UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

(Mark one)

 

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURTIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

Or

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

For the transition period from _______ to ________.

 

 

Commission File Number:  0-11709

 

FIRST CITIZENS BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

Tennessee                                                                             62-1180360

(State of Incorporation)                                                      (IRS Employer Id. No.)

 

P. O. Box 370, One First Citizens Place

Dyersburg, TN  38024

(Address of principal executive offices including zip code)

 

731-285-4410

(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 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes [X]   No [  ].

 

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

 

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [  ]                                                                                   Accelerated filer  [X]

Non-accelerated filer[  ] (Do not check if a smaller reporting company)      Smaller reporting company [  ]

 

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

 

Of the registrant's only class of common stock (no par value), there were 3,607,852 shares outstanding as of October 31, 2011.

 

 

 

 

 

 

 

 

 

PART I-FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

FIRST CITIZENS BANCSHARES, INC. & SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF SEPTEMBER 30, 2011 AND DECEMBER 31, 2010

(In Thousands)

 

 

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FIRST CITIZENS BANCSHARES, INC. & SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (cont’d)

AS OF SEPTEMBER 30, 2011 AND DECEMBER 31, 2010

 (In Thousands)

 

 

 

 

(1) Derived from audited financial statements.

 

See accompanying notes to consolidated financial statements.

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FIRST CITIZENS BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010

(Dollars in Thousands Except for Per Share Amounts)

 

 

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FIRST CITIZENS BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (cont’d)

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010

(Dollars in Thousands Except for Per Share Amounts)

 

 

 

 

See accompanying notes to consolidated financial statements.

 

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FIRST CITIZENS BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010

 (In Thousands)

 

 

 

See accompanying notes to consolidated financial statements.

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FIRST CITIZENS BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010

(Dollars in Thousands)

 

 

 

 

See accompanying notes to consolidated financial statements.

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FIRST CITIZENS BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

SEPTEMBER 30, 2011

 

 

Note 1 - Consolidated Financial Statements

 

The consolidated balance sheet as of September 30, 2011, the consolidated statements of income for the three and nine months ended September 30, 2011 and 2010, and the consolidated statements of equity and cash flows for the six-month periods then ended have been prepared by the Company without an audit.  The accompanying reviewed condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments necessary to present fairly the financial position, results of operations and cash flows at September 30, 2011 and for all periods presented have been made. Operating results for the reporting periods presented are not necessarily indicative of results that may be expected for the year ending December 31, 2011.  For further information, refer to the consolidated financial statements and footnotes thereto included in the company’s Annual Report on Form 10-K for the year ended December 31, 2010. 

 

Certain prior year balances have been reclassified to conform to current year presentation.  The consolidated financial statements include all accounts of First Citizens Bancshares, Inc. (the “Company”), and its subsidiary, First Citizens National Bank (the “Bank”).  First Citizens (TN) Statutory Trusts III and IV are reported under the equity method in accordance with generally accepted accounting principles for Variable Interest Entities for all periods presented.  These investments are included in other assets and the proportionate share of income (loss) is included in other non-interest income.  The Bank also has two wholly owned subsidiaries, First Citizens Financial Plus, Inc. and First Citizens Investments, Inc., which are consolidated into its financial statements.  First Citizens Holdings, Inc., a wholly owned subsidiary of First Citizens Investments, Inc., and First Citizens Properties, Inc. are also consolidated into the financial statements.  First Citizens Holdings, Inc. owns approximately 60% of preferred stock and 100% of common stock of First Citizens Properties, Inc.  Directors, executive officers and certain employees and affiliates of the Bank own approximately 40% of the preferred stock which is reported as Noncontrolling Interest in Consolidated Subsidiaries in the Consolidated Balance Sheets of the Company. 

 

The Bank has a 50% ownership interest in two insurance subsidiaries both of which are accounted for using the equity method.  The first is White and Associates/First Citizens Insurance, LLC, which is a general insurance agency offering a full line of insurance products.  The other is First Citizens/White and Associates Insurance Company whose principal activity is credit insurance.  The investments in these subsidiaries are included in Other Assets on the Balance Sheets presented in this report and earnings from these subsidiaries are recorded in Other Non-Interest Income on the Income Statements presented in this report. 

 

Note 2 - Organization

 

First Citizens Bancshares, Inc., is a bank holding company chartered December 14, 1982, under the laws of the State of Tennessee. On September 23, 1983, all outstanding shares of common stock of First Citizens National Bank were exchanged for an equal number of shares in First Citizens Bancshares, Inc.

 

Note 3 – Contingent Liabilities

 

There is no material pending or threatened litigation as of the current reportable date that would result in recognition of a liability.

 

Note 4 -- Cash Reserves and Interest-Bearing Deposits in Other Banks

 

 

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The Bank maintains cash reserve balances as required by the Federal Reserve Bank.  Average required balances during nine months ended September 30, 2011 and the year ended December 31, 2010 were approximately $500,000.  Amounts above the required minimum balance are reported as Interest-Bearing Deposits in Other Banks on the Consolidated Balance Sheets.  Balances in excess of required reserves held at the Federal Reserve Bank as of September 30, 2011 and December 31, 2010 were $34.1 million and $5.3 million, respectively.  Interest-bearing deposits in other banks also include short-term certificates of deposit held in increments that are within FDIC insurance limits and totaled $1.7 million and approximately $975,000 as of September 30, 2011 and December 31, 2010, respectively.

 

Note 5 – Investment Securities and Derivative Transactions

 

The amortized cost and fair value of available-for-sale securities as of September 30, 2011 and December 31, 2010 were as follows:

 

			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
As of September 30, 2011:
U. S. Treasury securities and obligations of U. S.
government agencies and corporations	$213,187		$  8,359		$            -		$221,546
Obligations of states and political subdivisions	104,158		8,757		-		112,915
All others	2,189		15		(1,651)		553
Total available-for-sale securities	$319,534		$17,131		$ (1,651)		$335,014
As of December 31, 2010:
U. S. Treasury securities and obligations of U. S.
government agencies and corporations	$189,280		$3,721		$ (1,558)		$191,443
Obligations of states and political subdivisions	99,774		3,073		(397)		102,450
All others	2,698		22		(1,790)		930
Total available-for-sale securities	$291,752		$6,816		$ (3,745)		$294,823

 

There were no securities classified as held-to-maturity or trading as of September 30, 2011 or December 31, 2010.

 

The following table summarizes contractual maturities of debt securities available-for-sale as of September 30, 2011 (in thousands):

 

	Available-for-Sale Securities
		Amortized Cost		Fair Value
Amounts maturing In:
One year or less		$      2,196		$    2,219
After one year through five years		7,758		8,237
After five years through ten years		44,105		47,302
After ten years*		265,452		277,218
		319,511		334,976
Equity securities		23		38
Total securities		$319,534		$335,014

 

^{*This table includes agency mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMO”) based on contractual maturities (primarily in the After ten years category).  However, the remaining lives of such securities is expected to be much shorter}

 

 

 

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Gross sales and realized gains (losses) on sale of available-for-sale securities are presented as follows (in thousands):

 

Nine months ended September 30:	Gross Sales			Gains		Losses		Net
2011 - Securities available-for-sale		$       37,865		$  943		$        -		$    943
2010 - Securities available-for-sale		$       62,839		$ 1,881		$        -		$ 1,881

 

The following table presents information on securities with gross unrealized losses at September 30, 2011, aggregated by investment category and the length of time that the individual securities have been in a continuous loss position (in thousands):

 

 

In reviewing the investment portfolio for other-than-temporary impairment of individual securities, consideration is given but not limited to (1) the length of time in which fair value has been less than cost and the extent of the unrealized loss, (2) the financial condition of the issuer, and (3) the positive intent and ability of the Company to maintain its investment in the issuer for a time that would provide for any anticipated recovery in the fair value.

 

As of September 30, 2011, the Company had three debt securities with unrealized losses and all three have been in an unrealized loss position for greater than 12 months.  The Company did not intend to sell any such securities in unrealized loss position and it was more likely than not that the Company would not be required to sell the securities prior to recovery of costs.  The three corporate debt securities are pooled collateralized debt obligation securities that are backed by trust-preferred securities (“TRUP CDOs”) issued by banks, thrifts and insurance companies.  These three bonds were rated below investment grade (BBB) by Moody’s and/or S&P as of September 30, 2011. 

 

The three TRUP CDOs have an aggregate book value of $2.2 million, fair market value of approximately $515,000 and each of the three are the mezzanine or “B” class tranches.  The unrealized losses totaling $1.7 million as of September 30, 2011 are reflected in accumulated other comprehensive income, net of tax.  The following table provides the book and market values of each security as well as information regarding the levels of excess subordination in the securities as of September 30, 2011 (dollars in thousands):

 

_________________

(1)	Book values reflect principal only and do not include interest capitalized or payment-in-kind (“PIK”) to the bond according to contractual terms of the bond if applicable.  The Company does not recognize PIK interest for book purposes and has these bonds on non-accrual status.

 

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(2)	The Over Collateral (“OC”) Ratio reflects the ratio of performing collateral to a given class of notes and is calculated by dividing the performing collateral by the sum of the current balance of a given class of notes plus all senior classes.
(3)	The Required OC Ratio for a particular class of bonds reflects the required overcollateralization ratio such that cash distributions may be made to lower classes of bonds.  If the OC Ratio is less than the Required OC ratio, cash is diverted from the lower classes of bonds to the senior bond classes.
(4)	The Required OC Ratio is not applicable in this case, as interest on Pretsl X for B-2 class is capitalized to the bond or PIK.

 

Security-specific collateral is used in the assumptions to project cash flows each quarter.  Issuers in default are assumed at zero recovery.  Issuers in deferral are assumed at a 15% recovery beginning two years from deferral date.  Forward interest rates are used to project future principal and interest payments allowing the model to indicate impact of over or undercollateralization for each transaction.  Higher interest rates generally increase credit stress on undercollateralized transactions by reducing excess interest (calculated as the difference between interest received from underlying collateral and interest paid on the bonds).  The discount rate is based on the original discount margin calculated at the time of purchase based on the purchase price.  The original discount margin is then added to the three-month LIBOR to determine the discount rate.  The discount rate is then used to calculate the present value for the then-current quarter’s projected cash flows.  If the present value of the then-current quarter’s projected cash flows is less than the prior quarter or less than the then-current book value of the security, that difference is recorded against earnings as the credit component of other-than-temporary impairment.  Additional credit losses totaled approximately $48,000 during the quarter ended September 30, 2011 were recognized against earnings during third quarter 2011.

 

The following is a tabular rollforward of the amount related to the pre-tax credit loss component recognized in earnings on debt securities for three and nine months ended September 30, 2011 and 2010 (in thousands):

 

 

See also discussion of valuation techniques and hierarchy for determining fair value of these securities at Note 11.

 

 

 

 

 

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Note 6 – Loans

 

Performing and non-performing loans by category were as follows as of September 30, 2011 and December 31, 2010 (in thousands):

 

 

_________________

*Non-Performing loans consist of loans that are on non-accrual status and loans 90 days past due and still accruing interest.

 

 

An aging analysis of loans outstanding by category as of September 30, 2011 and December 31, 2010 was as follows (in thousands):

 

 

 

 

 

Loans on non-accrual status as of September 30, 2011 and December 31, 2010 by category were as follows (in thousands):

 

 

Credit risk management procedures include assessment of loan quality through use of an internal loan rating system.  Each loan is assigned a rating upon origination and the rating may be revised over the life of the loan as circumstances warrant.  The rating system utilizes eight major classification types based on risk of loss with Grade 1 being the lowest level of risk and Grade 8 being the highest level of risk.  Loans internally rated Grade 1 to Grade 4 are considered “Pass” grade loans with low to average level of risk of credit losses.  Loans rated Grade 5 are considered “Special Mention” and generally have one or more circumstances that require additional monitoring but do not necessarily indicate a higher level of probable credit losses.  Loans rated Grade 6 or higher are loans with circumstances that generally indicate an above average level of risk for credit losses.  Loans by internal risk rating by category as of September 30, 2011 and December 31, 2010 were as follows:

 

 

 

Information regarding the Company’s impaired loans for the quarter ended September 30, 2011 and 2010 is as follows (in thousands):

 

 

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	Recorded Investment	Unpaid Principal Balance	Specific Allowance	Average Recorded Investment	Interest Income Recognized
September 30, 2011:
With no specific allocation recorded:
Commercial, financial and agricultural	$-	$-	N/A	$       5	$-
Real estate – construction	-	-	N/A	210	-
Real estate – mortgage	-	-	N/A	2,097	-
Installment loans to individuals	-	-	N/A	-	-
All other loans	-	-	N/A	-	-
With allocation recorded:
Commercial, financial and agricultural	$  500	$  500	$  50	$  548	$23
Real estate – construction(1)	1,236	1,236	572	1,131	0
Real estate – mortgage(2)	5,707	5,707	653	5,384	50
Installment loans to individuals(3)	166	166	36	188	-
All other loans	-	-	-	-	-
Total:
Commercial, financial and agricultural	$   500	$   500	$  50	$   553	$23
Real estate – construction	1,236	1,236	572	1,341	-
Real estate – mortgage	5,707	5,707	653	7,481	50
Installment loans to individuals	166	166	36	188	-
All other loans	-	-	-	-	-
September 30, 2010:
With no specific allocation recorded:
Commercial, financial and agricultural	$        -	$        -	N/A	$    138	$-
Real estate – construction	2,644	2,644	N/A	887	-
Real estate – mortgage	5,018	5,018	N/A	1,627	-
Installment loans to individuals	-	-	N/A	14	-
All other loans	-	-	N/A	58	-
With allocation recorded:
Commercial, financial and agricultural	$  500	$  500	$  50	$   421	$  18
Real estate – construction	1,209	1,209	635	5,107	206
Real estate – mortgage	4,000	4,000	586	7,770	229
Installment loans to individuals	202	202	34	181	2
All other loans	-	-	-	251	-
Total:
Commercial, financial and agricultural	$   500	$   500	$  50	$   559	$  18
Real estate – construction	3,853	3,853	635	5,993	206
Real estate – mortgage	9,018	9,018	586	9,397	229
Installment loans to individuals	202	202	34	194	2
All other loans	-	-	-	309	-

^{(1)   Impaired total for this category includes troubled debt restructurings with recorded investment totaling approximately $148,000 and a specific allowance of approximately $148,000.}

^{(2)   Impaired total for this category includes troubled debt restructurings with recorded investment totaling $2.6 million and specific allowance of approximately $255,000.}

^{(3)   Impaired total for this category includes troubled debt restructurings with recorded investment totaling approximately $8,000 and a specific allowance of less than $1,000.} 

 

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The Company adopted amendments in Accounting Standards Update No. 2011-01 as of September 30, 2011.  As a result, the Company reviewed loans classified as troubled debt restructurings (“TDRs”) that had been restructured during the nine months ended September 30, 2011 and confirmed that TDRs with a balance greater than or equal to $250,000 deemed to be impaired were properly identified as such and reviewed individually for impairment as reported in the impaired loan table above.  Loans meeting the criteria to be classified as TDRs with a balance less than $250,000 have historically been reviewed on a collective basis by risk code and loan category.  Reassessment of these loans on an individual basis upon adoption of the ASU No. 2011-01 for impairment did not result in a significant difference in the required allowance as the aggregate balance of loans reviewed was less than $20,000. 

 

Generally, loans are appropriately risk rated and identified for individual impairment review prior to when the restructure occurs.  Thus, in the normal life cycle of a loan, specific allocations if any are usually prior to a formal restructuring or at least at the time of restructuring rather than subsequent to modification.  Therefore, adoption of these amendments did not have a material impact on the volume of loans classified as TDRs or the related allowance for loan losses associated with TDRs.  Also, TDRs are included in non-accrual loans as reported in the above tables unless the loan has performed according to the modified terms for a length of time sufficient to support placing the loan on accrual status (generally six months).  Loans that have been restructured during the nine months ended September 30, 2011 consist of the following:

 

As of September 30, 2011
		Number of  Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings:
Commercial, financial and agricultural		0		$       -		$        -
Real estate – construction		1		155		148
Real estate – mortgage		4		2,577		2,554
Installment loans to individuals		2		9		8
All other loans		0		-		-
Total		7		$2,741		$2,710

 

Modification of the terms of the TDRs reported in the above table did not have a material impact to the consolidated financial statements or to the overall risk profile of the loan portfolio.  There were no TDRs that were modified during the year ended December 31, 2010 that re-defaulted in the nine months ended September 30, 2011.  The allowance for loan losses associated with the TDRs totaled approximately $407,000 as of September 30, 2011. 

 

 

Note 7 – Allowance for Loan Losses

 

The following table presents the breakdown of the allowance for loan losses by category and the percentage of each category in the loan portfolio to total loans as of September 30, 2011 and December 31, 2010 (dollars in thousands):

 

 

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	September 30, 2011		December 31, 2010
	Amount	% to Total Loans	Amount	% to Total Loans
Commercial, financial and agricultural	$1,461	14.93%	$   944	12.10%
Real estate – construction	1,771	7.39%	1,295	8.97%
Real estate – mortgage	4,439	71.78%	5,299	72.17%
Installment loans to individuals	378	5.24%	462	5.77%
All other loans	46	0.66%	28	0.99%
Total allowance for loan losses	$8,095	100.00%	$8,028	100.00%

 

 

An analysis of the allowance for loan losses by loan category for the nine months ended September 30, 2011 is as follows (in thousands):

 

	Beginning balance		Charge-offs		Recoveries		Provision		Ending balance
Allowance for loan losses
Commercial, financial and agricultural	$   944		($809)		$63		$1,263		$1,461
Real estate – construction	1,295		(378)		51		803		1,771
Real estate – mortgage	5,299		(755)		61		(166)		4,439
Installment loans to individuals	462		(144)		53		7		378
All other loans	28		0		0		18		46
Total	$8,028		($2,086)		$228		$1,925		$8,095

 

The allowance for loan losses is comprised of allocations for loans evaluated individually and loans evaluated collectively for impairment.  The allocations of the allowance for loan losses for outstanding loans by category evaluated individually and collectively were as follows as of September 30, 2011 and December 31, 2010 (in thousands):

 

 

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Note 8 – Bank Owned Life Insurance

 

The Bank has a significant investment in bank-owned life insurance policies (“BOLI”) and provides the associated fringe benefit to certain employees in the position of Vice President and higher after one year of service.  The cash surrender values of BOLI were $21.3 million and $21.7 million as of September 30, 2011 and December 31, 2010, respectively.  BOLI are initially recorded at the amount of premiums paid and are adjusted to current cash surrender values.  Changes in cash surrender values are recorded in other non-interest income and are based on premiums paid less expenses plus accreted interest income.  Earnings on BOLI resulted in non-interest income of approximately $175,000 and $190,000 for the quarters ended September 30, 2011 and 2010, respectively. 

 

The Company adopted guidance in ASC 715-60 effective January 1, 2008.  The cumulative effect adjustment to retained earnings for change in accounting principle was recorded January 1, 2008 in the amount of $1.9 million to accrue the post-retirement death benefits for endorsement split dollar life insurance plans.  Expense related to these accruals is reflected in Salaries and Employee Benefits on the Consolidated Income Statements.  Expense for this benefit totaled $15,000 for the nine months ended September 30, 2011 compared to $133,000 for the nine months ended September 30, 2010.  The decrease in expense in 2011 is attributable to a reduction in the liability associated with death benefit that was paid from policy proceeds.  The accrual for the post-retirement death benefits is included in Other Liabilities on the Consolidated Balance Sheet and totaled $2.4 million as of September 30, 2011 and $2.4 million as of December 31, 2010.   

 

Note 9 – Goodwill and Intangible Assets

 

Goodwill is not amortized and is tested for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired.  The goodwill impairment test is conducted in first quarter annually and is a two-step test.  The first step, used to identify potential impairment, involves comparing each reporting unit’s estimated fair value to its carrying value, including goodwill.  Currently the Company has one reporting unit and does not meet the tests to segment under generally accepted accounting standards.  If the estimated fair value of the reporting unit exceeds its carrying value, goodwill is considered not to be impaired. If the carrying value exceeds estimated fair value, thesre is an indication of potential impairment and the second step is performed to measure the amount of impairment.

 

 

 

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If required, the second step involves calculating an implied fair value of goodwill which is determined in a manner similar to the amount of goodwill calculated in a business combination, by measuring the excess of the estimated fair value of the reporting unit, as determined in the first step, over the aggregate estimated fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination.  If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment.  If the carrying value of goodwill exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess.  An impairment loss cannot exceed the carrying value of goodwill.

 

Our stock price has historically traded above its book value per common share and tangible book value per common share and was trading above its book value per common share and tangible book value per common share as of September 30, 2011.  In the event our stock price were to trade below its book value per common share and tangible book value per common share, an evaluation of the carrying value of goodwill would be performed as of the reporting date.  Such a circumstance would be one factor in our evaluation that could result in an eventual goodwill impairment charge. Additionally, should our future earnings and cash flows decline and/or discount rates increase, an impairment charge to goodwill and other intangible assets may also be required.

 

No impairment of goodwill is recorded in the current or prior reportable periods.  Total goodwill as of September 30, 2011 was $11.8 million or 1.15% of total assets or 11.69% of total equity. 

 

Amortization expense of the other identifiable intangibles was approximately $21,000 per quarter during the nine months ended September 30, 2011 and 2010.

 

Note 10 –Borrowings

 

The Bank has three sources of short-term borrowings, which consist of cash management advances from the FHLB, Treasury, Tax and Loan (“TT&L”) option note, and federal funds purchased from correspondent banks.  Short-term borrowings are used to manage seasonal fluctuations in liquidity. 

 

Cash management advances from FHLB are secured by one-to-four family first mortgages under the blanket collateral pledge agreement that also collateralizes long-term advances from FHLB and have maturities of 90 days or less.  There were no short-term borrowings outstanding against this line as of December 31, 2010 and totaled $4 million as of September 30, 2011.  The one $4 million short-term advance matures in October 2011.

 

The Bank is an Option B bank in regards to TT&L and up to $1 million in TT&L payments collected can be retained as a short-term option note.  This option note is callable upon demand by the TT&L.  The balance of this line was $1 million as of September 30, 2011 and as of December 31, 2010 and is reported in Short Term Borrowings in the Consolidated Balance Sheets.

 

The Bank has four correspondent bank federal fund lines of credit available totaling $54.5 million.  There were no federal funds purchased as of September 30, 2011 or December 31, 2010. 

 

The Bank had secured long-term advances from the FHLB totaling $37.1 million as of September 30, 2011 and $41.9 million as of December 31, 2010 that are reported in Other Borrowings on the Consolidated Balance Sheets.  FHLB borrowings are comprised primarily of fixed rate positions with principal due at call date or maturity date with interest rates ranging from 1.15% to 5.09%.  Most of these FHLB borrowings have quarterly call features and maturities range from 2011 to 2019.  Advances totaling $16 million require repayment if the call feature is exercised.  Under the existing and forecasted rate environments, borrowings with call features in place are not likely to be called in the next 12 months.  The Bank has one LIBOR based variable rate advance totaling $2.5 million with a rate of 0.24% as of September 30, 2011.  Also included in the FHLB borrowings total reported above is a pool of smaller balance amortizing advances that total $1.1 million as of September 30, 2011 and $1.4 million as of year-end 2010.  These smaller balance advances have rates ranging from 3.34% to 7.05% and maturities range from 2012 to 2019.  Obligations are secured by loans totaling $375 million consisting of the Bank’s entire portfolio of fully disbursed, one-to-four family residential mortgages, commercial mortgages, farm mortgages, second mortgages and multi-family residential mortgages.  The Bank had additional borrowing capacity of $114 million as of September 30, 2011.  Of the $37.1 million long-term advances as of September 30, 2011, principal due in twelve months totals $3.4 million.

 

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In March 2005, the Company formed a wholly owned subsidiary -- First Citizens (TN) Statutory Trust III.  The trust was created as a Delaware statutory trust for the sole purpose of issuing and selling trust preferred securities and using proceeds from the sale to acquire long-term subordinated debentures issued by the Company.  The debentures are the sole assets of the trust.  The Company owns 100% of the common stock of the trust.

 

On March 17, 2005, the Company, through First Citizens (TN) Statutory Trust III, sold 5,000 of its floating rate trust preferred securities at a liquidation amount of $1,000 per security for an aggregate amount of $5.0 million.  For the period beginning on (and including) the date of original issuance and ending on (but excluding) June 17, 2005, the rate per annum was 4.84%.  For each successive period beginning on (and including) June 17, 2005, and each succeeding interest payment date, interest accrues at a rate per annum equal to the three-month LIBOR plus 1.80%.  Interest payment dates are March 17, June 17, September 17, and December 17 during the 30-year term.  The entire $5.0 million in proceeds was used to reduce other debt at the Company.  The Company’s obligation under the debentures and related documents constitute a full and unconditional guarantee by the Company of the trust issuer’s obligations under the trust preferred securities. 

 

In March 2007, the Company formed a wholly owned subsidiary -- First Citizens (TN) Statutory Trust IV.  The trust was created as a Delaware statutory trust for the sole purpose of issuing and selling trust preferred securities and using proceeds from the sale to acquire long-term subordinated debentures issued by the Company.  The debentures are the sole assets of the trust.  The Company owns 100% of the common stock of the trust. 

 

In March 2007, the Company, through First Citizens (TN) Statutory Trust IV, sold 5,000 of its floating rate trust preferred securities at a liquidation amount of $1,000 per security for an aggregate amount of $5.0 million.  For the period beginning on (and including) the date of original issuance and ending on (but excluding) June 15, 2007, the rate per annum was 7.10%.  For each successive period beginning on (and including) June 15, 2007, and each succeeding interest payment date, interest accrues at a rate per annum equal to the three-month LIBOR plus 1.75%.  Interest payment dates are March 15, June 15, September 15, and December 15 during the 30-year term.  The purpose of proceeds was to refinance the debt issued through First Citizens (TN) Statutory Trust II at a lower spread to LIBOR and results in savings of approximately $92,500 annually.  First Citizens (TN) Statutory Trust II was dissolved as a result of this transaction.  The Company’s obligation under the debentures and related documents constitute a full and unconditional guarantee by the Company of the trust issuer’s obligations under the trust preferred securities. 

 

Although for accounting presentation the trust preferred securities are presented as debt (and reported in Other Borrowings on the Consolidated Balance Sheets), the outstanding balance qualifies as Tier I capital for regulatory reporting purposes subject to the limitation that the amount of the securities included in Tier I Capital cannot exceed 25% of total Tier I capital.

 

The Company is dependent on the profitability of its subsidiaries and their ability to pay dividends in order to service its long-term debt.

 

Note 11 – Fair Value Measurements

 

Fair value measurements are used to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  The Company measures fair value under guidance provided by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”), and was effective January 1, 2008 for all applicable financial and non-financial assets and liabilities.  ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosure requirements regarding fair value measurements.  ASC 820 does not expand the use of fair value in any new circumstances but clarifies the principle that fair value should be based on assumptions that market participants would use when pricing the asset or liability. ASC 820 outlines the following three acceptable valuation techniques may be used to measure fair value: 

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a.	Market approach—The market approach uses prices and other relevant information generated by market transactions involving identical or similar assets or liabilities.  This technique includes matrix pricing that is a mathematical technique used principally to value debt securities without relying solely on quoted prices for specific securities but rather by relying on securities’ relationship to other benchmark quoted securities.
b.	Income approach—The income approach uses valuation techniques to convert future amounts such as earnings or cash flows to a single present discounted amount.  The measurement is based on the value indicated by current market expectations about those future amounts.  Such valuation techniques include present value techniques, option-pricing models (such as the Black-Scholes-Merton formula or a binomial model), and multi-period excess earnings method (used to measure fair value of certain intangible assets).
c.	Cost approach—The cost approach is based on current replacement cost which is the amount that would currently be required to replace the service capacity of an asset.

 

Valuation techniques are selected as appropriate for the circumstances and for which sufficient data is available.  Valuation techniques are to be consistently applied, but a change in valuation technique or its application may be made if the change results in a measurement that is equally or more representative of fair value under the circumstances.  Revisions resulting from a change in valuation technique or its application are accounted for as a change in accounting estimate which does not require the change in accounting estimate to be accounted for by restating or retrospectively adjusting amounts reported in financial statements of prior periods or by reporting pro forma amounts for prior periods. 

 

ASC 820 also establishes a hierarchy that prioritizes information used to develop those assumptions.  The level in the hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.  The Company considers an input to be significant if it drives more than 10% of the total fair value of a particular asset or liability.  The hierarchy is as follows:

 

• Level 1 Inputs (Highest ranking):      Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

 

• Level 2 Inputs:      Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.  Such inputs may include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted market prices that are observable for the assets and liabilities such as interest rates and yield curves that are observable at commonly quoted intervals.

 

• Level 3 Inputs (Lowest ranking):       Unobservable inputs for determining fair values of assets and liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets and liabilities.

 

Assets and liabilities may be measured for fair value on a recurring basis (daily, weekly, monthly or quarterly) or on a non-recurring basis in periods subsequent to initial recognition.  Recurring valuations are measured regularly for investment securities.  Loans held for sale, other real estate and impaired loans are measured at fair value on a non-recurring basis and do not necessarily result in a change in the amount recorded on the Consolidated Balance Sheets.  Generally, these assets have non-recurring valuations that are the result of application of other accounting pronouncements that require the assets be assessed for impairment or at the lower of cost or fair value.  Fair values of loans held for sale are considered Level 2.  Fair values for other real estate and impaired loans are considered Level 3. 

 

 

 

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The Company obtains fair value measurements for securities from a third party vendor.  The majority of the available-for-sale securities are valued using Level 2 inputs.  Collateralized debt obligation securities that are backed by trust preferred securities and account for less than 1% of the available-for-sale securities portfolio are valued using Level 3 inputs.  The fair value measurements reported in Level 2 are primarily matrix pricing that considers observable data (such as dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and terms and conditions of bonds, and other factors).  Fair value measurements for pooled trust-preferred securities are obtained through the use of valuation models that include unobservable inputs which are considered Level 3. 

 

Certain non-financial assets and non-financial liabilities measured at fair value on a recurring basis include reporting units measured at fair value in the first step of a goodwill impairment test. Certain non-financial assets measured at fair value on a non-recurring basis include non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, as well as intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment. 

 

Effective January 1, 2008, the Company adopted ASC 820, which permits the Company to choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses on items for which the fair value measurement option has been elected are reported in earnings at each subsequent reporting date. The fair value option (i) may be applied instrument by instrument, with certain exceptions enabling the Company to record identical financial assets and liabilities at fair value or by another measurement basis permitted under generally accepted accounting principles, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire instruments and not to portions of instruments. Adoption of ASC 820 on January 1, 2008 did not have a material impact on the Company’s financial condition or results of operation.

 

Recurring Basis

 

The following are descriptions of valuation methodologies used for assets and liabilities measured at fair value on a recurring basis.

 

Available for Sale Securities

 

Fair values for available-for-sale securities are obtained from a third party vendor and are valued using Level 2 inputs, except for TRUP CDOs which are accounted for using Level 3 inputs.  TRUP CDOs accounted for less than 1% of the portfolio at September 30, 2011 and December 31, 2010. 

 

The markets for TRUP CDOs and other similar securities were not active at September 30, 2011 or December 31, 2010.  The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which these securities trade and then by a significant decrease in the volume of trades relative to historical levels.  The new issue market has also been relatively inactive. 

               

The market values for TRUP CDOs and other securities except for those issued or guaranteed by the U.S. Treasury have been very depressed relative to historical levels.  For example, the yield spreads for the broad market of investment grade and high yield corporate bonds reached all-time levels versus Treasuries at the end of November 2008 and remained close to those levels at September 30, 2011.  Therefore, low market prices for a particular bond may only have provided evidence of stress in credit markets in general rather than being an indicator of credit problems with a particular issuer over the past three years. 

 

Given conditions in debt markets for this type of security at September 30, 2011 and December 31, 2010 and the relative inactivity in the secondary and new issue markets, the Company determined:

 

• Few observable transactions existed and market quotations that were available were not reliable for purposes of determining fair value as of September 30, 2011 or December 31, 2010;

 

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• An income valuation approach technique (present value technique) that maximized the use of relevant observable inputs and minimized the use of unobservable inputs were equally or more representative of fair value than the market approach valuation technique used at prior measurement dates; and

 

• The Company’s TRUP CDOs should be classified within Level 3 of the fair value hierarchy because significant adjustments were required to determine fair value at the measurement date.

 

The Company’s TRUP CDO valuations were prepared by an independent third party. The third party’s approach to determining fair value involved these steps as of September 30, 2011 and December 31, 2010:

 

• The credit quality of the collateral was calibrated by assigning default probabilities to each issuer;

• Asset defaults were generated taking into account both the probability of default of the asset and an assumed level of correlation among the assets;

• A 50% level of correlation was assumed among assets from the same industry (e.g., banks with other banks) while a lower (30%) correlation level is assumed among those from different industries;

• The loss given default was assumed to be 100% (i.e., no recovery);

• The cash flows were forecast for the underlying collateral and applied to each TRUP CDO tranche to determine the resulting distribution among the securities;

• The calculations were modeled in 10,000 scenarios using a Monte Carlo engine;

• The expected cash flows for each scenario were discounted using a discount rate that the third party calculates for each bond that represents an estimate of the yield that would be required in today’s market for a bond with a similar credit profile as the bond in question; and

• The prices were aggregated and the average price was used for valuation purposes.

 

The Company recalculated the overall effective discount rates for these valuations.  The overall discount rates ranged from 19% to 45% and were highly dependent upon the credit quality of the collateral, the relative position of the tranche in the capital structure of the TRUP CDO and the prepayment assumptions.

 

A summary of assets and liabilities as of September 30, 2011 and December 31, 2010 measured at estimated fair value on a recurring basis is as follows (in thousands):

 

	Level 1		Level 2		Level 3		Total Fair
	Inputs		Inputs		Inputs		Value
September 30, 2011:
Financial assets:
Securities available-for-sale	$       -		$334,499		$      515		$335,014
December 31, 2010:
Financial assets:
Securities available-for-sale	$      -		$294,384		$      439		$294,823

 

 

The following table presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarters ended September 30, 2011 and 2010 (in thousands):

 

 

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	Three months ended September 30,				Nine months ended September 30,
	2011		2010		2011		2010
Available-for-sale securities:
Beginning balance	$     563		$1,509		$  439		$  1,727
Total unrealized gains (losses) included in:
Net income	(48)		(356)		(48)		(527)
Other comprehensive income	5		107		129		60
Purchases, sales, issuances and settlements, net	(5)