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| MCBI > SEC Filings for MCBI > Form 10-K on 16-Mar-2009 | All Recent SEC Filings |
16-Mar-2009
Annual Report
Special Cautionary Notice Regarding Forward-Looking Statements
Statements and financial discussion and analysis contained in this Annual Report on Form 10-K and documents incorporated herein by reference that are not historical statements of fact constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements describe the Company's future plans, strategies and expectations, are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company's control. In addition to the factors discussed in Item 1A "Risk Factors" of this Annual Report on Form 10-K, the important factors that could cause actual results to differ materially from the results, performance or achievements expressed or implied by the forward-looking statements include, without limitation:
• changes in interest rates and market prices, which could reduce the Company's net interest margins, asset valuations and expense expectations;
• changes in the levels of loan prepayments and the resulting effects on the value of the Company's loan portfolio;
• changes in local economic and business conditions which adversely affect the ability of the Company's customers to transact profitable business with the Company, including the ability of borrowers to repay their loans according to their terms or a change in the value of the related collateral;
• increased competition for deposits and loans adversely affecting rates and terms;
• the Company's ability to identify suitable acquisition candidates;
• the timing, impact and other uncertainties of the Company's ability to enter new markets successfully and capitalize on growth opportunities;
• increased credit risk in the Company's assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio;
• the failure of assumptions underlying the establishment of and provisions made to the allowance for loan losses;
• the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on the results of operation;
• changes in the availability of funds resulting in increased costs or reduced liquidity;
• a determination or downgrade in the credit quality and credit agency ratings of the securities in the Company's securities portfolio;
• increased asset levels and changes in the composition of assets and the resulting impact on our capital levels and regulatory capital ratios;
• the Company's ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes;
• the loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels; and
• changes in statutes and government regulations or their interpretations applicable to bank holding companies and our present and future banking and other subsidiaries, including changes in tax requirements and tax rates.
All written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements. Forward-looking statements speak only as of the date on which such statements are made. The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company analyzes the major elements of the Company's balance sheets and statements of income. This section should be read in conjunction with the Company's Consolidated Financial Statements and accompanying notes and other detailed information appearing elsewhere in this Annual Report on Form 10-K.
Critical Accounting Estimates
The Company has established various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of the Company's consolidated financial statements. Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, and are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company.
Allowance for loan losses. The Company believes the allowance for loan losses is a critical accounting estimate that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements. The Company's allowance for possible loan loss methodology is based on guidance provided in SEC Staff Accounting Bulletin No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues" and includes allowance allocations calculated in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS 118, and allowance allocations determined in accordance with SFAS No. 5, "Accounting for Contingencies." In estimating the allowance for loan losses, management reviews the effect of changes in the local real estate market on collateral values, the effect of current economic indicators on the loan portfolio and their probable impact on borrowers and increases or decreases in nonperforming and impaired loans. Changes in these factors may cause management's estimate of the allowance to increase or decrease and result in adjustments to the Company's provision for loan losses. See-"Financial Condition-Allowance for Loan Losses and the Reserve for Unfunded Lending Commitments."
Goodwill. The Company believes goodwill is a critical accounting estimate that requires significant judgment and estimates to be used in the preparation of its consolidated financial statements. The Company reviews goodwill for impairment on an annual basis, or more often, if events or circumstances indicate that it is more likely than not that the fair value of Metro United, the Company's only reporting unit with assigned goodwill, is below the carrying value of its equity. The Company's annual evaluation is performed as of August 31 of each year.
Annual Evaluation
In determining the fair value of Metro United, the Company primarily uses a review of the valuation of recent guideline bank acquisitions as well as discounted cash flow analysis. The guideline bank transactions were selected from a similar geographic footprint as Metro United or having a similar market focus, based on publicly available information. Valuation multiples such as price-to-book, price-to-tangible book, price-to-deposits, and price-to-earnings from the guideline transactions are compared with Metro United's operating results to derive its implied goodwill as of the valuation date. The Company also uses the discounted cash flow method to estimate the value of Metro United. The discounted cash flow method estimates the value of interest rate sensitive instruments by discounting the expected future cash flows using the current interest rates at which similar instruments with similar terms would be made. In addition, as a third method of determining fair value, quoted stock prices as of the valuation date for the Company and its peer guideline banks were used as a current comparative proxy. The values separately derived from each valuation technique (i.e., guideline transactions, discounted cash flows, and quoted market prices) are evaluated to assess whether goodwill was impaired.
Additional Evaluation
As a result of the decrease in the market price of the Company's stock to a level below book value during the fourth quarter of 2008, continued deterioration in the economy during the fourth quarter of 2008, and a net loss recorded by Metro United for the year ended December 31, 2008, the Company performed an additional valuation of goodwill as of December 31, 2008. Due to a lack of guideline bank acquisitions in the fourth quarter of 2008, the Company utilized a discounted cash flow analysis to determine the fair value of Metro United. Multi-year financial forecasts were developed by projecting net income for the next five years and discounting the average terminal values based on the valuation multiples listed in the previous paragraph in a normalized market. The financial forecasts considered several key business drivers such as anticipated loan and deposit growth, forward interest rates, historical performance, and industry and economic trends, among other considerations. The Company used an average growth rate of 6% for the 5-year period and discounted Metro United's terminal value using a 10% rate of return. The Company also performed a sensitivity analysis utilizing additional discount rates ranging from 8% to 15%.
The Company also considered the fair value of Metro United in relationship to the Company's stock price and performed a reconciliation to market price. This reconciliation was performed by first using the Company's market price on a minority basis with an estimated control premium of 30%. The Company then allocated the total fair value to both of its segments, Metro Bank and Metro United. The allocation was based upon an average of the following internal ratios:
• Metro United's assets as a percentage of total assets
• Metro United's loans as a percentage of total loans
• Metro United's deposits as a percentage of total deposits
• Metro United's stockholder's equity as a percentage of total stockholders' equity
The derived fair value of Metro United was then compared to the carrying value of its equity. As the carrying value of its equity exceeded the fair value, an additional goodwill impairment evaluation was performed which involves calculating the implied fair value of the Metro United's goodwill.
The implied fair value of goodwill is determined in the same manner as goodwill is recognized in a business combination. The fair value of Metro United's assets and liabilities, including previously unrecognized intangible assets, is individually determined. Significant judgment and estimates are involved in estimating the fair value of the assets and liabilities of Metro United. The value of the implied goodwill is highly sensitive to the estimated fair value of Metro United's net assets. The excess fair value of Metro United over the fair value of its net assets is the implied goodwill. The fair value of Metro United's net assets is estimated using recent data observed in the market, including similar assets and liabilities.
Observable market information is utilized to the extent available and relevant. The estimated fair values reflect management's assumptions regarding how a market participant would value the net assets and includes appropriate credit, liquidity, and market risk adjustments that are indicative of the current environment. The estimated liquidity and market risk adjustments on certain loan categories ranged from 20% to 50% due to the distressed nature of the market in California. The size of the implied goodwill was significantly affected by the estimated fair value of the loans pertaining to Metro United. The significant market risk adjustment that is a consequence of the current distressed market conditions was a significant contributor to the valuation discounts associated with these loans.
If the implied fair value of the goodwill for Metro United exceeds its carrying value of the goodwill, no goodwill impairment is recorded. Changes in the estimated fair value of the individual assets and liabilities may result in a different amount of implied goodwill, and ultimately the amount of goodwill impairment, if any. Sensitivity analysis is performed to assess the potential ranges of implied goodwill.
Based on the fair value of Metro United's assets and liabilities at December 31, 2008, the implied fair value of goodwill exceeded its carrying value. However, it is possible that future changes in the fair value of Metro
United's net assets could result in future goodwill impairment. For example, to the extent that market liquidity returns and the fair value of the individual assets of Metro United increases at a faster rate than the fair value of Metro United as a whole, that may cause the implied goodwill to be lower than the carrying value of goodwill, resulting in goodwill impairment. Ultimately, future potential changes in valuation assumptions may impact the estimated fair value of Metro United and cause its fair value to be below its carrying value, therefore resulting in an impairment of the goodwill. Subsequent to year end, the stock price has declined which may require reassessment of goodwill in the first or subsequent quarters of 2009.
Stock-based compensation.The Company believes stock-based compensation is a critical accounting estimate that requires significant judgment and estimates used in the preparation of its consolidated financial statements. The Company accounts for stock-based compensation in accordance with the fair value recognition provisions of SFAS No. 123R. The Company uses the Black-Scholes option-pricing model which requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them ("expected term"), the estimated volatility of the Company's common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements ("forfeitures"). Changes in the subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized on the consolidated statements of income.
Fair Value. The Company believes estimates of fair value are a critical accounting estimate that requires significant judgment and estimates used in the preparation of its consolidated financial statements. Certain portions of the Company's assets are reported on a fair value basis. Fair value is used on a recurring basis for certain assets in which fair value is the primary basis of accounting. The extent to which fair value is used on a recurring basis was significantly expanded upon the adoption of SFAS No. 157 and SFAS No. 159 effective on January 1, 2008. An example of this recurring use of fair value includes available for sale securities. Additionally, fair value is used on a non-recurring basis to evaluate assets for impairment or for disclosure purposes. Examples of these non-recurring uses of fair value include goodwill, intangible assets, and certain collateral dependent impaired loans. Depending on the nature of the asset, various valuation techniques and assumptions are used when estimating fair value. These valuation techniques and assumptions are in accordance with SFAS No. 157.
Fair value is the price that could be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Fair value determination in accordance with SFAS No. 157 requires that a number of significant judgments are made. First, where prices for identical assets and liabilities are not available, application of the three-level hierarchy established by SFAS No. 157 would require that similar assets are identified. If observable market prices are unavailable or impracticable to obtain, then fair value is estimated using modeling techniques such as discounted cash flow analyses. These modeling techniques incorporate the Company's assessments regarding assumptions that market participants would use in pricing the asset or the liability, including assumptions about the risks inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset, and the risk of nonperformance. Assessments with respect to assumptions that market participants would make are inherently difficult to determine and use of different assumptions could result in material changes to these fair value measurements. As required under SFAS No. 157, any use of significant, unobservable inputs would be described in Note 17, "Fair Value," to the Consolidated Financial Statements.
In estimating the fair values for investment securities the Company believes that independent, third-party market prices are the best evidence of exit price and where available, estimates are based on such prices. If such third-party market prices are not available on the exact securities owned, fair values are based on the market prices of similar instruments, independent pricing service estimates or are estimated using industry-standard or proprietary models whose inputs may be unobservable. When market observable data is not available, the valuation of financial instruments becomes more subjective and involves substantial judgment. The need to use unobservable inputs generally results from the lack of market liquidity for certain types of loans and securities, which results in diminished observability of both actual trades and assumptions that would otherwise be available to value these instruments.
Overview
The Company, primarily through the Banks, generates earnings from several sources. The Banks attract customer deposits through their nineteen branches located in the greater Houston, Dallas, San Diego, Los Angeles, and San Francisco metropolitan areas. The types of deposits vary from noninterest-bearing demand deposit transaction accounts to interest-bearing NOW and money market transaction accounts, savings accounts, and various termed time deposits such as certificates of deposit ("CD's") and individual retirement accounts ("IRA's"). With the funds attracted from the communities surrounding the branches, the Banks originate loans to individuals and small businesses to finance business operations, purchases of real estate, or other business opportunities. The Company's net interest income represents the difference between the interest income earned on interest-earning assets, including loans and securities, and the interest expense paid on interest-bearing liabilities, including customer deposits and other borrowed funds. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income. This represents the primary source of income generated by the Company during each fiscal year and can be found on the Statement of Income under "net interest income."
To complement net interest income, the Company also earns fee income from both deposits and loans through service fees and charges collected from customers, and fee income from letters of credit commissions through its international banking business. Generally, the Company receives the greater portion of its fees from its deposit customers in the form of service fees, NSF fees, and other fees for services provided to the customer. Loan related fees are generally earned from administrative document and processing fees, and other loan-related type fees. The fees collected by the Company may be found on the Statement of Income under "noninterest income." Offsetting these earnings are operating expenses referred to as "noninterest expense." Because banking is a very people intensive industry, the largest of the Company's operating expenses is salaries and employee benefits.
Total assets at December 31, 2008 were $1.58 billion, an increase of $120.5 million or 8.3% compared with $1.46 billion at December 31, 2007. The growth in assets was primarily a result of the loan growth through new loan originations. Total loans at December 31, 2008 were $1.35 billion, an increase of $144.1 million or 12.0% compared with $1.20 billion at December 31, 2007. Investment securities at December 31, 2008 were $102.1 million, down $35.6 million or 25.9% from $137.7 million at December 31, 2007. Total deposits at December 31, 2008 were $1.27 billion, an increase of $78.1 million or 6.6% compared with $1.19 billion at December 31, 2007. Other borrowings at December 31, 2008 were $139.0 million, up $39.2 million or 39.3% compared with $99.8 million at December 31, 2007. Junior subordinated debentures were $36.1 million at both December 31, 2008 and 2007.
Net income for the years ended December 31, 2008, 2007, and 2006 was $1.8 million, $12.2 million, and $13.5 million, respectively. Diluted earnings per share for the years ended December 31, 2008, 2007, and 2006 were $0.17, $1.10, and $1.22, respectively. The Company's returns on average assets for the years ended December 31, 2008, 2007, and 2006 were 0.12%, 0.90%, and 1.13%, respectively. The Company's returns on average equity for the same periods were 1.50%, 10.77%, and 13.63%, respectively. The 2008 decreases in net income, diluted earnings per share, return on average assets, and return on average equity were due to an increase in the provision for loan losses and other than temporary impairment on securities, and reduced net interest income, all the primary result of the deteriorating general economic conditions and downturn in the real estate market.
The provision for loan losses was $16.6 million for the year ended December 31, 2008, up $13.5 million or 429.4% compared with $3.1 million in 2007. The increase was primarily due to concerns of deteriorating economic conditions in both Texas and California, primarily in the residential and commercial real estate markets.
The provision for loan losses was $3.1 million for the year ended December 31, 2007, up $2.5 million or 413.9% compared with $612,000 in 2006. Although asset quality improved with a $2.5 million or 27.3% reduction in net nonperforming assets from December 31, 2006, to December 31, 2007, the provision for loan losses increased as a result of the 35.6% growth in total loans since December 31, 2006, and an increase in net charge offs in the fourth quarter of 2007.
Recent Developments
On October 3, 2008, the EESA (initially introduced as the TARP) was enacted. On October 14, 2008, the U.S. Treasury announced the CPP, which provides for direct equity investment of perpetual preferred stock by the U.S. Treasury in qualified financial institutions. The program is voluntary and requires an institution to comply with a number of restrictions and provisions, including limits on executive compensation, stock redemptions and declaration of dividends.
In connection with the Company's participation in the CPP, on January 16, 2009,
the Company issued and sold to the U.S. Treasury (i) 45,000 shares of its Fixed
Rate Cumulative Perpetual Preferred Stock, Series A, par value $1.00 per share,
with a liquidation value of $1,000 per share (the "Series A Preferred Stock"),
and (ii) a warrant ("Warrant") to purchase 771,429 shares of the Company's
Common Stock, at an exercise price of $8.75 per share, subject to certain
anti-dilution and other adjustments, for an aggregate purchase price of $45.0
million in cash. The Series A Preferred Stock and the Warrant were issued in a
private placement exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933, as amended. The Securities Purchase Agreement, dated
January 16, 2009, pursuant to which the securities issued to the U.S. Treasury
under the CPP were sold, prevents the Company for so long as the Series A
Preferred Stock remains outstanding, from declaring or paying any dividend
(other than regular quarterly cash dividends of not more than $0.04 per share)
without the consent of the U.S. Treasury until the third anniversary of the U.S.
Treasury's investment or until the U.S. Treasury has transferred all of the
Series A Preferred Stock to third parties, limits the Company's ability to
repurchase shares of its Common Stock (with certain exceptions), grants the
holders of the Series A Preferred Stock, the Warrant and the Company's Common
Stock to be issued upon exercise of the Warrant certain registration rights and
subjects the Company to certain executive compensation limitations included in
the EESA, as amended.
On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the TLGP announced by the FDIC on October 14, 2008 to prevent systemic risk, promote financial stability by preserving confidence in the banking system and encourage liquidity in order to ease lending to creditworthy businesses and consumers. The TLGP applies to, among others, all U.S. depository institutions insured by the FDIC and all U.S. bank holding companies, unless they have opted out. The Company, MetroBank and Metro United did not opt out and chose to participate in the TLGP. Under the TLGP, specific categories of newly issued senior unsecured debt issued by the Company, Metro Bank or Metro United on or before June 30, 2009 would be guaranteed by the FDIC until June 30, 2012. Under the transaction account guarantee component of the TLGP, all non-interest bearing transaction deposit accounts maintained at MetroBank and Metro United are insured in full by the FDIC until December 31, 2009, regardless of the standard maximum deposit insurance amounts. Coverage under the TLGP is available to eligible financial institutions at a cost of 50 to 100 basis points per annum, depending on the initial maturity of the senior unsecured debt and 10 basis points per annum for deposit insurance coverage on non-interest bearing transaction account deposits on balances above $250,000.
In February 2009, the Company was notified that a $3.9 million commercial land loan with accrued interest of $51,000, secured by commercial land with an appraised value net of selling costs of approximately $4.2 million, would not be repaid due to deterioration of the borrower's financial strength. Such amounts are not included above or reflected in the financial condition, results of operations, or cash flows of the Company as of and for the year ended December 31, 2008.
2008 Developments
The second representative office of MetroBank in China, located in the city of Chongqing, opened during the first quarter of 2008. During the second quarter of 2008, the Company opened a new branch in Garland, Texas as a part of the strategy to expand its presence in the greater Dallas metropolitan area.
On June 30, 2008, the Company recognized an other-than-temporary impairment charge of $1.5 million pre-tax, on its $14.2 million investment in the AMF Ultra Short Mortgage Fund (the "Fund"). In July 2008, the Company redeemed its shares in the Fund for approximately $2.2 million in cash, with the remaining value of approximately $10.5 million, net of a $57,000 loss distributed in the form of securities held by the Fund that approximated the Company's respective interest in each of the underlying securities.
In October 2008, the Company filed a "shelf" registration statement on Form S-3 . . .
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