Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

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

For the quarterly period ended September 30, 2010

or

 

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

Commission File Number: 001-16715

First Citizens BancShares, Inc.

(Exact name of Registrant as specified in its charter)

 

Delaware   56-1528994

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

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

(919) 716-7000

(Registrant’s telephone number, including area code)

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

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

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

 

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

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

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

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

(Number of shares outstanding, by class, as of November 8, 2010)

 

 

 


Table of Contents

 

INDEX

 

         Page(s)  

PART I.

 

FINANCIAL INFORMATION

  

Item 1.

  Financial Statements (Unaudited)   
  Consolidated Balance Sheets at September 30, 2010, December 31, 2009 and September 30, 2009      3   
 

Consolidated Statements of Income for the three and nine month periods ended September 30, 2010 and September 30, 2009

     4   
 

Consolidated Statements of Changes in Shareholders’ Equity for the nine month periods ended September 30, 2010 and September 30, 2009

     5   
 

Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2010 and September 30, 2009

     6   
  Notes to Consolidated Financial Statements      7   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      28   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      54   

Item 4.

  Controls and Procedures      54   

PART II.

 

OTHER INFORMATION

  
Item 1A.   Risk Factors      55   

Item 6.

  Exhibits      58   

 

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Table of Contents

 

Part 1

Item 1. Financial Statements (Unaudited)

First Citizens BancShares, Inc. and Subsidiaries

Consolidated Balance Sheets

Unaudited

 

     September 30*
2010
    December 31#
2009
    September 30*
2009
 
     (thousands, except share data)  

Assets

  

Cash and due from banks

   $ 493,786      $ 480,242      $ 723,031   

Overnight investments

     1,049,158        723,260        219,886   

Investment securities available for sale

     3,786,841        2,929,162        3,283,521   

Investment securities held to maturity

     2,645        3,603        3,788   

Loans held for sale

     79,853        67,381        78,485   

Loans and leases:

      

Covered by loss share agreements

     2,222,660        1,173,020        1,257,478   

Not covered by loss share agreements

     11,545,309        11,644,999        11,520,683   

Less allowance for loan and lease losses

     218,046        172,282        165,282   
                        

Net loans and leases

     13,549,923        12,645,737        12,612,879   

Premises and equipment

     845,478        837,082        836,456   

Other real estate owned:

      

Covered by loss share agreements

     99,843        93,774        102,600   

Not covered by loss share agreements

     47,523        40,607        44,703   

Income earned not collected

     83,204        60,684        68,845   

Receivable from FDIC for loss share agreements

     651,844        249,842        243,000   

Goodwill

     102,625        102,625        102,625   

Other intangible assets

     11,373        6,361        6,976   

Other assets

     245,195        225,703        186,083   
                        

Total assets

   $ 21,049,291      $ 18,466,063      $ 18,512,878   
                        

Liabilities

      

Deposits:

      

Noninterest-bearing

   $ 3,859,389      $ 3,215,414      $ 3,261,987   

Interest-bearing

     13,883,639        12,122,153        12,086,968   
                        

Total deposits

     17,743,028        15,337,567        15,348,955   

Short-term borrowings

     652,716        642,405        576,609   

Long-term obligations

     819,145        797,366        879,758   

Other liabilities

     116,198        129,610        192,872   
                        

Total liabilities

     19,331,087        16,906,948        16,998,194   

Shareholders’ Equity

      

Common stock:

      

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

     8,757        8,757        8,757   

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

     1,678        1,678        1,678   

Surplus

     143,766        143,766        143,766   

Retained earnings

     1,588,336        1,429,863        1,413,993   

Accumulated other comprehensive loss

     (24,333     (24,949     (53,510
                        

Total shareholders’ equity

     1,718,204        1,559,115        1,514,684   
                        

Total liabilities and shareholders’ equity

   $ 21,049,291      $ 18,466,063      $ 18,512,878   
                        

 

* Unaudited
# Derived from the 2009 Annual Report on Form 10-K.

See accompanying Notes to Consolidated Financial Statements.

 

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First Citizens BancShares, Inc. and Subsidiaries

Consolidated Statements of Income

 

     Three Months Ended September 30     Nine Months Ended September 30  
     2010     2009     2010     2009  
     (thousands, except share and per share data)  

Interest income

    

Loans and leases

   $ 264,819      $ 170,690      $ 654,434      $ 482,723   

Investment securities:

        

U. S. Government

     9,406        15,076        29,007        54,353   

Residential mortgage backed securities

     1,544        1,329        4,981        3,711   

Corporate bonds

     2,196        2,205        6,529        4,063   

State, county and municipal

     14        32        62        187   

Other

     77        242        159        613   
                                

Total investment securities interest and dividend income

     13,237        18,884        40,738        62,927   

Overnight investments

     572        116        1,591        533   
                                

Total interest income

     278,628        189,690        696,763        546,183   

Interest expense

        

Deposits

     37,087        43,574        116,294        145,410   

Short-term borrowings

     742        980        2,138        3,582   

Long-term obligations

     10,859        9,859        32,493        29,077   
                                

Total interest expense

     48,688        54,413        150,925        178,069   
                                

Net interest income

     229,940        135,277        545,838        368,114   

Provision for loan and lease losses

     59,873        18,265        108,629        57,747   
                                

Net interest income after provision for loan and lease losses

     170,067        117,012        437,209        310,367   

Noninterest income

        

Gain on acquisitions

     0        104,434        136,000        104,434   

Cardholder and merchant services

     27,982        25,306        80,276        70,905   

Service charges on deposit accounts

     18,063        20,336        56,403        57,350   

Wealth management services

     12,826        12,071        38,782        34,324   

Fees from processing services

     7,485        7,619        21,934        22,307   

Securities (losses) gains

     940        (177     1,885        (316

Other service charges and fees

     4,734        4,078        14,492        12,495   

Mortgage income

     3,013        2,844        6,347        8,665   

Insurance commissions

     1,980        1,926        6,580        6,221   

ATM income

     1,730        1,710        5,084        5,211   

Adjustments to FDIC receivable for loss share agreements

     (28,505     0        (13,053     0   

Other

     (279     706        (190     365   
                                

Total noninterest income

     49,969        180,853        354,540        321,961   

Noninterest expense

        

Salaries and wages

     74,727        66,131        221,362        195,428   

Employee benefits

     14,455        15,390        48,605        48,482   

Occupancy expense

     18,353        17,282        54,706        48,658   

Equipment expense

     17,251        14,990        49,670        44,462   

FDIC deposit insurance

     5,842        5,497        17,338        23,446   

Foreclosure-related expenses (income)

     (1,271     3,869        6,804        7,291   

Other

     47,494        41,340        133,092        110,345   
                                

Total noninterest expense

     176,851        164,499        531,577        478,112   
                                

Income before income taxes

     43,185        133,366        260,172        154,216   

Income taxes

     15,439        50,898        97,213        56,885   
                                

Net income

   $ 27,746      $ 82,468      $ 162,959      $ 97,331   
                                

Average shares outstanding

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

Net income per share

   $ 2.66      $ 7.90      $ 15.62      $ 9.33   
                                

See accompanying Notes to Consolidated Financial Statements.

 

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First Citizens BancShares, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

Unaudited

 

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

Balance at December 31, 2008

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

Comprehensive income:

               

Net income

     0         0         0         97,331        0        97,331   

Change in unrealized securities gains arising during period, net of $12,086 deferred tax benefit

     0         0         0         0        (17,908     (17,908

Change in unrecognized loss on cash flow hedge, net of $834 deferred tax

     0         0         0         0        1,278        1,278   
                     

Total comprehensive income

                  80,701   
                     

Cash dividends of $0.90 per share

     0         0         0         (9,392     0        (9,392
                                                   

Balance at September 30, 2009

   $ 8,757       $ 1,678       $ 143,766       $ 1,413,993      $ (53,510   $ 1,514,684   
                                                   

Balance at December 31, 2009

   $ 8,757       $ 1,678       $ 143,766       $ 1,429,863      $ (24,949   $ 1,559,115   

Adjustment resulting from adoption of change in accounting for QSPEs and controlling financial interests effective January 1, 2010

     0         0         0         4,904        0        4,904   

Comprehensive income:

               

Net income

     0         0         0         162,959        0        162,959   

Change in unrealized securities gains arising during period, net of $3,632 deferred tax

     0         0         0         0        5,567        5,567   

Less: reclassification adjustment for gains included in net income, net of $900 deferred tax

     0         0         0         0        (1,398     (1,398

Change in pension liability, net of $1,178 tax benefit

     0         0         0         0        1,830        1,830   

Change in unrecognized loss on cash flow hedge, net of $3,513 deferred tax benefit

     0         0         0         0        (5,383     (5,383
                     

Total comprehensive income

                  163,575   
                     

Cash dividends of $0.90 per share

     0         0         0         (9,390     0        (9,390
                                                   

Balance at September 30, 2010

   $ 8,757       $ 1,678       $ 143,766       $ 1,588,336      $ (24,333   $ 1,718,204   
                                                   

At September 30, 2010, Accumulated Other Comprehensive Loss includes on an after-tax basis $25,599 in unrealized gains on investment securities available for sale, $41,301 in unrealized losses resulting from the funded status of the defined benefit plan and an unrealized loss of $8,631 on cash flow hedges.

At September 30, 2009, Accumulated Other Comprehensive Income includes on an after-tax basis $27,483 in unrealized gains on investment securities available for sale, $75,815 in unrealized losses resulting from the funded status of the defined benefit plan and an unrealized loss of $5,178 on cash flow hedges.

See accompanying Notes to Consolidated Financial Statements.

 

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First Citizens BancShares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

 

     Nine months ended September 30  
     2010     2009  

OPERATING ACTIVITIES

    

Net income

   $ 162,959      $ 97,331   

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

    

Amortization of intangibles

     4,727        1,324   

Provision for loan and lease losses

     108,629        57,747   

Deferred tax (benefit) expense

     (82,228     30,148   

Change in current taxes payable

     2,260        5,743   

Depreciation

     46,565        42,453   

Change in accrued interest payable

     (4,348     (8,399

Change in income earned not collected

     (14,860     8,922   

Gain on acquisitions

     (136,000     (104,434

Securities losses (gains)

     (1,885     316   

Origination of loans held for sale

     (420,346     (614,857

Proceeds from sale of loans held for sale

     413,958        612,916   

Gain on sale of loans held for sale

     (6,084     (7,145

Loss on sale of other real estate

     1,005        2,808   

Net amortization of premiums and discounts

     (29,506     31,295   

Receivable from FDIC for loss share agreements

     66,427        0   

Net change in other assets

     67,944        3,634   

Net change in other liabilities

     41,399        (21,233
                

Net cash provided by operating activities

     220,616        138,569   
                

INVESTING ACTIVITIES

    

Net change in loans and leases outstanding

     526,380        95,736   

Purchases of investment securities available for sale

     (2,536,499     (1,643,560

Proceeds from maturities of investment securities held to maturity

     956        2,159   

Proceeds from maturities of investment securities available for sale

     1,686,400        1,414,910   

Proceeds from sales of investment securities available for sale

     38,384        151,556   

Net change in overnight investments

     (325,898     86,002   

Additions to premises and equipment

     (54,961     (79,980

Proceeds from sale of other real estate

     75,738        20,112   

Net cash received from acquisitions

     106,489        51,381   
                

Net cash provided (used) by investing activities

     (483,011     98,316   
                

FINANCING ACTIVITIES

    

Net change in time deposits

     (323,859     249,592   

Net change in demand and other interest-bearing deposits

     1,021,589        (288,922

Net change in short-term borrowings

     (481,098     (149,515

Origination of long-term obligations

     68,697        91,008   

Cash dividends paid

     (9,390     (9,392
                

Net cash provided (used) by financing activities

     275,939        (107,229
                

Change in cash and due from banks

     13,544        129,656   

Cash and due from banks at beginning of period

     480,242        593,375   
                

Cash and due from banks at end of period

   $ 493,786      $ 723,031   
                

CASH PAYMENTS FOR:

    

Interest

   $ 155,273      $ 186,468   

Income taxes

     126,964        17,705   
                

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

    

Unrealized securities gains (losses)

   $ 5,259      $ (29,994

Unrealized (loss) gain on cash flow hedge

     (8,896     2,112   

Change in pension liability

     3,008        0   

Acquisitions:

    

Assets acquired

     2,291,659        1,924,715   

Liabilities assumed

     2,155,861        1,819,745   

Net assets acquired

     135,798        104,970   
                

See accompanying Notes to Consolidated Financial Statements

 

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First Citizens BancShares, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

Note A

Accounting Policies and Other Matters

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

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

Management has evaluated subsequent events through the filing date of the Quarterly Report on Form 10-Q.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in BancShares’ 2009 Form 10-K. Certain amounts for prior periods have been reclassified to conform with statement presentations for 2010. However, the reclassifications have no effect on shareholders’ equity or net income as previously reported.

FDIC-Assisted Transactions

US GAAP requires that the acquisition method of accounting be used for all business combinations, including those resulting from FDIC-assisted transactions and that an acquirer be identified for each business combination. Under US GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. US GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date. In addition, acquisition-related costs and restructuring costs are recognized as period expenses as incurred.

During 2010 and 2009, BancShares’ wholly-owned subsidiary, First-Citizens Bank & Trust Company (FCB), acquired assets and assumed liabilities of four entities as noted below (collectively referred to as “the Acquisitions”) with the assistance of the Federal Deposit Insurance Corporation (FDIC), which had been appointed Receiver of each entity by its respective state banking authority.

 

Name of entity

  

Headquarters location

  

Date of transaction

Sun American Bank (SAB)    Boca Raton, Florida    March 5, 2010
First Regional Bank (First Regional)    Los Angeles, California    January 29, 2010
Venture Bank (VB)    Lacey, Washington    September 11, 2009
Temecula Valley Bank (TVB)    Temecula, California    July 17, 2009

The acquired assets and assumed liabilities were measured at estimated fair value. Management made significant estimates and exercised significant judgment in accounting for the Acquisitions. Management judgmentally assigned risk ratings to loans based on credit quality, appraisals and estimated collateral values, estimated expected cash flows, and applied appropriate liquidity and coupon discounts to measure fair values for loans. Other real estate acquired through foreclosure was valued based upon pending sales contracts and appraised values, adjusted for current market conditions. FCB also recorded identifiable intangible assets representing the estimated values of the assumed core deposits and other customer relationships. Management used quoted or current market prices to determine the fair value of investment securities, short-term borrowings and long-term obligations.

 

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Loans and Leases

Loans and leases that are held for investment purposes are carried at the principal amount outstanding. Loans that are classified as held for sale are carried at the lower of aggregate cost or fair value. Interest on substantially all loans is accrued and credited to interest income on a constant yield basis based upon the daily principal amount outstanding.

Acquired loans are recorded at fair value at the date of acquisition. The fair values of acquired loans with evidence of credit deterioration since origination (impaired loans) are recorded net of a nonaccretable difference and, if appropriate, an accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is the nonaccretable difference, which is included in the carrying amount of acquired loans. Subsequent decreases to expected cash flows will generally result in recognition of an allowance by a charge to provision for loan and lease losses. Subsequent increases in expected cash flows result in either a reversal of the provision for loan and lease losses to the extent of prior charges, or a reclassification of the difference from nonaccretable to accretable with a positive impact on the accretable yield. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan when there is a reasonable expectation regarding the amount and timing of such cash flows. BancShares did not initially estimate the amount and timing of cash flows for loans acquired from TVB and VB at the dates of the acquisitions, but cash flow analyses were performed on loans acquired from First Regional and SAB in order to determine the cash flows expected to be collected. BancShares is accounting for all acquired loans on a loan level basis since the majority of the portfolios acquired consist of large commercial loans.

Receivable from FDIC for Loss Share Agreements

The receivable from the FDIC for loss share agreements is measured separately from the related covered assets as it is not contractually embedded in the assets and is not transferable should the assets be sold. Fair value was estimated using projected cash flows related to the loss share agreements based on the expected reimbursements for losses using the applicable loss share percentages and the estimated true-up payment at the expiration of the loss share agreements, if applicable. These cash flows were discounted to reflect the estimated timing of the receipt of the loss share reimbursement from the FDIC and the true-up payment to the FDIC, when applicable. The FDIC receivable has been reviewed and updated prospectively as loss estimates related to covered loans and other real estate owned change, and as reimbursements are received or expected to be received from the FDIC. Post-acquisition adjustments to the FDIC receivable are offset by noninterest income.

Other Real Estate Owned Covered by Loss Share Agreements

Other real estate owned (OREO) covered by loss share agreements with the FDIC are reported exclusive of expected reimbursement cash flows from the FDIC. Subsequent downward adjustments to the estimated recoverable value of covered OREO result in a reduction of covered OREO, a charge to other noninterest expense and an increase in the FDIC receivable for the estimated amount to be reimbursed, with a corresponding amount recorded as other noninterest income. OREO is presented at the estimated present value that management expects to receive when the property is sold, net of related costs of disposal. Management used appraisals of properties to determine fair values and applied additional discounts where appropriate for passage of time or, in certain cases, for subsequent events occurring after the appraisal date.

Recently Adopted Accounting Policies and Other Regulatory Issues

Under revisions to US GAAP that became effective January 1, 2010, the concept of a qualifying special-purpose entity (QSPE) was removed, resulting in a change in the accounting for QSPEs that were previously exempt. Upon adoption, the off-balance sheet accounting treatment for the 2005 asset securitization of home equity loans was discontinued, and the loans that were sold in the securitization and the corresponding debt obligations were reported on the consolidated balance sheet in the first quarter of 2010. The adoption resulted in increases of $97,291 in noncovered revolving mortgage loans, $681 in allowance for loan and lease losses, $86,926 in long-term obligations, and $3,189 in deferred tax liabilities. The retained interest in the residual interest strip and the servicing asset were written off, resulting in reductions of $1,287 and $304 to investment securities available for sale and other assets, respectively. The adoption also resulted in an adjustment to the beginning balance of retained earnings in the amount of $4,904.

 

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Note B

Federally Assisted Acquisitions of First Regional Bank and Sun American Bank

On January 29, 2010, FCB purchased substantially all the assets and assumed substantially all the liabilities of First Regional from the FDIC, as Receiver. First Regional operated through 8 offices in the state of California, primarily serving Southern California. The FDIC took First Regional under receivership upon its closure by the California Department of Financial Institutions. FCB’s bid to the FDIC included the purchase of substantially all of First Regional’s assets at a discount of $299,400 in exchange for assuming certain First Regional deposits and certain other liabilities. No cash, deposit premium or other consideration was paid by FCB. FCB and the FDIC entered into loss share agreements regarding future losses incurred on loans and other real estate acquired through foreclosure existing at the acquisition date. Under the terms of the loss share agreements, there is no reimbursement by the FDIC until net losses reach $41,815. The FDIC will reimburse FCB for 80 percent of net losses incurred up to $1,017,000, and 95 percent of net losses exceeding $1,017,000.

The Purchase and Assumption Agreement between FCB and the FDIC also includes a true-up payment at the end of year 10. On March 17, 2020, the true-up measurement date, FCB is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of (i) 20 percent of the stated threshold, or $203.4 million, less (ii) the sum of (a) 25 percent of the asset discount, or $74.9 million, plus (b) 25 percent of the cumulative loss share payments plus (c) the cumulative servicing amount. The cumulative servicing amount is 1 percent of the average covered assets for each year during the terms of the loss share agreements. Current projections suggest a true-up payment of $67,219 will be payable under the First Regional loss share agreements. This estimate is subject to change over the term of the agreements.

The term for loss share on residential real estate loans is ten years, while the term for loss share on non-residential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. As a result of the loss share agreements with the FDIC and considering an estimate of a contingent true-up payment to the FDIC, FCB recorded a receivable of $365,170 at the time of acquisition. During the second and third quarters of 2010, adjustments were made to the FDIC receivable based on changes in loss estimates related to covered loans and other real estate owned that affect the respective acquisition date fair values. These adjustments were made retroactive to the first quarter of 2010 and increased the receivable by $13,525.

On March 5, 2010, FCB purchased substantially all the assets and assumed substantially all the liabilities of SAB from the FDIC, as Receiver. SAB operated 12 offices in the state of Florida, primarily serving South Florida. The FDIC took SAB under receivership upon its closure by the Florida Office of Financial Regulation. FCB’s bid to the FDIC included the purchase of substantially all of SAB’s assets at a discount of $69,400 in exchange for assuming certain SAB deposits and certain other liabilities. The FDIC paid FCB $31,965 in additional cash consideration at closing. FCB and the FDIC entered into loss share agreements regarding future losses incurred on loans and other real estate acquired through foreclosure existing at the acquisition date. Under the terms of the loss share agreements, the FDIC will reimburse FCB for 80 percent of net losses incurred up to $99,000 and 95 percent of net losses exceeding $99,000.

The Purchase and Assumption Agreement between FCB and the FDIC also includes a true-up payment at the end of year 10. On May 15, 2020, the true-up measurement date, FCB is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of (i) 20 percent of the stated threshold, or $19.8 million, less (ii) the sum of (a) 25 percent of the asset discount, or $17.5 million, plus (b) 25 percent of the cumulative loss share payments plus (c) the cumulative servicing amount. The cumulative servicing amount is 1 percent of the average covered assets for each year during the terms of the loss share agreements. Although no true-up payment is currently projected under the SAB loss share agreements, those projections are subject to change.

The term for loss share on residential real estate loans is ten years, while the term for loss share on non-residential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. As a result of the loss share agreements with the FDIC, FCB recorded a receivable of $92,360 at the time of acquisition. During the second quarter of 2010, adjustments were made to the FDIC receivable based on changes in loss estimates related to covered loans and other real estate owned that affect the respective acquisition date fair values. These adjustments were made retroactive to the first quarter of 2010 and decreased the receivable by $2,626.

 

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The acquisitions of First Regional and SAB were accounted for using the acquisition method of accounting. The statement of net assets acquired, adjustments to the acquisition date fair values made in the second and third quarters and the resulting bargain purchase gains are presented in the following tables. As indicated in the explanatory notes that accompany the following tables, the purchased assets, assumed liabilities and identifiable intangible assets were recorded at their respective acquisition date estimated fair values. Fair values are subject to refinement for up to one year after the closing date of each merger as additional information regarding closing date fair values becomes available. Adjustments to the estimated fair values made in the second and third quarters were based on additional information regarding the acquisition date fair values, which included updated appraisals on several commercial properties on acquired impaired loans and updated financial statements for some borrowers which allowed for adjustments to expected cash flows that more closely reflect the borrowers’ ability to repay the debt.

First quarter noninterest income as originally reported included bargain purchase gains of $137,447 that resulted from the 2010 Acquisitions. The gains resulted from the difference between the estimated fair values of acquired assets and assumed liabilities. During the second and third quarters of 2010, adjustments were made to the gains based on additional information regarding the respective acquisition date fair values. These adjustments were made retroactive to the first quarter of 2010, the period the 2010 acquisitions were consummated, resulting in an adjusted gain of $136,000. FCB recorded a deferred tax liability for the gains totaling $53,258. To the extent there are additional adjustments to the respective acquisition date fair values up to one year following the respective acquisitions, there will be additional adjustments to the gains.

The following tables identify the assets acquired and liabilities assumed by FCB from First Regional and SAB. The tables provide the balances recorded by First Regional and SAB at the time of the respective FDIC-assisted transactions, the fair value adjustments recorded and the resulting adjusted fair values recorded by FCB for the acquisition date.

First Regional Bank

Acquisition date: January 29, 2010

 

     As recorded
by  First
Regional
     Fair value
adjustments
at date of
acquisition
    Subsequent
acquisition-date
adjustments
    As recorded
by FCB
 
     (thousands)  

Assets

         

Cash and due from banks

   $ 37,508       $ —        $ —        $ 37,508   

Investment securities available for sale

     3,250         —          —          3,250   

Loans covered by loss share agreements

     1,853,325         (576,171 ) a      (16,905 ) a      1,260,249   

Other real estate owned covered by loss share agreements

     61,488         (20,353 ) b      791   b      41,926   

Income earned not collected

     6,048         —          —          6,048   

Receivable from FDIC for loss share agreements

     —           365,170   c      13,525   i      378,695   

Intangible assets

     —           9,110   d      —          9,110   

Other assets

     23,782         (500 ) e      —          23,282   
                                 

Total assets acquired

   $ 1,985,401       $ (222,744   $ (2,589   $ 1,760,068   
                                 

Liabilities

         

Deposits:

         

Noninterest-bearing

   $ 528,235       $ —        $ —        $ 528,235   

Interest-bearing

     759,484         —          —          759,484   
                                 

Total deposits

     1,287,719         —          —          1,287,719   

Short-term borrowings

     361,876         —          —          361,876   

Other liabilities

     1,188         1,547   h      —          2,735   
                                 

Total liabilities assumed

     1,650,783         1,547        —          1,652,330   
                                 

Excess of assets acquired over liabilities assumed

   $ 334,618          
               

Aggregate fair value adjustments

      $ (224,291   $ (2,589  
                     

Gain on acquisition of First Regional

          $ 107,738   
               

 

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Sun American Bank

Acquisition date: March 5, 2010

 

     As recorded
by SAB
     Fair  value
adjustments
at  acquisition
date
    Subsequent
acquisition-date
adjustments
    As recorded  by
FCB
 
     (thousands)  

Assets

         

Cash and due from banks

   $ 37,016       $ —        $ —        $ 37,016   

Investment securities available for sale

     66,968         —          —          66,968   

Loans covered by loss share agreements

     411,315         (123,707 ) a      3,283  a      290,891   

Other real estate owned covered by loss share agreements

     15,220         (7,200 ) b      —          8,020   

Income earned not collected

     1,612         —          —          1,612   

Receivable from FDIC for loss share agreements

     —           92,360  c      (2,626 ) i      89,734   

Intangible assets

     —           629  d      —          629   

Other assets

     4,473         —          —          4,473   
                                 

Total assets acquired

   $ 536,604       $ (37,918   $ 657      $ 499,343   
                                 

Liabilities

         

Deposits:

         

Noninterest-bearing

   $ 39,435       $ —        $ —        $ 39,435   

Interest-bearing

     380,577         —          —          380,577   
                                 

Total deposits

     420,012         —          —          420,012   

Short-term borrowings

     42,485         48  f      —          42,533   

Long-term obligations

     37,000         3,082  g      —          40,082   

Other liabilities

     853         51  h      —          904   
                                 

Total liabilities assumed

     500,350         3,181        —          503,531   
                                 

Excess of assets acquired over liabilities assumed

   $ 36,254          
               

Aggregate fair value adjustments

      $ (41,099   $ 657     
                     

Cash received from the FDIC

          $ 31,965   
               

Gain on acquisition of Sun American

          $ 27,777   
               

Explanation of fair value adjustments

a - Adjustment reflects the fair value adjustments based on FCB’ sevaluation of the acquired loan portfolio.

b - Adjustment reflects the estimated OREO losses based on FCB’s evaluation of the acquired OREO portfolio.

c - Adjustment reflects the estimated fair value of payments FCB will receive from the FDIC under the loss share agreements.

d - Adjustment reflects the estimated value of intangible assets, which includes core deposit intangibles and when applicable, trust customer relationships.

e - Adjustment reflects the amount needed to adjust the carrying value of other assets to estimated fair value.

f - Adjustment arises since the rates on short-term borrowings are higher than rates available on similar borrowings at date of acquisition.

g - Adjustment arises since the rates on long-term obligations are higher than rates available on similar borrowings at date of acquisition.

h - Adjustment reflects amount needed to adjust the carrying value of other liabilities to estimated fair value.

i - Adjustment to acquisition date fair value based on additional information received post-acquisition regarding acquisition date fair value.

 

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Results of operations for First Regional and SAB prior to their respective acquisition dates are not included in the income statement.

Due to the significant amount of fair value adjustments, the resulting accretion of those fair value adjustments and the protection resulting from the FDIC loss share agreements, historical results of First Regional and SAB are not relevant to BancShares’ results of operations. Therefore, no pro forma information is presented.

Note C

Investments

The aggregate values of investment securities at September 30, 2010, December 31, 2009 and September 30, 2009, along with unrealized gains and losses determined on an individual security basis are as follows:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

Investment securities available for sale

           

September 30, 2010

           

U. S. Government

   $ 3,112,152       $ 9,099       $       $ 3,121,251   

Corporate bonds

     479,935         9,254                 489,189   

Residential mortgage-backed securities

     151,355         4,891         110         156,136   

Equity securities

     1,132         17,865                 18,997   

State, county and municipal

     1,241         27                 1,268   
                                   

Total investment securities available for sale

   $ 3,745,815       $ 41,136       $ 110       $ 3,786,841   
                                   

December 31, 2009

           

U. S. Government

   $ 2,274,084       $ 14,005       $ 666       $ 2,287,423   

Corporate bonds

     481,341         4,326                 485,667   

Residential mortgage-backed securities

     126,601         4,489         752         130,338   

Equity securities

     2,377         14,245                 16,622   

State, county and municipal

     7,053         35         275         6,813   

Other

     1,937         362                 2,299   
                                   

Total investment securities available for sale

   $ 2,893,393       $ 37,462       $ 1,693       $ 2,929,162   
                                   

September 30, 2009

           

U. S. Government

   $ 2,611,698       $ 23,183       $ 178       $ 2,634,703   

Corporate bonds

     482,705         4,459         74         487,090   

Residential mortgage-backed securities

     112,235         3,117         1         115,351   

Equity securities

     2,591         13,985         31         16,545   

State, county and municipal

     7,185         193         2         7,376   

Other

     21,997         459                 22,456   
                                   

Total investment securities available for sale

   $ 3,238,411       $ 45,396       $ 286       $ 3,283,521   
                                   

Investment securities held to maturity

           

September 30, 2010

           

Residential mortgage-backed securities

   $ 2,645       $ 245       $ 26       $ 2,864   
                                   

Total investment securities held to maturity

   $ 2,645       $ 245       $ 26       $ 2,864   
                                   

December 31, 2009

           

Residential mortgage-backed securities

   $ 3,452       $ 256       $ 26       $ 3,682   

State, county and municipal

     151         1                 152   
                                   

Total investment securities held to maturity

   $ 3,603       $ 257       $ 26       $ 3,834   
                                   

September 30, 2009

           

Residential mortgage-backed securities

   $ 3,637       $ 278       $ 26       $ 3,889   

State, county and municipal

     151         1                 152   
                                   

Total investment securities held to maturity

   $ 3,788       $ 279       $ 26       $ 4,041   
                                   

 

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

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

 

     September 30, 2010      December 31, 2009      September 30, 2009  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

Investment securities available for sale

                 

Maturing in:

                 

One year or less

   $ 2,559,784       $ 2,567,076       $ 1,544,063       $ 1,554,657       $ 1,550,843       $ 1,563,140   

One through five years

     1,044,757         1,056,170         1,226,202         1,233,604         1,585,364         1,600,964   

Five through 10 years

     1,815         1,841         1,943         2,201         2,323         2,683   

Over 10 years

     138,327         142,757         118,808         122,078         97,290         100,189   

Equity securities

     1,132         18,997         2,377         16,622         2,591         16,545   
                                                     

Total investment securities available for sale

   $ 3,745,815       $ 3,786,841       $ 2,893,393       $ 2,929,162       $ 3,238,411       $ 3,283,521   
                                                     

Investment securities held to maturity

                 

Maturing in:

                 

One through five years

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

Five through 10 years

     2,512         2,689         3,306         3,497         3,487         3,700   

Over 10 years

     133         175         146         185         150         189   
                                                     

Total investment securities held to maturity

   $ 2,645       $ 2,864       $ 3,603       $ 3,834       $ 3,788       $ 4,041   
                                                     

The following table provides information regarding securities with unrealized losses as of September 30, 2010, December 31, 2009 and September 30, 2009:

 

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

September 30, 2010

                 

Investment securities available for sale:

                 

Residential mortgage-backed securities

   $ 10,364       $ 88       $ 535       $ 22       $ 10,899       $ 110   
                                                     

Total

   $ 10,364       $ 88       $ 535       $ 22       $ 10,899       $ 110   
                                                     

Investment securities held to maturity:

                 

Residential mortgage-backed securities

   $ —           —         $ 27       $ 26       $ 27       $ 26   

December 31, 2009

                 

Investment securities available for sale:

                 

U.S. Government

   $ 250,600       $ 666       $ —         $ —         $ 250,600       $ 666   

Residential mortgage-backed securities

     25,608         621         2,434         131         28,042         752   

State, county and municipal

     5,476         271         439         4         5,915         275   
                                                     

Total

   $ 281,684       $ 1,558       $ 2,873       $ 135       $ 284,557       $ 1,693   
                                                     

Investment securities held to maturity:

                 

Residential mortgage-backed securities

   $ —         $ —         $ 29       $ 26       $ 29       $ 26   

September 30, 2009

                 

Investment securities available for sale:

                 

U.S. Government

   $ 17,060       $ 108       $ 1,368       $ 70       $ 18,428       $ 178   

Corporate Bonds

     76,909         74         —           —           76,909         74   

Residential mortgage-backed securities

     —           —           16         1         16         1   

Equity securities

     34         31         —           —           34         31   

State, county and municipal

     —           —           441         2         441         2   
                                                     

Total

   $ 94,003       $ 213       $ 1,825       $ 73       $ 95,828       $ 286   
                                                     

Investment securities held to maturity:

                 

Residential mortgage-backed securities

   $ —         $ —         $ 33       $ 26       $ 33       $ 26   

 

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Investment securities with an aggregate fair value of $562 have had continuous unrealized losses for more than twelve months as of September 30, 2010 with an aggregate unrealized loss of $48. These 19 investments consist entirely of residential mortgage-backed securities. None of the unrealized losses identified as of September 30, 2010 related to the marketability of the securities or the issuer’s ability to honor redemption obligations. Consequently, the securities were not deemed to be other than temporarily impaired.

With respect to investment securities held to maturity, BancShares has the ability and intent to hold those securities until they mature.

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

 

    Three months ended September 30,     Nine months ended September 30,  
    2010     2009     2010     2009  

Gross gains on sales of investment securities available for sale

  $ 1,167      $ 104      $ 3,803      $ 104   

Gross losses on sales of investment securities available for sale

    (1     —          (1,506     —     

Other than temporary impairments of equity investments

    (226     (281     (412     (420
                               

Total securities gains (losses)

  $ 940      $ (177   $ 1,885      $ (316
                               

Investment securities having an aggregate carrying value of $2,015,500 at September 30, 2010, $2,121,783 at December 31, 2009 and $1,998,230 at September 30, 2009, were pledged as collateral to secure public funds on deposit, to secure certain short-term borrowings or collateral obligations and for other purposes as required by law.

 

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Note D

Loans and Leases

Loans and leases outstanding include the following as of the dates indicated:

 

     September 30, 2010      December 31, 2009      September 30, 2009  

Loans covered by loss share agreements

   $ 2,222,660       $ 1,173,020       $ 1,257,478   

Loans and leases not covered by loss share agreements

        

Real estate:

        

Construction and land development

     546,070         622,354         621,176   

Commercial mortgage

     4,696,183         4,552,078         4,514,554   

Residential mortgage

     917,415         864,704         876,001   

Revolving mortgage

     2,209,149         2,147,223         2,114,018   

Other mortgage

     155,509         158,187         101,802   
                          

Total real estate loans

     8,524,326         8,344,546         8,227,551   

Commercial and industrial

     1,774,340         1,832,670         1,822,526   

Consumer

     766,586         941,986         998,007   

Lease financing

     294,825         330,713         335,515   

Other

     185,232         195,084         137,084   
                          

Total loans and leases not covered by loss share agreements

   $ 11,545,309       $ 11,644,999       $ 11,520,683   
                          

 

    September 30, 2010     December 31, 2009     September 30, 2009  
    Impaired at
acquisition
date
    All  other
acquired
loans
    Total     Impaired  at
acquisition
date
    All other
acquired
loans
    Total     Impaired at
acquisition
date
    All other
acquired
loans
    Total  

Loans covered by loss share agreements:

                 

Real estate:

                 

Construction and land development

  $ 173,964      $ 397,027      $ 570,991      $ 22,700      $ 283,342      $ 306,042      $ 34,793      $ 392,642      $ 427,435   

Commercial mortgage

    132,049        999,134        1,131,183        36,820        553,579        590,399        40,490        605,087        645,577   

Residential mortgage

    36,933        45,836        82,769        8,828        143,481        152,309        3,387        57,193        60,580   

Revolving mortgage

    114        23,025        23,139        —          —          —          451        8,264        8,715   

Other mortgage

    43,023        177,001        220,024        331        21,307        21,638        344        3,325        3,669   
                                                                       

Total real estate loans

    386,083        1,642,023        2,028,106        68,679        1,001,709        1,070,388        79,465        1,066,511        1,145,976   

Commerical and industrial

    14,400        168,505        182,905        5,958        89,273        95,231        3,361        97,550        100,911   

Consumer

    116        6,852        6,968        255        4,259        4,514        287        6,793        7,080   

Other

    147        4,534        4,681        476        2,411        2,887        329        3,182        3,511   
                                                                       

Total loans covered by loss share agreements

  $ 400,746      $ 1,821,914      $ 2,222,660      $ 75,368      $ 1,097,652      $ 1,173,020      $ 83,442      $ 1,174,036      $ 1,257,478   
                                                                       

Outstanding balance

  $ 742,010      $ 2,535,003      $ 3,277,013      $ 200,310      $ 1,418,375      $ 1,618,685      $ 297,077      $ 1,566,084      $ 1,863,161   

 

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Impaired loans are loans that have evidence of deterioration in credit quality since origination, suggesting it is probable that all contractually required payments will not be collected. The following table provides information on all impaired loans, exclusive of those loans evaluated collectively as a homogeneous group.

 

    September 30, 2010     December 31, 2009     September 30, 2009  

Impaired loans:

     

Covered by loss share agreements

  $ 542,862      $ 116,446      $ 83,442   

Not covered by loss share agreements

    57,968        50,797        33,263   
                       

Total

  $ 600,830      $ 167,243      $ 116,705   
                       

Allowance for loan and lease losses related to:

     

Impaired loans covered by loss share agreements

  $ 40,046      $ 3,500        —     

Impaired loans and leases not covered by loss share agreements

    9,648        9,611        4,873   

Impaired loans with no allowance for loan and lease loss:

     

Loans covered by loss share agreements

    374,535        106,498        —     

Loans and leases not covered by loss share agreements

    7,348        9,902        9,331   

When the fair values of loans covered by loss share agreements with the FDIC (Covered Loans) were established, certain loans were identified as impaired. The following table provides changes in the carrying value of acquired impaired loans during the nine-month periods ended September 30, 2010 and 2009:

 

     2010     2009  

Balance, January 1

   $ 75,368      $ —     

Fair value of acquired impaired loans covered by loss share agreements

     412,627        99,625   

Reductions for repayments, foreclosures and decreases in fair value

     (87,249     (16,183
                

Balance, September 30

   $ 400,746      $ 83,442   
                

Cash flow analyses were prepared for First Regional and SAB loans deemed impaired at acquisition and those analyses are used to determine the amount of accretable yield recognized on those loans. Due to initial uncertainty regarding the timing of future cash flows, no accretable yield was initially measured for loans deemed impaired at acquisition from TVB and VB, and the cost recovery method is used to account for these loans.

The following table documents changes to the amount of accretable yield. For First Regional and SAB loans, improved cash flow estimates and receipt of unscheduled loan payments resulted in the reclassification of nonaccretable yield to accretable yield. For TVB and VB loans, receipt of unscheduled loan payments and improvements in expected losses resulted in the reclassification of nonaccretable yield to accretable yield.

 

     Accretable Yield  

Balance at December 31, 2009

   $ —     

Additions

     63,908   

Accretion

     (100,299

Reclassifications from (to) nonaccretable difference

     157,097   

Disposals

     (1,070
        

Balance at September 30, 2010

   $ 119,636   
        

Nonperforming loans and other risk elements are summarized below:

 

     September 30,
2010
     December 31,
2009
     September 30,
2009
 

Nonaccrual loans and leases:

        

Covered under loss share agreements

   $ 264,653       $ 116,446       $ 102,473   

Not covered under loss share agreements

     84,753         58,417         56,628   

Restructured loans:

        

Covered under loss share agreements

     65,417         10,013         —     

Not covered under loss share agreements

     53,374         55,025         4,990   
                          

Nonperforming loans and leases

   $ 468,197       $ 239,901       $ 164,091   
                          

Loans and leases 90 days or more past due and still accruing:

        

Covered under loss share agreements

   $ 365,207       $ —         $ —     

Not covered under loss share agreements

     18,059         27,766         16,507   

Other real estate owned:

        

Covered under loss share agreements

   $ 99,843       $ 93,774       $ 102,600   

Not covered under loss share agreements

     47,524         40,607         44,703   

Accruing loans and leases 90 days or more past due covered by loss share agreements include impaired loans acquired from First Regional and SAB that are accounted for using the accretable yield method.

 

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Note E

Allowance for Loan and Lease Losses

Activity in the allowance for loan and lease losses is summarized as follows:

 

            Nine months ended
September 30,
 
            2010     2009  

Balance, January 1

      $ 172,282      $ 157,569   

Adjustment resulting from adoption of change in accounting for QSPEs and controlling financial interests, effective January 1, 2010

        681      $ —     

Provision for loan and lease losses

       

Covered by loss share agreements

        62,455        —     

Not covered by loss share agreements

        46,174        57,747   

Loans and leases charged-off:

       

Covered by loss share agreements

        (22,122     —     

Not covered by loss share agreements

        (45,652     (53,694

Loans and leases recovered:

       

Not covered by loss share agreements

        4,228        3,660   
                   

Net charge-offs

        (63,546     (50,034
                   

Balance, September 30

      $ 218,046      $ 165,282   
                   

 

    September 30, 2010     December 31, 2009     September 30, 2009  

Allowance for loan and lease losses allocated to:

     

Loans covered by loss share agreements

  $ 43,839      $ 3,500      $ —     

Loans and leases not covered by loss share agreements

    174,207        168,782        165,282   
                       

Total

  $ 218,046      $ 172,282      $  165,282   
                       

Note F

Receivable from FDIC for Loss Share Agreements

The following table provides changes in the receivable from the FDIC during the first nine months of 2010 and 2009:

 

     Nine months  ended
September 30,
 
     2010     2009  

Balance at January 1

   $ 249,842      $ —     

Additional receivable from acquisitions

     468,429        242,520   

Accretion of discounts and premiums, net

     3,638        480   

Receipt of payments from FDIC

     (52,422     —     

Post-acquisition adjustments

     (17,643     —     
                

Balance at September 30

   $ 651,844      $ 243,000   
                

The receivable from the FDIC for loss share agreements is measured separately from the related covered assets and is recorded at fair value. The fair value was estimated using projected cash flows related to the loss share agreements based on the expected reimbursements for losses and the applicable loss share percentages.

 

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Post-acquisition adjustments represent the net change in loss estimates related to covered loans and other real estate owned as a result of changes in estimated fair values and the allowance for loan and lease losses related to covered loans. For loans covered by loss share agreements, subsequent decreases in the amount expected to be collected from the borrower result in a provision for loan and lease losses, an increase in the allowance for loan and lease losses, and a proportional adjustment to the receivable from the FDIC for the estimated amount to be reimbursed. Subsequent increases in the amount expected to be collected from the borrower result in the reversal of any previously recorded provision for loan and lease losses and related allowance for loan and lease losses and adjustments to the receivable from the FDIC, or prospective adjustment to the accretable yield and the related receivable from the FDIC if no provision for loan and lease losses had been recorded. Adjustments related to acquisition date fair values, made within one year after the closing date of the respective acquisition, are reflected in the bargain purchase gain.

Second quarter 2010 loss share filings were completed in the third quarter of 2010 and forwarded to the FDIC for review. These filings request reimbursement of $54.5 million from the FDIC for losses and covered servicing expenses. Due to inaccuracies with regard to the filings, the FDIC is delaying payment pending correction of the filings. In the opinion of management, substantially all of the requested $54.5 million will be received. The FDIC has also indicated that reimbursement of amounts claimed on future loss share filings will be deferred pending remediation of certain of our loss share filing processes.

Note G

Estimated Fair Values

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

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

Estimated fair values for certain financial assets and financial liabilities are provided in the following table:

 

     September 30, 2010      December 31, 2009      September 30, 2009  
     Carrying
Value
     Fair
Value
     Carrying
Value
     Fair
Value
     Carrying
Value
     Fair
Value
 

Cash and due from banks

   $ 493,786       $ 493,786       $ 480,242       $ 480,242       $ 723,031       $ 723,031   

Overnight investments

     1,049,158         1,049,158         723,260         723,260         219,886         219,886   

Investment securities available for sale

     3,786,841         3,786,841         2,929,162         2,929,162         3,283,521         3,283,521   

Investment securities held to maturity

     2,645         2,864         3,603         3,834         3,788         4,041   

Loans held for sale

     79,853         79,853         67,381         67,381         78,485         78,485   

Loans covered by loss share agreements, net of allowance for loan and lease losses

     2,178,821         2,150,909         1,169,520         1,169,520         1,257,478         1,256,659   

Loans and leases not covered by loss share agreements, net of allowance for loan and lease losses

     11,371,102         10,995,807         11,476,217         11,060,532         11,355,401         10,748,074   

Receivable from FDIC for loss share agreements

     651,844         654,210         249,842         249,842         243,000         243,000   

Income earned not collected

     83,204         83,204         60,684         60,684         68,845         68,845   

Stock issued by:

                 

Federal Home Loan Bank of Atlanta

     48,291         48,291         47,361         47,361         47,361         47,361   

Federal Home Loan Bank of San Francisco

     16,135         16,135         5,592         5,592         5,592         5,592   

Federal Home Loan Bank of Seattle

     4,490         4,490         4,490         4,490         4,490         4,490   

Deposits

     17,743,028         17,808,921         15,337,567         15,396,423         15,348,955         15,418,748   

Short-term borrowings

     652,716         652,716         642,405         642,405         576,609         576,609   

Long-term obligations

     819,145         851,107         797,366         788,004         879,758         901,180   

Accrued interest payable

     33,533         33,533         37,881         37,881         42,524         42,524   

 

 

 

 

 

 

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

Fair value represents the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, BancShares considers the principal or most advantageous market in which those assets or liabilities are sold and considers assumptions that market participants would use when pricing those assets or liabilities. As required under US GAAP, individual fair value estimates are ranked based on the relative reliability of the inputs used in the valuation. Fair values determined using level 1 inputs rely on active and observable markets to price identical assets or liabilities. In situations where identical assets and liabilities are not traded in active markets, fair values may be determined based on level 2 inputs, which exist when observable data exists for similar assets and liabilities. Fair values for assets and liabilities that are not actively traded in observable markets are based on level 3 inputs, which are considered to be nonobservable. It is BancShares’ policy to recognize transfers between levels of the fair value hierarchy at the end of the respective reporting period.

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

 

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For assets and liabilities carried at fair value on a recurring basis, the following table provides fair value information as of September 30, 2010, December 31, 2009 and September 30, 2009:

 

            Fair value measurements using:  

Description

   Fair value      Quoted prices in
active markets for
identical assets  and
liabilities

(Level 1 inputs)
     Quoted prices for
similar assets and
liabilities

(Level 2 inputs)
     Significant
unobservable inputs
(Level 3 inputs)
 
September 30, 2010            

Assets measured at fair value

           

Investment securities available for sale

           

U.S. Government

   $ 3,121,251       $ 3,121,251       $ —         $ —     

Corporate bonds

     489,189         489,189         —           —     

Residential mortgage-backed securities

     156,136         —           156,136         —     

Equity securities

     18,997         18,997         —           —     

State, county, municipal

     1,268         —           1,268         —     
                                   

Total

   $ 3,786,841       $ 3,629,437       $ 157,404       $ —     
                                   

Liabilities measured at fair value

           

Interest rate swaps accounted for as cash flow hedges

   $ 14,263       $ —         $ 14,263       $ —     

December 31, 2009

           

Assets measured at fair value

           

Investment securities available for sale

           

U.S. Government

   $ 2,287,423       $ 2,287,423       $ —         $ —     

Corporate bonds

     485,667         485,667         —           —     

Residential mortgage-backed securities

     130,338         —           130,338         —     

Equity securities

     16,622         16,622         —           —     

State, county, municipal

     6,813         —           6,813         —     

Other

     2,299         1,012         —           1,287   
                                   

Total

   $ 2,929,162       $ 2,790,724       $ 137,151       $ 1,287   
                                   

Liabilities measured at fair value

           

Interest rate swaps accounted for as cash flow hedges

   $ 5,367       $ —         $ 5,367       $ —     

September 30, 2009

           

Assets measured at fair value

           

Investment securities available for sale

           

U.S. Government

   $ 2,634,703       $ 2,634,703       $ —         $ —     

Corporate bonds

     487,090         487,090         —           —     

Residential mortgage-backed securities

     115,351         —           115,351         —     

Equity securities

     16,545         16,545         —           —     

State, county, municipal

     7,376         —           7,376         —     

Other

     22,456            20,267         2,189   
                                   

Total

   $ 3,283,521       $ 3,138,338       $ 142,994       $ 2,189   
                                   

Liabilities measured at fair value

           

Interest rate swaps accounted for as cash flow hedges

   $ 8,556       $ —         $ 8,556       $ —     

 

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Prices for US Government securities, corporate bonds and equity securities are readily available in the active markets in which those securities are traded and the resulting fair values are shown in the ‘Level 1 input’ column. Prices for mortgage-backed securities and state, county and municipal securities are obtained using the fair values of similar assets and the resulting fair values are shown in the ‘Level 2 input’ column. At December 31, 2009, the fair value for the retained residual interest from a securitization transaction was determined based on Level 3 nonobservable inputs. Based on changes to US GAAP related to accounting for QSPEs and controlling financial interests that became effective January 1, 2010, the previously securitized loans were consolidated and the residual interest strip was removed from the consolidated balance sheet. There were no transfers between Level 1 and Level 2 inputs during the nine months ended September 30, 2010.

At September 30, 2010, other assets include $68,916 of stock in various Federal Home Loan Banks (FHLB). The FHLB stock, which is redeemable only through the issuer, is carried at its par value. The investment in the FHLB stock is considered a long-term investment and its value is based on the ultimate recoverability of par value. Management has concluded that the investment in FHLB stock was not other-than-temporarily impaired as of September 30, 2010.

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

For those investment securities available for sale with fair values that are determined by reliance on significant nonobservable inputs, the following table identifies the factors causing the change in fair value during the first nine months of 2010 and 2009:

 

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

Description

   2010     2009  

Beginning balance, January 1 ,

   $ 1,287      $ 5,427   

Total gains (losses), realized or unrealized:

    

Included in earnings

     —          —     

Included in other comprehensive income

     —          (1,278

Purchases, sales , issuances and settlements, net

     —          (1,960

Transfers in/out of Level 3

     (1,287     —     
                

Ending balance, September 30

   $ —        $ 2,189   
                

No gains or losses were reported for the nine month periods ended September 30, 2010 and 2009 that relate to fair values estimated based on significant nonobservable inputs. The investment securities valued using level 3 inputs that were transferred out during the first quarter of 2010 result from changes in US GAAP adopted January 1, 2010 related to investments in the retained interest of a residual interest strip that resulted from an asset securitization.

 

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Certain assets and liabilities are carried at fair value on a nonrecurring basis. Loans held for sale are carried at the lower of aggregate cost or fair value and are therefore carried at fair value only when fair value is less than the asset cost. Certain impaired loans are also carried at fair value. For assets and liabilities carried at fair value on a nonrecurring basis, the following table provides fair value information as of September 30, 2010, December 31, 2009 and September 30, 2009:

 

            Fair value measurements using:  

Description

   Fair value      Quoted prices  in
active markets for
identical assets and
liabilities

(Level 1 inputs)
     Quoted prices  for
similar assets and
liabilities

(Level 2 inputs)
     Significant
nonobservable
inputs
(Level 3 inputs)
 

September 30, 2010

           

Loans held for sale

   $ 79,853       $ —         $ 79,853       $ —     

Impaired loans:

           

Covered by loss share agreements

     542,862         —           —           542,862   

Not covered by loss share agreements

     48,320         —           —           48,320   

December 31, 2009

           

Loans held for sale

     67,381         —           67,381         —     

Impaired loans:

           

Covered by loss share agreements

     112,946         —           —           116,446   

Not covered by loss share agreements

     44,686         —           —           40,895   

September 30, 2009

           

Loans held for sale

     38,328         —           38,328         —     

Impaired loans:

           

Covered by loss share agreements

     83,442         —           —           83,442   

Not covered by loss share

     19,055         —           —           19,055   

The values of loans held for sale are based on prices observed for similar pools of loans. The values of impaired loans are determined by either the collateral value or by the discounted present value of the expected cash flows. No financial liabilities were carried at fair value on a nonrecurring basis as of September 30, 2010 or December 31, 2009.

Certain non-financial assets and non-financial liabilities are measured at fair value on a nonrecurring basis. OREO is measured and reported at fair value using Level 2 inputs for observable market data or Level 3 inputs for valuations based on nonobservable criteria. During the nine month period ended September 30, 2010, foreclosures of other real estate not covered by loss share agreements totaled $24,241, all of which were valued using Level 3 inputs. In connection with the measurement and initial recognition of noncovered OREO, BancShares recognized loan charge-offs totaling $11,137. Based on updates to Level 3 inputs, noncovered OREO with a fair value of $8,025 as of September 30, 2010 incurred write-downs that totaled $2,344 during the nine month period ended September 30, 2010.

 

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Note H

Employee Benefit Plans

Pension expense is a component of employee benefits expense. For the three and nine month periods ended September 30, 2010 and 2009, the components of pension expense are as follows:

 

     Three months ended September 30,     Nine month periods ended September 30,  
     2010     2009     2010     2009  

Service cost

   $ 2,760      $ 3,190      $ 9,431      $ 9,472   

Interest cost

     5,192        5,517        17,738        16,384   

Expected return on assets

     (6,533     (6,982     (22,551     (20,733

Amortization of prior service cost

     42        53        157        157   

Amortization of net actuarial loss

     771        908        2,851        2,696   
                                

Total pension expense

   $ 2,232      $ 2,686      $ 7,626      $ 7,976   
                                

For the nine month periods ended September 30, 2010 and 2009 the assumed discount rate is 6.00 percent, the expected long-term rate of return on plan assets is 8.00 percent and the assumed rate of salary increases is 4.50 percent.

Note I

Contingencies

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

Note J

Derivatives

At September 30, 2010, BancShares had two interest rate swaps that qualify as cash flow hedges under US GAAP. The fair values of these derivatives are included in other liabilities in the consolidated balance sheets and in the net change in other liabilities in the consolidated statements of cash flows.

The interest rate swaps are used for interest rate risk management purposes and convert variable-rate exposure on outstanding debt to a fixed rate. The interest rate swaps each have a notional amount of $115,000, representing the amount of variable-rate trust preferred capital securities issued during 2006. The 2006 interest rate swap hedges interest payments through June 2011 and requires fixed-rate payments by BancShares at 7.125 percent in exchange for variable-rate payments of 175 basis points above 3-month LIBOR, which is equal to the interest paid to the holders of the trust preferred capital securities. The 2009 interest rate swap hedge interest payments from July 2011 through June 2016 and requires fixed-rate payments by BancShares at 5.50 percent in exchange for variable-rate payments of 175 basis points above 3-month LIBOR. As of September 30, 2010, collateral with a fair value of $14,734 was pledged to secure the existing obligation under the interest rate swaps. For both swaps, settlement occurs quarterly.

 

            Estimated fair value of liability  
     Notional amount
for all periods
     September 30, 2010      December 31, 2009     September 30, 2009  

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

   $ 115,000       $ 4,304       $ 7,424      $ 8,488   

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

     115,000         9,959         (2,057     68   
                            
      $ 14,263       $ 5,367      $ 8,556   
                            

 

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For cash flow hedges, the effective portion of the gain or loss due to changes in the fair value of the derivative hedging instrument is included in other comprehensive income, while the ineffective portion, representing the excess of the cumulative change in the fair value of the derivative over the cumulative change in expected future discounted cash flows on the hedged transaction, is recorded in the consolidated income statement. BancShares’ interest rate swaps have been fully effective since inception. Therefore, changes in the fair value of the interest rate swaps have had no impact on net income. For the nine month periods ended September 30, 2010 and 2009, BancShares recognized interest expense of $4,374 and $3,738, respectively, resulting from incremental interest paid to the interest rate swap counterparty, none of which related to ineffectiveness.

The following table discloses activity in accumulated other comprehensive income (loss) related to the interest rate swaps during the nine month periods ended September 30, 2010 and 2009.

 

     2010     2009  

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

   $ (3,248   $ (6,456

Other comprensive (loss) income recognized during nine month period ended September 30, net of tax

     (5,383     1,278   
                

Accumulated other comprehensive loss resulting from interest rate swaps as of September 30, net of tax

   $ (8,631   $ (5,178
                

Accumulated other comprehensive loss resulting from interest rate swaps as of July 1, net of tax

   $ (6,844   $ (3,897

Other comprensive (loss) income recognized during three month period ended September 30, net of tax

     (1,787     (1,281
                

Accumulated other comprehensive loss resulting from interest rate swaps as of September 30, net of tax

   $ (8,631   $ (5,178
                

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

 

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Note K

Segment Disclosures

BancShares conducts its banking operations through its two wholly-owned subsidiaries, FCB and ISB. Although FCB and ISB offer similar products and services to customers, each entity operates in distinct geographic markets, except California, Washington and Florida, and has separate management groups. Additionally, the financial results and trends of ISB reflect the de novo nature of its growth. During the third quarter of 2010, FCB filed applications with Federal and state banking regulators for permission to merge with ISB, with FCB being the surviving entity. Pending regulatory approval and the expiration of any applicable waiting periods, the merger of FCB and ISB is expected to occur during early 2011. Following the merger and for the immediate future, all ISB branches will continue to operate under the name IronStone Bank, which will then be a division of FCB. Management has currently made no decisions with respect to any prospective changes in segment reporting assuming the merger is approved by regulatory authorities.

FCB operates from a single charter from its branch network in North Carolina, Virginia, West Virginia, Maryland, Tennessee, California, Washington, Florida and Washington, DC. FCB’s entrance into California, Washington and Florida during 2009 and 2010 resulted from participation in FDIC-assisted transactions. ISB began operations in 1997 and operates from a thrift charter in Florida, Georgia, Texas, New Mexico, Arizona, California, Oregon, Washington, Colorado, Oklahoma, Missouri and Kansas.

Management has determined that FCB and ISB are reportable business segments. In the aggregate, FCB and its consolidated subsidiaries, which are integral to its branch operation, and ISB account for more than 90 percent of consolidated assets, revenues and net income. The ‘Other’ category in the accompanying table includes activities of the parent company and Neuse, Incorporated (Neuse), a subsidiary that owns real property used in the banking operation and owns other real estate. The other real estate owned (non-performing assets) by Neuse relates to loans originated by ISB. During 2009, Neuse purchased some of ISB’s OREO to reduce ISB’s nonperforming assets. To facilitate the potential purchase of additional OREO in the future, ISB has agreed to lend Neuse up to $15,000 under a revolving line of credit. No amount was owed by Neuse to ISB as of September 30, 2010 under the revolving line of credit.

The adjustments in the accompanying tables represent the elimination of the impact of certain intercompany transactions. The adjustments for interest income and interest expense neutralize the earnings and cost of intercompany borrowings. The adjustments to noninterest income and noninterest expense reflect the elimination of management fees and other service fees paid from one company to another within BancShares’ consolidated group.

 

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     ISB      FCB      Other      Total      Adjustments     Consolidated  

September 30, 2010

                

Total assets

   $ 2,802,818       $ 18,107,427       $ 2,298,026       $ 23,208,271       $ (2,158,980   $ 21,049,291   

Loans and leases:

                

Covered by loss share agreements

     —           2,222,660         —           2,222,660         —          2,222,660   

Not covered by loss share agreements

     2,259,999         9,285,310         —           11,545,309         —          11,545,309   

Allowance for loan and lease losses

     42,675         175,371         —           218,046         —          218,046   

Goodwill

     793         60,593         41,239         102,625         —          102,625   

Nonperforming assets:

                

Covered by loss share agreements

     —           429,913         —           429,913         —          429,913   

Not covered by loss share agreements

     77,220         91,912         16,519         185,651         —          185,651   

Deposits

     2,167,350         15,633,900         —           17,801,250         (58,222     17,743,028   

December 31, 2009

                

Total assets

   $ 2,573,605       $ 15,791,475       $ 2,181,898       $ 20,546,978       $ (2,080,915   $ 18,466,063   

Loans and leases:

                

Covered by loss share agreements

     —           1,173,020         —           1,173,020         —          1,173,020   

Not covered by loss share agreements

     2,194,659         9,450,340         —           11,644,999         —          11,644,999   

Allowance for loan and lease losses

     41,675         130,607         —           172,282         —          172,282   

Goodwill

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

Non performing assets:

                

Covered by loss share agreements

     —           220,233         —           220,233         —          220,233   

Not covered by loss share agreements

     62,881         76,622         14,546         154,049         —          154,049   

Deposits

     1,967,824         13,406,484         —           15,374,308         (36,741     15,337,567   

September 30, 2009

                

Total assets

   $ 2,637,409       $ 15,822,497       $ 2,156,373       $ 20,616,279       $ (2,103,401   $ 18,512,878   

Loans and leases:

                

Covered by loss share agreements

     —           1,257,478         —           1,257,478         —          1,257,478   

Not covered by loss share agreements

     2,176,504         9,344,179         —           11,520,683         —          11,520,683   

Allowance for loan and lease losses

     39,425         125,857         —           165,282         —          165,282   

Goodwill

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

Nonperforming assets

                

Covered by loss share agreements

     —           205,073         —           205,073         —          205,073   

Not covered by loss share agreements

     51,678         40,308         14,335         106,321         —          106,321   

Deposits

     2,024,574         13,353,069         —           15,377,643         (28,688     15,348,955   

 

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     As of and for the quarter ended September 30, 2010  
     ISB     FCB      Other     Total      Adjustments     Consolidated  

Interest income

   $ 34,225      $ 244,281       $ 333      $ 278,839       $ (211   $ 278,628   

Interest expense

     9,946        33,295         5,658        48,899         (211     48,688   
                                                  

Net interest income

     24,279        210,986         (5,325     229,940         —          229,940   

Provision for credit losses

     5,540        54,333         —          59,873         —          59,873   
                                                  

Net interest income after provision for credit losses

     18,739        156,653         (5,325     170,067         —          170,067   

Noninterest income

     4,943        47,159         (263     51,839         (1,870     49,969   

Noninterest expense

     22,228        155,614         879        178,721         (1,870     176,851   
                                                  

Income (loss) before income taxes

     1,454        48,198         (6,467     43,185         —          43,185   

Income taxes

     591        20,414         (5,566     15,439         —          15,439   
                                                  

Net income (loss)

   $ 863      $ 27,784       $ (901   $ 27,746       $ —        $ 27,746   
                                                  
     As of and for the quarter ended September 30, 2009  
     ISB     FCB      Other     Total      Adjustments     Consolidated  

Interest income

   $ 32,951      $ 155,938       $ 982      $ 189,871       $ (181   $ 189,690   

Interest expense

     12,285        36,689         5,620        54,594         (181     54,413   
                                                  

Net interest income

     20,666        119,249         (4,638     135,277         —          135,277   

Provision for credit losses

     7,545        10,720         —          18,265         —          18,265   
                                                  

Net interest income after provision for credit losses

     13,121        108,529         (4,638     117,012         —          117,012   

Noninterest income

     3,504        180,064         (282     183,286         (2,433     180,853   

Noninterest expense

     22,701        143,701         530        166,932         (2,433     164,499   
                                                  

Income (loss) before income taxes

     (6,076     144,892         (5,450     133,366         —          133,366   

Income taxes

     (2,174     54,975         (1,903     50,898         —          50,898   
                                                  

Net income (loss)

   $ (3,902   $ 89,917       $ (3,547   $ 82,468       $ —        $ 82,468   
                                                  
     As of and for the nine months ended September 30, 2010  
     ISB     FCB      Other     Total      Adjustments     Consolidated  

Interest income

   $ 100,700      $ 595,398       $ 1,249      $ 697,347       $ (584   $ 696,763   

Interest expense

     31,242        103,304         16,963        151,509         (584     150,925   
                                                  

Net interest income

     69,458        492,094         (15,714     545,838         —          545,838   

Provision for credit losses

     14,286        94,343         —          108,629         —          108,629   
                                                  

Net interest income after provision for credit losses

     55,172        397,751         (15,714     437,209         —          437,209   

Noninterest income

     12,132        348,642         (385     360,389         (5,849     354,540   

Noninterest expense

     67,249        468,636         1,541        537,426         (5,849     531,577   
                                                  

Income (loss) before income taxes

     55        277,757         (17,640     260,172         —          260,172   

Income taxes

     156        103,240         (6,183     97,213         —          97,213   
                                                  

Net income (loss)

   $ (101   $ 174,517       $ (11,457   $ 162,959       $ —        $ 162,959   
                                                  
     As of and for the nine months ended September 30, 2009  
     ISB     FCB      Other     Total      Adjustments     Consolidated  

Interest income

   $ 98,076      $ 443,979       $ 4,612      $ 546,667       $ (484   $ 546,183   

Interest expense

     40,905        120,672         16,976        178,553         (484     178,069   
                                                  

Net interest income

     57,171        323,307         (12,364     368,114                368,114   

Provision for credit losses

     26,686        31,061         —          57,747                57,747   
                                                  

Net interest income after provision for credit losses

     30,485        292,246         (12,364     310,367                310,367   

Noninterest income

     10,041        320,278         (828     329,491         (7,530     321,961   

Noninterest expense

     68,008        416,132         1,502        485,642         (7,530     478,112   
         &n