| COAST FINANCIAL HOLDINGS INC ITEM 1A RISK FACTORS An investment in our common shares involves certain risks |
| The risks and uncertainties described below are not the only risks that may have a material adverse effect on the Company |
| Additional risks and uncertainties also could adversely affect our business and our results |
| If any of the following risks actually occur, our business, financial condition or results of operations could be negatively affected, and the market price for our shares could decline |
| Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause the Company’s actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of the Company |
| Risks Related to Our Business We may not be able to grow at the rate we have during the past two fiscal years, and we may not be able to expand our banking franchise throughout the greater Tampa Bay region in a profitable and timely manner |
| We have grown rapidly in terms of branch expansion, total assets, net loans, and deposits, particularly since February 2004 |
| We may not be able to continue to grow at the same rate that we have grown during the past two fiscal years |
| In addition, our strategy calls for continued expansion and the opening of additional branches throughout the greater Tampa Bay region during the next few years |
| Our branch expansion strategy entails certain established risks, including: • the inability to identify and obtain attractive new locations throughout the greater Tampa Bay region at a reasonable cost; • the inability to obtain required regulatory approvals; • the risk that new branches do not become profitable in the time period that we project, if at all; and • the inability to secure the services of qualified senior management |
| Although our goal is to continue to expand our branch network in the greater Tampa Bay region over the next few years, we may not be able to maintain our expansion goals |
| Further, we can provide no assurance that we will be able to overcome these risks or any other problems encountered in executing our branch expansion strategy |
| Our success will be dependent on our ability to profitably manage our growth |
| We expect to continue to expand our franchise through branch expansion |
| Our ability to manage our growth successfully will depend on our ability to maintain cost controls and asset quality while attracting additional loans and deposits on favorable terms |
| Although we have been able to achieve significant and rapid growth, our expansion strategy could have an adverse impact on our profitability in the short term due to the operating and other noninterest expenses associated with growth and branching |
| The opening of new branches requires an investment of funds that will not generate profits for a period of time, if at all |
| Furthermore, our newly opened branches have historically tended to initially attract significantly more time deposits than core deposits resulting in a higher cost of funds which adversely affect net interest margins |
| If we are unable to improve the composition of our deposit base at our expansion branches, our net interest margins and, ultimately, our profitability may be adversely affected |
| In December 2005, Coast Bank began taking possession of the Acquired Branches and we anticipate opening all eight Acquired Branches after renovations in 2006 |
| Additionally, we also expect to open four de novo branches in 2006, three in Pinellas County and one in Manatee County |
| We may have difficulty managing our growth, which may divert resources and limit our ability to successfully expand our operations |
| Our rapid growth may place significant demands on our operations and management |
| Our future success will depend on the ability of our officers and other key employees to continue to implement and improve our 20 ______________________________________________________________________ [47]Table of Contents operational, credit, financial, management, and other internal risk controls and processes, along with our reporting systems and procedures, as the number of client relationships continue to expand |
| We may not successfully implement improvements to our management information and control systems and control procedures and processes in an efficient or timely manner and we may discover deficiencies in existing systems and controls |
| In particular, our controls and procedures must be able to accommodate an increase in expected loan volume and the infrastructure that comes with new branches |
| Our growth strategy may require us to incur additional expenditures to expand our administrative and operational infrastructure |
| If we are unable to manage future expansion in our operations, we may experience compliance and operational problems, have to slow the pace of growth, or have to incur additional expenditures beyond current projections to support such growth, any one of which could adversely affect our business |
| We cannot assure you that we will continue to be successful in increasing the volume of loans and deposits at acceptable risk levels, expanding our asset base to a targeted size, and managing the costs and implementation risks associated with our growth strategy |
| We also cannot provide you with any assurance that our further expansion will be profitable, that we will be able to maintain our historical rate of growth, or any growth, that we will be able to maintain capital sufficient to support our continued growth, or that we will be able to adequately and profitably manage that growth |
| Although we have generally expanded through the opening of a limited number of branches each year, we successfully bid for the right to lease the eight Acquired Branches located in the greater Tampa Bay region that were made available as a result of certain bank consolidations |
| As a result of this opportunity and our previously planned branch expansion for the ensuing year, we anticipate opening 12 new branches in 2006 which will double the number of our branches |
| The success of our 2006 expansion plans will depend on our ability to manage such rapid growth |
| In this regard, the acquisition and establishment of these branches, as well as geographic expansion, involve numerous risks, including among others, the time and cost to integrate the new operations and employees, unanticipated costs and delays, adverse short-term effects on operating results, the potential strain on our infrastructure, staff, internal controls and management, the failure of the acquisition or branching opportunity to meet growth and profitability expectations, risks associated with unanticipated problems or legal liabilities, potential tax and accounting issues, dependence on retaining, hiring, and training key personnel, and the diversion of management’s time and attention away from our core operations |
| We cannot assure you that we will be successful in overcoming these risks or any other problems encountered in connection with our expansion and growth strategy |
| Our growth strategy may require us to raise additional capital in the future and such capital may not be available when needed or at all |
| We anticipate that our capital resources following our offering in October 2005 will satisfy our capital requirements for the foreseeable future |
| However, we may need to raise additional capital in the future to support our continued growth |
| Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and on our financial performance |
| We cannot assure you that such capital will be available to us on acceptable terms or at all |
| If we are unable to raise additional capital on acceptable terms when needed, our ability to further expand our operations through internal growth or acquisitions could be limited |
| Rapid and significant changes in market interest rates may adversely affect our performance |
| Most of our assets and liabilities are monetary in nature and subject us to significant risks from changes in interest rates |
| Our profitability depends to a large extent on our net interest income, and changes in interest rates can impact our net interest income as well as the valuation of our assets and liabilities |
| Our current one-year gap position is slightly negative and as a result net interest income will be adversely affected if market interest rates rapidly and significantly change such that the interest we pay on deposits and borrowings increases faster than the interest earned on loans and investments |
| Accordingly, like most financial institutions, our results of operations are significantly affected by changes in interest rates and our ability to 21 ______________________________________________________________________ [48]Table of Contents manage interest rate risks |
| Changes in market interest rates, or changes in the relationships between short-term and long-term market interest rates, or changes in the relationships between different interest rate indices, can affect the interest rates charged on interest-earning assets differently than the interest rates paid on interest-bearing liabilities |
| This difference could result in an increase in interest expense relative to interest income, or a decrease in our interest rate spread |
| In the current interest rate environment, short-term rates have escalated while long-term rates have stayed low causing a flattening of the yield curve |
| This flattening of the yield curve is making it more difficult to earn the traditional spreads that we are accustomed to earning |
| As a result, our margin has contracted, which affects the overall profitability of the Bank |
| Our net interest margin depends on many factors that are partly or completely out of our control, including competition, federal economic monetary and fiscal policies, and general economic conditions |
| While we intend to continually take measures to mitigate the impact of changes in market interest rates, we cannot assure you that we will be successful |
| Despite our strategies to manage interest rate risks, changes in interest rates can still have a material adverse impact on our profitability |
| If we experience greater loan losses than anticipated, our earnings and our ability to fund our growth strategy may be adversely affected |
| As a lender, we are exposed to the risk that our customers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment |
| Credit losses are inherent in the business of making loans and could have a material adverse effect on our operating results |
| Our credit risk with respect to our real estate and construction loan portfolio will relate principally to the creditworthiness of individuals and the value of the real estate serving as security for the repayment of loans |
| Our credit risk with respect to our commercial and consumer loan portfolio will relate principally to the general creditworthiness of businesses and individuals within our local markets |
| Among loans of particular significance are those under-performing, under-collateralized, or high risk loans originated prior to February 2004 identified as part of our 2004 asset quality initiative to reduce the balances of loans that we determined had an unsatisfactory level of risk |
| At February 28, 2004, the composition of those loans was approximately dlra17dtta8 million of indirect automobile loans and dlra8dtta4 million of commercial loans |
| Although we have implemented a strategy to exit or restructure such lending relationships and have significantly reduced the amount outstanding, primarily due to such loans we increased our loan loss provision by dlra1dtta3 million in the second quarter of 2005, including those loans which resulted in a charge-off of dlra1dtta1 million |
| Of the dlra6dtta4 million in such loans currently existing, dlra3dtta9 million are indirect automobile loans, dlra2dtta0 million are non-classified commercial loans, and dlra500cmam000 are classified commercial loans |
| If we experience greater nonpayment levels than anticipated, our earnings and overall financial condition, as well as the value of our common shares, could be adversely affected |
| We make various assumptions and judgments about the collectibility of our loan portfolio and provide an allowance for potential loan losses based on a number of factors |
| If our assumptions or judgments are wrong, our allowance for loan losses may not be sufficient to cover our actual loan losses |
| Accordingly, we cannot assure you that our monitoring, procedures, and policies will reduce certain lending risks or that our allowance for loan losses will be adequate to cover actual losses |
| Further, we may have to increase our allowance in the future in response to the request of one of our primary banking regulators, to adjust for changing conditions and assumptions, or as a result of any deterioration in the quality of our loan portfolio |
| The actual amount of future provisions for loan losses cannot be determined at this time and may exceed the amounts of past provisions |
| Material additions to our allowance for loan losses would decrease our net earnings and could adversely affect our capital, which would limit our growth |
| A significant reduction in earnings could have an adverse effect on the market price for our common shares |
| We cannot give you assurance that such amount will be sufficient to cover our actual losses and in the future we may need to further increase our allowance |
| 22 ______________________________________________________________________ [49]Table of Contents Our construction-to-permanent residential loans are subject to additional risks |
| Our mortgage banking department originates a significant volume of residential real estate loans that are comprised primarily of construction-to-permanent financing |
| Although such loans are originated with the intent of selling many of them in the secondary market upon conversion to “permanent” financing, these loans are subject to risks during the construction phase that are not present in standard residential mortgage loans |
| These risks include: • the viability of the contractor; and • the contractor’s ability to complete the project, meet deadlines and time schedules, and to stay within cost estimates |
| Initially, before conversion to permanent financing, these loans are held in our construction loan portfolio |
| The sale of these loans in the secondary market allows us to hedge against interest rate risks related to such lending operations |
| The ability to sell these loans in the secondary market requires compliance with strict underwriting criteria |
| Currently, these loans are originated in the State of Florida |
| However, we anticipate expanding these lending activities into other states where we have less experience, which may entail additional risks |
| Our profitability and liquidity may be affected by changes in economic conditions in the areas where our operations or loans are concentrated |
| Our success will be dependent to a large extent upon the economic and population growth in the State of Florida and, in particular, in the greater Tampa Bay region or those areas where we make loans |
| Unlike larger banks that are more geographically diversified, we currently provide banking and financial services primarily to customers located in Manatee, Pinellas, and Sarasota counties, Florida |
| In addition, we currently make construction-to-permanent loans throughout the State of Florida and may, in the future, expand the geographic scope of those loans |
| If either the population or income the growth in the greater Tampa Bay region or in our lending area is slower than projected, income levels, deposits, and housing starts could be adversely affected and could result in the curtailment of our expansion, growth, and profitability |
| In addition, the ability of our customers to repay their loans will be impacted by the economic conditions in those areas |
| If the greater Tampa Bay region or areas where we make loans experience a downturn or a recession for a prolonged period of time, we would likely experience significant increases in nonperforming loans, which could lead to operating losses, impaired liquidity, and eroding capital |
| The high concentration of commercial and residential real estate loans exposes us to increased lending risks in the event of a downturn in real estate market |
| A significant portion of our loan portfolio is dependent on real estate |
| As of December 31, 2005, our loan portfolio included dlra225dtta4 in residential real estate and residential construction loans and dlra119dtta8 in commercial real estate loans, or 57dtta5prca and 30dtta6prca, respectively, of our total loan portfolio |
| Since our loans are collateralized primarily by real estate located in Florida, a downturn in the Florida real estate market could lead to a deterioration of our collateral and may expose us to an additional risk of loss |
| Our high concentration of commercial real estate and commercial loans expose us to increased lending risks |
| As of December 31, 2005, the composition of our loan portfolio was as follows: • commercial real estate loans of dlra119dtta8 million, or 30dtta6prca of total loans; • commercial loans of dlra17dtta8 million, or 4dtta5prca of total loans; • residential real estate loans of dlra59dtta4 million, or 15dtta1prca total loans; • residential construction loans of dlra166dtta0 million, or 42dtta4prca of total loans; and • consumer loans of dlra29dtta0 million, or 7dtta4prca of total loans |
| 23 ______________________________________________________________________ [50]Table of Contents Commercial real estate and commercial loans, which comprise 35dtta1prca of our total loan portfolio as of December 31, 2005, expose us to a greater risk of loss than our residential real estate, residential construction, and consumer loans, which comprise 64dtta9prca of our total loan portfolio as of December 31, 2005 |
| Commercial real estate loans and commercial loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential loans |
| Consequently, an adverse development with respect to one commercial real estate or commercial loan or one credit relationship may expose us to a significantly greater risk of loss compared to an adverse development with respect to one residential real estate, residential construction, or consumer loan |
| Hurricanes could cause a disruption in our operations which could have an adverse impact on the results of operations |
| Our operations are located on the gulf coast of central Florida, a region which is susceptible to hurricanes |
| Such weather events can cause disruption to our operations and could have a material adverse effect on our overall results of operations |
| During 2004 and 2005, four and two major hurricanes, respectively, hit the State of Florida |
| We maintain hurricane insurance, but some risks may not be adequately insured |
| Further, a hurricane in any of our market areas could adversely impact the ability of borrowers to timely repay their loans and may adversely impact the value of any collateral held by us |
| We will be subject to new internal control reporting requirements that will increase our compliance costs and failure to timely comply could adversely affect our reputation and the value of our common shares |
| We are required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as new rules and regulations adopted by the Securities and Exchange Commission (“SEC”), the Public Company Accounting Oversight Board (“PCAOB”), and the National Association of Securities Dealers |
| In particular, under current rules and regulations we will be required to include management and auditor reports on internal controls as part of our annual report for the year ending December 31, 2006 pursuant to Section 404 of the Sarbanes-Oxley Act |
| Unless these rules and regulations are revised so as to provide the Company with relief, later this year we expect to begin the process of evaluating our controls, including compliance with the SEC and PCAOB rules and guidelines on internal controls |
| Although we are unable to quantify the precise costs or the management commitment that will be necessary in connection therewith, we anticipate that the additional incremental costs will be between dlra200cmam000 and dlra250cmam000 for the first year of compliance and we expect to spend significant amounts of time to satisfy these rules |
| Moreover, we may not be able to complete our assessment of our internal controls in a timely manner |
| Our failure to comply with these internal controls rules may materially adversely affect our reputation, or ability to obtain the necessary certifications to our financial statements, and the value of our common shares |
| Additionally, if we are unable to receive a favorable opinion from our accountants as to management’s assessment of the adequacy of our internal controls, we may be unable to raise additional capital |
| We need to stay current on technological changes in order to compete and meet customer demands |
| The financial services market, including banking services, is undergoing rapid changes with frequent introductions of new technology-driven products and services |
| In addition to better serving customers, the effective use of technology increases efficiency and may enable financial institutions to reduce costs |
| Our future success may depend, in part, on our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in our operations |
| Many of our competitors have substantially greater resources to invest in technology improvements |
| Although we will continually invest in new technology, we cannot assure you that we will have sufficient resources or access to the necessary proprietary technology to remain competitive or that we will be able to successfully implement or market any new technology-driven products and services |
| 24 ______________________________________________________________________ [51]Table of Contents Risks Related to Our Industry Industry competition may have an adverse effect on our success |
| Our profitability depends on our ability to compete successfully |
| We operate in a highly competitive environment |
| Many of our competitors are larger and have greater resources than we do and have been in existence for a longer period of time |
| We will have to overcome historical bank-customer relationships to attract customers away from our competitors |
| In our market areas, we face competition from other commercial banks, savings and loan associations, credit unions, internet banks, finance companies, mutual funds, insurance companies, brokerage and investment banking firms, and other financial intermediaries that offer similar services |
| Some of those competitors are subject to similar regulations but have the advantages of larger established customer bases, higher legal lending limits, extensive branch networks, numerous ATMs, greater advertising-marketing budgets, and may offer certain services that we do not currently provide |
| Some of our nonbank competitors are not subject to the same extensive regulations that govern the Company or the Bank and may have greater flexibility in competing for business |
| We are subject to extensive governmental regulation, which could have an adverse impact on our operations |
| The banking industry is extensively regulated and supervised under both federal and state law |
| We are subject to the regulation and supervision of the Federal Reserve Bank (“FRB”), the FDIC, and the Florida Department of Financial Services (the “Florida Department”) |
| These regulations are intended primarily to protect depositors, the public, and the FDIC insurance funds, and not our stockholders |
| These regulations govern matters ranging from the regulation of certain debt obligations, changes in the control of bank holding companies and Florida state-chartered banks, and the maintenance of adequate capital to the general business operations and financial condition of the Bank, including permissible types, amounts and terms of loans and investments, to the amount of reserves against deposits, restrictions on dividends, establishment of branch offices, and the maximum interest rate that may be charged by law |
| We are subject to changes in federal and state banking law, as well as regulations and governmental policies, income tax laws, and accounting principles |
| Regulations affecting banks are undergoing continuous change, and the ultimate effect of such changes cannot be predicted |
| Regulations and laws may be modified at any time, and new legislation may be enacted that will affect us and our subsidiary |
| We cannot assure you that such modifications or new laws will not adversely affect us |
| Risks Related to an Investment in Our Common Shares We do not plan to pay cash dividends on our common shares in the foreseeable future |
| We do not expect to pay cash dividends on our common shares in the foreseeable future |
| The payment of cash dividends is subject to the discretion of our board of directors and its determination to declare such dividends, which will depend upon a number of factors, including capital requirements, regulatory limitations, restrictions on the payment of dividends by the Bank under Florida state law and regulations of the Florida Department, the results of operations and financial condition, tax considerations, and general economic conditions |
| The market price of our common shares has fluctuated, and could fluctuate significantly |
| The market price of our common shares has been and could be subject to wide fluctuations, including fluctuations in response to quarterly variations in our operating results, changes in earnings estimates by analysts, material announcements by us or our competitors, governmental or regulatory actions, acquisitions, the liquidity of the market of our common shares, changes in general economic and market conditions, changes in the securities markets, war and other conflicts, acts of terrorism, and other events, many of which are beyond our control |
| The stock market has experienced extreme price and volume fluctuations, which have affected market prices of smaller capitalization companies and have often been unrelated to the operating performance of such companies |
| In addition, if our operating results fall below the expectations of securities analysts and investors, the price of our common shares would likely decline, perhaps substantially |
| 25 ______________________________________________________________________ [52]Table of Contents Future issuances of additional securities could result in dilution of your ownership |
| We may determine from time to time to issue additional securities to raise additional capital, support growth, or to make acquisitions |
| Further, we may issue stock options or other stock grants to retain and motivate our employees |
| These issuances of our securities will dilute the ownership interests of the investors in this offering |
| New investors also may have rights, preferences and privileges senior to our current shareholders, which may adversely impact our current shareholders |
| Anti-takeover laws may adversely affect share value |
| Certain provisions of state and federal law and our articles of incorporation may make it more difficult for someone to acquire control of us without our Board of Directors’ approval |
| The provisions of Florida law that may delay or block an unsolicited takeover attempt include the Florida Affiliated Transactions Statute and the Florida Control-Share Acquisition Statute |
| Under federal law, a person, entity, or group must notify the federal banking agencies before acquiring 10prca or more of the outstanding voting stock of a bank holding company, including our shares |
| Banking agencies review the acquisition to determine if it will result in a change of control |
| The banking agencies have 60 days to act on the notice, and take into account several factors, including the resources of the acquiror, the needs of the community, and the antitrust effects of the acquisition |
| There also are provisions in our articles of incorporation that may be used to delay or block a takeover attempt |
| Under our articles of incorporation, we may designate and issue preferred shares without further shareholder action |
| As a result, we could issue preferred shares with advantageous terms to a friendly purchaser willing to oppose such a takeover attempt |
| As a result, these statutory provisions and provisions in our articles of incorporation could result in the Company being less attractive to a potential acquiror |
| These laws could result in shareholders receiving less for their shares than otherwise might be available in the event of a change of control of the Company |
| The common shares are not FDIC insured |
| The common shares are not savings or deposit accounts or other obligations of any bank and are not insured by the FDIC, the Bank Insurance Fund, or any other governmental agency or instrumentality, or any private insurer, and are subject to investment risk, including the possible loss of principal |
| A NOTE ABOUT FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K (including the exhibits hereto) contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, such as statements relating to our financial condition, results of operations, plans, objectives, future performance or expectations, and business operations |
| These statements relate to expectations concerning matters that are not historical fact |
| Accordingly, statements that are based on management’s projections, estimates, assumptions, and judgments constitute forward-looking statements |
| These forward-looking statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “approximately,” “intend,” “objective,” “goal,” “project,” and other similar words and expressions, or future or conditional verbs such as “will,” “should,” “would,” “could,” and “may |
| ” These forward-looking statements are based largely on information currently available to our management and on our current expectations, assumptions, plans, estimates, judgments and projections about our business and our industry, and such statements involve inherent risks and uncertainties |
| Although we believe our expectations are based on reasonable estimates and assumptions, they are not guarantees of performance and there are a number of known and unknown risks, uncertainties, contingencies, and other factors (many of which are outside our control) that could cause actual results to differ materially from those expressed or implied by such forward-looking statements |
| Accordingly, there is no assurance that our expectations will in fact occur or that our estimates or 26 ______________________________________________________________________ [53]Table of Contents assumptions will be correct, and we caution investors and all others not to place undue reliance on such forward-looking statements |
| Some factors include, but are not limited to those described under “Risk Factors,” and the following: • general economic conditions, either nationally or in Florida, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality or a decreased demand for our services and products; • changes in the interest rate environment which could reduce our margins and increase defaults in our loan portfolio, including those described under “Item 7 |
| Management’s Discussion and Analysis of Financial Condition and Results of Operations—Asset/Liability Management,” and “—Market Risk Management;” • the adequacy of the allowance for loan losses and the Bank’s asset quality, including those matters described in “Item 7 |
| Management’s Discussion and Analysis of Financial Condition and Results of Operations—Asset Quality,” and “—Financial Condition—Classification of Assets;” • changes in accounting policies and practices, as may be adopted by regulatory agencies as well as the Financial Accounting Standards Board; • changes in political conditions or in the legislative or regulatory environment that adversely affects the businesses in which we are engaged, including the impact of any changes in laws and regulations relating to banking, securities, taxes, and insurance; • changes occurring in consumer spending, saving, and borrowing habits; • changes in trade, tax, monetary, or fiscal policies, including the interest rate policies of the FRB; • money market and monetary fluctuations, and changes in inflation and in the securities markets; • changes in the Company’s organizational structure and in its compensation and benefit plans, including those necessitated by pressures in the labor market for attracting and retaining qualified personnel; • unanticipated litigation, regulatory, or other judicial proceedings; • the success of the Company at managing the risks involved in the foregoing; and • other risks which may be described in our future filings with the SEC under the Securities Exchange Act of 1934 |
| All written or oral forward-looking statements that are made or attributable to us are expressly qualified in their entirety by this cautionary notice |
| Such forward-looking statements speak only to the date that such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events |
| We do not promise to update forward-looking information to reflect actual results or changes in assumptions or other factors that could affect these statements other than material changes to such information |