First Financial Holdings, Inc. (the Company which may be referred to as First Financial, we, us, or our) is a Delaware corporation, a savings and loan holding company and a financial holding company under the Gramm-Leach-Bliley Act. The Company was incorporated in 1987. We operate principally through First Federal Savings and Loan Association of Charleston (First Federal), a federally-chartered stock savings and loan association. Our assets are over $2.6 billion as of September 30, 2006.
Our subsidiaries provide a full range of financial services designed to meet the financial needs of our customers, including the following:
|
|
• |
banking |
|
|
• |
cash management |
|
|
• |
retail investment services |
|
|
• |
mortgage banking |
|
|
• |
insurance, and |
|
|
• |
trust and investment management services. |
Based on asset size, First Federal is the largest financial institution headquartered in the Charleston, South Carolina metropolitan area and the third largest financial institution headquartered in South Carolina. We currently conduct business through 38 full service retail branch sales offices, 11 in-store (Wal-Mart Supercenters) retail branch sales offices, and three limited services branches located in the following counties: Charleston (18), Berkeley County (3), Dorchester (5), Hilton Head area of Beaufort County (3), Georgetown County (3), Horry County (14), Florence County (5) and the Sunset Beach area of Brunswick County, North Carolina (1).
Primarily we act as a financial intermediary by attracting deposits from the general public and using those funds, together with borrowings and other funds, to originate first mortgage loans on residential properties located in our primary market areas. We also make construction, consumer, non-residential mortgage and commercial business loans and invest in mortgage-backed securities, federal government and agency obligations, money market obligations and certain corporate obligations. Through subsidiaries of First Financial or subsidiaries of First Federal, we also engage in full-service brokerage activities, property, casualty, life and health insurance sales, third party administrative services, trust and fiduciary services, reinsurance of private mortgage insurance, premium finance activities and certain passive investment activities. Other than banking, insurance operations constitutes a reportable segment of business operations. For segmented financial information regarding our banking and insurance operations, see Note 24 of Notes to Consolidated Financial Statements contained in Item 8.
First Federal is a member of the Federal Home Loan Bank System and its deposits are insured by the Federal Deposit Insurance Corporation up to applicable limits. First Federal is subject to comprehensive regulation, examination and supervision by the Office of Thrift Supervision and the FDIC.
Subsidiary Activities of First Federal
The Carolopolis Corporation
The Carolopolis Corporation was incorporated in 1976 for the principal purpose of land acquisition and development and construction of various projects for resale. Development activities began in 1981 and ended in 1989. Carolopolis had been inactive for a number of years until 1996 when a lower tier corporation of Carolopolis was formed to operate and market for resale a commercial real estate property acquired through foreclosure by First Federal. Carolopolis is currently inactive.
Broad Street Holdings
Broad Street Holdings was incorporated in 1998 as the holding company for Broad Street Investments, Inc., which was also formed in 1998. Broad Street Investments has been organized as a real estate investment trust to hold real estate-related assets.
First Reinsurance Holdings
First Reinsurance Holdings was incorporated in 1998 as the holding company for First Southeast Reinsurance, Inc., a company also organized in 1998 and domiciled in Vermont. First Southeast Reinsurance reinsures mortgage insurance originated through mortgage insurance companies in connection with real estate loans originated by First Federal.
First Southeast Fiduciary & Trust
First Southeast Fiduciary & Trust Services, Inc. was incorporated in 1998 for the purpose of extending trust and other asset management services in a fiduciary capacity to customers of First Federal. Assets under management totaled $103.6 million at September 30, 2006.
Port City Ventures
Port City Ventures, LLC was incorporated in 2002 to hold the general partner’s interest in the limited partnership called North Central Apartments, LP, a low-income senior citizen housing development. North Central received approval in October 2003 for low income housing tax credits from the South Carolina State Housing Finance and Development Authority. We utilize these credits when we file our consolidated tax returns.
Great Atlantic Mortgage
Great Atlantic Mortgage was incorporated in 2005 as a joint venture with a local real estate firm to originate mortgages. Operations are based in Charleston, South Carolina with a sales office located in Pawleys Island, South Carolina. In early fiscal 2007 these operations were discontinued and Great Atlantic Mortgage is no longer active.
Subsidiary Activities of First Financial
Insurance Operations
|
|
First Southeast Insurance Services |
|
|
|
|
|
First Southeast Insurance Services also referred to as FSIns, formerly known as the Magrath Insurance Agency, was purchased by Peoples Federal in 1986. In 1988, the agency purchased two smaller insurance agencies. First Financial acquired Peoples Federal in 1992. During 1995 the Epps-McLendon Agency in Lake City, South Carolina was purchased. In 1995 the Adams Insurance Agency in Charleston, South Carolina, which had been purchased by First Federal in 1990, was purchased from a subsidiary of First Federal. During 2000, the operations of Associated Insurors of Myrtle Beach, South Carolina were acquired. Subsequent purchases have included the Hilton Head, Bluffton and Ridgeland operations of Kinghorn Insurance in 2001, Johnson Insurance Associates and Benefit Administrators of Columbia, South Carolina in 2002, Woodruff & Company, Inc. of Columbia, South Carolina in 2003, and Employer Benefit Strategies Inc. of Summerville, South Carolina in 2006. Also during 2003, Benefit Administrators, Inc., an affiliate of Johnson Insurance, a subsidiary of First Southeast Insurance Services, purchased third party health benefit administration relationships with a group of accounts located in the southeast from MCA Administrators, Inc., based in Pittsburgh, Pennsylvania. |
|
|
|
|
|
First Southeast Insurance Services is one of the largest independent insurance agencies in South Carolina. Its affiliate, Kinghorn Insurance Services, Inc. has the largest independent agency relationship with Allstate in the United States. |
|
|
|
|
|
Kimbrell Insurance Group, Inc. |
|
|
|
|
|
Kimbrell Insurance Group, Inc. was incorporated in January 2004 as the holding company for the operations of The Kimbrell Company, Inc., The Kimbrell Company, Inc./Florida, Preferred Markets, Inc., Preferred Markets, Inc./Florida and Atlantic Acceptance Corporation, which were purchased in 2004. The Kimbrell companies are a managing general agency specializing in placing coverage within the non-standard insurance market. Non-standard markets offer coverage to customers that have unusual or high-risk exposures. The Preferred Markets companies are a managing general agency specializing in placing coverage in standard insurance markets. Atlantic Acceptance Corporation is a premium finance company. |
First Southeast Investor Services
First Southeast Investor Services, incorporated in South Carolina, has been a NASD-registered introducing broker dealer since 1998. First Southeast Investor Services offers a variety of investment products and services in strategically located offices throughout First Financial’s market area and other selected markets within South Carolina and North Carolina.
Business Segments
Item 8, Note 24 to the Consolidated Financial Statements discusses First Financial’s business segments, which is incorporated in this document by reference.
Competition
We face strong competition in attracting savings deposits and originating real estate and other loans. The competition among the various financial institutions is based upon a variety of factors including the following:
|
|
• |
interest rates offered on deposit accounts, |
|
|
• |
interest rates charged on loans, |
|
|
• |
credit and service charges, |
|
|
• |
the quality of services rendered, |
|
|
• |
the convenience of banking facilities and, |
|
|
• |
in the case of loans to large commercial borrowers, relative lending limits. |
Direct competition for savings deposits principally comes from commercial banks and other savings institutions. Indirectly, we face competition from credit unions and for investors’ funds from short term money market securities and other corporate and government securities. Additionally, money market, stock, and fixed-income mutual funds have attracted an increasing share of household savings. Competition for loans principally comes from commercial banks, mortgage-banking companies, insurance companies, developers, tract builders and other institutional lenders. We compete for loans principally through the interest rates and loan fees charged and the efficiency and quality of the services provided to borrowers, developers, real estate brokers and home builders.
The banking industry continues to consolidate, which presents opportunities for First Financial to gain new business. However, consolidation may further intensify competition if additional financial services companies enter our market areas through acquisition of local financial institutions.
Size gives larger banks certain advantages in competing for business from large commercial customers. These advantages include higher lending limits and the ability to offer services in other areas of South Carolina and North Carolina. As a result, we concentrate our efforts on small- to medium-sized businesses and individuals. We believe we compete effectively in this market segment by offering quality – and personalized service.
Employees
At September 30, 2006, First Financial employed 847 full-time equivalent employees compared to 791 full-time equivalent employees at September 30, 2005. We provide our full-time employees and certain part-time employees with a comprehensive program of benefits, including medical and dental benefits, life insurance, long-term disability coverage, a profit-sharing plan and a 401(k) plan. Our employees are not represented by a collective bargaining agreement. Management considers its employee relations to be excellent.
How We Are Regulated
The following is a brief description of certain laws and regulations which are applicable to First Financial and First Federal.
Legislation is introduced from time to time in the U.S. Congress that may affect the operations of First Financial and First Federal. In addition, the regulations governing us may be amended from time to time by the respective regulators. Any such legislation or regulatory changes in the future could adversely affect us. We cannot predict whether any such changes may occur.
Regulation of First Federal
As a federally-chartered, federally-insured financial institution, First Federal is subject to federal regulation and oversight by the Office of Thrift Supervision, as its primary federal regulator, and the Federal Deposit Insurance Corporation, as its insurer of its deposits. Federally-chartered savings institutions are required to file periodic reports with the Office of Thrift Supervision and are subject to periodic examinations by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation. The investment and lending authority of savings institutions are prescribed by federal laws and regulations and these institutions are prohibited from engaging in any activities not permitted by the laws and regulations. This regulation and supervision primarily is intended for the protection of depositors and not for the purpose of protecting shareholders.
The Office of Thrift Supervision regularly examines First Federal and prepares a report that details its findings and notes any deficiencies in First Federal’s operations. The report is submitted to First Federal’s Board of Directors for their review and consideration. The Federal Deposit Insurance Corporation, as the insurer of First Federal’s deposits, also has the authority to examine First Federal. First Federal’s relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters such as the ownership of savings accounts and the form and content of First Federal’s mortgage requirements. Any change in these regulations, whether by the Federal Deposit Insurance Corporation, the Office of Thrift Supervision or Congress, could have a material adverse impact on the operations of First Financial and First Federal.
Office of Thrift Supervision. The Office of Thrift Supervision has extensive enforcement authority over all savings institutions and their holding companies, including First Federal and First Financial. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and-desist or removal orders and initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inaction may provide the basis for enforcement action, including misleading or untimely reports filed with the Office of Thrift Supervision. Except under certain circumstances, public disclosure of final enforcement actions by the Office of Thrift Supervision is required.
In addition, the investment, lending and branching authority of First Federal is prescribed by federal laws and it is prohibited from engaging in any activities not permitted by these laws. For example, no savings institution may invest in non-investment grade corporate debt securities. In addition, the permissible level of investment by federal institutions in loans secured by non-residential real property may not exceed 400% of total capital, except with approval of the Office of Thrift Supervision. Federal savings institutions are also generally authorized to branch nationwide. First Federal is in compliance with these restrictions.
All savings institutions are required to pay assessments to the Office of Thrift Supervision to fund the agency’s operations. The general assessments, paid on a semi-annual basis, are determined based on the savings institution’s total assets, including consolidated subsidiaries. First Federal’s annual Office of Thrift Supervision assessment for the fiscal year ended September 30, 2006 was $428 thousand.
Federal law provides that savings institutions are generally subject to the national bank limit on loans to one borrower. A savings institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily marketable collateral. At September 30, 2006, First Federal’s limit on loans to one borrower was $ 30 million. At September 30, 2006, First Federal’s largest loan commitment to a related group of borrowers was $27 million. Of this commitment, $ 25.4 million has been disbursed.
The Office of Thrift Supervision, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan.
Federal Home Loan Bank System. First Federal is a member of the Federal Home Loan Bank of Atlanta, which is one of 12 regional Federal Home Loan Banks that administer the home financing credit function of savings institutions. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the Federal Home Loan Bank, which are subject to the oversight of the Federal Housing Finance Board. All advances from the Federal Home Loan Bank are required to be fully secured by sufficient collateral as determined by the Federal Home Loan Bank.
As a member, First Federal is required to purchase and maintain stock in the FHLB of Atlanta. At September 30, 2006, First Federal had $26 million in Federal Home Loan Bank of Atlanta stock, which was in compliance with this requirement. In past years, First Federal has received substantial dividends on its Federal Home Loan Bank stock. The average dividend yield for fiscal 2006 and 2005 was 5.32% and 3.89%, respectively.
Federal Deposit Insurance Reform Act of 2005. The Federal Deposit Insurance Reform Act of 2005 was signed into law on February 8, 2006 and amended current laws regarding the federal deposit insurance system. The legislation merged the Bank Insurance Fund and the Savings Association Insurance Fund to form the Deposit Insurance Fund, eliminated any disparities in bank and thrift risk-based premium assessments, reduced the administrative burden of maintaining and operating two separate funds and established certain new insurance coverage limits and a mechanism for possible periodic increases. The legislation also gave the Federal Deposit Insurance Corporation greater discretion to identify the relative risks all institutions present to the Deposit Insurance Fund and set risk-based premiums.
Major provisions in the legislation include:
|
|
• |
merging the Savings Association Insurance Fund and Bank Insurance Fund, which became effective March 31, 2006; |
|
|
|
|
|
|
• |
maintaining basic deposit and municipal account insurance coverage at $100,000 but providing for a new basic insurance coverage for retirement accounts of $250,000. Insurance coverage for basic deposit and retirement accounts could be increased for inflation every five years in $10,000 increments beginning in 2011; |
|
|
|
|
|
|
• |
providing the Federal Deposit Insurance Corporation with the ability to set the designated reserve ratio within a range of between 1.15% and 1.50%, rather than maintaining 1.25% at all times regardless of prevailing economic conditions; |
|
|
|
|
|
|
• |
providing a one-time assessment credit of $4.7 billion to banks and savings associations in existence on December 31, 1996, which may be used to offset future premiums with certain limitations; and |
|
|
|
|
|
|
• |
requiring the payment of dividends of 100% of the amount that the insurance fund exceeds 1.5% of the estimated insured deposits and the payment of 50% of the amount that the insurance fund exceeds 1.35% of the estimated insured deposits (when the reserve is greater than 1.35% but no more than 1.5%): and |
|
|
|
|
|
|
• |
providing for a new risk-based assessment system and allowing the Federal Deposit Insurance Corporation to establish separate risk-based assessment systems for large and small members of the Deposit Insurance Fund. |
On November 2, 2006, the Federal Deposit Insurance Corporation set the designated reserve ratio for the deposit insurance fund at 1.25% of estimated insured deposits, and adopted final regulations to implement the risk-based deposit insurance assessment system mandated by the Deposit Insurance Reform Act of 2005, which is intended to more closely tie each bank’s deposit insurance assessments to the risk it poses to the deposit insurance fund. Under the new risk-based assessment system, the Federal Deposit Insurance Corporation will evaluate each institution’s risk based on three primary factors – supervisory ratings for all insured institutions, financial ratios for most institutions, and long-term debt issuer ratings for large institutions that have them. An institution’s assessment rate will depend upon the level of risk it poses to the deposit insurance system as measured by these factors. The new rates for most institutions will vary between 5 and 7 cents for every $100 of domestic insurable deposits.
The new assessment rates will take effect at the beginning of 2007. However, the Deposit Insurance Reform Act of 2005 provides credits to institutions that paid high premiums in the past to bolster the FDIC’s insurance reserves, as a result of which the Federal Deposit Insurance Corporation has announced that a majority of banks will have assessment credits to initially offset all of their premiums in 2007. Management does not believe it is possible at this time to reliably estimate the net assessment cost, if any that may be imposed on First Federal. There are a number of uncertain factors that could affect the assessment rate that the Federal Deposit Insurance Corporation will decide to apply to First Federal and the actual assessment credit that will be available to First Federal in 2007.
Insurance of Accounts and Regulation by the Federal Deposit Insurance Corporation. The deposits of First Federal are insured to the maximum extent permitted by the Deposit Insurance Fund, administered by the Federal Deposit Insurance Corporation, and are backed by the full faith and credit of the U.S. Government. As insurer, the Federal Deposit Insurance Corporation is authorized to conduct examinations of, and to require reporting by, insured institutions. It also may prohibit any insured institution from engaging in any activity determined by regulation or order to pose a serious threat to the Federal Deposit Insurance Corporation.
Each FDIC-insured institution is assigned to one of three capital groups which are based solely on the level of an institution’s capital level of “well capitalized,” “adequately capitalized,” and “undercapitalized.” These capital levels are defined in the same manner as under the prompt corrective action system discussed below. These three groups are then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered to be healthy to those which are considered to be of substantial supervisory concern. Assessment rates for insured institutions are determined semi-annually by the Federal Deposit Insurance Corporation and currently range from zero basis points for well-capitalized healthy institutions, to 27 basis points for undercapitalized institutions with substantial supervisory concerns. First Federal currently is considered well capitalized and has a zero assessment rate. See Federal Deposit Insurance Reform Act of 2005 above for changes effective 2007.
In addition, all institutions with deposits insured by the Federal Deposit Insurance Corporation are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize the predecessor to the Savings Association Insurance Fund. The assessment rate for the third quarter of 2006 was 0.0126% of insured deposits and is adjusted quarterly. These assessments will continue until the Financing Corporation bonds mature in 2019.
The Federal Deposit Insurance Corporation may terminate the deposit insurance of any insured depository institution, including First Federal, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the Federal Deposit Insurance Corporation. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the Federal Deposit Insurance Corporation. Management is aware of no existing circumstances which would result in termination of First Federal’s deposit insurance.
Prompt Corrective Action . The Office of Thrift Supervision is required to take certain supervisory actions against undercapitalized savings institutions, the severity of which depends upon the institution’s degree of undercapitalization. Generally, an institution that has a ratio of total capital to risk-weighted assets of less than 8%, a ratio of Tier I (core) capital to risk-weighted assets of less than 4%, or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be “undercapitalized.” An institution that has a total risk-based capital ratio less than 6%, a Tier I capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be “significantly undercapitalized” and an institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be “critically undercapitalized.” Subject to a narrow exception, the Office of Thrift Supervision is required to appoint a receiver or conservator for a savings institution that is “critically undercapitalized.” Office of Thrift Supervision regulations also require that a capital restoration plan be filed with the Office of Thrift Supervision within 45 days of the date a savings institution receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Compliance with the plan must be guaranteed by any parent holding company in an amount of up to the lesser of 5% of the institution’s assets or the amount which would bring the institution into compliance with all capital standards. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The Office of Thrift Supervision also could take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
At September 30, 2006, First Federal was categorized as “well capitalized” under the prompt corrective action regulations of the Office of Thrift Supervision.
Standards for Safety and Soundness. The federal banking regulatory agencies have prescribed, by regulation, guidelines for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings; and (viii) compensation, fees and benefits. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the Office of Thrift Supervision determines that First Federal fails to meet any standard prescribed by the guidelines, the Office of Thrift Supervision may require First Federal to submit to it an acceptable plan to achieve compliance with the standard. Office of Thrift Supervision regulations establish deadlines for the submission and review of such safety and soundness compliance plans. We are not aware of any conditions relating to these safety and soundness standards that would require us to submit of a plan of compliance to the Office of Thrift Supervision.
Qualified Thrift Lender Test. All savings institutions, including First Federal, are required to meet a qualified thrift lender test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its total assets as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under either test, such assets primarily consist of residential housing related loans and investments.
A savings institution that fails to meet the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a national bank charter. As of September 30, 2006, First Federal maintained 84.75% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test.
Capital Requirements . The Office of Thrift Supervision requires all savings associations, including First Federal, to meet three minimum capital standards:
|
|
(1) |
a tangible capital ratio requirement of 1.5% of total assets, as adjusted under Office of Thrift Supervision regulations; |
|
|
|
|
|
|
(2) |
a leverage ratio requirement of 3% of core capital to adjusted total assets, if a savings association has been assigned the highest composite rating of 1 under the Uniform Financial Institutions Ratings System (the minimum leverage capital ratio for any depository institution that does not have a composite examination rating of 1 is 4%, unless a higher leverage capital ratio is warranted by the particular circumstances or risk profile of the depository institution) and is not anticipating or expecting significant growth and have well-diversified risks; and |
|
|
|
|
|
|
(3) |
a risk-based capital ratio requirement of 8% of core and supplementary capital to total risk-weighted assets of which at least half must be core capital. |
In determining compliance with the risk-based capital requirement, a savings association must compute its risk-weighted assets by multiplying its assets and certain off-balance sheet items by risk-weights, which range from 0% for cash and obligations issued by the U.S. Government or its agencies to 100% for consumer and commercial loans, as assigned by the Office of Thrift Supervision capital regulation based on the risks that the Office of Thrift Supervision believes are inherent in the type of asset.
The Office of Thrift Supervision is authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis. The Office of Thrift Supervision and Federal Deposit Insurance Corporation are authorized, and under certain circumstances required, to take certain actions against savings associations that fail to meet their capital requirements. The Office of Thrift Supervision is generally required to take action to restrict the activities of an “undercapitalized association” (generally defined to be one with less than either a 4% core capital ratio, a 4% Tier 1 risk-based capital ratio or an 8% risk-based capital ratio). Any such association must submit a capital restoration plan and until such plan is approved by the Office of Thrift Supervision may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The Office of Thrift Supervision is authorized to impose the additional restrictions that are applicable to significantly undercapitalized associations.
See Note 22 of the Notes to Consolidated Financial Statements contained in Item 8 of this document for First Federal’s capital position relative to its applicable regulatory capital requirements.
Limitations on Capital Distribution., Office of Thrift Supervision regulations impose various restrictions on savings institutions with respect to the ability of First Federal to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. First Federal must file a notice or application with the Office of Thrift Supervision before making any capital distribution. First Federal generally may make capital distributions during any calendar year in an amount up to 100% of net income for the year-to-date plus retained net income for the two preceding years, so long as it is well-capitalized after the distribution. If First Federal, however, proposes to make a capital distribution when it does not meet the requirements to be adequately capitalized (or will not following the proposed capital distribution) or that will exceed these net income limitations, it must obtain Office of Thrift Supervision approval prior to making such distribution. The Office of Thrift Supervision may object to any distribution based on safety and soundness concerns.
First Financial is not subject to Office of Thrift Supervision regulatory restrictions on the payment of dividends. Dividends from First Financial, however, may depend, in part, upon its receipt of dividends from First Federal.
Privacy Standards. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999, which was enacted in 1999, modernized the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. First Federal is subject to Office of Thrift Supervision regulations implementing the privacy protection provisions of this Act. These regulations require First Federal to disclose its privacy policy, including identifying with whom it shares "non-public personal information," to customers at the time of establishing the customer relationship and annually thereafter.
Anti-Money Laundering and Customer Identification. Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") on October 26, 2001 in response to the terrorist events of September 11, 2001. The USA Patriot Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. Recently, Congress re-enacted certain expiring provisions of the USA Patriot Act.
Regulation of First Financial
General. First Financial is a registered unitary savings and loan company subject to regulatory oversight of the Office of Thrift Supervision. Accordingly, First Financial is required to file reports with the Office of Thrift Supervision and is subject to regulation and examination by the Office of Thrift Supervision. In addition, the Office of Thrift Supervision has enforcement authority over First Financial and its non-savings association subsidiaries, which also permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association.
Mergers and Acquisitions. Federal law and Office of Thrift Supervision regulations issued thereunder generally prohibit a savings and loan holding company without the prior approval of the Office of Thrift Supervision, from acquiring more than 5% of the voting stock of any other savings institution or savings and loan holding company or controlling the assets thereof. Office of Thrift Supervision regulations also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of such holding company, from acquiring control of any savings institution not a subsidiary of such savings and loan holding company, unless the Office of Thrift Supervision approves the acquisition.
Activities Restrictions. As a unitary savings and loan holding company, First Financial generally is not subject to activity restrictions. First Financial and its non-savings institution subsidiaries are subject to statutory and regulatory restrictions on their business activities specified by federal regulations, which include performing services and holding properties used by a savings institution subsidiary, activities authorized for savings and loan holding companies as of March 5, 1987, and non-banking activities permissible for bank holding companies pursuant to the Bank Holding Company Act of 1956 or authorized for financial holding companies pursuant to the Gramm-Leach-Bliley Financial Services Modernization Act of 1999.
If First Federal fails the qualified thrift lender test, within one year First Financial must register as, and will become subject to, the significant activity restrictions applicable to savings and loan holding companies (see “Regulation of First Federal – Qualified Thrift Lender Test” for information regarding First Federal’s qualified thrift lender test).
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 was signed into law on July 30, 2002 in response to public concerns regarding corporate accountability in connection with certain accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.
The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission, under the Securities Exchange Act of 1934 (“Exchange Act”).
The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and related rules and mandates. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
Regulation of Insurance Activities
We conduct insurance agency and brokerage activities through FSIns and Kimbrell and their subsidiaries. Our insurance entities are required to be licensed by or to have received approvals from the insurance department of the states in which we operate. Licensing requirements also generally apply to the individual employees of these entities who engage in agency and brokerage activities. Our insurance operations depend on the good standing under the licenses and approvals pursuant to which the insurance entities operate. Licensing laws and regulations vary from jurisdiction to jurisdiction. Generally, the insurance regulatory authorities are vested with relatively broad discretion as to the granting, renewing and revoking of licenses and approvals.
Lending Activities
General
We try to maintain a diversified loan portfolio to spread risk and reduce exposure to economic downturns that may occur in different segments of the economy, geographic locations or in particular industries. At September 30, 2006, our net loan portfolio totaled approximately $2.1 billion, or 77.5% of our total assets. Because lending activities comprise such a significant source of revenue, our main objective is to adhere to sound lending practices. Management also emphasizes lending in the local markets we serve. Our principal lending activity is the origination of loans secured by single-family residential real estate. However, we have, in recent years, focused more heavily on the origination of consumer and commercial business loans, land loans and non-residential real estate loans. Although federal regulations allow us to originate loans nationwide, the majority of loans are originated to borrowers in our local market areas of Charleston, Dorchester, Berkeley, Georgetown, Horry, Florence and Beaufort Counties in South Carolina and Brunswick County in North Carolina. However, manufactured housing has expanded to Florida, Georgia, Mississippi, Oklahoma and North Carolina.
We operate a correspondent lending program where we purchase first mortgage loans originated by unaffiliated mortgage lenders and brokers in South Carolina and North Carolina. These loans are subject to our underwriting standards and are accepted for purchase only after approval by our underwriters. Loans funded through the correspondent program totaled $29.5 million in fiscal 2006.
Several years ago, an indirect lending department was established to originate manufactured home loans and credit cards. In recent years, an out of market second mortgage program was added to our indirect lending program. The second mortgage program was discontinued during fiscal 2002 because of low volume. During fiscal 2006, we funded approximately $37.7 million in originations of manufactured home loans, substantially all of which were closed under this program.
We originate both fixed-rate and adjustable-rate loans. Generally, we sell and retain the servicing on agency qualifying fixed-rate loans. Other loans may be sold with servicing released. A large percentage of single-family loans are made pursuant to guidelines that will permit the sale of these loans in the secondary market to government agencies or private investors. Our primary single-family product is the conventional mortgage loan. However, loans are also originated that are either partially guaranteed by the Veterans Administration (“VA”) or fully insured by the Federal Housing Administration (“FHA”).
The following table summarizes outstanding loans by collateral type for real estate secured loans and by borrower type for all other loans. Collateral type represents the underlying assets securing the loan, rather than the purpose of the loan.
Table 1
LOAN PORTFOLIO COMPOSITION
(dollars in thousands)
|
|
|
September 30, |
|
|||||||||||||
|
|
|
|
|
|||||||||||||
|
|
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate - residential mortgages (1-4 family) |
|
$ |
910,497 |
|
$ |
928,505 |
|
$ |
987,825 |
|
$ |
1,104,578 |
|
$ |
1,196,066 |
|
|
Real estate - residential construction |
|
|
101,702 |
|
|
83,891 |
|
|
73,542 |
|
|
35,518 |
|
|
54,437 |
|
|
Commercial secured by real estate including multi-family |
|
|
283,016 |
|
|
261,105 |
|
|
223,994 |
|
|
210,315 |
|
|
199,393 |
|
|
Commercial financial and agricultural |
|
|
82,316 |
|
|
70,602 |
|
|
57,594 |
|
|
43,621 |
|
|
39,227 |
|
|
Land |
|
|
206,858 |
|
|
127,314 |
|
|
101,263 |
|
|
87,844 |
|
|
100,854 |
|
|
Home equity loans |
|
|
252,393 |
|
|
229,483 |
|
|
189,232 |
|
|
154,787 |
|
|
157,477 |
|
|
Mobile home loans |
|
|
173,801 |
|
|
156,545 |
|
|
143,502 |
|
|
129,934 |
|
|
111,830 |
|
|
Credit cards |
|
|
13,334 |
|
|
12,481 |
|
|
11,747 |
|
|
11,601 |
|
|
11,473 |
|
|
Other consumer loans |
|
|
119,741 |
|
|
100,624 |
|
|
91,370 |
|
|
81,000 |
|
|
93,831 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross loans receivable |
|
$ |
2,143,658 |
|
$ |
1,970,550 |
|
$ |
1,880,069 |
|
$ |
1,859,198 |
|
$ |
1,964,588 |
|
|
Allowance for loan losses |
|
|
(14,615 |
) |
|
(14,155 |
) |
|
(14,799 |
) |
|
(14,957 |
) |
|
(15,824 |
) |
|
Loans in process |
|
|
(69,043 |
) |
|
(68,958 |
) |
|
(48,423 |
) |
|
(42,448 |
) |
|
(23,832 |
) |
|
Net deferred loan costs and discounts |
|
|
1,129 |
|
|
952 |
|
|
738 |
|
|
139 |
|
|
(104 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans receivable, net |
|
$ |
2,061,129 |
|
$ |
1,888,389 |
|
$ |
1,817,585 |
|
$ |
1,801,932 |
|
$ |
1,924,828 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of Loans Receivable, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate - residential mortgages (1-4 family) |
|
|
44.2 |
% |
|
49.2 |
% |
|
54.3 |
% |
|
61.3 |
% |
|
62.1 |
% |
|
Real estate - residential construction |
|
|
4.9 |
|
|
4.4 |
|
|
4.1 |
|
|
2.0 |
|
|
2.8 |
|
|
Commercial secured by real estate including multi-family |
|
|
13.7 |
|
|
13.8 |
|
|
12.3 |
|
|
11.7 |
|
|
10.4 |
|
|
Commercial financial and agricultural |
|
|
4.0 |
|
|
3.7 |
|
|
3.2 |
|
|
2.4 |
|
|
2.0 |
|
|
Land |
|
|
10.0 |
|
|
6.7 |
|
|
5.6 |
|
|
4.9 |
|
|
5.2 |
|
|
Home equity loans |
|
|
12.3 |
|
|
12.2 |
|
|
10.4 |
|
|
8.6 |
|
|
8.2 |
|
|
Mobile home loans |
|
|
8.4 |
|
|
8.3 |
|
|
7.9 |
|
|
7.2 |
|
|
5.8 |
|
|
Credit cards |
|
|
0.7 |
|
|
0.7 |
|
|
0.6 |
|
|
0.6 |
|
|
0.6 |
|
|
Other consumer loans |
|
|
5.8 |
|
|
5.3 |
|
|
5.0 |
|
|
4.5 |
|
|
4.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross loans receivable |
|
|
104.0 |
% |
|
104.3 |
% |
|
103.4 |
% |
|
103.2 |
% |
|
102.0 |
% |
|
Allowance for loan losses |
|
|
(0.7 |
) |
|
(0.7 |
) |
|
(0.8 |
) |
|
(0.8 |
) |
|
(0.8 |
) |
|
Loans in process |
|
|
(3.4 |
) |
|
(3.7 |
) |
|
(2.6 |
) |
|
(2.4 |
) |
|
(1.2 |
) |
|
Net deferred loan costs and discounts |
|
|
0.1 |
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans receivable, net |
|
|
100.0 |
% |
|
100.0 |
% |
|
100.0 |
% |
|
100.0 |
% |
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table shows, at September 30, 2006, the dollar amount of adjustable-rate loans and fixed-rate loans in our portfolio based on their contractual terms to maturity. The amounts in the table do not include adjustments for deferred loan fees and discounts and allowances for loan losses. Demand loans, loans having no stated schedule of repayment and no stated maturity, and overdrafts are reported as due in one year or less. Contractual principal repayments of loans do not necessarily reflect the actual term of our loan portfolios. The average life of mortgage loans is substantially less than their contractual terms because of loan prepayments. The average life of mortgage loans tends to increase when current market rates on mortgage loans substantially exceed rates on existing mortgage loans. Correspondingly, when market rates on mortgages decline below rates on existing mortgage loans, the average life of these loans tends to be reduced.
Table 2
SELECTED LOAN MATURITIES AND INTEREST SENSITIVITY
(dollars in thousands)
|
Consolidated |
|
One Year |
|
After One |
|
Over Five |
|
Total |
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate mortgages |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Floating or adjustable interest rates |
|
$ |
99,917 |
|
$ |
56,424 |
|
$ |
552,833 |
|
$ |
709,174 |
|
|
Predetermined interest rates |
|
|
109,771 |
|
|
187,103 |
|
|
426,917 |
|
|
723,791 |
|
|
Consumer loans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Floating or adjustable interest rates |
|
|
14,348 |
|
|
14,363 |
|
|
228,122 |
|
|
256,833 |
|
|
Predetermined interest rates |
|
|
25,766 |
|
|
30,204 |
|
|
246,531 |
|
|
302,501 |
|
|
Commercial financial and agricultural |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Floating or adjustable interest rates |
|
|
25,201 |
|
|
6,735 |
|
|
453 |
|
|
32,389 |
|
|
Predetermined interest rates |
|
|
8,841 |
|
|
33,812 |
|
|
7,274 |
|
|
49,927 |
|
|
Total of loans with: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Floating or adjustable interest rates |
|
$ |
139,466 |
|
$ |
77,522 |
|
$ |
781,408 |
|
$ |
998,396 |
|
|
Predetermined interest rates |
|
$ |
144,378 |
|
$ |
251,119 |
|
$ |
680,722 |
|
$ |
1,076,219 |
|
Residential Mortgage Lending
At September 30, 2006, one- to four-family residential mortgage loans, including residential construction loans, totaled $1.01 billion, or 49.1% of total net loans receivable. We offer adjustable-rate mortgage loans (“ARMs”) and fixed-rate mortgage loans with terms generally ranging from 10 to 30 years.
Traditional types of ARMs currently offered by us have up to 30-year terms and interest rates which adjust annually after being fixed for a period of one, three, five, seven, or ten years in accordance with a designated index. ARMs may be originated with a 1% or 2% cap on any increase or decrease in the interest rate per year, with a 4%, 5% or 6% limit on the amount by which the interest rate can increase or decrease over the life of the loan.
We currently emphasize the origination of ARMs rather than long-term, fixed-rate mortgage loans for inclusion in our loan portfolio. In order to encourage the origination of ARMs with interest rates which adjust annually, we may offer a rate of interest on these loans below the fully-indexed rate for the initial period of the loan. These loans are underwritten on the basis of the fully-indexed rate. We presently offer single-family ARMs indexed to the one-year constant maturity treasury index or to a six month or one year LIBOR rate. While these loans are expected to adjust more quickly to changes in market interest rates, they may not adjust as rapidly as changes occur in our cost of funds.
We originate residential mortgage loans with loan-to-value ratios up to 103%. Generally, we require private mortgage insurance on mortgage loans exceeding an 80% loan-to-value ratio. Private mortgage insurance protects us against losses of at least 20% of the mortgage loan amount. Properties securing real estate loans made by us may be appraised either by appraisers we employ or by independent appraisers we select. Loans are usually originated pursuant to guidelines which will permit the sale of these loans in the secondary market.
The majority of our residential construction loans are made to finance the construction of individual owner-occupied houses with up to 90% loan-to-value ratios. These construction loans are generally structured to be converted to permanent loans at the end of the construction phase. Loan proceeds are disbursed in increments as construction progresses and as inspections justify. As part of our residential lending program, we also offer speculative construction loans with 80% loan-to-value ratios to qualified builders. Presently, we have approximately 60 such contractors who generated 163 loans totaling $67 million during fiscal 2006. The three largest builders by dollar volume were loaned $10 million to construct 13 homes in fiscal 2006. The three largest builders by number of units constructed 26 homes. In all cases, these loans were inspected by in-house personnel or contracted to engineers or qualified construction management specialists. The disbursements are calculated on a percentage of completion basis, always retaining sufficient funds to complete the project. These construction loans are generally at a competitive fixed rate of interest for one- or two-year periods. As noted below, we also offer lot loans intended for residential use, which may be on a fixed-rate or adjustable-rate basis.
Commercial Real Estate, Multi-family and Land Lending
At September 30, 2006, our commercial real estate and multifamily portfolio totaled $283.0 million, or 13.7% of total net loans. Loans made with land as security totaled $206.9 million, or 10.0% of total net loans. Land loans include both residential lot financing and loans secured by land used for business purposes.
Interest rates charged on permanent commercial real estate loans are determined by market conditions existing at the time of the loan commitment. Generally, loans have adjustable rates and the rate may be fixed for three to five years determined by market conditions, collateral and the relationship with the borrower. The amortization of the loans may vary but will not exceed 20 years. Terms are based either on the prime lending rate or LIBOR as the interest rate index or we may fix the rate of interest for a three year to five year period. Business loans to owner-users secured by these types of collateral are generally made on an adjustable rate basis.
Commercial real estate and multifamily loans are generally considered to be riskier than one- to four-family first mortgage loans because they typically have larger balances and are more likely to be affected by adverse conditions in the economy. Commercial and multifamily real estate loans also involve a greater degree of risk than one- to four-family residential mortgage loans because they usually have unpredictable cash flows and are more difficult to evaluate and monitor. For example, repayment of multifamily loans is dependent, in large part, on sufficient cash flow from the property to cover operating expenses and debt service. Rental income might not rise sufficiently over time to meet increases in the loan rate at repricing, or increases in operating expense (i.e., utilities, taxes). As a result, impaired loans are difficult to identify early. Because payments on loans secured by income properties often depend upon the successful operation and management of the properties, repayment of such loans may be affected by factors outside the borrower’s control, such as adverse conditions in the real estate market or the economy or changes in government regulation. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower’s ability to repay the loan and the value of the security for the loan may be impaired. In addition, many of our commercial real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment. Our commercial and multifamily construction loans are subject to similar risks as our residential construction loans, described above.
Because our loan portfolio contains a significant number of commercial and multifamily real estate loans with relatively large balances, the deterioration of one or a few of these loans may cause a significant increase in nonperforming loans. An increase in nonperforming loans could cause an increase in the provision for loan losses and an increase in loan charge-offs which could adversely impact our results of operations and financial condition.
Compared to one- to four-family first mortgage loans, land loans may involve larger loan balances to single borrowers, and the payment experience may be dependent on the successful development of the land and the sale of the lots. These risks can be significantly impacted by supply and demand conditions.
Commercial Business Lending
We are permitted under federal law to make secured or unsecured loans for commercial, corporate business and agricultural purposes including issuing letters of credit. The aggregate amount of these loans outstanding generally may not exceed 20% of our assets, provided that amounts in excess of 10% of total assets may be used only for s loans.
Our commercial business loans are generally made on a secured basis with terms that do not exceed five years. These loans typically have interest rates that change at periods ranging from 30 days to one year based either on prime lending rate or LIBOR as the interest rate index or to a fixed rate at the time of commitment for a period not exceeding five years. At September 30, 2006, our commercial business loans outstanding, which were secured by non-real estate collateral or were unsecured, totaled $82.3 million, which represented 4.0% of total net loans receivable. We generally obtain personal guarantees when arranging business financing.
Repayment of our commercial business loans is often dependent on cash flow of the borrower, which may be unpredictable, and collateral securing these loans may fluctuate in value. Our commercial business loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral is accounts receivable, inventory, equipment or real estate. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Other collateral securing loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
Consumer Lending
Federal regulations permit us to make secured and unsecured consumer loans up to 35% of assets. In addition, First Federal has lending authority above the 35% category for certain consumer loans, such as home equity loans, property improvement loans, mobile home loans and loans secured by savings accounts. Our consumer loans totaled $559.3 million at September 30, 2006, or 27.1% of total net loans. The largest component of consumer lending is comprised of single-family home equity lines of credit and other equity loans, currently totaling $252.4 million, or 45.1% of all consumer loans, at September 30, 2006. Mobile home loans comprised $173.8 million, or 31.1% of all consumer loans at September 30, 2006. Other consumer loans primarily consist of loans secured by boats, automobiles and credit cards.
Consumer loans may entail greater risk than one- to four-family first mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans.
A significant portion of our consumer loan portfolio is in mobile home loans. Mobile home lending involves additional risks as a result of higher loan-to-value ratios. Mobile home lending may also involve higher loan amounts than other types of consumer loans. The most frequent purchasers of mobile homes are retirees and younger, first time buyers. These borrowers may be deemed to be relatively high credit risks due to various factors, including, among other things, the manner in which they have handled previous credit, the absence or limited extent of their prior credit history or limited financial resources. Mobile home loan customers have historically been more adversely impacted by weak economic conditions, loss of employment and increases in other household costs. Consequently, mobile home loans bear a higher rate of interest, have a higher probability of default and may involve higher delinquency rates and greater servicing costs relative to loans to more creditworthy borrowers. In addition, the values of mobile homes decline over time and higher levels of inventories of repossessed and used mobile homes may affect the values of collateral and result in higher charge-offs and provisions for loan losses. During recent years, the level of default on mobile homes has decreased. While we expect the total outstanding balance of mobile homes to continue to grow over time, we do not anticipate that the mobile home portfolio will represent a significantly greater proportion of the portfolio than is currently the case.
Loan Sales and Servicing
While we originate adjustable-rate loans for our own portfolio, fixed-rate loans are generally made on terms that will permit them to be sold in the secondary market. We participate in secondary market activities by selling whole loans and participations in loans to the Federal Home Loan Bank (“FHLB”) of Atlanta under its Mortgage Partnership Program, the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and other institutional and private investors. This practice enables us to satisfy the demand for these loans in our local communities, to meet asset and liability management objectives and to develop a source of fee income through loan servicing. At September 30, 2006, we were servicing loans for others in the amount of $966.0 million.
Based on the current level of market interest rates and other factors, we intend to sell selected current originations of conforming 30-year and 15-year conventional fixed-rate mortgage loans. Our policy with respect to the sale of fixed-rate loans is dependent to a large extent on the general level of market interest rates. We may also sell adjustable-rate loans depending on market conditions at the time of origination. Sales of residential loans totaled $180.1 million in fiscal 2006, $216.5 million in fiscal 2005 and $214.6 million in fiscal 2004.
Investment Activities
First Federal is required under federal regulations to maintain adequate liquidity to ensure safe-and-sound operations. Investment decisions are made by authorized officers of First Financial and First Federal within policies established by both Boards of Directors.
At September 30, 2006, our investment and mortgage-backed securities portfolio totaled approximately $351.9 million, which included stock in the FHLB of Atlanta of $26.0 million. Investment securities included U.S. Government and agency obligations, corporate bonds and mutual funds approximating $29.4 million. Mortgage-backed securities totaled $296.5 million as of September 30, 2006. See Note 1 of Notes to Consolidated Financial Statements, contained in Item 8 of this document for a discussion of our accounting policy for investment and mortgage-backed securities. See Notes 5 and 6 of the Notes to Consolidated Financial Statements for additional information regarding investment and mortgage-backed securities and FHLB of Atlanta stock.
We achieve the objectives of our investment policies through investing in U.S. Government, federal agency and corporate debt securities, mortgage-backed securities, short-term money market instruments, mutual funds, loans and other investments as authorized by OTS regulations and specifically approved by the Boards of Directors of First Financial and First Federal. Our investment portfolio guidelines specifically identify those securities eligible for purchase and describe the operations and reporting requirements of the Investment Committee, which executes investment policy. Our primary objective in the management of the investment portfolio is to maintain a portfolio of high quality, highly liquid investments with returns competitive with short-term treasury or agency securities and highly rated corporate securities.
As a member of the FHLB System, First Federal is required to maintain an investment in the common stock of the FHLB of Atlanta. See “How We Are Regulated – Regulation of First Federal – Federal Home Loan Bank System.” The stock of the FHLB of Atlanta is redeemable at par value.
Securities may differ in terms of default risk, interest rate risk, liquidity risk and expected rate of return. Default risk is the risk that an issuer will be unable to make interest payments, or to repay the principal amount on schedule. We may invest in U.S. Government and federal agency obligations. U.S. Treasury obligations are regarded as free of default risk. The credit quality of corporate debt varies widely. We principally invest in corporate debt securities rated in one of the four highest categories by two nationally recognized investment rating services.
Our investment in mortgage-backed securities serves several primary functions. First, we may securitize whole loans for mortgage-backed securities issued by federal agencies to use as collateral for certain of our borrowings and to secure public agency deposits. Second, we may periodically securitize loans with federal agencies to reduce our credit risk exposure and to reduce regulatory risk-based capital requirements. Third, we acquire mortgage-backed securities from time to time to meet earning asset growth objectives and provide additional interest income when necessary to augment lower loan originations and replace loan portfolio runoff.
The following table sets forth the amortized cost and fair value of our investment and mortgage-backed securities, by type of security, as of September 30, 2006, 2005 and 2004. All of our investment and mortgage-backed securities were classified as “available for sale” as of the dates shown.
Table 3
INVESTMENT AND MORTGAGE-BACKED SECURITIES PORTFOLIO
(in thousands)
|
|
|
At September 30, |
|
||||||||||||||||
|
|
|
|
|
||||||||||||||||
|
|
|
2006 |
|
2005 |
|
2004 |
|
||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||
|
|
|
Amortized |
|
Fair |
|
Amortized |
|
Fair |
|
Amortized |
|
Fair |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities Available for Sale: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury and U.S. Government agencies and corporations |
|
$ |
7,246 |
|
$ |
7,270 |
|
$ |
3,425 |
|
$ |
3,366 |
|
$ |
3,245 |
|
$ |
3,230 |
|
|
State and municipal obligations |
|
|
450 |
|
|
453 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt and other securities |
|
|
18,001 |
|
|
17,939 |
|
|
22,425 |
|
|
22,503 |
|
|
15,889 |
|
|
15,869 |
|
|
Mutual funds |
|
|
3,733 |
|
|
3,733 |
|
|
2,155 |
|
|
2,154 |
|
|
9,827 |
|
|
9,827 |
|
|
Mortgage-backed securities |
|
|
301,194 |
|
|
296,493 |
|
|
346,841 |
|
|
341,533 |
|
|
349,199 |
|
|
346,847 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities available for sale |
|
$ |
330,624 |
|
$ |
325,888 |
|
$ |
374,846 |
|
$ |
369,556 |
|
$ |
378,160 |
|
$ |
375,773 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table provides information regarding the contractual maturities and weighted average yields of our investment and mortgage-backed securities held as of September 30, 2006.
Table 4
MATURITY AND YIELD SCHEDULE AS OF SEPTEMBER 30, 2006
(dollars in thousands)
|
|
|
Within |
|
After One |
|
After Five |
|
After Ten |
|
Total |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury and U.S. Government agencies and corporations |
|
$ |
7,246 |
|
|
|
|
|
|
|
|
|
|
$ |
7,246 |
|
|
State and municipal obligations |
|
|
|
|
|
|
|
|
|
|
$ |
450 |
|
|
450 |
|
|
Corporate debt and other securities |
|
|
|
|
|
|
|
|
|
|
|
18,001 |
|
|
18,001 |
|
|
Mutual funds |
|
|
3,733 |
|
|
|
|
|
|
|
|
|
|
|
3,733 |
|
|
Mortgage-backed securities |
|
|
46 |
|
$ |
322 |
|
$ |
7,974 |
|
|
292,852 |
|
|
301,194 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|