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| MCFI.OB > SEC Filings for MCFI.OB > Form 10-K on 31-Mar-2009 | All Recent SEC Filings |
31-Mar-2009
Annual Report
The discussion and analysis that follows is intended to assist readers in the understanding and evaluation of the financial condition and results of operations of the Company. It should be read in conjunction with the audited consolidated financial statements and accompanying notes included in this Annual Report on Form 10-K and the supplemental financial data appearing throughout this discussion and analysis. Because the Company's primary asset is the Bank, the discussion that follows focuses on the Bank's business and operations.
EXECUTIVE OVERVIEW
Significant accomplishments
In the opinion of its management, the Company's most significant accomplishments during 2008, which are discussed in more detail in this Item 7, were as follows:
• Total loans classified as held for investment increased 16.9%
• Commercial and industrial loans outstanding at year end increased 34.9%
• Average non-interest bearing deposits increased 7.1%
• Total deposits at year end increased 25.2%
• Non interest income excluding gain (loss) on investments increased 3.8%
• Non interest expense excluding the reversal of accrued employee benefits increased 3.2%
• Improved operating efficiencies
Challenges.
The Bank has achieved significant growth without the advent of acquisitions or mergers since first opening its doors in 1997. The financial industry in general is faced with many uncertainties and challenges. As management plans its strategic goals and objectives, future expectations of economic activity, and how these uncertainties could impact the Company's performance, must be taken into consideration. The challenges that we believe are most likely to have an impact on the operations of the Company in the foreseeable future are presented below:
• Sustaining profitable growth
• Managing margins in an abnormally low interest rate cycle
• Competition from bank and non-bank entities, including fierce price competition
• Uncertainty of real estate values
• Obtaining adequate funding of asset growth
• Maintaining liquidity during an uncertain economic environment
• Managing equity in an unpredictable capital market
• Managing asset quality during a period of economic uncertainty
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA
Selected Consolidated Financial Information and Other Data are presented in Table 1 of Item 6. The information in this table is derived in part from the audited consolidated financial statements and notes thereto of the Company. The information in this table does not purport to be complete and should be read in conjunction with the Company's consolidated financial statements that are included in this Annual Report on Form 10-K.
FINANCIAL CONDITION
DECEMBER 31, 2008 AND 2007
The Company reported total assets increasing by $73.7 million, or 15.8%, to $540.8 million at year-end 2008. This growth was principally reflected in increased loans. Loans, excluding those held for sale, increased by $62.9 million, or 16.9%, from $371.7 million at the beginning of the year to $434.7 million at year end. The increase in loans was composed principally of increases of $16.1 million in commercial mortgage loans, $16.3 million in residential mortgage loans (including income producing properties) and $16.3 million in commercial and industrial loans, all of which are segments of lending the Company targets and intends to continue targeting in the future. Investment securities increased by $323,000, or 0.5%, from $70.8 million to $71.1 million. Liquid assets, consisting of cash and demand balances due from banks, interest-earning deposits in other banks and investment securities, were 16.1% of
Deposits increased $94.1 million during 2008. Non-interest-bearing demand accounts increased $12.5 million, or 41.0%, time deposits increased $77.8 million or 29.6%, money market and NOW accounts increased $3.4 million, or 4.5%, and savings accounts increased 300,000 or 3.93%, over the amount of such deposits at December 31, 2007. The Bank also used wholesale brokered certificates of deposit and advances from the FHLB of Atlanta, Georgia as funding sources during 2008 to serve as a secondary source of funding asset growth. Borrowings from the FHLB decreased from $49.0 million at the end of 2007 to $25.0 million at December 31, 2008. Wholesale brokered certificates of deposit comprised approximately 22.8% of total certificate of deposit balances. Typically brokered certificates of deposit have similar terms to retail certificates of deposit issued in the Bank's local markets, with rates marginally lower than local market certificates of deposit rates.
Total shareholders' equity increased by $4.0 million, or 12.2%, during 2008. All capital ratios continue to place the Company and the Bank in excess of the minimum required to be a well-capitalized institution by regulatory measures. The proceeds from the exercising of stock options of $792,000 during 2008 increased shareholders' equity by that amount. The Company issued $4.8 million in Non-Cumulative Perpetual Preferred Stock on August 15, 2005 and $8.5 million in Trust Preferred Securities during prior years, so as to remain "well capitalized" under regulatory capital guidelines without diluting existing shareholders' ownership. The Trust Preferred Securities and Preferred Stock should provide sufficient capital to retain a "well-capitalized" designation as defined by regulatory capital guidelines for the foreseeable future. The Trust Preferred Securities qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a qualifying security in a consolidated subsidiary. The junior subordinated debentures issued to guarantee the Trust Preferred Securities do not qualify as Tier 1 regulatory capital. On July 2, 2003, the Federal Reserve issued a letter, SR 03-13, stating that notwithstanding any potential implications FIN 46R may have on reporting trust preferred securities on financial statements, trust preferred securities will continue to be included in Tier 1 capital until notice is given to the contrary. There can be no assurance that the Federal Reserve will continue to allow institutions to include trust-preferred securities in Tier I capital for regulatory capital purposes. In the event of a disallowance, there would be a reduction in the Company's consolidated capital ratios. However, the Company believes that the Bank would remain "well capitalized" under FDIC guidelines.
At December 31, 2008, the Bank was considered to be "well capitalized" under the FDIC guidelines.
NET INTEREST INCOME
Similar to most financial institutions, the primary component of earnings for the Bank is net interest income. Net interest income is the difference between interest income, principally from the loan and investment securities portfolios, and interest expense, principally on deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, "volume" refers to the average dollar level of interest-earning assets and interest-bearing liabilities, "spread" refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities and "margin" refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of non-interest-bearing liabilities. During the years ended December 31, 2008, 2007 and 2006, average interest-earning assets were $487.0 million, $427.1 million and $379.2 million, respectively. During these same years, the Bank's net yields on average interest-earning assets were 2.94%, 3.12% and 3.38%, respectively. The decrease in net yields from 2007 to 2008 is a reflection of the dramatic decrease in interest rates over the year. An overall decrease in spread which is the difference between yields earned on interest bearing assets less the interest paid on interest bearing liabilities was strongly influenced by extreme competitive pressures in our markets. The Bank's balance sheet is well positioned for changes in interest rates. When interest rates change, the Bank's earnings and net yields remain stable.
Table 2, following this discussion, "Average Balances and Net Interest Income", presents an analysis of the Bank's net interest income for 2008, 2007 and 2006.
Table 3, following this discussion, "Volume and Rate Variance Analysis", shows the amounts of changes in net interest income due to changes in volume and rates and illustrates that the change in the average volume of loans and the increase in average deposit rates were the predominant factors in the higher amount of net interest income realized by the Bank in 2008, when compared to 2007.
YEARS ENDED DECEMBER 31, 2008 AND 2007
Overview. The Company reported net income available to common shareholders of $3.3 million, or $0.66 per diluted common share, for the year ended December 31, 2008, compared with net income available to shareholders of $4.5 million, or $0.92 per diluted common share, for 2007, a decrease of $1.2 million or $0.26 per diluted share. Results for the 12 months ended December 31, 2008 included a one-time after tax adjustment of $248,000 related to Other Than Temporary Impairment of Mortgage Backed Securities. Results for the 12 months ended December 31, 2007 included a one-time after-tax adjustment of $579,000 related to the reversal of accrued benefits for a former executive officer. Excluding the effect of these adjustments, our diluted earnings per common share for 2008 would have been $0.71, compared to $0.80 for 2007.
Net Interest Income. Net interest income increased to $14.3 million for the year ended December 31, 2008, a $990,000 or 7.4% increase from the $13.3 million earned in 2007. Total interest income benefited from strong growth in the level of average earning assets offset by lower asset yields caused by the decrease in interest rates during the year. The rates earned on a significant portion of the Bank's loans adjust immediately when indexes like the prime rate change. Conversely, a large portion of interest-bearing liabilities, including certificates of deposit and Bank borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in the Bank's interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. Interest rate increases will generally result in an immediate increase in the Bank's interest income on loans, with a more delayed impact on interest expense because increases in interest costs will only occur upon renewals of certificates of deposit or borrowings. Average total interest-earning assets increased $59.8 million, or 14.0%, during 2008 compared to 2007, while the average yield decreased by 119 basis points from 7.27% to 6.08%. As interest rates decreased during 2008, the average rate on loans decreased year over year. The average rate on investment securities increased in 2008 compared to 2007, reflecting management's decision to purchase higher yielding securities during 2008 taking advantage of the unusual extremes in mortgaged backed securities prices in 2008. Average total interest-bearing liabilities increased by $52.1 million, or 13.7%, consistent with the increase in interest-earning assets. The average cost of interest-bearing liabilities decreased by 113 basis points from 4.66% to 3.53%. With the yield on earning assets decreasing more significantly than the cost of interest bearing liabilities, the Bank's net interest margin decreased by 18 basis points. For the year ended December 31, 2008, the net interest margin was 2.94%, while for the year ended December 31, 2007, the net interest margin was 3.12%. Table 3 reflects the volume and rate variances from 2008 vs. 2007.
Provision for Loan Losses. The Bank recorded $1.7 million in the provision for loan losses in 2008, an increase of $1.2 million from the $425,000 provision made in 2007. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower's ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. For 2008 the provision to loan losses was made in response to the weakened economy and real estate market experienced during 2008, large provisions were made each quarter during the year, total loans outstanding, net of loans held for sale, increased by $62.9 million in 2008 and by $58.1 million in 2007. At December 31, 2008, the allowance for loan losses was $5.6 million, an increase of $1.2 million, or 26.22%, from the $4.5 million at the end of 2007. The allowance represented 1.30% and 1.20%, respectively, of loans outstanding at the end of 2008 and 2007, net of loans held for sale. At December 31, 2008, the Bank had $3.1 million in non-accrual loans. In 2007, the Bank had $700,000 in non-accrual loans. It is management's opinion that reserve levels are adequate.
Non-Interest Income. Non-interest income decreased to $2.8 million for the year ended December 31, 2008 compared to $3.1 million for the year ended December 31, 2007, a decrease of $352,000 or 11.3%. A one time gain on the sale of other real estate in the amount of $536,000 offset by a one time loss related to Other Than Temporary Impairment of private label collateralized mortgage obligation securities with market value decreases greater than 30%in the amount of $490,000, resulted in a net affect of one time benefit in the amount of $46,000 in 2008. During 2007, a one time gain on the sale of other real estate in the amount of $481,000 accounted for 15.5% of total non-interest income. Excluding the net gain on the sale of other real estate, offset by the Other Than Temporary
Non-Interest Expenses. Non-interest expenses totaled $10 million for the year ended December 31, 2008, an increase of $1.2 million over the $8.8 million reported for 2007. Adjusting non-interest expense for a one-time adjustment of $905,000 related to the reversal of accrued benefits for a former executive officer, non-interest expense for 2007 would have totaled $9.7 million, an increase of $307,000 or 3.2%. Substantially all of this increase resulted from the Bank's growth and development during 2008 and 2007. Personnel costs after the one-time adjustment of $905 thousand related to the reversal of accrued benefits for a former executive officer increased by $3,000 in 2008. Professional and other services increased $74,000 or 15.6% primarily due to expenses incurred related to the preparation of anticipated regulatory changes and increases in legal fees and proceedings. Deposit and other insurance expense increased $80,000 or 22.7% because of increased FDIC premiums. Occupancy and equipment expense increased by $51,000 due to increases in maintenance costs and additional lease expense incurred with the relocation of our Green Valley Office located in Greensboro, NC. Data processing and other outside services decreased $19,000, or 1.7%, due to the renegotiation of our bank platform operating system contract. Advertising expense increased $131,000 reflecting new marketing strategies and programs during 2008. Table 5, following this discussion, presents a comparative analysis of the components of non-interest expenses for 2008, 2007 and 2006.
Income Taxes. The provision for income tax was $1.7 million in 2008 and $2.3 million in 2007. The effective tax rates were 32.2% and 32.4%, respectively, on income before income taxes.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2007 AND 2006
Overview. The Company reported net income available to common shareholders of $4.5 million, or $0.92 per diluted common share, for the year ended December 31, 2007, compared with net income available to shareholders of $3.5 million, or $0.73 per diluted common share, for 2006, an improvement of $1.0 million or $0.19 per diluted share. When adjusted for an after-tax one time adjustment of $579,000 related to the reversal of accrued benefits originally designated for the benefit of a former executive officer, net income available to common shareholders is $3.9 million, or $0.80 per diluted share, an increase of $412,000 or 11.8%. Net interest income increased $512,000, or 4.0%, in 2007, and the provision for loan losses increased $31,000, or 7.9%, while non-interest income increased by $804,000 or 34.9%. Non-interest expense decreased by $291,000 or 3.2% in 2007, when adjusted for a $905,000 pre-tax reversal of accrued benefits for a former executive officer, non-interest expense totaled $9.7 million in 2007 compared to $9.1 million in 2006, or an increase of 6.8%.
Net Interest Income. Net interest income increased to $13.3 million for the year ended December 31, 2007, a $512,000 or 4.0% increase from the $12.8 million earned in 2006. Total interest income benefited from strong growth in the level of average earning assets and higher asset yields caused by the increase in interest rates during the year. The rates earned on a significant portion of the Bank's loans adjust immediately when indexes like the prime rate change. Conversely, a large portion of interest-bearing liabilities, including certificates of deposit and Bank borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in the Bank's interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. Interest rate increases will generally result in an immediate increase in the Bank's interest income on loans, with a more delayed impact on interest expense because increases in interest costs will only occur upon renewals of certificates of deposit or borrowings. Average total interest-earning assets increased $48.0 million, or 12.7%, during 2007 compared to 2006, while the average yield increased by 13 basis points from 7.14% to 7.27%. As interest rates increased during 2007, the average rate on loans increased year over year. The average rate on investment securities increased in 2007 compared to 2006, reflecting management's decision to purchase higher yielding securities during 2007 as interest rates began to rise. Average total interest-bearing liabilities increased by $42.0 million, or 12.4%, consistent with the increase in interest-earning assets. The average cost of interest-bearing liabilities increased by 45 basis points from 4.21% to 4.66%. With the yield on earning assets increasing less significantly than the cost of interest bearing liabilities, the Bank's net interest margin decreased by 26 basis points. For the year ended December 31, 2007, the net interest margin was 3.12%, while for the year ended December 31, 2006, the net interest margin was 3.38%. Table 3 reflects the volume and rate variances from 2007 vs. 2006.
Non-Interest Income. Non-interest income increased to $3.1 million for the year ended December 31, 2007 compared to $2.3 million for the year ended December 31, 2006, an increase of $804,000 or 34.9%. A one time gain on the sale of other real estate in the amount of $481,000 accounted for 15.5% of total non-interest income. Excluding the gain on the sale of other real estate, non-interest income increased $323,000 or 14.0% for 2007. Mortgage operations income decreased to $600,000 in 2007, from $632,000 in 2006, reflecting a softening in the overall mortgage origination market. Service charges on deposit accounts in 2007 were $1.1 million, an increase of $114 thousand, or 12.1%, compared to $944,000 in 2006 reflecting the positive results of a focused marketing effort to increase demand deposit accounts. Table 4, following this discussion, is a comparative analysis of the components of non-interest income for 2007, 2006.
Non-Interest Expenses. Non-interest expenses totaled $8.8 million for the year ended December 31, 2007, a decrease of $291,000 over the $9.1 million reported for 2006. Adjusting non-interest expense for a one-time adjustment of $905,000 related to the reversal of accrued benefits for a former executive officer, non-interest expense for 2007 would have totaled $9.7 million, an increase of $614,000 or 6.8%. Substantially all of this increase resulted from the Bank's growth and development during 2007 and 2006. Personnel costs after a one-time adjustment of $905 thousand related to the reversal of accrued benefits originally designated for a former executive officer increased by $248,000 in 2007, or 4.8%. Professional and other services increased $69,000 primarily due to expenses incurred related to the preparation of anticipated regulatory changes. Deposit and other insurance expense increased $144,000 or 69.2% because of increased FDIC premiums. Occupancy and equipment expense increased by $7,000 due to increases in maintenance costs. Data processing and other outside services increased $99,000, or 14.7%, due to the enhancement of computer systems. Advertising expense decreased $90,000 reflecting new marketing strategies during 2007. Table 5, following this discussion, presents a comparative analysis of the components of non-interest expenses for 2007, 2006.
Income Taxes. The provision for income tax was $2.3 million in 2007 and $1.8 million in 2006. The effective tax rates were 32.4% and 31.1%, respectively, on income before income taxes. The increase in the effective tax rate for 2007 reflects an decrease in the proportion of tax-exempt income to total income for 2007 over 2006.
LIQUIDITY
The Bank's sources of liquidity are customer deposits, cash and demand balances due from other banks, interest-earning deposits in other banks and investment securities available for sale. These funds, together with loan and securities repayments, are used to fund loans and continuing operations. At December 31, 2008, the Bank had credit availability with the Federal Reserve Bank of $80.6 million and the FHLB of $125.8 million, with $25.0 million outstanding.
Total deposits were $467.9 million and $373.9 million at December 31, 2008 and 2007, respectively. The Bank's deposits increased 25.2% in 2008. Because the Bank's organic deposit growth was not sufficient in amount to meet the total funding needs of the Bank's asset growth, the Bank looked to alternative funding sources during 2008. In light of local market deposit competition during the year, the Bank found it less costly to access brokered certificates of deposits rather than compete for higher cost of funds sources within our local markets. The Bank will continue to evaluate all funding sources for cost, accessibility, dependability and efficiency. Brokered certificates of deposits increased $34.7 million during 2008, from $88.7 million in 2007 to $123.4 million in 2008, an increase of 39.2%.
At December 31, 2008 and 2007, time deposits represented 63.0% and 70.3%, respectively, of the Bank's total deposits. Certificates of deposit of $100,000 or more represented 59.9% and 51.5%, respectively, of the Bank's total deposits at December 31, 2008 and 2007. At December 31, 2008, the Bank had $7.0 million in public deposits and $123.4 million in brokered time deposits. These sources of funds are generally considered to be less stable than deposits from the Bank's local markets. However, management believes that other non-traditional funding time deposits are relationship oriented. While the Bank appreciates the need to pay competitive rates to retain these deposits, other subjective factors also influence deposit retention. Based upon prior experience, the Bank anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity. The Bank's aggregate wholesale funding (brokered CD's, wholesale NOW accounts, FHLB advances and FRB discount window borrowings) as a percentage of total assets decreased to 29.3% in 2008 from 32.6% in 2007. The wholesale funding aggregate decrease is due primarily to the strong acceptance by our retail customer base of CDARS (Certificate of Deposit Account Registry Service) a deposit placement network (an innovation that allows banks to offer up to $50 million of FDIC insurance per depositor by networking with other banks within the CDARS system). CDARS deposits have increased from $6.8 million in 2007 to $48.8 million in 2008, reflecting a strong flight to quality by our customer base during the 2008 unpredictable economic environment.
Management anticipates that the Bank will utilize non-local market funding sources such as wholesale NOW accounts, CDARS, FHLB advances, FRB advances and brokered certificates of deposits as a less costly diversified funding source to complement the Bank's local market deposits. Deposits, loan repayments, mortgage-backed securities prepayments, bond maturities, FHLB advances FRB discount window borrowings and current earnings will be employed to provide liquidity, generate loans, purchase securities, procure fixed assets and meet other operating needs incurred in normal banking activities.
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