| FIDELITY SOUTHERN CORP ITEM 1A RISK FACTORS The following risk factors and other information included in this Annual Report on Form 10-K should be carefully considered |
| The risks and uncertainties described below are not the only ones we face |
| Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may adversely impact our business operations |
| If any of the following risks occur, our business, financial condition, operating results, and cash flows could be materially adversely affected |
| RISKS RELATED TO OUR BUSINESS We could encounter difficulties in maintaining our growth |
| Over the last two years our assets have increased dlra314 million, or 28dtta7prca, from dlra1cmam092 million at December 31, 2003, to dlra1cmam406 million at December 31, 2005, primarily due to increases in real estate, construction, commercial and consumer loans |
| We expect to continue to experience growth in the amount of our assets, the level of our deposits and the scale of our operations |
| Achieving our growth targets requires us to attract customers that currently bank at other financial institutions in our markets, thereby increasing our share of the market |
| Our ability to successfully grow will depend on a variety of factors, including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas, and our ability to manage our growth |
| While we believe we have the management resources and internal systems in place to successfully manage our future growth, there can be no assurance that growth opportunities will be available or that we will successfully manage our growth |
| If we do not manage our growth effectively, we may not be able to achieve our business plan, and our business and prospects could be harmed |
| Our recent results may not be indicative of our future operating results |
| We have achieved significant growth in earnings per share in recent years |
| For example, net income per share from continuing operations (diluted) grew from $ |
| 18 for the year ended December 31, 2001, to dlra1dtta12 for the year ended December 31, 2005 |
| Our strong performance during this time period was, in part, the result of resolving regulatory issues, reducing the Company’s risk profile, improving asset quality, and managing expenses while growing earning assets |
| In the future, we will not have all of these earnings improvement opportunities and we may not have the benefit of a favorable interest rate environment or a strong residential mortgage market |
| Various factors, such as economic conditions, regulatory and legislative considerations, and competition may also impede or restrict our ability to increase earnings at a similar rate |
| Fluctuations in interest rates could reduce our profitability and affect the value of our assets |
| Like other financial institutions, our earnings and cash flows are subject to interest rate risk |
| Our primary source of income is net interest income, which is the difference between interest earned on loans and investments and the interest paid on deposits and borrowings |
| We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities and the relationships of various interest rates to each other |
| Over any defined period of time, our interest-earning assets may be more sensitive to changes in market interest rates than our interest-bearing liabilities, or vice versa |
| In addition, the individual market interest rates underlying our loan and deposit products (eg, prime versus competitive market deposit rates) may not change to the same degree over a given time period |
| In any event, if market interest rates should move contrary to our position, our earnings may be negatively affected |
| In addition, loan volume and quality and deposit volume and mix can be affected by market interest rates |
| Changes in levels of market interest rates could materially adversely affect our net interest spread, asset quality, origination volume and overall profitability |
| Interest rates have until recently been at historically low levels |
| However, from June 30, 2004, through December 31, 2005, the Federal Reserve increased its target for the Federal funds rate 13 times, from 1dtta00prca to 4dtta25prca |
| While these short-term market interest rates (which we use as a guide to price our deposits) have increased, longer-term market interest rates (which we use as a guide to price our longer- 13 _________________________________________________________________ [69]Table of Contents term loans) have not |
| This “flattening” of the market yield curve has had a negative impact on our interest rate spread and net interest margin to date |
| If short-term interest rates continue to rise, and if rates on our deposits and borrowing continue to reprice upwards faster than the rates on our long-term loans and investments, we would experience further compression of our interest rate spread and net interest margin, which would have a negative effect on our profitability |
| Income could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings |
| We principally manage interest rate risk by managing our volume and the mix of our earning assets and funding liabilities |
| In a changing interest rate environment, we may not be able to manage this risk effectively |
| If we are unable to manage interest rate risk effectively, our business, financial condition, and results of operations could be materially harmed |
| Changes in the level of interest rates also may negatively affect our ability to originate real estate loans, the value of our assets, and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings |
| Increases in longer-term interest rates may reduce our income from mortgage banking activities which would negatively impact our noninterest income and which would negatively impact our net interest income |
| Our mortgage banking operations have historically provided a significant portion of our noninterest income |
| We generate mortgage revenues primarily from gains on the sale of loans to investors on a servicing released basis |
| In a rising or higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors |
| This would result in a decrease in mortgage revenues and a corresponding decrease in noninterest income |
| In addition, our results of operations are affected by the amount of noninterest expenses associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment, data processing expenses, and other operating costs |
| During periods of reduced loan demand, such as we experienced in 2004 and 2005, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations |
| A significant portion of our loan portfolio is secured by real estate loans in the Atlanta, Georgia, metropolitan area and in eastern and northern Florida markets, and a downturn in real estate market values in those areas may adversely affect our business |
| Currently, our lending and other businesses are concentrated in the Atlanta, Georgia, metropolitan area and eastern and northern Florida |
| Our real estate mortgage and construction loans, which accounted for 39dtta6prca of our total loan portfolio as of December 31, 2005, are similarly concentrated |
| Therefore, conditions in these markets will strongly affect the level of our nonperforming loans and our results of operations and financial condition |
| Real estate values and the demand for mortgages and construction loans are affected by, among other things, changes in general and local economic conditions, changes in governmental regulation, monetary and fiscal policies, interest rates and weather |
| Declines in our real estate markets could adversely affect the demand for new real estate loans, and the value and liquidity of the collateral securing our existing loans |
| Adverse changes in our markets could also reduce our growth rate, impair our ability to collect loans, and generally affect our financial condition and results of operations |
| We may be unable to maintain and service our relationships with automobile dealers and we are subject to their willingness and ability to provide high quality indirect automobile loans |
| Our indirect automobile lending operation depends in large part upon our ability to maintain and service our relationships with automobile dealers, the strength of new and used automobile sales, the loan rate and other incentives offered by the automobile manufacturers and their captive finance companies, and the continuing ability of the consumer to qualify for and make payments on high quality automobile 14 _________________________________________________________________ [70]Table of Contents loans |
| There can be no assurance we will be successful in maintaining such dealer relationships or increasing the number of dealers with which we do business, or that our existing dealer base will continue to generate a volume of finance contracts comparable to the volume historically generated by such dealers |
| FSC’s profitability depends significantly on economic conditions in the Atlanta metropolitan area |
| The Company’s success depends primarily on the general economic conditions of the Atlanta metropolitan area and the specific local markets in which we operate |
| Unlike larger national or regional banks that are more geographically diversified, we provide banking and financial services to customers primarily in the Atlanta metropolitan areas including Fulton, Dekalb, Cobb, Clayton, and Gwinnett counties |
| The local economic conditions in these areas have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources |
| A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities, or other international or domestic occurrences, unemployment, changes in securities markets, or other factors could impact these local economic conditions and, in turn, have a material adverse effect on our financial condition and results of operations |
| FSC is subject to consumer and debtor protection laws |
| We are subject to numerous Federal and state consumer protection laws that impose requirements related to offering and extending credit |
| Federal and state governmental authorities may enact new laws and amend existing laws to regulate further the consumer credit industry or to reduce finance charges or other fees or charges that can be applicable to consumer loan accounts |
| Such laws, as well as any new regulations or rulings which may be adopted, may adversely affect our ability to collect on account balances or maintain existing levels of fees and charges with respect to the accounts |
| Any failure by us to comply with such legal requirements also could adversely affect our ability to collect the full amount of the account balances |
| Changes in Federal and state bankruptcy and debtor relief laws could adversely affect our results of operations and financial condition if such changes result in, among other things, additional administrative expenses and accounts being written off as uncollectible |
| Our activities are currently subject to a variety of statutes and regulations that are designed to protect consumers and include provisions that: • limit the interest and other charges collected or contracted for by the Bank; • govern the Bank’s disclosures of credit terms to consumer borrowers; • require the Bank to provide information to enable the public and public officials to determine whether it is fulfilling its obligation to help meet the housing needs of the community it serves; • prohibit the Bank from discriminating on the basis of race or other prohibited factors when it makes decisions to extend credit; • require that the Bank safeguard the nonpublic personal information of its customers, provide annual notices to consumers regarding the usage and sharing of such information, and limit disclosure of such information to third parties except under specific circumstances; and • govern the manner in which the Bank may collect consumer debts |
| The deposit operations of the Bank are also subject to laws and regulations that: • require the Bank to adequately disclose the interest rates and other terms of consumer deposit accounts; 15 _________________________________________________________________ [71]Table of Contents • impose a duty on the Bank to maintain the confidentiality of consumer financial records and prescribe procedures for complying with administrative subpoenas of financial records; and • govern automatic deposits to and withdrawals from deposit accounts with the Bank and the rights and liabilities of customers who use automated teller machines and other electronic banking services |
| FSC is subject to extensive governmental regulation |
| As discussed previously, we are subject to extensive supervision and regulation by Federal and state governmental agencies, including the FRB, the GDBF and the FDIC Future legislation, regulations, and government policy could adversely affect Fidelity and the financial institution industry as a whole, including the cost of doing business |
| Although the impact of such legislation, regulations, and policies cannot be predicted, future changes may alter the structure of, and competitive relationships among, financial institutions and the cost of doing business |
| FSC is subject to environmental liability risk associated with lending activities |
| A significant portion of the Company’s loan portfolio is secured by real property |
| During the ordinary course of business, the Company may foreclose on and take title to properties securing certain loans |
| In doing so, there is a risk that hazardous or toxic substances could be found on these properties |
| If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage |
| Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property |
| In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability |
| Although the Company has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards |
| The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations |
| We operate in a highly competitive industry and market area |
| The Company faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and may have more financial resources |
| Such competitors primarily include national, regional, and community banks within the markets in which we operate |
| Additionally, various out-of-state banks continue to enter or have announced plans to enter the market area in which we currently operate |
| We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, and other financial intermediaries |
| The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes, and continued consolidation |
| Banks, securities firms, and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking |
| Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems |
| Many of our competitors have fewer regulatory constraints and may have lower cost structures |
| Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services, as well as better pricing for those products and services |
| Our ability to compete successfully depends on a number of factors, including, among other things: • the ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical standards and safe, sound assets; • the ability to expand our market position; 16 _________________________________________________________________ [72]Table of Contents • the scope, relevance and pricing of products and services offered to meet customer needs and demands; • the rate at which we introduce new products and services relative to our competitors; • customer satisfaction with our level of service; and • industry and general economic trends |
| Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations |
| The allowance for loan losses may be insufficient |
| We maintain an allowance for loan losses, which is established and maintained through provisions charged to operations |
| Such provisions are based on management’s evaluation of the loan portfolio, including loan portfolio concentrations, current economic conditions, the economic outlook, past loan loss experience, adequacy of underlying collateral, and such other factors which, in management’s judgment, deserve consideration in estimating loan losses |
| Loans are charged off when, in the opinion of management, such loans are deemed to be uncollectible |
| Subsequent recoveries are added to the allowance |
| The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes |
| Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside our control, may require an increase in the allowance for loan losses |
| In addition, bank regulatory agencies periodically review the Company’s allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management |
| In addition, if charge-offs in future periods exceed the estimated charge-offs utilized in determining the sufficiency of the allowance for loan losses, we will need additional provisions to increase the allowance |
| Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations |
| See “Allowance for Loan Losses” in Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations” located elsewhere in this report for further discussion related to our process for determining the appropriate level of the allowance for loan losses |
| Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed |
| We are required by Federal regulatory authorities to maintain adequate levels of capital to support our operations |
| We anticipate our capital resources will satisfy our capital requirements for the foreseeable future |
| We may at some point, however, need to raise additional capital to support our continued growth |
| If we raise capital through the issuance of additional shares of our common stock or other securities, it would dilute the ownership interest of our current shareholders and may dilute the per share book value of our common stock |
| New investors may also have rights, preferences and privileges senior to our current shareholders, which may adversely impact our current shareholders |
| Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance |
| Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us |
| If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth or acquisitions could be materially impaired |
| 17 _________________________________________________________________ [73]Table of Contents The building of market share through our branching strategy could cause our expenses to increase faster than revenues |
| We intend to continue to build market share in the greater Atlanta metropolitan area through our branching strategy |
| We are planning four new branches that we intend to open within the next 24 months |
| There are considerable costs involved in opening branches and new branches generally require a period of time to generate sufficient revenues to offset their costs, especially in areas in which we do not have an established presence |
| Accordingly, any new branch can be expected to negatively impact our earnings for some period of time until the branch reaches certain economies of scale |
| Our expenses could be further increased if we encounter delays in the opening of any of our new branches |
| Finally, we have no assurance that our new branches will be successful, even after they have been established |
| The Company’s controls and procedures may fail or be circumvented |
| Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures |
| Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met |
| Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations, and financial condition |
| New lines of business or new products and services may subject us to additional risks |
| From time to time, we may implement new lines of business or offer new products and services within existing lines of business |
| There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed |
| In developing and marketing new lines of business and/or new products and services, we may invest significant time and resources |
| Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible |
| External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service |
| Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls |
| Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, results of operations, and financial condition |
| Our success depends, in large part, on our ability to attract and retain key people |
| Competition for the best people in most activities engaged in by the Company can be intense and we may not be able to hire people or to retain them |
| The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience, and the difficulty of promptly finding qualified replacement personnel |
| We currently have employment agreements and non-compete agreements with certain of our senior officers |
| Our information systems may experience an interruption or breach in security |
| We rely heavily on communications and information systems to conduct our business |
| Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems |
| While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed |
| The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss 18 _________________________________________________________________ [74]Table of Contents of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations |
| We may be unable to keep pace with technological change |
| The financial services industry is continually undergoing rapid technological change, with frequent introductions of new technology-driven products and services |
| The effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs |
| Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations |
| Many of our competitors have substantially greater resources to invest in technological improvements |
| We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers |
| Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business, financial condition, and results of operations |
| We are subject to claims and litigation |
| From time to time, customers make claims and take legal action pertaining to the Company’s performance of our responsibilities |
| Whether customer claims and legal action related to the Company’s performance of our responsibilities are founded or unfounded, or if such claims and legal actions are not resolved in a manner favorable to the Company, they may result in significant financial liability and/or adversely affect the market perception of the Company and our products and services, as well as impact customer demand for those products and services |
| Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations |
| Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business |
| Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our ability to conduct business |
| Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses |
| While we have never been affected by severe weather or natural disaster, acts of war or terrorism, or other adverse external events, we may be affected in the future |
| Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations |
| Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive |
| Our stock price can fluctuate significantly in response to a variety of factors including, among other things: • actual or anticipated variations in quarterly results of operations; • recommendations by securities analysts; • operating and stock price performance of other companies that investors deem comparable to us; • news reports relating to trends, concerns and other issues in the financial services industry; • perceptions in the marketplace regarding the Company and/or our competitors; 19 _________________________________________________________________ [75]Table of Contents • new technology used, or services offered, by competitors; • significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving the Company or our competitors; • failure to integrate acquisitions or realize anticipated benefits from acquisitions; • changes in government laws and regulation; and • geopolitical conditions such as acts or threats of terrorism or military conflicts |
| General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease, regardless of operating results |
| FSC’s common stock trading volume is less than that of other larger financial services companies |
| Although FSC’s common stock is listed for trading on NASDAQ, the trading volume in our common stock is less than that of larger financial services companies |
| A public trading market having the desired characteristics of depth, liquidity, and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time |
| This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control |
| Given the lower trading volume of FSC’s common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall |
| An investment in FSC’s common stock is not an insured deposit |
| FSC’s common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund, or by any other public or private entity |
| Investment in FSC’s common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this Report |
| As a result, if you acquire FSC’s common stock, you may lose some or all of your investment |
| RISKS ASSOCIATED WITH THE COMPANY’S INDUSTRY The earnings of financial services companies are significantly affected by general business and economic conditions |
| The Company’s operations and profitability are impacted by general business and economic conditions in the United States and abroad |
| These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, and the strength of the US economy and the local economies in which we operate, all of which are beyond our control |
| A deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for our products and services, among other things, any of which could have a material adverse impact on our financial condition and results of operations |
| Financial services companies depend on the accuracy and completeness of information about customers and counterparties |
| In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information |
| We may also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information |
| Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on our business and, in turn, our financial condition and results of operations |
| 20 _________________________________________________________________ [76]Table of Contents Consumers may decide not to use banks to complete their financial transactions |
| Technology and other changes are allowing parties to complete financial transactions that historically have involved banks |
| For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds |
| Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks |
| The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits |
| The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations |