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FSGI > SEC Filings for FSGI > Form 10-Q on 19-Nov-2012All Recent SEC Filings

Show all filings for FIRST SECURITY GROUP INC/TN

Form 10-Q for FIRST SECURITY GROUP INC/TN


19-Nov-2012

Quarterly Report


NOTE 2 - REGULATORY MATTERS, GOING CONCERN CONSIDERATIONS AND MANAGEMENT'S PLANS
Regulatory Matters
First Security Group, Inc.
On September 7, 2010, the Company entered into a Written Agreement (the Agreement) with the Federal Reserve Bank of Atlanta (the Federal Reserve), the Company's primary regulator. The Agreement is designed to enhance the Company's ability to act as a source of strength to the Company's wholly owned subsidiary, FSGBank, National Association (FSGBank or the Bank).
The Agreement prohibits the Company from declaring or paying dividends without prior written consent of the Federal Reserve. The Company is also prohibited from taking dividends, or any other form of payment representing a reduction of capital, from the Bank without prior written consent.
Within 60 days of the Agreement, the Company was required to submit to the Federal Reserve a written plan designed to maintain sufficient capital at the Company and the Bank. The Company submitted a copy of the Bank's capital plan that had previously been submitted to the Bank's primary regulator, the Office of the Comptroller of the Currency (OCC). Neither the Federal Reserve nor the OCC accepted the initially submitted capital plan. A revised five-year strategic and capital plan is currently being reviewed by the Federal Reserve. The Company is currently deemed not in compliance with certain provisions of the Agreement. Any material noncompliance may result in further enforcement actions by the Federal Reserve. Management believes the successful execution of the strategic initiatives discussed below will ultimately result in full compliance with the Agreement and position the Company for long-term growth and a return to profitability.
On September 14, 2010, the Company filed a Current Report on Form 8-K describing the Agreement. A copy of the Agreement is filed as Exhibit 10.1 to such Form 8-K. The foregoing summary is not complete and is qualified in all respects by reference to the actual language of the Agreement. FSGBank, N.A.
On April 28, 2010, pursuant to a Stipulation and Consent to the Issuance of a Consent Order, FSGBank consented and agreed to the issuance of a Consent Order by the OCC (the Order).


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The Bank and the OCC agreed to the areas of the Bank's operations that warrant improvement and on a plan for making those improvements. The Order required the Bank to develop and submit written strategic and capital plans covering at least a three-year period. The Board of Directors is required to ensure that competent management is in place in all executive officer positions to manage the Bank in a safe and sound manner. The Bank is also required to review and revise various policies and procedures, including those associated with credit concentration management, the allowance for loan and lease losses, liquidity management, criticized assets, loan review and credit. The Bank is continuing to work with the OCC to ensure the policies and procedures are both appropriate and fully implemented.
Within 120 days of the effective date of the Order, the Bank was required to achieve and thereafter maintain total capital at least equal to 13 percent of risk-weighted assets and Tier 1 capital at least equal to 9 percent of adjusted total assets. As of September 30, 2012, the ninth financial reporting period subsequent to the 120 day requirement, the Bank's total capital to risk-weighted assets was 8.3 percent and the Tier 1 capital to adjusted total assets was 3.8 percent. The Bank has notified the OCC of its non-compliance with the requirements of the Order.
During the third quarter of 2010, the OCC requested additional information and clarifications to the Bank's submitted strategic and capital plans as well as the management assessments. Subsequent to the resignation of the CEO in April 2011, the Bank requested an extension on the submission date for the strategic and capital plans until a new CEO was appointed and had sufficient time to modify the strategic plan. A revised five-year strategic plan has been submitted and is currently being reviewed by the OCC.
Effective with the Order, the Bank has been restricted from paying interest on deposits that is more than 0.75% above the rate applicable to the applicable market of the Bank as determined by the Federal Deposit Insurance Corporation (FDIC). Additionally, the Bank may not accept, renew or roll over brokered deposits without prior approval of the FDIC.
The Bank is currently deemed not in compliance with some provisions of the Order, including the capital requirements. Any material noncompliance may result in further enforcement actions by the OCC, including the OCC requiring that FSGBank develop a plan to sell, merge or liquidate. Management believes the successful execution of the strategic initiatives discussed below will ultimately result in full compliance with the Order and position the Bank for long-term growth and a return to profitability.
On April 29, 2010, the Company filed a Current Report on Form 8-K describing the Order. A copy of the Order is filed as Exhibit 10.1 to such Form 8-K. The foregoing summary is not complete and is qualified in all respects by reference to the actual language of the Order.
As of September 30, 2012, the Bank's Tier I leverage ratio fell below the minimum level for an "adequately capitalized" bank of 4%. Accordingly, the Bank is currently operating under additional Prompt Corrective Actions, as described below.
Prompt Corrective Action
The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories in which all institutions are placed: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The federal banking agencies have also specified by regulation the relevant capital levels for each category. The Bank had been deemed "adequately capitalized" for regulatory purposes since issuance of the Order in April 2010. As of October 30, 2012, based on the Bank's September 30, 2012 Report of Condition and Income, the Bank was deemed "undercapitalized" for regulatory purposes.
As a bank's capital position deteriorates, federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.

A "well capitalized" bank is one that is not required to meet and maintain a specific capital level for any capital measure, pursuant to any written agreement, order, capital directive, or other remediation, and significantly exceeds all of its capital requirements, which include maintaining a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 6%, and a Tier 1 leverage ratio of at least 5%. Generally, a classification as well capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action. However, a well capitalized bank may be reclassified as "adequately capitalized" based on criteria other than capital if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices, which requires certain remedial action.


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An "adequately capitalized" bank meets the required minimum level for each relevant capital measure, including a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4% and a Tier 1 leverage ratio of at least 4%. A bank that is adequately capitalized is prohibited from directly or indirectly accepting, renewing or rolling over any brokered deposits, absent applying for and receiving a waiver from the applicable regulatory authorities. Institutions that are not well capitalized are also prohibited, except in very limited circumstances where the FDIC permits use of a higher local market rate, from paying yields for deposits in excess of 75 basis points above a national average rate for deposits of comparable maturity, as calculated by the FDIC. In addition, all institutions are generally prohibited from making capital distributions and paying management fees to controlling persons if, subsequent to such distribution or payment, the institution would be undercapitalized. Finally, an adequately capitalized bank may be forced to comply with operating restrictions similar to those placed on undercapitalized banks.
An "undercapitalized" bank fails to meet the required minimum level for any relevant capital measure. A bank that reaches the undercapitalized level is likely subject to a formal agreement or another formal supervisory sanction. An undercapitalized bank is not only subject to the requirements placed on adequately capitalized banks, but also becomes subject to the following operating and managerial restrictions, which:
prohibit capital distributions;

prohibit payment of management fees to a controlling person;

require the bank to submit a capital restoration plan within 45 days of becoming undercapitalized;

require close monitoring of compliance with capital restoration plans, requirements and restrictions by the primary federal regulator;

restrict asset growth by requiring the bank to restrict its average total assets to the amount attained in the preceding calendar quarter;

prohibit the acceptance of employee benefit plan deposits;

require prior approval by the primary federal regulator for acquisitions, branching and new lines of business;

prohibit any material changes in accounting methods; and

other operating restrictions at the discretion of the bank's primary federal regulator.

The above requirements are generally consistent with the requirements under the Consent Order, with the primary exception of asset growth restriction. The Company has evaluated and determined that scheduled maturities of brokered deposits in the fourth quarter of 2012, as well as a maturing commercial repurchase agreement, will allow the Company to continue to seek growth in loans and customer deposits.
Going Concern Considerations
The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in this Note create substantial doubt about the Company's ability to continue as a going concern. These financial statements do not include any adjustments that may result should the Company be unable to continue as a going concern. Management believes the successful execution of the strategic initiatives discussed below should provide sufficient capital to alleviate any substantial doubt about the Company's ability to continue as a going concern.
The Company has experienced significant net operating losses for the three and nine months ended September 30, 2012 and years ended December 31, 2011, 2010, and 2009, substantially resulting from declining net interest margins and elevated levels of provision for loan losses. Losses on other real estate owned have also significantly impacted operating results of the company. Each of these financial trends was impacted by significant levels of nonperforming assets and related deterioration in the economy. As of September 30, 2012, the Bank's Tier 1 leverage ratio fell below 4%, which is the threshold for adequate capitalization, and thus triggering additional prompt corrective action restrictions, as described above.
The Company's ability to continue as a going concern is largely dependent on the ability of management to effectuate the strategic initiatives described below.


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Management's Plans

The Company's strategic initiatives address the actions necessary to restore profitability and achieve full compliance with all regulatory agreements, including, but not limited to, restoring capital to the prescribed regulatory levels of the Order. Management is pursuing various options to restore the Company's capital to a satisfactory level, including, but not limited to, a private placement of common stock. Since December 2011, the Company has been in preliminary discussions with multiple potential investors. Currently, the Company has received non-binding indications with potential investors for a recapitalization that would provide sufficient capital to gain compliance with the capital requirements of the Order while ensuring the recapitalization transaction would not trigger an ownership change under applicable tax regulations. The Company can give no assurances as to the terms on which any such transaction may take place, if at all.

During 2011 and through the first quarter of 2012, the Company underwent significant change within the Board of Directors and executive management. The changes were predicated on strengthening and deepening the Company's leadership in order to successfully execute a strategic and capital plan to return the Company to profitable operations, satisfy the requirements of the regulatory actions detailed above, and lower the level of problem assets to an acceptable level.

In December 2011, the Company appointed Michael Kramer as President and Chief Executive Officer. Subsequently, the Company appointed a Chief Credit Officer, Retail Banking Officer and Director of FSGBank's Wealth Management and Trust Department. The Company added three additional directors to the Board in 2011 and has added three additional directors in 2012, including a new independent Chairman of the Board, Larry D. Mauldin.

The Bank has successfully maintained elevated liquidity and has chosen to do so primarily by maintaining excess cash at the Federal Reserve. The Company's cash position as of September 30, 2012 was $211.8 million compared to $258.2 million and $276.8 million at December 31, 2011 and September 30, 2011, respectively.

The Company's contemplated recapitalization would enable the full implementation of the Company's strategic plan and should enable the Company to restore profitability and achieve full compliance with all regulatory agreements, including, but not limited to, restoring capital to the prescribed regulatory levels of the Order. The Company's strategic plan includes maintaining adequate liquidity, reducing nonperforming assets, and appropriately increasing the Company's capital ratios.
Regulatory Capital Ratios
Banks and bank holding companies, as regulated institutions, must maintain required levels of capital. OCC and the Federal Reserve, the primary federal regulators for FSGBank and the Company, respectively, have adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines. As described above, the Order requires FSGBank to achieve and maintain total capital to risk adjusted assets of at least 13% and a leverage ratio of at least 9%. The Order provided 120 days from April 28, 2010, the effective date of the Order, to achieve these ratios. FSGBank is currently not in compliance with the capital requirements.


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The following table compares the required capital ratios maintained by the Company and FSGBank:

                                 CAPITAL RATIOS

                                                              Minimum
                                                              Capital
                                                            Requirements
                                                            under Prompt
                                                             Corrective
                                           FSGBank             Action          First
September 30, 2012                     Consent  Order1       Provisions       Security      FSGBank
Tier 1 capital to risk adjusted assets          n/a                4.0 %          6.8 %         7.0 %
Total capital to risk adjusted assets          13.0 %              8.0 %          8.1 %         8.3 %
Leverage ratio                                  9.0 %              4.0 %          3.7 %         3.8 %

December 31, 2011
Tier 1 capital to risk adjusted assets          n/a                4.0 %          9.7 %         9.7 %
Total capital to risk adjusted assets          13.0 %              8.0 %         11.0 %        10.9 %
Leverage ratio                                  9.0 %              4.0 %          5.7 %         5.6 %

September 30, 2011
Tier 1 capital to risk adjusted assets          n/a                4.0 %         10.8 %        10.6 %
Total capital to risk adjusted assets          13.0 %              8.0 %         12.0 %        11.9 %
Leverage ratio                                  9.0 %              4.0 %          6.5 %         6.4 %


_____________

1 FSGBank was required to achieve and maintain these capital ratios within 120 days from April 28, 2010.


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NOTE 3 -SHARE-BASED COMPENSATION
As of September 30, 2012, the Company has three share-based compensation plans, the 2012 Long-Term Incentive Plan (the 2012 LTIP), the 2002 Long-Term Incentive Plan (the 2002 LTIP) and the 1999 Long-Term Incentive Plan (the 1999 LTIP). The plans are administered by the Compensation Committee of the Board of Directors (the Committee), which selects persons eligible to receive awards and determines the number of shares and/or options subject to each award, the terms, conditions and other provisions of the award. The plans are described in further detail below.
The 2012 LTIP was approved by the shareholders of the Company at the 2012 annual meeting as previously reported on a Current Report on Form 8-K filed June 26, 2012. The 2012 Long-Term Incentive Plan permits the Committee to make a variety of awards, including incentive and nonqualified options to purchase shares of First Security's common stock, stock appreciation rights, other share-based awards which are settled in either cash or shares of First Security's common stock and are determined by reference to shares of stock, such as grants of restricted common stock, grants of rights to receive stock in the future, or dividend equivalent rights, and cash performance awards, which are settled in cash and are not determined by reference to shares of First Security's common stock (Awards). These discretionary Awards may be made on an individual basis or through a program approved by the Committee for the benefit of a group of eligible persons. The number of shares available under the 2012 LTIP is 159,000. The 2002 LTIP was approved by the shareholders of the Company at the 2002 annual meeting and subsequently amended by the shareholders of the Company at the 2004 and 2007 annual meetings to increase the number of shares available for issuance under the 2002 LTIP by 480 thousand and 750 thousand shares, respectively. The total number of shares authorized for awards prior to the 10-for-1 reverse stock split was 1.5 million. As a result of the 10-for-1 reverse stock split in 2011, the total shares currently authorized under the 2002 LTIP is 151,800, of which not more than 20% may be granted as awards of restricted stock. Eligible participants include eligible employees, officers, consultants and directors of the Company or any affiliate. The exercise price per share of a stock option granted may not be less than the fair market value as of the grant date. The exercise price must be at least 110% of the fair market value at the grant date for options granted to individuals, who at the grant date, are 10% owners of the Company's voting stock (each a 10% owner). Restricted stock may be awarded to participants with terms and conditions determined by the Committee. The term of each award is determined by the Committee, provided that the term of any incentive stock option may not exceed ten years (five years for 10% owners) from its grant date. Each option award vests in approximately equal percentages each year over a period of not less than three years from the date of grant as determined by the Committee subject to accelerated vesting under terms of the 2002 LTIP or as provided in any award agreement. As a result of the Company's participation in TARP CPP, the terms of awards are also subject to compliance with applicable TARP compensation regulations.

Participation in the 1999 LTIP is limited to eligible employees. The total number of shares of stock authorized for awards prior to the 10-for-1 reverse stock split was 936 thousand. As a result of the 10-for-1 reverse stock split in 2011, the total shares currently authorized under the 1999 LTIP is 93,600, of which not more than 10% could be granted as awards of restricted stock. Under the terms of the 1999 LTIP, incentive stock options to purchase shares of the Company's common stock may not be granted at a price less than the fair market value of the stock as of the date of the grant. Options must be exercised within ten years from the date of grant subject to conditions specified by the 1999 LTIP. Restricted stock could also be awarded by the Committee in accordance with the 1999 LTIP. Generally, each award vests in approximately equal percentages each year over a period of not less than three years and vest from the date of grant as determined by the Committee subject to accelerated vesting under terms of the 1999 LTIP or as provided in any award agreement. As a result of the Company's participation in TARP CPP, the terms of awards are also subject to compliance with applicable TARP compensation regulations. Stock Options
The following table illustrates the effect on operating results for share-based compensation for the three and nine months ended September 30, 2012 and 2011.

                                               Three Months Ended                        Nine Months Ended
                                                 September 30,                             September 30,
                                              2012                2011                  2012                 2011
                                                                      (in thousands)
Stock option compensation expense    $            1           $         5     $          3               $        15
Stock option compensation expense,
net of tax 1                         $            1           $         3     $          2               $        10


__________________

1 Due to the deferred tax valuation allowance, tax benefit is reversed through the valuation allowance.


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During the nine months ended September 30, 2012 and 2011, no options were exercised.
The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the following assumptions: expected dividend yield, expected volatility, risk-free interest rate, expected life of the option and the grant date fair value. Expected volatilities are based on historical volatilities of the Company's common stock. The Company uses historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The fair value of options granted was determined using the following weighted-average assumptions as of the grant date. No options were granted during the nine months ended September 30, 2011.

                                     As of
                                 September 30,
                                     2012
Risk?free interest rate                1.27 %
Expected term, in years                 6.5
Expected stock price volatility       67.89 %
Dividend yield                            - %

The following table represents stock option activity for the nine months ended September 30, 2012:

                                                                          Weighted
                                                                           Average
                                                                          Remaining
                                                                         Contractual
                                                     Weighted Average     Term (in         Aggregate
                                          Shares      Exercise Price       years)       Intrinsic Value
Outstanding, January 1, 2012              48,205     $        82.58
Granted                                   83,000     $         3.03
Exercised                                      -
Forfeited                                  2,119
Outstanding, September 30, 2012          123,560     $        31.49            7.28     $        1,800
Exercisable, September 30, 2012           45,056     $        83.83            2.83                  -   1


__________________

1 As of September 30, 2012, the exercise price of all exercisable options exceeded the closing price of the Company's common stock of $2.25, resulting in no intrinsic value.
As of September 30, 2012, shares available for future option grants to employees and directors under existing plans were zero, zero, and 159,000 for the 1999 LTIP, 2002 LTIP, and 2012 LTIP, respectively.
As of September 30, 2012, there was $146 thousand of total unrecognized compensation cost related to nonvested stock options granted under the Plans. The cost is expected to be recognized over a weighted-average period of 2.56 years.
Restricted Stock

The Plans described above allow for the issuance of restricted stock awards that may not be sold or otherwise transferred until certain restrictions have lapsed. The unearned share-based compensation related to these awards is being amortized to compensation expense over the period the restrictions lapse. The share-based expense for these awards was determined based on the market price of the Company's stock at the grant date applied to the total number of shares that were anticipated to fully vest and then amortized over the vesting period.


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As of September 30, 2012, unearned share-based compensation associated with these awards totaled $278 thousand. The Company recognized $29 thousand and $82 thousand for the three and nine months ended September 30, 2012, respectively, and less than $1 thousand of compensation expense, net of forfeitures, in the three and nine months ended September 30, 2011, related to the amortization of deferred compensation that was included in salaries and benefits in the accompanying consolidated statements of operations. The remaining cost is . . .

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