Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 for such shorter period that the registrant was required to submit and post such files).
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act).
Yes o No þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
FIRST FINANCIAL HOLDINGS, INC.
NOTE 1. Basis of Presentation and Accounting Policies
The accompanying unaudited consolidated financial statements for First Financial Holdings, Inc. (First Financial) and its wholly-owned subsidiaries, including First Federal Bank (First Federal), a South Carolina-chartered commercial bank, have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions for Form 10-Q and Article 10 of Regulation S-X pursuant to the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.
Certain amounts have been reclassified to conform with the current year presentation. First Financials significant accounting policies are described in Note 1 to the Consolidated Financial Statements included in First Financials 2011 Annual Report on Form 10-K for the fiscal year ended September 30, 2011, as filed with the Securities and Exchange Commission (SEC) on December 13, 2011. For interim reporting purposes, First Financial follows the same basic accounting policies, as updated by the information contained in this report. For further information, refer to the consolidated financial statements and footnotes included in First Financials 2011 Annual Report on Form 10-K.
First Financial has one active wholly-owned trust formed for the purpose of issuing securities which qualify as regulatory capital and is considered a Variable Interest Entity (VIE). First Financial is not the primary beneficiary, and consequently, the trust is not consolidated in the accompanying consolidated financial statements. The trust issued $46.4 million in trust preferred securities to investors in 2004, which remains outstanding at September 30, 2012. The net proceeds from the issuance were used to purchase junior subordinated deferrable interest debentures issued by First Financial, which is the sole asset of the trust. The trust preferred securities held by this entity qualify as Tier 1 capital for First Financial and are classified as long-term debt on the Consolidated Balance Sheets, with the associated interest expense recorded in interest on borrowed money on the Consolidated Statements of Operations. The expected losses and residual returns for this entity are absorbed by the trust preferred security holders and, consequently, First Financial is not exposed to loss related to this VIE.
Change in Fiscal Year
On December 20, 2011, First Financials Board of Directors approved an amendment to Article VIII of First Financials bylaws to change First Financials fiscal year end from September 30th to December 31st of each year. The change was effective December 31, 2011 and the current fiscal year began on January 1, 2012 and will end on December 31, 2012. The change in fiscal year end resulted in a three-month transition period which began on October 1, 2011 and ended on December 31, 2011. As a result of its change in fiscal year, First Financial filed a Transition Report on Form 10-Q with the SEC on February 9, 2012 which covered the transition period from October 1, 2011 to December 31, 2011.
As a result of First Financials sale of its insurance agency subsidiary, First Southeast Insurance Services, Inc., which was completed on June 1, 2011, and its managing general insurance agency subsidiary, Kimbrell Insurance Group, Inc., which was completed on September 30, 2011, the financial condition, operating results, and the gain or loss on the sales, net of transaction costs and taxes, for these subsidiaries have been segregated from the financial condition and operating results of First Financials continuing operations throughout this report and, as such, are presented as discontinued operations. While all prior periods have been revised retrospectively to align with this treatment, these changes do not affect First Financials reported consolidated financial condition or operating results for any of the prior periods.
Recently Adopted Accounting Pronouncements
FASB ASU 2012-02, Intangibles Goodwill and Other (Topic 350) Testing Indefinite-Lived Assets for Impairment.
This ASU simplifies the guidance for testing the decline in the realizable value (impairment) of indefinite-lived intangible assets other than goodwill. The amendments will allow First Financial to make a qualitative evaluation about the likelihood of impairment of an indefinite-lived intangible asset to determine whether it should apply the quantitative test and calculate the fair value of the indefinite-lived intangible asset. Specifically, First Financial has the option to first assess qualitative factors (events and circumstances) that could have affected the significant inputs used in determining the fair value of the indefinite-lived intangible asset to determine whether it is more likely than not that the indefinite-lived intangible asset is impaired. If, after considering all relevant events and circumstances, First Federal concludes that it is more likely than not that the indefinite-lived intangible asset is impaired then First Financial is required to determine the fair value of the indefinite-lived intangible asset and compare the fair value with the carrying amount to determine the amount of impairment loss, if any. However, if First Financial concludes otherwise, then it is not required to take any further action. Under the amended guidance, First Financial may choose to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to calculating its fair value. The amendments do not change how an impairment loss is measured or how First Financial measures an impairment loss. ASU 2012-2 is effective for annual and interim impairment tests performed after September 15, 2012. The adoption of ASU 2012-02 did not have a material impact on its financial condition or results of operations.
FASB ASU 2011-05, Comprehensive Income (Topic 220) Presentation of Comprehensive Income as amended by Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2011-12, Comprehensive Income (Topic 220)-Deferral of the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update (ASU) 2011-05.
This ASU increases the prominence of other comprehensive income (OCI) in financial statements and provides two options for presenting OCI. The ASU eliminates the current placement near the statement of shareholders equity or detailed in the Consolidated Statement of Changes in Shareholders Equity. The ASU provides for an OCI statement to be included with the net income statement, and together the two will make a statement of total comprehensive income. Alternatively, businesses can have an OCI statement separate from a net income statement, but the two statements should appear consecutively within a financial report. The ASU does not affect the calculation of earnings per share. The adoption of ASU 2011-05 was effective December 15, 2011. First Financial elected to present a separate OCI statement which is located immediately following its Consolidated Statements of Operations.
FASB ASU 2011-04, Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs
This ASU amends the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. The ASU clarifies the application of existing fair value measurement requirements and changes principles or requirement for measuring fair value or for disclosing information about fair value measurements. The ASU requires new disclosures for any transfers between Levels 1 and 2 of the fair value hierarchy, not just significant transfers, and further expands focus on Level 3 measurements, including quantitative information about the significant unobservable inputs used for all Level 3 measurements, a qualitative discussion about the sensitivity of recurring Level 3 measurements to changes in the unobservable inputs disclosed, and a description of the valuation processes. The adoption of ASU 2011-04 was effective for reporting periods beginning on or after December 15, 2011 and is included in Note 8 to the Consolidated Financial Statements.
FASB ASU 2011-03, Transfer and Servicing (Topic 860) Reconsideration of Effective Control of Repurchase Agreements
This ASU improves the accounting for repurchase agreements and other agreements that entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. ASU 2011-03 removes from the assessment of effective control: (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation related to that criterion. Other criterions applicable to the assessment of effective control are not changed by the amendments in this ASU. The adoption of ASU 2011-03 was effective December 15, 2011 and did not have a material impact on First Financials financial condition or results of operations.
Recently Issued Accounting Pronouncements
FASB ASU 2012-06. Business Combinations (Topic 805) - Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution
This ASU addresses the diversity in practice about how to interpret the terms on the same basis and contractual limitations when subsequently measuring an indemnification asset recognized in a government-assisted (Federal Deposit Insurance Corporation or National Credit Union Administration) acquisition of a financial institution that includes a loss sharing agreement (indemnification agreement). When First Financial recognizes an indemnification asset (in accordance with Subtopic 805-20) as a result of a government-assisted acquisition of a financial institution and subsequently a change in the cash flows expected to be collected on the indemnification asset occurs (as a result of a change in cash flows expected to be collected on the assets subject to indemnification), First Financial should subsequently account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value should be limited to the contractual term of the indemnification agreement (that is, the lesser of the term of the indemnification agreement and the remaining life of the indemnified assets). This guidance is effective for annual periods beginning on or after December 15, 2012 and interim periods within those annual periods. First Financial has previously accounted for its indemnification asset in accordance with this guidance; accordingly, this guidance will have no impact on First Financials consolidated financial position, results of operations, or cash flows.
FASB ASU 2011-11, Balance Sheet (Topic 210) - Disclosures about Offsetting Assets and Liabilities.
This ASU addresses the differences in reporting between GAAP and International Financial Reporting Standards (IFRS) regarding offsetting (netting) assets and liabilities and enhances current disclosures. ASU 2011-11 requires First Financial to disclose both gross information and net information about instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The scope includes derivatives, sale and repurchase agreements and reverse sales and repurchase agreements, as well as securities borrowing and securities lending arrangements. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013 and interim periods within those annual periods. First Financial does not expect the adoption of ASU 2011-11 to have a material impact on its financial condition or results of operations.
NOTE 2. Acquisitions
Acquisitions are accounted for in accordance with Accounting Standards Codification (ASC) 805, Business Combinations, and assets acquired and liabilities assumed are recorded at their estimated fair value as of acquisition date. Determining the fair value of the assets and liabilities, especially the loan portfolio and other real estate owned (OREO), is a complex process involving significant judgment regarding the methods and assumptions used to calculate estimated fair values. The fair value assigned to loans and OREO is preliminary and subject to refinement for the earlier of up to one year after the closing date of the acquisition or as additional information becomes available. Acquisition-related costs are recognized as expenses in the period they are incurred. As of September 30, 2012, there have been no adjustments or changes to the initial fair values.
Liberty Savings Bank Branch Acquisition
On April 20, 2012, First Federal acquired five branches from Liberty Savings Bank (Liberty) in the Hilton Head, South Carolina market and the transaction included $22.2 million of performing loans and $113.2 million of deposits, as of the transaction date. First Federal consolidated three of the acquired branches with existing First Federal financial centers, adding a net of two new financial centers in the Hilton Head market. The acquired loans and time deposits were recorded at their estimated fair value based on expected contractual cash flows, which were discounted at market rates as of the acquisition date. The estimated fair value for the loans did not include a discount for credit quality as they were all performing loans as of the acquisition date. First Federal also recorded an intangible asset totaling $5.2 million, which represented the estimated fair value of the assumed core deposits (noninterest-bearing checking, interest-bearing checking, savings, and money market accounts) as well as the estimated value of a non-compete agreement between First Federal and Liberty. The amortization of the purchase accounting adjustments for the loans and time deposits is recorded in net interest income while the amortization of the intangible asset is recorded in noninterest expense on the Consolidated Statements of Operations.
Plantation Federal Bank FDIC-Assisted Acquisition
On April 27, 2012, First Federal assumed all deposits and substantially all assets and certain other liabilities of Plantation Federal Bank (Plantation), a full-service community bank headquartered in Pawleys Island, South Carolina, from the Federal Deposit Insurance Corporation (FDIC), as receiver for Plantation (the Transaction). Plantation operated three branches along the coast of South Carolina under the name of Plantation Federal and three branches in the Greenville, South Carolina market under the name of First Savers Bank. The Transaction was made pursuant to a purchase and assumption agreement, in the FDICs customary form, entered into by First Federal and the FDIC as of April 27, 2012 (a P&A Agreement).
In connection with the Transaction, the FDIC made a cash payment to First Federal of $46.0 million, and First Federal did not pay the FDIC a premium to assume the customer deposits. The P&A Agreement includes a customary loss sharing agreement with the FDIC, which covers $216.2 million at carrying value of acquired commercial loans and commercial OREO ($169.5 million at estimated fair value). First Federal will share in the losses on the covered asset pools and the FDIC is obligated to reimburse First Federal for 80% of all eligible losses with respect to covered assets, beginning with the first dollar of loss incurred through $55.0 million in losses. First Federal absorbs losses greater than $55.0 million up to $65.0 million. The FDIC will reimburse First Federal for 60% of all eligible losses in excess of $65.0 million. First Federal has a corresponding obligation to reimburse the FDIC according to the same arrangement for eligible recoveries with respect to the covered assets. The loss share agreement provides for FDIC loss sharing for five years and First Federal to reimburse the FDIC for recoveries for eight years.
The fair value of the loans acquired was estimated based on discounted cash flows, which take into consideration current portfolio interest rates and repricing characteristics as well as assumptions related to prepayment speeds. Loans with an estimated fair value of $139.8 million with credit deterioration were acquired and accounted for in accordance with ASC 310-30, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. First Federal estimated the fair value of the ASC 310-30 loans based on projected cash flows, the type of loan and related collateral, risk rating classification status and current market interest rates. Loans were grouped into pools according to similar characteristics and are treated in the aggregate when applying various valuation techniques. First Federal also estimated the amount of credit losses that are expected to be realized for the loan portfolio by estimating the liquidation value of collateral securing loans on nonaccrual status or classified as substandard or doubtful. Certain amounts related to these loans were estimates, such as as-is and liquidation collateral values provided for by appraisers, and are highly subjective. The discount rates take into consideration the market interest rate environment as of the acquisition date and a credit risk component based on the credit characteristics of each loan pool. The accretion of the fair value discount on the acquired loans is recorded in net interest income on the Consolidated Statements of Operations. The accretion of the fair value discount on the acquired OREO is recorded in noninterest expense on the Consolidated Statements of Operations.
The fair value of the FDIC indemnification asset associated with the covered assets was estimated at $34.3 million using projected cash flows related to the loss sharing agreement, based on the expected reimbursement for losses and the applicable loss sharing percentages for each loss tranche. The expected cash flows were discounted to reflect the uncertainty of the timing and receipt of the loss sharing reimbursement from the FDIC. The amount that First Federal realizes on the FDIC indemnification asset could differ materially from the carrying value, based on the timing and amount of collections on the acquired covered assets in future periods. To the extent the actual values realized are different from the estimate, the indemnification asset will generally be affected in an offsetting manner due to the loss share support from the FDIC. There is no contractual interest rate associated with the FDIC indemnification asset; however, a present value discount was recorded against the initial balance of the FDIC indemnification asset and this discount is accreted into net interest income on the Consolidated Statement of Operations. A liability for a potential true-up payment which may be owed to the FDIC related to the indemnification asset was established at an estimated fair value of $3.5 million, net of present value discount. The true-up liability was recorded in other liabilities on the Consolidated Balance Sheets and the amortization of the fair value discount is recorded in noninterest expense on the Consolidated Statements of Operations.
For the other assets acquired and liabilities assumed, First Federal used various methods to estimate fair value as of the acquisition date. For the investment securities and advances from the Federal Home Loan Bank (FHLB), the fair value was estimated using quoted or current market prices, including applicable prepayment termination charges. The fair value of time deposits was estimated based on expected contractual cash flows, which were discounted at current market rates. The accretion of the discount on the time deposits is recorded in net interest income on the Consolidated Statements of Operations. First Federal recorded a core deposit intangible representing the fair value of the assumed core deposits and the amortization of this intangible is recorded in noninterest expense on the Consolidated Statements of Operations.
During the three months ended June 30, 2012 a bargain purchase gain of $14.6 million was recorded in noninterest income on the Consolidated Statements of Operations. A $5.6 million deferred tax liability, representing the difference between the financial statement and tax bases of the assets acquired and liabilities assumed, was recorded in other liabilities on the Consolidated Balance Sheets during the three months ended June 30, 2012. The bargain purchase gain represents the amount by which the estimated fair value of the assets acquired exceeded the estimated fair value of the liabilities assumed, adjusted for the discount bid cash payment received from the FDIC as well as the establishment of the FDIC indemnification asset and its associated potential true-up liability.
Due to the significant amount of fair value adjustments, the resulting accretion and amortization of those adjustments and the protection from the FDIC loss share agreement, historical operating results for Plantation are not relevant to First Federals ongoing results of operations. The following table presents the assets acquired and liabilities assumed as of April 27, 2012, including the purchase accounting adjustments.
Explanation of fair value adjustments
During the three months ended September 30, 2012, First Federal exercised an option under the P&A Agreement to acquire Plantations Pawleys Island branch location at fair market value for $2.8 million, and the closing is expected to occur during the fourth quarter of 2012. First Federal consolidated an existing financial center into this location and consolidated Plantations remaining two coastal locations into First Federals existing financial centers during the third quarter of 2012, for no net increase in financial centers along the South Carolina coast. First Federal assumed the leases associated with the three locations in the Greenville, South Carolina market and acquired certain fixed assets totaling $625 thousand associated with the former Plantation locations during the third quarter of 2012.
Note 3. Investment Securities
The following table presents amortized cost, gross unrealized gains and losses, and estimated fair value on investment securities.
Securities with a fair market value of $127.2 million at September 30, 2012 and $237.8 million at December 31, 2011 were pledged to secure public and certain customer deposits, repurchase agreements, and advances from FHLB and the Federal Reserve Bank of Richmond. During the three months ended June 30, 2012, mortgage-backed securities totaling $203.6 million with an average yield of 1.79% were sold as part of a balance sheet restructuring initiative, generating a $3.5 million gain ($2.2 million after-tax). All of the sold investment securities were classified as Level 2 fair value financial instruments and had not previously recorded an other-than-temporary impairment (OTTI) charge. As of September 30, 2012, the only investment position that exceeded 10% of shareholders equity was mortgage-backed securities issued by Bank of America, representing 15.4% of shareholders equity.
The amortized cost and estimated fair value of investment securities by contractual maturity are presented in the following table. Expected maturities may differ from contractual maturities, as borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
The following table presents gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.
Management evaluates securities for OTTI on at least a quarterly basis. In determining OTTI, investment securities are evaluated according to ASC 320-10 and management considers many factors including: (1) the length of time and extent to which the fair value has been less than cost; (2) the financial condition and near-term prospects of the issuer; (3) whether the market decline was affected by macroeconomic conditions; and (4) whether First Financial has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether OTTI exists involves a high degree of subjectivity and is based on information available to management on the assessment date. Evaluations are performed on a more frequent basis as the degree to which fair value is below carrying cost or the length of time that the fair value has been continuously below carrying cost increases.
At September 30, 2012, the majority of unrealized losses were related to trust preferred collateralized debt obligations (CDOs) and private-label collateralized mortgage obligations (CMOs) as discussed below. For the three and nine months ended September 30, 2012, credit-related OTTI of $145 thousand and $359 thousand, respectively, were recorded in Other-than-temporary-impairment on investment securities on the Consolidated Statements of Operations. The total carrying value of securities affected by credit-related OTTI represents 9.5% of the carrying value of First Financials investment portfolio at September 30, 2012, which does not materially impact First Financials current liquidity and capital positions.
Collateralized Debt Obligations
The CDO portfolio is collateralized primarily with trust preferred securities issued by other financial institutions in pooled issuances. To determine the fair value, cash flow models for trust preferred CDOs provided by a third-party pricing service are utilized. The models estimate default vectors for the underlying issuers within each CDO security, estimate expected bank failures across the entire banking system to determine the impact on each CDO, and assign a risk rating to each individual issuer in the collateral pool. The individual risk ratings for the underlying securities in the pools were determined by a number of factors including Tier 1 capital ratio, return on assets, percent of nonperforming loans, percent of commercial and construction loans, and level of broker deposits for each underlying issuer. The risk ratings were used to determine an expected default vector for each CDO. The models assign assumptions for constant default rate, loss severity, recovery lags, and prepayment assumptions, which were reviewed for reasonableness and consistency by management. The projected cash flows were compared to book value to determine the amount of OTTI, if any. If a security is rated below investment grade by a credit rating agency, a stress test is performed to determine if the security has any OTTI. See Note 8 to the Consolidated Financial Statements for additional information on fair value.
The following table provides information regarding the CDO portfolio characteristics and OTTI losses.
As of September 30, 2012, management does not intend to sell these securities, nor is it more likely than not that First Financial will be required to sell the securities before the amortized cost basis is recovered as First Financial has adequate other sources of liquidity.
Collateralized Mortgage Obligations
The CMO portfolio is mainly comprised of private-label, non-agency mortgage-backed securities. To determine the fair value, cash flow models provided by a third-party pricing service are utilized. The models incorporate recent transaction volumes, price quotations and related price variability, available broker information, and market liquidity. As a result, the models estimate each securitys cash flow and adjusted price based on coupon, credit rating, constant prepayment rate, and required yields or spreads. If a private label security is rated below investment grade by a credit rating agency, a stress test is performed to determine if the
security has any OTTI. See Note 8 to the Consolidated Financial Statements for additional information on fair value.
The following table presents the investment grades assigned by the rating agencies and OTTI losses for the CMO securities which were in a loss position at September 30, 2012.
The OTTI in the table above was related to three securities with the following characteristics:
The credit ratings displayed in the above table reflect the lowest credit ratings by the major rating agencies. As of September 30, 2012, management does not intend to sell these securities, nor is it more likely than not that it will be required to sell these securities before the amortized cost basis is recovered as First Financial has adequate other sources of liquidity.
The following table presents the cumulative credit-related losses recognized in earnings.
NOTE 4. Loans and Other Repossessed Assets Acquired
The following table presents the loan portfolio by major category.
Total loans at September 30, 2012 included $275.0 million of loans acquired at estimated fair value in the Plantation and Liberty transactions. See Note 2 to the Consolidated Financial Statements for additional information regarding acquired loans. The loans held for sale are comprised of residential mortgage loans to be sold in the secondary market, and generally settle in 45 to 60 days.
On April 10, 2009, First Federal entered into a P&A Agreement with the FDIC to acquire certain assets and liabilities of Cape Fear Bank (Cape Fear). For Cape Fear, the entire loan portfolio and OREO is covered under the loss sharing agreement with the FDIC, while the P&A Agreement for Plantation covers certain commercial loans and commercial OREO. These covered loans are included in the table above and totaled $241.8 million at September 30, 2012 ($94.0 million related to Cape Fear and $147.8 million related to Plantation), compared with $141.4 million at December 31, 2011 (solely Cape Fear covered loans). See Note 5 to
the Consolidated Financial Statements for additional information regarding the FDIC indemnification asset associated with these acquisitions.
The following table presents the loan portfolio by age of delinquency.
Nonperforming assets include nonaccrual loans, loans delinquent 90 days or more and still accruing, restructured loans still accruing, and other repossessed assets acquired through foreclosure. With the exception of the credit card portfolio, loans are placed on nonaccrual status when they become 90 days delinquent. In addition, loans that were not delinquent in excess of 90 days but exhibited doubt as to the borrowers ability to repay all contractual principal and interest have been classified as impaired under ASC 310-10-35 and placed on nonaccrual status. The following table summarizes nonperforming assets.
Loans acquired in the Cape Fear and Plantation acquisitions that were performing at the time of acquisition, but have subsequently become nonaccrual are included in the tables above. Nonperforming loans acquired at acquisition are included in the current loan category in the Age Analysis Past Due Loans table above and, as such, are not included in the Nonperforming Assets table since these loans were adjusted to fair value at the acquisition date and accounted for under ASC 310-30.
In accordance with ASC 310-10-35, a loan is considered impaired when First Federal determines it is probable that the principal and interest due under the contractual terms of the loan will not be collected. Criticized and classified commercial loans (as defined in the Criticized Loans, Classified Loans and Other Risk Characteristics section of this Note) greater than $500,000 are reviewed for potential impairment as part of a monthly problem loan review process. In addition, homogeneous loans which have been modified are reviewed for potential impairment.
In assessing the impairment of a loan and the related reserve required for that loan, various methodologies are employed. Impairment measurement on loans that are not collateral dependent is determined primarily using the present value of expected future cash flows discounted at the loans effective interest rate. With respect to most real estate loans, and specifically if the loan is considered to be collected through a probable foreclosure, an approach that estimates the fair value of the underlying collateral is used. The collateral is appraised to reflect estimated realizable value (usually as is or liquidation value), with the market value being adjusted for estimated selling costs. First Federals policy is to update collateral appraisals on impaired loans at least annually, and more frequently if deemed necessary based on market conditions or specific circumstances. Significant downward trends in the real estate market can adversely affect First Federals collateral position. For larger credits or loans that are classified substandard or worse that rely primarily on real estate collateral for repayment, re-appraisal would occur earlier than the stated policy if management believes the market conditions have changed such that the existing appraisal may no longer reflect the current market value of the property. At a minimum, at the time a commercial loan with a principal balance of over $500,000 is downgraded to substandard or worse, or if the loan is determined to be impaired, the property securing the loan is re-appraised to update the value. In addition to updated appraisals, market bids or current offers may be utilized to estimate current value.
First Federal maintains a valuation reserve for impaired loans as part of the allowance for loan losses. Cash collected on impaired nonaccrual loans is applied to outstanding principal. A summary of impaired loans, related valuation reserves, and their effect on interest income follows.
The total recorded investment in covered impaired loans was $4.6 million as of September 30, 2012. These loans did not have a specific allowance as of September 30, 2012. The following table rolls forward the accretable yield associated with the ASC-310-30 loan portfolio associated with the Cape Fear and Plantation acquisitions.
During 2011 and 2012, First Federal reclassified some of the nonaccretable balance to accretable yield for the Cape Fear loans that were impaired at purchase. The reclassification was primarily the result of increased cash flow estimates due to revising loss projections based on actual
performance. This amount is recognized as a prospective yield adjustment and increases interest income over the remaining life of the loan pool.
Troubled Debt Restructuring (TDR)
First Federal accounts for certain loan modifications or restructurings as a TDR. In general, the modification or restructuring of a loan is considered a TDR if, for economic or legal reasons related to a borrowers financial difficulties, a concession is granted to the borrower that creditors would not otherwise consider. Concessions may relate to the contractual interest rate, maturity date, payment structure of the note or other actions. In accordance with GAAP, loans acquired under ASC 310-30 are not initially considered to be TDRs. The following table provides a summary of TDRs by accrual status. The TDRs on nonaccrual status are included in the nonperforming asset table above.
Once a loan is deemed to be a TDR, it is reviewed for potential impairment in accordance with ASC 310-10-35. The following table provides a summary of the loans that were restructured as TDRs during the three and nine months ended September 30, 2012 and 2011 and displays the incremental impact to the allowance for loan losses as a result of the modification.