DEF 14A 1 ddef14a.htm DEFINITIVE NOTICE & PROXY Definitive Notice & Proxy

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of the

Securities Exchange Act of 1934

 

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x Definitive Proxy Statement

 

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¨ Soliciting Material Pursuant to §240.14a-12

 

 

SOUTHEASTERN BANK FINANCIAL CORPORATION

 

 

(Name of Registrant as Specified In Its Charter)

 

 

  

 

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

 

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SOUTHEASTERN BANK FINANCIAL CORPORATION

3530 Wheeler Road

Augusta, Georgia 30909

NOTICE OF SPECIAL MEETING OF SHAREHOLDERS

To be held on December 17, 2008

TO THE SHAREHOLDERS OF SOUTHEASTERN BANK FINANCIAL CORPORATION:

You are hereby notified that a Special Meeting of Shareholders (the “Meeting”) of Southeastern Bank Financial Corporation, a Georgia corporation (the “Company”), will be held at the Cotton Exchange Office of the Company located at 32 Eighth Street, Augusta, Georgia on December 17, 2008, at 4:00 p.m, Eastern time for the following purposes:

 

  1. To vote upon a proposed amendment to the Company’s Articles of Incorporation to authorize a class of 10,000,000 shares of preferred stock, no par value. A copy of the amendment is set forth in Appendix A to this Proxy Statement.

 

  2. To grant management of the Company the authority to adjourn the Meeting to another time and date in order to allow the Board of Directors to solicit additional proxies or attendance at the Meeting.

 

  3. To transact such other business as may properly come before the Meeting or an adjournment thereof.

Information relating to the meeting and the proposals described above is set forth in the attached Proxy Statement. Shareholders of record at the close of business on November 7, 2008 are the only shareholders entitled to notice of and to vote at the Meeting.

 

By Order of the Board of Directors,

LOGO

Ronald L. Thigpen

Assistant Corporate Secretary

Augusta, Georgia

November 24, 2008

EACH SHAREHOLDER IS URGED TO EXECUTE AND RETURN THE ENCLOSED PROXY PROMPTLY IN THE ENCLOSED SELF-ADDRESSED ENVELOPE. IN THE EVENT A SHAREHOLDER DECIDES TO ATTEND THE MEETING, HE OR SHE MAY, IF SO DESIRED, REVOKE THE PROXY AND VOTE THE SHARES IN PERSON. YOUR BOARD RECOMMENDS THAT YOU VOTE IN FAVOR OF THE NOMINEES FOR DIRECTORS.


SOUTHEASTERN BANK FINANCIAL CORPORATION

3530 Wheeler Road

Augusta, Georgia 30909

PROXY STATEMENT

FOR

SPECIAL MEETING OF SHAREHOLDERS

To be Held on December 17, 2008

This Proxy Statement is furnished in connection with the solicitation of proxies for use at a Special Meeting of Shareholders (the “Meeting”) of Southeastern Bank Financial Corporation (the “Company”) to be held on December 17, 2008, at 4:00 p.m., Eastern Time and at any adjournment thereof, for the purposes set forth in this Proxy Statement. The accompanying proxy is solicited by the Board of Directors of the Company. The Meeting will be held at the Cotton Exchange Office of the Company located at 32 Eighth Street, Augusta, Georgia, 30901. This Proxy Statement and the accompanying Form of Proxy were first mailed to shareholders on or about November 24, 2008.

VOTING AND REVOCABILITY OF PROXY APPOINTMENTS

The Company has fixed November 7, 2008, as the record date (the “Record Date”) for determining the shareholders entitled to notice of and to vote at the Meeting. The Company’s only outstanding class of stock is its Common Stock. At the close of business on the Record Date, there were outstanding and entitled to vote approximately 5,987,451 shares of Common Stock held by approximately 540 shareholders of record, with each share being entitled to one vote. There are no cumulative voting rights. The approval of the proposals set forth in this Proxy Statement requires that a quorum be present at the Meeting. Shares representing a majority of the votes entitled to be cast at the meeting will constitute a quorum. In determining whether a quorum exists at the Meeting for purposes of all matters to be voted on, all votes “for” or “against,” as well as all abstentions (including votes to withhold in certain cases), will be counted.

The proposal to approve the proposed amendment to the Articles of Incorporation (the “Amendment Proposal”) requires the approval of at least a majority of the votes entitled to be cast on the proposal. The proposal to authorize management to adjourn the Meeting (the “Adjournment Proposal”) and, in general, any other proposal that is properly brought before the Meeting, will require that more votes be cast in favor of it than against it. Abstentions will be counted but broker non-votes will not be counted for purposes of determining the presence of a quorum. Both abstentions and broker non-votes will effectively constitute votes against the Amendment Proposal, but would not affect the approval of the Adjournment Proposal or, in general, other proposals properly brought before the Meeting.

All proxies will be voted in accordance with the instructions contained in the proxies. If no choice is specified, proxies will be voted “FOR” the Amendment Proposal, “FOR” the Adjournment Proposal and in the discretion of the persons appointed as proxies with respect to any other matter that may properly come before the Meeting. No proxy that is marked specifically “AGAINST” the Amendment Proposal will be voted in favor of the Adjournment Proposal unless it is marked specifically “FOR” the Adjournment Proposal. Any shareholder may revoke a proxy given pursuant to this solicitation prior to the Meeting by delivering an instrument revoking it, by delivering a duly executed proxy bearing a later date to the Company, or by attending the Meeting and voting in person. All written notices of revocation or other communications with respect to revocation of proxies should be addressed as follows: Southeastern Bank Financial Corporation, 3530 Wheeler Road, Augusta, Georgia, 30909, Attention: Ronald L. Thigpen, Executive Vice President.

The costs of preparing, assembling and mailing the proxy materials and of reimbursing brokers, nominees, and fiduciaries for the out-of-pocket and clerical expenses of transmitting copies of the proxy materials to the

 

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beneficial owners of shares held of record will be borne by the Company. Certain officers and employees of the Company or its subsidiaries, without additional compensation, may use their personal efforts, by telephone or otherwise, to obtain proxies in addition to this solicitation by mail. The Company expects to reimburse brokers, banks, custodians, and other nominees for their reasonable out-of-pocket expenses in handling proxy materials for beneficial owners of the Common Stock held in their names.

The Company anticipates that a representative of the Company’s independent certified public accounting firm, Crowe Horwath LLP, will be present at the Meeting and will have the opportunity to make a statement if they desire to do so and to respond to appropriate questions.

PROPOSAL 1: PROPOSAL TO AMEND THE ARTICLES OF INCORPORATION

The Board has approved, subject to receiving shareholder approval, an amendment to the Company’s Articles of Incorporation to authorize a class of 10,000,000 shares of preferred stock, no par value (the “Preferred Stock”). A copy of the amendment is set forth in Appendix A to this proxy statement. The Articles of Incorporation currently authorize only 10,000,000 shares of common stock, $1.00 par value. The amendment will vest in the Board the authority to determine by resolution the terms of one or more series of Preferred Stock, including the preferences, rights, and limitations of each series.

Provisions in a Company’s articles of incorporation authorizing preferred stock in this manner are often referred to as “blank check” provisions because they give a board of directors the flexibility, at any time or from time to time, without further shareholder approval (except as may be required by applicable laws, regulatory authorities, or the rules of any stock exchange on which the company’s securities are then listed), to create one or more series of preferred stock and to determine by resolution the terms of each such series. The authority of the board of directors with respect to each series, without limitation, includes a determination of the following: (a) the number of shares to constitute the series, (b) the liquidation rights, if any, (c) the dividend rights and rates, if any, (d) the rights and terms of redemption, (e) the voting rights, if any, which may be full, special, conditional, or limited, (f) whether the shares will be convertible or exchangeable into of securities of the Company, and the rates thereof, if any, (g) any limitations on the payment of dividends on the common stock while any series is outstanding, (h) any other provisions that are not inconsistent with the Articles of Incorporation, and (i) any other preference, limitations, or rights that are permitted by law.

The Board believes that authorization of the Preferred Stock in the manner proposed is in the best interests of the Company and its shareholders. Authorization of the Preferred Stock will provide the Company with greater flexibility in meeting future capital requirements by creating series of Preferred Stock customized to meet the needs of particular transactions and then prevailing market conditions. Series of Preferred Stock would also be available for issuance from time to time for any other proper corporate purposes, including in connection with strategic alliances, joint ventures, or acquisitions.

The Board believes that the flexibility to issue Preferred Stock can enhance the Board’s arm’s-length bargaining capability on behalf of the Company’s shareholders in a takeover situation. However, under some circumstances, the ability to designate the rights of, and issue, Preferred Stock could be used by the Board to make a change in control of the Company more difficult. See “Anti-Takeover Provisions of the Articles of Incorporation and Bylaws.”

The rights of the holders of the Company’s common stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. To the extent that dividends will be payable on any issued shares of Preferred Stock, the result would be to reduce the amount otherwise available for payment of dividends on outstanding shares of common stock and there might be restrictions placed on the Company’s ability to declare dividends on the common stock or to repurchase shares of common stock. The issuance of Preferred Stock having voting rights would dilute the voting power of the holders of common stock. To the extent that Preferred Stock is made convertible into shares of common stock, the effect, upon such

 

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conversion, would also be to dilute the voting power and ownership percentage of the holders of common stock. In addition, holders of Preferred Stock would normally receive superior rights in the event of any dissolution, liquidation, or winding-up of the Company, thereby diminishing the rights of the holders of common stock to distribution of the Company’s assets. Shares of Preferred Stock of any series would not entitle the holder to any pre-emptive right to purchase or subscribe for any shares of that or any other class.

The Board does not have any plans calling for the issuance of shares of Preferred Stock at the present time, other than the possible issuance of Preferred Stock to the U.S. Department of the Treasury (the “Treasury”) in connection with the Treasury’s recently announced Troubled Asset Relief Program (“TARP”) Capital Purchase Program described below. Regardless of whether the Company ultimately issues Preferred Stock under the TARP Capital Purchase Program, the Board believes that approval of the proposed amendment to the Articles of Incorporation is in the Company’s best interest for the reasons described above.

The TARP Capital Purchase Program

Description of Securities

On October 14, 2008, the U.S. Department of the Treasury announced the TARP Capital Purchase Program. This program was instituted by the Treasury pursuant to the Emergency Economic Stabilization Act of 2008 (“EESA”), which provides up to $700 billion to the Treasury to, among other things, take equity positions in financial institutions. The TARP Capital Purchase program encourages U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy.

Under the Capital Purchase program, the Treasury will purchase senior preferred shares of senior preferred stock from banks, bank holding companies, and other financial institutions. The senior preferred shares will qualify as Tier 1 capital for regulatory purposes and will rank senior to common stock and at an equal level in the capital structure with any existing preferred shares other than preferred shares that by their terms rank junior to any other existing preferred shares. The senior preferred shares purchased by the Treasury will pay a cumulative dividend rate of 5% per annum for the first five years they are outstanding and thereafter at a rate of 9% per annum. The senior preferred shares will be non-voting, but will have voting rights on matters that could adversely affect the shares. The shares will be callable at 100% of the issue price plus any accrued and unpaid dividends after three years. Prior to the end of three years, the senior preferred shares may be redeemed with the proceeds from a qualifying equity offering of any Tier 1 perpetual preferred or common stock. Treasury’s consent will be required for any increase in common dividends per share or certain equity repurchases until the third anniversary of the date of this investment unless prior to such third anniversary either the preferred stock issued to the Treasury is redeemed in whole or the Treasury has transferred all of the preferred stock to third parties.

If the Company participates in the Capital Purchase Program, the Company must issue to the Treasury warrants to purchase common stock with an aggregate market price equal to 15% of the senior preferred stock purchased by the Treasury. The exercise price on the warrants will be the market price of the Company’s common stock at the time of issuance, calculated on a
20-trading day trailing average. If the Company sells the maximum amount of preferred stock authorized under the Capital Purchase Program, the Company estimates that the ownership percentage of the current shareholders would be diluted by approximately 3% if the warrants were exercised. The amount of dilution will depend on the actual amount of capital received and on the average price of the Company’s stock for the 20-day period prior to Treasury approval.

Also, if the Company participates in the Program, the Company must adopt the Treasury’s standards for executive compensation and corporate governance set forth in Section 111 of EESA for the period during which the Treasury holds equity issued under this Program. To ensure compliance with these standards, the Company plans to enter into agreements with its senior executive officers who would be subject to these standards within the time frame prescribed by the Treasury for the Capital Purchase Program. The agreements would document

 

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each executive’s agreement to, among other things, “clawback” provisions relating to the repayment of incentive compensation based on materially inaccurate financial statements or performance metrics and limitations on certain post-termination “parachute” payments. The Company anticipates that its senior executive officers will execute such agreements in the event the Company’s participation in the Capital Purchase Program is approved.

See Appendix B for the Summary of Senior Preferred Terms and Summary of Warrant Terms as published by the Treasury.

The Company’s Participation

The Company has filed an application to participate in the Capital Purchase Program, but the Treasury must approve its participation. The Treasury has not yet advised the Company of its decision in that regard. The minimum subscription amount available to a participating institution is 1% of risk-weighted assets. The maximum subscription amount is the lesser of $25 billion or 3% of risk-weighted assets. For the Company, the minimum amount would be approximately $10.0 million and the maximum amount would be approximately $30.0 million. The Company has applied for $30.0 million under the Capital Purchase Program but may be approved to receive less or not be approved at all. If the Treasury were to deny the Company’s application or reduce the amount of capital available to the Company under the Capital Purchase Program, the Company’s liquidity, capital resources or results of operations would not be materially affected.

At September 30, 2008, the Company and its subsidiaries had capital ratios in excess of those required to be considered well-capitalized under banking regulations. The Board nevertheless believes it is prudent for the Company to apply for capital available under the TARP Capital Purchase Program because (i) it believes that the cost of capital under this program may be significantly lower than the cost of capital otherwise available to the Company at this time, and (ii) despite being well-capitalized, additional capital under the Treasury’s program would provide the Company and its subsidiaries additional flexibility to meet future capital needs that may arise. Specifically, if the Company receives the maximum $30.0 million of capital available to it under the Capital Purchase Program, the Company plans to contribute $22.0 million to its wholly-owned subsidiary, Georgia Bank & Trust Company (the “Bank”) and to retain the remainder of the proceeds at the parent company level to support the payment of dividends and for other general corporate purposes. If the Company receives the minimum $10.0 million available to it under the Program, it plans to contribute $7.0 million to the Bank and retain the remainder of the proceeds at the parent company level as described above. In either case, the Bank plans to use the additional capital to fund prudent loan growth in its markets and to further strengthen its capital position.

Pro Forma Financial Information

The unaudited pro forma condensed consolidated financial data set forth below has been derived by the application of pro forma adjustments to our historical financial statements for the year ended December 31, 2007 and the nine months ended September 30, 2008. The unaudited pro forma consolidated financial data gives effect to the events discussed below as if they had occurred January 1, 2007 in the case of the income statement data and September 30, 2008 in the case of the balance sheet data.

We have presented this data under two different scenarios:

 

   

the maximum investment, which assumes the issuance under the Capital Purchase Program of $30.0 million of preferred stock and the issuance of warrants to purchase 180,000 shares of common stock, assuming a purchase price of $24.99 per share (the average trading price of the common stock for the previous 20 days on which the stock traded on the Over-the-Counter Bulletin Board), and

 

   

the minimum investment, which assumes the issuance under the Capital Purchase Program of $10.0 million of preferred stock and the issuance of warrants to purchase 60,000 shares of common stock, assuming the same purchase price as in the maximum case.

 

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In each case, the data assumes investment of the proceeds in Federal Funds sold.

We present unaudited pro forma consolidated balance sheet data, including selected line items from our balance sheet and selected capital ratios, as of September 30, 2008. We also present unaudited pro forma condensed consolidated income statements for the year ended December 31, 2007 and the nine months ended September 30, 2008. The pro forma financial data may change materially based on the timing and utilization of the proceeds as well as certain other factors including the exercise price of the warrants, any subsequent changes in the common stock price, and the discount rate used to determine the fair value of the preferred stock.

The information should be read in conjunction with the Company’s audited financial statements and the related notes as filed as part of its Report on Form 10-K for the year ended December 31, 2007, and its unaudited consolidated financial statements and the related notes filed as part of its Quarterly Report on Form10-Q for the quarter ended September 30, 2008. These financial statements and related financial information about the Company are attached to this Proxy Statement as Appendices C and D, respectively.

The following unaudited pro forma consolidated financial data is not necessarily indicative of the financial position or results of operations that actually would have been attained had proceeds from the Capital Purchase Program been received, or the issuance of the warrants pursuant to the Capital Purchase Program been made, at the dates indicated, and is not necessarily indicative of the financial position or results of operations that will be achieved in the future. In addition, as noted above, the Company’s participation in the Capital Purchase Program is subject to shareholder approval of the proposed amendment to our Articles of Incorporation described in this Proxy Statement.

Pro Forma Financial Information Assuming Maximum $30.0 Million Investment

Southeastern Bank Financial Corporation

Pro Forma Consolidated Balance Sheet Data and Capital Ratios

(In thousands)

 

     September 30, 2008  
     Historical     Adjustments        As Adjusted  
     (unaudited)  

Balance Sheet:

         

Federal funds sold

   $ 43,210     $ 30,000      $ 73,210  

Common Equity

   $ 90,561     $ 1,934   -1    $ 92,495  

Preferred Equity

       28,066   -2    $ 28,066  
                         

Total shareholders’ equity

   $ 90,561     $ 30,000      $ 120,561  
                         

Capital Ratios:

         

Total risk-based capital to risk-weighted assets ratio

     11.66 %          14.07 %

Tier 1 capital ratio

     10.42 %          12.87 %

Leverage ratio

     8.54 %          10.60 %

Equity to assets ratio

     6.57 %          8.56 %

Tangible equity to tangible assets ratio

     6.56 %          8.55 %

Assumes that $30 million in proceeds are initially used to increase federal funds sold.

 

(1) Pro forma adjustment to common equity represents the fair value of 180,000 warrants.
(2) Pro forma adjustment to preferred equity represents the fair value of $30.0 million of preferred stock.

 

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Southeastern Bank Financial Corp.

Pro Forma Condensed Consolidated Statements of Income

(In thousands, except per share data)

 

     Historical 12
Months Ended
12/31/2007
   Adjustments          Pro forma 12
Months Ended
12/31/2007
    

(unaudited)

Net interest income

   $ 38,249    $ 1,557     -1    $ 39,806

Provision for losses on loans

     3,823      0          3,823
                        

Net interest income after provision for losses on loans

     34,426      1,557          35,983
                        

Non-interest income

     16,168           16,168

Non-interest expense

     32,508           32,508
                  

Income before income tax

     18,086           19,643

Income tax expense

     6,321      545     -2      6,866
                        

Net income

   $ 11,765    $ 1,012        $ 12,777

Less: Preferred dividends

     0      1,887     -3      1,887
                        

Net income available to common shareholders

   $ 11,765    $ (875 )      $ 10,890
                        

Basic earnings per share available to common stockholders

   $ 1.97    $ (0.15 )      $ 1.82
                        

Diluted earnings per share available to common stockholders

   $ 1.95    $ (0.16 )      $ 1.78
                        

Weighted average shares outstanding

          

Basic

     5,972,793           5,972,793
                  

Diluted

     6,045,862      61,301     -4      6,107,163
                        

 

(1) Assumes that the $30 million in Capital Purchase Program proceeds are used to increase Federal funds sold. The actual impact to net interest income would be different as the Company expects to utilize a portion of the proceeds to fund loan growth and acquisitions. However, such impact cannot be estimated at this time as the impact would vary based on the timing of when the loans are funded, the actual pricing of any such loans and timing of any acquisitions.
(2) Additional income tax expense is attributable to additional net interest income as described in Note 1.
(3) Consists of $1,500 of dividends on preferred stock at a 5% annual rate as well as $387 of accretion on discount on preferred stock upon issuance. The discount is determined based on the value that is allocated to the warrants upon issuance. The discount is accreted back to par value on a constant effective yield method (approximately 6.6%) over a five year term, which is the expected life of the preferred stock upon issuance. The estimated accretion is based on a number of assumptions which are subject to change. These assumptions include the discount (market rate at issuance) rate on the preferred stock and assumptions underlying the value of the warrants. The proceeds are allocated based on the relative fair value of the warrants as compared to the fair value of the preferred stock. The fair value of the warrants is determined under a Black-Scholes model. The model includes assumptions regarding the Company’s common stock price, dividend yield and stock price volatility, as well as assumptions regarding the risk-free interest rate. The lower the value of the warrants, the less negative impact on net income and earnings per share available to common shareholders. The fair value of the preferred stock is determined based on assumptions regarding the discount rate (market rate) on the preferred stock (currently estimated at 14%). The lower the discount rate, the less negative impact on net income and earnings per share available to common shareholders.
(4) As described in the section titled “Description of Securities,” the Treasury would receive warrants to purchase a number of shares of our common stock having an aggregate market price equal to 15% of the proceeds on the date of issuance with an exercise price equal to the trailing 20-day trading average leading up to the date of Treasury approval. This pro forma data assumes that the warrants would give the Treasury the option to purchase 180,000 shares of common stock. The pro forma adjustment shows the increase in diluted shares outstanding assuming that the warrants had been issued on January 1, 2007 at an exercise price of $24.99 (based on the average price from the previous 20 days on which the common stock traded as of November 17, 2008) and remained outstanding for the entire period presented. The treasury stock method was utilized to determine dilution of the warrants for the period presented.

 

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Southeastern Bank Financial Corp.

Pro Forma Condensed Consolidated Statements of Income

(In thousands, except per share data)

 

     Historical 9
Months Ended
9/30/2008
   Adjustments          Pro forma 9
Months Ended
9/30/2008
    

(unaudited)

Net interest income

   $ 30,049    $ 457     -1    $ 30,506

Provision for losses on loans

     4,996      0          4,996
                        

Net interest income after provision for losses on loans

     25,053      457          25,510
                        

Non-interest income

     12,820           12,820

Non-interest expense

     27,550           27,550
                  

Income before income tax

     10,323           10,780

Income tax expense

     3,405      160     -2      3,565
                        

Net income

   $ 6,918    $ 297        $ 7,215

Less: Preferred dividends

     0      1,415     -3      1,415
                        

Net income available to common shareholders

   $ 6,918    $ (1,118 )      $ 5,800
                        

Basic earnings per share available to common stockholders

   $ 1.16    $ (0.19 )      $ 0.97
                        

Diluted earnings per share available to common stockholders

   $ 1.15    $ (0.19 )      $ 0.96
                        

Weighted average shares outstanding

          

Basic

     5,967,310      0          5,967,310
                        

Diluted

     6,010,367      18,839     -4      6,029,206
                        

 

(1) Assumes that the $30 million in Capital Purchase Program proceeds are used to increase Federal funds sold. The actual impact to net interest income would be different as the Company expects to utilize a portion of the proceeds to fund loan growth and acquisitions. However, such impact cannot be estimated at this time as the impact would vary based on the timing of when the loans are funded, the actual pricing of any such loans and timing of any acquisitions.
(2) Additional income tax expense is attributable to additional net interest income as described in Note 1.
(3) Consists of $1,125 of dividends on preferred stock at a 5% annual rate as well as $290 of accretion on discount on preferred stock upon issuance. The discount is determined based on the value that is allocated to the warrants upon issuance. The discount is accreted back to par value on a constant effective yield method (approximately 6.6%) over a five year term, which is the expected life of the preferred stock upon issuance. The estimated accretion is based on a number of assumptions which are subject to change. These assumptions include the discount (market rate at issuance) rate on the preferred stock and assumptions underlying the value of the warrants. The proceeds are allocated based on the relative fair value of the warrants as compared to the fair value of the preferred stock. The fair value of the warrants is determined under a Black-Scholes model. The model includes assumptions regarding the Company’s common stock price, dividend yield and stock price volatility, as well as assumptions regarding the risk-free interest rate. The lower the value of the warrants, the less negative impact on net income and earnings per share available to common shareholders. The fair value of the preferred stock is determined based on assumptions regarding the discount rate (market rate) on the preferred stock (currently estimated at 14%). The lower the discount rate, the less negative impact on net income and earnings per share available to common shareholders.
(4) As described in the section titled “Description of Securities,” the Treasury would receive warrants to purchase a number of shares of our common stock having an aggregate market price equal to 15% of the proceeds on the date of issuance with an exercise price equal to the trailing 20-day trading average leading up to the date of Treasury approval. This pro forma data assumes that the warrants would give the Treasury the option to purchase 180,000 shares of common stock. The pro forma adjustment shows the increase in diluted shares outstanding assuming that the warrants had been issued on January 1, 2007 at an exercise price of $24.99 (based on the average price from the previous 20 days on which the common stock traded as of November 17, 2008) and remained outstanding for the entire period presented. The treasury stock method was utilized to determine dilution of the warrants for the period presented.

 

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Pro Forma Financial Information Assuming Minimum $10.0 Million Investment

Southeastern Bank Financial Corporation

Pro Forma Consolidated Balance Sheet Data and Capital Ratios

(In thousands)

 

      September 30, 2008  
      Historical     Adjustments        As
Adjusted
 
     (unaudited)  

Balance Sheet:

         

Federal funds sold

   $ 43,210     $ 10,000      $ 73,210  

Common Equity

   $ 90,561     $ 645   -1    $ 91,206  

Preferred Equity

       9,355   -2    $ 9,355  
                         

Total shareholders’ equity

   $ 90,561     $ 10,000      $ 100,561  
                         

Capital Ratios:

         

Total risk-based capital to risk-weighted assets ratio

     11.66 %          12.46 %

Tier 1 capital ratio

     10.42 %          11.23 %

Leverage ratio

     8.54 %          9.22 %

Equity to assets ratio

     6.57 %          7.24 %

Tangible equity to tangible assets ratio

     6.56 %          7.23 %

 

Assumes that $10 million in proceeds are initially used to increase federal funds sold.

 

(1) Pro forma adjustment to common equity represents the fair value of 60,000 warrants.
(2) Pro forma adjustment to preferred equity represents the fair value of $10.0 million of preferred stock.

 

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Southeastern Bank Financial Corp.

Pro Forma Condensed Consolidated Statements of Income

(In thousands, except per share data)

 

     Historical 12
Months Ended
12/31/2007
   Adjustments          Pro forma 12
Months Ended
12/31/2007
     (unaudited)

Net interest income

   $ 38,249    $ 519     -1    $ 38,768

Provision for losses on loans

     3,823      0          3,823
                        

Net interest income after provision for losses on loans

     34,426      519          34,945
                        

Non-interest income

     16,168           16,168

Non-interest expense

     32,508           32,508
                  

Income before income tax

     18,086           18,605

Income tax expense

     6,321      182     -2      6,503
                        

Net income

   $ 11,765    $ 337        $ 12,102

Less: Preferred dividends

     0      629     -3      629
                        

Net income available to common shareholders

   $ 11,765    $ (292 )      $ 11,473
                        

Basic earnings per share available to common stockholders

   $ 1.97    $ (0.05 )      $ 1.92
                        

Diluted earnings per share available to common stockholders

   $ 1.95    $ (0.05 )      $ 1.89
                        

Weighted average shares outstanding

          

Basic

     5,972,793           5,972,793
                  

Diluted

     6,045,862      20,430     -4      6,066,292
                        

 

(1) Assumes that the $10 million in Capital Purchase Program proceeds are used to increase Federal funds sold. The actual impact to net interest income would be different as the Company expects to utilize a portion of the proceeds to fund loan growth and acquisitions. However, such impact cannot be estimated at this time as the impact would vary based on the timing of when the loans are funded, the actual pricing of any such loans and timing of any acquisitions.
(2) Additional income tax expense is attributable to additional net interest income as described in Note 1.
(3) Consists of dividends of $500 on preferred stock at a 5% annual rate as well as $129 of accretion on discount on preferred stock upon issuance. The discount is determined based on the value that is allocated to the warrants upon issuance. The discount is accreted back to par value on a constant effective yield method (approximately 6.6%) over a five year term, which is the expected life of the preferred stock upon issuance. The estimated accretion is based on a number of assumptions which are subject to change. These assumptions include the discount (market rate at issuance) rate on the preferred stock and assumptions underlying the value of the warrants. The proceeds are allocated based on the relative fair value of the warrants as compared to the fair value of the preferred stock. The fair value of the warrants is determined under a Black-Scholes model. The model includes assumptions regarding the Company’s common stock price, dividend yield and stock price volatility, as well as assumptions regarding the risk-free interest rate. The lower the value of the warrants, the less negative impact on net income and earnings per share available to common shareholders. The fair value of the preferred stock is determined based on assumptions regarding the discount rate (market rate) on the preferred stock (currently estimated at 14%). The lower the discount rate, the less negative impact on net income and earnings per share available to common shareholders.
(4) As described in the section titled “Description of Securities,” the Treasury would receive warrants to purchase a number of shares of our common stock having an aggregate market price equal to 15% of the proceeds on the date of issuance with an exercise price equal to the trailing 20-day trading average leading up to the date of Treasury approval. This pro forma data assumes that the warrants would give the Treasury the option to purchase 60,000 of common stock. The pro forma adjustment shows the increase in diluted shares outstanding assuming that the warrants had been issued on January 1, 2007 at an exercise price of $24.99 (based on the average price from the previous 20 days on which the common stock traded as of November 17, 2008) and remained outstanding for the entire period presented. The treasury stock method was utilized to determine dilution of the warrants for the period presented.

 

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Southeastern Bank Financial Corp.

Pro Forma Condensed Consolidated Statements of Income

(In thousands, except per share data)

 

     Historical 9
Months Ended
9/30/2008
   Adjustments          Pro forma 9
Months Ended
9/30/2008
     (unaudited)

Net interest income

   $ 30,049    $ 152     -1    $ 30,201

Provision for losses on loans

     4,996      0          4,996
                        

Net interest income after provision for losses on loans

     25,053      152          25,205
                        

Non-interest income

     12,820           12,820

Non-interest expense

     27,550           27,550
                  

Income before income tax

     10,323           10,475

Income tax expense

     3,405      53     -2      3,458
                        

Net income

   $ 6,918    $ 99        $ 7,017

Less: Preferred dividends

     0      472     -3      472
                        

Net income available to common shareholders

   $ 6,918    $ (373 )      $ 6,545
                        

Basic earnings per share available to common stockholders

   $ 1.16    $ (0.06 )      $ 1.10
                        

Diluted earnings per share available to common stockholders

   $ 1.15    $ (0.06 )      $ 1.09
                        

Weighted average shares outstanding

          

Basic

     5,967,310      0          5,967,310
                        

Diluted

     6,010,367      6,279     -4      6,016,646
                        

 

(1) Assumes that the $10 million in Capital Purchase Program proceeds are used to increase Federal funds sold. The actual impact to net interest income would be different as the Company expects to utilize a portion of the proceeds to fund loan growth and acquisitions. However, such impact cannot be estimated at this time as the impact would vary based on the timing of when the loans are funded, the actual pricing of any such loans and timing of any acquisitions.
(2) Additional income tax expense is attributable to additional net interest income as described in Note 1.
(3) Consists of $375 of dividends on preferred stock at a 5% annual rate as well as $97 of accretion on discount on preferred stock upon issuance. The discount is determined based on the value that is allocated to the warrants upon issuance. The discount is accreted back to par value on a constant effective yield method (approximately 6.6%) over a five year term, which is the expected life of the preferred stock upon issuance. The estimated accretion is based on a number of assumptions which are subject to change. These assumptions include the discount (market rate at issuance) rate on the preferred stock and assumptions underlying the value of the warrants. The proceeds are allocated based on the relative fair value of the warrants as compared to the fair value of the preferred stock. The fair value of the warrants is determined under a Black-Scholes model. The model includes assumptions regarding the Company’s common stock price, dividend yield and stock price volatility, as well as assumptions regarding the risk-free interest rate. The lower the value of the warrants, the less negative impact on net income and earnings per share available to common shareholders. The fair value of the preferred stock is determined based on assumptions regarding the discount rate (market rate) on the preferred stock (currently estimated at 14%). The lower the discount rate, the less negative impact on net income and earnings per share available to common shareholders.
(4) As described in the section titled “Description of Securities,” the Treasury would receive warrants to purchase a number of shares of our common stock having an aggregate market price equal to 15% of the proceeds on the date of issuance with an exercise price equal to the trailing 20-day trading average leading up to the date of Treasury approval. This pro forma data assumes that the warrants would give the Treasury the option to purchase 60,000 shares of common stock. The pro forma adjustment shows the increase in diluted shares outstanding assuming that the warrants had been issued on January 1, 2007 at an exercise price of $24.99 (based on the average price from the previous 20 days on which the common stock traded as of November 17, 2008) and remained outstanding for the entire period presented. The treasury stock method was utilized to determine dilution of the warrants for the period presented.

 

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Vote Required for Approval

Adoption of this proposal requires the approval of at least a majority of the votes entitled to be cast at the Meeting.

The Board recommends that shareholders vote FOR the proposed amendment to the Articles of Incorporation to authorize the Board to issue Preferred Stock.

PROPOSAL 2: TO AUTHORIZE MANAGEMENT TO ADJOURN

THE SPECIAL MEETING

If the number of shares of common stock present or represented at the Meeting and voting in favor of the Amendment Proposal is insufficient to approve that proposal, the Company’s management may move to adjourn the meeting in order to enable the Board to continue to solicit additional proxies in favor of the Amendment Proposal. In that event, you will be asked to vote upon the Adjournment Proposal, but not the Amendment Proposal.

In this proposal, the Board is asking you to authorize the holder of any proxy solicited by the Board to vote in favor of adjourning the Meeting and any later adjournment under the circumstances described above. If the shareholders approve this proposal, management could adjourn the Meeting (and any adjourned section of the Meeting) to use the additional time to solicit additional proxies in favor of the Amendment Proposal, including the solicitation of proxies from shareholders that have previously voted against such proposal. Among other things, approval of the Adjournment Proposal could mean that even if proxies representing a sufficient number of votes against the Amendment Proposal have been received, management could adjourn the special meeting without a vote on the Amendment Proposal and seek to convince the holders of those shares to change their votes to vote in favor of the Amendment Proposal.

The Board believes that if the number of shares of common stock present or represented at the Meeting and voting in favor of the Amendment Proposal is insufficient to approve that proposal, it is in the best interests of the Company’s shareholders to enable the Board, for a limited period of time, to continue to seek to obtain a sufficient number of additional votes to approve the Amendment Proposal.

Vote Required for Approval

Adoption of the Adjournment Proposal requires that more votes be cast in favor of the proposal than against it at the Meeting.

The Board recommends that shareholders vote FOR the proposal to authorize management to adjourn the Meeting.

 

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ANTI-TAKEOVER PROVISIONS OF THE

ARTICLES OF INCORPORATION AND BYLAWS

In its bylaws, the Company has elected to be governed by the “business combination” and “fair price” statutes under the Georgia Business Corporation Code. The material provisions of these statutes are summarized below.

Georgia Business Combination Statute.

This statute precludes an interested shareholder (one owning 10% or more of the Company’s outstanding voting stock) from entering into certain business combinations (which are broadly defined) with the Company for a period of five years from the date of becoming an interested shareholder unless (i) prior to the acquisition in which he or she became an interested shareholder, approval of the board of directors of the acquisition or business combination was obtained; (ii) the interested shareholder acquired 90% of the outstanding voting stock as a result of the transaction in which he or she became an interested shareholder; or (iii) the interested shareholder, after the acquisition in which he or she became an interested shareholder, acquired 90% of the outstanding voting stock and the business combination was approved by a majority of the voting shares not held by the interested shareholder. The protection of the statute is available only if the Company “opts in” by adopting a bylaw provision specifically providing that the statute shall apply, and the Company has adopted such a provision. The statute provides protection by setting a five-year moratorium on business combinations with an interested shareholder if certain forms of approval are not obtained in advance of the business combination. This provision encourages potential acquirers to negotiate with the board of directors and discourages hostile or “two-tiered” takeovers whereby minority shareholders may be disadvantaged.

Georgia Fair Price Statute.

This statute is designed to deter “two-tiered” takeovers, which are one of the most coercive takeover techniques. In a “two-tiered” offer, the hostile offeror commences a tender offer for less than all of the target’s outstanding shares at a price much higher than that to be paid to remaining shareholders in the second-step “freeze-out merger.” Alternatively, shareholders may be offered all cash in the tender offer, but forced to accept more speculative securities in the “freeze-out merger.” Tender offers structured in either of these manners place pressure on the shareholders to tender their shares to avoid receiving the consideration of lower value to be paid in the second-step merger. Thus, these techniques may coerce shareholders into supporting a tender offer at a price they would otherwise reject as inadequate. The Fair Price Statute is designed to require that the second step transaction must be at the same price and for the same form of consideration as the initial offer. The protection of the statute is available only if the Company “opts in” by adopting a bylaw provision specifically providing that the statute shall apply, and the Company has adopted such a provision.

Similar Provisions of the Articles of Incorporation.

In addition, the Company’s articles of incorporation include provisions that provide similar anti-takeover protection to the statutory provisions described above. Subject to the exceptions listed below, these provisions require that a business combination with an interested shareholder (in this case, one owning more than 20% of the Company’s outstanding voting stock or an affiliate who owned more than 20% of such stock within the two years preceding the transaction) must be either: (i) approved by all of the continuing directors (those who are not affiliated with the interested shareholder and were directors before the interested shareholder acquired that status), provided there are a minimum of three continuing directors on the board, or (ii) recommended by at least two-thirds of the continuing directors and approved by a majority of the shares held by disinterested shareholders.

The voting requirements described in the preceding paragraph will not apply to a business combination in which the consideration received by the Company’s shareholders in a business combination with an interested shareholder meets or exceeds specified thresholds and is in either cash or the same form as the interested

 

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shareholder previously paid for his or her shares. Additionally, the approval of a majority of the continuing directors is required to reduce common dividends or fail to declare or pay full periodic dividends on preferred stock between when the interested shareholder has acquired that status and when the business combination is consummated.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information as of September 30, 2008, with respect to the Company’s directors, the executive officers named in the Summary Compensation Table in the proxy statement for the 2008 annual meeting of shareholders, shareholders known to the Company to own 5% or more of the Company’s common stock, and all current directors and executive officers of the Company as a group. Percentage calculations are based on 5,987,451 shares issued and outstanding. An asterisk (*) indicates ownership of less than one percent of the outstanding common stock.

Information relating to beneficial ownership of Common Stock by directors is based upon information furnished by each person using “beneficial ownership” concepts set forth in the rules of the Securities and Exchange Commission (“SEC”) under the Securities and Exchange Act of 1934, as amended. Under such rules, a person is deemed to be a “beneficial owner” of a security if that person has or shares “voting power,” which includes the power to vote or direct the voting of such security, or “investment power,” which includes the power to dispose of or to direct the disposition of such security. The person is also deemed to be a beneficial owner of any security of which that person has right to acquire beneficial ownership within 60 days. Under such rules, more than one person may be deemed to be a beneficial owner of the same securities, and a person may be deemed to be a beneficial owner of securities as to which he or she may disclaim any beneficial ownership. Accordingly, nominees are named as beneficial owners of shares as to which they may disclaim any beneficial interest. Except as indicated in other notes to this table describing special relationships with other persons and specifying shared voting or investment power, directors possess sole voting and investment power with respect to all shares of common stock set forth opposite their names. Where noted, exercisable options for executives are included in the number of shares beneficially owned.

 

Name and Address

  

Position(s) with the Company(1)

   Number of Shares
Beneficially Owned
    Percentage of
Ownership
 

William J. Badger

   Director    77,884 (2)   1.30 %

R. Daniel Blanton

3530 Wheeler Road

Augusta, Georgia 30909

   Director, President and Chief Executive Officer    481,066 (3)   8.03 %

W. Marshall Brown

   Director    5,227     *  

Patrick D. Cunning

   Director    5,527 (4)   *  

Warren A. Daniel

   Director    33,830 (5)   *  

Edward G. Meybohm

   Vice Chairman of the Board of the Company and Chairman of the Board of the Bank    284,274 (6)   4.75 %

Robert W. Pollard, Jr.

5863 Washington Road

Appling, Georgia 30802

   Chairman of the Board of the Company, Vice Chairman of the Board of the Bank    493,376 (7)   8.24 %

Larry S. Prather

   Director    47,015 (8)   *  

Darrell R. Rains

   Group Vice President and Chief Financial Officer    11,550 (9)   *  

 

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Name and Address

  

Position(s) with the Company(1)

   Number of Shares
Beneficially Owned
    Percentage of
Ownership
 

Randolph R. Smith, MD

1348 Walton Way

Suite 6300

Augusta, Georgia 30901

   Director    303,779 (10)   5.07 %

Ronald L. Thigpen

   Director, Executive Vice President and Chief Operating Officer    76,112 (11)   1.27 %

John W. Trulock, Jr.

   Director    3,594     *  

All current executive officers and directors as a group (10 persons)

      1,823,234 (12)   30.45 %

Other Beneficial Owners of Greater than 5% of the Company’s Common Stock

    

RWP, Sr., Enterprises, LLLP(13)

5863 Washington Road

Appling, GA 30802

   N/A    1,017,742     17.00 %

Levi A. Pollard

3310 Scotts Ferry Road

Appling, Georgia 30802

   N/A    407,096 (14)   6.80 %

 

* Represents less than one percent of the outstanding shares.
1. See “Election of Directors” for information regarding positions with the Bank and the Thrift.
2. Includes 8,208 shares held in Mr. Badger’s IRA and 3,216 shares held by Mrs. Badger and 13,333 shares pledged as collateral.
3. Includes 2,088 shares held in Mr. Blanton’s IRA, 187,019 shares held by Mr. Blanton’s wife, 7,537 shares held jointly with Mr. Blanton’s wife, 102,073 shares held in trust by Mr. Blanton’s wife as trustee for their minor children, 16,903 shares held in Mr. Blanton’s children’s name and 8,800 shares in exercisable options.
4. Includes 2,200 shares in exercisable options.
5. Includes 8,569 shares held in Mr. Daniel’s IRA.
6. Includes 67,731 shares held in an IRA plan as to which Mr. Meybohm is a beneficiary.
7. Includes 4,466 shares held by Mr. Pollard’s wife, 160,440 shares held in trust for their minor children, 1,773 shares held by Mr. Pollard’s children.
8. Includes 20,061 shares held in Mr. Prather’s IRA, 440 shares held in a partnership, 880 shares held in Mr. Prather’s name as custodian for grandchild and 550 shares held by Mr. Prather’s wife.
9. Includes 4,400 shares in exercisable options.
10. Includes 79,464 shares held in a pension and profit sharing plan as to which Dr. Smith is a beneficiary.
11. Includes 14,332 shares held in Mr. Thigpen’s IRA, 31,560 shares held jointly with Mr. Thigpen’s wife and exercisable options for 26,420 shares.
12. Includes 41,820 shares subject to exercisable options.
13. RWP, Sr. Enterprises LLLP is a family limited partnership with four general partners: Robert W. Pollard, Jr.; Levi A. Pollard, V; Patricia P. Blanton; and Lynn Pollard Nickerson. All voting, dispositive and other activities by the partnership are taken by majority vote of the general partners, and each general partner has equal voting rights.
14. Includes 45,094 shares held in trust for Mr. Pollard’s children and 770 shares held in trust for Mr. Pollards’ niece and nephews.

 

14


SHAREHOLDER PROPOSALS AND COMMUNICATIONS

Shareholder Proposals

To be included in the Company’s annual proxy statement, shareholder proposals not relating to the election of directors must be received by the Company at least 120 days before the one-year anniversary of the mailing date for the prior year’s proxy statement, which in our case would require that proposals be submitted prior to November 25, 2008 for the next year’s annual meeting. The persons named as proxies in the Company’s proxy statement for the meeting will, however, have discretionary authority to vote the proxies they have received as they see fit with respect to any proposals received less than 60 days prior to the meeting date. SEC Rule 14a-8 provides additional information regarding the content and procedure applicable to the submission of shareholder proposals.

Shareholder Communications

Shareholders wishing to communicate with the Board of Directors or with a particular director may do so in writing addressed to the Board, or to the particular director, and sending it to the Secretary of the Company at the Company’s principal office at 3530 Wheeler Road, Augusta, Georgia, 30909. The Secretary will promptly forward such communications to the applicable director or to the Chairman of the Board for consideration at the next scheduled meeting.

 

15


APPENDIX A

AMENDMENT

TO THE

ARTICLES OF INCORPORATION

OF

SOUTHEASTERN BANK FINANCIAL CORPORATION

Article Two of the Articles of Incorporation of Southeastern Bank Financial Corporation is hereby deleted in its entirety and the following new Article Two is inserted in its place:

ARTICLE TWO

(a) The aggregate number of shares of stock of all classes that the corporation shall have authority to issue is 20,000,000 shares, of which 10,000,000 shares shall be common stock, $3.00 par value per share, and of which 10,000,000 shares shall be preferred stock, no par value (“Preferred Stock”).

(b) The Board of Directors of the Company is hereby granted the authority, subject to the provisions of this Article Two and to the limitations prescribed by law, to classify the unissued shares of Preferred Stock into one or more series of Preferred Stock and with respect to each such series to fix by resolution or resolutions providing for the issuance of such series the terms, including the preferences, rights and limitations, of such series. Each series shall consist of such number of shares as shall be stated in the resolution or resolutions providing for the issuance of such series together with such additional number of shares as the Board of Directors by resolution or resolutions may from time to time determine to issue as a part of the series. The Board of Directors may from time to time decrease the number of shares of any series of Preferred Stock (but not below the number thereof then outstanding) by providing that any unissued shares previously assigned to such series shall no longer constitute part thereof and restoring such unissued shares to the status of authorized but unissued shares of Preferred Stock.

(c) The authority of the Board of Directors with respect to each series shall include, but not be limited to, determination of the following:

 

  (i) The number of shares constituting that series and the distinctive designation of that series;

 

  (ii) The dividend rate on the shares of that series, whether dividends shall be cumulative, and, if so, from which date or dates, and the relative rights of priority, if any, of payments of dividends on shares of that series;

 

  (iii) Whether that series shall have voting rights, in addition to the voting rights provided by law, and, if so, the terms of such voting rights;

 

  (iv) Whether that series shall have conversion privileges, and, if so, the terms and conditions of such conversion, including provisions for adjustment of the conversion rate in such events as the Board of Directors shall determine;

 

  (v) Whether or not the shares of that series shall be redeemable, and, if so, the terms and conditions of such redemption, including the date or dates upon or after which they shall be redeemable, and the amount per share payable in case of redemption, which amount may vary under different conditions and at different redemption rates;

 

  (vi) Whether that series shall have a sinking fund for the redemption or purchase of shares of that series, and, if so, the terms and amount of such sinking fund; and

 

  (vii) Any other relative rights, preferences and limitations of that series.

 

A-1


(d) The holders of shares of each series of Preferred Stock shall be entitled upon liquidation or dissolution, or upon the distribution of the assets, of the Company to such preferences as provided in the resolution or resolutions creating the series, and no more, before any distribution of the assets of the Company shall be made to the holders of any other series of Preferred Stock or to the holders of shares of Common Stock. Whenever the holders of shares of Preferred Stock of all series shall have been paid the full amounts to which they shall be entitled, the holders of shares of Common Stock shall be entitled to share ratably in all the remaining assets of the Company.

 

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APPENDIX B

TARP Capital Purchase Program

Senior Preferred Stock and Warrants

Summary of Senior Preferred Terms

 

Issuer:

Qualifying Financial Institution (“QFI”) means (i) any U.S. bank or U.S. savings association not controlled by a Bank Holding Company (“BHC”) or Savings and Loan Holding Company (“SLHC”); (ii) any U.S. BHC, or any U.S. SLHC which engages only in activities permitted for financial holdings companies under Section 4(k) of the Bank Holding Company Act, and any U.S. bank or U.S. savings association controlled by such a qualifying U.S. BHC or U.S. SLHC; and (iii) any U.S. BHC or U.S. SLHC whose U.S. depository institution subsidiaries are the subject of an application under Section 4(c)(8) of the Bank Holding Company Act; except that QFI shall not mean any BHC, SLHC, bank or savings association that is controlled by a foreign bank or company. For purposes of this program, “U.S. bank”, “U.S. savings association”, “U.S. BHC” and “U.S. SLHC” means a bank, savings association, BHC or SLHC organized under the laws of the United Sates or any State of the United States, the District of Columbia, any territory or possession of the United States, Puerto Rico, Northern Mariana Islands, Guam, American Samoa, or the Virgin Islands. The United States Department of the Treasury will determine eligibility and allocation for QFIs after consultation with the appropriate Federal banking agency.

 

Initial Holder:

United States Department of the Treasury (the “UST”).

 

Size:

QFIs may sell preferred to the UST subject to the limits and terms described below.

Each QFI may issue an amount of Senior Preferred equal to not less than 1% of its risk-weighted assets and not more than the lesser of (i) $25 billion and (ii) 3% of its risk-weighted assets.

 

Security:

Senior Preferred, liquidation preference $1,000 per share. (Depending upon the QFI’s available authorized preferred shares, the UST may agree to purchase Senior Preferred with a higher liquidation preference per share, in which case the UST may require the QFI to appoint a depositary to hold the Senior Preferred and issue depositary receipts.)

 

Ranking:

Senior to common stock and pari passu with existing preferred shares other than preferred shares which by their terms rank junior to any existing preferred shares.

 

Regulatory Capital Status:

Tier 1.

 

Term:

Perpetual life.

 

Dividend:

The Senior Preferred will pay cumulative dividends at a rate of 5% per annum until the fifth anniversary of the date of this investment and thereafter at a rate of 9% per annum. For Senior

 

B-1


 

Preferred issued by banks which are not subsidiaries of holding companies, the Senior Preferred will pay non-cumulative dividends at a rate of 5% per annum until the fifth anniversary of the date of this investment and thereafter at a rate of 9% per annum. Dividends will be payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year.

 

Redemption:

Senior Preferred may not be redeemed for a period of three years from the date of this investment, except with the proceeds from a Qualified Equity Offering (as defined below) which results in aggregate gross proceeds to the QFI of not less than 25% of the issue price of the Senior Preferred. After the third anniversary of the date of this investment, the Senior Preferred may be redeemed, in whole or in part, at any time and from time to time, at the option of the QFI. All redemptions of the Senior Preferred shall be at 100% of its issue price, plus (i) in the case of cumulative Senior Preferred, any accrued and unpaid dividends and (ii) in the case of noncumulative Senior Preferred, accrued and unpaid dividends for the then current dividend period (regardless of whether any dividends are actually declared for such dividend period), and shall be subject to the approval of the QFI’s primary federal bank regulator.

“Qualified Equity Offering” shall mean the sale by the QFI after the date of this investment of Tier 1 qualifying perpetual preferred stock or common stock for cash.

Following the redemption in whole of the Senior Preferred held by the UST, the QFI shall have the right to repurchase any other equity security of the QFI held by the UST at fair market value.

 

Restrictions on Dividends:

For as long as any Senior Preferred is outstanding, no dividends may be declared or paid on junior preferred shares, preferred shares ranking pari passu with the Senior Preferred, or common shares (other than in the case of pari passu preferred shares, dividends on a pro rata basis with the Senior Preferred), nor may the QFI repurchase or redeem any junior preferred shares, preferred shares ranking pari passu with the Senior Preferred or common shares, unless (i) in the case of cumulative Senior Preferred all accrued and unpaid dividends for all past dividend periods on the Senior Preferred are fully paid or (ii) in the case of non-cumulative Senior Preferred the full dividend for the latest completed dividend period has been declared and paid in full.

 

Common dividends:

The UST’s consent shall be required for any increase in common dividends per share until the third anniversary of the date of this investment unless prior to such third anniversary the Senior Preferred is redeemed in whole or the UST has transferred all of the Senior Preferred to third parties.

 

Repurchases:

The UST’s consent shall be required for any share repurchases (other than (i) repurchases of the Senior Preferred and (ii) repurchases of junior preferred shares or common shares in connection with any benefit plan in the ordinary course of business consistent with past

 

B-2


 

practice) until the third anniversary of the date of this investment unless prior to such third anniversary the Senior Preferred is redeemed in whole or the UST has transferred all of the Senior Preferred to third parties. In addition, there shall be no share repurchases of junior preferred shares, preferred shares ranking pari passu with the Senior Preferred, or common shares if prohibited as described above under “Restrictions on Dividends”.

 

Voting rights:

The Senior Preferred shall be non-voting, other than class voting rights on (i) any authorization or issuance of shares ranking senior to the Senior Preferred, (ii) any amendment to the rights of Senior Preferred, or (iii) any merger, exchange or similar transaction which would adversely affect the rights of the Senior Preferred.

If dividends on the Senior Preferred are not paid in full for six dividend periods, whether or not consecutive, the Senior Preferred will have the right to elect 2 directors. The right to elect directors will end when full dividends have been paid for four consecutive dividend periods.

 

Transferability:

The Senior Preferred will not be subject to any contractual restrictions on transfer. The QFI will file a shelf registration statement covering the Senior Preferred as promptly as practicable after the date of this investment and, if necessary, shall take all action required to cause such shelf registration statement to be declared effective as soon as possible. The QFI will also grant to the UST piggyback registration rights for the Senior Preferred and will take such other steps as may be reasonably requested to facilitate the transfer of the Senior Preferred including, if requested by the UST, using reasonable efforts to list the Senior Preferred on a national securities exchange. If requested by the UST, the QFI will appoint a depositary to hold the Senior Preferred and issue depositary receipts.

 

Executive Compensation:

As a condition to the closing of this investment, the QFI and its senior executive officers covered by the EESA shall modify or terminate all benefit plans, arrangements and agreements (including golden parachute agreements) to the extent necessary to be in compliance with, and following the closing and for so long as UST holds any equity or debt securities of the QFI, the QFI shall agree to be bound by, the executive compensation and corporate governance requirements of Section 111 of the EESA and any guidance or regulations issued by the Secretary of the Treasury on or prior to the date of this investment to carry out the provisions of such subsection. As an additional condition to closing, the QFI and its senior executive officers covered by the EESA shall grant to the UST a waiver releasing the UST from any claims that the QFI and such senior executive officers may otherwise have as a result of the issuance of any regulations which modify the terms of benefits plans, arrangements and agreements to eliminate any provisions that would not be in compliance with the executive compensation and corporate governance requirements of Section 111 of the EESA and any guidance or regulations issued by the Secretary of the Treasury on or prior to the date of this investment to carry out the provisions of such subsection.

 

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Summary of Warrant Terms

 

Warrant:

The UST will receive warrants to purchase a number of shares of common stock of the QFI having an aggregate market price equal to 15% of the Senior Preferred amount on the date of investment, subject to reduction as set forth below under “Reduction”. The initial exercise price for the warrants, and the market price for determining the number of shares of common stock subject to the warrants, shall be the market price for the common stock on the date of the Senior Preferred investment (calculated on a 20-trading day trailing average), subject to customary anti-dilution adjustments. The exercise price shall be reduced by 15% of the original exercise price on each six-month anniversary of the issue date of the warrants if the consent of the QFI stockholders described below has not been received, subject to a maximum reduction of 45% of the original exercise price.

 

Term:

10 years

 

Exercisability:

Immediately exercisable, in whole or in part

 

Transferability:

The warrants will not be subject to any contractual restrictions on transfer; provided that the UST may only transfer or exercise an aggregate of one- half of the warrants prior to the earlier of (i) the date on which the QFI has received aggregate gross proceeds of not less than 100% of the issue price of the Senior Preferred from one or more Qualified Equity Offerings and (ii) December 31, 2009. The QFI will file a shelf registration statement covering the warrants and the common stock underlying the warrants as promptly as practicable after the date of this investment and, if necessary, shall take all action required to cause such shelf registration statement to be declared effective as soon as possible. The QFI will also grant to the UST piggyback registration rights for the warrants and the common stock underlying the warrants and will take such other steps as may be reasonably requested to facilitate the transfer of the warrants and the common stock underlying the warrants. The QFI will apply for the listing on the national exchange on which the QFI’s common stock is traded of the common stock underlying the warrants and will take such other steps as may be reasonably requested to facilitate the transfer of the warrants or the common stock.

 

Voting:

The UST will agree not to exercise voting power with respect to any shares of common stock of the QFI issued to it upon exercise of the warrants.

 

Reduction:

In the event that the QFI has received aggregate gross proceeds of not less than 100% of the issue price of the Senior Preferred from one or more Qualified Equity Offerings on or prior to December 31, 2009, the number of shares of common stock underlying the warrants then held by the UST shall be reduced by a number of shares equal to the product of (i) the number of shares originally underlying the warrants (taking into account all adjustments) and (ii) 0.5.

 

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Consent:

In the event that the QFI does not have sufficient available authorized shares of common stock to reserve for issuance upon exercise of the warrants and/or stockholder approval is required for such issuance under applicable stock exchange rules, the QFI will call a meeting of its stockholders as soon as practicable after the date of this investment to increase the number of authorized shares of common stock and/or comply with such exchange rules, and to take any other measures deemed by the UST to be necessary to allow the exercise of warrants into common stock.

 

Substitution:

In the event the QFI is no longer listed or traded on a national securities exchange or securities association, or the consent of the QFI stockholders described above has not been received within 18 months after the issuance date of the warrants, the warrants will be exchangeable, at the option of the UST, for senior term debt or another economic instrument or security of the QFI such that the UST is appropriately compensated for the value of the warrant, as determined by the UST.

 

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APPENDIX C

 

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

The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company and its subsidiaries, Georgia Bank & Trust Company of Augusta (“GB&T”) and Southern Bank & Trust (“SB&T”), during the past three years. The discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and related notes to the consolidated financial statements.

Overview

The Company’s services include the origination of residential and commercial real estate loans, construction and development loans, and commercial and consumer loans. The Company also offers a variety of deposit programs, including noninterest-bearing demand, interest checking, money management, savings, and time deposits. In the Augusta-Richmond County, GA-SC metropolitan statistical area, GB&T had 12.87% of all deposits and was the second largest depository institution and the largest locally based institution at June 30, 2007 based on deposit levels, as cited from the FDIC’s website. Securities sold under repurchase agreements are also offered. Additional services include wealth management, trust, retail investment, and mortgage. As a matter of practice, most mortgage loans are sold in the secondary market; however, some mortgage loans are placed in the portfolio based on asset/liability management strategies. The Company continues to concentrate on increasing its market share through various new deposit and loan products and other financial services, by adding locations, and by focusing on the customer relationship management philosophy. The Company is committed to building lifelong relationships with its customers, employees, shareholders, and the communities it serves.

The Company’s primary source of income is from its lending activities followed by interest income from its investment activities, service charges and fees on deposits, and gain on sales of mortgage loans in the secondary market. Interest income on loans and investment securities increased primarily due to increased volumes. Service charges and fees on deposits increased due to increases in NSF income on retail and business checking accounts and debit/ATM card income, both the result of new account growth. Gain on sales of mortgage loans for 2007 did not change significantly over 2006. Both trust service fees and retail investment income experienced significant growth this year as the Company continues to focus on the expansion of the wealth management area. With the significant growth that the Company has seen over the year salary and benefit expenses have increased $1.5 Million from 2006 primarily from the opening of new locations, increased in commissions and increase in operational staff personnel somewhat offset by the increase in FAS 91 deferred cost expense. Occupancy expense increased $610,000 from 2006 primarily due to moving and equipment expense for the new operations facility and increased rent expenses on ATM’s. Provision expense increased $1.3 Million primarily due to the increase in downgrades in the loan portfolio.

The Company has experienced steady growth. Over the past four years, assets grew from $630.6 Million at December 31, 2003 to $1.2 Billion at December 31, 2007. From year end 2003 to year end 2007, loans increased $450.0 Million, and deposits increased $468.2 Million. Net income for the year ended 2003 was $7.9 Million compared to net income of $11.8 Million at year end 2007. The Company has paid cash dividends of $0.13 per share each quarter since 2004.

The Company meets its liquidity needs by managing cash and due from banks, federal funds purchased and sold, maturity of investment securities, principal repayments received from mortgage backed securities, and draws on lines of credit. Additionally, liquidity can be managed through structuring deposit and loan maturities. The Company funds loan and investment growth with core deposits, securities sold under repurchase agreements and Federal Home Loan Bank advances. During inflationary periods, interest rates generally increase and operating expenses generally rise. When interest rates rise, variable rate loans and investments produce higher earnings; however, deposit and other borrowings interest expense also rise. The Company monitors its interest

 

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rate risk as it applies to net income in a ramp up and down annually 200 basis points (2%) scenario and as it applies to economic value of equity in a shock up and down 200 (2%) basis points scenario. The Company monitors operating expenses through responsibility center budgeting. See “Interest Rate Sensitivity” below.

Critical Accounting Estimates

The accounting and financial reporting policies of the Company and its subsidiaries conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses as a critical accounting estimate that requires difficult, subjective judgment and is important to the presentation of the financial condition and results of operations of the Company.

The allowance for loan losses is established through a provision for loan losses charged to expense, which affects the Company’s earnings directly. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that management believes will be adequate to absorb losses on existing loans that become uncollectible, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to repay.

The Company segments its allowance for loan losses into the following three major categories: 1) identified losses for impaired loans; 2) general allocation for Classified/Watch loans; and 3) general allocation for loans with satisfactory ratings. Risk ratings are initially assigned in accordance with the Company’s loan and collection policy. An organizationally independent department reviews grade assignments on an ongoing basis. Management reviews current information and events regarding a borrowers’ financial condition and strengths, cash flows available for debt repayment, the related collateral supporting the loan and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual loan, management classifies the loan accordingly. If the loan is determined to be impaired, management allocates a portion of the allowance for loan losses for that loan based upon the present value of future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if collection of the loan is deemed to be dependent upon the collateral. Regulatory guidance is also considered. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement; however, cash receipts on impaired and nonaccrual loans for which the accrual of interest has been discontinued are generally applied first to principal and then to interest income depending upon the overall risk of principal loss to the Company. Impaired and Classified/Watch loans are aggressively monitored. The allocation for loans rated satisfactory is further subdivided into various types of loans as defined by regulatory reporting codes. The Company’s management also gives consideration to subjective factors such as, national and local economic conditions, bankruptcy trends, unemployment trends, loan concentrations, and competitive factors in the local market. These factors represent uncertainties in the Company’s business environment and are included in the various individual components of the allowance for loan losses.

Management believes that the allowance for loan losses is adequate. The loan portfolio is comprised of 85.7% real estate loans; 10.6% commercial, financial and agricultural loans; and 3.8% consumer loans. Commercial real estate comprises 26.8% of the loan portfolio, and of these loans 55.0% are owner occupied properties where the operations of the commercial entity provide the necessary cash flow to service the debt. For this portion of the real estate loan portfolio, repayment is not dependent upon the sale of the real estate held as collateral. Construction and development loans, 36.1% of the portfolio, have been an increasingly important portion of the real estate loan portfolio. The Company carefully monitors the loans in this category since the repayment of these loans is generally dependent upon the sale of the real estate in the normal course of business and can be impacted by national and local economic conditions. The residential category, 21.6% of the portfolio, represents those loans that the Company chooses to maintain in its portfolio rather than selling into the secondary

 

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market for marketing and competitive reasons and commercial loans secured by residential real estate. The residential held for sale category, 1.3% of the portfolio, comprises loans that are in the process of being sold into the secondary market. In these loans, the credit has been approved by the investor and the interest rate locked so that the Company minimizes credit and interest rate risk with respect to these loans. The Company has no large loan concentrations to individual borrowers. Unsecured loans at December 31, 2007 were $15.7 million. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may advise additions to the allowance based on their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.

Please see “Provision for Loan Losses, Net Charge-offs, and Allowance for Loan Losses” and “Non-Performing Assets” for a further discussion of the Company’s loans, loss experience, and methodology in determining the allowance.

Results of Operations

Total assets increased $172.0 million, or 16.5% in 2007 compared to year end 2006, primarily due to loan growth and an increase in available for sale investment securities somewhat offset by a decrease in cash and cash equivalents. The Company recorded net income of $11.8 million in 2007, a 5.4% increase over 2006. The increase in net income is attributable to increases in net interest income and noninterest income, somewhat offset by increases in noninterest expense. Interest income increased $13.6 million or 20.7% in 2007. Interest income on loans, including loan fees, was the principal contributor, representing an increase of $11.9 million over 2006. This was primarily the result of $132.8 million in loan growth for the Company in 2007. Interest income on investment securities increased $1.2 million in 2007 as a result of a $13.6 million increase in the annual average balance of the investment portfolio in 2007. Significant changes to noninterest income in 2007 include a $667,000 increase in service charges and fees on deposits related to new account growth, a gain on the sale of fixed assets of $1,002,000, and a $479,000 increase in retail investment income and an $271,000 increase in trust service fees due to the continued expansion of the wealth management area, somewhat offset by a $450,000 loss on the sale of investment securities.

The Company had total deposit growth of $150.4 million, or 18.8% in 2007. Interest expense on deposits increased $9.0 million as a result of this growth and higher interest rates. The most significant increase was in time deposits with an $80.7 million balance increase over 2006 year end with a corresponding $6.6 million increase in interest expense. Brokered CDs totaled $78.5 million at year end 2007 and accounted for $1.3 million of the increase in interest expense. The annual average balance of federal funds purchased and securities sold under repurchase agreements grew $3.3 million in 2007, with related interest expense increasing $266,000 over 2006. The Company was in a $17.5 million federal funds purchase position at 2007 year end, as compared to a $14.7 million federal funds sold position at 2006 year end. Provision for loan loss expense increased $1.3 million from 2006 primarily due to loan volume growth as well as increases in specifically-reserved loans, higher levels of Classified and Watch-rated debt and management’s assessment of current economic environment. Noninterest expense increased $3.6 million or 12.4% in 2007. Salaries and other personnel expense increased $1.5 million primarily as a result of additional employees in 2007 related to the Company’s continued growth and expansion into new markets. Premises and fixed asset expense increased $610,000 or 21.4% from 2006 due to increased depreciation expense and expenses incurred moving the Company’s operational facilities to the new operations center in Martinez, Georgia. Other operating expenses increased $1.4 million with the most significant increases reflected in the processing expense and IT maintenance expense categories. The Company continues to monitor operating expenses and uses responsibility center budgeting to assist in this endeavor. The operating efficiency ratio of 60.64% in 2007 is a 0.44% increase from 2006.

 

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The earnings performance of the Company is reflected in its return on average assets and average equity of 1.04% and 14.03%, respectively, during 2007 compared to 1.17% and 16.10%, respectively, during 2006. Return on equity decreased in 2007 due to 5.4% growth in net income compared to a 20.9% growth in average stockholders equity. The return on average assets and average equity was 1.27% and 16.15%, respectively, in 2005. Basic net income per share on weighted average common shares outstanding improved to $2.17 in 2007 compared to $2.10 in 2006 and $1.89 in 2005. Diluted net income per share on weighted average common and common equivalent shares outstanding improved to $2.14 in 2007 compared to $2.08 in 2006 and $1.86 in 2005. The Company has paid cash dividends of $0.13 per share each quarter since 2004.

Net Interest Income

The primary source of earnings for the Company is net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings. The following table shows the average balances of interest-earning assets and interest-bearing liabilities, average yields earned and rates paid on those respective balances, and the resulting interest income and interest expense for the periods indicated. Average balances are calculated based on daily balances, yields on non-taxable investments are not reported on a tax equivalent basis and average balances for loans include nonaccrual loans even though interest was not earned.

 

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Average Balances, Income and Expenses, Yields and Rates

 

    Year Ended Dec. 31, 2007   Year Ended Dec. 31, 2006   Year Ended Dec. 31, 2005
    Average
Amount
    Average
Yield or
Rate
    Amount
Paid or
Earned
  Average
Amount
    Average
Yield or
Rate
    Amount
Paid or
Earned
  Average
Amount
    Average
Yield or
Rate
    Amount
Paid or
Earned
    (Dollars in thousands)

ASSETS

                 

Interest-earning assets:

                 

Loans

  $ 811,509     8.16 %   $ 66,219   $ 664,101     8.18 %   $ 54,338   $ 547,414     7.11 %   $ 38,898

Investments

                 

Taxable

    209,082     5.27 %     11,023     189,321     5.09 %     9,633     158,017     4.56 %     7,206

Tax-exempt

    18,734     4.27 %     800     24,658     4.18 %     1,030     18,765     4.09 %     767

Federal funds sold

    21,434     5.19 %     1,112     12,248     4.90 %     600     12,106     3.14 %     380

Interest-bearing deposits in other banks

    506     5.34 %     27     612     4.08 %     25     884     2.94 %     26
                                               

Total interest-earning assets

    1,061,265     7.46 %   $ 79,181     890,940     7.37 %   $ 65,626     737,186     6.41 %   $ 47,277
                                               

Cash and due from banks

    25,624           19,977           17,096      

Premises and equipment

    26,676           22,242           19,208      

Other

    30,527           27,486           20,253      

Allowance for loan losses

    (11,029 )         (9,530 )         (8,662 )    
                                   

Total assets

  $ 1,133,063         $ 951,115         $ 785,081      
                                   

LIABILITIES AND STOCKHOLDERS’ EQUITY

Interest-bearing liabilities:

                 

NOW accounts

  $ 127,093     2.30 %   $ 2,926   $ 114,021     2.00 %   $ 2,277   $ 87,982     0.89 %   $ 787

Savings and money management accounts

    341,097     4.04 %     13,788     305,186     3.93 %     11,996     288,759     2.98 %     8,610

Time deposits

    317,298     5.18 %     16,433     213,889     4.59 %     9,826     145,209     3.08 %     4,476

Federal funds purchased / securities sold under repurchase agreements

    65,735     5.03 %     3,305     62,451     4.93 %     3,079     55,658     3.05 %     1,697

Other borrowings

    79,250     5.65 %     4,480     75,034     5.66 %     4,245     50,121     4.62 %     2,315
                                               

Total interest-bearing liabilities

    930,473     4.40 %     40,932     770,581     4.08 %     31,423     627,729     2.85 %     17,885
                                               

Noninterest-bearing demand deposits

    108,470           102,032           89,079      

Other liabilities

    10,270           9,185           6,618      

Stockholders’ equity

    83,850           69,317           61,655      
                                   

Total liabilities and stockholders’ equity

  $ 1,133,063         $ 951,115         $ 785,081      
                                   

Net interest spread

    3.06 %       3.29 %       3.56 %  

Benefit of noninterest sources

    0.54 %       0.55 %       0.42 %  

Net interest margin/income

    3.60 %   $ 38,249     3.84 %   $ 34,203     3.98 %   $ 29,392
                             

 

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The increase in average loans of $147.4 million and the increase in average investments of $13.8 million were funded by increases in average deposits of $152.4 million, Federal Home Loan Bank borrowings of $4.2 million, and federal funds purchased and securities sold under repurchase agreements of $3.3 million. For 2007, average total assets were $1,133 million, a 19.1% increase over 2005. Average interest-earning assets for 2007 were $1,061 million, or 93.7% of average total assets.

Interest income is the largest contributor to income. Interest income on loans, including loan fees, increased $11.9 million from 2006 to $66.2 million in 2007. The increase in loan interest income resulted from increased loan volume. Investment income increased $1.2 million to $11.8 million as a result of volume and higher investment yields in 2007. Interest income on federal funds sold increased primarily as the result of higher volume and a 0.29% increase in the average yield. Interest expense on deposits increased $9.0 million from 2006 to $33.1 million as the result of deposit growth and higher interest rates. Interest expense on federal funds purchased and securities sold under repurchase agreements increased $1.4 million, again due to growth and rising interest rates. Interest expense on other borrowings increased primarily due to an increase in the annual average balance. The overall result was an increase in net interest income of $4.0 million or 11.8% in 2007 from 2006. Average yields on interest-earning assets increased to 7.46% in 2007, compared to 7.37% in 2005.

Net interest income increased $4.8 million in 2006 compared to 2005 as a result of the growth in the volume of average earning assets and an increase in interest rates. Interest earning assets averaged $890.9 million in 2006, an increase of 16.4%, from the $737.2 million averaged in 2005. Average yields on earning assets increased to 7.37% in 2006, compared to 6.41% in 2005.

A key performance measure for net interest income is the “net interest margin”, or net interest income divided by average interest-earning assets. Unlike the “net interest spread” (the difference between interest rates earned on assets and interest rates paid on liabilities), the net interest margin is affected by the level of non-interest sources of funding used to support interest-earning assets. The Company’s net interest margin decreased to 3.60% in 2007 from 3.84% in 2006. In 2005, the net interest margin was 3.98%. The net interest margin deteriorated in 2007 as the average rate paid on interest-bearing deposits increased more quickly than the average rate on interest-earning assets. The high level of competition in the local market for both loans and deposits continues to influence the net interest margin. The net interest margin continues to be supported by demand deposits which provide a noninterest-bearing source of funds. The Company’s current marketing efforts are focused on increasing demand deposits and NOW accounts to help prevent further deterioration in the net interest margin. The net interest spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing sources of funds. The net interest spread eliminates the impact of noninterest-bearing funds and gives a direct perspective on the effect of market interest rate movements. As a result of changes in interest rates in 2007, the net interest spread decreased 23 basis points to 3.06% in 2007. The 2006 net interest spread of 3.29% also represented a decrease from 2005’s 3.56%.

Changes in the net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases in the average rates earned and paid on such assets and liabilities, the ability to manage the earning asset portfolio, and the availability of particular sources of funds, such as noninterest-bearing deposits. The following table: “Analysis of Changes in Net Interest Income” indicates the changes in the Company’s net interest income as a result of changes in volume and rate from 2007 to 2006, and 2006 to 2005. The analysis of changes in net interest income included in the following table indicates that on an overall basis in 2007 to 2006, the increase in the balances or volumes of interest-earning assets created a positive impact in net income. This was somewhat offset by the impact of increased volumes of interest-bearing liabilities. The rate environment of 2007 resulted in modest rate increases on interest-earning assets which were more than offset by rate increases on interest-bearing liabilities. In 2006 to 2005, the increase in the balances or volumes of interest-earning assets created a positive impact in net income which was partially offset by the impact of increased volumes of interest-bearing liabilities. Rising rates in 2006 resulted in rate increases on interest-bearing liabilities that exceeded rate increases on interest-earning assets.

 

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Analysis of Changes in Net Interest Income

 

     2007 vs. 2006
Increase (Decrease)
    2006 vs. 2005
Increase (Decrease)
 
     Average
Volume
    Average
Rate
    Combined     Total     Average
Volume
    Average
Rate
   Combined     Total  
     (Dollars in thousands)     (Dollars in thousands)  

Interest income from interest-earning assets:

                 

Loans

   $ 12,058     $  (133)     $ (44 )   $ 11,881     $ 8,296     $ 5,858    $ 1,286     $ 15,440  

Investments, taxable

     1,006       341       43       1,390       1,428       837      162       2,427  

Investments, tax-exempt

     (248 )     42       (24 )     (230 )     241       17      5       263  

Federal funds sold

     450       36       26       512       4       213      3       220  

Interest-bearing deposits in other banks

     (4 )     8       (1 )     2       (8 )     10      (3 )     (1 )
                                                               

Total

   $ 13,262     $ 293     $ (0 )   $ 13,555     $ 9,961     $ 6,935    $ 1,453     $ 18,349  
                                                               

Interest expense on interest-bearing liabilities:

                 

NOW accounts

   $ 261     $ 342     $ 45     $ 649     $ 232     $ 976    $ 282     $ 1,490  

Savings and money management accounts

     1,411       336       45       1,792       490       2,743      153       3,386  

Time deposits

     4,746       1,262       599       6,607       2,115       2,193      1,042       5,350  

Federal funds purchased / securities sold under repurchase agreements

     162       62       2       226       207       1,047      128       1,382  

Other borrowings

     239       (8 )     4       235       1,151       521      258       1,930  
                                                               

Total

   $ 6,819     $ 1,995     $ 695     $ 9,509     $ 4,195     $ 7,480    $ 1,863     $ 13,538  
                                                               

Change in net interest income

         $ 4,046            $ 4,811  
                             

The variances for each major category of interest-earning assets and interest-bearing liabilities are attributable to (a) changes in volume (changes in volume times prior year rate), (b) changes in rate (changes in rate times prior year volume) and (c) combined (changes in rate times the change in volume).

Noninterest Income

Noninterest income consists of revenues generated from a broad range of financial services and activities, including service charges on deposit accounts, gain on sales of loans, gain on sale of fixed assets, fee-based services, and products where commissions are earned through sales of products such as real estate mortgages, retail investment services, trust services, and other activities. In addition, the increase in cash surrender value of bank-owned life insurance and gains or losses realized from the sale of investment securities are included in noninterest income.

Noninterest income for 2007 was $16.2 million, an increase of $2.1 million or 15.2% from 2006. Service charges and fees on deposits increased $667,000 in 2007 primarily due to increases in NSF fees for retail checking accounts and debit/ATM card income, both the result of new account growth. The gain on the sale of fixed assets increased $1.0 million from 2006. The Company, in anticipation of moving its operational facilities, sold part of its operations campus which had a book value of $1.8 million resulting in a gain of $1.1 million. These increases were somewhat offset by decreases in service charges on non-personal deposit accounts due to increases in the earnings credit applied to average balances maintained in those accounts. Retail investment income increased $479,000 primarily due to production by new personnel. Other contributing factors include

 

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increases in trust services fees due to a $5.5 million increase in assets managed from 2006 and increases in the increase in cash-surrender value of bank-owned life insurance due to an additional purchase of $3.5 million in bank-owned life insurance in February 2007. A $237,000 loss recognized on the sale of agency securities resulted in a decrease in net investment securities gains (losses) from 2006.

Noninterest income for 2006 was $14.0 million, an increase of $1.7 million or 13.5% from 2005. Contributing factors include increases in gain on sales of loans in the secondary mortgage market due to higher mortgage loan volumes. The increase in cash surrender value of life insurance decreased due to reduced interest rates. These decreases were partially offset by increases in service charges and fees on deposits during the period primarily due to increases in NSF fees and ATM income, somewhat offset by decreases in service charges, all a result of new retail checking accounts. The decrease in service charge income was also attributable to increases in the earnings credit applied to average balances maintained in non-personal deposit accounts.

The following table presents the principal components of noninterest income for the last three years:

Noninterest Income

 

     Year Ended December 31,  
     2007     2006     2005  
     (Dollars in thousands)  

Service charges and fees on deposit accounts

   $ 6,409     $ 5,742     $ 5,363  

Gain on sales of loans

     5,185       5,154       5,089  

Gain on sale of fixed assets

     1,049       47       (7 )

Investment securities gains (losses), net

     (237 )     213       (86 )

Retail investment income

     1,267       788       455  

Trust service fees

     1,132       860       642  

Increase in cash surrender value of life insurance

     678       605       400  

Other

     685       631       515  
                        

Total noninterest income

   $ 16,168     $ 14,040     $ 12,371  
                        

Noninterest income as a percentage of total average assets

     1.70 %     1.79 %     1.84 %

Noninterest income as a percentage of total income

     19.77 %     20.75 %     26.06 %

Noninterest Expense

Noninterest expense totaled $32.5 million in 2007, an increase of 12.4% from 2006 noninterest expense of $28.9 million. Noninterest expense attributable to the Company’s expansion into new markets totaled $1.0 million for 2007. Salaries and other personnel expense increased $1.5 million due to offices opened in the Aiken and Greenville, South Carolina and Evans, Georgia markets, the expansion of the wealth management area, medical expenses, employer 401K expense, and stock options compensation expense somewhat offset by an increase in FAS 91 deferred cost expense. Operating expenses, excluding salary and employee benefits, increased $2.0 million in 2007. Processing expenses increased $271,000 primarily due to ATM processing fees related to new account growth of checking products. IT maintenance expense increased $276,000 primarily for increase in core software maintenance agreement and security maintenance. Due to the continued growth of the company, other expensed including communications, postage, and staff development increased $298,000 in 2007. Contributions increased as a result of a $250,000 donation made to Georgia Bank Foundation.

Noninterest expense totaled $28.9 Million in 2006, an increase of 15.5% from 2005 noninterest expense of $25.0 Million. Noninterest expense attributable to the Company’s expansion into new markets totaled $1.9 million for 2006. Salaries and other personnel expense increased $2.3 million due to offices opened in the Aiken, South Carolina and Athens, Georgia markets, the expansion of the wealth management area, medical expenses and stock options compensation expense recognized for the acceleration of the vesting period for two key

 

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employees and to comply with SFAS No. 123(R). Other operating expenses increased $1.5 million in 2006. Processing expenses increased $407,000 primarily due to retail investment processing fees related to increased production and fees associated with new account growth for both retail and business checking products. Professional fees increased $275,000 primarily for Sarbanes-Oxley 404 compliance, other advisory services and legal fees. Marketing expense increased $174,000 primarily due to advertising for expansion into the Athens and Aiken markets. Contributions increased as the result of a $200,000 donation made to Georgia Bank Foundation, and supplies expense increased $152,000 due to the continued growth of the Company

The Company continues to monitor expenditures in all organizational units by utilizing specific cost-accounting and reporting methods as well as responsibility center budgeting. The following table presents the principal components of noninterest expense for the years ended December 31, 2007, 2006 and 2005.

Noninterest Expense

 

     Year Ended December 31,  
     2007     2006     2005  
     (Dollars in thousands)  

Salaries and employee benefits

   $ 19,343     $ 17,806     $ 15,531  

Occupancy expense

     3,457       2,847       2,731  

Marketing & business development expense

     1,586       1,405       1,119  

Processing expense

     1,750       1,480       1,073  

Legal and professional fees

     1,508       1,369       1,094  

Data processing expense

     942       667       532  

Loan costs

     460       442       396  

Supplies expense

     704       660       508  

Other expense

     2,758       2,256       2,028  
                        

Total noninterest expense

   $ 32,508     $ 28,932     $ 25,012  
                        

Noninterest expense as a percentage of total average assets

     2.87 %     3.04 %     3.19 %

Operating efficiency ratio

     60.64 %     60.20 %     59.78 %

The Company’s efficiency ratio (noninterest expense as a percentage of net interest income and noninterest income, excluding gains and losses on the sale of investments) increased to 60.64% in 2007 compared to 60.20% in 2006, and 59.78% in 2005. Although the Company had significant increases in both net interest income and noninterest income, noninterest expense related to continued growth and expansion into new markets led to the deterioration of the efficiency ratio in 2007 and 2006. Expenses for growth and expansion were more than offset by income produced from existing operations.

Income Taxes

Income tax expense increased $648,000 or 11.4% in 2007 from 2006, and increased $718,000 or 14.5% in 2006 from 2005. The effective tax rate as a percentage of pre-tax income was 34.9% in 2007, 33.7% in 2006, and 33.2% in 2005. Higher income in 2007 resulted in taxable income over $15.0 million which was taxed at a higher federal income tax rate. The increase in the effective tax rate is primarily due to the graduated increase in the federal income tax rate from 34% in 2002 to 35% in 2007. Additionally, for federal income tax purposes, increases in nontaxable bank-owned life insurance income and tax-exempt municipals were generally offset by increases in nondeductible stock compensation expense. However, for state income tax purposes, the increase in nontaxable bank-owned life insurance income was significantly offset by Georgia disallowed agency interest income and increases in nondeductible stock compensation expense.

 

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Provision for Loan Losses, Net Charge-offs and Allowance for Loan Losses

The provision for loan losses is the charge to operating earnings necessary to maintain an adequate allowance for loan losses. The allowance for loan losses represents a reserve for losses in the loan portfolio. The Company has developed policies and procedures for evaluating the overall quality of its loan portfolio and the timely identification of problem credits. Management continues to review these policies and procedures and makes further improvements as needed. The adequacy of the Company’s allowance for loan losses and the effectiveness of the Company’s internal policies and procedures are also reviewed periodically by the Company’s regulators and the Company’s internal loan review personnel. The Company’s regulators may advise the Company to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.

The Company’s Board of Directors, with the recommendation of management, approves the appropriate level for the allowance for loan losses based upon internal policies and procedures, historical loan loss ratios, loan volume, size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, value of the collateral underlying the loans, specific problem loans and present or anticipated economic conditions and trends. The Company continues to refine the methodology on which the level of the allowance for loan losses is based, by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics.

For significant problem loans, management’s review consists of the evaluation of the financial condition and strengths of the borrower, cash flows available for debt repayment, the related collateral supporting the loan and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual problem loan, management classifies the loan accordingly and allocates a portion of the allowance for loan losses for that loan based on the results of the evaluations described above.

The table below indicates the allocated general allowance for all loans according to loan type determined through the Company’s comprehensive allowance methodology for the years indicated. Because these allocations are based upon estimates and subjective judgment, it is not necessarily indicative of the specific amounts or loan categories in which loan losses may occur.

The allowance for loan losses was decreased $694,000 in 2006 to eliminate the allowance allocated for unfunded lines and commitments and standby letters at December 31, 2005 to comply with SAB 108. This adjustment decreased the allowance for loan losses at January 1, 2006 from $9.1 million to $8.4 million. The allowance for loan losses was $9.8 million at December 31, 2006, a $1.3 million increase after the adjustment. Increases in outstanding loan balances were the primary reason for the increase somewhat offset by decreases in the allowance due to lower levels of Classified and Watch-rated debt, decreased reserves for specific loans and the change in the allowance calculation related to economic and market risk factors. In 2006, the loan loss method discussed under “Critical Accounting Estimates” was revised to include economic and market risk factors as part of the various individual components of the allowance for loan losses and to eliminate unfunded lines and commitments and standby letters of credit from the general allocation. Prior to 2006, economic and market risk factors were specifically identified and recorded as a separate component of the allowance and unfunded lines and commitments and standby letters of credit were included in the general allocation. With the two exceptions noted above, the loan loss method discussed under “Critical Accounting Estimates” was consistently applied to loans in 2007, 2006, 2005, 2004 and 2003.

 

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Allocation of the Allowance for Loan Loss

 

    December 31,  
    2007     2006     2005     2004     2003  
    Amount   Percent(1)     Amount   Percent(1)     Amount     Percent(1)     Amount     Percent(1)     Amount     Percent(1)  
    (Dollars in thousands)  

Balance at end of year

                   

Applicable to:

                   

Commercial, financial, agricultural

  $ 1,760   10.72 %   $ 1,254   10.78 %     1,060     10.71 %     1,164     12.09 %     1,151     13.09 %

Real estate-
construction

    4,344   36.54 %     3,139   35.58 %     2,288     30.74 %     1,648     25.76 %     1,249     20.87 %

Real estate-mortgage

    4,681   49.00 %     4,835   49.58 %     4,441     52.85 %     3,648     53.84 %     3,141     54.37 %

Consumer loans to individuals

    1,015   3.85 %     549   4.16 %     642     5.78 %     895     8.34 %     1,166     11.69 %

Lease financing

    —     0.00 %     —     0.02 %     —       0.02 %     —       0.00 %     —       0.00 %

Deferred loan origination fees

    —     (0.11 )%     —     (0.12 )%     —       (0.10 )%     —       (0.03 )%     —       (0.02 )%

Unfunded lines, commitments and standby letters of credit

            694     0.00 %     575     0.00 %     571     0.00 %

Other

    —     0.00 %     —     0.00 %     —       0.00 %     —       0.00 %     —       0.00 %
                                                                 

Balance at end of year

  $ 11,800   100.00 %   $ 9,777   100.00 %   $ 9,125     100.00 %   $ 7,930     100.00 %   $ 7,278     100.00 %

Proforma excluding unfunded

            (694 )       (575 )       (571 )  

lines, commitments and standby letters of credit

          $ 8,431       $ 7,355       $ 6,707    
                                     

 

(1) Percent of loans in each category to total loans

Additions to the allowance for loan losses, which are expensed on the Company’s income statement as the “provision for loan losses”, are made periodically to maintain the allowance for loan losses at an appropriate level based upon management’s evaluation of the potential risk in the loan portfolio. The Company’s provision for loan losses in 2007 was $3.8 million, an increase of $1.3 million, or 54.2% from the 2006 provision of $2.5 million.

The allocation of allowance for loan losses on real estate-construction loans grew $1.2 million in 2007 due to higher levels of net charge offs in this category coupled with growth of $51.6 million or 19.3% and in 2007. The decrease in the allowance for commercial, financial, and agricultural loans in 2006 is primarily due to $694,000 for unfunded lines and commitments and standby letters of credit in 2005 which were eliminated in 2006 to comply with SAB 108.

 

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The following table provides details regarding charge-offs and recoveries by loan category during the most recent five year period, as well as supplemental information relating to both net loan losses, the provision and the allowance for loan losses during each of the past five years. Net charge-offs for 2007 represented 0.22% of average loans outstanding, compared to 0.17% for 2006 and 0.12% for 2005.

 

    Allowances for Loan Losses
At December 31,
 
    2007     2006     2005     2004     2003  
    (Dollars in thousands)  

Total loans outstanding at end of period, net of unearned income

  $ 882,743     $ 749,969     $ 601,235     $ 494,170     $ 432,679  
                                       

Average loans outstanding, net of unearned income

  $ 811,509     $ 664,101     $ 547,414     $ 464,769     $ 420,023  
                                       

Balance of allowance for loan losses at beginning of year

  $ 9,777     $ 8,431 (1)   $ 7,930     $ 7,278     $ 6,534  

Charge-offs:

         

Commercial, financial and agricultural

    98       648       694       458       439  

Real estate—construction

    915       100       80       18       25  

Real estate—mortgage

    477       806       95       52       55  

Consumer

    1,086       386       736       1,165       1,102  
                                       

Total charge-offs

    2,576       1,940       1,605       1,693       1,621  
                                       

Recoveries of previous loan losses:

         

Commercial, financial and agricultural

    21       287       307       175       190  

Real estate—construction

    12       6       5       4       —    

Real estate—mortgage

    125       31       52       8       3  

Consumer

    618       484       594       570       478  
                                       

Total recoveries

    776       808       958       757       671  
                                       

Net loan losses

    1,800       1,132       647       936       950  

Provision for loan losses

    3,823       2,478       1,842       1,588       1,694  
                                       

Balance of allowance for loan losses at end of period

  $ 11,800     $ 9,777     $ 9,125       7,930       7,278  
                                       

Allowance for loan losses to period end loans

    1.34 %     1.30 %     1.52 %     1.60 %     1.68 %

Net charge-offs to average loans

    0.22 %     0.17 %     0.12 %     0.20 %     0.23 %

Proforma ALLL at end of period(2)

      $ 8,431     $ 7,355     $ 6,707  

Proforma ALLL to period end loans(2)

        1.40 %     1.49 %     1.55 %

 

(1) Includes adjustment of $694 for estimated overstatement of allowance for loan loss as of 12/31/05 as required by SAB 108.
(2) Proforma assumes adjustment to prior periods of amounts corrected pursuant to SAB108 under the iron curtain method.

At December 31, 2007, the allowance for loan losses was 1.34% of outstanding loans, up slightly from the 1.30% level at December 31, 2006 and the 1.52% level at December 31, 2005 (1.40% as adjusted for SAB 108). The Company experienced higher levels of net charge offs in the real estate construction and consumer categories in 2007. Management considers the allowance appropriate based upon its analysis of the potential risk in the portfolio using the methods previously discussed. Management’s judgment is based upon a number of assumptions about events which are believed to be reasonable, but which may or may not prove correct. While it is the Company’s policy to charge off in the current period the loans in which a loss is considered probable, there are additional risks of losses which cannot be quantified precisely or attributed to a particular loan or class of loans. Because these risks include present and forecasted economic conditions, management’s judgment as to the

 

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adequacy of the allowance is necessarily approximate and imprecise. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance will not be required. See “Critical Accounting Estimates.”

Financial Condition

Composition of the Loan Portfolio

Loans are the primary component of the Company’s interest-earning assets and generally are expected to provide higher yields than the other categories of earning assets. Those higher yields reflect the inherent credit risks associated with the loan portfolio. Management attempts to control and balance those risks with the rewards associated with higher returns.

Loans outstanding averaged $811.5 million in 2007 compared to $664.1 million in 2006 and $547.4 million in 2005. At December 31, 2007, loans totaled $882.7 million compared to $750.0 million at December 31, 2006, an increase of $132.8 million (17.7%). This compares to growth in 2006 of $148.8 million (24.8%) and loans outstanding of $601.2 million at December 31, 2005.

The Company continues to experience significant increases in loan volumes and balances. The increases are attributable to a stable local economy and the desire of a segment of the community to do business with a locally-owned and operated financial institution. Commercial real estate loans increased $37.9 million (19.1%) in 2007. Construction and development loans increased $51.6 million (19.3%) from year end 2006. Average loans as a percentage of average interest-earning assets and average total assets were 76.5% and 71.6%, respectively, in 2007. This compares to average loans as a percentage of average interest-earning assets and average total assets of 74.5% and 69.8%, respectively, in 2006.

 

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The following table sets forth the composition of the Company’s loan portfolio as of December 31 for the past five years. The Company’s loan portfolio does not contain any concentrations of loans exceeding 10% of total loans which are not otherwise disclosed as a category of loans in this table. The Company has not invested in loans to finance highly-leveraged transactions (“HLT”), such as leveraged buy-out transactions, as defined by the Federal Reserve and other regulatory agencies. Loans made by a bank for recapitalization or acquisitions (including acquisitions by management or employees) which result in a material change in the borrower’s financial structure to a highly-leveraged condition are considered HLT loans. The Company had no foreign loans or loans to lesser-developed countries as of December 31 of any of the years presented.

Loan Portfolio Composition

At December 31,

 

    2007     2006     2005     2004     2003  
    Amount     %     Amount     %     Amount     %     Amount     %     Amount     %  
    (Dollars in thousands)  

Commercial financial and agricultural

  $ 93,318     10.57 %   $ 80,823     10.78 %   $ 64,398     10.71 %   $ 59,763     12.09 %   $ 56,626     13.09 %
                                                                     

Real estate

                   

Commercial

  $ 236,358     26.78 %   $ 198,453     26.46 %   $ 156,896     26.10 %   $ 139,616     28.25 %   $ 129,223     29.87 %

Residential

    190,613     21.59 %     158,543     21.14 %     138,716     23.07 %     111,635     22.59 %     91,973     21.26 %

Residential held for sale

    11,303     1.28 %     14,857     1.98 %     22,147     3.68 %     14,779     2.99 %     14,047     3.25 %

Construction and development

    318,438     36.07 %     266,875     35.58 %     184,826     30.74 %     127,303     25.76 %     90,303     20.87 %
                                                                     

Total real estate

    756,712     85.72 %     638,728     85.17 %     502,585     83.59 %     393,333     79.59 %     325,546     75.24 %
                                                                     

Lease financing

    37     0.00 %     116     0.02 %     111     0.02 %     0     0.00 %     23     0.01 %

Consumer

                   

Direct

    25,569     2.90 %     24,146     3.22 %     24,343     4.05 %     24,185     4.89 %     25,967     6.00 %

Indirect

    4,237     0.48 %     6,232     0.83 %     9,752     1.62 %     16,436     3.33 %     23,964     5.54 %

Revolving

    3,819     0.43 %     843     0.11 %     656     0.11 %     600     0.12 %     631     0.15 %
                                                                     

Total consumer

    33,625     3.81 %     31,221     4.16 %     34,751     5.78 %     41,221     8.34 %     50,562     11.69 %
                                                                     

Deferred loan origination fees

    (949 )   -0.11 %     (919 )   -0.12 %     (610 )   -0.10 %     (147 )   -0.03 %     (78 )   -0.02 %
                                                                     

Total

  $ 882,743     100.00 %   $ 749,969     100.00 %   $ 601,235     100.00 %   $ 494,170     100.00 %   $ 432,679     100.00 %
                                                                     

Loans may be periodically renewed with principal reductions and appropriate interest rate adjustments. Loan maturities as of December 31, 2007 are set forth in the following table based upon contractual terms. Actual cash flows may differ as borrowers generally have the right to prepay without prepayment penalties.

 

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Loan Maturity Schedule

At December 31, 2007

 

($ in thousands)

   Within
One Year
    One to Five
Years
   After Five
Years
   Total  

Commercial, financial and agricultural

   $ 47,900     $ 38,714    $ 6,704    $ 93,318  

Real Estate

          

Construction and development

     253,413       57,467      7,558      318,438  

Mortgage

     184,389       201,216      52,669      438,274  

Lease financing

     37       —        —        37  

Consumer

     17,615       14,924      1,086      33,625  

Deferred loan origination fees

     (949 )     —        —        (949 )
                              

Total loans

   $ 502,405     $ 312,321    $ 68,017    $ 882,743  
                              

The following table presents an interest rate sensitivity analysis of the Company’s loan portfolio as of December 31, 2007. The loans outstanding are shown in the time period where they are first subject to repricing.

Sensitivity of Loans to Changes in Interest Rates

At December 31, 2007

 

($ in thousands)

   Within
One year
   One to Five
Years
   After Five
Years
   Total

Loans maturing or repricing with:

           

Predetermined interest rates

   $ 146,515    $ 232,857    $ 26,051    $ 405,423

Floating or adjustable interest rates

     440,881      35,412      1,027      477,320
                           

Total loans

   $ 587,396    $ 268,269    $ 27,078    $ 882,743
                           

Non-Performing Assets

As a result of management’s ongoing review of the loan portfolio, loans are classified as nonaccrual when it is not reasonable to expect collections of interest and principal under the original terms, generally when a loan becomes 90 days or more past due. These loans are classified as nonaccrual, even though the presence of collateral or the borrower’s financial strength may be sufficient to provide for ultimate repayment. When a loan is placed on nonaccrual, the interest which has been accrued but remains unpaid is reversed and deducted from current period interest income. No additional interest is accrued and recognized as income on the loan balance until the collection of both principal and interest becomes reasonably certain. Also, there may be write downs, and ultimately, the total charge-off of the principal balance of the loan, which could necessitate additional charges to earnings through the provision for loan losses.

If non accruing loans had been accruing interest under their original terms, approximately $198,000 in 2007, $118,000 in 2006 and $204,000 in 2005 would have been recognized as earnings.

The Company accounts for impaired loans under the provisions of Statement of Financial Accounting Standards (SFAS) No. 114 “Accounting by Creditors for Impairment of a Loan” as amended by SFAS No. 118 “Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures”, which requires that the Company identify impaired loans and evaluate the collectability of both contractual interest and principal of loans when assessing the need for a loss allowance. The provisions of SFAS No. 114 do not apply to large pools of smaller balance homogeneous loans which are collectively evaluated for impairment, loans that are measured at fair value or at the lower of cost or fair value, and debt securities. A loan is considered impaired, when based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the note agreement. The amount of the impairment is measured based on the present value of future cash flows discounted at the loan’s effective interest rate or, if the loan is collateral

 

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dependent or foreclosure is probable, the fair value of collateral, less estimated selling expenses. Regulatory guidance is also considered. At December 31, 2007 and 2006, the Company had impaired loans of $14.2 million and $1.5 million, respectively. Allowances for losses on impaired loans totaled $291,000 on balances of $1.7 million and $252,000 on balances of $590,000 respectively at December 31, 2007 and 2006 respectively. The amount of impaired loans for which there is no related allowance for credit losses totaled $12.4 million and $944,000 at December 31, 2007 and 2006 respectively.

Non-performing loans are defined as nonaccrual and renegotiated loans. When other real estate owned is included with non-performing loans, the result is non-performing assets. The following table, “Non-Performing Assets”, presents information on these assets and loans past due 90 days or more and still accruing interest as of December 31, for the past five years. Non-performing assets were $5.5 million at December 31, 2007 or 0.62% of total loans and other real estate owned. This compares to $2.4 million or 0.31% of total loans and other real estate owned at December 31, 2006.

Significant changes in nonaccrual loans during 2007 included an increase in non-performing assets for several large credits on nonaccrual. The largest credit placed on nonaccrual was a $1.7 million secured by commercial real estate. In addition, a loan for $800 thousand secured by residential real estate as well as a $410 unsecured loan to the same borrower were placed on nonaccrual.

Significant changes in nonaccrual loans during 2006 included a decrease in non-performing assets with balances less than $100,000, a $1.4 million decrease for two customers from a combination of collateral sale and charge-off, a $254,000 decrease for one customer removed from nonaccrual status, and an increase of $825,000 for two customers added to nonaccrual status.

At December 31, 2007 and 2006, there were no loans past due 90 days or more and still accruing. At December 31, 2005 and 2004 there were loans past due 90 days or more and still accruing of $1,000 and $29,000, respectively. All loans past due 90 days or more are classified as nonaccrual loans unless the loan officer believes that both principal and interest are collectible, in which case the loan continues to accrue interest.

 

     Non-Performing Assets
Year Ended December 31,
 
     2007     2006     2005     2004     2003  
     (Dollars in thousands)  

Nonaccrual loans

   $ 5,495     $ 2,351     $ 4,009     $ 2,972     $ 3,045  

Other real estate owned

     —         —         —         53       5  
                                        

Total nonperforming assets

   $ 5,495     $ 2,351     $ 4,009     $ 3,025     $ 3,050  
                                        

Loans past due 90 days or more and still accruing interest

   $ —       $ —       $ 1     $ 29     $ —    
                                        

Allowance for loan losses to period end total loans

     1.34 %     1.30 %     1.52 %     1.60 %     1.68 %

Allowance for loan losses to period end nonperforming loans

     214.74 %     415.87 %     227.56 %     262.15 %     238.62 %

Net charge-offs to average loans

     0.22 %     0.17 %     0.12 %     0.20 %     0.23 %

Nonperforming assets to period end loans

     0.62 %     0.31 %     0.67 %     0.61 %     0.70 %

Nonperforming assets to period end loans and other real estate owned

     0.62 %     0.31 %     0.67 %     0.61 %     0.70 %

Proforma data to illustrate the effect of SAB 108

          

Allowance for loan losses to period end net loans excluding amount applicable to unfunded lines, commitments and standby letters of credit

         1.40 %     1.49 %     1.55 %

Allowance for loan losses to period end nonperforming loans excluding amount applicable to unfunded lines, commitments and standby letters of credit

         210.30 %     243.14 %     219.90 %

 

C-16


Management is not aware of any loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been identified which (1) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (2) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

Off-Balance Sheet Arrangements

The Company is party to lines of credit with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Lines of credit are unfunded commitments to extend credit. These instruments involve, in varying degrees, exposure to credit and interest rate risk in excess of the amounts recognized in the financial statements. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unfunded commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company follows the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Unfunded commitments to extend credit where contractual amounts represent potential credit risk totaled $208.5 million and $202.6 million at December 31, 2007 and 2006, respectively. These commitments are primarily at variable interest rates.

The Company’s commitments are funded through internal funding sources of scheduled repayments of loans and sales and maturities of investment securities available for sale or external funding sources through acceptance of deposits from customers or borrowings from other financial institutions.

The following table is a summary of the Company’s commitments to extend credit, commitments under contractual leases as well as the Company’ contractual obligations, consisting of deposits, FHLB advances and borrowed funds by contractual maturity date.

 

Commitments and

Contractual Obligations

($ in thousands)

   Less than
1 Year
   1 - 3
Years
   3 - 5
Years
   More than
5 Years

Lines of credit

   $ 193,883    —      —      —  

Mortgage loan commitments

     14,616    —      —      —  

Lease agreements

     336    452    222    156

Deposits

     908,283    37,428    5,789    666

Federal funds purchased / Securities sold under repurchase agreements

     81,166    —      —      —  

FHLB advances

     —      24,000    6,000    29,000

Other borrowings

     500    —      —      —  

Subordinated debentures

     —      —      —      20,000
                     

Total commitments and contractual obligations

   $ 1,198,784    61,880    12,011    49,822
                     

Although management regularly monitors the balance of outstanding commitments to fund loans to ensure funding availability should the need arise, management believes that the risk of all customers fully drawing on all these lines of credit at the same time is remote.

 

C-17


Investment Securities

The Company’s investment securities portfolio increased $44.8 million to $246.9 million at year-end 2007 from 2006. The Company maintains an investment strategy of seeking portfolio yields within acceptable risk levels, as well as providing liquidity. The Company maintains two classifications of investments: “Held to Maturity” and “Available for Sale.” “Available for Sale” securities are carried at fair market value with related unrealized gains or losses included in stockholders’ equity as accumulated other comprehensive income, whereas the “Held to Maturity” securities are carried at amortized cost. As a consequence, with a higher percentage of securities being placed in the “Available for Sale” category, the Company’s stockholders’ equity is more volatile than it would be if a larger percentage of investment securities were placed in the “Held to Maturity” category. Although equity is more volatile, management has discretion, with respect to the “Available for Sale” securities, to proactively adjust to favorable market conditions in order to provide liquidity and realize gains on the sales of securities. The changes in values in the investment securities portfolio are not taken into account in determining regulatory capital requirements. (As of December 31, 2007, except for the U.S. Government agencies, there was no issuer who represented 10% or more of stockholders’ equity within the investment portfolio.) As of December 31, 2007 and 2006, the estimated fair value of investment securities as a percentage of their amortized cost was 100.0% and 98.8%, respectively. At December 31, 2007, the investment securities portfolio had gross unrealized gains of $2,097,000 and gross unrealized losses of $2,022,000, for a net unrealized gain of $75,000. As of December 31, 2006 and 2005, the investment securities portfolio had net unrealized losses of $2,400,000 and $3,302,000, respectively. The following table presents the amortized cost of investment securities held by the Company at December 31, 2007, 2006 and 2005.

Investment Securities

 

     December 31,
(Dollars in thousands)    2007    2006    2005

Available for sale:

        

U.S. Government Agencies

     96,166      77,717      68,646

Obligations of states and political subdivisions

     15,755      15,391      19,641

Mortgage-backed securities

     118,179      95,910      92,984

Corporate bonds

     9,722      5,987      9,071

Trust preferred

     5,314      6,358      10,133

Equity securities

     250      250      500
                    

Total

   $ 245,386    $ 201,613    $ 200,975
                    
     December 31,
     2007    2006    2005

Held to maturity:

        

Obligations of states and political subdivisions

   $ 1,435    $ 2,971    $ 3,776
                    

Total

   $ 1,435    $ 2,971    $ 3,776
                    

 

C-18


The following table represents maturities and weighted average yields of debt securities at December 31, 2007. Yields are based on the amortized cost of securities. Maturities are based on the contractual maturities. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

Maturity Distribution and Yields of

Investment Securities

(Dollars in thousands)

 

    December 31, 2007  
    Amortized Cost   Yield  

Available for Sale

   

US Government Agencies

   

Over one through five years

  $ 11,587   4.91 %

Over five through ten years

    44,324   5.49 %

Over ten years

    40,255   5.81 %
           

Total U. S. Government Agencies

  $ 96,166   5.55 %
           

Municipal Securities(1)

   

One year or less

  $ 250   4.51 %

Over five through ten years

    2,843   5.85 %

Over ten years

    12,662   6.24 %
           

Total Municipal Securities

  $ 15,755   6.14 %
           

Corporate Bonds

   

Over one through five years

  $ 1,011   7.31 %

Over five through ten years

    3,821   6.13 %

Over ten years

    4,890   6.70 %
           

Total Corporate Bonds

  $ 9,722   6.54 %
           

Trust Preferred

   

Over one through five years

  $ 1,014   6.39 %

Over five through ten years

    1,000   6.25 %

Over ten years

    3,300   7.32 %
           

Total Trust Preferred securities

  $ 5,314   6.94 %
           

Mortgage Backed Securities

   

Over one through five years

  $ 6,188   4.11 %

Over five through ten years

    11,493   4.48 %

Over ten years

    100,498   5.13 %
           

Total Mortgage Backed securities

  $ 118,179   5.01 %
           

Total Equity securities

  $ 250   0.00 %
           

Total Available for Sale

  $ 245,386   5.39 %
           

Held to Maturity

   

Municipal Securities(1)

   

Over one through five years

  $ 926   7.22 %

Over five through ten years

    509   7.73 %
           

Total Municipal Securities

  $ 1,435   7.40 %
           

Total Held to Maturity

  $ 1,435   7.40 %
           

Total Investment Securities

  $ 246,821   5.40 %
           

 

(1) Tax-equivalent yield

 

C-19


Asset/Liability Management, Interest Rate Sensitivity and Liquidity

General. It is the objective of the Company to manage assets and liabilities to preserve the integrity and safety of the deposit and capital base of the Company by protecting the Company from undue exposure to poor asset quality and interest rate risk. Additionally, the Company pursues a consistent level of earnings as further protection for the depositors and to provide an appropriate return to stockholders on their investment.

These objectives are achieved through compliance with an established framework of asset/liability, interest rate risk, loan, investment, and capital policies. Management is responsible for monitoring policies and procedures that result in proper management of the components of the asset/liability function to achieve stated objectives. The Company’s philosophy is to support quality asset growth primarily through growth of core deposits, which include non-volatile deposits of individuals, partnerships and corporations. Management seeks to invest the largest portion of the Company’s assets in loans that meet the Company’s quality standards. Alternative investments are made in the investment portfolio. The Company’s asset/liability function and related components of liquidity and interest rate risk are monitored on a continuous basis by management. The Board of Directors reviews and monitors these functions on a monthly basis.

Interest Rate Sensitivity. The process of asset/liability management involves monitoring the Company’s balance sheet in order to determine the potential impact that changes in the interest rate environment would have on net interest income so that the appropriate strategies to minimize any negative impact can be implemented. The primary objective of asset/liability management is to continue the steady growth of net interest income, the Company’s primary earnings component within a context of liquidity requirements.

In theory, interest rate risk can be minimized by maintaining a nominal level of interest rate sensitivity. In practice, however, this is made difficult because of uncontrollable influences on the Company’s balance sheet, including variations in both loan demand and the availability of funding sources.

The measurement of the Company’s interest rate sensitivity is one of the primary techniques employed by the Company in asset/liability management. The dollar difference between assets and liabilities which are subject to interest rate repricing within a given time period, including both floating rate or adjustable instruments and instruments which are approaching maturity, determine the interest sensitivity gap.

The Company manages its sensitivity to interest rate movements by adjusting the maturity of, and establishing rates on, the interest-earning asset portfolio and interest-bearing liabilities in line with management’s expectations relative to market interest rates. The Company would generally benefit from increasing market interest rates when the balance sheet is asset sensitive and would benefit from decreasing market rates when it is liability sensitive. At December 31, 2007, the Company’s interest rate sensitivity position was liability sensitive within the one-year horizon.

The following table “Interest Sensitivity Analysis” details the interest rate sensitivity of the Company at December 31, 2007. The principal balances of the various interest-earning and interest-bearing balance sheet instruments are shown in the time period where they are first subject to repricing, whether as a result of floating or adjustable rate contracts. Fixed rate time deposits are presented according to their contractual maturity while variable rate time deposits reprice with the prime rate and are presented in the within three months time frame. Prime savings accounts reprice at management’s discretion when prime is below 5% and at 50% of the prime rate when prime is greater than 5%. In the table presented below, prime savings reprices in the within three months time frame. Regular savings, money management and NOW accounts do not have a contractual maturity date and are presented as repricing at the earliest date in which the deposit holder could withdraw the funds. All other borrowings are shown in the first period in which they could reprice. In the one-year time period, the pricing mismatch on a cumulative basis was liability sensitive $351.7 million or 31.1% of total interest-earning assets. Management has procedures in place to carefully monitor the Company’s interest rate sensitivity as the rate environment changes. It should also be noted that all interest rates do not adjust at the same velocity. As an

 

C-20


example, the majority of the savings category listed below is priced on an adjustable basis. When prime is greater than 5%, it is fifty percent of the prime rate. Therefore, as the prime rate adjusts 100 basis points, the rate on this liability only adjusts 50 basis points. Moreover, varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities. Investments prepayments are reflected at their current prepayment speeds in the interest sensitivity analysis report. No other prepayments are reflected in the following interest sensitivity analysis report. Prepayments may have significant effects on the Company’s net interest margin. Hence, gap is only a general indicator of interest rate sensitivity and cannot be interpreted as an absolute measurement of the Company’s interest rate risk.

Interest Sensitivity Analysis

At December 31, 2007

 

    Within
Three
Months
    After Three
Through
Six Months
    After Six
Through
Twelve
Months
    Within One
Year
    One Year
Through
Five Years
    Over Five
Years
    Total
    (Dollars in thousands)

Interest-earning assets:

             

Loans

  $ 479,473     $ 46,336     $ 62,956     $ 588,765     $ 267,321     $ 26,657     $ 882,743

Investment securities

    8,103       5,789       12,293       26,185       99,041       121,638       246,864

Federal funds sold

    —         —         —         —         —         —         —  

Interest-bearing deposits in other banks

    500       —         —         500       —         —         500
                                                     

Total interest-earning assets

  $ 488,076     $ 52,125     $ 75,249     $ 615,450     $ 366,362     $ 148,295     $ 1,130,107
                                                     

Interest-bearing liabilities:

             

Money management accounts

  $ 73,609     $ 0     $ 0     $ 73,609     $ 0     $ 0     $ 73,609

Savings accounts

    289,731       —         —         289,731       —         —         289,731

NOW accounts

    132,186       —         —         132,186       —         —         132,186

Time deposits

    115,914       72,507       127,199       315,620       39,748       —         355,368

Federal funds purchased / securities sold under repurchase agreements

    81,166       —         —         81,166       —         —         81,166

Federal Home Loan Bank advances

    19,000       —         —         19,000       24,000       16,000       59,000

Notes and bonds payable

    500       —         —         500       —         —         500

Subordinated debentures

    20,000       —         —         20,000       —         —         20,000
                                                     

Total interest-bearing liabilities

  $ 732,106     $ 72,507     $ 127,199     $ 931,812     $ 63,748     $ 16,000     $ 1,011,560
                                                     

Period gap

  $ (244,030 )   $ (20,382 )   $ (51,950 )   $ (316,362 )   $ 302,614     $ 132,295    

Cumulative gap

  $ (244,030 )   $ (264,412 )   $ (316,362 )   $ (316,362 )   $ (13,748 )   $ 118,547    

Ratio of cumulative gap to total interest-earning assets

    -21.59 %     -23.40 %     -27.99 %     -27.99 %     -1.22 %     10.49 %  

 

C-21


Liquidity

Management of the Company’s liquidity position is closely related to the process of asset/liability management. Liquidity represents the ability to provide steady sources of funds for loan commitments and investment activities, as well as to provide sufficient funds to cover deposit withdrawals and payment of debt and operating obligations. The Company intends to meet its liquidity needs by managing cash and due from banks, federal funds sold and purchased, maturity of investment securities, principal repayments received from mortgage-backed securities and lines of credit as necessary. GB&T maintains a line of credit with the Federal Home Loan Bank at 10% of GB&T’s total assets. Federal Home Loan Bank advances are collateralized by eligible first mortgages, commercial real estate loans and investment securities. GB&T maintains repurchase lines of credit with SunTrust Robinson Humphrey, Atlanta, Georgia, for advances up to $20.0. At December 31, 2007, a $10.0 million repurchase agreement was outstanding with SunTrust Robinson Humphrey. GB&T has a federal funds purchased accommodation with Silverton Bank, Atlanta, Georgia, for advances up to $16.7 million and with SunTrust Bank, Atlanta, Georgia, for advances up to $10.0 million, while SB&T has a federal funds purchased accommodation with Silverton Bank, Atlanta, Georgia, for advances up to $3.3 Million. Additionally, liquidity needs can be satisfied by the structuring of the maturities of investment securities and the pricing and maturities on loans and deposits offered to customers. The Company also uses retail securities sold under repurchase agreements to fund growth. Retail securities sold under repurchase agreements were $48.6 million at December 31, 2007.

Deposits

The Company’s average deposits and other borrowings increased $166.3 million or 19.1% from 2006 to 2007. Average interest-bearing liabilities increased $159.9 million or 20.7% while average noninterest-bearing deposits increased $6.4 million or 6.3% from 2006 to 2007. Average deposits and borrowings increased $155.8 million or 21.7% from 2005 to 2006. Average interest-bearing liabilities increased $142.9 million or 22.8% from 2005 to 2006, while average noninterest-bearing deposits increased $13.0 million or 14.5% during the same period. The majority of the growth in deposits reflects the Company’s strategy of consistently emphasizing deposit growth, as deposits are the primary source of funding for balance sheet growth. Borrowed funds consist of short-term borrowings, securities sold under agreements to repurchase with the Company’s commercial customers and reverse repurchase agreements with SunTrust Robinson Humphrey, federal funds purchased, and borrowings from the Federal Home Loan Bank. Brokered certificates of deposit included in time deposits over $100,000 at December 31, 2007 and 2006 were $78.5 million and $67.4 million, respectively.

The following table presents the average amount outstanding and the average rate paid on deposits and borrowings by the Company for the years 2007, 2006 and 2005:

 

     Year ended December 31,  
     2007     2006     2005  
     Average
Amount
   Average
Rate
    Average
Amount
   Average
Rate
    Average
Amount
   Average
Rate
 
     (Dollars in thousands)  

Noninterest-bearing demand deposits

   $ 108,470    0.00 %   $ 102,032    0.00 %   $ 89,079    0.00 %

Interest-bearing liabilities:

               

NOW accounts

     127,093    2.30 %     114,021    2.00 %     87,982    0.89 %

Savings, money management accounts

     341,097    4.04 %     305,186    3.93 %     288,759    2.98 %

Time deposits

     317,298    5.18 %     213,889    4.59 %     145,209    3.08 %

Federal funds purchased/ securities sold under repurchase agreements

     65,735    5.03 %     62,451    4.93 %     55,658    3.05 %

Other borrowings

     79,250    5.65 %     75,034    5.66 %     50,121    4.62 %
                                       

Total interest-bearing liabilities

   $ 930,473    4.40 %   $ 770,581    4.08 %   $ 627,729    2.85 %
                                       

Total noninterest & interest-bearing liabilities

   $ 1,038,943      $ 872,613      $ 716,808   

 

C-22


The following table presents the maturities of the Company’s time deposits over $100,000 at December 31, 2007:

Maturities of Time Deposits

(Dollars in thousands)

 

     Time
Certificates
of Deposit
of $100,000
or More

Months to Maturity

  

Within 3 months

   $ 75,994

After 3 through 6 months

     49,022

After 6 through 12 months

     89,100
      

Within one year

     214,116

After 12 months

     29,385
      

Total

   $ 243,501
      

This table indicates that the majority of time deposits of $100,000 or more have a maturity of less than twelve months. This is reflective of both the Company’s market and recent interest rate environments. Large time deposit customers tend to be extremely rate sensitive, making these deposits a volatile source of funding for liquidity planning purposes. However, dependent upon pricing, these deposits are virtually always available in the Company’s market. At December 31, 2007, the Company had $21.2 million of brokered certificates of deposit that mature after 12 months. The Company does not have any time deposits of $100,000 or more that are not certificates of deposit.

Capital

Total stockholders’ equity was $89.8 million at December 31, 2007, increasing $10.8 million or 13.7% from the previous year. The increase was primarily the combination of retained earnings, earnings less dividends paid, in the amount of $8.9 million and an increase in accumulated other comprehensive income of $1,663,000. The increase in accumulated other comprehensive income represents a decrease in unrealized losses in the available for sale investment portfolio. The Company purchased 8,432 shares of treasury stock in 2007, and 1,600 shares in 2006 at a cost of $317,000 and $62,000, respectively, which is shown as a reduction of stockholders’ equity. The Company issued 400 shares of treasury stock in 2007, 800 shares in 2006, and 21,400 shares in 2005 at a price of $17,000, $31,000 and $263,000, respectively, for stock options which were exercised.

The Company’s average equity to average total assets was 7.40% in 2007 compared to 7.29% in 2006 and 7.85% in 2005. Capital is considered to be adequate to meet present operating needs and anticipated future operating requirements. Management is not aware of any trends, events or uncertainties that are reasonably likely to have a material effect on the Company’s capital resources or operations. The following table presents the return on equity and assets for the years 2007, 2006 and 2005.

Return on Equity and Assets

 

     Years ended December 31,  
     2007     2006     2005  

Return on average total assets

   1.04 %   1.17 %   1.27 %

Return on average equity

   14.03 %   16.10 %   16.15 %

Average equity to average assets ratio

   7.40 %   7.29 %   7.85 %

 

C-23


At December 31, 2007, the Company was well above the minimum capital ratios required under the regulatory risk-based capital guidelines. The following table presents the capital ratios for the Company and its subsidiaries.

ANALYSIS OF CAPITAL

 

     Required     Actual     Excess  
     Amount    %     Amount    %     Amount    %  
     (Dollars in thousands)  

Southeastern Bank Financial Corporation

               

12/31/2007

               

Risk-based capital:

               

Tier 1 capital

   $ 38,531    4.00 %   $ 109,589    11.38 %   $ 71,058    7.38 %

Total capital

     77,062    8.00 %     121,463    12.61 %     44,401    4.61 %

Tier 1 leverage ratio

     48,307    4.00 %     109,589    9.07 %     61,282    5.07 %

12/31/2006

               

Risk-based capital:

               

Tier 1 capital

   $ 33,222    4.00 %   $ 100,419    12.09 %   $ 67,197    8.09 %

Total capital

     66,445    8.00 %     110,422    13.29 %     43,977    5.29 %

Tier 1 leverage ratio

     41,065    4.00 %     100,419    9.78 %     59,354    5.78 %

Georgia Bank & Trust Company

               

12/31/2007

               

Risk-based capital:

               

Tier 1 capital

   $ 35,154    4.00 %   $ 88,095    10.02 %   $ 52,941    6.02 %

Total capital

     70,308    8.00 %     98,790    11.24 %     28,482    3.24 %

Tier 1 leverage ratio

     50,313    4.50 %     88,095    7.88 %     37,782    3.38 %

12/31/2006

               

Risk-based capital:

               

Tier 1 capital

   $ 31,649    4.00 %   $ 74,741    9.45 %   $ 43,092    5.45 %

Total capital

     63,298    8.00 %     84,173    10.64 %     20,875    2.64 %

Tier 1 leverage ratio

     44,401    4.50 %     74,741    7.57 %     30,340    3.07 %

Southern Bank & Trust

               

12/31/2007

               

Risk-based capital:

               

Tier 1 capital

   $ 3,248    4.00 %   $ 14,101    17.37 %   $ 10,853    13.37 %

Total capital

     6,495    8.00 %     15,117    18.62 %     8,622    10.62 %

Tier 1 leverage ratio

     3,389    4.00 %     14,101    16.64 %     10,712    12.64 %

12/31/2006 (opened 09/12/2006)

               

Risk-based capital:

               

Tier 1 capital

   $ 1,295    4.00 %   $ 9,438    29.16 %   $ 8,143    25.16 %

Total capital

     2,589    8.00 %     9,783    30.23 %     7,194    22.23 %

Tier 1 leverage ratio

     1,145    4.00 %     9,438    32.98 %     8,293    28.98 %

Cash Flows from Operating, Investing and Financing Activities

Net cash provided by operating activities was $17.6 million in 2007, a decrease of $3.2 million from 2006. A reduction in proceeds from sales of real estate loans was the main contributor with a decrease of $16.6 million in 2007, primarily the result of a lower volume of real estate loans originated and sold in the secondary market. Net cash provided by operating activities was $20.9 million in 2006, an increase of $14.7 million from 2005. The increase is primarily attributable to higher volumes of real estate loans originated and sold in the secondary market. In 2006, cash provided by proceeds from sales of real estate loans increased $15.0 million and an increase of $.3 million in cash used for real estate loans originated for sale.

 

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Net cash used in investing activities increased $26.4 million in 2007 to $190.4 million. Loan growth of $132.8 million caused a decrease in cash used of $18.9 million for 2007. These increases were somewhat offset by decreases in cash used of $41.6 million for net changes in the investment securities portfolio. Net cash used in investing activities increased $5.7 million in 2006 to $164.0 million. Net changes in the investment securities portfolio resulted in a $53.6 million increase in cash used in 2006. Loan growth of $157.3 million caused an increase in cash used of $56.8 million for 2006.

Net cash provided by financing activities in 2007 was $157.0 million, a decrease of $4.6 million from 2006. Deposit accounts provided cash flows of $150.4 million in 2007, an increase of $12.3 million over 2006. Cash provided by federal funds purchased and securities sold under repurchase agreements increased $8.1 million in 2007. Repayments of advances from Federal Home Loan Bank increased $6.0 million in 2007, partially offset by increases in new advances of $2.0 million in 2007 compared to 2006. Net cash provided by financing activities in 2006 was $161.5 million, an increase of $12.8 million from 2005. Net cash provided by changes in deposit accounts increased $31.2 million in 2006 to $138.1 million. Federal funds purchased and securities sold under repurchase agreements provided cash flows of $3.0 million in 2006, a decrease of $19.4 million over 2005. Advances from Federal Home Loan Bank increased $7.0 million in 2006, partially offset by repayments of $16.0 million in 2006 compared to repayment of $5.0 million in 2005. A new issuance of subordinated debentures provided $10.0 million in cash flows in 2006.

Forward-Looking Statements

The Company may from time to time make written or oral forward-looking statements, including statements contained in the Company’s filings with the Securities and Exchange Commission (the “Commission”) and its reports to shareholders. Statements made in such documents, other than those concerning historical information, should be considered forward-looking and subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The Company’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors, including unanticipated changes in the Company’s local economy, the national economy, governmental monetary and fiscal policies, deposit levels, loan demand, loan collateral values and securities portfolio values; difficulties in interest rate risk management; the effects of competition in the banking business; difficulties in expanding the Company’s business into new markets; changes in governmental regulation relating to the banking industry, including regulations relating to branching and acquisitions; failure of assumptions underlying the establishment of reserves for loan losses, including the value of collateral underlying delinquent loans; and other factors. The Company cautions that such factors are not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by, or on behalf of, the Company.

Recent Accounting Pronouncements

In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS No. 155), which permits fair value remeasurement for hybrid financial instruments that contain an embedded derivative that otherwise would require bifurcation. Additionally, SFAS No. 155 clarifies the accounting guidance for beneficial interests in securitizations. Under SFAS No. 155, all beneficial interests in a securitization will require an assessment in accordance with SFAS No. 133 to determine if an embedded derivative exists within the instrument. In January 2007, the FASB issued Derivatives Implementation Group Issue B40, Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets (DIG Issue B40). DIG Issue B40 provides an exemption from the embedded derivative test of paragraph 13(b) of SFAS No. 133 for instruments that would otherwise require bifurcation if the test is met solely because of a prepayment feature included within the securitized interest and prepayment is not controlled by the security holder. SFAS No. 155 and DIG Issue B40 are effective for fiscal years beginning after September 15, 2006. The adoption of SFAS No. 155 and DIG Issue B40 did not have a material impact on the Company’s consolidated financial position or results of operations.

 

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In March 2006, the FASB issued Statement No. 156, Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140. This Statement provides the following: 1) revised guidance on when a servicing asset and servicing liability should be recognized; 2) requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; 3) permits an entity to elect to measure servicing assets and servicing liabilities at fair value each reporting date and report changes in fair value in earnings in the period in which the changes occur; 4) upon initial adoption, permits a onetime reclassification of available-for-sale securities to trading securities for securities which are identified as offsetting the entity’s exposure to changes in the fair value of servicing assets or liabilities that a servicer elects to subsequently measure at fair value; and 5) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional footnote disclosures. This standard is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006 with the effects of initial adoption being reported as a cumulative-effect adjustment to retained earnings. Servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively based on a valuation model that calculates the present value of estimated future net servicing income. The adoption of this statement did not have a material impact on the Company’s consolidated financial position or results of operations.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48), which prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48 did not have a material effect on the financial statements.

In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5, Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life Insurance). This issue requires that a policyholder consider contractual terms of a life insurance policy in determining the amount that could be realized under the insurance contract. It also requires that if the contract provides for a greater surrender value if all individual policies in a group are surrendered at the same time, that the surrender value be determined based on the assumption that policies will be surrendered on an individual basis. Lastly, the issue discusses whether the cash surrender value should be discounted when the policyholder is contractually limited in its ability to surrender a policy. This issue is effective for fiscal years beginning after December 15, 2006. The adoption of this issue did not have a material impact on the Company’s consolidated financial statements.

On January 1, 2008, the Company adopted FASB Statement No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The standard is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of FASB Statement No. 157. This FSP delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The impact of adoption was not material to the Company’s consolidated financial statements.

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The new standard is effective for the Company on January 1, 2008. The Company did not elect the fair value option for any financial assets or financial liabilities as of January 1, 2008.

 

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On January 1, 2008, the Company adopted FASB Emerging Issues Task Force Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. The impact of adoption was not material to the Company’s consolidated financial statements.

Effects of Inflation and Changing Prices

Inflation generally increases the cost of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction and to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In addition, inflation can increase a financial institution’s cost of goods and services purchased, the cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and stockholders’ equity. Mortgage originations and refinancings tend to slow as interest rates increase, and can reduce the Company’s earnings from such activities and the income from the sale of residential mortgage loans in the secondary market.

Various information shown elsewhere herein will assist in the understanding of how well the Company is positioned to react to changing interest rates and inflationary trends. In particular, the summary of net interest income, the maturity distributions and compositions of the loan and security portfolios and the data on the interest sensitivity of loans and deposits should be considered.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market risk reflects the risk of loss due to changes in the market prices and interest rates. This loss could be reflected in diminished current market values or reduced net interest income in future periods.

The Company’s market risk arises primarily from the interest rate risk inherent in its lending and deposit activities. This risk is managed primarily by careful periodic analysis and modeling of the various components of the entire balance sheet. The investment portfolio is utilized to assist in minimizing interest rate risk in both loans and deposits due to the flexibility afforded in structuring the investment portfolio with regards to various maturities, cash flows and fixed or variable rates.

The following tables present all rate sensitive assets and liabilities by contractual amounts and maturity dates. Cash flows from mortgage backed securities reflect anticipated prepayments. For core deposits, without a contractual maturity date, cash flows are based on the earliest date at which the deposit holder could withdraw the funds. The fair value of rate sensitive assets and liabilities is presented in total. The fair value of investment securities is based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The fair value of loans is calculated using discounted cash flows by loan type. The discount rate used to determine the present value of the loan portfolio is an estimated market rate that reflects the credit and interest rate risk inherent in the loan portfolio. Fair values for certificates of deposit have been determined using discounted cash flows. The discount rate used is based on estimated market rates for deposits of similar remaining maturities. The carrying amounts of all other deposits, securities sold under repurchase agreements and variable interest rate borrowings approximated their fair values. The fair value of the Federal Home Loan Bank borrowings is obtained from the Federal Home Loan Bank and is

 

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calculated by discounting contractual cash flows using an estimated interest rate based on the current rates available to the Company for debt of similar remaining maturities and collateral terms.

Market Risk at December 31, 2007

 

(Dollars in thousands)    2008     2009     2010     2011     2012     There after     Total     Fair
Value

Rate Sensitive Assets:

                

Fixed interest rate loans

   149,764     99,402     97,257     18,330     19,254     25,654     409,661     406,384

Average interest rate

   6.88 %   7.65 %   7.49 %   7.53 %   7.41 %   7.26 %   7.29 %  

Variable interest rate loans

   353,652     46,882     15,806     8,544     5,897     42,300     474,081     474,081

Average interest rate

   7.71 %   7.16 %   7.13 %   7.00 %   7.01 %   6.87 %   7.54 %  

Fixed interest rate securities

   20,690     18,936     24,162     20,726     26,603     119,038     230,155     230,186

Average interest rate

   5.64 %   5.38 %   5.03 %   4.87 %   4.81 %   5.40 %   5.27 %  

Variable interest rate securities

   2,429,291     2,429     2,429     2,429     2,429     4,564     16,710     16,710

Average interest rate

   5.67 %   5.58 %   5.03 %   4.47 %   4.15 %   5.94 %   5.24 %  

Variable federal funds sold

   0     —       —       —       —       —       0     —  

Average interest rate

   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %  

Fixed interest-bearing deposits in other banks

   500     —       —       —       —       —       500     500

Average interest rate

   5.30 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   4.50 %  

Rate Sensitive Liabilities:

                

Noninterest-bearing deposits

   101,272     —       —       —       —       —       101,272     101,272

Average interest rate

   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %  

Money market accounts

   73,609     —       —       —       —       —       73,609     73,609

Average interest rate

   3.93 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   3.93 %  

Savings accounts

   289,731     —       —       —       —       —       289,731     289,731

Average interest rate

   3.58 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   3.58 %  

NOW accounts

   132,186     —       —       —       —       —       132,186     132,186

Average interest rate

   2.04 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   2.04 %  

Fixed interest rate time deposits < $100M

   91,348     9,007     1,286     947     434     0     103,022     103,130

Average interest rate

   5.01 %   4.62 %   4.42 %   4.73 %   4.47 %   0.00 %   4.97 %  

Variable interest rate time deposits < $100M

   6,686     2,159     —       —       —       —       8,845     8,846

Average interest rate

   4.45 %   4.45 %   0.00 %   0.00 %   0.00 %   0.00 %   4.45 %  

Fixed interest rate time deposits > $100M

   208,695     23,249     575     867     3,541     0     236,927     237,188

Average interest rate

   5.12 %   4.90 %   4.84 %   5.03 %   4.52 %   0.00 %   5.09 %  

Variable interest rate time deposits > $100M

   5,421     1,153     —       —       —       —       6,574     6,575

Average interest rate

   4.47 %   4.45 %   0.00 %   0.00 %   0.00 %   0.00 %   4.47 %  

Securities sold under repurchase agreements

   81,165     —       —       —       —       —       81,165     81,165

Average interest rate

   3.54 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   3.54 %  

Fixed Federal Home Loan Bank borrowings

   —       —       24,000     —       —       16,000     40,000     38,136

Average interest rate

   0.00 %   0.00 %   5.86 %   0.00 %   0.00 %   4.55 %   5.34 %  

Variable Federal Home Loan Bank borrowings

   —       —       —       —       —       19,000     19,000     18,641

Average interest rate

   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   4.67 %   4.67 %  

TT&L note borrowings

   500     —       —       —       —       —       500     500

Average interest rate

   6.47 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   6.47 %  

Subordinated debentures

   —       —       —       —       —       20,000     20,000     20,000

Average interest rate

   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   7.09 %   7.09 %  

 

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Market Risk at December 31, 2006

 

(Dollars in thousands)    2007     2008     2009     2010     2011     Thereafter     Total     Fair
Value

Rate Sensitive Assets:

                

Fixed interest rate loans

   152,899     65,317     33,137     9,730     9,957     34,245     305,285     301,323

Average interest rate

   7.26 %   7.48 %   7.63 %   7.54 %   7.42 %   6.82 %   7.31 %  

Variable interest rate loans

   312,995     46,641     15,220     6,894     5,421     57,513     444,684     444,684

Average interest rate

   8.48 %   8.45 %   8.24 %   8.14 %   8.17 %   7.16 %   8.29 %  

Fixed interest rate securities

   21,089     14,204     13,957     15,635     12,311     111,349     188,545     188,622

Average interest rate

   5.62 %   4.78 %   5.07 %   5.02 %   5.13 %   5.20 %   5.18 %  

Variable interest rate securities

   3,309     2,296     1,593     1,105     767     9,428     18,498     18,498

Average interest rate

   4.32 %   4.32 %   4.32 %   4.32 %   4.32 %   5.92 %   5.13 %  

Variable federal funds sold

   14,688     —       —       —       —       —       14,688     14,688

Average interest rate

   5.48 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   5.48 %  

Fixed interest-bearing deposits in other banks

   513     —       —       —       —       —       513     513

Average interest rate

   4.51 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   4.51 %  

Rate Sensitive Liabilities:

                

Noninterest-bearing deposits

   106,846     —       —       —       —       —       106,846     106,846

Average interest rate

   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %  

Money market accounts

   45,897     —       —       —       —       —       45,897     45,897

Average interest rate

   4.76 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   4.76 %  

Savings accounts

   255,066     —       —       —       —       —       255,066     255,066

Average interest rate

   4.03 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   4.03 %  

NOW accounts

   119,334     —       —       —       —       —       119,334     119,334

Average interest rate

   2.33 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   2.33 %  

Fixed interest rate time deposits < $100M

   59,020     10,869     1,230     1,231     1,074     427     73,851     73,605

Average interest rate

   4.88 %   5.04 %   3.93 %   4.40 %   4.71 %   1.59 %   4.86 %  

Variable interest rate time deposits < $100M

   —       6,908     —       —       —       —       6,908     6,918

Average interest rate

   0.00 %   5.40 %   0.00 %   0.00 %   0.00 %   0.00 %   5.40 %  

Fixed interest rate time deposits > $100M

   136,409     45,326     328     561     1,043     4,030     187,697     187,474

Average interest rate

   4.98 %   5.18 %   4.21 %   4.84 %   4.98 %   4.31 %   5.01 %  

Variable interest rate time deposits > $100M

   —       6,164     —       —       —       —       6,164     6,176

Average interest rate

   0.00 %   5.40 %   0.00 %   0.00 %   0.00 %   0.00 %   5.40 %  

Securities sold under repurchase agreements

   70,020     —       —       —       —       —       70,020     70,020

Average interest rate

   5.27 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   5.27 %  

Fixed Federal Home Loan Bank borrowings

   —       —       —       24,000     6,000     —       30,000     29,252

Average interest rate

   0.00 %   0.00 %   0.00 %   5.86 %   4.80 %   0.00 %   5.65 %  

Variable Federal Home Loan Bank borrowings

   5,000     —       —       —       —       25,000     30,000     29,994

Average interest rate

   5.44 %   0.00 %   0.00 %   0.00 %   0.00 %   4.85 %   4.95 %  

TT&L note borrowings

   1,000     —       —       —       —       —       1,000     1,000

Average interest rate

   4.62 %   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   4.62 %  

Subordinated debentures

   —       —       —       —       —       20,000     20,000     20,000

Average interest rate

   0.00 %   0.00 %   0.00 %   0.00 %   0.00 %   6.76 %   6.76 %  

 

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SOUTHEASTERN BANK FINANCIAL CORPORATION AND SUBSIDIARIES

Table of Contents

 

     Page

Reports of Independent Registered Public Accounting Firms

   C-31

Consolidated Balance Sheets

   C-32

Consolidated Statements of Income

   C-33

Consolidated Statements of Stockholders’ Equity and Comprehensive Income

   C-34

Consolidated Statements of Cash Flows

   C-36

Notes to Consolidated Financial Statements

   C-37

 

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