ITEM 1: BUSINESS
General
Weststar Financial Services Corporation (the “Registrant” or the “Company”) is a bank holding company formed in April 2000 to own all of the common stock of The Bank of Asheville (the “Bank”), a North Carolina-chartered bank that opened for business as a community bank in Asheville, Buncombe County, North Carolina in December 1997. On October 8, 2003, the Company formed Weststar Financial Services Corporation I (the “Trust”), a Delaware statutory trust. The Trust has had no operations subsequent to its formation in 2003 other than the issuance of trust preferred securities. At this time, the Company does not engage in any business activities on its own. It only owns the Bank, which engages in the commercial banking business, and the Trust, which was the legal entity formed for its issuance of $4.0 million in trust preferred securities in 2003. On October 19, 2004, the Company formed Bank of Asheville Mortgage Company, LLC, a mortgage broker, of which the Company owned a 50% interest. Bank of Asheville Mortgage Company, LLC was dissolved effective October 31, 2008.
Primary Market Area
The Registrant’s market area consists of Asheville, Buncombe County, North Carolina and surrounding areas. Buncombe County is part of the Asheville Rand McNally Metropolitan Area. Asheville is the county seat and the industrial center of Buncombe County with a population of approximately 71,100. In addition, Asheville is the commercial hub for several other prosperous towns in Buncombe County, including Arden, Biltmore Forest, Black Mountain, Montreat, Skyland, Weaverville and Woodfin. The total population of Buncombe County is 224,300. Statistics are the latest issued by the Asheville Metro Business Research Center.
Competition
Commercial banking in North Carolina is extremely competitive in large part due to a long history of statewide branching. Registrant competes in its market areas with some of the largest banking organizations in the state and the country and other financial institutions, such as federally and state-chartered savings and loan institutions and credit unions, as well as consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit. Many of Registrant’s competitors have broader geographic markets and higher lending limits than Registrant and are also able to provide more services and make greater use of media advertising. In Buncombe County as of June 30, 2008 (the latest date for which statistics are available) there were 88 offices of 19 different commercial and savings banks (including the largest banks in North Carolina), as well as offices of credit unions and various other entities engaged in the extension of credit. The Registrant accounted for 3.7% of total deposits held by commercial banks and savings banks in Buncombe County.
The enactment of legislation authorizing interstate banking has caused great increases in the size and financial resources of some of the Registrant’s competitors. In addition, as a result of interstate banking, out-of-state commercial banks have acquired North Carolina banks, which has heightened the competition among banks in North Carolina.
Despite the competition in its market area, the Registrant believes that it has certain competitive advantages that distinguish it from its competition. Registrant believes that its primary competitive advantages are its strong local identity and affiliation with the community and its emphasis on providing specialized services to small and medium-sized business enterprises, as well as professional and upper-income individuals. Registrant is locally owned and managed, making credit and other decisions that have a direct bearing on faster service and more efficiently obtained credit. Registrant offers customers modern, high-tech banking without forsaking community values such as prompt, personal service and friendliness. Registrant offers many personalized services and attracts customers by being responsive and sensitive to their individualized needs. Registrant also relies on goodwill and referrals from shareholders and satisfied customers, as well as traditional newspaper and radio media to attract new customers. To enhance a positive image in the community, Registrant supports and participates in local events and its officers and directors serve on boards of local civic and charitable organizations.
Employees
The Bank currently employs 53 full-time equivalent employees. Registrant does not have any officers or employees who are not also officers or employees of the Bank. None of the Registrant’s employees are covered by a collective bargaining agreement. The Registrant believes its relations with its employees to be good.
Regulation
Registrant is extensively regulated under both federal and state law. Generally, these laws and regulations are intended to protect depositors and borrowers, not shareholders. To the extent that the following information describes statutory and
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regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable law or regulation may have a material effect on the business of the Registrant.
THE BANK HOLDING COMPANY ACT. The Registrant is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”), and is required to register as such with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “FRB”). A bank holding company is required to file with the FRB annual reports and other information regarding its business operations and those of its subsidiaries. It is also subject to examination by the Federal Reserve Board and is required to obtain Federal Reserve Board approval prior to acquiring, directly or indirectly, more than 5% of the voting stock of any bank, unless it already owns a majority of the voting stock of such bank. Furthermore, a bank holding company must engage, with limited exceptions, in the business of banking or managing or controlling banks or furnishing services to or performing services for its subsidiary banks. One of the exceptions to this prohibition is the ownership of shares of a company the activities of which the FRB has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
STATE LAW. The Bank is subject to extensive supervision and regulation by the North Carolina Commissioner of Banks (the “Commissioner”). The Commissioner oversees state laws that set specific requirements for bank capital and regulate deposits in, and loans and investments by, banks, including the amounts, types, and in some cases, rates. The Commissioner supervises and performs periodic examinations of North Carolina-chartered banks to assure compliance with state banking statutes and regulations, and the Bank is required to make regular reports to the Commissioner describing in detail its resources, assets, liabilities and financial condition. Among other things, the Commissioner regulates mergers and acquisitions of state-chartered banks, the payment of dividends, loans to officers and directors, record keeping, types and amounts of loans and investments, and the establishment of branches.
DEPOSIT INSURANCE. As a member institution of the Federal Deposit Insurance Corporation (“FDIC”), the Bank’s deposits are insured up to a maximum of $250,000 per depositor through the Deposit Insurance Fund (“DIF”), administered by the FDIC, and each member institution is required to pay semi-annual deposit insurance premium assessments to the FDIC. The DIF assessment rates vary based on an institution’s capital position and other supervisory factors. The increase in basic federal deposit insurance coverage from $100,000 to $250,000 per depositor became effective on October 3, 2008 as part of the Emergency Economic Stabilization Act of 2008. The legislation provides that the basic deposit insurance limit will return to $100,000 per depositor after December 31, 2009.
The Bank of Asheville has chosen to participate in the transaction guarantee component of the FDIC Temporary Liquidity Guarantee Program. As of October 14, 2008, all non-interest-bearing transaction deposit accounts at our participating FDIC-Insured Institution, including all personal and business checking deposit accounts that do not earn interest, are fully insured for the entire amount in the deposit account. This unlimited insurance coverage is temporary and will remain in effect until December 31, 2009.
CAPITAL REQUIREMENTS. The federal banking regulators have adopted certain risk-based capital guidelines to assist in the assessment of the capital adequacy of a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit, and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans.
A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which include off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. “Tier 1,” or core capital, includes common equity, qualifying noncumulative perpetual preferred stock, minority interests in certain equity accounts of consolidated subsidiaries, less goodwill and other intangibles, subject to certain exceptions and restricted core capital elements, including trust preferred securities. “Tier 2,” or supplementary capital, includes among other things, limited-life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan and lease losses, subject to certain limitations and less required deductions. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. Banks and bank holding companies subject to the risk-based capital guidelines are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4% and a ratio of total capital to risk-weighted assets of at least 8%. The appropriate regulatory authority may set higher capital requirements when particular circumstances warrant. As of December 31, 2008, the Company was classified as “well-capitalized” with Tier 1 and Total Risk - Based Capital of 11.37% and 12.62%, respectively.
The federal banking agencies have adopted regulations specifying that they will include, in their evaluations of a bank’s capital adequacy, an assessment of the bank’s interest rate risk (“IRR”) exposure. The standards for measuring the adequacy and effectiveness of a banking organization’s IRR management include a measurement of board of director and senior management oversight, and a determination of whether a banking organization’s procedures for comprehensive risk
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management are appropriate for the circumstances of the specific banking organization.
Failure to meet applicable capital guidelines could subject a banking organization to a variety of enforcement actions, including limitations on its ability to pay dividends, the issuance by the applicable regulatory authority of a capital directive to increase capital and, in the case of depository institutions, the termination of deposit insurance by the FDIC, as well as the measures described under the heading “Federal Deposit Insurance Corporation Improvement Act of 1991” below, as applicable to undercapitalized institutions. In addition, future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of Registrant to grow and could restrict the amount of profits, if any, available for the payment of dividends to the shareholders.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991. In December, 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things:
·
publicly available annual financial condition and management reports for certain financial institutions, including audits by independent accountants,
·
the establishment of uniform accounting standards by federal banking agencies,
·
the establishment of a “prompt corrective action” system of regulatory supervision and intervention, based on capitalization levels, with greater scrutiny and restrictions placed on depository institutions with lower levels of capital,
·
additional grounds for the appointment of a conservator or receiver, and
·
restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements.
FDICIA also provides for increased funding of the FDIC insurance funds and the implementation of risk-based premiums.
A central feature of FDICIA is the requirement that the federal banking agencies take “prompt corrective action” with respect to depository institutions that do not meet minimum capital requirements. Pursuant to FDICIA, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions that they supervise. Under these regulations, a depository institution is classified in one of the following capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” An institution may be deemed by the regulators to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating with respect to asset quality, management, earnings or liquidity.
FDICIA provides the federal banking agencies with significantly expanded powers to take enforcement action against institutions which fail to comply with capital or other standards. Such action may include the termination of deposit insurance by the FDIC or the appointment of a receiver or conservator for the institution. FDICIA also limits the circumstances under which the FDIC is permitted to provide financial assistance to an insured institution before appointment of a conservator or receiver.
MISCELLANEOUS. The dividends that may be paid by Registrant are subject to legal limitations. The Bank is the only source of dividends that may be paid by the Registrant. In accordance with North Carolina banking law, dividends may not be paid by the Bank unless its capital surplus is at least 50% of its paid-in capital.
The earnings of Registrant will be affected significantly by the policies of the Federal Reserve Board, which is responsible for regulating the United States money supply in order to mitigate recessionary and inflationary pressures. Among the techniques used to implement these objectives are open market transactions in United States government securities, changes in the rate paid by banks on bank borrowings, and changes in reserve requirements against bank deposits. These techniques are used in varying combinations to influence overall growth and distribution of bank loans, investments, and deposits, and their use may also affect interest rates charged on loans or paid for deposits.
The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of Registrant.
Effective March 11, 2000, the Gramm-Leach-Bliley Act of 1999 allows a bank holding company to qualify as a “financial holding company” and, as a result, be permitted to engage in a broader range of activities that are “financial in nature” and in
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activities that are determined to be incidental or complementary to activities that are financial in nature. The Gramm-Leach-Bliley Act amends the Bank Holding Company Act to include a list of activities that are financial in nature, and the list includes activities such as underwriting, dealing in and making a market in securities, insurance underwriting and agency activities and merchant banking. The Federal Reserve Board is authorized to determine other activities that are financial in nature or incidental or complementary to such activities. The Gramm-Leach-Bliley Act also authorizes banks to engage through financial subsidiaries in certain of the activities permitted for financial holding companies. The Registrant has elected not to register as a financial holding company.
Registrant cannot predict what legislation might be enacted or what regulations might be adopted, or if enacted or adopted, the effect thereof on Registrant’s operations.
On October 26, 2001, the USA PATRIOT Act of 2001 was enacted. This act contains the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001, which sets forth anti-money laundering measures affecting insured depository institutions, broker-dealers and other financial institutions. The Act requires U.S. financial institutions to adopt new policies and procedures to combat money laundering and grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on the operation of financial institutions. This act has increased the overall cost of our regulatory compliance activities.
ITEM 2:
ITEM 2: PROPERTIES
The following table sets forth the location of the Registrant’s offices as of December 31, 2008.
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
In the normal course of its operations, the Company from time to time is party to various legal proceedings. Based upon information currently available, and after consultation with its legal counsel, management believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the Company’s business, financial position or results of operations.
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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PART II
ITEM 5:
ITEM 5: MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND REGISTRANT’S PURCHASES OF EQUITY SECURITIES
Market Summary
Weststar Financial Services Corporation stock is traded on the Over-The-Counter Bulletin Board under the symbol “WFSC.” There were 2,125,747 shares outstanding at December 31, 2008 owned by approximately 800 shareholders.
During 2008, 122,300 shares of the Company’s common stock were traded. The closing price of the stock on December 31, 2008 was $6.35.
The following table represents stock prices during the trading periods.
No cash dividends were paid in 2008 or 2007. A 25% stock dividend effected in the form of a 5-for-4 stock split was paid to shareholders in June 2007. Stock prices in the table above have been adjusted to reflect the stock dividend.
Stock Transfer Agent and Registrar
Registrar and Transfer Company
Commerce Drive
Cranford, NJ 07016
908.497.2300 or 800.368.5948
Shareholder Information
For information, contact Randall C. Hall, Executive Vice President and Secretary, Weststar Financial Services Corporation, 79 Woodfin Place, Asheville, North Carolina, 28801 or rhall@bankofasheville.com.
Annual Shareholders Meeting
The Annual Meeting of the shareholders of Registrant will be held at 3:00 p.m., Tuesday, April 28, 2009, at the Renaissance Asheville Hotel, One Thomas Wolfe Plaza, Asheville, North Carolina.
Independent Auditors
Dixon Hughes PLLC, 6525 Morrison Boulevard, Suite 516, Charlotte, NC 28211-3563
See Item 11 of this report for disclosure regarding securities authorized for issuance and equity compensation plans required by Item 201(d) of Regulation S-K.
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ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
Not applicable.
ITEM 7
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
MANAGEMENT’S DISCUSSION AND ANALYSIS
Management’s Discussion and Analysis is provided to assist in understanding and evaluating the Company’s results of operations and financial condition. The following discussion should be read in conjunction with the consolidated financial statements and related notes included elsewhere herein. Weststar Financial Services Corporation (the “Company”) is a holding company for The Bank of Asheville (the “Bank”), a state chartered commercial bank incorporated in North Carolina on October 29, 1997. The Bank provides consumer and commercial banking services in Buncombe County and surrounding areas. Common shares of the Bank were exchanged for common shares of Weststar Financial Services Corporation effective April 28, 2000. Weststar Financial Services Corporation formed Weststar Financial Services Corporation I (the “Trust”) during October 2003 in order to facilitate the issuance of trust preferred securities. The Trust is a statutory business trust formed under the laws of the state of Delaware, of which all common securities are owned by Weststar Financial Services Corporation. On October 19, 2004, the Company formed Bank of Asheville Mortgage Company, LLC (the “Mortgage Company”), a mortgage broker, of which the Company owned a 50% interest. During 2008, the Company and its partner in the Mortgage Company decided to close the Mortgage Company, which was dissolved effective October 31, 2008. Because Weststar Financial Services Corporation has no material operations and conducts no business on its own other than owning the Bank, the discussion contained in Management’s Discussion and Analysis concerns primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, Weststar Financial Services Corporation and the Bank are collectively referred to herein as the Company.
EXECUTIVE OVERVIEW
The year 2008 was a year ruled by negative economic indicators and widespread fear. One of the sources of 2008’s economic troubles was that the housing bubble burst, which sent home prices plunging and made foreclosures soar across the nation. In an attempt to shore up the housing market, federal officials in September seized Fannie Mae and Freddie Mac, placing them in a conservatorship amid concerns that steep mortgage losses were hurting their ability to remain viable and thus constrain the mortgage market. On October 3, lawmakers passed the Emergency Economic Stabilization Act of 2008, which included programs aimed at buying up soured mortgage assets and encouraging banks to resume lending in order to ease the growing credit crisis. Approximately $250 billon was used to inject equity into banks and another $40 billion went to American Insurance Group (“AIG”). The “big three” automakers also pressed lawmakers for funds to prevent a collapse in the auto industry. In December, the National Bureau of Economic Research confirmed that the United States had been in a recession for a year. In an effort to stimulate the economy, the Federal Reserve drastically lowered interest rates by 400 basis points during 2008 to its lowest rate on record by year end.
During 2008, the Company focused significant attention on maintaining asset quality, furthering asset growth and expanding its market share. Management adhered to prudent underwriting standards, expanded periodic reviews of loans of $100,000 or more, and enhanced its loan quality monitoring systems. Net charge-offs during 2008 totaled $271,429 compared to $200,680 during 2007. Non-performing assets totaled $521,108 and $283,470 at December 31, 2008 and 2007, respectively. Loans outstanding grew by $35,505,468 or 26.16% to $171,239,692 from December 31, 2007 to December 31, 2008. The investment portfolio decreased from $26,113,294 to $23,778,449 primarily as a result of increased loan demand.
The Company held deposit market share in Buncombe County of approximately 3.7% as of June 30, 2008, according to the latest Federal Deposit Insurance Corporation statistics. From December 31, 2007 to December 31, 2008 the Company’s deposits grew from $149,191,016 to $170,814,106 - an increase of 14.49%. During 2008, the majority of the Company’s deposit growth originated from time-deposits; rate sensitive customers sought to lock in rates during the falling interest rate environment. Lastly, as the need for funding loan growth intensified during the latter part of the year, the Company increased outstanding certificates of deposits from other financial institutions from $11,743,941 to $21,935,733.
The Company’s average interest rate spread decreased from 3.96% to 3.50% during 2008, which partially offset net earning asset growth, resulted in a 4.76% decrease in net interest income during 2008. As a result of loan growth, charge-offs and a continued deterioration in the national and local economic environment, the Company added $711,285 to its allowance for loan losses compared to $406,725 in 2007. The Company operates in a well diversified market. Major economic drivers include tourism, medical industry and light manufacturing. The unemployment rate remains relatively low, and the job market appears to be stable with no major layoffs. Non-interest income increased $49,447 primarily as a result increased mortgage loan origination fee income at the Bank level. During the second quarter, the Company and its partner in the Mortgage Company mutually agreed to terminate their relationship, and began the process to close the Mortgage Company. The Company then shifted originating mortgage loans through the Bank. Bank of Asheville Mortgage Company, LLC posted net operating losses of $30,590 during the year compared to net operating losses of $120,198 during 2007, of which $15,295 and $60,099 was the Company’s portion during 2008 and 2007, respectively. Securities losses totaled $1,093 during 2007 compared to none during 2008. Non-interest expenses totaled $6,132,224 and $5,553,236 in 2008 and 2007, respectively. Operating expenses increased as a result of increased expenses associated with supporting loan and deposit growth. Management monitors expenses closely and reviews each expense relative to the benefit provided. Net income totaled $1,301,312 in 2008 compared to $2,046,006 in 2007 - a decrease of 36.40%. Comprehensive income, which is the change in equity during a period excluding changes resulting from investments by shareholders and distributions to shareholders, net of tax totaled $1,304,927 and $2,166,783 in 2008 and 2007, respectively.
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RESULTS OF OPERATIONS
The following discussion relates to operations for the year ended December 31, 2008 compared to the year ended December 31, 2007.
COMPARED TO 2007
Net income for 2008 totaled $1,301,312 compared to $2,046,000 in 2007 or $.57 and $.89 per diluted share for 2008 and 2007, respectively. The return on average assets and equity, respectively, was .71% and 8.20% for 2008 compared to 1.24% and 14.62% in 2007. The decrease in net income was primarily attributable to a compression in the Company’s net interest margin following seven Federal Open Market Committee target funds rate cut initiatives totaling 400 basis points, increased provision for loan losses to accommodate loan growth and increased overhead to support loan and deposit growth.
Interest income, the primary source of revenue for the Company, was derived from interest-earning assets such as loans, investments and federal funds sold. The rate earned on interest-earning assets and dollar volume of the interest-earning assets drive interest income. Interest income totaled $12,227,824 for the year ended December 31, 2008 compared to $12,901,434 in 2007. Growth in the average balance of interest-earning assets increased from $157,701,528 to $177,046,378 or 12.27%, but was offset by a 128 basis point decrease in the rate on interest-earning assets, which resulted in an overall decreased interest income. Interest expense, derived from interest-bearing liabilities such as deposits and borrowed funds, totaled $4,984,250 in 2008 compared to $5,295,506 in 2007. The decrease in interest expense was primarily attributable to lower cost of funds following Federal Open Market Committee target funds rate cut initiatives. The average balance of interest-bearing liabilities grew from $122,327,327 in 2007 to $141,918,644 in 2008 or 16.02%, while the cost of funds decreased 82 basis points. A tight liquidity market both nationally and regionally intensified competition among financial institutions and resulted in maintaining a higher cost of funds than most likely would have been present during normal market conditions and compressed the Company’s net interest margin accordingly. With these unprecedented challenges, the Company’s net interest rate spread declined by 46 basis points.
As a result of loan growth, charge-offs and continued deterioration in the national and local economies, the Company added $711,285 to its allowance for loan losses compared to $406,725 in 2007. Charge-offs, net of recoveries, totaled $271,429 for 2008 compared to $200,680 for 2007. Nonperforming assets totaled $521,108 at the end of 2008 compared with $283,470 at the end of 2007.
Non-interest income totaled $1,624,110 in 2008 compared to $1,528,766 in 2007. Service charge fees on deposit accounts and other fees and commissions earned account for the majority of non-interest income. During 2008, the Company earned $1,139,125 from service charges on deposit accounts compared to $1,153,611 in 2007. The decrease resulted primarily from less revenue from overdraft fees, which is driven by overdraft activity. Other service fees and commissions totaled $435,991 in 2008 compared to $344,481 in 2007. The increase was primarily a result of fees from the origination of mortgage loans at the Bank level and increased fees from Visa, MasterCard and ATM interchange fees. During 2008, the Company and its partner in Bank of Asheville Mortgage Company, LLC agreed to dissolve the company, which closed effective October 31, 2008. Prior to June 2008, fees from the origination of mortgage loans were originated through the Mortgage Company. Thereafter, the Company’s subsidiary bank assumed the role as a mortgage broker for mortgage loan origination, which produced fee income of $56,600. Fees from Visa, MasterCard and ATM interchange activity generated $288,689 and $241,304 for 2008 and 2007, respectively. The Mortgage Company posted a net loss of $30,590 during 2008 of which $15,295 was the Company’s portion compared to $120,198 during 2007 of which $60,099 was the Company’s portion. The Company sold investment securities during 2007, which resulted in realized losses of $1,093 compared to none during 2008. Other income, primarily the fees from the sales of checks and deposit slips, net loan servicing fees and recoveries other than loans, provided additional income of $64,289 in 2008 compared to $91,866 in 2007.
Other expenses totaled $6,132,224 in 2008 compared to $5,553,236 in 2007. Expenses increased as a result of increased expenses associated with servicing the growth in loans and deposits, and increased marketing expenses. Salaries and benefits accounted for $3,186,975 in 2008 or 51.97% of other expenses compared to $2,684,511 or 48.34% in 2007. Equipment expenses totaled $419,377 in 2008 compared to $429,588 in 2007. (Income) expense associated with foreclosures totaled $44,898 during 2008 compared to $(8,593) during 2007. Data processing fees decreased by $34,539 as a result of contract negotiations and transferring selected services to a more competitively priced provider. Other non-interest expenses of $1,918,835 in 2008 compared to $1,851,052 in 2007 included sundry items such as marketing, accounting, occupancy, and insurance.
NET INTEREST INCOME
Net interest income (the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities, primarily deposits) represents the most significant portion of the Company’s earnings. It is management’s on-going
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policy to maximize net interest income, while maintaining an acceptable level of risk. Net interest income totaled $7,243,574 and $7,605,928 for 2008 and 2007, respectively, representing a decrease of 4.76% for 2008 over 2007 and a 46 basis point drop in interest rate spreads. The net interest margin declined 73 basis points from 4.93% in 2007 to 4.20% in 2008. Loan rates declined at a faster pace than deposit cost based on market and competitive conditions. The Company continues efforts to maximize this spread by management of both loan and deposit rates in order to support the overall earnings growth. The following table presents the daily average balances, interest income/expense and average rates earned and paid on interest-earning assets and interest-bearing liabilities of the Company for the last two years.
AVERAGE BALANCES AND INTEREST INCOME ANALYSIS
For the Years Ended December 31,
(1)
Nonaccrual loans have been included.
(2)
Includes investment in Federal Home Loan Bank.
(3)
Yields on tax-exempt investments have been adjusted to the tax equivalent basis using 34%.
(4)
Net yield on earning assets is computed by dividing net interest earned by average earning assets.
(5)
The interest rate spread is the interest earning assets rate less the interest earning liabilities rate.
Changes in interest income and interest expense can result from changes in both volume and rates. The following table sets forth the dollar amount of increase (decrease) in interest income and interest expense resulting from changes in the volume of interest earning assets and interest bearing liabilities and from changes in yields and rates.
Interest and Rate/Volume Variance
For the Years Ended December 31,
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(1)
The rate/volume variance for each category has been allocated equally on a consistent basis between rate and volume variance.
LIQUIDITY, INTEREST RATE SENSITIVITY AND MARKET RISKS
(INCLUDING QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS)
The objectives of the Company’s liquidity management policy include providing adequate funds to meet the cash needs of depositors and borrowers, as well as providing funds to meet the basic needs for on-going operations of the Company and regulatory requirements. Depositor cash needs, particularly those of commercial depositors, can fluctuate significantly depending on both business and economic cycles, while both retail and commercial deposits can fluctuate significantly based on the yields and returns available from alternative investment opportunities. Borrower cash needs are also often dependent upon business and economic cycles. In addition, the Company’s liquidity is affected by off-balance sheet commitments to lend in the forms of unfunded commitments to extend credit and standby letters of credit. As of December 31, 2008, such unfunded commitments to extend credit were $31,886,835.
Neither the Company nor its subsidiaries have historically incurred off-balance sheet obligations through the use of or investment in off-balance sheet derivative financial instruments or structured finance or special purpose entities organized as corporations, partnerships, limited liability companies or trusts. However, the Bank has contractual off-balance sheet obligations in the form of noncancelable operating leases with unrelated vendors. As of December 31, 2008, payments due under such operating lease arrangements were $184,530, $184,530, $188,280, $193,530 and $193,530 in 2009 through 2013, respectively.
Liquidity requirements of the Company are met primarily through two categories of funds. The first is core deposits, which includes demand deposits, savings accounts and certificates of deposit less than $100,000. The Company considers these to be a stable portion of the Company’s liability mix and results of on-going stable commercial and consumer banking relationships. At December 31, 2008 and 2007, core deposits totaled $144,014,424 or 84.31%, and $122,606,840 or 82.18%, respectively, of the Company’s total deposits.
The other principal methods of funding utilized by the Company are through large denomination certificates of deposit, federal funds purchased, repurchase agreements and other short-term and long-term borrowings. The Company’s policy is to emphasize core deposit growth rather than purchased or brokered liabilities as the cost of these funds is greater. Upstream correspondent banks, including the Federal Home Loan Bank of Atlanta, have made available to the Company lines of credit of approximately $18.3 million. Funding can also be borrowed from the Federal Reserve Bank’s discount window. Funds borrowed from the Federal Reserve Bank are based upon a percentage of the underlying collateral. The Company has incurred limited need to borrow from the Federal Reserve Bank; as a result no securities have been allocated to secure borrowings. As of December 31, 2008, the Bank had investment securities of approximately $975 pledged to secure repurchase agreements.
In the normal course of business, there are various outstanding contractual obligations that will require future cash outflows. In addition there are commitments and contingent liabilities, such as commitments to extend credit, which may or may not require future cash outflows. It has been the experience of the Company that deposit withdrawals are generally replaced with new deposits, thus not requiring any cash outflow. Based on that assumption, management believes that it can meet its contractual cash obligations from normal operations. See Note 13 to the consolidated financial statements included elsewhere in this report for more information on commitments and contingent liabilities.
The Company’s asset/liability management, or interest rate risk management, program is focused primarily on evaluating and managing the composition of its assets and liabilities in view of various interest rate scenarios. Factors beyond the Company’s control, such as market interest rates and competition, may also have an impact on the Company’s interest income and interest expense.
In the absence of other factors, the yield or return associated with the Company’s earning assets generally will increase from existing levels when interest rates rise over an extended period of time and, conversely, interest income will decrease when interest rates decline. In general, interest expense will increase when interest rates rise over an extended period of time and, conversely, interest expense will decrease when interest rates decline.
As a part of its interest rate risk management policy, the Company calculates an interest rate “gap.” Interest rate “gap” analysis is a common, though imperfect, measure of interest rate risk, which measures the relative dollar amounts of interest-earning assets and interest-bearing liabilities which reprice within a specific time period, either through maturity or rate adjustment. The “gap” is the difference between the amounts of such assets and liabilities that are subject to repricing. A “positive” gap for a given period means that the amount of interest-earning assets maturing or otherwise repricing within that period exceeds the amount of interest-bearing liabilities maturing or otherwise repricing within the same period. Accordingly, in a declining interest rate environment, an institution with a positive gap would generally be expected, absent
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the effects of other factors, to experience a decrease in the yield on its assets greater than the decrease in the cost of its liabilities, and its net interest income should be negatively affected. Conversely, the cost of funds for an institution with a positive gap would generally be expected to increase more slowly than the yield on its assets in a rising interest rate environment, and such institution’s net interest income generally would be expected to be positively affected by rising interest rates. Changes in interest rates generally have the opposite effect on an institution with a “negative” gap.
The majority of the Company’s deposits are rate-sensitive instruments with rates which tend to fluctuate with market rates. These deposits, coupled with the Company’s short-term time deposits, have increased the opportunities for deposit repricing. The Company places great significance on monitoring and managing the Company’s asset/liability position. The Company’s policy of managing its interest margin (or net yield on interest-earning assets) is to maximize net interest income while maintaining a stable deposit base. The Company’s deposit base is not generally subject to volatility experienced in national financial markets in recent years; however, the Company does realize the importance of minimizing such volatility while at the same time maintaining and improving earnings. A common method used to manage interest rate sensitivity is to measure, over various time periods, the difference or gap between the volume of interest-earning assets and interest-bearing liabilities repricing over a specific time period. However, this method addresses only the magnitude of funding mismatches and does not address the magnitude or relative timing of rate changes. Therefore, management prepares on a regular basis earnings projections based on a range of interest rate scenarios of rising, flat and declining rates in order to more accurately measure interest rate risk.
Interest-bearing liabilities and the loan portfolio are generally repriced to current market rates. The Company’s balance sheet is slightly liability-sensitive in the one-year time period; meaning that in a given period there will be more liabilities than assets subject to immediate repricing as the market rates change. Theoretically, during periods of falling rates, this results in increased net interest income. The opposite occurs during periods of rising rates.
The Company uses interest sensitivity analysis to measure the sensitivity of projected earnings to changes in interest rates. The sensitivity analysis takes into account the current contractual agreements that the Company has on deposits, borrowings, loans, investments and any commitments to enter into those transactions. The Company monitors interest sensitivity by means of computer models that incorporate the current volumes, average rates, scheduled maturities and payments and repricing opportunities of asset and liability portfolios. Using this information, the model estimates earnings based on projected portfolio balances under multiple interest rate scenarios. In an effort to estimate the effects of pure interest-rate risk, the Company assumes no growth in its balance sheet, because to do so could have the effect of distorting the balance sheet’s sensitivity to changing interest rates. The Company simulates the effects of interest rate changes on its earnings by assuming no change in interest rates as its base case scenario and either (1) gradually increasing or decreasing interest rates by over a twelve-month period or (2) immediately increasing or decreasing interest rates by 1% and 2%. Although these methods are subject to the accuracy of the assumptions that underlie the process and do not take into account the pricing strategies that management would undertake in response to sudden interest rate changes, the Company believes that these methods provide a better indication of the sensitivity of earnings to changes in interest rates than other analyses.
Income simulation through modeling is one tool that the Company uses in the asset/liability management process. The Company also considers a number of other factors in determining its asset/liability and interest rate sensitivity management strategies. Management strives to determine the most likely outlook for the economy and interest rates by analyzing external factors, including published economic projections and data, the effects of likely monetary and fiscal policies as well as any enacted or prospective regulatory changes. The Company’s current and prospective liquidity position, current balance sheet volumes and projected growth, accessibility of funds for short-term needs and capital maintenance are also considered. This data is combined with various interest rate scenarios to provide management with information necessary to analyze interest sensitivity and to aid in the development of strategies to manage the Company’s balance sheet.
The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2008, which are projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. In addition, the table reflects scheduled principal payments which will be received throughout the lives of mortgage-backed securities. The interest rate sensitivity of the Company’s assets and liabilities illustrated in the following table would vary substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.
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INTEREST RATE SENSITIVITY (GAP ANALYSIS)
DECEMBER 31, 2008
The Company has established an acceptable range of 80% to 120% for interest-earning assets as a percent of interest sensitive liabilities for the total one year gap.
The following table presents the maturity distribution of the Company’s loans by type, including fixed rate loans.
MATURITIES AND SENSITIVITIES OF CERTAIN LOANS TO CHANGES IN INTEREST RATES
AS OF DECEMBER 31, 2008
The Company paid an average rate of 3.37% on interest-bearing deposits during 2008 compared to 4.14% during 2007. A tight liquidity market both nationally and regionally intensified competition among financial institutions and resulted in maintaining a higher cost of funds than most likely would have been present during normal market conditions. Significant growth in deposits came from interest-bearing time deposit accounts as rate conscious customers sought to lock in higher yields in light of a continued decrease in interest rates. Additionally, as the need for funding loan growth increased throughout the year and liquidity tightened, the Company increased outstanding certificates of deposits from other financial institutions by $10,191,792 to $21,935,733. These funds are considered to be among the most rate sensitive, which resulted in a lower cost of funds than could have been obtained in the local consumer market. Total time deposits increased from $74,970,355 to $96,619,473 or 28.88%. In an effort to increase core deposits during 2008, the Company introduced a new NOW account, eZchecking, which pays an above market interest rate on balances up to $25,000. Qualifiers for the account include a minimum of 10 debit card transactions, one direct deposit and receipt of electronic statement each month. The Company earns interchange revenue from debit card usage and can deliver electronic statements more cost efficiently than through standard U.S. mail; these two factors effectively minimize the cost of funds on the product. At December 31, 2008, the Company had 789 eZchecking accounts totaling $9,283,769 in deposits. Approximately 51% of these accounts represent new relationships and 49% represent existing relationships that transferred from another deposit product. Total NOW
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accounts increased from $15,645,860 to $18,319,836 or 17.09%. Savings accounts grew by 13.55% to $2,207,173, while demand and money market accounts decreased by $2,963,486, partly attributable to the introduction and popularity of eZchecking. Increased customer awareness of interest rates increases the importance of rate management by the Company. The Company’s management continuously monitors market pricing, competitor rates, and profitability. Deposits continue to be the principal source of funds for continued growth, so the Company attempts to structure its rates so as to promote deposit and asset growth while at the same time increasing overall profit management. The daily average amounts of deposits of the Company are summarized below.
Average Deposits
For the Year Ended December 31, 2008
The above table includes deposits of $100,000 or more, which at December 31, 2008 totaled $26,799,682. The table below presents the maturities of deposits of $100,000 or more.
Maturities of Time Deposits of $100,000 or More
December 31, 2008
On October 14, 2008, the FDIC announced a new program, Temporary Liquidity Guarantee Program (“TLGP”), aimed at strengthening consumer confidence and encouraging liquidity in the banking system. Participation in the program is voluntary and funded by participating institutions; the Company has elected to participate. As part of the TLGP full coverage of non-interest-bearing deposit transaction accounts, regardless of amount, was instituted. Congress had previously increased from $100,000 to $250,000 on other accounts through December 31, 2009. The increase in FDIC insurance coverage will result in a 10 to 14 basis points (annualized) FDIC base insurance premium during the first quarter of 2009 and 12 to 16 basis points (annualized) during the second quarter of 2009 compared to 5 basis points (annualized) for 2008.
On February 27, 2009, the FDIC proposed amendments to the restoration plan for the Deposit Insurance Fund. This amendment proposes the imposition of a 20 basis point emergency special assessment on insured depository institutions as of June 30, 2009. The assessment is proposed to be collected on September 30, 2009. The interim rule would also permit the FDIC to impose an emergency special assessment after June 30, 2009 of up to 10 basis points, if necessary, to maintain public confidence in federal deposit insurance. Based on average deposits for the fourth quarter, this special assessment, if implemented as proposed, would equal approximately, $343,000. This special assessment if implemented as proposed will have a significant impact on the results of operations of the Company for 2009.
On March 5, 2009, the FDIC Chairman announced that the FDIC intends to lower the special assessment from 20 bais point to 10 basis points. The approval cutback is contingent on whether Congress clears legislation that would expand the FDIC’s line of credit with the Treasury to $100 billion. Legislation to increase the FDIC’s borrowing authority on a permanent basis is also expected to advance to Congress, which should aid in reducing the burden on the industry.
The assessment rates, including the special assessment, are subject to change at the discretion o the Board of Directors of the FDIC.
CAPITAL RESOURCES
In November 2008, the Company completed an application to participate in the Capital Purchase Program (“CPP”) of the U.S. Treasury’s Troubled Asset Relief program, or “TARP”. In January 2009 the Company received notice that it had received preliminary approval for $5,075,000. However, based upon analysis, the Company elected not to participate in the program. The Company’s capital ratios are substantially in excess of “well capitalized” regulatory ratios, and its asset quality has been better than the industry average. The Company concluded that the significant expense of the program and challenge to deploy the capital prudently and profitably were inconsistent with its long-term strategic objectives, and that participation in the CPP would not be in the best interest of Company’s shareholders.
As of December 31, 2008 and 2007, the Company’s ratio of total capital to risk-adjusted assets was 12.62%, and 14.29%, respectively. Average capital to average assets totaled 8.60% and 8.45% at December 31, 2008 and 2007, respectively. The Company remains well capitalized and fully expects to be able to meet future capital needs caused by growth and expansion as well as regulatory requirements. The Company is not aware of any current recommendation by regulatory authorities which if implemented would materially affect the Company’s liquidity, capital resources or operations.
As of December 31, 2008, the Trust had the following Trust Preferred Securities outstanding, and the Company had the following issues of junior subordinated debentures, all held by the Trust, outstanding:
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The Company owns all of the common stock of the Trust, which has issued trust preferred securities in conjunction with the Company issuing junior subordinated debentures to the Trust. The terms of the junior subordinated debentures are substantially the same as the terms of the trust preferred securities. The Company’s obligations under the debentures and a separate guarantee agreement constitute a full and unconditional guarantee by the Company of the obligations of the Trust.
Currently, regulatory capital rules allow trust preferred securities to be included as a component of regulatory capital. This treatment has continued despite the deconsolidation of these instruments for financial reporting purposes.
The trust preferred securities bear a rate of LIBOR plus 315 basis points and pay dividends quarterly. The rate is subject to quarterly resets. The Company’s source of funds for the required interest payments is derived from dividends paid by the Bank. The trust preferred securities mature 30 years from the original date of issuance, and are callable 5 years from the date of issuance. At this time, there are no plans to call the securities.
The Company used funds from the trust preferred securities to inject approximately $3.8 million of capital into the Bank during 2003. Additional capital allowed the Bank to support growth within its existing offices and to open two additional full-service offices within its market.
LOANS
Total loans outstanding at December 31, 2008 and 2007 were $171,239,692 and $135,734,224, respectively. Historically, the Bank has made loans within its market areas. The Bank generally considers its primary market to be Buncombe County in North Carolina. Emphasis is placed on commercial loans to small and medium sized business and consumers. The amounts and types of loans outstanding for the past five years are shown in the following table.
LOANS
December 31,
Real estate loans comprised 82% of the portfolio in 2008 compared to 80% in 2007. Commercial loans comprised 16% of the portfolio in 2008 compared to 18% in 2007, while consumer loans comprised 2% in both 2007 and 2008. Commercial loans of $27,923,001, consumer loans of $2,711,134 and real estate mortgage loans of $81,446,145 are loans for which the principal source of repayment is derived from the ongoing cash flow of the business and other generally recurring sources of income. Real estate construction loans of $59,486,736 are loans for which the principal source of repayment comes from the sale of real estate or from obtaining permanent financing. The Bank has a diversified loan portfolio with no concentrations to any one borrower. The Bank’s loan portfolio reflects a concentration in real estate lending; however, that lending is spread across a diverse group of businesses and industries. The Bank further mitigates its exposure to real estate construction lending by limiting the number of unsold houses to four per developer. Currently, home developer loans have an average balance of approximately $300,000 per unit. The Bank uses third party building inspectors to evaluate construction progress. Based upon reports provided by the inspectors the Bank stands better equipped to monitor and distribute loan draws according to percent of project completed. Approximately 30% of commercial real estate mortgage loans are owner-
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occupied. In general, owner-occupied loans pose lower risks than non-owner-occupied loans as there is lower risk of the borrower-tenant leaving the building for a better lease. Additionally, in the normal owner-occupied loan situation, personal guarantees for the loan are present.
NONPERFORMING ASSETS
December 31,
The Company has various financial instruments (outstanding commitments) with off-balance sheet risk that are issued in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Commitments to extend credit are legally binding agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally are issued at then current market rates and have fixed expiration dates of 1 year or other termination clauses. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts outstanding do not necessarily represent future cash requirements. Standby letters of credit represent conditional commitments issued by the Company to assure the performance of a customer to a third party. The unused portion of commitments to extend credit was $30,886,835 and $38,206,567 at December 31, 2008 and 2007, respectively.
Any loans classified by regulatory examiners as loss, doubtful, substandard or special mention that have not been disclosed hereunder, or under the “Loans” or “Asset Quality” narrative discussions do not (i) represent or result from trends or uncertainties that management expects will materially impact future operating results, liquidity or capital resources, or (ii) represent material credits about which management is aware of any information that causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.
The recorded investment in loans that are considered to be impaired was $349,976 and $195,683 at December 31, 2008 and 2007, respectively. The related allowance for loan losses determined was none and $120 at December 31, 2008 and 2007, respectively. The average recorded investment in impaired loans during the years ended December 31, 2008 and 2007 was $195,935 and $400,074, respectively. For the years ended December 31, 2008 and 2007, the Company recognized interest income from impaired loans of $350 and $1,535, respectively.
Potential problem loans consist of loans that are performing in accordance with contractual terms, but for which management has concerns about the ability of an obligor to continue to comply with repayment terms, because of the obligor’s potential operating or financial difficulties. Management monitors these loans closely and reviews their performance on a regular basis. These loans do not meet the standards for, and are therefore not included in, nonperforming assets. At December 31, 2008, the Company identified one potential problem loan totaling $400,756.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. The provision for loan losses is based upon management’s best estimate of the amount needed to maintain the allowance for loan losses at an adequate level. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of the current status of the portfolio, historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. Management analyzes the loan portfolio by loan type in considering each of the aforementioned factors and their impact upon the level of the allowance for loan losses.
This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. Therefore, while management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require the Company to recognize changes to the allowance for loan losses based on their judgments about information available to them at the time of their examination.
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A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impaired loans may also include restructured loans. A loan is considered restructured when the Company grants a concession to a borrower in financial difficulty. Generally, payments are past due 90 days or more, and the loan is considered as nonperforming. Impaired loans are divided into two categories: 1) loans where the borrower transfers assets to the Company; and 2) those where credit terms are modified. The latter includes foreclosures, reductions in the interest rate, extension of the maturity date and forgiveness of principal and/or interest payments. Typically, the Company negotiates a workout agreement with the borrower to modify the original credit terms rather than initiate foreclosure proceedings against the delinquent borrower. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.
The provision for loan losses represents a charge against income in an amount necessary to maintain the allowance at an appropriate level. The monthly provision for loan losses may fluctuate based on the results of this analysis. The allowance for loan losses at December 31, 2008 and 2007 was $2,529,981 and $2,090,125 or 1.48% and 1.54%, respectively, of gross loans outstanding. The ratio of net charge-offs to average loans outstanding was .18% and .16% during 2008 and 2007, respectively.
CHANGES IN THE ALLOWANCE FOR LOAN LOSSES
The Company operates in a well diversified market. Major economic drivers include tourism, medical industry and light manufacturing. The unemployment rate remains low, and the job market appears to be stable with no major layoffs. While the Company’s market has not experienced some of the extreme economic hardships as portrayed nationally, the Company and its market are not totally isolated. Residential mortgage sales in the market have slowed down; however the Company has not experienced the same magnitude as the national market. While the Bank’s losses related to real estate lending have been low historically, the volatility of the real estate development market loans in our market could result in additional
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increases in our exposure to losses if the economy continues to experience a downward trend.
Nonaccrual and restructured loans increased from $195,683 to $316,102. Current nonaccrual loans represent five loans with two customers. Although, the customers have resumed payments, management has continued to classify the relationships as nonaccrual until such time as the borrowers demonstrate a consistent and consecutive payment history. Management has reviewed each non-performing loan, supporting collateral, financial stability of each borrower and the relevant loan loss allowance. Throughout 2008, management continued its in-depth underwriting analysis, training and loan monitoring. Management continued its engagement of third party loan review services to supplement and validate overall loan review analytics and portfolio risk assessments. Based upon this analysis, management believes the allowance is adequate to support current loans outstanding.
During 2008, there were no changes in the estimation methods that affected our methodology for assessing the appropriateness of the formula and specific allowance for credit losses. However, during 2008, the Company initiated a more granular analysis to the loan portfolio. Broad loan categories were subdivided into smaller categories with similar risks and assigned a risk weighting. As a result, a more precise reserve was estimated that resulted in a slight decrease in the overall reserve as a percent to gross loans outstanding. Changes in estimates and assumptions regarding the effects of economic and business conditions on borrowers affect the assessment of the allowance.
The following table allocates the allowance for loan losses by loan category at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
INVESTMENT SECURITIES
In September 2008, the U.S. Department of Treasury and the Federal Housing Finance Agency announced that Freddie Mac and Fannie Mae were being placed under conservatorship; control of their management was transferred to the Federal Housing Finance Agency. In conjunction with this action, Freddie Mac and Fannie Mae were prohibited from paying dividends on their equity securities, which resulted in a significant loss in value of such equity securities. The decrease in value resulted in “other-than-temporary impairment” write-downs during the third quarter for those financial institutions that held these securities in their investment portfolios. The Company did not and does not hold any equity shares of either Freddie Mac or Fannie Mae in its securities portfolio, and therefore was not exposed to any potential charge to earnings as a result of “other-than-temporary impairment” of Freddie Mac or Fannie Mae equity securities.
At December 31, 2008 and 2007, securities carried at market value totaled $23,778,449 and $26,113,294, respectively, with amortized costs of $23,750,009 and $26,090,739, respectively. All investment securities are available for sale. Securities available for sale are securities which will be held for an indefinite period of time, including securities that management intends to use as part of its asset/liability management strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk or the need to increase regulatory capital or other similar factors.
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MATURITIES AND YIELDS OF DEBT SECURITIES
December 31, 2008
Available for sale: (1)
(1)
Securities available for sale are stated at amortized cost.
(2)
Yields on tax-exempt securities have been adjusted to the tax equivalent basis using 34%.
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
Management’s discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments regarding uncertainties that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, the Company evaluates its estimates which are based upon historical experience and on other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements. The
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Company considers the following accounting policies to be most critical in their potential effect on its financial position or results of operations:
ALLOWANCE FOR LOAN LOSSES
The most critical estimate concerns the Company’s allowance for loan losses. The Company records provisions for loan losses based upon known problem loans and estimated deficiencies in the existing loan portfolio. The Company’s methodology for assessing the appropriations of the allowance for loan losses consists of two key components, which are a specific allowance for identified problem or impaired loans and a formula allowance for the remainder of the portfolio.
Identified problem and impaired loans are measured for impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant change. The adequacy of the allowance is also reviewed by management based upon its evaluation of then-existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, collateral values, loan concentrations, changes in the mix and volume of the loan portfolio; trends in portfolio credit quality, including delinquency and charge-off rates; and current economic conditions that may affect a borrower’s ability to repay. Although management believes it has established and maintained the allowance for loan losses at appropriate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment.
INTEREST INCOME RECOGNITION
Interest on loans is included in income as earned based upon interest rates applied to unpaid principal. Interest is not accrued on commercial and mortgage loans 90 days or more past due. Interest is not accrued on other loans when management believes collection is doubtful. Interest accrued during the current calendar year but not collected for loans that are charged-off or placed on non-accrual is reversed against interest income. Accrued but uncollected interest from prior periods is charged-off against the allowance for loan losses. Interest on nonaccrual loans is accounted for on the cash-basis or cost-recovery method until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES
Investments are reviewed quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In making this judgment, management employs a systematic methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of investments. If the cost of an investment exceeds its fair value, management evaluates, among other factors, general market conditions, the duration and extent to which the fair value is less than cost, and the intent and ability to hold the investment. Management also considers specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, operational and financing cash flow factors, and rating agency actions. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis in the investment is established. If market, industry and/or investee conditions deteriorate, management may incur future impairments. No investments have been deemed other-than-temporarily impaired.
INFLATION
Since the assets and liabilities of a bank are primarily monetary in nature (payable in fixed, determinable amounts), the performance of a bank is affected more by changes in interest rates than inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same.
While the effect of inflation is normally not as significant as it is on those businesses that have large investments in plant and inventories, it does have an effect. There are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans and deposits. Also, general increases in the prices of goods and services will result in increased operating expense.
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SELECTED FINANCIAL INFORMATION AND OTHER DATA
FORWARD LOOKING STATEMENTS
The discussions presented in this annual report contain statements that are forward looking statements within the meaning of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995, which statements are inherently subject to risks and uncertainties. Forward looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words (and their derivatives) such as “expects,” “anticipates,” “believes,” “estimates,” “plans,” “projects,” or other statements concerning opinions or judgments of the Company and its management about future events. Factors that could influence the accuracy of such forward looking statements include, but are not limited to, the financial success or changing strategies of the Company’s customers or vendors, actions of government regulators, the level of market interest rates, and general economic conditions.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has various financial instruments (outstanding commitments) with off-balance sheet risk that are issued in the normal course of business to the meet the financing needs of its customers. See Note 13 to the consolidated financial statements included elsewhere in this report for more information regarding these commitments and contingent liabilities.
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ITEM 8:
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
Page No.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2008 and 2007
Consolidated Statements of Operations and Comprehensive Income
for the years ended December 31, 2008 and 2007
Consolidated Statements of Changes in Shareholders’ Equity
for the years ended December 31, 2008 and 2007
Consolidated Statements of Cash Flows
for the years ended December 31, 2008 and 2007
Notes to Consolidated Financial Statements
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of
Weststar Financial Services Corporation:
We have audited the accompanying consolidated balance sheets of Weststar Financial Services Corporation and Subsidiary (the “Company”) as of December 31, 2008 and 2007 and the related consolidated statements of operations and comprehensive income, changes in shareholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. 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 control 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 the Weststar Financial Services Corporation and Subsidiary as of December 31, 2008 and 2007 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
Charlotte, North Carolina
March 17, 2009
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2008 and 2007
See Notes to Consolidated Financial Statements.
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
Years Ended December 31, 2008 and 2007
See Notes to Consolidated Financial Statements.
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (Continued)
Years Ended December 31, 2008 and 2007
See Notes to Consolidated Financial Statements.
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years Ended December 31, 2008 and 2007
See Notes to Consolidated Financial Statements.
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2008 and 2007
See Notes to Consolidated Financial Statements.
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization - Weststar Financial Services Corporation is a holding company with one subsidiary, The Bank of Asheville (the “Bank”). The Bank is a state chartered commercial bank which was incorporated in North Carolina on October 29, 1997. The Bank provides consumer and commercial banking services in Buncombe County and surrounding areas. Common shares of The Bank of Asheville were exchanged for common shares of Weststar Financial Services Corporation on April 28, 2000. Weststar Financial Services Corporation formed Weststar Financial Services Corporation I (the “Trust”) during October 2003 in order to facilitate the issuance of trust preferred securities. The Trust is a statutory business trust formed under the laws of the state of Delaware, of which all common securities are owned by Weststar Financial Services Corporation. Bank of Asheville Mortgage Company, LLC (the “Mortgage Company”) is a state chartered limited liability company which was organized under the laws of North Carolina on October 19, 2004 of which Weststar Financial Services Corporation was a 50% owner. The Mortgage Company originated conventional mortgage loans. During 2008, the Company and its partner in the Mortgage Company elected to dissolve the partnership and closed the Mortgage Company on October 31, 2008.
Basis of Presentation - The consolidated financial statements include the accounts of Weststar Financial Services Corporation and its subsidiary, The Bank of Asheville (herein referred to collectively as the “Company”). All significant intercompany accounts and transactions have been eliminated.
Cash and Cash Equivalents - Cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
Investment Securities - Debt securities that the Company has the positive intent and ability to hold to maturity are classified as “held-to-maturity securities” and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as “trading securities” and reported at fair value, with unrealized gains and losses included in earnings. 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 reported as a component of other comprehensive income. Gains and losses on held for investment securities are recognized at the time of sale based upon the specific identification method. Declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are other than temporary, result in writedowns of the individual securities to their fair value. The related writedowns are included in earnings as realized losses. Premiums and discounts are recognized in interest expense or interest income, respectively, using the interest method over the period to maturity. Transfers of securities between classifications are accounted for at fair value. The Company has not classified any securities as trading or held-to-maturity securities.
Loans - Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs and any deferred fees or costs on originated loans.
Allowance for Loan Losses - The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. The provision for loan losses is based upon management’s best estimate of the amount needed to maintain the allowance for loan losses at an adequate level. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of the current status of the portfolio, historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. Management segments the loan portfolio by loan type in considering each of the aforementioned factors and their impact upon the level of the allowance for loan losses.
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan Losses (Continued)
This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Therefore, while management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require the Company to recognize changes to the allowance for loan losses based on their judgments about information available to them at the time of their examination.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.
Mortgage Servicing Rights
When mortgage loans are sold, the proceeds are allocated between the related loans and the retained servicing rights based on their relative fair values. Servicing assets are amortized over the average period of estimated net servicing income. The Company recorded amortization of mortgage servicing rights of $3,039 and $27,957 during the years ended December 31, 2008 and 2007, respectively.
All servicing assets are assessed for impairment based on their fair value. The Company recognized no impairment during the years ended December 31, 2008 and 2007.
Stock Compensation Plans - Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123R (revised 2004), "Share-Based Payment," ("SFAS No. 123R") which was issued by the Financial Accounting Standards Board (“FASB”) in December 2004. SFAS No. 123R revises SFAS No. 123 "Accounting for Stock Based Compensation," 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.
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock in Federal Home Loan Bank - As a requirement for membership, the Bank invested in stock of the Federal Home Loan Bank of Atlanta. This investment is carried at cost.
Premises and Equipment and Other Long-Lived Assets - Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization, computed by the straight-line method, are charged to operations over the assets’ estimated useful lives, which range from 25 to 39 years for buildings, 5 to 15 years for furniture and equipment or, in the case of leasehold improvements, the term of the lease, if shorter. Maintenance and repairs are charged to operations in the year incurred. Gains and losses on dispositions are included in current operations.
The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected cash flows related to the asset is less than the stated amount of the asset, an impairment loss is recognized.
Foreclosed Properties - Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed properties.
Income Taxes - Deferred income taxes are computed using the asset and liability approach. The tax effects of differences between the tax and financial accounting bases of assets and liabilities are reflected in the balance sheet at the tax rates expected to be in effect when the differences reverse. A valuation allowance is provided against deferred tax assets when realization is deemed not to be likely. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Uncertainty in Income Taxes applies to all “tax positions” within the scope of SFAS 109. The Company applies 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 larger amount of benefit that is greater than 50% likely of being realized upon ultimate settlement with the taxing authority.
In July 2006, the FASB issued Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109” (“FIN 48”), which is a change in accounting for income taxes. FIN 48 specifies how tax benefits for uncertain tax positions are to be recognized, measured, and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for uncertain tax positions should be classified on the balance sheet; and provides transition and interim period guidance, among other provisions. FIN 48 is effective for fiscal years beginning after December 15, 2006 and as a result, was effective for the Company in the first quarter of fiscal 2007. The adoption of FIN 48 did not have a material impact on the Company’s Consolidated Financial Statements.
Interest Income and Expense - The Company utilizes the accrual method of accounting. Substantially all loans earn interest on the level yield method based on the daily outstanding balance. The accrual of interest is discontinued when, in management’s judgment, the interest may not be collected.
The accrual of interest on mortgage, commercial and consumer loans is discontinued at the time the loan is 90 days delinquent. Other personal loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
Interest accrued during the current calendar year but not collected for loans that are charged-off is reversed against interest income. Accrued but uncollected interest from prior periods is charged-off against the allowance for loan losses. Interest on nonaccrual loans is accounted for on the cash-basis or cost-recovery method until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, generally a period of six months.
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and mortgage serving assets.
Net Income Per Share - Basic and diluted net income per common share have been computed by dividing net income for each period by the weighted average number of shares of common stock outstanding during each period.
Basic earnings per common share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. During 2008 and 2007, there were no shares excluded due to antidilution.
Basic and diluted net income per share have been computed based upon net income as presented in the accompanying statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding, after retroactively adjusting for the 5-for-4 stock split paid June 2007, as summarized below:
Comprehensive Income - Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. The Company’s sole component of accumulated other comprehensive income is unrealized gains (losses) on securities available for sale.
New Accounting Standards - In December 2007, the FASB issued SFAS 141(R), Business Combinations. SFAS 141(R) will significantly change how entities apply the acquisition method to business combinations. The most significant changes affecting how the Corporation will account for business combinations under this Statement include: the acquisition date will be date the acquirer obtains control; all (and only) identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree will be stated at fair value on the acquisition date; assets or liabilities arising from noncontractual contingencies will be measured at their acquisition date fair value only if it is more likely than not that they meet the definition of an asset or liability on the acquisition date; adjustments subsequently made to the provisional amounts recorded on the acquisition date will be made retroactively during a measurement period not to exceed one year; acquisition-related restructuring costs that do not meet the criteria in SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, will be expensed as incurred; transaction costs will be expensed as incurred; reversals of deferred income tax valuation allowances and income tax contingencies will be recognized in earnings subsequent to the measurement period; and the allowance for loan losses of an acquiree will not be permitted to be recognized by the acquirer. Additionally, SFAS 141(R) will require new and modified disclosures surrounding subsequent changes to acquisition-related contingencies, contingent consideration, noncontrolling interests, acquisition-related transaction costs, fair values and cash flows not expected to be collected for acquired loans, and an enhanced goodwill rollforward.
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Company will be required to prospectively apply SFAS 141(R) to all business combinations completed on or after January 1, 2009. Early adoption is not permitted. For business combinations in which the acquisition date was before the effective date, the provisions of SFAS 141(R) will apply to the subsequent accounting for deferred income tax valuation allowances and income tax contingencies and will require any changes in those amounts to be recorded in earnings. Management is currently evaluating the effects that SFAS 141(R) will have on the financial condition, results of operations, liquidity, and the disclosures that will be presented in the consolidated financial statements.
SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115.” SFAS 159 permits entities to choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. The fair value option (i) may be applied instrument by instrument, with certain exceptions, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire instruments and not to portions of instruments. SFAS 159 became effective for the Company on January 1, 2008 (see Note 14 - Fair Value Measurements).
SFAS No. 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157, with the exception of certain provisions, became effective for the Company on January 1, 2008 (see Note 14 - Fair Value Measurements).
The Emergency Economic Stabilization Act of 2008 (EESA) was enacted on October 3, 2008. The purpose of this law is to restore liquidity and stability to the financial system, while minimizing any potential long term negative impact on taxpayers. The law authorizes the United States Secretary of the Treasury to spend up to $700 billion to purchase distressed assets, especially mortgage-backed securities, from the nation's banks. The program under which the asset purchase will be administered is referred to as the Troubled Asset Relief Program (TARP).
The law also temporarily raises the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. The higher insurance limits took effect immediately and will be in effect through December 31, 2009. Additionally, the Federal Deposit Insurance Corporation (FDIC) announced on October 14, 2008, a new program aimed at strengthening consumer confidence and encouraging liquidity in the banking system.
The Temporary Liquidity Guarantee Program (TLGP) guarantees newly issued senior unsecured debt of banks, thrifts, and certain holding companies, and provides full coverage of non-interest bearing deposit transaction accounts, regardless of dollar amount. The program provides a three year guarantee of newly issued debt and increased insurance coverage through December 31, 2009. This two-pronged program will be funded through special fees paid by the financial institutions participating. The Company elected to participate in full coverage of non-interest bearing transaction accounts, but opted not to participate in the guarantee of senior unsecured debt.
Also on October 14, 2008, the U.S. Department of Treasury (“Treasury”) announced a voluntary Capital Purchase Program (CPP) to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy. The Treasury will purchase up to $250 billion of senior preferred stock. The program will be available to qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies engaged only in financial activities that elected to participate by November 14, 2008. Treasury will determine eligibility and allocations for interested parties after consultation with the appropriate federal banking agency. The minimum subscription amount available to a participating institution is 1 percent of risk-weighted assets. The maximum subscription amount is the lesser of $25 billion or 3 percent of risk-weighted assets.
The senior preferred shares will qualify as Tier 1 capital and will rank senior to common stock. The senior preferred shares will pay a cumulative dividend rate of 5 percent per annum for the first five years and will reset to a rate of 9 percent per annum after year five. The senior preferred shares will be non-voting, other than class voting rights on matters that could adversely affect the shares. The senior preferred shares will be callable at par after three years. Prior to the end of three years, the senior preferreds may be redeemed with the proceeds from a qualifying equity offering of any Tier 1 perpetual preferred or common stock. The Treasury may also transfer the senior preferred shares to a third
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
party at any time. In conjunction with the purchase of senior preferred shares, the Treasury will receive warrants to purchase a number of shares of preferred stock having an aggregate liquidation preference equal to 5% of the amount of
senior preferred shares purchased. The initial exercise price of the warrants will be $0.01 per share. The Treasury intends to immediately exercise the warrants. Only institutions deemed to be “healthy” will be eligible to purchase CPP.
Participation in these various programs carries certain restrictions with respect to the payment of dividends to common shareholders and executive compensation. In January 2009 the Company received notice that it had received preliminary approval for $5,075,000. However, based upon analysis, the Company elected not to participate in the program. The Company’s capital ratios are substantially in excess of “well capitalized” regulatory ratios, and its asset
quality has been better than the industry average. The Company concluded that the significant expense of the program and challenge to deploy the capital prudently and profitably were inconsistent with its long-term strategic objectives, and that participation in the CPP would not be in the best interest of Company shareholders.
On January 12, 2009, FASB released final FSP No. EITF 99-20-1, EITF 99-20-a, Amendments to the Impairment Guidance of EITF Issue No. 99-20. According to FASB, the FSP amends the impairment guidance in EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,” to achieve more consistent determination of whether an other-than-temporary impairment (OTTI) has occurred.
The FSP retains and emphasizes the OTTI guidance and required disclosures in Statement 115, FSP FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, SEC Staff Accounting Bulletin (SAB) Topic 5M, Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities, and other related literature.
On December 11, 2008, FASB released FSP 140-4, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement applies to public entities that are subject to the disclosure requirements of Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishements of Liabilities, and public enterprises that are subject to the disclosure requirement of Interpretation 46(R), Consolidation of Variable Interest Entities, as amended by this FSP. This FSP amends Interpretation 46(R) and highlights disclosure objectives that assist a user of the financial statements in understanding the nature of the transferor’s continuing involvement with transferred assets and involvement with variable interest entities and qualifying special purpose entities.
On May 15, 2008, the SEC issued a proposed rule that would require domestic and foreign companies that prepare their financial statements in accordance with U.S. Generally Accepted Accounting Principles or International Financial Reporting Standards to submit their financial information using XBRL for periods ending on or after December 15, 2008 for the largest public companies, and within two years after that for all public companies. In December 2008, the SEC voted to issue the final XBRL rules, which would require XBRL reporting by registrants with public float of more than $5 billion in periods ending after June 15, 2009; all other large accelerated files in periods ending after June 15, 2010; and all remaining registrants in periods ending after June 15, 2011. XBRL reporting would apply to all periodic quarterly and annual reports, registration statements, and Form 8-K reports that contain updated or revised financial statements that appear in a periodic report.
2.
INVESTMENT SECURITIES
The amortized cost, gross unrealized gains and losses and fair values of investment securities at December 31, 2008 and 2007 are as follows:
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
2.
INVESTMENT SECURITIES (continued)
Available-for-sale securities consist of the following at December 31, 2008:
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
2.
INVESTMENT SECURITIES (Continued)
Available-for-sale securities consist of the following at December 31, 2007:
For the year ended December 31, 2008 and 2007, proceeds from the sales of investment securities available for sale totaled none and $283,268, respectively. Gross realized losses from the sales in 2008 and 2007 amounted to none and $1,093, respectively.
Securities with carrying values of $1,418,608 and $1,915,652 at December 31, 2008 and 2007, respectively, were pledged to secure public monies on deposit as required by law.
The following tables show investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2008 and 2007. These investments represent securities that the Company has the positive intent and ability to hold to maturity. The unrealized losses on investment securities as of December 31, 2008 and 2007 are a result of volatility in the market during 2008 and 2007 and relate to 15 Municipal bonds and four Mortgage-backed securities at December 31, 2008 and two U.S. Government agency bonds, 15 Municipal bonds and 15 Mortgage-backed securities at December 31, 2007. All unrealized losses on investment securities resulted from changes in interest rates and are considered by management to be temporary given the credit ratings on these investment securities, the duration of the unrealized loss, and our intent and ability to retain our investment in a security for a period of time sufficient to allow for any anticipated recovery in market value.
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
2.
INVESTMENT SECURITIES (Continued)
December 31, 2008:
The aggregate cost of the Company’s cost method investment, Federal Home Loan Bank stock, totaled $585,600 and $463,300 at December 31, 2008 and 2007, respectively. The Company estimated that the fair value equaled the cost of the investment (that is, the investment was not impaired). The investment in Federal Home Loan Bank stock is not reflected in investment securities; the investment is carried as a separate line item in the financial statements.
3.
LOANS
Loans at December 31, 2008 and 2007 classified by type are as follows:
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
3.
LOANS (Continued)
Nonperforming assets at December 31, 2008 and 2007:
One loan in the amount of $48,049 was restructured during 2008 compared to none during 2007. Loans totaling $349,976 and $195,683 were considered impaired as of December 31, 2008 and 2007, respectively. Impaired loans of $349,976 and $195,683 had related allowances for loan losses of none and $120 at December 31, 2008 and 2007, respectively. The average recorded investment in impaired loans during the years ended December 31, 2008 and 2007 was $195,935 and $400,074, respectively. For the years ended December 31, 2008 and 2007, the Company recognized interest income from impaired loans of approximately $350 and $1,535, respectively.
Directors and officers of the Company and companies with which they are affiliated are customers of and borrowers from the Company in the ordinary course of business. At December 31, 2007, directors’ direct and indirect indebtedness to the Company aggregated $1,668,666. During 2008, $1,939,074 in new loans were made and repayments of $1,413,538 were collected, resulting in a balance of $2,194,202 at December 31, 2008. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transaction with other non-related borrowers. Management does not believe these loans involve more than the normal risk of uncollectibility or present other unfavorable features.
4.
ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31, 2008 and 2007 are as follows:
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
5.
PREMISES AND EQUIPMENT
Premises and equipment at December 31, 2008 and 2007 are as follows:
Depreciation expense for the years ended December 31, 2008 and 2007 amounted to $374,363 and $395,947, respectively.
6.
DEPOSIT ACCOUNTS
At December 31, 2008, the scheduled maturities of time deposits are as follows:
7. INCOME TAXES
The significant components of the income tax provision for the years ended December 31, 2008 and 2007 follow:
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
7.
INCOME TAXES (Continued)
The difference between the provision for income taxes and the amounts applied by applying the statutory federal income tax rate of 34% to income before income taxes is summarized below:
Significant components of deferred taxes at December 31, 2008 and 2007 are as follows:
The Company adopted the provisions of FASB Interpretation No. 48 (FIN 48). There was no material impact from the adoption of FIN 48. It is the Company’s policy to recognize interest and penalties associated with uncertain tax positions as components of income taxes. There were no interest or penalties accrued during the year. The Company’s federal and state tax returns are subject to examination for the years 2005, 2006 and 2007.
8.
LEASES
The Company leases certain banking facility premises and equipment under operating lease agreements. Future minimum rental payments are as follows:
The land for a branch office is leased from a partnership that includes a director of the Company. The monthly rent is
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
8.
LEASES (continued)
$3,600. Rental expense charged to operations under all operating lease agreements was $238,125 and $237,706 for the years ended December 31, 2008 and 2007, respectively.
9.
STOCK OPTIONS
In 2007, the Company’s shareholders approved the Weststar Financial Services Corporation 2007 Nonstatutory Stock Option Plan (“Nonstatutory Plan”) and the Weststar Financial Services Corporation 2007 Incentive Stock Option Plan (“Incentive Plan”). The maximum number of shares available for grant under the Nonstatutory Plan and Incentive Plan is 50,000 and 75,000, respectively. No options were granted from the respective pools or were outstanding at December 31, 2008.
In 2001, the Company’s shareholders approved the Weststar Financial Services Corporation 2001 Nonstatutory Stock Option Plan (“Nonstatutory Plan”) and the Weststar Financial Services Corporation 2001 Incentive Stock Option Plan (“Incentive Plan”). Under these plans, non-employee directors and employees were granted stock options on June 20, 2001. The maximum number of shares available for grant under the Nonstatutory Plan and Incentive Plan is 164,645 and 166,485, respectively. Of the maximum number of shares available for grant, 114,713 were outstanding under the Nonstatutory Plan and 138,672 were outstanding under the Incentive Plan at December 31, 2008. Option prices for both plans are established at market value, which was $3.26, on the dates granted by the Board of Directors.
Options granted became exercisable in accordance with the vesting schedule specified by the Board of Directors in the Plan agreements. Nonstatutory stock options vested over a two-year period with 46% vested at the date of grant and 27% per year beginning one year from the date of grant. Incentive stock options vested over a four-year period with 20% vested at the date of grant and 20% per year beginning one year from the date of grant. No vested option may be exercised more than ten years after the date of grant.
Stock option information related to the plans for the years ended December 31, 2008 and 2007 follows:
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WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
9.
STOCK OPTIONS (Continued)
There were 128,933 shares available for future grants at December 31, 2008. The aggregate intrinsic values of outstanding and exercisable shares at December 31, 2008 and 2007, respectively, were $782,960 and $1,826,382. All options were vested prior to adoption of SFAS No. 123(R).
10.
EMPLOYEE BENEFIT PLANS
The Company sponsors a defined contribution 401(k) plan which allows those employees who have attained the age of 21 years and worked 1,000 hours to elect to contribute a portion of their salary to the plan in accordance with the provisions and limits set forth in the plan document. The plan was established in March 1999. The Company makes discretionary matching contributions in an amount determined each plan year to each participant who makes 401(k) savings contributions during the year. The Company may also make a discretionary profit-sharing contribution for a plan year to those participants employed during the year. The Company’s contribution to the plan was $94,228 and $69,102 for the years ended December 31, 2008 and 2007, respectively.
During 2001, a key employee entered into a salary continuation agreement with the Company providing for periodic payments at the retirement or death of the employee. The present value of the estimated liability, which was $295,523 and $274,888 at December 31, 2008 and 2007, respectively, is being accrued over the vesting period defined in the agreement, which has fully vested. The related expense was $20,635 and $9,721 based upon a discount rate of 5.920% and 6.182% for the years ended December 31, 2008 and 2007, respectively. The Company is the owner and beneficiary of a life insurance policy on this key employee which will be used to fund the Company’s liability under the salary continuation agreement. The total net cash surrender value of this policy at December 31, 2008 was $224,936.
11.
BORROWINGS
SHORT-TERM BORROWINGS
The Company has $3,000,000 available in overnight federal fund lines of credit and an approximately $15,260,000 open line of credit with the Federal Home Loan Bank (FHLB). Pursuant to a collateral agreement with the FHLB, advances are collateralized by qualifying first mortgage loans. Federal funds purchased generally represent overnight borrowing by the Company for temporary funding requirements. Securities sold under agreements to repurchase represent short-term borrowings by the Bank collateralized by municipal securities.
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
11.
BORROWINGS (Continued)
Short-term borrowings at December 31 are summarized as follows:
A summary of selected data related to federal funds purchased, securities sold under agreements to repurchase and other short-term borrowed funds follows:
LONG-TERM DEBT
There was one advance from the FHLB in the amount of $4,000,000 at a fixed rate of 5.01% outstanding at December 31, 2008. The 4,000,000 advance is due in full on March 24, 2010; interest is payable monthly.
In 2004, the Company adopted FIN 46R, with no restatement of prior periods, resulting in the deconsolidation of Weststar Financial Services Corporation I, a statutory trust (the “Trust”), which was created for the sole purpose of issuing trust preferred securities. The implementation of FIN 46R resulted in the Company’s $124,000 investment in the common equity of the Trust being included in the condensed consolidated balance sheets as other assets with a corresponding increase to long-term debt. The Company is now recording greater interest expense and income received from the Trust with no effect on net income. The income and interest expensed received from and paid to the Trust, respectively, is being included in the consolidated statements of income and comprehensive income as other noninterest income and interest expense.
As of December 31, 2008, the Trust had the following Trust Preferred Securities outstanding, and the Company had the following issues of junior subordinated debentures, all held by the Trust, outstanding:
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
11. BORROWINGS (Continued)
LONG-TERM DEBT (Continued)
The Company owns all of the common stock of the Trust, which has issued trust preferred securities in conjunction with the Company issuing junior subordinated debentures to the Trust. The terms of the junior subordinated debentures are substantially the same as the terms of the trust preferred securities. The interest rate in effect is LIBOR plus 3.15%. At December 31, 2008 the effective rate was 7.97%. The Company’s obligations under the debentures and a separate guarantee agreement constitute a full and unconditional guarantee by the Company of the obligations of the Trust.
Currently, regulatory capital rules allow trust preferred securities to be included as a component of regulatory capital for the Company up to certain limits. This treatment has continued despite the deconsolidation of these instruments for financial reporting purposes.
12.
REGULATION AND REGULATORY RESTRICTIONS
The Company is regulated by the Board of Governors of the Federal Reserve System (“FRB”) and is subject to securities registration and public reporting regulations of the Securities and Exchange Commission. The Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”) and the North Carolina Commissioner of Banks.
The Company is not presently subject to any regulatory restrictions on dividends. The Company’s ability to pay dividends depends to a large extent on the amount of dividends paid by the Bank and any other subsidiaries. The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits as determined pursuant to North Carolina General Statutes Section 53-87. As of December 31, 2008, the Bank had undivided profits of $7,731,464. Additionally, current federal regulations require that the Bank maintain a ratio of total capital to assets, as defined by regulatory authorities, in excess of 6%. As of December 31, 2008, the ratio was 10.19% for the Bank, leaving all $7,731,464 of the Bank’s undivided profits available for the payment of dividends.
The Company is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification also are subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of December 31, 2008, the most recent regulatory notifications categorized the Company as well capitalized under the regulatory framework for prompt corrective action. Management believes, as of December 31, 2008 and 2007, that the Company meets all capital adequacy requirements to which it is subject. To be categorized as adequately capitalized under the regulatory framework for prompt corrective action, the Company must monitor the minimum capital ratios as set forth in the table below.
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
12.
REGULATION AND REGULATORY RESTRICTIONS (Continued)
The Company’s actual capital amounts and ratios are also presented in the table (dollar amounts in thousands):
13.
COMMITMENTS AND CONTINGENCIES
The Company has various financial instruments (outstanding commitments) with off-balance sheet risk that are issued in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Commitments to extend credit are legally binding 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts outstanding do not necessarily represent future cash requirements. Standby letters of credit represent conditional commitments issued by the Company to assure the performance of a customer to a third party. The unused portion of commitments to extend credit at December 31, 2008 and 2007 was $31,886,835 and $38,206,567, respectively.
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
13.
COMMITMENTS AND CONTINGENCIES (Continued)
The Company’s exposure to credit loss for commitments to extend credit and standby letters of credit is the contractual amount of those financial instruments. The Company uses the same credit policies for making commitments and issuing standby letters of credit as it does for on-balance sheet financial instruments. Each customer’s creditworthiness is evaluated on an individual case-by-case basis. The amount and type of collateral, if deemed necessary by management, is based upon this evaluation of creditworthiness. Collateral held varies, but may include marketable securities, deposits, property, plant and equipment, investment assets, inventories and accounts receivable. Management does not anticipate any significant losses as a result of these financial instruments.
In the normal course of its operations, the Company from time to time is party to various legal proceedings. Based upon information currently available, and after consultation with its legal counsel, management believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the Company’s business, financial position or results of operations.
14.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2008. These fair values estimates are based on relevant market information and information about fthe financial instruments. Fair value estimates are intended to represent the price an asset could be sold at or the price a liability could be settled for. However, given there is no active market or observable market transaction for many of the Company’s financial instruments, the Company has made estimates of many of these fair values, which are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significant affect the estimated values. Beginning with the year ended December 31, 2008, the fair value estimates are determined in accordance with SFAS 157.
Fair Value of Financial Instruments - SFAS No. 107, Disclosures About Fair Value of Financial Instruments, requires that the Company disclose estimated fair values for its financial instruments. Fair value methods and assumptions are set forth below for the Company’s consolidated financial instruments.
Cash and Cash Equivalents, Accrued Interest Receivable, and Accrued Interest Payable - The carrying amounts approximate their fair value because of the short maturity of these financial instruments.
Investment Securities - The fair value of securities, excluding the Federal Home Loan Bank stock, is based on quoted market prices. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
14.
FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Loans - Fair value of loans are estimated based on discounted expected cash flows. These cash flows include assumptions for prepayment estimates over the loans remaining life, considerations for the current interest rate environment compared to the weighted average rate of each portfolio credit, a credit risk component based on historical and expected performance of each portfolio and a liquidity adjustment related to the current market environments.
Deposits - The fair value of deposits with no stated maturity, such as non-interest-bearing demand deposits, savings, NOW, and money market accounts, is equal to the amount payable on demand as of the valuation date. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
Short-term borrowings and long-term debt - The fair values are based on discounting expected cash flows at the interest rate for debt with same or similar remaining maturities and collateral requirements.
Effective January 1, 2008, the Company adopted the provisions of SFAS No. 157, “Fair Value Measurements,” for financial assets and financial liabilities. In accordance with Financial Accounting Standards Board Staff Position (FSP) No. SFAS 157-2, “Effective Date of FASB Statement No. 157,” the Company will delay application of SFAS 157 for non-financial assets and non-financial liabilities, until January 1, 2009. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The application of SFAS 157 in situations where the market for a financial asset is not active was clarified by the issuance of FSP No. SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” in October 2008. FSP No. SFAS 157-3 became effective immediately and did not significantly impact the methods by which the Company determines the fair values of its financial assets.
Under SFAS 157, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair values. These levels are:
Level 1 Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2 Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3 Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques included use of option pricing models, discounted cash flow models and similar techniques.
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
Investment Securities Available-for-Sale
Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing modes or other model-based valuation techniques such as present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities included those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in an active over-the-counter markets and money market funds. Level 2 securities included mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
14.
FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Loans
The Company does not record loans at fair value on a recurring basis. However, from time to time a loan is considered impaired and a specific reserve is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS 114, “Accounting by Creditors for Impairment of a Loan,” (SFAS 114). The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flow. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investment in such loans. At December 31, 2008, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with SFAS 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.
Foreclosed Assets
Foreclosed assets are adjusted to fair value less estimated selling costs upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.
Assets measured at fair value on a recurring basis are summarized below:
Effective January 1, 2008, the Company adopted the provisions of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities -Including an amendment of FASB Statement No. 115.” SFAS 159 permits the Company to choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses on items for which the fair value measurement option has been elected are reported in earnings at each subsequent reporting date. The fair value option (i) may be applied instrument by instrument, with certain exceptions, thus the Company may record identical financial assets and liabilities at fair value or by another measurement basis permitted under generally accepted accounting principles, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire instruments and not to portions of instruments. Adoption of SFAS 159 on January 1, 2008 did not have a significant impact on the Company’s consolidated financial statements.
15.
PARENT COMPANY FINANCIAL DATA
The following is a summary of the condensed financial statements of Weststar Financial Corporation as of and for the years ended December 31, 2008 and 2007:
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
15.
PARENT COMPANY FINANCIAL DATA (continued)
Condensed Balance Sheets
December 31, 2008 and 2007
Index
WESTSTAR FINANCIAL SERVICES CORPORATION & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
15. PARENT COMPANY FINANCIAL DATA (Continued)
Index
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A(T):
ITEM 9A(T): CONTROLS AND PROCEDURES
At the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-14.
Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective (1) to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosure.
There were no changes in the Company’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company reviews its disclosure controls and procedures, which may include its internal control over financial reporting, on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. The Company's internal control over financial reporting is a process designed under the supervision of the Company's CEO and CFO to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. Management has made a comprehensive review, evaluation and assessment of the Company's internal control over financial reporting as of December 31, 2008. In making its assessment of internal control over financial reporting, management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control−−Integrated Framework. In accordance with Section 404 of the Sarbanes−Oxley Act of 2002, management makes the following assertions:
·
Management has implemented a process to monitor and assess both the design and operating effectiveness of internal control over financial reporting.
·
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect ot financial statement preparation and presentation.
·
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008. In making this assessment, it used criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on that assessment, we believe that, as of December 31, 2008, the Company’s internal control over financial reporting is effective based on those criteria.
This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management's report in this annual report.
ITEM 9B:
ITEM 9B: OTHER INFORMATION
None.
Index
PART III
ITEM 10:
ITEM 10:
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
See pages 5 - 12 of Registrant’s 2009 Annual Meeting Proxy Statement, as filed with the SEC pursuant to Rule 14a-6(b).
Code of Ethics
The Company has adopted a Code of Ethics that applies among others, to its principal executive officer and principal financial officer. The Company’s Code of Ethics is available at http://www.bankofasheville.com.
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
See pages 12 - 16 of Registrant’s 2009 Annual Meeting Proxy Statement, as filed with the SEC pursuant to Rule 14a-6(b).
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
In 2007, the Company’s shareholders approved the Weststar Financial Services Corporation 2007 Nonstatutory Stock Option Plan (“Nonstatutory Plan”) and the Weststar Financial Services Corporation 2007 Incentive Stock Option Plan (“Incentive Plan”). The maximum number of shares available for grant under the Nonstatutory Plan and Incentive Plan is 50,000 and 75,000, respectively. No options were granted from the respective pools or outstanding at December 31, 2008.
In 2001, the Company’s shareholders approved the Weststar Financial Services Corporation 2001 Nonstatutory Stock Option Plan (“Nonstatutory Plan”) and the Weststar Financial Services Corporation 2001 Incentive Stock Option Plan (“Incentive Plan”). Under these plans, non-employee directors and employees were granted stock options on June 20, 2001. The maximum number of shares available for grant under the Nonstatutory Plan and Incentive Plan is 164,645 and 166,485, respectively. Of the maximum number of shares available for grant, 114,713 were outstanding under the Nonstatutory Plan and 138,672 were outstanding under the Incentive Plan at December 31, 2008. Option prices for both plans are established at market value, which was $3.26, on the dates options were granted by the Board of Directors. The following chart contains details of the grants:
All share and per share amounts have been adjusted to reflect a 5-for-4 stock paid during 2007.
See pages 3 - 5 of Registrant’s 2009 Annual Meeting Proxy Statement, as filed with the SEC pursuant to Rule 14a-6(b), for additional information regarding Security Ownership of Certain Beneficial Owners and Management.
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
See pages 6 and 11 of Registrant’s 2009 Annual Meeting Proxy Statement, as filed with the SEC pursuant to Rule 14a-6(b).
ITEM 14:
ITEM 14: PRINCIPAL ACCOUNTANT FEES AND SERVICES
See pages 8 - 10 of Registrant’s 2009 Annual Meeting Proxy Statement, as filed with the SEC pursuant to Rule 14a-6(b).
Index
PART IV
ITEM 15:
ITEM 15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
1.
Financial statements filed as a part of this report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2008 and 2007
Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 2008 and 2007
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2008 and 2007
Consolidated Statements of Cash Flows for the years ended December 31, 2008 and
Notes to Consolidated Financial Statements
2.
Financial statement schedules required to be filed by Item 8 of this Form:
None
3.
Exhibits
3.1
Articles of Incorporation of the Registrant1
3.2
Bylaws of the Registrant1
10.1
Employment Agreement between the Bank and G. Gordon Greenwood, dated February 9, 2000 (a management contract)1
10.2
Employment Agreement between the Bank and Randall C. Hall, dated March 20, 1998 (a management contract)1
10.3
401(k) Savings Plan of the Bank (a compensatory plan)1
10.4
Incentive Stock Option Plan (a compensatory plan)2
10.5
Nonstatutory Stock Option Plan (a compensatory plan)2
10.6
Amended and Restated Declaration of Trust by and between Wells Fargo Bank, N.A., as Delaware Trustee and Institutional Trustee, Weststar Financial Services Corporation, as Sponsor, and certain Administrative Trustees, dated October 10, 20033
10.7
Indenture between Weststar Financial Services Corporation and Wells Fargo Bank, N.A., as Indenture Trustee, dated October 10, 20033
10.8
Guarantee Agreement by and between Weststar Financial Services Corporation and Wells Fargo Bank, N.A., as Guarantee Trustee, dated October 10, 20033
10.9
Floating Rate Junior Subordinated Debenture of Weststar Financial Services Corporation, dated October 10, 2003 (included as Exhibit A to Exhibit 10.8)3
10.10
Employment Agreement between the Bank and John R. Hamrick, dated February 18, 2005 (a management contract)4
10.11
Incentive Stock Option Plan (a compensatory plan)5
10.12
Nonstatutory Stock Option Plan (a compensatory plan)5
Index
21.1
Subsidiaries
23.1
Consent of Independent Registered Public Accounting Firm
31.1
Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1
Proxy Statement6
1.
Incorporated by reference to the Registration Statement on Form S-4 (Registration No. 333-30200, filed with the Securities and Exchange Commission on February 11, 2000)
2.
Incorporated by reference to the Registrant’s Annual Report on Form 10-KSB for the year ended December 31, 2001, filed with the Securities and Exchange Commission on March 22, 2002
3.
Incorporated by reference to the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 5,
4.
Incorporated by reference to Registrant’s Annual Report on Form 10-KSB, filed with the Securities and Exchange Commission on March 7,
5.
Incorporated by reference to the Registration Statement on Form S-8 (Registration No. 333-14500, filed with the Securities and Exchange Commission on August 16, 2007)
6.
As filed with the Securities and Exchange Commission pursuant to Rule 14a-6(b)
Index
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Index
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/W. Edward Anderson
W. Edward Anderson
Director
March 17, 2009
/s/M. David Cogburn, M.D.
M. David Cogburn, M.D.
Director
March 17, 2009
/s/Steven D. Cogburn
Steven D. Cogburn
Director
March 17, 2009
/s/G. Gordon Greenwood
G. Gordon Greenwood
President & Chief Executive Officer
March 17, 2009
/s/Patricia P. Grimes
Patricia P. Grimes
Director
March 17, 2009
/s/Randall C. Hall
Randall C. Hall
Secretary/Treasurer
Chief Financial Officer and
Principal Accounting Officer
March 17, 2009
/s/Darryl J. Hart
Darryl J. Hart
Director
March 17, 2009
/s/Carol L. King
Carol L. King
Director
March 17, 2009
/s/Stephen L. Pignatiello
Stephen L. Pignatiello
Director
March 17, 2009
/s/Laura A. Webb
Laura A. Webb
Director
March 17, 2009
/s/David N. Wilcox
David N. Wilcox
Director
March 17, 2009
Index
EXHIBIT INDEX
Exhibit
Number
Exhibit
Page
Number
3.1
Articles of Incorporation
*
3.2
Bylaws
*
10.1
Employment Agreement of G. Gordon Greenwood
*
10.2
Employment Agreement of Randall C. Hall
*
10.3
(k) Savings Plan
*
10.4
Incentive Stock Option Plan
*
10.5
Nonstatutory Stock Option Plan
*
10.6
Amended and Restated Declaration of Trust
*
10.7
Indenture between Weststar Financial Services Corporation and Wells Fargo Bank, N.A.
*
10.8
Guarantee Agreement by and between Weststar Financial Services Corporation and Wells Fargo Bank, N.A.
*
10.9
10.10
10.11
10.12
Floating Rate Junior Subordinated Debenture of Weststar Financial Services Corporation
Employment Agreement of John R. Hamrick.
Incentive Stock Option Plan
Nonstatutory Stock Option Plan
*
*
*
*
21.1
Subsidiaries
Filed
herewith
23.1
Consent of Independent Registered Public Accounting Firm
Filed
herewith
31.1
Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
Filed
herewith
31.2
Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
Filed
herewith
32.1
Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes Oxley Act of 2002
Filed
herewith
32.2
Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes Oxley Act of 2002
Filed
herewith
99.1
Proxy Statement
**
* Incorporated by reference.
** As filed with the SEC pursuant to Rule 14a-6(b).