Item 1. Description of Business
GENERAL
NB&T Financial Group, Inc. (“NB&T Financial” or the “Company”), an Ohio corporation, is a financial holding company which owns all of the issued and outstanding common shares of The National Bank and Trust Company, chartered under the laws of the United States (the “Bank”). The Bank is engaged in the commercial banking business in southwestern Ohio, providing a variety of consumer and commercial financial services. The primary business of the Bank consists of accepting deposits, through various consumer and commercial deposit products, and using such deposits to fund consumer loans, including automobile loans, loans secured by residential and non-residential real estate, and commercial and agricultural loans. All of the foregoing deposit and lending services are available at each of the Bank’s full-service offices. The Bank also has a trust department with assets under management of approximately $177.4 million. As of December 31, 2006, the Bank had 223 employees.
In 2006, the Company sold its Ada branch office, which had approximately $19.4 million in deposits. In addition, the Company closed its West Union office but serves the customers of that office from another branch office.
The Bank also operates its wholly-owned subsidiary, NB&T Insurance Agency, Inc. (“NB&T Insurance”). NB&T Insurance has four locations, with its principal office in Wilmington, Ohio. NB&T Insurance sells a full line of insurance products, including property and casualty, life, health, and annuities.
As a registered bank holding company and financial holding company under the Bank Holding Company Act, NB&T Financial is subject to regulation, examination and oversight by the Board of Governors of the Federal Reserve System (the “FRB”). The Bank, as a national bank, is subject to regulation, examination and oversight by the Office of the Comptroller of the Currency (the “OCC”) and special examination by the FRB. The Bank is a member of the Federal Reserve Bank of Cleveland. In addition, since its deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”), the Bank is also subject to some regulation, oversight and special examination by the FDIC. The Bank must file periodic financial reports with the FDIC, the OCC and the Federal Reserve Bank of Cleveland. Examinations are conducted periodically by these federal regulators to determine whether the Bank and NB&T Financial are in compliance with various regulatory requirements and are operating in a safe and sound manner.
Since its incorporation in 1980, NB&T Financial’s activities have been limited primarily to holding the common shares of the Bank. Consequently, the following discussion focuses primarily on the business of the Bank.
Lending Activities
General. The Bank’s income consists primarily of interest income generated by lending activities, including the origination of loans secured by residential and nonresidential real estate, commercial and agricultural loans, and consumer loans. Please refer to Table 7 on page 19, which summarizes the loan portfolio mix.
Commercial and Industrial Lending. The Bank originates loans to businesses in its market area, including “floor plan” loans to automobile and agricultural equipment dealers and loans guaranteed by the Small Business Administration. The typical commercial borrower is a small to mid-sized company with annual sales under $5,000,000. The majority of commercial loans are made at adjustable rates of interest tied to the prime rate. Commercial loans typically have terms of up to five years. Commercial and industrial lending entails significant risks. Such loans are subject to greater risk of default during periods of adverse economic conditions. Because such loans are secured by equipment, inventory, accounts receivable and other non-real estate assets, the collateral may not be sufficient to ensure full payment of the loan in the event of a default.
Commercial Real Estate. The Bank makes loans secured by commercial real estate located in its market area. Such loans generally are adjustable-rate loans for terms of up to 20 years. The types of properties securing loans in the Bank’s portfolio include warehouses, retail outlets and general industrial use properties. Commercial real estate lending generally entails greater risks than residential real estate lending. Such loans typically involve larger balances and depend on the income of the property to service the debt. Consequently, the risk of default on such loans may be more sensitive to adverse economic conditions. The Bank attempts to minimize such risks through prudent underwriting practices.
Real Estate Construction. The Bank originates loans for the purpose of constructing both commercial and residential buildings. The Company offers both construction-phase-only and permanent financing.
Agricultural Loans. The Bank makes agricultural loans, which include loans to finance farm operations, equipment purchases, and land acquisition. The repayment of such loans is significantly dependent upon income from farm operations, which can be adversely affected by weather and other physical conditions, government policies and general economic conditions.
Residential Real Estate. The Bank makes loans secured by one-to four-family residential real estate and multi-family (over four units) real estate located in its market area. The Bank originates both fixed-rate mortgage loans and adjustable-rate mortgage loans (“ARMs”) to meet the needs of its customers. The Bank will sell loans in the secondary market it does not intend to hold for the foreseeable future.
Installment Loans. The Bank makes a variety of consumer installment loans, including home equity loans, automobile loans, recreational vehicle loans, and overdraft protection. Beginning in the third quarter of 2006, the Company significantly reduced its indirect lending activities. Consumer loans involve a higher risk of default than loans secured by one- to four-family residential real estate, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciating assets, such as automobiles. Various federal and state laws, including federal and state bankruptcy and insolvency laws, may also limit the amount that can be recovered on such loans.
Credit Card Service. The Bank offers credit card services through a correspondent bank.
Loan Processing. Loan officers are authorized by the Board of Directors to approve loans up to specified limits. Loans exceeding the loan officers’ approval authority are referred to the Bank’s Senior Loan Committee. Any loans made by the Bank in excess of the limits established for the Senior Loan Committee must be approved by the Chairman of the Board and the President of the Bank as representatives of the Board of Directors. All loans in excess of $50,000 are reported to the Board on a monthly basis.
Loan Originations, Purchases and Sales. Although the Bank generally does not purchase loans, purchases could occur in the future. Residential real estate loans are originated for sale in the secondary market. From time to time, the Bank sells participation interests in loans it originates.
Allowance for Loan Losses. Federal regulations require that the Bank establish prudent general allowances for loan losses. Senior management, with oversight responsibility provided by the Board of Directors, reviews on a monthly basis the allowance for loan losses as it relates to a number of relevant factors, including but not limited to, historical trends in the level of non-performing assets and classified loans, current charge-offs and the amount of the allowance as a percent of the total loan portfolio. While management believes that it uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments, and net earnings could be significantly affected if circumstances differ substantially from the assumptions used in making the final determination.
Investment Activities
Funds not used in the Bank’s lending or banking function are dedicated to the investment portfolio. Those funds will be placed in investment programs approved by the Asset/Liability Management Committee (ALCO). The deployment of these funds will be consistent with the overall strategy and risk profile of the Bank. The Bank primarily invests in high-quality securities to provide sufficient liquidity, secure pledged deposits, minimize current tax liability, and increase earnings.
Trust Services
The Bank received trust powers in 1922 and had approximately $177.4 million in assets under management at December 31, 2006 in the Trust Department. These assets are not included in the Bank’s balance sheet because, under federal law, neither the Bank nor its creditors can assert any claim against funds held by the Bank in its fiduciary capacity. In addition to administering trusts, the services offered by the Trust Department include investment purchase and management, estate planning and administration, tax and financial planning and employee benefit plan administration.
Deposits and Borrowings
General Deposits have traditionally been the primary source of the Bank’s funds for use in lending and other investment activities. In addition to deposits, the Bank derives funds from interest payments and principal repayments on loans and income on earning assets. Loan payments are a relatively stable source of funds, while deposit inflows and outflows fluctuate more in response to general interest rates and money market conditions.
Deposits Deposits are attracted principally from within the Bank’s market area through the offering of numerous deposit instruments, including checking accounts, savings accounts, money market deposit accounts, and term certificate accounts. Interest rates paid, maturity terms, service fees and withdrawal penalties for the various types of accounts are established periodically by the Bank’s Asset/Liability Committee and the Executive Committee based on the Bank’s liquidity requirements, growth goals and market trends. The Company has also used brokers, on a limited basis, to obtain deposits. Currently the amount of deposits from outside the Bank’s market area is not significant.
Borrowings The Federal Reserve System functions as a central reserve bank providing credit for its member banks and certain other financial institutions. As a member in good standing of the Federal Reserve Bank of Cleveland, the Bank is authorized to apply for advances, provided certain standards of credit-worthiness have been met. The Bank is also a member of the Federal Home Loan Bank system. Short-term borrowings include securities sold under agreements to repurchase, federal funds purchased and U.S Treasury demand notes.
Competition
The Bank competes for deposits with other commercial banks, savings associations and credit unions and with the issuers of commercial paper and other securities, such as shares in money market mutual funds. The primary factors in competing for deposits are interest rates and convenience of office location. In making loans, the Bank competes with other commercial banks, savings associations, mortgage bankers, consumer finance companies, credit unions, leasing companies, insurance companies and other lenders. The Bank competes for loan originations primarily through the interest rates and loan fees it charges and through the efficiency and quality of services it provides to borrowers. Competition is affected by, among other things, the general availability of lendable funds, general and local economic conditions, current interest rate levels and other factors which are not readily predictable. For years the Bank has competed within its market area with several regional bank holding companies, each with assets far exceeding those of the Bank.
Item 1A.
Item 1A. Risk Factors
Like all financial companies, NB&T Financial’s business and results of operations are subject to a number of risks, many of which are outside of our control. In addition to the other information in this report, readers should carefully consider that the following important factors, among others, could materially impact our business and future results of operations.
Changes in interest rates could adversely affect our financial condition and results of operations.
Our results of operations depend substantially on our net interest income, which is the difference between (i) the interest earned on loans, securities and other interest-earning assets and (ii) the interest paid on deposits and borrowings. These rates are highly sensitive to many factors beyond our control, including general economic conditions, inflation, recession, unemployment, money supply and the policies of various governmental and regulatory authorities. If the interest we pay on deposits and other borrowings increases at a faster rate than the interest we receive on loans and other investments, our net interest income and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest we receive on loans and other investments falls more quickly than the interest we pay on deposits and borrowings. While we have taken measures intended to manage the risks of operating in a changing interest rate environment, there can be no assurance that these measures will be effective in avoiding undue interest rate risk.
Increases in interest rates also can affect the value of loans and other assets, including our ability to realize gains on the sale of assets. We originate loans for sale and for our portfolio. Increasing interest rates may reduce the origination of loans for sale and consequently the fee income we earn on such sales. Further, increasing interest rates may adversely affect the ability of borrowers to pay the principal or interest on loans and leases, resulting in an increase in non-performing assets and a reduction of income recognized.
Changes in national and local economic and political conditions could adversely affect our earnings, as our borrowers’ ability to repay loans and the value of the collateral securing our loans decline and as loans and deposits decline.
There are inherent risks associated with our lending activities, including credit risk, which is the risk that borrowers may not repay outstanding loans or the value of the collateral securing loans will decrease. Conditions such as inflation, recession, unemployment, changes in interest rates and money supply and other factors beyond our control may adversely affect the ability of our borrowers to repay their loans and the value of collateral securing the loans, which could adversely affect our earnings. Because we have a significant amount of real estate loans, a decline in the value of real estate could have a material adverse affect on us. As of December 31, 2006, 66% of our loan portfolio consisted of commercial and industrial, commercial real estate, real estate construction, installment and agricultural loans, all of which are generally viewed as having more risk of default than residential real estate loans and all of which, with the exception of installment loans, are typically larger than residential real estate loans. We attempt to manage credit risk through a program of underwriting standards, the review of certain credit decisions and an on-going process of assessment of the quality of the credit already extended. Economic and political changes could also adversely affect our deposits and loan demand, which could adversely affect our earnings and financial condition. Since substantially all of our loans are to individuals and businesses in Ohio, any decline in the economy of this market area could have a materially adverse effect on our credit risk and on our deposit and loan levels.
We operate in an extremely competitive market, and our business will suffer if we are unable to compete effectively.
In our market area, we encounter significant competition from other banks, savings and loan associations, credit unions, mortgage banking firms, securities brokerage firms, asset management firms and insurance companies. The increasingly competitive environment is a result primarily of changes in regulation and the accelerating pace of consolidation among financial service providers. NB&T Financial is smaller than many of our competitors. Many of our competitors have substantially greater resources and lending limits than we do and may offer services that we do not or cannot provide.
Legislative or regulatory changes or actions could adversely impact the financial services industry.
The financial services industry is extensively regulated. Banking laws and regulations are primarily intended for the protection of consumers, depositors and the deposit insurance funds, not to benefit our shareholders. Changes to laws and regulations or other actions by regulatory agencies may negatively impact us, possibly limiting the services we provide, increasing the ability of non-banks to compete with us or requiring us to change the way we operate. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on the operation of an institution and the ability to determine the adequacy of an institution’s allowance for loan losses. Failure to comply with applicable laws, regulations and policies could result in sanctions being imposed by the regulatory agencies, including the imposition of civil money penalties, which could have a material adverse effect on our operations and financial condition. The significant federal and state banking regulations that affect us are described in this annual report under the heading “Regulation.”
Our ability to pay cash dividends is limited.
We are dependent primarily upon the earnings of our operating subsidiaries for funds to pay dividends on our common shares. The payment of dividends by us and our subsidiaries is subject to certain regulatory restrictions. As a result, any payment of dividends in the future will be dependent, in large part, on our ability to satisfy these regulatory restrictions and our subsidiaries’ earnings, capital requirements, financial condition and other factors. Although our financial earnings and financial condition have allowed us to declare and pay periodic cash dividends to our shareholders, there can be no assurance that our dividend policy or size of dividend distribution will continue in the future.
The preparation of financial statements requires management to make estimates about matters that are inherently uncertain.
Management’s accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods in order to ensure that they comply with generally accepted accounting principles and reflect management’s judgment as to the most appropriate manner in which to record and report our financial condition and results of operations. One of the most critical estimates is the level of the allowance of loan losses. Due to the inherent nature of these estimates, we cannot provide absolute assurance that we will not significantly increase the allowance for loan losses or sustain loan losses that are significantly higher than the provided allowance.
Trading in our common shares is very limited, which may adversely affect the time and the price at which you can sell your NB&T Financial common shares.
Although the common shares of NB&T Financial are quoted on The Nasdaq Capital Market, trading in NB&T Financial’s common shares is not active, and the spread between the bid and the asked price is often wide. As a result, you may not be able to sell your shares on short notice, and the sale of a large number of shares at one time could temporarily depress the market price. The price at which you may be able to sell your common shares may be significantly lower than the price at which you could buy NB&T Financial common shares at that time.
Our organizational documents and the large percentage of shares controlled by management and family members of management may have the effect of discouraging a third party from acquiring us.
Our articles of incorporation and code of regulations contain provisions that make it more difficult for a third party to gain control or acquire us without the consent of the board of directors. These provisions could also discourage proxy contests and may make it more difficult for dissident shareholders to elect representatives as
directors and take other corporate actions. Moreover, as of March 1, 2007, directors and executive officers controlled the vote of 19.0% of the outstanding common shares of NB&T Financial in addition to the 3.9% of the outstanding shares with respect to which the Bank controls the vote as trustee and an additional 29.4% owned by relatives of a director. The provisions in our articles and code of regulations and the percentage of voting control by NB&T Financial affiliates and relatives could have the effect of delaying or preventing a transaction or a change in control that a shareholder might deem to be in the best interests of that shareholder.
REGULATION
General
Because of its ownership of all the outstanding stock of the Bank, NB&T Financial is subject to regulation, examination and oversight by the FRB as a bank holding company and financial holding company under the BHCA. The Bank, as a national bank, is subject to regulation, examination and oversight by the OCC and special examination by the FRB. The Bank is a member of the Federal Reserve Bank of Cleveland and a member of the Federal Home Loan Bank of Cincinnati. In addition, since its deposits are insured by the FDIC, the Bank is also subject to some regulation, oversight and special examination by the FDIC. The Bank must file periodic financial reports with the FDIC, the OCC and the Federal Reserve Bank of Cleveland. Examinations are conducted periodically by these federal regulators to determine whether the Bank and NB&T Financial are in compliance with various regulatory requirements and are operating in a safe and sound manner. In general, the FRB may initiate enforcement actions for violations of law and regulations.
Bank Holding Company Regulation
The FRB has adopted capital adequacy guidelines for bank holding companies, pursuant to which, on a consolidated basis, NB&T Financial must maintain total capital of at least 8% of risk-weighted assets. Risk-weighted assets consist of all assets, plus credit equivalent amounts of certain off-balance sheet items, which are weighted at percentage levels ranging from 0% to 100%, based on the relative credit risk of the asset. At least half of the total capital to meet this risk-based requirement must consist of core or “Tier 1” capital, which includes common stockholders’ equity, qualifying perpetual preferred stock (up to 25% of Tier 1 capital) and minority interests in the equity accounts of consolidated subsidiaries, less goodwill, certain other intangibles, and portions of certain nonfinancial equity investments. The remainder of total capital may consist of supplementary or “Tier 2 capital.” In addition to this risk-based capital requirement, the FRB requires bank holding companies to meet a leverage ratio of a minimum level of Tier 1 capital to average total consolidated assets of 3%, if they have the highest regulatory examination rating, well-diversified risk and minimal anticipated growth or expansion. All other bank holding companies are expected to maintain a leverage ratio of at least 4% of average total consolidated assets. NB&T Financial was in compliance with these capital requirements at December 31, 2006. For NB&T Financial’s capital ratios, see Note 15 to the Consolidated Financial Statements in Item 8.
A bank holding company is required by law to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” (defined in the regulations as not meeting minimum capital requirements) with the terms of the capital restoration plan filed by such subsidiary with its appropriate federal banking agency.
The BHCA restricts NB&T Financial’s ownership or control of the outstanding shares of any class of voting stock of any company engaged in a nonbanking business, other than companies engaged in certain activities determined by the FRB to be closely related to banking. In addition, the FRB has the authority to require a bank holding company to terminate any activity or relinquish control of any nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the determination by the FRB that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company. NB&T Financial currently has no nonbank subsidiaries, except subsidiaries of the Bank. The ownership of subsidiaries of the Bank is regulated by the OCC, rather than the FRB.
The Financial Services Modernization Act of 1999 permits bank holding companies to become financial holding companies and thereby affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized under the Federal Deposit Insurance Corporation Act of 1991 prompt corrective action provisions, is well managed, and has at least a satisfactory rating under the Community Reinvestment Act, by filing a declaration that the bank holding company wishes to become a financial holding company. In October 2006, NB&T Financial Group, Inc. became a financial holding company. No regulatory approval is required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board.
The Financial Services Modernization Act defines “financial in nature” to include:
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securities underwriting, dealing and market making;
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sponsoring mutual funds and investment companies;
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insurance underwriting and agency;
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merchant banking; and
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activities that the Federal Reserve Board has determined to be closely related to banking.
A national bank also may engage, subject to limitations on investment, in activities that are financial in nature, other than insurance underwriting, insurance company portfolio investment, real estate development and real estate investment, through a financial subsidiary of the bank, if the bank is well capitalized, well managed and has at least a satisfactory Community Reinvestment Act rating. Subsidiary banks of a financial holding company or national banks with financial subsidiaries must continue to be well capitalized and well managed in order to continue to engage in activities that are financial in nature without regulatory actions or restrictions, which could include divestiture of the financial in nature subsidiary or subsidiaries. In addition, a financial holding company or a bank may not acquire a company that is engaged in activities that are financial in nature unless each of the subsidiary banks of the financial holding company or the bank has a Community Reinvestment Act rating of satisfactory or better. NB&T Insurance is a financial subsidiary.
Transactions between NB&T Financial and the Bank are subject to statutory limits in Sections 23A and 23B of the Federal Reserve Act (the “FRA”), which limit the amounts of such transactions and require that the terms of the transactions be at least as favorable to the Bank as the terms would be of a similar transaction between the Bank and an unrelated party. NB&T Financial and the Bank were in compliance with these requirements and restrictions at December 31, 2006.
The FRB must approve the application of a bank holding company to acquire any bank or savings association.
National Bank Regulation
Office of the Comptroller of the Currency. The OCC is an office in the Department of the Treasury and is subject to the general oversight of the Secretary of the Treasury. The OCC is responsible for the regulation and supervision of all national banks, including the Bank. The OCC issues regulations governing the operation of national banks and, in accordance with federal law, prescribes the permissible investments and activities of national banks. The Bank is authorized to exercise trust powers in accordance with OCC guidelines. National banks are subject to regulatory oversight under various consumer protection and fair lending laws. These laws govern, among other things, truth-in-lending disclosure, equal credit opportunity, fair credit reporting and community reinvestment.
The Bank is required to meet certain minimum capital requirements set by the OCC. These requirements consist of risk-based capital guidelines and a leverage ratio, which are substantially the same as the capital
requirements imposed on NB&T Financial. The Bank was in compliance with those capital requirements at December 31, 2006. For the Bank capital ratios, see Note 15 to the Consolidated Financial Statements in Item 8. The OCC may adjust the risk-based capital requirement of a national bank on an individualized basis to take into account risks due to concentrations of credit or nontraditional activities.
The OCC has adopted regulations governing prompt corrective action to resolve the problems of capital deficient and otherwise troubled national banks. At each successively lower defined capital category, a national bank is subject to more restrictive and numerous mandatory or discretionary regulatory actions or limits, and the OCC has less flexibility in determining how to resolve the problems of the institution. In addition, the OCC generally can downgrade a national bank’s capital category, notwithstanding its capital level, if, after notice and opportunity for hearing, the national bank is deemed to be engaging in an unsafe or unsound practice, because it has not corrected deficiencies that resulted in it receiving a less than satisfactory examination rating on matters other than capital or it is deemed to be in an unsafe or unsound condition. The Bank’s capital at December 31, 2006, met the standards for the highest capital category, a well-capitalized bank.
A national bank is subject to restrictions on the payment of dividends, including dividends to a holding company. The Bank may not pay a dividend if it would cause the Bank not to meet its capital requirements. In addition, the dividends that a Bank subsidiary can pay to its holding company without prior approval of regulatory agencies is limited to net income plus its retained net income for the preceding two years. Based on the current financial condition of the Bank, the Bank does not expect these provisions to affect the current ability of the Bank to pay dividends to NB&T Financial in an amount customary for the Bank.
OCC regulations generally limit the aggregate amount that a national bank can lend to one borrower or aggregated groups of related borrowers to an amount equal to 15% of the bank’s unimpaired capital and surplus. A national bank may loan to one borrower an additional amount not to exceed 10% of the association’s unimpaired capital and surplus, if the additional amount is fully secured by certain forms of “readily marketable collateral.” Loans to executive officers, directors and principal shareholders and their related interests must conform to the OCC lending limits. All transactions between national banks and their affiliates, including NB&T Financial, must comply with Sections 23A and 23B of the FRA.
Federal Deposit Insurance Corporation. The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of federally insured banks and thrifts and safeguards the safety and soundness of the banking and thrift industries. The FDIC is authorized to establish annual assessment rates for deposit insurance. The FDIC has established a risk-based assessment system for members. Under this system, assessments vary based on the risk the institution poses to its deposit insurance fund. The risk level is determined based on the institution’s capital level and the FDIC’s level of supervisory concern about the institution. Insurance of deposits may be terminated by the FDIC if it finds that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition enacted or imposed by the institution’s regulatory agency.
In February of 2006, President Bush signed into law the Deposit Insurance Reform Act of 2005 and its companion bill, the Deposit Insurance Reform Conforming Amendments Act of 2005 (collectively, the “Deposit Insurance Reform Acts”), which provide for the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) to be merged into a new Deposit Insurance Fund (DIF). The Deposit Insurance Reform Acts provide for several additional changes to the deposit insurance system, including the following:
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Increasing the deposit insurance limit for retirement accounts from $100,000 to $250,000;
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Adjusting the deposit insurance limits (currently $100,000 for most accounts) every five years based on an inflation index, with the first adjustment to be effective on January 1, 2011;
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Providing pass-through deposit insurance for the deposits of employee benefit plans (but prohibiting undercapitalized depository institutions from accepting employee benefit plan deposits);
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Allocating an aggregate of $4.7 billion of one-time credits to offset the premiums of depository institutions based on their assessment bases at the end of 1996;
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Establishing rules for awarding cash dividends to depository institutions, based on their relative contributions to the DIF and its predecessor funds, when the DIF reserve ratio reaches certain levels; and
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Revising the rules and procedures for risk-based premium assessments.
As a result of the above change, the BIF and the SAIF were merged into the DIF in 2006. The Company has not yet experienced an increase in its insurance premiums due to the one-time credits; however, future insurance premiums may increase.
Federal Reserve Board. The FRA requires national banks to maintain reserves against their net transaction accounts (primarily checking and NOW accounts). The amounts are subject to adjustment by the FRB. At December 31, 2006, the Bank was in compliance with its reserve requirements.
Federal Home Loan Banks. The Federal Home Loan Banks (the FHLBs) provide credit to their members in the form of advances. As a member, the Bank must maintain an investment in the capital stock of the FHLB of Cincinnati in an amount equal to the greater of 1% of the aggregate outstanding principal amount of the Bank’s residential real estate loans, home purchase contracts and similar obligations at the beginning of each year, or 5% of its advances from the FHLB. The Bank is in compliance with this requirement with an investment in FHLB of Cincinnati stock having a book value of $8.3 million at December 31, 2006. The FHLB advances are secured by collateral in one or more specified categories. The amount a member may borrow from the FHLB is limited based upon the amounts of various assets held by the member.
Ohio Department of Insurance. The Bank’s insurance agency operating subsidiary is subject to the insurance laws and regulations of the State of Ohio and the Ohio Department of Insurance. The insurance laws and regulations require education and licensing of agencies and individual agents, require reports and impose business conduct rules.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable
Item 2.
Item 2. Properties
NB&T Financial and the Bank own and occupy their main offices located at 48 North South Street, Wilmington, Ohio. The National Bank and Trust Company also owns or leases 17 full-service branch offices and one remote drive-through ATM facility, all of which are located in Brown, Clermont, Clinton, Highland, and Warren Counties in Ohio. The Bank owns a building at 1600 West Main Street, Wilmington, Ohio, which serves as an operation center for the Bank and houses the Bank’s insurance agency.
Item 3.
Item 3. Legal Proceedings
Neither NB&T Financial nor the Bank is presently involved in any legal proceedings of a material nature. From time to time, the Bank is a party to legal proceedings incidental to its business to enforce its security interest in collateral pledged to secure loans made by the Bank.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
There were 3,232,432 common shares of the Company outstanding on December 31, 2006 held of record by approximately 404 shareholders of record other than brokers, banks and depositories, and approximately an additional 485 beneficial owners holding their shares in the names of brokers, banks and depositories. Dividends per share declared were $0.27 per share in each quarter in 2006 and were $0.26 per share in each quarter in 2005.
The Company’s shares trade on the Nasdaq Capital Market (formerly Nasdaq SmallCap Market) under the symbol NBTF. The following table summarizes the quarterly common stock prices and dividends declared for the last two years.
As a national bank, the Bank is subject to restrictions on the payment of dividends to the Company, which could restrict the ability of the Company to pay dividends. The Bank may not pay a dividend if it would cause the Bank not to meet its capital requirements. In addition, without regulatory approval, the Bank is limited to paying dividends equal to net income to date in the fiscal year plus its retained net income for the preceding two years.
The Company has an equity plan under which the Company may grant options, restricted stock and stock appreciation rights to selected directors and employees for up to 270,000 common shares of the Company. The Company also has a stock option plan that has been terminated but under which options to purchase shares remain exercisable. Finally, an option to purchase 30,000 shares was awarded to Mr. Limbert upon his employment. These options are may be exercised at $20.88, vest over five years and expire in 2016. The following table summarizes the securities authorized for issuance at December 31, 2006 under all equity compensation plans in existence at that date:
Unregistered Sales of Equity Securities and Use of Proceeds
None
Issuer Purchases of Equity Securities
(1) These shares were purchased from an outside broker in an independent transaction.
(2) These shares were purchased from the NB&T Financial Group, Inc. Employee Stock Ownership Plan in order to facilitate a distribution to a participant.
Performance Graph
The following line graph compares the yearly percentage change in NBTF’s cumulative total shareholder return against the cumulative return of The NASDAQ Composite Index, which includes all Nasdaq domestic and international based common type stocks listed on The NASDAQ Stock Market, and an index of banks with total assets of $500 million to $1 billion. The graph assumes the investment of $100 on December 31, 2001. Cumulative total shareholder return is measured by dividing (i) the sum of (A) the cumulative amount of dividends for the measurement period, assuming dividend reinvestment, and (B) the difference between the price of NBTF’s common shares at the end and at the beginning of the measurement period; by (ii) the price of NBTF’s common shares at the beginning of the measurement period.
NB&T Financial Group, Inc.
* Source: SNL Financial LC, Charlottesville, VA (434) 977-1600 © 2007
Item 6.
Item 6. Selected Financial Data
(Dollars and shares in thousands, except per share data)
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis comparing 2006 to prior years should be read in conjunction with the audited consolidated financial statements at December 31, 2006 and 2005 and for the three years ended December 31, 2006.
FORWARD-LOOKING STATEMENTS
Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,” “estimates,” “plans,” “may increase,” “may fluctuate,” “will likely result,” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” and “could” are generally forward-looking in nature and not historical facts. Results could differ materially from those expressed in such forward-looking statements due to a number of factors, including (1) changes in interest rates; (2) changes in national and local economic and political conditions; (3) competitive pressures in the retail banking, financial services, insurance and other industries; (4) changes in laws and regulations, including changes in accounting standards; (5) changes in policy by regulatory agencies; and (6) changes in the securities markets. Any forward-looking statements are not guarantees of future performance. They involve risks, uncertainties and assumptions, and actual results could differ materially from those contemplated by those forward-looking statements. Many of the factors that will determine these results are beyond the Company’s ability to control or predict. The Company disclaims any duty to update any forward-looking statements, all of which are qualified by the statements in this section. See Item 1.A. “Risk Factors” in this annual report for further discussion of the risks affecting the business of the Company and the value of an investment in its shares.
RESULTS OF OPERATIONS
EXECUTIVE SUMMARY
Net income for 2006 was $1.9 million, or $.58 per diluted share, compared to $4.1 million, or $1.30 per diluted share last year. In 2006, the Company undertook several initiatives to restructure its balance sheet, which reduced earnings for 2006. The Company incurred approximately $1.4 million in prepayment penalties from the early payoff of approximately $47.2 million in Federal Home Loan Bank debt. In addition, the Bank sold securities to reduce borrowings and fund a branch sale. The security losses were approximately $1.3 million, which was partially offset by a $1.1 million pre-tax gain on the branch sale in the fourth quarter of 2006. The Company also experienced a decline in its net interest income in 2006 of approximately $817,000 and a $555,000 increase in its provision for loan losses in 2006.
Net income for 2005 was $4.1 million, or $1.30 per diluted share, compared to $4.9 million, or $1.56 per diluted share, for 2004. The decrease in net income was primarily due to a declining net interest margin and fewer gains on security sales, partially offset by a decrease in the provision for loan losses due to lower charged-off loans and management’s evaluation of the current portfolio. Net interest income declined $1.1 million from $20.2 million in 2004 to $19.1 million in 2005, and security gains were down $685,000. Net loan charge-offs were $928,000, or 0.23% of average loans in 2005, compared to $2.52 million, or 0.62%, in 2004, contributing to the decline in loan loss provision from $1.9 million in 2004 to $775,000 in 2005. Performance ratios for 2005 included a return on assets of .63% and a return on equity of 6.98%, compared to .75% and 8.57%, respectively, in 2004.
NET INTEREST INCOME
Net interest income, the difference between interest income earned on interest-earning assets and interest expense incurred on interest-bearing liabilities, is the most significant component of the Company’s earnings. Net interest income is affected by changes in the volumes, rates and composition of interest-earning assets and interest-bearing liabilities. Table 1 reflects the components of the Company’s net interest income for each of the
three years ended December 31, 2006, setting forth: (i) average assets, liabilities and shareholders’ equity, (ii) interest income earned on interest-earning assets and interest expense incurred on interest-bearing liabilities, (iii) average yields earned on interest-earning assets and interest expense incurred on interest-bearing liabilities, and (iv) the net interest margin (i.e., net interest income divided by average interest-earning assets). Non-accrual loans have been included in the average loan balances.
TABLE 1-NET INTEREST INCOME AND NET INTEREST MARGIN
(Dollars in thousands)
(1) Includes nonaccrual loans and loan fees.
Net interest income declined to $18.3 million in 2006 from $19.1 million in 2005; however, the Company’s net interest margin increased to 3.26% for 2006 from 3.16% in 2005. Interest income increased $1.2 million to $34.1 million in 2006, while average interest-earning assets declined approximately 7.3% to $561.5 million. The average yield on earning assets increased to 6.07% in 2006 from 5.43% in 2005 with a shift in earning assets from investment securities to higher-yielding loans. Interest expense increased $2.0 million to $15.8 million in 2006 and average interest-bearing liabilities declined approximately 8.0% to $492.4 million. The average rate on
interest-bearing liabilities increased to 3.21% in 2006 from 2.57% in 2005. This increased rate is largely the result of increased competitive rates on money market accounts, short-term certificates of deposit and short-term borrowings, resulting from an increase in the targeted federal funds rate of 100 basis points from 4.25% to 5.25% in 2006.
Net interest income was $19.1 million in 2005, a decrease of $1.1 million compared to 2004. During 2005, the Federal Reserve increased its targeted federal funds rate 200 basis points from 2.25% to 4.25%. This action increased general market rates for terms of less than two years by a similar amount; however, longer-term rates increased only slightly. The Bank’s deposits and short-term borrowing costs are more closely associated with short-term rates. As a result, total interest expense increased $1.86 million to $13.8 million during 2005 despite a $9.7 million decrease in average outstanding interest-bearing liabilities. A higher percentage of the Bank’s earning assets have yields more closely associated with longer-term rates. Interest income increased $751,000 to $32.9 million in 2005 from $32.1 million in 2004. Unfortunately, this increase was not enough to offset the increase in interest expense, and the Bank’s net interest margin dropped from 3.31% in 2004 to 3.16% in 2005.
Net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. Table 2 presents an analysis of increases and decreases in interest income and expense in terms of changes in volume and interest rates during the three years ended December 31, 2006. Changes attributable to rate and volume are allocated to both rate and volume on an equal basis.
TABLE 2-NET INTEREST INCOME-RATE/VOLUME ANALYSIS
(Dollars in thousands)
NON-INTEREST INCOME
Table 3 details the components of non-interest income, excluding securities gains and losses, and the percentage change from the two previous years. Total non-interest income was $9.2 million in 2006, $8.3 million in 2005, and $8.5 million in 2004. Service charges on deposits decreased 2.4% in 2006 and 9.2% in 2005 largely due to decreased fees on overdrawn accounts and lower service charges on business checking accounts resulting from an increase in the average earnings credit. Other service charges and fees increased in 2006 and 2005 due to
additional fee income on debit card transactions. ATM network fees have decreased since 2004 as a result of the Company’s decision to discontinue this line of business due to lower profit margins and higher machine upgrade expenses. Bank owned life insurance (“BOLI”) income increased to $465,000 in 2006 compared $438,000 in 2005, due to an increase in the yield on the underlying investments. In October 2006, the Bank sold its Ada branch, resulting in a gain on sale of $1.1 million. Other income increased to $810,000 and $848,000 in 2006 and 2005, respectively, from $716,000 in 2004 due to increased gains on loan sales and loan extension fee income.
TABLE 3-NON-INTEREST INCOME
(Dollars in thousands)
Net loss on sales of securities totaled $1.1 million in 2006, compared to a gain of $101,000 in 2005. Proceeds from the sale of securities totaled $66.3 million in 2006, compared to $7.5 million in 2005. The securities were sold to reduce long-term borrowings and fund the sale of the Ada branch.
NON-INTEREST EXPENSE
Table 4 details the components of non-interest expense and the percentage change from the two previous years. Total non-interest expense was $23.3 million in 2006, $21.9 million in 2005 and $21.6 million in 2004.
TABLE 4-NON-INTEREST EXPENSE
(Dollars in thousands)
Prepayment penalties of $1.4 million were incurred in 2006 on the payoff of $47.2 million in long-term FHLB advances. Salaries and benefits expense, which is the largest component of non-interest expense, remained
relatively unchanged at $11.6 million in 2006 and 2005. Salaries and employee benefits expense increased 4.9% during 2005 due to merit increases and increased health insurance costs. Professional fees decreased $123,000 in 2006 due to decreased collections costs and increased $323,000 in 2005 from 2004 due to new corporate branding initiatives and executive search costs. Marketing and printing, postage and supplies expenses increased in 2006 as the Company’s new corporate brand was launched.
Occupancy expense declined $20,000 in 2006 due to closure of two branch offices. Occupancy expense increased $123,000 in 2005 largely due to increased maintenance and repair costs, utility costs and real estate taxes. Equipment expense declined from $2.0 million in 2005 and 2004 to $1.7 million in 2006. Most of this decrease is the result of closing two branches in 2006 and reduced depreciation and maintenance expenses related to the Company’s ATM network. Data processing expenses were up in 2006 due to conversion to a new data processing system in 2004. The maintenance fees on the new data processing system were waived for the first year, resulting in a partial year’s fees in both 2005 and 2004. In addition, debit card processing costs increased $47,000 in 2006 due to increasing transactions. Other non-interest expenses were down in 2005 from 2004 due to reorganization expenses related to the closing of two branches in 2004, reduced expenses associated with foreclosed real estate and lower education expense.
INCOME TAXES
Due to the security losses and prepayment penalty on FHLB advances with relatively the same level of tax-exempt income and tax-deductible expenses, the Company had a tax benefit for 2006. In 2005 and 2004, the effective tax rates were 15.2% and 17.7%, respectively.
FINANCIAL CONDITION
ASSETS
Due to the restructuring initiatives taken by the Company in 2006, average total assets decreased 7.0% during 2006 to $609.3 million. Average interest-earning assets decreased 7.3%, and were 92% of total average assets, compared to 93% in 2005 and 2004. Actual total assets declined $95,1 million as securities were reduced $88.7 million and FHLB advances and other borrowings were reduced $99.5 million during the 2006 restructuring of the balance sheet.
SECURITIES
The following table sets forth the composition of the Bank’s securities portfolio, based on amortized cost, at the dates indicated:
TABLE 5-SECURITIES PORTFOLIO
(Dollars in thousands)
In 2006, total securities declined $90.2 million to $82.8 million, compared to $173.0 million at December 31, 2005. Approximately $93.7 million in securities were sold in 2006 to pay off Federal Home Loan
Bank debt and fund the sale of one branch with total loans of approximately $4.5 million and total deposits of approximately $19.4 million. In addition, most of the Company’s repurchase agreements were moved to a third-party cash management fund in the third and fourth quarters of 2006, reducing the amount of securities necessary for pledging.
In 2005, total securities increased $3.6 million to $173.0 million, compared to $169.4 million at December 31, 2004. Approximately $7.6 million in U.S. Government agency and sponsored entity mortgage-backed securities were sold in 2005 with $16.6 million and $10.9 million reinvested in U.S. government sponsored entity notes and collateralized mortgage-backed securities, respectively. Approximately $6.6 million in U.S. Government sponsored entity notes were called or matured in 2005, and $9.7 million in payments were received on mortgage-backed securities.
The following table sets forth the amortized cost of the Bank’s securities portfolio at December 31, 2006. Expected maturities of individual securities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities are presented in the table based on current prepayment assumptions. U.S. Government agency and sponsored entity notes, as well as municipal securities, are categorized based on contractual maturity. Yields do not include the effect of income taxes.
TABLE 6-SECURITIES PORTFOLIO REPRICING
(Dollars in thousands)
LOANS
Table 7 shows loans outstanding at period end by type of loan. Commercial and industrial loans declined from $108.5 million in 2002 to $76.2 million in 2006. The decline in the commercial and industrial loan portfolio has been largely offset by an increase in commercial real estate, which increased from $28.2 million in 2002 to $87.0 million in 2006. In addition, real estate construction loans have grown to $20.0 million at December 31, 2006. The Company has experienced an increase in its commercial real estate and construction lending over the past five years because of the Company’s sales activities in the higher-growth Clermont and Warren counties. The Company continues to focus its commercial lending on small- to medium-sized companies with established track records in the Company’s market area.
Residential real estate loans declined $8.3 million to $140.1 million in 2006. One to four family real estate loans decreased approximately $2.9 million in 2006 due to the Ada branch sale. Home equity loans decreased
approximately $4.5 million due to lower volume from the increase in interest rates. Currently, the Company has approximately $21.8 million in residential real estate loans with a loan-to-value ratio greater than 80% for which private mortgage insurance has not been required. The Company does not offer residential real estate loan products with negative amortization.
Installment loans outstanding decreased $6.5 million to $64.2 million in 2006 from $70.7 million at December 31, 2005. Most of this decline is the result of the Company discontinuing its indirect lending activity in the third quarter of 2006. Installment loans also decreased $15.1 million from 2003 to 2004. This decrease occurred primarily in direct personal loans. Installment loans decreased to 16% of the portfolio at December 31, 2006 from 21% at December 31, 2003.
The Company has avoided concentration of commercial lending in any one industry. As of December 31, 2006, the highest commercial lending concentration was 8.1% for commercial rental real estate properties.
TABLE 7-LOAN PORTFOLIO
(Dollars in thousands)
Table 8 shows the amount of commercial, construction and agricultural loans outstanding as of December 31, 2006, which, based on contractual maturities, are due in the periods indicated. The table also sets forth the amounts of loans due after one year from December 31, 2006, which have predetermined rates and which have floating or adjustable rates.
TABLE 8-LOAN MATURITIES AND PRICE SENSITIVITY
(Dollars in thousands)
NON-PERFORMING ASSETS
Table 9 shows the amount of non-performing assets outstanding as of December 31 for each of the last five years:
TABLE 9-NON-PERFORMING ASSETS
(Dollars in thousands)
The Company’s policy is to place a commercial loan on non-accrual status when it reaches 90 days past due and any of the following conditions exist: 1) the borrower cannot meet the payment obligations under the loan; 2) full payment of principal and interest is not expected; 3) the borrower has filed for bankruptcy and a plan of reorganization or liquidation is not imminent; or 4) foreclosure action has been initiated. All other loans are typically placed on non-accrual status once they reach 90 days past due. The amount of non-accrual loans was $8.4 million at year-end 2006, compared to $8.2 million at year-end 2005, and included primarily two large loan relationships: 1) a $4.7 million nursing home loan, which is current on all payments at December 31, 2006; and 2) a $1.3 million loan secured by commercial office properties.
Other real estate owned increased in 2006 primarily due to adding one residential property for $745,000 associated with the relocation of the Company’s new Chief Executive Officer.
Interest income recognized in 2006 on non-accrual loans outstanding at December 31, 2006 was $0; however, interest income that would have been recognized had the loans been accruing would have been approximately $125,000.
ALLOWANCE FOR LOAN LOSSES
The provision for loan losses charged to expense was $1.3 million in 2006, an increase of $555,000 from the provision of $775,000 recorded in 2005, which was a decrease from $1.9 million in 2004. The higher provision for loan losses in 2006 is a result of increased bankruptcy filings by bank customers associated with recent bankruptcy law changes and additional specific reserves on commercial loans. Net charge-offs were $626,000, or 0.15% of average loans outstanding, in 2006, compared to $929,000, or 0.23%, for the same period in 2005.
Table 10 shows selected information relating to the Company’s allowance for loan losses. The allowance is maintained to absorb potential losses in the portfolio. If, as a result of charge-offs or increases in risk characteristics of the loan portfolio, the reserve is below the level considered by management to be adequate to absorb possible future loan losses, the provision for loan losses is increased. Loans deemed not collectible are charged off and deducted from the reserve. Recoveries on loans previously charged off are added to the reserve.
TABLE 10-ALLOWANCE FOR LOAN LOSSES
(Dollars in thousands)
Net charge-offs were higher in 2004 and 2003 with increased bankruptcies, foreclosures and changes in economic conditions. During 2003, management reappraised collateral securing loans, updated estimated
recovery rates, and used a third-party loan specialist to assist in identifying other potential loan weaknesses. Management then charged-off or charged-down problem loans and increased the loan loss provision in 2003 based upon evaluation of the loan portfolio and potential weaknesses of specific loans incorporating the updated estimates. The allowance for loan losses as a percent of total loans at December 31 was 1.16% in 2006, .97% in 2005, and 1.05% in 2004.
The Company allocates the allowance for loan losses to specifically classified loans and generally based on three-year net charge-off history. In assessing the adequacy of the allowance for loan losses, the Company considers three principal factors: (1) the three-year rolling average charge-off percentage applied to the current outstanding balance by portfolio type; (2) specific percentages applied to individual loans estimated by management to have a potential loss; and (3) estimated losses attributable to economic conditions. Economic conditions considered include unemployment levels, the condition of the agricultural business, and other local economic factors. Table 11 shows the allocation of the allowance for loan losses as of December 31, 2006.
TABLE 11-ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
(Dollars in thousands)
OTHER ASSETS
In September 2000, $10 million was used to purchase bank owned life insurance with a cash surrender value that increases tax-free during future years at an adjustable rate. At December 31, 2006, the cash surrender value was $13.1 million. The intangible assets consisted of core deposit intangibles of $1.6 million, which is amortized over the expected life of the related core deposits, and goodwill of $3.8 million, which is tested annually for impairment in accordance with SFAS No. 141. In 2006 and 2005, no goodwill was expensed due to impairment of value. The Ada branch, which was acquired in 2001 as part of the Sabina Bank acquisition, was sold in the fourth quarter of 2006 and approximately $419,000 in associated core deposit intangibles was expensed.
DEPOSITS
Table 12 presents a summary of period end deposit balances. Total deposits increased to $453.3 million in 2006 from $447.6 million in 2005 and $452.6 million in 2004. Non-interest bearing checking accounts have grown slightly since 2004 from 13% to 15% of total deposits. NOW accounts have remained relatively stable; however, balances do fluctuate seasonally within the public fund NOW accounts, which were approximately $23.1 million at December 31, 2006. Savings accounts have declined to 7% of total deposits at December 31, 2006 as customers moved to the higher-yielding money market account, which grew from $40.6 million, or 9% of total deposits, at December 31, 2005 to $76.0 million, or 17% of total deposits, at December 31, 2006. Certificates of deposit less than $100,000 increased $2.4 million in 2006 but continued to represent 32% of deposits at the end of 2006. Certificates of $100,000 and over are primarily short-term public funds and brokered deposits. Balances of such large certificates fluctuate depending on the Company’s pricing strategy and funding needs at any particular time and were up to 10% of total deposits in 2006 and 2005. Deposits are attracted principally from within the Company’s market area through the offering of numerous deposit instruments. Interest rates, maturity terms, service fees, and withdrawal penalties for the various types of accounts are established periodically by management based on the Company’s liquidity requirements, growth goals and market trends. The Company had approximately $5.6 million in brokered deposits at December 31, 2006. The amount of deposits currently from outside the Company’s market area is not significant.
The following table sets forth the dollar amount of time deposits maturing in the periods indicated:
TABLE 13-MATURITY OF TIME DEPOSITS
(Dollars in thousands)
OTHER BORROWINGS
At December 31, 2006, the Bank had outstanding $28.5 million of total borrowings from the FHLB. The advances have interest rates from 4.81% to 5.38% and are subject to restrictions or prepayment penalties. In addition, the FHLB has at its option the ability to convert $24,500,000 to variable rate three-month Libor advances. If the FHLB exercises this option, the Bank may repay the advances at interest rate reset dates with no penalty. During 2006, the Company paid off approximately $72.3 million in FHLB advances with a prepayment penalty of $1.4 million.
At December 31, 2006, the Company’s short-term borrowings consisted of $1.1 million in securities sold under repurchase agreements and $1.8 million in treasury demand notes. Securities sold under repurchase agreements has declined approximately $27.4 million since December 31, 2005 due to the introduction of a third-party cash management sweep. Table 14 sets forth certain information regarding the Company’s outstanding short-term borrowings at the dates and for the periods indicated:
TABLE 14-SHORT-TERM BORROWINGS
(Dollars in thousands)
In 2002, the Company participated in a securities sale commonly referred to as a “pooled trust preferred securities offering.” In that offering, the Company issued to a trust controlled by the Company $8.2 million in thirty-year debt securities. These securities have a quarterly adjustable interest rate equal to the three-month LIBOR rate plus 3.45% (currently 7.97%), and the trust issued capital securities of $8.0 million to an unrelated party. The securities issued by the Company are classified as Tier 1 capital for regulatory purposes, and the interest is deductible for federal income tax purposes. The Company made a capital contribution of $8 million of these funds to the Bank to improve its regulatory capital ratios.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has not entered into off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
CONTRACTUAL OBLIGATIONS
The following table summarizes the Company’s contractual obligations at December 31, 2006 and the periods the expected payments are due.
TABLE 15-CONTRACTUAL OBLIGATIONS
(Dollars in thousands)
December 31, 2006
(a) Variable purchase obligation includes service contracts based on variable pricing measures, such as number of accounts or items processed. Future obligations have been estimated based on recent activity and pricing.
CAPITAL
The Federal Reserve Board has adopted risk-based capital guidelines that assign risk weightings to assets and off-balance sheet items and also define and set minimum capital requirements (risk-based capital ratios). Bank holding companies must maintain total risk-based, Tier 1 risk-based and Tier 1 leverage ratios of 8%, 4% and 3%, respectively. At December 31, 2006, NB&T Financial met all of its capital requirements with a total risk-based capital ratio of 15.69%, a Tier 1 risk-based capital ratio of 14.54%, and a Tier 1 leverage ratio of 10.90%. For further information regarding NB&T Financial’s capital, see Note 15 to the Financial Statements in Item 8 of this annual report.
LIQUIDITY
Effective liquidity management ensures that the cash flow requirements of depositors and borrowers, as well as Company cash needs, are met. The Company manages liquidity on both the asset and liability sides of the balance sheet. The loan to deposit ratio at December 31, 2006, was 90.5%, compared to 93.3% at December 31, 2005. Loans to total assets were 73.9% at the end of 2005, compared to 64.2% at the same time last year. The securities portfolio is 100% available-for-sale securities that are readily marketable. Approximately 64.7% of the available-for-sale portfolio is pledged to secure public deposits, short-term and long-term borrowings and for other purposes as required by law. The balance of the available-for-sale securities could be sold if necessary for liquidity purposes. Also, a stable deposit base, consisting of over 88.9% core deposits, makes the Company less susceptible to large fluctuations in funding needs. The Company has short-term borrowing lines of credit with several correspondent banks. The Company also has both short- and long-term borrowing available through the FHLB. The Company has the ability to obtain deposits in the brokered certificate of deposit market to help provide liquidity to fund loan growth.
MARKET RISK MANAGEMENT
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to interest rate risk, exchange rate risk, equity price risk and commodity price risk. The Company does not maintain a trading account for any class of financial instrument, and is not currently subject to foreign currency exchange rate risk, equity price risk or commodity price risk. The Company’s market risk is composed primarily of interest rate risk.
The Bank manages its interest rate risk regularly through its Asset/Liability Committee. The Committee meets on a monthly basis and reviews various asset and liability management information, including but not limited to, the Bank’s interest rate risk position, liquidity position, projected sources and used of funds and economic conditions.
The Bank uses simulation models to manage interest rate risk. In the Bank’s simulation models, each asset and liability balance is projected over a one-year horizon. Net interest income is then projected based on expected cash flows and projected interest rates under a stable rate scenario and analyzed on a monthly basis. The results of this analysis are used in decisions made concerning pricing strategies for loans and deposits, balance sheet mix, securities portfolio strategies, liquidity and capital adequacy. The Bank’s current one-year simulation model under stable rates indicates increasing yields on interest-earning assets will exceed increasing costs of interest-bearing liabilities. This position could have a positive effect on projected net interest margin over the next twelve months.
Simulation models are also performed for ramped 100, 200 and 300 basis point increases or decreases in interest rates over one year. The results of these simulation models are compared with the stable rate simulation. The model includes assumptions as to repricing and expected prepayments, anticipated calls, and expected decay rates of transaction accounts under the different rate scenarios. The results of these simulations include changes in both net interest income and market value of equity. ALCO guidelines that measure interest rate risk by the percent of change from stable rates, and capital adequacy, have been established, and as Table 16 indicates at December 31, 2006, the results of these simulations are within those guidelines.
As with any method of measuring interest rate risk, certain shortcomings are inherent in the simulation modeling. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market rates. In addition, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while interest rates on other types may lag behind changes in market rates. Further, in the event of a change in interest rates, expected rates of prepayment on loans and mortgage-backed securities and early withdrawals from certificates of deposit may deviate significantly from those assumed in making the risk calculations. The Bank’s rate ramp simulation models provide results in extreme interest rate environments and results are used accordingly. Reacting to changes in economic conditions, interest rates and market forces, the Bank has been able to alter the mix of short-and long-term loans and investments, and increase or decrease the emphasis on fixed- and variable-rate products in response to changing market conditions.
IMPACT OF INFLATION AND CHANGING PRICES
The majority of a financial institution’s assets and liabilities are monetary in nature. Changes in interest rates affect the financial condition of a financial institution to a greater degree than inflation. Although interest rates are determined in large measure by changes in the general level of inflation, they do not change at the same rate or in the same magnitude, but rather react in correlation to changes in expected rate of inflation and to changes in monetary and fiscal policy. The Company’s ability to react to changes in interest rates has a significant impact on financial results. As discussed previously, management attempts to control interest rate sensitivity in order to protect against wide interest rate fluctuations.
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the notes to the Company’s consolidated financial statements for the year ended December 31, 2006. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective, or complex.
Allowance for Loan Losses-The allowance for loan losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for loan losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, collateral values, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs.
The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and historical loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for loan losses relating to impaired loans is based on the loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.
Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors, including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company’s evaluation of risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.
Goodwill and Other Intangibles-The Company records all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangibles, at fair value as required by SFAS 141. Goodwill is subject, at a minimum, to annual tests for impairment. Other intangible assets are amortized over their estimated useful lives using straight-line and accelerated methods, and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial goodwill and other intangibles recorded and subsequent impairment analysis requires management to make subjective judgments concerning estimates of how the acquired asset will perform in the future. Events and factors that may significantly affect the estimates include, among others, customer attrition, changes in revenue growth trends, specific industry conditions and changes in competition.
EFFECT OF RECENT ACCOUNTING STANDARDS
The Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, becomes effective for fiscal years beginning after December 15, 2006. Under this interpretation, a Company cannot hold excess tax reserves, unless it relates to a tax position taken that remains uncertain due to potential differences of interpretation between the taxpayer and the applicable taxing authority. This new standard is not anticipated to have a material impact on the Company’s financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
See “Market Risk Management” in Item 7, which is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
-INDEX-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audit Committee, Board of Directors and Stockholders
NB&T Financial Group, Inc.
Wilmington, Ohio
We have audited the accompanying consolidated balance sheets of NB&T Financial Group, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NB&T Financial Group, Inc. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
/s/ BKD, LLP
Cincinnati, Ohio
February 26,
NB&T Financial Group, Inc.
Consolidated Balance Sheets
December 31, 2006 and 2005
(Dollars in Thousands)
See Notes to Consolidated Financial Statements.
NB&T Financial Group, Inc.
Consolidated Statements of Income
Years Ended December 31, 2006, 2005 and 2004
(Dollars in Thousands, except per share amounts)
See Notes to Consolidated Financial Statements.
NB&T Financial Group, Inc.
Consolidated Statements of Stockholders’ Equity
Years Ended December 31, 2006, 2005 and 2004
(Dollars in Thousands)
See Notes to Consolidated Financial Statements.
NB&T Financial Group, Inc.
Consolidated Statements of Cash Flows
Years Ended December 31, 2006, 2005 and 2004
(Dollars in Thousands)
See Notes to Consolidated Financial Statements.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements
Years Ended December 31, 2006, 2005 and 2004
Note 1: Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
NB&T Financial Group, Inc. (“Company”) is a financial holding company whose principal activity is the ownership and management of its wholly-owned subsidiaries, The National Bank and Trust Company (the “Bank”) and NB&T Statutory Trust I (“Trust I”). In accordance with FIN 46R, Trust I is not consolidated into these financial statements. The Bank is primarily engaged in providing a full range of banking and financial services to individual and corporate customers in Brown, Clermont, Clinton, Highland, and Warren counties in Ohio. The Bank offers insurance products including property, casualty and life through its wholly-owned subsidiary, NB&T Insurance Agency, Inc. (“Agency”). The Bank is subject to competition from other financial institutions. The Bank is subject to the regulation of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company, the Bank and the Agency. All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.
Cash Equivalents
The Company considers all liquid investments with original maturities of three months or less to be cash equivalents.
Securities
The Company classifies all securities as available-for-sale securities, which are carried at fair value. The Company has no immediate plan to sell but may sell securities in the future. Unrealized gains and losses are recorded, net of related income tax effects, in other comprehensive income.
Amortization of premiums and accretion of discounts are recorded as interest income from securities. Realized gains and losses are recorded as net security gains (losses). Gains and losses on sales of securities are determined on the specific-identification method.
The Company evaluates its securities portfolio for impairment throughout the year. An impairment is recorded against individual equity securities if their cost significantly exceeds their fair value for a substantial amount of time. An impairment is also recorded for investments in debt securities, unless the decrease in fair value is attributed to interest rates and management has the intent and ability to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances adjusted for any charge-offs, the allowance for loan losses, any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Generally, loans are placed on non-accrual status at ninety days past due and interest is considered a loss, unless the loan is well-secured and in the process of collection.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogenous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment measurements.
Premises and Equipment
Depreciable assets are stated at cost less accumulated depreciation. Depreciation is charged to expense using the straight-line method over the estimated useful lives of the assets.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Federal Reserve and Federal Home Loan Bank Stock
Federal Reserve and Federal Home Loan Bank stock are required investments for institutions that are members of the Federal Reserve and Federal Home Loan Bank systems. The required investment in the common stock is based on a predetermined formula.
Foreclosed Assets Held for Sale
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net income or expense from foreclosed assets.
Goodwill
Goodwill is annually tested for impairment. If the implied fair value of goodwill is lower than its carrying amount, a goodwill impairment is indicated and goodwill is written down to its implied fair value. Subsequent increases in goodwill value are not recognized in the financial statements.
Intangible Assets
Intangible assets are being amortized on an accelerated basis over periods ranging from seven to eleven years. Such assets are periodically evaluated as to the recoverability of their carrying value.
Treasury Stock
Treasury stock is stated at cost. Cost is determined based on the average cost of all shares.
Income Taxes
Deferred tax assets and liabilities are recognized for the tax effects of differences between the financial statement and tax bases of assets and liabilities. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized. The Company files consolidated income tax returns with its subsidiaries.
Earnings Per Share
Earnings per share have been computed based upon the weighted-average common shares outstanding during each year. Unearned ESOP shares have been excluded from the computation of average shares outstanding.
Reclassifications
Certain reclassifications have been made to the 2005 and 2004 financial statements to conform to the 2006 financial statement presentation. These reclassifications had no effect on net income.
Note 2: Restriction on Cash and Due From Banks
The Bank is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank. The reserve required at December 31, 2006 was $6,981,000.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Note 3: Securities
The amortized cost and approximate fair values of securities are as follows (thousands):
The amortized cost and fair value of securities available for sale at December 31, 2006, by contractual maturity, are shown below (thousands). Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $53,477,000 at December 31, 2006, and $108,240,000 at December 31, 2005. The book value of securities sold under agreements to repurchase amounted to $1,093,000 and $29,046,000 at December 31, 2006 and 2005, respectively.
Gross gains of $11,000, $107,000 and $824,000 and gross losses of $1,353,000, $6,000 and $37,000 resulting from sales of available-for-sale securities were realized for 2006, 2005 and 2004, respectively. The tax benefit for net losses on securities transactions for 2006 was $456,000. The tax expense for net gains on securities transactions for 2005 and 2004 was $34,000 and $268,000, respectively.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
The table below indicates the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2006 and 2005. (Thousands)
Management evaluates securities for other-than-temporary impairment on a periodic basis. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost; (2) the financial condition of the issuer; and (3) the intent and ability of the company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The unrealized losses are due to the increase in interest rates since the securities were purchased. As management has the ability to hold these securities until the foreseeable future, no declines are deemed to be other-than-temporary.
Note 4: Loans and Allowance for Loan Losses
Categories of loans at December 31, include (thousands):
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Activity in the allowance for loan losses was as follows (thousands):
Impaired loans totaled $6,854,000 and $6,371,000 at December 31, 2006 and 2005, respectively. An allowance for loan losses of $1,800,000 and $529,000 relates to impaired loans of $6,047,000 and $5,197,000, at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, impaired loans of $807,000 and $1,174,000 had no related allowance for loan losses.
Interest of $74,000 and $102,000 was recognized, on a cash basis only, on average impaired loans of $6,414,000 and $3,262,000 for 2006 and 2005.
At December 31, 2006 and 2005, there were no accruing loans delinquent 90 days or more. Non-accruing loans at December 31, 2006 and 2005 were $8,365,000 and $8,178,000, respectively.
Note 5: Premises and Equipment
Major classifications of premises and equipment, stated at cost, were as follows (thousands):
During 2006, the Company sold a branch and two buildings located in northern Ohio. The book value of the premises and equipment sold was approximately $471,000.
Note 6: Operating Leases
The Bank has entered into certain operating leases for some of its branch locations. Operating lease expense was $79,000, $92,000, and $97,000 for years 2006, 2005, and 2004, respectively.
The minimum future lease payments for each of the next five years is as follows: (Thousands)
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Note 7: Goodwill
All goodwill is allocated to the banking segment of the business and totaled $3,825,000 and $3,830,000 at December 31, 2006 and 2005. A reclassification to deferred taxes was made in 2006, reducing the goodwill balance.
Note 8: Other Intangible Assets
The carrying basis and accumulated amortization of recognized intangible assets at December 31, 2006 and 2005, were (thousands):
Certain core deposit balances related to the Sabina acquisition were fully amortized in 2006.
Amortization expense for the years ended December 31, 2006 and 2005, was $665,000 and $686,000, respectively. Estimated amortization expense for each of the following five years is (thousands):
Note 9: Interest-Bearing Deposits
Interest-bearing deposits in denominations of $100,000 or more were $45,490,000 on December 31, 2006, and $47,013,000 on December 31, 2005. At December 31, 2006, the scheduled maturities of time deposits were as follows (thousands):
Note 10: Short-Term Borrowings
Short-term borrowings included the following (thousands):
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Securities sold under agreements to repurchase consist of obligations of the Company to other parties. The obligations are secured by U.S. agency notes, and such collateral is held by the Federal Reserve Bank. The maximum amount of outstanding agreements at any month end during 2006 and 2005 totaled $50,619,000 and $41,798,000 and the daily average of such agreements totaled $28,007,000 and $31,063,000. The agreements at December 31, 2006, mature daily.
The Bank has an unused letter of credit with the Federal Home Loan Bank in the amount of $10,000,000 expiring March 31, 2007.
Note 11: Long-Term Debt
Long-term debt consisted of the following components (thousands):
The Federal Home Loan Bank advances are secured by mortgage loans totaling $116,099,000 at December 31, 2006. Advances, at interest rates from 4.81 to 5.38 percent, are subject to restrictions or penalties in the event of prepayment. In addition, the Federal Home Loan Bank has at its option the ability to convert $24,500,000 to variable rate three-month Libor advances. If the Federal Home Loan Bank exercises this option, the Bank may repay the advance at interest rate reset dates with no penalty.
On June 26, 2002, NB&T Statutory Trust I (“Trust I”), a wholly owned subsidiary of the Company, closed a pooled private offering of 8,000 Capital Securities with a liquidation amount of $1,000 per security. The proceeds of the offering were loaned to the Company in exchange for junior subordinated debentures with terms similar to the Capital Securities. The sole assets of Trust I are the junior subordinated debentures of the Company and payments thereunder. The junior subordinated debentures and the back-up obligations, in the aggregate, constitute a full and unconditional guarantee by the Company of the obligations of Trust I under the Capital Securities. Distributions on the Capital Securities are payable quarterly at the annual rate of 3.45% over the 3 month LIBOR and are included in interest expense in the consolidated financial statements. These securities are considered Tier 1 capital (with certain limitations applicable) under current regulatory guidelines.
The junior subordinated debentures are subject to mandatory redemption, in whole or in part, upon repayment of the Capital Securities at maturity or their earlier redemption at the liquidation amount. Subject to the Company having received prior approval of the Federal Reserve, if then required, the Capital Securities are redeemable prior to the maturity date of June 26, 2032, at the option of the Company; on or after June 26, 2007 at par. Upon occurrence of specific events defined within the trust indenture, the Capital Securities may also be redeemed prior to June 26, 2007 at a premium. The Company has the option to defer distributions on the Capital Securities from time to time for a period not to exceed 20 consecutive semi-annual periods.
All outstanding Federal Home Loan Bank advances mature in 2011.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Note 12: Income Taxes
The provision for income taxes includes these components (thousands):
A reconciliation of income tax expense at the statutory rate to the Company’s actual income tax expense is shown below (thousands):
The tax effects of temporary differences related to deferred taxes shown on the balance sheets were (thousands):
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Note 13: Change in Accounting Principle
In 2006, the Company adopted SFAS 123(R) Share-Based Payments for the accounting of stock options and other equity awards. The Company adopted FAS 123(R) using the modified prospective method and previous years have not been restated. The Company’s current granted stock options vest over periods ranging from three to five years to selected employees and to all directors. The exercise price of each option is intended to equal the fair value of the Company’s stock on the date of grant. An option’s maximum term is ten years. The Company has used the Black-Scholes option pricing model for all grant date estimations of fair value as the Company believes its stock options have characteristics for which the Black-Scholes model provides an acceptable measure of fair value. The expected term of an option represents the period of time the Company expects the options granted to be outstanding. The Company bases this estimate on a number of factors including vesting period, historical data and expected volatility. The expected volatility used in the option pricing calculation is estimated considering historical volatility. The expected dividend yield represents the dividends expected to be paid on the underlying shares during the current year. The Company’s options do not permit option holders to receive dividends and therefore the expected dividend yield was factored into the calculation. The risk-free rate is assumed to be a short-term treasury rate on the date of grant such as a U.S. Treasury issue with a term equal to the expected term of the option. Our adoption of SFAS 123(R) impacted our results of operations by increasing salaries and benefits expense. The amount of the impact was immaterial to the Company for the year ended December 31, 2006.
For purposes of pro forma disclosure, for the period ended December 31, 2005 and 2004, the estimated fair value of the options is amortized to expense over the vesting period. Under the fair value method, the Company’s net income and earnings per share would have been (thousands, except per share amounts):
Note 14: Other Comprehensive Income (Loss)
Other comprehensive income (loss) components and related taxes were as follows (thousands):
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Note 15: Regulatory Matters
The Company and the subsidiary bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the subsidiary bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the subsidiary bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2006, that the Company and the subsidiary bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2006, the most recent notification from the regulators categorized the Company as well capitalized under the regulatory framework for prompt corrective action. To be categorized, the Company must maintain capital ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Company’s category.
The Company and subsidiary bank’s actual capital amounts and ratios are also presented in the following table (thousands):
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At December 31, 2006, no retained earnings were available for dividend declaration without prior regulatory approval.
Note 16: Related Party Transactions
The Bank had loans outstanding to executive officers, directors, significant shareholders and their affiliates (related parties). A summary of the related party loan activity follows (thousands):
In management’s opinion, such loans and other extensions of credit and deposits were made in the ordinary course of business and were made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons. Further, in management’s opinion, these loans did not involve more than normal risk of collectibility or present other unfavorable features.
Deposits from related parties held by the Bank at December 31, 2006 and 2005 totaled $971,000 and $851,000 respectively.
Note 17: Employee Benefits
The Company has a retirement savings 401(k) plan covering substantially all employees. Employees may contribute up to 50% of their compensation. The Bank will match up to 3% of an employee’s compensation for the first 8% of their compensation contributed to the plan. Employer contributions charged to expense for 2006, 2005 and 2004 were $211,000, $180,000 and $146,000, respectively.
Also, the Bank has a deferred compensation agreement with certain retired officers. The agreement provides level monthly or annual payments ranging from four to twenty years after retirement. The charge to expense for the agreement was $6,000, $245,000 and $246,000 for 2006, 2005 and 2004, respectively. Such charges reflect the straight-line accrual over the period until full eligibility of the present value of benefits due each participant on the full eligibility date, using a 6.5% discount factor.
The Company sponsors a leveraged employee stock ownership plan (ESOP) that covers substantially all employees who meet minimum age and length of service requirements. Shares of the Company’s common stock held by the ESOP were purchased with the proceeds of borrowings from the Company. The Company makes annual contributions to the ESOP equal to the ESOP’s debt service less dividends on unallocated shares received by the ESOP. All dividends on unallocated shares received by the ESOP are used to pay debt service. The ESOP shares initially were pledged as collateral for its debt. As the debt is repaid, shares are released from collateral and allocated to plan participants, based on the proportion of debt service paid in the year to total expected debt service. The Bank accounts for its ESOP in accordance with Statement of Position 93-6. As shares are released from collateral, the Company reports compensation expense equal to the current fair value of the shares. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of debt and accrued interest.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
ESOP compensation expense was $206,000, $192,000 and $247,000 for years 2006, 2005 and 2004, respectively. The ESOP shares as of December 31 were as follows:
Note 18: Stock Option Plan
The Company adopted a new Equity Plan in 2006, which is shareholder approved, and permits the Company to grant options, restricted stock or stock appreciation rights of up to 270,000 shares of common stock. The Company believes that such awards better align the interests of its directors and employees with those of its shareholders. Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant; those option awards generally vest based on three years of continuous service and have a ten-year contractual term. The previous plan, which was terminated in 2006, still has options to purchase 148,000 shares outstanding at December 31, 2006. These options vest over five years. Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the Plan). The compensation cost for the stock option expense recognized in 2006 was calculated for all grants based on the grant date’s fair value and totaled $63,000 for the year. The related tax benefit was $21,000.
The fair value of each option award is estimated on the date of grant using a binomial option valuation model that uses the assumptions noted in the following table. Expected volatility is based on historical volatility of the Company’s stock and other factors. The Company uses historical data to estimate option exercise and participant termination within the valuation model; separate groups of participants that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
A summary of option activity under the Plan as of December 31, 2006, and changes during the year then ended, is presented below.
The total intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004 was $9,000, $121,000 and $45,000, respectively.
As of December 31, 2006, there was $353,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 1.6 years.
Note 19: Earnings Per Share
Earnings per share (EPS) were computed as follows (thousands, except per share amounts):
Options to purchase 187,000 shares of common stock at $20.50 to $30.50 per share were outstanding at December 31, 2006, but not included in the computation of diluted EPS because the options’ exercise price was greater than the average market price of the common shares.
Options to purchase 120,700 shares of common stock at $22.00 to $30.50 per share were outstanding at December 31, 2005, but not included in the computation of diluted EPS because the options’ exercise price was greater than the average market price of the common shares.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Options to purchase 39,500 shares of common stock at $28.00 to $30.50 per share were outstanding at December 31, 2004, but not include in the computation of diluted EPS because the options’ exercise price was greater than the average market price of the common shares.
Note 20: Disclosures about Fair Value of Financial Instruments
The following table presents estimated fair values of the Company’s financial instruments. The fair values of certain of these instruments were calculated by discounting expected cash flows, which involves significant judgments by management and uncertainties. Fair value is the estimated amount at which financial assets or liabilities could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Because no market exists for certain of these financial instruments and because management does not intend to sell these financial instruments, the Company does not know whether the fair values shown below represent values at which the respective financial instruments could be sold individually or in the aggregate (thousands):
For purposes of the above disclosures of estimated fair value, the following assumptions were used as of December 31, 2006 and 2005. The estimated fair value for cash and cash equivalents, interest-bearing deposits, FRB and FHLB stock, accrued interest receivable, demand deposits, savings accounts, NOW accounts, certain money market deposits, short-term borrowings, and interest payable is considered to approximate cost. The estimated fair value for securities is based on quoted market values for the individual securities or for equivalent securities. The estimated fair value for loans receivable, including loans held for sale, net, is based on estimates of the rate the Bank would charge for similar loans at December 31, 2006 and 2005 applied for the time period until the loans are assumed to reprice or be paid. The estimated fair value for fixed-maturity time deposits as well as borrowings is based on estimates of the rate the Bank would pay on such liabilities at December 31, 2006 and 2005, applied for the time period until maturity. The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit and lines of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Note 21: Commitments and Credit Risk
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.
At December 31, 2006 and 2005, the Bank had outstanding commitments to originate business loans aggregating approximately $3,001,000 and $7,944,000, respectively. The commitments extended over varying periods of time with the majority being disbursed within a one-year period. Loan commitments at fixed rates of interest amounted to $266,000 and $0 at December 31, 2006 and 2005 respectively, with the remainder at floating market rates.
Letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
The Bank had total outstanding letters of credit amounting to $933,000 and $1,202,000, at December 31, 2006 and 2005, respectively, with terms ranging from 30 days to 3 years.
Mortgage loans in the process of origination represent amounts that the Bank plans to fund within a normal period of 60 to 90 days, some of which are intended for sale to investors in the secondary market. Forward commitments to sell mortgage loans are obligations to deliver loans at a specified price on or before a specified future date. The Bank acquires such commitments to reduce market risk on mortgage loans in the process of origination and mortgage loans held for sale.
Total mortgage loans in the process of origination amounted to $634,000 and $2,188,000 with no commitments to originate loans at fixed rates of interest. There were $144,000 and $0 mortgage loans held for sale at December 31, 2006 and 2005.
Lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Lines of credit generally have fixed expiration dates. Since a portion of the line may expire without being drawn upon, the total unused lines do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate. Management uses the same credit policies in granting lines of credit as it does for on-balance-sheet instruments.
At December 31, 2006, the Bank had granted unused lines of credit to borrowers aggregating approximately $28,538,000 and $23,913,000 for commercial lines and open-end consumers lines, respectively. At December 31, 2005, the Bank had granted unused lines of credit to borrowers aggregating approximately $29,847,000 and $24,507,000 for commercial lines and open-end consumers lines, respectively.
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
The Bank had $3,197,000 in Federal Funds sold invested at US Bank, LaSalle Bank and the Federal Home Loan Bank at December 31, 2006.
At December 31, 2006, the Bank had a commitment to purchase a parcel of land for $475,000, subject to certain contingencies prior to closing.
Note 22: Future Change in Accounting Principle
The Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, becomes effective for fiscal years beginning after December 15, 2006. Under this interpretation, a Company cannot hold excess tax reserves, unless it relates to a tax position taken that remains uncertain due to potential differences of interpretation between the taxpayer and the applicable taxing authority. This new standard is not anticipated to have a material impact on the Company’s financial statements.
Note 23: Condensed Financial Information (Parent Company Only)
Presented below is condensed financial information as to financial position, results of operations and cash flows of the Company (thousands):
Condensed Balance Sheets
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Condensed Statements of Income
Condensed Statements of Cash Flows
NB&T Financial Group, Inc.
Notes to Consolidated Financial Statements-(Continued)
Years Ended December 31, 2006, 2005 and 2004
Note 24: Selected Quarterly Data (Unaudited)
The following tables summarize selected quarterly results of operations for 2006 and 2005 (thousands, except per share amounts):
(A) The Company sold a branch located in northern Ohio in the fourth quarter of 2006, resulting in a gain of approximately $1,099,000.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
The Company’s principal executive officer and principal financial officer have concluded, based upon their evaluation of the Company’s disclosure controls and procedures as of December 31, 2006, that the Company’s disclosure controls and procedures were effective. During the quarter ended December 31, 2006, no changes have occurred in the Company’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information contained in the Proxy Statement under the captions “ELECTION OF DIRECTORS,” “EXECUTIVE OFFICERS” and “SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE” is incorporated herein by reference.
The Board of Directors has determined that Audit Committee Member, Charles L. Dehner, is an “audit committee financial expert,” as defined in 17 C.F.R. Section 229.407(d)(5), and that he is “independent” under the applicable rules of The NASDAQ Stock Market LLC.
The NB&T Financial Group, Inc. Code of Ethics is attached to this Form 10-K as Exhibit 14. Amendments to the Code of Ethics and waivers of the provisions of the Code of Ethics will be posted on the registrant’s web site at www.nbtdirect.com.
Item 11.
Item 11. Executive Compensation
The information contained in the Proxy Statement under the caption “COMPENSATION OF EXECUTIVE OFFICERS” AND “ELECTION OF DIRECTORS” is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information contained in the Proxy Statement under the caption “VOTING SECURITIES AND OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT” is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information contained in the Proxy Statement under the caption “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” is incorporated herein by reference. The Board of Directors of NBTF has determined that all of the directors except Messrs. Limbert and Smith are “independent” under the listing standards of The NASDAQ Stock Market, LLC (“Nasdaq”). In determining independence, the Board of Directors considered loan and deposit relationships with each director. The rules of Nasdaq do not deem such relationships to disqualify a director from being deemed independent. In addition, all loans and other extensions of credit were made and deposits accepted in the ordinary course of business and were made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons. Further, in management’s opinion, the loans did not involve more than normal risk of collectibility or present other unfavorable features. The Board of Directors does not believe such relationships interfere with the directors’ exercise of independent judgment in carrying out their responsibilities as directors.
Item 14.
Item 14. Principal Accountant Fees and Services
The information contained in the Proxy Statement under the caption “AUDITORS” is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)
(1) Financial Statements-See Index to Consolidated Financial Statements in Item 8 of this Form 10-K.
(2) Financial Statement Schedules-None
(b) Exhibits
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS