Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended June 30, 2009

or

 

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

Commission File Number: 001-16715

 

 

First Citizens BancShares, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   56-1528994

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

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

(919) 716-7000

(Registrant’s telephone number, including area code)

 

 

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

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

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

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

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

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

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

(Number of shares outstanding, by class, as of August 7, 2009)

 

 

 


Table of Contents

INDEX

 

         Page(s)
PART I. FINANCIAL INFORMATION   
Item 1.   Financial Statements (Unaudited)   
  Consolidated Balance Sheets at June 30, 2009, December 31, 2008 and June 30, 2008    3
  Consolidated Statements of Income for the three and six-month periods ended June 30, 2009, and June 30, 2008    4
  Consolidated Statements of Changes in Shareholders’ Equity for the six-month periods ended June 30, 2009, and June 30, 2008    5
  Consolidated Statements of Cash Flows for the six-month periods ended June 30, 2009, and June 30, 2008    6
  Notes to Consolidated Financial Statements    7-18
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    19-37
Item 3.   Quantitative and Qualitative Disclosures about Market Risk    38
Item 4.   Controls and Procedures    38
PART II. OTHER INFORMATION   
Item 1A.   Risk Factors    39-41
Item 4.   Submission of Matters to a Vote of Security Holders    42
Item 6.   Exhibits.    42

 

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Table of Contents

PART I

 

Item 1. Financial Statements (Unaudited)

Consolidated Balance Sheets

First Citizens BancShares, Inc. and Subsidiaries

 

     June 30
2009*
    December 31#
2008
    June 30
2008*
     (thousands, except share data)

Assets

      

Cash and due from banks

   $ 637,896      $ 593,375      $ 711,651

Overnight investments

     229,668        174,616        395,450

Investment securities available for sale

     3,745,385        3,219,980        2,966,296

Investment securities held to maturity

     4,140        5,873        6,957

Loans held for sale

     115,920        69,399        88,879

Loans and leases

     11,523,045        11,649,886        11,224,276

Less allowance for loan and lease losses

     162,282        157,569        144,533
                      

Net loans and leases

     11,360,763        11,492,317        11,079,743

Premises and equipment

     821,219        798,909        780,762

Other real estate owned

     33,301        29,956        12,750

Income earned not collected

     66,226        72,029        71,107

Goodwill

     102,625        102,625        102,625

Other intangible assets

     3,035        3,810        5,315

Other assets

     197,702        182,773        201,139
                      

Total assets

   $ 17,317,880      $ 16,745,662      $ 16,422,674
                      

Liabilities

      

Deposits:

      

Noninterest-bearing

   $ 2,974,494      $ 2,652,898      $ 2,668,207

Interest-bearing

     11,383,655        11,060,865        10,407,204
                      

Total deposits

     14,358,149        13,713,763        13,075,411

Short-term borrowings

     599,853        647,028        1,130,788

Long-term obligations

     735,803        733,132        609,277

Other liabilities

     189,862        208,364        119,916
                      

Total liabilities

     15,883,667        15,302,287        14,935,392

Shareholders’ Equity

      

Common stock:

      

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

     8,757        8,757        8,757

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

     1,678        1,678        1,678

Surplus

     143,766        143,766        143,766

Retained earnings

     1,334,655        1,326,054        1,299,346

Accumulated other comprehensive income (loss)

     (54,643     (36,880     33,735
                      

Total shareholders’ equity

     1,434,213        1,443,375        1,487,282
                      

Total liabilities and shareholders’ equity

   $ 17,317,880      $ 16,745,662      $ 16,422,674
                      

 

* Unaudited
# Derived from the 2008 Annual Report on Form 10-K.

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

Consolidated Statements of Income

First Citizens BancShares, Inc. and Subsidiaries

 

     Three months ended June 30    Six months ended June 30
     2009     2008    2009     2008
     (thousands, except share and per share data)

Interest income

         

Loans and leases

   $ 155,449      $ 167,145    $ 312,033      $ 344,309

Investment securities:

         

U. S. Government

     18,118        31,251      39,277        65,436

Mortgage-backed securities

     1,234        1,015      2,382        2,163

Corporate bonds

     1,580        —        1,858        —  

State, county and municipal

     104        53      155        106

Other

     164        251      371        525
                             

Total investment securities interest and dividend income

     21,200        32,570      44,043        68,230

Overnight investments

     192        2,285      417        6,366
                             

Total interest income

     176,841        202,000      356,493        418,905

Interest expense

         

Deposits

     48,890        64,857      101,836        144,116

Short-term borrowings

     1,281        3,859      2,602        12,040

Long-term obligations

     9,638        8,431      19,218        15,817
                             

Total interest expense

     59,809        77,147      123,656        171,973
                             

Net interest income

     117,032        124,853      232,837        246,932

Provision for credit losses

     20,759        13,363      39,482        23,278
                             

Net interest income after provision for credit losses

     96,273        111,490      193,355        223,654

Noninterest income

         

Cardholder and merchant services

     24,107        25,693      45,599        48,743

Service charges on deposit accounts

     19,163        21,034      37,014        41,015

Wealth management services

     11,481        12,746      22,253        25,928

Fees from processing services

     8,884        8,950      18,285        17,754

Securities (losses) gains

     (139     —        (139     8,051

Other service charges and fees

     4,068        4,382      8,417        8,472

Mortgage income

     2,369        1,750      5,821        3,740

Insurance commissions

     1,825        1,734      4,295        4,215

ATM income

     1,772        1,774      3,501        3,433

Other

     (366     1,537      (341     2,415
                             

Total noninterest income

     73,164        79,600      144,705        163,766

Noninterest expense

         

Salaries and wages

     63,751        63,627      129,297        126,412

Employee benefits

     15,773        13,016      33,092        31,199

Occupancy expense

     15,970        14,699      31,376        30,048

Equipment expense

     14,749        14,142      29,472        28,102

FDIC deposit insurance expense

     13,763        632      17,949        1,302

Foreclosure related expenses

     1,715        187      3,422        488

Other

     35,147        43,165      72,602        77,761
                             

Total noninterest expense

     160,868        149,468      317,210        295,312
                             

Income before income taxes

     8,569        41,622      20,850        92,108

Income taxes

     2,369        15,396      5,987        33,497
                             

Net income

   $ 6,200      $ 26,226    $ 14,863      $ 58,611
                             

Average shares outstanding

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

Net income per share

   $ 0.59      $ 2.51    $ 1.42      $ 5.62
                             

See accompanying Notes to Consolidated Financial Statements.

 

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Consolidated Statements of Changes in Shareholders’ Equity

First Citizens BancShares, Inc. and Subsidiaries

 

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

Balance at December 31, 2007

   $ 8,757    $ 1,678    $ 143,766    $ 1,246,473      $ 40,534      $ 1,441,208   

Comprehensive income:

               

Net income

     —        —        —        58,611        —          58,611   

Change in unrealized gains/losses on investment securities available for sale, net of $4,513 deferred tax benefit

     —        —        —        —          (6,998     (6,998

Unrealized gain on interest rate swap arising during period, net of $500 tax

     —        —        —        —          766        766   

Less reclassification adjustment for interest expense on interest rate swap included in net income, net of $370 tax

     —        —        —        —          (567     (567
                           

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

     —        —        —        —          199        199   
                           

Total comprehensive income

                  51,812   
                     

Cash dividends

     —        —        —        (5,738     —          (5,738
                                             

Balance at June 30, 2008

   $ 8,757    $ 1,678    $ 143,766    $ 1,299,346      $ 33,735      $ 1,487,282   
                                             

Balance at December 31, 2008

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

Comprehensive loss:

               

Net income

     —        —        —        14,863        —          14,863   

Change in unrealized gains/losses on investment securities available for sale, net of $13,108 deferred tax benefit

     —        —        —        —          (20,322     (20,322

Unrealized gain on interest rate swap arising during period, net of $2,591 tax

     —        —        —        —          3,971        3,971   

Less reclassification adjustment for interest expense on interest rate swap included in net income, net of $921 tax

     —        —        —        —          (1,412     (1,412
                           

Change in unrecognized loss on cash flow hedges, net of deferred tax

     —        —        —        —          2,559        2,559   
                           

Total comprehensive loss

                  (2,900
                     

Cash dividends

     —        —        —        (6,262     —          (6,262
                                             

Balance at June 30, 2009

   $ 8,757    $ 1,678    $ 143,766    $ 1,334,655      $ (54,643   $ 1,434,213   
                                             

See accompanying Notes to Consolidated Financial Statements.

At June 30, 2009, Accumulated Other Comprehensive Loss includes $25,069 in unrealized gains on investment securities available for sale, $75,815 in pension obligations recognized under FASB Statement No. 158, and an unrealized loss of $3,897 on cash flow hedges.

 

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Consolidated Statements of Cash Flows

First Citizens BancShares, Inc. and Subsidiaries

 

     Six months ended June 30,  
     2009     2008  
     (thousands)  

OPERATING ACTIVITIES

    

Net income

   $ 14,863      $ 58,611   

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

    

Amortization of intangibles

     869        1,027   

Provision for loan and lease losses

     39,482        23,278   

Deferred tax (benefit) expense

     8,589        (5,460

Change in current taxes payable

     (3,825     1,953   

Depreciation

     27,816        26,669   

Change in accrued interest payable

     8,884        (16,991

Change in income earned not collected

     5,803        8,236   

Securities losses (gains)

     139        (8,051

Origination of loans held for sale

     (483,656     (296,568

Proceeds from sale of loans

     442,659        286,238   

Gain on sale of loans

     (5,524     (3,366

Net amortization of premiums and discounts

     19,507        (1,164

Net change in other assets

     4,788        (10,103

Net change in pension and other liabilities

     (19,332     2,417   
                

Net cash provided by operating activities

     61,062        66,726   
                

INVESTING ACTIVITIES

    

Net (increase) decrease in loans outstanding

     71,765        (362,508

Purchases of investment securities available for sale

     (1,293,856     (745,977

Proceeds from maturities of investment securities held to maturity

     1,808        637   

Proceeds from maturities of investment securities available for sale

     715,300        966,448   

Net change in overnight investments

     (55,052     (129,241

Additions to premises and equipment

     (50,126     (49,737
                

Net cash used by investing activities

     (610,161     (320,378
                

FINANCING ACTIVITIES

    

Net change in time deposits

     (53,721     (221,195

Net change in demand and other interest-bearing deposits

     698,107        368,062   

Net change in short-term borrowings

     (47,501     (174,614

Origination of long-term obligations

     2,997        205,000   

Cash dividends paid

     (6,262     (5,738
                

Net cash provided by financing activities

     593,620        171,515   
                

Change in cash and due from banks

     44,521        (82,137

Cash and due from banks at beginning of period

     593,375        793,788   
                

Cash and due from banks at end of period

   $ 637,896      $ 711,651   
                

CASH PAYMENTS FOR:

    

Interest

   $ 114,772      $ 188,964   

Income taxes

     17,516        46,981   
                

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

    

Unrealized securities losses

   $ (33,430   $ (11,510

Unrealized gain on cash flow hedges

     4,229        329   

Transfers of loans to other real estate

     20,307        11,424   
                

See accompanying Notes to Consolidated Financial Statements.

 

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Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

Note A

Accounting Policies and Other Matters

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

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

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the 2008 First Citizens BancShares, Inc. Form 10-K. Certain amounts for prior periods have been reclassified to conform with statement presentations for 2009. However, the reclassifications have no effect on shareholders’ equity or net income as previously reported.

Current Accounting and Regulatory Issues

In March 2008, the FASB issued SFAS No. 161 Disclosures about Derivative Instruments and Hedging Activities (Statement 161). Statement 161 requires enhanced disclosures about how and why derivative instruments are used, how derivative instruments and related hedged items are accounted for under Statement 133 and how derivative instruments and related hedged items affect the balance sheet, income statement and statement of cash flows. Statement 161, which we adopted on January 1, 2009, resulted in expanded disclosures but had no material impact on financial condition, results of operations or liquidity.

Three FASB Staff Positions (FSPs) were effective June 30, 2009 for BancShares. FSP FAS 107-1 and APB 28-1 Interim Disclosures about Fair Value of Financial Instruments requires fair value disclosures about financial instruments in interim financial statements as well as disclosures about estimation methods and disclosure of changes in method from prior periods. FSP FAS 115-2 and FAS 124-2 Recognition and Presentation of Other-Than-Temporary Impairments (OTTI FSP) creates a new model for evaluating OTTI in debt securities. The OTTI FSP requires an entity to record an OTTI charge if it intends to sell a debt instrument or if it can not assert it is more likely than not that it will not have to sell the security before recovery. If the entity does not intend to sell the security but does not expect to recover the amortized cost basis, the amount of the impairment that results from issuer credit will be reported in earnings and the remaining impairment related to liquidity will be reflected in other comprehensive income. FSP FAS 157-4 Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly requires companies, as they are estimating fair values for assets and liabilities that are subject to fair value measurement, to consider various factors to determine whether there has been a significant decrease in the volume and level of activity compared to normal market activity and to consider whether an observed transaction was not orderly based on the weight of available evidence. Implementation of the three FSPs did not have a material impact on the consolidated financial statements but did result in expanded disclosures.

In May 2009, the FASB issued SFAS No. 165 Subsequent Events (Statement 165). Statement 165 addresses consideration of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. Statement 165 does not change the recording or recognition of subsequent events under generally accepted accounting principles but requires issuers to disclose the date through which subsequent events have been evaluated. For the financial statements and footnotes included in this Form 10-Q, subsequent events occurring prior to August 7, 2009 have been considered.

In June 2009, the FASB issued SFAS No. 166 Accounting for Transfers of Financial Assets (Statement 166) and SFAS No. 167 Amendments to FASB Interpretation No. 46(R) (Statement 167). Statement 166 removes the concept of a qualifying special-purpose entity and thereby compels the application of FASB Interpretation 46(R) by entities that were previously exempt due to their status as a qualified special-purpose entity. Statement 167 requires the evaluation of variable interests to determine whether a controlling financial interest exists. Upon the adoption of Statements 166 and 167 in 2010, the off balance sheet accounting treatment for the 2005 asset securitization of home equity loans will be discontinued, and the loans will be included on the consolidated balance sheet. The securitized loans totaled $98,043 as of June 30, 2009.

 

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In response to the challenges facing the financial services sector, several regulatory and governmental actions have been enacted including The Emergency Economic Stabilization Act, the TARP Capital Purchase Program and the Temporary Liquidity Guarantee Program (TLGP). Based on the expectation that our current capital levels will be adequate to sustain our growth for the foreseeable future, we did not apply to participate in the TARP Capital Purchase Program. Further, we waived the right to participate in the TLGP guarantee of unsecured debt. However, we did elect to participate in the TLGP’s enhanced deposit insurance program.

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

Note B

Investments

The aggregate values of investment securities at June 30 along with gains and losses determined on an individual security basis are as follows:

 

     Cost    Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value

Investment securities available for sale

           

June 30, 2009

           

U. S. Government

   $ 3,144,025    $ 27,447    $ 1,589    $ 3,169,883

Corporate bonds

     457,572      1,410      1,240      457,742

Residential mortgage-backed securities

     95,181      2,052      512      96,721

Equity securities

     2,862      12,071      336      14,597

State, county and municipal

     1,600      26      9      1,617

Other

     2,894      1,931      —        4,825
                           

Total investment securities available for sale

   $ 3,704,134    $ 44,937    $ 3,686    $ 3,745,385
                           

June 30, 2008

           

U. S. Government

   $ 2,836,558    $ 29,329    $ 7,808    $ 2,858,079

Residential mortgage-backed securities

     73,715      90      1,168      72,637

Equity securities

     3,558      21,678      41      25,195

State, county and municipal

     3,187      17      15      3,189

Other

     5,385      1,811         7,196
                           

Total investment securities available for sale

   $ 2,922,403    $ 52,925    $ 9,032    $ 2,966,296
                           

Investment securities held to maturity

           

June 30, 2009

           

Residential mortgage-backed securities

   $ 3,988    $ 266    $ 27    $ 4,227

State, county and municipal

     152      —        —        152
                           

Total investment securities held to maturity

   $ 4,140    $ 266    $ 27    $ 4,379
                           

June 30, 2008

           

Residential mortgage-backed securities

   $ 5,120    $ 128    $ 26    $ 5,222

State, county and municipal

     1,587      84      —        1,671

Other

     250      —        —        250
                           

Total investment securities held to maturity

   $ 6,957    $ 212    $ 26    $ 7,143
                           

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

 

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

 

     June 30, 2009    December 31, 2008    June 30, 2008
     Cost    Fair
Value
   Cost    Fair
Value
   Cost    Fair
Value

Investment securities available for sale

                 

Maturing in:

                 

One year or less

   $ 1,616,772    $ 1,630,131    $ 1,350,796    $ 1,375,709    $ 1,454,634    $ 1,470,675

One through five years

     1,986,438      1,999,122      1,705,774      1,739,791      1,382,535      1,388,018

Five through 10 years

     3,623      5,561      789      791      3,362      3,329

Over 10 years

     94,439      95,974      83,989      87,569      78,314      79,079

Equity securities

     2,862      14,597      3,950      16,120      3,558      25,195
                                         

Total investment securities available for sale

   $ 3,704,134    $ 3,745,385    $ 3,145,298    $ 3,219,980    $ 2,922,403    $ 2,966,296
                                         

Investment securities held to maturity

                 

Maturing in:

                 

One year or less

   $ —      $ —      $ 151    $ 151    $ 150    $ 152

One through five years

     152      152      —        —        250      250

Five through 10 years

     3,834      4,035      5,557      5,761      6,381      6,531

Over 10 years

     154      192      165      198      176      210
                                         

Total investment securities held to maturity

   $ 4,140    $ 4,379    $ 5,873    $ 6,110    $ 6,957    $ 7,143
                                         

The following table provides information regarding securities with unrealized losses as of June 30:

 

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

June 30, 2009

                 

Investment securities available for sale:

                 

U.S. Government

   $ 622,984    $ 1,589    $ —      $ —      $ 622,984    $ 1,589

Corporate bonds

     177,515      1,240      —        —        177,515      1,240

Residential mortgage-backed securities

     21,298      450      1,411      62      22,709      512

Equity securities

     485      336      —        —        485      336

State, county and municipal

     113      2      437      7      550      9
                                         

Total

   $ 822,395    $ 3,617    $ 1,848    $ 69    $ 824,243    $ 3,686
                                         

Investment securities held to maturity:

                 

Mortgage-backed securities

   $ —      $ —      $ 33    $ 27    $ 33    $ 27

June 30, 2008

                 

Investment securities available for sale:

                 

U.S. Government

   $ 704,076    $ 7,808    $ —      $ —      $ 704,076    $ 7,808

Equity securities

     643      41      —        —        643      41

Residential mortgage-backed securities

     45,132      646      13,927      522      59,059      1,168

State, county and municipal

     140      —        473      15      613      15
                                         

Total

   $ 749,991    $ 8,495    $ 14,400    $ 537    $ 764,391    $ 9,032
                                         

Investment securities held to maturity:

                 

Mortgage-backed securities

   $ —      $ —      $ 40    $ 26    $ 40    $ 26

 

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Table of Contents

Investment securities with an aggregate fair value of $1,914 have had continuous unrealized losses for more than twelve months as of June 30, 2009 with an aggregate unrealized loss of $123. These 26 investments include residential mortgage-backed and state, county and municipal securities. None of the unrealized losses identified as of June 30, 2009 related to the marketability of the securities or the issuer’s ability to honor redemption obligations. Consequently, the securities were not deemed to be other than temporarily impaired.

At June 30, 2009, there was no intent to sell any of the securities classified as available for sale. Furthermore, it is not more likely than not that BancShares will have to sell any such securities before a recovery of the carrying value. With respect to investment securities held to maturity, BancShares has the ability and intent to hold those securities until they mature.

At June 30, 2009, other assets includes $46,677 of Federal Home Loan Bank of Atlanta (FHLB Atlanta) stock compared to $45,797 at December 31, 2008 and $40,179 at June 30, 2008. The FHLB Atlanta stock, which is redeemable only through the issuer, is carried at its par value. The FHLB Atlanta discontinued payment of dividends in the fourth quarter of 2008 in response to concerns over continued volatility in the financial markets. The investment in the FHLB Atlanta stock is considered a long-term investment, and its value is based on the ultimate recoverability of par value. Management has concluded that the investment in FHLB Atlanta stock was not other-than-temporarily impaired as of June 30, 2009.

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

 

     Six months ended June 30,
     2009     2008

Gross gains on sales of investment securities available for sale

   $ —        $ 8,051

Other than temporary impairment loss on an equity investment

     (139     —  
              

Total securities gains (losses)

   $ (139   $ 8,051
              

During 2008, following the completion of Visa Inc.’s initial public offering, FCB’s former member-bank investment was converted into 486,905 shares of Class B common stock. Immediately thereafter, 188,238 shares of Visa Inc. Class B common stock were redeemed resulting in a gain of $8,051. The remaining 298,667 shares of Class B common stock are restricted and are carried at a fair value of $0.

Investment securities having an aggregate carrying value of $2,012,080 at June 30, 2009 and $2,282,908 at June 30, 2008, were pledged as collateral to secure public funds on deposit, to secure certain short-term borrowings and for other purposes as required by law.

Note C

Fair Value Disclosures

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

Because no market exists for many financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. For these financial instruments with a fixed interest rate, an analysis of the related cash flows was the basis for estimating fair values. The expected cash flows were then discounted to the valuation date using an appropriate discount rate. The discount rates used represent the rates under which similar transactions would be currently negotiated. For June 30, 2009, the fair value for loans, net of allowance for loan and lease losses included an adjustment of approximately 5 percent of gross loans to reflect the unfavorable liquidity conditions that existed in various financial markets. Generally, the fair value of variable rate financial instruments equals the book value.

 

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Table of Contents
     June 30, 2009    December 31, 2008    June 30, 2008
     Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value

Cash and due from banks

   $ 637,896    $ 637,896    $ 593,375    $ 593,375    $ 711,651    $ 711,651

Overnight investments

     229,668      229,668      174,616      174,616      395,450      395,450

Investment securities available for sale

     3,745,385      3,745,385      3,219,980      3,219,980      2,966,296      2,966,296

Investment securities held to maturity

     4,140      4,379      5,873      6,110      6,957      7,143

Loans held for sale

     115,920      115,920      69,399      69,399      88,879      88,879

Loans, net of allowance for loan and lease losses

     11,360,763      10,921,038      11,492,317      12,001,307      11,079,743      11,423,239

Income earned not collected

     66,226      66,226      72,029      72,029      71,107      71,107

Deposits

     14,358,149      14,435,457      13,713,763      13,810,690      13,075,411      13,135,698

Short-term borrowings

     599,853      599,853      647,028      647,028      1,130,788      1,130,788

Long-term obligations

     735,803      702,920      733,132      735,098      609,277      598,263

Accrued interest payable

     59,807      59,807      50,923      50,923      45,297      45,297

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

BancShares adopted the provisions of SFAS No. 157 Fair Value Measurements (Statement 157) and SFAS No. 159 The Fair Value Option for Financial Assets and Liabilities (Statement 159) on January 1, 2008. Statement 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. Statement 157 does not require any new fair value measurements, but clarifies and standardizes some divergent practices that have emerged since prior guidance was issued. Statement 157 creates a three-level hierarchy under which individual fair value estimates are to be ranked based on the relative reliability of the inputs used in the valuation. Statement 159 allows an entity to elect to measure certain financial assets and liabilities at fair value with changes in fair value recognized in the income statement each period. The statement also requires additional disclosures to identify the effects of an entity’s fair value election on its earnings. Upon the adoption of Statement 159, BancShares did not elect to report any assets and liabilities at fair value.

Statement 157 defines fair value as the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, BancShares considers the principal or most advantageous market in which those assets or liabilities are sold and considers assumptions that market participants would use when pricing those assets or liabilities. Fair values determined using level 1 inputs rely on active and observable markets to price identical assets or liabilities. In situations where identical assets and liabilities are not traded in active markets, fair values may be determined based on level 2 inputs, which exist when observable data exists for similar assets and liabilities. Fair values for assets and liabilities that are not actively traded in observable markets are based on level 3 inputs, which are considered to be unobservable.

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

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

 

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          Fair value measurements using:

Description

   Fair value    Quoted prices in
active markets for
identical assets and
liabilities
(Level 1 inputs)
   Quoted prices for
similar assets and
liabilities
(Level 2 inputs)
   Significant
unobservable inputs
(Level 3 inputs)

June 30, 2009

           

Assets measured at fair value

           

Investment securities available for sale

           

U.S. Government

   $ 3,169,883    $ 3,169,883    $ —      $ —  

Corporate bonds

     457,742      457,742      —        —  

Residential mortgage-backed securities

     96,721      —        96,721      —  

Equity securities

     14,597      14,597      —        —  

State, county, municipal

     1,617      —        1,617      —  

Other

     4,825      —        —        4,825
                           

Total

   $ 3,745,385    $ 3,642,222    $ 98,338    $ 4,825
                           

Liabilities measured at fair value

           

Interest rate swaps accounted for as cash flow hedges

     6,440      —        6,440      —  

December 31, 2008

           

Assets measured at fair value

           

Investment securities available for sale

           

U.S. Government

   $ 3,112,428    $ 3,112,428    $ —      $ —  

Residential mortgage-backed securities

     82,952      —        82,952      —  

Equity securities

     16,120      16,120      —        —  

State, county, municipal

     3,053      —        3,053      —  

Other

     5,427      —        —        5,427
                           

Total

   $ 3,219,980    $ 3,128,548    $ 86,005    $ 5,427
                           

Liabilities measured at fair value

           

Interest rate swap accounted for as cash flow hedges

     10,668      —        10,668      —  

Prices for US Government securities and corporate bonds are readily available in the active markets in which those securities are traded, and the resulting fair values are shown in the ‘Level 1 input’ column. Prices for residential mortgage-backed securities and for state, county and municipal securities are obtained using the fair values of similar securities, and the resulting fair values are shown in the ‘Level 2 input’ column. Prices for all other securities, which include a residual interest that was retained from a securitization transaction, are determined based on various assumptions that are not observable. The fair values for these investment securities are shown in the ‘Level 3 input’ column. With respect to the residual interest in the asset securitization, the assumed prepayment speed, discount rate and credit spread are not observable in the market due to illiquidity and the uniqueness of the underlying assets.

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

 

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For those investment securities available for sale with fair values that are determined by reliance on significant unobservable inputs, the following table identifies the factors causing the change in fair value during the first six months of 2009 and 2008:

 

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

Description

   2009     2008  

Beginning balance, January 1,

   $ 5,427      $ 9,924   

Total gains (losses), realized or unrealized:

    

Included in earnings

     —          —     

Included in other comprehensive income

     195        192   

Purchases, sales, issuances and settlements, net

     (797     (2,920

Transfers in/out of Level 3

     —          —     
                

Ending balance, June 30

   $ 4,825      $ 7,196   
                

No gains or losses were reported for the six-month periods ended June 30, 2009 and 2008 that relate to fair values estimated based on unobservable inputs.

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

 

     Fair value    Fair value measurements using:

Description

      Quoted prices in
active markets for
identical assets and
liabilities
(Level 1 inputs)
   Quoted prices for
similar assets and
liabilities
(Level 2 inputs)
   Significant
unobservable inputs
(Level 3 inputs)

June 30, 2009

           

Loans held for sale

   $ 39,997    $ —      $ —      $ 39,997

Impaired loans

     18,624      —        —        18,624

December 31, 2008

           

Loans held for sale

     69,399      —        —        69,399

Impaired loans

     27,858      —        —        27,858

The values of loans held for sale are based on prices observed for similar pools of loans. The values of impaired loans are determined by either the collateral value or by the discounted present value of the expected cash flows.

Certain non-financial assets and non-financial liabilities are measured at fair value on a nonrecurring basis. Other assets includes certain foreclosed assets that are measured and reported at fair value using Level 2 inputs for observable market data or, if needed, Level 3 inputs for valuations based on non-observable criteria. During the six month period ended June 30, 2009, foreclosures of other real estate totaled $20,307, all of which was valued using Level 3 inputs. In connection with the measurement and initial recognition of foreclosed assets, BancShares recognized charge-offs totaling $8,294. Based on updates to Level 3 inputs, foreclosed property with a fair value of $5,188 as of June 30, 2009 incurred write-downs that totaled $729 during the six-month period ended June 30, 2009.

 

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Table of Contents

At June 30, 2009, impaired loans, which include commercial purpose nonaccrual loans and troubled debt restructurings, totaled $35.1 million. Allowances for impaired loans represent the difference between the impaired loans’ carrying value and the estimated collateral value or the present value of anticipated cash flows. At June 30, 2009, $24.3 million of impaired loans required allowances of $5.7 million to adjust the loans to their fair value of $18.6 million. The remaining $10.8 million of impaired loans did not require allowances based on underlying collateral values. The calculation of allowance for impaired loans is highly dependent on collateral valuations. Since all impaired loans at June 30, 2009 are secured by real estate, fair values are based on appraised values with adjustments for various factors including estimated holding costs. Given the significant instability in real estate markets, particularly in the Atlanta, Georgia area and in Southwest Florida, the valuations are subject to significant variation based on further reductions or recoveries of property values.

Note D

Employee Benefit Plans

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

 

     Three month periods ended June 30,     Six month periods ended June 30,  
     2009     2008     2009     2008  

Service cost

   $ 3,669      $ 630      $ 6,282      $ 6,087   

Interest cost

     6,584        1,473        10,867        10,560   

Expected return on assets

     (8,584     (1,327     (13,751     (14,302

Amortization of prior service cost

     63        12        104        109   

Amortization of net actuarial loss

     1,075        503        1,788        503   
                                

Total pension expense

   $ 2,807      $ 1,291      $ 5,290      $ 2,957   
                                

The increase in pension expense during 2009 resulted from a change in the assumed discount rate used to estimate benefit obligations, a reduction in the expected rate of return on plan assets and an increase in the estimated future rate of salary increases. The assumed discount rate for 2009 is 6.00 percent, the expected long-term rate of return on plan assets is 8.00 percent and the assumed rate of salary increases is 4.50 percent.

During the first quarter of 2009, BancShares contributed $35,000 to the defined benefit plan.

Note E

Contingencies

On May 24, 2004, FCB filed a lawsuit in the Circuit Court of Greenbrier County, West Virginia against a customer alleging default under a master lease on a piece of equipment, eight promissory notes and two leases. The borrower asserted a counterclaim against FCB alleging breach of lease, breach of fiduciary duty, breach of duty of good faith and fair dealing, and tortuous interference with contractual relations. At trial, a jury returned a verdict against FCB and awarded a $4,125 judgment in favor of FCB’s customer. If the jury verdict stands, the customer will be entitled to pre-judgment interest of approximately $1,000 and post-judgment interest at a rate of 8.25 percent. FCB filed a motion to set aside the judgment or, in the alternative, for a new trial, but the Court denied FCB’s motion. FCB is appealing the Court’s action to the West Virginia Supreme Court of Appeals. FCB has posted an acceptable bond and execution of the judgment is stayed pending the outcome of the appeal. FCB strenuously denies liability and is vigorously pursuing appeal of the jury’s award.

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

 

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Table of Contents

Note F

Derivatives

At June 30, 2009, BancShares had two interest rate swaps that qualify as cash flow hedges under Statement of Financial Accounting Standards No. 133 Accounting for Derivative Instruments and Hedging Activities and Statement of Financial Accounting Standards No. 161 Disclosures about Derivative Instruments and Hedging Activities – an Amendment of FASB Statement No. 133. The fair values of these derivatives are included in other liabilities in the consolidated balance sheets and in the net change in other liabilities in the consolidated statements of cash flows.

The interest rate swaps are used for interest rate risk management purposes and convert variable-rate exposure on outstanding debt to a fixed rate. The interest rate swaps each have a notional amount of $115,000, representing the amount of variable-rate trust preferred capital securities issued during 2006. The 2006 interest rate swap hedges interest payments through June 2011 and requires fixed-rate payments by BancShares at 7.125 percent in exchange for variable-rate payments of 175 basis points above 3-month LIBOR, which is equal to the interest paid to the holders of the trust preferred capital securities. The 2009 interest rate swap hedges interest payments from July 2011 through June 2016 and requires fixed-rate payments by BancShares at 5.50 percent in exchange for variable-rate payments of 175 basis points above 3-month LIBOR. As of June 30, 2009, collateral with a fair value of $9,211 was pledged to secure the existing obligation under the interest rate swaps. For both swaps, settlement occurs quarterly.

 

     June 30, 2009     December 31, 2008
     Notional amount    Estimated fair value
of (asset) liability
    Notional amount    Estimated fair
value of liability

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

   $ 115,000    $ 8,792      $ 115,000    $ 10,668

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

     115,000      (2,352     —        —  
                    
      $ 6,440         $ 10,668
                    

For cash flow hedges, the effective portion of the gain or loss due to changes in the fair value of the derivative hedging instrument is included in other comprehensive income, while the ineffective portion, representing the excess of the cumulative change in the fair value of the derivative over the cumulative change in expected future discounted cash flows on the hedged transaction, is recorded in the consolidated income statement. BancShares’ interest rate swaps have been fully effective since inception. Therefore, changes in the fair value of the interest rate swaps have had no impact on net income. For the six-month periods ended June 30, 2009 and 2008, BancShares recognized interest expense of $2,338 and $937, respectively, resulting from the interest rate swaps, none of which relates to ineffectiveness.

The following table discloses activity in accumulated other comprehensive income related to the interest rate swaps during the six-month periods ended June 30, 2009 and 2008.

 

     2009     2008  

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

   $ (6,456   $ (3,240

Other comprehensive income recognized during six-month period ended June 30

     2,559        199   
                

Accumulated other comprehensive loss resulting from interest rate swaps as of June 30

   $ (3,897   $ (3,041
                

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

 

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Table of Contents

Note G

Segment Disclosures

BancShares conducts its banking operations through its two wholly-owned subsidiaries, FCB and ISB. FCB and ISB offer similar products and services to customers through operations conducted under separate charters. A substantial portion of our revenue is derived from our operations in North Carolina, Virginia, Georgia, Florida, California and Texas. The financial results and trends of ISB reflect the impact of the de novo nature of its growth.

In the aggregate, FCB and its consolidated subsidiaries, which are integral to its branch operation, and ISB account for more than 90 percent of consolidated assets, revenues and net income. Other includes activities of the parent company and Neuse, Incorporated (Neuse), a subsidiary that owns real property. During the second quarter of 2009 Neuse purchased from ISB foreclosed properties that had a carrying value of $7,801. This transaction will benefit ISB by reducing problem assets and improving certain operating ratios. To facilitate the potential purchase of additional foreclosed property in the future, ISB has agreed to lend Neuse up to $20,000 under a revolving line of credit.

The adjustments in the accompanying tables represent the elimination of the impact of certain inter-company transactions. The adjustments to interest income and interest expense neutralize the earnings and cost of inter-company borrowings. The adjustments to noninterest income and noninterest expense reflect the elimination of certain fees paid by one company to another within BancShares’ consolidated group. The adjustments to noninterest income and noninterest expense for six-month periods ended June 30, 2009 and 2008, include $4,570 and $4,770, respectively, paid by ISB to FCB for management fees and various other services including data and check processing.

 

     ISB    FCB    Other    Total    Adjustments     Consolidated

June 30, 2009

                

Total assets

   $ 2,654,534    $ 14,601,756    $ 2,181,110    $ 19,437,400    $ (2,119,520   $ 17,317,880

Loans and leases

     2,154,136      9,368,909      —        11,523,045      —          11,523,045

Allowance for loan and lease losses

     38,425      123,857      —        162,282      —          162,282

Goodwill

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

Nonperforming assets

     61,246      33,364      7,801      102,411      —          102,411

Deposits

     2,050,384      12,334,886      —        14,385,270      (27,121     14,358,149

December 31, 2008

                

Total assets

   $ 2,563,950    $ 13,879,815    $ 2,174,079    $ 18,617,844    $ (1,872,182   $ 16,745,662

Loans and leases

     2,208,024      9,441,862      —        11,649,886      —          11,649,886

Allowance for loan and lease losses

     37,335      120,234      —        157,569      —          157,569

Goodwill

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

Nonperforming assets

     46,755      24,911      —        71,666      —          71,666

Deposits

     1,970,795      11,782,062      —        13,752,857      (39,094     13,713,763

June 30, 2008

                

Total assets

   $ 2,651,340    $ 13,535,501    $ 2,605,523    $ 18,792,364    $ (2,369,690   $ 16,422,674

Loans and leases

     2,160,843      9,063,433      —        11,224,276      —          11,224,276

Allowance for loan and lease losses

     28,341      116,192      —        144,533      —          144,533

Goodwill

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

Nonperforming assets

     36,005      11,279      —        47,284      —          47,284

Deposits

     2,065,989      11,059,080      —        13,125,069      (49,658     13,075,411

 

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Table of Contents
     ISB     FCB    Other     Total    Adjustments     Consolidated

Three months ended June 30, 2009

              

Interest income

   $ 32,461      $ 143,061    $ 1,454      $ 176,976    $ (135   $ 176,841

Interest expense

     13,484        40,844      5,616        59,944      (135     59,809
                                            

Net interest income

     18,977        102,217      (4,162     117,032      —          117,032

Provision for loan and lease losses

     10,064        10,695      —          20,759      —          20,759
                                            

Net interest income after provision for loan and lease losses

     8,913        91,522      (4,162     96,273      —          96,273

Noninterest income

     3,318        72,891      (545     75,664      (2,500     73,164

Noninterest expense

     23,181        139,675      512        163,368      (2,500     160,868
                                            

Income (loss) before income taxes

     (10,950     24,738      (5,219     8,569      —          8,569

Income taxes

     (3,886     8,078      (1,823     2,369      —          2,369
                                            

Net income (loss)

   $ (7,064   $ 16,660    $ (3,396   $ 6,200    $ —        $ 6,200
                                            

Three months ended June 30, 2008

              

Interest income

   $ 34,446      $ 165,261    $ 5,938      $ 205,645    $ (3,645   $ 202,000

Interest expense

     18,705        54,194      7,893        80,792      (3,645     77,147
                                            

Net interest income

     15,741        111,067      (1,955     124,853      —          124,853

Provision for loan and lease losses

     5,959        7,404      —          13,363      —          13,363
                                            

Net interest income after provision for loan and lease losses

     9,782        103,663      (1,955     111,490      —          111,490

Noninterest income

     3,280        78,555      509        82,344      (2,744     79,600

Noninterest expense

     21,252        130,397      563        152,212      (2,744     149,468
                                            

Income (loss) before income taxes

     (8,190     51,821      (2,009     41,622      —          41,622

Income taxes

     (2,225     18,321      (700     15,396      —          15,396
                                            

Net income (loss)

   $ (5,965   $ 33,500    $ (1,309   $ 26,226    $ —        $ 26,226
                                            
     ISB     FCB    Other     Total    Adjustments     Consolidated

Six months ended June 30, 2009

              

Interest income

   $ 65,125      $ 288,041    $ 3,630      $ 356,796    $ (303   $ 356,493

Interest expense

     28,620        83,983      11,356        123,959      (303     123,656
                                            

Net interest income

     36,505        204,058      (7,726     232,837      —          232,837

Provision for loan and lease losses

     19,141        20,341      —          39,482      —          39,482
                                            

Net interest income after provision for loan and lease losses

     17,364        183,717      (7,726     193,355      —          193,355

Noninterest income

     6,537        143,811      (546     149,802      (5,097     144,705

Noninterest expense

     45,308        276,027      972        322,307      (5,097     317,210
                                            

Income (loss) before income taxes

     (21,407     51,501      (9,244     20,850      —          20,850

Income taxes

     (7,655     16,878      (3,236     5,987      —          5,987
                                            

Net income (loss)

   $ (13,752   $ 34,623    $ (6,008   $ 14,863    $ —        $ 14,863
                                            

Six months ended June 30, 2008

              

Interest income

   $ 70,206      $ 343,850    $ 14,348      $ 428,404    $ (9,499   $ 418,905

Interest expense

     38,707        123,781      18,984        181,472      (9,499     171,973
                                            

Net interest income

     31,499        220,069      (4,636     246,932      —          246,932

Provision for loan and lease losses

     11,472        11,806      —          23,278      —          23,278
                                            

Net interest income after provision for loan and lease losses

     20,027        208,263      (4,636     223,654      —          223,654

Noninterest income

     6,552        162,103      508        169,163      (5,397     163,766

Noninterest expense

     42,113        257,409      1,187        300,709      (5,397     295,312
                                            

Income (loss) before income taxes

     (15,534     112,957      (5,315     92,108      —          92,108

Income taxes

     (4,988     40,339      (1,854     33,497      —          33,497
                                            

Net income (loss)

   $ (10,546   $ 72,618    $ (3,461   $ 58,611    $ —        $ 58,611
                                            

 

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Note H

Subsequent Events

On July 17, 2009, FCB entered into a Purchase and Assumption Agreement (TVB Agreement) with the Federal Deposit Insurance Corporation (FDIC) to purchase substantially all the assets and assume the majority of the liabilities of Temecula Valley Bank (TVB) of Temecula, California. Immediately prior to the effectiveness of the TVB Agreement, the FDIC had seized TVB.

In its call report dated March 31, 2009, TVB reported:

 

Total assets

   $ 1,492,407

Loans and leases

     1,100,434

Deposits (includes $237,298 of brokered deposits)

     1,333,053

Nonaccrual loans

     146,628

Other real estate

     35,660

During the third quarter of 2009, FCB will record the purchased assets and assumed liabilities at fair value. Under the terms of the TVB Agreement, FCB has the option to purchase any owned bank premises or to assume the leases on any or all of the banking offices. Except for brokered deposits that were retained by the FDIC, FCB assumed all of the deposit liabilities of TVB.

Loans, other real estate owned by TVB and purchased by FCB, and reimbursable expenses incurred by FCB are subject to loss share agreements that allocate prospective losses between FCB and the FDIC.

The following table provides additional information regarding the loss share agreements:

 

Range of losses incurred on loans, other real estate and reimbursable expenses

   FDIC absorbs     FCB absorbs  

< $193,000

   —        100

$193,000 - $464,000

   80   20

> $464,000

   95   5

Due to substantial effort required to estimate the fair values of the assets purchased and liabilities assumed, the contingencies resulting from the acquisition, and various other calculations, the accounting for the TVB acquisition is not complete at the time the accompanying financial statements are filed. Until the fair values are established, any gain to be recognized during the third quarter of 2009 resulting from the TVB acquisition can not be calculated.

The TVB Agreement only covers the assets and liabilities of TVB. Neither the assets, liabilities nor the common stock of TVB’s former parent company, Temecula Valley Bancorp Inc., were purchased or assumed by FCB.

For the financial statements and footnotes included in this Form 10-Q, subsequent events occurring prior to August 7, 2009 have been considered.

 

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

INTRODUCTION

Management’s discussion and analysis of earnings and related financial data are presented to assist in understanding the financial condition and results of operations of First Citizens BancShares, Inc. and Subsidiaries (BancShares). This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and related notes presented within this report. Intercompany accounts and transactions have been eliminated. Although certain amounts for prior years have been reclassified to conform to statement presentations for 2009, the reclassifications have no effect on shareholders’ equity or net income as previously reported.

OVERVIEW

BancShares is a financial holding company with two wholly owned banking subsidiaries: First-Citizens Bank & Trust Company (FCB), a North Carolina-chartered bank, and IronStone Bank (ISB), a federally-chartered thrift institution. FCB operates branches in North Carolina, Virginia, West Virginia, Maryland, Tennessee and California. ISB operates in Georgia, Florida, Texas, New Mexico, Arizona, California, Oregon, Washington, Colorado, Oklahoma, Missouri and Kansas. FCB and ISB offer similar banking products and services to customers through branch operations under separate charters. Each entity operates in different geographic markets, except in southern California, where ISB and FCB both operate since FCB’s third quarter 2009 acquisition discussed below. ISB has maintained a focus on providing products and services to commercial and business customers, while FCB has a broader customer base, including commercial and retail relationships. FCB offers a wide array of wealth management services through its trust department and a wholly-owned broker-dealer subsidiary. The financial results and trends of ISB reflect the impact of the de-novo nature of its growth.

On July 17, 2009, FCB entered into a Purchase and Assumption Agreement (TVB Agreement) with the Federal Deposit Insurance Corporation (FDIC) to purchase substantially all the assets and assume the majority of the liabilities of Temecula Valley Bank (TVB) of Temecula, California. Immediately prior to the effectiveness of the TVB Agreement, the FDIC had seized TVB. At March 31, 2009, TVB reported total assets of $1.5 billion, loans of $1.1 billion and deposits of $1.3 billion. TVB also reported nonaccrual loans totaling $146.6 million and other real estate owned totaling $35.7 million.

During the third quarter of 2009, the purchased assets and assumed liabilities will be recorded at fair value. Loans and other real estate owned by TVB and purchased by FCB are subject to a loss share agreement that allocates prospective losses between FCB and the FDIC. Under the terms of the TVB Agreement, FCB has the option to purchase any owned bank premises or to assume the leases on any or all of the banking offices. Except for brokered deposits that were retained by the FDIC, FCB assumed all of the deposit liabilities of TVB.

The TVB Agreement only covers the assets and liabilities of TVB. Neither the assets, liabilities nor the common stock of TVB’s former parent company, Temecula Valley Bancorp Inc., were purchased or assumed by FCB.

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

Various external factors influence customer demand for our loan, lease and deposit products. In an effort to stimulate and control the rate of growth of economic activity, monetary actions by the Federal Reserve are significant to the interest rate environment in which we operate. At any point in time, both the existing level and anticipated movement of interest rates have a material impact on customer demand for our products, our pricing of those products and on our profitability.

 

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In addition to the interest rate environment, the general strength of the economy influences the demand for as well as the quality and collectibility of our loan and lease portfolio. External economic indicators such as consumer bankruptcy rates and business debt service capacity closely follow trends in the economic cycle.

Although we are unable to control the external factors that influence our business, through the utilization of various liquidity, interest rate and credit risk management tools, we seek to minimize the potentially adverse risks of unforeseen and potentially unfavorable economic trends and take advantage of favorable economic conditions when appropriate.

Financial institutions frequently focus their strategic and operating emphasis on maximizing profitability and therefore measure their relative success by reference to profitability measures such as return on average assets or return on average shareholders’ equity. BancShares’ profitability measures have historically compared unfavorably to the returns of similar-sized financial holding companies. Instead, we place primary emphasis upon asset quality, balance sheet liquidity and capital conservation, even when those priorities may be detrimental to short-term profitability.

Based on our organization’s strengths and competitive position within the financial services industry, we believe opportunities for significant growth and expansion exist. We operate in diverse and growing geographic markets and believe that through competitive products and superior customer service, we can increase our business volumes and profitability. In recent years, we have focused our efforts on businesses owners, medical and other professionals and financially active individuals.

We seek to increase fee income within our key business units including cardholder and merchant services, insurance, treasury services, wealth management and other private banking services. We also remain focused on opportunities to generate income by providing various processing services to other banks.

We attempt to mitigate certain of the risks that can endanger our profitability and growth prospects. While we are attentive to all areas of risk, economic factors are uniquely problematic due to the lack of control and the potential material impact upon our financial results. Specific economic risks include recession, rapid movements in interest rates, changes in the yield curve and significant shifts in inflation expectations.

As a result of costs arising from recent and projected failures of insured banks, the reserve level of the Federal Deposit Insurance Corporation’s (FDIC) Deposit Insurance Fund (DIF) has declined to less than the amount mandated by the Federal Deposit Insurance Reform Act of 2005. The FDIC has a legally-imposed duty to adopt a plan to restore the DIF to a specific level, and as a result increased deposit insurance rates and imposed a special assessment on all insured banks during the second quarter of 2009. The special assessment for BancShares totaled $7.8 million. Additional special assessments and further increases in FDIC insurance premiums could have a material negative impact upon our earnings.

PERFORMANCE SUMMARY

Weak economic conditions in our principal market areas have continued to have an adverse impact on our financial condition and results of operations through soft demand for our loan products, reduced noninterest income, a tighter net yield on interest-earning assets and provisions for credit costs. In various markets and throughout the country, unfavorable measures such as increased unemployment, falling real estate prices and increased default and bankruptcy rates demonstrate the difficult business conditions affecting the general economy.

BancShares’ earnings declined during the second quarter of 2009 compared to the second quarter of 2008. Consolidated net income during the second quarter of 2009 equaled $6.2 million, compared to $26.2 million earned during the corresponding period of 2008. The annualized return on average assets was 0.14 percent during the second quarter of 2009, compared to 0.64 percent during the same period of 2008. The annualized return on average equity was 1.73 percent during 2009, compared to 7.11 percent during the same period of 2008. Net income per share during the second quarter of 2009 totaled $0.59, compared to $2.51 during the second quarter of 2008. The $20.0 million or 76.4 percent earnings decrease resulted from a significant increase in noninterest expense, higher provision for loan and lease losses and lower revenues.

 

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Financial Summary    Table 1

 

     2009     2008     Six Months Ended June 30  
     Second
Quarter
   First
Quarter
    Fourth
Quarter
    Third
Quarter
    Second
Quarter
    2009     2008  
     (thousands, except share data and ratios)              

Summary of Operations

               

Interest income

   $ 176,841    $ 179,652      $ 195,366      $ 199,080      $ 202,000      $ 356,493      $ 418,905   

Interest expense

     59,809      63,847        71,211        71,761        77,147        123,656        171,973   
                                                       

Net interest income

     117,032      115,805        124,155        127,319        124,853        232,837        246,932   

Provision for credit losses

     20,759      18,723        22,142        20,195        13,350        39,482        23,278   
                                                       

Net interest income after provision for credit losses

     96,273      97,082        102,013        107,124        111,503        193,355        223,654   

Noninterest income

     73,164      71,541        72,182        77,536        79,600        144,705        163,766   

Noninterest expense

     160,868      156,342        155,800        155,559        149,481        317,210        295,312   
                                                       

Income before income taxes

     8,569      12,281        18,395        29,101        41,622        20,850        92,108   

Income taxes

     2,369      3,618        5,502        9,547        15,396        5,987        33,497   
                                                       

Net income

   $ 6,200    $ 8,663      $ 12,893      $ 19,554      $ 26,226      $ 14,863      $ 58,611   
                                                       

Net interest income-taxable equivalent

   $ 118,350    $ 117,225      $ 125,779      $ 128,872      $ 126,568      $ 235,575      $ 251,573   
                                                       

Per Share of Stock

               

Net income

   $ 0.59    $ 0.83      $ 1.24      $ 1.87      $ 2.51      $ 1.42      $ 5.62   

Cash dividends

     0.300      0.300        0.275        0.275        0.275        0.600        0.550   

Market price at period end (Class A)

     133.65      131.80        152.80        179.00        139.49        133.65        139.49   

Book value at period end

     137.45      137.65        138.33        144.17        142.54        137.45        142.54   

Tangible book value at period end

     127.32      127.48        128.13        133.92        132.24        127.32        132.24   
                                                       

Selected Quarterly Averages

               

Total assets

   $ 17,309,656    $ 16,945,383      $ 16,741,696      $ 16,377,570      $ 16,396,288      $ 17,128,427      $ 16,354,991   

Investment securities

     3,578,604      3,246,899        3,147,906        2,956,398        3,197,849        3,413,655        3,171,148   

Loans and leases

     11,621,450      11,659,873        11,665,522        11,440,563        11,154,400        11,640,555        11,058,053   

Interest-earning assets

     15,725,319      15,373,383        15,247,645        14,772,491        14,801,252        15,550,310        14,726,602   

Deposits

     14,316,103      13,897,701        13,544,762        13,003,821        12,969,423        14,107,973        12,940,377   

Interest-bearing liabilities

     12,840,612      12,596,452        12,471,757        12,187,085        12,281,649        12,719,207        12,295,390   

Long-term obligations

     734,042      733,087        730,360        613,046        609,301        733,567        542,516   

Shareholders’ equity

   $ 1,433,427    $ 1,438,109      $ 1,497,619      $ 1,496,573      $ 1,484,143      $ 1,435,695      $ 1,473,741   

Shares outstanding

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

Selected Quarter-End Balances

               

Total assets

   $ 17,317,880    $ 17,214,265      $ 16,745,662      $ 16,665,605      $ 16,422,674      $ 17,317,880      $ 16,422,674   

Investment securities

     3,749,525      3,324,770        3,225,853        2,935,593        2,973,253        3,749,525        2,973,253   

Loans and leases

     11,638,965      11,497,079        11,649,886        11,563,711        11,224,276        11,638,965        11,224,276   

Interest-earning assets

     15,618,157      15,706,732        15,119,754        14,891,934        14,681,858        15,618,157        14,681,858   

Deposits

     14,358,149      14,229,548        13,713,763        13,372,468        13,075,411        14,358,149        13,075,411   

Interest-bearing liabilities

     12,719,311      12,827,449        12,441,025        12,383,450        12,147,269        12,719,311        12,147,269   

Long-term obligations

     735,803      733,056        733,132        649,214        609,277        735,803        609,277   

Shareholders’ equity

   $ 1,434,213    $ 1,436,277      $ 1,443,375      $ 1,504,334      $ 1,487,282      $ 1,434,213      $ 1,487,282   

Shares outstanding

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

Selected Ratios and other data

               

Rate of return on average assets

     0.14      %0.21     0.31     0.64     0.64     0.18     0.72

Rate of return on average shareholders’ equity

     1.73      2.44        3.43        7.11        7.11        2.09        8.00   

Net yield on interest-earning assets

               

(taxable equivalent)

     3.01      3.09        3.28        3.47        3.44        3.05        3.43   

Allowance for loan and lease losses to to total loans and leases at period end

     1.41      1.39        1.35        1.32        1.28        1.41        1.28   

Nonperforming assets to total loans and leases plus other real estate at period end

     0.89      0.86        0.61        0.53        0.42        0.89        0.42   

Tier 1 risk-based capital ratio

     13.30      13.29        13.20        13.01        13.14        13.30        13.14   

Total risk-based capital ratio

     15.59      15.57        15.49        15.33        15.48        15.59        15.48   

Leverage capital ratio

     9.68      9.83        9.88        10.01        9.89        9.68        9.89   

Dividend payout ratio

     50.85      36.14        22.18        14.71        10.96        42.25        9.79   

Average loans and leases to average deposits

     81.18      83.90     86.13     87.98     86.01     82.51     85.45
                                                       

 

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For the first six months of 2009, BancShares recorded net income of $14.9 million, compared to $58.6 million earned during the first six months of 2008. The $43.7 million or 74.6 percent decrease was attributable to higher provision for loan and lease losses and noninterest expense and reduced revenues. Net income per share for the first six months of 2009 amounted to $1.42, compared to $5.62 during the same period of 2008. On an annualized basis, BancShares returned 0.18 percent on average assets during the first six months of 2009, compared to 0.72 percent from the corresponding period of 2008. Annualized return on average equity for the first six months of 2009 was 2.09 percent, down from 8.00 percent during the same period of 2008.

FDIC insurance expense has increased materially compared to the comparable periods of 2008, up $13.1 million during the second quarter of 2009 versus the second quarter of 2008 and $16.6 million on a year-to-date basis.

When compared to the first quarter of 2009, average loans and leases declined slightly during the second quarter due to soft economic conditions and customer desire to reduce outstanding debt obligations. Average deposits increased at a healthy pace during the second quarter, up $418.4 million or 3.0 percent. The strong deposit growth allowed the investment securities portfolio to increase by $331.7 million, or 10.2 percent, providing additional balance sheet liquidity.

Asset quality measurements weakened during the second quarter as net charge-offs increased to $20.8 million compared to $14.0 million the previous quarter. Net charge-offs as a percentage of average loans for the second quarter of 2009 equaled 0.73 percent. The allowance for loan and lease losses was up slightly from March 31, 2009 to $162.3 million, representing 1.41 percent of total loans and leases as of June 30, 2009. Nonperforming assets equaled $102.4 million at June 30, 2009, up $3.6 million or 3.6 percent from March 31, 2009. Continuing weakness in residential real estate markets, primarily in our Atlanta and southwest Florida markets, account for the majority of the increase in our net-charge offs and nonperforming assets.

The decline in residential real estate prices has adversely affected our financial results, primarily due to higher losses and costs arising from residential construction loans in the Atlanta, Georgia and southwest Florida markets. We have also observed higher delinquencies and losses in our revolving mortgage loan portfolio in North Carolina, Georgia and Florida. Because the majority of our commercial real estate loans are owner occupied, the decline in market values for commercial real estate has not had a material adverse impact on our delinquencies and losses. Because a substantial majority of our investment securities portfolio consists of U.S. Government securities and corporate bonds issued by financial institutions which are guaranteed by the full faith and credit of the United States of America, the carrying amount of our investment securities portfolio is generally not impacted by uncertainties in the credit markets.

INTEREST-EARNING ASSETS

Interest-earning assets include loans and leases, investment securities and overnight investments, all of which reflect varying interest rates based on the risk level and maturity of the underlying asset. Riskier investments typically carry a higher interest rate, but expose the investor to potentially higher levels of default. We have historically focused on maintaining exceptional asset quality, which results in a loan and lease portfolio subjected to strenuous underwriting and monitoring procedures. United States Treasury and U.S. government agency securities represent 84.5 percent of our investment securities portfolio. Debt obligations guaranteed by the Temporary Liquidity Guarantee Program represent 12.2 percent of the investment securities portfolio. Residential mortgage-backed securities designated as available for sale and carried at fair value represent 2.6 percent of total investment securities.

Generally, the investment securities portfolio grows and shrinks based on loan, lease and deposit trends. When deposit growth exceeds loan and lease demand, we invest excess funds in the securities portfolio. Conversely, when loan and lease demand exceeds deposit growth, we use proceeds from maturing securities to fund loan and lease demand. Overnight investments are selectively made with other financial institutions that are within our risk tolerance.

Loans and leases. At June 30, 2009 and 2008, loans and leases totaled $11.52 billion and $11.22 billion, respectively. The $298.8 million or 2.7 percent growth from June 30, 2008 to June 30, 2009 resulted from growth within the commercial and revolving mortgage portfolios and commercial and industrial loans, partially offset by reductions in consumer and construction loans.

Commercial mortgage loans totaled $4.40 billion at June 30, 2009, representing 38.2 percent of the total loan and lease portfolio. This represents an increase of $232.7 million or 5.6 percent since June 30, 2008. Demand for loans secured by owner-occupied medical and professional facilities remained strong during the second quarter, particularly in expansion markets. These loans are underwritten based primarily upon the cash flow from the operation of the business rather than the value of the real estate collateral.

 

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Loans and Leases   Table 2

 

     2009    2008
     Second
Quarter
   First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter
               (thousands)          

Real estate:

              

Construction and land development

   $ 677,884    $ 735,619    $ 778,315    $ 803,935    $ 815,005

Commercial mortgage

     4,397,247      4,336,382      4,343,809      4,265,501      4,164,592

Residential mortgage

     858,036      862,637      894,802      897,181      896,634

Revolving mortgage

     2,052,941      1,984,249      1,911,852      1,793,178      1,638,049

Other mortgage

     155,483      152,561      149,478      152,764      147,424
                                  

Total real estate loans

     8,141,591      8,071,448      8,078,256      7,912,559      7,661,704

Commercial and industrial

     1,858,910      1,857,092      1,885,358      1,886,847      1,797,042

Consumer

     1,070,290      1,132,059      1,233,075      1,317,421      1,337,820

Lease financing

     332,644      344,054      353,933      346,757      335,877

Other

     119,610      92,426      99,264      100,127      91,833
                                  

Total loans and leases

     11,523,045      11,497,079      11,649,886      11,563,711      11,224,276

Less allowance for loan and lease losses

     162,282      161,572      157,569      152,946      144,533
                                  

Net loans and leases

   $ 11,360,763    $ 11,335,507    $ 11,492,317    $ 11,410,765    $ 11,079,743
                                  

At June 30, 2009, revolving mortgage loans totaled $2.05 billion, representing 17.8 percent of total loans and leases outstanding, an increase of $414.9 million or 25.3 percent since June 30, 2008. Attractive rates have stimulated line utilization during 2009.

Commercial and industrial loans totaled $1.86 billion or 16.1 percent of total loans and leases outstanding. These loans increased $61.9 million or 3.4 percent since June 30, 2008, the result of moderate customer demand and sales efforts in expansion markets.

Residential mortgage loans totaled $858.0 million or 7.4 percent of total loans and leases at June 30, 2009, down $38.6 million or 4.3 percent from June 30, 2008. We continue to sell on a servicing released basis substantially all of our current production of residential mortgage loans.

Consumer loans totaled $1.07 billion or 9.3 percent of total loans and leases at June 30, 2009, compared to $1.34 billion or 11.9 percent of loans and leases at June 30, 2008. The continuing reduction in consumer loans results from the discontinuation of indirect lending through our sales finance division in late 2008.

Construction and land development loans totaled $677.9 million or 5.9 percent of total loans at June 30, 2009, a decrease of $137.1 million or 16.8 percent since June 30, 2008. Given the continuing soft residential real estate markets, we have reduced our emphasis on this area of lending, particularly in the Atlanta, Georgia and southwest Florida markets.

At March 31, 2009, TVB reported loans and leases with a carrying value of $1.10 billion. During the third quarter, these loans will be recorded at their fair value. Aside from the loans acquired from TVB, we anticipate modest increases in commercial mortgage and commercial and industrial loans in the second half of 2009, as we continue to build our customer base in new markets. We expect revolving mortgage loans will continue to grow due to sustained demand. All growth projections are subject to change as a result of economic deterioration or improvement, competitive forces and other external factors.

 

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Investment Securities    Table 3

 

     June 30, 2009     June 30, 2008  
     Cost    Fair
Value
   Average
Maturity (1)
(Yrs./Mos.)
   Taxable
Equivalent
Yield
    Cost    Fair
Value
   Average
Maturity (1)
(Yrs./Mos.)
   Taxable
Equivalent
Yield
 
     (thousands)  

Investment securities available for sale:

                      

U. S. Government:

                      

Within one year

   $ 1,616,292    $ 1,629,648    0/6    2.80   $ 1,452,932    $ 1,468,966    0/6    4.87

One to five years

     1,527,733      1,540,235    1/6    1.45        1,381,076      1,386,566    1/7    3.08   

Five to ten years

     —        —      —      —          2,550      2,547    5/0    4.90   

Over ten years

     —        —      —      —          —        —        
                                                  

Total

     3,144,025      3,169,883    1/1    2.14        2,836,558      2,858,079    1/0    3.99   

Residential mortgage-backed securities

                      

Within one year

     —        —      —      —          —        —        

One to five years

     23      21    2/1    5.38        40      37    3/1    5.40   

Five to ten years

     729      736    8/9    4.55        812      782    9/9    4.43   

Over ten years

     94,429      95,964    27/7    5.15        72,863      71,818    26/6    5.47   
                                                  

Total

     95,181      96,721    27/1    5.15        73,715      72,637    26/10    5.46   

State, county and municipal:

                      

Within one year

     480      483    0/8    4.82        1,702      1,709    0/10    3.90   

One to five years

     1,110      1,124    2/10    4.64        1,419      1,415    3/5    4.69   

Five to ten years

     —        —      —      —          —        —        

Over ten years

     10      10    11/5    4.97        66      65    20/5    4.44   
                                                  

Total

     1,600      1,617    2/3    4.70        3,187      3,189    2/4    4.26   

Corporate bonds (2)

                      

One to five years

     457,572      457,742    2/8    1.87        —        —      —      —     
                                                  

Total

     457,572      457,742    2/9    1.95        —        —      —      —     

Other

                      

Five to ten years

     2,894      4,825    8/11    11.03        —        —      —      —     

Over ten years

     —        —      —      —          5,385      7,196    12/1    11.13   
                                                  

Total

     2,894      4,825    9/5    11.05        5,385      7,196    12/1    11.13   

Equity securities

     2,862      14,597           3,558      25,195      
                                                  

Total investment securities available for sale

     3,704,134      3,745,385           2,922,403      2,966,296      
                                                  

Investment securities held to maturity:

                      

Residential mortgage-backed securities

                      

Five to ten years

     3,834      4,035    7/9    5.54     4,944      5,012    8/10    5.53

Over ten years

     154      192    18/2    6.45        176      210    19/8    6.41   
                                                  

Total

     3,988      4,227    8/2    5.58        5,120      5,222    9/2    5.72   

State, county and municipal:

                      

Within one year

     —        —             150      152    0/10    5.88   

One to five years

     152      152    4/4    5.55        —        —        

Five to ten years

     —        —             1,437      1,519    9/10    6.02   
                                                  

Total

     152      152    4/4    5.55        1,587      1,671    9/3    6.01   

Other

                      

One to five years

     —        —             250      250    0/4    3.25   
                                                  

Total

     —        —      —      —          250      250    0/4    3.25   
                                                  

Total investment securities held to maturity

     4,140      4,379    8/1    5.58        6,957      7,143    8/9    5.50   
                                                  

Total investment securities

   $ 3,708,274    $ 3,749,764         $ 2,929,360    $ 2,973,439      
                                                  

 

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

 

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Table of Contents

Investment securities. Investment securities available for sale totaled $3.75 billion at June 30, 2009, compared to $2.97 billion at June 30, 2008. The $779.1 million or 26.3 percent increase results from improved liquidity resulting from deposit growth offset in part by lower demand for treasury services products by commercial customers. Available-for-sale securities are reported at their aggregate fair value and unrealized gains and losses are included as a component of other comprehensive income, net of deferred taxes. Table 3 presents detailed information relating to the investment securities portfolio.

Income on interest-earning assets. Interest income amounted to $176.8 million during the second quarter of 2009, a $25.2 million or 12.5 percent decrease from the second quarter of 2008. The impact of falling asset yields more than offset the impact of growth in interest-earning assets. The taxable-equivalent yield on interest-earning assets for the second quarter of 2009 equaled 4.59 percent, compared to 5.53 percent for the corresponding period of 2008. Average interest-earning assets increased $924.1 million, the result of growth in average loans and investment securities.

Loan and lease interest income for the second quarter of 2009 equaled $155.4 million, a reduction of $11.7 million or 7.0 percent from the second quarter of 2008. The taxable-equivalent yield on the loan and lease portfolio equaled 5.45 percent during the second quarter of 2009, down 59 basis points from the same period of 2008. The lower yield resulted from origination of new loans and leases and adjustments of variable rate loans to current market rates. The impact of the declining loan yields more than offset the impact of the $467.1 million or 4.2 percent increase in average loans and leases during the second quarter of 2009.

Interest income earned on the investment securities portfolio amounted to $21.2 million during the second quarter of 2009 versus $32.6 million during the same period of 2008, a decrease of $11.4 million or 34.9 percent. This decrease is the net result of lower yields and higher average volume. The taxable-equivalent yield decreased 178 basis points from 4.24 percent in the second quarter of 2008 to 2.46 percent in the second quarter of 2009 due to the reinvestment of maturing securities at lower yields. Average investment securities increased $380.8 million or 11.9 percent from $3.20 billion during the second quarter of 2008 to $3.58 billion during the second quarter of 2009.

Interest income amounted to $356.5 million during the first six months of 2009, a $62.4 million or 14.9 percent decrease from the same period of 2008, the net result of lower yields and growth in interest-earning assets. The taxable-equivalent yield declined 111 basis points from 5.76 percent for the first six months of 2008 to 4.65 percent during the same period of 2009, caused by lower market interest rates during 2009.

For the six months ended June 30, 2009, loan and lease interest income equaled $312.0 million, a decrease of $32.3 million or 9.4 percent from the same period of 2008. The deterioration in interest income reflects the unfavorable effect of an 85 basis point decrease in loan and lease yields, the impact of which more than offset the benefit of a $582.5 million or 5.3 percent increase in average loans and leases.

For the six months ended June 30, 2009, income earned on the investment securities portfolio amounted to $44.0 million, compared to $68.2 million during the same period of 2008, a decrease of $24.2 million or 35.4 percent. This decrease was the result of lower interest rates, which more than offset the impact of liquidity-influenced portfolio growth. The yield on average investment securities declined 179 basis points resulting from the reinvestment of proceeds arising from maturing securities to current market rates. Average investment securities increased $242.5 million or 7.6 percent from $3.17 billion in 2008 to $3.41 billion in 2009.

Interest earned on overnight investments totaled $417,000 during the first six months of 2009 compared to $6.4 million during the same period of 2008, a $5.9 million decrease. Average balances declined by $1.3 million while the yield fell by 240 basis points.

 

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Consolidated Taxable Equivalent Rate/Volume Variance Analysis - Second Quarter

Table 4

 

     2009     2008     Increase (decrease) due to:  
     Average
Balance
   Interest
Income/
Expense
   Yield/
Rate
    Average
Balance
   Interest
Income/
Expense
   Yield/
Rate
    Volume     Yield/
Rate
    Total
Change
 

(thousands)

         (thousands)       

Assets

       

Loans and leases

   $ 11,621,450    $ 156,001    5.45   $ 11,154,400    $ 167,624    6.04   $ 5,909      $ (17,532   $ (11,623

Investment securities:

                      

U. S. Government

     3,123,823      18,826    2.42        3,077,879      32,416    4.22        384        (13,974     (13,590

Residential mortgage-backed securities

     100,399      1,234    4.93        79,778      1,057    5.33        265        (88     177   

Corporate bonds

     335,417      1,580    1.88        —        —          790        790        1,580   

State, county and municipal

     2,878      162    22.58        4,915      82    6.71        (74     154        80   

Other

     16,087      164    4.09        35,277      251    2.86        (166     79        (87
                                                                

Total investment securities

     3,578,604      21,966    2.46        3,197,849      33,806    4.24        1,199        (13,039     (11,840

Overnight investments

     525,265      192    0.15        449,003      2,285    2.05        212        (2,305     (2,093
                                                                

Total interest-earning assets

   $ 15,725,319    $ 178,159    4.59   $ 14,801,252    $ 203,715    5.53   $ 7,320      $ (32,876   $ (25,556
                                                                
Liabilities                       

Interest-bearing deposits:

                      

Checking With Interest

   $ 1,523,306    $ 357    0.09   $ 1,468,617    $ 294    0.08   $ 19      $ 44      $ 63   

Savings

     573,955      147    0.10        552,040      279    0.20        8        (140     (132

Money market accounts

     3,816,462      6,570    0.69        3,097,573      13,637    1.77        2,223        (9,290     (7,067

Time deposits

     5,561,474      41,816    3.02        5,365,159      50,647    3.80        1,731        (10,562     (8,831
                                                                

Total interest-bearing deposits

     11,475,197      48,890    1.71        10,483,389      64,857    2.49        3,981        (19,948     (15,967

Short-term borrowings

     631,373      1,281    0.81        1,188,959      3,859    1.31        (1,458     (1,120     (2,578

Long-term obligations

     734,042      9,638    5.25        609,301      8,431    5.53        1,676        (469     1,207   
                                                                

Total interest-bearing liabilities

   $ 12,840,612    $ 59,809    1.87   $ 12,281,649    $ 77,147    2.53   $ 4,199      $ (21,537   $ (17,338
                                                                

Interest rate spread

         2.72         3.00      
                                                                

Net interest income and net yield on interest-earning assets

      $ 118,350    3.02      $ 126,568    3.44   $ 3,121      $ (11,339   $ (8,218
                                                                

Average loan and lease balances include nonaccrual loans and leases and loans held for sale. Yields related to loans, leases and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only are stated on a taxable-equivalent basis assuming a statutory federal income tax rate of 35% and state income tax rate of 6.90% for each period. The taxable-equivalent adjustment was $1,318 for 2009 and $1,140 for 2008.

INTEREST-BEARING LIABILITIES

Interest-bearing liabilities include our interest-bearing deposits as well as short-term borrowings and long-term obligations. Deposits represent our primary funding source, although we also utilize non-deposit borrowings to augment our liquidity base and to fulfill commercial customer requirements for cash management services. Certain of our long-term borrowings also provide capital strength under existing guidelines established by the Federal Reserve Bank and other banking regulators.

Deposits. At June 30, 2009, deposits totaled $14.36 billion, an increase of $1.28 billion or 9.8 percent over June 30, 2008 caused by a surge in customer savings, continued demand for high-quality bank deposits and a desire by customers to seek safety from uncertain investment instruments. We continue to focus on deposit attraction and retention as a key business objective.

 

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Consolidated Taxable Equivalent Rate/Volume Variance Analysis - Six Months

                                                 Table 5  
     2009     2008     Increase (decrease) due to:  

(thousands)

   Average
Balance
   Interest
Income/
Expense
   Yield/
Rate
    Average
Balance
   Interest
Income/
Expense
   Yield/
Rate
    Volume     Yield/
Rate
    Total
Change
 

Assets

                      

Loans and leases

   $ 11,640,555    $ 313,146    5.42   $ 11,058,053    $ 345,288    6.27   $ 16,380      $ (48,522   $ (32,142

Investment securities:

                      

U. S. Government

     3,098,389      40,816    2.65        3,051,737      67,968    4.46        718        (27,870     (27,152

Residential mortgage-backed securities

     95,493      2,382    5.03        81,474      2,163    5.34        358        (139     219   

Corporate bonds

     197,882      1,858    1.88        —        —      —          929        929        1,858   

State, county and municipal

     3,649      241    13.32        4,939      163    6.64        (64     142        78   

Other

     18,242      371    4.10        32,998      525    3.20        (268     114        (154
                                                                

Total investment securities

     3,413,655      45,668    2.69        3,171,148      70,819    4.48        1,673        (26,824     (25,151

Overnight investments

     496,100      417    0.17        497,401      6,366    2.57        (15     (5,934     (5,949
                                                                

Total interest-earning assets

   $ 15,550,310    $ 359,231    4.65   $ 14,726,602    $ 422,473    5.76   $ 18,038      $ (81,280   $ (63,242
                                                                
Liabilities                       

Interest-bearing deposits:

                      

Checking With Interest

   $ 1,494,396    $ 779    0.11   $ 1,444,009    $ 664    0.09   $ (3   $ 118      $ 115   

Savings

     559,812      315    0.11        546,082      561    0.21        20        (266     (246

Money market accounts

     3,732,736      14,964    0.81        3,077,735      33,303    2.18        4,864        (23,203     (18,339

Time deposits

     5,554,801      85,778    3.11        5,430,347      109,588    4.06        2,178        (25,988     (23,810
                                                                

Total interest-bearing deposits

     11,341,745      101,836    1.81        10,498,173      144,116    2.76        7,059        (49,339     (42,280

Short-term borrowings

     643,895      2,602    0.81        1,254,701      12,040    1.93        (4,156     (5,282     (9,438

Long-term obligations

     733,567      19,218    5.24        542,516      15,817    5.83        5,266        (1,865     3,401   
                                                                

Total interest-bearing liabilities

   $ 12,719,207    $ 123,656    1.96   $ 12,295,390    $ 171,973    2.81   $ 8,169      $ (56,486   $ (48,317
                                                                

Interest rate spread

         2.69         2.95      
                                                                

Net interest income and net yield on interest-earning assets

      $ 235,575    3.05      $ 250,500    3.42   $ 9,869      $ (24,794   $ (14,925
                                                                

Average loan and lease balances include nonaccrual loans and leases and loans held for sale. Yields related to loans, leases and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only are stated on a taxable-equivalent basis assuming a statutory federal income tax rate of 35% and a state income tax rate of 6.90% for each period. The taxable-equivalent adjustment was $2,738 and $2,495 for 2009 and 2008, respectively.

At March 31, 2009, TVB reported deposits of $1.33 billion, $237.3 million of which were brokered deposits that were not assumed by FCB. However, we expect deposits resulting from the TVB acquisition to decline during the third and fourth quarters of 2009 as we apply less aggressive pricing strategies.

Short-term borrowings. At June 30, 2009, short-term borrowings totaled $599.9 million compared to $1.13 billion at June 30, 2008, a $530.9 million reduction. The 47.0 percent decline resulted from reduced demand for treasury service products caused by falling interest rates.

Long-term obligations. Long-term obligations equaled $735.8 million at June 30, 2009, up $126.5 million from June 30, 2008 due to borrowings from the Federal Home Loan Bank of Atlanta (FHLB) during the third and fourth quarters of 2008.

Expense on interest-bearing liabilities. Interest expense amounted to $59.8 million during the second quarter of 2009, a $17.3 million or 22.5 percent decrease from the second quarter of 2008. Significantly lower rates more than offset the impact of the growth in interest-bearing liabilities. The rate on average interest-bearing liabilities equaled 1.87 percent during the second quarter of 2009, a 66 basis point decrease in the aggregate blended rate on interest-bearing liabilities as compared to the second quarter of 2008. Average interest-bearing liabilities increased $559.0 million or 4.6 percent from the second quarter of 2008 to the second quarter of 2009, the net result of growth among interest-bearing deposits and a decline in short-term borrowings.

 

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Year-to-date interest expense equaled $123.7 million, compared to $172.0 million for the same period of 2008. The $48.3 million or 28.1 percent decrease results from lower interest rates, partially offset by the impact of growth in deposits and long-term borrowings. The rate on interest-bearing liabilities decreased from 2.81 percent during the first six months of 2008 to 1.96 percent for the same period of 2009, an 85 basis point drop. For the first six months of 2009, average interest-bearing liabilities increased $423.8 million or 3.4 percent from $12.30 billion to $12.72 billion. Average money market accounts increased $655.0 million or 21.3 percent to $3.73 billion while average time deposits increased $124.5 million or 2.3 percent to $5.55 billion, both of which we attribute in part to customers seeking to place deposits with high-quality banks. Average short-term borrowings decreased $610.8 million or 48.7 percent during 2009, due to rate-induced declines in treasury services balances. Average long-term obligations increased $191.1 million from $542.5 million to $733.6 million due to additional FHLB borrowings.

NET INTEREST INCOME

Net interest income totaled $117.0 million during the second quarter of 2009, a decrease of $7.8 million or 6.3 percent from the second quarter of 2008. The taxable-equivalent net yield on interest-earning assets equaled 3.02 percent for the second quarter of 2009, down 42 basis points from the second quarter 2008 net yield of 3.44 percent, and 7 basis points from the first quarter of 2009. For the six-month period ended June 30, 2009, net interest income decreased by $14.1 million or 5.7 percent from the same period of 2008 due to a 37 basis point contraction in the net yield on interest-earning assets. For both the second quarter and the first six months of 2009, the reduction in net interest income was due to the extremely low interest rate environment, the impact of which more than offset the benefit of balance sheet growth.

NONINTEREST INCOME

The growth of noninterest income is essential to our ability to sustain adequate levels of profitability. The primary sources of noninterest income are cardholder and merchant services income, service charges on deposit accounts, revenues derived from wealth management services and fees from processing services. During 2008, we also recorded a significant securities gain.

During the first half of 2009, noninterest income amounted to $144.7 million, compared to $163.8 million during the same period of 2008. Of the $19.1 million or 11.6 percent decrease in noninterest income, $8.1 million resulted from a 2008 securities gain recognized in conjunction with our investment in Visa, Inc. In addition to the impact of the Visa gain, due to weak economic conditions we experienced reductions in service charge income, wealth management services and cardholder and merchant services income during 2009.

Service charges on deposit accounts generated $37.0 million for the first six months of 2009, a decrease of $4.0 million or 9.8 percent from 2008. Reductions in transaction activity and lower interest rates caused service change and overdraft charges to decline during 2009.

Wealth management services generated $22.3 million in the first half of 2009 compared to revenues of $25.9 million in 2008. The $3.7 million or 14.2 percent decrease resulted from lower trust and brokerage income.

Cardholder and merchant services generated $45.6 million during the first six months of 2009, a decrease of $3.1 million or 6.5 percent compared to 2008. This decrease resulted primarily from lower interchange income, the result of reduced transaction volumes generated by both debit and credit cardholders.

Noninterest income benefited from improvements in fees from processing services and mortgage income. Mortgage income increased $2.1 million or 55.6 percent from $3.7 million in 2008 to $5.8 million in 2009. Servicing income and loan origination fees were up for the first six month period of 2009 caused by favorable impacts from higher refinance activity. Fees from processing services added $531,000 or 3.0 percent in 2009 caused by higher transaction volumes and the addition of new clients.

For the second quarter of 2009, noninterest income decreased $6.4 million or 8.1 percent from 2008. Consistent with the six month period, cardholder and merchant services income, service charges on deposit accounts and wealth management services all declined due to poor economic conditions. We anticipate that the trend of lower noninterest income will continue through the rest of 2009.

 

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NONINTEREST EXPENSE

The primary components of noninterest expense are salaries and employee benefit costs, occupancy expenses related to branch offices and support facilities, and equipment costs for branch offices and our technology infrastructure. During 2009, FDIC deposit insurance costs have emerged as a significant component of noninterest expense. Noninterest expense equaled $317.2 million for the first six months of 2009, a $21.9 million or 7.4 percent increase over the $295.3 million recorded during the same period of 2008.

Salaries and wages totaled $129.3 million for the first six months of 2009, an increase of $2.9 million or 2.3 percent when compared to the same period of 2008. The increase resulted from new branch offices, headcount additions in support functions during 2008 and the effect of mid-year 2008 merit increases. Employee benefits expense totaled $33.1 million for the first six months of 2009, an increase of $1.9 million or 6.1 percent. Pension expense increased $2.3 million while employee health costs increased $2.0 million during 2009. These increases were partially offset by lower executive retirement costs in 2009.

Occupancy expense amounted to $31.4 million during the first half of 2009 compared to $30.0 million during the same period of 2008. The $1.3 million or 4.4 percent increase resulted from higher expansion-related building costs. Furniture and equipment expense equaled $29.5 million in 2009, an increase of $1.4 million or 4.9 percent over the $28.1 million in 2008, primarily due to higher hardware and software costs.

FDIC deposit insurance expense increased $16.6 million from $1.3 million in the first six months of 2008 to $17.9 million in 2009, inclusive of a special assessment of $7.8 million. Expenses related to the maintenance, writedowns and resolution of other real estate increased $2.9 million during 2009 due to a significant increase in other real estate acquired through foreclosure in the Atlanta, Georgia and southwest Florida markets. Other expenses decreased $5.2 million or 6.6 percent from the first six months of 2008 to the same period of 2009 primarily due to a contingency accrual recorded during the second quarter of 2008 for a litigation exposure that has since been resolved.

For the second quarter of 2009, noninterest expense totaled $160.9 million, an $11.4 million or 7.6 percent increase over the same period of 2008. Employee benefits increased $2.8 million or 21.2 percent due to higher health insurance and pension costs. FDIC insurance expense increased $13.1 million in 2009 due to higher quarterly rates and the $7.8 million special assessment. Occupancy expense increased $1.3 million or 8.6 percent due from expansion of the branch network. Other expense decreased $8.0 million during the second quarter primarily due to the 2008 contingency accrual.

INCOME TAXES

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

Income tax expense amounted to $6.0 million during the six months ended June 30, 2009, compared to $33.5 million during the same period of 2008. The 82.1 percent decrease in income tax expense was primarily the result of lower pretax earnings. The effective tax rates for these periods were 28.7 percent and 36.4 percent, respectively. For both the three and six-month periods ended June 30, 2009, the favorable impact of various permanent differences remained largely unchanged while pretax income declined, resulting in a lower effective tax rate.

SHAREHOLDERS’ EQUITY AND CAPITAL ADEQUACY

We continually monitor the capital levels and ratios for BancShares and the subsidiary banks to ensure that they comfortably exceed the minimum requirements imposed by their respective regulatory authorities and to ensure that the subsidiary banks’ capital is appropriate given each bank’s growth projection and risk profile. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material effect on the financial statements. Table 6 provides information on capital adequacy for BancShares as of June 30, 2009 and 2008.

We believe that the TVB acquisition by FCB will result in an increase in risk-weighted assets of approximately $850.0 million. This increase will thereby reduce leverage ratios for both BancShares and FCB by 60 basis points and risk-based capital ratios by 90 basis points for BancShares and FCB. Both BancShares and FCB remain well-capitalized on a proforma basis.

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

 

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Capital Adequacy                 Table 6   
     Actual     Minimum
requirement
    Well-capitalized
requirement
 
     Amount    Ratio     Amount    Ratio     Amount    Ratio  
                (dollars in thousands)             
June 30, 2009                

Tier 1 risk-based capital

   $ 1,659,778    13.30   $ 499,310    4.00   $ 624,138    5.00

Total risk-based capital

     1,945,751    15.59     998,621    8.00     1,248,276    10.00

Tier 1 leverage capital

     1,659,778    9.68     514,363    3.00     1,028,726    6.00
June 30, 2008                

Tier 1 risk-based capital

     1,611,089    13.14     490,286    4.00     612,858    5.00

Total risk-based capital

     1,897,038    15.48     980,572    8.00     1,225,716    10.00

Tier 1 leverage capital

     1,611,089    9.89     488,665    3.00     977,330    6.00

The sustained growth and operating losses of ISB has required BancShares to infuse significant amounts of capital into ISB to support its expanding balance sheet. Since ISB was formed in 1997, BancShares has provided $366.3 million in capital. BancShares’ prospective capacity to provide capital to support the future growth and expansion of ISB is highly dependent upon FCB’s ability to return capital through dividends to BancShares. Dividends from FCB to BancShares provide the sole source for capital infusions into ISB. These dividends also fund BancShares’ payment of shareholder dividends and interest payments on a portion of its long-term obligations.

During 2009, our board of directors authorized the repurchase of up to 100,000 shares of Class A common stock and up to 25,000 shares of Class B common stock. The authorization does not require repurchase of any particular number of shares. Any shares of stock that are repurchased will be cancelled. No shares have been purchased as of June 30, 2009.

RISK MANAGEMENT

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

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

Credit risk. BancShares manages and monitors extensions of credit and the quality of the loan and lease portfolio through rigorous initial underwriting processes and periodic ongoing reviews. Underwriting standards reflect credit policies and procedures, and much of our credit approval process is centralized. We maintain a credit review function that conducts independent risk reviews and analyses for the purpose of ensuring compliance with credit policies and to monitor asset quality trends. The independent risk reviews include portfolio analysis by geographic location and horizontal reviews across industry sectors within the banking subsidiaries. We strive to identify potential credit problems as early as possible, to take charge-offs or write-downs as appropriate and to maintain adequate allowances for credit losses that are inherent in the loan and lease portfolio. The maintenance of excellent asset quality is one of our key performance measures.

 

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We maintain a well-diversified loan and lease portfolio and seek to avoid the risk associated with large concentrations within specific geographic areas or industries. Our continuing expansion has allowed us to mitigate our historic exposure to geographic risk concentration in North Carolina and Virginia. However, as we have entered new markets, we have endeavored to ensure that rigorous centralized underwriting and monitoring controls are functioning effectively. We will continue to place emphasis upon maintaining strong lending standards in new markets.

In recent years, we have aggressively sought opportunities to provide financial services to businesses associated with and professionals within the medical community. Due to strong growth within this segment of our loan and lease portfolio, our loans and leases to borrowers in medical, dental or related fields totaled $2.80 billion as of June 30, 2009, which represents 24.3 percent of total loans and leases outstanding, compared to $2.45 billion or 21.8 percent at June 30, 2008. Except for this single concentration, no other industry represented more than 10 percent of total loans and leases outstanding at June 30, 2009.

Nonperforming assets include nonaccrual loans and leases and other real estate owned, which includes foreclosed property and closed branch facilities. At June 30, 2009, BancShares’ nonperforming assets amounted to $102.4 million or 0.89 percent of loans and leases plus foreclosed properties, compared to $71.7 million at December 31, 2008 and $47.3 million at June 30, 2008. Nonaccrual loans totaled $63.8 million at June 30, 2009 compared to $39.4 million at December 31, 2008 and $34.5 million at June 30, 2008. Other real estate equaled $33.3 million, $30.0 million and $12.8 million as of the respective dates. The increases in nonaccrual loans and other real estate primarily result from residential construction loans secured by properties located in the Atlanta, Georgia and southwest Florida markets, areas that have suffered from significant excess housing capacity and falling property values. Our borrowers, who are dependent on proceeds from sales to fund their obligations to us, face significant liquidity challenges. As real estate markets remain soft, we will continue to closely monitor nonperforming assets, taking necessary actions to minimize potential exposure.

Residential construction loans in the Atlanta, Georgia and southwest Florida markets as of June 30, 2009 equaled $91.0 million, compared to $105.1 million at December 31, 2008. As of June 30, 2009, $30.1 million of the residential construction loans were classified as nonperforming, and $27.7 million were identified as potential problem loans due to concerns about borrowers’ abilities to comply with existing loan repayment terms. We continue to closely monitor past due and problem accounts to identify any loans and leases that should be classified as impaired or non-accrual.

At March 31, 2009, TVB reported nonaccrual loans with a carrying value of $146.6 million and other real estate owned with a carrying value of $35.7 million. Nonaccrual loans and other real estate will be recorded at fair value as of the acquisition date, which will result in significant increases in FCB’s nonperforming assets during the third quarter. Prospective losses realized on other real estate owned by TVB will be shared between the FDIC and FCB.

At June 30, 2009, the allowance for credit losses totaled $169.5 million or 1.46 percent of total loans and leases, up $20.4 million from June 30, 2008 when the coverage ratio equaled 1.35 percent. The allowance for credit losses includes the allowance for loan and lease losses and the reserve for unfunded commitments. We continuously analyze the growth and risk characteristics of the loan and lease portfolio under current economic conditions in order to evaluate the adequacy of the allowance. Such factors as the financial condition of borrowers, fair market value of collateral and other considerations are recognized in estimating probable credit losses.

Our exposure to subprime loans is limited to programs we initiated to provide financing for affordable housing in connection with our ongoing efforts to comply with the Community Reinvestment Act. The carrying value of these loans as of June 30, 2009 was $3.5 million.

 

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Summary of Loan and Lease Loss Experience and Risk Elements    Table 7

 

    2009     2008     Six Months Ended June 30  
    Second
Quarter
    First
Quarter
    Fourth
Quarter
    Third
Quarter
    Second
Quarter
    2009     2008  
    (thousands, except ratios)  

Allowance for loan and lease losses at beginning of period

  $ 161,572      $ 157,569      $ 152,946      $ 144,533      $ 141,591      $ 157,569      $ 136,974   

Provision for credit losses

    21,506        17,976        22,640        20,008        13,363        39,482        23,278   

Net charge-offs:

             

Charge-offs

    (22,048     (14,976     (19,119     (12,790     (11,566     (37,024     (18,172

Recoveries

    1,252        1,003        1,102        1,195        1,145        2,255        2,453   
                                                       

Net charge-offs

    (20,796     (13,973     (18,017     (11,595     (10,421     (34,769     (15,719
                                                       

Allowance for loan and lease losses at end of period

  $ 162,282      $ 161,572      $ 157,569      $ 152,946      $ 144,533      $ 162,282      $ 144,533   
                                                       

Reserve for unfunded commitments

  $ 7,213      $ 7,923      $ 7,176      $ 7,674      $ 7,487      $ 7,213      $ 7,487   

Average loans and leases

    11,621,450        11,659,873        11,665,522        11,440,563        11,154,400        11,640,555        11,058,053   

Loans and leases at period-end

    11,523,045        11,497,079        11,649,886        11,563,711        11,224,276        11,523,045        11,224,276   
                                                       

Risk Elements

             

Nonaccrual loans and leases

  $ 63,756      $ 62,903      $ 39,361      $ 39,598      $ 34,534      $ 63,756      $ 34,534   

Other real estate

    33,301        32,787        29,956        21,580        12,750        33,301        12,750   

Troubled debt restructurings

    5,334        3,100        2,349        988        —          5,334        —     
                                                       

Total nonperforming assets

  $ 102,391      $ 98,790      $ 71,666      $ 62,166      $ 47,284      $ 102,391      $ 47,284   
                                                       

Accruing loans and leases 90 days or more past due

  $ 25,988      $ 20,327      $ 22,459      $ 20,902      $ 10,885      $ 25,988      $ 10,885   
                                                       

Ratios

             

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

    0.73     0.49     0.61     0.40     0.38     0.60     0.29

Percent of loans and leases at period-end:

             

Allowance for loan and lease losses

    1.41        1.41        1.35        1.32        1.29        1.41        1.29   

Reserve for unfunded commitments

    0.06        0.07        0.06        0.07        0.07        0.06        0.07   

Nonperforming assets to total loans and leases plus other real estate

    0.89        0.86        0.61        0.54        0.42        0.89        0.42   

At June 30, 2009, the allowance for loan and lease losses totaled $162.3 million or 1.41 percent of total loans and leases, compared to $144.5 million or 1.29 percent of loans and leases at June 30, 2008. The $17.7 million increase in the allowance was attributable to additional provisions related to downgrades of residential construction loans. In addition, due to charge-off trends and projections of continuing losses, the loss estimates related to revolving mortgage loans and consumer loans were increased, resulting in a $9.1 million increase in the allowance during the second quarter of 2009. We continuously analyze the growth and risk characteristics of the loan and lease portfolio under current economic conditions in order to evaluate the adequacy of the allowance. The allowance model considers the financial condition of borrowers, fair market value of collateral and other factors in estimating probable credit losses.

 

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Management considers the allowance adequate to absorb estimated probable losses that relate to loans and leases outstanding at June 30, 2009, although future additions may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for credit losses. Such agencies may require the recognition of adjustments to the allowance based on their judgments of information available to them at the time of their examination.

The provision for loan and lease losses charged to operations during the first six months of 2009 equaled $39.5 million, compared to $23.3 million during the comparable period of 2008. The $16.2 million increase resulted from higher net charge-offs and the impact of changes made to the allowance model in recognition of deterioration in revolving mortgage and consumer loans. Net charge-offs during the first half of 2009 equaled $34.8 million compared to $15.7 million during 2008. Charge-offs increased in all loan categories, including a $7.5 million increase in charge-offs on residential construction loans and $3.1 million increases in losses on both Equity Line and unsecured revolving loans. On an annualized basis, net charge-offs represent 0.60 percent of average loans and leases during the first six months of 2009 compared to 0.29 percent in the first six months of 2008.

Table 7 provides details concerning the allowance and provision for loan and lease losses during the past five quarters.

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

We do not typically utilize interest rate swaps, floors, collars or other derivative financial instruments to attempt to hedge our rate sensitivity and general balance sheet interest rate risk. However, during the second quarter of 2006, in conjunction with the issuance of $115.0 million in trust preferred securities, we entered into an interest rate swap to synthetically convert the variable rate coupon on the securities to a fixed rate of 7.125 percent for a period of five years. As a result of favorable market interest rates during the second quarter of 2009, we entered into a second five-year interest rate swap that will similarly convert the variable coupon rate to a fixed rate of 5.50 percent from June 2011 through June 2016.

We assess our interest rate risk by simulating future amounts of net interest income under various interest rate scenarios and comparing those results to forecasted net interest income assuming stable rates. These simulations indicate that net interest income will vary by less than seven percent when interest rates rise or decline by 200 basis points. We also utilize the market value of equity as a tool in measuring and managing interest rate risk. The market value of equity as a percentage of the economic value of assets is estimated to range from 6.4 percent to 8.4 percent when interest rates move 200 basis points in either direction.

 

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Liquidity Risk. Liquidity risk results from the mismatching of asset and liability cash flows. We manage this risk by structuring our balance sheet prudently and by maintaining various borrowing resources to fund potential cash needs. We have historically maintained a strong focus on liquidity, and our deposit base represents our primary liquidity source. Through our deposit pricing strategies, we have the ability to stimulate or curtail deposit growth. We also maintain additional sources for borrowed funds through federal funds lines of credit and other borrowing facilities. At June 30, 2009, we had access to $525.0 million in unfunded borrowings through agreements with various correspondents. On a very limited basis, we also utilize deposit brokers to provide funding.

Once we have generated the needed liquidity and satisfied our loan and lease demand, residual liquidity is invested in overnight and longer-term investment products. Net of amounts pledged for various purposes, investment securities available for sale provide immediate liquidity as needed.

SEGMENT REPORTING

BancShares conducts its banking operations through its two banking subsidiaries, FCB and ISB. FCB and ISB offer similar products and services to customers. We monitor growth and financial results in these institutions separately and, within each institution, by geographic segregation.

Although FCB has grown through acquisition in certain of its markets, throughout its history the majority of its expansion has been accomplished on a de novo basis. Because of its size, the costs associated with FCB’s current rate of expansion are not material to its financial performance. Since ISB began operations in 1997, it has followed a de novo business model for growth and expansion. However, due to the rapid pace of its growth and the number of branch offices that have not attained sufficient size to achieve profitability, the financial results and trends of ISB are significantly affected by its current and continuing growth in markets and branch offices. Each new market ISB enters creates additional operating costs that are typically not fully offset by operating revenues until at least the third year after initial opening. Losses incurred since ISB’s inception total $77.4 million.

In the aggregate, FCB and ISB account for more than 90 percent of consolidated assets, revenues and net income. All other entities are combined for segment disclosure purposes, including activities of the parent company and Neuse, Incorporated (Neuse), a subsidiary that owns real property.

IronStone Bank. At June 30, 2009, ISB operated 56 facilities in twelve states. Assets totaled $2.65 billion at June 30, 2009 and 2008. ISB reported a net loss of $13.8 million during the first six months of 2009, compared to a net loss of $10.5 million reported during 2008. The higher net loss in 2009 resulted from a significant increase in the provision for loan and lease losses and higher noninterest expense. Net interest income increased $5.0 million from $31.5 million in 2008 to $36.5 million in 2009, the result of lower deposit interest rates and an improved net yield on interest-earning assets.

The provision for loan and lease losses totaled $19.1 million during the first six months of 2009, an increase of $7.7 million due to higher net charge-offs and allowances required by downgraded and nonperforming residential construction loans. Net charge-offs increased from $7.1 million in 2008 to $18.1 million in 2009. On an annualized basis, the ratio of current year net charge-offs to average loans and leases outstanding equaled 1.66 percent, compared to 0.67 percent in the prior year. For the second quarter of 2009, net charge-offs totaled $11.9 million, an increase of $6.6 million over the same period of 2008. Net charge-offs represent 2.19 percent of average loans and leases for the second quarter of 2008, compared to 0.98 percent for the same period of 2008.

Noninterest expense increased $3.2 million or 7.6 percent during the first half of 2009, versus the same period of 2008. Salaries and wages decreased $1.1 million or 6.9 percent during the first six months of 2009, the result of branch closings. Expenses related to the maintenance and resolution of other real estate surged $2.8 million due to higher balances of other real estate owned. FDIC deposit insurance expense increased $2.1 million due to higher rates and a special assessment. Similar variances were noted in the comparison of the second quarter of 2009 to the same period of 2008.

 

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During the second quarter of 2009 Neuse purchased from ISB foreclosed properties that had a carrying value of $7.8 million. This transaction will benefit ISB by reducing problem assets and improve certain operating ratios. To facilitate the potential purchase of additional foreclosed property in the future, ISB has agreed to lend Neuse up to $20.0 million under a revolving line of credit.

First-Citizens Bank & Trust Company. At June 30, 2009, FCB operated 343 branches in five mid-Atlantic states. As a result of the TVB transaction in July 2009, FCB added 11 branches in California. FCB’s total assets increased $1.07 billion from $13.54 billion at June 30, 2008 to $14.60 billion at June 30, 2009. First Citizens generated net income of $34.6 million during the first two quarters of 2009, compared to net income of $72.6 million during 2008. The $38.0 million decline in net income resulted from higher noninterest expense and provision for loan and lease losses and lower revenues.

Noninterest expense increased $18.6 million or 7.2 percent during 2009, primarily the result of a $14.6 million increase in FDIC insurance costs and a $4.0 million increase in salary expense. FDIC insurance expense was also the primary cause of the increase in noninterest expense during the second quarter of 2009, when compared to the same period of 2008.

The provision for loan and lease losses increased $8.5 million due an $8.1 million increase in net charge-offs. On an annualized basis, the ratio of current year net charge-offs to average loans and leases outstanding equaled 0.36 percent, compared to 0.19 percent in the prior year. The increase in the provision for loan and lease losses during the second quarter resulted from a $3.7 million increase in net charge-offs. Net charge offs in the second quarter of 2009 equaled 0.38 percent of total loans and leases, compared to 0.23 percent during the second quarter of 2008.

FCB’s net interest income decreased $16.0 million or 7.3 percent during 2009, due to falling interest rates and a reduction in the net yield on interest-earning assets. FCB’s noninterest income decreased $18.3 million or 11.3 percent during the first six months of 2009 due, in part, to an $8.1 million reduction in securities gains. Additionally, reductions were noted in wealth advisory services, deposit service charges and cardholder and merchant services income for the three- and six-month periods ended June 30, 2009, when compared to the same periods of 2008.

IMPAIRMENT

Under the provisions of Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (Statement 142), we are required to perform an impairment test each year to determine if goodwill is impaired. Since we adopted Statement 142, the annual impairment tests have been conducted as of July 31 each year, and have not indicated impairment exists.

Statement 142 also requires goodwill be tested for impairment as a result of other events including significant adverse change in the business climate. We performed an impairment test of our goodwill during the second quarter of 2009 due to the significant economic slowdown that began in 2008 and has continued into 2009. In addition, the market price of our common stock was slightly below book value at June 30, 2009.

Statement 142 provides a two-step method to evaluate and calculate impairment. The first step requires estimation of each reporting unit’s fair value. If the fair value exceeds the carrying value, no further testing is required. If the carrying value exceeds the fair value, we are required to determine whether an impairment charge must be recorded and, if so, the amount of such charge. Based on the results of the results of the first step, there was no indication of potential impairment for FCB’s goodwill; however, the test indicated that an impairment of ISB’s $793,000 of goodwill was possible.

The evaluation of impairment performed in the second step included the preparation of a fair value balance sheet for ISB to confirm whether impairment exists. Based on the fair value estimates considered in the analysis, including fair value discounts recognized on assets that are not carried at fair value, goodwill was not impaired for ISB. Therefore, no impairment of goodwill was recorded during the second quarter of 2009.

As of June 30, 2009, the market price of our common stock continued to trade below book value. If this situation persists or worsens, subsequent impairment tests may indicate that impairment exists for goodwill and other long-lived assets. An impairment charge could have a significant impact on our consolidated income statement. However, a goodwill impairment charge would not impact our capital ratios as those ratios are calculated using tangible capital amounts.

 

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LEGAL PROCEEDINGS

On May 24, 2004, FCB filed a lawsuit in the Circuit Court of Greenbrier County, West Virginia against a customer alleging default under a master lease on a piece of equipment, eight promissory notes and two leases. The borrower asserted a counterclaim against FCB alleging breach of lease, breach of fiduciary duty, breach of duty of good faith and fair dealing, and tortuous interference with contractual relations. At trial, a jury returned a verdict against FCB and awarded a $4.1 million judgment in favor of FCB’s customer. If the jury verdict stands, the customer will be entitled to pre-judgment interest of approximately $1.0 million and post-judgment interest at a rate of 8.25 percent. FCB filed a motion to set aside the judgment or, in the alternative, for a new trial, but the Court denied FCB’s motion. FCB is appealing the Court’s action to the West Virginia Supreme Court of Appeals. FCB has posted an acceptable bond and execution of the judgment is stayed pending the outcome of the appeal. FCB strenuously denies liability and is vigorously pursuing appeal of the jury’s award.

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

CURRENT ACCOUNTING AND REGULATORY ISSUES

In March 2008, the FASB issued SFAS No. 161 ‘Disclosures about Derivative Instruments and Hedging Activities’ (Statement 161). Statement 161 requires enhanced disclosures about how and why derivative instruments are used, how derivative instruments and related hedged items are accounted for under Statement 133 and how derivative instruments and related hedged items affect the balance sheet, income statement and statement of cash flows. Statement 161, which we adopted on January 1, 2009, resulted in expanded disclosures but had no material impact on financial condition, results of operations or liquidity.

Three FASB Staff Positions (FSPs) became effective for BancShares on June 30, 2009. FSP FAS 107-1 and APB 28-1 Interim Disclosures about Fair Value of Financial Instruments requires fair value disclosures about financial instruments in interim financial statements as well as disclosures about estimation methods and disclosure of changes in method from prior periods. FSP FAS 115-2 and FAS 124-2 Recognition and Presentation of Other-Than-Temporary Impairments (OTTI FSP) creates a new model for evaluating OTTI in debt securities. The OTTI FSP requires an entity to record an OTTI charge if it intends to sell a debt instrument or if it can not assert it is more likely than not that it will not have to sell the security before recovery. If the entity does not intend to sell the security but does not expect to recover the amortized cost basis, the amount of the impairment that results from issuer credit will be reported in earnings and the remaining impairment related to liquidity will be reflected in other comprehensive income. FSP FAS 157-4 Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly requires companies, as they are estimating fair values for assets and liabilities that are subject to fair value measurement, to consider various factors to determine whether there has been a significant decrease in the volume and level of activity compared to normal market activity and to consider whether an observed transaction was not orderly based on the weight of available evidence. Implementation of the three FSPs did not have a material impact on the consolidated financial statements, although additional disclosures have been provided.

In response to the challenges facing the financial services sector, several regulatory and governmental actions have been enacted including The Emergency Economic Stabilization Act, the TARP Capital Purchase Program and the Temporary Liquidity Guarantee Program (TLGP). Based on the expectation that our current capital levels will be adequate to sustain our growth for the foreseeable future, we did not apply to participate in the TARP Capital Purchase Program. Further, we waived the right to participate in the TLGP guarantee of unsecured debt. However, we did elect to participate in the TLGP’s enhanced deposit insurance program.

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

 

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FORWARD-LOOKING STATEMENTS

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

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

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

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

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

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the potential economic loss resulting from changes in market prices and interest rates. This risk can either result in diminished current fair values of financial instruments or reduced net interest income in future periods. As of June 30, 2009, BancShares’ market risk profile has not changed significantly from December 31, 2008. Changes in fair value that result from movement in market rates cannot be predicted with any degree of certainty. Therefore, the impact that future changes in market rates will have on the fair values of financial instruments is uncertain.

 

Item 4. Controls and Procedures

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

No change in BancShares’ internal control over financial reporting occurred during the second quarter of 2009 that had materially affected, or is reasonably likely to materially affect, BancShares’ internal control over financial reporting.

 

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PART II

 

Item 1A. Risk Factors

Unfavorable changes in economic conditions

BancShares’ business is highly affected by national, regional and local economic conditions. These conditions cannot be predicted or controlled, and may have a material impact on our operations and financial condition. Unfavorable economic developments such as an increase in unemployment rates, decreases in real estate values, rapid changes in interest rates, higher default and bankruptcy rates and various other factors could weaken the national economy as well as the economies of specific communities we serve. Weakness in our market areas could depress our earnings and financial condition because borrowers may not be able to repay their loans, collateral values may fall, and the general quality of our loan portfolio may decline.

Deposit insurance premiums

During 2009, due to a higher level of bank failures, the FDIC increased recurring deposit insurance premiums and imposed a special assessment on insured financial institutions. Due to the continuing volume of bank failures, it is possible that higher deposit insurance rates or additional special assessments will be required to restore the Deposit Insurance Fund to the Congressionally-established target.

Instability in real estate markets

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

Access to capital

Based on existing capital levels, BancShares and its subsidiary banks maintain well-capitalized ratios under current leverage and risk-based capital standards. On a proforma basis considering the impact of the acquisition of Temecula Valley Bank, BancShares and FCB retain their well-capitalized status. Historically, our primary capital sources have been retained earnings and debt issued through both private and public markets including trust preferred capital securities and subordinated debt. The market for trust preferred capital securities has been severely limited during the current economic environment, and our ability to raise capital by issuing trust preferred capital securities at reasonable rates is highly questionable. A lack of access to capital could limit our ability to make new loans, to meet our existing lending commitments and could potentially affect our liquidity and capital adequacy.

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

Condition of other financial institutions

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

 

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Changes in interest rates

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

Changes in banking laws

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

In addition, financial institutions are significantly affected by changes in economic and monetary policies. The current economic environment will likely result in increased compliance requirements, some of which may affect our results of operations.

Competition

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

Catastrophic events

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

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

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

Operational and data security risk

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

Liquidity

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

 

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Reliance on vendors

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

Litigation

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

Interpretation of tax laws and regulations

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

Changes in accounting standards

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

Mergers and acquisitions

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

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

Volatility in stock price and impairment of goodwill

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

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

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

 

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Item 4. Submission of Matters to a Vote of Security Holders

On April 27, 2009, at the Annual Meeting of Shareholders of Registrant, the shareholders considered the election of directors. The shareholder vote regarding the election of the nominees for Board of Directors was:

 

Nominee

   For    Withheld    Broker
Non-votes

J.M. Alexander, Jr.

   30,922,348    141,797    —  

C.H. Ames

   30,981,105    83,040    —  

V.E. Bell, III

   30,923,580    140,565    —  

G.H. Broadrick

   30,925,069    139,076    —  

H.H. Connell

   30,983,103    81,042    —  

H.M. Craig, III

   30,922,618    141,527    —  

H.L. Durham, Jr.

   30,752,230    311,915    —  

L.M. Fetterman

   31,014,246    49,899    —  

D.L. Heavner

   31,028,517    35,628    —  

F.B. Holding

   30,963,955    100,190    —  

F.B. Holding, Jr.

   30,994,540    69,605    —  

L.S. Jones

   31,021,980    42,165    —  

R.E. Mason, IV

   31,029,055    35,090    —  

R.T. Newcomb

   30,969,359    94,786    —  

L.T. Nunnellee, II

   31,013,994    50,151    —  

J.M. Parker

   30,983,083    81,062    —  

R.K. Shelton

   31,029,012    35,133    —  

R.C. Soles, Jr.

   30,953,281    110,864    —  

D.L. Ward, Jr.

   30,771,002    293,143    —  

 

Item 6. Exhibits

 

10    Separation Agreement and Release between Registrant’s subsidiary First-Citizens Bank & Trust Company and Joseph A. Cooper, Jr., dated July 8, 2009
31.1    Certification of Chief Executive Officer
31.2    Certification of Chief Financial Officer
32.1    Certifications of Chief Executive Officer
32.2    Certifications of Chief Financial Officer

 

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SIGNATURES

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

 

Dated: August 7, 2009   FIRST CITIZENS BANCSHARES, INC.
  (Registrant)
  By:  

/s/ KENNETH A. BLACK

    Kenneth A. Black
    Vice President, Treasurer and Chief Financial Officer

 

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