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| CADE > SEC Filings for CADE > Form 10-Q on 10-Aug-2009 | All Recent SEC Filings |
10-Aug-2009
Quarterly Report
Forward-Looking Information
The following provides a narrative discussion and analysis of significant changes in our results of operations and financial condition for the three and six months ended June 30, 2009. Certain information included in this discussion contains forward-looking statements and information that are based on management's beliefs, expectations and conclusions, drawn from certain assumptions and information currently available. The Private Securities Litigation Act of 1995 encourages the disclosure of forward-looking information by management by providing a safe harbor for such information. This discussion includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Although we believe that the expectations and conclusions reflected in such forward-looking statements are reasonable, such forward-looking statements are based on numerous assumptions (some of which may prove to be incorrect) and are subject to risks and uncertainties, which could cause the actual results to differ materially from our expectations. When used in this discussion, the words "anticipate," "believe," "estimate," "expect," "objective," "project," "forecast," "goal" and similar expressions are intended to identify forward-looking statements. In addition to any assumptions and other factors referred to specifically in connection with forward-looking statements, factors that could cause our actual results to differ materially from those contemplated in any forward-looking statements include, among others, increased competition, regulatory factors, economic conditions, changing interest rates, changing market conditions (including specifically the downturn in the U. S. real estate market), availability or cost of capital, changes in accounting standards and practices, employee workforce factors, ability to achieve cost savings and enhance revenues, the assimilation of acquired operations and establishing credit practices and efficiencies therein, acts of war or acts of terrorism or geopolitical instability and other effects of legal and administrative proceedings, changes in federal, state or local laws and regulations and other factors identified in Item 1A, "Risk Factors," and Item 7A, "Quantitative and Qualitative Disclosures about Market Risk," of our Annual Report on Form 10-K for the year ended December 31, 2008, and that may be discussed from time to time in other reports filed with the Securities and Exchange Commission subsequent to this report. Readers are cautioned not to place undue reliance on any forward-looking statements made by or on behalf of the Corporation. Any such statement speaks only as of the date the statement was made. We undertake no obligation to update or revise any forward-looking statements, whether as a result of changes in actual results, changes in assumptions or other factors affecting such statements.
For purposes of the following discussion and analysis of the Corporation's financial condition and results of operations, the words the "Corporation," "we," "us" and "our" refer to the combined entities of Cadence Financial Corporation and Cadence, unless the context suggests otherwise.
Introduction and Management Overview
The Corporation is a bank holding company that owns Cadence. Cadence operates in the states of Mississippi, Alabama, Tennessee, Florida and Georgia. Cadence's primary business is providing traditional commercial and retail banking services to customers. Cadence also provides other financial services, including trust services, mortgage services, insurance and investment products. Our stock is traded on The NASDAQ Global Select Market ("NASDAQ") under the ticker symbol of "CADE".
Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.
Summary of Six Months Ended June 30, 2009
Participation in Capital Purchase Program. In January 2009, we sold 44,000 shares of non-voting Series A preferred stock, for an aggregate purchase price of $44.0 million and issued a warrant to purchase up to 1,145,833 shares of our common stock to the U.S. Treasury under the CPP.
Net Interest Income. Our net interest income declined from $28.6 million in the first six months of 2008 to $23.0 million in the first six months of 2009. For the first six months of 2009, our net interest margin was 2.42%, compared to 3.17% for the first six months of 2008. Our loan yields declined by 145 basis points as compared to the first six months of 2008, partly due to the 175 basis point reduction in interest rates between June 30, 2008 and June 30, 2009. Our yield on earning assets declined by 159 basis points during this period, but was offset somewhat by a 5.6% increase in average earning assets.
Provision for Loan Losses. Our provision for loan losses was $55.8 million for the first six months of 2009, as compared to $6.3 million for the first six months of 2008. We incurred $29.8 million in net charge-offs for the first six months of 2009, compared to $5.4 million for the first six months of 2008. A significant portion of the increase in net charge-offs is attributable to two borrower relationships. Also, we significantly increased our allowance for loan losses during the six months of 2009. Our allowance for loan losses was $46.7 million at June 30, 2009, compared with our allowance for loan losses at December 31, 2008 of $20.7 million. We have experienced an increase in non-performing loans, mostly due to real estate construction and development loans. During the first six months of 2009, we noted increased weakness in our Middle Tennessee market.
Other Income (Noninterest Income). Our noninterest income, exclusive of securities gains and losses, was relatively flat between the first six months of 2008 and the first six months of 2009.
Other Expense (Noninterest Expense). During the first six months of 2009, total noninterest expenses increased by $70.5 million from the same period of 2008. Included in this increase is a $66.8 million impairment loss on goodwill. The remaining $3.7 million increase resulted primarily from increases in FDIC insurance premiums and expenses relating to OREO.
Net Income/(Loss). For the first six months of 2009, we reported a net loss applicable to common shareholders of $99.1 million, or $(8.32) per common share, compared to net income of $4.6 million, or $0.39 per common share, for the first six months of 2008.
Loan Portfolio. As of June 30, 2009, our loan portfolio was $1.244 billion, distributed among commercial real estate loans, commercial and industrial loans, 1-4 family mortgages and consumer loans. As of June 30, 2009, our loan portfolio was composed of approximately 61.0% variable rate loans and 39.0% fixed rate loans. Beginning in the third quarter of 2008, we made a concerted effort to reduce our concentration in commercial real estate loans, particularly residential construction and development loans, which typically have higher yields but also higher risk. Overall, our average loan balances declined by approximately $59.5 million, or 4.4%, from the first six months of 2008 to the first six months of 2009, to $1.293 billion for the first six months of 2009 from $1.353 billion for the first six months of 2008.
Investment Portfolio. The average balance of our investment portfolio was $454.7 million for the first six months of 2009, compared to $439.5 million for the first six months of 2008, representing an increase of $15.2 million, or 3.5%. However, our yield on securities declined by 53 basis points to 4.31% over this same period.
Federal Funds Sold and Other Interest-Bearing Assets. Our average balances in federal funds sold and other interest-bearing assets increased significantly from the first six months of 2008 to the first six months of 2009, from $20.2 million to $166.9 million. This variance resulted from our intentionally building liquidity by accumulating deposits and investing in short-term assets. Our yields on these assets declined from 2.59% for the first six months of 2008 to 0.27% for the first six months of 2009, which negatively affected our overall yield on earning assets.
Deposits. Our overall cost of funds declined by 94 basis points between the first six months of 2008 and the first six months of 2009. Average interest-bearing deposits increased 12.5% to $1.38 billion for the first six months
of 2009, compared to $1.23 billion for the first six months of 2008, somewhat offset by a decline of $74.0 million, or 19.3%, in average borrowed funds.
During the first quarter of 2009, we accumulated an additional $166 million in deposits, held at June 30, 2009 in our Federal Reserve account and in short-term U.S. Treasury obligations.
Summary of Quarter Ended June 30, 2009
Net Interest Income. Net interest income for the second quarter of 2009 was $10.7 million, compared to $14.0 million for the same quarter of 2008, a decrease of 24.1%. During the second quarter of 2009, the net interest margin was 2.21%, compared to 3.11% for the same period of 2008. This 90 basis point decrease in margin resulted primarily from our intentionally building liquidity by accumulating deposits and investing in short-term assets with lower yields and the fact that we were not able to decrease our cost of funding at the same rate that our yields declined on loans and investment securities. When comparing the second quarter of 2009 to the same quarter of 2008, we lost 147 basis points of yield on our earning assets but only reduced the cost of funds by 64 basis points. An increase of $121.0 million, or 6.7%, in our average earning assets partially offset the effect of the declining margin on our net interest income for the second quarter of 2009.
Provision for Loan Losses. The provision for loan losses increased from $3.3 million during the second quarter of 2008 to $23.0 million in the second quarter of 2009. This increase was due to a higher level of net charge-offs ($15.3 million in the second quarter of 2009 as compared to $2.5 million in the second quarter of 2008), as well as a significant increase in non-performing loans. Over half of the increase in net charge-offs in 2009 was attributed to a single relationship. The increase in non-performing loans was primarily due to the economy's impact on real estate-based loans. Also contributing to the increase in the provision for loan losses for the second quarter of 2009 was the updating of the three-year average historical loss factors for homogenous loan pools included in our allowance for loan losses methodology. The 2008 historical losses were significantly higher than the 2005 historical losses that they replaced.
Other Income (Noninterest Income). Our noninterest income, exclusive of securities gains and losses, declined by $65,000, or 1.3%, from the second quarter of 2008 to the second quarter of 2009.
Other Expense (Noninterest Expense). Noninterest expenses increased by $2.7 million, or 20.2%, during the second quarter of 2009, compared with the second quarter of 2008. This increase resulted primarily from increases in FDIC insurance premiums and expenses relating to OREO.
Net Income/(Loss). For the second quarter of 2009, we reported a net loss applicable to common shareholders of $14.7 million, or $(1.23) per common share, compared to net income of $1.9 million, or $0.16 per common share, for the second quarter of 2008.
Loan Portfolio. Our average loan balances declined by approximately $85.4 million, or 6.3%, to $1.273 billion for the second quarter of 2009, compared to $1.359 billion for the second quarter of 2008.
Investment Portfolio. The average balance of our investment portfolio was $441.8 million for the second quarter of 2009, compared to $434.7 million for the second quarter of 2008, representing an increase of $7.1 million, or 1.6%. Our yield on securities declined by 51 basis points to 4.24% over this same period.
Federal Funds Sold and Other Interest-Bearing Assets. Our average balances in federal funds sold and other interest-bearing assets increased significantly from the second quarter of 2008 to the second quarter of 2009, from $22.0 million to $221.3 million. This variance resulted from our intentionally building liquidity by accumulating deposits and investing in short-term assets. Our yields on these assets declined from 2.49% for the second quarter of 2008 to 0.26% for the second quarter of 2009, which negatively affected our overall yield on earning assets.
Deposits. Our overall cost of funds declined by 64 basis points between the second quarter of 2008 and the second quarter of 2009. Average interest-bearing deposits increased 16.7% to $1.42 billion for the second quarter of
2009, compared to $1.21 billion for the second quarter of 2008, somewhat offset by a decline of $98.0 million, or 24.6%, in average borrowed funds.
Outlook for Remainder of 2009
We believe our most significant challenge for the remainder of 2009 will be managing credit quality. We have taken an aggressive stance in addressing credit issues in our loan portfolio to minimize future risks, including taking an increased focus on underwriting standards and updating our loan policies. We have a special assets team in place to manage workout situations and assist in the timely disposition of defaulted assets. Our management information systems relating to loan concentrations provide us with current and detailed information about the status of the loans in our portfolio. Although we believe that these steps enhance our ability to manage credit quality, credit quality will remain an issue as long as current economic trends, including increasing unemployment rates and declining real estate prices, continue.
We continue to look for ways to grow noninterest income; however, the growth of noninterest income will remain a challenge under current economic conditions. We will also continue our efforts to control noninterest expenses. We expect our costs for FDIC insurance premiums to remain high for 2009, and we expect additional increases in OREO expenses based on recent additions. If rates remain flat as we currently expect, it will be difficult for us to expand our margin significantly. However, we also expect our deposits and wholesale funding balances to decline, as we intend to use our excess liquidity to absorb maturing liabilities to reduce interest expense, which should add some improvement to our margin.
Critical Accounting Policies
Our accounting and financial reporting policies conform to United States generally accepted accounting principles and to general practices within the banking industry. Note A of the Notes to Consolidated Financial Statements in our annual report contains a summary of our accounting policies. Management is of the opinion that Note A, read in conjunction with all other information in our annual report on Form 10-K for the year ended December 31, 2008, and the information in this quarterly report, including this Management's Discussion and Analysis, should be sufficient to provide the reader with the information needed to understand our financial condition and results of operations.
Critical Accounting Policies. We believe that the areas of the financial statements that require the most difficult, subjective and complex judgments, and therefore contain the most critical accounting estimates, are as follows:
• the provision for loan losses and the resulting allowance for loan losses;
• the liability and expense relating to our pension and other postretirement benefit plans;
• issues relating to other-than-temporary impairment losses in the investment portfolio; and
• goodwill and other intangible assets.
Provision/Allowance for Loan Losses. Our allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The allowance for loan losses is maintained at a level that we believe is adequate to absorb all probable losses on loans inherent in the loan portfolio. The amount of the allowance is affected by loan charge-offs, which decrease the allowance; recoveries on loans previously charged off, which increase the allowance; and the provision for loan losses charged to earnings, which increases the allowance. In determining the provision for loan losses, we monitor fluctuations in the allowance resulting from actual charge-offs and recoveries and periodically review the size and composition of the loan portfolio in light of current and anticipated economic conditions. If actual losses exceed the amount of the allowance for loan losses, our earnings could be adversely affected.
The allowance for loan losses represents management's estimate of the amount necessary to provide for losses inherent in the loan portfolio in the normal course of business. Due to the uncertainty of risks in the loan portfolio, management's judgment of the amount of the allowance necessary to absorb loan losses is approximate. The allowance for loan losses is also subject to regulatory examinations and determination by the regulatory agencies as to its adequacy.
The allowance for loan losses is comprised of the following three components:
specific reserves, general reserves and unallocated reserves. Generally, all
loans that are identified as impaired are reviewed on a quarterly basis in order
to determine whether a specific reserve is required. A loan is considered
impaired when, based on current information, it is probable that we will not
receive all amounts due in accordance with the contractual terms of the loan
agreement. Once a loan has been identified as impaired, management measures
impairment in accordance with Statement of Financial Accounting Standards (SFAS)
No. 114, "Accounting By Creditors for Impairment of a Loan," as amended by SFAS
No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition
and Disclosures." The measurement of impaired loans is based on the present
value of expected future cash flows discounted at the loan's effective interest
rate or the loan's observable market price, or based on the fair value of the
collateral if the loan is collateral-dependent. When management's measured value
of the impaired loan is less than the recorded investment in the loan, the
amount of the impairment is recorded as a specific reserve. These specific
reserves are determined on an individual loan basis based on our current
evaluation of our loss exposure for each credit, given the payment status,
financial condition of the borrower and value of any underlying collateral.
Loans for which specific reserves are provided are excluded from the general
reserve and unallocated reserve calculations described below. Changes in
specific reserves from period to period are the result in changes in the
circumstances of individual loans such as charge-offs, pay-offs, changes in
collateral values or other factors.
We also maintain a general reserve for each loan type in the loan portfolio. In determining the amount of the general reserve portion of our allowance for loan losses, we consider factors such as our historical loan loss experience, the growth, composition and diversification of our loan portfolio, current delinquency levels, adverse situations that may affect the borrower's ability to repay, estimated value of the underlying collateral, the results of recent regulatory examinations and general economic conditions. Established reserves for graded loans represent those criticized and classified loans where no impairment or specific reserve has been established. Reserves for these loans are based upon an average of the prior three-year loss factor. Homogeneous pools represent a pooling of non-criticized retail loan types. These loans are also reserved for based upon a three-year loss factor percentage. Other loan types include all other loans not included in the above commentary (not previously mentioned). These loans are non-criticized and are reserved for based upon the average of the prior three-year loss factor. We use this information to set the general reserve portion of the allowance for loan losses at a level we deem prudent.
Because there are additional risks of losses that cannot be quantified precisely or attributed to particular loans or types of loans, including general economic and business conditions and credit quality trends, we have established an unallocated portion of the allowance for loan losses based on our evaluation of these risks. The unallocated portion of our allowance is determined based on various factors, including general economic conditions of our market area, the growth, composition and diversification of our loan portfolio, types of collateral securing our loans, the experience level of our lending officers and staff, the quality of our credit risk management and the results of independent third party reviews of our classification of credits. The unallocated portion of the allowance for loan losses was $4.0 million, or 8.6% of the total allowance, as of June 30, 2009, and $4.0 million, or 19.3% of the total allowance, as of December 31, 2008.
Based on an evaluation of the loan portfolio, management presents a quarterly review of the allowance for loan losses to the Bank's executive committee and our full board of directors, indicating any change in the allowance for loan losses since the last review and any recommendations as to adjustments in the allowance for loan losses. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as events change. We used the same methodology and generally similar assumptions in assessing the allowance for both comparison periods. The allowance for loan losses was $46.7 million as of June 30, 2009, compared to $20.7 million as of December 31, 2008. This increase reflects further deterioration in our loan portfolio, due primarily to the lack of demand for residential housing, and the subsequent increase in net charge-offs.
Pension and Other Postretirement Benefit Plans. Another area that requires subjective and complex judgments is the liability and expense relating to our pension and other postretirement benefit plans. We maintain several benefit plans for our employees. They include a defined benefit pension plan, a defined contribution pension plan, a 401(k) plan and a deferred compensation plan. We make all contributions to these plans when they are due.
The defined benefit pension plan is the only plan that requires multiple assumptions to determine the liability under the plan. This plan has been frozen to new participants for several years. Management evaluates, reviews with
the plan actuaries, and updates as appropriate the assumptions used in the determination of pension liability, including the discount rate, the expected rate of return on plan assets, and increases in future compensation. Actual experience that differs from the assumptions could have a significant effect on our financial position and results of operations. The discount rate and the expected rate of return on the plan assets have a significant impact on the actuarially computed present value of future benefits that is recorded on the financial statements as a liability and the corresponding pension expense.
In selecting the expected rate of return, management, in consultation with the plan trustees, selected a rate based on assumptions compared to recent returns and economic forecasts. We consider the current allocation of the portfolio and the probable rates of return of each investment type. In selecting the appropriate discount rate, management, with the assistance of actuarial consultants, performs an analysis of the plan's projected benefit cash flows against discount rates from a national Pension Discount Curve (a yield curve used to measure pension liabilities). Based on the analysis, management used a discount rate of 5.75% in 2006 and 2007 and a discount rate of 6.0% in 2008. We used an expected rate of return of 7.5% for 2006, 2007 and 2008. From a historical perspective, the rates of return on the plan were 9.5% for 2006, 7.6% for 2007, and (21.7%) for 2008. Additionally, our philosophy has been to fund the plan annually to the maximum amount deductible under the Internal Revenue Service ("IRS") rules. As of December 31, 2008, the plan had a current accumulated benefit obligation of approximately $10.7 million, and plan assets with a fair value of approximately $10.7 million.
FASB Statement No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans," requires us to recognize the funded status of the plan (defined as the difference between the fair value of plan assets and the projected benefit obligation) on the balance sheet and to recognize in other comprehensive income any gains or losses and prior service costs or benefits not included as components of periodic benefit cost. Detailed information on our pension plan and the related impacts of these changes on the amounts recorded in our financial statements can be found in Note M (Employee Benefits) of the notes to consolidated financial statements (audited).
Other-Than-Temporary Impairment of Investment Securities. A third area that requires subjective and complex judgments on the part of management is the review of the investments in the investment portfolio for other-than-temporary impairments. Emerging Issue Task Force Issue 03-01 and FASB FSP FAS 115-1 and FAS 124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," require us to review our investment portfolio and determine if it has impairment losses that are other-than-temporary. In making its determination, management considers the following items:
• the length of time and extent to which the current market value is less than cost;
• evidence of a forecasted recovery;
• financial condition and the industry environment of the issuer, including whether the issuer is a government or government-backed agency (all of the mortgage-backed securities and collateralized mortgage obligations in our portfolio are issued by government-backed agencies);
• downgrades of the securities by rating agencies;
• whether there has been a reduction or elimination of dividends or interest payments;
• whether we have the intent or ability to hold the securities for a period of time sufficient to allow for anticipated recovery of fair value; and
• interest rate trends that may impact recovery and realization.
As of June 30, 2009, our investment portfolio included certain securities that were impaired by definition, but based on our review and consideration of the criteria listed above, we determined that none of the impairments were other-than-temporary.
Goodwill and Other Intangible Assets. FASB Statement No. 142, "Goodwill and Other Intangible Assets," eliminated the requirement to amortize goodwill; however, it does require periodic testing for impairment using a two-step approach. The first step is to determine whether impairment could exist. If the results of the first step of testing indicate that impairment does not exist, . . .
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