UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

ý           ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2005

 

OR

 

o           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                                            to                                 

 

Commission file number  0-14289

 

GREENE COUNTY BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

Tennessee

 

62-1222567

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

 

 

100 North Main Street, Greeneville, Tennessee

 

37743-4992

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:  (423) 639-5111.

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Securities registered pursuant to Section 12(g) of the Act:

 

Common Stock - $2.00 par value

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act 
    YES  
o   NO  ý

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act YES  o   NO  ý

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES  ý   NO  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o Accelerated filer ý Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES  o   NO  ý

 

The aggregate market value of the voting stock held by non-affiliates of the registrant on June 30, 2005 was $185 million. The market value calculation was determined using the closing sale price of the registrant’s common stock on June 30, 2005, as reported on the Nasdaq National Market. For purposes of this calculation, the term “affiliate” refers to all directors, executive officers and 10% shareholders of the registrant. As of the close of business on March 10, 2006 9,781,070 shares of the registrant’s common stock were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The following lists the documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated:

 

1.             Portions of Proxy Statement for 2006 Annual Meeting of Shareholders. (Part III)

 

 



 

PART I

 

Forward-Looking Statements

 

The information contained herein contains forward-looking statements that involve a number of risks and uncertainties. A number of factors, including those discussed herein, could cause results to differ materially from those anticipated by such forward-looking statements which are within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, such forward-looking statements are necessarily dependent upon assumptions, estimates and data that may be incorrect or imprecise. Accordingly, any forward-looking statements included herein do not purport to be predictions of future events or circumstances and may not be realized. Forward-looking statements can be identified by, among other things, the use of forward-looking terminology such as “intends,” “believes,” “expects,” “may,” “will,” “should,” “seeks,” “pro forma” or “anticipates,” or the negatives thereof, or other variations thereon of comparable terminology, or by discussions of strategy or intentions. Such statements may include, but are not limited to, projections of income or loss, expenditures, acquisitions, plans for future operations, financing needs or plans relating to services of the Company, as well as assumptions relating to the foregoing. The Company’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors, including, but not limited to those identified in “Item 1A. Risk Factors” in this Form 10-K and (1) unanticipated deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses; (2) lack of sustained growth in the economy in the markets that the Bank serves; (3) increased competition with other financial institutions in the markets that the Bank serves; (4) changes in the legislative and regulatory environment; (5) the Company’s successful implementation of its growth strategy; and (6) the loss of key personnel. All forward-looking statements herein are based on information available to us as of the date this Annual Report on Form 10-K was filed with the Securities and Exchange Commission (“SEC”).

 

ITEM 1. BUSINESS.

 

Presentation of Amounts

 

All dollar amounts set forth below, other than per-share amounts, are in thousands unless otherwise noted.

 

The Company

 

Greene County Bancshares, Inc. (the “Company”) was formed in 1985 and serves as the bank holding company for Greene County Bank (the “Bank”), which is a Tennessee-chartered commercial bank that conducts the principal business of the Company. At December 31, 2005, and based on Federal Reserve Board (“FRB”) data as of September 30, 2005, the Company believes it was the second largest bank holding company headquartered in the state of Tennessee. At December 31, 2005, the Company maintained a main office in Greeneville, Tennessee and 49 full-service bank branches (of which eleven are in leased operating premises) and nine separate locations operated by the Bank’s subsidiaries.

 

The Company’s assets consist primarily of its investment in the Bank and liquid investments. Its primary activities are conducted through the Bank. At December 31, 2005, the Company’s consolidated total assets were $1,619,989, its consolidated net loans, including loans held for sale, were $1,361,589, its total deposits were $1,295,879 and its total shareholders’ equity was $168,021.

 

The Company’s net income is dependent primarily on its net interest income, which is the difference between the interest income earned on its loans, investment assets and other interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. To a lesser extent, the Company’s net income also is affected by its noninterest income derived principally from service charges and fees as well as the level of noninterest expenses such as salaries and employee benefits.

 

1



 

The operations of the Company are significantly affected by prevailing economic conditions, competition and the monetary, fiscal and regulatory policies of governmental agencies. Lending activities are influenced by the general credit needs of individuals and small and medium-sized businesses in the Company’s market area, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily the rates paid on competing investments, account maturities and the levels of personal income and savings in the Company’s market area.

 

The principal executive offices of the Company are located at 100 North Main Street, Greeneville, Tennessee 37743-4992 and its telephone number is (423) 639-5111.

 

The Bank and its Subsidiaries

 

The Bank is a Tennessee-chartered commercial bank established in 1890 which has its principal executive offices in Greeneville, Tennessee. The principal business of the Bank consists of attracting deposits from the general public and investing those funds, together with funds generated from operations and from principal and interest payments on loans, primarily in commercial loans, commercial and residential real estate loans, and installment consumer loans. At December 31, 2005, the Bank had 48 full-service banking offices located in Greene, Washington, Blount, Knox, Hamblen, McMinn, Loudon, Hawkins, Sullivan, Cocke and Monroe Counties in East Tennessee and in Sumner, Rutherford, Davidson, Lawrence, Montgomery and Williamson Counties in Middle Tennessee. The Bank also operates two other full service branches–one located in nearby Madison County, North Carolina and the other in nearby Bristol, Virginia. Further, the Bank operates a trust and money management function doing business as President’s Trust from offices in Wilson County, Tennessee, and a mortgage banking operation in Knox County, Tennessee.

 

The Bank also offers other financial services through three wholly-owned subsidiaries. Through Superior Financial Services, Inc. (“Superior Financial”), the Bank operates eight consumer finance company offices located in Greene, Blount, Hamblen, Washington, Sullivan, Sevier, Knox and Bradley Counties, Tennessee. Through GCB Acceptance Corporation (“GCB Acceptance”), the Bank operates a sub-prime automobile lending company with a sole office in Johnson City, Tennessee. Through Fairway Title Co., the Bank operates a title company headquartered in Knox County, Tennessee. At December 31, 2005, these three subsidiaries had total combined assets of $31,083 and total combined loans, net of unearned interest, of $31,139.

 

Deposits of the Bank are insured by the Bank Insurance Fund (“BIF”) of the Federal Deposit Insurance Corporation (“FDIC”). The Bank is subject to supervision and regulation by the Tennessee Department of Financial Institutions (the “Banking Department”) and the FDIC. See “Regulation, Supervision and Governmental Policy.”

 

On November 21, 2003, the Company entered the Middle Tennessee market by completing its acquisition of Gallatin, Tennessee-based Independent Bankshares Corporation (“IBC”). IBC was the bank holding company for First Independent Bank, which had four offices in Gallatin and Hendersonville, Tennessee, in Sumner County, and Rutherford Bank and Trust, with three offices in Murfreesboro and Smyrna, Tennessee in Rutherford County. First Independent Bank and Rutherford Bank and Trust were subsequently merged with the Bank, with the Bank as the surviving entity. Consideration in the transaction included the issuance of 836,114 shares of the Company’s common stock and payment of approximately $9,060 in cash and $198 in stock options in exchange for all outstanding IBC common stock.

 

On November 15, 2004 the Company established banking operations in Nashville, Tennessee, with the opening of its first full-service branch of Middle Tennessee Bank & Trust, which, like all of the Bank’s bank brands, operates within the Bank’s structure. This new branch in Davidson County, Tennessee expanded the Company’s presence in the Middle Tennessee market and helped fill in the market between Sumner and Rutherford Counties.

 

The Company opened a new branch in Knoxville, Tennessee in late 2003 and expects to open its second branch in that city during the first-half of 2006.

 

On December 10, 2004 the Company purchased three full-service branches from National Bank of Commerce located in Lawrence County Tennessee. This purchase (“NBC transaction”) added to the Bank’s presence in Middle Tennessee.

 

2



 

On October 7, 2005, the Company purchased five bank branches in Montgomery County, Tennessee. This purchase (the “Clarksville transaction”) also adds to the Bank’s presence in Middle Tennessee.

 

Growth and Business Strategy

 

The Company expects that, over the intermediate term, its growth from mergers and acquisitions, including acquisitions of both entire financial institutions and selected branches of financial institutions, will continue. De novo branching is also expected to be a method of growth, particularly in high-growth and other demographically-desirable markets.

 

The Company’s strategic plan outlines geographic expansion within a 300-mile radius of its headquarters in Greene County, Tennessee. This could result in the Company expanding westward and eastward up to and including Nashville, Tennessee and Roanoke, Virginia, respectively, east/southeast up to and including the Piedmont area of North Carolina and western North Carolina, southward to northern Georgia and northward into eastern and central Kentucky. In particular, the Company believes the markets in and around Knoxville, Nashville and Chattanooga, Tennessee are highly desirable areas with respect to expansion and growth plans.

 

While the Bank operates under a single bank charter, it conducts business under 18 bank brands with a distinct community-based brand in almost every market. The Bank offers local decision making through the presence of its regional executives in each of its markets, while at the same time maintaining a cost effective organizational structure in its back office and support areas.

 

The Bank focuses its lending efforts predominately on individuals and small to medium-sized businesses while it generates deposits primarily from individuals in its local communities. To aid in deposit generation efforts, the Bank offers its customers extended hours of operation during the week as well as Saturday banking. The Bank also offers free online banking and recently established its High Performance Checking Program which it believes will allow it to generate a significant number of core transaction accounts with significant balances.

 

In addition to the Company’s business model, which is summarized in the paragraphs above entitled “The Company” and “The Bank and its Subsidiaries”, the Company is continuously investigating and analyzing other lines and areas of business. These include, but are not limited to, various types of insurance and real estate activities. Conversely, the Company frequently evaluates and analyzes the profitability, risk factors and viability of its various business lines and segments and, depending upon the results of these evaluations and analyses, may conclude to exit certain segments and/or business lines. Further, in conjunction with these ongoing evaluations and analyses, the Company may decide to sell, merge or close certain branch facilities.

 

Lending Activities

 

General. The loan portfolio of the Company is comprised of commercial, commercial and residential real estate and consumer loans. Such loans are primarily originated within the Company’s market areas of East and Middle Tennessee and are generally secured by residential or commercial real estate or business or personal property located in the counties of Greene, Washington, Hamblen, Sullivan, Hawkins, Blount, Knox, McMinn, Loudon, Monroe, Cocke, Sumner, Rutherford, Davidson, Lawrence and Montgomery Counties, Tennessee.

 

3



 

Loan Composition. The following table sets forth the composition of the Company’s loans at December 31 for each of the periods indicated.

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

Commercial

 

$

245,285

 

$

165,975

 

$

134,823

 

$

93,836

 

$

96,122

 

Commercial real estate

 

729,254

 

484,088

 

445,104

 

342,407

 

295,002

 

Residential real estate

 

319,797

 

319,713

 

295,528

 

233,128

 

210,489

 

Loans held-for-sale

 

2,686

 

1,151

 

3,546

 

6,646

 

7,945

 

Consumer

 

90,682

 

82,532

 

81,624

 

77,644

 

80,314

 

Other

 

3,476

 

4,989

 

6,134

 

14,938

 

13,779

 

Unearned interest

 

(9,852

)

(10,430

)

(10,988

)

(11,696

)

(13,159

)

Loans, net of unearned interest

 

$

1,381,328

 

$

1,048,018

 

$

955,771

 

$

756,903

 

$

690,492

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

$

(19,739

)

$

(15,721

)

$

(14,564

)

$

(12,586

)

$

(11,221

)

 

Loan Maturities. The following table reflects at December 31, 2005 the dollar amount of loans maturing based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and loans having no stated maturity are reported as due in one year or less.

 

 

 

Due in One

 

Due After One Year

 

Due After

 

 

 

 

 

Year or Less

 

Through Five Years

 

Five Years

 

Total

 

Commercial

 

$

137,299

 

$

97,131

 

$

10,855

 

$

245,285

 

Commercial real estate

 

300,439

 

385,951

 

42,864

 

729,254

 

Residential real estate

 

46,410

 

107,054

 

162,514

 

315,978

 

Loans held for sale

 

2,686

 

 

 

2,686

 

Consumer

 

25,111

 

54,613

 

4,925

 

84,649

 

Other

 

2,604

 

681

 

191

 

3,476

 

Total

 

$

514,549

 

$

645,430

 

$

221,349

 

$

1,381,328

 

 

The following table sets forth the dollar amount of the loans maturing subsequent to the year ending December 31, 2006 distinguished between those with predetermined interest rates and those with floating, or variable, interest rates.

 

 

 

Fixed Rate

 

Variable Rate

 

Total

 

Commercial

 

$

51,253

 

$

56,733

 

$

107,986

 

Commercial real estate

 

288,624

 

140,190

 

428,814

 

Residential real estate

 

144,828

 

124,740

 

269,568

 

Consumer

 

58,642

 

897

 

59,539

 

Other

 

731

 

141

 

872

 

Total

 

$

544,078

 

$

322,701

 

$

866,779

 

 

Commercial Loans. Commercial loans are made for a variety of business purposes, including working capital, inventory and equipment and capital expansion. At December 31, 2005, commercial loans outstanding totaled $245,285, or 18.01%, of the Company’s net loan portfolio. Such loans are usually amortized over one to seven years and generally mature within five years. Commercial loan applications must be supported by current financial information on the borrower and, where appropriate, by adequate collateral. Commercial loans are generally underwritten by addressing cash flow (debt service coverage), primary and secondary sources of repayment, financial strength of any guarantor, liquidity, leverage, management experience, ownership structure, economic conditions and industry-specific trends and collateral. The loan to value ratio depends on the type of collateral. Generally speaking, accounts receivable are financed between 70% and 80% of accounts receivable less than 90 days past due. If other collateral is taken to support the loan, the loan to value of accounts receivable may approach 85%. Inventory financing will range between 50% and 60% depending on the borrower and nature of inventory. The Company requires a first lien position for such loans. These types of loans are generally considered to be a higher credit risk than other loans originated by the Company.

 

4



 

Commercial Real Estate Loans. The Company originates commercial loans, generally to existing business customers, secured by real estate located in the Company’s market area. At December 31, 2005, commercial real estate loans totaled $729,254, or 53.56%, of the Company’s net loan portfolio. Commercial real estate loans are generally underwritten by addressing cash flow (debt service coverage), primary and secondary source of repayment, financial strength of any guarantor, strength of the tenant (if any), liquidity, leverage, management experience, ownership structure, economic conditions and industry specific trends and collateral. Generally, the Company will loan up to 80-85% of the value of improved property, 65% of the value of raw land and 75% of the value of land to be acquired and developed. A first lien on the property and assignment of lease is required if the collateral is rental property, with second lien positions considered on a case-by-case basis.

 

Residential Real Estate. The Company also originates one-to-four family, owner-occupied residential mortgage loans secured by property located in the Company’s primary market area. The majority of the Company’s residential mortgage loans consists of loans secured by owner-occupied, single-family residences. At December 31, 2005, the Company had $319,797, or 23.49%, of its net loan portfolio in residential real estate loans. Residential real estate loans generally have a loan-to-value ratio of 85% or less. These loans are underwritten by giving consideration to the ability to pay, stability of employment or source of income, credit history and loan-to-value ratio. Home equity loans make up approximately 27% of residential real estate loans. Home equity loans may have higher loan-to-value ratios when the borrower’s repayment capacity and credit history conform to underwriting standards. Superior Financial extends sub-prime mortgages to borrowers who generally have a higher risk of default than mortgages extended by the Bank. Sub-prime mortgages totaled $10,980, or 3.43%, of the Company’s residential real estate loans at December 31, 2005.

 

The Company sells most of its one-to-four family mortgage loans in the secondary market to Freddie Mac and other mortgage investors through the Bank’s mortgage banking operation. Sales of such loans to Freddie Mac and other mortgage investors totaled $39,788 and $49,892 during 2005 and 2004, respectively, and the related mortgage servicing rights were sold together with the loans.

 

Consumer Loans. At December 31, 2005, the Company’s consumer loan portfolio totaled $90,682, or 6.66%, of the Company’s total net loan portfolio. The Company’s consumer loan portfolio is composed of secured and unsecured loans originated by the Bank, Superior Financial and GCB Acceptance. The consumer loans of the Bank have a higher risk of default than other loans originated by the Bank. Further, consumer loans originated by Superior Financial and GCB Acceptance, which are finance companies rather than banks, generally have a greater risk of default than such loans originated by commercial banks and, accordingly, carry a higher interest rate. Superior Financial and GCB Acceptance consumer loans totaled approximately $30,011, or 33.10%, of the Company’s installment consumer loans at December 31, 2005. The performance of consumer loans will be affected by the local and regional economy as well as the rates of personal bankruptcies, job loss, divorce and other individual-specific characteristics.

 

Past Due, Special Mention, Classified and Nonaccrual Loans. The Company classifies its problem loans into three categories: past due loans, special mention loans and classified loans (both accruing and non-accruing interest).

 

When management determines that a loan is no longer performing and that collection of interest appears doubtful, the loan is placed on nonaccrual status. All loans that are 90 days past due are considered nonaccrual unless they are adequately secured and there is reasonable assurance of full collection of principal and interest. Management closely monitors all loans that are contractually 90 days past due, treated as “special mention” or otherwise classified or on nonaccrual status. Nonaccrual loans that are 120 days past due without assurance of repayment are charged off against the allowance for loan losses.

 

5



 

The following table sets forth information with respect to the Company’s nonperforming assets at the dates indicated. At these dates, the Company did not have any troubled debt restructurings.

 

 

 

At December, 31

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans accounted for on a nonaccrual basis

 

$

5,915

 

$

6,242

 

$

4,305

 

$

7,475

 

$

5,857

 

Accruing loans which are contractually past due 90 days or more as to interest or principal payments

 

809

 

664

 

224

 

307

 

871

 

Total nonperforming loans

 

6,724

 

6,906

 

4,529

 

7,782

 

6,728

 

Real estate owned:

 

 

 

 

 

 

 

 

 

 

 

Foreclosures

 

2,920

 

1,353

 

3,599

 

4,805

 

2,589

 

Other real estate held and repossessed assets

 

823

 

213

 

627

 

767

 

623

 

Total nonperforming assets

 

$

10,467

 

$

8,472

 

$

8,755

 

$

13,354

 

$

9,940

 

 

The Company’s continuing efforts to resolve nonperforming loans occasionally include foreclosures, which result in the Company’s ownership of the real estate underlying the mortgage. If nonaccrual loans at December 31, 2005 had been current according to their original terms and had been outstanding throughout 2005, or since origination if originated during the year, interest income on these loans would have been approximately $368. Interest actually recognized on these loans during 2005 was not significant.

 

Foreclosed real estate increased $1,567, or 115.8%, to $2,920 at December 31, 2005 from $1,353 at December 31, 2004. The real estate consists of 29 properties, of which seven are commercial properties with a carrying value of $1,932, 19 are single family residential properties with a carrying value of $883, one is a multi-family home with a carrying value of $25 and two are vacant lots with a carrying value of $80. Management expects to liquidate these properties during 2006. Management has recorded these properties at fair value less estimated selling cost and the subsequent sale of such properties is not expected to result in any adverse effect on the Company’s results of operations, subject to business and marketing conditions at the time of sale. Other repossessed assets increased $610, or 286.38%, to $823 at December 31, 2005 from $213 at December 31, 2004. The increase is due primarily to the repossession and pending liquidation of foreclosed rental equipment of $240 and $225 of stock not traded on a public market.

 

Total impaired loans increased by $2,469, or 20.22%, from $12,210 at December 31, 2004 to $14,679 at December 31, 2005. This increase is primarily reflective of additional impaired loans in the Bank resulting from several commercial relationships placed on nonaccrual status and in the process of litigation or foreclosure action.

 

At December 31, 2005, the Company had approximately $8,764 in loans that are not currently classified as nonaccrual or 90 days past due or otherwise restructured but which known information about possible credit problems of borrowers caused management to have concerns as to the ability of the borrowers to comply with present loan repayment terms. Such loans were considered classified by the Company and were composed primarily of various commercial, commercial real estate and consumer loans. The Company believes that these loans are adequately secured and management does not expect any material loss.

 

Allowance for Loan Losses. The allowance for loan losses is maintained at a level which management believes is adequate to absorb all probable losses on loans then present in the loan portfolio. The amount of the allowance is affected by:  (1) loan charge-offs, which decrease the allowance; (2) recoveries on loans previously charged-off, which increase the allowance; and (3) the provision of possible loan losses charged to income, which increases the allowance. In determining the provision for possible loan losses, it is necessary for management to monitor fluctuations in the allowance resulting from actual charge-offs and recoveries, and to periodically review the size and composition of the loan portfolio in light of current and anticipated economic conditions in an effort to evaluate portfolio risks. If actual losses exceed the amount of the allowance for loan losses, earnings of the Company could be adversely affected. The amount of the provision is based on management’s judgment of those risks. During the year ended December 31, 2005, the Company’s provision for loan losses increased by $529, or 9.06%, to $6,365 from $5,836 for the year ended December 31, 2004, while the allowance for loan losses increased by $4,018, or 25.56%, to $19,739 at

 

6



 

December 31, 2005 from $15,721 at December 31, 2004. The increase in the allowance for loan losses and provision for loan losses is attributable to the organic loan growth the company experienced in 2005. Also, the allowance for loan losses was increased by $1,467 in 2005 by the allowance acquired in the Clarksville transaction.

 

The following is a summary of activity in the allowance for loan losses for the periods indicated:

 

 

 

Year Ended December 31,

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at beginning of year

 

$

15,721

 

$

14,564

 

$

12,586

 

$

11,221

 

$

11,728

 

Reserve acquired in acquisition

 

1,467

 

363

 

1,340

 

 

 

Subtotal

 

17,188

 

14,927

 

13,926

 

11,221

 

11,728

 

 

 

 

 

 

 

 

 

 

 

 

 

Charge-offs:

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

(1,500

)

(1,538

)

(1,007

)

(1,216

)

(411

)

Commercial real estate

 

(189

)

(1,044

)

(664

)

(956

)

(997

)

Subtotal

 

(1,689

)

(2,582

)

(1,671

)

(2,172

)

(1,408

)

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

(622

)

(424

)

(745

)

(740

)

(669

)

Consumer

 

(3,250

)

(3,962

)

(4,381

)

(4,736

)

(5,753

)

Other

 

(22

)

(12

)

 

 

 

Total charge-offs

 

(5,583

)

(6,980

)

(6,797

)

(7,648

)

(7,830

)

 

 

 

 

 

 

 

 

 

 

 

 

Recoveries:

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

160

 

304

 

195

 

239

 

11

 

Commercial real estate

 

180

 

66

 

92

 

54

 

54

 

Subtotal

 

340

 

370

 

287

 

293

 

65

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

166

 

63

 

92

 

141

 

102

 

Consumer

 

1,246

 

1,504

 

1,281

 

1,514

 

1,197

 

Other

 

17

 

1

 

 

 

 

Total recoveries

 

1,769

 

1,938

 

1,660

 

1,948

 

1,364

 

Net charge-offs

 

(3,814

)

(5,042

)

(5,137

)

(5,700

)

(6,466

)

 

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

6,365

 

5,836

 

5,775

 

7,065

 

5,959

 

Balance at end of year

 

$

19,739

 

$

15,721

 

$

14,564

 

$

12,586

 

$

11,221

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of net charge-offs to average loans outstanding, net of unearned inome, during the period

 

0.32

%

0.51

%

0.64

%

0.80

%

0.94

%

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of allowance for loan losses to nonperforming loans

 

293.56

%

227.64

%

321.57

%

161.73

%

166.78

%

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of allowance for loan losses to total loans, net of unearned income

 

1.43

%

1.50

%

1.53

%

1.68

%

1.64

%

 

7



 

Breakdown of allowance for loan losses by category. The following table presents an allocation among the listed loan categories of the Company’s allowance for loan losses at the dates indicated and the percentage of loans in each category to the total amount of loans at the respective year-ends:

 

 

 

At December 31,

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

Balance at end of period
applicable to

 

Amount

 

Percent of
loan in
each
category
to total
loans

 

Amount

 

Percent of
loan in
each
category
to total
loans

 

Amount

 

Percent of
loan in
each
category
to total
loans

 

Amount

 

Percent of
loan in
each
category
to total
loans

 

Amount(1)

 

Percent of
loan in
each
category
to total
loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

4,797

 

17.76

%

$

3,666

 

15.68

%

$

3,001

 

13.95

%

$

1,998

 

12.21

%

$

2,072

 

13.66

%

Commercial real estate

 

8,889

 

52.80

%

5,939

 

45.73

%

4,737

 

46.04

%

3,961

 

44.56

%

3,144

 

41.93

%

Residential real estate

 

2,035

 

22.87

%

1,922

 

30.21

%

2,037

 

30.57

%

2,031

 

30.33

%

1,951

 

29.91

%

Loans held-for-sale

 

 

0.19

%

 

0.11

%

 

0.37

%

 

0.86

%

 

1.13

%

Consumer

 

3,960

 

6.13

%

3,856

 

7.80

%

4,080

 

8.44

%

4,153

 

10.10

%

3,581

 

11.41

%

Other

 

58

 

0.25

%

338

 

0.47

%

709

 

0.63

%

443

 

1.94

%

473

 

1.96

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Totals

 

$

19,739

 

100.0

%

$

15,721

 

100.0

%

$

14,564

 

100.0

%

$

12,586

 

100.0

%

$

11,221

 

100.0

%

 


(1) Balances related to certain loan categories have been reclassified in prior years to reflect revised allocation methods used in 2002.

 

Investment Activities

 

General. The Company maintains a portfolio of investments to provide liquidity and an additional source of income.

 

Securities by Category. The following table sets forth the carrying value of the securities, by major categories, held by the Company at December 31, 2005, 2004 and 2003:

 

 

 

At December 31,

 

 

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

Securities Held to Maturity:

 

 

 

 

 

 

 

U.S. Treasury securities and obligations of U.S. Government, corporations and agencies

 

$

 

$

250

 

$

748

 

Obligations of state and political subdivisions

 

2,630

 

3,382

 

4,136

 

Corporate Securities

 

749

 

749

 

748

 

 

 

 

 

 

 

 

 

Total

 

$

3,379

 

$

4,381

 

$

5,632

 

 

 

 

 

 

 

 

 

Securities Available for Sale:

 

 

 

 

 

 

 

U.S. Treasury securities and obligations of U.S. Government, corporations and agencies

 

$

40,755

 

$

26,989

 

$

24,720

 

Obligations of state and political subdivisions

 

1,700

 

1,821

 

1,880

 

Trust Preferred Securities

 

6,413

 

6,508

 

6,599

 

 

 

 

 

 

 

 

 

Total

 

$

48,868

 

$

35,318

 

$

33,199

 

 

8



 

Maturity Distributions of Securities. The following table sets forth the distributions of maturities of securities at amortized cost as of December 31, 2005:

 

 

 

Due in One
Year or Less

 

Due After One
Year through
Five Years

 

Due After Five
Years through
10 Years

 

Due After 10
Years

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

US Treasury securities and Federal agency obligations – available for sale

 

$

17,044

 

$

11,821

 

$

1,839

 

$

10,550

 

$

41,254

 

Federal agency obligations – held to maturity

 

 

 

 

 

 

Obligations of state and political subdivisions – available for sale

 

 

815

 

896

 

 

1,711

 

Obligations of state and political subdivisions – held to maturity

 

50

 

1,662

 

918

 

 

2,630

 

Other securities – available for sale

 

 

 

 

6,500

 

6,500

 

Other securities – held to maturity

 

 

493

 

256

 

 

749

 

 

 

 

 

 

 

 

 

 

 

 

 

Subtotal

 

$

17,094

 

$

14,791

 

$

3,909

 

$

17,050

 

$

52,844

 

 

 

 

 

 

 

 

 

 

 

 

 

Market value adjustment on available-for-sale securities

 

(138

)

(178

)

(13

)

(268

)

(597

)

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

16,956

 

$

14,613

 

$

3,896

 

$

16,782

 

$

52,247

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average yield (a) 

 

2.97

%

3.94

%

4.77

%

6.08

%

4.37

%

 


(a)           Actual yields on tax-exempt obligations do not differ materially from yields computed on a tax equivalent basis.

 

Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

9



 

Deposits

 

Deposits are the primary source of funds for the Company. Such deposits consist of checking accounts, regular savings deposits, NOW accounts, Money Market Accounts and market rate Certificates of Deposit. Deposits are attracted from individuals, partnerships and corporations in the Company’s market area. In addition, the Company obtains deposits from state and local entities and, to a lesser extent, U.S. Government and other depository institutions. The Company’s policy permits the acceptance of limited amounts of brokered deposits.

 

The following table sets forth the average balances and average interest rates based on daily balances for deposits for the periods indicated:

 

 

 

Year Ended December 31,

 

 

 

2005

 

2004

 

2003

 

 

 

Average

 

Average

 

Average

 

Average

 

Average

 

Average

 

 

 

Balance

 

Rate Paid

 

Balance

 

Rate Paid

 

Balance

 

Rate Paid

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Types of deposits (all in domestic offices):

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing demand deposits

 

$

125,071

 

 

$

105,763

 

 

$

73,432

 

 

Interest-bearing demand deposits

 

355,566

 

1.52

%

272,382

 

0.59

%

225,508

 

0.61

%

Savings deposits

 

68,053

 

0.36

%

63,732

 

0.26

%

54,857

 

0.36

%

Time deposits

 

591,608

 

3.01

%

466,392

 

2.24

%

384,836

 

2.87

%

Total deposits

 

$

1,140,298

 

 

 

$

908,269

 

 

 

$

738,633

 

 

 

 

The following table indicates the amount of the Company’s certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 2005:

 

 

 

Certificates of

 

Maturity Period

 

Deposits

 

 

 

 

 

Three months or less

 

$

66,426

 

Over three through six months

 

45,422

 

Over six through twelve months

 

51,361

 

Over twelve months

 

48,495

 

Total

 

$

211,704

 

 

10



 

Competition

 

To compete effectively, the Company relies substantially on local commercial activity; personal contacts by its directors, officers, other employees and shareholders; personalized services; and its reputation in the communities it serves.

 

According to data as of June 30, 2005 published by SNL Financial LC and using information from the FDIC, the Bank ranked as the largest independent commercial bank headquartered in East Tennessee, and its major market areas include Greene, Hamblen, Hawkins, Sullivan, Washington, Madison, Loudon, Blount, Knox, McMinn, Sumner, Rutherford, Davidson, Montgomery, Lawrence and Williamson Counties, Tennessee and portions of Cocke, Monroe and Jefferson Counties, Tennessee. In Greene County, in which the Company enjoyed its largest deposit share as of June 30, 2005, there were seven commercial banks and one savings bank, operating 25 branches and holding an aggregate of approximately $923 million in deposits as of June 30, 2005. The following table sets forth the Bank’s deposit share, excluding credit unions, in each county in which it has a full-service branch(s) as of June 30, 2005, according to data published by the FDIC:

 

County

 

Deposit Share

 

Greene, TN

 

37.00

%

Lawrence, TN

 

14.12

%

Hawkins, TN

 

13.22

%

Montgomery, TN(1)

 

12.85

%

Blount, TN

 

11.83

%

Sumner, TN

 

7.31

%

Cocke, TN

 

6.55

%

McMinn, TN

 

6.16

%

Hamblen, TN

 

5.46

%

Madison, NC

 

5.13

%

Washington, TN

 

5.02

%

Loudon, TN

 

4.54

%

Bristol, VA(2)

 

3.66

%

Rutherford, TN

 

2.73

%

Sullivan, TN

 

2.48

%

Monroe, TN

 

1.16

%

Knox, TN

 

0.23

%

Davidson, TN

 

0.19

%

Williamson, TN

 

0.01

%

 


(1) The Company acquired five full-service branches in Montgomery County on October 7, 2005.

(2) Bristol, VA is deemed a city.

 

Employees

 

As of December 31, 2005 the Company employed 561 full-time equivalent employees. None of the Company’s employees are presently represented by a union or covered under a collective bargaining agreement. Management considers relations with employees to be good.

 

Regulation, Supervision and Governmental Policy

 

The following is a brief summary of certain statutes, rules and regulations affecting the Company and the Bank. A number of other statutes and regulations have an impact on their operations. The following summary of applicable statutes and regulations does not purport to be complete and is qualified in its entirety by reference to such statutes and regulations.

 

11



 

Bank Holding Company Regulation. The Company is registered as a bank holding company under the Bank Holding Company Act (the “Holding Company Act”) and, as such, is subject to supervision, regulation and examination by the Board of Governors of the FRB.

 

Acquisitions and Mergers. Under the Holding Company Act, a bank holding company must obtain the prior approval of the FRB before (1) acquiring direct or indirect ownership or control of any voting shares of any bank or bank holding company if, after such acquisition, the bank holding company would directly or indirectly own or control more than 5% of such shares; (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company. Also, any company must obtain approval of the FRB prior to acquiring control of the Company or the Bank. For purposes of the Holding Company Act, “control” is defined as ownership of more than 25% of any class of voting securities of the Company or the Bank, the ability to control the election of a majority of the directors, or the exercise of a controlling influence over management or policies of the Company or the Bank.

 

The Change in Bank Control Act and the related regulations of the FRB require any person or persons acting in concert (except for companies required to make application under the Holding Company Act), to file a written notice with the FRB before such person or persons may acquire control of the Company or the Bank. The Change in Bank Control Act defines “control” as the power, directly or indirectly, to vote 25% or more of any voting securities or to direct the management or policies of a bank holding company or an insured bank.

 

Bank holding companies like the Company are currently prohibited from engaging in activities other than banking and activities so closely related to banking or managing or controlling banks as to be a proper incident thereto. The FRB’s regulations contain a list of permissible nonbanking activities that are closely related to banking or managing or controlling banks. A bank holding company must file an application or notice with the FRB prior to acquiring more than 5% of the voting shares of a company engaged in such activities. The Gramm-Leach-Bliley Act of 1999 (the “GLB Act”), however, greatly broadened the scope of activities permissible for bank holding companies. The GLB Act permits bank holding companies, upon election and classification as financial holding companies, to engage in a broad variety of activities “financial” in nature. The Company has not filed an election with the FRB to be a financial holding company, but may chose to do so in the future.

 

Capital Requirements. The Company is also subject to FRB guidelines that require bank holding companies to maintain specified minimum ratios of capital to total assets and capital to risk-weighted assets. See “Capital Requirements.”

 

Dividends. The FRB has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The FRB has issued a policy statement expressing its view that a bank holding company should pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company’s capital needs, asset quality, and overall financial condition. The Company does not believe compliance with this policy statement will limit the Company’s ability to maintain its dividend payment rate.

 

Support of Banking Subsidiaries. Under FRB policy, the Company is expected to act as a source of financial strength to its banking subsidiaries and, where required, to commit resources to support each of such subsidiaries. Further, if the Bank’s capital levels were to fall below minimum regulatory guidelines, the Bank would need to develop a capital plan to increase its capital levels and the Company would be required to guarantee the Bank’s compliance with the capital plan in order for such plan to be accepted by the federal regulatory authority.

 

Under the “cross guarantee” provisions of the Federal Deposit Insurance Act (the “FDI Act”), any FDIC-insured subsidiary of the Company such as the Bank could be liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of any other FDIC-insured subsidiary also controlled by the Company or (ii) any assistance provided by the FDIC to any FDIC-insured subsidiary of the Company in danger of default.

 

Transactions with Affiliates. The Federal Reserve Act, as recently amended by Regulation W, imposes legal restrictions on the quality and amount of credit that a bank holding company or its non-bank subsidiaries (“affiliates”) may obtain from bank subsidiaries of the holding company. For instance, these restrictions generally require that any such extensions of credit by a bank to its affiliates be on nonpreferential terms and be

 

12



 

secured by designated amounts of specified collateral. Further, a bank’s ability to lend to its affiliates is limited to 10% per affiliate (20% in the aggregate to all affiliates) of the bank’s capital and surplus.

 

Bank Regulation. As a Tennessee banking institution, the Bank is subject to regulation, supervision and regular examination by the Tennessee Department of Financial Institutions. Tennessee and federal banking laws and regulations control, among other things, required reserves, investments, loans, mergers and consolidations, issuance of securities, payment of dividends, and establishment of branches and other aspects of the Bank’s operations. Supervision, regulation and examination of the Company and the Bank by the bank regulatory agencies are intended primarily for the protection of depositors rather than for holders of the Common Stock of the Company.

 

Extensions of Credit. Under joint regulations of the federal banking agencies, including the FDIC, banks must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification standards, prudent underwriting standards, including loan-to-value limits that are clear and measurable, loan administration procedures and documentation, approval and reporting requirements. A bank’s real estate lending policy must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies (the “Interagency Guidelines”) that have been adopted by the federal banking regulators. The Interagency Guidelines, among other things, call upon depository institutions to establish internal loan-to-value limits for real estate loans that are not in excess of the loan-to-value limits specified in the Guidelines for the various types of real estate loans. The Interagency Guidelines state that it may be appropriate in individual cases to originate or purchase loans with loan-to-value ratios in excess of the supervisory loan-to-value limits. The aggregate amount of loans in excess of the supervisory loan-to-value limits, however, should not exceed 100% of total capital, and the total of such loans secured by commercial, agricultural, multifamily and other non-one-to-four family residential properties should not exceed 30% of total capital.

 

Federal Deposit Insurance. The deposits of the Bank are insured by the FDIC to the maximum extent provided by law, and the Bank is subject to FDIC deposit insurance assessments. The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. In early 2006, Congress passed the Federal Deposit Insurance Reform Act of 2005, which made certain changes to the Federal deposit insurance program. These changes included merging the Bank Insurance Fund and the Savings Association Insurance Fund, increasing retirement account coverage to $250,000 and providing for inflationary adjustments to general coverage beginning in 2010, providing the FDIC with authority to set the fund’s reserve ratio within a specified range, and requiring dividends to banks if the reserve ratio exceeds certain levels. The new statute grants banks an assessment credit based on their share of the assessment base on December 31, 1996, and the amount of the credit can be used to reduce assessments in any year subject to certain limitations. The Company does not anticipate this new assessment system will have a material affect on its operating results or financial condition.

 

Safety and Soundness Standards. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) required the federal bank regulatory agencies to prescribe, by regulation, non-capital safety and soundness standards for all insured depository institutions and depository institution holding companies. The FDIC and the other federal banking agencies have adopted guidelines prescribing safety and soundness standards pursuant to FDICIA. The safety and soundness guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. Among other things, the guidelines require banks to maintain appropriate systems and practices to identify and manage risks and exposures identified in the guidelines.

 

Capital Requirements. The FRB has established guidelines with respect to the maintenance of appropriate levels of capital by registered bank holding companies, and the FDIC has established similar guidelines for state-chartered banks, such as the Bank, that are not members of the FRB. The regulations of the FRB and FDIC impose two sets of capital adequacy requirements: minimum leverage rules, which require the maintenance of a specified minimum ratio of capital to total assets, and risk-based capital rules, which require the maintenance of specified minimum ratios of capital to “risk-weighted” assets. At December 31, 2005, the Company and the Bank satisfied the minimum required regulatory capital requirements. See Note 11 of Notes to Consolidated Financial Statements.

 

13



 

The FDIC has issued final regulations that classify insured depository institutions by capital levels and require the appropriate federal banking regulator to take prompt action to resolve the problems of any insured institution that fails to satisfy the capital standards. Under such regulations, a “well-capitalized” bank is one that is not subject to any regulatory order or directive to meet any specific capital level and that has or exceeds the following capital levels: a total risk-based capital ratio of 10%, a Tier 1 risk-based capital ratio of 6%, and a leverage ratio of 5%. As of December 31, 2005, the Bank was “well-capitalized” as defined by the regulations. See Note 11 of Notes to Consolidated Financial Statements for further information.

 

Legislative, Legal and Regulatory Developments: The banking industry is generally subject to extensive regulatory oversight. The Company, as a publicly held bank holding company, and the Bank, as a state-chartered bank with deposits insured by the FDIC, are subject to a number of laws and regulations. Many of these laws and regulations have undergone significant change in recent years. These laws and regulations impose restrictions on activities, minimum capital requirements, lending and deposit restrictions and numerous other requirements. Future changes to these laws and regulations, and other new financial services laws and regulations, are likely and cannot be predicted with certainty. Future legislative or regulatory change, or changes in enforcement practices or court rulings, may have a dramatic and potentially adverse impact on the Company and its bank and other subsidiaries.

 

USA Patriot Act. The President of the United States signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (the “Patriot Act”), into law on October 26, 2001. The Patriot Act establishes a wide variety of new and enhanced ways of combating international terrorism. The provisions that affect banks (and other financial institutions) most directly are contained in Title III of the act. In general, Title III amended existing law - primarily the Bank Secrecy Act - to provide the Secretary of Treasury (the “Treasury”) and other departments and agencies of the federal government with enhanced authority to identify, deter, and punish international money laundering and other crimes.

 

Among other things, the Patriot Act prohibits financial institutions from doing business with foreign “shell” banks and requires increased due diligence for private banking transactions and correspondent accounts for foreign banks. In addition, financial institutions will have to follow new minimum verification of identity standards for all new accounts and will be permitted to share information with law enforcement authorities under circumstances that were not previously permitted. These and other provisions of the Patriot Act became effective at varying times and the Treasury and various federal banking agencies are responsible for issuing regulations to implement the new law.

 

Additional Information

 

The Company maintains a website at www.mybankconnection.com and is not including the information contained on this website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. The Company makes available free of charge (other than an investor’s own internet access charges) through its website its Annual Report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after the Company electronically files such material with, or furnishes such material to, the Securities and Exchange Commission.

 

ITEM 1A.               RISK FACTORS.

 

The Company’s business strategy includes the continuation of growth plans, and its financial condition and results of operations could be affected if its business strategies are not effectively executed.

 

The Company intends to continue pursuing a growth strategy for its business through acquisitions and de novo branching. The Company’s prospects must be considered in light of the risks, expenses and difficulties occasionally encountered by financial services companies in growth stages, which may include the following: 

 

      Maintaining loan quality;

 

      Maintaining adequate management personnel and information systems to oversee such growth; and

 

      Maintaining adequate control and compliance functions.

 

14



 

Operating Results. There is no assurance that existing offices or future offices will maintain or achieve deposit levels, loan balances or other operating results necessary to avoid losses or produce profits. The Company’s growth and de novo branching strategy necessarily entails growth in overhead expenses as it routinely adds new offices and staff. The Company’s historical results may not be indicative of future results or results that may be achieved as the company continue to increase the number and concentration of its branch offices.

 

Development of Offices. There are considerable costs involved in opening branches and new branches generally do not generate sufficient revenues to offset their costs until they have been in operation for at least a year or more. Accordingly, the Company’s de novo branches may be expected to negatively impact its earnings during this period of time until the branches reach certain economies of scale.

 

Expansion into New Markets. Much of the Company’s recent growth has been focused in the highly competitive Nashville, Knoxville and Clarksville metropolitan markets. The customer demographics and financial services offerings in these markets are unlike those found in the East Tennessee markets that the Company has historically served. In the Nashville, Knoxville and Clarksville markets the Company faces competition from a wide array of financial institutions. The Company’s expansion into these new markets may be impacted if it is unable to meet customer demands or compete effectively with the financial institutions operating in these markets.

 

Regulatory and Economic Factors. The Company’s growth and expansion plans may be adversely affected by a number of regulatory and economic developments or other events. Failure to obtain required regulatory approvals, changes in laws and regulations or other regulatory developments and changes in prevailing economic conditions or other unanticipated events may prevent or adversely affect the Company’s continued growth and expansion.

 

Failure to successfully address the issues identified above could have a material adverse effect on the Company’s business, future prospects, financial condition or results of operations, and could adversely affect the Company’s ability to successfully implement its business strategy.

 

The Company could sustain losses if its asset quality declines.

 

The Company’s earnings are affected by its ability to properly originate, underwrite and service loans. The Company could sustain losses if it incorrectly assesses the creditworthiness of its borrowers or fails to detect or respond to deterioration in asset quality in a timely manner. Problems with asset quality could cause the Company’s interest income and net interest margin to decrease and its provisions for loan losses to increase, which could adversely affect the Company’s results of operations and financial condition.

 

An inadequate allowance for loan losses would reduce the Company’s earnings.

 

The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and takes a charge against earnings with respect to specific loans when their ultimate collectibility is considered questionable. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb losses, or if the bank regulatory authorities require the Bank to increase the allowance for loan losses as a part of their examination process, the Company’s earnings and capital could be significantly and adversely affected.

 

15



 

Liquidity needs could adversely affect the Company’s results of operations and financial condition.

 

The Company relies on dividends from the Bank as its primary source of funds. The primary source of funds of the Bank are customer deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters and international instability. Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions. Accordingly, the Company may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Such sources include Federal Home Loan Bank advances and federal funds lines of credit from correspondent banks. While the Company believes that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands. The Company may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should such sources not be adequate.

 

Competition from financial institutions and other financial service providers may adversely affect the Company’s profitability.

 

The banking business is highly competitive and the Company experiences competition in each of its markets from many other financial institutions. The Company competes with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other community banks and super-regional and national financial institutions that operate offices in the Company’s primary market areas and elsewhere.

 

Additionally, the Company faces competition from de novo community banks, including those with senior management who were previously affiliated with other local or regional banks or those controlled by investor groups with strong local business and community ties. These de novo community banks may offer higher deposit rates or lower cost loans in an effort to attract the Company’s customers, and may attempt to hire the Company’s management and employees.

 

The Company competes with these other financial institutions both in attracting deposits and in making loans. In addition, the Company has to attract its customer base from other existing financial institutions and from new residents. The Company expects competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. The Company’s profitability depends upon its continued ability to successfully compete with an array of financial institutions in its market areas.

 

The Company may face risks with respect to future expansion.

 

From time to time the Company may engage in additional de novo branch expansion as well as the acquisition of other financial institutions or parts of those institutions. The Company may also consider and enter into new lines of business or offer new products or services. In addition, the Company may receive future inquiries and have discussions with potential acquirors of the Company. Acquisitions and mergers involve a number of risks, including:

 

      the time and costs associated with identifying and evaluating potential acquisitions and merger partners;

 

      inaccuracies in the estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target institution;

 

      the time and costs of evaluating new markets, hiring experienced local management and opening new offices, and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;

 

      the Company’s ability to finance an acquisition and possible dilution to its existing shareholders;

 

16



 

      the diversion of the Company’s management’s attention to the negotiation of a transaction, and the integration of the operations and personnel of the combining businesses;

 

      entry into new markets where the Company lacks experience;

 

      the introduction of new products and services into the Company’s business;

 

      the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on the Company’s results of operations; and

 

      the risk of loss of key employees and customers.

 

The Company may incur substantial costs to expand. There can be no assurance that integration efforts for any future mergers or acquisitions will be successful. Also, the Company may issue equity securities, including common stock and securities convertible into shares of the Company’s common stock in connection with future acquisitions, which could cause ownership and economic dilution to the Company’s shareholders. There is no assurance that, following any future mergers or acquisitions, the Company’s integration efforts will be successful or the Company, after giving effect to the acquisition, will achieve profits comparable to or better than its historical experience.

 

The Company’s business is subject to the success of the local economies where it operates.

 

The Company’s success significantly depends upon the growth in population, income levels, deposits and housing starts in its market areas. If the communities in which the Company operates do not grow or if prevailing economic conditions locally or nationally are unfavorable, the Company’s business may not succeed. Adverse economic conditions in the Company’s specific market areas could reduce its growth rate, affect the ability of its customers to repay their loans to the Company and generally affect its financial condition and results of operations. Moreover, the Company cannot give any assurance that it will benefit from any market growth or favorable economic conditions in its primary market areas if they do occur.

 

Any adverse market or economic conditions in the state of Tennessee may increase the risk that the Company’s borrowers will be unable to timely make their loan payments. In addition, the market value of the real estate securing loans as collateral could be adversely affected by unfavorable changes in market and economic conditions. As of December 31, 2005, approximately 75.82% of the Company’s loans held for investment were secured by real estate. Of this amount, approximately 41.87% were commercial real estate loans, 27.76% were residential real estate loans and 30.37% were construction and development loans. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in the state of Tennessee could adversely affect the value of the Company’s assets, revenues, results of operations and financial condition.

 

Changes in interest rates could adversely affect the Company’s results of operations and financial condition.

 

Changes in interest rates may affect the Company’s level of interest income, the primary component of its gross revenue, as well as the level of its interest expense. Interest rates are highly sensitive to many factors that are beyond the Company’s control, including general economic conditions and the policies of various governmental and regulatory authorities. Accordingly, changes in interest rates could decrease the Company’s net interest income. Changes in the level of interest rates also may negatively affect the Company’s ability to originate real estate loans, the value of the Company’s assets and the Company’s ability to realize gains from the sale of its assets, all of which ultimately affects the Company’s earnings.

 

The Company relies heavily on the services of key personnel.
 

The Company depends substantially on the strategies and management services of R. Stan Puckett, its Chairman of the Board and Chief Executive Officer. Although the Company has entered into an employment agreement with him, the loss of the services of Mr. Puckett could have a material adverse effect on the Company’s business, results of operations and financial condition. The Company is also dependent on certain other key officers who have important customer relationships or are instrumental to its operations. Changes in key personnel and their responsibilities may be disruptive to the Company’s business and could have a material adverse effect on the Company’s business, financial condition and results of operations.

 

17



 

The Company believes that its future results will also depend in part upon its attracting and retaining highly skilled and qualified management and sales and marketing personnel, particularly in those areas where the Company may open new branches. Competition for such personnel is intense, and the Company cannot assure you that it will be successful in attracting or retaining such personnel.

 

The Company is subject to extensive regulation that could limit or restrict its activities.
 

The Company operates in a highly regulated industry and is subject to examination, supervision, and comprehensive regulation by various federal and state agencies including the Board of Governors of the FRB, the FDIC and the Tennessee Department of Financial Institutions. The Company’s regulatory compliance is costly and restricts certain of its activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. The Company is also subject to capitalization guidelines established by its regulators, which require it to maintain adequate capital to support its growth.

 

The laws and regulations applicable to the banking industry could change at any time, and the Company cannot predict the effects of these changes on its business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, the Company’s cost of compliance could adversely affect its ability to operate profitably.

 

The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission and Nasdaq that are now applicable to the Company, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. As a result, the Company has experienced, and may continue to experience, greater compliance costs.

 

The Company’s recent results may not be indicative of its future results.

 

The Company may not be able to sustain its historical rate of growth or may not even be able to grow its business at all. In addition, the Company’s recent growth may distort some of its historical financial ratios and statistics. In the future, the Company may not have the benefit of several recently favorable factors, such as a generally stable interest rate environment, a strong residential mortgage market, or the ability to find suitable expansion opportunities. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or prohibit the Company’s ability to expand its market presence.

 

The Company is subject to Tennessee anti-takeover statutes and certain charter provisions which could decrease its chances of being acquired even if the acquisition is in the Company’s shareholders’ best interests.

 

As a Tennessee corporation, the Company is subject to various legislative acts which impose restrictions on and require compliance with procedures designed to protect shareholders against unfair or coercive mergers and acquisitions. These statutes may delay or prevent offers to acquire the Company and increase the difficulty of consummating any such offers, even if the acquisition of the Company would be in its shareholders’ best interests. The Company’s amended and restated charter also contains provisions which may make it difficult for another entity to acquire it without the approval of a majority of the disinterested directors on its board of directors.

 

The amount of common stock owned by, and other compensation arrangements with, the Company’s officers and directors may make it more difficult to obtain shareholder approval of potential takeovers that they oppose.

 

As of March 10, 2006, directors and executive officers beneficially owned approximately 12.74% of the Company’s common stock. Agreements with the Company’s senior management also provide for significant payments under certain circumstances following a change in control. These compensation arrangements, together with the common stock and option ownership of the Company’s board of directors and management, could make it difficult or expensive to obtain majority support for shareholder proposals or potential acquisition proposals of us that the Company’s directors and officers oppose.

 

The Company’s continued pace of growth may require it to raise additional capital in the future, but that capital may not be available when it is needed.

 

18



 

The Company is required by federal and state regulatory authorities to maintain adequate levels of capital to support its operations. While the Company’s capital resources will satisfy its capital requirements for the foreseeable future, the Company may at some point, however, need to raise additional capital to support its continued growth.

 

The Company’s ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside its control, and on its financial performance. Accordingly, the Company cannot assure its shareholders that it will be able to raise additional capital if needed on terms acceptable to it. If the Company cannot raise additional capital when needed, its ability to further expand its operations through internal growth and acquisitions could be materially impaired.

 

The success and growth of the Company’s business will depend on its ability to adapt to technological changes.

 

The banking industry and the ability to deliver financial services is becoming more dependent on technological advancement, such as the ability to process loan applications over the Internet, accept electronic signatures, provide process status updates instantly and on-line banking capabilities and other customer expected conveniences that are cost efficient to the Company’s business processes. As these technologies are improved in the future, the Company may, in order to remain competitive, be required to make significant capital expenditures.

 

Even though the Company’s common stock is currently traded on The Nasdaq National Market, the trading volume in its common stock has been thin and the sale of substantial amounts of the Company’s common stock in the public market could depress the price of its common stock.

 

The Company cannot say with any certainty when a more active and liquid trading market for its common stock will develop or be sustained. Because of this, the Company’s shareholders may not be able to sell their shares at the volumes, prices, or times that they desire.

 

The Company cannot predict the effect, if any, that future sales of its common stock in the market, or availability of shares of its common stock for sale in the market, will have on the market price of the Company’s common stock. The Company, therefore, can give no assurance that sales of substantial amounts of its common stock in the market, or the potential for large amounts of sales in the market, would not cause the price of its common stock to decline or impair its ability to raise capital through sales of its common stock.

 

The market price of the Company’s common stock may fluctuate in the future, and these fluctuations may be unrelated to its performance. General market price declines or overall market volatility in the future could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices.

 

The Company may issue additional common stock or other equity securities in the future which could dilute the ownership interest of existing shareholders.

 

In order to maintain its capital at desired levels or required regulatory levels, or to fund future growth, the Company’s board of directors may decide from time to time to issue additional shares of common stock, or securities convertible into, exchangeable for or representing rights to acquire shares of its common stock. The sale of these shares may significantly dilute the Company’s shareholders ownership interest as a shareholder and the per share book value of its common stock. New investors in the future may also have rights, preferences and privileges senior to its current shareholders which may adversely impact its current shareholders.

 

The Company’s ability to declare and pay dividends is limited by law and it may be unable to pay future dividends.

 

The Company derives its income solely from dividends on the shares of common stock of the Bank. The Bank’s ability to declare and pay dividends is limited by its obligations to maintain sufficient capital and by other general restrictions on its dividends that are applicable to banks that are regulated by the FDIC and the Department of Financial Institutions. In addition, the FRB may impose restrictions on the Company’s ability to pay dividends on its common stock. As a result, the Company cannot assure its shareholders that it will declare or pay dividends on shares of its common stock in the future.

 

19



 

Holders of the Company’s junior subordinated debentures have rights that are senior to those of its common shareholders.

 

The Company has supported its continued growth through the issuance of trust preferred securities from special purpose trusts and accompanying junior subordinated debentures. At December 31, 2005, the Company had outstanding trust preferred securities and accompanying junior subordinated debentures totaling $13.4 million. Payments of the principal and interest on the trust preferred securities of these trusts are conditionally guaranteed by the Company. Further, the accompanying junior subordinated debentures the Company issued to the trusts are senior to its shares of common stock. As a result, the Company must make payments on the junior subordinated debentures before any dividends can be paid on its common stock and, in the event of its bankruptcy, dissolution or liquidation, the holders of the junior subordinated debentures must be satisfied before any distributions can be made on its common stock. The Company has the right to defer distributions on its junior subordinated debentures (and the related trust preferred securities) for up to five years, during which time no dividends may be paid on its common stock.

 

ITEM 1B.               UNRESOLVED STAFF COMMENTS.

 

None.

 

ITEM 2.  PROPERTIES.

 

At December 31, 2005, the Company maintained a main office in Greeneville, Tennessee in a building it owns, 49 full-service bank branches (of which 38 are owned premises and 11 are leased premises) and a leased office for trust and money management functions. In addition, the Bank’s subsidiaries operate from nine separate locations, all of which are leased.

 

ITEM 3.  LEGAL PROCEEDINGS.

 

The Company and its subsidiaries are subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of these pending claims and legal proceedings will not have a material adverse effect on the Company’s results of operations.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

 

No matters were submitted during the fourth quarter of 2005 to a vote of security holders of the Company through a solicitation of proxies or otherwise.

 

20



 

PART II

 

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

On March 10, 2006, Greene County Bancshares had 9,781,070 shares of common stock outstanding. The Company’s shares are traded on The Nasdaq National Market, under the symbol “GCBS”. As of March 10, 2006, the Company estimates that it had approximately 3,200 shareholders, including approximately 2,000 shareholders of record and approximately 1,200 beneficial owners holding shares in nominee or “street” name.

 

The following table shows the high and low sales price for the Company’s common stock as reported by The Nasdaq National Market for 2005 and 2004. The table also sets forth the dividends per share paid each quarter during 2005 and 2004.

 

 

 

High/Low Sales Price

 

Dividends Paid

 

 

 

During Quarter

 

Per Share

 

2005:

 

 

 

 

 

First quarter

 

$28.50 / 25.88

 

$

0.12

 

Second quarter

 

29.75 / 23.75

 

0.12

 

Third quarter

 

29.50 / 25.09

 

0.12

 

Fourth quarter

 

28.32 / 25.65

 

0.26

 

 

 

 

 

$

0.62

 

 

 

 

 

 

 

2004:

 

 

 

 

 

First quarter

 

$24.64 / 21.11

 

$

0.12

 

Second quarter

 

23.86 / 20.47

 

0.12

 

Third quarter

 

24.02 / 22.25

 

0.12

 

Fourth quarter

 

27.70 / 23.50

 

0.25

 

 

 

 

 

$

0.61

 

 

Holders of the Company’s common stock are entitled to receive dividends when, as and if declared by the Company’s board of directors out of funds legally available for dividends. Historically, the Company has paid quarterly cash dividends on its common stock, and its board of directors presently intends to continue to pay regular quarterly cash dividends. The Company’s ability to pay dividends to its shareholders in the future will depend on its earnings and financial condition, liquidity and capital requirements, the general economic and regulatory climate, the Company’s ability to service any equity or debt obligations senior to its common stock, including its outstanding trust preferred securities and accompanying junior subordinated debentures, and other factors deemed relevant by the Company’s board of directors. In order to pay dividends to shareholders, the Company must receive cash dividends from the Bank. As a result, the Company’s ability to pay future dividends will depend upon the earnings of the Bank, its financial condition and its need for funds.

 

21



 

Moreover, there are a number of federal and state banking policies and regulations that restrict the Bank’s ability to pay dividends to the Company and the Company’s ability to pay dividends to its shareholders. In particular, because the Bank is a depository institution and its deposits are insured by the FDIC, it may not pay dividends or distribute capital assets if it is in default on any assessment due to the FDIC. In addition, the Tennessee Banking Act prohibits the Bank from declaring dividends in excess of net income for the calendar year in which the dividend is declared plus retained net income for the preceding two years without the approval of the Commissioner of the Department of Financial Institutions. Also, the Bank is subject to regulations which impose certain minimum regulatory capital and minimum state law earnings requirements that affect the amount of cash available for distribution to the Company. Lastly, under Federal Reserve policy, the Company is required to maintain adequate regulatory capital, is expected to serve as a source of financial strength to the Bank and to commit resources to support the Bank. These policies and regulations may have the effect of reducing or eliminating the amount of dividends that the Company can declare and pay to its shareholders in the future. For information regarding restrictions on the payment of dividends by the Bank to the Company, see “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Liquidity and Capital Resources” in this Annual Report. See also Note 11 of Notes to Consolidated Financial Statements.

 

The Company made no repurchases of its common stock during the quarter ended December 31, 2005.

 

22



 

ITEM 6.  SELECTED FINANCIAL DATA.

 

 

 

At and for the Fiscal Years Ended December 31,

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest income

 

$

87,191

 

$

65,076

 

$

56,737

 

$

59,929

 

$

67,964

 

Total interest expense

 

28,405

 

16,058

 

15,914

 

18,680

 

28,463

 

Net interest income

 

58,786

 

49,018

 

40,823

 

41,249

 

39,501

 

Provision for loan losses

 

(6,365

)

(5,836

)

(5,775

)

(7,065

)

(5,959

)

Net interest income after provision for loan losses

 

52,421

 

43,182

 

35,048

 

34,184

 

33,542

 

Noninterest income:

 

 

 

 

 

 

 

 

 

 

 

Investment securities gains

 

 

 

 

46

 

 

Other income

 

14,756

 

13,028

 

11,588

 

10,484

 

9,593

 

Noninterest expense

 

(44,340

)

(36,983

)

(30,618

)

(29,199

)

(28,665

)

Income before income taxes

 

22,837

 

19,227

 

16,018

 

15,515

 

14,470

 

Income tax expense

 

(8,674

)

(7,219

)

(5,781

)

(5,702

)

(5,047

)

Net income

 

$

14,163

 

$

12,008

 

$

10,237

 

$

9,813

 

$

9,423

 

 

 

 

 

 

 

 

 

 

 

 

 

Per Share Data:

 

 

 

 

 

 

 

 

 

 

 

Net income, basic

 

$

1.73

 

$

1.57

 

$

1.48

 

$

1.44

 

$

1.38

 

Net income, assuming dilution

 

$

1.71

 

$

1.55

 

$

1.47

 

$

1.43

 

$

1.38

 

Dividends declared

 

$

0.62

 

$

0.61

 

$

0.59

 

$

0.58

 

$

0.56

 

Book value

 

$

17.20

 

$

14.22

 

$

13.31

 

$

10.94

 

$

10.06

 

Tangible book value(1)

 

$

13.15

 

$

11.12

 

$

10.57

 

$

10.53

 

$

9.64

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Condition Data:

 

 

 

 

 

 

 

 

 

 

 

Assets

 

$

1,619,989

 

$

1,233,403

 

$

1,108,522

 

$

899,396

 

$

811,612

 

Loans, net of unearned interest

 

$

1,378,642

 

$

1,046,867

 

$

952,225

 

$

750,257

 

$

682,547

 

Cash and investments

 

$

104,872

 

$

76,637

 

$

80,910

 

$

61,980

 

$

57,470

 

Federal funds sold

 

$

28,387

 

$

39,921

 

$

5,254

 

$

39,493

 

$

25,621

 

Deposits

 

$

1,295,879

 

$

988,022

 

$

907,115

 

$

719,323

 

$

653,913

 

FHLB advances and notes payable

 

$

105,146

 

$

85,222

 

$

63,030

 

$

82,359

 

$

67,978

 

Subordinated debentures

 

$

13,403

 

$

10,310

 

$

10,310

 

$

 

$

 

Federal funds purchased and repurchase agreements

 

$

17,498

 

$

13,868

 

$

12,896

 

$

10,038

 

$

10,375

 

Shareholders’ equity

 

$

168,021

 

$

108,718

 

$

101,935

 

$

74,595

 

$

68,627

 

Tangible shareholders’ equity(1)

 

$

128,399

 

$

85,023

 

$

80,965

 

$

71,799

 

$

65,721

 

 

 

 

 

 

 

 

 

 

 

 

 

Selected Ratios:

 

 

 

 

 

 

 

 

 

 

 

Interest rate spread

 

4.30

%

4.53

%

4.59

%

4.99

%

4.98

%

Net interest margin(2)

 

4.61

%

4.75

%

4.83

%

5.29

%

5.41

%

Return on average assets

 

1.02

%

1.06

%

1.12

%

1.17

%

1.20

%

Return on average equity

 

11.09

%

11.23

%

12.59

%

13.40

%

13.96

%

Return on average tangible equity(1)

 

14.04

%

13.95

%

13.38

%

13.93

%

14.30

%

Average equity to average assets

 

9.20

%

9.47

%

8.87

%

8.72

%

8.59

%

Dividend payout ratio

 

37.38

%

38.86

%

41.20

%

40.31

%

40.53

%

Ratio of nonperforming assets to total assets

 

0.65

%

0.69

%

0.79

%

1.48

%

1.22

%

Ratio of allowance for loan losses to nonperforming loans

 

293.56

%

227.64

%

321.70

%

161.73

%

166.78

%

Ratio of allowance for loan losses to total loans, net of unearned income

 

1.43

%

1.50

%

1.53

%

1.68

%

1.64

%

 


(1)   Tangible shareholders’ equity is shareholders’ equity less goodwill and intangible assets.

(2)   Net interest margin is the net yield on interest earning assets and is the difference between the interest yield earned on interest-earning assets less the interest rate paid on interest bearing liabilities.

 

23



 

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

 

Certain financial information included in our summary consolidated financial data is determined by methods other than in accordance with accounting principles generally accepted within the United States, or GAAP. These non-GAAP financial measures are “tangible book value per share,” “tangible shareholders’ equity,” and “return on average tangible equity.” The Company’s management uses these non-GAAP measures in its analysis of the Company’s performance.

 

   “Tangible book value per share” is defined as total equity reduced by recorded goodwill and other intangible assets divided by total common shares outstanding. This measure is important to investors interested in changes from period-to-period in book value per share exclusive of changes in intangible assets. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing total book value while not increasing the tangible assets of a company. For companies such as the Company that have engaged in business combinations, purchase accounting can result in the recording of significant amounts of goodwill related to such transactions.

   “Tangible shareholders’ equity” is shareholders’ equity less goodwill and other intangible assets.

   “Return on average tangible equity” is defined as earnings for the period divided by average equity reduced by average goodwill and other intangible assets.

 

These disclosures should not be viewed as a substitute for results determined in accordance with GAAP, and are not necessarily comparable to non-GAAP performance measures which may be presented by other companies. The following reconciliation table provides a more detailed analysis of these non-GAAP performance measures:

 

 

 

At and for the Fiscal Years Ended December 31,

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

Book value per share

 

$

17.20

 

$

14.22

 

$

13.31

 

$

10.94

 

$

10.06

 

Effect of intangible assets per share

 

$

(4.05

)

$

(3.10

)

$

(2.74

)

$

(.0.41

)

$

(0.42

)

Tangible book value per share

 

$

13.15

 

$

11.12

 

$

10.57

 

$

10.53

 

$

9.64

 

Return on average equity

 

11.09

%

11.23

%

12.59

%

13.40

%

13.96

%

Effect of intangible assets

 

2.95

%

2.72

%

0.79

%

0.53

%

0.34

%

Return on average tangible equity

 

14.04

%

13.95

%

13.38

%

13.93

%

14.30

%

 

24



 

ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

Net income increased by almost 18% over 2004 levels and totaled $14,163 for the full year 2005. The rise in net income was driven by an increase in earning assets, primarily loans. On a diluted per share basis, net income was $1.71 for 2005 compared with $1.55 for the same period a year ago, an increase of 10.3%. The lower percentage increase for diluted earnings per share is primarily a result of the issuance of 2.1 million shares of common stock at the end of the third quarter of 2005.

 

Net interest income for 2005, totaled $58,786, an improvement of 19.9% over the same period a year ago. The increase in net interest income was due to the increase in average earning assets, primarily loans, throughout 2005 and was partially offset by a reduction in the net interest margin from 4.75% in 2004 to 4.61% in 2005. The narrowing in the net interest margin was heavily influenced by the actions taken by the Federal Open Market Committee (“FOMC”) during 2005 to increase market rates eight times which sharply increased market interest rates by 200 basis points during the year and placed significant pressures on funding costs. Noninterest income grew by $1,728, or 13.3%, and totaled $14,756 for 2005. The successful implementation of a deposit gathering program plus the carryover effect of expansion initiatives in 2004 and the fourth quarter 2005 acquisition of the Clarksville branches all contributed to this improvement. Noninterest expenses, which were impacted by some assimilation costs associated with the Clarksville branch acquisition, totaled $44,340 for the year, up $7,357 from the prior year. Similarly with noninterest income, the Company’s expansion activity in 2004 and in 2005 has impacted the comparisons between years.

 

Critical Accounting Policies and Estimates

 

The Company’s consolidated financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported periods.

 

Management continually evaluates the Company’s accounting policies and estimates it uses to prepare the consolidated financial statements. In general, management’s estimates are based on current and projected economic conditions, historical experience, information from regulators and third party professionals and various assumptions that are believed to be reasonable under the then existing set of facts and circumstances. Actual results could differ from those estimates made by management.

 

The Company believes its critical accounting policies and estimates include the valuation of the allowance for loan losses and the fair value of financial instruments and other accounts. Based on management’s calculation, an allowance of $19,739, or 1.43%, of total loans, net of unearned interest was an adequate estimate of losses inherent in the loan portfolio as of December 31, 2005. This estimate resulted in a provision for loan losses on the income statement of $6,365 during 2005. If the mix and amount of future charge-off percentages differ significantly from those assumptions used by management in making its determination, the allowance for loan losses and provision for loan losses on the income statement could be materially affected. For further discussion of the allowance for loan losses and a detailed description of the methodology management uses in determining the adequacy of the allowance, see “BUSINESS – Lending Activities – Allowance for Loan Losses” located earlier, and “Changes in Results of Operations – Provision for Loan Losses” located below.

 

The consolidated financial statements include certain accounting and disclosures that require management to make estimates about fair values. Estimates of fair value are used in the accounting for securities available for sale, loans held for sale, goodwill, other intangible assets, and acquisition purchase accounting adjustments. Estimates of fair values are used in disclosures regarding securities held to maturity, stock compensation (in 2006 the fair value estimates will affect the accounting for stock options), commitments, and the fair values of financial instruments. Fair values are estimated using relevant market information and other assumptions such as interest rates, credit risk, prepayments and other factors. The fair values of financial instruments are subject to change as influenced by market conditions.

 

25



 

Changes in Results of Operations

 

Net income. Net income for 2005 was $14,163, an increase of 2,155, or 17.95%, as compared to net income of $12,008 for 2004. The increase is primarily attributable to an increase in net interest income of $9,768, or 19.93%, to $58,786 in 2005 from $49,018 in 2004 and resulted principally from higher average balances of loans. In addition, total noninterest income increased by $1,728, or 13.26%, to $14,756 in 2005 from $13,028 in 2004. The increase in noninterest income can be primarily attributed to higher fee income associated with additional volume of deposit-related activity. Offsetting, in part, these positive effects on net income was an increase in noninterest expense of $7,357, or 19.89%, to $44,340 in 2005 from $36,983 in 2004. The increase in noninterest expense resulted primarily as a result of the Company’s de novo branching initiatives into Davidson County and Williamson County, Tennessee, the NBC transaction in late-2004, the Clarksville transaction during the first part of the fourth quarter-2005 and the advertising cost associated with the Bank’s High Performance Checking Program.

 

Net income for 2004 was $12,008, an increase of $1,771, or 17.30%, as compared to net income of $10,237 for 2003. The increase is primarily attributable to an increase in net interest income of $8,195, or 20.07%, to $49,018 in 2004 from $40,823 in 2003 and resulted principally from higher average balances of loans. In addition, total noninterest income increased by $1,440, or 12.43%, to $13,028 in 2004 from $11,588 in 2003. The increase in noninterest income can be primarily attributed to a significant gain on the sale of OREO property, the gain on the sale of the Company’s credit card portfolio and higher fee income associated with additional volume of deposit-related activity. Offsetting, in part, these positive effects on net income was an increase in noninterest expense of $6,365, or 20.79%, to $36,983 in 2004 from $30,618 in 2003. The increase in noninterest expense resulted principally from the Company’s growth strategy reflected in the first full year of operations in Sumner and Rutherford Counties, Tennessee, resulting from the Company’s acquisition of Gallatin-based IBC in November, 2003, as well as the de novo branching initiative into Davidson County, Tennessee and the NBC transaction in Lawrence County, Tennessee, both of which occurred in the fourth quarter of 2004.

 

Net Interest Income. The largest source of earnings for the Company is net interest income, which is the difference between interest income on interest-earning assets and interest paid on deposits and other interest-bearing liabilities. The primary factors that affect net interest income are changes in volume and yields of earning assets and interest-bearing liabilities, which are affected in part by management’s responses to changes in interest rates through asset/liability management. During 2005, net interest income was $58,786 as compared to $49,018 in 2004, an increase of 19.93%. The Company experienced good growth in average balances of interest-earning assets, with average total interest-earning assets increasing by $244,151, or 23.67%, to $1,275,791 in 2005 from $1,031,640 in 2004. Most of the growth occurred in loans, with average loan balances increasing by $204,271, or 20.70%, to $1,191,077 in 2005 from $986,806 in 2004. Average balances of total interest-bearing liabilities also increased in 2005 from 2004, with average total interest-bearing deposit balances increasing by $212,721, or 26.51%, to $1,015,227 in 2005 from $802,506 in 2004, as the Company emphasized various types of deposits as a loan funding source. The Clarksville transaction, which closed on October 7, 2005 and in which the Company acquired approximately $112,000 in loans and $173,000 in deposits, had a slight effect on full year average balances of loans and deposits. Most of the increase in net interest income in 2005 compared to 2004 related to the increased loan volume resulting primarily from the Company’s organic loan growth, as well as the late-2004 NBC transaction. The positive net interest income impact of the increase in average loan volumes was partially offset by rising costs associated with both deposits and borrowed funds as the FOMC continued its trend of increasing market interest rates throughout the year.

 

Beginning in the second half of 2004, the FOMC embarked upon a program to increase short-term interest rates at, according to the FOMC’s statements, a “pace that is likely to be measured.”  As of December 31, 2004, the FOMC had increased short-term interest rates by 100 basis points. While the Company continues to maintain an interest rate risk position which is asset sensitive, a situation in which rate-sensitive assets reprice quicker than rate-sensitive liabilities, the FOMC’s commencement of increases in short-term interest rates in mid-2004 was not sufficient to compensate the Company for significant and sustained reductions in short-term interest rates beginning in early 2001, and the Company was unable to achieve upward momentum in the repricing of its major interest-earning assets. The Company’s aggressive loan pricing in 2004 in order to obtain market share in new markets and increase share in existing markets further exacerbated this situation. In addition, management had been controlling the growth of higher-yielding subprime loans in the Bank’s subsidiaries and focusing on increasing the balances of its traditional commercial, commercial real estate and residential real estate loans, thus reducing the percentage of subprime loans in the Company’s portfolio. This trend in the loan portfolio mix also placed pressure on loan yields. Consequently, the

 

26



 

Company’s yield on average loans declined to 6.44% in 2004 from 6.92% in 2003, and the Company’s net interest margin declined to 4.75% in 2004 from 4.83% in 2003. This decline represented the sixth consecutive year of net interest margin declines.

 

Average Balances, Interest Rates and Yields. Net interest income is affected by (i) the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities (“interest rate spread”) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. The Company’s interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. When the total of interest-earning assets approximates or exceeds the total of interest-bearing liabilities, any positive interest rate spread will generate net interest income. An indication of the effectiveness of an institution’s net interest income management is its “net yield on interest-earning assets,” which is net interest income divided by average interest-earning assets.

 

27



 

The following table sets forth certain information relating to the Company’s consolidated average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the periods presented.

 

 

 

2005

 

2004

 

2003

 

 

 

Average

 

 

 

Average

 

Average

 

 

 

Average

 

Average

 

 

 

Average

 

 

 

Balance

 

Interest

 

Rate

 

Balance

 

Interest

 

Rate

 

Balance

 

Interest

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Real estate loans

 

$

896,485

 

$

58,968

 

6.58

%

$

759,657

 

$

44,124

 

5.81

%

$

612,528

 

$

37,311

 

6.09

%

Commercial loans

 

208,964

 

13,651

 

6.53

%

145,870

 

7,685

 

5.27

%

105,629

 

5,532

 

5.24

%

Consumer and other loans-net(2) 

 

85,628

 

9,319

 

10.88

%

81,279

 

9,081

 

11.17

%

82,702

 

9,516

 

11.51

%

Fees on loans

 

 

2,136

 

 

 

 

2,690

 

 

 

 

3,085

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans (including fees)

 

$

1,191,077

 

$

84,074

 

7.06

%

$

986,806

 

$

63,580

 

6.44

%

$

800,859

 

$

55,444

 

6.92

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities(3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

$

48,774

 

$

1,920

 

3.94

%

$

29,382

 

$

1,040

 

3.54

%

$

28,297

 

$

946

 

3.34

%

Tax-exempt(4)

 

3,668

 

138

 

3.76

%

4,569

 

164

 

3.59

%

1,189

 

40

 

3.37

%

FHLB, Bankers Bank and other stock at cost

 

6,308

 

282

 

4.47

%

6,073

 

230

 

3.79

%

5,378

 

193

 

3.59

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total investment securities

 

$

58,750

 

$

2,340

 

3.98

%

$

40,024

 

$

1,434

 

3.58

%

$

34,864

 

$

1,179

 

3.38

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other short-term investments

 

25,964

 

777

 

2.99

%

4,810

 

62

 

1.29

%

9,769

 

114

 

1.17

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-earning assets

 

$

1,275,791

 

$

87,191

 

6.83

%

$

1,031,640

 

$

65,076

 

6.31

%

$

845,492

 

$

56,737

 

6.71

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

32,971

 

 

 

 

 

$

32,430

 

 

 

 

 

$

26,926

 

 

 

 

 

Premises and equipment

 

38,891

 

 

 

 

 

34,795

 

 

 

 

 

27,879

 

 

 

 

 

Other, less allowance for loan losses

 

40,943

 

 

 

 

 

31,156

 

 

 

 

 

16,190

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total noninterest-earning assets

 

$

112,805

 

 

 

 

 

$

98,381

 

 

 

 

 

$

70,995

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,388,596

 

 

 

 

 

$

1,130,021

 

 

 

 

 

$

916,487

 

 

 

 

 

 


(1) Average loan balances include nonaccrual loans. Interest income collected on nonaccrual loans has been included.

(2) Installment loans are stated net of unearned income.

(3) The average balance of and the related yield associated with securities available for sale are based on the cost of such securities.

(4) Tax exempt income has not been adjusted to tax-equivalent basis since it is not material.

 

28



 

 

 

2005

 

2004

 

2003

 

 

 

Average

 

 

 

Average

 

Average

 

 

 

Average

 

Average

 

 

 

Average

 

 

 

Balance

 

Interest

 

Rate

 

Balance

 

Interest

 

Rate

 

Balance

 

Interest

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings, NOW accounts and money markets

 

$

423,619

 

$

5,654

 

1.33

%

$

336,114

 

$

1,762

 

0.52

%

$

280,365

 

$

1,576

 

0.56

%

Time deposits

 

591,608

 

17,827

 

3.01

%

466,392

 

10,437

 

2.24

%

384,836

 

11,055

 

2.87

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total deposits

 

$

1,015,227

 

$

23,481

 

2.31

%

$

802,506

 

$

12,199

 

1.52

%

$

665,201

 

$

12,631

 

1.90

%