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| FNBN > SEC Filings for FNBN > Form 10-Q on 8-May-2009 | All Recent SEC Filings |
8-May-2009
Quarterly Report
The following presents management's discussion and analysis of the financial condition, changes in financial condition and results of operations of FNB United Corp. ("FNB United") and its wholly owned subsidiary, CommunityONE Bank, National Association (the "Bank"). FNB United and its subsidiary are collectively referred to as the "Company." This discussion should be read in conjunction with the financial statements and related notes included elsewhere in the quarterly report. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ
significantly from those anticipated in forward-looking statements as a result of various factors. The following discussion is intended to assist in understanding the financial condition and results of operations of the Company.
Executive Overview
Description of Operations
FNB United is a bank holding company with a full-service subsidiary bank, CommunityONE Bank, National Association, which offers a complete line of consumer, mortgage and business banking services, including loan, deposit, cash management, investment management and trust services, to individual and business customers. The Bank has offices in Alamance, Alexander, Ashe, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes counties in North Carolina.
Additionally, the Bank has a mortgage banking subsidiary, Dover Mortgage Company, which originates, underwrites and closes loans for sale into the secondary market. Dover has a retail origination network based in Charlotte and conducts wholesale operations in North Carolina, South Carolina, Georgia, Tennessee, Virginia, and Maine.
Executive Summary
The Company's total assets at March 31, 2009, were $2.2 billion, an increase of 5%, or $109.6 million from year-end 2008. Investments grew $94.9 million, or 41%, reflecting the Company's leveraging strategy to offset the earnings dilution resulting from participation in the Capital Purchase Program. Loans held for sale increased $12.8 million, or 35%, due to refinancing of residential mortgages. Gross loans held for investment totaled $1.6 billion at March 31, 2009, essentially flat from the prior year end.
Total deposits grew $91.9 million, to $1.6 billion in 2009, representing a 6% increase due primarily to increased consumer use of deposit account products in the current economic environment and an increase in the general consumer rate of savings. Borrowings decreased $23.6 million or 6%, during the first three months of 2009, compared to the period ended December 31, 2008. Total shareholders' equity increased $44.9 million compared to December 31, 2008 primarily as a result of $51.5 million of capital invested by the U.S. Treasury in the first quarter of 2009 partially offset by the $5.8 million net loss for the quarter.
The Company experienced a net loss of $5.8 million in the first quarter of 2009 compared to net income of $2.3 million for the same quarter in 2008 and is primarily the result of a $12.5 million increase in the provision for loan losses. These losses were partially offset by $5.2 million in lower income taxes.
Noninterest income increased 17.0% to $5.9 million for the first three months in 2009, compared to $5.0 million for the same period in 2008. Cardholder and merchant services income increased $126,000 due to increased interchange fees and surcharge fees, and income from mortgage loan sales increased by $845,000 attributable to sizable increases in 2009 production driven by refinancing activity.
Noninterest expense for the first quarter increased 2% to $15.8 million in 2009 from $15.5 million in 2008. The Company undertook a major noninterest expense improvement project during the second half of 2008, which included consolidation of operational functions, strong vendor management and tighter staffing models. This effort resulted in an 8%, or $717,000 decrease, in personnel expense when comparing the first three months of 2009 to the same period in 2008. This reduction was offset by increases in other expenses, primarily auditing fees and FDIC insurance costs, which were $325,000 and $262,000, respectively, higher than the same period in 2008. The Company also incurred noninterest expense of $290,000 in the first quarter of 2009 related to its write-off of an investment in a failed banker's bank.
Financial highlights are presented in the accompanying table.
Table 1 - Selected Financial Data
(dollars in thousands, except per share data) As of / For the Quarter Ended March 31,
2009 2008
Income Statement Data
Net interest income $ 14,132 $ 15,430
Provision for loan losses 14,059 1,514
Noninterest income 5,882 5,027
Noninterest expense 15,846 15,538
Net (loss)/income (5,767 ) 2,323
Preferred stock dividends (431 ) -
Net (loss)/income to common shareholders (6,198 ) 2,323
Balance Sheet Data
Assets $ 2,154,026 $ 2,035,283
Loans held for sale 48,948 15,121
Loans held for investment (1) 1,583,574 1,541,119
Allowance for loan losses 38,573 18,215
Goodwill 52,395 110,195
Deposits 1,606,696 1,485,649
Borrowings 342,202 312,901
Shareholders' equity 192,770 217,142
Per Common Share Data
Net (loss)/income per common share:
Basic $ (0.54 ) $ 0.20
Diluted (2) (0.54 ) 0.20
Cash dividends declared 0.025 0.150
Book value 12.69 19.01
Tangible book value 7.62 8.80
Performance Ratios
Return on average assets (1.11 ) % 0.48 %
Return on average tangible assets (1.14 ) 0.51
Return on average equity (3) (13.34 ) 4.29
Return on average tangible equity (19.96 ) 9.24
Net interest margin (tax equivalent) 3.03 3.68
Dividend payout on common shares (4) N/A 73.74
Asset Quality Ratios
Allowance for loan losses to period end loans held for investment 2.44 % 1.18 %
Nonperforming loans to period end allowance for loan losses 308.02 89.87
Net chargeoffs (annualized) to average loans held for investment 2.58 0.18
Nonperforming assets to period end loans held for investment
and foreclosed property (5) 8.03 1.33
Capital and Liquidity Ratios
Average equity to average assets 8.31 % 11.11 %
Leverage capital 9.59 7.23
Tier 1 risk based capital 10.86 7.43
Total risk based capital 12.94 9.70
Average loans to average deposits 105.66 103.76
Average loans to average deposits and borrowings 85.28 87.42
(1) Loans held for investment, net of unearned income, before allowance for loan losses.
(2) Assumes the exercise of outstanding dilutive options to acquire common stock. See Note 15 to FNB United's
consolidated financial statements.
(3) Net (loss) income to common shareholders, which excludes preferred stock dividends, divided by average realized
common equity which excludes accumulated other comprehensive income (loss).
(4) Not applicable to 2009 due to net loss.
(5) Nonperforming loans and nonperforming assets include loans past due 90 days or more that are still accruing interest.
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Application of Critical Accounting Policies
FNB United's accounting policies are in accordance with accounting principles generally accepted in the United States and with general practice within the banking industry and are fundamental to understanding management's discussion and analysis of results of operations and financial condition. FNB United's significant accounting policies are discussed in detail in Note 1 of the Consolidated Financial Statements contained in the Annual Report on Form 10-K for the year ended December 31, 2008.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and goodwill impairment. Actual results could differ from those estimates.
Allowance for Loan Losses
The allowance for loan losses, which is utilized to absorb actual losses in the loan portfolio, is maintained at a level consistent with management's best estimate of probable loan losses incurred as of the balance sheet date. FNB United's allowance for loan losses is also analyzed quarterly by management. This analysis includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk. The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group. Major loan portfolio subgroups include: risk graded commercial loans, mortgage loans, home equity loans, retail loans and retail credit lines. Management also analyzes the loan portfolio on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly. While management uses the best information available to make evaluations, future adjustments may be necessary, if economic or other conditions differ substantially from the assumptions used. See additional discussion under "Asset Quality."
Goodwill
FNB United has procedures to test goodwill for impairment on an annual basis or more frequently if necessary. The testing procedures evaluate possible impairment based on the following:
The test assigns tangible assets and liabilities, identified intangible assets and goodwill to a reporting unit and compares the fair value of this reporting unit to its carrying value including goodwill. The value is determined assuming a freely negotiated transaction between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Accordingly, to derive the fair value of the reporting unit, the following common approaches to valuing business combination transactions involving financial institutions are utilized by FNB United: (1) the comparable transactions approach - specifically based on earnings, book, assets and deposit premium multiples received in recent sales of comparable bank franchises; and (2) the discounted cash flow approach. The application of these valuation techniques takes into account the reporting unit's operating history, the current market environment and future prospects. As of the most recent quarter, the Bank was carrying goodwill.
If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and no second step is required. If not, a second test is required to measure the amount of goodwill impairment. The second test of the overall goodwill impairment compares the implied fair value of the reporting unit goodwill with the carrying amount of the goodwill. The impairment loss is equal to the excess of carrying value over fair value.
During 2008, FNB United performed impairment evaluations resulting in impairment charges of $57.8 million. Continued stock price weakness and an operating loss during the first quarter of 2009
necessitated another test of impairment. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company has reviewed entity-wide goodwill for impairment and determined that the fair value of the Company exceeds its carrying value as of March 31, 2009.
Summary
Management believes the accounting estimates related to the allowance for loan
losses and the goodwill impairment test are "critical accounting estimates"
because: (1) the estimates are highly susceptible to change from period to
period as they require management to make assumptions concerning the changes in
the types and volumes of the portfolios and anticipated economic conditions, and
(2) the impact of recognizing an impairment or loan loss could have a material
effect on FNB United's assets reported on the balance sheet as well as its net
earnings.
Results of Operations
Net Interest Income
Net interest income is the difference between interest income, principally from loans and investments, and interest expense, principally on customer deposits. Changes in net interest income result from changes in interest rates and in the volume, or average dollar level, and mix of earning assets and interest-bearing liabilities. An analysis is presented in Table 2 of the Company's net interest income on a taxable-equivalent basis and average balance sheets for the three-month period ended March 31, 2009 and 2008.
For the three months ended March 31, 2009, net interest income before the provision for loan losses was $14.1 million, a decrease of $1.3 million, or 8%, from $15.4 million for the same quarter in 2008. The decrease was primarily due to a 176 basis point decrease in the yield on average earning assets, which increased $218.2 million, partially offset by a 124 basis point decrease in the cost of average interest-bearing liabilities, which increased $209.0 million.
The net interest margin (taxable-equivalent net interest income divided by average earning assets) compressed 65 basis points to 3.03% for the three months ended March 31, 2009, compared to 3.68% in the same period in 2008. The decline in the net interest margin is due in part to a decline in the Federal Funds target rate from 2.25% at March 31, 2008 to 0.25% at March 31, 2009. Another variable impacting net interest margin is interest-earning assets repricing down faster than interest bearing liabilities. While the Company experienced a 176 basis point decrease in the yield on earning assets, the cost of interest-bearing liabilities only decreased 124 basis points. The $218.2 million growth in average earning assets was funded by higher cost deposits and wholesale borrowings.
The 2009 and 2008 changes in net interest income on a taxable equivalent basis, as measured by volume and rate variances, are analyzed in the table below. Volume refers to the average dollar level of earning assets and interest-bearing liabilities.
Table 2
Average Balances and Net Interest Income Analysis
Three Months Ended March 31,
2009 2008
(dollars in thousands) Average Average
Average Income / Yield / Average Income / Yield /
Balance (3) Expense Rate Balance (3) Expense Rate
Interest earning assets:
Loans (1)(2) $ 1,636,850 $ 21,642 5.36 % $ 1,506,582 $ 27,589 7.37 %
Taxable investment securities 224,403 3,067 5.54 142,048 1,893 5.36
Tax-exempt investment securities (1) 55,607 923 6.73 55,441 811 5.88
Other earning assets 23,321 80 1.39 17,893 253 5.69
Total earning assets 1,940,181 25,712 5.37 1,721,964 30,546 7.13
Non-earning assets:
Cash and due from banks 27,567 32,163
Goodwill and core deposit premium 58,087 116,655
Other assets, net 84,303 89,483
Total assets $ 2,110,138 $ 1,960,265
Interest-bearing liabilities:
Interest-bearing demand deposits 179,681 427 0.96 161,910 533 1.32
Savings deposits 39,260 25 0.26 41,316 61 0.59
Money market deposits 282,682 1,146 1.64 260,898 1,803 2.78
Time deposits 903,095 7,276 3.27 830,464 9,409 4.56
Retail repurchase agreements 20,296 33 0.66 30,183 249 3.32
Federal Home Loan Bank advances 224,372 1,598 2.89 169,398 1,692 4.02
Federal funds purchased 13,857 17 0.50 15,040 124 3.32
Other borrowed funds 111,702 692 2.51 56,702 909 6.45
Total interest-bearing liabilities 1,774,945 11,214 2.56 1,565,911 14,780 3.80
Noninterest-bearing liabilities and shareholders' equity:
Noninterest-bearing demand deposits 144,479 157,436
Other liabilities 15,452 19,202
Shareholders' equity 175,262 217,716
Total liabilities and equity $ 2,110,138 $ 1,960,265
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Net interest income and net yield on earning assets (4) $ 14,498 3.03 % $ 15,766 3.68 %
Interest rate spread (5) 2.81 % 3.34 %
(1) The fully tax equivalent basis
is computed using a federal tax rate
of 35%.
(2) The average loan balances
include nonaccruing loans.
(3) The average balances for all
years include market adjustments to
fair value for securities and loans
available/held for sale.
(4) Net yield on earning assets is
computed by dividing net interest
income by average earning assets.
(5) Earning asset yield minus
interest bearing liabilities rate.
Provision for Loan Losses
This provision is the charge against earnings to provide an allowance for probable losses inherent in the loan portfolio. The amount of each year's charge is affected by several considerations including management's evaluation of various risk factors in determining the adequacy of the allowance (see "Asset Quality"), actual loan loss experience and loan portfolio growth.
During the three-month period ended March 31, 2009, the provision for loan losses was $14.1 million, compared to $1.5 million in the same period of 2008. The level of the provision was driven by
deteriorating loan quality. Net charge-offs for the three months ended March 31, 2009 totaled $10.2 million, or 2.58% of annualized average loans, compared to $680,000, or .18% of annualized average loans for the same period in 2008. Approximately 64% of the 2009 first quarter charge-offs were comprised of land development loans.
Noninterest Income
For the three months ended March 31, 2009, noninterest income was $5.9 million, an increase of $0.9 million, or 17%, compared to the same period in 2008. The primary reason for this increase was the result of mortgage loan sales increasing $0.8 million.
Noninterest Expense
Noninterest expense for the first quarter was approximately $15.8 million in 2009 and $15.5 million in 2008. During the second half of 2008, the Company undertook a noninterest expense improvement project that included consolidation of operational functions, strong vendor management and tighter staffing models. The results of this project have yielded lower expenses for the first quarter of 2009 including reductions in salaries and benefits of $0.7 million and travel and entertainment expenses of $0.1 million. Losses related to other real estate owned were also $0.2 million lower than the prior year. These reductions were offset by increases in audit fees of $0.3 million, FDIC insurance costs of $0.3 million, write-off of investment in a failed banker's bank of $0.3 million, marketing initiatives of $0.2 million and occupancy expense of $0.2 million.
Provision for Income Taxes
The Company experienced an income tax benefit totaling $4.1 million for the first quarter of 2009 compared to a tax expense of $1.1 million for the same period in 2008. The decrease in the provision for 2009, compared to the prior year, results primarily from the decrease in taxable income. Our provision for income taxes, as a percentage of (loss)/income before income taxes, was 41.7% for the three months ended March 31, 2009, compared to 31.8% for the first three months ended March 31, 2008.
Financial Condition
Since December 31, 2008, the Company's assets have increased $109.6 million, to $2.2 billion at March 31, 2009. The principal factors causing this overall increase during the first three months of 2009 were a $94.9 million increase in net investment securities, combined with a $12.8 million increase in loans held for sale. Loans held for investment totaled $1.6 billion both at March 31, 2009 and at December 31, 2008. Investment securities of $328.1 million at March 31, 2009 were 41% higher than the $233.2 million balance at December 31, 2008.
Deposits totaled $1.6 billion at March 31, 2009, compared to $1.5 billion at December 31, 2008. At the end of the first quarter 2009, noninterest-bearing deposits were $143.1 million, or 9%, of total deposits, down 5% since the end of 2008. Borrowings at the Federal Home Loan Bank ("FHLB") totaled $172.9 million at March 31, 2009, compared to $238.9 million at December 31, 2008. The decrease in the FHLB borrowings was partially offset by an increase in federal funds purchased of $38 million. The Company accessed the Federal Reserve's Term Auction Liquidity Facility for the first time in January, 2009. Unlike FHLB funding, Federal Reserve funding allows construction and development loans as collateral.
Shareholders' equity is strong, with all of our regulatory capital ratios at levels that classify the Company as "well capitalized" under bank regulatory capital guidelines. Shareholders' equity was $192.8 million at the end of the . . .
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