Item 1. BUSINESS
Republic Bancshares, Inc. (the “Company” or “Republic” or “We”) is a bank holding company registered with the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956 (as amended). We conduct business mainly through our banking subsidiary, Republic Bank (the “Bank”); a Florida-chartered commercial bank headquartered in St. Petersburg, Florida and provide a broad range of traditional commercial banking services. At December 31, 2001, our branch network consisted of 71 branches throughout Florida and our consolidated assets totaled $2.5 billion, loans totaled $1.4 billion, deposits were $2.1 billion and stockholders’ equity was $172.0 million. The Bank’s activities are regulated by the Florida Department of Banking and Finance (the “Department”) and the Federal Deposit Insurance Corporation (the “FDIC”). Deposits are insured by the FDIC up to applicable limits, and the Bank is a member of the Federal Home Loan Bank of Atlanta (the “FHLB”).
Background and Prior Operating History
1994 - 1999: Expansion of the Retail Banking Franchise
During the latter part of 1994 and throughout 1995, the Bank increased its retail banking presence on the west coast of Florida. We opened 13 new branches, increasing our market presence in existing counties and expanding into Pasco County. In February 1996, we converted to a holding company structure.
During 1997 and 1998, we further expanded our retail banking franchise via our acquisition of Firstate Financial, F.A., a thrift institution headquartered in Orlando, Florida and, in September 1997, we acquired and merged in a stock-for-stock transaction with F.F.O. Financial Group, Inc. (“FFO”), St. Cloud, Florida, the holding company parent of First Federal Savings and Loan Association of Osceola County. That merger further increased our presence in central Florida by adding 11 branches in Brevard, Orange and Osceola Counties. At the time of the merger, FFO had total assets of $328.4 million, total loans of $222.4 million and total deposits of $281.3 million.
In June 1998, we acquired seven branch offices from BankAmerica, all of which were located in Florida. At acquisition, these branches had deposit liabilities of $199.9 million and loans of $114.4 million. We also acquired an additional BankAmerica branch located in Brunswick, Georgia, which has since been sold.
On August 13, 1998, we purchased a branch office in Deerfield Beach (Broward County), Florida from the Dime Savings Bank, F.S.B. At acquisition, the branch had $206.7 million of deposits.
On November 5, 1998, we acquired Bankers Savings Bank, F.S.B. (“BSB”), Coral Gables, Florida, and Lochaven Federal Savings and Loan Association (“Lochaven”), Orlando, Florida, in stock-for-stock transactions. At the date of acquisition, BSB had total assets of $70.0 million, total loans of $46.2 million and total deposits of $61.1 million. Lochaven had total assets of $56.5 million, total loans of $44.8 million and total deposits of $54.0 million.
During 1998, we purchased three branches and leased 22 branches from BankAmerica that had been closed in connection with their acquisition of Barnett Banks, N.A. Two of the purchased branches were in Hillsborough County and the third in Lee County. The leased branches were in Broward, Clay, Collier, Miami-Dade, Marion, Palm Beach, Pinellas and Volusia Counties. We had opened three of these branches by the end of 1998 and during 1999 we opened the remaining branches.
1996 - 1998: Non-Traditional Mortgage Banking Activities
In 1996, a mortgage banking operation was initiated that placed an emphasis on non-traditional mortgage products but losses from that operation in 1998 caused us to cease those activities. All out-of-state loan production offices were closed and we discontinued the telemarketing efforts that were the source of the majority of the loan originations by that mortgage banking unit. At year-end 1998, a restructuring charge of $6.7 million was recorded, primarily for severance benefits payable to mortgage banking employees whose positions were eliminated.
2000 - 2001: Positioning the Company for the Future
In March 2000, the board of directors of the Company and the Bank announced the appointment of Mr. William R. Klich as President and Chief Executive Officer of the Company and the Bank. Mr. Klich has over 31 years of banking experience and from 1990-1993 was the President and Chief Executive Officer for Coast Bank, F.S.B., located in Sarasota, Florida. After Coast Bank was acquired by SunTrust Banks in mid-1993, Mr. Klich remained with SunTrust Bank, Gulf Coast, as its Corporate Banking Executive. In early 1996, he was promoted to the position of Chairman and Chief Executive Officer of the $2.4 billion SunTrust Bank, Gulf Coast, serving Manatee, Sarasota and Charlotte Counties.
During 2000 and 2001, we focused our efforts on positioning the Company for the future, and implemented these strategic initiatives:
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Completed the restructuring of the branch franchise by selling seven branches and closing four underperforming offices. Two new offices were opened in 2001, four branch offices are scheduled to open in 2002 and one underperforming branch will be closed in 2002;
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Rounded out the management team by adding strong, experienced executives in key areas of the Company;
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Restructured holding company debt by adding $15.0 million of regulatory capital and paying off all senior debt;
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Strengthened the credit and underwriting process, implementing a traditional and conservatively-underwritten menu of lending products and building loan production to an annualized level of over $900 million per year, based on our production volume for the fourth quarter of 2001;
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Revamped deposit product lines by converting the entire checking account base into seven new customer-driven products to reduce, over time, dependence on non-core deposit sources;
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Continued the ongoing Profit Improvement Program, providing cost-savings to offset the additional expenses from growth in the loan and deposit production areas;
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Maintained strong capital and liquidity positions.
Business of Republic Bancshares, Inc.
Our business plan for 2002 and beyond includes a continuation of these principal business strategies:
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Concentration on and expansion of our core market;
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“Conservative” and “plain vanilla” lending;
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Diversification of the loan portfolio through the origination of consumer lending products through our retail banking outlets and the continued development of commercial lending activities to small and medium sized businesses as well as high net worth individuals;
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Implementation of residential lending as the cornerstone of our retail banking efforts;
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Reduction of nonperforming assets.
Subsequent Events - Sale of the Subordinate Tranche from a High LTV Loan Securitization
In 1998, the Bank securitized and sold $240.0 million of High LTV Loans, retained the residual interest from the securitization and purchased a $12.0 million subordinate tranche from the securitization for $10.9 million. In February 2002, the Bank sold the subordinate tranche for net proceeds approximately equal to the carrying value of the security. The sale substantially reduces exposure to future losses from High LTV Loan-related assets.
Critical Accounting Policies
Financial Reporting Release No. 60, which was recently released by the Securities and Exchange Commission, advises all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. The Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. The following is a brief discussion of the more significant accounting policies and methods used by us. The consolidated financial statements are prepared in accordance with generally accepted accounting principles, which require us to make estimates and assumptions. We believe that, of our significant accounting policies, the following may involve a higher degree of judgment and complexity.
Fair Value. Certain financial instruments are accounted for as trading assets and are recorded at fair value, with unrealized gains and losses reflected in results of operations. Fair values are based on listed market prices, where possible. If listed market prices are not readily available, fair value is determined based on other relevant factors and methods, including techniques using present value of cashflows. In preparing fair values using methods other than listed market prices, we employ financial models to estimate those fair values. Those pricing models and their underlying assumptions determine the amount and timing of unrealized gains and losses recognized, and the use of different pricing models or assumptions could produce different financial results. To the extent financial instruments have extended maturity dates, the Company’s estimates of fair value may involve greater subjectivity due to the lack of transparent market data available upon which to base modeling assumptions. The illiquid nature of certain securities or debt instruments (such as certain mortgage obligations and mortgage-related loan products) also requires a high degree of judgment in determining fair value.
Transfers of Financial Assets. From time to time we may engage in securitization activities. Gains and losses from securitizations are recognized in the consolidated statements of income when the Company relinquishes control of the transferred financial assets in accordance with Statement of Financial Accounting Standards (“SFAS”) SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement No. 125” and other related pronouncements. The gain or loss on the sale of financial assets depends in part on the previous carrying amount of the assets involved in the transfer, allocated between the assets sold and the retained interests based upon their respective fair values at the date of sale. We recognize any interests in the transferred assets and any liabilities incurred in securitization transactions on its consolidated statements of financial condition at fair value. Subsequently, changes in the fair value of interests accounted for as trading assets are recognized in the consolidated statements of income. The use of different pricing models or assumptions could produce different financial results.
Allowance for Loan Losses. The allowance for loan losses is established through a charge to the provision for loan losses. Provisions are made to reserve for estimated losses in outstanding loan balances. The allowance for loan losses is a significant estimate and is regularly evaluated by us for adequacy by taking
into consideration factors such as changes in the nature and volume of the loan portfolio; trends in actual and forecasted portfolio credit quality, including delinquency, charge-off and bankruptcy rates; and current economic conditions that may affect a borrower’s ability to pay. The use of different estimates or assumptions could produce different provisions for loan losses. Our actual provision for loan losses in future periods may differ from our estimates.
Income taxes. Our income tax policy records the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying consolidated balance sheets, as well as operating loss and tax credit carryforwards. We follow very specific and detailed guidelines regarding the recoverability of any tax assets recorded on the balance sheet and provide any necessary allowances if required.
Sources of Funds
Our primary source of funds for lending, investment and other general business purposes are deposit accounts. In addition to deposits, another principal source of funds is loan repayments. The Bank’s loan portfolio contains a significant amount of seasoned loans that are anticipated to repay rapidly during the next few years. If necessary, additional funding is available by borrowing from the FHLB, which has been granted a blanket lien on our residential loan portfolio as collateral. We have not relied on brokered deposits in the past and do not foresee a need to do so in the future. To the extent that short-term financing is required, we intend to rely on repurchase agreements, FHLB advances, and other traditional money market sources of funding. For additional discussion of asset/liability management policies and strategies see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management and Liquidity”.
We offer a full range of deposit services, including checking and other transaction accounts, savings accounts and time deposits. At December 31, 2001, time deposits in amounts of $100,000 or more constituted 12.03% of total deposits.
The following table shows the principal types of deposit accounts we offer and the aggregate amounts of those accounts at December 31, 2001 ($ in thousands):
At December 31, 2001, scheduled maturities of our time deposits were as follows ($ in thousands):
Lending Activities
We originate a full range of traditional lending products for our portfolio, using conservative underwriting guidelines that were revamped in 2000. Under our business plan, our residential loan originations will be made in our Florida markets using strong underwriting standards. Commercial real estate lending will continue to be an important line of business with this product line focused on borrowers within Florida. We will strongly emphasize development of our commercial lending products to small and medium-sized businesses and high net worth individuals and origination of consumer lending products, primarily home equity loans. Lending to borrowers outside Florida has been discontinued. We also discontinued mortgage warehouse lending and reduced our portfolio balance to $718,000, which was comprised of loan collateral in various stages of liquidation. Origination of subprime first lien loans and second lien High LTV Loans was eliminated and these portfolios are substantially reduced from prior years.
For 2001, loan originations from all product types totaled $703.3 million. Of this amount, originations of commercial real estate and commercial (business) loans totaled $312.2 million, consumer loan originations (primarily home equity loans) totaled $201.9 million and residential loan originations were $189.2 million.
The following tables show information about our loan portfolio, based on total dollars and percent of portfolio, by collateral type as of the dates indicated ($ in thousands):
The following table shows the maturities of our real estate secured loans at December 31, 2001 and 2000. Loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. This table also shows the dollar amount of loans scheduled to mature after one year, according to their interest rate characteristics ($ in thousands):
Credit Administration
Our loan approval process provides for various levels of lending authority to loan officers, the Officers’ Loan Committee, the Chairman, and the Chief Executive Officer. In addition, loans in excess of $5.0 million require the approval of the board of directors’ Loan Committee or a majority of the full board prior to funding. Loan purchases, when applicable, are made subject to the same underwriting standards as loan originations. To achieve consistency in underwriting policies and procedures, we have centralized the supervision of our loan approval process and all credit decision functions.
Our real estate lending consists of extensions of credit secured by real estate mortgages and loans made for the purpose of financing the construction of a building or other improvements to real estate. Using applicable regulatory guidelines as our basis, we have adopted comprehensive, written real estate lending policies that we believe are consistent with safe and sound banking practices. These lending policies reflect consideration of the Interagency Guidelines for Real Estate Lending Policies (the “Guidelines”) adopted by the federal banking agencies in December 1992, which set forth applicable standards for real estate lending.
Our lending policy addresses certain lending considerations set forth in the Guidelines, including loan-to-value (“LTV”) limits, loan administration procedures, underwriting standards, portfolio diversification standards and documentation, approval and reporting requirements. The LTV ratio framework, with a LTV ratio being the total amount of credit to be extended divided by the appraised value or purchase price of the property at the time the credit is originated, has been established for each category of real estate loans. Our policy, subject to certain approval exceptions, establishes, among other things, the following maximum LTV limits: raw land (60%); land development (75%); construction (commercial, multifamily and non-residential) - (80%) and improved property (60%-85%, depending on collateral type). Loans on one-to-four family residential (owner occupied) mortgages where the LTV exceeds 95% are not made, and any LTV ratio in excess of 80% generally requires appropriate insurance or additional security from readily marketable collateral. The board of directors reviews and approves our lending policies at least annually.
Our commercial (business) lending is based on a strategy of extending credit to the Florida business community, with commercial loans being made to small and medium-sized businesses and high net worth individuals with satisfactory cash flows.
We manage our loan portfolio on an ongoing basis using written portfolio management strategies, guidelines for underwriting standards and risk assessment, and procedures for ongoing identification and management of credit deterioration. We undertake regular portfolio reviews to estimate loss exposure and determine compliance with policies. (See “Item 1. Business - Asset Quality”).
Asset Quality
Allowance/Provision for Loan Losses
Loan loss allowance activity during 2001 included $17.0 million of loan charge-offs (net of recoveries), $613,000 reallocated from the allowance to loan discounts and a $16.2 million provision for loan losses. Activity during 2000 included a $20.7 million provision for loan losses, loan charge-offs (net of recoveries) of $15.0 million and $389,000 reallocated from the allowance to loan discounts.
The allowance for loan losses represents our estimate of an amount adequate to provide for probable losses inherent in the loan portfolio based on our historical data and the current status of the loan portfolio. However, there may be additional risks of losses in the future, which cannot be quantified precisely or attributed to particular loans or classes of loans. Because those risks include general economic trends, as well as available information about conditions affecting individual borrowers, our estimate of the allowance needed is necessarily an approximation. The allowance is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance in comparison to peers identified by the regulatory agencies.
We conduct an ongoing evaluation and grading of the loan portfolio according to an eight-point rating system. The loan ratings serve as a guideline in assessing the risk level of a particular loan and provide a basis for the estimation of the overall allowance necessary based on historical experience. The Bank’s Loan Review Department independently rates loans and, on a quarterly basis, meets with senior management and the loan officers to discuss all loans that have been identified as potential credit quality problems. The Loan Review Department reports its findings to the Directors’ Audit Committee to ensure independence of the loan grading function.
We believe that our loan loss allowance policy is consistent with policies established by federal and state regulatory agencies and that the level of our allowance is appropriate in light of our historical loss experience. Provisions for loan losses charged to expense during each period are made based on our estimation of the adequacy of the allowance when compared to the inherent risk of the existing portfolio.
The following table shows information concerning the activity in the allowance for loan losses during the periods indicated ($ in thousands):
The following table shows the allocation of the allowance based on certain subjective estimates and the percent of the loan portfolio for each category presented. The amount allocated to a particular segment should not be construed as the only amount available for future charge-offs that might occur within that segment. In addition, the amounts allocated by segment may not be indicative of future charge-off trends.
The allocation of the allowance may change from year to year should we determine that the risk characteristics of the loan portfolio and off-balance sheet commitments have changed ($ in thousands):
Nonperforming Assets
Nonperforming assets include: (1) loans which are 90 days or more past due; (2) loans which are less than 90 days past due but where sufficient doubt exists as to the possibility of collecting additional interest; and (3) other real estate (“ORE”) and other assets acquired in satisfaction of a loan. Nonperforming loans that are restructured and are current as to their revised terms remain in nonperforming status until there is sufficient payment history to warrant upgrade to performing status.
As a matter of policy, interest is not accrued on loans past due 90 days or more unless the loan is both well secured and in process of collection. If there is sufficient doubt as to the collection of future interest a loan may also be placed in non-accrual status before becoming 90 days or more past due. When a loan is placed in non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Interest income on non-accrual loans is recognized only when received.
Loans classified as nonaccrual totaled $46.2 million at December 31, 2001, compared with $49.4 million at December 31, 2000, a decrease of $3.2 million. At December 31, 2001 and 2000, we had nonperforming assets (including loans classified as non-accrual) of $63.3 million or 2.57% of total assets and $57.0 million or 2.33% of total assets, respectively. Accruing loans, which were 90 days past due amounted to $12,000 at December 31, 2001 and $1.2 million at December 31, 2000, and primarily consisted of loans in process of renewal. (See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Comparison of Balance Sheets at December 31, 2001 and 2000”).
The following table shows information regarding the components of nonperforming assets at the dates indicated ($ in thousands):
Other Real Estate
All ORE assets are recorded at the lower of cost or estimated fair market value, less selling costs, based on appraisal information that is updated when a property is taken into ORE and thereafter, when determined appropriate by management, but no less than annually.
The following table shows information regarding ORE balances, net of allowances, as of the dates indicated ($ in thousands):
Troubled Debt Restructurings
In a troubled debt restructuring (“TDR”), the creditor allows the debtor certain concessions that would normally not be granted, such as modifying the terms of the debt to a basis more favorable than those offered to other creditors or accepting third-party receivables in lieu of the debt. At December 31, 2001 and 2000, the loan portfolio included TDR’s amounting to $773,000 and $1.5 million, respectively. All restructured loans, as of December 31, 2001 and 2000, were performing loans.
Investment Activities
The investment portfolio serves a primary role in our balance sheet management. The decision to purchase or sell securities is based upon the current assessment of economic and financial conditions, including the interest rate environment and liquidity requirements. Florida statutes require that a specified minimum amount of liquid assets be maintained based primarily on the level of deposits. At December 31, 2001 and throughout the year, the amount of liquid assets maintained exceeded the regulatory minimum.
Employees
At December 31, 2001, we had 896 full-time equivalent employees, none of whom were represented by a union or other collective bargaining agreement.
Market Area
As of December 31, 2001, we operated 71 full-service branches in 17 counties throughout Florida, a highly competitive state for financial services of all kinds. Competition for deposits also exists from money market funds and credit unions. Consumers can choose from a wide range of suppliers of personal credit, including credit card companies, consumer finance companies, credit unions and mortgage bankers, as well as from competing financial institutions and through alternative delivery channels such as the Internet.
We ranked 12th among holding companies and 18th among all depository institutions in the state of Florida in terms of deposits held as of June, 2001, the latest date for which data is available. As the following table indicates, market share ranges from 0.06% in Lee County to 9.48% in Osceola County.
Branch Deposits in Florida by County
($ in thousands)
Market Risk
The market risk inherent in market sensitive instruments is the potential loss arising from changes in interest rates, which cause changes in prices of marketable equity securities. One of our primary objectives is to reduce fluctuations in net interest income caused by changes in interest rates. To manage interest rate risk, the board of directors has established interest-rate risk policies and procedures, which delegate to the Bank’s Asset/Liability Committee the responsibility to monitor and report on interest-rate risk, devise strategies to manage interest-rate risk, monitor loan originations and deposit activity, and approve pricing strategies.
Securities available for sale, which are those securities that may be sold prior to maturity as part of asset/liability management or in response to other factors, are carried at fair value with any valuation adjustment reported in a separate component of stockholders’ equity, net of tax effect. Trading securities at year-end 2001 included: (1) a subordinate tranche from a 1998 securitization of High LTV Loans (subsequently sold in February 2002, see “Subsequent Events”); (2) the resulting residual interests in cash flows from the 1997 and 1998 securitizations of High LTV Loans; and (3) the excess spread on interest-only strips receivable. These trading securities were carried at estimated market value with any unrealized gains or losses included in the statement of operations under “Gain (losses) on loans and securities, net”. Securities held to maturity were carried at amortized cost.
The table below shows principal amounts and related average interest rates, by year of maturity or repricing, for market sensitive instruments as of December 31, 2001 ($ in thousands).
For a description of the key assumptions used by us to measure market risk, see the discussion on interest sensitivity analysis under the caption “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management”.
Supervision and Regulation
We are extensively regulated under both federal and state law. The following is a brief summary of certain statutes, rules, and regulations affecting us. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referenced below and is not intended to be an exhaustive description of the statutes or regulations applicable to our business. Supervision, regulation, and examination by the bank regulatory agencies are intended primarily for the protection of depositors rather than stockholders.
Regulation of the Company
We are a bank holding company registered with the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). We are subject to the applicable provisions of the BHC Act and the supervision, examination, and regulations of the Federal Reserve.
The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before: (1) it may acquire direct or indirect ownership or control of any voting shares of any bank if, after such acquisition, the bank holding company will directly or indirectly own or control more than five percent of the voting shares of the bank; (2) it or any of its subsidiaries, other than a bank, may acquire all or substantially all of the assets of the bank; or (3) it may merge or consolidate with any other bank holding company. Similar federal statues require bank holding companies and other companies to obtain the prior approval of the Office of Thrift and Supervision (“OTS”) before acquiring ownership or control of a savings association.
The BHC Act further provides that the Federal Reserve may not approve any transaction that would result in a monopoly or would be in furtherance of any combination or conspiracy to monopolize or attempt to monopolize the business of banking in any section of the United States, or the effect of which may be substantially to lessen competition or to tend to create a monopoly in any section of the country, or that in any other manner would be in restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the communities to be served. Considerations of financial resources generally focuses on capital adequacy, and consideration of convenience and needs issues includes the parties’ performance under the Community Reinvestment Act of 1977 (the “CRA”).
The BHC Act, as amended by the interstate banking provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Banking Act”), authorizes any bank holding company located in Florida to acquire a bank located in any other state, and any bank holding company located outside Florida may lawfully acquire any Florida-based bank, regardless of state law to the contrary, in either case subject to certain deposit-percentage, aging requirements, and other restrictions. The Interstate Banking Act also generally provides that national and state-chartered banks may branch interstate through acquisitions of banks in other states, unless a state has “opted out” of the interstate branching provisions of the Interstate Banking Act prior to June 1, 1997. Neither Florida nor any other state in the southeastern United States has “opted out.” Accordingly, we would have the ability to acquire a bank in a state in the Southeast and consolidate the newly acquired bank and the Bank into a single bank with interstate branches.
The BHC Act, as currently in effect, generally prohibits us from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those activities determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity reasonably can be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices.
The Federal Reserve has determined that, as a general matter, bank holding companies and their non-bank subsidiaries may engage in, among other things, operating a thrift subsidiary, conducting discount securities brokerage activities, performing certain data processing services and acting as agent or broker in selling certain types of insurance in connection with credit transactions.
The BHC Act does not place territorial limitations on permissible non-banking activities of bank holding companies. Despite prior approval, the Federal Reserve has the power to order a bank holding company or its non-bank subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness, or stability of any bank subsidiary of the holding company.
Under Federal Reserve policy, bank holding companies are expected to act as a source of financial strength and support to their subsidiary banks. This support may be required at times when, absent such Federal Reserve policy, the holding company may not be inclined to provide it. In addition, any capital loans by a bank holding company to any bank subsidiary are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority payment.
The Gramm-Leach-Bliley Act (the “Act”) amends the BHC Act to authorize new “Financial Holding Companies” (“FHC”). Under the FHC provisions of the Act, a BHC can qualify to become a FHC if all of its bank and thrift subsidiaries are well capitalized and well managed and have a CRA rating of “satisfactory” or better. Once a BHC becomes a FHC, it is permitted to conduct any securities, insurance and merchant banking activities, as well as any other activities that are “financial in nature” or incidental or complementary to a financial activity, such as developing financial software, hosting internet web sites relating to financial matters and operating a travel agency. Under the regulatory structure prescribed by the Act, the Federal Reserve acts as the “umbrella regulator” for the FHC, with each FHC subsidiary subject to supervision and regulation by its own functional regulator or agency.
The Act also gives banks the option of conducting certain newly permitted financial activities in a subsidiary rather than using a FHC. Banks that satisfy the well capitalized, well managed and CRA requirements applicable to FHCs will be able to establish “financial subsidiaries” that are permitted to conduct all financial activities as agency and some financial activities as principal such as securities underwriting. The main activities in which financial subsidiaries currently are prohibited from engaging are insurance underwriting, real estate development and merchant banking.
Regulation of the Bank
The Bank is organized as a Florida-chartered commercial bank and is regulated and supervised by the Department. The FDIC serves as its primary federal regulator and the administrator of the fund that insures the Bank’s deposits. The Department and the FDIC conduct regular examinations, reviewing the adequacy of the loan loss reserves, quality of loans and investments, propriety of management practices, compliance with laws and regulations, and other aspects of operations. In addition to these regular examinations, the Bank must file quarterly reports containing detailed financial statements and schedules. Federal and Florida banking laws and regulations govern all areas of the operations of the Bank, including reserves, loans, mortgages, capital, issuances of securities, payment of dividends, and establishment of branches. As its primary regulators, the Department and the FDIC have authority to impose penalties, initiate civil and administrative actions, and take other steps intended to prevent the Bank from engaging in unsafe or unsound practices. The Bank is a member of the Bank Insurance Fund (“BIF”) and, as such, deposits in the Bank are insured by the FDIC to the maximum extent permissible by law.
The Bank is subject to the provisions of the CRA. Under the CRA, the Bank has a continuing and affirmative obligation consistent with their safe and sound operation to help meet the credit needs of their entire communities, including low and moderate-income individuals and neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit the Bank’s discretion to develop the types of products and services that it believes are best suited to their particular communities, consistent with the CRA. The CRA requires the appropriate federal bank regulatory agency (in the case of the Bank, the FDIC) in connection with their regular examinations, to assess a financial institution’s record in meeting the credit needs of the community serviced by it, including low and moderate-income neighborhoods. The evaluation focuses on three tests: (1) a lending test, to evaluate the institution’s record of making loans in its service areas; (2) an investment test, to evaluate the institution’s record of investing in community development projects; and (3) a service test, to evaluate the institution’s delivery of services through its branches and other offices. A federal banking agency’s assessment of a financial institution’s CRA record is made available to the public. Further, such assessment is required whenever the institution applies to, among other things, establish a new branch that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets of or assume the liabilities of, a federally-regulated financial institution. In the case where the Company applies for approval to acquire a bank or other bank holding company, the federal regulator approving the transaction will also assess the CRA records of the Bank. The Bank received a “Satisfactory” CRA rating in its most recent examination.
Transactions with Affiliates
There are multiple restrictions on the extent to which the Company and any future non bank subsidiaries can borrow or otherwise obtain credit from the Bank. There are also restrictions on the Bank’s purchase of, or investment in, the securities or other assets of the Company. In the event such transactions are permissible, they must be on the same terms and circumstances, including credit standards, that are substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with non-affiliated companies. No such transactions existed at December 31, 2001.
Deposit Insurance
The Bank is subject to FDIC deposit insurance assessments. The Bank is subject to a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. This system assigns an institution to one of three capital categories: (1) well capitalized; (2) adequately capitalized; and (3) undercapitalized. An institution is also assigned, by the FDIC, to one of three supervisory subgroups within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution’s primary federal regulator and information which the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds (which may include, if applicable, information provided by the institution’s state supervisor). An institution’s insurance assessment rate is then determined based on the capital category and supervisory category to which it is assigned, and attributed to the deposit insurance funds. Under the risk-based assessment system, there are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied. Assessment rates on deposits for an institution in the highest category (i.e., “well capitalized” and “healthy”) are less than assessment rates on deposits for an institution in the lowest category (i.e., “undercapitalized” and “substantial supervisory concern”).
The Bank, as a state-chartered commercial bank, is a member of BIF. However as part of the acquisitions the Bank has undertaken in the past, the Bank acquired deposits previously insured by the Savings Association Insurance Fund (the “SAIF”). Based on these acquisitions, the Bank is required to pay insurance premiums to the FDIC on a substantial portion of its deposits at the SAIF assessment rate notwithstanding its status as a BIF member. As of September 30, 2001, the most recent measurement date for assessment purposes, approximately 63.9% of the Bank’s deposits was treated as SAIF-insured deposits, with the remaining 36.1% of deposits being assessed at the BIF rate. Prior to enactment of the Deposit Insurance Funds Act of 1996 (the “Funds Act”), only assessments against SAIF member institutions were available to pay interest on the so-called “FICO Bonds”, which were issued by the Financing Corporation (the “FICO”) in the late 1980’s to fund the resolution of troubled thrifts. The Funds Act shifted a portion of the FICO funding obligations to the BIF member institutions beginning in 1997. Through the end of 1999, the FICO assessment rate on BIF-assessable deposits was required by the statute to be one-fifth of the SAIF rate. Beginning January 1, 2000, the FDIC equalized the FICO assessment rates for members of both insurance funds at 0.0212 percent. In 2001, the Bank’s total FICO payment obligation was $195,000, $128,000 of which was attributable to the Bank’s SAIF-assessable deposits and the balance of which was attributable to its BIF-assessable deposits.
Capital Requirements
We are required to comply with the capital adequacy standards established by the Federal Reserve (for the Company), and the FDIC (for the Bank). The minimum capital requirements applicable to the Company and the Bank are essentially the same. Failure to meet capital guidelines could subject us to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on the taking of brokered deposits, and certain other restrictions on our business, including growth and dividend restrictions. Substantial additional restrictions can be imposed upon us if we fail to meet applicable capital requirements under the federal prompt corrective action regulations. As of December 31, 2001, the Bank’s capital ratios were considered “well capitalized” for purposes of the agencies guidelines.
For additional information regarding capital requirements applicable to the Company and the Bank and their compliance with such requirements see “Note 15. Regulatory Capital Requirements”.
Payment of Dividends
Under Federal law, if, in the opinion of the FDIC, the Bank is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the depository institution, could include the payment of dividends), the FDIC may require, after notice and hearing, that the Bank cease and desist from such practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Prompt Corrective Action regulations adopted by the federal banking agencies in December 1992, the Bank may not pay any dividend to the Company if such payment would cause it to become “undercapitalized”. At December 31, 2001, the Bank’s regulatory capital ratios exceeded the minimum requirements for a “well-capitalized’ bank.
As a Florida-chartered commercial bank, the Bank is subject to the laws of Florida as to the payment of dividends. Under the Florida Financial Institutions Code, the prior approval of the Department is required if the total of all dividends declared by a bank in any calendar year will exceed the sum of a bank’s net retained profits (net income less any dividends paid) for that year and its retained net profits for the preceding two years. As of January 1, 2002, the Bank had a net retained profit deficit for dividend payment purposes of $9.5 million and is restricted from making dividend payments to the parent company until that deficit is cured. At December 31, 2001, the Company had unrestricted cash available for debt service payments of $6.9 million. The Company’s annual debt service payments total $4.7 million.
Federal Reserve System
The Federal Reserve system is used primarily for the settlement of funds between member banks. The Federal Reserve regulations require banks to maintain noninterest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations, effective November 19, 2001, generally require that reserves be maintained against aggregate transaction accounts as follows: (1) for accounts aggregating $41.3 million or less the reserve requirement is 3.0%; and (2) for accounts greater than $41.3 million, the reserve requirement is 10.0% against that portion of total transaction accounts in excess of $41.3 million. The first $5.7 million of otherwise reservable balances (subject to adjustments by the Federal Reserve) are exempted from the reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements imposed by the Department. Because required reserves must be maintained in the form of either vault cash, a noninterest bearing account at a Federal Reserve Bank or a pass-through account as defined by the Federal Reserve, the effect of this reserve requirement is to reduce the Bank’s interest earning assets. FHLB system members, including the Bank, also are authorized to borrow from the Federal Reserve “discount window”, but Federal Reserve regulations require institutions to exhaust all FHLB sources before borrowing from a Federal Reserve Bank.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank (“FHLB”) system. The FHLB system, which consists of 12 regional Federal Home Loan Banks is governed and regulated by the Federal Housing Finance Board (the “FHFB”). The FHLB provides a central credit facility for member institutions. As a member of the FHLB, we are required to acquire and hold shares of capital stock in the FHLB in an amount at least equal to the greater of one percent of the aggregate principal amount of our unpaid residential mortgage loans, home purchase contracts and similar obligations as of the close of each calendar year, or five percent of our borrowings from the FHLB (including advances and letters of credit issued by the FHLB on our behalf).
The FHLB makes advances to members in accordance with policies and procedures periodically established by the FHFB and the board of directors of the FHLB. Currently, outstanding advances from the FHLB are required to be secured by a member’s shares of stock in the FHLB and by certain types of mortgages and other assets. Interest rates charged for advances vary depending on maturity, the cost of funds to the FHLB and the purpose of the borrowing. As of December 31, 2001, we had $52.3 million of outstanding advances from the FHLB with an unused credit line totaling $396.5 million.
Liquidity
Under Florida banking regulations, we are required to maintain a daily liquidity position equal to at least 15% of our total transaction accounts and eight percent of our total non-transaction accounts, less those deposits of public funds for which security has been pledged as provided by law. We may satisfy our liquidity requirements with cash on hand (including cash items in process of collection), deposits held with the Federal Reserve, demand deposits due from correspondent banks, federal funds sold, interest bearing deposits maturing in 31 days or less and the market value of certain unencumbered, rated, investment-grade securities and securities issued by Florida or any county, municipality of other political subdivision within the state. The Department and FDIC review our liquidity position as part of their examinations. If we fail to comply with the liquidity requirements, we generally may not further diminish liquidity either by making any new loans (other than by discounting or purchasing bills of exchange payable at sight) or by paying dividends. At December 31, 2001, using applicable Florida regulations, the Bank’s liquidity position was $869.3 million compared to a minimum position of $183.2 million.
Monetary Policy and Economic Controls
The banking business is affected not only by general economic conditions, but also by the monetary policies of the Federal Reserve. Changes in the discount rate on member bank borrowing, availability of borrowing at the “discount window,” open market operations, the imposition of changes in reserve requirements against bank deposits and the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates are some of the instruments of monetary policy available to the Federal Reserve. The monetary policies have had a significant effect on the operating results of commercial banks and are expected to continue to do so in the future. The monetary policies of the Federal Reserve are influenced by various factors, including inflation, unemployment, short and long-term changes in the international trade balance and in the fiscal policies of the United States Government. Future monetary policies and the effect of such policies on the future business and earnings of the Bank cannot be predicted.
Effects of Inflation
As a financial institution, the majority of our assets are monetary in nature and, therefore, differ greatly from those of more industrial or commercial companies that have significant investments in fixed assets. The effects of inflation on the financial condition and results of operations, therefore, are less significant than the effects of changes in interest rates. The most significant effect of inflation is on noninterest expense, which tends to rise during periods of general inflation.
Changes in Accounting Standards
The Financial Accounting Standards Board (“FASB”) regularly issues proposals and guidelines on the accounting practices of commercial enterprises in general and financial institutions in particular. For additional information on the effect of any such issues on our financial condition and results of operation, see the Notes to Consolidated Financial Statements.
Item 2.
Item 2. PROPERTIES
Currently, the Bank operates 71 full-service branch banking offices located in 17 Florida counties, of which 35 are leased and 36 are owned. Our branches have square footage ranging from 43,000 square feet to 1,230 square feet with lease terms ranging from the year 2002 to the year 2022. Our executive offices are located at 111 Second Avenue N.E., Suite 300, St. Petersburg, Florida, 33701, where we leased approximately 45,000 square feet of space under a lease that expires in the year 2004. Our operations and servicing functions are conducted from a 77,000 square foot owned building located at 1400 66th Street N., St. Petersburg, FL 33710. We have various options to renew leases at most of our branch locations. We also have seven facilities that are not used for banking purposes, one of which is owned and six of which are leased. For further information regarding our lease obligations, see the Notes to Consolidated Financial Statements.
Item 3.
Item 3. LEGAL PROCEEDINGS
We are subject to various legal proceedings in the ordinary course of business. Based on information presently available, we do not believe that the ultimate outcome in such proceedings, in the aggregate, would have a material adverse effect on our financial position or results of operations.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Information required by this item is incorporated by reference from our Proxy Statement for the 2002 Annual Meeting.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Trading Market
Our common stock is currently traded on the NASDAQ National Market under the symbol “REPB”. The table below shows, the high, low and closing bid information for the common stock as regularly quoted on the NASDAQ National Market for the periods indicated.
These over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, markdown, or commission and may not necessarily reflect actual transactions.
Stockholders and Dividends
As of December 31, 2001, there were approximately 2,564 beneficial owners of our common stock. To date, the Company has not paid dividends on its common stock. Quarterly dividends on the 75,000 shares of our noncumulative perpetual preferred convertible stock totaling $.88 per share were paid in 2000 and 2001. In the second quarter of 2001, the holders of the Company’s perpetual preferred stock converted their holdings into the Company’s common stock (See “Note 13, Stockholders’ Equity”).
Item 6.
Item 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER INFORMATION
The following selected consolidated financial and other information as of and for each of the years ended December 31, 1997 through 2001, were derived from the audited consolidated financial statements.
The following information should be read in conjunction with “Item 7.
Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our balance sheets and statements of operations should be read in conjunction with “Item 6. Selected Consolidated Financial and Other Information”, the consolidated financial statements and the related notes included elsewhere therein.
Years Ended December 31, 2001 and 2000
Comparison of Balance Sheets at December 31, 2001 and 2000
Overview
Our total assets were $2.5 billion at December 31, 2001, and $2.4 billion at December 31, 2000, an increase of $18.7 million or 0.76%. During 2001, the Company undertook a strategy to sell those branch offices in areas outside its desired market area, which reduced asset growth. Excluding those branch sales transactions, total assets would have increased by $132.9 million.
Securities
During 2001, loan repayments, primarily from discontinued loan products, were substantial and the additional liquidity from loan runoff was invested in mortgage securities. At December 31, 2001, securities were $834.1 million, compared to $407.0 million at December 31, 2000, an increase of $427.1 million or 104.95%. At December 31, 2001, $792.7 million of securities were classified as available for sale, $21.5 million were classified as held to maturity and $19.9 million were trading assets, all of which were mortgage-related securities. Included in the trading asset category were several investments acquired in prior years, including: (1) a $10.9 million subordinate tranche purchased from a securitization of High LTV Loans in June 1998 which has since been sold (see “Item 1 - Business-Subsequent Events”); (2) $5.8 million in overcollateralization and residual interests in cash flows from a $60.0 million securitization in December 1997 and a $240.0 million securitization of High LTV Loans in June 1998; and (3) $3.2 million representing excess spread on mortgage servicing rights.
The market values assigned to the MBS classified as available for sale were derived using market quotations at December 31, 2001. Trading assets are evaluated at least quarterly with any valuation adjustment reflected as a trading gain or loss in the statement of operations. Under applicable accounting rules, use of quoted market values is the preferred method for valuing trading assets. However, where the market for those assets is illiquid and price quotations are not readily available, other methods are permitted, including techniques utilizing the present value of expected cash flows. We have used present value techniques to value our trading assets.
In the fourth quarter of 2001, we obtained current credit data on the loans underlying the trading assets related to High LTV Loan securitizations. Based on that analysis, which indicated some deterioration in the quality of the loans underlying the residual interest when compared to similar prior analysis, and on the historical loss history of those loans, an adjustment was made to the expected cumulative losses on each securitization (expressed as total lifetime losses as a percent of the original balance of loans in the securitization). The cumulative loss factor for the securitization completed in December 1997 was increased from an original estimate of 9.57% to a current estimate of 19.37%. The cumulative loss factor for the securitization completed in June 1998 was increased from an original estimate of 10.68% to a current estimate of 18.36%. As a result of that increase in expected future losses, a trading loss of $4.0 million was recorded for 2001. We believe these valuations are a reasonable approximation of the fair market value of the mortgage related securities classified as trading assets; however, there is no assurance that we could realize these values if these assets were sold in the current illiquid market for High LTV-related assets.
Loans
Total loans were $1.4 billion at December 31, 2001, compared to $1.7 billion at December 31, 2000, a decrease of $290.3 million, or 17.0%. The decrease was due to payoffs of discontinued loan products and to the overall rapid decline in interest rates, which caused loan prepayments to rise. This decline in the loan portfolio included: (1) $57.2 million from payoffs of out-of-state loans; (2) a decrease of $44.9 million from loans that were sold in the branch sales; (3) a $39.1 million decrease in warehouse lines of credit; (4) an $81.3 million decline from securitizing residential loans into mortgage securities; and (5) a $67.7 million net decrease in loans within the state of Florida.
Allowance for Loan Losses
The allowance for loan losses amounted to $32.0 million (2.25% of portfolio loans) at December 31, 2001, compared with $33.5 million (1.96% of portfolio loans) at December 31, 2000. At December 31, 2001, the ratio of the allowance for loan losses to nonperforming loans was 69.24% compared to 66.12% at the end of 2000. During 2001 we recorded a $16.2 million provision for loan losses. Other activity included $17.0 million of loan charge-offs (net of recoveries) and $613,000 reallocated from the allowance to loan discount. Net chargeoffs for the year included losses of $2.5 million on High LTV Loans and $6.5 million from warehouse lines of credit deemed uncollectible, which included a $5.9 million charge on a warehouse line to a now-defunct warehouse lender. We also charged off $808,000 of residential loans and $2.1 million of home equity loans; both comprised primarily of loans originated in the 1997-98 timeframe.
Nonperforming Assets
Nonperforming assets amounted to $63.3 million or 2.57% of total assets at December 31, 2001, compared with $57.0 million or 2.33% of total assets at December 31, 2000. Nonperforming loans totaled $46.2 million (or 3.25% of total loans) at December 31, 2001, a decrease of $4.4 million from December 31, 2000. Nonperforming one-to-four family residential mortgage loans decreased by $2.3 million, while nonperforming warehouse lines of credit and home equity loans decreased $3.0 million. ORE increased $11.2 million from $5.7 million at December 31, 2000, to $16.9 million at December 31, 2001.
Our nonperforming assets at year-end 2001 included a hotel in Wilmington, Delaware and a residential development in Naples, Florida, which we took ownership of in 2001, that accounted for $26.2 million or 41.5% of our total nonperforming assets. Residential loans in various stages of foreclosure account for an additional 22.4% of our total nonperforming assets.
Deposits
Total deposits were $2.1 billion at December 31, 2001, compared to $2.2 billion at December 31, 2000, a decrease of $27.5 million or 1.3%. The decline in deposits was largely due to the branch sales completed in 2001. Excluding those branch sales, total deposits would have increased by $89.8 million. Management’s business plan includes, as one of the principal strategies, a reduction in the dependence on time deposits as a source of funds. To this end, the mix of total deposits during 2001 improved with time deposits reduced to 56.6% of total deposits at year-end 2001, compared with 62.5% at the end of 2000. Transaction accounts, including checking and money market accounts, were 34.5% of total deposits and savings deposits were 8.9% of the total at year-end 2001 compared to 28.2% and 9.3%, respectively, at the end of 2000. Overall, since year-end 2000, certificates of deposit declined $142.6 million, of which $69.9 million resulted from the branch sales. Checking accounts (including non-retail deposits such as official checks) increased $27.1 million, while savings deposits decreased by $10.3 million.
Stockholders’ Equity
Stockholders’ equity was $172.0 million at December 31, 2001, or 7.00% of total assets, compared to $172.3 million or 7.06% of total assets at December 31, 2000. At December 31, 2001, the Bank’s tier 1 (“leverage”) capital ratio was 7.94%, its tier 1 risk-based capital ratio was 13.11%, and its total risk-based capital ratio was 14.39%, all in excess of FDIC guidelines for an institution to be considered a “well-capitalized” bank. The same ratios for the Company were 7.21%, 11.90% and 15.17%.
Comparison of Results of Operations for the Year Ended December 31, 2001 and
Overview
During 2001, the Company recorded a $4.0 million writedown to its interest-only residual investments and a $5.9 million chargeoff of a warehouse line of credit to Greatstone, a defunct mortgage lender. Both items were major factors leading to a $3.9 million or $0.37 per share net loss for the full year of 2001. On a cash basis, the 2001 net loss was $1.6 million or $0.14 per share. Excluding “special” items from 2001 cash results (which include the above two charges and $4.5 million in gains on sale of branches), the Company would have recorded cash basis net income for 2001 of $1.8 million or $0.17 per share.
Analysis of Net Interest Income (see table on page 26)
Net interest margin, the difference between the yield on earning assets and the cost of funds, including noninterest-bearing sources, was 2.99% for 2001 compared to 3.76% for 2000. On a quarterly basis throughout 2001, net interest margin fell to a yearly low of 2.91% in the third quarter of 2001 and then recovered to 3.08% in the fourth quarter. The changes in net interest margin throughout 2001 reflect the overall rapid decline in market interest rates that has taken place during the year. The repricing structure of the Company’s earning assets and interest bearing liabilities is “asset sensitive”, meaning that asset yield declines faster than funds costs during the first three to four months following a rate reduction. After that three to four month period passes, declining funds costs catch up with and then overtake the decline in asset yield. The series of consecutive rate cuts during 2001 lengthened the time needed to stabilize the net interest margin. During the fourth quarter of 2001 that stabilization took place with funds costs declining by 68 basis points while asset yield declined by a lesser amount, 41 basis points. Also contributing to the decline in net interest margin during the first three quarters of 2001 was a change in asset mix with a higher percentage of earning assets invested in mortgage securities and a reduced amount of loans outstanding. The Company’s plan to improve the quality of the loan portfolio, which included the sale of High LTV Loans, exit from the mortgage warehouse lending line of business and payoffs of out-of-state loans, all were major contributors to a decline in average loans outstanding.
The following table summarizes the average yields earned on interest earning assets and the average rates paid on interest bearing liabilities for the years ended December 31, 2001 and 2000 ($ in thousands):
Noninterest Income
Noninterest income for the year ended December 31, 2001, was $23.0 million compared with $7.3 million for the same period in 2000, an increase of $15.7 million. Gains on sale of new loan production increased by $472,000 to $1.0 million and gains on sale of investments (primarily from securitization and sale of loans) were $5.3 million, a $5.1 million increase. Also during 2001, noninterest income included $4.5 million of gains on sale of branch deposits, a $1.1 million gain of the sale of High LTV Loan servicing rights and a $4.0 million trading loss or writedown on the interest-only residual investment. For 2000, a $13.5 million writedown to the interest-only residual investment was recorded. Loan service fee income in 2001 was reduced by the high level of repayments to the loan servicing portfolio, which required an increased level of amortization of servicing rights. The following table reflects the components of noninterest income for the years ended December 31, 2001 and 2000 ($ in thousands):
Noninterest Expense
Total noninterest expenses for the year ended December 31, 2001, were $78.9 million, compared with $80.0 million for the same period in 2000, a decrease of $1.1 million. Operating expenses for the year ended December 31, 2001, included in the noninterest expense total, were $74.5 million, compared with $75.5 million for the same period in 2000, a decrease of $1.0 million.
The following table reflects the components of noninterest expense for the years ended December 31, 2001 and 2000 ($ in thousands):
Years Ended December 31, 2000 and 1999
Comparison of Balance Sheets at December 31, 2000 and 1999
Overview
Total assets were $2.4 billion at December 31, 2000, and $2.6 billion at December 31, 1999, a decrease of $125.4 million or 4.89%. The mix of our asset base changed substantially during the year as a result of the reinvestment into federal funds sold of funds from repayments of loans, primarily warehouse lines of credit and residential mortgages, and the sale of $41.5 million of High LTV Loans.
Investment Securities
Investment securities were $407.0 million at the end of 2000 compared to $453.0 million in 1999, a decrease of $46.1 million or 10.2%, mainly as a result of commercial paper maturing without replacement. At December 31, 2000, $348.5 million of securities were classified as available for sale; $33.8 million were classified as held to maturity and $24.6 million of mortgage related securities were trading assets. Included in the trading asset category were: (1) a $10.9 million subordinate tranche purchased from our securitization of High LTV Loans in June 1988; (2) $10.2 million in overcollateralization and residual interests in cash flows from a $60.0 million securitization in December 1997 and a $240.0 million securitization in June 1998; and (3) the excess spread on mortgage servicing rights, which amounted to $3.5 million at year-end 2000.
Loans
Total loans were $1.7 billion at December 31, 2000, compared to $1.9 billion for the same period in 1999, a decrease of $178.6 million or 9.4%. During the fourth quarter of 2000, we sold $41.5 million of High LTV Loans that comprised most of the $54.7 million reduction in that category. Other reductions to the loan portfolio included: (1) a decline of $57.0 million in warehouse lines of credit; (2) a decrease of $92.5 million of first lien residential mortgages; and (3) a decline of $27.4 million of commercial real estate, multifamily, construction and land development loans. These reductions were partially offset by a $34.3 million increase in commercial business loans and a $29.6 million increase in home equity loans that were originated through the Bank’s retail network.
Allowance for Loan Losses
The allowance for loan losses amounted to $33.5 million (1.96% of portfolio loans) at December 31, 2000, compared with $28.2 million (1.49% of portfolio loans) at December 31, 1999. At December 31, 2000, the allowance for loan losses included $32.8 million related to loans originated by us and $648,000 from discount allocations for the March 1995 purchased loans. During 2000, we recorded a $20.7 million provision for loan losses. Other activity included $15.0 million of loan charge-offs (net of recoveries) and $389,000 reallocated from the allowance to loan discount. Net chargeoffs for the year included losses of $5.6 million on High LTV Loans and $5.0 million from warehouse lines of credit deemed uncollectible. We also charged off $1.6 million of residential loans and $1.2 million of home equity loans; both comprised primarily of loans originated in the 1997-98 timeframe.
Nonperforming Assets
Nonperforming assets amounted to $57.0 million or 2.33% of total assets, at December 31, 2000, compared with $31.2 million, or 1.22% of total assets, at December 31, 1999. The increase resulted from two loans placed in nonperforming status in the third quarter of 2000; a $15.3 million loan secured by a hotel in Wilmington, Delaware, and a $13.1 million residential development loan in Naples, Florida. These two assets comprised 56.1% of total nonperforming loans. Nonperforming
loans totaled $50.6 million (or 2.96% of total loans) at the end of 2000, an increase of $25.5 million from the prior year-end. Nonperforming one-to-four family residential mortgage loans decreased by $4.3 million, while nonperforming warehouse lines of credit and home equity loans increased $2.8 million. ORE increased $397,000 from $5.3 million at December 31, 1999 to $5.7 million at December 31, 2000.
Deposits
Total deposits were $2.2 billion at December 31, 2000, compared to $2.3 billion at the prior year-end, a decrease of $135.4 million or 5.90%. The mix of total deposits during 2000 changed somewhat with time deposits comprising 62.5% of the total at year-end 2000, compared with 63.1% at the end of 1999. Transaction accounts, including checking and money market accounts were 28.2% of total deposits and savings deposits were 9.3% at year-end 2000, compared to 23.4% and 13.5%, respectively at the end of 1999. Overall, since year-end 1999, certificates of deposit have declined $96.9 million, which reflected the increasingly competitive market for deposit accounts. Checking accounts (including non-retail deposits such as official checks) decreased $12.8 million, while savings deposits declined by $110.1 million. These reductions were partially offset by a $84.4 million increase in money market deposits.
Senior Debt
As of December 31, 2000, our senior debt totaled $6.8 million and was comprised of a loan from SunTrust Bank, N.A. (“SunTrust”). We restructured the terms of the senior debt in December 2000 and made a principal reduction of $2.0 million on January 2, 2001. The $4.8 million remainder was repaid in January 2001.
Stockholders’ Equity
Stockholders’ equity was $172.3 million at December 31, 2000, or 7.06% of total assets, compared to $170.2 million, or 6.63% of total assets, at December 31, 1999. At December 31, 2000, the Bank’s tier 1 (“leverage”) capital ratio was 7.18%, its tier 1 risk-based capital ratio was 11.69%, and its total risk based capital ratio was 12.94%, all in excess of minimum FDIC guidelines for an institution to be considered a “well-capitalized” bank, while the same ratios for the Company were 6.30%, 10.27% and 12.69%.
Comparison of Results of Operations for the Years Ended December 31, 2000 and
Overview
A net loss of $4.6 million or $.46 per share was incurred for 2000 which included a $13.5 million unrealized trading loss or writedown on the interest-only residual investments from High LTV Loan securitizations. On a cash basis, the loss for 2000 was $2.0 million or $0.19 per share. Excluding the writedown on the residual investment, a cash basis profit of $6.4 million or $0.61 per share would have been recorded for 2000.
Analysis of Net Interest Income (see table on page 31)
Net interest income for 2000 was $89.7 million compared to $92.4 million for 1999, a $2.7 million or 2.88% decrease. Average asset yield increased 17 basis points from 8.10% for 1999 to 8.27% for 2000 but the $6.4 million increase in interest income was more than offset by a $9.1 million increase in interest expense. The average cost of interest bearing liabilities increased 40 basis points from 4.53% to 4.93%. Net interest spread, the difference between asset yield and cost of funds, decreased 23 basis points to 3.34%. Net interest margin, which includes the benefit of noninterest bearing funds, decreased from 3.92% for 1999 to 3.76% for 2000. Management estimated that the increase in nonperforming assets in 2000 reduced net interest income by approximately $1.9 million and reduced the net interest margin by eight basis points or one-half of the total 16 basis point decrease.
Noninterest Income
Noninterest income for 2000 was $7.3 million compared with $25.8 million for 1999, a decrease of $18.5 million. There were several reasons for the reduction, which included: (1) the $13.5 million writedown relating to our retained interest on High LTV securitizations; (2) gains on sale of branch deposits of $1.1 million and gains on branch relocations of $1.3 million, both recorded in 1999; and (3) a $3.1 million decrease in gains on sale of loans. Service fees on deposits in 2000 improved by $1.1 million, primarily from the introduction of several new fee-generating programs.
The following table reflects the components of noninterest income for the years ended December 31, 2000 and 1999 ($ in thousands):
The following table summarizes the average yields earned on interest earning assets and the average rates paid on interest bearing liabilities for the years ended December 31, 2000 and 1999 ($ in thousands):
Noninterest Expense
Total noninterest expenses for 2000 were $80.0 million compared with $88.1 million for the same period in 1999, a decrease of $8.1 million. Operating expenses for 2000, included in the noninterest expense total, were $75.5 million compared with $84.4 million, a decrease of $8.9 million. Most of the decrease resulted from cost savings following discontinuation of mortgage banking activities in 1999 and several cost containment programs initiated throughout 2000. Compensation expenses were lower by $4.3 million while costs associated with postage, supplies and other administrative expenses declined $3.3 million.
The following table reflects the components of noninterest expense for the years ended December 31, 2000 and 1999 ($ in thousands):
Selected Quarterly Financial Data
Summarized selected unaudited quarterly financial information for the years ended December 31, 2001 and 2000 follows ($ in thousands except share data):
Asset/Liability Management and Liquidity
Liquidity
At December 31, 2001, the Bank’s liquidity ratio, defined as net cash and investments of $869.3 million divided by net deposits and short-term liabilities of $2.3 billion, was 40.75% as compared to 26.86% at December 31, 2000. Net liquid assets were $686.2 million in excess of the amount required by Florida banking regulations.
The Asset/Liability Management Committee (“ALCO”) reviews our liquidity, which is our ability to generate sufficient cash flow to meet the funding needs of current loan demand, deposit withdrawals and other cash demands. The primary sources of funds consist of deposits, amortization and prepayments of loans, sales and maturities of investments, other funds from operations and our capital. We are a member of the FHLB and have the ability to borrow to supplement our liquidity needs with our borrowing capacity equal to 20% of our total assets. The Bank also maintains borrowing lines of credit using its investment portfolio as collateral.
Those FHLB borrowings, known as “advances”, are secured by the Bank’s mortgage loan portfolio, and the terms and rates charged for FHLB advances vary based on an institution’s loan portfolio and in response to general economic conditions. A variety of borrowing plans is offered by the FHLB, each with its own maturity and interest rate. The FHLB will consider various factors, including an
institution’s regulatory capital position, net income, quality and composition of assets, lending policies and practices, and level of current borrowings from all sources, in determining the amount of credit to extend to an institution. As of December 31, 2001, the Bank had $52.3 million of outstanding advances from the FHLB. (See “Item 1. Business - Supervision and Regulation - Federal Home Loan Bank System and Liquidity”).
Asset/Liability Management
The management of interest-rate risk is one of the most significant factors affecting the ability to achieve future earnings. One traditional measure of the mismatch of assets maturing or re-pricing within certain periods, and liabilities maturing or re-pricing within the same period, is the “gap” for such period. Controlling the maturity or re-pricing of an institution’s assets and liabilities in order to minimize interest rate risk is commonly referred to as gap management. “Negative gap” occurs when, during a specific time period, more of an institution’s liabilities are scheduled to re-price than its assets, so that, barring other factors affecting interest income and expense, in periods of rising interest rates the institution’s interest expense would increase more rapidly than its interest income, and in periods of falling interest rates the institution’s interest expense would decrease more rapidly than its interest income. “Positive gap” occurs when more of an institution’s assets are scheduled to re-price than its liabilities, so that, barring other factors affecting interest income and expense, in periods of falling interest rates the institution’s interest income would decrease more rapidly than its interest expense, and in periods of rising interest rates the institution’s interest income would increase more rapidly than its interest expense.
In addition to the traditional “gap” measurement, management also relied on the measurement of the duration of cash flows for the various assets and liabilities. Duration is the weighted average of the terms of future cash flows, where the present values of the cash flows are the weights. This is the effective term of a series of cash flows, comparable to the term of a zero coupon (single cash flow) instrument. The effective term is a measure of the price sensitivity of an instrument: the price of a longer term instrument is more sensitive than that of a shorter term instrument. At December 31, 2001, the duration of the Company’s assets was 2.1 years while the duration of its liabilities was 1.7 years.
We strive to maintain a cumulative one-year gap of no more than plus or minus 15% of total assets and to limit the change in net interest income over a one-year time horizon to no more than 15% of base net interest income, assuming an immediate and sustained 200 basis point change in market interest rates. We manage interest rate risk primarily by changing the maturity distribution of our investment portfolio and emphasizing loan originations carrying variable interest rates tied to interest-sensitive indices. Additionally, the Bank may utilize long-term fixed-rate advances from the FHLB to improve the match between interest earning assets and interest bearing liabilities. Currently, off-balance-sheet hedging instruments are not used to manage overall interest rate risk. We may expand our use of off-balance sheet hedging instruments to manage exposure to overall interest rate risk in the future, subject to board approval.
The cumulative one-year gap at December 31, 2001, was a negative $218.7 million, or a negative 8.89% (expressed as a percentage of total assets). Our net interest income sensitivity, assuming an immediate and sustained change in market interest rates of plus or minus 200 basis points, was a negative 15.30% change for minus 200 basis points and a negative 2.08% change for plus 200 basis points.
The following table presents the maturities or re-pricing of interest earning assets and interest bearing liabilities at December 31, 2001. The balances shown have been derived based on the financial characteristics of the various assets and liabilities. Adjustable and floating-rate assets are included in the period in which interest rates are next scheduled to adjust rather than their scheduled maturity dates. Fixed-rate loans are shown in the periods in which they are scheduled to be repaid according to contractual amortization and, where appropriate, prepayment assumptions, based on the coupon rates in the portfolio have been used to adjust the repayment amounts. Re-pricing of time deposits is based on their scheduled maturities. Based on an analysis of our deposit accounts and our experience in the markets in which we operate, we have incorporated the following “core” deposit assumptions in the repricing table:
Using those “core” deposits assumptions as well as current market indications for the level of asset prepayment activity, the interest rate sensitivity our balance sheet would be as follows ($ in thousands):
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required by this item is provided within the consolidated financial statements and notes thereto.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There are no items to report.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors of the Company
The information relating to the Directors appears in our Proxy Statement for the 2002 Annual Meeting of Stockholders under the caption “Proposal One-Election of Directors” and is incorporated by reference.
Senior Executive Officers of the Company and Bank
The following list sets forth the name and age of each executive officer of the Company or the Bank as of December 31, 2001, and all positions held by each such officer (and the period each such position has been held), a brief account of each such officer’s business experience during the past five years and certain other information:
William R. Klich (57) - Mr. Klich has served as Director of the Bank, President and Chief Executive Officer of the Company and the Bank since March 15, 2000. He was previously employed as Chairman and CEO of SunTrust Bank, Gulf Coast from 1996 to March, 2000, regional corporate banking executive of SunTrust Bank of Florida from 1993 to 1996 and President and CEO of Coast Bank, F.S.B. from 1990 to 1993. He has more than 31 years of commercial banking experience.
Gerald P. Ademy (55) - Executive Vice President of Corporate Services for Republic Bank. Mr. Ademy joined Bank of America in 1986. He held numerous Asset Management and Real estate Management positions including most recently Senior Vice President, Commercial Special Assets, Eastern U.S.
William R. Falzone (54) - Mr. Falzone has served as our Treasurer since March 1996 and Executive Vice President and Chief Financial Officer of the Bank since February 1994. He was employed at Florida Federal Savings Bank from 1983 through 1991 where he served as Director of Financial Services. Before joining the Company, he was a Senior Consultant for Stogniew and Associates, a nationwide consulting firm. He has more than 25 years of banking experience and is a certified public accountant.
E. Carl Goff (49) - Executive Vice President and Commercial Real Estate Manager, Mr. Goff joined Republic Bank in April 2000 as Senior Vice President of Commercial Real Estate. He has over 18 years of commercial real estate lending experience. Mr. Goff previously served with Barnett and SunTrust Banks.
Jon D. Harkins (54) - Mr. Harkins has served as Executive Vice President and Senior Lending Officer since September 2000. He joined us from First Union National Bank where he served in various lending and management positions for 25 years. Most recently, he served as Area President for Polk, Pasco and Highland Counties in Florida.
Mauro A. Harto (41) - Executive Vice President of the Bank and Residential Lending Manager since May of this year. Mr. Harto formerly was with SunTrust Bank in Sarasota from 1995-2000 where he served as Executive Vice President/Residential Lending Division Manager. He has over 15 years experience in all areas of mortgage production and mortgage operations.
Timothy J. Little (41) - Executive Vice President and Chief Credit Officer since September 2000. Mr. Little was Senior Vice President and West Coast Executive/Corporate Services for Huntington National Bank for two and one-half years. Previously, Mr. Little held numerous management, lending and credit administration positions with Barnett Bank for 12 years.
Rita J. Lowman (48) - Executive Vice President and Retail Line of Business Manager, has served in her present position with us since November 2000. Ms. Lowman joined Bank of America in 1985 and held various line, administrative and managerial positions including most recently, Consumer Executive/Senior Vice President of Southwest Florida.
Rudi Thompson (40) - Rudi Thompson joined Republic bank in March 2001 as Executive Vice President, Human Resources Director. Ms. Thompson previously served as Corporate First Vice President, Human Resources Relations Management for SunTrust Bank’s Central Florida Region.
Item 11.
Item 11. EXECUTIVE COMPENSATION
Information required by this item appears in our Proxy Statement for the 2002 Annual Meeting of Shareholders under the captions, “Executive Compensation and Benefits” and “Certain Transactions”, and is incorporated by reference.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item appears in the Proxy Statement for the 2002 Annual Meeting of Shareholders under the captions “Principal Stockholders” and “Security Ownership of Management” and is hereby incorporated by reference.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item appears in the Proxy Statement for the 2002 Annual Meeting of Shareholders under caption, “Certain transactions” and “Compensation Committee Interlocks and Insider Participation” and is hereby incorporated by reference.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To Republic Bancshares, Inc.:
We have audited the accompanying consolidated balance sheets of Republic Bancshares, Inc. (a Florida corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders’ equity, comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Republic Bancshares, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
Tampa, Florida,
January 28, 2002
REPUBLIC BANCSHARES, INC. & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands, except share data)
The accompanying notes are an integral part of these consolidated balance sheets
REPUBLIC BANCSHARES, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
($ in thousands, except per share data)
The accompanying notes are an integral part of these consolidated statements
REPUBLIC BANCSHARES, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
($ in thousands)
The accompanying notes are an integral part of these consolidated statements
REPUBLIC BANCSHARES, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
($ in thousands)
The accompanying notes are an integral part of these consolidated statements
REPUBLIC BANCSHARES, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in thousands)
The accompanying notes are an integral part of these consolidated statements
REPUBLIC BANCSHARES, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001
1. BUSINESS:
Basis of Presentation and Organization
The consolidated financial statements of Republic Bancshares, Inc. (the “Company” or “Republic” or “We”) include the accounts of the Company and its wholly owned subsidiaries, RBI Capital Trust I (“RBI”), and Republic Bank (the “Bank”) and the Bank’s wholly-owned subsidiary, Republic Insurance Agency, Inc. Financial data for 1999 includes results of operations for Republic Bank, F.S.B., the assets and deposits of which were sold in 1999 and the thrift was dissolved. All significant intercompany accounts and transactions have been eliminated. Our primary source of income is from the Bank, which operates 71 branches throughout Florida. The Bank’s primary source of revenue is derived from net interest income on loans and investments. The operations of the Company are reported as one operating segment.
Sale of Branches
On April 23, 2001, we completed the sale of five branch offices in Miami-Dade County, Florida, The loans assigned to the branches were purchased at par value, the fixtures and improvements and other assets assigned to four of the branches were purchased at their net book value and the buyer assumed $55.0 million of deposit liabilities of all five offices. We recognized a gain of $3.1 million on the transaction. There was no unamortized deposit premium associated with these branches.
On May 11, 2001, we completed the sale of two branch offices located in Lake City and Live Oak, Florida. The loans assigned to the branches were purchased at par value, the premises and other assets assigned to the two branches were purchased at their net book value and the buyer assumed $62.3 million of deposit liabilities. We recognized a gain of $1.4 million on the transaction, after deduction of the unamortized deposit premium paid to purchase the branches in 1998.
RBI Capital Trust I
RBI is our wholly owned subsidiary, formed on May 29, 1997, to issue cumulative trust preferred securities (the “Preferred Security or Securities”) to the public. We own all of the securities of RBI that possess general voting powers. The Preferred Securities, issued through a public offering on July 28, 1997, were sold at their $10 par value. RBI issued 2,875,000 shares of the Preferred Securities bearing a dividend rate of 9.10% for net proceeds of $27.4 million, after deducting underwriting commissions and other costs. RBI invested the proceeds in our junior subordinated debt, which also has an interest rate of 9.10%. The Junior Subordinated Debentures will mature on June 30, 2027 (the “Stated Maturity”), which date may be shortened to a date not earlier than June 30, 2002, if certain conditions are met (including the Company having received prior approval by the Board of Governors of the Federal Reserve System or any successor agency (the “Federal Reserve”) if then required under applicable Federal Reserve capital guidelines or policies). RBI’s sole asset is the holding company’s junior subordinated debt. Considered together, our obligations with respect to the issuance of the preferred securities constitute a full and unconditional guarantee by the bank holding company of RBI’s obligations with respect to the preferred securities. We used the proceeds from the junior subordinated debt to increase the Bank’s equity capital. Interest on the junior subordinated debentures and distributions on the Preferred Securities are payable
quarterly in arrears. Distributions on the Preferred Securities are cumulative and based upon the liquidation value of $10 per Preferred Security. We have the right, at any time, so long as no event of default has occurred and is continuing, to defer payments of interest on the junior subordinated debentures, which will require deferral of distribution on the Preferred Securities, for a period not exceeding 20 consecutive quarters, provided, that such deferral may not extend beyond the stated maturity of the junior subordinated debentures. If payments are deferred, we will not be permitted to declare cash dividends. The Preferred Securities are subject to mandatory redemption, in whole or in part, upon repayment of the junior subordinated debentures at maturity or their earlier redemption. We have the right to redeem the junior subordinated debentures in whole (but not in part) within 180 days following certain events whether occurring before or after June 30, 2002. The exercise of such right is subject to us receiving regulatory approval to do so if then required under applicable capital guidelines or regulatory policies. In addition, we have the right, at any time, to shorten the maturity of the junior subordinated debentures to a date not earlier than June 30, 2002. Exercise of this right is also subject to receiving regulatory approval to do so if then required under applicable capital guidelines or regulatory policies.
We have reported our obligation, with respect to the holders of the Preferred Securities, as a separate line item in the accompanying consolidated balance sheets under the caption “Company-obligated mandatorily redeemable preferred securities of subsidiary trust solely holding junior subordinated debentures of the Company”. The related dividend expense, net of the tax benefit, is reported as a separate line item in the accompanying consolidated statements of operations under the caption “Minority interest in income from subsidiary trust, net of tax”.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Estimates, Appraisals and Evaluations
The accompanying financial statements, in conformity with accounting principles generally accepted in the United States, requires management to make estimates, appraisals and evaluations of loans, other real estate owned and other assets and liabilities, and disclosure of contingent assets and liabilities. Changes in such estimates, appraisals and evaluations might be required because of rapidly changing economic conditions, changing economic prospects of borrowers and other factors. Actual results may differ from those estimates.
Securities
Securities that we have both the positive intent and ability to hold to maturity are classified as “Held to Maturity” and are carried at historical cost, adjusted for amortization of premiums and accretion of discounts. Securities classified as “Available for Sale” are those securities that may be sold prior to maturity as part of asset/liability management or in response to other factors and are carried at fair value with any unrealized gains or losses, net of applicable tax effect, reported in a separate component of stockholders’ equity. Securities identified as “Trading” include the subordinate tranche and the residual interests in cash flows from the securitization of High LTV Loans and the excess spread, interest-only strip related to securing first lien, residential loans. Trading securities are carried at fair value with any unrealized gains or losses included in the consolidated statements of operations under “Gain (loss) on loans and securities, net.”
Interest and dividends on securities and amortization of premiums and accretion of discounts using the effective interest rate method are together reported as interest income on securities. Gains and losses realized on sales of securities are generally determined on the specific identification method and are reported under “Gain (loss) on loans and securities, net”.
Accounting for Mortgage Servicing Rights (“MSR’s”)
MSR’s are carried at amortized cost and evaluated for impairment based on their fair value. We use an automated portfolio analysis system to value our MSR’s at the individual loan level. The model uses current market assumptions for default probabilities and prepayment speeds based upon individual loan factors, including interest rate, age, loan type, geography and demographics. The analysis also takes into consideration the historical aggregate characteristics of borrowers based on their geographic location. These factors are applied to each loan based on its own individual characteristics. The valuation is then stratified based upon predominant characteristics such as agency and interest rates to determine possible valuation losses within each category. We had no valuation allowances recorded for the years ended December 31, 2001 and 2000. The following table shows the amount of MSR’s which were capitalized and amortized, and the fair value of those assets as of December 31, for the periods indicated ($ in thousands):
Loans
Interest on commercial and real estate loans and substantially all installment loans is recognized monthly on the loan balance outstanding. Our policy is to discontinue accruing interest on loans 90 days or more delinquent and restructured loans that have not yet demonstrated a sufficient payment history, which, in our opinion, may be doubtful as to the collection of interest or principal. These loans are designated as “nonaccrual” and any accrued but unpaid interest previously recorded is reversed against current period interest income.
Loan origination and commitment fees, net of certain costs, are deferred and the amount is amortized as an adjustment to interest income using the effective interest rate method, generally over the contractual life of the loan. Unearned discounts and premiums on loans purchased are deferred and amortized as an adjustment to interest income on a basis that approximates level rates of return over the term of the loan.
Allowance for Loan Losses
The allowance for loan losses provides for risks of losses inherent in the credit extension process. Losses and recoveries are either charged or credited to the allowance. Our allowance is an amount that we believe will be adequate to absorb probable losses on existing loans that may become uncollectible, based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. The evaluations are periodically reviewed and adjustments are recorded in the period in which changes become known.
Accounting for Impairment of Loans
Our identification of loan impairment on an individual loan basis includes larger loans which are: (1) nonperforming and have been placed on non-accrual status; or (2) performing according to all contractual terms of the loan agreement but may have substantive indication of potential credit weakness. Other loans outside the scope of SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”, primarily smaller loans and loans of a homogeneous nature, are collectively evaluated for loss.
At December 31, 2001, $61.1 million of loans were considered impaired by us. Those loans required valuation allowances totaling $10.3 million, which are included within the overall allowance for loan losses at December 31, 2001. As of December 31, 2000, $53.4 million of loans were considered impaired by us. Approximately $45.9 million of these loans required valuation allowances, totaling $8.9 million, which were included within the overall allowance for loan losses at December 31, 2000.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets, except for leasehold improvements, where the lesser of the estimated useful life of the asset or the term of the lease is used. The useful lives used in computing depreciation and amortization are as follows:
Gains and losses on routine dispositions are reflected in current operations. Maintenance, repairs and minor improvements are charged to operating expenses, and major replacements and improvements are capitalized.
Other Real Estate (“ORE”)
ORE represents property acquired through foreclosure proceedings held for sale and real estate held for investment. ORE is net of a valuation allowance established to reduce cost to the lower of cost or fair value less to costs to sell. Losses are charged to the valuation allowance and recoveries are credited to the allowance. Declines in market value and gains and losses on disposal are reflected in current operations in ORE expense. Recoverable costs relating to the development and improvement of ORE are capitalized whereas routine holding costs are charged to expense.
Income Taxes
We follow the liability method, which establishes deferred tax assets and liabilities for the temporary differences between the financial reporting bases and the tax bases of our assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. Net deferred tax assets, whose realization is dependent on taxable earnings of future years, are recognized when a more-likely-than-not criterion is met, that is, unless a greater than 50% probability exists that the tax benefits will not actually be realized sometime in the future.
We file consolidated tax returns with the federal and state taxing authorities. A tax sharing agreement exists between us and our subsidiaries whereby taxes for the subsidiaries are computed as if the subsidiaries
were separate entities. Amounts to be paid or credited with respect to current taxes for the subsidiary are paid to or received from us.
Goodwill
Goodwill is an intangible asset, which represents the excess of the cost of an acquired enterprise over the fair market value of identifiable assets less the fair market value of liabilities acquired in purchase transactions. This goodwill was acquired in a 1997 acquisition and was being amortized on a straight-line basis over 10 years.
Premium on Deposits
A premium on deposits is recorded for the difference between cash received and the carrying value of deposits acquired in purchase transactions. This premium is being amortized on a straight-line basis over 10 years.
Time Deposits
Time deposits in amounts of $100,000 or more were $256.3 million as of December 31, 2001 and the scheduled maturities of those time deposits were as follows ($ in thousands):
Stock-Based Compensation Plans
We account for our stock-based compensation plans under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”. We adopted the disclosure option of SFAS No. 123, “Accounting for Stock-Based Compensation”, which requires that companies not electing to account for stock-based compensation as prescribed by the statement disclose the pro forma effects on earnings and earnings per share as if SFAS No. 123 had been adopted.
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the FASB issued SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as “derivatives”) and for hedging activities. It requires that entities recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. In June 1999, the FASB issued SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133”, which delayed the date for implementation to all fiscal quarters of all fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS
No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of SFAS No. 133”, which amends the accounting and reporting standards of SFAS No. 133 for certain derivative instruments and certain hedging activities. The adoption of SFAS No. 133, on January 1, 2001, did not have a material effect upon our results of operations or financial position.
Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of SFAS No. 125)
In September 2000, the FASB issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of SFAS No. 125)”. SFAS No. 140 revised the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but carries over most of SFAS No. 125’s provisions without consideration. SFAS No. 140 was effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001, and required additional disclosures relating to previous securitization transactions and collateral activity for the fiscal years ending after December 15, 2000. The adoption of SFAS No. 140 did not have a material effect upon our results of operations or financial position.
Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interest in Securitized Financial Assets
In January 2001, the Emerging Issues Task Force issued EITF 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets”, which provides guidance on the method used for the recognition and measurement of interest income and impairment of those retained interests. EITF 99-20 was effective for quarterly periods after March 15, 2001. The adoption of EITF 99-20 did not have a material effect upon our results of operations or financial position.
Financial Accounting and Reporting for Goodwill and Other Intangible Assets Acquired in a Business Combination at Acquisition
On July 20, 2001, the FASB issued SFAS No. 141, “Business Combinations”, and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 addresses financial accounting and reporting for goodwill and other intangible assets acquired in a business combination at acquisition. SFAS No. 141 requires the purchase method of accounting to be used for all business combinations initiated after June 30, 2001; establishes specific criteria for the recognition of intangible assets separately from goodwill; and requires unallocated negative goodwill to be written off immediately as an extraordinary gain (instead of being deferred and amortized). SFAS No. 142 addresses financial accounting and reporting for intangible assets acquired individually or with a group of other assets (but not those acquired in a business combination) at acquisition. SFAS No. 142 also addresses financial accounting and reporting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that goodwill will not be amortized but rather will be tested at least annually for impairment. It also provides that intangible assets that have finite useful lives will continue to be amortized over their useful lives, but those lives will no longer be limited to 40 years. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001, and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The provisions of SFAS No. 142 are effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 141 and SFAS No. 142 are not expected to have a material effect upon our financial position or results of operations.
Accounting for the Impairment or Disposal of Long-Lived Assets
In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 replaces SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of” and amends APB Opinion No. 30, “Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequent Occurring Events and Transactions”. SFAS No. 144 addresses the financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early application encouraged. The adoption of SFAS No. 144 is not expected to have a material effect upon our results of operations or financial position.
Accounting by Certain Entities (Including Entities with Trade Receivables) that Lend to or Finance the Activities of Others
In December 2001, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 01-6, “Accounting by Certain Entities (including Entities with Trade Receivables) that Lend to or Finance the Activities of Others”. SOP 01-6 clarifies that accounting and financial reporting practices for lending and financing activities should be the same regardless of the type of entity engaging in those activities and conforms, where appropriate, differences among the accounting and financial reporting provisions previously established by certain AICPA Audit and Accounting guides. SOP 01-6 is effective for fiscal years beginning after December 15, 2001. The adoption of SOP 01-6 is not expected to have a material effect upon our results of operations or financial position.
Cash Equivalents
For purposes of preparing the consolidated statements of cash flows, cash equivalents are defined to include cash and due from banks, interest bearing deposits and federal funds sold.
Reclassifications
Certain reclassifications have been made to prior period financial statements to conform to the 2001 financial statement presentation.
3. SECURITIES:
Our securities consisted primarily of mortgage-related securities (“MBS”) with a lesser amount of U.S. Treasury Securities, U.S. Agency Securities and Revenue Bonds. MBS, sometimes referred to as pass-through certificates, represent an interest in a pool of loans. The majority of the MBS securities in our portfolio are issued by three government agencies or corporations: (1) the Government National Mortgage Association (“GNMA”); (2) the Federal Home Loan Mortgage Corporation (“FHLMC”); and (3) the Federal National Mortgage Association (“FNMA”). During 2001, 2000 and 1999, we securitized conventional and government insured first lien mortgage loans with carrying values at securitization of $81.3 million, $0 and $85.6 million, respectively. Securities held to maturity are recorded at amortized cost, while securities available for sale and trading are recorded at estimated fair value.
The securities portfolio at December 31, 2001 and 2000, is summarized as follows ($ in thousands):
The amortized cost, estimated fair value and weighted average yield of securities at December 31, 2001, grouped by stated maturity of the security are shown below ($ in thousands):
Proceeds from sales of securities during the years ended December 31, 2001, 2000 and 1999 were $324.8 million, $42.4 million and $0, respectively. Gross gains of $2.7 million, $245,000 and $0 and gross losses of $2,100, $5,200 and $0, respectively, were realized on these sales. Securities with book and fair values of $82.7 million and $83.7 million, respectively, were pledged to secure repurchase agreements at December 31, 2001. The fair values assigned to the MBS classified as available for sale were derived using market quotations at December 31, 2001. Net unrealized holding losses on trading securities of $4.0 million, $13.5 million, and $470,000 were included in income during 2001, 2000, and 1999, respectively.
Securitized Financial Assets
At December 31, 2001, the trading asset category included a $10.9 million subordinate tranche purchased from our securitization of High LTV Loans in June 1998, $5.9 million in overcollateralization and residual interests in cash flows from securitizations in December 1997 and June 1998 and $3.2 million of excess servicing interest-only strips. We have recorded these assets at our estimate of their fair value. The other assets category on our balance sheet included $10.2 million of MSR’s.
Trading assets are evaluated at least quarterly with any valuation adjustment reflected as a trading gain or loss in the consolidated statement of operations under the caption “Gain (loss) on loans and securities, net”. Under generally accepted accounting principles, use of quoted market values is the preferred method for valuing trading assets. However, where the market for those assets is illiquid and price quotations are not readily available, other methods are permitted, including techniques utilizing the present value of expected cash flows to value our trading assets. We have used a present value methodology to value trading assets.
The accounting estimates and judgements used in the valuation of the residual interests from the December 1997 and June 1998 securitizations are summarized as follows ($ in thousands):
(1)
Expressed as the percent of total defaults over the expected life of the collateral to the initial collateral amount.
The following schedule summarizes the status and activity on the assets which are collateral for the two securitizations ($ in thousands):
Sensitivity in the Valuation of Securitized Financial Assets - The market values of the securities resulting from securitization of financial assets are extremely sensitive to changes in the assumptions used to calculate the expected cash flows from those assets. The measurements of the sensitivities presented are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on selected variations in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on fair value is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another factor (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.
Residual Interests in Cashflows from Securitizing High LTV Loans - Our approximation of the resulting fair values and the change from the current valuation due to two alternative changes in the discount rate, the prepayment speed and the cumulative lifetime default are as follows ($ in thousands):
MSR’s and Excess Servicing Interest-Only Strips - Our MSR’s at December 31, 2001 were $10.2 million representing the capitalized value of the rights to service $637.9 million of loans. Our excess servicing interest-only strips were $3.2 million representing the capitalized value of the rights to service $258.7 million of loans (the $258.7 million of loans with excess servicing is included in the overall $637.9 million servicing portfolio amount).
At December 31, 2001, the estimated fair value of the MSR’s was $12.9 million. The excess servicing interest-only strips were stated at their fair value of $3.2 million. Both assets are sensitive to changes in economic conditions, particularly changes in the expected offering rates for new mortgage loans which determine expected prepayment speeds, one of the major components of the valuation. We perform the sensitivity analysis on the MSR’s and the excess servicing interest-only strips as one combined asset. Our estimate of the change in fair value at December 31, 2001 for a given change in loan offering rates was as follows:
4. LOANS:
Loans at December 31, 2001 and 2000, are summarized as follows ($ in thousands):
Mortgage loans serviced for others as of December 31, 2001 and 2000, were $638.0 million and $1.3 billion respectively. Loans on which interest was not being accrued totaled approximately $46.2 million, $49.4 million, and $25.0 million at December 31, 2001, 2000 and 1999, respectively. Had interest been accrued on these loans at their originally contracted rates, interest income would have been increased by approximately $4.3 million, $3.1 million, and $3.0 million in the years ended December 31, 2001, 2000 and 1999, respectively. Loans past due 90 days or more and still accruing interest at December 31, 2001 and 2000, totaled approximately $12,000 and $1.2 million respectively. Restructured loans totaled $773,000 and $1.5 million during 2001 and 2000, respectively.
5. ALLOWANCE FOR LOAN LOSSES:
Changes in the allowance for loan losses were as follows ($ in thousands):
6. PREMISES AND EQUIPMENT:
Premises and equipment, net of accumulated depreciation and amortization at December 31, 2001 and 2000, included ($ in thousands):
Depreciation expense for 2001, 2000 and 1999 was $6.0 million, $6.9 million and $7.1 million, respectively.
7. OTHER REAL ESTATE:
The carrying value of loans converted to ORE through foreclosure proceedings totaled $19.0 million, and $7.9 million, for the years ended December 31, 2001 and 2000, respectively. Sales of ORE that were financed by us totaled $0 and $443,000 for the years ended December 31, 2001 and 2000, respectively.
Changes in the valuation for ORE were as follows ($ in thousands):
State banking regulations require us to dispose of all ORE acquired through foreclosure within five years of acquisition, with a possibility for additional extensions, each of up to five years. There are no properties that have exceeded the five-year holding period limitation.
8. INCOME TAXES:
The income tax provision or benefit, excluding the income tax benefit related to the minority interest from subsidiary trust, was comprised of the following ($ in thousands):
At December 31, 2001, we had approximately $5.4 million of remaining federal and $6.3 million of state net operating loss carryforwards. These carryforwards expire in the years 2005 through 2019. Recognition of net operating loss carryforwards incurred prior to 1998 are limited to approximately $732,000 each year under the rules of Internal Revenue Code Section 382. If the full amount of the limitation is not used in any years, the amount not used increases the allowable limit in the subsequent year.
Through mergers in 1997 and 1998, we acquired unrecognized deferred tax liabilities of approximately $3.2 million, and $86,000, respectively, related to base year reserves calculated under the thrift bad debt percentage method. If during any taxable year, we cease to be a bank, these reserves shall be taxed ratably over the six taxable year period beginning with such taxable year.
Our effective tax rate varies from the statutory rate of 34%. The reasons for this difference are as follows ($ in thousands):
Temporary differences created the following deferred tax assets and liabilities at December 31, 2001 and 2000 ($ in thousands):
An amount relating to the unrealized gain on available for sale securities, which is recorded directly to stockholders’ equity, and is a component of comprehensive income, increased by $2.0 million and $4.2 million, in 2001 and 2000, respectively.
9. OTHER BORROWINGS:
FHLB Advances
At December 31, 2001, we were required by our collateral agreement with the FHLB to maintain qualifying first mortgage loans in an amount equal to at least 100% of the FHLB advances outstanding as collateral. The FHLB advances at December 31, 2001 and 2000 were collateralized by such loans and securities totaling $52.3 million and $761,000, respectively, with an unused credit line of $396.5 million at December 31, 2001. In addition, all of our FHLB stock is pledged as collateral for such advances.
Maturities and average interest rates of advances from the FHLB as of December 31, 2001 and 2000, were as follows ($ in thousands):
7% Convertible Subordinated Debt Due 2014
In September 1999, we completed a private placement of $15.0 million 7.0% convertible subordinated debentures that mature on October 1, 2014 (the “1999 Debentures”) Each $1,000 principal amount of the 1999 Debentures is convertible at any time by the holder into 55.55556 shares of our $2.00 par value common stock (a conversion price of $18.00 per share). We can redeem the 1999 Debentures at any time after October 1, 2004 at fixed redemption prices. The 1999 Debentures may also be redeemed by us without a premium if the closing price of our common stock equals or exceeds $23.40 for 20 consecutive trading days.
7% Convertible Subordinated Debentures Due 2011
In May 2001, we completed a private placement of $15.0 million 7% convertible subordinated debentures maturing April 1, 2011 (the “2001 Debentures”). Each $1,000 principal amount of the 2001 Debentures is convertible by the holder at any time into 64.1026 shares of our $2.00 par value common stock (a conversion price of $15.60 per share). The 2001 Debentures can be redeemed by us at any time after April 1, 2003, without payment of any premium, provided the closing bid price of our common stock for not less than 20 consecutive trading days equals or exceeds $20.28. Regardless of the closing bid price of our common stock, we can redeem the 2001 Debentures at any time after April 1, 2006 at fixed redemption prices. The 2001 Debentures are subordinate to the 1999 Debentures. The net proceeds from the 2001 Debentures were used to repay $10.0 million of outstanding debt and the balance was used for general corporate purposes.
Holding Company Senior Debt, Term Subordinated Debt and Unsecured Notes
During 2001 we repaid all of our holding company senior debt, term subordinated debt and unsecured notes to one of our directors.
Holding Company Senior Debt - The holding company senior debt had a balance of $6.8 million at the end of 2000. The senior debt was originally borrowed in September 1998 in the amount of $25.0 million and was guaranteed by Mr. William R. Hough, our Chairman of the Board and principal shareholder. In September 1999, we paid down the principal amount by $15.0 million to a balance of $10.0 million using the net proceeds from sale of the 1999 Debentures, extended the maturity to March 31, 2001 and amended the terms so as to require monthly principal payments of $278,000 plus interest and a $5.0 million balloon payment on March 24, 2001. In December 2000, we further restructured the senior debt, made a $2.0 million payment in January 2001, with the $4.8 million remainder to be fully amortized over an 18-month period beginning in January 2001. The balance was paid off in May 2001 with the net proceeds from the 2001 Debentures.
Term Subordinated Debt - The term subordinated debt had a balance of $2.8 million at the end of 2000. In December 1998, we borrowed $7.0 million from certain members of our board of directors on an unsecured basis. In September 1999, we refinanced the unsecured debt to our directors by exchanging with them $4.3 million of the 1999 Debentures and $2.7 million non-convertible term subordinated debt, maturing in 2006. The term subordinated debt was paid off in May 2001 with the net proceeds from the 2001 Debentures.
Unsecured Notes -In 2000, we borrowed $3.5 million on an unsecured, revolving line of credit basis from Mr. William R. Hough, individually. The proceeds were used for holding company debt service. The loan was amended in December 2000 to extend the maturity to October 1, 2002. The unsecured notes to Mr. Hough totaling $3.5 million were paid off in May 2001 with the net proceeds from the 2001 Debentures.
10. CREDIT RISK CONCENTRATION, OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES
Loans Outside Florida
The majority of the loans outside Florida are located in the states of California, Texas, Georgia, and in the northeastern United States. At December 31, 2001, the composition of our loan portfolio, according to the location of the borrower or the real estate taken as underlying collateral, was as follows ($ in thousands):
(1)
New England has been defined by us to include the states of Connecticut, Delaware, Maine, Massachusetts, New Hampshire, Rhode Island and Vermont.
Off-Balance-Sheet Items
We enter into financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit, commercial and standby letters of credit and unfunded lines of credit. These instruments involve, to varying degrees, elements of credit and interest-rate risks that are not recognized in the accompanying consolidated balance sheets.
Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments discussed above is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.
A summary of financial instruments with off-balance-sheet risk at December 31, 2001, is as follows ($ in thousands):
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary upon extension of credit is based on our credit evaluation of the counter party. Collateral held varies but may include premises and equipment, inventory and accounts receivable. Unfunded lines of credit represent the undisbursed portion of lines of credit, which have been extended to customers.
Commercial and standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party, which typically do not extend beyond one year. The credit risk involved in issuing letters of credit is essentially the same as those involved in extending loan facilities to customers. Outstanding, unsecured standby letters of credit at December 31, 2001, totaled approximately $3.3 million.
Commitments
We have entered into a number of non-cancelable operating leases primarily for branch banking locations. At December 31, 2001, minimum rental commitments based on the remaining noncancelable lease terms were as follows ($ in thousands):
Total rent expense for the years ended December 31, 2001, 2000 and 1999, was $5.6 million, $5.6 million, and $6.0 million, respectively. Total rental income from subleases for the years ended December 31, 2001, 2000 and 1999, was $558,000, $1.1 million, and $909,000, respectively. In addition, we are obligated to make processing payments in relation to our computer facilities of approximately $1.8 million in 2002.
Contingencies
We are subject to various legal proceedings in the ordinary course of business. Based on information presently available, we do not believe that the ultimate outcome in such proceedings, in the aggregate, would have a material adverse effect on our financial position or results of operations.
11. EMPLOYEE BENEFIT PLANS:
We have a 401(k) retirement plan that covers substantially all employees. Our contributions were $214,000, $230,000, and $268,000 in the years ended December 31, 2001, 2000 and 1999, respectively.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS:
Generally, our practice and intent is to hold our financial instruments to maturity, unless otherwise designated. Where available, quoted market prices are used to determine fair value, however, most of our financial instruments lack quoted market prices. We have incorporated what we consider appropriate estimation methodologies for those financial instruments which lack quoted market prices which requires that a significant number of assumptions be used to determine fair value. Those assumptions include subjective assessments of current market conditions and perceived risks associated with financial instruments, among other things. A user of these financial statements might consider different assumptions to be more appropriate which could have a significant effect on the resulting estimated fair value. The estimated fair values presented neither include nor give effect to the intangible values associated with our business, existing customer relationships, and branch banking network, among other things.
The following estimates of the fair value of financial instruments held by us include only those instruments that could reasonably be evaluated. Cash and due from banks and federal funds sold were valued at cost. The securities portfolio was evaluated using market quotes, where available or fair market values based on a present value of cash flows technique. The fair value of the loan portfolio was evaluated using the present value of cash flows, after adjusting for credit deterioration and prepayment assumptions, based upon current rates we would use in extending credit with similar characteristics. These rates may not necessarily be the same as those which might be used by other financial institutions for similar loans. The value of our mortgage servicing rights was determined using the discounted cash flows of net income from servicing. The fair values disclosed for checking accounts, savings accounts, securities sold under agreements to repurchase, and certain money market accounts are, by definition, equal to the amount payable on demand at the reporting date. Fair values for time deposits and other borrowings are estimated using a discounted cash flow calculation that applies current interest rates to aggregated expected maturities. Standby letters of credit and commitments to extend credit typically result in loans with a market interest rate when funded. The recorded book value of deferred fee income approximates fair value.
These evaluations may incorporate specific value to us in accordance with our asset/liability strategies, interest rate projections and business plans at a specific point in time and therefore, should not necessarily be viewed as liquidation value. They should also not be used in determining our overall value as they exclude intangible aspects such as business and franchise value. The table below illustrates the estimated fair value of our financial instruments as of December 31, using the assumptions described above ($ in thousands):
13. STOCKHOLDERS’ EQUITY:
Perpetual Preferred Convertible Stock
In the second quarter of 2001, all of the holders of the Company’s 75,000 shares of perpetual preferred stock converted their holdings into the Company’s common stock, increasing the number of common shares outstanding by 750,000. The preferred stock had a liquidation preference of $88 per share and carried a noncumulative dividend of $3.52 per year, which was paid quarterly. The holders of the preferred stock voted with the holders of the common stock and were entitled to 10 votes per each share of preferred stock.
Dividends
Florida statutes limit the amount of dividends we can pay in any given year to that year’s net income plus retained net income from the two preceding years. Additionally, we cannot pay dividends if payment would cause us to be undercapitalized as defined by federal regulations.
The terms of our convertible subordinated debt require that we maintain unrestricted cash in the holding company equivalent to the next two interest payments as a prerequisite to paying common stock dividends. Under the Florida Financial Institutions Code, the prior approval of the Department is required if the total of all dividends declared by a bank in any calendar year exceeds the sum of the bank’s net profits for that year and its retained net profits for the preceding two years. As of January 1, 2002, there was a net retained deficit for dividend payment purposes of $9.5 million. The holding company had $6.9 million of unrestricted cash available to it for debt service. Our annual debt service requirement is approximately $4.7 million per year.
Non-qualified Stock Options
The board of directors may grant nonqualified options each year. As of December 31, 2001, 117,400 of such options were outstanding. The per share exercise price of each stock option is determined by the board of directors at the date of grant, vesting over a five year period.
1995 Incentive Stock Option Plan
On April 29, 1994, the shareholders approved a qualified incentive stock option plan for certain key employees. In 1995, the stockholders adopted the Republic Bancshares, Inc. 1995 Stock Option Plan (the “Plan”) as a replacement for the 1994 Stock Option Plan. The total number of shares that may be purchased pursuant to the Plan cannot exceed 1,125,000 shares over the life of the Plan and provides that the maximum number of options granted to any one individual in any fiscal year under the Plan cannot exceed 62,000. There is no limitation on the annual aggregate number of options to be granted in any fiscal year. Each option granted under the Plan will be exercisable by the grantee during a term, not to exceed 10 years, fixed by the compensation committee of the board of directors (the “Committee”). However, no more than 20% of the shares subject to such options shall vest annually beginning at date of grant. In the event of a change in control, or termination of employment without cause, all options granted become exercisable immediately. As of December 31, 2001, any performance options previously granted had all either been exercised or have expired.
Upon the grant of an option to a key employee, the Committee will fix the number of shares of common stock that the grantee may purchase upon exercise of the option, and the price at which the shares may be purchased. The exercise price for all options shall not be less than the fair market value at the date of the option grant. As of December 31, 2001, 627,860 options remained outstanding under this plan, with 288,994 shares available to be granted at a future time.
1997 Stock Appreciation Rights Plan
On October 21, 1997, the board of directors approved a Stock Appreciation Rights Plan (the “SAR Plan” and “SAR’s”). Under the SAR Plan, certain key employees have been granted the right to receive cash equal to the excess of the fair market value of a share of our common stock at the time of exercise, over the fair market value of a share of our common stock at date of grant, times the number of rights exercised. As of December 31, 2001, 17,900 SAR’s granted at the then current market value of $26.675 remained outstanding. No more than 20% of the SAR’s may vest annually, beginning at date of grant. The term of a SAR may vary, but shall not be less than one year or more than 10 years from the date of grant.
We record compensation expense equal to the appreciation of the fair market value of the stock times the number of outstanding SAR’s. As of December 31, 2001 and 2000, there had been no appreciation of our common stock over the fair market value at date of grant. Therefore, compensation expense has been recorded only for those rights which have been exercised.
Aggregate Stock Option Activity
We have adopted SFAS No. 123 for disclosure purposes only. The fair value of each option grant has been estimated as of the date of grant using an option pricing model with the following assumptions (weighted averages) for 2001, 2000 and 1999: risk-free interest rate of 4.54%, 5.08% and 6.34%, respectively, expected life of seven years, dividend rate of zero percent, and expected volatility of 32.1% for 2001, 41.1% for 2000 and 24.0% for 1999. The approximate fair value of the stock options granted in 2001, 2000, and 1999 is $806,000, $1.3 million and $2.9 million, respectively, which would be amortized as compensation expense over the five year vesting period of the options.
Had compensation cost been determined consistent with SFAS No. 123, utilizing the assumptions detailed above, our net income (loss) and earnings (loss) per share, as reported, would have been the following pro forma amounts ($ in thousands except share data):
A summary of the status of our stock option plans at December 31, 2001, 2000 and 1999, and for the years then ended is presented in the table below:
14. EARNINGS (LOSS) PER SHARE:
Net Income (Loss) Per Common and Common Equivalent Share
Diluted earnings (loss) per common and common equivalent shares have been computed by dividing net income (loss) by the weighted average common and common equivalent shares outstanding during the periods. The weighted average common and common equivalent shares outstanding has been adjusted to include the number of shares that would have been outstanding if the stock options had been exercised, at the average market price for the period, with the proceeds being used to buy shares from the market (i.e., the treasury stock method) and the perpetual preferred convertible stock and the convertible subordinated debentures had been converted to common stock at the earlier of the beginning of the year or the issue date (i.e., the if-converted method). Basic earnings (loss) per common share was computed by dividing net income (loss) less dividends paid on the perpetual preferred convertible stock, by the weighted average number of shares of common stock outstanding during the year. During 2001, there were 627,860 stock options and 1,794,872 shares related to convertible subordinated debt which would have been antidilutive. During 2000, there were 645,317 stock options, 833,334 shares related to convertible subordinated debt and 750,000 shares related to convertible preferred stock, which would have been antidilutive. During 1999, there were 298,140 stock options and 833,334 shares related to convertible subordinated debt, which were antidilutive.
Diluted and basic earnings per share in 2001 and 2000 were identical. The table below reconciles the calculation of diluted and basic earnings per share for 1999 ($ in thousands, except share data):
15. REGULATORY CAPITAL REQUIREMENTS:
We are required to comply with the three basic measures of capital adequacy established by the Federal Reserve and the FDIC, two risk-based measures and a leverage measure. All three applicable capital standards must be satisfied for a bank holding company or a bank to be considered in compliance.
The minimum guidelines for the ratio (“Risk-Based Capital Ratio”) of total capital (“Total Capital”) to risk-weighted assets (including certain off-balance-sheet items, such as standby letters of credit) is 8.0%. At least half of Total Capital (i.e., 4.0% of risk-weighted assets) must be comprised of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred convertible stock, and a limited amount of cumulative perpetual preferred convertible stock, less goodwill and certain other intangible assets (“Tier 1 Capital”). The remainder may consist of subordinated debt, other preferred stock, and a limited amount of loan loss reserves (“Tier 2 Capital”). In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio (the “Leverage Ratio”) of Tier 1 Capital to average assets, less goodwill and certain other intangible assets, of 3.0% for banks that meet certain specified criteria,
including having the highest regulatory rating. All other bank holding companies generally are required to maintain a Leverage Ratio of at least 3.0%, plus an additional margin of 100 to 200 basis points. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the Federal Reserve has indicated that it will consider a “tangible Tier I Capital leverage ratio” (deducting all intangibles) and other indicators of capital strength in evaluating proposals for expansion or new activities.
Failure to meet capital guidelines could subject us to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on the taking of brokered deposits, and certain other restrictions on our business. Substantial additional restrictions can be imposed upon FDIC-insured depository institutions that fail to meet applicable capital requirements under the federal prompt corrective action regulations.
As of December 31, 2001 and 2000, we were considered “well capitalized” according to the federal banking agencies’ guidelines. The table which follows sets forth the amounts of capital and capital ratios as of December 31, 2001 and 2000, and the applicable regulatory minimums ($ in thousands):
16. RELATED PARTY TRANSACTIONS:
Mr. William R. Hough, is chairman of the board of the Company, a director of the Company and the Bank, and our largest shareholder. Mr. Hough is also Chairman Emeritus and the controlling shareholder of William R. Hough & Co. (“WRHC”), a NASD-member investment-banking firm. During 1999, we entered into an agreement with WRHC whereby they would act as our agent in open-market purchases and sales of securities. WRHC is compensated under that agreement on a commission basis. During 2001, 2000 and 1999, we purchased $725.6 million, $114.8 million and $241.3 million respectively, of securities through WRHC and sold $285.9 million, $41.2 million and $0 of securities through WRHC. We also periodically purchase securities under agreement to repurchase at a rate based on the prevailing federal funds rate and one-eighth of one percent, per an agreement entered into on August 15, 1995. There were no such securities purchased from WRHC at December 31, 2001 and 2000.
In 2000, we had borrowed from Mr. Hough, individually, $3.5 million on an unsecured, revolving line of credit basis and $1.5 million via term subordinated debt. The proceeds were used for holding company debt service. On May 8, 2001, we repaid both obligations in full.
WRHC participated as a selling agent in the placement of the $15.0 million of convertible subordinated debentures due 2011 (the “Debentures”) that were issued on May 8, 2001 and was paid an $89,000 fee for its sales efforts. Mr. Hough, individually, purchased $3.7 million of the Debentures. No fee was paid on sale of the Debentures to Mr. Hough or to any other of our directors who purchased the Debentures. In September 1999, WRHC acted as sales agent for a private placement to accredited investors of $15.0 million of our 7.0% convertible subordinated debentures (the “Debentures”) maturing on October 1, 2014. WRHC was paid fees in an amount equal to $215,000 and were reimbursed for their out-of-pocket expenses.
WRHC offers sales of insurance and mutual fund products and investment advisory services on our premises. Previously we were paid a commission based on the net profits earned from sales of investment products on our premises. For 2001, that arrangement was amended so that commissions paid to us would be based on gross revenues. Fee income earned from this relationship was $190,700 and $250,400 during 2001 and 2000, respectively.
Certain other directors and executive officers, members of their immediate families, and entities with which such persons are associated are customers of ours. As such, they had transactions in the ordinary course of business with us. All loans and commitments to lend included in those transactions were made in the ordinary course of business, upon substantially the same terms. Features including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and, in our opinion, have not involved more than the normal risk of collectibility or presented other unfavorable features.
17. BANK HOLDING COMPANY FINANCIAL STATEMENTS:
Republic Bancshares, Inc.
Parent-Only Condensed Balance Sheets
($ in thousands)
Republic Bancshares, Inc.
Parent-Only Condensed Statements of Operations
($ in thousands)
Republic Bancshares, Inc.
Parent-Only Condensed Cash Flow Statements
($ in thousands)
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, we have duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
REPUBLIC BANCSHARES, INC.
By: /s/ William R. Klich
William R. Klich
President and Chief Executive
Officer
Date: March 5, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
INDEX TO EXHIBITS
23.0 Consent of Independent Certified Public Accountants