[August 08, 2011] SEACOAST BANKING CORP OF FLORIDA - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) SECOND QUARTER 2011 The following discussion and analysis is designed to provide a better understanding of the significant factors related to the Company's results of operations and financial condition. Such discussion and analysis should be read in conjunction with the Company's Condensed Consolidated Financial Statements and the related notes included in this report. For purposes of the following discussion, the words the "Company," "we," "us," and "our" refer to the combined entities of Seacoast Banking Corporation of Florida and its direct and indirect wholly owned subsidiaries. EARNINGS OVERVIEW The past three years have been difficult for the U.S. economy and for the financial services industry generally. Higher credit costs, primarily the result of loan portfolio pressure stemming from ongoing deterioration in real estate values, as well as increasing unemployment and other factors, negatively impacted the Company's earnings. Property value declines, which began in late 2007, continued through 2010 in most of our markets. While the Company did not have material exposure to many of the issues that originally plagued the industry (e.g., sub-prime loans, structured investment vehicles and collateralized debt obligations), the Company's exposure to construction and land development and the residential housing sector pressured its loan portfolio, resulting in increased credit costs and foreclosed asset expenses. As the economic downturn continued, consumer confidence and weak economic conditions began to impact areas of the economy outside of the housing sector and restrained new loan demand from credit worthy borrowers. Throughout this difficult operating environment, the Company has been proactively positioning its business for growth in the future by aggressively focusing on improving credit quality, de-risking the overall loan portfolio, disposing of problem assets, and focusing on growing core deposits. As a result of these efforts, the Company reported net income of $358,000 and $1,113,000 for the first and second quarters of 2011, its first profits since the first quarter of 2008. Net gain available to common shareholders (after preferred dividends and accretion of preferred stock discount) for the second quarter of 2011 totaled $176,000 or $0.00 per average common diluted share, a significant improvement when compared to losses for the first quarter of 2011 of $579,000 or $0.01 per average share diluted, and 2010 for the fourth, third, second and first quarters of $11,142,000 or $0.12 per average common diluted share, $8,575,000 or $0.09 per average common diluted share, $14,733,000 or $0.25 per average common diluted share, and $2,501,000 or $0.04 per average common diluted share, respectively. The better performance for the first six months of 2011 reflects lower credit costs (including lower provisioning for loan losses), and reflects our determination in tackling risk exposures over that past couple years while planning for growth prospectively. The net interest margin decreased 12 basis points during the second quarter of 2011 from the first quarter of 2011, but was improved by 9 basis points from the second quarter of 2010's margin. A decline in loans, higher cash liquidity, and lower loan and investment security yields have been 22 -------------------------------------------------------------------------------- Table of Contents largely offset by improved loan quality and a larger investment securities portfolio. The Company has continued to benefit from lower rates paid for interest bearing liabilities due to the Federal Reserve's reduction in interest rates. The Company has improved its acquisition, retention and mix of deposits and this has resulted in lower funding costs and improved profitability. The average cost of interest bearing liabilities was 0.95 percent for the second quarter of 2011, compared to 0.98 percent for the first quarter of 2011, and was 22 basis points lower compared to the second quarter of 2010. Loans as a percentage of average earning assets declined and securities increased during the quarter, compared to the first quarter of 2011 and second quarter of 2010. The yield on earning assets declined by 24 basis points during the second quarter of 2011, compared to the first quarter of 2011, and was 10 basis points lower than for the second quarter of 2010. Loan demand has been better during the first six months of 2011 with improved loan production but is expected to continue to be challenging, and may impede further improvement to the yield on earning assets. Noninterest income totaled $4.2 million and $4.5 million for the first and second quarters of 2011, respectively, compared to $4.2 million and $4.3 million for the first and second quarters of 2010, respectively, $4.5 million for the third quarter of 2010, and $5.2 million for the fourth quarter of 2010. Fourth quarter 2010's result included a $600,000 gain on the sale of the Company's merchant business. A surge in home purchase closings before year-end and a seasonal slowing of home purchase transactions in early 2011 resulted in mortgage banking revenues during the first quarter of 2011 declining $185,000 compared to the fourth quarter of 2010. However, improved stability in home prices and greater transaction volumes in the second quarter of 2011 resulted in higher income from residential real estate production, up $114,000 from first quarter 2011's result and up $45,000 year over year. Revenue from wealth management services was $8,000 lower but service charges on deposits were $94,000 higher when compared to second quarter 2010 as were improved results in interchange income, greater by $173,000 for the second quarter of 2011. Consumer activity and spending has improved, affected by economic conditions getting better and directly affecting many of the Company's fee-based business activities. Service charges and fees derived from customer relationships increased as a result of more accounts and households as a result of the retail deposit growth strategy. Overdraft fees related to check card payments beginning in the third quarter of 2010 were impacted by a requirement that customers elect to opt in for overdraft protection to be available for these types of payments, but the negative impacts were mostly offset by increased fees as a result of the growth in new deposit account households. Noninterest expenses decreased by $594,000 versus first quarter 2011's result but were $202,000 higher when compared to the second quarter of 2010. Expenses associated with other real estate owned and asset dispositions were stable compared to the reduced level of the first quarter of 2011, but higher by $1.2 million compared to the prior year's second quarter. Overhead related to salaries and wages, the largest component of overall overhead, were nearly unchanged compared to the first quarter of 2011 and were $242,000 lower than the second quarter of 2010. Lower provisioning for loan losses for the first and second quarters of 2011 of $0.6 million and $0.9 million, respectively, compared to provisioning of $4.0 million, $8.9 million, $16.8 million and $2.1 million for the fourth, third, second and first quarters of 2010, respectively. Provisions for loans losses were much higher during 2009 and 2010 as a result of higher net charge-offs and the Company increasing its allowance for loan losses to loans outstanding ratio to over 3 percent 23 -------------------------------------------------------------------------------- Table of Contents during these years. The allowance for loan losses to loans outstanding ratio at June 30, 2011 was 2.63 percent. CRITICAL ACCOUNTING ESTIMATES The preparation of consolidated financial statements requires management to make judgments in the application of certain of its accounting policies that involve significant estimates and assumptions. Management, after consultation with the Company's Audit Committee, believes the most critical accounting estimates and assumptions that involve the most difficult, subjective and complex assessments are: • the allowance and the provision for loan losses; • the fair value and other than temporary impairment of securities; • realization of deferred tax assets; and • contingent liabilities. The following is a discussion of the critical accounting policies intended to facilitate a reader's understanding of the judgments, estimates and assumptions underlying these accounting policies and the possible or likely events or uncertainties known to us that could have a material effect on our reported financial information. Allowance and Provision for Loan Losses The information contained on pages 29-31 and 38-48 related to the "Provision for Loan Losses", "Loan Portfolio", "Allowance for Loan Losses" and "Nonperforming Assets" is intended to describe the known trends, events and uncertainties which could materially affect the Company's accounting estimates related to our allowance for loan losses. Fair Value and Other than Temporary Impairment of Securities Classified as Available for Sale At June 30, 2011, outstanding securities designated as available for sale totaled $611,231,000. The fair value of the available for sale portfolio at June 30, 2011 was more than historical amortized cost, producing net unrealized gains of $8,167,000 that have been included in other comprehensive income (loss) as a component of shareholders' equity (net of taxes). The Company made no change to the valuation techniques used to determine the fair values of securities during 2011 and 2010. The fair value of each security available for sale was obtained from independent pricing sources utilized by many financial institutions. The fair value of many state and municipal securities are not readily available through market sources, so fair value estimates are based on quoted market price or prices of similar instruments. Generally, the Company obtains one price for each security. However, actual values can only be determined in an arms-length transaction between a willing buyer and seller that can, and often do, vary from these reported values. Furthermore, significant changes in recorded values due to changes in actual and perceived economic conditions can occur rapidly, producing greater unrealized losses or gains in the available for sale portfolio. 24 -------------------------------------------------------------------------------- Table of Contents The credit quality of the Company's securities holdings currently is investment grade. Any securities rated below investment grade are tested for other than temporary impairment, or "OTTI". As of June 30, 2011, the Company's investment securities, except for approximately $9.1 million of securities issued by states and their political subdivisions, generally are traded in liquid markets. U.S. Treasury and U.S. Government agency obligations totaled $527.8 million, or 86 percent of the total available for sale portfolio. The remainder of the portfolio primarily consists of private label securities secured by collateral originated in 2005 or prior with low loan to values, and current FICO scores above 700. Generally these securities have credit support exceeding 5%. The collateral underlying these mortgage investments are primarily 30- and 15-year fixed rate, 5/1 and 10/1 adjustable rate mortgage loans. Historically, the mortgage loans serving as collateral for those investments have had minimal foreclosures and losses. These investments are reviewed quarterly for other than temporary impairment, by considering the following primary factors: percent decline in fair value, rating downgrades, subordination, duration, amortized loan-to-value, and the ability of the issuers to pay all amounts due in accordance with the contractual terms. Prices obtained from pricing services are usually not adjusted. Based on our internal review procedures and the fair values provided by the pricing services, we believe that the fair values provided by the pricing services are consistent with the principles of ASC 820. However, on occasion pricing provided by the pricing services may not be consistent with other observed prices in the market for similar securities. Using observable market factors, including interest rate and yield curves, volatilities, prepayment speeds, loss severities and default rates, the Company may at times validate the observed prices using a discounted cash flow model and using the observed prices for similar securities to determine the fair value of its securities. Changes in the fair values, as a result of deteriorating economic conditions and credit spread changes, should only be temporary. Further, management believes that the Company's other sources of liquidity, as well as the cash flow from principal and interest payments from the securities portfolio, reduces the risk that losses would be realized as a result of a need to sell securities to obtain liquidity. The Company also holds stock in the Federal Home Loan Bank of Atlanta ("FHLB") totaling $6.0 million as of June 30, 2011, $0.4 million lower than at year-end 2010. The Company accounts for its FHLB stock based on the industry guidance in ASC 942, Financial Services-Depository and Lending, which requires the investment to be carried at cost and evaluated for impairment based on the ultimate recoverability of the par value. We evaluated our holdings in FHLB stock at June 30, 2011 and believe our holdings in the stock are ultimately recoverable at par. We do not have operational or liquidity needs that would require redemption of the FHLB stock in the foreseeable future and, therefore, have determined that the stock is not other-than-temporarily impaired. Realization of Deferred Tax Assets At June 30, 2011, the Company has net deferred tax assets ("DTA") of $16.9 million which are supported by tax planning strategies that could produce gains from transactions involving bank premises, investments, and other items that could be implemented during the NOL carry forward period. 25 -------------------------------------------------------------------------------- Table of Contents As a result of the losses incurred in 2008, 2009, and 2010 the Company was and is in a three-year cumulative pretax loss position. A cumulative loss position is considered significant negative evidence in assessing the prospective realization of a DTA from a forecast of future taxable income. The use of the Company's forecast of future taxable income was not considered positive evidence which could be used to offset the negative evidence at this time. Therefore, the Company has recorded deferred tax valuation allowances for its net operating loss carryforwards totaling approximately $47 million at June 30, 2011. Should the economy show signs of improvement and our credit costs continue to moderate, management anticipates that increased reliance on its forecast of future taxable earnings would result in tax benefits as the recording of valuation allowances would no longer be necessary. It is management's opinion that Seacoast National's future taxable income will ultimately allow for the recovery of the NOL, and the realization of its deferred tax assets. Contingent Liabilities The Company is subject to contingent liabilities, including judicial, regulatory and arbitration proceedings, and tax and other claims arising from the conduct of our business activities. These proceedings include actions brought against the Company and/or our subsidiaries with respect to transactions in which the Company and/or our subsidiaries acted as a lender, a financial advisor, a broker or acted in a related activity. Accruals are established for legal and other claims when it becomes probable the Company will incur an expense and the amount can be reasonably estimated. Company management, together with attorneys, consultants and other professionals, assesses the probability and estimated amounts involved in a contingency. Throughout the life of a contingency, the Company or our advisors may learn of additional information that can affect our assessments about probability or about the estimates of amounts involved. Changes in these assessments can lead to changes in recorded reserves. In addition, the actual costs of resolving these claims may be substantially higher or lower than the amounts reserved for those claims. At June 30, 2011 and 2010, the Company had no significant accruals for contingent liabilities. RESULTS OF OPERATIONS NET INTEREST INCOME Net interest income (on a fully taxable equivalent basis) for the second quarter of 2011 totaled $16,596,000, increasing from 2011's first quarter by $78,000 or 0.5 percent, and higher than second quarter 2010's result by $310,000 or 1.9 percent. The following table details net interest income and margin results (on a tax equivalent basis) for the past five quarters: Net Interest Net Interest Income Margin (Dollars in thousands) (tax equivalent) (tax equivalent) Second quarter 2010 $ 16,286 3.27 % Third quarter 2010 16,532 3.35 Fourth quarter 2010 16,379 3.42 First quarter 2011 16,518 3.48 Second quarter 2011 16,596 3.36 26 -------------------------------------------------------------------------------- Table of Contents Fully taxable equivalent net interest income is a common term and measure used in the banking industry but is not a term used under generally accepted accounting principles ("GAAP"). We believe that these presentations of tax-equivalent net interest income and tax equivalent net interest margin aid in the comparability of net interest income arising from both taxable and tax-exempt sources over the periods presented. We further believe these non-GAAP measures enhance investors' understanding of the Company's business and performance, and facilitate an understanding of performance trends and comparisons with the performance of other financial institutions. The limitations associated with these measures are the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently, including as a result of using different assumed tax rates. These disclosures should not be considered an alternative to GAAP. The following information is provided to reconcile GAAP measures and tax equivalent net interest income and net interest margin on a tax equivalent basis. Second First Fourth Third Second Quarter Quarter Quarter Quarter Quarter 2011 2011 2010 2010 2010 (Dollars in thousands) Non-taxable interest income $ 109 $ 119 $ 112 $ 138 $ 135 Tax Rate 35 % 35 % 35 % 35 % 35 % Net interest income (TE) $ 16,596 $ 16,518 $ 16,379 $ 16,532 $ 16,286 Total net interest income (not TE) 16,541 16,456 16,321 16,461 16,217 Net interest margin (TE) 3.36 % 3.48 % 3.42 % 3.35 % 3.27 % Net interest margin (not TE) 3.35 3.47 3.41 3.33 3.25 Net interest income and net interest margin (on a tax equivalent basis) have stabilized despite the challenging lending environment and the reduction of interest due to nonaccrual loans. Net interest margin on a tax equivalent basis decreased 12 basis points to 3.36 percent for the second quarter of 2011 compared to the first quarter of 2011, but was 9 basis points higher year over year. The level of nonaccrual loans and changes in the earning assets mix have been the primary forces that have adversely affected net interest income and net interest margin when comparing results for 2011 and 2010 to 2009 and prior periods. The earning asset mix changed year over year impacting net interest income. For the second quarter of 2011, average loans (the highest yielding component of earning assets) as a percentage of average earning assets totaled 61.7 percent, compared to 67.3 percent a year ago. Average securities as a percent of average earning assets increased from 19.5 percent a year ago to 30.0 percent during the second quarter of 2011 and interest bearing deposits and other investments decreased to 8.3 percent in 2011 from 13.2 percent in 2010. In addition to decreasing average total loans as a percentage of earning assets, the mix of loans changed, with volumes related to commercial real estate representing 45.4 percent of total loans at June 30, 2011 (compared to 48.8 percent at June 30, 2010). This reflects our reduced exposure to commercial construction and land development loans on residential and commercial properties, which declined by $20.3 million and $24.5 million, respectively, from June 30, 2010 to June 30, 2011. Lower yielding residential loan balances with individuals (including home equity loans and lines, and personal construction loans) represented 46.2 percent of total loans at June 30, 2011 (versus 42.7 percent a year ago) (see "Loan Portfolio"). 27 -------------------------------------------------------------------------------- Table of Contents The yield on earning assets for the second quarter of 2011 was 4.12 percent, ten basis points lower than for 2010 in the second quarter, a reflection of the lower interest rate environment and earning asset mix. The Federal Reserve has indicated its intent to continue rates at their historical lows for an extended period. The following table details the yield on earning assets (on a tax equivalent basis) for the past five quarters: 2nd 1st 4th 3rd 2nd Quarter Quarter Quarter Quarter Quarter 2011 2011 2010 2010 2010 Yield 4.12 % 4.26 % 4.24 % 4.23 % 4.22 % The yield on loans decreased 10 basis points to 5.09 percent over the last twelve months, with nonaccrual loans totaling $46.2 million or 3.9 percent of total loans at June 30, 2011 (versus $90.9 million or 7.0 percent of total loans a year ago), improving the yield on our loan portfolio. The yield on investment securities was lower, decreasing 35 basis points year over year to 3.11 percent for the second quarter of 2011, due primarily to purchases of securities at lower yields available in current markets, which diluted the overall portfolio yield year over year. This compares to dilution in yield of 56 basis points during the first quarter of 2011 year over year. Interest bearing deposits and other investments yielded 0.48 percent for the second quarter of 2011, slightly above second quarter 2010's yield of 0.41 percent. The Company has over $125 million of cash liquidity it can invest in securities or loans at higher yields when management deems it appropriate. Average earning assets for the second quarter of 2011 decreased $42.9 million or 2.1 percent compared to 2010's second quarter average balance. Average loan balances decreased $140.0 million or 10.3 percent to $1,221.4 million, while average investment securities were $200.5 million or 50.9 percent higher totaling $594.8 million and average interest bearing deposits and other investments decreased $103.5 million or 38.7 percent to $163.8 million. The decline in average earning assets is consistent with reduced funding as a result of a planned reduction in brokered deposits (only $7.5 million remain outstanding at June 30, 2011) and certificates of deposit (principally single service deposit customers). Commercial and commercial real estate loan production for the six months of 2011 totaled approximately $28 million, compared to production for all of 2010 and 2009 of $10 million and $14 million, respectively. Period-end total loans outstanding have declined by $111.7 million or 8.6 percent since June 30, 2010. In comparison, the decline in loans was more severe a year ago, decreasing during the second quarter of 2010 year over year by $283.7 million or 17.9 percent. Economic conditions in the markets the Company serves have continued to be challenging, but possibly to a lessened degree if the consensus opinion that conditions will improve in 2011 is realized. At June 30, 2011 the Company's total commercial and commercial real estate loan pipeline was $60 million, versus $28 million at December 31, 2010 and $14 million at June 30, 2010. A total of 20 applications were received seeking restructured residential mortgages during the second quarter of 2011, compared to 17 application during the first quarter of 2011 and 37, 28, 15 and 21 in the first, second, third and fourth quarters of 2010, respectively. The Company continues to lend, and we have expanded our residential mortgage loan originations and seek to expand loans to small businesses in 2011. However, as consumers and businesses seek to reduce 28 -------------------------------------------------------------------------------- Table of Contents their borrowings, and the economy remains weak, opportunities to lend prudently to creditworthy borrowers are expected to remain a challenge. Closed residential mortgage loan production for the first and second quarters of 2011 totaled $32 million and $50 million, respectively, of which $13 million and $18 million was sold servicing released. In comparison, closed residential mortgage loan production for the first, second, third and fourth quarters of 2010 totaled $33 million, $33 million, $38 million and $49 million, respectively, of which $17 million, $26 million, $29 million and $28 million was sold servicing-released, respectively. Applications for residential mortgages totaled $80 million and $60 million, respectively, during the first and second quarters of 2011, compared to $52 million and $55 million during the same periods in 2010, and $244 million for all of 2010. Existing home sales and home mortgage loan refinancing activity in the Company's markets have increased, but demand for new home construction is expected to remain soft during 2011. During the first and second quarters of 2011 there were no securities gains or losses. In comparison, during the first and second quarters of 2010, proceeds from the sale of mortgage backed securities totaling $59.2 million and $27.9 million, respectively, resulted in securities gains of $2,100,000 and $1,377,000, respectively. Purchases in 2011 have been conducted principally to reinvest funds from maturities and loan principal repayments, as well as to reinvest excess funds (an interest bearing deposit) at the Federal Reserve Bank. During the first and second quarters of 2010 maturities (entirely pay-downs) totaled $35.2 million and $33.2 million, respectively, and securities portfolio purchases totaled $56.8 million and $74.7 million, respectively. The cost of average interest-bearing liabilities in the second quarter of 2011 decreased 3 basis points to 0.95 percent from first quarter 2011 and was 22 basis points lower than for the second quarter of 2010, reflecting the lower interest rate environment and improved deposit mix. The following table details the cost of average interest bearing liabilities for the past five quarters: 1st 1st 4th 3rd 2nd Quarter Quarter Quarter Quarter Quarter 2011 2011 2010 2010 2010 Rate 0.95 % 0.98 % 1.01 % 1.09 % 1.17 % For the first six months of 2011, the Company's retail core deposit focus continues to produce strong growth in core deposit customer relationships when compared to prior year results. The improved deposit mix and lower rates paid on interest bearing deposits during 2011 (and last several quarters) reduced the overall cost of total deposits to 0.70 percent for the second quarter of 2011, 24 basis points lower than the same quarter a year ago. A significant component favorably affecting the Company's net interest margin, the average balances of lower cost interest bearing deposits (NOW, savings and money market) totaled 61.1 percent of total average interest bearing deposits for the second quarter of 2011, an improvement compared to the average of 60.6 percent a year ago. The average rate for lower cost interest bearing deposits for the second quarter of 2011 was 0.31 percent, down by 25 basis points from 2010's rate for the same period. Certificate of deposit ("CD") rates paid were also lower during the second quarter of 2011, averaging 1.74 percent, a 25 basis point decrease compared to 2010' second quarter result. Average CDs (the highest cost component of interest bearing deposits) were 38.9 percent of interest bearing deposits for 2011's second quarter, compared to 39.4 percent a year ago. 29 -------------------------------------------------------------------------------- Table of Contents Average short-term borrowings have been principally comprised of sweep repurchase agreements with customers of Seacoast National, which increased $18.3 million to $105.1 million or 21.1 percent from the second quarter of 2010. Public fund clients with larger balances have the most significant influence on average sweep repurchase agreement balances outstanding during the year, with balances typically peaking during the fourth and first quarters each year. During 2011 and 2010, no federal funds purchased were utilized. Other borrowings are comprised of subordinated debt of $53.6 million related to trust preferred securities issued by trusts organized by the Company, and advances from the FHLB of $50.0 million. No changes have occurred to other borrowings since year-end 2009. Company management believes its market expansion, branding efforts and retail deposit growth strategies have produced new relationships and core deposits, which have assisted in maintaining a stable net interest margin. Reductions in nonperforming assets also are expected to be accretive to the Company's future net interest margin. PROVISION FOR LOAN LOSSES Management determines the provision for loan losses charged to operations by continually analyzing and monitoring delinquencies, nonperforming loans and the level of outstanding balances for each loan category, as well as the amount of net charge-offs, and by estimating losses inherent in its portfolio. While the Company's policies and procedures used to estimate the provision for loan losses charged to operations are considered adequate by management, factors beyond the control of the Company, such as general economic conditions, both locally and nationally, make management's judgment as to the adequacy of the provision and allowance for loan losses necessarily approximate and imprecise (see "Nonperforming Assets" and "Allowance for Loan Losses"). The provision for loan losses is the result of a detailed analysis estimating an appropriate and adequate allowance for loan losses. The analysis includes the evaluation of impaired loans as prescribed under FASB Accounting Standards Codification ("ASC") 310 as well as, an analysis of homogeneous loan pools not individually evaluated as prescribed under ASC 450. For the first and second quarters of 2011 a lower provisioning for loan losses of $0.6 million and $0.9 million, respectively, was recorded, a substantial improvement over provisioning in 2010 for the first, second, third and fourth quarters of $2.1 million, $16.7 million, $8.9 million and $4.0 million, respectively. The net charge-offs for the first and second quarters of 2011 totaled $4.0 million for each quarter, respectively, compared to net charge-offs for the first, second, third and fourth quarters of 2010 of $3.5 million, $20.2 million, $10.7 million and $4.7 million, respectively. Net charge-offs represented 1.32 percent of average total loans for the first six months of 2011, versus 2.95 percent of average total loans for all of 2010. Delinquency trends show continued stability (see "Nonperforming Assets"). Note E to the financial statements (titled "Impaired Loans and Valuation Allowance for Loan Losses") provides certain information concerning the Company's allowance and provisioning for loan losses for the first six months of 2011 and 2010. The Company's commercial construction and land development loans for residential properties have been reduced to $12.2 million or 1.0 percent of total loans at June 30, 2011 (see "Loan 30 -------------------------------------------------------------------------------- Table of Contents Portfolio"), down from approximately $32.5 million or 2.5 percent of total loans at June 30, 2010. Total commercial real estate ("CRE") loans have declined 14.8 percent from $634.1 million at June 30, 2010 to $540.0 million at June 30, 2011. Under regulatory guidelines for commercial real estate concentrations, Seacoast National's total commercial real estate loans outstanding (as defined in the guidance) represented 186 percent of total risk based capital at June 30, 2011. The Company has also reduced its concentrations of large individual loan relationships over the periods compared, which the Company believes has reduced overall risk in its loan portfolio. The following table details the Company's reduced exposure to large commercial construction and land development loans for residential properties over the past five quarters, as evidenced by loans in this portfolio with balances of $4 million or more declining from $10.2 million at June 30, 2010 to no outstanding balance at June 30, 2011. Of the remaining $12.2 million in commercial construction and land development loans for residential properties with balances of less than $4 million, $1.2 million or 10 percent are classified as nonperforming. QUARTERLY TRENDS - LOANS AT END OF PERIOD (Dollars in Millions) 2011 2010 2011 Nonperforming 2nd Qtr 3rd Qtr 4th Qtr 1st Qtr 2nd Qtr 2nd Qtr No. Residential Construction and Land Development Condominiums >$4 mil $ - $ - $ - $ - $ - $ - - <$4 mil 0.9 0.9 0.9 0.5 - - - Town homes >$4 mil - - - - - - - <$4 mil - - - - - - - Single Family Residences >$4 mil - - - - - - - <$4 mil 3.6 3.8 - - - - - Single Family Land & Lots >$4 mil 5.9 - - - - - - <$4 mil 9.6 10.3 7.0 6.6 6.5 0.1 2 Multifamily >$4 mil 4.3 - - - - - - <$4 mil 8.2 6.3 6.1 6.1 5.7 1.1 2 TOTAL >$4 mil 10.2 - - - - - - TOTAL <$4 mil 22.3 21.3 14.0 13.2 12.2 1.2 4 GRAND TOTAL $ 32.5 $ 21.3 $ 14.0 $ 13.2 $ 12.2 $ 1.2 4 The Company's other loan portfolios related to residential real estate are amortizing loans. The Company has never offered sub-prime, Alt A, Option ARM or any negative amortizing residential loans, programs or products, although it has originated and holds residential mortgage loans from borrowers with original or current FICO credit scores that are currently less than "prime" FICO credit scores. Substantially all residential originations have been underwritten to conventional loan agency standards, including loans having balances that exceed agency value limitations. The Company selectively adds residential mortgage loans to its portfolio, primarily loans with adjustable rates. Home equity loans (amortizing loans for home improvements with maturities of 31 -------------------------------------------------------------------------------- Table of Contents 10 to 15 years) totaled $63.1 million and home equity lines totaled $56.9 million at June 30, 2011, compared to $79.0 million and $58.8 million at June 30, 2010. Each borrower's credit was fully documented as part of the Company's underwriting of home equity lines. The Company never promoted home equity lines greater than 80 percent of value or used credit scoring solely as the underwriting criteria. Therefore this portfolio of loans, primarily to customers with other relationships to Seacoast National, has performed better than portfolios of our peers. Net charge-offs for the six months ended June 30, 2011 totaled $244,000 for home equity lines, compared to $1,694,000 for all of 2010, and home equity lines past due 90 days or more and nonaccrual lines (aggregated) were $1,415,000 and $414,000 at June 30, 2011 and 2010, respectively. Congress and bank regulators have encouraged recipients of Troubled Asset Relief Program ("TARP") capital to use such capital to make more loans. In that respect, the Company has successfully increased its residential mortgage production in 2011 and 2010. A total of 630 applications were taken during 2011 with an aggregate value of $140 million with $82 million in loans closed, compared to 1,168 applications taken for all of 2010 with an aggregate value of $244 million and $152 million in loans closed. Existing home sales and home mortgage loan refinancing activity in the Company's markets have increased, however demand for new home construction is expected to remain soft. NONINTEREST INCOME Noninterest income, excluding gains or losses from securities, totaled $4,547,000 for the second quarter of 2011, $295,000 or 6.9 percent higher than for 2010's second quarter and $338,000 or 8.0 percent higher than the first quarter 2011. Noninterest income accounted for 21.6 percent of total revenue (net interest income plus noninterest income, excluding securities gains or losses) in the second quarter of 2011, compared to 20.8 percent a year ago. Noninterest income for the first and second quarters of 2011, and the second quarter of 2010, is detailed as follows: 2nd Qtr 1st Qtr 2nd Qtr (Dollars in thousands) 2011 2011 2010 Service charges on deposits $ 1,546 $ 1,442 $ 1,452 Trust income 517 523 491 Mortgage banking fees 509 395 464 Brokerage commissions and fees 223 320 257 Marine finance fees 349 298 310 Interchange income 995 891 822 Other deposit-based EFT fees 79 90 82 Other income 329 250 374 Total $ 4,547 $ 4,209 $ 4,252 For the second quarter of 2011, revenues from the Company's wealth management services businesses (trust and brokerage) decreased year over year, by $8,000 or 1.1 percent, and were lower than the first quarter of 2011 by $103,000 or 12.2 percent. Included in the $8,000 decrease, trust revenue was higher by $26,000 or 5.3 percent and brokerage commissions and fees were lower by $34,000 or 13.2 percent. Economic uncertainty is the primary issue affecting 32 -------------------------------------------------------------------------------- Table of Contents clients of the Company's wealth management services. It is expected that fees from wealth management will continue to improve as the economy and stock market improve. Included in the $34,000 overall decline in brokerage commissions and fees for second quarter 2011 was a decrease of $38,000 in aggregate brokerage and mutual fund commissions. Higher inter vivos trust, estate and agency trust fees were the primary cause for the higher trust income versus a year ago, as these increased $11,000, $10,000 and $6,000, respectively. For the six months ended June 30, 2011, income from the company's wealth management services was $73,000 or 4.8 percent higher compared to 2010. Service charges on deposits for the second quarter of 2011 were $94,000 or 6.5 percent higher year over year versus 2010's second quarter result, and were $104,000 or 7.2 percent higher when compared to first quarter 2011. Overdraft fees represented approximately 75 percent of total service charges on deposits for the second quarter of 2011, slightly below the average of 76 percent for all of 2010 and the second quarter of 2010. We are pleased with this result considering all financial institutions adopted procedures beginning on July 1, 2010 expected to result in a negative impact on overdraft fee income. Remaining service charges on deposits increased $35,000 or 10.0 percent to $388,000. Service charges on deposits increased each quarter throughout 2010 and for the first six months of 2011 year over year, reflecting the growth in core deposit households over the last couple years. Year-to-date service charges on deposits for 2011 increased $164,000 or 5.8 percent year over year to $2,988,000. For the second quarter of 2011, fees from the non-recourse sale of marine loans originated by our Seacoast Marine Division of Seacoast National increased $39,000 or 12.6 percent compared to second quarter 2010, and compared to first quarter 2011 were $51,000 or 17.1 percent higher. Approximately $5 million of first quarter 2011's marine loan production was placed in our loan portfolio, thereby reducing the percentage of production sold during the first quarter of 2011. The Seacoast Marine Division originated $23 million and $21 million in loans during the first and second quarters of 2011, respectively, compared to $25 million, $17 million, $17 million and $20 million in loans during the first, second, third and fourth quarters of 2010 (a total of $79 million for 2010), respectively. Of the loans originated during the first and second quarters of 2011, and first, second, third and fourth quarters of 2010, $18 million, $19 million, $20 million, $17 million, $17 million and $20 million were sold (84.1 percent of production for 2011 and 93.7 percent of production for all of 2010). Production levels have been significantly lower since the end of 2008 and are reflective of the general economic downturn. Lower attendance at boat shows by consumers, manufacturers, and marine retailers over the past couple years has resulted in lower marine sales and loan volumes. The Seacoast Marine Division is headquartered in Ft. Lauderdale, Florida with lending professionals in Florida, California, Washington and Oregon. Greater usage of check or debit cards over the past several years by core deposit customers and an increased cardholder base has increased our interchange income. For second quarter 2011, interchange income increased $173,000 or 21.0 percent from second quarter 2010, and was $104,000 or 11.7 percent higher than first quarter 2011. Other deposit-based electronic funds transfer ("EFT") income decreased $3,000 or 3.7 percent from second quarter 2010 and compared to first quarter 2011, was $11,000 or 12.2 percent lower. Interchange revenue is dependent upon business volumes transacted, as well as the fees permitted by VISA® and MasterCard®. At present, the Dodd-Frank regulation is not expected to impact this source of fee revenue for Seacoast National materially, but is expected to significantly reduce fees collected by 33 -------------------------------------------------------------------------------- Table of Contents larger financial institutions that may in turn affect Seacoast National unfavorably as markets adjust to this legislative change. The Company originates residential mortgage loans in its markets, with loans processed by commissioned employees of Seacoast National. Many of these mortgage loans are referred by the Company's branch personnel. Mortgage banking fees in the second quarter of 2011 increased $45,000 or 9.7 percent from second quarter 2010, and were $114,000 or 28.9 percent higher than first quarter 2011. A seasonal slowing on home purchase transactions in early 2011 was the primary cause for the lower results for the first quarter of 2011. Mortgage banking revenue as a component of overall noninterest income was 10.3 percent for the first six months of 2011, compared to 11.0 percent for all of 2010. Mortgage revenues are dependent upon favorable interest rates, as well as good overall economic conditions, including the volume of new and used home sales. We are beginning to see some signs of stability for residential real estate sales and activity in our markets, with transactions increasing, prices firming and affordability improving. The Company had more mortgage loan origination opportunities in markets it serves during 2010 and this is expected to continue during 2011. The Company increased production in 2010 and 2011 by increasing its market share and the Company was the number one originator in its Martin, St. Lucie and Indian River counties of home purchase mortgages. The Company has only had to repurchase two sold mortgage loans and believes that its processes and controls make it unlikely that it has any material exposure in the future. For the first six months of 2011, mortgage banking income was $19,000 or 2.1 percent higher than a year ago. Other income for second quarter 2011 decreased $45,000 or 12.0 percent compared to the second quarter a year ago, but from first quarter 2011 was $79,000 or 31.6 percent higher. Of the $45,000 decline for 2011 compared to second quarter 2010, merchant income (net) was $52,000 lower and the primary cause. Contributing significantly to the increase from first quarter 2011 operating income from a Community Reinvestment Act (CRA) investment was $113,000 higher, a result of fair market value adjustments (declining valuations) on realty held recorded during the first quarter. NONINTEREST EXPENSES The Company's overhead ratio has typically been in the low 60's in years prior to the recession. Lower earnings in 2010, 2009, and 2008 resulted in this ratio increasing to 104.6 percent, 86.9 percent and 77.8 percent, respectively. For the first six months of 2011, the overhead ratio was 91.7 percent. When compared to second quarter 2010, total noninterest expenses for second quarter 2011 increased by $202,000 or 1.1 percent to $19,073,000, and when compared to first quarter 2011, expenses were lower by $594,000 or 3.0 percent. The primary cause for the increase in 2011 over 2010 was higher net losses on OREO and repossessed assets and asset disposition costs (aggregated), by $1,168,000 versus second quarter a year ago. For the first six months ended June 30, 2011, noninterest expenses were $3,103,000 or 7.4 percent lower versus a year ago, totaling $38,740,000. Noninterest expenses for the second quarter of 2011 have been in line with our expectations. Salaries, wages and benefits combined totaled $7,971,000, lower by $224,000 or 2.7 percent than the same quarter in 2010. Executive cash incentive compensation has not been accrued in 2011, nor was any paid in 2010, 2009 or 2008. Cost reductions were also achieved in communication 34 -------------------------------------------------------------------------------- Table of Contents costs, marketing expenses, and FDIC assessments, all of which declined when compared to second quarter 2010's results. While salaries and wages for the second quarter of 2011 decreased $242,000 or 3.6 percent to $6,534,000 when compared to the prior year's second quarter, employee benefit costs were slightly higher, by $18,000 or 1.3 percent to total $1,437,000. Salary and wages were nominally lower compared to first quarter of 2011. Severance during the second quarter 2011 was $186,000 lower than in the second quarter a year ago. Commission and incentive payments on revenues generated from wealth management and lending production were higher for 2011, up by 183,000 or 37.5 percent compared to second quarter 2010, but were more than offset by deferred origination costs on loan production that were $214,000 or 84.3 percent higher year over year, reflecting improved loan production. Base salaries for the second quarter 2011 were $14,000 or 0.2 percent lower year over year compared to second quarter 2010, with 414 full time equivalent employees ("FTE's") employed at June 30, 2011. The Company recognized lower claims experience during the second quarter of 2011 for its self-funded health care plan compared to second quarter 2010, with a decrease of $10,000 in expenditures. More than offsetting, 401K costs were $20,000 higher for second quarter 2011 versus a year ago and unemployment compensation costs were $9,000 higher year over year for the second quarter of 2011, due primarily to the state of Florida increasing unemployment compensation rates to replenish funding pools for disbursements. Employee benefit costs were $160,000 or 5.0 percent lower for the first half of 2011 compared to a year ago. The Company has met with its self-funded plan provider and discussed possible impacts of U.S. Health Care Reform and determined that no immediate or material financial statement impacts are apparent. Outsourced data processing costs totaled $1,699,000 for the second quarter of 2011, an increase of $196,000 or 13.0 percent from second quarter a year ago, and year-to-date outsourced data processing costs for 2011 increased $239,000 or 8.0 percent. Seacoast National utilizes third parties for its core data processing systems. Outsourced data processing costs are directly related to the number of transactions processed. Core data processing and software licensing costs were $164,000 and $43,000 higher for second quarter 2011, versus a year ago for the second quarter. Outsourced data processing costs can be expected to increase as the Company's business volumes grow and new products such as bill pay, internet banking, etc. become more popular. Telephone and data line expenditures, including electronic communications with customers and between branch locations and personnel, as well as third party data processors, decreased by $83,000 or 20.6 percent to $319,000 for the second quarter of 2011 when compared to second quarter 2010, and for the six months ended June 30, 2011 were $193,000 or 24.1 percent lower than a year ago. Improved systems and monitoring of services utilized as well as reducing the number telephone lines has reduced our communication costs, and these costs should continue to be lower prospectively. Total occupancy, furniture and equipment expenses for the second quarter of 2011 grew $41,000 or 1.6 percent to $2,537,000 year over year, versus second quarter 2010. For the six months ended June 30, 2011, these costs were 0.6 percent higher as well. Included in the $41,000 increase during the second quarter of 2011 were write-offs for equipment at closed branch offices of $52,000 that compared to gains on the sale of equipment of $35,000 a year ago, an increase of $87,000 year over year. Lease payments for bank premises were higher by $23,000 35 -------------------------------------------------------------------------------- Table of Contents and rental income (a contra-expense item) was $21,000 less for the second quarter of 2011. Partially offsetting, lower depreciation and real estate taxes on bank owned property were lower, declining $66,000 and $25,000, respectively. For the second quarter of 2011, marketing expenses, including sales promotion costs, ad agency production and printing costs, newspaper and radio advertising, and other public relations costs associated with the Company's efforts to market products and services, decreased by $246,000 or 26.9 percent to $667,000 when compared to the second quarter of 2010. Year-to-date for 2011, marketing expense is $150,000 or 9.6 percent lower than a year ago. Marketing expenses for 2011 and 2010 reflect a focused campaign in our markets targeting the customers of competing financial institutions and promoting our brand. Agency fees, public relations costs, donations (and sponsorships), and business meals and entertainment were ramped up the most during the second quarter of 2010, increasing $51,000, $33,000, $18,000 and $36,000, respectively, year over year. More than offsetting, media costs (newspaper, television and radio advertising), sales promotions and direct mail activities declined during the second quarter of 2011 versus a year ago, by $190,000, $25,000 and $145,000, respectively. Legal and professional fees were nearly the same year over year for the second quarter, decreasing by $17,000 or 1.1 percent to $1,585,000 for the second quarter of 2011, compared to a year ago, and were $361,000 or 9.7 percent lower for the first half of 2011 compared to 2010. Legal fees were $88,000 higher for the second quarter of 2011 year over year, primarily costs related to problem assets, principally OREO. Also, regulatory examination fees and CPA fees on an aggregate basis were $17,000 higher for the second quarter of 2011 than a year ago. More than offsetting, professional fees were $124,000 lower for 2011 versus second quarter 2010's expenditures, reflecting higher costs for strategic planning and risk management assistance in 2010. The Company uses the consulting services of a former bank regulator who also serves as a director of Seacoast National to assist it with its compliance with the bank's formal agreement with the OCC and regulatory examinations. For the six months ended June 30, 2011, Seacoast National paid $125,000 for these services, compared to $301,000 in the first half of 2010. The FDIC assessment for the first quarter and second quarters of 2011 totaled $959,000 and $688,000, respectively, compared to first, second, third and fourth quarter 2010's assessments of $1,006,000, $1,039,000, $966,000 and $947,000, respectively. The FDIC mandated the prepayment of assessments for three years plus fourth quarter 2009's assessment on December 30, 2009. The amount of the prepayment totaled $14.8 million. As of April 1, 2011, the FDIC's calculation of assessments has changed, utilizing total assets less Tier 1 risk-based capital as a base for calculation, versus average total deposits. Applicable premium rates have been adjusted for the change in the base, with specific adjusting risk factors deemed important by the FDIC utilized in the determination of applicable premium rates. Assessments under the FDIC's new methodology were $271,000 lower compared to the first quarter of 2011 and $351,000 lower compared to the second quarter a year ago, and should compare favorably to prior year assessments prospectively. Still, the Company remains exposed to higher FDIC insurance costs, with assessment rates possibly increasing depending on the severity of bank failures and their impact on the FDIC's Deposit Insurance Fund. Net losses on other real estate owned (OREO) and repossessed assets, and asset disposition expenses associated with the management of OREO and repossessed assets (aggregated) totaled $1,535,000 and $1,583,000 for the first and second quarters of 2011, compared to $4,073,000, 36 -------------------------------------------------------------------------------- Table of Contents $415,000, $1,436,000 and $9,885,000 for the first, second, third and fourth quarters of 2010, respectively. These costs were more moderate during the second and third quarters of 2010 as well. Of the $3,118,000 total for 2011 year-to-date, assets disposition costs summed to $1,527,000 and net losses on OREO and repossessed assets totaled $1,591,000. Other noninterest expenses decreased $282,000 or 12.2 percent to $2,024,000 for the second quarter of 2011 when comparing to the same period a year ago. Decreasing year over year from 2010's second quarter were stationery and supplies costs (down $33,000), amortization of intangible assets (down $34,000), property appraisals (down $120,000), directors fees (down $60,000), postage (down $89,000) and employee placement costs (down $65,000, including headhunter fees). Also, favorably affecting the second quarter of 2011 versus a year ago was a reversal of $184,000 for an accrual for a cash settlement with a brokerage subsidiary client based on a favorable outcome. Higher year over year were check printing costs (up $20,000, due to higher transaction account volumes), bank paid closing costs and referral fees (up $64,000), charge-offs related to robbery and customer fraud (up $112,000), and mileage reimbursement and other related travel costs (up $41,000), filing and licensing fees (up $15,000, primarily for brokers), employee relations (up $18,000), and bank meetings (up $19,000). Other noninterest expenses for the six month period ended June 30, 2011 were $586,000 or 12.3 percent lower than in 2010 for the same period. One-time cash settlements for a branch lease and to a client of Seacoast National's brokerage subsidiary (each for $150,000) recorded during the first quarter of 2010, combined with the reversal of $184,000 during the second quarter of 2011 for the brokerage settlement, accounted for $484,000 of the decrease from last year for the first six months. INCOME TAXES The provision for the income taxes (benefits) for the first and second quarters of 2011 totaled $0.2 million and $0.4 million, respectively, and the benefit for the net loss for the first, second, third and fourth quarters of 2010 totaled $(0.6) million, $(5.3) million, $(2.8) million and $(3.9) million, respectively. The deferred tax valuation allowance was decreased or increased by a like amount, and therefore there was no change in the carrying value of deferred tax assets which are supported by tax planning strategies (see "Critical Accounting Estimates - Deferred Tax Assets"). CAPITAL RESOURCES The Company's equity capital at June 30, 2011 totaled $171.1 million and the ratio of shareholders' equity to period end total assets was 8.22 percent, compared with 8.93 percent at June 30, 2010, and 8.25 percent at December 31, 2010. Seacoast's management uses certain "non-GAAP" financial measures in its analysis of the Company's performance. Seacoast's management uses this measure to assess the quality of capital and believes that investors may find it useful in their analysis of the Company. This capital measure is not necessarily comparable to similar capital measures that may be presented by other companies. The Company's capital position remains strong, with a total risk-based capital ratio of 18.92 percent at June 30, 2011, higher than June 30, 2010's ratio of 18.85 percent and higher than 17.84 percent at December 31, 2010. 37 -------------------------------------------------------------------------------- Table of Contents The Company and Seacoast National are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal bank regulatory authority may prohibit the payment of dividends where it has determined that the payment of dividends would be an unsafe or unsound practice. The Company is a legal entity separate and distinct from Seacoast National and its other subsidiaries, and the Company's primary source of cash and liquidity, other than securities offerings and borrowings, is dividends from its bank subsidiary. Prior OCC approval presently is required for any payments of dividends from Seacoast National to the Company. The OCC and the Federal Reserve have policies that encourage banks and bank holding companies to pay dividends from current earnings, and have the general authority to limit the dividends paid by national banks and bank holding companies, respectively, if such payment may be deemed to constitute an unsafe or unsound practice. If, in the particular circumstances, either of these federal regulators determined that the payment of dividends would constitute an unsafe or unsound banking practice, either the OCC or the Federal Reserve may, among other things, issue a cease and desist order prohibiting the payment of dividends by Seacoast National or us, respectively. Under a recently adopted Federal Reserve policy, the board of directors of a bank holding company must consider different factors to ensure that its dividend level is prudent relative to the organization's financial position and is not based on overly optimistic earnings scenarios such as any potential events that may occur before the payment date that could affect its ability to pay, while still maintaining a strong financial position. As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company, such as Seacoast, should consult with the Federal Reserve and eliminate, defer, or significantly reduce the bank holding company's dividends if: (i) its net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) its prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; or (iii) it will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. As a result of our participation in the TARP CPP program, additional restrictions have been imposed on our ability to declare or increase dividends on shares of our common stock, including a restriction on paying quarterly dividends above $0.01 per share. Specifically, we are unable to declare dividend payments on our common, junior preferred or pari passu preferred shares if we are in arrears on the dividends on the Series A Preferred Stock. Further, without the Treasury's approval, we are not permitted to increase dividends on our common stock above $0.01 per share until December 19, 2011 unless all of the Series A Preferred Stock has been redeemed or transferred by the Treasury. In addition, we cannot repurchase shares of common stock or use proceeds from the Series A Preferred Stock to repurchase trust preferred securities. The consent of the Treasury generally is required for us to make any stock repurchase until December 19, 2011 unless all of the Series A Preferred Stock has been redeemed or transferred by the Treasury to a third party. Further, our common, junior preferred or pari passu preferred shares may not be repurchased if we have not declared and paid all Series A Preferred Stock dividends. Beginning in the third quarter of 2008, we reduced the dividend on our common stock to $0.01 per share and, as of May 19, 2009, we suspended the payment of dividends. On May 19, 2009, our board of directors decided to suspend regular quarterly cash dividends on our outstanding common stock and Series A Preferred Stock pursuant to a request from the Federal Reserve as a 38 -------------------------------------------------------------------------------- Table of Contents result of recently adopted Federal Reserve policies related to dividends and other distributions. The Company suspended the payment of dividends on its trust preferred securities as well. Dividends will be suspended until such time as dividends are allowed by the Federal Reserve. As of June 30, 2011, our accumulated deferred dividend payments on Series A Preferred Stock was $6,274,000 and our accumulated deferred interest payment on trust preferred securities was $2,473,000. At June 30, 2011, the capital ratios for the Company and its subsidiary, Seacoast National, were as follows: Seacoast Seacoast Minimum to be (Consolidated) National Well Capitalized* June 30, 2011: Tier 1 capital ratio 17.65 % 16.13 % 6 % Total risk-based capital ratio 18.92 % 17.40 % 10 % Tier 1 leverage ratio 10.23 % 9.35 % 5 % * For subsidiary bank only FINANCIAL CONDITION Total assets decreased $9,949,000 or 0.5 percent from June 30, 2010 to $2,082,863,000 at June 30, 2011. LOAN PORTFOLIO Total loans (net of unearned income) were $1,188,945,000 at June 30, 2011, $111,655,000 or 8.6 percent less than at June 30, 2010, and $51,663,000 or 4.2 percent less than at December 31, 2010. The following table details loan portfolio composition at June 30, 2011, December 31, 2010 and June 30, 2010: June 30, December 31, June 30, (In thousands) 2011 2010 2010 Construction & land development $ 49,193 $ 79,306 $ 106,825 Commercial real estate 516,935 543,603 562,873 Residential real estate 523,062 516,994 519,645 Commercial and financial 48,012 48,825 49,949 Consumer 51,351 51,602 61,005 Other loans 392 278 303 Total $ 1,188,945 $ 1,240,608 $ 1,300,600 As shown in the loan table above, construction and land development loans declined $57.6 million or 53.9 percent to $49.2 million from June 30, 2010. The primary cause for the decrease in construction and land development loans was a reduction in commercial construction and land development loans for residential and commercial properties of $20.3 million or 62.5 percent and $27.9 million or 71.9 percent, respectively. Total outstanding balances for these portfolios have 39 -------------------------------------------------------------------------------- Table of Contents been reduced to $12.2 million and $10.9 million, respectively, at June 30, 2011. Construction and land development loans to individuals for personal residences included in total construction and land development loans were lower as well, declining $9.5 million or 26.7 percent to $26.1 million at June 30, 2011. Also declining were home equity mortgages and home equity lines, declining $15.9 million or 20.1 percent and $1.9 million or 3.2 percent, respectively, and totaling $63.1 million and $56.9 million at June 30, 2011. Adjustable and fixed rate residential real estate mortgages were higher year over year, by $18.4 million or 6.2 percent and $2.8 million or 3.3 percent, respectively, to $314.3 million and $88.8 million at June 30, 2011. At June 30, 2011, approximately $314 million or 60 percent of the Company's residential mortgage balances were adjustable, compared to $296 million or 57 percent at June 30, 2010. Loans secured by residential properties having fixed rates totaled approximately $89 million at June 30, 2011, of which 15- and 30-year mortgages totaled approximately $27 million and $62 million, respectively. The remaining fixed rate balances were comprised of home improvement loans, most with maturities of 10 years or less. In comparison, loans secured by residential properties having fixed rates totaled approximately $86 million at June 30, 2010, with 15- and 30-year fixed rate residential mortgages totaling approximately $28 million and $58 million, respectively. The Company also has a small home equity line portfolio totaling approximately $57 million at June 30, 2011, slightly lower than the $59 million that was outstanding at June 30, 2010. Commercial and financial loans and consumer loans (principally installment loans to individuals) decreased $1.9 million or 3.8 percent and $9.7 million or 15.9 percent, respectively, from a year ago to $48.0 million and $51.3 million at June 30, 2011, reflecting the impact on lending of the economic downturn. Commercial loans decreased and totaled $48.0 million at June 30, 2011, compared to $49.9 million a year ago. Commercial lending activities are directed principally towards businesses whose demand for funds are within the Company's lending limits, such as small- to medium-sized professional firms, retail and wholesale outlets, and light industrial and manufacturing concerns. Such businesses are smaller and subject to the risks of lending to small to medium sized businesses, including, but not limited to, the effects of a downturn in the local economy, possible business failure, and insufficient cash flows. The consumer loan portfolio (including installment loans, loans for automobiles, boats, and other personal, family and household purposes, and indirect loans through dealers to finance automobiles) totaled $51.3 million (versus $61.0 million a year ago), real estate construction loans to individuals secured by residential properties which totaled $6.7 million (versus $8.2 million a year ago), and residential lot loans to individuals which totaled $19.4 million (versus $27.4 million a year ago). 40 -------------------------------------------------------------------------------- Table of Contents Construction and land development loans, including loans secured by commercial real estate, were comprised of the following types of loans at June 30, 2011 and 2010: June 30 2011 2010 (In millions) Funded Unfunded Total Funded Unfunded Total Construction and land development* Residential: Condominiums $ - $ - $ - $ 0.9 $ - $ 0.9 Town homes - - - - - - Single Family Residences - - - 3.6 1.0 4.6 Single Family Land & Lots 6.5 - 6.5 15.5 0.1 15.6 Multifamily 5.7 - 5.7 12.5 - 12.5 12.2 - 12.2 32.5 1.1 33.6 Commercial: Office buildings - 0.4 0.4 - - - Retail trade - - - - - - Land 10.3 - 10.3 38.5 0.1 38.6 Industrial - - - 0.3 - 0.3 Healthcare - - - - - - Churches & educational Facilities - - - - - - Lodging - - - - - - Convenience Stores 0.6 - 0.6 - - - Marina - - - - - - Other - - - - - - 10.9 0.4 11.3 38.8 0.1 38.9 23.1 0.4 23.5 71.3 1.2 72.5 Individuals: Lot loans 19.4 - 19.4 27.4 - 27.4 Construction 6.7 11.2 17.9 8.2 7.0 15.2 26.1 11.2 37.3 35.6 7.0 42.6 Total $ 49.2 $ 11.6 $ 60.8 $ 106.9 $ 8.2 $ 115.1 * Reassessment of collateral assigned to a particular loan over time may result in amounts being reassigned to a more appropriate loan type representing the loan's intended purpose, and for comparison purposes prior period amounts have been restated to reflect the change. The Company's largest remaining commercial land loan of $21 million was foreclosed and sold in the second quarter 2011 under contract to the Florida Power and Light (an investor-owned utility company providing electric power throughout Florida, and a national provider of electricity services) late in the second quarter 2011. No further loss was recognized regarding this credit. Commercial real estate mortgage loans, excluding construction and development loans, were comprised of the following loan types at June 30, 2011 and 2010: June 30 2011 2010 (In millions) Funded Unfunded Total Funded Unfunded Total Office buildings $ 120.0 $ 0.8 $ 120.8 $ 128.2 $ 1.1 $ 129.3 Retail trade 149.6 - 149.6 155.9 - 155.9 Industrial 68.5 0.1 68.6 84.0 1.1 85.1 Healthcare 26.3 0.9 27.2 29.4 0.1 29.5 Churches and educational facilities 28.2 - 28.2 28.5 - 28.5 41 -------------------------------------------------------------------------------- Table of Contents June 30 2011 2010 (In millions) Funded Unfunded Total Funded Unfunded Total Recreation 2.8 - 2.8 3.0 0.4 3.4 Multifamily 16.8 - 16.8 23.6 - 23.6 Mobile home parks 2.4 - 2.4 2.6 - 2.6 Lodging 20.0 - 20.0 23.4 - 23.4 Restaurant 4.3 - 4.3 4.6 - 4.6 Agriculture 9.2 1.2 10.4 10.8 0.5 11.3 Convenience Stores 20.0 - 20.0 21.0 - 21.0 Marina 21.5 - 21.5 22.3 - 22.3 Other 27.3 0.3 27.6 25.5 0.3 25.8 Total $ 516.9 $ 3.3 $ 520.2 $ 562.8 $ 3.5 $ 566.3 Fixed rate and adjustable rate loans secured by commercial real estate, excluding construction loans, totaled approximately $331 million and $186 million, respectively, at June 30, 2011, compared to $327 million and $236 million, respectively, a year ago. The Company selectively adds residential mortgage loans to its portfolio, primarily loans with adjustable rates. The Company's asset mitigation personnel handle all foreclosure actions together with outside legal counsel and has never had its foreclosure documentation or processes questioned by any party involved in the transaction. Exposure to market interest rate volatility with respect to long-term fixed rate mortgage loans held for investment is managed by attempting to match maturities and re-pricing opportunities and through loan sales of most fixed rate product. At June 30, 2011, the Company had commitments to make loans of $97 million, compared to $95 million at June 30, 2010. Loan Concentrations Over the past three years, the Company has been pursuing an aggressive program to reduce exposure to loan types that have been most impacted by stressed market conditions in order to achieve lower levels of credit loss volatility. The program included aggressive collection efforts, loan sales and early stage loss mitigation strategies focused on the Company's largest loans. Successful execution of this program has significantly reduced our exposure to larger balance loan relationships (including multiple loans to a single borrower or borrower group). Commercial loan relationships greater than $10 million were reduced by $473.7 million to $123.8 million at June 30, 2011 compared with year-end 2007. Commercial Relationships Greater than $10 Million (dollars in thousands) June 30, Dec. 31, Dec. 31, Dec. 31, Dec. 31, 2011 2010 2009 2008 2007 Performing $ 95,936 $ 112,469 $ 145,797 $ 374,241 $ 592,408 Performing TDR* 14,842 28,286 31,152 - - Nonaccrual 13,065 20,913 28,525 14,873 5,152 Total $ 123,843 $ 161,668 $ 205,474 $ 389,114 $ 597,560 Top 10 Customer Loan Relationships $ 132,758 $ 151,503 $ 173,162 $ 228,800 $ 266,702 * TDR = Troubled debt restructures 42 -------------------------------------------------------------------------------- Table of Contents Commercial loan relationships greater than $10 million as a percent of tier 1 capital and the allowance for loan losses was reduced to 50.8 percent at June 30, 2011, compared with 66.5 percent at year-end 2010, 85.9 percent at year-end 2009, 162.1 percent at the end of 2008 and 258.1 percent at the end of 2007. Concentrations in total construction and development loans and total commercial real estate (CRE) loans have also been substantially reduced. As shown in the table below, under regulatory guidance for construction and land development and commercial real estate loan concentrations as a percentage of total risk based capital, Seacoast National's loan portfolio in these categories (as defined in the guidance) have improved. June 30, Dec. 31, Dec. 31, Dec. 31, Dec. 31, 2011 2010 2009 2008 2007 Construction & Land Development Loans to Total Risk Based Capital 24 % 39 % 81 % 206 % 265 % CRE Loans to Total Risk Based Capital 186 % 218 % 274 % 389 % 390 % 43 -------------------------------------------------------------------------------- Table of Contents Below is the geographic location of the Company's construction and land development loans (excluding loans to individuals) as a percent of total construction and land development loans. The significant increase in St. Lucie County at June 30, 2011 was caused by the overall decline in construction and land development loans, which declined from $71.3 million at June 30, 2010 to $23.1 million at June 30, 2011. % of Total Construction and Land Development Loans Florida County 2011 2010 St. Lucie 21.9 8.8 Brevard 16.0 6.8 Martin 15.1 6.6 Okeechobee 12.1 4.2 Palm Beach 11.4 34.4 Indian River 8.1 17.5 Broward 6.5 0.0 Orange 2.7 4.2 Lake 2.3 1.0 Hendry 2.2 1.0 Marion 1.0 0.4 Columbia 0.4 0.2 Charlotte 0.2 1.6 Collier 0.0 3.5 Miami-Dade 0.0 8.3 Volusia 0.0 1.4 Other 0.1 0.1 Total 100.0 100.0 ALLOWANCE FOR LOAN LOSSES Management continuously monitors the quality of the loan portfolio and maintains an allowance for loan losses it believes sufficient to absorb probable losses inherent in the loan portfolio. The allowance for loan losses totaled $31,231,000 or 2.63 percent of total loans at June 30, 2011, $9,050,000 lower than at June 30, 2010 and $6,513,000 less than at December 31, 2010. The allowance for loan losses framework has two basic elements: specific allowances for loans individually evaluated for impairment, and a formula-based component for pools of homogeneous loans within the portfolio that have similar risk characteristics, which are not individually evaluated. The first element of the ALLL analysis involves the estimation of allowance specific to individually evaluated impaired loans, including accruing and nonaccruing restructured commercial and consumer loans. In this process, a specific allowance is established for impaired loans based on an analysis of the most probable sources of repayment, including discounted cash flows, liquidation of collateral, or the market value of the loan itself. It is the Company's policy to charge off any portion of the loan deemed a loss. Restructured consumer loans are also evaluated in this element of the estimate. As of June 30, 2011, the specific allowance related to 44 -------------------------------------------------------------------------------- Table of Contents impaired loans individually evaluated totaled $11.6 million, compared to $10.3 million as of June 30, 2010. The second element of the ALLL, the general allowance for homogeneous loan pools not individually evaluated, is determined by applying allowance factors to pools of loans within the portfolio that have similar risk characteristics. The general allowance factors are determined using a baseline factor that is developed from an analysis of historical net charge-off experience and qualitative factors designed and intended to measure expected losses. These baseline factors are developed and applied to the various loan pools. Adjustments may be made to baseline reserves for some of the loan pools based on an assessment of internal and external influences on credit quality not fully reflected in the historical loss. These influences may include elements such as changes in concentration risk, macroeconomic conditions, and/or recent observable asset quality trends. In addition, our analyses of the adequacy of the allowance for loan losses also takes into account qualitative factors such as credit quality, loan concentrations, internal controls, audit results, staff turnover, local market conditions and loan growth. The Company's independent Credit Administration Department assigns all loss factors to the individual internal risk ratings based on an estimate of the risk using a variety of tools and information. Its estimate includes consideration of the level of unemployment which is incorporated into the overall allowance. In addition, the portfolio is segregated into a graded loan portfolio, residential, installment, home equity, and unsecured signature lines, and loss factors are calculated for each portfolio. The loss factors assigned to the graded loan portfolio are based on historical migration of actual losses by grade and a range of losses over various periods. Loss factors for the other portfolios are based on historical losses over the prior 12 months and prospective factors that consider loan type, delinquencies, loan to value, purpose of the loan, and type of collateral. Our charge-off policy meets or exceeds regulatory minimums. Losses on unsecured consumer loans are recognized at 90 days past due compared to the regulatory loss criteria of 120 days. Secured consumer loans, including residential real estate, are typically charged-off or charged down between 120 and 180 days past due, depending on the collateral type, in compliance with Federal Financial Institution Examination Council guidelines. Commercial loans and real estate loans are typically placed on nonaccrual status when principal or interest is past due for 90 days or more, unless the loan is both secured by collateral having realizable value sufficient to discharge the debt in-full and the loan is in the legal process of collection. Secured loans may be charged-down to the estimated value of the collateral with previously accrued unpaid interest reversed. Subsequent charge-offs may be required as a result of changes in the market value of collateral or other repayment prospects. Initial charge-off amounts are based on valuation estimates derived from appraisals, broker price opinions, or other market information. Generally, new appraisals are not received until the foreclosure process is completed; however, collateral values are evaluated periodically based on market information and incremental charge-offs are recorded if it is determined that collateral values have declined from their initial estimates. 45 -------------------------------------------------------------------------------- Table of Contents Management continually evaluates the allowance for loan losses methodology seeking to refine and enhance this process as appropriate, and it is likely that the methodology will continue to evolve over time. In general, collateral values for residential real estate have declined since 2006, with values being more stable over the last 18 months to 30 months. Loans originated from 2005 through 2007 have seen property values decline approximately 50 percent from their original appraised values, more than the decline on loans originated in other years. Declining residential collateral value has affected our actual loan losses over the last three years, but values appear to be stabilizing over the last twelve months. Residential loans that become 90 days past due are placed on nonaccrual. A specific allowance is made for any loan that becomes 120 days past due. Residential loans are subsequently written down if they become 180 days past due and such write-downs are supported by a current appraisal, consistent with current banking regulations. Our Loan Review unit is independent, and performs loan reviews and evaluates a representative sample of credit extensions after the fact for appropriate individual internal risk ratings. Loan Review has the authority to change internal risk ratings and is responsible for assessing the adequacy of credit underwriting. This unit reports directly to the Directors' Loan Committee of Seacoast National's Board of Directors. During the first and second quarters of 2011, net charge-offs totaled $4,031,000 and $4,024,000, respectively, compared to net charge-offs of during the first, second, third and fourth quarters of 2010 of $3,541,000, $20,209,000, $10,700,000 and $4,678,000, respectively. Some of the increase in charge-offs during 2010 was related to loan sales to reduce risk in the loan portfolio. Note E to the financial statements (titled "Impaired Loans and Valuation Allowance for Loan Losses) summarizes the Company's allocation of the allowance for loan losses to construction and land development loans, commercial and residential estate loans, commercial and financial loans, and consumer loans, and provides more specific detail regarding charge-offs and recoveries for each loan component and the composition of the loan portfolio at June 30, 2011. Although there is no assurance that we will not have elevated charge-offs in the future, we believe that we have significantly reduced the risks in our loan portfolio and that with stabilizing market conditions, future charge-offs should decline. The allowance as a percentage of loans outstanding was 2.63 percent at June 30, 2011, compared to 3.10 percent at June 30, 2010 and 3.04 percent at December 31, 2010. The allowance for loan losses represents management's estimate of an amount adequate in relation to the risk of losses inherent in the loan portfolio. Concentrations of credit risk, discussed under the caption "Loan Portfolio" of this discussion and analysis, can affect the level of the allowance and may involve loans to one borrower, an affiliated group of borrowers, borrowers engaged in or dependent upon the same industry, or a group of borrowers whose loans are predicated on the same type of collateral. The Company's most significant concentration of credit is a portfolio of loans secured by real estate. At June 30, 2011, the Company had $1.089 billion in loans secured by real estate, representing 91.6 percent of total loans, down from $1.189 billion, representing 91.4 percent at June 30, 2010. In addition, the Company is subject to a geographic concentration of credit because it only operates in central and southeastern Florida. The Company's exposure to construction and land development credits is secured by project assets and personal guarantees and totals $49.2 million at June 30, 46 -------------------------------------------------------------------------------- Table of Contents 2011, down from $106.9 million at June 30, 2010. The Company considers exposure to this industry group, together with an assessment of current trends and expected future financial performance in our evaluation of the adequacy of the allowance for loan losses. The significant decline in this concentration is one factor which supports the lower overall allowance for loan losses at June 30, 2011 compared to June 30, 2010. While it is the Company's policy to charge off in the current period loans in which a loss is considered probable, there are additional risks of future losses that cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, borrower payment behaviors and local market conditions as well as conditions affecting individual borrowers, management's judgment of the allowance is necessarily approximate and imprecise. The allowance is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses in comparison to a group of peer companies identified by the regulatory agencies. In assessing the adequacy of the allowance, management relies predominantly on its ongoing review of the loan portfolio, which is undertaken both to ascertain whether there are probable losses that must be charged off and to assess the risk characteristics of the portfolio in aggregate. This review considers the judgments of management, and also those of bank regulatory agencies that review the loan portfolio as part of their regular examination process. Our bank regulators have generally agreed with our credit assessment however the regulators could seek additional provisions to our allowance for loan losses, which will reduce our earnings. Seacoast National entered into a formal agreement with the Office of the Comptroller of the Currency (the "OCC") on December 16, 2008 to improve its asset quality. Under the formal agreement, Seacoast National's board of directors appointed a compliance committee to monitor and coordinate Seacoast National's performance under the formal agreement. The formal agreement provides for the development and implementation of written programs to reduce Seacoast National's credit risk, monitor and reduce the level of criticized assets, and manage commercial real estate loan ("CRE") concentrations in light of current adverse CRE market conditions. The Company believes it has complied with this formal agreement. NONPERFORMING ASSETS Nonperforming assets (NPAs) at June 30, 2011 totaled $72,042,000 and are comprised of $46,165,000 of nonaccrual loans and $25,877,000 of other real estate owned ("OREO"), compared to $109,903,000 at June 30, 2010 (comprised of $90,885,000 in nonaccrual loans and $19,018,000 of OREO). At June 30, 2011, approximately 98.7 percent of nonaccrual loans were secured with real estate, the remainder principally by marine vessels. See the table below for details about nonaccrual loans. At June 30, 2011, nonaccrual loans have been written down by approximately $20.2 million or 35.2 percent of the original loan balance (including specific impairment reserves). OREO has increased since June 30, 2010, as problem loans migrated to foreclosure. Prospectively, the Company anticipates write-downs and/or charge-offs related to OREO sales should be limited. 47 -------------------------------------------------------------------------------- Table of Contents The table below shows the nonperforming inflows by quarter for 2011, 2010 and 2009: New Nonperforming Loans 2011 2010 2009 First Quarter $ 11,349 $ 11,895 $ 37,170 Second Quarter 19,874 22,560 46,303 Third Quarter 8,151 75,295 Fourth Quarter 9,990 36,196 No sales of loans occurred during the first quarter of 2011, but as previously forecast the Company closed on contracts liquidating $27.5 million of nonperforming loans and $3.5 million of OREO properties during the second quarter of 2011 (including its largest land credit reducing NPAs by $21 million for this single asset). For 2010, sales totaled $28 million at an average price of nearly 56 percent of the outstanding ledger balance. The Company pursues loan restructurings in selected cases where it expects to realize better values than may be expected through traditional collection activities. The Company has worked with retail mortgage customers, when possible, to achieve lower payment structures in an effort to avoid foreclosure. Troubled debt restructurings ("TDRs") are part of the Company's loss mitigation activities and can include rate reductions, payment extensions and principal deferrals. Company policy requires TDRs be classified as nonaccrual loans until (under certain circumstances) performance can be verified, which usually requires six months of performance under the restructured loan terms. Accruing restructured loans totaled $60.2 million at June 30, 2011 compared to 64.9 million at June 30, 2010. Nonaccrual Loans Accruing June 30, 2011 Non- Per- Restructured (In thousands) Current forming Total Loans Construction & land development Residential $ 1,140 $ 39 $ 1,179 $ 2,504 Commercial - 6 6 - Individuals 594 764 1,358 691 1,734 809 2,543 3,195 Residential real estate mortgages 8,588 5,089 13,677 21,541 Commercial real estate mortgages 5,842 23,480 29,322 34,923 Real estate loans 16,164 29,378 45,542 59,659 Commercial and financial - - - 111 Consumer 107 516 623 468 $ 16,271 $ 29,894 $ 46,165 $ 60,238 At June 30, 2011 and 2010, total TDRs (performing and nonperforming) were comprised of the following loans by type of modification: 2011 2010 (Dollars in thousands) Number Amount Number Amount Rate reduction 91 $ 24,175 73 $ 20,299 Maturity extended with change in terms 113 45,850 129 65,635 Forgiveness of principal 2 2,434 2 2,624 Payment structure changed to allow for interest only payments 4 2,497 1 416 Not elsewhere classified 18 15,580 5 6,021 228 $ 90,537 210 $ 94,995 48 -------------------------------------------------------------------------------- Table of Contents All impaired loans are reviewed quarterly to determine if valuation adjustments are necessary based on known changes in the market and/or the project assumptions. When necessary, the "As Is" appraised value may be adjusted based on more recent appraisal assumptions received by the Company on other similar properties, the tax assessed market value, comparative sales and/or an internal valuation. If an updated assessment is deemed necessary and an internal valuation cannot be made, an external "As Is" appraisal will be obtained. If the "As Is" appraisal does not appropriately reflect the current fair market value, in the Company's opinion, a specific reserve is established and/or the loan is written down to the current fair market value. Collateral dependent, impaired loans are loans that are solely dependent on the liquidation of the collateral for repayment. All OREO/REPO loans are reviewed quarterly to determine if valuation adjustments are necessary based on known changes in the market and/or project assumptions. When necessary, the "As Is" appraisal is adjusted based on more recent appraisal assumptions received by the Company on other similar properties, the tax assessment market value, comparative sales and/or an internal valuation is performed. If an updated assessment is deemed necessary, and an internal valuation cannot be made, an external appraisal will be requested. Upon receipt of the "As Is" appraisal a charge-off is recognized for the difference between the loan amount and its current fair market value. "As Is" values are used to measure fair market value on impaired loans, OREO and REPOs. Any loan that is partially charged-off remains in nonperforming status until it is paid off regardless of current valuation of the loan. In accordance with regulatory reporting requirements, loans are placed on non-accrual following the Retail Classification of Loan interagency guidance. Typically loans 90 days or more past due are reviewed for impairment, and if deemed impaired, are placed on non-accrual. Once impaired, the current fair market value of the collateral is assessed and a specific reserve and/or charge-off taken. Quarterly thereafter, the loan carrying value is analyzed and any changes are appropriately made as described above. Upon receipt of an appraisal, an appraisal review is performed and a specific reserve or charge-off is processed, if warranted. SECURITIES At June 30, 2011, the Company had no trading securities, $611,231,000 in securities available for sale (representing 96.0 percent of total securities), and securities held for investment of $25,159,000 (4.0 percent of total securities). The Company's securities portfolio increased $242.6 million or 61.6 percent from June 30, 2010 and $174.4 million or 37.7 percent from December 31, 2010. 49 -------------------------------------------------------------------------------- Table of Contents The duration of the investment portfolio at June 30, 2011 was 2.6 years, unchanged compared to a year ago. Cash and due from banks and interest bearing deposits (aggregated) totaled $166,891,000 at June 30, 2011, compared to $312,285,000 at June 30, 2010, which reflects the decline in the loan portfolio and funds from the capital raised during 2010. The Company has maintained additional liquidity during the uncertain environment and may use these funds to increase loans and investments as the economy continues to improve. Company management considers the overall quality of the securities portfolio to be high. The Company has no exposure to securities with subprime collateral and had no Fannie Mae or Freddie Mac preferred stock when these entities were placed in conservatorship. The Company holds no interests in trust preferred securities. DEPOSITS AND BORROWINGS The Company continues to utilize a focused retail deposit growth strategy that has successfully generated core deposit relationships and increased services per household since its implementation in the first quarter of 2008. During the first and second quarters of 2011, Seacoast National added 2,146 and 1,825 new core deposit households, respectively, up by 470 new deposit households or 28.0 percent and 179 new deposit households or 10.8 percent from the prior year. Net core household growth increased by 3.3 percent over the last twelve months with new personal checking relationships up 17.3 percent and new commercial business checking relationships increasing 9.0 percent during the second quarter of 2011 compared to the same quarter in 2010. While favorable, growth in checking relationships during the second quarter of 2011 was less dramatic than first quarter 2011's growth over prior year, as second quarter 2010 was when a major competitor in the Company's Treasure Coast market failed allowing the Company to benefit from an elevated number of customers migrating to Seacoast National at that time. Average noninterest bearing demand deposit balances for the second quarter of 2011 increased 18.2 percent compared to second quarter 2010 and noninterest bearing demand deposits totaled 19.1 percent of total deposits at June 30, 2011, compared to 16.1 percent one year earlier. Total deposits decreased $34,433,000, or 2.0 percent, to $1,681,461,000 at June 30, 2011 compared to one year earlier, reflecting declining brokered deposits and single service time deposits. Since June 30, 2010, interest bearing deposits (NOW, savings and money markets deposits) decreased $46,173,000 or 5.3 percent to $831,371,000, noninterest bearing demand deposits increased $45,421,000 or 16.4 percent to $321,876,000, and CDs decreased $33,681,000 or 6.0 percent to $528,214,000. Included in CDs, brokered time deposits decreased $12,256,000 to $7,532,000 at June 30, 2011 from the prior year. Of the $7,532,000 balance at June 30, 2011, $6,138,000 is attributable to CDARs. Funds deposited under the CDARs program are required to be classified as brokered deposits. The Company has historically priced CDs conservatively and has continued to follow this strategy FDIC deposit insurance has been permanently increased from $100,000 to $250,000 per depositor based on recent legislation passed by Congress. The increase had been temporarily in place since October 14, 2008 and was set to expire on December 31, 2013. In addition, until its expiration on December 31, 2010, the FDIC's Temporary Liquidity Guarantee ("TLG") program 50 -------------------------------------------------------------------------------- Table of Contents guaranteed the entire amount in any eligible noninterest bearing transaction deposit account to the extent such balances were not covered by FDIC insurance. Seacoast National participated in the TLG program to offer the best possible FDIC coverage to its customers. While the TLG program expired December 31, 2010, provisions under the recent Dodd-Frank legislation will provide coverage for all noninterest bearing transaction account balances at all financial institutions through December 31, 2012. Securities sold under repurchase agreements increased over the past twelve months by $27,517,000 or 36.5 percent to $102,827,000 at June 30, 2011. Repurchase agreements are offered by Seacoast National to select customers who wish to sweep excess balances on a daily basis for investment purposes. Public funds comprise a significant amount of the outstanding balance, with safety a major concern for these customers. At June 30, 2011, the number of sweep repurchase accounts was 168, compared to 183 a year ago. At June 30, 2011, other borrowings were comprised of subordinated debt of $53.6 million related to trust preferred securities issued by trusts organized by the Company, and advances from the Federal Home Loan Bank ("FHLB") of $50.0 million. The FHLB advances mature in 2017. For second quarter 2011 and 2010, the weighted average cost of our FHLB advances was 3.22 percent, unchanged. The Company has two wholly owned trust subsidiaries, SBCF Capital Trust I and SBCF Statutory Trust II that were formed in 2005, and in 2007, the Company formed an additional wholly owned trust subsidiary, SBCF Statutory Trust III. The 2005 trusts each issued $20.0 million (totaling $40.0 million) of trust preferred securities and the 2007 trust issued an additional $12.0 million in trust preferred securities. All trust preferred securities are guaranteed by the Company on a junior subordinated basis. The Federal Reserve's rules permit qualified trust preferred securities and other restricted capital elements to be included as Tier 1 capital up to 25 percent of core capital, net of goodwill and intangibles. The Company believes that its trust preferred securities qualify under these revised regulatory capital rules and expects that it will be able to treat all $52.0 million of trust preferred securities as Tier 1 capital. For regulatory purposes, the trust preferred securities are added to the Company's tangible common shareholders' equity to calculate Tier I capital. The weighted average interest rate of our outstanding subordinated debt related to trust preferred securities was 1.90 percent during the second quarter of 2011, compared to 1.87 percent for the same period during 2010. OFF-BALANCE SHEET TRANSACTIONS In the normal course of business, we engage in a variety of financial transactions that, under generally accepted accounting principles, either are not recorded on the balance sheet or are recorded on the balance sheet in amounts that differ from the full contract or notional amounts. These transactions involve varying elements of market, credit and liquidity risk. The two primary off-balance sheet transactions the Company has engaged in are: • derivatives, intended to manage exposure to interest rate risk; and • commitments to extend credit and standby letters of credit, intended to facilitate customers' funding needs or risk management objectives. 51 -------------------------------------------------------------------------------- Table of Contents Derivative transactions are often measured in terms of a notional amount, but this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the instruments. The notional amount is not usually exchanged, but is used only as the basis upon which interest or other payments are calculated. The derivatives the Company uses to manage exposure to interest rate risk are interest rate swaps. All interest rate swaps are recorded on the balance sheet at fair value with realized and unrealized gains and losses included either in the results of operations or in other comprehensive income, depending on the nature and purpose of the derivative transaction. The credit risk of these transactions is managed by establishing a credit limit for counterparties and through collateral agreements. The fair value of interest rate swaps recorded in the balance sheet at June 30, 2011 included derivative product assets of $44,000. In comparison, at June 30, 2010 net derivative product assets of $41,000 were outstanding. Lending commitments include unfunded loan commitments and standby and commercial letters of credit. A large majority of loan commitments and standby letters of credit expire without being funded, and accordingly, total contractual amounts are not representative of our actual future credit exposure or liquidity requirements. Loan commitments and letters of credit expose the Company to credit risk in the event that the customer draws on the commitment and subsequently fails to perform under the terms of the lending agreement. Loan commitments to customers are made in the normal course of our commercial and retail lending businesses. For commercial customers, loan commitments generally take the form of revolving credit arrangements. For retail customers, loan commitments generally are lines of credit secured by residential property. These instruments are not recorded on the balance sheet until funds are advanced under the commitment. For loan commitments, the contractual amount of a commitment represents the maximum potential credit risk that could result if the entire commitment had been funded, the borrower had not performed according to the terms of the contract, and no collateral had been provided. Loan commitments were $97 million at June 30, 2011, and $95 million at June 30, 2010. INTEREST RATE SENSITIVITY Fluctuations in interest rates may result in changes in the fair value of the Company's financial instruments, cash flows and net interest income. This risk is managed using simulation modeling to calculate the most likely interest rate risk utilizing estimated loan and deposit growth. The objective is to optimize the Company's financial position, liquidity, and net interest income while limiting their volatility. Senior management regularly reviews the overall interest rate risk position and evaluates strategies to manage the risk. The Company's most recent Asset and Liability Management Committee ("ALCO") model simulation indicates net interest income would increase 10.5 percent if interest rates are shocked 200 basis points up over the next 12 months and 5.8 percent if interest rates are shocked up 100 basis points. Recent regulatory guidance has placed more emphasis on rate shocks. 52 -------------------------------------------------------------------------------- Table of Contents The Company had a positive gap position based on contractual and prepayment assumptions for the next 12 months, with a positive cumulative interest rate sensitivity gap as a percentage of total earning assets of 4.5 percent, based on its most recent ALCO modeling. This result includes assumptions for core deposit re-pricing recently validated for the Company by an independent third party consulting group. The computations of interest rate risk do not necessarily include certain actions management may undertake to manage this risk in response to changes in interest rates. Derivative financial instruments, such as interest rate swaps, options, caps, floors, futures and forward contracts may be utilized as components of the Company's risk management profile. LIQUIDITY MANAGEMENT Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liability, as well as the risk of not being able to meet unexpected cash needs. Liquidity planning and management are necessary to ensure the ability to fund operations cost effectively and to meet current and future potential obligations such as loan commitments and unexpected deposit outflows. Funding sources primarily include customer-based core deposits, collateral-backed borrowings, cash flows from operations, and asset securitizations and sales. Cash flows from operations are a significant component of liquidity risk management and we consider both deposit maturities and the scheduled cash flows from loan and investment maturities and payments. Deposits are also a primary source of liquidity. The stability of this funding source is affected by numerous factors, including returns available to customers on alternative investments, the quality of customer service levels, safety and competitive forces. We routinely use securities and loans as collateral for secured borrowings. In the event of severe market disruptions, we have access to secured borrowings through the FHLB and the Federal Reserve Bank of Atlanta. Contractual maturities for assets and liabilities are reviewed to meet current and expected future liquidity requirements. Sources of liquidity, both anticipated and unanticipated, are maintained through a portfolio of high quality marketable assets, such as residential mortgage loans, securities held for sale and interest bearing deposits. The Company also has access to borrowed funds such as an FHLB line of credit and the Federal Reserve Bank of Atlanta under its borrower-in-custody program. The Company is also able to provide short term financing of its activities by selling, under an agreement to repurchase, United States Treasury and Government agency securities not pledged to secure public deposits or trust funds. At June 30, 2011, Seacoast National had available lines of credit under current lendable collateral value, which are subject to change, of $322 million and an unsecured federal funds line of credit of $10.0 million. Seacoast National had $379 million of United States Treasury and Government agency securities and mortgage backed securities not pledged and available for use under repurchase agreements, and had an additional $200 million in residential and commercial real estate loans available as collateral. In comparison, at June 30, 2010, the Company had available lines of credit of $321 million, and had $103 million of Treasury and Government agency securities and mortgage backed securities not pledged and available for use under repurchase agreements, as well as an additional $236 million in residential and commercial real estate loans available as collateral. 53 -------------------------------------------------------------------------------- Table of Contents Liquidity, as measured in the form of cash and cash equivalents (including interest bearing deposits), totaled $166,891,000 on a consolidated basis at June 30, 2011 as compared to $312,285,000 at June 30, 2010. The composition of cash and cash equivalents has changed from a year ago. Over the past twelve months, cash and due from banks decreased $189,000 to $28,782,000 and interest bearing deposits decreased to $138,109,000 from $283,314,000. The interest bearing deposits are maintained in Seacoast National's account at the Federal Reserve Bank of Atlanta. Cash and cash equivalents vary with seasonal deposit movements and are generally higher in the winter than in the summer, and vary with the level of principal repayments and investment activity occurring in Seacoast National's securities and loan portfolios. The Company does not rely or is dependent on off-balance sheet financing or wholesale funding. The Company is a legal entity separate and distinct from Seacoast National and its other subsidiaries. Various legal limitations, including Section 23A of the Federal Reserve Act and Federal Reserve Regulation W, restrict Seacoast National from lending or otherwise supplying funds to the Company or its non-bank subsidiaries. The Company has traditionally relied upon dividends from Seacoast National and securities offerings to provide funds to pay the Company's expenses, to service the Company's debt and to pay dividends upon Company common stock. In 2008 and 2007, Seacoast National paid dividends to the Company that exceeded its earnings in those years. Seacoast National cannot currently pay dividends to the Company without prior OCC approval. At June 30, 2011, the Company had cash and cash equivalents at the parent of approximately $21.3 million, comprised of remaining proceeds from our common stock offering which was consummated in the second quarter of 2010. In comparison, at June 30, 2010, the Company had cash and cash equivalents at the parent of approximately $23.0 million, comprised of remaining funds provided through a common stock offering consummated in the second quarter of 2010. All of the TARP CPP funds derived in December 2008 have been contributed as additional capital to Seacoast National. The Company has suspended all dividends upon its Series A preferred stock issued through the TARP CPP and its common stock, and has deferred distributions on its subordinated debt related to trust preferred securities issued through affiliated trusts. Additional losses could prolong Seacoast National's inability to pay dividends to its parent without regulatory approval (see "Capital Resources"). EFFECTS OF INFLATION AND CHANGING PRICES The condensed consolidated financial statements and related financial data presented herein have been prepared in accordance with U.S. GAAP, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money, over time, due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the general level of inflation. However, inflation affects financial institutions by increasing their cost of goods and services purchased, as well as the cost of salaries and benefits, occupancy expense, and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and shareholders' equity. Mortgage originations and re- 54 -------------------------------------------------------------------------------- Table of Contents financings tend to slow as interest rates increase, and higher interest rates likely will reduce the Company's earnings from such activities and the income from the sale of residential mortgage loans in the secondary market. SPECIAL CAUTIONARY NOTICE REGARDING FORWARD LOOKING STATEMENTS Various of the statements made herein under the captions "Management's Discussion and Analysis of Financial Condition and Results of Operations", "Quantitative and Qualitative Disclosures about Market Risk", "Risk Factors" and elsewhere, are "forward-looking statements" within the meaning and protections of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause the actual results, performance or achievements of Seacoast to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. You should not expect us to update any forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as "may," "will," "anticipate," "assume," "should," "support", "indicate," "would," "believe," "contemplate," "expect," "estimate," "continue," "further", "point to," "project," "could," "intend" or other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation: • the effects of future economic and market conditions, including seasonality; • governmental monetary and fiscal policies, as well as legislative, tax and regulatory changes; • legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators, and changes in the scope and cost of FDIC insurance and other coverage; • changes in accounting policies, rules and practices; • the risks of changes in interest rates on the level and composition of deposits, loan demand, liquidity and the values of loan collateral, securities, and interest sensitive assets and liabilities; interest rate risks, sensitivities and the shape of the yield curve; • the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in our market areas and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the Internet; • the failure of assumptions underlying the establishment of reserves for possible loan losses; 55 -------------------------------------------------------------------------------- Table of Contents • the risks of mergers and acquisitions, include, without limitation, unexpected transaction costs, including the costs of integrating operations; the risks that the businesses will not be integrated successfully or that such integration may be more difficult, time-consuming or costly than expected; • the potential failure to fully or timely realize expected revenues and revenue synergies, including as the result of revenues following the merger being lower than expected; • the risk of deposit and customer attrition; any changes in deposit mix; unexpected operating and other costs, which may differ or change from expectations; • the risks of customer and employee loss and business disruption, including, without limitation, as the result of difficulties in maintaining relationships with employees; increased competitive pressures and solicitations of customers by competitors; as well as the difficulties and risks inherent with entering new markets; and • other risks and uncertainties described herein and in our annual report on Form 10-K for the year ended December 31, 2010 and otherwise in our Securities and Exchange Commission, or "SEC", reports and filings. All written or oral forward-looking statements attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made. 56 -------------------------------------------------------------------------------- Table of Contents [ Back To TMCnet.com's Homepage ]