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SFNC > SEC Filings for SFNC > Form 10-K on 12-Mar-2013All Recent SEC Filings

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Form 10-K for SIMMONS FIRST NATIONAL CORP


12-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

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 management's estimate of probable losses in the loan portfolio. 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.

Prior to the fourth quarter of 2012, we measured the appropriateness of the allowance for loan losses in its entirety using (a)ASC 450-20 which includes quantitative (historical loss rates) and qualitative factors (management adjustment factors) such as (1) lending policies and procedures, (2) economic outlook and business conditions, (3) level and trend in delinquencies, (4) concentrations of credit and (5) external factors and competition; which are combined with the historical loss rates to create the baseline factors that are allocated to the various loan categories; (b) specific allocations on impaired loans in accordance with ASC 310-10; and (c) the unallocated amount.

The unallocated amount was evaluated on the loan portfolio in its entirety and was based on additional factors, such as (1) trends in volume, maturity and composition, (2) national, state and local economic trends and conditions, (3) the experience, ability and depth of lending management and staff and (4) other factors and trends that will affect specific loans and categories of loans, such as a heightened risk in agriculture, credit card and commercial real estate loan portfolios.

As of December 31, 2012, we refined our allowance calculation. As part of the refinement process, we evaluated the criteria previously applied to the entire loan portfolio, and used to calculate the unallocated portion of the allowance, and applied those criteria to each specific loan category. For example, the impact of national, state and local economic trends and conditions was evaluated by and allocated to specific loan categories.

After this refinement, the allowance is calculated monthly based on management's assessment of several factors such as (1) historical loss experience based on volumes and types, (2) volume and trends in delinquencies and nonaccruals, (3) lending policies and procedures including those for loan losses, collections and recoveries, (4) national, state and local economic trends and conditions, (5) concentrations of credit within the loan portfolio, (6) the experience, ability and depth of lending management and staff and (7) other factors and trends that will affect specific loans and categories of loans. We establish general allocations for each major loan category. This category also includes allocations to loans which are collectively evaluated for loss such as credit cards, one-to-four family owner occupied residential real estate loans and other consumer loans. General reserves have been established, based upon the aforementioned factors and allocated to the individual loan categories. Allowances are accrued for probable losses 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.


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 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 at least 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 12, Employee Benefit Plans, in the accompanying 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.

2012 Overview


On October 19, 2012, our wholly-owned bank subsidiary, Simmons First National Bank ("SFNB" or the "lead bank"), entered into a purchase an assumptions agreement with loss share arrangements with the FDIC to purchase approximately $180 million in assets and assume substantially all of the deposits and certain other liabilities of Excel Bank of Sedalia, Missouri ("Excel"), with three branches in the Kansas City metro area and one branch in the St. Louis metro area. We recognized a pre-tax bargain purchase gain of $2.3 million on the transaction and incurred pre-tax merger related costs of $1.1 million. After taxes, the combined nonrecurring items from the transaction contributed $725,000 to net income, or $0.04 diluted earnings per share.

On September 14, 2012, SFNB 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 certain 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.

These Missouri acquisitions were the third and fourth 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. The acquisitions were strategic in that they complement 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 year ended December 31, 2012, was $27.7 million, or $1.64 diluted earnings per share, compared to $25.4 million, or $1.47 diluted earnings per share in 2011, an increase of $0.17, or 11.6%. We are pleased with our 2012 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. Our on-going efficiency initiatives helped offset increases from added overhead from our acquisitions resulting in a very modest increase in our non-interest expense. Net income in 2010 was $37.1 million, or $2.15 diluted earnings per share.

Net income for both 2012 and 2011 included several significant nonrecurring items that impacted net income, mostly related to our FDIC-assisted acquisitions. Excluding all nonrecurring items, core earnings for the year ended December 31, 2012, were $26.9 million, or $1.59 diluted core earnings per share, compared to $25.0 million, or $1.45 diluted core earnings per share in 2011. Diluted core earnings per share increased by $0.14, or 9.7%. See Reconciliation of Non-GAAP Measures and Table 21 - Reconciliation of Core Earnings (non-GAAP) for additional discussion of non-GAAP measures.

Stockholders' equity as of December 31, 2012, was $406.1 million, a decrease of $1.8 million, or approximately 0.45%, from December 31, 2011, primarily due to our stock repurchase program. Book value per share was $24.55 and tangible book value per share was $20.66. Our ratio of stockholders' equity to total assets was 11.5% and the ratio of tangible stockholders' equity to tangible assets was 9.9% at December 31, 2012. The Company's Tier I leverage ratio of 10.8%, as well as our other regulatory capital ratios, remain significantly above the "well capitalized" levels. See Table 18 - Risk-Based Capital for regulatory capital ratios. 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. Beginning with the first quarter of 2012, we increased our quarterly dividend from $0.19 to $0.20 per share. On an annual basis, the $0.80 per share dividend results in a 3.3% return based on our recent stock price.

Total loans, including loans acquired, were $1.9 billion at December 31, 2012, an increase of $184.3 million, or 10.6%, from the same period in 2011. Loans acquired in FDIC-assisted transactions grew $135.6 million, net of discounts, and legacy loans (excluding acquired loans) grew $48.7 million, or 3.1%. We believe this organic loan growth is very positive in that the growth is coming throughout our markets in Arkansas, Kansas and Missouri, and at a time when the economy remains in a slow recovery.

Loans covered by FDIC loss share agreements, which provide 80% Government guaranteed protection against credit risk on those covered assets, were $210.8 million at December 31, 2012, compared to $158.1 million at December 31, 2011.

Although the general state of the national economy has shown signs of improvement, it remains somewhat unsettled. Despite the continued challenges, overall, we continue to have good asset quality, compared to the rest of the industry. The allowance for loan losses as a percent of total loans was 1.71% at December 31, 2012. Non-performing loans equaled 0.74% of total loans. Non-performing assets were 1.29% of total assets. The allowance for loan losses was 231.62% of non-performing loans. The Company's net charge-offs for 2012 were 0.40% of total loans. Excluding credit cards, net charge-offs for 2012 were 0.26% of total loans.

Total assets at December 31, 2012, were $3.5 billion, an increase of $207.4 million, or 6.3%, over the period ended December 31, 2011.

Simmons First National Corporation is an Arkansas based financial holding company with $3.5 billion in assets and eight community banks in Pine Bluff, Lake Village, Jonesboro, Rogers, Searcy, Russellville, El Dorado and Hot Springs, Arkansas. Our eight subsidiary banks conduct financial operations from 96 offices, of which 92 are financial centers, located in 55 communities in Arkansas, Kansas and Missouri.

Efficiency Initiatives

We previously reported that we hired a consultant to help us identify and implement revenue enhancements, process improvements and branch staff level adjustments. The implementation was fully completed in 2012, with total annual benefits from the efficiency initiative of approximately $5 million before tax. A portion of the benefit is from revenue enhancements, with the remainder from non-interest expense savings. We assured our associates that no one would lose their job as a result of this initiative, as all positions impacted were/are being eliminated through attrition.

During June 2010, as scheduled as part of our branch right sizing initiative, and after much deliberation and analysis, we closed or consolidated nine financial centers, primarily smaller branches in rural areas. During June 2011, we closed another small branch. We believe most of the customers have been absorbed into other Simmons locations in close proximity to the closed branches. After the closings, we now have 74 financial centers in Arkansas, still one of the best footprints in the state. As a result of these closings, we recorded a one-time, nonrecurring pre-tax charge of $372,000, or $0.01 to diluted earnings per share in 2010, and $141,000 in 2011. Again, staff reductions were realized through attrition and associates at the affected branches were reassigned to other locations. Our branch right sizing initiative has been under way for some time. Over the last several years we have added numerous new financial centers, closed several and relocated others. We will continue our efforts to manage our product delivery system in the most efficient manner possible.

Both our efficiency and branch right sizing initiatives resulted in significant cost savings and staff reductions. Since the beginning of both projects in early 2009, our staffing levels are down considerably. As mentioned earlier, all of the staffing reduction was realized through attrition, and no associate lost their job.


Net Interest Income


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%.

The FRB sets various benchmark rates, including the Federal Funds rate, and thereby influences the general market rates of interest, including the deposit and loan rates offered by financial institutions. The Federal Funds rate, which is the cost to banks of immediately available overnight funds, has remained unchanged at 0.00% - 0.25% since December 16, 2008. Our loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, has remained unchanged at 3.25% since December 16, 2008.

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 consistent with our current interest rate sensitivity.

For the year ended December 31, 2012, net interest income on a fully taxable equivalent basis was $118.2 million, an increase of $4.6 million, or 4.0%, from the same period in 2011. The increase in net interest income was the result of a $0.2 million decrease in interest income and a $4.8 million decrease in interest expense.

Limiting the decrease in interest income to $0.2 million can be attributed to our FDIC-assisted acquisitions. The acquired covered loans generated an additional $5.6 million in interest income for 2012. A 27 basis point decline in yield on the loan portfolio, excluding covered loans, resulted in a $4.3 million decrease in interest income, while the increasing average balance of the loan portfolio resulted in a $0.3 million increase in interest income. The remaining decrease in interest income is primarily due to a 53 basis point decline in the yield on investment securities.

Regarding the $5.6 million increase in interest income from covered loans, a $10.4 million increase resulted from higher average yields on the covered loans, increasing to 15.48% in 2012 from 8.90% in 2011. The yield increase was primarily 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 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 year ended December 31, 2012, the adjustments increased interest income by $10.6 million and decreased non-interest income by $9.8 million compared to 2011. The net increase to 2012 pre-tax income was $851,000 over 2011. 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 $19.2 million and the remaining adjustment to the indemnification assets that will reduce non-interest income is $16.8 million. Of the remaining adjustments, we expect to recognize $9.6 million of interest income and a $9.1 million reduction of non-interest income for a net addition to pre-tax income of approximately $540,000 in 2013. The accretable yield adjustments recorded in future periods will change as we continue to evaluate expected cash flows from the acquired loan pools.


The $10.4 million interest income increase from covered loan yields was partially offset by a $4.8 million decrease in interest income due to the anticipated declining balances in the portfolio, resulting in the $5.6 million interest income increase from covered loans.

The $4.8 million decrease in interest expense for 2012 was primarily the result of a 21 basis point decrease in cost of funds due to competitive repricing during a low interest rate environment, coupled with a shift in our mix of interest bearing deposits. The lower interest rates accounted for a $4.0 million decrease in interest expense. The most significant component of this decrease was the $2.8 million decrease associated with the repricing of our 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. Historically, approximately 80% of our time deposits reprice in one year or less. As a result, the average rate paid on time deposits decreased 32 basis points from 1.24% to 0.92%. Lower rates on interest bearing transaction and savings accounts resulted in an additional $1.2 million decrease in interest expense, with the average rate decreasing by 9 basis points from 0.30% to 0.21%.

Our net interest margin was 3.93% for the year ended December 31, 2012, up 8 basis points from 2011. Our margin has been strengthened by a higher yield on covered loans, including the impact of the accretable yield adjustments discussed above. Also, the acquisition of loans, along with our ability to stabilize the size of our legacy loan portfolio, has allowed us to increase our level of higher yielding assets over 2011. Conversely, while keeping us prepared to benefit from rising interest rates, our high levels of liquidity continue to compress our margin.

Our net interest margin was 3.85% and 3.78% for the years ended December 31, 2011 and 2010, respectively.

Tables 1 and 2 reflect an analysis of net interest income on a fully taxable equivalent basis for the years ended December 31, 2012, 2011 and 2010, respectively, as well as changes in fully taxable equivalent net interest margin for the years 2012 versus 2011 and 2011 versus 2010.

Table 1: Analysis of Net Interest Income

(FTE =Fully Taxable Equivalent)

                                              Years Ended December 31
(In thousands)                           2012          2011          2010

Interest income                        $ 129,134     $ 129,056     $ 128,955
FTE adjustment                             4,705         4,970         5,012

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