Item 1. Business
The term “the Company” is used throughout this Annual Report on Form 10-K to refer to Main Street Banks, Inc. and its subsidiaries. The term “Parent Company” is used to refer to Main Street Banks, Inc. wherever a distinction between Main Street Banks, Inc. and its subsidiaries aids in the understanding of this Annual Report on Form 10-K.
Significant Recent Matter
On December 15, 2005, Main Street Banks, Inc. announced it had signed a definitive agreement to be acquired by BB&T Corporation (BB&T). The transaction is subject to customary regulatory approvals as well as the approval of a majority of Main Street Banks, Inc. outstanding common stock. The Company expects that the transaction will close during the second quarter of 2006.
Business Overview
The Parent Company is a financial holding company which engages through its subsidiaries, Main Street Bank (“the Bank”) Main Street Insurance Services, Inc. (“MSII”), Piedmont Settlement Services, Inc. (“Piedmont”) (inactive as of June 30, 2005, dissolved as of December 31, 2005) and MSB Payroll Solutions, LLC in providing a full range of banking, mortgage banking, investment and insurance services to its retail and commercial customers located primarily in Barrow, Clarke, Cobb, DeKalb, Forsyth, Fulton, Gwinnett, Newton, Rockdale and Walton counties in Georgia. The Parent Company was incorporated on March 16, 1994 as a Georgia business corporation. Its executive offices are located at 3500 Lenox Road, Atlanta, Georgia 30326, and its telephone number is 770-786-3441. The Company has no foreign activities.
Effective November 17, 2000, the Parent Company became a financial holding company under the provisions of the Gramm-Leach-Bliley Act of 1999 (“GLB Act”), which amended the Bank Holding Company Act and expanded the activities in which the Company may engage. After becoming a financial holding company, in December 2000 the Parent Company acquired Williamson Insurance Agency, Inc. and Williamson & Musselwhite Insurance Agency, Inc. Upon consummation of the acquisition, the two insurance companies were combined with the Bank’s existing insurance division as a single subsidiary and the name was ultimately changed to Main Street Insurance Services, Inc. In January of 2004 MSII acquired substantially all of the assets of Banks Moneyhan Hayes Insurance Agency, Inc.
The Parent Company
Under Federal Reserve policy, the Parent Company is expected to act as a source of financial strength and to commit resources to support the Bank. In addition, any capital loans by a bank holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Subsidiary Bank
The Bank, a state chartered commercial bank, provides traditional deposit, lending, mortgage and securities brokerage services. Main Street Bank conducts a general banking business at 24 bank offices in Georgia. The Bank performs banking services customary for full service banks of similar size and character. Such services include receiving demand and time deposits, making personal and commercial loans and furnishing personal and commercial checking accounts.
Insurance Subsidiary
The Parent Company, through its wholly owned subsidiary, MSII, makes available to its customers and others, as agent for a variety of insurance companies, term life insurance, fixed-rate annuities, property and casualty insurance and other insurance products.
Products and Services
The Company provides a full range of traditional banking, mortgage banking, investment, and insurance services to individual and corporate customers.
Loans. The Company’s primary lending activities include real estate loans (mortgage and construction), commercial and industrial loans to small and medium sized businesses and consumer loans. The Company originates first mortgage loans and enters into a commitment to sell these loans in the secondary market. The Company limits its interest rate risk on such loans originated by entering into a commitment to sell individual loans immediately after the customer locks in their rate.
The Company’s management has strategically located its branches in high growth markets and has taken advantage of an increase in residential and commercial growth in the northern counties of metropolitan Atlanta, Georgia. The Company primarily lends in markets where it has physical branch locations.
Management seeks to achieve consistent growth within its primary market areas while maintaining a quality loan portfolio with acceptable yields. The Company monitors its lending objectives primarily through its Credit Review committees. The Company’s lending objectives are clearly defined in its Lending Policy, which is reviewed annually and approved by the Board of Directors. New loans for borrowers with total credit exposure exceeding $750,000 require co-approval by officers in the Bank’s Credit Administration Department. New loans with credit exposure exceeding $5,000,000 require additional approval by one or more executive officers of the Bank. New loans with credit exposure exceeding $12,500,000 require prior approval by the Board of Directors, which also reviews specific credit approvals exceeding $5,000,000 made during the prior month.
The Credit Review committee process includes the Executive Review Committee, the Eastern and Western Senior Review Committees, and the Credit Risk Management Committee. The Executive Review Committee is chaired by the President of the Bank and includes officers from the Credit Administration and Credit Review Departments. The Executive Review Committee annually reviews credit analysis and financial statements for borrowers with credit relationships exceeding $1,500,000 in exposure. The Eastern and Western Senior Review Committees annually review credit analysis and financial statements for borrowers with credit relationships exceeding $500,000 in total credit exposure up to $2,500,000 in total credit exposure. These committees are chaired by officers from the Credit Administration department and its members include officers from the Credit Review and branch administration areas. These committees also review delinquent loan accounts and overdrawn deposit accounts during the monthly meeting. The Credit Risk Management Committee meets on a quarterly basis and reviews the Bank’s larger adversely graded loans. This committee is chaired by officers from the Bank’s Credit Review Department and includes officers from the Credit Administration and branch administration areas.
Commercial mortgage lending has significantly contributed to the Bank’s loan growth during the past several years. Loans included in this category are for the acquisition or refinancing of commercial buildings, a majority of which are owner-occupied. These loans are underwritten based on our estimates of the borrower’s ability to meet certain minimum debt service requirements and the value of the underlying collateral to meet certain loan to value guidelines. The Bank also seeks security interests in equipment or other business assets of the borrower as well as personal guaranties.
The Bank also underwrites loans to finance the construction of residential properties and commercial properties, which include speculative and pre-sale properties. Speculative construction loans involve a higher degree of risk, as these are made on the basis that a borrower expects to be able to sell the project to a potential buyer after a project is completed. Pre-sale construction loans usually have a pre-qualified buyer under contract before construction is to begin. The major risk for pre-sale loans is completing the project in a timely manner and according to plan specifications. Non-residential construction loans include construction loans for churches, commercial buildings, strip shopping centers, and acquisition and development loans. These loans also carry a higher degree of risk and are subject to clear underwriting guidelines. All construction loans are secured by first liens on real estate and generally have floating interest rates. The Bank conducts periodic inspections either directly or through an agent prior to approval of periodic draws on these loans. Our management focuses on the borrowers’ past experience in completing projects in a timely manner and the borrowers’ financial condition with special emphasis placed on the borrowers’ liquidity ratios. Although construction loans are deemed to be of higher risk, the Bank believes that it can monitor and manage this risk properly.
The Bank also underwrites residential real estate loans. Generally, these loans are owner-occupied and are amortized over a 15 to 20 year period with three to five year maturity or repricing. Typically, a borrower’s debt to income ratio cannot exceed 36% and the loan to appraised value ratio cannot exceed 89.9%.
The Bank also underwrites non real estate related commercial and industrial loans. Generally, these asset based loans are for working capital purposes and are secured by inventory, accounts receivable, equipment, or personal guarantees. The Bank’s underwriting standards for this type of lending include requiring the borrower to maintain certain working capital and debt ratios as well as a positive cash flow from operations. Borrowers in this category will generally have a debt service coverage ratio of at least 1.3 to 1.0. The Bank also seeks to perfect its security interests in the borrower’s inventory, accounts receivable, equipment or other business assets of the borrower as well as personal guaranties.
The Bank does not originate and does not currently hold in its portfolio any foreign loans.
The Bank is an active participant in the origination of Small Business Administration (“SBA”) loans. These loans are solicited from the Company’s market areas, and are generally underwritten in the same manner as conventional loans generated for the Bank’s portfolio. The portion of loans that are secured by the guaranty of the SBA may from time to time be sold in the secondary market to provide additional liquidity, and to provide a source of fee income from premiums on sold loans.
Consumer loans include automobile loans, recreational vehicle loans, boat loans, home improvement loans, home equity loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 120 months and vary based upon the nature of collateral and size of the loan. Consumer loans involve greater risk than residential mortgage loans. This is due to the fact that these loans may be unsecured or secured by rapidly depreciating assets such as automobiles. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan balance. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability and thus are more likely to be adversely affected by factors such as job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws may limit the amount which can be recovered on such loans.
In addition to interest earned on loans, the Bank receives income through the servicing of loans and loan fees charged in connection with loan originations and modifications, late payments, changes of property ownership and for miscellaneous services related to its loans. The Bank sells fixed-rate and variable-rate residential mortgage loans in the secondary market through an arrangement with several investors. This program allows the Bank to offer more attractive rates in its highly competitive market. Mortgage banking activity is conducted primarily in the Bank’s market area. The Bank does not service those loans sold in the secondary market. Income from these activities varies from period to period with the volume and type of loans made.
The Bank charges loan origination fees which are calculated as a percentage of the amount loaned. The fees received in connection with the origination of conventional, single-family and residential real estate loans are typically two to three points (one point being equivalent to 1% of the principal amount of the loan). In addition, the Bank typically receives fees of one or two points in connection with the origination of conventional, multi-family residential loans and commercial real estate loans. Loan fees and certain direct loan costs are deferred and the net fee or cost is amortized into income over the expected life of the loan.
Bank regulators require insured depository institutions to use a classification system for monitoring their problem assets. Under this classification system, problem assets are classified as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection of principal in full,” on the basis of currently existing facts, conditions and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the Company to risk sufficient to warrant classification in one of the above categories, but which possess some weakness, are required to be designated “special mention” by management.
When an insured depository institution classifies problem assets as either “substandard” or “doubtful,” it may establish allowances for loan losses in an amount deemed prudent by management. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the assets so classified or to charge off such amount. The Bank’s determination as to the classification of its assets and the amount of its allowances is subject to review by its federal and state regulators, which may require the establishment of additional loss allowances.
Allowance for Loan Losses. The provision for loan losses is the annual cost of providing an allowance or reserve for estimated losses on loans. The amount for each year is dependent upon many factors including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of loan portfolio quality, the value of collateral and general economic and market factors.
Management monitors the entire loan portfolio in an effort to identify problem loans and risks in the portfolio on a timely basis, and to maintain an appropriate allowance for estimated losses on loans. Loan review procedures, including loan grading, periodic credit rescoring and trend analysis of loan portfolio performance, are utilized by the Company’s Credit Review Department in the process. Management’s involvement continues throughout the process and includes participation in the work-out process and recovery activity. These formalized procedures are monitored internally by the Credit Review Department. Such internal review procedures are quantified in periodic reports to senior management and to the Board of Directors and are used in determining whether such loans represent probable loss to the Company. Our regulators also review our credit quality and may classify credits differently from us.
The allowance for loan losses is established by risk group as follows:
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Large classified loans are evaluated individually with specific reserves allocated based on management’s review.
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The remainder of the portfolio is allocated a portion of the allowance based on past loss experience and our adjustments as to the economic conditions for the particular loan portfolio. Allocation weights are assigned based on the Company’s historical loan loss experience in each loan category, although a higher allocation weight may be used if current conditions indicate that loan losses may exceed historical experience.
Investment Securities - The Bank must maintain a sufficient level of liquid assets (including specified short-term securities and certain other investments) as determined by management. Our regulators also review our liquidity. The level of liquid assets varies depending upon several factors, including: (i) the yields on investment alternatives, (ii) management’s judgment as to the attractiveness of the yields then available in relation to other opportunities, (iii) expectation of future yield levels, and (iv) management’s projections as to the short-term demand for funds to be used for loans and other activities. Current regulatory and accounting guidelines regarding securities (including mortgage backed securities) require us to categorize securities as “held to maturity,” “available for sale” or “trading.” Securities classified as “available for sale” are reported for financial reporting purposes at fair value with net changes in the market value from period to period included as a separate component of stockholders’ equity, net of income taxes. Securities, including mortgage-backed securities, are classified at the time of purchase, based upon management’s intentions and abilities, as securities held to maturity or securities available for sale. Debt securities acquired with the intent and ability to hold to maturity are classified as held to maturity and are stated at cost and adjusted for amortization of premium and accretion of discount, which are computed using the level yield method and recognized as adjustments of interest income. All other debt securities are classified as available for sale to serve as a source of liquidity, to manage interest rate risk, and to provide a source of earnings.
The changes in fair value in our available for sale portfolio reflect market conditions and vary, either positively or negatively, based primarily on changes in general levels of market interest rates relative to the yields of the portfolio.
The Bank’s investment portfolio policy authorizes investments in instruments such as: (i) U.S. Treasury obligations, (ii) U.S. federal agency or federally sponsored agency obligations, (iii) municipal obligations, (iv) mortgage-backed securities and collateralized mortgage obligations, (v) certificates of deposit, (vi) investment grade corporate bonds and commercial paper, (vii) mutual funds; and (viii) trust preferred securities. The Board of Directors may authorize additional types of investments, however all investments at December 31, 2005 were within the existing authorized categories.
As a source of liquidity and to supplement its lending activities the Bank has invested in residential mortgage-backed securities. Mortgage-backed securities can serve as collateral for borrowings by the Bank and, through repayments, as a source of liquidity. Mortgage-backed securities represent an interest in a pool of residential or other
types of mortgages. Principal and interest payments are passed from the mortgage originators, through intermediaries (generally governmental sponsored entities or “GSE”) that pool and repackage the loans in the form of securities, to investors, like the Bank. The GSEs, which include GinnieMae, FreddieMac and FannieMae, may guarantee the payment of principal and interest to investors.
Mortgage-backed securities typically are issued with stated principal amounts. The securities are backed by pools of mortgages that have loans with interest rates that are within a range and have varying maturities. The underlying pool of mortgages can be composed of either fixed rate or adjustable rate mortgage loans. The interest rate risk characteristics of the underlying pool of mortgages (i.e., fixed rate or adjustable rate) and the prepayment risk, are passed on to the holders of the mortgage-backed securities. The life of a mortgage-backed pass-through security is equal to the life of the underlying mortgages. Expected maturities will differ from contractual maturities due to scheduled repayments and because borrowers may have the right to prepay obligations which may or may not have prepayment penalties.
The Bank also invests in mortgage-related securities, primarily collateralized mortgage obligations or “CMOs”, issued or sponsored by GinnieMae, FreddieMac and FannieMae and can invest in securities of private issuers as well. Investments in private issuer collateralized mortgage obligations can be made because these issues generally are higher yielding than agency sponsored collateralized mortgage obligations with similar average life and payment characteristics. All such investments must be rated at least A1/ A+. Collateralized mortgage obligations are a type of debt security that aggregates pools of mortgages and mortgage-backed securities and creates different classes of collateralized mortgage obligations securities with varying maturities and amortization schedules as well as a residual interest with each class having different risk characteristics. The cash flows from the underlying collateral are usually divided into “tranches” or classes whereby tranches have descending priorities with respect to the distribution of principal and interest repayment of the underlying mortgages and mortgage backed securities as opposed to pass- through mortgage backed securities where cash flows are distributed pro rata to all security holders. A particular tranche or class may carry prepayment risk which may be different from that of the underlying collateral and other tranches. We invest only in investment grade tranches of CMOs with investment ratings of at least A1/A+ (Moody’s / S&P).
The Bank’s investments also include certain other investments. These investments are recorded at cost which approximates market value. These other approved investments include Federal Home Loan Bank of Atlanta or “FHLB” stock. The Bank also participates in Community Reinvestment Act (CRA) qualified investments of high quality and limited risk that benefit our communities and promote our compliance with that Act.
Deposits. The Company offers a full range of depository accounts and services to both individuals and businesses. These deposit accounts have a wide range of interest rates and terms and consist of demand, savings, money market and time accounts.
The Bank’s current savings deposit products include passbook savings accounts, demand deposit accounts, NOW accounts, money market deposit accounts and time deposits. Terms on interest-bearing deposit accounts range from three months to ten years. Included among these savings deposit products are Individual Retirement Account (“IRA”) certificates and Keogh Plan retirement certificates (collectively “retirement accounts”). The Bank offers preferred rates for time deposits in denominations of $100,000 or more at terms ranging from one month to five years.
The principal methods used by the Bank to attract deposit accounts include the offering of a wide variety of services and accounts, competitive interest rates and convenient office locations and service hours.
In recent years, the Bank has been required by market conditions to rely increasingly on different types of short-term certificate accounts and other savings deposit alternatives that are more responsive to market interest rates than passbook accounts and regulated fixed-rate, fixed-term certificates that were historically the Bank’s primary source of savings deposits. As a result of deregulation and consumer preference for shorter term, market-rate sensitive accounts, the Bank has, like many financial institutions, experienced a significant shift in savings deposits towards relatively short-term, market-rate accounts. In recent years, the Bank has been successful in attracting IRA retirement accounts which have provided the Bank with a relatively stable source of longer-term funds.
The Bank attempts to control the flow of savings deposits by pricing its accounts to remain generally competitive with other financial institutions in its market area, but does not necessarily seek to match the highest rates paid by competing institutions. In this regard, the senior officers of the Bank meet weekly to determine the interest rates which the Bank will offer to the general public in our various markets.
Rates established by the Bank are also affected by the amount of funds needed by the Bank on both a short-term and long-term basis, alternative sources of funds and the projected level of interest rates in the future. The ability of the Bank to attract and maintain savings deposits and the Bank’s cost of funds have been, and will continue to be, significantly affected by economic and competitive conditions.
Brokered deposits are deposits obtained by the Bank utilizing an outside broker that is typically paid a fee. The Bank will utilize brokered deposits to obtain deposits with maturities and options that assist with the management of various balance sheet interest rate risks. These deposits typically have a higher interest rate than deposits obtained locally, but provide other benefits such as:
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Obtaining deposits not available in the Bank’s market area.
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Targeting a specific maturity and preferred dollar amount to assist in liquidity and interest rate risk management.
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Issuing long-term time deposits with continuous call options outside the Bank’s market area. This allows the Bank to obtain the options it desires to manage the balance sheet without running the risk of impacting its local depositors by calling time deposits when rates decline.
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Reducing the operating costs the Bank incurs compared to the costs of issuing time deposits in its local market area.
Brokered time deposits are set up on the Bank’s core processing system; however, normal retail documentation is not required on these deposits. Our goal is to limit total issuance of brokered deposits to not more than 10% of deposits in aggregate. In 2005 brokered deposits through any one Broker were limited to 2% of assets. Brokered deposits were $177.5 million at December 31, 2005 or 10.3% of total deposits and 7.5% of total assets.
National deposits are obtained from banks, savings & loans and credit unions by advertising our time deposit rates on the Internet. These are treated similarly to retail time deposits with the same documentation. Our policy states national deposits are not to exceed 15% of assets. National time deposits will be obtained in small denominations, usually $99,000, and are obtained from a wide variety of depositors. Internet generated deposits were $165.9 million at December 31, 2005 or 9.6% of total deposits and 7.0% of total assets.
Other Funding Sources: The Bank is eligible to obtain advances from the FHLB upon collateral consisting of the FHLB common stock the Bank owns, securities owned by the Bank and held in safekeeping by the FHLB and certain of its residential mortgages provided certain standards related to credit worthiness have been met. Such advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. FHLB advances are generally available to meet seasonal and other withdrawals of deposit accounts and to expand our lending base on a long-term basis through the extension of maturities of liabilities.
The Bank also, from time to time, enters into sales of securities under agreements to repurchase. Such repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as liabilities on the balance sheet.
Insurance Services. The Company provides insurance services to individuals and businesses through its subsidiary, MSII. MSII provides a variety of insurance products for consumers including life, health, homeowners, automobile and umbrella liability coverage. Commercial products include coverage for property, general liability, worker’s compensation and group life and health. MSII is an insurance agency and does not underwrite policies but rather acts as a broker.
Investment Services. The Company, through a division of the Bank, provides its customers with comprehensive investment and brokerage services through an arrangement with Invest Financial Corporation. Products and services include stocks and bonds, mutual funds, annuities, 401(k) plans, life insurance, individual retirement accounts, simplified employee pension accounts, estate planning and financial needs analysis.
Business Acquisitions
Since 1995, the Company has been reviewing and analyzing possible acquisition and growth opportunities in the Atlanta metropolitan area. Its strategic plan has been to enhance shareholder value by creating a larger high performing banking company in the Atlanta area. The goal has been to provide broader and more comprehensive services to its customers, create efficiencies in the administration and service functions and provide a larger shareholder base with a more liquid security trading on a national market.
During 2003 the Company acquired First Colony Bancshares, Inc., the former holding company of First Colony Bank, a $320 million asset holding company headquartered in Alpharetta, Georgia (“First Colony”). First Colony’s banking offices in Alpharetta, Roswell, and Cumming gave the Bank a strong presence in North Fulton County and the Cumming Office augmented the Company’s presence in Forsyth County. First Colony Bank was merged into the Bank.
During 2003 the Company completed the acquisition of the remaining 50% interest from the other partners of Piedmont Settlement Services, LLP, a Pennsylvania limited liability partnership, acting as a third party provider of mortgage loan related services. Upon this acquisition, the operations were transferred upstream to an intermediate holding company that subsequently changed its name to Piedmont Settlement Services, Inc. During 2005, the assets and operations of Piedmont were transferred to the Bank. Piedmont was inactive as of June 30, 2005 and was dissolved as of December 31, 2005.
During 2004 MSII acquired substantially all of the assets of Banks Moneyhan Hayes Insurance Agency, Inc. (“BMIA”), an insurance agency headquartered in Conyers, Georgia. BMIA’s insurance agency offices are located in Conyers and Athens, Georgia and sells business and property and casualty insurance, as well as group life and health. BMIA was the dominant insurance agency in Newton and Rockdale counties and allowed us to further expand our customer base in our geographic markets.
Market Area and Competition
The Company’s primary service area is in the counties north and east of Atlanta, Georgia. These counties include Barrow, Clarke, Cobb, DeKalb, Forsyth, Fulton, Gwinnett, Newton, Rockdale and Walton counties. The Company’s marketing strategy emphasizes its local nature and involvement in the communities located in its primary service area.
Since July 1, 1995, numerous interstate acquisitions involving Georgia-based financial institutions have been announced or consummated. Though interstate banking has resulted in significant changes in the structure of financial institutions in the southeastern region, including the Bank’s primary service areas, management does not feel that such changes have had or will have a significant impact upon its operations.
The Bank encounters vigorous competition from other commercial banks, savings and loan associations and other financial institutions and intermediaries in the Bank’s primary service areas.
The Bank competes with other banks in its primary service area in obtaining new deposits and accounts, making loans, obtaining branch banking locations and providing other banking services. The Bank also competes with savings and loan associations and credit unions for savings and transaction deposits, time deposits and various types of retail and commercial loans.
The Bank must compete with other financial intermediaries, including mortgage banking firms and real estate investment trusts, small loan and finance companies, insurance companies, credit unions, leasing companies and certain government agencies. Competition exists for time deposits and, to a more limited extent, demand and transaction deposits offered by a number of other financial intermediaries and investment alternatives, including money market mutual funds, brokerage firms, government and corporate bonds and other securities.
Competition for banking services in the State of Georgia is not limited to institutions headquartered in the State. A number of large interstate banks, bank holding companies and other financial institutions and intermediaries have established loan production offices, small loan companies and other offices and affiliates in the State of Georgia. Many of the interstate financial organizations that compete in the Georgia market engage in regional, national or international operations and have substantially greater financial resources than the Company.
Management expects that competition will remain intense in the future due to State and Federal laws and regulations, and the entry of additional bank and non-bank competitors in its markets.
Employees
As of December 31, 2005, the Company had a total of 549 full-time equivalent employees. These employees are provided with fringe benefits in varying combinations, including health, accident, disability and life insurance plans. None of the Company’s employees are subject to a collective bargaining agreement and the Company has never experienced a work stoppage. The Company also maintains training, educational and affirmative action programs designed to prepare employees for positions of increasing responsibility. In the opinion of management the Company enjoys good relations with its employees.
Government Monetary Fiscal Policy
The Company is affected by the credit policies of monetary authorities including the Board of Governors of the Federal Reserve System (“Federal Reserve”). An important function of the Federal Reserve is to regulate the national supply of bank credit. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market operations in United States Government securities, changes in the discount rate, reserve requirements on member bank deposits and funds availability regulations. These instruments are used in varying combinations to influence the overall growth of bank loans, investments and deposits and may also affect interest rate charges on loans or paid on deposits.
The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of financial institutions in the past and will continue to do so in the future. In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no reasonable prediction can be made as to the future impact that changes in interest rates, deposit levels, or loan demand may have on the business and income of the Parent Company and its subsidiaries.
Supervision and Regulation
Supervision, regulation and examination of the Parent Company, the Bank and their subsidiaries is intended primarily for the protection of depositors rather than holders of Parent Company securities. The Parent Company is a financial holding company registered with the Federal Reserve and the Georgia Department of Banking and Finance under the Bank Holding Company Act of 1956 (“BHC Act”), as amended, (the “BHC Act”) and the Georgia Bank Holding Company Act, respectively. As a result, it is subject to the supervision, examination and reporting requirements of these acts and the regulations of the Federal Reserve and the Georgia Department of Banking and Finance issued under these acts. To remain as a financial holding company, a bank holding company must demonstrate that each of its bank subsidiaries is well capitalized and well managed and has a rating of “satisfactory” or better under the Community Reinvestment Act of 1977 (“CRA”).
The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (1) it may acquire direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than five percent of the voting shares of the bank; (2) it or any of its subsidiaries, other than a bank, may acquire all or substantially all of the assets of any bank; or (3) it may merge or consolidate with any other bank holding company.
The Gramm-Leach-Bliley Act (“GLB Act”) was enacted on November 12, 1999. The GLB Act permits bank holding companies meeting certain management, capital and community reinvestment standards to engage in a substantially broader range of non-banking activities than were permitted previously, including insurance underwriting and merchant banking activities. The BHC Act was amended to permit a financial holding company to engage in any activity and acquire and retain any company that the Federal Reserve determines to be (a) financial in nature or incidental to such financial activity or (b) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. The GLB Act repealed sections 20 and 32 of the Glass Steagall Act, permitting affiliations of banks with securities firms and registered investment companies. The GLB Act permits banks to be under common control with securities firms, insurance companies, investment companies and other financial interests if these companies are subsidiaries of a financial holding company. Some of these affiliations are also permissible for bank subsidiaries. The GLB Act gives the Federal Reserve broad authority to regulate financial holding companies, but provides for functional regulation of subsidiary activities by the Securities and Exchange Commission, the Federal Trade Commission, state insurance and securities authorities and similar regulatory agencies.
The GLB Act includes significant provisions regarding the privacy of financial information. These financial privacy provisions generally require a financial institution to adopt a privacy policy regarding its practices for sharing nonpublic personal information and to disclose that policy to its customers, both at the time the customer relationship is established and at least annually during the relationship. These provisions also prohibit the Company from disclosing nonpublic personal financial information to third parties unless customers have the opportunity to opt out of the disclosure.
The Federal Reserve Act generally imposes certain limitations on extensions of credit and other transactions by and between banks that are members of the Federal Reserve and other affiliates (which includes any holding company of which a bank is a subsidiary and any other non-bank subsidiary of such holding company). Banks that are not members of the Federal Reserve also are subject to these limitations. Further, federal law prohibits a bank holding company and its subsidiaries from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property or the furnishing of services.
In December 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) was enacted. This act recapitalized the Bank Insurance Fund (“BIF”), of which the Bank is a member; substantially revised statutory provisions, including capital standards; restricted certain powers of state banks; gave regulators the authority to limit officer and director compensation; and required holding companies to guarantee the capital compliance of their banks in certain instances. FDICIA, which became effective in December 1992, among other things, requires the federal banking agencies to take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. FDICIA established five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized,” as defined by regulations adopted by the Federal Reserve, the Federal Deposit Insurance Corporation (“FDIC”) and the other federal depository institution regulatory agencies. A depository institution is well capitalized if it significantly exceeds the minimum level required by regulation for each relevant capital measure, adequately capitalized if it meets such measure, undercapitalized if it fails to meet any such measure, significantly undercapitalized if it is significantly below such measure, and critically undercapitalized if it fails to meet any critical capital level set forth in the regulations. The critical capital level must be a level of tangible equity capital equal to the greater of 2 percent of total tangible assets or 65 percent of the minimum leverage ratio to be prescribed by regulation. An institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. Generally, subject to a narrow exception, FDICIA requires the banking regulator to appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category.
Under the agency rule implementing the prompt corrective action provisions, an institution that (i) has a Total Capital ratio of 10.0% or greater, a Tier 1 Capital ratio of 6.0% or greater, and a Leverage Ratio of 5.0% or greater and (ii) is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the appropriate federal banking agency is deemed to be “well capitalized.” An institution with a Total Capital ratio of 8.0% or greater, a Tier 1 Capital ratio of 4.0% or greater, and a Leverage Ratio of 4.0% or greater is considered to be “adequately capitalized.” A depository institution that has a Total Capital ratio of less than 8.0%, a Tier 1 Capital ratio of less than 4.0%, or a Leverage Ratio of less than 4.0% is considered to be “undercapitalized.” A depository institution that has a Total Capital ratio of less than 6.0%, a Tier 1 Capital ratio of less than 3.0%, or a Leverage Ratio of less than 3.0% is considered to be “significantly undercapitalized,” and an institution that has a tangible equity capital to assets ratio equal to or less than 2.0% is deemed to be “critically undercapitalized.” For purposes of the regulation, the term “tangible equity” includes core capital elements counted as Tier 1 Capital for purposes of the risk-based capital standards plus the amount of outstanding cumulative perpetual preferred stock (including related surplus), minus all intangible assets with certain exceptions. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency.
Under FDICIA, a bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to certain limitations. The obligation of a controlling bank holding company under FDICIA to fund a capital restoration plan is limited to the lesser of 5.0% of an undercapitalized subsidiary’s assets and the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches, or engaging in any new line of business, except in accordance with an accepted capital restoration plan or with the approval of the FDIC. In addition, the appropriate federal banking agency is given authority with respect to any undercapitalized depository institution to take any of the actions it is required to or may take with respect to a significantly undercapitalized institution as described below if it determines “that those actions are necessary to carry out the purpose” of FDICIA.
If a depository institution fails to meet regulatory capital requirements, the regulatory agencies can require submission and funding of a capital restoration plan by the institution, place limits on its activities, require the raising of additional capital and, ultimately, require the appointment of a conservator or receiver for the institution. The obligation of a controlling FHC under FDICIA to fund a capital restoration plan is limited to the lesser of 5.0% of an undercapitalized subsidiary’s assets or the amount required to meet regulatory capital requirements. If the controlling FHC fails to fulfill its obligations under FDICIA and files (or has filed against it) a petition under the Federal Bankruptcy Code, the FDIC’s claim may be entitled to a priority in such bankruptcy proceeding over third party creditors of the bank holding company.
For those institutions that are significantly undercapitalized or undercapitalized and either fail to submit an acceptable capital restoration plan or fail to implement an approved capital restoration plan, the appropriate federal banking agency must require the institution to take one or more of the following actions: (i) sell enough shares, including voting shares, to become adequately capitalized; (ii) merge with (or be sold to) another institution (or holding company), but only if grounds exist for appointing a conservator or receiver; (iii) restrict certain transactions with banking affiliates as if the “sister bank” exception to the requirements of Section 23A of the Federal Reserve Act did not exist; (iv) otherwise restrict transactions with bank or non-bank affiliates; (v) restrict interest rates that the institution pays on deposits to prevailing rates in the institution’s region; (vi) restrict asset growth or reduce total assets; (vii) alter, reduce, or terminate activities; (viii) hold a new election of directors; (ix) dismiss any director or senior executive officer who held office for more than 180 days immediately before the institution became undercapitalized, provided that in requiring dismissal of a director or senior officer, the agency must comply with certain procedural requirements, including the opportunity for an appeal in which the director or officer will have the burden of proving his or her value to the institution; (x) employ “qualified” senior executive officers; (xi) cease accepting deposits from correspondent depository institutions; (xii) divest certain non-depository affiliates which pose a danger to the institution; or (xiii) be divested by a parent holding company. In addition, without the prior approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to any senior executive officer or increase the rate of compensation for such an officer without regulatory approval. At December 31, 2005, the Parent Company and the Bank were both “well capitalized” and were not subject to any of the foregoing restrictions.
The Community Reinvestment Act of 1977 (“CRA”) and the regulations of the Federal Reserve and the FDIC implementing that act are intended to encourage regulated financial institutions to help meet the credit needs of their local community or communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of such financial institutions. The CRA and its implementing regulations provide that the appropriate regulatory authority will assess the records of regulated financial institutions in satisfying their continuing and affirmative obligations to help meet the credit needs of their local communities as part of their regulatory examination of the institution. The results of such examinations are made public and are taken into account upon the filing of any application to establish a domestic branch or to merge or to acquire the assets or assume the liabilities of a bank. In the case of a bank holding company, the CRA performance record of the banks involved in the transaction are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other bank holding company. An unsatisfactory record can substantially delay or block the transaction. The Bank’s most recent CRA examination was in May, 2005 and the bank received a “Satisfactory” rating.
The Omnibus Budget Reconciliation Act of 1993 provides that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such an institution in the “liquidation or other resolution” of such an institution by any receiver.
USA Patriot Act: On October 26, 2001, President Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”). The USA Patriot Act is intended to allow the federal government to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. Title III of the USA Patriot Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act.
Among its provisions, the USA Patriot Act requires each financial institution: (i) to establish an anti-money laundering program, (ii) to establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks and (iii) to avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, the USA Patriot Act contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money
laundering activities. The federal banking agencies have begun proposing and implementing regulations interpreting the USA Patriot Act. Compliance with the USA Patriot Act did not have a significant impact on the financial condition or results of operations of the Company.
Sarbanes-Oxley Act: On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), which is intended to address systemic and structural weaknesses of the capital markets in the United States that were perceived to have contributed to recent corporate scandals. The Sarbanes-Oxley Act created the Public Company Accounting Oversight Board (“PCAOB”) to oversee the conduct of audits of public companies. The duties of PCAOB include (i) registering public accounting firms that prepare audit reports, (ii) establishing auditing, quality control, ethics, independence and other standards for the preparation of audit reports, (iii) conducting inspections of registered public accounting firms and (iv) otherwise promoting high professional standards among, and improving the quality of audit services offered by auditors of public companies. The PCAOB is funded from assessments on public companies and is subject to the oversight of the Securities and Exchange Commission. In addition, the Sarbanes-Oxley Act attempts to strengthen the independence of public company auditors by, among other things, (i) prohibiting public company auditors from providing certain non-audit services to their audit clients, (ii) requiring a company’s audit committee to preapprove all audit and non-audit services being provided by its independent auditor, (iii) requiring the rotation of audit partners and (iv) prohibiting an auditor from auditing a client that has as its chief executive officer, chief financial officer, chief accounting officer or controller a person that was employed by the auditor during the previous year.
The Sarbanes-Oxley Act also attempts to enhance the responsibility of corporate management by, among other things, (i) requiring the Chief Executive Officer and Chief Financial Officer of public companies to provide certain certifications in their periodic reports regarding the accuracy of the periodic reports filed with the Securities and Exchange Commission, (ii) prohibiting officers and directors of public companies from fraudulently influencing an accountant engaged in the audit of the company’s financial statements, (iii) requiring chief executive officers and chief financial officers to forfeit certain bonuses in the event of a misstatement of financial results, (iv) prohibiting officers and directors found to be unfit from serving in a similar capacity with other public companies, (v) prohibiting officers and directors from trading in the company’s equity securities during pension blackout periods and (vi) requiring the Securities and Exchange Commission to issue standards of professional conduct for attorneys representing public companies. In addition, public companies whose securities are listed on a national securities exchange or association must satisfy the following additional requirements: (i) the company’s audit committee must appoint and oversee the company’s auditors, (ii) each member of the company’s audit committee must be independent, (iii) the company’s audit committee must establish procedures for receiving complaints regarding accounting, internal accounting controls and audit-related matters, (iv) the company’s audit committee must have the authority to engage independent advisors and (v) the company must provide appropriate funding to its audit committee, as determined by the audit committee.
The Sarbanes-Oxley Act contains several provisions intended to enhance the quality of financial disclosures of public companies, including provisions that (i) require that financial disclosures reflect all material correcting adjustments identified by the company’s auditors, (ii) require the disclosure of all material off-balance sheet transactions, (iii) require the Securities and Exchange Commission to issue rules regarding the use by public companies of pro forma financial information, (iv) with certain limited exceptions, including an exception for financial institutions making loans in compliance with federal banking regulations, prohibit public companies from making personal loans to its officers and directors, (v) with certain limited exceptions, require directors, officers and principal shareholders of public companies to report changes in their ownership in the company’s securities within two business days of the change, (vi) require a company’s management to provide a report of its assessment of the internal controls of the company in its annual report and requires auditors to attest to managements assertion of the internal controls, (vii) require public companies to adopt codes of conduct for senior financial officers and (viii) require companies to disclose whether the company’s audit committee has a financial expert as a member.
Under the Sarbanes-Oxley Act, the Securities and Exchange Commission was directed to adopt rules designed to protect the independence of research analysts and to require research analysts to disclose conflicts of interest and potential conflicts of interest. The Sarbanes-Oxley Act also directs that certain studies be conducted by the Comptroller General and the Securities and Exchange Commission, including studies regarding the function of credit rating agencies and the role of investment banks and financial advisers might have on earnings.
The Sarbanes-Oxley Act imposes criminal liability for certain acts, including altering documents involving federal investigations, bankruptcy proceedings, and corporate audits and increases the penalties for certain offenses, including mail and wire fraud. In addition, the Sarbanes-Oxley Act gives added protection to corporate whistle-blowers.
Although the Company has incurred additional expense in complying with the provisions of the Sarbanes-Oxley Act and the regulations promulgated by the Securities and Exchange Commission thereunder, such compliance has not had a material impact on the Company’s financial condition or results of operations.
Other: The United States Congress continues to consider a number of wide-ranging proposals for altering the structure, regulation, and competitive relationships of the nation’s financial institutions. It cannot be predicted whether or in what form further legislation may be adopted or the extent to which the business of the Company may be affected thereby.
FDIC Insurance Assessments
Pursuant to FDICIA, the FDIC adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The risk-based system, which went into effect on January 1, 1994, assigns an institution to one of three capital categories: (i) well capitalized; (ii) adequately capitalized; and (iii) undercapitalized. These three categories are substantially similar to the prompt corrective action categories described above, with the “undercapitalized” category including institutions that are undercapitalized, significantly undercapitalized, and critically undercapitalized for prompt corrective action purposes. An institution is also assigned by the FDIC to one of three supervisory subgroups within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution’s primary federal regulator and information which the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds (which may include, if applicable, information provided by the institution’s state supervisor). An institution’s insurance assessment rate is then determined based on the capital category and supervisory category to which it is assigned. Under the final risk-based assessment system, there are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied.
The Bank is assessed at the well-capitalized level where the premium rate is currently zero. Like all insured banks, the Bank also must pay a quarterly assessment of approximately $.02 per $100 of assessable deposits to pay off bonds that were issued in the late 1980’s by a government corporation, the Financing Corporation, to raise funds to cover costs of the resolution of the savings and loan crisis.
Under the Federal Deposit Insurance Act (“FDIA”), insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC.
Capital Adequacy
The Parent Company and the Bank are required to comply with the capital adequacy standards established by the Federal Reserve and the FDIC. There are two basic measures of capital adequacy for bank holding companies that have been promulgated by the Federal Reserve: a risk-based measure and a leverage measure. All applicable capital standards must be satisfied for a bank holding company to be considered in compliance.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
The minimum guideline for the ratio of total capital (“Total Capital”) to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8.0%. At least half of the Total Capital must be composed of common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets (“Tier 1 Capital”). The remainder may consist of subordinated debt, other preferred stock, and a limited amount of loan loss reserves. The minimum guideline for the Tier 1 Capital ratio is 4.0%. At December 31, 2005, the Company’s consolidated Tier 1 Capital and Total Capital ratios were 12.59% and 13.84%, respectively.
In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and certain other intangible assets (the “Leverage Ratio”), of 4.0% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies generally are required to maintain a Leverage Ratio of at least 4.0% plus an additional cushion of 100 to 200 basis points. The Company’s Leverage Ratio at December 31, 2005, was 10.69%.
The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the Federal Reserve has indicated that it will consider a “tangible Tier 1 Capital leverage ratio” (deducting all intangibles) and other indicators of capital strength in evaluating proposals for expansion or new activities.
The Bank is subject to risk-based and leverage capital requirements adopted by the FDIC, which are substantially similar to those adopted by the Federal Reserve. The Bank was in compliance with applicable minimum capital requirements as of December 31, 2005. Neither the Parent Company nor the Bank has been advised by any federal banking agency of any violations of specific minimum capital ratio requirement applicable to it.
Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including the termination of deposit insurance by the FDIC and to certain restrictions on its business.
Safety and Soundness Standards
Main Street Bank is a Georgia chartered commercial bank and subject to the supervision, examination and reporting requirements of the Georgia Department of Banking and Finance and the FDIC.
The FDIC and the Georgia Department of Banking and Finance regularly examine the operations of the Bank and are given the authority to approve or disapprove mergers, consolidations, and the establishment of branches and similar corporate actions. The FDIC and the Georgia Department of Banking and Finance also have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law.
FDIA, as amended by FDICIA and the Riegle Community Development and Regulatory Improvement Act of 1994, requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits and such other operational and managerial standards as the agencies deem appropriate. The federal bank regulatory agencies adopted in 1995 a set of guidelines prescribing safety and soundness standards pursuant to FDICIA, as amended.
The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal stockholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of FDICIA. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties. The federal bank regulatory agencies also proposed guidelines for asset quality and earnings standards.
Website Availability of Reports Filed with the Securities and Exchange Commission
The Company maintains an Internet website located at www.mainstreetbank.com on which, among other things, the Company makes available, free of charge, various reports that it files with, or furnishes to the Securities and Exchange
Commission (“SEC”), including its Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports. These reports are made available as soon as reasonably practicable after these reports are filed with, or furnished to the SEC.
Item 1A.
Item 1A. Risk Factors
Our business involves a high degree of risk. Below are some of the material risks that we face.
Credit Risk and Loan Concentration: A major risk facing lenders is the risk of losing principal and interest as a result of a borrower’s failure to perform according to the terms of the loan agreement, or “credit risk.” Real estate loans include residential mortgages and construction and commercial loans secured by real estate. The Company’s credit risk with respect to its real estate loans relates principally to the value of the underlying collateral. The Company’s credit risk with respect to its commercial loans relates principally to the general creditworthiness of the borrowers, who primarily are individuals and small and medium-sized businesses in the Company’s primary service areas. There can be no assurance that the allowance for loan losses will be adequate to cover future losses in the existing loan portfolios. Loan losses exceeding the Company’s historical rates could have a material adverse affect on the results of operations and financial condition of the Company. Changes in interest rates may also negatively impact earnings if rate sensitive assets and liabilities are not properly matched.
Potential Impact of Change in Interest Rates: The earnings of the Company depends to a large extent upon its net interest income, which is the difference between interest income on interest-earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and borrowings. The net interest income of the Company would be adversely affected if changes in market interest rates resulted in the interest-bearing assets of the Company being reduced because of softening loan demand. In addition, a decline in interest rates may result in greater than normal prepayments of the higher interest-bearing obligations held by the Company.
Management Information Systems: The sophistication and level of risk of the Company’s business requires the utilization of thorough and accurate management information systems. Failure of management to effectively implement, maintain, update and utilize updated management information systems could prevent management from recognizing in a timely manner deterioration in the performance of its business, particularly its loan portfolios. Such failure to effectively implement, maintain, update and utilize comprehensive management information systems could have a material adverse effect on the results of operations and financial condition of the Company.
Potential Impact of Significant Growth: The Company has grown loans, deposits, fee businesses, and employees rapidly both internally and through acquisition. The ability of the Company to manage this growth in a disciplined manner is imperative. The Company must thoroughly plan on how to support this growth from a human resources, training, operational, financial and technology standpoint. Also, high management and employee turnover during a period of rapid growth could have a negative impact on internal controls. The failure to successfully manage this growth could have a material adverse effect on the operating results and financial conditions of the company.
Adverse Economic Conditions: The Company’s major lending activities are real estate and commercial loans. Residential mortgage loans are also produced for resale. An increase in interest rates could have a material adverse effect on the housing industries and consumer spending generally. In addition, an increase in interest rates could cause a decline in the value of residential mortgages. These events could adversely affect the results of operations and financial condition of the Company.
Governmental Regulation - Banking: The Parent Company and the Bank are subject to extensive supervision, regulation and control by several Federal and State governmental agencies, including the Federal Reserve, FDIC, and the Georgia Department of Banking and Finance. Future legislation, regulations and government policy could adversely affect the Company and the financial institutions industry as a whole, including the cost of doing business. Although the impact of such legislation, regulation and policies cannot be predicted, future changes may alter the structure of and competitive relationships among financial institutions.
Consumer and Debtor Protection Laws: The Company is subject to numerous Federal and State consumer protection laws that impose requirements related to offering and extending credit. The United States Congress and state governments may enact laws and amend existing laws to regulate further the consumer industry or to reduce finance charges or other fees or charges applicable to credit card and other consumer revolving loan accounts. Such laws, as well as any new laws or rulings which may be adopted, may adversely affect the Company’s ability to collect on account
balances or maintain previous levels of finance charges and other fees and charges with respect to the accounts. Any failure by the Company to comply with such legal requirements also could adversely affect its ability to collect the full amount of the account balances. Changes in federal and state bankruptcy and debtor relief laws could adversely affect the results of operations and financial condition of the Company if such changes result in, among other things, additional administrative expenses and accounts being written off as uncollectible.
Composition of Real Estate Loan Portfolio: The real estate loan portfolio of the Company includes residential mortgages and construction and commercial loans secured by real estate. The Company generates most of its real estate mortgage loans in Georgia. Therefore, conditions of this real estate market could strongly influence the level of the Company’s non-performing mortgage loans and the results of operations and financial condition of the Company. Real estate values and the demand for mortgages and construction loans are affected by, among other things, changes in general or local economic conditions, changes in governmental rules or policies, the availability of loans to potential purchasers, and acts of nature. Although the Company’s underwriting standards are intended to protect the Company against adverse general and local real estate trends, declines in real estate markets could adversely impact the demand for new real estate loans, and the value of the collateral securing the Company’s loans.
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
The Company’s corporate headquarters are located at 3500 Lenox Road, Atlanta, Georgia. The main office of the Bank is located at 1134 Clark Street, Covington, Georgia. The Bank leases space for its headquarters and various support functions. These support functions include: an operations center, bank headquarters, and accounting facilities.
The Bank has 24 branch offices located in Barrow, Clarke, Cobb, DeKalb, Forsyth, Fulton, Gwinnett, Newton, Rockdale and Walton counties, Georgia, 17 of which are owned and 7 of which are leased. Deposit and loan operations, proof, information technology, and purchasing are located in leased space at 2118 Usher Street in Covington, Georgia. Accounting, Risk Management and Compliance are in leased space at 1122 Pace Street in Covington, Georgia. Human Resources and SBA Lending are located in leased space located at the Covington Professional Park on Highway 278, Covington, Georgia. The Bank’s corporate headquarters is in leased space at 1121 Floyd Street, Covington, Georgia. The Bank also leases a building in Covington, Georgia, adjacent to the owned facility on Pace Street, which serves as the location of the Branch Operations and Treasury departments.
Item 3.
Item 3. Legal Proceedings
Neither the Company nor any of its subsidiaries are a party to, nor is any of their property the subject of, any material pending legal proceedings, other than ordinary routine proceedings incidental to the business of the Company. To our knowledge, no such material proceedings were contemplated or threatened against us or our subsidiaries. From time to time, the Parent Company and its subsidiaries are parties to legal proceedings in the ordinary course of business, including legal proceedings to enforce its security interests in collateral. Management, after consultation with legal counsel, does not anticipate that current litigation will have a material adverse effect on the Company’s financial position or results of operations or cash flows.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders by solicitation of proxies or otherwise during the fourth quarter of 2005.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Market Prices. Our common stock trades on the NASDAQ under the symbol “MSBK.”
The following table sets forth the high and low closing prices and the end of the quarter closing price of the common stock of the Parent Company and the dividends paid thereon during the periods indicated:
As of February 28, 2006, there were approximately 1,639 shareholders of record of the Parent Company’s common stock. The Company believes that there are a significant number of shares of Common Stock held either in nominee name or street name brokerage accounts and consequently, the Company is unable to determine the number of beneficial owners of the Common Stock.
Dividend Policy and History. Neither the Parent Company’s articles of incorporation nor the bylaws set forth any restriction on the ability of the Parent Company to issue dividends to its shareholders. The Georgia Business Corporation Code, though, forbids any distribution which, after being given effect, would leave the Parent Company unable to pay its debts as they become due in the usual course of business. Additionally, the Georgia Business Corporation Code provides that no distribution shall be made if, after giving it effect, the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed to satisfy any preferential dissolution rights.
The Parent Company is a legal entity separate and distinct from its subsidiaries. Substantially all of the Parent Company’s revenues result from amounts paid as dividends to the Parent Company by its subsidiaries. The Bank is subject to statutory and regulatory limitations on the payment of dividends to the Parent Company, and the Parent Company is subject to statutory and regulatory limitations on dividend payments to its shareholders.
If in the opinion of the federal banking regulators, a depository institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, the regulatory authority may require, after notice and hearing, that the institution cease and desist from the practice. The Federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under FDICIA, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. The federal agencies have also issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.
The Georgia Financial Institutions Code and the Georgia Banking Department’s regulations provide:
•
that dividends of cash or property may be paid only out of the Bank’s retained earnings;
•
that dividends may not be paid if the Banks’ paid-in capital and retained earnings which are set aside for dividend payment and other distributions do not, in combination, equal at least 20% of the Bank’s capital stock;
•
that dividends may not be paid without prior approval of the Georgia Banking Department if:
•
the Bank’s total classified assets at its most recent examination exceed 80% of its equity capital;
•
the aggregate amount of dividends to be declared exceeds 50% of the Bank’s net profits after taxes but before dividends for the previous calendar year;
•
the ratio of total equity capital to adjusted assets is less than 6%.
The payment of dividends by the Parent Company may also be affected or limited by other factors, such as a requirement by the Federal Reserve to maintain adequate capital above regulatory guidelines.
In connection with its acquisition by BB&T the “Agreement and Plan of Merger” limits dividends the Company may pay to quarterly cash dividends in an amount not to exceed the per share amount declared and paid in accordance with past practices.
Recent sales of unregistered securities. On January 2, 2004, the Company acquired substantially all of the assets of Banks Moneyhan Hayes Insurance Agency, Inc. As consideration for this acquisition, the Parent Company issued 271,111 shares of its common stock to the shareholders of Banks Moneyhan in a transaction that was exempt from registration under section 4 (2) of the Securities Act of 1933.
Item 6.
Item 6. Selected Financial Data
The following table sets forth selected financial data for the last five years. The acquisitions of Banks Moneyhan Hayes Insurance Agency, Inc. on January 2, 2004, First Colony Bancshares, Inc. on May 22, 2003 and First National Bank of Johns Creek on December 11, 2002 have significantly affected the comparability of selected financial data. Specifically, since these acquisitions were accounted for using the purchase method of accounting, the assets of the acquired institutions were recorded at their fair values and the excess purchase price over the net fair value of the assets was recorded as goodwill and the results of operations for these businesses have been included in the Company’s results since the date these acquisitions were completed. Accordingly, the level of our assets and liabilities and our results of operations for these businesses have significantly impacted the information below. Discussion of these acquisitions can be found in the Business Combinations section of Part 1, Item 1and in Note B - Acquisitions in the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.
* Long-term obligations include Federal Home Loan Bank advances, and Subordinated Debt. Discussions of Borrowings can be found in Note I - Borrowings section of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is management’s discussion and analysis of certain significant factors which have affected the Company’s financial position at December 31, 2005 as compared to December 31, 2004 and a comparison of operating results for the years ended December 31, 2005, 2004 and 2003. These comments should be read in conjunction with the Company’s consolidated financial statements and accompanying notes appearing elsewhere herein.
Executive Overview
The year ended December 31, 2005 was both an exciting and challenging year for Main Street Banks, Inc. The Company experienced significant growth during the year.
The 2005 operating results were highlighted by:
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Loans increased $103.5 million or 6.1%, compared to the prior year.
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Total deposits increased $21.3 million, or 1.2% during the year. The deposit mix improved as transaction deposits grew 31% compared to December 31, 2004.
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Net interest income increased $ 8.7 million or 10.6% compared to the prior year.
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Provision for loan losses increased during 2005 to $8.2 million from $7.4 million in 2004 and from $5.2 million in 2003. The primary reasons for the increases were loan growth and losses in a former officer’s loan portfolio.
On December 15, 2005, Main Street Banks, Inc. announced it had signed a definitive agreement to be acquired by BB&T Corporation (BB&T). The transaction is subject to customary regulatory approvals as well as the approval of a majority of Main Street Banks, Inc. outstanding common stock. The Company expects that the transaction will close during the second quarter of 2006. During 2006, in addition to preparing for its acquisition by BB&T, the Company intends to:
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Continue strong internal growth of loans and deposits
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Maintain asset quality by:
1. Keeping delinquency trends stable,
2. Limiting shared national credits,
3. Having a high percentage of portfolio well collateralized, and
4. Keeping nonperforming assets low through active management and disciplined underwriting criteria.
Critical Accounting Policies
The accounting and reporting policies of the Parent Company and its subsidiaries are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. A summary of our significant accounting policies is included in Note A to Notes to our Consolidated Financial Statements. Certain accounting policies require management to make significant estimates and assumptions, which have a material impact on the carrying value of certain assets and liabilities and the results of operations, and the Company considers these to be critical accounting policies. The following are the accounting policies that management believes are most important to the portrayal of our financial condition and results of operations and require management’s most difficult, subjective, or complex judgments. The estimates and assumptions used are based on historical experience and other factors, which management believes to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and results of operations for the reporting periods.
Allowance for Loan Losses: An allowance for loan losses is based on management’s opinion of an amount that is adequate to absorb probable losses inherent in the loan portfolio. The allowance for loan losses is established through a
provision for losses based on management’s evaluation. The evaluation, which includes a review of all loans on which full collection may not be reasonably assumed, considers, among other matters, the fair market value or the estimated net realizable value of the underlying collateral, management’s estimate of probable credit losses, historical loan loss experience, and other factors that warrant recognition in providing for an adequate loan loss allowance. Changes in the factors used by management to determine the adequacy of the allowance or the availability of new information could cause the allowance for loan losses to be increased or decreased in future periods. In addition, bank regulatory agencies, as part of their examination process, may require that additions or reductions be made to the allowance for loan losses based on their judgments and estimates.
Income Taxes: The calculation of the Company’s income tax provision and related current and deferred tax assets and liabilities require the use of estimates and judgments in its determination. As part of the Company’s evaluation and implementation of business strategies, consideration is given to the regulations and tax laws that apply to the specific facts and circumstances for any transaction under evaluation. This analysis includes the amount and timing of the realization of income tax liabilities or benefits. Management closely monitors tax developments in order to evaluate the effect they may have on the Company’s overall tax position.
Goodwill: In our financial statements, we have recorded $102.0 million of goodwill and other intangible assets, which represents the amount by which the price we paid for acquired businesses exceeds the fair value of tangible assets acquired less the liabilities assumed. The determination of whether these assets are impaired involved significant judgments based upon management’s short and long-term projections of future performance. Certain of these forecasts reflect assumptions regarding our ability to sustain or increase business. Changes in strategy and/or market conditions may result in changes to recorded asset balances. On at least an annual basis, the Company conducts an evaluation to assess whether the fair value of our recorded goodwill and other intangible assets exceeds the aggregate carrying value of these assets. As long as the aggregate fair value exceeds the aggregate carrying value, no impairment is recognized in our financial statements. For the year ended December 31, 2005, management determined that there was no impairment of goodwill or intangible assets.
Net Income and Earnings per Share
The Company’s net income was $29.4 million, $31.0 million, $26.7 million for the years ended December 31, 2005, 2004, and 2003, respectively. Basic earnings per share were $1.37, $1.59, and $1.49 for the same periods, respectively, and diluted earnings per share were $1.35, $1.54, and $1.44 for the same periods.
Earning Assets and Liabilities
Average earning assets in 2005 increased 12.7% over 2004 due principally to a 12.0% increase in total loans and a 26.9% increase in taxable investment securities, offset partially by a 47.2% decrease in Federal Funds sold and Securities purchased under resell agreements. The average earning assets mix in 2005 changed only slightly from 2004 with loans at 83.2% and 84.0% for 2005 and 2004, respectively, and total investment securities at 16.2% and 15.0% for 2005 and 2004, respectively. The mix of earning assets is monitored on a continuous basis in order to optimize earning assets and limit interest rate risk.
The following table presents the total dollar amount of average balances, interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates.
(1) Fee income related to loans of $9,657, $10,980, and $9,078 for the years ended December 31, 2005, 2004, and 2003, respectively, is included in interest income.
(2) Non-accrual loans of $13,516, $12,255, and $11,548 at December 31, 2005, 2004 and 2003, respectively, are included in the average loan balances.
(3) To make pre-tax income and resultant yields on tax-exempt investments comparable to those on taxable investments, a tax-equivalent adjustment has been computed using a federal income tax rate of 34%.
(4) The net interest margin is equal to the net interest income divided by average interest-earning assets
Results of Operations
For the year ended December 31, 2005, Main Street Banks, Inc. reported net income of $29.4 million or $1.35 per diluted share compared with net income of $31.0 million ($1.54 per diluted share) and $26.7 million ($1.44 per diluted share) for 2004 and 2003, respectively.
During 2005 there were several events that occurred that had an impact on the financial performance of the Company, as follows:
Elevated charge-offs in a problem loan portfolio - The Company performed a comprehensive review of a problem loan portfolio originated by a former lending officer. This problem portfolio was first announced in November 2004. With the assistance of a nationally recognized auditing and consulting firm, the Company conducted a review and identified $4.4 million in charge-offs in the problem portfolio that were charged-off in the first and second quarters of 2005. These charge-offs negatively impacted the provision expense in 2005.
Write-offs of assets - The Company combined the operations of its loan settlement services subsidiary, Piedmont Settlement Services, including the staff and systems, into the Bank to aid in the centralization of consumer loan document preparation and to improve corporate efficiency. The associated assets in this subsidiary were written off in the second quarter. The Company recognized a loss of $0.4 million during the second quarter of 2005. The Company’s first quarter results were also impacted by a $0.5 million loss for the replacement of a banking center in Conyers, Georgia. This center was demolished to provide for the opening of a newly constructed full-service banking center.
Loss on sale of available for sale securities - Due to changes in liquidity requirements and asset liability management decisions, management chose to recognize a total of $2.3 million in pre-tax losses by U.S. Government agency and mortgage backed securities with a book value of $84.9 million in the third and fourth quarters of 2005.
Additional income tax expenses - Based upon an analysis of its income tax position, the Company’s income tax expense includes an additional income tax provision of $0.6 million in the second quarter.
Sale of 504 SBA loans - Income from SBA lending was higher than normal due to the sale, in the second quarter of 2005, of $10.2 million in loans from the SBA 504 program. Loans originated under this program are initially retained by the Company and are periodically sold in bulk after certain seasoning requirements. The Company recognized a net gain on these sales of $0.5 million.
High Performance Checking campaign - The Company’s free consumer checking program, High Performance Checking, was launched in late March 2005 and is enhancing growth in checking balances and fee income. During 2005, the Company continued to emphasize low cost core deposits through its High Performance Checking program. During 2005 the Company incurred $0.7 million of expense related to this program.
Increased professional services expense - The Company has incurred $0.6 million in additional professional services expense related to accounting, legal and consultant services. These services were necessary to complete the review of the problem loan portfolio, an income tax review, and to aid in the remediation of material weaknesses identified during the Company’s assessment of compliance with the requirements of internal control reporting and Sarbanes-Oxley Section 404. Also, in the fourth quarter of 2005 the Company incurred $0.3 million of merger related legal expenses related to its pending acquisition by BB&T.
Purchase of additional BOLI - During the first quarter of 2005 the Company purchased $15.0 million in additional Bank Owned Life Insurance. This transaction generated an additional $0.6 million in revenue in 2005 that will be used to fund employee benefit programs.
The primary factors that impacted the financial results in 2004 were as follows:
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The acquisition of Banks Moneyhan Hayes Insurance Agency, Inc. in January, 2004
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The acquisition of First Colony in May of 2003
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We continued to experience significant loan growth throughout 2004
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We experienced slower than expected deposit growth in 2004
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The opening of the Midtown Banking Center
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The sale of SBA loans and investment securities
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The successful conversion to a new operating system platform
The Company’s total average assets increased $242.7 million or 11.4% during 2005 as compared to 2004, due primarily to growth in the loan portfolio and increases in BOLI as noted above. This was offset to some degree by a decrease in the investment portfolio of $90.5 million, primarily due to the sale of $70 million of available for sale investment securities in the fourth quarter of 2005. Average loans, net of unearned income, increased 11.6% or $183.4 million in 2005 compared to 2004. The growth in loans continues to be attributable to a strong economy in the Atlanta metropolitan area. Average total deposits increased by 9.6% or $150.2 million due primarily to an ongoing deposit campaign and seasonal public funds.
Return on average assets for the year ended December 31, 2005 was 1.24%. This compares to 1.45% for the same period in 2004. Return on average equity for the year ended December 31, 2005 was 10.23% on average equity of $287.3 million. This compares to 14.15% on average equity of $218.7 million for the same period in 2004.
Net Interest Income: Net interest income for 2005 was $91.1 million compared to $82.4 million in 2004, an increase of 10.6% or $8.7 million. The increase in net interest income was largely the result of overall balance sheet growth and the corresponding increase in average interest earning assets, which grew 11.4% over the December 31, 2004 level coupled with increasing interest rates. Growth in average loans of $183.4 million or 11.6% provided the bulk of the increase in earning assets and contributed most significantly to the growth in net interest income. Interest on earning assets yielded 6.84% in 2005 versus 6.3% in 2004, a 54 basis point increase. The cost of interest bearing liabilities increased 79 basis points to 2.9% from 2.11% in 2004 primarily due to rate increases. Other investment income increased to $1.1 million at December 31, 2005 compared to $0.8 million for the same period in 2004, an increase of 37.5% or $0.3 million. This increase is mainly attributable to the Bank’s increased investment in FHLB capital stock of $4.7 million, which was required in order to increase borrowing capacity from the FHLB.
The following schedule presents the dollar amount of changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the change related to higher outstanding balances and the change in interest rates. For purposes of this table, changes attributable to both rate and volume have been allocated to rate.
To make pre-tax income and resultant yields on tax-exempt investments comparable to those on taxable investments, a tax-equivalent adjustment has been computed using a federal income tax rate of 34%.
Provision for Loan Losses: Management’s policy is to maintain the allowance for loan losses at a level sufficient to absorb estimated probable losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and decreased by charge-offs, net of recoveries. The allowance for loan losses is established through a provision
for losses based on management’s evaluation of loan portfolio data, specific loan allowance, and current economic conditions. The evaluation, which includes a review of all loans on which full collection may not be reasonably assumed, considers among other matters, economic conditions, the fair market value or the estimated net realizable value of the underlying collateral, management’s estimate of probable credit losses, historical loan loss experience, and other factors that warrant recognition in providing for an adequate loan loss allowance. As these factors change, the level of loan loss provision changes. The allowance for loan losses at December 31, 2005 was $25.2 million representing 1.40% of outstanding loans, compared to $25.2 million, representing 1.48% of outstanding loans as of December 31, 2004. The 2005 provision of $8.2 million was $.8 million higher than the provision of $7.4 million in 2004. This exceeded the provision of $5.2 million recorded in 2003. The increase in the provision expense is the result of consistent growth in the loan portfolio and losses in the former loan officer’s portfolio mentioned above Other factors influencing the level of the allowance did not change significantly in 2005 compared to 2004 and 2003. Net loans charged off in 2005 were $8.2 million compared to $3.4 million in 2004 and $2.9 million in 2003.
Non-interest Income: For 2005, non-interest income totaled $28.2 million, a decrease of $2.5 million over non-interest income of $30.6 million in 2004, which represented a 8.0% decrease. The decrease was primarily due to a net loss on sale of investment securities of $1.9 million in 2005 versus a net gain on sale of investment securities of $1.2 million in 2004 and a loss on premises and equipment of $0.9 million only partially offset by increases and decreases in other items included in other income.
The following table presents the major categories of non-interest income:
The following table represents the composition of insurance agency income:
The following table represents the composition of mortgage banking income:
Non-interest Expense: For the years ended 2005, 2004, and 2003, non-interest expense totaled $67.9 million, $62.6 million, and $52.9 million, respectively. The following table presents the major categories of non-interest expense:
For 2005, non-interest expense increased 8.4% or $5.3 million over 2004. From 2004 to 2003, non-interest expense increased by 18.3%. The majority of the increase in 2005 and 2004 was related to an increase in salary and employee benefits expenses. Personnel related costs rose to $39.8 million or a 6.3% increase in 2005 compared to $37.5 million and $30.3 million in 2004 and 2003 respectively.
These increases were primarily related to staffing increases concurrent with expansion of offices and business lines and increases in health insurance costs, and increases in 401(k) matching expenses. Performance based compensation, including bonuses and commissions, contributed to increases in the salaries and employee benefits category in 2004 compared to 2003 due to the achievement of higher performance levels in virtually all of the Company’s operating units.
Income Taxes: Income tax expense includes both Federal income tax and Georgia state income tax. The amount of Federal income tax expense is influenced by the amount of taxable income, the amount of tax-exempt income and the amount of non-deductible expenses. In 2005, income tax expense was $13.8 million compared to $12.0 million in 2004. In 2003, income tax expense was $10.8 million. The Company’s effective tax rates in 2005, 2004, and 2003, respectively, were 31.9%, 28.0%, and 28.9%. The tax expense in 2005 includes a one time extra provision of $0.6 million based on an analysis by the Company of its income tax position.
Loans
At December 31, 2005, loans, net of unearned income, were $1.8 billion, an increase of $103.5 million or 6.1% over net loans at December 31, 2004 of $1.7 billion. The growth in the loan portfolio was attributable to a consistent focus on quality loan production and strong loan markets in the state. Residential mortgage and commercial real estate loans increased $52.0 million or 4.6% from December 31, 2004 while real estate construction loans increased $53.0 million or 13.2% over the same period. The Company continues to monitor the composition of the loan portfolio to ensure that the market risk to the balance sheet is not adversely affected by the impact of changes in the economic environment on any one segment of the portfolio.
The Company primarily focuses on the following loan categories: (1) commercial and industrial, (2) real estate construction, (3) residential mortgage, (4) commercial real estate, and (5) consumer loans. The Company’s management has strategically located its branches in high growth markets and has taken advantage of a surge in residential and industrial growth in northern counties of Metropolitan Atlanta, Georgia.
Loans are stated at unpaid principal balances, net of unearned income and deferred loan fees. Interest is accrued only if deemed collectible. The following table represents the composition of the Company’s loan portfolio:
To accomplish the Company’s lending objectives, management seeks to achieve consistent growth within its primary market areas while maximizing loan yields and maintaining a high quality loan portfolio. The Company monitors its lending objectives primarily through its Pricing and Credit Review committees. The Company’s lending objectives are clearly defined in its Lending Policy, which is reviewed annually and approved by the Board of Directors. New loans for borrowers with total credit exposure exceeding $750,000 require co-approval by officers in the Bank’s Credit Administration department. New loans with credit exposure exceeding $5,000,000 require additional approval by one or more Executive Officers of the Bank. New loans with credit exposure exceeding $12,500,000 require prior approval by the Board of Directors, which also reviews specific credit approvals exceeding $5,000,000 during the prior month.
The Credit Review committee system includes the Executive Review Committee, the Eastern and Western Senior Review Committees, and the Credit Risk Management Committee. The Executive Review Committee is chaired by the President of the Bank and includes officers from the Credit Administration and Credit Review Departments. The Executive Review Committee annually reviews credit analysis and financial statements for borrowers with credit relationships exceeding $2,500,000 in exposure. The Eastern and Western Senior Review Committees annually review credit analysis and financial statements for borrowers with credit relationships exceeding $500,000 in total credit exposure up to $2,500,000 in total credit exposure. This committee is chaired by officers from the Credit Administration department and its members include officers from the Credit Review and branch administration areas. These committees also review delinquent loan accounts and overdrawn deposit accounts during the monthly meeting. The Credit Risk Management Committee meets on a quarterly basis and reviews the Bank’s larger adversely graded loans. This committee is chaired by officers from the Bank’s Credit Review department and includes officers from the Credit Administration and branch administration areas.
Commercial mortgage lending has significantly contributed to the Bank’s loan growth during the past several years. Loans included in this category are primarily for the acquisition or refinancing of owner-occupied commercial buildings. These loans are underwritten on the borrower’s ability to meet certain minimum debt service requirements and the value of the underlying collateral to meet certain loan to value guidelines. The Bank also perfects its interest in equipment or other business assets of the borrower and obtains personal guaranties.
The Bank also underwrites loans to finance the construction of residential properties and commercial properties, which include speculative and pre-sale loans. Speculative construction loans involve a higher degree of risk, as these are made on the basis that a borrower will be able to sell the project to a potential buyer after a project is completed. Pre-sale construction loans usually have a pre-qualified buyer under contract before construction is to begin. The major risk for pre-sale loans is getting the project completed in a timely manner and according to plan specifications. Non-residential construction loans include construction loans for churches, commercial buildings, strip shopping centers, and acquisition and development loans. These loans also carry a higher degree of risk and require strict underwriting guidelines. All construction loans are secured by first liens on real estate and generally have floating interest rates. The Bank conducts periodic inspections either directly or through an agent prior to approval of periodic draws on these loans. As an underwriting guideline, management focuses on the borrowers’ past experience in completing projects in a timely manner and the borrowers’ financial condition with special emphasis placed on liquidity ratios. Although construction loans are deemed to be of higher risk, the Bank believes that it can monitor and manage this risk properly.
The Bank also underwrites residential real estate loans. Generally, these loans are owner-occupied and are amortized over a 15 to 20 year period with three to five year maturity or repricing. The underwriting criteria for these loans are very similar to the underwriting criteria used in the mortgage industry. Typically, a borrower’s debt to income ratio cannot exceed 36% and the loan to appraised value ratio cannot exceed 89.9%. However, the Bank’s knowledge of its customers and its market allows the Company to be more flexible in meeting its customers’ needs.
The Bank also underwrites commercial and industrial loans. Generally, these loans are for working capital purposes and are secured by inventory, accounts receivable, or equipment. The Bank maintains strict underwriting standards for this type of lending. Potential borrowers must meet certain working capital and debt ratios as well as generate positive cash flow from operations. Borrowers in this category will generally have a debt service coverage ratio of at least 1.3 to 1.0. The Bank will also perfect its interest in equipment or other business assets of the borrower and obtain personal guaranties.
The Bank does not originate and does not currently hold in its portfolio any foreign loans.
The Bank is also an active participant in the origination of Small Business Administration (“SBA”) loans. These loans are solicited from the Company’s market areas, and are generally underwritten in the same manner as conventional loans generated for the Bank’s portfolio. The portion of loans that are secured by the guaranty of the SBA may from time to time be sold in the secondary market to provide additional liquidity, and to provide a source of fee income.
Consumer loans include automobile loans, recreational vehicle loans, boat loans, home improvement loans, home equity loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 120 months and vary based upon the nature of collateral and size of the loan. Consumer loans involve greater risk than residential mortgage loans. This is due to the fact that these loans may be unsecured or secured by rapidly depreciating assets such as automobiles. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan balance. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by factors such as job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws may limit the amount which can be recovered on such loans.
The contractual maturity ranges of the commercial and industrial, commercial real estate and real estate-construction portfolios and the amount of such loans with predetermined interest rates and floating rates in each maturity range as of December 31, 2005 are summarized as follows:
Investment Securities
The Company uses its securities portfolio as a source of income, a source of liquidity and to manage interest rate risk. At December 31, 2005, investment securities totaled $236.9 million, a decrease of $90.3 million from $327.2 million at December 31, 2004. At December 31, 2005, investment securities represented 10.1% of total assets, compared to 14.1% of total assets at December 31, 2004. The average yield on a fully taxable equivalent basis on the investment portfolio for the year ended December 31, 2005 was 4.2% compared to a yield of 4.5% for the year ended December 31, 2004 and 4.7% for the year ended December 31, 2003. Approximately $47.1 million or 19.9% of investment securities reprice within one year.
The following table presents the amortized costs and fair value of securities classified as available for sale and held-to-maturity at December 31, 2005, 2004, and 2003:
The following table summarizes the contractual maturity of investment securities and their weighted average yields as of December 31, 2005. Average yields on investments are based on amortized cost.
Mortgage-backed securities are securities which have been developed by pooling real estate mortgages and are principally issued by federal agencies such as the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. These securities are deemed to have high credit ratings, minimum regular monthly cash flows of principal and interest, and are guaranteed by the issuing agencies.
At December 31, 2005, 13.8% of the mortgage-backed securities the Company held had contractual final maturities of more than five years. However, unlike U.S. Government agency securities, which have a lump sum payment at maturity, mortgage-backed securities provide cash flows from regular principal and interest payments and principal prepayments throughout the lives of the securities. Mortgage-backed securities which are purchased at a premium will generally suffer decreasing net yields as interest rates drop because homeowners tend to refinance their mortgages. Thus, the premium paid must be amortized over a shorter period. Conversely, these securities purchased at a discount will obtain higher net yields in a decreasing interest rate environment. As interest rates rise, the opposite will generally be true. During a period of increasing interest rates, fixed rate mortgage-backed securities do not tend to experience heavy prepayments of principal and consequently, their average lives will not be unduly shortened. If interest rates fall, prepayments will increase, and the average life of these securities will decrease.
The Company has adopted Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” At the date of purchase, the Company is required to classify debt securities into one of three categories: held to maturity, trading, or available for sale. Equity securities are classified as available for sale. At each reporting date, the appropriateness of the classification is reassessed. Investments in securities are classified as held to maturity and measured at amortized cost in the financial statements only if management has the positive intent and ability to hold those securities to maturity.
Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and measured at fair value in the financial statements with unrealized gains and losses included in earnings. The Company does not have any securities classified as trading securities. Investments not classified as either held to maturity or trading are classified as available for sale and measured at fair value in the financial statements with unrealized gains and losses reported, net of tax, in accumulated other comprehensive income, a separate component of shareholders’ equity, until realized.
The Company periodically tests securities for other than temporary impairment. All agency and mortgaged backed securities that the Company owns are implied to be backed by the full faith and credit of the United States government. Therefore there are no impairments caused by credit quality even though increasing interest rates have caused some impairments in the portfolio. Moreover, management does not feel at this time that interest rate fluctuations have caused any other than temporary impairments in the Company’s municipal bond portfolio. At December 31, 2005 upon review of the investment portfolio, management has the positive intent and ability to hold all remaining impaired securities to maturity or recovery; however management acknowledges that these impaired securities may be sold in future periods in response to significant, unanticipated changes in asset liability management, unanticipated future market moves or business plan changes.
Deposits
The Bank offers a variety of deposit accounts having a wide range of interest rates and terms. The Bank’s deposits consist of demand, savings, money market, and time accounts. The Bank relies primarily on competitive pricing policies and customer service to attract and retain these deposits. Brokered and Internet time deposits at December 31, 2005 were
$344.2 million compared to $283.8 million at December 31, 2004. The Bank uses brokered and internet time deposits as additional sources of funds to provide for the funding needs of the Bank. Brokered and internet time deposits comprised 19.9% and 16.6% of our total deposits and 14.7% and 12.2% of our total assets at December 31, 2005 and 2004, respectively. The Bank’s lending and investing activities are funded principally by deposits, approximately 52.1% of which are demand, money market and savings deposits. Deposits at December 31, 2005 were $1.7 billion, an increase of $21.3 million or 1.24% from $1.7 billion at December 31, 2004. Non-interest-bearing deposits were $252.0 million at December 31, 2005 or 12.1% from $225.0 million at December 31, 2004. Time deposits were $829.1 million at December 31, 2005, an increase of $48.9 million, or 6.27% from $780.2 million at December 31, 2004. The deposit growth was primarily due to the growth in brokered deposits. Due to the increase in the Bank’s lending activities during 2004 and 2005, the Bank has increased its participation in brokered and internet time deposits.
The daily average balances and weighted average rates paid on deposits for each of the years ended December 31, 2005, 2004, and 2003 are presented below:
The following table sets forth the amount of the Company’s time deposits that are $100,000 or greater by time remaining until maturity as of December 31, 2005:
Borrowed Funds
Deposits are the primary source of funds for the Company’s lending and investment activities. The Company obtains additional funds from the Federal Home Loan Bank (“FHLB”) and correspondent banks. At December 31, 2005, the Company had borrowings of $188.0 million in the form of term FHLB advances and $70.9 million in securities sold under repurchase agreements and other overnight funding compared to $201.1 million and $73.4 million, respectively, at December 31, 2004. The Company’s weighted average interest rate on term FHLB advances for the years ended December 31, 2005 and 2004 was 3.3% and 2.7%, respectively. For a more detailed discussion of the borrowings of the Company, see Note I to the Company’s consolidated financial statements included herein.
Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance risk in the normal course of business to meet the financing needs of its customers. The financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. As of December 31, 2005 the Company had $348.5 million in commitments to extend credit and $6.2 million in standby letters of credit that were outstanding.
The Company is exposed to credit loss in the event of nonperformance by the customer on financial instruments. The Company uses its normal credit policies in granting loan commitments and issuing standby letters of credit.
The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, property, land, plant and equipment, residential real estate, and income-producing commercial properties on those commitments for which collateral is deemed necessary, as well as personal guaranties.
Capital
Capital management consists of providing equity to support both current and future operations. The Company is subject to capital adequacy requirements imposed by the Federal Reserve Board, the FDIC and the Georgia Department of Banking and Finance.
Both the Federal Reserve Board and the FDIC have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profiles among bank holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets.
Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
The risk-based capital standards issued by the Federal Reserve Board require all bank holding companies to have “Tier 1 capital” of at least 4.0% and “Total risk-based capital” (Tier 1 and Tier 2) of at least 8.0% of total risk-adjusted assets. “Tier 1 capital” generally includes common shareholders’ equity and qualifying perpetual preferred stock together with related surpluses and retained earnings, less deductions for goodwill and various other intangibles. “Tier 2 capital” may consist of a limited amount of intermediate-term preferred stock, a limited amount of term subordinated debt, certain hybrid capital instruments and other debt securities, perpetual preferred stock not qualifying as Tier 1 capital, and a limited amount of the general valuation allowance for loan losses. The sum of Tier 1 capital and Tier 2 capital is “Total risk-based capital.”
The Federal Reserve Board has also adopted guidelines which supplement the risk-based capital guidelines with a minimum ratio of Tier 1 capital to average total consolidated assets (“leverage ratio”) of 3.0% for institutions with well diversified risk, including no undue interest rate exposure, excellent asset quality, high liquidity, good earnings, and that are generally considered to be strong banking organizations, rated composite 1 under applicable federal guidelines, and that are not experiencing or anticipating significant growth. Other banking organizations are required to maintain a leverage ratio of at least 4.0% to 5.0%. These rules further provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels and comparable to peer group averages, without significant reliance on intangible assets.
The following table provides a comparison of the Company’s and the Bank’s leverage and risk-weighted capital ratios as of December 31, 2005 to the minimum and well-capitalized regulatory standards:
Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991, each federal banking agency revised its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of nontraditional activities, as well as reflect the actual performance and expected risk of loss on multifamily mortgages. The Company is subject to capital adequacy guidelines of the FDIC that are substantially similar to the Federal Reserve Board’s guidelines. Also pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991, the FDIC has promulgated regulations setting the levels at which an insured institution such as the Company would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” Under the FDIC’s regulations, the Company is classified “well capitalized” for purposes of prompt corrective action.
Shareholders’ equity increased to $295.2 million at December 31, 2005 from $279.0 million at December 31, 2004, an increase of $16.2 million or 5.8%. This increase was primarily the combined result of net income of $29.4 million and exercise of stock options and changes in restricted stock totaling $3.8 million, less dividends declared on common stock of $13.1 million and net change in unrealized losses on investment securities available for sale and net change in the fair value of derivative instruments of $3.9 million.
In December 2003, the Board approved a $100.0 million shelf offering. The net proceeds from the future sale of the securities, if any, would be used for general corporate purposes, including repurchasing shares of our common stock, acquisitions of other companies, and extending credit to, or funding investments in, our subsidiaries. The precise amounts and timing of the use of the net proceeds will depend upon the Company’s, and subsidiaries’ of the Company, funding requirements and the availability of other funds. Until the Company uses the net proceeds from the sale of any of our securities for general corporate purposes, the Company would use the net proceeds to reduce short-term indebtedness or for temporary investments. The SEC declared the Form S-3 registration statement effective on January 15, 2004.
On December 14, 2004, Main Street closed a public offering of 1,500,000 shares of its common stock. All shares were sold at $31.25 per share, pursuant to an underwriting agreement dated December 8, 2004. On December 30, 2004, the company issued an additional 225,000 shares as a result of the underwriters exercising their entire over-allotment option in connection with the public offering. The proceeds of this issuance were used for general corporate purposes.
Subordinated Debt
The Parent Company owns all of the outstanding common stock of Main Street Banks Statutory Trust I and Main Street Banks Statutory Trust II. The trusts have issued mandatorily redeemable trust preferred securities (“Capital Securities”). As guarantor, the Parent Company unconditionally guarantees payment of accrued and unpaid distributions required to be paid on the capital securities, the redemption price when a capital security is called for redemption, and amounts due if the Trust is liquidated or terminated.
The Trusts used the proceeds from the issuance of their Capital Securities and common stock to buy debentures of the Company. These debentures are the Trust’s only assets and their interest payments from the debentures finance the distributions paid on the Capital Securities. The Company’s financial statements reflect the debentures or the related income effects.
The capital securities must be redeemed when the related debentures mature. Each issue of capital securities carries an interest rate identical to that of the related debenture. The capital securities qualify as Tier 1 Capital, subject to regulatory limitations, under guidelines established by the Board of Governors of the Federal Reserve System. Under these guidelines, the value of the Capital Securities that can be included in the calculation of Tier 1 Capital is limited to 25%. The Company has the right to redeem its debentures: (i) in whole or in part, on or after November 15, 2007 (for debentures owned by Main Street Banks Statutory Trust I) and June 30, 2008 (for debentures owned by Main Street Banks Statutory Trust II); and (ii) in whole at any time within 90 days following the occurrence and during the continuation of a tax event or capital treatment event (as defined in the offering circulars). If the debentures purchased by Main Street Banks Statutory Trust I or Main Street Banks Statutory Trust II are redeemed before they mature, the redemption price will be the principal amount, plus any accrued but unpaid interest.
Allowance for Loan Losses
The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The allowance for loan losses is based on management’s evaluation of the size and composition of the loan portfolio, the level of non-performing and past due loans, historical trends of charged-off loans and recoveries, prevailing economic conditions and other factors management deems appropriate. The Company’s management has established an allowance for loan losses which it believes is adequate for probable losses inherent in the loan portfolio. Based on a credit evaluation of the loan portfolio, management presents a quarterly review of the allowance for loan losses to the Company’s Board of Directors. The review that management has developed primarily focuses on risk by evaluating the level of loans in certain risk categories. These categories have also been established by management and take the form of loan grades. These loan grades closely mirror regulatory classification guidelines and include pass loan categories 1 through 4 and special mention, substandard, doubtful, and loss categories of 5 through 8, respectively. By grading the loan portfolio in this manner the Company’s management is able to effectively evaluate the portfolio by risk, which management believes is the most effective way to analyze the loan portfolio and thus analyze the adequacy of the allowance for loan losses. Management also reviews charge-offs and recoveries on a quarterly basis to identify trends.
The Company’s risk management processes include a loan review program to evaluate the credit risk in the loan portfolio. The Credit Review department is independent of the loan function and reports to the Executive Vice President of Risk Management. Through the credit review process, the Company maintains a classified loan watch list which, along with the delinquency report of loans, serves as a tool to assist management in assessing the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. Loans classified as “substandard” are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain financial ratios, uncertain repayment sources, deterioration in underlying collateral values, or poor financial condition which may jeopardize recoverability of the debt. Loans classified as “doubtful” are those loans that have characteristics similar to substandard loans but have an increased risk of loss, or at least a portion of the loan may require being charged-off. Loans classified as “loss” are those loans that are in the process of being charged-off.
The allowance for loan losses is established by risk group as follows:
•
Large classified loans are evaluated individually with specific reserves allocated based on management’s review.
•
The remainder of the portfolio is allocated a portion of the allowance based on past loss experience and the economic conditions for the particular loan category. Allocation weights are assigned based on the Company’s historical loan loss experience in each loan category, although a higher allocation weight may be used if current conditions indicate that loan losses may exceed historical experience.
When determining the adequacy of the allowance for loan losses, management considers changes in the size and character of the loan portfolio, changes in nonperforming and past due loans, historical loan loss experience, the existing risk of individual loans, concentrations of loans to specific borrowers or industries and current economic conditions. The Company’s level of non-performing assets as a percentage of loans plus other real estate increased from .85% in 2004 to .99% in 2005. The primary area of growth in non-performing assets was the SBA portfolio. These loans are generally secured by real estate as well as a partial U.S. government guarantee. As a result, such loans when moved to non-accrual do not have as significant an impact on the allowance. The Allowance for Loan Losses as a percentage of year-end loans declined from 1.48% in 2004 to 1.40% in 2005 as a result of charge-offs against specific reserves established for a problem loan portfolio and reflecting a greater share of real estate-secured and government-guaranteed loans within the Bank’s large classified loans.
The following represents the allocation of the loan loss allowance by loan category:
* Percentage of respective loan types to total loans.
For the year ending December 31, 2005, net charge-offs totaled $8.2 million or 0.46% of average loans outstanding for the period, net of unearned income, compared to $3.4 million or 0.21% in net charge-offs for the same period in 2004. The increase was primarily a result of the previously discussed charge-offs. The provision for loan losses for the year ended December 31, 2005 was $8.2 million compared to $7.4 million for the same period in 2004. The allowance for loan losses totaled $25.2 million or 1.40% of total loans, net of unearned income at December 31, 2005, compared to $25.2 million or 1.48% of total loans at December 31, 2004.
With the acquisition of First Colony Bank and John’s Creek in 2004, the Bank acquired total loans of $283.7 million with a related allowance for loan losses of $4.3 million. There were no purchase accounting adjustments made to the allowance related to this acquisition.
The following table presents an analysis of the allowance for loan losses and other related data:
The Company believes that the allocation of its allowance for loan losses is reasonable. When management is able to identify specific loans or categories of loans which require specific amounts of reserve, allocations are assigned to those categories. Federal and state bank regulators also require that banks maintain a reserve that is sufficient to absorb an estimated amount of potential losses based on management’s perception of economic conditions, loan portfolio growth, historical charge-off experience and exposure concentrations.
The Company believes that the allowance for loan losses at December 31, 2005 is adequate to cover losses inherent in the portfolio as of such date. There can be no assurance that the Company will not sustain losses in future periods, which could be substantial in relation to the size of the allowance for loan losses at December 31, 2005.
The allowance for loan losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance for loan losses in comparison to a group of peer banks identified by the regulators. During their routine examinations of banks, the FDIC and the Georgia Department of Banking and Finance may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, credit evaluations and allowance for loan loss methodology differ materially from those of management.
While it is the Bank’s policy to charge off in the current period loans for which a loss is considered probable, there are additional risks of future losses which cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, management’s judgment as to the adequacy of the allowance is necessarily approximate and imprecise.
Non-Performing Assets
The Company has several procedures in place to assist management in maintaining the overall quality of its loan portfolio. The Company has established written guidelines contained in its Lending Policy for the collection of past due loan accounts. These guidelines explain the Company’s policy on the collection of loans over 30, 60, and 90 days delinquent. Generally, loans over 90 days delinquent are placed in a non-accrual status.
However, if the loan is deemed to be in process of collection, it may be maintained on an accrual basis. The Company’s management conducts continuous training and communicates regularly with loan officers to make them aware of its lending policy and the collection policy contained therein. The Company’s management has also staffed its collection department with properly trained staff to assist lenders with collection efforts and to maintain records and develop reports on delinquent borrowers. The Company had non-performing assets of $17.8 million, $14.4 million, and $13.5 million as of December 31, 2005, 2004, and 2003, respectively. For 2005, 2004, and 2003, the gross amount of interest income that would have been recorded on non-performing loans, if all such loans had been accruing interest at the original contract rate, was approximately $725,119, $476,612, and $286,706, respectively. The Company did not have any loans that were “troubled debt restructurings” as defined by SFAS No. 15. The Company records real estate acquired through foreclosure at the lesser of the outstanding loan balance or the fair value at the time of foreclosure, less estimated costs to sell.
The Company usually disposes of real estate acquired through foreclosure within one year; however, if it is unable to dispose of the foreclosed property, the property’s value is assessed at least annually and written down to its fair value less costs to sell.
The following table presents information regarding non-performing assets at the dates indicated:
Interest Rate Sensitivity and Liquidity
Asset Liability Management: The Company’s primary market risk exposures are credit (as discussed previously), interest rate risk and to a lesser degree, liquidity risk. The Bank operates under an Asset Liability and Risk Management policy approved by the Board of Directors of the Bank through the Asset and Liability Committee (“ALCO”). The policy outlines limits on interest rate risk in terms of changes in net interest income and changes in the net market values of assets and liabilities over certain changes in interest rate environments. These measurements are made through a simulation model which projects the impact of changes in interest rates on the Bank’s assets and liabilities. The policy also outlines responsibility for monitoring interest rate risk, and the process for the approval, implementation and monitoring of interest rate risk strategies to achieve the Bank’s interest rate risk objectives.
The Bank’s ALCO is comprised of senior officers of the Bank. The ALCO makes all tactical and strategic decisions with respect to the sources and uses of funds that may affect net interest income. The ALCO’s decisions are based upon policies established by the Bank’s Board of Directors, which are designed to meet three goals: manage interest rate risk, improve interest rate spread and maintain adequate liquidity.
The ALCO has developed a program of action which includes, among other things, the following: (i) selling substantially all conforming, long-term, fixed rate mortgage originations, (ii) originating and retaining for the portfolio shorter term, higher yielding loan products which meet the Company’s underwriting criteria; and (iii) actively managing the Company’s interest rate risk exposure.
Interest Rate Risk: The normal course of business activity exposes the Company to interest rate risk. Interest rate risk is managed within an overall asset and liability framework for the Company. The principal objectives of asset and liability management are to guide the sensitivity of net interest spreads to potential changes in interest rates and enhance profitability in ways that promise sufficient reward for recognized and controlled risk. Funding positions are kept within predetermined limits designed to ensure that risk-taking is not excessive and that liquidity is properly managed. The Company employs sensitivity analysis in the form of a net interest income simulation to help characterize the market risk arising from changes in interest rates. In addition, fluctuations in interest rates usually result in changes in the fair market value of the Company’s financial instruments, cash flows and net interest income. The Company’s interest rate risk position is managed by ALCO.
The Company uses a simulation modeling process to measure interest rate risk and evaluate potential strategies. The Company’s net interest income simulation includes all financial assets and liabilities. This simulation measures both the term risk and basis risk in the Company’s assets and liabilities. The simulation also captures the option characteristics of products, such as caps and floors on floating rate loans, the right to pre-pay mortgage loans without penalty and the ability of customers to withdraw deposits on demand. These options are modeled through the use of primarily historical customer behavior and statistical analysis. Other interest rate-related risks such as prepayment, basis and option risk are also considered. Simulation results quantify interest risk under various interest rate scenarios. Management then develops and implements appropriate strategies. The Board of Directors regularly reviews the overall rate risk position and asset and liability management strategies.
The Company uses three standard scenarios-rates unchanged, rising rates, and declining rates-in analyzing interest rate sensitivity. The rising and declining rate scenarios cover a 100 basis points upward and downward rate shock. The following table illustrates the expected effect a given interest rate shift would have on the fair market value of the Balance Sheet and the annualized projected net interest income of the Company as of December 31, 2005.
Change in Interest Rates
Increase / (Decrease) in
FMV of Balance Sheet
Increase / (Decrease) in
Net Interest Income
+ 100 basis points
4.68%
3.93%
- 100 basis points
(5.19)%
(4.45)%
These simulated computations should not be relied upon as indicative of actual future results. Further, the computations do not contemplate certain actions that management may undertake in response to future changes in interest rates.
In 2006, the Company will continue to face term risk and basis risk and may be confronted with several risk scenarios. If interest rates rise, net interest income may actually increase if deposit rates lag increases in market rates. The Company could, however, experience significant pressure on net interest income if there is a substantial increase in deposit rates relative to market rates. A declining interest rate environment might result in a decrease in loan rates, while deposit rates remain relatively stable, which could also create significant risk to net interest income. ALCO’s subcommittee, the pricing committee, meets weekly to establish interest rates on loans and deposits and review interest rate sensitivity and liquidity positions.
Derivative Instruments and Hedging Activities: Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”) and Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (“SFAS 149”), as amended and interpreted, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. As required by SFAS 133, the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.
For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction. For derivatives not designated as hedges, changes in fair value are recognized in earnings.
Interest rate swaps are currently utilized by the Company to hedge the interest rate risk associated with pools of loans that bear interest based upon the prime rate. The interest rate swaps synthetically convert the floating interest rate payments received on pools of assets bearing interest based upon the prime rates to fixed interest receipts. The Company assesses hedge effectiveness and measures hedge ineffectiveness on a quarterly basis for each hedging relationship. The Company performs its effectiveness testing by comparing the present value of the cumulative change in the variable interest payments on each swap to the present value of the cumulative change in the overall variable receipts on the underlying loans since the inception of the hedge. Hedge ineffectiveness is recognized to the extent that the cumulative change on the swap exceeds the cumulative change on the hedged variable interest receipts on the loans. If the ratio of the cumulative changes in the variable interest payments on a swap to the cumulative changes in the variable receipts on the underlying loans is outside of the range of 80% to 120%, the Company considers the hedging relationship to no longer be highly effective and would redesignate the interest rate swap from its hedging relationship. Subsequent changes in the value of the derivative would be remeasured directly through earnings.
The Company’s objective in using derivatives is to add stability to net interest income and to manage its exposure to interest rate movements or other identified risks. To accomplish this objective, the Company primarily uses interest
rate swaps as part of its cash flow hedging strategy. Interest rate swaps designated as cash flow hedges involve the receipt of fixed-rate amounts in exchange for floating-rate payments over the life of the agreements without exchange of the underlying principal amount.
Market risk is the adverse effect that changes in interest rates or the implied volatility of interest rates have on the value of a financial instrument. The Company manages the market risk associated with interest rate contracts by establishing and monitoring limits as to the types and degree of risk that may be undertaken.
The Company’s derivatives activities are monitored by its ALCO as part of its risk-management oversight of the Company’s treasury functions. The Company’s ALCO is responsible for approving various hedging strategies that are
developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into the Company’s overall interest rate risk management and trading strategies.
The following chart illustrates the Bank’s derivative positions as of December 31, 2005. Market values have been determined by published bid prices or bid quotations for interest rate swaps received from securities dealers. Amounts are in thousands.
Interest Rate Swaps
Liquidity: Liquidity involves the Company’s ability to raise funds to support asset growth or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate on an ongoing basis. During the past three years, the Company’s liquidity needs have primarily been met by growth in core deposits, advances from Federal Home Loan Bank, and additional capital. The Company’s cash and Federal Funds sold and cash flows from amortizing investment and loan portfolios have generally created an adequate liquidity position. Executive management reviews liquidity monthly. This review is from a regulatory as well as static and a four-quarter forecasted standpoint.
Market and public confidence in the financial strength of the Company and financial institutions in general will determine the Company’s access to supplementary sources of liquidity. The Company’s capital levels and asset quality determine levels at which the Company can access supplementary funding sources. Maintaining a steady funding base is achieved by diversifying funding sources, competitively pricing deposit products, and extending the contractual maturity of liabilities. This reduces the Company’s exposure to roll over risk on deposits and limits reliance on volatile short-term purchased funds. As such, the Company relies primarily on customer deposits, securities sold under repurchase agreements and shareholders’ equity to fund interest-earning assets.
Short-term funding needs arise from funding of loan commitments and requests for new loans and from declines in deposits or other funding sources. The Company’s strategy is to fund assets to the maximum extent possible with core deposits that provide a sizable source of relatively stable and low-cost funds. Core deposits include all deposits, except time deposits of $100,000 and over.
The Atlanta Federal Home Loan Bank (“FHLB”) is also a major source of liquidity for the Bank. The FHLB allows member banks to borrow against their eligible collateral to satisfy their liquidity requirements. Subject to certain limitations, the Bank may borrow funds from the Atlanta FHLB in the form of advances. Credit availability from the Atlanta FHLB to the Bank is based on the Bank’s financial and operating condition. Borrowings from the FHLB to the Bank were $188.0 million for term advances and $36.0 million in overnight funding at December 31, 2005. In addition to creditworthiness, the Bank must own a minimum amount of FHLB capital stock. The Bank had no unused borrowing capacity with FHLB as of December 31, 2005. The Bank uses FHLB advances for both long-term and short-term liquidity needs.
Management believes the Company has sufficient liquidity to meet all reasonable borrower, depositor, and creditor needs in the present economic environment. The Company has not received any recommendations from regulatory authorities that would materially affect liquidity, capital resources or operations.
Additionally, the Bank has Federal Funds purchased lines with SunTrust, First Tennessee, the Bankers Bank and BB&T in the amount of $25 million, $10 million, $30 million and $25 million, respectively. The Company also has a line of credit with SunTrust in the amount of $20 million. At December 31, 2005, $4.9 million of the Bankers Bank line had been used and $25 million of the BB&T line had been used. There were no outstanding balances on the other lines of credit.
In December 2004, the Company raised $51.1 million from the sale of 1,750,000 shares of common stock. The Company purchased bonds with the net proceeds from this sale.
Interest Rate Sensitivity: Interest rate sensitivity is a measure of exposure to changes in net interest income due to changes in market interest rates. The difference of interest earning assets less interest bearing liabilities repricing or maturing in a given period of time is commonly referred to as “GAP.” A positive GAP indicates an excess of interest rate sensitive assets over interest rate sensitive liabilities; a negative GAP indicates an excess of interest rate sensitive liabilities over interest rate sensitive assets.
The GAP analysis is prepared using either actual repricing intervals or maturity dates when stated. Loans held for sale are included in less than three months since it is management’s intent to sell them within that time. Equity securities having no stated maturity are reported after five years. In the current interest rate environment, the Company’s NOW accounts and savings deposits have been relatively insensitive to interest rate changes. However, the Company considers a portion of money market accounts to be rate sensitive based on historical growth trends and management’s expectations. Shortcomings are inherent in any GAP analysis since certain assets and liabilities may not move proportionally as interest rates change.
The following table presents the Company’s interest sensitivity GAP between interest earnings assets and interest bearing liabilities at December 31, 2005.
Impact of Inflation and Changing Prices
The effects of inflation on the local economy and on the Company’s operating results have been relatively modest for the past several years. Since substantially all of the Company’s assets and liabilities are monetary in nature, such as cash, securities, loans and deposits, their values are less sensitive to the effects of inflation than to changing interest rates, which do not necessarily change in accordance with inflation rates.
The Company manages the impact of interest rate fluctuations by managing the net interest margin and relationship between its interest sensitive assets and liabilities. Changes in interest rates will affect the volume of loans generated and the values of investment securities and collateral held. Increasing interest rates generally decrease the value of securities and collateral and reduce loan demand, especially the demand for real estate loans. Declining interest rates tend to increase the value of securities and increase the demand for loans.
Contractual Obligations
The following table sets forth the principal maturities of our material contractual obligations owing to third parties at December 31, 2005 (in thousands):
Future payments for interest and operating lease obligations to third parties at December 31, 2005 are as follows (in thousands):
Other Accounting Matters
FASB Staff Position on FAS No. 115-1 and FAS No. 124-1 (“the FSP”), “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” was issued in November 2005 and addresses the determination of when an investment is considered impaired; whether the impairment is other-than-temporary; and how to measure an impairment loss. The FSP also addresses accounting considerations subsequent to the recognition of an other-than-temporary impairment on a debt security, and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The FSP replaces the impairment guidance on Emerging issues Task Force (EITF) Issue No. 03-1 with references to existing authoritative literature concerning other-than-temporary determinations. Under the FSP, losses arising from impairment deemed to be other-than-temporary, must be recognized in earnings at an amount equal to the entire difference between the securities cost and its fair value at the financial statement date, without considering partial recoveries subsequent to that date. The FSP also required that an investor recognize an other-than-temporary impairment loss when a decision to sell a security has been made and the investor does not expect the fair value of the security to fully recover prior to the expected time of sale. The FSP is effective for reporting periods beginning after December 15, 2005. The initial adoption of this statement did not have a material impact on the Company’s consolidated financial statements.
In December 2004, the FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services, with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. This Statement is a revision to Statement 123 and APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. This Statement requires measurement of the cost of employee services received in exchange for stock compensation based on the grant date fair value of the employee stock options. Incremental compensation costs arising from subsequent modifications of awards after the grant date must be recognized. The Company will adopt this Standard on January 1, 2006 under the modified prospective method of application. Under that method, the company will recognize compensation costs for new grants of share-based awards, awards modified after the effect date, and the remaining portion of the fair value of the unvested awards at the adoption date. Excluding the impact of employee stock options granted after December 31, 2005, the Company estimates the adoption of SFAS No. 123R will result in a reduction of net income of approximately $0.8 million or $.04 per share in 2006.
The FASB issued an FSP on December 15, 2005, “SOP 94-6-1 - Terms of Loan Products That May Give Rise to a Concentration of Credit Risk” which addresses the disclosure requirements for certain nontraditional mortgage and other loan products the aggregation of which may constitute a concentration of credit risk under existing accounting literature. Pursuant to this FSP, the FASB’s intentions were to reemphasize the adequacy of such disclosures and noted that the recent popularity of certain loan products such as negative amortization loans, high loan-to-value loans, interest only loans, teaser rate loans, option adjusted rate mortgage loans and other loan product types may aggregate to the point of being a concentration of credit risk to an issuer and thus may require enhanced disclosures under existing guidance. This FSP was effective immediately. We have evaluated the impact of this FSP and have concluded that our disclosures are consistent with the objectives of the FSP.
Quarterly Financial Information (Unaudited)
The following table sets forth certain consolidated quarterly financial information of the Company. This information is derived from unaudited consolidated financial statements, which include, in the opinion of management, all normal recurring adjustments which management considers necessary for a fair presentation of the results for such periods.
The results for any quarter are not necessarily indicative of results for any future period. This information should be read in conjunction with the Company’s consolidated financial statements and the notes thereto included elsewhere in this report.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company’s primary risk exposures (as discussed previously) are credit risk, interest rate risk and to a lesser degree, liquidity risk. The Bank operates under an Asset Liability and Risk Management policy approved by the Board of Directors of the Bank through the Asset and Liability Committee (“ALCO”). The policy outlines limits on interest rate risk in terms of changes in net interest income and changes in the net market values of assets and liabilities over certain changes in interest rate environments. These measurements are made through a simulation model which projects the impact of changes in interest rates on the Bank’s assets and liabilities. The policy also outlines responsibility for monitoring interest rate risk, and the process for the approval, implementation and monitoring of interest rate risk strategies to achieve the Bank’s interest rate risk objectives.
The Bank’s ALCO is comprised of senior officers of the Bank. The ALCO makes all tactical and strategic decisions with respect to the sources and uses of funds that may affect net interest income, including net interest spread and net interest margin. The ALCO’s decisions are based upon policies established by the Bank’s Board of Directors, which are designed to meet three goals: manage interest rate risk, improve interest rate spread and maintain adequate liquidity.
The ALCO has developed a program of action which includes, among other things, the following: (i) selling substantially all conforming, long-term, fixed rate mortgage originations, (ii) originating and retaining for the portfolio shorter term, higher yielding loan products which meet the Company’s underwriting criteria; and (iii) actively managing the Company’s interest rate risk exposure.
Additional information required by Item 305 of Regulation S-K is set forth under Item 7 of this report.
Item 8.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Board of Directors
Main Street Banks, Inc.
We have audited the accompanying consolidated balance sheets of Main Street Banks, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Main Street Banks, Inc. and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Main Street Banks, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2006 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
March 13, 2006
Atlanta, Georgia
Main Street Banks, Inc. and Subsidiaries
Consolidated Balance Sheets
See accompanying Notes to Consolidated Financial Statements
Main Street Banks, Inc. and Subsidiaries
Consolidated Statements of Income
See accompanying Notes to Consolidated Financial Statements
Main Street Banks, Inc. and Subsidiaries
Consolidated Statements of Shareholders’ Equity
See accompanying Notes to Consolidated Financial Statements
Main Street Banks, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
See accompanying Notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A - Significant Accounting Policies
Basis of Presentation: The consolidated financial statements include the accounts of the Parent Company (“Company”) and its wholly owned subsidiaries, Main Street Bank (“the Bank”) Main Street Insurance Services, Inc. (“MSII”), Piedmont Settlement Services, Inc. (“Piedmont”) (inactive as of June 30, 2005, dissolved as of December 31, 2005) and MSB Payroll Solutions, LLC. All significant intercompany transactions and balances have been eliminated in consolidation.
Nature of Operations: Main Street Banks, Inc. is a bank holding company which conducts business primarily in Barrow, Clarke, Cobb, DeKalb, Forsyth, Fulton, Gwinnett, Newton, Rockdale and Walton counties in Georgia through its wholly owned subsidiaries, Main Street Bank and MSII. The Bank provides a full range of traditional banking, mortgage banking, investment services and insurance services to individual and corporate customers in its primary market areas and surrounding counties.
During 2001 the Bank formed MSB Holdings, Inc., a holding company and MSB Investments Inc., a real estate investment trust (“REIT”). These companies were established in order to strengthen the Bank’s capital position. The establishment of a REIT subsidiary allowed the Bank to increase the effective yield on its real estate related assets and residential mortgage loan portfolios by transferring a portion of those assets and loans to an entity that receives favorable tax treatment.
Use of Estimates in the Preparation of the Financial Statements: The consolidated financial statements of Main Street Banks, Inc. and Subsidiaries are prepared in accordance with U.S. generally accepted accounting principles, and practices within the financial services industry, which require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, evaluation of goodwill impairment, evaluation of income taxes, and the valuation of other real estate acquired in connection with foreclosures or in satisfaction of loans. Management believes that the allowance for loan losses is adequate and the valuation of goodwill and other real estate is appropriate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. The Company’s results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory agencies.
Reclassification: Certain previously reported amounts have been reclassified to conform to the 2005 financial statement presentation. These reclassifications had no effect on net income or total stockholders’ equity.
Segments: The Company does not currently report financial results by business segment. The Company tests all business segments on a quarterly basis to determine whether any individual segment represents more than 10% of total assets of the Company or contributes more than 10% to the revenue or net income of the Company.
Cash and Cash Equivalents: For purposes of presentation in the statement of cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits in banks, Federal Funds sold and securities purchased under agreements to resell. Generally, Federal Funds and securities purchased under agreements to resell are purchased and sold for one-day periods.
Investment Securities: Investment securities are classified into three categories. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as “held-to-maturity securities” and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as “trading securities” and reported at fair value, with unrealized gains and losses included in earnings. Debt securities not classified as either held-to-maturity securities or trading securities and equity securities not classified as trading securities are classified as “available-for-sale securities” and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of other comprehensive income. No securities have been classified as trading securities by the Company as of December 31, 2005.
Premiums and discounts related to securities are amortized or accreted over the life of the related security as an adjustment to the yield using the effective interest method and considering prepayment assumptions. Dividend and interest income is recognized when earned.
Management conducts regular reviews to assess whether the values of our investments are impaired and if any impairment is other than temporary. If we determine that the value of any investment is other than temporarily impaired, we record a charge against earnings in the amount of the impairment. The determination of whether other than temporary impairment has occurred involves significant assumptions, estimates and judgments by management. Changing economic conditions - global, regional or related to industries of specific issuers - could adversely affect these values. At December 31, 2005 upon review of the investment portfolio, management has the positive intent and ability to hold all remaining impaired securities to maturity or recovery. There was no other than temporary impairment for securities recorded in the years ending December 31, 2005, 2004, and 2003.
Securities Purchased Under Agreement to Resell: Securities purchased under resell agreements are recorded at the amounts at which the securities are acquired plus accrued interest. The Company enters into purchases of U. S. Government and agency securities under resell agreements to resell substantially identical securities.
The securities underlying the resell agreements are delivered by appropriate entry into a third-party custodian’s account designated by the Company under a written custodial agreement that explicitly recognizes the Company’s interest in the securities.
Loans: Loans are stated at the principal amounts outstanding reduced by purchase discounts, deferred net loan fees and costs, and unearned income. Interest income on loans is generally recognized over the terms of the loans based on the unpaid daily principal amount outstanding. If the collectibility of interest appears doubtful, the accrual thereof is discontinued. When accrual of interest is discontinued, all current period unpaid interest is reversed. Interest income on such loans is subsequently recognized only to the extent cash payments are received, the full recovery of principal is anticipated, or after full principal has been recovered when collection of principal is in question.
The Company evaluates loans for impairment when a loan is internally risk rated as substandard or doubtful. The Company measures impairment based upon the present value of the loan’s expected future cash flows discounted at the loan’s effective interest rate, except where foreclosure or liquidation is probable or when the primary source of repayment is provided by real estate collateral. In these circumstances, impairment is measured based upon the fair value of the collateral. In addition, in certain circumstances, impairment may be based on the loan’s observable estimated fair value. Impairment with regard to substantially all of the Company’s impaired loans has been measured based on the fair value of the underlying collateral. The Company’s policy for recognizing interest income on impaired loans is consistent with its nonaccrual policy. At the time the contractual payments on a loan are deemed to be uncollectible, generally at 90 days past due, the Company’s policy is to record a charge-off against the Allowance for Loan Losses. As of December 31, 2005, the Company had $9.8 million in loans that were in excess of 90 days past due, of which $2.0 million are classified as nonaccrual.
Nonperforming assets include loans classified as nonaccrual or renegotiated and foreclosed real estate. It is the general policy of the Company to stop accruing interest income and place the recognition of interest on a cash basis when any commercial, industrial or commercial real estate loan is 90 to 120 days, depending on the type of loan, or more past due as to principal or interest and/or the ultimate collection of either is in doubt, unless collection of both principal and interest is assured by way of collateralization, guarantees or other security. Accrual of interest income on consumer loans, including residential real estate loans, is suspended when any payment of principal or interest, or both, is more than 120 days delinquent. When a loan is placed on nonaccrual status, any interest previously accrued but not collected is reversed against current income unless the collateral for the loan is sufficient to cover the accrued interest or a guarantor assures payment of interest.
Gains on sales of loans are recognized at the time of sale, as determined by the difference between the net sales proceeds and the net book value of the loans sold.
Loan origination fees, net of direct loan origination costs, are deferred and recognized as income over the life of the related loan on a level-yield basis.
Allowance for Loan Losses: The allowance for loan losses is established through a provision for loan losses charged to expense. The allowance represents an amount which, in management’s judgment, will be adequate to absorb probable losses inherent in the existing loan portfolio. Management’s judgment in determining the adequacy of the allowance is based on evaluations of the collectibility of loans taking into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions that may affect the borrower’s ability to pay, overall portfolio quality and review of specific problem loans. Periodic revisions are made to the allowance when circumstances which necessitate such revisions become known. Recognized losses are charged to the allowance for loan losses, while subsequent recoveries are added to the allowance.
Other Real Estate Owned: Other real estate owned represents property acquired through foreclosure or in settlement of loans and is recorded at the lower of cost or fair value, based on current market appraisals, less estimated selling expenses. Losses incurred in the acquisition of foreclosed properties are charged against the allowance for loan losses at the time of foreclosure. Subsequent write-downs of other real estate are charged to current operations.
Mortgage Loans Held for Sale: The Company originates first mortgage loans for sale in the secondary market. Mortgage loans held for sale are recorded at the lower of cost or market on an individual loan basis. Market value is determined based on outstanding commitments from investors and prevailing market conditions. Gains and losses on sales of loans are recognized at settlement date and are determined as the difference between the net sales proceeds and carrying value of the loans sold. The Company limits its interest rate risk on such loans originated by selling individual loans immediately after the customers lock into their rate.
Accounting for Derivatives and Hedging Activities: The Company periodically uses derivatives, primarily interest rate swaps and floors, as part of the Company’s overall interest rate risk management. These derivatives are designated as hedges of exposure to changes in the fair value of interest-bearing assets or liabilities and modify the interest rate characteristics of the hedged item. To qualify for special hedge accounting, a derivative must be designated and documented as a hedge and be highly effective in offsetting changes in the hedged item. The Company evaluates the effectiveness of each hedging relationship at the inception of the hedge and on an ongoing basis each month. The effective portion of each hedge is recognized in earnings if a fair value hedge or in other comprehensive income if a cash flow hedge. Ineffective portions of a hedging relationship are recognized in earnings. Amounts receivable or payable on each derivative are recognized in net interest income. If the hedged item no longer exists, previously unrecognized gains and losses are recognized in earnings and future changes in the value of the derivative will be reflected in earnings.
Securities Sold Under Repurchase Agreements: The Company uses securities sold under repurchase agreements as an investment option for some commercial customers. Such securities sold under repurchase agreements are classified as secured borrowings, and generally mature within one to four days from the transaction date. The Company also uses securities sold under repurchase agreements as a funding source, which may have longer maturities up to three years or more. Securities sold under repurchase agreements are reflected at the amount of cash received in connection with the transaction. The Company monitors the fair value of the underlying securities.
Financial Instruments: In the ordinary course of business, the Company enters into off-balance-sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or when related fees are earned.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition to such commitment. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Total commitments to extend credit at December 31, 2005 and 2004 include $205.9 million and $198.6 million, respectively, in undisbursed credit lines and $142.6 million and $179.8 million, respectively, in unfunded construction and development loans. The Company’s experience has been that approximately 80 percent of loan commitments are ultimately drawn upon by customers.
The Company issues standby letters of credit, which are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and expire in decreasing amounts with terms ranging from one to four years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds various assets as collateral supporting those commitments for which collateral is deemed necessary. The maximum potential payments the Company could be required to make under outstanding standby letters of credit was $6.2 million and $7.5 million as of December 31, 2005 and 2004, respectively.
Comprehensive Income: Financial Accounting Standards Board (“FASB”) Statement No. 130, Reporting Comprehensive Income, describes comprehensive income as the total of all components of comprehensive income, including net income. Other comprehensive income refers to revenues, expenses, gains and losses that under accounting principles generally accepted in the United States are included in comprehensive income but excluded from net income. Currently, the Company’s other comprehensive income consists of unrealized gains and losses on available for sale securities and the value of derivatives qualifying for special hedge accounting as cash flow hedges.
Income Taxes: The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates that will be in effect when the differences are expected to reverse.
Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Property and Equipment: Premises and equipment are reported at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight line method over the estimated useful lives of the assets. The estimated useful lives of premises and equipment are: (1) building and leasehold improvements - 5 to 35 years, (2) furniture, fixtures and equipment - 1 to 7 years, (3) automobiles - 1 to 5 years. Leasehold improvements are amortized over the shorter of the estimated useful lives of the improvements or the term of the related lease.
Goodwill and other intangible assets: The adoption of Statement of Financial Accounting Standards No. 142 (“SFAS 142”) resulted in the Company no longer amortizing goodwill. Goodwill is assigned to individual acquisitions on a stand alone basis. Goodwill was tested for impairment in November 2005. The fair value of the reporting unit was estimated using a market value approach. The test indicated that no impairment charge was required. Other intangible assets primarily consists of core deposit intangibles and customer lists.
Earnings per Share: The Company accounts for earnings per share in accordance with FASB Statement No. 128, Earnings Per Share (“Statement 128”). Basic earnings per share (“EPS”) is computed by dividing net income available to common shareholders by the weighted average common shares outstanding for the period. Diluted EPS is calculated by adding to the shares outstanding the additional net effect of employee stock options that could be exercised into common shares. The computation of diluted earnings per share is as follows:
Stock Based Compensation: The Company has elected to follow Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its employee stock options. Also, pro forma information regarding net income and net income per share as required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 2005, 2004, and 2003: risk-free interest of 4.42%, 4.19%, and 4.21%, respectively; dividend yield of 2.14%, 1.97%, and 2.09%, respectively; volatility factor of the expected market price of the Company’s common stock of 25.90%, 19.9%, and 23.1%, respectively; and a weighted-average expected life of the options of 8 years in each of 2005, 2004 and 2003. The weighted-average fair value of options granted during 2005, 2004, and 2003 was $8.45, $6.76, and $6.69, respectively.
For purposes of pro forma disclosures, the estimated fair value of the options granted in 2005, 2004, and 2003 is amortized to expense over the options’ vesting period. The Company’s pro forma information follows (in thousands except per share data):
Recently Issued Accounting Standards: FASB Staff Position on FAS No. 115-1 and FAS No. 124-1 (“the FSP”), “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” was issued in November 2005 and addresses the determination of when an investment is considered impaired; whether the impairment is other-than-temporary; and how to measure an impairment loss. The FSP also addresses accounting considerations subsequent to the recognition of an other-than-temporary impairment on a debt security, and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The FSP replaces the impairment guidance on Emerging issues Task Force (EITF) Issue No. 03-1 with references to existing authoritative literature concerning other-than-temporary determinations. Under the FSP, losses arising from impairment deemed to be other-than-temporary, must be recognized in earnings at an amount equal to the entire difference between the securities cost and its fair value at the financial statement date, without considering partial recoveries subsequent to that date. The FSP also required that an investor recognize an other-than-temporary impairment loss when a decision to sell a security has been made and the investor does not expect the fair value of the security to fully recover prior to the expected time of sale. The FSP is effective for reporting periods beginning after December 15, 2005. The initial adoption of this statement is not expected to have a material impact on the Company’s consolidated financial statements.
The Company periodically tests securities for other than temporary impairment. All impairments in agency and mortgaged backed securities identified are caused by increasing interest rates and not by credit quality. Management does not feel at this time that interest rate fluctuations have caused any significant other than temporary impairments in the Company’s municipal bond portfolio.
In December 2004, the FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services, with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. This Statement is a revision to Statement 123 and APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. This Statement requires measurement of the cost of employee services received in exchange for stock compensation based on the grant date fair value of the employee stock options. Incremental compensation costs arising from subsequent modifications of awards after the grant date must be recognized. The Company will adopt this Standard on January 1, 2006 under the modified prospective method of application. Under that method, the Company will recognize compensation costs for new grants of share-based awards, awards modified after the effect date, and the remaining portion of the fair value of the unvested awards at the adoption date. Excluding the impact of employee stock options granted after December 31, 2005, the Company estimates the adoption of SFAS No. 123R will result in a reduction of net income of approximately $0.8 million or $.04 per share in 2006.
The FASB issued an FSP on December 15, 2005, “SOP 94-6-1 - Terms of Loan Products That May Give Rise to a Concentration of Credit Risk” which addresses the disclosure requirements for certain nontraditional mortgage and other loan products the aggregation of which may constitute a concentration of credit risk under existing accounting literature. Pursuant to this FSP, the FASB’s intentions were to reemphasize the adequacy of such disclosures and noted that the recent popularity of certain loan products such as negative amortization loans, high loan-to-value loans, interest only loans, teaser rate loans, option adjusted rate mortgage loans and other loan product
types may aggregate to the point of being a concentration of credit risk to an issuer and thus may require enhanced disclosures under existing guidance. This FSP was effective immediately. We have evaluated the impact of this FSP and have concluded that the our disclosures are consistent with the objectives of the FSP.
Note B - Acquisitions
On December 15, 2005, Main Street Banks, Inc. announced it had signed a definitive agreement to be acquired by BB&T Corporation (BB&T). The transaction is subject to customary regulatory approvals as well as the approval of a majority of Main Street Banks, Inc. outstanding common stock. The Company expects that the transaction will close during the second quarter of 2006.
On January 2, 2004, MSII acquired substantially all of the assets of Banks Moneyhan Hayes Insurance Agency, Inc. (“BMIA”), an insurance agency headquartered in Conyers, Georgia. This acquisition provided MSII with an opportunity to expand its market share in Clarke and Rockdale Counties, Georgia. The transaction was accounted for as a purchase business combination and accordingly, the results of operations of BMIA are included from the acquisition date. The Company issued 271,109 shares of its common stock as consideration. The purchase price was based on the market value of the 271,109 shares issued at the closing market price of the Company’s common stock of $25.82 on December 5, 2003, the date the acquisition was announced. The Company allocated the purchase price among the BMIA assets acquired and liabilities assumed based on their fair values at the time the merger was consummated and the remainder of the purchase price was allocated to identifiable intangibles and goodwill. Goodwill of $4.7 million and Intangible Assets of $2.8 million were created as a result of the transaction. Intangible assets include covenants not to compete and customer lists and will be amortized over a 5 to 15 year period. The Company estimates that $212,000 of the amortization expense for these intangible assets will be deductible for tax purposes in 2004. This acquisition also includes an “earn-out” provision which is based upon future revenue and earnings goals, for a period of five years. The maximum potential for future undiscounted payments the Company could be required to make under this “earn-out” provision is $1.2 million. The “earn-out” will be booked as additional Goodwill in the amounts and at the times that it is deemed to be earned. Summarized below is an initial allocation of assets and liabilities acquired (in thousands):
* During 2005, MSII recorded an additional $0.3 million in goodwill as a result of the “earn-out” provision.
On August 4, 2003, the Company, through an intermediate subsidiary, completed the acquisition of the remaining 50% interest from the other partners of Piedmont Settlement Services, L.L.P., a Pennsylvania limited liability partnership. The assets and liabilities of the Pennsylvania partnership were subsequently transferred to Piedmont Settlement Services, Inc. (Piedmont), a wholly owned subsidiary of the Company. The purchase price for this acquisition was $183,500. There was no goodwill or intangible asset created as a result of this acquisition. The transaction has been accounted for as a purchase and accordingly, the results of operations of Piedmont are included from the acquisition date. All activity and assets of Piedmont were transferred to MSB as of June 30, 2005. Piedmont was dissolved as of December 31, 2005.
On May 22, 2003, the Company completed its acquisition of First Colony Bancshares, Inc., parent of First Colony Bank, a $320 million asset bank headquartered in Alpharetta, Georgia. The merger provides Main Street with a natural extension of its Atlanta community bank franchise into Roswell, Alpharetta and nearby areas of north Fulton County, Georgia. The transaction was accounted for as a purchase business combination and accordingly, the results of operations of First Colony Bank are included from the acquisition date. The Company allocated the purchase price among the First Colony assets acquired and liabilities assumed based on their fair values at the time the merger was consummated and the remainder of the purchase price was allocated to identifiable intangibles and goodwill. Main Street issued 2.6 million shares of its common stock and paid $45.0 million in cash in exchange for all outstanding shares of First Colony Bancshares. The value of the 2.6 million shares issued was determined based on the Company’s closing
market price of $19.61 on December 11, 2002, the date the acquisition was announced. Core deposit intangible assets of $1.9 million and Goodwill of $72.9 million were created as a result of the transaction. The core deposit intangible assets will be amortized over 10 years. None of the resulting goodwill is deductible for federal income tax purposes. The Company estimates that $1.3 million of previously existing core deposit intangibles recorded by First Colony will be deductible for federal income tax purposes in future years. Summarized below is the allocation of assets and liabilities acquired (in thousands):
In accordance with FAS 141 the following tables present unaudited summary information on a pro forma basis as if the acquisitions had occurred as of the beginning of each of the periods presented. The pro forma information does not necessarily reflect the results of operations that would have occurred if the acquisition had occurred at the beginning of the periods presented or of any results which may be expected to occur in the future.
Note C - Cash and Due From Banks
The Company is required to maintain average reserve balances with the Federal Reserve Bank, on deposit with national banks, or in cash. The average reserve requirements were $266,000 and $25,000 at December 31, 2005 and 2004 respectively.
Note D - Investment Securities
The following table details unrealized gains and losses on investment securities held to maturity and investment securities available for sale as of December 31, 2005 and 2004.
Those investment securities available for sale, which have an unrealized loss position at December 31, 2005, are detailed below:
Those investment securities available for sale, which have an unrealized loss position at December 31, 2004, are detailed below:
At December 31, 2005, there were 12 obligations of U.S. Government agencies and corporations, one obligation of a state or political subdivisions, and 13 mortgage-backed securities with an unrealized loss for less than 12 months. There were 10 obligations of U.S. government agencies and corporations, six obligations of state and political subdivisions, and 14 mortgage-backed securities with an unrealized loss for longer than 12 months. Management does not believe any individual unrealized loss as of December 31, 2005 or 2004 represent an other-than-temporary impairment and has
concluded that these unrealized losses are the result of changes in interest rates and not the result of a change in credit quality. Management also notes that the unrealized losses reported for U.S. Government agencies and corporations and mortgage-backed securities relate primarily to securities issued by FHLB, FNMA, FHLMC and GNMA. At December 31, 2005 upon review of the investment portfolio, management has the intent and ability to hold all remaining impaired securities to maturity; however management acknowledges that these impaired securities may be sold in future periods in response to significant, unanticipated changes in asset liability management, unanticipated future market moves or business plan changes.
The amortized cost and estimated fair value of investment securities held to maturity and available for sale at December 31, 2005, by contractual maturity or until recovery, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or repay obligations without call or prepayment penalties.
Other investments are recorded at cost and are composed of the following:
During 2005, 2004 and 2003, proceeds from sales of investment securities available for sale were $114.2 million, $54.3 million, and $22.3 million, respectively with gross realized net gains of $1,185,263 and $730,120 in 2004 and 2003 and with gross realized net losses of $1,938,372 in 2005. The tax impact of the loss or gain on these transactions was ($602,835), $396,483, and $248,241 for the years ended December 31, 2005, 2004, and 2003, respectively. The method followed in determining the cost of investments sold is specific identification.
Securities with carrying values of $168.1 million and $188.5 million and estimated fair values of $164.7 million and $189.2 million at December 31, 2005 and 2004, respectively, were pledged to secure public deposits.
Note E - Loans
The following table represents the composition of the loan portfolio at December 31, 2005 and 2004:
At December 31, 2005 the Company had a market value adjustment on loans that were acquired during the First Colony Bancshares, Inc. acquisition of $0.3 million which is reflected in the loan amounts above and is being amortized monthly.
At December 31, 2005 approximately $344.8 million of loans were pledged to secure Federal Home Loan Bank advances and for other purposes as required or permitted by law.
A substantial portion of the Company’s loans are secured by real estate in northeast Georgia communities, primarily in Barrow, Clarke, Cobb, DeKalb, Forsyth, Fulton, Gwinnett, Newton, Rockdale, and Walton counties. In addition, a substantial portion of real estate acquired through foreclosure consists of single-family residential properties and land located in these same markets. The ultimate collectibility of a substantial portion of the Company’s loan portfolio and the recovery of a substantial portion of the carrying amount of real estate are susceptible to changes in market conditions in northeast Georgia.
The Company occasionally sells the guaranteed portion of Small Business Administration (“SBA”) loans to third parties and retains the servicing rights for these loans. The Company has limited recourse related to these sales if a loan sold by the Bank defaults within 90 days of sale. A servicing asset has been recorded for these loans. The Company recognized a gain of $3.6 million on the sale of SBA loans during 2005 and $3.1 million on the sale of SBA loans during 2004. The Company serviced $59.6 million and $24.6 million of SBA loans for others as of December 31, 2005 and 2004, respectively.
A summary of the activity in the allowance for loan losses for the years ended December 31, 2005, 2004 and 2003 follows:
Non-performing assets at December 31, 2005 and 2004 are detailed in the following table:
At December 31, 2005 and 2004, the Bank had nonaccrual loans aggregating $13.5 million and $12.3 million respectively. Interest that would have been recorded on nonaccrual loans had they been in accruing status was approximately $725 thousand in 2005, $477 thousand in 2004, and $287 thousand in 2003.
At December 31, 2005 and 2004, the Bank had impaired loans with an outstanding balance of $21.3 million and $12.8 million, respectively with a related allocation of the allowance for loan losses of $2.8 million and $3.7 million at December 31, 2005 and 2004. The average balance of impaired loans was approximately $7.6 million, $6.3 million and $6.3 million for the years ended December 31, 2005, 2004, and 2003, respectively. The interest recognized on such loans in 2005, 2004, and 2003 was immaterial.
The Bank completes an impairment analysis for each loan relationship of grades 5 through 8 (special mention to loss) with outstanding balances or commitments of $250,000 or greater as of each calendar quarter-end.
Note F - Goodwill and Other Intangible Assets
Goodwill and other intangible assets as of December 31, 2005 are detailed in the following table in thousands:
The changes in the carrying amount of goodwill and other intangible assets for the years ended December 31, 2005 and 2004 are as follows:
The Company recognized no amortization expense related to goodwill, and recognized amortization expense on intangible assets for each of the years ended December 31, 2005, 2004 and 2003 of $521,137, $507,584, and $364,499, respectively. Core deposit intangibles and customer lists intangibles are being amortized over 10 years and 15 years, respectively. The estimated amortization expense for each of the five succeeding fiscal years is as follows (in thousands):
Note G - Premises and Equipment
Premises and equipment are composed of the following:
Depreciation and amortization expense totaled $3.8 million, $3.7 million, and $3.2 million for the years ended December 31, 2005, 2004 and 2003, respectively.
The Company leases certain facilities and equipment for use in its business. The lease for facilities generally runs for periods of 10 to 20 years with various renewal options, while leases for equipment generally have terms not in excess of 5 years. The majority of the leases for facilities contain rental escalation clauses tied to changes in price indices. Certain real property leases contain purchase options. Management expects that most leases will be renewed or replaced with new leases in the normal course of business.
The following is a schedule of future minimum rentals required under operating leases that have initial or remaining noncancellable lease terms in excess of one year as of December 31, 2005, for leased facilities:
Rental expense for all operating leases charged to earnings totaled $1.9 million, $1.9 million, and $1.0 million for years ended December 31, 2005, 2004 and 2003, respectively.
Note H - Deposits
The deposit mix for the years ended December 31, 2005 and 2004 are as follows:
The Company had $389.1 million, and $370.7 million in time deposits over $100,000 at December 31, 2005 and 2004, respectively. Interest expense on these deposits was $12.3 million, $9.0 million, and $6.9 million for the years ended December 31, 2005, 2004 and 2003, respectively.
The following table summarizes the maturities of time deposits at December 31, 2005:
Note I - Borrowings
At December 31, 2005 and 2004 the Company had term advances from the Federal Home Loan Bank totaling $188.0 million and $201.1 million, respectively and overnight advances of $36.0 million and $50.0 million, respectively. The Company has pledged all of its eligible residential mortgage loans secured by first mortgages on one-to-four family dwellings as collateral. The Company has also pledged eligible commercial real estate loans. The Company is allowed to borrow up to 80% of the balance of the eligible first mortgage loans pledged as collateral, and up to 50% of the eligible commercial real estate loans. The Company had no unused borrowing capacity with FHLB as of December 31, 2005 and had unused borrowing capacity of $48.5 million as of December 31, 2004. This decrease is the result of an increase in the amount borrowed at the Federal Home Loan Bank, although additional collateral has been added including investment securities. At December 31, 2005, the Company has 11 advances with rates between 2.60% and 4.80%.
The following table stratifies the Bank’s borrowings as short-term and long-term as of December 31, 2005 and 2004:
The aggregate stated maturities of long-term debt outstanding are summarized as follows:
At December 31, 2005 the Company had additional borrowings outstanding as shown in the table below:
Government agency and mortgage backed securities with a carrying value of $10.1 million and a fair value of $10.2 million are pledged as collateral for the securities sold under repurchase agreements noted above.
Note J - Subordinated Debt
On May 22, 2003, Main Street Banks, Inc. completed the sale of $45.0 million of Main Street Banks Statutory Trust II floating rate trust preferred securities with a maturity date of June 30, 2033 and a stated liquidation amount of $1,000 per Capital Security. Interest on the Capital Securities is to be paid on the last day of each March, June, September, and December and is reset quarterly based on the three month London InterBank offered rate (“3-Month LIBOR”) plus 325 basis points at the end of the preceding quarter, provided, however, that prior to May 22, 2008, the 3-Month LIBOR shall not exceed 8.75%. The proceeds from such issuances, together with the proceeds of the related issuance of common securities of the Trust purchased by the Company, were invested in Floating Subordinated Debentures (the “Debentures”) of the Company. The sole assets of the Trust are the Debentures. The Debentures are unsecured and rank junior to all senior debt of the Company. The Company owns all of the common securities of the Trust. Main Street Banks, Inc. used the Debentures from this offering to fund a portion of the price paid to acquire First Colony Bancshares, Inc., Alpharetta, Georgia.
November 15, 2002, the Company executed a $5.0 million floating rate Cumulative Trust Preferred Securities transaction offered and sold by Main Street Banks Statutory Trust I, having a liquidation amount of $1,000 each. The proceeds from such issuances, together with the proceeds of the related issuance of common securities of the Trust purchased by the Company, were invested in Floating Subordinated Debentures (the “Debentures”) of the Company. The sole assets of the Trust are the Debentures. The Debentures are unsecured and rank junior to all senior debt of the Company. The Company owns all of the common securities of the Trust.
The Company has the right to redeem its debentures: (i) in whole or in part, on or after November 15, 2007 (for debentures owned by Main Street Banks Statutory Trust I) and June 30, 2008 (for debentures owned by Main Street Banks Statutory Trust II); and (ii) in whole at any time within 90 days following the occurrence and during the continuation of a tax event or capital treatment event (as defined in the offering circulars). If the debentures purchased by Main Street Banks Statutory Trust I or Main Street Banks Statutory Trust II are redeemed before they mature, the redemption price will be the principal amount, plus any accrued but unpaid interest.
Subordinated debt is summarized below:
Note K - Income Taxes
For the years ended December 31, 2005, 2004 and 2003, income tax expense consists of:
Income tax differed from the amount computed by applying the federal statutory income tax rate to pretax earnings for the following reasons:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2005 and 2004, are presented below:
Note L - Commitments and Contingencies
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of their customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.
The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The Company’s exposure to credit loss in the event of nonperformance by the customer to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as are used for on-balance-sheet instruments.
The following represents the Company’s commitments to extend credit and standby letters of credit as of December 31, 2005:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Total commitments to extend credit at December 31, 2005 and 2004 include $205.9 million and $198.6 million, respectively, in undisbursed credit lines and $142.6 million and $179.9 million, respectively, in unfunded construction and development loans. The Company’s experience has been that approximately 80 percent of loan commitments are ultimately drawn upon by customers.
The Company issues standby letters of credit, which are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and expire in decreasing amounts with terms ranging from one to four years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds various assets as collateral supporting those commitments for which collateral is deemed necessary. At December 31, 2005, the maximum potential amount of future undiscounted payments the Company could be required to make under outstanding standby letters of credit was $6.2 million. The fair value of these standby letters of credit was $57 thousand and $69 thousand at December 31, 2005 and 2004, respectively. This amount was not recorded in the balance sheet as a liability in accordance with FIN 45 due to the immateriality of the amount.
The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, residential real estate, and income-producing commercial properties on those commitments for which collateral is deemed necessary.
Note M - Derivatives
The Company uses interest rate products, primarily interest rate swaps and floors, as part of its management of interest rate risk. As of December 31, 2005 and 2004, the Company was party to interest rate swap and floor contracts with $150.0 million and $270.0 million of notional amounts outstanding. The notional balance does not represent the amount the Company is obligated to pay or receive under these contracts. Rather, amounts receivable or payable under these contracts are determined based on whether the fixed rate to be received by the Company exceeds the floating rate to be paid by the Company for each interest calculation period. Regarding interest rate floors, the Company receives a payment from the counterparty if the Prime rate decreases below a certain level. The Company is exposed to credit risk to the extent that a counterparty fails to pay amounts owed to the Company under these agreements. The Company manages this credit risk by entering into agreements with counterparties with credit ratings acceptable under its risk management policy. These derivatives are designated as cash flow hedges of Prime-based loan receipts on a designated pool of Prime-based loans.
The Company’s objective in using derivatives is to add stability to interest income and/or interest expense and to manage its exposure to interest rate movements or other identified risks. To accomplish this objective, the Company primarily uses interest rate swaps as part of its cash flow hedging strategy. Interest rate swaps designated as cash flow hedges involve the receipt of fixed-rate amounts in exchange for variable-rate payments over the life of the agreements without exchange of the underlying principal amount.
Market risk is the adverse effect that changes in interest rates or the implied volatility of interest rates have on the value of a financial instrument. The Company manages the market risk associated with interest rate contracts by establishing and monitoring limits as to the types and degree of risk that may be undertaken.
The Company’s derivatives activities are monitored by its Asset/ Liability Committee as part of its risk-management oversight of the Company’s treasury functions. The Company’s Asset/ Liability Management Committee is responsible for approving various hedging strategies that are developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into the Company’s overall interest rate risk management and trading strategies.
The following chart illustrates the Bank’s derivative positions as of December 31, 2005, dollars in thousands.
Interest Rate Swaps
The following chart illustrates the Bank’s derivative positions as of December 31, 2004, dollars in thousands.
Interest Rate Swaps
Interest Rate Floors
Note N - Related Party Transactions
Directors, executive officers, and their related interests were customers of the Company and had other transactions with the Company in the ordinary course of business. Loans outstanding to certain directors, executive officers, and their related interests at December 31, 2005 and 2004 were $3.9 million and $3.7 million, respectively. For the years ended December 31, 2005 and 2004, $1.9 million and $5.1 million, respectively of such loans were made and loan repayments totaled $1.7 million and $5.3 million for the respective years. It is the policy of the Company that such transactions are made on substantially the same terms as those prevailing at the time for comparable loans to other persons and do not involve more than normal risks of collectability or present other unfavorable features. All of these loans are in a current and performing status as of the report date. These individuals and their related interests also maintain customary demand and time deposit accounts with the Company. These totaled approximately $3.6 million and $2.2 million at December 31, 2005 and 2004, respectively.
The Company has operating leases for bank premises that are owned by related parties. These related parties consist of an individual who is a primary shareholder and member of the Board of Directors, and also an individual who is an Executive Officer of the Company. Terms for these related party leases are substantially the same as those that would be expected to prevail in the marketplace. During 2005, 2004 and 2003, total lease payments under these related party leases totaled approximately $576,000, $550,000, and $398,000, respectively.
The Company has entered into various construction projects with a related party. The Company contracted with the related party for the completion of construction of two new branch offices located at Hwy 20 in Conyers, Georgia and at Cobb Galleria Parkway in Cobb County, Georgia. These projects were completed in 2005 and the Company paid approximately $438,000 under these contracts during 2005. The Company believes that the terms of these contracts are at least as favorable to it as terms available from unrelated third parties.
The Company has an existing Fed Funds line for additional short-term funding with BB&T for up to $25 million. The rate of interest on this line will vary daily. The line will expire on December 22, 2006.
Note O - Employee Benefits
The Company sponsors a 401(k) Employee Savings Plan that permits employees to defer annual cash compensation as specified under the plan. All employees of the Company who are over the age of 21 and have worked 1,000 hours or more in their first 12 months of employment or 1,000 hours or more in any calendar year thereafter are eligible to participate, except for project consultants or employees hired for the first time by the Company after January 1, 2003. Employees are generally vested after 5 years of service. The Board of Directors determines the annual Company contribution, which was $594,233, $530,916, and $423,758, in 2005, 2004 and 2003, respectively.
The Company has a Management Incentive Bonus Plan for key executives that provides annual cash awards, if approved, based on eligible compensation and achieving earnings goals. The Company also has a General Bonus Plan that provides for annual cash awards to eligible employees as established by the Board of Directors. The total expense under these plans was $6.3 million, $8.0 million, and $5.1 million in 2005, 2004, and 2003 respectively.
Note P - Stock Options and Long-Term Compensation Plans
The Company has a nonqualified Restricted Stock Award Plan and a Long-term Incentive Plan which grant restricted stock and other stock based compensation to key executives and officers of the Company. In the case of restricted stock, Company executives and officers designated as an “eligible executive” will vest in the number of shares of common stock awarded under the plan based on service over a five-year period. A total of 960,000 shares were authorized to be issued under the plans, with 761,742 shares of restricted stock issued as of December 31, 2005. No restricted stock has been issued under these plans since December 31, 2000.
In 2000 and 2001, respectively, the Board of Directors and Shareholders approved the Omnibus Stock Ownership and Long-Term Incentive Plan (“Omnibus Plan”) under which incentive stock options and non-qualified stock options to acquire shares of common stock, restricted stock, stock appreciation rights or units may be granted to eligible employees. A total of 800,000 shares were initially authorized to be issued under the plan and the Board of Directors and Shareholders approved an additional 800,000 shares to be used under the plan in 2003. Under the plan, 213,880 and 177,920 shares of restricted stock were issued as of December 31, 2005 and 2004, respectively. A total of 89,981 and 59,377 shares were vested with 123,899 and 118,543 shares issued and unvested as of December 31, 2005 and 2004.
During 2005, the Company issued 35,960 shares of restricted stock and granted 217,456 options under the Omnibus Plan. Including all types of awards, which include the above-mentioned option and restricted stock awards, the total number of share awards issued under the Omnibus Plan were 1,259,167 and 1,005,751 shares at December 31, 2005 and 2004, respectively. Option prices under all stock option plans are equal to the fair value of the Company’s common stock on the date of the grant. The options vest over time periods determined by the Compensation Committee of the Board of Directors and expire ten years from date of grant.
A summary of the Company’s stock option activity and related information is as follows:
Following is a summary of the status of options outstanding at December 31, 2005:
Note Q - Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. The regulations require the Company and the Bank to meet specific capital adequacy guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital (as defined) to total average assets (as defined), and minimum ratios of Tier 1 and total capital (as defined) to risk-weighted assets (as defined). To be considered adequately capitalized (as defined) under the regulatory framework for prompt corrective action, the Company and the Bank must maintain minimum Tier 1 leverage, Tier 1 risk-based, and total risk-based ratios. The following is a summary of the Company’s and the Bank’s capital ratios at December 31, 2005 and 2004:
Banking regulations limit the amount of dividends that may be paid to the Parent without prior approval of the applicable regulatory agency. Under current state banking laws, the approval of the Georgia Department of Banking and Finance is required if the total of all dividends declared by the Banks in the calendar year exceeds 50 percent of the net profits for the previous calendar year and the ratio of equity capital to adjusted total assets is less than 6 percent. At December 31, 2005, The Bank had $1.2 million available to pay additional dividends to the Parent. During 2003, the Bank received approval from the Georgia Department of Banking and Finance to pay additional dividends to the Parent for the purpose of completing the acquisition of the First National Bank of Johns Creek. Accordingly, at December 31, 2003, the Company would have required further Georgia Department of Banking and Finance approval to pay additional dividends.
Note R - Legal Matters
Neither the Company nor any of its subsidiaries are a party to, nor is any of their property the subject of, any material pending legal proceedings, other than ordinary routine proceedings incidental to the business of the Company.
To our knowledge, no such material proceedings were contemplated or threatened against us or our subsidiaries. From time to time, the Parent Company and its subsidiaries are parties to legal proceedings in the ordinary course of business to enforce its security interest. Management, after consultation with legal counsel, does not anticipate that current litigation will have a material adverse effect on the Company’s financial position or results of operations or cash flows.
Note S - Fair Value of Financial Instruments
The assumptions used in the estimation of the fair value of the Company’s financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather represent a good-faith estimate of the increase or decrease in value of financial instruments held by the Company since purchase, origination or issuance.
Short-term financial instruments are valued at their carrying amounts reported in the balance sheet, which are reasonable estimates of fair value due to the relatively short period to maturity of the instruments. This approach applies to cash and cash equivalents, short-term investments, short-term borrowings and certain other assets and liabilities.
Investment securities - The fair value of investment securities held to maturity and available for sale is estimated based on published bid prices or bid quotations received from securities dealers. The carrying amount of other investments approximates fair value.
Loans - For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. For all other loans, fair values are calculated by discounting the contractual cash flows using estimated market rates which reflect the credit and interest rate risk inherent in the loan, or by using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Mortgage loans held for sale - The carrying amount of mortgage loans held for sale approximates fair value.
Deposits - The fair value of deposits with no stated maturity, such as demand, NOW and MMDA, and savings accounts, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows using the rates currently offered for deposits of similar remaining maturities.
Fair values for long-term debt and guaranteed preferred beneficial interests in debentures are based on quoted market prices for similar instruments or estimated using discounted cash flow analysis and the Company’s current incremental borrowing rates for similar types of instruments.
Derivatives - Derivative instruments (interest rate swaps and floors) are recorded on the balance sheet at fair value. Fair value is estimated based on published bid prices or bid quotations for interest rate swaps and floors received from securities dealers.
Off-balance sheet instruments - Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the borrowers’ credit standing.
Subordinated debt and Trust preferred securities - The carrying amount of subordinated debt and trust preferred securities approximates fair value.
Accrued interest - The carrying amount of accrued interest receivable and payable approximates fair value.
Estimated fair values of the Company’s financial instruments are as follows:
Note T - Stock Repurchase Plan
On March 31, 2002, the Company announced a stock repurchase program whereby the Company was authorized to acquire up to 500,000 shares of its common stock. The shares are to be repurchased from time to time in the open market at prevailing market prices or in privately negotiated transactions. The extent and time of any repurchase will depend on market conditions and other corporate considerations. This repurchase plan replaced a plan approved in September 2001, which authorized the repurchase of up to 150,000 shares of common stock. Repurchased shares will be available for use in connection with the Company’s stock option plans and other compensation programs, or for other corporate purposes as determined by the Company’s Board of Directors. During 2003, the Company repurchased 100,000 shares of its outstanding common stock under this repurchase plan. No repurchases were made in 2004 and 2005.
Note U - Parent Company
Main Street Banks, Inc.
(Parent Company)
Condensed Balance Sheet
Main Street Banks, Inc.
(Parent Company)
Condensed Statement of Income
Main Street Banks, Inc.
(Parent Company)
Condensed Statement of Cash Flows
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Management’s assessment of Internal controls
Evaluation of Disclosure Controls and Procedures. The Company conducted an evaluation, with the participation of its Chief Executive Officer, Chief Financial Officer, Risk Management Officer, Internal Audit and Security Officer, and Principal Accounting Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2005. The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported on a timely basis.
Based upon that evaluation, the Chief Executive Officer and Principal Accounting Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2005 to give reasonable assurance in alerting them in a timely fashion to material information relating to the Company that is required to be included in the reports that the Company files under the Exchange Act.
Management’s Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer, Chief Financial Officer, Risk Management Officer, Internal Audit and Security Officer, and Principal Accounting Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2005 based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2005.
Management’s assessment of the effectiveness of the Company’s Internal Control over Financial Reporting as of December 31, 2005 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which appears below.
There have been no changes to the Company’s internal control over financial reporting that occurred since the beginning of the Company’s fourth quarter of 2005 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Chief Executive Officer and Chief Financial Officer Certifications. The Company’s Chief Executive Officer and Chief Financial Officer have filed with the Securities and Exchange Commission the certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1 and 31.2 to the Company’s 2005 Form 10-K.
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Main Street Banks, Inc.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Main Street Banks, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Main Street Banks, Inc.’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. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, 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, management’s assessment that Main Street Banks, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Main Street Banks, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005 based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Main Street Banks, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005 and our report dated March 13, 2006 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
March 13, 2006
Atlanta, Georgia
Item 9B.
Item 9B. Other Information
None
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Board of Directors
The following table sets forth the name of each current director of the Company; a description of his position and offices with the Company (other than as a director) and with Main Street Bank, the Company’s wholly owned bank subsidiary, if any; and a brief description of his principal occupation and business experience during the past five years and certain other information, including his age as of March 11, 2006. The table also sets forth the class of each director. The terms of the Class I directors expire in 2007; the terms of the Class II directors expire in 2008; and the terms of the Class III directors expire in 2006. The Board of Directors has determined that the following five directors, constituting a majority of the Board, are independent pursuant to Nasdaq Stock Market listing standards: C. Candler Hunt; Frank B. Turner; John R. Burgess, Sr.; P. Harris Hines; and Harry L. Hudson, Jr.
Messrs. Fowler and Turner are first cousins. Mr. Hay is Mr. Fowler’s nephew.
In a letter dated December 1, 1999 to the Board of Directors of the Company, Mr. Fowler stated that it was his present intention for a period of six years following May 24, 2000, to take such action as reasonably necessary at the Board level and to vote all shares of Company Stock over which he has voting control, including the shares owned by family trusts, to maintain the same equal ratio of the number of previous Main Street Banks Incorporated and First Sterling
Banks, Inc. directors. He also stated that it is his intention to specifically vote the shares over which he has voting control for the reelection to the Company Board of Directors of Eugene L. Argo upon the expiration of his term in 2002 and for the reelection of Edward C. Milligan, P. Harris Hines and Harry L. Hudson, Jr. when their terms expire in 2003. Mr. Fowler did vote his shares in favor of Mr. Argo at the Company’s 2002 Annual Meeting of Shareholders and in favor of Messrs. Milligan, Hines and Hudson at the Company’s 2003 Annual Meeting of Shareholders. Mr. Argo, who was reelected to the Company’s Board of Directors, retired as a director during 2002. No replacement for Mr. Argo has been nominated at this time.
He also expressed his intention that if any of these persons failed to complete their terms of office he would support for election to those vacant positions the person who is or persons who are nominated by the remaining members of the group composed of Messrs. Argo, Milligan, Hines and Hudson.
Mr. Fowler’s letter is simply an expression of his intention on December 1, 1999. It is not legally binding against him. He can change his mind at any time and take action which is completely different from his expressed intention on December 1, 1999. If he desires, he could vote against the directors named above or their nominees.
Executive Officers
The table set forth below shows for each of the Company’s executive officers (a) the person’s name, (b) his age at March 11, 2006, (c) the year he was first elected as an executive officer of the Company, and (d) his present positions with the Company and his other business experience for the past five years. Officers are elected at the Annual Meeting of the Board of Directors for terms of one year or until their earlier resignation, termination or removal from office.
Name
Age
Position with the Company and
Business Experience During The Past Five Years
Samuel B. Hay III
Mr. Hay serves as President and Chief Executive Officer of the Company and as a member of the Company’s Board of Directors. He assumed the role of Chief Executive Officer on January 1, 2005. Mr. Hay also serves as Chief Executive Officer of Main Street Bank and as a member of its Board of Directors.
Max S. Crowe
Mr. Crowe serves as Executive Vice President and Chief Banking Officer of the Company, positions he has held since 2002. Prior to joining the Company, Mr. Crowe served as Regional President of BB&T for over five years. Mr. Crowe serves as a director of Main Street Bank.
Name
Age
Position with the Company and
Business Experience During The Past Five Years
David W. Brooks II
Mr. Brooks serves as Executive Vice President and Chief Financial Officer of the Company. He assumed these roles in 2005. He was previously employed by Wachovia Corporation for 24 years. Before joining the Company, Mr. Brooks served as Senior Vice President and Group Executive responsible for strategic planning, treasury policy and research, asset pricing, treasury risk management and Basel implementation in Charlotte, North Carolina.
John T. Monroe
Mr. Monroe serves as Executive Vice President and Chief Credit Officer of Main Street Bank, a position he has held since 2002. From 1989 until 2002 Mr. Monroe served as Senior Credit Manager with BB&T.
Gary S. Austin
Mr. Austin serves as Executive Vice President-Risk Management. He joined Main Street Bank in 2003. Previously, Mr. Austin served as corporate risk manager for RBC Centura from 2000 to 2003.
Richard A. Blair
Mr. Blair serves as Executive Vice President-Administration and Operations. He has been with Main Street Bank since 2003. Previously, Mr. Blair worked in the operations department of Wachovia Bank from 1978 to 2003.
See “Board of Directors” above for description of prior business experience of Mr. Hay.
Audit Committee
The Company has a separately designated standing audit committee established in accordance with section 3(a)(58)(A) of the Securities Exchange Act of 1934. The primary functions of the Audit Committee are to see that an audit program is in place to protect the assets of the Company, assure that adequate internal controls exist, and appoint, compensate and oversee the work of the Company’s independent registered public accounting firm. In accordance with Section 301 of the Sarbanes-Oxley Act of 2002, the Audit Committee is directly responsible for the appointment, compensation and oversight (with a direct report relationship) of the work of the Company’s independent registered public accounting firm. The current members of the Audit Committee are: P. Harris Hines (Chairman), Frank B. Turner and C. Candler Hunt. The Board of Directors has adopted a written charter for the Audit Committee. A copy of the Audit Committee Charter was attached to the Company’s 2004 Proxy Statement as Appendix A.
The Board of Directors has determined that each member of the Audit Committee is independent in accordance with the recently amended Nasdaq Stock Market listing standards and applicable Securities and Exchange Commission (“SEC”) regulations. None of the members of the Audit Committee has participated in the preparation of the financial statements of the Company at any time during the past three years. The Board has also determined that Frank B. Turner meets the criteria specified under applicable SEC regulations for an “audit committee financial expert” and that all Committee members are financially sophisticated.
Section 16(a) Beneficial Ownership Reporting Compliance
Our directors and executive officers, and beneficial owners of 10% or more of our common stock, must file reports with the Securities and Exchange Commission showing the number of shares of our common stock and derivative securities convertible into our common stock they beneficially own, as well as any changes in their beneficial ownership. Copies of these reports must be provided to us. Based on our review of these reports and the written representations of our directors and executive officers, we believe that all required reports were filed in 2005, and, other than disclosed in prior proxy statements, in preceding years, except the following: Messrs. Monroe, Brooks, Milligan and Crowe each filed a late Form 4 in January 2006 covering the surrender of shares of restricted stock to satisfy tax withholding obligations; Mr. Milligan filed a late Form 4 in August 2005 covering the exercise of stock options; and Mr. Hudson filed a late Form 4 in April 2005 covering the exercise of stock options.
Code of Ethics and Conduct
The Company’s Board of Directors has adopted a Code of Ethics and Conduct that is applicable to all directors, officers and employees. The code complies with the requirements of NASD Rule 4350(n). The Company will provide a copy of its Code of Ethics and Conduct to any person without charge upon request. All requests should be addressed to Main Street Banks, Inc., 3500 Lenox Road, Atlanta, Georgia 30326, Attention: Investor Relations. Any amendment to the Code of Ethics and Conduct that applies to the Company’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, will be posted on the Company’s web site, which is www.mainstreetbank.com.
Item 11.
Item 11. Executive Compensation
Executive Compensation
The table below shows information concerning the compensation paid to the Chief Executive Officer and the Company’s four most highly compensated executive officers for services to the Company in all capacities for the years ended 2005, 2004 and 2003.
The number and value of the aggregate restricted stock holdings at the end of 2005 are as follows:
Mr. Hay was granted 5,357 shares of restricted stock on December 14, 2005. This stock will vest at 20% per year beginning on January 1, 2007 and on each anniversary thereafter.
Mr. Crowe was granted 3,514 shares of restricted stock on December 14, 2005. This stock will vest at 20% per year beginning on January 1, 2007 and on each anniversary thereafter.
Mr. Brooks was granted 27,000 shares of restricted stock on May 23, 2005. This stock will vest at 20% per year beginning January 1, 2006 and on each anniversary thereafter. Mr. Brooks was also granted 3,214 shares of restricted stock on December 14, 2005. This stock will vest at 20% per year beginning on January 1, 2007 and on each anniversary thereafter.
Mr. Monroe was granted 1,929 shares of restricted stock on December 14, 2005. This stock will vest at 20% per year beginning on January 1, 2007 and on each anniversary thereafter.
Mr. Blair was granted 5,000 shares of restricted stock on August 29, 2005. This stock will vest at 20% per year beginning January 1, 2007 and on each anniversary thereafter. Mr. Blair was also granted 1,607 shares of restricted stock on December 14, 2005. This stock will vest at 20% per year beginning on January 1, 2007 and on each anniversary thereafter.
Dividends are payable on the Company’s restricted stock described above.
Includes amounts contributed by the Company to Mr. Hay’s account in the Company’s 401(k) plan of $7,000 for 2005, $6,500 for 2004 and $6,000 for 2003; taxable amount on excess life insurance of $404 for 2005, $436 for 2004 and $420 for 2003; and personal use of Company automobile of $1,751 for 2005, $1,140 for 2004 and $1,108 for 2003.
Includes amounts contributed by the Company to Mr. Crowe’s account in the Company’s 401(k) plan of $7,000 for 2005, $6,500 for 2004 and $4,531 for 2003; taxable amount on excess life insurance of $966 for 2005, $1,003 for 2004 and $966 for 2003; and personal use of Company automobile of $2,539 for 2005, $2,551 for 2004 and $2,828 for 2003.
Includes taxable amount on excess life insurance of $339; and personal use of Company automobile of $2,985.
Includes amounts contributed by the Company to Mr. Monroe’s account in the Company’s 401(k) plan of $6,003 for 2005, $5,580 for 2004 and $2,887 for 2003; taxable amount on excess life insurance of $606 for 2005, $654 for 2004 and $420 for 2003; and personal use of Company automobile of $5,654 for 2005, $6,494 for 2004 and $8,793 for 2003.
Includes amounts contributed by the Company to Mr. Blair’s account in the Company’s 401(k) plan of $7,000 for 2005; taxable amount on excess life insurance of $1,515 for 2005, $1,542 for 2004 and $114 for 2003; and an automobile allowance of $3,400 for 2005.
Stock Options
The following table sets forth information in regard to stock options granted to the Chief Executive Officer and the Company’s most highly compensated executive officers in 2005. Each executive’s stock options vest in equal installments over five years beginning on the first anniversary of the grant date.
Option Grants in Last Fiscal Year
[Individual Grants]
The following table sets forth information in regard to exercise of stock options and the fiscal year-end value of unexercised options for each of the named executives:
Aggregate Option Exercises in Last Fiscal Year and FY-End Option Values
Director Compensation
During 2005, the Company’s non-employee directors were paid a $1,200 monthly retainer fee plus $1,000 for each Board meeting attended (including meetings of the Board of Directors of Main Street Bank) and $250 for each committee meeting ($500 for the Chairperson) attended on days other than the day of a Board meeting. The Company’s directors were paid a total of $140,250 for such services in 2005.
Consulting and Employment Agreements with Directors and Executives
On May 22, 2003, the Company entered into a consulting agreement with T. Ken Driskell in connection with its acquisition of First Colony Bancshares, Inc. Mr. Driskell served as the President and Chief Executive Officer of First Colony and now serves as a director of the Company. The Company has also entered into employment agreements with Robert R. Fowler III, the Chairman of the Board’s Executive Committee, Edward C. Milligan, Chairman of the Board of Directors, and with each of the named executive officers listed in the summary compensation table above. Descriptions of these agreements follow below and in the following section entitled “Changes in Employment Agreements in Anticipation of the Company’s Acquisition by BB&T”.
T. Ken Driskell. The Company entered into a five-year consulting agreement with T. Ken Driskell on May 22, 2003. Mr. Driskell serves on the Company’s and Main Street Bank’s Board of Directors and provides consulting services in regard to their operations in the Alpharetta and Roswell, Georgia areas.
Pursuant to the consulting agreement, the Company pays Mr. Driskell a consulting fee equal to $8,333.33 per month and provides him with a car allowance of $750 per month. The Company also provides health insurance to Mr. Driskell and his family. If the Company terminates Mr. Driskell’s consulting agreement other than for cause or Mr. Driskell terminates for good reason, then:
the Company will pay to Mr. Driskell his consulting fee for the remainder of the term of the agreement as if his service had not been terminated; and
for the remainder of the term of the agreement, or such longer period as may be provided by the terms of the appropriate plan, program, practice or policy, the Company will continue benefits to Mr. Driskell or his family at least equal to those which would have been provided to them in accordance with the Company’s health insurance plan if Mr. Driskell’s services had not been terminated, provided, however, that if Mr. Driskell becomes re-employed with another employer and is eligible to receive medical and health insurance benefits under another employer provided plan, the medical benefits described herein will be secondary to those provided under such other plans during such applicable period of eligibility.
The consulting agreement also contains restrictions on the ability of Mr. Driskell to compete with the Company for a period equal to the greater of (i) five years from May 22, 2003 or (ii) two years from the termination of the consulting agreement. He is also restricted on the disclosure and use of the Company’s confidential information and trade secrets and in his ability to solicit the Company’s customers with whom he had material contact during the 12-month period immediately preceding the termination of his services under the agreement. In return for his agreement to abide by these restrictive covenants, the Company pays to Mr. Driskell a restrictive covenant fee equal to $16,666.67 per month for five years. This payment is in addition to the consulting fee described above.
Robert R. Fowler III. Mr. Fowler has an employment agreement with the Company dated May 24, 2000 by which he was initially employed as Chairman of the Board of Directors of the Company and Vice Chairman of the Board of Directors of Main Street Bank. In May 2002, Mr. Fowler resigned as Chairman and became the Chairman of the Board’s Executive Committee. He retained his position and duties as Vice Chairman of the Board of Directors of Main Street Bank in accordance with the employment agreement. As Chairman of the Executive Committee, Mr. Fowler is an active participant in strategic planning, business development and development and maintenance of corporate shareholder and community relations for the Company. He also advises the Board of Directors with respect to proposed mergers and acquisitions. The term of the agreement ends on June 30, 2008.
Mr. Fowler receives an annual base salary that was initially set at $200,000 and is subject to annual increases of at least three percent (3%) and such other increases as may be approved by the Board of Directors. Main Street Bank provides Mr. Fowler with a split dollar insurance agreement which provides for a $2,000,000 face amount of life insurance on his life. If Mr. Fowler is terminated for any reason other than for cause or if Mr. Fowler voluntarily terminates for good reason then the Company will continue to pay Mr. Fowler his base salary for the remainder of the term and will continue his welfare plans for such time period. If Mr. Fowler becomes re-employed with another employer then the medical and other welfare benefits provided by the Company will be secondary to those provided under the other employer’s plan.
The agreement provides for restrictions on Mr. Fowler’s ability to compete with the Company during the term of the agreement and for two years following his termination of service with the Company. He is also restricted in disclosing and using the Company’s confidential information and trade secrets. He is also restricted from soliciting the Company’s customers with whom he has had material contact during the 12 months immediately preceding the termination of his service. In consideration for Mr. Fowler entering into the restrictive covenants, the Company shall pay $200,000 per year throughout the term.
Edward C. Milligan. On September 8, 2004 the Company entered into an employment agreement with Mr. Milligan that superseded his earlier employment agreement. Under the new employment agreement, Mr. Milligan was employed as the Chairman of the Company and as Chairman of Main Street Bank effective January 1, 2005. His term of employment expires on December 31, 2009. Mr. Milligan’s initial annual base salary is $250,000 and is subject to annual increases of 3% and such other increases as may be approved by the Board of Directors. If Mr. Milligan is terminated at any time during the term by the Company for any reason other than for cause or if Mr. Milligan voluntarily terminates his employment with the Company for good reason then the Company will continue to pay to Mr. Milligan his base salary for the remainder of the term as if his service had not been terminated. The Company will also continue to provide benefits to Mr. Milligan and his family at least equal to those provided if his employment had not been terminated. The employment agreement also contains restrictions on the ability of Mr. Milligan to compete with the Company for a period of two years following the date of termination for any reason whatsoever. He is also restricted on the disclosure and use of the Company’s confidential information and trade secrets and in his ability to solicit the Company’s customers with whom he had material contact during the 12-month period immediately preceding his termination. In consideration for Mr. Milligan’s entering into the restrictive covenants, the Company shall pay $200,000 per year throughout the term.
Samuel B. Hay III. On September 8, 2004 the Company entered into an employment agreement with Mr. Hay that superseded his earlier employment agreement. Under the new employment agreement, Mr. Hay became the President and Chief Executive Officer of the Company effective January 1, 2005. His term of employment is for an initial period of three years with automatic one-year extensions beginning on January 1, 2008 and on each anniversary thereafter. Either party, by notice to the other, may cause the term of the employment to cease to extend automatically. Mr. Hay’s initial annual base salary is $300,000 and is subject to annual increases of 3% and such other increases as may be approved by the Board of Directors. If Mr. Hay is terminated at any time during the term by the Company for any reason other than for cause or if Mr. Hay voluntarily terminates his employment with the Company for good reason or if the Company ceases to automatically extend the employment period other than for cause, then the Company will pay to Mr. Hay an amount equal to the sum of: (i) his pro rated targeted annual bonus for the year of termination based on the number of days employed during such year and (ii) three times the sum of his annual base salary plus his targeted annual bonus for the year of termination. The Company will also continue to provide benefits to Mr. Hay and his family at least equal to those provided if his employment had not been terminated. If Mr. Hay is re-employed during such three-year period, the medical and other welfare benefits that the Company is obligated to provide under the employment agreement would be secondary to those provided by the new employer. The employment agreement also contains restrictions on the ability of Mr. Hay to compete with the Company for a period of two years following the date of termination for any reason whatsoever. He is also restricted on the disclosure and use of the Company’s confidential information and trade secrets and in his ability to solicit the Company’s customers with whom he had material contact during the 12-month period immediately preceding his termination.
Max S. Crowe. Effective April 11, 2002, the Company entered into an employment agreement by which Mr. Crowe is employed as the Executive Vice President and Chief Banking Officer of the Company and as President and Chief Operating Officer of the Bank. His term of employment is for an initial period of three years with automatic one-year extensions beginning on April 11, 2004 and on each anniversary thereafter. Either party, by notice to the other, may cause the term of the employment to cease to extend automatically. Mr. Crowe’s base salary is subject to annual increases of 3% and such other increases as may be approved by the Board of Directors. If Mr. Crowe is terminated at any time during the term by the Company for any reason other than for cause or if Mr. Crowe voluntarily terminates his employment with the Company for good reason or if the Company ceases to automatically extend the employment period other than for cause, then the Company will pay to Mr. Crowe an amount equal to the sum of: (i) his pro rated targeted annual bonus for the year of termination based on the number of days employed during such year and (ii) three times the sum of his annual base salary plus his targeted annual bonus for the year of termination. The Company will also continue to provide benefits to Mr. Crowe and his family at least equal to those provided if his employment had not been terminated. If Mr. Crowe is re-employed during such three-year period, the medical and other welfare benefits that the Company is obligated to provide under the employment agreement would be secondary to those provided by the new employer. The employment agreement also contains restrictions on the ability of Mr. Crowe to compete with the Company for a period of two years following the date of termination for any reason whatsoever. He is also restricted on the disclosure and use of the Company’s confidential information and trade secrets and in his ability to solicit the Company’s customers with whom he had material contact during the 12-month period immediately preceding termination.
David W. Brooks II. The Company has entered into an employment agreement with Mr. Brooks effective June 6, 2005. Under the employment agreement, Mr. Brooks serves as the executive vice president and chief financial officer of the Company. His term of employment is for an initial period of three years with automatic one-year extensions beginning on June 6, 2007, and on each anniversary thereafter. Either party, by notice to the other, may cause the term of the employment to cease to extend automatically. Mr. Brooks’ annual base salary is $225,000 subject to annual increases of three percent (3%) and such other increases as may be approved by the board of directors. If Mr. Brooks is terminated at any time during the term by the Company for any reason other than for cause or if Mr. Brooks voluntarily terminates his employment with the Company for good reason or if the Company ceases to automatically extend the employment period other than for cause, then the Company will pay to Mr. Brooks an amount equal to three times the sum of his annual base salary and target bonus for the year of termination. The Company will also continue to provide benefits to Mr. Brooks and his family at least equal to those provided if his employment had not been terminated. If Mr. Brooks is re-employed during such three-(3)-year period, the medical and other welfare benefits that the Company is obligated to provide under the employment agreement would be secondary to those provided by the new employer. The employment agreement also contains restrictions on the ability of Mr. Brooks to compete with the Company for a period of two years following the date of termination for any reason whatsoever. He is also restricted on the disclosure and use of the Company’s confidential information and trade secrets and in his ability to solicit the Company’s customers with whom he had material contact during the 12-month period preceding his termination. Mr. Brooks was paid
an initial bonus of $33,000 and he was paid a bonus of $85,000 in December 2005. Mr. Brooks was granted 27,000 shares of restricted stock and options to purchase 30,000 shares of the Company’s common stock.
John T. Monroe. Effective May 15, 2002, Main Street Bank entered into an employment agreement by which Mr. Monroe is employed as Executive Vice President and Chief Credit Officer of the Bank. His term of employment is for an initial period of two years with automatic one-year extensions beginning on May 15, 2003 and on each anniversary thereafter. Either party, by notice to the other, may cause the term of the employment to cease to extend automatically. Mr. Monroe’s base salary is subject to annual increases of 3% and such other increases as may be approved by the Board of Directors. If Mr. Monroe is terminated at any time during the term by the Bank for any reason other than for cause or if Mr. Monroe voluntarily terminates his employment with the Bank for good reason or if the Bank ceases to automatically extend the employment period other than for cause, then the Bank will pay to Mr. Monroe an amount equal to the sum of: (i) his pro rated targeted annual bonus for the year of termination based on the number of days employed during such year and (ii) two times the sum of his annual base salary plus his targeted annual bonus for the year of termination. The Bank will also continue to provide benefits to Mr. Monroe and his family at least equal to those provided if his employment had not been terminated. If Mr. Monroe is re-employed during such one-year period, the medical and other welfare benefits that the Bank is obligated to provide under the employment agreement would be secondary to those provided by the new employer. The employment agreement also contains restrictions on the ability of Mr. Monroe to compete with the Bank for a period of two years following the date of termination for any reason whatsoever. He is also restricted on the disclosure and use of the Bank’s confidential information and trade secrets and in his ability to solicit the Bank’s customers with whom he had material contact during the 12-month period immediately preceding termination.
Richard A. Blair. The employment contract with Mr. Blair was entered into on October 4, 2005 to be effective September 15, 2005. Under the employment agreement, Mr. Blair serves as Executive Vice President - Administration and Operations of the Company and its banking subsidiary Main Street Bank. His term of employment is for an initial period of two years with automatic one-year extensions beginning on September 15, 2007, and on each anniversary thereafter. Either party, by notice to the other, may cause the term of the employment to cease to extend automatically. Mr. Blair’s annual base salary was initially $150,000 subject to annual increases of three percent (3%) and such other increases as may be approved by the board of directors. If Mr. Blair is terminated at any time during the term by the Company for any reason other than for cause or if Mr. Blair voluntarily terminates his employment with the Company for good reason or if the Company ceases to automatically extend the employment period other than for cause, then the Company will pay to Mr. Blair an amount equal to two times the sum of his annual base salary and target bonus for the year of termination. For a period of two years the Company will also continue to provide benefits to Mr. Blair and his family at least equal to those provided if his employment had not been terminated. If Mr. Blair is re-employed during such two-(2)-year period, the medical and other welfare benefits that the Company is obligated to provide under the employment agreement would be secondary to those provided by the new employer. The employment agreement also contains restrictions on the ability of Mr. Blair to compete with the Company for a period of two years following the date of termination for any
reason whatsoever. He is also restricted on the disclosure and use of the Company’s confidential information and trade secrets and in his ability to solicit the Company’s customers with whom he had material contact during the 12-month period preceding his termination.
The employment agreements for Messrs. Hay, Crowe, Brooks, Monroe and Blair provide that additional payments will be made to such persons to reimburse them for any excise taxes that may be owed in the event that payments under such agreements exceed the limitations of Section 280G of the Internal Revenue Code.
Changes in Employment Agreements in Anticipation of the Company’s Acquisition by BB&T
As previously announced, the Company’s Board of Directors has approved a merger combining the Company and BB&T Corporation. In anticipation of the pending merger certain modifications to the contracts described above have been made or are expected to be made. Descriptions of these modifications follow.
Existing Employment Agreements with the Company
Messrs. Hay, Milligan and Fowler’s existing employment agreement with the Company will be terminated upon completion of the merger. The termination of each employment agreement will obligate the Company to make certain payments to each executive and will cause each executive’s outstanding stock options and other incentive awards to immediately vest and any restrictions on awards of restricted stock to lapse. Messrs. Hay, Milligan and Fowler have agreed to amend their existing employment agreements with the Company prior to the closing of the merger to reduce the amounts of these payments by an aggregate amount of $1 million. Upon completion of the merger, under the terms of their respective employment agreements, as amended, each of Messrs. Hay, Milligan and Fowler will receive a lump-sum payment in the amounts of $1,480,187, $1,745,409 and $150,881, respectively.
Upon completion of the merger, David W. Brooks, Executive Vice President and Chief Financial Officer, will have the right to terminate his existing employment agreement with the Company for “good reason” which generally is defined in his employment agreements to mean an adverse change in position or responsibility, a reduction in base salary, elimination of any material employee benefits, relocation outside of the Atlanta, Georgia metropolitan area or material breach of the employment agreement by the Company. If Mr. Brooks terminates his employment agreement for “good reason,” the Company expects that he will receive a termination payment of $1,147,163.
Claims Agreements with the Company
The Company entered into Claims Agreements that modify its existing employment agreements with Max S. Crowe, Executive Vice President and Chief Banking Officer, John T. Monroe, Executive Vice President and Chief Credit Officer, and Richard A. Blair, Executive Vice President, Administration and Operations. The Claims Agreements clarify and reduce the consideration payable to each officer in the event of a change of control under their existing
employment agreements, and provide waivers and releases of claims to additional or different consideration from that provided in the Claims Agreements. The Claims Agreements also provide for the acceleration of certain benefits to such officers in connection with each officer’s agreement to (i) continue his service with the Company through the closing of the merger; and (ii) general releases of claims against the Company and BB&T. Under the Claims Agreements, upon completion of the merger, Messrs. Crowe, Monroe and Blair are entitled to lump sum payments of $1,257,702, $623,630 and $502,192, respectively.
Compensation Committee Interlocks and Insider Participation
The primary functions of the Compensation Committee are to evaluate and administer the compensation of the Company’s Chief Executive Officer and other executive officers and to review the general compensation programs of the Company. The current members of the Compensation Committee are: C. Candler Hunt (Chairman), P. Harris Hines and Harry L. Hudson, Jr.. No member of the Committee is an employee of the Company or any subsidiary of the Company or was formerly an officer of the Company or one of its subsidiaries.
Compensation Committee Report
The Compensation Committee is responsible for evaluating the remuneration of executives of the Company to provide competitive levels of compensation which take into account the annual and long-term performance goals, whether there has been above average corporate performance, the levels of an individual’s initiative, responsibility and achievements, and the need of the Company to attract and retain well trained and highly motivated executives. The Committee fixes the compensation of the CEO and the other executive officers. All decisions by the Committee relating to the compensation of the CEO and the other executive officers are reviewed by the full Board of Directors.
Executive officers’ overall compensation is intended to be consistent with the compensation paid to executives of financial institutions and of other companies similar in size, complexity, and character to the Company, provided that the performance of the Company and the executive officer warrants the compensation being paid.
Mr. Hay’s annual base compensation was increased to $300,000 effective January 2005. In December 2005, Mr. Hay received incentive compensation of $63,000 for his performance in 2005. In determining Mr. Hay’s compensation for 2005, the Committee considered the Company’s performance in regard to the following factors: earnings per share growth; growth of loans and checking account balances; credit quality; service quality; and safety and soundness.
Compensation paid to the named executive officers of the Company in 2005, as reflected in the preceding compensation tables, consisted of the following elements: base salary, bonus, matching contributions paid with respect to the 401(k) Plan, restricted stock grants, incentive and non-qualified stock options and certain perquisites. In addition, the Company has adopted certain broad-based employee benefit plans in which executives, and other officers together with employees, have the option to participate. Benefits under these plans are not directly or indirectly tied to the Company’s performance, except that contributions by the Company to the 401(k) Plan are voluntary, at the election of the Board of Directors. Bonuses were granted to each named executive officer based upon certain performance criteria for their services in 2005.
Compensation Committee
C. Candler Hunt, Chairman
P. Harris Hines
Harry L. Hudson, Jr.
Shareholder Return Performance Graph
Set forth below is a line graph comparing the percentage change in the cumulative shareholder return on the Company’s Common Stock with the cumulative total return on the Nasdaq Stock Market (U.S. Companies) index and the SNL $1B - $5B Bank index.
The graph assumes $100 invested on December 31, 2000, in the Common Stock of the Company and in each of the two indexes. The comparison also assumes that all dividends are reinvested.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters
Equity Compensation Plan Information Table
Security Ownership
The following tables set forth certain information regarding the Company’s Common Stock owned, as of March 1, 2006 by: each person who beneficially owns more than 5% of the outstanding shares of the Company’s stock;
each director of the Company;
each executive officer of the Company who is named in the cash compensation table above; and
all the Company directors and executive officers as a group.
Except as otherwise indicated, the persons named in the tables below have sole voting and investment powers with respect to all shares shown as beneficially owned by them. The information shown below is based upon information furnished by the named persons and based upon “beneficial ownership” concepts set forth in rules issued under the Securities Exchange Act of 1934. Under these rules, a person is deemed to be a “beneficial owner” of a security if that person has or shares “voting power,” which includes the power to vote or to direct the voting of the security, or “investment power,” which includes the power to dispose or to direct the disposition of the security. A person is also deemed to be a beneficial owner of any security of which that person has the right to acquire beneficial ownership within 60 days. More than one person may be deemed to be a beneficial owner of the same securities. Under applicable SEC rules, the number of outstanding shares of Common Stock used in the computation of the “Percent of Class” includes currently exercisable stock options owned by the shareholder.
Management of the Company is aware of only two persons or entities which beneficially own 5% or more of the Company’s Common Stock as described in the following table:
Mr. Fowler’s stock ownership includes the following:
* The shares beneficially owned by the Fowler Children’s Trust are also included in shares beneficially owned by Mr. Fowler.
Mr. Fowler is the executor of the Estate of Louly T. Fowler, Trustee of the Children’s Trust, sole trustee for all three Grandchildren’s Trusts as well as one of the Generation Skipping Tax Exempt Trusts and Co-Trustee of the other two Generation Skipping Tax Exempt Trusts described above.
The following table sets forth the beneficial stock ownership of each director and named executive officer and for all directors and executive officers as a group:
Mr. Blair’s ownership includes 3,103 shares of stock obtainable upon the exercise of options and 6,607 shares of restricted stock issued to Mr. Blair pursuant to the Company’s restricted stock award program.
Mr. Brooks’ ownership includes 24,814 shares of restricted stock issued to Mr. Brooks pursuant to the Company’s restricted stock award program.
Mr. Burgess’ ownership includes 35,133 shares of stock held by his spouse.
Mr. Crowe’s ownership consists of 16,254 shares obtainable upon the exercise of options and 22,267 shares of restricted stock issued under the Company’s restricted stock award plan.
Mr. Driskell’s ownership includes 52,278 shares of stock held for his benefit under an Individual Retirement Account and 1,322 shares of stock held for the benefit of his spouse under an Individual Retirement Account. Mr. Driskell disclaims beneficial ownership of the 1,322 shares of stock held for the benefit of his spouse under an Individual Retirement Account.
Mr. Fowler’s ownership is described under the preceding table.
Mr. Hay’s stock ownership includes 32,359 obtainable upon the exercise of options and 16,332 shares of restricted stock issued to Mr. Hay pursuant to the Company’s restricted stock award plan. It also includes 28,506 shares held by Hay/Fowler LLLP, of which Mr. Hay serves as a general partner.
Mr. Hunt’s ownership includes 15,973 shares of stock obtainable upon the exercise of options.
Mr. Milligan’s stock ownership includes 111,712 shares of stock obtainable upon the exercise of the options, 845 shares held by his minor child, 1,331 held in a deferred compensation plan, 2,990 held in his 401(k) plan and 13,858 shares of restricted stock issued under the Company’s restricted stock award plan.
Mr. Monroe’s ownership consists of 21,280 shares of Company stock obtainable upon the exercise of options and 9,584 shares of restricted stock issued under the Company’s restricted stock award plan.
Mr. Turner’s ownership includes 15,973 shares of stock obtainable upon the exercise of options and 2,400 shares of stock owned by Mr. Turner’s spouse. Mr. Turner disclaims beneficial ownership of the 2,400 shares of stock held by his spouse.
The stock ownership of the Company’s directors and executive officers, as a group (13 persons), includes 216,654 shares of Company stock obtainable upon the exercise of options.
Item 13.
Item 13. Certain Relationships and Related Transactions
The Company’s directors and certain business organizations and individuals associated with them are customers of and have banking transactions with the Company’s subsidiary bank in the ordinary course of business. Such transactions include loans, commitments, lines of credit and letters of credit. All of those transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not and do not involve more than normal risk of collectability or present any other unfavorable features. Additional transactions with these persons and businesses are anticipated in the future.
Robert R. Fowler III, Chairman of the Executive Committee of the Board, or entities he controls have entered into the following lease agreements with Main Street Bank:
Service Center: 2118 Usher Street, Covington, Georgia. Landlord is Robert R. Fowler III. Current monthly rent is $14,102.
Main Office Branch: 1134 Clark Street, Covington, Georgia. Landlord is Hunter/Fowler, LP. Current monthly rent is $10,220.53.
Accounting and Risk Management Office: 1122 Pace Street, Covington, Georgia. Landlord is Hunter/Fowler, LP. Current monthly rent is $6,138.71.
Additional Part of Accounting Office: 1114 Pace Street, Covington, Georgia. Landlord is Hunter/Fowler, LP and Robin H. Fowler. Current monthly rent is $2,220.00.
Covington Executive Offices: 1121 Floyd Street, Covington, Georgia. Landlord is Hunter/Fowler, LP and Robin H. Fowler. Current monthly rent is $3,874.71.
Credit Cottage: 1132 Floyd Street, Covington, Georgia. Landlord is Hunter/Fowler, LP and Robin H. Fowler. Current monthly rent is $2,652.25.
Free Standing ATM in Oxford, Georgia: Landlord is Robert R. Fowler III, Fowler Children’s Trust and T.H. Avery. Current monthly rent is $400.00.
Administrative Office - Annex to Covington Executive Offices: 2141 Emory Street, Covington, Georgia. Landlord is Robert R. Fowler III. Current monthly rent is $1,750.00.
The Company has entered into various construction contracts with Sunbelt Builders Inc., which is owned in part by Samuel B. Hay III’s sister and brother-in-law. Mr. Hay serves as a director of the Company and as its President and Chief Executive Officer. The contracts, which are in addition to other contracts with Sunbelt disclosed in previous reports, covered the construction of two new branch offices located in Rockdale County and Cobb County, Georgia. The construction covered by these contracts was completed during 2005. In 2005 the Company paid approximately $438,000 pursuant to these contracts.
The Company believes that the terms of the transactions described above are at least as favorable to it as terms available from unrelated third parties.
Item 14.
Item 14. Principal Accountant Fees and Services
Audit Fees
The Company’s independent public accountant, Ernst & Young LLP, billed the Company $440,728 for 2005 and $589,985 for 2004 for professional services relating to the annual audit, the reviews of the Company’s quarterly reports on Form 10-Q, and other services that are normally provided by the accountant in connection with statutory and regulatory filings. The Audit Committee of the Board of Directors of the Company has considered whether the providing of the services covered under the captions “Audit-Related Fees,” “Tax Fees” and “All Other Fees” is compatible with maintaining the independence of Ernst & Young LLP.
Audit-Related Fees
Ernst & Young LLP billed the Company $20,000 for 2005 and $19,000 for 2004 for professional services relating to the Company’s pension plan and $0 for 2005 and $14,600 for 2004 for professional services relating to internal control reviews, agreed upon procedures and other audit-related services.
Tax Fees
Ernst & Young LLP billed the Company $0 for 2005 and $44,600 for 2004 for professional services relating to tax compliance, tax advice and tax planning.
All Other Fees
Ernst & Young LLP did not bill the Company for any professional services during 2005 or 2004 except those described above.
Preapproval by Audit Committee
Under the Audit Committee’s charter, the Audit Committee is required to give advanced approval of any non-audit services to be performed by the Company’s independent public accountants, provided that such services are not otherwise prohibited by law. Therefore 100% of the services described under the headings “Audit-Related Fees”, “Tax Fees” and “All Other Fees” were pre-approved by the Audit Committee.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
The following financial statements are filed as part of this report under Item 8:
The following are filed with or incorporated by reference into this report
* Denotes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this form.
** Filed with the Registrant’s Form 10-K filed with the Commission on March 15, 2004.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MAIN STREET BANKS, INC.
(Registrant)
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: