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SGB > SEC Filings for SGB > Form 10-K on 1-Apr-2013All Recent SEC Filings

Show all filings for SOUTHWEST GEORGIA FINANCIAL CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-K for SOUTHWEST GEORGIA FINANCIAL CORP


1-Apr-2013

Annual Report


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

For further information about the Corporation, see selected statistical information on pages 12 - 26 of this report on Form 10-K.

Overview

The Corporation is a full-service community bank holding company headquartered in Moultrie, Georgia. The community of Moultrie has been served by the Bank since 1928. We provide comprehensive financial services to consumer, business and governmental customers, which, in addition to conventional banking products, include a full range of mortgage banking, trust, investment and insurance services. Our primary market area incorporates Colquitt County, where we are headquartered, and Baker, Lowndes, Thomas, and Worth Counties, each contiguous with Colquitt County, and the surrounding counties of southwest Georgia. We have six full service banking facilities and six automated teller machines.

Our strategy is to:

maintain the diversity of our revenue, including both interest and noninterest income through a broad base of business,
strengthen our sales and marketing efforts while developing our employees to provide the best possible service to our customers,
expand our market share where opportunity exists, and
grow outside of our current geographic market either through de-novo branching or acquisitions into areas proximate to our current market area.

We believe that investing in sales and marketing in this challenging market will provide us with a competitive advantage. To that end, we expanded geographically with a full-service banking center that was completed and opened in June 2010 and a mortgage origination office that opened in January 2011 both in Valdosta, Georgia. Continuing our expansion in the Valdosta market, we opened our second banking center in March 2012.

The Corporation's profitability, like most financial institutions, is dependent to a large extent upon net interest income, which is the difference between the interest received on earning assets and the interest paid on interest-bearing liabilities. The Corporation's earning assets are primarily loans, securities, and short-term interest-bearing deposits with banks and the interest-bearing liabilities are principally customer deposits and borrowings. Net interest income is highly sensitive to fluctuations in interest rates. For example, after the overnight borrowing rate for banks reached 5.25% in September 2007, the Federal Reserve Bank began decreasing it incrementally until it had been decreased by approximately 5% to a range of 0% to 0.25%. This historically low interest rate level has remained unchanged for the period from October 2008 through December 2012. To address interest rate fluctuations, we manage our balance sheet in an effort to diminish the impact should interest rates suddenly change.

Broadening our revenue sources helps to reduce the risk and exposure of our financial results to the impact of changes in interest rates, which are outside of our control. Sources of noninterest income include our insurance agency and Empire, the Corporation's commercial mortgage banking subsidiary, as well as fees on customer accounts, and trust and retail brokerage services. In2012, noninterest income, at 28.7% of the Corporation's total revenue, remained stable when compared with 28.3% in 2011.

Our profitability is also impacted by operating expenses such as salaries, employee benefits, occupancy, and income taxes. Our lending activities are significantly influenced by regional and local factors such as changes in population, competition among lenders, interest rate conditions and prevailing market rates on competing uses of funds and investments, customer preferences and levels of personal income and savings in the Corporation's primary market area.

The economic downturn continues to challenge our region; however, our strength and stability in the market and our focused efforts enabled us to achieve positive results in 2012. We continued to invest in our people and communities, fully aware of the near-term impact that would have on earnings. Although the economy is slowly recovering, regulatory burdens continue to outpace growth opportunities. Despite those challenges, we will continue to focus on our customers and believe that our strategic positioning, strong balance sheet and capital levels position us to sustain our franchise, capture market share and build customer loyalty.

At the end of 2012, the Corporation's nonperforming assets decreased to $1.849 million from $3.621 million at December 31, 2011, due to a decrease of $1.128 million in nonaccrual loans and $668 thousand in foreclosed assets when compared to the end of 2011.

Critical Accounting Policies

In the course of the Corporation's normal business activity, management must select and apply many accounting policies and methodologies that lead to the financial results presented in the consolidated financial statements of the Corporation. Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy because of the uncertainty and subjectivity inherent in estimating the levels of allowance needed to cover probable credit losses within the loan portfolio and the material effect that these estimates have on the Corporation's results of operations. We believe that the allowance for loan losses as of December 31, 2012, is adequate; however, under adverse conditions or assumptions, future additions to the allowance may be necessary. There have been no significant changes in the methods or assumptions used in our accounting policies that would have resulted in material estimates and assumptions changes. Note 1 to the Consolidated Financial Statements provides a description of our significant accounting policies and contributes to the understanding of how our financial performance is reported.

Results of Operations

Performance Summary

For the year ended December 31, 2012, net income was $1.94 million, up $478 thousand from net income of $1.46 million for 2011. The improvement in net income was primarily due to a $1.5 million increase in net interest income after provision for loan losses. Interest income and fees on loans increased $1.0 million, interest expense declined $296 thousand, and provision for loan losses decreased $539 thousand, partially offset by a $417 thousand decrease in interest income on securities and other investments. Offsetting this revenue growth was an increase in salaries and employee benefits of $1.0 million, due primarily to an additional $798 thousand contribution to the pension plan. On a per share basis, we had a net income of $0.76 per diluted share for 2012 compared with a net income of $0.57 per diluted share for 2011.

For the year ended December 31, 2011, net income was $1.46 million, down $395 thousand from net income of $1.86 million for 2010. The decline in net income was mainly due to an increase in salaries and employee benefits of $746 thousand related to additional staffing in Valdosta, Georgia. Also, losses on the sale or disposition of assets increased $191 thousand and the net gain on sale of securities decreased $154 thousand when compared with 2010. Service charges on deposit accounts decreased $149 thousand compared with 2010. Offsetting these decreases in net income, net interest income increased $782 thousand primarily as a result of lower interest paid on deposits and increased income from interest and fees on loans. On a per share basis, we had a net income of $0.57 per diluted share for 2011 compared with a net income of $0.73 per diluted share for 2010.

We measure our performance on selected key ratios, which are provided for the last three years in the following table:

                                                         2012       2011       2010
Return on average total assets                           0.60 %     0.48 %     0.62 %
Return on average stockholders' equity                   6.62 %     5.25 %     6.89 %
Average stockholders' equity to average total assets     8.99 %     9.06 %     8.95 %
Net interest margin (tax equivalent)                     4.22 %     4.11 %     3.90 %

Net Interest Income

Net interest income after provision for loan losses increased $1.47 million, or 14.8%, to $11.39 million for 2012 when compared with 2011. While total interest income increased $630 thousand, total interest expense decreased $296 thousand. The Corporation recognized a $445 thousand provision for loan losses in 2012, a $539 thousand decrease compared with $984 thousand in 2011. The provision decrease was a result of improved credit quality. As a result of the current interest rate environment, interest paid on deposits declined by $258 thousand to $1.11 million at the end of 2012. The average rate paid on average time deposits of $93.8 million decreased 36 basis points when compared with 2011. Interest on total borrowings also declined $36 thousand when compared with the prior year. Interest and fees on loans increased $1.05 million mainly due to an increase in average net loan volume of $20.1 million. Partially offsetting this increase, interest income from investment securities decreased $477 thousand mainly due to $12.6 million lower volume of investment securities compared with 2011.

For the year 2011, net interest income after provision for loan losses increased $398 thousand, or 4.2%, to $9.93 million when compared with 2010. While total interest income increased $88 thousand as well as total interest expense decreased $694 thousand, the increase in net interest income was partially offset by a $384 thousand increase in the provision for loan losses. The Corporation recognized a $984 thousand provision for loan losses in 2011 compared with $600 thousand in 2010. The provision increase was a result of loan growth as well as increased charge-offs compared with 2010. As a result of the current interest rate environment, interest paid on deposits declined by $684 thousand to $1.4 million at the end of 2011. The average rate paid on average time deposits of $93.7 million decreased 57 basis points when compared with 2010. Interest on total borrowings also declined $10 thousand when compared 2010. Interest and fees on loans increased $465 thousand mainly due to an increase in average net loans volume of $12.9 million. Partially offsetting this increase, interest income from investment securities decreased $357 thousand mainly due to $20.2 million lower volume of investment securities compared with 2010.

Net Interest Margin

Net interest margin, which is the net return on earning assets, is a key performance ratio for evaluating net interest income. It is computed by dividing net interest income by average total earning assets.

Net interest margin increased 22 basis points to 4.22% for 2012 when compared with 2011. Net interest margin was 4.11% for 2011, a 21 basis point increase from 3.90% in 2010. The increase in net interest margin was mainly impacted by a change in asset mix and much lower deposit costs.

Noninterest Income



Noninterest income is an important contributor to net earnings. The following
table summarizes the changes in noninterest income during the past three years:



                                            2012                      2011                      2010
                                                             (Dollars in thousands)
                                    Amount      % Change      Amount      % Change      Amount      % Change
Service charges on deposit
accounts                           $ 1,242         (8.7 )%   $ 1,360         (9.9 )%   $ 1,509        (11.2 )%
Income from trust services             205         (4.2 )        214        (11.4 )        241         13.7
Income from retail brokerage
services                               382         17.9          324          7.9          300         12.8
Income from insurance services       1,280          0.6        1,273         13.2        1,125          5.2
Income from mortgage banking
services                             1,676         13.5        1,477          9.4        1,351          1.8
Provision for foreclosed asset
losses                                (320 )        6.7         (300 )       (9.1 )       (275 )     (100.0 )
Gain (loss) on the sale or
disposition of assets                   24       (115.0 )       (160 )         NM           31        100.0
Gain on the sale of securities         338        (11.4 )        381        (28.7 )        535        109.5
Gain (loss) on the impairment of
equity securities                        0       (100.0 )        (12 )     (100.0 )          0          0.0
Other income                           698         15.8          602          5.6          570          9.5

Total noninterest income           $ 5,525          7.1 %    $ 5,159         (4.2 )%   $ 5,387          0.4 %

*NM = not meaningful

For 2012, noninterest income was $5.52 million, up from $5.16 million in the same period of 2011. The increase was primarily attributed to a $199 thousand increase in income from mortgage banking services. We recognized a $184 thousand higher gain on the sale or disposition of assets and a $96 thousand increase in other income due mostly to debit card income in 2012 compared with the same period last year. Income from retail brokerage and insurance services increased $58 thousand and $7 thousand, respectively, compared with 2011. Partially offsetting these increases, service charges on deposit accounts declined $118 thousand when compared with 2011. Also, the net gain on the sale of securities and the provision for foreclosed asset losses was $31 thousand and $20 thousand lower, respectively, compared with 2011.

For 2011, noninterest income was $5.16 million, down from $5.39 million in the same period of 2010. Net gain on sale of securities decreased $154 thousand to $381 thousand in 2011, and an increase in losses on the disposition of assets of $191 thousand, mainly due to loss on the sale of foreclosed properties, was recognized in 2011. Excluding the gains and losses on sales of securities and other assets, noninterest income increased $129 thousand in 2011. The decline was also a result of decreased service charges on deposit accounts of $149 thousand, a decrease in income from trust services of $28 thousand, and a $25 thousand increase in provision for changes in market value of foreclosed properties compared with same period in 2010. Increases in income occurred from insurance, retail brokerage, and mortgage banking services which increased $149 thousand, $24 thousand and $127 thousand, respectively.

Noninterest Expense



Noninterest expense includes all expenses of the Corporation other than interest
expense, provision for loan losses and income tax expense. The following table
summarizes the changes in the noninterest expenses for the past three years:



                                                 2012                          2011                        2010
                                                                    (Dollars in thousands)
                                        Amount          % Change       Amount      % Change         Amount        % Change
Salaries and employee benefits      $      8,717            13.0 %   $  7,717          10.7 %   $     6,971           9.6 %
Occupancy expense                          1,006             5.6          953           6.9             891           5.3
Equipment expense                            940            15.8          812           9.8             739          10.9
Data processing expense                    1,082             4.1        1,039           5.0             989           6.9
Amortization of intangible assets            220             0.5          219           5.6             208           0.0
Other operating expenses                   2,631             1.3        2,596          (3.0 )         2,676         (21.9 )

Total noninterest expense           $     14,596             9.4 %   $ 13,336           6.9 %   $    12,474           0.3 %

Noninterest expense increased $1.26 million to $14.60 million in 2012 compared with the same period in 2011. The change was mainly due to a $1.0 million year-over-year increase in salary and employee benefits due primarily to an additional $750 thousand contribution to the pension plan due to increased pension fund withdrawals and lower returns on the fixed income investment portion of the fund. Also in 2012, occupancy, equipment, and data processing expense increased $54 thousand, $128 thousand and $43 thousand, respectively, related to the Valdosta market expansion and enhancing information technology infrastructure. Also, amortization of intangible assets remained flat. Other operating expense increased $34 thousand mostly due to increased legal fees of $134 thousand which was partially offset by lower FDIC insurance assessments and expenses related to foreclosed properties of $31 thousand and $72 thousand, respectively.

For 2011, noninterest expense increased $862 thousand to $13.34 million compared with 2010. The change was mainly due to a $746 thousand year-over-year increase in salary and employee benefits due primarily to Valdosta's staffing increase. Also in 2011, pension contributions were $195 thousand higher due to increased pension fund withdrawals and lower returns on the fixed income investment portion of the fund. The cost of providing employee medical insurance has also risen 14% in 2011. Occupancy, equipment, and data processing expense increased $61 thousand, $72 thousand and $50 thousand, respectively, related to the Valdosta market expansion. Also, amortization of intangible assets increased $12 thousand. Other operating expense decreased $80 thousand mostly due to lower FDIC insurance assessments.

The efficiency ratio (noninterest expense divided by total noninterest income plus tax equivalent net interest income), a measure of productivity, remained relatively flat at 81.1% for 2012, compared with 80.6% for 2011 and 77.9% for 2010. The high efficiency ratios were primarily related to overhead in the Corporation's non-banking segments: commercial mortgage banking services, insurance agency and trust and brokerage operations.

Federal Income Tax Expense

The Corporation had an expense of $381 thousand for federal income taxes in 2012 compared with an expense of $287 thousand in 2011 and $584 thousand for the year ending December 31, 2010. These amounts resulted in an effective tax rate of 16.5%, 16.4%, and 23.9%, for 2012, 2011, and 2010, respectively. See Note 10 of the Corporation's Notes to Consolidated Financial Statements for further details of tax expense.

Uses and Sources of Funds

The Corporation, primarily through the Bank, acts as a financial intermediary. As such, our financial condition should be considered in terms of how we manage our sources and uses of funds. Our primary sources of funds are deposits and borrowings. We invest our funds in assets, and our earning assets are what provide us income.

Total average assets increased $6 million to $325.8 million in 2012 as compared with 2011. The increase in total average assets is primarily attributable to a higher level of average total loans of $20.2 million and an increase in average investment of interest-bearing deposits with banks of $9.4 million. These increases were partially offset by a decrease in investment securities of $11.5 million. The Corporation's earning assets, which include loans, investment securities, certificates of deposit with other banks and interest-bearing deposits with banks, averaged $295.1 million in 2012, a 6.6% increase from $277.0 million in 2011. The average volume for interest-bearing deposits increased $20.5 million compared with the prior year. For 2012, average earning assets were comprised of 65% loans, 27% investment securities, and 8% deposit balances with banks. The ratio of average earning assets to average total assets remained flat at 90.6% for 2012 compared with 90.1% for 2011.

Loans

Loans are one of the Corporation's largest earning assets and uses of funds. Because of the importance of loans, most of the other assets and liabilities are managed to accommodate the needs of the loan portfolio. During 2012, average net loans represented 65% of average earning assets and 59% of average total assets.

The composition of the Corporation's loan portfolio at December 31, 2012, 2011, and 2010 was as follows:

                                             2012                         2011                       2010
                                                                (Dollars in thousands)

            Category                  Amount        % Change      Amount       % Change       Amount       % Change

Commercial, financial, and
agricultural                       $    40,507        10.4 %    $  36,678        31.7 %    $   27,852         8.2 %
Real estate:
  Construction                          16,989        28.5 %       13,224       (21.8 )%       16,900         8.4 %
  Commercial                            70,059        15.6 %       60,599        27.2 %        47,649        (5.3 )%
  Residential                           62,433         5.5 %       59,178        14.7 %        51,610         0.6 %
  Agricultural                          10,169        61.9 %        6,283       (25.5 )%        8,428        16.7 %
Consumer & other                         4,010       (25.3 )%       5,370         0.9 %         5,320       (47.1 )%
    Total loans                    $   204,167        12.6 %    $ 181,332        14.9 %    $  157,759        (1.6 )%
Unearned interest and discount             (30 )       0.0 %          (30 )     (15.4 )%          (26 )      13.3 %
Allowance for loan losses               (2,845 )      (8.2 )%      (3,100 )     (12.5 )%       (2,755 )      (8.8 )%
    Net loans                      $   201,292        13.0 %    $ 178,202        15.0 %    $  154,978        (1.7 )%

Total year-end balances of loans increased $22.8 million while average total loans increased $20.2 million in 2012 compared with 2011. All real estate loan categories as well as commercial, financial and agricultural loans experienced growth in 2012. The ratio of total loans to total deposits at year end decreased to 70.0% in 2012 compared with 72.9% in 2011. The loan portfolio mix at year-end 2012 consisted of 8.3% loans secured by construction real estate, 34.3% loans secured by commercial real estate, 30.6% of loans secured by residential real estate, and 5.0% of loans secured by agricultural real estate. The loan portfolio also included other commercial, financial, and agricultural purposes of 19.8% and installment loans to individuals for consumer purposes of 2.0%.

Allowance and Provision for Possible Loan Losses

The allowance for loan losses represents our estimate of the amount required for probable loan losses in the Corporation's loan portfolio. Loans, or portions thereof, which are considered to be uncollectible are charged against this allowance and any subsequent recoveries are credited to the allowance. There can be no assurance that the Corporation will not sustain losses in future periods which could be substantial in relation to the size of the allowance for loan losses at December 31, 2012.

We have a loan review program in place which provides for the regular examination and evaluation of the risk elements within the loan portfolio. The adequacy of the allowance for loan losses is regularly evaluated based on the review of all significant loans with particular emphasis on nonaccruing, past due, and other potentially impaired loans that have been identified as possible problems.

The allowance for loan losses was $2.845 million, or 1.4% of total loans outstanding, as of December 31, 2012. This level represented a $255 thousand decrease from the corresponding 2011 year-end amount which was 1.7% of total loans outstanding.

There was a provision for loan losses of $445 thousand in 2012 compared with a provision for loan losses of $984 thousand in 2011. See Part I, Item 1, "Table 4
- Loan Portfolio" of the Guide 3 for details of the changes in the allowance for loan losses.

Investment Securities

The investment portfolio serves several important functions for the Corporation. Investments in securities are used as a source of income to complement loan demand and to satisfy pledging requirements in the most profitable way possible. The investment portfolio is a source of liquidity when loan demand exceeds funding availability, and is a vehicle for adjusting balance sheet sensitivity to cushion against adverse rate movements. Our investment policy attempts to provide adequate liquidity by maintaining a portfolio with significant cash flow for reinvestment. The Corporation's investment securities represent 23% of our assets and consist largely of 57% state, county and municipal securities. Also, the portfolio includes 32% U.S. Government sponsored pass-thru residential mortgage-backed securities and 11% U.S. Government Agency securities.

The following table summarizes the contractual maturity of investment securities at their carrying values as of December 31, 2012:

                                              Securities          Securities Held to
Amounts Maturing In:                      Available for Sale           Maturity              Total
                                                             (Dollars in thousands)
One year or less                          $           0           $       2,809           $    2,809
After one through five years                      2,309                  14,183               16,492
After five through ten years                     11,950                  26,379               38,329
After ten years                                   7,279                  16,493               23,772
Equity securities                                   134                       0                  134
Total investment securities               $      21,672           $      59,864           $   81,536

At year-end 2012, the total investment portfolio grew slightly to $81.5 million, an increase of $556 thousand, compared with $81.0 million at year-end 2011. The increase was mainly due to purchases of $30.1 million of U.S. Government Agencies and municipal securities. Partially offsetting these purchases were calls and maturities of $7.4 million of U.S. Government Agencies and municipals as well as residential mortgage-backed securities principal paydowns of approximately $12.5 million. Additionally, we sold $8.8 million of longer-term residential mortgage-backed securities resulting in a net gain of $338 thousand. The average investment portfolio decreased $12.5 million to $77.7 million in 2012 from $90.2 million in 2011.

We will continue to actively manage the size, components, and maturity structure of the investment securities portfolio. Future investment strategies will continue to be based on profit objectives, economic conditions, interest rate risk objectives, and balance sheet liquidity demands.

Nonperforming Assets

Nonperforming assets are defined as nonaccrual loans, loans that are 90 days past due and still accruing, other-than-temporarily impaired preferred stock, and property acquired by foreclosure. The level of nonperforming assets decreased $1.772 million at year-end 2012 compared with year-end 2011. This decrease was primarily due to a decrease in nonaccrual loans as well as a decrease in foreclosed properties. Nonaccrual loans decreased as payments brought loans current or no more than 30-89 days past due when compared with the previous year. Foreclosed assets decreased $668 thousand when compared to the prior year end. Partially offsetting the decrease in nonaccrual loans and foreclosed assets, other-than-temporarily impaired preferred stock increased $24 thousand. Nonperforming assets were approximately $1.849 million, or .53% of total assets as of December 31, 2012, compared with $3.621 million, or 1.18% of total assets at year-end 2011.

Deposits and Other Interest-Bearing Liabilities

Our primary source of funds is deposits. The Corporation offers a variety of deposit accounts having a wide range of interest rates and terms. We rely primarily on competitive pricing policies and customer service to attract and retain these deposits.

. . .

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