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SFNC > SEC Filings for SFNC > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for SIMMONS FIRST NATIONAL CORP

Form 10-Q for SIMMONS FIRST NATIONAL CORP


9-Nov-2012

Quarterly Report


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

OVERVIEW

On September 14, 2012, our wholly-owned bank subsidiary, Simmons First National Bank ("SFNB", or "the Bank"), entered into a purchase and assumption agreement with loss share arrangements and a separate loan sale agreement with the FDIC to purchase approximately $280 million in total assets and assume substantially all of the deposits and other liabilities of Truman Bank of St. Louis, Missouri ("Truman"), with four branches in the St. Louis metro area. We recognized a pre-tax bargain purchase gain of $1.1 million on the transaction and incurred pre-tax merger related costs of $815,000. After taxes, the combined nonrecurring items from the transaction contributed $185,000 to net income, or $0.01 to diluted earnings per share.

The Truman acquisition was the third of several that we anticipate making over the next several years, which is the reason we raised $71 million in additional capital in November 2009. On October 19, 2012, the Bank entered into a purchase and assumption agreement with loss share arrangements with the FDIC to purchase approximately $184 million in assets and assume all of the deposits and substantially all other liabilities of Excel Bank of Sedalia, Missouri. Our fourth acquisition was strategic in that it complements the footprint we have been building in the Kansas and Missouri market. We fully expect to pursue other opportunities to expand our footprint in that geographic region through additional FDIC and/or traditional acquisitions going forward.

Our net income for the three months ended September 30, 2012, was $6.8 million and diluted earnings per share were $0.41, compared to $0.42 diluted earnings per share for the same period of 2011. Net income for the nine month period ended September 30, 2012, was $19.7 million and diluted earnings per share were $1.16, compared to $1.10 diluted earnings per share for the same period of 2011.

Excluding the nonrecurring items from the Truman acquisition and other nonrecurring items from 2011 (see Table 13 in the Reconciliation of non-GAAP Measures section of this Item for details of the nonrecurring items), diluted core earnings per share decreased $0.02, or 4.8%, for the three months ended September 30, 2012, and increased $0.07, or 6.5%, for the nine months ended September 30, 2012, when compared to the same periods of 2011. We are pleased with our third quarter earnings performance. We continue to benefit significantly from strong asset quality, which has resulted in a reduction in our provision for loan losses from 2011, and from our on-going efficiency initiatives that resulted in a decrease in our year-to-date non-interest expense.

Stockholders' equity as of September 30, 2012, was $404.2 million, book value per share was $24.26 and tangible book value per share was $20.47. Our ratio of stockholders' equity to total assets was 11.8% and the ratio of tangible stockholders' equity to tangible assets was 10.2% at September 30, 2012. The Company's Tier I leverage ratio of 11.7%, as well as our other regulatory capital ratios, remain significantly above the "well capitalized" levels (see Table 12 in the Capital section of this Item).

Our excess capital positions us to continue to take advantage of unprecedented acquisition opportunities through FDIC-assisted transactions of failed banks. We continue to actively pursue the right opportunities that meet our strategic plan regarding mergers and acquisitions. We have added to our normal FDIC acquisition strategy our intention to place "economic" bids, as we feel there will be some unique FDIC opportunities that will need to be liquidated, and will allow us to leverage our loss share infrastructure.


We continue to allocate our earnings, less dividends, to our stock repurchase program. We believe our stock, at its recent market price, continues to be an excellent investment. We increased our quarterly dividend from $0.19 to $0.20 per share, beginning with the first quarter. On an annual basis, the $0.80 per share dividend results in a 3.3% return based on our recent stock price.

Total assets were $3.41 billion at September 30, 2012, compared to $3.32 billion at December 31, 2011. Total loans, including loans acquired, were $1.86 billion at September 30, 2012, compared to $1.74 billion at December 31, 2011. Despite continued challenges in the Northwest Arkansas region, overall, we continue to have good asset quality.

Simmons First National Corporation is an Arkansas based financial holding company with eight community banks in Pine Bluff, Lake Village, Jonesboro, Rogers, Searcy, Russellville, El Dorado and Hot Springs, Arkansas. Our eight banks conduct financial operations from 96 offices, of which 92 are financial centers, located in 55 communities in Arkansas, Kansas and Missouri.

CRITICAL ACCOUNTING POLICIES

Overview

We follow accounting and reporting policies that conform, in all material respects, to generally accepted accounting principles and to general practices within the financial services industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

We consider accounting estimates to be critical to reported financial results if
(i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements.

The accounting policies that we view as critical to us are those relating to estimates and judgments regarding (a) the determination of the adequacy of the allowance for loan losses, (b) acquisition accounting and valuation of covered loans and related indemnification asset, (c) the valuation of goodwill and the useful lives applied to intangible assets, (d) the valuation of employee benefit plans and (e) income taxes.

Allowance for Loan Losses on Loans Not Covered by Loss Share

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.


The allowance is maintained at a level considered appropriate to provide for potential loan losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio as of period end and at a level considered appropriate in relation to the estimated risk inherent in the loan portfolio. This estimate is based on management's evaluation of the loan portfolio, as well as on prevailing and anticipated economic conditions and historical losses by loan category. General reserves have been established, based upon the aforementioned factors and allocated to the individual loan categories. Allowances are accrued on specific loans evaluated for impairment for which the basis of each loan, including accrued interest, exceeds the discounted amount of expected future collections of interest and principal or, alternatively, the fair value of loan collateral. The unallocated reserve generally serves to compensate for the uncertainty in estimating loan losses, including the possibility of changes in risk ratings and specific reserve allocations in the loan portfolio as a result of our ongoing risk management system.

A loan is considered impaired when it is probable that we will not receive all amounts due according to the contractual terms of the loan. This includes loans that are delinquent 90 days or more, nonaccrual loans and certain other loans identified by management. Certain other loans identified by management consist of performing loans with specific allocations of the allowance for loan losses. Specific allocations are applied when quantifiable factors are present requiring an allocation other than that we established based on our analysis of historical losses for each loan category. Accrual of interest is discontinued and interest accrued and unpaid is removed at the time such amounts are delinquent 90 days unless management is aware of circumstances which warrant continuing the interest accrual. Interest is recognized for nonaccrual loans only upon receipt and only after all principal amounts are current according to the terms of the contract.

Acquisition Accounting, Covered Loans and Related Indemnification Asset

We account for our acquisitions under ASC Topic 805, Business Combinations, which requires the use of the purchase method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to the acquired loans is recorded on the acquisition date as the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in ASC Topic 820, exclusive of the shared-loss agreements with the FDIC. The fair value estimates associated with the loans include estimates related to expected prepayments and the amount and timing of undiscounted expected principal, interest and other cash flows.

Over the life of the acquired loans, we continue to estimate cash flows expected to be collected on pools of loans sharing common risk characteristics, which are treated in the aggregate when applying various valuation techniques. We evaluate at each balance sheet date whether the present value of our pools of loans determined using the effective interest rates has decreased significantly and if so, recognize a provision for loan loss in our consolidated statement of income. For any significant increases in cash flows expected to be collected, we adjust the amount of accretable yield recognized on a prospective basis over the pool's remaining life.

Because the FDIC will reimburse us for losses incurred on certain acquired loans, an indemnification asset is recorded at fair value at the acquisition date. The indemnification asset is recognized at the same time as the indemnified loans, and measured on the same basis, subject to collectability or contractual limitations. The shared-loss agreements on the acquisition date reflect the reimbursements expected to be received from the FDIC, using an appropriate discount rate, which reflects counterparty credit risk and other uncertainties.


The shared-loss agreements continue to be measured on the same basis as the related indemnified loans, as prescribed by ASC Topic 805. Deterioration in the credit quality of the loans (immediately recorded as an adjustment to the allowance for loan losses) would immediately increase the basis of the shared-loss agreements, with the offset recorded through the consolidated statement of income. Increases in the credit quality or cash flows of loans (reflected as an adjustment to yield and accreted into income over the remaining life of the loans) decrease the basis of the shared-loss agreements, with such decrease being accreted into income over 1) the same period or 2) the life of the shared-loss agreements, whichever is shorter. Loss assumptions used in the basis of the indemnified loans are consistent with the loss assumptions used to measure the indemnification asset. Fair value accounting incorporates into the fair value of the indemnification asset an element of the time value of money, which is accreted back into income over the life of the shared-loss agreements.

Upon the determination of an incurred loss the indemnification asset will be reduced by the amount owed by the FDIC. A corresponding, claim receivable is recorded until cash is received from the FDIC. For further discussion of our acquisition and loan accounting, see Note 5, Loans Acquired, in the accompanying Condensed Notes to Consolidated Financial Statements included elsewhere in this report.

Goodwill and Intangible Assets

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Other intangible assets represent purchased assets that also lack physical substance but can be separately distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset or liability. We perform an annual goodwill impairment test, and more than annually if circumstances warrant, in accordance with ASC Topic 350, Intangibles - Goodwill and Other, as amended by ASU 2011-08 - Testing Goodwill for Impairment. ASC Topic 350 requires that goodwill and intangible assets that have indefinite lives be reviewed for impairment annually, or more frequently if certain conditions occur. Impairment losses on recorded goodwill, if any, will be recorded as operating expenses.

Employee Benefit Plans

We have adopted various stock-based compensation plans. The plans provide for the grant of incentive stock options, nonqualified stock options, stock appreciation rights and bonus stock awards. Pursuant to the plans, shares are reserved for future issuance by the Company upon exercise of stock options or awarding of bonus shares granted to directors, officers and other key employees.

In accordance with ASC Topic 718, Compensation - Stock Compensation, the fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model that uses various assumptions. This model requires the input of highly subjective assumptions, changes to which can materially affect the fair value estimate. For additional information, see Note 13, Stock Based Compensation, in the accompanying Condensed Notes to Consolidated Financial Statements included elsewhere in this report.


Income Taxes

We are subject to the federal income tax laws of the United States, and the tax laws of the states and other jurisdictions where we conduct business. Due to the complexity of these laws, taxpayers and the taxing authorities may subject these laws to different interpretations. Management must make conclusions and estimates about the application of these innately intricate laws, related regulations, and case law. When preparing the Company's income tax returns, management attempts to make reasonable interpretations of the tax laws. Taxing authorities have the ability to challenge management's analysis of the tax law or any reinterpretation management makes in its ongoing assessment of facts and the developing case law. Management assesses the reasonableness of its effective tax rate quarterly based on its current estimate of net income and the applicable taxes expected for the full year. On a quarterly basis, management also reviews circumstances and developments in tax law affecting the reasonableness of deferred tax assets and liabilities and reserves for contingent tax liabilities.

NET INTEREST INCOME

Overview

Net interest income, our principal source of earnings, is the difference between the interest income generated by earning assets and the total interest cost of the deposits and borrowings obtained to fund those assets. Factors that determine the level of net interest income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, the level of non-performing loans and the amount of non-interest bearing liabilities supporting earning assets. Net interest income is analyzed in the discussion and tables below on a fully taxable equivalent basis. The adjustment to convert certain income to a fully taxable equivalent basis consists of dividing tax-exempt income by one minus the combined federal and state income tax rate of 39.225%.

Our practice is to limit exposure to interest rate movements by maintaining a significant portion of earning assets and interest bearing liabilities in short-term repricing. Historically, approximately 70% of our loan portfolio and approximately 80% of our time deposits have repriced in one year or less. These historical percentages are fairly consistent with our current interest rate sensitivity.

Net Interest Income Quarter-to-Date Analysis

For the three month period ended September 30, 2012, net interest income on a fully taxable equivalent basis was $29.1 million, an increase of $0.6 million, or 2.03%, over the same period in 2011. The increase in net interest income was the result of a $0.6 million decrease in interest income and a $1.2 million decrease in interest expense.

Limiting the decrease in interest income to $0.6 million can be attributed to our FDIC-assisted acquisitions. The acquired covered loans generated an additional $1.1 million in interest income. The declining yield in our loan portfolio, excluding loans acquired, caused a $1.2 million decrease in interest income. The remaining decrease in interest income is primarily due to a 56 basis point decline in the yield on investment securities.


Regarding the $1.1 million increase in interest income from covered loans, a $2.8 million increase resulted from higher average yields on the covered loans, increasing to 17.02% in 2012 from 8.59% in 2011. The yield increase was due to additional yield accretion recognized in conjunction with the fair value of the loan pools acquired in the 2010 FDIC-assisted transactions as discussed in Note 5, Loans Acquired, in the accompanying Condensed Notes to Consolidated Financial Statements included elsewhere in this report. Each quarter, we estimate the cash flows expected to be collected from the acquired loan pools. Beginning in the fourth quarter of 2011, this cash flows estimate increased based on the payment histories and reduced loss expectations of the loan pools. This resulted in increased interest income that is spread on a level-yield basis over the remaining expected lives of the loan pools. The increases in expected cash flows also reduce the amount of expected reimbursements under the loss sharing agreements with the FDIC, which are recorded as indemnification assets. The estimated adjustments to the indemnification assets will be amortized on a level-yield basis over the remainder of the loss sharing agreements or the remaining expected life of the loan pools, whichever is shorter, and are recorded in non-interest expense.

For the three months ended September 30, 2012, the adjustments increased interest income by $2.9 million and decreased non-interest income by $2.7 million. The net increase to pre-tax income was $186,000 for the three months ended September 30, 2012. Because these adjustments will be recognized over the estimated remaining lives of the loan pools and the remainder of the loss sharing agreements, respectively, they will impact future periods as well. The current estimate of the remaining accretable yield adjustment that will positively impact interest income is $18.0 million and the remaining adjustment to the indemnification assets that will reduce non-interest income is $15.8 million. Of the remaining adjustments, we expect to recognize $2.6 million of interest income and a $2.4 million reduction of non-interest income during the remainder of 2012. The accretable yield adjustments recorded in future periods will change as we continue to evaluate expected cash flows from the acquired loan pools.

The $2.8 million interest income increase from covered loan yields was partially offset by a $1.7 million decrease in interest income due to the anticipated declining balances in the portfolio, resulting in the $1.1 million interest income increase from covered loans.

The $1.2 million decrease in interest expense is the result of a 19 basis point decrease in cost of funds due to competitive repricing during a low interest rate environment. The lower interest rates accounted for a $1.0 million decrease in interest expense, while declining volume caused a $0.2 million decrease in interest expense. The most significant component of this decrease was the $0.7 million decrease associated with the repricing of the Company's time deposits that resulted from time deposits that matured during the period or were tied to a rate that fluctuated with changes in market rates. As a result, the average rate paid on time deposits decreased 32 basis points from 1.20% to 0.88%. Lower rates on interest bearing transaction and savings accounts resulted in an additional $0.2 million decrease in interest expense, with the average rate decreasing by 8 basis points from 0.28% to 0.20%.

Net Interest Income Year-to-Date Analysis

For the nine month period ended September 30, 2012, net interest income on a fully taxable equivalent basis was $86.5 million, an increase of $1.4 million, or 1.6%, over the same period in 2011. The increase in net interest income was the result of a $2.4 million decrease in interest income which was more than offset by $3.7 million decrease in interest expense.

Limiting the decrease in interest income to $2.4 million can be attributed to our FDIC-assisted acquisitions. The acquired covered loans generated an additional $3.4 million in interest income. A 23 basis point decline in yield on the loan portfolio, excluding loans acquired, resulted in a $2.7 million decrease in interest income, while the declining balance of the loan portfolio caused a $1.9 million decrease in interest income. The remaining decrease in interest income is primarily due to an 84 basis point decline in the yield on investment securities.


Regarding the $3.4 million increase in interest income from covered loans, an $8.9 million increase resulted from higher average yields on the covered loans, increasing to 16.33% in 2012 from 8.41% in 2011. The yield increase was due to additional yield accretion recognized in conjunction with the fair value of the loan pools acquired in the 2010 FDIC-assisted transactions. For the nine months ended September 30, 2012, the adjustments increased interest income by $9.1 million and decreased non-interest income by $8.2 million. The net increase to pre-tax income was $859,000 for the nine months ended September 30, 2012.

The $8.9 million interest income increase from covered loan yields was partially offset by a $5.5 million decrease in interest income due to the anticipated declining balances in the portfolio, resulting in the $3.4 million interest income increase from covered loans for the nine months ended September 30, 2012.

The $3.7 million decrease in interest expense is primarily the result of a 20 basis point decrease in cost of funds due to competitive repricing during a low interest rate environment. The lower interest rates accounted for a $2.9 million decrease in interest expense, while a decline in the average balance of interest bearing liabilities reduced interest expense by $0.8 million. The most significant component of this decrease was the $2.0 million decrease associated with the repricing of the Company's time deposits that resulted from time deposits that matured during the period or were tied to a rate that fluctuated with changes in market rates. As a result, the average rate paid on time deposits decreased 30 basis points from 1.27% to 0.97%. Lower rates on interest bearing transaction and savings accounts resulted in an additional $0.9 million decrease in interest expense, with the average rate decreasing by 10 basis points from 0.31% to 0.21%.

Net Interest Margin

Our net interest margin increased 8 basis points to 3.94% for the three month period ended September 30, 2012, when compared to 3.86% for the same period in 2011. For the nine month period ended September 30, 2012, net interest margin increased 4 basis points to 3.91%, when compared to 3.87% for the same period in 2011. The margin has been strengthened by a higher yield on covered loans. Conversely, while keeping us prepared to benefit from rising interest rates, our high levels of liquidity continue to compress our margin.


Net Interest Income Tables

Table 1 and 2 reflect an analysis of net interest income on a fully taxable equivalent basis for the three month and nine month periods ended September 30, 2012 and 2011, respectively, as well as changes in fully taxable equivalent net interest margin for the three month and nine month periods ended September 30, 2012, versus September 30, 2011.

Table 1: Analysis of Net Interest Margin
(FTE =Fully Taxable Equivalent)

                                         Three Months Ended          Nine Months Ended
                                            September 30,              September 30,
(In thousands)                            2012          2011         2012         2011

Interest income                        $   31,712     $ 32,206     $ 94,893     $  97,075
FTE adjustment                              1,149        1,233        3,560         3,739

Interest income - FTE                      32,861       33,439       98,453       100,814
Interest expense                            3,771        4,927       11,985        15,712

Net interest income - FTE              $   29,090     $ 28,512     $ 86,468     $  85,102

Yield on earning assets - FTE                4.45 %       4.53 %       4.45 %        4.59 %
Cost of interest bearing liabilities         0.65 %       0.84 %       0.69 %        0.89 %
Net interest spread - FTE                    3.80 %       3.69 %       3.76 %        3.70 %
Net interest margin - FTE                    3.94 %       3.86 %       3.91 %        3.87 %

Table 2: Changes in Fully Taxable Equivalent Net Interest Margin

                                                                    Three Months Ended       Nine Months Ended
                                                                      September 30,            September 30,
(In thousands)                                                        2012 vs. 2011            2012 vs. 2011

Decrease due to change in earning assets                           $             (1,529 )   $            (6,333 )
Increase due to change in earning asset yields                                      951                   3,972
Increase due to change in interest bearing liabilities                              170                     797
Increase due to change in interest rates paid on interest
bearing liabilities                                                                 986                   2,930

Increase in net interest income                                    $                578     $             1,366


Table 3 shows, for each major category of earning assets and interest bearing liabilities, the average (computed on a daily basis) amount outstanding, the interest earned or expensed on such amount and the average rate earned or expensed for the three and nine month periods ended September 30, 2012 and 2011. The table also shows the average rate earned on all earning assets, the average rate expensed on all interest bearing liabilities, the net interest spread and the net interest margin for the same periods. The analysis is . . .

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