Item 1. Business
First State Financial Corporation
First State Financial Corporation (the “Company,” “Holding Company,” “we,” “our”) was incorporated under the laws of the State of Florida on August 13, 1997. We are a registered bank holding company under the Bank Holding Company Act of 1956, as amended. Our wholly-owned subsidiary and principal asset is First State Bank (the “Bank”), a state banking association.
The Bank is engaged in community-oriented commercial and retail banking, focusing on the needs of individuals and small- to medium-sized businesses in the West Central region of Florida. Our primary source of earnings is derived from income generated by our ownership and operation of the Bank. Unless the context otherwise requires, references herein to the Company includes the Company and the Bank on a consolidated basis.
The Company is a legal entity separate and distinct from the Bank, and there are various legal limitations on the ability of the Bank to finance or otherwise supply funds to the Company. In particular, under federal banking law, the Bank may not declare a dividend that exceeds undivided profits. In addition, the approval of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and Florida Office of Financial Regulation (“Florida Office”) is required if the total amount of all dividends declared in a calendar year exceeds the Bank’s net profits, as defined, for that year combined with its retained profits for the preceding two years. The Federal Reserve and the Florida Office also have the authority to limit further the payment of dividends by the Bank under certain circumstances.
First State Bank
The Bank is operated as a network of community bank branches, with three branches located in Sarasota County and four branches located in Pinellas County. The Bank primarily focuses on providing personalized banking services to small to medium-sized businesses and individuals within the market areas where our banking offices are located. We believe this local market strategy enables the Bank to attract and retain low cost core deposits, which provide substantially all of the Bank’s funding requirements.
Deposit products include certificates of deposit, checking and other demand deposits, NOW accounts, savings accounts, and money market accounts. The transaction accounts and time certificates are tailored to the principal market areas at rates competitive to those in the area. All deposit accounts are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the maximum limits permitted by law. The Bank also offers ATM cards through membership in the STAR and CIRRUS ATM networks. We believe that by being associated with shared networks of ATMs, we can better serve our customers who are accustomed to the convenience of using ATMs.
Other services offered by the Bank include safe deposit boxes, wire transfers, direct deposit of payroll and social security payments, night depository, travelers’ checks, banking by mail and the internet. The Bank does not presently provide fiduciary or appraisal services.
The Bank conducts commercial and consumer banking business, which primarily consists of attracting deposits from the areas served by it offices and using those deposits, together with funds derived from other sources, to originate a variety of commercial, consumer, and real estate loans, including commercial loans collateralized by real estate.
We consider the general business of retail banking to be our only operating segment.
Note about Forward-Looking Statements
This From 10-K contains forward-looking statements, such as statements relating to our financial condition, results of operations, plans, objectives, future performance and business operations. These statements relate to expectations concerning matters that are not historical facts. These forward-looking statements reflect our current views and expectations based largely upon the information currently available to us and are subject to inherent risks and uncertainties. Although we believe our expectations are based on reasonable assumptions, they are not guarantees of future performance and there are a number of important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. By making these forward-looking statements, we do not undertake to update them in any manner except as may be required by our disclosure obligations in filings we make with the Securities and Exchange Commission under the Federal securities laws. Our actual results may differ materially from our forward-looking statements.
Principal Sources of Revenue
The Bank’s primary source of revenue is interest income. The table below shows the amount of total consolidated revenues resulting from interest and fees on loans, interest and dividends on investment securities and other interest and non-interest income for each of the last three years.
Additional information required to be reported under this item regarding the results of operations is within the Management Discussion and Analysis of the Company’s 2007 Annual Report and is incorporated herein by reference.
Competition
The banking business is highly competitive. We compete with other commercial banks, savings and loans, credit unions, and other financial service companies operating in the West Central region of Florida. As of June 30, 2007 (the most recent date for deposit data compiled by the FDIC), there were approximately 189 banking offices representing 45 financial institutions operating in Sarasota County holding approximately $11.4 billion in deposits. In Pinellas County, there were approximately 342 offices representing 38 financial institutions holding over $23.5 billion in deposits. We believe that our community bank focus, with our emphasis on service to small- to medium-sized businesses, individuals, and professional concerns, gives us opportunities in these markets. Nevertheless, a number of these competitors are well established in the West Central region. Most of them have substantially greater resources and lending limits than we have and offer services that we do not currently provide. As a result of these competitive factors, we may have to pay higher rates of interest to attract deposits.
Employees
At December 31, 2007, the Company and its subsidiary employed 118 full-time employees and 8 part-time employees. None of these employees are covered by a collective bargaining agreement. We consider our relationship with our employees to be good.
Available information
The Company’s common stock is traded on the NASDAQ Stock Market under the symbol “FSTF.” A copy of our Annual Report on Form 10-K along with copies of our quarterly reports on Form 10-Q and current
reports on Form 8-K required to be filed with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended, are available free of charge from the Company upon written request to Marion DeLay, Corporate Secretary, First State Financial Corporation, 22 South Links Ave., Sarasota, FL 34236, or you may contact Ms. DeLay through the Investor Relations section of the Company’s website at www.firststatefl.com. (Reference to the Company’s website in this Annual Report on Form 10-K does not in any way incorporate information contained in such website into this report.)
Supervision and Regulation
We are subject to extensive state and federal banking laws and regulations which impose specific requirements or restrictions on, and provide for general regulatory oversight of, virtually all aspects of operations. These laws and regulations are generally intended to protect depositors, not shareholders. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects. Our operations may be affected by legislative changes and the policies of various regulatory authorities. We cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.
The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on our operations. It is intended only to briefly summarize some material provisions.
Sarbanes-Oxley Act of 2002: In 2002 the Sarbanes-Oxley Act of 2002 (the “Act”) was enacted which mandated a variety of reforms intended to address corporate and accounting fraud. The Act provides for the establishment of a Public Company Accounting Oversight Board (“PCAOB”) which enforces auditing, quality control and independence standards for firms that audit SEC-reporting companies and is funded by fees from all SEC-reporting companies. The Act imposes higher standards for auditor independence and restricts performance of consulting services by auditing firms to companies they audit. Any non-audit services being provided to an audit client requires preapproval by the Company’s audit committee members. The Act requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement.
The Act also increases the oversight and authority of audit committees of publicly traded companies. Audit committee members must be independent under the securities laws and are barred from accepting consulting, advisory or other compensatory fees from the issuer. Audit committees of publicly traded companies have authority to retain their own counsel and other advisors funded by the company. Audit committees must establish procedures for the receipt, retention and treatment of complaints regarding accounting and auditing matters and procedures for confidential, anonymous submission of employee concerns regarding questionable accounting or auditing matters.
It is unlawful for any person who is not a registered public accounting firm (“RPAF”) with the PCAOB to audit an SEC-reporting company. Under the Act, a RPAF is prohibited from performing statutorily mandated audit services for a company if such company’s chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions has been employed by such firm and participated in the audit of such company during the one-year period preceding the audit initiation date. The Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the Company’s financial statements for the purpose of rendering the financial statements materially misleading. The Act requires the RPAF that issues the audit report to obtain an understanding of internal control, assess the risk that a material weakness exists, test and evaluate the design and operating effectiveness of internal control and report on the Company’s internal controls. In addition, the Act requires that each financial report required to be prepared in accordance with generally accepted accounting principles and filed with the SEC reflect all material correcting adjustments that are identified by a RPAF in accordance with generally accepted accounting principles and the rules and regulations of the SEC.
Community Reinvestment Act: Under the Community Reinvestment Act (“CRA”) and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate income areas, consistent with safe and sound banking practice. The CRA requires the adoption by each institution of a CRA statement for each of its market areas describing the depository institution’s efforts to assist in its community’s credit needs. Depository institutions are periodically examined for compliance with CRA and are periodically assigned ratings in this regard. Banking regulators consider a depository institution’s CRA rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiary.
At its last examination, First State Bank received a “satisfactory” rating.
Anti-Money Laundering and USA Patriot Act of 2001: In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the Patriot Act”). The Patriot Act is intended to strengthen U.S. law enforcement’s and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. 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.
Check 21: Enacted in 2003, the Check Clearing for the 21st Century Act, also known as Check 21, gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check. Some of the major provisions include:
•
Allows check truncation without making it mandatory;
•
Demands that every financial institution communicate to accountholders in writing a description of its substitute check processing program and their rights under the law;
•
Legalizes substitutions for and replacements of paper checks without agreement from consumers;
•
Keeps in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements are in place;
•
Cautions that when accountholder’s request verification, financial institutions must produce the original check (or a copy that accurately represents the original) and demonstrate that the account debit was accurate and valid; and
•
Requires recrediting of funds to an individual’s account on the next business day after a consumer proves the financial institution has erred.
The Gramm-Leach-Bliley Act: The Gramm-Leach-Bliley Act, previously known as the Financial Services Modernization Act of 1999, repealed the restrictions on banks affiliating with securities firms contained in sections 20 and 32 of the Glass-Steagall Act. The Act also permits bank holding companies that become financial holding companies to engage in a statutorily provided list of financial activities, including insurance and securities underwriting and agency activities, merchant banking, and insurance company portfolio investment activities. The Act also authorized activities that are “complementary” to financial activities.
The Act is intended, in part, to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, the Act may have the result of increasing the amount of competition that we face from larger institutions and other types of companies.
The Bank Holding Company Act: Under the Bank Holding Company Act, we are subject to periodic examination by the Federal Reserve and are required to file periodic reports of our operations and any additional information that the Federal Reserve may require. Our activities at the holding company level are limited to:
•
Banking and managing or controlling banks;
•
Furnishing services to or performing services for its subsidiaries; and
•
Engaging in other activities that the Federal Reserve determines to be so closely related to banking and managing or controlling banks as to be a proper incident thereto.
With certain limited exceptions, the Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:
•
acquiring substantially all the assets of any bank;
•
acquiring direct or indirect ownership or control of any voting shares of any bank if after the acquisition it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares); or
•
merging or consolidating with another bank holding company.
In addition, and subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities. The regulations provide a procedure to challenge the control presumption.
Under the Bank Holding Company Act, a bank holding company is generally prohibited from engaging in, or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in non-banking activities unless the Federal Reserve Board, by order or regulation, has found those activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the Federal Reserve Board has determined by regulation to be proper incidents to the business of a bank holding company include:
•
making or servicing loans and certain types of leases;
•
engaging in certain insurance and discount brokerage activities;
•
performing certain data processing services;
•
acting in certain circumstances as a fiduciary or investment or financial adviser;
•
owning savings associations; and
•
making investments in certain corporations or projects designed primarily to promote community welfare.
The Federal Reserve Board imposes certain capital requirements on us under the Bank Holding Company Act, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are described below under “Capital Regulations.” Subject to capital requirements and certain other restrictions, we are able to borrow money to make a capital contribution to our bank, and these loans may be repaid from dividends paid from our bank to us. We are also able to raise capital for contribution to our bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.
In accordance with Federal Reserve Board policy, we are expected to act as a source of financial strength to our bank and to commit resources to support our bank in circumstances in which we might not otherwise do so. Under the Bank Holding Company Act, the Federal Reserve Board may require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary, other than a non-bank subsidiary of a bank, upon the Federal Reserve Board’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.
FDIC Improvement Act: Among other things, the FDIC Improvement Act (“the FDICIA”) provides the federal bank regulatory agencies with broad powers to take prompt corrective action to resolve problems of insured depository institutions. The extent of those powers depends upon whether the institution in question is “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized”, or “critically undercapitalized.” A depository institution’s capital tier will depend upon where its capital levels compare to various established capital measures and certain other factors, as established by regulation. As of December 31, 2007, the Bank met the definition of a “well capitalized” institution.
The FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be “undercapitalized”. “Undercapitalized” depository institutions are subject to growth limitations and are required to submit a capital restoration plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized”. “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. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.
The FDICIA further requires an increase in the frequency of “full-scope, on-site” examinations and expands audit requirements. In addition, federal bank regulatory agencies are required to review and prescribe uniform accounting standards that are at least as stringent as Generally Accepted Accounting Principles.
Pursuant to the FDICIA, the Federal Reserve and the other federal bank regulatory agencies adopted real estate lending guidelines pursuant to which each insured depository institution is required to adopt and maintain written real estate lending policies in conformity with the prescribed guidelines. Under these guidelines, each institution is expected to set loan-to-value ratios not exceeding the supervisory limits set forth in the guidelines. A loan-to-value ratio is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated. The guidelines also require that the institution’s real estate policy require proper loan documentation and that it establish prudent underwriting standards.
The FDICIA also contains the Truth in Savings Act. The purpose of the Truth in Savings Act is to require the clear and uniform disclosure of the rates of interest which are payable on deposit accounts by depository institutions and the fees that are assessable against deposit accounts, so that consumers can make a meaningful comparison between the competing claims of financial institutions with regard to deposit accounts and products.
The FDICIA permits only a “well capitalized” depository institution to accept brokered deposits without prior regulatory approval. Under implementing regulations, “well capitalized” banks may accept brokered deposits with a waiver from the FDIC (subject to certain restrictions on payments of rates), while “undercapitalized” banks may not accept brokered deposits. The regulations contemplate that the definitions of “well capitalized”, “adequately capitalized”, and “undercapitalized” will be the same as the definitions adopted by the agencies to implement the prompt corrective action provisions of the FDICIA (as described above).
The Bank is subject to the provisions of FDICIA relating to internal controls. These provisions require that the Bank document and test its internal control structure and report on it on an annual basis. As of December 31, 2007, the Bank complied with all applicable sections of the regulation and reported as required in 2007.
Payment of Dividends: The Bank is subject to legal limitations on the frequency and amount of dividends paid to us. The Federal Reserve or the FDIC may restrict the ability of a bank to pay dividends if such payments would constitute an unsafe or unsound banking practice. These regulations and restrictions may limit our ability to obtain funds from the Bank for our cash needs, including funds for acquisitions and the payment of dividends, interest, and operating expenses.
In addition, Florida law places certain restrictions on the declaration of dividends from state-chartered banks to their holding companies. Under the Florida law, the Board of Directors of a state-chartered bank, after charging off bad debts, depreciation, and other worthless assets, if any, and making provisions for reasonably anticipated future losses on loans and other assets, may quarterly, semi-annually, or annually declare a dividend of up to the aggregate of net profits of that period, combined with the bank’s retained net profits for the preceding two years and, with the approval of the Florida Office, declare a dividend from retained net profits which accrued prior to the preceding two years. Before declaring such dividends, 20% of the net profits for the preceding period as is covered by the dividend must be transferred to the surplus fund of the bank until this fund becomes equal to the amount of the bank’s common stock then issued and outstanding. A state-chartered bank may not declare any dividend if (i) its net income from the current year combined with the retained net income for the preceding two years is a loss, or (ii) the payment of such dividend would cause the capital account of the bank to fall below the minimum amount required by law, regulation, order, or any written agreement with the Florida Office or a federal regulatory agency.
Capital Regulations: The Federal Reserve and FDIC have adopted risk-based capital guidelines for banks and bank holding companies that are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and account for off-balance sheet items. The guidelines are minimums, and the regulators have noted that banks and bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios in excess of the minimums. We have not received any notice indicating that either our bank or our holding company is subject to higher capital requirements.
FDICIA established a capital-based regulatory scheme designed to promote early intervention for troubled banks which requires the FDIC to choose the least expensive resolution of bank failures. The new capital-based regulatory framework contains five categories of compliance with regulatory capital requirements, including “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” To quality as a “well capitalized” institution, a bank must have a leverage ratio of no less than 5%, a Tier 1 risk-based ratio of no less than 6%, and a total risk-based capital ratio of no less than 10%, and the bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level. Currently, we qualify as “well capitalized.”
Under the FDICIA regulations, the applicable agency can treat an institution as if it were in the next lower category if the agency determines (after notice and an opportunity for hearing) that the institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice. The degree of regulatory scrutiny of a financial institution increases, and the permissible activities of the institution decreases, as it moves downward through the capital categories. Institutions that fall into one of the three undercapitalized categories may be required to do some or all of the following:
•
submit a capital restoration plan;
•
raise additional capital;
•
restrict their growth, deposit interest rates, and other activities;
•
improve their management;
•
eliminate management fees; or
•
divest themselves of all or a part of their operations.
These capital guidelines can affect us in several ways. If we grow at a rapid pace, our capital may be depleted too quickly, and a capital infusion from our holding company may be necessary which could impact our ability to pay dividends. Our capital levels currently are adequate; however, rapid growth, poor loan portfolio performance, poor earnings performance, or a combination of these factors could change our capital position in a relatively short period of time. If we fail to meet these capital requirements, our bank would be required to develop and file a plan with its primary federal banking regulator describing the
means and a schedule for achieving the minimum capital requirements. In addition, our bank would generally not receive regulatory approval of any application that requires the consideration of capital adequacy, such as a branch or merger application, unless our bank could demonstrate a reasonable plan to meet the capital requirement within a reasonable period of time. A bank that is not “well capitalized” is also subject to certain limitations relating to so-called “brokered” deposits. Bank holding companies controlling financial institutions can be called upon to boost the institutions’ capital and to partially guarantee the institutions’ performance under their capital restoration plans.
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities, and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.
New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationship of the nation’s financial institutions. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.
Item 1A.
Item 1A. Risk Factors
Unless the context indicates otherwise, all references in this Item to “we,” “us” or “our,” refer to First State Financial Corporation and its subsidiary. An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that we believe affect us are described below. The risks and uncertainties described below in bold are not the only ones we face. Additional risks and uncertainties that we are not aware of or focused on or currently deemed immaterial may also impair business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and shareholders could lose all or part of their investment.
While we attempt to manage the risk from changes in market interest rates, interest rate risk management techniques are not exact. A rapid or substantial increase or decrease in interest rates could adversely affect our net interest income and results of operations.
Our net income depends primarily upon our net interest income. Net interest income is income that remains after deducting, from total income generated by earning assets, the interest expense attributable to the acquisition of the funds required to support earning assets. Income from earning assets includes income from loans and investment securities. The amount of interest income is dependent on many factors including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates and levels of non-performing loans. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, rates paid on borrowed funds and levels of non-interest bearing demand deposits and equity capital.
Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities. That means either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest earning assets, or vice versa. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could reduce net interest income. We are unable to predict changes in market interest rates which are affected by many factors beyond our control including
inflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets. As of December 31, 2007, we were an asset-sensitive financial institution (assets repricing within one year exceeded liabilities repricing within one year). Net interest income is not only affected by the level and direction of interest rates, but also by the shape of the yield curve, relationships between interest sensitive instruments and key driver rates, as well as balance sheet growth, client loan and deposit preferences and the timing of changes in these variables.
We may encounter unexpected financial and operating problems due to our rapid growth, as our strategy to grow in assets and locations may not be successful.
Our total assets have grown from $147.4 million as of December 31, 2001 to $474.9 million as of December 31, 2007. The largest contributor to our growth has been the expansion of our loan portfolio. Although we believe that we have implemented appropriate internal policies and procedures to handle this growth, our rapid growth may result in pressure on our capital requirements as we seek to maintain our “well-capitalized” designation.
As a strategy, we have sought to increase the size of our franchise through rapid growth and by aggressively pursuing business development opportunities. We can provide no assurance that we will continue to be successful in increasing the volume of loans and deposits at acceptable risk levels and upon acceptable terms. Our ability to grow externally will depend on a variety of factors including the availability of desirable acquisition and business opportunities, and our ability to integrate acquisitions into our growth strategy.
We face the risk that loan losses, including unanticipated loan losses due to changes in loan portfolios, fraud and economic factors, will exceed the allowance for loan losses and that additional increases in the allowance will be required which would cause our net income to decline and could have a negative impact on our capital and financial position.
Making loans is an essential element of our business, and we recognize there is a risk that customer loans will not be repaid. The risk of nonpayment is affected by a number of factors, including:
•
the duration of the loan;
•
credit risks of a particular borrower;
•
changes in economic and industry conditions; and
•
in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.
We attempt to maintain an appropriate allowance for loan losses to provide for potential losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors including the ongoing review and grading of the loan portfolio, consideration of past loan loss experience as well as that of the banking industry, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, the size and diversity of individual large credits, and other qualitative and quantitative factors which could affect probable credit losses. We determine that amount of the allowance for loan losses by considering these factors and by using estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on our historical loss experience as well as that of the banking industry with additional qualitative factors for various issues, and allocations of reserves for special situations that are unique to the measurement period with consideration of current economic trends and conditions, all of which are susceptible to significant change. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly.
There is no precise method of predicting loan losses, and therefore we always face the risk that charge-off in future periods will exceed our allowance for loan losses, and that additional increases in the allowance for loan losses will be required. Additions to the allowance for loan losses would cause net income to decline in the periods(s) in which such additions occur and could also have a material adverse impact on our capital and financial position.
Our success is largely dependent on our ability to attract and retain talented employees for key positions. We do not have employment or noncompete agreements with our employees.
Our success is largely dependent on the personal contacts of our officers and employees in our market areas. None of our employees are parties to an employment or noncompete agreement. If we were to lose any key employee, temporarily or permanently, our business could be hurt. We could be particularly hurt if our key employees went to work for our competitors.
Our exposure to credit risk is increased by our commercial real estate and commercial business lending.
Commercial real estate and commercial business lending generally involve higher credit risks than single-family residential or consumer lending. Such loans involve larger loan balances to a single borrower or groups of related borrowers. At December 31, 2007, we had a balance of $219.0 million in commercial real estate loans and $73.8 million in commercial business loans. Considering our entire loan portfolio is $402.0 million, these loans represent over 73% of our portfolio.
Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends more on successful development of their properties. These loans also involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. The borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property.
Commercial business loans are typically based on the borrower’s ability to repay the loans from the cash flow of the business. Such loans involve greater risk because the availability of funds to repay each loan depends substantially on the success of the business itself. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, and fluctuate in value based on the success of the business.
New accounting or tax pronouncement or interpretations may be issued by the accounting profession, regulators or other government bodies which could change existing accounting methods. Changes in accounting methods could negatively impact our results of operations and financial position.
Current accounting and tax rules, standards, policies, and interpretations influence the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. Events that may not have a direct impact on us, such as a bankruptcy of major U.S. companies, have resulted in legislators, regulators, and authoritative bodies, such as the Financial Accounting Standards Board, the Securities and Exchange Commission, the Public Company Accounting Oversight Board, and various taxing authorities responding by adopting and/or proposing substantive revision to laws, regulations, rules, standards, policies, and interpretations, New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. A change in accounting standards may adversely affect reported financial condition and results of operations.
Our business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in, or disruption to, our business and a negative impact on the results of operations.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems, whether due to severe weather, natural disasters, acts of war or terrorism, criminal activity or other factors, could result in failures or disruptions in general
ledger, deposit, loan, customer relationship management, and other systems. While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures interruptions or security breaches or our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our results of operations.
Our vendors could fail to fulfill their contractual obligations, resulting in a material interruption in, or disruption to, our business and a negative impact on the results of operations.
We have entered into subcontracts for the supply of current and future services, such as data processing and certain information technology and communication functions. These services must be available on a continuous and timely basis and be in compliance with any regulatory requirements. Failure to do so could substantially harm our business.
We often purchase services from vendors under agreements that typically can be terminated on a periodic basis. There can be no assurance, however, that vendors will be able to meet their obligation under these agreements or that we will be able to compel them to do so. Risks of relying on vendors include the following.
•
If an existing agreement expires or a certain service is discontinued by a vendor, then we may not be able to continue to offer our customers the same breadth of products and our operating results would likely suffer unless we are able to find an alternate supply of a similar service.
•
Agreements we may negotiate in the future may commit us to certain minimum spending obligations. It is possible we will not be able to create the market demand to meet such obligations.
•
If market demand for our products increased suddenly, our current vendors might not be able to fulfill our commercial needs, which would require us to seek new arrangements or new sources of supply, and may result in substantial delays in meeting market demand.
•
We may not be able to control or adequately monitor the quality of service we receive from our vendors. Poor quality services could damage our reputation with our customers.
Our controls and procedures may fail or be circumvented which could have a material adverse effect on our business, results of operations and financial condition.
We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurance that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, result of operations and financial condition.
Certain provisions of Florida law may discourage or prevent a takeover of our company and result in a lower market price for our common stock.
Florida laws, as well as certain federal regulations, contain anti-takeover provisions that apply to us. While these provisions may offer us flexibility in managing our business, they could discourage potential buyers from seeking to acquire us, even though certain shareholders may wish to participate in such a transaction. These provisions could adversely affect the market price of our common stock.
The continued economic downturn, and the negative economic effects caused by terrorist attacks, potential attacks and other destablizing events, will likely continue to contribute to the deterioration of the quality of our loan portfolio and could reduce our customer base, level of deposits, and demand for financial products such as loans.
High inflation, natural disasters, acts of terrorism, an escalation of hostilities or other international or domestic occurrences, increased unemployment, changes in securities markets and other factors could have a negative impact on the economy of the regions in which we operate. A sustained economic downturn in our markets would likely contribute to the deterioration of the quality of our loan portfolio by impacting the ability of our customers to repay loans, the value of the collateral securing loans, and may reduce the level of deposits in our banking subsidiary and the stability of our deposits.
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
Executive and administrative offices of First State Financial Corporation and First State Bank are located at 22 South Links Avenue, Sarasota, Florida 34236. The Bank also owns and operates the following branch offices:
•
5700 Clark Road, Sarasota, Florida 34233 (a one story building of approximately 4,737 square feet);
•
7555 Dr. Martin Luther King, Jr. Street North, St. Petersburg, Florida 33702 (a two story building of approximately 10,100 square feet);
•
2832 4th Street North, St. Petersburg, Florida 33704 (a one story building of approximately 2,100 square feet);
•
and 7101 Park Street North, Seminole, Florida 33777 (a one story building of approximately 2,544 square feet).
In January 2006, the Bank began occupying 5,283 square feet on the second floor of its offices located at 22 South Links Avenue, Sarasota, Florida 34236. This space is leased for a period of five years and expires December 31, 2010. The Bank leases a banking office at 2323 Stickney Point Road, Sarasota, Florida 34231. This branch consists of approximately 6,700 square feet and is leased for a period until May 31, 2017. The Bank leases a banking office at 13075 Walsingham Road, Largo, FL 33774. This branch consists of approximately 3,964 square feet and is leased for a period until April 30, 2022. The Bank leases office space at 10901 Roosevelt Boulevard, Suite 1000C, St. Petersburg, FL 33716. This facility consists of approximately 12,146 square feet and is leased for a period of ten years.
Additional information relating to our lease commitments is set forth in Note 4 of the Company’s Annual Report and is incorporated herein by reference. The condition of all properties is considered good and all are adequately covered by insurance.
Item 3.
Item 3. Legal Proceedings
The Company and the Bank are periodically parties to or otherwise involved in legal proceedings arising in the normal course of business, such as claims to enforce liens, claims involving the making and servicing of real property loans, and other issues incident to their respective businesses. We do not believe that there is any pending or threatened proceeding against First State Financial Corporation or First State Bank which, if determined adversely, would have a material adverse effect on our consolidated financial position.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of First State Financial Corporation security holders during the fourth quarter of the year ended December 31, 2007.
Part II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Information required to be reported under this item is set forth in the section entitled “Capital” within the “Management Discussion and Analysis” of the Company’s 2007 Annual Report and is incorporated herein by reference.
PERFORMANCE GRAPH
Our common stock trades in the NASDAQ National Market System under the symbol FSTF. We began trading on the NASDAQ National System on December 10, 2004. Prior to that date there was no public market for our common stock.
The information and graph required to be reported under this item is set forth in the sections entitled “Performance Graph” of the Company’s 2008 Proxy Statement and is incorporated herein by reference.
Item 6.
Item 6. Selected Financial Data
Information required to be reported under this item is set forth in the table entitled, “Selected Five Year Data” in the Company’s 2007 Annual Report and is incorporated herein by reference.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Information required to be reported under this item is set forth in the “Management Discussion and Analysis” section of the Company’s 2007 Annual Report and is incorporated herein by reference.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Information required to be reported under this item is set forth in the section entitled “Asset/Liability Management and Interest Rate Risk” of the Company’s 2007 Annual Report and is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
Information required to be reported under this item is set forth in the Financial Statements of the Company’s 2007 Annual Report and is incorporated by herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rule 13a-15 of the Securities Exchange Act of 1934, that are designed to cause the material information required to be disclosed by the Bank in the reports it files or submits under the Securities Exchange Act of 1934 to be recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms. In designing and evaluating the disclosure controls and procedures, management recognized that a control design, no matter how well operated, can provide only reasonable, not absolute, assurance that the objectives of the control design are met. Due to inherent limitations in all control designs, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer our controls and procedures in place as of the end of the period covered by this report were evaluated. They concluded that our disclosure controls and procedures were effective. No significant deficiencies or material weaknesses in the design or operation of internal controls which could adversely affect our ability to record, process, summarize, and report financial data have been identified. We made no significant changes in our internal disclosure controls and procedures or in other factors that could significantly affect these controls subsequent to the date of evaluation by management, including the Chief Executive Officer and Chief Financial Officer.
Report on Management’s Assessment of Internal Control over Financial Reporting
The management of First State Financial Corporation is responsible for establishing and maintaining effective control over financial reporting. Internal control over financial reporting is defined under applicable Securities and Exchange Commission rules as a process designed under the supervision of the Corporation’s Chief Executive Officer and Chief Financial Officer and effected by the Corporation’s Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Corporation’s financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The Corporation’s internal control over financial reporting includes those policies and procedures that:
•
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and disposition of the assets of the Corporation:
•
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of management and the directors of the Corporation; and
•
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Corporation’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As of December 31, 2007, management with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Corporation’s internal control over financial reporting based on the criteria for effective internal control over financial reporting established in “Internal Control - Integrated Framework,” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on the assessment, management determined that the Corporation’s internal control over financial reporting was effective as of December 31, 2007.
Crowe Chizek and Company LLC, the independent registered public accounting firm that audited the consolidated financial statements of the Corporation included in this Annual Report on Form 10-K, has issued an attestation report on the Corporation’s internal control over financial reporting as of December 31, 2007. The report, which expresses unqualified opinions on the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2007, is included in this Item under the heading “Attestation Report of Independent Registered Public Accounting Firm.”
/s/ Dennis Grinsteiner
Dennis Grinsteiner
Executive Vice President and Chief Financial Officer
/s/ John E. “Jed” Wilkinson
John E. “Jed” Wilkinson
President and Chief Executive Officer
Changes in Internal Control over Financial Reporting
As of the end of the period covered by this report, we performed an evaluation under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its internal control over financial reporting pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation enhancements were made to the financial reporting process, however no changes were made that were considered material or reasonably likely to materially affect, the Bank’s internal control over financial reporting.
Additional information required to be reported under this item is set forth in the section entitled “Report of Independent Registered Public Accounting Firm” of the Company’s 2007 Annual Report and is incorporated herein by reference.
Item 9B.
Item 9B. Other Information
Not applicable.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The Company has a Code of Ethics that applies to its principal executive officer and principal financial officer (who is also its principal accounting officer), a copy of which is included with this Form 10-K as Exhibit 14.1. The information required to be reported under this item is set forth in the sections titled “Election of Directors,” “Executive Officers of the Company,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Report of the Audit Committee” of the Company’s 2008 Proxy Statement and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information required to be reported under this item is set forth in the section entitled “Executive Compensation,” “Compensation Committee Report on Executive Compensation” and “Compensation Committee Interlocks and Insider Participation,” of the Company’s 2008 Proxy Statement and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required to be reported under this item is set forth in the sections entitled “Stock Ownership Information” and “Equity Compensation Plan Information at December 31, 2007” of the Company’s 2008 Proxy Statement and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required to be reported under this item is set forth in the sections entitled “Certain Relationships and Related Transactions” and “Board Governance” of the Company’s 2008 Proxy Statement and is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required to be reported under this item is set forth in the section entitled “Selection of Independent Registered Certified Public Accounting Firm” of the Company’s 2008 Proxy Statement and is incorporated herein by reference.
Part IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this report:
1. Financial statements:
Reference is made to Item 8 of Part II to this Annual Report on Form 10-K which incorporates by reference the Company’s financial statements contained in the Company’s 2007 Annual Report attached as Exhibit 13.1 to this report.
2. Financial statement schedules:
The financial statement schedules are either included in the financial statements or are not applicable.
3. Exhibits:
3.1 Articles of Incorporation, as amended, of the Company. Incorporated by reference to the comparable exhibit number in the Company’s Registration Statement on Form S-1, No. 333-119800 (“Registration Statement”).
3.2 By-Laws incorporated by reference to the comparable exhibit number in the Company’s Registration Statement.
4.1 Specimen Common Stock Certificate incorporated by reference to the comparable exhibit number in the Company’s Registration Statement.
10.2 First State Financial Corporation 2004 Stock Plan. Incorporated by reference to the Company’s Registration Statement on Form S-8, No. 333-124835.
10.4 Promissory Note between First State Financial Corporation and Independent Bankers’ Bank of Florida and related Business Loan Agreement and Commercial Pledge Agreement, dated April 30, 2004. Incorporated by reference to the comparable exhibit number in the Company’s Registration Statement.
10.5 Standard Office Building Lease between Links Associates, Ltd. and First State Bank, dated September 20, 2005. Incorporated by reference to the comparable exhibit number in the Company’s 2005 Annual Report on Form 10-K.
10.6 Standard Office Building Lease between Clearwater Retail Partners, LLC and First State Bank dated May 1, 2006. Incorporated by reference to the comparable exhibit number in the Company’s 2006 Annual Report on Form 10-K.
10.7 Lease between Oasis Largo, LLC and First State Bank, dated May 10, 2007. Incorporated by reference to the comparable exhibit number in the Company’s September 2007 Report on Form 10-Q.
10.8 Lease agreement between PBC Associates, L.L.C. and First State Bank, dated December 11, 2006. Incorporated by reference to the comparable exhibit number in the Company’s September 2007 Report on Form 10-Q.
10.9 Lease agreement between Winkal Holdings, L.L.C. and First State Financial Corp, dated July, 2007. Incorporated by reference to the comparable exhibit number in the Company’s September 2007 Report on Form 10-Q.
11.1 Computation of Earnings Per Common and Common Equivalent Share. Information required to be reported under this exhibit is set forth in Note 9 of the Company’s 2007 Annual Report and is incorporated herein by reference.
13.1 2007 Annual Report to Shareholders of First State Financial Corporation. Except for those portions of the Annual Report which are expressly incorporated by reference in this Form 10-K, the Annual Report is furnished for the information of the Securities and Exchange Commission only and is not to be deemed “filed” as part of such Form 10-K attached herewith.
14.1 Code of Ethics incorporated by reference to the comparable exhibit number in the Company’s 2004 Report on Form 10-K.
21.1 List of subsidiaries
23.1 Consent of Independent Registered Public Accounting Firm
31.1 Certification of the Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
Chief Executive Officer and Chief Financial Officer’s certification required under Section 906 of Sarbanes-Oxley Act of 2002
SIGNATURES
Pursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be duly signed on its behalf by the undersigned, thereunto duly authorized.
FIRST STATE FINANCIAL CORPORATION
/s/ John E. “Jed” Wilkinson
President and Chief Executive Officer
/s/ Dennis Grinsteiner
Executive Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on March 3, 2008.
Signatures
Title
/s/ John E. “Jed” Wilkinson
President, Chief Executive Officer and Director (principal executive officer)
/s/ Robert H. Beymer
Director
/s/ Daniel Harrington
Director
/s/ Marshall Reynolds
Director
/s/ Neal Scaggs
Chairman of the Board and Director
/s/ Robert L. Shell, Jr.
Director
/s/ Thomas W. Wright
Director
Exhibit Index