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| CAPB > SEC Filings for CAPB > Form 10-Q on 14-Aug-2008 | All Recent SEC Filings |
14-Aug-2008
Quarterly Report
"Net Operating income" is defined as net income less the effect of the non-cash
goodwill impairment charge. "Return on average tangible equity" is defined as
earnings for the period divided by average equity reduced by average goodwill
and other intangible assets. "Return on average tangible assets" is defined as
earnings for the period divided by average assets reduced by average goodwill
and other intangible assets. Our management includes these measures because it
believes that they are important when measuring CapitalSouth's performance
against entities with varying levels of goodwill and other intangibles. These
measures are used by many investors as part of their analysis of the bank
holding company's performance.
"Average tangible equity to average tangible assets" is defined as average total
equity reduced by recorded average intangible assets divided by average total
assets reduced by recorded average intangible assets. This measure is important
to many investors in the marketplace who are interested in the equity to assets
ratio exclusive of the effect of changes in average intangible assets on average
equity and average total assets.
"Tangible book value per share" is defined as total equity reduced by recorded
intangible assets divided by total common shares outstanding. This measure is
important to many investors in the marketplace who are 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 book value of the Company.
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 bank holding companies. The following
reconciliation table provides a more detailed analysis of these non-GAAP
performance measures.
For the Three Months Ended June 30, For the Six Months Ended June 30,
2008 2007 2008 2007
(Dollar amounts in thousands, except per share amounts)
Book value of equity $ 29,757 $ 42,657 $ 29,757 $ 42,657
Intangible assets 807 1,276 807 1,276
Book value of tangible equity $ 28,950 $ 41,381 $ 28,950 $ 41,381
Average assets $ 755,168 $ 504,062 $ 760,968 $ 497,629
Average intangible assets 10,277 1,276 10,392 1,276
Average tangible assets $ 744,891 $ 502,786 $ 750,576 $ 496,353
Return on average assets (8.73 %) 0.71 % (4.25 %) 0.65 %
Effect of average intangible assets (0.12 %) 0.01 % (0.06 %) 0.00 %
Return on average tangible assets (8.85 %) 0.72 % (4.31 %) 0.65 %
Average equity $ 46,779 $ 42,700 $ 47,094 $ 42,293
Average intangible assets 10,315 1,276 10,429 1,276
Average tangible equity $ 36,464 $ 41,424 $ 36,665 $ 41,017
Return on average equity (140.96 %) 8.43 % (68.64 %) 7.64 %
Effect of average intangible assets (39.87 %) 0.26 % (19.52 %) 0.24 %
Return on average tangible equity (180.83 %) 8.69 % (88.16 %) 7.88 %
Net operating (loss) income $ (7,032 ) $ 897 $ (6,710 ) $ 1,603
Goodwill impairment charge 9,363 - 9,363 -
Net (loss) income $ (16,395 ) $ 897 $ (16,073 ) $ 1,603
Per share:
Book value $ 7.16 $ 14.23 $ 7.16 $ 14.23
Effect of intangible assets 0.20 0.43 0.20 0.43
Tangible book value $ 6.96 $ 13.80 $ 6.96 $ 13.80
Net operating (loss) income $ (1.69 ) $ 0.30 $ (1.62 ) $ 0.54
Goodwill impairment charge (2.26 ) - (2.25 ) -
Net (loss) income $ (3.95 ) $ 0.30 $ (3.87 ) $ 0.54
Per diluted share:
Net operating (loss) income $ (1.69 ) $ 0.30 $ (1.62 ) $ 0.53
Goodwill impairment charge (2.26 ) - (2.25 ) -
Net (loss) income $ (3.95 ) $ 0.30 $ (3.87 ) $ 0.53
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percentages are annualized
Critical Accounting Policies
The accounting and financial policies of the Company conform to accounting
principles generally accepted in the United States and to general practices
within the banking industry. The allowance for loan losses, valuation of other
real estate owned, and goodwill impairment are accounting policies applied by
the Company which are deemed critical. Critical accounting policies are defined
as policies which are important to the portrayal of the Company's financial
condition and results of operations and require management's most difficult,
subjective or complex judgments. These estimates and judgments involve
significant uncertainties and are susceptible to change. If different conditions
exist or occur, depending upon the magnitude of the changes, our actual
financial condition and financial results could differ significantly.
Other real estate owned, consisting of properties obtained through foreclosure
or in satisfaction of loans, is reported at the lower of cost or fair value,
determined on the basis of current appraisals, comparable sales, and other
estimates of value obtained principally from independent sources, adjusted for
estimated selling costs. At the time of foreclosure, any excess of the loan
balance over the fair value of the real estate held as collateral is treated as
a charge against the allowance for loan losses. Gains or losses on sale and any
subsequent adjustments in value are recorded as a component of noninterest
expense.
With the deterioration of goodwill and the subsequent write-down of all
remaining goodwill on the Company's balance sheet, goodwill impairment will
cease to be a critical accounting policy for the Company after the second
quarter of 2008. For a more detailed discussion on these critical accounting
policies, see "Critical Accounting Policies and Estimates" on page 31 of the
Company's Annual Report on Form 10-K for the year ended December 31, 2007.
Recent Developments
The State Banking Department of Alabama and the Federal Reserve Bank of Atlanta
recently completed the fieldwork for a regularly scheduled examination of the
Bank during the second quarter. The reported results of the Company reflect
discussions with regulators on the allowance for loan losses and loan
charge-offs, among other matters. The Company has been advised orally that a
formal enforcement action will be issued because of the impact of the high level
of nonperforming assets on the financial performance of the Bank. Though the
particular terms of such enforcement action are not known at this time, the
Company expects that it will require improvement in Bank earnings, lower
nonperforming loan levels, increased Bank capital, revisions to various policies
as well as other possible corrective actions.
The Company has already begun taking steps consistent with meeting these
requirements. The Company has filed a registration statement for a rights
offering for shares of its common stock. The registration statement has not
become effective but the Company anticipates it being declared effective by the
SEC in the third quarter of 2008 and concluding and closing the offering prior
to year end.
Financial Condition
Investment Securities and Federal Funds Sold
Investment securities totaled $96,441,690 at June 30, 2008 and $83,026,918 at
December 31, 2007. The following table shows the amortized cost of the Company's
securities by their stated maturities (this maturity schedule excludes security
prepayment and call features), as well as the tax equivalent yields for each
maturity range.
Maturity of Investment Securities - Amortized Cost
June 30, 2008
Less than One year to Five years to More than
one year five years ten years ten years Total
U. S. Government agency securities $ 3,999,643 $ 29,992,025 $ 19,343,401 $ 3,626,268 $ 56,961,337
Mortgage-backed securities - 7,407,106 3,537,915 1,012,355 11,957,376
Collateralized mortgage obligations - - 2,607,585 3,868,071 6,475,656
Municipal securities 779,775 1,793,655 13,021,125 4,035,290 19,629,845
Corporate securities - 1,034,998 1,021,361 - 2,056,359
Total $ 4,779,418 $ 40,227,784 $ 39,531,387 $ 12,541,984 $ 97,080,573
Tax equivalent yield 3.96 % 3.88 % 4.42 % 4.36 %
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On a quarterly basis, the Company makes an assessment to determine whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other-than-temporary basis. The Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; recent events specific to the issuer or industry; and for debt securities, external credit ratings and recent downgrades. Securities on which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss
in securities gains (losses). Gross unrealized losses at June 30, 2008, are
primarily caused by interest rate changes. The Company has reviewed these
securities in accordance with its accounting policy for other-than-temporary
impairment discussed above and recorded $78,000 in impairment losses on its
available-for-sale securities sold after quarter end at a loss. The Company does
not consider any other securities to be other-than-temporarily impaired.
However, without recovery in the near term such that liquidity returns to the
markets and spreads return to levels that reflect underlying credit
characteristics, additional other-than-temporary impairments may occur in future
periods.
All securities held are traded in liquid markets. As of June 30, 2008, the
Company owned securities from three issuers in which the aggregate book value
from these issuers exceeded 10% of stockholders' equity. As of June 30, 2008,
the book value and fair value of the securities from each of these issuers was
as follows:
Book Value Fair Value
Federal National Mortgage Association $ 21,397,086 $ 21,159,592
Federal Home Loan Mortgage Corporation 15,030,719 15,011,361
Federal Home Loan Bank 27,348,602 27,204,036
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At June 30, 2008, the Company had $35,768 in federal funds sold compared with
$230,064 in federal funds sold at December 31, 2007.
Loans
Total loans were $589,060,000 at June 30, 2008, a decrease of $33,051,000, or
5.31%, over total loans of $622,111,000 at December 31, 2007. Due to the general
deterioration in the real estate sector, the Company has tightened its credit
criteria for loans secured by real estate. We are actively reducing our
concentration of construction loans and land acquisition and development loans.
Accordingly, we have reduced our balances outstanding in these type loans by
$27,967,000 or 14.2% since year-end.
The following table details the change in the loan portfolio composition,
including loans held-for-sale, for the periods ending June 30, and March 31,
2008 and December 31, 2007:
June 30, 2008 March 31, 2008 December 31, 2007
Amount % Amount % Amount %
(Dollar amounts in thousands)
Loans
Construction and land
development $ 168,491 28.43 % $ 186,819 30.31 % $ 196,458 31.21 %
Farmland 7,871 1.33 10,573 1.72 7,909 1.26
1-4 family
residential 134,768 22.74 138,080 22.40 144,520 22.96
Multifamily 25,657 4.33 29,155 4.73 30,009 4.77
Nonfarm
nonresidential 148,396 25.04 140,534 22.80 141,240 22.44
Commercial &
industrial 99,665 16.82 103,414 16.78 101,652 16.15
Consumer 7,733 1.30 7,779 1.26 7,742 1.23
Total loans, net $ 592,581 100.00 % $ 616,354 100.00 % $ 629,530 100.00 %
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Asset Quality
The allowance for loan losses is established and maintained at levels management
deems adequate to absorb anticipated credit losses from identified and otherwise
inherent risks in the loan portfolio as of the balance sheet date. In assessing
the adequacy of the allowance, we review the quality of, and risks in, loans in
the portfolio. We also consider such factors as:
• specific known risks;
• our loan loss experience;
• adverse situations that may affect a borrower's ability to repay;
• the status and amount of past due and nonperforming loans;
• underlying estimated values of collateral securing loans;
• current and anticipated economic conditions; and
• other factors which management believes affect the allowance for loan losses.
An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan losses is prepared by our credit administration department and presented to our subsidiary bank's board of directors on a monthly basis. In addition, loan reviews are performed regularly on the quality of the loan portfolio and related adequacy of the allowance by an individual independent of the lending function. We have outsourced loan review of loans in excess of $3 million to an experienced loan review company which reviews these loans and provides reports approximately two times per year. Based on our analysis, which includes risk factors such as charge-off rates, past dues and loan growth, we may determine our future loan loss provision needs to increase or decrease in order for us to maintain the allowance at a level sufficient to absorb
inherent credit losses. If we become aware that any of these factors have
materially changed, our estimate of credit losses in the loan portfolio and the
related allowance could also change. All loans have a risk grade assigned at the
time the loan is booked. These risk grades are evaluated periodically for
appropriateness based on the performance of the borrower and as new information
is received on the borrower's financial condition. The related allowance is
determined based on the risk grade assigned to the loan unless the loan is
classified as special mention, substandard, doubtful or loss. Once a loan is
classified, an evaluation is made on a specific allowance to be assigned.
Accordingly, changes in classification of a loan may change the amount of
allowance allocated for that loan. The allowance for loan losses is replenished
through a provision for loan losses that is charged against our earnings. As a
result, variations in the allowance directly affect our earnings.
While it is the Company's policy to provide for loan losses in the current
period when a loss is considered probable, there are additional risks of future
losses which cannot be quantified precisely or attributed to particular loans or
classes of loans. Because these risks include the state of the economy,
management's judgment as to the adequacy of the allowance is necessarily
approximate and imprecise.
The Company recorded annualized net charge-offs, as a percentage of average
loans, of 1.37% in the second quarter of 2008 compared with net charge-offs of
0.49% in the first quarter of 2008. Charge-offs in the first and second quarters
consisted of 35.8% and 37.4% respectively, related to write-downs taken on loans
being transferred into Other Real Estate Owned ("OREO") based on updated
valuations. In evaluating the adequacy of the allowance for loan losses, the
Company continues to update external appraisals on the properties underlying the
nonperforming loans and thus provide additional reserves as needed for
collateral deficiencies or changes in macroeconomic factors. Charge-offs reduce
the allowance balance and accordingly have an impact on the calculation of the
adequacy of the allowance. We determine the required allowance based on the
composition of the loan portfolio, its classifications, any known collateral
deficiencies, past due status and general economic conditions. We provide for
any shortfall in the calculated allowance compared to our recorded allowance for
loan losses through the provision for loan losses. The Company increased its
loan loss provision to $9,350,000 in the second quarter of 2008 compared with
$658,000 in the first quarter of 2008 based on updated collateral valuations,
general market conditions, and the impact of regulatory actions. The allowance
for loan losses was 2.73% of total period-end net loans and 46.00% of period-end
nonperforming loans as of June 30, 2008, compared with 1.44% and 30.93%
respectively, at March 31, 2008. Based on current appraisal valuations and other
valuation data, the Company believes that reserves are adequate to absorb future
losses in the loan portfolio.
Analysis of Changes in Allowance for Loan Losses
Six Months Ended Year Ended
June 30, December 31,
2008 2007 2007
(Dollar amounts in thousands)
Allowance for loan losses:
Beginning of period $ 8,876 $ 4,329 $ 4,329
Provision for loan losses 10,007 362 3,516
Sub-total 18,883 4,691 7,845
Charged-off loans:
Real estate loans 356 1 319
Installment loans 112 13 26
Commercial loans 1 2,360 1 -
Other loans - - 148
Total charged-off 2,828 15 493
Recoveries of charged-off loans
Real estate loans - 13 20
Installment loans 20 18 31
Commercial loans 1 7 2 11
Total recoveries 27 33 62
Net charged-off (recovered) loans 2,801 (18 ) 431
Acquired allowance for loan losses - - 1,462
. . .
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