Item 1. Business.
Trinity Capital Corporation
General. Trinity Capital Corporation (“Trinity”), a financial holding company organized under the laws of the State of New Mexico, is the sole shareholder of Los Alamos National Bank (the “Bank”) and the sole shareholder of Title Guaranty & Insurance Company (“Title Guaranty”). The Bank is the sole shareholder of TCC Advisors Corporation (“TCC Advisors”) as well as the sole shareholder of Finance New Mexico Fund IV, LLC, a Delaware Limited Liability Company (“FNM Investment Fund IV”). The Bank is also a member of Cottonwood Technology Group, LLC (“Cottonwood”), a management consulting and counseling company for technology start up companies and which is also designed to manage venture capital funds. FNM Investment Fund IV is a member of Finance New Mexico--Investor Series IV, LLC, a New Mexico Limited Liability Company (“FNM CDE IV”), an entity created to fund loans and investments in a New Market Tax Credit project.
Trinity is located in Los Alamos, New Mexico, a small community in the Jemez Mountains of Northern New Mexico. Los Alamos has approximately 18,000 residents and enjoys worldwide recognition as the birthplace of the atomic bomb. Today, Los Alamos National Laboratory (the “Laboratory”) remains a pre-eminent research facility for scientific and technological development in numerous scientific fields. The Laboratory employs (directly and indirectly) approximately 9,650 residents of Northern New Mexico, making it the largest employer in Los Alamos County. The Laboratory remains the cornerstone of the community and has attracted numerous other scientific businesses to the area.
The Bank was founded in 1963 by local investors to provide convenient, full-service banking to the unique scientific community that developed around the Laboratory and continues to expand its market share and customer-base. Los Alamos National Bank is a full-service commercial banking institution with six bank offices in Los Alamos, White Rock, Santa Fe and Albuquerque, New Mexico. The Bank provides a broad range of banking products and services, including credit, cash management, deposit, asset management and trust services to our targeted customer base of individuals and small and medium-sized businesses. As of December 31, 2009, the Bank had total assets of $1.7 billion, net loans of $1.2 billion and deposits (net of deposits of affiliates) of $1.5 billion.
In 1999, the Bank established its first office in Santa Fe after acquiring a substantial number of customers based in Santa Fe. In 2004, the Bank added a second office in Santa Fe to better serve its growing customer-base and continue to attract new customers. Trinity acquired a ground lease covering additional land in Santa Fe where a third Santa Fe Bank office was constructed which opened in October 2009. The Bank opened its third Santa Fe office to better serve our customers on the southern side of Santa Fe and attract additional commercial and consumer customers based in this area. Based upon the Federal Deposit Insurance Corporation’s Summary of Deposits ("SOD") Report containing data as of June 30 of each year, the Bank held the largest share of deposits in Santa Fe County in 2007, 2008 and 2009. In 2005, the Bank determined the need for an additional site in Albuquerque, New Mexico to serve our commercial loan customers and established a Loan Production Office. The Bank expanded its charter at the end of 2007 to provide for the ability to provide full banking services out of its Albuquerque office.
Trinity acquired Title Guaranty in May 2000, making it the only title company in New Mexico to be owned by a financial institution. Title Guaranty is a title insurance company organized under the laws of the State of New Mexico doing business in Los Alamos and Santa Fe Counties. Title Guaranty opened its Santa Fe office in the Bank’s downtown Santa Fe facility in February 2005. The services provided by Title Guaranty complement those provided by Trinity’s other subsidiaries. Title Guaranty provides title insurance, closing services, escrow and notary service, title searches and title reports for Los Alamos and Santa Fe Counties.
The Bank created TCC Advisors in February 2006 to enable us to manage certain assets and register with the SEC as a Registered Investment Advisor should we choose to do so in the future. In February 2006, TCC Funds, a Delaware statutory trust was created with Trinity as its sponsor, to allow for the creation of a mutual fund. Both of these entities are dormant with no planned use at this time. TCC Appraisals was a real estate appraisal company created by Trinity in January 2006 and was dissolved in January 2009 following the sale of its assets in May 2008. In August of 2008, the Bank joined Cottonwood as a 26% member. Cottonwood assists in the management and counsels start up companies involved in technology transfer from research institutions in New Mexico as well as establishing and managing venture funds. Additionally, the Bank entered a consulting agreement with Cottonwood to provide services to assist the Bank in its venture banking, start up banking and high tech banking portfolio. The Bank currently holds a 24% interest in Cottonwood as described below. Additionally, the Bank is participating in a venture capital fund managed by Cottonwood. In 2009, the Bank created FNM Investment Fund IV to acquire a 99.99% interest in FNM CDE IV. Both of these entities were created for the sole purpose of funding loans to and investments in a New Market Tax Credit project located in downtown Albuquerque, New Mexico.
Corporate Structure. Trinity was organized in 1975 as a bank holding company, as defined in the Bank Holding Company Act of 1956, as amended (“BHCA”), and in 2000 elected to become a financial holding company, as defined in the BHCA. Trinity acquired the stock of the Bank in 1977 and serves as the holding company for the Bank. In 2000, Trinity purchased Title Guaranty. Title Guaranty and the Bank are wholly-owned subsidiaries of Trinity. The Bank created both TCC Advisors and TCC Funds in February 2006; both entities are currently dormant. In addition, Trinity owns all the common shares of four business trusts, created by Trinity for the sole purpose of issuing trust preferred securities which had an aggregate outstanding balance of $37.1 million at December 31, 2009. Trinity’s sole business is the ownership of the outstanding shares of the Bank, Title Guaranty and the administration of the Trusts. The address of our headquarters is 1200 Trinity Drive, Los Alamos, New Mexico 87544, our main telephone number is (505) 662-5171 and our general email address is tcc@lanb.com.
Trinity maintains a website at www.lanb.com/Media-and-Investors.aspx. We make available free of charge on or through our website, the annual report on Form 10-K, proxy statements, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission. The Company will also provide copies of its filings free of charge upon written request to: TCC Stock Representative, Trinity Capital Corporation, Post Office Box 60, Los Alamos, New Mexico 87544. In addition, you may read and copy any materials we filed with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers such as Trinity. Trinity’s filings are available free of charge on the SEC’s website at http://www.sec.gov.
Regulation and Supervision
Financial institutions, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, the growth and earnings performance of Trinity may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory authorities, including the Office of the Comptroller of the Currency (the “OCC”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the Federal Deposit Insurance Corporation (the “FDIC”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities and securities laws administered by the Securities and Exchange Commission (the “SEC”) and state securities authorities have an impact on the business of Trinity. The effect of these statutes, regulations and regulatory policies may be significant, and cannot be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial institutions regulate, among other things, the scope of business, the kinds and amounts of investments, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers and consolidations and the payment of dividends. This system of supervision and regulation establishes a comprehensive framework for the respective operations of Trinity and its subsidiaries and is intended primarily for the protection of FDIC-insured deposits and depositors of the Bank, rather than shareholders. In addition to this generally applicable regulatory framework, turmoil in the credit markets in recent years has prompted the enactment of unprecedented legislation that has allowed the U.S. Department of the Treasury (the “Treasury”) to make equity capital available to qualifying financial institutions to help restore confidence and stability in the U.S. financial markets, which imposes additional requirements on institutions in which the Treasury invests.
The following is a summary of the material elements of the regulatory framework that currently applies to Trinity and its subsidiaries. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. Additionally, in response to the global financial crisis that began in 2007, various legislative and regulatory proposals have been issued addressing, among other things, the restructuring of the federal bank regulatory system, more stringent regulation of consumer products such as mortgages and credit cards, and safe and sound compensation practices. At this time, the Company is unable to determine whether any of these proposals will be adopted as proposed. As such, the following is qualified in its entirety by reference to applicable law. Any change in statutes, regulations or regulatory policies may have a material effect on the business of Trinity and its subsidiaries.
General. Trinity is a financial holding company. As a financial holding company, Trinity is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956 (“BHCA”). In accordance with Federal Reserve policy, Trinity is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where Trinity might not otherwise do so. Under the BHCA, Trinity is subject to periodic examination by the Federal Reserve. Trinity is also required to file with the Federal Reserve periodic reports of Trinity’s operations and such additional information regarding Trinity and its subsidiaries as the Federal Reserve may require.
The TARP Capital Purchase Program. On October 14, 2008, Treasury announced a program that provided Tier 1 capital (in the form of perpetual preferred stock) to eligible financial institutions. This program, known as the TARP Capital Purchase Program (the “CPP”), allocated $250 billion from the $700 billion authorized by the Emergency Economic Stabilization Act of 2008 ("EESA") to Treasury for the purchase of senior preferred shares from qualifying financial institutions (the “CPP Preferred Stock”). Eligible institutions were able to sell equity interests to Treasury in amounts equal to between 1% and 3% of the institution’s risk-weighted assets. Trinity determined participation in CPP to be in its best interests based upon the economic uncertainties of the deep recession, the benefits of holding additional capital and the relatively low cost of participation. As part of this program, Trinity received $35.5 million in capital in March of 2009. The funds were immediately distributed to the Bank to facilitate lending and investments, and to expand our business within our market areas. While the CPP imposes certain restrictions upon operation, governance and compensation, the Company determined that the affect was minimal. Trinity’s federal regulators, the Treasury and the Treasury’s Office of the Inspector General maintain significant oversight over Trinity as a participating institution, to evaluate how it is using the capital provided and to ensure that it strengthens its efforts to help its borrowers avoid foreclosure, which is one of the core aspects of the EESA.
TARP-Related Compensation and Corporate Governance Requirements. As noted above, on March, 2009, the Company participated in this program by issuing 35,500 shares of the Company’s Series A Preferred Stock to Treasury for a purchase price of $35.5 million in cash and issued warrants which were immediately exercised by Treasury for 1,777 shares of the Company's Series B Preferred Stock. The Series A Preferred Stock is non-voting and pays dividends at the rate of 5% per annum for the first five years and thereafter at a rate of 9% per annum. The Series B Preferred Stock is also non-voting and pays dividends at the rate of 9% per annum from the date of the transaction.
In addition to the restrictions on the Company’s ability to pay dividends on and repurchase its stock, as described below under “Dividends,” participation in the TARP Capital Purchase Program also includes certain requirements and restrictions regarding compensation that were expanded significantly by the American Recovery and Reinvestment Act of 2009 (“ARRA”), as implemented by Treasury’s Interim Final Rule on TARP Standards for Compensation and Corporate Governance. These requirements and restrictions include, among others, the following: (i) a prohibition on paying or accruing bonuses, retention awards and incentive compensation, other than qualifying long-term restricted stock or pursuant to certain preexisting employment contracts, to the Company’s five most highly-compensated employees; (ii) a general prohibition on providing severance benefits, or other benefits due to a change in control of the Company, to the Company’s senior executive officers (“SEOs”) and next five most highly compensated employees; (iii) a requirement to make subject to clawback any bonus, retention award, or incentive compensation paid to any of the SEOs and any of the next twenty most highly compensated employees if such compensation was based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria; (iv) a requirement to establish a policy on luxury or excessive expenditures; (v) a requirement to provide shareholders with a non-binding advisory “say on pay” vote on executive compensation; (vi) a prohibition on deducting more than $500,000 in annual compensation, including performance-based compensation, to the executives covered under Internal Revenue Code Section 162(m); (vii) a requirement that the compensation committee of the board of directors evaluate and review on a semi-annual basis the risks involved in employee compensation plans; and (viii) a prohibition on providing tax “gross-ups” to the Company’s SEOs and the next 20 most highly compensated employees. These requirements and restrictions will remain applicable to the Company until it has redeemed the Preferred Stock held by Treasury in full. These requirements and the affect upon Trinity are discussed in more detail in the Compensation Discussion and Analysis section in Trinity’s proxy statement, which is incorporated by reference in this Form 10-K.
Incentive Compensation. On October 22, 2009, the Federal Reserve issued a comprehensive proposal on incentive compensation policies (the “Incentive Compensation Proposal”) intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The Incentive Compensation Proposal, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. Banking organizations were instructed to begin an immediate review of their incentive compensation policies to ensure that they do not encourage excessive risk-taking and implement corrective programs as needed. Deficiencies in the incentive compensation arrangements must be immediately addressed.
Additionally, the Incentive Compensation Proposal will require the Federal Reserve to review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as us, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.
The BHCA generally prohibits Trinity from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be “so closely related to banking ... as to be a proper incident thereto.” This authority would permit Trinity to engage in a variety of banking-related businesses, including the ownership and operation of a thrift, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.
Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies, such as trinity, may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Trinity has elected (and the Federal Reserve has accepted Trinity’s election) to operate as a financial holding company. However, given the recent regulatory issues involving the Bank, as discussed below, Trinity does not meet these eligibility requirements and will be required by the Federal Reserve to terminate its financial holding company status and its operations derived therefrom, unless it restores the Bank to well-managed and maintains well-capitalized status within a timeframe specified by the Federal Reserve.
Capital Requirements. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital falls below minimum required levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.
The Federal Reserve’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a risk-based requirement expressed as a percentage of total assets weighted according to risk; and (ii) a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others. For purposes of these capital standards, Tier 1 capital consists primarily of permanent stockholders’ equity less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus certain other debt and equity instruments that do not qualify as Tier 1 capital and a portion of the company’s allowance for loan and lease losses.
The risk-based and leverage standards described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, credit risk, the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels. As of December 31, 2009, Trinity had regulatory capital in excess of the Federal Reserve’s minimum requirements.
Dividends. Trinity’s ability to pay dividends to its shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. New Mexico law prohibits Trinity from paying dividends if, after giving effect to the dividend: (i) Trinity would be unable to pay its debts as they become due in the usual course of its business; or (ii) Trinity’s total assets would be less than the sum of its total liabilities and (unless Trinity’s articles of incorporation otherwise permit) the maximum amount that then would be payable, in any liquidation, in respect of all outstanding shares having preferential rights in liquidation. Additionally, as a bank holding company, the Company’s ability to declare and pay dividends is subject to the guidelines of the Federal Reserve regarding capital adequacy and dividends. The Federal Reserve guidelines generally require the Company to review the effects of the cash payment of dividends on common stock and other Tier 1 capital instruments (i.e., perpetual preferred stock and trust preferred securities) in light of our earnings, capital adequacy and financial condition. In addition, as a matter of policy, the Federal Reserve has indicated that bank holding companies should not pay dividends on common stock (or make distributions on trust preferred securities) using funds from the CPP. As a general matter, the Federal Reserve indicates that the board of directors of a bank holding company should eliminate, defer or significantly reduce the dividends if: (i) the company’s net income available to stockholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is inconsistent with the company's capital needs and overall current and prospective financial condition; or (iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. Given recent developments concerning the Bank described further below, the Federal Reserve has notified Trinity that it will place restrictions on its ability to pay dividends.
Furthermore, with respect to Trinity’s participation in the CPP, the terms of the CPP Preferred Stock will provide that no dividends on any common or preferred stock that ranks equal to or junior to the CPP Preferred Stock may be paid unless and until all accrued and unpaid dividends for all past dividend periods on the CPP Preferred Stock have been fully paid. Additionally, Trinity is prohibited from paying a semi-annual dividend in excess of the amount paid in the last dividend paid prior to participating in CPP during the first three years. This means that Trinity may not pay in excess of $0.40/share as a semi-annual dividend on its common stock without the prior permission from Treasury until March 27, 2012. From March 28, 2012 to March 27, 2019, if Trinity has not yet redeemed Preferred Shares held by Treasury, Trinity may increase its dividends on its common stock by no more than 3% per year. Thereafter, Trinity may not pay any dividends on its common stock until it redeems all Preferred Shares held by Treasury. Trinity anticipates redeeming all such shares prior to March 27, 2019. Finally, the ability of Trinity to pay dividends to its common shareholders is largely dependent upon receiving dividends from the Bank as further discussed in “Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in Item 5 of this Form 10-K. In addition, during the term of its participation in the CPP, Trinity may not repurchase outstanding common shares or redeem any of the trust preferred securities without the prior approval of Treasury.
Federal Securities Regulation. Trinity’s common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Consequently, Trinity is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.
Los Alamos National Bank
General. Los Alamos National Bank (“Bank”) is a national banking organization created under the laws of the United States of America. The Bank is regulated primarily by the OCC, a branch of the Department of Treasury. The Bank currently has six full-service bank offices. In February 2006, the Bank created TCC Advisors as a wholly owned subsidiary of the Bank. In August of 2008, the Bank joined Cottonwood and currently holds a 24% interest. Cottonwood works with local start up companies involved in technology transfer from research institutions. Additionally, the Bank entered a consulting agreement with Cottonwood to provide services to assist the Bank in its venture banking, start up banking and high tech banking portfolio. The Bank is also the sole member of FNM Investment Fund IV which holds a 99.99% interest in FNM CDE IV, created to fund loans and investments in a New Market Tax Credit Project in Albuquerque, New Mexico.
Products and Services. The Bank provides a full range of financial services for deposit customers and we lend money to credit-worthy borrowers at competitive interest rates. Our strategy has been to position ourselves in the market as a low-fee, high-value community bank. Our products include certificates of deposits, checking and saving accounts, on-line banking, Individual Retirement Accounts, loans, mortgage loan servicing, trust and investment services, international services, and safe deposit boxes. These business activities make up our three key processes: investment of funds, generation of funds and service-for-fee income. We achieved our success in part by minimizing charges relating to the investment and generation of funds processes, i.e. loans, credit cards, checking, and savings accounts. The profitability of our operations depend primarily on our net interest income, which is the difference between total interest earned on interest-earning assets and total interest paid on interest-bearing liabilities, and our ability to maintain efficient operations. In addition to our net interest income, we produce income through our mortgage servicing operations and other income processes, such as trust and investment services. A more complete description of our products and services makeup can be found under “Management’s Discussion and Analysis and Results of Operations” in Item 7 in this Form 10-K.
Lending Activities.
General. We provide a broad range of commercial and retail lending services to corporations, partnerships, individuals and government agencies. We actively market our services to qualified borrowers. Lending officers build relationships with new borrowers entering our market areas as well as long-standing members of the local business community. We have established lending policies which include a number of underwriting factors to be considered in making a loan, including location, loan to value ratio, cash flow and the credit history of the borrower. Our current maximum legal lending limit to one borrower is approximately $26.5 million; however, the Bank may impose additional limitations on the amount it is willing to lend to one borrower as part of its credit risk management policies. Our loan portfolio is comprised primarily of loans in the areas of commercial real estate, residential real estate, construction, general commercial and consumer lending. As of December 31, 2009, residential mortgages made up approximately 32.2% of our loan portfolio; commercial real estate loans comprised approximately 36.4%; construction lending comprised 15.6%; general commercial loans comprised 11.1%; and consumer lending comprised 4.7%. In addition, the Bank originates residential mortgage loans for sale to third parties, primarily the Federal National Mortgage Association ("Fannie Mae"), and service many of these loans for the buyers.
Commercial Real Estate Loans. The largest portion of our loan portfolio is comprised of commercial real estate loans. Our focus in Commercial Real Estate lending concentrates on loans to building contractors and developers. The primary repayment risk for a commercial real estate loan is the failure of the business due to economic events or governmental regulations outside of the control of the borrower or lender that negatively impact the future cash flow and market values of the affected properties. We have collateralized these loans and, in most cases, take personal guarantees to help assure repayment. Our commercial real estate loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying real estate collateral. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the real estate and enforcement of a personal guarantee, if any exists.
Residential Real Estate Loans. Residential mortgage lending has been an important part of our business since our formation in 1963. The majority of the residential mortgage loans we originate and retain are in the form of 15- and 30-year variable rate loans. We also originate 15- to 30-year fixed rate residential mortgages and sell most of these loans to outside investors. In 2009, we originated approximately $397.1 million in residential mortgage loans sold to third parties. We retain the servicing of almost all of the residential mortgages we originate. We believe the retention of mortgage servicing provides us with a relatively steady source of fee income as compared to fees generated solely from mortgage origination operations. Moreover, the retention of such servicing rights allows us to continue to have regular contact with mortgage customers and solidify relationships with those customers. As of December 31, 2009, the total sold residential mortgage loan portfolio we service on behalf of third parties was $1.0 billion. We do not engage in financing sub-prime loans nor do we participate in any sub-prime lending programs. We participate in the current Treasury programs, including Home Affordable Modification Program, to work with borrowers who are in danger of or who have defaulted on residential mortgage loans.
Construction Loans. We have been active in financing construction of residential and commercial properties in New Mexico, primarily in Northern New Mexico. This type of lending has decreased in the past eighteen months because of the current economic downturn and the affect it has had on real estate sales. We manage the risk of construction lending through the use of underwriting and construction loan guidelines and require the work be done by reputable contractors. Construction loans are structured either to be converted to permanent loans at the end of the construction phase or to be paid off upon receiving financing from another financial institution. The amount financed on construction loans is based on the appraised value of the property, as determined by an independent appraiser, and an analysis of the potential marketability and profitability of the project and the costs of construction. Construction loans generally have terms that do not exceed 24 months. Loan proceeds are typically disbursed on a percentage of completion basis, as determined by inspections, with all construction required to be completed prior to the final disbursement of funds.
Construction loans afford us the opportunity to increase the interest rate sensitivity of our loan portfolio and to receive yields higher than those obtainable on adjustable rate mortgage loans secured by existing residential properties. These higher yields correspond to the higher risks associated with construction lending.
Commercial Loans. The Bank is an active commercial lender. Our focus in commercial lending concentrates on loans to business services companies and retailers. The Bank provides various credit products to our commercial customers including lines of credit for working capital and operational purposes and term loans for the acquisition of equipment and other purposes. Collateral on commercial loans typically includes accounts receivable, furniture, fixtures, inventory and equipment. In addition, almost all commercial loans have personal guarantees to assure repayment. The terms of most commercial loans range from one to seven years. A significant portion of our commercial business loans reprice within one year or have floating interest rates.
Consumer Loans. We also provide all types of consumer loans including motor vehicle, home improvement, student loans, credit cards, signature loans and small personal credit lines. Consumer loans typically have shorter terms and lower balances with higher yields as compared to our other loans, but generally carry higher risks of default. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances.
Additional information on the risks associated with our banking activities and products and concentrations can be found under “Risk Factors” in Section 1A of this Form 10-K.
Market Area.
General. The economy in Northern New Mexico has seen significant increases in unemployment and has experienced slower than historical levels of activity in both real estate and retail segments of the economy. Unemployment in New Mexico in 2009 remained comparatively low with an average rate of 6.8% compared to a national average unemployment rate of 9.7%. New Mexico’s 2.6% increase in unemployment from December 2008 to December 2009 compares to a national unemployment rate increase of 3.9% during the same period. Foreclosure rates in New Mexico during 2009 remained lower than the national average. New Mexico remains aggressive in lobbying new businesses to move to the state and the high percentage of federal government spending in the state allows the economy to stay relatively steady in times of volatility. Management believes the overall outlook for the New Mexico economy in 2010 is continued recession but with modest growth in the Federal Reserve's Tenth District, which includes New Mexico and its surrounding states, as predicted by the Federal Reserve’s Beige Book. A moderate recovery is expected to begin in 2010, which should commence with improvements in the housing sector.
Los Alamos. The Bank’s customers are concentrated in Northern and Central New Mexico, particularly in Santa Fe and Los Alamos Counties. The city of Los Alamos, the base of our operations, lies within Los Alamos County. Los Alamos County has approximately 18,000 residents. As of December 31, 2009, the Bank had approximately $36.4 million in commercial loans, $172.7 million in commercial real estate loans, $201.8 in residential loans, $61.1 million in construction loans, $31.1 in consumer and other loans and $750.7 million in deposits in Los Alamos County. The stability of the Los Alamos market has provided a solid base for the Company throughout our history. As virtually all communities suffer from the economic downturn, the effect in Los Alamos County have been minimized by federal government spending, primarily in the form of providing approximately $2.2 billion toward funding Laboratory projects and operations. Los Alamos County has the lowest unemployment rate in the state at 3.0% and consistently has the highest personal per capita and median family income levels.
Los Alamos County experienced minimal growth in its population of 0.2% from 1990 to 2000 and an estimated decrease of 1.1% from April 1, 2000 to July 1, 2008, due in part to the lack of significant parcels of land for development. The primary employer in Los Alamos County is the Laboratory, one of the world’s premier national security and scientific research and development institutions. The Laboratory is operated by Los Alamos National Security, LLC for the Department of Energy. The Laboratory employs more than 9,000 employees and an additional 650 subcontractors. Most of the employees are scientists, engineers and technicians working in the areas of national security, bio-sciences, chemistry, computer science, earth and environmental sciences, materials science and physics, contributing to Los Alamos County’s exceptional percentages of the population with high school diplomas or equivalents (96.3%) and those with bachelor or higher degrees (60.5%) compared with national averages of 85.0% and 27.7% respectively. The concentration of highly skilled and highly educated residents provides the Bank with a sophisticated customer base and supports an average median income approximately 197% of the national average and an unemployment rate (3.0%) less than one-third the national average (9.7%). While unemployment continues to climb throughout the nation, Los Alamos County has remained relatively stable with a reported unemployment rate for January 2010 of 2.7% (the lowest in the state), compared to a state unemployment rate of 5.1% and a national unemployment rate of 9.7%. Median home values (based upon 2000 data) in Los Alamos County are well above average, $228,300 compared to $119,600 nationally, as is homeownership, at 78.6% compared to a national average of 66.2%.
Santa Fe. In 1999, the Bank opened its first full-service office in Santa Fe, New Mexico and opened a second full-service office in Downtown Santa Fe in August of 2004. The Bank opened a third full-service office in south Santa Fe in October of 2009. The Bank’s continued expansion into Santa Fe has permitted the convenient provision of products and services to our existing customer base in Santa Fe as well as attracting new customers. As of December 31, 2009, the Bank had approximately $58.3 million in commercial loans, $179.6 million in commercial real estate loans, $174.1 in residential loans, $91.3 million in construction loans, $18.6 in consumer and other loans and $668.6 million in deposits in the greater Santa Fe area. As of June 30, 2009, the Bank was the largest depository in Santa Fe according to the FDIC’s SOD Report for the third year in a row. The Santa Fe market has provided a solid base for the Company over the past several years. Santa Fe County is home to the state capitol and the state government. The state and federal government are the area’s largest employers. Consequently, this market has been affected less by economic downturns than other areas. However, beginning in the second half of 2009, the state government began to impose furloughs and is currently set to pass tax increases and budget cuts to balance the state budget due to lower revenues.
Santa Fe serves as the capitol of New Mexico and is located approximately 35 miles southeast of Los Alamos. Santa Fe County has approximately 144,000 residents with its local economy based primarily on government and tourism. We expanded to the Santa Fe market, in part, to take advantage of the population growth, which has been higher than the state and national averages. Santa Fe County is one of the fastest growing counties in the state, with an estimated increase in population of 45.5% from 1990 to 2008 compared to 31.0% for the state and 22.3% for the country as a whole; and 11.3% between April 1, 2000 and July 1, 2008, compared to 9.1% for the state and 6.9% for the country as a whole. Santa Fe County also has higher than average percentages of its population with high school diplomas or equivalents (84.5%) and those with bachelor or higher degrees (36.9%). The average median income in Santa Fe County is slightly higher (1.17%) than the national average and unemployment level (5.8%) approximately 40% less than the national average (9.7%) based on December 2009 data. The Santa Fe Metropolitan Statistical Area (“MSA”) had the lowest unemployment rate for the three largest MSAs in the state at 5.8% in December 2009. Median home values in Santa Fe County (based upon 2000 data) are 55.36% above the national average, at $189,400 compared to $119,600 nationally, and homeownership is slightly higher at 68.6% compared to a national average of 66.2%.
Albuquerque. The Bank opened a Loan Production Office in the Uptown area of Albuquerque, New Mexico in 2005. The Bank received approval from the OCC on December 31, 2007 to provide full-services at this location. The Bank is currently evaluating its present and future opportunities in the Albuquerque area and incorporating these into our business strategy. As of December 31, 2009, the Bank had approximately $44.0 million in commercial loans, $99.9 million in commercial real estate loans, $24.1 in residential loans, $41.8 million in construction loans, $8.8 in consumer and other loans and $49.1 million in deposits in the greater Albuquerque area. Albuquerque is a city of approximately 522,000 residents and is located approximately 60 miles south of Los Alamos. The Albuquerque economy is more varied than either Los Alamos or Santa Fe, with no predominant industry or employer.
Albuquerque had an estimated increase in population of 15.9% from 2000 to 2008 compared to 9.1% for the state and 6.9% for the country as a whole. Albuquerque and its surrounding areas are some of the fastest growing in the state: the City of Rio Rancho, on the northern limits of Albuquerque grew 51.0% from 2000 to 2008; Sandoval County to the north of Albuquerque, which includes the City of Rio Rancho, grew 93.1% from 1990 to 2008 and 35.0% from April 1, 2000 to July 1, 2008; and Bernalillo County, which includes Albuquerque, grew 32.2% from 1990 to 2008 and 14.2% from April 1, 2000 to July 1, 2008. Albuquerque has higher than national and state averages in the percentage of its population with high school diplomas or equivalents (85.9%) and those with bachelor or higher degrees (31.8%). The average median income in Albuquerque is 26.4% lower than the national average and the unemployment rate was 7.1% in December 2009, 2.6% lower than the national average (9.7%). Albuquerque’s unemployment rate increased significantly (2.8%) from December 2008 to December 2009. Median home values in Albuquerque (based upon 2000 data) are 6.68% above the national average, at $127,600 compared to $119,600 nationally, but homeownership is slightly lower at 60.4% compared to a national average of 66.2%.
Competition. We face strong competition both in originating loans and in attracting deposits. Competition in originating real estate loans comes primarily from other commercial banks, savings institutions and mortgage bankers making loans secured by real estate located in our market area. Commercial banks and finance companies, including finance company affiliates of automobile manufacturers, provide vigorous competition in consumer lending. We compete for real estate and other loans principally on the basis of the interest rates and loan fees we charge, the types of loans we originate and the quality and speed of services we provide to borrowers. Insurance companies and internet-based financial institutions present growing areas of competition both for loans and deposits.
There is substantial competition in attracting deposits from other commercial banks, savings institutions, money market and mutual funds, credit unions and other investment vehicles. Our ability to attract and retain deposits depends on our ability to provide investment opportunities that satisfy the requirements of investors as to rate of return, liquidity, risk and other factors. Under the Gramm-Leach-Bliley Act enacted in 2000, securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. This has significantly changed the competitive environment in which we conduct business. The financial services industry has also become more competitive as technological advances enable companies to provide financial services to customers outside their traditional geographic markets and provide alternative methods for financial transactions. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.
Employees. As of December 31, 2009, the Bank had approximately 302 full time-equivalent employees. We are not a party to any collective bargaining agreements. Employee relations are excellent as evidenced by the results of our annual employee satisfaction surveys. Over the last eight years, the results of the employee satisfaction survey have consistently shown satisfaction levels exceeding our peers according to the independent consultant hired to administer and evaluate our surveys.
Regulation and Supervision
General. Los Alamos National Bank is a national bank, chartered by the OCC under the National Bank Act. The deposit accounts of the Bank are insured by the FDIC’s Deposit Insurance Fund (“DIF”) to the maximum extent provided under federal law and FDIC regulations, and the Bank is a member of the Federal Reserve System. As a national bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the OCC, the chartering authority for national banks. The FDIC, as administrator of the DIF, also has regulatory authority over the Bank. The Bank is also a member of the Federal Home Loan Bank System, which provides a central credit facility primarily for member institutions.
Regulatory Proceedings Against the Bank. On January 26, 2010, the Bank and the OCC entered into a formal written agreement (the “Agreement”). The Agreement is based on the concerns of the OCC due to an excessive level of classified assets and concentrations of credit. The Agreement contains, among other things, directives for the Bank to take specific actions, within time frames specified therein, to address risk management and capital matters that, in the view of the OCC, may impact the Bank’s overall safety and soundness. Specifically, the Bank is required to, among other things: (i) continue to develop, implement and ensure adherence to written programs designed to reduce the level of credit risk in the Bank’s loan portfolio; (ii) review, revise and ensure adherence to a written capital program; (iii) comply with its approved capital program, which calls for maintaining higher than the regulatory minimum capital ratios; and (iv) obtain prior OCC approval before paying dividends.
If the OCC is not satisfied with the corrective actions that are taken in order to address the deficiencies as set forth in the Agreement, the OCC could take further enforcement actions, including requiring the sale or liquidation of the Bank. In such case, there can be no assurance that the proceeds of any such sale or liquidation would result in a full return of capital to investors. A copy of the Agreement was filed as part of the Company’s Current Report on Form 8-K filed on February 1, 2010 with the SEC. The filing is available on the SEC’s website and the Company’s website.
In addition, because the Bank entered into the Agreement, it also is required to: (i) obtain prior approval for the appointment of new directors and the hiring or promotion of senior executive officers; (ii) comply with restrictions on severance payments and indemnification payments to institution-affiliated parties; and (iii) refrain from accepting or renewing brokered deposits.
Deposit Insurance. The FDIC currently maintains the Deposit Insurance Fund (the “DIF”), which was created in 2006 in the merger of the Bank Insurance Fund and the Savings Association Insurance Fund. The deposit accounts of our subsidiary bank are insured by the DIF to the maximum amount provided by law. This insurance is backed by the full faith and credit of the United States Government.
As insurer, the FDIC is authorized to conduct examinations of and to require reporting by DIF-insured institutions. It also may prohibit any DIF-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the DIF. The FDIC also has the authority to take enforcement actions against insured institutions.
In February 2009, the FDIC adopted a final regulation that provided for the replenishment of the Deposit Insurance Fund over a period of seven years. The restoration plan changed the FDIC’s base assessment rates and the risk-based assessment system. The risk-based premium system provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based upon supervisory and capital evaluations. The assessment rate for an individual institution is determined according to a formula based on a weighted average of the institution’s individual CAMELS component ratings plus either six financial ratios or, in the case of an institution with assets of $10.0 billion or more, the average ratings of its long-term debt. Well-capitalized institutions (generally those with CAMELS composite ratings of 1 or 2) are grouped in Risk Category I and their initial base assessment rate for deposit insurance is set at an annual rate of between 12 and 16 basis points. The initial base assessment rate for institutions in Risk Categories II, III and IV is set at annual rates of 22, 32 and 50 basis points, respectively. These initial base assessment rates are adjusted to determine an institution’s final assessment rate based on its brokered deposits, secured liabilities and unsecured debt. The adjustments include higher premiums for institutions that rely significantly on excessive amounts of brokered deposits, including CDARS, higher premiums for excessive use of secured liabilities, including Federal Home Loan Bank advances and adding financial ratios and debt issuer ratings to the premium calculations for banks with over $10 billion in assets, while providing a reduction for all institutions for their unsecured debt. Total base assessment rates after adjustments range from 7 to 24 basis points for Risk Category I, 17 to 43 basis points for Risk Category II, 27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for Risk Category IV. Rates increase uniformly by 3 basis points effective January 1, 2011.
In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize a predecessor to the Deposit Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2019.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged or is engaging in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or written agreement entered into with the FDIC. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
On May 22, 2009, the FDIC announced a five basis point special assessment on each insured depository institution’s assets minus its Tier 1 capital as of June 30, 2009. The FDIC collected the Bank’s special assessment amounting to $701 thousand on September 30, 2009. The special assessment was fully expensed by the Company in the second quarter of 2009.
On November 12, 2009, the FDIC adopted regulations that required insured depository institutions to prepay on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and all of 2010, 2011 and 2012, along with their quarterly risk-based assessment for the fourth quarter of 2009. The FDIC collected the Bank’s pre-paid assessments amounting to $8.1 million on December 30, 2009. Of the $8.1 million, $517 thousand was expensed in the fourth quarter of 2009 with the remaining $7.6 million to be expensed over the three year period.
FDIC Temporary Liquidity Guarantee Program. In conjunction with the Treasury’s actions to address the credit and liquidity crisis in financial markets, on October 14, 2008, the FDIC announced the Temporary Liquidity Guarantee Program. One component of the Temporary Liquidity Guarantee Program is the Transaction Account Guarantee Program, which temporarily provides participating institutions with unlimited deposit insurance coverage for non-interest bearing and certain low-interest bearing transaction accounts maintained at FDIC insured institutions. All institutions that did not opt out of the Transaction Account Guarantee Program were subject to a 10 basis point per annum assessment on amounts in excess of $250,000 in covered transaction accounts through December 31, 2009. On August 26, 2009, the FDIC extended the Transaction Account Guarantee Program for an additional six months through June 30, 2010. Beginning January 1, 2010, the assessment levels increased to 15 basis points, 20 basis points or 25 basis points per annum, based on the risk category to which an institution is assigned for purposes of the risk-based premium system. The Bank did not opt out of the six-month extension of the Transaction Account Guarantee Program. As a result, the Bank, like every other FDIC-insured depository institution in the United States that did not opt out of the Transaction Account Guarantee Program, is incurring fees on amounts in excess of $250,000 in covered transaction accounts.
Supervisory Assessments. National banks are required to pay supervisory assessments to the OCC to fund the operations of the OCC. The amount of the assessment is calculated using a formula that takes into account the bank’s size and its supervisory condition. During the years ended December 31, 2009 and 2008, the Bank paid supervisory assessments to the OCC totaling $301 thousand and $280 thousand, respectively.
Capital Requirements. The OCC has established the following minimum capital standards for national banks, such as the Bank: (i) a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others; and (ii) a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. In general, the components of Tier 1 capital and total capital are the same as those for bank holding companies discussed above.
The capital requirements described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, the regulations of the OCC provide that additional capital may be required to take adequate account of, among other things, interest rate risk, credit risk, the risks posed by concentrations of credit, nontraditional activities or securities trading activities.
Further, federal law and regulations provide various incentives to financial institutions to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a financial institution that is “well-capitalized” may qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities and may qualify for expedited processing of other required notices or applications. Additionally, one of the criteria that determines a bank holding company’s eligibility to operate as a financial holding company is a requirement that all of its financial institution subsidiaries be “well-capitalized.” Under the regulations of the OCC, in order to be “well-capitalized” a financial institution must maintain a ratio of total capital to total risk-weighted assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or greater.
Federal law also provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.
As of December 31, 2009: (i) the Bank was not subject to a directive from the OCC to increase its capital; (ii) the Bank exceeded its minimum regulatory capital requirements under OCC capital adequacy guidelines; and (iii) the Bank was “well-capitalized,” as defined by OCC regulations.
Dividends. The primary source of funds for Trinity is dividends from the Bank. Under the National Bank Act, a national bank may pay dividends out of its undivided profits in such amounts and at such times as the bank’s board of directors deems prudent. Without prior OCC approval, however, a national bank may not pay dividends in any calendar year that, in the aggregate, exceed the bank’s year-to-date net income plus the bank’s retained net income for the two preceding years.
The payment of dividends by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2009. As of December 31, 2009, approximately $45.6 million was available to be paid as dividends by the Bank. Notwithstanding the availability of funds for dividends, however, the OCC may prohibit the payment of dividends by the Bank if it determines such payment would constitute an unsafe or unsound practice. By virtue of express restrictions set forth in the Agreement, the Bank may not pay any dividend unless it complies with certain provisions of the Agreement and receives a prior written determination of no supervisory objection from the OCC.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.
Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on extensions of credit to Trinity, on investments in the stock or other securities of Trinity and the acceptance of the stock or other securities of Trinity as collateral for loans. The Bank also is subject to certain restrictions imposed by federal law on extensions of credit by the Bank to its directors and officers, to directors and officers of Trinity and its subsidiaries, to principal shareholders of Trinity and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of Trinity or the Bank or a principal shareholder of Trinity may obtain credit from banks with which the Bank maintains correspondent relationships.
Safety and Soundness Standards. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.
Branching Authority. National banks headquartered in New Mexico, such as the Bank, have the same branching rights in New Mexico as banks chartered under New Mexico law, subject to OCC approval. New Mexico law grants New Mexico-chartered banks the authority to establish branches anywhere in the State of New Mexico, subject to receipt of all required regulatory approvals.
Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is permitted only in those states the laws of which expressly authorize such expansion.
Financial Subsidiaries. Under Federal law and OCC regulations, national banks are authorized to engage, through “financial subsidiaries,” in any activity that is permissible for a financial holding company and any activity that the Secretary of the Treasury, in consultation with the Federal Reserve, determines is financial in nature or incidental to any such financial activity, except (i) insurance underwriting, (ii) real estate development or real estate investment activities (unless otherwise permitted by law), (iii) insurance company portfolio investments and (iv) merchant banking. The authority of a national bank to invest in a financial subsidiary is subject to a number of conditions, including, among other things, requirements that the bank must be well-managed and well-capitalized (after deducting from capital the bank’s outstanding investments in financial subsidiaries). The Bank has no unapproved or pending applications to establish any financial subsidiaries.
Federal Reserve System. Federal Reserve regulations, as presently in effect, require depository institutions to maintain reserves against their transaction accounts (primarily NOW and regular checking accounts), as follows: for transaction accounts aggregating $55.2 million or less, the reserve requirement is 3% of total transaction accounts; and for transaction accounts aggregating in excess of $55.2 million, the reserve requirement is $1.3 million plus 10% of the aggregate amount of total transaction accounts in excess of $55.2 million. The first $10.7 million of otherwise reservable balances are exempted from the reserve requirements. These reserve requirements are subject to annual adjustment by the Federal Reserve. The Bank is in compliance with the foregoing requirements. Beginning in the third quarter of 2008, the reserves at the Federal Reserve Bank earn interest.
Title Guaranty & Insurance Company
General. Title Guaranty is a title insurance company organized under the laws of New Mexico and doing business in Los Alamos and Santa Fe Counties. Trinity acquired Title Guaranty in May of 2000 to provide services related to the lending activities of the Bank. Title Guaranty has provided services to the Los Alamos community since its founding in 1963 and handled approximately 78% of the mortgages recorded in Los Alamos County in 2009. Title Guaranty has one competitor in Los Alamos County, which handled approximately 22% of the mortgages recorded in Los Alamos County in 2009. Title Guaranty opened a second office in the Bank’s Downtown Santa Fe facility in February 2005, and currently leases a title plant for Santa Fe County to provide title services and products. Title Guaranty faces strong competition in Santa Fe County from nine other title companies. In 2009, Title Guaranty handled approximately 10% of the mortgages recorded in Santa Fe County. Title Guaranty is regulated by the New Mexico Public Regulation Commission’s Department of Insurance with which Title Guaranty is required to file annual experience reports and who audits Title Guaranty annually. The annual experience report requires that Title Guaranty be audited annually by a certified public accountant.
Products and Services. The products and services offered by Title Guaranty include: title insurance; closings, including purchase/sale, commercial, construction, refinance, tax deferred exchange, relocation, and courtesy; escrow and notary services; title searches; and title reports. Title insurance covers lenders, investors, and property owners from potential losses that can arise in real estate ownership and is typically required for loans collateralized by real property. To streamline its processes, Title Guaranty employs current technology allowing customers to view the status of their file online. Title Guaranty’s national underwriters are Chicago Title Insurance Company, Commonwealth Land Title Insurance Company, Fidelity National Title Insurance Company, First American Title Company, and Lawyers Title Insurance Corporation.
Employees. As of December 31, 2009, Title Guaranty had 13 full time-equivalent employees. Title Guaranty is not a party to any collective bargaining agreements. Employee relations are excellent as evidenced by the results of our annual employee satisfaction surveys.
TCC Appraisal Services Corporation
TCC Appraisals was an appraisal company organized under the laws of New Mexico and doing business in Los Alamos County which Trinity acquired in January 2006 to provide services related to the lending activities of the Bank. Trinity sold the assets of TCC Appraisals in May 2008 and dissolved the company as of January 2009.
Cottonwood Technology Group, LLC
In August 2008, the Bank obtained a 26% interest in Cottonwood Technology Group, LLC (“Cottonwood”). This entity is owned by the Bank, the Los Alamos Commerce & Development Corporation and David Blivin. Cottonwood is focused on assisting new technologies, primarily those developed at New Mexico’s research and educational institutions, reach the market by providing management advice and capital consulting. Cottonwood is also engaged in the management and solicitation of funds for a venture capital fund, Cottonwood Technology Fund, in which the Bank is an investor. Additionally, the Bank entered consulting agreement with Cottonwood under which Cottonwood provides services to assist the Bank in its venture banking, start up banking and high tech banking portfolio. The Bank currently holds a 24% interest in Cottonwood.
FNM Investment Fund IV, LLC and FNM CDE IV, LLC
In 2009, the Bank created Finance New Mexico Investment Fund IV, LLC, a Delaware Limited Liability Company (“FNM Investment Fund IV”) to acquire a 99.99% interest in Finance New Mexico--Investor Series IV, LLC, a New Mexico Limited Liability Company (“FNM CDE IV”). Both entities were created to facilitate loans to and to participate in investments in a New Market Tax Credit project in downtown Albuquerque, New Mexico. The other member of FNM CDE IV is the New Mexico Finance Authority, a state instrumentality, which serves as manager.
Trinity Capital Trust I, III, IV and V
Trinity Capital Trust I, Trinity Capital Trust III, Trinity Capital Trust IV, and Trinity Capital Trust V (the “Trusts”) are Delaware statutory business trusts formed in 2000, 2004, 2005, and 2006, for the purpose of issuing $10 million, $6 million, $10 million, and $10 million in trust preferred securities and lent the proceeds to Trinity. Trinity redeemed all amounts due under Trinity Capital Trust II in December 2006 and dissolved the entity. Trinity guarantees, on a limited basis, payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities. All trust preferred securities are currently included in the Tier 1 capital of Trinity for regulatory capital purposes.
Item 1A.
Item 1A. Risk Factors
In addition to the other information in this Annual Report on Form 10-K, shareholders or prospective investors should carefully consider the following risk factors:
Difficult economic and market conditions have adversely affected our industry. Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and commercial real estate loans and resulted in significant write-downs of assets by many financial institutions across the United States. General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by many financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reductions in general business activity. Financial institutions have also generally experienced decreased access to deposits and borrowings. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, results of operations and financial condition. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. In particular, we may face the following risks in connection with these events:
·
we potentially face increased regulation of our industry and compliance with such regulation may increase our costs and limit our ability to pursue business opportunities;
·
customer demand for loans secured by real estate could be reduced due to weaker economic conditions, an increase in unemployment, a decrease in real estate values or an increase in interest rates;
·
the process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. The level of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates which may, in turn, impact the reliability of the process; and
·
the value of the portfolio of investment securities that we hold may be adversely affected.
Higher FDIC deposit insurance premiums and assessments could significantly increase our non-interest expense. FDIC insurance premiums increased significantly in 2009 and we expect to pay higher FDIC premiums in the future. Recent bank failures have substantially depleted the insurance fund of the FDIC and reduced the fund's ratio of reserves to insured deposits. The FDIC implemented a special assessment equal to five basis points of each insured depository institution's assets minus Tier 1 capital as of June 30, 2009. We recorded an expense of $701 thousand in the second quarter of 2009 for this special assessment. In November 2009, the FDIC amended its assessment regulations to require insured depository institutions to prepay their estimated quarterly regular risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 30, 2009. We prepaid $7.6 million, which will be expensed in the normal course of business throughout this three-year period.
We participate in the FDIC's Transaction Account Guarantee Program, or TAGP, for non-interest-bearing transaction deposit accounts. The TAGP is a component of the FDIC's Temporary Liquidity Guarantee Program, or TLGP. The TAGP was originally set to expire on December 31, 2009, but the FDIC established an extension period for the TAGP to run from January 1, 2010 through June 30, 2010. During the extension period, the fees for participating banks range from 15 to 25 basis points on the amounts in such accounts above the amounts covered by FDIC deposit insurance, depending on the risk category to which the bank is assigned for deposit insurance assessment purposes.
To the extent that assessments under the TAGP are insufficient to cover any loss or expenses arising from the TLGP, the FDIC is authorized to impose an emergency special assessment on all FDIC-insured depository institutions. The FDIC has authority to impose charges for the TLGP upon depository institution holding companies, as well. These charges would cause the premiums and TAGP assessments charged by the FDIC to increase. These actions could significantly increase our non-interest expense for the foreseeable future.
Our profitability is dependent upon the health of the markets in which we operate. We operate our banking offices in Los Alamos, White Rock, Santa Fe and Albuquerque, New Mexico. In late 2007 and all of 2008 and 2009, the United States economy experienced a severe downturn. While the severity of the recession in our markets has not been as bad as other parts of the country, our markets experienced significant difficulties due to the downturn in the national economy. A continued downturn in economic conditions, particularly within our market areas in Northern New Mexico, could result in a decrease in demand for our products and services, an increase in loan delinquencies and defaults and high or increased levels of problem assets and foreclosures. Moreover, because of our geographic concentration, we are less able than other regional or national financial institutions to diversify our credit risks across multiple markets.
As the largest employer in Northern New Mexico, the health of the Laboratory is central to the economic health of both Northern and Central New Mexico. The main indicator of the Laboratory’s health is its funding. The Laboratory’s 2010 fiscal budget of approximately $2.2 billion appears stable with the President’s initial 2011 fiscal budget proposals showing increased levels of approximately $2.6 billion. Any material decrease in the Laboratory’s funding may affect our customers’ business and financial interests, adversely affect economic conditions in our market area, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations.
Interest rates and other conditions impact our results of operations. Our profitability is in part a function of net interest margin. Like most banking institutions, our net interest margin will be affected by general economic conditions and other factors, including fiscal and monetary policies of the federal government, that influence market interest rates and our ability to respond to changes in such rates. At any given time, our assets and liabilities will be such that they are affected differently by a given change in interest rates. As a result, an increase or decrease in rates, the length of loan terms or the mix of adjustable and fixed rate loans in our portfolio could have a positive or negative effect on our net income, capital and liquidity. We measure interest rate risk under various rate scenarios and using specific criteria and assumptions. A summary of this process, along with the results of our net interest income simulations is presented at “Quantitative and Qualitative Disclosures About Market Risk” included under Item 7A of Part II of this report. Although we believe our current level of interest rate sensitivity is reasonable and effectively managed, significant fluctuations in interest rates may have an adverse effect on our business, financial condition and results of operations.
Changes in future rules applicable to TARP recipients could adversely affect our business, results of operations and financial condition. On March 27, 2009, we issued $35.5 million of our Fixed Rate Cumulative Perpetual Preferred Stock, Series A, to the U.S. Treasury pursuant to the TARP Capital Purchase Program, along with warrants to purchase 1,777 shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series B, which the Treasury immediately exercised. The rules and policies applicable to recipients of capital under the TARP Capital Purchase Program continue to evolve and their scope, timing and effect cannot be predicted. Any redemption of the securities sold to the U.S. Treasury to avoid these restrictions would require prior OCC, Federal Reserve and U.S. Treasury approval. Based on guidelines recently issued by the Federal Reserve, institutions seeking to redeem TARP Capital Purchase Program preferred stock must demonstrate an ability to access the long-term debt markets without reliance on the FDIC's TLG, successfully demonstrate access to public equity markets and meet a number of additional requirements and considerations before such institutions can redeem any securities sold to the U.S. Treasury.
Our ability to attract and retain management and key personnel may affect future growth and earnings, and the recent economic stimulus legislation imposes new compensation restrictions that could adversely affect our ability to do so. Much of our success and growth has been influenced strongly by our ability to attract and retain management experienced in banking and financial services and familiar with the communities in our market areas. Our ability to retain executive officers, the current management teams, branch managers and loan officers of our bank subsidiary will continue to be important to the successful implementation of our strategy. It is also critical, as we grow, to be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about our market areas to implement our community-based operating strategy. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, results of operations and financial condition.
The American Recovery and Reinvestment Act of 2009 that was signed into law in February 2009 includes extensive new restrictions on our ability to pay retention awards, bonuses and other incentive compensation during the period in which we have any outstanding securities held by the U.S. Treasury that were issued under the TARP Capital Purchase Program. Many of the restrictions are not limited to our senior executives and could cover other employees whose contributions to revenue and performance can be significant. The limitations may adversely affect our ability to recruit and retain these key employees in addition to our senior executive officers, especially if we are competing for talent against institutions that are not subject to the same restrictions. The Federal Reserve, and perhaps the FDIC, are contemplating proposed rules governing the compensation practices of financial institutions and these rules, if adopted, may make it more difficult to attract and retain the people we need to operate our businesses and limit our ability to promote our objectives through our compensation and incentive programs.
We must effectively manage our credit risk, including risks specific to real estate value due to the large concentration of real estate loans in our loan portfolio. There are risks inherent in making any loan, including risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions. We attempt to minimize our credit risk through prudent loan underwriting procedures, careful monitoring of the concentration of our loans within specific industries, monitoring of our collateral values and market conditions, and periodic independent reviews of outstanding loans by our audit department, a third-party loan review as well as external auditors. However, we cannot assure such approval and monitoring procedures will eliminate these credit risks.
The majority of the Bank’s loan portfolio is invested in commercial real estate, residential real estate, construction, general commercial and consumer lending. The maximum amount we can loan to any one customer and their related entities (our “legal lending limit”) is smaller than the limits of our national and regional competitors with larger lending limits. While there is little demand for loans over our legal lending limit ($26.5 million), we can and have engaged in participation loans with other financial institutions to respond to customer requirements. However, there are some loans and relationships that we cannot effectively compete for due to our size.
Real estate lending (including commercial, construction, and residential) is a large portion of our loan portfolio. These categories constitute $1.05 billion, or approximately 84.2% of our total loan portfolio as of December 31, 2009. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Although a significant portion of such loans are secured by real estate as a secondary form of collateral, adverse developments affecting real estate values in one or more of our markets could increase the credit risk associated with our loan portfolio. Additionally, commercial real estate lending typically involves larger loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties.
The Bank’s residential mortgage loan operations include origination, sale and servicing. The Bank’s residential mortgage loan portfolio does not include subprime mortgages and contains a limited number of non-traditional residential mortgages. The Bank employs prudent underwriting standards in making residential mortgage loans. The majority of the residential mortgage loans originated by the Bank are sold to third-party investors, primarily to the Federal National Mortgage Association (“Fannie Mae”). The Bank continues to service the majority of loans that are sold to third-party investors, to build on our relationship with the customers and provide a continuing source of income through mortgage servicing right fees. The Bank purchased mortgage-backed securities in 2009 based upon the returns and quality of these assets. Neither Trinity nor the Bank engaged in loan pools, such as CDOs, SIVs, or other instruments which contain subprime mortgage loans and have seen significant losses in value. As such, Trinity does not foresee any charge-offs, write-downs or other losses outside the ordinary course of business with respect to our residential mortgage operations.
The current real estate market in New Mexico has slowed, but not to the same extent as other areas of the nation. Residential real estate time on-the-market has increased, and home values have generally declined during 2009 in our market areas. If loans collateralized by real estate become troubled during a time when market conditions are declining or have declined, we may not be able to realize the amount of security anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition. To mitigate such risk, we employ the use of independent third parties to conduct appraisals on our real estate collateral and adhere to limits set on the percentages for the loan amount to the appraised value of the collateral. We continually monitor the real estate markets and economic conditions in the areas in which our loans are concentrated.
Our construction and development loans are based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate and we may be exposed to more losses on these projects than on other loans. At December 31, 2009, construction loans, including land acquisition and development, totaled $194.2 million, or 15.6%, of our total loan portfolio. Construction, land acquisition and development lending involve additional risks because funds are advanced based upon the value of the project, which is of uncertain value prior to its completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation of real property and the general effects of the national and local economies, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project. If we are forced to foreclose on a project prior to or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure, sale and holding costs. In addition, we may be required to fund additional amounts to complete the project and may have to hold the property for an unspecified period of time. We have attempted to address these risks through our underwriting procedures, compliance with applicable regulations, requiring that advances typically be made on a percentage of completion basis as determined by independent third party inspectors, and by limiting the amount of construction development lending.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio. Lending money is a substantial part of our business. Every loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
·
cash flow of the borrower and/or the project being financed;
·
the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
·
the credit history of a particular borrower;
·
changes in economic and industry conditions; and
·
the duration of the loan.
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management through a periodic review and consideration of several factors, including, but not limited to:
·
our general reserve, based on our historical default and loss experience;
·
our specific reserve, based on our evaluation of non-performing loans and their underlying collateral; and
·
current macroeconomic factors and model imprecision factors.
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material negative effect on our financial condition and results of operations.
Our pace of growth may be limited due to current conditions in the capital markets in general and the financial services industry specifically. We anticipate that our existing capital resources will satisfy our capital requirements for the foreseeable future and will support our ability to increase our lending and grow. However, our ability to support continued growth in the future, both internally and through acquisitions, may be dependent on our ability to raise additional capital. Due to current conditions in the capital markets in general, and the financial services industry specifically, it is unlikely that we will be able to raise inexpensive capital in the near future. Accordingly, until conditions in the capital markets, particularly for financial services companies, improve significantly, our ability to further expand our operations through internal growth and acquisitions may be limited.
We may need to raise additional capital in the future, which may not be available when it is needed. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We manage our growth rate and risk profile to ensure that our existing capital resources will satisfy our capital requirements for the foreseeable future. However, regulatory requirements, growth in assets outpacing growth in capital or our growth strategy may present conditions that would create a need for additional capital from the capital markets. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. There may not always be capital available or available on favorable terms. These conditions may alter our strategic direction and require us to manage our growth to remain within capital limits relying solely on our earnings for capital formation, thereby materially reducing our growth rate.
Our growth must be effectively managed and our growth strategy involves risks that may impact our net income. As part of our general growth strategy, we may expand into additional communities or attempt to strengthen our position in our current markets to take advantage of expanding market share by opening new offices. To the extent that we undertake additional office openings, we are likely to experience the effects of higher operating expenses relative to operating income from the new operations for a period of time, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets. Our current growth strategies involve internal growth from our current offices. The newest office (opened in October 2009) is approximately 15,000 square feet. Our experience has been rapid absorption of our Santa Fe offices, with our existing Santa Fe offices becoming profitable well ahead of budget; however, such rapid absorption is not guaranteed in the future.
We must compete with other banks and financial institutions in all lines of business. The banking and financial services business in our market is highly competitive. Our competitors include large regional banks, local community banks, savings institutions, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds, credit unions and other non-bank financial service providers. Many of these competitors are not subject to the same regulatory restrictions and may therefore enable them to provide customers with an alternative to traditional banking services.
Increased competition in our market and market changes, such as interest rate changes, force management to better control costs in order to absorb any resultant narrowing of our net interest margin, i.e., the spread between the interest rates earned on investments and loans and the interest rates paid on deposits and other interest-bearing liabilities. Without effective management and cost controls, net income may be adversely impacted by changing conditions and competition. Our efficiency leads to a decreased cost of operation that allows us to effectively anticipate and respond to market and competitive changes without adversely affecting net income.
Government regulation can result in limitations on our operations. We operate in a highly regulated environment and are subject to supervision and regulation by a number of governmental regulatory agencies, including the Federal Reserve, the OCC the FDIC and Treasury. Regulations adopted by these agencies, which are generally intended to provide protection for depositors and customers rather than for the benefit of shareholders, govern a comprehensive range of matters relating to ownership and control of our shares, our acquisition of other companies and businesses, permissible activities for us to engage in, maintenance of adequate capital levels and other aspects of our operations. These bank regulators possess broad authority to prevent or remedy unsafe or unsound practices or violations of law. The laws and regulations applicable to the banking industry could change at any time and we cannot predict the affects of these changes on our business and profitability. However, any changes in regulation could increase our cost of compliance and adversely affect profitability.
In January of 2010, the Bank entered into an Agreement with the OCC as described in Item 1 above. The Agreement is focused on reducing our classified loans and reducing our loan concentration in commercial real estate. As part of the Agreement, we agreed to develop and maintain a number of initiatives and policies, most of which were already implemented or are in the process of being implemented. If we are unable to comply with or adhere to all of the provisions in the Agreement, we could become subject to further regulatory enforcement actions, which could affect our business and operations.
Technology is continually changing and we must effectively implement new innovations in providing services to our customers. The financial services industry is undergoing rapid technological changes with frequent innovations in technology-driven products and services. In addition to better serving customers, the effective use of technology increases our efficiency and enables us to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers using innovative methods, processes and technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand our market areas. In order to anticipate and develop new technology, we employ a full staff of internal information system developers and consider this area a core part of our business. In the past, we have been able to respond to technological changes faster and with greater flexibility than our competitors. However, we must continue to make substantial investments in technology, which may affect our net income.
There is a limited trading market for our common shares and, as with all companies, shareholders may not be able to resell shares at or above the price shareholders paid for them. Our common stock is not listed on any automated quotation system or securities exchange and no firm makes a market in our stock. The trading in our common shares has less liquidity than many other companies quoted on the national securities exchanges or markets. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the market of willing buyers and sellers of our common shares at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. We cannot insure volume of trading in our common shares will increase in the future.
System failure or breaches of our network security could subject us to increased operating costs, damage to our reputation, litigation and other liabilities. The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and may cause existing and potential customers to refrain from doing business with us as well as damage to our reputation in general.
The Federal Financial Institutions Examination Council (FFIEC) issued guidance for “Strong Authentication/Two Factor Authentication” in the Internet banking environment. All financial institutions were required to make changes to their online banking systems to meet the new FFIEC requirements. In response to this guidance, Trinity incorporated multiple layers of security to protect our customers’ financial data. We further employ external information technology auditors to conduct extensive auditing and testing for any weaknesses in our systems, controls, firewalls and encryption to reduce the likelihood of any security failures or breaches. Although we, with the help of third-party service providers and auditors, intend to continue implementing security technology and establish operational procedures to prevent such damage, there can be no assurance that these security measures will be successful. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer transaction data. A failure of such security measures could have a material adverse affect on our financial condition and results of operations.
We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors. Employee errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Employee errors could include data processing system failures and errors. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence. To mitigate operational risks, we maintain a system of internal controls and insurance coverage. Should our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse affect on our business, financial condition and results of operations.
Our ability to pay dividends is limited. As of December 31, 2009, we had $37.1 million of junior subordinated debentures that are held by four business trusts that we control. Interest payments on the debentures must be paid before we pay dividends on our capital stock, including our common stock. In 2009, the interest payments totaled $2.7 million; however, the amount is subject to change each year due to a variable rate applicable to $6 million of the debentures. We have the right to defer interest payments on the debentures for up to 20 consecutive quarters. However, if we elect to defer interest payments, all deferred interest must be paid before we may pay dividends on our capital stock. Deferral of interest payments could also cause a decline in the market price of our common stock.
As a result of our participation in the CPP, until March of 2012, we may not increase the dividends payable on our common stock beyond the $0.40 semi-annual dividend that we had most recently declared prior to Treasury’s investment, without the consent of Treasury, provided Treasury still holds the Preferred Stock. Additionally, we may not pay any dividends on our common stock unless all accrued dividends on the Preferred Stock have been paid in full. Pursuant to the written Agreement with the OCC, the Bank must obtain prior approval for payment of dividends. Finally, because of the Agreement and the circumstances leading to its issuance by the OCC, we will need to seek the approval of the Federal Reserve prior to the holding company paying dividends on its common stock or distributions on the trust preferred securities and the Preferred Stock.
Recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system. The Board of Governors of the Federal Reserve System, the U.S. Congress, Treasury, the FDIC, the SEC and others enacted ESSA, ARRA and numerous other actions to address the liquidity and crisis that triggered the recession that began in 2007. These measures include homeowner relief that encourage loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. The purpose of these legislative and regulatory actions is to stabilize the U.S. banking system, improve the flow of credit and foster an economic recovery. The regulatory and legislative initiatives described above may not have their desired effects, however. If volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition and results of operations could be materially and adversely affected.
Material weaknesses or other deficiencies in our internal controls over financial reporting, including potential failure to prevent or detect errors or fraud, could affect the accuracy of our reported financial results. Management identified a material weakness in internal controls over financial reporting in 2009, relating to two material adjustments made by our auditors, as referenced in “Controls and Procedures” in Item 9A, of this Form 10-K. One of the required adjustments was based upon the valuation of certain collateral for a loan due to new information about the borrower and the underlying collateral learned in February 2010. The other adjustment was based upon an error in accrual treatment of FDIC pre-paid assessments. Trinity believes these are isolated events and is reviewing its controls and procedures to ensure such adjustments will not occur in the future. Internal control weaknesses or deficiencies may continue to affect our ability to close our financial reporting on a timely basis or report accurate numbers. In addition, acquisitions of companies lacking sufficient financial and internal control expertise may affect our ability to comply with public company reporting requirements in the future, including meeting filing deadlines established by the SEC, and ensuring that our Company-wide controls and procedures are adequate to provide financial information in a timely and reliable matter. Our ability to attract and retain qualified financial experts will also impact our ability to comply with financial reporting and Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) regulations. If we are not able to adequately comply with the requirements of Section 404 of Sarbanes-Oxley, we may be subject to sanctions or investigation by regulatory authorities. This type of action could adversely affect our financial results or investors’ confidence in our company and our ability to access capital markets and could cause our stock price to decline.
Item 1B.
Item 1B. Unresolved Staff Comments.
None
Item 2.
Item 2. Properties.
As of March 15, 2010, the Company conducted operations through six locations as shown below. Trinity is headquartered in the main Bank office in Los Alamos, New Mexico. Four banking offices are owned by the Bank and are not subject to any mortgages or material encumbrances. The Bank’s Albuquerque office is in leased office space and the Cerrillos Road office is subject to a Ground Lease as further discussed in Note 11 - “Description of Leasing Arrangements” on Page 94. In addition to our offices, the Bank operates 31 automatic teller machines (“ATMs”) throughout Northern New Mexico. The ATMs are housed either on bank properties or on leased property.
Properties
Address
Entity
Company Headquarters
Trinity Drive
Los Alamos, New Mexico 87544
Trinity
Los Alamos Office
Trinity Drive
Los Alamos, New Mexico 87544
Bank, Title Guaranty
White Rock Office
Rover
White Rock, New Mexico 87544
Bank
Santa Fe Office I (Galisteo)
Galisteo
Street Santa Fe, New Mexico 87505
Bank
Santa Fe Office II (Downtown)
Griffin Street
Santa Fe, New Mexico 87501
Bank, Title Guaranty
Albuquerque Office
Indian School Road N.E.
Albuquerque, New Mexico 87110
Bank
Santa Fe Office III (Cerrillos Road)
Cerrillos Road Santa Fe, New Mexico
Bank
Item 3.
Item 3. Legal Proceedings.
Trinity, the Bank, Title Guaranty, Cottonwood, FNM Investment Fund IV, FNM CDE IV, TCC Advisors and TCC Funds are not involved in any pending legal proceedings, other than routine legal proceedings occurring in the normal course of business and those otherwise specifically stated herein, which, in the opinion of management, in the aggregate, are material to our consolidated financial condition.
Item 4.
Item 4. [Reserved]
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Trinity’s common stock is not listed on any automated quotation system or securities exchange. No firm makes a market in our stock. As of March 16, 2010, there were 6,440,784 shares of common stock outstanding and approximately 1,500 shareholders of record. The most recent reported sale price of Trinity’s stock as of December 31, 2009 was $20.00 per share.
The tables below show the reported high and low sales prices of the common stock during the periods indicated. The prices below are only the trades where the price was disclosed to the Company. Sales where the value of the shares traded were not given to us, are not included. The following figures have been adjusted for all stock splits:
Quarter ending
High sales price
Low sales price
December 31, 2009
$
22.50
$
20.00
September 30, 2009
23.00
21.00
June 30, 2009
22.40
21.50
March 31, 2009
22.50
21.50
December 31, 2008
$
24.30
$
21.75
September 30, 2008
25.00
23.50
June 30, 2008
25.50
24.40
March 31, 2008
28.00
24.45
Dividend Policy
Since January 2008, Trinity paid dividends on our common stock as follows:
Date paid
Amount per share
January 15, 2010
$
0.27
July 10, 2009
0.40
January 9, 2009
0.40
July 11, 2008
0.40
January 11, 2008
0.40
Trinity’s ability to pay dividends to shareholders is largely dependent upon the dividends it receives from the Bank and the Bank is subject to regulatory limitations on the amount of cash dividends it may pay. The Bank’s ability to pay dividends is subject to the prior approval of the OCC under the terms of the Agreement entered into on January 26, 2010. Please see “Business-Trinity Capital Corporation-Supervision and Regulation-Dividends” and “Business-Los Alamos National Bank-Supervision and Regulation-Dividends” under Item 1 of this Form 10-K for a more detailed description of these limitations.
We have the right to, and may from time to time, enter into borrowing arrangements or issue other debt instruments, the provisions of which may contain restrictions on payment of dividends and other distributions on Trinity common stock and Trinity preferred stock. We have issued in the aggregate approximately $37.1 million in junior subordination debentures to Trinity Capital Trust I, Trinity Capital Trust III, Trinity Capital Trust IV and Trinity Capital Trust V. All of the common stock of the trusts is owned by Trinity and the debentures are the only assets of the trusts. Under the terms of the debentures, we may be prohibited, under certain circumstances, from paying dividends on shares of our common stock. None of these circumstances currently exist.
The terms of the CPP Preferred Stock issued in March of 2009 place certain restrictions on the Trinity’s ability to pay dividends on its common stock. First, no dividends on Trinity’s common stock can be paid unless all accrued dividends on Treasury’s CPP Preferred Stock have been paid in full. Second, until the third anniversary of the date of Treasury’s investment, Trinity may not increase the dividends paid on its common stock above a semi-annual dividend of $0.40 per share without first obtaining the consent of Treasury. After the third anniversary date, Trinity may increase dividends on common stock no more than 3% per year without first obtaining the consent of Treasury. After the tenth anniversary date, Trinity may not pay dividends on common stock until Treasury’s investment is repaid.
Due to the Agreement and the circumstances leading to its issuance by the OCC, we must seek approval from the Federal Reserve and the OCC prior to the Company and the Bank paying dividends on its common stock or distributions by the Company on the trust preferred securities and the Preferred Stock.
Issuer Purchases of Equity Securities
During the fourth quarter of 2009, we made no repurchases of any class of our equity securities.
Shareholder Return Performance Graph
The following graph and related information shall not be deemed to be filed, but rather furnished to the SEC by inclusion herein.
The following graph shows a comparison of cumulative total returns for Trinity, the NASDAQ Stock Market, an index of all bank stocks followed by SNL, an index of bank stock for banks with $1 billion to $5 billion in total assets followed by SNL, and an index of bank stocks that are quoted on the Pink Sheets followed by SNL. SNL no longer provides the index of bank stocks quoted on both the OTC Bulletin Board and on Pink Sheets. The cumulative total shareholder return computations assume the investment of $100.00 on December 31, 2004 and the reinvestment of all dividends. Figures for Trinity’s common stock represent inter-dealer quotations, without retail markups, markdowns or commissions and do not necessarily represent actual transactions. The graph was prepared using data provided by SNL Securities LC, Charlottesville, Virginia.
[Missing Graphic Reference]
Item 6.
Item 6. Selected Financial Data.
The following table sets forth certain consolidated financial and other data of Trinity at the dates and for the periods indicated.
_________________________
(1)
Computed by dividing total stockholders’ equity, including net stock owned by Employee Stock Ownership Plan (“ESOP”), by shares outstanding at end of period.
(2)
Computed by dividing dividends declared per common share by earnings per common share.
(3)
Computed by dividing dividends on consolidated statements of changes in stockholders’ equity by weighted average common shares outstanding.
The following table reconciles net interest income on a fully tax-equivalent basis for the periods presented:
_________________________
(1)
Calculated by dividing net income by average assets.
(2)
Calculated by dividing net income by the average stockholders’ equity, including stock owned by ESOP participants, net of unearned ESOP shares, during the year.
(3)
Calculated by dividing net income by the average stockholders’ equity, including stock owned by ESOP participants, net of unearned ESOP shares, during the year, less preferred stock and associated amortization and accretion.
(4)
Calculated by dividing net interest income (adjusted to a fully tax-equivalent basis, adjusting for federal and state exemption of interest income and certain other permanent income tax differences) by average earning assets.
(5)
Calculated by dividing operating expense by the sum of net interest income and other income.
_________________________
(1)
Ratios presented are for Trinity on a consolidated basis. See Item 7.
Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Capital Resources.”
Our summary consolidated financial information and other financial data contain information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (GAAP). These measures include net interest margin on a fully tax-equivalent basis and average equity including junior subordinated debt owed to unconsolidated trusts to average assets. Management uses these non-GAAP measures in its analysis of the Company’s performance. The tax-equivalent adjustment to net interest margin recognizes the income tax savings when comparing taxable and tax-exempt assets and adjusting for federal and state exemption of interest income and certain other permanent income tax differences. Reconciliations of net interest income on a fully tax equivalent basis to net interest income and net interest margin on a fully tax equivalent basis to net interest margin are contained in tables under “Net interest income.” Banking and financial institution regulators include junior subordinated debt owed to unconsolidated trusts when assessing capital adequacy. Management believes the presentation of the financial measures excluding the impact of these items provides useful supplemental information that is helpful in understanding our financial results, as they provide a method to assess management’s success in utilizing non-equity sources of capital. Management also believes that it is a standard practice in the banking industry to present net interest income and net interest margin on a fully tax equivalent basis, and accordingly believes the presentation of the financial measures may be useful for peer comparison purposes. This disclosure should not be viewed as a substitute for the results determined to be in accordance with GAAP, nor is it necessarily comparable to non GAAP performance measures that may be presented by other companies.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
This discussion is intended to focus on certain financial information regarding Trinity and the Bank and is written to provide the reader with a more thorough understanding of its financial statements. The following discussion and analysis of Trinity’s financial position and results of operations should be read in conjunction with the information set forth in Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” and the consolidated financial statements and notes thereto appearing under Item 8 of this report
Special Note Concerning Forward-Looking Statements
This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.
The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries are detailed in the “Risk Factors” section included under Item 1A of Part I of this Form 10-K. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
Critical Accounting Policies
Allowance for Loan Losses: The allowance for loan losses is that amount which, in management’s judgment, is considered appropriate to provide for probable losses in the loan portfolio. In analyzing the adequacy of the allowance for loan losses, management uses a comprehensive loan grading system to determine risk potential in the portfolio, and considers the results of periodic internal and external loan reviews. Historical loss experience factors and specific reserves for impaired loans, combined with other considerations, such as delinquency, non-accrual, trends on criticized and classified loans, economic conditions, concentrations of credit risk, and experience and abilities of lending personnel, are also considered in analyzing the adequacy of the allowance. Management uses a systematic methodology, which is applied at least quarterly, to determine the amount of allowance for loan losses and the resultant provisions for loan losses it considers adequate to provide for anticipated loan losses. This methodology includes a periodic detailed analysis of the loan portfolio, a systematic loan grading system and a periodic review of the summary of the allowance for loan and lease loss balance. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.
Three methods are used to evaluate the adequacy of the allowance for loan losses: (1) specific identification, based on management’s assessment of loans in our portfolio and the probability that a charge-off will occur in the upcoming quarter; (2) losses probable in the loan portfolio besides those specifically identified, based upon a migration analysis of the percentage of loans currently performing that have probable losses; and (3) qualitative adjustments based on management’s assessment of certain risks such as delinquency trends, watch-list and classified trends, changes in concentrations, economic trends, industry trends, non-accrual trends, exceptions and loan-to-value guidelines, management and staff changes and policy or procedure changes.
While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, as an integral part of their examination process regulatory agencies periodically review our allowance for loan losses and may require us to make additions to the allowance based on their evaluation of information available at the time of their examinations.
During 2009 the Company experienced continued deterioration in asset quality, as measured by non-performing assets and classified loans that are still performing. As the Company has consistently maintained a high percentage of real-estate loans, the weak real estate market in the areas of the Company’s operations has resulted in a significant number of loans being downgraded or placed on non-accrual status. Management remains concerned about possible losses in its real estate loan portfolio. Management deemed the additional allocations during 2009 to be a necessary and prudent step to reserve against probable losses indicated by the continued deterioration in asset quality. Management will continue to closely monitor asset quality in general and real estate loan quality in particular and is committed to act aggressively to minimize further losses.
Mortgage Servicing Right (MSR) Assets: Servicing residential mortgage loans for third-party investors represents a significant business activity of the Bank. As of December 31, 2009, mortgage loans serviced for others totaled $1.0 billion. The net carrying amount of the MSRs on these loans total $7.6 million as of December 31, 2009. The expected and actual rates of mortgage loan prepayments are the most significant factors driving the value of MSRs. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced. In determining the fair value of the MSRs, mortgage interest rates, which are used to determine prepayment rates and discount rates, are held constant over the estimated life of the portfolio. Fair values of the MSRs are calculated on a monthly basis. The values are based upon current market conditions and assumptions, which incorporate the expected life of the loans, estimated costs to service the loans, servicing fees to be received and other factors. MSRs are carried at the lower of the initial capitalized amount, net of accumulated amortization, or fair value.
The fair value of the MSRs is driven primarily by the effect current mortgage interest rates have on the likelihood borrowers will prepay the underlying mortgages by refinancing at a lower rate. Accordingly, higher interest rates decrease the likelihood of prepayment, extending the life of the MSRs and increasing the value of these assets. Lower interest rates increase the likelihood of prepayment, contracting the life of the MSRs and decreasing the value of these assets. This can have a significant impact on our income. There is no certainty on the direction and amount of interest rate changes looking forward, and therefore, there is no certainty on the amount or direction of the change in valuation.
An analysis of changes in mortgage servicing rights assets follows:
Below is an analysis of changes in the mortgage servicing right assets valuation allowance:
The fair values of the MSRs were $8.8 million, $5.7 million and $8.5 million on December 31, 2009, 2008 and 2007, respectively.
The primary risk characteristics of the underlying loans used to stratify the servicing assets for the purposes of measuring impairment are interest rate and original term.
Our valuation allowance is used to recognize impairments of our MSRs. An MSR is considered impaired when the market value of the MSR is below the amortized book value of the MSR. The MSRs are accounted by risk tranche, with the interest rate and term of the underlying loan being the primary strata used in distinguishing the tranches. Each tranche is evaluated separately for impairment.
We have our MSRs analyzed for impairment on a monthly basis. The underlying loans on all serviced loans are analyzed and, based upon the value of MSRs that are traded on the open market, a current market value for each risk tranche in our portfolio is assigned. We then compare that market value to the current amortized book value for each tranche. The change in market value (up to the amortized value of the MSR) is recorded as an adjustment to the MSR valuation allowance, with the offset being recorded as an addition or a reduction to income.
The impairment is analyzed for other than temporary impairment on a quarterly basis. The MSRs would be considered other than temporarily impaired if there is likelihood that the impairment would not be recovered before the expected maturity of the asset. If the underlying mortgage loans have been amortized at a rate greater than the amortization of the MSR, the MSR may be other than temporarily impaired. As of December 31, 2009, none of the MSRs were considered other than temporarily impaired.
The following assumptions were used to calculate the market value of the MSRs as of December 31, 2009, 2008 and 2007:
Overview. Despite the continued national economic weakness in 2009, the Company remained profitable and growing. We remained the largest single market-share holder in our two markets (Santa Fe and Los Alamos Counties), as measured by the Summary of Deposits (SOD) Reports compiled by the FDIC as of June 30, 2009. While earnings were significantly lower in 2009, Trinity was able to end the year with income of approximately $3.2 million before the required dividends on preferred shares issued under the CPP. Such income was after a provision for loan losses in 2009 of approximately $26.0 million. As a prudent measure against possible losses in our loan portfolio, provision for loan losses was raised by $17.8 million (representing a 218.0% increase over provision in 2008).
The national and state economies remain weak, after experiencing the worst recession in the post-World War 2 era. The Company continues to experience challenges in its loan portfolio, with higher than typically experienced levels of non-performing loans and foreclosed properties. In response to these challenges, and to proactively position the Company to meet these challenges, we have continued to reduce our concentrations in the commercial real estate and construction real estate portfolios, increased capital by participating in the Treasury’s CPP and have taken other steps in compliance with the Letter of Agreement with the OCC.
Income Statement Analysis
Net Income-General. Trinity’s net income available to common shareholders for the year ended December 31, 2009, totaled $1.6 million, or $0.24 diluted earnings per common share, compared to $8.0 million, or $1.23 diluted earnings per common share, for 2008, a decrease of $6.4 million in net income available to common shareholders and a decrease of $0.99 in diluted earnings per common share. This decrease in net income available to common shareholders was primarily due to an increase in the provision for loan losses expense of $17.8 million and an increase in non-interest expense of $5.3 million. The provision for loan losses increased pursuant to management’s loan loss reserve analysis, as a prudent measure against possible losses in the Bank’s loan portfolio, given the higher than normal levels of non-performing loans and current difficult economic conditions in our markets. The increase in non-interest expense was primarily due to an increase in FDIC insurance premiums and an increase in legal, professional and accounting fees, as well as an increase in salaries and employee benefits. The increase in FDIC insurance premiums was experienced industry-wide and we expect higher premiums to continue into the future. In addition, deterioration in asset quality that led to the Agreement with the OCC will likely increase the assessment rate the Bank will pay in 2010 and until these conditions improve. The increase in legal, professional and accounting fees was primarily due to expenses directly related to collection efforts on nonperforming loans. The increase in salaries and employee benefits was due to increased staff costs associated with the opening of our newest office in Santa Fe. In addition, non-interest income increased $8.9 million and net interest income increased $6.5 million. The increase in non-interest income was mainly due to an increase in gains in sales of loans and securities. The increase in net interest income was mainly due to a decrease in interest expense that exceeded the decrease of interest income, as our rates adjusted to the lower interest rate environment. Income tax expenses decreased $2.8 million mainly due to lower pre-tax income, as well as the benefit of certain tax credits obtained by the Company. Finally, in 2009 there were dividends and discount accretion on preferred shares issued to the Treasury as part of Trinity’s participation in the CPP of $1.6 million; there were no such dividends and discount accretion in 2008.
The profitability of the Company’s operations depends primarily on its net interest income, which is the difference between total interest earned on interest-earning assets and total interest paid on interest-bearing liabilities. The Company’s net income is also affected by its provision for loan losses as well as other income and other expenses. The provision for loan losses reflects the amount management believes to be adequate to cover probable credit losses in the loan portfolio. Non-interest income or other income consists of mortgage loan servicing fees, trust fees, loan and other fees, service charges on deposits, gain on sale of loans, gain on sale of securities, title insurance premiums and other operating income. Other expenses include salaries and employee benefits, occupancy expenses, data processing expenses, marketing, amortization and valuation of mortgage servicing rights, amortization and valuation of other intangible assets, supplies expense, loss on other real estate owned, postage, bankcard and ATM network fees, legal, professional and accounting fees, FDIC insurance premiums and other expenses.
The amount of net interest income is affected by changes in the volume and mix of interest-earning assets, the level of interest rates earned on those assets, the volume and mix of interest-bearing liabilities, and the level of interest rates paid on those interest-bearing liabilities. The provision for loan losses is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio, as well as economic and market conditions. Other income and other expenses are impacted by growth of operations and growth in the number of accounts through both acquisitions and core banking business growth. Growth in operations affects other expenses as a result of additional employees, branch facilities and promotional marketing expenses. Growth in the number of accounts affects other income including service fees as well as other expenses such as computer services, supplies, postage, telecommunications and other miscellaneous expenses.
Net Interest Income. The following tables present, for the periods indicated, the total dollar amount of interest income from average interest earning assets and the resultant yields, as well as the interest expense on average interest bearing liabilities, and the resultant costs, expressed both in dollars and rates:
_________________________
(1)
Average loans include non-accrual loans of $53.8 million, $26.5 million and $9.9 million for 2009, 2008 and 2007. Interest income includes loan origination fees of $2.8 million, $2.6 million and $3.4 million for the years ended December 31, 2009, 2008 and 2007.
(2)
Non-taxable investment income is presented on a fully tax-equivalent basis, adjusting for federal and state exemption of interest income and certain other permanent income tax differences.
(3)
Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities and is presented on a fully tax-equivalent basis.
(4)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
In 2009, net interest income on a fully tax-equivalent basis increased $6.7 million (14.1%) to $54.4 million from $47.7 million in 2008. This increase resulted from a decrease in interest expense of $11.9 million (33.3%), which was partially offset by a decrease in interest income on a fully tax-equivalent basis of $5.2 million (6.3%). The decrease in interest expense was primarily due to a decrease on the cost on interest-bearing liabilities of 121 basis points, which accounted for a $15.5 million decrease in interest expense. This was partially offset by an increase in average interest-bearing liabilities of $143.2 million (12.0%), which accounted for a $3.6 million increase in interest expense. Interest income decreased primarily due to a decrease in the yield on interest-earning assets of 93 basis points, which accounted for a decrease of $9.1 million in interest income on a fully tax-equivalent basis. This was partially offset by an increase in average interest-earning assets of $141.5 million (10.4%), accounting for an increase of $3.9 million in interest income on a fully tax-equivalent basis. The net interest margin expressed in a fully tax-equivalent basis increased 12 basis points to 3.64% in 2009 from 3.52% in 2008.
In 2008, net interest income on a fully tax-equivalent basis decreased $1.8 million (3.7%) to $47.7 million from $49.5 million in 2007. This decrease resulted from a decrease in interest income on a fully tax-equivalent basis of $13.9 million (14.3%), which was partially offset by a decrease in interest expense of $12.1 million (25.1%). The decrease in interest income on a fully tax-equivalent basis was primarily due to a decrease on the yield on interest-earning assets of 117 basis points, which accounted for a $15.6 million decrease in interest income on a fully tax-equivalent basis. This was partially offset by an increase in average interest-earning assets of $25.7 million (1.9%), which accounted for a $1.7 million increase in interest income on a fully tax-equivalent basis. Interest expense decreased primarily due to a decrease in the cost of interest-bearing liabilities of 98 basis points, which accounted for a decrease of $10.9 million in interest expense. In addition, average interest-bearing liabilities decreased $8.7 million (0.7%), accounting for a decrease of $1.2 million in interest expense. The net interest margin expressed in a fully tax-equivalent basis decreased 21 basis points to 3.52% in 2008 from 3.73% in 2007.
Volume, Mix and Rate Analysis of Net Interest Income. The following table presents the extent to which changes in volume, changes in interest rates, and changes in the interest rates times the changes in volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided on changes in each category due to (i) changes attributable to changes in volume (change in volume times the prior period interest rate) and (ii) changes attributable to changes in interest rate (changes in rate times the prior period volume). Changes attributable to the combined impact of volume and rate have been allocated proportionally to the changes due to volume and the changes due to rate.
(1)
Non-taxable investment income is presented on a fully tax-equivalent basis, adjusting for federal and state exemption of interest income and certain other permanent income tax differences.
Other Income. Changes in other income between 2009, 2008 and 2007 were as follows:
In 2009, other income increased $8.9 million (77.5%) to $20.5 million from $11.5 million in 2008. Gain on sale of loans increased $5.7 million (283.1%) mainly due to an increase in the volume of loans sold in 2009 compared to 2008. The increased volume of loan sales was due to a high volume of mortgage loan refinances due to a historically low mortgage loan interest environment. Gain on sale of securities increased $2.0 million (358.2%) mainly due to an increase in volume of securities sold in 2009 compared to 2008. These security sales were based upon interest rate risk and liquidity management decisions, as management increased liquidity by moving these securities into cash and reduced their rate sensitivity to a rising interest rate environment.. Title insurance premiums increased $549 thousand (67.4%) due to a higher volume of policies sold due to the high mortgage loan refinance activity in 2009. Trust fees increased $371 thousand (34.0%) largely due to fees on additional assets under management obtained through the Allocca and Brunett acquisition which closed in October 2008 (discussed in the notes to the financial statements below).
In 2008, other income increased $1.0 million (9.9%) to $11.5 million from $10.5 million in 2007. Gain on sale of securities increased $493 mainly due to an increase in the volume of securities sold in 2008 compared to 2007. The increased volume of security sales was based upon interest rate risk and liquidity management decisions. Gain on sale of loans increased $369 thousand mainly due to an increase in the price on loans sold in 2008 compared to 2007. Loan and other fees increased $196 thousand mainly due to an increase in fees collected from ATM operations due largely to more foreign (non-Bank customer) transactions. Other operating income decreased $165 thousand mainly due to decrease of appraisal fee income due to the sale of TCC Appraisals in the second quarter of 2008.
Other Expenses. Changes in other expenses between 2009 and 2008 and between 2008 and 2007 are as follows:
Other expenses increased $5.3 million (13.9%) to $43.3 million in 2009 from $38.0 million in 2008. FDIC insurance premiums increased $2.6 million (381.7%) reflecting an increase which was experienced industry-wide. We expect these fees to also be increased due to the conditions which led to the Agreement with the OCC. Legal, professional and accounting fees increased $1.5 million (96.6%) largely due to additional expenses incurred in the collection of nonperforming loans. Salaries and employee benefits increased $1.2 million (6.3%) largely due to additional staffing required for the new office in Santa Fe. Loss on the sale of other real estate owned increased $996 thousand (754.5%) due to the increased volume of foreclosed real estate transactions in 2009. Data processing expenses increased $559 thousand (24.4%) largely due to an increase in software maintenance expenses due to the completion of a data processing backup site in the new office in Santa Fe. Amortization and valuation of mortgage servicing rights decreased $2.5 million (58.5%) largely due to a decrease in the valuation allowance for mortgage servicing rights, caused by a higher interest rate environment at December 2009 compared to December 2008. (Though interest rates during 2009 were typically lower than in 2008, the valuation allowance is based upon the calculated market values as of the end of the year.)
Other expenses increased $3.4 million (9.9%) to $38.0 million in 2008 from $34.6 million in 2007. Amortization and valuation of mortgage servicing rights increased $1.9 million largely due to an increase in the valuation allowance for mortgage servicing rights, caused by a lower interest rate environment. FDIC insurance premiums increased $546 thousand mainly due to an increase in the rates charged by the FDIC. Data processing expenses increased $440 thousand mainly due to costs associated with software maintenance contracts. Salaries and employee benefits expense increased $354 thousand primarily due to normal merit increases in salaries, which was partially offset by a decrease in bonuses paid to employees for 2008, as a direct result of the Company’s decrease in net income. Supplies expense decreased $345 thousand primarily due to one-time costs of supplies and stationary associated with a revision to the Bank’s logo and related marketing initiatives in 2007 which were not repeated in 2008.
Income Taxes. In 2009, income tax expense decreased by $2.8 million (61.5%) from the previous year to a total of $1.8 million from $4.6 million, and the effective tax rate decreased from 36.4% in 2008 to 35.7% in 2009. The decrease in the effective tax rate was mainly attributable to the effect of tax credits obtained by the Company in 2009.
In 2008, income tax expense decreased by $2.8 million (37.8%) from the previous year to a total of $4.6 million from $7.4 million, although the effective tax rate increased from 35.6% in 2007 to 36.4% in 2008. The increase in the effective tax rate was mainly attributable to the lower rate of accrual in 2007 due to an immaterial over accrual of income taxes in 2006. This estimate was not adjusted in 2008.
Balance Sheet Analysis
Balance Sheet-General. Total assets at December 31, 2009 were $1.7 billion, an increase in $259.0 million (18.3%) from December 31, 2008. Cash and cash equivalents increased $182.2 million (721.4%), total investment securities increased $40.2 million (34.2%) and other real estate owned increased $14.4 million (611.6%). The increase in cash and cash equivalents was due to a decision by management to keep higher than historically normal levels of liquidity during the current economic downturn. During the same period, total liabilities increased $227.4 million (17.1%), increasing to $1.6 billion. The increase in total liabilities was primarily due to an increase in total deposits of $216.9 million (17.3%) and a net increase in short- and long-term borrowings of $10.0 million (42.3%). Stockholders’ equity (including stock owned by the Employee Stock Ownership Plan) increased $31.6 million (34.6%) to $122.9 million on December 31, 2009 compared to $91.3 million on December 31, 2008. This increase was primarily due to the issuance of $35.5 million in preferred shares to Treasury under the CPP.
Investment Securities. The primary purposes of the investment portfolio are to provide a source of earnings for the purpose of managing liquidity, to provide collateral to pledge against public deposits and to control interest rate risk. In managing the portfolio, the Company seeks to obtain the objectives of safety of principal, liquidity, diversification and maximized return on funds. For an additional discussion with respect to these matters, see “Liquidity and Sources of Capital” under Item 2 and “Asset Liability Management” under Item 7A
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Asset Liability Management
Our net interest income is subject to “interest rate risk” to the extent that it can vary based on changes in the general level of interest rates. It is our policy to maintain an acceptable level of interest rate risk over a range of possible changes in interest rates while remaining responsive to market demand for loan and deposit products. The strategy we employ to manage our interest rate risk involves measuring our risk using an asset/liability simulation model and adjusting the maturity of securities in our investment portfolio to manage that risk.
Interest rate risk is also measured by analyzing the extent to which the repricing of assets and liabilities are mismatched to create an interest sensitivity “gap.” An asset or liability is considered to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest earning assets maturing or repricing within a specific time period and the amount of interest bearing liabilities maturing or repricing within that same time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, therefore, a negative gap would tend to adversely affect net interest income. Conversely, during a period of falling interest rates, a negative gap position would tend to result in an increase in net interest income.
The following tables set forth the amounts of interest earning assets and interest bearing liabilities outstanding at December 31, 2009, which we anticipate, based upon certain assumptions, to reprice or mature in each of the future time periods shown. Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period was determined based on the earlier of the term to repricing or the term to repayment of the asset or liability. These tables are intended to provide an approximation of the projected repricing of assets and liabilities at December 31, 2009 on the basis of contractual maturities and scheduled rate adjustments within a three-month period and subsequent selected time intervals. The loan amounts in the table reflect principal balances expected to be reinvested and/or repriced as a result of contractual amortization and rate adjustments on adjustable-rate loans. The contractual maturities and amortization of loans and investment securities reflect modest prepayment assumptions. While NOW, money market and savings deposit accounts have adjustable rates, it is assumed that the interest rates on these accounts will not adjust immediately to changes in other interest rates. Therefore, the table is calculated assuming that these accounts will reprice based upon an historical analysis of decay rates of these particular accounts, with repricing assigned to these accounts from 1 to 10 months.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets may lag behind changes in market rates. Additionally, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Therefore, we do not rely solely on a gap analysis to manage our interest rate risk, but rather we use what we believe to be the more reliable simulation model relating to changes in net interest income.
Based on simulation modeling at December 31, 2009 and December 31, 2008, our net interest income would change over a one-year time period due to changes in interest rates as follows:
Change in Net Interest Income Over One Year Horizon
Our simulations used assume the following:
1. Changes in interest rates are immediate.
2. It is our policy that interest rate exposure due to a 2% interest rate rise or fall be limited to 15% of our annual net interest income, as forecasted by the simulation model. As demonstrated by the table above, our interest rate risk exposure was within this policy at December 31, 2009.
Changes in net interest income between the periods above reflect changes in the composition of interest earning assets and interest bearing liabilities, related interest rates, repricing frequencies, and the fixed or variable characteristics of the interest earning assets and interest bearing liabilities. Projections of income given by the model are not actual predictions, but rather show our relative interest rate risk. Actual interest income may vary from model projections.
Item 8.
Item 8. Financial Statements and Supplementary Data.
TRINITY CAPITAL CORPORATION AND SUBSIDIARIES
FINANCIAL STATEMENTS
Audited Financial Statements December 31, 2009, 2008, and 2007
INDEX
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
AUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2009. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009, based upon criteria in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on the assessment, management identified the following material weakness in the company's internal control over financial reporting:
We made two material adjustments to our financial statements during the audit process. One of the adjustments was based upon a change in the valuation of certain collateral for a loan due to new information about the borrower and underlying collateral that existed at December 31, 2009 and was learned in February 2010. The other adjustment was based upon an error in accrual treatment of FDIC pre-paid assessments. Trinity believes these are isolated events. However, Trinity is reviewing its controls and procedures for capturing and assessing subsequent events and pre-paid assessments to ensure such adjustments will not occur in the future. Because of the material weakness described in the preceding paragraph, management believes that, as of December 31, 2009, the Company’s internal control over financial reporting was not effective based on those criteria.
The Company’s independent auditors have issued an attestation report on management's assessment of the Company's internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Trinity Capital Corporation
We have audited Trinity Capital Corporation’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Trinity Capital Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion the company’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on timely basis. The following material weakness has been identified and included in management’s assessment: Management did not record all expenses in the proper year and did not properly identify subsequent events which impacted the impairment of loans. This resulted in two audit adjustments which, when combined, had a material impact to the balances within the financial statements. This material weakness was considered in determining the nature, timing and extent of audit tests applied in our audit of the 2009 financial statements, and this report does not affect our report dated March 16, 2010 on those financial statements.
In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Trinity Capital Corporation has not maintained effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations on the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheets and the related statements of income, stockholders’ equity and comprehensive income, and cash flows of Trinity Capital Corporation, and our report dated March 16, 2010 expressed an unqualified opinion.
/s/ Moss Adams LLP
Albuquerque, NM
March 16,
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Trinity Capital Corporation
We have audited the accompanying consolidated balance sheet of Trinity Capital Corporation and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2009. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Trinity Capital Corporation and subsidiaries as of December 31, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Trinity Capital Corporation’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 16, 2010 expressed an adverse opinion thereon.
/s/ Moss Adams LLP
Albuquerque, NM
March 16,
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2009 and 2008
(Amounts in thousands, except share data)
(Continued on following page)
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2009 and 2008
(Amounts in thousands, except share data)
(Continued from previous page)
The accompanying notes are an integral part of these consolidated financial statements.
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2009, 2008 and 2007
(Amounts in thousands except per share data)
(Continued on following page)
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2009, 2008 and 2007
(Amounts in thousands except per share data)
(Continued from previous page)
The accompanying notes are an integral part of these consolidated financial statements.
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2009, 2008 and 2007
(Amounts in thousands except share and per share data)
(Continued on following page)
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2009, 2008 and 2007
(Amounts in thousands except share and per share data)
(Continued from previous page)
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2009, 2008 and 2007
(Amounts in thousands except share and per share data)
(Continued from previous page)
The accompanying notes are an integral part of these consolidated financial statements.
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2009, 2008 and 2007
(Amounts in thousands)
(Continued on following page)
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2009, 2008 and 2007
(Amounts in thousands)
(Continued from previous page)
(Continued on following page)
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2009, 2008 and 2007
(Amounts in thousands)
(Continued from previous page)
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies
Consolidation: The accompanying consolidated financial statements include the consolidated balances and results of operations of Trinity Capital Corporation (“Trinity”) and its wholly owned subsidiaries: Los Alamos National Bank (the “Bank”), Title Guaranty & Insurance Company (“Title Guaranty”), TCC Advisors Corporation (“TCC Advisors”) and TCC Funds, collectively referred to as the “Company.” Trinity Capital Trust I (“Trust I”), Trinity Capital Trust III (“Trust III”), Trinity Capital Trust IV (“Trust IV”) and Trinity Capital Trust V (“Trust V”), collectively referred to as the “Trusts,” are trust subsidiaries of Trinity but are not consolidated in these financial statements (see “Consolidation” accounting policy below). Trinity sold the assets of TCC Appraisals as of May 1, 2008 and terminated the business of TCC Appraisals in January 2009. Termination of TCC Appraisals has had an immaterial effect on Trinity’s financial results. In August 2008, the Bank obtained a 26% interest in Cottonwood Technology Group, LLC (“Cottonwood”) and on July 13, 2009 the Bank assigned 2% of its interests to the other members of the company. This entity is owned by the Bank, the Los Alamos Commerce & Development Corporation and an individual not otherwise associated with Trinity or the Bank. Cottonwood completed the initial close on a pre-seed and seed stage investment fund in October 2009 and is focused on assisting new technologies, primarily those developed at New Mexico’s research and educational institutions, reach the market by providing management advice and capital consulting. The Bank’s full capital investment of $150 thousand was made in July 2009 and is reflected in these financial statements. In October 2008, the Bank purchased the assets of Allocca & Brunett, Inc., an investment advisory company in Santa Fe, New Mexico. Management expects to continue to transfer the assets of Allocca & Brunett to the Bank over the next year. In 2009, the Bank created Finance New Mexico Investment Fund IV, LLC (“FNM Investment Fund IV”) and is the only member. FNM Investment Fund IV, was created to acquire a 99.99% interest in FNM Investor Series IV, LLC (“FNM Investor Series IV”), 0.01% interest in which is held by Finance New Mexico, a governmental instrumentality. These entities were both created to enable the funding of loans to and investments in a New Market Tax Credit project.
Basis of financial statement presentation: The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany items and transactions have been eliminated in consolidation. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. In accordance with applicable accounting standards, the Company does not consolidate statutory trusts established for the sole purpose of issuing trust preferred securities and related trust common securities. See Note 10 below for more detail. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the year. Actual results could differ from those estimates. Areas involving the use of management's estimates and assumptions, which are more susceptible to change in the near term, include the allowance for loan losses, initial recording and subsequent valuation for impairment of mortgage servicing rights, income tax accounting, and other intangible asset impairment analysis.
The Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) became effective on July 1, 2009. At that date, the ASC became FASB’s officially recognized source of authoritative U.S. GAAP applicable to all public and non-public non-governmental entities, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to U.S. GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.
Nature of operations: The Company provides a variety of financial services to individuals, businesses and government organizations through its offices in Los Alamos, Santa Fe and Albuquerque, New Mexico. Its primary deposit products are term certificate, NOW and savings accounts and its primary lending products are commercial, residential and construction real estate loans. The Company also offers trust and wealth management services and title insurance products.
The Bank conducts its operations from its main office in Los Alamos and separate office locations in Albuquerque, Santa Fe and White Rock, New Mexico. The Bank also operates drive-up facilities and 31 automatic teller machines (ATM’s) in Los Alamos, Santa Fe and surrounding geographic areas. Title Guaranty conducts its operations from its offices in Los Alamos and Santa Fe.
Deposits with banks, federal funds sold and securities purchased under resell agreements: For purposes of reporting cash flows, cash and cash equivalents includes cash on hand, amounts due from banks (including cash items in process of clearing), interest-bearing deposits with banks and federal funds sold.
Investment securities available for sale: Securities classified as available for sale are debt securities the Bank intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Bank's assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available for sale are reported at fair value with unrealized gains or losses reported as other comprehensive income, net of the related deferred tax effect. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings.
Purchase premiums and discounts are generally recognized in interest income using the interest method over the term of the securities. For mortgage-backed securities, estimates of prepayments are considered in the constant yield calculations.
Declines in the fair value of individual securities classified as available for sale below their amortized cost that are determined to be other than temporary (OTTI) result in write-downs of the individual securities to their fair value with the resulting write-downs included in current earnings as realized losses. Impairment is assessed at the individual security level. An investment security is impaired if the fair value of the security is less than its amortized cost basis. Once the security is impaired, a determination must be made to see if it is OTTI.
In determining OTTI losses, management considers many factors, including: current market conditions, fair value in relationship to cost; extent and nature of the change in fair value; issuer rating changes and trends; whether to sell the security before recovery of the amortized cost basis of the investment, which may be maturity; and other factors. For debt securities, if management intends to sell the security or it is likely that the Bank will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If management does not intend to sell the security and it is not likely that the Bank will be required to sell the security, but management does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Project cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, i.e., the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income. Impairment losses related to call other factors are presented as separate categories within other comprehensive income.
Investment securities held to maturity: Securities classified as held to maturity are those securities that the Company has the ability and positive intent to hold until maturity. These securities are reported at amortized cost. Sales of investment securities held to maturity within three months of maturity are treated as maturities.
Other investments: The Bank, as a member of the Federal Home Loan Bank of Dallas (the “FHLB”), is required to maintain an investment in capital stock of the FHLB based upon borrowings made from the FHLB and based upon various classes of loans in the Bank’s portfolio. FHLB and Federal Reserve Bank stock do not have readily determinable fair values as ownership is restricted and it lacks a market. As a result, these stocks are carried at cost and evaluated periodically by management for impairment.
The Company’s investment in the unconsolidated trusts is also reported as an investment in this line of the balance sheet. Also included is the Bank’s investment in certain venture capital funds. In addition, the Bank has other non-marketable investments that are carried at cost and evaluated periodically by management for impairment. Investments with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in the case of fixed rate investments, from rising interest rates. At each financial statement date, management assesses each investment to determine if impaired investments are temporarily impaired or if the impairment is other than temporary based upon the evidence available. Evidence evaluated includes (if applicable), but is not limited to, industry analyst reports, credit market conditions, and interest rate trends. If negative evidence outweighs positive evidence that the carrying amount is recoverable within a reasonable period of time, the impairment is deemed to be other-than-temporary and the security is written down in the period in which such determination is made.
Loans held for sale: Loans held for sale are those loans the Company intends to sell. They are carried at the lower of aggregate cost or market value. Gains and losses on sales of loans are recognized at settlement dates and are determined by the difference between the sales proceeds plus the value of the mortgage servicing rights compared to the carrying value of the loans. These are generally sold within 30 to 60 days of origination.
Loans: Loans are stated at the amount of unpaid principal reduced by the allowance for loan losses and unearned income.
Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the related loan’s yield. The Company is amortizing these amounts over the estimated life of the loan. Commitment fees based upon a percentage of a customer’s unused line of credit and fees related to standby letters of credit are recognized over the commitment period. Net deferred fees on real estate loans sold in the secondary market reduce the cost basis in such loans.
Interest on loans is accrued and reported as income using the interest method on daily principal balances outstanding. The Bank generally discontinues accruing interest on loans when the loan becomes 90 days or more past due or when management believes that the borrower’s financial condition is such that collection of interest is doubtful. Cash collections on nonaccrual loans are credited to the loan balance, and no interest income is recognized on those loans until the principal balance has been determined to be collectible. Loans renegotiated in troubled debt restructurings are those loans on which concessions in terms have been granted because of a borrower’s financial difficulty.
Loans, other than those included in large groups of smaller-balance homogeneous loans, are considered impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impairment (if any) and any subsequent changes are included in the allowance for loan losses.
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that collectability of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb probable losses on existing loans, based on an evaluation of the collectability of loans in the portfolio and prior loss experience. The allowance for loan losses is based on management’s evaluation of the loan portfolio giving consideration to the nature and volume of the loan portfolio, the value of underlying collateral, overall portfolio quality, review of specific problem loans, and prevailing economic conditions that may affect the borrower’s ability to pay. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the subsidiary Bank’s allowance for loan losses, and may require the subsidiary bank to recognize additions to its allowance based on their judgments of information available to them at the time of their examinations.
Premises and equipment: Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization is computed by the straight-line method for buildings and computer equipment over their estimated useful lives. Leasehold improvements are amortized over the term of the related lease or the estimated useful lives of the improvements, whichever is shorter. For owned and capitalized assets, estimated useful lives range from three to 39 years. Maintenance and repairs are charged to expense as incurred, while major improvements are capitalized and amortized to operating expense over their identified useful life. Generally, the useful life on software is three years; on computer and office equipment, five years; on furniture, 10 years; and on building and building improvements, 10 to 39 years.
Other real estate owned (“OREO”): OREO includes real estate assets that have been received in full or partial satisfaction of debt. OREO is initially recorded and subsequently carried at the lower of cost or fair value less estimated selling costs. Any valuation adjustments required at the date of transfer are charged to the allowance for loan losses. Subsequently, unrealized losses and realized gains and losses on sale are included in other non-interest income. Operating results from OREO are recorded in other non-interest expense.
Mortgage servicing rights: The Bank recognizes, as separate assets, rights to service mortgage loans for others, whether the rights are acquired through purchase or after origination and sale of mortgage loans. In cases where the mortgage loan is originated and sold, the total cost of the mortgage loan is allocated to the mortgage servicing right and to the loan based on their relative fair values.
The carrying amount of mortgage servicing rights, and the amortization thereon, is periodically evaluated in relation to estimated fair value. The Bank stratifies the underlying mortgage loan portfolio by certain risk characteristics, such as loan type, interest rate and maturity, for purposes of measuring impairment. The Bank estimates the fair value of each stratum by calculating the discounted present value of future net servicing income based on management’s best estimate of remaining loan lives. The Bank has determined that the primary risk characteristic of the mortgage servicing rights is the contractual interest rate of the underlying mortgage loans.
The carrying value of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenues.
Other intangible assets. The Company may obtain intangible assets other than mortgage servicing rights from time to time. In certain cases, these assets have no definite life and are not amortized. Other intangible assets may have an expected useful life and are amortized over this life. All intangible assets are tested periodically for impairment and, if deemed impaired, the assets are written down to the current value, with the impairment amount being charged to current earnings.
Prepaid expenses. The Company may pay certain expenses before the actual costs are incurred. In this case, these expenses are recognized as an asset. These expenses are amortized as expense over the period of time in which the costs are incurred. The original term of these prepaid expenses generally range from three months to five years. The most significant single prepaid expense as of December 31, 2009 was a $7.6 million prepaid FDIC insurance premium to be amortized over a period of three years.
Earnings per common share: Basic earnings per 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 were determined assuming that all stock options were exercised at the beginning of the years presented. Unearned shares owned by the Employee Stock Ownership Plan (ESOP) are treated as not outstanding for the purposes of computing basic earnings per common share.
Average number of shares used in calculation of earnings per common share and diluted earnings per common share are as follows:
Certain stock options were not included in the above calculation, as these stock options would have an anti-dilutive effect as the exercise price is greater than current market prices. The total number of shares excluded was 356,500, 314,500 and 262,500 as of December 31, 2009, 2008 and 2007, respectively.
Comprehensive income: Comprehensive income includes net income, as well as the change in net unrealized gain on investment securities available for sale, net of tax. Comprehensive income is presented in the following table:
Segment reporting: The Company is managed as one unit and does not have separate operating segments. The Company’s chief operating decision-makers use consolidated results to make operating and strategic decisions.
Transfers of financial assets: Transfers of financial assets are accounted for as sales only when the control over the financial assets has been surrendered. Control over transferred assets is deemed surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Impairment of long-lived assets: Management periodically reviews the carrying value of its long-lived assets to determine if impairment has occurred or whether changes in circumstances have occurred that would require a revision to the remaining useful life. In making such determination, management evaluates the performance, on an undiscounted basis, of the underlying operations or assets which give rise to such amount.
Income taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carryforwards, and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Stock-based compensation: The Company’s 1998 Stock Option Plan (“1998 Plan”) and Trinity Capital Corporation 2005 Stock Incentive Plan (“2005 Plan”) were created for the benefit of key management and select employees. Under the 1998 Plan, 400,000 shares (as adjusted for the stock split of December 19, 2002) from shares held in treasury or authorized but unissued common stock are reserved for granting options. Under the 2005 Plan, 500,000 shares from shares held in treasury or authorized but unissued common stock are reserved for granting stock-based incentive awards. Both of these plans were approved by the Company’s shareholders. The Board of Directors determines vesting and pricing of the awards. All stock options granted through December 31, 2005 were granted at or above the market value of the stock at the date of the grant, with the exception of the July 1998 stock option grant which was granted at $0.25 below the last reported sale price on the date of grant. All stock options vest in equal amounts over a three year period and must be exercised within ten years of the date of grant. Stock appreciation rights granted after December 31, 2005 were also granted at or above the market value of the stock at the date of the grant, with the exception of the January 1, 2006 stock appreciation right grants which were approved on December 15, 2005 and granted at the December 31, 2005 closing price to take advantage of accounting changes favorable to Trinity; all mature at five years.
Preferred stock: Preferred stock callable at the option of the Company is initially recorded at the amount of proceeds received. Any discount from the liquidation value is accreted to the preferred stock and charged to retained earnings. The accretion is recorded using the level-yield method. Preferred dividends paid (declared and accrued) and any accretion is deducted from net income for computing income available to common shareholders and earnings per share computations.
Recent accounting pronouncements:
On July 1, 2009, the Accounting Standards Codification became FASB’s officially recognized source of authoritative U.S. generally accepted accounting principles applicable to all public and non-public non-governmental entities, superseding existing FASB, AICPA, EITF and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to U.S. GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.
ASC Topic 260, “Earnings Per Share.” On January 1, 2009, the Company adopted new authoritative accounting guidance under ASC Topic 260, “Earnings Per Share,” which provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method, as discussed above. The adoption of this guidance did not significantly impact the Company’s previously reported financial statements.
ASC Topic 320, “Investments-Debt and Equity Securities.” New authoritative accounting guidance under ASC Topic 320, “Investments-Debt and Equity Securities,” (i) changes existing guidance for determining whether an impairment is other than temporary to debt securities and (ii) replaces the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis. Under ASC Topic 320, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. The Company adopted the provisions of the new authoritative accounting guidance under ASC Topic 320 during the first quarter of 2009. Adoption of the new guidance did not significantly impact the Company’s financial statements.
ASC Topic 805, “Business Combinations.” On January 1, 2009, new authoritative accounting guidance under ASC Topic 805, “Business Combinations,” became applicable to the Company’s accounting for business combinations closing on or after January 1, 2009. ASC Topic 805 applies to all transactions and other events in which one entity obtains control over one or more other businesses. ASC Topic 805 requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process required under previous accounting guidance whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their estimated fair value. ASC Topic 805 requires acquirers to expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed, as was previously the case under prior accounting guidance. Assets acquired and liabilities assumed in a business combination that arise from contingencies are to be recognized at fair value if fair value can be reasonably estimated. If fair value of such an asset or liability cannot be reasonably estimated, the asset or liability would generally be recognized in accordance with ASC Topic 450, “Contingencies.” Under ASC Topic 805, the requirements of ASC Topic 420, “Exit or Disposal Cost Obligations,” would have to be met in order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting and, instead, that contingency would be subject to the probable and estimable recognition criteria of ASC Topic 450, “Contingencies”.
ASC Topic 810, “Consolidation.” New authoritative accounting guidance under ASC Topic 810, “Consolidation,” amended prior guidance to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Under ASC Topic 810, a non-controlling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, ASC Topic 810 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. The new authoritative accounting guidance under ASC Topic 810 became effective for the Company on January 1, 2009, and did not have a significant impact on the Company’s financial statements.
Further new authoritative accounting guidance under ASC Topic 810 amends prior guidance to change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. The new authoritative accounting guidance requires additional disclosures about the reporting entity’s involvement with variable-interest entities and any significant changes in risk exposure due to that involvement as well as its affect on the entity’s financial statements. The new authoritative accounting guidance under ASC Topic 810 was effective January 1, 2010 and is not expected to have a significant impact on the Company’s financial statements.
ASC Topic 815, “Derivatives and Hedging.” New authoritative accounting guidance under ASC Topic 815, “Derivatives and Hedging,” amends prior guidance to amend and expand the disclosure requirements for derivatives and hedging activities to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under ASC Topic 815, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. To meet those objectives, the new authoritative accounting guidance requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. The new authoritative accounting guidance under ASC Topic 815 became effective for the Company on January 1, 2009 and the required disclosures are reported in Note 18 below.
ASC Topic 820, “Fair Value Measurements and Disclosures.” ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of ASC Topic 820 became effective for the Company on January 1, 2008 for financial assets and financial liabilities and on January 1, 2009 for non-financial assets and non-financial liabilities (see Note 20 below).
Additional new authoritative accounting guidance under ASC Topic 820 affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction, and clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. ASC Topic 820 requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. The new accounting guidance amended prior guidance to expand certain disclosure requirements. The Company adopted the new authoritative accounting guidance under ASC Topic 820 during the first quarter of 2009. Adoption of the new guidance did not significantly impact the Company’s financial statements.
Further new authoritative accounting guidance (Accounting Standards Update No. 2009-5) under ASC Topic 820 provides guidance for measuring the fair value of a liability in circumstances in which a quoted price in an active market for the identical liability is not available. In such instances, a reporting entity is required to measure fair value utilizing a valuation technique that uses (i) the quoted price of the identical liability when traded as an asset, (ii) quoted prices for similar liabilities or similar liabilities when traded as assets, or (iii) another valuation technique that is consistent with the existing principles of ASC Topic 820, such as an income approach or market approach. The new authoritative accounting guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The forgoing new authoritative accounting guidance under ASC Topic 820 became effective for the Company’s financial statements for periods ending after October 1, 2009 and did not have a significant impact on the Company’s financial statements.
ASC Topic 860, “Transfers and Servicing.” New authoritative accounting guidance under ASC Topic 860, “Transfers and Servicing,” amends prior accounting guidance to enhance reporting about transfers of financial assets, including securitizations, and where companies have continuing exposure to the risks related to transferred financial assets. The new authoritative accounting guidance eliminates the concept of a “qualifying special-purpose entity” and changes the requirements for derecognizing financial assets. The new authoritative accounting guidance also requires additional disclosures about all continuing involvements with transferred financial assets including information about gains and losses resulting from transfers during the period. The new authoritative accounting guidance under ASC Topic 860 became effective January 1, 2010, and is not expected to have a significant impact on the Company’s financial statements.
Note 2. Restrictions on Cash and Due From Banks
The Bank is required to maintain reserve balances in cash or on deposit with the Federal Reserve Bank, based on a percentage of deposits. As of December 31, 2009, the Bank had sufficient balances in cash and there was no reserve balance requirement at the Federal Reserve Bank. As of December 31, 2008, the reserve requirement at the Federal Reserve Bank was $2.4 million.
The Company maintains some of its cash in bank deposit accounts at financial institutions other than its subsidiaries that, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents.
Note 3. Investment Securities
Carrying amounts and fair values of investment securities are summarized as follows:
Realized net gains on sale of securities available for sale are summarized as follows:
A summary of unrealized loss information for investment securities, categorized by security type, at December 31, 2009 and 2008, was as follows:
At December 31, 2009, $65.4 million in debt securities had unrealized losses with aggregate depreciation of 2.3% of the Company’s amortized cost basis. Of these securities, $3.4 million had a continuous unrealized loss position for twelve months or longer with an aggregate depreciation of 12.3%. The unrealized losses relate principally to the general change in interest rates and illiquidity, and not credit quality, that has occurred since the securities purchase dates, and such unrecognized losses or gains will continue to vary with general interest rate level fluctuations in the future. As management does not intend to sell the securities, and it is likely that it will not be required to sell the securities before their anticipated recovery, no declines are deemed to be other-than-temporary.
The amortized cost and fair value of investment securities, as of December 31, 2009, by contractual maturity are shown below. Maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
Securities with carrying amounts of $49.5 million and $27.5 million at December 31, 2009 and 2008, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.
Note 4. Loans
Loans consisted of:
Loans are made to individuals as well as commercial and tax exempt entities. Specific loan terms vary as to interest rate, repayment and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated, in that the majority of loan customers are located in the markets serviced by the Bank.
Non-performing loans as of December 31, 2009, 2008 and 2007, were as follows:
There were no loans past due more than 90 days and still accruing interest at the end of 2009, 2008 or 2007. The reduction in interest income associated with loans on non-accrual status was $3.4 million, $2.3 million and $882 thousand for the years ended December 31, 2009, 2008 and 2007.
Information about impaired loans as of and for the years ended December 31, 2009, 2008 and 2007, is as follows:
Total troubled debt restructures, both those in accrual and non-accrual status, were $8.2 million, $3.3 million and $521 thousand as of December 31, 2009, 2008 and 2007, respectively.
Activity in the allowance for loan losses was as follows:
Loans outstanding to executive officers and directors of the Company, including companies in which these individuals have management control or beneficial ownership, at December 31, 2009 and 2008, were approximately $5.0 million and $4.2 million. In the opinion of management, these loans have similar terms to other customer loans. An analysis of the activity related to these loans for the years ended December 31, 2009 and 2008 is as follows:
Note 5. Loan Servicing and Mortgage Servicing Rights
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid balance of these loans as of December 31, 2009 and 2008 is summarized as follows:
Custodial balances on deposit at the Bank in connection with the foregoing loan servicing were approximately $4.9 million and $6.2 million as of December 31, 2009 and 2008. There were no custodial balances on deposit with other financial institutions during 2009 and 2008.
An analysis of changes in mortgage servicing rights asset follows:
Below is an analysis of changes in the mortgage servicing right asset valuation allowance:
The fair values of the MSRs were $8.8 million, $5.7 million and $8.5 million on December 31, 2009, 2008 and 2007, respectively.
The primary risk characteristics of the underlying loans used to stratify the servicing assets for the purposes of measuring impairment are interest rate and original term.
Our valuation allowance is used to recognize impairments of our MSRs. An MSR is considered impaired when the market value of the MSR is below the amortized book value of the MSR. The MSRs are accounted by risk tranche, with the interest rate and term of the underlying loan being the primary strata used in distinguishing the tranches. Each tranche is evaluated separately for impairment.
Our MSRs are analyzed for impairment on a monthly basis. The underlying loans on all serviced loans are analyzed and, based upon the value of MSRs that are traded on the open market, a current market value for each risk tranche in our portfolio is assigned. We then compare that market value to the current amortized book value for each tranche. The change in market value (up to the amortized value of the MSR) is recorded as an adjustment to the MSR valuation allowance, with the offset being recorded as an addition or a reduction to income.
The following assumptions were used to calculate the market value of the MSRs as of December 31, 2009, 2008 and 2007:
Note 6. Other intangible assets
In October 2008, the Bank purchased a customer list from Allocca & Brunett, Inc., an investment advisory company in Santa Fe, New Mexico, for $800 thousand. The purpose of this acquisition was to broaden our customer base and increase assets under management in the Bank’s trust operations. This customer list is considered an intangible asset under ASC Topic 350, "Intangibles-Goodwill and Other.". Under ASC Topic 350, an intangible asset with a finite life shall be amortized over the useful life of the asset. Where the useful life is not known, estimates are permissible.
The useful life of the purchased customer list has been estimated at three years, based upon the purchase agreement entered into between the Bank and Allocca & Brunett, Inc. This intangible asset is to be amortized to a residual value of zero at the end of the period using a straight-line amortization method.
The value of the asset is primarily derived from the expectation that the customers of Allocca & Brunett, Inc. will be substantially acquired by the Bank during the amortization period. An additional payment of $352 thousand was made on the anniversary date of the closing date in 2009 per the acquisition contract. This additional cost is being amortized over the remaining two years of estimated useful life of the original asset. Additional payments to Allocca & Brunett, Inc. may be required on the basis of the assets held by the Bank on each of the next two anniversaries of the closing date. The conversion of these accounts shall be monitored and, if the conversion rate falls below expectations, this asset may be deemed impaired. The customer list would be reviewed for impairment under FASB ASC Topic 350, "Intangibles-Goodwill and Other.". This impairment will be realized as an expense in the period in which it is recognized. Management expects to integrate the assets of Allocca & Brunett into the Bank’s existing Investment Services Department over the next twelve months.
During the years ended December 31, 2009 and 2008, $296 thousand and $44 thousand were amortized, respectively. The expected amortization of other intangible assets over the next five years at December 31, 2009 is as follows:
In addition to the acquired customer list, the Company had $3 thousand in trademarks as non-amortizing intangible assets outstanding as of December 31, 2009 and 2008.
Note 7. Premises and Equipment
Premises and equipment consisted of:
Depreciation on premises and equipment totaled $2.7 million, $2.4 million and $2.3 million for the years ended December 31, 2009, 2008 and 2007. The construction in progress as of December 31, 2008 was for the new office in Santa Fe, completed in 2009.
Note 8. Deposits
Deposits consisted of:
At December 31, 2009, the scheduled maturities of time certificates were as follows:
As of December 31, 2009 and 2008, the Company had $5.7 million and $1.0 million, respectively, in certificates of deposit held under the Certificate of Deposit Registry Service (CDARS). Under the service agreements, customer certificates of deposit in excess of the FDIC insurance limits are exchanged with deposits at other financial institutions, resulting in no net change in total deposits but resulting in increased FDIC insurance coverage. Under regulatory guidelines and certain conditions, these may be considered brokered deposits. The Company had no non-CDARS brokered deposits at December 31, 2009 or 2008.
Note 9. Short- and Long-term Borrowings, including Borrowings made by Employee Stock Ownership Plan (ESOP)
Notes payable to the Federal Home Loan Bank (FHLB) at December 31, 2009 and 2008, were secured by a blanket assignment of mortgage loans or other collateral acceptable to FHLB, and generally had a fixed rate of interest, interest payable monthly and principal due at end of term, unless otherwise noted. The total value of loans under the blanket assignment, as of December 31, 2009, was $441.3 million.
The following is a summary of debt payments required for years after 2009.
Note 10. Junior Subordinated Debt Owed to Unconsolidated Trusts
The following table presents details on the junior subordinated debt owed to unconsolidated trusts as of December 31, 2009:
On the dates of issue indicated above, the Trusts, being Delaware statutory business trusts, issued trust preferred securities (the “trust preferred securities”) in the amount and at the rate indicated above. These securities represent preferred beneficial interests in the assets of the Trusts. The trust preferred securities will mature on the dates indicated, and are redeemable in whole or in part at the option of Trinity at any time after the date of first redemption indicated above, with the approval of the Federal Reserve Board and in whole at any time upon the occurrence of certain events affecting their tax or regulatory capital treatment. The Trusts also issued common equity securities to Trinity in the amounts indicated above. The Trusts used the proceeds of the offering of the trust preferred securities to purchase junior subordinated deferrable interest debentures (the “debentures”) issued by Trinity, which have terms substantially similar to the trust preferred securities. Trinity has the right to defer payments of interest on the debentures at any time or from time to time for a period of up to ten consecutive semi-annual periods with respect to each interest payment deferred. Under the terms of the debentures, under certain circumstances of default or if Trinity has elected to defer interest on the debentures, Trinity may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of its capital stock. Trinity used the majority of the proceeds from the sale of the debentures to add to Tier 1 and Tier 2 capital in order to support its growth and to purchase treasury stock.
Trinity owns all of the outstanding common securities of the Trusts. The Trusts are considered variable interest entities (VIEs) under ASC Topic 810, "Consolidation." Because Trinity is not the primary beneficiary of the Trusts, the financial statements of the Trusts are not included in the consolidated financial statements of the Company.
In March 2005, the Board of Governors of the Federal Reserve System issued a final rule allowing bank holding companies to continue to include qualifying trust preferred securities in their Tier 1 Capital for regulatory capital purposes, subject to a 25% limitation to all core (Tier I) capital elements, net of goodwill less any associated deferred tax liability. The final rule provides a five-year transition period, ending March 31, 2009, for application of the aforementioned quantitative limitation. In April 2009, this five-year transition period was extended for an additional year. As of December 31, 2009, 100% of the trust preferred securities noted in the table above qualified as Tier 1 capital under the final rule adopted in March 2005.
Payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities are guaranteed by Trinity on a limited basis. Trinity also entered into an agreement as to expenses and liabilities with the Trusts pursuant to which it agreed, on a subordinated basis, to pay any costs, expenses or liabilities of the Trusts other than those arising under the trust preferred securities. The obligations of Trinity under the junior subordinated debentures, the related indenture, the trust agreement establishing the Trusts, the guarantee and the agreement as to expenses and liabilities, in the aggregate, constitute a full and unconditional guarantee by Trinity of the Trusts’ obligations under the trust preferred securities.
Issuance costs of $615 thousand related to Trust I and Trust III were deferred and are being amortized over the period until mandatory redemption of the securities in March 2030 and September 2034, respectively. During 2009, 2008 and 2007, $14 thousand of these issuance costs were amortized in each year. The total amount of the issuance costs of the issue paid off in 2006 was amortized that year. Unamortized issuance costs were $283 thousand, $297 thousand and $311 thousand at December 31, 2009, 2008 and 2007, respectively. There were no issuance costs associated with the other trust preferred security issues.
Dividends accrued and unpaid to securities holders totaled $478 thousand and $485 thousand on December 31, 2009 and 2008, respectively.
Under the terms of the securities purchase agreement between the Company and the U.S. Treasury pursuant to which the Company issued its Series A Preferred Stock as part of the TARP Capital Purchase Program, prior to the earlier of (i) March 27, 2012 and (ii) the date on which all of the shares of the Series A and Series B Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not redeem our trust preferred securities (or the related junior subordinated notes), without the consent of Treasury. See Note 23 below.
Note 11. Description of Leasing Arrangements
The Company is leasing land in Santa Fe on which it has built a banking office. The construction of the office was completed in 2009. The lease has an 8 year term and expires in 2014, and contains an option to purchase the land at a set price at the termination of the initial term of the lease. This lease is classified as a capital lease. The Company also holds a note and mortgage on this land, and the interest payments received on the note are approximately equal to the payments made on the lease and the principal due at maturity (simultaneous with the lease maturity) will largely offset the option purchase price.
In addition, the Company leases certain equipment, ATM location space, office space and storage space from other parties under operating leases expiring through 2010. Lease payments for the years ended December 31, 2009, 2008 and 2007 totaled $402 thousand, $370 thousand and $361 thousand, respectively.
The following is a schedule by years of future minimum lease payments under capital leases together with the present value of the net minimum lease payments as of December 31, 2009:
Commitments for minimum future rentals under the operating leases were as follows at December 31, 2009:
Note 12. Retirement Plans
The Company has a qualified Employee Stock Ownership Plan (“ESOP”) for the benefit of all employees who are at least 18 years of age and have completed 1,000 hours of service during the Plan year. The employee’s interest in the ESOP vests over a period of six years. The ESOP was established in January 1989 and is a defined contribution plan subject to the requirements of the Employee Retirement Income Security Act of 1974.
The ESOP is funded by annual discretionary contributions by the Company as determined by its Board of Directors. The Company’s discretionary contributions to the ESOP in 2009, 2008 and 2007 were approximately $342 thousand, $564 thousand and $483 thousand, respectively.
The ESOP had a note payable of $271 thousand outstanding with a local bank as of December 31, 2007. The note required annual principal payments of $471 thousand with the final payment of principal made on January 20, 2008. Interest was variable at Citibank Prime (7.25% at December 31, 2007) and was payable semi-annually. Collateral for this loan was Company stock owned by the ESOP and unallocated to the plan participants. Shares were released from collateral based upon the ratio of principal and interest paid during the year to total principal and interest paid for the current year and payable for all future plan years. Allocations of common stock purchased, released and forfeited are based on the eligible compensation of each participant. The note payable was recorded as debt and the shares pledged as collateral netted against stock owned by ESOP participants in the accompanying balance sheets. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of debt and accrued interest. The note was paid off in full on January 14, 2008. All shares pledged as collateral were released and allocated to plan participants.
All shares held by the ESOP, acquired prior to the issuance of ASC 718-40 are included in the computation of average common shares and common share equivalents. This accounting treatment is grandfathered for shares purchased prior to December 31, 1992. As permitted by ASC 718-40, compensation expense for shares released is equal to the original acquisition cost of the shares if acquired prior to December 31, 1992. As shares acquired after ASC 718-40 were released from collateral, the Company reported compensation expense equal to the current fair value of the shares, and the shares became outstanding for earnings-per-share computations.
Shares of the Company held by the ESOP acquired prior to December 31, 1992 totaled 229,787 and 235,250 shares at December 31, 2009 and 2008, respectively.
Shares of the Company held by the ESOP acquired after December 31, 1992 are as follows:
There was no compensation expense recognized for ESOP shares acquired prior to December 31, 1992 during the years 2009, 2008 and 2007. Compensation expense recognized for ESOP shares acquired after December 31, 1992 during 2009, 2008 and 2007 was $341 thousand, $611 thousand and $666 thousand, respectively.
Under federal income tax regulations, the employer securities that are held by the Plan and its participants and that are not readily tradable on an established market or that are subject to trading limitations include a put option (liquidity put). The liquidity put is a right to demand that the Company buy shares of its stock held by the participant for which there is no readily available market. The put price is representative of the fair value of the stock. The Company may pay the purchase price over a five-year period. The purpose of the liquidity put is to ensure that the participant has the ability to ultimately obtain cash. The fair value of the allocated shares subject to repurchase was $12.5 million and $13.1 million as of December 31, 2009 and 2008.
The Company’s employees may also participate in a tax-deferred savings plan (401(k)) to which the Company does not contribute.
Note 13. Stock Incentives
The Company’s 1998 Stock Option Plan (“1998 Plan”) and Trinity Capital Corporation 2005 Stock Incentive Plan (“2005 Plan”) were created for the benefit of key management and select employees. Under the 1998 Plan, 400,000 shares (as adjusted for the stock split of December 19, 2002) from shares held in treasury or authorized but unissued common stock are reserved for granting options. Under the 2005 Plan, 500,000 shares from shares held in treasury or authorized but unissued common stock are reserved for granting stock-based incentive awards. Both of these plans were approved by the Company’s shareholders. The Board of Directors determine vesting and pricing of the awards. All stock options granted through December 31, 2005 were granted at or above the market value of the stock at the date of the grant, with the exception of the July 1998 stock option grant which was granted at $0.25 below the last reported sale price on the date of grant. All stock options vest in equal amounts over a three year period and must be exercised within ten years of the date of grant. Stock appreciation rights granted after December 31, 2005 were also granted at or above the market value of the stock at the date of the grant, with the exception of the January 1, 2006 stock appreciation right grants which were approved on December 15, 2005 and granted at the December 31, 2005 closing price to take advantage of accounting changes favorable to Trinity. All stock appreciation rights vest and mature at five years.
The Company is required by ASC Topic 718, "Compensation" to recognize compensation expense for share-based compensation. The Company uses the Black-Scholes model to value the stock options and stock appreciation rights on the date of the grant, and recognizes this expense over the remaining vesting term for the stock options or stock appreciation rights. Key assumptions used in this valuation method (detailed below) are the volatility of the Company’s stock price, a risk-free rate of return (using the U.S. Treasury yield curve) based on the expected term from grant date to exercise date and an annual dividend rate based upon the current market price. Expected term from grant date is based upon the historical time from grant to exercise experienced by the Company. Because share-based compensation vesting in the current periods was granted on a variety of dates, the assumptions are presented as weighted averages in those assumptions.
The following table details the assumptions used in the Black-Scholes model for share-based compensation granted during the respective periods. There were no stock incentives granted in 2009 or 2008. The weighted-average grant date fair value of stock incentives granted during 2007 was $3.74.
A summary of stock option and stock appreciation right activity under the 1998 Plan and the 2005 Plan as of December 31, 2009, and changes during the year is presented below:
Steve W. Wells exercised 14,000 non-qualified stock options at $20.00 per share in June of 2009. The total intrinsic value of options exercised during 2009, 2008 and 2007 was $52 thousand, $62 thousand and $64 thousand.
As of December 31, 2009, there was $257 thousand of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 2005 Plan. There was no unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 1998 plan. That cost is expected to be recognized over a weighted-average vesting period of 1.9 years. During 2009, we expensed $147 thousand for stock appreciation rights that will vest in 2011 and 2012.
Note 14. Income Taxes
The Company adopted the provisions of Accounting Standards Codification (“ASC”) 740-10, Income Taxes, formerly, FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN48”), on January 1, 2007. ASC 740 sets forth the criterion an individual tax position should meet for some or all of the income tax benefit to be recognized in a taxable entity’s financial statements. Under the guidelines of ASC 740, an entity should recognize the financial statement benefit of a tax position if it determines that it is more likely than not that the position will be sustained on examination. The term, “more likely than not”, means a likelihood of more than 50 percent.” In assessing whether the more-likely-than-not criterion is met, the Company should assume that the tax position will be reviewed by the applicable taxing authority and all available information is known to the taxing authority. Management has analyzed ASC 740, relating to "Uncertain Tax Positions" for tax years after 2005 and continues to believe there is no financial statement impact to the Company. The Company is no longer subject to income tax examinations by taxing authorities for years before 2006 for its federal and New Mexico filings.
The current and deferred components of the provision for Federal income tax expense for the years 2009, 2008 and 2007 are as follows:
A deferred tax asset or liability is recognized to reflect the net tax effects of temporary differences between the carrying amounts of existing assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant temporary differences that gave rise to the deferred tax assets and liabilities as of December 31, 2009 and 2008 were as follows:
The net deferred tax asset of $4.9 million and $1.8 million in 2009 and 2008, respectively, was reported in deferred income taxes on the balance sheet.
A valuation allowance is established when it is more likely than not that all or a portion of a deferred tax will not be realized. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset will be realized. The amount of the deferred tax asset considered realizable could be reduced as the Company's circumstances change.
Items causing differences between the Federal statutory tax rate and the effective tax rate are summarized as follows:
Note 15. Commitments, Contingencies and Off-Balance Sheet Activities
Credit-related financial instruments: The Company is a party to credit-related commitments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These credit-related commitments include commitments to extend credit, standby letters of credit and commercial letters of credit. Such credit-related commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual amount of these credit-related commitments. The Bank follows the same credit policies in making credit-related commitments as it does for on-balance-sheet instruments.
At December 31, 2009 and 2008, the following credit-related commitments were outstanding whose contract amounts represent credit risk:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require a payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Bank, is based on management’s credit evaluation of the customer. Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. Overdraft protection agreements are uncollateralized, but most other unfunded commitments have collateral. These unfunded lines of credit usually do not contain a specified maturity date and may not necessarily be drawn upon to the total extent to which the Bank is committed.
Outstanding Letters of Credit: In addition to short and long term borrowings from the Federal Home Loan Bank (FHLB), the FHLB has issued letters of credit to various public entities with deposits at the Bank. These letters of credit are issued to collateralize the deposits of these entities at the Bank as required or allowed under law. The total value of these letters of credit was $292.1 million and $157.7 million as of December 31, 2009 and December 31, 2008, respectively. As of December 31, 2009, all letters of credit had original terms of approximately one year. These letters are secured under the blanket assignment of mortgage loans or other collateral acceptable to the FHLB that also secures our short and long term borrowings from FHLB.
Commercial and standby letters of credit are conditional credit-related commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers. The Bank generally holds collateral supporting those credit-related commitments, if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the credit-related commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above. If the credit-related commitment is funded, the Bank would be entitled to seek recovery from the customer. At December 31, 2009 and 2008, no amounts have been recorded as liabilities for the Company’s potential obligations under these credit-related commitments. The fair value of these credit-related commitments is approximately equal to the fees collected when granting these letters of credit. These fees collected were $24 thousand and $38 thousand as of December 31, 2009 and 2008 respectively, and are included in “other liabilities” on the Company’s balance sheet.
Concentrations of credit risk: The majority of the loans, commitments to extend credit, and standby letters of credit have been granted to customers in Los Alamos, Santa Fe and surrounding communities. Although the Bank has a diversified loan portfolio, a substantial portion of its loans are made to businesses and individuals associated with, or employed by, Los Alamos National Laboratory (“the Laboratory”). The ability of such borrowers to honor their contracts is predominately dependent upon the continued operation and funding of the Laboratory. Investments in securities issued by state and political subdivisions involve governmental entities within the state of New Mexico. The distribution of commitments to extend credit approximates the distribution of loans outstanding. Standby letters of credit are granted primarily to commercial borrowers.
Note 16. Preferred Equity Issues
On March 27, 2009, the Company issued two series of preferred shares to the Treasury under the Capital Purchase Program (“CPP”). Below is a table disclosing the information on these two series’:
Dividends are paid quarterly to Treasury, and the amount of any unpaid dividends outstanding at the end of the quarter is an outstanding liability in “other liabilities” on the balance sheet. The amount of dividends accrued and unpaid as of December 31, 2009 was $242 thousand.
The difference between the liquidation value of the preferred shares and the original cost is accreted (for Series B) or amortized (for Series A) over 10 years. The net difference of this amortization and accretion is posted directly to capital. For 2009, a net amount of $135 thousand was accreted to equity.
Both the dividends and net accretion on the preferred shares reduce the amount of net income available to common shareholders. For 2009, the total of these two amounts was $1.6 million.
The securities purchase agreement between the Company and Treasury provides that prior to the earlier of (i) March 27, 2012 and (ii) the date on which all of the shares of the Series A and Series B Preferred Stock have been redeemed by the Company or transferred by Treasury to third parties, the Company may not, without the consent of Treasury, (a) pay a cash dividend on the Company’s common stock of more than $0.40 per share or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of the Company’s common stock or preferred stock, other than the Series A or Series B Preferred Stock, or trust preferred securities. In addition, under the terms of the Series A and Series B Preferred Stock, the Company may not pay dividends on its common stock unless it is current in its dividend payments on the Series A and Series B Preferred Stock.
Note 17. Litigation
Trinity, the Bank, Title Guaranty, Cottonwood, TCC Advisors, FNM Investment Fund IV or TCC Funds are not involved in any pending legal proceedings, other than routine legal proceedings occurring in the normal course of business and those otherwise specifically stated herein, which, in the opinion of management, in the aggregate, are material to our consolidated financial condition.
Note 18. Derivative Financial Instruments
In the normal course of business, the Bank uses a variety of financial instruments to service the financial needs of customers and to reduce its exposure to fluctuations in interest rates. Derivative instruments that the Bank uses as part of its interest rate risk management strategy include mandatory forward delivery commitments and rate lock commitments.
As a result of using over-the-counter derivative instruments, the Bank has potential exposure to credit loss in the event of nonperformance by the counterparties. The Bank manages this credit risk by selecting only well established, financially strong counterparties, spreading the credit risk amongst many such counterparties and by placing contractual limits on the amount of unsecured credit risk from any single counterparty. The Bank’s exposure to credit risk in the event of default by counterparty is the current cost of replacing the contracts net of any available margins retained by the Bank. However, if the borrower defaults on the commitment the Bank requires the borrower to cover these costs.
The Company’s derivative instruments outstanding at December 31, 2009, include commitments to fund loans held for sale. The interest rate lock commitment was valued at fair market value at inception. The rate locks will continue to be adjusted for changes in value resulting from changes in market interest rates.
The Company originates single-family residential loans for sale pursuant to programs with the Federal National Mortgage Association (“FNMA”). At the time the interest rate is locked in by the borrower, the Bank concurrently enters into a forward loan sale agreement with respect to the sale of such loan at a set price in an effort to manage the interest rate risk inherent in the locked loan commitment. Any change in the fair value of the loan commitment after the borrower locks in the interest rate is substantially offset by the corresponding change in the fair value of the forward loan sale agreement related to such loan. The period from the time the borrower locks in the interest rate to the time the Bank funds the loan and sells it to FNMA is generally 60 days. The fair value of each instrument will rise or fall in response to changes in market interest rates subsequent to the dates the interest rate locks and forward loan sale agreements are entered into. In the event that interest rates rise after the Bank enters into an interest rate lock, the fair value of the loan commitment will decline. However, the fair value of the forward loan sale agreement related to such loan commitment should increase by substantially the same amount, effectively eliminating the Company’s interest rate and price risk.
At December 31, 2009, the Company had notional amounts of $5.0 million in contracts with customers and $14.3 million in contracts with FNMA for interest rate lock commitments outstanding related to loans being originated for sale. The related fair values of these commitments were an asset of $251 thousand and a liability of $1 thousand as of December 31, 2009.
The Company has outstanding loan commitments, excluding undisbursed portion of loans in process and equity lines of credit, of approximately $123.0 million and $154.9 million as of December 31, 2009 and 2008, respectively. Of these commitments outstanding, the breakdown between fixed- and adjustable-rate loans is as follows:
Note 19. Regulatory Matters
The Company’s primary source of cash is dividends from the Bank. Generally, the Bank is subject to certain restrictions on dividends that it may declare without prior regulatory approval, including as a result of the Agreement with the OCC as described in Item 1 above. Generally, the Company cannot pay dividends that exceed its net income or which may weaken its financial health. The Bank cannot pay dividends in any calendar year that, in the aggregate, exceed the Bank’s year-to-date net income plus its retained income for the two proceeding years. Additionally, the Bank cannot pay dividends that are in excess of the amount which would cause the Bank to fall below the minimum required for capital adequacy purposes. The Company is subject to additional dividend restrictions due to its participation in.the CPP.
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and 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’s and the Bank’s assets, liabilities, and certain off-balance-sheet items are calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). The Company and the Bank meet all capital adequacy requirements to which they are subject as of December 31, 2009.
As of December 31, 2009, the Bank was “well capitalized” as defined by OCC regulations. To be categorized as well capitalized the Bank must maintain the total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the well capitalized column in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s status as “well-capitalized.” The Company has in place a capital plan which provides for certain internal minimum capital ratios which take into consideration certain risk factors, requires the routine and frequent review of the Company’s capital position and identifies sources for additional capital should it be necessary.
The required and actual amounts and ratios for the Company and the Bank are presented below:
_________________________
N/A-not applicable
Note 20. Fair Value Measurements
ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert expected future amounts, such as cash flows or earnings, to a single present value amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
·
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
·
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
·
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company's creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
Foreign currency in vault. This is valued at current market values in actively traded currency markets. Changes in fair market values are recorded in other income.
Securities Available for Sale. The fair values of securities available for sale are determined by quoted prices in active markets, when available. If quoted market prices are not available, the fair value is determined by a matrix pricing, which is a mathematical technique, widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.
Derivatives. Derivative assets and liabilities represent interest rate contracts between the Company and loan customers, and between the Company and outside parties to whom we have made a commitment to sell residential mortgage loans at a set interest rate. These are valued based upon the differential between the interest rates upon the inception of the contract and the current market interest rates for similar products. Changes in market value are recorded in current earnings.
The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of December 31, 2009 and 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):
Financial Instruments Recorded at Fair Value on a Nonrecurring Basis
The Company may be required, from time to time, to measure certain financial assets and financial liabilities at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period.
Impaired Loans. 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 ASC Topic 310. 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 flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2009, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with ASC Topic 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. Collateral values are estimated using Level 3 inputs based on customized discounting criteria. For a majority of impaired loans, the Company obtains a current external appraisal. Other valuation techniques are used as well, including internal valuations, comparable property analysis and contractual sales information.
Loans held for sale. Loans held for sale are valued based upon open market quotes obtained from the Federal National Mortgage Association (FNMA). Market pricing is based upon mortgage loans with similar terms and interest rates. The change in market value (up to the amortized value of the loans held for sale) is recorded as an adjustment to the loans held for sale valuation allowance, with the offset being recorded as an addition or a reduction to current earnings.
Mortgage Servicing Rights. Mortgage servicing rights (MSRs) are valued based upon the value of MSRs that are traded on the open market and a current market value for each risk tranche in our portfolio is assigned. We then compare that market value to the current amortized book value for each tranche. The change in market value (up to the amortized value of the MSR) is recorded as an adjustment to the MSR valuation allowance, with the offset being recorded as an addition or a reduction to current earnings. Only the tranches deemed impaired are included in the following table.
Non-Financial Assets and Non-Financial Liabilities Recorded at Fair Value
Application of ASC Topic 820 to non-financial assets and non-financial liabilities became effective January 1, 2009. The Company has no non-financial assets or non-financial liabilities measured at fair value on a recurring basis. Certain non-financial assets and non-financial liabilities measured at fair value on a non-recurring basis include foreclosed assets and other non-financial long-lived assets measured at fair value.
Other Real Estate and Repossessed Vehicles Owned (Foreclosed Assets). Foreclosed assets, upon initial recognition, are measured and reported at fair value through a charge-off to the allowance for possible loan losses based upon the fair value of the foreclosed asset. The fair value of foreclosed assets, upon initial recognition, are estimated using Level 3 inputs based on customized discounting criteria.
During 2009, certain foreclosed assets, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for loan losses based upon the fair value of the foreclosed asset, less estimated costs of disposal. The fair value of foreclosed asset, upon initial recognition, is estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria. Foreclosed assets measured at fair value (less estimated disposal costs) upon initial recognition totaled $25.0 million (utilizing Level 3 valuation inputs) during the year ended December 31, 2009. In connection with the measurement and initial recognition of the foregoing foreclosed assets, the Company recognized charge-offs of the allowance for loan losses totaling $3.7 million. Other than foreclosed assets measured at fair value (less estimated disposal costs) upon initial recognition, a total of $2.0 million in foreclosed assets were remeasured at fair value during the year ended December 31, 2009, resulting in a charge of $283 thousand to current earnings.
Assets measured at fair value on a nonrecurring basis as of December 31, 2009 and 2008 are included in the table below (in thousands):
Note 21. Condensed Parent Company Financial Information
The condensed financial statements of Trinity Capital Corporation (parent company only) are presented below:
Balance Sheets
Statements of Income
Statements of Cash Flows
Note 22. Income by Quarter (Unaudited)
Presented in the table below is the income of the Company by quarter:
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the officers who certify our financial reports and to other members of senior management and the board of directors and to ensure that information that is required to be disclosed in reports we filed with the SEC is properly and timely recorded, processed, summarized and reported. A review and evaluation was performed by our management, including the Company's Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2009 pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based upon and as of the date of that review and evaluation, the CEO and CFO identified two controls which were deficient, as described in Management’s Report of Internal Control over Financial Reporting, and concluded that our current disclosure controls and procedures were not effective as of December 31, 2009. Management is reviewing its disclosure controls and procedures to ensure their effectiveness in the future
Management’s Report on Internal Control Over Financial Reporting
Management’s Report on Internal Control over Financial Reporting appears under Item 8, “Financial Statements and Supplemental Data” on page 63 of this Form 10-K.
Changes in Internal Control over Financial Reporting
There have been no changes to our internal control over financial reporting during the last fiscal quarter that have affected, or are reasonably likely to affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
None
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The following information is incorporated herein by reference to Trinity’s Proxy Statement for the Annual Meeting of Shareholders under the headings indicated: information with respect to Trinity’s directors, under the heading “Item I - Election of Directors;” information regarding Trinity’s audit committee and its designation of an audit committee financial expert, under the heading “Board of Directors and Corporate Governance - Audit Committee;” information regarding compliance with Section 16(a) of the Securities Exchange Act, under the heading “Section 16(a) Beneficial Ownership Reporting Compliance;” and information regarding Trinity’s executive officers, under the heading “Named Executive Officers.”
Trinity’s Code of Business Conduct and Business Ethics (the “Code”) exemplifies Trinity’s history of requiring adherence to high standards of ethical conduct and business practices. Trinity’s Code is available on Trinity’s website at www.lanb.com/TCC-Corporate-Governance.aspx. All of Trinity’s employees, officers, including the Chief Executive Officer, the Chief Financial Officer, and all directors are required to fully comply with the Code. If Trinity’s Code is amended or a waiver is granted, such modification or waiver will be posted promptly on the website in accordance with SEC rules.
Item 11.
Item 11. Executive Compensation.
The information regarding executive compensation appears in Trinity’s Proxy Statement for the Annual Meeting of Shareholders under the headings: “Compensation Discussion and Analysis,” “Executive Compensation” and “Director Compensation” and is incorporated herein by reference; provided, however, that the Compensation Committee Report is deemed furnished in this report and will not be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act as a result of furnishing the disclosure in this manner.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information regarding security ownership of certain beneficial owners and management appears in the Company’s Proxy Statement for the Annual Meeting of Shareholders under the heading “Security Ownership of Certain Beneficial Owners, Directors and Management” and is incorporated herein by reference.
Aggregated Equity Plan Information. Our current stock-based benefit plans and arrangements consist of the 1998 Stock Option Plan that was approved by shareholders at the 1998 Annual Meeting and the Trinity Capital Corporation 2005 Stock Incentive Plan that was approved by shareholders at the 2005 Annual Meeting. The following table provides information regarding the plans as of December 31, 2009.
Plan category
Number of securities to be issued upon exercise of outstanding options
Weighted-average exercise price of outstanding options
Number of securities remaining available for future issuance
Equity compensation plans approved by security holders
412,500
$ 27.03
333,500
Equity compensation plans not approved by security holders
-
-
-
Total
412,500
$ 27.03
333,500
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information regarding certain relationships and related transactions appears in the Company’s Proxy Statement for the Annual Meeting of Shareholders under the headings “Board of Directors and Corporate Governance - Director Independence” and “Board of Directors and Corporate Governance - Related Party Transactions” and is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information regarding the principal accounting fees and services appears in the Company’s Proxy Statement for the Annual Meeting of Shareholders under the heading “Item II - Approval of Independent Registered Public Accountants” and is hereby incorporated by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
Financial Statements. All financial statements of Trinity are set forth under Item 8 of this Form 10-K.
Exhibits. The following exhibits are filed as part of this Form 10-K:
_________________________
(1) Incorporated by reference to the Company’s Form 10 filed on April 30, 2003, as amended.
(2) Incorporated by reference to the Company’s Form 8-K filed August 22, 2005
(3) Incorporated by reference to the Company’s Form S-8 filed on July 28, 2005
(4) Incorporated by reference to the Company’s Form 10-Q filed on August 9, 2005
(5) Incorporated by reference to the Company’s Form 10-Q filed on November 9, 2006
(6) Incorporated by reference to the Company’s Form 10-K for the fiscal year ended December 31,
(7) Incorporated by reference to the Company’s Form 10-K for the fiscal year ended December 31,
(8) Incorporated by reference to the Company’s Form 10-K for the fiscal year ended December 31,
(9) Incorporated by reference to the Company’s Form 8-K filed on March 27, 2009
(10) Incorporated by reference to the Company’s Form 10-Q filed on May 11, 2009
(11) Incorporated by reference to the Company’s Form 8-K filed on February 1, 2010
(12) Incorporated by reference to the Company’s Form 10-K for the fiscal year ended December 31,
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.