) was approved by FNB’s shareholders at their 2006 annual meeting and authorized the issuance of up to 500,000 shares of FNB common stock pursuant to the exercise of various rights granted under the 2006 FNB Omnibus Plan. Under the 2006 FNB Omnibus Plan, participants may be granted or awarded eligible options, rights to receive restricted shares of common stock and/or performance units. Except with respect to awards then outstanding, all awards must be granted or awarded on or before May 18, 2016.
Upon the Merger, each option to acquire a share of FNB common stock granted pursuant to the 2006 FNB Omnibus Plan and the 1996 FNB Omnibus Plan that was outstanding and unexercised immediately prior to the Merger was converted into an option to acquire 1.07 shares of the Company’s common stock.
The following is a summary of stock option activity and related information for the years ended December 31:
The following is a summary of information on outstanding and exercisable options at December 31, 2010:
Note 15 - Net income (loss) per share
The following is a reconciliation of the numerator and denominator of basic and diluted net income (loss) per share of common stock (in thousands, except share data):
On December 31, 2010, there were 821,767 options that were antidilutive since the exercise price exceeded the average market price for the year. There were 13,442 restricted stock units and a warrant to purchase 2,567,255 shares that were dilutive, and the dilutive effect of those restricted stock units and warrant are reflected in the table above.
On December 31, 2009, there were 896,991 options, 15,664 restricted stock units and a warrant to purchase 2,567,255 shares outstanding. On December 31, 2008, there were 1,049,517 options, 12,003 restricted stock units and a warrant to purchase 2,567,255 shares outstanding. In each case the options, the restricted stock units and the warrant were antidilutive as a result of the Company’s net loss for 2009 and 2008.
See Note 21 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K for a description of the warrant.
Note 16 - Parent company only
The parent company’s principal asset is its investment in its subsidiary, the Bank. The principal source of income of the parent company is dividends received from the Bank. The following presents condensed financial information of the parent company (in thousands):
Note 17 - Off-balance sheet arrangements
The Company’s consolidated financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of business and which involve elements of credit risk, interest rate risk and liquidity risk. These commitments and contingent liabilities are commitments to extend credit and standby letters of credit. A summary of the contractual amounts of the Bank’s exposure to off-balance sheet risk at December 31 is as follows (in thousands):
The Bank’s exposure to credit loss in the event of nonperformance by the other party to these commitments is equal to the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Note 18 - Employee benefit plans
The Company has three defined benefit retirement plans as follows:
•
A pension plan, which is the result of the merger of two legacy pension plans. The first plan was a plan covering substantially all of the former employees of Lexington State Bank, and which was curtailed in December 2006. The second plan was a plan covering substantially all of the former employees of FNB Southeast, which was curtailed prior to the Merger. These two plans were merged into one plan, effective December 31, 2008.
•
A supplemental executive retirement plan (“SERP”) covering certain executive and former executive officers, which was curtailed in 2008; and
•
A retiree health benefit plan, which provides partial health insurance benefits for certain early retired former employees of Lexington State Bank, which was curtailed in 2007.
The disclosures presented represent combined information for all of the employee benefit plans. The retiree health benefit plan is not a material part of the aggregate information.
The pension plan, the retiree health benefit plan and the SERP provide for benefits to be paid to eligible employees at retirement based primarily upon years of service with the Company and a percentage of qualifying compensation during the employee’s final years of employment. Contributions to the pension plan were based upon the projected unit credited actuarial funding method and comply with the funding requirements of the Employee Retirement Income Security Act. Contributions prior to the curtailments were intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Plan assets consist primarily of cash and cash equivalents, U.S. government securities, and securities. The following tables outline the changes in these pension obligations, assets and funded status for the years ended December 31, 2010 and 2009, and the assumptions and components of net periodic pension cost for the two and three years in the period ended December 31, 2010 (in thousands):
Target asset allocations are established based on periodic evaluations of risk/reward under various economic scenarios and with varying asset class allocations. The near-term and long-term impact on obligations and asset values are projected and evaluated for funding and financial accounting implications. Actual allocation and investment performance is reviewed quarterly. The current target allocation ranges, along with the actual allocation as of December 31, 2010, are included in the accompanying table.
The assumed expected return on assets considers the current level of expected returns on risk-free investments (primarily government bonds), the historical level of risk premium associated with the other asset classes in the portfolio and the expectation for future returns of each asset class. The expected return of each asset class is weighted based on the target allocation to develop the expected long-term rate of return on assets. This resulted in the selection of the 8.25% rate used in 2010 and to be used for 2011. The required contributions for 2010 were approximately $1,150,000, and the required contributions for 2011 are expected to be approximately $1,106,000. The expected benefit payments for the next ten years are as follows: (1) 2011 - $1,376,000, (2) 2012 - $1,406,000, (3) 2013 - $1,505,000, (4) 2014 - $1,494,000, (5) 2015 - $1,523,000, and (6) 2016 through 2020 - $9,010,000.
The Company also has a separate contributory 401(k) savings plan covering substantially all employees. Prior to year end 2007, the separate plans of the two legacy banks were merged into the current 401(k) savings plan. The 401(k) savings plan allows eligible employees to contribute up to a fixed percentage of their compensation, with the Bank matching a portion of each employee’s contribution. The Bank’s contributions were $792,000 for 2010, $748,000 for 2009 and $878,000 for 2008. The 401(k) savings plan contribution expense is reported under personnel expense in the consolidated statements of income.
Three deferred compensation plans allow the directors of the Company to defer compensation. Each plan participant makes an annual election to either receive that year’s compensation or to defer receipt until his or her death, disability or retirement. The deferred compensation balances of two of these plans are maintained in a rabbi trust. The balances in the trust at December 31, 2010 and 2009 were $4,000,000 and $3,134,000, respectively. The third plan acquires shares of the Company’s common stock in the open market and holds these shares in a trust at cost, as a component of shareholders’ equity, until distributed.
Note 19 - Regulatory matters
The primary source of funds for dividends paid by the Company to its shareholders is dividends received from the Bank plus cash on hand of $6.2 million as of December 31, 2010. The Bank is restricted as to dividend payout by state laws applicable to banks and may pay dividends only out of undivided profits. At December 31, 2010, the Bank had undivided profits of approximately $56.4 million. Additionally, dividends paid by the Company and the Bank may be limited by minimum capital requirements imposed by banking regulators. The Bank is currently restricted from paying dividends to Bancorp unless it receives advance approval from the FDIC and the Commissioner. Additionally, the Company’s Board of Directors has resolved not to declare or pay any dividend, common or preferred, or make any payments on trust preferred securities without the prior approval of the Federal Reserve Bank. During 2008, the Company first reduced its quarterly cash dividend, and later suspended the payment of cash dividends, based on the highly uncertain economic conditions and in the interest of preserving capital. As a consequence of the Company’s participation in the U.S. Department of the Treasury (the “U.S. Treasury”) Capital Purchase Program (the “CPP”), regulatory approval is currently required before the Company may increase dividends payable on its common stock to more than the last quarterly cash dividend ($0.05) declared prior to October 14, 2008.
The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possible additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the 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. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes that as of December 31, 2010, both the Company and the Bank meet all capital adequacy requirements to which they are subject.
The most recent notification from the NC Commissioner of Banks categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the accompanying table (in thousands, except percentages).
Note 20 - Fair value of financial instruments
The following methods and assumptions were used to estimate the fair value for each class of the Company’s financial instruments.
Cash and cash equivalents. The carrying amounts for cash and due from banks approximate fair value because of the short maturities of those instruments.
Investment securities. In accordance with GAAP, the fair value of investment securities is based on quoted prices in active markets for identical assets, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities, corresponding to the “significant other observable inputs” definition of GAAP. The fair value of equity investments in the restricted stock of the FHLB equals the carrying value.
Loans. The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Substantially all residential mortgage loans held for sale are pre-sold and their carrying value approximates fair value. The fair value of variable rate loans with frequent repricing and negligible credit risk approximates book value.
Investment in bank-owned life insurance. The carrying value of bank-owned life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.
Deposits. The fair value of noninterest-bearing demand deposits and NOW, savings, and money market deposits are the amounts payable on demand at the reporting date. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.
Federal funds purchased and retail repurchase agreements. The carrying value of federal funds purchased and retail repurchase agreements are considered to be a reasonable estimate of fair value.
Wholesale repurchase agreements and other borrowings. The fair values of these liabilities are estimated using the discounted values of the contractual cash flows. The discount rate is estimated using the rates currently in effect for similar borrowings.
Accrued interest. The carrying amounts of accrued interest approximate fair value.
Financial instruments with off-balance sheet risk. The carrying value of financial instruments with off-balance sheet risk is considered to approximate fair value, since a large majority of these future financing commitments would result in loans that have variable rates and/or relatively short terms to maturity. For other commitments, generally of a short-term nature, the carrying value is considered to be a reasonable estimate of fair value. The various financial instruments were disclosed in Note 17.
The estimated fair values of financial instruments for the years ending December 31 (in thousands):
The fair value estimates are made at a specific point in time based on relevant market and other information about the financial instruments. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on current economic conditions, risk characteristics of various financial instruments, and such other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. In addition, the tax ramifications related to the realization of the
unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
The table below presents the assets measured at fair value on a recurring basis categorized by the level of inputs used in the valuation of each asset (in thousands):
The table below presents the assets measured at fair value on a non-recurring basis categorized by the level of inputs used in the valuation of each asset (in thousands):
Note 21 - U.S. Treasury Capital Purchase Program
Pursuant to the CPP, on December 12, 2008, Bancorp issued and sold to the U.S. Treasury (i) 52,372 shares of Bancorp’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 2,567,255 shares of Bancorp’s common stock at an exercise price of $3.06 per share, representing an aggregate market price of approximately $7.9 million, for an aggregate purchase price of $52,372,000 in cash. The Warrant may be exercised by U.S. Treasury at any time before it expires on December 12, 2018. Subject to the approval of the federal banking regulators, the Series A Preferred Stock may be redeemed in whole or in part, at any time and from time to time. Once an institution notifies the U.S. Treasury that it would like to repay its investment, the U.S. Treasury must permit repayment subject to consultation with the federal banking regulators. All such redemptions will be at 100% of the issue price, plus any accrued and unpaid dividends. The fair value of the Warrant of $1,497,000 was estimated on the date of the grant using the Black-Scholes option-pricing model. The holders of the Series A Preferred Stock are entitled to receive cumulative dividends of 5 percent for the first five years and 9 percent thereafter.
Note 22 - Pending sale of Virginia operations
On December 21, 2010, the Bank entered into an agreement to sell its Harrisonburg, Virginia operations. Under the terms of the sale, which is expected to be completed during the second quarter of 2011, the Bank will sell deposits of approximately $59.3 million and loans of approximately $73.5 million at book value. The Bank will also sell its branch in Harrisonburg, as well as a parcel of land located in Waynesboro, Virginia. An impairment charge of $339,000 was recorded during the fourth quarter of 2010 for the expected loss on the sale of the real property.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company’s management, including its CEO, CFO, and Chief Accounting Officer (“CAO”), evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2010. Based upon that evaluation, the Company’s CEO, CFO and CAO each concluded that as of December 31, 2010, the end of the period covered by this Annual Report on Form 10-K, the Company effectively maintained disclosure controls and procedures.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s CEO, CFO and CAO to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Management has made a comprehensive review, evaluation and assessment of the Company’s internal control over financial reporting as of December 31, 2010. In making its assessment of internal control over financial reporting, management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on this assessment, management believes that, as of December 31, 2010, the Company’s internal control over financial reporting is effective. In accordance with Section 404 of the Sarbanes-Oxley Act of 2002, management makes the following assertions:
•
Management has implemented a process to monitor and assess both the design and operating effectiveness of internal control over financial reporting.
•
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s independent registered public accounting firm, Grant Thornton LLP, has issued an audit report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. This Report of Independent Registered Public Accounting Firm is included in Item 8, Financial Statements and Supplementary Data.
Changes in Internal Control over Financial Reporting
Management of the Company has evaluated, with the participation of the Company’s CEO, CFO, and CAO, changes in the Company’s internal control over financial reporting during the fourth quarter of 2010. In connection with such evaluation, the Company has determined that there have been no changes in internal control over financial reporting during the fourth quarter that have materially affected or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
(a) Directors and Executive Officers-The information required by this Item regarding directors, nominees and executive officers of Bancorp is set forth under the Proxy Statement sections captioned “Proposal 1 - Election of Directors,” “Executive Officers of the Company,” and “Board Committees - Audit Committee,” which sections are incorporated herein by reference.
(b) Section 16(a) Compliance - The information required by this Item regarding compliance with Section 16(a) of the Exchange Act is set forth under the Proxy Statement section captioned “Section 16(a) Beneficial Ownership Reporting Compliance,” which section is incorporated herein by reference.
(c) Audit Committee - The information required by the Item regarding Bancorp’s Audit Committee, including the Audit Committee Finance Expert, is set forth under the Proxy Statement sections captioned “Board Committees - Audit Committee” and “Board Committees - Audit Committee Report,” which sections are incorporated by reference.
(d) Code of Ethics - The information required by the Item regarding codes of ethics is set forth under the Proxy Statement section captioned “Code of Business Conduct and Ethics,” which section is incorporated by reference.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the Proxy Statement sections captioned “Compensation Discussion and Analysis”, “Grant of Plan-Based Awards”, “Discussion on Base Salary”, “Outstanding Equity Awards at Fiscal Year-End”, “Option Exercises and Stock Vested”, “ Pension Benefits”, “Nonqualified Deferred Compensation”, “Potential Payments Upon Termination or Change in Control”, “Director Compensation”, “Directors’ Fees and Practices”, “Board Committees - Compensation Committee Interlocks and Insider Participation” and “Board Committees - Compensation Committee Report,” which sections are incorporated by reference.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is set forth under the Proxy Statement sections captioned “Security Ownership of Certain Beneficial Owners” and “How Much Common Stock do our Directors and Executive Officers Own?” and in Item 5 of this Annual Report on Form 10-K, which sections and Item are incorporated herein by reference.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is set forth under the Proxy Statement sections captioned “Proposal 1 - Election of Directors,” “Certain Relationships and Related Transactions,” “Board Committees”, “Board Committees - Compensation Committee Interlocks and Insider Participation,” and “Board Committees - Related Party matters,” which sections are incorporated herein by reference.
Item 14.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is set forth under the Proxy Statement section captioned “Proposal 2: Ratification of Appointment of Grant Thornton as Our Independent Registered Public Accounting Firm for the Fiscal Year Ended December 31, 2011,” which section is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)(1) Financial Statements. The following financial statements and supplementary data are included in Item 8 of this report.
(a)(2) Financial Statement Schedules. All applicable financial statement schedules required under Regulation S-X have been included in the Notes to Consolidated Financial Statements.
(a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed below. The management contracts and compensatory plans or arrangements required to be filed as exhibits to this Form 10-K are listed as exhibits 10.1 through 10.37 (excluding exhibits 10.30 and 10.35) in the Exhibit Index.
(b) The exhibits to the Form 10-K begin on page 97 of this Report.
(c) See 15(a)(2) above.
Exhibit Index
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX