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SBFC > SEC Filings for SBFC > Form 10-Q on 26-Oct-2012All Recent SEC Filings




Quarterly Report

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

(Dollar amounts are expressed in thousands unless otherwise noted)


Southeastern Bank Financial Corporation (the "Company") is a Georgia corporation that is a bank holding company registered with the Board of Governors of the Federal Reserve System (the "Federal Reserve") under the Bank Holding Company Act of 1956, as amended (the "BHCA"). Southeastern Bank Financial Corporation (OTCQB: SBFC) trades on OTCQB, the marketplace for companies that are current in their reporting with a U.S. regulator. Investors can find Real-Time quotes and market information for the Company on The Company's wholly-owned subsidiary, Georgia Bank & Trust Company of Augusta ("GB&T"), primarily does business in the Augusta-Richmond County, GA-SC metropolitan area. GB&T was organized by a group of local citizens and commenced business on August 28, 1989, with one branch location. Today, it is Augusta's largest community banking company operating nine full service branches in Augusta, Martinez, and Evans, Georgia. GB&T also operates three full service branches in North Augusta and Aiken, South Carolina under the name "Southern Bank & Trust, a division of Georgia Bank & Trust Company of Augusta." Mortgage origination offices are located in Augusta and Savannah, Georgia and in Aiken, South Carolina. The Company's Operations Center is located in Martinez, Georgia.

The Company's primary market includes Richmond and Columbia Counties in Georgia and Aiken County in South Carolina, all part of the Augusta-Richmond County, GA-SC metropolitan statistical area (MSA). The Augusta market area has a diversified economy based principally on government, public utilities, health care, manufacturing, construction, and wholesale and retail trade. Augusta is one of the leading medical centers in the Southeast.

The Company's services include the origination of residential and commercial real estate loans, construction and development loans, and commercial and consumer loans. The Company also offers a variety of deposit programs, including noninterest-bearing demand, interest checking, money management, savings, and time deposits. In the primary market area, Augusta-Richmond County, GA-SC metropolitan area, the Company had 19.26% of all deposits and was the second largest depository institution at June 30, 2012, as cited from the Federal Deposit Insurance Corporation's ("FDIC") website. Securities sold under repurchase agreements are also offered. Additional services include wealth management, trust, retail investment, and mortgage. As a matter of practice, most mortgage loans are sold in the secondary market; however, some mortgage loans are placed in the portfolio based on asset/liability management strategies. The Company continues to concentrate on increasing its market share through various new deposit and loan products and other financial services and by focusing on the customer relationship management philosophy. The Company is committed to building life-long relationships with its customers, employees, shareholders, and the communities it serves.

The Company's primary source of income is from its lending activities followed by interest income from its investment activities, service charges and fees on deposits, and gain on sales of mortgage loans in the secondary market. Interest income on loans decreased during the first nine months of 2012 as compared to the first nine months of 2011 due primarily to decreased loan yields and to a lesser extent reduced volume. Interest income on investment securities was relatively the same but with declining yields offset by a larger investment portfolio. Decreases in consumer non-sufficient funds ("NSF") income on retail checking accounts, due primarily to decreased economic activity, were mostly offset by increases in such fees on commercial accounts and also from increased ATM/Debit card income for the first nine months of 2012. For the nine month period, gain on sales of loans increased due to increased mortgage originations and refinancing activity during the first nine months of the year. Investment securities gains increased on a net basis during the first nine months of 2012 as compared to the same period last year due in part to selected sales of higher duration securities to reduce exposure to rising interest rates and the reduction of other-than-temporary losses during the first nine months of 2012.

                       Table 1 - Selected Financial Data

                                                      September 30,       December 31,       September 30,
                                                          2012                2011               2011
                                                                     (Dollars in thousands)

Assets                                               $     1,673,105     $    1,614,773     $     1,609,426
Investment securities                                        676,089            603,759             596,936
Loans                                                        853,927            846,010             838,777
Deposits                                                   1,436,343          1,419,222           1,401,272

Annualized return on average total assets                       0.85 %             0.69 %              0.67 %
Annualized return on average equity                            11.32 %            10.23 %             10.18 %

Although the Company continues to focus on the net interest margin, regulatory capital levels, liquidity management, asset quality and risk mitigation, the Company is also focused on generating loans to offset declining investment portfolio yields. Asset levels have increased slightly and are the result primarily of increased investment portfolio balances over the comparable periods in an effort to maintain net interest income.

Annualized return on average total assets and annualized return on average equity have improved in 2012 as compared to 2011. The increased returns were due primarily to reduced provision for loan losses, increased sales of mortgage loans and increased net interest income. Partially offsetting these were increased salaries and employee expenses and other real estate losses. Net income for the nine months ended September 30, 2012 was $10,539 compared to $8,031 for the same period in 2011.

The Company meets its liquidity needs by managing cash and due from banks, federal funds purchased and sold, maturity of investment securities, principal repayments from mortgage-backed securities, and draws on lines of credit. Additionally, liquidity can be managed through structuring deposit and loan maturities. The Company funds loan and investment growth with core deposits, securities sold under repurchase agreements, Federal Home Loan Bank advances and other wholesale funding including brokered certificates of deposit. During inflationary periods, interest rates generally increase and operating expenses generally rise. When interest rates rise, variable rate loans and investments produce higher earnings; however, deposit and other borrowings interest expense also rise. The Company monitors its interest rate risk as it applies to net interest income in a ramp up and down annually 400 basis points (4.00%) scenario and as it applies to economic value of equity in a shock up and down 400 basis points (4.00%) scenario. The Company monitors operating expenses through responsibility center budgeting.

Forward-Looking Statements

Southeastern Bank Financial Corporation may, from time to time, make written or oral forward-looking statements, including statements contained in the Company's filings with the Securities and Exchange Commission (the "Commission") and its reports to shareholders. Statements made in such documents, other than those concerning historical information, should be considered forward-looking and subject to various risks and uncertainties. Such forward-looking statements are made based upon management's belief as well as assumptions made by, and information currently available to, management pursuant to "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. The Company's actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors, including unanticipated changes in the Company's local economies, the national economy, governmental monetary and fiscal policies, deposit levels, loan demand, loan collateral values and securities portfolio values; difficulties in interest rate risk management; the effects of competition in the banking business; difficulties in expanding the Company's business into new markets; changes in governmental regulation relating to the banking industry, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act; failure of assumptions underlying the establishment of reserves for loan losses, including the value of collateral underlying delinquent loans; and other factors. The Company cautions that such factors are not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by, or on behalf of, the Company.

Critical Accounting Estimates

The accounting and financial reporting policies of the Company and its subsidiary conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses, determining the fair values of financial instruments including other real estate owned, interest rate swap derivatives, investment securities, and other-than-temporary impairment as critical accounting estimates that requires difficult, subjective judgment and are important to the presentation of the financial condition and results of operations of the Company.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses charged to expense, which affects the Company's earnings directly. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that reflects management's estimate of the level of probable incurred losses in the portfolio. Factors considered by management in determining the adequacy of the allowance include, but are not limited to: (1) detailed reviews of individual loans; (2) historical and current trends in loan charge-offs for the various portfolio segments evaluated; (3) the level of the allowance in relation to total loans and to historical loss levels;
(4) levels and trends in non-performing and past due loans; (5) collateral values of properties securing loans; and (6) management's assessment of economic conditions. The Company's Board of Directors reviews the recommendations of management regarding the appropriate level for the allowance for loan losses based upon these factors.

The provision for loan losses is the charge to operating earnings necessary to maintain an adequate allowance for loan losses. The Company has developed policies and procedures for evaluating the overall quality of its loan portfolio and the timely identification of problem credits. Management continues to review these policies and procedures and makes further improvements as needed. The adequacy of the Company's allowance for loan losses and the effectiveness of the Company's internal policies and procedures are also reviewed periodically by the Company's regulators and the Company's internal loan review personnel. The Company's regulators may advise the Company to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.

The Company continues to refine the methodology on which the level of the allowance for loan losses is based, by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement; however, cash receipts on impaired and nonaccrual loans for which the accrual of interest has been discontinued are applied to principal and interest income depending upon the overall risk of principal loss to the Company.

Fair Value of Financial Instruments

A significant portion of the Company's assets are financial instruments carried at fair value. This includes securities available-for-sale, loans held for sale, certain impaired loans, mortgage banking derivatives, interest rate swap derivatives and other real estate owned. At September 30, 2012 and December 31, 2011 the percentage of total assets measured at fair value was 43.13% and 40.52%, respectively. The majority of assets carried at fair value are based on either quoted market prices or market prices for similar instruments. At September 30, 2012, 2.51% of assets measured at fair value were based on significant unobservable inputs. This represents approximately 1.08% of the Company's total assets. See Note 4 "Fair Value Measurements" in the "Notes to Consolidated Financial Statements" herein for additional disclosures regarding the fair value of financial instruments.

Other Real Estate Owned

Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Costs related to the development and improvement of real estate owned are capitalized.

Interest Rate Swap Derivatives

The fair value of interest rate swap derivatives is determined based on discounted cash flow valuation models using observable market data as of the measurement date. The fair value adjustment is included in other liabilities. See Note 1 "Summary of Significant Accounting Policies" in the "Notes to Consolidated Financial Statements" herein for additional disclosures regarding the fair value of financial instruments.

Investment Securities

The fair values for available-for-sale securities are generally based upon quoted market prices or observable market prices for similar instruments. These values take into account recent market activity as well as other market observable data such as interest rate, spread and prepayment information. When market observable data is not available, which generally occurs due to the lack of liquidity for certain securities, the valuation of the security is subjective and may involve substantial judgment. The Company conducts periodic reviews to identify and evaluate each available-for-sale security that has an unrealized loss for other-than-temporary impairment. An unrealized loss exists when the fair value of an individual security is less than its amortized cost basis. The primary factors the Company considers in determining whether an impairment is other-than-temporary are the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and whether the Company intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. As of September 30, 2012, the Company had approximately $1,864 of available-for-sale securities, which is approximately 0.11% of total assets, valued using unobservable inputs (Level 3). These securities were primarily non-agency mortgage-backed securities and single issuer subordinated debentures issued by financial institutions.

Results of Operations

Net income for the first nine months of 2012 was $10,539, an increase of $2,508 compared with net income of $8,031 for the first nine months of 2011. The change in net income was primarily due to reduced provision for loan losses, increased gain on sales of mortgage loans and increased net interest income offset in part by increased operating expenses.

Noninterest income increased $2,073 or 14.85% for the nine months ended September 30, 2012 and resulted primarily from increased gain on sales of loans and investment securities. Retail investment income, trust fees and cash surrender value of bank-owned life insurance also increased over the comparable periods. The increase in gain on sales of loans was primarily due to increased origination volumes and spreads during the first nine months of 2012. Retail investment income increased due to increased brokerage activity and assets under management. Net investment securities gains year to date are $432 as compared to net securities gains of $267 in 2011.

Noninterest expense totaled $32,780 for the nine months ended September 30, 2012, an increase of $2,320, or 7.62% compared to the same period ended September 30, 2011. Notable changes included an increase in salaries and other personnel expense of $2,136, an increase of $219 in other real estate losses and a decrease in FDIC insurance of $175.

                     Table 2 - Selected Balance Sheet Data

                                               September 30,       December 31,             Variance
                                                   2012                2011           Amount           %
                                                                  (Dollars in thousands)
Cash, due from banks
   and interest-bearing deposits              $        54,167     $       69,841     $ (15,674 )      (22.44 %)
Investment securities                                 676,089            603,759        72,330         11.98 %
Loans                                                 853,927            846,010         7,917          0.94 %
Other real estate owned                                 4,067              6,209        (2,142 )      (34.50 %)
Assets                                              1,673,105          1,614,773        58,332          3.61 %
Deposits                                            1,436,343          1,419,222        17,121          1.21 %
Securities sold under repurchase agreements               654                701           (47 )       (6.70 %)
Advances from Federal Home Loan Bank                   64,000             39,000        25,000         64.10 %
Liabilities                                         1,540,402          1,497,744        42,658          2.85 %
Stockholders' equity                                  132,703            117,029        15,674         13.39 %

Table 2 highlights significant changes in the balance sheet at September 30, 2012 as compared to December 31, 2011. Total assets increased $58,332 and reflect an increase in investment securities of $72,330 coupled with an decrease in cash, due from banks and interest bearing deposits of $15,674. Total liabilities increased $42,658 and reflect an increase in deposits of $17,121 and an increase in advances from Federal Home Loan Bank of $25,000.

The Company has continued to maintain a relatively high level of liquid funds in light of current economic conditions but has elected to invest a portion of these funds and funds obtained through deposit growth and loan repayments into the investment portfolio. Loan demand was weak during the first nine months of 2012 and resulted in a minor increase in loans of $7,917 or 0.94%. The change in investment securities during the year included maturities and calls of bonds and selected sales of high duration securities for interest rate risk management purposes. These changes coupled with reinvestment of proceeds contributed to the average yield of the taxable investment portfolio declining from 3.00% to 2.61%. The yield on the tax exempt portfolio declined from 4.04% to 3.43% and resulted primarily from additions to the portfolio with lower yielding securities.

The $17,121 increase in deposits was primarily in savings accounts and demand deposits. Brokered deposits remained relatively unchanged and totaled $155,955 at September 30, 2012 compared to $153,560 at December 31, 2011. Savings and money market accounts increased $21,917, noninterest-bearing accounts increased $13,802, NOW accounts decreased $11,057 and non brokered retail time deposits decreased $9,936.

The annualized return on average assets for the Company was 0.85% for the nine months ended September 30, 2012, compared to 0.67% for the same period last year.

The annualized return on average stockholders' equity was 11.32% for the nine months ended September 30, 2012, compared to 10.18% for the same period last year.

Net Interest Income

The primary source of earnings for the Company is net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings. The following table shows the average balances of interest-earning assets and interest-bearing liabilities, annualized average yields earned and rates paid on those respective balances, and the actual interest income and interest expense for the periods indicated. Average balances are calculated based on daily balances, yields on non-taxable investments are not reported on a tax equivalent basis and average balances for loans include nonaccrual loans even though interest was not earned.

       Table 3 - Average Balances, Income and Expenses, Yields and Rates

                                 Three Months Ended Sept 30, 2012                    Three Months Ended Sept 30, 2011
                                                Annualized                                          Annualized
                                                  Average        Amount                               Average        Amount
                              Average            Yield or        Paid or          Average            Yield or        Paid or
                              Amount               Rate          Earned           Amount               Rate          Earned
                                                                (Dollars in thousands)
  Loans                   $       875,801              5.27 %   $  11,742     $       877,342              5.66 %   $  12,636
  Investment securities
   Taxable                        567,698              2.46 %       3,491             520,963              3.03 %       3,940
   Tax-exempt                      76,842              3.35 %         643              53,117              3.84 %         510
deposits in other banks            11,112              0.54 %          15              17,997              0.47 %          22
interest-earning assets   $     1,531,453              4.09 %   $  15,891     $     1,469,419              4.60 %   $  17,108

  Deposits                $     1,265,737              0.70 %   $   2,227     $     1,262,385              1.06 %   $   3,381
  Securities sold under
   agreements                         728              0.41 %           1                 642              0.62 %           1
  Other borrowings                 83,938              3.23 %         683              74,947              3.37 %         637
liabilities               $     1,350,403              0.86 %   $   2,911     $     1,337,974              1.19 %   $   4,019

Net interest
margin/income:                                         3.34 %   $  12,980                                  3.51 %   $  13,089

       Table 4 - Average Balances, Income and Expenses, Yields and Rates

                                 Nine Months Ended Sept 30, 2012                    Nine Months Ended Sept 30, 2011
                                               Annualized                                         Annualized
                                                 Average        Amount                              Average        Amount
                             Average            Yield or        Paid or         Average            Yield or        Paid or
                              Amount              Rate          Earned           Amount              Rate          Earned
                                                               (Dollars in thousands)
  Loans                   $      869,602              5.30 %   $  34,960     $      879,489              5.73 %   $  38,090
  Investment securities
   Taxable                       558,787              2.61 %      10,934            525,168              3.00 %      11,830
   Tax-exempt                     72,551              3.43 %       1,867             47,849              4.04 %       1,450
deposits in other banks           19,689              0.42 %          62             28,008              0.44 %          93
interest-earning assets   $    1,520,629              4.16 %   $  47,823     $    1,480,514              4.61 %   $  51,463

  Deposits                $    1,271,807              0.77 %   $   7,318     $    1,271,616              1.19 %   $  11,289
  Securities sold under
   agreements                      1,961              0.61 %           9                670              1.04 %           5
  Other borrowings                78,381              3.25 %       1,911             78,470              3.43 %       2,014
liabilities               $    1,352,149              0.91 %   $   9,238     $    1,350,756              1.32 %   $  13,308

Net interest
margin/income:                                        3.35 %   $  38,585                                 3.41 %   $  38,155

Third Quarter 2012 compared to Third Quarter 2011:

Net interest income decreased $109 (0.83%) during the three month period as compared to the same period in 2011. Loan interest income decreased $894 (7.07%) in the three month period primarily as a result of decreased yields and slightly lower volumes. Nonaccrual loans resulted in the reversal of $24 in interest income compared to $59 in 2011. Deposit interest expense decreased $1,154 (34.13%) in the three month period primarily as a result of declining deposit costs on the Company's checking and savings account products. Due to these reductions and the low interest rate environment, the quarterly annualized average rate of interest bearing liabilities decreased from 1.19% at September 30, 2011 to 0.86% at September 30, 2012.

The Company's net interest margin for the quarter was 3.34% as compared to 3.51% for the 2011 quarter. The decrease in the net interest margin for the three month period was impacted primarily by declining loans, loan yields and investment portfolio yields offset in part by decreased costs of interest bearing deposits. In addition, the Company added to both its taxable and tax exempt investment securities portfolios. Average taxable investment securities . . .

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