Item 1. Business
General. We are a registered bank holding company incorporated in Missouri in 1978 and headquartered in St. Louis, Missouri. We operate through our wholly owned subsidiary bank holding company, The San Francisco Company, or SFC, and SFC's wholly owned subsidiary bank, First Bank, both headquartered in St. Louis, Missouri. First Bank operates through its subsidiaries, as listed below, and its branch banking offices. First Bank's subsidiaries are wholly owned, except for SBLS LLC, which was 51.0% owned by First Bank and 49.0% owned by First Capital America, Inc. as of December 31, 2006.
>> First Bank Business Capital, Inc.; >> Missouri Valley Partners, Inc., or MVP; >> Adrian N. Baker & Company, or Adrian Baker; >> Universal Premium Acceptance Corporation and its wholly owned subsidiary, UPAC of California, Inc., or collectively, UPAC; and >> Small Business Loan Source LLC, or SBLS LLC.
First Bank currently operates 195 branch offices in California, Illinois, Missouri and Texas, with 217 automated teller machines, or ATMs, across the four states. Over the last ten years, our organization has grown significantly, primarily as a result of our acquisition strategy, as well as through internal growth. At December 31, 2006, we had assets of $10.16 billion, loans, net of unearned discount, of $7.67 billion, deposits of $8.44 billion and stockholders' equity of $800.4 million.
Through First Bank, we offer a broad range of financial services, including commercial and personal deposit products, commercial and consumer lending, and many other financial products and services. Commercial and personal deposit products include demand, savings, money market and time deposit accounts. In addition, we market combined basic services for various customer groups, including packaged accounts for more affluent customers, and sweep accounts, lock-box deposits and cash management products for commercial customers. Commercial lending includes commercial, financial and agricultural loans, real estate construction and development loans, commercial real estate loans, small business lending, asset-based loans, trade financing and insurance premium financing. Consumer lending includes residential real estate, home equity and installment lending. Other financial services include mortgage banking, debit cards, brokerage services, employee benefit and commercial and personal insurance services, internet banking, remote deposit, ATMs, telephone banking, safe deposit boxes, and trust, private banking and institutional money management services. The revenues generated by First Bank and its subsidiaries consist primarily of interest income, generated from our loan and investment security portfolios, service charges and fees generated from our deposit products and services, and fees generated by our mortgage banking, insurance services, and trust, private banking and institutional money management services businesses. Our extensive line of products and services are offered to customers primarily within our geographic areas, which include eastern Missouri, Illinois, including the Chicago metropolitan area, southern and northern California, and Houston and Dallas, Texas. Certain loan products, including small business loans and insurance premium financing loans, are available nationwide through our subsidiaries, SBLS LLC and UPAC.
Primary responsibility for managing our banking units rests with the officers and directors of each unit, but we centralize many of our overall corporate policies, procedures and administrative functions and provide centralized operational support functions for our subsidiaries. This practice allows us to achieve various operating efficiencies while allowing our banking units to focus on customer service.
Various trusts, established by and administered by and for the benefit of Mr. James F. Dierberg, our Chairman of the Board, and members of his immediate family, own all of our voting stock. Mr. Dierberg and his family, therefore, control our management and policies.
We have formed numerous affiliated Delaware or Connecticut business or statutory trusts. These trusts operate as financing entities and were created for the sole purpose of issuing trust preferred securities, and the sole assets of the trusts are our subordinated debentures. In conjunction with the formation of our financing entities and their issuance of the trust preferred securities, we issued subordinated debentures to each of our financing entities in amounts equivalent to the respective trust preferred securities plus the amount of the common securities of the individual trusts, as outlined in the following table and more fully described in Note 12 to our Consolidated Financial Statements. We pay interest on our subordinated debentures to our respective financing entities. In turn, our financing entities pay distributions to the holders of the trust preferred securities. The interest payable on our subordinated debentures is included in interest expense in our consolidated statements of income.
The trust preferred securities issued by First Preferred Capital Trust IV are publicly held and traded on the New York Stock Exchange, or NYSE. The remaining trust preferred securities were issued in private placements. The trust preferred securities have no voting rights except in certain limited circumstances. A summary of the outstanding trust preferred securities issued by our affiliated statutory and business trusts, and our related subordinated debentures issued to our respective trusts in conjunction with the trust preferred securities offerings, is as follows:
Recent Developments. At the regular meeting of the First Banks, Inc., or First Banks, Board of Directors held on January 26, 2007, Mr. Allen H. Blake announced his retirement and resigned his positions as Director, President and Chief Executive Officer of First Banks, effective March 31, 2007. Upon acceptance of Mr. Blake's resignation, the Board of Directors elected Mr. Terrance M. McCarthy as President and Chief Executive Officer of First Banks, effective April 1, 2007.
Strategy. In the development of our banking franchise, we have focused on building and reorganizing our infrastructure as necessary to accomplish our objectives for organic growth, and to supplement this growth with de novo and acquisition strategies to further expand our banking franchise. Our organization is structured to leverage a strong sales force in each of our major market areas in an effort to continue to provide quality financial products and the highest level of customer service to our expanding customer base. Within the individual markets, the sales organization is supported by a regional structure to position it to serve the market opportunities within each area in the four states in which we operate. We are committed to serving the small business and mid-sized commercial segments along with the retail consumer market. We have devoted significant resources to improving our infrastructure dedicated to rapid approval, underwriting and documentation of consumer loans, strengthening our small business services area, increasing our commercial business development staff, reorganizing our marketing and product management areas, improving the quality and depth of our regional commercial and consumer management groups, and increasing resources for financial service product line and delivery systems, branch development and training, and administrative and operational support.
In the past three years, we have added three business lines, including an insurance premium financing company, an insurance brokerage agency and a small business lending group, providing our customers with new and expanded products and services to complement our existing line of financial services. In line with our small business lending strategy, we segmented the loan origination and servicing functions and added new business development officers throughout our markets. With the significant expansion of our Chicago banking franchise in the past three years, we have created a complete regional structure in the Chicago area as well as three additional commercial banking groups to enable our credit administration, commercial real estate and commercial and industrial banking groups, branch administration, credit review, and human resources and training functions to better serve our customers and employees. We continue to focus on modifying and effectively repositioning our internal and external resources to better serve the markets in which we operate. Although these efforts have led to certain increased capital expenditures and noninterest expenses, we expect they will lead to additional internal growth, more efficient operations and improved profitability over the long term, in accordance with our long-term corporate vision.
In the development of our banking franchise, we acquire other entities providing financial services as one means of achieving our growth objectives and to augment internal growth. Acquisitions may serve to enhance our presence in a given market, to expand the extent of our market area, to enable us to enter new or noncontiguous markets or to enable us to expand the array of financial services that we provide. Due to the nature of our ownership, we have elected to engage only in those acquisitions that can be accomplished for cash, rather than by issuing securities, which given the characteristics of the acquisition arena may, at times, place us at a competitive disadvantage relative to other acquirers offering stock transactions. This results from the market attractiveness of other financial institutions' stock and the advantages of tax-free exchanges to the selling shareholders. Our acquisition activities are generally somewhat sporadic because we may consummate multiple transactions in a particular period, followed by a substantially less active acquisition period.
Furthermore, the intangible assets recorded in conjunction with these acquisitions create an immediate reduction in our regulatory capital, providing further financial disincentives to paying large premiums in cash acquisitions.
Recognizing these facts, we generally follow certain patterns in our acquisitions. First, we generally acquire several smaller institutions, sometimes over an extended period of time, rather than a single larger one. We attribute this approach to the constraints imposed by the amount of funds required for a larger transaction, as well as the opportunity to minimize the aggregate premium required through smaller individual transactions. We may, however, periodically acquire larger institutions that provide us with the opportunity to rapidly expand our market presence in a highly desired market area. Secondly, in some acquisitions, we may acquire institutions having significant asset-quality, ownership, regulatory or other problems. We seek to address the risks of these issues by adjusting the acquisition pricing, accompanied by appropriate remedial attention after consummation of the transaction. In these institutions, these issues may diminish their attractiveness to other potential acquirers, and therefore may reduce the amount of acquisition premium required. Finally, we may pursue our acquisition strategy in other geographic areas, or pursue internal growth more aggressively because cash transactions may not be economically viable in extremely competitive acquisition markets.
Our acquisitions have allowed us to significantly expand our presence throughout our geographic markets, improve operational efficiencies, convey a more consistent image and quality of service and more cohesively market and deliver our products and services. Following our acquisitions, various undertakings are necessary to effectively integrate the acquired entities into our business systems and culture. While the specific activities required are dependent upon the individual circumstances surrounding each acquisition, the majority of our efforts have been concentrated in various areas including, but not limited to: (a) improving asset quality; (b) reducing unnecessary, duplicative and/or excessive expenses including personnel, information technology and certain other operational and administrative expenses; (c) maintaining, repairing and, in some cases, refurbishing bank premises necessitated by the deferral of such projects by some of the acquired entities; (d) renegotiating long-term leases that provide space in excess of that necessary for banking activities and/or at rates in excess of current market rates, or subleasing excess space to third parties; (e) relocating branch offices that are not adequate, conducive or convenient for banking operations; and (f) managing actual or potential litigation that existed with respect to acquired entities to minimize the overall costs of negotiation, settlement or litigation.
The post-acquisition process also includes the combining of separate and distinct entities together to form a cohesive organization with common objectives and focus. We have invested and continue to invest significant resources to reorganize staff, recruit and train personnel where needed, and establish the direction and focus necessary for the combined entity to take advantage of the opportunities available to it. This investment generally contributes to increases in noninterest expense, and results in the creation of new banking units within the newly integrated combined entity, which convey a more consistent image and quality of service. The new banking units provide a broad array of banking products to their customers and generally compete effectively in their marketplaces, even in the presence of other financial institutions with much greater resources. While some of these modifications do not contribute to reductions of noninterest expense, they contribute to the commercial and retail business development efforts of the combined entity, and ultimately to their prospects for improving future profitability.
Our business strategy also encompasses the opening of de novo branch offices as another means of achieving our growth objectives, particularly when our acquisition prospects are somewhat limited, primarily due to the market environment requiring significantly higher premiums in order to transact financial institution acquisitions. Our de novo branch strategy also provides similar opportunities to our acquisition strategy by allowing us to enhance our presence in our existing markets and enter new markets. Additionally, we generally have more flexibility in selecting the most opportunistic sites for our de novo branches, constructing the branch offices in accordance with our standard business model and marketing and promoting our customized products and services under our long-established trade name. We have plans underway to open several de novo branch offices over the next few years. We expect to further concentrate our efforts on this portion of our business strategy while continuing to identify viable acquisition candidates at reasonable acquisition premiums that are commensurate with our established acquisition strategy.
Acquisitions. In the continuing development of our banking franchise, we emphasize acquiring other financial institutions and financial services companies as one means of achieving our growth objectives. After we consummate an acquisition, we expect to enhance the franchise of the acquired entity by supplementing the marketing and business development efforts to broaden the customer bases, strengthening particular segments of the business or filling voids in the overall market coverage.
During the three years ended December 31, 2006, we completed ten bank acquisitions, four branch office purchases, the acquisition of an insurance premium financing company and an insurance brokerage agency, and purchased substantially all of the assets and assumed certain liabilities of a company that originates, sells and services SBA loans to small business concerns. As
demonstrated in the following table, our acquisitions during the past three years have significantly increased our banking franchise presence in the dynamic market areas of metropolitan Chicago, Dallas and Houston, and further augmented our existing markets in southern California and the Midwest. We funded these acquisitions from available cash reserves, borrowings under our secured credit facility and proceeds from the issuance of subordinated debentures.
These transactions, which are further described in Note 2 to our Consolidated Financial Statements, are summarized as follows:
Despite the significant expenses we incurred in the amalgamation of the acquired entities into our corporate culture and systems, and in the expansion of our organizational capabilities, the earnings of the acquired entities and the increased net interest income resulting from the transition in the composition of our loan and deposit portfolios have contributed to improving net income. For the years ended December 31, 2006, 2005 and 2004, net income was $111.7 million, $96.9 million and $82.9 million, respectively. Additional information pertaining to our business and results of operations is included in the information set forth in pages 18 through 51 of Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and in pages 101 through 102 of "Note 20 to our Consolidated Financial Statements," and is incorporated herein by reference. Although we may encounter certain short-term adverse effects on our operating results associated with acquisitions, we believe the long-term benefits of our acquisition program will exceed the short-term issues encountered with certain acquisitions. Accordingly, in addition to concentrating on internal growth through continued efforts to further develop our corporate infrastructure and product and service offerings, we expect to continue to identify and pursue opportunities for further growth through acquisitions and expansionary de novo branch activities.
Pending Acquisitions. On November 7, 2006, we entered into an Agreement and Plan of Reorganization providing for the acquisition of Royal Oaks Bancshares, Inc. and its wholly owned banking subsidiary, Royal Oaks Bank, ssb (collectively, Royal Oaks). Royal Oaks was headquartered in Houston, Texas and operated five banking offices in the Houston area and was in the process of opening an additional de novo branch banking office, which is now scheduled to open in the second quarter of 2007. As further described in Note 25 to our Consolidated Financial Statements, we completed our acquisition of Royal Oaks on February 28, 2007.
De Novo Branch Offices. During the three years ended December 31, 2006, we opened the following five de novo branch offices:
Branch Office Location Date Opened ---------------------- ----------- Farmington, Missouri January 18, 2005 San Diego, California August 16, 2004 McKinney, Texas July 19, 2004 Wildwood, Missouri February 20, 2004 Houston, Texas February 9, 2004
Acquisition and Integration Costs. Certain costs associated with our acquisitions are accrued as of the respective consummation dates, including costs that we incur related to salary continuation agreements, or other similar agreements, of executive management and certain other employees of the acquired entities that were in place prior to the acquisition dates, and costs relating to adjustments to the staffing levels of the acquired entities or to the anticipated termination of information technology or item processing contracts of the acquired entities prior to their stated contractual expiration dates. A summary of the cumulative acquisition and integration costs attributable to our acquisitions, which were accrued as of the consummation dates of the respective acquisition, are summarized in Note 2 to our Consolidated Financial Statements. These acquisition and integration costs are reflected in accrued and other liabilities in our consolidated balance sheets. As the obligation to make payments under these agreements is accrued at the consummation date, such payments do not have any impact on our consolidated statements of income. We also incur integration costs associated with our acquisitions that are expensed in our consolidated statements of income that relate principally to additional costs incurred in conjunction with the information technology conversions of the respective entities, as further discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations --Comparison of Results of Operations for 2006 and 2005, and --Comparison of Results of Operations for 2005 and 2004."
Lending Activities. As further discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations --Loans and Allowance for Loan Losses," our business development efforts are primarily focused on the origination of the following general loan types: commercial, financial and agricultural loans; real estate construction and land development loans; commercial real estate mortgage loans; and to a lesser extent, residential real estate mortgage loans. Our lending strategy emphasizes quality, growth and diversification. Throughout our organization, we employ a common credit underwriting policy. In addition to underwriting based on estimates and projection of financial strength, collateral values and future cash flows, most loans to borrowing entities other than individuals require the guarantee of the parent company or entity sponsor, or in the case of smaller entities, the personal guarantees of the principals. Our enhanced business development resources continue to assist in the realignment of certain acquired loan portfolios, which were skewed toward loan types that reflected the abilities and experiences of the management members of the acquired entities. In order to achieve a more diversified portfolio, to address asset-quality issues in the portfolios and to achieve a higher interest yield on our loan portfolio, we reduced a substantial portion of the loans that were acquired in certain acquisitions through payments, refinancing with other financial institutions, charge-offs and, in certain instances, sales of loans. As the acquired loan portfolios decrease, we attempt to replenish them with higher yielding loans that are internally generated by our business development function. With our acquisitions, we have expanded our business development function into the newly acquired market areas. We also continued to grow through internal growth. Consequently, in spite of relatively large reductions in certain acquired portfolios, our aggregate loan portfolio, net of unearned discount, increased 41.7% from $5.41 billion at December 31, 2001, to $7.67 billion at December 31, 2006.
In addition to restructuring our loan portfolio, we also have experienced a change in the composition of our deposit base, through deposit development programs and the mix of deposits acquired through our recent acquisitions. A majority of our deposit development programs are directed toward increased transaction accounts, such as demand and savings accounts. However, we have recently experienced increased time deposits, coupled with higher deposit rates paid on certain products, resulting from the highly competitive rate market. We have also expanded our development of multiple account relationships with individual customers by broadening our relationship with existing customers and the products provided to our customers. This growth is accomplished by cross-selling various products and services, packaging account types and offering incentives to deposit customers on other deposit or non-deposit services. The expansion of our small business market lending provides additional opportunities to cross sell other financial services such as investment, trust, insurance and traditional personal banking services to small business owners. In addition, commercial borrowers are encouraged to maintain their operating deposit accounts with us. Our time deposits have increased to $3.83 billion at December 31, 2006, representing 45.3% of total deposits, as compared to $3.15 billion, or 41.8% of total deposits, at December 31, 2005. Our demand and savings accounts have increased to $4.62 billion at December 31, 2006, representing 54.7% of total deposits, as compared to $4.39 billion, or 58.2% of total deposits, at December 31, 2005, reflecting our continued focus on transactional accounts and full service deposit relationships with our customers.
Commercial, Financial and Agricultural. Our commercial, financial and agricultural loan portfolio, including lease financing, was $1.93 billion, or 25.2% of total loans, at December 31, 2006, compared to $1.62 billion, or 23.1% of total loans, at December 31, 2005. The primary component of commercial, financial and agricultural loans is commercial loans, which are made based on the borrowers' general credit strength and ability to generate cash flows for repayment from income sources. Most of these loans are made on a secured basis, generally involving the use of company equipment, inventory and/or accounts receivable, and, from time to time, real estate, as collateral. Regardless of collateral, substantial emphasis is placed on the borrowers' ability to generate cash flow sufficient to operate the business and provide coverage of debt servicing requirements. Commercial loans are frequently renewable annually, although some terms may be as long as five years. These loans typically require the borrower to maintain certain operating covenants appropriate for the specific business, such as profitability, debt service coverage and current asset and leverage ratios, which are generally reported and monitored on a quarterly basis and subject to more detailed annual reviews. Commercial loans are made to customers primarily located in First Bank's geographic trade areas of California, Illinois, Missouri and Texas who are engaged in manufacturing, retailing, wholesaling and service businesses. This portfolio is not concentrated in large specific industry segments that are characterized by sufficient homogeneity that would result in significant concentrations of credit exposure. Rather, it is a highly diversified portfolio that encompasses many industry segments. Within both our real estate and commercial lending portfolios, we strive for the highest degree of diversity that is practicable. We also emphasize the development of other service relationships, particularly deposit accounts, with our commercial borrowers.
Real Estate Construction and Development. Our real estate construction and land development loan portfolio was $1.83 billion, or 23.9% of total loans, at December 31, 2006, compared to $1.56 billion, or 22.3% of total loans, at December 31, 2005. Real estate construction and land development loans include commitments for construction of both residential and commercial properties. Commercial real estate projects often require commitments for permanent financing from other lenders upon completion of the project and, more typically, may include a short-term amortizing component of the financing from the bank. Commitments for construction of multi-tenant commercial and retail projects generally require lease commitments from a substantial primary tenant or tenants prior to commencement of construction. We typically engage in multi-phase, multi-tenant projects, as opposed to large vertical projects, that allow us to complete the projects in phases and limit the number of tenant building starts based upon successful lease and/or sale of the tenant units. We finance some projects for borrowers whose home office is located within our trade area but the particular project may be outside our normal trade area. Although we generally do not engage in developing commercial and residential construction lending business outside of our trade area, certain loans acquired in recent acquisitions have been related to projects outside our trade area. Residential real estate construction and development loans are made based on the cost of land acquisition and development, as well as the construction of the residential units. Although we finance the cost of display units and units held for sale, a substantial portion of the loans for individual residential units have purchase commitments prior to funding. Residential condominium projects are funded as the building construction progresses, but funding of unit finishing is generally based on firm sales contracts.
Commercial Real Estate. Our commercial real estate loan portfolio was $2.20 billion, or 28.7% of total loans, at December 31, 2006, compared to $2.11 billion, or 30.1% of total loans, at December 31, 2005. Commercial real estate loans include loans for which the intended source of repayment is rental and other income from the real estate. This includes commercial real estate developed for lease to third parties as well as the owner's occupancy. The underwriting of owner occupied commercial real estate loans generally follows the procedures for commercial lending described above, except that the collateral is real estate, and the loan term may be longer. The primary emphasis in underwriting loans for which the source of repayment is the performance of the collateral is the projected cash flow from the real estate and its adequacy to cover the operating costs of the project and the debt service requirements. Secondary emphasis is placed on the appraised value of the real estate, with the requirement that the appraised liquidation value of the collateral must be adequate to repay the debt and related interest in the event the cash flow becomes insufficient to service the debt. Generally, underwriting terms require the loan principal not to exceed 80% of the appraised value of the collateral and the loan maturity not to exceed ten years. Commercial real estate loans are made for commercial office space, retail properties, hospitality, industrial and warehouse facilities and recreational properties. We rarely finance commercial real estate or rental properties that do not have lease commitments for a majority of the rentable space.
Residential Real Estate Mortgage. Our residential real estate mortgage loan portfolio was $1.27 billion, or 16.6% of total loans, at December 31, 2006, compared to $1.21 billion, or 17.3% of total loans, at December 31, 2005. Residential real estate mortgage loans are primarily loans secured by single-family, owner-occupied properties. These loans include both adjustable rate and fixed rate mortgage loans. Although we typically originate residential real estate mortgage loans for sale in the secondary mortgage market in the form of a mortgage-backed security or to various private third-party investors, from time-to-time, we retain certain residential mortgage loans in our loan portfolio as directed by management's business strategies. These strategies are reflected in the expansion of our one-to-four family residential real estate mortgage loans, excluding loans held for sale, since 2004, with a home equity product line campaign in mid-2004 and our business strategy decision in mid-2003 to retain a portion of our new loan production in our real estate mortgage portfolio to provide more diversification within our loan portfolio and to compensate for continued weak loan demand in other sectors of our loan portfolio at that time. In addition, in the third quarter of 2005, we began retaining additional mortgage loan production in our residential real estate mortgage portfolio, including 15-year fixed rate, conforming conventional adjustable rate mortgages and other similar products, which contributed to an increase in this portion of our loan portfolio and represented a strategy we employed throughout the first and second quarters of 2006 prior to reverting to our longer-term business strategy of selling the majority of our mortgage loan production in the secondary mortgage market.
Nonperforming Loans. Our nonperforming loans were $48.7 million, $97.2 million and $85.8 million at December 31, 2006, 2005 and 2004, respectively, representing 0.64%, 1.38% and 1.40%, respectively, of total loans, as further discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations --Loans and Allowance for Loan Losses." These levels of nonperforming loans, particularly in 2004 and 2005, are higher than our historical averages which we attribute to our acquisitions, growth within our loan portfolio and increased commercial lending activities. During 2004 and 2005, our commercial real estate portfolio experienced increasing amounts of nonperforming loans, largely attributable to the problem loans acquired with our acquisition of CIB Bank in November 2004, as further discussed below. During 2004, 2005 and 2006, we also experienced increasing amounts of nonperforming loans within our real estate construction and development loan portfolio, reflective of current market conditions surrounding land acquisition and development loans, including slowdowns in unit sales.
Although the level of nonperforming loans associated with our acquisitions completed in 2006 and 2005 was not significant, the level of nonperforming loans associated with our acquisitions completed in 2004 was substantial. We had been experiencing higher levels of nonperforming loans during 2002 and 2003, primarily attributable to general economic conditions, additional problems identified in certain acquired loan portfolios and the continued deterioration of the portfolio of leases in our commercial leasing portfolio, particularly the segment related to the airline industry following the events of September 11, 2001. Throughout 2004, we had begun to exhibit a substantial improvement in the level of our nonperforming loans, primarily as a result of significant loan payoffs, the sale of a portion of our commercial leasing portfolio in mid-2004, the sale of certain acquired nonperforming loans, the strengthening of certain loans and our continued efforts to improve asset quality. However, we experienced a significant increase in the level of our nonperforming loans associated with our acquisition of CIB Bank in November 2004. As of the date of the acquisition, CIB Bank had $60.3 million of nonperforming loans, which represented approximately 8.8% of CIB Bank's total loan portfolio, largely attributable to a significant concentration in commercial real estate loans outstanding to a relatively small number of borrowers. When we analyzed the CIB Bank acquisition during our due diligence process prior to the acquisition, we determined the level of problem loans that we expected to acquire with this acquisition would, when combined with our existing portfolio of such loans, result in a level of problem loans that was unacceptable to management. Consequently, during the fourth quarter of 2004, we completed the sale of approximately $50.2 million of problem loans, including $19.1 million of nonperforming loans, which include loans on nonaccrual status and restructured loans. We had anticipated these problems in negotiating the acquisition price of CIB Bank. While CIB Bank had utilized a long-term workout strategy to address certain nonperforming assets, our strategy was to address problem assets in a more accelerated manner. Accordingly, we elected to hold for sale a portion of the problem assets acquired from CIB Bank. In December 2004, we transferred $18.3 million of CIB Bank's nonperforming loans to loans held for sale and recorded a corresponding charge of $5.4 million to our allowance for loan losses to reduce the loans held for sale to their estimated fair value, net of costs,
that was expected to be realized at the time of the sale, resulting in $12.9 million of loans classified as held for sale at December 31, 2004, that were subsequently sold in early 2005, as further discussed below. Furthermore, we increased the allowance for loan losses by $15.7 million to reflect the additional reserves associated with the loans transferred to loans held for sale and the application of our loss factors to CIB Bank's loan portfolio risk ratings. This reflects our use of strategies for more rapid disposition and recovery of certain acquired classified and nonperforming assets. The level of nonperforming loans related to our CIB Bank acquisition declined to $50.5 million at December 31, 2004, representing 58.8% of our total nonperforming loans. As further described in Note 2 to our Consolidated Financial Statements, we completed the sale of the loans during the first and second quarters of 2005. As a result of loan payoffs prior to the sales and sales prices significantly in excess of the original third-party bid estimates for certain loans held for sale, we recorded a $10.0 million reduction in goodwill to adjust loans held for sale, net of the related tax effect.
During 2005, we experienced continued improvement in our portfolio of nonperforming loans through the first nine months of the year, however, further deterioration of certain acquired loans in the fourth quarter of 2005 contributed to an increase in nonperforming loans for 2005 and the decision to sell certain loans and transfer them to our loans held for sale portfolio. This increase was primarily associated with the deterioration of a few large credit relationships during the fourth quarter of 2005, including two relationships totaling $31.5 million. As a result, on December 31, 2005, we recognized $7.6 million of loan charge-offs in conjunction with the transfer of approximately $59.7 million of nonperforming loans to our held for sale portfolio (of which $6.0 million in charge-offs and $56.1 million of loans transferred were associated with the CIB Bank acquired portfolio). These loans included the two large credit relationships that had deteriorated during the fourth quarter of 2005 and one credit relationship of $12.4 million that was included in nonperforming loans at December 31, 2004 with a value of $14.5 million, all of which were acquired in the purchase of CIB Bank. The $59.7 million represented the estimated fair value, net of costs, that was expected to be realized at the time of sale. The overall increase in nonperforming loans in 2005 was partially offset by significant improvement of 21.0% in the level of nonperforming loans during the first three quarters of 2005 resulting from the sale of certain acquired nonperforming loans, strengthening of certain loans, and loan payoffs and/or external refinancing of various credits. A portion of the loan payoffs and sales during the first quarter of 2005 pertaining to certain acquired nonperforming loans that were classified as loans held for sale as of December 31, 2004 contributed to a reallocation of the purchase price on our acquisition of CIB Bank, as previously discussed and further described in Note 2 to our Consolidated Financial Statements. The level of nonperforming loans related to our CIB Bank acquisition, which had declined to $32.8 million at the end of the third quarter of 2005 from sales of loans and additional loan payoffs, increased to $55.0 million, or 56.6% of nonperforming loans, at December 31, 2005 as a result of the further deterioration of the few credit relationships in the fourth quarter of 2005, as previously mentioned. Through loan payoffs, the sale of certain remaining nonperforming loans and continued aggressive collection efforts, we did not have any nonperforming loans associated with our acquisition of CIB Bank at December 31, 2006, as further discussed below.
In January 2006, we received a payoff on one of the nonperforming loans in our held for sale portfolio, reducing the held for sale portfolio by $12.4 million and resulting in the recognition of a $5.0 million loan recovery. In addition, in March 2006, we completed the sale of a majority of the remaining nonaccrual loans in our held for sale portfolio, reducing the held for sale portfolio by $32.5 million, and in September 2006, we recorded a $1.1 million write-down on a remaining nonperforming loan in our held for sale portfolio and transferred the loan at its estimated fair value of $13.5 million back to our loan portfolio. We subsequently received a payoff on this nonperforming loan for the amount of the adjusted carrying value in December 2006. Furthermore, in the fourth quarter of 2006, we elected to sell certain nonperforming loans and recognized loan charge-offs of $2.3 million in conjunction with the transfer of $32.6 million of certain loans to our held for sale portfolio prior to their sale, including $14.8 million of nonperforming loans. We completed the sale of these loans held for sale in December 2006 and recognized a pre-tax gain of $3.7 million. These reductions in loans during 2006 were partially offset by deterioration within our one-to-four family residential loan portfolio primarily due to current market conditions, as well as several credit relationships, primarily within our residential development and construction portfolio in late 2006, that were placed on nonaccrual status during 2006.
We believe the levels of our nonperforming assets, while largely attributable to our acquisitions and the overall risk in our loan portfolio, are also reflective of cyclical trends experienced within the banking industry as a result of economic conditions within our market areas. During 2006, we successfully reduced our nonperforming loans by $48.5 million, or 49.9%, and we will continue our efforts to further reduce the overall level of these assets through an ongoing process of problem loan work-outs, loan payoffs and external refinancings, and possibly additional sales of certain nonperforming loans. Loans past due 90 days or more and still accruing interest remained relatively flat, totaling $5.7 million at December 31, 2006, compared to $5.6 million at December 31, 2005, but showed significant improvement during 2005, decreasing $23.1 million from $28.7 million at December 31, 2004. Loan charge-offs, net of recoveries, decreased to $6.8 million for 2006, from $13.4 million for 2005, and $24.8 million for 2004, as further discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations --Loans and Allowance for Loan Losses."
SBLS LLC's purchase of substantially all of the assets of SBLS in August 2004 resulted in an increase to nonperforming loans of $8.8 million, which represented approximately 36.7% of SBLS's loan portfolio at the time of acquisition. SBLS LLC held a significant concentration of assets associated with the shrimping vessel industry, reflected in both loans and other repossessed assets. The shrimping vessel industry concentration and its depressed status were reflected in our net asset purchase price. SBLS LLC's asset concentration associated with the distressed shrimping vessels industry further deteriorated in 2005 due to higher interest rates, increased fuel costs, and the physical damage to several of the vessels by Hurricane Katrina. As a result, the SBA agreed to repurchase SBLS LLC's entire shrimping vessels portfolio, and these loans were placed in liquidation status resulting in the recognition of substantial loan losses in 2005. Throughout 2006, the majority of these loans have been fully liquidated via completion of the sale of the underlying collateral and/or the collection of insurance proceeds associated with vessels that were deemed to be irreparable. SBLS LLC's nonperforming loans have declined substantially since the date of acquisition to $1.6 million at December 31, 2006, from $1.8 million and $6.2 million at December 31, 2005 and 2004, respectively. SBLS LLC's net loan charge-offs were $256,000 for 2006, compared to $3.8 million in 2005 and $690,000 in 2004.
Market Areas. As of December 31, 2006, First Bank's 187 banking facilities were located in California, Illinois, Missouri and Texas. First Bank operates in the St. Louis metropolitan area, in eastern Missouri and throughout Illinois, including Chicago. First Bank also operates in southern California, including San Diego and the greater Los Angeles metropolitan area, including Ventura County, Riverside County and Orange County; in Santa Barbara County; in northern California, including the greater San Francisco, San Jose and Sacramento metropolitan areas; and in Texas in the Houston and Dallas metropolitan areas. Our larger networks of branch offices are located in high growth markets, specifically the Los Angeles, Chicago and St. Louis metropolitan areas.
The following table lists the geographic market areas in which First Bank operates, total deposits, deposits as a percentage of total deposits and the number of locations as of December 31, 2006:
Competition and Branch Banking. The activities in which First Bank engages are highly competitive. Those activities and the geographic markets served primarily involve competition with other banks, some of which are affiliated with large regional or national holding companies, and other financial services companies. Financial institutions compete based upon interest rates offered on deposit accounts and other credit and service charges, the types of products and quality of services rendered, the convenience of branch facilities, interest rates charged on loans and, in the case of loans to large commercial borrowers, relative lending limits.
Our principal competitors include other commercial banks, savings banks, savings and loan associations, mutual funds, finance companies, including insurance premium financing companies, trust companies, insurance brokerage companies, credit unions, mortgage companies, leasing companies, private issuers of debt obligations and suppliers of other investment alternatives, such as securities firms and financial holding companies. Many of our non-bank competitors are not subject to the same degree of regulation as that imposed on bank holding companies, federally insured banks and national or state chartered banks. As a result, such non-bank competitors have advantages over us in providing certain services. We also compete with major multi-bank holding companies, which are significantly larger than us and have greater access to capital and other resources.
We believe we will also continue to face competition in the acquisition of independent banks, savings banks, branch offices and other financial companies. We often compete with larger financial institutions that have substantially greater resources available for making acquisitions.
Subject to regulatory approval, commercial banks operating in California, Illinois, Missouri and Texas are permitted to establish branches throughout their respective states, thereby creating the potential for additional competition in our service areas.
Supervision and Regulation
General. Along with First Bank, we are extensively regulated by Federal and state laws and regulations which are designed to protect depositors of First Bank and the safety and soundness of the U.S. banking system, not our stockholders. To the extent this discussion refers to statutory or regulatory provisions, it is not intended to summarize all such provisions and is qualified in its entirety by reference to the relevant statutory and regulatory provisions. Changes in applicable laws, regulations or regulatory policies may have a material effect on our business and prospects. We are unable to predict the nature or extent of the effects on our business and earnings that new federal and state legislation or regulation may have. The enactment of the legislation described below has significantly affected the banking industry generally and is likely to have ongoing effects on First Bank and us in the future.
As a registered bank holding company under the Bank Holding Company Act of 1956, as amended, we are subject to regulation and supervision of the Board of Governors of the Federal Reserve System, or Federal Reserve. We file annual reports with the Federal Reserve and provide to the Federal Reserve additional information as it may require.
Since First Bank is an institution chartered by the State of Missouri and a member of the Federal Reserve, both the State of Missouri Division of Finance and the Federal Reserve supervise, regulate and examine First Bank. First Bank is also regulated by the Federal Deposit Insurance Corporation, or FDIC, which provides deposit insurance of up to $100,000 for each insured depositor.
Bank Holding Company Regulation. The activities of bank holding companies are generally limited to the business of banking, managing or controlling banks, and other activities that the Federal Reserve has determined to be so closely related to banking or managing or controlling banks as to the proper incident thereto. In addition, under the Gramm-Leach-Bliley Act, or GLB Act, which was enacted in November 1999 and is further discussed below, a bank holding company, whose control depository institutions are "well-capitalized" and "well-managed" (as defined in Federal Banking Regulations), and which obtains "satisfactory" Community Reinvestment Act (discussed briefly below) ratings, may declare itself to be a "financial holding company" and engage in a broader range of activities. As of this date, we are not a "financial holding company."
We are also subject to capital requirements applied on a consolidated basis, which are substantially similar to those required of First Bank (briefly summarized below). The Bank Holding Company Act also requires a bank holding company to obtain approval from the Federal Reserve before:
>> acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls a majority of such shares);
>> acquiring all or substantially all of the assets of another bank or bank holding company; or
>> merging or consolidating with another bank holding company.
The Federal Reserve will not approve any acquisition, merger or consolidation that would have a substantially anti-competitive result, unless the anti-competitive effects of the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial factors in reviewing acquisitions and mergers.
Safety and Soundness and Similar Regulations. We are subject to various regulations and regulatory policies directed at the financial soundness of First Bank. These include, but are not limited to, the Federal Reserve's source of strength policy, which obligates a bank holding company such as us to provide financial and managerial strength to its subsidiary banks; restrictions on the nature and size of certain affiliate transactions between a bank holding company and its subsidiary depository institutions and restrictions on extensions of credit by its subsidiary banks to executive officers, directors, principal stockholders and the related interests of such persons.
Regulatory Capital Standards. The federal bank regulatory agencies have adopted substantially similar risk-based and leverage capital guidelines for banking organizations. Risk-based capital ratios are determined by classifying assets and specified off-balance sheet obligations and financial instruments into weighted categories, with higher levels of capital being required for categories deemed to represent greater risk. Federal Reserve policy also provides that banking organizations generally, and particularly those that are experiencing internal growth or actively making acquisitions, are expected to maintain capital positions that are substantially above the minimum supervisory levels, without significant reliance on intangible assets.
Under the risk-based capital standard, the minimum consolidated ratio of total capital to risk-adjusted assets required for bank holding companies is 8%. At least one-half of the total capital must be composed of common equity, retained earnings, qualifying noncumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less certain items such as goodwill and certain other intangible assets, which amount is referred to as "Tier I capital." The remainder may consist of qualifying hybrid capital instruments, perpetual debt, mandatory convertible debt securities, a limited amount of subordinated debt, preferred stock that does not qualify as Tier I capital and a limited amount of loan and lease loss reserves, which amount, together with Tier I capital, is referred to as "Total Risk-Based Capital."
In addition to the risk-based standard, we are subject to minimum requirements with respect to the ratio of our Tier I capital to our average assets less goodwill and certain other intangible assets, or the Leverage Ratio. Applicable requirements provide for a minimum Leverage Ratio of 3% for bank holding companies that have the highest supervisory rating, while all other bank holding companies must maintain a minimum Leverage Ratio of at least 4% to 5%. The Office of the Comptroller of the Currency and the FDIC have established capital requirements for banks under their respective jurisdictions that are consistent with those imposed by the Federal Reserve on bank holding companies.
Information regarding our capital levels and First Bank's capital levels under the federal capital requirements is contained in Note 21 to our Consolidated Financial Statements appearing elsewhere in this report. As further described in
Note 21 to our Consolidated Financial Statements, on March 1, 2005, the Federal Reserve adopted a final rule, Risk-Based Capital Standards: Trust Preferred Securities and the Definition of Capital, which allows for the continued inclusion, on a limited basis, of trust preferred securities in Tier I capital. Under the final rule, trust preferred securities and other restricted core capital elements will be subject to stricter quantitative limits. The Federal Reserve's final rule limits restricted core capital elements to 25% of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability.
Prompt Corrective Action. The FDIC Improvement Act requires the federal bank regulatory agencies to take prompt corrective action in respect to depository institutions that do not meet minimum capital requirements. A depository institution's status under the prompt corrective action provisions depends upon how its capital levels compare to various relevant capital measures and other factors as established by regulation.
The federal regulatory agencies have adopted regulations establishing relevant capital measures and relevant capital levels. Under the regulations, a bank will be:
>> "well capitalized" if it has a total risk-based capital ratio of 10% or greater, a Tier I capital ratio of 6% or greater and a Leverage Ratio of 5% or greater and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure;
>> "adequately capitalized" if it has a total risk-based capital ratio of 8% or greater, a Tier I capital ratio of 4% or greater and a Leverage Ratio of 4% or greater (3% in certain circumstances);
>> "undercapitalized" if it has a total risk-based capital ratio of less than 8%, a Tier I capital ratio of less than 4% or a Leverage Ratio of less than 4% (3% in certain circumstances);
>> "significantly undercapitalized" if it has a total risk-based capital ratio of less than 6%, a Tier I capital ratio of less than 3% or a Leverage Ratio of less than 3%; and
>> "critically undercapitalized" if its tangible equity is equal to or less than 2% of its average quarterly tangible assets.
Under certain circumstances, a depository institution's primary federal regulatory agency may use its authority to lower the institution's capital category. The banking agencies are permitted to establish individual minimum capital requirements exceeding the general requirements described above. Generally, failing to maintain the status of "well capitalized" or "adequately capitalized" subjects a bank to restrictions and limitations on its business that become progressively more severe as the capital levels decrease.
A bank is prohibited from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the bank would thereafter be "undercapitalized." Limitations exist for "undercapitalized" depository institutions regarding, among other things, asset growth, acquisitions, branching, new lines of business, acceptance of brokered deposits and borrowings from the Federal Reserve System. These institutions are also required to submit a capital restoration plan that includes a guarantee from the institution's holding company. "Significantly undercapitalized" depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized," requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. The appointment of a receiver or conservator may be required for "critically undercapitalized" institutions.
Dividends. Our primary source of funds in the future is the dividends, if any, paid by First Bank. The ability of First Bank to pay dividends is limited by federal laws, by regulations promulgated by the bank regulatory agencies and by principles of prudent bank management. Under the most restrictive of these requirements, the future payment of dividends from First Bank is limited to approximately $135.0 million at December 31, 2006, unless prior permission of the regulatory authorities is obtained.
Customer Protection. First Bank is also subject to consumer laws and regulations intended to protect consumers in transactions with depository institutions, as well as other laws or regulations affecting customers of financial institutions generally. These laws and regulations mandate various disclosure requirements and substantively regulate the manner in which financial institutions must deal with their customers. First Bank must comply with numerous regulations in this regard and is subject to periodic examinations with respect to its compliance with the requirements.
Community Reinvestment Act. The Community Reinvestment Act of 1977 requires that, in connection with examinations of financial institutions within their jurisdiction, the federal banking regulators evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those financial institutions. These factors are also considered in evaluating mergers, acquisitions and other applications to expand.
The Gramm-Leach-Bliley Act. The GLB Act, enacted in 1999, amended and repealed portions of the Glass-Steagall Act and other federal laws restricting the ability of bank holding companies, securities firms and insurance companies to affiliate with each other and to enter new lines of business. The GLB Act established a comprehensive framework to permit financial companies to expand their activities, including through such affiliations, and to modify the federal regulatory structure governing some financial services activities. This authority of financial firms to broaden the types of financial services offered to customers and to affiliates with other types of financial services companies may lead to further consolidation in the financial services industry. However, it may lead to additional competition in the markets in which we operate by allowing new entrants into various segments of those markets that are not the traditional competitors in those segments. Furthermore, the authority granted by the GLB Act may encourage the growth of larger competitors.
The GLB Act also adopted consumer privacy safeguards requiring financial services providers to disclose their policies regarding the privacy of customer information to their customers and, subject to some exceptions, allowing customers to "opt out" of policies permitting such companies to disclose confidential financial information to non-affiliated third parties.
The Sarbanes-Oxley Act. In July 2002, the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, was enacted. Sarbanes-Oxley imposes a myriad of corporate governance and accounting measures designed to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of disclosures under securities laws. All public companies that file periodic reports with the Securities and Exchange Commission, or SEC, are affected by Sarbanes-Oxley.
Sarbanes-Oxley addresses, among other matters: (i) the creation of an independent accounting oversight board to oversee the audit of public companies and auditors who perform such audits; (ii) auditor independence provisions which restrict non-audit services that independent accountants may provide to their audit clients; (iii) additional corporate governance and responsibility measures which require the chief executive officer and chief financial officer to certify financial statements, to forfeit salary and bonuses in certain situations, and protect whistleblowers and informants; (iv) expansion of the audit committee's authority and responsibility by requiring that the audit committee have direct control of the outside auditor, be able to hire and fire the auditor, and approve all non-audit services; (v) requirements that audit committee members be independent; (vi) disclosure of a code of ethics; and (vii) enhanced penalties for fraud and other violations. The provisions of Sarbanes-Oxley also require that management assess the effectiveness of internal control over financial reporting and that the independent auditor issue a report on management's attestation on internal control over financial reporting. However, because we are a non-accelerated filer, this provision of Sarbanes-Oxley will not become effective for us until the fiscal year ended December 31, 2007.
Sarbanes-Oxley has and is expected to continue to increase the administrative costs of doing business for public companies; however, we cannot predict the significance of such increase.
The USA Patriot Act. The Patriot Act was enacted in October 2001 in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. that occurred on September 11, 2001. The Patriot Act is intended to strengthen the ability of U.S. law enforcement agencies and the intelligence communities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. The Patriot Act is expected to increase the administrative costs and burden of doing business for financial institutions; however, while we cannot predict the full impact of such an increase, we do not expect it to differ from that of other financial institutions.
Reserve Requirements; Federal Reserve System and Federal Home Loan Bank System. The Federal Reserve requires all depository institutions to maintain reserves against their transaction accounts and non-personal time deposits. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements. Institutions are authorized to borrow from the Federal Reserve Bank discount window, but Federal Reserve regulations require institutions to exhaust other reasonable alternative sources of funds, including advances from Federal Home Loan Banks, before borrowing from the Federal Reserve Bank.
First Bank is a member of the Federal Reserve System and the Federal Home Loan Bank System. As a member, First Bank is required to hold investments in regional banks within those systems. First Bank was in compliance with these requirements at December 31, 2006, with investments of $10.3 million in stock of the Federal Home Loan Bank of Des Moines and $24.9 million in stock of the Federal Reserve Bank of St. Louis. First Bank also holds an investment of $784,000 in stock of the Federal Home Loan Bank of San Francisco and $54,000 in stock of the Federal
Home Loan Bank of Dallas, as a nonmember, to collateralize certain Federal Home Loan Bank advances assumed in conjunction with certain acquisition transactions.
Monetary Policy and Economic Control. The commercial banking business is affected by legislation, regulatory policies and general economic conditions as well as the monetary policies of the Federal Reserve. The instruments of monetary policy available to the Federal Reserve include the following: (i) changes in the discount rate on member bank borrowings and the targeted federal funds rate; (ii) the availability of credit at the discount window; (iii) open market operations; (iv) the imposition of changes in reserve requirements against deposits of domestic banks; (v) the imposition of changes in reserve requirements against deposits and assets of foreign branches; and (vi) the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates.
These monetary policies are used in varying combinations to influence overall growth and distributions of bank loans, investments and deposits, and this use may affect interest rates charged on loans or paid on liabilities. The monetary policies of the Federal Reserve have had a significant effect on the operating results of commercial banks and are expected to do so in the future. Such policies are influenced by various factors, including inflation, unemployment, and short-term and long-term changes in the international trade balance and in the fiscal policies of the U.S. Government. We cannot predict the effect that changes in monetary policy or in the discount rate on member bank borrowings will have on our future business and earnings or those of First Bank.
Employees
As of March 28, 2007, we employed approximately 2,930 employees. None of the employees are subject to a collective bargaining agreement. We consider our relationships with our employees to be good.
Item 1A.
Item 1A. Risk Factors
Readers of our Annual Report on Form 10-K should consider the risk factors described below in conjunction with the other information included in this Annual Report on Form 10-K, including Management's Discussion and Analysis of Financial Condition and Results of Operations, our Selected Financial Data, our Consolidated Financial Statements and the related notes thereto, and the financial and other data contained elsewhere in this report. See also "Special Note Regarding Forward-Looking Statements" appearing at the beginning of this report.
We pursue acquisitions to supplement our internal growth. Acquisitions involve varying degrees of inherent risk that could affect our profitability. Acquisitions of other banks or businesses may expose us to asset quality problems, higher than anticipated expenses, operational problems or unknown or contingent liabilities of the entities we acquire. If the quantity of these problems exceeds our estimates, our earnings and financial condition may be adversely affected. Furthermore, acquisitions generally require integration of the acquired entity's systems and procedures with ours in order to make the transaction economically feasible. This integration process is complicated and time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not conducted successfully and with minimal effect on the business and its customers, we may not realize the anticipated economic benefits of particular acquisitions within the expected time frame, and we may lose higher than expected numbers of customers or employees of the acquired business.
Competition for acquisitions in the financial services industry and our status as a privately held company make our efforts to grow through acquisitions difficult. We face intense competition from other financial institutions in pursuing acquisitions, particularly related to price. Prices at which acquisitions can be made fluctuate with market conditions. We have experienced times during which acquisitions could not be made in specific markets at prices our management considered acceptable, and we expect that this situation will happen again. Because of our intention to remain a closely held company, we do not use our common stock to make acquisitions. Our use of cash as acquisition consideration can be a disadvantage in acquisitions relative to other prospective acquirers in those instances in which selling stockholders desire a tax-free exchange.
Geographic distance between our operations increases operating costs and makes efforts to standardize operations more difficult. We operate banking offices in California, Illinois, Missouri and Texas. The noncontiguous nature of many of our geographic markets increases operating costs and makes it more difficult for us to standardize our business practices and procedures. As a result of our geographic dispersion, we face the following challenges, among others: (a) operation of information technology and item processing functions at remote locations including the transportation of documents and increased communications line charges from various service providers; (b) control of correspondent accounts, reserve balances and wire transfers in different time zones; (c) familiarizing personnel with our business environment, banking practices and customer requirements at geographically dispersed locations; (d) providing administrative support, including accounting, human resources, credit administration, loan servicing, internal audit and credit review at significant distances; and (e) establishing and monitoring compliance with our corporate policies and procedures in different areas.
Our emphasis on commercial real estate lending and real estate construction and development lending has increased our credit risk. Our expanded level of commercial real estate and construction and development lending may carry with it greater credit risk than the credit risk associated with residential real estate lending. A substantial portion of our loans are secured by commercial real estate. Commercial real estate and real estate construction and development loans were $2.20 billion and $1.83 billion, respectively, at December 31, 2006, representing 29.6% and 24.6%, respectively, of our loan portfolio, excluding loans held for sale. As previously discussed under "Business --Lending Activities," during 2004 and 2005, we experienced increasing amounts of nonperforming loans within our commercial real estate portfolio, largely attributable to the problem loans acquired with our acquisition of CIB Bank in November 2004, and we have taken steps to significantly reduce the level of nonperforming loans during 2005 and 2006. During 2006, we experienced increasing amounts of nonperforming loans within our real estate construction and development loan portfolios, reflective of current market conditions surrounding land acquisition and development loans, including slowdowns in unit sales. Adverse developments affecting real estate in one or more of our markets could further increase the credit risk associated with our loan portfolio, as further discussed under "Business --Lending Activities" and "Management's Discussion and Analysis of Financial Condition and Results of Operations --Loans and Allowance for Loan Losses." The Department of the Treasury, Federal Reserve and FDIC collectively issued guidance entitled, "Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices," that focuses on financial institutions that have high and increasing concentrations of commercial real estate loans on their balance sheets that make them more vulnerable to cyclical commercial real estate markets, and is intended to reinforce the institution's risk management practices and appropriate capital levels associated with these concentrations.
Decreases in interest rates could have a negative impact on our profitability. Our earnings are principally dependent on our ability to generate net interest income. Net interest income is affected by many factors that are partly or completely beyond our control, including competition, general economic conditions and the policies of regulatory authorities, including the monetary policies of the Federal Reserve. Under our current interest rate risk position, our net interest income could be negatively affected by a decline in interest rates, as further discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations --Interest Rate Risk Management."
Our interest rate risk hedging activities may not effectively reduce volatility in earnings. To offset the risks associated with the effects of changes in market interest rates, we periodically enter into transactions designed to hedge our interest rate risk. The accounting for such hedging activities under U.S. generally accepted accounting principles requires our hedging instruments to be recorded at fair value. The effect of certain of our hedging strategies may result in volatility in our quarterly and annual earnings as interest rates change or as the volatility in the underlying derivatives markets increases or decreases. The volatility in earnings is primarily a result of marking to market certain of our hedging instruments and/or modifying our overall hedge position, as further discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations --Interest Rate Risk Management."
The financial services business is highly competitive, and we face competitive disadvantages because of our size and the nature of banking regulation. We encounter strong direct competition for deposits, loans and other financial services in all of our market areas. Our larger competitors, which have significantly greater resources, may have advantages over us in providing certain services. Our principal competitors include other commercial banks, savings banks, savings and loan associations, mutual funds, finance companies, trust companies, insurance companies, leasing companies, credit unions, mortgage companies, private issuers of debt obligations and suppliers of other investment alternatives, such as securities firms and financial holding companies. Many of our non-bank competitors are not subject to the same degree of regulation as that imposed on bank holding companies, federally insured banks and national or state chartered banks. As a result, such non-bank competitors may have advantages over us in providing certain services.
We may not be able to implement technological change as effectively as our competitors. The financial services industry has in the past and continues to undergo rapid technological change related to delivery and availability of products and services and operating efficiencies. In many instances technological improvements require significant capital expenditures, and many of our larger competitors have significantly greater resources to absorb such capital expenditures than we may have available.
We operate in a highly regulated environment. Recently enacted, proposed and future legislation and regulations may increase our cost of doing business. We and our subsidiaries are subject to extensive federal and state legislation, regulation and supervision. Recently enacted, proposed and future legislation and regulations have had and are expected to continue to have a significant impact on the financial services industry. Some of the legislative and regulatory changes, including the Sarbanes-Oxley Act and the USA Patriot Act,
have and are expected to continue to increase our costs of doing business, particularly personnel and technology expenses necessary to maintain compliance with the expanded regulatory requirements. Additionally, the legislative and regulatory changes could reduce our ability to compete in certain markets, as further discussed under "Business -- Supervision and Regulation."
Item 1B.
Item 1B. Unresolved Staff Comments
We are not an accelerated filer or a large accelerated filer, as defined in Rule 12b-2 of the Securities Exchange Act of 1934, or the Exchange Act, nor are we a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Consequently, Item 1B is not applicable to us.
Item 2.
Item 2. Properties
We own our office building, which houses our principal place of business, located at 135 North Meramec, Clayton, Missouri 63105. The property is in good condition and consists of approximately 60,353 square feet, of which approximately 1,791 square feet is currently leased to others. Of our other 186 offices and four operations and administrative facilities at December 31, 2006, 105 are located in buildings that we own and 85 are located in buildings that we lease.
We consider the properties at which we do business to be in good condition generally and suitable for our business conducted at each location. To the extent our properties or those acquired in connection with our acquisition of other entities provide space in excess of that effectively utilized in the operations of First Bank, we seek to lease or sub-lease any excess space to third parties. Additional information regarding the premises and equipment utilized by First Bank appears in Note 7 to our Consolidated Financial Statements appearing elsewhere in this report.
Item 3.
Item 3. Legal Proceedings
In the ordinary course of business, we and our subsidiaries become involved in legal proceedings. Our management, in consultation with legal counsel, believes the ultimate resolution of existing proceedings will not have a material adverse effect on our business, financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information. There is no established public trading market for our common stock. Various trusts, which were established by and are administered by and for the benefit of Mr. James F. Dierberg, our Chairman of the Board, and members of his immediate family, own all of our voting stock.
Dividends. In recent years, we have paid minimal dividends on our Class A Convertible Adjustable Rate Preferred Stock and our Class B Non-Convertible Adjustable Rate Preferred Stock, and have paid no dividends on our Common Stock. Our ability to pay dividends is limited by regulatory requirements and our credit agreement, and by the receipt of dividend payments from First Bank, which is also subject to regulatory requirements. The dividend limitations are further described in Note 11 and Note 22 to our Consolidated Financial Statements appearing elsewhere in this report.
Item 6.
Item 6. Selected Financial Data
The selected consolidated financial data set forth below are derived from our consolidated financial statements. This information is qualified by reference to our Consolidated Financial Statements appearing elsewhere in this report. This information should be read in conjunction with such Consolidated Financial Statements, the related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following presents management's discussion and analysis of our financial condition and results of operations as of the dates and for the periods indicated. This discussion should be read in conjunction with our "Selected Financial Data," our Consolidated Financial Statements and the related notes thereto, and the other financial data appearing elsewhere in this report. This discussion set forth in Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements with respect to our financial condition, results of operations and business. These forward-looking statements are subject to certain risks and uncertainties, not all of which can be predicted or anticipated. Various factors may cause our actual results to differ materially from those contemplated by the forward-looking statements herein. We do not have a duty to and will not update these forward-looking statements. Readers of our Annual Report on Form 10-K should therefore consider these risks and uncertainties in evaluating forward-looking statements and should not place undue reliance on forward-looking statements. See "Special Note Regarding Forward-Looking Statements" appearing at the beginning of this report and "Item 1A - Risk Factors," appearing elsewhere in this report.
RESULTS OF OPERATIONS
Overview
Net income was $111.7 million, $96.9 million and $82.9 million for the years ended December 31, 2006, 2005 and 2004, respectively. Our return on average assets and our return on average stockholders' equity were 1.16% and 15.26%, respectively, for the year ended December 31, 2006, compared to 1.10% and 15.11%, respectively, for 2005, and 1.10% and 14.44%, respectively, for 2004. Our financial results for 2006 represented record earnings for us, both for the year and for the fourth quarter of 2006, and resulted in our achievement of surpassing the $100.0 million earnings milestone.
Our record earnings in 2006 were driven by an 18.0% increase in net interest income and a 17.5% increase in noninterest income. Our average interest-earning assets increased 8.7% and, coupled with higher prevailing interest rates, contributed to a $58.8 million increase in net interest income and improvement in our net interest margin, which increased 35 basis points to 4.36% for 2006, from 4.01% for 2005. Noninterest income increased to $112.9 million in 2006, from $96.1 million in 2005. The increases in net interest income and noninterest income were partially offset by an increase in our provision for loan losses and higher levels of noninterest expense. Noninterest expense increased 15.0% to $319.2 million in 2006, from $277.6 million in 2005. The increased expenses are commensurate with significant expansion of our branch office network and employee base in several key markets resulting from our acquisitions of other financial institutions in 2005 and 2006, and the acquisition of an insurance premium financing company and an insurance brokerage agency in 2006. Our aggressive and diligent efforts to improve asset quality resulted in a 44.4% reduction in nonperforming assets during 2006. The increase in net income for 2005 was primarily attributable to a significant reduction in our provision for loan losses, as further discussed below, and increased net interest income resulting from net interest-earning assets provided by our acquisitions, higher yields earned on those assets and internal loan growth. However, our net interest income was adversely affected by a decline in earnings on interest rate swap agreements associated with our interest rate risk management program, primarily resulting from increasing prevailing interest rates and the maturity and termination of certain interest rate swap agreements, as further discussed under "--Interest Rate Risk Management."
We recorded a provision for loan losses of $12.0 million for the year ended December 31, 2006, compared to a negative provision for loan losses of $4.0 million for the year ended December 31, 2005, and a provision for loan losses of $25.8 million for the year ended December 31, 2004. We attribute the increase in our provision for loan losses in 2006 primarily to loan portfolio growth, both external and organic, coupled with the deterioration of certain large credit relationships primarily associated with the real estate sector of our loan portfolio, including our one-to-four family residential loan portfolio. The decrease in our provision for loan losses in 2005 was commensurate with the decreasing credit risk that existed in our loan portfolio at that time. While we had recorded a negative provision for loan losses of $8.0 million for the first nine months of 2005, reflecting a 21.0% improvement in nonperforming loans during this period from the sale of certain acquired nonperforming loans, the strengthening of certain loans, loan payoffs and/or external refinancing of various credits, and a significant reduction in net loan charge-offs, the level of nonperforming loans increased during the fourth quarter of 2005 as a result of further deterioration of a small number of large credit relationships, which resulted in a fourth quarter provision for loan losses of $4.0 million. We continue to closely monitor the level of our nonperforming assets in accordance with our credit risk guidelines and focus on methods to improve our management of these assets based on changing economic conditions throughout our market areas.
Financial Condition and Average Balances
Our average total assets were $9.61 billion for the year ended December 31, 2006, compared to $8.81 billion and $7.54 billion for the years ended December 31, 2005 and 2004, respectively, reflecting increases of $797.7 million and $1.27 billion, respectively. Our total assets reached a record high of $10.16 billion at December 31, 2006, compared to $9.17 billion and $8.73 billion at December 31, 2005 and 2004, respectively, representing increases of $988.4 million and $437.5 million, respectively. We attribute the increase in our total assets in 2006 and 2005 to a combination of organic growth and growth through acquisitions in our target markets completed during the past three years, including our acquisition of CIB Bank in late 2004, which provided assets of $1.20 billion. Our acquisitions completed in 2004, 2005 and 2006 provided total assets at the time of the transactions of $1.38 billion, $280.3 million and $794.3 million, in aggregate, respectively, as well as the related intangible assets associated with these transactions. As previously mentioned, our acquisitions completed in 2006 included the acquisition of two financial service companies, an insurance premium financing company and an insurance brokerage company, thereby providing our business with new opportunities, and expanding the broad array of products and services available to our customers.
Our interest-earning assets averaged $8.86 billion for the year ended December 31, 2006, compared to $8.15 billion and $6.91 billion for the years ended December 31, 2005 and 2004, respectively, while our interest-bearing liabilities averaged $7.50 billion for the year ended December 31, 2006, compared to $6.82 billion and $5.78 billion for the years ended December 31, 2005 and 2004, respectively. We used funds from the growth of average deposits of $809.9 million and maturities of investment securities to fund internal loan growth and to reinvest in higher-yielding investment securities in 2006. We issued additional subordinated debentures, as further described below, which we primarily used to fund our bank acquisitions in 2006 and to refinance existing, higher-cost subordinated debentures on their optional call date at the end of the year. Our average other borrowings declined $191.2 million as a result of a reduction of certain term repurchase agreements utilized in conjunction with our interest rate risk management program. The increase in our average assets for 2005 was primarily funded by an increase in average deposits of $1.04 billion; an increase in average other borrowings of $85.7 million, an increase in notes payable of $33.2 million; and an increase in average subordinated debentures of $38.8 million. Funds available from maturities and sales of investment securities during 2005 were primarily used to fund loan growth, and a portion of the remaining funds available from maturities of investment securities were reinvested in higher-yielding available-for-sale investment securities.
Average loans, net of unearned discount, were $7.47 billion, $6.44 billion and $5.51 billion for the years ended December 31, 2006, 2005 and 2004, respectively. Our acquisitions completed during 2005 and 2006 provided total loans, net of unearned discount, of $209.6 million and $545.1 million, respectively. Internal loan growth of $584.2 million for 2006 reflects: a $234.1 million increase in our real estate construction and development portfolio; and a $289.8 million increase in our real estate mortgage portfolio resulting from management's business decision to retain certain residential mortgage loan production in our residential real estate mortgage portfolio during the first half of 2006, partially offset by the securitization of $138.9 million of certain residential mortgage loans in early 2006 which shifted these assets to available-for-sale investment securities; and the transfer of approximately $130.0 million of certain loans to our held for sale portfolio, which were subsequently sold in 2006 in conjunction with sales of existing loans originated and held for sale. Internal loan growth for 2006 also resulted from a $120.4 million increase in our loans held for sale portfolio, reflecting: (a) the timing of loan originations and subsequent sales of residential mortgage loans in the secondary mortgage market; partially offset by (b) the sale of certain nonperforming loans that were transferred to our held for sale portfolio on December 31, 2005, (c) the transfer and subsequent sale of certain performing and nonperforming loans in the fourth quarter of 2006; and (d) the payoff of two significant nonperforming loans, totaling $27.3 million in aggregate, that were included in our held for sale portfolio at December 31, 2005, as further discussed under "--Loans and Allowance for Loan Losses." Internal loan growth of $687.5 million for 2005 was primarily generated from a $286.8 million increase in our real estate mortgage portfolio resulting from management's business decision to retain additional mortgage loan product production in our residential real estate mortgage portfolio, and a home equity product line campaign that we held in mid-2004; a $241.9 million increase in our real estate construction and development portfolio; and a $194.8 million increase in our loans held for sale portfolio, including approximately $59.7 million of nonperforming loans that were transferred to the loans held for sale portfolio at December 31, 2005, as further discussed under "--Loans and Allowance for Loan Losses." This increase was partially offset by reductions in a portion of our nonperforming loan portfolio due to the sale of certain nonperforming loans in early 2005, loan payoffs and/or external refinancing of various credits.
Investment securities averaged $1.27 billion, $1.64 billion and $1.28 billion for the years ended December 31, 2006, 2005 and 2004, respectively. Funds available from maturities of investment securities, deposit growth and excess short-term investments were utilized to fund internal loan growth during the majority of 2006, and the remaining funds were reinvested in higher-yielding
investment securities. These securities purchases primarily occurred late in 2006 and resulted from funds available from deposit growth in excess of loan demand. The sale of available-for-sale investment securities associated with the termination of $200.0 million of term repurchase agreements in the first half of 2006 was partially offset by an increase in the securities portfolio due to the securitization of $138.9 million of certain of our residential mortgage loans held in our loan portfolio, an increase in our trading securities portfolio of $77.8 million, and the addition of $37.3 million of securities obtained with our bank acquisitions completed in 2006. We attribute the increase in 2005 primarily to our 2004 and 2005 acquisitions, which provided investment securities, in aggregate, of $438.0 million and $20.1 million, respectively. Funds available from maturities of investment securities, deposit growth and an increase in our other borrowings were used to fund loan growth and for the reinvestment in additional higher-yielding available-for-sale investment securities. Throughout 2005, short-tem investments were utilized to fund an anticipated level of attrition associated with our acquisitions, primarily time deposits acquired with CIB Bank. Average short-term investments declined $49.1 million to $70.3 million for the year ended December 31, 2005, from $119.4 million in 2004.
Nonearning assets averaged $754.7 million, $662.4 million and $633.2 million for the years ended December 31, 2006, 2005 and 2004, respectively. The increases in 2006 and 2005 are largely attributable to our acquisitions completed in 2005 and 2006, which increased our capital expenditures, thus contributing to an overall increase in bank premises and equipment, partially offset by continued related depreciation and amortization, and an increase in intangible assets recognized in conjunction with the acquisitions. Aggregate intangible assets recorded in conjunction with our acquisitions completed in 2005 and 2006, including goodwill, core deposit intangibles associated with our bank and branch acquisitions, and the customer list intangibles associated with our purchases of Adrian Baker and UPAC, were $25.8 million and $110.7 million, respectively. Our derivative financial instruments averaged ($4.0) million, ($3.1) million and $25.9 million for the years ended December 31, 2006, 2005 and 2004, respectively. This reflects a decline in the fair value of certain derivative financial instruments and the maturity and/or termination of certain of our interest rate swap agreements during 2005 and 2006, as further discussed under "--Interest Rate Risk Management" and in Note 5 to our Consolidated Financial Statements. In addition, purchases of land, bank premises and equipment for future de novo branch offices further contributed to the overall increases in nonearning assets during these periods.
We use deposits as our primary funding source and acquire them from a broad base of local markets, including both individual and corporate customers. Deposits averaged $8.01 billion, $7.20 billion and $6.17 billion for the years ended December 31, 2006, 2005 and 2004, respectively. Our year-end deposits were $8.44 billion, $7.54 billion and $7.15 billion at December 31, 2006, 2005 and 2004, respectively, reflecting increases of $901.3 million for 2006 and $389.9 million for 2005. The increases in 2006 and 2005 were primarily attributable to organic growth stemming from our deposit development programs throughout the periods, including enhanced product and service offerings coupled with marketing campaigns, in addition to our acquisitions of banks and/or branches in our target markets that were completed in 2005 and 2006, which provided aggregate deposits of $238.1 million and $475.6 million, respectively, at the time of their acquisition. The change in the composition of our deposit mix reflects continued efforts to expand our existing customer relationships by increasing the number and types of products provided, efforts to increase transactional accounts, such as savings and demand accounts through our deposit development campaigns, coupled with trends toward increased time deposits and higher deposit rates paid on certain products resulting from the highly competitive rate market environment. Average time deposits were $3.63 billion, $2.91 billion and $2.04 billion for the years ended December 31, 2006, 2005 and 2004, respectively. Average demand and savings deposits were $4.38 billion, $4.30 billion and $4.13 billion for the years ended December 31, 2006, 2005 and 2004, respectively. The overall growth in deposits was partially offset by an anticipated level of attrition associated with our recent acquisitions, particularly savings and time deposits acquired from CIB Bank, including brokered and internet deposits, and continued aggressive competition within our market areas.
Other borrowings averaged $380.5 million, $571.7 million and $486.0 million for the years ended December 31, 2006, 2005 and 2004, respectively. The decrease in the average balances for 2006 reflects the termination of $150.0 million and $50.0 million of term repurchase agreements in the first and second quarters of 2006, respectively, partially offset by a $100.0 million term repurchase agreement entered into in the third quarter of 2006, as further described in Note 5 and Note 10 to our Consolidated Financial Statements. We also attribute the decrease to the prepayment of $35.3 million of Federal Home Loan Bank, or FHLB, advances that were assumed with certain bank acquisitions, and a decrease in daily repurchase agreements, principally in connection with the cash management activities of our commercial deposit customers. The increase in the average balances for 2005 reflects $250.0 million of term repurchase agreements that we entered into in conjunction with our interest rate risk management program during 2004, partially offset by the termination of $50.0 million of term repurchase agreements in the fourth quarter of 2005. The increase in average balances for 2005 also reflects an increase in daily repurchase agreements, as well as an increase in average FHLB advances, primarily associated with our bank acquisitions, to $44.2 million for 2005, compared to $21.0 million for 2004.
Our notes payable averaged $88.8 million, $36.8 million and $3.7 million for the years ended December 31, 2006, 2005 and 2004, respectively. The increases in 2006 and 2005 were attributable to the addition of a term loan in conjunction with the restructuring of our overall financing arrangement in 2005. In conjunction with our Amended and Restated Secured Credit Agreement that we entered into in August 2005 to restructure our overall financing arrangement, we borrowed $80.0 million on the term loan in August 2005 and borrowed the remaining $20.0 million on the term loan in November 2005. The proceeds of the term loan were used to fund our acquisition of International Bank of California, or IBOC, and to partially fund the repayment of our 10.24% subordinated debentures issued to First Preferred Capital Trust II, or FPCT II, in September 2005, as further discussed below. As further described in Note 11 to our Consolidated Financial Statements, on August 10, 2006, we entered into an amendment to our Amended and Restated Secured Credit Agreement and reduced certain components of our financing arrangement, including the overall pricing structure. We subsequently repaid $35.0 million of the term loan during 2006, reducing the balance to $65.0 million at December 31, 2006, from $100.0 million at December 31, 2005. Furthermore, during 2005, we repaid in full the $15.0 million outstanding advance drawn under our revolving credit line in 2004 to partially fund our acquisition of CIB Bank.
Subordinated debentures issued to our affiliated statutory and business trusts averaged $281.5 million, $259.2 million and $220.4 million for the years ended December 31, 2006, 2005 and 2004, respectively. During 2006, we issued a total of $139.2 million of variable rate subordinated debentures in private placements through four newly-formed statutory trusts: specifically, $41.2 million issued to First Bank Statutory Trust IV on March 1, 2006; $20.6 million issued to First Bank Statutory Trust V on April 28, 2006; $25.8 million issued to First Bank Statutory Trust VI on June 16, 2006; and $51.5 million issued to First Bank Statutory Trust VII on December 14, 2006. On December 31, 2006, we repaid in full $56.9 million of 9.0% fixed rate subordinated debentures, as further described in Note 12 to our Consolidated Financial Statements. The increase in 2005 reflects our issuance of $61.9 million of variable rate subordinated debentures late in 2004, specifically, $20.6 million issued to First Bank Statutory Trust II in September 2004 and $41.2 million issued to First Bank Statutory Trust III in November 2004, partially offset by the repayment in full of $59.3 million of 10.24% subordinated debentures on September 30, 2005 that were issued to FPCT II, as further described in Note 12 to our Consolidated Financial Statements. The repayment of these subordinated debentures was funded by the term loan.
Stockholders' equity averaged $731.9 million, $641.5 million and $574.3 million for the years ended December 31, 2006, 2005 and 2004, respectively. The increase for 2006 reflects net income of $111.7 million, a $6.8 million increase in accumulated other comprehensive income, which was comprised of $4.9 million associated with the change in our unrealized gains and losses on available-for-sale investment securities and $1.9 million associated with the change in the fair value of our derivative financial instruments, partially offset by dividends paid on our Class A and Class B preferred stock. We primarily attribute the increase for 2005 to net income of $96.9 million, partially offset by dividends paid on our Class A and Class B preferred stock, and an $18.1 million decrease in accumulated other comprehensive income, which was comprised of $13.8 million associated with the change in our unrealized gains and losses on available-for-sale investment securities and $4.3 million associated with the change in the fair value of our derivative financial instruments. These decreases were reflective of changes in prevailing interest rates, a decline in the fair value of our derivative financial instruments, and the maturity of certain interest rate swap agreements designated as cash flow hedges during 2005, as further discussed under "--Interest Rate Risk Management" and in Note 5 to our Consolidated Financial Statements.
The following table sets forth, on a tax-equivalent basis, certain information relating to our average balance sheets, and reflects the average yield earned on our interest-earning assets, the average cost of our interest-bearing liabilities and the resulting net interest income for the periods presented.
The following table indicates, on a tax-equivalent basis, the changes in interest income and interest expense that are attributable to changes in average volume and changes in average rates, in comparison with the preceding year. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the dollar amounts of the change in each.
Net Interest Income
The primary source of our income is net interest income. Net interest income (expressed on a tax-equivalent basis) increased to $386.0 million for the year ended December 31, 2006, from $327.0 million and $301.3 million for the years ended December 31, 2005 and 2004, respectively. Our net interest margin was 4.36% for the year ended December 31, 2006, compared to 4.01% and 4.36% for the years ended December 31, 2005 and 2004, respectively. Net interest income is the difference between the interest earned on our interest-earning assets, such as loans and investment securities, and the interest paid on our interest-bearing liabilities, such as deposits and borrowings. Net interest income is affected by the level and composition of assets, liabilities and stockholders' equity, as well as the general level of interest rates and changes in interest rates. Interest income on a tax-equivalent basis includes the additional amount of interest income that would have been earned if our investment in certain tax-exempt interest-earning assets had been made in assets subject to federal, state and local income taxes yielding the same after-tax income. Net interest margin is determined by dividing net interest income on a tax-equivalent basis by average interest-earning assets. The interest rate spread is the difference between the average equivalent yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
We attribute the increase in net interest income in 2006 to an 8.7% increase in our average interest-earning assets stemming from internal growth and growth through acquisitions of banks and other financial service companies, combined with higher yields on those assets commensurate with the prevailing interest rates in our markets. The increase in average interest-earning assets reflects increases in average loans and average short-term investments, and the transfer of funding from lower-yielding investment securities to higher-yielding loans. The increase in our interest income was partially offset by increased interest expense related to increasing deposit balances along with a continued redistribution of deposit balances toward higher-yielding products and higher interest rates paid on those deposits, as well as increased interest expense paid on the overall levels of our other borrowings and subordinated debentures. Our overall borrowing levels reflect the reduction in the use of higher cost funding sources, such as term repurchase agreements and FHLB advances. Our average notes payable increased $52.0 million as a result of the term loan advances we borrowed in August 2005 and November 2005. Our average subordinated debentures, which support acquisitions and are also utilized for other corporate
purposes, increased $22.3 million as a result of our issuance of $139.2 million of variable rate subordinated debentures through four newly-formed statutory trusts, partially offset by the repayment of $56.9 million of 9.0% fixed rate subordinated debentures on December 31, 2006. In addition, our net interest income was adversely affected by a decline in earnings on our interest rate swap agreements that were entered into in conjunction with our interest rate risk management program, as further discussed below.
We primarily credit the increase in net interest income in 2005 to interest-earning assets provided by our acquisitions completed in 2004 and 2005, internal loan growth coupled with higher interest rates on loans, higher-yielding investment securities and the repayment of our 10.24% subordinated debentures in September 2005. The overall increase in our net interest income was partially offset by: (a) increased interest expense associated with deposit growth, higher interest rates paid on deposits, and a redistribution of deposit balances toward higher-yielding products; (b) the mix of the CIB Bank deposit base acquired; (c) increased levels of other borrowings, including our term loan, coupled with increased interest rates on such borrowings; and (d) the issuance of $61.9 million of additional subordinated debentures in late 2004 through two newly formed statutory trusts; partially offset by our repayment of $59.3 million of 10.24% subordinated debentures in September 2005. These transactions, coupled with our use of derivative financial instruments, have allowed us to reduce our overall interest expense associated with our subordinated debentures as the additional subordinated debentures have been issued at significantly lower interest rates.
Derivative financial instruments that were entered into in conjunction with our interest rate risk management program to mitigate the effects of decreasing interest rates reduced our net interest income by $5.0 million for the year ended December 31, 2006, whereas these derivative financial instruments contributed to increases in our net interest income of $2.2 million and $50.1 million, respectively, for the years ended December 31, 2005 and 2004. The decreased earnings on our interest rate swap agreements for 2006 and 2005 contributed to reductions in our net interest margin of approximately eight basis points and 59 basis points, respectively, and reflects higher interest rates and maturities of $750.0 million of interest rate swap agreements designated as cash flow hedges and $50.0 million of interest rate swap agreements designated as fair value hedges during 2004; the maturity of $200.0 million and $100.0 million of interest rate swap agreements designated as cash flow hedges in March 2005 and April 2006, respectively; and the termination of $150.0 million, $101.2 million and $25.0 million of interest rate swap agreements designated as fair value hedges in February 2005, May 2005 and February 2006, respectively. However, the earnings on our interest rate swap agreements significantly contributed to our ability to maintain our net interest margin in 2004. During the third quarter of 2006, we significantly expanded our utilization of derivative financial instruments, as further described in Note 5 to our Consolidated Financial Statements, to reduce our exposure to falling interest rates. The Company has implemented various methods to reduce the effect of decreasing interest rates on our net interest income, including the funding of investment security purchases through the issuance of term repurchase agreements. However, the reduction of our interest rate swap agreements has resulted in a substantial reduction of our net interest income and further compression of our net interest margin, which has been partially offset by the impact of the rising rate environment experienced in 2005 and 2006, as further discussed below.
The yield on our loan portfolio was 7.79% for the year ended December 31, 2006, compared to 6.59% and 6.21% for 2005 and 2004, respectively. Average loans, net of unearned discount, were $7.47 billion for the year ended December 31, 2006, in comparison to $6.44 billion and $5.51 billion for the years ended December 31, 2005 and 2004, respectively. Increases in prevailing interest rates that began in mid-2004 and continued throughout 2005 and 2006 contributed to the increased yields on our loan portfolio during 2005 and 2006. During 2006, the Federal Reserve increased the targeted federal funds rate, resulting in four increases in the prime rate of interest from 7.25% at December 31, 2005 to 8.25% at December 31, 2006. During 2005, the Federal Reserve increased the targeted federal funds rate, resulting in eight increases in the prime rate of interest from 5.25% at December 31, 2004 to 7.25% at December 31, 2005. The prime rate of interest increased from 4.00% at January 1, 2004 to 5.25% at December 31, 2004. These interest rates are reflected not only in the rate of interest earned on loans that are indexed to the prime rate, but also in other assets and liabilities which either have variable or adjustable rates, or which have matured or repriced during these periods. Although the rising interest rate environment contributed to the increase in our loan yields during 2005 and 2006, total interest income on our loan portfolio was adversely impacted by decreased earnings on our interest rate swap agreements designated as cash flow hedges. These interest rate swap agreements reduced our interest income on loans by $4.2 million for the year ended December 31, 2006, in contrast to increasing our interest income on loans by $2.6 million and $38.3 million in 2005 and 2004, respectively. The yields on our loan portfolio were impacted by higher interest rates and the maturities and/or termination of interest rate swap agreements designated as cash flow hedges of $750.0 million in 2004, $200.0 million in 2005 and $100.0 million in 2006, which resulted in decreased earnings on our swap agreements, thereby contributing to a reduction in interest on our loan portfolio. Specifically, the impact of the swap agreements resulted in a compression of our net interest income of approximately $6.9 million for 2006 compared to 2005, and $35.7 million for 2005 compared to 2004, as further discussed under "--Interest Rate Risk Management." Interest income on our loan
portfolio for 2006 includes a $2.0 million recovery of interest and fees from the payoff of a single nonaccrual loan, as further described under "--Loans and Allowance for Loan Losses." The lower yield on our loan portfolio during 2004 reflected increased competition, continued weak loan demand and generally lower prevailing interest rates during the period, despite the increases in the prime lending rate during the second half of 2004.
For the years ended December 31, 2006, 2005 and 2004, the aggregate weighted average rate paid on our interest-bearing deposit portfolio was 3.21%, 2.14% and 1.44%, respectively. We attribute the increase in 2006 to the continued rising interest rate environment and a change in the mix of our average deposits which reflects a trend towards increased time deposits over transactional accounts, coupled with higher interest rates paid on deposits commensurate with the highly competitive rate market that continues to exert pressure on our net interest margin. We attribute the increase in 2005 to the rising interest rate environment and the mix of the CIB Bank deposit base acquired in November 2004, which included higher cost time deposits, including brokered and internet deposits. In addition, decreased earnings associated with certain of our interest rate swap agreements designated as fair value hedges, as well as the termination of $150.0 million notional amount of fair value hedges in February 2005, resulted in a decrease in our net interest income of approximately $8.5 million for 2005, compared to 2004, as further described in Note 5 to our Consolidated Financial Statements. While deposit growth continues to provide an adequate funding source for our loan portfolio, competitive pressures on deposits within our markets continue to impact our deposit pricing.
The aggregate weighted average rate paid on our other borrowings was 4.42% for the year ended December 31, 2006, compared to 3.19% and 1.26% for the years ended December 31, 2005 and 2004, respectively, reflecting changes in the short-term interest rate environment that began in mid-2004. The increase in the aggregate weighted average rates paid on our other borrowings in 2006 and 2005 also reflects the termination of $200.0 million of term repurchase agreements in 2006, partially offset by a $100.0 million term repurchase agreement entered into during 2006, and the termination of a $50.0 million term repurchase agreement in November 2005, and the impact of the related spreads to the London Interbank Offering Rate, or LIBOR, as further described in Note 5 and Note 10 to our Consolidated Financial Statements.
The aggregate weighted average rate on our notes payable was 6.22%, 6.26% and 13.84% for the years ended December 31, 2006, 2005 and 2004, respectively. The aggregate weighted average rates paid reflect changing market interest rates during these periods, and unused credit commitment and letter of credit facility fees on our secured credit agreement with a group of unaffiliated financial institutions, as well as other fees paid in conjunction with the annual renewal of this financing arrangement. The overall cost of this funding source during 2004 was significantly higher due to fees associated with the credit facility coupled with minimal borrowings under the revolving credit line during 2004. Exclusive of these fees, the aggregate weighted average rate paid on our notes payable was 6.11%, 4.93% and 2.87% for the years ended December 31, 2006, 2005 and 2004, respectively. Amounts outstanding under our term loan bear interest at a floating rate equal to LIBOR, plus a margin determined by the outstanding loan balances and our profitability for the preceding four calendar quarters. Amounts outstanding under our revolving line of credit bear interest at a floating rate equal to the lead bank's prime rate or, at our option, at LIBOR plus a margin determined by the outstanding loan balances and our profitability for the preceding four calendar quarters. Thus, our secured credit agreement represents a relatively high-cost funding source as increased advances have the effect of increasing the weighted average rate of our non-deposit liabilities. As further described in Note 11 to our Consolidated Financial Statements, we borrowed $80.0 million on our term loan in August 2005 and $20.0 million on our term loan in November 2005, and on August 10, 2006, we entered into an amendment to our Amended and Restated Secured Credit Agreement and reduced certain components of our financing arrangement, including the overall pricing structure. During 2006, we repaid $35.0 million of the term loan, reducing the balance to $65.0 million at December 31, 2006, from $100.0 million at December 31, 2005. Also, during 2005, we repaid the remaining outstanding balance of $15.0 million drawn under our revolving credit line that we had drawn in November 2004 to partially fund our acquisition of CIB Bank.
The aggregate weighted average rate paid on our subordinated debentures was 8.11%, 7.93% and 6.85% for the years ended December 31, 2006, 2005 and 2004, respectively. The aggregate weighted average rates reflect the issuance of $139.2 million of variable rate subordinated debentures in private placements through four newly formed statutory trusts, partially offset by the repayment of $56.9 million of 9.0% fixed rate subordinated debentures on December 31, 2006, as well as the repayment of $59.3 million of 10.24% subordinated debentures in September 2005 and the issuance of $61.9 million of subordinated debentures in late 2004. The refinancing of the outstanding subordinated debentures that carried a higher fixed interest rate improved our net interest income and net interest margin. However, the earnings impact of our interest rate swap agreements had a declining impact on the reduction of interest expense associated with our subordinated debentures. These interest rate swap agreements, which reduced interest expense by $5.7 million and $2.0 million during 2004 and 2005, respectively, increased interest expense by $814,000 during 2006. These swap agreements, which were designated as fair value hedges, were terminated in May 2005 and February 2006, as further discussed under "--Interest Rate Risk Management" and in Note 5 to our Consolidated Financial Statements.
Comparison of Results of Operations for 2006 and 2005
Net Income. Net income was $111.7 million for the year ended December 31, 2006, compared to $96.9 million for 2005. Our return on average assets and our return on average stockholders' equity were 1.16% and 15.26%, respectively, for the year ended December 31, 2006, compared to 1.10% and 15.11%, respectively, for 2005. Net income for 2006 reflects increased net interest income and noninterest income, partially offset by an increase in our provision for loan losses, higher levels of noninterest expense and an increase in our provision for income taxes.
The increase in earnings in 2006 reflects our continuing efforts to strengthen earnings while focusing on reducing the overall level of our nonperforming assets. The increase in net interest income and net interest margin resulted from (a) an increase in average interest-earning assets stemming from internal loan growth and growth through acquisitions, and (b) higher yields earned on those assets as a result of an increased interest rate environment; partially offset by increased interest expense associated with an increasing deposit base coupled with higher interest rates paid on deposits and on our short-term and long-term borrowings, and the adverse impact of a decline in earnings on our interest rate swap agreements associated with our interest rate risk management program, as further discussed under "--Net Interest Income." The increase in net income in 2006 was partially offset by a significant increase in our provision for loan losses, which resulted from loan portfolio growth and the deterioration of certain credit relationships despite an overall improvement in our nonperforming loans throughout 2006, as further discussed under "--Provision for Loan Losses." The increase in our noninterest income in 2006 was attributable to increased gains on loans sold and held for sale associated with mortgage banking activities and the sale of certain loans, commission fee income associated with our insurance brokerage agency acquired in March 2006, increased service charges on deposit accounts and customer service fees related to higher deposit balances stemming from product development efforts and deposits associated with our 2005 and 2006 acquisitions, and gains on the sale of other assets, as further discussed under "--Noninterest Income." The overall increase in the level of noninterest expense for 2006 reflects increased salaries and employee benefits expense, occupancy expenses and amortization of intangible assets, commensurate with the significant expansion of our branch office network and employee base resulting from our acquisitions of an insurance premium financing company and an insurance brokerage agency in 2006, the addition of 20 branch offices associated with acquisitions in 2005 and 2006, and an increase in the full-time equivalent employee base during 2006, as further discussed under "--Noninterest Expense."
Provision for Loan Losses. We recorded a provision for loan losses of $12.0 million for the year ended December 31, 2006. The provision recorded during 2006 was primarily driven by significant growth within our loan portfolio, coupled with deterioration within our one-to-four family residential portfolio in addition to the deterioration of certain other credits, including four large credit relationships within our residential development and construction portfolio during the later part of 2006 that were primarily driven by current market conditions, including slowdowns in unit sales, as further discussed under "Business -- Lending Activities" and "--Loans and Allowance for Loan Losses." We recorded a $4.0 million negative provision for loan losses for the year ended December 31, 2005 to reduce our allowance for loan losses to a level commensurate with the decreasing credit risk that existed in the loan portfolio at that time. Our nonperforming loans decreased $48.5 million, or 49.9%, to $48.7 million at December 31, 2006, from $97.2 million at December 31, 2005. The decrease in the overall level of nonperforming loans during 2006 reflects our efforts to improve asset quality through the sale of nonperforming loans and loan payoffs, as well as the strengthening of certain credit relationships, as further discussed under "--Loans and Allowance for Loan Losses." The overall decrease was partially offset by several significant credit relationships that were downgraded and placed on nonaccrual status during 2006, as previously mentioned.
Our allowance for loan losses was $145.7 million at December 31, 2006, compared to $135.3 million at December 31, 2005, representing 1.90% and 1.93% of loans, net of unearned discount, respectively, and 299.05% and 139.23% of nonperforming loans, respectively. The allowance for loan losses at December 31, 2006 includes $5.2 million of balances acquired in conjunction with our 2006 acquisitions. Our net loan charge-offs declined to $6.8 million from $13.4 million for the years ended December 31, 2006 and 2005, respectively. Our net loan charge-offs for 2006 were 0.09% of average loans, representing a significant improvement over 0.21% in 2005. Loan charge-offs were $22.2 million for 2006, compared to $33.1 million in 2005, and loan recoveries were $15.4 million for 2006, compared to $19.8 million in 2005. Loan charge-offs for 2006 included approximately $3.3 million of loan charge-offs associated with two significant residential development project relationships that were placed on nonaccrual status during 2006, in addition to $2.3 million of charge-offs recorded in conjunction with the transfer of certain portfolio loans to our loans held for sale portfolio prior to their sale in December 2006. Loan recoveries for 2006 included $5.0 million recorded on the payoff of a single loan that was transferred to our held for sale portfolio on December 31, 2005.
Under our loan policy, loans are placed on nonaccrual status once principal or interest payments become 90 days past due. However, individual loan officers may submit written requests for approval to continue the accrual of interest on loans that become 90 days past due. These requests must be submitted for approval consistent with the authority levels provided in our credit approval policies, and they are only granted if an expected near term future event, such as a pending renewal or expected payoff, exists at the time the loan becomes 90 days past due. If the expected near term future event does not occur as anticipated, the loan is then placed on nonaccrual status. Management considers the nonperforming assets trends in its overall assessment of the adequacy of the allowance for loan losses.
Tables summarizing nonperforming assets, past due loans and charge-off and recovery experience are presented under "--Loans and Allowance for Loan Losses."
Noninterest Income and Expense. The following table summarizes noninterest income and noninterest expense for the years ended December 31, 2006 and 2005:
Noninterest Income. Noninterest income was $112.9 million for the year ended December 31, 2006, in comparison to $96.1 million for 2005. Noninterest income consists primarily of service charges on deposit accounts and customer service fees, mortgage-banking revenues, investment management income and other income.
Service charges on deposit accounts and customer service fees increased to $43.3 million from $39.8 million for the years ended December 31, 2006 and 2005, respectively. The increase in service charges and customer service fees is primarily attributable to: (a) increased deposit account balances associated with internal growth and our acquisitions of banks completed in 2005 and 2006, as further discussed under "--Financial Condition and Average Balances" and in Note 2 to our Consolidated Financial Statements; (b) additional products and services available and utilized by our retail and commercial customer base; (c) increased fee income from customer service charges for non-sufficient funds and returned check fees coupled with enhanced control of fee waivers; and (d) pricing increases on certain service charges and customer service fees instituted to reflect current market conditions.
The gain on loans sold and held for sale increased to $26.0 million from $20.8 million for the years ended December 31, 2006 and 2005, respectively. We primarily attribute the increase in 2006 to: (a) a $1.7 million gain, before applicable income taxes, recorded on the sale of certain nonperforming loans in March 2006 that were transferred to our loans held for sale portfolio on December 31, 2005; (b) the recognition of $1.2 million and $927,000 of income in March 2006 and April 2006, respectively, generated from the capitalization of mortgage servicing rights pertaining to the securitization and transfer to our investment portfolio of $77.1 million and $61.8 million, respectively, of residential mortgage loans held in our loan portfolio, as further described in Note 6 to our Consolidated Financial Statements; (c) net gains of $2.4 million recorded on the sale of $278.7 million of certain residential mortgage loans, as further discussed under "--Mortgage Banking Activities" and "--Loans and Allowance for Loan Losses;" and (d) a $3.7 million gain, before applicable income taxes, recorded on the sale, in December 2006, of 44 loans in our loans held for sale portfolio, of which 26 were nonperforming loans, as further
discussed under "--Loans and Allowance for Loan Losses." The increase in our gain on loans sold and held for sale was partially offset by a $1.1 million write-down of the carrying value of a nonperforming loan that was transferred to our loans held for sale portfolio on December 31, 2005, and subsequently transferred back into our loan portfolio at fair value in September 2006, as further discussed under "--Loans and Allowance for Loan Losses."
Noninterest income includes a net loss on investment securities of $1.8 million and $2.9 million for the years ended December 31, 2006 and 2005, respectively. The net loss for 2006 resulted primarily from sales of certain available-for-sale investment securities associated with the full termination of three $50.0 million term repurchase agreements and the partial termination of $50.0 million of a $150.0 million term repurchase agreement, as further described in Note 3, Note 5 and Note 10 to our Consolidated Financial Statements, partially offset by a gain of $389,000 on the redemption of common stock held as an available-for-sale investment security. The net loss for 2005 resulted from the sale of certain available-for-sale investment securities associated with the termination of a $50.0 million term repurchase agreement.
Bank-owned life insurance investment income was $3.1 million for the year ended December 31, 2006, in comparison to $4.9 million in 2005. The decrease reflects a reduced return on the performance of the underlying investments surrounding the insurance contracts which is primarily attributable to the portfolio mix of investments and overall market conditions.
Investment management income generated by MVP, our institutional money management subsidiary, was $8.4 million for the year ended December 31, 2006, in comparison to $8.6 million in 2005, reflecting decreased portfolio management fee income as a result of current market conditions.
Insurance product income generated by Adrian Baker, our insurance brokerage agency acquired on March 31, 2006, as further described in Note 2 to our Consolidated Financial Statements, was $4.8 million for the year ended December 31, 2006.
Other income was $29.1 million and $24.9 million for the years ended December 31, 2006 and 2005, respectively. We attribute the primary components of the increase in other income to:
>> an increase of $3.1 million in gains on sales of other assets, including a $2.8 million gain recognized on the sale of an asset that was acquired as settlement in full of a loan charged-off in prior years and a gain of $885,000 recognized on the sale of assets that were acquired with our acquisition of CIB Bank;
>> an increase of $1.7 million attributable to interest due on tax refunds associated with the filing of amended federal income tax returns for the years from 2000 through 2004;
>> a release fee of $938,000 received on funds collected from a loan previously sold in March 2005, in which First Bank was entitled to 25% of any future fees collected on the loan under a defined release fee agreement that was entered into in conjunction with the loan sale;
>> a net increase of $839,000 in loan servicing fees, which was primarily attributable to a decrease of $966,000 in impairment charges on SBA servicing rights and a decrease of $1.5 million in the amortization of servicing rights, as further described in Note 6 to our Consolidated Financial Statements; partially offset by a decrease of $1.6 million in fees from loans serviced for others;
>> a decrease of $680,000 in net losses on our derivative instruments;
>> an increase of $652,000 in gains on sales of other real estate. Gains on sales of other real estate were $2.0 million for the year ended December 31, 2006, and included a $1.5 million gain recognized on the sale of a parcel of other real estate in January 2006 acquired with our acquisition of CIB Bank. Gains on sales of other real estate for the year ended December 31, 2005 were $1.3 million; and
>> income associated with continued growth and expansion of our banking franchise, including our de novo branch offices and our acquisitions completed during 2005 and 2006; partially offset by
>> a decrease of $2.5 million in recoveries of certain loan principal balances that had been previously charged-off by the financial institutions prior to their acquisitions by First Banks.
Noninterest Expense. Noninterest expense was $319.2 million for the year ended December 31, 2006, in comparison to $277.6 million for 2005. Our efficiency ratio was 64.18% for the year ended December 31, 2006, compared to 65.83% for 2005. The efficiency ratio is used by the financial services industry to measure an organization's operating efficiency. The efficiency ratio represents the ratio of noninterest expense to the sum of net interest income and noninterest income. The increase in noninterest expense was primarily attributable to our 2005 and 2006 acquisitions, including salaries and employee benefits expense, occupancy expense and information technology fees, as well as increases in amortization of intangible assets and other expense.
We record the majority of integration costs attributable to our acquisitions as of the consummation date of our purchase business combinations. These costs include, but are not limited to, items such as:
>> write-downs and impairment of assets of the acquired entities that will no longer be usable subsequent to the consummation date, primarily data processing equipment, incompatible hardware and software, bank signage, etc. These adjustments are generally recorded as of the consummation date as an allocation of the purchase price with the offsetting adjustment recorded as an increase to goodwill. For all periods presented, these adjustments are not material to our operations;
>> costs associated with a planned exit of an activity of the acquired entity that is not associated with or is not expected to generate revenues after the consummation date, such as credit card lending. These costs are generally recorded as of the consummation date through the establishment of an accrued liability with the offsetting adjustment recorded as an increase to goodwill. These costs are infrequently encountered and, for all periods presented, are not material to our operations;
>> planned involuntary employee termination benefits, as further discussed under "Business --Acquisitions - Acquisition and Integration Costs" and Note 2 to our Consolidated Financial Statements; and
>> contractual obligations of the acquired entities that existed prior to the consummation date that either have no economic benefit to the combined entity or have a penalty that we will incur to cancel the contractual obligation. These contractual obligations generally relate to existing information technology and item processing contracts of the acquired entities that include penalties for early termination. The acquisition of specialized entities does not typically result in costs associated with integration of information technology systems as the existing systems remain in use. In conjunction with the merger and integration of our acquisitions, the acquired banks are converted to our existing information technology and item processing systems. Consequently, the costs associated with terminating the existing contracts of the acquired entities are generally recorded as of the consummation date through the establishment of an accrued liability with the offsetting adjustment recorded as an increase to goodwill as further discussed under "Business -- Acquisitions - Acquisition and Integration Costs" and Note 2 to our Consolidated Financial Statements.
We make adjustments to the fair value of the acquired entities' assets and liabilities for these items as of the consummation date and include them in the allocation of the overall acquisition cost. We also incur costs associated with our acquisitions that are expensed in our consolidated statements of income. These costs relate specifically to additional costs incurred in conjunction with the information technology and item processing conversions of the acquired entities, as well as training of personnel on First Bank's systems, as further described and quantified below.
Salaries and employee benefits increased by $27.1 million to $166.9 million for the year ended December 31, 2006, from $139.8 million in 2005. We attribute the overall increase to increased salaries and employee benefits expenses associated with an aggregate of 20 additional branches acquired in 2005 and 2006, one de novo branch opened in 2005, the acquisitions of UPAC and Adrian Baker, in addition to generally higher salary and employee benefit costs associated with employing and retaining qualified personnel, including the implementation of enhanced incentive compensation and employee benefit plans. Our total full-time equivalent employees increased to approximately 2,630 at December 31, 2006 from approximately 2,290 at December 31, 2005.
Occupancy, net of rental income, and furniture and equipment expense was $43.9 million and $38.1 million for the years ended December 31, 2006 and 2005, respectively. The increase reflects higher levels of expense resulting from our de novo activities and acquisitions in 2005 and 2006, as discussed above, as well as increased technology equipment expenditures, continued expansion and renovation of certain corporate and branch offices, and increased depreciation expense associated with acquisitions and capital expenditures.
Information technology and item processing fees were $37.1 million and $35.5 million for the years ended December 31, 2006 and 2005, respectively. As more fully described in Note 19 to our Consolidated Financial Statements, First Services, L.P., a limited partnership indirectly owned by our Chairman and members of his immediate family, provides information technology and various operational support services to our subsidiaries and us. Information technology fees also include fees paid to outside servicers associated with our mortgage lending and trust divisions, our small business lending and institutional money management subsidiaries, and UPAC and Adrian Baker. The increased level of information technology fees was primarily attributable to the additional branch offices provided by our acquisitions and de novo branch office openings; certain de-conversion costs from other providers associated with our acquisitions; growth and technological advancements consistent with our product and service offerings; and continued expansion and upgrades to technological equipment,
networks and communication channels, including costs to maintain security and provide compliance with the Sarbanes-Oxley Act of 2002; partially offset by expense reductions resulting from information technology conversions of our acquisitions completed in 2005 and 2006, as well as the achievement of certain efficiencies associated with the implementation of various technology projects.
Legal, examination and professional fees was $8.8 million and $9.3 million for the years ended December 31, 2006 and 2005, respectively. The continued expansion of overall corporate activities, the ongoing professional services utilized by certain of our acquired entities, and the levels of legal fees associated with certain litigation matters have all contributed to the overall expense levels in 2005 and 2006.
Amortization of intangible assets was $8.2 million and $4.9 million for the years ended December 31, 2006 and 2005, respectively. The increase is attributable to core deposit intangibles associated with our acquisitions completed in 2005 and 2006, in addition to the customer list intangibles associated with our acquisitions of Adrian Baker and UPAC in March 2006 and May 2006, respectively, as further described in Note 2 and Note 8 to our Consolidated Financial Statements.
Charitable contributions expense was $6.5 million and $5.9 million for the years ended December 31, 2006 and 2005, respectively. The increase is primarily attributable to an increase in charitable contributions made to the Dierberg Operating Foundation, Inc. and The Dierberg Foundation, charitable foundations established by our Chairman and members of his immediate family, as further described in Note 19 to our Consolidated Financial Statements.
Other expense was $31.6 million and $29.4 million for the years ended December 31, 2006 and 2005, respectively. Other expense encompasses numerous general and administrative expenses including insurance, freight and courier services, correspondent bank charges, miscellaneous losses and recoveries, expenses on other real estate owned, memberships and subscriptions, transfer agent fees, sales taxes and travel, meals and entertainment. The increase in other expense was primarily attributable to:
>> a $617,000 specific reserve established in March 2006 and an increase of $746,000 to the specific reserve in June 2006 for the estimated loss associated with a $3.1 million unfunded letter of credit acquired with our acquisition of CIB Bank;
>> a $470,000 loss recognized on a liquidation sale of residential real estate and personal property of an SBA guaranteed loan; and
>> expenses associated with continued growth and expansion of our banking franchise, including our de novo branch offices and our acquisitions completed during 2005 and 2006; partially offset by
>> a decrease of $1.5 million of expenditures on other real estate. Expenses on other real estate were $520,000 for the year ended December 31, 2006. Expenses on other real estate were $2.0 million for the year ended December 31, 2005, and included expenditures of $1.1 million related to a parcel of other real estate acquired in conjunction with our CIB Bank acquisition.
Provision for Income Taxes. The provision for income taxes was $55.1 million for the year ended December 31, 2006, representing an effective income tax rate of 33.1%, in comparison to $52.5 million, representing an effective income tax rate of 35.5%, for the year ended December 31, 2005. The increase in our provision for income taxes primarily reflects our increased earnings. In 2006, we reversed a $2.9 million federal tax reserve and a $1.9 million state tax reserve as they were no longer deemed necessary as a result of the resolution of a potential tax liability. In 2005, we reversed a $3.3 million state tax reserve as it was no longer deemed necessary as a result of the resolution of a potential tax liability. In addition, we recorded net tax benefits of $5.6 million and $2.1 million relating to the utilization of certain federal and state tax credits for the years ended December 31, 2006 and 2005, respectively. Excluding these transactions, our effective income tax rate was 38.5% and 38.4% for the years ended December 31, 2006 and 2005, respectively.
Comparison of Results of Operations for 2005 and 2004
Net Income. Net income was $96.9 million for the year ended December 31, 2005, compared to $82.9 million for 2004. Our return on average assets and our return on average stockholders' equity were 1.10% and 15.11%, respectively, for the year ended December 31, 2005, compared to 1.10% and 14.44%, respectively, for 2004. Results for 2005 reflect increased net interest income and noninterest income, and a negative provision for loan losses, partially offset by increased noninterest expense and an increased provision for income taxes. The increase in 2005 reflects our continuing efforts to strengthen earnings and simultaneously improve asset quality. Net interest-earning assets provided by our 2004 and 2005 acquisitions, higher-yielding investment securities, and internal loan growth coupled with higher interest rates on loans contributed to increased interest income in 2005. However, net interest income was adversely affected by a decline in earnings on our interest rate swap agreements associated with our interest
rate risk management program, primarily resulting from increasing prevailing interest rates and the maturity and termination of certain interest rate swap agreements; increased interest expense as a result of higher interest rates on deposits and a redistribution of deposit balances toward higher-yielding products in conjunction with the CIB Bank deposit base acquired in November 2004; increased levels of borrowings coupled with increased rates on such borrowings; and the issuance of additional subordinated debentures late in 2004 to partially fund our acquisition of CIB Bank, as further discussed under "--Net Interest Income." Despite the increasing interest rate environment, overall conditions within our markets and the impact of the decline in earnings on our interest rate swap agreements continue to exert pressure on our net interest income and our net interest margin. The increase in net income in 2005 also resulted from a significant reduction in our provision for loan losses as a result of overall improvement in our nonperforming loans during 2005, exclusive of a deterioration of certain credits in the fourth quarter of 2005 that we transferred to our loans held for sale portfolio, as further discussed under "--Provision for Loan Losses." We primarily attribute the increased noninterest income to additional noninterest income associated with our 2004 and 2005 acquisitions, increased gains on mortgage loans sold and held for sale, increased investment management fee income, and increased service charges on deposit accounts and customer service fees related to higher deposit balances; partially offset by net losses on sales of available-for-sale investment securities and the recognition of impairment on our SBA servicing assets, as further discussed under "--Noninterest Income." The overall increase in our operating expenses for 2005, as further discussed under "--Noninterest Expense," primarily reflects increased expense levels resulting from our 2004 and 2005 acquisitions and the addition of five de novo branch offices in 2004 and 2005, significant charitable contributions expense and increases in salaries and employee benefits expenses.
Provision for Loan Losses. We recorded a $4.0 million negative provision for loan losses for the year ended December 31, 2005, in comparison to a provision for loan losses of $25.8 million for the year ended December 31, 2004. Our net loan charge-offs declined to $13.4 million from $24.8 million for the years ended December 31, 2005 and 2004, respectively. As further discussed under "--Lending Activities" and "--Loans and Allowance for Loan Losses," while we had recorded a negative provision for loan losses of $8.0 million for the first nine months of 2005, reflecting a 21.0% improvement in our nonperforming loans during this period as a result of the sale of certain acquired nonperforming loans, the strengthening of certain loans, loan payoffs and external refinancing of various credits, and a significant reduction in net loan charge-offs, the level of nonperforming loans increased during the fourth quarter of 2005 following further deterioration of a few large credit relationships, resulting in a fourth quarter provision for loan losses of $4.0 million. Our nonperforming loans, which had decreased to $67.8 million at September 30, 2005 from $85.8 million at December 31, 2004, increased $29.4 million during the fourth quarter of 2005, resulting in a balance of $97.2 million at December 31, 2005. The increase in nonperforming loans in the fourth quarter of 2005 is primarily attributable to further deterioration of a small number of credit relationships, including two large credit relationships associated with our CIB Bank purchase of $14.9 million and $16.6 million, or $31.5 million in aggregate. On December 31, 2005, we recognized $7.6 million of loan charge-offs to reduce the loans to their estimated fair value, net of costs, that is expected to be realized at the time of the sale, and transferred approximately $59.7 million of nonperforming loans to our held for sale portfolio, which included several of the relationships that deteriorated during the fourth quarter of 2005. Included in the loan charge-offs and loans transferred to our held for sale portfolio were $6.0 million of loan charge-offs and approximately $49.6 million of nonperforming loans that were associated with our CIB Bank purchase. In January 2006, we received a payoff of one of the nonperforming loans in our held for sale portfolio that had a carrying value of $12.4 million at December 31, 2005, and recorded a $5.0 million loan recovery. Furthermore, in March 2006, we completed the sale of a majority of the remaining nonaccrual loans in our held for sale portfolio that had a carrying value of approximately $32.5 million in aggregate, at December 31, 2005.
Tables summarizing nonperforming assets, past due loans and charge-off and recovery experience are presented under "--Loans and Allowance for Loan Losses."
Noninterest Income and Expense. The following table summarizes noninterest income and noninterest expense for the years ended December 31, 2005 and 2004:
Noninterest Income. Noninterest income was $96.1 million for the year ended December 31, 2005, in comparison to $87.2 million for 2004. Noninterest income consists primarily of service charges on deposit accounts and customer service fees, mortgage-banking revenues, investment management income and other income.
Service charges on deposit accounts and customer service fees increased to $39.8 million from $38.2 million for the years ended December 31, 2005 and 2004, respectively. The increase in service charges and customer service fees is primarily attributable to:
>> increased demand deposit account balances associated with internal growth and our acquisitions of Continental Community Bank and Trust Company, or CCB, and CIB Bank completed in 2004, and our acquisitions completed in 2005;
>> additional products and services available and utilized by our retail and commercial customer base;
>> increased fee income from customer service charges for non-sufficient funds and returned check fees coupled with enhanced control of fee waivers;
>> higher earnings allowances on commercial deposit accounts;
>> increased fee income associated with automated teller machine services and debit cards; and
>> pricing increases on certain service charges and customer service fees instituted to reflect current market conditions.
The gain on loans sold and held for sale increased to $20.8 million from $18.5 million for the years ended December 31, 2005 and 2004, respectively. The increase in 2005 is partially attributable to an increase of $2.0 million of gains on SBA loans sold by SBLS LLC. The increase is also attributable to an increase in gains on mortgage loans sold resulting from an increase in the volume of mortgage loan sales in the secondary market as a result of increased loan origination volumes. In general, new residential mortgage loan production of 15-year fixed rate, conforming conventional adjustable rate mortgages and other similar products is being retained in our portfolio, while other loans, primarily 20 and 30-year fixed rate loans, are typically being sold in the secondary loan markets.
Noninterest income includes a net loss on investment securities of $2.9 million for the year ended December 31, 2005, in comparison to a net gain on investment securities of $257,000 in 2004. The net loss for 2005 resulted from the sale of certain available-for-sale investment securities associated with the termination of a $50.0 million term repurchase agreement in the fourth quarter of 2005. The net gain for 2004 resulted primarily from the sales of certain available-for-sale investment securities held by acquired institutions that did not meet our overall investment objectives.
Bank-owned life insurance investment income was $4.9 million for the year ended December 31, 2005, in comparison to $5.2 million in 2004. The decrease in investment income reflects a reduced return on the performance of the underlying securities surrounding the insurance contracts which is primarily attributable to the portfolio mix of investments and overall market conditions.
Investment management income generated by MVP was $8.6 million for the year ended December 31, 2005, in comparison to $6.9 million in 2004, reflecting increased portfolio management fee income attributable to new business development and overall growth in assets under management.
Other income was $24.9 million and $18.1 million for the years ended December 31, 2005 and 2004, respectively. We attribute the primary components of the increase in other income to:
>> an increase of $3.6 million attributable to recoveries of certain loan principal balances that had been charged-off by the various respective financial institutions prior to their acquisition by First Banks;
>> an increase of $3.1 million attributable to the reversal of a specific reserve on a letter of credit assumed with the CIB Bank acquisition and collection of the related fees resulting from the cancellation of the letter of credit;
>> a net decrease in losses on the valuation or sale of certain repossessed assets, primarily related to our commercial leasing portfolio. Net gains for 2005 were $696,000 and included $464,000 of gains on two sales of repossessed leasing equipment. Net losses for 2004 were $1.6 million and included a $750,000 write-down on repossessed aircraft leasing equipment and a $1.3 million write-down on repossessed equipment unrelated to the airline industry, partially offset by gains of $350,000 on the sale of other repossessed aircraft leasing equipment;
>> an increase of $713,000 reflecting reductions of a contingent liability established in conjunction with the sale of a portion of our commercial leasing portfolio in June 2004. The reductions of the contingent liability in 2005 and 2004 of $1.1 million and $375,000, respectively, were the result of further reductions in related lease balances for the specific pools of leases sold;
>> a recovery of agent loan collection expenses of $739,000 as permitted under a loan participation agreement prior to recovery of principal and interest, from funds collected from the liquidation of a portion of the collateral that secured the loan by the receiver;
>> a $602,000 net increase in loan servicing fees. The net increase is primarily attributable to: increased fees from loans serviced for others, primarily attributable to a $2.3 million increase in SBLS LLC loan servicing fees, offset by an $887,000 increase in amortization of SBA servicing rights and the recognition of a $2.4 million impairment charge on our SBA servicing rights following substantial damage to several shrimping vessels within the servicing portfolio caused by the effects of Hurricane Katrina; a $199,000 decrease in mortgage loan servicing fees, including a lower level of interest shortfall on mortgage loans, offset by a $1.6 million decrease in amortization of mortgage servicing rights; and increased unused commitment fees of $281,000;
>> an increase of $584,000 in fees from fiduciary activities;
>> a $448,000 decrease in net losses on our derivative instruments; and
>> our acquisitions completed in 2004 and 2005; partially offset by
>> a decrease of $2.4 million in gains on sales of other real estate. Gains on sales of other real estate were $1.3 million for the year ended December 31, 2005, and included approximately $972,000 of gains recorded on the sale of six holdings of other real estate. Gains on sales of other real estate were $3.7 million for the year ended December 31, 2004, and included a $2.7 million gain recorded in the first quarter of 2004 on the sale of residential and recreational development property that was transferred to other real estate in January 2003 and approximately $390,000 of gains recorded on the sale of two additional holdings of other real estate;
>> a decline of $1.2 million in rental income associated with reduced commercial leasing activities;
>> a decrease of $1.0 million in gains on sales of branches, net of expenses. Gains, net of expenses, on the sale of two Midwest banking offices totaled $1.0 million and reflected a $390,000 gain, net of expenses, on the sale of one of our Missouri branch banking offices in February 2004, and a $630,000 gain, net of expenses, on the sale of one of our Illinois banking offices in April 2004. There were no sales of branch banking offices in 2005; and
>> a net increase in losses, net of gains, on the disposition of certain assets, primarily attributable to a $459,000 net loss resulting from the demolition of a branch drive-thru facility and a $277,000 net loss resulting from the sale of a former CIB Bank branch facility during 2005.
Noninterest Expense. Noninterest expense was $277.6 million for the year ended December 31, 2005, in comparison to $233.2 million for 2004. Our efficiency ratio was 65.83% for the year ended December 31, 2005, compared to 60.23% for 2004. The increases in noninterest expense and our efficiency ratio for 2005 were primarily attributable to increases in expenses resulting from our 2004 and 2005 acquisitions and the addition of five de novo branch offices in 2004 and 2005, and increases in salaries and employee benefits expense, information technology expense, charitable contributions expense, expenses on other real estate, and other expense.
Salaries and employee benefits increased by $22.3 million to $139.8 million for the year ended December 31, 2005, from $117.5 million in 2004. We attribute the overall increase to increased salaries and employee benefits expenses associated with an aggregate of 27 additional branches acquired in 2004 and 2005 and five de novo branches opened in 2004 and 2005; and the addition of a regional structure in Chicago following our significant expansion in the Chicago market area, including credit administration, commercial real estate and commercial and industrial banking groups, branch administration, credit review and human resource and training functions. The increase is also attributable to generally higher salary and employee benefit costs associated with employing and retaining qualified personnel, including enhanced incentive compensation and employee benefits plans. Our number of employees on a full-time equivalent basis increased to approximately 2,290 at December 31, 2005, from approximately 2,170 at December 31, 2004.
Occupancy, net of rental income, and furniture and equipment expense totaled $38.1 million and $36.9 million for the years ended December 31, 2005 and 2004, respectively. The increase is primarily attributable to higher levels of expense resulting from our acquisitions in 2004 and 2005, which added 27 branch offices, and the opening of five de novo branch offices in 2004 and 2005, as well as the formation of separate small business banking loan origination offices in most of our market areas. The increase is also attributable to increased technology equipment expenditures, continued expansion and renovation of certain corporate and branch offices, including additional production and administrative offices, and increased depreciation expense associated with acquisitions and capital expenditures.
Information technology and item processing fees were $35.5 million and $32.0 million for the years ended December 31, 2005 and 2004, respectively. The increased level of fees is primarily attributable to the additional branch offices provided by our acquisitions and de novo branch office openings; certain de-conversion costs from other providers associated with our acquisitions, growth and technological advancements consistent with our product and service offerings; and continued expansion and upgrades to technological equipment, networks and communication channels; partially offset by expense reductions resulting from information technology conversions of our acquisitions completed in 2004, as well as the achievement of certain efficiencies associated with the implementation of various technology projects. Legal, examination and professional fees were $9.3 million and $7.4 million for the years ended December 31, 2005 and 2004, respectively. The continued expansion of overall corporate activities, the ongoing professional services utilized by certain of our acquired entities, and increased legal fees associated with commercial loan documentation, collection efforts and certain litigation costs primarily related to our various acquired entities have all contributed to the overall expense levels in 2004 and 2005. The increase in 2005 is also attributable to $471,000 of fees paid for accounting and other services, including operational and systems support, provided by the seller of CIB Bank pursuant to a service agreement to provide services from the November 2004 sale date through the system conversion date in February 2005.
Amortization of intangible assets was $4.9 million and $2.9 million for the years ended December 31, 2005 and 2004, respectively. The increase is attributable to core deposit intangibles associated with our acquisitions completed in 2004 and 2005.
Communications and advertising and business development expenses were $9.1 million and $7.4 million for the years ended December 31, 2005 and 2004, respectively. The expansion of our sales, marketing and product group in 2004 and broadened advertising campaigns have contributed to higher expenditures and are consistent with our continued focus on expanding our banking franchise and the products and services available to our customers. Our spring and fall advertising campaigns have contributed to the increase in 2005. We continue our efforts to manage these expenses through renegotiation of contracts, enhanced focus on advertising and promotional activities in markets that offer greater benefits, as well as ongoing cost containment efforts.
Charitable contribution expense was $5.9 million and $577,000 for the years ended December 31, 2005 and 2004, respectively. The increase in 2005 was primarily attributable to charitable contributions of $2.5 million and $1.5 million, respectively, in December 2005 to The Dierberg Foundation and the Dierberg Operating Foundation, Inc. The increase is also attributable to a $1.5 million contribution in May 2005 to an urban revitalization development project
located in the city of St. Louis. In exchange for this contribution, we received Missouri state tax credits that will be utilized to reduce certain state income taxes.
Other expense was $29.4 million and $23.5 million for the years ended December 31, 2005 and 2004, respectively. Other expense encompasses numerous general and administrative expenses including insurance, freight and courier services, correspondent bank charges, miscellaneous losses and recoveries, expenses on other real estate owned, memberships and subscriptions, transfer agent fees, sales taxes and travel, meals and entertainment. The increase is primarily attributable to:
>> an increase of $1.6 million of expenditures on other real estate. Expenditures on other real estate were $2.0 million for the year ended December 31, 2005, and included expenses of $1.1 million in preparation for the sale of a parcel of other real estate acquired with the acquisition of CIB Bank. Expenditures on other real estate were $364,000 for the year ended December 31, 2004;
>> increased losses and adjustments to the carrying value of certain affordable housing credit partnership investments; and
>> expenses associated with continued growth and expansion of our banking franchise, including our de novo branch offices and acquisitions completed during 2004 and 2005, particularly CIB Bank.
Provision for Income Taxes. The provision for income taxes was $52.5 million for the year ended December 31, 2005, representing an effective income tax rate of 35.5%, in comparison to $45.3 million, representing an effective income tax rate of 35.4%, for the year ended December 31, 2004. The increase in our provision for income taxes primarily reflects our increased earnings. During 2005 and 2004, we reversed $3.3 million and $2.8 million of state tax reserves, respectively, that were no longer deemed necessary as a result of the resolution of a potential tax liability. Additionally, in 2005, we recorded a net tax benefit of $2.1 million relating to our utilization of certain federal and state tax credits. Excluding these transactions, our effective income tax rate was 38.4% and 37.5% for the years ended December 31, 2005 and 2004.
Interest Rate Risk Management
For financial institutions, the maintenance of a satisfactory level of net interest income is a primary factor in achieving acceptable income levels. However, the maturity and repricing characteristics of the institution's loan and investment portfolios may differ significantly from those within its deposit structure. The nature of the loan and deposit markets within which a financial institution operates and its objectives for business development within those markets at any point in time influence these characteristics. In addition, the ability of borrowers to repay loans and depositors to withdraw funds prior to stated maturity dates introduces divergent option characteristics that operate primarily as interest rates change. These factors cause various elements of the institution's balance sheet to react in different manners and at different times relative to changes in interest rates, potentially leading to increases or decreases in net interest income over time. Depending upon the direction and magnitude of interest rate movements and their effect on the specific components of the institution's balance sheet, the effects on net interest income can be substantial. Consequently, managing a financial institution requires establishing effective control over the exposure of the institution to changes in interest rates.
We strive to manage our interest rate risk by:
>> maintaining an Asset Liability Committee, or ALCO, responsible to our Board of Directors and Executive Management, to review the overall interest rate risk management activity and approve actions taken to reduce risk;
>> employing a financial simulation model to determine our exposure to changes in interest rates;
>> coordinating the lending, investing and deposit-generating functions to control the assumption of interest rate risk; and
>> utilizing various financial instruments, including derivatives, to offset inherent interest rate risk should it become excessive.
The objective of these procedures is to limit the adverse impact that changes in interest rates may have on our net interest income.
The ALCO has overall responsibility for the effective management of interest rate risk and the approval of policy guidelines. The ALCO includes our President and Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, Chief Investment Officer and the senior officers of finance and risk management, and certain other officers. The Asset Liability Management Group, which monitors interest rate risk, supports the ALCO, prepares analyses for review by the ALCO and implements actions that are either specifically directed by the ALCO or established by policy guidelines.
In managing sensitivity, we strive to reduce the adverse impact on earnings by managing interest rate risk within internal policy constraints. Our policy is to manage exposure to potential risks associated with changing interest rates by maintaining a balance sheet posture in which annual net interest income is not significantly impacted by reasonably possible near-term changes in interest rates. To measure the effect of interest rate changes, we project our net income over a two-year horizon on a pro forma basis. The analysis assumes various scenarios for increases and decreases in interest rates including both instantaneous and gradual, and parallel and non-parallel shifts in the yield curve, in varying amounts. For purposes of arriving at reasonably possible near-term changes in interest rates, we include scenarios based on actual changes in interest rates, which have occurred over a two-year period, simulating both a declining and rising interest rate scenario.
We are "asset-sensitive," indicating that our assets would generally reprice with changes in interest rates more rapidly than our liabilities, and our simulation model indicates a loss of projected net interest income should interest rates decline. While a decline in interest rates of less than 100 basis points has a relatively minimal impact on our net interest income, an instantaneous parallel decline in the interest yield curve of 100 basis points indicates a pre-tax projected loss of approximately 3.7% of net interest income, based on assets and liabilities at December 31, 2006. Although we do not anticipate that instantaneous shifts in the yield curve as projected in our simulation model are likely, these are indications of the effects that changes in interest rates would have over time.
We also prepare and review a more traditional interest rate sensitivity position in conjunction with the results of our simulation model. The following table presents the projected maturities and periods to repricing of our rate sensitive assets and liabilities as of December 31, 2006, adjusted to account for anticipated prepayments:
Management made certain assumptions in preparing the foregoing table. These assumptions included:
>> loans will repay at projected repayment rates;
>> mortgage-backed securities, included in investment securities, will repay at projected repayment rates;
>> interest-bearing demand accounts and savings deposits will behave in a projected manner with regard to their interest rate sensitivity; and
>> fixed maturity deposits will not be withdrawn prior to maturity.
A significant variance in actual results from one or more of these assumptions could materially affect the results reflected in the foregoing table.
Our overall asset-sensitive position at December 31, 2006 remained relatively consistent at $1.39 billion, or 13.65% of our total assets, in comparison to our overall asset-sensitive position of $1.34 billion, or 14.60% of our total assets, at December 31, 2005. However, we were in a liability-sensitive position on a cumulative basis through the twelve-month time horizon of $608.4 million, or 5.99% of our total assets, at December 31, 2006, whereas we were in an asset-sensitive position on a cumulative basis through the twelve-month time horizon of $117.1 million, or 1.28% of our total assets, at December 31, 2005. We primarily attribute the liability-sensitive position on a cumulative basis through the twelve-month time horizon in 2006 to an increase in money market deposits and an increase in the repricing of time deposits within the twelve-month time horizon as a result of the current interest rate environment and economic conditions.
The interest-sensitivity position is one of several measurements of the impact of interest rate changes on net interest income. Its usefulness in assessing the effect of potential changes in net interest income varies with the constant change in the composition of our assets and liabilities and changes in interest rates. For this reason, we place greater emphasis on our simulation model for monitoring our interest rate risk exposure.
As previously discussed, we utilize derivative financial instruments to assist in our management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities. The derivative financial instruments we held as of December 31, 2006 and 2005 are summarized as follows:
The notional amounts of our derivative financial instruments do not represent amounts exchanged by the parties and, therefore, are not a measure of our credit exposure through our use of these instruments. The credit exposure represents the loss we would incur in the event the counterparties failed completely to perform according to the terms of the derivative financial instruments and the collateral held to support the credit exposure was of no value.
For the year ended December 31, 2006, we realized net interest expense of $5.0 million on our derivative financial instruments, whereas for the years ended December 31, 2005 and 2004, we realized net interest income of $2.2 million and $50.1 million, respectively, on our derivative financial instruments. The decreased earnings for 2006 and 2005 are primarily attributable to increases in prevailing interest rates, the maturity of $200.0 million and $100.0 million notional amount of interest rate swap agreements designated as cash flow hedges in March 2005 and April 2006, respectively, and the termination of $150.0 million, $101.2 million and $25.0 million notional amount of interest rate swap agreements designated as fair value hedges in February 2005, May 2005 and February 2006, respectively. Although we have implemented other methods to mitigate the reduction in net interest income associated with our derivatives, the maturity and termination of the swap agreements has resulted in a compression of our net interest margin of approximately eight basis points for the year ended December 31, 2006, in comparison to 2005. In addition, the increasing interest rate environment has mitigated a portion of the effect of the reduced earnings on our derivative financial instruments. During the third quarter of 2006, we significantly expanded our utilization of derivative financial instruments, as further described in Note 5 to our Consolidated Financial Statements, in an effort to reduce the adverse impact that falling interest rates could have on our net interest income.
We recorded net losses on derivative instruments, which are included in noninterest income in our consolidated statements of income, of $390,000, $1.1 million and $1.5 million for the years ended December 31, 2006, 2005 and 2004, respectively. The net losses recorded in 2006 reflect changes in the value of our interest rate floor agreements entered into in September 2005 and 2006, and changes in the value of our interest rate cap agreements entered into in September 2006. The net losses recorded in 2005 reflect changes in the value of our fair value hedges and the underlying hedged liabilities, and changes in the value of our interest rate floor agreement entered into in September 2005. Information regarding our derivative financial instruments outlined in the table above is further discussed in Note 5 to our Consolidated Financial Statements appearing elsewhere in this report.
Mortgage Banking Activities
Our mortgage banking activities consist of the origination, purchase and servicing of residential mortgage loans. The purchase of loans to be held for sale is primarily limited to loans that we acquire in conjunction with our acquisition of other financial institutions. Generally, we sell our production of residential mortgage loans in the secondary loan markets. However, in mid-2003, as a result of continued weak loan demand in other sectors of our loan portfolio, we made a business strategy decision to retain a portion of new residential mortgage loan production in our real estate mortgage portfolio, generally represented by production originated in our St. Louis production offices with the exception of 20 and 30-year fixed rate loans which are typically sold in the secondary loan markets. Furthermore, in the third quarter of 2005, we revised our strategy and began retaining additional mortgage loan production in our residential real estate mortgage portfolio, including 15-year fixed rate, conforming conventional adjustable rate mortgages and other similar products, and continued this strategy through the first six months of 2006, as further discussed in "--Loans and Allowance for Loan Losses." Servicing rights may either be retained or released with respect to conventional, FHA and VA conforming fixed-rate and conventional adjustable rate residential mortgage loans.
For the three years ended December 31, 2006, 2005 and 2004, we originated residential mortgage loans held for sale and held for portfolio totaling $1.28 billion, $1.60 billion and $1.14 billion, respectively, and sold residential mortgage loans totaling $1.11 billion, $1.14 billion and $1.03 billion, respectively. The origination and purchase of residential mortgage loans and the related sale of the loans provides us with additional sources of income including the gain or loss realized upon sale, the interest income earned while the loan is held awaiting sale and the ongoing loan servicing fees from the loans sold with servicing rights retained. Mortgage loans serviced for investors aggregated $1.04 billion, $1.01 billion and $1.06 billion at December 31, 2006, 2005 and 2004, respectively.
The gain on mortgage loans originated for resale, including loans sold and held for sale, was $18.6 million, $18.1 million and $17.8 million for the years ended December 31, 2006, 2005 and 2004, respectively. We determine these gains, net of losses, on a lower of cost or market basis. These gains are realized at the time of sale. The cost basis reflects both the adjustments of the carrying values of loans held for sale to the lower of cost, adjusted to include the cost of hedging the loans held for sale, or current market values, as well as the adjustments for any gains or losses on loan commitments for which the interest rate has been established, net of anticipated underwriting "fallout," adjusted for the cost of hedging these loan commitments. Fallout represents loans not funded due to issues discovered during the underwriting process or withdrawal of the loan request by the customer. The increase in gains in 2006 is primarily attributable to the recognition of $2.1 million of servicing income generated from the capitalization of mortgage servicing rights pertaining to the securitization and transfer to our investment portfolio of $138.9 million of residential mortgage loans held in our loan portfolio, as further described in Note 6 to our Consolidated Financial Statements; and net gains of $386,000, $1.1 million and $909,000 recorded on the sale of $100.0 million, $101.6 million and $77.1 million of certain residential mortgage loans in August 2006, October 2006 and December 2006, respectively, of which $127.8 million represented loans held in our portfolio and $150.9 million represented loans held for sale; partially offset by management's decision to retain additional loan volume in our residential real estate mortgage portfolio during the first six months of 2006, as discussed above. The increase for 2005 is primarily attributable to the continued growth of our mortgage banking activities and the relatively high volume of loans originated and sold commensurate with the prevailing interest rate environment, partially offset by management's decision to retain additional loan volume in our residential real estate mortgage portfolio, as discussed above.
Interest income on loans held for sale was $18.2 million for the year ended December 31, 2006, in comparison to $11.7 million and $8.8 million for the years ended December 31, 2005 and 2004, respectively. The amount of interest income realized on loans held for sale is a function of the average balance of loans held for sale, the period for which the loans are held and the prevailing interest rates when the loans are made. The average balance of loans held for sale was $247.0 million, $184.1 million and $133.3 million for the years ended December 31, 2006, 2005 and 2004, respectively. On an annualized basis, our yield on the portfolio of loans held for sale was 7.39%, 6.36% and 6.61% for the years ended December 31, 2006, 2005 and 2004, respectively. This compares with our cost of funds, as a percentage of average interest-bearing liabilities, of 3.49%, 2.47% and 1.64% for the years ended December 31, 2006, 2005 and 2004, respectively.
We report mortgage loan servicing fees in other noninterest income in our consolidated statements of income, net of amortization of mortgage servicing rights, interest shortfall and mortgage-backed security guarantee fee expense. Interest shortfall equals the difference between the interest collected from a loan-servicing customer upon prepayment of the loan and a full month's interest that is required to be remitted to the security owner. Our net mortgage loan servicing fees contributed to an overall reduction in our other noninterest income of $1.4 million, $1.2 million and $2.6 million for the years ended December 31, 2006, 2005 and 2004, respectively, which included the amortization of mortgage servicing rights of $4.1 million, $5.0 million and $6.5 million for the years ended December 31, 2006, 2005 and 2004, respectively. We attribute the slight decrease in net loan servicing fees in 2006 to a reduction in fees associated with the retention of a portion of loan production in our residential mortgage loan portfolio, as previously discussed, partially offset by reduced amortization of mortgage servicing rights. We attribute the increase in net loan servicing fees in 2005 to reduced amortization of mortgage servicing rights, partially offset by a reduction in fees associated with a lower volume of loans serviced for others and the retention of a portion of loan production in our residential mortgage loan portfolio.
Our interest rate risk management policy provides certain hedging parameters to reduce the interest rate risk exposure arising from changes in loan prices from the time of commitment until the sale of the security or loan. To reduce this exposure, we use forward commitments to sell fixed-rate mortgage-backed securities at a specified date in the future. At December 31, 2006, 2005 and 2004, we had $56.0 million, $47.7 million and $35.3 million, respectively, of loans held for sale and related commitments, net of committed loan sales and estimated underwriting fallout, of which $54.0 million, $47.0 million and $34.0 million, respectively, were hedged through the use of such forward commitments.
Investment Securities
We classify the securities within our investment portfolio as trading, available for sale or held to maturity. Our investment security portfolio consists primarily of securities designated as available for sale. During the fourth quarter of 2005, we began to engage in the trading of investment securities. The investment security portfolio was $1.46 billion at December 31, 2006, compared to $1.34 billion and $1.81 billion at December 31, 2005 and 2004, respectively. We attribute the increase in the investment securities portfolio in 2006 to: an increase in the available-for-sale securities portfolio due to the securitization of $138.9 million of certain of our residential mortgage loans held in our loan portfolio; an increase in our trading securities portfolio of $77.8 million; reinvestment of funds available from maturities in higher-yielding securities; and an increase of $37.3 million relating to securities acquired through our acquisitions completed in 2006; partially offset by the sale of the underlying available-for-sale investment securities associated with the termination of $200.0 million of term repurchase agreements, as further described in Note 3, Note 5 and Note 10 to our Consolidated Financial Statements. Funds available from maturities of investment securities during 2005 were primarily used to fund loan growth, resulting in the decrease in our investment securities portfolio in 2005. A portion of the remaining funds available from maturities of investment securities were reinvested in higher-yielding available-for-sale investment securities. The decrease also reflects the sale of the underlying available-for-sale investment securities associated with the termination of a $50.0 million term repurchase agreement.
Loans and Allowance for Loan Losses
Interest earned on our loan portfolio represents the principal source of income for First Bank. Interest and fees on loans were 90.0%, 85.9% and 86.5% of total interest income for the years ended December 31, 2006, 2005 and 2004, respectively. We recognize interest and fees on loans as income using the interest method of accounting. Loan origination fees are deferred and accreted to interest income over the estimated life of the loans using the interest method of accounting. The accrual of interest on loans is discontinued when it appears that interest or principal may not be paid in a timely manner in the normal course of business. We generally record payments received on nonaccrual and impaired loans as principal reductions, and defer the recognition of interest income on loans until all principal has been repaid or an improvement in the condition of the loan has occurred that would warrant the resumption of interest accruals.
Loans, net of unearned discount, represented 75.5% of our assets as of December 31, 2006, compared to 76.6% of our assets at December 31, 2005. Loans, net of unearned discount, increased $645.7 million to $7.67 billion at December 31, 2006 from $7.02 billion at December 31, 2005. The overall increase in loans, net of unearned discount, in 2006 is primarily attributable to internal loan growth of $584.2 million and our acquisitions completed in 2006, which provided loans, net of unearned discount, of $545.1 million, in aggregate. This increase was partially offset by the securitization of certain residential mortgage loans that we transferred to our investment portfolio, and the sale and/or payoff of certain nonperforming loans, as further discussed below. Loans, net of unearned discount, increased $882.8 million to $7.02 billion at December 31, 2005 from $6.14 billion at December 31, 2004. Our acquisitions completed in 2005 provided loans, net of unearned discount, of $209.6 million, in aggregate. Exclusive of these acquisitions, our loans, net of unearned discount, increased $687.5 million in 2005, as a result of internal loan growth. In addition, we reduced our loans and leases by $14.3 million in the first and second quarters of 2005 from the sale of certain nonperforming loans, resulting from management's business decision in late 2004 to reduce the level of our nonperforming assets through the sale of certain nonperforming loans. We attribute the net increase in our loan portfolio in 2006 primarily to:
>> an increase of $315.1 million in our commercial, financial and agricultural portfolio, primarily attributable to an increase of $214.9 million associated with our acquisitions completed during 2006, including $149.2 million of loans provided by our acquisition of UPAC in May 2006, in addition to continued internal loan production growth within this portfolio;
>> an increase of $268.2 million in our real estate construction and development portfolio resulting from internal growth due to new loan originations and seasonal fluctuations on existing and available credit lines, as well as a $34.2 million increase associated with our acquisitions completed in 2006; and
>> an increase of $145.4 million in our real estate mortgage portfolio resulting from: (a) internal loan growth of $289.8 million, largely attributable to the retention of certain mortgage loan production in our residential real estate mortgage portfolio during the first six months of 2006 following management's business strategy decision in the third quarter of 2005 to retain certain additional mortgage loan product production in our residential real estate mortgage portfolio; (b) our acquisitions completed during 2006, which provided real estate mortgage loans of $293.0 million; partially offset by (c) the securitization of $77.1 million and $61.8 million of certain residential mortgage loans in March 2006 and April 2006, respectively, which resulted in a change in our asset structure from residential mortgage loans to available-for-sale investment securities; and (d) the sale of approximately $127.8 million of residential mortgage loans in the third and fourth quarters of 2006; partially offset by
>> a decrease of $98.8 million in loans held for sale resulting from (a) the timing of loan originations and subsequent sales in the secondary mortgage market; (b) the payoff and/or sale of approximately $44.9 million of certain acquired loans that we transferred to our held for sale portfolio on December 31, 2005; and (c) the transfer of a $13.5 million nonperforming loan from our loans held for sale portfolio to our commercial real estate loan portfolio after recording a $1.1 million write-down of the credit to its estimated fair value at the time of transfer. We subsequently received a payoff on this credit for the amount of its revised carrying value in December 2006.
In our evaluation of acquisitions, it is anticipated that as we apply our standards for credit structuring, underwriting, documentation and approval, a portion of the existing borrowers will elect to refinance their loans with another financial institution, because of one or more of the following factors: (a) there may be an aggressive effort by other financial institutions to attract them; (b) they do not accept the changes involved, or (c) they are unable to meet our credit requirements. In addition, another portion of the portfolio may either enter our remedial collection process to reduce undue credit exposure or improve problem loans, or may be charged-off. The amount of this attrition will vary substantially among acquisitions depending on the strength and discipline within the credit function of the acquired institution; the magnitude of problems contained in the acquired portfolio; the aggressiveness of competing institutions to attract business; and the significance of the acquired institution to the overall banking market. Typically, in acquisitions of institutions that have strong credit cultures prior to their acquisitions and operate in moderately large markets, there is relatively little attrition that occurs after the acquisition. However, in those acquisitions in which the credit discipline has been weak, and particularly those in small metropolitan or rural areas, we can experience substantially greater attrition. Generally, this process occurs within approximately six to 12 months after completion of the acquisition.
During the five years ended December 31, 2006, loans, net of unearned discount, increased from $5.41 billion at December 31, 2001 to $7.67 billion at December 31, 2006, an increase of $2.26 billion, or 41.7%. Throughout this period, we have achieved significant growth through implementation of our acquisition strategy and we have also enhanced our capabilities for achieving and managing internal growth. A key element of this process has been the expansion of our corporate business development staff, which is responsible for the internal development and management of both loan and deposit relationships with commercial customers. While this process was occurring, in an attempt to achieve more diversification, a higher level of interest yield and a reduction in interest rate risk within our loan portfolio, we also focused on repositioning our portfolio. As the corporate business development effort continued to originate a substantial volume of new loans, nearly all of our conforming residential mortgage loan production was historically sold in the secondary mortgage market until management's decision in 2003 to retain a portion of the new loan production in our real estate mortgage portfolio to offset continued weak loan demand in other sectors of our loan portfolio and management's decision in the third quarter of 2005 to retain additional mortgage loan product production in our residential real estate mortgage portfolio, including 15-year fixed rate, conforming conventional adjustable rate mortgages and other similar products. Furthermore, our lease financing portfolio, which now represents an insignificant portion of our loan portfolio, was reduced as a result of (a) the discontinuation of our New Mexico based leasing operation in 2002, the transfer of all responsibilities for the existing portfolio to a new leasing staff in St. Louis, Missouri, a change in our overall business strategy resulting in reduced commercial leasing activities and repayment of leases by borrowers, and (b) the sale of a significant portion of our remaining commercial leasing portfolio, which reduced the portfolio by approximately $33.1 million to $9.6 million at June 30, 2004. We have also reduced our consumer lending by discontinuing the origination of indirect auto loans and selling our student loan and credit card loan portfolios. This allowed us to fund part of the growth in corporate lending through reductions in indirect automobile and other consumer-related loans.
As previously mentioned, our acquisitions have contributed to an increase in the portfolios of new loans during the five years ended December 31, 2006. In certain cases, these acquired portfolios contained significant loan problems, which we had anticipated and attempted to consider in our acquisition pricing. As we resolved the asset quality issues, the portfolios of the acquired entities tended to decline due to the elimination of problem loans and because many of the resources that would otherwise be directed toward generating new loans were concentrated on improving or eliminating existing problem relationships. We continued to experience this trend, most significantly as a result of our acquisition of CIB Bank in November 2004, although we have been successful in satisfactorily addressing the problem credits acquired with that acquisition, as further discussed below.
The following table summarizes the components of changes in our loan portfolio, net of unearned discount, for the five years ended December 31, 2006:
We seek to maintain a lending strategy that emphasizes quality, growth and diversification. Throughout our organization, we employ a common credit underwriting policy. Our commercial lenders focus principally on small to middle-market companies. Consumer lenders focus principally on residential loans, including home equity loans and other consumer financing opportunities arising out of our branch banking network.
Commercial, financial and agricultural loans include loans that are made primarily based on the borrowers' general credit strength and ability to generate cash flows for repayment from income sources even though such loans may also be secured by real estate or other assets. Real estate construction and development loans, primarily relating to residential properties and commercial properties, represent financing secured by real estate under construction. Real estate mortgage loans consist primarily of loans secured by single-family, owner-occupied properties and various types of commercial properties on which the income from the property is the intended source of repayment. Consumer and installment loans are loans to individuals and consist of a mix of secured and unsecured loans, including preferred credit and loans secured by automobiles. Loans held for sale are primarily fixed and adjustable rate residential mortgage loans pending sale in the secondary mortgage market in the form of a mortgage-backed security, or to various private third-party investors.
The following table summarizes the composition of our loan portfolio by major category and the percent of each category to the total portfolio as of the dates presented:
Nonperforming assets include nonaccrual loans, restructured loans and other real estate. The following table presents the categories of nonperforming assets and certain ratios as of the dates presented:
Nonperforming loans, consisting of loans on nonaccrual status and certain restructured loans, were $48.7 million at December 31, 2006, in comparison to $97.2 million and $85.8 million at December 31, 2005 and 2004, respectively. Other real estate owned was $6.4 million, $2.0 million and $4.0 million at December 31, 2006, 2005 and 2004, respectively. Our nonperforming assets, consisting of nonperforming loans and other real estate owned, were $55.2 million, $99.2 million and $89.8 million at December 31, 2006, 2005 and 2004, respectively. A significant portion of our nonperforming loans in 2004 and 2005 included loans associated with our acquisition of CIB Bank in November 2004, which totaled $55.0 million, or 56.6% of our nonperforming loans, at December 31, 2005, and $50.5 million, or 58.8% of our nonperforming loans, at December 31, 2004. At December 31, 2006, we did not have any nonperforming loans associated with our CIB Bank acquisition. The decrease in nonperforming loans primarily resulted from our plans to reduce nonperforming assets through the sale of certain nonperforming loans, loan payoffs and/or external refinancing of certain credit relationships. We attribute the 44.4% net decrease in our nonperforming assets during the year ended December 31, 2006 to the following:
>> the payoff of two significant nonperforming loans totaling $27.3 million, in aggregate;
>> following the transfer of 11 nonperforming loans totaling approximately $59.7 million to our held for sale portfolio on December 31, 2005, as further discussed below, in January 2006, we received a payoff on one of the loans held for sale that had a carrying value of $12.4 million at December 31, 2005. In conjunction with this payoff, we recognized a loan recovery of $5.0 million and interest and late fees of $2.0 million on the payoff of the loan. In March 2006, we completed the sale of the majority of the remaining loans held for sale that had a carrying value of approximately $32.5 million, in aggregate, at December 31, 2005, and recorded a pre-tax gain of approximately $1.7 million on the sale of these loans. Additionally, in September 2006, we recorded a $1.1 million write-down on the single remaining nonperforming loan held for sale and transferred the loan at its estimated fair value of $13.5 million back into our loan portfolio. We subsequently received a payoff on this nonperforming loan in December 2006 in the amount of the loan's adjusted carrying value;
>> in December 2006, we completed the sale of $32.6 million of loans, which included approximately $14.8 million of acquired nonperforming loans, and recorded a pre-tax gain of approximately $3.7 million on the sale of these loans. In addition, we recognized loan charge-offs of $2.3 million in conjunction with the transfer of these commercial loans to our loans held for sale portfolio prior to their sale; and
>> overall improvement in the level of nonperforming assets resulting from our continued focus on improving asset quality through an ongoing process of problem loan work-outs, exclusive of the deterioration of certain credit relationships discussed below; the sale of certain acquired nonperforming loans; the strengthening of certain loans; and loan payoffs and/or external refinancing of various credits, as further discussed below.
The overall reduction in our nonperforming assets was partially offset by deterioration within our one-to-four family residential loan portfolio as a result of current market conditions, and the deterioration of several credit relationships, primarily within our residential development and construction portfolio, during the later part of 2006 that were driven by current market conditions, including slowdowns in unit sales.
As further discussed under "Business --Lending Activities," the increase in nonperforming loans in 2005 was primarily attributable to the deterioration of a few large credit relationships in our Midwest region during the fourth quarter of 2005, partially offset by significant improvement in the overall level of our nonperforming loans during the first nine months of 2005. The increase in nonperforming loans in the fourth quarter of 2005 was primarily attributable to further deterioration of a small number of credit relationships in our Midwest region, including two large relationships of $14.9 million and $16.6 million, or $31.5 million in aggregate, that were acquired in the purchase of CIB Bank. On December 31, 2005, we recognized $7.6 million of loan charge-offs to reduce the loans to their estimated fair value, net of costs, that was expected to be realized at the time of the sale, and transferred approximately $59.7 million of nonperforming loans to our held for sale portfolio, which included several of the relationships that deteriorated during the fourth quarter of 2005 and one credit relationship of $12.4 million, which was included in nonperforming loans at December 31, 2004 with a value of $14.5 million. Included in these loan charge-offs and loans transferred to our held for sale portfolio were $6.0 million of loan charge-offs and approximately $49.6 million of nonperforming loans that were associated with our CIB Bank purchase. As previously discussed, during 2006, we sold the majority of these loans held in our loans held for sale portfolio, received payoffs on certain credits, and transferred one loan back into our loan portfolio and subsequently received payment in full of the remaining balance.
The improvement of our nonperforming loans during the first nine months of 2005 primarily resulted from: our continued emphasis on improving asset quality; the sale of approximately $14.3 million of certain acquired nonperforming loans; strengthening of certain loans; and loan payoffs and/or external refinancing of various credits, including $97.3 million of loan payoffs on 14 credit relationships during the first and second quarters of 2005. A portion of the loan payoffs and sales during the first quarter of 2005 pertaining to certain acquired nonperforming loans that were classified as loans held for sale as of December 31, 2004 contributed to a reallocation of the purchase price on our acquisition of CIB Bank, as further described in Note 2 to our Consolidated Financial Statements. We also recorded a $1.6 million write-down on an acquired parcel of other real estate owned to its estimated fair value based upon additional data received. This write-down was recorded as an acquisition-related adjustment in the first quarter of 2005 and is further discussed in Note 2 to our Consolidated Financial Statements. In addition, our nonperforming assets
associated with our acquisition of SBLS in August 2004 decreased by $4.0 million during 2005, primarily resulting from $3.8 million of loan charge-offs, which reduced SBLS LLC's nonperforming assets to $2.3 million at December 31, 2005. SBLS LLC previously had a significant concentration of assets associated with the shrimping vessels industry, which were reflected in both nonperforming loans and other repossessed assets. The SBA agreed to repurchase SBLS LLC's entire shrimping vessels portfolio, and these loans were placed in liquidation status in 2005. Throughout 2006, the majority of these loans have been fully liquidated via completion of the sale of the underlying collateral and/or the collection of insurance proceeds associated with vessels that were heavily damaged by Hurricane Katrina and deemed to be irreparable.
The increase in nonperforming loans in 2004 was primarily associated with our 2004 acquisitions, partially offset by substantial improvement in our existing portfolio of nonperforming assets as a result of significant loan payoffs, the liquidation of foreclosed property, the sale of certain nonperforming loans and the sale of a portion of our commercial leasing portfolio. The increase in nonperforming loans in 2003 and 2002 was primarily attributable to the current economic conditions that existed during those periods, additional problems identified in two acquired loan portfolios and continuing deterioration in our commercial leasing portfolio, particularly the segment of the portfolio related to the airline industry.
Loans past due 90 days or more and still accruing interest were $5.7 million and $5.6 million at December 31, 2006 and 2005, respectively, reflecting a decrease of approximately $23.1 million from $28.7 million at December 31, 2004. The overall levels of such delinquencies at December 31, 2006 and 2005 are primarily reflective of the continued growth in our loan portfolio. The substantial increase in 2004 resulted from our acquisitions of CIB Bank and CCB, which comprised $27.2 million of our loans past due 90 days or more and still accruing interest at December 31, 2004. A significant portion of these loans were past due as to contractual maturity and pending renewal at December 31, 2004; however, the majority of the loan payments were current and in accordance with the contractual terms of the underlying credit agreements.
Our allowance for loan losses as a percentage of loans, net of unearned discount, was 1.90%, 1.93% and 2.46% at December 31, 2006, 2005 and 2004, respectively. Our allowance for loan losses as a percentage of nonperforming loans increased to 299.05% at December 31, 2006, from 139.23% and 175.65% at December 31, 2005 and 2004, respectively, and primarily resulted from the reduction in nonperforming loans in 2006. Our allowance for loan losses was $145.7 million at December 31, 2006, compared to $135.3 million and $150.7 million at December 31, 2005 and 2004, respectively. As further described in the table below and under "--Business - Lending Activities," the allowance for loan losses also reflects an increase of $5.2 million and $2.0 million in 2006 and 2005, respectively, and an increase of $33.8 million in 2004, of balances acquired in conjunction with our acquisitions, including a $15.7 million increase to reflect the application of our loss factors to CIB Bank's loan portfolio risk ratings, reflecting our strategies for more rapid resolution of certain acquired classified and nonperforming assets. This adjustment was partially offset by our reclassification, at the time of acquisition, of CIB Bank's specific reserves of $21.7 million as a reduction of the basis of the individual loan relationships (which had no impact on our net loan balances), and the transfer of $18.3 million of nonperforming loans to loans held for sale, resulting in a corresponding charge of $5.4 million to the allowance for loan losses to reduce the loans held for sale to their estimated fair value, net of broker costs, that was expected to be realized at the time of sale.
Loan charge-offs decreased to $22.2 million for the year ended December 31, 2006, compared to $33.1 million and $50.6 million for the comparable periods in 2005 and 2004, respectively. Loan recoveries were $15.4 million for the year ended December 31, 2006, compared to $19.8 million and $25.9 million for the comparable periods in 2005 and 2004, respectively. Loan charge-offs, net of recoveries, decreased to $6.8 million for the year ended December 31, 2006, compared to $13.4 million and $24.8 million for the comparable periods in 2005 and 2004, respectively. Net loan charge-offs for 2006 include $2.3 million of loans charged-off in conjunction with the transfer of certain commercial loans to the loans held for sale portfolio prior to their sale in the fourth quarter of 2006, and a $5.0 recovery recorded in the first quarter of 2006 on the payoff of a single nonperforming loan. Net loan charge-offs for 2005 included $7.6 million of charge-offs associated with the $59.7 million of loans transferred to our held for sale portfolio at December 31, 2005, as previously discussed. We continue to closely monitor our loan portfolio and address the ongoing challenges posed by the economic environment, including reduced loan demand and highly competitive markets within certain sectors of our loan portfolio. We consider this in our overall assessment of the adequacy of the allowance for loan losses.
The level of nonperforming assets from our 2004 acquisitions significantly contributed to increased levels of problem loans and past due loans, and we anticipated the level of nonperforming and delinquent loans would continue during 2005 and, to a lesser degree, during 2006 as we worked to resolve the underlying issues associated with the nonperforming assets of the acquired portfolios, including our efforts to actively market and sell a significant portion of the nonperforming loans, as discussed above. In addition, although we have experienced improvement in our nonperforming asset levels in 2006, we continue our efforts to reduce the overall level of these assets in accordance with our credit risk guidelines.
As of December 31, 2006, 2005, 2004, 2003 and 2002, $67.1 million, $124.3 million, $161.8 million, $109.4 million and $98.2 million, respectively, of loans not included in the table above were identified by management as having potential credit problems, or problem loans. The decline in the level of problem loans during 2005 and 2006 primarily reflects improvement in the management of these loans and success in resolving certain of the problem loans associated with our 2004 and 2005 acquisitions. The significant increase in the level of problem loans for the year ended December 31, 2004 was primarily attributable to our acquisition of CIB Bank, in addition to internal portfolio growth and economic conditions within certain sectors of the markets in which we operate. The significant level of problem loans for the year ended December 31, 2003 was primarily due to continuing deterioration of our commercial leasing portfolio, internal and external portfolio growth, the gradual slow down and uncertainties that occurred in the economy in the markets in which we operate, as well as residual problem loans stemming from one of our 2001 acquisitions. Certain acquired loan portfolios exhibited varying degrees of distress prior to their acquisition. While these problems had been identified and considered in our acquisition pricing, the acquisitions led to an increase in nonperforming assets and problem loans. Management continues its efforts to reduce nonperforming and problem loans and re-define overall strategy and business plans with respect to our loan portfolio as deemed necessary.
Our credit management policies and procedures focus on identifying, measuring and controlling credit exposure. These procedures employ a lender-initiated system of rating credits, which is ratified in the loan approval process and subsequently tested in internal credit reviews, external audits and regulatory bank examinations. The system requires the rating of all loans at the time they are originated or acquired, except for homogeneous categories of loans, such as residential real estate mortgage loans and consumer loans. These homogeneous loans are assigned an initial rating based on our experience with each type of loan. We adjust the ratings of the homogeneous loans based on payment experience subsequent to their origination.
We include adversely rated credits, including loans requiring close monitoring that would not normally be considered classified credits by regulators, on our monthly loan watch list. Loans may be added to our watch list for reasons that are temporary and correctable, such as the absence of current financial statements of the borrower or a deficiency in loan documentation. Other loans are added to our watch list whenever any adverse circumstance is detected which might affect the borrower's ability to comply with the contractual terms of the loan. The delinquency of a scheduled loan payment, deterioration in the borrower's financial condition identified in a review of periodic financial statements, a decrease in the value of the collateral securing the loan, or a change in the economic environment within which the borrower operates could initiate the addition of a loan to our watch list. Loans on our watch list require periodic detailed loan status reports prepared by the responsible officer which are discussed in formal meetings with credit review and credit administration staff members. Upgrades and downgrades of loan risk ratings may be initiated by the responsible loan officer. However, upgrades of risk ratings associated with significant credit relationships and/or problem credit relationships may only be made with the concurrence of appropriate regional or senior regional credit officers.
Each month, the credit administration department provides management with detailed lists of loans on the watch list and summaries of the entire loan portfolio by risk rating. These are coupled with analyses of changes in the risk profile of the portfolio, changes in past-due and nonperforming loans and changes in watch list and classified loans over time. In this manner, we continually monitor the overall increases or decreases in the level of risk in our loan portfolio. Factors are applied to the loan portfolio for each category of loan risk to determine acceptable levels of allowance for loan losses. In addition, a quarterly evaluation of each lending unit is performed based on certain factors, such as lending personnel experience, recent credit reviews, loan concentrations and other factors. Based on this evaluation, changes to the allowance for loan losses may be required due to the perceived risk of particular portfolios. The calculated allowance required for the portfolio is then compared to the actual allowance balance to determine the adjustments necessary to maintain the allowance at an appropriate level. In addition, management exercises a certain degree of judgment in its analysis of the overall adequacy of the allowance for losses. In its analysis, management considers the changes in the portfolio, including growth, composition, the ratio of net loans to total assets, and the economic conditions of the regions in which we operate. Based on this quantitative and qualitative analysis, adjustments are made to the allowance for loan losses. Such adjustments are reflected in our consolidated statements of income.
The allocation of the allowance for loan losses by loan category is a result of the application of our risk rating system augmented by qualitative analysis. The same procedures we employ to determine the overall risk in our loan portfolio and our requirements for the allowance for loan losses determine the distribution of the allowance by loan category. Consequently, the distribution of the allowance will change from period to period due to (a) changes in the aggregate loan balances by loan category; (b) changes in the identified risk in each loan in the portfolio over time, excluding those homogeneous categories of loans such as consumer and installment loans and residential real estate mortgage loans for which risk ratings are changed based on payment performance; and (c) changes in loan concentrations by borrower.
Since the methods of calculating the allowance requirements have not significantly changed over time, the reallocations among different categories of loans that appear between periods are the result of changes in the balances of the individual loans that comprise the aggregate portfolio due to the factors listed above. However, the perception of risk with respect to particular loans within the portfolio will change over time as a result of the characteristics and performance of those loans, as well as the overall economic trends and market trends, including our actual and expected trends in nonperforming loans. Consequently, while there are no specific allocations of the allowance resulting from economic or market conditions or actual or expected trends in nonperforming loans, these factors are considered in the initial assignment of risk ratings to loans and in subsequent changes to those risk ratings.
The following table is a summary of our loan loss experience for the five years ended December 31, 2006:
Deposits
Deposits are the primary source of funds for First Bank. Our deposits consist principally of core deposits from our local market areas, including individual and corporate customers.
The following table sets forth the distribution of our average deposit accounts for the years indicated and the weighted average interest rates on each category of deposits:
Capital and Dividends
Historically, we have accumulated capital to support our acquisitions by retaining most of our earnings. We pay relatively small dividends on our Class A convertible, adjustable rate preferred stock and our Class B adjustable rate preferred stock, totaling $786,000 for the years ended December 31, 2006, 2005 and 2004.
Management believes as of December 31, 2006 and 2005, First Bank and we were "well capitalized," as defined in regulations adopted pursuant to the FDIC Improvement Act of 1991. First Bank's and our actual and required capital ratios are further described in Note 21 to our Consolidated Financial Statements.
As of December 31, 2006, we had nine affiliated Delaware or Connecticut statutory and business trusts that were created for the sole purpose of issuing trust preferred securities. As further described in Note 12 to our Consolidated Financial Statements, the sole assets of the statutory and business trusts are our subordinated debentures.
A summary of the outstanding trust preferred securities issued by our affiliated statutory and business trusts, and our related subordinated debentures issued to the respective trusts in conjunction with the trust preferred securities offerings as of December 31, 2006, is as follows:
For regulatory reporting purposes, the trust preferred securities are eligible for inclusion, subject to certain limitations, in our Tier 1 capital. Because of these limitations, as of December 31, 2006, $19.8 million of the trust preferred securities was not eligible for inclusion in our Tier 1 capital; however, this amount was eligible for inclusion in our total risk-based capital. In addition, as further described in Note 25 to our Consolidated Financial Statements, in February 2007, we issued $25.8 million of subordinated debentures to First Bank Statutory Trust VIII, a newly-formed Delaware statutory trust.
Liquidity
Our liquidity is the ability to maintain a cash flow that is adequate to fund operations, service debt obligations and meet obligations and other commitments on a timely basis. We receive funds for liquidity from customer deposits, loan payments, maturities of loans and investments, sales of investments and earnings. In addition, we may avail ourselves of other sources of funds by issuing certificates of deposit in denominations of $100,000 or more, borrowing federal funds, selling securities under agreements to repurchase and utilizing borrowings from the FHLB and other borrowings, including our term loan and our revolving credit line. The aggregate funds acquired from these sources were $1.86 billion and $1.72 billion at December 31, 2006 and 2005, respectively.
The following table presents the maturity structure of these other sources of funds, which consists of certificates of deposit of $100,000 or more and other borrowings, including our notes payable, at December 31, 2006:
In addition to these sources of funds, First Bank has established a borrowing relationship with the Federal Reserve Bank of St. Louis. This borrowing relationship, which is secured by commercial loans, provides an additional liquidity facility that may be utilized for contingency purposes. At December 31, 2006 and 2005, First Bank's borrowing capacity under the agreement was approximately $639.1 million and $743.6 million, respectively. In addition, First Bank's borrowing capacity through its relationship with the FHLB was approximately $666.0 million and $679.3 million at December 31, 2006 and 2005, respectively. We had FHLB advances outstanding of $4.0 million and $39.3 million at December 31, 2006 and 2005, respectively, all of which represent advances assumed in conjunction with various acquisitions. On March 17, 2006 and May 10, 2006, we prepaid $20.5 million and $14.8 million of FHLB advances, respectively, that were assumed in conjunction with previous acquisitions, as further described in Note 10 to our Consolidated Financial Statements.
In addition to our owned banking facilities, we have entered into long-term leasing arrangements to support our ongoing activities. The required payments under such commitments and other obligations at December 31, 2006 were as follows:
Management believes the available liquidity and operating results of First Bank will be sufficient to provide funds for growth and to permit the distribution of dividends to us sufficient to meet our operating and debt service requirements, both on a short-term and long-term basis, and to pay the interest on the subordinated debentures that we issued to our affiliated statutory and business financing trusts.
Critical Accounting Policies
Our financial condition and results of operations presented in our Consolidated Financial Statements, accompanying notes to our Consolidated Financial Statements, selected consolidated and other financial data appearing elsewhere in this report, and management's discussion and analysis of financial condition and results of operations are, to a large degree, dependent upon our accounting policies. The selection and application of our accounting policies involve judgments, estimates and uncertainties that are susceptible to change.
We have identified the following accounting policies that we believe are the most critical to the understanding of our financial condition and results of operations. These critical accounting policies require management's most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could be a reasonable likelihood. The impact and any associated risks related to our critical accounting policies on our business operations is discussed throughout "--Management's Discussion and Analysis of Financial Condition and Results of Operations," where such policies affect our reported and expected financial results. A detailed discussion on the application of these and other accounting policies is summarized in Note 1 to our Consolidated Financial Statements appearing elsewhere in this report.
Loans and Allowance for Loan Losses. We maintain an allowance for loan losses at a level we consider adequate to provide for probable losses in our loan portfolio. The determination of our allowance for loan losses requires management to make significant judgments and estimates based upon a periodic analysis of our loans held for portfolio and held for sale considering, among other factors, current economic conditions, loan portfolio composition, past loan loss experience, independent appraisals, the fair value of underlying loan collateral, our customers' ability to repay their loans and selected key financial ratios. If actual events prove the estimates and assumptions we used in determining our allowance for loan losses were incorrect, we may need to make additional provisions for loan losses. For further discussion, refer to "--Loans and Allowance for Loan Losses" and Note 4 to our Consolidated Financial Statements appearing elsewhere in this report.
Derivative Financial Instruments. We utilize derivative financial instruments to assist in our management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities. The judgments and assumptions that are most critical to the application of this critical accounting policy are those affecting the estimation of fair value and hedge effectiveness. Fair value is based on quoted market prices where available. If quoted market prices are unavailable, fair value is based on quoted market prices of comparable derivative instruments. Factors that affect hedge effectiveness include the initial selection of the derivative that will be used as a hedge and how well changes in its cash flow or fair value have correlated and are expected to correlate with changes in the cash flow or fair value of the underlying hedged asset or liability. Past correlation is easy to demonstrate, but expected correlation depends upon projections and trends that may not always hold true within acceptable limits.
Changes in assumptions and conditions could result in greater than expected inefficiencies that, if large enough, could reduce or eliminate the economic benefits anticipated when the hedges were established and/or invalidate continuation of hedge accounting. Greater inefficiency and/or discontinuation of hedge accounting are likely to result in increased volatility in our reported earnings. For cash flow hedges, this would result as more or all of the change in the fair value of the affected derivative being reported in noninterest income. For fair value hedges, there may be some impact on our reported earnings as the change in the fair value of the affected derivative may not be offset by changes in the fair value of the underlying hedged asset or liability. For further discussion, refer to "--Effects of New Accounting Standards," "--Interest Rate Risk Management" and Note 5 to our Consolidated Financial Statements appearing elsewhere in this report.
Deferred Tax Assets. We recognize deferred tax assets for the estimated future tax effects of temporary differences, net operating loss carryforwards and tax credits. We recognize deferred tax assets subject to management's judgment based upon available evidence that realization is more likely than not. Our deferred tax assets are reduced, if necessary, by a deferred tax asset valuation allowance. In the event that we determine we would not be able to realize all or part of our deferred tax assets in the future, we would need to adjust the recorded value of our deferred tax assets, which would result in a direct charge to our provision for income taxes in the period in which such determination is made. For further discussion, refer to "--Comparison of Results of Operations for 2006 and 2005 - Provision for Income Taxes," "--Comparison of Results of Operations for 2005 and 2004 - Provision for Income Taxes," and Note 13 to our Consolidated Financial Statements appearing elsewhere in this report.
Business Combinations. We emphasize acquiring other financial institutions as one means of achieving our growth objectives. The determination of the fair value of the assets and liabilities acquired in these transactions, as well as the returns on investment that may be achieved, requires management to make significant judgments and estimates based upon detailed analyses of the existing and future economic value of such assets and liabilities and/or the related income streams, including the resulting intangible assets. If actual events prove the estimates and assumptions we used in determining the fair values of the acquired assets and liabilities or the projected income streams were incorrect, we may need to make additional adjustments to the recorded values of such assets and liabilities, which could result in increased volatility in our reported earnings. In addition, we may need to make additional adjustments to the recorded value of our intangible assets, which may impact our reported earnings and directly impacts our regulatory capital levels. For further discussion, refer to "--Acquisitions" and Note 2, Note 8 and Note 21 to our Consolidated Financial Statements appearing elsewhere in this report.
Effects of New Accounting Standards
In November 2005, the Financial Accounting Standards Board, or FASB, issued FASB Staff Position, or FSP, FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The FSP addresses determining when an investment is considered impaired and whether that impairment is other than temporary, and measuring an impairment loss. The FSP also addresses the accounting after an entity recognizes an other-than-temporary impairment, and requires certain disclosures about unrealized losses that the entity did not recognize as other-than-temporary impairment. The FSP was effective for reporting periods beginning after December 15, 2005. On January 1, 2006, we implemented the requirements of FSP FAS 115-1 and FAS 124-1, which did not have a material effect on our financial condition or results of operations.
In May 2005, the FASB issued SFAS No. 154 -- Accounting Changes and Error Corrections. SFAS No. 154, a replacement of Accounting Principles Bulletin Opinion No. 20 -- Accounting Changes and SFAS No. 3 -- Reporting Accounting Changes in Interim Financial Statements, requires retrospective application for voluntary changes in accounting principles unless it is impracticable to do so. SFAS No. 154 was effective for accounting changes and corrections of errors in fiscal years beginning after December 15, 2005. Early application was permitted for accounting changes and corrections of errors during fiscal years beginning after June 1, 2005. On January 1, 2006, we implemented the requirements of SFAS No. 154, which did not have a material effect on our financial condition or results of operations.
In February 2006, the FASB issued SFAS No. 155 -- Accounting For Certain Hybrid Financial Instruments, an amendment of SFAS No. 133 -- Accounting For Derivative Instruments and Hedging Activities and SFAS No. 140. SFAS No. 155 allows entities to remeasure at fair value a hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation from the host instrument, if the holder irrevocably elects to account for the whole instrument on a fair value basis. Subsequent changes in the fair value of the instrument would be recognized in earnings. In January 2007, the FASB posted to its website revisions to certain SFAS No. 133 implementation issues that were affected by the issuance of SFAS No. 155 and SFAS No. 156 (discussed below). These revisions provide a narrow scope exception for securitized interests in prepayable financial assets that only contain an embedded derivative that results from the embedded call options in the underlying prepayable financial assets if certain criteria are met. SFAS No. 155 is effective for financial instruments acquired, issued, or subject to a remeasurement event occurring after the beginning of the
first fiscal year that begins after September 15, 2006. Early adoption is permitted as of the beginning of the fiscal year unless the entity has already issued interim financial statements during that fiscal year. We are currently evaluating the requirements of SFAS No. 155 to determine its impact on our financial condition and results of operations.
In March 2006, the FASB issued SFAS No. 156 - Accounting for Servicing of Financial Assets. SFAS No. 156, an amendment of FASB SFAS No. 140 - Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, addresses the recognition and measurement of separately recognized servicing assets and liabilities and allows mark-to-market accounting for servicing rights resulting in reporting that is similar to fair value hedge accounting, but without the effort and system costs needed to identify effective hedging instruments and document hedging relationships. SFAS No. 156 is effective for fiscal years beginning after September 15, 2006. Early adoption is permitted as of the beginning of an entity's fiscal year unless the entity has already issued interim financial statements during that fiscal year. We implemented SFAS No. 156 on January 1, 2007, which did not have a material impact on our financial condition or results of operations.
In June 2006, the FASB issued FASB Interpretation No. 48 -- Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS No. 109 -- Accounting for Income Taxes. FASB Interpretation No. 48 clarifies the accounting for uncertainty in income taxes in financial statements and prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken. The FASB Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The FASB Interpretation is effective for fiscal years beginning after December 15, 2006. We implemented FASB Interpretation No. 48 on January 1, 2007, which did not have a material impact on our financial condition, results of operations, or our beginning retained earnings.
In September 2006, the SEC issued SEC Staff Accounting Bulletin, or SAB, No. 108 - - Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 addresses the methods in which uncorrected errors in previous years should be considered when quantifying errors in current-year financial statements, and requires an entity to consider the effect of all carry over and reversing effects of prior-year misstatements when quantifying errors in current-year financial statements. The SAB does not change the SEC staff's previous guidance on evaluating the materiality of errors in financial statements. SAB No. 108 allows an entity to record the effects of adopting the guidance as a cumulative-effect adjustment to retained earnings. This adjustment must be reported as of the beginning of the first fiscal year ending after November 15, 2006. In December 2006, we implemented the requirements of SAB No. 108, which had no impact on our financial condition or results of operations.
In September 2006, the FASB issued SFAS No. 157 - Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in U.S. generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, and does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted as of the beginning of an entity's fiscal year unless the entity has already issued interim financial statements during that fiscal year. We are currently evaluating the requirements of SFAS No. 157 to determine its impact on our financial condition and results of operations.
In February 2007, the FASB issued SFAS No. 159 - The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of SFAS No. 115. SFAS No. 159 provides entities with an option to report selected financial assets and liabilities at fair value in an effort to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Retrospective application is not allowed. Early adoption is permitted as of the beginning of an entity's fiscal year that begins on or before November 15, 2007, provided the entity also elects to adopt all of the provisions of SFAS No. 157 at the early adoption date. We are currently evaluating the requirements of SFAS No. 159 to determine their impact on our financial condition and results of operations.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The quantitative and qualitative disclosures about market risk are included under "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Risk Management" appearing on pages 35 through 37 of this report.
Effects of Inflation
Inflation affects financial institutions less than other types of companies. Financial institutions make relatively few significant asset acquisitions that are directly affected by changing prices. Instead, the assets and liabilities are primarily monetary in nature. Consequently, interest rates are more
significant to the performance of financial institutions than the effect of general inflation levels. While a relationship exists between the inflation rate and interest rates, we believe this is generally manageable through our asset-liability management program.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data appear on pages 63 through 106 of this report.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Our Chief Executive Officer and our Chief Financial Officer have evaluated the effectiveness of our "disclosure controls and procedures" (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act. There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fourth quarter of 2006 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Board of Directors and Committees of the Board
Our Board of Directors consists of seven members. The Board determined that Messrs. Gundaker, Steward and Yaeger are independent. Each of our directors identified in the following table was elected or appointed to serve a one-year term and until his successor has been duly qualified for office.
Committees and Meetings of the Board of Directors
Three members of our Board of Directors currently serve on the Audit Committee, all of whom the Board of Directors determined to be independent; there are no other committees of the Board of Directors. The Audit Committee assists the Board of Directors in fulfilling the Board's oversight responsibilities with respect to the quality and integrity of the consolidated financial statements, financial reporting process and systems of internal controls. The Audit Committee also assists the Board of Directors in monitoring the independence and performance of the independent auditors, the internal audit department and the operation of ethics programs. The Audit Committee operates under a written charter adopted by the Board of Directors.
The members of the Audit Committee as of March 28, 2007 were Mr. Gordon A. Gundaker, Mr. David L. Steward and Mr. Douglas H. Yaeger, who serves as the Chairman of the Audit Committee and the audit committee financial expert.
Audit Committee Report
The Audit Committee is responsible for oversight of our financial reporting process on behalf of the Board of Directors. Management has primary responsibility for our financial statements and financial reporting, including internal controls, subject to the oversight of the Audit Committee and the Board of Directors. In fulfilling its responsibilities, the Audit Committee reviewed the audited consolidated financial statements with management and discussed the acceptability of the accounting principles used, the reasonableness of significant judgments made and the clarity of the disclosures.
The Audit Committee reviewed with the Independent Registered Public Accounting Firm, who is responsible for planning and carrying out a proper audit and expressing an opinion on the conformity of our audited consolidated financial statements with U.S. generally accepted accounting principles, their judgments as to the acceptability of the accounting principles we use, and such other matters as are required to be discussed with the Audit Committee by Statement on Auditing Standards No. 61, Communications with Audit Committees, as amended. In addition, the Audit Committee discussed with the Independent Registered Public Accounting Firm its independence from management and the Company, including the matters required by Standard No. 1 of the Independence Standards Board, and the Audit Committee considered the compatibility of non-audit services provided by the Independent Registered Public Accounting Firm with the firm's independence. KPMG LLP has provided the Audit Committee with the written disclosures and letter required by Standard No. 1 of the Independence Standards Board.
The Audit Committee discussed with our Internal Audit Department and Independent Registered Public Accounting Firm the overall scope and plans for their respective audits. The Audit Committee met with the Internal Audit Department and Independent Registered Public Accounting Firm with and without management present to discuss the results of their examinations, their evaluations of our internal controls and the overall quality of our financial reporting.
In reliance on the reviews and discussions referred to above, the Audit Committee recommended to the Board of Directors that the audited consolidated financial statements be included in the Annual Report on Form 10-K as of and for the year ended December 31, 2006 for filing with the SEC.
Audit Committee ---------------
Douglas H. Yaeger, Chairman of the Audit Committee Gordon A. Gundaker David L. Steward
Code of Ethics for Principal Executive Officer and Financial Professionals
The Board of Directors has approved a Code of Ethics for Principal Executive Officer and Financial Professionals that covers the Principal Executive Officer, the Chief Financial Officer, the Chief Operating Officer, the Chief Credit Officer, the Chief Investment Officer, the Senior Vice President and Controller, the Senior Vice President - Director of Taxes, the Senior Vice President - Director of Management Accounting, and all professionals serving in a Corporate Finance, Accounting, Treasury, Tax or Investor Relations role. These individuals are also subject to the policies and procedures adopted by First Banks that govern the conduct of all of its employees. The Code of Ethics for Principal Executive Officer and Financial Professionals is included as an exhibit to this Annual Report on Form 10-K.
Code of Conduct for Employees, Officers and Directors
The Board of Directors has approved a Code of Conduct applicable to all employees, officers and directors of First Banks that addresses conflicts of interest, honesty and fair dealing, accounting and auditing matters, political activities and application and enforcement of the Code of Conduct. The Code of Conduct is available on First Banks' website, www.firstbanks.com, under "About us." ------------------
Executive Officers
Our executive officers, each of whom was elected to the office(s) indicated by the Board of Directors, as of March 28, 2007, were as follows:
Item 11.
Item 11. Executive Compensation
Compensation Discussion and Analysis. As outlined in the stock ownership table included in "Item 12
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth, as of March 28, 2007, certain information with respect to the beneficial ownership of all classes of our voting capital stock by each person known to us to be the beneficial owner of more than five percent of the outstanding shares of the respective classes of our stock:
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Review and Approval of Related Person Transactions. We review all relationships and transactions in which we and our directors and executive officers and their immediate family members and entities in which such persons have a significant interest are participants to determine whether such persons have a direct or indirect material interest. Our management collects information from the executive officers and the directors regarding the related person transactions and determines whether we or a related person has a direct or indirect material interest in the transaction. If we determine that a transaction is directly or indirectly material to us or a related person, then the transaction is disclosed in accordance with applicable requirements. In addition, the Audit Committee of our Board of Directors reviews and approves or ratifies any related person transaction that is required to be so disclosed. In the event that a member of the Audit Committee is a related person to such a transaction, such member may not participate in the discussion or vote regarding approval or ratification of the transaction.
Related Person Transactions. Outside of normal customer relationships, no directors, executive officers or shareholders holding over 5% of our voting securities, and no corporations or firms with which such persons or entities are associated, currently maintain or have maintained since the beginning of the last full fiscal year, any significant business or personal relationship with our subsidiaries or us, other than that which arises by virtue of such position or ownership interest in our subsidiaries or us, except as set forth in "Item 11 - - Executive Compensation - Compensation of Directors," or as described in the following paragraphs.
First Bank has had in the past, and may have in the future, loan transactions and related banking services in the ordinary course of business with our directors and/or their affiliates. These loan transactions have been made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated persons and did not involve more than the normal risk of collectibility or present other unfavorable features. First Bank does not extend credit to our officers or to officers of First Bank, except extensions of credit secured by mortgages on personal residences, loans to purchase automobiles and personal credit card accounts.
Certain of our shareholders, directors and officers and their respective affiliates have deposit accounts and related banking services with First Bank. It is First Bank's policy not to permit any of its officers or directors or their affiliates to overdraw their respective deposit accounts. Deposit account overdraft protection may be approved for persons or entities under a plan whereby a credit limit has been established in accordance with First Bank's standard credit criteria.
Transactions with related parties, including transactions with affiliated persons and entities, are described in Note 19 to our Consolidated Financial Statements on pages 100 through 101 of this report.
Director Independence. Our Board of Directors has determined that Messrs. Gordon A. Gundaker, David L. Steward and Douglas H. Yaeger have no material relationship with us and each is independent. Our Audit Committee of the Board of Directors is composed only of independent directors. In order to be considered independent, our Board of Directors must determine that a director does not have any direct or indirect material relationship with us as provided under the rules of the New York Stock Exchange, or NYSE. In making such a determination, the Board of Directors considers all relationships between us, or any of our subsidiaries, and the director, or any of his immediate family members, or any entity with which the director or any of his immediate family members is affiliated by reason of being a partner, officer or significant shareholder thereof. In assessing the independence of our directors, the Board of Directors considered all relationships between us and our directors based primarily upon responses of the directors to questions posed through a directors' and officers' questionnaire. The Board of Directors considered each of the related person transaction discussed above in making its independence determination.
First Banks has only preferred securities listed on the NYSE and, pursuant to the General Application section of NYSE Rule 303A, is not subject to NYSE Rule 303A.01 requiring a majority of independent directors. Messrs. Dierberg, Blake, McCarthy and Schepman are not independent because they are each current or former executive officers of the company.
Item 14.
Item 14. Principal Accounting Fees and Services
Fees of Independent Registered Public Accounting Firm
During 2006 and 2005, KPMG LLP served as our Independent Registered Public Accounting Firm and provided services to our affiliates and us. The following table sets forth fees for professional audit services rendered by KPMG LLP for the audit of our consolidated financial statements and other audit services in 2006 and 2005:
Policy Regarding the Approval of Independent Auditor Provision of Audit and Non-Audit Services
Consistent with the Securities and Exchange Commission requirements regarding auditor independence, the Audit Committee recognizes the importance of maintaining the independence, in fact and appearance, of our independent auditors. As such, the Audit Committee has adopted a policy for pre-approval of all audit and permissible non-audit services provided by our independent auditors. Under the policy, the Audit Committee, or its designated member, must pre-approve services prior to commencement of the specified service. The requests for pre-approval are submitted to the Audit Committee or its designated member by the Director of Audit with a statement as to whether in his/her view the request is consistent with the Securities and Exchange Commission's rules on auditor independence. The Audit Committee reviews the pre-approval requests and the fees paid for such services at their regularly scheduled quarterly meetings or at special meetings.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) 1. Financial Statements and Supplementary Data - The financial statements and supplementary data filed as part of this Report are included in Item 8.
2. Financial Statement Schedules - These schedules are omitted for the reason they are not required or are not applicable.
3. Exhibits - The exhibits are listed in the index of exhibits required by Item 601 of Regulation S-K at Item (b) below and are incorporated herein by reference.
(b) The index of required exhibits is included beginning on page 110 of this Report.
(c) Not Applicable.
FIRST BANKS, INC.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - --------------------------------------------------------------------------------
The Board of Directors and Stockholders First Banks, Inc.:
We have audited the accompanying consolidated balance sheets of First Banks, Inc. and subsidiaries (the Company) as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Banks, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP ------------
St. Louis, Missouri March 28, 2007
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the significant accounting policies followed by First Banks, Inc. and subsidiaries (First Banks or the Company):
Basis of Presentation. The accompanying consolidated financial statements of First Banks have been prepared in accordance with U.S. generally accepted accounting principles and conform to predominant practices within the banking industry. Management of First Banks has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare the consolidated financial statements in conformity with U.S. generally accepted accounting principles. Actual results could differ from those estimates.
Principles of Consolidation. The consolidated financial statements include the accounts of the parent company and its subsidiaries, giving effect to the minority interest in one subsidiary, as more fully described below, and in Note 2 and Note 19 to the Consolidated Financial Statements. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications of 2005 and 2004 amounts have been made to conform to the 2006 presentation.
First Banks operates through its wholly owned subsidiary bank holding company, The San Francisco Company (SFC), and SFC's wholly owned subsidiary bank, First Bank, both headquartered in St. Louis, Missouri. First Bank operates through its branch banking offices and subsidiaries: First Bank Business Capital, Inc.; Missouri Valley Partners, Inc. (MVP); Adrian N. Baker & Company (Adrian Baker); Universal Premium Acceptance Corporation (UPAC) and its wholly owned subsidiary, UPAC of California, Inc.; and Small Business Loan Source LLC (SBLS LLC). All of the subsidiaries are wholly owned, except for SBLS LLC, which is 51.0% owned by First Bank and 49.0% owned by First Capital America, Inc. (FCA) as of December 31, 2006.
Cash and Cash Equivalents. Cash, due from banks and short-term investments, which include federal funds sold and interest-bearing deposits, are considered to be cash and cash equivalents for purposes of the consolidated statements of cash flows. Federal funds sold were $152.2 million and $65.0 million at December 31, 2006 and 2005, respectively, and interest-bearing deposits were $1.4 million and $9.0 million at December 31, 2006 and 2005, respectively.
First Bank is required to maintain certain daily reserve balances on hand in accordance with regulatory requirements. These reserve balances maintained in accordance with such requirements were $24.7 million and $24.3 million at December 31, 2006 and 2005, respectively.
Investment Securities. The classification of investment securities as trading, available for sale or held to maturity is determined at the date of purchase.
Investment securities designated as trading, which represent any security held for near term sale, are stated at fair value. Realized and unrealized gains and losses are included in noninterest income.
Investment securities designated as available for sale, which represent any security that First Banks has no immediate plan to sell but which may be sold in the future under different circumstances, are stated at fair value. Realized gains and losses are included in noninterest income, based on the amortized cost of the individual security sold. Unrealized gains and losses, net of related income tax effects, are recorded in accumulated other comprehensive income. All previous fair value adjustments included in the separate component of accumulated other comprehensive income (loss) are reversed upon sale. Premiums and discounts incurred relative to the par value of securities purchased are amortized or accreted, respectively, on the level-yield method taking into consideration the level of current and anticipated prepayments.
Investment securities designated as held to maturity, which represent any security that First Banks has the positive intent and ability to hold to maturity, are stated at cost, net of amortization of premiums and accretion of discounts computed on the level-yield method taking into consideration the level of current and anticipated prepayments.
A decline in the market value of any available-for-sale or held-to-maturity investment security below its carrying value that is deemed to be other than temporary results in a reduction in the cost basis of the carrying value to fair value. The other-than-temporary impairment is charged to noninterest income and a new cost basis is established. When determining other-than-temporary impairment, consideration is given as to whether First
Banks has the ability and intent to hold the investment security until a market price recovery and whether evidence indicating the carrying value of the investment security is recoverable outweighs evidence to the contrary.
Loans Held for Portfolio. Loans held for portfolio are carried at cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Interest and fees on loans are recognized as income using the interest method. Loan origination fees are deferred and accreted to interest income over the estimated life of the loans using the interest method. Loans held for portfolio are stated at cost as First Banks has the ability and it is management's intention to hold them to maturity.
The accrual of interest on loans is discontinued when it appears that interest or principal may not be paid in a timely manner in the normal course of business or once principal or interest payments become 90 days past due under the contractual terms of the loan agreement. Generally, payments received on nonaccrual and impaired loans are recorded as principal reductions. Interest income is recognized after all delinquent principal has been repaid or an improvement in the condition of the loan has occurred that warrants resumption of interest accruals.
A loan is considered impaired when it is probable that First Banks will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the loan agreement. Loans on nonaccrual status are considered to be impaired loans. When measuring impairment, the expected future cash flows of an impaired loan are discounted at the loan's effective interest rate. Alternatively, impairment is measured by reference to an observable market price, if one exists, or the fair value of the collateral for a collateral-dependent loan. Regardless of the historical measurement method used, First Banks measures impairment based on the fair value of the collateral when foreclosure is probable. Additionally, impairment of a restructured loan is measured by discounting the total expected future cash flows at the loan's effective rate of interest as stated in the original loan agreement.
Loans Held for Sale. Loans held for sale are comprised of residential mortgage loans held for sale in the secondary mortgage market, frequently in the form of a mortgage-backed security, U.S. Small Business Administration (SBA) loans awaiting sale of the guaranteed portion to the SBA, and commercial real estate loans which may be identified for sale to specific buyers to achieve credit or loan concentration objectives. Loans held for sale are carried at the lower of cost or market value, which is determined on an individual loan basis. Additionally, the carrying value of the residential mortgage loans held for sale also includes the cost of hedging the loans held for sale. The amount by which cost exceeds market value is recorded in a valuation allowance as a reduction of loans held for sale. Changes in the valuation allowance are reflected as part of the gain on loans sold and held for sale in the consolidated statements of income in the periods in which the changes occur. Gains or losses on the sale of loans held for sale are determined on a specific identification basis and reflect the difference between the value received upon sale and the carrying value of the loans held for sale, including the cost of hedging the residential mortgage loans held for sale. Loans held for sale transferred to loans held for portfolio or available-for-sale investment securities are transferred at fair value.
Loan Servicing Income. Loan servicing income is included in noninterest income and represents fees earned for servicing real estate mortgage loans owned by investors and originated by First Bank's mortgage banking operation, as well as SBA loans to small business concerns that are originated by SBLS LLC, First Bank's majority-owned subsidiary that originates, sells and services SBA loans. These fees are net of federal agency guarantee fees, interest shortfall, amortization of loan servicing rights and impairment valuation allowances. Such fees are generally calculated on the outstanding principal balance of the loans serviced and are recorded as income when earned.
Allowance for Loan Losses. The allowance for loan losses is maintained at a level considered adequate to provide for probable losses. The provision for loan losses is based on a monthly analysis of the loans held for portfolio, considering, among other factors, current economic conditions, loan portfolio composition, past loan loss experience, independent appraisals, loan collateral, payment experience and selected key financial ratios. Adjustments are reflected in the consolidated statements of income in the periods in which they become known. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require First Banks to modify its allowance for loan losses based on their judgment about information available to them at the time of their examination.
Derivative Instruments and Hedging Activities. First Banks utilizes derivative instruments and hedging strategies to assist in the management of interest rate sensitivity and to modify the repricing, maturity and option characteristics of certain assets and liabilities. First Banks uses such derivative instruments solely to reduce its interest rate risk exposure. Derivative instruments are recorded in the consolidated balance sheets and
measured at fair value. At inception of a derivative transaction, First Banks designates the derivative instrument as either a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedges) or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedges). For all hedging relationships, First Banks documents the hedging relationship and its risk-management objectives and strategy for entering into the hedging relationship including the hedging instrument, the hedged item(s), the nature of the risk being hedged, how the hedging instrument's effectiveness in offsetting the hedged risk will be assessed and a description of the method the Company will utilize to measure hedge ineffectiveness. This process also includes linking all derivative instruments that are designated as fair value hedges or cash flow hedges to the underlying assets and liabilities or to specific firm commitments or forecasted transactions. First Banks also assesses, both at the hedge's inception and on an ongoing basis, whether the derivative instruments that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of the hedged item(s). First Banks discontinues hedge accounting prospectively when it is determined that the derivative instrument is no longer effective in offsetting changes in the fair value or cash flows of the hedged item(s), the derivative instrument expires or is sold, terminated, or exercised, the derivative instrument is de-designated as a hedging instrument because it is unlikely that a forecasted transaction will occur, a hedged firm commitment no longer meets the definition of a firm commitment, or management determines that designation of the derivative instrument as a hedging transaction is no longer appropriate.
A summary of First Banks' accounting policies for its derivative instruments and hedging activities is as follows:
>> Interest Rate Swap Agreements - Cash Flow Hedges. Interest rate swap agreements designated as cash flow hedges are accounted for at fair value. The effective portion of the change in the cash flow hedge's gain or loss is initially reported as a component of other comprehensive income and subsequently reclassified into noninterest income when the underlying transaction affects earnings. The ineffective portion of the change in the cash flow hedge's gain or loss is recorded in noninterest income on each monthly measurement date. The net interest differential is recognized as an adjustment to interest income or interest expense of the related asset or liability being hedged. In the event of early termination, the net proceeds received or paid on the interest rate swap agreements are recognized immediately in noninterest income.
>> Interest Rate Swap Agreements - Fair Value Hedges. Interest rate swap agreements designated as fair value hedges are accounted for at fair value. Changes in the fair value of the swap agreements are recognized currently in noninterest income. The change in the fair value of the underlying hedged item is recognized as an adjustment to the carrying amount of the underlying hedged item and is also reflected currently in noninterest income. All changes in fair value are measured on a monthly basis. The net interest differential is recognized as an adjustment to interest income or interest expense of the related asset or liability being hedged. In the event of early termination or ineffectiveness, the net proceeds received or paid on the interest rate swap agreements are recognized immediately in noninterest income and the future net interest differential, if any, is recognized prospectively in noninterest income. The cumulative change in the fair value of the underlying hedged item is deferred and amortized or accreted to interest income or interest expense over the weighted average life of the related asset or liability. If, however, the underlying hedged item is repaid, the cumulative change in the fair value of the underlying hedged item is recognized immediately in noninterest income.
>> Interest Rate Cap and Floor Agreements. Interest rate cap and floor agreements are accounted for at fair value. Changes in the fair value of interest rate cap and floor agreements are recognized in noninterest income on each monthly measurement date.
>> Interest Rate Lock Commitments. Commitments to originate loans for subsequent sale in the secondary market (interest rate lock commitments), which primarily consist of commitments to originate fixed rate residential mortgage loans, are recorded at fair value. Changes in the fair value are recognized in noninterest income on a monthly basis.
>> Forward Commitments to Sell Mortgage-Backed Securities. Forward commitments to sell mortgage-backed securities are recorded at fair value. Changes in the fair value of forward commitments to sell mortgage-backed securities are recognized in noninterest income on a monthly basis.
Bank Premises and Equipment, Net. Bank premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Amortization of leasehold improvements is calculated using the straight-line method over the shorter of the useful life of the related asset or the term of the lease. Bank premises and improvements are depreciated over five to 40 years and equipment is depreciated over three to seven years.
Goodwill and Other Intangible Assets. Goodwill and other intangible assets consist of goodwill, core deposit intangibles and customer list intangibles. Goodwill and intangible assets with indefinite useful lives are not amortized, but instead tested for impairment at least annually. Intangible assets with definite useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144. First Banks amortizes, on a straight-line basis, its core deposit intangibles, customer list intangibles and goodwill associated with transactions structured as purchases of certain assets and assumption of selected liabilities (P&A Transactions). Core deposit intangibles are amortized over the estimated periods to be benefited, which has been estimated at five to seven years, and customer list intangibles are amortized over the estimated periods to be benefited, which has been estimated at seven to 16 years. Goodwill associated with P&A Transactions is amortized over the estimated periods to be benefited, which has been estimated to be 15 years. Goodwill associated with stock purchases is not amortized, but instead, is tested annually for impairment in accordance with First Banks' existing methods of measuring and recording impairment losses, as described below.
First Banks reviews intangible assets for impairment whenever events or changes in circumstances indicate the carrying value of an underlying asset may not be recoverable. First Banks measures recoverability based upon the future cash flows expected to result from the use of the underlying asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying value of the underlying asset, First Banks recognizes an impairment loss. The impairment loss recognized represents the amount by which the carrying value of the underlying asset exceeds the fair value of the underlying asset. If an asset being tested for recoverability was acquired in a business combination accounted for using the purchase method, goodwill that arose in the transaction is included as part of the asset grouping in determining recoverability. If some but not all of the assets acquired in that transaction are being tested, goodwill is allocated to the assets being tested for recoverability on a pro rata basis using the relative fair values of the long-lived assets and identifiable intangibles acquired at the acquisition dates. In instances where goodwill is identified with assets that are subject to an impairment loss, the carrying amount of the identified goodwill is eliminated before reducing the carrying amounts of impaired long-lived assets and identifiable intangibles. As such adjustments become necessary, they are reflected in the consolidated statements of income in the periods in which they become known.
Mortgage Servicing Rights. Mortgage servicing rights are capitalized by allocating the total cost of the mortgage loans to mortgage servicing rights and the loans (without mortgage servicing rights) based on the relative fair values of the two components. Upon capitalizing the mortgage servicing rights, they are amortized, in proportion to the related estimated net servicing income on a basis that approximates the disaggregated, discounted basis, over the expected lives of the related loans, which is approximately five to seven years. The weighted average amortization period of mortgage servicing rights is approximately five years.
The value of mortgage servicing rights is adversely affected when mortgage interest rates decline which normally causes mortgage loan prepayments to increase. When loans are prepaid or refinanced, the related unamortized balance of the mortgage servicing rights is charged to amortization expense. The determination of the fair value of the mortgage servicing rights is performed quarterly based upon an independent third party valuation. Based on these analyses, a comparison of the fair value of the mortgage servicing rights with the carrying value of the mortgage servicing rights is made, with impairment, if any, recognized at that time. The impairment analyses are prepared using stratifications of the mortgage servicing rights based on the predominant risk characteristics of the underlying mortgage loans, including size, interest rate, weighted average original term, weighted average remaining term and estimated prepayment speeds. As part of these analyses, the fair value of the mortgage servicing rights for each stratum is compared to the carrying value of the mortgage servicing rights for each stratum. To the extent the carrying value of the mortgage servicing rights exceeds the fair value of the mortgage servicing rights for a stratum, First Banks recognizes impairment equal to the amount by which the carrying value of the mortgage servicing rights for a stratum exceeds the fair value. Impairment is recognized through a valuation allowance that is recorded as a reduction of mortgage servicing rights. The valuation allowance may be reversed based upon subsequent improvement in the fair value of a stratum; however, First Banks does not recognize fair value of the mortgage
servicing rights in excess of the carrying value of mortgage servicing rights for any stratum. Changes in the valuation allowance are reflected in the consolidated statements of income in the periods in which the change occurs.
SBA Servicing Rights. SBA servicing rights are capitalized by allocating the total cost of the SBA loans to servicing rights and the loans (without servicing rights) based on the relative fair values of the two components. The fair value of servicing rights is computed using the present value of the estimated future servicing income in excess of such income estimated at a normal servicing fee rate. The servicing rights, net of the valuation allowance, are amortized in proportion to, and over the period of, the estimated net servicing revenue of the underlying SBA loans, which range from seven to 25 years. The weighted average amortization period of the SBA servicing rights is approximately 18 years. The determination of the fair value of the SBA servicing rights is performed monthly based upon quarterly independent third party valuation analyses. Based on these analyses, a comparison of the fair value of the SBA servicing rights with the carrying value of the SBA servicing rights is made, with impairment, if any, recognized at that time. The predominant risk characteristics of the underlying SBA loans used to stratify SBA servicing rights for purposes of measuring impairment include size, interest rate, weighted average original term, weighted average remaining term and estimated prepayment speeds. To the extent the carrying value of the SBA servicing rights exceeds the fair value of the SBA servicing rights, First Banks recognizes impairment equal to the amount by which the carrying value of the SBA servicing rights exceeds the fair value. Impairment is recognized through a valuation allowance that is recorded as a reduction of SBA servicing rights. Changes in the valuation allowance are reflected in the consolidated statements of income in the periods in which the change occurs. First Banks does not recognize fair value of the SBA servicing rights in excess of the carrying value of SBA servicing rights for any stratum.
Other Real Estate. Other real estate, consisting of real estate acquired through foreclosure or deed in lieu of foreclosure, is stated at the lower of cost or fair value less applicable selling costs. The excess of cost over fair value of the property at the date of acquisition is charged to the allowance for loan losses. Subsequent reductions in carrying value, to reflect current fair value or costs incurred in maintaining the properties, are charged to expense as incurred. Other real estate was $6.4 million and $2.0 million at December 31, 2006 and 2005, respectively.
Income Taxes. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in the tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. First Banks, Inc. and its eligible subsidiaries file a consolidated federal income tax return and unitary or consolidated state income tax returns in all applicable states.
Financial Instruments With Off-Balance Sheet Risk. A financial instrument is defined as cash, evidence of an ownership interest in an entity, or a contract that conveys or imposes on an entity the contractual right or obligation to either receive or deliver cash or another financial instrument. First Banks utilizes financial instruments to reduce the interest rate risk arising from its financial assets and liabilities. These instruments involve, in varying degrees, elements of interest rate risk and credit risk in excess of the amount recognized in the consolidated balance sheets. "Interest rate risk" is defined as the possibility that interest rates may move unfavorably from the perspective of First Banks due to maturity and/or interest rate adjustment timing differences between interest-earning assets and interest-bearing liabilities. The risk that a counterparty to an agreement entered into by First Banks may default is defined as "credit risk."
First Banks is a party to commitments to extend credit and commercial and standby letters of credit in the normal course of business to meet the financing needs of its customers. These commitments involve, in varying degrees, elements of interest rate risk and credit risk in excess of the amount reflected in the consolidated balance sheets.
Earnings Per Common Share. Basic earnings per common share (EPS) are computed by dividing the income available to common stockholders (the numerator) by the weighted average number of shares of common stock outstanding (the denominator) during the year. The computation of dilutive EPS is similar except the denominator is increased to include the number of additional shares of common stock that would have been outstanding if the dilutive potential shares had been issued. In addition, in computing the dilutive effect of convertible securities, the numerator is adjusted to add back any convertible preferred dividends.
(2) ACQUISITIONS AND INTEGRATION COSTS
Completed Acquisitions. During the three years ended December 31, 2006, First Banks completed the following acquisitions:
Goodwill and other intangible assets associated with the acquisitions included in the table above are not deductible for tax purposes, with the exception of P&A Transactions and the goodwill associated with the purchase of assets and assumption of liabilities of Small Business Loan Source, Inc. (SBLS). For 2006, 2005 and 2004 acquisitions, goodwill and other intangible assets in the amounts of $110.7 million, $25.8 million and $18.6 million, respectively, were assigned to First Bank.
The consolidated financial statements include the financial position and results of operations of the aforementioned transactions for the periods subsequent to the respective acquisition dates, and the assets acquired and liabilities assumed were recorded at their estimated fair value on the acquisition dates. These fair value adjustments for the acquisitions completed in 2006 represent current estimates and are subject to further adjustments as the valuation data is finalized. The aforementioned acquisitions were funded from available cash reserves, borrowings under First Banks' term loan and revolving credit agreements, and/or proceeds from the issuance of subordinated debentures.
On July 30, 2004, First Banks completed its acquisition of CMC and its wholly owned banking subsidiary, Continental Community Bank and Trust Company (CCB) for $4.2 million in cash, and redeemed in full all of the outstanding subordinated promissory notes of CMC, including accumulated accrued and unpaid interest, totaling $4.5 million in aggregate. The acquisition served to expand First Banks' banking franchise in Chicago, Illinois. The transaction was funded through internally generated funds. CMC, through CCB, operated two banking offices in the Chicago suburban communities of Aurora and Villa Park. At the time of the transaction, CMC had assets of $140.7 million, loans, net of unearned discount, of $73.6 million and deposits of $104.6 million. Preliminary goodwill of $1.5 million was subsequently adjusted to $100,000 during the third quarter of 2005, and the core deposit intangibles, which are being amortized over seven years utilizing the straight-line method, were $2.0 million. CMC was merged with and into SFC and CCB was merged with and into First Bank at the time of the acquisition.
On August 31, 2004, SBLS LLC, a Nevada-based limited liability company and subsidiary of First Bank, purchased substantially all of the assets and assumed certain liabilities of SBLS, headquartered in Houston, Texas, in exchange for cash and certain payments contingent on future valuations of specifically identified assets, including servicing assets and retained interests in securitizations, as further described in Note 24 to the Consolidated Financial Statements. The transaction was funded through internally generated funds. At the time of the transaction, SBLS LLC purchased from SBLS assets of $47.1 million, including $24.0 million of SBA loans, net of unearned discount, and $15.1 million of SBA servicing rights, and assumed $1.5 million of liabilities, resulting in a net cash payment of $45.6 million. Goodwill was $5.9 million. In conjunction with this transaction, on August 30, 2004, First Bank granted to FCA, a corporation owned by First Banks' Chairman and members of his immediate family, an option to purchase Membership Interests of SBLS LLC. FCA exercised this option on June 30, 2005 and paid First Bank $7.4 million in cash. As a result of this transaction, SBLS LLC became 51.0% owned by First Bank and 49.0% owned by FCA, and accordingly, effective June 30, 2005, FCA's ownership interest is recognized as minority interest in subsidiary in the consolidated balance sheets and, beginning July 1, 2005, the related minority interest in income or loss of subsidiary is recognized in the consolidated statements of income.
On November 30, 2004, First Banks completed its acquisition of Hillside Investors, Ltd. (Hillside) and its wholly owned banking subsidiary, CIB Bank (collectively, CIB Bank), headquartered in Hillside, Illinois, for approximately $67.4 million in cash. The acquisition served to significantly expand First Banks' banking franchise in Chicago, Illinois. The transaction was funded through the issuance of subordinated debentures associated with two private placements of $60.0 million in aggregate of trust preferred securities through newly formed affiliated statutory trusts, as further described in Note 12 to the Consolidated Financial Statements. The acquisition was also funded through borrowings under the Company's revolving line of credit with a group of unaffiliated financial institutions. CIB Bank operated 16 banking offices in the Chicago, Illinois metropolitan area, including ten offices in Cook County, three offices in Lake County, two offices in Will County and one office in DuPage County. At the time of the transaction, CIB Bank had assets of $1.20 billion, loans, net of unearned discount, of $683.3 million, investment securities of $393.2 million and deposits of $1.10 billion. Preliminary goodwill was $4.3 million and the core deposit intangibles, which are being amortized over seven years utilizing the straight-line method, were $13.4 million. As further described below, goodwill and core deposit intangibles were subsequently adjusted during the first quarter of 2005. Hillside was merged with and into SFC and CIB Bank was merged with and into First Bank on December 1, 2004.
During the first quarter of 2005, First Banks recorded certain acquisition-related adjustments pertaining to its acquisition of CIB Bank. Acquisition-related adjustments included additional purchase accounting adjustments necessary to appropriately adjust the preliminary goodwill of $4.3 million recorded at the time of the acquisition, which was based upon current estimates available at that time, to reflect the receipt of additional valuation data. The aggregate adjustments resulted in a purchase price reallocation among goodwill, core deposit intangibles and bank premises and equipment. The purchase price reallocation resulted in the reallocation of $3.1 million of negative goodwill to core deposit intangibles and bank premises and equipment, thereby reducing such assets by $2.8 million and $2.4 million, net of the related tax effect of $1.1 million and $941,000, respectively. Following the recognition of the acquisition-related adjustments, goodwill recorded was reduced from $4.3 million to zero and the core deposit intangibles, which are being amortized over seven years utilizing the straight-line method, were reduced from $13.4 million to $10.6 million, net of the related tax effect. The individual components of the $4.3 million acquisition-related adjustments to goodwill and the $3.1 million purchase price reallocation recorded in the first quarter of 2005 are summarized as follows:
>> a $1.6 million increase in goodwill to adjust time deposits, net of the related tax effect, to their estimated fair value;
>> a $967,000 increase in goodwill to adjust other real estate owned, net of the related tax effect, to its estimated fair value;
>> a $10.0 million reduction in goodwill to adjust loans held for sale, net of the related tax effect, to their estimated fair value. These adjustments were based upon the receipt of loan payoffs and significantly higher sales prices received over the original third-party bid estimates, for certain loans held for sale. All of the acquired nonperforming loans that had been held for sale as of December 31, 2004 had either been sold or repaid as of March 31, 2005, with the exception of one credit relationship, which was subsequently sold in April 2005;
>> a $1.7 million increase in goodwill, net of the related tax effect, and a related decrease in core deposit intangibles of $2.8 million, resulting from the purchase price reallocation; and
>> a $1.4 million increase in goodwill, net of the related tax effect, and a related decrease in bank premises and equipment of $2.4 million, resulting from the purchase price reallocation.
On April 29, 2005, First Banks completed its acquisition of FBA Bancorp, Inc. (FBA) and its wholly owned subsidiary, First Bank of the Americas, S.S.B. (FBOTA), for $10.5 million in cash. The acquisition served to expand First Banks' banking franchise in Chicago, Illinois. The transaction was funded through internally generated funds. FBA was headquartered in Chicago, Illinois, and through FBOTA, operated three banking offices in the southwestern Chicago metropolitan communities of Back of the Yards, Little Village and Cicero. At the time of the acquisition, FBA had assets of $73.3 million, loans, net of unearned discount, of $54.3 million and deposits of $55.7 million. Goodwill was $2.8 million, and the core deposit intangibles, which are being amortized over seven years utilizing the straight-line method, were $1.7 million. FBA was merged with and into SFC, and FBOTA was merged with and into First Bank at the time of the acquisition.
On September 23, 2005, First Bank completed its acquisition of certain assets and assumption of the deposit liabilities of the Roodhouse, Illinois branch office of Bank and Trust Company, an Illinois commercial bank (Roodhouse Branch). At the time of the transaction, the Roodhouse Branch had deposit liabilities of $5.1 million. Total assets consisted primarily of cash received upon assumption of the deposit liabilities. The core deposit intangibles, which are being amortized over seven years utilizing the straight-line method, were $100,000.
On September 30, 2005, First Banks completed its acquisition of International Bank of California (IBOC) for $33.7 million in cash. The acquisition served to further expand First Banks' banking franchise in Southern California, providing five additional banking offices in Los Angeles, California, including one branch in downtown Los Angeles and four branches in eastern Los Angeles County, in Alhambra, Arcadia, Artesia and Rowland Heights. The transaction was funded with a portion of the proceeds of First Banks' $100.0 million term loan, as further described in Note 11 to the Consolidated Financial Statements. At the time of the acquisition, IBOC had assets of $151.6 million, loans, net of unearned discount, of $113.5 million and deposits of $132.1 million. Goodwill was $12.0 million, and the core deposit intangibles, which are being amortized over seven years utilizing the straight-line method, were $3.8 million. IBOC was merged with and into First Bank at the time of the acquisition.
On October 31, 2005, First Banks completed its acquisition of Northway State Bank (NSB) for $10.3 million in cash. The acquisition served to expand First Banks' banking franchise in Chicago, Illinois. The transaction was funded through internally generated funds. NSB was headquartered in Grayslake, Illinois, and operated one banking office in Lake County in the northern Chicago metropolitan area. At the time of the acquisition, NSB had assets of $50.4 million, loans, net of unearned discount, of $41.8 million and deposits of $45.2 million. Preliminary goodwill of $3.8 million was subsequently adjusted to $4.5 million during the third quarter of 2006, and the core deposit intangibles, which are being amortized over seven years utilizing the straight-line method, were $909,000. NSB was merged with and into First Bank at the time of the acquisition.
On January 3, 2006, First Banks acquired the majority of the outstanding common stock of First National Bank of Sachse (FNBS), and subsequently acquired the remaining outstanding common stock of FNBS in January 2006, for $20.8 million in cash, in aggregate. FNBS was headquartered and operated one banking office in Sachse, Texas, located in the northeast Dallas metropolitan area. The acquisition served to expand First Banks' banking franchise in Texas. The transaction was funded through internally generated funds. At the time of the acquisition, FNBS had assets of $76.2 million, loans, net of unearned discount, of $49.3 million, deposits of $66.2 million and stockholders' equity of $9.9 million. Goodwill was $8.8 million, and the core deposit intangibles, which are being amortized over five years utilizing the straight-line method, were $3.6 million. FNBS was merged with and into First Bank on January 24, 2006.
On January 20, 2006, First Bank completed its acquisition of the branch office of Dallas National Bank in Richardson, Texas (Richardson Branch). At the time of the acquisition, the Richardson Branch had assets of $1.1 million, including loans, net of unearned discount, of $144,000, and deposits of $1.1 million. Total assets consisted primarily of loans, fixed assets and cash received upon assumption of deposit liabilities and certain assets.
On March 31, 2006, First Bank completed its acquisition of Adrian Baker for $7.4 million in cash and certain payments contingent on the future earnings of Adrian Baker for each of the years in the three-year period following the closing date of the transaction. Adrian Baker is an insurance brokerage agency based in Clayton, Missouri that provides a comprehensive range of employee benefit and commercial and personal insurance services on a nationwide basis. The acquisition served to diversify First Banks' products and services in this specialized industry. The transaction was funded through internally generated funds. At the time of the acquisition, Adrian Baker had assets of $3.0 million and stockholders' equity of $810,000. Goodwill was $4.3 million, and the customer list intangibles, which are being amortized over 15 years utilizing the straight-line method, were $3.7 million. Adrian Baker operates as a wholly owned subsidiary of First Bank.
On April 28, 2006, First Banks completed its acquisition of Pittsfield Community Bancorp, Inc. and its wholly owned banking subsidiary, Community Bank of Pittsfield (collectively, Community Bank) for $5.1 million in cash. Community Bank was headquartered in Pittsfield, Illinois and operated two banking offices, one in Pittsfield, Illinois, and one in Mount Sterling, Illinois. On June 16, 2006, First Bank completed its sale of the Mount Sterling office to Beardstown Savings, s.b. The acquisition served to expand First Banks' banking franchise in Pittsfield, Illinois. The transaction was funded through internally generated funds. At the time of the acquisition, after giving effect to the sale of the Mount Sterling office, Community Bank had assets of $17.6 million, loans, net of unearned discount, of $11.1 million, deposits of $12.3 million and stockholder's equity of $3.9 million. Goodwill was $807,000, and the core deposit intangibles, which are being amortized over five years utilizing the straight-line method, were $517,000. Community Bank was merged with and into First Bank at the time of the acquisition.
On May 1, 2006, First Banks acquired the majority of the outstanding common stock of First Independent National Bank (FINB), and subsequently acquired the remaining outstanding common stock in May 2006, for $19.2 million in cash, in aggregate. FINB was headquartered in Plano, Texas and operated two banking offices in Plano, Texas, located in Collin County. In addition, at the time of the acquisition, FINB was in the process of opening a de novo branch banking office located in the Preston Forest Shopping Center in Dallas County, which subsequently opened on June 26, 2006. The acquisition served to expand First Banks' banking franchise in Texas. The transaction was funded through internally generated funds and the issuance of subordinated debentures associated with a private placement of $40.0 million of trust preferred securities through a newly formed affiliated statutory trust, as further described in Note 12 to the Consolidated Financial Statements. At the time of the acquisition, FINB had assets of $68.2 million, loans, net of unearned discount, of $59.6 million, deposits of $55.5 million and stockholders' equity of $7.3 million. Goodwill was $9.3 million, and the core deposit intangibles, which are being amortized over five years utilizing the straight-line method, were $2.5 million. FINB was merged with and into First Bank on May 16, 2006.
On May 31, 2006, First Bank completed its acquisition of KIF, Inc., an Iowa corporation, and its wholly owned subsidiaries, UPAC, a Missouri corporation, and UPAC of California, Inc., a California corporation (collectively, UPAC), for $52.7 million in cash. In conjunction with the acquisition of UPAC, First Banks repaid in full the outstanding senior and subordinated notes of UPAC, which totaled $125.9 million at the time of the acquisition. UPAC is an insurance premium financing company headquartered in the Kansas City suburb of Lenexa, Kansas and operates in 49 states. The acquisition served to diversify First Banks' products and services in this highly-specialized industry. The transaction was funded through internally generated funds and a $52.0 million short-term Federal Home Loan Bank (FHLB) advance. At the time of the acquisition, UPAC had assets of $152.8 million, loans, net of unearned discount, of $149.2 million and stockholders' equity of $18.3 million. Goodwill was $25.4 million, and the customer list intangibles, which are being amortized over 16 years utilizing the straight-line method, were $19.3 million. KIF, Inc. was merged with and into UPAC on June 30, 2006. UPAC of California, Inc. operates as a wholly owned subsidiary of UPAC, which operates as a wholly owned subsidiary of First Bank.
On August 15, 2006, First Banks completed its acquisition of San Diego Community Bank (SDCB) for $25.5 million in cash. SDCB was headquartered in Chula Vista, California, which is located approximately ten miles south of downtown San Diego, and operated two other banking offices in Kearney Mesa and Otay Mesa. The acquisition served to expand First Banks' banking franchise in southern California. The transaction was funded through internally generated funds and the issuance of subordinated debentures associated with the private placement of $20.0 million of trust preferred securities through a newly formed affiliated statutory trust, as further described in Note 12 to the Consolidated Financial Statements. At the time of the acquisition, SDCB had assets of $91.7 million, loans, net of unearned discount, of $78.6 million, deposits of $76.1 million and stockholders' equity of $12.3 million. Goodwill was $7.5 million, and the core deposit intangibles, which are being amortized over five years utilizing the straight-line method, were $4.3 million. SDCB was merged with and into First Bank at the time of the acquisition.
On August 31, 2006, First Banks completed its acquisition of TeamCo, Inc. and its wholly owned banking subsidiary, Oak Lawn Bank (collectively, Oak Lawn) for $13.9 million in cash. Oak Lawn was headquartered in Oak Lawn, Illinois, which is located approximately 15 miles southwest of the Chicago Loop in Chicago Southland, and operated a second banking office in Orland Park, Illinois, which is located approximately 39 miles southwest of downtown Chicago. The acquisition served to expand First Banks' banking franchise in Chicago, Illinois. The transaction was funded through internally generated funds and the issuance of subordinated debentures associated with the private placement of $25.0 million of trust preferred securities through a newly formed affiliated statutory trust, as further described in Note 12 to the Consolidated Financial Statements. At the time of the acquisition, Oak Lawn had assets of $67.9 million, loans, net of unearned discount, of $43.1 million, deposits of $60.1 million and stockholders' equity of $5.5 million. Goodwill was $7.3 million, and the core deposit intangibles, which are being amortized over five years utilizing the straight-line method, were $2.3 million. Oak Lawn was merged with and into First Bank at the time of the acquisition.
On November 3, 2006, First Bank completed its acquisition of the First Bank of Beverly Hills' banking office located in Beverly Hills, California (Beverly Drive Office). At the time of the acquisition, the Beverly Drive Office had assets of $157.5 million and deposits of $156.1 million. Total assets consisted primarily of cash received upon assumption of deposit liabilities and certain assets. The core deposit intangibles, which are being amortized over five years utilizing the straight-line method, were $8.7 million.
On November 10, 2006, First Bank completed its acquisition of MidAmerica National Bank's three banking offices located in Peoria and Bloomington, Illinois (collectively, MidAmerica Offices). At the time of the acquisition, the MidAmerica Offices had, on a combined basis, assets of $158.3 million including loans, net of unearned discount, of $154.1 million, and deposits of $48.2 million. The core deposit intangibles, which are being amortized over five years utilizing the straight-line method, were $2.4 million.
Pending Acquisitions. On November 7, 2006, First Banks entered into an Agreement and Plan of Reorganization providing for the acquisition of Royal Oaks Bancshares, Inc. and its wholly owned banking subsidiary, Royal Oaks Bank, ssb (collectively, Royal Oaks). Royal Oaks was headquartered in Houston, Texas and operated five banking offices in the Houston area. In addition, at the time of the acquisition, Royal Oaks was in the process of opening a de novo branch banking office located in the Heights, near downtown Houston, which is expected to be completed in the second quarter of 2007. As further described in Note 25 to the Consolidated Financial Statements, First Banks completed its acquisition of Royal Oaks on February 28, 2007.
Acquisition and Integration Costs. First Banks accrues certain costs associated with its acquisitions as of the respective consummation dates. The accrued costs relate to adjustments to the staffing levels of the acquired entities or to the anticipated termination of information technology or item processing contracts of the acquired entities prior to their stated contractual expiration dates. The most significant costs that First Banks incurs relate to salary continuation agreements, or other similar agreements, of executive management and certain other employees of the acquired entities that were in place prior to the acquisition dates. These agreements provide for payments over periods generally ranging from two to 15 years and are triggered as a result of the change in control of the acquired entity. Other severance benefits for employees that are terminated in conjunction with the integration of the acquired entities into First Banks' existing operations are normally paid to the recipients within 90 days of the respective consummation date and are expensed in the consolidated statements of income as incurred. The accrued severance balance of $386,000 as of December 31, 2006, as summarized in the following table, is comprised of contractual obligations under salary continuation agreements to seven individuals with remaining terms ranging from approximately
two months to nine years. As the obligation to make payments under these agreements is accrued at the consummation date, such payments do not have any impact on the consolidated statements of income. First Banks also incurs integration costs associated with acquisitions that are expensed in the consolidated statements of income. These costs relate principally to additional costs incurred in conjunction with the information technology conversions of the respective entities. The following table summarizes the cumulative acquisition and integration costs attributable to the Company's acquisitions, which were accrued as of the consummation dates of the respective acquisition and are reflected in accrued and other liabilities in the consolidated balance sheets:
(3) INVESTMENTS IN DEBT AND EQUITY SECURITIES
Securities Available for Sale. The amortized cost, contractual maturity, gross unrealized gains and losses and fair value of investment securities available for sale at December 31, 2006 and 2005 were as follows:
Proceeds from sales of available-for-sale investment securities were $198.0 million, $147.1 million and $26.3 million for the years ended December 31, 2006, 2005 and 2004, respectively. Gross gains of $389,300 and $257,100 were realized on sales of available-for-sale investment securities for the years ended December 31, 2006 and 2004, respectively. There were no gross gains on the sale of these securities during the year ended December 31, 2005. Gross losses of $2.7 million and $2.9 million were realized on sales of available-for-sale investment securities during the years ended December 31, 2006 and 2005, respectively. The gross losses for the year ended December 31, 2006 include a loss of $2.7 million that resulted from the sale of $197.0 million of available-for-sale investment securities for liquidity purposes, including the related termination of $200.0 million in aggregate of term repurchase agreements, as further described in Note 5 and Note 10 to the Consolidated Financial Statements. The gross loss of $2.9 million for the year ended December 31, 2005 resulted from the sale of $150.0 million of available-for-sale investment securities for liquidity purposes, including the related termination of a $50.0 million term repurchase agreement, as further described in Note 5 to the Consolidated Financial Statements. There were no gross losses realized on sales of available-for-sale investment securities in 2004.
Proceeds from calls of investment securities were $27.5 million, $16.6 million and $63.1 million for the years ended December 31, 2006, 2005 and 2004, respectively. There were no gross gains realized on called securities in 2006, 2005 and 2004. Gross losses of $2,100 and $3,800 were realized on these called securities during the years ended December 31, 2006 and 2005, respectively. There were no gross losses realized on called securities in 2004. Net gains on trading securities for the year ended December 31, 2006 were $97,000.
First Bank is a member of the Federal Home Loan Bank (FHLB) system and the Federal Reserve Bank (FRB) system and maintains investments in FHLB and FRB stock. These investments are recorded at cost, which represents redemption value. The investment in FRB stock is maintained at a minimum of 6% of First Bank's capital stock and capital surplus. The investment in FHLB of Des Moines stock is maintained at an amount equal to 0.12% of First Bank's total assets as of December 31, 2004, up to a maximum of $10.0 million, plus 4.45% of advances and 0.15% of outstanding standby letters of credit. First Bank also holds an investment in stock of the FHLB of Dallas and the FHLB of San Francisco, as a nonmember, to collateralize certain FHLB advances assumed in conjunction with certain acquisition transactions. The investment in FHLB of Dallas stock is maintained at a minimum of 4.10% of advances. The investment in FHLB of San Francisco stock is maintained at a minimum of 4.70% of advances.
Investment securities with a carrying value of approximately $586.4 million and $619.4 million at December 31, 2006 and 2005, respectively, were pledged in connection with deposits of public and trust funds, securities sold under agreements to repurchase and for other purposes as required by law.
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006 and 2005, were as follows:
U.S. Government sponsored agencies and mortgage-backed securities - The unrealized losses on investments in mortgage-backed securities and other agency securities were caused by fluctuations in interest rates. The contractual terms of these securities are guaranteed by government-sponsored enterprises. It is expected that the securities would not be settled at a price less than the amortized cost. Because First Banks has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired. At December 31, 2006, the unrealized losses for U.S. government sponsored agencies for 12 months or more included 19 securities, and the unrealized losses for mortgage-backed securities for 12 months or more included 138 securities. At December 31, 2005, the unrealized losses for U.S. government sponsored agencies for 12 months or more included 14 securities, and the unrealized losses for mortgage-backed securities for 12 months or more included 62 securities.
State and political subdivisions and corporate debt securities - The unrealized losses on investments in state and political subdivisions and corporate debt securities were caused by fluctuations in interest rates. It is expected that the securities would not be settled at a price less than the amortized cost. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because First Banks has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired. At
December 31, 2006, the unrealized losses for state and political subdivisions for 12 months or more included 53 securities. At December 31, 2005, the unrealized losses for state and political subdivisions for 12 months or more included seven securities.
(4) LOANS AND ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31, 2006, 2005 and 2004 were as follows:
At December 31, 2006 and 2005, First Banks had $48.7 million and $97.2 million of impaired loans, consisting of loans on nonaccrual status. Interest on nonaccrual loans that would have been recorded under the original terms of the loans was $3.7 million, $9.9 million and $4.4 million for the years ended December 31, 2006, 2005 and 2004, respectively. Of these amounts, $1.3 million, $3.4 million and $716,000 was recorded as interest income on such loans in 2006, 2005 and 2004, respectively. The allowance for loan losses includes an allocation for each impaired loan. The aggregate allocation of the allowance for loan losses related to impaired loans was approximately $9.7 million and $20.1 million at December 31, 2006 and 2005, respectively. The average recorded investment in impaired loans was $73.6 million, $79.9 million and $77.3 million for the years ended December 31, 2006, 2005 and 2004, respectively. The amount of interest income recognized using a cash basis method of accounting during the time these loans were impaired was $3.7 million, $3.6 million and $717,000 in 2006, 2005 and 2004, respectively. At December 31, 2006 and 2005, First Banks had $5.7 million and $5.6 million, respectively, of loans past due 90 days or more and still accruing interest.
First Banks' primary market areas are the states of Missouri, Illinois, Texas and California. At December 31, 2006 and 2005, approximately 90% and 91% of the total loan portfolio, respectively, and 77% and 83% of the commercial, financial and agricultural loan portfolio, respectively, were made to borrowers within these states.
Real estate lending constituted the only significant concentration of credit risk. Real estate loans comprised approximately 74% and 76% of the loan portfolio at December 31, 2006 and 2005, respectively, of which 26% and 27%, respectively, were made to consumers in the form of residential real estate mortgages and home equity lines of credit. First Bank also offers residential real estate mortgage loans with terms that require interest only payments. At December 31, 2006, the balance of such loans was $332.6 million, of which $276.5 million were held for portfolio and $56.1 million were held for sale. At December 31, 2005, the balance of such loans was $332.3 million, of which $194.6 million were held for portfolio and $137.7 million were held for sale.
In general, First Banks is a secured lender. At December 31, 2006 and 2005, 99% of the loan portfolio was collateralized. Collateral is required in accordance with the normal credit evaluation process based upon the creditworthiness of the customer and the credit risk associated with the particular transaction.
Loans to directors, their affiliates and executive officers of First Banks, Inc. were approximately $55.9 million and $37.9 million at December 31, 2006 and 2005, respectively, as further described in Note 19 to the Consolidated Financial Statements.
(5) DERIVATIVE INSTRUMENTS
First Banks utilizes derivative financial instruments to assist in the management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities. Derivative financial instruments held by First Banks at December 31, 2006 and 2005 are summarized as follows:
The notional amounts of derivative financial instruments do not represent amounts exchanged by the parties and, therefore, are not a measure of First Banks' credit exposure through its use of these instruments. The credit exposure represents the loss First Banks would incur in the event the counterparties failed completely to perform according to the terms of the derivative financial instruments and the collateral held to support the credit exposure was of no value.
For the year ended December 31, 2006, First Banks realized net interest expense of $5.0 million on its derivative financial instruments, whereas for the years ended December 31, 2005 and 2004, First Banks realized net interest income of $2.2 million and $50.1 million, respectively, on its derivative financial instruments. First Banks recorded net losses on derivative instruments, which are included in noninterest income in the consolidated statements of income, of $390,000, $1.1 million and $1.5 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Cash Flow Hedges. First Banks entered into the following interest rate swap agreements, which have been designated as cash flow hedges, to effectively lengthen the repricing characteristics of certain interest-earning assets to correspond more closely with their funding source with the objective of stabilizing cash flow, and accordingly, net interest income over time:
>> During September 2000, March 2001, April 2001, March 2002 and July 2003, First Banks entered into interest rate swap agreements of $600.0 million, $200.0 million, $175.0 million, $150.0 million and $200.0 million notional amount, respectively. The underlying hedged assets are certain loans within First Banks' commercial loan portfolio. The swap agreements provide for First Banks to receive a fixed rate of interest and pay an adjustable rate of interest equivalent to the weighted average prime lending rate minus 2.70%, 2.82%, 2.82%, 2.80% and 2.85%, respectively. The terms of the swap agreements provide for First Banks to pay and receive interest on a quarterly basis. In November 2001, First Banks terminated $75.0 million notional amount of the swap agreements originally entered into in April 2001 in order to appropriately modify its overall hedge position in accordance with its interest rate risk management program, and on April 2, 2006, the remaining $100.0 million notional amount of these swap agreements matured. In addition, the $150.0 million notional swap agreement that was entered into in March 2002 matured in March 2004, the $600.0 million notional swap agreements that were entered into in September 2000 matured in September 2004, and the $200.0 million notional swap agreement that was entered into in March 2001 matured in March 2005.
>> On September 14, 2006, First Banks entered into a $200.0 million notional amount three-year interest rate swap agreement and a $200.0 million notional amount four-year interest rate swap agreement. The underlying hedged assets are certain loans within First Banks' commercial loan portfolio. The swap agreements provide for First Banks to receive a fixed rate of interest and pay an adjustable rate of interest equivalent to the weighted average prime lending rate minus 2.86%. The terms of the swap agreements provide for First Banks to pay and receive interest on a quarterly basis.
The amount receivable by First Banks under the swap agreements was $7.0 million and $2.4 million at December 31, 2006 and 2005, respectively, and the amount payable by First Banks under the swap agreements was $2.7 million and $2.5 million at December 31, 2006 and 2005, respectively.
The maturity dates, notional amounts, interest rates paid and received and fair value of First Banks' interest rate swap agreements designated as cash flow hedges as of December 31, 2006 and 2005 were as follows:
Fair Value Hedges. First Banks entered into the following interest rate swap agreements, which have been designated as fair value hedges, to effectively shorten the repricing characteristics of certain interest-bearing liabilities to correspond more closely with their funding source with the objective of stabilizing net interest income over time:
>> During January 2001, First Banks entered into $150.0 million notional amount of five-year interest rate swap agreements that provided for First Banks to receive a fixed rate of interest and pay an adjustable rate of interest equivalent to the three-month London Interbank Offering Rate (LIBOR). The underlying hedged liabilities were a portion of First Banks' other time deposits. The terms of the swap agreements provided for First Banks to pay interest on a quarterly basis and receive interest on a semiannual basis. In February 2005, First Banks terminated the swap agreements. The termination of the swap agreements resulted from an increasing level of ineffectiveness associated with the correlation of the hedge positions between the swap agreements and the underlying hedged liabilities that had been anticipated as the swap agreements neared their originally scheduled maturity dates in January 2006. The resulting $3.1 million basis adjustment of the underlying hedged liabilities was recorded as interest expense over the remaining weighted average maturity of the underlying hedged liabilities of approximately ten months. At December 31, 2005, the basis adjustments associated with these swap agreements were fully amortized.
>> During May 2002, March 2003 and April 2003, First Banks entered into $55.2 million, $25.0 million and $46.0 million notional amount, respectively, of interest rate swap agreements that provided for First Banks to receive a fixed rate of interest and pay an adjustable rate of interest equivalent to the three-month LIBOR plus 2.30%, 2.55% and 2.58%, respectively. The underlying hedged liabilities were a portion of First Banks' subordinated debentures. The terms of the swap agreements provided for First Banks to pay and receive interest on a quarterly basis. The amounts receivable and payable by First Banks under the swap agreements at December 31, 2005 were $506,000 and $420,000, respectively. In May 2005, First Banks terminated the $55.2 million and $46.0 million notional swap agreements in order to appropriately modify future hedge positions in accordance with First Banks' interest rate risk management program. The resulting $854,000 basis adjustment of the underlying hedged liabilities, in aggregate, was being recorded as a reduction of interest expense over the remaining maturities of the underlying hedged liabilities, which ranged from 26 to 28 years at the time of the termination. Effective February 16, 2006, First Banks terminated the remaining $25.0 million notional swap agreement. In conjunction with this transaction, First Banks recorded the resulting $1.7 million basis adjustment of the underlying hedged liabilities and the remaining balance of the basis adjustments associated with the swap agreements that were terminated in May 2005, totaling $834,000, in the consolidated statements of
income. The recognition of the net basis adjustments on all of the terminated fair value interest rate swap agreements resulted in a pre-tax loss of $849,000 that was recorded in February 2006.
The maturity date, notional amount, interest rate paid and received and fair value of First Banks' interest rate swap agreement designated as a fair value hedge as of December 31, 2005 was as follows:
Interest Rate Floor Agreements. In September 2005, First Bank entered into a $100.0 million notional amount three-year interest rate floor agreement in conjunction with its interest rate risk management program. The interest rate floor agreement provides for First Bank to receive a quarterly fixed rate of interest of 5.00% should the three-month LIBOR equal or fall below the strike price of 2.00%. On August 24, 2006, First Bank entered into a $200.0 million notional amount three-year interest rate floor agreement in conjunction with the restructuring of a term repurchase agreement, as further described in Note 10 to the Consolidated Financial Statements, to further stabilize net interest income in the event of a declining rate scenario. The interest rate floor agreement provides for First Bank to receive a quarterly adjustable rate of interest equivalent to the differential between the strike price of 4.00% and the three-month LIBOR should the three-month LIBOR equal or fall below the strike price. The carrying value of the interest rate floor agreements, which is included in other assets in the consolidated balance sheets, was $376,000 and $70,000 at December 31, 2006 and 2005, respectively.
Interest Rate Floor Agreements Embedded in Term Repurchase Agreements. First Bank has term repurchase agreements under master repurchase agreements with unaffiliated third parties, as further described in Note 10 to the Consolidated Financial Statements. The underlying securities associated with the term repurchase agreements are mortgage-backed securities and callable U.S. Government agency securities and are held by other financial institutions under safekeeping agreements. The term repurchase agreements were entered into with the objective of stabilizing net interest income over time, further protecting net interest margin against changes in interest rates and providing funding for security purchases. The interest rate floor agreements included within the term repurchase agreements (and the interest rate cap agreements previously included within the term repurchase agreements) represent embedded derivative instruments which, in accordance with existing accounting literature governing derivative instruments, are not required to be separated from the term repurchase agreements and accounted for separately as a derivative financial instrument. As such, the term repurchase agreements are reflected in other borrowings in the consolidated balance sheets and the related interest expense is reflected as interest expense on other borrowings in the consolidated statements of income. As further described in Note 10 to the Consolidated Financial Statements, in March 2005, in accordance with the Company's interest rate risk management program, First Bank modified its term repurchase agreements under master repurchase agreements with unaffiliated third parties to terminate the interest rate cap agreements previously embedded within the agreements and simultaneously enter into interest rate floor agreements, also embedded within the agreements. These modifications resulted in adjustments to the existing interest rate spread to LIBOR for the underlying agreements. The modified terms of the term repurchase agreements became effective during the second quarter of 2005. First Bank did not incur any costs associated with the modifications of the agreements nor did the modifications result in a change to the accounting treatment of the embedded derivative instruments.
As further described in Note 3 and Note 10 to the Consolidated Financial Statements, in November 2005, First Bank terminated its $50.0 million term repurchase agreement with a maturity date of August 15, 2006, and simultaneously recognized a loss of $2.9 million on the sale of available-for-sale investment securities associated with the termination of the
term repurchase agreement. In addition, on February 14, 2006, First Bank terminated its two $50.0 million term repurchase agreements with maturity dates of June 14, 2007, and recognized a $1.6 million loss on the sale of $100.0 million of available-for-sale investment securities associated with the termination of the term repurchase agreements; on March 28, 2006, First Bank terminated the $50.0 million term repurchase agreement with a maturity date of August 1, 2007, and recognized a $746,000 loss on the sale of $50.0 million of available-for-sale investment securities associated with the termination of the term repurchase agreement; and on April 28, 2006, First Bank terminated $50.0 million of the $150.0 million term repurchase agreement with a maturity date of January 12, 2007, and recognized a $310,000 loss on the sale of $50.0 million of available-for-sale investment securities associated with the termination of the term repurchase agreement. The Company's termination transactions entered into in 2006 resulted in a reduction of $200.0 million of its term repurchase agreements, the recognition of a $2.7 million loss on the sale of $200.0 million of investment securities held in its available-for-sale investment portfolio, and prepayment penalties of $306,000 incurred in conjunction with the early termination of the term repurchase agreements. Additionally, on August 24, 2006, First Bank restructured the remaining $100.0 million term repurchase agreement to extend the maturity date to October 12, 2010 and to modify the pricing structure, including the interest rate floor strike price, as further described in Note 10 to the Consolidated Financial Statements. First Bank did not incur any costs associated with the restructuring of the agreement.
On July 14, 2006, First Bank entered into a $100.0 million four-year term repurchase agreement under a master repurchase agreement with an unaffiliated third party, as further described in Note 10 to the Consolidated Financial Statements. The underlying securities associated with the term repurchase agreement are U.S. Government agency collateralized mortgage obligation securities and are held by other financial institutions under a safekeeping agreement.
Interest Rate Cap Agreements. On September 14, 2006, First Bank entered into a $200.0 million notional amount three-year interest rate cap agreement and a $200.0 million notional amount four-year interest rate cap agreement in conjunction with the interest rate swap agreements designated as cash flow hedges that First Banks entered into on September 14, 2006, as previously described, to limit the net interest expense associated with First Banks' interest rate swap agreements in the event of a rising rate scenario. The $200.0 million notional amount three-year interest rate cap agreement provides for First Bank to receive a quarterly adjustable rate of interest equivalent to the differential between the three-month LIBOR and the strike price of 7.00% should the three-month LIBOR exceed the strike price. The $200.0 million notional amount four-year interest rate cap agreement provides for First Bank to receive a quarterly adjustable rate of interest equivalent to the differential between the three-month LIBOR and the strike price of 7.50% should the three-month LIBOR exceed the strike price. The carrying value of the interest rate cap agreements, which is included in other assets in the consolidated balance sheets, was $139,000 at December 31, 2006.
Pledged Collateral. At December 31, 2006, First Banks had accepted cash of $4.2 million as collateral in connection with its interest rate swap agreements. At December 31, 2005, First Banks had a $2.0 million letter of credit issued on its behalf to the counterparty and had pledged investment securities available for sale with a fair value of $5.1 million and cash of $1.8 million as collateral in connection with its interest rate swap agreements.
Interest Rate Lock Commitments / Forward Commitments to Sell Mortgage-Backed Securities. Derivative financial instruments issued by First Banks consist of interest rate lock commitments to originate fixed-rate loans to be sold. Commitments to originate fixed-rate loans consist primarily of residential real estate loans. These net loan commitments and loans held for sale are hedged with forward contracts to sell mortgage-backed securities. The carrying value of these interest rate lock commitments included in other assets in the consolidated balance sheets was ($17,000) and ($49,000) at December 31, 2006 and 2005, respectively.
(6) SERVICING RIGHTS
Mortgage Banking Activities. At December 31, 2006 and 2005, First Banks serviced mortgage loans for others totaling $1.04 billion and $1.01 billion, respectively. Borrowers' escrow balances held by First Banks on such loans were $5.7 million and $5.0 million at December 31, 2006 and 2005, respectively. Changes in mortgage servicing rights, net of amortization, for the years ended December 31, 2006 and 2005 were as follows:
First Banks did not incur any impairment of mortgage servicing rights during the years ended December 31, 2006, 2005 and 2004.
Amortization of mortgage servicing rights at December 31, 2006 has been estimated in the following table:
Other Servicing Activities. At December 31, 2006 and 2005, First Banks serviced SBA loans for others totaling $143.4 million and $163.4 million, respectively. Changes in SBA servicing rights, net of amortization and impairment, for the years ended December 31, 2006 and 2005 were as follows:
First Banks recognized impairment of $1.4 million, $2.4 million and $459,000 for the years ended December 31, 2006, 2005 and 2004, respectively. The impairment of $1.4 million recorded for the year ended December 31, 2006 primarily resulted from a decline in the fair value of the SBA servicing assets below the carrying value attributable to the placement of certain loans on nonaccrual status and payoffs received on certain existing loans. The impairment of $2.4 million recorded for the year ended December 31, 2005 resulted from a decline in the fair value of the SBA servicing assets below the carrying value following substantial damage to several shrimping vessels within the servicing portfolio caused by the effects of Hurricane Katrina, as well as continued distress affecting the U.S. shrimping industry and the ability of these borrowers to repay their loans.
Amortization of SBA servicing rights at December 31, 2006 has been estimated in the following table:
(7) BANK PREMISES AND EQUIPMENT, NET
Bank premises and equipment, net of accumulated depreciation and amortization, were comprised of the following at December 31, 2006 and 2005:
Depreciation and amortization expense for the years ended December 31, 2006, 2005 and 2004 was $18.9 million, $17.4 million and $18.6 million, respectively.
First Banks leases land, office properties and equipment under operating leases. Certain of the leases contain renewal options and escalation clauses. Total rent expense was $18.0 million, $15.5 million and $13.2 million for the years ended December 31, 2006, 2005 and 2004, respectively. Future minimum lease payments under noncancellable operating leases extend through 2084 as follows:
First Banks also leases to unrelated parties a portion of its banking facilities. Rental income associated with these leases was $5.9 million, $6.4 million and $5.8 million for the years ended December 31, 2006, 2005 and 2004, respectively.
(8) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets, net of amortization, were comprised of the following at December 31, 2006 and 2005:
Amortization of intangible assets was $8.2 million, $4.9 million and $2.9 million for the years ended December 31, 2006, 2005 and 2004, respectively. As of December 31, 2006, the remaining estimated life of the amortization period for core deposit intangibles, customer list intangibles and goodwill associated with P&A Transactions was six years, 16 years and eight years, respectively. Amortization of intangible assets, including amortization of core deposit intangibles, customer list intangibles and goodwill associated with P&A Transactions, has been estimated in the following table, and does not take into consideration any potential future acquisitions or branch office purchases.
Changes in the carrying amount of goodwill for the years ended December 31, 2006 and 2005 were as follows:
(9) MATURITIES OF TIME DEPOSITS
A summary of maturities of time deposits of $100,000 or more and other time deposits as of December 31, 2006 is as follows:
(10) OTHER BORROWINGS
Other borrowings were comprised of the following at December 31, 2006 and 2005:
The average balance of other borrowings was $380.5 million and $571.7 million, respectively, and the maximum month-end balance of other borrowings was $535.7 million and $604.3 million, respectively, for the years ended December 31, 2006 and 2005. The average rates paid on other borrowings during the years ended December 31, 2006, 2005 and 2004 were 4.42%, 3.19% and 1.26%, respectively. Interest expense on securities sold under agreements to repurchase was $16.1 million, $16.5 million and $5.4 million for the years ended December 31, 2006, 2005 and 2004, respectively. Interest expense on FHLB advances was $689,000, $1.6 million and $716,000 for the years ended December 31, 2006, 2005 and 2004, respectively. The assets underlying the daily securities sold under agreements to repurchase and the FHLB advances are held by First Banks. The underlying securities associated with the term repurchase agreements are mortgage-backed securities and callable U.S. Government agency securities and are held by other financial institutions under safekeeping agreements. As further described in Note 5 to the Consolidated Financial Statements, the interest rate floor agreements included within the term repurchase agreements (and the interest rate cap agreements previously included within the term repurchase agreements) represent embedded derivative instruments. In accordance with the Company's interest rate risk management program, First Bank modified its term repurchase agreements under master repurchase agreements with unaffiliated third parties in March 2005 to terminate the interest rate cap agreements previously embedded within the agreements and simultaneously enter into interest rate floor agreements, also embedded within the agreements. These modifications resulted in adjustments to the existing interest rate spread to LIBOR for the underlying agreements, as set forth in the following table. The modified terms of the agreements became effective during the second quarter of 2005. First Bank did not incur any costs associated with the modifications of the agreements nor did the modifications result in a change to the accounting treatment of the embedded derivative instruments.
The maturity dates, par amounts, interest rate spreads and interest rate floor strike prices on First Bank's term repurchase agreements as of December 31, 2006 and 2005 were as follows:
(11) NOTES PAYABLE
On August 10, 2006, First Banks entered into a First Amendment to its Amended and Restated Secured Credit Agreement with a group of unaffiliated financial institutions (Amended Credit Agreement). The Amended Credit Agreement, in the amount of $96.0 million, amended the previous Amended and Restated Secured Credit Agreement dated August 11, 2005 in the amount of $122.5 million that provided a $15.0 million senior secured revolving credit facility, a $7.5 million senior secured standby letter of credit facility and a $100.0 million senior secured term loan facility (Term Loan) (collectively, the Credit Agreements). The primary changes to the structure of the financing arrangement relate to a reduction of certain components of the secured credit facilities, a reduction in the overall pricing structure of the secured credit facilities, and the renewal of the revolving credit and letter of credit facilities. The Amended Credit Agreement provides a $10.0 million senior secured revolving credit facility (Revolving Credit) that matures on August 9, 2007 and a $1.0 million senior secured standby letter of credit facility (LC Facility) that matures on August 9, 2007, in addition to the existing Term Loan that matures on August 10, 2008 and had a balance of $85.0 million at the time of the amendment. The Amended Credit Agreement also provides First Banks an option to increase the Revolving Credit, which is limited to two increase requests from August 10, 2006 until its maturity date, by an amount of up to $40.0 million provided such increase will not cause the Revolving Credit to exceed $50.0 million. Interest is payable on the outstanding principal loan balances under the Revolving Credit at a floating rate equal to either the lender's prime rate or, at First Banks' option, LIBOR plus a margin determined by the outstanding loan balances and First Banks' net income for the preceding four calendar quarters. If the loan balances outstanding under the Revolving Credit are accruing at the prime rate,
interest is payable quarterly in arrears. If the loan balances outstanding under the Revolving Credit are accruing at LIBOR, interest is payable based on the one, two, three or six-month LIBOR, as selected by First Banks. First Banks is also subject to a quarterly commitment fee on the unused portion of the Revolving Credit. First Banks had not drawn any advances on the Revolving Credit as of December 31, 2006. First Banks borrowed $80.0 million on the Term Loan in August 2005 and borrowed the remaining $20.0 million in November 2005. Interest is payable on the outstanding principal loan balance of the Term Loan at a floating rate equal to LIBOR plus a margin determined by the outstanding loan balance and First Banks' net income for the preceding four calendar quarters. The outstanding principal balance of the Term Loan is payable in quarterly installments of $5.0 million, at a minimum, with the remainder of the Term Loan balance to be repaid in full, including any unpaid interest, upon its maturity date. As of December 31, 2006, First Banks had made payments of $35.0 million on the outstanding principal balance of the Term Loan, reducing the balance from $100.0 million at December 31, 2005 to $65.0 million at December 31, 2006. The interest rate for outstanding borrowings under the Credit Agreements at December 31, 2006 and 2005 was 6.25% and 5.38%, respectively. Letters of credit issued to unaffiliated third parties on behalf of First Banks under the Credit Agreements were $450,000 and $2.9 million at December 31, 2006 and 2005, respectively, and had not been drawn on by the counterparties.
The Amended Credit Agreement requires maintenance of certain minimum capital ratios for First Banks and First Bank, certain maximum nonperforming assets ratios for First Bank and a minimum return on assets ratio for First Banks. In addition, it contains additional covenants, including a limitation on the amount of dividends on First Banks' common stock that may be paid to stockholders. The Amended Credit Agreement is secured by First Banks' ownership interest in the capital stock of SFC and First Bank. First Banks and First Bank were in compliance with all restrictions and requirements of the Credit Agreements at December 31, 2006 and 2005.
The average balance and maximum month-end balance of borrowings outstanding under the Credit Agreements during the years ended December 31, 2006 and 2005 were as follows:
The average rates paid on the outstanding borrowings during the years ended December 31, 2006, 2005 and 2004 were 6.22%, 6.26% and 13.84%, respectively. Interest expense recognized on borrowings under the Amended Credit Agreement includes commitment, arrangement and renewal fees. During 2004, the average rate paid on the outstanding borrowings reflects a marginal increased level of commitment, arrangement and renewal fees on a much smaller base of borrowings outstanding during the year, thereby causing the average rate paid to be significantly higher than in 2006 and 2005.
(12) SUBORDINATED DEBENTURES
First Banks has formed various affiliated Delaware or Connecticut statutory and business trusts (collectively, the Trusts) that were created for the sole purpose of issuing trust preferred securities. The trust preferred securities were issued in private placements, with the exception of First Preferred Capital Trust II, First Preferred Capital Trust III and First Preferred Capital Trust IV, which were issued in underwritten public offerings. First Banks owns all of the common securities of the Trusts. The gross proceeds of the offerings were used by the Trusts to purchase fixed rate or variable rate subordinated debentures from First Banks. The subordinated debentures are the sole asset of the Trusts.
A summary of the subordinated debentures issued to the Trusts in conjunction with the trust preferred securities offerings at December 31, 2006 and 2005 were as follows:
In connection with the issuance of the trust preferred securities, First Banks made certain guarantees and commitments that, in the aggregate, constitute a full and unconditional guarantee by First Banks of the obligations of the Trusts under the trust preferred securities. First Banks' distributions accrued on the subordinated debentures were $22.4 million, $20.9 million and $19.0 million for the years ended December 31, 2006, 2005 and 2004, respectively. The distributions payable on all of First Banks' subordinated debentures are included in interest expense in the consolidated statements of income. Deferred issuance costs associated with First Banks' subordinated debentures are included as a reduction of subordinated debentures in the consolidated balance sheets and are amortized on a straight-line basis.
Subsequent to December 31, 2006, First Banks, through a newly formed statutory trust affiliate, issued $25.8 million of subordinated debentures, as more fully described in Note 25 to the Consolidated Financial Statements. The structure of the trust preferred securities currently satisfies the regulatory requirements for inclusion, subject to certain limitations, in First Banks' capital base.
(13) INCOME TAXES
Provision for income taxes attributable to income from continuing operations for the years ended December 31, 2006, 2005 and 2004 consists of:
The effective rates of federal income taxes for the years ended December 31, 2006, 2005 and 2004 differ from the federal statutory rates of taxation as follows:
The $4.2 million, $2.1 million and $2.8 million reductions in the prior year contingency reserve, reflected in 2006, 2005 and 2004, respectively, resulted from reversals of federal and state tax reserves no longer deemed necessary.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2006 and 2005 were as follows:
The realization of First Banks' net deferred tax assets is based on the availability of carrybacks to prior taxable periods, the expectation of future taxable income and the utilization of tax planning strategies. Based on these factors, management believes it is more likely than not that First Banks will realize the recognized net deferred tax assets of $57.5 million at December 31, 2006.
Changes in the deferred tax asset valuation allowance for the years ended December 31, 2006, 2005 and 2004 were as follows:
Upon completion of the acquisition of CIB Bank, the net deferred tax assets associated with the acquisition were evaluated to determine whether it is more likely than not that the net deferred tax assets will be recognized in the future. The ability to utilize the net deferred tax assets recorded in connection with the acquisition is subject to a number of limitations. Among these limitations is the restriction that any built-in loss (the fair value was less than the tax basis) that existed at the date of acquisition, if realized within the first five years subsequent to the date of acquisition, will be deferred and must be carried forward and subjected to rules similar to the rules for carrying forward net operating losses. Based upon these factors, management determined that a valuation allowance should be established for CIB Bank in the amount of $21.4 million. Subsequent reductions in the valuation allowance will be credited to goodwill.
At December 31, 2006 and 2005, the accumulation of prior years' earnings representing tax bad debt deductions was approximately $29.8 million. If these tax bad debt reserves were charged for losses other than bad debt losses, First Banks would be required to recognize taxable income in the amount of the charge. It is not contemplated that such tax-restricted retained earnings will be used in a manner that would create federal income tax liabilities.
At December 31, 2006 and 2005, for federal income taxes purposes, First Banks had net operating loss carryforwards relating to pre-acquisition tax losses of acquired entities of approximately $75.0 million and $101.5 million, respectively. At December 31, 2006, the net operating loss carryforwards for First Banks expire as follows:
During 2004, First Banks recognized built-in losses associated with the acquisition of CIB Bank. A portion of the realized built-in losses was deferred for 2004 and is required to be carried forward subject to rules similar to the rules for carrying forward net operating losses. Utilization of the realized built-in losses is allowed subsequent to the utilization of any net operating loss carryforwards associated with the acquisition of CIB Bank. Consequently, at December 31, 2006, First Banks had deferred built-in loss carryforwards of approximately $8.0 million. Utilization of the deferred built-in loss carryforwards is allowed beginning in the year 2020, and such losses will expire in the year 2024.
(14) EARNINGS PER COMMON SHARE
The following is a reconciliation of basic and diluted EPS for the years ended December 31, 2006, 2005 and 2004:
(15) CREDIT COMMITMENTS
First Banks is a party to commitments to extend credit and commercial and standby letters of credit in the normal course of business to meet the financing needs of its customers. These instruments involve, in varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The interest rate risk associated with these credit commitments relates primarily to the commitments to originate fixed-rate loans. As more fully described in Note 5 to the Consolidated Financial Statements, the interest rate risk of the commitments to originate fixed-rate loans has been hedged with forward commitments to sell mortgage-backed securities. The credit risk amounts are equal to the contractual amounts, assuming the amounts are fully advanced and the collateral or other security is of no value. First Banks uses the same credit policies in granting commitments and conditional obligations as it does for on-balance sheet items.
Commitments to extend fixed and variable rate credit, and commercial and standby letters of credit at December 31, 2006 and 2005 were as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, equipment, income-producing commercial properties or single family residential properties. In the event of nonperformance, First Banks may obtain and liquidate the collateral to recover amounts paid under its guarantees on these financial instruments.
Commercial and standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Most letters of credit extend for less than one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Upon issuance of the commitments, First Banks typically holds marketable securities, certificates of deposit, inventory, real property or other assets as collateral supporting those commitments for which collateral is deemed necessary. The standby letters of credit at December 31, 2006 expire, at various dates, within 10 years.
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of financial instruments is management's estimate of the values at which the instruments could be exchanged in a transaction between willing parties. These estimates are subjective and may vary significantly from amounts that would be realized in actual transactions. In addition, other significant assets are not considered financial assets including servicing assets, deferred income tax assets, bank premises and equipment and goodwill and other intangible assets. Furthermore, the income taxes that would be incurred if First Banks were to realize any of the unrealized gains or unrealized losses indicated between the estimated fair values and corresponding carrying values could have a significant effect on the fair value estimates and have not been considered in any of the estimates.
The estimated fair value of First Banks' financial instruments at December 31, 2006 and 2005 were as follows:
The following methods and assumptions were used in estimating the fair value of financial instruments:
Cash and cash equivalents and accrued interest receivable: The carrying values reported in the consolidated balance sheets approximate fair value.
Investment securities: The fair value of trading and available-for-sale investment securities is the amount reported in the consolidated balance sheets. The fair value of held-to-maturity investment securities is based on quoted market prices where available. If quoted market prices were not available, the fair value was based on quoted market prices of comparable instruments.
Net loans: The fair value of most loans held for portfolio was estimated utilizing discounted cash flow calculations that applied interest rates currently being offered for similar loans to borrowers with similar risk profiles. The fair value of loans held for sale, which is the amount reported in the consolidated balance sheets, is based on quoted market prices where available. If quoted market prices were not available, the fair value was based on quoted market prices of comparable instruments. The carrying value of loans is net of the allowance for loan losses and unearned discount.
Derivative instruments and bank-owned life insurance: The fair value of derivative instruments, including cash flow hedges, fair value hedges, interest rate floor and cap agreements, and interest rate lock commitments, and bank-owned life insurance is based on quoted market prices where available. If quoted market prices were not available, the fair value was based on quoted market prices of comparable instruments.
Forward commitments to sell mortgage-backed securities: The fair value of forward commitments to sell mortgage-backed securities is based on quoted market prices. The fair value of these commitments has been reflected in the consolidated balance sheets in the carrying value of the loans held for sale portfolio.
Deposits: The fair value of deposits generally payable on demand (i.e., noninterest-bearing and interest-bearing demand and savings accounts) is considered equal to their respective carrying amounts as reported in the consolidated balance sheets. The fair value of demand deposits does not include the benefit that results from the low-cost funding provided by deposit
liabilities compared to the cost of borrowing funds in the market. The fair value disclosed for time deposits was estimated utilizing a discounted cash flow calculation that applied interest rates currently being offered on similar deposits to a schedule of aggregated monthly maturities of time deposits. If the estimated fair value is lower than the carrying value, the carrying value is reported as the fair value of time deposits.
Other borrowings, notes payable and accrued interest payable: The carrying values reported in the consolidated balance sheets approximate fair value.
Subordinated debentures: The fair value is based on quoted market prices.
Off-Balance Sheet Financial Instruments: The fair value of commitments to extend credit, standby letters of credit and financial guarantees is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the likelihood of the counterparties drawing on such financial instruments and the credit worthiness of the counterparties. These fees in aggregate are not considered material, and as such, were not assigned a value for purposes of this disclosure.
(17) EMPLOYEE BENEFITS
First Banks' 401(k) plan is a self-administered savings and incentive plan covering substantially all employees. Employer match contributions are determined annually under the plan by First Banks' Board of Directors. Employee contributions were limited to $15,000 of gross compensation for 2006. Total employer contributions under the plan were $3.9 million, $2.4 million and $2.1 million for the years ended December 31, 2006, 2005 and 2004, respectively. The plan assets are held and managed under a trust agreement with First Bank's trust department.
First Banks' nonqualified deferred compensation plan, which covers a select group of employees, is administered by an independent third party. The plan is exempt from the participation, vesting, funding and fiduciary requirements of the Employee Retirement Income Security Act of 1974. Participants may contribute from 1% to 25% of their salary and up to 100% of their bonuses on a pre-tax basis. Balances outstanding under the plan, which are reflected in accrued and other liabilities in the consolidated balance sheets, were $8.1 million and $6.2 million at December 31, 2006 and 2005, respectively. Plan expense recorded under the plan, which is reflected in salaries and employee benefits expense in the consolidated statements of income, was $845,000, $592,000 and $450,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
(18) STOCKHOLDERS' EQUITY
First Banks has two classes of preferred stock outstanding. The Class A preferred stock is convertible into shares of common stock at a rate based on the ratio of the par value of the preferred stock to the current market value of the common stock at the date of conversion, to be determined by independent appraisal at the time of conversion. Shares of Class A preferred stock may be redeemed by First Banks at any time at 105.0% of par value. The Class B preferred stock may not be redeemed or converted. The redemption of any issue of preferred stock requires the prior approval of the Board of Governors of the Federal Reserve System (Federal Reserve). The holders of the Class A and Class B preferred stock have full voting rights. Dividends on the Class A and Class B preferred stock are adjustable quarterly based on the highest of the Treasury Bill Rate or the Ten Year Constant Maturity Rate for the two-week period immediately preceding the beginning of the quarter. This rate shall not be less than 6.0% nor more than 12.0% on the Class A preferred stock, or less than 7.0% nor more than 15.0% on the Class B preferred stock. The annual dividend rates for the Class A and Class B preferred stock were 6.0% and 7.0%, respectively, for the years ended December 31, 2006, 2005 and 2004.
Other comprehensive income (loss) of $6.8 million, ($18.1) million and ($31.0) million, as presented in the accompanying Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income, is reflected net of income tax expense (benefit) of $3.7 million, ($9.7) million and ($16.7) million at December 31, 2006, 2005 and 2004, respectively.
In December 2006, First Banks recorded an increase in additional paid-in capital of $3.8 million which related to the utilization of net operating losses that were acquired with the acquisition of First Banks America, Inc. (FBA) and its wholly-owned subsidiary BankTEXAS N.A., in 1994. Effective December 1994, the FBA Board of Directors approved the implementation of a
quasi-reorganization. In accordance with the provisions of SFAS No. 109 and under the requirements for completing the quasi-reorganization, tax benefits for deductible temporary differences and net operating loss carryforwards that existed at the date of the quasi-reorganization and are subsequently recognized are generally reported as a direct addition to contributed capital.
(19) TRANSACTIONS WITH RELATED PARTIES
Outside of normal customer relationships, no directors or officers of First Banks, no shareholders holding over 5% of First Banks' voting securities and no corporations or firms with which such persons or entities are associated currently maintain or have maintained, since the beginning of the last full fiscal year, any significant business or personal relationships with First Banks or its subsidiaries, other than that which arises by virtue of such position or ownership interest in First Banks or its subsidiaries, except as described in the following paragraphs.
First Services, L.P., a limited partnership indirectly owned by First Banks' Chairman and members of his immediate family, provides information technology, item processing and various related services to First Banks, Inc. and its subsidiaries. Fees paid under agreements with First Services, L.P. were $30.6 million, $29.6 million and $26.6 million for the years ended December 31, 2006, 2005 and 2004, respectively. First Services, L.P. leases information technology and other equipment from First Bank. During 2006, 2005 and 2004, First Services, L.P. paid First Bank $4.2 million, $4.3 million and $4.3 million, respectively, in rental fees for the use of that equipment.
First Brokerage America, L.L.C., a limited liability company indirectly owned by First Banks' Chairman and members of his immediate family, received approximately $3.0 million, $2.6 million and $3.3 million for the years ended December 31, 2006, 2005 and 2004, respectively, in gross commissions paid by unaffiliated third-party companies. The commissions received were primarily in connection with the sales of annuities, securities and other insurance products to customers of First Bank.
First Title Guaranty LLC D/B/A First Banc Insurors (First Title), a limited liability company owned by First Banks' Chairman and members of his immediate family, received approximately $221,000, $379,000 and $514,000 for the years ended December 31, 2006, 2005 and 2004, respectively, in commissions for insurance policies purchased by First Banks or customers of First Bank from unaffiliated third-party insurers. The insurance premiums on which these commissions were earned were competitively bid, and First Banks deems the commissions First Title earned from unaffiliated third-party companies to be comparable to those that would have been earned by an unaffiliated third-party agent.
On May 31, 2006, Adrian Baker, a newly acquired subsidiary of First Bank, purchased the personal and commercial insurance book of business from First Title. First Bank engaged an independent third party to perform a business valuation of the personal and commercial insurance book of business of First Title, which was determined to be approximately $270,000 and is being amortized over seven years utilizing the straight-line method.
During 2006, First Bank contributed $5.0 million in cash to the Dierberg Operating Foundation, Inc., a charitable foundation established by First Banks' Chairman and members of his immediate family. In addition, on November 15, 2006, First Banks contributed 26,962 shares of common stock held in its available-for-sale investment securities portfolio with a fair value of $1.0 million to the Dierberg Operating Foundation, Inc. In conjunction with this transaction, First Banks recorded charitable contribution expense of $1.0 million, which was partially offset by a gain on the contribution of these available-for-sale investment securities of $121,000, representing the difference between the cost basis and the fair value of the common stock on the date of the contribution. In addition, First Banks recognized a tax benefit of $522,000 associated with this transaction. During 2005, First Bank contributed $2.5 million in cash to The Dierberg Foundation, a charitable foundation established by First Banks' Chairman and members of his immediate family, and $1.5 million in cash to the Dierberg Operating Foundation, Inc. First Banks did not make any charitable contributions to these organizations during 2004.
First Banks periodically purchases various products from Hermannhof, Inc. and Dierberg Star Lane Vineyards, entities that are controlled by First Banks' Chairman and members of his immediate family. First Banks utilizes these products primarily for customer and employee events and promotions, and business development functions. During the years ended December 31, 2006, 2005 and 2004, First Banks purchased products aggregating approximately $376,000, $320,000 and $189,000, respectively, from these entities.
First Bank leases certain of its in-store branch offices and ATM sites from Dierbergs Markets, Inc., a grocery store chain headquartered in St. Louis, Missouri that is owned and operated by the brother of First Banks' Chairman and members of his immediate family. Total rent expense incurred by First Bank under the lease obligation contracts was $385,000, $335,000 and $297,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
In August 2004, First Bank granted to FCA, a corporation owned by First Banks' Chairman and members of his immediate family, a written option to purchase 735 Membership Interests of SBLS LLC, a wholly owned limited liability company of First Bank, at a price of $10,000 per Membership Interest, or $7.4 million in aggregate. The option could have been exercised by FCA at any time prior to its expiration, which was extended to June 30, 2005. On June 30, 2005, FCA exercised this option and paid $7.4 million in cash. Consequently, SBLS LLC became 51.0% owned by First Bank and 49.0% owned by FCA as of June 30, 2005.
In June 2005, SBLS LLC executed a Multi-Party Agreement by and among SBLS LLC, First Bank, Colson Services Corp., fiscal transfer agent for the SBA, and the SBA, in addition to a Loan and Security Agreement by and among First Bank and the SBA (collectively, the Agreement) that provides a $50.0 million warehouse line of credit for loan funding purposes. The Agreement provided for an initial maturity date of June 30, 2008, which was extended on June 15, 2006 by First Bank to June 30, 2009. Interest is payable monthly, in arrears, on the outstanding loan balances at a rate equal to First Bank's prime lending rate minus 50 basis points. Advances under the Agreement are secured by the assignment of the majority of the assets of SBLS LLC. The balance of advances outstanding under this line of credit was $47.5 million and $31.4 million at December 31, 2006 and 2005, respectively. Interest expense recorded under the Agreement by SBLS LLC was $3.0 million and $1.9 million for the years ended December 31, 2006 and 2005, respectively. The balance of the advances under the Agreement and the related interest expense recognized by SBLS LLC are fully eliminated for purposes of the Consolidated Financial Statements.
First Bank has had in the past, and may have in the future, loan transactions in the ordinary course of business with its directors and/or their affiliates. These loan transactions have been made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated persons and did not involve more than the normal risk of collectibility or present other unfavorable features. Loans to directors, their affiliates and executive officers of First Banks, Inc. were approximately $55.9 million and $37.9 million at December 31, 2006 and 2005, respectively. First Bank does not extend credit to its officers or to officers of First Banks, Inc., except extensions of credit secured by mortgages on personal residences, loans to purchase automobiles, personal credit card accounts and deposit account overdraft protection under a plan whereby a credit limit has been established in accordance with First Bank's standard credit criteria.
In August 2005, First Bank entered into a contract with World Wide Technology, Inc. (WWT), a wholly owned subsidiary of World Wide Technology Holding Co., Inc. (WWTHC). WWTHC is an electronic procurement and logistics company in the information technology industry headquartered in St. Louis, Missouri. The contract provided for WWT to provide information technology services associated with the initial phase of the upgrade of personal computers to First Bank employees in an ongoing effort to further standardize the technological infrastructure throughout the First Bank branch banking network. Mr. David L. Steward, a director of First Banks and a member of the Audit Committee of First Banks, serves as the Chairman of the Board of Directors of WWTHC. Prior to entering into this contract, the Audit Committee of First Banks reviewed and approved the utilization of WWT for information technology services for this phase of the project with fees not to exceed $500,000. First Bank made payments of $7,000 and $471,000 under the contract for the first phase of the project for the years ended December 31, 2006 and 2005, respectively. During 2006, First Bank evaluated the second phase of its corporate-wide personal computer upgrade project and entered into a contract with WWT on August 21, 2006 for additional information technology services. Prior to entering into this contract, the Audit Committee of First Banks reviewed and approved the utilization of WWT for this phase of the project with fees not to exceed $500,000. First Bank made payments of $367,000 under the contract for the second phase of the project for the year ended December 31, 2006.
(20) BUSINESS SEGMENT RESULTS
First Banks' business segment is First Bank. The reportable business segment is consistent with the management structure of First Banks, First Bank and the internal reporting system that monitors performance. First Bank provides similar products and services in its defined geographic areas through its branch network. The products and services offered include a broad range of commercial and personal deposit products, including demand, savings, money market and time deposit accounts. In addition, First Bank markets combined basic services for various customer groups, including packaged accounts for more affluent customers, and sweep accounts, lock-box deposits and cash management products for commercial customers. First Bank also offers both consumer and commercial loans. Consumer lending includes residential real estate, home equity and installment lending. Commercial lending includes commercial, financial and agricultural loans, real estate construction and development loans, commercial
real estate loans, asset-based loans, trade financing and insurance premium financing. Other financial services include mortgage banking, debit cards, brokerage services, employee benefit and commercial and personal insurance services, internet banking, automated teller machines, telephone banking, safe deposit boxes and trust, private banking and institutional money management services. The revenues generated by First Bank and its subsidiaries consist primarily of interest income, generated from the loan and investment security portfolios, service charges and fees generated from the deposit products and services, and fees generated by our mortgage banking, insurance services, and trust, private banking and institutional money management services businesses. The geographic areas include eastern Missouri, Illinois, including Chicago, southern and northern California, and Houston and Dallas, Texas. The products and services are offered to customers primarily within First Banks' respective geographic areas.
The business segment results are consistent with First Banks' internal reporting system and, in all material respects, with U.S. generally accepted accounting principles and practices predominant in the banking industry. Such principles and practices are summarized in Note 1 to the Consolidated Financial Statements. The business segment results are summarized as follows:
(21) REGULATORY CAPITAL
First Banks and First Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on First Banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, First Banks and First Bank must meet specific capital guidelines that involve
quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require First Banks and First Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of December 31, 2006 and 2005, First Banks and First Bank were each well capitalized. As of December 31, 2006, the most recent notification from First Banks' primary regulator categorized First Banks and First Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, First Banks and First Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table.
At December 31, 2006 and 2005, First Banks' and First Bank's required and actual capital ratios were as follows:
In March 2005, the Federal Reserve adopted a final rule, Risk-Based Capital Standards: Trust Preferred Securities and the Definition of Capital, which allows for the continued limited inclusion of trust preferred securities in Tier 1 capital. The Federal Reserve's final rule limits restricted core capital elements to 25% of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability. Amounts of restricted core capital elements in excess of these limits may generally be included in Tier 2 capital. Specifically, amounts of qualifying trust preferred securities and cumulative perpetual preferred stock in excess of the 25% limit may be included in Tier 2 capital, but will be limited, together with subordinated debt and limited-life preferred stock, to 50% of Tier 1 capital. In addition, the final rule provides that in the last five years before the maturity of the underlying subordinated note, the outstanding amount of the associated trust preferred securities is to be excluded from Tier 1 capital and included in Tier 2 capital, subject to one-fifth amortization per year. The final rule provides for a five-year transition period, ending March 31, 2009, for the application of the quantitative limits. Until March 31, 2009, the aggregate amount of qualifying cumulative perpetual preferred stock and qualifying trust preferred securities that may be included in Tier 1 capital is limited to 25% of the sum of the following core capital elements: qualifying common stockholders' equity, qualifying noncumulative and cumulative perpetual preferred stock, qualifying minority interest in the equity accounts of consolidated subsidiaries and qualifying trust preferred securities. First Banks has evaluated the impact of the final rule on the Company's financial condition and results of operations, and determined the implementation of the Federal Reserve's final rules that will be effective in March 2009 would reduce First Banks' Tier 1 capital (to risk-weighted assets) and Tier 1 capital (to average assets) to 7.86% and 7.34%, respectively, and would not have an impact on total capital (to risk-weighted assets), as of December 31, 2006.
(22) DISTRIBUTION OF EARNINGS OF FIRST BANK
First Bank is restricted by various state and federal regulations as to the amount of dividends that are available for payment to First Banks, Inc. Under the most restrictive of these requirements, the future payment of dividends from First Bank is limited to approximately $135.0 million at December 31, 2006, unless prior permission of the regulatory authorities is obtained.
(23) PARENT COMPANY ONLY FINANCIAL INFORMATION
Following are condensed balance sheets of First Banks, Inc. as of December 31, 2006 and 2005, and condensed statements of income and cash flows for the years ended December 31, 2006, 2005 and 2004:
(24) CONTINGENT LIABILITIES
In October 2000, First Banks entered into two continuing guaranty contracts. For value received, and for the purpose of inducing a pension fund and its trustees and a welfare fund and its trustees (the Funds) to conduct business with MVP, First Bank's institutional investment management subsidiary, First Banks irrevocably and unconditionally guaranteed payment of and promised to pay to each of the Funds any amounts up to the sum of $5.0 million to the extent MVP is liable to the Funds for a breach of the Investment Management Agreements (including the Investment Policy Statement and Investment Guidelines), by and between MVP and the Funds and/or any violation of the Employee Retirement Income Security Act by MVP resulting in liability to the Funds. The guaranties are continuing guaranties of all obligations that may arise for transactions occurring prior to termination of the Investment Management Agreements and are coexistent with the term of the Investment Management Agreements. The Investment Management Agreements have no specified term but may be terminated at any time upon written notice by the Trustees or, at First Banks' option, upon thirty days written notice to the Trustees. In the event of termination of the Investment Management Agreements, such termination shall have no effect on the liability of First Banks with respect to obligations incurred before such termination. The obligations of First Banks are joint and several with those of MVP. First Banks does not have any recourse provisions that would enable it to recover from third parties any amounts paid under the contracts nor does First Banks hold any assets as collateral that, upon occurrence of a required payment under the contract, could be liquidated to recover all or a portion of the amount(s) paid. At December 31, 2006, First Banks had not recorded a liability for the obligations associated with these guaranty contracts as the likelihood that First Banks will be required to make payments under the contracts is remote.
In August 2004, SBLS LLC acquired substantially all of the assets and assumed certain liabilities of SBLS, as further described in Note 2 to the Consolidated Financial Statements. The Amended and Restated Asset Purchase Agreement (Asset Purchase Agreement) governing this transaction provided for certain payments to the seller contingent on future valuations of specifically identified assets, including servicing assets and retained interests in securitizations. SBLS LLC was not required to make any payments to the seller as of September 30, 2006 and September 30, 2005, the first and second measurement dates under the terms of the Asset Purchase Agreement. However, in October 2006, SBLS LLC made a payment of $375,000, as settlement in full of all obligations associated with these contingent payments pursuant to a mutual agreement amongst the parties. As of December 31, 2005, SBLS LLC had not recorded a liability for the obligations associated with these contingent payments, as the likelihood that SBLS LLC would be required to make payments under the Asset Purchase Agreement was not ascertainable at that time.
In the ordinary course of business, First Banks and its subsidiaries become involved in legal proceedings. Management, in consultation with legal counsel, believes the ultimate resolution of these proceedings will not have a material adverse effect on the financial condition or results of operations of First Banks and/or its subsidiaries.
(25) SUBSEQUENT EVENTS (UNAUDITED)
On February 23, 2007, First Bank Statutory Trust VIII (FBST VIII), a newly formed Delaware statutory trust, issued 25,000 variable rate trust preferred securities at $1,000 per security in a private placement, and issued 774 common securities to First Banks at $1,000 per security. First Banks owns all of the common securities of FBST VIII. The gross proceeds of the offering were used by FBST VIII to purchase $25.8 million of variable rate subordinated debentures from First Banks, maturing on March 30, 2037. The maturity date of the subordinated debentures may be shortened, at the option of First Banks, to a date not earlier than March 30, 2012, if certain conditions are met. The subordinated debentures are the sole asset of FBST VIII. In connection with the issuance of the FBST VIII preferred securities, First Banks made certain guarantees and commitments that, in the aggregate, constitute a full and unconditional guarantee by First Banks of the obligations of FBST VIII under the FBST VIII preferred securities. Proceeds from the issuance of the subordinated debentures to FBST VIII, net of offering expenses, were $25.8 million. The distribution rate on the FBST VIII preferred securities is equivalent to the three-month LIBOR plus 161.0 basis points, and is payable quarterly in arrears beginning March 30, 2007.
On February 28, 2007, First Banks completed its acquisition of Royal Oaks, located in Houston, Texas, for $38.6 million in cash. The acquisition served to expand First Banks' banking franchise in Houston, Texas. The transaction was funded through internally generated funds and the issuance of the FBST VIII trust preferred securities. At the time of the acquisition, Royal Oaks had assets of $206.9 million, loans, net of unearned discount, of $175.5 million, deposits of $159.1 million and stockholders' equity of $9.6 million. The assets acquired and liabilities assumed were recorded at their estimated fair value on the acquisition date. The fair value adjustments represent current estimates and are subject to further adjustment as the valuation data is finalized. Preliminary goodwill, which is not deductible for tax purposes, was approximately $29.0 million. Royal Oaks was merged with and into First Bank at the time of the acquisition.
FIRST BANKS, INC.
INVESTOR INFORMATION - --------------------------------------------------------------------------------
FIRST BANKS, INC. PREFERRED SECURITIES - --------------------------------------
The preferred securities of First Preferred Capital Trust IV are traded on the New York Stock Exchange with the ticker symbol "FBSPrA." The preferred securities of First Preferred Capital Trust IV are represented by a global security that has been deposited with and registered in the name of The Depository Trust Company, New York, New York (DTC). The beneficial ownership interests of these preferred securities are recorded through the DTC book-entry system. The high and low preferred securities prices and the dividends declared for 2006 and 2005 are summarized as follows:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FIRST BANKS, INC.
By: /s/ Allen H. Blake ----------------------------------------- Allen H. Blake President and Chief Executive Officer (Principal Executive Officer)
By: /s/ Steven F. Schepman ---------------------------------------- Steven F. Schepman Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)
INDEX TO EXHIBITS
Exhibit Number Description ------ -----------
2.1 Stock Purchase Agreement by and among First Banks, Inc., The San Francisco Company, CIB Marine Bancshares, Inc., Hillside Investors, Ltd., and CIB Bank, dated August 12, 2004 (incorporated herein by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K dated August 12, 2004).
3.1 Restated Articles of Incorporation of the Company, as amended (incorporated herein by reference to Exhibit 3(i) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).
3.2 By-Laws of the Company (incorporated herein by reference to Exhibit 3.2 to Amendment No. 2 to the Company's Registration Statement on Form S-1, File No. 33-50576, dated September 15, 1992).
4.1 Agreement as to Expenses and Liabilities between First Banks, Inc. and First Preferred Capital Trust IV, dated April 1, 2003 (relating to First Preferred Capital Trust IV ("First Preferred IV")) (incorporated herein by reference to Exhibit 10.20 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).
4.2 Preferred Securities Guarantee Agreement by and between First Banks, Inc. and Fifth Third Bank, dated April 1, 2003 (relating to First Preferred IV) (incorporated herein by reference to Exhibit 10.21 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).
4.3 Indenture between First Banks, Inc. and Fifth Third Bank, as Trustee, dated April 1, 2003 (relating to First Preferred IV) (incorporated herein by reference to Exhibit 10.22 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).
4.4 Amended and Restated Trust Agreement among First Banks, Inc., as Depositor, Fifth Third Bank, as Property Trustee, Wilmington Trust Company, as Delaware Trustee, and the Administrative Trustees, dated April 1, 2003 (relating to First Preferred IV) (incorporated herein by reference to Exhibit 10.23 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).
4.5 Indenture between First Banks, Inc., as Issuer, and Wilmington Trust Company, as Trustee, dated as of April 10, 2002 (incorporated herein by reference to Exhibit 4.15 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
4.6 Guarantee Agreement for First Bank Capital Trust, dated as of April 10, 2002 (incorporated herein by reference to Exhibit 4.16 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
4.7 Amended and Restated Declaration of Trust of First Bank Capital Trust, dated as of April 10, 2002 (incorporated herein by reference to Exhibit 4.17 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
4.8 Floating Rate Junior Subordinated Debt Security Certificate of First Banks, Inc., dated April 10, 2002 (incorporated herein by reference to Exhibit 4.18 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
4.9 Capital Security Certificate of First Bank Capital Trust, dated as of April 10, 2002 (incorporated herein by reference to Exhibit 4.19 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
4.10 Indenture between First Banks, Inc., as Issuer, and U.S. Bank National Association, as Trustee, dated as of March 20, 2003 (incorporated herein by reference to Exhibit 10.6 to Amendment No. 4 to the Company's Registration Statement on Form S-2, File No. 333-102549, dated March 24, 2003).
4.11 Amended and Restated Declaration of Trust by and among U.S. Bank National Association, as Institutional Trustee, First Banks, Inc., as Sponsor, and Allen H. Blake, Terrance M. McCarthy and Lisa K. Vansickle, as Administrators, dated as of March 20, 2003 (incorporated herein by reference to Exhibit 10.7 to Amendment No. 4 to the Company's Registration Statement on Form S-2, File No. 333-102549, dated March 24, 2003).
4.12 Guarantee Agreement by and between First Banks, Inc. and U.S. Bank National Association, dated as of March 20, 2003 (incorporated herein by reference to Exhibit 10.8 to Amendment No. 4 to the Company's Registration Statement on Form S-2, File No. 333-102549, dated March 24, 2003).
4.13 Placement Agreement by and among First Banks, Inc., First Bank Statutory Trust and SunTrust Capital Markets, Inc., dated as of March 20, 2003 (incorporated herein by reference to Exhibit 10.9 to Amendment No. 4 to the Company's Registration Statement on Form S-2, File No. 333-102549, dated March 24, 2003).
4.14 Junior Subordinated Debenture of First Banks, Inc., dated as of March 20, 2003 (incorporated herein by reference to Exhibit 10.10 to Amendment No. 4 to the Company's Registration Statement on Form S-2, File No. 333-102549, dated March 24, 2003).
4.15 Capital Securities Subscription Agreement by and among First Bank Statutory Trust, First Banks, Inc. and STI Investment Management, Inc., dated as of March 20, 2003 (incorporated herein by reference to Exhibit 10.11 to Amendment No. 4 to the Company's Registration Statement on Form S-2, File No. 333-102549, dated March 24, 2003).
4.16 Common Securities Subscription Agreement by and between First Bank Statutory Trust and First Banks, Inc., dated as of March 20, 2003 (incorporated herein by reference to Exhibit 10.12 to Amendment No. 4 to the Company's Registration Statement on Form S-2, File No. 333-102549, dated March 24, 2003).
4.17 Debenture Subscription Agreement by and between First Banks, Inc. and First Bank Statutory Trust, dated as of March 20, 2003 (incorporated herein by reference to Exhibit 10.13 to Amendment No. 4 to the Company's Registration Statement on Form S-2, File No. 333-102549, dated March 24, 2003).
4.18 Indenture between First Banks, Inc., as Issuer, and Wilmington Trust Company, as Trustee, dated as of September 20, 2004 (incorporated herein by reference to Exhibit 4.26 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.19 Amended and Restated Declaration of Trust by and among Wilmington Trust Company, as Delaware Trustee and the Institutional Trustee, First Banks, Inc., as Sponsor, and Allen H. Blake, Terrance M. McCarthy and Lisa K. Vansickle, as Administrators, dated as of September 20, 2004 (incorporated herein by reference to Exhibit 4.27 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.20 Guarantee Agreement by and between First Banks, Inc. and Wilmington Trust Company, dated as of September 20, 2004 (incorporated herein by reference to Exhibit 4.28 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.21 Placement Agreement by and among First Banks, Inc., First Bank Statutory Trust II and FTN Financial Capital Markets and Keefe, Bruyette & Woods, as Placement Agents, dated as of September 10, 2004 (incorporated herein by reference to Exhibit 4.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.22 Floating Rate Junior Subordinated Deferrable Interest Debenture of First Banks, Inc., dated as of September 20, 2004 (incorporated herein by reference to Exhibit 4.30 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.23 Capital Securities Subscription Agreement by and among First Bank Statutory Trust II, First Banks, Inc. and First Tennessee Bank National Association, dated as of September 20, 2004 (incorporated herein by reference to Exhibit 4.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.24 Capital Securities Subscription Agreement by and between First Bank Statutory Trust II, First Banks, Inc. and Preferred Term Securities XV, Ltd., dated as of September 20, 2004 (incorporated herein by reference to Exhibit 4.32 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.25 Capital Securities Certificate P-1 of First Bank Statutory Trust II, dated September 20, 2004 (incorporated herein by reference to Exhibit 4.33 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.26 Capital Securities Certificate P-2 of First Bank Statutory Trust II, dated September 20, 2004 (incorporated herein by reference to Exhibit 4.34 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.27 Indenture between First Banks, Inc., as Issuer, and Wilmington Trust Company, as Trustee, dated as of November 23, 2004 (incorporated herein by reference to Exhibit 4.35 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.28 Amended and Restated Declaration of Trust by and among Wilmington Trust Company, as Delaware Trustee and the Institutional Trustee, First Banks, Inc., as Sponsor, and Terrance M. McCarthy, Peter D. Wimmer and Lisa K. Vansickle, as Administrators, dated as of November 23, 2004 (incorporated herein by reference to Exhibit 4.36 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.29 Guarantee Agreement by and between First Banks, Inc. and Wilmington Trust Company, dated as of November 23, 2004 (incorporated herein by reference to Exhibit 4.37 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.30 Placement Agreement by and among First Banks, Inc., First Bank Statutory Trust III and FTN Financial Capital Markets and Keefe, Bruyette & Woods, as Placement Agents, dated as of November 22, 2004 (incorporated herein by reference to Exhibit 4.38 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.31 Floating Rate Junior Subordinated Deferrable Interest Debenture of First Banks, Inc., dated as of November 23, 2004 (incorporated herein by reference to Exhibit 4.39 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.32 Capital Securities Subscription Agreement by and among First Bank Statutory Trust III, First Banks, Inc. and First Tennessee Bank National Association, dated as of November 23, 2004 (incorporated herein by reference to Exhibit 4.40 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.33 Capital Securities Certificate P-1 of First Bank Statutory Trust III, dated November 23, 2004 (incorporated herein by reference to Exhibit 4.41 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
4.34 Indenture between First Banks, Inc., as Issuer, and Wilmington Trust Company, as Trustee, dated as of March 1, 2006 (incorporated herein by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).
4.35 Amended and Restated Declaration of Trust by and among Wilmington Trust Company, as Delaware Trustee and the Institutional Trustee, First Banks, Inc., as Sponsor, and Allen H. Blake, Peter D. Wimmer and Lisa K. Vansickle, as Administrators, dated as of March 1, 2006 (incorporated herein by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).
4.36 Guarantee Agreement by and between First Banks, Inc. and Wilmington Trust Company, dated as of March 1, 2006 (incorporated herein by reference to Exhibit 4.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).
4.37 Placement Agreement by and among First Banks, Inc., First Bank Statutory Trust IV and FTN Financial Capital Markets and Keefe, Bruyette & Woods, as Placement Agents, dated as of February 16, 2006 (incorporated herein by reference to Exhibit 4.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).
4.38 Floating Rate Junior Subordinated Deferrable Interest Debenture of First Banks, Inc., dated as of March 1, 2006 (incorporated herein by reference to Exhibit 4.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).
4.39 Capital Securities Subscription Agreement by and among First Bank Statutory Trust IV, First Banks, Inc. and First Tennessee Bank National Association, dated as of March 1, 2006 (incorporated herein by reference to Exhibit 4.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).
4.40 Capital Securities Subscription Agreement by and among First Bank Statutory Trust IV, First Banks, Inc. and Preferred Term Securities XXI, Ltd., dated as of March 1, 2006 (incorporated herein by reference to Exhibit 4.7 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).
4.41 Capital Securities Certificate P-1 of First Bank Statutory Trust IV, dated March 1, 2006 (incorporated herein by reference to Exhibit 4.8 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).
4.42 Capital Securities Certificate P-2 of First Bank Statutory Trust IV, dated March 1, 2006 (incorporated herein by reference to Exhibit 4.9 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).
4.43 Indenture between First Banks, Inc., as Issuer, and Wilmington Trust Company, as Trustee, dated as of April 28, 2006 (incorporated herein by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.44 Amended and Restated Declaration of Trust of First Bank Statutory Trust V by and among Wilmington Trust Company, as Delaware Trustee and the Institutional Trustee, First Banks, Inc., as Sponsor, and Allen H. Blake, Peter D. Wimmer and Lisa K. Vansickle, as Administrators, dated as of April 28, 2006 (incorporated herein by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.45 Guarantee Agreement by and between First Banks, Inc. and Wilmington Trust Company, dated as of April 28, 2006 (incorporated herein by reference to Exhibit 4.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.46 Placement Agreement by and among First Banks, Inc., First Bank Statutory Trust V and FTN Financial Capital Markets and Keefe, Bruyette & Woods, as Placement Agents, dated as of April 27, 2006 (incorporated herein by reference to Exhibit 4.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.47 Floating Rate Junior Subordinated Deferrable Interest Debenture of First Banks, Inc., dated as of April 28, 2006 (incorporated herein by reference to Exhibit 4.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.48 Capital Securities Subscription Agreement by and among First Bank Statutory Trust V, First Banks, Inc. and First Tennessee Bank National Association, dated as of April 28, 2006 (incorporated herein by reference to Exhibit 4.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.49 Capital Securities Certificate P-1 of First Bank Statutory Trust V, dated as of April 28, 2006 (incorporated herein by reference to Exhibit 4.7 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.50 Indenture between First Banks, Inc., as Issuer, and Wells Fargo Bank, National Association, as Trustee, dated as of June 16, 2006 (incorporated herein by reference to Exhibit 4.8 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.51 Amended and Restated Declaration of Trust of First Bank Statutory Trust VI by and among Wells Fargo Delaware Trust Company, as Delaware Trustee, Wells Fargo Bank, National Association, as Institutional Trustee, First Banks, Inc., as Sponsor, and Allen H. Blake and Lisa K. Vansickle, as Administrators, dated as of June 16, 2006 (incorporated herein by reference to Exhibit 4.9 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.52 Guarantee Agreement by and between First Banks, Inc. and Wells Fargo Bank, National Association, dated as of June 16, 2006 (incorporated herein by reference to Exhibit 4.10 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.53 Purchase Agreement among First Bank Statutory Trust VI, Issuer, First Banks, Inc., Sponsor, and Bear, Stearns & Co. Inc., Initial Purchaser, dated as of June 14, 2006 (incorporated herein by reference to Exhibit 4.11 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.54 Junior Subordinated Debt Security due 2036 of First Banks, Inc., dated as of June 16, 2006 (incorporated herein by reference to Exhibit 4.12 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.55 Debenture Subscription Agreement by and between First Banks, Inc. and First Bank Statutory Trust VI, dated as of June 16, 2006 (incorporated herein by reference to Exhibit 4.13 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.56 Capital Securities Certificate P-001 of First Bank Statutory Trust VI, dated as of June 16, 2006 (incorporated herein by reference to Exhibit 4.14 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
4.57 Indenture between First Banks, Inc., as Issuer, and Wilmington Trust Company, as Trustee, dated as of December 14, 2006 - filed herewith.
4.58 Amended and Restated Declaration of Trust of First Bank Statutory Trust VII by and among Wilmington Trust Company, as Delaware Trustee and the Institutional Trustee, First Banks, Inc., as Sponsor, and Terrance M. McCarthy, Peter D. Wimmer and Lisa K. Vansickle, as Administrators, dated as of December 14, 2006 - filed herewith.
4.59 Guarantee Agreement by and between First Banks, Inc. and Wilmington Trust Company, dated as of December 14, 2006 - filed herewith.
4.60 Placement Agreement by and among First Banks, Inc., First Bank Statutory Trust VII and FTN Financial Capital Markets and Keefe, Bruyette & Woods, as Placement Agents, dated as of December 6, 2006 - filed herewith.
4.61 Floating Rate Junior Subordinated Deferrable Interest Debenture of First Banks, Inc., dated as of December 14, 2006 - filed herewith.
4.62 Capital Securities Subscription Agreement by and among First Bank Statutory Trust VII, First Banks, Inc. and First Tennessee Bank National Association, dated as of December 14, 2006 - filed herewith.
4.63 Capital Securities Subscription Agreement by and among First Bank Statutory Trust VII, First Banks, Inc. and Preferred Term Securities XXIV, Ltd., dated as of December 14, 2006 - filed herewith.
4.64 Capital Securities Certificate P-1 of First Bank Statutory Trust VII, dated as of December 14, 2006 - filed herewith.
4.65 Capital Securities Certificate P-2 of First Bank Statutory Trust VII, dated as of December 14, 2006 - filed herewith.
10.1 Shareholders' Agreement by and among James F. Dierberg II and Mary W. Dierberg, Trustees under the Living Trust of James F. Dierberg II, dated July 24, 1989, Michael James Dierberg and Mary W. Dierberg, Trustees under the Living Trust of Michael James Dierberg, dated July 24, 1989; Ellen C. Dierberg and Mary W. Dierberg, Trustees under the Living Trust of Ellen C. Dierberg dated July 17, 1992, and First Banks, Inc. (incorporated herein by reference to Exhibit 10.3 to the Company's Registration Statement on Form S-1, File No 33-50576, dated August 6, 1992).
10.2 Comprehensive Banking System License and Service Agreement dated as of July 24, 1991, by and between the Company and FiServ CIR, Inc. (incorporated herein by reference to Exhibit 10.4 to the Company's Registration Statement on Form S-1, File No. 33-50576, dated August 6, 1992).
10.3 AFS Customer Agreement by and between First Banks, Inc. and Advanced Financial Solutions, Inc., dated January 29, 2004 (incorporated herein by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004).
10.4 Management Services Agreement by and between First Banks, Inc. and First Bank, dated February 28, 2004 (incorporated herein by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004).
10.5 Service Agreement by and between First Services, L.P. and First Banks, Inc., dated May 1, 2004 (incorporated herein by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).
10.6 Service Agreement by and between First Services, L.P. and First Bank, dated May 1, 2004 (incorporated herein by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).
10.7 Service Agreement by and between First Banks, Inc. and First Services, L.P., dated May 1, 2004 (incorporated herein by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).
10.8* First Banks, Inc. Executive Incentive Compensation Plan (incorporated herein by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
10.9* First Banks, Inc. Nonqualified Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
10.10* First Amendment to First Banks, Inc. Nonqualified Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004).
10.11 Amended and Restated Secured Credit Agreement ($100.0 million Term Loan Facility, $15.0 million Revolving Credit Facility and $7.5 million Letter of Credit Facility), dated as of August 11, 2005, by and among First Banks, Inc. and Wells Fargo Bank, National Association, as Agent, JP Morgan Chase Bank, N.A., LaSalle Bank National Association, The Northern Trust Company, Union Bank of California, N.A., Fifth Third Bank (Chicago) and U.S. Bank National Association (incorporated herein by reference to Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
10.12 First Amendment to the Amended and Restated Secured Credit Agreement ($85.0 million Term Loan Facility, $10.0 million Revolving Credit Facility and $1.0 million Letter of Credit Facility), dated as of August 10, 2006, by and among First Banks, Inc. and Wells Fargo Bank, National Association, as Agent, JP Morgan Chase Bank, N.A., LaSalle Bank National Association, The Northern Trust Company, Union Bank of California, N.A., Fifth Third Bank (Chicago) and U.S. Bank National Association (incorporated herein by reference to Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2006).
14.1 Code of Ethics for Principal Executive Officer and Financial Professionals (incorporated herein by reference to Exhibit 14 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003).
21.1 Subsidiaries of the Company - filed herewith.
31.1 Rule 13a-14(a) / 15d-14(a) Certifications of Chief Executive Officer - filed herewith.
31.2 Rule 13a-14(a) / 15d-14(a) Certifications of Chief Financial Officer - filed herewith.
32.1 Section 1350 Certifications of Chief Executive Officer - filed herewith.
32.2 Section 1350 Certifications of Chief Financial Officer - filed herewith.
* Exhibits designated by an asterisk in the Index to Exhibits relate to management contracts and/or compensatory plans or arrangements.