Item 1. Business
General. First Banks, Inc., or we, or the Company, is a registered bank holding company incorporated in Missouri in 1978 and headquartered in St. Louis, Missouri. We operate through our wholly owned subsidiary bank holding company, The San Francisco Company, or SFC, headquartered in St. Louis, Missouri, and SFC’s wholly owned subsidiary bank, First Bank, also headquartered in St. Louis, Missouri. A list of First Bank’s subsidiaries at December 31, 2014 is included as Exhibit 21.1 and incorporated herein by reference. First Bank’s subsidiaries are wholly owned except FB Holdings, LLC, or FB Holdings, which is 53.23% owned by First Bank and 46.77% owned by First Capital America, Inc., or FCA, a corporation owned and operated by the Company’s Chairman of the Board and members of his immediate family, including Mr. Michael Dierberg, Vice Chairman of the Company, and Ms. Ellen Dierberg Milne, Director of the Company, as further described in Note 20 to our consolidated financial statements. At December 31, 2014, we had assets of $5.94 billion, loans, net of net deferred loan fees, or total loans, of $3.15 billion, deposits of $4.85 billion and stockholders’ equity of $512.4 million.
First Bank currently operates 129 branch offices in California, Florida, Illinois and Missouri, with 160 automated teller machines, or ATMs, across the four states. Through First Bank, we offer a broad range of financial services, including commercial and personal deposit products, commercial and consumer lending, and many other financial products and services. Commercial and personal deposit products include demand, savings, money market and time deposit accounts. In addition, we market combined basic services for various client groups, including packaged accounts for more affluent clients, and sweep accounts, lock-box deposits and cash management products for commercial clients. Commercial lending includes commercial, financial and agricultural loans, real estate construction and development loans, commercial real estate loans and small business lending. Consumer lending includes residential real estate, home equity and installment lending. Other financial services include mortgage banking, debit cards, brokerage services, internet banking, remote deposit, mobile banking, ATMs, telephone banking, safe deposit boxes, and trust and private banking services. The revenues generated by First Bank and its subsidiaries consist primarily of interest income generated from our loan and investment security portfolios, service charges and fees generated from deposit products and services, and fees and commissions generated by our mortgage banking and trust and private banking business units. Our extensive line of products and services are offered to clients primarily within our geographic areas, which presently include eastern Missouri, southern Illinois, southern and northern California, and Florida's Bradenton, Palmetto and Longboat Key communities. Primary responsibility for managing our banking units rests with the officers and directors of each unit, but we centralize many of our overall corporate policies, procedures and administrative functions and provide centralized operational support functions for our subsidiaries. This practice allows us to achieve various operating efficiencies while allowing our banking units to focus on client service.
Capital Structure.
Voting Stock. Various trusts, established by and administered by and for the benefit of Mr. James F. Dierberg and members of his immediate family, own all of our voting stock other than the Class C Preferred Stock and Class D Preferred Stock that have limited voting rights, as discussed below. Mr. Dierberg and his family, therefore, control our management and policies.
Trust Preferred Securities. We have formed numerous affiliated Delaware or Connecticut business or statutory trusts. These trusts operate as financing entities and were created for the sole purpose of issuing trust preferred securities. The sole assets of the trusts are our junior subordinated debentures. In conjunction with the formation of our financing entities and their issuance of the trust preferred securities, we issued junior subordinated debentures to each of our financing entities in amounts equivalent to the respective trust preferred securities plus the amount of the common securities of the individual trusts. The trust preferred securities have no voting rights except in certain limited circumstances. The trust preferred securities issued by First Preferred Capital Trust IV are publicly held and traded on the New York Stock Exchange, or NYSE. The remaining trust preferred securities were issued in private placements. See Note 12 to our consolidated financial statements for further discussion regarding our junior subordinated debentures relating to our trust preferred securities.
Class C Fixed Rate Cumulative Perpetual Preferred Stock and Class D Fixed Rate Cumulative Perpetual Preferred Stock. On December 31, 2008, the Company entered into a Letter Agreement, including a Securities Purchase Agreement - Standard Terms, or Purchase Agreement, with the United States Department of the Treasury, or the U.S. Treasury, pursuant to the Troubled Asset Relief Program’s Capital Purchase Program, or CPP. Under the terms of the Purchase Agreement, on December 31, 2008, we issued to the U.S. Treasury, 295,400 shares of senior preferred stock, or Class C Preferred Stock, and a warrant, or Warrant, to acquire up to 14,784.78478 shares of a separate series of senior preferred stock, or Class D Preferred Stock (at an exercise price of $1.00 per share), for an aggregate purchase price of $295.4 million, pursuant to the standard CPP terms and conditions for non-public companies as described and set forth in the Purchase Agreement and the Warrant. Pursuant to the terms of the Warrant, the U.S. Treasury exercised the Warrant on December 31, 2008 and paid the exercise price by having us withhold, from the shares of Class D Preferred Stock that would otherwise be delivered to the U.S. Treasury upon such exercise, shares of Class D Preferred Stock issuable upon exercise of the Warrant with an aggregate liquidation amount equal in value to the aggregate exercise price
of $14,784.78. The senior preferred stock and the Warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.
During the third quarter of 2013, the U.S. Treasury completed two auctions that resulted in the sale of our Class C Preferred Stock and Class D Preferred Stock to unaffiliated third party investors. We did not receive any proceeds from the sale and the sale did not have any effect on the terms of the outstanding Class C Preferred Stock and Class D Preferred Stock, including our obligation to satisfy accrued and unpaid dividends prior to the payment of any dividend or other distribution to holders of junior or parity stock (including our common stock, Class A Preferred Stock and Class B Preferred Stock).
We suspended the payment of cash dividends on our Class C Preferred Stock and Class D Preferred Stock beginning with the regularly scheduled quarterly dividend payments on the preferred stock that would otherwise have been made in August 2009. We declared and accrued dividends on our Class C Preferred Stock and Class D Preferred Stock quarterly throughout the deferral period until the fourth quarter of 2013, when we ceased declaring dividends on our Class C Preferred Stock and Class D Preferred Stock. The aggregate amount of these deferred and accrued dividend payments was $77.8 million at December 31, 2014. See Note 13 to our consolidated financial statements for further discussion regarding our Class C Preferred Stock and Class D Preferred Stock.
Recent Developments and Other Matters.
Dividend from First Bank and Payment of Deferred Interest on Junior Subordinated Debentures. On January 31, 2014, the Company received regulatory approval from the Federal Reserve Bank of St. Louis, or FRB, under the then-existing Written Agreement and subject to certain conditions, which granted First Bank the authority to pay a dividend to the Company, and the authority to the Company to utilize such funds, for the sole purpose of paying the accumulated deferred interest payments on the Company's outstanding junior subordinated debentures issued in connection with the Company's $345.0 million of trust preferred securities. In February 2014, First Bank paid a dividend of $70.0 million to the Company.
On March 14, 2014, the Company paid interest on all of the junior subordinated debentures of $66.4 million to the respective trustees, which was subsequently distributed to the trust preferred securities holders on the respective interest payment dates in March and April, 2014. Since that time, the Company has continued to pay interest on its junior subordinated debentures to the respective trustees on the regularly scheduled quarterly payment dates. Such interest payments have been funded through additional dividends from First Bank. Pursuant to Missouri Revised Statutes, First Bank is required to obtain approval from the Missouri Division of Finance, or the MDOF, prior to paying any dividends to the Company. The MDOF has complete discretion to grant any such approval and therefore, it is not known whether the MDOF will approve any such future requests. See Note 12 to our consolidated financial statements for further discussion regarding our junior subordinated debentures relating to our trust preferred securities.
Capital Plan. We have been working since the beginning of 2008 to strengthen our capital ratios and improve our financial performance. Additionally, on August 10, 2009, we announced the adoption of our Capital Optimization Plan, or Capital Plan, designed to improve our capital ratios and financial performance through certain divestiture activities, asset reductions and expense reductions. We adopted our Capital Plan in order to, among other things, preserve our regulatory capital. A summary of the primary initiatives completed as of December 31, 2014 is shown in the table below.
Strategy. Our strategy emphasizes profitable growth within our market areas, aggressive management of asset quality risks, and preservation and enhancement of regulatory capital. We have developed several plans around these actions, including the previously discussed Capital Plan, in addition to actions intended to improve overall profitability and asset quality, including the following:
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Developing new loan growth strategies, primarily within our commercial and industrial, commercial real estate and residential mortgage segments;
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Strengthening our branch network through the continual assessment and realignment of the branch network to ensure we are delivering our products and services through appropriate market locations that best correspond to the individual needs of the communities that we serve, and preserving and enhancing a cost-effective deposit generating function that allow us to maintain our core funding position;
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Expanding our wealth management and treasury management teams and related noninterest income opportunities;
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Increasing the volume of loans sold in the secondary market in our mortgage division through an expanded sales force and enhanced marketing initiatives;
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Evaluating opportunities to reduce noninterest expenses through several efficiency measures, including branch sales and/or consolidations; and
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Accelerating the reduction of nonaccrual loans and other real estate to reduce noninterest expenses associated with these assets, including legal fees, other real estate write-downs and other real estate expenses related to property preservation, taxes, insurance and other items;
We believe the successful completion of the various components of these action items would substantially improve our financial performance. If we are not able to successfully complete a substantial portion of the action items, our business, financial condition, including our regulatory capital ratios, and results of operations may be materially and adversely affected and our ability to withstand continued adverse economic uncertainty could be threatened.
Lending Activities. As further discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations -Loans and Allowance for Loan Losses,” our business development efforts have historically been focused on the origination of the following general loan types: commercial, financial and agricultural loans; real estate construction and land development loans; commercial real estate mortgage loans and residential real estate mortgage loans. Our lending strategy emphasizes quality and diversification. Throughout our organization, we employ a common credit underwriting policy. In addition to underwriting based on estimates and projection of financial strength, collateral values and future cash flows, most loans to borrowing entities other than individuals require the guarantee of the parent company or entity sponsor, or in the case of smaller entities, the personal guarantees of the principals.
Commercial, Financial and Agricultural. Our commercial, financial and agricultural loan portfolio was $695.3 million, or 22.3% of total loans held for portfolio, at December 31, 2014, compared to $600.7 million, or 21.2% of total loans held for portfolio, at December 31, 2013. During recent years, we have attempted to diversify our loan portfolio by increasing our commercial, financial and agricultural lending opportunities. The primary component of commercial, financial and agricultural loans is commercial
loans, which are made based on the borrowers’ general credit strength and ability to generate cash flows for repayment from income sources. Most of these loans are made on a secured basis, generally involving the use of company equipment, inventory and/or accounts receivable, and, from time to time, real estate, as collateral. Regardless of collateral, primary emphasis is placed on the borrowers’ ability to generate cash flow sufficient to operate the business and provide coverage of debt servicing requirements. Commercial loans are frequently renewable annually, although some terms may be as long as five years. These loans typically require the borrower to satisfy certain operating covenants appropriate for the specific business, such as profitability, debt service coverage and current asset and leverage ratios, which are generally reported and monitored on a quarterly basis and subject to more detailed annual reviews. Commercial loans are made to clients primarily located in First Bank’s geographic trade areas of California, Missouri and Illinois that are engaged in manufacturing, retailing, wholesaling and service businesses. This portfolio is not concentrated in large specific industry segments that are characterized by sufficient homogeneity that would result in significant concentrations of credit exposure. Rather, it is a highly diversified portfolio that encompasses many industry segments. Within both our real estate and commercial lending portfolios, we strive for the highest degree of diversity that is practicable. We also emphasize the development of other service relationships, particularly deposit accounts, with our commercial borrowers.
Real Estate Construction and Development. Our real estate construction and land development loan portfolio was $89.9 million, or 2.9% of total loans held for portfolio, at December 31, 2014, compared to $121.7 million, or 4.3% of total loans held for portfolio, at December 31, 2013. Real estate construction and land development loans include commitments for construction of both residential and commercial properties. Commercial real estate projects often require commitments for permanent financing from other lenders upon completion of the project and, more typically, may include a short-term amortizing component of the initial financing. Commitments for construction of multi-tenant commercial and retail projects generally require lease commitments from a substantial primary tenant or tenants prior to commencement of construction. We typically engage in multi-phase, multi-tenant projects, as opposed to large vertical projects, that allow us to complete the financing for the projects in phases and limit the number of tenant building starts based upon successful lease and/or sale of the tenant units. We finance some projects for borrowers whose home office is located within our trade area but the particular project may be outside our normal trade area. Although we generally do not engage in developing commercial and residential construction lending business outside of our trade area, certain loans acquired in acquisitions from time to time and certain other loans have been related to projects outside of our trade area. Residential real estate construction and development loans are made based on the cost of land acquisition and development, as well as the construction of the residential units. Although we finance the cost of display units and units held for sale, in most instances a substantial portion of the loans for individual residential units have purchase commitments prior to funding. Residential condominium projects are funded as the building construction progresses, but funding of unit finishing is generally based on firm sales contracts.
Commercial Real Estate. Our commercial real estate loan portfolio was $1.18 billion, or 37.9% of total loans held for portfolio, at December 31, 2014, compared to $1.05 billion, or 37.0% of total loans held for portfolio, at December 31, 2013. Commercial real estate loans include loans for which the intended source of repayment is rental and other income from the real estate. This includes commercial real estate developed for lease to third parties as well as the owner’s occupancy. The underwriting of owner-occupied commercial real estate loans generally follows the procedures for commercial lending described above, except that the collateral is real estate, and the loan term may be longer. The primary emphasis in underwriting loans for which the source of repayment is the performance of the collateral is the projected cash flow from the real estate and its adequacy to cover the operating costs of the project and the debt service requirements. Secondary emphasis is placed on the appraised value of the real estate, with the requirement that the appraised liquidation value of the collateral must be adequate to repay the debt and related interest in the event the cash flow becomes insufficient to service the debt. Generally, underwriting terms require the loan principal not to exceed 80% of the appraised value of the collateral and the loan maturity not to exceed ten years. Commercial real estate loans are made for commercial office space, retail properties, industrial and warehouse facilities and recreational properties. We typically only finance commercial real estate or rental properties that have lease commitments for a majority of the rentable space.
Residential Real Estate Mortgage. Our one-to-four-family residential real estate mortgage loan portfolio was $1.02 billion, or 32.6% of total loans held for portfolio, at December 31, 2014, compared to $921.5 million, or 32.5% of total loans held for portfolio, at December 31, 2013. Residential real estate mortgage loans are primarily loans secured by single-family, owner-occupied properties. These loans include both adjustable rate and fixed rate mortgage loans. We typically originate residential real estate mortgage loans for sale in the secondary mortgage market in the form of a mortgage-backed security or to various private third-party investors, although from time-to-time, we may purchase and/or retain certain originated residential mortgage loans, including home equity loans, in our loan portfolio as directed by management’s business strategies. Our residential real estate mortgage loans are generated through our branch office network as well as our mortgage division and are underwritten in accordance with conforming terms that allow the loans to be sold into the secondary market. We do not offer Alt A and Sub-prime mortgage loan products. Servicing rights may either be retained or released with respect to conventional, FHA and VA conforming fixed-rate and conventional adjustable rate residential mortgage loans.
Market Areas. As of December 31, 2014, First Bank’s 129 banking facilities were located in California, Florida, Illinois and Missouri. First Bank presently operates in the St. Louis metropolitan area, in eastern Missouri and throughout southern Illinois.
First Bank also operates in southern California, including San Diego and the greater Los Angeles metropolitan area, including Ventura County, Riverside County and Orange County; in Santa Barbara County; in northern California, including the greater San Francisco and Sacramento metropolitan areas; and in Florida's Bradenton, Palmetto and Longboat Key communities.
The following table lists the geographic market areas in which First Bank operates, total deposits, deposits as a percentage of total deposits and the number of locations as of December 31, 2014:
Competition and Branch Banking. The activities in which First Bank engages are highly competitive. Those activities and the geographic markets served primarily involve competition with other banks, some of which are affiliated with large regional or national holding companies, and other financial services companies. Financial institutions compete based upon interest rates offered on deposit accounts and other credit and service charges, the types of products and quality of services rendered, the convenience of branch facilities, interest rates charged on loans and, in the case of loans to large commercial borrowers, relative lending limits.
Our principal competitors include other commercial banks, savings banks, savings and loan associations, and finance companies, including trust companies, credit unions, mortgage companies, leasing companies, private issuers of debt obligations and suppliers of other investment alternatives, such as securities firms and financial holding companies. Many of our non-bank competitors are not subject to the same degree of regulation as that imposed on bank holding companies, federally insured banks and national or state chartered banks. As a result, such non-bank competitors have advantages over us in providing certain services. We also compete with major multi-bank holding companies, which are significantly larger than us and have greater access to capital and other resources.
Employees. We employed approximately 1,167 full-time equivalent employees at December 31, 2014. None of the employees are subject to a collective bargaining agreement. We consider our relationships with our employees to be good.
Supervision and Regulation.
General. Along with First Bank, we are extensively regulated by federal and state laws and regulations which are designed to protect depositors of First Bank and the safety and soundness of the U.S. banking system, not our debt holders or stockholders. To the extent this discussion refers to statutory or regulatory provisions, it is not intended to summarize all such provisions and is qualified in its entirety by reference to the relevant statutory and regulatory provisions. Changes in applicable laws, regulations or regulatory policies may have a material effect on our business and prospects. We are unable to predict the nature or extent of the effects on our business and earnings that new federal and state legislation or regulation may have. The enactment of the legislation described below has significantly affected the banking industry generally and is likely to have ongoing effects on First Bank and us in the future.
As a registered bank holding company under the Bank Holding Company Act of 1956, as amended, we are subject to regulation and supervision of the Board of Governors of the Federal Reserve System, or Federal Reserve. We file annual reports with the Federal Reserve and provide to the Federal Reserve additional information as it may require. Many of our subsidiaries are also subject to the laws and regulations of both the federal government and the various states in which they conduct business. As an originator of small business loans, we are also regulated by the U.S. Small Business Administration, or SBA.
Regulatory Agreements. On May 19, 2014, the Company entered into a Memorandum of Understanding, or MOU, with the FRB. The MOU is characterized by regulatory authorities as an informal action that is neither published nor made publicly available by the FRB and is used when circumstances warrant a milder form of action than a formal supervisory action. Under the terms of the MOU, the Company agreed, among other things, to provide certain information to the FRB including, but not limited to, progress of achieving its Capital Plan, notice of plans to materially change its Capital Plan, parent company cash flow plans and summaries of nonperforming asset classifications. In addition, the Company agreed not to do any of the following without the prior approval of the FRB: (i) declare or pay any dividends on its common or preferred stock; (ii) incur or guarantee any debt; (iii) redeem any of the Company's outstanding common or preferred stock; and (iv) cause First Bank to pay dividends in excess of its earnings or make a capital distribution that would cause First Bank's Tier 1 Leverage Ratio to fall below 9.0%. The FRB has complete discretion to grant any such approval and therefore, it is not known whether the FRB would approve any such request.
While the Company intends to take such actions as may be necessary to comply with the requirements of the MOU, there can be no assurance that such efforts will not have adverse effects on the operations and financial condition of the Company or First Bank. If the Company fails to comply with the terms of the MOU, further enforcement action could be taken by the FRB which could have a materially adverse effect on the Company's business, financial condition or results of operations.
Former Regulatory Agreements. On May 19, 2014, the FRB terminated the written agreement dated March 24, 2010, by and among the Company, SFC, First Bank and the FRB, or Written Agreement. The Written Agreement previously required the Company and First Bank to take certain steps intended to improve their overall financial condition. Pursuant to the Written Agreement, the Company prepared and filed with the FRB a number of specific plans designed to strengthen and/or address the following matters: (i) board oversight over the management and operations of the Company and First Bank; (ii) credit risk management practices; (iii) lending and credit administration policies and procedures; (iv) asset improvement; (v) capital; (vi) earnings and overall financial condition; and (vii) liquidity and funds management.
Bank Holding Company Regulation. The activities of bank holding companies are generally limited to the business of banking, managing or controlling banks, and other activities that the Federal Reserve has determined to be so closely related to banking or managing or controlling banks as to the proper incident thereto. In addition, under the Gramm-Leach-Bliley Act, or GLB Act, which was enacted in November 1999 and is further discussed below, a bank holding company, whose control depository institutions are “well-capitalized” and “well-managed” (as defined in Federal Banking Regulations), and which obtains “satisfactory” Community Reinvestment Act (discussed briefly below) ratings, may declare itself to be a “financial holding company” and engage in a broader range of activities. As of this date, we are not a “financial holding company.”
We are also subject to capital requirements applied on a consolidated basis, which are substantially similar to those required of First Bank (briefly summarized below). The Bank Holding Company Act also requires a bank holding company to obtain approval from the Federal Reserve before:
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Acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls a majority of such shares);
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Acquiring all or substantially all of the assets of another bank or bank holding company; or
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Merging or consolidating with another bank holding company.
The Federal Reserve will not approve any acquisition, merger or consolidation that would have a substantially anti-competitive result, unless the anti-competitive effects of the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial factors in reviewing acquisitions and mergers.
Safety and Soundness and Similar Regulations. We are subject to various regulations and regulatory policies directed at the financial soundness of First Bank. These include, but are not limited to: the Federal Reserve’s source of strength policy, which obligates a bank holding company such as us to provide financial and managerial strength to its subsidiary banks; restrictions on the nature and size of certain affiliate transactions between a bank holding company and its subsidiary depository institutions; and restrictions on extensions of credit by its subsidiary banks to executive officers, directors, principal stockholders and the related interests of such persons. In addition, pursuant to the Dodd-Frank Act, the longstanding source of strength policy has been given the force of law and additional regulations promulgated by the Federal Reserve to further implement the intent of the statutory provision are possible. As in the past, such financial support from the Company may be required at times when, without this legal requirement, the Company may not be inclined to provide it or may not be able to do so.
Capital Adequacy Requirements. The Company and First Bank are each required to comply with applicable capital adequacy standards established by the Federal Reserve. The current risk-based capital standards applicable to the Company and First Bank, parts of which are currently in the process of being phased-in, are based on the December 2010 final capital framework for strengthening international capital standards, known as Basel III, of the Basel Committee on Banking Supervision, or the Basel Committee. Prior to January 1, 2015, the risk-based capital standards applicable to the Company and First Bank, or the General Risk-Based Capital Rules, were based on the 1988 Capital Accord, known as Basel I, of the Basel Committee.
General Risk-Based Capital Rules. The General Risk-Based Capital rules were intended to make regulatory capital requirements sensitive to differences in credit and market risk profiles among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items were assigned to weighted risk categories. Capital was classified as Tier 1 (or core) capital or Tier 2 (or supplementary) capital depending on its characteristics. Under the General Risk-Based Capital Rules, Tier 1 capital included common equity, retained earnings, qualifying noncumulative perpetual preferred stock (including related surplus), non-controlling interests in equity accounts of consolidated subsidiaries, and a limited amount of certain restricted core capital elements (including subordinated debt and related trust preferred securities), less goodwill, most intangible assets and certain other assets, and Tier 2 capital included qualifying subordinated debt,
qualifying mandatorily convertible debt securities, perpetual preferred stock not included in the definition of Tier 1 capital, a limited amount of certain restricted core capital elements not eligible for inclusion in Tier 1 capital (including subordinated debt and related trust preferred securities), and a limited amount of the allowance for loan losses.
Under the General Risk-Based Capital Rules, the Company and First Bank were each required to maintain Tier 1 capital and Total capital (that is, the sum of Tier 1 and Tier 2 capital) equal to at least 4.0% and 8.0%, respectively, of total risk-weighted assets (including certain off-balance sheet items, such as unfunded loan commitments greater than one year and standby letters of credit).
In addition to the General Risk-Based Capital Rules, we are subject to minimum requirements with respect to the ratio of our Tier I capital to our average assets less goodwill and certain other intangible assets, or the Leverage Ratio. Applicable requirements provide for a minimum Leverage Ratio of 3% for bank holding companies that have the highest supervisory rating, while all other bank holding companies must maintain a minimum Leverage Ratio of at least 4% to 5%.
First Bank was categorized as well capitalized at December 31, 2014 and 2013 under the prompt corrective action provisions of the General Risk-Based Capital Rules. The Company was categorized as adequately capitalized under the regulatory capital standards established for bank holding companies by the Federal Reserve at December 31, 2014 and 2013, as further described in Note 14 to our consolidated financial statements.
Basel III and the Final Capital Rules. In July 2013, the federal bank regulators approved final rules, or the Final Capital Rules, implementing the Basel III framework as well as certain provisions of the Dodd-Frank Act. The Final Capital Rules also substantially revise the risk-based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including the Company and First Bank, as compared to the General Risk-Based Capital Rules. The Final Capital Rules revise the components of capital and address other issues affecting the numerator in regulatory capital ratios. The Final Capital Rules also address asset risk weights and other issues affecting the denominator in regulatory capital ratios and replace the existing general risk-weighting approach based on Basel I with a more risk-sensitive approach. The Final Capital Rules became effective for the Company and First Bank on January 1, 2015 (subject to a phase-in period for certain provisions). The Final Capital Rules:
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Include a new minimum common equity Tier 1 capital ratio of 4.5% of risk-weighted assets and raise the minimum Tier 1 capital ratio from 4.0% to 6.0% of risk-weighted assets;
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Require institutions to maintain a capital conservation buffer composed of common equity Tier 1 capital of 2.5% above the minimum risk-based capital requirements in order to avoid limitations on capital distributions, including dividend payments (unless a waiver is granted by the Federal Reserve) and certain discretionary bonus payments to executive officers (unless a waiver is granted by the Federal Reserve). In addition, institutions that do not maintain the required capital conservation buffer may also be limited in their ability to make payments on trust preferred securities. The capital conservation buffer is measured relative to risk-weighted assets and will be phased in over a four-year period beginning on January 1, 2016 with an initial requirement of 0.625%, that subsequently increases to 1.25%, 1.875% and 2.5% on January 1, 2017, 2018 and 2019, respectively;
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Implement new constraints on the inclusion of minority interests, mortgage servicing assets, deferred tax assets and certain investments in the capital of unconsolidated financial institutions in Tier 1 capital;
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Increase risk-weightings for past-due loans, certain commercial real estate loans and some equity exposures;
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Require trust preferred securities and cumulative perpetual preferred stock to be phased out of Tier 1 capital for banks with assets greater than $15.0 billion as of December 31, 2009; and
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Allow non-advanced banking organizations, such as us, a one-time option to filter certain accumulated other comprehensive income components, such as unrealized gains and losses on available-for-sale investment securities, out of regulatory capital.
The Final Capital Rules revise the capital levels for depository institutions under the prompt corrective action regulations for depository institutions, as discussed below under "-Prompt Corrective Action."
The calculation of common equity Tier 1 capital is different from the calculation of common equity under U.S. generally accepted accounting principles, or GAAP. Most significantly for the Company, the Company's deferred tax assets, which are included in the calculation of common equity under GAAP, will be substantially phased out over time from the required calculation of common equity Tier 1 capital for regulatory purposes. The deferred tax assets are scheduled to be substantially phased out from inclusion in the calculation of common equity Tier 1 capital in 2018. Absent a substantial increase in qualifying common equity, the Company will not meet the common equity Tier 1 requirement under the Final Capital Rules. The inability to remain adequately capitalized under the Final Capital Rules could materially adversely impact our financial condition, results of operations, ability to grow, and ability to make dividend payments and interest payments on capital stock and trust preferred securities.
Prompt Corrective Action. The FDIC Improvement Act, or FDICIA, requires the federal bank regulatory agencies to take prompt corrective action in respect to depository institutions that do not meet minimum capital requirements. A depository institution’s status under the prompt corrective action provisions depends upon how its capital levels compare to various relevant capital measures and other factors as established by regulation. FDICIA establishes five capital categories (“well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized”), and the federal banking agencies must take certain mandatory supervisory actions, and are authorized to take other discretionary actions, with respect to institutions which are undercapitalized, significantly undercapitalized or critically undercapitalized. The severity of these mandatory and discretionary supervisory actions depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, FDICIA requires the banking regulators to appoint a receiver or conservator for an institution that is critically undercapitalized. As of December 31, 2014, First Bank was well capitalized.
An institution that is classified as well-capitalized based on its capital levels may be treated as adequately capitalized, and an institution that is adequately capitalized or undercapitalized based upon its capital levels may be treated as though it were undercapitalized or significantly undercapitalized, respectively, if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment.
An institution that is categorized as undercapitalized, significantly undercapitalized or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking regulator. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except in accordance with an accepted capital restoration plan or with the approval of the FDIC. Institutions that are significantly undercapitalized or undercapitalized and either fail to submit an acceptable capital restoration plan or fail to implement an approved capital restoration plan may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions failing to submit or implement an acceptable capital restoration plan are subject to appointment of a receiver or conservator.
Dividend Restrictions. Our primary source of funds is the dividends, if any, paid by First Bank. The ability of First Bank to pay dividends is limited by federal laws, by regulations promulgated by the bank regulatory agencies and by principles of prudent bank management. The dividend limitations are further described in Note 22 to our consolidated financial statements appearing elsewhere in this report. In addition, First Bank has agreed not to declare or pay any dividends, without the prior consent of the FRB, that would cause First Bank to pay dividends in excess of its earnings or make a capital distribution that would cause First Bank's Tier 1 Leverage Ratio to fall below 9.0% without the prior consent of the FRB. Furthermore, pursuant to Missouri Revised Statutes, First Bank is required to obtain approval from the MDOF prior to paying any dividends to the Company. The FRB and the MDOF have complete discretion to grant any such approvals and therefore, it is not known whether the FRB and/or the MDOF will approve any such requests in the future.
Deposit Insurance. The FDIC maintains the Deposit Insurance Fund, or the DIF, which was created in 2006. The deposit accounts of First 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. 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. We do not know of any practice, condition or violation that might lead to termination of our deposit insurance.
The FDIC imposes assessments for deposit insurance on an insured institution on a quarterly basis. The Dodd-Frank Act (as defined and further described below) required the FDIC to establish rules setting insurance premium assessments based on an institution’s average total assets minus its average tangible equity instead of its deposits. These rules were finalized in February 2011 and set base assessment rates for institutions in one of four risk categories based upon supervisory and capital evaluations. The initial base assessment rates are adjusted to determine an institution’s final assessment rate based on its brokered deposits and unsecured debt. On November 18, 2014, the FDIC approved a final rule that revised the risk-based deposit insurance assessment system to reflect changes in the regulatory capital rules that went into effect on January 1, 2015 and go into effect on January 1, 2018. The final rule revises the ratios and ratio thresholds for capital evaluations used in the risk-based deposit insurance assessment system and revises the assessment base calculation for custodial banks.
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 DIF. These assessments will continue until the Financing Corporation bonds mature in 2019. Pursuant to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio, or DRR, that is, the ratio of the DIF to insured deposits. The FDIC has
adopted a plan under which it will meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by the Dodd-Frank Act.
Consumer Protection. First Bank is also subject to consumer laws and regulations intended to protect consumers in transactions with depository institutions, as well as other laws or regulations affecting clients of financial institutions generally. These laws and regulations mandate various disclosure requirements and substantively regulate the manner in which financial institutions must deal with their clients. First Bank must comply with numerous regulations in this regard and is subject to periodic examinations with respect to its compliance with the requirements.
Community Reinvestment Act. The Community Reinvestment Act of 1977, or CRA, requires that, in connection with examinations of financial institutions within their jurisdiction, the federal banking regulators evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those financial institutions. These factors are also considered in evaluating mergers, acquisitions and other applications to expand.
The Gramm-Leach-Bliley Act. The GLB Act, enacted in 1999, amended and repealed portions of the Glass-Steagall Act and other federal laws restricting the ability of bank holding companies, securities firms and insurance companies to affiliate with each other and to enter new lines of business. The GLB Act established a comprehensive framework to permit financial companies to expand their activities, including through such affiliations, and to modify the federal regulatory structure governing some financial services activities. The GLB Act also adopted consumer privacy safeguards requiring financial services providers to disclose their policies regarding the privacy of client information to their clients and, subject to some exceptions, allowing clients to “opt out” of policies permitting such companies to disclose confidential financial information to non-affiliated third parties.
The Sarbanes-Oxley Act. The Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, imposes a myriad of corporate governance and accounting measures designed to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of disclosures under securities laws. All public companies that file periodic reports with the SEC are affected by Sarbanes-Oxley. Sarbanes-Oxley addresses, among other matters: (i) the creation of an independent accounting oversight board to oversee the audit of public companies and auditors who perform such audits; (ii) auditor independence provisions which restrict non-audit services that independent accountants may provide to their audit clients; (iii) additional corporate governance and responsibility measures which require the chief executive officer and chief financial officer to certify financial statements, to forfeit salary and bonuses in certain situations, and protect whistleblowers and informants; (iv) expansion of the audit committee’s authority and responsibility by requiring that the audit committee have direct control of the outside auditor, be able to hire and fire the auditor, and approve all non-audit services; (v) requirements that audit committee members be independent; (vi) disclosure of a code of ethics; and (vii) enhanced penalties for fraud and other violations. The provisions of Sarbanes-Oxley also require that management assess the effectiveness of internal control over financial reporting and that the independent auditor issue an attestation report on management’s report on internal control over financial reporting. As we are a non-accelerated filer, management’s report on internal control over financial reporting was not subject to attestation by the Company’s Independent Registered Public Accounting Firm as of December 31, 2014, as further discussed under “Item 9A - Controls and Procedures.”
The USA Patriot Act. The USA Patriot Act, or Patriot Act, is intended to strengthen the ability of U.S. law enforcement agencies and the intelligence communities to work cohesively to combat terrorism on a variety of fronts. The impact of the Patriot Act on financial institutions is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.
Reserve Requirements; Federal Reserve System and Federal Home Loan Bank System. First Bank is a member of the Federal Reserve System and the Federal Home Loan Bank System. As a member, First Bank is required to hold investments in those systems. First Bank was in compliance with these requirements at December 31, 2014, as further described in Note 1 to our consolidated financial statements.
The Federal Reserve requires all depository institutions to maintain reserves against their transaction accounts and non-personal time deposits. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements.
First Bank has established a borrowing relationship with the FRB, which is primarily secured by commercial loans, and provides an additional liquidity facility that may be utilized for contingency purposes. First Bank also has established a borrowing relationship with the FHLB of Des Moines. The borrowing relationship is secured by one-to-four-family residential, multi-family residential and commercial real estate loans. First Bank requests advances and/or repays advances from the FHLB based on its current and
future projected liquidity needs. See further discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations -Liquidity Management.”
Monetary Policy and Economic Control. The commercial banking business is affected by legislation, regulatory policies and general economic conditions as well as the monetary policies of the Federal Reserve. The instruments of monetary policy available to the Federal Reserve include the following: (i) changes in the discount rate on member bank borrowings and the targeted federal funds rate; (ii) the availability of credit at the discount window; (iii) open market operations; (iv) the imposition of and changes in reserve requirements against deposits of domestic banks; (v) the imposition of and changes in reserve requirements against deposits and assets of foreign branches; and (vi) the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates.
These monetary policies are used in varying combinations to influence overall growth and distributions of bank loans, investments and deposits, and this use may affect interest rates charged on loans or paid on liabilities. The monetary policies of the Federal Reserve have had a significant effect on the operating results of commercial banks and are expected to do so in the future. Such policies are influenced by various factors, including inflation, unemployment, and short-term and long-term changes in the international trade balance and in the fiscal policies of the U.S. Government. We cannot predict the effect that changes in monetary policy or in the discount rate on member bank borrowings will have on our future business and earnings or those of First Bank.
United States Securities and Exchange Commission. We are also under the jurisdiction of the SEC and certain state securities commissions for matters relating to the offering and sale of our securities. We are subject to disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. The securities issued by one of our affiliated trusts are registered under the Securities Exchange Act of 1934 and are listed on the NYSE under the trading symbol “FBSPrA,” and therefore, we are subject to certain rules and regulations of the NYSE.
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) made extensive changes in the regulation of financial institutions and their holding companies. The Dodd-Frank Act created a Consumer Financial Protection Bureau, or CFPB, as an independent bureau of the Federal Reserve Board. The CFPB assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations, a function currently assigned to primary regulators, and has authority to impose new requirements. However, institutions of less than $10 billion in assets, such as First Bank, will continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and be subject to the enforcement authority of, their primary regulator. Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall impact on the operations and financial condition of the Company.
Incentive Compensation. In 2010, federal banking agencies issued comprehensive guidance on incentive compensation policies, or Incentive Compensation Guidance, 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 guidance, 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. Any deficiencies in compensation practices that are identified may be incorporated into the organization’s supervisory ratings, which can affect its ability to make acquisitions or perform other actions. The guidance provides that 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. In 2011, the federal banking agencies issued a joint proposed rule pursuant to the Dodd-Frank Act that would prohibit incentive compensation arrangements that would encourage inappropriate risk for certain financial institutions with $1 billion or more in assets and heightened standards for the largest of these institutions. The final rules have not yet been adopted by the Federal Reserve. The scope and content of the federal banking agencies’ policies on executive compensation are continuing to develop. It cannot be determined at this time whether compliance with such policies will adversely affect our ability to hire, retain and motivate our key employees.
Other Future Legislation and Changes in Regulations. In addition to the specific proposals described above, from time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of
operations of the Company. A change in statutes, regulations or regulatory policies applicable to us or any of our subsidiaries could have a material effect on the Company’s business, financial condition or results of operations.
Item 1A.
Item 1A. Risk Factors
Readers of our Annual Report on Form 10-K should consider the risk factors described below in conjunction with the other information included in this Annual Report on Form 10-K, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, our Selected Financial Data, our consolidated financial statements and the related notes thereto, and the financial and other data contained elsewhere in this report. See also “Special Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results” appearing at the beginning of this report. The order of the risk factors described below is not indicative of likelihood or significance.
We could be compelled to seek additional capital in the future, but capital may not be available when it is needed or on acceptable terms. Our holding company, First Banks, Inc., was adequately capitalized and First Bank was well capitalized at December 31, 2014. Failure to continue to meet minimum capital requirements can initiate certain actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Our ability to raise additional capital in the future, if deemed necessary, will depend on conditions in the capital markets, economic conditions, our financial performance and a number of other factors, many of which are outside of our control. Accordingly, we cannot be assured of our ability to raise additional capital on terms acceptable to us. If we determine it is necessary to raise additional capital and are unable to do so, on terms satisfactory to us, our financial condition, results of operations, business prospects and our regulatory capital ratios and those of First Bank may be materially and adversely affected. We may also be subjected to increased regulatory supervision, which could result in the imposition of additional regulatory restrictions on our operations and/or regulatory enforcement actions and could also potentially limit our future growth opportunities. These restrictions could negatively impact our ability to manage or expand our operations in a manner that we may deem beneficial to our stockholders and could result in significant increases in our operating expenses or decreases in our revenues.
The Final Capital Rules may materially adversely affect our capital adequacy and the costs of conducting business. The Federal Reserve adopted Final Capital Rules in July, 2013 that substantially amended the regulatory risk-based capital rules applicable to the Company and First Bank, including significant changes to holding company and bank capital requirements, as further described in “Item 1 -Business - Supervision and Regulation - Capital Adequacy Requirements.” The Final Capital Rules include new risk-based capital and leverage ratios, which will be phased in from 2015 to 2019, and introduce a new common equity Tier 1 ratio.
The Company's common equity calculated under U.S. generally accepted accounting principles will diverge from the Company's common equity Tier 1 Capital as calculated for regulatory purposes. As further described under “Item 1. Business -Supervision and Regulation - Capital Adequacy Requirements,” the Federal Reserve, in July, 2013, promulgated regulations that impose a new common equity Tier 1 capital requirement that became effective for the Company on January 1, 2015. Absent a substantial increase in qualifying common equity, the Company will not meet the common equity Tier 1 capital requirement under the Final Capital Rules. The inability to remain adequately capitalized under the Final Capital Rules could materially adversely impact our financial condition, results of operations, ability to grow, and could prohibit the payment of dividends on our capital stock and interest on our junior subordinated debentures (and the related trust preferred securities).
The Company’s ability to increase its common equity Tier 1 capital is constrained by the Company’s private ownership structure. As previously described above, absent a substantial increase in qualifying common equity, the Company will not meet the common equity Tier 1 capital requirement under the Final Capital Rules. All of the Company’s common stock is held by trusts created by and for the benefit of Mr. James F. Dierberg and members of his immediate family. The Company cannot issue a meaningful number of additional shares of common stock without an amendment of the Company’s Articles of Incorporation which would require the approval of the holders of common stock. Such holders have indicated their intention to maintain the Company as a privately held institution. Furthermore, applicable law would require continued control of an amount of the Company's capital stock that, in the aggregate, represents 50% of the Company's value by the current holders of the Company’s common stock, Class A Preferred Stock and Class B Preferred Stock in order to avoid limitations on the use of the Company's deferred tax assets. For these reasons, the Company’s ability to substantially increase its common equity Tier 1 capital in order to meet the Final Capital Rules is more limited than it otherwise might be for a publicly traded company with widely dispersed ownership.
The Company entered into an MOU with the Federal Reserve Bank of St. Louis. As further described under “Item 1. Business -Supervision and Regulation - Regulatory Agreements,” the Company entered into an MOU with the FRB on May 19, 2014. While we intend to take such actions as may be necessary to comply with the requirements of the MOU, there can be no assurance that such efforts will not have adverse effects on the operations and financial condition of the Company or First Bank. If we fail to comply with the terms of the MOU, further enforcement action could be taken by the FRB which could have a materially adverse effect on our business, financial condition, results of operations and cash flows. Furthermore, under the MOU, the Company must receive approval from the FRB prior to declaring or paying any dividends on its common or preferred stock, or prior to causing
First Bank to pay dividends in excess of its earnings or make a capital distribution that would cause First Bank's Tier 1 Leverage Ratio to fall below 9.0%. The FRB has complete discretion to grant any such approval and therefore, it is not known whether the FRB would approve any such request. If First Bank is unable to pay future dividends, we may not be able to make the interest payments on our outstanding junior subordinated debentures, which represent the source of distributions to holders of trust preferred securities. In addition, pursuant to Missouri Revised Statutes, First Bank is required to obtain approval from the MDOF prior to paying any dividends to the Company. The MDOF has complete discretion to grant any such approval and therefore, it is not known whether the MDOF will approve any such requests in the future.
We are subject to extensive government regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not security holders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. The Dodd-Frank Act instituted major changes to the banking and financial institutions regulatory regimes in light of the ongoing performance of and government intervention in the financial services sector. Other changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. For a further discussion of these matters, see “Item 1. Business -Supervision and Regulation.”
It is possible that the Company may have to establish a valuation allowance against its net deferred tax assets. As further discussed in Note 17 to the consolidated financial statements, in the fourth quarter of 2013, the Company reversed substantially all of its existing valuation allowance against its net deferred tax assets. Deferred tax assets represent the tax effect of the difference between the book and tax basis of the Company's assets and liabilities and are assessed periodically by management to determine if they are realizable. Factors in management's determination of whether the deferred tax assets are realizable include the Company's performance, including the ability to generate taxable net income. If, based on available information, it is more likely than not that the deferred tax assets will not be realized in any subsequent period, then a valuation allowance must be established with a corresponding charge to income tax expense. Consequently, although the Company reversed substantially all of its valuation allowance against its net deferred tax assets in the fourth quarter of 2013, future facts and circumstances may require the Company to establish a valuation allowance. Charges to establish a valuation allowance with respect to the Company's deferred tax assets could have a material adverse effect on its financial condition and results of operations.
The Company and its subsidiaries may not be able to realize the benefit of the remaining deferred tax assets. The Company records deferred tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in years in which those temporary differences are expected to be recovered or settled. The deferred tax assets can be recognized in future periods dependent upon a number of factors, including the ability to realize the asset through carrybacks or carryforwards to taxable income in prior or future years, the future reversal of existing taxable temporary differences, future taxable income, and the possible application of future tax planning strategies. While substantially all of the Company's previously recorded valuation allowance against its net deferred tax assets was recovered in 2013, the remaining deferred tax assets may not be recoverable which could result in an adverse impact on the Company's financial condition and results of operations.
Changes in economic conditions could negatively and materially impact our business. Our business is directly affected by factors such as economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government monetary and fiscal policies and inflation, all of which are beyond our control. A deterioration in economic conditions or lack of improvement in economic conditions may result in adverse consequences such as the following, any of which could negatively and materially impact or continue to negatively and materially impact our business:
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Loan delinquencies may increase;
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Problem assets and foreclosures may increase;
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Demand for our products and services may decline;
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Low cost or noninterest bearing deposits may decrease; and
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Collateral pledged to us by our clients for loans made by us, especially residential and commercial real estate property, may decline, in turn reducing our clients’ borrowing power, and thereby reducing the value of the underlying assets and collateral associated with our existing loans.
Our emphasis on commercial real estate lending and real estate construction and development lending could increase our credit risk. A substantial portion of our loans are secured by commercial real estate. Commercial real estate and real estate construction
and development loans were $1.18 billion and $89.9 million, respectively, at December 31, 2014, representing 37.9% and 2.9%, respectively, of our total loans held for portfolio. Although we experienced improvement in asset quality levels in these portfolios during 2014, as discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations -Loans and Allowance for Loan Losses,” we have experienced high levels of nonperforming loans within our real estate construction and development portfolio and commercial real estate portfolio in recent years, reflective of weakened market conditions surrounding land acquisition and development loans as a result of increased developer inventories, slower lot and home sales, and declining market values. Adverse developments affecting real estate in one or more of our markets could increase the credit risk associated with our loan portfolio.
Weakness in the residential real estate market could adversely affect us. Our one-to-four-family residential real estate mortgage loans were $1.02 billion at December 31, 2014, representing 32.6% of our total loans held for portfolio. Weakness in the residential real estate market could result in price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held, mortgage loan originations and gains recognized on the sale of mortgage loans. In the event our allowance for loan losses is insufficient to cover such losses, our financial condition and results of operations may be adversely affected.
Our allowance for loan losses may not be sufficient to cover our actual loan losses, which could adversely affect our results of operations or financial condition. As a lender, we are exposed to the risk that our loan clients may not repay their loans according to their contractual terms and that the collateral securing the payment of these loans may be insufficient to assure repayment in full. Significant loan losses could have a material adverse effect on our results of operations. Management makes various assumptions and judgments about the collectability of our loan portfolio, which are based in part on:
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Current economic conditions and their estimated effects on specific borrowers;
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An evaluation of the existing relationships among loans, potential loan losses and the present level of the allowance for loan losses;
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Management’s internal review of the loan portfolio, including existing compliance with established policies and procedures; and
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Results of examinations of our loan portfolio by regulatory agencies.
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management’s best estimate of probable incurred loan losses inherent in our loan portfolio. Additional loan losses will likely continue to occur in the future and may occur at a rate greater than we have experienced historically. In determining the amount of the allowance for loan losses, we rely on an analysis of our loan portfolio, experience, and evaluation of general economic, political and regulatory conditions, industry and geographic concentrations, and certain other factors. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and judgment and requires us to make significant estimates of current credit risk and future trends, all of which may undergo material changes. If our assumptions and analysis prove to be incorrect, our current allowance for loan losses may not be sufficient. In addition, adjustments may be necessary to allow for unexpected volatility or deterioration in the local or national economy or other factors such as changes in interest rates that may be beyond our control. In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of management. Any increase in our allowance for loan losses or loan charge-offs could have a material adverse effect on our results of operations.
Our nonperforming loans also impact the sufficiency of our allowance for loan losses. Nonperforming loans totaled $57.5 million as of December 31, 2014. In addition to those loans currently identified and classified as nonperforming loans, management is aware that other possible credit problems may exist with certain borrowers. These include loans that are migrating from grades with lower risks of loss probabilities into grades with higher risks of loss probabilities as performance and potential repayment issues surface. We monitor these loans and adjust the loss rates in our allowance for loan losses accordingly. The most severe of these loans are credits that are classified as substandard loans due to either less than satisfactory performance history, lack of borrower’s paying capacity, or potentially inadequate collateral. Substandard, or potential problem loans, totaled $25.2 million at December 31, 2014. We also make concessions to modify the contractual terms of certain loans when the borrower is experiencing financial difficulty. These modifications are generally made to either prevent a loan from being placed on nonaccrual status or to return a nonaccrual loan to performing status based on the expectations that the borrower can adequately perform in accordance with the modified terms. These loans are classified as performing troubled debt restructurings and totaled $80.6 million at December 31, 2014.
We are subject to credit quality risks and our credit policies may not be sufficient to avoid losses. We are subject to the risk of losses resulting from the failure of borrowers, guarantors and related parties to pay interest and principal amounts on their loans. Our credit policies and credit underwriting and monitoring and collection procedures may not prevent losses, particularly during periods in which the local, regional or national economy suffers a general decline. If borrowers fail to repay their loans according to the contractual terms of the loans, our financial condition and results of operations will be adversely affected.
Our home equity lines of credit portfolio could expose us to additional credit risk and impact our results of operations. Home equity lines of credit were $395.5 million, or 12.7% of our total loans held for portfolio, at December 31, 2014. Our home equity lines of credit typically have a 10-year revolving period whereby the borrower is required to pay only interest on the loans during the draw period. After the revolving period, the loan converts to a fully-amortizing loan whereby the borrower is required to pay both interest, typically at a variable rate, and principal, typically a 15-year amortization period. As a result, the borrower's monthly payment could significantly increase upon the start of the amortization period, and increase further with a rise in interest rates. If the borrower is unable to make the required payments on the fully-amortizing loans, we could experience increased loan delinquencies and credit losses which could have an adverse affect on our financial condition and results of operations.
Mortgage loan repurchase obligations or claims from third parties could result in material losses. We have sold significant amounts of residential mortgage loans directly to government-sponsored enterprises, Fannie Mae (FNMA) and Freddie Mac (FHLMC) (collectively, the GSEs), and to investors other than GSEs as whole loans. In connection with these sales, we make or have made various representations and warranties, breaches of which may result in a requirement that we repurchase the mortgage loans, or otherwise make whole or provide other remedies to the counterparties. We have recorded an estimated liability related to possible mortgage repurchase losses of $2.4 million as of December 31, 2014. Our estimated liability for possible loss is based on then-currently available information and is dependent on various factors, including our historical claims and settlement experience, projections of future defaults, and significant judgment and assumptions that are subject to change. As such, the future possible loss related to our representations and warranties may materially change in the future based on factors beyond our control or if actual experiences are different from our assumptions, including, without limitation, estimated repurchase rates, economic conditions, estimated home prices, consumer and counterparty behavior, and a variety of other judgmental factors. Adverse developments with respect to one or more of the assumptions underlying the estimated liability and the corresponding estimated range of possible loss could result in significant increases to future provisions and/or the estimated range of possible loss. If future representations and warranties losses occur in excess of our recorded liability and estimated range of possible loss, such losses could have a material adverse effect on our cash flows, financial condition and results of operations.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition. Liquidity is essential to our business. An inability to raise funds through traditional deposits, brokered deposits, borrowings, the sale of securities or loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities and on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent and ongoing turmoil faced by banking organizations and the continued deterioration and instability in credit markets.
We rely on commercial and retail deposits, advances from the FHLB of Des Moines and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits and advances as necessary, we might not be able to replace such funds in the future if, among other things, our results of operations or financial condition or the results of operations or financial condition of the FHLB of Des Moines or overall market conditions were to change.
There can be no assurance these sources of funds will be adequate for our liquidity needs and we may be compelled to seek additional sources of financing in the future. Likewise, we may seek additional debt in the future to achieve our business objectives. There can be no assurance additional borrowings, if sought, would be available to us or, if available, would be on terms acceptable to us. If additional financing sources are unavailable or not available on reasonable terms, our financial condition, results of operations and future prospects could be materially adversely affected.
We actively monitor the depository institutions that hold our cash operating account balances. It is possible that access to our cash equivalents will be impacted by adverse conditions in the financial markets. Our emphasis is primarily on safety of principal and we seek to diversify our cash balances among counterparties to minimize exposure to any one of these entities. The financial statements and other relevant data of the counterparties are routinely reviewed as part of our asset/liability management process. Balances in our accounts with financial institutions in the U.S. may exceed the FDIC insurance limits. While we monitor and adjust the balances in our accounts as appropriate, these balances could be impacted if the financial institutions fail and could be subject to other adverse conditions in the financial markets. At December 31, 2014, our cash and cash equivalents totaled $205.4 million, of which $47.3 million was maintained in our cash operating account at the FRB.
We rely on dividends from our subsidiaries for most of our revenue. The Company is a separate and distinct legal entity from its subsidiaries. We receive substantially all of our revenue from dividends from our subsidiaries. These dividends are the principal source of funds to pay dividends on our preferred stock and interest and principal on our debt. Various federal and/or state laws and regulations limit the amount of dividends that First Bank and certain nonbank subsidiaries may pay to the Company. In the event First Bank is unable to pay future dividends, we may not be able to service our debt (including our junior subordinated debentures issued in connection with the issuance of our outstanding trust preferred securities), pay obligations or pay dividends
on our preferred stock. The inability to receive dividends from First Bank could have a material adverse effect on our business, financial condition and results of operations. As further described under “Item 1. Business -Supervision and Regulation,” First Bank has agreed not to declare or pay any dividends, without the prior consent of the FRB, that would cause First Bank to pay dividends in excess of its earnings or make a capital distribution that would cause First Bank's Tier 1 Leverage Ratio to fall below 9.0%. Furthermore, pursuant to Missouri Revised Statutes, First Bank is required to obtain approval from the MDOF prior to paying any dividends to the Company. We are unable to predict whether or when the FRB or the MDOF will grant such consent in the future. The MDOF has complete discretion to grant any such approval and therefore, it is not known whether the MDOF will approve any such requests in the future.
The Company’s ability to pay dividends on its capital stock may be limited under the terms of the Company’s debt. As of December 31, 2014, the Company had $345.0 million of junior subordinated debentures issued in connection with its outstanding trust preferred securities, as further described in Note 12 to the consolidated financial statements. Payments of principal and interest on the junior subordinated debentures (and the related payments on the trust preferred securities) are conditionally guaranteed by the Company. The rights of the holders of the Company’s junior subordinated debentures are senior in ranking to the rights of the holders of the Company’s common stock and preferred stock. As a result, the Company may only pay dividends on its common stock or preferred stock if the payments on its junior subordinated debentures (and the related trust preferred securities) are current and, in the event of its bankruptcy, dissolution or liquidation, the holders of the Company’s junior subordinated debentures must be satisfied before any distributions can be made to its stockholders.
Holders of the Company’s Common Stock, Class A Preferred Stock and Class B Preferred Stock may have interests that are different from the holders of the Company’s Class C Preferred Stock and Class D Preferred Stock. The holders of the Company’s Class C Preferred Stock and Class D Preferred Stock have limited voting rights. All of the Company’s Common Stock, Class A Preferred Stock and Class B Preferred Stock are held by trusts established by and administered by and for the benefit of Mr. James F. Dierberg and members of his immediate family. The holders of the Company’s Common Stock, Class A Preferred Stock and Class B Preferred Stock may have different interests from the holders of the Company’s Class C Preferred Stock and Class D Preferred Stock and could vote, or not vote, to approve transactions that may be considered desirable by the holders of the Company’s Class C Preferred Stock and Class D Preferred Stock.
Our ability to pay interest or meet dividend obligations on our junior subordinated debentures and our Class C Preferred Stock and Class D Preferred Stock, and our ability to redeem such securities, could be hindered by the completed initiatives associated with our Capital Plan. As further described under “Item 1. Recent Developments and Other Matters -Capital Plan,” we have completed a number of initiatives associated with our Capital Plan, including sales of branch offices, sales of certain loans and sales of nonbank subsidiaries. While these transactions were considered necessary by the Company to improve our regulatory capital ratios and preserve our regulatory capital in the short-term, these transactions have also decreased our sources of revenue and could hinder the probability and timing of future repayment of these obligations.
The Company may be adversely affected by the soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse affect on our financial condition and results of operations.
Markets have experienced, and may continue to experience, periods of high volatility accompanied by reduced liquidity. Financial markets are susceptible to severe events evidenced by rapid depreciation in asset values accompanied by a reduction in asset liquidity. Under these extreme conditions, hedging and other risk management strategies may not be as effective at mitigating losses as they would be under more normal market conditions. Moreover, under these conditions, market participants are particularly exposed to trading strategies employed by many market participants simultaneously and on a large scale, such as crowded trades. Our risk management and monitoring processes seek to quantify and mitigate risk to more extreme market moves. Severe market events have historically been difficult to predict, however, and we could realize significant losses if unprecedented extreme market events were to occur, such as the recent conditions experienced in the global financial markets and global economy.
Negative perception could adversely affect our business, impacting our financial condition, results of operations and cash flows. Risk of negative perception or publicity is inherent in any business. Although the Company takes steps to minimize reputation risk in dealing with clients and other constituencies, the Company is inherently exposed to the risk of negative perception by the public and our clients as a result of, but not limited to, our prior participation in the CPP under the Emergency Economic Stabilization Act of 2008, or EESA, and as a result of actions imposed by our regulators. The risk of negative perception by the public and our clients may adversely affect the Company’s ability to maintain and attract clients and employees.
Our controls and procedures may fail or be circumvented. Our management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurance that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, financial condition and results of operations.
The Company’s deposit insurance premiums could be substantially higher in the future, which could have a material adverse effect on our future earnings. The Dodd-Frank Act established 1.35% as the minimum designated reserve ratio, or DRR (the ratio of the DIF to insured deposits). It is possible that our insurance premiums will increase in the future as a result of the required minimum DRR and/or an increase in our risk assessment rating.
Significant legal actions could subject us to substantial liabilities. We are from time to time subject to claims related to our operations. These claims and legal actions, including supervisory actions by our regulators, could involve monetary claims and significant defense costs. As a result, we may be exposed to substantial liabilities, which could adversely affect our results of operations and financial condition.
Geographic distance between our operations increases operating costs and makes efforts to standardize operations more difficult. We operate banking offices in California, Florida, Illinois and Missouri. The noncontiguous nature of many of our geographic markets increases operating costs and makes it more difficult for us to standardize our business practices and procedures. As a result of our geographic dispersion, we face the following challenges, among others: (a) familiarizing personnel with our business environment, banking practices and client requirements at geographically dispersed locations; (b) providing administrative support, including accounting, human resources, credit administration, loan servicing, internal audit and credit review at significant distances; and (c) establishing and monitoring compliance with our corporate policies and procedures in different areas.
Decreases in interest rates could have a negative impact on our profitability. Our earnings are principally dependent on our ability to generate net interest income. Net interest income is affected by many factors that are partly or completely beyond our control, including competition, general economic conditions and the policies of regulatory authorities, including the monetary policies of the Federal Reserve. Under our current interest rate risk profile, our net interest income has been and could be negatively affected by a further decline in interest rates, as further discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations -Interest Rate Risk Management.”
The financial services business is highly competitive, and we face competitive disadvantages because of our size and the nature of banking regulation. We encounter strong direct competition for deposits, loans and other financial services in all of our market areas. Our larger competitors, which have significantly greater resources, may have advantages over us in providing certain services. Our principal competitors include other commercial banks, savings banks, savings and loan associations, mutual funds, finance companies, trust companies, insurance companies, leasing companies, credit unions, mortgage companies, private issuers of debt obligations and suppliers of other investment alternatives, such as securities firms and financial holding companies. Many of our non-bank competitors are not subject to the same degree of regulation as that imposed on bank holding companies, federally insured banks and national or state chartered banks. As a result, such non-bank competitors may have advantages over us in providing certain services and may make it more difficult for us to achieve our objectives, such as increasing the size of our loan portfolio, attracting clients and implementing our business strategy and profit improvement initiatives.
Non-compliance with the USA Patriot Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions. The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of clients seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. Although we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.
We provide treasury management services to money services businesses, which include: check cashers, issuers/sellers of traveler’s checks, money orders and stored value cards, and money transmitters. Money services businesses pose a higher level of risk of compliance with regulatory guidance. We provide treasury management services to the check cashing industry, offering check clearing, monetary instrument, depository, and credit services. We also provide treasury management services to money transmitters. Financial institutions that open and maintain accounts for money services businesses are expected to apply the requirements of the USA Patriot Act and Bank Secrecy Act, as they do with all accountholders, on a risk-assessed basis. As with any category of accountholder, there will be money services businesses that pose little risk of money laundering or lack of compliance with other laws and regulations and those that pose a significant risk. Providing treasury management services to
money services businesses represents a significant compliance and regulatory risk, and failure to comply with all statutory and regulatory requirements could result in fines or sanctions.
We may not be able to implement technological change as effectively as our competitors. The financial services industry has undergone in the past and continues to undergo rapid technological change related to delivery and availability of new technology-driven products and services and operating efficiencies that enable financial institutions to better serve clients and to reduce costs. In many instances technological improvements require significant capital expenditures, and many of our larger competitors have significantly greater resources to absorb such capital expenditures than we may have available. As such, we may be at a competitive disadvantage in our ability to retain existing clients and compete for new clients in the marketplace.
We are subject to operational and financial risks associated with our reliance on employees, systems, and counterparties and certain failures. Our business operates in many diverse markets and relies on the ability of our employees and systems to process a high number of transactions. Operational risk is the risk of loss resulting from our operations, including, but not limited to, the risk of fraud by employees or persons outside of our Company, unauthorized access to our computer systems, the execution of unauthorized transactions by our employees, errors relating to transaction processing and technology, breaches in internal controls and data security, compliance requirements, and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and client attrition due to potential negative publicity. Third parties with whom we do business could also be sources of operational risk to us, including risks relating to breakdowns or failures of such parties’ own systems or employees. We could suffer significant regulatory action or consequences, damage to our reputation and financial loss in the event of a breakdown in the internal control system, improper operation of systems, improper employee actions, or if personal, confidential or proprietary client information in our possession were to be mishandled or misused, including situations in which the information is erroneously provided to parties who are not permitted to have the information, either by fault of our systems, employees, or counterparties, or where the information is intercepted or otherwise inappropriately taken by third parties.
A breach in the security of our systems, a breach in systems of our third party vendors or cyber attacks, could disrupt our business, result in the disclosure of confidential information, damage our reputation and create significant financial and legal exposure. Information security risks for financial institutions have generally increased in recent years, in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions and the increased sophistication and activities of organized crime, hackers, terrorists, activists and other external parties. Although we devote significant resources to maintain and regularly upgrade our systems and processes that are designed to protect the security of our computer systems, software, networks and other technology assets, and the confidentiality, integrity and availability of information belonging to the Company and our clients, there is no assurance that our security measures will provide absolute security. In fact, many other financial services institutions and companies engaged in data processing have reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage systems, often through the introduction of computer viruses or malware, cyberattacks and other means. Several financial institutions have experienced attacks from technically sophisticated and well-resourced third parties that were intended to disrupt normal business activities by making internet banking systems inaccessible to clients for extended time periods. Although these types of attacks have not breached our data security systems, they require substantial resources to defend and may affect client satisfaction and behavior.
Despite efforts to ensure the integrity of our systems, it is possible that we may not be able to anticipate or to implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently or are not recognized until launched, and because security attacks can originate from a wide variety of sources, including persons who are involved with organized crime or associated with external service providers or who may be linked to terrorist organizations or hostile foreign governments. Those parties may also attempt to fraudulently induce employees, clients or other users of our systems to disclose sensitive information in order to gain access to our data or that of our clients. These risks may increase in the future as we continue to increase our mobile payments and other internet-based product offerings and expand our internal usage of web-based products and applications.
If our security systems were penetrated or circumvented, it could cause serious negative consequences, including significant disruption of our operations, misappropriation of our confidential information or that of our clients, or damage to our computers or systems and those of our clients and counterparties, and could result in violations of applicable privacy and other laws, financial loss to us or to our clients, loss of confidence in our security measures, client dissatisfaction, significant litigation exposure, and harm to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations.
Cybersecurity and the continued development and enhancement of our internal controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a key focus for us. While our policies and procedures are designed to prevent or limit the impact of any such failure, interruption or security breach, there
can be no assurance that any such failure, interruption or security breach will not occur. While we closely monitor and evaluate the financial and operational risks associated with reliance on technology and information systems on an ongoing basis and maintain insurance coverage for such risks, any such failure, interruption or security breach could materially adversely affect our business, financial condition and results of operations, including a resulting loss in client business, damage to our reputation, misappropriation of sensitive information, corruption of data, disruption of internet banking activities or other operations, and possible exposure to regulatory scrutiny and litigation.
Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business. Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue, and/or cause us to incur additional expenses. Changing climate conditions may increase the frequency of natural disasters such as hurricanes, windstorms and other severe weather conditions. Although we have established policies and procedures addressing these types of events, the occurrence of any such event could have a material adverse effect on our business, financial condition and results of operations.
The Company is subject to claims and litigation pertaining to fiduciary responsibility. From time to time, clients make claims and take legal action pertaining to the performance of our fiduciary responsibilities. Whether client claims and legal action related to the performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact client demand for our products and services. Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition, results of operations and cash flows.
The Company is exposed to risk of environmental liabilities with respect to properties to which we take title. In the course of our business, we may own or foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law or contractual claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, cash flows, liquidity and results of operations could be materially and adversely affected.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
We own our office building, which houses our principal place of business, located at 135 North Meramec, Clayton, Missouri 63105. The property is in good condition and consists of approximately 60,353 square feet, of which approximately 10,923 square feet is currently leased to others. Of our other 128 offices and two operations and administrative facilities at December 31, 2014, 72 are located in buildings that we own and 58 are located in buildings that we lease.
We consider the properties at which we do business to be in good condition generally and suitable for our business conducted at each location. To the extent our properties or those acquired in connection with our acquisition of other entities provide space in excess of that effectively utilized in the operations of First Bank, we seek to lease or sublease any excess space to third parties. Additional information regarding the premises and equipment utilized by First Bank appears in Note 5 to our consolidated financial statements appearing elsewhere in this report.
Item 3.
Item 3. Legal Proceedings
The information required by this item is set forth in Part II, Item 8 - Financial Statements and Supplementary Data, under Note 24, Contingent Liabilities, to our consolidated financial statements appearing elsewhere in this report and is incorporated herein by reference.
In the ordinary course of business, we and our subsidiaries become involved in legal proceedings, including litigation arising out of our efforts to collect outstanding loans. It is not uncommon for collection efforts to lead to so-called “lender liability” suits in which borrowers may assert various claims against us. From time to time, we are party to other legal matters arising in the normal course of business. While some matters pending against us specify damages claimed by plaintiffs, others do not seek a specified amount of damages or are at very early stages of the legal process. We record a loss accrual for all legal matters for which we deem a loss is probable and can be reasonably estimated. We are not presently party to any legal proceedings the resolution of which we believe is reasonably likely to have a material adverse effect on our business, financial condition or results of operations.
The Company entered into an MOU with the FRB, dated May 19, 2014, as further described under “Item 1. Business -Supervision and Regulation - Regulatory Agreements” and in Note 14 to our consolidated financial statements.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information. There is no established public trading market for our common stock. Various trusts, which were established by and are administered by and for the benefit of Mr. James F. Dierberg, our Chairman of the Board, and members of his immediate family, including Mr. Michael Dierberg, our Vice Chairman, and Ms. Ellen Dierberg Milne, Director of the Company, own all of our voting stock.
Dividends. We have not paid any dividends on our Common Stock.
In August 2009, we announced the suspension of the payment of cash dividends on our outstanding Class A Convertible Adjustable Rate Preferred Stock and our Class B Non-Convertible Adjustable Rate Preferred Stock beginning with the scheduled dividend payments that would have otherwise been made in September 2009. Prior to this time, we paid minimal dividends on our Class A Convertible Adjustable Rate Preferred Stock and our Class B Non-Convertible Adjustable Rate Preferred Stock.
In February 2009 and May 2009, we paid the regularly scheduled quarterly dividends on our Class C Preferred Stock and Class D Preferred Stock, which were pre-approved and authorized for payment by the FRB. In August 2009, we also announced the deferral of dividend payments on our Class C Preferred Stock and Class D Preferred Stock beginning with the regularly scheduled quarterly dividend payments that would otherwise have been made in August 2009, however, we continued to declare and accrue such dividends and the related additional cumulative dividends on our deferred dividend payments in our consolidated financial statements until the fourth quarter of 2013, when we ceased declaring dividends on our Class C Preferred Stock and Class D Preferred Stock, as further discussed in Note 13 to the Company's consolidated financial statements.
Our ability to pay dividends is limited by regulatory requirements and by the receipt of dividend payments from First Bank, which is also subject to regulatory requirements. As previously discussed under “Item 1. Business -Supervision and Regulation,” under the terms of the MOU, First Bank has agreed not to declare or pay any dividends, without the prior consent of the FRB, that would cause First Bank to pay dividends in excess of its earnings or make a capital distribution that would cause First Bank's Tier 1 Leverage Ratio to fall below 9.0%. Furthermore, pursuant to Missouri Revised Statutes, First Bank is required to obtain approval from the MDOF prior to paying any dividends to the Company. The FRB and/or the MDOF have complete discretion to grant any such approvals and therefore, it is not known whether the FRB and/or the MDOF will approve any such requests in the future. The dividend limitations are further described in Note 13 and Note 22 to our consolidated financial statements appearing elsewhere in this report.
Item 6.
Item 6. Selected Financial Data. The selected consolidated financial data set forth below are derived from our consolidated financial statements. This information is qualified by reference to our consolidated financial statements appearing elsewhere in this report. This information should be read in conjunction with such consolidated financial statements, the related notes thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 1A -Risk Factors.”
Selected Financial Data (continued):
(1)
The selected data is presented on a continuing basis. Certain reclassifications of 2013, 2012, 2011 and 2010 amounts have been made to conform to the 2014 presentation.
(2)
Net interest margin is the ratio of net interest income (expressed on a tax-equivalent basis) to average interest-earning assets.
(3)
Tangible noninterest expense to average assets is the ratio of noninterest expense (excluding goodwill impairment and amortization of intangible assets) to average assets.
(4)
Efficiency ratio is the ratio of noninterest expense to the sum of net interest income and noninterest income. Tangible efficiency ratio is the ratio of noninterest expense (excluding goodwill impairment and amortization of intangible assets) to the sum of net interest income and noninterest income.
(5)
Nonperforming assets consist of nonaccrual loans and other real estate.
(6)
The capital ratios at December 31, 2014, 2013, 2012 and 2011 reflect the implementation of new Federal Reserve rules that became effective on March 31, 2011. See “Item 1 -Business - Supervision and Regulation - Capital Adequacy Requirements” for discussion of new rules that became effective on January 1, 2015.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following presents management’s discussion and analysis of our financial condition and results of operations as of the dates and for the periods indicated. This discussion should be read in conjunction with our “Selected Financial Data,” our consolidated financial statements and the related notes thereto, and the other financial data appearing elsewhere in this report. This discussion set forth in Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements with respect to our financial condition, results of operations and business. These forward-looking statements are subject to certain risks and uncertainties, not all of which can be predicted or anticipated. Various factors may cause our actual results to differ materially from those contemplated by the forward-looking statements herein. We do not have a duty to and do not undertake any obligation to update these forward-looking statements. Readers of our Annual Report on Form 10-K should therefore consider these risks and uncertainties in evaluating forward-looking statements and should not place undue reliance on forward-looking statements. See “Special Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results” appearing at the beginning of this report and “Item 1A -Risk Factors,” appearing elsewhere in this report.
RESULTS OF OPERATIONS
Overview
All financial information in this Annual Report on Form 10-K is reported on a continuing operations basis, unless otherwise noted. See Note 2 to our consolidated financial statements appearing elsewhere in this report for further discussion regarding our discontinued operations.
We recorded net income of $21.7 million for the year ended December 31, 2014, compared to net income, including discontinued operations, of $241.7 million for the year ended December 31, 2013 and net income, including discontinued operations, of $26.3 million for the year ended December 31, 2012. Our net income reflects the following:
•
Net interest income of $147.6 million for the year ended December 31, 2014, compared to $148.7 million in 2013 and $171.2 million in 2012, and a net interest margin of 2.77% for the year ended December 31, 2014, compared to 2.56% in 2013 and 2.80% in 2012;
•
A negative provision for loan losses of $7.0 million and $5.0 million for the years ended December 31, 2014 and 2013, respectively, compared to a provision for loan losses of $2.0 million in 2012;
•
Noninterest income of $56.0 million for the year ended December 31, 2014, compared to $64.0 million in 2013 and $64.6 million in 2012;
•
Noninterest expense of $176.9 million for the year ended December 31, 2014, compared to $285.5 million in 2013 (including goodwill impairment of $107.3 million) and $199.2 million in 2012;
•
A provision for income taxes of $12.2 million for the year ended December 31, 2014, compared to a benefit for income taxes of $288.5 million in 2013 (reflecting the reversal of substantially all of our valuation allowance against our net deferred tax assets) and a benefit for income taxes of $139,000 in 2012;
•
Net income from discontinued operations, net of tax, of $21.2 million in 2013 and a net loss from discontinued operations, net of tax, of $8.8 million in 2012; and
•
A net loss attributable to noncontrolling interest in subsidiary of $76,000 for the year ended December 31, 2014, compared to net income attributable to noncontrolling interest in subsidiary of $179,000 in 2013 and a net loss attributable to noncontrolling interest in subsidiary of $297,000 in 2012.
Net Interest Income and Average Balance Sheets
The primary source of our income is net interest income. Net interest income is the difference between the interest earned on our interest-earning assets, such as loans and investment securities, and the interest paid on our interest-bearing liabilities, such as deposits and borrowings. Net interest income is affected by the level and composition of assets, liabilities and stockholders’ equity, as well as the general level of interest rates and changes in interest rates. Interest income on a tax-equivalent basis includes the additional amount of interest income that would have been earned if our investment in certain tax-exempt interest-earning assets had been made in assets subject to federal, state and local income taxes yielding the same after-tax income. Net interest margin is determined by dividing net interest income on a tax-equivalent basis by average interest-earning assets. The interest rate spread is the difference between the average equivalent yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
The following table sets forth, on a tax-equivalent basis, certain information on a continuing basis relating to our average balance sheets, and reflects the average yield earned on our interest-earning assets, the average cost of our interest-bearing liabilities and the resulting net interest income for the years ended December 31, 2014, 2013 and 2012:
(1)
For purposes of these computations, nonaccrual loans are included in the average loan amounts.
(2)
Interest income on loans includes loan fees.
(3)
Information is presented on a tax-equivalent basis assuming a tax rate of 35%. The tax-equivalent adjustments were $121,000, $182,000 and $213,000 for the years ended December 31, 2014, 2013 and 2012, respectively.
(4)
Net interest margin is the ratio of net interest income (expressed on a tax-equivalent basis) to average interest-earning assets.
Our balance sheet is presently asset sensitive, and as such, exclusive of recent improvement over 2013 levels, our net interest margin has been negatively impacted by the low interest rate environment. Our asset-sensitive position, coupled with the high level of average lower-yielding short-term investments and investment securities as a percentage of our interest-earning assets, has negatively impacted our net interest income. We built a significant amount of available balance sheet liquidity since 2009 in anticipation of the completion of certain transactions associated with our Capital Plan, which while necessary to complete these transactions, has negatively impacted our net interest margin. We continue our efforts to re-define our overall strategy and business plans with respect to our loan portfolio, including focusing on loan growth initiatives to redeploy available funds into higher-yielding assets, as further discussed below.
Comparison of 2014 and 2013. Net interest income, expressed on a tax-equivalent basis, decreased $1.2 million to $147.7 million for the year ended December 31, 2014, compared to $148.9 million in 2013. Our net interest margin increased 21 basis points to 2.77% for the year ended December 31, 2014, from 2.56% in 2013.
We attribute the increase in our net interest margin to a change in the mix of our interest-earning assets to reflect loan growth and a decline in our lower-yielding cash and cash equivalents, in addition to an increase in the average yield on our investment securities and a decrease in the cost of our interest-bearing liabilities, partially offset by a decrease in the average yield on our loan portfolio due to the lower interest rate environment and competitive markets with respect to loan originations. We attribute the decrease in our net interest income to a lower average balance of interest-earning assets, primarily resulting from the sale of First Bank's Association Bank Services, or ABS, line of business during the fourth quarter of 2013, partially offset by a decrease in interest expense on our junior subordinated debentures. The average yield earned on our interest-earning assets increased 19 basis points to 3.17% for the year ended December 31, 2014, compared to 2.98% in 2013, while the average rate paid on our interest-bearing liabilities decreased six basis points to 0.54% for the year ended December 31, 2014, compared to 0.60% in 2013. Average interest-earning assets decreased $481.2 million to $5.33 billion for the year ended December 31, 2014, compared to $5.81 billion in 2013. Average interest-bearing liabilities decreased $67.8 million to $3.95 billion for the year ended December 31, 2014, compared to $4.02 billion in 2013.
Interest income on our loan portfolio, expressed on a tax-equivalent basis, increased $217,000 for the year ended December 31, 2014, as compared to 2013. Average loans increased $127.6 million to $2.95 billion for the year ended December 31, 2014, from $2.82 billion in 2013, while the yield on our loan portfolio decreased 18 basis points to 4.01% for the year ended December 31, 2014, compared to 4.19% in 2013. The increase in average loans primarily reflects continued growth in our production loan volumes, partially offset by the exit of certain of our problem credit relationships, as further discussed under “-Loans and Allowance for Loan Losses.” The yield on our loan portfolio continues to be adversely impacted by the lower levels of prime and LIBOR interest rates, as a significant portion of our loan portfolio is priced to these indices, as well as significant competitive pressure on interest rates throughout our markets regarding new loan originations. However, continued growth in loan volumes is expected to positively impact the level of earnings on our loan portfolio in the future.
Interest income on our investment securities, expressed on a tax-equivalent basis, decreased $4.1 million for the year ended December 31, 2014, as compared to 2013. Average investment securities decreased $396.5 million for the year ended December 31, 2014, as compared to 2013. The yield earned on our investment securities portfolio increased 20 basis points to 2.28% for the year ended December 31, 2014, compared to 2.08% in 2013. During 2014, we sold certain investment securities to fund loan growth and to pay all of the cumulative deferred interest on our junior subordinated debentures relating to the Company's trust preferred securities in March 2014. We continue to maintain a high level of investment securities in an effort to support future loan growth opportunities.
Interest income on our short-term investments decreased $529,000 for the year ended December 31, 2014, as compared to 2013. Average short-term investments decreased $215.5 million for the year ended December 31, 2014, as compared to 2013. During 2013, we held a higher level of average short-term investments in preparation for the sales of our ABS line of business during the fourth quarter of 2013 and our Northern Florida Region during the second quarter of 2013. The yield on our short-term investments was 0.27% for the year ended December 31, 2014, compared to 0.26% in 2013, reflecting the investment of a significant portion of funds in our short-term investments in our correspondent bank account with the FRB, which currently earns 0.25%.
Interest expense on our interest-bearing deposits decreased $808,000 for the year ended December 31, 2014, as compared to 2013. Average total deposits decreased $6.5 million to $4.84 billion for the year ended December 31, 2014, from $4.84 billion in 2013. A decrease in average interest-bearing deposits of $78.6 million was partially offset by an increase in average noninterest-bearing deposits of $72.0 million for the year ended December 31, 2014, as compared to 2013. The decrease in average interest-bearing deposits primarily reflects anticipated reductions of higher rate certificates of deposit, partially offset by organic growth in demand deposits and money market deposits through deposit development programs, including marketing campaigns and enhanced product and service offerings. The mix in our deposit portfolio volumes for 2014, as compared to 2013, primarily reflects a shift from time deposits to interest-bearing and noninterest-bearing demand deposits and savings and money market deposits. Decreases in our average time deposits of $122.2 million for 2014 as compared to 2013, were partially offset by increases in average interest-bearing and noninterest-bearing demand deposits of $31.1 million and $72.0 million, respectively, and an increase in average savings and money market deposits of $12.5 million for 2014, as compared to 2013. The aggregate weighted average rate paid on our interest-bearing deposit portfolio decreased two basis points to 0.23% for the year ended December 31, 2014, as compared to 0.25% in 2013. The weighted average rate paid on our time deposit portfolio decreased seven basis points to 0.47% in 2014, from 0.54% in 2013; the weighted average rate paid on our savings and money market deposit portfolio increased three basis points to 0.17% in 2014, from 0.14% in 2013; and the weighted average rate paid on our interest-bearing demand deposits remained unchanged at 0.06% in 2014 and 2013.
Interest expense on our junior subordinated debentures decreased $2.1 million for the year ended December 31, 2014, as compared to 2013. The aggregate weighted average rate paid on our junior subordinated debentures decreased 60 basis points to 3.65% for the year ended December 31, 2014, from 4.25% in 2013. The aggregate weighted average rates reflect additional interest expense accrued on the regularly scheduled deferred interest payments on our junior subordinated debentures until March 2014, when we paid all of the cumulative deferred interest, as further discussed in Note 12 to our consolidated financial statements. The additional
interest expense accrued on the regularly scheduled deferred interest payments of $796,000 and $2.8 million for the years ended December 31, 2014 and 2013, respectively, increased the weighted average rate paid on our junior subordinated debentures by 22 and 79 basis points in 2014 and 2013, respectively. The aggregate weighted average rates also reflect a decline in LIBOR rates during the periods, as approximately 79.4% of our junior subordinated debentures are variable rate.
Comparison of 2013 and 2012. Net interest income, expressed on a tax-equivalent basis, decreased $22.5 million to $148.9 million for the year ended December 31, 2013, compared to $171.4 million in 2012. Our net interest margin decreased 24 basis points to 2.56% for the year ended December 31, 2013, from 2.80% in 2012.
We attribute the decrease in our net interest margin and net interest income to a lower average balance of interest-earning assets, a change in the mix of our interest-earning assets, which shifted from loans and investment securities to low-yielding cash and cash equivalents in anticipation of the completion of certain of our capital initiatives during 2013, and a decrease in the average yield on loans due to the low interest rate environment during these periods. The decrease was partially offset by a decrease in interest-bearing liabilities and the average rate paid on our interest-bearing liabilities resulting from the continued change in the mix of our average deposits and the continued re-pricing of certificates to current market interest rates upon maturity. The average yield earned on our interest-earning assets decreased 30 basis points to 2.98% for the year ended December 31, 2013, compared to 3.28% in 2012, while the average rate paid on our interest-bearing liabilities decreased nine basis points to 0.60% for the year ended December 31, 2013, compared to 0.69% in 2012. Average interest-earning assets decreased $314.8 million to $5.81 billion for the year ended December 31, 2013, compared to $6.13 billion in 2012. Average interest-bearing liabilities decreased $259.5 million to $4.02 billion for the year ended December 31, 2013, compared to $4.28 billion in 2012.
Interest income on our loan portfolio, expressed on a tax-equivalent basis, decreased $24.0 million for the year ended December 31, 2013, as compared to 2012. Average loans decreased $235.9 million to $2.82 billion for the year ended December 31, 2013, from $3.05 billion in 2012. The decrease in average loans primarily reflects a substantial level of loan payoffs and principal payments and the exit of certain of our problem credit relationships. The yield on our loan portfolio decreased 46 basis points to 4.19% for the year ended December 31, 2013, compared to 4.65% in 2012. The yield on our loan portfolio continues to be adversely impacted by the lower levels of prime and LIBOR interest rates, as a significant portion of our loan portfolio is priced to these indices.
Interest income on our investment securities, expressed on a tax-equivalent basis, decreased $4.4 million for the year ended December 31, 2013, as compared to 2012. Average investment securities decreased $195.6 million for the year ended December 31, 2013, as compared to 2012. The decrease in average investment securities primarily reflects the reinvestment of proceeds from sales and maturities of certain investment securities into cash and cash equivalents to build liquidity in anticipation of the sale of our ABS line of business, which was completed during the fourth quarter of 2013. The yield earned on our investment securities portfolio decreased two basis points to 2.08% for the year ended December 31, 2013, compared to 2.10% in 2012.
Interest income on our short-term investments increased $314,000 for the year ended December 31, 2013, as compared to 2012. Average short-term investments increased $115.9 million for the year ended December 31, 2013, as compared to 2012. The increase in our average short-term investments reflects the utilization of funds available from the decline in our loan portfolio and sales and maturities of investment securities to increase our liquidity position in anticipation of the sale of our ABS line of business, which was completed during the fourth quarter of 2013, partially offset by a decline in average deposit balances. The yield on our short-term investments was 0.26% for the year ended December 31, 2013, compared to 0.25% in 2012, reflecting the investment of a significant portion of funds in our short-term investments in our correspondent bank account with the FRB, which currently earns 0.25%.
Interest expense on our interest-bearing deposits decreased $5.7 million for the year ended December 31, 2013, as compared to 2012. Average total deposits decreased $213.7 million to $4.84 billion for the year ended December 31, 2013, from $5.06 billion in 2012. Average interest-bearing deposits decreased $261.3 million for the year ended December 31, 2013, as compared to 2012. The decrease in average interest-bearing deposits primarily reflects anticipated reductions of higher rate certificates of deposit and promotional money market deposits, partially offset by organic growth through deposit development programs, including marketing campaigns and enhanced product and service offerings. The mix in our deposit portfolio volumes for 2013, as compared to 2012, primarily reflects a shift from time deposits and savings and money market deposits to interest-bearing and noninterest-bearing demand deposits. Decreases in our average time deposits and savings and money market deposits of $237.2 million and $61.9 million, respectively, for 2013 as compared to 2012, were partially offset by increases in average interest-bearing and noninterest-bearing demand deposits of $37.8 million and $47.7 million, respectively, for 2013 as compared to 2012. The aggregate weighted average rate paid on our interest-bearing deposit portfolio decreased 13 basis points to 0.25% for the year ended December 31, 2013, as compared to 0.38% in 2012, reflecting the re-pricing of certificate of deposit accounts to current market interest rates upon maturity and our efforts to reduce deposit costs across our deposit portfolio. The weighted average rate paid on our time deposit portfolio declined 26 basis points to 0.54% in 2013, from 0.80% in 2012; the weighted average rate paid on our savings and money market deposit portfolio declined four basis points to 0.14% in 2013, from 0.18% in 2012; and the weighted average rate paid on our interest-bearing demand deposits declined to 0.06% in 2013, from 0.07% in 2012.
Interest expense on our junior subordinated debentures increased $207,000 for the year ended December 31, 2013, as compared to 2012. The aggregate weighted average rate paid on our junior subordinated debentures increased to 4.25% for the year ended December 31, 2013, compared to 4.19% in 2012. The aggregate weighted average rates also reflect additional interest expense accrued on the regularly scheduled deferred interest payments on our junior subordinated debentures of $2.8 million and $2.0 million for the years ended December 31, 2013 and 2012, respectively. The additional interest expense accrued on the regularly scheduled deferred interest payments increased the weighted average rate paid on our junior subordinated debentures by approximately 79 and 58 basis points in 2013 and 2012, respectively. The increase in additional interest expense accrued on the regularly scheduled deferred interest payments was partially offset by a decline in LIBOR rates during the periods.
Rate / Volume
The following table indicates, on a tax-equivalent basis, the changes in interest income and interest expense on a continuing basis that are attributable to changes in average volume and changes in average rates, in comparison with the preceding year. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the dollar amounts of the change in each.
(1)
For purposes of these computations, nonaccrual loans are included in the average loan amounts.
(2)
Interest income on loans includes loan fees.
(3)
Information is presented on a tax-equivalent basis assuming a tax rate rate of 35%.
Provision for Loan Losses
Comparison of 2014 and 2013. We recorded a negative provision for loan losses of $7.0 million for the year ended December 31, 2014. We recorded a negative provision for loan losses of $5.0 million for the year ended December 31, 2013. We primarily attribute the negative provision for loan losses of $7.0 million during the year ended December 31, 2014 to continued improvement in most asset quality metrics, as further discussed below, in addition to improving economic trends in our markets and in our loan portfolio. We attribute the negative provision for loan losses of $5.0 million during the year ended December 31, 2013 to significant improvement in asset quality metrics such as the decline in nonaccrual loans of $56.9 million, of which $27.2 million was in the real estate construction and development portfolio, which incurred substantial net charge-offs from 2008 through 2011.
Our potential problem loans were $25.2 million at December 31, 2014, compared to $109.5 million at December 31, 2013, reflecting a decrease in potential problem loans of $84.3 million, or 77.0%. The significant decrease in our potential problem loans primarily reflects the aggregate payoff of $54.1 million of potential problem real estate construction and development loans in a single credit relationship in our Southern California region and an upgrade of a related credit from potential problem to pass classification in the third quarter of 2014. Our nonaccrual loans were $57.5 million at December 31, 2014, compared to $53.0 million at December 31, 2013, reflecting an increase in nonaccrual loans of $4.5 million, or 8.5%. During the fourth quarter of 2014, we downgraded a single $19.1 million multi-family residential loan relationship from performing troubled debt restructuring, or performing TDR, to nonaccrual classification, after recording loan charge-offs of $8.4 million on this loan relationship during 2014. Despite the addition of this $19.1 million loan to nonaccrual loans, the total balance of nonaccrual loans increased only $4.5
million during 2014, reflecting the resolution of several other nonaccrual loans. The improvement in our overall asset quality levels at December 31, 2014, as compared to December 31, 2013, which was primarily driven by resolution of certain potential problem and nonaccrual loans, is further discussed under “-Loans and Allowance for Loan Losses.”
Our net loan charge-offs were $7.2 million for the year ended December 31, 2014, compared to $5.6 million in 2013. Our net loan charge-offs were 0.24% of average loans in 2014, compared to 0.20% of average loans in 2013. Loan charge-offs were $21.9 million for 2014, compared to $25.8 million in 2013, and loan recoveries were $14.8 million for 2014, compared to $20.3 million in 2013.
Tables summarizing nonperforming assets, past due loans and charge-off and recovery experience are presented under “-Loans and Allowance for Loan Losses.”
Comparison of 2013 and 2012. We recorded a negative provision for loan losses of $5.0 million for the year ended December 31, 2013. We recorded a provision for loan losses of $2.0 million for the year ended December 31, 2012. We attribute the negative provision for loan losses of $5.0 million during the year ended December 31, 2013 to significant improvement in asset quality metrics such as the decline in nonaccrual loans of $56.9 million, of which $27.2 million was in the real estate construction and development portfolio, which incurred substantial net charge-offs from 2008 through 2011.
Our nonaccrual loans were $53.0 million at December 31, 2013, compared to $109.9 million at December 31, 2012, reflecting a decrease in nonaccrual loans of $56.9 million, or 51.8%. The decrease in the overall level of nonaccrual loans during 2013 was primarily driven by resolution of certain nonaccrual loans, gross loan charge-offs, and transfers to other real estate exceeding net additions to nonaccrual loans.
Our net loan charge-offs decreased to $5.6 million for the year ended December 31, 2013, compared to $48.1 million in 2012. Our net loan charge-offs were 0.20% of average loans in 2013, compared to 1.57% of average loans in 2012. Loan charge-offs were $25.8 million for 2013, compared to $78.1 million in 2012, and loan recoveries were $20.3 million for 2013, compared to $30.0 million in 2012.
Noninterest Income
Comparison of 2014 and 2013. Noninterest income decreased $7.9 million to $56.0 million for the year ended December 31, 2014, from $64.0 million in 2013. The decrease in our noninterest income was primarily attributable to reduced gains on sale of other real estate, declines in the fair value of servicing rights and a decline in other income, partially offset by increased net gains on investment securities and gains on loans sold and held for sale. The following table summarizes noninterest income for the years ended December 31, 2014 and 2013:
The increase in gains on residential mortgage loans sold and held for sale was primarily attributable to an increase in loan production volumes associated with an increase in refinancing activity in our mortgage banking division.
Net gains on investment securities for 2014 reflect the sale of certain investment securities to reposition the balance sheet and to fund loan growth and other corporate transactions. Net gains on investment securities for 2013 reflect the sale of certain investment securities in anticipation of corporate transactions, partially offset by other-than-temporary impairment of $407,000 on a single municipal investment security classified as held-to-maturity. Proceeds from sales of available-for-sale investment securities were $343.5 million for the year ended December 31, 2014, as compared to $143.7 million for 2013.
The decrease in net gains on sales of other real estate reflects sales of other real estate properties with an aggregate carrying value of $15.2 million at a net gain of $1.6 million during the year ended December 31, 2014, as compared to sales of other real estate properties with an aggregate carrying value of $27.9 million at a net gain of $6.0 million in 2013, including a gain of $2.7 million on the sale of a single property in the second quarter of 2013.
The decrease in the fair value of mortgage and SBA servicing rights primarily reflects changes in mortgage interest rates and the related changes in estimated prepayment speeds during the periods, as well as changes in cash flow assumptions underlying SBA loans serviced for others.
The decrease in other income primarily reflects income of $1.2 million recognized on the call of an SBA loan securitization in the first quarter of 2013 and income from two litigation settlements aggregating $815,000 in the fourth quarter of 2013, partially offset by a gain of $1.1 million on the sale of a former branch facility in the fourth quarter of 2014.
Comparison of 2013 and 2012. Noninterest income decreased $658,000 to $64.0 million for the year ended December 31, 2013, from $64.6 million in 2012. The decrease in our noninterest income was primarily attributable to lower service charges on deposit accounts and client service fees, reduced gains on loans sold and held for sale and decreased net gains on investment securities, partially offset by increased gains on sales of other real estate and reduced declines in the fair value of servicing rights. The following table summarizes noninterest income for the years ended December 31, 2013 and 2012:
The decrease in service charges on deposit accounts and client service fees primarily reflects reduced non-sufficient funds and returned check fee income on retail and commercial accounts coupled with changes in our deposit mix during the periods.
The decrease in gains on residential mortgage loans sold and held for sale was primarily attributable to a decline in loan production volume in our mortgage banking division associated with a decrease in refinancing activity. New interest rate lock commitments were $316.6 million for 2013, as compared to $608.7 million for 2012.
Net gains on investment securities for 2013 reflect the sale of certain investment securities in anticipation of the sale of our ABS line of business, which was completed during the fourth quarter of 2013, partially offset by other-than-temporary impairment of $407,000 recorded during the first quarter of 2013. Net gains on investment securities for 2012 reflect the sale of certain investment securities to partially fund the purchase of certain residential real estate loans in 2012 and to reposition the investment securities portfolio based on our ongoing evaluation of liquidity requirements and overall market and economic conditions during the periods. Proceeds from sales of available-for-sale investment securities were $143.7 million for the year ended December 31, 2013, as compared to $315.2 million for 2012.
The increase in net gains on sales of other real estate reflects sales of other real estate properties with an aggregate carrying value of $27.9 million at a net gain of $6.0 million in 2013, including a gain of $2.7 million on the sale of a single property in the second quarter of 2013, as compared to sales of other real estate properties with an aggregate carrying value of $45.9 million at a net gain of $2.6 million in 2012.
The increase in the fair value of mortgage and SBA servicing rights primarily reflects changes in mortgage interest rates and the related changes in estimated prepayment speeds, as well as changes in cash flow assumptions underlying SBA loans serviced for others.
The increase in other income primarily reflects the following:
•
Income of $1.2 million recognized on the call of an SBA loan securitization in the first quarter of 2013;
•
Income from two litigation settlements aggregating $815,000 in the fourth quarter of 2013; and
•
A loss on the sale of certain bank-owned properties of $1.1 million during 2012; partially offset by
•
Income from a litigation settlement of $561,000 in the first quarter of 2012; and
•
A gain on the sale of a Community Reinvestment Act, or CRA, investment of $402,000 during the first quarter of 2012 .
Noninterest Expense
Comparison of 2014 and 2013. Noninterest expense decreased $108.6 million to $176.9 million for the year ended December 31, 2014, from $285.5 million in 2013. The decrease in our noninterest expense during 2014, as compared to 2013, was primarily attributable to goodwill impairment of $107.3 million in 2013, decreased FDIC insurance expense, a lower level of expenses associated with our nonperforming assets and potential problem loans, and a reduction of other operating expenses, partially offset by an increase in salaries and employee benefits expense and information technology fees. The following table summarizes noninterest expense for the years ended December 31, 2014 and 2013:
The overall increase in salaries and employee benefits expense primarily reflects normal compensation increases, increases in staffing levels in certain key revenue-generating functions and an increase in incentive compensation.
The decrease in occupancy, net of rental income, and furniture and equipment expense primarily resulted from profit improvement initiatives and reduced expenditures associated with branch closures in 2013.
The increase in information technology fees is primarily associated with a planned investment in the expansion of certain of our information technology programs resulting in an increase in fees paid to First Services, L.P. As more fully described in Note 20 to our consolidated financial statements, First Services, L.P., a limited partnership indirectly owned by our Chairman and members of his immediate family, provides information technology and various operational support services to our subsidiaries and us. Information technology fees also include fees paid to outside servicers associated with our mortgage lending, trust and small business lending divisions as well as our payroll processing department.
The decrease in legal, examination and professional fees reflects a decline in legal expenses associated with loan collection activities, divestiture activities and litigation matters in 2014, in comparison to the level of such expenses during 2013.
We recorded a goodwill impairment charge of $107.3 million in the fourth quarter of 2013, as further described in Note 6 to our consolidated financial statements.
The decrease in FDIC insurance expense is reflective of reduced average assets levels at First Bank and changes in assessment rates for 2014, as compared to 2013.
The decrease in write-downs and expenses on other real estate for 2014, as compared to 2013, reflects a reduction in the overall number and balance of our other real estate properties, which declined to $55.7 million at December 31, 2014, from $66.7 million at December 31, 2013. Other real estate expenses, exclusive of write-downs, such as taxes, insurance, and repairs and maintenance, decreased $1.1 million to $2.2 million in 2014, from $3.3 million in 2013. Write-downs related to the revaluation of certain other real estate properties decreased to $2.1 million in 2014, from $2.4 million in 2013.
Other expense encompasses numerous general and administrative expenses including communications, insurance, freight and courier services, correspondent bank charges, loan expenses, miscellaneous losses and recoveries, memberships and subscriptions, transfer agent fees, sales taxes, travel, meals and entertainment, overdraft losses and other nonrecurring expenses. The decrease in the overall level of other expense during 2014, as compared to 2013, is reflective of a decrease in loan expenses related to collection and other matters to $2.2 million in 2014, as compared to $2.8 million in 2013; and a provision for estimated mortgage repurchase losses of $1.2 million in 2013, as further described in Note 24 to our consolidated financial statements. We did not record a provision for estimated mortgage repurchase losses in 2014.
Comparison of 2013 and 2012. Noninterest expense increased $86.3 million to $285.5 million for the year ended December 31, 2013, from $199.2 million in 2012. The increase in our noninterest expense during 2013, as compared to 2012, was primarily attributable to goodwill impairment of $107.3 million and an increase in salaries and employee benefits expense, partially offset
by a lower level of expenses associated with our nonperforming assets and potential problem loans, decreased FDIC insurance expense and the implementation of certain measures intended to improve efficiency through the reduction of operating expenses. The following table summarizes noninterest expense for the years ended December 31, 2013 and 2012:
The overall increase in salaries and employee benefits expense reflects normal compensation increases, increases in staffing levels in certain key revenue-generating functions, an increase in incentive compensation as a result of our improved financial performance and an increase in severance expense associated with the sale of our ABS line of business, partially offset by a decrease in benefits expenses, including medical claims and prescription expenses.
The increase in occupancy, net of rental income, and furniture and equipment expense primarily resulted from a $787,000 decrease in rent expense during the first quarter of 2012 associated with the transfer of a lease obligation to an unaffiliated third party and the related reversal of the corresponding straight-line rent liability.
The decrease in information technology fees is primarily due to the implementation of certain profit improvement initiatives and related fee reductions with First Services, L.P. Information technology fees also include fees paid to outside servicers associated with our mortgage lending, trust and small business lending divisions as well as our payroll processing department.
The decrease in legal, examination and professional fees reflects a decline in legal expenses associated with loan collection activities, divestiture activities and litigation matters in comparison to the level of such expenses during 2012.
We recorded a goodwill impairment charge of $107.3 million in the fourth quarter of 2013.
The increase in advertising and business development expense is reflective of increased advertising during 2013 as compared to 2012 to further market our products and services throughout our geographic market areas.
The decrease in FDIC insurance expense is reflective of a reduction in our assessment rate, effective October 2, 2012, in addition to reduced asset levels during 2013, as compared to 2012.
The decrease in write-downs and expenses on other real estate for 2013, as compared to 2012, reflects a decline in the overall number and balance of our other real estate properties to $66.7 million at December 31, 2013, from $92.0 million at December 31, 2012. Write-downs related to the revaluation of certain other real estate properties decreased $12.1 million to $2.4 million in 2013, from $14.5 million in 2012. Other real estate and repossessed asset expenses, exclusive of write-downs, such as taxes, insurance, and repairs and maintenance, decreased to $3.3 million in 2013, from $4.2 million in 2012.
The decrease in the overall level of other expense during 2013, as compared to 2012, is reflective of the following:
•
Loan expenses related to collection and other matters of $2.8 million during 2013, as compared to $3.6 million in 2012;
•
Amortization expense and losses associated with CRA investments of $654,000 during 2013, as compared to $1.2 million in 2012;
•
Provision for estimated mortgage repurchase losses of $1.2 million during 2013, as compared to $2.3 million in 2012, as previously discussed; and
•
An expense of $2.3 million associated with a fair value adjustment on bank-owned facilities of eight of our Florida branches previously reported as discontinued operations that were reclassified to continuing operations during the fourth quarter of 2012.
Provision (Benefit) for Income Taxes.
Comparison of 2014 and 2013. We recorded a provision for income taxes of $12.2 million for the year ended December 31, 2014, compared to a benefit for income taxes of $288.5 million for the year ended December 31, 2013. During the fourth quarter of 2013, we reversed substantially all of the valuation allowance against our net deferred tax assets, previously established in 2008, as further discussed below. As such, interim periods beginning January 1, 2014 and the year ended December 31, 2014 reflect the initial periods in which a provision for income taxes is recorded in the statements of income without a related deferred tax asset valuation allowance.
Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expenses. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results adjusted for the results of discontinued operations and changes in accounting policies and incorporate assumptions including the amount of future state and federal pre-tax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts and future taxable income and are consistent with the plans and estimates we are using to manage the underlying business.
After analysis of all available positive and negative evidence, we reversed substantially all of our valuation allowance against our net deferred tax assets. We concluded that, as of December 31, 2013, it was more likely than not that substantially all of our net deferred tax assets would be realized in future years. This conclusion was primarily based on eight consecutive quarters of profitability, in addition to the significant improvement in our asset quality metrics and regulatory capital ratios over the last few years and certain other relevant factors.
Comparison of 2013 and 2012. We recorded a benefit for income taxes of $288.5 million for the year ended December 31, 2013, compared to a benefit for income taxes of $139,000 for the year ended December 31, 2012. The benefit for income taxes during 2013 reflects the reversal of substantially all of our valuation allowance against our net deferred tax assets, as previously discussed. The benefit for income taxes during 2012 reflects the establishment of the full deferred tax asset valuation allowance during 2008. The deferred tax asset valuation allowance was primarily established as a result of our three-year cumulative operating loss for the years ended December 31, 2008, 2007 and 2006, after considering all available objective evidence and potential tax planning strategies related to the amount of the deferred tax assets that are more likely than not to be realized.
The level of our benefit for income taxes and the deferred tax asset valuation allowance are more fully described in Note 17 to our consolidated financial statements.
Income (Loss) from Discontinued Operations, Net of Tax
We recorded income from discontinued operations, net of tax, of $21.2 million for the year ended December 31, 2013, compared to a loss from discontinued operations, net of tax, of $8.8 million in 2012. The income (loss) from discontinued operations, net of tax, for 2013 and 2012 is reflective of the following:
•
A gain of $28.6 million associated with the sale of our ABS line of business on November 22, 2013, after the write-off of goodwill allocated to the transaction of $18.0 million;
•
A gain of $408,000 associated with the sale of eight of our retail branches in our Northern Florida Region on April 19, 2013, after the write-off of goodwill allocated to the Northern Florida Region of $700,000; and
•
Other income (loss) from all discontinued operations during the respective periods.
See Note 2 to our consolidated financial statements for further discussion of discontinued operations.
Net (Loss) Income Attributable to Noncontrolling Interest in Subsidiary
Net (loss) income attributable to noncontrolling interest in subsidiary, comprised of the noncontrolling interest in the net (losses) income of FB Holdings, was $(76,000) for the year ended December 31, 2014, compared to $179,000 in 2013. The net loss attributable to noncontrolling interest in subsidiary for 2014, as compared to the net income for 2013, is reflective of lower income and reduced gains on the sale of other real estate properties.
Net income (loss) attributable to noncontrolling interest in subsidiary was $179,000 for the year ended December 31, 2013, compared to $(297,000) in 2012. The net income attributable to noncontrolling interest in subsidiary for 2013, as compared to the net loss for 2012, is reflective of reduced expenses and write-downs on other real estate properties associated with the reduction of loans and other real estate balances in FB Holdings, partially offset by lower gains on the sale of other real estate properties.
Noncontrolling interest in our subsidiaries is more fully described in Note 1 and Note 20 to our consolidated financial statements.
FINANCIAL CONDITION
Total assets increased $16.5 million to $5.94 billion at December 31, 2014, from $5.92 billion at December 31, 2013. The increase in our total assets was primarily attributable to an increase in our loan portfolio and our cash and cash equivalents, partially offset by a decrease in our investment securities portfolio and our other real estate, as further described below.
Cash and cash equivalents, which are comprised of cash and short-term investments, increased $15.0 million to $205.4 million at December 31, 2014, from $190.4 million at December 31, 2013. A significant portion of funds in our short-term investments are maintained in our correspondent bank account with the FRB, as further discussed under “-Liquidity Management.” The increase in our cash and cash equivalents was primarily attributable to the following:
•
A net decrease in our investment securities portfolio of $271.7 million, excluding amortization and the fair value adjustment on our available-for-sale investment securities;
•
An increase in our deposit balances of $35.6 million;
•
Sales of other real estate resulting in the receipt of cash proceeds from these sales of $16.9 million; and
•
Recoveries of loans previously charged off of $14.8 million;
•
A net increase in our securities sold under agreements to repurchase of $21.7 million; and
•
Cash generated by operating earnings; partially offset by
•
An increase in loans of $321.7 million, exclusive of loan charge-offs and transfers of loans to other real estate, as further discussed below;
•
The payment of $66.4 million of cumulative deferred interest payments on our junior subordinated debentures in March 2014, which was distributed to the trust preferred securities holders on the respective interest payment dates in March and April, 2014; and
•
A payment of $15.5 million in January 2014 associated with the final payment to Union Bank in conjunction with the sale of our ABS line of business in November 2013.
Investment securities decreased $288.1 million to $2.06 billion at December 31, 2014, from $2.35 billion at December 31, 2013. We sold certain investment securities during 2014 to reposition the balance sheet and fund loan growth and other corporate transactions, including the payment of all of the cumulative deferred interest on our junior subordinated debentures relating to the Company's trust preferred securities in March 2014. Funds available from sales of available-for-sale investment securities of $343.5 million and maturities and/or calls of investment securities of $299.9 million were partially utilized to purchase investment securities of $370.0 million during 2014. The net decrease is partially offset by an increase in the fair value adjustment of $9.3 million on our available-for-sale investment securities resulting from a decrease in market interest rates during 2014. We continue to maintain a high level of investment securities in an effort to support future loan growth opportunities, maximize our net interest income and net interest margin, and maintain appropriate liquidity levels and appropriate diversification within our investment securities portfolio. Additional information regarding our investment securities portfolio is more fully described in Note 3 to our consolidated financial statements.
Total loans increased $292.1 million to $3.15 billion at December 31, 2014, from $2.86 billion at December 31, 2013. The increase primarily reflects new loan production as a result of successful efforts to expand existing loan relationships and develop new loan relationships, specifically in our commercial, financial and agricultural portfolio, which increased $94.6 million, and our real estate mortgage portfolio, which increased $224.2 million. These increases were partially offset by principal repayments and/or payoffs on nonperforming, potential problem and other loans, including the payoff of an aggregate of $54.1 million of potential problem real estate construction and development loans in a single credit relationship in the third quarter of 2014, as further discussed under “-Loans and Allowance for Loan Losses.”
Other real estate decreased $11.0 million to $55.7 million at December 31, 2014, from $66.7 million at December 31, 2013. The decrease primarily reflects sales of other real estate properties of $15.2 million and write-downs of $2.1 million primarily attributable to declining real estate values on certain properties, partially offset by additions to other real estate of $7.6 million. Other real estate at December 31, 2014 included a single property in our Southern California region with a carrying value of $37.6 million, which was subsequently sold in January 2015, resulting in a gain of $4.6 million during the first quarter of 2015.
Deposits increased $35.6 million to $4.85 billion at December 31, 2014, from $4.81 billion at December 31, 2013. The increase reflects growth in demand and savings and money market deposits of $91.4 million and $64.4 million, respectively, partially offset by a decrease in certificates of deposit of $120.2 million.
Securities sold under agreements to repurchase (in connection with daily cash management activities of our commercial deposit clients), increased $21.7 million to $64.9 million at December 31, 2014, from $43.1 million at December 31, 2013, reflecting changes in client balances associated with this product segment.
Accrued expenses and other liabilities decreased $77.4 million to $113.7 million at December 31, 2014, from $191.1 million at December 31, 2013. The decrease was primarily attributable to a decrease of $62.5 million in accrued interest payable on our junior subordinated debentures primarily associated with the payment of all of the cumulative deferred interest on our junior subordinated debentures relating to the Company's trust preferred securities in March 2014, as further described in Notes 12 and 13 to our consolidated financial statements. The decrease was also attributable to the final settlement amount of $15.5 million paid to Union Bank in January 2014 in conjunction with the sale of our ABS line of business in November 2013.
Stockholders’ equity, including noncontrolling interest in subsidiary, increased $24.2 million to $512.4 million at December 31, 2014, from $488.3 million at December 31, 2013. The increase primarily reflects net income of $21.7 million and a net increase in accumulated other comprehensive income of $2.6 million.
Loans and Allowance for Loan Losses
Loan Portfolio Composition. Total loans represented 53.1% of our assets as of December 31, 2014, compared to 48.3% of our assets at December 31, 2013. Total loans increased $292.1 million to $3.15 billion at December 31, 2014 from $2.86 billion at December 31, 2013. The following table summarizes the composition of our loan portfolio by portfolio segment and the percent of each portfolio segment to the total portfolio as of the dates presented:
The following table summarizes the composition of our loan portfolio by geographic region and/or business segment at December 31, 2014 and 2013:
We attribute the net increase in our loan portfolio in 2014 primarily to:
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An increase of $94.6 million, or 15.7%, in our commercial, financial and agricultural portfolio, primarily attributable to an increase in new loan production within this portfolio segment;
•
A decrease of $31.8 million, or 26.1%, in our real estate construction and development portfolio, primarily attributable to the payoff of an aggregate of $54.1 million of potential problem loans in a single credit relationship in our Southern California region during the third quarter of 2014, as further discussed below, partially offset by new loan production within this portfolio segment. We have significantly reduced our exposure to our real estate construction and development portfolio over the past several years. Of the remaining portfolio balance, only $3.4 million, or 3.8%, of these loans were on nonaccrual status and no loans were considered potential problem loans as of December 31, 2014;
•
An increase of $95.2 million, or 10.3%, in our one-to-four-family residential real estate loan portfolio. The following table summarizes the composition of our one-to-four-family residential real estate loan portfolio as of December 31, 2014 and 2013:
Our residential mortgage loan portfolio consists of loans associated with our Mortgage Division in addition to loans originated to clients from our retail branch banking network. New loan production within this portfolio generally consists of jumbo adjustable rate and 10 and 15-year fixed rate mortgages. The increase in our residential mortgage loan portfolio of $49.0 million, or 8.6%, during 2014 is primarily attributable to the purchase of $52.7 million of performing one-to-four-family residential real estate loans from another financial institution in August 2014 in addition to new loan production from our Mortgage Division, partially offset by principal payments, loan refinancings and loan charge-offs. As of December 31, 2014, $90.1 million, or 14.5%, of our residential mortgage loan portfolio is considered impaired, consisting of nonaccrual loans of $13.9 million and performing TDRs of $76.2 million, including loans modified in the Home Affordable Modification Program, or HAMP, of $69.5 million.
Our home equity portfolio consists of loans originated to clients from our retail branch banking network. The increase in this portfolio of $46.2 million, or 13.2%, during 2014 is primarily attributable to new loan production within this loan product type;
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A decrease of $5.9 million, or 4.8%, in our multi-family residential real estate portfolio, primarily attributable to principal payments and loan charge-offs of $8.8 million exceeding new loan production within this portfolio segment. As of December 31, 2014, $19.7 million, or 17.1%, of this portfolio is on nonaccrual status, including a single $19.1 million loan in our Chicago Region, as further described below;
•
An increase of $134.8 million, or 12.9%, in our commercial real estate portfolio primarily attributable to new loan production within this portfolio segment. The following table summarizes the composition of our commercial real estate portfolio by loan type as of December 31, 2014 and 2013:
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An increase of $5.9 million, or 22.9%, in our loans held for sale portfolio, primarily resulting from the origination of loans and the timing of subsequent sales into the secondary mortgage market.
We attribute the net decrease in our loan portfolio in 2013 primarily to:
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A decrease of $9.6 million, or 1.6%, in our commercial, financial and agricultural portfolio, primarily reflecting the sale of $20.8 million of such loans at par value associated with our ABS line of business during the fourth quarter of 2013, partially offset by new loan production;
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A decrease of $53.3 million, or 30.5%, in our real estate construction and development portfolio, primarily attributable to our continued efforts to reduce the overall level of our special mention, potential problem and nonaccrual loans within this portfolio segment. We received a payoff of $29.6 million during the third quarter of 2013 on a single credit relationship in our Northern California region, of which $19.6 million of the loan relationship was on nonaccrual status and $10.0 million was considered a performing TDR. The payoff of this loan relationship also resulted in a recovery to the allowance for loan losses of $2.2 million. Of the remaining portfolio balance of $121.7 million, $4.9 million, or 4.0%, of these loans were on nonaccrual status as of December 31, 2013 and $73.4 million, or 60.3%, of these loans were considered potential problem loans, including a $60.3 million loan relationship in our Southern California region, as further discussed below;
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A decrease of $65.3 million, or 6.6%, in our one-to-four-family residential real estate loan portfolio primarily attributable to gross loan charge-offs of $12.7 million, transfers to other real estate of $6.2 million and principal payments; partially
offset by new loan production. The following table summarizes the composition of our one-to-four-family residential real estate loan portfolio as of December 31, 2013 and 2012:
The decrease in our residential mortgage portfolio of $60.1 million, or 9.5%, during 2013 is primarily attributable to principal payments resulting from loan refinancings, gross loan charge-offs and transfers to other real estate; partially offset by new loan production into this portfolio, consisting of jumbo adjustable rate and 10 and 15-year fixed rate mortgages. As of December 31, 2013, $98.2 million, or 17.2%, of this portfolio is considered impaired, consisting of nonaccrual loans of $20.1 million and performing TDRs of $78.2 million, including loans modified in the HAMP, of $69.9 million.
The decrease in our home equity portfolio of $5.1 million, or 1.4%, during 2013 is primarily attributable to principal payments, gross loan charge-offs, and ordinary and seasonal fluctuations experienced within this loan product type. As of December 31, 2013, $7.4 million, or 2.1%, of this portfolio is on nonaccrual status;
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An increase of $17.6 million, or 17.0%, in our multi-family residential real estate portfolio primarily attributable to new loan production within this portfolio segment. As of December 31, 2013, $29.7 million, or 24.5%, of this portfolio is considered impaired, consisting of nonaccrual loans of $1.7 million and performing TDRs of $28.0 million, consisting solely of one loan relationship in our Chicago region restructured during the fourth quarter of 2012, as further described below under "Performing Troubled Debt Restructurings."
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An increase of $78.6 million, or 8.1%, in our commercial real estate portfolio primarily attributable to new loan production within this portfolio segment, partially offset by our efforts to reduce the overall level of our special mention, potential problem and nonaccrual loans within this portfolio segment, including the payoff of a $13.7 million credit relationship in the fourth quarter of 2013 that was classified as a potential problem loan at December 31, 2012 and the payoff of a $5.2 million performing TDR in the second quarter of 2013. The following table summarizes the composition of our commercial real estate portfolio by loan type as of December 31, 2013 and 2012:
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A decrease of $40.6 million, or 61.4%, in our loans held for sale portfolio primarily resulting from a decline in origination volumes and the timing of subsequent sales into the secondary mortgage market.
Loans at December 31, 2014 mature as follows:
The following table summarizes the components of changes in our total loan portfolio for the five years ended December 31, 2014:
Nonperforming Assets. Nonperforming assets include nonaccrual loans and other real estate. The following table presents the categories of nonperforming assets and certain ratios as of the dates presented:
Our nonperforming assets, consisting of nonaccrual loans and other real estate, were $113.1 million, $119.7 million and $201.9 million at December 31, 2014, 2013 and 2012, respectively. We have been successful in reducing our overall level of nonperforming assets as a result of the completion of several of our asset quality improvement initiatives.
We attribute the $4.5 million, or 8.5%, net increase in our nonaccrual loans during the year ended December 31, 2014 to the following:
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An increase in nonaccrual loans of $17.9 million in our multi-family residential loan portfolio. During the fourth quarter of 2014, we downgraded a single $19.1 million multi-family residential loan relationship in our Chicago region from performing TDR to nonaccrual classification, after recording loan charge-offs on this loan relationship of $8.4 million during 2014;
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A decrease in nonaccrual loans of $6.7 million, or 24.4%, in our one-to-four-family residential real estate loan portfolio driven by gross loan charge-offs of $6.6 million, transfers to other real estate of $5.9 million and payments received, partially offset by additions to nonaccrual loans during the year. We continue to modify loans under the HAMP where deemed economically advantageous to our borrowers and us; and
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A decline in nonaccrual loans in our commercial, financial and agricultural, real estate construction and development and commercial real estate loan portfolios of $1.0 million, $1.5 million and $4.2 million, respectively.
Despite the addition of the single $19.1 million multi-family residential loan relationship to nonaccrual loans, the total balance of nonaccrual loans increased only $4.5 million during 2014, reflecting the resolution of several other nonaccrual loans.
The decrease in other real estate of $11.0 million, or 16.5%, during 2014 was primarily driven by the sale of other real estate properties with an aggregate carrying value of $15.2 million at a net gain of $1.6 million and write-downs of $2.1 million attributable to declining real estate values on certain properties, partially offset by additions to other real estate. Other real estate at December 31, 2014 included a single property in our Southern California region with a carrying value of $37.6 million. This property was subsequently sold in January 2015, resulting in a gain of $4.6 million during the first quarter of 2015.
We attribute the $56.9 million, or 51.8%, net decrease in our nonaccrual loans during the year ended December 31, 2013 to the following:
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A decrease in nonaccrual loans of $8.5 million, or 44.8%, in our commercial, financial and agricultural portfolio, primarily driven by gross loan charge-offs of $5.6 million and payments received, partially offset by additions to nonaccrual loans during the year;
•
A decrease in nonaccrual loans of $27.2 million, or 84.7%, in our real estate construction and development loan portfolio, reflecting our continued efforts to reduce the overall level of our special mention, potential problem and nonaccrual loans within this portfolio segment, including the payoff of $19.6 million of nonaccrual loans associated with a single credit relationship in our Northern California region during the third quarter of 2013, as previously discussed, a $6.5 million paydown on a large loan relationship in our Southern California region during the third quarter of 2013 and slowing in the level of deterioration in this portfolio due in part to the decline in the total portfolio balance;
•
A decrease in nonaccrual loans of $7.9 million, or 22.4%, in our one-to-four-family residential real estate loan portfolio driven by gross loan charge-offs of $12.7 million, transfers to other real estate of $6.2 million and payments received, partially offset by additions to nonaccrual loans during the year;
•
A decrease in nonaccrual loans of $5.0 million, or 73.5%, in our multi-family residential loan portfolio primarily driven by payoffs and payments received, including a $2.5 million payoff on a nonperforming TDR during the second quarter of 2013, partially offset by additions to nonaccrual loans during the year; and
•
A decrease in nonaccrual loans of $8.2 million, or 49.9%, in our commercial real estate portfolio primarily driven by gross loan charge-offs of $6.7 million, transfers to other real estate and payments received, partially offset by additions to nonaccrual loans during the year.
The decrease in other real estate of $25.3 million, or 27.5%, during 2013 was primarily driven by the sale of other real estate properties with an aggregate carrying value of $27.9 million at a net gain of $6.0 million and write-downs of $2.4 million attributable to declining real estate values on certain properties, partially offset by additions to other real estate.
As of December 31, 2014, 2013 and 2012, loans identified by management as TDRs aggregating $26.5 million, $10.6 million and $40.0 million, respectively, were on nonaccrual status and were classified as nonperforming loans.
Performing Troubled Debt Restructurings. The following table presents the categories of performing TDRs as of December 31, 2014 and 2013:
Our performing TDRs decreased $30.0 million, or 27.1%, during 2014. Our performing TDRs at December 31, 2013 consisted of a single $28.0 million multi-family residential loan relationship in our Chicago region that was restructured during the fourth quarter of 2012. After recording loan charge-offs on this loan relationship of $8.4 million during 2014, we downgraded the remaining $19.1 million balance on this loan from performing TDR to nonaccrual classification during the fourth quarter of 2014.
Potential Problem Loans. As of December 31, 2014 and 2013, loans aggregating $25.2 million and $109.5 million, respectively, which were not classified as nonperforming assets or performing TDRs, were identified by management as having potential credit problems, or potential problem loans. These loans are generally defined as commercial loans having an internally assigned
grade of substandard and consumer loans which are greater than 30 days past due. The following table presents the categories of our potential problem loans as of December 31, 2014 and 2013:
Potential problem loans decreased $84.3 million, or 77.0%, during 2014, reflecting our successful efforts in reducing the overall level of our potential problem loans as a result of the completion of several of our asset quality improvement initiatives. The significant decrease in our potential problem loans was primarily attributable to the payoff of an aggregate of $54.1 million of potential problem loans in a single credit relationship in our Southern California region during the third quarter of 2014. In addition, primarily as a result of this transaction, the single $19.0 million remaining loan related to this credit relationship was upgraded to a pass classification during the third quarter of 2014. The remaining decrease in our potential problem loans reflects transfers of certain potential problem loans to special mention status, transfers to nonaccrual status and payment activity.
Our credit risk management policies and procedures, as further described under “-Allowance for Loan Losses,” focus on identifying potential problem loans. Potential problem loans may be identified by the assigned lender, the credit administration department or the internal credit review department. Specifically, the originating loan officers have primary responsibility for monitoring and overseeing their respective credit relationships, including, but not limited to: (a) periodic reviews of financial statements; (b) periodic site visits to inspect and evaluate loan collateral; (c) ongoing communication with primary borrower representatives; and (d) appropriately monitoring and adjusting the risk rating of the respective credit relationships should ongoing conditions or circumstances associated with the relationship warrant such adjustments. In addition, in the current economic environment, our credit administration department and our internal credit review department are reviewing a number of loans with varying credit exposure in which we, or other financial institutions, have experienced significant loan charge-offs, such as real estate construction and development and one-to-four-family residential real estate loans, and on loan portfolio segments that appear to be most likely to generate additional loan charge-offs in the future. We include adversely rated credits, including potential problem loans, on our monthly loan watch list. Loans on our watch list require regular detailed loan status reports prepared by the responsible officer which are discussed in formal meetings with internal credit review and credit administration staff members that are generally conducted on a quarterly basis. The primary purpose of these meetings is to closely monitor these loan relationships and further develop, modify and oversee appropriate action plans with respect to the ultimate and timely resolution of the individual loan relationships.
Each loan is assigned an FDIC collateral code at the time of origination which provides management with information regarding the nature and type of the underlying collateral supporting all individual loans, including potential problem loans. Upon identification of a potential problem loan, management makes a determination of the value of the underlying collateral via a third party appraisal and/or an assessment of value from our internal appraisal review department. The estimated value of the underlying collateral is a significant factor in the risk rating and allowance for loan losses allocation assigned to potential problem loans.
Potential problem loans are regularly evaluated for impaired loan status by lenders, the credit administration department and the internal credit review department. When management makes the determination that a loan should be considered impaired, an initial specific reserve is allocated to the impaired loan, if necessary, until the loan is charged down to the appraised value of the underlying collateral, typically within 30 to 90 days of becoming impaired. Management typically utilizes appraisals performed no earlier than 180 days prior to the charge-off, and in most cases, appraisals utilized are dated within 60 days of the charge-off. As such, management typically addresses collateral shortfalls through charge-offs as opposed to recording specific reserves on individual loans. Once a loan is charged down to the appraised value of the underlying collateral, management regularly monitors the carrying value of the loan for any additional deterioration and records additional reserves or charge-offs as necessary. As a general guideline, management orders new appraisals on any impaired loan or other real estate property in which the most recent appraisal is more than 18 months old; however, management also orders new appraisals on impaired loans or other real estate properties if management determines new appraisals are prudent based on many different factors, such as a rapid change in market conditions in a particular region.
Allowance for Loan Losses. Our allowance for loan losses decreased to $66.9 million at December 31, 2014, from $81.0 million and $91.6 million at December 31, 2013 and 2012, respectively. The decrease in our allowance for loan losses of $14.2 million
during 2014 was primarily attributable to net loan charge-offs of $7.2 million and a negative provision for loan losses of $7.0 million.
We primarily attribute the negative provision for loan losses of $7.0 million during the year ended December 31, 2014 to the continued improvement in most asset quality metrics, including the payoff of an aggregate of $54.1 million of potential problem real estate construction and development loans in a single credit relationship in our Southern California region and an upgrade of a related credit from potential problem to pass classification, in addition to improving economic trends in our markets and in our loan portfolio.
Our allowance for loan losses as a percentage of total loans was 2.12%, 2.84% and 3.13% at December 31, 2014, 2013 and 2012, respectively. The decrease in the allowance for loan losses as a percentage of total loans during 2014 was primarily attributable to the decrease in our potential problem loans, which generally require a higher allowance for loan losses relative to the amount of the loans than the remainder of the loan portfolio, in addition to a decrease in our historical net loan charge-off experience as a result of declining charge-off levels for the years ended December 31, 2014 and 2013, as compared to the years ended December 31, 2012, 2011 and 2010.
Our allowance for loan losses as a percentage of nonaccrual loans was 116.35%, 153.02% and 83.37% at December 31, 2014, 2013 and 2012, respectively. The decrease in the allowance for loan losses as a percentage of nonaccrual loans during 2014 was primarily attributable to the increase in nonaccrual loans, a portion of which did not carry a specific allowance for loan losses as these loans had been charged down to the estimated fair value of the related collateral less estimated costs to sell.
The following table is a summary of the changes in the allowance for loan losses for the five years ended December 31, 2014:
Our net loan charge-offs were $7.2 million, $5.6 million and $48.1 million for the years ended December 31, 2014, 2013 and 2012, respectively. Our net loan charge-offs as a percentage of average loans were 0.24%, 0.20% and 1.57% for the years ended December 31, 2014, 2013 and 2012, respectively.
The slight increase in our net loan charge-off levels in 2014, as compared to 2013, is primarily attributable to the following:
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A decrease in net loan recoveries associated with our real estate construction and development portfolio of $4.8 million. Net loan recoveries associated with this portfolio were $1.9 million in 2014, compared to $6.7 million in 2013. Net loan recoveries for 2013 included a $2.2 million recovery associated with the payoff of a $29.6 million credit relationship in our Northern California region;
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A decrease in net loan charge-offs associated with our one-to-four-family residential loan portfolio of $6.0 million in 2013. Net loan charge-offs associated with this portfolio were $2.3 million in 2014, compared to $8.3 million in 2013, reflecting continued improvement in the asset quality metrics of our Mortgage Division portfolio.
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An increase in net loan charge-offs associated with our multi-family residential portfolio of $8.6 million. Net loan charge-offs associated with this portfolio were $8.6 million in 2014, compared to $17,000 in 2013. Net loan charge-offs for 2014 included an aggregate of $8.4 million in charge-offs associated with the downgrade of a single $19.1 million multi-family residential loan relationship in our Chicago region from performing TDR to nonaccrual classification, as previously discussed; and
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A decrease in net loan charge-offs associated with our commercial real estate portfolio of $5.7 million. Net loan recoveries associated with this portfolio were $2.0 million in 2014, compared to net loan charge-offs of $3.7 million in 2013.
The decrease in our net loan charge-off levels in 2013, as compared to 2012, is primarily attributable to the following:
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A decrease in net loan charge-offs associated with our commercial, financial and agricultural portfolio of $4.2 million. Net loan charge-offs associated with this portfolio were $276,000 in 2013, compared to $4.5 million in 2012. Net loan charge-offs for 2012 included aggregate charge-offs of $2.5 million associated with the sale of $19.4 million of loans;
•
A decrease in net loan charge-offs associated with our real estate construction and development portfolio of $13.3 million. Net loan recoveries associated with this portfolio were $6.7 million in 2013, compared to net loan charge-offs of $6.6 million in 2012. Net loan recoveries for 2013 included a $2.2 million recovery associated with the payoff of a $29.6 million credit relationship in our Northern California region;
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A decrease in net loan charge-offs associated with our one-to-four-family residential loan portfolio of $8.3 million in 2013. Net loan charge-offs associated with this portfolio were $8.3 million in 2013, compared to $16.6 million in 2012, and primarily included net loan charge-offs in our Mortgage Division portfolio; and
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A decrease in net loan charge-offs associated with our commercial real estate portfolio of $14.2 million. Net loan charge-offs associated with this portfolio were $3.7 million in 2013, compared to $17.9 million in 2012. Net loan charge-offs for 2012 included aggregate charge-offs of $11.2 million associated with the sale of $43.9 million of loans.
Each month, the credit administration department provides management with detailed lists of loans on the watch list and summaries of the entire loan portfolio by risk rating. These are coupled with analyses of changes in the risk profile of the portfolio, changes in past-due and nonperforming loans and changes in watch list and classified loans over time. In this manner, we continually monitor the overall increases or decreases in the level of risk in our loan portfolio. Factors are applied to the loan portfolio for each category of loan risk to determine acceptable levels of allowance for loan losses. Furthermore, management continuously monitors and analyzes concentrations in our real estate portfolio. These procedures include enhanced reporting to track land, lot, construction and finished inventory levels within our real estate construction and development portfolio. In addition, a quarterly evaluation of each lending unit is performed based on certain factors, such as lending personnel experience, recent credit reviews, loan concentrations and other factors. Based on this evaluation, changes to the allowance for loan losses may be required due to the perceived risk of particular portfolios. In addition, management exercises a certain degree of judgment in its analysis of the overall adequacy of the allowance for loan losses. In its analysis, management considers the changes in the portfolio, including growth, composition, the ratio of net loans to total assets, and the economic conditions of the regions in which we operate. Based on this quantitative and qualitative analysis, adjustments are made to the allowance for loan losses. Such adjustments are reflected in our consolidated statements of income.
We record charge-offs on nonperforming loans typically within 30 to 90 days of the credit relationship reaching nonperforming loan status. We measure impairment and the resulting charge-off amount based primarily on third party appraisals. As such, rather than carrying specific reserves on nonperforming loans, we generally recognize a loan loss through a charge to the allowance for loan losses once the credit relationship reaches nonperforming loan status.
The allocation of the allowance for loan losses by loan category is a result of the application of our risk rating system augmented by historical loss data by loan type and other qualitative analysis. Consequently, the distribution of the allowance for loan losses will change from period to period due to the following factors:
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Changes in the aggregate loan balances by loan category;
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Changes in the identified risk in individual loans in our loan portfolio over time, excluding those homogeneous categories of loans such as consumer and installment loans and residential real estate mortgage loans for which risk ratings are changed based on payment performance;
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Changes in historical loss data as a result of recent charge-off experience by loan type; and
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Changes in qualitative factors such as changes in economic conditions, the volume of nonaccrual and potential problem loans by loan category and geographical location, and changes in the value of the underlying collateral for collateral-dependent loans.
The following table is a summary of the allocation of the allowance for loan losses for the five years ended December 31, 2014:
The following table is a summary of the ratio of the allocated allowance for loan losses to loans by category as of December 31, 2014 and 2013 is as follows:
The changes in the percentage of the allocated allowance for loan losses to loans in these portfolio segments are reflective of changes in the overall level of special mention loans, potential problem loans, performing TDRs and nonaccrual loans within each of these portfolio segments, in addition to other qualitative and quantitative factors, including loan growth in certain portfolio segments.
Deposits
Deposits are the primary source of funds for First Bank. Our deposits consist principally of core deposits from our local market areas, including individual and corporate clients. The following table sets forth the distribution of our average deposit accounts for the years ended December 31, 2014, 2013 and 2012, and the weighted average interest rates paid on each category of deposits:
Capital and Dividends
As previously discussed under “Item 1 -Business - Supervision and Regulation,” under the terms of the MOU with the FRB, the Company agreed, among other things, not to do any of the following without the prior approval of the FRB: (i) declare or pay any dividends on our common or preferred stock; (ii) incur or guarantee any debt; (iii) redeem any of our outstanding common or preferred stock; and (iv) cause First Bank to pay dividends in excess of its earnings or make a capital distribution that would cause First Bank's Tier 1 Leverage Ratio to fall below 9.0%. In addition, pursuant to Missouri Revised Statutes, First Bank is also required to obtain approval from the MDOF prior to paying any dividends to the Company. The FRB and the MDOF have complete discretion to grant any such approvals and therefore, it is not known whether the FRB or the MDOF will approve any such requests in the future. The dividend limitations are further described in Note 13 and Note 22 to our consolidated financial statements.
On December 31, 2008, the Company issued: (a) 295,400 shares of Class C Fixed Rate Cumulative Perpetual Preferred Stock, par value $1.00 per share, and liquidation preference of $1,000.00 per share; and (b) 14,770 shares of Class D Fixed Rate Cumulative Perpetual Preferred Stock, par value $1.00 per share, and liquidation preference of $1,000.00 per share, to the U.S. Treasury pursuant to the Company’s then-participation in the CPP program, as further described in “Item 1 -Business - Capital Structure” and in Note 13 to our consolidated financial statements. During the third quarter of 2013, the U.S. Treasury completed two auctions that resulted in the sale of our Class C Preferred Stock and Class D Preferred Stock to unaffiliated third party investors. We did not receive any proceeds from the sale and the sale did not have any effect on the terms of the outstanding Class C Preferred Stock and Class D Preferred Stock, including our obligation to satisfy accrued and unpaid dividends prior to the payment of any dividend or other distribution to holders of junior or parity stock (including our common stock, Class A Preferred Stock and Class B Preferred Stock), and an increase in the dividend rate on the Class C Preferred Stock from 5.00% to 9.00%, which commenced with the dividend payment date of February 15, 2014. The Class C Preferred Stock and Class D Preferred Stock qualify as Tier 1 capital. Dividends on our Class C Preferred Stock and Class D Preferred Stock, which carry annual dividend rates of 9.00% as of December 31, 2014, are payable quarterly.
We suspended the payment of cash dividends on our outstanding common stock and preferred stock beginning with the regularly scheduled quarterly dividend payments on the preferred stock that would otherwise have been made in August and September, 2009, as further described in Note 13 to our consolidated financial statements. We have declared and accrued $68.4 million of regularly scheduled dividend payments on our Class C Preferred Stock and Class D Preferred Stock, and have accrued an additional $9.4 million of cumulative dividends on such deferred dividend payments at December 31, 2014. As such, the aggregate amount of these deferred and accrued dividend payments was $77.8 million at December 31, 2014. We ceased declaring dividends on our Class C Preferred Stock and Class D Preferred Stock during the fourth quarter of 2013. If we had declared and accrued dividends on our Class C Preferred Stock and Class D Preferred Stock during the fourth quarter of 2013 and the year ended December 31, 2014, we would have accrued an additional $37.3 million of dividend payments, and our aggregate deferred and accrued dividend payments would have been $115.1 million at December 31, 2014. We continue to evaluate whether declaring dividends on our Class C Preferred Stock and Class D Preferred Stock is appropriate in future periods. The Company's cessation of declaring and accruing dividends on its Class C Preferred Stock and Class D Preferred Stock did not have any effect on the terms of the outstanding Class C Preferred Stock and Class D Preferred Stock, including our obligations thereunder, as previously described.
Effective August 10, 2009, we also suspended the declaration of dividends on our Class A Convertible, Adjustable Rate Preferred Stock and our Class B Adjustable Rate Preferred Stock. Prior to that time, we declared and paid relatively small dividends on our Class A and Class B preferred stock.
The Company’s and First Bank’s capital ratios at December 31, 2014 and 2013 were as follows:
First Bank was categorized as well capitalized at December 31, 2014 and 2013 under the prompt corrective action provisions of the regulatory capital standards. The Company was categorized as adequately capitalized under the minimum regulatory capital standards established for bank holding companies by the Federal Reserve at December 31, 2014 and 2013. First Bank’s and the Company's actual and required capital ratios are further described in Note 14 to our consolidated financial statements.
Trust Preferred Securities and Junior Subordinated Debentures. As of December 31, 2014, we had 13 affiliated Delaware or Connecticut statutory and business trusts that were created for the sole purpose of issuing trust preferred securities. As further described in Note 12 to our consolidated financial statements, the sole assets of the statutory and business trusts are our junior subordinated debentures. A summary of the outstanding trust preferred securities issued by our affiliated statutory and business trusts, and our related junior subordinated debentures issued to the respective trusts in conjunction with the trust preferred securities offerings as of December 31, 2014, is as follows:
For regulatory reporting purposes, the trust preferred securities are currently eligible for inclusion, subject to certain limitations, in our Tier 1 and Tier 2 capital. Because of these limitations, as of December 31, 2014, $208.8 million of trust preferred securities were not eligible for inclusion in our Tier 1 capital. Of the $208.8 million not eligible for inclusion in our Tier 1 capital, $142.2 million was eligible for inclusion in our Tier 2 capital and $66.6 million was not eligible for inclusion in our Tier 2 capital.
In August 2009, we announced the deferral of our regularly scheduled interest payments on our outstanding junior subordinated debentures relating to our $345.0 million of trust preferred securities beginning with the regularly scheduled quarterly interest payments that would otherwise have been made in September and October, 2009. The terms of the junior subordinated debentures and the related trust indentures allow us to defer such payments of interest for up to 20 consecutive quarterly periods without triggering a payment default or penalty. The Company had deferred such payments for 18 quarterly periods as of December 31, 2013. These payments aggregated $62.7 million at December 31, 2013.
On January 31, 2014, the Company received regulatory approval from the FRB under the then-existing Written Agreement, subject to certain conditions, which granted First Bank the authority to pay a dividend to the Company, and the authority to the Company to utilize such funds, for the sole purpose of paying the accumulated deferred interest payments on the Company's outstanding junior subordinated debentures issued in connection with the Company's trust preferred securities. In February 2014, First Bank paid a dividend of $70.0 million to the Company.
On March 14, 2014, the Company paid interest on all of the junior subordinated debentures of $66.4 million to the respective trustees, which was subsequently distributed to the trust preferred securities holders on the respective interest payment dates in March and April, 2014. Since that time, the Company has continued to pay interest on its junior subordinated debentures to the
respective trustees on the regularly scheduled quarterly payment dates. Such interest payments have been funded through additional dividends from First Bank, as further described in Note 12 to our consolidated financial statements.
Basel III and the Final Capital Rules. As previously discussed under “Item 1 -Business - Capital Adequacy Requirements,” in July 2013, the federal bank regulators approved the Final Capital Rules implementing the Basel III framework as well as certain provisions of the Dodd-Frank Act. The Final Capital Rules include a new minimum common equity Tier 1 capital ratio of 4.5% of risk-weighted assets and raise the minimum Tier 1 capital ratio from 4.0% to 6.0% of risk-weighted assets.
The calculation of common equity Tier 1 capital is different from the calculation of common equity under U.S. generally accepted accounting principles, or GAAP. Most significantly for the Company, the Company's net deferred tax assets, which are included in the calculation of common equity under GAAP, will be substantially phased out over time from the required calculation of common equity Tier 1 capital for regulatory purposes. To illustrate the difference between common equity under GAAP and common equity Tier 1 capital for regulatory purposes, the Company’s common equity under GAAP as of December 31, 2014, 2014 was $82.8 million, which includes net deferred tax assets of $271.8 million. In 2016, the majority of the Company’s net deferred tax assets will be excluded from the regulatory calculation of common equity Tier 1 capital due to the phase in requirements of the Final Capital Rules. As a direct result of this exclusion and the phase in of other required changes in the regulatory calculation of common equity Tier 1 capital, if, hypothetically, the Company were to apply the Final Capital Rules applicable in 2016 as of December 31, 2014, the Company’s common equity Tier 1 capital as of December 31, 2014 using the Final Capital Rules applicable in 2016 would be negative $83.7 million, or $166.5 million less than the Company’s common equity under GAAP. The net deferred tax assets attributable to net operating loss and tax credit carryforwards, which comprised over 87.0% of the Company's net deferred tax assets as of December 31, 2014, are scheduled to be phased out entirely from inclusion in the calculation of common equity Tier 1 capital in 2019.
In light of the Company’s current capital position and the future changes in the calculation of regulatory capital as a result of the Final Capital Rules, absent a substantial increase in qualifying common equity, the Company will not meet the common equity Tier 1 requirement under the Final Capital Rules. The inability to remain adequately capitalized under the Final Capital Rules could materially adversely impact our financial condition, results of operations, and ability to grow. In addition, the inability to meet the capital conservation buffer (which becomes applicable to the Company in 2016) would preclude the Company from making dividend payments on capital stock (unless a waiver is granted by the Federal Reserve) and may preclude the Company from making interest payments on trust preferred securities. It is not known whether the Federal Reserve would grant such a waiver.
See further information regarding these matters under "Item 1A -Risk Factors."
INTEREST RATE RISK MANAGEMENT
The maintenance of a satisfactory level of net interest income is a primary factor in our ability to achieve acceptable income levels. However, the maturity and repricing characteristics of our loan and investment portfolios may differ significantly from those within our deposit structure. The nature of the loan and deposit markets within which we operate, and our objectives for business development within those markets at any point in time, influence these characteristics. In addition, the ability of borrowers to repay loans and the possibility of depositors withdrawing funds prior to stated maturity dates introduces divergent option characteristics that fluctuate as interest rates change. These factors cause various elements of our balance sheet to react in different manners and at different times relative to changes in interest rates, typically leading to increases or decreases in net interest income over time. Depending upon the direction and magnitude of interest rate movements and their effect on the specific components of our balance sheet, the effects on net interest income can be substantial. Consequently, it is critical that we establish effective control over our exposure to changes in interest rates. We strive to manage our interest rate risk by:
•
Maintaining an Asset Liability Committee, or ALCO, responsible to our Board of Directors and Executive Management, to review the overall interest rate risk management activity and approve actions taken to reduce risk;
•
Employing a financial simulation model to determine our exposure to changes in interest rates;
•
Coordinating the lending, investing and deposit-generating functions to control the assumption of interest rate risk; and
•
Utilizing various financial instruments, including derivatives, to offset inherent interest rate risk should it become excessive.
The objective of these procedures is to limit the adverse impact that changes in interest rates may have on our net interest income.
The ALCO has overall responsibility for the effective management of interest rate risk and the approval of policy guidelines. The ALCO includes our President and Chief Executive Officer, Chief Financial Officer, Controller, Chief Investment Officer, Chief Credit Officer, Director of Risk Management and Audit, Director of Retail Banking, and certain other senior officers. The Asset Liability Management Group, which monitors interest rate risk, supports the ALCO, prepares analyses for review by the ALCO and implements actions that are either specifically directed by the ALCO or established by policy guidelines.
In managing sensitivity, we strive to reduce the adverse impact on earnings by managing interest rate risk within internal policy constraints. Our policy is to manage exposure to potential risks associated with changing interest rates by maintaining a balance sheet posture in which annual net interest income is not significantly impacted by reasonably possible near-term changes in interest rates. To measure the effect of interest rate changes, we project our net income over a two-year horizon on a pro forma basis. The analysis assumes various scenarios for increases and decreases in interest rates including both instantaneous and gradual, and parallel and non-parallel, shifts in the yield curve, in varying amounts. For purposes of arriving at reasonably possible near-term changes in interest rates, we include scenarios based on actual changes in interest rates, which have occurred over a two-year period, simulating both a declining and rising interest rate scenario.
We are “asset-sensitive,” indicating that our assets would generally re-price with changes in interest rates more rapidly than our liabilities, and our simulation model indicates a loss of projected net interest income should interest rates decline. While a decline in interest rates of less than 50 basis points was projected to have a relatively minimal impact on our net interest income, an instantaneous parallel decline in the interest yield curve of 50 basis points indicates a pre-tax projected loss of approximately 4.9% of net interest income, based on assets and liabilities at December 31, 2014. At December 31, 2014, we remain in an asset-sensitive position and thus, remain subject to a higher level of risk in a declining interest rate environment. Although we do not anticipate that instantaneous shifts in the yield curve as projected in our simulation model are likely, these are indications of the effects that changes in interest rates would have over time. Our asset-sensitive position, coupled with historically low interest rate levels, has negatively impacted our net interest income and is expected to continue to impact the level of our net interest income throughout the near future.
We also prepare and review a more traditional interest rate sensitivity position in conjunction with the results of our simulation model. The following table presents the projected maturities and periods to repricing of our rate sensitive assets and liabilities as of December 31, 2014, adjusted to account for anticipated prepayments:
(1)
Loans are presented net of net deferred loan fees.
Management made certain assumptions in preparing the foregoing table. These assumptions included:
•
Loans will repay at projected repayment rates;
•
Mortgage-backed securities, included in investment securities, will repay at projected repayment rates;
•
Interest-bearing demand accounts and savings deposits will behave in a projected manner with regard to their interest rate sensitivity; and
•
Fixed maturity deposits will not be withdrawn prior to maturity.
A significant variance in actual results from one or more of these assumptions could materially affect the results reflected in the foregoing table.
We were in an overall asset-sensitive position of $1.38 billion, or 23.3% of our total assets at December 31, 2014. We were in an overall liability-sensitive position on a cumulative basis through the twelve-month time horizon of $809.8 million, or 13.6% of our total assets at December 31, 2014.
The interest-sensitivity position is one of several measurements of the impact of interest rate changes on net interest income. Its usefulness in assessing the effect of potential changes in net interest income varies with the constant change in the composition of our assets and liabilities and changes in interest rates. For this reason, we place greater emphasis on our simulation model for monitoring our interest rate risk exposure.
In the past, we have utilized derivative instruments to assist in our management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities. We may also sell interest rate swap agreement contracts to certain clients who wish to modify their interest rate sensitivity. There were no interest rate swap agreement contracts outstanding at December 31, 2014 and 2013. Our derivative instruments are more fully described in Note 8 to our consolidated financial statements.
LIQUIDITY MANAGEMENT
First Bank. Our liquidity is the ability to maintain a cash flow that is adequate to fund operations, service debt obligations and meet obligations and other commitments on a timely basis. First Bank receives funds for liquidity from client deposits, loan payments, maturities of loans and investments, sales of investments and earnings before provision for loan losses. In addition, we may avail ourselves of other sources of funds by issuing certificates of deposit in denominations of $100,000 or more (including certificates issued through the Certificate of Deposit Account Registry Service, or CDARS program), selling securities under agreements to repurchase, and utilizing borrowings from the FHLB, the FRB and other borrowings.
As a financial intermediary, we are subject to liquidity risk. We closely monitor our liquidity position through our Liquidity Management Committee and we continue to implement actions deemed necessary to maintain an appropriate level of liquidity in light of ongoing market conditions, changes in loan funding needs, operating and debt service requirements, current deposit trends and events that may occur in conjunction with our Capital Plan. We analyze and manage short-term and long-term liquidity through an ongoing review of internal funding sources, projected cash flows from loans, securities and client deposits, internal and competitor deposit pricing structures and maturity profiles of current borrowing sources. We utilize planning, management reporting and adverse stress scenarios to monitor sources and uses of funds on a daily basis to assess cash levels to ensure adequate funds are available to meet normal business operating requirements and to supplement liquidity needs to meet unusual demands for funds that may result from an unexpected change in client deposit levels or potential planned or unexpected liquidity events that may arise from time to time.
Our cash and cash equivalents were $205.4 million and $190.4 million at December 31, 2014 and 2013, respectively. A significant portion of these funds were maintained in our correspondent bank account with the FRB. The increase in our cash and cash equivalents of $15.0 million is further discussed under “-Financial Condition.”
Our unpledged investment securities decreased $337.0 million to $1.68 billion at December 31, 2014, from $2.02 billion at December 31, 2013, and are mostly comprised of highly liquid and readily marketable available-for-sale investment securities. The combined level of cash and cash equivalents and unpledged investment securities provided us with total available liquidity of $1.89 billion and $2.21 billion at December 31, 2014 and 2013, respectively. Our available liquidity of $1.89 billion represents 31.8% of total assets, at December 31, 2014, in comparison to $2.21 billion, or 37.3% of total assets, at December 31, 2013. Our loan-to-deposit ratio increased to 64.9% at December 31, 2014 from 59.4% at December 31, 2013.
During 2014, we reduced our aggregate funds acquired from other sources of funds by $12.6 million to $419.6 million at December 31, 2014, from $432.2 million at December 31, 2013. These other sources of funds include certificates of deposit of $100,000 or more and other borrowings, which are comprised of daily securities sold under agreements to repurchase. The decrease was attributable to a reduction in certificates of deposit of $100,000 or more of $34.3 million, partially offset by an increase in our daily repurchase agreements of $21.7 million. The following table presents the maturity structure of these other sources of funds at December 31, 2014:
In addition to these sources of funds, First Bank has established a borrowing relationship with the FRB. First Bank's borrowing capacity through its relationship with the FRB was approximately $256.6 million and $283.9 million at December 31, 2014 and 2013, respectively. This borrowing relationship, which is secured primarily by commercial loans, provides an additional liquidity facility that may be utilized for contingency liquidity purposes. First Bank did not have any FRB borrowings outstanding at December 31, 2014 or 2013.
First Bank also has a borrowing relationship with the FHLB. First Bank's borrowing capacity through its relationship with the FHLB was approximately $396.9 million and $379.1 million at December 31, 2014 and 2013, respectively. The borrowing relationship is secured by one-to-four-family residential, multi-family residential and commercial real estate loans. First Bank requests advances and/or repays advances from the FHLB based on its current and future projected liquidity needs. First Bank did not have any FHLB advances outstanding at December 31, 2014 or 2013.
As a means of further contingency funding, First Bank may use broker dealers to acquire deposits to fund both short-term and long-term funding needs, including brokered money market accounts, and has available funding, subject to certain limits, through the CDARS program. First Bank had $4.0 million and $4.9 million of time deposits through the CDARS program at December 31, 2014 and 2013, respectively, and $5.2 million of brokered money market accounts at December 31, 2014 and 2013. Exclusive of the CDARS program and brokered money market accounts, First Bank does not generally utilize broker dealers to acquire deposits.
We believe First Bank has sufficient liquidity to meet its current and future near-term liquidity needs; however, no assurance can be made that First Bank's liquidity position will not be materially, adversely affected in the future.
First Banks, Inc. First Banks, Inc. is a separate and distinct legal entity from its subsidiaries. The Company's liquidity position is affected by dividends received from its subsidiaries and the amount of cash and other liquid assets on hand, payment of interest on trust preferred securities and other debt instruments issued by the Company, dividends paid on common and preferred stock (all of which are presently suspended or deferred), capital contributions the Company makes into its subsidiaries, any redemption of debt for cash issued by the Company, and proceeds the Company raises through the issuance of debt and/or equity instruments, if any. The Company's unrestricted cash totaled $21.6 million and $1.9 million at December 31, 2014 and 2013, respectively.
We cannot pay any dividends on our common or preferred stock without the prior approval of the FRB, as previously discussed under “Item 1 -Business - Supervision and Regulation - Regulatory Agreements."
In August 2009, we announced the deferral of our regularly scheduled interest payments on our outstanding junior subordinated debentures relating to our $345.0 million of trust preferred securities beginning with the regularly scheduled quarterly interest payments that would otherwise have been made in September and October, 2009. The terms of the junior subordinated debentures and the related trust indentures allow us to defer such payments of interest for up to 20 consecutive quarterly periods without triggering a payment default or penalty. The Company had deferred such payments for 18 quarterly periods as of December 31, 2013. These deferred payments aggregated $62.7 million at December 31, 2013.
On January 31, 2014, the Company received regulatory approval from the FRB under the former Written Agreement, subject to certain conditions, which granted First Bank the authority to pay a dividend to the Company, and the authority to the Company to utilize such funds, for the sole purpose of paying the accumulated deferred interest payments on the Company's outstanding junior subordinated debentures issued in connection with the Company's trust preferred securities. In February 2014, First Bank paid a dividend of $70.0 million to the Company and the Company notified the trustees of the trust preferred securities of its intention to pay all cumulative interest that had been deferred on the junior subordinated debentures relating to our trust preferred securities, on the regularly scheduled quarterly payment dates in March and April, 2014. The aggregate amount owed on all of the junior subordinated debentures relating to our trust preferred securities at the respective March and April, 2014 payment dates was $66.4 million. On March 14, 2014, the Company paid interest on the junior subordinated debentures of $66.4 million to the respective trustees, which was subsequently distributed to the trust preferred securities holders on the respective interest payment dates in March and April, 2014, as further described under "Item 1 -Business - Recent Developments and Other Matters - Dividend from First Bank and Payment of Interest on Junior Subordinated Debentures" and in Note 12 to our consolidated financial statements. Subsequent to this payment, the Company has the ability to enter into future deferral periods of up to 20 consecutive quarterly periods without triggering a payment default or penalty. However, since that time, the Company has continued to pay interest on its junior subordinated debentures to the respective trustees on the regularly scheduled quarterly payment dates. Such interest payments have been funded through additional dividends from First Bank.
Without the payment of dividends from First Bank, the Company currently lacks the source of income and the liquidity to make future interest payments on the subordinated debentures associated with its trust preferred securities. Given restrictions placed upon First Bank, including regulatory restrictions, it may not be able to provide the Company with dividends in an amount sufficient to pay the interest on the trust preferred securities. In such case, the Company would have to pursue alternative funding sources, but there can be no assurance that the Company will be able to identify and obtain alternative funding due to the uncertainty of our ability to access future liquidity through debt markets. As further described under “Item 1A -Risk Factors,” the Company's
ability to access debt markets on terms satisfactory to us will depend on our financial performance and conditions in the capital markets, economic conditions and a number of other factors, many of which are outside of our control.
During the period of deferral of interest on our regularly scheduled interest payments on our outstanding junior subordinated debentures relating to our $345.0 million of trust preferred securities, we were not allowed to, among other things and with limited exceptions, pay cash dividends on or repurchase our common stock or preferred stock or make any payment on outstanding debt obligations that rank equally with or junior to our junior subordinated debentures. Accordingly, we also suspended the payment of cash dividends on our outstanding common stock and preferred stock beginning with the regularly scheduled quarterly dividend payments on our preferred stock that would otherwise have been made in August and September 2009, as further described under “-Capital and Dividends,” and in Note 13 to our consolidated financial statements. We have deferred and accrued $68.4 million of regularly scheduled dividend payments on our Class C Preferred Stock and Class D Preferred Stock, and have accrued an additional $9.4 million of cumulative dividends on such deferred dividend payments at December 31, 2014. As such, the aggregate amount of these deferred and accrued dividend payments was $77.8 million at December 31, 2014. If we had continued to declare and accrue dividends on our Class C Preferred Stock and Class D Preferred Stock during the fourth quarter of 2013 and the year ended December 31, 2014, we would have accrued an additional $4.1 million and $33.2 million, respectively, of dividend payments, and our aggregate deferred and accrued dividend payments would have been $115.1 million at December 31, 2014, as further described in Note 13 to our consolidated financial statements.
The Company's financial position will be adversely affected if it experiences increased liquidity needs and any of the following events occur:
•
First Bank is unable or prohibited by its regulators to pay future dividends to the Company sufficient to satisfy the Company's operating cash flow needs. The Company's ability to receive future dividends from First Bank to assist the Company in meeting its operating requirements, both on a short-term and long-term basis, is currently subject to certain restrictions, as further described above and under “Item 1 -Business - Supervision and Regulation - Regulatory Agreements;”
•
We deem it advisable, or are required by regulatory authorities, to use cash maintained by the Company to support the capital position of First Bank;
•
First Bank fails to remain “well-capitalized” and, accordingly, First Bank is required to pledge additional collateral against its borrowings and is unable to do so. As discussed above, First Bank has no outstanding borrowings at December 31, 2014, with the exception of $64.9 million of daily repurchase agreements utilized by clients as an alternative deposit product, and has substantial borrowing capacity through its relationships with the FHLB and the FRB, as previously discussed; or
•
The Company has difficulty raising cash through the future issuance of debt or equity instruments or by accessing additional sources of credit, as further described above.
The Company's financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing on terms acceptable to us is not available in the marketplace. If we are required to rely more heavily on more expensive funding sources to support our business, our revenues may not increase proportionately to cover our costs. In this case, our operating margins would be materially adversely affected. A lack of liquidity and/or cost-effective funding alternatives could lead to the Company's inability to meet its financial commitments and related contractual obligations associated with its junior subordinated debentures, which would have a material adverse effect on our business, financial condition and results of operations.
Other Commitments and Contractual Obligations. We have entered into long-term leasing arrangements and other commitments and contractual obligations in conjunction with our ongoing operating activities. The required payments under such leasing arrangements, other commitments and contractual obligations at December 31, 2014 were as follows:
(1)
Amounts exclude ASC Topic 740 unrecognized tax liabilities of $873,000 and related accrued interest expense of $195,000 for which the timing of payment of such liabilities cannot be reasonably estimated as of December 31, 2014.
(2)
Amounts exclude the related accrued interest expense on certificates of deposit of $333,000 as of December 31, 2014.
(3)
Amounts exclude the accrued interest expense on junior subordinated debentures of $374,000 as of December 31, 2014, accrued dividends declared on preferred stock of $77.8 million and undeclared dividends of $37.3 million as of December 31, 2014.
(4)
Represents liquidation preference amounts payable upon redemption of the Class C Preferred Stock and the Class D Preferred Stock of $295.4 million and $17.3 million, respectively.
CRITICAL ACCOUNTING POLICIES
Our financial condition and results of operations presented in our consolidated financial statements, notes to our consolidated financial statements, selected consolidated and other financial data appearing elsewhere in this report, and management’s discussion and analysis of financial condition and results of operations are, to a large degree, dependent upon our accounting policies. The selection and application of our accounting policies involve judgments, estimates and uncertainties that are susceptible to change.
We have identified the following accounting policies that we believe are the most critical to the understanding of our financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could be a reasonable likelihood. The impact and any associated risks related to our critical accounting policies on our business operations is discussed throughout “-Management’s Discussion and Analysis of Financial Condition and Results of Operations,” where such policies affect our reported and expected financial results. A detailed discussion of the application of these and other accounting policies is summarized in Note 1 to our consolidated financial statements appearing elsewhere in this report.
Allowance for Loan Losses. We maintain an allowance for loan losses at a level we consider appropriate to provide for probable losses in our loan portfolio. The determination of our allowance for loan losses requires management to make significant judgments and estimates based upon a periodic analysis of our loans held for portfolio and held for sale considering, among other factors, current economic conditions, loan portfolio composition, past loan loss experience, independent appraisals, the fair value of underlying loan collateral, our clients’ ability to repay their loans and selected key financial ratios. If actual events prove the estimates and assumptions we used in determining our allowance for loan losses were incorrect, we may need to make additional provisions for loan losses. Any increases in our allowance for loan losses will result in a decrease in net income and capital, and may have a material adverse effect on our financial condition and results of operations. For further discussion, refer to “-Loans and Allowance for Loan Losses,” “Item 1A -Risk Factors” and Note 4 to our consolidated financial statements appearing elsewhere in this report.
Deferred Tax Assets. We recognize deferred tax assets for the estimated future tax effects of temporary differences, net operating loss carryforwards and tax credits. We recognize deferred tax assets subject to management’s judgment based upon available evidence that realization is more likely than not. Our deferred tax assets are reduced, if necessary, by a deferred tax asset valuation allowance. In the event that we determine we would not be able to realize all or part of our deferred tax assets in the future, we would need to adjust the recorded value of our deferred tax assets, which would result in a direct charge to our provision for income taxes in the period in which such determination is made. For further discussion, refer to “-(Benefit) Provision for Income Taxes,” and Note 1 and Note 17 to our consolidated financial statements appearing elsewhere in this report.
EFFECTS OF NEW ACCOUNTING STANDARDS
In July 2013, the FASB issued ASU 2013-11 - Income Taxes (Topic 740) - Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. As a result of applying this ASU, an unrecognized tax benefit is presented as a reduction of a deferred tax asset for a net operating loss or other tax credit carry-forward when settlement in this manner is available under the tax law. The assessment of whether settlement is available under the tax law is based on facts and circumstances as of the balance sheet reporting date and does not consider future events (i.e., upcoming expiration of related net operating loss carry-forwards). This classification does not affect an entity’s analysis of the realization of its deferred tax assets. This ASU is effective for interim and annual periods beginning after December 15, 2013. We adopted the requirements of this ASU on January 1, 2014, which did not have a material impact on our consolidated financial statements or results of operations or the disclosures presented in our consolidated financial statements.
In January 2014, the FASB issued ASU 2014-01 - Investments - Equity Method and Joint Ventures (Topic 323) - Accounting for Investments in Qualified Affordable Housing Projects. This ASU provides guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for low-income housing tax credit. The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments require new recurring disclosures about all investments in qualified affordable housing projects irrespective of the method used to account for the investments. This ASU is effective for interim and annual periods beginning after December 15, 2014. Early adoption is permitted. We are currently evaluating the requirements of this ASU to determine the impact on our consolidated financial statements and results of operations and the disclosures to be presented in our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09 - Revenue from Contracts with Customers (Topic 606). The core principle of this ASU is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU identifies a five-step model and related application guidance which will replace most existing revenue recognition guidance. This ASU is effective for interim and annual periods beginning after December 15, 2016. An entity may choose to adopt the ASU either retrospectively or through a cumulative effect adjustment as of the beginning of the first period for which it applies the new guidance. Early adoption is not permitted. We are currently evaluating the requirements of this ASU to determine the method of adoption and the impact on our consolidated financial statements and results of operations and the disclosures to be presented in our consolidated financial statements.
In August 2014, the FASB issued ASU 2014-15 - Presentation of Financial Statements - Going Concern (Subtopic 205-40) - Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern. The ASU describes how an entity's management should evaluate for each annual and interim reporting period whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date that the financial statements are issued and sets disclosure requirements about how this information should be communicated. This ASU is effective for the annual period after December 15, 2016, and for interim and annual periods thereafter. Early adoption is not permitted. We are currently evaluating the requirements of this ASU to determine the impact on the disclosures to be presented in our consolidated financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The quantitative and qualitative disclosures about market risk are included under “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Risk Management” appearing on pages 44 through 46 of this report.
Effects of Inflation. Inflation affects financial institutions less than other types of companies. Financial institutions make relatively few significant asset acquisitions that are directly affected by changing prices. Instead, the assets and liabilities are primarily monetary in nature. Consequently, interest rates are more significant to the performance of financial institutions than the effect of general inflation levels. While a relationship exists between the inflation rate and interest rates, we believe this is generally manageable through our asset-liability management program.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data appear on pages 65 through 116 of this report and are incorporated by reference herein.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
On December 19, 2014, the Audit Committee of the Board of Directors (the "Audit Committee") of First Banks, Inc. dismissed KPMG LLP as the Company’s Independent Registered Public Accounting Firm upon completion of their audit of the Company's consolidated financial statements as of and for the year ending December 31, 2014, and the issuance of their report thereon, and approved the engagement of Crowe Horwath LLP as the Company's Independent Registered Public Accounting Firm for the fiscal year ending December 31, 2015. For additional information regarding this matter, please refer to our Current Report on Form 8-K as filed with the SEC on December 29, 2014. There have been no disagreements with the Company’s Independent Registered Public Accounting Firm for the two-year period ended December 31, 2014.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
The Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this report. Based on such evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective as of December 31, 2014 to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its President and Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the President and Chief Executive Officer and the Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Our internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of our assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP and that receipts and expenditures are being made only in accordance with authorizations of management and our directors, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our consolidated 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 circumstances or that the degree of compliance with the policies and procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014, based on the framework set forth by the 1992 Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. Based on that assessment, management concluded that, as of December 31, 2014, the Company’s internal control over financial reporting is effective based on the criteria established in COSO’s Internal Control - Integrated Framework.
This annual report does not include an attestation report of the Company’s Independent Registered Public Accounting Firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s Independent Registered Public Accounting Firm.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Board of Directors and Committees of the Board
Our Board of Directors consists of nine members. The Board determined that Messrs. Blake, Cooper, Poelker, Rounsaville and Yaeger are independent. Each of our directors identified in the following table was elected to serve a one-year term and until his or her successor has been duly qualified for office.
(continued)
(1)
Mr. Michael J. Dierberg is the son of Mr. James F. Dierberg. See Item 12. Security Ownership of Certain Beneficial Owners and Management.
(2)
At the regular meeting of the First Banks, Inc. Board of Directors held on October 30, 2014, Mr. Terrance M. McCarthy announced his retirement and resigned his positions as Director, President and Chief Executive Officer of the Company, effective February 13, 2015. Upon acceptance of Mr. McCarthy's resignation as Director, President and Chief Executive Officer of the Company, the Board of Directors elected Mr. Timothy J. Lathe as Director, President and Chief Executive Officer of the Company, effective February 13, 2015. Mr. McCarthy will serve as Senior Advisor to the Chief Executive Officer to assist with the transition of leadership through July 1, 2015, and in that role, will continue to receive his salary and benefits, as disclosed in "Item 11
Item 11. Executive Compensation
Compensation Discussion and Analysis.
General. The purpose of this Compensation Discussion and Analysis is to provide information about the philosophies and principles of the Company regarding the compensation program for our executive officers including our Chief Executive Officer, Chief Financial Officer and the three most highly compensated other executive officers (collectively, our “Named Executive Officers” or “NEOs”). Our Named Executive Officers for 2014 were as follows:
•
Timothy J. Lathe, Executive Vice President and Chief Banking Officer (President and Chief Executive Officer as of February 13, 2015)
•
Michael J. Dierberg, Vice Chairman
•
Lisa K. Vansickle, Executive Vice President and Chief Financial Officer
•
John H. Montgomery, Executive Vice President and Chief Credit Officer
•
Terrance M. McCarthy, President and Chief Executive Officer (retired as of February 13, 2015)
Compensation Objective. The objective of our executive compensation policies and practices is to attract and retain talented key executives that will contribute to the achievement of strategic goals and the growth and success of the Company in order to enhance the long-term value of the Company. Compensation is based upon the achievement of corporate goals and objectives, as established by the Compensation Committee. Rewards for performance are designed to motivate the continued strong performance of key executives on a long-term basis.
Our executive compensation program is designed to reward the achievement of financial results in accordance with our corporate goals and objectives within the limits of our ownership structure. The compensation program of the Company is reflective of its ownership structure. As outlined in the stock ownership table included in "Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth, as of March 24, 2015, certain information with respect to the beneficial ownership of all classes of our capital stock by each person known to us to be the beneficial owner of more than five percent of the outstanding shares of the respective classes of our stock:
1.
Each of the above-named trustees and beneficial owners are United States citizens, and the business address for each such individual is 135 North Meramec, Clayton, Missouri 63105. Mr. James F. Dierberg, our Chairman of the Board, and Mrs. Mary W. Dierberg, are husband and wife, and Messrs. James F. Dierberg II and Michael J. Dierberg, our Vice Chairman, and Ms. Ellen D. Milne, our Director, are their adult children.
2.
Due to the relationship between Mr. James F. Dierberg, his wife and their children, Mr. Dierberg is deemed to share voting and investment power over these shares.
3.
Due to the relationship between Mr. James F. Dierberg, his wife and First Bank, Mr. Dierberg is deemed to share voting and investment power over these shares.
4.
Convertible into common stock, based on the appraised value of the common stock at the date of conversion.
5.
Sole voting and investment power.
6.
Shares were previously issued to the U.S. Treasury pursuant to the CPP. The Class C Preferred Stock and the Class D Preferred Stock were sold to unaffiliated third party investors during the third quarter of 2013. The holders of the Class C Preferred Stock and the Class D Preferred Stock have no voting rights except in certain limited circumstances as previously described under "-Business - Capital Structure."
The following table sets forth, as of March 24, 2015, certain information with respect to the beneficial ownership of all classes of the capital securities of our subsidiary, FB Holdings, by each of our directors and named executive officers:
(1) See further discussion of the membership interests of FB Holdings in Note 20 to our consolidated financial statements.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Review and Approval of Related Person Transactions. We review all relationships and transactions in which we and our directors and executive officers and their immediate family members and entities in which such persons have a significant interest are participants to determine whether such persons have a direct or indirect material interest. Our management collects information from the executive officers and the directors regarding the related person transactions and determines whether we or a related person has a direct or indirect material interest in the transaction. If we determine that a transaction is directly or indirectly material to us or a related person, then the transaction is disclosed in accordance with applicable requirements. In addition, the Audit Committee of our Board of Directors reviews and approves or ratifies any related person transaction that is required to be so disclosed. In the event that a member of the Audit Committee is a related person to such a transaction, such member may not participate in the discussion or vote regarding approval or ratification of the transaction.
Related Person Transactions. Outside of normal client relationships, no directors, executive officers or shareholders holding over 5% of our voting securities, and no corporations or firms with which such persons or entities are associated, currently maintain or have maintained since the beginning of the last full fiscal year, any significant business or personal relationship with our subsidiaries or us, other than that which arises by virtue of such position or ownership interest in our subsidiaries or us, except as set forth in “Item 11 - Executive Compensation - Compensation of Directors,” or as described in the following paragraphs.
First Bank has had in the past, and may have in the future, loan transactions and related banking services in the ordinary course of business with our directors and/or their affiliates. These loan transactions have been made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated persons and did not involve more than the normal risk of collectability or present other unfavorable features. First Bank does not extend credit to our officers or to officers of First Bank, except extensions of credit secured by mortgages on personal residences, loans to purchase automobiles and personal credit card accounts.
Certain of our shareholders, directors and officers and their respective affiliates have deposit accounts and related banking services with First Bank. It is First Bank’s policy not to permit any of its officers or directors or their affiliates to overdraw their respective deposit accounts. Deposit account overdraft protection may be approved for persons or entities under a plan whereby a credit limit has been established in accordance with First Bank’s standard credit criteria.
Transactions with related parties, including transactions with affiliated persons and entities, are described in Note 20 to our consolidated financial statements on pages 110 through 111 of this report, which descriptions are incorporated by reference herein, and in Note 11 to our consolidated financial statements.
Director Independence. Our Board of Directors has determined that Messrs. Allen H. Blake, James A. Cooper, John S. Poelker, Guy Rounsaville, Jr. and Douglas H. Yaeger have no material relationship with us and each is independent. Our Audit Committee and our Compensation Committee are comprised solely of independent directors. In order to be considered independent, our Board of Directors must determine that a director does not have any direct or indirect material relationship with us as provided under the rules of the NYSE. In making such a determination, the Board of Directors considers all relationships between us, or any of our subsidiaries, and the director, or any of his immediate family members, or any entity with which the director or any of his immediate family members is affiliated by reason of being a partner, officer or significant shareholder thereof. In assessing the independence of our directors, the Board of Directors considered all relationships between us and our directors based primarily upon responses of the directors to questions posed through a directors’ and officers’ questionnaire. The Board of Directors considered each of the related person transactions discussed above in making its independence determination.
The Company has preferred securities of only one of its capital trusts listed on the NYSE and, pursuant to the General Application section of NYSE Rule 303A, is not subject to NYSE Rule 303A.01 requiring a majority of independent directors. Messrs. James F. Dierberg, Michael J. Dierberg and Timothy J. Lathe are not independent because they are each current executive officers of the Company. Ms. Ellen D. Milne is not independent because she is a principal shareholder of the Company and the daughter and sister of James F. Dierberg and Michael J. Dierberg, respectively.
Item 14.
Item 14. Principal Accounting Fees and Services
Fees of Independent Registered Public Accounting Firm
During 2014 and 2013, KPMG LLP served as our Independent Registered Public Accounting Firm and provided services to our affiliates and us. The following table sets forth fees for professional audit services rendered by KPMG LLP for the audit of our consolidated financial statements and other audit services in 2014 and 2013:
(1)
For 2014 and 2013, audit fees include the audit of the consolidated financial statements of the Company, as well as services provided for reporting requirements under FDICIA and mortgage banking activities, which are included in the audit fees of the Company, as these services are closely related to the audit of the Company’s consolidated financial statements. Audit fees also include other accounting and reporting consultations.
(2)
For 2014 and 2013, tax fees consist of tax filing, compliance and other advisory services.
Policy Regarding the Approval of Independent Auditor Provision of Audit and Non-Audit Services
Consistent with the SEC requirements regarding auditor independence, the Audit Committee recognizes the importance of maintaining the independence, in fact and appearance, of our independent auditors. As such, the Audit Committee has adopted a policy for pre-approval of all audit and permissible non-audit services provided by our independent auditors. Under the policy, the Audit Committee, or its designated member, must pre-approve services prior to commencement of the specified service. The requests for pre-approval are submitted to the Audit Committee or its designated member by the Director of Risk Management and Audit with a statement as to whether in his/her view the request is consistent with the SEC’s rules on auditor independence. The Audit Committee reviews the pre-approval requests and the fees paid for such services at their regularly scheduled quarterly meetings or at special meetings.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)
1.
Financial Statements and Supplementary Data - The financial statements and supplementary data filed as part of this Report are included in Item 8.
2.
Financial Statement Schedules - These schedules are omitted for the reason they are not required or are not applicable.
3.
Exhibits - The exhibits are listed in the index of exhibits required by Item 601 of Regulation S-K at Item (b) below and are incorporated herein by reference.
(b)
The index of required exhibits is included beginning on page 120 of this Report.
(c)
Not Applicable.
FIRST BANKS, INC.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
First Banks, Inc.:
We have audited the accompanying consolidated balance sheets of First Banks, Inc. and subsidiaries (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Banks, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.
St. Louis, Missouri
March 24, 2015
FIRST BANKS, INC.
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the consolidated financial statements.
FIRST BANKS, INC.
CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of the consolidated financial statements.
FIRST BANKS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
The accompanying notes are an integral part of the consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
FIRST BANKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FIRST BANKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
The accompanying notes are an integral part of the consolidated financial statements.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The accompanying consolidated financial statements of First Banks, Inc. and subsidiaries (the Company) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and conform to predominant practices within the banking industry. Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare the consolidated financial statements in conformity with GAAP. Actual results could differ from those estimates. Certain reclassifications of 2013 and 2012 amounts have been made to conform to the 2014 presentation. All financial information is reported on a continuing operations basis, unless otherwise noted. See Note 2 to the consolidated financial statements for a discussion regarding discontinued operations.
Principles of Consolidation. The consolidated financial statements include the accounts of the parent company and its subsidiaries, giving effect to the noncontrolling interest in subsidiaries, as more fully described below and in Note 20 to the consolidated financial statements. All significant intercompany accounts and transactions have been eliminated.
The Company operates through its wholly owned subsidiary bank holding company, The San Francisco Company (SFC), headquartered in St. Louis, Missouri, and SFC’s wholly owned subsidiary bank, First Bank, also headquartered in St. Louis, Missouri. First Bank operates through its branch banking offices and subsidiaries: FB Holdings, LLC (FB Holdings); Small Business Loan Source LLC; SBRHC, Inc.; FBSA Missouri, Inc.; FBSA California, Inc.; and First Banc Insurance Services Corporation. All of the subsidiaries are wholly owned as of December 31, 2014, except FB Holdings, which is 53.23% owned by First Bank and 46.77% owned by First Capital America, Inc. (FCA), a corporation owned and operated by the Company’s Chairman of the Board and members of his immediate family, including Mr. Michael Dierberg, Vice Chairman of the Company, and Ms. Ellen Dierberg Milne, Director of the Company, as further described in Note 20 to the consolidated financial statements. FB Holdings is included in the consolidated financial statements and the noncontrolling ownership interest is reported as a component of stockholders’ equity in the consolidated balance sheets as “noncontrolling interest in subsidiary” and the earnings or loss, net of tax, attributable to the noncontrolling ownership interest, is reported as “net (loss) income attributable to noncontrolling interest in subsidiary” in the consolidated statements of income.
Significant Accounting Policies:
Cash and Cash Equivalents. Cash, due from banks and short-term investments, which include federal funds sold and interest-bearing deposits, are considered to be cash and cash equivalents for purposes of the consolidated statements of cash flows. Interest-bearing deposits were $105.1 million and $98.1 million at December 31, 2014 and 2013, respectively. The Company did not have any federal funds sold outstanding at December 31, 2014 and 2013. First Bank is required to maintain certain daily reserve balances on hand in accordance with regulatory requirements. The reserve balances required to be maintained in accordance with such requirements were $10.0 million and $11.5 million at December 31, 2014 and 2013, respectively.
Federal Reserve Bank and Federal Home Loan Bank Stock. First Bank is a member of the Federal Reserve Bank of St. Louis (FRB) system and the Federal Home Loan Bank (FHLB) system and maintains investments in FRB and FHLB stock. These investments are recorded at cost, which represents redemption value. The investment in FRB stock is maintained at a minimum of 6% of First Bank’s capital stock and capital surplus. The investment in FHLB of Des Moines stock is maintained at an amount equal to 0.12% of First Bank’s total assets as of December 31 of the preceding year, up to a maximum of $10.0 million, plus 4.45% of advances. Investments in FRB and FHLB of Des Moines stock were $23.4 million and $7.0 million, respectively, at December 31, 2014, and $19.6 million and $7.8 million, respectively, at December 31, 2013.
Investment Securities. The classification of investment securities as available for sale or held to maturity is determined at the date of purchase. Investment securities designated as available for sale, which represent any security that the Company has no immediate plan to sell but which may be sold in the future under different circumstances, are stated at fair value. Realized gains and losses are included in noninterest income, based on the amortized cost of the individual security sold. Unrealized gains and losses, net of related income tax effects, are recorded in accumulated other comprehensive income (loss). All previous fair value adjustments included in the separate component of accumulated other comprehensive income (loss) are reversed upon sale. Premiums and discounts incurred relative to the par value of securities purchased are amortized or accreted, respectively, on the level-yield method taking into consideration the level of current and anticipated prepayments. Investment securities designated as held to maturity, which represent any security that the Company has the positive intent and ability to hold to maturity, are stated at cost, net of amortization of premiums and accretion of discounts computed on the level-yield method taking into consideration the level of current and anticipated prepayments. Any reclassification of available-for-sale investment securities to held-to-maturity investment securities are recorded at fair value, and the gross unrealized gain or loss on available-for-sale investment securities at the time of transfer is recorded as additional premium or discount on the securities and amortized or accreted over the remaining lives of the respective securities. A decline in the fair value of any available-for-sale or held-to-maturity investment security below its carrying value that is deemed to be other than temporary results in a reduction in the cost basis of the carrying value to fair value.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The other-than-temporary impairment, which is not expected to be reversed, is charged to noninterest income and a new cost basis is established. When determining other-than-temporary impairment, consideration is given as to whether the Company has the ability and intent to hold the investment security until a market price recovery and whether evidence indicating the carrying value of the investment security is recoverable outweighs evidence to the contrary.
Loans Held for Portfolio. Loans held for portfolio are carried at cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Interest and fees on loans are recognized as income using the interest method. Loan origination fees and costs are deferred and accreted to interest income over the estimated life of the loans using the interest method. Loans held for portfolio are stated at cost as the Company has the ability and it is management’s intention to hold them to maturity.
The accrual of interest on loans is discontinued when it appears that interest or principal may not be paid in a timely manner in the normal course of business or once principal or interest payments become 90 days past due under the contractual terms of the loan agreement. Generally, payments received on nonaccrual and impaired loans are recorded as principal reductions. Interest income is recognized after all delinquent principal has been repaid or an improvement in the condition of the loan has occurred that warrants resumption of interest accruals.
A loan is considered impaired when it is probable that the Company will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the loan agreement. Loans on nonaccrual status and restructured loans are considered to be impaired loans. When measuring impairment, the expected future cash flows of an impaired loan are discounted at the loan’s effective interest rate. Alternatively, impairment is measured by reference to an observable market price, if one exists, or the fair value of the collateral for a collateral-dependent loan. Regardless of the historical measurement method used, the Company measures impairment based on the fair value of the collateral when foreclosure is probable.
A loan is classified as a troubled debt restructuring when all of the following conditions are present: (i) the borrower is experiencing financial difficulty, (ii) the Company makes a concession to the original contractual loan terms, and (iii) the Company would not consider the concessions but for economic or legal reasons related to the borrower’s financial difficulty. These concessions may include, but are not limited to, rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses. A loan that is modified at a market rate of interest may no longer be classified as a troubled debt restructuring in the calendar year subsequent to the restructuring if it is in compliance with the modified terms. Performance prior to the restructuring is considered when assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of the restructuring or after a shorter performance period.
Acquired impaired loans are classified as nonaccrual loans and are initially measured at fair value with no allocated allowance for loan losses. An allowance for loan losses is recorded to the extent there is further credit deterioration subsequent to the acquisition date.
Loans Held for Sale. Loans held for sale are comprised of residential mortgage loans held for sale in the secondary mortgage market, frequently in the form of a mortgage-backed security, U.S. Small Business Administration (SBA) loans awaiting sale of the guaranteed portion to the SBA, and commercial real estate loans which may be identified for sale to specific buyers to achieve credit or loan concentration objectives. One-to-four-family residential mortgage loans held for sale are carried at fair value on a recurring basis. The determination of fair value is based on quoted market prices of comparable instruments obtained from independent pricing vendors based on recent trading activity and other relevant information. Other loans held for sale, primarily SBA loans, are carried at the lower of cost or market value, which is determined on an individual loan basis. The amount by which cost exceeds market value is recorded in a valuation allowance as a reduction of loans held for sale. Changes in the valuation allowance are reflected as part of the gain on loans sold and held for sale in the consolidated statements of income in the periods in which the changes occur. Gains or losses on the sale of loans held for sale are determined on a specific identification basis and reflect the difference between the value received upon sale and the carrying value of the loans held for sale, including any recourse reserve established for potential repurchase obligations. Loans held for sale transferred to loans held for portfolio or available-for-sale investment securities are transferred at fair value.
Loan Servicing Income. Loan servicing income is included in noninterest income and represents fees earned for servicing real estate mortgage loans owned by investors and originated by First Bank’s mortgage banking operation, as well as SBA loans to small business concerns. These fees are net of federal agency guarantee fees and interest shortfall. Such fees are generally calculated on the outstanding principal balance of the loans serviced and are recorded as income when earned.
Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology follows the accounting guidance set forth in GAAP and the Interagency Policy Statement on the Allowance for Loan and Lease Losses, which was jointly issued by the Company’s regulatory
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
agencies. Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to nonaccrual loans, past due loans, substandard loans, special mention loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified problem loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.
The level of the allowance for loan losses reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss and recovery experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate determination of the appropriate level of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. The Company monitors whether or not the allowance for loan loss allocation model, as a whole, calculates an appropriate level of allowance for loan losses that moves in direct correlation to the general macroeconomic and loan portfolio conditions the Company experiences over time.
The Company’s allowance for loan losses consists of three elements: (i) specific valuation allowances based on probable losses on impaired loans; (ii) historical valuation allowances determined based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances based on general economic conditions and other risk factors both internal and external to the Company.
The specific valuation allowances established for probable losses on impaired loans are based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flows, as well as evaluation of legal options available to the Company. The amount of impairment is measured based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the fair value of the underlying collateral less applicable selling costs, or the observable market price of the loan. If foreclosure is probable or the loan is collateral dependent, impairment is measured using the fair value of the loan’s collateral, less estimated costs to sell. Large groups of homogeneous loans, such as residential mortgage, home equity and consumer and installment loans, are aggregated and collectively evaluated for impairment.
Historical valuation allowances are calculated based on the historical loss experience of specific types of loans. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are updated on a quarterly basis based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool.
The components of the general valuation allowances include (i) additional reserves allocated to specific loan portfolio segments as a result of applying a qualitative adjustment factor to the base historical loss allocation; (ii) additional reserves allocated to specific geographical regions where negative trends are being experienced; and (iii) additional reserves established based on consideration of trends in past due loans, potential problem loans, performing troubled debt restructurings and nonaccrual loans and other qualitative and quantitative factors both internal and external to the Company which could affect potential credit losses.
Management believes the level of the Company’s allowance for loan losses is appropriate. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions.
In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require the Company to modify its allowance for loan losses based on their judgment about information available to them at the time of their examination.
Derivative Instruments and Hedging Activities. The Company utilizes derivative instruments and hedging strategies to assist in the management of interest rate sensitivity and to modify the repricing, maturity and option characteristics of certain assets and liabilities. The Company uses such derivative instruments solely to reduce its interest rate risk exposure. Interest rate lock commitments and forward commitments to sell mortgage-backed securities are considered derivative instruments. First Bank also offers interest rate swap agreement contracts to certain clients who wish to modify their interest rate sensitivity positions. A summary of the Company’s accounting policies for its current derivative instruments and hedging activities is as follows:
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
•
Interest Rate Lock Commitments. Commitments to originate loans for subsequent sale in the secondary market (interest rate lock commitments), which primarily consist of commitments to originate fixed rate residential mortgage loans, are recorded at fair value. Fair values are based upon quoted market prices. The value of loan servicing rights is also incorporated into fair value measurements for mortgage loan commitments. Changes in the fair value of interest rate lock commitments are recognized in noninterest income on a monthly basis.
•
Forward Commitments to Sell Mortgage-Backed Securities. Forward commitments to sell mortgage-backed securities are recorded at fair value. Changes in the fair value of forward commitments to sell mortgage-backed securities are recognized in noninterest income on a monthly basis.
•
Client Interest Rate Swap Agreement Contracts. Derivative instruments are offered to clients to assist in hedging their risks of adverse changes in interest rates. First Bank serves as an intermediary between its clients and the financial markets. Each contract between First Bank and its clients is offset by a matching interest rate swap contract with offsetting pay/receive rates between First Bank and various counterparties. These contracts do not qualify for hedge accounting. Client interest rate swap agreement contracts are carried at fair value. Changes in the fair value are recognized in noninterest income on a monthly basis. As each client contract is paired with an offsetting contract, there is no significant impact to net income (loss).
Bank Premises and Equipment, Net. Bank premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Amortization of leasehold improvements is calculated using the straight-line method over the shorter of the useful life of the related asset or the term of the lease. Bank premises and improvements are depreciated over five to 40 years and equipment is depreciated over three to seven years.
Servicing Rights. The Company has mortgage servicing rights and SBA servicing rights, which are measured at fair value as permitted by ASC Topic 860 - Accounting for Servicing of Financial Assets. Changes in the fair value of mortgage and SBA servicing rights are recognized in earnings in the period in which the change occurs and such changes are reflected in other noninterest income in the consolidated statements of income. Servicing rights are valued based on valuation models that utilize assumptions based on the predominant risk characteristics of the underlying loans, including size, interest rate, weighted average life, cost to service and estimated prepayment speeds. The valuation models estimate the present value of estimated future net servicing income.
Mortgage and SBA servicing rights are capitalized upon the sale of the underlying loan at estimated fair value. The fair value of mortgage and SBA servicing rights fluctuates based on changes in interest rates and certain other assumptions utilized to value the mortgage and SBA servicing rights. The value is adversely affected when interest rates decline which normally causes loan prepayments to increase. The determination of the fair value of the mortgage and SBA servicing rights is performed monthly based upon an independent third party valuation. The valuation analysis is prepared using stratifications of the mortgage and SBA servicing rights based on the predominant risk characteristics of the underlying loans, including size, interest rate, weighted average original term, weighted average remaining term and estimated prepayment speeds.
Other Real Estate. Other real estate is stated at the lower of cost or fair value less applicable selling costs. The excess of cost over fair value of the property at the date of acquisition is charged to the allowance for loan losses. Subsequent reductions in carrying value, to reflect current fair value or costs incurred in maintaining the other real estate, are charged to noninterest expense as incurred.
Income Taxes. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in the tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are then recorded to reduce deferred tax assets to the amounts management concludes are more-likely-than-not to be realized. The Company and its eligible subsidiaries file a consolidated federal income tax return and unitary or consolidated state income tax returns in all applicable states.
The Company’s policy is to separately disclose any interest or penalties arising from the application of federal or state income taxes. Interest related to unrecognized tax benefits is included in interest expense and penalties related to unrecognized tax benefits are included in noninterest expense.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states. Management of the Company believes the accrual for tax liabilities is adequate for all open audit years based on its assessment of many factors, including past experience and interpretations of tax law applied to the facts of each matter. This assessment relies on estimates and assumptions.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Noncontributory Defined Benefit Pension Plan. The Company has a noncontributory defined benefit pension plan covering certain former employees of a bank holding company acquired by the Company in 1994 (the Plan) and subsequently merged with and into the Company on December 31, 2002. The Company discontinued the accumulation of benefits under the Plan in 1994, and as such, there is no longer any service cost being accrued by Plan participants. The Company records annual amounts relating to the Plan based on calculations that incorporate various actuarial and other assumptions including discount rates, mortality rates, and assumed rates of return. The Company reviews these assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends when deemed appropriate. The funded status of the Plan is recognized as a net asset or liability and changes in the Plan’s funded status are recognized through other comprehensive income to the extent those changes are not included in the net periodic cost.
Financial Instruments With Off-Balance Sheet Risk. A financial instrument is defined as cash, evidence of an ownership interest in an entity, or a contract that conveys or imposes on an entity the contractual right or obligation to either receive or deliver cash or another financial instrument. The Company utilizes financial instruments to reduce the interest rate risk arising from its financial assets and liabilities. These instruments involve, in varying degrees, elements of interest rate risk and credit risk in excess of the amount recognized in the consolidated balance sheets. “Interest rate risk” is defined as the possibility that interest rates may move unfavorably from the perspective of the Company due to maturity and/or interest rate adjustment timing differences between interest-earning assets and interest-bearing liabilities. The risk that a counterparty to an agreement entered into by the Company may default is defined as “credit risk.”
The Company is a party to commitments to extend credit and commercial and standby letters of credit in the normal course of business to meet the financing needs of its clients. These commitments involve, in varying degrees, elements of interest rate risk and credit risk in excess of the amount reflected in the consolidated balance sheets.
Earnings (Loss) Per Common Share. Basic earnings (loss) per common share (EPS) are computed by dividing the income (loss) available to common stockholders (the numerator) by the weighted average number of shares of common stock outstanding (the denominator) during the year. The computation of dilutive EPS is similar except the denominator is increased to include the number of additional shares of common stock that would have been outstanding if the dilutive potential shares had been issued. In addition, in computing the dilutive effect of convertible securities, the numerator is adjusted to add back any convertible preferred dividends.
NOTE 2 - DISCONTINUED OPERATIONS
Discontinued Operations. The assets and liabilities associated with the transactions described (and defined) below were previously reported in the First Bank segment and were sold as part of the Company’s Capital Optimization Plan (Capital Plan). The Company applied discontinued operations accounting in accordance with ASC Topic 205-20, “Presentation of Financial Statements - Discontinued Operations,” to the operations of First Bank's Association Bank Services line of business and Northern Florida Region for the years ended December 31, 2013 and 2012, as applicable. The Company did not allocate any consolidated interest that is not directly attributable to or related to discontinued operations. All financial information in the consolidated financial statements and notes to the consolidated financial statements is reported on a continuing operations basis, unless otherwise noted.
Association Bank Services. On May 13, 2013, First Bank entered into a Purchase and Assumption Agreement that provided for the sale of certain assets and the transfer of certain liabilities, primarily deposits, of First Bank's Association Bank Services (ABS) line of business, to Union Bank, N.A. (Union Bank), headquartered in San Francisco, California. ABS, previously headquartered in Vallejo, California, provided a full range of services to homeowners associations and community management companies. The transaction was completed on November 22, 2013. Under the terms of the agreement, Union Bank assumed $572.1 million of deposits, as well as certain other liabilities, and paid a premium on certain deposit accounts acquired in the transaction. Union Bank also purchased certain assets, including $20.8 million of loans, at par value. The transaction resulted in a gain of $28.6 million, after the write-off of goodwill of $18.0 million allocated to the transaction in the fourth quarter of 2013.
Northern Florida Region. On November 21, 2012, First Bank entered into a Branch Purchase and Assumption Agreement that provided for the sale of certain assets and the transfer of certain liabilities associated with eight of First Bank’s retail branches located in Pinellas County, Florida to HomeBanc National Association (HomeBanc), headquartered in Lake Mary, Florida. The transaction was completed on April 19, 2013. Under the terms of the agreement, HomeBanc assumed $120.3 million of deposits, purchased the premises and equipment, and assumed the leases associated with these eight retail branches. The transaction resulted in a gain of $408,000, after the write-off of goodwill of $700,000 allocated to the Northern Florida Region, primarily during the second quarter of 2013.
On April 5, 2013, First Bank closed its three remaining retail branches located in Hillsborough County and in Pasco County. The closure of these three remaining retail branches in the Northern Florida Region resulted in expense of $2.3 million during the second quarter of 2013 attributable to continuing obligations under facility leasing arrangements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Income from discontinued operations, net of tax, for the year ended December 31, 2013 was as follows:
Loss from discontinued operations, net of tax, for the year ended December 31, 2012 was as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 - INVESTMENTS IN DEBT AND EQUITY SECURITIES
Securities Available for Sale. The amortized cost, contractual maturity, gross unrealized gains and losses and fair value of investment securities available for sale at December 31, 2014 and 2013 were as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Securities Held to Maturity. The amortized cost, contractual maturity, gross unrealized gains and losses and fair value of investment securities held to maturity at December 31, 2014 and 2013 were as follows:
Proceeds from sales of available-for-sale investment securities were $343.5 million, $143.7 million and $315.2 million for the years ended December 31, 2014, 2013 and 2012, respectively. Gross realized gains and gross realized losses on investment securities for the years ended December 31, 2014, 2013 and 2012 were as follows:
Other-than-temporary impairment for the year ended December 31, 2013 includes impairment of $407,000 recorded during the first quarter of 2013 on a municipal investment security classified as held-to-maturity. Investment securities with a carrying value of $349.0 million and $283.7 million at December 31, 2014 and 2013, respectively, were pledged in connection with deposits of public and trust funds, securities sold under agreements to repurchase and for other purposes as required by law.
During the first quarter of 2013, the Company reclassified certain of its available-for-sale investment securities to held-to-maturity investment securities at their respective fair values, which totaled $242.5 million, in aggregate. The net gross unrealized gain on these available-for-sale investment securities at the time of transfer was $5.0 million, in aggregate. On June 30, 2012, the Company reclassified certain of its available-for-sale investment securities to held-to-maturity investment securities at their respective fair values, which totaled $729.1 million, in aggregate. The net gross unrealized gain on these available-for-sale investment securities at the time of transfer was $11.7 million, in aggregate. The determination of the reclassifications were made by management based on the Company’s current and expected future liquidity levels and the resulting intent to hold such investment securities to maturity. The net gross unrealized gains on these available-for-sale investment securities at the time of transfer was recorded as additional premium on the securities and is being amortized over the remaining lives of the respective securities, as further described in Note 13 to the consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2014 and 2013, were as follows:
The Company does not believe the investment securities that were in an unrealized loss position at December 31, 2014 and 2013 are other-than-temporarily impaired. The unrealized losses on the investment securities were primarily attributable to fluctuations in interest rates. It is expected that the securities would not be settled at a price less than the amortized cost. Because the decline in fair value is attributable to changes in interest rates and not credit loss, and because the Company does not intend to sell these investments and it is more likely than not that the Company will not be required to sell these investments before the anticipated recovery of the remaining amortized cost basis or maturity, these investments are not considered other-than-temporarily impaired. The unrealized losses for investment securities for 12 months or more at December 31, 2014 and 2013 included 47 and 12 securities, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES
The following table summarizes the composition of the loan portfolio at December 31, 2014 and 2013:
The Company's loan portfolio is primarily comprised of residential and commercial real estate loans, and commercial, financial and agricultural loans. The Company primarily lends to borrowers within its primary market areas of California, Florida, southern Illinois and eastern Missouri. The Company maintains a diversified portfolio with limited industry concentrations of credit risk. Real estate lending constitutes the only significant concentration of credit risk. Real estate loans comprised approximately 77% and 78% of the loan portfolio at December 31, 2014 and 2013, respectively, of which 43% and 42%, respectively, were made to consumers in the form of residential real estate mortgages and home equity lines of credit. First Bank also offers residential real estate mortgage loans with terms that require interest only payments. At December 31, 2014, the balance of such loans, all of which were held for portfolio, was approximately $12.7 million, of which approximately 5.1% were delinquent. At December 31, 2013, the balance of such loans, all of which were held for portfolio, was approximately $16.0 million, of which approximately 5.1% were delinquent. In general, the Company is a secured lender. At December 31, 2014 and 2013, 98% and 99% of the loan portfolio was collateralized. Collateral is required in accordance with the normal credit evaluation process based upon the creditworthiness of the client and the credit risk associated with the particular transaction. First Bank also originates certain one-to-four-family residential mortgage loans for sale in the secondary market. First Bank has a repurchase obligation on these loans in the event of fraud or, on certain loans, early payment default. The early payment default provisions generally range from four months to one year after sale of the loan in the secondary market. First Bank has not sold any one-to-four-family residential mortgage loans into the secondary market with early payment default provisions since 2007, as further described in Note 24 to the consolidated financial statements.
Loans to directors, their affiliates and executive officers of the Company were approximately $28.8 million and $12.0 million at December 31, 2014 and 2013, respectively, as further described in Note 20 to the consolidated financial statements.
Loans with a carrying value of approximately $1.05 billion and $1.03 billion at December 31, 2014 and 2013, respectively, were pledged as collateral under borrowing arrangements with the FRB and the FHLB. At December 31, 2014 and 2013 and for the years then ended, First Bank had no advances outstanding under these borrowing arrangements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Aging of Loans. The following table presents the aging of loans by loan classification at December 31, 2014 and 2013:
Under the Company’s loan policy, loans are placed on nonaccrual status once principal or interest payments become 90 days past due. However, individual loan officers may submit written requests for approval to continue the accrual of interest on loans that become 90 days past due. These requests may be submitted for approval consistent with the authority levels provided in the Company’s credit approval policies, and they are only granted if an expected near term future event, such as a pending renewal or expected payoff, exists at the time the loan becomes 90 days past due. If the expected near term future event does not occur as anticipated, the loan is then placed on nonaccrual status.
Credit Quality Indicators. The Company’s credit management policies and procedures focus on identifying, measuring and controlling credit exposure. These procedures employ a lender-initiated system of rating credits, which is ratified in the loan approval process and subsequently tested in internal credit reviews, external audits and regulatory bank examinations. The system requires the rating of all loans at the time they are originated or acquired, except for homogeneous categories of loans, such as residential real estate mortgage loans and consumer loans. These homogeneous loans are assigned an initial rating based on the Company’s experience with each type of loan. The Company adjusts the ratings of the homogeneous loans based on payment experience subsequent to their origination.
The Company includes adversely rated credits, including loans requiring close monitoring that would not normally be considered classified credits by the Company’s regulators, on its monthly loan watch list. Loans may be added to the Company’s watch list for reasons that are temporary and correctable, such as the absence of current financial statements of the borrower or a deficiency in loan documentation. Loans may also be added to the Company’s watch list whenever any adverse circumstance is detected which might affect the borrower’s ability to comply with the contractual terms of the loan. The delinquency of a scheduled loan payment, deterioration in the borrower’s financial condition identified in a review of periodic financial statements, a decrease in the value of the collateral securing the loan, or a change in the economic environment within which the borrower operates could initiate the addition of a loan to the Company’s watch list. Loans on the Company’s watch list require periodic detailed loan status reports prepared by the responsible officer which are discussed in formal meetings with credit review and credit administration staff members. Upgrades and downgrades of loan risk ratings may be initiated by the responsible loan officer. However, upgrades of risk ratings associated with significant credit relationships and/or problem credit relationships may only be made with the concurrence of appropriate regional credit officers.
Under the Company’s risk rating system, special mention loans are those loans that do not currently expose the Company to sufficient risk to warrant classification as substandard, troubled debt restructuring (TDR) or nonaccrual, but possess weaknesses
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
that deserve management’s close attention. Substandard loans include those loans characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. A loan is classified as a TDR when a borrower is experiencing financial difficulties that lead to the restructuring of a loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. Loans classified as TDRs which are accruing interest are classified as performing TDRs. Loans classified as TDRs which are not accruing interest are classified as nonperforming TDRs and are included with all other nonaccrual loans for presentation purposes. Loans classified as nonaccrual have all the weaknesses inherent in those loans classified as substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of the currently existing facts, conditions and values, highly questionable and improbable. Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans.
The following tables present the credit exposure of the loan portfolio by internally assigned credit grade and payment activity as of December 31, 2014 and 2013:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Impaired Loans. Loans deemed to be impaired include performing TDRs and nonaccrual loans. Impaired loans with outstanding balances equal to or greater than $500,000 are evaluated individually for impairment. For these loans, the Company measures the level of impairment based on the present value of the estimated projected cash flows, or if the impaired loans are collateral dependent, the estimated value of the collateral, less applicable selling costs. If the current valuation is lower than the current book balance of the loan, the amount of the difference is evaluated for possible charge-off. In instances where management determines that a charge-off is not appropriate, a specific reserve is established for the individual loan in question. This specific reserve is included as a part of the overall allowance for loan losses.
The following tables present the recorded investment, unpaid principal balance, related allowance for loan losses, average recorded investment and interest income recognized while on impaired status for impaired loans without a related allowance for loan losses and for impaired loans with a related allowance for loan losses by loan classification at December 31, 2014 and 2013:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Recorded investment represents the Company’s investment in its impaired loans reduced by cumulative charge-offs recorded against the allowance for loan losses on these same loans. At December 31, 2014 and 2013, the Company had recorded charge-offs of $55.0 million and $54.9 million, respectively, on its impaired loans, representing the difference between the unpaid principal balance and the recorded investment reflected in the tables above. The unpaid principal balance represents the principal amount contractually owed to the Company by the borrowers on the impaired loans.
Interest on impaired loans that would have been recorded under the original terms of the loans was $11.9 million, $13.4 million and $21.7 million for the years ended December 31, 2014, 2013 and 2012, respectively. Of these amounts, $3.6 million, $4.3 million and $6.0 million was recorded as interest income on such loans in 2014, 2013 and 2012, respectively.
Troubled Debt Restructurings. In the ordinary course of business, the Company modifies loan terms across loan types, including both consumer and commercial loans, for a variety of reasons. Modifications to consumer loans may include, but are not limited to, changes in interest rate, maturity, amortization and financial covenants. In the original underwriting, loan terms are established that represent the then current and projected financial condition of the borrower. Over any period of time, modifications to these loan terms may be required due to changes in the original underwriting assumptions. These changes may include the financial covenants of the borrower as well as underwriting standards.
Loan modifications are generally performed at the request of the borrower, whether commercial or consumer, and may include reductions in interest rates, changes in payments and maturity date extensions. Although the Company does not have formal, standardized loan modification programs for its commercial or consumer loan portfolios, it addresses loan modifications on a case-by-case basis and also participates in the United States Department of the Treasury's (U.S. Treasury) Home Affordable Modification Program (HAMP). HAMP gives qualifying homeowners an opportunity to refinance into more affordable monthly payments, with the U.S. Treasury compensating the Company for a portion of the reduction in monthly amounts due from borrowers participating in this program. At December 31, 2014 and 2013, the Company had $72.7 million and $75.3 million, respectively, of modified loans in the HAMP program.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For a loan modification to be classified as a TDR, all of the following conditions must be present: (1) the borrower is experiencing financial difficulty, (2) the Company makes a concession to the original contractual loan terms and (3) the Company would not consider the concessions but for economic or legal reasons related to the borrower’s financial difficulty. Modifications of loan terms to borrowers experiencing financial difficulty are made in an attempt to protect as much of the investment in the loan as possible. These modifications are generally made to either prevent a loan from becoming nonaccrual or to return a nonaccrual loan to performing status based on the expectations that the borrower can adequately perform in accordance with the modified terms.
The determination of whether a modification should be classified as a TDR requires significant judgment after taking into consideration all facts and circumstances surrounding the transaction. No single characteristic or factor, taken alone, is determinative of whether a modification should be classified as a TDR. The fact that a single characteristic is present is not considered sufficient to overcome the preponderance of contrary evidence. Assuming all of the TDR criteria are met, the Company considers one or more of the following concessions to the loan terms to represent a TDR: (1) a reduction of the stated interest rate, (2) an extension of the maturity date or dates at a stated interest rate lower than the current market rate for a new loan with similar terms or (3) forgiveness of principal or accrued interest.
Loans renegotiated at a rate equal to or greater than that of a new loan with comparable risk at the time the contract is modified are excluded from TDR classification in the calendar years subsequent to the renegotiation if the loan is in compliance with the modified terms for at least six months.
The Company does not accrue interest on any TDRs unless it believes collection of all principal and interest under the modified terms is reasonably assured. Generally, six months of consecutive payment performance by the borrower under the restructured terms is required before a TDR is returned to accrual status. However, the period could vary depending upon the individual facts and circumstances of the loan. TDRs accruing interest are classified as performing TDRs. The following table presents the categories of performing TDRs as of December 31, 2014 and 2013:
The Company does not accrue interest on TDRs which have been modified for a period less than six months or are not in compliance with the modified terms. These loans are considered nonperforming TDRs and are included with other nonaccrual loans for classification purposes. The following table presents the categories of loans considered nonperforming TDRs as of December 31, 2014 and 2013:
Both performing and nonperforming TDRs are considered to be impaired loans. When an individual loan is determined to be a TDR, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less applicable selling costs. The impairment amount is either charged off as a reduction to the allowance for loan losses or provided for as a specific reserve within the allowance for loan losses. The allowance for loan losses allocated to TDRs was $6.1 million and $9.1 million at December 31, 2014 and 2013, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following tables present loans classified as TDRs that were modified during the years ended December 31, 2014 and 2013:
The following tables present TDRs that defaulted within 12 months of modification during the years ended December 31, 2014 and 2013:
Upon default of a TDR, which is considered to be 90 days or more past due under the modified terms, impairment is measured based on the fair value of the underlying collateral less applicable selling costs. The impairment amount is either charged off as a reduction to the allowance for loan losses or provided for as a specific reserve within the allowance for loan losses.
Allowance for Loan Losses. Changes in the allowance for loan losses for the years ended December 31, 2014, 2013 and 2012 were as follows:
The following table represents a summary of changes in the allowance for loan losses by portfolio segment for the years ended December 31, 2014 and 2013:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table represents a summary of the impairment method used by loan category at December 31, 2014 and 2013:
NOTE 5 - BANK PREMISES AND EQUIPMENT, NET
Bank premises and equipment, net of accumulated depreciation and amortization, were comprised of the following at December 31, 2014 and 2013:
The Company capitalized interest cost of $104,000, $71,000 and $31,000 during the years ended December 31, 2014, 2013 and 2012, respectively.
Depreciation and amortization expense for the years ended December 31, 2014, 2013 and 2012 was $11.7 million, $11.8 million and $12.0 million, respectively.
The Company leases land, office properties and equipment under operating leases. Certain of the leases contain renewal options and escalation clauses. Total rent expense was $9.7 million, $10.6 million and $11.5 million for the years ended December 31, 2014, 2013 and 2012, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Future minimum lease payments under non-cancellable operating leases extend through 2028 as follows:
The Company also leases to unrelated parties a portion of its banking facilities. Rental income associated with these leases was $4.5 million, $4.3 million and $4.1 million for the years ended December 31, 2014, 2013 and 2012, respectively.
NOTE 6 - GOODWILL
The Company did not have any goodwill at December 31, 2014 and 2013. First Bank recorded goodwill impairment of $107.3 million for the year ended December 31, 2013, as further discussed below. Changes in the carrying amount of goodwill for the year ended December 31, 2013 was as follows:
The Company allocated goodwill of $18.0 million to the sale of the ABS line of business, as discussed in Note 2 to the consolidated financial statements, based on the relative fair value of the ABS line of business and the portion of the First Bank segment that was retained.
Taking into account the results of a goodwill impairment analyses performed for the year ended December 31, 2013, the Company recorded goodwill impairment of $107.3 million for the year ended December 31, 2013, primarily reflecting the increase in carrying value of the Company as a result of the reversal of substantially all of the Company's valuation allowance against its deferred tax assets during the fourth quarter of 2013, as further described in Note 17 to the consolidated financial statements.
NOTE 7 - SERVICING RIGHTS
Mortgage Banking Activities. At December 31, 2014 and 2013, the Company serviced mortgage loans for others totaling $1.37 billion and $1.33 billion, respectively. Borrowers’ escrow balances held by the Company on such loans were $8.6 million and $7.9 million at December 31, 2014 and 2013, respectively. Changes in mortgage servicing rights for the years ended December 31, 2014 and 2013 were as follows:
(1)
The change in fair value resulting from changes in valuation inputs or assumptions used in valuation model primarily reflects the change in discount rates and prepayment speed assumptions, primarily due to changes in interest rates.
(2)
Other changes in fair value reflect changes due to the collection/realization of expected cash flows over time.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Other Servicing Activities. At December 31, 2014 and 2013, the Company serviced SBA loans for others totaling $114.4 million and $139.1 million, respectively. Changes in SBA servicing rights for the years ended December 31, 2014 and 2013 were as follows:
(1)
The change in fair value resulting from changes in valuation inputs or assumptions used in valuation model primarily reflects the change in discount rates and prepayment speed assumptions, primarily due to changes in interest rates.
(2)
Other changes in fair value reflect changes due to the collection/realization of expected cash flows over time.
NOTE 8 - DERIVATIVE INSTRUMENTS
The Company utilizes derivative instruments to assist in the management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities. The following table summarizes derivative instruments held by the Company, their notional amount, estimated fair values and their location in the consolidated balance sheets at December 31, 2014 and 2013:
Interest Rate Lock Commitments / Forward Commitments to Sell Mortgage-Backed Securities. Derivative instruments issued by the Company consist of interest rate lock commitments to originate fixed-rate loans to be sold. Commitments to originate fixed-rate loans consist primarily of residential real estate loans. These interest rate lock commitments and loans held for sale are hedged with forward contracts to sell mortgage-backed securities, which expire in March 2015. The fair value of the interest rate lock commitments and forward contracts to sell mortgage-backed securities are included in other assets in the consolidated balance sheets. Changes in the fair value of interest rate lock commitments and forward commitments to sell mortgage-backed securities are recognized in noninterest income on a monthly basis.
Client Interest Rate Swap Agreements. First Bank offers interest rate swap agreements to certain clients to assist in hedging their risks of adverse changes in interest rates. First Bank serves as an intermediary between its clients and the financial markets. Each interest rate swap agreement between First Bank and its clients is offset by an interest rate swap agreement between First Bank and various counterparties. These interest rate swap agreements do not qualify for hedge accounting treatment. Changes in the fair value of client interest rate swap agreements are recognized in noninterest income on a monthly basis. Each client contract is paired with an offsetting contract, and as such, there is no significant impact to net income (loss). There were no outstanding client interest rate swap agreements at December 31, 2014 and 2013.
The following table summarizes amounts included in the consolidated statements of income for the years December 31, 2014, 2013 and 2012 related to non-hedging derivative instruments:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9 - MATURITIES OF TIME DEPOSITS
Time deposits of $250,000 or more were $82.4 million and $81.3 million at December 31, 2014 and 2013, respectively.
A summary of maturities of time deposits at December 31, 2014 is as follows:
NOTE 10 - OTHER BORROWINGS
Other borrowings were comprised solely of daily securities sold under agreement to repurchase of $64.9 million and $43.1 million at December 31, 2014 and 2013, respectively. First Bank had no outstanding FHLB advances as of and for the years ended December 31, 2014 and 2013.
The average balance of other borrowings was $45.5 million and $34.8 million, and the maximum month-end balance of other borrowings was $64.9 million and $44.4 million for the years ended December 31, 2014 and 2013, respectively.
The average rates paid on other borrowings during the years ended December 31, 2014, 2013 and 2012 were (0.02)%, (0.03)% and (0.05)%, respectively. The negative average rates paid on other borrowings during the years ended December 31, 2014, 2013 and 2012 resulted from capitalized interest cost for the years ended December 31, 2014, 2013 and 2012, as more fully described in Note 5 to the consolidated financial statements, and the reversal of accrued interest related to unrecognized tax benefits associated with FASB Interpretation No. 48 (codified under ASC 740-10) for the year ended December 31, 2012, as more fully described in Note 17 to the consolidated financial statements. Interest expense on securities sold under agreements to repurchase was $45,000, $34,000 and $33,000 for the years ended December 31, 2014, 2013 and 2012, respectively.
NOTE 11 - NOTES PAYABLE
On March 20, 2013, the Company entered into a Revolving Credit Note and a Stock Pledge Agreement (the Credit Agreement) with Investors of America Limited Partnership (Investors of America LP), as further described in Note 20 to the consolidated financial statements. The agreement provided for a $5.0 million secured revolving line of credit to be utilized for general working capital needs. This borrowing arrangement, which matured on March 31, 2014, had an interest rate of LIBOR plus 300 basis points. There were no balances outstanding under the Credit Agreement from its origination date through its maturity date.
NOTE 12 - SUBORDINATED DEBENTURES
As of December 31, 2014, the Company had 13 affiliated Delaware or Connecticut statutory and business trusts (collectively, the Trusts) that were created for the sole purpose of issuing trust preferred securities. The trust preferred securities were issued in private placements, with the exception of First Preferred Capital Trust IV, which was issued in a publicly underwritten offering. The Company owns all of the common securities of the Trusts. The sole assets of the statutory and business trusts are the Company's junior subordinated debentures. The gross proceeds of the offerings were used by the Trusts to purchase variable rate or fixed rate junior subordinated debentures from the Company. In connection with the issuance of the trust preferred securities, the Company made certain guarantees and commitments that, in the aggregate, constitute a full and unconditional guarantee by the Company of the obligations of the Trusts under the trust preferred securities.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following is a summary of the junior subordinated debentures issued to the Trusts in conjunction with the trust preferred securities offerings at December 31, 2014 and 2013:
(1)
The junior subordinated debentures are callable at the option of the Company on the call date shown at 100% of the principal amount plus accrued and unpaid interest.
(2)
The interest rates paid on the trust preferred securities are based on either a variable rate or a fixed rate. The variable rate is based on the three-month LIBOR plus the basis point spread shown.
The Company’s distributions accrued on the junior subordinated debentures were $12.9 million, $15.0 million and $14.8 million for the years ended December 31, 2014, 2013 and 2012, respectively, and are included in interest expense in the consolidated statements of income. Deferred issuance costs associated with the Company’s junior subordinated debentures are included as a reduction of junior subordinated debentures in the consolidated balance sheets and are amortized using a method which approximates the level-yield method to the maturity date of the respective junior subordinated debentures. The structure of the trust preferred securities currently satisfies the regulatory requirements for inclusion, subject to certain limitations, in the Company’s capital base, as further discussed in Note 14 to the consolidated financial statements.
In August 2009, the Company announced the deferral of its regularly scheduled interest payments on its outstanding junior subordinated debentures relating to its $345.0 million of trust preferred securities beginning with the regularly scheduled quarterly interest payments that would otherwise have been made in September and October, 2009. The terms of the junior subordinated debentures and the related trust indentures allow the Company to defer such payments of interest for up to 20 consecutive quarterly periods without triggering a payment default or penalty. The Company had deferred such payments for 18 quarterly periods as of December 31, 2013. The Company had deferred $56.0 million of its regularly scheduled interest payments as of December 31, 2013. In addition, the Company had accrued additional interest expense of $6.7 million as of December 31, 2013 on the regularly scheduled deferred interest payments based on the interest rate in effect for each junior subordinated note issuance in accordance with the respective terms of the underlying agreements. During a deferral period, the respective trusts suspend the declaration and payment of dividends on the trust preferred securities. During a deferral period, the Company may not, among other things and with limited exceptions, pay cash dividends on or repurchase its common stock or preferred stock nor make any payment on outstanding debt obligations that rank equally with or junior to the junior subordinated debentures. Accordingly, the Company also suspended the payment of cash dividends on its outstanding common stock and preferred stock beginning with the regularly scheduled quarterly dividend payments on the preferred stock that would otherwise have been made in August and September, 2009, as further described in Note 13 to the consolidated financial statements.
Under its previous Written Agreement (as defined in Note 14 to the consolidated financial statements) with the FRB, which was terminated on May 19, 2014, the Company agreed, among other things, to provide certain information to the FRB, including, but not limited to, prior notice regarding the issuance of additional trust preferred securities. The Company also agreed not to make any distributions of interest or other sums on its outstanding trust preferred securities without the prior approval of the FRB, as further described in Note 14 to the consolidated financial statements.
On January 31, 2014, the Company received regulatory approval from the FRB under the then-existing Written Agreement, subject to certain conditions, which granted First Bank the authority to pay a dividend to the Company, and the authority to the Company to utilize such funds, for the sole purpose of paying the accumulated deferred interest payments on the Company's outstanding
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
junior subordinated debentures issued in connection with the Company's trust preferred securities. In February 2014, First Bank paid a dividend of $70.0 million to the Company. The aggregate amount owed on all of the junior subordinated debentures relating to the trust preferred securities at the respective March and April, 2014 payments totaled $66.4 million. On March 14, 2014, the Company paid interest on the junior subordinated debentures of $66.4 million to the respective trustees, which was subsequently distributed to the trust preferred securities holders on the respective interest payment dates in March and April, 2014. Since that time, the Company has continued to pay interest on its junior subordinated debentures to the respective trustees on the regularly scheduled quarterly payment dates. Such interest payments have been funded through additional dividends from First Bank.
Under its MOU with the FRB, First Bank has agreed not to declare or pay any dividends, without the prior consent of the FRB, that would cause First Bank to pay dividends in excess of its earnings or make a capital distribution that would cause First Bank's Tier 1 Leverage Ratio to fall below 9.0%. Furthermore, pursuant to Missouri Revised Statutes, First Bank is required to obtain approval from the MDOF prior to paying any dividends to the Company, as further described in Note 14 to the consolidated financial statements. The Company is unable to predict whether or when the FRB and/or the MDOF will grant such consent in the future.
Without the payment of dividends from First Bank, the Company currently lacks the source of income and the liquidity to make future interest payments on the junior subordinated debentures associated with its trust preferred securities. Given restrictions placed upon First Bank, including regulatory restrictions, it may not be able to provide the Company with dividends in an amount sufficient to pay the future interest on the trust preferred securities. In such case, the Company would have to pursue alternative funding sources, but there can be no assurance that the Company will be able to identify and obtain alternative funding due to the uncertainty that such alternative funding sources would be available to the Company on terms and conditions that are acceptable to the Company. The Company has the ability to enter into future deferral periods of up to 20 consecutive quarterly periods without triggering a payment default or penalty.
NOTE 13 - STOCKHOLDERS’ EQUITY
Common Stock. There is no established public trading market for the Company’s common stock. Various trusts, which were established by and are administered by and for the benefit of the Company’s Chairman of the Board and members of his immediate family (including Mr. Michael Dierberg, Vice Chairman of the Company, and Ms. Ellen Dierberg Milne, Director of the Company), own all of the voting stock of the Company other than the Class C Preferred Stock and Class D Preferred Stock that have limited voting rights, as described below.
Preferred Stock. The Company has four classes of preferred stock outstanding. The Class A Convertible Adjustable Rate Preferred Stock (Class A Preferred Stock) is convertible into shares of common stock at a rate based on the ratio of the par value of the preferred stock to the current market value of the common stock at the date of conversion, to be determined by independent appraisal at the time of conversion. Shares of Class A Preferred Stock may be redeemed by the Company at any time at 105.0% of par value. The Class B Non-Convertible Adjustable Rate Preferred Stock (Class B Preferred Stock) may not be redeemed or converted. The holders of the Class A and Class B Preferred Stock have full voting rights. Dividends on the Class A and Class B Preferred Stock are adjustable quarterly based on the highest of the Treasury Bill Rate or the Ten Year Constant Maturity Rate for the two-week period immediately preceding the beginning of the quarter. This rate shall not be less than 6.0% nor more than 12.0% on the Class A Preferred Stock, or less than 7.0% nor more than 15.0% on the Class B Preferred Stock. Effective August 10, 2009, the Company suspended the declaration of dividends on its Class A and Class B Preferred Stock.
On December 31, 2008, the Company issued 295,400 shares of Class C Fixed Rate Cumulative Perpetual Preferred Stock (Class C Preferred Stock) and 14,770 shares of Class D Fixed Rate Cumulative Perpetual Preferred Stock (Class D Preferred Stock) to the United States Department of the Treasury (U.S. Treasury) in conjunction with the U.S. Treasury’s Troubled Asset Relief Program’s Capital Purchase Program (CPP). The Class C Preferred Stock has a par value of $1.00 per share and a liquidation preference of $1,000 per share. The holders of the Class C Preferred Stock have no voting rights except in certain limited circumstances. The Class C Preferred Stock carried an annual dividend rate equal to 5% for the first five years, payable quarterly in arrears beginning February 15, 2009. The annual dividend rate increased to 9% per annum on February 15, 2014. The Class D Preferred Stock has a par value of $1.00 per share and a liquidation preference of $1,000 per share. The holders of the Class D Preferred Stock have no voting rights except in certain limited circumstances. The Class D Preferred Stock carries an annual dividend rate equal to 9%, payable quarterly in arrears beginning February 15, 2009. The Class C Preferred Stock and the Class D Preferred Stock qualify as Tier 1 capital. Effective February 17, 2009, the Class C Preferred Stock and the Class D Preferred Stock may be redeemed at any time without penalty and without the need to raise new capital, subject to consultation with the Company’s primary regulatory agency. The Class D Preferred Stock may not be redeemed until all of the outstanding shares of the Class C Preferred Stock have been redeemed. In addition, prior to the U.S. Treasury's sale of the Class C Preferred Stock and Class D Preferred Stock (as further described below), the U.S. Treasury had certain supervisory and oversight duties and responsibilities under the CPP and, pursuant to the terms of the agreement governing the issuance of the Class C Preferred Stock
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and the Class D Preferred Stock to the U.S. Treasury (Purchase Agreement), the U.S. Treasury was empowered to unilaterally amend any provision of the Purchase Agreement with the Company to the extent required to comply with any changes in applicable federal statutes. As a result of the Company’s deferral of dividends to the U.S. Treasury for an aggregate of six quarters, the U.S. Treasury had the right to elect two directors to the Company’s Board. On July 13, 2011, the U.S. Treasury elected two members to the Company’s Board of Directors. In addition to the right to elect two directors to the Company’s Board of Directors, the holders of the Class C Preferred Stock and Class D Preferred Stock have limited voting rights, except as required by law or to the extent such rights are waived. For as long as shares of the Class C Preferred Stock or Class D Preferred Stock are outstanding, in addition to any other vote or consent of the shareholders required by law or the Company’s articles of incorporation, the vote or consent of holders of at least 66 2/3% of the shares of the Class C Preferred Stock or Class D Preferred Stock outstanding is required for any authorization or issuance of shares ranking senior to the Class C Preferred Stock or Class D Preferred Stock, respectively; any amendments to the rights of the Class C Preferred Stock or Class D Preferred Stock that adversely affect the rights, privileges or voting power of the Class C Preferred Stock or Class D Preferred Stock, respectively; or initiation and completion of any merger, share exchange or similar transaction unless the shares of Class C Preferred Stock or Class D Preferred Stock, respectively, remain outstanding, or, if the Company is not the surviving entity in such transaction, are converted into or exchanged for preferred securities of the surviving entity that have the same rights, preferences, privileges and voting power of the Class C Preferred Stock and Class D Preferred Stock.
The Company allocated the total proceeds received under the CPP of $295.4 million to the Class C Preferred Stock and the Class D Preferred Stock based on the relative fair values of the respective classes of preferred stock at the time of issuance. The discount on the Class C Preferred Stock of $17.3 million was accreted to retained earnings on a level-yield basis over five years (through the fourth quarter of 2013). Accretion of the discount on the Class C Preferred Stock was $3.6 million for the years ended December 31, 2013 and 2012.
During the third quarter of 2013, the U.S. Treasury completed two auctions that resulted in the sale of the Company's Class C Preferred Stock and Class D Preferred Stock to unaffiliated third party investors. The Company did not receive any proceeds from the sale and the sale did not have any effect on the terms of the outstanding Class C Preferred Stock and Class D Preferred Stock, including the Company's obligation to satisfy accrued and unpaid dividends prior to the payment of any dividend or other distribution to holders of junior or parity stock (including the Company's common stock, Class A Preferred Stock and Class B Preferred Stock), and an increase in the dividend rate on the Class C Preferred Stock from 5% to 9%, commencing with the dividend payment date of February 15, 2014. Furthermore, the sale of the Class C Preferred Stock and Class D Preferred Stock did not have any effect on the Company's regulatory capital, financial condition or results of operations.
The redemption of any issue of preferred stock requires the prior approval of the Federal Reserve. In addition, the Company, under its MOU with the FRB, has agreed, among other things, to provide certain information to the FRB including, but not limited to, progress of achieving its Capital Plan and notice of plans to materially change its Capital Plan. Furthermore, the Company agreed not to declare or pay any dividends on its common or preferred stock without the prior approval of the FRB, as further described in Note 14 to the consolidated financial statements. The FRB has complete discretion to grant any such approval and therefore, it is not known whether the FRB would approve any such request.
The Company suspended the payment of cash dividends on its outstanding common stock and preferred stock beginning with the regularly scheduled quarterly dividend payments on the preferred stock that would otherwise have been made in August and September, 2009. The Company has declared and accrued $68.4 million of its regularly scheduled dividend payments on its Class C Preferred Stock and Class D Preferred Stock at December 31, 2014 and 2013, and has accrued an additional $9.4 million of cumulative dividends on such deferred dividend payments at December 31, 2014 and 2013. As such, the aggregate amount of these deferred and accrued dividend payments was $77.8 million at December 31, 2014 and 2013.
The Company ceased declaring dividends on its Class C Preferred Stock and Class D Preferred Stock during the fourth quarter of 2013. Previously, the Company had declared and accrued dividends on its Class C Preferred Stock and Class D Preferred Stock quarterly throughout the deferral period. If the Company had continued to declare and accrue dividends on its Class C Preferred Stock and Class D Preferred Stock during the fourth quarter of 2013 and the year ended December 31, 2014, the Company would have accrued an additional $4.1 million and $33.2 million, respectively, of dividend payments, and the Company's aggregate deferred and accrued dividend payments would have been $115.1 million at December 31, 2014. The Company will continue to evaluate whether declaring dividends on its Class C Preferred Stock and Class D Preferred Stock is appropriate in future periods. The Company's cessation of declaring and accruing dividends on its Class C Preferred Stock and Class D Preferred Stock did not have any effect on the terms of the outstanding Class C Preferred Stock and Class D Preferred Stock, including the Company's obligations thereunder, as previously described.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Accumulated Other Comprehensive Income (Loss). The following table summarizes changes in accumulated other comprehensive income (loss), net of tax, by component, for the years ended December 31, 2014, 2013 and 2012:
Other comprehensive income (loss) of $2.6 million, $(37.8) million and $29.2 million, as presented in the consolidated statements of changes in stockholders’ equity, is reflected net of income tax expense (benefit) of $1.8 million, $(6.5) million and $(6.4) million for the years ended December 31, 2014, 2013 and 2012, respectively.
NOTE 14 - REGULATORY CAPITAL AND OTHER REGULATORY MATTERS
Regulatory Capital. The Company and First Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain actions by regulators that, if undertaken, could have a direct material effect on the operations and financial condition of the Company and First Bank. Under these capital requirements, the Company and First Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and First Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets (Tier 1 leverage ratio).
The Company was categorized as adequately capitalized under minimum regulatory capital standards established for bank holding companies by the Federal Reserve at December 31, 2014 and 2013. The Company must maintain minimum total capital, Tier 1 capital and Tier 1 leverage ratios as set forth in the table below in order to meet the minimum capital adequacy standards.
First Bank was categorized as well capitalized at December 31, 2014 and 2013 under the prompt corrective action provisions of the regulatory capital standards. First Bank must maintain minimum total capital, Tier 1 capital and Tier 1 leverage ratios as set forth in the table below in order to be categorized as well capitalized.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At December 31, 2014 and 2013, the Company's and First Bank's required and actual capital ratios were as follows:
____________________
(1)
The reduction in First Bank's regulatory capital ratios during 2014 primarily resulted from the payment of $95.0 million of dividends to the Company in 2014.
Basel III and the Final Capital Rules. In July 2013, the federal bank regulators approved final rules (the Final Capital Rules) implementing the Basel III framework as well as certain provisions of the Dodd-Frank Act. The Final Capital Rules also substantially revise the risk-based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including the Company and First Bank, as compared to the general risk-based capital rules. The Final Capital Rules revise the components of capital and address other issues affecting the numerator in regulatory capital ratios. The Final Capital Rules also address asset risk weights and other issues affecting the denominator in regulatory capital ratios and replace the existing general risk-weighting approach based on Basel I with a more risk-sensitive approach. The Final Capital Rules became effective for the Company and First Bank on January 1, 2015 (subject to a phase-in period for certain provisions). The Final Capital Rules:
•
Include a new minimum common equity Tier 1 capital ratio of 4.5% of risk-weighted assets and raise the minimum Tier 1 capital ratio from 4.0% to 6.0% of risk-weighted assets;
•
Require institutions to maintain a capital conservation buffer composed of common equity Tier 1 capital of 2.5% above the minimum risk-based capital requirements in order to avoid limitations on capital distributions, including dividend payments (unless a waiver is granted by the Federal Reserve) and certain discretionary bonus payments to executive officers (unless a waiver is granted by the Federal Reserve). In addition, institutions that do not maintain the required capital conservation buffer may also be limited in their ability to make payments on trust preferred securities. The capital conservation buffer is measured relative to risk-weighted assets and will be phased in over a four-year period beginning on January 1, 2016 with an initial requirement of 0.625%, that subsequently increases to 1.25%, 1.875% and 2.5% on January 1, 2017, 2018 and 2019, respectively;
•
Implement new constraints on the inclusion of minority interests, mortgage servicing assets, deferred tax assets and certain investments in the capital of unconsolidated financial institutions in Tier 1 capital;
•
Increase risk-weightings for past-due loans, certain commercial real estate loans and some equity exposures;
•
Require trust preferred securities and cumulative perpetual preferred stock to be phased out of Tier 1 capital for banks with assets greater than $15.0 billion as of December 31, 2009; and
•
Allow non-advanced banking organizations, such as us, a one-time option to filter certain accumulated other comprehensive income components, such as unrealized gains and losses on available-for-sale investment securities, out of regulatory capital.
The calculation of common equity Tier 1 capital is different from the calculation of common equity under GAAP. Most significantly for the Company, the Company's net deferred tax assets, which are included in the calculation of common equity under GAAP, will be substantially phased out over time from the required calculation of common equity Tier 1 capital for regulatory purposes. The net deferred tax assets attributable to net operating loss and tax credit carryforwards, which comprised over 87.0% of the Company's net deferred tax assets as of December 31, 2014, are scheduled to be phased out entirely from inclusion in the calculation of common equity Tier 1 capital in 2019.
In light of the Company's current capital and the future changes in the calculation of regulatory capital as a result of the Final Capital Rules, absent a substantial increase in qualifying common equity, the Company will not meet the common equity Tier 1 requirement under the Final Capital Rules. The inability to remain adequately capitalized under the Final Capital Rules could materially adversely impact the Company's financial condition, results of operations, and ability to grow. In addition, the inability to meet the capital conservation buffer would preclude the Company from making dividend payments on capital stock and may
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
preclude the Company from making interest payments on trust preferred securities absent a waiver of the Final Capital Rules by the Federal Reserve. It is not known whether the Federal Reserve would grant such a waiver.
Regulatory Agreements. On May 19, 2014, the FRB terminated the Written Agreement (Written Agreement), dated March 24, 2010, by and among the Company, SFC, First Bank and the FRB. The Written Agreement previously required the Company and First Bank to take certain steps intended to improve their overall financial condition, as previously described in "Item 1. - Business - Supervision and Regulation -Regulatory Agreements" in the Company's Annual Report on Form 10-K as of and for the year ended December 31, 2013. Pursuant to the Written Agreement, the Company prepared and filed with the FRB a number of specific plans designed to strengthen and/or address the following matters: (i) board oversight over the management and operations of the Company and First Bank; (ii) credit risk management practices; (iii) lending and credit administration policies and procedures; (iv) asset improvement; (v) capital; (vi) earnings and overall financial condition; and (vii) liquidity and funds management.
The Written Agreement required, among other things, that the Company and First Bank obtain prior approval from the FRB to pay dividends. In addition, the Company was required to obtain prior approval from the FRB to: (i) take any other form of payment from First Bank representing a reduction in capital of First Bank; (ii) make any distributions of interest, principal or other sums on junior subordinated debentures or trust preferred securities; (iii) incur, increase or guarantee any debt; or (iv) purchase or redeem any shares of the Company's stock. The FRB had complete discretion to grant any such approval. On January 31, 2014, the Company received regulatory approval from the FRB under the former Written Agreement, subject to certain conditions, which granted First Bank the authority to pay a dividend to the Company, and the authority to the Company to utilize such funds, for the sole purpose of paying the accumulated deferred interest payments on the Company's outstanding junior subordinated debentures issued in connection with the Company's trust preferred securities. In February 2014, First Bank paid a dividend of $70.0 million to the Company and the Company subsequently paid interest on the junior subordinated debentures of $66.4 million , as further described in Note 12 to the consolidated financial statements.
Pursuant to the terms of the Written Agreement, the Company and First Bank submitted a written plan to the FRB to maintain sufficient capital at the Company, on a consolidated basis, and at First Bank, on a standalone basis. In addition, the Agreement also required the Company and First Bank to notify the FRB if the regulatory capital ratios of either entity fell below those set forth in the capital plans that were accepted by the FRB, and specifically if First Bank fell below the criteria for being well capitalized under the regulatory framework for prompt corrective action. The Company was also required to notify the FRB before appointing any new directors or senior executive officers or changing the responsibilities of any senior executive officer position. The Written Agreement also required the Company and First Bank to comply with certain restrictions regarding indemnification and severance payments although First Bank was notified, as of October 16, 2013, by the FRB that such restriction was no longer applicable to First Bank. The Agreement was specifically enforceable by the FRB in court.
Prior to entering into the Written Agreement on March 24, 2010, the Company and First Bank had entered into a memorandum of understanding and an informal agreement, respectively, with the FRB and the Missouri Division of Finance (MDOF). Each of the agreements were characterized by regulatory authorities as informal actions that were neither published nor made publicly available by the agencies and are used when circumstances warrant a milder form of action than a formal supervisory action, such as a written agreement or cease and desist order. The memorandum of understanding with the FRB was replaced and superseded by the Written Agreement. The informal agreement with the MDOF, dated September 18, 2008, was terminated effective September 11, 2013.
On May 19, 2014, the Company entered into a Memorandum of Understanding (MOU) with the FRB. The MOU is characterized by regulatory authorities as an informal action that is neither published nor made publicly available by the FRB and is used when circumstances warrant a milder form of action than a formal supervisory action. Under the terms of the MOU, the Company agreed, among other things, to provide certain information to the FRB including, but not limited to, progress of achieving its Capital Plan, notice of plans to materially change its Capital Plan, parent company cash flow plans and summaries of nonperforming asset classifications. In addition, the Company agreed not to do any of the following without the prior approval of the FRB: (i) declare or pay any dividends on its common or preferred stock; (ii) incur or guarantee any debt; (iii) redeem any of the Company's outstanding common or preferred stock; and (iv) cause First Bank to pay dividends in excess of its earnings or make a capital distribution that would cause First Bank's Tier 1 Leverage Ratio to fall below 9.0%. The FRB has complete discretion to grant any such approval and therefore, it is not known whether the FRB would approve any such request.
While the Company intends to take such actions as may be necessary to comply with the requirements of the MOU with the FRB, there can be no assurance that such efforts will not have adverse effects on the operations and financial condition of the Company or First Bank. If the Company fails to comply with the terms of the MOU, further enforcement action could be taken by the FRB which could have a materially adverse effect on the Company's business, financial condition or results of operations.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15 - FAIR VALUE DISCLOSURES
In accordance with ASC Topic 820, “Fair Value Measurements and Disclosures,” financial assets and financial liabilities that are measured at fair value subsequent to initial recognition are grouped into three levels of inputs or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the reliability of assumptions used to determine fair value. The three input levels of the valuation hierarchy are as follows:
Level 1 Inputs -
Valuation is based on quoted prices in active markets for identical instruments in active markets.
Level 2 Inputs -
Valuation is based on quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 Inputs -
Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
The following describes valuation methodologies used to measure financial assets and financial liabilities at fair value, as well as the general classification of such financial instruments pursuant to the valuation hierarchy:
Available-for-sale investment securities. Available-for-sale investment securities are recorded at fair value on a recurring basis. Available-for-sale investment securities included in Level 1 are valued using quoted market prices. Where quoted market prices are unavailable, the fair value included in Level 2 is based on quoted market prices of comparable instruments obtained from independent pricing vendors based on recent trading activity and other relevant information.
Loans held for sale. Mortgage loans held for sale are carried at fair value on a recurring basis. The determination of fair value is based on quoted market prices of comparable instruments obtained from independent pricing vendors based on recent trading activity and other relevant information. Other loans held for sale are carried at the lower of cost or market value, which is determined on an individual loan basis. The fair value is based on the prices secondary markets are offering for portfolios with similar characteristics. The Company classifies mortgage loans held for sale subjected to recurring fair value adjustments as recurring Level 2. The Company classifies other loans held for sale subjected to nonrecurring fair value adjustments as nonrecurring Level 2.
Impaired loans. The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans are considered impaired when, in the judgment of management based on current information and events, it is probable that payment of all amounts due under the contractual terms of the loan agreement will not be collected. Acquired impaired loans are classified as nonaccrual loans and are initially measured at fair value with no allocated allowance for loan losses. An allowance for loan losses is recorded to the extent there is further credit deterioration subsequent to the acquisition date. 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. Once a loan is identified as impaired, management measures the impairment in accordance with ASC Topic 310-10-35, “Receivables.” Impairment is measured by reference to an observable market price, if one exists, the expected future cash flows of an impaired loan discounted at the loan’s effective interest rate, or the fair value of the collateral for a collateral-dependent loan. In most cases, the Company measures fair value based on the value of the collateral securing the loan. Collateral may be in the form of real estate or personal property, including equipment and inventory. The vast majority of the collateral is real estate. The value of the collateral is determined based on third party appraisals as well as internal estimates. These measurements are classified as nonrecurring Level 3.
Other real estate. Certain other real estate, upon initial recognition, is re-measured and reported at fair value through a charge-off to the allowance for loan losses based upon the estimated fair value of the other real estate. The fair value of other real estate, upon initial recognition, is estimated using Level 3 inputs based on third party appraisals, and where applicable, discounted based on management’s judgment taking into account current market conditions, distressed or forced sale price comparisons and other factors in effect at the time of valuation. The Company classifies other real estate subjected to nonrecurring fair value adjustments as Level 3.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Derivative instruments. Substantially all derivative instruments utilized by the Company are traded in over-the-counter markets where quoted market prices are not readily available. Derivative instruments utilized by the Company currently include interest rate lock commitments and forward commitments to sell mortgage-backed securities. For these derivative instruments, fair value is based on market observable inputs utilizing pricing systems and valuation models, and where applicable, the values are compared to the market values calculated independently by the respective counterparties. The Company classifies its derivative instruments as Level 2.
Servicing rights. The valuation of mortgage and SBA servicing rights is performed by an independent third party. The valuation models estimate the present value of estimated future net servicing income, using market-based discount rate assumptions, and utilize assumptions based on the predominant risk characteristics of the underlying loans, including principal balance, interest rate, weighted average life, and certain unobservable inputs, including cost to service, estimated prepayment speed rates and default rates. Changes in the fair value of servicing rights occur primarily due to the realization of expected cash flows, as well as changes in valuation inputs and assumptions. Significant increases (decreases) in any of the unobservable inputs would result in a significantly lower (higher) fair value of the servicing rights. The Company classifies its servicing rights as Level 3.
Goodwill. The valuation of goodwill to determine impairment is performed on an annual basis, or more frequently if there is an event or circumstance that would indicate impairment may have occurred. The Company operates as a single reporting unit. The annual measurement date for the goodwill impairment test was December 31. The goodwill impairment test is a two-step process which requires the Company to make assumptions regarding fair value. The first step consists of estimating the fair value of the reporting unit using a number of factors, including projected future operating results and business plans, economic projections, anticipated future cash flows, discount rates, and comparable marketplace fair value data from within a comparable industry grouping. The estimated fair value of its reporting unit is compared to the carrying value, which includes allocated goodwill. If the estimated fair value is less than the carrying value, the second step is completed to compute the impairment amount by determining the implied fair value of goodwill, which requires the allocation of the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. Any remaining unallocated fair value represents the implied fair value of goodwill, which is compared to the corresponding carrying value to compute the amount of goodwill impairment. The Company recorded goodwill impairment of $107.3 million for the year ended December 31, 2013, as further described in Note 6 to the consolidated financial statements. The Company classifies its goodwill as Level 3.
Nonqualified Deferred Compensation Plan. The Company’s nonqualified deferred compensation plan is recorded at fair value on a recurring basis. The unfunded plan allows participants to hypothetically invest in various specified investment options such as equity funds, international stock funds, capital appreciation funds, money market funds, bond funds, mid-cap value funds and growth funds. The nonqualified deferred compensation plan liability is valued based on quoted market prices of the underlying investments. The Company classifies its nonqualified deferred compensation plan liability as Level 1.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Items Measured on a Recurring Basis. Assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 and 2013 are reflected in the following table:
There were no transfers between Levels 1 and 2 of the fair value hierarchy for the years ended December 31, 2014 and 2013.
The following table presents the changes in Level 3 assets measured on a recurring basis for the years ended December 31, 2014 and 2013:
(1)
Gains or losses (realized/unrealized) are included in noninterest income in the consolidated statements of income.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Items Measured on a Nonrecurring Basis. From time to time, the Company measures certain assets at fair value on a nonrecurring basis. 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. Assets measured at fair value on a nonrecurring basis as of December 31, 2014 and 2013 are reflected in the following table:
Non-Financial Assets and Non-Financial Liabilities. Certain non-financial assets measured at fair value on a nonrecurring basis include other real estate (upon initial recognition or subsequent impairment), non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment.
Other real estate measured at fair value upon initial recognition totaled $7.6 million, $9.5 million and $24.2 million for the years ended December 31, 2014, 2013 and 2012, respectively. In addition to other real estate measured at fair value upon initial recognition, the Company recorded write-downs to the balance of other real estate of $2.1 million, $2.4 million and $14.5 million to noninterest expense for the years ended December 31, 2014, 2013 and 2012, respectively.
Fair Value of Financial Instruments. The fair value of financial instruments is management’s estimate of the values at which the instruments could be exchanged in a transaction between willing parties. These estimates are subjective and may vary significantly from amounts that would be realized in actual transactions. In addition, other significant assets are not considered financial assets including deferred income tax assets, bank premises and equipment and goodwill. Furthermore, the income taxes that would be incurred if the Company were to realize any of the unrealized gains or unrealized losses indicated between the estimated fair values and corresponding carrying values could have a significant effect on the fair value estimates and have not been considered in any of the estimates. The following summarizes the methods and assumptions used in estimating the fair value of all other financial instruments:
Cash and cash equivalents and accrued interest receivable. The carrying values reported in the consolidated balance sheets approximate fair value.
Held-to-maturity investment securities. The fair value of held-to-maturity investment securities is based on quoted market prices where available. If quoted market prices are not available, the fair value is based on quoted market prices of comparable instruments. The Company classifies its held-to-maturity investment securities as Level 2.
Loans. The fair value of loans held for portfolio uses an exit price concept and reflects discounts the Company believes are consistent with liquidity discounts in the market place. Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial and industrial, real estate construction and development, commercial real estate, one-to-four-family residential real estate, home equity and consumer and installment. The fair value of loans is estimated by discounting the future cash flows, utilizing assumptions for prepayment estimates over the loans’ remaining life and considerations for the current interest rate environment compared to the weighted average rate of the loan portfolio. The fair value analysis also includes other assumptions to estimate fair value, intended to approximate those factors a market participant would use in an orderly transaction, with adjustments for discount rates, interest rates, liquidity, and credit spreads, as appropriate. The Company classifies its loans held for portfolio as Level 3.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FRB and FHLB stock. The carrying values reported in the consolidated balance sheets for FRB and FHLB stock, which are carried at cost, represent redemption value and approximate fair value.
Deposits. The fair value of deposits payable on demand with no stated maturity (i.e., noninterest-bearing and interest-bearing demand, and savings and money market accounts) is considered equal to their respective carrying amounts as reported in the consolidated balance sheets. The fair value of demand deposits does not include the benefit that results from the low-cost funding provided by deposit liabilities compared to the cost of borrowing funds in the market. The fair value disclosed for time deposits is estimated utilizing a discounted cash flow calculation that applies interest rates currently being offered on similar deposits to a schedule of aggregated monthly maturities of time deposits. If the estimated fair value is lower than the carrying value, the carrying value is reported as the fair value of time deposits. The Company classifies its time deposits as Level 3.
Other borrowings and accrued interest payable. The carrying values reported in the consolidated balance sheets for variable rate borrowings approximate fair value. The fair value of fixed rate borrowings is based on quoted market prices where available. If quoted market prices are not available, the fair value is based on discounting contractual maturities using an estimate of current market rates for similar instruments. The Company classifies its other borrowings, comprised of securities sold under agreement to repurchase, as Level 1. The carrying values reported in the consolidated balance sheets for accrued interest payable approximate fair value.
Subordinated debentures. The fair value of subordinated debentures is based on quoted market prices of comparable instruments. The Company classifies its subordinated debentures as Level 3.
Off-Balance Sheet Financial Instruments. The fair value of commitments to extend credit, standby letters of credit and financial guarantees is based on estimated probable credit losses. The Company classifies its off-balance sheet financial instruments as Level 3.
The estimated fair value of the Company’s financial instruments at December 31, 2014 was as follows:
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The estimated fair value of the Company’s financial instruments at December 31, 2013 was as follows:
NOTE 16 - CREDIT COMMITMENTS
The Company is a party to commitments to extend credit and commercial and standby letters of credit in the normal course of business to meet the financing needs of its clients. These instruments involve, in varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The interest rate risk associated with these credit commitments relates primarily to the commitments to originate fixed-rate loans. As more fully described in Note 8 to the consolidated financial statements, the interest rate risk of the commitments to originate fixed-rate loans has been hedged with forward commitments to sell mortgage-backed securities. The credit risk amounts are equal to the contractual amounts, assuming the amounts are fully advanced and the collateral or other security is of no value. The Company uses the same credit policies in granting commitments and conditional obligations as it does for on-balance sheet items.
Commitments to extend fixed and variable rate credit, and commercial and standby letters of credit, at December 31, 2014 and 2013 were as follows:
Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each client’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, equipment, income-producing commercial properties or single-family residential properties. In the event of nonperformance, the Company may obtain and liquidate the collateral to recover amounts paid under its guarantees on these financial instruments.
Commercial and standby letters of credit are conditional commitments issued to guarantee the performance of a client to a third party. The letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Most letters of credit extend for less than one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to clients. Upon issuance of the commitments, the Company typically holds marketable securities, certificates of deposit, inventory, real property or other assets as collateral supporting those commitments for which collateral is deemed necessary. The standby letters of credit at December 31, 2014 expire, at various dates, within five years.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Standby letters of credit issued by the FHLB on First Bank’s behalf were $2.8 million and $25.9 million at December 31, 2014 and 2013, respectively.
The reserve for letters of credit and unfunded loan commitments was $12,000 and $2.7 million at December 31, 2014 and 2013. The reserve at December 31, 2013 included a specific reserve of $2.4 million on a single letter of credit relationship. This reserve was utilized during the year ended December 31, 2014 to absorb a loss on this letter of credit relationship at the time of its funding.
NOTE 17 - INCOME TAXES
The provision (benefit) for income taxes from continuing operations for the years ended December 31, 2014, 2013 and 2012 consists of the following:
The effective rates of federal income taxes for the years ended December 31, 2014, 2013 and 2012 differ from the federal statutory rates of taxation as follows:
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2014 and 2013 were as follows:
The realization of the Company’s net deferred tax assets is based on the expectation of future taxable income and the utilization of tax planning strategies. The Company had a full valuation allowance against its net deferred tax assets at December 31, 2012. The deferred tax asset valuation allowance was recorded in accordance with ASC Topic 740, “Income Taxes.” Under ASC Topic 740, the Company is required to assess whether it is more likely than not that some portion or all of its deferred tax assets will not be realized. Pursuant to ASC Topic 740, concluding that a deferred tax asset valuation allowance is not required is difficult when there is significant evidence which is objective and verifiable, such as the lack of recoverable taxes, excess of reversing deductible differences over reversing taxable differences and cumulative losses in recent years.
In evaluating the ability to recover deferred tax assets within the jurisdiction from which they arise, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and results of recent operations. In projecting future taxable income, the Company begins with historical results adjusted for the results of discontinued operations and changes in accounting policies and incorporates assumptions including the amount of future state and federal pre-tax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts and future taxable income and are consistent with the plans and estimates management uses to manage the underlying business.
After analysis of all available positive and negative evidence, the Company reversed substantially all of its valuation allowance against its net deferred tax assets, which was reflected as a benefit for income taxes in the consolidated statements of income and as an adjustment to accumulated other comprehensive income of $319.1 million and $6.1 million, respectively, for the year ended December 31, 2013. The Company concluded that, as of December 31, 2013, it was more likely than not that substantially all of its net deferred tax assets would be realized in future years. This conclusion was primarily based on projected future taxable income, in addition to cumulative earnings resulting from eight consecutive quarters of profitability (excluding the goodwill impairment charge recognized during the fourth quarter of 2013), significant improvement in asset quality metrics and certain other relevant factors. The Company reversed an additional $8.0 million of its valuation allowance against its net deferred tax
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
assets during the year ended December 31, 2014, which was reflected as a benefit for income taxes in the consolidated statements of income and was primarily attributable to a reduction of the Illinois state tax rate. If the Company’s estimate of realizability of its net deferred tax assets changes in the future, an adjustment to the valuation allowance would be recorded, which would either increase or decrease income tax expense in such period.
The valuation allowance reserves for certain state net operating loss carryovers, federal and state tax credits and capital loss carryovers which are projected to expire prior to their utilization, based upon projected taxable income at December 31, 2014. The Company has reserved for this benefit in its valuation allowance but will continue to evaluate the potential future utilization of these items and will record an adjustment to the valuation allowance in the period a change is warranted.
Changes in the deferred tax asset valuation allowance for the years ended December 31, 2014, 2013 and 2012 were as follows:
At December 31, 2014 and 2013, the Company’s unrecognized tax benefits for uncertain tax positions, excluding interest and penalties, were $873,000 and $881,000, respectively. A reconciliation of the beginning and ending balance of these unrecognized tax benefits for the years ended December 31, 2014 and 2013 is as follows:
At December 31, 2014 and 2013, the total amount of unrecognized tax benefits that would affect the provision for income taxes, prior to the consideration of the deferred tax asset valuation allowance, was $575,000 and $580,000, respectively. It is the Company’s policy to separately disclose any interest or penalties arising from the application of federal or state income taxes. Interest related to unrecognized tax benefits is included in interest expense and penalties related to unrecognized tax benefits are included in noninterest expense. At December 31, 2014 and 2013, interest accrued for uncertain tax positions was $195,000 and $144,000, respectively. The Company recorded interest expense of $51,000 and $28,000 for the years ended December 31, 2014 and 2013, respectively, compared to a reduction to interest expense of $20,000 related to unrecognized tax benefits for the year ended December 31, 2012. There were no penalties for uncertain tax positions accrued at December 31, 2014 and 2013, nor did the Company recognize any expense for such penalties in 2014, 2013 and 2012.
The Company continually evaluates the unrecognized tax benefits associated with its uncertain tax positions. It is reasonably possible that the total unrecognized tax benefits as of December 31, 2014 could decrease by approximately $553,000 by December 31, 2015 as a result of the lapse of statutes of limitations or potential settlements with the federal and state taxing authorities, of which the impact to the provision for income taxes, prior to the consideration of the deferred tax asset valuation allowance, is estimated to be approximately $368,000.
The Company files consolidated and separate income tax returns in the U.S. federal jurisdiction and in various state jurisdictions. Management of the Company believes the accrual for tax liabilities is adequate for all open audit years based on its assessment of many factors, including past experience and interpretations of tax law applied to the facts of each matter. This assessment relies on estimates and assumptions. The Company’s federal income tax returns through 2008 have been examined by the IRS. Years subsequent to 2008 could contain matters that could be subject to differing interpretations of applicable tax laws and regulations as they relate to the amount, timing or inclusion of revenue and expenses. The Company has recorded a tax benefit only for those positions that meet the “more likely than not” standard. The Company’s current estimate of the resolution of various state examinations, none of which are in process, is reflected in accrued income taxes; however, final settlement of the examinations or changes in the Company’s estimate may result in future income tax expense or benefit.
The Company is no longer subject to U.S. federal and Illinois income tax examination for the years prior to 2009 and is no longer subject to California, Florida, Missouri and various other state income tax examination by the tax authorities for the years prior
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
to 2008. The Company had a federal tax examination for tax years through 2008, which was closed during 2010, and a California tax examination for the 2004 and 2005 tax years, which was closed during 2008. An Illinois tax examination of the 2007 and 2008 tax years was completed during 2011 with no changes to the returns as originally filed. A California tax examination for the 2005 and 2006 tax years was completed during 2012 with no changes to the amended returns as filed. A Texas tax examination for the 2007 and 2008 tax years was completed during 2013, which resulted in minor changes to the returns as originally filed. While the statute of limitations for the 2008 and 2009 tax years has expired for the majority of the states in which the Company is subject to income tax, the Company generated net operating loss carryforwards in 2008 and 2009 which, if realized, are subject to examination in order to validate the net operating loss carryforward. Thus, while closed, the 2008 and 2009 tax years for these states are still subject to examination. The statute of limitations will expire for 2008 and 2009 when the statute of limitations expires for the year the net operating loss carryforward is realized.
At December 31, 2014 and 2013, the accumulation of prior years’ earnings representing tax bad debt deductions was zero and $29.8 million, respectively. If these tax bad debt reserves were charged for losses other than bad debt losses, the Company would be required to recognize taxable income in the amount of the charge. Effective December 31, 2013, the Company recorded a deferred tax liability in the amount of $10.6 million as it was projected that First Bank would make a nondividend distribution to the Company in 2014. Nondividend distributions include distributions in excess of First Bank’s current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock and distributions in partial or complete liquidation. The nondividend distribution will be considered to have been made from First Bank’s unrecaptured tax bad debt reserve. To the extent the distribution is made from these reserves, the nondividend distribution will be included in First Bank’s taxable income in the year of the distribution. It has been determined that a nondividend distribution, in excess of $29.8 million, occurred during the year ended December 31, 2014 and will be included in First Bank's taxable income for the year then ended.
At December 31, 2014 and 2013, for federal income tax purposes, the Company had net operating loss carryforwards of approximately $529.3 million and $571.8 million, respectively. At December 31, 2014, the Company’s federal net operating loss carryforwards expire as follows:
At December 31, 2014 and 2013, for state income tax purposes, the Company had net operating loss carryforwards of approximately $719.5 million and $785.4 million, respectively, and a related deferred tax asset of $58.7 million and $66.6 million, respectively. The state net operating loss carryforwards are primarily from the states of California, Florida, Illinois and Missouri ("Footprint States"). At December 31, 2014, the Company’s state net operating loss carryforwards expire as follows:
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 18 - EARNINGS PER COMMON SHARE
The following is a reconciliation of basic and diluted earnings per share for the years ended December 31, 2014, 2013 and 2012:
NOTE 19 - BUSINESS SEGMENT RESULTS
The Company’s business segment is First Bank. The reportable business segment is consistent with the management structure of the Company, First Bank and the internal reporting system that monitors performance. First Bank provides similar products and services in its defined geographic areas through its branch network. The products and services offered include a broad range of commercial and personal deposit products, including demand, savings, money market and time deposit accounts. In addition, First Bank markets combined basic services for various client groups, including packaged accounts for more affluent clients, and sweep accounts, lock-box deposits and cash management products for commercial clients. First Bank also offers consumer and commercial loans. Consumer lending includes residential real estate, home equity and installment lending. Commercial lending includes commercial, financial and agricultural loans, real estate construction and development loans, commercial real estate loans and small business lending. Other financial services include mortgage banking, debit cards, brokerage services, internet banking, remote deposit, mobile banking, ATMs, telephone banking, safe deposit boxes, and trust and private banking services. The revenues generated by First Bank and its subsidiaries consist primarily of interest income generated from the loan and investment security portfolios, service charges and fees generated from deposit products and services, and fees generated by the Company’s mortgage banking and trust and private banking business units. The Company’s products and services are offered to clients primarily within its geographic areas, which include eastern Missouri, southern Illinois, southern and northern California, and Florida’s Bradenton, Palmetto and Longboat Key communities. Certain loan products are available nationwide.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The business segment results are consistent with the Company’s internal reporting system and, in all material respects, with GAAP and practices predominant in the banking industry. Such principles and practices are summarized in Note 1 to the consolidated financial statements. The business segment results are summarized as follows:
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 20 - TRANSACTIONS WITH RELATED PARTIES
Outside of normal client relationships, no directors or officers of the Company, no shareholders holding over 5% of the Company’s voting securities and no corporations or firms with which such persons or entities are associated currently maintain or have maintained, since the beginning of the last full fiscal year, any significant business or personal relationships with the Company or its subsidiaries, other than that which arises by virtue of such position or ownership interest in the Company or its subsidiaries, except as described in the following paragraphs.
First Services, L.P. First Services, L.P. (First Services), a limited partnership indirectly owned by the Company’s Chairman and members of his immediate family, including Mr. Michael Dierberg, Vice Chairman of the Company, and Ms. Ellen Dierberg Milne, Director of the Company, provides information technology, item processing and various related services to the Company and First Bank. Fees charged by First Services to First Bank (net of payments from First Services to First Bank for rental of information technology and other equipment) were $20.2 million, $18.9 million and $19.8 million for the years ended December 31, 2014, 2013 and 2012, respectively. In addition, First Services paid $1.7 million, $1.7 million and $1.8 million for the years ended December 31, 2014, 2013 and 2012, respectively, in rental payments to First Bank for occupancy of certain First Bank premises from which business is conducted.
First Services has an Affiliate Services Agreement with the Company and First Bank that relates to various services provided to First Services, including certain human resources, payroll, employee benefit and training services, accounting services, insurance services, vendor payment processing services and advisory services. Fees incurred under the Affiliate Services Agreement by First Services were $202,000, $284,000 and $183,000 for the years ended December 31, 2014, 2013 and 2012, respectively.
First Brokerage America, L.L.C. First Brokerage America, L.L.C. (First Brokerage), a limited liability company indirectly owned by the Company’s Chairman and members of his immediate family, including Mr. Michael Dierberg, Vice Chairman of the Company, and Ms. Ellen Dierberg Milne, Director of the Company, received approximately $4.6 million, $4.5 million and $4.3 million for the years ended December 31, 2014, 2013 and 2012, respectively, in gross commissions paid by unaffiliated third-party companies. The commissions received primarily resulted from sales of annuities, securities and other insurance products to clients of First Bank. First Brokerage paid approximately $470,000, $438,000 and $401,000 for the years ended December 31, 2014, 2013 and 2012, respectively, to First Bank in rental payments for occupancy of certain First Bank premises from which brokerage business is conducted.
Dierberg Vineyards / Wineries. The Company periodically purchases various products from Hermannhof, Inc. and Dierberg Star Lane Vineyards, entities that are owned and operated by the Company’s Chairman and members of his immediate family, including Mr. Michael Dierberg, Vice Chairman of the Company, and Ms. Ellen Dierberg Milne, Director of the Company. The Company utilizes these products primarily for client and employee events and promotions, and business development functions. During the years ended December 31, 2014 and 2013, the Company purchased products aggregating approximately $165,000 and $129,000, respectively, from these entities.
Dierbergs Markets, Inc. First Bank leases certain of its in-store branch offices and automated teller machine (ATM) sites from Dierbergs Markets, Inc., a grocery store chain headquartered in St. Louis, Missouri that is owned and operated by the brother of the Company’s Chairman and members of his immediate family. Total rent expense incurred by First Bank under the lease obligation contracts was $511,000, $491,000 and $498,000 for the years ended December 31, 2014, 2013 and 2012, respectively.
First Capital America, Inc. / FB Holdings, LLC. FB Holdings operates as a majority-owned subsidiary of First Bank and was formed in 2008 for the primary purpose of holding and managing certain nonperforming loans and assets and to permit an efficient vehicle for the investment of additional capital by the Company’s sole owner of its Class A and Class B Preferred Stock. First Bank contributed cash of $9.0 million and nonperforming loans and assets with a fair value of approximately $133.3 million and FCA, a corporation owned by the Company’s Chairman and members of his immediate family, including Mr. Michael Dierberg, Vice Chairman of the Company, and Ms. Ellen Dierberg Milne, Director of the Company, contributed cash of $125.0 million to FB Holdings during 2008. As a result, First Bank owned 53.23% and FCA owned the remaining 46.77% of FB Holdings as of December 31, 2014. FCA's ownership in FB Holdings is reflected as a component of stockholders’ equity in the consolidated balance sheets.
FB Holdings receives various services provided by First Bank, including loan servicing and special assets services as well as various other financial, legal, human resources and property management services. Fees paid under the agreement by FB Holdings to First Bank were $124,000 for the year ended December 31, 2012.
Investors of America Limited Partnership. On March 20, 2013, the Company entered into a $5.0 million Credit Agreement with Investors of America, LP, as further described in Note 11 to the consolidated financial statements. Investors of America, LP is a Nevada limited partnership that was created by and for the benefit of the Company’s Chairman and members of his immediate family, including Mr. Michael Dierberg, Vice Chairman of the Company, and Ms. Ellen Dierberg Milne, Director of the Company.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The borrowing arrangement matured on March 31, 2014. There were no balances outstanding under the Credit Agreement from its origination date through its maturity date.
Loans to Directors, Executive Officers and/or their Affiliates. First Bank has had in the past, and may have in the future, loan transactions in the ordinary course of business with its directors, executive officers and/or their affiliates. These loan transactions have been made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated persons and did not involve more than the normal risk of collectability or present other unfavorable features. Loans to directors, their affiliates and executive officers of the Company were $28.8 million and $12.0 million at December 31, 2014 and 2013, respectively. First Bank does not extend credit to its officers or to officers of the Company, except extensions of credit secured by mortgages on personal residences, loans to purchase automobiles, personal credit card accounts and deposit account overdraft protection under a plan whereby a credit limit has been established in accordance with First Bank’s standard credit criteria.
Depositary Accounts of Directors, Executive Officers and/or their Affiliates. Certain directors, executive officers and/or their affiliates maintain funds on deposit with First Bank in the ordinary course of business. These deposit transactions include demand, savings and time accounts, and have been established on the same terms, including interest rates, as those prevailing at the time for comparable transactions with unaffiliated persons.
NOTE 21 - EMPLOYEE BENEFITS
401(k) Plan. The Company’s 401(k) plan is a self-administered savings and incentive plan covering substantially all employees. Employer match contributions are determined annually under the plan by the Company’s Board of Directors. Employee contributions were limited to $17,500 of gross compensation for 2014. Employer contributions under the plan were $2.3 million for each of the years ended December 31, 2014, 2013 and 2012. The plan assets are held and managed under a trust agreement with First Bank’s trust department.
Nonqualified Deferred Compensation Plan. The Company’s nonqualified deferred compensation plan (the NQDC Plan), which covers a select group of employees, is administered by an independent third party. The NQDC Plan is exempt from the participation, vesting, funding and fiduciary requirements of the Employee Retirement Income Security Act of 1974. Although the NQDC Plan allows the Company to credit the accounts of any participant with discretionary contributions, no such discretionary contributions have been made since the NQDC Plan’s inception. Participants may contribute from 1% to 25% of their salary and up to 100% of their bonuses on a pre-tax basis.
Balances outstanding under the NQDC Plan, which are reflected in accrued and other liabilities in the consolidated balance sheets, were $6.8 million and $6.6 million at December 31, 2014 and 2013, respectively. The Company recognized salaries and employee benefits expense related to the NQDC Plan of $266,000, $962,000 and $614,000 for the years ended December 31, 2014, 2013 and 2012, respectively, resulting from net earnings incurred by participants on the underlying investments in the plan.
Noncontributory Defined Benefit Pension Plan. The Company has a noncontributory defined benefit pension plan covering certain former employees of a bank holding company acquired by the Company in 1994 and subsequently merged with and into the Company on December 31, 2002. The Company discontinued the accumulation of benefits under the Plan in 1994, and as such, there is no longer any service cost being accrued by Plan participants.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of the Plan’s change in the projected benefit obligation and change in the fair value of Plan assets for the years ended December 31, 2014 and 2013 and amounts recognized in the Company’s consolidated balance sheets as of December 31, 2014 and 2013 is as follows:
The Company’s accrued pension liability of $4.4 million and $2.6 million at December 31, 2014 and 2013, respectively, represents the difference between the fair value of the Plan assets and the projected benefit obligation of the Plan, and is reflected in accrued expenses and other liabilities in the consolidated balance sheets.
The following table reflects the weighted average assumptions used to determine the net periodic benefit cost and benefit obligation for the years ended December 31, 2014 and 2013:
A summary of the components of net periodic benefit cost for the years ended December 31, 2014 and 2013 is as follows:
Amounts recognized in accumulated other comprehensive income consist of:
The Plan’s investment strategy is focused on maximizing asset returns. The target allocations for Plan assets are 52% fixed income, 40% equity securities and 8% cash and other sectors. Asset allocations can fluctuate between acceptable ranges commensurate with market volatility. Debt securities include U.S. Treasuries, investment-grade corporate bonds of companies from diversified industries and mortgage-backed securities. Equity securities primarily include investments in large capitalization companies located in the United States.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The fair value of Plan assets at December 31, 2014 and 2013 was comprised of the following:
Equity and debt securities included in Level 1 are valued using quoted market prices. Where quoted market prices are unavailable, the fair value of equity and debt securities included in Level 2 is based on quoted market prices of comparable instruments obtained from independent pricing vendors based on recent trading activity and other relevant information.
The Company expects to contribute $470,000 to the Plan in 2015. Pension benefit payments are expected to be paid to Plan participants by the Plan as follows:
NOTE 22 - DISTRIBUTION OF EARNINGS OF FIRST BANK
First Bank is restricted by various state and federal regulations as to the amount of dividends that are available for payment to the Company. Under the most restrictive of these requirements, the payment of dividends is limited in any calendar year to the net profit of the current year combined with the retained net profits of the preceding two years. Permission must be obtained for dividends exceeding these amounts. Under its MOU with the FRB, First Bank has agreed not to declare or pay any dividends, without the prior consent of the FRB, that would cause First Bank to pay dividends in excess of its earnings or make a capital distribution that would cause First Bank's Tier 1 Leverage Ratio to fall below 9.0%, as further described in Note 14 to the consolidated financial statements. Furthermore, pursuant to Missouri Revised Statutes, First Bank is required to obtain approval from the MDOF prior to paying any dividends to the Company. The Company is unable to predict whether or when the FRB or the MDOF will grant such consents in the future.
On January 31, 2014, the Company received regulatory approval from the FRB, which granted First Bank the authority to pay a dividend to the Company and the authority to the Company to utilize such funds, for the sole purpose of paying the accumulated deferred interest payments on the Company's outstanding junior subordinated debentures issued in connection with the Company's trust preferred securities. In February 2014, First Bank paid a dividend of $70.0 million to the Company, as further described in Note 12 to the consolidated financial statements. Since that time, First Bank has continued to pay quarterly dividends to the Company, and the Company has continued to pay interest on its junior subordinated debentures to the respective trustees on the regularly scheduled quarterly payment dates. First Bank paid a total of $95.0 million of dividends to the Company during the year ended December 31, 2014, as further described in Note 23 to the consolidated financial statements.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 23 - PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed balance sheets of First Banks, Inc. as of December 31, 2014 and 2013 and condensed statements of income and cash flows for the years ended December 31, 2014, 2013 and 2012 are shown below:
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF INCOME
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
The parent company’s unrestricted cash was $21.6 million and $1.9 million at December 31, 2014 and 2013, respectively. The Company's $5.0 million Credit Agreement matured on March 31, 2014, as further described in Note 11 and Note 20 to the consolidated financial statements. There were no balances outstanding under the Credit Agreement since its origination date through its maturity date.
The Company’s obligations related to dividends on its Class C Preferred Stock and Class D Preferred Stock have been deferred, as further described in Note 13 to the consolidated financial statements.
On January 31, 2014, the Company received regulatory approval from the FRB under the then-existing Written Agreement, subject to certain conditions, which granted First Bank the authority to pay a dividend to the Company, and the authority to the Company to utilize such funds, for the sole purpose of paying the accumulated deferred interest payments on the Company's outstanding junior subordinated debentures issued in connection with the Company's $345.0 million of trust preferred securities. The aggregate amount owed on all of the junior subordinated debentures relating to the trust preferred securities at the respective March and April, 2014 payments totaled $66.4 million, as further described in Note 12 to the consolidated financial statements. In February 2014, First Bank paid a dividend of $70.0 million to the Company. On March 14, 2014, the Company paid interest on the junior subordinated debentures of $66.4 million to the respective trustees, which was subsequently distributed to the trust preferred securities holders on the respective interest payment dates in March and April, 2014. Since that time, the Company has continued to pay interest on its junior subordinated debentures to the respective trustees on the regularly scheduled quarterly payment dates. Such interest payments have been funded through additional dividends from First Bank.
FIRST BANKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 24 - CONTINGENT LIABILITIES
Litigation Matters. In the ordinary course of business, the Company and its subsidiaries become involved in legal proceedings, including litigation arising out of the Company’s efforts to collect outstanding loans. It is not uncommon for collection efforts to lead to so-called “lender liability” suits in which borrowers may assert various claims against the Company. From time to time, the Company is party to other legal matters arising in the normal course of business. While some matters pending against the Company specify damages claimed by plaintiffs, others do not seek a specified amount of damages or are at very early stages of the legal process. The Company records a loss accrual for all legal matters for which it deems a loss is probable and can be reasonably estimated. Management, after consultation with legal counsel, believes the ultimate resolution of these existing proceedings is not reasonably likely to have a material adverse effect on the business, financial condition or results of operations of the Company and/or its subsidiaries and the range of possible additional loss in excess of amounts accrued is not material.
Regulatory Matters. The Company entered into an MOU with the FRB, dated May 19, 2014. Additionally, on May 19, 2014, the FRB terminated the Written Agreement, dated March 24, 2010, by and among the Company, SFC, First Bank and the FRB. Effective September 11, 2013, the MDOF terminated an informal agreement, dated as of September 18, 2008, by and among First Bank and the MDOF. These agreements are further described in Note 14 to the consolidated financial statements.
Reserve for Mortgage Repurchase Losses. The Company's mortgage banking division, in the normal course of business, sells residential mortgage loans directly to government-sponsored enterprises (GSEs), and to a lessor extent, to investors other than GSEs, as whole loans. In connection with these sales, the Company makes customary representations and warranties that the loans meet certain requirements. In the event of breaches of its representations and warranties, such as documentation or underwriting deficiencies, the Company may be required to either repurchase the mortgage loans with the identified defects, or in most cases, otherwise indemnify or "make whole" the investors for their losses on the loans. First Bank also, on certain loans, has a repurchase obligation on these loans in the event of early payment default. The early payment default provisions generally range from four months to one year after sale of the loan in the secondary market. First Bank has not sold any one-to-four-family residential mortgage loans into the secondary market with early payment default provisions since 2007.
The Company had unresolved claims with GSEs and other financial institutions associated with loan principal balances of $12.7 million and $13.5 million as of December 31, 2014 and 2013, respectively. The Company's mortgage repurchase reserve for its potential repurchase or make whole liability associated with representation and warranty claims and early payment default provisions was $2.4 million and $2.5 million as of December 31, 2014 and 2013, respectively. The estimated liability for mortgage repurchase losses represents the Company's best estimate of losses for representation and warranty obligations and early payment default provisions. The mortgage repurchase reserve is based on then-currently available information and is dependent on various factors, including historical claims and settlement experience, projections of future defaults, and significant judgment and assumptions that are subject to change. The estimated loss may materially change in the future based on factors beyond the Company's control or if actual experiences are different from the Company's assumptions, including, without limitation, estimated repurchase rates, economic conditions, estimated home prices, consumer and counterparty behavior, and a variety of other judgmental factors. Adverse developments with respect to one or more of the assumptions underlying the estimated liability and the corresponding estimated range of possible loss could result in significant increases to future provisions and/or the estimated range of possible loss. Because the Company typically sold loans with early payment default provisions as servicing released, the Company is unable to track the outstanding balances or delinquency status of the majority of the loans that may be subject to repurchase under early payment default provisions.
FIRST BANKS, INC.
QUARTERLY CONDENSED FINANCIAL DATA - UNAUDITED
FIRST BANKS, INC.
INVESTOR INFORMATION
FIRST BANKS, INC. TRUST PREFERRED SECURITIES
The preferred securities of First Preferred Capital Trust IV are traded on the New York Stock Exchange with the ticker symbol “FBSPrA.” The preferred securities of First Preferred Capital Trust IV are represented by a global security that has been deposited with and registered in the name of The Depository Trust Company, New York, New York (DTC). The beneficial ownership interests of these preferred securities are recorded through the DTC book-entry system. The high and low preferred securities prices and the dividends declared for 2014 and 2013 are summarized as follows:
First Preferred Capital Trust IV (Issue Date - April 2003) - FBSPrA
(1)
Amounts exclude the additional accrued interest on any cumulative unpaid dividends following the announcement of the deferral of such dividend payments in August 2009, until March 2014 when the Company paid all of the accumulated deferred interest payments on its junior subordinated debentures to the trustees, which was subsequently distributed to the trust preferred securities holders on the respective interest payment dates in March and April 2014.
FOR INFORMATION CONCERNING FIRST BANKS, INC., PLEASE CONTACT:
TRANSFER AGENT:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FIRST BANKS, INC.
By:
/s/
Timothy J. Lathe
Timothy J. Lathe
President and Chief Executive Officer
(Principal Executive Officer)
Dated as of: March 24, 2015
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 date indicated.
INDEX TO EXHIBITS