10-K 1 d638508d10k.htm FORM 10K Form 10K
Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2013

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 000-32017

 

 

CENTERSTATE BANKS, INC.

(Name of registrant as specified in its charter)

 

 

 

Florida   59-3606741

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

42745 U.S. Highway 27, Davenport, Florida   33837
(Address of principal executive offices)   (Zip Code)

Issuer’s telephone number, including area code: (863) 419-7750

Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $0.01 per share

Securities registered pursuant to Section 12(g) of the Act: None

 

 

The registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x

The registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ¨    NO  x

Check whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 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 90 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation SK contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

The registrant is a shell company, as defined in Rule 12b-2 of the Exchange Act.    YES  ¨    NO  x

The aggregate market value of the Common Stock of the registrant held by non-affiliates of the registrant (20,934,149 shares) on June 30, 2013, was approximately $181,708,000. The aggregate market value was computed by reference to the last sale of the Common Stock of the registrant at $8.68 per share on June 28, 2013. For the purposes of this response, directors, executive officers and holders of 5% or more of the registrant’s Common Stock are considered the affiliates of the issuer at that date.

As of February 28, 2014 there were outstanding 35,405,907 shares of the registrant’s Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on April 24, 2014 to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days of the registrant’s fiscal year end are incorporated by reference into Part III, of this Annual Report on Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

 

         Page  

PART I

     1   

Item 1.

  Business      1   
  General      1   
  Note about Forward-Looking Statements      3   
  Lending Activities      3   
  Deposit Activities      4   
  Investments      4   
  Correspondent Banking      5   
  Data Processing      5   
  Effect of Governmental Policies      6   
  Interest and Usury      6   
  Supervision and Regulation      6   
  Competition      14   
  Employees      15   
  Statistical Profile and Other Financial Data      15   
  Availability of Reports furnished or filed with SEC      15   

Item 1A

  Risk Factors      15   

Item 1B

  Unresolved Staff Comments      24   

Item 2.

  Properties      24   

Item 3.

  Legal Proceedings      25   

Item 4.

  [Removed and Reserved]      25   
PART II      26   

Item 5.

  Market for Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities      26   

Item 6.

  Selected Consolidated Financial Data      28   

Item 7

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      34   

Item 7A.

  Quantitative and Qualitative Disclosures about Market Risks      73   

Item 8.

  Financial Statements and Supplementary Data      73   

Item 9.

  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure      73   

Item 9A.

  Controls and Procedures      73   

Item 9B.

  Other Information      73   

PART III

     74   

Item 10.

  Directors, Executive Officers and Corporate Governance      74   

Item 11.

  Executive Compensation      74   

Item 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      74   

Item 13.

  Certain Relationships and Related Transactions, and Director Independence      74   

Item 14.

  Principal Accountant Fees and Services      74   

Item 15.

  Exhibits and Financial Statement Schedules      74   
SIGNATURES      138   
EXHIBIT INDEX      139   


Table of Contents

PART I

 

Item 1. Business

General

CenterState Banks, Inc. (“We,” “Our,” “CenterState,” “CSFL,” or the “Company”) was incorporated under the laws of the State of Florida on September 20, 1999. CenterState is a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and owns all the outstanding shares of CenterState Bank of Florida, N.A. (“CSB” or the “Bank”), and R4ALL, Inc. (“R4ALL”) a non bank subsidiary.

The Company was formed and commenced operations by acquiring CenterState Bank Central Florida, N.A. (“Central”), CenterState Bank, N.A. (“CSNA”) and First National Bank of Polk County (“FNB/Polk”) in June of 2000. Central and CSNA commenced operations in 1989. FNB/Polk commenced operations in 1992.

CSB commenced operations in April of 2000 and was acquired by the Company on December 31, 2002. In January 2006, FNB/Polk was merged with CSB.

The Company purchased CenterState Bank Mid Florida in March of 2006 and merged it with CSNA in November of 2007. In April of 2007 we purchased Valrico State Bank (“VSB”). In December 2010 Central and CSNA were merged into CSB. In June 2012 VSB was merged into CSB.

In September 2009 we formed a separate non bank subsidiary, R4ALL, for the purpose of acquisition and disposition of troubled assets from our subsidiary bank(s).

Through our subsidiary bank, CSB, we acquired assets and deposits from four failed financial institutions from the Federal Deposit Insurance Corporation (“FDIC”) in 2009 and 2010, and a fifth and sixth in January of 2012.

In January 2011, we acquired four branch banking offices with approximately $113 million of deposits and approximately $121 million of performing loans from TD Bank, N.A.

In November 2011, we acquired Federal Trust Corporation in Sanford, Florida, with approximately $157 million of selected performing loans, $198 million of deposits and five branch banking offices from The Hartford Insurance Group, Inc., the sole owner of Federal Trust Corporation.

On January 17, 2014, we consummated our previously announced acquisition of Gulfstream Bancshares, Inc. (“Gulfstream”) which added four additional branches (approximately $479 million of deposits) and two additional counties, Palm Beach and Martin.

Headquartered in Davenport, Florida between Orlando and Tampa, we provide a range of consumer and commercial banking services to individuals, businesses and industries throughout our branch network located within twenty counties throughout Central, Northeast and Southeastern Florida. Following the closing of our Gulfstream merger on January 17, 2014, our 59 bank branch offices were located in the following Florida counties:

 

Citrus    Indian River    Orange    Polk
Hendry    Lake    Osceola    Putnam
Hernando    Marion    Pasco    Sumter
Hillsborough    Okeechobee    Seminole    St. Lucie
Volusia    Duval    Martin    Palm Beach

 

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On January 21, 2014, we announced efficiency and enhanced profitability initiatives including the closing and consolidation of seven smaller branches plus a standalone drive thru facility (counted as a branch for regulatory purposes). The branches are scheduled to be closed in mid-April, when at that time we will operate from a total of 51 branch locations.

On January 29, 2014, we announced that we have signed a definitive agreement, subject to normal regulatory approvals and shareholder approval and other conditions, to acquire First Southern Bancorp, Inc. (“FSOB”). The acquisition is expected to close during the second half of 2014. FSOB operates through 17 branches (approximately $887 million of deposits) in Southeast, Central and Northeast Florida. There is some branch overlap and we expect to consolidate and close potentially 10 of those branches.

The basic services we offer include: demand interest-bearing and noninterest-bearing accounts, money market deposit accounts, time deposits, safe deposit services, cash management, direct deposits, notary services, money orders, night depository, travelers’ checks, cashier’s checks, domestic collections, savings bonds, bank drafts, automated teller services, drive-in tellers, and banking by mail and by internet. In addition, we make residential and commercial real estate loans, secured and unsecured commercial loans and consumer loans. We provide automated teller machine (ATM) cards, thereby permitting customers to utilize the convenience of larger ATM networks. We also offer internet banking services to our customers. We also offer trust services to customers throughout our existing markets in Florida. We also have a wealth management division that offers other financial products to our customers, including mutual funds, annuities and other products.

Our revenue is primarily derived from interest on, and fees received in connection with, real estate and other loans, interest and dividends from investment securities and short-term investments, and commissions on bond sales. The principal sources of funds for our lending activities are customer deposits, repayment of loans, and the sale and maturity of investment securities. Our principal expenses are interest paid on deposits, and operating and general administrative expenses.

In addition to providing traditional deposit and lending products and services to our commercial and retail customers through our 59 locations, we also operate a correspondent banking and bond sales division. The division is integrated with and part of our subsidiary bank, CSB, located in Winter Haven, Florida, although the majority of our bond salesmen, traders and operations personnel are physically housed in leased facilities located in Birmingham, Alabama and Atlanta, Georgia. The business lines of this division are primarily divided into three inter-related revenue generating activities. The first, and largest, revenue generator is commissions earned on fixed income security sales. The second category includes: (a) correspondent bank deposits (i.e., federal funds purchased) and (b) correspondent bank checking accounts and clearing services. The third, and smallest revenue generating category, includes fees from safe-keeping activities, bond accounting services for correspondents, and asset/liability consulting related activities. The customer base includes small to medium size financial institutions primarily located in Southeastern United States.

As is the case with banking institutions generally, our operations are materially and significantly influenced by the real estate market, general economic conditions and by related monetary and fiscal policies of financial institution regulatory agencies, including the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Deposit flows and costs of funds are influenced by interest rates on competing investments and general market rates of interest. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn is affected by the interest rates at which such financing may be offered and other factors affecting local demand and availability of funds. We face strong competition in the attraction of deposits (our primary source of lendable funds) and in the origination of loans. See “Competition.”

At December 31, 2013, our primary asset is our ownership of 100% of the stock of our subsidiary bank. At December 31, 2013, we had total consolidated assets of $2,415,567,000, total consolidated loans of $1,474,179,000, total consolidated deposits of $2,056,231,000, and total consolidated stockholders’ equity of $273,379,000.

 

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Note about Forward-Looking Statements

This Form 10-K contains forward-looking statements, such as statements relating to our financial condition, results of operations, plans, objectives, future performance and business operations. These statements relate to expectations concerning matters that are not historical facts. These forward-looking statements reflect our current views and expectations based largely upon the information currently available to us and are subject to inherent risks and uncertainties. Although we believe our expectations are based on reasonable assumptions, they are not guarantees of future performance and there are a number of important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. By making these forward-looking statements, we do not undertake to update them in any manner except as may be required by our disclosure obligations in filings we make with the Securities and Exchange Commission under the Federal securities laws. Our actual results may differ materially from our forward-looking statements.

Lending Activities

We offer a range of lending services, including real estate, consumer and commercial loans, to individuals and small businesses and other organizations that are located in or conduct a substantial portion of their business in our market area. Our consolidated loans at December 31, 2013 and 2012 were $1,474,179,000, or 61% and $1,435,863,000 or 61%, respectively, of total consolidated assets. The interest rates charged on loans vary with the degree of risk, maturity, and amount of the loan, and are further subject to competitive pressures, money market rates, availability of funds, and government regulations. We have no foreign loans or loans for highly leveraged transactions. We do have immaterial amounts of loans with foreigners on property located within our Florida market area, primarily vacation and second homes.

Our loans are concentrated in three major areas: real estate loans, commercial loans and consumer loans. A majority of our loans are made on a secured basis. As of December 31, 2013, approximately 87% of our consolidated loan portfolio consisted of loans secured by mortgages on real estate, 10% of the loan portfolio consisted of commercial loans (not secured by real estate) and 3% of our loan portfolio consisted of consumer and other loans.

Approximately 15.6% of our loans, or $230,273,000, are covered by FDIC loss sharing agreements related to the acquisition of three failed financial institutions during the third quarter of 2010 and two during the first quarter of 2012. Pursuant to the terms of the loss sharing agreements, the FDIC is obligated to reimburse us for 80% of losses with respect to the covered loans beginning with the first dollar of loss incurred, subject to the terms of the agreements. We will reimburse the FDIC for its share of recoveries with respect to the covered loans. The loss sharing agreements applicable to single family residential mortgage loans provide for FDIC loss sharing and our reimbursement to the FDIC for recoveries for ten years. The loss sharing agreements applicable to commercial loans provide for FDIC loss sharing for five years and our reimbursement to the FDIC for a total of eight years for recoveries.

Our real estate loans are secured by mortgages and consist primarily of loans to individuals and businesses for the purchase, improvement of or investment in real estate, for the construction of single-family residential and commercial units, and for the development of single-family residential building lots. These real estate loans may be made at fixed or variable interest rates. Generally, we do not make fixed-rate commercial real estate loans for terms exceeding five years. Loans in excess of five years are generally adjustable. Our residential real estate loans generally are repayable in monthly installments based on up to a 15-year or a 30-year amortization schedule with variable or fixed interest rates.

Our commercial loan portfolio includes loans to individuals and small-to-medium sized businesses located primarily in eighteen Florida counties listed under “Business” or contiguous counties for working capital, equipment purchases, and various other business purposes. A majority of commercial loans are secured by equipment or similar assets, but these loans may also be made on an unsecured basis. Commercial loans may be made at variable or fixed rates of interest. Commercial lines of credit are typically granted on a one-year basis, with loan covenants and monetary thresholds. Other commercial loans with terms or amortization schedules of longer than one year will normally carry interest rates which vary with the prime lending rate and will become payable in full and are generally refinanced in three to five years. Commercial and agricultural loans not secured by real estate amounted to approximately 10% and 9% of our Company’s total loan portfolio as of December 31, 2013 and 2012, respectively.

 

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Our consumer loan portfolio consists primarily of loans to individuals for various consumer purposes, but includes some business purpose loans which are payable on an installment basis. The majority of these loans are for terms of less than five years and are secured by liens on various personal assets of the borrowers, but consumer loans may also be made on an unsecured basis. Consumer loans are made at fixed and variable interest rates, and are often based on up to a five-year amortization schedule.

For additional information regarding our loan portfolio, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Loan originations are derived primarily from employee loan officers within our local market areas, but can also be attributed to referrals from existing customers and borrowers, advertising, or walk-in customers.

Certain credit risks are inherent in making loans. These include prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers. In particular, longer maturities increase the risk that economic conditions will change and adversely affect collectability. We attempt to minimize credit losses through various means. In particular, on larger credits, we generally rely on the cash flow of a debtor as the source of repayment and secondarily on the value of the underlying collateral. In addition, we attempt to utilize shorter loan terms in order to reduce the risk of a decline in the value of such collateral.

Deposit Activities

Deposits are the major source of our funds for lending and other investment activities. We consider the majority of our regular savings, demand, NOW and money market deposit accounts to be core deposits. These accounts comprised approximately 81% and 76% of our consolidated total deposits at December 31, 2013 and 2012, respectively. Approximately 19% of our consolidated deposits at December 31, 2013, were certificates of deposit compared to 24% at December 31, 2012. Generally, we attempt to maintain the rates paid on our deposits at a competitive level. Time deposits of $100,000 and over made up approximately 10% of consolidated total deposits at December 31, 2013 and 12% at December 31, 2012. The majority of the deposits are generated from market areas where we conduct business. Generally, we do not accept brokered deposits and we do not solicit deposits on a national level. We obtain all of our deposits from customers in our local markets. For additional information regarding the Company’s deposit accounts, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Deposits.”

Investments

Our investment securities portfolio available for sale was $457,086,000 and $425,758,000 at December 31, 2013 and 2012, respectively, representing 19% and 26% of our total consolidated assets. At December 31, 2013, approximately 91% of this portfolio was invested in U.S. government mortgage backed securities (“MBS”), specifically residential FNMA, FHLMC, and GNMA MBSs. We do not own any private label MBSs. Approximately 9%, or $40,201,000, of this portfolio is invested in municipal securities. Our investments are managed in relation to loan demand and deposit growth, and are generally used to provide for the investment of excess funds at acceptable risks levels while providing liquidity to fund increases in loan demand or to offset fluctuations in deposits. Investment securities available for sale are recorded on our balance sheet at market value at each balance sheet date. Any change in market value is recorded directly in our stockholders’ equity account and is not recognized in our income statement unless the security is sold or unless it is impaired and the impairment is other than temporary. During 2013, we sold approximately $69,495,000 of these securities and recognized a net gain on the sales of approximately $1,060,000.

We have selected these types of investments because such securities generally represent what we believe to be a minimal investment risk. Occasionally, we may purchase certificates of deposits of national and state banks. These investments may exceed $250,000 in any one institution (the limit of FDIC insurance for deposit accounts). Federal funds sold, money market accounts and interest bearing deposits held at the Federal Reserve Bank represent the excess cash we have available over and above daily cash needs. Federal funds sold and money market funds are invested on an overnight basis with approved correspondent banks.

 

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We monitor changes in financial markets. In addition to investments for our portfolio, we monitor daily cash positions to ensure that all available funds earn interest at the earliest possible date. A portion of the investment account is invested in liquid securities that can be readily converted to cash with minimum risk of market loss. These investments usually consist of obligations of U.S. government agencies, mortgage backed securities and federal funds. The remainder of the investment account may be placed in investment securities of different type and/or longer maturity. Daily surplus funds are sold in the federal funds market for one business day. We attempt to stagger the maturities of our securities so as to produce a steady cash-flow in the event cash is needed, or economic conditions change.

We also have a trading securities portfolio managed at our subsidiary bank. For this portfolio, realized and unrealized gains and losses are included in trading securities revenue, a component of non interest income in our Consolidated Statement of Operations and Comprehensive Income. Securities purchased for this portfolio have primarily been municipal securities and are held for short periods of time. During 2013 we purchased approximately $198,186,000 of securities for this portfolio and sold $203,489,000 recognizing a net gain on sale of approximately $255,000. At December 31, 2013 we had no securities in our trading portfolio.

Correspondent Banking

We have a correspondent banking and bond sales business segment which operates as a division within our subsidiary bank. Its primary revenue generating activities are as follows: 1) the first, and largest revenue generator, is commissions earned on fixed income security sales; 2) the second category is interest income spread earned on correspondent bank deposits (i.e., federal funds purchased) and correspondent bank checking account deposits; and 3) the third revenue generating category, includes fees from safe-keeping activities, bond accounting services for correspondents, asset/liability consulting related activities, international wires, and other clearing and corporate checking account services. The customer base includes small to medium size financial institutions primarily located in Southeastern United States.

Data Processing

We use a single in-house core data processing solution. The core data processing system provides automated general ledgers, deposit processing and accounting services, and loan processing and accounting services.

During July and August of 2010, our subsidiary bank, CSB, acquired three failed financial institutions from the FDIC. Each of these acquired banks did not convert and merge their data processing systems into our subsidiary bank until the summer of 2011. They each operated under different legacy systems for almost a year, which caused cost inefficiencies in the short-term. The branches purchased from TD Bank, N.A. in January of 2011 were converted on the day of acquisition. The Federal Trust Bank acquisition closed on November 1, 2011 and was converted 40 days later into our core processing systems on December 9, 2011, minimizing short-term inefficiencies. In January 2012, we acquired two additional failed financial institutions from the FDIC. Each operated under their legacy data processing systems until we converted them into our subsidiary bank’s core system in May and June of 2012.

A division of our subsidiary bank provides item processing services and certain other information technology (“IT”) services for the bank and the Company overall. These services include; sorting, encoding, processing, and imaging checks and rendering checking and other deposit statements to commercial and retail customers, as well as providing IT services, including intranet and internet services for our bank and the Company overall.

 

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Effect of Governmental Policies

Our earnings and business are and will be affected by the policies of various regulatory authorities of the United States, especially the Federal Reserve. The Federal Reserve, among other things, regulates the supply of credit and deals with general economic conditions within the United States. The instruments of monetary policy employed by the Federal Reserve for these purposes influence in various ways the overall level of investments, loans, other extensions of credit and deposits, and the interest rates paid on liabilities and received on assets.

Interest and Usury

We are subject to numerous state and federal statutes that affect the interest rates that may be charged on loans. These laws do not, under present market conditions, deter us from continuing the process of originating loans.

Supervision and Regulation

Banks and their holding companies, and many of their affiliates, are extensively regulated under both federal and state law. The following is a brief summary of certain statutes, rules, and regulations affecting our Company, and our subsidiary bank. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and is not intended to be an exhaustive description of the statutes or regulations applicable to the business of our Company and subsidiary bank. Supervision, regulation, and examination of banks by regulatory agencies are intended primarily for the protection of depositors, rather than shareholders.

Bank Holding Company Regulation. Our Company is a bank holding company, registered with the Federal Reserve under the BHC Act. As such, we are subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the Federal Reserve.

Under current law and Federal Reserve policy, a bank holding company is expected to act as a source of financial and managerial strength to its subsidiary bank and to maintain resources adequate to support its bank. The term “source of financial strength” is defined under the Dodd-Frank Act as the ability of a company to provide financial assistance to its insured depository institution subsidiaries in the event of financial distress. The appropriate federal banking agency for such a depository institution may require reports from companies that control the insured depository institution to assess their abilities to serve as a source of strength and to enforce compliance with the source-of-strength requirements. The appropriate federal banking agency may also require a holding company to provide financial assistance to a bank with impaired capital. Under this requirement, in the future, we could be required to provide financial assistance to our subsidiary bank should it experience financial distress. Based on our ownership of a national bank subsidiary, the OCC could assess us if the capital of our subsidiary bank were to become impaired. If a holding company fails to pay an imposed assessment within three months, it could be ordered to sell its stock of its subsidiary bank to cover the deficiency.

Bank holding companies also have minimum capital requirements which must be maintained to remain in regulatory compliance. The BHC Act requires that a bank holding company obtain the prior approval of the Federal Reserve before (i) acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, (ii) taking any action that causes a bank to become a subsidiary of the bank holding company, or (iii) merging or consolidating with any other bank holding company.

The BHC Act further provides that the Federal Reserve may not approve any transaction that would result in a monopoly or would be in furtherance of any combination or conspiracy to monopolize or attempt to monopolize the business of banking in any section of the United States, or the effect of which may be substantially to lessen competition or to tend to create a monopoly in any section of the country, or that in any other manner would be in restraint of trade, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience, and needs of the community to be served. Consideration of financial resources generally focuses on capital adequacy and consideration of convenience and needs issues includes the parties’ performance under the Community Reinvestment Act of 1977 (the “CRA”), both of which are discussed below.

 

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Banks are subject to the provisions of the CRA. Under the terms of the CRA, the appropriate federal bank regulatory agency is required, in connection with its examination of a bank, to assess such bank’s record in meeting the credit needs of the community served by that bank, including low- and moderate-income neighborhoods. The regulatory agency’s assessment of the bank’s record is made available to the public. Further, such assessment is required of any bank which has applied to:

 

    establish a new branch office that will accept deposits,

 

    relocate an office, or

 

    merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution

In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the record of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application.

The BHC Act generally prohibits a bank holding company from engaging in activities other than banking, or managing or controlling banks or other permissible subsidiaries, and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those activities determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices. For example, factoring accounts receivable, acquiring or servicing loans, leasing personal property, conducting securities brokerage activities, performing certain data processing services, acting as agent or broker in selling credit life insurance and certain other types of insurance in connection with credit transactions, and certain insurance underwriting activities have all been determined by regulations of the Federal Reserve to be permissible activities of bank holding companies. Despite prior approval, the Federal Reserve has the power to order a holding company or its subsidiaries to terminate any activity or terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness, or stability of any bank subsidiary of that bank holding company.

Dodd-Frank Act. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, was enacted into law. The Dodd-Frank Act has a broad impact on the financial services industry, including providing for potentially significant regulatory and compliance changes including, among other things, (1) enhanced resolution authority of troubled and failing banks and their holding companies; (2) potential changes to capital and liquidity requirements; (3) changes to regulatory examination fees; (4) changes to assessments to be paid to the FDIC for federal deposit insurance; and (5) numerous other provisions designed to improve supervision and oversight of, and strengthening safety and soundness for, the financial services sector. Additionally, the Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve, the Office of the Comptroller of the Currency, or the OCC, and the Federal Deposit Insurance Corporation, or the FDIC. Many of the requirements called for in the Dodd-Frank Act will be implemented over time and most will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements. Failure to comply with any such laws, regulations, or principles or changes thereto, may negatively impact our results of operations and financial condition. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our investors and shareholders.

 

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The following items provide a brief description of the impact of the Dodd-Frank Act on our operations and activities, both currently and prospectively.

 

    Increased Capital Standards and Enhanced Supervision. The federal banking agencies have published a final rule to establish minimum leverage and risk-based capital requirements for banks and bank holding companies. Compliance with heightened capital standards may reduce our ability to generate or originate revenue-producing assets and thereby restrict revenue generation from banking and non-banking operations. The Dodd-Frank Act also increases regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agency. Compliance with new regulatory requirements and expanded examination processes could increase the Company’s cost of operations.

 

    The Consumer Financial Protection Bureau. The Dodd-Frank Act created a new, independent Consumer Financial Protection Bureau, or the Bureau, within the Federal Reserve. The Bureau is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The Bureau has rulemaking authority over many of the statutes governing products and services offered to bank consumers. The Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are stricter than those regulations promulgated by the Bureau and state attorneys general are permitted to enforce consumer protection rules adopted by the Bureau against certain state-chartered institutions. Any such new regulations could increase our cost of operations and, as a result, could limit our ability to expand into these products and services.

 

    Deposit Insurance. The Dodd-Frank Act makes permanent the $250,000 deposit insurance limit for insured deposits. Amendments to the Federal Deposit Insurance Act also revise the assessment base against which an insured depository institution’s deposit insurance premiums paid to the FDIC’s Deposit Insurance Fund, or the DIF, will be calculated. Under the amendments, the assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity.

 

    Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.

 

    Transactions with Insiders. Insider transaction limitations are expanded through the strengthening on loan restrictions to insiders and the expansion of the types of transactions subject to the, various limits.

 

    Enhanced Lending Limits. The Dodd-Frank Act strengthens the existing limits on a depository institution’s credit exposure to one borrower. Current banking law limits a depository institution’s ability to extend credit to one person (or group of related persons) in an amount exceeding certain thresholds. The Dodd-Frank Act expands the scope of these restrictions to include credit exposure arising from derivative transactions, repurchase agreements, and securities lending and borrowing transactions.

 

    Loss of Federal Preemption. The Dodd-Frank Act restricts the preemption of state law by federal law and disallows subsidiaries and affiliates of national banks from availing themselves of such preemption.

 

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    Interstate Branching. The Dodd-Frank Act, subject to a state’s restrictions on intrastate branching, now permits interstate branching. Therefore, a bank may enter a new state by acquiring a branch of an existing institution or by establishing a new branch office. As a result, there will be no need for the entering bank to acquire or merge with an existing institution in the target state. This ability to establish a de novo branch across state lines will have the effect of increasing competition within a community bank’s existing markets and may create downward pressure on the franchise value for existing community banks.

 

    Compensation Practices. The Dodd-Frank Act provides that the appropriate federal regulators must establish standards prohibiting as an unsafe and unsound practice any compensation plan of a bank holding company or other covered financial institution that provides an insider or other employee with “excessive compensation” or compensation that gives rise to excessive risk or could lead to a material financial loss to such organization.

Basel III. In 2010 the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced an agreement to a strengthened set of capital requirements known as Basel III. In July 2013, the OCC and the Federal Reserve approved a final rule that establishes a new regulatory capital framework that incorporates revisions to the Basel capital framework, including Basel III and other elements. The rule strengthens the definition of regulatory capital, increases risk-based capital requirements, and amends the methodologies for determining risk-weighted assets. The rule applies to all national banks. Subject to various transition periods, the rule is effective for certain banks (including CenterState) on January 1, 2015. Among other things, the rule:

 

    Implements strict eligibility criteria for regulatory capital instruments.

 

    Revises the Prompt Corrective Act action framework to incorporate new regulatory capital minimum thresholds.

 

    Adds a new common equity Tier 1 capital ratio of 4.5% and increases the minimum Tier 1 capital ratio requirement from 4% to 6%.

 

    Improves the measure of risk-weighted assets to enhance risk sensitivity.

 

    Retains the existing regulatory capital framework for one-to-four family residential mortgage exposures.

 

    Allows banks where the rule becomes effective on January 1, 2015 to retain the existing treatment for accumulated other comprehensive income through a one-time election.

 

    Allows certain depository institution holding companies to continue to include in Tier 1 capital previously issued trust preferred securities and cumulative perpetual preferred stock.

 

    Limits capital distributions and certain discretionary bonus payments if banks do not maintain a capital conservation buffer of common equity Tier 1 capital above minimum capital requirements.

 

    Establishes due diligence requirements for securitization exposures.

Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act permits the creation of financial services holding companies that can offer a full range of financial products under a regulatory structure based on the principle of functional regulation. The law eliminated the legal barriers to affiliations among banks and securities firms, insurance companies, and other financial services companies. The law also provides financial organizations with the opportunity to structure these new financial affiliations through a holding company structure or a financial subsidiary. The law reserves the role of the Federal Reserve as the supervisor for bank holding companies. At the same time, the law also provides a system of functional regulation which is designed to utilize the various existing federal and state regulatory bodies. The law also sets up a process for coordination between the Federal Reserve and the Secretary of the Treasury regarding the approval of new financial activities for both bank holding companies and national bank financial subsidiaries.

 

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The law also includes a minimum federal standard of financial privacy. Financial institutions are required to have written privacy policies that must be disclosed to customers. The disclosure of a financial institution’s privacy policy must take place at the time a customer relationship is established and not less than annually during the continuation of the relationship. The act also provides for the functional regulation of bank securities activities. The law repealed the exemption that banks were afforded from the definition of “broker,” and replaced it with a set of limited exemptions that allow the continuation of some historical activities performed by banks. In addition, the act amended the securities laws to include banks within the general definition of dealer. Regarding new bank products, the law provides a procedure for handling products sold by banks that have securities elements. In the area of CRA activities, the law generally requires that financial institutions address the credit needs of low-to-moderate income individuals and neighborhoods in the communities in which they operate. Bank regulators are required to take the CRA ratings of a bank or of the bank subsidiaries of a holding company into account when acting upon certain branch and bank merger and acquisition applications filed by the institution. Under the law, financial holding companies and banks that desire to engage in new financial activities are required to have satisfactory or better CRA Act ratings when they commence the new activity.

Bank Regulation. CSB is chartered under the national banking laws and is subject to comprehensive regulation, examination and supervision by the OCC. The deposits of the Bank are insured by the FDIC to the extent provided by law. The Bank also is subject to various laws and regulations applicable to banks. Such regulations include limitations on loans to a single borrower and to its directors, officers and employees; restrictions on the opening and closing of branch offices; the maintenance of required capital and liquidity ratios; the granting of credit under equal and fair conditions; and the disclosure of the costs and terms of such credit. The Bank submits to its examining agencies periodic reports regarding its financial condition and other matters. The bank regulatory agencies have a broad range of powers to enforce regulations under their jurisdiction, and to take discretionary actions determined to be for the protection and safety and soundness of banks, including the institution of cease and desist orders and the removal of directors and officers. The bank regulatory agencies also have the authority to approve or disapprove mergers, consolidations, and similar corporate actions.

There are various statutory limitations on our ability to pay dividends. The bank regulatory agencies also have the general authority to limit the dividend payment by banks if such payment may be deemed to constitute an unsafe and unsound practice. For information on the restrictions on the right of our Bank to pay dividends to us, see Part II—Item 5 “Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”

Under federal law, federally insured banks are subject, with certain exceptions, to certain restrictions on any extension of credit to their parent holding companies or other affiliates, on investment in the stock or other securities of affiliates, and on the taking of such stock or securities as collateral from any borrower. In addition, banks are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or the providing of any property or service.

The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) imposed major regulatory reforms, stronger capital standards and stronger civil and criminal enforcement provisions. FIRREA also provides that a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with:

 

    the default of a commonly controlled FDIC insured depository institution; or

 

    any assistance provided by the FDIC to a commonly controlled FDIC insured institution in danger of default.

The FDIC Improvement Act of 1993 (“FDICIA”) made a number of reforms addressing the safety and soundness of deposit insurance funds, supervision, accounting, and prompt regulatory action, and also implemented other regulatory improvements. Periodic full-scope, on-site examinations are required of all insured depository institutions. The cost for conducting an examination of an institution may be assessed to that institution, with special

 

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consideration given to affiliates and any penalties imposed for failure to provide information requested. Insured state banks also are precluded from engaging as principal in any type of activity that is impermissible for a national bank, including activities relating to insurance and equity investments. The Act also recodified restrictions on extensions of credit to insiders under the Federal Reserve Act.

Incentive Compensation Arrangements. In 2010 the Federal Reserve and other regulators jointly published final guidance for structuring incentive compensation arrangements at financial organizations, which guidelines are applicable to all financial institutions. The guidance does not set forth any formulas or pay caps for, but contain certain principles which companies would be required to follow with respect to, employees and groups of employees that may expose the company to material amounts of risk. The three primary principles are (i) balanced risk-taking incentives, (ii) compatibility with effective controls and risk management, and (iii) strong corporate governance. The Federal Reserve will now monitor compliance with this guidance as a part of its safety and soundness oversight.

Capital Requirements. The Federal Reserve and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the risk-based standard, capital is classified into two tiers. Tier 1 capital consists of common shareholders’ equity (excluding the unrealized gain (loss) on available-for-sale securities), trust preferred securities subject to certain limitations, and minus certain intangible assets and disallowed deferred tax assets. Tier 2 capital consists of the general allowance for credit losses except for certain limitations. An institution’s qualifying capital base for purposes of its risk-based capital ratio consists of the sum of its Tier 1 and Tier 2 capital. Until the Basel III capital ratios are phased in at January 1, 2015, the regulatory minimum requirements are 4% for Tier 1 and 8% for total risk-based capital. At December 31, 2013, our Tier 1 and total risk-based capital ratios were 16.6% and 17.9%, respectively.

FDICIA contains “prompt corrective action” provisions pursuant to which banks are to be classified into one of five categories based upon capital adequacy, ranging from “well capitalized” to “critically undercapitalized” and which require (subject to certain exceptions) the appropriate federal banking agency to take prompt corrective action with respect to an institution which becomes “significantly undercapitalized” or “critically undercapitalized.”

The OCC and the FDIC have issued regulations to implement the “prompt corrective action” provisions of FDICIA. In general, the regulations define the five capital categories as follows:

 

    an institution is “well capitalized” if it has a total risk-based capital ratio of 10% or greater, has a Tier 1 risk-based capital ratio of 6% or greater, has a leverage ratio of 5% or greater and is not subject to any written capital order or directive to meet and maintain a specific capital level for any capital measures;

 

    an institution is “adequately capitalized” if it has a total risk-based capital ratio of 8% or greater, has a Tier 1 risk-based capital ratio of 4% or greater, and has a leverage ratio of 4% or greater;

 

    an institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8%, has a Tier 1 risk-based capital ratio that is less than 4% or has a leverage ratio that is less than 4%;

 

    an institution is “significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital ratio that is less than 3% or a leverage ratio that is less than 3%; and

 

    an institution is “critically undercapitalized” if its “tangible equity” is equal to or less than 2% of its total assets.

The OCC and the FDIC, after an opportunity for a hearing, have authority to downgrade an institution from “well capitalized” to “adequately capitalized” or to subject an “adequately capitalized” or “undercapitalized” institution to the supervisory actions applicable to the next lower category, for supervisory concerns.

Generally, FDICIA requires that an “undercapitalized” institution must submit an acceptable capital restoration plan to the appropriate federal banking agency within 45 days after the institution becomes “undercapitalized” and the agency must take action on the plan within 60 days. The appropriate federal banking agency may not accept a capital restoration plan unless, among other requirements, each company having control of the institution has guaranteed that the institution will comply with the plan until the institution has been adequately capitalized on average during each of the three consecutive calendar quarters and has provided adequate assurances of performance. The aggregate liability under this provision of all companies having control of an institution is limited to the lesser of:

 

    5% of the institution’s total assets at the time the institution becomes “undercapitalized” or

 

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    the amount which is necessary, or would have been necessary, to bring the institution into compliance with all capital standards applicable to the institution as of the time the institution fails to comply with the plan filed pursuant to FDICIA

An “undercapitalized” institution may not acquire an interest in any company or any other insured depository institution, establish or acquire additional branch offices or engage in any new business unless the appropriate federal banking agency has accepted its capital restoration plan, the institution is implementing the plan, and the agency determines that the proposed action is consistent with and will further the achievement of the plan, or the appropriate Federal banking agency determines the proposed action will further the purpose of the “prompt corrective action” sections of FDICIA.

If an institution is “critically undercapitalized,” it must comply with the restrictions described above. In addition, the appropriate Federal banking agency is authorized to restrict the activities of any “critically undercapitalized” institution and to prohibit such an institution, without the appropriate Federal banking agency’s prior written approval, from:

 

    entering into any material transaction other than in the usual course of business;

 

    engaging in any covered transaction with affiliates (as defined in Section 23A(b) of the Federal Reserve Act);

 

    paying excessive compensation or bonuses; and

 

    paying interest on new or renewed liabilities at a rate that would increase the institution’s weighted average costs of funds to a level significantly exceeding the prevailing rates of interest on insured deposits in the institution’s normal market areas.

The “prompt corrective action” provisions of FDICIA also provide that in general no institution may make a capital distribution if it would cause the institution to become “undercapitalized.” Capital distributions include cash (but not stock) dividends, stock purchases, redemptions, and other distributions of capital to the owners of an institution.

Additionally, FDICIA requires, among other things, that:

 

    only a “well capitalized” depository institution may accept brokered deposits without prior regulatory approval and

 

    the appropriate federal banking agency annually examine all insured depository institutions, with some exceptions for small, “well capitalized” institutions and state-chartered institutions examined by state regulators.

FDICIA also contains a number of consumer banking provisions, including disclosure requirements and substantive contractual limitations with respect to deposit accounts.

As of December 31, 2013, our subsidiary Bank met the capital requirements of a “well capitalized” institution. Our subsidiary bank has agreed with its primary regulator, OCC, to maintain a Tier 1 leverage ratio (Tier 1 Capital divided by average assets) of at least 8%. At December 31, 2013, its Tier 1 leverage ratio was 10.4%.

Enforcement Powers. Congress has provided the federal bank regulatory agencies with an array of powers to enforce laws, rules, regulations and orders. Among other things, the agencies may require that institutions cease and desist from certain activities, may preclude persons from participating in the affairs of insured depository institutions, may suspend or remove deposit insurance, and may impose civil money penalties against institution-affiliated parties for certain violations.

 

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Maximum Legal Interest Rates. Like the laws of many states, Florida law contains provisions on interest rates that may be charged by banks and other lenders on certain types of loans. Numerous exceptions exist to the general interest limitations imposed by Florida law. The relative importance of these interest limitation laws to the financial operations of the Banks will vary from time to time, depending on a number of factors, including conditions in the money markets, the costs and availability of funds, and prevailing interest rates.

Change of Control. Federal law restricts the amount of voting stock of a bank holding company and a bank that a person may acquire without the prior approval of banking regulators. The overall effect of such laws is to make it more difficult to acquire a bank holding company and a bank by tender offer or similar means than it might be to acquire control of another type of corporation. Consequently, shareholders of the Company may be less likely to benefit from the rapid increases in stock prices that may result from tender offers or similar efforts to acquire control of other companies. Federal law also imposes restrictions on acquisitions of stock in a bank holding company and a state bank. Under the federal Change in Bank Control Act and the regulations thereunder, a person or group must give advance notice to the Federal Reserve before acquiring control of any bank holding company, and the OCC before acquiring control of any national bank. Upon receipt of such notice, the bank regulatory agencies may approve or disapprove the acquisition. The Change in Bank Control Act creates a rebuttable presumption of control if a member or group acquires a certain percentage or more of a bank holding company’s or bank’s voting stock, or if one or more other control factors set forth in the Act are present.

Anti-Money Laundering Requirements. Under federal law, including the Bank Secrecy Act, the PATRIOT Act and the International Money Laundering Abatement and Anti-Terrorist Financing Act, certain types of financial institutions, including insured depository institutions, must maintain anti-money laundering programs that include established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. Among other things, these laws are intended to strengthen the ability of U.S. law enforcement agencies and intelligence communities to work together to combat terrorism on a variety of fronts. Financial institutions are prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and customer identification in their dealings with non-U.S. financial institutions and non-U.S. customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious information maintained by financial institutions. Bank regulators routinely examine institutions for compliance with these obligations and they must consider an institution’s compliance in connection with the regulatory review of applications, including applications for banking mergers and acquisitions. The regulatory authorities have imposed “cease and desist” orders and civil money penalty sanctions against institutions found to be violating these obligations.

The OFAC is responsible for helping to insure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC publishes lists of persons, organizations and countries suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If we or our Bank find a name on any transaction, account or wire transfer that is on an OFAC list, we or our Bank must freeze or block such account or transaction, file a suspicious activity report and notify the appropriate authorities.

Consumer Laws and Regulations. Banks and other financial institutions are subject to numerous laws and regulations intended to protect consumers in their transactions with banks. These laws include, among others, laws regarding unfair and deceptive acts and practices and usury laws, as well as the following consumer protection statutes: Truth in Lending Act, Truth in Savings Act, Electronic Funds Transfer Act, Expedited Funds Availability Act, Equal Credit Opportunity Act, Fair and Accurate Credit Transactions Act, Fair Housing Act, Fair Credit Reporting Act, Fair Debt Collection Act, GLB Act, Home Mortgage Disclosure Act, Right to Financial Privacy Act and Real Estate Settlement Procedures Act.

Many states and local jurisdictions have consumer protection laws analogous, and in addition, to those listed above. These federal, state and local laws regulate the manner in which financial institutions deal with customers when taking deposits, making loans or conducting other types of transactions. Failure to comply with these laws and regulations could give rise to regulatory sanctions, customer rescission rights, action by state and local attorneys general and civil or criminal liability.

 

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Sarbanes-Oxley Act. In 2002, the Sarbanes-Oxley Act was enacted which imposes a myriad of corporate governance and accounting measures designed that shareholders are treated and have full and accurate information about the public companies in which they invest. All public companies are affected by the Act. Some of the principal provisions of the Act include:

 

    the creation of an independent accounting oversight board (“PCAOB”) to oversee the audit of public companies and auditors who perform such audits;

 

    auditor independence provisions which restrict non-audit services that independent accountants may provide to their audit clients;

 

    additional corporate governance and responsibility measures which (a) require the chief executive officer and chief financial officer to certify financial statements and internal controls and to forfeit salary and bonuses in certain situations, and (b) protect whistleblowers and informants;

 

    expansion of the authority and responsibilities of the company’s audit, nominating and compensation committees;

 

    mandatory disclosure by analysts of potential conflicts of interest; and

 

    enhanced penalties for fraud and other violations.

Effect of Governmental Policies. Our earnings and businesses are affected by the policies of various regulatory authorities of the United States, especially the Federal Reserve. The Federal Reserve, among other things, regulates the supply of credit and deals with general economic conditions within the United States. The instruments of monetary policy employed by the Federal Reserve for those purposes influence in various ways the overall level of investments, loans, other extensions of credit, and deposits, and the interest rates paid on liabilities and received on assets.

Competition

We encounter strong competition both in making loans and in attracting deposits. The deregulation of the banking industry and the widespread enactment of state laws which permit multi-bank holding companies as well as an increasing level of interstate banking have created a highly competitive environment for commercial banking. In one or more aspects of its business, we compete with other commercial banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries. Most of these competitors, some of which are affiliated with bank holding companies, have substantially greater resources and lending limits, and may offer certain services that we do not currently provide. In addition, many of our non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks. Legislation has continued to heighten the competitive environment in which financial institutions must conduct their business, and the potential for competition among financial institutions of all types has increased significantly.

To compete, we rely upon specialized services, responsive handling of customer needs, and personal contacts by its officers, directors, and staff. Large multi-branch banking competitors tend to compete primarily by rate and the number and location of branches while smaller, independent financial institutions tend to compete primarily by rate and personal service.

 

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Employees

As of December 31, 2013, we had a total of approximately 693 full-time equivalent employees. The employees are not represented by a collective bargaining unit. We consider relations with employees to be good.

Statistical Profile and Other Financial Data

Reference is hereby made to the statistical and financial data contained in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for statistical and financial data providing a review of our Company’s business activities.

Availability of Reports furnished or filed with the Securities and Exchange Commission (SEC)

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available on our internet website at www.centerstatebanks.com.

 

Item 1A. Risk Factors

We have identified risk factors described below, which should be viewed in conjunction with the other information contained in this document and information incorporated by reference, including our consolidated financial statements and related notes. If any of the following risks or other risks which have not been identified or which we may believe are immaterial or unlikely, actually occur, our business, financial condition and results of operations could be harmed. As noted previously, this report contains forward-looking statements that involve risks and uncertainties, including statements about our future plans, objectives, intentions and expectations. Many factors, including those described below, could cause actual results to differ materially from those discussed in forward-looking statements.

Risks relating to our industry and operations

The banking crisis that began in 2008 in the United States and globally has adversely affected our industry, including our business, and may continue to have an adverse effect on our business in the future.

Dramatic declines in the housing market which began in 2008, and increases in unemployment and under-employment, negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. The crisis caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. This economic turmoil and tightening of credit led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and the lack of confidence in the financial markets adversely affected the banking industry, as well as financial condition and operating results. Although economic conditions have been slowly improving, future market developments could affect consumer confidence levels and cause adverse changes in loan payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and the provision for credit losses. Changes in the financial services industry and the effects of the Dodd-Frank Act, Basel III and other regulatory responses to the credit crisis also could negatively affect us by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance.

The soundness of other financial institutions could adversely affect us.

Our ability to engage in routine funding and other transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. Defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and losses of depositor, creditor and counterparty confidence and could lead to losses or defaults by us or by other institutions. We could experience increases in deposits and assets as a result of other banks’ difficulties or failure, which would increase the capital we need to support our growth.

 

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Recent Legislative and Regulatory Initiatives Could Affect Our Operations

The Dodd-Frank Act has resulted in sweeping changes in the regulation of financial institutions aimed at strengthening the sound operation of the financial services sector. The Dodd-Frank Act’s provisions that have received the most public attention have generally been those applying to or more likely to affect larger institutions. However, the Act contains numerous other provisions that will affect all banks and bank holding companies, and will fundamentally change the system of oversight. Some of these provisions may have the consequence of increasing our expenses, decreasing our revenues, and changing the activities in which we choose to engage. The environment in which banking organizations will operate, including legislative and regulatory changes affecting capital, liquidity, supervision, permissible activities, corporate governance and compensation, changes in fiscal policy and steps to eliminate government support for banking organizations, may have long-term effects on the business model and profitability of banking organizations that cannot now be foreseen. The specific impact of the Dodd-Frank Act on our current activities or new financial activities that we may consider in the future, our financial performance, and the markets in which we operate, will depend on the manner in which the relevant agencies develop and implement the required rules and the reaction of market participants to these regulatory developments.

Our loan portfolio includes commercial and commercial real estate loans that may have higher risks.

Our commercial and commercial real estate loans at December 31, 2013 and 2012 were $672.0 million and $604.7 million, respectively, or 54% and 53% of total loans, excluding loans covered by FDIC loss share agreements. Commercial and commercial real estate loans generally carry larger loan balances and can involve a greater degree of financial and credit risk than other loans. As a result, banking regulators continue to give greater scrutiny to lenders with a high concentration of commercial real estate loans in their portfolios, and such lenders are expected to implement stricter underwriting, internal controls, risk management policies and portfolio stress testing, as well as higher capital levels and loss allowances. The increased financial and credit risk associated with these types of loans are a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans.

The federal bank regulatory agencies have released guidance on “Concentrations in Commercial Real Estate Lending” (the “Guidance”). The Guidance defines commercial real estate loans as exposures secured by raw land, land development and construction (including 1-4 family residential construction), multi-family property, and non-farm nonresidential property where the primary or a significant source of repayment is derived from rental income associated with the property (that is, loans for which 50% or more of the source of repayment comes from third party, non-affiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. The Guidance requires that appropriate processes be in place to identify, monitor and control risks associated with real estate lending concentrations. This could include enhanced strategic planning, underwriting policies, risk management, internal controls, portfolio stress testing and risk exposure limits as well as appropriately designed compensation and incentive programs. Higher allowances for loan losses and capital levels may also be required. The Guidance is triggered when commercial real estate loan concentrations exceed either:

total reported loans for construction, land development, and other land of 100% or more of a bank’s total capital (as of December 31, 2013, our consolidated ratio was 17%); or

Total reported loans secured by multifamily and nonfarm nonresidential properties and loans for construction, land development, and other land of 300% or more of a bank’s total capital (as of December 31, 2013, our consolidated ratio was 118%).

The Guidance applies to the lending activities of our subsidiary bank. Regulators have the right to request banks to maintain elevated levels of capital or liquidity due to commercial real estate loan concentrations, and could do so, especially if there is a further downturn in our local real estate markets.

 

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In addition, when underwriting a commercial or industrial loan, we may take a security interest in commercial real estate, and, in some instances upon a default by the borrower, we may foreclose on and take title to the property, which may lead to potential financial risks for us under applicable environmental laws. If hazardous substances were discovered on any of these properties, we may be liable to governmental agencies or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether the Company knew of, or were responsible for, the contamination.

Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate or commercial project. If the cash flows from the project are reduced, a borrower’s ability to repay the loan may be impaired. This cash flow shortage may result in the failure to make loan payments. In such cases, we may be compelled to modify the terms of the loan. In addition, the nature of these loans is such that they are generally less predictable and more difficult to evaluate and monitor. As a result, repayment of these loans may, to a greater extent than residential loans, be subject to adverse conditions in the real estate market or economy.

Our business is subject to the success of the local economies where we operate.

Our success significantly depends upon the growth in population, income levels, deposits and housing starts in our primary and secondary markets. During the recent economic downturn, the rate of growth of each of these four factors has decreased substantially and in some cases has turned negative. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally continue to remain challenging, our business may be adversely affected. Our specific market areas have experienced decreased growth, which has affected the ability of our customers to repay their loans to us and has generally affected our financial condition and results of operations. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.

A significant portion of our loan portfolio is secured by real estate, substantially all of which is located in Florida, and events that negatively impact the real estate market could hurt our resultant business.

Substantially all of our loans are concentrated in Florida and subject to the volatility of the state’s economy and real estate market. With our loans concentrated in Florida, the decline in local economic conditions has adversely affected the values of our real estate collateral and will likely continue to do so for the foreseeable future. Consequently, a continued decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse.

In addition to relying on the financial strength and cash flow characteristics of the borrower in each case, we often secure loans with real estate collateral. At December 31, 2013, approximately 87% of our loans have real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower but may deteriorate in value during the time credit is extended. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.

An inadequate allowance for loan losses would reduce our earnings.

The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectability of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectability is considered

 

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questionable. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb losses, or if bank regulatory authorities require us to increase the allowance for loan losses as a part of their examination process, our earnings and capital could be significantly and adversely affected.

A lack of liquidity could affect our operations and jeopardize our financial condition.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our funding sources include federal funds purchased, securities sold under repurchase agreements, non-core deposits, and short- and long-term debt. There are other sources of liquidity available to us should they be needed, including our ability to acquire additional non-core deposits, the issuance and sale of debt securities, and the issuance and sale of preferred or common securities in public or private transactions. Our access to funding sources in amounts adequate to finance or capitalize our activities or on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Our ability to borrow could be impaired by factors that are not specific to us, such as further disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.

We are required to maintain capital to meet regulatory requirements, and if we fail to maintain sufficient capital, whether due to losses, an inability to raise additional capital or otherwise, our financial condition, liquidity and results of operations, as well as our ability to maintain regulatory compliance, would be adversely affected.

Our bank holding company and our subsidiary bank must meet regulatory capital requirements and maintain sufficient liquidity. Banking organizations experiencing growth, especially those making acquisitions are expected to hold additional capital, above regulatory minimums. From time to time, the regulators implement changes to these regulatory capital adequacy guidelines, such as through the Dodd-Frank Act and the Basel III initiatives described above. It is anticipated that when fully implemented by the banking agencies and fully phased-in, these standards will result in higher and more stringent capital requirements for us and our banking subsidiary. In particular, the Basel III proposals will require us to maintain an increased minimum ratio of Tier 1 common equity to risk weighed assets.

Actions (if necessary) to increase capital, may adversely affect us. Our ability to raise additional capital, when and if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry and market condition, and governmental activities, many of which are outside our control, and on our financial condition and performance. Accordingly, we cannot assure you that we will be able to raise additional capital if needed or on terms acceptable to us. If we fail to meet these capital and other regulatory requirements, our financial condition, liquidity and results of operations would be materially and adversely affected.

Our failure to remain “well capitalized” for bank regulatory purposes could affect customer confidence, our ability to grow, our costs of funds and FDIC insurance costs, our ability to pay dividends on common stock and make distributions on our trust preferred securities, our ability to make acquisitions, and our business, results of operations and financial condition. Under FDIC rules, if our subsidiary bank ceases to be a “well capitalized” institution for bank regulatory purposes, the interest rates that it pays and its ability to accept brokered deposits may be restricted. Although we had no wholesale brokered deposits as of December 31, 2013, we had approximately $0.3 million of in-market CDARs deposits, which are considered brokered deposits for regulatory purposes.

Our business strategy includes continued growth, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.

We intend to continue pursuing a growth strategy for our business. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in significant growth stages of development. Particularly in light of prevailing economic conditions, we cannot assure you we will be able to

 

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expand our market presence in our existing markets or successfully enter new markets or that any such expansion will not adversely affect our results of operations. Failure to manage our growth effectively could have a material adverse effect on our business, future prospects, financial condition or results of operations, and could adversely affect our ability to successfully implement our business strategy. Also, if our growth occurs more slowly than anticipated or declines, our operating results could be materially adversely affected.

Our ability to successfully grow will depend on a variety of factors including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas, our ability to continue to implement and improve our operational, credit, financial, management and other risks controls and processes and our reporting systems and procedures in order to manage a growing number of client relationships, and our ability to integrate our acquisitions and develop consistent policies throughout our various businesses. While we believe we have the management resources and internal systems in place to successfully manage our future growth, there can be no assurance growth opportunities will be available or growth will be successfully managed. In addition, if we are unable to manage future expansion in our operations, we may experience compliance and operational problems, have to slow the pace of growth, or have to incur additional expenditures beyond current projections to support such growth, any of which could adversely affect our business.

We may face risks with respect to future expansion.

We may acquire other financial institutions through FDIC assisted transactions or otherwise or parts of those institutions in the future and we may engage in additional de novo branch expansion. We may also consider and enter into new lines of business or offer new products or services. We also may receive future inquiries and have discussions with potential acquirors of us. Acquisitions and mergers involve a number of risks, including:

the time and costs associated with identifying and evaluating potential acquisitions and merger partners;

inaccurate estimates and judgments regarding credit, operations, management and market risks of the target institution;

the time and costs of evaluating new markets, hiring experienced local management and opening new offices, and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;

our ability to receive regulatory approvals on terms that are acceptable to us;

our ability to finance an acquisition and possible dilution to our existing shareholders;

the diversion of our management’s attention to the negotiation of a transaction, and the integration of the operations and personnel of the combining businesses;

entry into new markets where we lack experience;

the strain of growth on our infrastructure, staff, internal controls and management, which may require additional personnel, time and expenditures;

exposure to potential asset quality issues with acquired institutions;

the introduction of new products and services into our business;

the possibility of unknown or contingent liabilities;

the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations; and

the risk of loss of key employees and customers.

We may incur substantial costs to expand, and we can give no assurance such expansion will result in the levels of profits we seek. There can be no assurance that integration efforts for any future mergers or acquisitions will be successful. Also, we may issue equity securities, including common stock and securities convertible into shares of our common stock, in connection with future acquisitions, which could cause ownership and economic

 

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dilution to our current shareholders and to investors purchasing common stock in this offering. There is no assurance that, following any future mergers or acquisitions, our integration efforts will be successful or our company, after giving effect to the acquisition, will achieve profits comparable to or better than our historical experience.

The FDIC-assisted transactions we have engaged in or may engage in could present additional risks to our business.

We have closed six FDIC-assisted transactions and continue to seek opportunities to continue to acquire the assets and liabilities of other failed banks in FDIC-assisted transactions. Current and future FDIC-assisted transactions present the risks of acquisitions, generally, as well as some risks specific to these transactions. These FDIC-assisted transactions typically provide for FDIC assistance, including potential loss-sharing, to an acquirer to mitigate the credit risks of acquired loans and securities, which, may include loss-sharing. FDIC-assisted transactions have many of the same risks we could face in acquiring another open bank without FDIC assistance, including risks associated with competitive bidding and pricing of such transactions, the risk of loss of deposits and, liquidity through runoff or customer attrition, and failure to realize the anticipated acquisition benefits in the amounts and within the timeframes we expect. In addition, because these acquisitions provide for limited diligence and negotiation of terms, these transactions may pose risks not present in open bank transactions. Loss sharing with the FDIC reduces the credit risks of, and capital required for, FDIC-assisted transactions, but requires additional resources and time to service acquired problem loans, costs related to integration of personnel and operating systems, and the establishment of processes and internal controls to service acquired assets in accordance with FDIC standards. We are subject to audit by the FDIC at its discretion to insure we are in compliance with the terms of our FDIC agreements. We may experience difficulties with complying with the requirements of the loss sharing agreements, the terms of which are extensive and failure to comply with any of the terms could result in a specific asset or group of assets losing their loss sharing coverage. The FDIC also has the right to refuse or delay payment partially or in full for such loan losses if we fail to comply with the terms of the loss sharing agreements, which are extensive. Our loss sharing agreements also impose limitations on how we manage loans covered by loss sharing. If we are unable to manage these risks, FDIC-assisted acquisitions could have material adverse effect on our business, financial condition and results of operations.

Attractive acquisition opportunities may not be available to us in the future.

While we seek continued organic growth, as our earnings and capital position improve, we may consider the acquisition of other businesses, including, as discussed above, failed depository institutions offered for sale in FDIC-assisted transactions. The FDIC determines the timing and terms of the sale of failed institutions, and selects the winning bidder based on the “least cost” to the FDIC. The failed banks offered for sale may or may not meet our business objectives. We expect that other banking and financial companies, many of which have significantly greater resources, will compete with us to acquire financial services businesses. This competition could increase prices for potential acquisitions, including the premiums on deposits and the prices paid for assets in FDIC-assisted transactions. This could reduce our potential returns, and reduce the attractiveness of these opportunities and increase their credit and other risks. Also, acquisitions are subject to various regulatory approvals. If we fail to receive the appropriate regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests. Among other things, our regulators consider our capital, liquidity, profitability, regulatory compliance and levels of goodwill and intangibles when considering acquisition and expansion proposals. Any acquisition could be dilutive to our earnings and shareholders’ equity per share of our common stock.

Our recent results may not be indicative of our future results.

We may not be able to sustain our historical rate of growth or may not even be able to grow our business at all. In addition, our recent growth may distort some of our historical financial ratios and statistics. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or prohibit our ability to expand our market presence. If we experience a significant decrease in our historical rate of growth, our results of operations and financial condition may be adversely affected due to a high percentage of our operating costs being fixed expenses.

 

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Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, there is no assurance as to our ability to raise additional capital if needed on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.

Our asset and liability structures are monetary in nature and are affected by a variety of factors, including changes in interest rates, which can impact the value of our assets.

Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earnings assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Because different types of assets and liabilities may react differently and at different times to market interest rate changes, changes in interest rates can increase or decrease net interest income. Interest rates are sensitive to many factors that are beyond our control, including general economic conditions, competition and policies of various governmental and regulatory agencies and, in particular, the policies of the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest our Banks receive on loans and investment securities and the amount of interest they pay on deposits and borrowings, but such changes could also affect (i) the Bank’s ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, including the available for sale securities portfolio, and (iii) the average duration of our interest-earning assets. Changes in monetary policy could also expose us to the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest rates or rates indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk), including a prolonged flat or inverted yield curve environment. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations.

Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.

The FDIC insures deposits at FDIC-insured depository institutions, such as our subsidiary bank, up to applicable limits. The amount of a particular institution’s deposit insurance assessment is based on that institution’s risk classification under an FDIC risk-based assessment system. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to its regulators. Market developments have significantly depleted the deposit insurance fund of the FDIC (which is referred to as the “DIF”) and reduced the ratio of reserves to insure deposits. As a result of recent economic conditions and the enactment of the Dodd-Frank Act, the FDIC has increased the deposit insurance assessment rates and thus raised deposit premiums for insured depository institutions. If these increases are insufficient for the DIF to meet its funding requirements, there may need to be further special assessments or increases in deposit insurance premiums. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay even higher FDIC premiums than the recently increased levels. Any future additional assessments, increases or required prepayments in FDIC insurance premiums may materially adversely affect results of operations, including by reducing our profitability or limiting our ability to pursue business opportunities.

 

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Past levels of market volatility are unprecedented.

The capital and credit markets have experienced volatility and disruption the past several years. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial condition or performance. If these periodic market disruptions and volatility continue or worsen, we may experience adverse effects, which may be material, on our ability to maintain or access capital and on our business, financial condition and results of operations.

Our cost of funds may increase as a result of general economic conditions, FDIC insurance assessments, interest rates and competitive pressures.

Our cost of funds may increase as a result of general economic conditions, FDIC insurance assessments, interest rates and competitive pressures. We have traditionally obtained funds principally through local deposits and we have a base of lower cost transaction deposits. Generally, we believe local deposits are a less expensive and more stable source of funds than other borrowings because interest rates paid for local deposits are typically lower than interest rates charged for borrowings from other institutional lenders and reflect a mix of transaction and time deposits, whereas brokered deposits typically are higher cost time deposits. Our costs of funds and our profitability and liquidity are likely to be adversely affected, if and to the extent we have to rely upon higher cost borrowings from other institutional lenders or brokers to fund loan demand or liquidity needs, and changes in our deposit mix and growth could adversely affect our profitability and the ability to expand our loan portfolio.

Competition from financial institutions and other financial service providers may adversely affect our profitability.

The banking business is highly competitive and we experience competition in our markets from many other financial institutions. We compete with commercial banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national and international financial institutions that operate offices in our primary market areas and elsewhere.

We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our primary markets, we may face a competitive disadvantage as a result of our smaller size, lack of geographic diversification and inability to spread our marketing costs across a broader market. Although we compete by concentrating our marketing efforts in our primary markets with local advertisements, personal contacts, and greater flexibility and responsiveness in working with local customers, we can give no assurance this strategy will be successful.

We are subject to extensive regulation that could limit or restrict our activities.

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various federal and state agencies, including the Federal Reserve, the OCC, the FDIC, FINRA, and the SEC. These regulations are primarily intended to protect depositors, not shareholders. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth.

The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.

 

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We are dependent upon the services of our management team.

Our future success and profitability are substantially dependent upon the management and banking abilities of our senior executives. Although we currently have employment agreements in place with our senior management team, we cannot guarantee you that our senior executives will remain with us. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition and results of operations. We believe that our future results will also depend in part upon our attracting and retaining highly skilled and qualified management and sales and marketing personnel. Competition for such personnel is intense, and we cannot assure you that we will be successful in retaining such personnel.

Technological changes affect our business, and we may have fewer resources than many competitors to invest in technological improvements.

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to serving clients better, the effective use of technology may increase efficiency and may enable financial institutions to reduce costs. Our future success will depend, in part, upon our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in operations. We may need to make significant additional capital investments in technology in the future, and we may not be able to effectively implement new technology-driven products and services. Many competitors have substantially greater resources to invest in technological improvements.

Hurricanes or other adverse weather events would negatively affect our local economies or disrupt our operations, which would have an adverse effect on our business or results of operations.

Our market areas in Florida are susceptible to hurricanes and tropical storms and related flooding and wind damage. Such weather events can disrupt operations, result in damage to properties and negatively affect the local economies in the markets where they operate. We cannot predict whether or to what extent damage that may be caused by future hurricanes will affect our operations or the economies in our current or future market areas, but such weather events could result in a decline in loan originations, a decline in the value or destruction of properties securing our loans and an increase in delinquencies, foreclosures or loan losses. Our business or results of operations may be adversely affected by these and other negative effects of future hurricanes or tropical storms, including flooding and wind damage. Many of our customers have incurred significantly higher property and casualty insurance premiums on their properties located in our markets, which may adversely affect real estate sales and values in those markets.

Risks Relating to our Common Stock

We have various provisions in our articles of incorporation that could impede a takeover of CenterState.

Our articles of incorporation contain provisions providing for the ability to issue preferred stock without shareholder approval. Although these provisions were not adopted for the express purpose of preventing or impeding the takeover of CenterState without the approval of our board of directors, such provisions may have that effect. Such provisions may prevent our shareholders from taking part in a transaction in which our shareholders could realize a premium over the current price of our common stock.

Future capital needs could result in dilution of shareholder investment.

Our board of directors may determine from time to time there is a need to obtain additional capital through the issuance of additional shares of our common stock or other securities. These issuances would dilute the ownership interest of our shareholders and may dilute the per share book value of our common stock. New investors also may have rights, preferences and privileges senior to our shareholders which may adversely impact our shareholders.

 

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The trading volume in our common stock and the sale of substantial amounts of our common stock in the public market could depress the price of our common stock

We cannot predict the effect, if any, that future sales of our common stock in the market, or availability of shares of our common stock for sale in the market, will have on the market price of our common stock. We therefore can give no assurance that sales of substantial amounts of our common stock in the market, or the potential for large amounts of sales in the market, would not cause the price of our common stock to decline or impair our ability to raise capital through sales of our common stock.

Our ability to pay dividends is limited and we may be unable to pay future dividends

During the last 19 fiscal quarters, we paid cash dividends of $0.01 per common share. Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital. The ability of our subsidiary bank to pay dividends to us is limited by our obligations to maintain sufficient capital and by other general restrictions on our dividends that are applicable to national banks that are regulated by the OCC. If we do not satisfy these regulatory requirements, we will be unable to pay dividends on our common stock.

Holders of our junior subordinated debentures have rights that are senior to those of our common stockholders

We have helped support our continued growth through the issuance of, and the acquisition of, through prior mergers, trust preferred securities from special purpose trusts and accompanying junior subordinated debentures. At December 31, 2013, we had outstanding trust preferred securities and accompanying junior subordinated debentures totaling $17.5 million. In addition, we assumed in the Gulfstream merger $10.0 million of trust preferred securities and accompanying junior subordinated debentures issued by Gulfstream. Payments of the principal and interest on these debt instruments are conditionally guaranteed by us. Further, the accompanying junior subordinated debentures we issued to the special purpose trusts are senior to our shares of common stock. As a result, we must make payments on the junior subordinated debentures before any dividends can be paid on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the junior subordinated debentures must be satisfied before any distributions can be made on our common stock. We have the right to defer distributions on our junior subordinated debentures (and the related trust preferred securities) for up to five years, during which time no dividends may be paid on our common stock.

Our shareholders include five funds owning approximately 27% of our common stock and they may exercise significant influence over us and their interests may be different from our other shareholders.

Our shareholders include five funds that collectively own approximately 27% of the outstanding shares of our common stock. While the federal banking laws require prior bank regulatory approval if shareholders owning in excess of 9.9% of a bank holding company’s outstanding voting shares desire to act in concert, nonetheless the five funds could vote the same way on matters submitted to our shareholders without being deemed to be acting in concert and, if so, could exercise significant influence over us and actions taken by our shareholders. Interests of institutional funds may be different from our other shareholders. Accordingly, given their collective ownership, the funds could have significant influence over whether or not a proposal submitted to our shareholders receives required shareholder approval.

 

Item 1B. Unresolved Staff Comments

None

 

Item 2. Properties

Our Holding Company owns no real property. Our corporate office is leased from our subsidiary bank, and is located at 42745 U.S. Highway 27, Davenport, Florida 33837. At the end of 2013, through our subsidiary bank, we operated a total of 55 banking offices in 18 counties in central and northeast Florida. We own 45 and lease 10 of these offices. In addition to our banking locations, we lease non-banking office space in Winter Haven, Florida for IT and operations purposes. We also lease office space for our Correspondent banking division, primarily in Birmingham, Alabama and in Atlanta, Georgia. See Note 8 to the Consolidated Financial Statements of our Company included in this Annual Report on Form 10-K and Managements Discussion and Analysis – Bank Premises and Equipment, for additional information regarding our premises and equipment.

 

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Item 3. Legal Proceedings

Our subsidiary bank is periodically a party to or otherwise involved in legal proceedings arising in the normal course of business, such as claims to enforce liens, claims involving the making and servicing of real property loans, and other issues incident to their respective businesses. The Bank also has received and responded to several grand jury subpoenas (the “Subpoenas”) from the United States District Court for the Northern District of Florida related to an approximately $3.8 million loan the Bank extended to Coastal Community Investments, Inc., a bank holding company (“Coastal”) in December 2008 (the “Coastal Loan”). The Coastal Loan was guaranteed and paid by the FDIC under the Temporary Liquidity Guaranty Program following the failure of Coastal’s bank subsidiaries. The Bank is cooperating with the government’s investigation and has provided the information requested in the Subpoenas. In accordance with law and the Bank’s articles of association and bylaws, the Bank is advancing legal expenses to several Bank officers where separate representation from the Bank was deemed advisable.

We do not believe any pending or threatened legal proceedings in the ordinary course against the Bank would have a material adverse effect on our consolidated results of operations or consolidated financial position, however, we cannot predict the timing or findings of the grand jury investigation or their effects upon us.

 

Item 4. [Removed and Reserved]

 

 

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PART II

 

Item 5. Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The shares of our Common Stock are traded on the NASDAQ Global Select Market. The following sets forth the high and low trading prices for trades of our Common Stock that occurred during 2013 and 2012.

 

     2013      2012  
     High      Low      High      Low  

1st Quarter

   $ 8.98       $ 8.33       $ 8.28       $ 6.29   

2nd Quarter

   $ 9.39       $ 7.38       $ 8.38       $ 6.55   

3rd Quarter

   $ 10.42       $ 8.67       $ 9.22       $ 7.11   

4th Quarter

   $ 10.80       $ 9.16       $ 9.15       $ 7.00   

As of December 31, 2013, there are 30,112,475 shares of common stock outstanding. As of this same date we have approximately 776 shareholders of record, as reported by our transfer agent, Continental Stock Transfer & Trust Company.

Dividends

We have historically paid cash dividends on a quarterly basis, on the last business day of the calendar quarter. The following sets forth per share cash dividends paid during 2013 and 2012.

 

     2013      2012  

1st Quarter

   $ 0.01       $ 0.01   

2nd Quarter

   $ 0.01       $ 0.01   

3rd Quarter

   $ 0.01       $ 0.01   

4th Quarter

   $ 0.01       $ 0.01   

The payment of dividends is a decision of our Board of Directors based upon then-existing circumstances, including our rate of growth, profitability, financial condition, existing and anticipated capital requirements, the amount of funds legally available for the payment of cash dividends, regulatory constraints and such other factors as the Board determines relevant. Our source of funds for payment of dividends is dividends received from our Bank, or excess cash available to us. Payments by our subsidiary Bank to us are limited by law and regulations of the bank regulatory authorities. There are various statutory and contractual limitations on the ability of our Bank to pay dividends to us. The bank regulatory agencies also have the general authority to limit the dividends paid by banks if such payment may be deemed to constitute an unsafe and unsound practice. Our Bank may not pay dividends from its paid-in surplus. All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts. In addition, a national bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital, unless there has been transferred to surplus no less than one/tenth of the bank’s net profits of the preceding two consecutive half-year periods (in the case of an annual dividend). The approval of the OCC is required if the total of all dividends declared by a national bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus.

Share Repurchases

We did not repurchase any shares of our common stock during 2013.

 

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Stock Plans

With respect to information regarding our securities authorized for issuance under equity incentive plans, the information contained in the section entitled “Equity Compensation Plan Information” in our Definitive Proxy Statement for the 2014 Annual Meeting of Shareholders is incorporated herein by reference.

Performance Graph

Shares of our common stock are traded on the NASDAQ Global Select Market. The following graph compares the yearly percentage change in cumulative shareholder return on the Company’s common stock, with the cumulative total return of the S&P 500 Index and the SNL Southeast Bank Index, since December 31, 2008 (assuming a $100 investment on December 31, 2008 and reinvestment of all dividends).

 

LOGO

 

     2008      2009      2010      2011      2012      2013  

CenterState Banks, Inc.

     100         59         47         39         50         60   

S&P 500

     100         123         139         139         158         205   

SNL Southeast Bank Index

     100         99         95         55         91         122   

 

 

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Item 6. Selected Consolidated Financial Data

Use of Non-GAAP Financial Measures and Ratios

The accounting and reporting policies of the Company conform to generally accepted accounting principles (“GAAP”) in the United States and prevailing practices in the banking industry. However, certain non-GAAP performance measures and ratios are used by management to evaluate and measure the Company’s performance. These include taxable-equivalent net interest income (including its individual components), net interest margin (including its individual components), the efficiency ratio, tangible assets, tangible shareholders’ equity, tangible book value per common share, and tangible equity to tangible assets. Management believes that these measures and ratios provide users of the Company’s financial information with a more meaningful view of the performance of the interest-earning assets and interest-bearing liabilities and of the Company’s operating efficiency. Other financial holding companies may define or calculate these measures and ratios differently. Management also uses non-GAAP financial measures to help explain the variance in total non-interest expenses excluding merger and acquisition related expenses, impairment of bank property held for sale, credit related expenses and correspondent banking division expenses between the periods presented. Management uses this non-GAAP financial measure in its analysis of the Company’s performance and believes this presentation provides useful supplemental information, and a clearer understanding of the Company’s non-interest expense between periods presented.

Management reviews yields on certain asset categories and the net interest margin of the Company and its banking subsidiaries on a fully taxable equivalent basis. In this non-GAAP presentation, net interest income is adjusted to reflect tax-exempt interest income on an equivalent before-tax basis. This measure ensures the comparability of net interest income arising from both taxable and tax-exempt sources. Net interest income on a fully taxable equivalent basis is also used in the calculation of the Company’s efficiency ratio. The efficiency ratio is calculated by dividing non-interest expense (less nonrecurring items, credit related expenses and intangible amortization ) by total taxable-equivalent net interest income and non-interest income (less securities gains or losses, FDIC indemnification income and nonrecurring items). The efficiency ratio is also calculated excluding correspondent income and expense from the calculation. These measures provide an estimate of how much it costs to produce one dollar of revenue. The items excluded from this calculation provide a better match of revenue from daily operations to operational expenses.

Tangible assets is defined as total assets reduced by goodwill and other intangible assets. Tangible common equity is defined as total common equity reduced by goodwill and other intangible assets. Tangible common equity to tangible assets is defined as tangible common equity divided by tangible assets. These measures are important to many investors in the marketplace who are interested in the common equity to assets ratio exclusive of the effect of changes in intangible assets on common equity and total assets.

Tangible common equity per common share outstanding is defined as tangible common equity divided by total common shares outstanding. This measure is important to many investors in the marketplace who are interested in changes from period to period in book value per share exclusive of changes in intangible assets. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing total book value while not increasing our tangible book value.

These disclosures should not be considered in isolation or a substitute for results determined in accordance with GAAP, and are not necessarily comparable to non-GAAP performance measures which may be presented by other bank holding companies. Management compensates for these limitations by providing detailed reconciliations between GAAP information and the non-GAAP financial measures.

 

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The following tables present a reconciliation of certain non-GAAP performance measures and ratios used by the Company to evaluate and measure the Company’s performance to the most directly comparable GAAP financial measures:

 

     Years ended December 31,  

(Dollars in thousands, except per share data)

   2013     2012     2011     2010     2009  

Income Statement Non-GAAP measures and ratios

          

Interest income (GAAP)

          

Noncovered loans

   $ 55,897      $ 58,050      $ 54,497      $ 51,538      $ 53,428   

Covered loans

     32,377        23,542        11,396        4,159        —     

Securities—taxable

     9,889        11,297        14,296        16,833        18,436   

Securities—tax-exempt

     1,430        1,423        1,422        1,424        1,472   

Federal funds sold and other

     785        638        632        626        608   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Interest income (GAAP)

     100,378        94,950        82,243        74,580        73,944   

Taxable equivalent adjustment

          

Noncovered loans

     628        646        539        113        100   

Securities—tax-exempt

     744        697        678        645        626   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total tax equivalent adjustment

     1,372        1,343        1,217        758        726   

Interest income—tax equivalent

          

Noncovered loans

     56,525        58,696        55,036        51,651        53,528   

Covered loans

     32,377        23,542        11,396        4,159        —     

Securities—taxable

     9,889        11,297        14,296        16,833        18,436   

Securities—tax-exempt

     2,174        2,120        2,100        2,069        2,098   

Federal funds sold and other

     785        638        632        626        608   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income—tax equivalent

     101,750        96,293        83,460        75,338        74,670   

Total interest expense (GAAP)

     (5,885     (8,481     (12,207     (16,742     (22,290
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income—tax equivalent

   $ 95,865      $ 87,812      $ 71,253      $ 58,596      $ 52,380   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (GAAP)

   $ 94,493      $ 86,469      $ 70,036      $ 57,838      $ 51,654   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Yields and costs

          

Yield on noncovered loans—tax equivalent

     4.79     5.21     5.31     5.49     5.80

Yield on loans—tax equivalent

     6.18     5.67     5.46     5.45     5.80

Yield on securities tax-exempt—tax equivalent

     5.19     5.41     5.88     5.94     5.73

Yield on interest earning assets (GAAP)

     4.93     4.58     4.30     4.30     4.54

Yield on interest earning assets—tax equivalent

     5.00     4.65     4.36     4.34     4.58

Cost of interest bearing liabilities (GAAP)

     0.39     0.51     0.81     1.22     1.66

Net interest spread (GAAP)

     4.54     4.07     3.49     3.08     2.88

Net interest spread—tax equivalent

     4.61     4.14     3.55     3.12     2.92

Net interest margin (GAAP)

     4.64     4.18     3.66     3.33     3.17

Net interest margin—tax equivalent

     4.71     4.24     3.72     3.38     3.22

Efficiency ratio

          

Non interest income (GAAP)

   $ 33,946      $ 59,261      $ 101,972      $ 54,933      $ 30,052   

Gain on sale of securities

     (1,060     (2,423     (3,464     (7,034     (2,516

Nonrecurring income

     —          (453     (57,020     (1,377     —     

FDIC indemnification income

     (5,542     (6,017     (1,132     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted non interest income

     27,344        50,368        40,356        46,522        27,536   

Correspondent banking non interest income

     (20,410     (35,707     (27,066     (34,314     (18,746
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted non interest income, ex. correspondent

     6,934        14,661        13,290        12,208        8,790   

Net interest income before provision (GAAP)

     94,493        86,469        70,036        57,838        51,654   

Total tax equivalent adjustment

     1,372        1,343        1,217        758        726   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net interest income

     95,865        87,812        71,253        58,596        52,380   

Correspondent net interest income

     (2,854     (4,023     (3,822     (4,967     (6,622
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net interest income, ex. correspondent

     93,011        83,789        67,431        53,629        45,758   

 

29


Table of Contents
     Years ending December 31,  

continued from previous page

   2013     2012     2011     2010     2009  

Non interest expense (GAAP)

     110,762        121,980        114,689        93,325        68,714   

CDI and Trust intangible amortization

     (1,191     (1,372     (804     (519     (792

Credit related expenses

     (12,730     (11,206     (12,696     (6,278     (4,553

Nonrecurring expense

     (722     (3,328     (7,696     (769     (1,200
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted non interest expense

   $ 96,119      $ 106,074      $ 93,493      $ 85,759      $ 62,169   

Correspondent non interest expense

     (22,491     (30,651     (25,461     (28,837     (15,954
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted non interest expense, ex. correspondent

     73,629        75,423        68,032        56,922        46,215   

Efficiency ratio, including correspondent banking

     78     77     84     82     78

Efficiency ratio, excluding correspondent banking

     74     77     84     86     85

 

Analysis of changes in interest income and expense

   Net change December 31, 2013 versus 2012  
     Volume     Rate     Net change  

Loans—tax equivalent

     (709     7,373        6,664   

Securities—tax-exempt—tax equivalent

     143        (89     54   

Total interest income—tax equivalent

     (1,551     7,008        5,457   

Net interest income—tax equivalent

     149        7,904        8,053   

Analysis of changes in interest income and expense

   Net change December 31, 2012 versus 2011  
     Volume     Rate     Net change  

Loans—tax equivalent

     13,261        2,545        15,806   

Securities—tax-exempt—tax equivalent

     194        (174     20   

Total interest income—tax equivalent

     12,310        523        12,833   

Net interest income—tax equivalent

     12,408        4,151        16,559   

 

                 increase/
(decrease) $
    increase/
(decrease) %
 

Non interest expense analysis

   2013     2012      

Total non-interest expense (GAAP)

   $ 110,762      $ 121,980      $ (11,218     (9.2 %) 

Less: merger, acquisition, conversion expenses

     (722     (2,714     1,992        (73.4 %) 

Less: impairment of bank property held for sale

     —          (614     614        (100.0 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     110,040        118,652        (8,612     (7.3 %) 

Less: credit related expenses

     (12,730     (11,206     (1,524     13.6

Less: correspondent segment

     (20,498     (28,168     7,670        (27.2 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expense excluding credit cost, correspondent segment, merger related expenses, and impairment of bank property held for sale (Non-GAAP)

   $ 76,812      $ 79,278      $ (2,466     (3.1 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Years ended December 31,  

(Dollars in thousands, except per share data)

   2013     2012     2011     2010     2009  

Balance Sheet Non-GAAP measures and ratios

          

Total assets

   $ 2,415,567      $ 2,363,240      $ 2,284,459      $ 2,062,924      $ 1,751,299   

Goodwill

     (44,924     (44,924     (38,035     (38,035     (32,840

Intangible assets, net

     (6,116     (7,307     (5,203     (3,921     (2,422
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Tangible assets

   $ 2,364,527      $ 2,311,009      $ 2,241,221      $ 2,020,968      $ 1,716,037   

Common stockholders’ equity

   $ 273,379      $ 273,531      $ 262,633      $ 252,249      $ 229,410   

Goodwill

     (44,924     (44,924     (38,035     (38,035     (32,840

Intangible assets, net

     (6,116     (7,307     (5,203     (3,921     (2,422
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Tangible common stockholders’ equity

   $ 222,339      $ 221,300      $ 219,395      $ 210,293      $ 194,148   

Book value per common share

   $ 9.08      $ 9.09      $ 8.74      $ 8.41      $ 8.90   

Effect of intangible assets

   ($ 1.69   ($ 1.73   ($ 1.44   ($ 1.40   ($ 1.37

Tangible book value per common share

   $ 7.38      $ 7.36      $ 7.30      $ 7.01      $ 7.53   

Equity to total assets

     11.32     11.57     11.50     12.23     13.10

Effect of intangible assets

     (1.91 %)      (1.99 %)      (1.71 %)      (1.82 %)      (1.79 %) 

Tangible common equity to tangible assets

     9.40     9.58     9.79     10.41     11.31

 

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Table of Contents

The selected consolidated financial data presented below should be read in conjunction with management’s discussion and analysis of financial condition and results of operations, and the consolidated financial statements and footnotes thereto, of the Company at December 31, 2013 and 2012, and the three year period ended December 31, 2013, presented elsewhere herein. Operating results for prior periods are not necessarily indicative of results that might be expected for any future period.

Selected Consolidated Financial Data

For the twelve month period ending or as of December 31

 

(Dollars in thousands except for share and per share data)

   2013     2012     2011     2010     2009  

SUMMARY OF OPERATIONS:

          

Total interest income

   $ 100,378      $ 94,950      $ 82,243      $ 74,580      $ 73,944   

Total interest expense

     (5,885     (8,481     (12,207     (16,742     (22,290
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     94,493        86,469        70,036        57,838        51,654   

Provision for loan losses

     76        (9,220     (45,991     (29,624     (23,896
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     94,569        77,249        24,045        28,214        27,758   

Non-interest income

     15,832        23,237        16,599        13,826        9,620   

Income from correspondent banking and bond sales division

     17,023        32,806        24,889        32,696        17,916   

Net gain on sale of securities available for sale

     1,060        2,423        3,464        7,034        2,516   

Bargain purchase gain, acquisition of institution

     —          453        57,020        1,377        —     

Gain on sale of bank branch office real estate

     31        342        —          —          —     

Impairment charge- core deposit intangible

     —          —          —          —          (1,200

Credit related expenses

     (12,730     (11,206     (12,696     (6,278     (4,553

Non-interest expense

     (98,032     (110,774     (101,993     (87,047     (62,961
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     17,753        14,530        11,328        (10,178     (10,904

Income tax (expense) benefit

     (5,510     (4,625     (3,419     4,240        4,687   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 12,243      $ 9,905      $ 7,909      $ (5,938   $ (6,217
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

PER COMMON SHARE DATA:

          

Basic earnings (loss) per share

   $ 0.41      $ 0.33      $ 0.26      $ (0.22   $ (0.47

Diluted earnings (loss) per share

   $ 0.41      $ 0.33      $ 0.26      $ (0.22   $ (0.47

Common equity per common share outstanding

   $ 9.08      $ 9.09      $ 8.74      $ 8.41      $ 8.90   

Tangible common equity per common share outstanding

   $ 7.38      $ 7.36      $ 7.30      $ 7.01      $ 7.53   

Dividends per common share

   $ 0.04      $ 0.04      $ 0.04      $ 0.04      $ 0.07   

Actual shares outstanding

     30,112,475        30,079,767        30,055,499        30,004,761        25,773,229   

Weighted average common shares outstanding

     30,102,777        30,073,959        30,034,573        27,608,211        17,905,042   

Diluted weighted average common shares outstanding

     30,220,127        30,141,863        30,039,187        27,608,211        17,905,042   

BALANCE SHEET DATA:

          

Assets

   $ 2,415,567      $ 2,363,240      $ 2,284,459      $ 2,062,924      $ 1,751,299   

Total loans

     1,474,179        1,435,863        1,283,766        1,128,955        959,021   

Allowance for loan losses

     20,454        26,682        27,944        26,267        23,289   

Total deposits

     2,056,231        1,997,232        1,919,789        1,685,594        1,305,036   

Short-term borrowings

     50,366        57,724        69,276        97,284        195,501   

Corporate debentures

     16,996        16,970        16,945        12,500        12,500   

Common stockholders’ equity

     273,379        273,531        262,633        252,249        229,410   

Total stockholders’ equity

     273,379        273,531        262,633        252,249        229,410   

Tangible capital

     222,339        221,300        219,395        210,293        194,148   

Goodwill

     44,924        44,924        38,035        38,035        32,840   

Core deposit intangible (CDI)

     4,958        5,944        5,203        3,921        2,422   

Trust intangible

     1,158        1,363        —          —          —     

Average total assets

     2,381,620        2,445,902        2,176,571        1,935,495        1,771,034   

Average loans

     1,439,069        1,451,492        1,216,086        1,023,597        923,080   

Average interest earning assets

     2,034,542        2,070,990        1,914,812        1,734,746        1,628,798   

Average deposits

     2,087,004        2,062,682        1,800,998        1,517,302        1,254,169   

Average interest bearing deposits

     1,425,858        1,555,755        1,407,942        1,214,435        1,047,436   

Average interest bearing liabilities

     1,502,481        1,652,460        1,512,898        1,369,417        1,346,051   

Average total stockholders’ equity

     273,852        269,282        253,398        243,063        206,914   

 

31


Table of Contents

Selected Consolidated Financial Data — continued

For the twelve month period ending or as of December 31

 

(Dollars in thousands)

   2013     2012     2011     2010     2009  

SELECTED FINANCIAL RATIOS:

          

Return on average assets

     0.51     0.40     0.36     (0.31 %)      (0.35 %) 

Return on average equity

     4.47     3.68     3.12     (2.44 %)      (3.00 %) 

Dividend payout

     10     12     15     na        na   

Efficiency ratio (1)

     78     77     84     82     78

Efficiency ratio, excluding correspondent (2)

     74     77     84     86     85

Net interest margin, tax equivalent basis (3)

     4.71     4.24     3.72     3.38     3.22

Net interest spread, tax equivalent basis (4)

     4.61     4.14     3.55     3.12     2.92

CAPITAL RATIOS:

          

Tier 1 leverage ratio

     10.38     9.91     10.49     10.33     11.36

Risk-based capital

          

Tier 1

     16.64     16.63     17.79     18.01     17.99

Total

     17.89     17.89     19.05     19.28     19.25

Tangible common equity ratio

     9.40     9.58     9.79     10.41     11.31

ASSET QUALITY RATIOS:

          

Net charge-offs to average loans (5)

     0.52     0.93     4.28     2.83     1.51

Allowance to period end loans (5)

     1.58     2.11     2.46     2.82     2.43

Allowance for loan losses to non-performing loans

     73     93     71     40     55

Non-performing assets to total assets

     1.39     1.41     2.16     3.81     3.05

OTHER DATA:

          

Banking locations

     55        55        58        53        38   

Full-time equivalent employees

     693        689        655        602        478   

 

(1) Efficiency ratio is non-interest expense (less non-recurring items, credit related expenses and intangible amortization) divided by the sum of the tax equivalent net interest income before the provision for loan losses plus non-interest income (less non-recurring items and FDIC indemnification income).
(2) Efficiency ratio is same as (1) above excluding correspondent banking non-interest expense (including indirect expense allocations) from the numerator and excluding correspondent banking net interest income and non-interest income from the denominator.
(3) Net interest margin is net interest income divided by total average earning assets.
(4) Net interest spread is the difference between the average yield on earning assets and the average yield on average interest bearing liabilities.
(5) Excludes loans covered by FDIC loss share agreements.

 

32


Table of Contents

Quarterly Financial Information

The following table sets forth, for the periods indicated, certain consolidated quarterly financial information. This information is derived from our unaudited financial statements which include, in the opinion of management, all normal recurring adjustments which management considers necessary for a fair presentation of the results for such periods. The sum of the four quarters of earnings per share may not equal the total earnings per share for the full year due to rounding. This information should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this document. The results for any quarter are not necessarily indicative of results for future periods.

Selected Quarterly Data

(unaudited)

 

(Dollars in thousands except

for per share data)

   2013     2012  
   4Q     3Q     2Q     1Q     4Q     3Q     2Q     1Q  

Interest income

   $ 25,479      $ 26,034      $ 24,487      $ 24,378      $ 23,265      $ 23,608      $ 24,587      $ 23,490   

Interest expense

     (1,398     (1,424     (1,507     (1,556     (1,726     (1,941     (2,304     (2,510
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     24,081        24,610        22,980        22,822        21,539        21,667        22,283        20,980   

Provision for loan losses

     (183     1,273        (1,374     360        (2,169     (2,425     (1,894     (2,732
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     23,898        25,883        21,606        23,182        19,370        19,242        20,389        18,248   

Non-interest income

     2,105        5,698        3,951        4,109        5,870        7,054        5,849        4,806   

Income from correspondent banking and bond sales division

     3,070        2,909        4,904        6,140        6,450        8,606        9,966        7,784   

Bargain purchase gain on acquisition

     —          —          —          —          —          —          —          453   

Gain on sales of securities available for sale

     22        —          1008        30        420        675        726        602   

Non-interest expenses

     (26,449     (29,850     (27,373     (27,090     (28,530     (31,706     (31,658     (30,086
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax

     2,646        4,640        4,096        6,371        3,580        3,871        5,272        1,807   

Income tax expense

     (846     (1,531     (1,338     (1,795     (1,344     (1,229     (1,558     (494
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 1,800      $ 3,109      $ 2,758      $ 4,576      $ 2,236      $ 2,642      $ 3,714      $ 1,313   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share

   $ 0.06      $ 0.10      $ 0.09      $ 0.15      $ 0.07      $ 0.09      $ 0.12      $ 0.04   

Diluted earnings per common share

   $ 0.06      $ 0.10      $ 0.09      $ 0.15      $ 0.07      $ 0.09      $ 0.12      $ 0.04   

 

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Table of Contents
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

(All dollar amounts in this Item 7 are in thousands of dollars, except shares

and per share data or when specifically identified.)

Some of the statements in this report constitute forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995 and the Securities Exchange Act of 1934. These statements related to future events, other future financial performance or business strategies, and include statements containing terminology such as “may,” “will,” “should,” “expects,” “scheduled,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “potential,” or “continue” or the negative of such terms or other comparable terminology. Actual events or results may differ materially from the results anticipated in these forward looking statements, due to a variety of factors, including, without limitation: the effects of future economic conditions; governmental monetary and fiscal policies, as well as legislative and regulatory changes; the risks of changes in interest rates and the level and composition of deposits, loan demand, and the values of loan collateral; and the effects of competition from other commercial banks, thrifts, consumer finance companies, and other financial institutions operating in our market area and elsewhere. All forward looking statements attributable to our Company are expressly qualified in their entirety by these cautionary statements. We disclaim any intent or obligation to update these forward looking statements, whether as a result of new information, future events or otherwise. There is no assurance that future results, levels of activity, performance or goals will be achieved.

Our discussion and analysis of earnings and related financial data are presented herein to assist investors in understanding the financial condition of our Company at December 31, 2013 and 2012, and the results of operations for the years ended December 31, 2013, 2012 and 2011. This discussion should be read in conjunction with the consolidated financial statements and related footnotes of our Company presented elsewhere herein.

Executive Summary

Organizational structure

Our consolidated financial statements include the accounts of CenterState Banks, Inc. (the “Parent Company,” “Company,” “Corporate,” “CenterState,” “Holding Company”, “CSFL”, “we’ or “our”), and our wholly owned subsidiary bank (“CSB” and the “Bank”) and our non bank subsidiary R4ALL, Inc. (“R4ALL”).

In December 2010 we merged our three national chartered banks together, with CSB as the surviving bank. In June of 2012 we merged our state charted bank, Valrico State Bank, into CSB. We currently have one subsidiary bank, and one non bank subsidiary, R4ALL. R4ALL has no employees and its sole purpose is to acquire and dispose of troubled assets from our only surviving subsidiary bank. The general administrative and recording keeping activities are performed by one of our employees, and the managing of the troubled assets and disposition thereof is managed by the special asset disposition team employed by CSB.

At the Holding Company level, we perform functions that include strategic planning, merger and acquisition functions, investor relations, capital management, financial reporting, income tax management and reporting, loan review, internal audit, risk assessment and monitoring, and generally oversee and monitor the activities of our subsidiary bank. All of the operating activities associated with and related to the commercial and retail banking business, as well as the correspondent banking business, is performed and managed at the subsidiary bank level.

 

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A condensed consolidating balance sheet at December 31, 2013 and a condensed consolidating statement of operations for the year ending December 31, 2013 are presented below.

 

Condensed Consolidating Balance Sheet                PARENT              

At December 31, 2013

   CSB     R4ALL     COMPANY     Eliminations     Consolidated  

Cash and due from banks

   $ 21,581      $ 26      $ 966      $ (992   $ 21,581   

Federal funds sold and Federal Reserve deposits

     153,308        —          —          —          153,308   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents

     174,889        26        966        (992     174,889   

Investment securities available for sale, at fair value

     457,086        —          —          —          457,086   

Loans covered by FDIC loss share agreements

     230,273        —          —          —          230,273   

Loans, excluding those covered by FDIC loss share

     1,242,793        1,113        —          —          1,243,906   

Allowance for loan losses

     (20,272     (182     —          —          (20,454

Bank premises and equipment, net

     96,177        —          442        —          96,619   

Goodwill

     44,924        —          —          —          44,924   

Core deposit intangibles

     4,958        —          —          —          4,958   

OREO covered by FDIC loss share agreements

     19,111        —          —          —          19,111   

OREO not covered by FDIC loss share agreements

     5,514        895        —          —          6,409   

Investment in subsidiaries

     —          —          244,312        (244,312     —     

All other assets

     154,280        470        49,256        (46,160     157,846   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

   $ 2,409,733      $ 2,322      $ 294,976      $ (291,464   $ 2,415,567   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Deposits

   $ 2,057,223      $ —        $ —        $ (992   $ 2,056,231   

Other borrowings

     50,366        —          16,996        —          67,362   

All other liabilities

     60,154        —          4,601        (46,160     18,595   

Total stockholders’ equity

     241,990        2,322        273,379        (244,312     273,379   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,409,733      $ 2,322      $ 294,976      $ (291,464   $ 2,415,567   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
Condensed Consolidating Statement of Operations     PARENT              

For the 12 month period ending December 31, 2013

   CSB     R4ALL     COMPANY     Eliminations     Consolidated  

Interest income

   $ 100,263      $ 115      $ —        $ —        $ 100,378   

Interest expense

     (5,283     —          (602     —          (5,885
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     94,980        115        (602     —          94,493   

Provision for loan losses

     80        (4     —          —          76   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after loan loss provision

     95,060        111        (602     —          94,569   

Non interest income

     34,790        2        14,686        (15,532     33,946   

Non interest expense

     (107,701     (369     (3,538     846        (110,762
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income before income tax provision

     22,149        (256     10,546        (14,686     17,753   

Income tax (provision) benefit

     7,565        (358     (1,697     —          5,510   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 14,584      $ 102      $ 12,243      $ (14,686   $ 12,243   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Through our subsidiary bank, we conduct commercial and retail banking business consisting of attracting deposits from the general public and applying those funds to the origination of commercial real estate loans, residential real estate loans, construction, development and land loans, and commercial loans and consumer loans. Most of our loans are secured by real estate located in Florida.

Our profitability depends primarily on net interest income, which is the difference between interest income generated from interest-earning assets (i.e. loans and investments) less the interest expense incurred on interest-bearing liabilities (i.e. customer deposits and borrowed funds). Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities, and the interest rate earned and paid on these balances. Net interest income is dependent upon the interest rate spread which is the difference between the average yield earned on our interest-earning assets and the average rate paid on our interest-bearing liabilities. The

 

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interest rate spread is impacted by interest rates, deposit flows, and loan demand. Additionally, our profitability is affected by such factors as the level of non-interest income and expenses, the provision for credit losses, and the effective tax rate. Non-interest income consists primarily of service fees on deposit accounts and related services, and also includes commissions earned on bond sales, brokering single family home loans, Trust services, sale of mutual funds, annuities and other non-traditional and non-insured investments. Non-interest expense consists of compensation, employee benefits, occupancy and equipment expenses, and other operating expenses.

At December 31, 2013, our subsidiary bank operated through 55 bank branch locations in 18 counties in Florida as summarized in the table below:

 

Citrus

   Indian River    Orange    Polk

Hendry

   Lake    Osceola    Putnam

Hernando

   Marion    Pasco    Sumter

Hillsborough

   Okeechobee    Seminole    St. Lucie

Volusia

   Duval      

On January 17, 2014, we consummated our previously announced acquisition of Gulfstream Bancshares, Inc. (“Gulfstream”) which added four additional branches (approximately $479 million of deposits) and two additional counties, Palm Beach and Martin, to the list above.

On January 21, 2014, we announced efficiency and enhanced profitability initiatives including the closing and consolidation of seven smaller branches plus a standalone drive thru facility (counted as a branch for regulatory purposes). The branches are scheduled to be closed in mid-April, which at that time we will operate from a total of 51 branch locations.

On January 29, 2014, we announced that we have signed a definitive agreement, subject to normal regulatory approvals and shareholder approval, to acquire First Southern Bancorp, Inc. (“FSOB”). The acquisition is expected to close during the second half of 2014. FSOB operates through 17 branches (approximately $887 million of deposits) in Southeast, Central and Northeast Florida. There is some branch overlap and we expect to consolidate and close potentially 10 of these branches.

Correspondent banking division

We also operate a correspondent banking and bond sales division. The division is integrated with and part of our subsidiary bank, CSB, located in Winter Haven, Florida, although the majority of our bond salesmen, traders and operations personnel are physically housed in leased facilities located in Birmingham, Alabama and Atlanta, Georgia. The business lines of this division are primarily divided into three inter-related revenue generating activities. The first, and largest, revenue generator is commissions earned on fixed income security sales. The second category includes: (a) correspondent bank deposits (i.e., federal funds purchased) and (b) correspondent bank checking accounts. The third, revenue generating category, includes fees from safe-keeping activities, bond accounting services for correspondents, asset/liability consulting related activities, and correspondent clearing account services. The customer base includes small to medium size financial institutions primarily located in Florida, Alabama, Georgia, North Carolina, South Carolina, Tennessee, Virginia and West Virginia.

Critical Accounting Policies

Our accounting policies are integral to understanding the results reported. Accounting policies are described in detail in Note 1 of the notes to the consolidated financial statements. The critical accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. We have established policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies involving significant management valuation judgments.

 

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Allowance for Loan Losses

The allowance for loan losses represents our estimate of probable incurred losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. The allowance for loan losses is determined based on our assessment of several factors: reviews and evaluation of individual loans, changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on specific borrowers and industry concentrations, historical loan loss experiences and the level of classified and nonperforming loans.

Changes in the financial condition of individual borrowers, in economic conditions, in historical loss experience and in the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for loan losses and the associated provision for loan losses.

We use a standardized loan grading system which is integral to our risk assessment function related to lending. Loan officers assign a loan grade to newly originated loans in accordance with the standard loan grades. Throughout the lending relationship, the loan officer is responsible for periodic reviews, and if warranted he/she will downgrade or upgrade a particular loan based on specific events and/or analyses. We use a loan grading system of 1 through 7. Grade 1 is “excellent” and grade 7 is “doubtful.” Loans graded 5 or higher are placed on a watch list each month end and reported to the bank’s board of directors. Our loan review officers, who are independent of the lending function and are not employees of our subsidiary bank, periodically review loan portfolios and lending relationships. The loan review officer may disagree with the bank’s grade on a particular loan and subsequently downgrade or upgrade such loan(s) based on his risk analysis.

Our Chief Credit Officer (“CCO”), our Chief Special Asset Disposition Manager (“CSPA”) and their teams are responsible for identifying and reporting all impaired loans, non-accrual loans, TDRs and OREO. They hold monthly meetings with our CEO, our subsidiary bank CEO, and a senior level accounting officer who along with the CCO and CSPA is ultimately responsible for preparing the Company’s allowance for loan loss calculations each quarter. The Company’s CFO and others also attend these meetings periodically. The CCO, CSPA and their teams make sure that all non-performing loans, subject to ASC 310, as well as OREO properties have a current appraisal (less than one year old) and that the asset is written down to 90% of the current appraisal, or less under certain circumstances, such as a listing price in the case of OREO, or a time value adjustment in the case of loans with appraisals approaching their one year life, and the related collateral is either in a type of category or in a market area with declining values. When these monthly meetings start, these teams have already evaluated their positions and have identified the course of action on each of the troubled assets listed. The purpose of the meetings is to allow the sharing of information and allow our CEO and the CEO of our lead subsidiary bank to review these evaluations with our CCO and CSPA, and either approve or modify their recommendations.

We maintain an allowance for loan losses that we believe is adequate to absorb probable incurred losses inherent in our loan portfolio. The allowance consists of three components. The first component consists of amounts specifically reserved (“specific allowance”) for specific loans identified as impaired, as defined by FASB Accounting Standards Codification No. 310 (“ASC 310”). Impaired loans are those loans that management has estimated will not repay as agreed upon. Each of these loans is required to have a written analysis supporting the amount of specific reserve allocated to the particular loan, if any. That is to say, a loan may be impaired (i.e. not expected to repay as agreed), but may be sufficiently collateralized such that we expect to recover all principal and interest eventually, and therefore no specific reserve is warranted.

The second component is a general reserve (“general allowance”) on all of the Company’s loans other than those identified as impaired. We group these loans into categories with similar characteristics and then apply a loss factor to each group which is derived from our historical loss factor for that category adjusted for current internal and external environmental factors, as well as for certain loan grading factors.

 

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The third component consists of amounts reserved for purchased credit-impaired loans. On a quarterly basis, the Company updates the amount of loan principal and interest cash flows expected to be collected, incorporating assumptions regarding default rates, loss severities, the amounts and timing of prepayments and other factors that are reflective of current market conditions. Probable decreases in expected loan principal cash flows trigger the recognition of impairment, which is then measured as the present value of the expected principal loss plus any related foregone interest cash flows discounted at the pool’s effective interest rate. Impairments that occur after the acquisition date are recognized through the provision for loan losses. Probable and significant increases in expected principal cash flows would first reverse any previously recorded allowance for loan losses; any remaining increases are recognized prospectively as interest income. The impacts of (i) prepayments, (ii) changes in variable interest rates, and (iii) any other changes in the timing of expected cash flows are recognized prospectively as adjustments to interest income. Disposals of loans, which may include sales of loans, receipt of payments in full by the borrower, or foreclosure, result in removal of the loan from the purchased credit impaired portfolio. The aggregate of these three components results in our total allowance for loan losses.

Goodwill and Intangible Assets

Goodwill resulting from business combinations prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any non-controlling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selected November 30 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet. We have $45 million of goodwill on our consolidated balance sheet at December 31, 2013.

Other intangible assets consist of core deposit intangible and trust intangible assets arising from whole bank and branch acquisitions. They are initially measured at fair value and then amortized on an accelerated method over their estimated useful lives, generally 10 years.

Goodwill and intangible assets are described further in Note 9 of the notes to the consolidated financial statements.

Income Taxes

We determine our income tax expense based on management’s judgments and estimates regarding permanent differences in the treatment of specific items of income and expense for financial statement and income tax purposes. These permanent differences result in an effective tax rate, which differs from the federal statutory rate. In addition, we recognize deferred tax assets and liabilities, recorded in the Consolidated Statements of Financial Condition, based on management’s judgment and estimates regarding timing differences in the recognition of income and expenses for financial statement and income tax purposes.

We must also assess the likelihood that any deferred tax assets will be realized through the reduction or refund of taxes in future periods and establish a valuation allowance for those assets for which recovery is not more likely than not. In making this assessment, management must make judgments and estimates regarding the ability to realize the asset through carryback to taxable income in prior years, the future reversal of existing taxable temporary differences, future taxable income, and the possible application of future tax planning strategies. Management believes that it is more likely than not that deferred tax assets included in the accompanying Consolidated Statements of Financial Condition will be fully realized, although there is no guarantee that those assets will be recognizable in future periods. We have a net deferred tax asset of $5.3 million in our consolidated balance sheet at December 31, 2013. For additional discussion of income taxes, see Notes 1 and 16 of “Notes to Consolidated Financial Statements” in Item 8 of this Form 10-K.

 

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Purchased Credit-Impaired Loans

We account for acquisitions under the purchase accounting method. All identifiable assets acquired and liabilities assumed are recorded at fair value. We review each loan or loan pool acquired to determine whether there is evidence of deterioration in credit quality since inception and if it is probable that the Company will be unable to collect all amounts due under the contractual loan agreements. We consider expected prepayments and estimated cash flows including principal and interest payments at the date of acquisition. The amount in excess of the estimated future cash flows is not accreted into earnings. The amount in excess of the estimated future cash flows over the book value of the loan is accreted into interest income over the remaining life of the loan (accretable yield). The Company records these loans on the acquisition date at their net realizable value. Thus, an allowance for estimated future losses is not established on the acquisition date. We refine our estimates of the fair value of loans acquired for up to one year from the date of acquisition. Subsequent to the date of acquisition, we update the expected future cash flows on loans acquired on a quarterly basis. Losses or a reduction in cash flow which arise subsequent to the date of acquisition are reflected as a charge through the provision for loan losses. An increase in the expected cash flows adjusts the level of the accretable yield recognized on a prospective basis over the remaining life of the loan.

FDIC Loss Share Receivable

We have entered into agreements with the FDIC for reimbursement of losses within acquired loan portfolios. The FDIC loss share receivable is recorded at fair value on the date of acquisition based upon the expected reimbursements to be received from the FDIC adjusted by a discount rate which reflects counter party credit risk and other uncertainties. Changes in the underlying credit quality of the loans covered by the FDIC loss share receivable result in either an increase or a decrease in the FDIC loss share receivable. Deterioration in loan credit quality increases the FDIC loss share receivable; increases in credit quality decrease the FDIC loss share receivable. Proceeds received for reimbursement of incurred losses reduce the FDIC loss share receivable.

 

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COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2013 AND DECEMBER 31, 2012.

Net Income

Our net income for the year ended December 31, 2013 was $12,243 or $0.41 per share basic and diluted, compared to $9,905 or $0.33 per share basic and diluted for the year ended December 31, 2012. Some of the primary reasons for the increase included higher net interest income due to a higher net interest margin and lower loan loss provision expense due to improved credit metrics and credit environment, which partially offset lower bond sales revenue from our correspondent division and higher FDIC indemnification asset (“IA”) amortization expense. These and other factors contributing to our 2013 results are discussed below.

Net Interest Income/Margin

Net interest income consists of interest income generated by earning assets, less interest expense.

Net interest income increased $8,024, or 9% to $94,493 during the year ended December 31, 2013 compared to $86,469 for the same period in 2012. The increase was the result of a $5,428 increase in interest income plus a $2,596 decrease in interest expense.

Interest earning assets averaged $2,034,542 during the year ended December 31, 2013 as compared to $2,070,990 for the same period in 2012, a decrease of $36,448, or 1.8%. The yield on average interest earning assets increased 35 basis points (“bps”) to 4.93% (35 bps to 5.00% tax equivalent basis) during the year ended December 31, 2013, compared to 4.58% (4.65% tax equivalent basis) for the same period in 2012. The combined net effects of the $36,448 decrease in average interest earning assets and the increase in yields on average interest earning assets resulted in the $5,428 ($5,457 tax equivalent basis) increase in interest income between the two years.

Interest bearing liabilities averaged $1,502,481 during the year ended December 31, 2013 as compared to $1,652,460 for the same period in 2012, a decrease of $149,979, or 9.1%. The cost of average interest bearing liabilities decreased 12 bps to 0.39% during the year ended December 31, 2013, compared to 0.51% for 2012. The combined net effects of the $149,979 decrease in average interest bearing liabilities and the 12 bps decrease in cost of average interest bearing liabilities resulted in the $2,596 decrease in interest expense between the two years. See the tables “Average Balances – Yields & Rates,” and “Analysis of Changes in Interest Income and Expenses” below.

 

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Average Balances (8) – Yields & Rates

 

     Years Ended December 31,  
     2013     2012  
     Average     Interest      Average     Average     Interest      Average  
     Balance     Inc / Exp      Rate     Balance     Inc / Exp      Rate  

ASSETS:

              

Noncovered loans (1) (2) (7)

   $ 1,179,796      $ 56,525         4.79   $ 1,126,784      $ 58,696         5.21

Covered loans (9)

     259,273        32,377         12.49     324,708        23,542         7.25

Securities available for sale—taxable

     413,840        9,889         2.39     458,946        11,297         2.46

Securities available for sale—tax exempt (7)

     41,888        2,174         5.19     39,183        2,120         5.41

Federal funds sold and other

     139,745        785         0.56     121,369        638         0.53
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST EARNING ASSETS

   $ 2,034,542      $ 101,750         5.00   $ 2,070,990      $ 96,293         4.65

Allowance for loan losses

     (23,985          (26,872     

All other assets

     371,063             401,784        
  

 

 

        

 

 

      

TOTAL ASSETS

   $ 2,381,620           $ 2,445,902        
  

 

 

        

 

 

      

LIABILITIES & STOCKHOLDERS’ EQUITY

              

Deposits:

              

Now

   $ 457,856      $ 362         0.08   $ 410,384      $ 457         0.11

Money market

     312,151        476         0.15     331,449        730         0.22

Savings

     238,497        132         0.06     239,147        266         0.11

Time deposits

     417,354        4,215         1.01     574,775        6,076         1.06

Repurchase agreements

     21,693        78         0.36     21,388        86         0.40

Federal funds purchased

     37,941        20         0.06     53,803        28         0.05

Other borrowed funds (3)

     5        —           0.00     4,556        201         4.41

Corporate debenture (4)

     16,984        602         3.54     16,958        637         3.76
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST BEARING LIABILITIES

   $ 1,502,481        5,885         0.39   $ 1,652,460        8,481         0.51

Demand deposits

     584,523             506,927        

Other liabilities

     20,764             17,233        

Total stockholders’ equity

     273,852             269,282        
  

 

 

        

 

 

      

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 2,381,620           $ 2,445,902        
  

 

 

        

 

 

      

NET INTEREST SPREAD (tax equivalent basis) (5)

          4.61          4.14
       

 

 

        

 

 

 

NET INTEREST INCOME (tax equivalent basis)

     $ 95,865           $ 87,812      
    

 

 

        

 

 

    

NET INTEREST MARGIN (tax equivalent basis) (6)

          4.71          4.24
       

 

 

        

 

 

 

 

(1) Loan balances are net of deferred origination fees and costs. Non-accrual loans are included in total loan balances.
(2) Interest income on average loans includes loan fee recognition of $408 and $511 for the years ended December 31, 2013 and 2012, respectively.
(3) Includes short-term (usually overnight) Federal Home Loan Bank advances and other short term borrowings.
(4) Includes net amortization of origination costs and amortization of purchase accounting adjustment of $26 and $25 during year ended December 31, 2013 and 2012, respectively.
(5) Represents the average rate earned on interest earning assets minus the average rate paid on interest bearing liabilities.
(6) Represents net interest income divided by total earning assets.
(7) Interest income and rates include the effects of a tax equivalent adjustment using applicable statutory tax rates to adjust tax exempt investment income on tax exempt investment securities and loans to a fully taxable basis.
(8) Averages balances are average daily balances.
(9) Covered loans are loans purchased from the FDIC pursuant to assisted acquisitions of failed financial institutions, and are covered with respect to certain loss sharing agreements with the FDIC.

 

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Non-accrual loans: A loan is moved to nonaccrual status in accordance with our policy typically after 90 days of non-payment, or less than 90 days of non-payment if management determines that the full timely collection of principal and interest becomes doubtful. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. All interest accrued but not received for loans placed on nonaccrual, is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Analysis of Changes in Interest Income and Expenses

 

     Net Change Dec 31, 2013 versus 2012  
     Volume     Rate     Net
Change
 

INTEREST INCOME

      

Loans (tax equivalent basis)

   $ (709   $ 7,373      $ 6,664   

Securities available for sale—taxable

     (1,085     (323     (1,408

Securities available for sale—tax exempt

     143        (89     54   

Federal funds sold and other

     101        46        147   
  

 

 

   

 

 

   

 

 

 

TOTAL INTEREST INCOME (tax equivalent basis)

   $ (1,550   $ 7,007      $ 5,457   
  

 

 

   

 

 

   

 

 

 

INTEREST EXPENSE

      

Deposits

      

NOW accounts

   $ 48      $ (143   $ (95

Money market accounts

     (40     (214     (254

Savings

     (1     (133     (134

Time deposits

     (1,600     (261     (1,861

Repurchase agreements

     1        (9     (8

Federal funds purchased

     (8     —          (8

Other borrowed funds

     (100     (101     (201

Corporate debenture

     1        (36     (35
  

 

 

   

 

 

   

 

 

 

TOTAL INTEREST EXPENSE

   $ (1,699   $ (897   $ (2,596
  

 

 

   

 

 

   

 

 

 

NET INTEREST INCOME (tax equivalent basis)

   $     149      $     7,904      $     8,053   
  

 

 

   

 

 

   

 

 

 

The table above details the components of the changes in net interest income for the last two years. For each major category of interest earning assets and interest bearing liabilities, information is provided with respect to changes due to average volume and changes due to rates, with the changes in both volumes and rates allocated to these two categories based on the proportionate absolute changes in each category.

Provision for Loan Losses

The provision for loan losses decreased $9,296 to a negative provision of $(76) during the year ending December 31, 2013 compared to $9,220 for the comparable period in 2012. Our policy is to maintain the allowance for loan losses at a level sufficient to absorb probable incurred losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses, which is a charge to current period earnings, and is decreased by charge-offs, net of recoveries on prior loan charge-offs. Therefore, the provision for loan losses (Income Statement effect) is a residual of management’s determination of allowance for loan losses (Balance Sheet approach). In determining the adequacy of the allowance for loan losses, we consider those levels maintained by conditions of individual borrowers, the historical loan loss experience, the general economic environment, the overall portfolio composition, and other information. As these factors change, the level of loan loss provision changes. Our loss factors associated with our general allowance for loan losses is the primary reason causing the decrease in our provision expense due to our continued improvement in substantially all of our credit metrics, in particular our historical loss factors which is a derivative of our historical charge-off rates. See “credit quality and allowance for loan losses” regarding the allowance for loan losses for additional information.

 

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Non-Interest Income

Non-interest income for the year ended December 31, 2013 was $33,946 compared to $59,261 for the comparable period in 2012. This decrease was the result of the following components listed in the table below

 

                 $     %  
                 increase     increase  
     2013     2012     (decrease)     (decrease)  

Income from correspondent banking and bond sales division

   $ 17,023      $ 32,806      $ (15,783     (48.1 %) 

Other correspondent banking related revenue

     3,387        2,901        486        16.8

Wealth management related revenue

     4,551        3,760        791        21.0

Service charges on deposit accounts

     8,457        6,598        1,859        28.2

Debit, prepaid, ATM and merchant card related fees

     5,420        4,623        797        17.2

Bank owned life insurance income

     1,328        1,436        (108     (7.5 %) 

Other service charges and fees

     985        1,340        (355     (26.5 %) 

Gain on sale of securities

     1,060        2,423        (1,363     (56.3 %) 

Bargain purchase gain

     —          453        (453     (100.0 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     42,211        56,340        (14,129     (25.1 %) 

FDIC indemnification asset- amortization

     (13,807     (3,096     (10,711     346.0

FDIC indemnification income

     5,542        6,017        (475     (7.9 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

   $ 33,946      $ 59,261      ($ 25,315     (42.7 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

As shown in the table above, the primary reasons for the decrease in non-interest income year to year are decreases in revenue from our correspondent banking division (i.e. bond sales) and FDIC indemnification asset amortization.

Income from correspondent banking and bond sales division means the spread earned from buying and selling fixed income securities among our correspondent bank customers. We do not take a position in the transaction, but merely earn a spread for facilitating it. Gross revenue depends on the amount of sales volume, which is volatile from period to period. Sales volume was substantially less in the current year compared to 2012. The decrease in volume is likely due to increases in market interest rates thereby causing unrealized losses in our correspondent bank customers’ securities portfolios. Many of our correspondent bank customers may be reluctant to execute sales and realize the loss if there are other possible strategies they can use which is likely a primary contributing factor to reduced sales volume.

The FDIC indemnification asset (“IA”) is producing amortization (versus accretion) due to reductions in the estimated losses in the FDIC covered loan portfolio. To the extent current projected losses in the covered loan portfolio are less than previously projected losses, the related projected reimbursements from the FDIC contemplated in the IA are less, which produces a negative income accretion in non-interest income. This event corresponds to the increase in yields in the FDIC covered loan portfolio, although there is not perfect correlation. Higher expected cash flows (i.e. less expected future losses) on the loan side of the equation is accreted into interest income over the life of the related loan pool. The lower expected reimbursement from the FDIC (i.e. 80% of the lower expected future losses) is amortized over the lesser of the remaining life of the related loan pool(s) or the remaining term of the loss share period.

 

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At December 31, 2013, the total IA on our balance sheet was $73,433. Of this amount, we estimate to receive reimbursements from the FDIC of approximately $39,513 related to future estimated losses, and estimates to expense approximately $33,920 for previously estimated losses that are no longer expected. The $33,920 is now estimated to be paid, or has been paid, by the borrower (or has been or is estimated to be realized upon the sale of OREO) instead of a reimbursement from the FDIC. At December 31, 2013, the $33,920 previously estimated reimbursements from the FDIC will be amortized as expense (negative accretion) in our non-interest income as summarized below.

 

Year

        

Year

      

2014

     46.3   2018      5.2

2015

     20.5   2019      4.5

2016

     13.2   2020 thru 2022      3.9
       

 

 

 

2017

     6.4   Total      100.0
       

 

 

 

Future estimated losses and future estimated cash flows related to our FDIC covered loan portfolio are analyzed by management each quarter and adjusted accordingly. Historically, management has been adjusting future estimated losses downward, due to improvement in the economy, real estate market and recent historical payment performance of the underlying loans. The result has been higher interest accretion in the covered loan portfolio and higher IA amortization expense than previously estimated.

Our other FDIC income related line item in the table above, FDIC indemnification income, has two components. The first relates to losses on FDIC covered OREO. To the extent we incur a loss on the sale of OREO, 80% of the loss is reimbursable from the FDIC. The 80% reimbursable amount is recognized as FDIC indemnification income in this line item during the same period the expense or loss on OREO is recognized in our non-interest expenses. The second component relates to provision for loan loss expenses related to impairments on any of our covered loan pools. To the extent we incur a loan loss provision expense we recognize FDIC indemnification income in an amount equal to approximately 80% of such expense during the same period the expense was recognized in provision for loan loss expense.

 

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Non-Interest Expense

Non-interest expense for the year ended December 31, 2013 decreased $11,218, or 9.2%, to $110,762, compared to $121,980 for 2012. The table below breaks down the individual components.

 

                 $     %  
                 increase     increase  
     2013     2012     (decrease)     (decrease)  

Employee salaries and wages

   $ 47,175      $ 56,232      $ (9,057     (16.1 %) 

Employee incentive/bonus compensation

     4,965        3,938        1,027        26.1

Employee stock based compensation

     609        631        (22     (3.4 %) 

Employer 401K matching contributions

     1,219        1,144        75        6.6

Deferred compensation expense

     569        501        68        13.5

Health insurance and other employee benefits

     3,557        3,985        (428     (10.7 %) 

Payroll taxes

     3,018        3,235        (217     (6.7 %) 

Other employee related expenses

     1,293        1,051        242        23.1

Incremental direct cost of loan origination

     (2,036     (779     (1,257     161.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Total salaries, wages and employee benefits

   $ 60,369      $ 69,938      $ (9,569     (13.7 %) 

Loss (gain) on sale of OREO

     228        (140     368        (262.9 %) 

Loss on sale of FDIC covered OREO

     2,894        1,325        1,569        118.4

Valuation write down of OREO

     1,085        1,011        74        7.3

Valuation write down of FDIC covered OREO

     4,927        3,247        1,680        51.7

Loss on repossessed assets other than real estate

     401        123        278        226.0

Loan put back expense

     4        1,632        (1,628     (99.8 %) 

Foreclosure and repossession related expenses

     1,732        2,487        (755     (30.4 %) 

Foreclosure and repo expenses, FDIC (note 1)

     1,459        1,521        (62     (4.1 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total credit related fees

     12,730        11,206        1,524        13.6

Occupancy expense

     7,702        8,697        (995     (11.4 %) 

Depreciation of premises and equipment

     5,876        5,678        198        3.5

Supplies, stationary and printing

     1,121        1,124        (3     (0.3 %) 

Marketing expenses

     2,517        2,564        (47     (1.8 %) 

Data processing expense

     3,784        3,988        (204     (5.1 %) 

Legal, auditing and other professional fees

     3,754        2,527        1,227        48.6

Bank regulatory related expenses

     2,369        2,429        (60     (2.5 %) 

Postage and delivery

     1,084        1,148        (64     (5.6 %) 

ATM and debit card related expenses

     1,802        1,347        455        33.8

CDI amortization

     986        1,155        (169     (14.6 %) 

Trust intangible amortization

     204        217        (13     (6.0 %) 

Internet and telephone banking

     1,083        945        138        14.6

Operational write-offs and losses

     118        697        (579     (83.1 %) 

Correspondent accounts and Federal Reserve charges

     459        527        (68     (12.9 %) 

Conferences/Seminars/Education/Training

     584        510        74        14.5

Director fees

     405        374        31        8.3

Travel expenses

     399        317        82        25.9

Other expenses

     2,694        3,264        (570     (17.5 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

   $ 110,040      $ 118,652      $ (8,612     (7.3 %) 

Merger, acquisition and conversion related expenses

     722        2,714        (1,992     (73.4 %) 

Impairment of bank property held for sale

     —          614        (614     (100.0 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

   $ 110,762      $ 121,980      $ (11,218     (9.2 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

 

note 1: These are foreclosure related expenses related to FDIC covered assets, and are shown net of FDIC reimbursable amounts pursuant to FDIC loss share agreements.

Excluding merger, acquisition and conversion related expenses and impairment of bank property held for sale identified above, total non-interest expense decreased $8,612 or 7.3% year to year as shown in the above table.

 

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The table below removes credit related expenses and correspondent segment expenses, which is primarily compensation related and varies significantly with levels of bond sales volumes.

 

                 $     %  
                 increase     increase  
     2013     2012     (decrease)     (decrease)  

Total non-interest expense

   $ 110,762      $ 121,980      $ (11,218     (9.2 %) 

Less: merger, acquisition, conversion, expenses

     (722     (2,714     1,992        (73.4 %) 

Less: impairment bank property held for sale

     —          (614     614        (100.0 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     110,040        118,652        (8,612     (7.3 %) 

Less: credit related expenses

     (12,730     (11,206     (1,524     13.6

Less: correspondent segment

     (20,498     (28,168     7,670        (27.3 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expense, excluding credit cost, correspondent segment, and merger, acquisition and conversion related expenses, and impairment of bank property held for sale

   $ 76,812      $ 79,278      $ (2,466     (3.1 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Excluding merger, acquisition and conversion related expense and impairment of bank property held for sale, and excluding credit cost and our correspondent division, the remaining non-interest expense approximates the operating expense of our core commercial and consumer banking segment. As shown in the table above, this expense decreased approximately $2,466, or 3.1% year to year. The reasons for this decrease include the following:

 

    The Company closed a total of 15 branches in 2012 (four in the first quarter, six in the second quarter, and four in the third quarter). We incurred the related expenses in 2012 for these branches until the offices were closed.

 

    In addition, the two failed banks we acquired in 2012 operated on two different core processing systems, which were not converted to our core processing system until May and June of 2012, adding elevated cost in terms of data processing, personnel and other temporary inefficiencies above the normalized incremental operating expenses.

 

    In addition to consolidating and closing branches, and a reduction in workforce, we also initiated other cost efficiencies and revenue enhancements during 2012 that were fully implemented during the entire year of 2013.

Income Tax Provision

We recognized an income tax expense for the year ended December 31, 2013 of $5,510 (an effective tax rate of 31.0%) compared to $4,625 (an effective tax rate of 31.8%) for the year ended December 31, 2012.

 

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COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2012 AND DECEMBER 31, 2011.

Net Income

Our net income for the year ended December 31, 2012 was $9,905 or $0.33 per share basic and diluted, compared to $7,909 or $0.26 per share basic and diluted for the year ended December 31, 2011. The primary reason for the increase was higher interest income resulting from the January 2012 acquisitions of Central Florida State Bank and First Guaranty Bank & Trust, as well as lower credit cost. These and other factors contributing to our 2012 results are discussed below.

Net Interest Income/Margin

Net interest income consists of interest income generated by earning assets, less interest expense.

Net interest income increased $16,433, or 23% to $86,469 during the year ended December 31, 2012 compared to $70,036 for the same period in 2011. The increase was the result of a $12,707 increase in interest income plus a $3,726 decrease in interest expense.

Interest earning assets averaged $2,070,990 during the year ended December 31, 2012 as compared to $1,914,812 for the same period in 2011, an increase of $156,178, or 8.2%. The yield on average interest earning assets increased 28 basis points (“bps”) to 4.58% (29 bps to 4.65% tax equivalent basis) during the year ended December 31, 2012, compared to 4.30% (4.36% tax equivalent basis) for the same period in 2011. The combined net effects of the $156,178 increase in average interest earning assets and the increase in yields on average interest earning assets resulted in the $12,707 ($12,833 tax equivalent basis) increase in interest income between the two years.

Interest bearing liabilities averaged $1,652,460 during the year ended December 31, 2012 as compared to $1,512,898 for the same period in 2011, an increase of $139,562, or 9.2%. The cost of average interest bearing liabilities decreased 30 bps to 0.51% during the year ended December 31, 2012, compared to 0.81% for 2011. The combined net effects of the $139,562 increase in average interest bearing liabilities and the 30 bps decrease in cost of average interest bearing liabilities resulted in the $3,726 decrease in interest expense between the two years. See the tables “Average Balances – Yields & Rates,” and “Analysis of Changes in Interest Income and Expenses” below.

 

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Average Balances (8) – Yields & Rates

 

     Years Ended December 31,  
     2012     2011  
     Average     Interest      Average     Average     Interest      Average  
     Balance     Inc / Exp      Rate     Balance     Inc / Exp      Rate  

ASSETS:

              

Noncovered loans (1) (2) (7)

   $ 1,126,784      $ 58,696         5.21   $ 1,035,496      $ 55,036         5.31

Covered loans (9)

     324,708        23,542         7.25     180,590        11,396         6.31

Securities available for sale—taxable

     458,946        11,297         2.46     492,666        14,296         2.90

Securities available for sale—tax exempt (7)

     39,183        2,120         5.41     35,727        2,100         5.88

Federal funds sold and other

     121,369        638         0.53     170,333        632         0.37
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST EARNING ASSETS

   $ 2,070,990      $ 96,293         4.65   $ 1,914,812      $ 83,460         4.36

Allowance for loan losses

     (26,872          (27,265     

All other assets

     401,784             289,024        
  

 

 

        

 

 

      

TOTAL ASSETS

   $ 2,445,902           $ 2,176,571        
  

 

 

        

 

 

      

LIABILITIES & STOCKHOLDERS’ EQUITY

              

Deposits:

              

Now

   $ 410,384      $ 457         0.11   $ 313,178      $ 665         0.21

Money market

     331,449        730         0.22     263,089        899         0.34

Savings

     239,147        266         0.11     208,254        562         0.27

Time deposits

     574,775        6,076         1.06     623,421        9,373         1.50

Repurchase agreements

     21,388        86         0.40     15,949        84         0.53

Federal funds purchased

     53,803        28         0.05     70,940        48         0.07

Other borrowed funds (3)

     4,556        201         4.41     5,012        127         2.54

Corporate debenture (4)

     16,958        637         3.76     13,055        449         3.43
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST BEARING LIABILITIES

   $ 1,652,460        8,481         0.51   $ 1,512,898        12,207         0.81

Demand deposits

     506,927             393,056        

Other liabilities

     17,233             17,219        

Total stockholders’ equity

     269,282             253,398        
  

 

 

        

 

 

      

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 2,445,902           $ 2,176,571        
  

 

 

        

 

 

      

NET INTEREST SPREAD (tax equivalent basis) (5)

          4.14          3.55
       

 

 

        

 

 

 

NET INTEREST INCOME (tax equivalent basis)

     $ 87,812           $ 71,253      
    

 

 

        

 

 

    

NET INTEREST MARGIN (tax equivalent basis) (6)

          4.24          3.72
       

 

 

        

 

 

 

 

(10) Loan balances are net of deferred origination fees and costs. Non-accrual loans are included in total loan balances.
(11) Interest income on average loans includes loan fee recognition of $511 and $362 for the years ended December 31, 2012 and 2011, respectively.
(12) Includes short-term (usually overnight) Federal Home Loan Bank advances and other short term borrowings.
(13) Includes net amortization of origination costs and amortization of purchase accounting adjustment of $25 and $5 during year ended December 31, 2012 and 2011, respectively.
(14) Represents the average rate earned on interest earning assets minus the average rate paid on interest bearing liabilities.
(15) Represents net interest income divided by total earning assets.
(16) Interest income and rates include the effects of a tax equivalent adjustment using applicable statutory tax rates to adjust tax exempt investment income on tax exempt investment securities and loans to a fully taxable basis.
(17) Averages balances are average daily balances.
(18) Covered loans are loans purchased from the FDIC pursuant to assisted acquisitions of failed financial institutions, and are covered with respect to certain loss sharing agreements with the FDIC.

 

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Analysis of Changes in Interest Income and Expenses

 

     Net Change Dec 31, 2012 versus 2011  
     Volume     Rate     Net
Change
 

INTEREST INCOME

      

Loans (tax equivalent basis)

   $ 13,261      $ 2,545      $ 15,806   

Securities available for sale—taxable

     (932     (2,067     (2,999

Securities available for sale—tax exempt

     194        (174     20   

Federal funds sold and other

     (213     219        6   
  

 

 

   

 

 

   

 

 

 

TOTAL INTEREST INCOME (tax equivalent basis)

   $ 12,310      $ 523      $ 12,833   
  

 

 

   

 

 

   

 

 

 

INTEREST EXPENSE

      

Deposits

      

NOW accounts

   $ 167      $ (374   $ (207

Money market accounts

     199        (368     (169

Savings

     73        (369     (296

Time deposits

     (686     (2,612     (3,298

Repurchase agreements

     25        (23     2   

Federal funds purchased

     (10     (10     (20

Other borrowed funds

     (13     86        73   

Corporate debenture

     147        42        189   
  

 

 

   

 

 

   

 

 

 

TOTAL INTEREST EXPENSE

   $ (98   $ (3,628   $ (3,726
  

 

 

   

 

 

   

 

 

 

NET INTEREST INCOME (tax equivalent basis)

   $     12,408      $     4,151      $     16,559   
  

 

 

   

 

 

   

 

 

 

The table above details the components of the changes in net interest income for the last two years. For each major category of interest earning assets and interest bearing liabilities, information is provided with respect to changes due to average volume and changes due to rates, with the changes in both volumes and rates allocated to these two categories based on the proportionate absolute changes in each category.

Provision for Loan Losses

The provision for loan losses (expense) decreased $36,771 to $9,220 during the year ending December 31, 2012 compared to $45,991 for the comparable period in 2011. Our policy is to maintain the allowance for loan losses at a level sufficient to absorb probable incurred losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses, which is a charge to current period earnings, and is decreased by charge-offs, net of recoveries on prior loan charge-offs. Therefore, the provision for loan losses (Income Statement effect) is a residual of management’s determination of allowance for loan losses (Balance Sheet approach). In determining the adequacy of the allowance for loan losses, we consider those levels maintained by conditions of individual borrowers, the historical loan loss experience, the general economic environment, the overall portfolio composition, and other information. As these factors change, the level of loan loss provision changes. Also, the loan loss provision in 2011 was elevated due to the sale of credit impaired loans in the wholesale market during 2011. Because of the large bargain purchase gains recognized pursuant to the acquisition of Federal Trust Bank and the acquisition of branches and loans from TD Bank during 2011, management determined that the Company had sufficient capital to allow for the loss related to the sale of these troubled loans in the wholesale market, and elected to purge the loans at discounts versus management time and energy working them through the foreclosure process and eventually selling the repossessed assets in future years. In addition, the put back period related to our Federal Trust Bank loans expired during the fourth quarter of 2012, at which time additional allowance for loan losses were added to the general allowance pursuant to this segment of performing loans, also effecting our loan loss provision. See “credit quality and allowance for loan losses” regarding the allowance for loan losses for additional information.

 

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Non-Interest Income

Non-interest income for the year ended December 31, 2012 was $59,261 compared to $101,972 for the comparable period in 2011. This increase was the result of the following components listed in the table below

 

                 $     %  
                 increase     increase  
     2012     2011     (decrease)     (decrease)  

Income from correspondent banking and bond sales division

   $ 32,806      $ 24,889      $ 7,917        31.8

Other correspondent banking related revenue

     2,901        2,177        724        33.3

Wealth management related revenue

     3,760        1,801        1,959        108.8

Service charges on deposit accounts

     6,598        6,316        282        4.5

Debit, prepaid, ATM and merchant card related fees

     4,623        3,194        1,429        44.7

Bank owned life insurance income

     1,436        967        469        48.5

Other service charges and fees

     1,340        1,515        (175     (11.6 %) 

Gain on sale of securities

     2,423        3,464        (1,041     (30.1 %) 

Bargain purchase gain

     453        57,020        (56,567     (99.2 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     56,340        101,343        (45,003     (44.4 %) 

FDIC indemnification asset- amortization

     (3,096     (503     (2,593     515.5

FDIC indemnification income

     6,017        1,132        4,885        431.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

   $ 59,261      $ 101,972      ($ 42,711     (41.9 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

As shown in the table above, the primary reasons for the decrease in non-interest income year to year was the bargain purchase gain from the January 2011 purchase of branches and loans from TD Bank, N.A. and the November 2011 purchase of Federal Trust Bank (“FTB”) from The Hartford Insurance Group, Inc. In both cases, selected performing loans were purchased at a 10% discount with regard to TD Bank, N.A. transaction and a 23% discount with regard to the FTB transaction, which was the primary reason for the bargain purchase gains in 2011. In 2012, the Company acquired Central Florida State Bank pursuant to an FDIC assisted transaction resulting in a bargain purchase gain of $453.

The correspondent banking bond sales division is a volatile business. While 2012 was its best year to date for bond sales, we expect significant future volatility in the fixed income business, and therefore do not consider their initial four year performance necessarily a trend.

The FDIC indemnification asset (“IA”) is producing amortization (versus accretion) due to reductions in the estimated losses in the FDIC covered loan portfolio. To the extent current projected losses in the covered loan portfolio are less than previously projected losses, the related projected reimbursements from the FDIC contemplated in the IA are less, which produces a negative income accretion in non-interest income. This event corresponds to the increase in yields in the FDIC covered loan portfolio, although there is not perfect correlation. Higher expected cash flows (i.e. less expected future losses) on the loan side of the equation is accreted into interest income over the life of the related loan pool. The lower expected reimbursement from the FDIC (i.e. 80% of the lower expected future losses) is amortized over the lesser of the remaining life of the related loan pool(s) or the remaining term of the loss share period.

At December 31, 2012, the total IA on the Company’s balance sheet was $119,289. Of this amount, the Company estimated, at December 31, 2012, that it would receive reimbursements from the FDIC of approximately $99,289 related to future estimated losses, and estimated that it would expense approximately $19,653 for previously estimated losses that are no longer expected. The $19,653 was estimated to be paid, or has been paid, by the borrower (or has been or is estimated to be realized upon the sale of OREO) instead of a reimbursement from the FDIC. At December 31, 2012, the $19,653 previously estimated reimbursements from the FDIC will be amortized as expense (negative accretion) in the Company’s non-interest income over the lesser of the remaining life of the related loan pool(s) or the remaining term of the loss share period. At December 31, 2012 it was expected that more than 50% of it would be amortized in the following three years. Management analyzes its FDIC covered loan portfolio each quarter, and each quarter subsequent to December 31, 2012, management’s estimates of future losses within the covered loan portfolio has improved. As such, each quarter the expected reimbursements from the FDIC declines and our FDIC amortization expense increases. See our related discussion one year later (at December 31, 2013) regarding IA amortization on page 43.

 

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Our other FDIC income related line item in the table above, FDIC indemnification income, has two components. The first relates to losses on FDIC covered OREO. To the extent we incur a loss on the sale of OREO, 80% of the loss is reimbursable from the FDIC. The 80% reimbursable amount is recognized as FDIC indemnification income in this line item during the same period the expense or loss on OREO is recognized in our non-interest expenses. The second component relates to provision for loan loss expenses related to impairments on any of our covered loan pools. To the extent we incur a loan loss provision expense we recognize FDIC indemnification income in an amount equal to approximately 80% of such expense during the same period the expense was recognized in provision for loan loss expense.

We acquired a Trust business pursuant to our January 2012 acquisition of a failed financial institution in an FDIC assisted transaction. The business has been producing approximately $300 of gross fees per quarter and is the primary reason for the increase in our wealth management related revenue listed in the table above.

Our bank owned life insurance revenue (“BOLI”) increased due the purchase of $10,000 additional BOLI during the first quarter of 2012.

 

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Non-Interest Expense

Non-interest expense for the year ended December 31, 2012 increased $7,291, or 6.4%, to $121,980, compared to $114,689 for 2011. The table below breaks down the individual components.

 

                 $     %  
                 increase     increase  
     2012     2011     (decrease)     (decrease)  

Employee salaries and wages

   $ 56,232      $ 47,150      $ 9,082        19.3

Employee incentive/bonus compensation

     3,938        2,830        1,108        39.2

Employee stock based compensation

     631        705        (74     (10.5 %) 

Employer 401K matching contributions

     1,144        983        161        16.4

Deferred compensation expense

     501        460        41        8.9

Health insurance and other employee benefits

     3,985        3,215        770        24.0

Payroll taxes

     3,235        2,844        391        13.7

Other employee related expenses

     1,051        585        466        79.7

Incremental direct cost of loan origination

     (779     (527     (252     47.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Total salaries, wages and employee benefits

   $ 69,938      $ 58,245      $ 11,693        20.1

(Gain) loss on sale of OREO

     (140     732        (872     (119.1 %) 

Loss (gain) on sale of FDIC covered OREO

     1,325        (187     1,512        (808.6 %) 

Valuation write down of OREO

     1,011        4,939        (3,928     (79.5 %) 

Valuation write down of FDIC covered OREO

     3,247        1,812        1,435        79.2

Loss on repossessed assets other than real estate

     123        377        (254     (67.4 %) 

Loan put back expense

     1,632        755        877        116.2

Foreclosure and repossession related expenses

     2,487        3,078        (591     (19.2 %) 

Foreclosure and repo expenses, FDIC (note 1)

     1,521        1,190        331        27.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Total credit related fees

     11,206        12,696        (1,490     (11.7 %) 

Occupancy expense

     8,697        8,271        426        5.2

Depreciation of premises and equipment

     5,678        4,207        1,471        35.0

Supplies, stationary and printing

     1,124        1,285        (161     (12.5 %) 

Marketing expenses

     2,564        2,791        (227     (8.1 %) 

Data processing expense

     3,988        4,680        (692     (14.8 %) 

Legal, auditing and other professional fees

     2,527        2,729        (202     (7.4 %) 

Bank regulatory related expenses

     2,429        2,621        (192     (7.3 %) 

Postage and delivery

     1,148        930        218        23.4

ATM and debit card related expenses

     1,207        1,631        (424     (26.0 %) 

CDI amortization

     1,155        804        351        43.7

Trust intangible amortization

     217        —          217        n/a   

Impairment of bank property held for sale

     614        —          614        n/a   

Internet and telephone banking

     945        1,005        (60     (6.0 %) 

Operational write-offs and losses

     697        553        144        26.0

Correspondent accounts and Federal Reserve charges

     527        471        56        11.9

Conferences/Seminars/Education/Training

     510        498        12        2.4

Director fees

     374        294        80        27.2

Travel expenses

     317        134        183        136.6

Other expenses

     3,404        3,148        256        8.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

   $ 119,266      $ 106,993      $ 12,273        11.5

Merger, acquisition and conversion related expenses

     2,714        7,696        (4,982     (64.7 %) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

   $ 121,980      $ 114,689      $ 7,291        6.4
  

 

 

   

 

 

   

 

 

   

 

 

 

 

note 1: These are foreclosure related expenses related to FDIC covered assets, and are shown net of FDIC reimbursable amounts pursuant to FDIC loss share agreements.

 

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Excluding merger, acquisition and conversion related expenses identified above, total non-interest expense increased $12,273 or 11.5% year to year as shown in the above table. The table below removes credit related expenses and correspondent segment expenses, which is primarily compensation related and varies significantly with levels of bond sales volumes.

 

                 $     %  
                 increase     increase  
     2012     2011     (decrease)     (decrease)  

Total non-interest expense

   $ 121,980      $ 114,689      $ 7,291        6.4

Less: merger, acquisition, conversion, expenses

     (2,714     (7,696     (4,982     (64.7 %) 

Less: impairment bank property held for sale

     (614     —          614        na   
  

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     118,652        106,993        11,659        10.9

Less: credit related expenses

     (11,206     (12,696     (1,490     (11.7 %) 

Less: correspondent segment

     (28,168     (23,883     4,285        17.9
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expense, excluding credit cost, correspondent segment, and merger, acquisition and conversion related expenses, and impairment of bank property held for sale

   $ 79,278      $ 70,414      $ 8,864        12.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Excluding merger, acquisition and conversion related expense and impairment of bank property held for sale, and excluding credit cost and our correspondent division, the remaining non-interest expense approximates the operating expense of our core commercial and consumer banking segment. As shown in the table above, this expense increased approximately $8,864, or 12.6% year to year. The reasons for this increase include the following:

 

    In January 2012, we acquired two failed financial institutions which included 12 branches in the aggregate. The Company consolidated three branches in the first quarter of 2012 and another six branches in the second quarter of 2012. We incurred the related incremental expenses in 2012 for these branches until they closed. In addition, the two failed banks operated on two different core processing systems, which were not converted to our core processing system until May and June of 2012, adding elevated cost in terms of data processing, personnel and other temporary inefficiencies above the normalized incremental operating expenses.

 

    In November 2011, we acquired five branches from The Hartford Insurance Group, Inc. The additional operating costs of these five branches were included in our 2011 expenses for two months versus all twelve months in 2012.

 

    In addition to closing 10 of the 12 branches we acquired in 2012, we also closed an additional branch in February 2012 and four more branches at the end of August 2012.

 

    In addition to consolidating and closing branches, and a reduction in workforce, we also initiated other cost efficiencies and revenue enhancements during the year. Our quarterly operating expenses decreased by approximately 9% in the fourth quarter compared to our high water mark in the second quarter of 2012.

Income Tax Provision

We recognized an income tax expense for the year ended December 31, 2012 of $4,625 (an effective tax rate of 31.8%) compared to $3,419 (an effective tax rate of 30.2%) for the year ended December 31, 2011. The reason our effective tax rate was lower than our statutory tax rate in 2012 and 2011 is because we had tax exempt income in excess of non-deductible expenses thereby decreasing our taxable income below our book pre-tax income as recorded in our Consolidated Statement of Operations.

 

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COMPARISON OF BALANCE SHEETS AT DECEMBER 31, 2013 AND DECEMBER 31, 2012

Overview

Our total assets grew by $52,327, or 2.2%, from $2,363,240 at December 31, 2012 to $2,415,567 at December 31, 2013. The growth was primarily caused by a $58,999, or 3.0%, growth in our deposits between the same two period ends. The deposit growth occurred primarily during the fourth quarter due to certain large deposits from taxing agencies and other temporary transactional type deposits. Average total deposits year to year decreased approximately 2.5% and average total assets decreased approximately 2.6% between 2013 and 2012.

Investment securities available for sale

We account for our securities at fair value and classify them as available for sale, except for trading securities. Unrealized holding gains and losses are included as a separate component of shareholders’ equity, net of the effect of deferred income taxes.

We invest primarily in direct obligations of the United States, obligations guaranteed as to the principal and interest by the United States, mortgage backed securities, municipal securities and obligations of government sponsored entities and agencies of the United States. The Federal Reserve Bank and the Federal Home Loan Bank also require equity investments to be maintained by us, which are shown separately in our consolidated balance sheet.

Our available for sale portfolio totaled $457,086 at December 31, 2013 and $425,758 at December 31, 2012, or 19% and 18%, respectively, of total assets. See the tables below for a summary of security type, maturity and average yield distributions.

We use our security portfolio primarily as a tool to manage our balance sheet, manage our regulatory capital ratios, as a source of liquidity and a base from which to pledge assets for repurchase agreements and public deposits. When our liquidity position exceeds expected loan demand, other investments are considered as a secondary earnings alternative. Approximately 91% of investment securities available for sale are mortgage backed securities. The cash flows from these securities are used to meet cash needs or will be reinvested to maintain a desired liquidity position. We have designated all of our securities as available for sale, except our trading portfolio, to provide flexibility, in case an immediate need for liquidity arises. We believe the composition of the portfolio offers flexibility in managing our liquidity position and interest rate sensitivity, without adversely impacting our regulatory capital levels. The available for sale portfolio is carried at fair market value and had a net unrealized loss of approximately $7,300 at December 31, 2013, compared to a net unrealized gain of approximately $11,709 at December 31, 2012.

If our management intends to sell or it is more likely than not we will be required to sell the security before recovery of our amortized cost basis, less any current period credit loss, the other than temporary impairment (“OTTI”) will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If our management does not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI will be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. The assessment of whether an OTTI decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

The tables below summarize the maturity distribution of securities, weighted average yield by range of maturities, and distribution of securities for the periods provided. Yields are not presented on a tax equivalent basis in the table below.

 

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     One year or less     Over one through
five years
    Over five through
ten years
    Over ten years     Total  

AVAILABLE-FOR-SALE

   $      %     $      %     $      %     $      %     $      %  

US government sponsored entities and agencies

   $ —           —     $ 4         4.46   $ —           —     $ —           —     $ 4         4.46

State, county, and municipal

     —           —       1,917         3.88     12,491         3.55     25,792         3.54     40,201         3.56

Mortgage-backed securities

     13         4.90     5,411         4.59     33,633         2.87     377,825         2.61     416,881         2.65
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 13         4.90   $ 7,332         4.40   $ 46.124         3.05   $ 403,617         2.67   $ 457,086         2.73

Distribution of Investment Securities

 

     December 31, 2013      December 31, 2012      December 31, 2011  
     Amortized      Fair      Amortized      Fair      Amortized      Fair  

AVAILABLE-FOR-SALE

   Cost      Value      Cost      Value      Cost      Value  

US government sponsored entities and agencies

   $ 4       $ 4       $ 7,465       $ 7,546       $ 78,455       $ 78,877   

State, county, and municipal

     39,728         40,201         42,570         45,022         39,312         41,293   

Mortgage-backed securities

     424,654         416,881         364,014         373,190         464,237         470,994   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 464,386       $ 457,086       $ 414,049       $ 425,758       $ 582,004       $ 591,164   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

We also have a trading securities portfolio. For this portfolio, realized and unrealized gains and losses are included in trading securities revenue, a component of non interest income in our Consolidated Statement of Operations and Comprehensive Income. Securities purchased for this portfolio have primarily been municipal securities and are held for short periods of time. This activity was initiated to take advantage of market opportunities, when presented, for short term revenue gains. The table below summarizes our trading activity during the years presented.

 

     2013     2012  

Beginning balance

   $ 5,048      $ —     

Purchases

     198,186        367,105   

Proceeds from sales

     (203,489     (362,747

Net realized gain on sales

     255        715   

Mark-to-market adjustment

     —          (25
  

 

 

   

 

 

 

Ending balance

   $ —        $ 5,048   
  

 

 

   

 

 

 

Loans

Lending-related income is the most important component of our net interest income and is a major contributor to profitability. The loan portfolio is the largest component of earning assets, and it therefore generates the largest portion of revenues. The absolute volume of loans and the volume of loans as a percentage of earning assets is an important determinant of net interest margin as loans are expected to produce higher yields than securities and other earning assets. Average loans during the year ended December 31, 2013, were $1,439,069, or 71% of average earning assets, as compared to $1,451,492, or 70% of average earning assets, for the year ending December 31, 2012. Total loans at December 31, 2013 and 2012 were $1,474,179 and $1,435,863, respectively, an increase of $38,316, or 2.7%. This also represents a loan to total asset ratio of 61% and 61% and a loan to deposit ratio of 72% and 72%, at December 31, 2013 and 2012, respectively.

Approximately 15.6% of our total loans, or $230,273, are covered by FDIC loss sharing agreements related to the acquisition of three failed financial institutions during the third quarter of 2010 and two during the first quarter of 2012. Pursuant to the terms of the loss sharing agreements, the FDIC is obligated to reimburse us for 80% of losses with respect to the covered loans beginning with the first dollar of loss incurred, subject to the terms of the agreements. We will reimburse the FDIC for its share of recoveries with respect to the covered loans. The loss sharing agreements applicable to single family residential mortgage loans provide for FDIC loss sharing and our reimbursement to the FDIC for recoveries for ten years. The loss sharing agreements applicable to commercial loans provides for FDIC loss sharing for five years and our reimbursement to the FDIC for a total of eight years for recoveries.

 

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Of the 84.4% of our loans, or $1,243,906 not covered by FDIC loss sharing agreements, approximately 84% are collateralized by real estate, 12% are commercial non real estate loans and the remaining 4% are consumer and other non real estate loans. The loans collateralized by real estate are further delineated as follows.

Residential real estate loans: These are single family home loans originated within our local market areas by employee loan officers or purchased from TD Bank, N.A. and The Hartford Insurance Group with two and one year put back options that expired on January 20, 2013 and November 1, 2012, respectively. We do not use loan brokers to originate loans for our own portfolio, nor do we acquire loans outside of our geographical markets. The size of this portfolio is $458,331 representing approximately 37% of our total loans, excluding those covered by FDIC loss share agreements. Within this category there are approximately $10,162 non performing (non-accrual) loans (92 loans) as of December 31, 2013.

Commercial real estate loans: This is the largest category ($528,710) of our loan portfolio representing approximately 43% of our total loans, excluding those covered by FDIC loss share agreements. This category, along with commercial non real estate lending, is our primary business. There is no significant concentration by type of property in this category but there is a geographical concentration such that the properties are all located within Florida, primarily central Florida. The borrowers are a mix of professionals, doctors, lawyers, and other small business people. Approximately 52% of these loans are owner occupied. Within this category there are approximately $13,925 non performing (non-accrual) loans (40 loans) as of December 31, 2013.

Land, development and construction loans: We have no construction or development loans with national builders. We do business with local builders and developers that have typically been long time customers. This category represents approximately 5% ($62,503) of our total loan portfolio. The majority of this amount is land development, lots, and other land loans. Approximately $1,099 of loans in this category are non performing (non-accrual) loans (12 loans) as of December 31, 2013, of which substantially all are collateralized by residential building lots, commercial building lots, undeveloped land and vacant land both residential and commercial.

Loan concentrations are considered to exist where there are amounts loaned to multiple borrowers engaged in similar activities, which collectively could be similarly impacted by economic or other conditions and when the total of such amounts would exceed 25% of total capital. Due to the lack of diversified industry and the relative proximity of markets served, we have concentrations in geographic regions as well as in types of loans funded.

 

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The tables below provide a summary of the loan portfolio composition and maturities for the periods provided below.

Loan Portfolio Composition

 

Types of Loans

at December 31:

   2013      2012     2011     2010     2009  

Loans not covered by FDIC loss share agreements

           

Real estate loans:

           

Residential

   $ 458,331       $ 428,554      $ 405,923      $ 255,571      $ 251,634   

Commercial

     528,710         480,494        447,459        410,162        438,540   

Land, development and construction

     62,503         55,474        89,517        109,380        115,937   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

     1,049,544         964,522        942,899        775,113        806,111   

Commercial

     143,263         124,225        126,064        100,906        98,273   

Consumer and other loans

     50,695         51,279        51,391        55,379        55,376   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total loans—gross

     1,243,502         1,140,026        1,120,354        931,398        959,760   

Less: unearned fees/costs

     404         (458     (639     (728     (739
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total loans not covered by FDIC loss share agreements

     1,243,906         1,139,568        1,119,715        930,670        959,021   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Loans covered by FDIC loss share agreements

           

Real estate loans:

           

Residential

     120,030         142,480        99,270        110,586        —     

Commercial

     100,012         134,413        54,184        68,286        —     

Land, development and construction

     6,381         13,259        8,231        13,653        —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

     226,423         290,152        161,685        192,525        —     

Commercial

     3,850         6,143        2,366        5,760        —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total loans covered by FDIC loss share agreements

     230,273         296,295        164,051        198,285        —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 1,474,179       $ 1,435,863      $ 1,283,766      $ 1,128,955      $ 959,021   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

The repayment of loans is a source of additional liquidity for us. The following table sets forth the loans maturing within specific intervals at December 31, 2013, excluding unearned net fees and costs.

Loan Maturity Schedule

 

     December 31, 2013  
     0 – 12
Months
     1 – 5
Years
     Over 5
Years
     Total  

All loans other than construction, development, land

   $ 131,474       $ 403,625       $ 869,792       $ 1,404,891   

Real estate—land, development and construction

     18,864         28,510         21,510         68,884   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 150,338       $ 432,135       $ 891,302       $ 1,473,775   
  

 

 

    

 

 

    

 

 

    

 

 

 

Fixed interest rate

   $ 109,242       $ 361,304       $ 322,216       $ 792,762   

Variable interest rate

     41,096         70,831         569,086         681,013   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 150,338       $ 432,135       $ 891,302       $ 1,473,775   
  

 

 

    

 

 

    

 

 

    

 

 

 

The information presented in the above table is based upon the contractual maturities of the individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon their maturity. Consequently, management believes this treatment presents fairly the maturity structure of the loan portfolio. See “Liquidity and Market Risk Management” for a discussion regarding the repricing structure of the loan portfolio.

Credit Quality and Allowance for Loan Losses

We maintain an allowance for loan losses that we believe is adequate to absorb probable incurred losses inherent in our loan portfolio. The allowance is increased by the provision for loan losses, which is a charge to current period earnings and decreased by loan charge-offs net of recoveries of prior period loan charge-offs. Loans are charged against the allowance when management believes collection of the principal is unlikely.

 

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The allowance consists of three components. The first component consists of amounts reserved for impaired loans, as defined by ASC 310. Impaired loans are those loans that management has estimated will not repay as agreed pursuant to the loan contract. Each of these loans is required to have a written analysis supporting the amount of specific reserve allocated to the particular loan, if any. That is to say, a loan may be impaired (i.e. not expected to repay as agreed), but may be sufficiently collateralized such that we expect to recover all principal and interest eventually, and therefore no specific reserve is warranted.

The second component is a general reserve on all of our loans other than those identified as impaired and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced over the most recent two years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. The following portfolio segments have been identified:

Residential real estate

Commercial real estate

Construction and land development

Commercial and industrial (not collateralized by real estate)

Consumer (not collateralized by real estate)

The historical loss factors for each portfolio segment is adjusted for current internal and external environmental factors, as well as for certain loan grading factors. The environmental factors that we consider are listed below.

We consider changes in the levels of and trends in past due loans, non-accrual loans and impaired loans, and the volume and severity of adversely classified or graded loans. Also, we consider changes in the value of underlying collateral for collateral-dependent loans.

We consider levels of and trends in charge-offs and recoveries.

We consider changes in the nature and volume of the portfolio and in the terms of loans.

We consider changes in lending policies, procedures and practices, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses. We also consider changes in the quality of our loan review system.

We consider changes in the experience, ability, and depth of our lending management and other relevant staff.

We consider changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments (national and local economic trends and conditions).

We consider the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in our existing portfolio (industry conditions).

We consider the existence and effect of any concentrations of credit, and changes in the level of such concentrations.

The third component consists of amounts reserved for purchased credit-impaired loans. On a quarterly basis, we update the amount of loan principal and interest cash flows expected to be collected, incorporating assumptions regarding default rates, loss severities, the amounts and timing of prepayments and other factors that are reflective of current market conditions. Probable decreases in expected loan principal cash flows trigger the recognition of impairment, which is then measured as the present value of the expected principal loss plus any related foregone interest cash flows discounted at the pool’s effective interest rate. Impairments that occur after the

 

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acquisition date are recognized through the provision for loan losses. Probable and significant increases in expected principal cash flows would first reverse any previously recorded allowance for loan losses; any remaining increases are recognized prospectively as interest income. The impacts of (i) prepayments, (ii) changes in variable interest rates, and (iii) any other changes in the timing of expected cash flows are recognized prospectively as adjustments to interest income. Disposals of loans, which may include sales of loans, receipt of payments in full by the borrower, or foreclosure, result in removal of the loan from the purchased credit impaired portfolio. The aggregate of these three components results in our total allowance for loan losses.

In the table below we have shown the components, as discussed above, of our allowance for loan losses at December 31, 2013 and 2012.

 

     Dec 31, 2013     Dec 31, 2012     increase (decrease)  
     loan      ALLL            loan      ALLL            loan     ALLL        
     balance      balance      %     balance      balance      %     balance     balance        

Non impaired loans

   $ 1,219,796       $ 17,883         1.47   $ 1,091,389       $ 23,011         2.11   $ 128,407      $ (5,128     -64bps   

Impaired loans

     24,110         1,811         7.51     48,179         1,022         2.12     (24,069     789        539bps   
  

 

 

    

 

 

      

 

 

    

 

 

      

 

 

   

 

 

   

Loans (note 1)

     1,243,906         19,694         1.58     1,139,568         24,033         2.11     104,338        (4,339     -53bps   

Covered loans (note 2)

     230,273         760           296,295         2,649           (66,022     (1,889  
  

 

 

    

 

 

      

 

 

    

 

 

      

 

 

   

 

 

   

Total loans

   $ 1,474,179       $ 20,454         1.39   $ 1,435,863       $ 26,682         1.86   $ 38,316      $ (6,228     -47bps   
  

 

 

    

 

 

      

 

 

    

 

 

      

 

 

   

 

 

   

 

Note1: Total loans not covered by FDIC loss share agreements.
Note2: Loans covered by FDIC loss share agreements. Eighty percent of any losses in this portfolio will be reimbursed by the FDIC and recognized as FDIC indemnification income and included in non-interest income within the Company’s Consolidated Statement of Operations and Comprehensive Income. Four loan pools with an aggregate carrying value of $8,005 are impaired as of December 31, 2013, and have a specific allowance of $760. The aggregate carrying value of $8,005 represents approximately 77% of the underlying loan balances outstanding.

The general loan loss allowance (non-impaired loans) decreased by $5,128, or 64 bps to 1.47% of non-impaired loan balance outstanding as of the end of 2013 as compared to 2.11% at the end of 2012. This is a result of changes in historical charge off rates, changes in current environmental factors and changes in the loan portfolio mix.

The specific loan loss allowance (impaired loans) is the aggregate of the results of individual analyses prepared for each one of the impaired loans not covered by an FDIC loss sharing agreement on a loan by loan basis. We recorded partial charge offs in lieu of specific allowance for a number of the impaired loans. Our impaired loans were written down by $2,772 to $24,110 ($22,299 when the $1,811 specific allowance is considered) at December 31, 2013 from their legal unpaid principal balance outstanding of $26,882 at the same date. As such, in the aggregate, our total impaired loans have been written down to approximately 83% of their legal unpaid principal balance.

Any losses in loans covered by FDIC loss share agreements, as described in note 2 above, are reimbursable from the FDIC to the extent of 80% of any losses. These loans are being accounted for pursuant to ASC Topic 310-30. On a quarterly basis, the Company updates the amount of loan principal and interest cash flows expected to be collected, incorporating assumptions regarding default rates, loss severities, the amounts and timing of prepayments and other factors that are reflective of current market conditions. Probable decreases in expected loan principal cash flows trigger the recognition of impairment, which is then measured as the present value of the expected principal loss plus any related foregone interest cash flows discounted at the pool’s effective interest rate. Impairments that occur after the acquisition date are recognized through the provision for loan losses.

We believe our allowance for loan losses was adequate at December 31, 2013. However, we recognize that many factors can adversely impact various segments of the Company’s market and customers, and therefore there is no assurance as to the amount of losses or probable losses which may develop in the future. The table below summarizes the changes in allowance for loan losses during the previous five years.

 

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The table below sets forth the activity in the allowance for loan losses for the periods presented.

Activity in Allowance for Loan Losses

 

     2013     2012     2011     2010     2009  

Loans not covered by FDIC loss share agreements:

          

Balance, beginning of year

   $ 24,033      $ 27,585      $ 26,267      $ 23,289      $ 13,335   

Loans charged-off:

          

Residential real estate

     (3,701     (3,968     (9,306     (4,306     (3,442

Commercial real estate

     (1,144     (2,862     (11,179     (8,131     (3,001

Construction & land development

     (310     (4,646     (7,717     (4,994     (6,457

Commercial & industrial

     (120     (231     (1,971     (774     (830

Consumer

     (903     (807     (1,091     (523     (353
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans charged-off

     (6,178     (12,514     (31,264     (18,728     (14,083

Loans charged-off—loan sales:

          

Residential real estate

     —          —          (3,019     —          —     

Commercial real estate

     —          —          (11,153     (8,361     —     

Construction & land development

     —          —          (456     —          —     

Commercial & industrial

     —          —          (220     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans charged-off—loan sales

     —          —          (14,848     (8,361     —     

Recoveries on loans previously charged-off:

          

Residential real estate

     432        378        542        178        16   

Commercial real estate

     417        871        665        42        6   

Construction & land development

     193        604        251        167        43   

Commercial & industrial

     51        22        82        11        29   

Consumer

     181        157        258        45        47   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loan recoveries

     1,274        2,032        1,798        443        141   

Net charge-offs

     (4,904     (10,482     (44,314     (26,646     (13,942

Provision for loan losses charged to expense

     565        6,930        45,632        29,624        23,896   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance at end of period for loans not covered by FDIC loss share agreements

   $ 19,694      $ 24,033      $ 27,585      $ 26,267      $ 23,289   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans covered by FDIC loss share agreements:

          

Balance, beginning of year

   $ 2,649      $ 359      $ —        $ —        $ —     

Loans charged-off:

          

Residential real estate

     —          —          —          —          —     

Commercial real estate

     (1,248     —          —          —          —     

Construction & land development

     —          —          (293     —          —     

Commercial & industrial

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans charged-off

     (1,248     —          (293     —          —     

Recoveries on loans previously charged-off:

          

Residential real estate

     —          —          —          —          —     

Commercial real estate

     —          —          —          —          —     

Construction & land development

     —          —          293        —          —     

Commercial & industrial

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loan recoveries

     —          —          293        —          —     

Net charge-offs

     (1,248     —          —          —          —     

Provision for loan losses charged to expense

     (641     2,290        359        —       <