ITEM 1.
BUSINESS.
General
Altrust Financial Services, Inc. (“Altrust”) was incorporated in 1985 as Cullman Bancshares, Inc., an Alabama corporation, which changed its name in 1996 to Altrust Financial Services, Inc. Altrust is a bank holding company registered with the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended, and a financial holding company registered under the Gramm-Leach-Bliley Act of 1999. Altrust primarily conducts its business through Peoples Bank of North Alabama (“Peoples Bank”), its wholly-owned bank subsidiary.
Peoples Bank is an Alabama bank that commenced operations in September 1977 as Peoples Bank of Holly Pond. Peoples Bank opened its first branch in the city of Cullman, Alabama in September 1983, and adopted the name Peoples Bank of Cullman County. In June 1994, Peoples Bank of Cullman County changed its name to Peoples Bank of North Alabama.
On May 31, 2002, Peoples Bank acquired six branches in Marshall County, Alabama from Community Bank, an Alabama commercial bank. In connection with the acquisition, Peoples Bank acquired approximately $58.8 million in loans and approximately $4.7 million of other assets (including capitalized leases), and assumed approximately $79.6 million of deposits and other liabilities. Peoples Bank paid Community Bank a core deposit premium of approximately $4.9 million, or eight percent of the core deposits acquired in the transaction, of which approximately $4.0 million was allocated to goodwill and approximately $900,000 was allocated to core deposit intangibles. On February 2, 2004, Peoples Bank acquired another small branch in Morris, Alabama from The Bank, an Alabama commercial bank. In connection with the Morris branch acquisition, Peoples Bank acquired approximately $8.2 million in assets and approximately $8.2 million in deposit liabilities. Included in the assets acquired in the Morris branch acquisition were approximately $693,000 of goodwill and approximately $45,000 of core deposit intangibles. In September 2005, Peoples Bank purchased two branch buildings from Regions Bank (“Regions”), one in Cordova, Alabama and one in Blountsville, Alabama. As of December 31, 2006, these branches had deposits of approximately $16.1 million and $11.4 million respectively. In August 2005, Peoples Bank also entered into a lease-purchase agreement with Bow Tie, LLC for a branch building in Decatur, Alabama pursuant to which Peoples Bank will lease the branch for 14 calendar months. The building has now been purchased for $375,000. In connection with the lease purchase agreement, the Bank advanced a $381,000 purchase money loan to Bow Tie, LLC, at a rate of 6.5%, with the loan dated June 23, 2005 paid off in September of 2006. On February 27, 2006, a new full-service branch was opened in Decatur, Morgan County, and had $8 million in total deposits at December 31, 2006. A second smaller branch was opened in Decatur in a strip-mall on September 11, 2006, with $758,000 in total deposits at December 31, 2006.
Peoples Bank is a member of the Federal Deposit Insurance Corporation (“FDIC”) and its deposits are insured by the FDIC up to the maximum permitted by law. Peoples Bank is supervised, regulated and examined by the FDIC and the Alabama Superintendent of Banks. Peoples Bank is also a member of the Federal Home Loan Bank (“FHLB”) of Atlanta.
Peoples Bank is primarily engaged in retail and commercial banking in Blount, Cullman, Marshall, Walker and Morgan Counties, Alabama, as well as the northern portion of Jefferson County, Alabama. Peoples Bank provides mostly traditional banking services including the taking of demand and time deposits and the making of secured and unsecured consumer loans and commercial loans to its business customers.
Altrust has two other wholly-owned subsidiaries, Southern Insurance of Cullman, Inc. (“Southern Insurance”), and Southern Appraisal Services, Inc. (“Southern Appraisal”). Southern Insurance was incorporated in 1993 under the laws of the State of Alabama. Southern Insurance acts as an agent for obtaining title insurance for Peoples Bank’s real estate customers. Southern Insurance receives commissions on title policy premiums as compensation for its services. Southern Appraisal was incorporated in Alabama in 2003 and provides real estate appraisal services. Revenues and expenses of both subsidiaries account for less than 3% of Altrust’s consolidated revenues and expenses. Revenues are included in consolidated non-interest income, and expenses are included in consolidated non-interest expense.
As of December 31, 2006, Altrust had total consolidated assets of approximately $426 million, total consolidated liabilities, including deposits, of approximately $378 million, consolidated shareholders’ equity of approximately $35 million and approximately $13 million in redeemable common stock held by ESOP at fair market value.
Our principal executive offices, including the principal executive offices of Peoples Bank, are located at 811 2nd Avenue S.W., Cullman, Alabama 35055, and our telephone number is (256) 737-7000.
Business Strategy
Altrust seeks to serve the banking and financial needs of the northern Alabama communities where we have offices. As a financial holding company, Altrust is permitted to engage in a variety of activities which are financial in nature but which may not be permissible for our bank and bank holding competitors. Our objective has been to develop a market niche with profitable consumers and small businesses with emphasis on the number of account relationships, along with growth of deposit dollars.
Peoples Bank offers personalized and flexible banking services to the communities in our market area and is able to react quickly to changes in those communities offering products specific to community needs.
Market Area
Peoples Bank operates 29 offices within its primary market area in Blount, Cullman, Marshall, Morgan, and Walker Counties, Alabama, as well as the northern portion of Jefferson County, Alabama. Our market area is largely comprised of rural and residential communities with related agricultural, retail and commercial development.
Banking Operations
Peoples Bank’s services are retail-oriented and aimed at individuals and small to medium-sized owner-operated businesses located within our north Alabama market area. Peoples Bank provides a broad range of traditional banking and financial services to its customers, but its activities consist mostly of taking demand and time deposits and making secured and unsecured consumer and commercial loans.
Lending Activities
The principal lending activity of Peoples Bank has been the origination for its own portfolio of adjustable-rate and fixed-rate loans secured by various forms of collateral.
One- to Four-Family Residential Mortgage Loans. Peoples Bank’s residential real estate lending activity consists of the origination of one- to four-family, owner-occupied, residential mortgage loans secured by property located in Peoples Bank’s primary market area. Peoples Bank originates both adjustable-rate and fixed-rate residential mortgage loans. Peoples Bank may, from time to time, sell residential mortgage loans from our loan portfolio in the secondary market.
Construction Lending. Peoples Bank engages in construction lending originating loans to qualified borrowers for construction of one- to four-family residential properties and, on a limited basis, for commercial properties. Nearly all of Peoples Bank’s construction loan properties are located in Peoples Bank’s primary market area.
Commercial Loans. Peoples Bank’s commercial lending activities are primarily loans secured by commercial properties. These loans consist of permanent loans secured by small office buildings, apartment buildings, churches, shopping centers and convenience stores. Commercial real estate secured loans are generally originated in amounts up to 75% of the appraised value of the property on an annual adjustable-rate basis with terms of up to 20 years.
Consumer and Other Installment Loans. Consumer loans consist of savings account loans, personal secured and unsecured loans, automobile loans, watercraft loans, recreational vehicle loans, and home improvement loans. Nearly all of Peoples Bank’s consumer loans have fixed rates of interest.
Investment Activities
Peoples Bank invests in securities, principally U.S. government and agency securities, state, county and municipal securities, mortgage-backed securities, and other investment grade securities. All of our securities are classified as available-for-sale. See Note 2 to our audited financial statements set forth in Item 8 of this report for further discussion on our investment activities.
The carrying value of investment securities pledged to secure public funds on deposit, advances from the FHLB, and for other purposes as required by law was $91,043,216 at December 31, 2006.
Other investments include a restricted investment in the FHLB of Atlanta stock to comply with a membership requirement and to secure available lines of credit from the FHLB. Other investments also include an investment in Banker’s Bank stock, Alabama Bankers’ Bank stock, and an investment in CBAA Services, Inc., a group purchasing entity organized by the Community Bankers Association of Alabama.
Source of Funds
General. The major sources of Peoples Bank’s funds for lending and other investment purposes are deposits, scheduled principal repayments, prepayment of loans and mortgage-backed securities, maturities of investment securities, certain borrowings, and operations. Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and market conditions.
Deposits. We attract customer deposits principally from within our primary market area by offering a broad selection of deposit instruments, including demand deposit accounts, checking accounts, savings, money market deposit, term certificate accounts and individual retirement accounts. Deposit account terms vary according to the minimum balance required, the time period the funds must remain on deposit and the interest rate. All deposit accounts are insured by the FDIC up to the maximum amount permitted by law.
Borrowings. We may obtain advances from the FHLB of Atlanta to supplement Peoples Bank’s supply of lendable funds. Advances from the FHLB of Atlanta may be secured by a pledge of Peoples Bank’s stock in the FHLB of Atlanta, a portion of Peoples Bank’s first mortgage loans, and any securities obtained through leveraged transactions. The FHLB of Atlanta has agreed to make advances to us up to a total amount equal to 30 percent of our total assets. To maintain our eligibility to borrow up to 30 percent of our assets, we must (i) maintain a CAMELS rating of 1 or 2, including an asset quality rating of 1 or 2, (ii) have a satisfactory collateral audit performed by the FHLB of Atlanta, and (iii) maintain an advances-to-assets ratio of greater than 20 percent. At December 31, 2006, Peoples Bank had outstanding FHLB advances of $62.8 million which we had utilized to purchase certain securities which are now classified as “available-for-sale” in our investment portfolio.
Peoples Bank also has unsecured lines of credit with correspondent banks. First Tennessee Bank has extended to Peoples Bank a federal funds line of credit. This accommodation is subject to Peoples Bank maintaining a demand deposit account with First Tennessee Bank. As of December 31, 2006, Peoples Bank had no amounts outstanding under this accommodation.
The Bankers Bank has also extended Peoples Bank a federal funds line of credit. Peoples Bank must maintain a demand deposit account with The Bankers Bank and may not have an advance balance outstanding for more than 14 days. Upon a default in payment by Peoples Bank, The Bankers Bank has the right to offset the amount of that default against any other obligations it may owe Peoples Bank. As of December 31, 2006, Peoples Bank had $2.45 million outstanding under The Bankers Bank federal funds line of credit.
First American Bank has also extended a federal funds line to Peoples Bank. No amounts were outstanding to First American at December 31, 2006 under this line of credit.
Subsidiary Activity. Altrust has three wholly-owned subsidiaries, all incorporated under the laws of the State of Alabama. These include Peoples Bank, Southern Insurance, and Southern Appraisal. Southern Insurance is an approved agent for Chicago Title Insurance Company, Chicago, Illinois, and Stewart Title Insurance Company,
Houston, Texas. Southern Insurance acts as an agent for obtaining title insurance for Peoples Bank’s real estate customers. No other products or services are offered by Southern Insurance. Southern Insurance receives commissions on title policy premiums as compensation for its services. Southern Appraisal provides real estate appraisal services to bank customers.
Seasonality, Cycles
We do not consider our banking operations to be seasonal in nature. Most cities and counties in which Peoples Bank has branch locations have diversified industries with a mix of farming and industry. Other than the poultry industry in Cullman County, which is one of the largest poultry producing counties in the country, there is no other single industry that we believe has a material economic, seasonal or cyclical effect on Peoples Bank. Peoples Bank has been making loans in Cullman County for nearly 25 years allowing Peoples Bank to study the poultry industry’s demand cycles and price fluctuations over the years. Management believes it has the knowledge and experience necessary to deal with the poultry industry’s cycles and risks.
Competition
Peoples Bank operates in highly competitive markets. Peoples Bank competes directly for deposits in its commercial banking market with other commercial banks, savings and loan associations, credit unions, mortgage brokers and mortgage companies, mutual funds, securities brokers, and insurance companies, locally, regionally and nationally, some of which compete with offerings by mail, telephone, computer and the Internet. In its commercial and consumer lending activities, Peoples Bank competes with other financial institutions as well as consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit to customers located in our market area. Interest rates, both on loans and deposits, and prices of services are significant competitive factors among financial institutions generally. Important competitive factors, such as office location, types and quality of services and products, office hours, customer service, a local presence, community reputation and continuity of personnel, among others, are and continue to be a focus of Peoples Bank.
Many of the largest banks operating in Alabama, including some of the largest banks in the region, have offices in our markets. Many of these institutions have greater resources, broader geographic markets and higher lending limits and may offer various services we do not offer. In addition, these institutions are better equipped to afford and make broader use of media advertising, support services, and electronic technology. To offset these competitive disadvantages, Peoples Bank depends on its reputation as an independent and locally-owned community bank, its personal service, its greater community involvement and its ability to make credit and other business decisions quickly and locally.
Employees
On December 31, 2006, we had approximately 165 full-time equivalent (FTE) employees. We consider our employee relations to be good, and we have no collective bargaining agreements with any employees.
Statistical Disclosure
Certain statistical and financial information (as required by Guide 3) is included in response to Item 7 of this Form 10-K set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
SUPERVISION AND REGULATION
The banking and financial services industry is extensively regulated under both federal and state law. The following discussion summarizes certain statutes, rules and regulations affecting our business and operations. This summary is qualified in its entirety by reference to the statutory and regulatory provisions referred to below and elsewhere and is not intended to be an exhaustive description of the statutes or regulations applicable to us. Changes in the laws and regulations that apply to us can affect our operations in substantial and unpredictable ways. We cannot accurately predict whether legislation will be enacted, and, if enacted, the ultimate effect that it or any implementing regulations will have on our business, financial condition or results of operations.
The Company is required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as new rules and regulations adopted by the SEC and the Public Company Accounting Oversight Board. In particular, we are required to include management and independent auditor reports on internal controls as part of our annual report on Form 10-K pursuant to Section 404 of the Sarbanes-Oxley Act beginning for our fiscal years ended December 31, 2007 and 2008. We have evaluated our controls, including compliance with the SEC rules on internal controls, and have and expect to continue to spend significant amounts of time and money on compliance with these rules. Our failure to comply with these internal control rules may materially adversely affect our reputation, ability to obtain the necessary certifications to financial statements, and the values of our securities. The assessments of financial reporting controls as of December 31, 2006 are included elsewhere in this report with no material weaknesses reported.
Supervision, regulation, and examination of holding companies and banks by bank regulatory agencies are intended primarily for the protection of depositors rather than holders of our securities, including our common stock.
Holding Company Regulation
General
Altrust is a bank holding company within the meaning of the Bank Holding Company Act, as amended (the “BHC Act”) and a financial holding company within the meaning of the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (the “GLB Act”), and is subject to supervision, examination, and reporting by the Federal Reserve. The State of Alabama does not currently regulate bank holding companies, but does regulate Altrust’s bank subsidiary, Peoples Bank. Altrust is required to file with the Federal Reserve periodic reports and any additional information as the Federal Reserve may require. The Federal Reserve regularly examines Altrust and may examine its subsidiaries.
Investment Activities
The BHC Act requires prior Federal Reserve approval for, among other things:
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the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank; and
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a merger or consolidation of a bank holding company with another bank holding company.
The Change in Bank Control Act and Federal Reserve regulations also generally require a notice and prior action thereon if anyone not subject to the BHC Act application acquires 10% or more of a bank’s or its parent holding company’s securities where the bank or holding company has a class of securities registered under the Exchange Act.
A bank holding company may acquire direct or indirect ownership or control of voting shares of any company that is engaged directly or indirectly in banking, managing or controlling banks, or performing services for its authorized subsidiaries. A bank holding company may also engage in or acquire an interest in a company that engages in activities that the Federal Reserve has determined by regulation or order to be so closely related to banking as to be a proper incident to those activities.
The BHC Act permits acquisitions of banks by bank holding companies, such that the Company and any other bank holding company, whether located in Alabama or elsewhere, may acquire a bank located in any other state, subject to certain deposit-percentage, age of bank charter requirements, and other restrictions. Federal law also permits national and state-chartered banks to branch interstate through acquisitions of banks in other states. Alabama permits interstate branching. Under the Alabama Banking Code, with the prior approval of the Alabama Superintendent, an Alabama bank may establish, maintain and operate one or more branches in a state other than the State of Alabama pursuant to a merger transaction in which the Alabama bank is the resulting bank. In addition, one or more Alabama banks may enter into a merger transaction with one or more out-of-state banks, and an out-of-state bank resulting from such transaction may maintain and operate the branches of the Alabama bank that participated in such merger.
The GLB Act, made substantial revisions to the statutory restrictions separating banking activities from certain other financial activities. Under the GLB Act, bank holding companies that are well-capitalized and well-managed and meet other conditions can elect to become “financial holding companies.” Financial holding companies and their subsidiaries are permitted to acquire or engage in previously impermissible activities such as insurance underwriting, securities underwriting and distribution, travel agency activities, board insurance agency activities, merchant banking, and other activities that the Federal Reserve determines to be financial in nature or complementary to those activities. In addition, under the merchant banking authority added by the GLB Act and Federal Reserve regulations, financial holding companies are authorized to invest in companies that engage in activities that are not financial in nature, as long as the financial holding company makes its investment with the intention of limiting the investment in duration, does not manage the company on a day-to-day basis, and the investee company does not cross-market with any of the financial holding company’s controlled depository institutions. Financial holding companies continue to be subject to the overall oversight and supervision of the Federal Reserve, but the GLB Act applies the concept of functional regulation to the activities conducted by subsidiaries. For example, insurance activities would be subject to supervision and regulation by state insurance authorities. Altrust received approval as a financial holding company on April 23, 2000.
Source of Financial Strength
Federal Reserve policy requires a bank holding company to act as a source of financial and managerial strength to its subsidiary banks. This means that a bank holding company must be prepared to use available resources to provide adequate capital funds to its bank subsidiaries during periods of financial stress and must have sufficient financial flexibility and capital-raising capacity to provide ongoing support to the banks. In addition, under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, or “FIRREA,” if a bank holding company has more than one bank or thrift subsidiary, each of the bank holding company’s subsidiary depository institutions are responsible for any losses to the FDIC as a result of an affiliated depository institution’s failure. As a result, a bank holding company may be required to loan money to its subsidiaries in the form of capital notes or other
instruments which qualify as capital under regulatory rules. Any loans from a bank holding company to its subsidiary banks likely will be unsecured and subordinated to the bank’s depositors and perhaps to other creditors of that bank.
Transactions With Affiliates
Altrust is a legal entity separate and distinct from Peoples Bank. Various legal limitations restrict Peoples Bank from lending or otherwise supplying funds to Altrust or its other affiliates. Section 23A of the Federal Reserve Act limits a bank’s “covered transactions,” which include extensions of credit with any affiliate, to 10% of the bank’s capital and surplus. All covered and exempt transactions between a bank and its affiliates must be on terms and conditions consistent with safe and sound banking practices, and banks and their subsidiaries are prohibited from purchasing low-quality assets from the bank’s affiliates. Finally, all of a bank’s extensions of credit to an affiliate must be appropriately secured by acceptable collateral, generally United States government or agency securities.
Section 23B of the Federal Reserve Act requires that covered and exempt transactions among affiliates be on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for transactions with unaffiliated companies.
Bank Regulation
General
Peoples Bank is an Alabama bank whose deposits are insured by the Federal Deposit Insurance Corporation, or the “FDIC.” Peoples Bank is subject to regulation and examination by the Alabama Superintendent of Banks and by the FDIC. The Alabama Superintendent of Banks and the FDIC regulate and examine all of Peoples Bank’s operations, including its overall financial condition and resources, loan loss reserves, the quality of its loan portfolio, mortgages, payments of dividends, interest rates charged, the establishment of branches, the actions of its directors and management, the investment of its funds, and compliance with its charter and the applicable law.
The powers of Alabama-chartered banks include provisions designed to provide these banks with competitive equality to the powers of national banks. In addition, the GLB Act permits banks to engage in “financial activities” through subsidiaries in a manner similar to financial holding companies.
Dividends
Dividends from Peoples Bank historically have been Altrust’s primary source of funds for servicing debt and paying cash dividends to our stockholders.
As to the payment of dividends, Peoples Bank is subject to the laws and regulations of the state of Alabama. During 2006 and 2005, Peoples Bank paid cash dividends to Altrust of $6,381,603 and $1,437,045 respectively. During 2004, Peoples Bank paid $1,043,819 in cash dividends to Altrust.
In addition, Altrust and Peoples Bank are subject to various regulatory policies and requirements that affect the payment of dividends, including requirements to maintain adequate capital. The appropriate federal and state regulatory authorities are authorized to determine, based on the financial condition of a bank or bank holding company, that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of those dividends. The FDIC and the Alabama Superintendent have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsound and unsafe banking practice.
As to Altrust, the Federal Reserve may prohibit the payment of dividends to our stockholders if it determines that the payment would constitute an unsafe or unsound practice. The Federal Reserve’s position is that a bank holding company should not pay dividends if it is experiencing earnings weaknesses or other financial pressures and should not pay dividends that exceed its net income, that are inconsistent with its capital position or that could only be funded in ways that weaken its financial health, such as by borrowing or selling its assets. In addition, a bank holding company must not pay dividends if such payment would affect its ability to provide adequate financial support for its subsidiary banks.
Safety and Soundness
The FDIC has adopted the Federal Financial Institutions Examination Council’s, or the “FFIEC,” internal rating system for assessing the soundness of financial institutions on a uniform basis and for identifying those institutions requiring special supervisory attention. Each financial institution is assigned a confidential composite “CAMELS” rating based on an evaluation and rating of the following six components of an institution’s financial condition and operations:
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Capital adequacy;
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Asset quality;
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Management;
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Earnings;
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Liquidity; and
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Sensitivity to market risk.
For most institutions, the FFIEC has indicated that market risk primarily reflects exposures to changes in interest rates. When regulators evaluate this component, consideration is expected to be given to the sensitivity of the financial institution’s earnings or the economic value of its capital to adverse changes in interest rates, foreign exchange rates, commodity prices, or equity prices; management’s ability to identify, measure, monitor and control exposure to market risk; the nature and complexity of interest rate risk exposure arising from non-trading positions; and the adequacy of its capital and earnings in relation to its level of exposure.
Capital Regulations
The federal bank regulatory agencies have adopted risk-based capital guidelines for bank holding companies and banks. The guideline for a minimum ratio of capital to risk-weighted assets, including certain off-balance-sheet activities, such as standby letters of credit, is 8.0%. At least half of the total capital must consist of “Tier 1 Capital,” which includes common equity, retained earnings and a limited amount of qualifying preferred stock, less goodwill. The remainder may consist of “Tier 2 Capital,” which includes non-qualifying preferred stock, qualifying subordinated, perpetual, and/or mandatory convertible debt, term subordinated debt, intermediate term preferred stock and up to 45.0% of the pretax unrealized holding gains on available-for-sale equity securities with readily determinable market values that are prudently valued, and a limited amount of any loan loss allowance.
All bank holding companies and banks are expected to hold capital commensurate with the level and nature of their risks, including the volume and severity of their problem loans. The federal agencies have established minimum leverage ratio guidelines for bank holding companies, national banks, and state banks, which provide for a minimum leverage ratio of Tier 1 Capital to adjusted average quarterly assets equal to 3.0%, plus an additional cushion of 1.0% to 2.0% if the institution has less than the highest regulatory rating. The guidelines also provide that institutions experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels. Higher capital may be required in individual cases, depending upon a bank holding company’s risk profile. Lastly, the Federal Reserve’s guidelines indicate that the Federal Reserve will continue to consider a “Tangible Tier 1 Leverage Ratio,” calculated by deducting all intangibles, in evaluating proposals for expansion or new activity.
The Federal Deposit Insurance Corporation Improvement Act (the “FDICIA”) requires the federal banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements. FDICIA established five capital tiers:
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well capitalized;
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adequately capitalized;
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undercapitalized;
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significantly undercapitalized; and
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critically undercapitalized.
A depository institution’s capital tier will depend upon how its capital levels compare to various measures and certain other factors, as established by regulation. The capital measures used by the federal banking regulators are:
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the Total Capital ratio, which is the ratio of the total of Tier 1 Capital and Tier 2 Capital to total risk-weighted assets;
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the Tier 1 Capital ratio; and
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the Leverage Ratio.
Under these regulations, a bank will be:
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“well capitalized” if it has a Total Capital ratio of 10.0% or greater, a Tier 1 Capital ratio of 6.0% or greater, and is not subject to any written agreement, order, capital directive, or prompt corrective action directive by a federal bank regulatory agency to meet and maintain a specific capital level for any capital measure;
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“adequately capitalized” if it has a Total Capital ratio of 8.0% or greater, a Tier 1 Capital ratio of 4.0% or greater, and a leverage ratio of 4.0% or greater - or 3.0% in some circumstances - and is not well capitalized;
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“undercapitalized” if it has a Total Capital ratio of less than 8.0% or a Tier 1 capital ratio of less than 4.0%, or 3.0% in some circumstances;
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“significantly undercapitalized” if it has a Total Capital ratio of less than 6.0%, a Tier 1 Capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%; or
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“critically undercapitalized” if its tangible equity is equal to or less than 2.0% of average quarterly tangible assets.
In addition to Federal regulatory capital requirements, the Bank is required by the Alabama State Banking Department to maintain a Tier 1 Leverage Capital ratio of at least 7% and remain well capitalized as a result of the acquisition of the six Community branches in 2002. If at any time the Bank’s Tier 1 Leverage Capital ratio falls below 7%, the Bank is to submit a capital plan to the State Banking Department Superintendent for approval.
The following table sets forth Altrust’s and Peoples Bank’s capital information as of December 31, 2006:
CAPITAL ADEQUACY RATIOS
(Dollars in thousands)
Community Reinvestment Act
Altrust and Peoples Bank are subject to the Community Reinvestment Act, or the “CRA,” and the federal banking agencies’ related regulations. Under the CRA, all banks and thrifts have a continuing and affirmative obligation, consistent with their safe and sound operation, to help meet the credit needs for their entire communities, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires a depository institution’s primary federal regulator, in connection with its examination of the institution, to assess the institution’s record of assessing and meeting the credit needs of the community served by that institution, including low- and moderate-income neighborhoods. The regulatory agency’s assessment of the institution’s record is made available to the public. Further, such assessment is required of any institution that has applied to:
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charter a bank;
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obtain deposit insurance coverage for a newly-chartered institution;
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establish a new branch office that accepts deposits;
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relocate an office; or
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merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution.
A less than satisfactory CRA rating will slow, if not preclude, expansion of banking activities.
As a result of the GLB Act, CRA agreements with private parties must be disclosed and annual CRA reports must be made to a bank’s primary federal regulator and no new activities authorized under the GLB Act may be commenced by a bank holding company or by a financial subsidiary if any of its subsidiaries received less than a “satisfactory” CRA rating in its latest CRA examination. Federal CRA regulations require that evidence of discriminatory, illegal or abusive lending practice be considered in the CRA evaluation.
Consumer Regulations
Interest and certain other charges collected or contracted for by Peoples Bank are subject to state usury laws and certain federal laws concerning interest rates. Peoples Bank’s loan operations are also subject to certain federal laws applicable to credit transactions, such as:
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the federal Truth-In-Lending Act governing disclosures of credit terms to consumer borrowers;
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the Home Mortgage Disclosure Act of 1975 requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
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the Equal Credit Opportunity Act prohibiting discrimination on the basis of race, creed, or other prohibited factors in extending credit;
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the Fair Credit Reporting Act of 1978 governing the use and provision of information to credit reporting agencies;
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the Fair Debt Collection Act governing the manner in which consumer debts may be collected by collection agencies;
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The GLB Act, which requires banks and their affiliated companies to adopt and disclose privacy policies, including policies regarding the sharing of personal information they obtain from customers with third parties; and
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the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
Enforcement Policies and Actions
The Federal Reserve, the FDIC, and the Alabama Superintendent monitor compliance with laws and regulations. Violations of laws and regulations, or other unsafe and unsound practices, may result in these agencies imposing fines or penalties, issuing cease and desist orders or memorandums of understanding, or taking other enforcement actions. Under certain circumstances, these agencies may enforce these remedies directly against officers, directors, employees and others participating in the affairs of a bank or bank holding company. The regulatory agencies have extensive powers to enforce their agreements with banks and bank holding companies, including, among other actions, civil money penalties, and possible proceedings to terminate FDIC insurance.
Fiscal and Monetary Policy
Banking is a business that depends on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings, constitutes the major portion of a bank’s earnings. Thus, our earnings and growth will be subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve.
The Federal Reserve regulates the supply of money through various means, including open market dealings in United States government securities, the discount rate at which banks may borrow from the Federal Reserve, and the reserve requirements on deposits. The monetary policies of the Federal Reserve historically have had a significant effect on the operating results of commercial banks and will continue to do so in the future. The conditions in the national and international economies and money markets, as well as the actions and changes in policy by monetary and fiscal authorities, and their effect on us cannot be predicted. In 2006, the Federal Reserve raised the targeted federal funds rate from 4.25% to 5.25%, but has held this rate steady since June 30, 2006.
USA PATRIOT Act
Under the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, (“USA PATRIOT”), financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers.
The USA PATRIOT Act requires financial institutions to establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum standards for these programs, including:
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the development of internal policies, procedures, and controls;
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the designation of a compliance officer;
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an ongoing employee training program; and
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an independent audit function to test the programs.
The International Money Laundering Abatement and Anti-Terrorism Funding Act of 2001 restricts money laundering by terrorists in the United States and abroad. This Act specifies new “know your customer” requirements that will obligate financial institutions to take actions to verify the identity of the account holders in connection with opening an account at any U.S. financial institution. Banking regulators will consider compliance with the act’s money laundering provisions in making decisions regarding approval of acquisitions and mergers. In addition, sanctions for violations of the act can be imposed in an amount equal to twice the sum involved in the violating transaction, up to $1.0 million.
Insurance Regulation
Southern Insurance acts as an agent to obtain title insurance under various title insurance underwriters who are regulated by the Alabama Department of Insurance.
Federal Deposit Insurance Reform Act
Peoples Bank is subject to FDIC deposit insurance assessments. Peoples Bank’s deposits are insured by the FDIC’s Deposit Insurance Fund (“DIF”). Peoples Bank is subject to FDIC assessments for such deposit insurance, as well as assessments by the FDIC to pay interest on the Financing Corporation (“FICO”) bonds. During 2004 through 2006, the FDIC’s risk-based deposit insurance assessment schedule ranged from zero to 27 basis points per annum. Peoples Bank paid $29,940 FDIC deposit insurance premiums, and FICO assessments of approximately $34,708, $32,814 and $29,940 in 2006, 2005 and 2004, respectively.
Congress passed the Federal Deposit Insurance Reform Act in February 2006. Deposits remain insured up to a maximum of $100,000, but the amount of deposits that are FDIC insured will be adjusted every five years based on inflation. Retirement accounts will be insured up to $250,000, and a bank that is less than adequately capitalized will not be able to accept employee benefit deposits. This law also changes the way FDIC insurance assessments and credits are calculated.
The FDIC has adopted new risk-based deposit premium rules following the Reform Act, to achieve the new targeted designated reserve ratio specified in the Reform Act. The new rules set forth the following risk categories and initial deposit insurance assessment rates:
Peoples Bank expects that it will pay FDIC deposit insurance assessments in 2007 based upon the lowest rate of Category I. Peoples Bank is also entitled to a one-time credit provided by the Reform Act and FDIC rules for deposit insurance premiums previously paid. This credit is estimated at approximately $131,366. Peoples Bank’s estimated FDIC insurance assessments for 2007 are $153,500 before the credit, and this assessment will change with the levels of our deposits, and as a result of quarterly changes by the FDIC in its assessment rates or changes in Peoples Bank’s risk category. Any credits unused in 2007 may be applied to reduce up to 90% of deposit insurance assessments in future years.
FICO assessments are set by the FDIC quarterly and ranged from 1.54 basis points of FDIC assessable deposits in the first quarter of 2004 to 1.46 basis points in the last quarter of 2004, 1.44 basis points in the first quarter of 2005 to 1.34 basis points in the last quarter of 2005, and 1.32 basis points in the first quarter of 2006 to 1.24 basis points in the last quarter of 2006. The FICO assessment rate for the first quarter of 2007 is 1.22 basis points.
Legislative and Regulatory Changes
Legislative and regulatory proposals regarding changes in banking laws, the regulation of banks, thrifts and other financial institutions, as well as bank and bank holding company powers are being considered by the executive branch of the Federal government, Congress and various state governments, including Alabama. Proposals pending in Congress would, among other things, allow banks to pay interest on checking accounts and to establish interstate branches de novo. It cannot be predicted whether any proposals will be adopted, and, if adopted, how these proposals will affect us.
During 2006, the federal bank regulatory agencies released guidance on “Concentrations in Commercial Real Estate Lending” (the “Guidance”). The Guidance defines commercial real estate (“CRE”) loans as exposures secured by raw land, land development and construction (including 1-4 family residential construction), multi-family property, and non-farm nonresidential property where the primary or a significant source of repayment is derived from rental income associated with the property (that is, loans for which 50% or more of the source of repayment comes from third party, non-affiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. Loans to REITs and unsecured loans to developers that closely correlate to the inherent risks in CRE markets would also be considered CRE loans under the Guidance. Loans on owner occupied CRE are generally excluded from the Guidance.
The Guidance is triggered where either:
•
Total reported loans for construction, land development, and other land represent 100% or more of the bank’s total capital; or
•
Total reported loans secured by multifamily and non-farm nonresidential properties and loans for construction, land development, and other land represent 300% or more of the bank’s total capital.
The requirements of the Guidance may also be triggered where the bank has had a sharp increase in CRE lending or has significant concentrations of CRE secured by a particular property type. Banks that are subject to the Guidance’s triggers will need to implement enhanced strategic planning, CRE underwriting policies, risk management and internal controls, portfolio stress testing, risk exposure limits, and other policies , including management compensation and incentives, to address the CRE risks. Higher allowances for loan losses and capital levels may also be appropriate.
Altrust believes that the Guidance is not currently applicable as it is below the thresholds as of December 31, 2006. But they will monitor on a quarterly basis whether they are approaching the limits that would trigger the Guidance in order to implement greater internal controls and monitoring.
ITEM 1A.
ITEM 1A.
RISK FACTORS.
We may not be able to successfully manage our growth or implement our growth strategies, which may adversely affect our results of operations and financial condition.
During the last five years, we have experienced significant growth. A key aspect of our business strategy is our continued growth and expansion. Our ability to continue to grow depends, in part, upon our ability to:
•
open new branch offices or acquire existing branches or other financial institutions;
•
attract deposits to those locations;
•
identify attractive loan and investment opportunities; and
•
attract and retain skilled leaders for such new branches or financial institutions.
We may not be able to successfully implement our growth strategy if we are unable to identify attractive markets, locations or opportunities for future expansion. Our ability to manage our growth successfully will also depend on whether we can maintain capital levels adequate to support our growth, maintain cost controls and asset quality and successfully integrate any businesses we acquire into our organization.
We rely heavily on our management team and the unexpected loss of any of those personnel could adversely affect our operations. We depend on our ability to attract and retain key personnel.
We are a customer-focused and relationship-driven organization. We expect our future growth to be driven in a large part by the relationships maintained with our customers by our President and Chief Executive Officer, J. Robin Cummings, and our other executive and senior lending officers. We have not entered into employment agreements with any of our management team or key personnel. We have no other assurances that we will be able to continue to retain the services of other management. The unexpected loss of Mr. Cummings or other key employees could have a material adverse effect on our business and possibly result in reduced revenues and earnings. We maintain key man life insurance policies solely for our CEO, Robin Cummings. We maintain bank-owned life insurance on Mr. Cummings and various other senior officers.
The implementation of our business strategy will also require us to continue to attract, hire, motivate and retain skilled personnel to develop new customer relationships as well as new financial products and services. Many experienced banking professionals employed by our competitors are covered by agreements not to compete or solicit their existing customers if they were to leave their current employment. These agreements make our recruitment of these professionals more difficult. The market for these professionals is competitive, and we cannot assure you that we will be successful in attracting, hiring, motivating or retaining them.
We may incur losses if we are unable to successfully manage interest rate risk.
Our profitability will depend in substantial part upon the spread between the interest rates earned on loans and investments and interest rates paid on deposits and other interest-bearing liabilities. We may pay above-the-market rates to attract depositors as we have done in some of our marketing promotions in the past. Changes in interest rates will affect our operating performance and financial condition in diverse ways including the pricing of securities, loans and deposits, the volume of mortgage loan originations and the value we can recognize on the sale of mortgage and home equity loans in the secondary market. We attempt to minimize our exposure to interest rate risk, but we will be unable to eliminate it. Based on our asset/liability position at December 31, 2006, we anticipate that an increase in interest rates would benefit our net interest income in the short term. Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal economic, monetary and fiscal policies, and economic conditions generally.
Our leveraged investment strategy has risks of loss.
We entered into a leveraged investment strategy of using borrowings under available FHLB of Atlanta lines of credit to purchase investment securities to improve our net interest income during a period when a slow economy and increased competition in our market areas made additional loan growth difficult. Consequently, we increased our borrowings under available lines of credit and used the proceeds from these borrowings to purchase interest-earning securities having expected yields in excess of the cost to us of the borrowings used to fund those securities purchases. Through this leveraged strategy, we were able to increase our net interest income from investments by approximately $1.0 million in 2004. In 2005, we earned approximately $3.6 million on these leveraged investments, and earned approximately $3.1 million in 2006.
Changes in the level of interest rates may negatively affect the value of our assets. Approximately $108 million or 88% of our total securities portfolio are fixed-rate securities. Fixed rate securities are generally affected more negatively by increases in our interest rates. GAAP requires us to reduce our shareholders’ equity, or book value, by the amount of any decrease, net of tax, in the market value of our securities available-for-sale. A decline in the market value of our assets may limit our ability to borrow additional funds or result in our lenders requiring additional collateral from us under our loan credit agreements. As a result, we could be required to sell some of our investments under adverse market conditions, upon terms that are not favorable to us, in order to maintain our liquidity. If those sales are made at prices lower than the amortized costs of the investments, we will incur losses.
Changes in interest rates also may affect our net interest income, which is the difference between the interest income that we earn on our interest-earning investments and the interest expense that we incur in financing our investments. In a period of rising interest rates, our interest expense could increase in different amounts and at different rates and times than the interest that we earn on our assets. If the net differential between our interest income on our assets and our interest expense to carry such securities was reduced, our net income would be reduced. Interest rate fluctuations resulting in our interest expense exceeding our interest income could result in operating losses for us and may limit or eliminate our ability to pay dividends to our shareholders. The return on our investments, the cash available for paying dividends to our shareholders and the amount of capital to support our capital adequacy may be reduced to the extent that changes in market conditions cause the costs of our financings to increase relative to the income that can be derived from the assets we hold in our portfolio. Further, the leverage we have incurred through our FHLB advances may exacerbate any losses we incur.
We may be adversely affected by economic conditions in our market area, particularly in Cullman County.
We are headquartered in northern Alabama, and our market includes Blount, Cullman, Marshall and Morgan Counties, Alabama, as well as the northern portion of Jefferson County, Alabama. Because our lending is concentrated in this area, we will be affected by the general economic conditions in north central Alabama. Changes in the economy may influence the growth rate of our loans and deposits, the quality of the loan portfolio and loan and deposit pricing and the performance of our bank and insurance subsidiaries. A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control would impact these local economic conditions and could negatively affect the demand for banking products and services generally and our financial condition and performance.
The factors are particularly applicable in Cullman County, which is a large poultry-producing area. Though we do not have significant credit exposure to the poultry business, because this area is heavily dependent on a single industry, the downturn in the poultry industry could have a negative impact on local economic conditions and real estate collateral values generally, which could negatively affect our profitability.
Deterioration in local, regional, national or global economic conditions could result in, among other things, an increase in loan delinquencies, a decrease in property values, a change in housing turnover rate or a reduction in the level of bank deposits. Particularly, a weakening of the real estate or employment market in our primary market area could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability. Substantially all of our real estate loans are collateralized by properties located in the northern Alabama market area, and substantially all of our loans are made to borrowers who live in and conduct business in this market area. Any material economic deterioration in this market area could have an adverse impact on our profitability.
If our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.
We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses in our loan portfolio. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of our customers relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed our current estimates. Growing loan portfolios are, by their nature, unseasoned. As a result, estimating loan loss allowances is more difficult for us, and may be more susceptible to changes and to losses exceeding estimates, than more seasoned portfolios. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in our loan portfolio, we cannot fully predict such losses or that our loan loss allowance will be adequate in the future. Excessive loan losses could have a material adverse effect on our financial performance. Because of our growth strategy, we expect that our earnings will be negatively affected by loan growth, which generally requires us to make additions to our allowance for loan losses. Consistent with our loan loss reserve methodology, there may be possible additions to our loan loss reserve levels as a result of our growth strategy, which may affect our short-term earnings.
Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in the amount of our provision for loan losses or in loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.
Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.
We face vigorous competition from other banks and other financial institutions, including savings and loan associations, savings banks, finance companies and credit unions for deposits, loans and other financial services in our market area. A number of these banks and other financial institutions are significantly larger than we are and have substantially greater access to capital and other resources, as well as larger lending limits and branch systems, and offer a wider array of banking services.
To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations which may offer more favorable financing than we can. Many of our non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors have advantages over us in providing certain services. This competition may reduce or limit our margins and our market share, and may adversely affect our results of operations and financial condition.
Our profitability may suffer because of rapid and unpredictable changes in the highly regulated environment in which we operate.
We are subject to extensive supervision by several governmental regulatory agencies at the federal and state levels. Recently enacted, proposed and future banking legislation and regulations have had, and will continue to have, or may have a significant impact on the financial services industry. These regulations, which are intended to protect our depositors and not our shareholders, and the interpretation and application of them by federal and state regulators, are beyond our control, may change rapidly and unpredictably and can be expected to influence our earnings and growth. Our success depends on our continued ability to maintain compliance with these regulations. Some of these regulations may increase our costs and thus place other financial institutions that are not subject to similar regulation in stronger, more favorable competitive positions.
If we need additional capital in the future to continue our growth, we may not be able to obtain it on terms that are favorable to us. This could negatively affect our performance and the value of our common stock.
Our business strategy calls for continued growth. We anticipate that we will be able to support this growth through the generation of additional deposits at existing and new branch locations as well as investment opportunities. However, we may need to raise additional capital in the future to support our continued growth and to maintain our capital levels. Our ability to raise capital through the sale of additional securities will depend primarily
upon our financial condition, including our degree of leverage, and the condition of financial markets at that time. We may not be able to obtain additional capital in the amounts or on terms satisfactory to us. Our growth may be constrained if we are unable to raise additional capital as needed.
We are subject to regulatory risks associated with commercial real estate lending growth and concentrations
Commercial real estate or “CRE” is cyclical and poses risks of possible loss due to concentration levels and similar risks of the asset, especially since the Company has 11.01% of its portfolio in CRE loans as of December 31, 2006. The banking regulators are giving CRE lending greater scrutiny, and may require banks with higher levels of CRE loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for possible losses and capital levels as a result of CRE lending growth and exposures. See “Supervision and Regulation - Commercial Real Estate Lending and Concentrations.”
A downturn in the real estate market could hurt our business.
A downturn in the real estate market could hurt our business because many of our loans are secured by real estate. Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies and acts of nature. If real estate prices decline, the value of real estate collateral securing our loans could be reduced. Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans. As of December 31, 2006, approximately 80.48% of our loan portfolio consisted of loans collateralized by various types of real estate. Substantially all of our real property collateral is located in northern Alabama. If there is a significant decline in real estate values, especially in north central Alabama, the collateral for our loans will provide less security. Any such downturn could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our executive officers, directors and other five percent or greater shareholders and entities affiliated with them own a large percentage of our company, and could influence matters requiring approval by our shareholders.
As of December 31, 2006, our executive officers, directors, and other five percent or greater shareholders and entities affiliated with them, beneficially owned approximately 25.83% of our outstanding common stock (excluding Employee Stock Ownership Plan shares). These shareholders, acting together, are capable of influencing matters requiring approval by our shareholders, including the election of directors. Thus, actions might be taken even if other shareholders oppose their efforts. This concentration of ownership might also have the effect of delaying or preventing a change of control even if such a transaction is favored by other shareholders.
Some of our loan concentrations present a business risk if segments of the economy suffer a downturn.
Our loan portfolio is concentrated in consumer finance loans and real estate mortgages. Although we do not believe that the concentration of our loans in consumer finance lending areas currently pose an undue risk to us, a downturn in the local economy that negatively affects the ability of our consumer borrowers to repay their loans could have a significant adverse effect on our financial condition and performance.
We face credit quality risks and our credit policies may not be sufficient to avoid losses.
We lend primarily to individuals and small- to medium- size businesses, which may expose us to greater risks than if we made loans principally to larger, better-capitalized businesses with longer operating histories. Although we maintain credit policies and underwriting and credit monitoring procedures to manage our risk of loss, these policies and procedures may not prevent losses as a result of unexpected defaults by our borrowers, which could harm our results of operations and financial condition.
If we are required to write down goodwill and other intangible assets, our financial condition and results of operations could be negatively affected.
When we acquire a business, a substantial portion of the purchase price of the acquisition is allocated to goodwill and other identifiable intangible assets. The amount of the purchase price which is allocated to goodwill and other intangible assets is determined by the excess of the purchase price over the net identifiable assets acquired. Under current accounting standards, if we determine goodwill or intangible assets are impaired, we will be required to write down the value of these assets. We conduct an annual review to determine whether goodwill and other identifiable intangible assets are impaired. We cannot assure you that we will not be required to take an impairment charge in the future. Any impairment charge would have a negative effect on our shareholders’ equity and results of operations that could materially and adversely affect the value of our common stock.
Altrust’s and Peoples Bank’s ability to pay dividends is limited.
Altrust’s only source of funds for the payment of principal of, and interest on, its indebtedness, as well as for the payment of dividends on its common stock, is from dividends paid to Altrust by Peoples Bank. As a result, Altrust’s success and ability to pay dividends on its common stock depends upon the earnings and capital position of Peoples Bank. Peoples Bank’s ability to pay dividends to Altrust is limited by its obligation to maintain sufficient capital and by other general restrictions on its dividends that are applicable to Alabama banks and banks that are regulated by the FDIC. No assurances can be made as to whether or how much Altrust will declare dividends on its common stock.
We are required to maintain capital to meet regulatory requirements, and if we fail to maintain sufficient capital, our financial condition, liquidity and results of operations would be adversely affected.
We and our subsidiary bank must meet regulatory capital requirements. If we fail to meet these capital and other regulatory requirements, our financial condition, liquidity and results of operations would be materially and adversely affected. Our failure to remain “well capitalized” and “well managed” for regulatory purposes could affect customer confidence, our ability to grow, our costs of funds and FDIC insurance, our ability to raise brokered deposits, our ability to pay dividends on common stock and our ability to make acquisitions, and we would no longer meet the requirements for remaining a financial holding company.
We will be subject to internal control reporting requirements that increase compliance costs and failure to comply timely could adversely affect our reputation and the value of our securities.
We are required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as rules and regulations adopted by the SEC and the Public Company Accounting Overnight Board. In particular, beginning for the year ending December 31, 2007 we will be required to include management and independent auditor reports on internal controls as part of our annual report on Form 10-K pursuant to Section 404 of the Sarbanes-Oxley Act. We expect to spend significant amounts of time and money on compliance with these rules. Our failure to comply with these internal control rules may materially adversely affect our reputation, ability to obtain the necessary certifications to financial statements, and the value of our securities.
Technological changes affect our business, and we may have fewer resources than many of our competitors to invest in technological improvements.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to serving customers better, the effective use of technology may increase efficiency and may enable financial institutions to reduce costs. Our future success will depend, in part, upon our ability to use technology to provide products and services that increase customer convenience and to create additional efficiencies in our operations. We may need to make significant additional capital investments in technology in the future, and we may not be able to effectively implement new technology-driven products and services. Many of our competitors have substantially greater resources to invest in technological improvements.
ITEM 2.
ITEM 2.
PROPERTIES.
We primarily conduct our business through our main office located at 811 2nd Avenue S.W., Cullman, Alabama and our 29 branch offices owned or leased in the ordinary course of our business located throughout Alabama. In 2005 we relocated Peoples Bank’s operations center from Arab, Alabama to a leased building in Cullman, Alabama. The remaining Arab branch offices continue to offer full-service banking to our customers in this area.
In March 2005, Peoples Bank opened a full-service branch at an 840 square foot leased facility in Scant City, Marshall County, Alabama.
During the first quarter of 2005, we entered into an agreement with Regions Bank to acquire two existing branch office properties, a 3,276 square foot facility in Cordova, Alabama and a 3,085 square foot facility in
Blountsville, Alabama. We acquired these properties late in the third quarter of 2005, with the approval of branch applications by the Alabama Superintendent of Banks and the FDIC. These branches were converted to Peoples Bank branches immediately following their acquisition.
In 2006 we continued to open new branch locations, opening our second and third branches in Decatur, Alabama (Morgan County) at 1737 6th Ave SE and 303 Beltline Road SW. We feel Decatur has potential to be a high growth market, relative to our other locations, and we expect good short-term growth potential with these branches.
Additionally, in October 2006 we opened a small branch in Crane Hill, at 9462 County Road 946 in a rural area in Cullman County.
We presently believe that none of these facilities are, individually, material to our operations, and if forced for any reason to vacate or sell any of these facilities, we presently believe that we would be able to timely identify and occupy suitable alternative locations on equally favorable terms or at favorable costs. For information about the amounts at which bank premises, equipment and leases are recorded in our financial statements, see our consolidated financial statements and the accompanying notes to consolidated financial statements included elsewhere in this report.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS.
We are involved in legal proceedings from time to time that arise in the ordinary course of our business. Although we cannot determine the ultimate disposition of these proceedings, we do not believe that adverse determinations in any of the claims and proceedings currently pending or threatened against us would have, individually or in the aggregate, a material adverse effect upon our consolidated financial condition, liquidity or results of operations.
We are involved in a lawsuit with a construction loan customer with a loan balance of approximately $1.6 million secured by commercial real estate valued substantially higher. This suit has subsequently been appealed by SAIA Construction, the excavating company employed by the customer, which is the adverse party, to the Alabama Supreme Court, but no material loss is expected due to the adequacy of the real estate collateral.
We have not incurred any penalties for failing to include, in our tax returns, any information required to be disclosed under Section 6011 of the Internal Revenue Code of 1986, as amended (the “Code”) with respect to a reportable transaction under the Code that is required to be reported under Code Section 6707A(e).
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of shareholders of the Company through the solicitation of proxies or otherwise during the fourth quarter of the fiscal year ended December 31, 2006.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
There is no established public trading market for our common stock. Our stock is not traded on any exchange but is listed currently on the OTC Bulletin Board under the ticker symbol “ATFS”. Morgan Keegan currently makes a market in our stock, but trading is minimal at this time.
The following table sets forth the estimated price range for fair-market sales of our common stock for each quarter for the last two fiscal years. The data is provided for information purposes only and should not be viewed as indicative of the actual or market value of our common stock. As previously indicated, trading is minimal.
Limited actual sales transactions occurred during 2006, with prices normally at $11.00 per share, based on amounts orally reported to us by sellers at the point of transfer of shares on our stockholder ledger. We do not expect that an active trading market aside from the current listing on the OTC Bulletin Board will develop in the near future.
As of December 31, 2006, there were approximately 622 holders of our common stock.
Dividends
The following table sets forth the dividends paid per share of Altrust common stock in 2006 and 2005.
Dividends Declared
Per Share of
Altrust Common
Stock
We paid cash dividends totaling $1,305,443 and $6,839,000 for 2005 and 2006, respectively. A “special” one-time $1 per share dividend was paid in the first quarter of 2006, which allowed us to pay off the remaining $1.7 million debt incurred by our ESOP, with dividends paid on ESOP shares. No stock dividends were declared or paid during the reported periods.
Payment of future dividends, if any, will be at the discretion of our board of directors and will depend upon our earnings, our financial condition, the capital adequacy of Altrust and Peoples Bank, our need for funds, and other relevant factors, including applicable restrictions and governmental policies and regulations.
Unless we diversify our business or acquire other financial institutions, we expect to continue to rely upon dividends that we receive from Peoples Bank as our primary source of funds to pay dividends to our shareholders. Additional information regarding restrictions on the ability of Altrust or Peoples Bank to pay dividends is contained in this report under the section entitled “Business-Supervision and Regulation.”
Securities Authorized for Issuance Under Equity Compensation Plans
Altrust has no common equity subject to outstanding options or warrants to purchase, or securities convertible into, common equity.
The following table sets forth information relating to the Company’s equity compensation plans as of December 31, 2006:
EQUITY COMPENSATION PLAN INFORMATION
OTHER EQUITY COMPENSATION PLAN INFORMATION
Recent Sales of Unregistered Securities
Altrust did not sell any unregistered securities in 2006.
Repurchases of Equity Securities by Altrust and its Affiliates
Altrust did not repurchase equity securities in 2006.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion and financial information is presented to aid in understanding our financial position and results of operations and should be read in conjunction with our consolidated financial statements included under Item 8 of this report. The emphasis of this discussion will be on the years 2004, 2005 and 2006; in addition, financial information for prior years will also be presented when appropriate. Certain amounts in prior year financial statements have been reclassified to conform to the current year presentation.
Altrust Financial Services, Inc. (“Altrust”) was incorporated in 1985 as Cullman Bancshares, Inc., an Alabama corporation, which changed its name in 1996 to Altrust Financial Services, Inc. Altrust is a bank holding company registered with the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended, and a financial holding company registered under the Gramm-Leach-Bliley Act of 1999. Altrust primarily conducts its business through Peoples Bank of North Alabama (“Peoples Bank”), its wholly-owned bank subsidiary.
Peoples Bank is an Alabama bank that commenced operations in September 1977 as Peoples Bank of Holly Pond. Peoples Bank opened its first branch in the city of Cullman, Alabama in September 1983, and adopted the name Peoples Bank of Cullman County. In June 1994, Peoples Bank of Cullman County changed its name to Peoples Bank of North Alabama.
On May 31, 2002, Peoples Bank acquired six branches in Marshall County, Alabama from Community Bank, an Alabama commercial bank. In connection with the acquisition, Peoples Bank acquired approximately $58.8 million in loans and approximately $4.7 million of other assets (including capitalized leases), and assumed approximately $79.6 million of deposits and other liabilities. Peoples Bank paid Community Bank a core deposit premium of approximately $4.9 million, or eight percent of the core deposits acquired in the transaction, of which approximately $4.0 million was allocated to goodwill and approximately $900,000 was allocated to core deposit intangibles. On February 2, 2004, Peoples Bank acquired another small branch in Morris, Alabama from The Bank, an Alabama commercial bank. In connection with the Morris branch acquisition, Peoples Bank acquired approximately $8.2 million in assets and approximately $8.2 million in deposit liabilities. Included in the assets acquired in the Morris branch acquisition were approximately $693,000 of goodwill and approximately $45,000 of core deposit intangibles. In September 2005, People’s Bank purchased two branch buildings from Regions Bank (“Regions”), one in Cordova, Alabama and one in Blountsville, Alabama. As of December 31, 2006, these branches had deposits of approximately $16.1 million and $11.4 million respectively. In August 2005, we also entered into a lease-purchase agreement with Bow Tie, LLC for a branch building in Decatur, Alabama pursuant to which we were to lease the branch for 14 calendar months. This branch opened in February of 2006. After the term of the lease, the building was purchased for $375,000. In connection with the lease purchase agreement, the Bank advanced a $385,000 purchase money loan to Bow Tie, LLC, at a rate of 6.5%, with the loan paid off in October of 2006. In September of 2006, we opened a third branch in Decatur, which had $1.5 million in loans and $0.8 million in deposits at December 31, 2006. In October of 2006, we opened a small branch in Crane Hill, Cullman County, which had $0.4 million in deposits at December 31, 2006.
Peoples Bank is a member of the Federal Deposit Insurance Corporation (“FDIC”) and its deposits are insured by the FDIC up to the maximum permitted by law. Peoples Bank is supervised, regulated and examined by the FDIC and the Alabama Superintendent of Banks. Peoples Bank is also a member of the Federal Home Loan Bank of Atlanta.
Peoples Bank is primarily engaged in retail and commercial banking in Blount, Cullman, Marshall, Walker and Morgan Counties, Alabama, as well as the northern portion of Jefferson County, Alabama. Peoples Bank provides mostly traditional banking services; including the taking of demand and time deposits and the making of secured and unsecured consumer loans and commercial loans to its business customers.
Altrust has two other wholly-owned subsidiaries, Southern Insurance of Cullman, Inc. (“Southern Insurance”), and Southern Appraisal Services, Inc. (“Southern Appraisal”). Southern Insurance was incorporated in 1993 under the laws of the State of Alabama. Southern Insurance acts as an agent for obtaining title insurance for Peoples Bank’s real estate customers. Southern Insurance receives commissions on title policy premiums as compensation for its services. Southern Appraisal was incorporated in Alabama in 2003 and provides real estate appraisal services. Revenues and expenses of both subsidiaries account for less than 3% of Altrust’s consolidated revenues and expenses. Revenues are included in consolidated non-interest income, and expenses are included in consolidated non-interest expense.
As of December 31, 2006, Altrust had total consolidated assets of approximately $426 million, total consolidated liabilities, including deposits, of approximately $378 million, consolidated shareholders’ equity of approximately $35 million and approximately $13 million in redeemable common stock held by ESOP at fair market value.
This discussion and analysis may contain statements with respect to our financial condition, results of operations, future performance and business that are considered “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those anticipated as a result of certain risks, uncertainties and other factors, which are more fully discussed under the heading “Special Cautionary Notice Regarding Forward Looking Statements” in this report.
CRITICAL ACCOUNTING POLICIES
Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices accepted within the banking industry. Our significant accounting policies are described in the notes to our consolidated financial statements included under Item 8 of this report. Certain accounting policies require management to make significant estimates and assumptions that have a material impact on the carrying value of certain assets and liabilities, and we consider these to be critical accounting policies. The estimates and assumptions used are based on historical experience and other factors that management believes to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and on our results of operations for the reporting periods.
We believe the following are the critical accounting policies that require the most significant estimates and assumptions and that are particularly susceptible to a significant change in the preparation of our financial statements.
Valuation of Investment Securities
Investment securities can be classified into three categories. Debt securities that we have the intent and ability to hold to maturity are classified as “held-to-maturity securities” and are reported at amortized cost. As of December 31, 2006, we did not have any securities classified as “held-to-maturity.” Debt and equity securities that are bought and held with the intent to sell the securities in the near term are classified as “trading securities” and reported at their fair value, with unrealized gains and losses included in earnings. We did not have any securities classified as trading securities as of December 31, 2006. Debt securities not classified as either held-to-maturity securities or trading securities, and equity securities not classified as trading securities, are classified as “available-for-sale securities” and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of other comprehensive income. We had $122.5 million in securities classified as available-for-sale as of December 31, 2006.
Premiums and discounts related to securities are amortized or accreted over the life of the related security as an adjustment to the yield using the effective interest method and considering prepayment assumptions. Dividend and interest income is recognized when earned.
Gains and losses on sales or calls of securities are recognized on the trade date based on the adjusted cost basis of the specific security. Declines in fair value of individual held-to-maturity and available-for-sale securities to below their cost that are other than temporary result in write-downs of the individual securities to their fair value.
Management conducts regular reviews to assess whether the values of our investments are impaired and whether any such impairment is other than temporary. If management determines that the value of any investment is other-than-temporarily impaired, we record a charge against earnings equal to the amount of the impairment. The determination of whether other-than-temporary impairment has occurred involves significant assumptions, estimates and judgments by management. Changing economic conditions - global, regional or related to industries of specific issuers - could adversely affect these values. We recorded no impairment of our investment securities during 2006.
Allowance and Provision for Loan Losses
The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions and other risks inherent in the portfolio. Allowances for impaired loans are generally determined based on collateral values or the present value of the estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination.
RESULTS OF OPERATIONS
General
Our principal source of revenue comes from net interest income, which is the difference between:
•
income we receive on our interest-earning assets, such as investment securities and loans; and
•
payments we make on our interest-bearing sources of funds, such as deposits and borrowings.
The level of net interest income is determined primarily by the average balances, or volume, of our interest-earning assets and the various rate spreads between these interest-earning assets and our funding sources. Changes in our net interest income from period to period result from, among other things:
•
increases or decreases in the volumes of interest-earning assets and interest-bearing liabilities;
•
increases or decreases in the average rates earned and paid on those assets and liabilities;
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our ability to manage our interest-earning asset portfolio, which includes loans; and
•
availability and costs of particular sources of funds, such as non-interest-bearing deposits, and our ability to “match” our interest-earning assets and interest-bearing liabilities.
Comparison of Years Ended December 31, 2006, December 31, 2005 and December 31, 2004
Overview
The purpose of this discussion is to assist in the understanding of the significant changes in the financial condition and results of operations of the Company and its subsidiaries during each of 2004, 2005, and 2006. This discussion and analysis is intended to supplement and highlight information contained in, and should be read in conjunction with, the Company’s consolidated financial statements and related notes and the selected financial data presented elsewhere in this report.
Items of note for 2006 include:
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Opening of our second Decatur, Morgan County, branch in February 2006 (purchased in August 2005). This previously leased building was purchased for $375,000.
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A third branch in Decatur, Morgan County was opened in September in leased space in a high-traffic strip mall.
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A small rural branch was opened in Crane Hill, Cullman County, in October 2006, in what we consider to be an underserved area.
A summary of several key 2005 developments include:
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The establishment of two new branches in Cordova and Blountsville. Branch buildings were purchased from Regions, and a successful campaign to attract previous Regions customers resulted in year end deposits of $15.4 million and $10.7 million, respectively.
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The entering into a lease-purchase agreement in August 2005 for a branch building in Decatur, Alabama. We believe this will enable us to expand our presence in the Decatur market, which we feel has outstanding growth potential.
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Implementation of a new overdraft privilege program in the latter part of 2005. We believe this will be an added benefit to our customers and will enhance our non-interest income levels.
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Solid 8% growth in our loan portfolio, which grew to $212 million at December 31, 2005, up from $195 million at December 31, 2004. This growth was funded by the deposit growth mentioned above.
Net Income
Our net income for the 12 month period ended December 31, 2006 was approximately $6.1 million representing a 24% increase over net income for the 12 month period ended December 31, 2005. Net income for the 12 months ended December 31, 2005 was approximately $4.9 million, an increase of $1.5 million, or 46%, over net income of approximately $3.4 million for 2004. Diluted earnings per common share increased to $1.09 for the year ended December 31, 2006 compared to $0.93 for the fiscal year ended December 31, 2005, and as compared to $0.64 for the fiscal year ended December 31, 2004, based upon the weighted average of common shares and common share equivalents outstanding of 5,577,642, 5,287,285 and 5,277,933, for 2006, 2005 and 2004 respectively.
The increase of $1.2 million in net income for the year ended December 31, 2006 is due primarily to a $1.9 million increase in non-interest income, primarily due to increased net overdraft fees resulting from increased fees generated as a result of our new overdraft protection program. This interest income was offset by increased interest expense attributable to increased rates we paid on customer interest-bearing deposits and to interest paid on our FHLB borrowings used in connection with our leveraged securities investment transaction. Investment income declined approximately $160,000 for the year ended December 31, 2006 relative to the same period in 2005. This was due to normal pay-downs on our mortgage-backed government agency securities of approximately $12.2 million, resulting in a decline of interest earned. Interest and fees on loans increased approximately $3.9 million, due to a 16% increase in loans. These increases were offset by increases in interest expense of $2.5 million, with a $3.0 million increase in deposit interest expense, with $648,000 due to an 18% volume increase of yearly average interest-bearing deposits from $218 million to $257 million, and $2.3 million due to a 54% average rate increase from 1.67% to 2.57%, mainly due to a rising rate environment, particularly due to competition in the local Cullman market. Reduction of approximately $490,000 was realized on other borrowed funds primarily due to pay-down of FHLB advances from $78.35 million to $62.8 million at December 31, 2005 and 2006 respectively.
We continued to see an increase in net non-sufficient funds (“NSF”) fees in 2006, due to a 32% increase in average demand deposits. NSF fees increased from $5.14 million in 2005 to $8.02 million in 2006. NSF fees were approximately $4.2 million in 2004. The increased deposits were partially a result of our High Performance Checking Acquisition Marketing Program, evidenced, for example, by a 46% increase in demand deposits at our Cullman Main branch from a 2005 average of $10.3 million to a 2006 average of $15 million. Average demand deposits were $40.8 million, $30.8 million and $25.4 million for 2006, 2005 and 2004, respectively. Increased NSF fee income was also a result of implementing our new John M. Floyd and Associates overdraft protection program.
Net Interest Income
Net interest income is the principal component of our earnings and represents the difference between revenue generated by interest-earning assets and the interest costs related to funding those assets. Net interest income is affected by changes in the volume of and rates earned or paid on interest-earning assets and interest-bearing liabilities. The net interest margin is net interest income as a percent of average earning assets.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2006, 2005 and 2004
(Dollars In Thousands)
The following table shows a summary of the changes in interest income and interest expense resulting from changes in volume and changes in rates for each category of interest-earning assets and interest-bearing liabilities for the periods indicated.
Rates reflected in the table above were not calculated on a tax equivalent basis.
We have experienced increases in net interest income during the last two years relating to the rate component because of its net asset sensitivity position. As interest rates have risen, net interest income has been positively affected. Competitive pressures relating to deposit rates may weaken the net interest margin in future periods. For additional information relating to our interest rate sensitivity, refer to the discussions under “Quantitative and Qualitative Disclosures about Market Risk.”
Our net interest income increased approximately 9.7% to $14.4 million, in the year ended December 31, 2006 compared to $13.1 million in the year ended December 31, 2005. Net interest income increased 5.8% to $13.1 million for the year ended December 31, 2005 compared to net interest income of $12.4 million for the year ended December 31, 2004. The most important factor contributing to the increase in net interest income between 2005 and 2004 was an increase of approximately $1.8 million in interest income from investment securities, resulting from our leveraged investment strategy initiated in 2004. While this leveraged investment strategy increased net interest income, it also decreased our overall net interest margin as the net interest spread between the interest we pay on the FHLB borrowings used to fund the purchase of investment securities in our leveraged strategy and the interest we earn on the securities purchased with those borrowings is lower than our historical net interest spread. The increase in net interest income was due to the substantial leveraged portfolio investments we made in 2004, financed through FHLB borrowings. As in 2005, although the leverage strategy increased net interest income in 2004, it also decreased our net interest margin because the interest rate spread on the leveraged investments was substantially lower than our historical net interest margin.
Average earning assets increased to $366 million in 2006, an increase of $20 million or 5.8% over the average $346 million for 2005. Loans increased $37 million, or 18.8%, offset by a $10.1 million decline in available-for-sale securities, primarily due to $12.2 million in normal pay-downs on mortgage-backed securities, with $8.2 million
re-invested in various securities. Average earning assets were $346 million for 2005, which was 15% higher than average earning assets in 2004. Average earning assets of approximately $302 million in 2004 were 27% higher than the approximately $237 million of average earning assets in 2003. Competitive pressures, Federal Reserve Bank monetary policies, and the composition of interest-earning assets and interest-bearing liabilities affect our net interest margin. For the year ended 2005, our net interest margin decreased 23 basis points to 3.89% from 4.12% for the year ended 2004. Net interest margin for 2004 decreased from the net interest margin of 4.93% for 2003.
The following table details average balances (using daily averages) of interest-earning assets and interest-bearing liabilities, the amount of interest earned or paid thereon, and the yield or rate for the years ended December 31, 2006, 2005 and 2004.
For the purposes of the Average Consolidated Balance Sheets above, non-accruing loans are included, but no revenue is recognized on such loans once so classified. Loan fees of approximately $937,000, $776, 000 and $701,000 are included for 2006, 2005 and 2004, respectively. Tax exempt security income is not calculated on a tax equivalent basis.
Allowance for Loan Losses
The allowance for loan losses is based on management’s evaluation of the economic conditions, volume and composition of the loan portfolio, historical charge off experience, the level of nonperforming and past due loans,
and other indicators derived from reviewing the loan portfolio. Management performs such reviews quarterly and makes appropriate adjustments to the provision for loan losses to maintain our allowance for loan losses at an appropriate level.
The allowance for loan losses was $2.6 million, $2.4 million and $2.5 million as of December 31, 2006, 2005 and 2004, respectively. This stable level in our allowance for loan losses is the result of improvements in the quality of our loan portfolio through our use of progressive reviews of larger loans, requiring that such loans go through internal loan committee, Executive Loan Committee, and board approvals. Tighter underwriting standards have also been implemented, resulting in more conservative lending and better collateralization. Net charge-offs for the year ended December 31, 2006 totaled approximately $144,000, compared to approximately $210,000 for the same period ended December 31, 2005 and approximately $248,000 for the same period ended December 31, 2004.
Our management believes that its current credit-granting and administration processes follow a comprehensive and disciplined approach that mitigates risk and lowers the likelihood of significant increases in charge-offs and non-performing loans, however, all credit-granting processes require subjective judgments and estimates.
Non-Interest Income
Our primary source of non-interest income is non-sufficient funds fees, service charges and other fees we earn on our deposit accounts. Total non-interest income totaled approximately $9.39 million for the year ended December 31, 2006, up approximately 26% from the approximately $7.45 million realized in the same period ended December 31, 2005 and $6.19 million for the 12 month period ended December 31, 2004. The increase from 2005 to 2006 was predominantly due to an increase of approximately $3.1 million in service charges and fees on deposits, due to an increase in the number of checking accounts resulting from our High Performance Checking Acquisition Marketing Program and the implementation of a new overdraft privilege program in the fourth quarter of 2005. The increase in deposits attributable to our High Performance Checking Acquisition Marketing Program resulted in an increase in the total non-sufficient funds charges and other service charges we earned in 2006 accounting for most of our non-interest income improvement in 2006.
Non-Interest Expense
Non-interest expense increased to approximately $14.5 million from approximately $13.9 million for the year ended December 31, 2006 compared to the same period ended December 31, 2005. This 4.3% increase was primarily a result of an approximate $679,000 increase in salaries and benefits, due to a full year of wage costs at Cordova and Blountsville for 2006 versus only one quarter in 2005, with approximately $200,000 of increase shown on these two branches alone. The remaining increase was due to health insurance cost increases of approximately 13%, and the remainder yearly salary increases. Higher legal and professional fees were incurred, with professional service expenses increasing from $692,000 in 2005 to $833,000 in 2006. Expenditures for legal and professional services were higher due to continued SEC regulatory filing and compliance assistance costs, and consulting fees paid for our overdraft protection program, with $181,000 paid in 2006, versus only $23,000 in 2005 during the new program’s implementation stage.
Total non-interest expense for the year ended December 31, 2005 was $13.9 million, compared to $13.3 million for the year ended December 31, 2004. Total salaries and benefits expense for 2005 was $5.9 million, a decrease of approximately $229,000, or 3.7%, from $6.2 million for 2004, a result of cost containment efforts utilizing more part-time employees, resulting in a slight reduction of number of full-time equivalent employees. Professional fees increased from approximately $313,000 in 2004 to approximately $692,000 in 2005. This increase was again due to increased legal and accounting fees associated with the new SEC regulatory environment.
Amortization of core deposit intangibles decreased approximately $362,000 in the year ended 2005 compared to the year ended 2004 with the carrying value of core deposit intangibles declining to approximately $879,000 at December 31, 2005, from approximately $1,031,000 at December 31, 2004 due to reclassification of some intangibles into goodwill through use of an outside appraiser. Under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, the value and estimated lives of these intangibles will be periodically
evaluated for possible impairment. For more information, see the notes to our Financial Statements. Amortization of core deposit intangibles increased $45,000 in 2004 due to amortization of our Morris branch deposit premium and the methodology of accelerated amortization in earlier years. Total amortization of core deposit intangibles was $153,757, $152,343, and $513,901 for the years ended December 31, 2006, 2005, and 2004 respectively.
Net occupancy expense increased from $1.9 million in 2005 to $2.3 million in 2006, an approximate $400,000 or 21% increase. Full-year occupation expenses at Cordova and Blountsville accounted for $63,000 of this increase, and new branches, one at Crane Hill and two at Decatur, accounted for $93,000 of this increase. Ad valorem taxes increased by $93,000, a result of the State of Alabama’s yearly reappraisal program, and additional taxes on the new branches. Net occupancy expense in 2005 was approximately $1.9 million, a slight increase of approximately $100,000 over 2004, a result of increased lease expense for our Locust Fork branch which opened in September 2004, our Scant City branch which opened in March 2005, and our operating center in Cullman which opened in January 2005. We also leased additional space at our Baileyton branch during the third quarter of 2005, further increasing our lease expense. We did not renew our leases for our Arab downtown branch due to relocating our operations center to Cullman, resulting in a reduction of our lease expense by $2,800 per month starting in April 2004.
Our non-interest expenses include operating expenses attributable to Southern Insurance and Southern Appraisal which accounted for less than 3% of consolidated non-interest expenses each of 2006, 2005 and 2004.
Income Taxes
Income tax expense increased to approximately $2.9 million for the year ended December 31, 2006 from approximately $1.7 million for the year ended December 31, 2005. These levels represent an effective tax rate on pre-tax earnings of 32% and 25% for the year ended December 31, 2006 and 2005, respectively. The actual dollar increase was due to increased net income levels over the prior year. The increase in the effective rate was due to tax deductibility in 2005 of dividends paid on our ESOP shares, which were used for payoff in 2006 on the principal on the then outstanding ESOP debt. Income tax expense for 2004 was an effective tax rate of 32%, with an expense of $1.6 million on earnings of $4.9 million.
FINANCIAL CONDITION
Overview
During the year ended December 31, 2006, our total assets increased by approximately $23 million, or 5.7% to approximately $426 million from approximately $403 million at December 31, 2005. This increase resulted primarily from an approximate $35 million increase in loans partially offset by an approximately $7 million decrease in securities available-for-sale due to scheduled pay-downs and maturities, and a reduction in cash and due from banks of approximately $5 million. At December 31, 2005 total assets increased 2.45% to approximately $403.33 million from approximately $393.69 million at December 31, 2004. This small increase resulted primarily from an approximate $16.5 million increase in loans partially offset by an $8.1 million decrease in securities available-for-sale due to scheduled pay-downs and maturities.
Loans
Total loans increased approximately $35 million, or 16.5%, from December 31, 2005 to year end 2006, and were up 7.7%, or approximately $15 million, from December 31, 2004 to year end 2005. This increase in total loans was attributable primarily to an increase in residential mortgage loans that resulted from modest improvements in general economic conditions and our increased focus on real estate lending. Residential mortgage levels increased during the year ended December 31, 2006 were partially offset by a $1 million, or 3.6% decrease in commercial loans, which was attributable to the payoff of several larger commercial loans which have not been replaced in our portfolio at this time. We experienced an increase of approximately $20 million or 16% in our residential mortgage loan category at December 31, 2005 compared to December 31, 2004.
Average loans increased 18.5% between the years ended December 31, 2005 and 2006 and comprised 63.8% of average earning assets for the year ended December 31, 2006, compared to 56.9% for the year ended December 31, 2005.
The following table presents a summary of the loan portfolio by category for the past five years:
The following table sets forth the maturity distribution of our loan portfolio as of December 31, 2006. Our loan policy does not permit renewal of loans that are past due, loans where the interest due is not collected or to prevent delinquency.
SELECTED LOAN MATURITY AND INTEREST RATE ANALYSIS
(000’S)
(1) includes commercial loans secured by real estate
Allowance for Loan Losses
The allowance for loan losses represents management’s assessment of the risk associated with extending credit and its evaluation of the quality of the loan portfolio. We analyze the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain a level considered adequate to absorb probable loan losses. In assessing the adequacy of the allowance, we review the size, quality and risk of loans in the portfolio. We also consider such factors as our loan loss experience, the amount of past due and nonperforming loans, specific known risks, underlying collateral values securing loans, current and anticipated economic conditions and other factors which affect the allowance for loan losses. An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan losses is prepared by management and presented to the Bank’s Executive Loan Committee on a monthly basis. We also engage outside loan review services for all credits over $500,000.
As we continue to grow the loan portfolio through new loan accounts, these new loans have limited historical loss experience on which to base a specific reserve. As a result, management’s determinations as to amounts that should be added to the general reserve with respect to new loan growth are necessarily imprecise. The following table presents a summary of changes in the allowance for loan losses for the past five years.
Analysis of Changes in Allowance for Loan Losses
Year Ended December 31,
(in 000’s)
Our allowance for loan losses is subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses in comparison to a group of peer banks identified by the regulators. During their routine examinations of banks, the FDIC and the Alabama Superintendent of Banks may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, credit evaluations and allowance for loan loss methodology differ materially from those of management. For additional information, refer to the disclosures under the heading “Business-Supervision and Regulation.”
While it is our policy to charge off in the current period loans for which a loss is considered probable, there are additional risks of future losses which cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, management’s judgment as to the adequacy of the allowance is necessarily approximate and imprecise.
We estimate our allowance for possible loan losses based upon the type of loan and loan commitment, and whether or not the credit has been classified as special mention, substandard, doubtful or loss. An allowance equal to 5% of special mention, 15% of substandard, 50% of doubtful loans and 100% of loss loans is made and such amounts are adjusted if deemed insufficient based on the individual circumstances of the specific loan.
The following table sets forth the allocation of our allowance for loan losses by loan category:
We believe that our allowance for loan losses at December 31, 2006 is sufficient to absorb probable losses inherent in our loan portfolio based on our assessment of the information available. Our assessment is based on management’s judgment and involves some uncertainty. As a result of such uncertainty, the adequacy of the allowance for loan losses cannot be determined with precision and may be subject to change in future periods. We may also be required to increase the provision for loan losses in future periods based on periodic examination by bank regulatory authorities.
Interest on loans is normally accrued from the date an advance is made. The performance of loans is evaluated primarily on the basis of a review of each customer relationship over a period of time and the judgment of lending officers as to the ability of borrowers to meet the repayment terms of loans. If there is reasonable doubt as to the repayment of a loan in accordance with the agreed terms, the loan may be placed on a non-accrual basis pending the sale of any collateral or a determination as to whether sources of repayment exist. This action may be taken even though the financial condition of the borrower or the collateral may be sufficient ultimately to reduce or satisfy the obligation. Generally, when a loan is placed on a non-accrual basis, all payments are applied to reduce principal to the extent necessary to eliminate doubt as to the repayment of the loan. Thereafter, any interest income on a non-accrual loan is recognized only on a cash basis.
Nonperforming Assets
Nonperforming assets include non-accrual loans, accruing loans contractually past due 90 days or more, restructured loans, other real estate, and other real estate under contract for sale. Loans are placed on non-accrual status when management has concerns about our ability to collect the loan’s outstanding principal and interest, and generally when loans are 90 days or more past due. While nonperforming assets represent potential losses to us, we do not expect them to result in any material losses because we believe most of our non-performing loans to be adequately secured. We do not have any commitments to lend additional funds to borrowers under loans on non-accrual status as of December 31, 2006.
Our lending officers are responsible for the ongoing review and administration of loans assigned to them. As such, they make the initial identification of loans which present some difficulty in collection or where circumstances indicate that the possibility of loss exists. The responsibilities of the lending officers include the collection effort on a delinquent loan. To strengthen internal controls in the collection of delinquent loans, senior management and Peoples Bank’s Executive Loan Committee are informed of the status of delinquent and “watch” or problem loans on a monthly basis. Senior management reviews the allowance for loan losses and makes recommendations to the Executive Loan Committee as to loan charge-offs on a monthly basis.
Generally, we evaluate loans for impairment when a loan is internally risk rated and included on our internal “watch list.” The watch list includes all non-accrual loans and all loans contractually past due 90 days or more and still accruing interest. The watch list also includes other loans that have documentation deficiencies or where management has learned additional information about the borrower that calls into doubt the borrower’s repayment ability. At the time a loan is placed on non-accrual status, interest previously accrued but not collected is reversed and charged against current earnings. Loans that are contractually past due 90 days or more which are well secured and are in the process of collection generally are not placed on non-accrual status. The aggregate amount of the watch list loans that may be partially impaired as of December 31, 2006, was approximately $7.6 million, compared to $5.1 million at December 31, 2005 and $13.2 million at December 31, 2004. This increase was primarily due to one larger loan, which is now in litigation. Even though borrowers of watch list loans, other than non-accrual and non-performing loans, are expected to make payments of principal and interest as contractually scheduled, these loans are still evaluated for impairment. Impairment with regard to substantially all of our impaired loans has been measured based on the fair value of the underlying collateral.
The table below summarizes our non-performing assets for the past five years.
Non-performing Assets
The following table sets forth our non-accrual and past-due loans and the amount of interest foregone in 2006 on our non-performing assets.
(1) Interest income that would have been recorded, if the loans had been current and in accordance with original terms.
We had $166,000 of restructured loans that were in compliance with modified terms at December 31, 2006. We have no other interest-bearing assets that would be required to be disclosed as non-performing assets if they were loans.
Investment Securities
The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for investing available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits and borrowed funds.
We use three categories to classify our securities: “held-to-maturity” “trading securities” and “available-for-sale.” As of December 31, 2006, all of our investment securities were classified as available-for-sale. Our securities portfolio at December 31, 2006 consisted primarily of United States agency bonds and mortgage-backed securities. While we have no plans to liquidate a significant amount of any of our securities, these securities may be used for liquidity purposes should management deem it to be in our best interest. At December 31, 2006 we also held stock of the FHLB of Atlanta with a book value of approximately $3.6 million. There is no market value for stock of the FHLB of Atlanta as the securities are not traded. We also held approximately $458,000 of the common stock of The Bankers Bank, Atlanta, Georgia, $350,000 in Alabama Banker’s Bank common stock, and $20,000 of CBAA Services, Inc. common stock as of December 31, 2006.
Our investment securities portfolio balance was relatively unchanged between year-end 2005 and year end 2006. We continued to carry our entire investment securities portfolio as available-for-sale during the 12-months ended December 31, 2006. Normal pay-downs on mortgage-backed securities investments was offset by an increase in market valuation of the securities portfolio which resulted in a decreased unrealized loss component in shareholders’ equity from a loss of $1,937,241 at December 31, 2005 to a loss of $1,316,104 at December 31, 2006, causing a net decline in portfolio securities available-for-sale from $128,878,054 at December 31, 2005 to $122,459,777 at December 31, 2006.
Since December 31, 2005, there were $7.5 million in scheduled pay-downs and maturities of our advances from the FHLB and no significant changes in our Banker’s Bank or CBAA Services, Inc. stock investments.
The following table indicates the carrying value of our portfolio of investment securities available-for-sale at the end of each of the last three years:
Our securities available-for-sale portfolio included gross unrealized gains of $69,116 and gross unrealized losses of $2,262,624 at December 31, 2006. The fair market value of our investment securities portfolio varies significantly as interest rates change. The following tables present the maturities and weighted average yields of our investment securities at December 31, 2006:
The above tables of maturities and weighted average yields do not include equity securities held by us, which consist of investments in the stock of the FHLB of Atlanta, common stock of The Bankers Bank, Atlanta, Georgia, and common stock of CBAA Services, Inc., in the aggregate amount of $4.46 million, as such investments lack a contractual maturity. Yields on tax exempt obligations have been calculated on a tax equivalent basis.
Deposits
Our total deposits were approximately $307 million and $272 million at December 31, 2006 and 2005, respectively, representing an increase of approximately $35 million or 13% from the level at 2005 year-end. This increase was largely due to higher time deposit rates due to market pressure. Four branches, Cullman Main, Gardendale, Warrior, and Locust Fork, accounted for 63% of this total deposits increase. Our new Decatur Beltline branch accounted for an additional 19% of this deposit growth. Total deposits were $242 million at December 31, 2004, as mentioned above.
Interest-bearing deposits represented 86% of total deposits at December 31, 2006 compared to 84% at December 31, 2005, and 88% at December 31, 2004. The overall mix of deposits remained relatively stable from December 31, 2004 to December 31, 2006, with an increase in percentage of time deposits to total deposits from 36.2% to 46.4% from 2005 to 2006 due to our time deposit rate increases to meet market demand.
The composition of our average deposits, including the increase in the proportion of interest-bearing deposits relative to total deposits, is indicative of the interest rate conscious market in which we operate. We cannot provide any assurance that we can maintain or increase our market share of deposits in our highly competitive market area in the future.
The average daily balance of deposits and rates paid on those deposits are summarized for the three years ended December 31, 2006 in the following table.
Maturities of time certificates of deposit outstanding at December 31, 2006 are summarized as follows:
Liquidity
Liquidity involves our ability to raise funds to support asset growth, meet deposit withdrawals and other borrowing needs, maintain reserve requirements, and otherwise sustain our operations. This is accomplished through maturities and repayments of our loans and investments, our deposit growth, and our access to sources of funds other than deposits, such as the federal funds market and borrowings from the FHLB and other lenders, as well as the ability to liquidate securities available-for-sale.
As of December 31, 2006, we had access to advances of up to 30% of our assets from the FHLB, with the potential to increase the line of credit to up to 40% of assets upon our meeting certain eligibility criteria as specified in the FHLB’s Credit and Collateral Policy. Under the 30% limitation, we had remaining credit availability from the FHLB of approximately $65 million, after existing advances of $62.8 million previously used in our leveraged transaction to purchase securities for our portfolio. Advances from the FHLB may be secured by a pledge of our holdings of FHLB stock and a portion of our first mortgage loans, with the leveraged securities purchased with FHLB borrowings being pledged as collateral. In addition, we also have $30 million of available unsecured federal funds lines of credit with correspondent banks, with approximately $2.4 million outstanding at December 31, 2006. The maximum amount outstanding on our FHLB advances at any month end during 2006 was approximately $81.3 million. The average amount outstanding during 2006 was approximately $67.2 million.
As of December 31, 2004, we had purchased approximately $94.6 million of investment securities with borrowings of approximately $96.4 million under our available lines of credit with the FHLB of Atlanta. The table below sets forth certain maturity and rate information with respect to our FHLB of Atlanta borrowings and the investment securities we purchased with the proceeds of those borrowings as of December 31, 2005 and 2006.
Our average liquid assets consist of cash and amounts due from banks, interest-bearing deposits in other banks, federal funds sold, investment securities (such as the FHLB, Banker’s Bank and CBAA stock) and securities held for sale. These average liquid assets totaled approximately $149 million and approximately $165 million during the twelve month periods ended December 31, 2006 and December 31, 2005, respectively, representing 50% and 66% of average deposits for those periods, respectively. The decrease in average liquid assets is due to normal pay-downs and maturities in our securities portfolio, which declined $10 million from approximately $134 million
to approximately $124 million, and a decline in federal funds invested of approximately $6 million for the years ended December 31, 2005 and December 31, 2006. These funds were used to help fund the increase in average loans of $37 million from $197 million to $234 million for twelve months ending December 31, 2005 and 2006 respectively.
We actively manage the levels, types and maturities of interest-earning assets in relation to the sources available to fund current and future needs. We believe our liquidity sources are adequate to meet our operating needs and we do not know of any trends, events or uncertainties which will increase or decrease our liquidity in any material way.
Capital Resources
Our capital adequacy is measured by risk-based and leverage capital guidelines. The risk-based capital guidelines assign weighted levels of risk to various asset categories. Among other things, these guidelines currently require us to maintain a minimum ratio of 8.0% of total capital to risk-adjusted assets. Under the guidelines, one-half of our required capital must consist of Tier 1 Capital, which would include such things as our tangible common shareholders’ equity and any qualifying perpetual preferred stock. The leverage guidelines provide for a minimum ratio of Tier 1 Capital to total assets of 3.0% if we meet certain requirements, including having the highest regulatory rating, and cushion the ratio by an additional 1.0% to 2.0% otherwise. The guidelines also specify that bank holding companies that are experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the Federal Reserve continues to consider a “Tangible Tier 1 Leverage Ratio,” calculated without the inclusion of intangible assets, in evaluating proposals for expansion or new activities. The Federal Reserve has not advised Altrust, and the FDIC has not advised Peoples Bank, of any specific minimum leverage ratio or Tangible Tier 1 Leverage Ratio that we are required to meet. The Alabama Superintendent required us to have a Tier 1 Leverage Capital Ratio of at least 7% immediately following the Community Bank branch acquisition as a condition to its approval of our purchase of the Community Bank branches and this requirement is still in effect. As a result of the capital raised in our private placement on April 19, 2002 and our issuance of common stock pursuant to SEC Regulation A on July 31, 2003, we currently satisfy this requirement.
FDICIA established five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare to various measures and certain other factors, as established by regulation. Altrust and the Bank both exceed the capital requirements established for well capitalized banks and bank holding companies under FDICIA guidelines. See the disclosures under the heading “Business-Supervision and Regulation” for more information.
Shareholders’ equity totaled $35.1 million at December 31, 2006, or 8.2% of total consolidated assets which was a decrease of approximately $2.8 million from shareholders’ equity of $37.9 million, representing 9.4% of consolidated assets at December 31, 2005. This decrease was primarily due to payment of a “special” $1 per share dividend totaling approximately $5.5 million, in the first quarter of 2006. Net income increased equity by $6.05 million, and was reduced further by payment of regular dividends totaling $0.33 per share, or approximately $1.8 million. There was also a $4.6 million decrease in equity due to the increase in the valuation for the redeemable common stock. At December 31, 2004, our total consolidated shareholders’ equity was $35.3 million, or 9% of total consolidated assets.
The increase of $2.6 million in total consolidated shareholders’ equity from 2004 to 2005 was mainly due to approximately $4.9 million of net income, partially offset by approximately $1.3 million of dividends paid. Increases in total consolidated shareholders’ equity was also offset by increases in redeemable common stock held by the ESOP of approximately $208,000 as explained in Note 14 to the financial statements. Increases in the cash obligation for the ESOP are effected through a reduction of retained earnings. Unrealized losses on available for sale investment securities further reduced shareholders’ equity at December 31, 2005 compared to December 31, 2004.
The decrease in the ratio of shareholders’ equity to total assets for 2004 resulted from an increase in over $114 million in total assets, primarily due to the $96.4 million in leveraged securities purchases we made for our securities investment portfolio in 2004. In addition, our shareholders’ equity was reduced as a result of our reacquisition of almost $382,000 of our outstanding shares of common stock, our payment of over $817,000 in dividends to holders of our common stock, and a $1.9 million decline from increased redeemable common shares held by the ESOP. Mitigating the reduction in shareholders’ equity relative to total consolidated assets in 2004 was our $3.4 million in net income, the reduction by over $550,000 of the principal amount outstanding of borrowings from First Tennessee, which was used to fund the purchase of shares for our ESOP, and payments of $153,000 we received upon the exercise of outstanding stock options.
We remained well capitalized at December 31, 2006. The increase in Peoples Bank’s various capital ratios from year-end 2004 presented in the table below resulted mainly from the net income and reduction of ESOP debt as stated above.
The regulatory capital ratios for Peoples Bank exceed the minimum required ratios, and Peoples Bank has been categorized as “well-capitalized” in the most recent notice received from its primary regulatory agency.
CAPITAL ADEQUACY RATIOS
(Dollars in Thousands)
*Information derived from the Bank’s Call Report. All ratios are for the Bank only except for the shareholder’s equity to total assets which is calculated on a consolidated basis and includes redeemable ESOP shares in the calculation of shareholders’ equity.
Return on Equity and Assets
The following table shows the return on assets (net income divided by average assets), return on equity (net income divided by average equity), dividend payout ratio (dividends declared per share divided by net income per share) and equity to assets ratio (average equity divided by average total assets) for the years ended December 31, 2006, 2005 and 2004.
The return on assets ratio improved from 2005 to 2006, due to our increased level of loans at higher rates than in 2005, with average loan rates increasing from 7.10% to 7.66% at December 31, 2005 and 2006 respectively, and loan balances increasing from $212 million to $247 million. Return on equity ratio improved due to the reduction in equity from the special $1 per share dividend mentioned above, and the increase in net income from
$4.9 million to $6.1 million for years ended December 31, 2005 and 2006. The higher dividend payout ratio in 2006 was also due to the special $1 per share dividend, which also caused the decline in the equity to asset ratio, also affected by the increase in assets due to the loan balance increase.
The return on assets ratio improved from 2004 to 2005, and the return on equity ratio also improved. The return on assets ratio improved due to an increase of approximately $17 million in loans, which replaced the reduction in portfolio securities. Since we achieved higher earnings rates on our loans than we earned on our securities, replacing investment securities with loans improved our return on assets in 2005. Our non-interest income also improved in 2005.
The return on equity ratio showed improvement primarily due to a net income increase of approximately $1.5 million from 2004 to 2005. Our equity was reduced due to an increase of approximately $1.7 million in unrealized losses on securities, partially offset by an increase in equity due to pay-down of the ESOP debt with normal company contributions and application of dividends on allocated ESOP shares.
Return on equity ratios, increased in 2004 from 2003, due to implementation of a regular quarterly dividend payout program starting in the second quarter of 2004, with $817,000 in dividends paid in 2004 versus non paid in 2003, causing a reduction in equity in 2004. A $1.9 million reduction in equity also occurred in 2004 due to an increase in the fair market value of stock held in the ESOP plan, with this valuation reclassified from equity and booked to a contra-equity account called “Redeemable common stock held by ESOP at fair market value” (see Note 14 to the financial statements for a more detailed discussion). These equity reductions were offset by net income of $3.4 million in 2004 but the ratio actually declined mainly due to the increased assets portion of the ratio, which was due to our leveraged securities acquisitions mentioned elsewhere in this report and discussed more fully in Note 7 to the audited financial statements.
Off-Balance Sheet Arrangements
As of December 31, 2006, we had no material unconditional purchase obligations that were not recorded on the balance sheet.
In the normal course of business, we are party to credit-related financial instruments with off-balance-sheet risk to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters-of-credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
Our exposure to credit loss is represented by the contractual amount of these commitments. We follow the same credit policies in making off-balance sheet commitments as we do for on-balance-sheet instruments.
At December 31, 2006 and 2005, the following financial instruments were outstanding whose contract amounts represent credit risk:
Off-Balance Sheet Arrangements
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. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements of our customers or amounts we will actually lend. The amount of collateral obtained, if it is deemed necessary by us, is based on management’s credit evaluation of the customer.
Standby letters-of-credit are conditional lending commitments issued by us to guarantee the performance of a customer to a third party. These letters-of-credit are primarily issued to support public and private borrowing arrangements. Almost all letters-of-credit issued by us have expiration dates within one year, but the majority are automatically renewable for the beneficiary. The credit risk involved in issuing letters-of-credit is essentially the same as that involved in extending loan to customers.
Contractual Obligations
The following table summarizes payments due from us under specified long-term and certain other contractual obligations as of December 31, 2006. Obligations under deposit contracts and short-term FHLB of Atlanta advances are not included. The maturities of time deposits are scheduled in Note 6 to the consolidated financial statements. Note 7 to the consolidated financial statements provides information on short-term FHLB of Atlanta advances outstanding at year-end 2006. Purchase obligations represent legal and binding contracts to purchase services or goods that cannot be settled or terminated without paying substantially all of the contractual amounts. Not included are a number of contracts entered into to support ongoing operations that either do not specify fixed or minimum amounts of goods or services or are cancelable on short notice without cause and without significant penalty.
CONTRACTUAL OBLIGATIONS
Payments due by period from December 31, 2006
(in 000’s)
(1) Balances are included with borrowings in our consolidated financial statements.
Effects of Inflation and Changing Prices
Inflation generally increases the costs of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant effect on the performance of a financial institution than the effects of general levels of inflation. In addition, inflation affects financial institutions’ cost of goods and services purchased, cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and stockholders’ equity. Mortgage originations and re-financings tend to slow as interest rates increase, and such increases likely will reduce the Company’s volume of such activities.
Item 7A.
Item 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in economic conditions, interest rates, regulations and laws. Different organizations are affected by different market risks. We do not conduct foreign exchange transactions or trading activities which would subject us to exchange rate and price risks.
Commercial banks and other financial institutions are subject to interest rate risk. Interest rate risk is the risk to earnings or market value of equity from the potential movement in interest rates. The primary purpose of managing interest rate risk is to reduce the effects of interest rate volatility, achieve reasonable stability of earnings and preserve the value of our equity. Changes in interest rates affect, among other things, our net interest income, volume of loan production and the fair value of financial instruments and our loan portfolio.
We manage our exposure to fluctuations in interest rates through policies established by our Asset/Liability Committee ALCO. The ALCO meets periodically to monitor interest rate risk exposure and to implement strategies to reduce the effects of interest rate fluctuations on our balance sheet and earnings. A key component of our interest rate risk management policy is the maintenance of an appropriate mix of interest-earning assets, which consists primarily of intermediate and long-term loans and investment securities, and interest-bearing liabilities, which consists primarily of customer deposits. To achieve an appropriate asset/liability mix, the ALCO uses interest rate sensitivity “gap” analysis to match the scheduled re-pricing and maturities of our interest-earning assets and our interest-bearing liabilities within defined time periods. The interest rate sensitivity gap is the difference between the interest-earning assets and interest-bearing liabilities scheduled to mature or re-price within a given period of time. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitivity liabilities exceeds the amount of interest rate sensitive assets. A negative gap typically indicates that rising interest rates will negatively affect net interest income while a positive gap typically indicates that rising interest rates will result in improvements in net interest income. Conversely, falling interest rates typically result in improvements to net interest income when a negative gap exists but have a negative effect on net interest income when a positive gap exists.
At December 31, 2006, our cumulative one-year gap was a negative $73.4 million, or 17.2% of total assets, which would tend to indicate that our interest-earning assets will re-price during 2006 at a rate slower than our interest-bearing liabilities. However, in our experience, not all liabilities shown in our gap analysis as being subject to re-pricing during a given period will in fact undergo significant re-pricing even as market interest rates change. For example, we have a base of core deposits consisting of interest-bearing checking and savings accounts whose average balances and interest rates paid generally fluctuate little with changes in the levels of market rates of interest. Consequently, these relatively static interest-bearing liabilities, while sensitive to market interest rates and therefore included in our interest rate sensitivity gap analysis, tend to have a much greater effect on our gap analysis then they do on our actual net interest margin. Because the effects of these interest-bearing liabilities tends to be overstated in our gap analysis, we believe that the spread between our interest-earning assets and interest-bearing liabilities will actually decrease in the near term rising interest rate environment, notwithstanding our negative gap, as the rates we are required to pay on these more static interest-bearing deposit accounts fails to keep pace with the increases in interest rates we earn on loans as market rates rise.
The following table summarizes our interest-sensitive assets and liabilities as of December 31, 2006. Variable rate loans are shown in the category of due “One month to Three Months” because they re-price with changes in the prime-lending rate. Fixed rate loans are presented assuming the entire loan matures on the final due date. However, payments actually are made at regular intervals and are not reflected in this schedule. Additionally, demand deposits and savings accounts have no stated maturity, but it has been our experience that these accounts are not as highly
rate sensitive as other of our interest-earning assets and interest-bearing liabilities. Accordingly, the following analysis assumes 40% of interest-bearing demand deposit accounts, and 10% of savings accounts re-price within one year.
INTEREST SENSITIVITY GAP ANALYSIS
We continually try to manage our interest rate sensitivity gap. Attempting to reduce the gap is a constant challenge in a changing interest rate environment and one of the objectives of our asset/liability management strategy. Based on our current GAAP analysis, we are in a cumulative liability sensitive position for most time periods, except for two. This means that if interest rates increase during these cumulative liability periods, net interest margin will decrease. If interest rates decrease, then net interest margin will increase.
Additionally, we use other tools to monitor and manage interest rate sensitivity. One of which, is the shock test. The shock test projects the effect of an interest rate increase and decrease of 100 and 200 basis points on our rate sensitive assets and liabilities.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
BOARD OF DIRECTORS AND SHAREHOLDERS
ALTRUST FINANCIAL SERVICES, INC.
We have audited the accompanying consolidated balance sheets of Altrust Financial Services, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal controls over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 Altrust Financial Services, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
Atlanta, Georgia
, 2007
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2006 and 2005
See accompanying notes to consolidated financial statements.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2006, 2005, and 2004
See accompanying notes to consolidated financial statements.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31, 2006, 2005 and 2004
See accompanying notes to consolidated financial statements.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years ended December 31, 2006, 2005 and 2004
See accompanying notes to consolidated financial statements.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2006, 2005, and 2004
See accompanying notes to consolidated financial statements.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years ended December 31, 2006, 2005, and 2004
See accompanying notes to consolidated financial statements.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of consolidation: The consolidated financial statements include the accounts of Altrust Financial Services, Inc. (the “Company”) and its wholly owned subsidiaries, Peoples Bank of North Alabama (the “Bank”), Southern Insurance of Cullman, Inc. and Southern Appraisal Services, Inc. All significant inter-company balances and transactions have been eliminated in consolidation.
Nature of operations: The Company is a bank holding company headquartered in Cullman, Alabama, which through its subsidiary Peoples Bank of North Alabama provides a full range of banking services to individual and corporate customers throughout central and north Alabama.
Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, valuation of foreclosed real estate, and fair values of financial instruments are particularly subject to change.
Cash, Due from Banks and Cash Flows: For purposes of reporting cash flows, cash and due from banks includes cash on hand, cash items in process of collection and amounts due from banks. Cash flows from loans, federal funds sold, interest-bearing deposits in banks, FHLB, Bankers Bank and other stock, deposits, other borrowings and federal funds purchased are reported net.
The Bank is required to maintain reserve balances in cash or on deposit with the Federal Reserve Bank based on a percentage of deposits. The total of those reserve balances were approximately $50,000 and $50,000 at December 31, 2006 and 2005, respectively.
Investment securities: Securities are classified as available for sale when they might be sold before maturity. Unrealized holding gains and losses, net of tax, on securities available for sale are reported as a net amount in a separate component of shareholders’ equity until realized. Gains and losses on the sale of securities available for sale are determined using the specific-identification method. The amortization of premiums and the accretion of discounts are recognized in interest income using methods approximating the interest method over the period to maturity.
Declines in the fair value of individual available-for-sale securities below their cost that are other than temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses.
Investments in Equity Securities Carried at Cost: Investment in Federal Home Loan Bank (“FHLB”) stock, which is carried at cost because it can only be redeemed at par, is a required investment based on the Bank’s membership and amount of borrowing with the FHLB. The Bank also carries certain other equity securities at cost, which approximates fair value.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Loans: Loans are stated at unpaid principal balances, less the allowance for loan losses.
Interest on all loans is recognized as income based upon the applicable rate applied to the daily outstanding principal balance of the loans. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are generally applied as a reduction of the loan principal balance. Interest income on nonaccrual loans is recognized only to the extent of interest payments received.
Allowance for loan losses: The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions and other risks inherent in the portfolio. Allowances for impaired loans are generally determined based on collateral values or the present value of the estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for losses on loans. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination.
Foreclosed real estate: At the time of foreclosure, foreclosed real estate is recorded at fair value less cost to sell, which becomes the property’s new basis. Any write downs based on the asset’s fair value at date of acquisition are charged to the allowance for loan losses. After foreclosure, these assets are carried at the lower of their new cost basis or fair value less cost to sell. Costs incurred in maintaining foreclosed real estate and subsequent adjustments to the carrying amount of the property are included in other operating expenses.
Premises and equipment: Premises and equipment are stated at cost less accumulated depreciation. Expenditures for additions and major improvements that significantly extend the useful lives of the assets are capitalized. Expenditures for repairs and maintenance are charged to expense as incurred. Assets which are disposed of are removed from the accounts and the resulting gains or losses are recorded in operations. Depreciation is calculated on a straight-line basis over the assets useful lives, which range from 3 to 10 years for furniture, fixtures and equipment, while buildings and components range from 10 to 30 years.
Bank owned life insurance: The Company has purchased life insurance policies on certain key executives. Company owned life insurance is recorded at its cash surrender value, or the amount that can be realized.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Goodwill and Other Intangible Assets: Goodwill results from prior business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Other intangible assets consist of core deposit intangibles arising from whole bank and branch acquisitions and are determined by an independent consulting firm. They are initially measured at fair value and then are amortized on an accelerated method considering estimated deposit account attrition, which ranges from seven to fifteen years. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified.
Income taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
Long Term Assets: Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Earnings Per Common Share: Basic earnings per common share are net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options. Pursuant to the requirements of AICPA Statement of Position (SOP) 93-6, Employers’ Accounting for Employee Stock Ownership Plans, the weighted average number of common shares outstanding during the period excludes common shares that are restricted and have not been released or committed to be released and allocated to plan participants of the Employee Stock Ownership Plan. The number of common shares excluded for the periods of December 31, 2006, 2005, and 2004 were -0-, 211,997, and 275,289, respectively.
Employee stock ownership plan: The Company and its subsidiaries have an Employee Stock Ownership Plan (ESOP) which covers substantially all employees. Contributions to the ESOP are determined by the Board of Directors.
Loan Commitments and Related Financial Instruments: Financial instruments, which include credit card arrangements, commitments to make loans and standby letters of credit, are issued to meet customer financing needs. The face amount for these items represents the exposure to loss before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Instruments such as stand by letters of credit are considered financial guarantees in accordance with FASB Interpretation No. 45. The fair value of these financial guarantees is not material.
Debt cancellation contracts: The Bank issues debt cancellation contracts on certain loans as an additional service product to its customers. The contracts represent an agreement by the Bank to cancel the debt of the borrower upon said borrower’s death. Contracts are limited to $30,000 per borrower. The Bank charges fees equivalent to that authorized by the state banking authorities, and sets aside 100% of all fees as a reserve for potential claims. At various intervals the reserve is analyzed by management for adequacy with adjustments for estimated earned portions recorded into income. The reserve for debt cancellation contracts, including amounts estimated as unearned, was $169,280 and $169,423 at December 31, 2006 and 2005, respectively.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Debt cancellation contracts (Continued)
There were 851 contracts outstanding at December 31, 2006 with total outstanding principal of $4,739,473 for an average loan size of $5,569. The following roll-forward shows the activity involved with this product and the reserve:
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Comprehensive income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as a separate component of equity.
Advertising: Advertising costs are expensed as incurred. Advertising expense for the years ended December 31, 2006, 2005 and 2004 was $319,231, $621,374, and $394,008, respectively.
Segments: Internal financial reporting is primarily reported and aggregated in three lines of business: banking, mortgage insurance and appraisal services. Banking accounts for nearly 100% of revenues for the years presented.
Stock-Based Compensation: Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS No. 123R”) using the modified prospective method. According to SFAS No. 123R, the total cost of the Company’s share based awards is equal to the grant date fair value and recognized as expense on a straight line basis over the service periods of the awards. For the year ended December 31, 2006 stock option expense of $137,856 was recorded in the income statement in net income. As of December 31, 2006, the Company had $381,970 of unrecognized stock option expense which will be recognized over 4.9 years.
As allowed under SFAS No. 123, the Company applied APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations in accounting for its stock option plans prior to January 2006. Accordingly, no compensation expense was recognized for options granted with exercises prices equal to the fair market value of the Company’s common stock on the grant date.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following illustrates the effect on net income available to common shareholders if the Company had applied the fair value recognition provisions of SFAS No. 123 to the years ended December 31, 2005 and 2004:
Reclassifications: Certain items in prior year financial statements have been reclassified to conform to the 2006 presentation with no change to net income or shareholders’ equity as previously reported.
New accounting pronouncements: In June 2006, the FASB issued FASB Interpretation No. 48 (FIN48), Accounting for Uncertainty in Income Taxes. FIN 48, which is effective for years beginning after December 15, 2006, applies to all “tax positions” within the scope of SFAS 109. This statement requires a “more-likely-than-not” threshold for initial recognition of a tax benefit in the financial statements, and requires measurement of the amount of benefit to be recognized based upon the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement with the taxing authority. The cumulative effect of initially applying FIN 48 is recorded in opening retained earnings of the year of adoption. The impact of implementation on the Company’s financial statements is not expected to be material.
In September 2006, the FASB issued FAS 157, Fair Value Measurements. FAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The impact of implementation on the Company’s financial statements is not expected to be material.
In September 2006, the Emerging Issues Task Force (EITF) reached a final consensus on Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF 06-4 requires that for a split-dollar life insurance arrangement, an employer should recognize a liability for future benefits in accordance with FAS 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. Under the guidance, the purchase of an endorsement type policy does not constitute a settlement since the policy does not qualify as nonparticipating because the policyholders are subject to the favorable and unfavorable experience of the insurance company. EITF 06-4 is effective for fiscal years beginning after December 15, 2007. The impact of implementation on the Company’s financial statements is not expected to be material.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In September 2006, the EITF reached a final consensus on Issue 06-5, Accounting for Purchases of Life Insurance. EITF 06-5 provides guidance on FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance. Under the guidance, the policyholder should consider any additional amounts included in the contractual terms of the policy in determining the amount that could be realized under the insurance contract. In addition, the policyholder should also determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2006. The impact of implementation on the Company’s financial statements is not expected to be material.
In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. SFAS 158 amends SFAS 87, Employers’ Accounting for Pensions, SFAS 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, SFAS 106 Employers’ Accounting for Postretirement Benefits Other Than Pensions and SFAS 132(R), Employers’ Disclosures about Pensions and Other Postretirement Benefits. SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 is effective for fiscal years beginning after December 15, 2006. The impact of implementation on the Company’s financial statements will not be material.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”. This statement replaces APB Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”. SFAS No. 154 changes the requirements for the accounting for and reporting of a voluntary change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principles or error corrections, unless it is impractical to determine the period-specific effects or when a pronouncement includes specific transition provisions. This statement is effective for accounting changes and corrections of error made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 (revised 2004) did not have a material impact on the Company’s financial condition or results of operations of the Company.
In November 2005 The FASB issued FASB Staff Position No. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (the “FSP”). This FSP addresses the determination of when an investment is considered impaired; whether the impairment is other than temporary; and how to measure an impairment loss. The FSP also addresses accounting considerations subsequent to the recognition of an other-than-temporary impairment on a debt security, and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The FSP replaces the impairment guidance in EITF Issue No. 03-1 with references to existing authoritative literature concerning other-than-temporary determinations SFAS No. 115 and SEC Staff Accounting Bulletin 59. Under the FSP, impairment losses must be recognized in earnings equal to the entire difference between the security’s cost and its fair value at the financial statement date, without considering partial recoveries subsequent to that date. The FSP also requires that an investor recognize an other-than-temporary impairment loss when a decision to sell a security has been made and the investor does not expect the fair value of the security to fully recover prior to the expected time of sale. The FSP was effective for reporting periods beginning after December 15, 2005. The application of the FSP did not have a material impact on the Company’s financial condition or results of operations.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
New Accounting Pronouncements (Continued)
In September 2006, the SEC issued SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 provides interpretive guidance on how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in the current year financial statements. SAB 108 requires registrants to quantify misstatements using both an income statement and balance sheet approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. If prior years are not restated, the cumulative effect adjustment is recorded in opening accumulated earnings as of the beginning of the fiscal year of adoption. SAB 108 is effective for fiscal years ending on or after November 15, 2006. The application of SAB 108 did not have a material impact on the Company’s financial condition or results of operations.
NOTE 2 - INVESTMENT SECURITIES
Securities are summarized as follows:
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 2 - INVESTMENT SECURITIES (CONTINUED)
Provided below is a summary of securities available-for-sale which were in an unrealized loss position at December 31, 2006 and 2005. Approximately 99% of the unrealized loss for 2006 was comprised of 74 securities in a continuous loss position for twelve months or more. The “U.S. Government sponsored entities” category of investments is comprised of 10 FHLB and FNMA bonds, all of which have been in an unrealized loss position for greater than 12 months. The Bank has the ability and intent to hold these securities until such time as the value recovers or the securities mature. Further, the Bank believes the deterioration in value on these securities is attributable to changes in market interest rates and not credit quality of the issuer.
Contractual maturities of securities available for sale at December 31, 2006 are shown below.
Sales of securities available for sale during 2006, 2005 and 2004 were $1,456,172, $0, and $14,433,438 and resulted in gross realized losses of $43,517 in 2006 and gross realized gains of $0, and $8,438 in 2005 and 2004, respectively.
The carrying value of investment securities pledged to secure public funds on deposit, advances from the Federal Home Loan Bank and for other purposes as required by law was approximately $91,043,216 and $105,580,380, at December 31, 2006 and 2005, respectively.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 2 - INVESTMENT SECURITIES (CONTINUED)
Other investments include a restricted investment in Federal Home Loan Bank stock for membership requirement and to secure available lines of credit. The amount of investment in this stock was $3,631,900 and $4,358,000 at December 31, 2006 and 2005, respectively. Other investments also include an investment in Alabama Bankers Bank stock of $350,000 at December 31, 2006, an investment in Bankers Bank stock of $457,758 at December 31, 2006 and 2005, and an investment in CBAA Services, Inc. of $20,000 at December 31, 2006 and 2005.
NOTE 3 - LOANS
The composition of loans as of December 31, 2006 and 2005 is summarized as follows:
Activity in the allowance for loan losses is as follows:
Impaired loans were as follows:
Impaired loans include restructured loans of $345,682 that were in compliance with modified terms as of December 31, 2006. The effect on earnings of restructured loans was not significant for 2006, 2005, or 2004.
Nonperforming loans were as follows:
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 3 - LOANS (CONTINUED)
In the ordinary course of business, the Company has granted loans to certain related parties, including directors, executive officers, and their affiliates. The interest rates on these loans were substantially the same as rates prevailing at the time of the transaction and repayment terms are customary for the type of loan. Changes in related party loans for the year ended December 31, 2006 are as follows:
NOTE 4 - PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
The above schedule includes land and building covered by a capitalized lease obligation in connection with the acquisition of the Marshall County branches in 2002. Under the terms of the agreement, the Company is to pay sixty monthly payments of $14,000 beginning June 1, 2002 and the balance of $2,621,543 on June 1, 2007. As of December 31, 2006 the capitalized lease is summarized as follows:
The provisions for depreciation charged to occupancy and equipment expense for the years ended December 31, 2006, 2005 and 2004 were $1,112,400, $810,197, and $691,636 respectively.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 4 - PREMISES AND EQUIPMENT (CONTINUED)
The Bank leases land and building space under noncancellable operating leases. Future minimum lease payments under noncancellable operating leases are summarized as follows:
For the years ended December 31, 2006, 2005 and 2004, annual rental expense on operating leases was $189,442, $215,505, and $197,100, respectively.
NOTE 5 - GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
Goodwill is no longer amortized and is periodically evaluated for impairment. No impairment was recognized in 2006 or in 2005.
Core deposit and other intangibles
Core deposit intangibles had a gross carrying amount of $3,053,069 for years ended 2006 and 2005 and accumulated amortization of $2,327,674 and $2,173,916 for the same periods, respectively. Aggregate amortization expense was $153,758 for year ended 2006, $152,343 for year ended 2005, and $513,901 for year ended 2004.
Estimated amortization expense for each of the next five years is as follows:
NOTE 6 - DEPOSITS
Deposits at year-end were as follows:
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 6 - DEPOSITS (CONTINUED)
The scheduled maturities of time deposits at December 31, 2006 are as follows:
NOTE 7 - BORROWINGS
Advances from the Federal Home Loan Bank at December 31, 2006 and 2005 are summarized as follows:
Scheduled maturities of FHLB advances over the next five years and thereafter are as follows:
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 7 - BORROWINGS (CONTINUED)
The fixed rate advances with maturities in 2009 include $12,500,000 of principal reducing credits requiring annual payments of principal.
The advances are collateralized by securities with a fair value of $70,753,840 and by a blanket lien on the Company’s 1-4 family mortgage loans and real estate loans. Qualifying real estate loans eligible as collateral for borrowings from the Federal Home Loan Bank amounted to approximately $78,000,000 as of December 31, 2006.
Federal Funds Purchased
In addition to the above, at December 31, 2006 and 2005, the Company had available lines of credit totaling approximately $30,000,000 with various financial institutions for borrowing on a short-term basis, with no balance outstanding in 2005 and $2,448,000 at December 31, 2006. These lines are subject to annual renewals with varying interest rates.
NOTE 8 - STOCK OPTIONS
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS No. 123R”) which was issued by the Financial Accounting Standards Board in December 2004. SFAS No. 123R revises SFAS No. 123 “Accounting for Stock Based Compensation (“SFAS 123”),” and supersedes APB No. 25, “Accounting for Stock Issued to Employees,” (“APB No. 25”) and its related interpretations. SFAS No. 123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95 “Statement of Cash Flows,” to require that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.
The Company adopted SFAS No. 123R using the modified prospective application as permitted under SFAS No. 123R. Accordingly, prior period amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption.
Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the Company’s common stock on the date of grant.
The Company has a qualified stock option plan for key employees (the “employee plan”) and has reserved 250,000 shares of common stock. Options are granted at the fair market value of the Company’s common stock on the date of grant. All options under the employee plan expire ten years from the date of grant and vest after five years. At December 31, 2006, 193,200 options were available for grant.
The Company also has non-qualified stock option plans for directors (the “director plans”) and has reserved 750,000 shares of common stock. Options are granted at fair market value. All options under these plans expire ten years from the date of grant and vest after five years. At December 31, 2006, 629,200 options were available for grant.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 8 - STOCK OPTIONS (CONTINUED)
The Company also had an employee and director plan that was implemented in 1995. Under that plan, a total of 520,000 shares were reserved of which 272,000 were issued and were outstanding at December 31, 2004. This plan was replaced by a new plan for 2004 as noted above.
Other pertinent information related to the options follows:
At December 31, 2006, the 412,000 options outstanding had a range of exercise prices of $7.60 to $11.80 per share and the weighted average remaining contractual life for those options was 6.2 years. Information pertaining to options outstanding at December 31, 2006 is as follows:
The total aggregate intrinsic value of options (which is the amount by which the stock price exceeded the exercise price of the options) exercised during the years ended December 31, 2006 and 2005, was $177,472 and $89,712, respectively. The total fair value of shares vesting during the years ended December 31, 2006 and 2005, was $137,856 and $128,175, respectively. As of December 31, 2006, there was $381,970 of total unrecognized compensation cost related to non-vested share-based compensation arrangements, which is expected to be recognized over a weighted-average period of 2.1 years.
The adoption of SFAS 123R and its fair value compensation cost recognition provisions are different from the nonrecognition provisions under SFAS 123 and the intrinsic value method for compensation cost allowed under APB 25. The effect (increase/(decrease)) of the adoption of SFAS 123R is as follows:
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 8 - STOCK OPTIONS (CONTINUED)
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
NOTE 9 - REGULATORY CAPITAL MATTERS
The Bank is subject to dividend restrictions set forth by the Alabama State Banking Department. Under such restrictions, the Bank may not, without the prior approval of the Alabama State Banking Department, declare dividends in excess of the sum of the current year’s earnings plus the retained earnings from the prior two years. The dividends as of December 31, 2006, that the Bank could declare, without the approval of the Alabama State Banking Department amounted to approximately $5,242,000.
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the state and federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators, that if undertaken, could have a direct material effect on the Bank and the Company’s consolidated financial statements. Under regulatory capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines involving quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification under the prompt corrective guidelines are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 9 - REGULATORY CAPITAL MATTERS (CONTINUED)
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total risk-based capital and Tier 1 capital to risk-weighted assets (as defined in the regulations), and Tier 1 capital to adjusted total assets (as defined). Management believes, as of December 31, 2006, that the Company and the Bank meet all capital adequacy requirements to which it is subject.
As of December 31, 2006, the most recent notification from the Federal Deposit Insurance Corporation, categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To remain categorized as well capitalized, the Bank will have to maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as disclosed in the table below. There are no conditions or events since the most recent notification that management believes have changed the Bank’s category.
In addition, the Alabama Superintendent of Banking has further required the Bank to maintain a Tier 1 Leverage Ratio of at least 7%, as a condition to a previous branches acquisition transaction and this requirement is still in effect. The Bank is in compliance with this requirement as of December 31, 2006.
The capital ratios for the consolidated holding company do not materially differ from those shown above and thus are not shown separately.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 10 - OTHER OPERATING INCOME AND EXPENSES
The major components of other operating income and expense included in noninterest income and noninterest expense are as follows:
NOTE 11 - INCOME TAXES
The components of income tax expense (benefit) are as follows:
The Company’s total income tax expense differs from the amounts computed by applying the Federal income tax statutory rates to income before income taxes. A reconciliation of the differences is as follows:
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 11 - INCOME TAXES (CONTINUED)
The components of the net deferred tax asset are as follows:
Management of the Company believes its net deferred tax asset is recoverable.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
Loan Commitments
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, credit card arrangements, and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. A summary of the Bank’s commitments and contingent liabilities is approximately as follows:
Commitments to extend credit, credit card arrangements, commercial letters of credit and standby letters of credit all include exposure to some credit loss in the event of nonperformance of the customer. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet financial instruments.
Because these instruments have fixed maturity dates, and because many of them expire without being drawn upon, they do not generally present any significant liquidity risk to the Bank.
Contingencies
In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material effect on the Company’s financial statements
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 13 - CONCENTRATIONS OF CREDIT
The Company originates primarily commercial, residential, and consumer loans to customers in the Bank’s market area. The ability of the majority of the Company’s customers to honor their contractual loan obligations is dependent on the economy in this area.
The Company’s loan portfolio is primarily concentrated in loans secured by real estate of which a substantial portion is secured by real estate in the Company’s primary market area. In addition, a substantial portion of the other real estate owned is located in that same market. Accordingly, the ultimate collectibility of the loan portfolio and the recovery of the carrying amount of other real estate owned are susceptible to changes in market conditions in the Company’s primary market area.
NOTE 14 - EMPLOYEE STOCK OWNERSHIP PLAN
The Company has adopted an Employee Stock Ownership Plan (the “ESOP”) which enables eligible employees of the Bank to own Company common stock.
The ESOP is a noncontributory plan that provides retirement and disability benefits for eligible employees, and death benefits. Employees who are credited with one thousand hours of service in any twelve-month period or who have completed three consecutive months of service may become participants in the Plan.
Benefits under the Plan depend upon a participant’s years of credited service with the Company or the Bank and the annual allocation of employer contributions based upon the ratio that the compensation of the participant bears to the total compensation of all participants. A participant is 20% vested in their accrued benefits after completion of three years of service. Vesting increases 20% per year for the next four years with the participant becoming fully vested upon completion of seven years of service.
During 1999, the ESOP borrowed $5,212,856 from an unrelated financial institution. The funds were used to acquire 661,950 shares (after stock split) of the Company’s stock. The Company, as plan sponsor, guaranteed the loan, and in accordance with generally accepted accounting principles accounted for the aforementioned leveraged transaction by recording the debt of the ESOP as a liability and recorded an offsetting reduction of equity. As debt principal was paid, these accounts were correspondingly reduced.
The shares pledged against the ESOP loan were held in escrow. The restricted shares were released based upon a formula calculation of principal and interest paid as a percentage of the total principal and interest to be paid under terms of the loan agreement; however, the lender could not hold more fair market value collateral than the outstanding loan principal. Dividends paid on unallocated shares are expensed as compensation.
In accordance with the ESOP, the Company is expected to honor the rights of participants to liquidate their ownership of the common stock in the event of termination. To the extent that allocated shares of common stock held by the ESOP are not readily traded, a sponsor must reflect the maximum cash obligation related to those securities outside of stockholders’ equity to liabilities. As of December 31, 2006 and 2005, the allocated shares held by the ESOP were 1,087,819 and 875,822 respectively, with a fair value and maximum cash obligation of $12,836,264 and $8,232,727 respectively.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 14 - EMPLOYEE STOCK OWNERSHIP PLAN (CONTINUED)
The following summarizes the applicable activity and balances regarding the ESOP:
The accrued and unpaid contribution amounts were $451,463, $617,069, and $620,631 at December 31, 2006, 2005 and 2004, respectively.
The indebtedness described above is included in liabilities and as a reduction of equity. As guarantor of the ESOP loan, the Company was subject to certain restrictive covenants (financial and other). For 2005, any covenant non-compliance issues that may have existed were resolved by the final payoff of the ESOP debt in January 2006 as discussed below.
The entire balance of the ESOP debt was paid off on January 31, 2006. This was facilitated through application of the Company’s 2005 ESOP compensation contribution, regular 2005 and first quarter 2006 dividends, and a special one-time $1 per share cash dividend declared and paid in January of 2006. In the first quarter of 2006, this resulted in an approximate $2 million increase to the balance sheet presentation of the redeemable common stock held by the ESOP at fair market value, relating to the allocation to Plan participants of the remaining 211,997 unallocated shares in the ESOP Trust. Additionally, shareholders’ equity was increased in 2006 by a credit to unearned compensation related to ESOP debt of $1,726,762, previously reflected as contra equity. Because of tax benefits relating to the payment of cash dividends to the ESOP Trust, the net effect of recording compensation expense for the fair value of the ESOP shares released in 2006 was not material to 2006 operations.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 15 - EARNINGS PER SHARE
A reconciliation of the numerators and denominators of the earnings per common share and earnings per common share assuming dilution computations are presented below.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 16 - RELATED PARTY TRANSACTIONS
Loans
As more fully described in Note 3, the Bank made loans to related parties during 2006 and 2005 which amounted to $6,234,130 and $13,381,340 at December 31, 2006 and 2005, respectively.
Deposits
Deposits from related parties held by the Bank at December 31, 2006 amounted to $2,667,417.
Leases
The Bank has a lease agreement with a director for the lease of a branch facility. The lease is of comparable terms and conditions as would be from an independent party. The lease is on a month-to-month basis with monthly rental payments of $1,400.
The Bank has a lease agreement with Walker Brothers, Ltd., an affiliated business of certain directors, for the lease of an operations facility. The lease is of comparable terms and conditions as would be from an independent party. The lease is for three years with monthly rental payments of $1,680. The Bank also leases additional space for this facility from Walker Brothers, Ltd., on a month to month basis with monthly rental payments of $1,040.
Construction
During 2006, 2005 and 2004, the Bank contracted with Walker Brothers, Ltd., for the construction and remodeling of facilities and miscellaneous supplies. Total amounts paid to this related party during 2006, 2005 and 2004 amounted to $23,170, $78,645, and $375,586, respectively.
Appraisal evaluation services
During 2006, 2005 and 2004, the Bank utilized the services of a real estate firm owned by a former director’s family member for evaluations on loans secured by real estate and not requiring independent certification. The former director is an employee of the firm and performs the evaluations. The total amount paid during 2004 was $13,046. No amounts were paid in 2006 and 2005. Additionally, Southern Appraisal Services, Inc. (one of the company’s subsidiaries) paid this former director $10,311, $16,160, and $6,765 during 2006, 2005 and 2004, respectively, in fees and expenses for appraisal services.
NOTE 17 - SEGMENT INFORMATION
In addition to banking, the Company is engaged in other areas of operation through its non-bank subsidiaries offering services and products to enhance and compliment its banking operations. Southern Insurance of Cullman, Inc. acts as an agent for obtaining title insurance for the Bank’s real estate loan customers and to offer various services to the Bank’s customers. Southern Appraisal Services, Inc. provides real estate appraisal services.
The Company’s non-bank subsidiaries do not meet the quantitative threshold for disclosure on a separate basis. The combined revenue of these subsidiaries for 2006, 2005 and 2004 was less than 3% of consolidated revenues each year and has been included in non-interest income. The combined expenses of these subsidiaries for 2006, 2005 and 2004 was less than approximately 3% of consolidated expenses and has been included in non-interest expense.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 18 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS No. 107, Disclosures about Fair Values of Financial Instruments, excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments.
Cash and cash equivalents: The carrying amounts reported in the consolidated statements of financial condition for cash and cash equivalents approximate those assets’ fair values.
Investment securities: Fair values for investment securities are based on quoted market prices, where available. If a quoted market price is not available, fair value is based on quoted market prices of comparable instruments.
Other investments: Fair values for other investments are considered to be their cost as they are redeemed at par value.
Loans, net: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair value is based on carrying amounts. The fair value of other loans (for example, fixed rate commercial real estate, mortgage loans, and industrial loans) is estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. Fair value for impaired loans is estimated using discounted cash flow analysis, or underlying collateral values, where applicable.
Accrued interest and dividends receivable: The carrying amount of accrued interest and dividends receivable approximates its fair value.
Cash surrender value of life insurance: The carrying amount of bank owned life insurance approximates its fair value.
Deposits: The fair value disclosed for demand deposits is, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts approximate their fair values. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Accrued interest payable: The carrying amount of accrued interest payable approximates its fair value.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 18 - FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
Federal funds purchased, FHLB advances, debt of ESOP and the capitalized lease obligation: The carrying amounts for the short-term portions of these borrowings approximate their fair values. The long term portions are estimated using a discounted cash flow calculation that applies interest rates currently available for similar terms.
Loan commitments: Fair values of the Company’s off-balance sheet financial instruments are based on fees currently charged to enter into similar agreements. Since the majority of the Company’s other off-balance sheet instruments consist of nonfee-producing, variable-rate commitments, the Company has determined they do not have a distinguishable fair value.
The carrying amounts and estimated fair values of the Company’s financial instruments as of December 31, 2006 and 2005 are as follows:
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 19 - BUSINESS COMBINATION
On September 22, 2003, the Company entered into an “Acquisition Agreement” with THE BANK, an Alabama banking corporation, whereby the Company acquired a branch operation in Morris, Alabama. The transaction was approved by the regulatory agencies and closed on February 6, 2004. The Company paid a deposit premium of 9% for the branch, which resulted in the Company recording intangible assets of $738,038. The identifiable intangible asset associated with the fair value of the core deposit base, as determined by an independent consulting firm, was determined to be $45,102 and is being amortized as expense on a straight-line method over a seven-year period. The remaining intangible asset of $692,936 has been classified as goodwill, and thus will not be systematically amortized, but rather will be subject to an annual impairment test. The amortization of the identifiable intangible asset is included in the accompanying Consolidated Statements of Income beginning on the acquisition date of February 6, 2004. The operating results of these branches would be immaterial to the results of the Company and therefore pro forma results of operations have not been presented.
The following table summarizes the fair value of assets acquired and liabilities assumed at the date of acquisition.
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 20 - PARENT COMPANY CONDENSED FINANCIAL STATEMENTS
Balance Sheets
Years ended December 31, 2006 and 2005
Statements of Income
Years ended December 31, 2006, 2005, and 2004
ALTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005, and 2004
NOTE 20 - PARENT COMPANY CONDENSED FINANCIAL STATEMENTS (CONTINUED)
Statements of Cash Flows
Years ended December 31, 2006, 2005, and 2004
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES.
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
The Company’s management, with the participation of the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report on Form 10-K. Based on that evaluation, the CEO and CFO have concluded that the disclosure controls and procedures as of the end of the period covered by this annual report are effective in recording, processing, summarizing and reporting, in a timely manner, the information that the Company is required to disclose in its Exchange Act reports.
There were no changes in the Company’s internal control over financial reporting during the fiscal quarter ending December 31, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information required by this section is incorporated by reference to the section titled “Outstanding Voting Securities of the Company and Principal Holders Thereof” and “Election of Directors” and “Additional Information Concerning the Company’s Board of Directors and Committees” and “Executive Officers” in the definitive proxy statement for the Company’s Annual Meeting of shareholders to be held on May 17, 2007 (“Annual Meeting”).
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION.
The information required by this section is incorporated by reference to the section titled “Executive Compensation and Other Information” in the definitive proxy statement for the Annual Meeting which will be filed no later than April 30, 2007.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The information required by this section is incorporated by reference to the section titled “Outstanding Voting Securities of the Company and Principal Holders Thereof” in the definitive proxy statement for the Annual Meeting.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information required by this section is incorporated by reference to the section titled “Certain Relationships and Transactions” in the definitive proxy statement for the Annual Meeting.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this section is incorporated by reference to the section titled “Independent Public Accountants” in the definitive proxy statement for the Annual Meeting.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) The following documents are filed as part of this report:
(1) Financial Statements-Please refer to Item 8 of this report.
(2) Financial Statements Schedules- All schedules are omitted as the required information is inapplicable or the information is presented in the financial statements or the related notes set forth in Item 8 of this report.
(3) A list of the exhibits required by Item 601 of Regulation S-K to be filed as a part of this report is shown on the “Exhibit Index” filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Cullman, State of Alabama, on April 2, 2007.
ALTRUST FINANCIAL SERVICES, INC.
By:
/s/ J. Robin Cummings
J. Robin Cummings
President and Chief Executive Officer
This offering statement has been signed by the following persons in the capacities and on the date indicated.
EXHIBIT INDEX
* denotes management contract or compensatory plan or arrangement.