UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For the period ended June 30, 1999 Commission File Number: 0-16471 First Citizens BancShares, Inc (Exact name of Registrant as specified in its charter) Delaware 56-1528994 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 239 Fayetteville Street, Raleigh, North Carolina 27601 (Address of principal executive offices) (zip code) (919) 716-7000 (Registrant's telephone number, including area code) 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 twelve 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 ninety days. Yes X No _____ Class A Common Stock--$1 Par Value-- 8,905,199 shares Class B Common Stock--$1 Par Value-- 1,720,360 shares (Number of shares outstanding, by class, as of August 13, 1999) INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets at June 30, 1999, December 31, 1998, and June 30, 1998 Consolidated Statements of Income for the three-month and six-month periods ended June 30, 1999, and June 30, 1998 Consolidated Statements of Changes in Shareholders' Equity for the six-month periods ended June 30, 1999 and 1998 Consolidated Statements of Cash Flows for the six-month periods ended June 30, 1999, and June 30, 1998 Notes to Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Market Risk Disclosure PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders On April 26, 1999 at the Annual Meeting of Sharesholders of Registrant two matters were considered by the shareholders: (a) Election of Directors - The shareholder vote regarding the election of the nominees for Board of Directors was: Nominee For Withheld ---------------------------------------------------------------- J.M. Alexander, Jr. 33,051,839 180,446 T.L. Bissett 33,058,798 173,487 B.I. Boyle 33,058,313 173,972 G.H. Broadrick 33,060,698 171,587 H.M. Craig, III 33,061,839 170,446 B.M. Farnsworth 33,058,313 173,972 L.M. Fetterman 33,061,698 170,587 C.P. Holding 33,056,542 175,743 F.B. Holding 33,060,524 171,761 F.B. Holding, Jr. 33,060,639 171,646 L.R. Holding 33,060,598 171,687 C.B.C. Holt 33,058,798 173,487 E.A. Hubbard 33,061,698 170,587 J.B. Hyler, Jr. 33,059,139 173,146 G.D. Johnson 33,057,698 174,587 F.R. Jones 33,061,798 170,487 L.S. Jones 33,058,839 173,446 J.T. Maloney, Jr. 33,058,798 173,487 J.C. Mayo, Jr. 33,059,398 172,887 W. McKay 33,058,798 173,487 B.D. Nash 33,060,098 172,187 L.T. Nunnellee, II 33,059,298 172,987 T.O. Shaw 33,050,198 182,087 R.C. Soles, Jr. 33,061,298 170,987 D.L. Ward, Jr. 33,024,291 207,994 The directors elected at the April 26, 1999 meeting listed above represent the entire board of directors. (b) Appointment of KPMG LLP as independed public accountants The shareholder vote regarding the appointment of KPMG LLP was: For 33,182,778 Against 7,680 Abstain 41,827 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. None. (b) Reports on Form 8-K. During the quarter ended June 30, 1999, Registrant filed no Current Reports on Form 8-K. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST CITIZENS BANCSHARES, INC. (Registrant) Dated: August 13, 1999 By:/s/Kenneth A. Black Kenneth A. Black Vice President, Treasurer, and Chief Financial Officer First Citizens BancShares, Inc and Subsidiaries Second Quarter 1999 Consolidated Balance Sheets First Citizens BancShares, Inc. and Subsidiaries June 30* December 31# June 30* (thousands, except share data) 1999 1998 1998 Assets Cash and due from banks $453,646 $502,955 $485,905 Investment securities held to maturity 1,952,502 2,135,372 2,322,673 Investment securities available for sale 22,974 24,957 26,098 Overnight investments 295,197 232,725 - Loans 6,376,372 6,195,591 5,886,315 Less reserve for loan losses 96,765 96,115 90,240 - ----------------------------------------------------------------------------------------------------------------- Net loans 6,279,607 6,099,476 5,796,075 Premises and equipment 382,548 367,076 345,015 Income earned not collected 59,101 61,652 66,471 Other assets 182,902 181,574 182,611 - ----------------------------------------------------------------------------------------------------------------- Total assets $9,628,477 $9,605,787 $9,224,848 - ----------------------------------------------------------------------------------------------------------------- Liabilities Deposits: Noninterest-bearing $1,323,017 $1,296,713 $1,213,630 Interest-bearing 6,847,416 6,815,695 6,585,288 - ----------------------------------------------------------------------------------------------------------------- Total deposits 8,170,433 8,112,408 7,798,918 Short-term borrowings 518,350 568,140 547,069 Long-term obligations 156,870 158,801 159,456 Other liabilities 90,254 105,689 90,703 - ----------------------------------------------------------------------------------------------------------------- Total liabilities 8,935,907 8,945,038 8,596,146 Shareholders' Equity Common stock: Class A - $1 par value (8,905,199; 8,905,199; and 8,905,199 shares issued, respectively) 8,906 8,906 8,906 Class B - $1 par value (1,720,360; 1,720,360; and 1,720,360 shares issued, respectively) 1,720 1,720 1,720 Surplus 143,760 143,760 143,760 Retained earnings 531,356 497,316 464,823 Accumulated other comprehensive income 6,828 9,047 9,493 - ----------------------------------------------------------------------------------------------------------------- Total shareholders' equity 692,570 660,749 628,702 - ----------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $9,628,477 $9,605,787 $9,224,848 - ----------------------------------------------------------------------------------------------------------------- * Unaudited # Derived from the Consolidated Balance Sheet included in the 1998 Annual Report on Form 10-K. See accompanying Notes to Consolidated Financial Statements. First Citizens BancShares, Inc and Subsidiaries Second Quarter 1999 Consolidated Statements of Income First Citizens BancShares, Inc. and Subsidiaries Three Months Ended June 30 Six Months Ended June 30 (thousands, except per share data; unaudited) 1999 1998 1999 1998 - --------------------------------------------------------------------------------------------------------------------- Interest income Loans $124,046 $117,485 $246,701 $229,651 Investment securities: U. S. Government 28,883 35,662 58,166 70,837 State, county and municipal 37 54 75 112 Other 119 18 239 36 - --------------------------------------------------------------------------------------------------------------------- Total investment securities interest income 29,039 35,734 58,480 70,985 Overnight investments 3,875 1,316 7,235 3,369 - --------------------------------------------------------------------------------------------------------------------- Total interest income 156,960 154,535 312,416 304,005 Interest expense Deposits 60,484 64,315 121,353 128,189 Short-term borrowings 5,180 6,103 10,839 12,571 Long-term obligations 3,157 3,225 6,342 4,330 - --------------------------------------------------------------------------------------------------------------------- Total interest expense 68,821 73,643 138,534 145,090 - --------------------------------------------------------------------------------------------------------------------- Net interest income 88,139 80,892 173,882 158,915 Provision for loan losses 2,178 5,267 4,840 9,662 - --------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 85,961 75,625 169,042 149,253 Noninterest income Trust income 3,500 3,023 7,007 6,054 Service charges on deposit accounts 14,209 11,902 25,809 22,662 Credit card income 7,569 6,212 13,891 11,535 Other service charges and fees 12,215 11,289 23,465 21,003 Net gain (loss) on loans held for sale 452 1,114 2,045 2,203 Securities gains - - 777 - Other 1,326 1,680 4,472 3,521 - --------------------------------------------------------------------------------------------------------------------- Total noninterest income 39,271 35,220 77,466 66,978 Noninterest expense Salaries and wages 39,798 34,385 78,895 68,043 Employee benefits 7,765 7,037 15,323 13,783 Occupancy expense 7,355 7,083 14,486 13,641 Equipment expense 9,301 9,416 18,532 18,196 Other 29,168 26,070 57,369 51,210 - --------------------------------------------------------------------------------------------------------------------- Total noninterest expense 93,387 83,991 184,605 164,873 - --------------------------------------------------------------------------------------------------------------------- Income before income taxes 31,845 26,854 61,903 51,358 Income taxes 11,542 9,309 22,552 18,153 - --------------------------------------------------------------------------------------------------------------------- Net income $20,303 $17,545 $39,351 $33,205 - --------------------------------------------------------------------------------------------------------------------- Per Share Net income $1.91 $1.68 $3.70 $3.07 Cash dividends 0.25 0.25 0.50 0.50 - --------------------------------------------------------------------------------------------------------------------- See accompanying Notes to Consolidated Financial Statements. First Citizens BancShares, Inc. and Subsidiaries Second Quarter 1999 Consolidated Statements of Changes in Shareholders' Equity First Citizens BancShares, Inc. and Subsidiaries Accumulated Class A Class B Other Common Common Retained Comprehensive Total (thousands, except share data, unaudited) Stock Stock Surplus Earnings Income Equity Balance at December 31, 1997 $8,906 $1,722 $143,760 $437,794 $9,458 $601,640 Redemption of 1,894 shares of Class B common stock (2) (202) (204) Obligation to repurchase common stock (624) (624) Net income 33,205 33,205 Unrealized securities gains, net of taxes 35 35 Cash dividends (5,350) (5,350) ======================================================================================================================== Balance at June 30, 1998 $8,906 $1,720 $143,760 $464,823 $9,493 $628,702 ======================================================================================================================== Balance at December 31, 1998 $8,906 $1,720 $143,760 $497,316 $9,047 $660,749 Net income 39,351 39,351 Unrealized securities losses, net of taxes (2,219) (2,219) Cash dividends (5,311) (5,311) ======================================================================================================================== Balance at June 30, 1999 $8,906 $1,720 $143,760 $531,356 $6,828 $692,570 ======================================================================================================================== See accompanying Notes to Consolidated Financial Statements. First Citizens BancShares, Inc. and Subsidiaries Second Quarter 1999 Consolidated Statements of Cash Flows First Citizens BancShares, Inc. and Subsidiaries Six months ended June 30 (thousands, unaudited) 1999 1998 Operating Activities Net income $39,351 $33,205 Adjustments to reconcile net income to cash provided (used) by operating activities: Amortization of intangibles 5,871 5,476 Provision for loan losses 4,840 9,662 Deferred tax expense (benefit) (2,667) 3,988 Change in current taxes payable (5,956) 1,068 Depreciation 15,107 13,091 Change in accrued interest payable (3,753) (2,252) Change in income earned not collected 2,551 160 Securities gains (777) - Origination of loans held for sale (311,502) (210,298) Proceeds from sale of loans held for sale 368,081 210,581 Gain on loans held for sale (2,045) (2,203) Net amortization of premiums and discounts 6,635 4,995 Net change in other assets (3,072) (12,011) Net change in other liabilities (5,725) (77,108) - ---------------------------------------------------------------------------------------------------------------- Net cash provided (used) by operating activities 106,939 (21,646) - ---------------------------------------------------------------------------------------------------------------- Investing Activities Net increase in loans outstanding (239,505) (433,702) Purchases of investment securities held to maturity (486,398) (465,505) Purchases of investment securities available for sale (2,630) - Proceeds from maturities of investment securities held to maturity 662,633 594,998 Proceeds from sales of investment securities available for sale 1,710 - Net change in overnight investments (62,472) 81,775 Dispositions of premises and equipment 6,311 9 Additions to premises and equipment (36,890) (46,082) Purchase of branches, net of cash received - 249,702 - ---------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (157,241) (18,805) - ---------------------------------------------------------------------------------------------------------------- Financing Activities Net change in time deposits (28,446) (309,924) Net change in demand and other interest-bearing deposits 86,471 233,218 Net change in short-term borrowings (51,721) (48,155) Origination of long-term obligations - 150,000 Proceeds from issuance of common stock - - Cash dividends paid (5,311) (5,350) - ---------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 993 19,585 - ---------------------------------------------------------------------------------------------------------------- Change in cash and due from banks (49,309) (20,866) Cash and due from banks at beginning of period 502,955 506,771 ================================================================================================================ Cash and due from banks at end of period $453,646 $485,905 ================================================================================================================ Cash payments for: Interest $142,288 $148,137 Income taxes 30,199 21,234 Supplemental disclosure of noncash investing and financing activities: Unrealized securities gains (losses), net of taxes (2,219) 35 Obligation to repurchase common stock - 624 - ---------------------------------------------------------------------------------------------------------------- See accompanying Notes to Consolidated Financial Statements First Citizens BancShares, Inc. and Subsidiaries Second Quarter 1999 Note A Accounting Policies The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete statements. In the opinion of management, the consolidated statements contain all material adjustments necessary to present fairly the financial position of First Citizens BancShares, Inc. as of and for each of the periods presented, and all such adjustments are of a normal recurring nature. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the financial statements and for the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. These financial statements should be read in conjunction with the financial statements and notes included in the 1998 First Citizens BancShares, Inc. Annual Report, which is incorporated by reference on Form 10-K. Certain amounts for prior periods have been reclassified to conform with statement presentations for 1999. However, the reclassifications have no effect on shareholders' equity or net income as previously reported. Note B Comprehensive Income The following table displays comprehensive income for the periods indicated: Three Months Ended June 30 Six Months Ended June 30 (thousands) 1999 1998 1999 1998 - ----------------------------------------------------------------------------------------------------------------------- Net income $20,303 $17,545 $39,351 $33,205 Other comprehensive income (loss) (1,330) (1,244) (2,219) 35 ======================================================================================================================= Comprehensive income $18,973 $16,301 $37,132 $33,240 ======================================================================================================================= Note C Net Income per Share Earnings per share is calculated by dividing income applicable to common shares by the weighted average number of common shares outstanding during the period. For 1998, income applicable to common shares represents net income adjusted for change in the obligation to purchase common shares. BancShares had no potential common stock for all periods presented. Net income per share is calculated based on the following amounts for the three months ended June 30: Three Months Ended June 30 Six Months Ended June 30 (thousands) 1999 1998 1999 1998 - ---------------------------------------------------------------------------------------------------------------------------------- Net income $20,303 $17,545 $39,351 $33,205 Less change in obligation to purchase common shares - (224) - 624 - ---------------------------------------------------------------------------------------------------------------------------------- Net income applicable to common shares $20,303 $17,769 $39,351 $32,581 ================================================================================================================================== Weighted average common shares outstanding 10,625,559 10,626,702 10,625,559 10,627,076 - ---------------------------------------------------------------------------------------------------------------------------------- Financial Summary Table 1 1999 1998 Six Months Ended (thousands, except per share data Second First Fourth Third Second June 30 and ratios) Quarter Quarter Quarter Quarter Quarter 1999 1998 - ----------------------------------------------------------------------------------------------------------------------------------- Summary of Operations Interest income .......................$ 156,960 $ 155,456 $ 158,101 $ 157,381 $ 154,535 $ 312,416 $ 304,005 Interest expense ...................... 68,821 69,713 73,057 73,924 73,643 138,534 145,090 Net interest income ................... 88,139 85,743 85,044 83,457 80,892 173,882 158,915 Provision for loan losses ............. 2,178 2,662 4,893 5,324 5,267 4,840 9,662 Net interest income after provision for loan losses ................... 85,961 83,081 80,151 78,133 75,625 169,042 149,253 Noninterest income .................... 39,271 38,195 42,439 36,000 35,220 77,466 66,978 Noninterest expense ................... 93,387 91,218 91,226 86,114 83,991 184,605 164,873 Income before income taxes ............ 31,845 30,058 31,364 28,019 26,854 61,903 51,358 Income taxes .......................... 11,542 11,010 11,648 9,931 9,309 22,552 18,153 Net income ............................$ 20,303 $ 19,048 $ 19,716 $ 18,088 $ 17,545 $ 39,351 $ 33,205 Net interest income-taxable equivalent $ 88,703 $ 86,338 $ 85,838 $ 83,988 $ 81,397 $ 175,041 $ 159,938 Selected Averages Total assets ..........................$ 9,605,512 $ 9,517,513 $ 9,315,347 $ 9,183,571 $ 9,142,981 $ 9,561,845 $ 9,035,770 Investment securities ................. 2,066,519 2,091,575 2,087,308 2,244,014 2,461,590 2,078,978 2,452,339 Loans ................................. 6,289,714 6,180,106 6,169,556 6,024,822 5,711,599 6,235,303 5,593,736 Interest-earning assets ............... 8,659,199 8,558,123 8,413,435 8,305,482 8,269,008 8,618,671 8,168,864 Deposits .............................. 8,139,147 8,018,971 7,914,649 7,744,217 7,755,945 8,079,391 7,688,015 Interest-bearing liabilities .......... 7,490,958 7,495,944 7,410,007 7,244,949 7,241,686 7,508,518 7,169,308 Long-term obligations ................. 157,453 158,307 159,196 158,353 159,984 157,877 108,187 Shareholders' equity ..................$ 683,771 $ 668,087 $ 651,656 $ 635,521 $ 621,605 $ 675,883 $ 614,545 Shares outstanding .................... 10,625,559 10,625,559 10,625,559 10,625,559 10,626,702 10,625,559 10,627,076 Selected Period-End Balances Total assets ..........................$ 9,628,477 $ 9,702,163 $ 9,605,787 $ 9,194,842 $ 9,224,848 $ 9,628,477 $ 9,224,848 Investment securities ................. 1,975,476 2,099,882 2,160,329 2,115,343 2,348,771 1,975,476 2,348,771 Loans ................................. 6,376,372 6,244,828 6,195,591 6,132,422 5,886,315 6,376,372 5,886,315 Interest-earning assets ............... 8,647,045 8,694,710 8,588,645 8,257,765 8,235,086 8,647,045 8,235,086 Deposits .............................. 8,170,433 8,179,098 8,112,408 7,771,093 7,798,918 8,170,433 7,798,918 Interest-bearing liabilities .......... 7,522,636 7,620,262 7,542,636 7,260,204 7,291,813 7,522,636 7,291,813 Long-term obligations ................. 156,870 157,529 158,801 158,801 159,456 156,870 159,456 Shareholders' equity ..................$ 692,570 $ 676,253 $ 660,749 $ 643,673 $ 628,702 $ 692,570 $ 628,702 Shares outstanding .................... 10,625,559 10,625,559 10,625,559 10,625,559 10,625,559 10,625,559 10,625,559 Profitability Ratios (averages) Rate of return (annualized) on: Total assets .......................... 0.85% 0.81% 0.84% 0.78% 0.77% 0.83% 0.74% Shareholders' equity .................. 11.91 11.56 12.00 11.29 11.32 11.74 10.90 Dividend payout ratio ................. 13.09 13.97 13.51 14.71 14.88 13.51 16.29 Loans to deposits ..................... 77.28% 77.07% 77.95% 77.80% 73.64% 77.18% 72.25% Shareholders' equity to total assets .. 7.12 7.02 7.00 6.92 6.80 7.07 7.85 Time certificates of $100,000 or more to total deposits ..................... 8.91 9.04 8.88 8.85 9.15 8.95 9.36 Per Share of Stock Net income ............................$ 1.91 $ 1.79 $ 1.85 $ 1.70 $ 1.68 $ 3.70 $ 3.07 Cash dividends ........................ 0.25 0.25 0.25 0.25 0.25 0.50 0.50 Book value at period end .............. 65.18 63.64 62.18 60.58 59.17 65.18 59.17 Tangible book value at period end ..... 54.05 52.27 50.73 49.17 47.02 54.05 47.02 First Citizens BancShares, Inc. and Subsidiaries Second Quarter 1999 Outstanding Loans by Type Table 2 1999 1998 - -------------------------------------------------------------------------------------------------------------------------- Second First Fourth Third Second (thousands) Quarter Quarter Quarter Quarter Quarter - -------------------------------------------------------------------------------------------------------------------------- Real estate: Construction and land development $169,755 $166,123 $157,603 $156,892 $140,651 Mortgage: 1-4 family residential 1,254,010 1,276,945 1,299,508 1,327,411 1,351,708 Commercial 1,641,846 1,594,076 1,495,214 1,378,086 1,257,465 Equity Line 685,924 613,510 617,062 641,746 647,117 Other 164,719 160,690 160,289 157,830 153,074 Commercial and industrial 952,206 889,962 845,068 802,653 756,371 Consumer 1,391,491 1,437,897 1,516,712 1,564,041 1,483,333 Lease financing 106,684 95,557 93,680 91,655 83,713 Other 9,737 10,068 10,455 12,108 12,883 - -------------------------------------------------------------------------------------------------------------------------- Total loans 6,376,372 6,244,828 6,195,591 6,132,422 5,886,315 - -------------------------------------------------------------------------------------------------------------------------- Less reserve for loan losses 96,765 96,340 96,115 94,135 90,240 - -------------------------------------------------------------------------------------------------------------------------- Net loans $6,279,607 $6,148,488 $6,099,476 $6,038,287 $5,796,075 - -------------------------------------------------------------------------------------------------------------------------- First Citizens BancShares, Inc. and Subsidiaries Second Quarter 1999 Investment Securities Table 3 June 30, 1999 June 30, 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Average Taxable Average Taxable Book Fair Maturity Equivalent Book Fair Maturity Equivalent (thousands) Value Value (Yrs./Mos.) Yield Value Value (Yrs./Mos.) Yield - ------------------------------------------------------------------------------------------------------------------------------------ Securities held to maturity: U. S. Government: Within one year $1,372,194 $1,372,493 0/6 5.75 % $1,024,510 $1,025,911 0/7 5.84 % One to five years 572,467 563,890 1/5 5.41 1,286,493 1,289,838 1/6 5.90 Five to ten years 200 203 8/2 8.21 353 341 6/5 7.02 Over ten years 4,519 4,522 23/1 7.07 3,800 3,911 19/4 7.44 - ------------------------------------------------------------------------------------------------------------------------------------ Total 1,949,380 1,941,108 0/10 5.65 2,315,156 2,320,001 1/1 5.87 State, county and municipal: Within one year 237 241 0/10 7.90 1,611 1,616 0/5 6.30 One to five years 2,410 2,462 2/5 7.21 2,766 2,852 3/3 7.32 Over ten years 160 163 18/2 9.14 175 175 19/2 9.14 - ------------------------------------------------------------------------------------------------------------------------------------ Total 2,807 2,866 3/2 7.38 4,552 4,643 2/10 7.02 Other: Within one year 10 10 0/1 0.06 2,900 2,899 0/3 7.50 One to five years 55 55 2/8 5.47 65 65 3/3 4.63 Five to ten years 250 250 9/1 2.25 - - - - - ------------------------------------------------------------------------------------------------------------------------------------ Total 315 315 7/8 2.74 2,965 2,964 0/6 7.44 - ------------------------------------------------------------------------------------------------------------------------------------ Total securities held to maturity 1,952,502 1,944,289 0/10 5.65 % 2,322,673 2,327,608 1/1 5.88 % Marketable equity securities 11,333 22,974 - - 10,352 26,098 - - - ------------------------------------------------------------------------------------------------------------------------------------ Total investment securities 1,963,835 1,967,263 - - 2,333,025 2,353,706 - - - ------------------------------------------------------------------------------------------------------------------------------------ First Citizens BancShares, Inc. and Subsidiaries Second Quarter 1999 Consolidated Taxable Equivalent Rate/Volume Variance Analysis - Second Quarter Table 4 1999 1998 Increase (decrease) due to: Interest Interest Average Income/ Yield/ Average Income/ Yield/ Yield/ Total (thousands) Balance Expense Rate Balance Expense Rate Volume Rate Change Assets Total loans $6,289,714 $124,592 7.95 % $5,711,599 $117,961 8.23 % $11,240 ($4,609) $6,631 Investment securities: U. S. Government 2,038,593 28,883 5.68 2,427,278 35,662 5.89 (5,608) (1,171) (6,779) State, county and municipal 2,892 55 7.63 4,633 83 7.19 (32) 4 (28) Other 25,034 119 1.91 29,679 18 0.24 (13) 114 101 - ------------------------------------------------------------------------------------------------------------------------------------ Total investment securities 2,066,519 29,057 5.64 2,461,590 35,763 5.83 (5,653) (1,053) (6,706) Overnight investments 302,966 3,875 5.13 95,819 1,316 5.51 2,748 (189) 2,559 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-earning assets $8,659,199 $157,524 7.30 % $8,269,008 $155,040 7.48 % $8,335 ($5,851) $2,484 - ------------------------------------------------------------------------------------------------------------------------------------ Liabilities Deposits: Checking With Interest $1,086,135 $1,782 0.66 % $1,047,360 $2,812 1.08 % $86 ($1,116) ($1,030) Savings 669,254 2,717 1.63 708,424 3,343 1.89 (176) (450) (626) Money market accounts 1,328,802 11,157 3.37 1,083,999 9,522 3.52 2,094 (459) 1,635 Time deposits 3,726,677 44,828 4.82 3,742,286 48,638 5.21 (187) (3,623) (3,810) - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits 6,810,868 60,484 3.56 6,582,069 64,315 3.92 1,817 (5,648) (3,831) Federal funds purchased 40,377 472 4.69 54,665 753 5.53 (182) (99) (281) Repurchase agreements 110,931 978 3.54 71,516 760 4.26 382 (164) 218 Master notes 315,718 3,072 3.90 312,489 3,683 4.73 37 (648) (611) Other short-term borrowings 55,611 658 4.75 60,963 907 5.97 (72) (177) (249) Long-term obligations 157,453 3,157 8.04 159,984 3,225 8.09 (50) (18) (68) - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities $7,490,958 $68,821 3.68 $7,241,686 $73,643 4.08 % $1,932 ($6,754) ($4,822) - ------------------------------------------------------------------------------------------------------------------------------------ Interest rate spread 3.62 % 3.40 % - ------------------------------------------------------------------------------------------------------------------------------------ Net interest income and net yield on interest-earning assets $88,703 4.11 % $81,397 3.95 % $6,403 $903 $7,306 - ------------------------------------------------------------------------------------------------------------------------------------ Average loan balances include nonaccrual loans. Yields related to loans and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only, are stated on a taxable-equivalent basis assuming a statutory federal income tax rate of 35% for each period, and state income tax rates of 7.00% for 1999 and 7.25 % for 1998. First Citizens BancShares, Inc. and Subsidiaries Second Quarter 1999 Consolidated Taxable Equivalent Rate/Volume Variance Analysis - Six Months Table 5 1999 1998 Increase (decrease) due to: - ------------------------------------------------------------------------------------------------------------------------------------ Interest Interest Average Income/ Yield/ Average Income/ Yield/ Yield/ Total (thousands) Balance Expense Rate Balance Expense Rate Volume Rate Change - ---------------------------------------------------------------------------------------------------------------------------------- Assets Total loans $6,235,303 $247,824 7.99 % $5,593,736 $230,613 8.28 % $25,799 ($8,588) $17,211 Investment securities: U. S. Government 2,050,931 58,166 5.72 2,418,883 70,837 5.91 (10,588) (2,083) (12,671) State, county and municipal 2,972 111 7.53 4,744 173 7.35 (65) 3 (62) Other 25,075 239 1.92 28,712 36 0.25 (20) 223 203 - ------------------------------------------------------------------------------------------------------------------------------- Total investment securities 2,078,978 58,516 5.68 2,452,339 71,046 5.84 (10,673) (1,857) (12,530) Overnight investments 304,390 7,235 4.79 122,789 3,369 5.53 4,648 (782) 3,866 - ------------------------------------------------------------------------------------------------------------------------------- Total interest-earning assets $8,618,671 $313,575 7.32 % $8,168,864 $305,028 7.51 % $19,774 ($11,227) $8,547 - ------------------------------------------------------------------------------------------------------------------------------- Liabilities Deposits: Checking With Interest $1,078,954 $3,706 0.69 % $1,023,200 $5,450 1.07 % $240 ($1,984) ($1,744) Savings 695,067 5,396 1.57 700,223 6,551 1.89 (46) (1,109) (1,155) Money market accounts 1,302,195 21,501 3.33 1,072,381 18,966 3.57 3,940 (1,405) 2,535 Time deposits 3,733,927 90,750 4.90 3,754,677 97,222 5.22 (526) (5,946) (6,472) - ------------------------------------------------------------------------------------------------------------------------------- Total interest-bearing deposits 6,810,143 121,353 3.59 6,550,481 128,189 3.95 3,608 (10,444) (6,836) Federal funds purchased 59,797 1,382 4.66 53,238 1,449 5.49 165 (232) (67) Repurchase agreements 108,944 1,901 3.52 65,732 1,398 4.29 837 (334) 503 Master notes 313,960 6,040 3.88 304,026 7,129 4.73 213 (1,302) (1,089) Other short-term borrowings 57,797 1,516 5.29 87,643 2,595 5.97 (834) (245) (1,079) Long-term obligations 157,877 6,342 8.10 108,187 4,330 8.07 1,992 20 2,012 - ------------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities$7,508,518 $138,534 3.72 % $7,169,307 $145,090 4.08 % $5,981 ($12,537) ($6,556) - ------------------------------------------------------------------------------------------------------------------------------- Interest rate spread 3.60 % 3.43 % - ------------------------------------------------------------------------------------------------------------------------------- Net interest income and net yield on interest-earning assets $175,041 4.10 % $159,938 3.95 % $13,793 $1,310 $15,103 - ------------------------------------------------------------------------------------------------------------------------------- Average loan balances include nonaccrual loans. Yields related to loans and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only, are stated on a taxable-equivalent basis assuming a statutory federal income tax rate of 35% for each period, and state income tax rates of 7.00% for 1999 and 7.25 % for 1998. First Citizens BancShares, Inc. and Subsidiaries Second Quarter 1999 Summary of Loan Loss Experience and Risk Elements Table 6 1999 1998 Six Months Ended Second First Fourth Third Second June 30 (thousands, except ratios) Quarter Quarter Quarter Quarter Quarter 1999 1998 - --------------------------------------------------------------------------------------------------------------------------------- Reserve balance at beginning of period $96,340 $96,115 $94,135 $90,240 $85,985 $96,115 $84,360 Provision for loan losses 2,178 2,662 4,893 5,324 5,267 4,840 9,662 Net charge-offs: Charge-offs (3,231) (3,465) (3,913) (2,815) (3,930) (6,696) (7,339) Recoveries 1,478 1,028 1,000 1,386 2,918 2,506 3,557 - --------------------------------------------------------------------------------------------------------------------------------- Net charge-offs (1,753) (2,437) (2,913) (1,429) (1,012) (4,190) (3,782) - ------------------------------------------------------------------------------------------------------------------------------- Reserve balance at end of period $96,765 $96,340 $96,115 $94,135 $90,240 $96,765 $90,240 ================================================================================================================================= Historical Statistics Balances Average total loans $6,289,714 $6,180,106 $6,169,556 $6,024,822 $5,711,599 $6,235,303 $5,593,736 Total loans at period-end 6,376,372 6,244,828 6,195,591 6,132,422 5,886,315 6,376,372 5,886,315 - --------------------------------------------------------------------------------------------------------------------------------- Risk Elements Nonaccrual loans $11,465 $12,322 $12,489 $11,492 $12,335 $11,465 $12,335 Other real estate acquired through foreclosure 2,030 3,062 1,529 1,202 1,170 2,030 1,170 - --------------------------------------------------------------------------------------------------------------------------------- Total nonperforming assets $13,495 $15,384 $14,018 $12,694 $13,505 $13,495 $13,505 - --------------------------------------------------------------------------------------------------------------------------------- Accruing loans 90 days or more past due $5,181 $5,541 $5,721 $4,761 $4,168 $5,181 $4,168 - --------------------------------------------------------------------------------------------------------------------------------- Ratios Net charge-offs (annualized) to average total loans 0.11 % 0.16 % 0.19 % 0.09 % 0.07 % 0.14 % 0.14 % Reserve for loan losses to total loans at period-end 1.52 1.54 1.55 1.54 1.53 1.52 1.53 Nonperforming assets to total loans plus foreclosed real estate at period-end 0.21 0.25 0.23 0.21 0.23 0.21 0.23 - --------------------------------------------------------------------------------------------------------------------------------- First Citizens BancShares, Inc. and Subsidiaries Second Quarter 1999 INTRODUCTION Management's discussion and analysis of earnings and related financial data are presented to assist in understanding the financial condition and results of operations of First Citizens BancShares, Inc. and Subsidiaries ("BancShares"). This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and related notes presented within this report. The focus of this discussion concerns BancShares' two banking subsidiaries. First-Citizens Bank & Trust Company ("FCB") operates branches in North Carolina, West Virginia, and Virginia. Atlantic States Bank operates offices in Georgia and Florida. SUMMARY BancShares realized an increase in earnings during the second quarter of 1999 compared to the second quarter of 1998. Consolidated net income during the second quarter of 1999 was $20.3 million, compared to $17.5 million earned during the corresponding period of 1998. Net income per share during the second quarter of 1999 totaled $1.91, compared to $1.68 during the second quarter of 1998. Return on average assets was 0.85 percent for the second quarter of 1999 compared to 0.77 percent during the same period of 1998. For the first six months of 1999, BancShares recorded net income of $39.4 million, compared to $33.2 million earned during the first six months of 1998. The 18.5 percent increase was the net result of higher net interest income and higher noninterest income as well as a lower provision for loan losses, partially offset by higher noninterest expense. Net income per share for the first six months of 1999 was $3.70, compared to $3.07 during the same period of 1998. BancShares returned 0.83 percent on average assets during the first six months of 1999 compared to 0.74 percent during the corresponding period of 1998. Various profitability, liquidity and capital ratios are presented in Table 1. To understand the changes and trends in interest-earning assets and interest-bearing liabilities, refer to the average balance sheets presented in Table 4 for the second quarter and Table 5 for the first six months of 1999 and 1998. INTEREST-EARNING ASSETS Interest-earning assets for the second quarter of 1999 averaged $8.66 billion, an increase of $390.2 million or 4.7 percent from the second quarter of 1998. For the six months ended June 30, 1999, earning assets averaged $8.62 billion, an increase of $449.8 million or 5.5 percent over the same period of 1998. These increases result from growth in the loan portfolio. Loans. At June 30, 1999 and 1998, gross loans totaled $6.38 billion and $5.89 billion, respectively. As of December 31, 1998, gross loans were $6.20 billion. The $490 million growth in loans from June 30, 1998 to June 30, 1999 results from growth within BancShares' commercial and business loan products, and retail real estate lending. Table 2 details outstanding loans by type for the past five quarters. During the second quarter of 1999, loans averaged $6.29 billion, an increase of $578.1 million or 10.1 percent from the comparable period of 1998. Loan growth resulted from strong demand for commercial and business loans. Loans originated for commercial purposes averaged $2.34 billion during the second quarter of 1999, compared to $1.94 billion during the second quarter of 1998, an increase of $400.4 million or 20.58 percent. Residential mortgage loans averaged $645.6 million during the second quarter of 1999, a decrease of $181.1 million, or 21.9 percent, during the same period of 1998. The reduction in residential mortgage loans is due to strong refinance activity in 1998 coupled with loan rates consummated in late 1998. For the year-to-date, gross loans have averaged $6.24 billion for 1999 compared to $5.59 billion for the same period of 1998. This $641.6 million or 11.47 percent increase is likewise due to growth among commercial and business loans and retail real estate lending. As of June 30, 1999, $29.8 million in fixed-rate residential mortgage loans are classified as held for sale. All loans held for sale are carried at the lower of cost or fair value. Mortgage loan sale activity during the first six months of 1999 has resulted from two primary goals. First, as in the past, management seeks to lessen the exposure to changes in interest rates by selling portions of its long-term fixed-rate loan production. Second, loan sales provide liquidity to meet ongoing loan demand. The sales of residential mortgage loans has supported both objectives. Despite the recent upward pressure on interest rates, management anticipates continued growth among commercial and business lending. Management projects more modest demand for traditional installment loans from retail customers. All growth projections, however, remain dependent on interest rates, as any continued upward pressure on interest rates will likely deter retail borrowers and may also slow commercial loan growth. Investment securities. At June 30, 1999 and 1998, the investment portfolio totaled $1.98 billion and $2.35 billion, respectively. At December 31, 1998, the investment portfolio was $2.16 billion. The 8.6 percent reduction in the investment portfolio since December 31, 1998 resulted from maturities used to fund loan growth, which grew at a faster pace than deposits. All securities that are classified as held-to-maturity reflect BancShares' ability and positive intent to hold those investments until maturity. Marketable equity securities are classified as available-for-sale and are reported at their aggregate fair value. Table 3 presents detailed information relating to the investment securities portfolio. Income on Interest-Earning Assets. Interest income amounted to $157.0 million during the second quarter of 1999, a 1.6 percent increase over the second quarter of 1998. Balance sheet growth contributed to higher interest income in the second quarter of 1999 when compared to the same period of 1998. The taxable-equivalent yield on interest-earning assets for the second quarter of 1999 was 7.30 percent, compared to 7.48 percent for the corresponding period of 1998. The lower yield on earning assets during 1999 results primarily from a reduction in the blended taxable-equivalent loan yield. The commercial and business loan growth focused on strong underwriting and resulted in high quality loans with lower yields. Additionally, during 1999, BancShares offered lower introductory rates on its home equity lines of credit. Substantially all of these loans will adjust to current market rates during the fourth quarter of 1999. Loan interest income for the second quarter of 1999 was $124.0 million, an increase of $6.6 million or 5.58 percent from the second quarter of 1998, due to volume growth. The taxable-equivalent yield on the loan portfolio was 7.95 percent during the second quarter of 1999, compared to 8.23 percent during the same period of 1998, the reduction resulting from lower market rates. Further, during 1999, the composition of the loan portfolio has shifted towards lower yielding commercial and business loans. For the six months ended June 30, 1999, loan interest income was $246.7 million, an increase of $17.1 million or 7.42 percent over the same period of 1998. The increase in interest income reflects the growth in the loan portfolio. Income earned on the investment securities portfolio amounted to $29.0 million during the second quarter of 1999 and $35.7 million during the same period of 1998, a decrease of $6.7 million or 18.7 percent. This decrease is the result of a $395.1 million or 16.0 percent decrease in the average securities portfolio. The investment securities portfolio taxable-equivalent yield fell to 5.64 percent for the quarter ended June 30, 1999, compared to 5.83 percent for the quarter ended June 30, 1998. For the six months ended June 30, 1999, interest income from investment securities was $58.5 million, compared to $71.0 million during the same period of 1998, a decrease of 17.6 percent. This decrease is the result of a $373.4 million decrease in the average securities portfolio. INTEREST-BEARING LIABILITIES At June 30, 1999 and 1998, interest-bearing liabilities totaled $7.52 billion and $7.29 billion, respectively, compared to $7.54 billion as of December 31, 1998. During the second quarter of 1999, interest-bearing liabilities averaged $7.5 billion, an increase of $249.30 million or 3.44 percent from the second quarter of 1998. This increase primarily resulted from growth in interest bearing money market deposits. Deposits. At June 30, 1999, total deposits were $8.17 billion, an increase of $371.5 million or 4.8 percent over June 30, 1998. Compared to the December 31, 1998 balance of $8.11 billion, total deposits have increased slightly. Average interest-bearing deposits were $6.81 billion during the second quarter of 1999 compared to $6.58 billion during the second quarter of 1998, an increase of 3.48 percent. Much of the increase is due to average money market accounts, which increased $244.8 million from the second quarter of 1998 to the second quarter of 1999. Average time deposits decreased $38.8 million from the second quarter of 1998 to the second quarter of 1999, while average Checking With Interest accounts increased $15.6 million between the two periods. Time deposits of $100,000 or more averaged 8.91 percent of total average deposits during the second quarter of 1999, compared to 9.15 percent during the same period of 1998. Borrowed Funds. At June 30, 1999, short-term borrowings totaled $518.4 million compared to $568.1 million at December 31, 1998 and $547.1 million at June 30, 1998. For the quarters ended June 30, 1999 and 1998, short-term borrowings averaged $522.6 million and $499.6 million, respectively. This increase resulted from growth among repurchase agreements. Long-term obligations averaged $157.4 million during the second quarter of 1999, compared to $160.0 million during the second quarter of 1998. Expense on Interest-Bearing Liabilities. BancShares' interest expense amounted to $68.8 million during the second quarter of 1999, a $4.8 million or 6.5 percent decrease from the second quarter of 1998. The lower interest expense was the result of rate reductions, the impact of which more than offset the growth in average interest bearing deposits. The rate on these liabilities was 3.68 percent during the second quarter of 1999 compared to 4.08 percent during the same period of 1998. For the year-to-date, interest expense was $138.5 million, compared to $145.1 million for the same period of 1998. The 4.52 percent decrease results from lower interest rates. NET INTEREST INCOME Net interest income totaled $88.1 million during the second quarter of 1999, an increase of 9.0 percent from the second quarter of 1998. The taxable-equivalent net yield on interest-earning assets was 4.11 percent for the second quarter of 1999, an increase of 16 basis points from the 3.95 percent reported for the second quarter of 1998. The taxable equivalent interest rate spread for the second quarter of 1999 was 3.62 percent compared to 3.40 percent for the same period of 1998. The improved interest rate spread and net yield on interest-earning assets result from growth in interest-earning assets and a further reduction in interest expense on interest-bearing liabilities than interest-earning assets. A principal objective of BancShares' asset/liability management function is to manage interest rate risk or the exposure to changes in interest rates. Management maintains portfolios of interest-earning assets and interest-bearing liabilities with maturities or repricing opportunities that will protect against wide interest rate fluctuations, thereby limiting, to the extent possible, the ultimate interest rate exposure. Management is aware of the potential negative impact that movements in market interest rates may have on net interest income. Market risk is the potential economic loss resulting from changes in market prices and interest rates. This risk can either result in diminished current fair values or reduced net interest income in future periods. As of June 30, 1999, BancShares' market risk profile has not changed significantly from December 31, 1998. ASSET QUALITY Reserve for loan losses. Management continuously analyzes the growth and risk characteristics of the total loan portfolio under current economic conditions in order to evaluate the adequacy of the reserve for loan losses. Such factors as the financial condition of the borrower, fair market value of collateral and other considerations are recognized in estimating probable credit losses. At June 30, 1999, the reserve for loan losses amounted to $96.8 million or 1.52 percent of loans outstanding. This compares to $96.1 million or 1.55 percent at December 31, 1998, and $90.2 million or 1.53 percent at June 30, 1998. Management considers the established reserve adequate to absorb losses that relate to loans outstanding at June 30, 1999. While management uses available information to establish provisions for loan losses, future additions to the reserve may be necessary based on changes in economic conditions or other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the reserve for loan losses. Such agencies may require the recognition of adjustments to the reserve based on their judgments of information available to them at the time of their examination. The provision for loan losses charged to operations during the second quarter of 1999 was $2.2 million, compared to $5.3 million during the second quarter of 1998. For the six month periods ended June 30, total provision for loan losses was $4.8 million for 1999 and $9.7 million for 1998. The $4.8 million decrease primarily results from the lower rate of growth in the loan portfolio during 1999. During 1998, BancShares experienced strong loan growth, which resulted in higher provision for loan losses during that period. Net charge-offs for the three months ended June 30, 1998 totaled $1.8 million, compared to net charge-offs of $1.0 million during the same period of 1998. On an annualized basis, these net charge-offs represent 0.11 percent and 0.07 percent of average loans outstanding during the respective periods. Net charge-offs for the six month period ended June 30, 1999 totaled $4.2 million, compared to $3.8 million during the same period of 1998. As a percentage of average loans outstanding, the losses represent 0.14 percent for both periods on an annualized basis. Gross charge-offs totaled $6.7 million and $7.3 million for the six month periods ended June 30, 1999 and 1998 respectively. Gross recoveries were $2.5 million and $3.6 million for the respective periods. Management remains committed to maintaining high levels of credit quality. Table 6 provides details concerning the reserve and provision for loan losses over the past five quarters and for the year-to-date for 1999 and 1998. Nonperforming assets. At June 30, 1999, BancShares' nonperforming assets amounted to $13.5 million or 0.21 percent of gross loans plus foreclosed properties, compared to $14.0 million at December 31, 1998, and $13.5 million at June 30, 1998. Management continues to closely monitor nonperforming assets, taking necessary actions to minimize potential exposure. NONINTEREST INCOME During the first six months of 1999, noninterest income was $77.5 million, compared to $67.0 million during the same period of 1998. The $10.5 million or 15.7 percent increase was primarily due to growth in service charges on deposits and improved credit card income. During the first six months of 1999, total service charges on deposits was $25.8 million, compared to $22.7 million earned during the same period of 1998. This increase resulted from a revised service charge structure and increased bad check charges. Noninterest income from the credit card operation contributed an additional $2.35 million during the first six months of 1999 compared to the same period of 1998. This increase represents a 20.4 percent increase over the same period of 1998, the result of higher merchant income and interchange income generated by card usage. BancShares also reported a $2.5 million increase in other service charges and fees during the first six months of 1999, an 11.7 percent increase. Growth in mortgage servicing income and fees generated by First Citizens Investor Services contributed to this increase. Results from the sale of current production of residential mortgage loans and adjustments of loans held for sale to the lower of cost or fair value are included in other income. BancShares recorded net gains of $2.0 million for the first six months of 1999, compared to net gains on sales of $2.2 million during the same period of 1998 on available for sale loans. NONINTEREST EXPENSE Noninterest expense was $184.6 million for the first six months of 1999, a 12.0 percent increase over the $164.9 million recorded during the same period of 1998. Much of the $19.7 million increase in noninterest expense relates to franchise expansion and the investments required to support that growth. Personnel-related expenses increased $12.4 million during 1999 when compared to the same period of 1998. This 15.1 percent increase reflects the growth in employee population required to staff new branch offices throughout the franchise. Employee benefits expense increased $1.5 million or 11.2 percent during the first six months of 1999, compared to the corresponding period of 1998 due to the larger employee population and increased pension costs. Occupancy expense increased 6.2 percent during the first six months of 1999, the result of higher rent and depreciation expense for new and renovated branch facilities. The $6.2 million increase in other expenses resulted from higher credit card processing costs, legal expense, and higher ATM related costs. INCOME TAXES Income tax expense amounted to $22.6 million during the first six months of 1999, compared to $18.2 million during the same period of 1998, a 24.2 percent increase resulting from higher pre-tax income. The effective tax rates for these periods were 36.4 percent and 35.3 percent, respectively, the increase resulting from higher state income tax obligations. LIQUIDITY Management relies on the investment portfolio as a source of liquidity, with maturities designed to provide needed cash flows. Further, retail deposits generated throughout the branch network have enabled management to fund asset growth and maintain liquidity. In the event additional liquidity is needed, BancShares maintains readily available sources to borrow funds through its correspondent network. SHAREHOLDERS' EQUITY AND CAPITAL ADEQUACY BancShares maintains an adequate capital position and exceeds all minimum regulatory capital requirements. At June 30, 1999 and 1998, the leverage capital ratio of BancShares was 7.56 percent and 7.10 percent, respectively, surpassing the minimum level of 3 percent. As a percentage of risk-adjusted assets, BancShares' Tier 1 capital ratio was 10.01 percent at June 30, 1999, and 9.95 percent as of June 30, 1998. The minimum ratio allowed is 4 percent of risk-adjusted assets. The total risk-adjusted capital ratio was 11.33 percent at June 30, 1999 and 11.20 percent as of June 30, 1998. The minimum total capital ratio is 8 percent. BancShares and its subsidiary banks exceed the capital standards established by their respective regulatory agencies. YEAR 2000 PREPARATIONS BancShares continues to devote significant resources to the efforts related to preparation for the arrival of year 2000. As is the case with most financial institutions, BancShares is heavily dependent on technologies which, in turn, are highly date sensitive. During 1996, recognizing the significance of the Y2K problem, BancShares retained a qualified consultant to plan and direct the process by which the Y2K project would proceed. The consultant works under the supervision of a Y2K Executive Steering Committee, which includes BancShares' Chief Financial Officer and Chief Information Officer. This committee provides ongoing updates to the Board of Directors. BancShares has divided its Y2K efforts into five areas - mainframe computing, non-mainframe computing, non-information technology, integration testing and business continuity planning. The progress made to date in each of these areas is, in managemenT's opinion, appropriate. State of Readiness - With respect to mainframe computing, remediation and testing has been completed on all mission critical applications. With respect to non-mainframe computing, remediation and testing has been completed for all of the mission-critical and approximately 95% of non-mission critical applications. With respect to non-information technology assets and services, management has identified those that may be impacted by Y2K. Those assets and services are currently proceeding through a validation process, with all mission-critical assets and services having been validated. Business continuity planning efforts are proceeding according to plan. The three initial phases, project initiation, risk assessment, and continuity plan development have been completed. Continuity plan validation will be completed by August 31, 1999. Costs - BancShares estimates that the total cost of the Y2K project will be approximately $8.8 million. Currently, BancShares projects the cost of Y2K efforts will be $1.8 million during 1999. For the first six months of 1999, BancShares has recognized expenses totaling $1.0 million for Y2K compliance. All costs related to the Y2K project are expensed as incurred. Risks - The implications of the Y2K problem, whether the result of BancShares' own failure to achieve readiness or the failure of a material customer or vendor to achieve readiness, could have a material adverse impact on BancShares' operations and its results of operations. However, management believes the efforts underway will minimize the likelihood of such a crisis. BancShares believes its most reasonably likely worst case scenario will be a failure by certain customers and vendors to achieve Y2K readiness. With respect to its customers, BancShares has identified its material borrowers and has requested disclosures from those borrowers as to their readiness and their risks. Based on these findings, management has identified customers who, in management's opinion, may experience some distress as a result of Y2K. The assessments have been completed on all such customers who exceeded the established parameters. For key vendors who provide goods and services, BancShares has requested status reports that describe their efforts to achieve Y2K readiness. Most of the requests have been honored, and, based on these responses, except for exposures related to public utilities, there are no known risks among the identified vendors. Regulatory agencies that have authority over BancShares and its subsidiaries have determined that Y2K testing and certification are key safety and soundness issues in conjunction with regulatory exams. Therefore, failure to address the Y2K issue in an appropriate manner could result in supervisory action, including the reduction of the supervisory rating, the denial of applications for approval of mergers or acquisitions or the imposition of penalties. Contingency Plans - Throughout the project, BancShares has developed contingency plans whenever it is apparent that specific applications will not achieve Y2K compliance. Based on the respective situation, the inclination to replace the application or to assess the impact of the non-compliant asset or service will determine how the matter will be resolved. For BancShares' most reasonably likely worst case scenario, contingency plans are already active. As previously described, BancShares has actively evaluated the status of readiness efforts of key customers and vendors and made necessary modifications, including downgrading of exposure to customers who are believed to be at risk of Y2K non-compliance. Management will continue to evaluate deficiencies that become apparent and to establish contingency plans to protect BancShares and to minimize its exposure to Y2K uncertainties. CURRENT ACCOUNTING AND REGULATORY ISSUES In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. As a result of BancShares' limited use of derivative instruments, the adoption of SFAS No. 133 should not have a material impact on its consolidated financial statements. SFAS No. 133 becomes effective during 2001 for BancShares. Management is not aware of any current recommendations by regulatory authorities that, if implemented, would have or would be reasonably likely to have a material effect on liquidity, capital ratios or results of operations. FORWARD-LOOKING STATEMENTS This discussion may contain statements that could be deemed forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act, which statements are inherently subject to risks and uncertainties. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words (and their derivatives) such as "expect," "believe," "estimate," "plan," "project," "anticipate," or other statements concerning opinions or judgment of BancShares and its management about future events. Factors that could influence the accuracy of such forward-looking statements include, but are not limited to, the financial success or changing strategies of BancShares' customers, actions of government regulators, the level of market interest rates, and general economic conditions.