Summary of WGNB CORP - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following analysis compares the Company's results of operations for the three month periods ended March 31, 2009 and 2008 and reviews important factors affecting the Company's financial condition at March 31, 2009, compared to December 31, 2008. These comments should be read in conjunction with the Company's consolidated financial statements and accompanying notes appearing in this Report.

Cautionary Notice Regarding Forward-Looking Statements

Certain of the statements made in this Report and in documents incorporated by reference herein, including matters discussed under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as oral statements made by the Company or its officers, directors or employees, may constitute forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such forward-looking statements are based on management's beliefs, current expectations, estimates and projections about the financial services industry, the economy and about the Company and the Bank in general. The words "expect," "anticipate," "intend," "plan," "believe," "seek," "estimate" and similar expressions are intended to identify such forward-looking statements. Such forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to differ materially from historical results or from any results expressed or implied by such forward-looking statements. The Company cautions readers that the following important factors, among others, could cause the Company's actual results to differ materially from the forward-looking statements contained in this Report:

? the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which we must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable;

? the effect of changes in accounting policies, standards, guidelines or principles, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board;

? the effect of changes in our organization, compensation and benefit plans;

? the effect on our competitive position within our market area of the increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services;

? the effect of changes in interest rates;

? the effect of compliance, or failure to comply within stated deadlines, of the provisions of our formal agreement with our primary regulators;

? the effect of changes in the business cycle and downturns in local, regional or national economies;

? the effect of the continuing deterioration of the local economies in which we conduct operations which results in, among other things, a deterioration in credit quality or a reduced demand for credit, including a resultant adverse effect on our loan portfolio and allowance for loan and lease losses;

? the possibility that our allowance for loan and lease losses proves to be inadequate or that federal and state regulators who periodically review our loan portfolio require us to increase the provision for loan losses or recognize loan charge-offs;

? the effect of the current and anticipated deterioration in the housing market and the residential construction industry which may lead to increased loss severities and further worsening of delinquencies and non-performing assets in our loan portfolios;

? the effect of the significant number of construction loans we have in our loan portfolios, which may pose more credit risk than other types of mortgage loans typically made by banking institutions due to the disruptions in credit and housing markets.

? the effect of troubled institutions in our market area continuing to dispose of problem assets which, given the already excess inventory of residential homes and lots will continue to negatively impact home values and increase the time it takes us or our borrowers to sell existing inventory;

? the effect of public perception that banking institutions are risky institutions for purposes of regulatory compliance or safeguarding deposits which may cause depositors nonetheless to move their funds to larger institutions;

? the possibility that we could be held responsible for environmental liabilities of properties acquired through foreclosure;

The Company cautions that the foregoing list of important factors is not exclusive. The Company undertakes no obligation to publicly update or revise any forward-looking statements.

Critical Accounting Policies

The Company has established various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of its financial statements. These significant accounting policies are described in the notes to the consolidated financial statements filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2008 (the "2008 Notes"). 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 these accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which 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 value of assets and liabilities and the results of operations of the Company. All accounting policies are important, and all policies described in the 2008 Notes should be reviewed for a greater understanding of how the Company's financial performance is recorded and reported.

The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of the Company's consolidated financial statements. The allowance for loan losses represents management's estimate of probable loan losses inherent in the loan portfolio. Calculation of the allowance for loan losses is a critical accounting estimate due to the significant judgment, assumptions and estimates related to the amount and timing of estimated losses, consideration of current and historical trends and the amount and timing of cash flows related to impaired loans. Please refer to the section of the Company's Annual Report on 10-K for the year ended December 31, 2008 entitled "Balance Sheet Overview - Provision and Allowance for Possible Loan and Lease Losses" and Note 1 and Note 4 to the 2008 Notes for a detailed description of the Company's estimation processes and methodology related to the allowance for loan losses.

Results of Operations

Overview

The net loss for the three months ended March 31, 2009 was $3.0 million or $0.54 per diluted common share. The Company originally announced a net loss of $1.6 million, or $0.31 per diluted common share. However, additional adjustments were detected by management in April as the result of its normal loan analysis and asset impairment process that provided additional evidence with respect to conditions that existed at March 31, 2009. The adjustments are reflected in the Company's operations for the quarter ended March 31, 2009 and include certain write-downs of foreclosed property, an equity investment in a financial institution and accrued interest on impaired loans, additions to the allowance for loan loss and the corresponding tax benefit.

Comparing the earnings performance of the first quarter ended March 31, 2009 to the first quarter ended March 31, 2008, the impact of the continued deterioration of credit quality is a significant factor. The Company recorded net earnings in the amount of $1.83 million, or $0.30 per diluted common share, in the first quarter ended March 31, 2008. The operating environment for community banking, particularly those institutions like us that have historically invested in the community's real estate projects, has changed significantly over the past year when comparing quarterly data. The residential real estate market in the west Georgia area has been hard hit by the economic downturn that the southeastern region and the nation have been experiencing over the past eighteen to twenty-four months.

Real estate values have declined significantly depending on a particular location or property type in our market area. The demand for the property has diminished such that borrowers unable to sell their property are depleting their financial resources to service both their debt and the development and marketing expenses of the residential real estate construction or development project. In many cases, the borrowers owe more than the property is now worth. The deterioration of the collectability of construction and development loans has caused the Company to increase its loan loss provision, charge-off accrued interest on the impaired collateral dependent loans, place the loans on non-accruing status, incur collection costs (primarily legal costs) for the collection of loans, incur ownership costs (real estate taxes, property maintenance and insurance) of foreclosed property and potentially incur additional write-downs on property value in the post-foreclosure valuation process. The Company also incurs interest expense on the deposits used to fund the non-performing loan or foreclosed property which reduces net interest income.

Net interest income decreased $3.0 million, or 40.4 percent, from the first quarter of 2008 to the first quarter of 2009. The decline in net interest income is primarily due to the impact of funding non-performing assets that have accumulated since the first quarter of 2008 and maintaining large amounts of liquidity necessary to provide customers with the comfort they desire to ensure that their deposits are both available and safe. Rapidly declining yields on liquid assets and loans has also contributed to the decrease in net interest income when comparing the first quarter of 2009 with the first quarter of 2008.

The provision for loan loss for the first quarter of 2009 was $4.0 million, an increase of $3.2 million, or 427 percent, compared to the first quarter of 2008. The loss on sale and write-down of foreclosed property in the first three months of 2009 was $1.5 million compared to a gain of $12 thousand for the same period in 2008. This computes to a reduction of income in the amount of $1.5 million comparing the periods. We have been successful in reducing operating expenses except for the expense of maintaining and carrying foreclosed property and collecting on non-performing loans. In total, non-interest expense decreased by $247 thousand, or 3.8 percent, comparing the first quarter of 2009 with 2008. However, expense on loans and foreclosed property increased by $231 thousand, or 74.1 percent. The loss before income taxes was $5.1 million in the first quarter of 2009 compared to earnings before taxes in the amount of $2.4 million in the first quarter of 2008, for a reduction between the two periods of $7.5 million. The reduction of net interest income ($3.0 million), the reduction of salaries and employee benefits ($447 thousand), the increase in loan loss provision ($3.2 million), the increase in the loss on sale and write down of foreclosed property ($1.5 million) and the increase in expense on loans and foreclosed property ($231 thousand) accounted for the $7.5 million of the reduction in earnings before taxes.

To better understand the recent operating trends, it is helpful to compare the operating results of the first quarter of 2009 with the fourth quarter of 2008. The net loss before taxes of $5.1 million for the first quarter of 2009 was reduced compared to the net loss (before taxes and goodwill charge) in the fourth quarter of 2008. The net loss before taxes for the fourth quarter of 2008 (excluding a goodwill impairment charge in the amount of $24.1 million) was $6.5 million, a decrease in pretax loss of $1.4 million, comparing the first quarter of 2009 to the fourth quarter of 2008. The difference in the results for the first quarter of 2009 and the fourth quarter of 2008 can be traced primarily to a decrease in the loan loss provision of $700 thousand. During the fourth quarter of 2008, the Company charged-off interest income on impaired loans in the amount of $541 thousand compared to a net recovery in the first quarter of 2009 of previously charged-off interest in the amount of $26 thousand, a difference of $567 thousand. The expense on loans and foreclosed property in the fourth quarter of 2008 was $1.2 million compared to $543 thousand for the first quarter of 2009, a decrease in expense of $657 thousand.

Total non-interest expense, comparing the first quarter of 2009 to the fourth quarter of 2008 (not including the goodwill impairment charge which was classified as non-interest expense in the fourth quarter of 2008) decreased by $1.6 million, or 20.0 percent. As described above, expense on loans and foreclosed property decreased by $657 thousand. Salary and employee benefit expense decreased by $682 thousand, or 21.5 percent, comparing the fourth quarter of 2008 to the first quarter of 2009. Management is making every effort to reduce expenses and preserve capital.

Management and the board remain concerned about the remainder of 2009 in terms of real estate values. Many of the Company's foreclosed properties and collateral on non-performing collateral dependent loans must be re-evaluated at least annually for their fair values. If current trends continue, as the properties are re-appraised, the values may be lower than previous appraisals. We believe our valuation process has, to date, yielded accurate market values based on our recent sales efforts and other market intelligence. Improved property, for example a lot with a residence, has a more determinable value since sales for comparison purposes are typically more recent. Developed or undeveloped lots, in contrast, require more judgment on the part of management as the excess supply of residential lots, fewer sales for comparative purposes and more frequent distressed sales of these types of properties make valuation more difficult.

The rising cost of deposit insurance also remains a concern of management for the remainder of 2009. Our deposit insurance assessment applicable for the next three months reflects an increased cost of three times that for the previous three months. In addition, there are proposals currently pending before Congress requesting a special assessment of deposit insurance on banks in the amount of 20 basis points. If approved, this additional assessment could amount to approximately $1.5 million for the Bank.

Non-performing assets as of March 31, 2009 were $125.9 million, or 18.8 percent of total loans plus foreclosed property, compared to $54.5 million, or 8.0 percent of total loans plus foreclosed property, as of March 31, 2008 and $122.0 million, or 18.0 percent of total loans plus foreclosed property, as of December 31, 2008. The $125.9 million in non-performing assets was comprised primarily of 24 loan relationships ranging in outstanding balances from $1 million to $8 million. The performing residential real estate construction and acquisition and development portfolio not including impaired and non-accrual loans was $113.0 million as of March 31, 2009 and comprised primarily of 12 loan relationships ranging in balance from $1 million to $7 million.

Some evidence suggests that we may be seeing improved conditions in the residential real estate market. During the first quarter of 2009, 20 properties totaling approximately $3.8 million were placed under contract but had not closed as of March 31, 2009. The increase in non-performing loans also slowed in the first quarter of 2009. In the fourth quarter of 2008, for example, non-performing assets increased by $21.6 million, or 21.6 percent from September 30, 2008 to December 31, 2008. In the first quarter of 2009, non-performing assets increased by $3.9 million, or 3.2 percent from December 31, 2008 to March 31, 2009. The increase in the first quarter of 2009 was primarily attributable to two loan relationships. Our problem loans have related to the same loan relationships we have been monitoring over the past 12 to 18 months as they have migrated from classified loans, to impaired non-performing loans and, ultimately, to foreclosed property. Stated differently, the total number of problem credit relationships is not increasing as rapidly as in preceding quarters.

Net Interest Income

Net interest income decreased by $3.0 million, or 40.4 percent, from the first quarter of 2008 to the first quarter of 2009. Total interest income for the first quarter of 2009 decreased by $4.0 million, or 28.1 percent, while total interest expense decreased by $1.0 million, or 15.0 percent. The decrease in net interest income from the first quarter of 2008 to the first quarter of 2009 was most impacted by the increase in non-performing assets and liquidity (defined as cash and cash equivalents). The average balance of non-performing loans and foreclosed property increased from $38.0 million and $14.6 million, respectively, through the first quarter of 2008 to $75.0 million and $47.6 million, respectively, through the first quarter of 2009. The average balance of interest-bearing liquidity was $56.9 million through March 31, 2009 compared to $6.7 million through March 31 2008. The total increase in average balance of non-performing assets and liquidity was $120.2 million which means the Bank needed to carry $120.2 million more deposits at a weighted average cost of 2.79 percent to fund non-performing assets and low yielding liquidity. Stated differently, the Bank incurred an estimated $838 thousand ($120.2 million x 2.79 percent/4) of interest expense on deposits to carry non-performing assets. Non-performing assets have no yield and our liquid balances had an average yield of approximately 30 basis points in the first quarter of 2009. Our goal is to reduce both non-performing assets and liquidity for the remainder of 2009. This can be achieved by selling non-performing assets and reducing higher cost deposits such as certificates of deposit as they mature, thereby reducing liquidity.

The net interest margin was also negatively impacted by the increase in non-performing assets and liquidity. The net interest margin for the first quarter of 2008 was 3.39 percent compared to 2.38 percent through the first quarter of 2009, a decrease of approximately 1.0 percent. The compression in the net interest margin was not only caused by the increase in non-performing assets and liquidity but by other factors as well. Certain of our adjustable rate loans and deposits, for example, are tied to short-term interest rates such as the prime rate and the federal target discount rate. Many of our adjustable rate loans and deposits have adjusted downward in response to the decline in short term interest rates. However, many certificates of deposit will be maturing and re-pricing at a much lower rates in the coming quarters. Our forward interest rate risk analysis indicates that the cost of funds will be decreasing in the near term, because of the re-pricing of certificates of deposit to lower market rates and the reduction of certificates of deposit as a ratio of total deposits. Additionally, our average yield on earning assets will be increasing as liquidity is decreased as a ratio to total earning assets.

The Bank was more asset-sensitive in the first quarter of 2009, that is, more assets, as a total, re-priced than deposits. As market interest rates approach zero, demand deposit rates "bottom out" at near zero. However, asset yields had decreased more in the first quarter in comparison to demand deposit rates. We have placed interest rate floors on many of our loans which will be advantageous to the Bank's interest income and net interest margin as our cost of funds decreases. Over the next two quarters, we believe the contraction of the net interest margin should reverse to expansion as non-performing assets decrease, liquidity and certificates of deposit are reduced and/or re-priced.

Non-Interest Income

Non-interest income decreased by $1.6 million, or 64.8 percent, when comparing the first quarter of 2009 to first quarter of 2008. As discussed above, the reduction in non-interest income was primarily attributable to the loss on sale and write-down of foreclosed property in the first quarter of 2009 compared to a gain on sale of foreclosed property of $12 thousand in the first quarter of 2008. In the first three months of 2009, we closed on sales in the amount of $756 thousand in book value of foreclosed property for a loss of $62 thousand, and we wrote-down foreclosed property by $1.5 million due to updated appraisals on properties or other valuation criteria.

Service charge income decreased by $251 thousand, or 16.3 percent, when comparing the first quarters of 2009 and 2008. The decrease was the result of less overdraft charges on deposit accounts. This trend is counterintuitive since one would expect that, as the economy weakens, overdraft charges on deposit accounts would increase or at least remain consistent. Despite an increase in the number of demand deposit accounts, overdraft fees have decreased on a first quarter over quarter basis, by $239 thousand, or 16.9 percent. We can only conclude that our customers are changing their overdraft habits in order to conserve their money. All other service charge income has remained relatively stable.

Mortgage fee income decreased by $48 thousand, or 41.3 percent, from first quarter 2008 to first quarter 2009. Again, the decrease in mortgage origination volume is counterintuitive. With mortgage rates at a historical low, one would expect that the demand for refinancing and home purchases would be greater. On the contrary, increased unemployment, increased underwriting standards and the lack of a stabilized value in residential real estate have diminished demand for mortgages. If values in the residential real estate market are able to stabilize, the demand for mortgage loans could increase. In March of 2009, applications increased after two consecutive quarters of very low volume. But as underwriting standards have increased and appraisals have been scrutinized, fewer applicants are qualifying for mortgages.

During the first quarter of 2009, the brokerage division generated $133 thousand in brokerage fees which represented a $22 thousand, or 19.6 percent, increase compared to the first quarter of 2008. As the equity markets have firmed, customers are seeking investment opportunities which have stimulated the volume of brokerage fees. The brokerage division was cumulatively profitable by $9 thousand in the first quarter of 2009 compared to a $6 thousand loss in the first quarter of 2008.

Other non-interest income such as ATM network fees increased by $9 thousand, or 2.3 percent. The increase in ATM network fees is ordinary in nature based on increased volume. The Company recorded a gain on the sale of securities in the amount of $489 thousand in the first quarter of 2009 compared to a $47 thousand gain in the first quarter of 2008. In addition, the Company charged-down an equity investment in an institution by $79 thousand. We consider these gains and charge-down non-recurring in nature. The sale of securities was part of a strategy to reposition the investment portfolio away from non-taxable municipal securities into taxable investments. The Company is not receiving a current tax benefit from its non-taxable municipal securities because it is not generating taxable income. In instances where we could increase the yield on the investment security, we sold municipal securities and reinvested the proceeds in taxable mortgage backed securities and municipal securities to generate taxable income to offset taxable losses. Because of the increase in the bond market over the past three months, the sales generated a larger than historic gain.

Miscellaneous income decreased by $142 thousand, or 63.6 percent, comparing the first quarter of 2009 to the first quarter of 2008. During the first quarter of 2009, we incurred miscellaneous loss totaling $163 thousand that was non-recurring in nature.

Non-interest Expense

When comparing total non-interest expense for the three month periods ended March 31, 2009 with the same period of 2008, we experienced a decrease of $247 thousand, or 3.8 percent. Although the total decrease in non-interest expense was modest, there has been a significant change in the management of non-interest expense. We have responded to the increase in non-performing assets by implementing cost-saving measures such as reducing staff, employee benefits and other expense in the first quarter of 2009. In total, management has reduced expenses such that we estimate a cost savings of approximately $2.5 million to $3.0 million from that reported in 2008. However, we do expect that expense on loans and foreclosed property will increase in 2009 compared to 2008 because the amount of impaired loans and foreclosed property has increased significantly since the first part of 2008.

Salaries and employee benefits decreased by $447 thousand, or 12.3 percent, as of March 31, 2009 compared to the same period in 2008. As of March 31, 2008, we had 273 full time equivalent employees compared to 231 full time equivalent employees at March 31, 2009, a reduction of 42 full time equivalent employees, or 15.4 percent. Salary expense decreased by $275 thousand, or 10.0 percent, and benefits expense decreased by $172 thousand, or 19.9 percent, from the first quarter of 2008 to the same period in 2009. The reduction in salaries was directly attributable to reduction in full time equivalent employees. Virtually all departments and branches were affected by staff reduction. The Bank closed its loan production office and Banco de Progreso Branch in Coweta County in the fourth quarter of 2008 and its Banco de Progreso Branch in Carrollton in the first quarter of 2009. The decrease in employee benefits came primarily from the reduction in the 401k match from (up to) six percent of an employee's salary to one percent and no bonus accruals in 2009.

Following the second quarter of 2008, management and the Board of Directors determined that aggressive cost cutting measures would need to be taken in order to preserve capital through the downturn in the residential real estate market and credit quality. The expense line item that is the largest and most discretionary is salaries and benefits. The following measures were taken to reduce salary and benefits expense: reduction in the full time equivalent employee count by 20 percent; cessation of bonuses and increases in salary for 2009; reduction of the 401k match from six percent to one percent; and utilization of greater efficiencies in departmental and customer service operations. The Board of Directors reduced their director fees two times in the last fifteen months although they are meeting more frequently than in the past. Certain committees are not being compensated for some or all of their meetings. Management's goal was to reduce salary and benefits expense by $2.5 million, for a savings of 17 to 20 percent in 2009 from salary and benefits expense realized in 2008.

Occupancy expense in the first quarter of 2009 decreased $92 thousand, or 9.0 percent, when compared to the first quarter of 2008. The decrease in occupancy . . .