XNAS:FMFC Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
Or
 
 
 
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
 

Commission File Number 000-09424

FIRST M&F CORPORATION
(Exact name of registrant as specified in its charter)
MISSISSIPPI
(State or other jurisdiction of
Incorporation or organization)
64-0636653
(I.R.S. Employer Identification Number)
 
 
134 West Washington Street,  Kosciusko, Mississippi
(Address of principal executive offices)
39090
(Zip Code)

662-289-5121
(Registrant’s telephone number, including area code)

No Change
(Former name, former address and former fiscal year,
if changed since the last report)

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.
x Yes   o No   

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer  o
Non-accelerated filer  o  (Do not check if a smaller reporting company)
Smaller reporting company x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date
Common stock, $5 par value
 
9,162,721 Shares
Title of Class
 
Shares Outstanding at April 30, 2012



FIRST M&F CORPORATION

FORM 10-Q

INDEX

 
 
Page
PART 1:
FINANCIAL INFORMATION
 
 
 
 
Item 1
Financial Statements (unaudited):
3
 
Consolidated Statements of Condition
3
 
Consolidated Statements of Operations
4
 
Consolidated Statements of Comprehensive Income
5
 
Consolidated Statements of Stockholders’ Equity
6
 
Consolidated Statements of Cash Flows
7
 
Notes to Consolidated Financial Statements
9
 
 
 
Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operation
46
 
 
 
Item 3
Quantitative and Qualitative Disclosures About Market Risk
67
 
 
 
Item 4
Controls and Procedures
68
 
 
 
PART II:
OTHER INFORMATION
 
 
 
 
Item 1
Legal Proceedings
69
 
 
 
Item 1A
Risk Factors
69
 
 
 
Item 2
Unregistered Sales of Equity Securities and Use of Proceeds
69
 
 
 
Item 3
Defaults upon Senior Securities
69
 
 
 
Item 4
Mine Safety Disclosures
69
 
 
 
Item 5
Other Information
69
 
 
 
Item 6
Exhibits
70
 
 
 
SIGNATURES
 
71
 
 
 
EXHIBIT INDEX
 
72
 
 
 
CERTIFICATIONS
 
 

2


FIRST M & F CORPORATION AND SUBSIDIARY

PART I: FINANCIAL INFORMATION

Item 1 – Financial Statements (Unaudited)

Consolidated Statements of Condition
(Dollars in thousands)
 
 
 
 
 
 
March 31,
2012
 
December 31,
2011
 
 
 
 
 
(Unaudited)
 
(Note 1)
Assets
 
 
 
 
Cash and due from banks
 
$
38,688

 
$
39,976

Interest bearing bank balances
 
51,900

 
39,391

Federal funds sold
 
25,000

 
25,000

Securities available for sale, amortized cost of $361,199 and $315,890
 
365,970

 
320,774

Loans held for sale
 
28,684

 
26,073

Loans, net of unearned income
 
979,495

 
996,340

Allowance for loan losses
 
(16,084
)
 
(14,953
)
Net loans
 
963,411

 
981,387

Bank premises and equipment
 
37,831

 
37,989

Accrued interest receivable
 
6,098

 
6,122

Other real estate
 
34,636

 
36,952

Other intangible assets
 
4,479

 
4,586

Bank owned life insurance
 
22,674

 
22,477

Other assets
 
27,771

 
27,924

 
 
$
1,607,142

 
$
1,568,651

Liabilities and Stockholders’ Equity
 
 

 
 

Liabilities:
 
 

 
 

Noninterest-bearing deposits
 
$
238,603

 
$
231,718

Interest-bearing deposits
 
1,171,905

 
1,139,745

Total deposits
 
1,410,508

 
1,371,463

Federal funds purchased and repurchase agreements
 
3,738

 
4,398

Other borrowings
 
41,673

 
43,001

Junior subordinated debt
 
30,928

 
30,928

Accrued interest payable
 
868

 
1,023

Other liabilities
 
8,072

 
8,242

Total liabilities
 
1,495,787

 
1,459,055

Commitments and contingencies
 


 


Stockholders’ equity:
 
 

 
 

Preferred stock; 2,000,000 shares authorized; 30,000 shares issued and outstanding
 
17,877

 
17,564

Common stock of $5.00 par value; 50,000,000 shares authorized: 9,162,721 and 9,154,936 shares issued and outstanding
 
45,814

 
45,775

Additional paid-in capital
 
31,892

 
31,895

Nonvested restricted stock awards
 
700

 
674

Retained earnings
 
15,508

 
14,456

Accumulated other comprehensive income (loss)
 
(436
)
 
(768
)
Total equity
 
111,355

 
109,596

 
 
$
1,607,142

 
$
1,568,651


The accompanying notes are an integral part of these financial statements.

3


FIRST M & F CORPORATION AND SUBSIDIARY

Consolidated Statements of Operations
(Unaudited)
(Dollars in thousands, except per share data)
 
Three Months Ended
 
 
March 31
 
 
2012
 
2011
Interest income: 
 
 
 
 
Interest and fees on loans
 
$
14,158

 
$
15,375

Interest on loans held for sale
 
173

 
41

Taxable investments
 
1,490

 
1,771

Tax-exempt investments
 
318

 
314

Federal funds sold
 
15

 
16

Interest bearing bank balances
 
51

 
52

Total interest income
 
16,205

 
17,569

Interest expense:
 
 

 
 

Deposits
 
2,513

 
3,847

Federal funds purchased and repurchase agreements
 
6

 
15

Other borrowings
 
451

 
524

Junior subordinated debt
 
271

 
458

Total interest expense
 
3,241

 
4,844

Net interest income
 
12,964

 
12,725

Provision for loan losses
 
2,280

 
2,580

Net interest income after provision for loan losses
 
10,684

 
10,145

Noninterest income:
 
 

 
 

Deposit account income
 
2,457

 
2,458

Mortgage banking income
 
567

 
356

Agency commission income
 
829

 
892

Trust and brokerage income
 
140

 
133

Bank owned life insurance income
 
187

 
183

Other income
 
650

 
656

Securities gains, net
 
591

 
1,349

Total investment other-than-temporary impairment losses
 

 
(240
)
Portion of loss reclassified from other comprehensive income (before taxes)
 

 
(56
)
Net investment impairment losses recognized
 

 
(296
)
Total noninterest income
 
5,421

 
5,731

Noninterest expenses:
 
 

 
 

Salaries and employee benefits
 
6,863

 
6,956

Net occupancy expenses
 
908

 
989

Equipment expenses
 
463

 
465

Software and processing expenses
 
362

 
399

Telecommunication expenses
 
245

 
225

Marketing and business development expenses
 
237

 
205

Foreclosed property expenses
 
1,456

 
2,353

FDIC insurance assessments
 
514

 
774

Intangible asset amortization
 
107

 
107

Other expenses
 
2,831

 
2,338

Total noninterest expenses
 
13,986

 
14,811

Income before income taxes
 
2,119

 
1,065

Income tax expense
 
512

 
115

Net income
 
$
1,607

 
$
950

Dividends and accretion on preferred stock
 
463

 
432

Net income applicable to common stock
 
$
1,144

 
$
518

Net income allocated to common shareholders
 
$
1,139

 
$
515

Earnings per share:
 
 

 
 

Basic
 
$
0.12

 
$
0.06

Diluted
 
$
0.12

 
$
0.06


The accompanying notes are an integral part of these financial statements.

4


FIRST M & F CORPORATION AND SUBSIDIARY

Consolidated Statements of Comprehensive Income
(Unaudited)

(Dollars in thousands)
 
Three Months Ended
 
 
March 31
 
 
2012
 
2011
Net income
 
$
1,607

 
$
950

Other comprehensive income (loss):
 
 

 
 

Unrealized gains (losses) on securities: 
 
 

 
 

Unrealized gains on securities available for sale arising during the period, net of tax of $156 and $188 for the three months ended March 31
 
269

 
316

Unrealized gains (losses) on other-than-temporarily impaired securities available for sale arising during the period, net of tax of $20 and $25 for the three months ended March 31
 
33

 
(43
)
Reclassification adjustment for gains on securities available for sale included in net income, net of tax of $220 and $503 for the three months ended March 31
 
(371
)
 
(846
)
Reclassification adjustment for credit related other-than- temporary impairment losses on securities available for sale included in net income, net of tax of $0 and $110 for the three months ended March 31
 

 
186

Unrealized losses net of settlements on cash flow hedge arising during the period, net of tax of $40 and $64 for the three months ended March 31
 
66

 
107

Defined benefit pension plans:
 
 

 
 

Amortization of prior service cost, net of tax of $0 and $2 for the three months ended March 31
 

 
(4
)
Amortization of actuarial loss, net of tax of $199 and $91 for the three months ended March 31
 
335

 
155

Other comprehensive income (loss)
 
332

 
(129
)
Total comprehensive income
 
$
1,939

 
$
821


The accompanying notes are an integral part of these financial statements.

5


FIRST M & F CORPORATION AND SUBSIDIARY

Consolidated Statements of Stockholders' Equity
Three Months Ended March 31, 2012 and 2011
(Unaudited)

(Dollars in thousands, except per share data)
 
 
 
 
 
 
 
 
 
 
 
 
Preferred Stock
 
Common Stock
 
Additional Paid-In Capital
 
Nonvested Restricted Stock Awards
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Total
January 1, 2011
 
$
16,390

 
$
45,534

 
$
31,883

 
$
784

 
$
12,225

 
$
249

 
$
107,065

Net income
 

 

 

 

 
950

 

 
950

Cash dividends ($.01 per share)
 

 

 

 

 
(92
)
 

 
(92
)
8,967 shares granted to directors
 

 
45

 
(11
)
 

 

 


 
34

Dividends and accretion on preferred stock
 
283

 

 

 

 
(432
)
 

 
(149
)
Share-based compensation expense recognized
 

 

 
1

 
(1
)
 

 

 

Net change
 

 

 

 

 

 
(129
)
 
(129
)
March 31, 2011
 
$
16,673

 
$
45,579

 
$
31,873

 
$
783

 
$
12,651

 
$
120

 
$
107,679

January 1, 2012
 
$
17,564

 
$
45,775

 
$
31,895

 
$
674

 
$
14,456

 
$
(768
)
 
$
109,596

Net income
 

 

 

 

 
1,607

 

 
1,607

Cash dividends ($.01 per share)
 

 

 

 

 
(92
)
 

 
(92
)
7,785 shares granted to directors
 

 
39

 
(6
)
 

 

 

 
33

Dividends and accretion on preferred stock
 
313

 

 

 

 
(463
)
 

 
(150
)
Share-based compensation expense recognized
 

 

 
3

 
26

 

 

 
29

Net change
 

 

 

 

 

 
332

 
332

March 31, 2012
 
$
17,877

 
$
45,814

 
$
31,892

 
$
700

 
$
15,508

 
$
(436
)
 
$
111,355


The accompanying notes are an integral part of these financial statements.

6


FIRST M & F CORPORATION AND SUBSIDIARY

Consolidated Statements of Cash Flows
(Unaudited)

(Dollars in thousands)
 
Three Months Ended
 
 
March 31
 
 
2012
 
2011
Cash flows from operating activities:
 
 
 
 
Net income
 
$
1,607

 
$
950

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

 
 

Share-based compensation
 
62

 
34

Amortization of pension costs
 
505

 
211

Depreciation and amortization
 
583

 
652

Provision for loan losses
 
2,280

 
2,580

Net investment amortization
 
1,014

 
559

Net change in unearned fees/deferred costs on loans
 
(238
)
 
40

Capitalized dividends on FHLB stock
 
(7
)
 
(7
)
Gain on securities available for sale
 
(591
)
 
(1,349
)
Impairment loss on securities available for sale
 

 
296

Gain on loans held for sale
 
(525
)
 
(210
)
Other real estate losses
 
1,223

 
2,018

Other asset sales losses
 
66

 
70

Deferred income taxes
 
510

 
114

Originations of loans held for sale, net of repayments
 
(30,473
)
 
(12,553
)
Sales proceeds of loans held for sale
 
26,226

 
16,426

(Increase) decrease in:
 
 

 
 

Accrued interest receivable
 
24

 
(339
)
Cash surrender value of bank owned life insurance
 
(187
)
 
(183
)
Other assets
 
(345
)
 
266

Increase (decrease) in:
 
 

 
 

Accrued interest payable
 
(155
)
 
(103
)
Other liabilities
 
(196
)
 
(775
)
Net cash provided by operating activities
 
1,383

 
8,697

Cash flows from investing activities:
 
 

 
 

Purchases of securities available for sale
 
(97,327
)
 
(74,537
)
Sales of securities available for sale
 
33,982

 
41,421

Maturities of securities available for sale
 
17,612

 
13,680

Purchases of loans held for investment
 

 
(821
)
Net decrease in other loans held for investment
 
16,423

 
5,094

Net (increase) decrease in:
 
 

 
 

Interest bearing bank balances
 
(12,509
)
 
(8,305
)
Federal funds sold
 

 

Bank premises and equipment
 
(314
)
 
(366
)
Net purchases of bank owned life insurance
 
(9
)
 
(15
)
Proceeds from sales of other real estate and other repossessed assets
 
2,660

 
2,630

Net cash used in investing activities
 
(39,482
)
 
(21,219
)

7


FIRST M & F CORPORATION AND SUBSIDIARY

Consolidated Statements of Cash Flows
(Unaudited)

(Dollars in thousands)
 
Three Months Ended
 
 
March 31
 
 
2012
 
2011
Cash flows from financing activities:
 
 
 
 
Net increase in deposits
 
$
39,040

 
$
24,657

Net decrease in short-term borrowings
 
(660
)
 
(18,920
)
Proceeds from other borrowings
 

 
686

Repayments of other borrowings
 
(1,327
)
 
(2,575
)
Common dividends paid
 
(92
)
 
(92
)
Preferred dividends paid
 
(150
)
 
(149
)
Net cash provided by financing activities
 
36,811

 
3,607

Net decrease in cash and due from banks
 
(1,288
)
 
(8,915
)
Cash and due from banks at January 1
 
39,976

 
45,099

Cash and due from banks at March 31
 
$
38,688

 
$
36,184

Supplemental disclosures:
 
 

 
 

Total interest paid
 
$
3,400

 
$
4,952

Total income taxes paid
 
186

 
1

 
 
 
 
 
Transfers of loans from held for sale to held for investment
 
1,997

 

Transfers of loans to foreclosed property
 
1,565

 
3,182

U. S. Treasury preferred dividend accrued but unpaid
 
75

 
75

Accretion on U. S. Treasury preferred stock
 
313

 
283


The accompanying notes are an integral part of these financial statements.


8

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)





Note 1:  Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The condensed balance sheet as of December 31, 2011, has been derived from audited financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The condensed consolidated financial statements include all entities in which the Company has a controlling financial interest. Therefore, the condensed consolidated financial statements of First M & F Corporation include the financial statements of Merchants and Farmers Bank, a wholly owned subsidiary, and the Bank’s wholly owned subsidiaries, First M & F Insurance Company, Inc., M & F Financial Services, Inc., M & F Bank Securities Corporation, M & F Insurance Agency, Inc., M & F Insurance Group, Inc., and M & F Business Credit, Inc. The consolidated financial statements also include the Bank’s 55% ownership in MS Statewide Title, LLC, a title insurance agency. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2011. Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.

The Company is substantially in the business of community banking and therefore is considered a banking operation with no separately reportable segments.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future economic and market conditions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although our estimates and assumptions contemplate current economic conditions and how we expect them to change in the future, it is reasonably possible that in future months actual conditions could be worse than those anticipated, which could materially affect our financial condition and results of operations. The allowance for loan losses, the fair value of financial instruments, the fair value of other real estate, the valuation of deferred tax assets and other-than-temporary investment impairments represent significant estimates.

Reclassifications

Certain reclassifications have been made to the 2011 financial statements to be consistent with the 2012 presentation.

Loans Held for Sale

Loans held for sale, consisting primarily of mortgages, are accounted for at the lower of cost or fair value applied on an individual loan basis. Valuation changes are recorded in mortgage banking income.

Loans Held for Investment

Loans that management has the ability and intent to hold for the foreseeable future or until maturity or payoff are considered held for investment. Loans held for investment are stated at the principal amount outstanding, net of unearned income and an allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. Loan origination fees and direct loan origination costs, as well as purchase premiums and discounts, are deferred and recognized over the life of the related loans as adjustments to interest income using the level yield method.

The Bank discontinues the accrual of interest on loans and recognizes income only as received (places the loans in nonaccrual status) when, in the judgment of management, the collection of interest, but not necessarily principal, is doubtful. Unpaid accrued interest is charged against interest income on loans when they are placed in nonaccrual status. Payments received on loans in nonaccrual status are generally applied as a reduction to principal until such time that the Company expects to collect the remaining contractual principal. When a borrower of a loan that is in nonaccrual status can demonstrate the ability to repay the loan in accordance with its contractual terms, then the loan may be returned to accruing status. The Company determines past due status on all loans based on their contractual repayment terms. Loans are considered past due if either an interest or principal payment is past due in accordance with the loan’s contractual repayment terms.

A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Bank measures impaired and restructured loans at the present value of expected future cash flows, discounted at the loan's effective interest rate, or the fair value of collateral if the loan is collateral dependent. Interest on impaired loans is recorded on a cash basis if the loans are in nonaccrual status.

9

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 1:  (Continued)

Allowance and Provision for Loan Losses

The allowance for loan losses is established through provisions for loan losses charged against earnings. Loans are considered uncollectible when available information confirms that the loan can’t be collected in full. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is maintained at a level believed to be adequate by management to absorb estimated probable loan losses. Management’s periodic evaluation of the adequacy of the allowance for loan losses is based on estimated credit losses for specifically identified impaired loans as well as estimated probable credit losses inherent in the remainder of the loan portfolio based primarily on historical loss rates. Several asset quality metrics, both quantitative and qualitative, are considered in estimating both specific impairments and in the application of historical loss rates. The fundamental tool used by management to estimate individual impairment allowances and contingency allowances is the individual loan risk rate. For the purpose of determining allowances, management segregates the loan portfolio primarily by risk rating and secondarily by whether the loan is collateral dependent. Management considers a number of factors in assigning risk rates to individual loans and in determining impairment allowances and in the application of historical loss rates, including: past due trends, current trends, current economic conditions, industry exposure, internal and external loan reviews, loan performance, the estimated value of underlying collateral, evaluation of a borrower’s financial condition and other factors considered relevant. Loans not reviewed for specific impairment allowances are grouped into risk pools with similar traits and subjected to historical loss rates to estimate losses in each pool. Troubled debt restructurings are considered to be impaired loans and are included with the loans that are individually reviewed for impairment allowances. Troubled debt restructurings are loans in which the Company has granted a concession to the borrower which would not otherwise be considered due to the borrower’s financial difficulties.

Certain risk characteristics are common to all real estate lending, whether it be construction and land development, commercial real estate or residential real estate. Real property values can fall, creating loan to value problems that can be exacerbated by over supply and falling demand. General economic conditions including increasing or stagnant unemployment rates can have a negative effect on normally credit-worthy borrowers in each real estate segment. Debt service ratios can weaken if real estate sales fall off or have not fully recovered. Commercial and asset-based lending credits are directly affected by swings in the economy and the inherent risks from lower retail sales, due to lower consumer and commercial demand, falling rental prices and rental vacancies. Unemployment also can weigh heavily on business credits and put additional strain on commercial cash flows. Consumer lending is most directly affected by unemployment issues and consumer confidence in the economy and jobs market. Retail lending volumes and credit-worthiness can come under strain as prices rise and income opportunities decline. The Company considers all of these qualitative risks in its determination of not only individual loan risk grading but also decisions about individual loan impairments and the need for any overall environmental factor or any adjustment of historical loss rates.

The Company monitors available credit on large lines to identify any off-balance sheet credit risks that may arise. Available credit lines are also taken into consideration for loans that are individually tested for impairment amounts. Any lines for which there is insufficient collateral or other sources of repayment will have impairment amounts accrued for deficiencies above the amount of the outstanding loan balance. The Company generally has the contractual right to suspend available credit on a commitment when a contractual default occurs. Available lines are generally suspended, except for the completion of construction projects, when loans are restructured. The Company did not have a liability accrued for any off-balance sheet credit risks at March 31, 2012 or December 31, 2011.

Management’s evaluation of the allowance for loan losses is inherently subjective as it requires material estimates. The actual amounts of loan losses realized in the near term could differ from the amounts estimated in arriving at the allowance for loan losses reported in the financial statements.

Concentrations of Credit

Substantially all of the Company's loans, commitments and standby and commercial letters of credit have been granted to borrowers who are customers in the Company's market area. As a result, the Company is subject to this concentration of credit risk. A substantial portion of the loan portfolio, as presented in Note 4, is represented by loans collateralized by real estate. The ability of the borrowers to honor their contracts is dependent upon the real estate market and general economic conditions in the Company's market area.

Restricted Cash Balances

The Company has entered into an interest rate swap agreement designed to convert floating rate interest payments on subordinated debentures into fixed rate payments. The Company had pledged interest bearing bank balances as collateral to the interest rate swap counterparty in the amounts of $2.251 million at March 31, 2012 and $1.861 million at December 31, 2011.

The Company held $100 thousand in certificates of deposit and $401 thousand in other interest bearing bank balances at March 31, 2012 and $100 thousand in certificates of deposit and $100 thousand in other interest bearing bank balances at December 31, 2011 in commercial banks as compensating balances for a third party credit card originator and a third party debit card processor. The amounts are included in interest-bearing bank balances.

10

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 2:  Fair Value

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. Valuation techniques use certain inputs to arrive at fair value. Inputs to valuation techniques are the assumptions that market participants would use in pricing the asset or liability. They may be observable or unobservable. Applicable accounting principles establish a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is as follows:

Level 1 Inputs – Unadjusted quoted market prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 Inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds or credit risks) or inputs that are derived principally from or corroborated by market data.

Level 3 Inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

11

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 2:  (Continued)

The following table summarizes assets and liabilities measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 
 
 
 
Fair Value Measurements at
March 31, 2012, Using
 
 
 
Assets/Liabilities
Measured at 
Fair
Value
 
Quoted
Prices In
Active
Markets
For
Identical
Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
(Dollars in thousands)
 
March 31, 2012
 
(Level 1)
 
(Level 2)
 
(Level 3)
U.S. Government sponsored entities
 
$
76,125

 
$

 
$
76,125

 
$

Mortgage-backed investments
 
226,312

 

 
226,312

 

Obligations of states and political subdivisions
 
59,198

 

 
59,198

 

Collateralized debt obligations
 
872

 

 

 
872

Other debt securities
 
3,463

 

 
3,463

 

Total securities available for sale
 
$
365,970

 
$

 
$
365,098

 
$
872

Interest rate swap asset
 

 

 

 

Mortgage derivative assets
 
435

 

 

 
435

 
 
$
366,405

 
$

 
$
365,098

 
$
1,307

 
 
 
 
 
 
 
 
 
Interest rate swap liability
 
$
1,728

 
$

 
$

 
$
1,728

Mortgage derivative liabilities
 
354

 

 

 
354

 
 
$
2,082

 
$

 
$

 
$
2,082


 
 
 
 
Fair Value Measurements at
December 31, 2011, Using
 
 
 
Assets/Liabilities
Measured at 
Fair
Value
 
Quoted
Prices In
Active
Markets
For
Identical
Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
(Dollars in thousands)
 
December 31,
2011
 
(Level 1)
 
(Level 2)
 
(Level 3)
U.S. Government sponsored entities
 
$
58,792

 
$

 
$
58,792

 
$

Mortgage-backed investments
 
203,686

 

 
203,686

 

Obligations of states and political subdivisions
 
54,142

 

 
54,142

 

Collateralized debt obligations
 
819

 

 

 
819

Other debt securities
 
3,335

 

 
3,335

 

Total available for sale securities
 
$
320,774

 
$

 
$
319,955

 
$
819

Interest rate swap asset
 

 

 

 

Mortgage derivative assets
 
269

 

 

 
269

 
 
$
321,043

 
$

 
$
319,955

 
$
1,088

 
 
 
 
 
 
 
 
 
Interest rate swap liability
 
$
1,834

 
$

 
$

 
$
1,834

Mortgage derivative liabilities
 
291

 

 

 
291

 
 
$
2,125

 
$

 
$

 
$
2,125


12

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 2:  (Continued)

U.S. Treasury, Government sponsored entity and mortgage-backed securities. Securities issued by the U.S. Treasury and Government sponsored entities and mortgage-backed securities are traded in a dealer market and are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service that primarily uses trading activity in the dealer market to determine market prices.

Obligations of states and political subdivisions. Municipal securities include investments that are traded in a dealer market and investments that trade infrequently and are reported using Level 2 inputs. The fair value measurements are obtained from both an independent pricing service and from a pricing matrix that considers observable inputs such as dealer quotes, market yield curves, credit information (including observable default rates) and the instrument’s contractual terms and conditions, obtained from a municipal security data provider.

Other debt securities. Other debt securities trade in a dealer market and are reported using Level 2 inputs. The fair value measurements are provided by an independent pricing service and are derived from trading activity in the dealer market.

Collateralized debt obligations. The Company owns certain beneficial interests in collateralized debt obligations secured by community bank trust preferred securities. These interests do not trade in a liquid market, and therefore, market quotes are not a reliable indicator of their ultimate realizability. The Company utilizes a discounted cash flow model using inputs of (1) market yields of trust-preferred securities as the discount rate and (2) expected cash flows which are estimated using assumptions related to defaults, deferrals and prepayments to determine the fair values of these beneficial interests. Many of the factors that adjust the timing and extent of cash flows are based on judgment and not directly observable in the markets. Therefore, these fair values are classified as Level 3 valuations for accounting and disclosure purposes.

Mortgage Derivatives. Mortgage derivative assets and liabilities represent the fair values of the interest rate lock commitments (IRLCs) of the Company to originate mortgages at certain rates as well as the commitments, or forward sale agreements (FSAs), to sell the mortgages to investors at locked prices within a specified period of time. The Company uses an internal valuation model with observable market data inputs consisting primarily of dealer quotes, market yield curves and estimated servicing values, and non-observable inputs such as credit-related adjustments and estimated pull-through rates. These instruments are classified as Level 3 fair values. Mortgage derivative assets are included in other assets and mortgage derivative liabilities are included in other liabilities in the Company’s statement of condition.

Interest rate swap. The interest rate swap is valued using a discounted cash flow model. Future net cash flows are estimated based on the forward LIBOR rate curve, the payment terms of the swap and potential credit events. These cash flows are discounted using a rate derived from the forward swap curve, with the resulting fair value being classified as a Level 3 valuation.

13

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 2:  (Continued)

The following table reports the activity for the first three months of 2012 and 2011 in assets measured at fair value on a recurring basis using significant unobservable (Level 3) inputs.

(Dollars in thousands)
 
Three Months Ended
 
 
March 31, 2012
 
 
Collateralized Debt Obligations
 
Mortgage Derivatives
 
Interest Rate Swap
Beginning Balance
 
$
819

 
$
(22
)
 
$
(1,834
)
Total gains or losses (realized/unrealized):
 
 

 
 

 
 

Other-than-temporary impairment included in earnings
 

 

 

Other-than-temporary impairment (included in) transferred from other comprehensive income
 

 

 

Other gains/losses included in other comprehensive income
 
53

 

 
(40
)
Net swap settlement recorded
 

 

 
146

IRLC and FSA issuances
 

 
(353
)
 

IRLC and FSA expirations and fair value changes included in earnings
 

 
230

 

IRLC transfers into closed loans/FSA transferred on sales
 

 
226

 

Ending Balance
 
$
872

 
$
81

 
$
(1,728
)
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date
 
$

 
$

 
$
(146
)

 
 
Three Months Ended
(Dollars in thousands)
 
March 31, 2011
 
 
Collateralized Debt Obligations
 
Mortgage Derivatives
 
Interest Rate Swap
Beginning Balance
 
$
934

 
$
218

 
$
817

Total gains or losses (realized/unrealized):
 
 

 
 

 
 

Other-than-temporary impairment included in earnings
 
(296
)
 

 

Other-than-temporary impairment (included in) transferred from other comprehensive income
 
56

 

 

Other gains/losses included in other comprehensive income
 
172

 

 
142

Net swap settlement recorded
 

 

 
29

IRLC and FSA issuances
 

 
167

 

IRLC and FSA expirations and fair value changes included in earnings
 

 
(43
)
 

IRLC transfers into closed loans/FSA transferred on sales
 

 
(310
)
 

Ending Balance
 
$
866

 
$
32

 
$
988

The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date
 
$
(296
)
 
$

 
$
(29
)

14

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 2:  (Continued)

The following table summarizes certain quantitative information about valuation techniques and significant unobservable inputs used in determining Level 3 fair value measurements.

 
 
Fair Value at
 
Valuation
 
Unobservable
 
 
(Dollars in thousands)
 
March 31, 2012
 
Techniques
 
Inputs
 
Range
Collateralized debt obligations
 
$
872

 
Discounted cash flow
 
Discount margin
Default rates
 
17.50% - 25.00%
  0.25% - 2.45%

Mortgage interest rate lock agreements
 
(193
)
 
Discounted cash flow
 
Pull-through rates
 

85.00%

Mortgage forward sale agreements
 
274

 
Consensus pricing
 
Pull-through rates
 

85.00%

Interest rate swap
 
(1,728
)
 
Discounted cash flow
 
Discount rate
 
0.52
%

Collateralized debt obligations: The discount margins for the collateralized debt obligations is the margin added to the libor yield curve. The margins are based on averages of observed market transactions for similar preferred securities and adjusted to reflect the lack of liquidity in the trust preferred CDO market. The default rates are annual rates based on a credit scoring analysis of the underlying collateral issuers. The default rates are used in estimating the timing and amounts of expected cash flows.

Mortgage interest rate lock agreements: The pull-through rate is estimated based on closing activity from a sample time period. The pull-though rate is applied as a probability estimate that is multiplied by the estimated price in arriving at an expected price.

Mortgage forward sale agreements: The pull-through rate is estimated based on data provided by mortgage investors. The pull-through rate is applied as a probability estimate that is multiplied by the estimated price in arriving at an expected price.

Interest rate swap: A LIBOR swap yield curve is used to discount the expected cash flows. The yield curve is constructed from swap quotes, adjusted by returns on underlying collateral and adjusted by a margin, consisting primarily of credit and liquidity factors, constructed in a proprietary model. The rate disclosed is a weighted average of the rates along the discount curve.

The following tables summarize assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2012, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 
 
 
 
Fair Value Measurements Using
 
 
 
 
Quoted
Prices in
Active
Markets for
Identical
Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
(Dollars in thousands)
 
03/31/12 (a)
 
(Level 1)
 
(Level 2)
 
(Level 3)
Impaired loans
 
$
10,253

 
$

 
$

 
$
11,353

Loan foreclosures
 
1,511

 

 

 
1,511

Other real estate
 
8,550

 

 

 
8,550


15

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 2:  (Continued)

The following tables summarize assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2011, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 
 
 
 
Fair Value Measurements Using
 
 
 
 
Quoted
Prices in
Active
Markets for
Identical
Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
(Dollars in thousands)
 
12/31/11 (a)
 
(Level 1)
 
(Level 2)
 
(Level 3)
Impaired loans
 
$
15,533

 
$

 
$

 
$
15,533

Loan foreclosures
 
11,304

 

 

 
11,304

Other real estate
 
13,788

 

 

 
13,788


(a)
These amounts represent the resulting carrying amounts on the consolidated statement of condition for impaired real estate-secured loans and other real estate for which fair value re-measurements took place during the period. Loan foreclosures represent the fair value portion of the carrying amounts of other real estate properties that were re-measured at the point of foreclosure during the period.

The following table summarizes losses recognized related to nonrecurring fair value measurements of individual assets or portfolios:

 
 
Three Months Ended
 
 
March 31
(Dollars in thousands)
 
2012
 
2011
Impaired loans (a)
 
$
2,847

 
$
2,060

Loan foreclosures (b)
 
379

 
472

Other real estate (c)
 
1,100

 
2,054


(a)
Represents additional impairments on loans which are based on the appraised value of the collateral. These impairments are accrued in the allowance for loan losses and charged to provision for loan loss expense.
(b)
Represents foreclosures of loans secured by real estate when the foreclosed value is lower than the carrying value of the loan. These amounts are charged to the allowance for loan losses with the fair value of the foreclosed property being recorded in other real estate.
(c)
Represents related losses of foreclosed properties that were measured at fair value subsequent to their initial acquisition.

Impaired Loans. Collateral dependent loans, which are loans for which the repayment is expected to be provided solely by the underlying collateral, are valued for impairment purposes by using the fair value of the underlying collateral. For collateral dependent loans, collateral values are estimated using Level 3 inputs based on observable market data and other internal estimates.

Loan Foreclosures. Certain foreclosed assets, upon initial recognition, were re-measured and reported at fair value through a charge-off to the allowance for possible loan losses based upon the fair value of the foreclosed asset. The fair value of a foreclosed asset, upon initial recognition, is estimated using Level 3 inputs based on appraisals, observable market data and other internal estimates.

Other real estate. Other real estate consists primarily of real estate from loans that have been foreclosed on. It is carried at the lower of cost or fair value less costs to sell. Subsequent to foreclosure, these properties may experience further market declines. When this occurs, the Company writes the property down to management’s best estimate of what the market may be willing to pay. Management considers recent appraisals when available, what other properties have sold for, how long properties have been on the market, the condition of the property, the availability of liquid buyers and other assumptions that market participants may use in determining a price at which they would acquire the property. Since certain significant inputs to these estimates are management-derived and unobservable, fair values are reported as using Level 3 inputs.

16

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 2:  (Continued)

Fair Value of Financial Instruments

The following tables present the carrying amounts and fair values of the Company’s financial instruments at March 31, 2012 and December 31, 2011:
 
 
 
 
 
 
Fair Value Measurements at
March 31, 2012, Using
 
 
March 31, 2012
 
Quoted Prices In Active Markets For Identical Assets (Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
(Dollars in thousands)
 
Carrying Amount
 
Estimated Fair Value
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and short-term investments
 
$
115,588

 
$
115,588

 
$
115,588

 
$

 
$

Securities available for sale
 
365,970

 
365,970

 

 
365,098

 
872

Loans held for sale
 
28,684

 
28,918

 

 

 
28,918

Loans held for investment
 
963,411

 
894,498

 

 

 
894,498

Agency accounts receivable
 
181

 
181

 
181

 

 

Accrued interest receivable
 
6,098

 
6,098

 
13

 
1,693

 
4,391

Nonmarketable equity investments
 
7,387

 
7,387

 

 

 
7,387

Investments in unconsolidated VIEs
 
3,353

 
3,353

 

 

 
3,353

Mortgage derivative assets
 
435

 
435

 

 

 
435

Financial liabilities:
 
 

 
 

 
 
 
 
 
 
Noninterest-bearing deposits
 
238,603

 
238,603

 
238,603

 

 

NOW, MMDA and savings deposits
 
765,137

 
765,137

 
765,137

 

 

Certificates of deposit
 
406,768

 
413,947

 

 

 
413,947

Short-term borrowings
 
3,738

 
3,738

 
3,738

 

 

Other borrowings
 
41,673

 
44,503

 

 

 
44,503

Junior subordinated debt
 
30,928

 
25,034

 

 

 
25,034

Agency accounts payable
 
579

 
579

 
579

 

 

Accrued interest payable
 
868

 
868

 
54

 

 
814

Mortgage derivative liabilities
 
354

 
354

 

 

 
354

Other financial instruments:
 
 

 
 

 
 
 
 
 
 
Commitments to extend credit and letters of credit
 
(2
)
 
(318
)
 

 

 
(318
)
Interest rate swap
 
(1,728
)
 
(1,728
)
 

 

 
(1,728
)

















17

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 2:  (Continued)
 
 
December 31, 2011
(Dollars in thousands)
 
Carrying Amount
 
Estimated Fair Value
Financial assets:
 
 
 
 
Cash and short-term investments
 
$
104,367

 
$
104,367

Securities available for sale
 
320,774

 
320,774

Loans held for sale
 
26,073

 
27,053

Loans held for investment
 
981,387

 
921,351

Agency accounts receivable
 
217

 
217

Accrued interest receivable
 
6,122

 
6,122

Nonmarketable equity investments
 
7,380

 
7,380

Investments in unconsolidated VIEs
 
3,425

 
3,425

Mortgage derivative assets
 
269

 
269

Financial liabilities:
 
 
 
 
Noninterest-bearing deposits
 
231,718

 
231,718

NOW, MMDA and savings deposits
 
707,798

 
707,798

Certificates of deposit
 
431,947

 
439,518

Short-term borrowings
 
4,398

 
4,398

Other borrowings
 
43,001

 
45,193

Junior subordinated debt
 
30,928

 
25,204

Agency accounts payable
 
641

 
641

Accrued interest payable
 
1,023

 
1,023

Mortgage derivative liabilities
 
291

 
291

Other financial instruments:
 
 
 
 
Commitments to extend credit and letters of credit
 
(4
)
 
(320
)
Interest rate swap
 
(1,834
)
 
(1,834
)

The following methods and assumptions were used by the Company in estimating the fair value of financial instruments:

Cash and due from banks, interest-bearing deposits with banks and Federal funds sold are valued at their carrying amounts which are reasonable estimates of fair value due to the relatively short period to maturity of the instruments.

Securities available for sale are predominantly valued based on prices obtained from an independent nationally recognized pricing service and market yield matrices. An external pricing service is used to electronically provide prices by CUSIP number. These prices include exchange quoted prices, dealer quoted prices and prices derived from market yields published by specialized financial database providers. The price per instrument provided by the pricing service is used and not adjusted. Typically, all securities except for some small municipal issues and the collateralized debt obligations are priced by the primary external provider. For issues that are not priced by the primary provider, we use a third-party value provided by a broker-dealer affiliate of a correspondent bank. The broker-dealer’s valuation system uses prices provided by (1) the same external pricing service that the Company uses, (2) Standard & Poor’s, (3) matrix pricing with market yield inputs provided by Bloomberg and a municipal securities market data provider and (4) the broker-dealer’s trading staff. Any quotes provided by a broker-dealer are usually non-binding. However, the Company rarely uses solicited broker-dealer quotes to price any of its securities. The broker-dealer prices all municipal securities through its pricing matrix. At March 31, 2012, the only securities that were not priced by the primary provider were 10 municipal bonds representing 5 issuers and the collateralized debt obligations. The broker-dealer’s matrix prices were used for the municipal securities and a third-party provider’s modeled prices were used for the collateralized debt obligations (CDOs).

CDOs are valued by an external party using a model. The model inputs are (1) discount margins based on current market activity and (2) cash flows based upon contractual amounts adjusted for expected defaults, expected deferrals and expected prepayments. Expected defaults and deferrals are determined through a credit analysis of and risk rating assignment to each obligor of the collateral that funds the investment vehicles. Most of these inputs are not directly observable in the market, resulting in the fair values being classified as Level 3 valuations within the fair value accounting hierarchy.

The primary method of validation of investment security values is the comparison of the prices that are received from the primary pricing service provider with the prices that are used in the broker-dealer’s valuation system. The fair values used for selected agency, mortgage-backed and corporate securities are also periodically checked by comparing them to prices obtained from Bloomberg. The CDOs are validated by comparing the fair values with market activity of similar instruments. Management reviews the documentation provided with the CDO pricing and impairment models to assure that sound valuation methodologies are used and to determine whether or not the significant inputs are reasonable.

18

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 2:  (Continued)

Loans held for sale are valued by discounting the estimated cash flows using current market rates for instruments with similar credit ratings and maturities and adjusting those rates using dealer pricing adjustments for characteristics unique to the borrower’s circumstances or the structuring of the credit.

Loans held for investment are valued by discounting the estimated future cash flows, using rates at which these loans would currently be made to borrowers with similar credit ratings and similar maturities.

Agency accounts receivable are trade receivables of M&F Insurance Group, Inc. These receivables are short-term in nature and therefore the fair value is assumed to be the carrying value. These receivables are carried in other assets in the statement of condition.

Accrued interest receivable is short-term in nature and therefore the fair value is assumed to be the carrying value.

Nonmarketable equity securities are primarily securities of the Federal Home Loan Banks for which the carrying value is estimated to be an accurate approximation of fair value. These equity securities are carried in other assets in the statement of condition.

Investments in unconsolidated VIEs are the Company’s investment in the First M&F Statutory Trust I, which acquired the Company’s junior subordinated debt through funding provided by the issuance of trust preferred securities, and an investment in a low income housing tax credit entity. The investment in the statutory trust depends on the Company’s own cash flows and therefore, the carrying value is an accurate approximation of fair value. The low income housing tax credit investment is a limited partnership interest for which the carrying value is assumed to be a reasonable estimate of its fair value. These investments are carried in other assets in the statement of condition.

Noninterest-bearing deposits do not pay interest and do not have defined maturity dates. Therefore, the carrying value is estimated to be equivalent to fair value for these deposits.

NOW, MMDA and savings deposits pay interest and generally do not have defined maturity dates. Although there are some restrictions on access to certain savings deposits, these restrictions are not expected to have a material effect on the value of the deposits. Therefore, the fair value for NOW, MMDA and savings deposits is estimated to be their carrying value.

Certificates of deposit pay interest and do have defined maturity dates. The fair value of certificates of deposit is estimated by discounting the future cash flows, using current market rates for certificates of deposit of similar maturities.

Short-term borrowings are highly liquid and therefore the net book value of the majority of these financial instruments approximates fair value due to the short term nature of these items.

The fair value of other borrowings, which consist of Federal Home Loan Bank advances and borrowings from correspondent banks is estimated by discounting the future cash flows, using current market rates for borrowings of similar terms and maturities.

Junior subordinated debt is valued by discounting the expected cash flows using a current market rate for similar instruments.

Agency accounts payable are trade payables of M&F Insurance Group, Inc. due to insurance companies. These payables are very short term in nature and therefore the fair value of the payables is estimated to be their carrying value. These payables are carried in other liabilities in the statement of condition.

Accrued interest payable is short-term in nature and therefore the fair value is estimated to be the carrying value.

Commitments to extend credit and letters of credit are valued based on the fees charged to enter into similar credit arrangements.

Mortgage origination and sale commitments are considered derivatives and are therefore carried at fair value with the changes in fair value recorded in mortgage banking income. Mortgage-related commitments with positive values are carried in other assets and those with negative values are carried in other liabilities in the statement of condition. Mortgage derivatives are valued using a combination of market discount rates, dealer quotes, estimated servicing values and pull-through rates.

The interest rate swap is being used to hedge the interest cash flows on the Company’s junior subordinated debentures. It is valued using a discounted cash flow methodology with cash flows being estimated from the 3-month LIBOR curve and discount rates derived from the swap curve.

19

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 3:  Investment Securities

The following is a summary of the amortized cost and fair value of securities available for sale at March 31, 2012 and December 31, 2011:

 
 
 
 
Gross Unrealized
 
 
(Dollars in thousands)
 
Amortized Cost
 
Gains
 
Losses
 
Fair Value
March 31, 2012:
 
 
 
 
 
 
 
 
U.S. Government sponsored entities
 
$
76,215

 
$
187

 
$
277

 
$
76,125

Mortgage-backed investments
 
221,558

 
4,970

 
216

 
226,312

Obligations of states and political subdivisions
 
56,840

 
2,534

 
176

 
59,198

Collateralized debt obligations
 
3,137

 

 
2,265

 
872

Other debt securities
 
3,449

 
45

 
31

 
3,463

 
 
$
361,199

 
$
7,736

 
$
2,965

 
$
365,970

December 31, 2011:
 
 

 
 

 
 

 
 

U.S. Government sponsored entities
 
$
58,714

 
$
174

 
$
96

 
$
58,792

Mortgage-backed investments
 
198,832

 
5,016

 
162

 
203,686

Obligations of states and political subdivisions
 
51,763

 
2,459

 
80

 
54,142

Collateralized debt obligations
 
3,137

 

 
2,318

 
819

Other debt securities
 
3,444

 
25

 
134

 
3,335

 
 
$
315,890

 
$
7,674

 
$
2,790

 
$
320,774


Provided below is a summary of securities available for sale which were in an unrealized loss position and the length of time that individual securities have been in a continuous loss position at March 31, 2012 and December 31, 2011. Securities on which we have taken only credit-related other-than-temporary-impairment (OTTI) write-downs are categorized as being “less than 12 months” or “12 months or more” in a continuous loss position based on the point in time that the fair value declined to below the amortized cost basis and not the period of time since the OTTI write-down.

(Dollars in thousands)
 
Less Than 12 Months
 
12 Months or More
 
Total
 
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
March 31, 2012:
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Government sponsored entities
 
$
38,552

 
$
277

 
$

 
$

 
$
38,552

 
$
277

Mortgage-backed investments
 
53,900

 
216

 

 

 
53,900

 
216

Obligations of states and political subdivisions
 
7,507

 
176

 

 

 
7,507

 
176

Collateralized debt obligations
 

 

 
872

 
2,265

 
872

 
2,265

Other debt securities
 
2,427

 
31

 

 

 
2,427

 
31

 
 
$
102,386

 
$
700

 
$
872

 
$
2,265

 
$
103,258

 
$
2,965

December 31, 2011:
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Government sponsored entities
 
$
23,734

 
$
96

 
$

 
$

 
$
23,734

 
$
96

Mortgage-backed investments
 
32,280

 
162

 

 

 
32,280

 
162

Obligations of states and political subdivisions
 
7,613

 
80

 

 

 
7,613

 
80

Collateralized debt obligations
 

 

 
819

 
2,318

 
819

 
2,318

Other debt securities
 
2,317

 
134

 

 

 
2,317

 
134

 
 
$
65,944

 
$
472

 
$
819

 
$
2,318

 
$
66,763

 
$
2,790


20

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 3:  (Continued)

At March 31, 2012, there were 26 U.S. government sponsored entity securities with unrealized losses less than 12 months. There were 22 mortgage-backed securities with unrealized losses less than 12 months. There were 23 municipal securities with unrealized losses less than 12 months. There were 2 corporate securities with unrealized losses less than 12 months. The unrealized losses associated with the U.S. government sponsored entity, mortgage-backed and corporate securities were primarily driven by changes in market rates and not due to the credit quality of the securities. The municipal securities that were in unrealized loss positions for less than a year were in unrealized loss positions due primarily to fluctuations in interest rates and market liquidity. A review of the municipal securities portfolio did not indicate any credit deterioration.

There are five collateralized debt obligations that represent the majority of unrealized losses in the investment portfolio. These obligations are secured by commercial bank trust preferred securities. Management has evaluated these instruments for impairment as of each quarter end within the accounting guidelines for determining impairments for beneficial interests using the discounted cash flow approach prescribed, which required management to make assumptions concerning the estimates of the ultimate collectability of the contractual cash flows of the beneficial interests owned. Credit downgrades of the beneficial interests are also factored in when determining whether the impairments in these securities are other-than-temporary. The discounted cash flow estimates depend on the expected cash flows that the beneficial interest issuer will receive on its investments in the trust preferred securities (the CDO collateral) of the commercial bank investees. The ability of the banks that issued trust preferred securities to the beneficial interest issuer to pay their obligations is determined based on an analysis of the financial condition of the banks. Generally, the same factors that result in credit rating downgrades of the beneficial interests also result in negative adjustments to the expected cash flows of the underlying collateral. This analysis results in an estimate of the timing and amount of cash flows derived from a determination of how many would default on their obligations and how many would eventually pay off their obligations and the timing of those events. Those estimated cash flows would first pay off more senior beneficial interests if certain collateral coverage ratios are not maintained, with the remaining amounts eventually flowing through to the interests owned by the Company. Based on this type of analysis for each beneficial interest issuer, the cash flows of each of the five beneficial interests owned by the Company are projected and discounted to their present values and compared to the amortized cost book values of the interests. This analysis has resulted in other-than-temporary impairment (OTTI) conditions for all five of the securities since 2008. During the first quarter of 2011, three of the securities incurred other-than-temporary impairments that resulted in $296 thousand in credit-related losses being charged against earnings with the remaining non-credit-related losses being charged to other comprehensive income. During the first quarter of 2012, none of the securities incurred other-than-temporary impairments. Management believes that as the economy improves, the deferrals related to the CDO collateral will cure and provide enough cash flows to the CDOs for the Company to recover its adjusted book values.

Management does not intend to sell any investment securities that have unrealized losses before the time that those losses could be recovered. Management has evaluated the investment securities that have unrealized losses within the framework of the Company’s liquidity and capital needs as well as its ability to hold those securities over an extended recovery period. Management’s evaluation involved (1) assessing whether significant future cash outflows would occur that would require the liquidation of securities and (2) determining if the balance sheet would need to be managed or reduced in a way that would require the liquidation of securities to meet regulatory capital ratio requirements. This analysis was performed to determine if it was more likely than not that the investments would have to be sold before their anticipated recoveries. Management determined that it was not more likely than not that the investments would have to be disposed of prior to their anticipated recoveries. In estimating whether there are other-than-temporary impairment losses on debt securities management considers (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) historical cash flows and economic factors that could detrimentally affect those cash flows and (4) changes in credit ratings of the issuers.

The following table provides a roll forward of the cumulative activity related to credit losses on debt securities for which a portion of an other-than-temporary impairment was recognized in other comprehensive income.

 
 
Three Months Ended
(Dollars in thousands)
 
March 31
 
 
2012
 
2011
Beginning balance
 
$
1,863

 
$
1,232

OTTI credit losses on previously impaired securities
 

 
296

Ending balance
 
$
1,863

 
$
1,528


The fair values of our CDOs could decline in the future if the underlying performance of the collateral for the trust preferred CDOs deteriorates and credit enhancements in the form of seniority in the cash flow waterfalls do not provide sufficient protection to our contractual principal and interest. As a result, there is a risk that additional OTTI may occur in the future if the economy deteriorates.

21

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 3:  (Continued)

The following is a summary of gains and losses on securities available for sale:

 
 
Three Months Ended
(Dollars in thousands)
 
March 31
 
 
2012
 
2011
Proceeds from sales
 
$
33,982

 
$
41,421

Gross realized gains
 
682

 
1,358

Gross realized losses
 
91

 
9

Net gains from sales
 
$
591

 
$
1,349

Gross recognized losses related to the credit component of other-than-temporary impairments
 
$

 
$
296


Realized gains and losses on securities available for sale are determined using the specific amortized cost of the securities sold.

Securities with a carrying value totaling $237.991 million at March 31, 2012 and $211.988 million at December 31, 2011 were pledged to secure an interest rate swap, public deposits, short-term borrowings and for other purposes required or permitted by law.

The amortized cost and fair values of debt securities available for sale at March 31, 2012, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay certain obligations with, or without, call or prepayment penalties. Mortgage-backed securities receive monthly payments based on the cash flows of the underlying collateral. Therefore, their stated maturities do not represent the timing of principal amounts received and no maturity distributions are shown for these securities.

(Dollars in thousands)
 
Amortized Cost
 
Fair Value
One year or less
 
$
27,404

 
$
27,401

After one through five years
 
68,202

 
69,550

After five through ten years
 
29,887

 
30,930

After ten years
 
14,148

 
11,777

 
 
139,641

 
139,658

Mortgage-backed investments
 
221,558

 
226,312

 
 
$
361,199

 
$
365,970


22

FIRST M & F CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)




Note 4:  Loans and Allowance for Loan Losses

The Bank's loan portfolio includes commercial, consumer, agricultural and residential loans originated primarily in its markets in central and north Mississippi, southwest Tennessee, central Alabama and the Florida panhandle. The following is a summary of the Bank's loans held for investment, net of unearned income of $1.748 million at March 31, 2012 and $2.045 million at December 31, 2011:

(Dollars in thousands)
 
March 31,
2012
 
December 31,
2011
Construction and land development loans
 
$
70,087

 
$
69,325

Other commercial real estate loans
 
498,724

 
505,180

Asset-based loans
 
35,909

 
37,540

Other commercial loans
 
108,410

 
117,790

Home equity loans
 
36,098

 
37,024

Other 1-4 family residential loans
 
188,891

 
186,815

Consumer loans
 
41,376

 
42,666

Total loans
 
$
979,495

 
$
996,340


The Bank uses loans as collateral for borrowings at the Federal Reserve Bank and a Federal Home Loan Bank. Approximately $13.021 million and $18.005 million of commercial and consumer loans were pledged to a line of credit with the Federal Reserve Bank at March 31, 2012 and December 31, 2011 respectively. Approximately $193.398 million and $216.201 million of individual real estate-secured loans were pledged to the Federal Home Loan Bank at March 31, 2012 and December 31, 2011, respectively.

During the first quarter of 2011 the Company purchased $821 thousand in commercial real estate loan participations. No loan purchases were made during the first quarter of 2012.

During the first quarter of 2012 the Company transferred $1.997 million of mortgage loans from held-for-sale status into the portfolio of loans held for investment. No loans were transferred from the held-for-sale portfolio into loans held for investment during the first quarter of 2011.

The following table presents a summary of the past due status of all loans, including nonaccrual loans, by type at March 31, 2012:

(Dollars in thousands)
 
30-59 Days Past Due
 
60-89 Days Past Due
 
Greater Than 90 Days
 
Total Past Due