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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
Commission File Number 0-15572
FIRST BANCORP
(Exact Name of Registrant as Specified in its Charter)
North Carolina 56-1421916
(State of Incorporation) (I.R.S. Employer Identification Number)
341 North Main Street, Troy, North Carolina 27371-0508
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (910) 576-6171
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
(Title of each class)
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 90 days. |X| YES |_| NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy of information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to the Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). |X| YES |_| NO
The aggregate market value of the voting stock, Common Stock, no par
value, held by non-affiliates of the registrant, based on the average bid and
asked prices of the Common Stock as of the last trading day prior to June 30,
2003 as reported on the NASDAQ National Market System, was approximately
$209,719,000. Shares of Common Stock held by each officer and director and by
each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
The number of shares of the Registrant's Common Stock outstanding on
February 20, 2004 was 9,481,628.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement to be filed pursuant to
Regulation 14A are incorporated herein by reference into Part III.
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CROSS REFERENCE INDEX
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Page (s)
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PART I
Item 1 Business 4
Item 2 Properties 11
Item 3 Legal Proceedings 11
Item 4 Submission of Matters to a Vote of Shareholders 12
PART II
Item 5 Market for the Registrant's Common Stock and Related
Shareholder Matters 12
Item 6 Selected Consolidated Financial Data 12, 43
Item 7 Management's Discussion and Analysis of Results of
Operations and Financial Condition 12
Critical Accounting Policies 12
Merger and Acquisition Activity 14
Statistical Information
Net Interest Income 19, 44
Average Balances and Net Interest Income Analysis 19, 44
Volume and Rate Variance Analysis 19, 45
Provision for Loan Losses 21, 50
Noninterest Income 22, 45
Noninterest Expenses 23, 45
Income Taxes 24, 46
Distribution of Assets and Liabilities 25, 46
Securities 26, 46
Loans 27, 48
Nonperforming Assets 28, 49
Allowance for Loan Losses and Loan Loss Experience 30, 49
Deposits 32, 51
Borrowings 32
Liquidity, Commitments, and Contingencies 33, 52
Off-Balance Sheet Arrangements and Derivative Financial Instruments 35
Interest Rate Risk (Including Quantitative
and Qualitative Disclosures About Market Risk) 35, 52
Return on Assets and Equity 37, 53
Capital Resources and Shareholders' Equity 37, 53
Inflation 39
Current Accounting Matters 39
Item 7A Quantitative and Qualitative Disclosures About Market Risk 42
Forward-Looking Statements 42
Item 8 Financial Statements and Supplementary Data:
Consolidated Balance Sheets as of December 31, 2003 and 2002 55
Consolidated Statements of Income for each of the years in the
three-year period ended December 31, 2003 56
Consolidated Statements of Comprehensive Income for each of the
years in the three-year period ended December 31, 2003 57
2
Begins on
Page (s)
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Consolidated Statements of Shareholders' Equity for each of the years
in the three-year period ended December 31, 2003 58
Consolidated Statements of Cash Flows for each of the years
in the three-year period ended December 31, 2003 59
Notes to Consolidated Financial Statements 60
Independent Auditors' Report 95
Selected Consolidated Financial Data 43
Quarterly Financial Summary 54
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures 96
Item 9A Controls and Procedures 96
PART III
Item 10 Directors and Executive Officers of the Registrant; Compliance
with Section 16 (a) of the Exchange Act 96*
Item 11 Executive Compensation 96*
Item 12 Security Ownership of Certain Beneficial Owners and Management 96*
Item 13 Certain Relationships and Related Transactions 96*
Item 14 Principal Accountant Fees and Services
Part IV
Item 15 Exhibits, Financial Statement Schedules and Reports of Form 8-K 97
SIGNATURES 99
* Information called for by portions of Part III (Items 10 through 14) is
incorporated herein by reference to the Registrant's definitive Proxy
Statement for the 2004 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission.
3
PART I
Item 1. Business
General Description
The Company
First Bancorp (the "Company") is a bank holding company. The principal
activity of the Company is the ownership and operation of First Bank (the
"Bank"), a state chartered bank with its main office in Troy, North Carolina.
The Company also owns and operates two nonbank subsidiaries: Montgomery Data
Services, Inc. ("Montgomery Data"), a data processing company and First Bancorp
Financial Services, Inc. ("First Bancorp Financial"), which owns and operates
various real estate. The Company is also the parent to three statutory business
trusts created under the laws of the State of Delaware, which have issued a
total of $40 million in trust preferred debt securities. All of the Company's
subsidiaries are fully consolidated for financial reporting purposes.
The Bank has two wholly owned subsidiaries, First Bank Insurance Services,
Inc. ("First Bank Insurance") and First Montgomery Financial Services
Corporation ("First Montgomery"). First Bank Insurance was acquired as an active
insurance agency in 1994 in connection with the Company's acquisition of a bank
that had an insurance subsidiary. On December 29, 1995, the insurance agency
operations of First Bank Insurance were divested. From December 1995 until
October 1999, First Bank Insurance was inactive. In October 1999, First Bank
Insurance began operations again as a provider of non-FDIC insured investments
and insurance products. Currently, First Bank Insurance's primary business
activity is the placement of property and casualty insurance coverage. First
Montgomery, a Virginia company incorporated on November 2, 2001, was formed to
acquire real estate in Virginia and lease the property to the Bank. First Troy
Realty Corporation ("First Troy") was incorporated on May 12, 1999 and is a
subsidiary of First Montgomery. First Troy allows the Bank to centrally manage a
portion of its residential, mortgage, and commercial real estate loan portfolio.
The Company was incorporated in North Carolina on December 8, 1983, as
Montgomery Bancorp, for the purpose of acquiring 100% of the outstanding common
stock of the Bank through stock-for-stock exchanges. On December 31, 1986, the
Company changed its name to First Bancorp to conform its name to the name of the
Bank, which had changed its name from Bank of Montgomery to First Bank in 1985.
The Bank was organized in 1934 and began banking operations in 1935 as the
Bank of Montgomery, named for the county in which it operated. As of December
31, 2003, the Bank operated in a 21 county area centered in Troy, North
Carolina. Troy, population 3,400, is located in the center of Montgomery County,
approximately 60 miles east of Charlotte, 50 miles south of Greensboro, and 80
miles southwest of Raleigh. The Bank conducts business from 57 branches located
within a 120-mile radius of Troy, covering principally a geographical area from
Latta, South Carolina to the southeast, to Wallace, North Carolina to the east,
to Mayodan, North Carolina to the north, to Wytheville, Virginia to the
northwest, and Harmony, North Carolina to the west. The Bank's newest branch,
which opened on January 20, 2004 in Abingdon, Virginia, brought the Bank's total
branch network to 58 branches, with 53 of the branches being in North Carolina,
three branches being in South Carolina (all in Dillon County), and two branches
in Virginia, where the Bank operates under the name "First Bank of Virginia."
Ranked by assets, the Bank was the 7th largest bank in North Carolina as of
December 31, 2003.
On September 14, 2000, the Company completed the merger acquisition of
First Savings Bancorp, Inc. ("First Savings"). The merger was accounted for as a
pooling-of-interests and accordingly, all financial results for prior periods
have been restated to include the combined results of the Company and First
Savings. At the time of the merger, First Savings had approximately $310 million
in assets, and in connection with the merger the Company issued approximately
4.4 million shares of stock, nearly doubling its number of shares outstanding.
For information about other merger and acquisition activity, see "Merger and
Acquisition Activity" under Item 7
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- - Management's Discussion and Analysis of Results of Operations and Financial
Condition.
The Bank provides a full range of banking services, including the
accepting of demand and time deposits, the making of secured and unsecured loans
to individuals and businesses, and the offering of credit cards and debit cards.
In 2003, as in recent prior years, the Bank accounted for substantially all of
the Company's consolidated net income.
The Company's principal executive offices are located at 341 North Main
Street, Troy, North Carolina 27371-0508, and its telephone number is (910)
576-6171. Unless the context requires otherwise, references to the "Company" in
this annual report on Form 10-K shall mean collectively First Bancorp and its
subsidiaries.
General Business
The Bank engages in a full range of banking activities, providing such
services as checking, savings, NOW and money market accounts and other time
deposits of various types; loans for business, agriculture, real estate,
personal uses, home improvement and automobiles; credit cards; debit cards;
letters of credit; IRAs; safe deposit box rentals; bank money orders; and
electronic funds transfer services, including wire transfers, automated teller
machines, and bank-by-phone capabilities. Because the majority of the Bank's
customers are individuals and small to medium-sized businesses located in the
counties it serves, management does not believe that the loss of a single
customer or group of customers would have a material adverse impact on the Bank.
There are no seasonal factors that tend to have any material effect on the
Bank's business, and the Bank does not rely on foreign sources of funds or
income. Because the Bank operates primarily within the central Piedmont region
of North Carolina, the economic conditions within that area could have a
material impact on the Company. See additional discussion below in the section
entitled "Territory Served and Competition."
Beginning in 1999, First Bank Insurance began offering non-FDIC insured
investment and insurance products, including mutual funds, annuities, long-term
care insurance, life insurance, and company retirement plans, as well as
financial planning services (the "investments division"). In May 2001, First
Bank Insurance added to its product line when it acquired two insurance agencies
that specialized in the placement of property and casualty insurance. In October
2003, the "investments division" of First Bank Insurance became a part the Bank.
The sole activity of First Bank Insurance is now the placement of property and
casualty insurance products.
Montgomery Data's primary business is to provide electronic data
processing services for the Bank. Ownership and operation of Montgomery Data
allows the Company to do all of its electronic data processing without paying
fees for such services to an independent provider. Maintaining its own data
processing system also allows the Company to adapt the system to its individual
needs and to the services and products it offers. Although not a significant
source of income, Montgomery Data has historically made its excess data
processing capabilities available to area financial institutions for a fee.
Montgomery Data now has four outside customers that provided gross revenues of
$333,000, $303,000, and $205,000 for the years ended December 31, 2003, 2002,
and 2001, respectively.
First Bancorp Financial was organized under the name of First Recovery in
September of 1988 for the purpose of providing a back-up data processing site
for Montgomery Data and other financial and non-financial clients. First
Recovery's back-up data processing operations were divested in 1994. First
Bancorp Financial now owns and leases the First Recovery building. First Bancorp
Financial periodically purchases parcels of real estate from the Bank that were
acquired through foreclosure or from branch closings. The parcels purchased
consist of real estate having various purposes. First Bancorp Financial actively
pursues the sale of these properties.
First Bancorp Capital Trust I was organized in October 2002 for the
purpose of issuing $20 million in debt securities. These borrowings are due on
November 7, 2032 and were structured as trust preferred capital securities,
which qualify as capital for regulatory capital adequacy requirements. These
debt securities are
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callable by the Company at par on any quarterly interest payment date beginning
on November 7, 2007. The interest rate on these debt securities adjusts on a
quarterly basis at a rate of three-month LIBOR plus 3.45%. This rate may not
exceed 12.50% through November 2007.
First Bancorp Capital Trust II and First Bancorp Capital Trust III were
organized in December 2003 for the purpose of issuing $20 million in debt
securities ($10 million were issued from each trust). These borrowings are due
on December 19, 2033 and were also structured as trust preferred capital
securities in order to qualify as regulatory capital. These debt securities are
callable by the Company at par on any quarterly interest payment date beginning
on January 23, 2009. The interest rate on these debt securities adjusts on a
quarterly basis at a weighted average rate of three-month LIBOR plus 2.70%.
First Montgomery was incorporated on November 2, 2001. First Montgomery's
business activities are currently limited to the selection and acquisition of
real estate in Virginia that is leased to the Bank for use as bank branches.
First Troy was incorporated on May 12, 1999 as a subsidiary of the Bank.
Upon the formation of First Montgomery as a subsidiary of the Bank, the Bank
contributed its interest in First Troy to First Montgomery, resulting in First
Troy becoming a subsidiary of First Montgomery. First Troy allows the Bank to
centrally manage a portion of its residential, mortgage, and commercial real
estate loan portfolio. First Troy has elected to be treated as a real estate
investment trust for tax purposes.
Territory Served and Competition
The Company's headquarters are located in Troy, Montgomery County, North
Carolina. The Company serves primarily the south central area of the Piedmont
region of North Carolina. The following table presents, for each county the
Company operates in, the number of bank branches operated by the Company within
the county, the approximate amount of deposits with the Company in the county as
of December 31, 2003, the Company's approximate market share, and the number of
bank competitors located in the county.
No. of Deposits Market Number of
County Branches (in millions) Share Competitors
----------------- -------- ------------- --------- -----------
Anson, NC 1 $ 11 4.9% 4
Cabarrus, NC 2 23 1.3% 8
Chatham, NC 2 39 7.4% 9
Davidson, NC 2 106 6.9% 8
Dillon, SC 3 62 25.2% 2
Duplin, NC 2 44 16.7% 6
Guilford, NC 1 32 0.5% 21
Harnett, NC 3 76 10.1% 7
Iredell, NC 1 21 1.4% 10
Lee, NC 4 99 15.3% 6
Montgomery, NC 5 84 34.9% 4
Moore, NC 10 294 25.0% 10
Randolph, NC 4 44 3.6% 13
Richmond, NC 1 22 5.5% 4
Robeson, NC 5 115 14.9% 9
Rockingham, NC 1 3 0.0% 8
Rowan, NC 2 38 3.4% 10
Scotland, NC 2 40 14.9% 5
Stanly, NC 4 71 9.7% 5
Wake, NC 1 9 0.1% 19
Wythe, VA 1 16 3.5% 8
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Total 57 $ 1,249
==== =========
The Company's 57 branches and facilities are primarily located in small
communities whose economies are
6
based primarily on services, manufacturing and light industry. Although the
Company's market is predominantly small communities and rural areas, the area is
not dependent on agriculture. Textiles, furniture, mobile homes, electronics,
plastic and metal fabrication, forest products, food products and cigarettes are
among the leading manufacturing industries in the trade area. Leading producers
of lumber, socks, hosiery and area rugs are located in Montgomery County. The
Pinehurst area within Moore County is a widely known golf resort and retirement
area. The High Point area is widely known for its furniture market.
Additionally, several of the communities served by the Company are "bedroom"
communities serving Charlotte and Greensboro in addition to smaller cities such
as Albemarle, Asheboro, High Point, Pinehurst and Sanford.
As shown in the table above, approximately 24% of the Company's deposit
base is in Moore County, and, accordingly, material changes in competition, the
economy or population of Moore County could materially impact the Company. No
other county comprises more than 10% of the Company's deposit base.
The Company competes in its various market areas with, among others,
several large interstate bank holding companies that are headquartered in North
Carolina. These large competitors have substantially greater resources than the
Company, including broader geographic markets, higher lending limits and the
ability to make greater use of large-scale advertising and promotions. A
significant number of interstate banking acquisitions have taken place in the
past decade, thus further increasing the size and financial resources of some of
the Company's competitors, three of which are among the largest bank holding
companies in the nation. Moore County, which as noted above comprises a
disproportionate share of the Company's deposits, is a particularly competitive
market, with at least ten other financial institutions having a physical
presence. See "Supervision and Regulation" below for a further discussion of
regulations in the Company's industry that affect competition.
The Company competes not only against banking organizations, but also
against a wide range of financial service providers, including federally and
state chartered savings and loan institutions, credit unions, investment and
brokerage firms and small-loan or consumer finance companies. Competition among
financial institutions of all types is virtually unlimited with respect to legal
ability and authority to provide most financial services. The Company also
experiences competition from internet banks, particularly in the area of time
deposits.
However, the Company believes it has certain advantages over its
competition in the areas it serves. The Company seeks to maintain a distinct
local identity in each of the communities it serves and actively sponsors and
participates in local civic affairs. Most lending and other customer-related
business decisions can be made without delays often associated with larger
systems. Additionally, employment of local managers and personnel in various
offices and low turnover of personnel enable the Company to establish and
maintain long-term relationships with individual and corporate customers.
Lending Policy and Procedures
Conservative lending policies and procedures and appropriate underwriting
standards are high priorities of the Bank. Loans are approved under the Bank's
written loan policy, which provides that lending officers, principally branch
managers, have authority to approve loans of various amounts up to $100,000.
Each of the Bank's regional senior lending officers has discretion to approve
secured loans in principal amounts up to $350,000 and together can approve loans
up to $2,000,000. Lending limits may vary depending upon whether the loan is
secured or unsecured.
The Bank's board of directors reviews and approves loans that exceed
management's lending authority, loans to executive officers, directors, and
their affiliates and, in certain instances, other types of loans. New credit
extensions are reviewed daily by the Bank's senior management and at least
monthly by the board of directors.
The Bank continually monitors its loan portfolio to identify areas of
concern and to enable management to take corrective action. Lending officers and
the board of directors meet periodically to review past due loans and portfolio
quality, while assuring that the Bank is appropriately meeting the credit needs
of the communities it
7
serves. Individual lending officers are responsible for pursuing collection of
past-due amounts and monitoring any changes in the financial status of the
borrowers.
The Bank's internal audit department evaluates specific loans and overall
loan quality at individual branches as part of its regular branch reviews. The
Bank also contracts with an independent consulting firm to review new loan
originations meeting certain criteria, as well as to assign risk grades to
existing credits meeting certain thresholds. The consulting firm's observations,
comments, and risk grades, including variances with the Bank's risk grades, are
shared with the audit committee of the Company's board of directors, and are
considered by management in setting Bank policy, as well as in evaluating the
adequacy of the allowance for loan losses. For additional information, see
"Allowance for Loan Losses and Loan Loss Experience" under Item 7 below.
Investment Policy and Procedures
The Company has adopted an investment policy designed to optimize the
Company's income from funds not needed to meet loan demand in a manner
consistent with appropriate liquidity and risk objectives. Pursuant to this
policy, the Company may invest in federal, state and municipal obligations,
federal agency obligations, public housing authority bonds, industrial
development revenue bonds, Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Mortgage Corporation and
Student Loan Marketing Association securities. Additionally, during 2001 the
Company's board of directors approved limited investments in corporate bonds
(see below). Except for corporate bonds, the Company's investments must be rated
at least Baa by Moody's or BBB by Standard and Poor's. Securities rated below A
are periodically reviewed for creditworthiness. The Company may purchase
non-rated municipal bonds only if such bonds are in the Company's general market
area and determined by the Company to have a credit risk no greater than the
minimum ratings referred to above. Industrial development authority bonds, which
normally are not rated, are purchased only if they are judged to possess a high
degree of credit soundness to assure reasonably prompt sale at a fair value. In
2001, the Company's board of directors authorized the Company to invest a
portion of its security portfolio in high quality corporate bonds, with the
amount of bonds related to any one issuer not to exceed the Company's legal
lending limit. Prior to purchasing a corporate bond, the Company's management
performs due diligence on the issuer of the bond, and the purchase is not made
unless the Company believes that the purchase of the bond bears no more risk to
the Company than would an unsecured loan to the same company.
The Company's investment officers implement the investment policy, monitor
the investment portfolio, recommend portfolio strategies, and report to the
Company's investment committee. Reports of all purchases, sales, issuer calls,
net profits or losses and market appreciation or depreciation of the bond
portfolio are reviewed by the Company's board of directors each month. Once a
quarter, the Company's interest rate risk exposure is evaluated by the board of
directors. Once a year, the written investment policy is reviewed by the board
of directors and the Company's portfolio is compared with the portfolios of
other companies of comparable size.
Mergers and Acquisitions
As part of its operations, the Company has pursued an acquisition strategy
over the years to augment its internal growth and regularly evaluates the
potential acquisition of, or merger with, and holds discussions with, various
financial institutions. The Company's acquisitions to date have generally fallen
into one of three categories - 1) an acquisition of a financial institution or
branch thereof within a market in which the Company operates, 2) an acquisition
of a financial institution or branch thereof in a market contiguous to a market
in which the Company operates, or 3) an acquisition of a company that has
products or services that the Company does not currently offer.
The Company believes that by pursuing these types of acquisition
opportunities the Company can enhance its earnings by any combination or all of
the following: 1) achieving cost efficiencies, 2) enhancing the acquiree's
earnings or gaining new customers by introducing a more successful banking model
with more products and services to the acquiree's market base, 3) increasing
customer satisfaction or gaining new customers by providing
8
more locations for the convenience of customers, and 4) leveraging the Company's
customer base by offering new products and services.
In the last three years, the Company has made acquisitions in all three of
the aforementioned categories of acquisitions. In 2001, acquisitions resulted in
the Company adding $116.2 million in loans and $204.6 million in deposits,
expansion into four contiguous markets (Lumberton, Pembroke, St. Pauls, and
Thomasville), provided another branch for customers in one of the Company's
newer markets (Salisbury), and gave the Company the ability to offer property
and casualty insurance coverage. In 2002, the Company completed the acquisition
of a branch within its market geography (Broadway, located in Lee County) with
approximately $8.4 million in deposits and $3.1 million in loans. In 2003, the
Company completed acquisitions that added approximately $72.5 million in loans
and $160.8 million in deposits that were in the contiguous or nearly contiguous
markets of Dillon County SC, Duplin County NC, Harmony NC, and Fairmont NC. In
2003, the Company also purchased another property and casualty insurance agency
that provides efficiencies of scale with the one purchased in 2001.
The Company plans to continue to evaluate acquisition opportunities that
could potentially benefit the Company and its shareholders. These opportunities
may include acquisitions that do not fit the categories discussed above. For a
further discussion of recent acquisition activity, see "Merger and Acquisition
Activity" under Item 7 below.
Employees
As of December 31, 2003, the Company had 505 full-time and 89 part-time
employees. The Company is not a party to any collective bargaining agreements
and considers its employee relations to be good.
Supervision and Regulation
As a bank holding company, the Company is subject to supervision,
examination and regulation by the Board of Governors of the Federal Reserve
System and the North Carolina Office of the Commissioner of Banks. The Bank is
subject to supervision and examination by the Federal Deposit Insurance
Corporation and the North Carolina Office of the Commissioner of Banks. For
additional information, see also Note 15 to the consolidated financial
statements.
Supervision and Regulation of the Company
The Company is a bank holding company within the meaning of the Bank
Holding Company Act of 1956, as amended, and is required to register as such
with the Board of Governors of the Federal Reserve System (the "Federal Reserve
Board"). The Company is also regulated by the North Carolina Office of
the Commissioner of Banks (the "Commissioner") under the Bank Holding Company
Act of 1984.
A bank holding company is required to file quarterly reports and other
information regarding its business operations and those of its subsidiaries with
the Federal Reserve Board. It is also subject to examination by the Federal
Reserve Board and is required to obtain Federal Reserve Board approval prior to
making certain acquisitions of other institutions or voting securities. The
Commissioner is empowered to regulate certain acquisitions of North Carolina
banks and bank holding companies, issue cease and desist orders for violations
of North Carolina banking laws, and promulgate rules necessary to effectuate the
purposes of the Bank Holding Company Act of 1984.
Regulatory authorities have cease and desist powers over bank holding
companies and their nonbank subsidiaries where their actions would constitute a
serious threat to the safety, soundness or stability of a subsidiary bank. Those
authorities may compel holding companies to invest additional capital into
banking subsidiaries upon acquisitions or in the event of significant loan
losses or rapid growth of loans or deposits.
9
In 1999, the U.S. enacted legislation that allowed bank holding companies
to engage in a wider range of non-banking activities, including greater
authority to engage in securities and insurance activities. Under the
Gramm-Leach-Bliley Act (the "Act"), a bank holding company that elects to become
a financial holding company may engage in any activity that the Federal Reserve
Board, in consultation with the Secretary of the Treasury, determines by
regulation or order is (i) financial in nature, (ii) incidental to any such
financial activity, or (iii) complementary to any such financial activity and
does not pose a substantial risk to the safety or soundness of depository
institutions or the financial system generally. This Act made significant
changes in U.S. banking law, principally by repealing certain restrictive
provisions of the 1933 Glass-Steagall Act. The Act lists certain activities that
are deemed to be financial in nature, including lending, exchanging,
transferring, investing for others, or safeguarding money or securities;
underwriting and selling insurance; providing financial, investment, or economic
advisory services; underwriting, dealing in or making a market in, securities;
and any activity currently permitted for bank holding companies by the Federal
Reserve Board under Section 4(c)(8) of the Holding Company Act. The Act does not
authorize banks or their affiliates to engage in commercial activities that are
not financial in nature. A bank holding company may elect to be treated as a
financial holding company only if all depository institution subsidiaries of the
holding company are well-capitalized, well-managed and have at least a
satisfactory rating under the Community Reinvestment Act. At the present time,
the Company does not anticipate applying for status as a financial holding
company under the Act.
National and state banks are also authorized by the Act to engage, through
"financial subsidiaries," in any activity that is permissible for a financial
holding company (as described above) and any activity that the Secretary of the
Treasury, in consultation with the Federal Reserve Board, determines is
financial in nature or incidental to any such financial activity, except (i)
insurance underwriting, (ii) real estate development or real estate investment
activities (unless otherwise permitted by law), (iii) insurance company
portfolio investments and (iv) merchant banking. The authority of a national or
state bank to invest in a financial subsidiary is subject to a number of
conditions, including, among other things, requirements that the bank be
well-managed and well-capitalized (after deducting from the bank's capital
outstanding investments in financial subsidiaries).
The United States Congress and the North Carolina General Assembly have
periodically considered and adopted legislation that has resulted in, and could
result in further, deregulation of both banks and other financial institutions.
Such legislation could modify or eliminate geographic restrictions on banks and
bank holding companies and current restrictions on the ability of banks to
engage in certain nonbanking activities. For example, the Riegle-Neal Interstate
Banking Act, which was enacted several years ago, allows expansion of interstate
acquisitions by bank holding companies and banks. This and other legislative and
regulatory changes have increased the ability of financial institutions to
expand the scope of their operations, both in terms of services offered and
geographic coverage. Such legislative changes have placed the Company in more
direct competition with other financial institutions, including mutual funds,
securities brokerage firms, insurance companies, investment banking firms, and
internet banks. The Company cannot predict what other legislation might be
enacted or what other regulations might be adopted or, if enacted or adopted,
the effect thereof on the Company's business.
Supervision and Regulation of the Bank
Federal banking regulations applicable to all depository financial
institutions, among other things, (i) provide federal bank regulatory agencies
with powers to prevent unsafe and unsound banking practices; (ii) restrict
preferential loans by banks to "insiders" of banks; (iii) require banks to keep
information on loans to major shareholders and executive officers; and (iv) bar
certain director and officer interlocks between financial institutions.
As a state chartered bank, the Bank is subject to the provisions of the
North Carolina banking statutes and to regulation by the Commissioner. The
Commissioner has a wide range of regulatory authority over the activities and
operations of the Bank, and the Commissioner's staff conducts periodic
examinations of the Bank and its affiliates to ensure compliance with state
banking regulations. Among other things, the Commissioner regulates
10
the merger and consolidation of state chartered banks, the payment of dividends,
loans to officers and directors, recordkeeping, types and amounts of loans and
investments, and the establishment of branches. The Commissioner also has cease
and desist powers over state chartered banks for violations of state banking
laws or regulations and for unsafe or unsound conduct that is likely to
jeopardize the interest of depositors.
The dividends that may be paid by the Bank to the Company are subject to
legal limitations under North Carolina law. In addition, regulatory authorities
may restrict dividends that may be paid by the Bank or the Company's other
subsidiaries. The ability of the Company to pay dividends to its shareholders is
largely dependent on the dividends paid to the Company by its subsidiaries.
The Bank is a member of the Federal Deposit Insurance Corporation (the
"FDIC"), which currently insures the deposits of member banks. For this
protection, each bank pays a quarterly statutory assessment, based on its level
of deposits, and is subject to the rules and regulations of the FDIC. The FDIC
also is authorized to approve conversions, mergers, consolidations and
assumptions of deposit liability transactions between insured banks and
uninsured banks or institutions, and to prevent capital or surplus diminution in
such transactions where the resulting, continuing, or assumed bank is an insured
nonmember bank. In addition, the FDIC monitors the Bank's compliance with
several banking statutes, such as the Depository Institution Management
Interlocks Act and the Community Reinvestment Act of 1977. The FDIC also
conducts periodic examinations of the Bank to assess its compliance with banking
laws and regulations, and it has the power to implement changes in or
restrictions on a bank's operations if it finds that a violation is occurring or
is threatened.
Neither the Company nor the Bank can predict what other legislation might
be enacted or what other regulations might be adopted, or if enacted or adopted,
the effect thereof on the Bank's operations.
See "Capital Resources and Shareholders' Equity" under Item 7 below for a
discussion of regulatory capital requirements.
Available Information
The Company maintains a corporate Internet site at www.firstbancorp.com
which contains a link within the "Investor Relations" section of the site to
each of its filings with the Securities and Exchange Commission. These filings
can also be accessed at the Securities and Exchange Commission's website located
at www.sec.gov. Information included on our Internet site is not incorporated by
reference into this annual report.
Item 2. Properties
The main offices of the Company, the Bank and First Bancorp Financial are
located in a three-story building in the central business district of Troy,
North Carolina. The building houses administrative, training and bank teller
facilities. The Bank's Operations Division, including customer accounting
functions, offices and operations of Montgomery Data, and offices for loan
operations, are housed in a one-story steel frame building approximately
one-half mile west of the main office. The Company operates 58 bank branches and
facilities. The Company owns all its bank branch premises except twelve branch
offices for which the land and buildings are leased and four branch offices for
which the land is leased but the building is owned. There are no other options
to purchase or lease additional properties. The Company considers its facilities
adequate to meet current needs.
Item 3. Legal Proceedings
Various legal proceedings may arise in the ordinary course of business and
may be pending or threatened against the Company and/or its subsidiaries. The
Company is not involved in any pending legal proceedings that management
believes could have a material effect on the consolidated financial position of
the Company.
11
Item 4. Submission of Matters to a Vote of Shareholders
No matters were submitted to a vote of shareholders during the fourth
quarter of 2003.
PART II
Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters
The Company's common stock trades on the NASDAQ National Market System of
the NASDAQ Stock Market under the symbol FBNC. Tables 1 and 22, included in
"Management's Discussion and Analysis" below, set forth the high and low market
prices of the Company's common stock as traded by the brokerage firms that
maintain a market in the Company's common stock and the dividends declared for
the periods indicated. All amounts prior to the Company's September 2000
acquisition of First Savings, except for the Company's stock price, have been
restated to include the combined results of First Bancorp and First Savings. See
"Business - Supervision and Regulation" and Note 15 to the consolidated
financial statements for a discussion of regulatory restrictions on the payment
of dividends. As of December 31, 2003, there were approximately 2,500
shareholders of record and another 2,700 shareholders whose stock is held in
"street name."
Item 6. Selected Financial Data
Table 1 sets forth selected consolidated financial data for the Company.
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Management's discussion and analysis is intended to assist readers in
understanding the Company's results of operations and changes in financial
position for the past three years. This review should be read in conjunction
with the consolidated financial statements and accompanying notes beginning on
page 55 of this report and the supplemental financial data contained in Tables 1
through 22 included with this discussion and analysis.
CRITICAL ACCOUNTING POLICIES
The accounting principles followed by the Company and the methods of
applying these principles conform with accounting principles generally accepted
in the United States of America and with general practices followed by the
banking industry. Certain of these principles involve a significant amount of
judgment and/or use of estimates based on the Company's best assumptions at the
time of the estimation. The Company has identified two policies as being more
sensitive in terms of judgments and estimates, taking into account their overall
potential impact to the Company's consolidated financial statements - 1) the
allowance for loan losses, and 2) intangible assets.
Allowance for Loan Losses
Due to the estimation process and the potential materiality of the amounts
involved, the Company has identified the accounting for the allowance for loan
losses and the related provision for loan losses as an accounting policy
critical to the Company's consolidated financial statements. The provision for
loan losses charged to operations is an amount sufficient to bring the allowance
for loan losses to an estimated balance considered adequate to absorb losses
inherent in the portfolio.
Management's determination of the adequacy of the allowance is based
primarily on a mathematical model that estimates the appropriate allowance for
loan losses. This model has two components. The first component involves the
estimation of losses on loans defined as "impaired loans." A loan is considered
to be impaired when, based on current information and events, it is probable the
Company will be unable to collect all amounts due according to the contractual
terms of the loan agreement. The estimated valuation allowance is the
difference, if
12
any, between the loan balance outstanding and the value of the impaired loan as
determined by either 1) an estimate of the cash flows that the Company expects
to receive from the borrower discounted at the loan's effective rate, or 2) in
the case of a collateral-dependent loan, the fair value of the collateral.
The second component of the allowance model is to estimate losses for all
loans not considered to be impaired loans. First, loans that have been risk
graded by the Company as having more than "standard" risk but are not considered
to be impaired are assigned estimated loss percentages generally accepted in the
banking industry. Loans that are classified by the Company as having normal
credit risk are segregated by loan type, and estimated loss percentages are
assigned to each loan type, based on the historical losses, current economic
conditions, and operational conditions specific to each loan type.
The reserve estimated for impaired loans is then added to the reserve
estimated for all other loans. This becomes the Company's "allocated allowance."
In addition to the allocated allowance derived from the model, management also
evaluates other data such as the ratio of the allowance for loan losses to total
loans, net loan growth information, nonperforming asset levels and trends in
such data. Based on this additional analysis, the Company may determine that an
additional amount of allowance for loan losses is necessary to reserve for
probable losses. This additional amount, if any, is the Company's "unallocated
allowance." The sum of the allocated allowance and the unallocated allowance is
compared to the actual allowance for loan losses recorded on the books of the
Company and any adjustment necessary for the recorded allowance to equal the
computed allowance is recorded as a provision for loan losses. The provision for
loan losses is a direct charge to earnings in the period recorded.
Although management uses the best information available to make
evaluations, future adjustments may be necessary if economic, operational, or
other conditions change. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Company's
allowance for loan losses. Such agencies may require the Company to recognize
additions to the allowance based on the examiners' judgment about information
available to them at the time of their examinations.
For further discussion including a review of the range of provisions for
loan losses and its impact on reported results in recent periods, see
"Nonperforming Assets" and "Allowance for Loan Losses and Loan Loss Experience"
under "Analysis of Financial Condition and Changes in Financial Condition."
Intangible Assets
Due to the estimation process and the potential materiality of the amounts
involved, the Company has also identified the accounting for intangible assets
as an accounting policy critical to the Company's consolidated financial
statements.
When the Company completes an acquisition transaction, the excess of the
purchase price over the amount by which the fair market value of assets acquired
exceeds the fair market value of liabilities assumed represents an intangible
asset. The Company must then determine the identifiable portions of the
intangible asset, with any remaining amount classified as goodwill. Identifiable
intangible assets associated with these acquisitions are generally amortized
over the estimated life of the related asset, whereas goodwill is tested
annually for impairment, but not systematically amortized. Assuming no goodwill
impairment, it is beneficial to the Company's future earnings to have a lower
amount assigned to identifiable intangible assets and higher amount of goodwill
as opposed to having a higher amount considered to be identifiable intangible
asset and a lower amount classified as goodwill.
For the Company, the only identifiable intangible asset typically recorded
in connection with a whole-bank or bank branch acquisition is the value of the
core deposit intangible, whereas when the Company acquires an insurance agency,
the primary identifiable intangible asset is the value of the acquired customer
list. Determining the amount of identifiable intangible assets and their average
lives involves multiple assumptions and estimates and is typically determined by
performing a discounted cash flow analysis, which involves a combination of any
or all of the following assumptions: customer attrition/runoff, alternative
funding costs, deposit servicing costs, and discount rates. The Company
typically engages a third party consultant to assist in each analysis. For the
whole-bank and bank branch transactions recorded to date, the core deposit
intangible in each case has been estimated to have a ten year life, with an
accelerated rate of amortization. For the 2003 insurance agency acquisition, the
identifiable intangible asset related to the customer list was determined to
have a ten year life, with amortization occurring on a straight-line basis.
Subsequent to the initial recording of the identifiable intangible assets
and goodwill, the Company amortizes the identifiable intangible assets over
their estimated average lives, as discussed above. In addition, on an at least
an annual basis, goodwill is evaluated for impairment by comparing the fair
value of the Company's reporting units to their related carrying value,
including goodwill (the Company's community banking operations is its only
material reporting unit). At its last evaluation, the fair value of the
Company's community banking operations exceeded its carrying value, including
goodwill. If the carrying value of a reporting unit were ever to exceed its fair
value, the Company would determine whether the implied fair value of the
goodwill, using a discounted cash flow analysis, exceeded the carrying value of
the goodwill. If the carrying value of the goodwill exceeded the implied fair
value of the goodwill, an impairment loss would be recorded in an amount equal
to that excess. Performing such a discounted cash flow analysis would involve
the significant use of estimates and assumptions.
The Company reviews identifiable intangible assets for impairment whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. The Company's policy is that an impairment loss is recognized,
equal to the difference between the asset's carrying amount and its fair value,
if the sum of the expected undiscounted future cash flows is less than the
carrying amount of the asset. Estimating future cash flows involves the use of
multiple estimates and assumptions, such as those listed above.
The foregoing accounting policy was adopted by the Company effective on
January 1, 2002 in accordance with newly issued accounting standards for
goodwill and other intangible assets. For acquisitions occurring prior to
January 1, 2002, the Company generally did not separately identify its
identifiable intangible assets from its goodwill, as all intangible assets were
amortized under accounting standards then in effect. According to the transition
provisions of the accounting standards that changed the Company's accounting
policy to that described above, the entire amount of those combined intangible
assets was accounted for entirely as non-amortizable goodwill. See the section
entitled "Current Accounting Matters" below for further discussion.
MERGER AND ACQUISITION ACTIVITY
Over the past three fiscal years, the Company has completed several
acquisitions, which has resulted in significant amounts of intangible assets
being recorded by the Company, as detailed below. As noted above, the accounting
for intangible assets changed significantly in 2002 with the Company being
required under new accounting standards to cease the amortization of goodwill.
See the section entitled "Current Accounting Matters" below and Note 2 and Note
6 to the consolidated financial statements for additional information regarding
intangible assets and their amortization under previous and current accounting
standards.
The Company completed the following acquisitions during 2003:
(a) Uwharrie Insurance Group - On January 2, 2003, the Company completed
the acquisition of Uwharrie Insurance Group, a Montgomery County based property
and casualty insurance agency. With eight employees, Uwharrie Insurance Group,
Inc. serves approximately 5,000 customers, primarily from its Troy-based
headquarters, and had annual commissions of approximately $500,000. The primary
reason for the acquisition was to gain efficiencies of scale with the Company's
existing property and casualty insurance business. The acquisition resulted in
the Company recording an intangible asset of approximately $544,000. Based on an
14
independent appraisal, $50,000 of the intangible asset recorded was determined
to be attributable to the value of the noncompete agreement signed as part of
the transaction and is being amortized over its two year life, $151,000 was
determined to be attributable to the value of the customer list and is being
amortized on a straight-line basis over ten years, and the remaining $343,000
was determined to be goodwill and thus will not be systematically amortized, but
rather will be subject to an annual impairment test.
(b) On January 15, 2003, the Company completed the acquisition of Carolina
Community Bancshares, Inc. (CCB), the parent company of Carolina Community Bank,
a South Carolina community bank with three branches in Dillon County, South
Carolina. This represented the Company's first entry into South Carolina. Dillon
County, South Carolina is contiguous to Robeson County, North Carolina, a county
where the Company already operated four branches. The Company's primary reason
for the acquisition was to expand into a contiguous market with facilities,
operations and experienced staff in place. In this transaction, the shareholders
of CCB received 0.8 shares of the Company's stock and $20.00 in cash for each
share of CCB stock they owned at the time of closing. The transaction was
completed on January 15, 2003, with the Company paying cash of $8.3 million,
issuing 332,888 shares of common stock that were valued at approximately $8.4
million, and assuming employee stock options with an intrinsic value of
approximately $0.9 million. As of the date of the acquisition, CCB had
approximately $48 million in loans, $59 million in deposits and $70 million in
total assets. In connection with the acquisition of CCB, the Company recorded
total intangible assets of $11.2 million, of which $771,000 was determined to be
the value of the core deposit base and is being amortized on an accelerated
basis over ten years, and $10.4 million was determined to be goodwill and thus
will not be systematically amortized, but rather will be subject to an annual
impairment test.
(c) On October 24, 2003, the Company completed the acquisition of four
branches of RBC Centura Bank located in Fairmont, Harmony, Kenansville, and
Wallace, all in North Carolina. As of the date of the acquisition, the branches
had a total of approximately $102 million in deposits and $25 million in loans.
The primary reason for the acquisition was to expand into new markets and
increase the Company's customer base. Subject to certain limitations, the
Company paid a deposit premium of 14.1% for the branches, which resulted in the
Company recording intangible assets relating to this purchase of $14.2 million.
The identifiable intangible asset associated with the fair value of the core
deposit base, as determined by an independent consulting firm, was valued at
approximately $1.3 million and is being amortized as expense on an accelerated
basis over a ten year period. The remaining intangible asset of $12.9 million
has been classified as goodwill, and thus will not be systematically amortized,
but rather will be subject to an annual impairment test.
15
The following table contains a condensed balance sheet that indicates the
amount assigned to each major asset and liability as of the respective
acquisition dates for the 2003 acquisitions described above.
Uwharrie Carolina RBC
Insurance Community Centura
Assets acquired Group Bank Branches Total
--------------------------------- --------- --------- -------- -----
(in millions)
Cash $ -- 7.0 62.4 69.4
Securities -- 13.1 -- 13.1
Loans, gross -- 47.7 24.8 72.5
Allowance for loan losses -- (0.8) (0.3) (1.1)
Premises and equipment -- 0.8 1.0 1.8
Other -- 1.5 0.2 1.7
----- ---- ---- ----
Total assets acquired -- 69.3 88.1 157.4
----- ---- ---- ----
Liabilities assumed
Deposits -- 58.9 102.0 160.9
Borrowings -- 2.1 -- 2.1
Other -- 0.6 0.3 0.9
----- ---- ---- ----
Total liabilities assumed -- 61.6 102.3 163.9
----- ---- ---- ----
Value of cash paid and/or stock
issued to stock-holders of
acquiree 0.5 18.9 n/a 19.4
----- ---- ---- ----
Intangible assets recorded $ 0.5 11.2 14.2 25.9
===== ==== ==== ====
The Company completed one acquisition in 2002 as follows:
(a) Broadway branch purchase - On October 4, 2002, the Company completed
the purchase of a branch of RBC Centura located in Broadway, North Carolina. The
Company assumed the branch's $8 million in deposits and $3 million in loans. The
primary reason for this acquisition was to increase the Company's presence in
Lee County, a market where the Company already had two branches with a large
customer base. An intangible asset of $0.7 million, all of which was allocated
to goodwill, was recorded in connection with this acquisition.
The Company's acquisitions completed during 2001 were as follows:
(a) Salisbury branch purchase - On December 17, 2001, the Company
completed the purchase of a branch of First Union National Bank located in
Salisbury, North Carolina. The Company assumed the branch's $30 million in
deposits and $9 million in loans. The primary reason for this acquisition was to
increase the Company's presence in Salisbury, a market that the Company entered
in 2000 with the opening of a de novo branch. An intangible asset of $3.2
million was recorded in connection with this acquisition, all of which is
classified as nonamortized goodwill by the Company.
(b) Insurance agency acquisitions - On May 30, 2001, the Company completed
the purchase of two insurance agencies - Aberdeen Insurance & Realty Company and
Hobbs Insurance and Realty Company. Both agencies were located in Moore County
and specialized in placing property and casualty insurance coverage for
individuals and businesses in the Moore County area. The primary reason for this
acquisition was to give the Company the platform to offer property and casualty
insurance to its entire customer base. In completing the acquisition, the
agencies were merged into First Bank Insurance Services, Inc. Approximately
16,000 shares of Company stock were issued in connection with the acquisition of
the two agencies. An intangible asset of $243,000 was recorded in connection
with the acquisition, which is being amortized on a straight-line basis over ten
years.
(c) Century Bancorp, Inc. - On May 17, 2001, the Company completed the
purchase of Century Bancorp, Inc. ("Century"). Century was the holding Company
for Home Savings, Inc., SSB, a one branch savings institution
16
located in Thomasville, NC. Century had total assets of $107 million, total
loans of $90 million, and total deposits of $72 million. The primary reason for
the acquisition was to expand into a contiguous market. In accordance with the
terms of the merger agreement, the Company issued approximately 586,000 shares
of common stock and paid cash of approximately $13.2 million to Century
shareholders in exchange for all shares of Century outstanding. An intangible
asset of $3.2 million was recorded in connection with this acquisition, all of
which is classified as nonamortized goodwill by the Company
(d) Robeson and Scotland counties branch purchase - On March 26, 2001, the
Company completed the purchase of four branches from First Union National Bank
with aggregate deposits of approximately $103 million and aggregate loans of
approximately $17 million. The four branches acquired were in Lumberton,
Pembroke, St. Pauls (all located in Robeson County, NC), and Laurinburg
(Scotland County, NC). The primary reason for the acquisition was to leverage
the Company's capital by expanding into three contiguous markets (Lumberton,
Pembroke and St. Pauls) and increase market share in one market (Laurinburg).
Total intangible assets of $14.6 million were recorded in connection with the
purchase, all of which is classified as nonamortized goodwill by the Company
As discussed above, each of the above transactions was accounted for using
the purchase method of accounting. The following table presents a summary of the
fair market value of assets acquired and liabilities assumed in the purchases
described above:
Salisbury Insurance Robeson and Scotland
Assets acquired branch agencies Century counties branches Total
------------------------------ --------- --------- ------- --------------------- -------
(in millions)
Cash $17.7 -- 5.9 70.2 93.8
Securities -- -- 9.0 -- 9.0
Loans, gross 9.3 -- 90.2 16.7 116.2
Allowance for loan losses (0.2) -- (0.6) (0.3) (1.1)
Premises and equipment 0.5 0.1 0.6 1.9 3.1
Other -- -- 1.4 -- 1.4
----- ----- ------ ------ -------
Total assets acquired 27.3 0.1 106.5 88.5 222.4
----- ----- ------ ------ -------
Liabilities assumed
Deposits 30.3 -- 71.7 102.6 204.6
Borrowings -- -- 13.5 -- 13.5
Other 0.2 -- 2.5 0.5 3.2
----- ----- ------ ------ -------
Total liabilities assumed 30.5 -- 87.7 103.1 221.3
----- ----- ------ ------ -------
Value of cash paid and/or stock
issued to stock-holders of
acquiree n/a 0.3 22.0 n/a 22.3
----- ----- ------ ------ -------
Intangible assets recorded $ 3.2 0.2 3.2 14.6 21.2
===== ===== ====== ====== =======
There are many factors that the Company considers when evaluating how much
to offer for potential acquisition candidates - in the form of a purchase price
comprised of cash and/or stock for a whole company purchase or a deposit premium
in a branch purchase. Most significantly, the Company compares expectations of
future earnings per share on a stand-alone basis with projected future earnings
per share assuming completion of the acquisition under various pricing
scenarios. Significant assumptions that affect this analysis include the
estimated future earnings stream of the acquisition candidate, the amount of
cost efficiencies that can be realized, and the interest rate earned/lost on the
cash received/paid. In addition to the earnings per share comparison, the
Company also considers other factors including (but not limited to): marketplace
acquisition statistics, location of the candidate in relation to the Company's
expansion strategy, market growth potential, management of the candidate,
potential integration issues (including corporate culture), and the size of the
acquisition candidate.
ANALYSIS OF RESULTS OF OPERATIONS
Net interest income, the "spread" between earnings on interest-earning
assets and the interest paid on
17
interest-bearing liabilities, constitutes the largest source of the Company's
earnings. Other factors that significantly affect operating results are the
provision for loan losses, noninterest income such as service fees and
noninterest expenses such as salaries, occupancy expense, equipment expense and
other overhead costs, as well as the effects of income taxes.
Overview - 2003 Compared to 2002
Net income for the year ended December 31, 2003 amounted to $19,417,000,
or $2.03 per diluted share, a 12.7% increase in net income and a 9.7% increase
in diluted earnings per share over the net income of $17,230,000, or $1.85 per
diluted share, reported for the twelve months ended December 31, 2002.
The increase in net income in 2003 was primarily attributable to an
increase in net interest income. Net interest income for the year ended December
31, 2003 amounted to $55.8 million, an increase of $6.4 million, or 12.9%, over
the $49.4 million recorded in 2002. The increase in net interest income was
caused primarily by growth in the Company's loans and deposits. Average loans
outstanding during 2003 were $1.11 billion, or 16.6% higher than in 2002, while
average deposits outstanding increased by 14.1% in 2003 to $1.15 billion.
The positive impact on net interest income from the increases in loans and
deposits more than offset a slightly lower net interest margin realized in 2003
compared to 2002. The Company's net interest margin (tax-equivalent net interest
income divided by average earning assets) for the year ended December 31, 2003
was 4.52% compared to the 4.58% net interest margin realized for 2002. The
slight decrease in net interest margin was caused primarily by the negative
impact of the interest rate cuts initiated by the Federal Reserve in the fourth
quarter of 2002 and the second quarter of 2003. The acquisition of the four RBC
Centura Bank branches in October 2003 also negatively impacted the Company's net
interest margin as a result of the high mix of cash assumed in the acquisition.
Partially offsetting the increases in net interest income realized in 2003
was a higher provision for loan losses recorded by the Company. The provision
for loan losses for 2003 was $2,680,000 compared to $2,545,000 in 2002. The
higher provision for loan losses was due to high loan growth realized by the
Company in 2003 and not because of credit quality concerns. Internally generated
net loan growth in 2003 totaled $148 million compared to $105 million in 2002.
Most components of noninterest income and noninterest expense also
increased in 2003 as a result of the Company's overall growth. Noninterest
income for 2003 was also positively impacted by 1) high refinancing activity
driven by the low interest rate environment that increased the amount of fees
from presold mortgages, 2) the acquisition of Uwharrie Insurance Group, which
increased commissions from financial product sales, and 3) securities gains.
The Company's income taxes increased 14.4% from $9,282,000 in 2002 to
$10,617,000 in 2003. The increase in income tax expense was a result of higher
income before income taxes. The effective income tax rate for both years was
approximately 35%.
Overview - 2002 Compared to 2001
Net income for the year ended December 31, 2002 amounted to $17,230,000,
or $1.85 per diluted share, a 25.9% increase in diluted earnings per share over
the $1.47 per diluted share for the year ended December 31, 2001. In accordance
with the adoption of two new accounting standards, the Company discontinued the
amortization of most of its intangible assets in 2002. If the newly adopted
accounting standards related to intangible assets had been applicable in 2001,
the Company would have recorded additional net income of $1,160,000, or
approximately $0.12 per diluted share, for the twelve months ended December 31,
2001.
The most significant factor in the Company's increase in net income from
2001 to 2002 was an $8.3 million,
18
or 20.3%, increase in net interest income. The increase in net interest income
was a result of a higher level of average earning assets and a higher net
interest margin. Average earning assets increased 10.9% in 2002, while the
Company's net interest margin (tax-equivalent net interest income divided by
average earning assets) increased from 4.23% in 2001 to 4.58% in 2002.
Partially offsetting the increase in net interest income was a higher
provision for loan losses. Although asset quality ratios generally improved in
2002, the Company's provision for loan losses more than doubled due to high loan
growth, amounting to $2,545,000 in 2002 compared to $1,151,000 in 2001. In 2002,
the Company experienced $105 million in internal loan growth compared to $28
million in 2001.
Noninterest income increased 24.0% and noninterest expense increased 12.8%
in 2002 compared to 2001, primarily as a result of the Company's growth,
including a full year's impact of the acquisitions completed in 2001.
Noninterest income was also positively affected in 2002 by increased mortgage
loan refinancing activity that increased mortgage origination fees, as well as
the offering of a check overdraft product beginning in August 2001 that
increased fees earned on deposit accounts for a full 12 months in 2002.
The increase in noninterest expenses was partially offset by the near
elimination of amortization expense related to intangible assets. As noted
above, in 2002 the Company adopted two new accounting standards that required
the Company to cease amortization of virtually all of its intangible assets.
Excluding amortization expense in 2001 related to intangible assets that ceased
to be amortized in 2002, the Company's noninterest expenses increased 19.1% in
2002.
The Company's income taxes increased 27.0% from $7,307,000 in 2001 to
$9,282,000 in 2002. The increase in income tax expense was a result of higher
income before income taxes. The effective income tax rate for both years was
approximately 35%.
Net Interest Income
Net interest income on a reported basis amounted to $55,760,000 in 2003,
$49,390,000 in 2002, and $41,053,000 in 2001. For internal purposes and in the
discussion that follows, the Company evaluates its net interest income on a
tax-equivalent basis by adding the tax benefit realized from tax-exempt
securities to reported interest income. Net interest income on a
taxable-equivalent basis amounted to $56,278,000 in 2003, $49,925,000 in 2002,
and $41,645,000 in 2001.
Table 2 analyzes net interest income on a taxable-equivalent basis. The
Company's net interest income on a taxable-equivalent basis increased by 12.7%
in 2003 and 19.9% in 2002. There are two primary factors that cause changes in
the amount of net interest income recorded by the Company - 1) growth in loans
and deposits, and 2) the Company's net interest margin (tax-equivalent net
interest income divided by average interest-earning assets).
As illustrated in Table 3, in both 2003 and 2002, net interest
income was positively impacted by higher amounts of average loans and deposits
outstanding. In 2003, the average amount of loans outstanding increased 16.6%
and the average amount of deposits outstanding increased 14.1%. In 2002, the
average amount of loans outstanding grew by 14.8%, while the average amount of
deposits increased by 12.3%. The higher amounts of loans and deposits
outstanding in 2002 and 2003 were a result of both internal growth, as well as
growth achieved in corporate acquisitions. In 2003, most of the loan growth was
generated internally while most of the deposit growth was assumed in
acquisitions. The Company internally generated $148 million in net loan growth
in 2003, while $73 million was assumed in acquisitions. Internally generated
deposit growth in 2003 amounted to $33 million, while the Company assumed $161
million in deposits through acquisitions during the year. In 2002, the increase
in the average amount of loans and deposits outstanding was partially a result
of a full year's effect of high 2001 growth as well as growth realized in 2002,
most all of which was internally generated. In 2002, loans grew by $108 million,
with all but $3 million of the growth internally generated, while deposits grew
by $56 million, with all but $8 million internally generated.
19
In 2003, the positive impact on net interest income from the increases in
loans and deposits more than offset slightly lower net interest margins realized
in 2003 compared to 2002, while in 2002 a higher net interest margin enhanced
net interest income. The Company's net interest margin (tax-equivalent net
interest income divided by average earning assets) was 4.52% in 2003 compared to
4.58% in 2002 and 4.23% in 2001. The variations in net interest margin over the
past two years have largely been a result of the Federal Reserve's interest rate
policies during that time, as discussed below.
In 2001, the Company's interest rate spreads were negatively impacted by
the Federal Reserve Board cutting interest rates 11 times totaling 475 basis
points, which resulted in a decrease in the Company's net interest margin to
4.23% (from 4.53% in 2000). Although at January 1, 2001 the Company has had more
interest-sensitive liabilities than interest-sensitive assets subject to
repricing within twelve months, the Company's interest-sensitive assets repriced
sooner (generally the day following the interest rate cut) and by a larger
percentage (generally by the same number of basis points that the Federal
Reserve discount rate was decreased) than did the Company's interest-sensitive
liabilities that were subject to repricing. The Company's primary
interest-sensitive assets are its interest-bearing cash, maturing investments,
and adjustable rate loans (which are typically 45%-55% of the Company's total
loan portfolio), while its primary interest-sensitive liabilities consist of the
following 1) savings, NOW, and money market deposits, and 2) time deposits.
Interest rates paid on savings, NOW and money market deposits are set by
management of the Company, and although the interest rates on these accounts
were decreased by the Company within days of each of the Federal Reserve rate
cuts that have occurred in recent years, it has not been possible to reduce the
interest rates by the full amount of the Federal Reserve cuts due to competitive
considerations and the already relatively low rates paid on these types of
accounts. Interest rates paid on time deposits are generally fixed and not
subject to automatic adjustment. When time deposits mature, the Company has the
opportunity, at the customers' discretion, to renew the time deposit at a rate
set by the Company. Because time deposits that are interest-sensitive in a
twelve month horizon mature throughout the twelve month period, any change in
the renewal rate will affect only a portion of the twelve month period. Also,
although changes in interest rates on renewing time deposits generally track
rate changes in the interest rate environment, the Company has not been able in
recent years to decrease rates on renewing time deposits by the corresponding
decreases in the Federal Reserve discount rate because of competitive pressures
in the Company's market.
In 2002, there were no changes to interest rates initiated by the Federal
Reserve for the first ten months of the year. This allowed a significant portion
of the Company's time deposit portfolio that had been originated when rates were
higher to mature and reprice at lower rates - as noted above, much of the
Company's interest-sensitive assets had repriced immediately in 2001 when the
rate cuts were made and did not experience further declines. Largely due to
these factors, the Company's net interest margin increased in each of the first
three quarters of 2002, peaking at 4.78% in the third quarter of 2002. The 50
basis point rate cut announced by the Federal Reserve on November 6, 2002
negatively impacted the Company's net interest margin in the fourth quarter of
2002 and into 2003 in much the same way as the 2001 rate cuts did. The Company's
fourth quarter of 2002 net interest margin decreased to 4.53% from the 4.78%
margin realized in the third quarter of 2002.
In 2003, although the Company's deposits continued to reprice downward,
the 50 basis rate cut in November 2002 and the subsequent June 27, 2003 rate cut
of 25 basis points had a more pronounced and a longer lasting negative impact on
the Company's net interest margin than previous rate cuts because of the
inability of the Company to reset deposit rates by an amount (because of their
already near-zero rates) that would offset the negative impact of the rate cut
on the yields earned on the Company's interest earning assets. Despite the
relatively stable interest rate environment in 2003, with just the one rate cut
in June, this factor was largely responsible for preventing a rebound in net
interest margin similar to that realized in 2002. For the first three quarters
of 2003, the Company's net interest margin was within six basis points of the
4.53% margin realized in the fourth quarter of 2002.
The Company's net interest margin of 4.44% in the fourth quarter of 2003
was negatively impacted by the
20
acquisition of four RBC Centura Bank branches in October 2003 as a result of the
high mix of cash assumed in the acquisition. In connection with this
acquisition, the Company received approximately $62 million in cash that was not
able to immediately be deployed into a mix of assets with higher yields
consistent with the Company's typical mix.
Another negative factor on the Company's net interest margin over the past
two years, which has had a heightened impact from the declining interest rate
environment, has been a significant change in the Company's loan mix from fixed
rate loans to adjustable rate loans. Since December 31, 2001, the Company has
experienced a shift in its loan portfolio from having 57% fixed rate loans and
43% adjustable rate loans to a mix of 57% adjustable rate and 43% fixed rate.
The primary reason for this shift has been that with interest rates at a
historically low level, the Company has more attractively priced adjustable rate
loans in order to avoid locking in fixed rate loans at a time when most
economists believe that rates will rise. Although the Company will benefit from
having a higher percentage of adjustable rate loans upon a rise in rates, the
shift has negatively impacted the Company in the declining rate environment
experienced over the past two years.
Another factor that positively impacted the Company's net interest margin
when comparing 2002 to 2001 was the reinvestment of funds received in the
Company's 2001 acquisitions and the mix of loans and deposits assumed in the
acquisitions. The March 2001 acquisition of four branches from First Union
National Bank resulted in the Company receiving $70.2 million in cash. The
Company was not able to immediately redeploy the cash received into a mix of
higher yielding investments and loans consistent with the Company's historic
asset mix, and therefore the Company's net interest margin was negatively
impacted. In 2002, due to the high loan growth experienced by the Company, a
significant portion of this cash was redeployed into loans with higher interest
rates than the short-term investments in which the cash had been invested.
Additionally, in connection with the acquisition of Century Bancorp in May 2001,
the Company assumed a high mix of residential mortgage loans and time deposits
(which are generally the lowest yielding type of loan and highest rate type of
deposit). This mix of loans and deposits negatively impacted net interest
margins in 2001. In 2002, many of Century's loans were refinanced by the
borrowers and then resold in the secondary market by the Company, with the
resulting funds used to fund the Company's commercial loan growth (which
generally has higher interest rates than residential mortgages). In addition,
many of Century's time deposits also had the opportunity to reprice at lower
rates in 2002, thus positively impacting the net interest margin.
See additional information regarding net interest income in the section
entitled "Interest Rate Risk."
Provision for Loan Losses
The provision for loan losses charged to operations is an amount
sufficient to bring the allowance for loan losses to an estimated balance
considered appropriate to absorb probable losses inherent in the portfolio.
Management's determination of the adequacy of the allowance is based on the
level of loan growth, an evaluation of the portfolio, current economic
conditions, historical loan loss experience and other risk factors.
The Company recorded provisions for loan losses of $2,680,000 in 2003
compared to $2,545,000 in 2002 and $1,151,000 in 2001.
The increase in the provisions for loan losses in each of the past two
years has been primarily related to increases in the Company's net internal loan
growth, as asset quality ratios have remained fairly stable. Net internal loan
growth in 2003 was $147.8 million compared to $105.2 million in 2002 and $28.1
million in 2001. The remaining loan growth of $72.5 million in 2003, $3.1
million in 2002, and $116.2 million in 2001 came by way of acquisitions with a
preexisting allocation for loan losses already in place. A specific reserve of
$250,000 that was established in 2002 related to the Company's largest
nonaccrual loan relationship also impacted the Company's 2002 provision for loan
losses.
See the section entitled "Allowance for Loan Losses and Loan Loss
Experience" below for a more detailed
21
discussion of the allowance for loan losses. The allowance is monitored and
analyzed regularly in conjunction with the Company's loan analysis and grading
program, and adjustments are made to maintain an adequate allowance for loan
losses.
Noninterest Income
Noninterest income recorded by the Company amounted to $14,918,000 in
2003, $11,968,000 in 2002, and $9,655,000 in 2001.
As shown in Table 4, core noninterest income, which excludes gains and
losses from sales of securities, loans, and other assets, amounted to
$14,612,000 in 2003, a 22.3% increase from the $11,946,000 in 2002. The 2002
core noninterest income of $11,946,000 was 25.7% higher than the $9,506,000
recorded in 2001.
See Table 4 and the following discussion for an understanding of the
components of noninterest income.
Service charges on deposit accounts in 2003 amounted to $7,938,000, a
15.8% increase compared to the $6,856,000 recorded in 2002. The 2002 amount of
$6,856,000 was 30.2% higher than the 2001 amount of $5,265,000. The primary
factors that have increased the amount of service charges on deposits have been
1) periodic rate increases, 2) service charges earned from internally generated
deposit growth, and 3) services charges earned from acquired deposits. Deposit
service charge rates are generally increased 2%-4% per year, while internal
growth among deposit transaction accounts was 4.2% in 2003 and 10.1% in 2002.
The acquisition of CCB on January 15, 2003 contributed approximately $650,000 in
deposit service charges during 2003, while the acquisition of the four RBC
Centura branches on October 24, 2003 contributed approximately $125,000 in
deposit service charges in 2003 - the $775,000 in deposit service charges from
these two acquisitions accounted for approximately 11.3% of the 15.8% increase
in service charges on deposit accounts in 2003. The increase in service charges
on deposit accounts from 2001 to 2002 was also impacted by the acquisition of
five First Union branches during 2001 and the introduction of a product in
August 2001 that charges a fee for allowing customers to overdraw their deposit
account. Realizing a full twelve months of income in 2002 from the 2001 branch
acquisitions impacted deposit service charge income by approximately $550,000,
while having the overdraft product for a full twelve months increased deposit
service charges realized in 2002 by approximately $875,000 over 2001.
Other service charges, commissions and fees amounted to $2,710,000 in
2003, a 16.0% increase from the $2,336,000 earned in 2002. The 2002 amount of
$2,336,000 was 14.2% higher than the $2,046,000 recorded in 2001. This category
of noninterest income includes items such as safety deposit box rentals, fees
from sales of personalized checks, check cashing fees, credit card and merchant
income, debit card income, and ATM charges. This category of income grew
primarily because of increases in these activity-related fee services as a
result of overall growth in the Company's total customer base, including growth
achieved from corporate acquisitions.
Fees from presold mortgages amounted to $2,327,000 in 2003, a 35.8%
increase from the 2002 amount of $1,713,000. The 2002 amount was a 36.1%
increase from the $1,259,000 recorded in 2001. The increases in the past two
years have been primarily attributable to a higher level of mortgage loan
refinancings caused by the progressively lower interest rate environment. In the
last 3-4 months of 2003 and continuing into 2004, a rise in mortgage interest
rates has significantly slowed mortgage refinancing activity and thus negatively
impacted the amount of these fees realized by the Company.
Commissions from sales of insurance and financial products amounted to
$1,304,000 in 2003, $738,000 in 2002, and $731,000 in 2001. This line item
includes commissions the Company receives from three sources - 1) sales of
credit insurance associated with new loans, 2) commissions from the sales of
investment, annuity, and long-term care insurance products, and 3) commissions
from the sale of property and casualty insurance. The following table presents
the contribution of each of the three sources to the total amount recognized in
this line item:
22
($ in thousands) 2003 2002 2001
------ ---- ----
Commissions earned from:
Sales of credit insurance $ 300 326 389
Sales of investments, annuities, and long
term care insurance 299 210 227
Sales of property and casualty insurance 705 202 115
------ --- ---
Total $1,304 738 731
====== === ===
The variance in the commissions from sales of credit insurance has been
primarily due to fluctuations in the annual profit sharing bonus that the
Company received from the insurance carriers for which the Company acts as a
broker. The increase in commissions from sales of investments, annuities, and
long term care insurance is primarily due to the hiring of additional staff in
this area during 2003. As it relates to commissions earned from the sale of
property and casualty insurance, the Company began realizing these commissions
upon the May 2001 completion of the purchase of two insurance companies that
specialize in such insurance. The increase in these commissions from 2001 to
2002 was the result of realizing a full year of commissions, whereas the
increase in 2003 was a result of the acquisition of Uwharrie Insurance Group,
which was completed on January 2, 2003. See the section above entitled "Merger
and Acquisition Activity" for additional discussion.
Data processing fees amounted to $333,000 in 2003, $303,000 in 2002, and
$205,000 in 2001. As noted earlier, Montgomery Data makes its excess data
processing capabilities available to area financial institutions for a fee.
These fees have increased as a result of an increase in data processing clients
from two clients to four clients in the past three years, as well as an increase
in the size and number of transactions generated by those clients.
Noninterest income not considered to be "core" amounted to net gains of
$306,000 in 2003, $22,000 in 2002, and $149,000 in 2001. The 2003 net gain of
$306,000 primarily related to securities gains of $218,000 and an $82,000 gain
from a sale of vacant land located beside one of the Company's existing
branches. The $218,000 in securities gains related to sales initiated in the
third and fourth quarters of 2003. In the third quarter of 2003, the Company
sold a corporate bond at a gain of $82,000 in order to realize current income,
as well as to lock-in a gain on the security, which had an approaching call
date. In the fourth quarter of 2003, the Company sold a pool of mortgage-backed
securities at a total gain of $136,000 in order to realize current income, as
well as to dispose of the securities before their low, amortizing, principal
balance significantly affected their liquidity - the securities sold had an
average principal balance of $400,000 and were paying down by approximately
$25,000 per month. The 2002 net gain of $22,000 primarily related to
miscellaneous securities gains of $25,000. The 2001 net gain of $149,000
primarily related to a $79,000 gain from the sale of two buildings that the
Company previously operated as branches that were consolidated with other
branches in the same towns, and securities that were sold at a $61,000 gain.
Noninterest Expenses
Noninterest expenses for 2003 were $37,964,000, compared to $32,301,000 in
2002 and $28,634,000 in 2001. Table 5 presents the components of the Company's
noninterest expense during the past three years.
Based on the recorded amounts noted above, noninterest expenses increased
17.5% in 2003 and 12.8% in 2002. The growth rate from 2001 to 2002 was impacted
by a change in accounting for intangible assets, which served to reduce the year
to year increase. As of January 1, 2002 the Company ceased to record
amortization expense related to its goodwill, which eliminated almost all of the
Company's amortization expense. Adjusting the reported amount in 2001 to exclude
amortization expense related to intangible assets that ceased to be amortized
beginning on January 1, 2002, the increase in noninterest expenses from 2001 to
2002 was 19.1%.
The increases in noninterest expenses over the past two years have
occurred in nearly every line item of
23
expense and have been primarily as a result of the significant growth
experienced by the Company, both internally and by acquisition. Over the past
two years, the number of the Company's branches has increased from 45 to 57, and
the number of full time/part time employees has increased from 358/69 at
December 31, 2001 to 505/89 at December 31, 2003. Additionally, from December
31, 2001 to December 31, 2003, the amount of loans outstanding increased 37% and
deposits increased 25%.
Income Taxes
The provision for income taxes was $10,617,000 in 2003, $9,282,000 in
2002, and $7,307,000 in 2001.
The increase in income tax expense over the past two years has been
directly correlated with the increase in the Company's income before income
taxes, as the effective tax rate for each of the years ended December 31, 2003,
2002 and 2001 was approximately 35%.
Table 6 presents the components of tax expense and the related effective
tax rates.
ANALYSIS OF FINANCIAL CONDITION AND CHANGES IN FINANCIAL CONDITION
Overview
Over the past two years the Company has achieved high increases in its
levels of loans and deposits through a combination of internal growth and growth
from acquisitions. The following table presents information regarding the nature
of the Company's growth in 2003 and 2002:
Percentage
Balance at Balance at Total growth,
(in thousands) beginning of Internal Growth from end of percentage excluding
period growth acquisitions period growth acquisitions
------------ -------- ------------ ---------- ------- ------------
2003
Loans $ 998,547 147,821 72,527 1,218,895 22.1% 14.8%
========== ======== ======== ========== ======= =======
Deposits - Noninterest bearing 112,380 (3,714) 37,833 146,499 30.4% -3.3%
Deposits - Savings, NOW, and Money
Market 387,691 24,583 50,602 462,876 19.4% 6.3%
Deposits - Time>$100,000 199,794 21,525 17,216 238,535 19.4% 10.8%
Deposits - Time<$100,000 356,092 (9,814) 55,176 401,454 12.7% -2.8%
---------- -------- -------- ---------- ------- -------
Total deposits $1,055,957 32,580 160,827 1,249,364 18.3% 3.1%
========== ======== ======== ========== ======= =======
2002
Loans $ 890,310 105,154 3,083 998,547 12.2% 11.8%
========== ======== ======== ========== ======= =======
Deposits - Noninterest bearing 96,065 14,665 1,650 112,380 17.0% 15.3%
Deposits - Savings, NOW, and Money
Market 353,439 30,930 3,322 387,691 9.7% 8.8%
Deposits - Time>$100,000 189,948 9,846 -- 199,794 5.2% 5.2%
Deposits - Time<$100,000 360,829 (8,206) 3,469 356,092 -1.3% -2.3%
---------- -------- -------- ---------- ------- -------
Total deposits $1,000,281 47,235 8,441 1,055,957 5.6% 4.7%
========== ======== ======== ========== ======= =======
As can be seen in the table above, the Company experienced high increases
in loans in each of the years 2003 and 2002 with total growth of 22.1% and
12.2%, respectively. Internal loan growth was strong both years, amounting to
14.8% in 2003 and 11.8% in 2002. Loans assumed in acquisitions boosted the 2003
loan growth rate from 14.8% to 22.1%, while acquired loan growth in 2002 was
insignificant.
Deposits increased 18.3% in 2003 and 5.6% in 2002. Internally generated
deposit growth was modest in both
24
years, amounting to 3.1% in 2003 and 4.7% in 2002. Deposits assumed in the CCB
acquisition and the purchase of the four RBC Centura branches totaling $161
million boosted total deposit growth from 3.1% to 18.3%, while acquired deposits
in 2002 (branch acquisition in Broadway, NC) added $8.4 million in deposits,
increasing the total deposit growth from 4.7% to 5.6%.
The Company believes the significantly higher internal growth rates for
loans compared to deposits over the past two years is largely attributable to
the type of customers the Company has been able to attract. Most of the
Company's loan growth has come from small-business customers that need loans in
order to expand their business, and have few deposits. Additionally, the Company
has found it difficult to compete for retail deposits in recent years. The
Company frequently competes against banks in the marketplace that either 1) are
so large that they enjoy better economies of scale over the Company and can thus
offer higher rates, or 2) are recently started banks that are focused on
building market share, and not necessarily positive earnings, by offering high
deposit rates. The Company enjoys advantages in the loan marketplace by having
seasoned lenders in place that have the experience necessary to oversee the
completion of a loan and the autonomy to be able to make timely decisions.
With loan growth exceeding deposit growth over each of the past two years,
the Company's liquidity has been reduced. In 2001, the Company's liquidity had
improved significantly as a result of receiving $81 million in net cash in
connection with acquisitions. These funds served as the primary source of
funding needs in 2002. In 2003, although the Company's acquired deposits
exceeded its acquired loans by $88 million, internal loan growth exceeded
internal deposit growth by $115 million, which resulted in a reduction in the
Company's liquidity. The Company increased its borrowings from $30 million to
$76 million in 2003 in order to fund the excess loan growth.
The Company's significant acquisition activity over the past three years
has required the Company to raise capital in order to maintain its
"well-capitalized" capital ratio status. Accordingly, the Company raised capital
in each of the fourth quarters of 2002 and 2003 by issuing $20 million each year
(for a total of $40 million) in trust preferred debt securities, which qualify
as regulatory capital for the Company. All of the Company's capital ratios have
significantly exceeded the minimum regulatory thresholds for all periods covered
by this report.
Although the Company's market area, the central Piedmont region of North
Carolina, has experienced recessionary times over the past several years
consistent with the national economy, the Company's asset quality ratios have
remained fairly stable over the past three years with net-charges offs to
average loans ranging from 9 basis points to 11 basis points and nonperforming
assets to total assets ranging from 36 basis points to 45 basis points.
The Company does not participate in large syndicated credits that have
resulted in large credit losses at several other North Carolina-based banks.
Distribution of Assets and Liabilities
Table 7 sets forth the percentage relationships of significant components
of the Company's balance sheets at December 31, 2003, 2002, and 2001.
The most significant variance in the percentages over the past two years
has been the increase in the percentage of loans to total assets, which
increased from 77% at December 31, 2001 to 82% at December 31, 2003, and the
declining percentage of deposits to total assets which declined from 88% to 84%
over that same two year period. These changes are a result of the high loan
growth and lower deposit growth experienced over that same time period that was
discussed in the section above. On the asset side, the increasing loan
percentage has been offset by a lower amount of securities and short term
investments held by the company, while on the liability side, an increase in
borrowings has offset the lower deposit percentage. Although a higher reliance
on borrowings negatively impacts the Company's net interest margin because of
their higher cost compared to deposits, the Company has used the proceeds from
the borrowings to fund loans, which carry a higher interest
25
rate than the borrowings, and thus the net effect is a positive impact on net
interest income.
Securities
Information regarding the Company's securities portfolio as of December
31, 2003, 2002, and 2001 is presented in Tables 8 and 9.
The composition of the investment securities portfolio reflects the
Company's investment strategy of maintaining an appropriate level of liquidity
while providing a relatively stable source of income. The investment portfolio
also provides a balance to interest rate risk and credit risk in other
categories of the balance sheet while providing a vehicle for the investment of
available funds, furnishing liquidity, and supplying securities to pledge as
required collateral for certain deposits.
Total securities available for sale and held to maturity amounted to
$117.7 million, $80.8 million, and $112.8 million at December 31, 2003, 2002,
and 2001, respectively. The increase in securities available for sale from
December 31, 2002 to December 31, 2003 was primarily attributable to security
purchases with funds obtained from the October 2003 RBC Centura branch purchase.
The decrease in securities from December 31, 2001 to December 31, 2002 was
primarily attributable to called and maturing bonds, as well as a high level of
principal repayments on mortgage-backed securities due to the low interest rate
environment. Instead of reinvesting the maturities/paydowns back into
securities, the proceeds were used to fund the high loan growth experienced.
The mix of the types of the Company's securities was similar at December
31, 2003 as it was two years earlier. In the intervening year of 2002, the mix
of securities changed due to the above noted variances in the receipt of
maturities/paydowns of the various categories of investments, as the Company
purchased very few securities as a result of the proceeds of the
maturities/paydowns being used to fund loan growth. Upon the Company's purchase
of the four branches of RBC Centura on October 24, 2003, the Company received
approximately $62 million cash, a significant portion of which was invested in
securities. The Company purchased primarily U.S. Government agency securities
with these funds in order to assure a portfolio mix consistent with the
Company's investment policy, which limits the amount of mortgage-backed
securities and corporate bonds in which the Company can invest.
The majority of the Company's U.S. Government agency debt securities are
issued by the Federal Home Loan Bank and carry one maturity date, often with an
issuer call feature, while the mortgage-backed securities have been primarily
issued by Freddie Mac and Fannie Mae and vary in their repayment in correlation
with the underlying pools of home mortgage loans. The Company's investment in
corporate bonds is primarily comprised of trust preferred securities issued by
other North Carolina bank holding companies.
Included in mortgage-backed securities at December 31, 2003 were
collateralized mortgage obligations (CMOs) with an amortized cost of $21,648,000
and a fair value of $21,458,000. Included in mortgage-backed securities at
December 31, 2002 were CMOs with an amortized cost of $12,590,000 and a fair
value of $12,720,000. Included in mortgage-backed securities at December 31,
2001 were CMOs with an amortized cost of $21,703,000 and a fair value of
$21,866,000. The CMOs that the Company has invested in are substantially all
"early tranche" pieces of the CMO, which minimizes long-term interest rate risk
to the Company.
At December 31, 2003, net unrealized gains of $1,868,000 were included in
the carrying value of securities classified as available for sale, compared to a
net unrealized gain of $1,399,000 at December 31, 2002 and a net unrealized gain
of $1,024,000 at December 31, 2001. The increase in the unrealized gain position
at each of the past two year ends are a result of the progressively lower
interest rate environment in effect at each period end. Management evaluated any
unrealized losses on individual securities at each year end and determined them
to be of a temporary nature and caused by fluctuations in market interest rates,
not by concerns about the ability of the issuers to meet their obligations. Net
unrealized gains, net of applicable deferred income taxes, of $1,140,000,
$853,000, and $677,000 have been reported as part of a separate component of
shareholders' equity (accumulated other comprehensive income) as of December 31,
2003, 2002, and 2001, respectively.
26
The fair value of securities held to maturity, which the Company carries
at amortized cost, was more than the carrying value at December 31, 2003 and
2002 by $700,000 and $767,000, respectively. Management evaluated any unrealized
losses on individual securities at each year end and determined them to be of a
temporary nature and caused by fluctuations in market interest rates, not by
concerns about the ability of the issuers to meet their obligations.
Table 9 provides detail as to scheduled contractual maturities and book
yields on securities available for sale and securities held to maturity at
December 31, 2003. Mortgage-backed and other amortizing securities are shown
maturing in the time periods consistent with their estimated lives based on
expected prepayment speeds.
The weighted average taxable-equivalent yield for the securities available
for sale portfolio was 4.85% at December 31, 2003. The expected weighted average
life of the available for sale portfolio using the call date for above-market
callable bonds, the maturity date for all other non-mortgage-backed securities,
and the expected life for mortgage-backed securities, was 5.0 years.
The weighted average taxable-equivalent yield for the securities held to
maturity portfolio was 6.19% at December 31, 2003. The expected weighted average
life of the held to maturity portfolio using the call date for above-market
callable bonds and the maturity date for all other securities, was 2.5 years.
As of December 31, 2003 and 2002, the Company held no investment
securities of any one issuer, other than U.S. Treasury and U.S. Government
agencies or corporations, in which aggregate book values and market values
exceeded 10% of shareholders' equity.
Loans
Table 10 provides a summary of the loan portfolio composition at each of
the past five year ends.
The loan portfolio is the largest category of the Company's earning assets
and is comprised of commercial loans, real estate mortgage loans, real estate
construction loans, and consumer loans. The Company restricts virtually all of
its lending to its 21 county market area, which is located in the central
Piedmont region of North Carolina, and one county each in Virginia and South
Carolina. The diversity of the region's economic base has historically provided
a stable lending environment.
Loans outstanding increased $220.3 million, or 22.1%, to $1.22 billion
during 2003. Approximately $148 million of the 2003 growth was from net internal
loan growth, while $73 million was assumed in acquisitions. Loans outstanding
increased $108.2 million, or 12.2%, to $998.5 million during 2002. Approximately
$105 million of the 2002 growth was from net internal loan growth, while $3
million was assumed in acquisitions. The majority of the 2003 and 2002 loan
growth occurred in loans secured by real estate, with approximately $174.5
million, or 79.2% in 2003, and $99.5 million, or 91.9%, in 2002 of the net loan
growth occurring in real estate mortgage or real estate construction loans.
Over the years, the Company's loan mix has remained fairly consistent,
with real estate loans (mortgage and construction) comprising approximately 85%
of the loan portfolio, commercial, financial, and agricultural loans comprising
10%, and consumer installment loans comprising approximately 5% of the
portfolio.
At December 31, 2003, $1.038 billion, or 85.1%, of the Company's loan
portfolio was secured by liens on real property. Included in this total are
$549.9 million, or 45.1% of total loans, in loans secured by liens on 1-4 family
residential properties and $487.9 million, or 40.0% of total loans, in loans
secured by liens on other types of real estate. At December 31, 2002, $863.3
billion, or 86.4%, of the Company's loan portfolio was secured by liens on real
property. Included in this total were $466.5 million, or 46.7% of total loans,
in loans secured by liens on 1-4 family residential properties and $396.8
million, or 39.7% of total loans, in loans secured by liens on
27
other types of real estate. The Company's $1.038 billion in real estate mortgage
loans at December 31, 2003 can be further classified as follows - for comparison
purposes, the classification of the Company's $863.3 million real estate loan
portfolio at December 31, 2002 is shown in parenthesis:
o $361.2 million, or 29.6% of total loans (vs. $305.0 million,
or 30.5% of total loans), are primarily dependent on cash flow
from a commercial business for repayment.
o $360.8 million, or 29.6% of total loans (vs. $306.5 million,
or 30.7% of total loans), are traditional residential mortgage
loans in which the borrower's personal income is the primary
repayment source.
o $98.2 million, or 8.1% of total loans (vs. $68.1 million, or
6.8% of total loans), are real estate construction loans.
o $95.8 million, or 7.9% of total loans (vs. $72.7 million or
7.3% of total loans), are home equity loans.
o $93.3 million, or 7.7% of total loans (vs. $87.3 million, or
8.7% of total loans), are personal consumer installment loans
in which the borrower has provided residential real estate as
collateral.
o $28.5 million, or 2.3% of total loans (vs. $23.7 million or
2.4% of total loans), are primarily dependent on cash flow
from agricultural crop sales.
Table 11 provides a summary of scheduled loan maturities over certain time
periods, with fixed rate loans and adjustable rate loans shown separately.
Approximately 22% of the Company's loans outstanding at December 31, 2003 mature
within one year and 71% of total loans mature within five years. The percentages
of variable rate loans and fixed rate loans as compared to total performing
loans were 57.0% and 43.0%, respectively, as of December 31, 2003. The Company
intentionally makes a blend of fixed and variable rate loans so as to reduce
interest rate risk. As noted in the section above entitled "Net Interest
Income," the Company has experienced a significant shift in its fixed/variable
loan mix over the past two years.
Nonperforming Assets
Nonperforming assets include nonaccrual loans, loans past due 90 or more
days and still accruing interest, restructured loans and other real estate. As a
matter of policy the Company places all loans that are past due 90 or more days
on nonaccrual basis, and thus there were no loans at any of the past five year
ends that were 90 days past due and still accruing interest. Table 12 summarizes
the Company's nonperforming assets at the dates indicated.
Nonaccrual loans are loans on which interest income is no longer being
recognized or accrued because management has determined that the collection of
interest is doubtful. Placing loans on nonaccrual status negatively impacts
earnings because (i) interest accrued but unpaid as of the date a loan is placed
on nonaccrual status is either deducted from interest income or is charged-off,
(ii) future accruals of interest income are not recognized until it becomes
probable that both principal and interest will be paid and (iii) principal
charged-off, if appropriate, may necessitate additional provisions for loan
losses that are charged against earnings. In some cases, where borrowers are
experiencing financial difficulties, loans may be restructured to provide terms
significantly different from the originally contracted terms.
Nonperforming loans (which includes nonaccrual loans and restructured
loans) as of December 31, 2003, 2002 and 2001 totaled $4,295,000, $3,107,000,
and $3,891,000, respectively. Nonperforming loans as a percentage of total loans
amounted to 0.35%, 0.30%, and 0.44%, at December 31, 2003, 2002, and 2001,
respectively. The variances in nonperforming loans over the past two years have
been primarily due to changes in nonaccrual loans, as restructured loans have
not changed significantly. The increase in nonaccrual loans from December 31,
2002 to December 31, 2003 relates primarily to the Company placing five loans
totaling $1.3 million on nonaccrual basis during the year. Each of these
unrelated loans has an outstanding loan balance of between $225,000 and
$325,000, and each loan is secured by real estate. The Company believes that any
losses related to these loans will not be material.
The decrease in nonaccrual loans from December 31, 2001 to December 31,
2002 relates primarily to a
28
decrease in the outstanding balance of the Company's largest nonaccrual loan
relationship. During 2001, the Company placed a loan relationship on nonaccrual
status that had an outstanding balance of $1.9 million at December 31, 2001.
This relationship, secured primarily by real estate, was placed on nonaccrual
status due to liquidity problems experienced by the borrower. The borrower has
been actively working to sell real estate to pay down the balance, and during
2002 several sales were completed that resulted in the Company receiving
paydowns of approximately $900,000. At December 31, 2002, the Company had
accepted a nonbinding proposal from a third party that would result in the
receipt of approximately $750,000 of the $1.0 million balance. Accordingly, in
the fourth quarter of 2002, the Company established a specific impaired loan
valuation allowance of $250,000 for this relationship. During the first quarter
of 2003, because the Company believed that there was a high likelihood that the
terms of the nonbinding proposal would occur, the Company charged-off the
$250,000 specific reserve that had been established, resulting in a $750,000
balance. Over the course of the remainder of 2003, numerous delays occurred
relating to the pay-off proposal, and management of the Company is no longer
sure whether it will occur. The Company continues to actively seek collection of
the loan. During the third quarter of 2003, the borrower sold a piece of real
estate, the net proceeds of which were used to pay down the principal balance by
$87,000, resulting in a remaining balance of $663,000 at December 31, 2003. The
Company has assigned a specific impaired loan valuation allowance of $125,000 to
the remaining balance at December 31, 2003.
If the nonaccrual loans and restructured loans as of December 31, 2003,
2002 and 2001 had been current in accordance with their original terms and had
been outstanding throughout the period (or since origination if held for part of
the period), gross interest income in the amounts of approximately $319,000,
$246,000 and $320,000 for nonaccrual loans and $2,000, $6,000 and $10,000 for
restructured loans would have been recorded for 2003, 2002 and 2001,
respectively. Interest income on such loans that was actually collected and
included in net income in 2003, 2002 and 2001 amounted to approximately
$102,000, $55,000 and $76,000 for nonaccrual loans (prior to their being placed
on nonaccrual status) and $2,000, $6,000 and $7,000 for restructured loans,
respectively.
Management routinely monitors the status of certain large loans that, in
management's opinion, have credit weaknesses that could cause them to become
nonperforming loans. In addition to the nonperforming loan amounts discussed
above, management believes that an estimated $6.5-$7.0 million of loans that
were performing in accordance with their contractual terms at December 31, 2003
have the potential to develop problems depending upon the particular financial
situations of the borrowers and economic conditions in general. Management has
taken these potential problem loans into consideration when evaluating the
adequacy of the allowance for loan losses at December 31, 2003 (see discussion
below).
Loans classified for regulatory purposes as loss, doubtful, substandard,
or special mention that have not been disclosed in the problem loan amounts and
the potential problem loan amounts discussed above do not represent or result
from trends or uncertainties that management reasonably expects will materially
impact future operating results, liquidity, or capital resources, or represent
material credits about which management is aware of any information that causes
management to have serious doubts as to the ability of such borrowers to comply
with the loan repayment terms.
Other real estate includes foreclosed, repossessed, and idled properties.
Other real estate has not varied materially at any of the past three year ends,
amounting to $1,398,000 at December 31, 2003, $1,384,000 at December 31, 2002,
and $1,253,000 at December 31, 2001. Other real estate represented 0.09%, 0.11%,
and 0.11% of total assets at the end of 2003, 2002, and 2001, respectively. The
Company's management believes that the fair values of the items of other real
estate, less estimated costs to sell, equal or exceed their respective carrying
values at the dates presented.
29
Allowance for Loan Losses and Loan Loss Experience
The allowance for loan losses is created by direct charges to operations.
Losses on loans are charged against the allowance in the period in which such
loans, in management's opinion, become uncollectible. The recoveries realized
during the period are credited to this allowance. The Company considers its
procedures for recording the amount of the allowance for loan losses and the
related provision for loan losses to be a critical accounting policy. See the
heading "Critical Accounting Policies" above for further discussion.
The factors that influence management's judgment in determining the amount
charged to operating expense include past loan loss experience, composition of
the loan portfolio, evaluation of probable inherent losses and current economic
conditions.
The Company uses a loan analysis and grading program to facilitate its
evaluation of probable inherent loan losses and the adequacy of its allowance
for loan losses. In this program, risk grades are assigned by management and
tested by the Company's internal audit department and an independent third party
consulting firm. The testing program includes an evaluation of a sample of new
loans, loans that management identifies as having potential credit weaknesses,
loans past due 90 days or more, nonaccrual loans and any other loans identified
during previous regulatory and other examinations.
The Company strives to maintain its loan portfolio in accordance with what
management believes are conservative loan underwriting policies that result in
loans specifically tailored to the needs of the Company's market areas. Every
effort is made to identify and minimize the credit risks associated with such
lending strategies. The Company has no foreign loans, few agricultural loans and
does not engage in significant lease financing or highly leveraged transactions.
Commercial loans are diversified among a variety of industries. The majority of
loans captioned in the tables discussed below as "real estate" loans are
primarily various personal and commercial loans where real estate provides
additional security for the loan. Collateral for virtually all of these loans is
located within the Company's principal market area.
The allowance for loan losses amounted to $13,569,000 at December 31, 2003
compared to $10,907,000 as of December 31, 2002 and $9,388,000 at December 31,
2001. This represented 1.11%, 1.09%, and 1.05%, of loans outstanding as of
December 31, 2003, 2002, and 2001, respectively. The slight increases in this
percentage is primarily a result of a slight shift in the composition of the
Company's loan portfolio from residential mortgage loans to commercial loans -
commercial loans carry a higher reserve percentage in the Company's allowance
for loan loss model than do residential mortgage loans. The slight shift from
residential mortgage loans to commercial loans has been intentional. Two of the
Company's recent bank acquisitions (First Savings Bancorp in September 2000 and
Century Bancorp in May 2001) had loan portfolios that were highly concentrated
in residential mortgage loans. As many of those loans have refinanced at lower
rates over the past 24 months, the Company chose to sell them in the secondary
market instead of holding them in the Company's loan portfolio. This strategy
was implemented in an effort to shift the Company's loan portfolio to having a
higher percentage of commercial loans, which are generally shorter term in
nature and have higher interest rates.
As noted in Table 12, the Company's allowance for loan losses as a
percentage of nonperforming loans ("coverage ratio") amounted to 316% at
December 31, 2003, compared to 362% at December 31, 2002 and 241% at December
31, 2001. The change in the coverage ratio is inversely proportional to the
level of nonperforming loans at each period end. Due to the secured nature of
virtually all of the Company's loans that are on nonaccrual status, the variance
in the coverage ratio is not necessarily indicative of the relative adequacy of
the allowance for loan losses.
Table 13 sets forth the allocation of the allowance for loan losses at the
dates indicated. The portion of these reserves that was allocated to specific
loan types in the loan portfolio increased to $13,416,000 at December 31, 2003
from $10,833,000 at December 31, 2002 and $9,343,000 at December 31, 2001. The
23.3% increase in the
30
amount of the allocated allowance during 2003 is consistent with the 22.1%
increase in total loans outstanding. Similarly, the 16.5% increase in the amount
of the allocated allowance during 2002 is consistent with the 12.2% increase in
total loans outstanding. The slightly higher increase in the allocated allowance
compared to the increase in loan growth for each of the past two years relates
to the Company's loan mix shifting slightly from residential real estate loans
to commercial real estate loans (which carry a higher reserve allocation in the
Company's allowance model) as discussed two paragraphs above. In addition to the
allocated portion of the allowance for loan losses, the Company maintains an
unallocated portion that is not assigned to any specific category of loans, but
rather is intended to reserve for the inherent risk in the overall portfolio and
the intrinsic inaccuracies associated with the estimation of the allowance for
loan losses and its allocation to specific loan categories. The amount of the
unallocated portion of the allowance for loan losses did not vary materially at
any of the past three year ends, while the decrease in the unallocated allowance
from 1999 to 2000 was related to the Company segregating and assigning higher
reserve percentages to particular loan types that were identified during 2000 as
having inherently higher risk (this resulted in a portion of the allowance for
loan losses shifting from "unallocated" to "allocated"). These additional risk
characteristics were noted by management as a part of its ongoing analysis and
review of its loan portfolio and historical charge-off experience, and did not
result from any deterioration of the portfolio during 2000.
Management considers the allowance for loan losses adequate to cover
probable loan losses on the loans outstanding as of each reporting date. It must
by emphasized, however, that the determination of the allowance using the
Company's procedures and methods rests upon various judgments and assumptions
about economic conditions and other factors affecting loans. No assurance can be
given that the Company will not in any particular period sustain loan losses
that are sizable in relation to the amount reserved or that subsequent
evaluations of the loan portfolio, in light of conditions and factors then
prevailing, will not require significant changes in the allowance for loan
losses or future charges to earnings.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the allowances for loan losses and
losses on foreclosed real estate. Such agencies may require the Company to
recognize additions to the allowances based on the examiners' judgments about
information available to them at the time of their examinations.
For the years indicated, Table 14 summarizes the Company's balances of
loans outstanding, average loans outstanding, and a detailed rollforward of the
allowance for loan losses. In addition to the increases to the allowance for
loan losses related to normal provisions, the increases in the dollar amounts of
the allowance for loan losses in each of the most recent three years were also
affected by amounts recorded to provide for loans assumed in corporate
acquisitions. In 2003, the Company recorded $1,083,000 to the allowance for loan
losses related to loans assumed in two corporate acquisitions. Approximately
$333,000 of the $1,083,000 related to $24.8 million in loans assumed in the
October 2003 RBC Centura branch acquisition, while $750,000 related to the CCB
acquisition. The $750,000 addition related to CCB represented the book value of
CCB's allowance for loan losses on the date of the acquisition. In 2002, $50,000
was recorded for loans assumed in the Broadway branch acquisition in which the
Company assumed approximately $3 million in loans. In 2001, the Company recorded
$1,125,000 to the allowance for loan losses related to loans assumed in two
corporate acquisitions. Approximately $520,000 of the $1,125,000 related to
$26.0 million in mostly consumer loans assumed in the March 2001 and December
2001 branch acquisitions, while $605,000 related to the Century acquisition. The
$605,000 addition related to Century represented the book value of Century's
allowance for loan losses on the date of the acquisition.
The Company's net loan charge offs did not fluctuate significantly in any
of the past three years, amounting to approximately $1,101,000 in 2003,
$1,076,000 in 2002, and $781,000 in 2001. This represents 0.10%, 0.11%, and
0.09% of average loans during 2003, 2002, and 2001 respectively.
31
Deposits
The average amounts of deposits of the Company and the average yield paid
for those deposits for the years ended December 31, 2003, 2002 and 2001 are
presented in Table 15. Average deposits grew to $1.153 billion in 2003, an
increase of $142.7 million, or 14.1%. In 2002, the Company's average deposits
experienced growth of $110.7 million, or 12.3%. Approximately half of the
increase in average deposits in 2003 was a result of deposits assumed via
acquisition during the year - CCB's deposit base of $59 million was assumed by
the Company on January 15, 2003, while the assumption of the $102 million in
deposits in the RBC branch purchase acquisition on October 24, 2003 increased
average balances for the year by approximately $18 million during the 2.1 months
they were owned by the Company in 2003. Most of the remainder of the 2003 growth
in average deposits related to the internal deposit growth of $33 million
experienced during the year, as well as the full year's effect of the $47
million in internally generated deposit growth in 2002, nearly all of which was
experienced in the second half of the year.
Approximately half of the increase in average deposits in 2002 related to
corporate acquisitions completed in the previous year (2001), which increased
deposits outstanding a total of $204.6 million over the course of the year. The
effect of having the acquired 2001 deposits for all 12 months in 2002 coupled
with the 5.6% increase in the year end balance at December 31, 2002 compared to
December 31, 2001 resulted in the 12.3% increase in average deposits for the
year.
The 14.1% increase in average deposits in 2003 occurred in all categories
of deposits, with interest-bearing demand deposits increasing by 8.5%, savings
deposits increasing by 25.7%, time deposits 7.5%, time deposits greater than
$100,000 increasing by 23.4% and noninterest-bearing deposits experiencing the
highest growth at 26.0%. The higher percentage growth in the non-time deposit
categories, except time deposits greater than $100,000, continued the trend the
Company noted in 2002 in which many time deposit customers deposited their
maturing time deposits into other categories of deposits rather than renew their
time deposits at the historically low rates in effect. The increase in time
deposits greater than $100,000 was largely a result of the Company offering
competitive interest rates on this product in order to fund the strong loan
growth experienced.
The 12.3% increase in average deposits in 2002 was primarily driven by
increases in the non-time deposit categories. During 2002, average
noninterest-bearing demand deposits increased 23.6%, interest-bearing demand
deposits increased 21.8%, and savings deposits increased 26.3%. Average time
deposits and time deposits greater than $100,000 increased at lower rates of
2.2% and 8.8% respectively. The higher increases in non-time deposits were
primarily a result of the mix of the Company's 2001 deposit acquisitions and the
mix of the Company's 2002 deposit growth. The Company's 2001 acquisitions were
comprised of a high mix of non-time deposits, while in 2002 the Company noted
that many customers deposited their maturing time deposits into other categories
of deposits rather than renewing their time deposits at the historically low
rates in effect.
As of December 31, 2003, the Company held approximately $238.5 million in
time deposits of $100,000 or more and other time deposits of $401.5 million.
Table 16 is a maturity schedule of time deposits of $100,000 or more as of
December 31, 2003. This table shows that 87.5% of the Company's time deposits
greater than $100,000 mature within one year.
At each of the past three year ends, the Company had no brokered deposits,
nor had the Company issued any time deposits through foreign offices, nor did
the Company believe that it held any deposits by foreign depositors.
Borrowings
At December 31, 2003, the Company has three sources of readily available
borrowing capacity - 1) an approximately $220 million line of credit with the
FHLB, of which $36 million was outstanding at December 31,
32
2003 and $10 million was outstanding at December 31, 2002, 2) a $50 million
overnight federal funds line of credit with a correspondent bank, none of which
was outstanding at December 31, 2003 or 2002, and 3) an approximately $56
million line of credit through the Federal Reserve Bank of Richmond's (FRB)
discount window, none of which was outstanding at December 31, 2003 or 2002.
The Company's line of credit with the FHLB totaling approximately $220
million can be structured as either short-term or long-term borrowings,
depending on the particular funding or liquidity need and is secured by the
Company's FHLB stock and a blanket lien on its one-to-four family residential
loan portfolio. The Company had $36 million outstanding under this line of
credit at December 31, 2003, with $25 million outstanding on an overnight basis
and the other $11 million maturing in $1 million to $5 million increments in
each of the years from 2005 to 2009.
The Company's correspondent bank relationship allows the Company to
purchase up to $50 million in federal funds on an overnight, unsecured basis.
This line of credit was not drawn upon during any of the past three years.
The Company also has a line of credit with the FRB discount window. This
line is secured by a blanket lien on a portion of the Company's commercial,
consumer and real estate portfolio (excluding 1-4 family). Based on the
collateral owned by the Company as of December 31, 2003, the available line of
credit is approximately $56 million. This line of credit was established
primarily in connection with the Company's Y2K liquidity contingency plan and
has not been drawn on since inception. The FRB has indicated that it would not
expect lines of credit that have been granted to financial institutions to be a
primary borrowing source. The Company plans to maintain this line of credit,
although it is not expected that it will be drawn upon except in unusual
circumstances.
In addition to the lines of credit described above, in which the Company
has $36 million outstanding, the Company also had a total of $40 million in
trust preferred security debt outstanding at December 31, 2003. The Company
issued $20 million of this debt on October 29, 2002 and an additional $20
million on December 19, 2003. These borrowings each have 30 year final
maturities and were structured as trust preferred capital securities that
qualify as Tier I capital for regulatory capital adequacy requirements. These
debt securities are callable by the Company at par on any quarterly interest
payment date five years after their issue date. The interest rate on these debt
securities adjusts on a quarterly basis at a rate of three-month LIBOR plus
3.45% for the securities issued in 2002 and LIBOR plus 2.70% for the securities
issued in 2003.
Average short-term borrowings for each of the past five years were less
than thirty percent of total shareholders' equity at all times during each
period.
Liquidity, Commitments, and Contingencies
The Company's liquidity is determined by its ability to convert assets to
cash or acquire alternative sources of funds to meet the needs of its customers
who are withdrawing or borrowing funds, and to maintain required reserve levels,
pay expenses and operate the Company on an ongoing basis. The Company's primary
liquidity sources are net income from operations, cash and due from banks,
federal funds sold and other short-term investments. The Company's securities
portfolio is comprised almost entirely of readily marketable securities which
could also be sold to provide cash.
As noted above, in addition to internally generated liquidity sources, the
Company has the ability to obtain borrowings from the following three sources -
1) an approximately $220 million line of credit with the FHLB, 2) a $50 million
overnight federal funds line of credit with a correspondent bank, and 3) an
approximately $56 million line of credit through the Federal Reserve Bank of
Richmond's discount window.
The Company's on-balance-sheet liquidity declined in both 2003 and 2002 as
a result of the strong loan
33
growth that outpaced deposit growth during each year. The imbalance in the loan
growth compared to the deposit growth increased the loan to deposit ratio from
89.0% at December 31, 2001 to 94.6% at December 31, 2002 to 97.6% at December
31, 2003. Additionally, the percentage of balance sheet assets that are
generally regarded as being liquid (consisting of cash, due from banks, federal
funds sold, presold mortgages in process of settlement and securities) decreased
from 20.7% of total deposits and borrowings at December 31, 2001 to 16.0% at
December 31, 2002 to 12.3% at December 31, 2003.
In the normal course of business there are various outstanding contractual
obligations of the Company that will require future cash outflows. In addition,
there are commitments and contingent liabilities, such as commitments to extend
credit, that may or may not require future cash outflows.
Table 18 reflects the contractual obligations and other commercial
commitments of the Company outstanding as of December 31, 2003. Of the $45
million in borrowings maturing in more than five years, $5 million relates to
FHLB debt that has a call option whereby the FHLB may call the debt in 2004 -
based on the interest rates in effect at December 31, 2003, the Company does not
expect this borrowing to be called by the FHLB. Also, any of the Company's $36
million in outstanding borrowings with the FHLB may be accelerated immediately
by the FHLB in certain circumstances, including material adverse changes in the
condition of the Company or if the Company's qualifying collateral amounts to
less than 1.33 times the amount of borrowings outstanding. At December 31, 2003,
the Company's qualifying collateral amounted to 8.8 times the amount of
borrowings outstanding.
In the normal course of business there are various outstanding commitments
and contingent liabilities, such as commitments to extend credit, which are not
reflected in the financial statements. Table 18 also reflects other commercial
commitments of the Company outstanding as of December 31, 2003. This table
reflects that as of December 31, 2003, the Company had outstanding loan
commitments of $211,714,000 (the sum of credit cards and lines of credit and
loan commitments line items). Of that amount, $186,878,000 were at variable
rates and $24,836,000 were at fixed rates. Included in outstanding loan
commitments were unfunded commitments of $111,631,000 on revolving credit plans,
of which $103,049,000 were at variable rates and $8,582,000 were at fixed rates.
In addition to the credit card and other loan commitments described above,
at December 31, 2003 and 2002, the Company had $3,320,000 and $2,279,000 in
standby letters of credit outstanding, respectively. The Company has no carrying
amount for these standby letters of credit. The nature of the standby letters of
credit is a guarantee made on behalf the Company's customers to suppliers of the
customers to guarantee payments owed to the supplier by the customer. The
standby letters of credit have two to three year terms, and the payment of the
guarantees would generally be triggered by a continued nonpayment of an
obligation owed by the customer to the supplier. The maximum potential amount of
future payments (undiscounted) the Company could be required to make under the
guarantees in the event of nonperformance by the parties to whom credit or
financial guarantees have been extended is represented by the contractual amount
of the financial instruments discussed above. In the event that the Company is
required to honor a standby letter of credit, a note, already executed with the
customer, is triggered which provides repayment terms and any collateral. Over
the past ten years, the Company has had to honor one standby letter of credit,
which was repaid by the borrower without any loss to the Company.
It has been the experience of the Company that deposit withdrawals are
generally replaced with new deposits, thus not requiring any net cash outflow.
Based on that assumption, management believes that it can meet its contractual
cash obligations and existing commitments from normal operations.
The Company is not involved in any legal proceedings that, in management's
opinion, could have a material effect on the consolidated financial position of
the Company.
Despite the decline in on-balance-sheet liquidity levels in 2002 and 2003
discussed above, the Company's management believes its liquidity sources,
including unused lines of credit, are at an acceptable level and remain
34
adequate to meet its operating needs in the foreseeable future. The Company will
continue to monitor its liquidity position carefully and will explore and
implement strategies to increase liquidity if deemed appropriate.
Off-Balance Sheet Arrangements and Derivative Financial Instruments
Off-balance sheet arrangements include transactions, agreements, or other
contractual arrangements in which the Company has obligations or provides
guarantees on behalf of an unconsolidated entity. The Company has no off-balance
sheet arrangements of this kind.
Derivative financial instruments include futures, forwards, interest rate
swaps, options contracts, and other financial instruments with similar
characteristics. The Company has not engaged in derivatives activities through
December 31, 2003 and has no current plans to do so.
Interest Rate Risk (Including Quantitative and Qualitative Disclosures About
Market Risk - Item 7A.)
Net interest income is the Company's most significant component of
earnings. Notwithstanding changes in volumes of loans and deposits, the
Company's level of net interest income is continually at risk due to the effect
that changes in general market interest rate trends have on interest yields
earned and paid with respect to the various categories of earning assets and
interest-bearing liabilities. It is the Company's policy to maintain portfolios
of earning assets and interest-bearing liabilities with maturities and repricing
opportunities that will afford protection, to the extent practical, against wide
interest rate fluctuations. The Company's exposure to interest rate risk is
analyzed on a regular basis by management using standard GAP reports, maturity
reports, and an asset/liability software model that simulates future levels of
interest income and expense based on current interest rates, expected future
interest rates, and various intervals of "shock" interest rates. Over the years,
the Company has been able to maintain a fairly consistent yield on average
earning assets (net interest margin). Over the past five calendar years the
Company's net interest margin has ranged from a low of 4.23% (realized in 2001)
to a high of 4.58% (realized in 2002). During that five year period the prime
rate of interest has ranged from a low of 4.00% to a high of 9.50%.
In 2001, the Company experienced downward pressure on its net interest
margin, primarily as a result of the significant decreases in the interest rate
environment - the Company's interest-earning assets adjusted downwards quicker
and by a greater amount than did the Company's interest-bearing liabilities. In
the first quarter of 2002, the Company's 4.36% net interest margin was the
highest it had been since the fourth quarter of 2000, primarily as a result of
the stable interest rate environment, when for the first time in five quarters,
there were no decreases in rates initiated by the Federal Reserve. This allowed
a significant portion of the Company's time deposits that were originated during
periods of higher interest rates and matured during the quarter to reprice at
lower levels, whereas the Company's rate sensitive interest-earning assets had
repriced lower immediately upon the rate cuts by the Federal Reserve in 2001,
and thus did not experience further rate reductions. There were also no changes
in rates in the second or third quarters of 2002, which allowed the Company's
time deposits to continue to mature and reprice at lower levels. As a result,
the Company's net interest margin for the third quarter of 2002 was 4.78%, its
highest level since the Company's merger with First Savings Bancorp in 2000.
Consistent with what occurred in 2001, the 50 basis point (0.50%) rate cut
initiated by the Federal Reserve on November 6, 2002 negatively impacted the
Company's net interest margin as interest-sensitive assets repriced downwards
sooner and by a greater amount than did the Company's interest-sensitive
liabilities. The Company's net interest margin for the fourth quarter of 2002
was 4.53%, a 25 basis point decrease from the third quarter of 2002. In 2003,
although the Company's deposits continued to reprice downward, the 50 basis
point rate cut in November 2002 and the subsequent June 27, 2003 rate cut of 25
basis points had a more pronounced and a longer lasting negative impact on the
Company's net interest margin than previous rate cuts because of the inability
of the Company to reset deposit rates by an amount (because of their already
near-zero rates) that would offset the negative impact of the rate cut on the
yields earned on the Company's interest earning assets. Despite the relatively
stable interest rate environment in 2003, with just the one rate cut in June,
this factor was largely responsible for preventing a rebound in net interest
margin similar to that realized in 2002. For the first three quarters of 2003,
the Company's net interest margin was within six basis points of the 4.53%
margin realized in the fourth quarter of 2002. The Company's net interest margin
of 4.44% in the fourth quarter of 2003 was negatively impacted by the
acquisition of four RBC Centura Bank branches in October 2003 as a result of the
high mix of cash assumed in the acquisition (as opposed to higher yielding
assets). In connection with this
35
acquisition, the Company received approximately $62 million in cash that was not
able to immediately be deployed into a mix of assets with higher yields
consistent with the Company's typical mix. Additionally, as discussed in more
detail in the section "Net Interest Income" above, the Company has experienced
a shift in its loan portfolio from having more fixed rate loans to having more
adjustable rate loans, which has also negatively impacted the Company's net
interest margin.
Table 17 sets forth the Company's interest rate sensitivity analysis as of
December 31, 2003, using stated maturities for all instruments except
mortgage-backed securities (which are allocated in the periods of their expected
payback) and securities and borrowings with call features that are expected to
be called (which are shown in the period of their expected call). As illustrated
by this table, the Company had $329.8 million more in interest-bearing
liabilities that are subject to interest rate changes within one year than
earning assets. This generally would indicate that net interest income would
experience downward pressure in a rising interest rate environment and would
benefit from a declining interest rate environment. However, this method of
analyzing interest sensitivity only measures the magnitude of the timing
differences and does not address earnings, market value, or management actions.
Also, interest rates on certain types of assets and liabilities may fluctuate in
advance of changes in market interest rates, while interest rates on other types
may lag behind changes in market rates. In addition to the effects of "when"
various rate-sensitive products reprice, market rate changes may not result in
uniform changes in rates among all products. For example, included in
interest-bearing liabilities at December 31, 2003 subject to interest rate
changes within one year are deposits totaling $462.9 million comprised of NOW,
savings, and certain types of money market deposits with interest rates set by
management. These types of deposits historically have not repriced
coincidentally with or in the same proportion as general market indicators.
Thus, the Company believes that in the near term (twelve months), net
interest income would not likely experience significant downward pressure from
rising interest rates. Similarly, management would not expect a significant
increase in near term net interest income from falling interest rates (In fact,
it has been the Company's experience that each interest rate cut occurring
during the past three years has negatively impacted (at least temporarily) the
Company's net interest margin). Generally, as discussed above, when rates
change, the Company's interest-sensitive assets that are subject to adjustment
reprice immediately at the full amount of the change, while the Company's
interest-sensitive liabilities that are subject to adjustment reprice at a lag
to the rate change and typically not to the full extent of the rate change. The
net effect is that in the twelve month horizon, as rates change, the impact of
having a higher level of interest-sensitive liabilities is substantially negated
by the later and typically lower proportionate change these liabilities
experience compared to interest sensitive assets. However, as previously
discussed, recent rate cuts, particularly the two rate cuts totaling 75 basis
points that have occurred since September 30, 2002, may have a more pronounced
and a longer lasting negative impact on the Company's net interest margin than
previous rate cuts because of the inability of the Company to reset deposit
rates by an amount (because of their already near-zero rates) that would offset
the negative impact of the rate cut on the yields earned on the Company's
interest earning assets. Additionally, as previously discussed, over the past
two years, the Company has originated significantly more adjustable rate loans
compared to fixed rate loans. In the current interest rate environment,
adjustable rate loans generally carry lower initial interest rates than fixed
rate loans. If the trend of originating more adjustable rate loans than fixed
rate loans continues into 2004, which the Company expects will occur, the
Company's net interest margin will continue to be negatively impacted.
Accordingly, under the assumption of a stable interest rate environment in 2004,
the Company would not expect its net interest margin to rebound as it did in
2002 when rates were stable, but instead projects that its net interest margin
would decline slightly to approximately 4.30%-4.40% due to the factors just
discussed. If interest rates were to further decline, the Company expects that
its net interest margin would decline further in 2004, whereas if interest rates
were to increase, the Company expects that its 2004 net interest margin would be
positively impacted.
The Company has no market risk sensitive instruments held for trading
purposes, nor does it maintain any foreign currency positions. Table 19 presents
the expected maturities of the Company's other than trading market risk
sensitive financial instruments. Table 19 also presents the estimated fair
values of market risk
36
sensitive instruments as estimated in accordance with Statement of Financial
Accounting Standards No. 107, "Disclosures About Fair Value of Financial
Instruments." The Company's assets and liabilities each have estimated fair
values that are slightly higher than their carrying value. This is due to the
yields on these portfolios being higher than market yields at December 31, 2003
for instruments with maturities similar to the remaining term of the portfolios,
due to the declining interest rate environment.
See additional discussion regarding net interest income, as well as
discussion of the changes in the annual net interest margin in the section
entitled "Net Interest Income" above.
Return on Assets and Equity
Table 20 shows return on assets (net income divided by average total
assets), return on equity (net income divided by average shareholders' equity),
dividend payout ratio (dividends per share divided by net income per share) and
shareholders' equity to assets ratio (average shareholders' equity divided by
average total assets) for each of the years in the three-year period ended
December 31, 2003.
Capital Resources and Shareholders' Equity
Shareholders' equity at December 31, 2003 amounted to $141.9 million
compared to $124.0 million at December 31, 2002. The two basic components
typically affecting the Company's shareholders' equity are net income, which
increases shareholders' equity, and dividends declared, which decreases
shareholders' equity. In 2003, net income of $19,417,000 increased equity, while
dividends declared of $8,835,000 reduced equity.
Two other items significantly impacted shareholders' equity in 2003. In
connection with the Company's acquisition of CCB in January 2003, the Company
issued 0.8 shares of stock for each share of CCB stock outstanding, which
resulted in the Company issuing a total of 333,000 shares of stock valued at
$9.3 million, which increased shareholders equity. Also, the Company continued
to actively manage its capital and number of common shares outstanding through
stock repurchases. In 2003, the Company repurchased a total of 209,380 shares of
its common stock at an average price of $24.83, which reduced shareholders'
equity by $5.2 million. At December 31, 2003, the Company had a remaining
authorization from its board of directors to repurchase 160,000 shares of stock.
Other items affecting shareholders' equity in 2003 were 1) proceeds of
$1,167,000 received from common stock issued as a result of stock option
exercises, 2) proceeds of $1,277,000 received from the issuance of stock into
the Company's dividend reinvestment plan, 3) a $546,000 increase to equity
related to the tax benefit that the Company realized due to exercises of
nonqualified stock options, and 4) other comprehensive income of $210,000, which
was comprised of the $287,000 increase in the net unrealized gain, net of taxes,
of the Company's available for sale securities that was reduced by an adjustment
to the Company's pension liability of $77,000, net of taxes.
In 2002, in addition to repurchasing 185,000 shares of stock totaling
$4,410,000, which reduced equity, other items affecting shareholders' equity
were 1) proceeds of $1,033,000 received from common stock issued as a result of
stock option exercises, 2) proceeds of $1,174,000 received from the issuance of
stock into the Company's dividend reinvestment plan, 3) a $382,000 increase to
equity related to the tax benefit that the Company realized due to exercises of
nonqualified stock options, and 4) other comprehensive income of $75,000, which
was comprised of the $176,000 increase in the net unrealized gain, net of taxes,
of the Company's available for sale securities that was reduced by an adjustment
to the Company's pension liability of $101,000, net of taxes.
In 2001, in addition to repurchasing 457,000 shares of stock at a cost of
$10,468,000, which reduced equity, one other item had a significant effect on
shareholders' equity - common stock issued in acquisitions, which primarily
related to the Company's May 2001 acquisition of Century in which approximately
586,000 shares of
37
common stock were issued. The issuance of stock in connection with the Company's
acquisitions increased shareholders' equity by $9.2 million in 2001. Other items
affecting shareholders' equity in 2001 were 1) proceeds of $731,000 received
from common stock issued as a result of stock option exercises, 2) proceeds of
$564,000 received from the issuance of stock into the Company's dividend
reinvestment plan, and 3) other comprehensive income, which was comprised
entirely of the change in the unrealized gain or loss, net of taxes, of the
Company's available for sale securities and amounted to $421,000 in 2001.
The Company is not aware of any recommendations of regulatory authorities
or otherwise which, if they were to be implemented, would have a material effect
on its liquidity, capital resources, or operations.
The Company and the Bank must comply with regulatory capital requirements
established by the FED and FDIC. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional discretionary, actions
by regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company and the Bank must
meet specific capital guidelines that involve quantitative measures of the
Company's assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Company's and Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors. These capital standards
require the Company and the Bank to maintain minimum ratios of "Tier 1" capital
to total risk-weighted assets ("Tier I Capital Ratio") and total capital to
risk-weighted assets ("Total Capital Ratio") of 4.00% and 8.00%, respectively.
Tier 1 capital is comprised of total shareholders' equity, excluding unrealized
gains or losses from the securities available for sale, less intangible assets,
and total capital is comprised of Tier 1 capital plus certain adjustments, the
largest of which for the Company and the Bank is the allowance for loan losses.
Risk-weighted assets refer to the on- and off-balance sheet exposures of the
Company and the Bank, adjusted for their related risk levels using formulas set
forth in Federal Reserve Board and FDIC regulations.
In addition to the risk-based capital requirements described above, the
Company and the Bank are subject to a leverage capital requirement, which calls
for a minimum ratio of Tier 1 capital (as defined above) to quarterly average
total assets ("Leverage Ratio) of 3.00% to 5.00%, depending upon the
institution's composite ratings as determined by its regulators. The FED has not
advised the Company of any requirement specifically applicable to it.
Table 21 presents the Company's regulatory capital ratios as of December
31, 2003, 2002, and 2001. In 2002, as a result of the Company forecasting that
its strategic growth goals would likely result in the need for additional
capital, the Company issued $20 million in debt structured as trust preferred
capital securities that qualify as capital for regulatory capital adequacy
requirements - see "Borrowings" above for further discussion. As a result of the
issuance of the trust preferred securities, the Company's capital ratios
increased significantly at December 31, 2002 compared to December 31, 2001. In
2003, while at all times the Company's regulatory capital ratios far exceeded
regulatory minimums, the ratios decreased significantly as a result of the
Company's acquisitions, which increased assets and decreased tangible capital.
The Company's issuance of an additional $20 million in trust preferred
securities in December 2003 partially offset the decrease in regulatory capital
ratios resulting from the effects of the acquisitions. Because of limitations on
the amount of Tier I capital that can be comprised of trust preferred
securities, only $29.8 million of the $40 million in trust preferred securities
outstanding is includable as Tier I capital for the Company at December 31,
2003, with the remaining $10.2 million being included as Tier II capital.
In addition to the minimum capital requirements described above, the
regulatory framework for prompt corrective action also contains specific capital
guidelines for a bank's classification as "well capitalized." The specific
guidelines are as follows - Tier I Capital Ratio of at least 6.00%, Total
Capital Ratio of at least 10.00%, and a Leverage Ratio of at least 5.00%. The
Bank's regulatory ratios exceeded the threshold for "well-capitalized" status at
December 31, 2003, 2002 and 2001.
38
The Company's goal is to maintain its "well-capitalized" status at all
times. Based on the Company's capital position at December 31, 2003 and
considering that there are no pending acquisitions, the Company does not
anticipate needing to raise capital in the foreseeable future. The Company
estimates, based on criteria provided by trust preferred security pool
underwriters, that it has the credit capacity to issue approximately $20 million
more in trust preferred securities. The Company also believes that it has the
ability to raise capital in a secondary stock offering should the need arise.
See "Supervision and Regulation" under "Business" above and Note 15 to the
consolidated financial statements for discussion of other matters that may
affect the Company's capital resources.
Inflation
Because the assets and liabilities of a bank are primarily monetary in
nature (payable in fixed determinable amounts), the performance of a bank is
affected more by changes in interest rates than by inflation. Interest rates
generally increase as the rate of inflation increases, but the magnitude of the
change in rates may not be the same. The effect of inflation on banks is
normally not as significant as its influence on those businesses that have large
investments in plant and inventories. During periods of high inflation, there
are normally corresponding increases in the money supply, and banks will
normally experience above average growth in assets, loans and deposits. Also,
general increases in the price of goods and services will result in increased
operating expenses.
Current Accounting Matters
The Company prepares its consolidated financial statements and related
disclosures in conformity with standards established by, among others, the
Financial Accounting Standards Board (the "FASB"). Because the information
needed by users of financial reports is dynamic, the FASB frequently issues new
rules and proposes new rules for companies to apply in reporting their
activities. The following paragraphs contain information regarding recently
adopted accounting standards that affected the Company and new standards that
have not yet been adopted that have the potential to affect the Company.
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, "Business Combinations" (Statement 141), and SFAS No. 142, "Goodwill
and Other Intangible Assets" (Statement 142). Statement 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. Statement 141 also specifies criteria that intangible
assets acquired in a purchase method business combination must meet in order to
be recognized and reported apart from goodwill. The Company adopted this
statement July 1, 2001. Statement 142 requires that all goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead tested
for impairment at least annually in accordance with the provisions of Statement
142. Statement 142 also requires that identifiable intangible assets with
estimable useful lives be amortized over their respective estimated useful lives
to their estimated residual values, and reviewed for impairment in accordance
with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." Certain provisions of Statement 142
relating to business combinations consummated after June 30, 2001 were adopted
by the Company on July 1, 2001. The remaining provisions were adopted on January
1, 2002. In connection with Statement 142's transitional goodwill impairment
evaluation, the statement required the Company to perform an assessment of
whether there was an indication that goodwill is impaired as of the date of
adoption. The Company completed this assessment during the first quarter of 2002
and determined that there was no goodwill impairment. The Company has also
performed annual impairment tests since the date of adoption, and the Company
determined for each of those tests that there was no goodwill impairment. See
Note 6 to the consolidated financial statements for additional disclosures
related to Statement 142.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (Statement 144), which addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. This standard provides guidance on differentiating between long-lived
assets to be
39
held and used, long-lived assets to be disposed of other than by sale and
long-lived assets to be disposed of by sale. Statement 144 supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." Statement 144 also supersedes Accounting Principles
Board Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." This statement was adopted by
the Company on January 1, 2002 and did not have a material impact on the
Company's financial statements.
In August 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (Statement 146), which addresses
financial accounting and reporting costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)."
Under EITF Issue No. 94-3, an entity recognized a liability for an exit cost on
the date that the entity committed itself to an exit plan. In Statement 146, the
Board acknowledges that an entity's commitment to a plan does not, by itself,
create a present obligation to other parties that meets the definition of a
liability. An obligation becomes a present obligation when a transaction or
event occurs that leaves an entity little or no discretion to avoid the future
transfer or use of assets to settle the liability. Statement 146 also
establishes that fair value is the objective for the initial measurement of the
liability. Statement 146 will be effective for exit or disposal activities that
are initiated after December 31, 2002. The Company adopted the provisions of
this statement effective January 1, 2003 and will apply the provisions to any
exit or disposal activities initiated after that date. The Company did not have
exit or disposal activities that were subject to accounting under Statement 146
in 2003.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions" (Statement 147), which addresses the financial
accounting and reporting for the acquisition of all or part of a financial
institution. This standard removes certain acquisitions of financial
institutions from the scope of SFAS No. 72, "Accounting for Certain Acquisitions
of Bank or Thrift Institutions" (Statement 72). This statement requires
financial institutions to reclassify goodwill arising from a qualified business
acquisition from Statement 72 goodwill to goodwill subject to the provisions of
Statement 142. The reclassified goodwill is no longer amortized but is subject
to an annual impairment test, pursuant to Statement 142. The Company adopted
Statement 147 in the fourth quarter of 2002, but effective as of January 1,
2002. Statement 147 required the Company to retroactively restate its previously
issued 2002 interim consolidated financial statements to reverse reclassified
Statement 72 goodwill amortization expense recorded in the first three quarters
of the 2002 fiscal year. Accordingly, $1,068,000 in amortization expense that
had been recorded during the first nine months of 2002 was retroactively
reversed by reducing the respective quarters' amortization expense and
increasing intangible assets. The associated income tax expense recorded related
to the reversal of amortization expense amounted to $374,000 for that same nine
month period.
In November 2002, the FASB issued Financial Interpretation No. 45 (FIN
45), "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others", which addresses the
disclosure to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees. FIN 45 requires the guarantor
to recognize a liability for the non-contingent component of the guarantee, such
as the obligation to stand ready to perform in the event that specified
triggering events or conditions occur. The initial measurement of this liability
is the fair value of the guarantee at inception. The recognition of the
liability is required even if it is not probable that payments will be required
under the guarantee or if the guarantee was issued with a premium payment or as
part of a transaction with multiple events. The disclosure requirements were
effective for interim and annual financial statements ending after December 15,
2002 and are contained in Note 12 to the consolidated financial statements. The
initial recognition and measurement provisions were effective for all guarantees
within the scope of FIN 45 issued or modified after December 31, 2002, the
impacts of which were not material to the Company. The Company issues standby
letters of credit whereby the Company guarantees performance if a specified
triggering event or condition occurs, primarily nonpayment by the Company's
customer to their supplier. The standby letters of credit are generally for
terms for one year, at which time they may be renewed for another year if both
parties agree. See Note 12 to
40
the accompanying audited consolidated financial statements.
In December 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" (FAS 148) an amendment of FASB
Statement No. 123, "Accounting for Stock-Based Compensation" (FAS 123), which
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, FAS 148 amends the disclosure requirements of FAS 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition provisions of the statement are
effective for financial statements for fiscal years ending after December 15,
2002 while the disclosure requirements are effective for interim periods
beginning after December 15, 2002, with early application encouraged. The
adoption of SFAS 148 required enhanced disclosures for the Company's stock-based
employee compensation plan for the year ended December 31, 2002. The Company
does not have any plans to change its method of accounting for stock-based
employee compensation, but has furnished the expanded disclosures in Note 1(k)
in the accompanying audited consolidated financial statements.
In January 2003, the FASB issued Financial Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities," which was subsequently revised in
December 2003. FIN 46 addresses the consolidation by business enterprises of
certain variable interest entities. The provisions of this interpretation became
effective for the Company on January 31, 2003 as it relates to variable interest
entities created or purchased after that date. In October 2003, the FASB issued
guidance that provided for a deferral of the effective date of applying FIN 46
to entities created before February 1, 2003, to no later than December 31, 2003.
In addition, the deferral permitted a company to apply FIN 46 as of July 1,
2003, to some or all of the variable interest entities in which it holds an
interest, and the rest on December 31, 2003. In December 2003, the FASB issued a
revision to (FIN 46R), which clarified and interpreted certain of the provisions
of FIN 46, without changing the basic accounting model in FIN 46. The provisions
of FIN 46R are effective no later than March 31, 2004. However, companies must
apply either FIN 46 or FIN 46R to those entities considered special purpose
entities no later than December 31, 2003. The adoption of FIN 46 did not have an
impact on the Company's financial position or results of operations. The Company
has identified no investments in variable interest entities that would require
consolidation under FIN 46. For the Company, beginning with the first quarter of
2004, the application of FIN 46R will result in the de-consolidation of the
trusts that have issued the trust preferred capital securities currently
reported in the consolidated financial statements. The trust preferred capital
securities are currently disclosed as long-term borrowings within the
consolidated financial statements. The de-consolidation of the trust will
instead cause the disclosure of junior subordinated debentures between the
Company and the trust subsidiary. Currently, the junior subordinated debentures
are eliminated in consolidation, resulting in the disclosure of long-term
borrowings. The impact of this change will not have a material effect on the
Company's consolidated financial statements. Treatment of trust preferred
securities within the Company's capital ratio calculations in light of FIN 46 is
pending further guidance from the banking regulators. If the banking regulators
change the capital treatment for trust preferred securities, the Company's Tier
1 and total capital could be reduced by the amount of outstanding trust
preferred securities, but the Company believes that its capital classifications
would not fall below the level of "adequately" capitalized and that the Company
has other options available to raise capital, including but not limited to a
secondary stock offering. Additional information regarding the Company's trust
preferred securities is included in Note 9 in the accompanying audited
consolidated financial statements.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 (Statement 149), "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities," which amends and clarifies financial accounting and
reporting for derivative instruments and for hedging activities under Statement
of Financial Accounting Standards No. 133. Adoption of Statement 149 on July 1,
2003 did not have a material effect on the Company's consolidated financial
statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 (Statement 150), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity", which establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a
41
liability (or an asset in some circumstances). This Statement is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. It is to be implemented by reporting the cumulative effect of a change
in accounting principle for financial instruments created before the issuance
date of the Statement and still existing at the beginning of the interim period
of adoption. Adoption of Statement 150 on July 1, 2003 did not have a material
effect on the Company's consolidated financial statements.
In November 2003, the FASB ratified a consensus reached by its Emerging
Issues Task Force ("EITF") regarding quantitative and qualitative disclosures
required by EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment
and Its Application to Certain Investments." EITF Issue No. 03-1 requires
certain quantitative and qualitative disclosures as it relates to investments
that have unrealized losses that have not been recognized as
other-than-temporary impairments and is effective for fiscal years ending after
December 15, 2003. The additional disclosures required for the Company are
included in Note 3 in the accompanying audited consolidated financial
statements.
In December 2003, the FASB issued Statement of Financial Accounting
Standards No. 132 (revised 2003) (Statement 132(R)), "Employers' Disclosures
about Pensions and Other Postretirement Benefits." Statement 132(R) revises
employers' disclosures about pension plans and other postretirement plans, but
does not change the measurement or recognition of those plans. Statement No.
132(R) requires additional disclosures about the assets, obligations, cash
flows, and net periodic pension cost of defined benefit plans and other defined
benefit postretirement plans. Most of the provisions of Statement 132(R) are
effective for financial statements with fiscal years after December 15, 2003,
with certain provisions becoming effective for fiscal years ending after June
15, 2004. The additional disclosures required for the Company are included in
Note 11 in the accompanying audited consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information responsive to this Item is found in Item 7 under the
caption "Interest Rate Risk."
FORWARD-LOOKING STATEMENTS
The discussion in Part I and Part II of this report contains 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," or other statements concerning opinions or
judgment of the Company 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 the Company's
customers, the Company's level of success in integrating acquisitions, actions
of government regulators, the level of market interest rates, and general
economic conditions.
42
Table 1 Selected Consolidated Financial Data
================================================================================
Year Ended December 31,
($ in thousands, except per share ------------------------------------------------------------------------
and nonfinancial data) 2003 2002 2001 2000 (1) 1999
---------- --------- --------- -------- -------
Income Statement Data
Interest income $ 74,667 73,261 76,773 72,915 61,591
Interest expense 18,907 23,871 35,720 34,220 26,488
Net interest income 55,760 49,390 41,053 38,695 35,103
Provision for loan losses 2,680 2,545 1,151 1,605 910
Net interest income after provision 53,080 46,845 39,902 37,090 34,193
Noninterest income 14,918 11,968 9,655 4,729 5,647
Noninterest expense 37,964 32,301 28,634 26,741 21,752
Income before income taxes 30,034 26,512 20,923 15,078 18,088
Income taxes 10,617 9,282 7,307 5,736 6,234
Net income 19,417 17,230 13,616 9,342 11,854
Earnings per share - basic 2.07 1.89 1.51 1.05 1.32
Earnings per share - diluted 2.03 1.85 1.47 1.03 1.27
============================================================================================================================
Per Share Data
Cash dividends declared $ 0.94 0.90 0.88 0.77 0.63
Market Price
High 32.23 27.52 28.08 17.25 20.00
Low 22.95 20.20 15.50 12.06 13.31
Close 31.20 23.51 22.55 15.75 16.50
Book value - stated 15.03 13.59 12.81 12.54 12.09
Tangible book value 9.66 10.83 10.12 12.01 11.50
============================================================================================================================
Selected Balance Sheet Data (at year end)
Total assets $1,475,769 1,218,146 1,144,691 915,167 889,531
Loans 1,218,895 998,547 890,310 746,089 643,224
Allowance for loan losses 13,569 10,907 9,388 7,893 6,674
Intangible assets 50,701 25,169 24,488 4,630 5,261
Deposits 1,249,364 1,055,957 1,000,281 770,379 712,139
Borrowings 76,000 30,000 15,000 26,200 62,500
Total shareholders' equity 141,856 123,985 116,726 110,684 106,980
============================================================================================================================
Selected Average Balances
Assets $1,339,823 1,162,708 1,046,030 909,800 823,571
Loans 1,113,426 954,885 831,817 701,317 597,951
Earning assets 1,245,679 1,090,666 983,628 867,269 782,492
Deposits 1,153,385 1,010,693 899,989 744,835 680,749
Interest-bearing liabilities 1,065,950 928,686 837,563 724,152 643,921
Shareholders' equity 137,293 120,943 115,620 110,093 107,913
============================================================================================================================
Ratios
Return on average assets 1.45% 1.48% 1.30% 1.03% 1.44%
Return on average equity 14.14% 14.25% 11.78% 8.49% 10.98%
Net interest margin (taxable-equivalent basis) 4.52% 4.58% 4.23% 4.53% 4.56%
Shareholders' equity to assets at year end 9.61% 10.18% 10.20% 12.09% 12.03%
Loans to deposits at year end 97.56% 94.56% 89.01% 96.85% 90.32%
Net charge-offs to average loans 0.10% 0.11% 0.09% 0.06% 0.06%
Efficiency ratio 53.32% 52.19% 55.82% 60.75% 52.59%
============================================================================================================================
(1) Results for the year ended December 31, 2000 were significantly impacted
by merger-related charges.
================================================================================
43
Table 2 Average Balances and Net Interest Income Analysis
================================================================================
Year Ended December 31,
------------------------------------------------------------------------------------------------------
2003 2002 2001
-------------------------------- -------------------------------- ---------------------------------
Interest Interest Interest
Average Avg. Earned Average Avg. Earned Average Avg. Earned
($ in thousands) Volume Rate or Paid Volume Rate or Paid Volume Rate or Paid
---------- ------- --------- ---------- ------- ---------- ---------- -------- ----------
Assets
Loans (1) $1,113,426 6.23% $ 69,318 $ 954,885 6.99% $ 66,742 $ 831,817 8.18% $ 68,055
Taxable securities 81,211 4.80% 3,902 83,642 5.93% 4,961 98,645 6.46% 6,372
Non-taxable securities (2) 14,238 8.33% 1,186 14,823 8.51% 1,262 16,280 8.60% 1,400
Short-term investments,
primarily federal funds 36,804 2.12% 779 37,316 2.23% 831 36,886 4.17% 1,538
---------- --------- ---------- ---------- ---------- ----------
Total interest-
earning assets 1,245,679 6.04% 75,185 1,090,666 6.77% 73,796 983,628 7.87% 77,365
--------- ---------- ----------
Cash and due from banks 31,189 26,330 25,618
Bank premises and
equipment, net 23,371 20,769 16,781
Other assets 39,584 24,943 20,003
---------- ---------- ----------
Total assets $1,339,823 $1,162,708 $1,046,030
========== ========== ==========
Liabilities and Equity
Savings, NOW and money
market deposits $ 414,525 0.53% 2,215 $ 368,807 0.97% 3,588 $ 300,387 1.78% 5,354
Time deposits >$100,000 229,758 2.56% 5,892 186,178 3.67% 6,825 171,096 5.88% 10,058
Other time deposits 379,603 2.37% 9,001 352,964 3.51% 12,376 345,350 5.48% 18,941
---------- --------- ---------- ---------- ---------- ----------
Total interest-bearing
deposits 1,023,886 1.67% 17,108 907,949 2.51% 22,789 816,833 4.21% 34,353
Borrowings 42,064 4.28% 1,799 20,737 5.22% 1,082 20,729 6.59% 1,367
---------- --------- ---------- ---------- ---------- ----------
Total interest-
bearing liabilities 1,065,950 1.77% 18,907 928,686 2.57% 23,871 837,562 4.26% 35,720
--------- ---------- ----------
Non-interest-
bearing deposits 129,499 102,744 83,156
Other liabilities 7,081 10,335 9,692
Shareholders' equity 137,293 120,943 115,620
---------- ---------- ----------
Total liabilities and
shareholders' equity $1,339,823 $1,162,708 $1,046,030
========== ========== ==========
Net yield on interest-
earning assets and
net interest income 4.52% $ 56,278 4.58% $ 49,925 4.23% $ 41,645
========= ========== ==========
Interest rate spread 4.26% 4.20% 3.61%
Average prime rate 4.12% 4.67% 6.93%
- --------------------------------------------------------------------------------
(1) Average loans include nonaccruing loans, the effect of which is to lower
the average rate shown. Interest earned includes recognized loan fees in
the amounts of $1,235,000, $938,000, and $738,000 for 2003, 2002, and
2001, respectively.
(2) Includes tax-equivalent adjustments of $519,000, $535,000, and $592,000 in
2003, 2002, and 2001, respectively, to reflect the federal and state
benefit of the tax-exempt securities, reduced by the related nondeductible
portion of interest expense.
================================================================================
44
Table 3 Volume and Rate Variance Analysis
================================================================================
Year Ended December 31, 2003 Year Ended December 31, 2002
------------------------------------ --------------------------------------
Change Attributable to Change Attributable to
---------------------- ----------------------
Total Total
Changes Changes Increase Changes Changes Increase
(In thousands) in Volumes in Rates (Decrease) in Volumes in Rates (Decrease)
---------- -------- ---------- ---------- --------- ----------
Interest income (tax-equivalent):
Loans $ 10,476 (7,900) 2,576 $ 9,335 (10,648) (1,313)
Taxable securities (130) (929) (1,059) (929) (482) (1,411)
Non-taxable securities (49) (27) (76) (125) (13) (138)
Short-term investments, principally
federal funds sold (11) (41) (52) 14 (721) (707)
--------- -------- --------- --------- --------- ---------
Total interest income 10,286 (8,897) 1,389 8,295 (11,864) (3,569)
--------- -------- --------- --------- --------- ---------
Interest expense:
Savings, NOW and money
market deposits 345 (1,718) (1,373) 943 (2,709) (1,766)
Time deposits>$100,000 1,358 (2,291) (933) 720 (3,953) (3,233)
Other time deposits 783 (4,158) (3,375) 342 (6,907) (6,565)
--------- -------- --------- --------- --------- ---------
Total interest-bearing deposits 2,486 (8,167) (5,681) 2,005 (13,569) (11,564)
Borrowings 1,012 (295) 717 -- (285) (285)
--------- -------- --------- --------- --------- ---------
Total interest expense 3,498 (8,462) (4,964) 2,005 (13,854) (11,849)
--------- -------- --------- --------- --------- ---------
Net interest income $ 6,788 (435) 6,353 $ 6,290 1,990 8,280
========= ======== ========= ========= ========= =========
(1) Changes attributable to both volume and rate are allocated equally between
rate and volume variances.
Table 4 Noninterest Income
================================================================================
Year Ended December 31,
---------------------------------
(In thousands) 2003 2002 2001
------- ------- ------
Service charges on deposit accounts $ 7,938 6,856 5,265
Other service charges, commissions, and fees 2,710 2,336 2,046
Fees from presold mortgages 2,327 1,713 1,259
Commissions from sales of insurance and
financial products 1,304 738 731
Data processing fees 333 303 205
------- ------- ------
Total core noninterest income 14,612 11,946 9,506
Loan sale gains 2 11 9
Securities gains, net 218 25 61
Other gains (losses), net 86 (14) 79
------- ------- ------
Total $14,918 11,968 9,655
======= ======= ======
Table 5 Noninterest Expenses
================================================================================
Year Ended December 31,
---------------------------------
(In thousands) 2003 2002 2001
------- ------- ------
Salaries $17,756 15,079 12,534
Employee benefits 4,381 3,388 3,083
------- ------- ------
Total personnel expense 22,137 18,467 15,617
Occupancy expense 2,366 2,077 1,734
Equipment related expenses 2,555 2,128 1,631
Amortization of intangible assets 224 31 1,535
Stationery and supplies 1,498 1,445 1,279
Telephone 1,229 932 688
Non-credit losses 198 97 167
Other operating expenses 7,757 7,124 5,983
------- ------- ------
Total $37,964 32,301 28,634
======= ======= ======
================================================================================
45
Table 6 Income Taxes
================================================================================
(In thousands) 2003 2002 2001
------- ----- -----
Current - Federal $ 9,578 8,964 7,256
- State 614 464 102
Deferred - Federal 425 (146) (51)
------- ----- -----
Total $10,617 9,282 7,307
======= ===== =====
Effective tax rate 35.3% 35.0% 34.9%
======= ===== =====
Table 7 Distribution of Assets and Liabilities
================================================================================
As of December 31,
---------------------------------------
2003 2002 2001
-------- -------- ---------
Assets
Interest-earning assets
Net loans 82% 81% 77%
Securities available for sale 7 5 8
Securities held to maturity 1 1 1
Short term investments 2 6 6
-------- -------- ---------
Total interest-earning assets 92 93 92
Noninterest-earning assets
Cash and due from banks 2 2 3
Premises and equipment 2 2 2
Other assets 4 3 3
-------- -------- ---------
Total assets 100% 100% 100%
======== ======== =========
Liabilities and shareholders' equity
Demand deposits - noninterest bearing 10% 9% 8%
Savings, NOW, and money market deposits 31 32 31
Time deposits of $100,000 or more 16 17 17
Other time deposits 27 29 32
-------- -------- ---------
Total deposits 84 87 88
Borrowings 5 2 1
Accrued expenses and other liabilities 1 1 1
-------- -------- ---------
Total liabilities 90 90 90
Shareholders' equity 10 10 10
-------- -------- ---------
Total liabilities and shareholders' equity 100% 100% 100%
======== ======== =========
Table 8 Securities Portfolio Composition
================================================================================
As of December 31,
---------------------------------------
(In thousands) 2003 2002 2001
-------- -------- ---------
Securities available for sale:
U.S. Treasury $ -- -- 512
U.S. Government agencies 35,808 13,529 28,111
Mortgage-backed securities 48,473 35,208 52,227
Corporate bonds 13,415 11,507 8,663
Equity securities 5,759 5,535 6,956
-------- -------- ---------
Total securities available for sale 103,455 65,779 96,469
-------- -------- ---------
Securities held to maturity:
State and local governments 12,947 13,951 16,130
Other 1,259 1,039 208
-------- -------- ---------
Total securities held to maturity 14,206 14,990 16,338
-------- -------- ---------
Total securities $117,661 80,769 112,807
======== ======== =========
Average total securities during year $ 95,449 98,465 114,925
======== ======== =========
================================================================================
46
Table 9 Securities Portfolio Maturity Schedule
================================================================================
As of December 31,
----------------------------------------
2003
----------------------------------------
Book Fair Book
($ in thousands) Value Value Yield (1)
-------- --------- ---------
Securities available for sale:
U.S. Government agencies
Due within one year $ 515 513 1.00%
Due after one but within five years 15,844 15,989 3.42%
Due after five but within ten years 18,866 19,306 5.50%
-------- --------- ------
Total 35,225 35,808 4.49%
-------- --------- ------
Mortgage-backed securities
Due within one year 1,262 1,301 3.92%
Due after one but within five years 25,877 25,921 3.94%
Due after five but within ten years 19,390 19,371 4.40%
Due after ten years 1,926 1,880 4.70%
-------- --------- ------
Total 48,455 48,473 4.18%
-------- --------- ------
Corporate debt securities
Due within one year 857 861 4.06%
Due after one but within five years 538 549 3.40%
Due after ten years 10,759 12,005 8.34%
-------- --------- ------
Total 12,154 13,415 7.82%
-------- --------- ------
Equity securities 5,753 5,759 3.92%
-------- --------- ------
Total securities available for sale
Due within one year 2,634 2,675 3.39%
Due after one but within five years 42,259 42,459 4.12%
Due after five but within ten years 38,256 38,677 4.94%
Due after ten years 18,438 19,644 6.56%
-------- --------- ------
Total $101,587 103,455 4.85%
======== ========= ======
Securities held to maturity:
State and local governments
Due within one year $ 1,305 1,317 5.46%
Due after one but within five years 7,707 8,101 6.48%
Due after five but within ten years 3,339 3,593 7.61%
Due after ten years 596 636 7.15%
-------- --------- ------
Total 12,947 13,647 6.70%
-------- --------- ------
Other
Due after one but within five years 1,259 1,259 1.01%
-------- --------- ------
Total 1,259 1,259 1.01%
-------- --------- ------
Total securities held to maturity
Due within one year 1,305 1,317 5.46%
Due after one but within five years 8,966 9,360 5.71%
Due after five but within ten years 3,339 3,593 7.61%
Due after ten years 596 636 7.15%
-------- --------- ------
Total $ 14,206 14,906 6.19%
======== ========= ======
(1) Yields on tax-exempt investments have been adjusted to a taxable
equivalent basis using a 35% tax rate.
================================================================================
47
Table 10 Loan Portfolio Composition
================================================================================
As of December 31,
--------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------- ------------------- -------------------- --------------------- -------------------
% of % of % of % of % of
Total Total Total Total Total
($ in thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Commercial,
financial, &
agricultural $ 117,287 9.62% $ 88,291 8.84% $ 79,695 8.94% $ 76,507 10.24% $ 58,574 9.10%
Real estate -
construction 98,189 8.05% 68,162 6.82% 66,304 7.44% 57,608 7.71% 36,823 5.72%
Real estate -
mortgage(1) 939,578 77.05% 795,148 79.57% 697,498 78.29% 571,638 76.55% 512,080 79.52%
Installment loans
to individuals 64,444 5.28% 47,648 4.77% 47,471 5.33% 41,047 5.50% 36,450 5.66%
---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------
Loans, gross 1,219,498 100.00% 999,249 100.00% 890,968 100.00% 746,800 100.00% 643,927 100.00%
====== ====== ====== ====== ======
Unamortized net
deferred loan
fees & unearned
income (603) (702) (658) (711) (703)
---------- ---------- ---------- ---------- ----------
Total loans, net $1,218,895 $ 998,547 $ 890,310 $ 746,089 $ 643,224
========== ========== ========== ========== ==========
(1) The majority of these loans are various personal and commercial loans
where real estate provides additional security for the loan.
Table 11 Loan Maturities
================================================================================
As of December 31, 2003
--------------------------------------------------------------------------------------------
Due within Due after one year but Due after five
one year within five years years Total
-------------------- ---------------------- --------------------- --------------------
($ in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
---------- ------- ----------- -------- ---------- ------- ---------- -------
Variable Rate Loans:
Commercial, financial, and
agricultural $ 39,255 4.47% $ 29,228 4.42% $ 2,180 5.46% $ 70,663 4.48%
Real estate - construction 73,415 4.56% 8,038 4.36% 2,414 3.84% 83,867 4.52%
Real estate - mortgage 74,727 4.53% 192,777 4.46% 256,004 5.32% 523,508 4.89%
Installment loans
to individuals 873 4.65% 6,403 6.97% 1,409 6.70% 8,685 6.69%
---------- ---------- ---------- ----------
Total at variable rates 188,270 4.53% 236,446 4.52% 262,007 5.31% 686,723 4.83%
---------- ---------- ---------- ----------
Fixed Rate Loans:
Commercial, financial, and
agricultural 9,680 7.03% 30,226 6.85% 7,485 6.05% 47,391 6.76%
Real estate - construction 16,658 5.97% 721 6.93% 742 5.04% 18,121 5.97%
Real estate - mortgage 39,641 7.20% 289,584 6.63% 78,910 7.18% 408,135 6.79%
Installment loans
to individuals 8,336 7.99% 41,835 9.02% 4,080 7.29% 54,251 8.73%
---------- ---------- ---------- ----------
Total at fixed rates 74,315 6.99% 362,366 6.92% 91,217 7.07% 527,898 6.96%
---------- ---------- ---------- ----------
Subtotal 262,585 5.23% 598,812 5.97% 353,224 5.76% 1,214,621 5.76%
Nonaccrual loans 4,274 -- -- 4,274
---------- ---------- ---------- ----------
Loans, gross $ 266,859 $ 598,812 $ 353,224 $1,218,895
========== ========== ========== ==========
The above table is based on contractual scheduled maturities. Early repayment of
loans or renewals at maturity are not considered in this table.
================================================================================
48
Table 12 Nonperforming Assets
================================================================================
As of December 31,
--------------------------------------------------------
($ in thousands) 2003 2002 2001 2000 1999
------- ------- ------ ------ ------
Nonaccrual loans $ 4,274 2,976 3,808 626 1,424
Restructured loans 21 41 83 237 257
Accruing loans >90 days past due -- -- -- -- --
------- ------- ------ ------ ------
Total nonperforming loans 4,295 3,017 3,891 863 1,681
Other real estate (included in other assets) 1,398 1,384 1,253 893 906
------- ------- ------ ------ ------
Total nonperforming assets $ 5,693 4,401 5,144 1,756 2,587
======= ======= ====== ====== ======
Nonperforming loans as a percentage
of total loans 0.35% 0.30% 0.44% 0.12% 0.26%
Nonperforming assets as a percentage of
loans and other real estate 0.47% 0.44% 0.58% 0.24% 0.40%
Nonperforming assets as a percentage of
total assets 0.39% 0.36% 0.45% 0.19% 0.29%
Allowance for loan losses as a percentage
of nonperforming loans 315.93% 361.52% 241.27% 914.60% 397.03%
Table 13 Allocation of the Allowance for Loan Losses
================================================================================
As of December 31,
--------------------------------------------------------
($ in thousands) 2003 2002 2001 2000 1999
------- ------- ------ ------ ------
Commercial, financial, and agricultural $ 2,420 1,890 1,643 1,574 726
Real estate - construction 641 483 449 393 255
Real estate - mortgage 8,920 7,416 6,230 4,849 4,078
Installment loans to individuals 1,435 1,094 1,021 817 587
------- ------- ------ ------ ------
Total allocated 13,416 10,883 9,343 7,633 5,646
Unallocated 153 24 45 260 1,028
------- ------- ------ ------ ------
Total $13,569 10,907 9,388 7,893 6,674
======= ======= ====== ====== ======
================================================================================
49
Table 14 Loan Loss and Recovery Experience
================================================================================
As of December 31,
---------------------------------------------------------------------------
($ in thousands) 2003 2002 2001 2000 1999
----------- --------- --------- --------- ---------
Loans outstanding at end of year $ 1,218,895 998,547 890,310 746,089 643,224
=========== ========= ========= ========= =========
Average amount of loans outstanding $ 1,113,426 954,885 831,817 701,317 597,951
=========== ========= ========= ========= =========
Allowance for loan losses, at
beginning of year $ 10,907 9,388 7,893 6,674 6,100
Provision for loan losses 2,680 2,545 1,151 1,605 910
Additions related to loans assumed in
corporate acquisitions 1,083 50 1,125 -- --
----------- --------- --------- --------- ---------
14,670 11,983 10,169 8,279 7,010
----------- --------- --------- --------- ---------
Loans charged off:
Commercial, financial and agricultural (205) (598) (89) (171) (53)
Real estate - mortgage (705) (230) (181) (3) (126)
Installment loans to individuals (431) (383) (642) (301) (269)
----------- --------- --------- --------- ---------
Total charge-offs (1,341) (1,211) (912) (475) (448)
----------- --------- --------- --------- ---------
Recoveries of loans previously charged-off:
Commercial, financial and agricultural 73 33 27 10 27
Real estate - mortgage 30 15 48 20 17
Installment loans to individuals 137 87 56 59 68
----------- --------- --------- --------- ---------
Total recoveries 240 135 131 89 112
----------- --------- --------- --------- ---------
Net charge-offs (1,101) (1,076) (781) (386) (336)
----------- --------- --------- --------- ---------
Allowance for loan losses, at end of year $ 13,569 10,907 9,388 7,893 6,674
=========== ========= ========= ========= =========
Ratios:
Net charge-offs as a percent of average loans 0.10% 0.11% 0.09% 0.06% 0.06%
Allowance for loan losses as a
percent of loans at end of year 1.11% 1.09% 1.05% 1.06% 1.04%
Allowance for loan losses as a multiple
of net charge-offs 12.32x 10.14x 12.02x 20.45x 19.86x
Provision for loan losses as a percent of net
charge-offs 243.42% 236.52% 147.38% 415.80% 270.83%
Recoveries of loans previously charged-off
as a percent of loans charged-off 17.90% 11.15% 14.36% 18.74% 25.00%
================================================================================
50
Table 15 Average Deposits
================================================================================
Year Ended December 31,
----------------------------------------------------------------------------------
2003 2002 2001
----------------------- ------------------------- -----------------------
Average Average Average Average Average Average
($ in thousands) Amount Rate Amount Rate Amount Rate
---------- ------- ---------- -------- ---------- -------
Interest-bearing demand deposits $ 308,750 0.47% $ 284,657 0.93% $ 233,770 1.77%
Savings deposits 105,775 0.72% 84,150 1.13% 66,617 1.82%
Time deposits 379,603 2.37% 352,964 3.67% 345,350 5.48%
Time deposits > $100,000 229,758 2.56% 186,178 3.51% 171,096 5.88%
---------- ---------- ----------
Total interest-bearing deposits 1,023,886 1.67% 907,949 2.51% 816,833 4.21%
Noninterest-bearing deposits 129,499 -- 102,744 -- 83,156 --
---------- ---------- ----------
Total deposits $1,153,385 1.48% $1,010,693 2.25% $ 899,989 3.82%
========== ========== ==========
Table 16 Maturities of Time Deposits of $100,000 or More
================================================================================
As of December 31, 2003
---------------------------------------------------------------------------------
3 Months Over 3 to 6 Over 6 to 12 Over 12
(In thousands) or Less Months Months Months Total
--------- ----------- ------------ -------- ---------
Time deposits of $100,000 or more $ 97,174 61,474 50,180 29,707 238,535
========= ======== ======== ======== =========
Table 17 Interest Rate Sensitivity Analysis
================================================================================
Repricing schedule for interest-earning assets and interest-bearing
liabilities held as of December 31, 2003
--------------------------------------------------------------------------
3 Months Over 3 to 12 Total Within Over 12
($ in thousands) or Less Months 12 Months Months Total
--------- ------------ ------------ ---------- ----------
Earning assets:
Loans, net of deferred fees $ 598,400 65,729 664,129 554,766 1,218,895
Securities available for sale 8,407 31,790 40,197 63,258 103,455
Securities held to maturity 200 2,193 2,393 11,813 14,206
Short-term investments 27,906 -- 27,906 -- 27,906
--------- --------- ---------- ---------- ----------
Total earning assets $ 634,913 99,712 734,625 629,837 1,364,462
========= ========= ========== ========== ==========
Percent of total earning assets 46.53% 7.31% 53.84% 46.16% 100.00%
Cumulative percent of total earning assets 46.53% 53.84% 53.84% 100.00% 100.00%
Interest-bearing liabilities:
Savings, NOW and money market deposits $ 462,876 -- 462,876 -- 462,876
Time deposits of $100,000 or more 97,174 111,654 208,828 29,707 238,535
Other time deposits 126,315 201,377 327,692 73,762 401,454
Borrowings 65,000 -- 65,000 11,000 76,000
--------- --------- ---------- ---------- ----------
Total interest-bearing liabilities $ 751,365 313,031 1,064,396 114,469 1,178,865
========= ========= ========== ========== ==========
Percent of total interest-bearing liabilities 63.74% 26.55% 90.29% 9.71% 100.00%
Cumulative percent of total interest-
bearing liabilities 63.74% 90.29% 90.29% 100.00% 100.00%
Interest sensitivity gap $(116,452) (213,319) (329,771) 515,368 185,597
Cumulative interest sensitivity gap (116,452) (329,771) (329,771) 185,597 185,597
Cumulative interest sensitivity gap
as a percent of total earning assets -8.53% -24.17% -24.17% 13.60% 13.60%
Cumulative ratio of interest-sensitive
assets to interest-sensitive liabilities 84.50% 69.02% 69.02% 115.74% 115.74%
================================================================================
51
Table 18 Contractual Obligations and Other Commercial Commitments
================================================================================
Payments Due by Period (in thousands)
Contractual -------------------------------------------------------------
Obligations On Demand or
- --------------------------------------- Less After
As of December 31, 2003 Total than 1 Year 1-3 Years 4-5 Years 5 Years
- --------------------------------------- ---------- ----------- --------- --------- -------
Borrowings $ 76,000 25,000 3,000 3,000 45,000
Operating leases 2,460 376 555 392 1,137
---------- --------- ------ ------ ------
Total contractual cash obligations,
excluding deposits 78,460 25,376 3,555 3,392 46,137
Deposits 1,249,364 1,148,963 63,425 36,081 895
---------- --------- ------ ------ ------
Total contractual cash obligations,
including deposits $1,327,824 1,174,339 66,980 39,473 47,032
========== ========= ====== ====== ======
Amount of Commitment Expiration Per Period (in thousands)
Other Commercial -------------------------------------------------------------
Commitments Total
- --------------------------------------- Amounts Less After
As of December 31, 2003 Committed than 1 Year 1-3 Years 4-5 Years 5 Years
- --------------------------------------- ---------- ----------- --------- --------- -------
Credit cards $ 15,026 7,513 7,513 -- --
Lines of credit and loan commitments 196,688 99,442 5,726 3,177 88,343
Standby letters of credit 3,320 3,311 9 -- --
---------- --------- ------ ------ ------
Total commercial commitments $ 215,034 110,266 13,248 3,177 88,343
========== ========= ====== ====== ======
Table 19 Market Risk Sensitive Instruments
================================================================================
Expected Maturities of Market Sensitive Instruments Held
at December 31, 2003 Occurring in Indicated Year
-----------------------------------------------------------------------------
Average Estimated
Interest Fair
($ in thousands) 2004 2005 2006 2007 2008 Beyond Total Rate Value
---------- ------- ------- ------- ------- ------- --------- -------- ----------
Due from banks,
interest-bearing $ 12,632 -- -- -- -- -- 12,632 0.90% $ 12,632
Federal funds sold 13,967 -- -- -- -- -- 13,967 0.90% 13,967
Presold mortgages in process
of settlement 1,307 -- -- -- -- -- 1,307 5.25% 1,307
Debt Securities- at
amortized cost (1) (2) 42,039 11,888 11,384 12,286 10,277 22,166 110,040 4.95% 112,602
Loans - fixed (3) (4) 96,574 67,601 90,356 95,947 103,136 64,710 518,324 7.01% 525,931
Loans - adjustable (3) (4) 222,517 69,562 71,028 71,925 127,469 133,796 696,297 4.83% 697,167
---------- ------- ------- ------- ------- ------- --------- ------- ----------
Total $ 389,036 149,051 172,768 180,158 240,882 220,672 1,352,567 5.60% $1,363,606
========== ======= ======= ======= ======= ======= ========= ======= ==========
Savings, NOW, and
money market
deposits $ 462,876 -- -- -- -- -- 462,876 0.48% $ 462,876
Time deposits 539,588 48,664 14,761 22,168 13,913 895 639,989 2.11% 642,027
Borrowings - fixed (2) -- 1,000 2,000 2,000 1,000 5,000 11,000 4.23% 11,383
Borrowings - adjustable 25,000 -- -- -- -- 40,000 65,000 3.06% 65,000
---------- ------- ------- ------- ------- ------- --------- ------- ----------
Total $1,027,464 49,664 16,761 24,168 14,913 45,895 1,178,865 1.54% $1,181,286
========== ======= ======= ======= ======= ======= ========= ======= ==========
(1) Tax-exempt securities are reflected at a tax-equivalent basis using a 35%
tax rate.
(2) Securities and borrowings with call dates within 12 months of December 31,
2003 that have above market interest rates are assumed to mature at their
call date for purposes of this table. Mortgage securities are assumed to
mature in the period of their expected repayment based on estimated
prepayment speeds.
(3) Excludes nonaccrual loans.
(4) Single-family mortgage loans are assumed to mature in the period of their
expected repayment based on estimated prepayment speeds. All other loans
are shown in the period of their contractual maturity.
52
Table 20 Return on Assets and Equity
================================================================================
For the Year Ended December 31,
-------------------------------------------------------------
2003 2002 2001
------ ------ ------
Return on assets 1.45% 1.48% 1.30%
Return on equity 14.14% 14.25% 11.78%
Dividend payout ratio 45.41% 47.62% 58.28%
Average shareholders' equity to average assets 10.25% 10.40% 11.05%
Table 21 Risk-Based and Leverage Capital Ratios
================================================================================
As of December 31,
---------------------------------------------------
($ in thousands) 2003 2002 2001
----------- ---------- ----------
Risk-Based and Leverage Capital
Tier I capital:
Common shareholders' equity $ 141,856 123,985 116,726
Trust preferred securities - up to
allowable Tier I inclusion limit 29,801 20,000 --
Intangible assets (50,701) (25,169) (24,488)
Accumulated other
comprehensive income (962) (752) (677)
----------- ---------- ----------
Total Tier I leverage capital 119,994 118,064 91,561
----------- ---------- ----------
Tier II capital:
Remainder of trust preferred securities 10,199 -- --
Allowable allowance for loan losses 13,569 10,907 9,388
----------- ---------- ----------
Tier II capital additions 23,768 10,907 9,388
----------- ---------- ----------
Total risk-based capital $ 143,762 128,971 100,949
=========== ========== ==========
Risk adjusted assets $ 1,182,966 957,158 857,933
Tier I risk-adjusted assets
(includes Tier I capital adjustments) 1,131,303 931,237 832,768
Tier II risk-adjusted assets
(includes Tiers I and II capital adjustments) 1,144,697 942,144 842,156
Fourth quarter average assets 1,431,031 1,195,930 1,109,460
Adjusted fourth quarter average assets
(includes Tier I capital adjustments) 1,379,368 1,170,009 1,084,295
Risk-based capital ratios:
Tier I capital to Tier I risk adjusted assets 10.61% 12.68% 10.99%
Minimum required Tier I capital 4.00% 4.00% 4.00%
Total risk-based capital to
Tier II risk-adjusted assets 12.56% 13.69% 11.99%
Minimum required total risk-based capital 8.00% 8.00% 8.00%
Leverage capital ratios:
Tier I leverage capital to
adjusted fourth quarter average assets 8.70% 10.09% 8.44%
Minimum required Tier I leverage capital 4.00% 4.00% 4.00%
================================================================================
53
Table 22 Quarterly Financial Summary
================================================================================
2003 2002
------------------------------------------------ ---------------------------------------------
($ in thousands except Fourth Third Second First Fourth Third Second First
per share data) Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
---------- --------- --------- --------- --------- --------- --------- ---------
Income Statement Data
Interest income, taxable
equivalent $ 19,299 18,591 18,690 18,605 18,252 18,797 18,512 18,235
Interest expense 4,471 4,431 4,883 5,122 5,370 5,654 6,046 6,801
Net interest income,
taxable equivalent 14,828 14,160 13,807 13,483 12,882 13,143 12,466 11,434
Taxable equivalent,
adjustment 125 119 133 141 131 127 136 141
Net interest income 14,703 14,041 13,674 13,342 12,751 13,016 12,330 11,293
Provision for loan losses 925 695 540 520 755 575 775 440
Net interest income after
provision for losses 13,778 13,346 13,134 12,822 11,996 12,441 11,555 10,853
Noninterest income 3,781 3,802 3,602 3,733 3,181 2,889 2,901 2,997
Noninterest expense 10,091 9,273 9,352 9,248 8,363 8,133 8,063 7,742
Income before income taxes 7,468 7,875 7,384 7,307 6,814 7,197 6,393 6,108
Income taxes 2,611 2,819 2,573 2,614 2,395 2,538 2,232 2,117
Net income 4,857 5,056 4,811 4,693 4,419 4,659 4,161 3,991
- ----------------------------------------------------------------------------------------------------------------------------------
Per Share Data
Earnings per share - basic $ 0.52 0.54 0.51 0.50 0.48 0.51 0.45 0.44
Earnings per share - diluted 0.51 0.53 0.50 0.49 0.48 0.50 0.45 0.43
Cash dividends declared 0.24 0.24 0.23 0.23 0.23 0.23 0.22 0.22
Market Price
High $ 32.23 31.00 26.98 26.32 25.79 27.50 27.52 23.74
Low 28.06 25.15 24.23 22.95 22.15 22.01 21.85 20.20
Close 31.20 28.01 25.91 25.17 23.51 24.71 27.51 22.82
Book value 15.03 14.70 14.45 14.19 13.59 13.38 13.11 12.90
- ----------------------------------------------------------------------------------------------------------------------------------
Selected Average Balances
Assets $1,431,031 1,334,177 1,315,792 1,278,290 1,195,930 1,163,122 1,151,723 1,140,057
Loans 1,188,045 1,127,947 1,087,932 1,049,781 990,489 979,489 946,279 903,283
Earning assets 1,324,635 1,243,195 1,222,448 1,192,435 1,128,763 1,091,119 1,080,077 1,062,705
Deposits 1,221,215 1,146,683 1,140,309 1,105,333 1,039,880 1,002,770 1,004,886 995,236
Interest-bearing liabilities 1,136,788 1,057,358 1,047,765 1,021,886 955,950 928,672 916,788 913,334
Shareholders' equity 141,629 137,655 136,360 133,526 124,081 120,731 120,136 118,824
- ----------------------------------------------------------------------------------------------------------------------------------
Ratios
Return on average assets 1.35% 1.50% 1.47% 1.49% 1.47% 1.59% 1.45% 1.42%
Return on average equity 13.61% 14.57% 14.15% 14.25% 14.13% 15.31% 13.89% 13.62%
Average equity to average
assets 9.90% 10.32% 10.36% 10.45% 10.38% 10.38% 10.43% 10.42%
Equity to assets at
end of period 9.61% 10.17% 10.21% 10.09% 10.18% 10.45% 9.94% 10.29%
Tangible equity to assets
at end of period 6.18% 7.48% 7.44% 7.34% 8.11% 8.36% 7.91% 8.16%
Average loans to average
deposits 97.28% 98.37% 95.41% 94.97% 95.25% 97.68% 94.17% 90.76%
Average earning assets to
interest-bearing liabilities 116.52% 117.58% 116.67% 116.69% 118.08% 117.49% 117.81% 116.35%
Net interest margin 4.44% 4.52% 4.53% 4.59% 4.53% 4.78% 4.63% 4.36%
Allowance for loan losses
to gross loans 1.11% 1.11% 1.10% 1.11% 1.09% 1.07% 1.05% 1.05%
Nonperforming loans as a
percent of total loans 0.35% 0.38% 0.34% 0.28% 0.30% 0.31% 0.29% 0.37%
Nonperforming assets as a
percent of loans and other
real estate 0.47% 0.46% 0.45% 0.40% 0.44% 0.44% 0.42% 0.56%
Nonperforming assets as a
percent of total assets 0.39% 0.39% 0.37% 0.33% 0.36% 0.37% 0.34% 0.45%
Net charge-offs as a percent
of average loans 0.13% 0.08% 0.07% 0.11% 0.17% 0.09% 0.14% 0.04%
================================================================================
54
Item 8. Financial Statements
and Supplementary Data
First Bancorp and Subsidiaries
Consolidated Balance Sheets
December 31, 2003 and 2002
($ in thousands) 2003 2002
===============================================================================================
ASSETS
Cash & due from banks, noninterest-bearing $ 36,315 26,733
Due from banks, interest-bearing 12,632 30,753
Federal funds sold 13,967 16,167
----------- ---------
Total cash and cash equivalents 62,914 73,653
----------- ---------
Securities available for sale (costs of
$101,587 in 2003 and $64,380 in 2002) 103,455 65,779
Securities held to maturity (fair values of
$14,906 in 2003 and $15,757 in 2002) 14,206 14,990
Presold mortgages in process of settlement 1,307 19,268
Loans 1,218,895 998,547
Less: Allowance for loan losses (13,569) (10,907)
----------- ---------
Net loans 1,205,326 987,640
----------- ---------
Premises and equipment 25,356 22,239
Accrued interest receivable 6,087 5,341
Intangible assets 50,701 25,169
Other assets 6,417 4,067
----------- ---------
Total assets $ 1,475,769 1,218,146
=========== =========
LIABILITIES
Deposits: Demand - noninterest-bearing $ 146,499 112,380
Savings, NOW, and money market 462,876 387,691
Time deposits of $100,000 or more 238,535 199,794
Other time deposits 401,454 356,092
----------- ---------
Total deposits 1,249,364 1,055,957
Borrowings 76,000 30,000
Accrued interest payable 2,138 2,466
Other liabilities 6,411 5,738
----------- ---------
Total liabilities 1,333,913 1,094,161
----------- ---------
SHAREHOLDERS' EQUITY
Common stock, No par value per share
Authorized: 20,000,000 shares
Issued and outstanding: 9,435,294 shares in 2003 and
9,121,630 shares in 2002 55,392 48,313
Retained earnings 85,502 74,920
Accumulated other comprehensive income 962 752
----------- ---------
Total shareholders' equity 141,856 123,985
----------- ---------
Total liabilities and shareholders' equity $ 1,475,769 1,218,146
=========== =========
See accompanying notes to consolidated financial statements.
55
First Bancorp and Subsidiaries
Consolidated Statements of Income
Years Ended December 31, 2003, 2002 and 2001
($ in thousands, except per share data) 2003 2002 2001
================================================================================================================
INTEREST INCOME
Interest and fees on loans $ 69,318 66,742 68,055
Interest on investment securities:
Taxable interest income 3,902 4,961 6,372
Tax-exempt interest income 668 727 808
Other, principally overnight investments 779 831 1,538
---------- ---------- -----------
Total interest income 74,667 73,261 76,773
---------- ---------- -----------
INTEREST EXPENSE
Savings, NOW and money market 2,215 3,588 5,354
Time deposits of $100,000 or more 5,892 6,825 10,058
Other time deposits 9,001 12,376 18,941
Borrowings 1,799 1,082 1,367
---------- ---------- -----------
Total interest expense 18,907 23,871 35,720
---------- ---------- -----------
Net interest income 55,760 49,390 41,053
Provision for loan losses 2,680 2,545 1,151
---------- ---------- -----------
Net interest income after provision for loan losses 53,080 46,845 39,902
---------- ---------- -----------
NONINTEREST INCOME
Service charges on deposit accounts 7,938 6,856 5,265
Other service charges, commissions and fees 2,710 2,336 2,046
Fees from presold mortgage loans 2,327 1,713 1,259
Commissions from sales of insurance and financial products 1,304 738 731
Data processing fees 333 303 205
Securities gains 218 25 61
Loan sale gains 2 11 9
Other gains (losses) 86 (14) 79
---------- ---------- -----------
Total noninterest income 14,918 11,968 9,655
---------- ---------- -----------
NONINTEREST EXPENSES
Salaries 17,756 15,079 12,534
Employee benefits 4,381 3,388 3,083
---------- ---------- -----------
Total personnel expense 22,137 18,467 15,617
Occupancy expense 2,366 2,077 1,734
Equipment related expenses 2,555 2,128 1,631
Intangibles amortization 224 31 1,535
Other operating expenses 10,682 9,598 8,117
---------- ---------- -----------
Total noninterest expenses 37,964 32,301 28,634
---------- ---------- -----------
Income before income taxes 30,034 26,512 20,923
Income taxes 10,617 9,282 7,307
---------- ---------- -----------
NET INCOME $ 19,417 17,230 13,616
========== ========== ===========
Earnings per share:
Basic $ 2.07 1.89 1.51
Diluted 2.03 1.85 1.47
Weighted average common shares outstanding:
Basic 9,384,314 9,138,750 9,032,453
Diluted 9,567,404 9,320,721 9,273,769
See accompanying notes to consolidated financial statements.
56
First Bancorp and Subsidiaries
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2003, 2002 and 2001
($ in thousands) 2003 2002 2001
==============================================================================================================
Net income $ 19,417 17,230 13,616
-------- ------- -------
Other comprehensive income:
Unrealized gains on securities
available for sale:
Unrealized holding gains arising
during the period, pretax 688 400 702
Tax expense (268) (209) (242)
Reclassification to realized gains (218) (25) (61)
Tax expense 85 10 22
Adjustment to minimum pension liability:
Additional pension charge related to unfunded pension
liability (127) (165) --
Tax benefit 50 64 --
-------- ------- -------
Other comprehensive income 210 75 421
-------- ------- -------
Comprehensive income $ 19,627 17,305 14,037
======== ======= =======
See accompanying notes to consolidated financial statements.
57
First Bancorp and Subsidiaries
Consolidated Statements of Shareholders' Equity
Years Ended December 31, 2003, 2002 and 2001
Accumulated Total
Common Stock Other Share-
---------------------- Retained Comprehensive holders'
(In thousands, except per share) Shares Amount Earnings Income Equity
==================================================================================================================================
Balances, January 1, 2001 8,827 $ 50,148 60,280 256 110,684
------- --------- -------- ------ ---------
Net income 13,616 13,616
Cash dividends declared ($0.88 per share) (7,981) (7,981)
Common stock issued under
stock option plans 116 731 731
Common stock issued into
dividend reinvestment plan 25 564 564
Common stock issued in acquisitions 602 9,159 9,159
Purchases and retirement of common stock (457) (10,468) (10,468)
Other comprehensive income 421 421
------- --------- -------- ------ ---------
Balances, December 31, 2001 9,113 50,134 65,915 677 116,726
------- --------- -------- ------ ---------
Net income 17,230 17,230
Cash dividends declared ($0.90 per share) (8,225) (8,225)
Common stock issued under
stock option plans 144 1,033 1,033
Common stock issued into
dividend reinvestment plan 50 1,174 1,174
Tax benefit realized from exercise of
nonqualified stock options 382 382
Purchases and retirement of common stock (185) (4,410) (4,410)
Other comprehensive income 75 75
------- --------- -------- ------ ---------
Balances, December 31, 2002 9,122 48,313 74,920 752 123,985
------- --------- -------- ------ ---------
Net income 19,417 19,417
Cash dividends declared ($0.94 per share) (8,835) (8,835)
Common stock issued in acquisition 333 9,284 9,284
Common stock issued under
stock option plans 141 1,167 1,167
Common stock issued into
dividend reinvestment plan 49 1,277 1,277
Tax benefit realized from exercise of
nonqualified stock options 546 546
Purchases and retirement of common stock (210) (5,195) (5,195)
Other comprehensive income 210 210
------- --------- -------- ------ ---------
Balances, December 31, 2003 9,435 $ 55,392 85,502 962 141,856
======= ========= ======== ====== =========
See accompanying notes to consolidated financial statements.
58
First Bancorp and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2003, 2002 and 2001
($ in thousands) 2003 2002 2001
=============================================================================================================================
Cash Flows From Operating Activities
Net income $ 19,417 17,230 13,616
Reconciliation of net income to net cash provided by operating activities:
Provision for loan losses 2,680 2,545 1,151
Net security premium amortization 362 240 50
Gains on sales of loans (2) (11) (9)
Gains on sales of securities available for sale (218) (25) (61)
Loss on disposal of premises and equipment -- 33 --
Other nonoperating gains (86) (19) (79)
Loan fees and costs deferred, net of amortization (99) 45 (35)
Depreciation of premises and equipment 2,236 1,875 1,424
Tax benefit realized from exercise of nonqualified stock options 546 382 --
Amortization of intangible assets 224 31 1,535
Deferred income tax expense (benefit) 425 (322) (51)
Decrease (increase) in presold mortgages in process of settlement 17,961 (8,555) (9,677)
Decrease in accrued interest receivable 29 574 983
Decrease (increase) in other assets (1,338) 1,287 855
Decrease in accrued interest payable (601) (1,024) (1,559)
Increase (decrease) in other liabilities (67) (3,306) 3,873
--------- -------- -------
Net cash provided by operating activities 41,469 10,980 12,016
--------- -------- -------
Cash Flows From Investing Activities
Proceeds from sales of loans 41 104 378
Purchases of securities available for sale (73,663) (12,723) (39,750)
Purchases of securities held to maturity (317) (252) (2)
Proceeds from sales of securities available for sale 7,750 1,012 2,348
Proceeds from maturities/issuer calls of securities available for sale 38,908 41,929 48,903
Proceeds from maturities/issuer calls of securities held to maturity 3,850 2,235 2,905
Net increase in loans (149,877) (107,192) (30,490)
Purchases of premises and equipment (3,666) (5,643) (3,216)
Net cash received in purchase of branches 62,427 4,493 87,892
Net cash received (paid) in insurance agency acquisitions (564) -- 40
Net cash paid in bank acquisitions (2,256) -- (8,112)
--------- -------- -------
Net cash provided (used) by investing activities (117,367) (76,037) 60,896
--------- -------- -------
Cash Flows From Financing Activities
Net increase in deposits 32,580 47,234 25,266
Proceeds from (repayments of) borrowings, net 44,000 15,000 (24,700)
Cash dividends paid (8,670) (8,136) (7,929)
Proceeds from issuance of common stock 2,444 2,207 1,295
Purchases and retirement of common stock (5,195) (4,410) (10,468)
--------- -------- -------
Net cash provided (used) by financing activities 65,159 51,895 (16,536)
--------- -------- -------
Increase (Decrease) In Cash And Cash Equivalents (10,739) (13,162) 56,376
Cash And Cash Equivalents, Beginning Of Year 73,653 86,815 30,439
--------- -------- -------
Cash And Cash Equivalents, End Of Year $ 62,914 73,653 86,815
========= ======== =======
Supplemental Disclosures Of Cash Flow Information:
Cash paid during the period for:
Interest $ 19,508 24,885 37,034
Income taxes 9,858 14,167 2,865
Non-cash transactions:
Transfer of securities from held to maturity to available for sale -- -- 31,220
Foreclosed loans transferred to other real estate 537 825 820
Unrealized gain on securities available for sale, net of taxes 287 176 421
Premises and equipment transferred to other real estate -- 228 425
See accompanying notes to consolidated financial statements.
59
First Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2003
Note 1. Summary of Significant Accounting Policies
(a) Basis of Presentation - The consolidated financial statements include
the accounts of First Bancorp (the Company) and its wholly owned subsidiaries:
First Bank (the Bank); Montgomery Data Services, Inc. (Montgomery Data); First
Bancorp Financial Services, Inc. (First Bancorp Financial), and First Bancorp
Capital Trusts I, II, and III. The Bank has two wholly owned subsidiaries: First
Bank Insurance Services, Inc. (First Bank Insurance), and First Montgomery
Financial Services Corporation (First Montgomery). First Montgomery has one
wholly owned subsidiary - First Troy Realty Corporation (First Troy). All
significant intercompany accounts and transactions have been eliminated.
The Company is a bank holding company. The principal activity of the
Company is the ownership and operation of First Bank, a state chartered bank
with its main office in Troy, North Carolina. Other subsidiaries include
Montgomery Data, a data processing company whose primary client is First Bank,
and First Bancorp Financial, a real estate investment subsidiary, both of which
are headquartered in Troy. The Company is also the parent company for three
statutory trusts that were formed in 2002 and 2003 for the purpose of issuing a
total of $40 million in debt securities. These securities qualify as Tier I
capital for regulatory capital adequacy requirements. First Bank Insurance is a
provider of non-FDIC insured investment and insurance products. First Montgomery
is a Virginia incorporated company that acquires real estate in Virginia and
leases the property to the Bank. First Troy was formed in 1999 and allows the
Bank to centrally manage a portion of its real estate loan portfolio. First Troy
has elected to be treated as a real estate investment trust for tax purposes.
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 that affect the reported amounts of
assets and liabilities and disclosure of contingent liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The most significant estimates made by the Company in the preparation of its
consolidated financial statements are the determination of the allowance for
loan losses, the valuation of other real estate, the valuation allowance for
deferred tax assets and fair value estimates for financial instruments.
(b) Cash and Cash Equivalents - The Company considers all highly liquid
assets such as cash on hand, noninterest-bearing and interest-bearing amounts
due from banks and federal funds sold to be "cash equivalents."
(c) Securities - Securities classified as available for sale are purchased
with the intent to hold to maturity. However, infrequent sales may be necessary
due to liquidity needs arising from unanticipated deposit and loan fluctuations,
changes in regulatory capital and investment requirements, or changes in market
conditions, including interest rates and market values of securities held in the
portfolio. Investments in securities available for sale are stated at fair value
with the resultant unrealized gains and losses included as a component of
shareholders' equity, net of applicable deferred income taxes.
Securities are classified as held to maturity at the time of purchase when
the Company has the ability and positive intent to hold such securities to
maturity. Investments in securities held to maturity are stated at amortized
cost.
A decline in the market value of any available-for-sale or
held-to-maturity security below cost that is deemed to be other than temporary
results in a reduction in carrying amount to fair value. The impairment is
charged to earnings and a new cost basis for the security is established.
60
Gains and losses on sales of securities are recognized at the time of sale
based upon the specific identification method. Premiums and discounts are
amortized into income on a level yield basis, with premiums being amortized to
the earliest call date and discounts being accreted to the stated maturity date.
(d) Premises and Equipment - Premises and equipment are stated at cost
less accumulated depreciation. Depreciation, computed by the straight-line
method, is charged to operations over the estimated useful lives of the
properties, which range from 5 to 40 years or, in the case of leasehold
improvements, over the term of the lease, if shorter. Maintenance and repairs
are charged to operations in the year incurred. Gains and losses on dispositions
are included in current operations.
(e) Loans - Loans are stated at the principal amount outstanding, less
unearned income and deferred nonrefundable loan fees, net of certain origination
costs. Interest on loans is accrued on the unpaid principal balance outstanding.
Net deferred loan origination costs/fees are capitalized and recognized as a
yield adjustment over the life of the related loan. Unearned income for each of
the reporting periods was immaterial.
A loan is placed on nonaccrual status when, in management's judgment, the
collection of interest appears doubtful. The accrual of interest is discontinued
on all loans that become 90 days or more past due with respect to principal or
interest. While a loan is on nonaccrual status, the Company's policy is that all
cash receipts are applied to principal. Once the recorded principal balance has
been reduced to zero, future cash receipts are applied to recoveries of any
amounts previously charged off. Further cash receipts are recorded as interest
income to the extent that any interest has been foregone. Loans are removed from
nonaccrual status when they become current as to both principal and interest and
when concern no longer exists as to the collectibility of principal or interest.
In some cases, where borrowers are experiencing financial difficulties, loans
may be restructured to provide terms significantly different from the originally
contracted terms.
Commercial loans greater than $100,000 that are on nonaccrual status are
evaluated regularly for impairment. A loan is considered to be impaired when,
based on current information and events, it is probable the Company will be
unable to collect all amounts due according to the contractual terms of the loan
agreement. Impaired loans are measured using either 1) an estimate of the cash
flows that the Company expects to receive from the borrower discounted at the
loan's effective rate, or 2) in the case of a collateral-dependent loan, the
fair value of the collateral is used to value the loan. While a loan is
considered to be impaired, the Company's policy is that interest accrual is
discontinued and all cash receipts are applied to principal. Once the recorded
principal balance has been reduced to zero, future cash receipts are applied to
recoveries of any amounts previously charged off. Further cash receipts are
recorded as interest income to the extent that any interest has been foregone.
(f) Presold Mortgages in Process of Settlement and Loans Held for Sale -
As a part of normal business operations, the Company originates residential
mortgage loans that have been pre-approved by secondary investors. The terms of
the loans are set by the secondary investors, and the purchase price that the
investor will pay for the loan is agreed to prior to the funding of the loan by
the Company. Generally within three weeks after funding, the loans are
transferred to the investor in accordance with the agreed-upon terms. The
Company records gains from the sale of these loans on the settlement date of the
sale equal to the difference between the proceeds received and the carrying
amount of the loan. The gain generally represents the portion of the proceeds
attributed to service release premiums received from the investors and the
realization of origination fees received from borrowers which were deferred as
part of the carrying amount of the loan. Between the initial funding of the
loans by the Company and the subsequent reimbursement by the investors, the
Company carries the loans on its balance sheet at cost.
Periodically, the Company originates commercial loans that are intended
for resale. The Company carries these loans at the lower of cost or fair value
at each reporting date. There were no such loans held for sale as of December
31, 2003 or 2002.
(g) Allowance for Loan Losses - The provision for loan losses charged to
operations is an amount sufficient
61
to bring the allowance for loan losses to an estimated balance considered
adequate to absorb losses inherent in the portfolio. Management's determination
of the adequacy of the allowance is based on an evaluation of the portfolio,
current economic conditions, historical loan loss experience and other risk
factors. While management uses the best information available to make
evaluations, future adjustments may be necessary if economic and other
conditions differ substantially from the assumptions used.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to recognize additions to the allowance based
on the examiners' judgment about information available to them at the time of
their examinations.
(h) Other Real Estate - Other real estate owned consists primarily of real
estate acquired by the Company through legal foreclosure or deed in lieu of
foreclosure. The property is initially carried at the lower of cost (generally
the loan balance plus additional costs incurred for improvements to the
property) or estimated fair value of the property less estimated selling costs.
If there are subsequent declines in fair value, the property is written down to
its fair value through a charge to expense. Capital expenditures made to improve
the property are capitalized. Costs of holding real estate, such as property
taxes, insurance and maintenance, less related revenues during the holding
period, are charged to operations.
(i) Income Taxes - Income taxes are accounted for under the asset and
liability method. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date. Deferred tax assets are reduced, if necessary, by
the amount of such benefits that are not expected to be realized based upon
available evidence.
(j) Intangible Assets - The Company has adopted Statement of Financial
Standards (SFAS) No. 141, entitled "Business Combinations" (Statement 141), SFAS
No. 142, entitled "Goodwill and Other Intangible Assets" (Statement 142) and
SFAS No. 147, entitled "Acquisitions of Certain Financial Institutions"
(Statement 147). Certain provisions of Statement 142 relating to business
combinations consummated after June 30, 2001 were adopted by the Company on July
1, 2001. The remaining provisions of Statement 142 and all provisions of
Statement 141 and Statement 147 were adopted effective January 1, 2002.
Under these standards, all business combinations must be accounted for
using the purchase method of accounting. Identifiable intangible assets are
recognized separately and are amortized over their estimated useful lives, which
for the Company has generally been ten years and at an accelerated rate.
Goodwill is recognized in business combinations to the extent that the price
paid exceeds the fair value of the net assets acquired, including any
identifiable intangible assets. Goodwill is not amortized, but is subject to
fair value impairment tests on at least an annual basis. Each of the Company's
impairment tests conducted in 2002 and 2003 indicated no goodwill impairment.
See Note 1(r) for additional discussion.
Prior to January 1, 2002, the Company's policy was to amortize all
acquisition-related intangible assets on a straight-line basis over their
estimated useful lives, with a minimum amortization period of 5 years and a
maximum amortization period of 15 years. The Company's core deposit intangible
assets allocated with acquisitions made sine January 1, 2002 are amoritized over
a 10 year period using an accelerated method.
In accordance with applicable accounting standards, the Company records an
intangible asset in connection with a defined benefit pension plan to fully
accrue for its liability. This intangible asset is adjusted annually in
accordance with actuarially determined amounts. The amount of this intangible
asset was $93,000 and $217,000 at December 31, 2003 and 2002, respectively.
62
(k) Stock Option Plan - At December 31, 2003, the Company has five
stock-based employee compensation plans, which are described more fully in Note
14. The Company accounts for those plans under the recognition and measurement
principles of Accounting Principles Board Opinion No. 25 (APB Opinion No. 25),
"Accounting for Stock Issued to Employees," and related interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," to
stock-based employee compensation.
Year Ended December 31,
-----------------------------------------------
(In thousands except per share data) 2003 2002 2001
---------- -------- ---------
Net income, as reported $ 19,417 17,230 13,616
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (319) (256) (198)
---------- -------- ---------
Pro forma net income $ 19,098 16,974 13,418
========== ======== =========
Earnings per share: Basic - As reported $ 2.07 1.89 1.51
Basic - Pro forma 2.04 1.86 1.49
Diluted - As reported 2.03 1.85 1.47
Diluted - Pro forma 2.00 1.82 1.45
(l) Per Share Amounts - Basic Earnings Per Share is calculated by dividing
net income by the weighted average number of common shares outstanding during
the period. Diluted Earnings Per Share is computed by assuming the issuance of
common shares for all dilutive potential common shares outstanding during the
reporting period. Currently, the Company's only potential dilutive common stock
issuances relate to options that have been issued under the Company's stock
option plans. In computing Diluted Earnings Per Share, it is assumed that all
such dilutive stock options are exercised during the reporting period at their
respective exercise prices, with the proceeds from the exercises used by the
Company to buy back stock in the open market at the average market price in
effect during the reporting period. The difference between the number of shares
assumed to be exercised and the number of shares bought back is added to the
number of weighted average common shares outstanding during the period. The sum
is used as the denominator to calculate Diluted Earnings Per Share for the
Company.
The following is a reconciliation of the numerators and denominators used
in computing Basic and Diluted Earnings Per Share:
For the Years Ended December 31,
---------------------------------------------------------------------------------------------------------
2003 2002 2001
--------------------------------- --------------------------------- ---------------------------------
($ in thousands, Income Shares Per Income Shares Per Income Shares Per
except per share (Numer- (Denom- Share (Numer- (Denom- Share (Numer- (Denom- Share
amounts) ator) inator) Amount ator) inator) Amount ator) inator) Amount
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Basic EPS $ 19,417 9,384,314 $ 2.07 $ 17,230 9,138,750 $ 1.89 $ 13,616 9,032,453 $ 1.51
========= ========= =========
Effect of dilutive
securities -- 183,090 -- 181,971 -- 241,316
--------- --------- --------- --------- --------- ---------
Diluted EPS $ 19,417 9,567,404 $ 2.03 $ 17,230 9,320,721 $ 1.85 $ 13,616 9,273,769 $ 1.47
========= ========= ========= ========= ========= ========= ========= ========= =========
For the year ended December 31, 2003, there were no antidilutive options
since the exercise price for each option outstanding was less that the average
market price for the year. For the years ended December 31, 2002,
63
and 2001, there were options of 24,000, and 144,250, respectively, that were
antidilutive since the exercise price exceeded the average market price for the
year. These options were omitted from the calculation of diluted earnings per
share for their respective years.
(m) Fair Value of Financial Instruments - Statement of Financial
Accounting Standards No. 107, "Disclosures About Fair Value of Financial
Instruments" (SFAS No. 107), requires that the Company disclose estimated fair
values for its financial instruments. Fair value methods and assumptions are set
forth below for the Company's financial instruments.
Cash and Due from Banks, Federal Funds Sold, Presold Mortgages in Process
of Settlement, Accrued Interest Receivable, and Accrued Interest Payable - The
carrying amounts approximate their fair value because of the short maturity of
these financial instruments.
Available for Sale and Held to Maturity Securities - Fair values are based
on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments.
Loans - Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as commercial,
financial and agricultural, real estate construction, real estate mortgages and
installment loans to individuals. Each loan category is further segmented into
fixed and variable interest rate terms. For variable rate loans, the carrying
value is a reasonable estimate of the fair value. For fixed rate loans, fair
value is determined by discounting scheduled future cash flows using current
interest rates offered on loans with similar risk characteristics. Fair values
for impaired loans are estimated based on discounted cash flows or underlying
collateral values, where applicable.
Deposits - The fair value of deposits with no stated maturity, such as
non-interest-bearing demand deposits, savings, NOW, and money market accounts,
is equal to the amount payable on demand as of the valuation date. The fair
value of certificates of deposit is based on the discounted value of contractual
cash flows. The discount rate is estimated using the rates currently offered for
deposits of similar remaining maturities.
Borrowings - The fair value of borrowings is based on the discounted value
of contractual cash flows. The discount rate is estimated using the rates
currently offered by the Company's lenders for debt of similar remaining
maturities.
Commitments to Extend Credit and Standby Letters of Credit - At December
31, 2003 and 2002, the Company's off-balance sheet financial instruments had no
carrying value. The large majority of commitments to extend credit and standby
letters of credit are at variable rates and/or have relatively short terms to
maturity. Therefore, the fair value for these financial instruments is
considered to be immaterial.
(n) Impairment - Goodwill is evaluated for impairment on at least an
annual basis by comparing the fair value of its reporting units to their related
carrying value. If the carrying value of a reporting unit exceeds its fair
value, the Company determines whether the implied fair value of the goodwill,
using a discounted cash flow analysis, exceeds the carrying value of the
goodwill. If the carrying value of the goodwill exceeds the implied fair value
of the goodwill, an impairment loss is recorded in an amount equal to that
excess.
For all other long-lived assets, including identifiable intangible assets,
the Company reviews them for impairment whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. The
Company's policy is that an impairment loss is recognized if the sum of the
undiscounted future cash flows is less than the carrying amount of the asset.
Any of long-lived assets to be disposed of are reported at the lower of the
carrying amount or fair value, less costs to sell.
To date, the Company has not had to record any impairment write-downs of
its long-lived assets or goodwill.
64
See Note 1(r) for additional discussion regarding recent accounting standards
related to impairment.
(o) Comprehensive Income - Comprehensive income is defined as the change
in equity during a period for non-owner transactions and is divided into net
income and other comprehensive income. Other comprehensive income includes
revenues, expenses, gains, and losses that are excluded from earnings under
current accounting standards. The components of accumulated other comprehensive
income for the Company are as follows:
December 31, December 31, December 31,
2003 2002 2001
------------ ------------ ------------
Unrealized gain on securities
available for sale $ 1,868 1,399 1,024
Deferred tax liability (728) (546) (347)
------------ ------- -------
Net unrealized gain on securities
available for sale 1,140 853 677
------------ ------- -------
Additional minimum pension liability (292) (165) --
Deferred tax asset 114 64 --
------------ ------- -------
Net additional minimum pension
liability (178) (101) -
------------ ------- -------
Total accumulated other
comprehensive income $ 962 752 677
============ ======= =======
(p) Segment Reporting - SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" requires management to report selected
financial and descriptive information about reportable operating segments. It
also establishes standards for related disclosures about products and services,
geographic areas, and major customers. Generally, disclosures are required for
segments internally identified to evaluate performance and resource allocation.
The Company's operations are primarily within the commercial banking segment,
and the financial statements presented herein reflect the results of that
segment. Also, the Company has no foreign operations or customers.
(q) Reclassifications - Certain amounts for prior years have been
reclassified to conform to the 2003 presentation. The reclassifications had no
effect on net income or shareholders' equity as previously presented, nor did
they materially impact trends in financial information.
(r) Recent Accounting Pronouncements - On January 1, 2001, the Company
adopted Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This Statement
established accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. On January
1, 2001, the Company transferred, as permitted by the standard upon its
adoption, held-to-maturity securities with an amortized cost of approximately
$31.7 million to the available for sale category at fair value. The unrealized
loss at the time of the transfer was approximately $513,000, and was included as
a component of other comprehensive income, net of tax. The Company does not
engage in any hedging activities and, other than the aforementioned transfer of
securities, the adoption of the statement had no impact on the Company.
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, "Business Combinations" (Statement 141), and SFAS No. 142, "Goodwill
and Other Intangible Assets" (Statement 142). Statement 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. Statement 141 also specifies criteria that intangible
assets acquired in a purchase method business combination must meet in order to
be recognized and reported apart from goodwill. The Company adopted this
statement July 1, 2001. Statement 142 requires that all goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead tested
for impairment at least annually in accordance with the
65
provisions of Statement 142. Statement 142 also requires that identifiable
intangible assets with estimable useful lives be amortized over their respective
estimated useful lives to their estimated residual values, and reviewed for
impairment in accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Certain
provisions of Statement 142 relating to business combinations consummated after
June 30, 2001 were adopted by the Company on July 1, 2001. The remaining
provisions were adopted on January 1, 2002. In connection with Statement 142's
transitional goodwill impairment evaluation, the statement required the Company
to perform an assessment of whether there was an indication that goodwill is
impaired as of the date of adoption. The Company completed this initial
assessment during the first quarter of 2002 and determined that there was no
goodwill impairment. The Company has also performed annual impairment tests
since the date of adoption, and the Company determined for each of those tests
that there was no goodwill impairment. See Note 6 for additional disclosures
related to Statement 142.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (Statement 144), which addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. This standard provides guidance on differentiating between long-lived
assets to be held and used, long-lived assets to be disposed of other than by
sale and long-lived assets to be disposed of by sale. Statement 144 supersedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." Statement 144 also supersedes Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." This statement was
adopted by the Company on January 1, 2002 and did not have a material impact on
the Company's financial statements.
In August 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (Statement 146), which addresses
financial accounting and reporting costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)."
Under EITF Issue No. 94-3, an entity recognized a liability for an exit cost on
the date that the entity committed itself to an exit plan. In Statement 146, the
Board acknowledges that an entity's commitment to a plan does not, by itself,
create a present obligation to other parties that meets the definition of a
liability. An obligation becomes a present obligation when a transaction or
event occurs that leaves an entity little or no discretion to avoid the future
transfer or use of assets to settle the liability. Statement 146 also
establishes that fair value is the objective for the initial measurement of the
liability. Statement 146 will be effective for exit or disposal activities that
are initiated after December 31, 2002. The Company adopted the provisions of
this statement effective January 1, 2003 and will apply the provisions to any
exit or disposal activities initiated after that date. The Company did not have
any exit or disposal activities that were required to be accounted for under
Statement 146.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions" (Statement 147), which addresses the financial
accounting and reporting for the acquisition of all or part of a financial
institution. This standard removes certain acquisitions of financial
institutions from the scope of SFAS No. 72, "Accounting for Certain Acquisitions
of Bank or Thrift Institutions" (Statement 72). This statement requires
financial institutions to reclassify goodwill arising from a qualified business
acquisition from Statement 72 goodwill to goodwill subject to the provisions of
Statement 142. The reclassified goodwill is no longer amortized but is subject
to an annual impairment test, pursuant to Statement 142. The Company adopted
Statement 147 in the fourth quarter of 2002, but effective as of January 1,
2002. Statement 147 required the Company to retroactively restate its previously
issued 2002 interim consolidated financial statements to reverse reclassified
Statement 72 goodwill amortization expense recorded in the first three quarters
of the 2002 fiscal year. Accordingly, $1,068,000 in amortization expense that
had been recorded during the first nine months of 2002 was retroactively
reversed by reducing the respective quarters' amortization expense and
increasing intangible assets. The associated income tax expense recorded related
to the reversal of amortization expense amounted to $374,000 for that same nine
month period.
66
In November 2002, the FASB issued Financial Interpretation No. 45 (FIN
45), "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others", which addresses the
disclosure to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees. FIN 45 requires the guarantor
to recognize a liability for the non-contingent component of the guarantee, such
as the obligation to stand ready to perform in the event that specified
triggering events or conditions occur. The initial measurement of this liability
is the fair value of the guarantee at inception. The recognition of the
liability is required even if it is not probable that payments will be required
under the guarantee or if the guarantee was issued with a premium payment or as
part of a transaction with multiple events. The disclosure requirements were
effective for interim and annual financial statements ending after December 15,
2002 and are contained in Note 12. The initial recognition and measurement
provisions were effective for all guarantees within the scope of FIN 45 issued
or modified after December 31, 2002, the impacts of which were not material to
the Company. The Company issues standby letters of credit whereby the Company
guarantees performance if a specified triggering event or condition occurs,
primarily nonpayment by the Company's customer to their supplier. The standby
letters of credit are generally for terms for one year, at which time they may
be renewed for another year if both parties agree. See Note 12.
In December 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" (FAS 148) an amendment of FASB
Statement No. 123, "Accounting for Stock-Based Compensation" (FAS 123), which
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, FAS 148 amends the disclosure requirements of FAS 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition provisions of the statement are
effective for financial statements for fiscal years ending after December 15,
2002 while the disclosure requirements are effective for interim periods
beginning after December 15, 2002, with early application encouraged. The
adoption of SFAS 148 required enhanced disclosures for the Company's stock-based
employee compensation plan for the year ended December 31, 2002. The Company
does not have any plans to change its method of accounting for stock-based
employee compensation, but has furnished the expanded disclosures in Note 1(k).
In January 2003, the FASB issued Financial Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities," which was subsequently revised in
December 2003. FIN 46 addresses the consolidation by business enterprises of
certain variable interest entities. The provisions of this interpretation became
effective for the Company on January 31, 2003 as it relates to variable interest
entities created or purchased after that date. In October 2003, the FASB issued
guidance that provided for a deferral of the effective date of applying FIN 46
to entities created before February 1, 2003, to no later than December 31, 2003.
In addition, the deferral permitted a company to apply FIN 46 as of July 1,
2003, to some or all of the variable interest entities in which it holds an
interest, and the rest on December 31, 2003. In December 2003, the FASB issued a
revision to (FIN 46R), which clarified and interpreted certain of the provisions
of FIN 46, without changing the basic accounting model in FIN 46. The provisions
of FIN 46R are effective no later than March 31, 2004. However, companies must
apply either FIN 46 or FIN 46R to those entities considered special purpose
entities no later than December 31, 2003. The adoption of FIN 46 did not have an
impact on the Company's financial position or results of operations. The Company
has identified no investments in variable interest entities that would require
consolidation under FIN 46. For the Company, beginning with the first quarter of
2004, the application of FIN 46R will result in the de-consolidation of the
trusts that have issued the trust preferred capital securities currently
reported in the consolidated financial statements. The trust preferred capital
securities are currently disclosed as long-term borrowings within the
consolidated financial statements. The de-consolidation of the trust will
instead cause the disclosure of junior subordinated debentures between the
Company and the trust subsidiary. Currently, the junior subordinated debentures
are eliminated in consolidation, resulting in the disclosure of long-term
borrowings. The impact of this change will not have a material effect on the
Company's consolidated financial statements. Treatment of trust preferred
securities within the Company's capital ratio calculations in light of FIN 46 is
pending further guidance from the banking regulators. If the banking regulators
change the capital treatment for trust preferred securities, the Company's Tier
1 and total capital could be reduced by the amount of outstanding trust
preferred securities,
67
but the Company believes that its capital classifications would not fall below
the level of "adequately" capitalized. Additional information regarding the
Company's trust preferred securities is included in Note 9.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 (Statement 149), "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities," which amends and clarifies financial accounting and
reporting for derivative instruments and for hedging activities under Statement
of Financial Accounting Standards No. 133. Adoption of Statement 149 on July 1,
2003 did not have a material effect on the Company's consolidated financial
statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 (Statement 150), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity", which establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances). This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. It is to be implemented by reporting the cumulative effect of a change in
accounting principle for financial instruments created before the issuance date
of the Statement and still existing at the beginning of the interim period of
adoption. Adoption of Statement 150 on July 1, 2003 did not have a material
effect on the Company's consolidated financial statements.
In November 2003, the FASB ratified a consensus reached by its Emerging
Issues Task Force ("EITF") regarding quantitative and qualitative disclosures
required by EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment
and Its Application to Certain Investments." EITF Issue No. 03-1 requires
certain quantitative and qualitative disclosures as it relates to investments
that have unrealized losses that have not been recognized as
other-than-temporary impairments and is effective for fiscal years ending after
December 15, 2003. The additional disclosures required for the Company are
included in Note 3.
In December 2003, the FASB issued Statement of Financial Accounting
Standards No. 132 (revised 2003) (Statement 132(R)), "Employers' Disclosures
about Pensions and Other Postretirement Benefits." Statement 132(R) revises
employers' disclosures about pension plans and other postretirement plans, but
does not change the measurement or recognition of those plans. Statement No.
132(R) requires additional disclosures about the assets, obligations, cash
flows, and net periodic pension cost of defined benefit plans and other defined
benefit postretirement plans. Most of the provisions of Statement 132(R) are
effective for financial statements with fiscal years after December 15, 2003,
with certain provisions becoming effective for fiscal years ending after June
15, 2004. The additional disclosures required for the Company are included in
Note 11.
Note 2. Completed Acquisitions
Since January 1, 2001, the Company has completed several acquisitions.
The Company completed the following acquisitions during 2003. The results
of each acquired company are included in First Bancorp's results for the period
ended December 31, 2003 beginning on their respective acquisition dates.
(a) Uwharrie Insurance Group - On January 2, 2003, the Company completed
the acquisition of Uwharrie Insurance Group, a Montgomery County based property
and casualty insurance agency. With eight employees, Uwharrie Insurance Group,
Inc. serves approximately 5,000 customers, primarily from its Troy-based
headquarters, and has annual commissions of approximately $500,000. The primary
reason for the acquisition was to gain efficiencies of scale with the Company's
existing property and casualty insurance business. In accordance with the terms
of the merger agreement, the Company paid cash in the amount of $546,000 to
complete the acquisition. In addition, the Company incurred $18,000 in other
direct costs to complete the acquisition. As of the date of the acquisition, the
value of the assets of Uwharrie Insurance Group amounted to
68
$20,000 (consisting primarily of premises and equipment), which resulted in the
Company recording an intangible asset of approximately $544,000. Based on an
independent appraisal, the allocation among types of intangible assets and
related amortization periods are:
Type of Intangible Asset Allocated Amount Amortization Period
- -------------------------------------- ---------------- -------------------------
Value of Noncompete Agreement $ 50,000 Two years - straight-line
Value of Customer List 151,000 Ten years - straight-line
Goodwill 343,000 Not applicable
----------------
Total Intangible Assets $ 544,000
================
For tax purposes, each of the intangible assets recorded will result in
tax-deductible amortization expense. No pro forma earnings information has been
presented due to the immateriality of the acquisition.
(b) On January 15, 2003, the Company completed the acquisition of Carolina
Community Bancshares, Inc. (CCB), the parent company of Carolina Community Bank,
a South Carolina community bank with three branches in Dillon County, South
Carolina. This represented the Company's first entry into South Carolina. Dillon
County, South Carolina is contiguous to Robeson County, North Carolina, a county
where the Company operates four branches. The Company's primary reason for the
acquisition was to expand into a contiguous market with facilities, operations
and experienced staff in place. The terms of the agreement called for
shareholders of Carolina Community to receive 0.8 shares of First Bancorp stock
and $20.00 in cash for each share of Carolina Community stock they own. The
transaction was completed on January 15, 2003 with the Company paying cash of
$8.3 million, issuing 332,888 shares of common stock that were valued at
approximately $8.4 million, and assuming employee stock options with an
intrinsic value of approximately $0.9 million. The value of the stock issued was
determined using a Company stock price of $25.22, which was the average price of
Company stock during the five day period beginning two days before the
acquisition announcement and ending two days after the acquisition announcement.
The value of the employee stock options assumed was determined using the
Black-Scholes option-pricing model.
69
This acquisition has been accounted for using the purchase method of
accounting for business combinations, and accordingly, the assets and
liabilities of CCB were recorded based on estimates of fair values as of January
15, 2003. The following is a condensed balance sheet disclosing the amount
assigned to each major asset and liability caption of CCB as of January 15,
2003, and the related fair value adjustments recorded by the Company to reflect
the acquisition. It is not expected that any portion of the intangible assets
recorded will be deductible for income tax purposes.
As Fair As
($ in thousands) Recorded by Value Recorded by
CCB Adjustments First Bancorp
----------- ----------- -------------
Assets
Cash and cash equivalents $ 7,048 -- 7,048
Securities 12,995 99 (a) 13,094
Loans, gross 47,716 -- 47,716
Allowance for loan losses (751) -- (751)
Premises and equipment 799 (45) (b) 754
Other - Identifiable intangible asset -- 771 (c) 771
Other 1,697 (243) (d) 1,454
-------- ------- ---------
Total 69,504 582 70,086
-------- ------- ---------
Liabilities
Deposits $ 58,861 -- 58,861
Borrowings 2,000 115 (e) 2,115
Other 722 (88) (f) 634
-------- ------- ---------
Total 61,583 27 61,610
-------- ------- ---------
Net identifiable assets acquired 8,476
Total cost of acquisition
Cash $ 8,322
Value of stock issued 8,395
Value of assumed options 889
Direct costs of acquisition 1,270
-------
Total cost of acquisition 18,876
---------
Goodwill recorded through December 31, 2003 $ 10,400
=========
Explanation of Fair Value Adjustments
(a) This fair value adjustment represents the net unrealized gain of
CCB's held-to-maturity securities portfolio. This fair value
adjustment was recorded by the Company as a premium on securities
and will be amortized as a reduction of investment interest income
over the life of the related securities, which have an average life
of approximately four years.
(b) This fair value adjustment represents the book value of certain
equipment owned by CCB that became obsolete upon the acquisition.
(c) This fair value adjustment represents the value of the core deposit
base assumed in the acquisition based on a study performed by an
independent consulting firm. This amount was recorded by the Company
as an identifiable intangible asset and will be amortized as expense
on an accelerated basis over a ten year period based on an
amortization schedule provided by the consulting firm.
70
(d) This fair value adjustment represents the net deferred tax liability
recorded related to the other fair value adjustments.
(e) This fair value adjustment was recorded because the interest rates
of CCB's borrowings exceeded current interest rates on similar
borrowings. This amount will be amortized to reduce interest expense
over the remaining lives of the related borrowings, which have a
weighted average life of approximately 3.7 years.
(f) This fair value adjustment represents the carrying value of a
retirement plan liability that was terminated in accordance with the
terms of the merger agreement.
The following unaudited pro forma financial information presents the
combined results of the Company and CCB as if the acquisition had occurred as of
January 1, 2002, after giving effect to certain adjustments, including
amortization of the core deposit intangible, an assumed cost of funds related to
the cash paid of 6%, and related income tax effects. The pro forma financial
information does not necessarily reflect the results of operations that would
have occurred had the Company and CCB constituted a single entity during such
period. Because the acquisition took place on January 15, 2003, pro forma
results for 2003 are not provided.
($ in thousands, except share Year Ended
data) December 31, 2002
-----------------
Net interest income $ 52,200
Noninterest income 2,720
Net income 17,748
Earnings per share
Basic 1.87
Diluted 1.83
The above pro forma results include charges recorded by CCB in the fourth
quarter of 2002 related to the impending merger with the Company. These expenses
amounted to $255,375 on a pretax basis and $198,432 on an after-tax basis.
(c) On October 24, 2003, the Company completed the acquisition of four
branches of RBC Centura Bank located in Fairmont, Harmony, Kenansville, and
Wallace, all in North Carolina. As of the date of the acquisition, the branches
had a total of approximately $102 million in deposits and $25 million in loans.
The primary reason for the acquisition was to expand into new markets and
increase the Company's customer base. Subject to certain limitations, the
Company paid a deposit premium of 14.1% for the branches, which resulted in the
Company recording intangible assets relating to this purchase of $14.2 million,
all of which is deductible for tax purposes. The identifiable intangible asset
associated with the fair value of the core deposit base, as determined by an
independent consulting firm, was determined to be approximately $1.3 million and
is being amortized as expense on an accelerated basis over a ten year period
based on an amortization schedule provided by the consulting firm. The remaining
intangible asset of $12.9 million has been classified as goodwill, and thus will
not be systematically amortized, but rather will be subject to an annual
impairment test in accordance with Statement 147, as described in Note 1 above.
The primary factors that contributed to a purchase price that resulted in
recognition of goodwill were the Company's desire to expand in four new markets
with facilities, operations and experienced staff in place. These four branches'
operations are included in the accompanying Consolidated Statements of Income
beginning on the acquisition date of October 24, 2003. Historical financial
information related to the four branches while owned by RBC Centura Bank is not
available, and thus pro forma results of operations have not been presented.
71
The following table contains a condensed balance sheet that indicates the
amount assigned to each major asset and liability as of the respective
acquisition dates for the 2003 acquisitions described above.
Uwharrie Carolina RBC
Insurance Community Centura
Assets acquired Group Bank Branches Total
-------------------------------- --------- --------- -------- -----
(in millions)
Cash $ -- 7.0 62.4 69.4
Securities -- 13.1 -- 13.1
Loans, gross -- 47.7 24.8 72.5
Allowance for loan losses -- (0.8) (0.3) (1.1)
Premises and equipment -- 0.8 1.0 1.8
Other -- 1.5 0.2 1.7
----- ----- ----- -----
Total assets acquired -- 69.3 88.1 157.4
----- ----- ----- -----
Liabilities assumed
Deposits -- 58.9 102.0 160.9
Borrowings -- 2.1 -- 2.1
Other -- 0.6 0.3 0.9
----- ----- ----- -----
Total liabilities assumed -- 61.6 102.3 163.9
----- ----- ----- -----
Value of cash paid and/or stock
issued to stock-holders of
acquiree 0.5 18.9 n/a 19.4
----- ----- ----- -----
Intangible assets recorded $ 0.5 11.2 14.2 25.9
===== ===== ===== =====
The Company completed one acquisition in 2002 as follows:
(a) Broadway branch purchase - On October 4, 2002, the Company completed
the purchase of a branch of RBC Centura located in Broadway, North Carolina. The
Company assumed the branch's $8 million in deposits and $3 million in loans. The
primary reason for this acquisition was to increase the Company's presence in
Lee County, a market in which the Company already had two branches with a large
customer base. An intangible asset of $0.7 million, all of which is deductible
for tax purposes, was recorded in connection with this acquisition. The entire
intangible asset was determined to be goodwill that is not subject to
amortization (see Note 1(r)). The primary factors that contributed to a purchase
price that resulted in recognition of goodwill were the Company's desire to
expand in Lee County with a facility, operations, and experienced staff in
place. The Broadway branch's operations are included in the accompanying
Consolidated Statements of Income beginning on the acquisition date of October
4, 2002.
The Company completed one whole-company acquisition and several branch
purchases in 2001. The following is a brief description of each purchase, which
is then followed by a table containing a condensed balance sheet that indicates
the amount assigned to each major asset and liability of the entities purchased
as of their respective acquisition date.
(a) Salisbury branch purchase - On December 17, 2001, the Company
completed the purchase of a branch of First Union National Bank located in
Salisbury, North Carolina. The Company assumed the branch's $30 million in
deposits and $9 million in loans. The primary reason for this acquisition was to
increase the Company's presence in Salisbury, a market that the Company entered
in 2000 with the opening of a de novo branch. An intangible asset of $3.2
million, all of which is deductible for tax purposes, was recorded in connection
with this acquisition. This intangible asset was amortized on a straight-line
basis over 15 years until the Company adopted Statement 147 (see Note 1(r)) as
of January 1, 2002, at which time it ceased to be amortized. The primary factors
that contributed to a purchase price that resulted in recognition of goodwill
were the Company's desire to expand in Salisbury with a facility, operations,
and experienced staff in place. The Salisbury branch's operations are included
in the accompanying Consolidated Statements of Income beginning on the
acquisition date of December 17, 2001.
72
(b) Insurance agency acquisitions - On May 30, 2001, the Company completed
the purchase of two insurance agencies - Aberdeen Insurance & Realty Company and
Hobbs Insurance and Realty Company. Both agencies were located in Moore County
and specialized in placing property and casualty insurance coverage for
individuals and businesses in the Moore County area. The primary reason for this
acquisition was to give the Company the platform to offer property and casualty
insurance to its entire customer base. In completing the acquisition, the
agencies were merged into First Bank Insurance Services, Inc. Approximately
16,000 shares of Company stock were issued in connection with the acquisition of
the two agencies. An intangible asset of $243,000 was recorded in connection
with the acquisition, none of which is deductible for tax purposes, and is being
amortized on a straight-line basis over 15 years. This intangible asset has been
determined to be an identifiable intangible asset as defined in Statement 142
(see discussion in Note 1(r)) and thus continues to be amortized. The insurance
agencies' operations are included in the accompanying Consolidated Statements of
Income beginning on the acquisition date of May 30, 2001. No pro forma earnings
information has been presented due to the immateriality of the acquisitions.
(c) Century Bancorp, Inc. - On May 17, 2001, the Company completed the
purchase of Century Bancorp, Inc. ("Century"). Century was the holding company
for Home Savings, Inc., SSB, a one branch savings institution located in
Thomasville, NC. Century had total assets of $107 million, total loans of $90
million, and total deposits of $72 million. The primary reason for the
acquisition was to expand into a contiguous market. In accordance with the terms
of the merger agreement, the Company issued approximately 586,000 shares of
common stock and paid cash of approximately $13.2 million to Century
shareholders in exchange for all shares of Century outstanding. An intangible
asset of $3.2 million, none of which is deductible for tax purposes, was
recorded in connection with this acquisition and was amortized on a
straight-line basis over 15 years until the Company's January 1, 2002 adoption
of Statement 142 (see Note 1(r)), at which time it ceased to be amortized. The
primary factors that contributed to a purchase price that resulted in
recognition of goodwill were the Company's desire to expand into Century's
market area with a facility, operations and experienced staff in place.
Century's operations are included in the accompanying Consolidated
Statements of Income beginning on the acquisition date of May 17, 2001. The
following table reflects the pro forma combined results of operations, assuming
the Century acquisition had occurred at the beginning of 2001:
2001
-------
Net interest income $42,028
Net income 13,793
Earnings per share - diluted 1.45
(d) Robeson and Scotland Counties branch purchase - On March 26, 2001, the
Company completed the purchase of four branches from First Union National Bank
with aggregate deposits of approximately $103 million and aggregate loans of
approximately $17 million. The four branches acquired were in Lumberton,
Pembroke, St. Pauls (all located in Robeson County, NC), and Laurinburg
(Scotland County, NC). The primary reason for the acquisition was to leverage
the Company's capital by expanding into three contiguous markets (Lumberton,
Pembroke and St. Pauls) and increase market share in one market (Laurinburg). An
intangible asset of $14.6 million, all of which is deductible for tax purposes
was recorded in connection with this purchase. This intangible asset was
amortized on a straight-line basis over 15 years until the Company adopted
Statement 147 (see Note 1(r)) as of January 1, 2002, at which time it ceased to
be amortized. The primary factors that contributed to a purchase price that
resulted in recognition of goodwill were the Company's desire to expand in three
contiguous markets and increase market share in an existing market with
facilities, operations and experienced staff in place. These four branches'
operations are included in the accompanying Consolidated Statements of Income
beginning on the acquisition date of March 26, 2001.
73
The following table contains a condensed balance sheet that indicates the
amount assigned to each major asset and liability as of the respective
acquisition dates for the 2001 acquisitions described above.
Robeson and
Salisbury Insurance Scotland
Assets acquired branch agencies Century counties branches Total
--------------------------------- --------- --------- ------- ----------------- -----
(in millions)
Cash $17.7 -- 5.9 70.2 93.8
Securities -- -- 9.0 -- 9.0
Loans, gross 9.3 -- 90.2 16.7 116.2
Allowance for loan losses (0.2) -- (0.6) (0.3) (1.1)
Premises and equipment 0.5 0.1 0.6 1.9 3.1
Other -- -- 1.4 -- 1.4
----- ----- ----- ----- -----
Total assets acquired 27.3 0.1 106.5 88.5 222.4
----- ----- ----- ----- -----
Liabilities assumed
Deposits 30.3 -- 71.7 102.6 204.6
Borrowings -- -- 13.5 -- 13.5
Other 0.2 -- 2.5 0.5 3.2
----- ----- ----- ----- -----
Total liabilities assumed 30.5 -- 87.7 103.1 221.3
----- ----- ----- ----- -----
Value of cash paid and/or stock
issued to stock-holders of
acquiree n/a 0.3 22.0 n/a 22.3
----- ----- ----- ----- -----
Intangible assets recorded $ 3.2 0.2 3.2 14.6 21.2
===== ===== ===== ===== =====
74
Note 3. Securities
The book values and approximate fair values of investment securities at
December 31, 2003 and 2002 are summarized as follows:
2003 2002
-------------------------------------------- -------------------------------------------
Amortized Fair Unrealized Amortized Fair Unrealized
(In thousands) Cost Value Gains (Losses) Cost Value Gains (Losses)
--------- ------- ----- -------- --------- ------ ----- --------
Securities available for sale:
U.S. Government agencies $ 35,225 35,808 590 (7) 12,953 13,529 576 --
Mortgage-backed securities 48,455 48,473 410 (392) 34,265 35,208 968 (25)
Corporate bonds 12,154 13,415 1,261 -- 11,613 11,507 101 (207)
Equity securities 5,753 5,759 24 (18) 5,549 5,535 -- (14)
-------- ------- ----- ---- ------ ------ ----- ----
Total available for sale $101,587 103,455 2,285 (417) 64,380 65,779 1,645 (246)
======== ======= ===== ==== ====== ====== ===== ====
Securities held to maturity:
State and local governments $ 12,947 13,647 700 -- 13,951 14,718 767 --
Other 1,259 1,259 -- -- 1,039 1,039 -- --
-------- ------- ----- ---- ------ ------ ----- ----
Total held to maturity $ 14,206 14,906 700 -- 14,990 15,757 767 --
======== ======= ===== ==== ====== ====== ===== ====
Included in mortgage-backed securities at December 31, 2003 were
collateralized mortgage obligations with an amortized cost of $21,649,000 and a
fair value of $21,458,000. Included in mortgage-backed securities at December
31, 2002 were collateralized mortgage obligations with an amortized cost of
$12,590,000 and a fair value of $12,720,000.
The Company owned Federal Home Loan Bank stock with a cost and fair value
of $5,550,000 at December 31, 2003 and $5,325,000 at December 31, 2002, which is
included in equity securities above and serves as part of the collateral for the
Company's line of credit with the Federal Home Loan Bank (see Note 9 for
additional discussion). The investment in this stock is a requirement for
membership in the Federal Home Loan Bank system.
The following table presents information regarding securities with
unrealized losses at December 31, 2003:
Securities in an Unrealized Securities in an Unrealized
Loss Position for Loss Position for
Less than 12 Months More than 12 Months Total
--------------------------- --------------------------- ----------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
----------- ----------- ------------- ---------- ---------- ----------
U.S. Government agencies $ 2,041 7 -- -- 2,041 7
Mortgage-backed securities 20,322 392 -- -- 20,322 392
Corporate bonds -- -- -- -- -- --
Equity securities 20 2 24 16 44 18
State and local governments -- -- -- -- -- --
Other -- -- -- -- -- --
------- ------ ------ ------ ------ ------
Total temporarily impaired securities $22,383 401 24 16 22,407 417
======= ====== ====== ====== ====== ======
In the above table, all of the securities that have been in an unrealized
loss position for less than twelve months are bonds that the company has
determined are in a loss position due to interest rate factors, and not because
of credit quality concerns. Therefore, the Company expects to collect the full
par value of each bond upon maturity with no accounting loss. The immaterial
amount of securities that have been in an unrealized loss position for a
continuous twelve months are equity holdings that the Company believes will
eventually recover their value.
75
The book values and approximate fair values of investment securities at
December 31, 2003, by contractual maturity, are summarized in the table below.
Expected maturities may differ from contractual maturities because issuers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
Securities Available for Sale Securities Held to Maturity
----------------------------- ---------------------------
Amortized Fair Amortized Fair
(In thousands) Cost Value Cost Value
------------ ------------ ------------ -----------
Debt securities
Due within one year $ 1,372 1,374 $ 1,305 1,317
Due after one year but within five years 16,382 16,538 8,966 9,360
Due after five years but within ten years 18,866 19,306 3,339 3,593
Due after ten years 10,759 12,005 596 636
Mortgage-backed securities 48,455 48,473 -- --
-------- ------- ------- ------
Total debt securities 95,834 97,696 14,206 14,906
Equity securities 5,753 5,759 -- --
-------- ------- ------- ------
Total securities $101,587 103,455 $14,206 14,906
======== ======= ======= ======
At December 31, 2003 and 2002, investment securities with book values of
$37,719,000 and $37,902,000, respectively, were pledged as collateral for public
and private deposits.
Sales of securities available for sale with aggregate proceeds of
$7,750,000 in 2003, $1,012,000 in 2002, and $2,348,000 in 2001 resulted in gross
gains of $218,000 and no gross losses in 2003, gross gains of $27,000 and gross
losses of $2,000 in 2002, and gross gains of $61,000 in 2001.
Note 4. Loans and Allowance for Loan Losses
Loans at December 31, 2003 and 2002 are summarized as follows:
(In thousands) 2003 2002
----------- --------
Commercial, financial, and agricultural $ 117,287 88,291
Real estate - construction 98,189 68,162
Real estate - mortgage 939,578 795,148
Installment loans to individuals 64,444 47,648
----------- --------
Subtotal 1,219,498 999,249
Unamortized net deferred loan fees (603) (702)
----------- --------
Loans, net of deferred fees $ 1,218,895 998,547
=========== ========
Loans described above as "Real estate - mortgage" included loans secured
by 1-4 family dwellings in the amounts of $549,900,000 and $466,600,000 as of
December 31, 2003 and 2002, respectively, with such loans being pledged as
collateral for certain borrowings (see Note 9). The loans above also include
loans to executive officers and directors and to their associates totaling
approximately $9,775,000 and $9,552,000 at December 31, 2003 and 2002,
respectively. During 2003, additions to such loans were approximately $3,838,000
and repayments totaled approximately $3,615,000. These loans were made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other non-related
borrowers. Management does not believe these loans involve more than the normal
risk of collectibility or present other unfavorable features.
76
Nonperforming assets at December 31, 2003 and 2002 are as follows:
(In thousands) 2003 2002
------ -----
Loans: Nonaccrual loans $4,274 2,976
Restructured loans 21 41
Accruing loans greater than 90 days past due -- --
------ -----
Total nonperforming loans 4,295 3,017
Other real estate (included in other assets) 1,398 1,384
------ -----
Total nonperforming assets $5,693 4,401
====== =====
If the nonaccrual loans and restructured loans as of December 31, 2003,
2002 and 2001 had been current in accordance with their original terms and had
been outstanding throughout the period (or since origination if held for part of
the period), gross interest income in the amounts of approximately $319,000,
$246,000 and $320,000 for nonaccrual loans and $2,000, $6,000 and $10,000 for
restructured loans would have been recorded for 2003, 2002 and 2001,
respectively. Interest income on such loans that was actually collected and
included in net income in 2003, 2002 and 2001 amounted to approximately
$102,000, $55,000 and $76,000 for nonaccrual loans (prior to their being placed
on nonaccrual status) and $2,000, $6,000 and $7,000 for restructured loans,
respectively.
Activity in the allowance for loan losses for the years ended December 31,
2003, 2002 and 2001 is as follows:
(In thousands) 2003 2002 2001
-------- ------- ------
Balance, beginning of year $ 10,907 9,388 7,893
Provision for loan losses 2,680 2,545 1,151
Recoveries of loans charged-off 240 135 131
Loans charged-off (1,341) (1,211) (912)
Allowance recorded related to loans
assumed in corporate acquisitions 1,083 50 1,125
-------- ------- ------
Balance, end of year $ 13,569 10,907 9,388
======== ======= ======
At December 31, 2003 and 2002, the recorded investment in loans considered
to be impaired was $1,449,000 and $1,431,000, respectively, of which all were on
a nonaccrual basis at each year end. The related allowance for loan losses for
the impaired loans at December 31, 2003 and 2002 was $341,000 and $290,000,
respectively. At December 31, 2003 and 2002, there was $242,000 and $162,000 in
impaired loans for which there was no related allowance. The average recorded
investments in impaired loans during the years ended December 31, 2003, 2002,
and 2001 were approximately $1,590,000, $1,822,000, and $2,450,000,
respectively. For the years ended December 31, 2003, 2002, and 2001, the Company
recognized no interest income on those impaired loans during the period that
they were considered to be impaired.
77
Note 5. Premises and Equipment
Premises and equipment at December 31, 2003 and 2002 consist of the
following:
(In thousands) 2003 2002
-------- -------
Land $ 5,829 4,486
Buildings 18,492 16,212
Furniture and equipment 15,895 14,093
Leasehold improvements 645 569
-------- -------
Total cost 40,861 35,360
Less accumulated depreciation and amortization (15,505) (13,121)
-------- -------
Net book value of premises and equipment $ 25,356 22,239
======== =======
Note 6. Goodwill and Other Intangible Assets
The following is a summary of the gross carrying amount and accumulated
amortization of amortized intangible assets as of December 31, 2003 and December
31, 2002 and the carrying amount of unamortized intangible assets as of December
31, 2003 and December 31, 2002.
December 31, 2003 December 31, 2002
---------------------------- ----------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
(In thousands) Amount Amortization Amount Amortization
-------------- ------------ -------------- ------------
Amortized intangible assets:
Customer lists $ 394 54 243 23
Noncompete agreements 50 25 -- --
Core deposit premiums 2,441 429 335 261
------- ------- ------- --------
Total $ 2,885 508 578 284
======= ======= ======= ========
Unamortized intangible assets:
Goodwill $48,231 24,658
======= =======
Pension $ 93 217
======= =======
The following table presents the estimated amortization expense for
intangible assets for each of the five calendar years ending December 31, 2008
and the estimated amount amortizable thereafter. These estimates are subject to
change in future periods to the extent management determines it is necessary to
make adjustments to the carrying value or estimated useful lives of amortized
intangible assets.
Estimated
Amortization Expense
(In thousands)
--------------------
2004 $ 379
2005 290
2006 242
2007 220
2008 219
Thereafter 1,027
-----------
Total $ 2,377
===========
The following tables present the adjusted effect on net income and on
basic and diluted earnings per share excluding the amortization of goodwill for
the years ended December 31, 2003, 2002 and 2001. See Note 1(r) for
78
discussion.
For the Years Ended December 31,
(Dollars in thousands, except -----------------------------------------------------
earnings per share amounts) 2003 2002 2001
---------- ---------- ----------
Reported net income $ 19,417 17,230 13,616
Add back: Goodwill amortization, net of taxes -- -- 1,160
---------- ---------- ----------
Adjusted net income $ 19,417 17,230 14,776
========== ========== ==========
Basic earnings per share:
As reported $ 2.07 1.89 1.51
Goodwill amortization -- -- 0.13
---------- ---------- ----------
Adjusted basic earnings per share $ 2.07 1.89 1.64
========== ========== ==========
Diluted earnings per share:
As reported $ 2.03 1.85 1.47
Goodwill amortization -- -- 0.12
---------- ---------- ----------
Adjusted diluted earnings per share $ 2.03 1.85 1.59
========== ========== ==========
Note 7. Income Taxes
Total income taxes for the years ended December 31, 2003, 2002 and 2001
were allocated as follows:
(In thousands) 2003 2002 2001
-------- ------ -----
Net income $ 10,617 9,282 7,307
Stockholders' equity, for unrealized holding gain on
debt and equity securities for financial reporting purposes 183 199 220
Stockholders' equity, for tax benefit of additional pension charge (50) (64) --
-------- ------ -----
Total income taxes $ 10,750 9,417 7,527
======== ====== =====
The components of income tax expense (benefit) for the years ended
December 31, 2003, 2002 and 2001 are as follows:
(In thousands) 2003 2002 2001
------- ------ ------
Current - Federal $ 9,578 8,964 7,256
- State 614 464 102
Deferred - Federal 425 (146) (51)
------- ------ ------
Total $10,617 9,282 7,307
======= ====== ======
79
The sources and tax effects of temporary differences that give rise to
significant portions of the deferred tax assets (liabilities) at December 31,
2003 and 2002 are presented below:
(In thousands) 2003 2002
------- ------
Deferred tax assets:
Allowance for loan losses $ 4,300 3,658
Excess book over tax retirement plan cost 372 278
Basis of investment in subsidiary 69 69
Net loan fees recognized for tax reporting purposes 166 166
Reserve for employee medical expense for financial reporting purposes 20 20
Deferred compensation 149 145
State net operating loss carryforwards 214 62
Trust preferred security issuance costs 49 7
Accruals, book versus tax 193 --
Minimum pension liability adjustment 114 64
All other 57 138
------- ------
Gross deferred tax assets 5,703 4,607
Less: Valuation allowance (214) (135)
------- ------
Net deferred tax assets 5,489 4,472
------- ------
Deferred tax liabilities:
Loan fees (978) (1,282)
Excess tax over book pension cost (754) (346)
Depreciable basis of fixed assets (1,493) (1,051)
Amortizable basis of intangible assets (1,606) (413)
Unrealized gain on securities available for sale (729) (546)
FHLB stock dividends (439) (439)
Book versus tax basis difference - securities (84) --
All other (2) (113)
------- ------
Gross deferred tax liabilities (6,085) (4,190)
------- ------
Net deferred tax asset (liability) - included in other assets $ (596) 282
======= ======
A portion of the annual change in the net deferred tax asset (liability)
relates to unrealized gains and losses on securities available for sale. The
related 2003 and 2002 deferred tax expense of approximately $183,000 and
$199,000, respectively has been recorded directly to shareholders' equity.
Additionally, a portion of the annual change in the net deferred tax asset
(liability) relates to an additional pension charge. The related 2003 and 2002
deferred tax expense (benefit) of ($50,000) and ($64,000), respectively, has
been recorded directly to shareholders' equity. Purchase acquisitions also
increased the net deferred tax liability by $320,000 in 2003. The balance of the
2003 and 2002 change in the net deferred tax asset (liability) of $425,000 and
($146,000), respectively, is reflected as a deferred income tax expense
(benefit) in the consolidated statement of income.
The 2003 valuation allowance relates to state net operating loss
carryforwards. It is management's belief that the realization of the remaining
net deferred tax assets is more likely than not.
Retained earnings at December 31, 2003 and 2002 includes approximately
$6,869,000 representing pre-1988 tax bad debt reserve base year amounts for
which no deferred income tax liability has been provided since these reserves
are not expected to reverse or may never reverse. Circumstances that would
require an accrual of a portion or all of this unrecorded tax liability are a
reduction in qualifying loan levels relative to the end of 1987, failure to meet
the definition of a bank, dividend payments in excess of accumulated tax
earnings and profits, or other distributions in dissolution, liquidation or
redemption of the Bank's stock.
80
The following is a reconcilement of federal income tax expense at the
statutory rate of 35% to the income tax provision reported in the financial
statements.
(In thousands) 2003 2002 2001
-------- ------ ------
Tax provision at statutory rate $ 10,512 9,279 7,323
Increase (decrease) in income taxes resulting from:
Tax-exempt interest income (286) (300) (341)
Non-deductible interest expense 16 24 46
Non-deductible portion of amortization of
intangible assets -- -- 178
State income taxes, net of federal benefit 361 290 66
Change in valuation allowance 78 12 5
Other, net (64) (23) 30
-------- ------ ------
Total $ 10,617 9,282 7,307
======== ====== ======
Note 8. Deposits
At December 31, 2003, the scheduled maturities of time deposits are as
follows:
(In thousands)
2004 $ 539,588
2005 48,664
2006 14,761
2007 22,168
2008 13,913
Thereafter 895
------------
$ 639,989
============
81
Note 9. Borrowings and Borrowings Availability
The following table presents information regarding the Company's
outstanding borrowings at December 31, 2003 and 2002:
Description Due date Call Feature Amount Interest Rate
- -------------- -------------------------- ------------------------- ------------ -----------------------
2003
- --------------
FHLB Overnight January 1, 2004, renewable None $ 25,000,000 1.20% subject to
Borrowings daily change daily
FHLB Term Note Due January 16, 2005 None 1,000,000 4.01% fixed
FHLB Term Note Due March 13, 2006 None 2,000,000 2.44% fixed
FHLB Term Note Due March 13, 2007 None 2,000,000 2.91% fixed
FHLB Term Note Due June 23, 2008 None 1,000,000 5.51% fixed
FHLB Term Note Due on April 21, 2009 By FHLB on April 21, 2004 5,000,000 5.26% fixed
Trust Preferred Due on November 7, 2032 By Company on a quarterly 20,000,000 4.60% at Dec. 31, 2003
Securities basis beginning on November adjustable rate
7, 2007 3 month LIBOR + 3.45%
Trust Preferred Due on January 23, 2034 By Company on a 20,000,000 3.85% at Dec. 31, 2003
Securities quarterly basis beginning adjustable rate
on January 23, 2009 3 month LIBOR + 2.70%
------------ -----------------------
Total borrowings/
weighted 3.23% (4.23% excluding
average rate $ 76,000,000 overnight borrowings)
============ =======================
2002
- --------------
FHLB Term Note Due on May 5, 2003 None $ 5,000,000 7.49% fixed
FHLB Term Note Due on April 21, 2009 By FHLB on April 21, 2004 5,000,000 5.26% fixed
Trust Preferred Securities Due on November 7, 2032 By Company on a quarterly 20,000,000 5.27% at Dec. 31, 2002
basis beginning on November adjustable rate
7, 2007 3 month LIBOR + 3.45%
------------ -----------------------
Total borrowings/
weighted
average rate $ 30,000,000 5.64%
============ =======================
In the tables above, only the $5 million due to the FHLB on April 21, 2009
has a lender call provision, which allows the FHLB, at their option, to call the
bond on April 21, 2004. The call provision provides interest rate protection to
the FHLB in the event that prevailing market interest rates are higher than the
note rate on the date of the call. Additionally, the outstanding borrowings
noted above may be accelerated immediately by the FHLB in certain circumstances
including material adverse changes in the condition of the Company or if the
Company's qualifying collateral amounts to less than 1.33 times the amount of
FHLB borrowings outstanding. At December 31, 2003, the Company's qualifying
collateral amounted to 8.8 times the amount of FHLB borrowings outstanding.
In the above table, the $20 million in borrowings due on November 7, 2032
relate to borrowings structured as trust preferred capital securities that were
issued by First Bancorp Capital Trust I, a subsidiary of the Company, on October
29, 2002 and qualify as Tier I capital for regulatory capital adequacy
requirements. These debt securities are callable by the Company at par on any
quarterly interest payment date beginning on November 7, 2007. The interest rate
on these debt securities adjusts on a quarterly basis at a rate of three-month
LIBOR plus 3.45%. This rate may not exceed 12.50% through November 2007. The
Company incurred approximately
82
$615,000 in debt issuance costs related to the issuance that were recorded as
prepaid expenses and are included in the "Other Assets" line item of the
consolidated balance sheet. These debt issuance costs are being amortized as
interest expense until the earliest possible call date of November 7, 2007.
In the above table, the $20 million in borrowings due on January 23, 2034
relate to borrowings structured as trust preferred capital securities that were
issued by First Bancorp Capital Trusts II and III ($10 million by each trust),
subsidiaries of the Company, on December 19, 2003 and qualify as Tier I capital
for regulatory capital adequacy requirements. These debt securities are callable
by the Company at par on any quarterly interest payment date beginning on
January 23, 2009. The interest rate on these debt securities adjusts on a
quarterly basis at a rate of three-month LIBOR plus 2.70%. The Company incurred
approximately $580,000 of debt issuance costs related to the issuance that were
recorded as prepaid expenses and are included in the "Other Assets" line item of
the consolidated balance sheet. These debt issuance costs are being amortized as
interest expense until the earliest possible call date of January 23, 2009.
At December 31, 2003, the Company has three sources of readily available
borrowing capacity - 1) an approximately $220 million line of credit with the
FHLB, of which $36 million was outstanding at December 31, 2003 and $10 million
was outstanding at December 31, 2002, 2) a $50 million overnight federal funds
line of credit with a correspondent bank, none of which was outstanding at
December 31, 2003 or 2002, and 3) an approximately $56 million line of credit
through the Federal Reserve Bank of Richmond's (FRB) discount window, none of
which was outstanding at December 31, 2003 or 2002.
The Company's line of credit with the FHLB totaling approximately $220
million can be structured as either short-term or long-term borrowings,
depending on the particular funding or liquidity need and is secured by the
Company's FHLB stock and a blanket lien on its one-to-four family residential
loan portfolio.
The Company's correspondent bank relationship allows the Company to
purchase up to $50 million in federal funds on an overnight, unsecured basis.
The Company had no borrowings outstanding under this line at December 31, 2003
or 2002. This line of credit was not drawn upon during any of the past three
years.
The Company also has a line of credit with the FRB discount window. This
line is secured by a blanket lien on a portion of the Company's commercial,
consumer and real estate portfolio (excluding 1-4 family). Based on the
collateral owned by the Company as of December 31, 2003, the available line of
credit is approximately $56 million. This line of credit was established
primarily in connection with the Company's Y2K liquidity contingency plan and
has not been drawn on since inception. The FRB has indicated that it would not
expect lines of credit that have been granted to financial institutions to be a
primary borrowing source. The Company plans to maintain this line of credit,
although it is not expected that it will be drawn upon except in unusual
circumstances.
Note 10. Leases
Certain bank premises are leased under operating lease agreements.
Generally, operating leases contain renewal options on substantially the same
basis as current rental terms. Rent expense charged to operations under all
operating lease agreements was $324,000 in 2003, $280,000 in 2002, and $243,000
in 2001.
83
Future obligations for minimum rentals under noncancelable operating
leases at December 31, 2003 are as follows:
(In thousands)
Year ending December 31:
2004 $ 376
2005 306
2006 249
2007 222
2008 170
Later years 1,137
-------
Total $ 2,460
=======
Note 11. Employee Benefit Plans
401(k) Plan. The Company sponsors a retirement savings plan pursuant to
Section 401(k) of the Internal Revenue Code. Employees who have completed one
year of service are eligible to participate in the plan. An eligible employee
may contribute up to 15% of annual salary to the plan. The Company contributes
an amount equal to 75% of the first 6% of the employee's salary contributed.
Participants vest in Company contributions at the rate of 20% after one year of
service, and 20% for each additional year of service, with 100% vesting after
five years of service. The Company's matching contribution expense was $528,000,
$450,000, and $382,000, for the years ended December 31, 2003, 2002 and 2001,
respectively. Based on meeting certain financial goals, the Company made
additional discretionary matching contributions to the plan of $175,000 in 2003,
$150,000 in 2002, and $100,000 in 2001. The Company's matching and discretionary
contributions are made in the form of Company stock. Employees are not permitted
to invest their own contributions in Company stock.
Pension Plan. The Company sponsors a noncontributory defined benefit
retirement plan (the "Pension Plan"), which is intended to qualify under Section
401(a) of the Internal Revenue Code. Employees who have attained age 21 and
completed one year of service are eligible to participate in the Retirement
Plan. The Pension Plan provides for a monthly payment, at normal retirement age
of 65, equal to one-twelfth of the sum of (i) 0.75% of Final Average Annual
Compensation (5 highest consecutive calendar years' earnings out of the last 10
years of employment) multiplied by the employee's years of service not in excess
of 40 years, and (ii) 0.65% of Final Average Annual Compensation in excess of
"covered compensation" multiplied by years of service not in excess of 35 years.
"Covered compensation" means the average of the social security taxable wage
base during the 35 year period ending with the year the employee attains social
security retirement age. Early retirement, with reduced monthly benefits, is
available at age 55 after 15 years of service. The Pension Plan provides for
100% vesting after 5 years of service, and provides for a death benefit to a
vested participant's surviving spouse. The costs of benefits under the
Retirement Plan, which are borne by First Bancorp and/or its subsidiaries, are
computed actuarially and defrayed by earnings from the Retirement Plan's
investments. The compensation covered by the Pension Plan includes total
earnings before reduction for contributions to a cash or deferred profit-sharing
plan (such as the 401(k) plan described above) and amounts used to pay group
health insurance premiums and includes bonuses (such as amounts paid under the
incentive compensation plan). Compensation for the purposes of the Pension Plan
may not exceed statutory limits; such limit was $200,000 in 2003 and 2002, and
$170,000 in 2001.
The Company's contributions to the Pension Plan are based on computations
by independent actuarial consultants and are intended to provide the Company
with the maximum deduction for income tax purposes. The contributions are
invested to provide for benefits under the Retirement Plan. Because of the
significant employer contribution made to the Retirement Plan during 2003 and
the high return on assets experienced, the Company does not expect that any
contributions will be required by funding regulations in 2004. However the
Company expects to make a discretionary contribution of approximately $950,000
during 2004.
Funds in the Retirement Plan are invested in a mix of investment types in
accordance with the Retirement
84
Plan's investment policy, which is intended to provide a reasonable return while
maintaining proper diversification. Except for Company stock, all of the
Retirement Plan's assets are invested in an unaffiliated bank money market
account or mutual funds. The investment policy of the Retirement Plan does not
permit the use of derivatives, except to the extent that derivatives are used by
any of the mutual funds invested in by the Retirement Plan. The following table
presents information regarding the mix of investments of the Retirement Plan's
assets at December 31, 2003 and its targeted mix, as set out by the Plan's
investment policy:
Balance at % of Total Assets at Targeted %
Investment type December 31, 2003 December 31, 2003 of Total Assets
------------------------------- ---------------------- -------------------- ---------------
(Dollars in thousands)
Fixed income investments
Money market account $ 1,077 13% 3-5%
US government bond fund 807 10% 10-20%
US corporate bond fund 632 8% 0-10%
Equity investments
Large cap value fund 2,147 25% 20-30%
Large cap growth fund 1,982 23% 20-30%
Mid-small cap growth fund 1,309 15% 15-25%
Foreign equity fund - - 0-10%
Company stock 544 6% 0-10%
-------------- ------
Total $ 8,498 100%
============== ======
For 2002 and 2003, the Company used an expected long-term
rate-of-return-on-assets assumption of 9.00%, while in 2001 the rate was assumed
at 9.50%. The Company arrived at its assumed rate-of-return based primarily on
1) the asset mix of the Retirement Plan's assets, which is generally 75%
equities and 25% fixed income, and 2) the Company's observation of historical
long-term rates-of-return on similar assets. The Company believes that equity
securities have, on average, produced a long-term rate-of-return of 10-12% per
year, while fixed income securities have averaged 5-7%. The Company generally
does not adjust the assumed rate-of-return based on short-term market results.
However, the Company reduced the assumed rate-of-return in 2002 to 9.00% from
9.50% to reflect a slightly more conservative assumption in light of
recessionary economic conditions.
The following table reconciles the beginning and ending balances of the
Pension Plan's projected benefit obligation, as computed by the Company's
independent actuarial consultants. The Pension Plan's accumulated benefit
obligation is also presented:
(In thousands) 2003 2002 2001
------- ------ ------
Projected benefit obligation at beginning of year $ 7,475 6,082 4,704
Service cost 690 492 357
Interest cost 527 427 375
Actuarial loss 1,175 441 709
Effect of amendments 85 70 --
Benefits paid (60) (37) (63)
------- ------ ------
Projected benefit obligation at end of year $ 9,892 7,475 6,082
======= ====== ======
Accumulated benefit obligation at end of year $ 6,164 4,647 4,006
======= ====== ======
85
The following table reconciles the beginning and ending balances of the
Pension Plan's assets:
(In thousands) 2003 2002 2001
------- ------ ------
Plan assets at beginning of year $ 5,126 4,893 4,005
Actual return on plan assets 1,387 (610) (49)
Employer contributions 2,045 880 1,000
Benefits paid (60) (37) (63)
------- ------ ------
Plan assets at end of year $ 8,498 5,126 4,893
======= ====== ======
The following table presents information regarding the funded status of
the Pension Plan, the amounts not recognized in the consolidated balance sheets,
and the amounts recognized in the consolidated balance sheets:
(In thousands) 2003 2002
------- ------
Funded status $(1,394) (2,349)
Unrecognized net actuarial loss 2,997 2,884
Unrecognized prior service cost 366 398
Unrecognized transition obligation 49 51
------- ------
Prepaid pension cost $ 2,018 984
======= ======
Net pension cost for the Pension Plan included the following components
for the years ended December 31, 2003, 2002 and 2001:
(In thousands) 2003 2002 2001
------- ---- ----
Service cost - benefits earned during the period $ 690 492 357
Interest cost on projected benefit obligation 527 427 375
Expected return on plan assets (507) (475) (387)
Net amortization and deferral 301 159 107
------- ---- ----
Net periodic pension cost $ 1,011 603 452
======= ==== ====
Supplemental Executive Retirement Plan. The Company sponsors a
Supplemental Executive Retirement Plan (the "SERP Plan") for the benefit of
certain senior management executives of the Company. The purpose of the SERP
Plan is to provide additional monthly pension benefits to ensure that each such
senior management executive would receive lifetime monthly pension benefits
equal to 3% of his or her final average compensation multiplied by his or her
years of service (maximum of 20 years) to the Company or its subsidiaries,
subject to a maximum of 60% of his or her final average compensation. The amount
of a participant's monthly SERP benefit is reduced by (i) the amount payable
under the Company's qualified Retirement Plan (described above), and (ii) fifty
percent (50%) of the participant's primary social security benefit. Final
average compensation means the average of the 5 highest consecutive calendar
years of earnings during the last 10 years of service prior to termination of
employment.
The Company's funding policy with respect to the SERP Plan is to fund the
related benefits through investments in life insurance policies, which are not
considered plan assets for the purpose of determining the SERP Plan's funded
status. The cash surrender values of the life insurance policies are included in
the line item "other assets."
86
The following table reconciles the beginning and ending balances of the
SERP Plan's benefit obligation, as computed by the Company's independent
actuarial consultants:
(In thousands) 2003 2002 2001
------ ------ ------
Projected benefit obligation at beginning of year $1,248 1,070 765
Service cost 105 69 52
Interest cost 88 73 67
Actuarial loss 179 140 190
Effect of amendments 11 (104) --
Benefits paid -- -- (4)
------ ------ ------
Projected benefit obligation at end of year $1,631 1,248 1,070
====== ====== ======
Accumulated benefit obligation at end of year $1,391 1,115 934
====== ====== ======
The following table presents information regarding the funded status of
the SERP Plan, the amounts not recognized in the consolidated balance sheets,
and the amounts recognized in the consolidated balance sheets:
(In thousands) 2003 2002
------- ------
Funded status $(1,631) (1,248)
Unrecognized net actuarial loss 578 425
Unrecognized prior service cost 84 93
Additional minimum liability (385) (382)
------- ------
Accrued pension cost $(1,354) (1,112)
======= ======
Net pension cost for the SERP Plan included the following components for
the years ended December 31, 2003, 2002 and 2001:
(In thousands) 2003 2002 2001
---- ---- ----
Service cost - benefits earned during the period $105 69 52
Interest cost on projected benefit obligation 88 73 67
Net amortization and deferral 45 36 48
---- ---- ----
Net periodic pension cost $238 178 167
==== ==== ====
The following assumptions were used in determining the actuarial
information for the Retirement Plan and the SERP Plan for the years ended
December 31, 2003, 2002 and 2001:
2003 2002 2001
-------------------- --------------------- ----------------------
Retirement SERP Retirement SERP Retirement SERP
Plan Plan Plan Plan Plan Plan
---------- ---- ---------- ---- ---------- ----
Discount rate used to determine net periodic
pension cost 6.75% 6.75% 7.25% 7.25% 7.75% 7.75%
Discount rate used to calculate end of year
liability disclosures 6.25% 6.25% 6.75% 6.75% 7.25% 7.25%
Expected long-term rate of return on assets 9.00% n/a 9.00% n/a 9.50% n/a
Rate of compensation increase 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
Included in intangible assets at December 31, 2003 and 2002 is $93,000 and
$217,000, respectively, that has been recognized in connection with the accrual
of the additional minimum liability for the SERP Plan.
Split Dollar Life Insurance Plan. Effective January 1, 1993, the Company
adopted a Split Dollar Life Insurance Plan (the "Split Dollar Plan") whereby
individual whole life insurance is made available to certain senior management
officers designated and approved by the Board of Directors. Coverages for each
officer are
87
approximately $100,000. The Company pays the premiums under this plan and
maintains a collateral interest in each participant's policy equal to the sum of
premiums paid. If a policy is terminated or becomes payable because of the death
of a participant, the premiums paid by the Company are recovered before any
payment is made to the participant or the participant's beneficiary. In
addition, the Company will recover its investment in the policy before transfer
of the policy to the participant. Upon the death of a participant, the
participant's designated beneficiary will receive a death benefit equal to the
amount of coverage under his or her policy that is in excess of the amount of
cumulative premiums paid by the Company. The amounts of insurance premiums paid
by the Company in 2003, 2002 and 2001 under the Split-Dollar Plan on behalf of
all executive officers as a group were $18,000, $32,000 and $29,000,
respectively. In response to new regulations, no premiums were paid related to
policies of the Company's executive officers during 2003. In addition,
subsequent to December 31, 2003, the Company is taking steps to terminate all
aspects of the Split Dollar Plan.
Note 12. Commitments and Contingencies
See Note 10 with respect to future obligations under noncancelable
operating leases.
In the normal course of business there are various outstanding commitments
and contingent liabilities such as commitments to extend credit, which are not
reflected in the financial statements. As of December 31, 2003, the Company had
outstanding loan commitments of $211,714,000, of which $186,878,000 were at
variable rates and $24,836,000 were at fixed rates. Included in outstanding loan
commitments were unfunded commitments of $111,631,000 on revolving credit plans,
of which $103,049,000 were at variable rates and $8,582,000 were at fixed rates.
At December 31, 2003 and 2002, the Company had $3,320,000 and $2,279,000,
respectively in standby letters of credit outstanding. The Company has no
carrying amount for these standby letters of credit at either of those dates.
The nature of the standby letters of credit is a guarantee made on behalf of the
Company's customers to suppliers of the customers to guarantee payments owed to
the supplier by the customer. The standby letters of credit are generally for
terms for one year, at which time they may be renewed for another year if both
parties agree. The payment of the guarantees would generally be triggered by a
continued nonpayment of an obligation owed by the customer to the supplier. The
maximum potential amount of future payments (undiscounted) the Company could be
required to make under the guarantees in the event of nonperformance by the
parties to whom credit or financial guarantees have been extended is represented
by the contractual amount of the financial instruments discussed above. In the
event that the Company is required to honor a standby letter of credit, a note,
already executed with the customer, is triggered which provides repayment terms
and any collateral. Over the past ten years, the Company has had to honor one
standby letter of credit, which was repaid by the borrower without any loss to
the Company. Management expects any draws under existing commitments to be
funded through normal operations.
The Bank grants primarily commercial and installment loans to customers
throughout its market area, which consists of Anson, Cabarrus, Chatham,
Davidson, Duplin, Guilford, Harnett, Iredell, Lee, Montgomery, Moore, Randolph,
Richmond, Robeson, Rowan, Scotland, Stanly and Wake Counties in North Carolina,
Dillon County in South Carolina, and Wythe County in Virginia. The real estate
loan portfolio can be affected by the condition of the local real estate market.
The commercial and installment loan portfolios can be affected by local economic
conditions.
The Company is not involved in any legal proceedings which, in
management's opinion, could have a material effect on the consolidated financial
position of the Company.
88
Note 13. Fair Value of Financial Instruments
Fair value estimates as of December 31, 2003 and 2002 and limitations
thereon are set forth below for the Company's financial instruments. Please see
Note 1 for a discussion of fair value methods and assumptions, as well as fair
value information for off-balance sheet financial instruments.
December 31, 2003 December 31, 2002
------------------------------- ------------------------------
Carrying Estimated Carrying Estimated
(In thousands) Amount Fair Value Amount Fair Value
---------- ---------- --------- ----------
Cash and due from banks,
noninterest-bearing $ 36,315 36,315 $ 26,733 26,733
Due from banks, interest-bearing 12,632 12,632 30,753 30,753
Federal funds sold 13,967 13,967 16,167 16,167
Securities available for sale 103,455 103,455 65,779 65,779
Securities held to maturity 14,206 14,906 14,990 15,757
Presold mortgages in process
of settlement 1,307 1,307 19,268 19,268
Loans, net of allowance 1,205,326 1,213,803 987,640 998,256
Accrued interest receivable 6,087 6,087 5,341 5,341
Deposits 1,249,364 1,251,402 1,055,957 1,058,569
Borrowings 76,000 76,383 30,000 30,447
Accrued interest payable 2,138 2,138 2,466 2,466
Limitations Of Fair Value Estimates. Fair value estimates are made at a
specific point in time, based on relevant market information and information
about the financial instrument. These estimates do not reflect any premium or
discount that could result from offering for sale at one time the Company's
entire holdings of a particular financial instrument. Because no market exists
for a significant portion of the Company's financial instruments, fair value
estimates are based on judgments regarding future expected loss experience,
current economic conditions, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in nature and
involve uncertainties and matters of significant judgment and therefore cannot
be determined with precision. Changes in assumptions could significantly affect
the estimates.
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. Significant assets and liabilities that are not
considered financial assets or liabilities include net premises and equipment,
intangible and other assets such as foreclosed properties, deferred income
taxes, prepaid expense accounts, income taxes currently payable and other
various accrued expenses. In addition, the income tax ramifications related to
the realization of the unrealized gains and losses can have a significant effect
on fair value estimates and have not been considered in any of the estimates.
Note 14. Stock Option Plan
Pursuant to provisions of the Company's 1994 Stock Option Plan (the
"Option Plan"), options to purchase up to 705,000 shares of First Bancorp's
authorized but unissued common stock may be granted to employees ("Employee
Options") and directors ("Nonemployee Director Options") of the Company and its
subsidiaries. The purposes of the Option Plan are (i) to align the interests of
participating employees and directors with the Company's shareholders by
reinforcing the relationship between shareholder gains and participant rewards,
(ii) to encourage equity ownership in the Company by participants, and (iii) to
provide an incentive to employee participants to continue their employment with
the Company.
Since the inception of the Option Plan, each nonemployee director has been
granted 1,500 Nonemployee Director Options on June 1 of each year. Employee
Options were granted to substantially all officers at the inception of the
Option Plan and since then have been granted to new officers, officers that have
assumed
89
increased responsibilities, and for performance rewards. For both Employee and
Nonemployee Director Options, the option price is the fair market value of the
stock at the date of grant. Employee Options vest 20% per year over a five-year
period. Director Options are 100% vested on the date of grant. All options
expire not more than 10 years from the date of grant. Forfeited options become
available for future grants.
At December 31, 2003, there were 106,150 additional shares available for
grant under the Option Plan. The per share weighted-average fair value of
options granted during 2003, 2002, and 2001 was $7.55, $6.75, and $6.87,
respectively on the date(s) of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions:
2003 2002 2001
---- ---- ----
Expected dividend yield 3.73% 3.79% 3.80%
Risk-free interest rate 3.30% 4.60% 5.09%
Expected life 8 years 8 years 8 years
Expected volatility 33.08% 33.50% 35.00%
The Company assumed three stock option plans in connection with its merger
acquisition of First Savings Bancorp in September 2000. The three plans included
two nonqualified plans for directors and an incentive plan for employees. In
connection with the assumption of these three plans, 391,584 options (after
adjusting for the exchange ratio) for shares of stock previously granted by
First Savings were assumed. All unvested options of First Savings that were
outstanding on September 14, 2000 became immediately vested as a result of
change-in-control provisions contained in the plans that were triggered by the
merger. The Company also assumed a stock option plan in connection with its
merger acquisition of Century. A total of 18,656 options (after adjusting for
the exchange ratio) for shares of stock previously granted by Century were
assumed and became immediately vested as a result of change-in-control
provisions contained in the plan that were triggered by the merger. No
additional option grants will be made under the provisions of the assumed plans.
Instead, all option grants subsequent to the merger dates are made from the
Company's Option Plan.
The Company applies APB Opinion No. 25 in accounting for its Plan and,
accordingly, no compensation cost has been recognized for its stock options in
the financial statements. Note 1(k) reflects the pro forma effects had the
Company determined compensation cost based on the fair value at the grant date
for its stock options under SFAS No. 123.
90
The following table sets forth a summary of the activity of the Company's
outstanding options, including the options related to First Savings and Century,
since December 31, 2000:
Options Exercisable
Options Outstanding at Year End
----------------------- --------------------------
Weighted- Weighted-
Average Average
Number of Exercise Number of Exercise
Shares Price Shares Price
--------- ---------- --------- ----------
Balance at December 31, 2000 698,895 $ 11.50 688,895 $ 11.45
Granted 140,750 23.05
Assumed in corporate
acquisition 18,656 15.33
Exercised (145,777) 9.52
Forfeited -- --
Expired -- --
Balance at December 31, 2001 712,524 14.28 587,774 12.58
Granted 21,000 23.05
Exercised (166,842) 9.28
Forfeited -- --
Expired -- --
Balance at December 31, 2002 566,682 16.04 468,082 14.71
Granted 51,000 24.53
Assumed in corporate acquisition 52,000 6.25
Exercised (151,176) 9.57
Forfeited -- --
Expired -- --
Balance at December 31, 2003 518,506 $ 17.78 417,722 $ 16.58
The following table summarizes information about the stock options outstanding
at December 31, 2003:
Options Outstanding Options Exercisable
------------------------------------------------ -------------------------
Weighted- Weighted- Weighted-
Number Average Average Number Average
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices at 12/31/03 Contractual Life Price at 12/31/03 Price
--------------- ----------- ---------------- --------- ----------- ---------
$6.00 to $9.99 77,762 1.5 $ 7.49 77,762 $ 7.49
$10.00 to $13.99 35,837 2.9 11.75 35,837 11.75
$14.00 to $17.99 163,367 5.4 16.37 159,367 16.42
$18.00 to $21.99 30,250 4.6 19.52 26,916 19.29
$22.00 to $26.00 211,290 7.8 23.43 117,840 23.63
------- ----- --------- -------- ---------
518,506 5.6 $ 17.78 417,722 $ 16.58
======= ===== ========= ======== =========
Note 15. Regulatory Restrictions
The Company is regulated by the Board of Governors of the Federal Reserve
System ("FED") and is subject to securities registration and public reporting
regulations of the Securities and Exchange Commission. The Bank is regulated by
the Federal Deposit Insurance Corporation ("FDIC") and the North Carolina Office
of the Commissioner of Banks.
The primary source of funds for the payment of dividends by First Bancorp
is dividends received from its subsidiary, First Bank. The Bank, as a North
Carolina banking corporation, may pay dividends only out of
91
undivided profits as determined pursuant to North Carolina General Statutes
Section 53-87. As of December 31, 2003, the Bank had undivided profits of
approximately $82,656,000 which were available for the payment of dividends. As
of December 31, 2003, approximately $76,992,000 of the Company's investment in
the Bank is restricted as to transfer to the Company without obtaining prior
regulatory approval.
The average reserve balance maintained by the Bank under the requirements
of the Federal Reserve was approximately $401,000 for the year ended December
31, 2003.
The Company and the Bank must comply with regulatory capital requirements
established by the FED and FDIC. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional discretionary, actions
by regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company and the Bank must
meet specific capital guidelines that involve quantitative measures of the
Company's assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Company's and Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors. These capital standards
require the Company and the Bank to maintain minimum ratios of "Tier 1" capital
to total risk-weighted assets ("Tier I Capital Ratio") and total capital to
risk-weighted assets of 4.00% and 8.00% ("Total Capital Ratio"), respectively.
Tier 1 capital is comprised of total shareholders' equity, excluding unrealized
gains or losses from the securities available for sale, less intangible assets,
and total capital is comprised of Tier 1 capital plus certain adjustments, the
largest of which for the Company and the Bank is the allowance for loan losses.
Risk-weighted assets refer to the on- and off-balance sheet exposures of the
Company and the Bank, adjusted for their related risk levels using formulas set
forth in FED and FDIC regulations.
In addition to the risk-based capital requirements described above, the
Company and the Bank are subject to a leverage capital requirement, which calls
for a minimum ratio of Tier 1 capital (as defined above) to quarterly average
total assets ("Leverage Ratio) of 3.00% to 5.00%, depending upon the
institution's composite ratings as determined by its regulators. The FED has not
advised the Company of any requirement specifically applicable to it.
In addition to the minimum capital requirements described above, the
regulatory framework for prompt corrective action also contains specific capital
guidelines applicable to banks for classification as "well capitalized," which
are presented with the minimum ratios, the Company's ratios and the Bank's
ratios as of December 31, 2003 and 2002 in the following table. Based on the
most recent notification from its regulators, the Bank is well capitalized under
the framework for prompt corrective action. There are no conditions or events
since that notification that management believes have changed the Company's
category.
92
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------- ------------------------- -------------------------
($ in thousands) Amount Ratio Amount Ratio Amount Ratio
--------- ------- --------- ------- -------- -------
(must equal or exceed) (must equal or exceed)
As of December 31, 2003
Total Capital Ratio
Company $ 143,762 12.56% $ 91,575 8.00% $ N/A N/A
Bank 122,657 10.73% 91,429 8.00% 114,286 10.00%
Tier I Capital Ratio
Company 119,994 10.61% 45,252 4.00% N/A N/A
Bank 109,263 9.67% 45,179 4.00% 67,768 6.00%
Leverage Ratio
Company 119,994 8.70% 55,175 4.00% N/A N/A
Bank 109,263 7.93% 55,140 4.00% 68,925 5.00%
As of December 31, 2002
Total Capital Ratio
Company $ 128,971 13.69% $ 75,372 8.00% $ N/A N/A
Bank 108,855 11.57% 75,245 8.00% 94,056 10.00%
Tier I Capital Ratio
Company 118,064 12.68% 37,249 4.00% N/A N/A
Bank 97,948 10.54% 37,186 4.00% 55,779 6.00%
Leverage Ratio
Company 118,064 10.09% 46,800 4.00% N/A N/A
Bank 97,948 8.38% 46,745 4.00% 58,432 5.00%
Note 16. Supplementary Income Statement Information
Components of other operating expenses exceeding 1% of total income for
any of the years ended December 31, 2003, 2002 and 2001 are as follows:
(In thousands) 2003 2002 2001
------ ----- -----
Stationery and supplies $1,498 1,445 1,279
Telephone 1,229 932 688
Note 17. Condensed Parent Company Information
Condensed financial data for First Bancorp (parent company only) follows:
CONDENSED BALANCE SHEETS As of December 31,
---------------------------
(In thousands) 2003 2002
-------- -------
Assets
Cash on deposit with bank subsidiary $ 20,794 19,818
Investment in wholly-owned subsidiaries, at equity 162,224 125,525
Land 7 7
Other assets 1,056 604
-------- -------
Total assets $184,081 145,954
======== =======
Liabilities and shareholders' equity
Borrowings $ 40,000 20,000
Other liabilities 2,225 1,969
-------- -------
Total liabilities 42,225 21,969
Shareholders' equity 141,856 123,985
-------- -------
Total liabilities and shareholders' equity $184,081 145,954
======== =======
93
CONDENSED STATEMENTS OF INCOME Year Ended December 31,
------------------------------------------------
(In thousands) 2003 2002 2001
-------- ------- -------
Dividends from wholly-owned subsidiaries $ 3,400 8,650 16,300
Undistributed earnings of wholly-owned subsidiaries 17,453 9,207 --
Dividends received from wholly-owned subsidiaries in excess of earnings -- -- (2,280)
Interest expense (1,110) (205) --
All other income and expenses, net (326) (422) (404)
-------- ------- -------
Net income $ 19,417 17,230 13,616
======== ======= =======
CONDENSED STATEMENTS OF CASH FLOWS Year Ended December 31,
------------------------------------------------
(In thousands) 2003 2002 2001
-------- ------- -------
Operating Activities:
Net income $ 19,417 17,230 13,616
Dividends received in excess of earnings (equity in undistributed
earnings) of subsidiaries (17,453) (9,207) 2,280
Tax benefit realized from
exercise of nonqualified stock options -- 382 --
Amortization of securities and intangible assets 60
Decrease (increase) in other assets (667) (595) 40
Increase (decrease) in other liabilities 90 (157) (48)
-------- ------- -------
Total - operating activities 1,447 7,653 15,888
-------- ------- -------
Investing Activities:
Net cash paid in acquisitions (9,050) -- (12,447)
-------- ------- -------
Total - investing activities (9,050) -- (12,447)
-------- ------- -------
Financing Activities:
Advance from subsidiary -- -- 13,304
Proceeds from borrowings 20,000 20,000 --
Payment of cash dividends (8,670) (8,136) (7,929)
Proceeds from issuance of common stock 2,444 2,207 1,295
Purchases and retirement of common stock (5,195) (4,410) (10,468)
-------- ------- -------
Total - financing activities 8,579 9,661 (3,798)
-------- ------- -------
Net increase (decrease) in cash and cash equivalents 976 17,314 (357)
Cash and cash equivalents, beginning of year 19,818 2,504 2,861
-------- ------- -------
Cash and cash equivalents, end of year $ 20,794 19,818 2,504
======== ======= =======
Supplemental Disclosures of Cash Flow Information:
Non-cash transactions:
Repayment of cash advance from subsidiary
with non-cash assets $ -- -- 13,304
94
Independent Auditors' Report
The Board of Directors
First Bancorp
We have audited the accompanying consolidated balance sheets of First
Bancorp and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of income, comprehensive income, shareholders' equity
and cash flows for each of the years in the three-year period ended December 31,
2003. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of First
Bancorp and subsidiaries as of December 31, 2003 and 2002, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, on
January 1, 2002, the Company adopted Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets," and on October 1, 2002, the
Company adopted Statement of Financial Accounting Standards No. 147,
"Acquisitions of Certain Financial Institutions."
/s/ KPMG LLP
Charlotte, North Carolina
February 20, 2004
95
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
During the two years ended December 31, 2003, and any subsequent interim
periods, there were no changes in accountants and/or disagreements on any
matters of accounting principles or practices or financial statement
disclosures.
Item 9A. Controls and Procedures
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our chief
executive officer and chief financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on the
evaluation, our chief executive officer and chief financial officer concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information required to be included in our periodic reports
with the Securities and Exchange Commission. It should be noted that the design
of any system of controls is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions,
regardless of how remote. In addition, no change in our internal control over
financial reporting has occurred during, or subsequent to, the period covered by
this report that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant
Incorporated herein by reference is the information under the captions
"Directors, Nominees and Executive Officers," "Section 16(a) Beneficial
Ownership Reporting Compliance," and "Corporate Governance" from the Company's
definitive proxy statement to be filed pursuant to Regulation 14A.
Item 11. Executive Compensation
Incorporated herein by reference is the information under the caption
"Compensation of Executive Officers" and "Board Committees, Attendance, and
Compensation" from the Company's definitive proxy statement to be filed pursuant
to Regulation 14A.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated herein by reference is the information under the captions
"Principal Holders of First Bancorp Voting Securities," "Directors, Nominees and
Executive Officers," and "Equity Compensation Plan Information" from the
Company's definitive proxy statement to be filed pursuant to Regulation 14A.
Item 13. Certain Relationships and Related Transactions
Incorporated herein by reference is the information under the caption
"Certain Transactions" from the Company's definitive proxy statement to be filed
pursuant to Regulation 14A.
Item 14. Principal Accountant Fees and Services
Incorporated herein by reference is the information under the caption
"Principal Accountant Fees and Services" from the Company's definitive proxy
statement to be filed pursuant to Regulation 14A.
96
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements - See Item 8 and the Cross Reference Index on
page 2 for information concerning the Company's consolidated
financial statements and report of independent auditors.
2. Financial Statement Schedules - not applicable
3. Exhibits
The following exhibits are filed with this report or, as noted, are
incorporated by reference. Management contracts, compensatory plans
and arrangements are marked with an asterisk (*).
3.a Copy of Articles of Incorporation of the Company and amendments
thereto were filed as Exhibits 3.a.i through 3.a.v to the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 2002,
and are incorporated herein by reference.
3.b Copy of the Amended and Restated Bylaws of the Company.
4 Form of Common Stock Certificate was filed as Exhibit 4 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June
30, 1999, and is incorporated herein by reference.
10 Material Contracts
10.a Data Processing Agreement dated October 1, 1984 by and between Bank
of Montgomery (First Bank) and Montgomery Data Services, Inc. was
filed as Exhibit 10(k) to the Registrant's Registration Statement
Number 33-12692, and is incorporated herein by reference.
10.b First Bank Salary and Incentive Plan, as amended, was filed as
Exhibit 10(m) to the Registrant's Registration Statement Number
33-12692, and is incorporated herein by reference. (*)
10.c Indemnification Agreement between the Company and its Directors and
Officers was filed as Exhibit 10(t) to the Registrant's Registration
Statement Number 33-12692, and is incorporated herein by reference.
10.d First Bancorp Senior Management Supplemental Executive Retirement
Plan was filed as Exhibit 10(d) to the Company's Annual Report on
Form 10-K for the year ended December 31, 2001, and is incorporated
herein by reference. (*)
10.e First Bancorp Senior Management Split-Dollar Life Insurance
Agreements between the Company and the Executive Officers were filed
as Exhibit 10(e) to the Company's Annual Report on Form 10-K for the
year ended December 31, 2001, and are incorporated herein by
reference. (*)
10.f First Bancorp 1994 Stock Option Plan was filed as Exhibit 10(f) to
the Company's Annual Report on Form 10-K for the year ended December
31, 2001, and is incorporated herein by reference. (*)
10.g Employment Agreement between the Company and James H. Garner dated
August 17, 1998 was filed as Exhibit 10(l) to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1998, and is incorporated by reference (Commission File Number
000-15572). (*)
10.h Employment Agreement between the Company and Anna G. Hollers dated
August 17, 1998 was filed as Exhibit 10(m) to the Company's
Quarterly Report on Form 10-Q for the quarter ended September
97
30, 1998, and is incorporated by reference (Commission File Number
000-15572). (*)
10.i Employment Agreement between the Company and Teresa C. Nixon dated
August 17, 1998 was filed as Exhibit 10(n) to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1998, and is incorporated by reference (Commission File Number
000-15572). (*)
10.j Employment Agreement between the Company and Eric P. Credle dated
August 17, 1998 was filed as Exhibit 10(p) to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998, and is
incorporated herein by reference (Commission File Number 333-71431).
(*)
10.k Employment Agreement between the Company and David G. Grigg dated
August 17, 1998 was filed as Exhibit 10.r to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 and is
incorporated herein by reference. (*)
10.l Employment Agreement between the Company and John F. Burns dated
September 14, 2000 was filed as Exhibit 10.w to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2000 and is incorporated herein by reference. (*)
10.m Employment Agreement between the Company and James G. Hudson, Jr.
dated May 17, 2001 was filed as Exhibit 10(p) to the Company's
Annual Report on Form 10-K for the year ended December 31, 2001, and
is incorporated herein by reference. (*)
10.n Employment Agreement between the Company and R. Walton Brown dated
January 15, 2003 was filed as Exhibit 10(b) to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2003
and is incorporated herein by reference. (*)
21 List of Subsidiaries of Registrant.
23.a Consent of Independent Auditors of Registrant, KPMG LLP
31.a Chief Executive Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley
Act of 2002.
31.b Chief Financial Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley
Act of 2002.
32.a Chief Executive Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
32.b Chief Financial Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
(b) There was one report on Form 8-K filed during the quarter ended
December 31, 2003.
On October 24, 2003, the Company filed a report on Form 8-K
regarding its October 23, 2003 news release in which it announced
its earnings for the quarter ended September 30, 2003. The full text
of the news release dated October 23, 2003 was attached as Exhibit
99(a) to this Form 8-K filing.
(c) Exhibits - see (a)(3) above
(d) No financial statement schedules are filed herewith.
Copies of exhibits are available upon written request to: First Bancorp, Anna G.
Hollers, Executive Vice President, P.O. Box 508, Troy, NC 27371
98
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, FIRST BANCORP has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of Troy, and State of North Carolina, on the 9th day of March, 2004.
First Bancorp
By: /s/ James H. Garner
-------------------
James H. Garner
President, Chief Executive Officer and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed on behalf of the Company by the following persons and in
the capacities and on the dates indicated.
Executive Officers
/s/ James H. Garner
-------------------
James H. Garner
President, Chief Executive Officer and Treasurer
/s/ Anna G. Hollers /s/ Eric P. Credle
------------------- ------------------
Anna G. Hollers Eric P. Credle
Executive Vice President Senior Vice President
Secretary Chief Financial Officer
March 9, 2004 (Principal Accounting Officer)
March 9, 2004
Board of Directors
/s/ Jesse S. Capel /s/ William E. Samuels
------------------ ----------------------
Jesse S. Capel William E. Samuels
Chairman of the Board Vice-Chairman of the Board
Director Director
March 9, 2004 March 9, 2004
/s/ Jack D. Briggs /s/ George R. Perkins, Jr.
------------------ --------------------------
Jack D. Briggs George R. Perkins, Jr.
Director Director
March 9, 2004 March 9, 2004
/s/ R. Walton Brown /s/ Thomas F. Phillips
------------------- ----------------------
R. Walton Brown Thomas F. Phillips
Director Director
March 9, 2004 March 9, 2004
/s/ H. David Bruton /s/ Edward T. Taws
------------------- ------------------
H. David Bruton Edward T. Taws
Director Director
March 9, 2004 March 9, 2004
/s/ David L. Burns /s/ Frederick H. Taylor
------------------ -----------------------
David L. Burns Frederick H. Taylor
Director Director
March 9, 2004 March 9, 2004
99
/s/ John F. Burns /s/ Virginia C. Thomasson
----------------- -------------------------
John F. Burns Virginia C. Thomasson
Director Director
March 9, 2004 March 9, 2004
/s/ Goldie H. Wallace-Gainey /s/ A. Jordan Washburn
---------------------------- ----------------------
Goldie H. Wallace-Gainey A. Jordan Washburn
Director Director
March 9, 2004 March 9, 2004
/s/ James H. Garner /s/ Dennis A. Wicker
------------------ --------------------
James H. Garner Dennis A. Wicker
Director Director
March 9, 2004 March 9, 2004
/s/ James G. Hudson, Jr. /s/ John C. Willis
------------------------ ------------------
James G. Hudson, Jr. John C. Willis
Director Director
March 9, 2004 March 9, 2004
100