Chattanooga-Based FSG Bank Now Deemed "Undercapitalized"; Draws Up Plan Aimed At Preventing Takeover Through Shares Buyout

Losses At $23.5 Million Over Past 9 Months

  • Monday, November 26, 2012

First Security Group, Inc., parent firm of the Chattanooga-based FSG Bank, has now been deemed "undercapitalized" after losses totaling $130 million over almost four years.

Bank officials noted the designation could result in federal regulators ordering FSG Bank "to develop a plan to sell, merge or liquidate."

Bank officials said they believe the successful execution of certain strategic iniiatives "will ultimately result in full compliance with the order and position the bank for long-term growth and a return to profitability."

They also said they have been in talks with multiple potential investors since December 2011, but they noted, "The company can give no assurances as to the terms on which any such transaction may take place, if at all."

Losses for the third quarter of 2012 were $9.4 million. For the first nine months of this year, they were $23.5 million.

The "undercapitalized" designation places FSG Bank under additional stringent oversight of federal regulators, who earlier began monitoring the bank.

FSG Bank officials announced plans designed to deter outside interests from taking control of the bank by buying up large amounts of its shares.

The bank's board of directors has adopted a tax benefits preservation plan "designed to preserve the value of certain of the company’s deferred tax assets primarily associated with net operating loss carryforwards (NOLs) under Section 382 of the Internal Revenue Code." The bank intends to seek stockholder approval of the plan at its 2013 annual meeting of stockholders.

Officials said, "NOLs can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the company’s ability to use its NOLs would be limited if there was an 'ownership change' under Section 382. This would occur if stockholders owning (or deemed to own under the tax rules) 5% or more of the company’s stock increase their aggregate ownership of outstanding shares of the company’s common stock by more than 50 percentage points over a defined period of time. The plan is intended to reduce the likelihood of an 'ownership change' occurring as a result of the buying and selling of the company’s common stock."

“The primary purpose of the tax preservation plan is to protect the value of our NOLs for our shareholders,” stated Michael Kramer, president and CEO of First Security Group. “As we continue to make progress towards our capital initiatives, minimizing any significant changes in our shareholder base becomes critically important to ensuring the success of our plan.”

Officials said, "In connection with the plan, the company has declared a dividend of one preferred stock purchase right for each share of common stock outstanding as of the close of business on November 12, 2012. Effective today, any stockholder or group that acquires beneficial ownership of 5 percent or more of the company’s outstanding stock (an “acquiring person”) could be subject to significant dilution in its holdings if the company’s board of directors does not approve such acquisition. Existing stockholders holding 5 percent or more of the company’s common stock will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, in its discretion, the board of directors may exempt certain transactions and certain persons whose acquisition of securities is determined by the board not to jeopardize the company’s deferred tax assets.

"The rights will expire upon the earlier of (i) October 30, 2022, (ii) the beginning of a taxable year with respect to which the board of directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the board of directors determines that the plan is no longer needed to preserve the tax benefits, (iv) the final adjournment of the company’s 2013 Annual Meeting of Stockholders if stockholder approval of the plan has not been received before such time, (iv) the final adjournment of the third annual meeting of stockholders following the last annual meeting of stockholders at which the plan was most recently approved by stockholders, unless the plan receives stockholder re-approval at such third annual meeting, and (v) certain other events as described in the plan.

"Additional information regarding the plan will be provided in a Current Report on Form 8-K and in a Registration Statement on Form 8-A which the company intends to file with the Securities and Exchange Commission. In addition, the company’s stockholders of record as of November 12, 2012 will be mailed a detailed summary of the plan. "

Bank officials said in a filing with the Securities and Exchange Commission, "The bank is currently deemed not in compliance with some provisions of the Order, including the capital requirements. Any material noncompliance may result in further enforcement actions by the OCC, including the OCC requiring that FSG Bank develop a plan to sell, merge or liquidate. Management believes the successful execution of the strategic iniiatives discussed below will ultimately result in full compliance with the Order and position the bank for long-term growth and a return to profitability.

"As of September 30, 2012, the Bank's Tier I leverage ratio fell below the minimum level for an 'adequately capitalized' bank of 4%. Accordingly, the bank is currently operating under additional Prompt Corrective Actions, as described below.

"The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories in which all institutions are placed: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The federal banking agencies have also specified by regulation the relevant capital levels for each category.

"The bank had been deemed "adequately capitalized" for regulatory purposes since issuance of the Order in April 2010. As of October 30, 2012, based on the Bank's September 30, 2012 Report of Condition and Income, the bank was deemed "undercapitalized" for regulatory purposes.

"As a bank's capital position deteriorates, federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.

"A 'well capitalized' bank is one that is not required to meet and maintain a specific capital level for any capital measure, pursuant to any written agreement, order, capital directive, or other remediation, and significantly exceeds all of its capital requirements, which include maintaining a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 6%, and a Tier 1 leverage ratio of at least 5%. Generally, a  classification as well capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action. However, a well capitalized bank may be reclassified as 'adequately capitalized' based on criteria other than capital if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices, which requires certain remedial action.

"An 'adequately capitalized' bank meets the required minimum level for each relevant capital measure, including a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4% and a Tier 1 leverage ratio of at least 4%. A bank that is adequately capitalized is prohibited from directly or indirectly accepting, renewing or rolling over any brokered deposits, absent applying for and receiving a waiver from the applicable regulatory authorities. Institutions that are not well capitalized are also prohibited, except in very limited circumstances where the FDIC permits use of a higher local market rate, from paying yields for deposits in excess of 75 basis points above a national average rate for deposits of comparable maturity, as calculated by the FDIC. In addition, all institutions are generally prohibited from making capital distributions and paying management fees to controlling persons if, subsequent to such distribution or payment, the institution would be undercapitalized. Finally, an adequately capitalized bank may be forced to comply with operating restrictions similar to those placed on undercapitalized banks.

"An 'undercapitalized' bank fails to meet the required minimum level for any relevant capital measure. A bank that reaches the undercapitalized level is likely subject to a formal agreement or another formal supervisory sanction. An undercapitalized bank is not only subject to the requirements placed on adequately capitalized banks, but also becomes subject to the following operating and managerial restrictions, which:

- Prohibit capital distributions

- Prohibit payment of management fees to a controlling person

- Require the bank to submit a capital restoration plan within 45 days of becoming undercapitalized

- Require close monitoring of compliance with capital restoration plans, requirements and restrictions by the primary federal regulator

- Restrict asset growth by requiring the bank to restrict its average total assets to the amount attained in the preceding calendar quarter

- Prohibit the acceptance of employee benefit plan deposits

- Require prior approval by the primary federal regulator for acquisitions, branching and new lines of business

- Prohibit any material changes in accounting methods, and

- Other operating restrictions at the discretion of the primary federal regulator.

"The above requirements are generally consistent with the requirements under the Consent Order, with the primary exception of asset growth restriction. The company has evaluated and determined that scheduled maturities of brokered deposits in the fourth quarter of 2012, as well as a maturing commercial repurchase agreement, will allow the company to continue to seek growth in loans and customer deposits.

"The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in this Notecreate substantial doubt about the company's ability to continue as a going concern. These financial statements do not include any adjustments that may result should the company be unable to continue as a going concern. Management believes the successful execution of the strategic initiatives discussed below should provide sufficient capital to alleviate any substantial doubt about the company's ability to continue as a going concern.

"The company has experienced significant net operating losses for the three and nine months ended September 30, 2012 and years ended December 31, 2011, 2010, and 2009, substantially resulting from declining net interest margins and elevated levels of provision for loan losses.

"Losses on other real estate owned have also significantly impacted operating results of the company. Each of these financial trends was impacted by significant levels of nonperforming assets and related deterioration in the economy. As of September 30, 2012, the bank's Tier 1 leverage ratio fell below 4%, which is the threshold for adequate capitalization, and thus triggering additional prompt corrective action restrictions, as described above.

"The company's ability to continue as a going concern is largely dependent on the ability of management to effectuate the strategic initiatives described below.

"The company’s strategic initiatives address the actions necessary to restore profitability and achieve full compliance with all regulatory agreements, including, but not limited to, restoring capital to the prescribed regulatory levels of the Order. Management is pursuing various options to restore the Company’s capital to a satisfactory level, including, but not limited to, a private placement of common stock. Since December 2011, the company has been in preliminary discussions with multiple potential investors. Currently, the company has received non-binding indications with potential investors for a recapitalization that would provide sufficient capital to gain compliance with the capital requirements of the Order while ensuring the recapitalization transaction would not trigger an ownership change under applicable tax regulations. The company can give no assurances as to the terms on which any such transaction may take place, if at all.

"During 2011 and through the first quarter of 2012, the company underwent significant change within the board of directors and executive management. The changes were predicated on strengthening and deepening the company’s leadership in order to successfully execute a strategic and capital plan to return the company to profitable operations, satisfy the requirements of the regulatory actions detailed above, and lower the level of problem assets to an acceptable level.

"In December 2011, the company appointed Michael Kramer as president and chief executive officer. Subsequently, the company appointed a chief credit officer, retail banking officer and director of FSGBank’s Wealth Management and Trust Department. The company added three additional directors to the board in 2011 and has added three additional directors in 2012, including a new independent chairman of the board, Larry D. Mauldin.

"The bank has successfully maintained elevated liquidity and has chosen to do so primarily by maintaining excess cash at the Federal Reserve. The company’s cash position as of September 30, 2012 was $211.8 million compared to $258.2 million and $276.8 million at December 31, 2011 and September 30, 2011, respectively.

"The company's contemplated recapitalization would enable the full implementation of the company's strategic plan and should enable the company to restore profitability and achieve full compliance with all regulatory agreements, including, but not limited to, restoring capital to the prescribed regulatory levels of the Order. The company’s strategic plan includes maintaining adequate liquidity, reducing nonperforming assets, and appropriately increasing the company’s capital ratios.

"Banks and bank holding companies, as regulated institutions, must maintain required levels of capital. OCC and the Federal Reserve, the primary federal regulators for FSG Bank and the company, respectively, have adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines. As described above, the Order requires FSG Bank to achieve and maintain total capital to risk adjusted assets of at least 13% and a leverage ratio of at least 9%. The Order provided 120 days from April 28, 2010, the effective date of the Order, to achieve these ratios. FSG Bank is currently not in compliance with the capital requirements."

 

 

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