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| FSNM > SEC Filings for FSNM > Form 10-Q on 7-Aug-2009 | All Recent SEC Filings |
7-Aug-2009
Quarterly Report
Forward-Looking Statements
Certain statements in this Form 10-Q are forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). These statements are based on management's current expectations or predictions of future results or events. We make these forward-looking statements in reliance on the safe harbor provisions provided under the Private Securities Litigation Reform Act of 1995.
All statements, other than statements of historical fact, included in this Form 10-Q which relate to performance, development or activities that we expect or anticipate will or may happen in the future, are forward looking statements. The discussions regarding our growth strategy, expansion of operations in our markets, acquisitions, dispositions, competition, loan and deposit growth, timing of new branch openings, capital expectations, and response to consolidation in the banking industry include forward-looking statements. Other forward-looking statements may be identified by the use of forward-looking words such as "believe," "expect," "may," "might," "will," "should," "seek," "could," "approximately," "intend," "plan," "estimate," or "anticipate" or the negative of those words or other similar expressions.
Forward-looking statements involve inherent risks and uncertainties and are based on numerous assumptions. They are not guarantees of future performance. A number of important factors could cause actual results to differ materially from those in the forward-looking statement. Some factors include changes in interest rates, local business conditions, government regulations, loss of key personnel or inability to hire suitable personnel, faster or slower than anticipated growth, economic conditions, our competitors' responses to our marketing strategy or new competitive conditions, and competition in the geographic and business areas in which we conduct our operations. Forward-looking statements contained herein are made only as of the date made, and we do not undertake any obligation to update them to reflect events or circumstances after the date of this report to reflect the occurrence of unanticipated events.
Because forward-looking statements involve risks and uncertainties, we caution that there are important factors, in addition to those listed above, that may cause actual results to differ materially from those contained in the forward-looking statements. These factors are included in our Form 10-K for the year ended December 31, 2008, as filed with the Securities and Exchange Commission. We have also included our revised risk factors that are relevant for the current period.
Risk Factors
It may be difficult to trade our shares if we are unable to maintain our listing on the Nasdaq Stock Market or if our stock becomes subject to the penny stock rules of the Securities and Exchange Commission ("SEC").
Our shares are currently listed with Nasdaq on its Global Select Market. This listing is dependent on us maintaining certain minimum listing standards, including, among others, minimum bid price and stockholders' equity standards. If we continue to incur losses as we did in 2008 and in the six months ended June 30, 2009 and cannot maintain the standards for continued listing on the Nasdaq Global Select Market, our common stock could be subject to delisting. Trading in our common stock could then be conducted on the over-the-counter market on the OTC Bulletin Board, and we could become subject to the penny stock rules maintained by the SEC. These rules impose additional sales practice requirements on broker-dealers. The additional sales practice requirements could materially adversely affect the willingness or ability of broker-dealers to sell our common stock. As a result, it may be difficult to sell shares or to obtain accurate quotations as to the price of our shares. In addition, it may be more difficult for us to obtain additional equity financing due to liquidity concerns of potential investors. In the past six months, our share price has been below $1.00, but not for thirty consecutive business days, the determining time for failure to meet the minimum bid price on Nasdaq. We have not received a notice from Nasdaq concerning our trading price. Although Nasdaq previously suspended its rules requiring a minimum bid price until July 31, 2009, such rules have now been reinstated. We believe we are currently in compliance with all other listing standards applicable to us. There can be no assurance that we will be able to maintain compliance or that the Nasdaq Stock Market will not revise the standards in a way that would make it more difficult for us to comply.
We operate in a highly regulated environment; changes in federal and state laws and regulations and accounting principles may adversely affect us.
We are a bank holding company. Bank holding companies and their subsidiaries operate in a highly regulated environment, subject to extensive supervision and examination by federal and state bank regulatory agencies. We are subject to changes in federal and state law, as well as changes in regulation and governmental policies, income tax law, and accounting principles. Any change in applicable regulations, or federal or state legislation, or in accounting principles could have a significant impact on us and our results of operations. Additional legislation or regulations, including the EESA ("Emergency Economic Stabilization Act") and any other legislation or regulation that could be brought about by the current credit and liquidity crisis, may significantly affect our powers, authority, and operations. If new legislation, regulations, or accounting principles are enacted or adopted, our results of operations and financial condition may be adversely affected.
In particular, we are subject to the Bank Holding Company Act of 1956, as amended, and to regulation and supervision by the Federal Reserve Board. First Community Bank, as a state member bank of the Federal Reserve System, is subject to regulation and supervision by the Federal Reserve Board and the New Mexico Financial Institutions Division of the Regulation and Licensing Department and, because its deposits are insured, by the Federal Deposit Insurance Corporation. Our operations in Arizona may also be subject to regulation and supervision by the Arizona State Banking Department. Regulators have significant discretion and power to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank holding companies in the performance of the regulators' supervisory and enforcement duties. If regulators exercise these powers, our results of operations and financial condition may be adversely affected.
The Federal Reserve Board has a policy stating that a bank holding company is expected to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support the subsidiary bank. Under this doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank and may charge the bank holding company with engaging in unsafe and unsound practices if it fails to commit resources to such a subsidiary bank. A capital injection may be required at times when the holding company may be required to borrow the funds or otherwise obtain the funds from external sources. If we are required to make such a capital injection, we may need to seek capital in order to do so and we may not be able to borrow or otherwise raise capital on favorable terms, or at all.
Non-compliance of our Regulator Agreement may adversely affect our operations.
As a result of the most recent safety and soundness examination of the Company and our subsidiary First Community Bank, which was conducted jointly by the Federal Reserve and the New Mexico Financial Institutions Division, we entered into an agreement on July 2, 2009 (the "Regulator Agreement"). Under the terms of the Regulator Agreement, we agreed, among other things, to engage an independent consultant acceptable to the regulators to assess
the Bank's management and staffing needs, assess the qualifications and performance of all officers of the Bank, and assess the current structure and compositions of the Bank's board of directors and its committees. In addition, within 60 days of the Regulator Agreement, the Company and or the Bank will submit a written plan to strengthen lending and credit risk management practices and improve the Bank's position regarding past due loans, problem loans, classified loans, and other real estate owned; maintain sufficient capital at the Bank, holding company and the consolidated level; improve the Bank's earnings and overall condition; and improve management of the Bank's liquidity position, funds management process, and interest rate risk management. The Company and or the Bank have also agreed to maintain an adequate allowance for loan and lease losses; charge-off or collect assets classified as "loss" in the Report of Examination that have not been previously collected or charged off; not to pay any dividends; not to distribute any interest, principal or other sums on trust preferred securities; not to issue, increase or guarantee any debt; not to purchase or redeem any shares of the Company's stock; and not to accept any new brokered deposits, even if the Bank is considered well capitalized. There can be no assurance that the Company and or the Bank's plans or level of capital will be deemed sufficient by the Regulators. Compliance with the terms of the Regulator Agreement may be expensive, and may take a significant amount of time of our management. However, if we fail to comply with the terms of the Regulator Agreement, we may be subject to further regulations.
Defaults in the repayment of loans may negatively affect our business.
A borrower's default on its obligations under one or more of our loans may result in lost principal and interest income and increased operating expenses as a result of the allocation of management time and resources to the collection and work-out of the loan. In certain situations, where collection efforts are unsuccessful or acceptable work-out arrangements cannot be reached, we may have to write-off the loan in whole or in part. In these situations, we may acquire real estate or other assets, if any, which secure the loan through foreclosure or other similar available remedies. In these cases, the amount owed under the defaulted loan often exceeds the value of the assets acquired.
We regularly make a determination of an allowance for loan losses based on available information, including the quality of and trends in our loan portfolio, economic conditions, the value of the underlying collateral, historical charge-offs, and the level of our non-accruing loans. Provisions for this allowance result in an expense for the period. Given the current economic conditions and trends, management believes we will continue to experience credit deterioration and higher levels of nonperforming loans in the near-term, which may cause us to continue to have negative earnings or otherwise adversely impact our financial condition and results of operations.
To qualify as collateral under the FHLB credit policy, loans must not be past due 90 days or more or classified substandard or below. Continuing deterioration of the loan performance could result in the Company being unable to satisfy the collateral requirements of the FHLB and the financial condition of the Company may be adversely affected.
As of June 30, 2009, our allowance for loan losses was $109.1 million or 4.89% of total loans held for investment. Our allowance for loan losses may not be sufficient to cover future loan losses. Future adjustments to the allowance for loan losses may be necessary if economic conditions differ substantially from the assumptions used or further adverse developments arise with respect to our nonperforming or performing loans. Material additions to our allowance for loan losses could have a material adverse effect on our financial condition and results of operations.
In addition, bank regulatory agencies periodically review our allowance for loan losses and the values we attribute to real estate acquired through foreclosure or other similar remedies. These regulatory agencies may require us to adjust our determination of the value for these items. If we are required to adjust our allowance for loan losses, our results of operations and financial condition may be adversely affected.
Our profitability depends significantly on local and overall economic conditions.
Our success is dependent to a significant extent upon local economic conditions in the communities we serve and the general economic conditions in the United States. The economic conditions, including real estate values, in these areas and throughout the United States, have a significant impact on loan demand, the ability of borrowers to repay these loans, and the value of the collateral securing these loans. The current decline in general economic conditions, including the decline in real estate values, has resulted in an increase in our nonperforming assets and an increase in our charge-offs on defaulted loans during 2008. A further decline in economic conditions, including depressed real estate values, over a prolonged period of time in any of these areas could cause additional significant increases in nonperforming assets and could continue to affect our ability to recover on defaulted loans by foreclosing and selling the real estate collateral, which could continue to cause decreased operating results, liquidity, and capital. As of June 30, 2009, approximately 86% of the book value of our loan portfolio consisted of loans collateralized by various types of real estate.
Our loan portfolio is currently concentrated in New Mexico, Colorado, Utah, and Arizona. Adverse economic conditions in these states could have a greater effect on our ability to attract deposits and result in high rates of loss and delinquency on our loan portfolio compared to competitors who may have more geographic diversification.
We may not be able to meet the cash flow requirements of our depositors and borrowers unless we have sufficient liquidity.
Liquidity is the ability to meet current and future cash flow needs on a timely basis at a reasonable cost. Our liquidity is used to make loans and to repay deposit liabilities as they become due or are demanded by customers. We regularly monitor our overall liquidity position to ensure that various alternative strategies exist to cover unanticipated events that could affect liquidity. Without sufficient liquidity from these potential sources, we may not be able to meet the cash flow requirements of our depositors and borrowers. Also, see Item 2: "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources."
The recent disruption and illiquidity in the credit markets are continuing challenges that have generally made potential funding sources more difficult to access, less reliable, and more expensive. In addition, liquidity in the inter-bank market, as well as the markets for commercial paper, certificates of deposits, and other short-term instruments have significantly contracted. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions. These market conditions have made the management of our own and our customers' liquidity significantly more challenging. At December 31, 2008, all outstanding borrowings with the FHLB were collateralized by a blanket pledge agreement on the Company's loan portfolio. Subsequent to December 31, 2008, the FHLB notified the Company that its blanket lien will be replaced by a custody arrangement, whereby the FHLB will have custody and endorsement of the loans that collateralize its FHLB borrowings. Sufficient collateral was delivered to satisfy the original requirements of the custody arrangement; however, effective July 29, 2009, the FHLB increased the collateral requirement. Loan collateral with approximately $900 million in par value and approximately $90 million in cash and investment securities has been delivered as collateral to FHLB and management expects to deliver an additional $425 million in par value of loans and investment securities if needed to satisfy the additional requirements. Management believes that we have sufficient loan and investment securities collateral to deliver to the FHLB to fully satisfy the new requirements. However, as the collateral values are determined subjectively by the FHLB, there is no assurance that the FHLB will not require additional collateral or repayment of existing borrowings. Based on our current status with the FHLB, the Company no longer has the ability to draw down additional advances. Under the terms of the Bank's agreement with the FHLB, the FHLB may at its own option call the outstanding debt due and payable if any of the following have occurred: the Bank has suspended payment to any creditor or there has been an acceleration of the maturity of any indebtedness of the Bank to others; the FHLB reasonably and in good faith determines that a material adverse change has occurred in the financial condition of the Bank; or the FHLB reasonably and in good faith deems itself insecure in the collateral even though the Bank is not otherwise in default.
Based on the Company's agreement with the FHLB and the FHLB's credit policy, as the existing borrowings mature, they will be allowed to continuously renew for like amounts, but for terms not to exceed thirty days. The Company has not received any notice from the FHLB regarding a call of its outstanding debt.
A further deterioration in the credit markets or a prolonged period without improvement of market liquidity could adversely affect our liquidity and financial position, including our regulatory capital ratios, and could adversely affect our business, results of operations, and prospects.
Supervisory guidance on commercial real estate concentrations could restrict our activities and impose financial requirements or limitations on the conduct of our business.
The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation have joint supervisory guidance on sound risk management practices for concentrations in commercial real estate lending. The guidance is intended to help ensure that institutions pursuing a significant commercial real estate lending strategy remain healthy and profitable while continuing to serve the credit needs of their communities. The agencies are concerned that rising commercial real estate loan concentrations may expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in commercial real estate markets. The guidance reinforces and enhances existing regulations and guidelines for safe and sound real estate lending. The guidance provides supervisory criteria, including numerical indicators to assist in identifying institutions
with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny. The guidance does not limit banks' commercial real estate lending, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. The lending and risk management practices will be taken into account in supervisory evaluation of capital adequacy. Our commercial real estate portfolio as of June 30, 2009, meets the definition of commercial real estate concentration as set forth in the final guidelines. If our risk management practices are found to be deficient, it could result in increased reserves and capital costs.
Fluctuations in interest rates could reduce our profitability.
Our net interest income may be reduced by changes in the interest rate environment. Our earnings depend to a significant extent on the interest rate differential. The interest rate differential or "spread" is the difference between the interest earned on loans, securities, and other interest-earning assets, and interest paid on deposits, borrowings, and other interest-bearing liabilities. These rates are highly sensitive to many factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory authorities. In particular, changes in the discount rate by the Board of Governors of the Federal Reserve System ("Federal Reserve") usually lead to changes in interest rates, which affect our interest income, interest expense, and securities portfolio. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. Loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. We cannot assure you that we can minimize our interest rate risk. In addition, an increase in the general level of interest rates may adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially and adversely affect our net interest spread, asset quality, loan origination volume, which may cause us to continue to have negative earnings or otherwise adversely impact our results of operations and financial condition.
In addition, our net income is affected by our interest rate sensitivity. Interest rate sensitivity is the difference between our interest-earning assets and our interest-bearing liabilities maturing or repricing within a given time period. Interest rate sensitivity is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. Since the middle of 2007, and as of December 31, 2008, the Federal Reserve has lowered the discount rate 500 basis points which has negatively impacted our interest spread. As of June 30, 2009, our cumulative interest rate gap for the period up to three months was a positive $636.4 million. If additional rate decreases occur, our results of operations and financial condition may be further adversely affected.
Our real estate construction loan portfolio may expose us to increased credit risk.
At June 30, 2009, our portfolio of real estate construction loans totaled $835.6 million or 37.2% of total loans. Approximately 43% of these loans are related to residential construction and approximately 57% are for commercial purposes or vacant land. During 2007, 2008, and the first half of 2009, the housing markets declined, evidenced by excess lot inventory and higher levels of completed unsold housing inventory. The decline in the housing market, sub-prime loan crisis, and tightening of credit markets has led to higher than normal foreclosure rates on a national level. Of the states that we operate in, Arizona, where we have the lowest dollar amount of real estate construction loans, has had the largest downturn in the residential real estate market. Although New Mexico, Colorado, and Utah have not experienced as significant a downturn in the residential real estate market, foreclosure rates have had a ripple effect on the construction industry as well as the acquisition and development sectors exposing us to increased credit risk within our construction loan portfolio.
Banking regulations have restricted our ability to pay dividends.
The Company and First Community Bank are both currently precluded from paying dividends pursuant to the Regulator Agreement. There is no assurance that the Company or First Community Bank will be able or permitted to resume paying dividends.
Although we hold all of the outstanding capital stock of First Community Bank, we are a legal entity separate and distinct from First Community Bank. Our ability to pay dividends on our common stock or service our obligations will depend primarily on the ability of First Community Bank to pay dividends to us. First Community Bank's ability to pay dividends and make other capital distributions to us is governed by federal and state law. Federal and state regulatory limitations on a bank's dividends generally are based on the bank's capital levels and current and retained earnings. The earnings of First Community Bank may not be sufficient to make capital distributions to us in an amount sufficient for us to service our obligations or to pay dividends on our common stock. During the third quarter of 2008, we suspended the payment of interest on all of our existing trust preferred securities, pursuant to an informal agreement with regulators. We have since entered into the Regulator Agreement which prohibits us from making such payments.
First Community Bank is prohibited under federal law from paying any dividend that would cause it to become "undercapitalized." It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available from the past year and only if prospective earnings retention is consistent with the organization's expected future needs and financial condition. Federal Reserve Board policy also provides that bank holding companies should not maintain such a level of cash dividends that would undermine the bank holding company's ability to provide financial resources as needed to its insured banking subsidiaries. Additionally, the Federal Reserve Board has the right to object to a distribution on safety and soundness grounds. Depending upon the circumstances, the Federal Reserve Board could take the position that paying a dividend would constitute an unsafe or unsound banking practice.
The terms of our trust preferred securities may restrict our ability to pay dividends.
The terms of our trust preferred securities allow us to suspend payments of interest, at our option, for up to five years. Since we have exercised our option to suspend those payments, we are prohibited from paying any dividends on any class of capital stock for as long as the trust preferred interest payments remain suspended. Pursuant to the Regulator Agreement, we are prohibited from paying interest on all of our existing trust preferred securities. Our ability to make interest payments on the trust preferred securities is highly dependent on receiving dividends from First Community Bank. There is no assurance that we will be able to resume making the interest payments.
Consolidated Condensed Balance Sheets
Our total assets decreased by $422.7 million from $3.415 billion as of December 31, 2008, to $2.992 billion as of June 30, 2009. The decrease in total assets is primarily due to the branch sale of approximately $387 million in loans and $20 million in premises and equipment. Our deposits decreased by $324.6 million from $2.523 billion at December 31, 2008, to $2.198 billion at June 30, 2009. The decrease in deposits is primarily due to the branch sale of approximately $512 million in deposits and a reduction in brokered deposits of $112 million, offset by in increase in our non-brokered deposits of $296 million.
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