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FIRST CITIZENS BANCSHARES INC /DE/ - Quarter Report: 2010 September (Form 10-Q)

Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2010

or

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 001-16715

First Citizens BancShares, Inc.

(Exact name of Registrant as specified in its charter)

 

Delaware   56-1528994

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

4300 Six Forks Road, Raleigh, North Carolina   27609
(Address of principle executive offices)   (Zip code)

(919) 716-7000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days.    Yes   x    No  ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the Registrant was required to submit and post such files)    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of ‘accelerated filer’ and ‘large accelerated filer’ in Rule 12b-2 of the Exchange Act:[

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Class A Common Stock—$1 Par Value—8,756,778 shares

Class B Common Stock—$1 Par Value—1,677,675 shares

(Number of shares outstanding, by class, as of November 8, 2010)

 

 

 


Table of Contents

 

INDEX

 

         Page(s)  

PART I.

 

FINANCIAL INFORMATION

  

Item 1.

  Financial Statements (Unaudited)   
  Consolidated Balance Sheets at September 30, 2010, December 31, 2009 and September 30, 2009      3   
 

Consolidated Statements of Income for the three and nine month periods ended September 30, 2010 and September 30, 2009

     4   
 

Consolidated Statements of Changes in Shareholders’ Equity for the nine month periods ended September 30, 2010 and September 30, 2009

     5   
 

Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2010 and September 30, 2009

     6   
  Notes to Consolidated Financial Statements      7   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      28   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      54   

Item 4.

  Controls and Procedures      54   

PART II.

 

OTHER INFORMATION

  
Item 1A.   Risk Factors      55   

Item 6.

  Exhibits      58   

 

2


Table of Contents

 

Part 1

Item 1. Financial Statements (Unaudited)

First Citizens BancShares, Inc. and Subsidiaries

Consolidated Balance Sheets

Unaudited

 

     September 30*
2010
    December 31#
2009
    September 30*
2009
 
     (thousands, except share data)  

Assets

  

Cash and due from banks

   $ 493,786      $ 480,242      $ 723,031   

Overnight investments

     1,049,158        723,260        219,886   

Investment securities available for sale

     3,786,841        2,929,162        3,283,521   

Investment securities held to maturity

     2,645        3,603        3,788   

Loans held for sale

     79,853        67,381        78,485   

Loans and leases:

      

Covered by loss share agreements

     2,222,660        1,173,020        1,257,478   

Not covered by loss share agreements

     11,545,309        11,644,999        11,520,683   

Less allowance for loan and lease losses

     218,046        172,282        165,282   
                        

Net loans and leases

     13,549,923        12,645,737        12,612,879   

Premises and equipment

     845,478        837,082        836,456   

Other real estate owned:

      

Covered by loss share agreements

     99,843        93,774        102,600   

Not covered by loss share agreements

     47,523        40,607        44,703   

Income earned not collected

     83,204        60,684        68,845   

Receivable from FDIC for loss share agreements

     651,844        249,842        243,000   

Goodwill

     102,625        102,625        102,625   

Other intangible assets

     11,373        6,361        6,976   

Other assets

     245,195        225,703        186,083   
                        

Total assets

   $ 21,049,291      $ 18,466,063      $ 18,512,878   
                        

Liabilities

      

Deposits:

      

Noninterest-bearing

   $ 3,859,389      $ 3,215,414      $ 3,261,987   

Interest-bearing

     13,883,639        12,122,153        12,086,968   
                        

Total deposits

     17,743,028        15,337,567        15,348,955   

Short-term borrowings

     652,716        642,405        576,609   

Long-term obligations

     819,145        797,366        879,758   

Other liabilities

     116,198        129,610        192,872   
                        

Total liabilities

     19,331,087        16,906,948        16,998,194   

Shareholders’ Equity

      

Common stock:

      

Class A - $1 par value (8,756,778 shares issued for all periods)

     8,757        8,757        8,757   

Class B - $1 par value (1,677,675 shares issued for all periods)

     1,678        1,678        1,678   

Surplus

     143,766        143,766        143,766   

Retained earnings

     1,588,336        1,429,863        1,413,993   

Accumulated other comprehensive loss

     (24,333     (24,949     (53,510
                        

Total shareholders’ equity

     1,718,204        1,559,115        1,514,684   
                        

Total liabilities and shareholders’ equity

   $ 21,049,291      $ 18,466,063      $ 18,512,878   
                        

 

* Unaudited
# Derived from the 2009 Annual Report on Form 10-K.

See accompanying Notes to Consolidated Financial Statements.

 

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First Citizens BancShares, Inc. and Subsidiaries

Consolidated Statements of Income

 

     Three Months Ended September 30     Nine Months Ended September 30  
     2010     2009     2010     2009  
     (thousands, except share and per share data)  

Interest income

    

Loans and leases

   $ 264,819      $ 170,690      $ 654,434      $ 482,723   

Investment securities:

        

U. S. Government

     9,406        15,076        29,007        54,353   

Residential mortgage backed securities

     1,544        1,329        4,981        3,711   

Corporate bonds

     2,196        2,205        6,529        4,063   

State, county and municipal

     14        32        62        187   

Other

     77        242        159        613   
                                

Total investment securities interest and dividend income

     13,237        18,884        40,738        62,927   

Overnight investments

     572        116        1,591        533   
                                

Total interest income

     278,628        189,690        696,763        546,183   

Interest expense

        

Deposits

     37,087        43,574        116,294        145,410   

Short-term borrowings

     742        980        2,138        3,582   

Long-term obligations

     10,859        9,859        32,493        29,077   
                                

Total interest expense

     48,688        54,413        150,925        178,069   
                                

Net interest income

     229,940        135,277        545,838        368,114   

Provision for loan and lease losses

     59,873        18,265        108,629        57,747   
                                

Net interest income after provision for loan and lease losses

     170,067        117,012        437,209        310,367   

Noninterest income

        

Gain on acquisitions

     0        104,434        136,000        104,434   

Cardholder and merchant services

     27,982        25,306        80,276        70,905   

Service charges on deposit accounts

     18,063        20,336        56,403        57,350   

Wealth management services

     12,826        12,071        38,782        34,324   

Fees from processing services

     7,485        7,619        21,934        22,307   

Securities (losses) gains

     940        (177     1,885        (316

Other service charges and fees

     4,734        4,078        14,492        12,495   

Mortgage income

     3,013        2,844        6,347        8,665   

Insurance commissions

     1,980        1,926        6,580        6,221   

ATM income

     1,730        1,710        5,084        5,211   

Adjustments to FDIC receivable for loss share agreements

     (28,505     0        (13,053     0   

Other

     (279     706        (190     365   
                                

Total noninterest income

     49,969        180,853        354,540        321,961   

Noninterest expense

        

Salaries and wages

     74,727        66,131        221,362        195,428   

Employee benefits

     14,455        15,390        48,605        48,482   

Occupancy expense

     18,353        17,282        54,706        48,658   

Equipment expense

     17,251        14,990        49,670        44,462   

FDIC deposit insurance

     5,842        5,497        17,338        23,446   

Foreclosure-related expenses (income)

     (1,271     3,869        6,804        7,291   

Other

     47,494        41,340        133,092        110,345   
                                

Total noninterest expense

     176,851        164,499        531,577        478,112   
                                

Income before income taxes

     43,185        133,366        260,172        154,216   

Income taxes

     15,439        50,898        97,213        56,885   
                                

Net income

   $ 27,746      $ 82,468      $ 162,959      $ 97,331   
                                

Average shares outstanding

     10,434,453        10,434,453        10,434,453        10,434,453   

Net income per share

   $ 2.66      $ 7.90      $ 15.62      $ 9.33   
                                

See accompanying Notes to Consolidated Financial Statements.

 

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First Citizens BancShares, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

Unaudited

 

     Class A
Common
Stock
     Class B
Common
Stock
     Surplus      Retained
Earnings
    Accumulated
Other
Comprehensive
Income (loss)
    Total
Shareholders’
Equity
 
     (thousands, except share and per share data)  

Balance at December 31, 2008

   $ 8,757       $ 1,678       $ 143,766       $ 1,326,054      $ (36,880   $ 1,443,375   

Comprehensive income:

               

Net income

     0         0         0         97,331        0        97,331   

Change in unrealized securities gains arising during period, net of $12,086 deferred tax benefit

     0         0         0         0        (17,908     (17,908

Change in unrecognized loss on cash flow hedge, net of $834 deferred tax

     0         0         0         0        1,278        1,278   
                     

Total comprehensive income

                  80,701   
                     

Cash dividends of $0.90 per share

     0         0         0         (9,392     0        (9,392
                                                   

Balance at September 30, 2009

   $ 8,757       $ 1,678       $ 143,766       $ 1,413,993      $ (53,510   $ 1,514,684   
                                                   

Balance at December 31, 2009

   $ 8,757       $ 1,678       $ 143,766       $ 1,429,863      $ (24,949   $ 1,559,115   

Adjustment resulting from adoption of change in accounting for QSPEs and controlling financial interests effective January 1, 2010

     0         0         0         4,904        0        4,904   

Comprehensive income:

               

Net income

     0         0         0         162,959        0        162,959   

Change in unrealized securities gains arising during period, net of $3,632 deferred tax

     0         0         0         0        5,567        5,567   

Less: reclassification adjustment for gains included in net income, net of $900 deferred tax

     0         0         0         0        (1,398     (1,398

Change in pension liability, net of $1,178 tax benefit

     0         0         0         0        1,830        1,830   

Change in unrecognized loss on cash flow hedge, net of $3,513 deferred tax benefit

     0         0         0         0        (5,383     (5,383
                     

Total comprehensive income

                  163,575   
                     

Cash dividends of $0.90 per share

     0         0         0         (9,390     0        (9,390
                                                   

Balance at September 30, 2010

   $ 8,757       $ 1,678       $ 143,766       $ 1,588,336      $ (24,333   $ 1,718,204   
                                                   

At September 30, 2010, Accumulated Other Comprehensive Loss includes on an after-tax basis $25,599 in unrealized gains on investment securities available for sale, $41,301 in unrealized losses resulting from the funded status of the defined benefit plan and an unrealized loss of $8,631 on cash flow hedges.

At September 30, 2009, Accumulated Other Comprehensive Income includes on an after-tax basis $27,483 in unrealized gains on investment securities available for sale, $75,815 in unrealized losses resulting from the funded status of the defined benefit plan and an unrealized loss of $5,178 on cash flow hedges.

See accompanying Notes to Consolidated Financial Statements.

 

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First Citizens BancShares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

 

     Nine months ended September 30  
     2010     2009  

OPERATING ACTIVITIES

    

Net income

   $ 162,959      $ 97,331   

Adjustments to reconcile net income to cash provided by operating activities:

    

Amortization of intangibles

     4,727        1,324   

Provision for loan and lease losses

     108,629        57,747   

Deferred tax (benefit) expense

     (82,228     30,148   

Change in current taxes payable

     2,260        5,743   

Depreciation

     46,565        42,453   

Change in accrued interest payable

     (4,348     (8,399

Change in income earned not collected

     (14,860     8,922   

Gain on acquisitions

     (136,000     (104,434

Securities losses (gains)

     (1,885     316   

Origination of loans held for sale

     (420,346     (614,857

Proceeds from sale of loans held for sale

     413,958        612,916   

Gain on sale of loans held for sale

     (6,084     (7,145

Loss on sale of other real estate

     1,005        2,808   

Net amortization of premiums and discounts

     (29,506     31,295   

Receivable from FDIC for loss share agreements

     66,427        0   

Net change in other assets

     67,944        3,634   

Net change in other liabilities

     41,399        (21,233
                

Net cash provided by operating activities

     220,616        138,569   
                

INVESTING ACTIVITIES

    

Net change in loans and leases outstanding

     526,380        95,736   

Purchases of investment securities available for sale

     (2,536,499     (1,643,560

Proceeds from maturities of investment securities held to maturity

     956        2,159   

Proceeds from maturities of investment securities available for sale

     1,686,400        1,414,910   

Proceeds from sales of investment securities available for sale

     38,384        151,556   

Net change in overnight investments

     (325,898     86,002   

Additions to premises and equipment

     (54,961     (79,980

Proceeds from sale of other real estate

     75,738        20,112   

Net cash received from acquisitions

     106,489        51,381   
                

Net cash provided (used) by investing activities

     (483,011     98,316   
                

FINANCING ACTIVITIES

    

Net change in time deposits

     (323,859     249,592   

Net change in demand and other interest-bearing deposits

     1,021,589        (288,922

Net change in short-term borrowings

     (481,098     (149,515

Origination of long-term obligations

     68,697        91,008   

Cash dividends paid

     (9,390     (9,392
                

Net cash provided (used) by financing activities

     275,939        (107,229
                

Change in cash and due from banks

     13,544        129,656   

Cash and due from banks at beginning of period

     480,242        593,375   
                

Cash and due from banks at end of period

   $ 493,786      $ 723,031   
                

CASH PAYMENTS FOR:

    

Interest

   $ 155,273      $ 186,468   

Income taxes

     126,964        17,705   
                

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

    

Unrealized securities gains (losses)

   $ 5,259      $ (29,994

Unrealized (loss) gain on cash flow hedge

     (8,896     2,112   

Change in pension liability

     3,008        0   

Acquisitions:

    

Assets acquired

     2,291,659        1,924,715   

Liabilities assumed

     2,155,861        1,819,745   

Net assets acquired

     135,798        104,970   
                

See accompanying Notes to Consolidated Financial Statements

 

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First Citizens BancShares, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

Note A

Accounting Policies and Other Matters

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial information. Accordingly, they do not include all of the information and notes required by US GAAP for complete financial statements.

In the opinion of management, the consolidated financial statements contain all material adjustments necessary to present fairly the financial position of First Citizens BancShares, Inc. and Subsidiaries (BancShares) as of and for each of the periods presented, and all such adjustments are of a normal recurring nature. The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the financial statements and the reported amounts of income and expenses during the period. Actual results could differ from those estimates.

Management has evaluated subsequent events through the filing date of the Quarterly Report on Form 10-Q.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in BancShares’ 2009 Form 10-K. Certain amounts for prior periods have been reclassified to conform with statement presentations for 2010. However, the reclassifications have no effect on shareholders’ equity or net income as previously reported.

FDIC-Assisted Transactions

US GAAP requires that the acquisition method of accounting be used for all business combinations, including those resulting from FDIC-assisted transactions and that an acquirer be identified for each business combination. Under US GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. US GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date. In addition, acquisition-related costs and restructuring costs are recognized as period expenses as incurred.

During 2010 and 2009, BancShares’ wholly-owned subsidiary, First-Citizens Bank & Trust Company (FCB), acquired assets and assumed liabilities of four entities as noted below (collectively referred to as “the Acquisitions”) with the assistance of the Federal Deposit Insurance Corporation (FDIC), which had been appointed Receiver of each entity by its respective state banking authority.

 

Name of entity

  

Headquarters location

  

Date of transaction

Sun American Bank (SAB)    Boca Raton, Florida    March 5, 2010
First Regional Bank (First Regional)    Los Angeles, California    January 29, 2010
Venture Bank (VB)    Lacey, Washington    September 11, 2009
Temecula Valley Bank (TVB)    Temecula, California    July 17, 2009

The acquired assets and assumed liabilities were measured at estimated fair value. Management made significant estimates and exercised significant judgment in accounting for the Acquisitions. Management judgmentally assigned risk ratings to loans based on credit quality, appraisals and estimated collateral values, estimated expected cash flows, and applied appropriate liquidity and coupon discounts to measure fair values for loans. Other real estate acquired through foreclosure was valued based upon pending sales contracts and appraised values, adjusted for current market conditions. FCB also recorded identifiable intangible assets representing the estimated values of the assumed core deposits and other customer relationships. Management used quoted or current market prices to determine the fair value of investment securities, short-term borrowings and long-term obligations.

 

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Loans and Leases

Loans and leases that are held for investment purposes are carried at the principal amount outstanding. Loans that are classified as held for sale are carried at the lower of aggregate cost or fair value. Interest on substantially all loans is accrued and credited to interest income on a constant yield basis based upon the daily principal amount outstanding.

Acquired loans are recorded at fair value at the date of acquisition. The fair values of acquired loans with evidence of credit deterioration since origination (impaired loans) are recorded net of a nonaccretable difference and, if appropriate, an accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is the nonaccretable difference, which is included in the carrying amount of acquired loans. Subsequent decreases to expected cash flows will generally result in recognition of an allowance by a charge to provision for loan and lease losses. Subsequent increases in expected cash flows result in either a reversal of the provision for loan and lease losses to the extent of prior charges, or a reclassification of the difference from nonaccretable to accretable with a positive impact on the accretable yield. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan when there is a reasonable expectation regarding the amount and timing of such cash flows. BancShares did not initially estimate the amount and timing of cash flows for loans acquired from TVB and VB at the dates of the acquisitions, but cash flow analyses were performed on loans acquired from First Regional and SAB in order to determine the cash flows expected to be collected. BancShares is accounting for all acquired loans on a loan level basis since the majority of the portfolios acquired consist of large commercial loans.

Receivable from FDIC for Loss Share Agreements

The receivable from the FDIC for loss share agreements is measured separately from the related covered assets as it is not contractually embedded in the assets and is not transferable should the assets be sold. Fair value was estimated using projected cash flows related to the loss share agreements based on the expected reimbursements for losses using the applicable loss share percentages and the estimated true-up payment at the expiration of the loss share agreements, if applicable. These cash flows were discounted to reflect the estimated timing of the receipt of the loss share reimbursement from the FDIC and the true-up payment to the FDIC, when applicable. The FDIC receivable has been reviewed and updated prospectively as loss estimates related to covered loans and other real estate owned change, and as reimbursements are received or expected to be received from the FDIC. Post-acquisition adjustments to the FDIC receivable are offset by noninterest income.

Other Real Estate Owned Covered by Loss Share Agreements

Other real estate owned (OREO) covered by loss share agreements with the FDIC are reported exclusive of expected reimbursement cash flows from the FDIC. Subsequent downward adjustments to the estimated recoverable value of covered OREO result in a reduction of covered OREO, a charge to other noninterest expense and an increase in the FDIC receivable for the estimated amount to be reimbursed, with a corresponding amount recorded as other noninterest income. OREO is presented at the estimated present value that management expects to receive when the property is sold, net of related costs of disposal. Management used appraisals of properties to determine fair values and applied additional discounts where appropriate for passage of time or, in certain cases, for subsequent events occurring after the appraisal date.

Recently Adopted Accounting Policies and Other Regulatory Issues

Under revisions to US GAAP that became effective January 1, 2010, the concept of a qualifying special-purpose entity (QSPE) was removed, resulting in a change in the accounting for QSPEs that were previously exempt. Upon adoption, the off-balance sheet accounting treatment for the 2005 asset securitization of home equity loans was discontinued, and the loans that were sold in the securitization and the corresponding debt obligations were reported on the consolidated balance sheet in the first quarter of 2010. The adoption resulted in increases of $97,291 in noncovered revolving mortgage loans, $681 in allowance for loan and lease losses, $86,926 in long-term obligations, and $3,189 in deferred tax liabilities. The retained interest in the residual interest strip and the servicing asset were written off, resulting in reductions of $1,287 and $304 to investment securities available for sale and other assets, respectively. The adoption also resulted in an adjustment to the beginning balance of retained earnings in the amount of $4,904.

 

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Note B

Federally Assisted Acquisitions of First Regional Bank and Sun American Bank

On January 29, 2010, FCB purchased substantially all the assets and assumed substantially all the liabilities of First Regional from the FDIC, as Receiver. First Regional operated through 8 offices in the state of California, primarily serving Southern California. The FDIC took First Regional under receivership upon its closure by the California Department of Financial Institutions. FCB’s bid to the FDIC included the purchase of substantially all of First Regional’s assets at a discount of $299,400 in exchange for assuming certain First Regional deposits and certain other liabilities. No cash, deposit premium or other consideration was paid by FCB. FCB and the FDIC entered into loss share agreements regarding future losses incurred on loans and other real estate acquired through foreclosure existing at the acquisition date. Under the terms of the loss share agreements, there is no reimbursement by the FDIC until net losses reach $41,815. The FDIC will reimburse FCB for 80 percent of net losses incurred up to $1,017,000, and 95 percent of net losses exceeding $1,017,000.

The Purchase and Assumption Agreement between FCB and the FDIC also includes a true-up payment at the end of year 10. On March 17, 2020, the true-up measurement date, FCB is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of (i) 20 percent of the stated threshold, or $203.4 million, less (ii) the sum of (a) 25 percent of the asset discount, or $74.9 million, plus (b) 25 percent of the cumulative loss share payments plus (c) the cumulative servicing amount. The cumulative servicing amount is 1 percent of the average covered assets for each year during the terms of the loss share agreements. Current projections suggest a true-up payment of $67,219 will be payable under the First Regional loss share agreements. This estimate is subject to change over the term of the agreements.

The term for loss share on residential real estate loans is ten years, while the term for loss share on non-residential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. As a result of the loss share agreements with the FDIC and considering an estimate of a contingent true-up payment to the FDIC, FCB recorded a receivable of $365,170 at the time of acquisition. During the second and third quarters of 2010, adjustments were made to the FDIC receivable based on changes in loss estimates related to covered loans and other real estate owned that affect the respective acquisition date fair values. These adjustments were made retroactive to the first quarter of 2010 and increased the receivable by $13,525.

On March 5, 2010, FCB purchased substantially all the assets and assumed substantially all the liabilities of SAB from the FDIC, as Receiver. SAB operated 12 offices in the state of Florida, primarily serving South Florida. The FDIC took SAB under receivership upon its closure by the Florida Office of Financial Regulation. FCB’s bid to the FDIC included the purchase of substantially all of SAB’s assets at a discount of $69,400 in exchange for assuming certain SAB deposits and certain other liabilities. The FDIC paid FCB $31,965 in additional cash consideration at closing. FCB and the FDIC entered into loss share agreements regarding future losses incurred on loans and other real estate acquired through foreclosure existing at the acquisition date. Under the terms of the loss share agreements, the FDIC will reimburse FCB for 80 percent of net losses incurred up to $99,000 and 95 percent of net losses exceeding $99,000.

The Purchase and Assumption Agreement between FCB and the FDIC also includes a true-up payment at the end of year 10. On May 15, 2020, the true-up measurement date, FCB is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of (i) 20 percent of the stated threshold, or $19.8 million, less (ii) the sum of (a) 25 percent of the asset discount, or $17.5 million, plus (b) 25 percent of the cumulative loss share payments plus (c) the cumulative servicing amount. The cumulative servicing amount is 1 percent of the average covered assets for each year during the terms of the loss share agreements. Although no true-up payment is currently projected under the SAB loss share agreements, those projections are subject to change.

The term for loss share on residential real estate loans is ten years, while the term for loss share on non-residential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. As a result of the loss share agreements with the FDIC, FCB recorded a receivable of $92,360 at the time of acquisition. During the second quarter of 2010, adjustments were made to the FDIC receivable based on changes in loss estimates related to covered loans and other real estate owned that affect the respective acquisition date fair values. These adjustments were made retroactive to the first quarter of 2010 and decreased the receivable by $2,626.

 

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The acquisitions of First Regional and SAB were accounted for using the acquisition method of accounting. The statement of net assets acquired, adjustments to the acquisition date fair values made in the second and third quarters and the resulting bargain purchase gains are presented in the following tables. As indicated in the explanatory notes that accompany the following tables, the purchased assets, assumed liabilities and identifiable intangible assets were recorded at their respective acquisition date estimated fair values. Fair values are subject to refinement for up to one year after the closing date of each merger as additional information regarding closing date fair values becomes available. Adjustments to the estimated fair values made in the second and third quarters were based on additional information regarding the acquisition date fair values, which included updated appraisals on several commercial properties on acquired impaired loans and updated financial statements for some borrowers which allowed for adjustments to expected cash flows that more closely reflect the borrowers’ ability to repay the debt.

First quarter noninterest income as originally reported included bargain purchase gains of $137,447 that resulted from the 2010 Acquisitions. The gains resulted from the difference between the estimated fair values of acquired assets and assumed liabilities. During the second and third quarters of 2010, adjustments were made to the gains based on additional information regarding the respective acquisition date fair values. These adjustments were made retroactive to the first quarter of 2010, the period the 2010 acquisitions were consummated, resulting in an adjusted gain of $136,000. FCB recorded a deferred tax liability for the gains totaling $53,258. To the extent there are additional adjustments to the respective acquisition date fair values up to one year following the respective acquisitions, there will be additional adjustments to the gains.

The following tables identify the assets acquired and liabilities assumed by FCB from First Regional and SAB. The tables provide the balances recorded by First Regional and SAB at the time of the respective FDIC-assisted transactions, the fair value adjustments recorded and the resulting adjusted fair values recorded by FCB for the acquisition date.

First Regional Bank

Acquisition date: January 29, 2010

 

     As recorded
by  First
Regional
     Fair value
adjustments
at date of
acquisition
    Subsequent
acquisition-date
adjustments
    As recorded
by FCB
 
     (thousands)  

Assets

         

Cash and due from banks

   $ 37,508       $ —        $ —        $ 37,508   

Investment securities available for sale

     3,250         —          —          3,250   

Loans covered by loss share agreements

     1,853,325         (576,171 ) a      (16,905 ) a      1,260,249   

Other real estate owned covered by loss share agreements

     61,488         (20,353 ) b      791   b      41,926   

Income earned not collected

     6,048         —          —          6,048   

Receivable from FDIC for loss share agreements

     —           365,170   c      13,525   i      378,695   

Intangible assets

     —           9,110   d      —          9,110   

Other assets

     23,782         (500 ) e      —          23,282   
                                 

Total assets acquired

   $ 1,985,401       $ (222,744   $ (2,589   $ 1,760,068   
                                 

Liabilities

         

Deposits:

         

Noninterest-bearing

   $ 528,235       $ —        $ —        $ 528,235   

Interest-bearing

     759,484         —          —          759,484   
                                 

Total deposits

     1,287,719         —          —          1,287,719   

Short-term borrowings

     361,876         —          —          361,876   

Other liabilities

     1,188         1,547   h      —          2,735   
                                 

Total liabilities assumed

     1,650,783         1,547        —          1,652,330   
                                 

Excess of assets acquired over liabilities assumed

   $ 334,618          
               

Aggregate fair value adjustments

      $ (224,291   $ (2,589  
                     

Gain on acquisition of First Regional

          $ 107,738   
               

 

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Sun American Bank

Acquisition date: March 5, 2010

 

     As recorded
by SAB
     Fair  value
adjustments
at  acquisition
date
    Subsequent
acquisition-date
adjustments
    As recorded  by
FCB
 
     (thousands)  

Assets

         

Cash and due from banks

   $ 37,016       $ —        $ —        $ 37,016   

Investment securities available for sale

     66,968         —          —          66,968   

Loans covered by loss share agreements

     411,315         (123,707 ) a      3,283  a      290,891   

Other real estate owned covered by loss share agreements

     15,220         (7,200 ) b      —          8,020   

Income earned not collected

     1,612         —          —          1,612   

Receivable from FDIC for loss share agreements

     —           92,360  c      (2,626 ) i      89,734   

Intangible assets

     —           629  d      —          629   

Other assets

     4,473         —          —          4,473   
                                 

Total assets acquired

   $ 536,604       $ (37,918   $ 657      $ 499,343   
                                 

Liabilities

         

Deposits:

         

Noninterest-bearing

   $ 39,435       $ —        $ —        $ 39,435   

Interest-bearing

     380,577         —          —          380,577   
                                 

Total deposits

     420,012         —          —          420,012   

Short-term borrowings

     42,485         48  f      —          42,533   

Long-term obligations

     37,000         3,082  g      —          40,082   

Other liabilities

     853         51  h      —          904   
                                 

Total liabilities assumed

     500,350         3,181        —          503,531   
                                 

Excess of assets acquired over liabilities assumed

   $ 36,254          
               

Aggregate fair value adjustments

      $ (41,099   $ 657     
                     

Cash received from the FDIC

          $ 31,965   
               

Gain on acquisition of Sun American

          $ 27,777   
               

Explanation of fair value adjustments

a - Adjustment reflects the fair value adjustments based on FCB’ sevaluation of the acquired loan portfolio.

b - Adjustment reflects the estimated OREO losses based on FCB’s evaluation of the acquired OREO portfolio.

c - Adjustment reflects the estimated fair value of payments FCB will receive from the FDIC under the loss share agreements.

d - Adjustment reflects the estimated value of intangible assets, which includes core deposit intangibles and when applicable, trust customer relationships.

e - Adjustment reflects the amount needed to adjust the carrying value of other assets to estimated fair value.

f - Adjustment arises since the rates on short-term borrowings are higher than rates available on similar borrowings at date of acquisition.

g - Adjustment arises since the rates on long-term obligations are higher than rates available on similar borrowings at date of acquisition.

h - Adjustment reflects amount needed to adjust the carrying value of other liabilities to estimated fair value.

i - Adjustment to acquisition date fair value based on additional information received post-acquisition regarding acquisition date fair value.

 

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Results of operations for First Regional and SAB prior to their respective acquisition dates are not included in the income statement.

Due to the significant amount of fair value adjustments, the resulting accretion of those fair value adjustments and the protection resulting from the FDIC loss share agreements, historical results of First Regional and SAB are not relevant to BancShares’ results of operations. Therefore, no pro forma information is presented.

Note C

Investments

The aggregate values of investment securities at September 30, 2010, December 31, 2009 and September 30, 2009, along with unrealized gains and losses determined on an individual security basis are as follows:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

Investment securities available for sale

           

September 30, 2010

           

U. S. Government

   $ 3,112,152       $ 9,099       $       $ 3,121,251   

Corporate bonds

     479,935         9,254                 489,189   

Residential mortgage-backed securities

     151,355         4,891         110         156,136   

Equity securities

     1,132         17,865                 18,997   

State, county and municipal

     1,241         27                 1,268   
                                   

Total investment securities available for sale

   $ 3,745,815       $ 41,136       $ 110       $ 3,786,841   
                                   

December 31, 2009

           

U. S. Government

   $ 2,274,084       $ 14,005       $ 666       $ 2,287,423   

Corporate bonds

     481,341         4,326                 485,667   

Residential mortgage-backed securities

     126,601         4,489         752         130,338   

Equity securities

     2,377         14,245                 16,622   

State, county and municipal

     7,053         35         275         6,813   

Other

     1,937         362                 2,299   
                                   

Total investment securities available for sale

   $ 2,893,393       $ 37,462       $ 1,693       $ 2,929,162   
                                   

September 30, 2009

           

U. S. Government

   $ 2,611,698       $ 23,183       $ 178       $ 2,634,703   

Corporate bonds

     482,705         4,459         74         487,090   

Residential mortgage-backed securities

     112,235         3,117         1         115,351   

Equity securities

     2,591         13,985         31         16,545   

State, county and municipal

     7,185         193         2         7,376   

Other

     21,997         459                 22,456   
                                   

Total investment securities available for sale

   $ 3,238,411       $ 45,396       $ 286       $ 3,283,521   
                                   

Investment securities held to maturity

           

September 30, 2010

           

Residential mortgage-backed securities

   $ 2,645       $ 245       $ 26       $ 2,864   
                                   

Total investment securities held to maturity

   $ 2,645       $ 245       $ 26       $ 2,864   
                                   

December 31, 2009

           

Residential mortgage-backed securities

   $ 3,452       $ 256       $ 26       $ 3,682   

State, county and municipal

     151         1                 152   
                                   

Total investment securities held to maturity

   $ 3,603       $ 257       $ 26       $ 3,834   
                                   

September 30, 2009

           

Residential mortgage-backed securities

   $ 3,637       $ 278       $ 26       $ 3,889   

State, county and municipal

     151         1                 152   
                                   

Total investment securities held to maturity

   $ 3,788       $ 279       $ 26       $ 4,041   
                                   

 

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Investments in corporate bonds represent debt securities issued by various financial institutions under the Temporary Liquidity Guarantee Program. These debt obligations were issued with the full faith and credit of the United States of America. The guarantee for these securities is triggered when an issuer defaults on a scheduled payment.

The following table provides maturity information for investment securities as of the dates indicated. Callable securities are assumed to mature on their earliest call date.

 

     September 30, 2010      December 31, 2009      September 30, 2009  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

Investment securities available for sale

                 

Maturing in:

                 

One year or less

   $ 2,559,784       $ 2,567,076       $ 1,544,063       $ 1,554,657       $ 1,550,843       $ 1,563,140   

One through five years

     1,044,757         1,056,170         1,226,202         1,233,604         1,585,364         1,600,964   

Five through 10 years

     1,815         1,841         1,943         2,201         2,323         2,683   

Over 10 years

     138,327         142,757         118,808         122,078         97,290         100,189   

Equity securities

     1,132         18,997         2,377         16,622         2,591         16,545   
                                                     

Total investment securities available for sale

   $ 3,745,815       $ 3,786,841       $ 2,893,393       $ 2,929,162       $ 3,238,411       $ 3,283,521   
                                                     

Investment securities held to maturity

                 

Maturing in:

                 

One through five years

   $ —         $ —         $ 151       $ 152       $ 151       $ 152   

Five through 10 years

     2,512         2,689         3,306         3,497         3,487         3,700   

Over 10 years

     133         175         146         185         150         189   
                                                     

Total investment securities held to maturity

   $ 2,645       $ 2,864       $ 3,603       $ 3,834       $ 3,788       $ 4,041   
                                                     

The following table provides information regarding securities with unrealized losses as of September 30, 2010, December 31, 2009 and September 30, 2009:

 

     Less than 12 months      12 months or more      Total  
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 

September 30, 2010

                 

Investment securities available for sale:

                 

Residential mortgage-backed securities

   $ 10,364       $ 88       $ 535       $ 22       $ 10,899       $ 110   
                                                     

Total

   $ 10,364       $ 88       $ 535       $ 22       $ 10,899       $ 110   
                                                     

Investment securities held to maturity:

                 

Residential mortgage-backed securities

   $ —           —         $ 27       $ 26       $ 27       $ 26   

December 31, 2009

                 

Investment securities available for sale:

                 

U.S. Government

   $ 250,600       $ 666       $ —         $ —         $ 250,600       $ 666   

Residential mortgage-backed securities

     25,608         621         2,434         131         28,042         752   

State, county and municipal

     5,476         271         439         4         5,915         275   
                                                     

Total

   $ 281,684       $ 1,558       $ 2,873       $ 135       $ 284,557       $ 1,693   
                                                     

Investment securities held to maturity:

                 

Residential mortgage-backed securities

   $ —         $ —         $ 29       $ 26       $ 29       $ 26   

September 30, 2009

                 

Investment securities available for sale:

                 

U.S. Government

   $ 17,060       $ 108       $ 1,368       $ 70       $ 18,428       $ 178   

Corporate Bonds

     76,909         74         —           —           76,909         74   

Residential mortgage-backed securities

     —           —           16         1         16         1   

Equity securities

     34         31         —           —           34         31   

State, county and municipal

     —           —           441         2         441         2   
                                                     

Total

   $ 94,003       $ 213       $ 1,825       $ 73       $ 95,828       $ 286   
                                                     

Investment securities held to maturity:

                 

Residential mortgage-backed securities

   $ —         $ —         $ 33       $ 26       $ 33       $ 26   

 

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Investment securities with an aggregate fair value of $562 have had continuous unrealized losses for more than twelve months as of September 30, 2010 with an aggregate unrealized loss of $48. These 19 investments consist entirely of residential mortgage-backed securities. None of the unrealized losses identified as of September 30, 2010 related to the marketability of the securities or the issuer’s ability to honor redemption obligations. Consequently, the securities were not deemed to be other than temporarily impaired.

With respect to investment securities held to maturity, BancShares has the ability and intent to hold those securities until they mature.

For each period presented, securities gains (losses) include the following:

 

    Three months ended September 30,     Nine months ended September 30,  
    2010     2009     2010     2009  

Gross gains on sales of investment securities available for sale

  $ 1,167      $ 104      $ 3,803      $ 104   

Gross losses on sales of investment securities available for sale

    (1     —          (1,506     —     

Other than temporary impairments of equity investments

    (226     (281     (412     (420
                               

Total securities gains (losses)

  $ 940      $ (177   $ 1,885      $ (316
                               

Investment securities having an aggregate carrying value of $2,015,500 at September 30, 2010, $2,121,783 at December 31, 2009 and $1,998,230 at September 30, 2009, were pledged as collateral to secure public funds on deposit, to secure certain short-term borrowings or collateral obligations and for other purposes as required by law.

 

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Note D

Loans and Leases

Loans and leases outstanding include the following as of the dates indicated:

 

     September 30, 2010      December 31, 2009      September 30, 2009  

Loans covered by loss share agreements

   $ 2,222,660       $ 1,173,020       $ 1,257,478   

Loans and leases not covered by loss share agreements

        

Real estate:

        

Construction and land development

     546,070         622,354         621,176   

Commercial mortgage

     4,696,183         4,552,078         4,514,554   

Residential mortgage

     917,415         864,704         876,001   

Revolving mortgage

     2,209,149         2,147,223         2,114,018   

Other mortgage

     155,509         158,187         101,802   
                          

Total real estate loans

     8,524,326         8,344,546         8,227,551   

Commercial and industrial

     1,774,340         1,832,670         1,822,526   

Consumer

     766,586         941,986         998,007   

Lease financing

     294,825         330,713         335,515   

Other

     185,232         195,084         137,084   
                          

Total loans and leases not covered by loss share agreements

   $ 11,545,309       $ 11,644,999       $ 11,520,683   
                          

 

    September 30, 2010     December 31, 2009     September 30, 2009  
    Impaired at
acquisition
date
    All  other
acquired
loans
    Total     Impaired  at
acquisition
date
    All other
acquired
loans
    Total     Impaired at
acquisition
date
    All other
acquired
loans
    Total  

Loans covered by loss share agreements:

                 

Real estate:

                 

Construction and land development

  $ 173,964      $ 397,027      $ 570,991      $ 22,700      $ 283,342      $ 306,042      $ 34,793      $ 392,642      $ 427,435   

Commercial mortgage

    132,049        999,134        1,131,183        36,820        553,579        590,399        40,490        605,087        645,577   

Residential mortgage

    36,933        45,836        82,769        8,828        143,481        152,309        3,387        57,193        60,580   

Revolving mortgage

    114        23,025        23,139        —          —          —          451        8,264        8,715   

Other mortgage

    43,023        177,001        220,024        331        21,307        21,638        344        3,325        3,669   
                                                                       

Total real estate loans

    386,083        1,642,023        2,028,106        68,679        1,001,709        1,070,388        79,465        1,066,511        1,145,976   

Commerical and industrial

    14,400        168,505        182,905        5,958        89,273        95,231        3,361        97,550        100,911   

Consumer

    116        6,852        6,968        255        4,259        4,514        287        6,793        7,080   

Other

    147        4,534        4,681        476        2,411        2,887        329        3,182        3,511   
                                                                       

Total loans covered by loss share agreements

  $ 400,746      $ 1,821,914      $ 2,222,660      $ 75,368      $ 1,097,652      $ 1,173,020      $ 83,442      $ 1,174,036      $ 1,257,478   
                                                                       

Outstanding balance

  $ 742,010      $ 2,535,003      $ 3,277,013      $ 200,310      $ 1,418,375      $ 1,618,685      $ 297,077      $ 1,566,084      $ 1,863,161   

 

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Impaired loans are loans that have evidence of deterioration in credit quality since origination, suggesting it is probable that all contractually required payments will not be collected. The following table provides information on all impaired loans, exclusive of those loans evaluated collectively as a homogeneous group.

 

    September 30, 2010     December 31, 2009     September 30, 2009  

Impaired loans:

     

Covered by loss share agreements

  $ 542,862      $ 116,446      $ 83,442   

Not covered by loss share agreements

    57,968        50,797        33,263   
                       

Total

  $ 600,830      $ 167,243      $ 116,705   
                       

Allowance for loan and lease losses related to:

     

Impaired loans covered by loss share agreements

  $ 40,046      $ 3,500        —     

Impaired loans and leases not covered by loss share agreements

    9,648        9,611        4,873   

Impaired loans with no allowance for loan and lease loss:

     

Loans covered by loss share agreements

    374,535        106,498        —     

Loans and leases not covered by loss share agreements

    7,348        9,902        9,331   

When the fair values of loans covered by loss share agreements with the FDIC (Covered Loans) were established, certain loans were identified as impaired. The following table provides changes in the carrying value of acquired impaired loans during the nine-month periods ended September 30, 2010 and 2009:

 

     2010     2009  

Balance, January 1

   $ 75,368      $ —     

Fair value of acquired impaired loans covered by loss share agreements

     412,627        99,625   

Reductions for repayments, foreclosures and decreases in fair value

     (87,249     (16,183
                

Balance, September 30

   $ 400,746      $ 83,442   
                

Cash flow analyses were prepared for First Regional and SAB loans deemed impaired at acquisition and those analyses are used to determine the amount of accretable yield recognized on those loans. Due to initial uncertainty regarding the timing of future cash flows, no accretable yield was initially measured for loans deemed impaired at acquisition from TVB and VB, and the cost recovery method is used to account for these loans.

The following table documents changes to the amount of accretable yield. For First Regional and SAB loans, improved cash flow estimates and receipt of unscheduled loan payments resulted in the reclassification of nonaccretable yield to accretable yield. For TVB and VB loans, receipt of unscheduled loan payments and improvements in expected losses resulted in the reclassification of nonaccretable yield to accretable yield.

 

     Accretable Yield  

Balance at December 31, 2009

   $ —     

Additions

     63,908   

Accretion

     (100,299

Reclassifications from (to) nonaccretable difference

     157,097   

Disposals

     (1,070
        

Balance at September 30, 2010

   $ 119,636   
        

Nonperforming loans and other risk elements are summarized below:

 

     September 30,
2010
     December 31,
2009
     September 30,
2009
 

Nonaccrual loans and leases:

        

Covered under loss share agreements

   $ 264,653       $ 116,446       $ 102,473   

Not covered under loss share agreements

     84,753         58,417         56,628   

Restructured loans:

        

Covered under loss share agreements

     65,417         10,013         —     

Not covered under loss share agreements

     53,374         55,025         4,990   
                          

Nonperforming loans and leases

   $ 468,197       $ 239,901       $ 164,091   
                          

Loans and leases 90 days or more past due and still accruing:

        

Covered under loss share agreements

   $ 365,207       $ —         $ —     

Not covered under loss share agreements

     18,059         27,766         16,507   

Other real estate owned:

        

Covered under loss share agreements

   $ 99,843       $ 93,774       $ 102,600   

Not covered under loss share agreements

     47,524         40,607         44,703   

Accruing loans and leases 90 days or more past due covered by loss share agreements include impaired loans acquired from First Regional and SAB that are accounted for using the accretable yield method.

 

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Note E

Allowance for Loan and Lease Losses

Activity in the allowance for loan and lease losses is summarized as follows:

 

            Nine months ended
September 30,
 
            2010     2009  

Balance, January 1

      $ 172,282      $ 157,569   

Adjustment resulting from adoption of change in accounting for QSPEs and controlling financial interests, effective January 1, 2010

        681      $ —     

Provision for loan and lease losses

       

Covered by loss share agreements

        62,455        —     

Not covered by loss share agreements

        46,174        57,747   

Loans and leases charged-off:

       

Covered by loss share agreements

        (22,122     —     

Not covered by loss share agreements

        (45,652     (53,694

Loans and leases recovered:

       

Not covered by loss share agreements

        4,228        3,660   
                   

Net charge-offs

        (63,546     (50,034
                   

Balance, September 30

      $ 218,046      $ 165,282   
                   

 

    September 30, 2010     December 31, 2009     September 30, 2009  

Allowance for loan and lease losses allocated to:

     

Loans covered by loss share agreements

  $ 43,839      $ 3,500      $ —     

Loans and leases not covered by loss share agreements

    174,207        168,782        165,282   
                       

Total

  $ 218,046      $ 172,282      $  165,282   
                       

Note F

Receivable from FDIC for Loss Share Agreements

The following table provides changes in the receivable from the FDIC during the first nine months of 2010 and 2009:

 

     Nine months  ended
September 30,
 
     2010     2009  

Balance at January 1

   $ 249,842      $ —     

Additional receivable from acquisitions

     468,429        242,520   

Accretion of discounts and premiums, net

     3,638        480   

Receipt of payments from FDIC

     (52,422     —     

Post-acquisition adjustments

     (17,643     —     
                

Balance at September 30

   $ 651,844      $ 243,000   
                

The receivable from the FDIC for loss share agreements is measured separately from the related covered assets and is recorded at fair value. The fair value was estimated using projected cash flows related to the loss share agreements based on the expected reimbursements for losses and the applicable loss share percentages.

 

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Post-acquisition adjustments represent the net change in loss estimates related to covered loans and other real estate owned as a result of changes in estimated fair values and the allowance for loan and lease losses related to covered loans. For loans covered by loss share agreements, subsequent decreases in the amount expected to be collected from the borrower result in a provision for loan and lease losses, an increase in the allowance for loan and lease losses, and a proportional adjustment to the receivable from the FDIC for the estimated amount to be reimbursed. Subsequent increases in the amount expected to be collected from the borrower result in the reversal of any previously recorded provision for loan and lease losses and related allowance for loan and lease losses and adjustments to the receivable from the FDIC, or prospective adjustment to the accretable yield and the related receivable from the FDIC if no provision for loan and lease losses had been recorded. Adjustments related to acquisition date fair values, made within one year after the closing date of the respective acquisition, are reflected in the bargain purchase gain.

Second quarter 2010 loss share filings were completed in the third quarter of 2010 and forwarded to the FDIC for review. These filings request reimbursement of $54.5 million from the FDIC for losses and covered servicing expenses. Due to inaccuracies with regard to the filings, the FDIC is delaying payment pending correction of the filings. In the opinion of management, substantially all of the requested $54.5 million will be received. The FDIC has also indicated that reimbursement of amounts claimed on future loss share filings will be deferred pending remediation of certain of our loss share filing processes.

Note G

Estimated Fair Values

Fair value estimates are made at a specific point in time based on relevant market information and information about each financial instrument. Where information regarding the fair value of a financial instrument is publicly available, those values are used, as is the case with investment securities, residential mortgage loans and certain long-term obligations. In these cases, an open market exists in which those financial instruments are actively traded.

Because no market exists for many financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. For those financial instruments with a fixed interest rate, an analysis of the related cash flows was the basis for estimating fair values. The expected cash flows were then discounted to the valuation date using an appropriate discount rate. The discount rates used represent the rates under which similar transactions would be currently negotiated. For each period presented, the fair value for loans, net of allowance for loan and lease losses, included an adjustment to reflect the unfavorable liquidity conditions that existed in various financial markets. Generally, the fair value of variable rate financial instruments equals the book value.

Estimated fair values for certain financial assets and financial liabilities are provided in the following table:

 

     September 30, 2010      December 31, 2009      September 30, 2009  
     Carrying
Value
     Fair
Value
     Carrying
Value
     Fair
Value
     Carrying
Value
     Fair
Value
 

Cash and due from banks

   $ 493,786       $ 493,786       $ 480,242       $ 480,242       $ 723,031       $ 723,031   

Overnight investments

     1,049,158         1,049,158         723,260         723,260         219,886         219,886   

Investment securities available for sale

     3,786,841         3,786,841         2,929,162         2,929,162         3,283,521         3,283,521   

Investment securities held to maturity

     2,645         2,864         3,603         3,834         3,788         4,041   

Loans held for sale

     79,853         79,853         67,381         67,381         78,485         78,485   

Loans covered by loss share agreements, net of allowance for loan and lease losses

     2,178,821         2,150,909         1,169,520         1,169,520         1,257,478         1,256,659   

Loans and leases not covered by loss share agreements, net of allowance for loan and lease losses

     11,371,102         10,995,807         11,476,217         11,060,532         11,355,401         10,748,074   

Receivable from FDIC for loss share agreements

     651,844         654,210         249,842         249,842         243,000         243,000   

Income earned not collected

     83,204         83,204         60,684         60,684         68,845         68,845   

Stock issued by:

                 

Federal Home Loan Bank of Atlanta

     48,291         48,291         47,361         47,361         47,361         47,361   

Federal Home Loan Bank of San Francisco

     16,135         16,135         5,592         5,592         5,592         5,592   

Federal Home Loan Bank of Seattle

     4,490         4,490         4,490         4,490         4,490         4,490   

Deposits

     17,743,028         17,808,921         15,337,567         15,396,423         15,348,955         15,418,748   

Short-term borrowings

     652,716         652,716         642,405         642,405         576,609         576,609   

Long-term obligations

     819,145         851,107         797,366         788,004         879,758         901,180   

Accrued interest payable

     33,533         33,533         37,881         37,881         42,524         42,524   

 

 

 

 

 

 

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For off-balance sheet commitments and contingencies, carrying amounts are reasonable estimates of the fair values for such financial instruments. Carrying amounts include unamortized fee income and, in some cases, reserves for any credit losses from those financial instruments. These amounts are not material to BancShares’ financial position.

Fair value represents the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, BancShares considers the principal or most advantageous market in which those assets or liabilities are sold and considers assumptions that market participants would use when pricing those assets or liabilities. As required under US GAAP, individual fair value estimates are ranked based on the relative reliability of the inputs used in the valuation. Fair values determined using level 1 inputs rely on active and observable markets to price identical assets or liabilities. In situations where identical assets and liabilities are not traded in active markets, fair values may be determined based on level 2 inputs, which exist when observable data exists for similar assets and liabilities. Fair values for assets and liabilities that are not actively traded in observable markets are based on level 3 inputs, which are considered to be nonobservable. It is BancShares’ policy to recognize transfers between levels of the fair value hierarchy at the end of the respective reporting period.

Among BancShares’ assets and liabilities, investment securities available for sale and interest rate swaps accounted for as cash flow hedges are reported at their fair values on a recurring basis. Certain other assets are adjusted to their fair value on a nonrecurring basis, including loans held for sale, which are carried at the lower of cost or market. Impaired loans, OREO, goodwill and other intangible assets are periodically tested for impairment. Loans held for investment, deposits, short-term borrowings and long-term obligations are not reported at fair value. BancShares did not elect to voluntarily report any assets or liabilities at fair value.

 

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For assets and liabilities carried at fair value on a recurring basis, the following table provides fair value information as of September 30, 2010, December 31, 2009 and September 30, 2009:

 

            Fair value measurements using:  

Description

   Fair value      Quoted prices in
active markets for
identical assets  and
liabilities

(Level 1 inputs)
     Quoted prices for
similar assets and
liabilities

(Level 2 inputs)
     Significant
unobservable inputs
(Level 3 inputs)
 
September 30, 2010            

Assets measured at fair value

           

Investment securities available for sale

           

U.S. Government

   $ 3,121,251       $ 3,121,251       $ —         $ —     

Corporate bonds

     489,189         489,189         —           —     

Residential mortgage-backed securities

     156,136         —           156,136         —     

Equity securities

     18,997         18,997         —           —     

State, county, municipal

     1,268         —           1,268         —     
                                   

Total

   $ 3,786,841       $ 3,629,437       $ 157,404       $ —     
                                   

Liabilities measured at fair value

           

Interest rate swaps accounted for as cash flow hedges

   $ 14,263       $ —         $ 14,263       $ —     

December 31, 2009

           

Assets measured at fair value

           

Investment securities available for sale

           

U.S. Government

   $ 2,287,423       $ 2,287,423       $ —         $ —     

Corporate bonds

     485,667         485,667         —           —     

Residential mortgage-backed securities

     130,338         —           130,338         —     

Equity securities

     16,622         16,622         —           —     

State, county, municipal

     6,813         —           6,813         —     

Other

     2,299         1,012         —           1,287   
                                   

Total

   $ 2,929,162       $ 2,790,724       $ 137,151       $ 1,287   
                                   

Liabilities measured at fair value

           

Interest rate swaps accounted for as cash flow hedges

   $ 5,367       $ —         $ 5,367       $ —     

September 30, 2009

           

Assets measured at fair value

           

Investment securities available for sale

           

U.S. Government

   $ 2,634,703       $ 2,634,703       $ —         $ —     

Corporate bonds

     487,090         487,090         —           —     

Residential mortgage-backed securities

     115,351         —           115,351         —     

Equity securities

     16,545         16,545         —           —     

State, county, municipal

     7,376         —           7,376         —     

Other

     22,456            20,267         2,189   
                                   

Total

   $ 3,283,521       $ 3,138,338       $ 142,994       $ 2,189   
                                   

Liabilities measured at fair value

           

Interest rate swaps accounted for as cash flow hedges

   $ 8,556       $ —         $ 8,556       $ —     

 

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Prices for US Government securities, corporate bonds and equity securities are readily available in the active markets in which those securities are traded and the resulting fair values are shown in the ‘Level 1 input’ column. Prices for mortgage-backed securities and state, county and municipal securities are obtained using the fair values of similar assets and the resulting fair values are shown in the ‘Level 2 input’ column. At December 31, 2009, the fair value for the retained residual interest from a securitization transaction was determined based on Level 3 nonobservable inputs. Based on changes to US GAAP related to accounting for QSPEs and controlling financial interests that became effective January 1, 2010, the previously securitized loans were consolidated and the residual interest strip was removed from the consolidated balance sheet. There were no transfers between Level 1 and Level 2 inputs during the nine months ended September 30, 2010.

At September 30, 2010, other assets include $68,916 of stock in various Federal Home Loan Banks (FHLB). The FHLB stock, which is redeemable only through the issuer, is carried at its par value. The investment in the FHLB stock is considered a long-term investment and its value is based on the ultimate recoverability of par value. Management has concluded that the investment in FHLB stock was not other-than-temporarily impaired as of September 30, 2010.

Under the terms of the existing cash flow hedges, BancShares pays a fixed payment to the counterparty in exchange for receipt of a variable payment that is determined based on the 3-month LIBOR rate. The fair value of the cash flow hedges are therefore based on projected LIBOR rates for the duration of the hedges, values that, while observable in the market, are subject to adjustment due to pricing considerations for the specific instrument.

For those investment securities available for sale with fair values that are determined by reliance on significant nonobservable inputs, the following table identifies the factors causing the change in fair value during the first nine months of 2010 and 2009:

 

     Investment securities available for sale
with fair values based on significant
nonobservable inputs
 

Description

   2010     2009  

Beginning balance, January 1 ,

   $ 1,287      $ 5,427   

Total gains (losses), realized or unrealized:

    

Included in earnings

     —          —     

Included in other comprehensive income

     —          (1,278

Purchases, sales , issuances and settlements, net

     —          (1,960

Transfers in/out of Level 3

     (1,287     —     
                

Ending balance, September 30

   $ —        $ 2,189   
                

No gains or losses were reported for the nine month periods ended September 30, 2010 and 2009 that relate to fair values estimated based on significant nonobservable inputs. The investment securities valued using level 3 inputs that were transferred out during the first quarter of 2010 result from changes in US GAAP adopted January 1, 2010 related to investments in the retained interest of a residual interest strip that resulted from an asset securitization.

 

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Certain assets and liabilities are carried at fair value on a nonrecurring basis. Loans held for sale are carried at the lower of aggregate cost or fair value and are therefore carried at fair value only when fair value is less than the asset cost. Certain impaired loans are also carried at fair value. For assets and liabilities carried at fair value on a nonrecurring basis, the following table provides fair value information as of September 30, 2010, December 31, 2009 and September 30, 2009:

 

            Fair value measurements using:  

Description

   Fair value      Quoted prices  in
active markets for
identical assets and
liabilities

(Level 1 inputs)
     Quoted prices  for
similar assets and
liabilities

(Level 2 inputs)
     Significant
nonobservable
inputs
(Level 3 inputs)
 

September 30, 2010

           

Loans held for sale

   $ 79,853       $ —         $ 79,853       $ —     

Impaired loans:

           

Covered by loss share agreements

     542,862         —           —           542,862   

Not covered by loss share agreements

     48,320         —           —           48,320   

December 31, 2009

           

Loans held for sale

     67,381         —           67,381         —     

Impaired loans:

           

Covered by loss share agreements

     112,946         —           —           116,446   

Not covered by loss share agreements

     44,686         —           —           40,895   

September 30, 2009

           

Loans held for sale

     38,328         —           38,328         —     

Impaired loans:

           

Covered by loss share agreements

     83,442         —           —           83,442   

Not covered by loss share

     19,055         —           —           19,055   

The values of loans held for sale are based on prices observed for similar pools of loans. The values of impaired loans are determined by either the collateral value or by the discounted present value of the expected cash flows. No financial liabilities were carried at fair value on a nonrecurring basis as of September 30, 2010 or December 31, 2009.

Certain non-financial assets and non-financial liabilities are measured at fair value on a nonrecurring basis. OREO is measured and reported at fair value using Level 2 inputs for observable market data or Level 3 inputs for valuations based on nonobservable criteria. During the nine month period ended September 30, 2010, foreclosures of other real estate not covered by loss share agreements totaled $24,241, all of which were valued using Level 3 inputs. In connection with the measurement and initial recognition of noncovered OREO, BancShares recognized loan charge-offs totaling $11,137. Based on updates to Level 3 inputs, noncovered OREO with a fair value of $8,025 as of September 30, 2010 incurred write-downs that totaled $2,344 during the nine month period ended September 30, 2010.

 

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Note H

Employee Benefit Plans

Pension expense is a component of employee benefits expense. For the three and nine month periods ended September 30, 2010 and 2009, the components of pension expense are as follows:

 

     Three months ended September 30,     Nine month periods ended September 30,  
     2010     2009     2010     2009  

Service cost

   $ 2,760      $ 3,190      $ 9,431      $ 9,472   

Interest cost

     5,192        5,517        17,738        16,384   

Expected return on assets

     (6,533     (6,982     (22,551     (20,733

Amortization of prior service cost

     42        53        157        157   

Amortization of net actuarial loss

     771        908        2,851        2,696   
                                

Total pension expense

   $ 2,232      $ 2,686      $ 7,626      $ 7,976   
                                

For the nine month periods ended September 30, 2010 and 2009 the assumed discount rate is 6.00 percent, the expected long-term rate of return on plan assets is 8.00 percent and the assumed rate of salary increases is 4.50 percent.

Note I

Contingencies

BancShares and various subsidiaries have been named as defendants in various legal actions arising from their normal business activities in which damages in various amounts are claimed. Although the amount of any ultimate liability with respect to those other matters cannot be determined, in the opinion of management, any such liability will not have a material effect on BancShares’ consolidated financial statements.

Note J

Derivatives

At September 30, 2010, BancShares had two interest rate swaps that qualify as cash flow hedges under US GAAP. The fair values of these derivatives are included in other liabilities in the consolidated balance sheets and in the net change in other liabilities in the consolidated statements of cash flows.

The interest rate swaps are used for interest rate risk management purposes and convert variable-rate exposure on outstanding debt to a fixed rate. The interest rate swaps each have a notional amount of $115,000, representing the amount of variable-rate trust preferred capital securities issued during 2006. The 2006 interest rate swap hedges interest payments through June 2011 and requires fixed-rate payments by BancShares at 7.125 percent in exchange for variable-rate payments of 175 basis points above 3-month LIBOR, which is equal to the interest paid to the holders of the trust preferred capital securities. The 2009 interest rate swap hedge interest payments from July 2011 through June 2016 and requires fixed-rate payments by BancShares at 5.50 percent in exchange for variable-rate payments of 175 basis points above 3-month LIBOR. As of September 30, 2010, collateral with a fair value of $14,734 was pledged to secure the existing obligation under the interest rate swaps. For both swaps, settlement occurs quarterly.

 

            Estimated fair value of liability  
     Notional amount
for all periods
     September 30, 2010      December 31, 2009     September 30, 2009  

2006 interest rate swap hedging variable rate exposure on trust preferred capital securities 2006-2011

   $ 115,000       $ 4,304       $ 7,424      $ 8,488   

2009 interest rate swap hedging variable rate exposure on trust preferred capital securities 2011-2016

     115,000         9,959         (2,057     68   
                            
      $ 14,263       $ 5,367      $ 8,556   
                            

 

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For cash flow hedges, the effective portion of the gain or loss due to changes in the fair value of the derivative hedging instrument is included in other comprehensive income, while the ineffective portion, representing the excess of the cumulative change in the fair value of the derivative over the cumulative change in expected future discounted cash flows on the hedged transaction, is recorded in the consolidated income statement. BancShares’ interest rate swaps have been fully effective since inception. Therefore, changes in the fair value of the interest rate swaps have had no impact on net income. For the nine month periods ended September 30, 2010 and 2009, BancShares recognized interest expense of $4,374 and $3,738, respectively, resulting from incremental interest paid to the interest rate swap counterparty, none of which related to ineffectiveness.

The following table discloses activity in accumulated other comprehensive income (loss) related to the interest rate swaps during the nine month periods ended September 30, 2010 and 2009.

 

     2010     2009  

Accumulated other comprehensive loss resulting from interest rate swaps as of January 1, net of tax

   $ (3,248   $ (6,456

Other comprensive (loss) income recognized during nine month period ended September 30, net of tax

     (5,383     1,278   
                

Accumulated other comprehensive loss resulting from interest rate swaps as of September 30, net of tax

   $ (8,631   $ (5,178
                

Accumulated other comprehensive loss resulting from interest rate swaps as of July 1, net of tax

   $ (6,844   $ (3,897

Other comprensive (loss) income recognized during three month period ended September 30, net of tax

     (1,787     (1,281
                

Accumulated other comprehensive loss resulting from interest rate swaps as of September 30, net of tax

   $ (8,631   $ (5,178
                

BancShares monitors the credit risk of the interest rate swap counterparty.

 

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Note K

Segment Disclosures

BancShares conducts its banking operations through its two wholly-owned subsidiaries, FCB and ISB. Although FCB and ISB offer similar products and services to customers, each entity operates in distinct geographic markets, except California, Washington and Florida, and has separate management groups. Additionally, the financial results and trends of ISB reflect the de novo nature of its growth. During the third quarter of 2010, FCB filed applications with Federal and state banking regulators for permission to merge with ISB, with FCB being the surviving entity. Pending regulatory approval and the expiration of any applicable waiting periods, the merger of FCB and ISB is expected to occur during early 2011. Following the merger and for the immediate future, all ISB branches will continue to operate under the name IronStone Bank, which will then be a division of FCB. Management has currently made no decisions with respect to any prospective changes in segment reporting assuming the merger is approved by regulatory authorities.

FCB operates from a single charter from its branch network in North Carolina, Virginia, West Virginia, Maryland, Tennessee, California, Washington, Florida and Washington, DC. FCB’s entrance into California, Washington and Florida during 2009 and 2010 resulted from participation in FDIC-assisted transactions. ISB began operations in 1997 and operates from a thrift charter in Florida, Georgia, Texas, New Mexico, Arizona, California, Oregon, Washington, Colorado, Oklahoma, Missouri and Kansas.

Management has determined that FCB and ISB are reportable business segments. In the aggregate, FCB and its consolidated subsidiaries, which are integral to its branch operation, and ISB account for more than 90 percent of consolidated assets, revenues and net income. The ‘Other’ category in the accompanying table includes activities of the parent company and Neuse, Incorporated (Neuse), a subsidiary that owns real property used in the banking operation and owns other real estate. The other real estate owned (non-performing assets) by Neuse relates to loans originated by ISB. During 2009, Neuse purchased some of ISB’s OREO to reduce ISB’s nonperforming assets. To facilitate the potential purchase of additional OREO in the future, ISB has agreed to lend Neuse up to $15,000 under a revolving line of credit. No amount was owed by Neuse to ISB as of September 30, 2010 under the revolving line of credit.

The adjustments in the accompanying tables represent the elimination of the impact of certain intercompany transactions. The adjustments for interest income and interest expense neutralize the earnings and cost of intercompany borrowings. The adjustments to noninterest income and noninterest expense reflect the elimination of management fees and other service fees paid from one company to another within BancShares’ consolidated group.

 

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     ISB      FCB      Other      Total      Adjustments     Consolidated  

September 30, 2010

                

Total assets

   $ 2,802,818       $ 18,107,427       $ 2,298,026       $ 23,208,271       $ (2,158,980   $ 21,049,291   

Loans and leases:

                

Covered by loss share agreements

     —           2,222,660         —           2,222,660         —          2,222,660   

Not covered by loss share agreements

     2,259,999         9,285,310         —           11,545,309         —          11,545,309   

Allowance for loan and lease losses

     42,675         175,371         —           218,046         —          218,046   

Goodwill

     793         60,593         41,239         102,625         —          102,625   

Nonperforming assets:

                

Covered by loss share agreements

     —           429,913         —           429,913         —          429,913   

Not covered by loss share agreements

     77,220         91,912         16,519         185,651         —          185,651   

Deposits

     2,167,350         15,633,900         —           17,801,250         (58,222     17,743,028   

December 31, 2009

                

Total assets

   $ 2,573,605       $ 15,791,475       $ 2,181,898       $ 20,546,978       $ (2,080,915   $ 18,466,063   

Loans and leases:

                

Covered by loss share agreements

     —           1,173,020         —           1,173,020         —          1,173,020   

Not covered by loss share agreements

     2,194,659         9,450,340         —           11,644,999         —          11,644,999   

Allowance for loan and lease losses

     41,675         130,607         —           172,282         —          172,282   

Goodwill

     793         101,832         —           102,625         —          102,625   

Non performing assets:

                

Covered by loss share agreements

     —           220,233         —           220,233         —          220,233   

Not covered by loss share agreements

     62,881         76,622         14,546         154,049         —          154,049   

Deposits

     1,967,824         13,406,484         —           15,374,308         (36,741     15,337,567   

September 30, 2009

                

Total assets

   $ 2,637,409       $ 15,822,497       $ 2,156,373       $ 20,616,279       $ (2,103,401   $ 18,512,878   

Loans and leases:

                

Covered by loss share agreements

     —           1,257,478         —           1,257,478         —          1,257,478   

Not covered by loss share agreements

     2,176,504         9,344,179         —           11,520,683         —          11,520,683   

Allowance for loan and lease losses

     39,425         125,857         —           165,282         —          165,282   

Goodwill

     793         101,832         —           102,625         —          102,625   

Nonperforming assets

                

Covered by loss share agreements

     —           205,073         —           205,073         —          205,073   

Not covered by loss share agreements

     51,678         40,308         14,335         106,321         —          106,321   

Deposits

     2,024,574         13,353,069         —           15,377,643         (28,688     15,348,955   

 

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     As of and for the quarter ended September 30, 2010  
     ISB     FCB      Other     Total      Adjustments     Consolidated  

Interest income

   $ 34,225      $ 244,281       $ 333      $ 278,839       $ (211   $ 278,628   

Interest expense

     9,946        33,295         5,658        48,899         (211     48,688   
                                                  

Net interest income

     24,279        210,986         (5,325     229,940         —          229,940   

Provision for credit losses

     5,540        54,333         —          59,873         —          59,873   
                                                  

Net interest income after provision for credit losses

     18,739        156,653         (5,325     170,067         —          170,067   

Noninterest income

     4,943        47,159         (263     51,839         (1,870     49,969   

Noninterest expense

     22,228        155,614         879        178,721         (1,870     176,851   
                                                  

Income (loss) before income taxes

     1,454        48,198         (6,467     43,185         —          43,185   

Income taxes

     591        20,414         (5,566     15,439         —          15,439   
                                                  

Net income (loss)

   $ 863      $ 27,784       $ (901   $ 27,746       $ —        $ 27,746   
                                                  
     As of and for the quarter ended September 30, 2009  
     ISB     FCB      Other     Total      Adjustments     Consolidated  

Interest income

   $ 32,951      $ 155,938       $ 982      $ 189,871       $ (181   $ 189,690   

Interest expense

     12,285        36,689         5,620        54,594         (181     54,413   
                                                  

Net interest income

     20,666        119,249         (4,638     135,277         —          135,277   

Provision for credit losses

     7,545        10,720         —          18,265         —          18,265   
                                                  

Net interest income after provision for credit losses

     13,121        108,529         (4,638     117,012         —          117,012   

Noninterest income

     3,504        180,064         (282     183,286         (2,433     180,853   

Noninterest expense

     22,701        143,701         530        166,932         (2,433     164,499   
                                                  

Income (loss) before income taxes

     (6,076     144,892         (5,450     133,366         —          133,366   

Income taxes

     (2,174     54,975         (1,903     50,898         —          50,898   
                                                  

Net income (loss)

   $ (3,902   $ 89,917       $ (3,547   $ 82,468       $ —        $ 82,468   
                                                  
     As of and for the nine months ended September 30, 2010  
     ISB     FCB      Other     Total      Adjustments     Consolidated  

Interest income

   $ 100,700      $ 595,398       $ 1,249      $ 697,347       $ (584   $ 696,763   

Interest expense

     31,242        103,304         16,963        151,509         (584     150,925   
                                                  

Net interest income

     69,458        492,094         (15,714     545,838         —          545,838   

Provision for credit losses

     14,286        94,343         —          108,629         —          108,629   
                                                  

Net interest income after provision for credit losses

     55,172        397,751         (15,714     437,209         —          437,209   

Noninterest income

     12,132        348,642         (385     360,389         (5,849     354,540   

Noninterest expense

     67,249        468,636         1,541        537,426         (5,849     531,577   
                                                  

Income (loss) before income taxes

     55        277,757         (17,640     260,172         —          260,172   

Income taxes

     156        103,240         (6,183     97,213         —          97,213   
                                                  

Net income (loss)

   $ (101   $ 174,517       $ (11,457   $ 162,959       $ —        $ 162,959   
                                                  
     As of and for the nine months ended September 30, 2009  
     ISB     FCB      Other     Total      Adjustments     Consolidated  

Interest income

   $ 98,076      $ 443,979       $ 4,612      $ 546,667       $ (484   $ 546,183   

Interest expense

     40,905        120,672         16,976        178,553         (484     178,069   
                                                  

Net interest income

     57,171        323,307         (12,364     368,114                368,114   

Provision for credit losses

     26,686        31,061         —          57,747                57,747   
                                                  

Net interest income after provision for credit losses

     30,485        292,246         (12,364     310,367                310,367   

Noninterest income

     10,041        320,278         (828     329,491         (7,530     321,961   

Noninterest expense

     68,008        416,132         1,502        485,642         (7,530     478,112   
                                                  

Income (loss) before income taxes

     (27,482     196,392         (14,694     154,216                154,216   

Income taxes

     (9,828     71,852         (5,139     56,885                56,885   
                                                  

Net income (loss)

   $ (17,654   $ 124,540       $ (9,555     97,331       $      $ 97,331   
                                                  

 

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

INTRODUCTION

Management’s discussion and analysis of earnings and related financial data are presented to assist in understanding the financial condition and results of operations of First Citizens BancShares, Inc. and Subsidiaries (BancShares). This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and related notes presented within this report. Intercompany accounts and transactions have been eliminated. Although certain amounts for prior years have been reclassified to conform to statement presentations for 2010, the reclassifications have no effect on shareholders’ equity or net income as previously reported. Unless otherwise noted, the terms we, us and BancShares refer to the consolidated financial position and consolidated results of operations for BancShares.

FDIC-ASSISTED TRANSACTIONS

Participation in FDIC-assisted transactions has provided significant growth opportunities for BancShares during 2010 and 2009. These transactions have allowed us to enter attractive markets and we believe these transactions will provide long-term financial benefits. Additionally, purchase price discounts and FDIC indemnification agreements have resulted in significant acquisition gains. From a risk management perspective, in each of the four FDIC-assisted transactions completed as of September 30, 2010, loss share agreements protect us from a substantial portion of the credit and asset quality risk that we would otherwise incur.

Issues affecting comparability of financial statements. As estimated exposures related to the acquired assets that are covered under the loss share agreements change based on post-acquisition events, our adherence to accounting principles generally accepted in the United States of America (US GAAP) and accounting policy elections we have made create various complexities that affect the comparability of our current results of operations to earlier periods. Adjustments affecting assets covered under loss share agreements are recorded on a gross basis on our balance sheet and income statement. Consequential adjustments to the carrying value of the FDIC receivable that reflect the change in the estimated loss of the covered assets are recorded with an offset to noninterest income.

Several of the key issues affecting comparability are summarized below:

 

   

When post acquisition events suggest that the amount of cash flows we will ultimately receive for a loan covered under a loss share agreement is less than originally expected:

 

   

An allowance for loan and lease losses is established for the post-acquisition exposure that has emerged with a corresponding increase to provision for loan and lease losses;

 

   

The receivable from the FDIC is adjusted to reflect the indemnified portion of the post-acquisition exposure with a corresponding increase to noninterest income;

 

   

When post acquisition events suggest that the amount of cash flows we will ultimately receive for a loan covered under a loss share agreement is greater than originally expected:

 

   

Any allowance for loan and lease losses that was previously established for post-acquisition exposure is reversed with a corresponding credit to provision for loan and lease losses; if no allowance had been established in earlier periods, the amount of the improvement in the cash flow projection results in a reclassification from the nonaccretable difference created at the acquisition date to an accretable yield; the newly-identified accretable yield will be accreted into income in future periods over the remaining life of the loan as a credit to interest income;

 

   

The receivable from the FDIC is adjusted to reflect the indemnified portion of the post-acquisition exposure with a corresponding decrease to noninterest income recognized on a basis substantially consistent with the recognition methodology for the indemnified asset.

 

   

When actual payments received on loans are different from initial estimates, large nonrecurring discount accretion may be recognized during a specific period; discount accretion is recognized as a credit to interest income.

Balance sheet impact. The 2010 transactions involving First Regional and SAB represented the third and fourth transactions involving BancShares since July 17, 2009. Table 1 provides information regarding the four entities from which we have acquired assets and assumed liabilities in FDIC-assisted transactions during 2010 and 2009. Adjustments to acquisition date fair values and the related acquisition gains are subject to change for one year following the closing date of each respective acquisition.

 

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FDIC-Assisted Transactions

Table 1

 

                   Fair value of  

Entity

   Date of transaction      # branches      Loans acquired      Deposits assumed      Short-term
borrowings
assumed
     Long-term
obligations assumed
 
     (thousands)  

Sun American Bank

     March 5, 2010         12       $ 290,891       $ 420,012       $ 42,533       $ 40,082   

First Regional Bank

     January 29, 2010         8         1,260,249         1,287,719         361,876         —     

Venture Bank

     September 11, 2009         18         456,995         709,091         —           55,618   

Temecula Valley Bank

     July 17, 2009         11         855,583         965,431         79,096         —     
                                               

Total

        49       $ 2,863,718       $ 3,382,253       $ 483,505       $ 95,700   
                                               

Although US GAAP allows for acquired loans to be accounted for in designated pools, we have elected to account for our acquired loans on a non-pooled basis. We made that election for loans acquired to date based on the average loan size and the lack of large numbers of homogenous loans. The non-pool election could potentially accentuate volatility in net interest income.

Income statement impact. The four FDIC-assisted transactions created acquisition gains recognized at the time of the respective transaction. For the nine-month period ended September 30, 2010, acquisition gains totaled $136.0 million compared to $104.4 million during the same period of 2009. Additionally, the acquired loans, deposits and borrowings originated by the four banks have affected net interest income, provision for loan and lease losses and noninterest income. Increases to noninterest expense have resulted from incremental staffing and facility costs for the branch locations resulting from the FDIC-assisted transactions. Various fair value discounts and premiums that were previously recorded are being accreted and amortized into income over the life of the underlying asset or liability.

As previously discussed, post-acquisition changes that affect the amount of expected cash flows can result in recognition of provision for loan and lease losses or the reversal of previously-recognized provision for loan and lease losses. During the nine-month period ended September 30, 2010 total provision for loan losses related to acquired loans equaled $62.5 million. No provision expense was recorded during the same period of 2009 related to acquired loans.

When actual loan payments are received prior to the assumed repayment, the accretion of discounts recorded on loan balances is accelerated. During the nine-month period ended September 30, 2010, discount accretion related to unanticipated payment of loans for which a fair value discount had been recorded, equaled $74.9 million. No discount for unscheduled loan payments was accreted during the same period of 2009.

Unscheduled payment of loan balances and post-acquisition deterioration of covered loans also results in adjustments to the FDIC receivable for changes in the estimated amount that would be covered under the respective loss share agreement. During the nine-month period ended September 30, 2010, the adjustment to the FDIC receivable resulting from large unscheduled payments exceeded the amount of the adjustment for post-acquisition deterioration, resulting in a net reduction to the FDIC receivable and contributing to a net charge of $13.1 million to noninterest income.

First Regional Bank. On January 29, 2010, First-Citizens Bank & Trust Company (FCB) entered into an agreement with the FDIC to purchase substantially all the assets and assume the majority of the liabilities of First Regional Bank (First Regional) of Los Angeles, California. Immediately prior to the effectiveness of the transaction, the FDIC had been appointed Receiver of First Regional by the California Department of Financial Institutions.

Table 2 identifies the assets acquired and liabilities assumed, the fair value adjustments, the amounts recorded by FCB, and the calculation of the gain recognized.

 

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First Regional Bank    Table 2

Acquisition date: January 29, 2010

  

 

     As recorded by
First Regional
     Fair  value
adjustments
at  acquisition
date
    Subsequent
acquisition-date
adjustments
    As recorded
by FCB
 
     (thousands)  

Assets

         

Cash and due from banks

   $ 37,508       $ —        $ —        $ 37,508   

Investment securities available for sale

     3,250         —          —          3,250   

Loans covered by loss share agreements

     1,853,325         (576,171     (16,905     1,260,249   

Other real estate owned covered by loss share agreements

     61,488         (20,353     791        41,926   

Income earned not collected

     6,048         —          —          6,048   

Receivable from FDIC for loss share agreements

     —           365,170        13,525        378,695   

Intangible assets

     —           9,110        —          9,110   

Other assets

     23,782         (500     —          23,282   
                                 

Total assets acquired

   $  1,985,401       $ (222,744   $ (2,589   $ 1,760,068   
                                 

Liabilities

         

Deposits:

         

Non interest-bearing

   $ 528,235       $ —        $ —        $ 528,235   

Interest-bearing

     759,484         —          —          759,484   
                                 

Total deposits

     1,287,719         —          —          1,287,719   

Short-term borrowings

     361,876         —          —          361,876   

Other liabilities

     1,188         1,547        —          2,735   
                                 

Total liabilities assumed

     1,650,783         1,547        —          1,652,330   
                                 

Excess of assets acquired over liabilities assumed

   $ 334,618          
               

Aggregate fair value adjustments

      $ (224,291   $ (2,589  
                     

Gain on acquisition of First Regional

          $ 107,738   
               

The loans and other real estate acquired through foreclosure are covered by loss share agreements that provide for the FDIC to absorb 80 percent of losses incurred on covered loans and other real estate in excess of $41.8 million. The 80 percent coverage ratio applies to losses up to $1.0 billion with losses in excess of $1.0 billion covered by the FDIC at a rate of 95 percent. FCB recorded a receivable from the FDIC equal to $365.2 million as an estimate of the fair value of the amount that will be reimbursed by the FDIC from the loss share agreements. The Purchase and Assumption Agreement between FCB and the FDIC includes a true-up payment at the end of year 10. On March 17, 2020, the true-up measurement date, FCB is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of (i) 20 percent of the stated threshold, or $203.4 million, less (ii) the sum of (a) 25 percent of the asset discount, or $74.9 million, plus (b) 25 percent of the cumulative loss share payments plus (c) the cumulative servicing amount. The cumulative servicing amount is 1 percent of the average covered assets for each year during the terms of the loss share agreements. Current projections suggest a true-up payment of $67.2 million will be payable for the contractual obligations related to the First Regional loss share agreements. This estimate is subject to change over the term of the agreements.

First quarter noninterest income included a bargain purchase gain of $110.3 million that resulted from the FDIC-assisted acquisition of First Regional. During the second and third quarters of 2010, adjustments were made to the initial gain based on additional information regarding the respective acquisition date fair values, which reduced the gain by $2.6 million. These adjustments were made retroactive to the first quarter of 2010 resulting in an adjusted gain of $107.7 million. Our operating results for the period ended September 30, 2010 include the results of the acquired assets and liabilities for the period from January 29, 2010 through September 30, 2010. Accretion and amortization of various purchase accounting discounts and premiums were recorded in the first three quarters of 2010.

 

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Sun American Bank. On March 5, 2010, FCB entered into an agreement with the FDIC to purchase substantially all the assets and assume the majority of the liabilities of Sun American Bank (SAB) of Boca Raton, Florida. Immediately prior to the effectiveness of the acquisition, the FDIC had been appointed Receiver of SAB by the Florida Office of Financial Regulation.

Table 3 identifies the assets acquired and liabilities assumed, the fair value adjustments, the amounts recorded by FCB, and the calculation of the gain recognized.

 

Sun American Bank      Table 3   
Acquisition date: March 5, 2010   

 

     As recorded
by SAB
     Fair value
adjustments
at acquisition
date
    Subsequent
acquisition-date
adjustments
    As recorded  by
FCB
 
     (thousands)  

Assets

         

Cash and due from banks

   $ 37,016       $ —        $ —        $ 37,016   

Investment securities available for sale

     66,968         —          —          66,968   

Loans covered by loss share agreements

     411,315         (123,707     3,283        290,891   

Other real estate owned covered by loss share agreements

     15,220         (7,200     —          8,020   

Income earned not collected

     1,612         —          —          1,612   

Receivable from FDIC for loss share agreements

     —           92,360        (2,626     89,734   

Intangible assets

     —           629        —          629   

Other assets

     4,473         —          —          4,473   
                                 

Total assets acquired

   $ 536,604       $ (37,918   $ 657      $ 499,343   
                                 

Liabilities

         

Deposits :

         

Noninterest-bearing

   $ 39,435       $ —        $ —        $ 39,435   

Interest-bearing

     380,577         —          —          380,577   
                                 

Total deposits

     420,012         —          —          420,012   

Short-term borrowings

     42,485         48        —          42,533   

Long-term obligations

     37,000         3,082        —          40,082   

Other liabilities

     853         51        —          904   
                                 

Total liabilities assumed

     500,350         3,181        —          503,531   
                                 

Excess of assets acquired over liabilities assumed

   $ 36,254          
               

Aggregate fair value adjustments

      $ (41,099   $ 657     
                     

Cash received from the FDIC

          $ 31,965   
               

Gain on acquisition of Sun American

          $ 27,777   
               

The loans and other real estate acquired through foreclosure are covered by loss share agreements that provide for the FDIC to absorb 80 percent of all losses incurred on covered loans and other real estate up to $99.0 million. Losses in excess of $99.0 million are covered by the FDIC at a rate of 95 percent. FCB recorded a receivable from the FDIC equal to $92.4 million as an estimate of the fair value of the amount that will be reimbursed by the FDIC from the loss share agreements. The Purchase and Assumption Agreement between FCB and the FDIC includes a true-up payment at the end of year 10. On May 15, 2020, the true-up measurement date, FCB is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of (i) 20 percent of the stated threshold, or $19.8 million, less (ii) the sum of (a) 25 percent of the asset discount, or $17.5 million, plus (b) 25 percent of the cumulative loss share payments plus (c) the cumulative servicing amount. The cumulative servicing amount is 1 percent of the average covered assets for each year during the terms of the loss share agreements. Although no true-up payment is currently projected under the SAB loss share agreements, those projections are subject to change.

 

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First quarter noninterest income included a bargain purchase gain of $27.1 million that resulted from the FDIC-assisted acquisition of SAB. During the second quarter of 2010, adjustments were made to the initial gain based on additional information regarding the respective acquisition date fair values, which increased the gain by $656,000. These adjustments were made retroactive to the first quarter of 2010 resulting in an adjusted gain of $27.8 million. Our operating results for the period ended September 30, 2010 include the results of the acquired assets and liabilities for the period from March 5, 2010 through September 30, 2010. Accretion and amortization of various purchase accounting discounts and premiums were recorded in the first three quarters of 2010.

EXECUTIVE OVERVIEW AND PERFORMANCE SUMMARY

BancShares is a financial holding company headquartered in Raleigh, North Carolina that offers full-service banking through two wholly-owned banking subsidiaries, First-Citizens Bank & Trust Company (FCB), a North Carolina-chartered bank, and IronStone Bank (ISB), a federally-chartered thrift institution. FCB operates branches in eight states and the District of Columbia. ISB operates branches in urban areas of twelve states. Beyond the traditional branch network, we offer customer sales and service through telephone, online banking and an extensive ATM network.

During the third quarter of 2010, FCB filed applications with Federal and state banking regulators for permission to merge with ISB, with FCB being the surviving entity. Pending regulatory approval and the expiration of any applicable waiting periods, the merger of FCB and ISB is expected to occur during early 2011. Following the merger and for the immediate future, all ISB branches will continue to operate under the name IronStone Bank, which will then be a division of FCB. The merger will result in minor expense reductions due to the elimination of various activities that are currently performed separately for both entities. The transaction will also allow liquidity to be managed more efficiently throughout the merged network and for the ISB branches to increase commercial lending activities. The merger is not expected to have a material impact on the consolidated financial position, results of operations or liquidity position of BancShares.

BancShares’ earnings and cash flows are primarily derived from the commercial banking activities conducted by its banking subsidiaries. We offer commercial and consumer loans, deposit and treasury services products, cardholder and merchant services, wealth management services as well as various other products and services typically offered by commercial banks. FCB and ISB gather deposits from retail and commercial customers. BancShares and its subsidiaries also secure funding through various non-deposit sources. We invest the liquidity generated from these funding sources in interest-earning assets such as loans and leases, investment securities and overnight investments. We also invest in the bank premises, furniture and equipment used to conduct the subsidiaries’ commercial banking business.

Various external factors influence the focus of our business efforts. Due to unprecedented asset quality challenges, capital shortages and the onset of a global economic recession, the U.S. banking industry has experienced serious financial challenges during the period from 2008 through 2010. During this time of industry-wide turmoil, while maintaining our long-standing attention to prudent banking practices, we elected to participate in FDIC-assisted transactions involving distressed financial institutions. Participation in FDIC-assisted transactions creates opportunities to significantly increase our business volumes in markets in which we presently operate and to expand our banking presence to additional markets which we deem demographically attractive. For each of the four FDIC-assisted transactions that we have completed as of September 30, 2010, loss share agreements protect us from a substantial portion of the asset quality risk that we would otherwise incur. Additionally, purchase discounts and fair value adjustments on acquired assets and assumed liabilities have resulted in significant acquisition gains that have resulted in the creation of a substantial portion of the equity required to fund the transactions.

Despite the recognition of significant acquisition gains during 2010 and 2009, recessionary economic conditions, high rates of unemployment, and a growing inability for some businesses and consumers to meet their debt service obligations continue to exert pressure on our core earnings and profitability. Other customers continue to repay existing debt or defer new borrowings due to lingering economic uncertainty.

 

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Real estate demand in many of our markets remains weak, resulting in continued depressed real estate prices that have adversely affected collateral values for many borrowers. In particular, the stressed residential real estate markets in Georgia and Florida adversely impacted the asset quality and profitability of ISB during 2009 and to a lesser extent the results of operations during 2010. In an effort to assist customers experiencing financial difficulty, we have selectively agreed to modify existing loan terms to provide relief to customers who are experiencing liquidity challenges or other circumstances that could affect their ability to meet their debt obligations. These modifications are typically executed only if a customer is current and we believe that the modification will result in the avoidance of default.

The demand for our deposit and treasury services products has been influenced by extraordinarily low interest rates and instability in alternative investment markets. Our balance sheet liquidity position remains strong, but our continuing participation in FDIC-assisted transactions creates pressure on liquidity management due to the difficulty of assumed deposit retention at a reasonable cost.

Ongoing economic weakness continues to have a significant impact on virtually all financial institutions in the United States, including BancShares. In addition to the various actions previously enacted by governmental agencies and the Dodd-Frank Wall Street Reform and Consumer Protection Act, it is possible that further changes will occur as the Federal government attempts to restore stability to the financial services sector.

We operate in diverse geographic markets and can increase our business volumes and profitability by offering competitive products and superior customer service. In addition to our focus on retaining customers of the four banks involved in the FDIC-assisted transactions, we continue to concentrate our marketing efforts on business owners, medical and other professionals and financially active individuals. We seek to increase fee income in areas such as wealth management, cardholder and merchant services, and insurance and treasury services. Leveraging on our investments in technology, we also focus on opportunities to generate income by providing various processing services to other banks.

BancShares’ consolidated net income during the third quarter of 2010 equaled $27.7 million, a decrease of $54.8 million from the $82.5 million earned during the corresponding period of 2009. The annualized return on average assets and equity amounted to 0.52 percent and 6.46 percent respectively, during the third quarter of 2010, compared to 1.83 and 22.45 percent during the same period of 2009. Net income per share during the third quarter of 2010 totaled $2.66, compared to $7.90 during the third quarter of 2009. The decrease in net income for the third quarter of 2010 was due to acquisition gains recorded in the third quarter of 2009 resulting from two FDIC-assisted transactions with an after-tax impact of $63.5 million or $6.09 per share.

For the nine-month period ending September 30, 2010, net income equaled $163.0 million compared to $97.3 million earned during the same period of 2009. Return on assets and equity during 2010 equaled 1.05 percent and 13.17 percent respectively, up from 0.75 percent and 9.01 percent during the nine-month period ended September 30, 2009. Net income per share equaled $15.62 during the first nine months of 2010 compared to $9.33 in the first nine months of 2009. The increase in net income during 2010 was attributable to higher gains arising from FDIC-assisted transactions and significantly improved net interest income. During 2010, the after-tax impact of the acquisition gains resulting from FDIC-assisted transactions totaled $82.7 million or $7.93 per share compared to $63.5 million or $6.09 per share during 2009.

Net interest income increased $94.7 million from $135.3 million in the third quarter of 2009 to $229.9 million in 2010, an increase of 70.0 percent. This increase is a result of balance sheet growth caused primarily by acquisitions and discount accretion of $74.9 million recognized on acquired loans that had large unscheduled loan payments since acquisition. The net yield on interest-earning assets improved by 152 basis points from 3.41 in the third quarter 2009 to 4.93 percent in 2010 due to accreted loan discounts, favorable changes in deposit costs and the positive impact of yields and rates on acquired loans and assumed deposits. Year to date net interest income increased $177.7 million, or 48.3 percent during 2010. The net yield on interest-earning assets equaled 4.02 percent during the nine-month period ended September 30, 2010 compared to 3.17 percent for the same period of 2009. For both the third quarter and the year to date, the impact of accreted loan discounts resulting from large unscheduled loan payments on acquired loans significantly impacted the taxable-equivalent net yield on interest-earning assets. Since such large unscheduled payments are unpredictable, the yield on interest-earning assets may decline or be volatile in future periods. Improvements in expected cashflows on impaired loans identified in the third quarter of 2010 resulted in the reclassification of nonaccretable difference, which will increase the amount of accretable yield recognized in future periods.

 

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The provision for loan and lease losses recorded during the third quarter of 2010 equaled $59.9 million, compared to $18.3 million during the third quarter of 2009. Of the $59.9 million increase, $43.1 million related to post-acquisition deterioration of acquired loans covered by loss share agreements with the FDIC. The gross amount of newly-identified exposures is recorded as provision for loan and lease losses with the FDIC receivable adjusted through an offset to noninterest income for the portion that is covered by the FDIC at the appropriate indemnification rate. During the first nine months of 2010, the provision for loan and lease losses equaled $108.6 million, an increase of $50.9 million or 88.1 percent from the same period of 2009.

Noninterest income decreased $130.9 million or 72.4 percent in the third quarter of 2010 when compared to the third quarter of 2009 due to 2009 acquisition gains of $104.4 million and $28.5 million of charges resulting from adjustments to the FDIC receivable for assets covered by loss share agreements. Noninterest income increased $32.6 million or 10.1 percent in the first nine months of 2010 when compared to the same period of 2009. The increase during the nine-month period ended September 30, 2010 is primarily due to higher acquisition gains, and cardholder and merchant services income. These increases were partially offset by $13.1 million of charges resulting from adjustments to the FDIC receivable.

Noninterest expense increased $12.4 million or 7.5 percent in the third quarter of 2010 and $53.5 million or 11.2 percent in the first nine months of 2010 when compared to the same period in 2009. The increase in noninterest expense is primarily due to acquisition related activities, including operating costs for acquired branches and expenses related to the operation and disposition of other real estate.

 

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Financial Summary   Table 4

 

    2010     2009     Nine months ended September 30  
    Third
Quarter
    Second
Quarter
    First
Quarter
    Fourth
Quarter
    Third
Quarter
    2010     2009  
    (thousands, except share data and ratios)  

Summary of Operations

             

Interest income

  $ 278,628      $ 217,435      $ 200,700      $ 191,976      $ 189,690      $ 696,763      $ 546,183   

Interest expense

    48,688        52,573        49,664        49,575        54,413        150,925        178,069   
                                                       

Net interest income

    229,940        164,862        151,036        142,401        135,277        545,838        368,114   

Provision for loan and lease losses

    59,873        31,826        16,930        21,617        18,265        108,629        57,747   
                                                       

Net interest income after provision for loan and lease losses

    170,067        133,036        134,106        120,784        117,012        437,209        310,367   

Gains on acquisitions

    0        0        136,000        0        104,970        136,000        104,434   

Adjustments to FDIC receivable

    (28,505     12,713        2,739        0        0        (13,053     —     

Other noninterest income

    78,474        79,909        73,210        82,264        75,883        231,593        217,527   

Noninterest expense

    176,851        181,776        172,950        174,165        164,499        531,577        478,112   
                                                       

Income before income taxes

    43,185        43,882        173,105        28,883        133,366        260,172        154,216   

Income taxes

    15,439        15,280        66,494        9,883        50,898        97,213        56,885   
                                                       

Net income

  $ 27,746      $ 28,602      $ 106,611      $ 19,000      $ 82,468      $ 162,959      $ 97,331   
                                                       

Net interest income, taxable equivalent

  $ 231,006      $ 165,937      $ 151,870      $ 143,446      $ 136,426      $ 549,019      $ 372,001   
                                                       

Per Share Data

             

Net income

  $ 2.66      $ 2.74      $ 10.02      $ 1.82      $ 7.90      $ 15.62      $ 9.33   

Cash dividends

    0.300        0.300        0.300        0.300        0.300        0.900        0.900   

Market price at period end (Class A)

    185.27        192.33        198.76        164.01        159.10        185.27        159.10   

Book value at period end

    164.67        162.28        159.91        149.42        145.16        164.67        145.16   

Tangible book value at period end

    153.74        151.21        148.68        138.98        134.66        153.74        134.66   
                                                       

Selected Quarterly Averages

             

Total assets

  $ 21,164,235      $ 21,222,673      $ 19,957,379      $ 18,386,775      $ 17,892,599      $ 20,740,796      $ 17,385,950   

Investment securities

    3,810,057        3,732,320        3,060,237        3,134,971        3,596,422        3,536,952        3,506,187   

Loans and leases (covered and noncovered)

    13,917,278        14,202,809        13,789,081        12,877,150        12,078,390        13,941,556        11,788,104   

Interest-earning assets

    18,605,130        18,778,108        17,507,787        16,319,611        15,862,964        18,272,392        15,686,614   

Deposits

    17,823,807        17,881,444        16,576,039        15,291,720        14,792,449        17,431,667        14,338,639   

Interest-bearing liabilities

    15,433,653        15,598,726        14,681,127        13,467,532        13,137,412        15,212,048        12,860,140   

Long-term obligations

    914,938        921,859        964,944        795,646        810,049        905,187        759,341   

Shareholders’ equity

  $ 1,705,005      $ 1,679,837      $ 1,593,072      $ 1,535,828      $ 1,457,599      $ 1,654,900      $ 1,444,605   

Shares outstanding

    10,434,453        10,434,453        10,434,453        10,434,453        10,434,453        10,434,453        10,434,453   
                                                       

Selected Quarter-End Balances

             

Total assets

  $ 21,049,291      $ 21,105,769      $ 21,215,692      $ 18,466,063      $ 18,512,878      $ 21,049,291      $ 18,512,878   

Investment securities

    3,789,486        3,771,861        3,378,482        2,932,765        3,287,309        3,789,486        3,287,309   

Loans and leases (covered and noncovered)

    13,847,822        14,080,660        14,242,302        12,818,019        12,778,161        13,847,822        12,856,646   

Deposits

    17,743,028        17,787,241        17,843,827        15,337,567        15,348,955        17,743,028        15,348,955   

Shareholders’ equity

    1,718,204        1,693,309        1,668,593        1,559,115        1,514,684        1,718,204        1,514,684   
                                                       

Selected Ratios and Other Data

             

Rate of return on average assets (annualized)

    0.52     0.54     2.12     0.41     1.83     1.05     0.75

Rate of return on average shareholders’ equity (annualized)

    6.46        6.83        26.62        4.92        22.45        13.17        9.01   

Net yield on interest-earning assets (taxable equivalent)

    4.93        3.54        3.52        3.49        3.41        4.02        3.17   

Allowance for loan and lease losses to total loans and leases:

             

Covered by loss share agreements

    1.97        0.68        0.26        0.30        —          1.97        —     

Not covered by loss share agreements

    1.51        1.48        1.46        1.45        1.43        1.51        1.43   

Nonperforming assets to total loans and leases plus other real estate:

             

Covered by loss
share agreements

    18.51        13.94        9.50        17.39        15.08        18.51        15.08   

Not covered by loss share agreements

    1.60        1.36        1.37        1.32        0.92        1.60        0.92   

Tier 1 risk-based capital ratio

    14.38        14.26        13.81        13.34        13.33        14.38        13.33   

Total risk-based capital ratio

    16.45        16.33        16.04        15.59        15.58        16.45        15.58   

Leverage capital ratio

    9.04        8.90        9.34        9.54        9.73        9.04        9.73   

Dividend payout ratio

    11.28        10.95        2.99        16.48        3.80        5.76        9.65   

Average loans and leases to average deposits

    78.08        79.43        83.19        84.21        81.65        79.98        82.21   
                                                       

Average loans and leases includes nonaccrual loans and loans held for sale.

 

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INTEREST-EARNING ASSETS

Interest-earning assets include loans and leases, investment securities and overnight investments, all of which reflect varying interest rates based on the risk level and repricing characteristics of the underlying asset. Riskier investments typically carry a higher interest rate, but expose us to potentially increased levels of default.

We have historically focused on maintaining high asset quality, which results in a loan and lease portfolio subjected to strenuous underwriting and monitoring procedures. That focus on asset quality also influences the composition of our investment securities portfolio. At September 30, 2010, United States Treasury and government agency securities represent 82.3 percent of our investment securities portfolio; corporate bonds issued under the FDIC’s Treasury Liquidity Guaranty Program represent 12.9 percent; and residential mortgage-backed securities represent 4.2 percent of the total portfolio. Overnight investments are selectively made with other financial institutions that are within our risk tolerance.

During 2010, changes in our interest-earning assets primarily reflect the impact of assets acquired in the FDIC-assisted transactions. Changes in the investment securities portfolio primarily result from trends among loans and leases, deposits and short-term borrowings. When inflows arising from deposit and treasury services products exceed loan and lease demand, we invest excess funds in the securities portfolio. Conversely, when loan demand exceeds growth in deposits and short-term borrowings, we allow overnight investments to decline and use proceeds from maturing securities to fund loan demand.

During the third quarter of 2010, interest-earning assets averaged $18.61 billion, an increase of $2.74 billion or 17.3 from the third quarter of 2009. This increase results from assets acquired in the FDIC-assisted transactions and deposit growth within our legacy branch network in excess of loan and lease demand.

Loans and leases. At September 30, 2010, December 31, 2009 and September 30, 2009, loans and leases totaled $13.77 billion, $12.82 billion and $12.78 billion, respectively. Loans covered by loss share agreements with the FDIC totaled $2.22 billion at September 30, 2010 compared to $1.17 billion at December 31, 2009 and $1.26 billion at September 30, 2009. Loans not covered by loss share agreements equaled $11.55 billion at September 30, 2010, a slight decrease from December 31, 2009 but up marginally from September 30, 2009.

Commercial real estate loans not covered by loss share agreements totaled $4.70 billion at September 30, 2010, 40.7 percent of noncovered loans and leases. This balance represents an increase of $144.1 million or 3.2 percent since December 31, 2009 and $181.6 million or 4.0 percent since September 30, 2009. Demand for loans secured by owner-occupied medical and professional facilities remained reasonably strong through December 31, 2009, but has weakened during the first nine months of 2010. These loans are underwritten based primarily upon the cash flow from the operation of the business rather than the value of the real estate collateral.

At September 30, 2010, revolving mortgage loans not covered by loss share agreements totaled $2.21 billion, representing 19.1 percent of total noncovered loans outstanding, an increase of $61.9 million or 2.9 percent since December 31, 2009 and $95.1 million or 4.5 percent compared to September 30, 2009. The 2010 increase results from changes to accounting for QSPEs and controlling financial interests that became effective on January 1, 2010. As a result of the accounting change, $97.3 million of revolving mortgage loans that were previously securitized, sold and removed from the consolidated balance sheet were returned to the balance sheet in the first quarter of 2010 upon adoption of the new accounting guidance.

Commercial and industrial loans not covered by loss share agreements equaled $1.77 billion or 15.4 percent of total noncovered loans and leases. These loans decreased $58.3 million or 3.2 percent since December 31, 2009 and $48.2 million or 2.6 percent since September 30, 2009 due to a decline in customer demand driven by recessionary economic conditions.

 

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Loans and Leases   Table 5

 

     2010      2009  
     Third
Quarter
     Second
Quarter
     First
Quarter
     Fourth
Quarter
     Third
Quarter
 
                          (thousands
)
        

Loans covered by loss share agreements

   $ 2,222,660       $ 2,367,090       $ 2,602,261       $ 1,173,020       $ 1,257,478   

Loans and leases not covered by loss share agreements:

              

Real estate:

              

Construction and land development

     546,070         627,899         644,031         622,3 54         621,176   

Commercial mortgage

     4,696,183         4,625,351         4,589,291         4,552,078         4,514,554   

Residential mortgage

     917,415         921,346         912,955         864,704         876,001   

Revolving mortgage

     2,209,149         2,187,978         2,159,581         2,147,223         2,114,018   

Other mortgage

     155,509         157,333         161,770         158,187         101,802   
                                            

Total real estate loans

     8,524,326         8,519,907         8,467,628         8,344 ,546         8,227,551   

Commercial and industrial

     1,774,340         1,801,465         1,793,195         1,832 ,670         1,822,526   

Consumer

     766,586         815,008         864,238         941,986         998,007   

Lease financing

     294,825         300,047         316,912         330,713         335,515   

Other

     185,232         186,067         198,068         195,084         137,084   
                                            

Total loans and leases not covered by loss share agreements

     11,545,309         11,622,494         11,640,041         11,644,999         11,520,683   
              

Total loans and leases

     13,767,969         13,989,584         14,242,302         12,818,019         12,778,161   

Less allowance for loan and lease losses

     218,046         188,169         176,273         172,282         165,282   
                                            

Net loans and leases

   $ 13,549,923       $ 13,801,415       $ 14,066,029       $ 12,645,737       $ 12,612,879   
                                            

 

    September 30, 2010     December 31, 2009     September 30, 2009  
    Impaired at
acquisition
date
    All other
acquired
loans
    Total     Impaired  at
acquisition
date
    All other
acquired
loans
    Total     Impaired  at
acquisition
date
    All other
acquired
loans
    Total  

Loans covered by loss share agreements:

                 

Real estate:

                 

Construction and land development

  $ 173,964      $ 397,027      $ 570,991      $ 22,700      $ 283,342      $ 306,042      $ 34,793     $ 392,642      $ 427,435   

Commercial mortgage

    132,049        999,134        1,131,183        36,820        553,579        590,399        40,490        605,087        645,577   

Residential mortgage

    36,933        45,836        82,769        8,828        143,481        152,309        3,387        57,193        60,580   

Revolving mortgage

    114        23,025        23,139        —          —          —          451        8,264        8,715   

Other mortgage

    43,023        177,001        220,024        331        21,307        21,638        344        3,325        3,669   
                                                                       

Total real estate loans

    386,083        1,642,023        2,028,106        68,679        1,001,709        1,070,388        79,465        1,066,511        1,145,976   

Commercial and industrial

    14,400        168,505        182,905        5,958        89,273        95,231        3,361        97,550        100,911   

Consumer

    116        6,852        6,968        255        4,259        4,514        287        6,793        7,080   

Other

    147        4,534        4,681        476        2,411        2,887        329        3,182        3,511   
                                                                       

Total loans covered by loss share agreements

  $ 400,746      $ 1,821,914      $ 2,222,660      $ 75,368      $ 1,097,652      $ 1,173,020      $ 83,442      $ 1,174,036      $ 1,257,478   
                                                                       

Construction and land development loans not covered by loss share agreements totaled $546.1 million or 4.7 percent of total loans at September 30, 2010, a decrease of $76.3 million or 12.3 percent since December 31, 2009 and a decrease of $75.1 million or 12.1 percent since September 30, 2009. Of the $546.1 million of noncovered construction loans outstanding as of September 30, 2010, $43.7 million was in the Atlanta, Georgia and southwest Florida markets. Both of these market areas experienced significant reductions in real estate values during the continuing recession. The majority of the remaining $502.3 million of noncovered construction and land development loans are in North Carolina and Virginia where real estate values have declined more modestly.

 

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Consumer loans not covered by loss share agreements totaled $766.6 million at September 30, 2010, down $175.4 million or 18.6 percent since December 31, 2009 and $231.4 million or 23.2 percent from September 30, 2009. This decline results from our decision during 2008 to discontinue originations of sales finance loans through our dealer network and the general decline in consumer borrowing in 2009 and 2010 due to recessionary economic conditions.

Among loans covered by loss share agreements, commercial real estate loans totaled $1.13 billion at September 30, 2010, representing 50.9 percent of the total covered portfolio compared to $590.4 million or 50.3 percent of total covered loans as of December 31, 2009. Construction and land development loans totaled $571.0 million, or 25.7 percent of total covered loans at September 30, 2010, an increase of $265.0 million from the December 31, 2009 total of $306.0 million, which represented 26.1 percent of the total covered loans. Commercial and industrial loans totaled $182.9 million or 8.2 percent of total covered loans at September 30, 2010, an increase of $87.7 million from the December 31, 2009 total of $95.2 million, which represented 8.1 percent of total covered loans. Residential mortgage loans covered by the FDIC totaled $82.8 million or 3.7 percent of the covered portfolio as of September 30, 2010 compared to $152.3 million or 13.0 percent of total covered loans at December 31, 2009.

We expect non-acquisition loan growth for the next several quarters to be extremely limited due to the generally weak demand for loans and widespread customer desire to deleverage. Loan projections are subject to change due to further economic deterioration or improvement and other external factors.

Investment securities. Investment securities available for sale equaled $3.79 billion at September 30, 2010, compared to $2.93 billion at December 31, 2009 and $3.28 billion at September 30, 2009. Available for sale securities are reported at their aggregate fair value, and unrealized gains and losses are included as a component of other comprehensive income, net of deferred taxes.

Income on interest-earning assets. Interest income amounted to $278.6 million during the third quarter of 2010, an $88.9 million or 46.9 percent increase from the third quarter of 2009. During the third quarter of 2010, the improvement in interest income was the result of higher average balances, accretion of discounts on acquired loans with large unscheduled payments since acquisition and the recognition of accretable yield. Average interest-earning assets increased $2.74 billion or 17.3 percent from $15.86 billion to $18.61 billion. The taxable-equivalent yield on interest-earning assets equaled 5.97 percent for the third quarter of 2010, compared to 4.66 percent for the corresponding period of 2009 as reflected in Table 7.

For the first nine months of 2010, interest income equaled $696.8 million, a $150.6 million or 27.6 percent increase from the first nine months of 2009 also caused by higher average balances and discount accretion. Average interest-earning assets for the first nine months of 2010 increased $2.59 billion or 16.5 percent from $15.69 billion to $18.27 billion. The taxable-equivalent yield on interest-earning assets equaled 5.12 percent for the first nine months of 2010 compared to 4.69 percent for the corresponding period of 2009 as reflected in Table 8.

Loan and lease interest income for the third quarter of 2010 equaled $264.8 million, an increase of $94.1 million from the third quarter of 2009, the combined result of higher average volume and discount accretion. Average loans and leases increased $1.84 billion or 15.2 percent from the third quarter of 2009 to the third quarter of 2010. The taxable-equivalent yield was 7.57 percent during the third quarter of 2010, a 210 basis point increase from the same period of 2009. The increased yield resulted primarily from $74.9 million of discount accreted into income during the third quarter related to large unscheduled loan payments.

Loan and lease interest income for the first nine months of 2010 equaled $654.4 million, an increase of $171.7 million from the first nine months of 2009 due to improved average balances and discount accretion. Average loans and leases increased $2.15 billion or 18.3 percent from the first nine months of 2009 to the first nine months of 2010. The taxable-equivalent yield was 6.29 percent during the first nine months of 2010, an 82 basis point increase from the same period of 2009.

 

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Investment Securities   Table 6

 

     September 30, 2010     December 31, 2009  
     Cost      Fair
Value
     Average
Maturity  (1)

(Yrs./Mos.)
     Taxable
Equivalent
Yield
    Cost      Fair
Value
     Average
Maturity (1)
(Yrs./Mos.)
     Taxable
Equivalent
Yield
 
                          (thousands)                       

Investment securities available for sale:

                      

U.S. Government:

                      

Within one year

   $ 2,484,247       $ 2,490,981         0/5         1.23   $ 1,543,760       $ 1,554,353         0/6         1.91

One to five years

     627,905         630,270         1/4         0.63        730,324         733,070         1/3         1.12   

Total

     3,112,152         3,121,251         0/7         1.11        2,274,084         2,287,423         1/9         1.65   

Residential mortgage-backed securities

                      

Within one year

     3         1         0/6         5.91        —           —           —           —     

One to five years

     11,220         11,547         3/2         1.23        13,430         13,729         2/4         1.24   

Five to ten years

     1,815         1,841         8/2         3.63        917         914         8/3         4.96   

Over ten years

     138,317         142,747         27/1         4.82        112,254         115,695         26/4         5.38   
                                                                      

Total

     151,355         156,136         25/1         4.54        126,601         130,338         23/10         4.40   

State, county and municipal:

                      

Within one year

     339         343         0/7         5.01        303         304         0/2         4.86   

One to five years

     892         915         1/10         4.66        1,107         1,138         2/4         4.64   

Over ten years

     10         10         10/2         4.97        5,643         5,371         15/7         5.18   
                                                                      

Total

     1,241         1,268         1/7         4.76        7,053         6,813         13/10         5.08   

Corporate bonds (2)

                      

Within one year

     75,195         75,751         0/8         1.26        —           —           —           —     

One to five years

     404,740         413,438         1/7         1.92        481,341         485,667         2/2         1.83   
                                                                      

Total

     479,935         489,189         1/5         1.82        481,341         485,667         2/2         1.83   

Other

                      

Five to ten years

     —           —           —           —          1,026         1,287         8/5         11.03   

Over ten years

     —           —           —           —          911         1,012         21/0         14.49   
                                                          

Total

     —           —           —           —          1,937         2,299         13/11         12.55   

Equity securities

     1,132         18,997              2,377         16,622         
                                              

Total investment securities available for sale

     3,745,815         3,786,841              2,893,393         2,929,162         
                                              

Investment securities held to maturity:

                      

Residential mortgage-backed securities

                      

Five to ten years

     2,512         2,689         6/6         5.55     3,306         3,497         7/3         5.54

Over ten years

     133         175         17/5         6.50        146         185         18/3         6.48   
                                                                      

Total

     2,645         2,864         7/1         5.60        3,452         3,682         7/9         5.58   

State, county and municipal:

                      

One to five years

     —           —                151         152         3/10         5.50   
                                                                      

Total

     —           —           0         0.00        151         152         8/6         6.01   

Total investment securities held to maturity

     2,645         2,864         7/1         5.60        3,603         3,834         8/8         5.69   
                                                                      

Total investment securities

   $ 3,748,460       $ 3,789,705            $ 2,896,996       $ 2,932,996         
                                              

 

(1) Average maturity assumes callable securities mature on their earliest call date; yields are based on amortized cost; yields related to securities that are exempt from federal and/or state income taxes are stated on a taxable-equivalent basis assuming statutory rates of 35.0 percent for federal income tax purposes and 6.9 percent for state income taxes for all periods.
(2) Debt securities issued pursuant to the Transitional Liquidity Guarantee Program.

 

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Interest income earned on the investment securities portfolio amounted to $13.2 million during the third quarter of 2010 and $18.9 million during the same period of 2009, a decrease of $5.6 million or 29.9 percent. This decrease in income is the result of substantially lower yields. The taxable-equivalent yield decreased 74 basis points from 2.17 percent in the third quarter of 2009 to 1.43 percent in the third quarter of 2010. This reduction in yields was caused by extraordinarily low market interest rates. We anticipate the yield on investment securities will remain depressed until the Federal Reserve begins to raise the benchmark fed funds rates, an action that would likely lead to higher asset yields.

Interest income earned on the investment securities portfolio during the first nine months of 2010 amounted to $40.7 million, compared to $62.9 million during the same period of 2009, a decrease of $22.2 million or 35.3 percent. The taxable-equivalent yield decreased 95 basis points from 2.56 percent in the first nine months of 2009 to 1.61 percent during the same period of 2010.

INTEREST-BEARING LIABILITIES

Interest-bearing liabilities include interest-bearing deposits as well as short-term borrowings and long-term obligations. Deposits represent our primary funding source, although we also utilize non-deposit borrowings to stabilize our liquidity base and to fulfill commercial customer demand for treasury services. Certain of our long-term borrowings currently qualify as capital under guidelines established by the Federal Reserve and other banking regulators. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions that cause $265 million of trust preferred capital securities to fully cease qualification as Tier I capital effective January 1, 2015.

Deposits. At September 30, 2010, total deposits equaled $17.74 billion, an increase of $2.41 billion or 15.7 percent since December 31, 2009 and $2.39 billion or 15.6 percent over September 30, 2009 due to the assumption of deposit liabilities resulting from the FDIC-assisted transactions and healthy organic growth.

Due to our historic focus on maintaining a liquid balance sheet, we continue to focus on deposit retention as a key business objective. We endeavor to retain a significant portion of core demand and money market account balances and reasonably priced time deposits assumed in the FDIC-assisted transactions. Upon the onset of economic recovery, our ability to satisfy customer loan demand could be constrained unless we are able to continue to generate new deposits at a reasonable cost.

Long-term obligations. Long-term obligations equaled $906.1 million at September 30, 2010, up $108.8 million from December 31, 2009 and $26.4 million from September 30, 2009. The increase since December 31, 2009 resulted from the assumption of Federal Home Loan Bank (FHLB) obligations in the FDIC-assisted transactions.

Expense on interest-bearing liabilities. Interest expense amounted to $48.7 million during the third quarter of 2010, a $5.7 million or 10.5 percent decrease from the third quarter of 2009. The reduced level of interest expense was the net result of lower rates, partially offset by higher average volume. The rate on average interest-bearing liabilities equaled 1.25 percent during the third quarter of 2010, a 39 basis point decrease from the third quarter of 2009. Average interest-bearing liabilities increased $2.30 billion or 17.5 percent from third quarter of 2009 to the third quarter of 2010 due to the four FDIC-assisted transactions since July 2009 and strong organic growth in legacy markets.

Average interest-bearing deposits were $13.96 billion during the third quarter of 2010, an increase of $2.25 billion or 19.2 percent from the third quarter of 2009. Average money market accounts increased $931.8 million or 23.7 percent from the third quarter of 2009, due to the FDIC-assisted transactions and customers holding available liquidity in flexible deposit accounts. During the third quarter of 2010, time deposits averaged $6.58 billion, up $949.0 million or 16.9 percent from the third quarter of 2009 resulting from the FDIC-assisted transactions.

 

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For the quarters ended September 30, 2010 and September 30, 2009, short-term borrowings averaged $559.4 million and $616.9 million, respectively. The $57.5 million or 9.3 percent reduction in average short-term borrowings since the third quarter of 2009 resulted from reductions in overnight investments by treasury management customers caused by extraordinarily low market interest rates.

During the first nine months of 2010, interest expense equaled $150.9 million, compared to $178.1 million during the first nine months of 2009, a 15.2 percent decrease. The rate on average interest-bearing liabilities equaled 1.33 percent during the first nine months of 2010, a 52 basis point decrease from the first nine months of 2009. Average interest-bearing liabilities increased $2.35 billion or 18.3 percent from the first nine months of 2009 to the first nine months of 2010.

NET INTEREST INCOME

Net interest income totaled $229.9 million during the third quarter of 2010, an increase of $94.7 million or 70.0 percent from the third quarter of 2009. The taxable-equivalent net yield on interest-earning assets equaled 4.93 percent for the third quarter of 2010, up 152 basis points from the 3.41 percent recorded for the third quarter of 2009. During the first nine months of 2010, net interest income totaled $545.8 million, an increase of $177.7 million or 48.3 percent from the first nine months of 2010. The taxable-equivalent net yield on interest-earning assets equaled 4.02 percent for the first nine months of 2010, up 85 basis points from the 3.17 percent recorded for the first nine months of 2009. The increase in the net yield on interest-earning assets in each of the respective 2010 periods was due to favorable changes in deposit costs and the positive impact of yields and rates on acquired loans and assumed deposits and accretion of discounts on acquired loans.

Net interest income for the third quarter and first nine months of 2010 included $74.9 million of accretion income related to unscheduled payments received on acquired loans. No such accretion was recognized during 2009. Without the benefit of the accretion of this discount into loan interest income, the year-to-date taxable-equivalent loan yield would have declined 71 basis points from 6.29 percent to 5.58 percent, compared to 5.47 percent during 2009; the taxable-equivalent yield on interest-earning assets would have declined 54 basis points from 5.12 percent to 4.58 percent, compared to 4.69 percent during 2009; and the taxable-equivalent net yield on interest earning assets would have declined 55 basis points from 4.02 percent to 3.47 percent, compared to 3.17 percent during 2009.

Without the benefit of the accretion for unscheduled loan payments, the third quarter taxable-equivalent loan yield would have declined 214 basis points from 7.57 percent to 5.43 percent, compared to 5.47 percent during the third quarter of 2009; the taxable-equivalent yield on interest-earning assets would have declined 160 basis points from 5.97 percent to 4.37 percent, compared to 4.66 percent during 2009, and the taxable-equivalent net yield on interest-earning assets would have declined 160 basis points from 4.93 percent to 3.33 percent. Therefore, based on changes to balance sheet composition but prior to the recognition of the accreted discount related to unscheduled loan payments for acquired loans, the taxable-equivalent net yield on interest-earning assets fell to 3.33 percent during the third quarter of 2010 compared to 3.54 percent in the second quarter of 2010 and 3.41 percent during the third quarter of 2009.

The continuing accretion of fair value discounts resulting from acquired loans will likely continue to influence net interest income in future periods. Unless additional concerns about future payments exist, discounts associated with loans that display large unscheduled payments will be recognized in interest income on an accelerated basis. Discounts related to loans that have been repaid will be accreted into interest income at the time the loan obligation is satisfied.

 

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Consolidated Taxable Equivalent Rate/Volume Variance Analysis - Third Quarter    Table 7

 

     2010     2009     Increase (decrease) due to:  
     Average
Balance
     Interest
Income/
Expense
     Yield/
Rate
    Average
Balance
     Interest
Income/
Expense
     Yield/
Rate
    Volume     Yield/
Rate
    Total
Change
 
     (thousands)  

Assets

  

Loans and leases

   $ 13,917,278       $ 265,489         7.57   $ 12,078,390       $ 171,231         5.47   $ 27,839      $ 66,419      $ 94,258   

Investment securities:

                      

U.S. Government

     3,134,719         9,796         1.25        2,968,553         15,667         2.11        716        (6,587     (5,871

Residential mortgage-backed securities

     166,654         1,544         3.68        104,587         1,329         5.04        681        (466     215   

Corporate bonds

     488,693         2,196         1.80        481,121         2,205         1.83        31        (40     (9

State, county and municipal

     1,413         23         6.46        2,811         49         6.92        (24     (2     (26

Other

     18,578         77         1.64        39,350         242         2.44        (107     (58     (165
                                                                            

Total investment securities

     3,810,057         13,636         1.43        3,596,422         19,492         2.17        1,297        (7,153     (5,856

Overnight investments

     877,795         572         0.26        188,152         116         0.24        432        24        456   
                                                                            

Total interest-earning assets

   $ 18,605,130       $ 279,697         5.97   $ 15,862,964       $ 190,839         4.66   $ 29,568      $ 59,290      $ 88,858   
                                                                            

Liabilities

                      

Interest-bearing deposits:

                      

Checking With Interest

   $ 1,772,328       $ 469         0.10   $ 1,540,271       $ 395         0.10   $ 66      $ 8      $ 74   

Savings

     744,049         309         0.16        608,019         170         0.11        50        89        139   

Money market accounts

     4,866,864         6,427         0.52        3,935,047         5,896         0.59        1,306        (775     531   

Time deposits

     6,576,090         29,882         1.80        5,627,096         37,113         2.62        5,333        (12,564     (7,231
                                                                            

Total interest-bearing deposits

     13,959,331         37,087         1.05        11,710,433         43,574         0.15        6,755        (13,242     (6,487

Short-term borrowings

     559,384         742         0.53        616,930         980         0.63        (87     (151     (238

Long-term obligations

     914,938         10,859         4.75        810,049         9,859         4.87        1,266        (266     1,000   
                                                                            

Total interest-bearing liabilities

   $ 15,433,653       $ 48,688         1.25   $ 13,137,412       $ 54,413         1.64   $ 7,934      $ (13,659   $ (5,725
                                                                            

Interest rate spread

           4.72           3.02      
                                  

Net interest income and net yield on interest-earning assets

      $ 231,008         4.93      $ 136,426         3.41   $ 21,634      $ 72,949      $ 94,583   
                                                                

Loans and leases include loans covered by loss share agreements, loans not covered by loss share agreements, nonaccrual loans and loans held for sale. Yields related to loans, leases and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only are stated on a taxable-equivalent basis assuming statutory federal income tax rates of 35.0 percent and state income tax rates of 6.9 percent for each period. The taxable-equivalent adjustment was $1,067 and $1,149 for 2010 and 2009, respectively. The rate/volume variance is allocated equally between the changes in volume and rate.

 

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Consolidated Taxable Equivalent Rate/Volume Variance Analysis - Nine Months   Table 8

 

     2010     2009     Increase (decrease) due to:  
      Average
Balance
     Interest
Income/
Expense
     Yield/
Rate
    Average
Balance
     Interest
Income/
Expense
     Yield/
Rate
    Volume     Yield/
Rate
    Total
Change
 
     (thousands)  

Assets

                      

Loans and leases

   $ 13,941,556       $ 656,377         6.29   $ 11,788,104       $ 484,376         5.47   $ 93,903      $ 78,098      $ 172,001   

Investment securities:

                      

U.S. Government

     2,860,745         30,208         1.44        3,054,634         56,484         2.47        (3,150     (23,126     (26,276

Residential mortgage-backed securities

     165,701         4,981         4.02        98,558         3,711         5.03        2,270        (1,000     1,270   

Corporate bonds

     487,660         6,529         1.79        293,333         4,063         2.77        3,297        (831     2,466   

State, county and municipal

     2,144         99         6.17        3,367         290         11.52        (81     (110     (191

Other

     20,702         159         1.03        56,295         613         1.46        (331     (123     (454
                                                                            

Total investment securities

     3,536,952         41,976         1.61        3,506,187         65,161         2.56        2,005        (25,190     (23,185

Overnight investments

     793,884         1,591         0.27        392,323         533         0.18        667        391        1,058   
                                                                            

Total interest-earning assets

   $ 18,272,392       $ 699,944         5.12   $ 15,686,614       $ 550,070         4.69   $ 96,575      $ 53,299      $ 149,874   
                                                                            

Liabilities

                      

Interest-bearing deposits:

                      

Checking With Interest

   $ 1,721,525       $ 1,459         0.11   $ 1,509,855       $ 1,174         0.10   $ 165      $ 120      $ 285   

Savings

     711,113         955         0.18        576,058         485         0.11        140        330        470   

Money market accounts

     4,752,379         21,084         0.59        3,800,914         20,860         0.73        4,700        (4,476     224   

Time deposits

     6,541,980         92,796         1.90        5,579,164         122,891         2.94        17,238        (47,333     (30,095
                                                                            

Total interest-bearing deposits

     13,726,997         116,294         1.13        11,465,991         145,410         1.69        22,243        (51,359     (29,116

Short-term borrowings

     579,864         2,138         0.49        634,808         3,582         0.75        (259     (1,185     (1,444

Long-term obligations

     905,187         32,493         4.80        759,341         29,077         5.12        7,942        (4,526     3,416   
                                                                            

Total interest-bearing liabilities

   $ 15,212,048       $ 150,925         1.33   $ 12,860,140       $ 178,069         1.85   $ 29,926      $ (57,070   $ (27,144
                                                                            

Interest rate spread

           3.79           2.84      
                                  

Net interest income and net yield on interest-earning assets

      $ 549,019         4.02      $ 372,001         3.17   $ 66,649      $ 110,369      $ 177,018   
                                                                

Loans and leases include loans covered by loss share agreements, loans not covered by loss share agreements, nonaccrual loans and loans held for sale. Yields related to loans, leases and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only are stated on a taxable-equivalent basis assuming statutory federal income tax rates of 35.0 percent and state income tax rates of 6.9 percent for each period. The taxable-equivalent adjustment was $3,181 and $3,887 for 2010 and 2009, respectively. The rate/volume variance is allocated equally between the changes in volume and rate.

NONINTEREST INCOME

Growth of noninterest income is essential to our ability to sustain adequate profitability levels. Traditionally, the primary sources of noninterest income are cardholder and merchant services income, service charges on deposit accounts, revenues derived from wealth management services and fees from processing services. During 2010 and 2009, these traditional sources of noninterest income have been augmented with acquisition gains resulting from FDIC-assisted transactions.

 

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During the first nine months of 2010, noninterest income amounted to $354.5 million, compared to $322.0 million during the same period of 2009. The majority of the $32.6 million increase during 2010 is due to $31.6 million in higher acquisition gains recognized in conjunction with FDIC-assisted transactions. Net charges of $13.1 million were recorded during 2010 resulting from adjustments to the FDIC receivable. Large unscheduled payments that are indicative of post-acquisition improvement in covered assets trigger reductions in the FDIC receivable, which are recorded with a debit to noninterest income. Post-acquisition deterioration in covered assets triggers increases in the FDIC receivable, which are recorded with a credit to noninterest income. During 2010, the adjustments to the FDIC receivable resulting from improvements in covered assets exceeded the adjustments to the FDIC receivable resulting from deterioration of covered assets, resulting in a net debit recorded in noninterest income.

During the first nine months of 2010, noninterest income amounted to $354.5 million, compared to $322.0 million during the same period of 2009. The majority of the $32.6 million increase during 2010 is due to $31.6 million in higher acquisition gains recognized in conjunction with FDIC-assisted transactions. $13.1 million of charges were recorded during 2010 resulting from adjustments to the FDIC receivable.

Cardholder and merchant services generated $28.0 million of revenue during the third quarter of 2010, an increase of $2.7 million or 10.6 percent compared to the third quarter of 2009. During the first nine months of 2010, cardholder and merchant services generated $80.3 million of revenue, compared to $70.9 million during the same period of 2009. This $9.4 million or 13.2 percent increase resulted from growth in merchant discount and interchange income from credit cards and Visa check cards. Transaction volume continued to grow both within our legacy franchise and as a result of acquisitions. Income derived from Visa check cards is likely to result in lower fees upon the issuance of regulations arising from the provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act. The impact upon our fee income is uncertain and is dependent upon the regulations.

Service charges on deposit accounts equaled $18.1 million and $20.3 million for the third quarter of 2010 and 2009, respectively. The $2.3 million or 11.2 percent decrease was caused in part by lower levels of bad check charges. During the first nine months of 2010, service charges on deposit accounts decreased $947,000 or 1.7 percent to $56.4 million, largely as a result of the third quarter implementation of the revised Regulation E and lower commercial service charges from reduced business activity by commercial customers.

Fees from wealth management services amounted to $12.8 million during the third quarter of 2010 and $38.8 million year-to-date compared to $12.1 million and $34.3 million, respectively during the same period of 2009. The improved fee income during both periods was due to higher trust, brokerage and asset management revenues.

Noninterest income recognized during the third quarter of 2010 from securities transactions, net of writedowns of securities that are other than temporarily impaired (OTTI), increased $1.1 million over the third quarter of 2009. For the nine-month period ended September 30, 2010, net securities transactions generated $1.9 million in noninterest income, an increase of $2.2 million over 2009.

NONINTEREST EXPENSE

The primary components of noninterest expense are salaries and related employee benefits, occupancy costs for branch offices and support facilities, and equipment and software costs related to branch offices and technology. Noninterest expense amounted to $176.9 million in the third quarter of 2010, up $12.4 million or 7.5 percent from the third quarter of 2009. $8.5 million of the increase is attributable to the FDIC-assisted acquisitions including branch offices, support staff within the acquired markets and various foreclosure-related costs. Noninterest expense equaled $531.6 million for the first nine months of 2010, a $53.5 million or 11.2 percent increase over the $478.1 million recorded during the same period of 2009. Expenses arising from the acquisitions equaled $55.4 million, up $48.9 million from 2009.

Salaries and wages increased $8.6 million or 13.0 percent during the third quarter of 2010 and $25.9 million or 13.3 percent during the first nine months of 2010 when compared to the same period of 2009. The increase principally resulted from headcount growth resulting from the FDIC-assisted transactions. Employee benefits expense totaled $14.5 million for the third quarter of 2010 and $48.6 million for the first nine months of 2010. Although the year-to-date 2010 level of employee benefits was unchanged, costs declined $935,000 or 6.1 percent due to favorable health claims experience.

 

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Occupancy expense totaled $18.4 million in the third quarter of 2010, up $1.1 million or 6.2 percent from 2009. Year-to-date occupancy expense increased $6.0 million or 12.4 percent. Acquisitions accounted for $5.4 million of the year-to-date increase. Higher rent expense and depreciation on bank buildings were the primary causes of the larger expense.

Equipment expense increased $5.2 million or 11.7 percent year-to-date for 2010 caused primarily by higher hardware and software costs.

FDIC deposit insurance increased $345,000 in the third quarter of 2010 but declined $6.1 million year-to-date when compared to the same periods of 2009. Costs related to a special FDIC deposit insurance assessment in the amount of $7.8 million were incurred in the third quarter of 2009.

Foreclosure-related expenses, which include costs to maintain and dispose of foreclosed properties as well as any gains or losses recognized, decreased $5.1 million during the third quarter of 2010 and $487,000 year-to-date when compared to the same periods of 2009. The majority of the third quarter reduction was due to gains recognized on sales of foreclosures arising from the FDIC-assisted transactions. For the nine-month period, expenses in ISB declined by $1.9 million as foreclosure activity in Georgia and Florida slowed. This reduction was largely offset by higher expenses related to the FDIC-assisted transactions, the majority of which are reimbursable under the FDIC loss share agreements.

Other expenses increased $22.7 million or 20.6 percent year-to-date when compared to the same periods of 2009. Collection expenses for loans arising from the FDIC-assisted transactions, the majority of which are reimbursable under the FDIC loss share agreements, increased $2.7 million and $11.7 million from the comparable nine month and three month periods of 2009. Amortization expense from purchase accounting adjustments and core deposit intangibles arising from the FDIC-assisted transactions increased $3.4 million year-to-date. Costs related to our customer loyalty programs increased $2.8 million year-to-date, primarily due to higher costs related to a new debit card program, partially offset by a nonrecurring adjustment to the assumed redemption rate related to a mature credit card program. Cardholder and merchant processing costs increased $2.6 million due to higher transaction volumes, while other third party processing expense grew $2.8 million year-to-date, much of which relates the FDIC-assisted transactions. Other expenses for the third quarter of 2010 reflected similar trends when compared to the third quarter of 2009.

INCOME TAXES

We monitor and evaluate the potential impact of current events on the estimates used to establish income tax expenses and income tax liabilities. On a periodic basis, we evaluate our income tax positions based on current tax law, positions taken by various tax auditors within the jurisdictions that BancShares is required to file income tax returns as well as potential or pending audits or assessments by such tax auditors.

Income tax expense amounted to $97.2 million during the nine months ended September 30, 2010, compared to $56.9 million during the same period of 2009. The $40.3 million increase in income tax expense was the direct result of significantly higher pre-tax earnings. The effective tax rates for these periods equaled 37.4 percent and 36.9 percent, respectively. The slightly higher effective tax rate for 2010 reflects the diluted impact of various favorable permanent differences on the current year’s pre-tax income.

SHAREHOLDERS’ EQUITY AND CAPITAL ADEQUACY

We continually monitor the capital levels and ratios for BancShares and the subsidiary banks to ensure that they comfortably exceed the minimum requirements imposed by their respective regulatory authorities and to ensure that the subsidiary banks’ capital is appropriate given each bank’s growth projection and risk profile. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material effect on the financial statements. Table 9 provides information on capital adequacy for BancShares as of September 30, 2010, December 31, 2009 and September 30, 2009.

BancShares continues to exceed minimum capital standards and the banking subsidiaries remain well-capitalized. Due to the adequacy of our capital levels, we did not apply for TARP funding under the TARP Capital Purchase Program.

 

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The sustained growth and operating losses of ISB has required BancShares to infuse significant amounts of capital into ISB to support its expanding balance sheet. Since ISB was formed in 1997, BancShares has provided $404.2 million in capital. BancShares’ capacity to provide capital to support ISB has been highly dependent upon FCB’s ability to return capital through dividends to BancShares. Dividends from FCB to BancShares provide the sole source for capital infusions into ISB. These dividends also fund BancShares’ payment of shareholder dividends and interest payments on a portion of its long-term obligations.

As previously discussed, FCB has filed applications with regulatory authorities for approval to merge with ISB. Under the terms of the merger, FCB will be the surviving entity, although branches of ISB will continue to operate under the name ‘IronStone Bank’, which will become a division of FCB. Pending regulatory approval and consummation of the proposed merger, the requirement for dividends by FCB to facilitate capital infusions by BancShares into ISB will cease and the former branches of ISB will have the ability to increase commercial lending activities.

The Tier 2 capital of BancShares and FCB includes qualifying subordinated debt that was issued in 2005 with a scheduled maturity date of September 1, 2015. Beginning in the third quarter of 2010, the amount of this qualifying subordinated debt that is eligible Tier 2 capital decreased $25.0 million to $100.0 million since the scheduled maturity date is within 5 years. The amount eligible for Tier 2 capital will decrease by 20 percent of the issued amount each year until the scheduled maturity date. Tier 2 capital is part of total risk-based capital, reflected in Table 9.

The Dodd-Frank Wall Street Reform and Consumer Protection Act contain provisions that will eliminate our ability to include $265 million of trust preferred capital securities in Tier I risk-based capital effective January 1, 2015. BancShares’ trust preferred capital securities that currently qualify as Tier 1 capital will be phased out in equal increments of $88.3 million over a three year term, beginning in 2013. Based on BancShares’ capital structure as of September 30, 2010, the impact of the reduction of $88.3 million would result in a Tier 1 leverage capital ratio of 8.20 percent, a Tier 1 risk-based capital ratio of 13.05 percent, and a Total risk-based capital ratio 15.12 percent. Elimination of the full $265 million of trust preferred capital securities from the September 30, 2010 capital structure would result in a proforma Tier 1 leverage capital ratio of 7.78 percent, a Tier 1 risk-based capital ratio of 12.38 percent, and a Total risk-based capital ratio of 14.45 percent. Although these are significant decreases, BancShares would continue to remain well-capitalized under current regulatory guidelines. FCB and ISB will also remain well-capitalized on a proforma basis.

 

Capital Adequacy   Table 9

 

     Actual     Minimum requirement     Well-capitalized requirement  
     Amount      Ratio     Amount      Ratio     Amount      Ratio  
     (dollars in thousands)  

September 30, 2010

               

Tier 1 risk-based capital

   $ 1,906,806         14.38   $ 530,344         4.00   $ 795,516         6.00

Total risk-based capital

     2,180,810         16.45     1,060,688         8.00     1,325,860         10.00

Tier 1 leverage capital

     1,906,806         9.04     635,343         3.00     1,058,906         5.00

December 31, 2009

               

Tier 1 risk-based capital

     1,752,384         13.34     498,517         4.00     623,146         6.00

Total risk-based capital

     2,047,684         15.59     997,034         8.00     1,246,292         10.00

Tier 1 leverage capital

     1,752,384         9.54     505,517         3.00     1,011,033         5.00

September 30, 2009

               

Tier 1 risk-based capital

     1,734,984         13.33     520,781         4.00     650,976         6.00

Total risk-based capital

     2,028,621         15.58     1,041,562         8.00     1,301,952         10.00

Tier 1 leverage capital

     1,734,984         9.73     534,835         3.00     1,069,671         5.00

 

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RISK MANAGEMENT

In the normal course of business, BancShares is exposed to various risks. To manage the major risks that are inherent in the operation of a financial holding company and to provide reasonable assurance that our long-term business objectives will be attained, various policies and risk management processes identify, monitor and manage risk within acceptable tolerances. Management continually refines and enhances its risk management policies and procedures to maintain effective risk management programs and processes.

The most prominent risk exposures are credit, interest rate and liquidity risk. Credit risk is the risk of not collecting the amount of a loan or investment when it is contractually due. Interest rate risk is the potential reduction of net interest income as a result of changes in market interest rates. Liquidity risk is the possible inability to fund obligations to depositors, creditors, investors or borrowers.

Credit risk. BancShares manages and monitors extensions of credit and the quality of the loan and lease portfolio through rigorous initial underwriting processes and periodic ongoing reviews. With respect to loans that we originate, underwriting standards reflect credit policies applied by our centralized credit decision process. Acquired loans are evaluated at the time of acquisition and are recorded at fair value.

We maintain an independent credit review function that conducts risk reviews and analyses for the purpose of ensuring compliance with credit policies and to monitor asset quality trends. The risk reviews include portfolio analysis by geographic location and horizontal reviews across industry sectors within the banking subsidiaries. We strive to identify potential credit problems as early as possible, to take charge-offs or write-downs as appropriate and to maintain adequate allowances for loan and lease losses that are inherent in the loan and lease portfolio. The maintenance of excellent asset quality is one of our key performance measures.

We maintain a well-diversified loan and lease portfolio and seek to avoid the risk associated with large concentrations within specific geographic areas or industries. Despite our focus on diversification, several characteristics of our loan and lease portfolio subject us to notable risk. These include our concentration of real estate loans, medical-related loans, and the existence of high loan-to-value loans.

We have historically carried a significant concentration of real estate secured loans, although our underwriting policies principally rely on adequate borrower cash flow rather than underlying collateral values. When we do rely on underlying real property values, we favor financing secured by owner-occupied real property and as a result a large percentage of our real estate secured loans are owner-occupied. At September 30, 2010, loans secured by real estate not covered by loss share agreements totaled $8.52 billion or 73.8 percent of total noncovered loans and leases compared to $8.34 billion or 71.7 percent of noncovered loans and leases at December 31, 2009 and $8.23 billion or 71.4 percent at September 30, 2009.

In recent years, we have sought opportunities to provide financial services to businesses associated with and professionals within the medical community. Due to strong loan growth among customers within this industry, our noncovered loans and leases to borrowers in medical, dental or related fields totaled $3.01 billion as of September 30, 2010, which represents 25.9 percent of loans and leases not covered by loss share agreements, compared to $2.93 billion or 25.1 percent of noncovered loans and leases at December 31, 2009 and $2.87 billion or 24.9 percent of noncovered loans and leases at September 30, 2009. No other industry represented more than 10 percent of total noncovered loans and leases outstanding at September 30, 2010.

Nonperforming assets include nonaccrual loans and leases, other real estate owned (OREO) and restructured loans that are both covered and not covered by FDIC loss share agreements. At September 30, 2010, BancShares’ nonperforming assets amounted to $615.6 million or 4.42 percent of total loans and leases plus OREO, compared to $374.3 million or 2.89 percent at December 31, 2009 and $311.4 million or 2.41 percent at September 30, 2009. The $241.3 million and $304.2 million surge in nonperforming assets since December 31, 2009 and September 30, 2009, respectively was primarily due to the high levels of nonperforming assets resulting from the FDIC-assisted transactions during 2010. Of the $615.6 million in nonperforming assets at September 30, 2010, $429.9 million or 69.8 percent is covered by FDIC loss share agreements that provide significant loss protection to FCB. The nonperforming assets covered by loss share agreements represent 18.51 percent of total covered assets, compared to 17.4 percent at December 31, 2009, the slight increase resulting from the First Regional and SAB transactions and continuing asset resolution efforts related to assets acquired during the FDIC-assisted transactions during 2010 and 2009.

 

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Nonperforming assets not covered by loss share agreements amounted to $185.7 million as of September 30, 2010, or 1.60 percent of noncovered loans and leases plus OREO compared to $154.0 million or 1.32 percent at December 31, 2009 and $106.3 million or 0.92 percent at September 30, 2009. The $79.3 million increase in noncovered nonperforming assets since September 30, 2009 was due to restructured loans and weak economic conditions causing higher levels of defaults.

Restructured loans not covered by loss share agreements equaled $53.4 million at September 30, 2010, compared to $55.0 million at December 31, 2009 and $5.0 million at September 30, 2009, the result of modifications made to performing loans to support borrowers who were at risk of defaulting on their loan repayment obligations.

OREO not covered by loss share agreements totaled $47.5 million at September 30, 2010, compared to $40.6 million at December 31, 2009 and $44.7 million at September 30, 2009. A significant portion of the OREO not covered by loss share agreements relates to real estate exposures in the Atlanta, Georgia and southwest Florida markets arising from residential construction activities. Both markets have experienced significant over-development that has resulted in extremely weak sales of new residential units and significant declines in property values. Once acquired, OREO is periodically reviewed to ensure that the fair value of the property supports the carrying value, with write downs recorded when necessary.

At September 30, 2010, the allowance for loan and lease losses allocated to noncovered loans totaled $175.0 million or 1.51 percent of loans and leases not covered by loss share agreements, compared to $168.8 million or 1.45 percent at December 31, 2009 and $165.3 million or 1.43 percent at September 30, 2009. The $6.2 million and $9.7 million increase in the allowance for noncovered loan and lease losses since December 31, 2009 and September 30, 2009, respectively, was due to deterioration in credit quality within noncovered commercial loans, revolving mortgage loans, and residential construction loans. An additional allowance of $43.0 million relates to covered loans at September 30, 2010, established as a result of post-acquisition deterioration in credit quality for certain covered loans.

Management considers the allowance adequate to absorb estimated probable losses that relate to loans and leases outstanding at September 30, 2010, although future additions may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan and lease losses. Such agencies may require adjustments to the allowance based on information available to them at the time of their examination.

The provision for loan and lease losses recorded during the third quarter of 2010 equaled $59.9 million, compared to $31.8 million during the second quarter of 2010 and $18.3 million during the third quarter of 2009. The $41.6 million increase since the third quarter of 2009 resulted from post-acquisition deterioration of acquired loans covered by loss share agreements with the FDIC. Exclusive of losses related to covered loans, net charge-offs equaled $14.4 million during the third quarter of 2010, compared to $15.3 million during the third quarter of 2009. On an annualized basis, net charge-offs represented 0.49 percent of average noncovered loans and leases during the third quarter of 2010 compared to 0.53 percent during the third quarter of 2009. Net charge-offs on covered loans equaled $15.6 million in the third quarter of 2010. No covered loan charge-offs were recorded in the third quarter of 2009. The impact of the higher provision for loan and lease losses resulting from post- acquisition deterioration triggered adjustments to the FDIC receivable which are offset by noninterest income.

The provision for loan and lease losses during the first nine months of 2010 equaled $108.6 million, up $50.9 million or 88.1 percent from the comparable period of 2009. Approximately $63.5 million of the current year increase was caused by higher net charge-offs and post-acquisition deterioration of acquired loans covered by loss share agreements with the FDIC. Net charge-offs of noncovered loans totaled $40.6 million in 2010, down $9.4 million from 2009 as a result of reduced losses on residential construction loans. Annualized year-to-date net charge-offs of noncovered loans represented 0.47 percent of average noncovered loans and leases for 2010, compared to 0.57 percent for 2009. Net charge-offs on loans covered by loss share agreements equaled $22.9 million in the nine-month period ended September 30, 2010, while no covered loan charge-offs were recorded in the comparable period of 2009.

Table 10 provides details concerning the allowance for loan and lease losses during the past five quarters.

 

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Allowance for Loan and Lease Loss Experience and Risk Elements      Table 10   

 

    2010     2009     Nine Months Ended September 30  
    Third
Quarter
    Second
Quarter
    First
Quarter
    Fourth
Quarter
    Third
Quarter
    2010     2009  
    (thousands, except ratios)  

Allowance for loan and lease losses at beginning of period

  $ 188,169      $ 176,273      $ 172,282      $ 165,282      $ 162,282      $ 172,282      $ 157,569   

Adjustment resulting from adoption of change in accounting for QSPEs and controlling financial interests effective January 1, 2010

    —          —       

 

681

  

    —          —          681        —     
             

Provision for loan and lease losses

             

Covered by loss share agreements

    42,597        16,554        3,310        3,506        —          62,461        —     

Not covered by loss share agreements

    17,276        15,272        13,620        18,111        18,266        46,168        57,747   

Net charge-offs of loans and leases:

             

Charge-offs

    (31,172     (21,744     (14,858     (15,660     (16,671     (67,774     (53,694

Recoveries

    1,176        1,814        1,238        1,043        1,405        4,228        3,660   
                                                       

Net charge-offs of loans and leases

    (29,996     (19,930     (13,620     (14,617     (15,266     (63,546     (50,034
                                                       

Allowance for loan and lease losses at end of period

  $ 218,046      $ 188,169      $ 176,273      $ 172,282      $ 165,282      $ 218,046      $ 165,282   
                                                       

Allowance for loan and lease losses at end of period allocated to loans and leases:

             

Covered by loss share agreements

  $ 43,028      $ 16,006      $ 6,810      $ 3,500      $ —        $ 43,028      $ —     

Not covered by loss share agreements

    175,018        172,163        169,463        168,782        165,282        175,018        165,282   

Detail of net charge-offs of loans and leases:

             

Covered by loss share agreements

  $ 15,575      $ 7,358      $ —        $ —        $ —        $ 22,933      $ —     

Not covered by loss share agreements

    14,421        12,572        13,620        14,617        15,266        40,613        50,034   
                                                       

Total net charge-offs

  $ 29,996      $ 19,930      $ 13,620      $ 14,617      $ 15,266      $ 63,546      $ 50,034   
                                                       

Reserve for unfunded commitments

  $ 7,623      $ 7,414      $ 7,180      $ 7,130      $ 7,282      $ 7,414      $ 7,282   

Average loans and leases:

             

Covered by loss share agreements

    2,257,888        2,502,756        2,051,145        1,212,978        653,126        2,278,198        —     

Not covered by loss share agreements

    11,659,390        11,700,053        11,737,654        11,664,172        11,436,706        11,675,699        11,791,960   

Loans and leases at period-end:

             

Covered by loss sharing agreements

    2,222,660        2,367,090        2,602,261        1,173,020        1,257,478        2,222,660        1,257,478   

Not covered by loss sharing agreements

    11,545,309        11,622,494        11,640,041        11,644,999        11,520,683        11,545,309        11,520,683   

Risk Elements

             

Nonaccrual loans and leases

             

Covered by loss share agreements

  $ 264,653      $ 218,007      $ 123,602      $ 116,446      $ 102,473      $ 264,653      $ 102,473   

Not covered by loss share agreements

    84,753        73,179        61,904        58,417        56,628        84,753        56,628   

Other real estate

             

Covered by loss share agreements

    99,843        98,416        109,783        93,774        102,600        99,843        102,600   

Not covered by loss share agreements

    47,524        46,763        48,368        40,607        44,703        47,524        44,703   

Troubled debt restructurings

             

Covered by loss share agreements

    65,417        46,155        24,216        10,013        —          65,417        —     

Not covered by loss share agreements

    53,374        36,644        49,309        55,025        4,990        53,374        4,990   
                                                       

Total nonperforming assets

  $ 615,564      $ 519,164      $ 417,182      $ 374,282      $ 311,394      $ 615,564      $ 311,394   
                                                       

Nonperforming assets covered by loss share agreements

  $ 429,913      $ 362,578      $ 257,601      $ 220,233      $ 205,073      $ 429,913      $ 205,073   

Nonperforming assets not covered by loss share agreements

    185,651        156,586        159,581        154,049        106,321        185,651        106,321   
                                                       

Total nonperforming assets

  $ 615,564      $ 519,164      $ 417,182      $ 374,282      $ 311,394      $ 615,564      $ 311,394   
                                                       

Accruing loans and leases 90 days or more past due:

             

Covered by loss share agreements

  $ 365,207      $ 301,977      $ 345,465      $ —        $ —        $ 365,207      $ —     

Not covered by loss share agreements

    18,059        18,305        23,701        27,766        16,507        18,059        16,507   
                                                       

Ratios

             

Net charge-offs of noncovered loans (annualized) to average noncovered loans and leases

    0.49     0.43     0.47     0.50     0.53     0.47     0.57

Allowance for loan and lease losses to total loans and leases:

             

Covered by loss share agreements

    1.97        0.68        0.26        0.30        —          1.97        —     

Not covered by loss share agreements

    0.99        1.48        1.46        1.45        1.43        1.51        1.43   

Nonperforming assets to total loans and leases plus other real estate:

             

Covered by loss share agreements

    18.51        14.71        9.50        17.39        15.08        18.51        15.08   

Not covered by loss share agreements

    1.60        1.34        1.37        1.32        0.92        1.60        0.92   

Total

    4.42        3.67        2.90        2.89        2.41        4.42        2.41   

Accruing loans and leases 90 days or more past due covered by loss share agreements includes impaired loans acquired from First Regional and SAB that are being accounted for using the accretable yield method.

 

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Interest rate risk. Interest rate risk results principally from assets and liabilities maturing or repricing at different points in time, from assets and liabilities repricing at the same point in time but in different amounts and from short-term and long-term interest rates changing in different magnitudes, an event frequently described by the resulting impact on the shape of the yield curve. Market interest rates also have an impact on the interest rate and repricing characteristics of loans and leases that are originated as well as the rate characteristics of our interest-bearing liabilities.

We assess our interest rate risk by simulating future amounts of net interest income under various interest rate scenarios and comparing those results to forecasted net interest income assuming stable rates. Due to the extremely low level of interest rates, the calculation of downward rate simulations is not applicable, and thus we focus our simulations on rising rate interest rate scenarios. These simulations indicate that net interest income will increase by 4.6 percent to 10.9 percent depending upon the speed with which rates increase. Our projections do not incorporate assumptions of likely customer migration of short-term deposit instruments to long-term instruments as rates rise. Such transfer could dampen the majority of the calculated favorable changes. We also utilize the market value of equity as a tool in measuring and managing interest rate risk. The market value of equity is estimated to range from 8.8 percent with no change in interest rates to 7.8 percent when rates move up immediately by 200 basis points.

We do not typically utilize interest rate swaps, floors, collars or other derivative financial instruments to attempt to hedge our rate sensitivity and interest rate risk. However, during 2006, we entered into an interest rate swap to synthetically convert the variable rate on $115.0 million of junior subordinated debentures to a fixed rate of 7.125 percent for a period of five years. During 2009, we entered into a second interest rate swap covering the period from June 2011 to June 2016 at a fixed interest rate of 5.50 percent. Both of the interest rate swaps qualify as hedges under US GAAP.

Liquidity risk. Liquidity risk results from the mismatching of asset and liability cash flows and the potential inability to secure adequate amounts of funding from traditional sources of liquidity. BancShares manages this risk by structuring its balance sheet prudently and by maintaining various borrowing resources to fund potential cash needs. BancShares has historically maintained a strong focus on liquidity, and we have traditionally relied on our deposit base as our primary liquidity source. Short-term borrowings resulting from commercial treasury customers have also been an important source of liquidity in recent years, although the majority of those borrowings must be collateralized thereby potentially restricting the use of the resulting liquidity. Through our deposit and treasury services pricing strategies, we have the ability to stimulate or curtail liability growth.

Exclusive of deposits assumed in the FDIC-assisted transactions, deposits increased during 2010 and 2009 due to an improved domestic savings rate and a desire by customers to seek safety from uncertain investment instruments. While deposits have continued to grow despite falling interest rates, lower rates have caused a decline in treasury services balances.

We occasionally utilize borrowings from the Federal Home Loan Bank of Atlanta as an alternative source of liquidity, and to assist in matching the maturities of longer dated interest-earning assets. At September 30, 2010, we had sufficient collateral pledged to provide access to $1.50 billion of additional borrowings. Additionally, we maintain federal funds lines of credit and other borrowing facilities. At September 30, 2010, BancShares had contingent access to $500.0 million in unsecured borrowings through its various sources.

Once we have satisfied our loan demand and other funding needs, residual liquidity is held in cash or invested in overnight investments and investment securities available for sale. Net of amounts pledged for various purposes, the amount of such immediately available balance sheet liquidity approximated $2.68 billion at September 30, 2010 compared to $1.36 billion at September 30, 2009.

 

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SEGMENT REPORTING

BancShares conducts its banking operations through its two banking subsidiaries, FCB and ISB. Although FCB and ISB offer similar products and services to customers, each entity operates in distinct geographic markets and has separate management groups, with the exception of California, Washington and Florida where both now operate as a result of the FDIC-assisted transactions. We monitor growth and financial results in these institutions separately and, within each institution, by geographic segregation. During the third quarter of 2010, FCB filed applications with Federal and state banking regulators for permission to merge with ISB, with FCB being the surviving entity. Pending regulatory approval and the expiration of any applicable waiting periods, the merger of FCB and ISB is expected to occur during early 2011. Following the merger and for the immediate future, all ISB branches will continue to operate under the name IronStone Bank, which will then be a division of FCB.

Although FCB has grown through acquisition in certain of its markets, throughout its history the majority of its expansion has been accomplished on a de novo basis. Since ISB began operation in 1997, it has followed a similar business model for growth and expansion on a de novo basis. Due to the rapid pace of its growth and the number of branch offices that have not attained sufficient size to achieve profitability, the financial results and trends of ISB have been significantly affected by the large percentage of markets that are relatively new. Each new market that ISB has entered created additional operating costs that are typically not fully offset by operating revenues until three to five years of operation. Losses incurred since ISB’s inception total $86.0 million, due not only to the rapid rate of expansion but also to large credit costs incurred during the last several years.

IronStone Bank. At September 30, 2010, ISB operated 58 facilities in twelve states. ISB’s total assets equaled $2.80 billion at September 30, 2010 compared to $2.64 billion at September 30, 2009, an increase of $165.4 million or 6.3 percent. ISB recorded a net loss of $101,000 during the first nine months of 2010, compared to a net loss of $17.7 million during the same period of 2009. We believe that current year operating results will be favorable compared to 2009 due to lower credit costs and improved net interest income.

Net interest income increased $12.3 million during the first nine months of 2010, the result of an improved net yield on interest-earning assets. The provision for credit losses decreased $12.4 million during the first nine months of 2010 due to lower net charge-offs and provisions in the residential construction loan portfolio. Net charge-offs decreased from $24.6 million in the first nine months of 2009 to $13.3 million in the comparable period of 2010. On an annualized basis, the ratio of current year net charge-offs to average loans and leases outstanding equaled 0.79 percent, compared to 1.50 percent in the prior year.

ISB’s noninterest income increased $2.1 million or 20.8 percent during the first half of 2010, due to increases in cardholder and merchant services income and gains on securities transactions. Noninterest expense fell $759,000 or 1.1 percent during the first half of 2010, versus the same period of 2009. Total personnel expense increased $2.0 million or 7.1 percent as a result of merit increases and new offices opened in late-2009. Occupancy expense was also up by $850,000 or 6.8 percent. Other expense declined $3.5 million from the prior year primarily due to a reduction in foreclosure-related expenses and FDIC deposit insurance.

First-Citizens Bank & Trust Company. At September 30, 2010, FCB operated 393 branches in eight states and Washington, DC. FCB’s total assets increased from $15.82 billion at September 30, 2009 to $18.11 billion at September 30, 2010, an increase of $2.28 billion or 14.4 percent as a result of assets acquired in FDIC-assisted transactions and general growth within our legacy branches. FCB recorded net income of $174.5 million during the first nine months of 2010 compared to $124.5 million during the same period of 2009. This represents a $50.0 million increase in net income attributable to acquisition gains and an increase in net interest income. Excluding the acquisition gains recognized in 2010 and 2009, First Citizens had pre-tax income of $141.8 million for the first nine months of 2010, compared to $92.0 million for the same period of 2009. FCB’s net interest income increased $168.8 million or 52.2 percent during 2010, due to higher average interest-earning assets, an improved net yield on interest-earning assets and recognition of accretable yield for large unscheduled payments on acquired loans.

The provision for loan and lease losses increased $63.3 million due to higher net charge-offs and higher provision for losses on acquired loans. FCB’s ratio of net charge-offs to average noncovered loans and leases equaled 0.40 percent for the first nine months of 2010 compared to 0.36 percent for the same period of 2009. FCB’s noninterest income increased $28.4 million during the first nine months of 2010, primarily the result of the nonrecurring gain from the FDIC-assisted transactions. Improvements were also noted in wealth advisory services and cardholder and merchant services income. Reductions were noted in fees from processing services, mortgage income and ATM income. Noninterest expense increased $52.5 million or 12.6 percent during 2010, caused principally by increased costs as a result of the FDIC-assisted transactions.

 

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LEGAL PROCEEDINGS

BancShares and various subsidiaries have been named as defendants in various legal actions arising from our normal business activities in which damages in various amounts are claimed. Although the amount of any ultimate liability with respect to those other matters cannot be determined, in the opinion of management, any such liability will not have a material effect on BancShares’ consolidated financial statements.

CURRENT ACCOUNTING AND REGULATORY ISSUES

Beginning with the first annual reporting period after November 15, 2009, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. Therefore, formerly qualifying special-purpose entities (as defined under previous accounting standards) must be evaluated for consolidation by reporting entities in accordance with applicable consolidation guidance. If the evaluation results in consolidation, the reporting entity should apply the transition guidance provided in the pronouncement that requires consolidation. In addition, an enterprise is required to perform an analysis to determine whether the enterprise’s variable interest give it a controlling financial interest in a variable interest entity. This change is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets and variable interest entities. In 2005, FCB securitized and sold approximately $250 million of HELOC loans through the use of a QSPE. This QSPE was determined to be a variable interest entity (VIE) for which FCB is obligated to now recognize the underlying assets and liabilities in the consolidated financial statements. The assets and liabilities were recorded in the first quarter of 2010 with an increase in loans of $97.3 million, an increase in debt of $86.9 million, removal of the carrying value of the residual interest strip in the amount of $1.3 million, recognition of $3.2 million in deferred tax liability, increase in the allowance for loan and losses of $681,000, decrease to the servicing asset for $304,000 and an adjustment to beginning retained earnings for $4.9 million.

Beginning January 1, 2010, new accounting guidance requires expanded disclosures related to fair value measurements including (i) the amounts of significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (ii) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (iii) the policy for determining when transfers between levels of the fair value hierarchy are recognized and (iv) for recurring fair value measurements of assets and liabilities in Level-3 of the fair value hierarchy, a gross presentation of information about purchases, sales, issuances and settlements. The guidance further clarifies that (i) fair value measurement disclosures should be provided for each class of assets and liabilities (rather than major category), which would generally be a subset of assets or liabilities within a line item in the statement of financial position and (ii) company’s should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair value hierarchy. The disclosures related to the gross presentation of purchases, sales, issuances and settlements of assets and liabilities included in Level 3 of the fair value hierarchy will be required beginning January 1, 2011. The remaining disclosure requirements and clarifications became effective on January 1, 2010 and are included in Note G – Estimated Fair Values.

In July, 2010, the FASB issued Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Loss (ASU 2010-20). In an effort to provide financial statement users with greater transparency about the allowance for loan and lease losses, ASU 2010-20 requires enhanced disclosures regarding the nature of credit risk inherent in the portfolio and how risk is analyzed and assessed in determining the amount of the allowance. Changes in the allowance will also require disclosure. The end-of-period disclosures are effective for BancShares on December 31, 2010. The disclosures related to activity during a period are effective during 2011. The provisions of ASU 2010-20 will affect disclosures regarding the allowance for loan and lease losses, but will have no material impact on financial condition, results of operations or liquidity.

 

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The enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act will result in expansive changes in many areas affecting the financial services industry in general and BancShares in particular. The legislation provides broad economic oversight, consumer financial services protection, investor protection, rating agency reform and derivative regulatory reform. Various corporate governance requirements will result in expanded proxy disclosures and shareholder rights. Additional provisions address the mortgage industry in an effort to strengthen lending practices. Deposit insurance reform will result in permanent FDIC protection for up to $250,000 of deposits and will require the FDIC’s Deposit Insurance Fund to maintain 1.35 percent of insured deposits with the burden for closing the shortfall falling to banks with more than $10.0 billion in assets.

The legislation also imposes new regulatory capital requirements for banks that will result in the disallowance of qualified trust preferred capital securities as Tier 1 capital beginning in 2013. This legislation requires the reduction in Tier 1 capital by the amount of qualified trust preferred capital securities in equal increments over a three year period beginning in 2013. BancShares has $265 million in trust preferred capital securities that is currently outstanding and included as Tier 1 capital. The elimination of $88.3 million from Tier 1 capital will be required over the three year period beginning in 2013.

Due to the breadth of the impact of the new legislation and the pending issuance of regulations implementing the legislation, we are unable to estimate the impact of fully complying with the various provisions.

Although it is likely that further regulatory actions will arise as the Federal government attempts to address the economic situation, management is not aware of any further recommendations by regulatory authorities that, if implemented, would have or would be reasonably likely to have a material effect on liquidity, capital ratios or results of operations.

FORWARD-LOOKING STATEMENTS

Statements in this Report and exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in our Annual Report on Form 10-K and in other documents filed by us from time to time with the Securities and Exchange Commission.

Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “projects,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of BancShares’ management about future events.

Factors that could influence the accuracy of those forward-looking statements include, but are not limited to, the financial success or changing strategies of our customers, customer acceptance of our services, products and fee structure, the competitive nature of the financial services industry, our ability to compete effectively against other financial institutions in our banking markets, actions of government regulators, the level of market interest rates and our ability to manage our interest rate risk, changes in general economic conditions that affect our loan and lease portfolio, the abilities of our borrowers to repay their loans and leases, the values of real estate and other collateral, the impact of the Acquisitions, and other developments or changes in our business that we do not expect.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We have no obligation to update these forward-looking statements.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the potential economic loss resulting from changes in market prices and interest rates. This risk can either result in diminished current fair values of financial instruments or reduced net interest income in future periods. As of September 30, 2010, BancShares’ market risk profile has not changed significantly from December 31, 2009. Changes in fair value that result from movement in market rates cannot be predicted with any degree of certainty. Therefore, the impact that future changes in market rates will have on the fair values of financial instruments is uncertain.

 

Item 4. Controls and Procedures

BancShares’ management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of BancShares’ disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (Exchange Act). Based on their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, BancShares’ disclosure controls and procedures were effective to provide reasonable assurance that BancShares is able to record, process, summarize and report in a timely manner the information required to be disclosed in reports it files under the Exchange Act.

No change in BancShares’ internal control over financial reporting occurred during the third quarter of 2010 that had materially affected, or is reasonably likely to materially affect, BancShares’ internal control over financial reporting.

 

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PART II

 

Item 1A. Risk Factors

Unfavorable changes in economic conditions

BancShares’ business is highly affected by national, regional and local economic conditions. These conditions cannot be predicted or controlled, and may have a material impact on our operations and financial condition. Unfavorable economic developments such as an increase in unemployment rates, decreases in real estate values, rapid changes in interest rates, higher default and bankruptcy rates and various other factors could weaken the national economy as well as the economies of specific communities that we serve. Weakness in our market areas, continuation or deepening of the current recession or a prolonged recovery could depress our earnings and financial condition because borrowers may not be able to repay their loans, collateral values may fall, and loans that are currently performing and other long-lived assets may become impaired.

Mergers and acquisitions

We must receive federal and state regulatory approvals before we can acquire a bank or bank holding company or acquire assets and assume liabilities of failed banks from the FDIC. Prior to granting approval, bank regulators will consider, among other factors, the effect of the acquisition on competition, financial condition and future prospects including current and projected capital ratios, the competence, experience and integrity of management, our record of compliance with laws and regulations, and the convenience and needs of the communities to be served, including our record of compliance under the Community Reinvestment Act. We cannot be certain when or if any required regulatory approvals will be granted or what conditions may be imposed by the approving authority.

In addition to the risks related to regulatory approvals, complications in the conversion of operating systems, data systems and products may result in the loss of customers, damage to our reputation, operational problems, one-time costs currently not anticipated or reduced cost savings resulting from a merger or acquisition. The integration could result in higher than expected deposit attrition, loss of key employees, disruption of our businesses or the businesses of the acquired company, or otherwise adversely affect our ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition.

With respect to the FDIC-assisted transactions, the exposures to prospective losses on certain assets are generally covered by loss share agreements with the FDIC. These loss share agreements impose certain obligations on us that, in the event of noncompliance could result in the delay of payments from the FDIC or potential disallowance of our rights under the loss share agreements.

Instability in real estate markets

Disruption in residential housing markets including reduced sales activity and falling market prices have adversely affected collateral values and customer demand, particularly with respect to our operations in Atlanta, Georgia and southwest Florida. Instability in residential and commercial real estate markets could result in higher credit losses in the future if customers default on loans that, as a result of lower property values, are no longer adequately collateralized. The weak real estate markets could also affect our ability to sell real estate acquired through foreclosure.

Liquidity

Liquidity is essential to our businesses. Our deposit base represents our primary source of liquidity, and we typically have the ability to stimulate deposit growth through our pricing strategies. However, in circumstances where our ability to generate needed liquidity is impaired, we would need access to alternative liquidity sources such as overnight or other short-term borrowings. While we maintain access to alternative funding sources, we are dependent on the availability of collateral, the counterparty’s willingness to lend to us and their liquidity capacity.

Gain on acquisitions

The acquisition gains recorded during 2010 are preliminary and subject to revision for a period of one year following the respective acquisition date. Adjustments may be recorded based on additional information received after the acquisition date that affects the respective acquisition date fair values of assets acquired and liabilities assumed. Downward adjustments in values of assets acquired or increases in values of liabilities assumed on the date of acquisition would lower the gains on acquisitions.

 

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Deposit insurance premiums

During 2009, due to a higher level of bank failures, the FDIC increased recurring deposit insurance premiums, imposed a special assessment on insured financial institutions, and required insured financial institutions to prepay three years of deposit premiums. Due to the continuing volume of bank failures, it is probable that a continued high level of funding will be required from insured financial institutions. In addition, recently enacted legislation contains various provisions to reform certain elements of the current deposit insurance system including a higher minimum reserve ratio that must be attained by 2020. These changes could result in further increases in the amount of deposit insurance premiums that we pay.

Access to capital

Based on existing capital levels, BancShares and its subsidiary banks maintain well-capitalized ratios under current leverage and risk-based capital standards including the impact of the acquisitions in 2010 of First Regional and SAB. Historically, our primary capital sources have been retained earnings and debt issued through both private and public markets including trust preferred securities and subordinated debt. The market for trust preferred securities has been severely limited during the current economic environment, and our ability to raise capital by issuing new trust preferred securities at reasonable rates is highly questionable.

Additionally, recent legislation has affected our ability to rely on trust preferred securities as a source of capital. Under the provisions of the 2010 legislation, we will be required to remove one-third of the securities that currently qualify in each of the three years beginning 2013. The elimination of the full $265.0 million would result in a 200 basis point reduction in both BancShares’ Tier 1 risk-based capital and its Total risk-based at September 30, 2010 on a pro forma basis. Our Tier 1 leverage capital ratio would decline by 126 basis points. Although BancShares would remain well-capitalized on a pro forma basis, the impact of this legislation on other financial institutions may create an even greater scarcity of capital and result in additional bank failures. A lack of access to capital could limit our ability to consummate additional acquisitions, make new loans, meet our existing lending commitments, and could potentially affect our liquidity and capital adequacy.

Reduction in credit ratings

The major rating agencies regularly evaluate our creditworthiness and assign credit ratings to the debt of BancShares and FCB. The agencies’ ratings are based on a number of factors, some of which are not within our control. In addition to factors specific to our financial strength and performance, the rating agencies also consider conditions generally affecting the financial services industry. In light of the difficulties currently confronting the financial services industry, there can be no assurance that we will maintain our current credit ratings. Rating reductions could adversely affect our access to funding sources and the cost of obtaining funding. Long-term debt ratings also factor into the calculation of deposit insurance premiums, and a reduction in our subsidiary bank’s ratings would increase premiums and expense.

Condition of other financial institutions

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to numerous financial service providers, including banks, brokers and dealers in securities and other institutional clients. Transactions with other financial institutions expose us to credit risk in the event of default of the counterparty. These types of losses could materially and adversely affect our results of operations or earnings.

Changes in interest rates

Our earnings and financial condition are highly dependent upon net interest income. Compression of interest rate spreads adversely affects our earnings and financial condition. We cannot predict with certainty changes in interest rates or actions by the Federal Reserve that may have a direct impact on market interest rates. While we maintain policies and procedures designed to mitigate the risks associated with changes in interest rates, those changes may nonetheless have significant adverse effects on our profitability.

Changes in banking laws

Financial institutions are regulated under federal and state banking laws and regulations that primarily focus on the protection of depositors, federal deposit insurance funds and the banking system as a whole. Federal and state banking regulators possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums and limitations on activities that could have a material adverse effect on our results of operations.

In addition, financial institutions are significantly affected by changes in economic and monetary policies. Recently enacted legislation will likely result in increased compliance requirements through the establishment of the Bureau of Consumer Financial Protection.

 

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Competition

There is intense competition among commercial banks in our market areas. In addition, we compete with other providers of financial services, such as credit unions, consumer finance companies, commercial finance and leasing companies, brokerage and wealth management firms as well as other institutions that deliver their products and services through alternative delivery networks. Some of our larger competitors, including various banks that have a significant presence in our market areas, have the capacity to offer products and services we do not offer.

Catastrophic events

The occurrence of catastrophic events including weather-related events such as hurricanes, tropical storms, floods, windstorms or severe winter weather, as well as earthquakes, pandemic disease, fires and other catastrophes could adversely affect our consolidated financial condition or results of operations.

In addition to natural catastrophic events, man-made events such as acts of terror and governmental response to acts of terror could adversely affect general economic conditions, which could have a material impact on our results of operations.

Unpredictable natural and other disasters could have an adverse effect if those events materially disrupt our operations or affect customers’ access to the financial services we offer. Although we carry insurance to mitigate our exposure to certain catastrophic events, catastrophic events could nevertheless affect our results of operations.

Operational and data security risk

We are exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk of illegal activities conducted by employees or outsiders, data security risk and operational errors. Our dependence on automated systems, including the automated systems used by acquired entities and third parties, to record and process transactions may further increase the risk that technical failures or tampering of those systems will result in losses that are difficult to detect. We are also subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control.

Reliance on vendors

Third party vendors provide key components of our business infrastructure. Failures of these third parties to provide services for any reason could adversely affect our ability to deliver products and services to our customers. Replacing critical third party vendors could also result in interruption of service and significant expense.

Litigation 

The frequency of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high. Substantial legal liability or significant regulatory action against us may have material adverse financial effects or cause significant reputational harm.

Interpretation of tax laws and regulations

Our interpretation of federal, state or local tax laws and regulations that allow for our estimation of tax liabilities may differ from tax authorities. Those differing interpretations may result in the disallowance of deductions or credits, differences in the timing of deductions or other differences that could result in the payment of additional taxes, interest or penalties that could materially affect our results of operations.

Changes in accounting standards

The Financial Accounting Standards Board periodically modifies the standards that govern the preparation of our financial statements. These changes are not predictable and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results or a cumulative adjustment to retained earnings.

Volatility in stock price and impairment of goodwill

Market prices of our common stock price can fluctuate widely in response to a variety of factors including expectations of operating results, actual operating results, market perception of business combinations, stock prices of other companies that are similar to BancShares, general market expectations related to the financial services industry, and the potential impact of government actions affecting the financial services industry.

General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of our operating results.

Goodwill is tested for impairment at least annually and the impairment test compares the estimated fair value of a reporting unit with its net book value. A write-off of impaired goodwill could have a significant impact on our results of operations, but would not impact our capital ratios as such ratios are calculated using tangible capital amounts.

 

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Item 6. Exhibits

 

31.1    Certification of Chief Executive Officer
31.2    Certification of Chief Financial Officer
32.1    Certification of Chief Executive Officer
32.2    Certification of Chief Financial Officer

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated: November 8, 2010   FIRST CITIZENS BANCSHARES, INC.
   

(Registrant)

 

By:

 

/s/ KENNETH A. BLACK

  Kenneth A. Black
 

Vice President, Treasurer

and Chief Financial Officer

 

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