SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20552
--------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended March 31, 2006 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________to___________________
Commission File Number 0-29040
---------
Fidelity Bankshares, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 65-1101656
- -------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
205 Datura Street, West Palm Beach, Florida 33401
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(561) 803-9900
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name,former address and former fiscal year,if changed since last report)
Indicate by check mark whether the Registrant has filed all reports
required to be filed by Sections 13, or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No
Indicate by check mark whether the Registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [ ] Accelerated Filer [X] Non-Accelerated Filer [ ]
Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes[ ] No |X|
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date: There were 25,174,191 shares
of the Registrant's common stock par value $.10 per share outstanding as of
April 30, 2006.
<Page>
FIDELITY BANKSHARES, INC.
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................................1
Unaudited Condensed Consolidated Statements of Financial
Condition as of December 31, 2005 and March 31, 2006............2
Unaudited Condensed Consolidated Statements of Operations
for the three months ended March 31, 2005 and 2006..............3
Unaudited Condensed Consolidated Statements of Comprehensive
Operations for the three months ended March 31, 2005 and 2006...4
Unaudited Condensed Consolidated Statements of Cash Flows for
the three months ended March 31, 2005 and 2006..................5
Notes to Unaudited Condensed Consolidated Financial Statements...6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................16
Item 3. Quantitative and Qualitative Disclosure About Market Risk.......22
Item 4. Controls and Procedures.........................................25
PART II. OTHER INFORMATION...............................................26
Item 1. Legal Proceedings...............................................26
Item 1A. Risk Factors....................................................27
Item 2. Changes in Securities and Stock Repurchases.....................27
Item 3. Default Upon Senior Securities..................................27
Item 4. Submission of Matters to a Vote of Security Holders.............27
Item 5. Other Information...............................................27
Item 6. Exhibits........................................................27
EXHIBITS
Section 302 Certification.......................................27
Section 906 Certification.......................................27
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FIDELITY BANKSHARES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
- --------------------------------------------------------------------------------
December 31, March 31,
2005 2006
================ ===================
ASSETS (In thousands, except share data)
CASH AND CASH EQUIVALENTS:
Cash and amounts due from depository institutions.............................. $ 150,657 $ 101,545
Interest-earning deposits...................................................... 39,283 104,590
----------- -----------
Total cash and cash equivalents............................................ 189,940 206,135
----------- -----------
SECURITIES AVAILABLE FOR SALE....................................................... 410,473 380,489
SECURITIES HELD TO MATURITY ( fair value - $241,463 and $235,532
at December 31, 2005 and March 31, 2006, respectively)............................. 242,497 237,445
LOANS RECEIVABLE, net of allowance for loan losses - $16,171 and $16,521 at
December 31, 2005 and March 31, 2006, respectively................................ 3,036,710 3,202,425
OFFICE PROPERTIES AND EQUIPMENT, net................................................ 91,164 92,389
FEDERAL HOME LOAN BANK STOCK, at cost............................................... 11,398 11,959
FORECLOSED ASSETS, net.............................................................. 1,793 -
ACCRUED INTEREST RECEIVABLE......................................................... 16,273 16,782
DEFERRED INCOME TAX ASSET........................................................... 11,933 12,960
GOODWILL .......................................................................... 14,256 14,256
CORE DEPOSIT INTANGIBLES............................................................ 6,528 6,337
OTHER ASSETS 49,646 58,914
----------- -----------
TOTAL ASSETS $ 4,082,611 $ 4,240,091
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
DEPOSITS:
Non-interest bearing........................................................... $ 485,425 $ 534,522
Interest bearing............................................................... 3,055,449 3,132,974
----------- -----------
Total deposits............................................................. 3,540,874 3,667,496
OTHER BORROWED FUNDS................................................................ 54,113 77,094
ADVANCES FROM FEDERAL HOME LOAN BANK................................................ 92,364 83,878
ADVANCES BY BORROWERS FOR TAXES AND INSURANCE....................................... 1,461 10,500
JUNIOR SUBORDINATED DEBENTURES...................................................... 53,608 53,608
OTHER LIABILITIES................................................................... 55,423 55,966
----------- ----------
TOTAL LIABILITIES.............................................................. 3,797,843 3,948,542
----------- ----------
STOCKHOLDERS' EQUITY:
PREFERRED STOCK, 2,000,000 shares authorized, none issued........................... - -
COMMON STOCK ($.10 par value) 30,000,000 authorized shares:
outstanding 25,114,716 at December 31, 2005 and 25,171,641 at
March 31, 2006............................................................. 2,511 2,517
ADDITIONAL PAID IN CAPITAL.......................................................... 167,197 168,264
RETAINED EARNINGS - substantially restricted........................................ 129,842 135,745
TREASURY STOCK - at cost, 416,799 shares at December 31, 2005 and
402,434 shares at March 31, 2006............................................... (1,794) (1,746)
COMMON STOCK ALLOCATED TO:
Employee stock ownership plan.................................................. (3,561) (3,474)
Recognition and retention plan................................................. (1,785) (1,470)
ACCUMULATED OTHER COMPREHENSIVE LOSS................................................ (7,642) (8,287)
------------ -----------
TOTAL STOCKHOLDERS' EQUITY..................................................... 284,768 291,549
------------ -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.......................................... $ 4,082,611 $ 4,240,091
============ ===========
See Notes to Unaudited Condensed Consolidated Financial Statements.
2
FIDELITY BANKSHARES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
For the
Three Months Ended
March 31,
2005 2006
====================================
(In thousands, except per share data)
Interest income:
Loans............................................................. $ 37,342 $ 52,238
Securities........................................................ 7,579 7,739
Other investments................................................. 403 1,688
-------- --------
Total interest income......................................... 45,324 61,665
-------- --------
Interest expense:
Deposits.......................................................... 10,818 24,855
Federal Home Loan Bank advances and other borrowings.............. 4,433 2,583
-------- --------
Total interest expense........................................ 15,251 27,438
-------- --------
Net interest income.................................................... 30,073 34,227
Provision for loan losses.............................................. 572 440
-------- --------
Net interest income after provision for loan losses.................... 29,501 33,787
-------- --------
Other income:
Service charges on deposit accounts............................... 2,501 3,017
Fees for other banking services................................... 2,233 2,286
Net gain on sale of loans......................................... 352 115
Miscellaneous..................................................... 387 414
-------- --------
Total other income............................................ 5,473 5,832
-------- --------
Operating expense:
Employee compensation and benefits................................ 13,608 15,497
Occupancy and equipment........................................... 3,350 3,772
Data processing................................................... 1,438 1,839
Marketing......................................................... 786 801
Miscellaneous..................................................... 4,754 4,951
-------- --------
Total operating expense....................................... 23,936 26,860
-------- --------
Income before provision for income taxes............................... 11,038 12,759
Provision for income taxes............................................. 4,222 4,883
-------- --------
Net income............................................... $ 6,816 $ 7,876
======== ========
Earnings per share:
Basic............................................................. $ 0.29 $ 0.32
======== ========
Diluted........................................................... $ 0.28 $ 0.31
======== ========
Dividends declared per share........................................... $ 0.08 $ 0.08
======== ========
See Notes to Unaudited Condensed Consolidated Financial Statements.
3
<Page>
FIDELITY BANKSHARES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
- --------------------------------------------------------------------------------
For the
Three Months Ended
March 31,
2005 2006
=========================
(In thousands)
Net Income.................................................................. $ 6,816 $ 7,876
Other comprehensive loss, net of tax:
Unrealized losses on assets available for sale......................... (4,784) (645)
--------- --------
Comprehensive income........................................................ $ 2,032 $ 7,231
========= ========
See Notes to Unaudited Condensed Consolidated Financial Statements.
4
<Page>
FIDELITY BANKSHARES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------
For the Three Months Ended
March 31,
2005 2006
==========================
(In thousands)
CASH FLOWS FROM (FOR) OPERATING ACTIVITIES:
Net Income............................................................. $ 6,816 $ 7,876
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation........................................................ 1,523 2,234
Amortization of core deposit intangibles............................ - 190
ESOP compensation expense........................................... 299 439
Stock-based compensation expense................................. 315 315
Accretion of discounts, amortization of premiums and intangible
assets, and other deferred yield items............................. (1,409) (1,354)
Provision for loan losses........................................... 572 440
Provisions for losses and net (gains) losses on sales of real estate 2 (368)
owned
Net (gain) loss on sale of:
Loans......................................................... (352) (115)
Office properties and equipment............................... 10 5
Change in operating assets and liabilities, net of acquisitions:
Increase in accrued interest receivable............................. (1,105) (508)
Decrease (increase) in other assets................................. 1,549 (9,423)
Increase in drafts payable.......................................... 185 2,893
Decrease in deferred income taxes................................... (503) (589)
Increase (decrease) in other liabilities............................ 4,097 (2,341)
-------- --------
Net cash provided by (used for) operating activities.......... 11,999 (306)
-------- --------
CASH FLOW FROM (FOR) INVESTING ACTIVITIES:
Loan originations and principal payments on loans...................... (93,392) (175,348)
Principal payments received on:
Securities available for sale.................................... 19,553 15,648
Securities held to maturity...................................... 4,333 9,568
Purchases of:
Loans............................................................... (11,683) -
Securities available for sale.................................... (2,332) (1,565)
Securities held to maturity......................................... - (4,388)
Federal Home Loan Bank stock........................................ (1,688) (920)
Office properties and equipment..................................... (3,497) (3,489)
Proceeds from sales of:
Loans............................................................... 10,327 10,467
Federal Home Loan Bank stock........................................ 2,119 359
Repossessed assets acquired in settlement of loans.................. - 2,300
Proceeds from maturities securities available for sale................. - 15,000
Other.................................................................. 158 (92)
-------- ---------
Net cash used for investing activities........................ (76,102) (132,460)
--------- ---------
CASH FLOW FROM (FOR) FINANCING ACTIVITIES:
Proceeds from the exercise of stock options............................ 31 769
Cash dividends paid.................................................... (1,912) (1,964)
Net increase (decrease) in:
NOW accounts, demand deposits and savings accounts.................. 88,996 207,654
Certificates of deposit............................................. (36,097) (81,032)
Advances from Federal Home Loan Bank................................ (28,395) (8,486)
Other borrowed funds................................................ 3,721 22,981
Advances by borrowers for taxes and insurance....................... 5,544 9,039
--------- ---------
Net cash provided by financing activities..................... 31,888 148,961
--------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS................... (32,215) 16,195
CASH AND CASH EQUIVALENTS, beginning of period......................... 149,409 189,940
--------- ---------
CASH AND CASH EQUIVALENTS, end of period............................... $117,194 $206,135
========= =========
See Notes to Unaudited Condensed Consolidated Financial Statements.
5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accounting and reporting policies of Fidelity Bankshares, Inc. (the
"Company") and its subsidiary Fidelity Federal Bank & Trust (the "Bank") conform
with accounting principles generally accepted in the United States of America
and with predominant practices within the banking and thrift industry. The
Company has not changed its accounting and reporting policies from those
disclosed in its 2005 Annual Report on Form 10-K.
These consolidated financial statements have been prepared in accordance with
the instructions for Form 10-Q and Item 303 (b) of Regulation S-K and do not
include all disclosures required by accounting principles generally accepted in
the United States of America for a complete presentation of our financial
condition and results of operations. In the opinion of management, the
information reflects all adjustments (consisting only of normal recurring
adjustments) which are necessary in order to make the financial statements not
misleading and for a fair presentation of the results of operations for such
periods. The results for the period ended March 31, 2006 should not be
considered as indicative of results for a full year. For further information,
refer to the consolidated financial statements and footnotes included in our
annual report on Form 10-K for the year ended December 31, 2005.
Use of Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
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.
Reclassifications - Certain amounts in the financial statements have been
reclassified to conform with the March 31, 2006 presentation. The presentation
of the income statement for March 31, 2005 has been reclassified to eliminate
certain intercompany income and expense items between the Bank and it's
wholly-owned subsidiary, Fidelity Realty Appraisal Services, Inc., to conform
with the March 31, 2006 presentation. Elimination of such intercompany income
and expense for the three months ending March 31, 2005 and 2006 is as follows:
For the Three Months Ended
March 31,
----------------------------
2005 2006
============================
(In thousands)
Fees for other banking services $ (662) $ (603)
------- -------
Total Other Income (662) (603)
------- -------
Employee compensation and benefits (342) (368)
Miscellaneous operating expenses (320) (235)
------- -------
Total operating expense (662) (603)
------- -------
Effect on net income $ - $ -
======= =======
6
<Page>
2. STOCK PLANS AND STOCK-BASED COMPENSATION
The Company has two stock plans which include the 2002 Incentive Stock Benefit
Plan ("Option Plan") and the 2002 Recognition and Retention Plan ("RR Plan").
Under the Option Plan, the Company has reserved 1,304,391 shares of common
stock, of which all but 3,175 options have been granted. All stock options have
an exercise price that is equal to the fair market value of the Company's stock
on the date the options were granted. The term of the stock option awards is ten
years from the date of grant. On December 29, 2005 the Benefits Committee of the
Board of Directors of the Company approved the accelerated vesting and
exercisability of all unvested and unexercisable stock options granted as part
of the Plan held by directors, officers or employees on December 30, 2005. As a
result, all previously unvested options became fully vested on December 30,
2005.
Under the RR Plan, the Company reserved and granted 521,757 shares of common
stock to key employees and outside directors to encourage such individuals to
remain with the Bank. These granted shares vest and are allocated to the
affected employees and directors ratably over five years, subject to various
conditions requiring their acceleration. All awards have a grant price that is
equal to the fair market value of the Company's stock on the date that the
awards were granted.
The following is a summary of stock-based award activity during the three months
ended March 31, 2006:
Weighted-Average Aggregate
Number of Weighted-Average Remaining Intrinsic Value
Shares Exercise Price Contractual Life (In Thousands)
-------------------------------------------------------------
Outstanding as of December 31, 2005 1,188,877 $ 15.19
Granted - -
Exercised 56,925 13.51
Forfeited - -
--------- -------
Outstanding as of March 31, 2006 1,131,952 $ 15.28 6.2 $ 20,771
========= ======= ===== ========
Exercisable as of March 31, 2006 1,131,952 $ 15.28 6.2 $ 20,771
========= ======= ===== ========
Weighted-
Number of Average Weighted-Average
Restricted Grant-Date Fair Remaining
Shares Value Contractual Life
---------------------------------------------------
Unvested as of December 31, 2005 186,570 $ 13.51
Awarded - -
Released - -
Forfeited - -
---------- -------
Unvested as of March 31, 2006 186,570 $ 13.51 0.6
========== ======= =====
The aggregate intrinsic value for stock options and restricted stock in the
preceding tables represents the total pre-tax intrinsic value, based on the
Company's closing stock price of $33.63 as of March 31, 2006. These amounts
represent the total pre-tax intrinsic value that would have been received by the
holders of the stock-based awards had the awards been exercised and sold as of
that date. During the three months ended March 31, 2006, the total intrinsic
value of stock options exercised was $1.1 million. For these options exercised,
7
the Company received cash of $769,000 and realized a tax benefit from the
exercise of stock option of $364,000. The Company has a policy of issuing new
shares to satisfy share option exercises.
Additional information regarding options outstanding and exercisable as of March
31, 2006, is as follows:
Weighted-Average
Remaining Weighted-Average
Range of exercise prices Number of Shares Contractual Life Exercise Price
- ----------------------------------------------------------------------------------------------------------
$13.51 971,817 6.2 $ 13.51
16.93 5,760 6.2 16.93
22.38 13,292 6.2 22.38
23.13 11,388 6.2 23.13
24.71 6,000 6.2 24.71
24.75 10,917 6.2 24.75
24.90 8,030 6.2 24.90
25.12 27,868 6.2 25.12
25.30 3,951 6.2 25.30
25.59 7,815 6.2 25.59
27.67 50,250 6.2 25.67
33.33 14,864 5.5 33.33
--------- ------ ----------
1,131,952 6.2 $ 15.28
========= ====== ==========
On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (Revised), "Share-Based Payment" ("SFAS No. 123(R)"), which
amended SFAS No. 123. SFAS No. 123(R) requires measurement of the cost of
share-based payment transactions to employees at the fair value of the award on
the grant date and recognition of expense over the requisite service, which is
generally the vesting period. Prior to January 1, 2006, the Company accounted
for stock-based compensation under Accounting Principles Board ("APB") Opinion
No. 25. APB Opinion No. 25 recognizes compensation expense based on the
intrinsic value of the equity instrument awarded. Prior to January 1, 2006, no
stock-based compensation cost for stock option grants was reflected in net
income as all options granted had an exercise price equal to the market value of
the underlying common stock on the date of grant.
SFAS No. 123(R) requires a modified prospective application and the Company has
applied the statement to new awards and to awards modified, repurchased, or
cancelled beginning January 1, 2006. At December 31, 2005 there were no unvested
stock options outstanding. For the three months ended March 31, 2006,
approximately $195,000 in compensation expense, net of related tax effects, has
been recognized in employee compensation and benefits in the condensed
consolidated statement of operations related to restricted stock. Compensation
costs for these awards are based on fair value at the original grant date. The
fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model and is based on certain assumptions
including: expected volatility based on the historical price of the Company's
stock over the expected life of the option; the risk free rate of return based
on the U.S. Treasury yield curve in effect at the time of grant for the expected
term of the option; the expected life based on the period of time the options
are expected to be outstanding using historical data to estimate option exercise
and employee termination; and dividend yield based on the Company's history and
expectation of dividend payments. No stock options were granted during the three
months ended March 31, 2006 and March 31, 2005, respectively.
As the Company has applied the modified prospective application, the Company did
not restate prior periods. The pro forma disclosures required by SFAS No. 148
for the three month period ended March 31, 2005 are presented below (dollars in
thousands, except per share amounts).
8
<Page>
For the
Three Months Ended
March 31, 2005
===========================
(In thousands, except per
share amounts)
Net Income, as reported....................................................... $ 6,816
Add: Total stock-based employee compensation expense included in
reported net earnings, net of related tax effects...................... 195
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects............................................ (322)
------------
Pro forma net income.......................................................... $ 6,689
============
Basic - as reported....................................................... 0.29
Basic - pro forma......................................................... 0.28
Diluted - as reported..................................................... 0.28
Diluted - pro forma....................................................... 0.27
The assumptions used to determine the stock-based employee compensation expense
determined under the fair value based method for all awards for the quarter
ended March 31, 2005 include an expected volatility of 28.93%, a risk free rate
of return of 2.78%, an expected life of 5 years, and an expected dividend yield
of 1.97%.
As of March 31, 2006, there were no unvested stock options outstanding and, as
such, no related unrecognized compensation costs. As of March 31, 2006 the total
unrecognized compensation cost related to restricted stock was $1.5 million,
which is expected to be recognized over a period of 1.1 years.
9
<Page>
3. EARNINGS PER SHARE
Earnings per share was computed by dividing net income by the weighted average
number of shares of common stock outstanding during the three months ended March
31, 2005 and 2006. Adjustments have been made to give effect to the shares that
would be outstanding, assuming the exercise of dilutive stock options and
recognition and retention plan shares, all of which are considered common stock
equivalents.
For the Three Months Ended
March 31,
-------------------------------
2005 2006
Net income.................................................. $ 6,816,000 $ 7,876,000
=========== ===========
Weighted average common shares outstanding:
Shares outstanding...................................... 24,425,133 25,152,632
Less: weighted average uncommitted ESOP................. (586,826) (534,650)
------------ ------------
Total................................................ $23,838,307 $24,617,982
============ ============
Basic earnings per share............. $ 0.29 $ 0.32
============ ============
Weighted average common shares outstanding.................. $23,838,307 $24,617,982
Additional dilutive shares related to stock options and
recognition and retention plan shares....................... 751,082 733,160
------------ ------------
Total weighted average common shares and equivalents
outstanding for dilutes earnings per share computation..... $24,571,467 $25,369,064
============ ============
Diluted earnings per share............... $ 0.28 $ 0.31
============ ============
4. LOANS RECEIVABLE
Loans receivable at December 31, 2005 and at March 31, 2006, consist of the
following:
December 31, March 31,
2005 2006
============== =================
(In Thousands)
One- to four- family, residential real estate mortgages.............. $1,061,487 $1,110,276
Commercial and multi-family real estate mortgages.................... 1,082,719 1,145,714
Real estate construction-primarily residential....................... 390,751 436,067
Land loans-primarily residential..................................... 71,502 69,781
---------- ----------
Total first mortgage loans........................................... 2,606,459 2,761,838
Consumer loans....................................................... 295,622 306,739
Commercial business loans............................................ 153,916 153,908
---------- ----------
Total loans, net of loans in process................................. 3,055,997 3,222,485
Deduct:
Unearned discounts, premiums and deferred loan fees, (costs), net 3,116 3,539
Allowance for loan losses....................................... 16,171 16,521
---------- ----------
Loans receivable-net................................................. $3,036,710 $3,202,425
========== ==========
During the quarter ended March 31, 2006, the Company sold $ 10.4 million in
loans, which resulted in net gains of $115,000. During the quarter ended March
31, 2005, the Company sold $10.0 million in loans, which resulted in net gains
of approximately $352,000.
10
<Page>
At December 31, 2005 and March 31, 2006, the Bank had $845,000 and $1.7 million
in loans held for sale or transfer, respectively.
5. ALLOWANCE FOR LOAN LOSSES
An analysis of the changes in the allowance for loan losses for the year ended
December 31, 2005 and the three months ended March 31, 2005 and 2006, is as
follows:
For the Year For the Three Months
Ended Ended
December 31, March 31,
2005 2005 2006
=================== ==========================
(In Thousands) (In Thousands)
Balance at beginning of period...... $ 13,628 $13,628 $ 16,171
Current provision................... 1,877 572 440
Effect of Acquisition............... 995 - -
Charge-offs......................... (330) (2) (90)
Recoveries.......................... 1 - -
------------ -------- --------
Ending balance...................... $ 16,171 $14,198 $ 16,521
============ ======== ========
An analysis of the recorded investment in impaired loans owned by the Bank at
the end of each period and the related specific valuation allowance for impaired
loans is as follows:
December 31, 2005 March 31, 2006
=======================================================
Loan Related Loan Related
Balance Allowance Balance Allowance
------------ ------------- ------------- --------------
(In Thousands)
Impaired loan balances and related allowances:
Loans with related allowance for loan losses................ $ 627 $ 334 $ 959 $ 194
Loans without related allowance for loan losses............. 6,818 - 6,020 -
-------- -------- -------- --------
Total.............................................. $ 7,445 $ 334 $ 6,979 $ 194
======== ======== ======== ========
The Bank's policy for interest income on impaired loans is to reverse all
accrued interest against interest income if a loan becomes more than 90 days
delinquent, and to cease accruing interest thereafter. Interest ultimately
collected is credited to income in the period of recovery.
11
6. DEPOSITS
The weighted-average interest rates on deposits at December 31, 2005 and March
31, 2006 were 2.63% and 2.75%, respectively. Deposit accounts, by type, at
December 31, 2005 and March 31, 2006 consist of the following:
December 31, March 31,
Account Type and Rate 2005 2006
============================
(In Thousands)
Non-interest-bearing checking accounts..................... $ 485,425 $ 534,522
Interest-bearing checking and funds transfer accounts...... 820,588 921,431
Passbook and statement accounts............................ 825,117 836,531
Variable-rate money market accounts........................ 507,664 553,964
Certificates of deposit.................................... 902,080 821,048
----------- -----------
Total...................................................... $ 3,540,874 $ 3,667,496
=========== ===========
7. DEFINED BENEFIT PENSION PLAN
Employees hired prior to January 1, 2001 participate in the Bank's qualified
defined benefit pension plan covering substantially all such employees. The plan
calls for benefits to be paid to eligible employees at retirement based
primarily upon years of service with the Bank and compensation rates during
those years. The Bank's policy is to fund the qualified retirement plan in an
amount that falls between the minimum contribution required by the Employee
Retirement Income Security Act and maximum tax deductible contribution. Plan
assets consist primarily of common stock, U.S. Government obligations and
certificates of deposit.
Components of net periodic benefit cost are as follows:
For the
Three Months Ended
-----------------------------
March 31,
-----------------------------
2005 2006
============= ===============
(In thousands)
Service cost........................................... $ 596 $ 630
Interest cost.......................................... 407 434
Expected return on assets.............................. (405) (460)
Net amortization....................................... 256 244
-------- -------
Net periodic pension expense........................... $ 854 $ 848
======== =======
During 2005 the Company contributed $4.7 million to the plan. The Company
expects to contribute $3.5 million for the year 2006 in the second or third
quarter.
12
<Page>
8. REGULATORY CAPITAL
The Company's subsidiary, Fidelity Federal Bank & Trust, is a regulated
financial institution. Its regulatory capital amounts and ratios are presented
in the following table:
To be Considered
Minimum for Well Capitalized
Capital Adequacy for Prompt Corrective
Actual Purposes Action Provisions
------------------------------------------------------------------------------
Ratio Amount Ratio Amount Ratio Amount
------------------------------------------------------------------------------
(Dollars in Thousands)
As of December 31, 2005 Stockholders'
Equity and ratio to total assets 8.0% $326,560
========
Unrealized decrease in market value
of assets available for sale
(net of applicable income taxes) 5,785
Goodwill and other intangible assets. (21,365)
Disallowed servicing assets.......... (364)
--------
Tangible capital and ratio to
adjusted total assets........... 7.6% $310,616 1.5% $ 61,055
======== ======== ====== =========
Tier I (core) capital and ratio to
adjusted total assets........... 7.6% $310,616 3.0% $ 122,109 5.0% $ 203,516
======== ======== ====== ========= ====== =========
Tier I (core) capital and ratio to
risk-weighted total assets...... 10.8% $310,616 4.0% $ 115,552 6.0% $ 173,328
======== ======== ====== ========= ====== =========
Allowable Tier 2 capital:
General loan valuation allowances ... 15,380
--------
Total risk-based capital and ratio to
risk-weighted total assets...... 11.3% $325,996 8.0% $ 231,104 10.0% $ 288,880
======== ======== ====== ========= ====== =========
Total assets......................... $4,082,716
Adjusted total assets................ $4,070,316
==========
Risk-weighted assets................. $2,888,804
As of March 31, 2006 Stockholders'
Equity and ratio to total assets 7.9% $ 334,429
========
Unrealized decrease in market value
of assets available for sale
(net of applicable income taxes) 6,430
Goodwill and other intangible assets. (21,156)
Disallowed servicing assets.......... (347)
--------
Tangible capital and ratio to
adjusted total assets........... 7.6% $319,356 1.5% $ 63,341
======== ======== ====== =========
Tier I (core) capital and ratio to
adjusted total assets........... 7.6% $319,356 3.0% $ 126,681 5.0% $ 211,136
======== ======== ====== ========= ====== =========
Tier I (core) capital and ratio to
risk-weighted total assets...... 10.6% $319,356 4.0% $ 120,122 6.0% $ 180,183
======== ======== ====== ========= ====== =========
Allowable Tier 2 capital:
General loan valuation allowances ... 15,827
--------
Total risk-based capital and ratio to
risk-weighted total assets...... 11.1% $335,183 8.0% $ 240,244 10.0% $ 300,305
======== ======== ====== ========= ====== =========
Total assets......................... $4,237,789
Adjusted total assets................ $4,222,716
==========
Risk-weighted assets................. $3,003,049
13
9. SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
For the Three Months Ended
-----------------------------
March 31,
-----------------------------
2005 2006
============================
(In Thousands)
Mortgage-backed securities retained from the
securitization of mortgage loans....................... $ 202,816 $ -
========= ========
10. CONTINGENCIES
The Company is subject to various claims, legal actions and complaints arising
in the ordinary course of business. In the Company's opinion, the disposition of
these matters will not have a material adverse effect on our consolidated
financial condition, results of operations or cash flows.
On July 1, 2003, Fidelity Federal Bank & Trust was named as the sole defendant
in the lawsuit, James Kehoe v. Fidelity Federal Bank & Trust, filed in the
United States District Court for the Southern District of Florida. In this
action, James Kehoe ("Kehoe"), on behalf of himself and other similarly situated
persons, alleged that Fidelity Federal violated the Driver Privacy Protection
Act by obtaining driver registration information from the State of Florida for
use in Fidelity Federal's marketing efforts. Kehoe seeks as damages the
statutory minimum of $2,500 per class member. Kehoe has alleged that the class
numbers over 560,000 individuals. On June 14, 2004, the Court granted Fidelity
Federal's Motion for Summary Judgment and entered a Final Judgment in favor of
Fidelity Federal against Kehoe ruling that there could be no statutory minimum
damages award unless there were actual damages. This issue was one of several
issued raised by Fidelity Federal. The Court did not rule on the other issues.
Kehoe appealed the ruling to the 11th Circuit Court of Appeals, and on August
26, 2005, the Circuit Court reversed the Trial Court's Order of Summary Judgment
and remanded the case back to the Trial Court for further proceedings, stating
that actual damages need not be proved before an award of the statutory minimum
damages of $2,500 per individual could be made. Consequently, the potential
damages that could be awarded would be the result of multiplying the statutory
minimum of $2,500 per class member by the total class of defendants. However,
the Circuit Court also stated that the Trial Court "in its discretion, may
fashion what it deems to be an appropriate award." The Circuit Court also stated
that, "the use of the word `may' suggests that the award of any damages is
permissive and discretionary." Fidelity Federal's Motion for Summary Judgment on
one of the issues was heard by the Trial Court on April 27, 2006 but has not yet
been ruled on by the court. Additionally, the briefings in opposition to Kehoe's
Motion for Class Certification are almost complete. Fidelity Federal in
consultation with counsel, has concluded that the likelihood of the class being
certified is remote, and the damages if awarded, would be minimal. Therefore,
Fidelity Federal intends to vigorously defend the case.
On February 18, 2004, Fidelity Federal Bank & Trust was named as defendant in a
lawsuit William Adams et al., vs. Thomson Financial, Inc., Fidelity Federal Bank
& Trust, N.A., Fidelity Investments Services, L.L.C., d/b/a Fidelity
Investments, National Financial Services, L.L.C., f/k/a National Financial
Services Corporation, Zoe Marrero, filed in the Fifteenth Judicial Circuit in
and for Palm Beach County, Florida. The plaintiffs in this case have alleged
various causes of action against numerous defendants which arise from
plaintiffs' investments in various entities controlled and operated by Thomas
Abrams, who was convicted of running a Ponzi Scheme. Fidelity Federal is a named
14
<Page>
defendant in one count of the complaint alleging aiding and abetting breaches of
fiduciary duty. The allegations are based upon Fidelity Federal allowing Abrams
to set up accounts with Fidelity Federal, deposit monies in them, issue bank
checks based upon the deposits and instructions from authorized signatories on
the accounts and generally offer banking services to the Abrams entities.
Plaintiffs make additional allegations that Fidelity Federal solicited clients
for the Abrams entities and pressured clients to place deposits with the Abrams
entities and Fidelity Federal, which are without basis. There is no specific
request for damages, other than the jurisdictional amount of in excess of
$15,000. The Plaintiffs allege they lost in excess of $18,000,000 investing with
Abrams. The actual amount of losses incurred by the plaintiffs are as of yet
undetermined. On May 20, 2005, the Court entered an Order granting in part
Fidelity Federal's Motion to Dismiss the Second Amended Complaint. The Court
struck all of Plaintiff's claims for non-economic damages (e.g., custodial
damages), and dismissed the aiding and abetting breach of fiduciary duty claim,
with leave to amend, based on each Plaintiff's failure to allege specific
ultimate facts that the bank's alleged actions were the proximate cause of
plaintiff's losses. A Fourth Amended Complaint was filed on January 27, 2006. We
intend to vigorously defend our position on the basis that we acted solely as a
depository bank in the transactions and allegations of improper conduct by the
bank are factually inaccurate.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
16
<Page>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General.
Fidelity Bankshares, Inc. (the "Company") is the parent company of Fidelity
Federal Bank & Trust ("Fidelity Federal" or the "Bank"). The Company conducts no
business other than holding the common stock of the Bank and common shares in
its special purpose trusts, Fidelity Capital II and Fidelity Capital III.
Consequently, the Company's net income is primarily derived from the Bank. The
Bank's net income is primarily dependent on its net interest income, which is
the difference between interest income earned on its investments in mortgage
loans and mortgage-backed securities, other investment securities and loans, and
its cost of funds consisting of interest paid on deposits and borrowings. The
Bank's net income also is affected by its provision for loan losses, as well as
by the amount of other income, including income from fees and service charges,
net gains and losses on sales of investments, and operating expense such as
employee compensation and benefits, deposit insurance premiums, occupancy and
equipment costs, and income taxes. Earnings of the Bank also are affected
significantly by general economic and competitive conditions, particularly
changes in market interest rates, government policies and actions of regulatory
authorities, which events are beyond the control of the Bank. In particular, the
general level of market interest rates tends to be highly cyclical.
Forward-Looking Statements.
When used in this report, the words or phrases "will likely result," "are
expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, including, among
other things, changes in economic conditions in the Company's market area,
changes in policies by regulatory agencies, fluctuations in interest rates,
demand for loans in the Company's market area and competition that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. The Company wishes to caution readers not to place
undue reliance on any such forward-looking statements, which speak only as of
the date made. The Company wishes to advise readers that the factors listed
above could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
Changes in Financial Condition.
Our assets increased by $157.5 million, from $4.1 billion at December 31, 2005
to $4.2 billion at March 31, 2006. Cash and cash equivalents have increased by
$16.2 million. Securities available for sale decreased by $30.0 million, as the
Bank has been using the cash flow from securities to fund loan production. The
loan portfolio increased by $165.7 million, net. All other assets increased by
$5.6 million. Borrowings from the Federal Home Loan Bank decreased by $8.5
million. Funds were provided for asset growth and the decrease in borrowings
from the Federal Home Loan Bank primarily from an increase in stockholders'
equity of $6.8 million and an increase in deposits of $126.6 million.
Results of Operations.
Net income for the quarter ended March 31, 2006 was $7.9 million, a $1.1 million
increase compared to $6.8 million for the same 2005 quarter. This increase was
attributable to an increase of $4.2 million in net interest income together with
17
<Page>
an increase in other income of $359,000. The increase in net interest income
consisted of an increase in interest income of $16.3 million which was partially
offset by an increase in interest expense of $12.1 million. In addition, net
income was affected by increases in operating expenses of $2.9 million, an
increase in the provision for income taxes of $661,000 and a decrease in the
provision for loan losses of $132,000 for the quarter ended March 31, 2006
compared to the quarter ended March 31, 2005.
Interest Income.
Interest income for the quarter ended March 31, 2006, totaled $61.6 million,
representing an increase of $16.3 million or 36.1% from $45.3 million for the
same quarter in 2005. Interest income from loans increased $14.9 million,
primarily as a result of a 24.0% increase in the average balance of loans to
$3.1 billion from $2.5 billion for the quarters ended March 31, 2006 and 2005,
respectively along with an increase in the average yield on loans to 6.72% for
the quarter ended March 31, 2006 from 5.95% for the same period ended March 31,
2005. Interest income from securities increased to $7.7 million for the quarter
ended March 31, 2006 from $7.5 million for the 2005 quarter. This 2.1% increase
was attributable to the average yield of these securities increasing to 4.79%
from 4.49%, partially offset by a decrease in the average balance of these
securities to $646.2 million from $675.0 million. We have been using proceeds
from the repayment of these securities to fund loan growth. Interest income on
other investments increased by $1.2 million due mainly to an increase in the
average balance of these investments to $167.3 million from $55.9 million for
the quarters ended March 31, 2006 and 2005, respectively.
Interest Expense.
Interest expense for the quarter ended March 31, 2006, totaled $27.4 million, an
increase of $12.1 million, or 79.9%, from $15.3 million for the same quarter in
2005. The reason for this increase was an increase in interest expense on
deposits of $14.0 million offset by a decrease in interest expense from
borrowings of $1.9 million. The average balance of interest bearing deposits
increased by $734.8 million, or 30.4% to $3.2 billion for the quarter ended
March 31, 2006 compared to $2.4 billion for the quarter ended March 31, 2005 and
the average cost of those deposits also increased to 3.15% compared to 1.79% for
the comparative quarter. The decrease in interest expense on borrowings was
caused by a decrease in the average balance of these borrowings to $205.2
million from $347.9 million and a slight decrease in the average cost of
borrowed funds to 5.04% for the quarter ended March 31, 2006 from 5.10% for the
comparable 2005 quarter. As mentioned above, the Company has reduced its
borrowings from the Federal Home Loan Bank.
Net Interest Income.
During the quarter ended March 31, 2006, the Company's interest income increased
by $16.3 million compared to the same quarter in 2005, while interest expense
increased by $12.1 million, resulting in net interest income of $34.2 million
for the quarter ended March 31, 2006, a $4.2 million, or 13.8%, increase from
the quarter ended March 31, 2005.
Provision for Loan Losses.
The provision for loan losses was $440,000 for the quarter ended March 31, 2006,
compared to $572,000 for the quarter ended March 31, 2005. The provision for the
quarter ended March 31, 2006 is deemed adequate by management, reflecting the
risks inherent in the Bank's loan portfolio. As indicated above, the decrease in
18
<Page>
our loan loss provision reflects the decrease in our ratio of non-performing
assets to total assets. At March 31, 2006 our allowance for loan losses was
239.01% of nonperforming assets, compared to 203.65% at March 31, 2005.
Allowances for loan losses are based on management's estimate of losses inherent
in the loan portfolio. We provide both general valuation allowances (for
unspecified, probable losses) and specific valuation allowances (for known
losses) in our portfolio. General valuation allowances are added to our capital
for purposes of calculating our regulatory risk-based capital. We conduct a
monthly review of our loan portfolio, including impaired loans, to determine
whether any loans require classification or the establishment of appropriate
valuation allowances. As we continue to increase our origination of commercial
business loans, consumer loans and commercial real estate loans, and such loans
traditionally have a higher risk of loss than residential mortgage loans, our
provision for loan losses is likely to increase in future periods.
Other Income.
Other income for the quarter ended March 31, 2006 was $5.8 million, representing
an increase of $359,000 compared to the same quarter in 2005. The increase is
primarily attributable to an increase in service charges on deposit accounts of
$516,000. Partially offsetting these increases was a $237,000 decrease in gain
on the sale of loans and securities.
Operating Expense.
Compared to the quarter ending March 31, 2006, operating expense for the quarter
ending March 31, 2005 increased by $2.9 million to $26.9 million. Of this
increase, $1.9 million is attributable to compensation and benefits. Increases
in compensation and benefits expense were primarily attributable to operating 51
offices in the quarter ended March 31, 2006 compared to 42 offices in the
quarter ended March 31, 2005, as well as an increase in incentive compensation
as a result of increased profitability, additional personnel to serve deposit
and loan customers, and normal salary increases. Occupancy and equipment costs
and data processing costs increased by $422,000 and $401,000, respectively,
which reflects our continued costs in developing customer service facilities and
acquiring technology equipment. Miscellaneous operating costs also increased by
$197,000 to $5.0 million for the quarter ended March 31, 2006 compared to the
same quarter in 2005 primarily due to amortization of core deposit intangibles
of $190,000 during the quarter ended March 31, 2006 as a result of our
acquisition of First Community Bancorp in April 2005.
Income Taxes.
The income tax provision was $4.9 million for the quarter ended March 31, 2006
compared to $4.2 million for the quarter ended March 31, 2005. The provision
reflects the current rates paid for Federal and state income taxes applied to
the Company's pre-tax income.
Other Comprehensive Income (Loss).
The Company's only change in Other Comprehensive Operations for the three months
ended March 31, 2006 and 2005 is the change in the unrealized gain or loss on
securities available for sale.
Comprehensive income for the quarter ended March 31, 2006 was $7.2 million
compared to comprehensive income of $2.0 million for the quarter ended March 31,
2005. During the quarter ended March 31, 2006, due to rising market interest
rates, the market value of the Company's assets available for sale decreased by
19
<Page>
$1.1 million which, net of income tax of $438,000, resulted in other
comprehensive loss of $645,000. During the three months ended March 31, 2005,
the market value of the Company's securities available for sale decreased by
$7.8 million which, net of income tax of $3.0 million, resulted in other
comprehensive loss of $4.8 million.
Reclassifications.
The presentation of the income statement for March 31, 2005 has been
reclassified to eliminate certain intercompany income and expense items between
the Bank and it's wholly-owned subsidiary, Fidelity Realty Appraisal Services,
Inc., to conform with the March 31, 2006 presentation. Elimination of such
intercompany income and expense for the three months ending March 31, 2005 and
2006 is as follows:
For the Three Months Ended
March 31,
-------------------------------
2005 2006
===============================
(In thousands)
Fees for other banking services $ (662) $(603)
------ ------
Total Other Income (662) (603)
------ ------
Employee compensation and benefits (342) (368)
Miscellaneous operating expenses (320) (235)
------ ------
Total operating expense (662) (603)
------ ------
Effect on net income $ - $ -
====== ======
Liquidity and Capital Resources.
The Bank is required to maintain minimum levels of liquid assets as defined by
OTS regulations. This requirement, which varies from time to time depending upon
economic conditions and deposit flows, is based upon a percentage of deposits
and short-term borrowings. The Bank's liquidity ratio averaged 9.55% during the
month of March 2005. Liquidity ratios averaged 9.73% for the quarter ended March
31, 2006. The Bank adjusts its liquidity levels in order to meet funding needs
of loan originations, deposit outflows, payment of real estate taxes on mortgage
loans, and repayment of borrowings and loan commitments. The Bank also adjusts
liquidity as appropriate to meet its asset and liability management objectives.
The Bank's primary sources of funds are deposits, amortization and prepayment of
loans and mortgage-backed securities and other short-term investments, as well
as earnings and funds provided from operations. While scheduled principal
repayments on loans and mortgage-backed securities are a relatively predictable
source of funds, deposit flows and loan prepayments are greatly influenced by
general interest rates, economic conditions and competition. The Bank manages
the pricing of its deposits to maintain a desired deposit balance. In addition,
the Bank invests excess funds in short-term interest-earning and other assets,
which provide liquidity to meet lending requirements. Short-term
interest-earning deposits with the FHLB of Atlanta amounted to $88.2 million at
March 31, 2006. Other assets qualifying for liquidity at March 31, 2006,
including unpledged mortgage-backed securities guaranteed by Fannie Mae and
20
<Page>
Freddie Mac, were $214.0 million. For additional information about cash flows
from the Company's operating, financing and investing activities, see the
Unaudited Consolidated Statements of Cash Flows included in the Unaudited
Consolidated Financial Statements. The primary sources of cash are net income,
principal repayments on loans and mortgage-backed securities, increases in
deposit accounts and advances from the FHLB.
Liquidity management is both a daily and long-term function of business
management. If the Bank requires funds beyond its ability to generate them
internally, borrowing agreements exist with the FHLB which provide an additional
source of funds. At March 31, 2006, the Bank had $83.9 million in advances from
the FHLB. At March 31, 2006, the Bank had commitments to extend credit for or
purchase loans of $283.7 million, in addition to undisbursed loan proceeds on
closed loans of $538.3 million and undisbursed revolving lines of credit of
$276.7 million. Certificates of deposit scheduled to mature in less than one
year at March 31, 2006 totaled $727.2 million. Based on prior experience,
management believes that a significant portion of such deposits will remain with
the Bank.
New Accounting Pronouncements
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of
Financial Assets - An Amendment of FASB Statement No. 140. This standard amends
the guidance in FASB Statement No. 140, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities. Among other
requirements, SFAS No. 156 requires an entity to recognize a servicing asset or
servicing liability each time it undertakes an obligation to service a financial
asset by entering into a servicing contract for a transfer of the servicer's
financial assets that meets the requirements for sale accounting, a transfer of
the servicer's financial assets to a qualifying special-purpose entity in a
guaranteed mortgage securitization in which the transferor retains all of the
resulting securities and classifies them as either available-for-sale securities
or trading securities in accordance with SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities, or an acquisition or assumption of an
obligation to service a financial asset that does not relate to financial assets
of the servicer or its consolidated affiliates. SFAS No. 156 is effective as of
the beginning of an entity's first fiscal year that begins after September 15,
2006. This statement is not expected to have a material effect on the Company's
financial statements.
In December 2005, the FASB issued FASB Staff Position ("FSP") SOP 94-6-1, Terms
of Loan Products That May Give Rise to a Concentration of Credit Risk. The
guidance requires the disclosure of concentrations of loans with certain
features that may increase the creditor's exposure to risk of nonpayment. These
loans are often referred to as "non-traditional" loans and include features such
as high LTV ratios, terms that permit payments smaller than the interest
accruals and loans where the borrower is subject to significant payment
increases over the life of the loan. The Bank's management has evaluated the
impact of this FSP and has concluded that our disclosures are consistent with
the objectives of the FSP.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment. Under this promulgation, companies are required to reflect costs
associated with employee stock options in their income statements at fair value.
This statement became effective for the Company on January 1, 2006. At December
30, 2005 all options previously granted by the Company were fully vested. As
such, there was no effect on net income for the year 2006 relating to options
granted prior to January 1, 2006.
21
<Page>
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Market Risk Analysis.
As a holding company for a financial institution, the Company's primary
component of market risk is interest rate volatility. Fluctuations in interest
rates will ultimately impact both the level of income and expense recorded on a
large portion of the Bank's assets and liabilities, and the market value of all
interest-earning assets and interest-bearing liabilities, other than those which
possess a short term to maturity. Since the majority of the Company's
interest-bearing liabilities and nearly all of the Company's interest-earning
assets are held by the Bank, virtually all of the Company's interest rate risk
exposure lies at the Bank level. As a result, all significant interest rate risk
management procedures are performed by management of the Bank. Based upon the
nature of the Bank's operations, the Bank is not subject to foreign currency
exchange or commodity price risk. The Bank's loan portfolio is concentrated
primarily in Palm Beach, Martin and Broward Counties in Florida and is therefore
subject to risks associated with the local economy. As of March 31, 2006, the
Company does not own any trading assets other than $1.6 million of assets held
in trust by the Senior Management Performance Incentive Award Program, a
deferred compensation plan, which can be actively traded by and are held for the
benefit of senior management. Income in these accounts accrues to and losses are
solely absorbed by senior management. At March 31, 2006, the Company does not
have any hedging transactions in place such as interest rate swaps and caps.
Asset and Liability Management-Interest Rate Sensitivity Analysis.
The majority of our assets and liabilities are monetary in nature, which
subjects us to significant interest rate risk. As stated above, the majority of
our interest-bearing liabilities and nearly all of our interest-earning assets
are held by the Bank and, therefore, nearly all of our interest rate risk is at
the Bank level.
We monitor interest rate risk by various methods, including "gap" analysis. Gap
analysis attempts to measure the difference between the amount of interest
earning assets expected to mature or reprice within a specific period of time
compared to the amount of interest-bearing liabilities maturing or repricing
within a specified period of time. An interest rate sensitive gap is considered
positive when the amount of interest-earning assets exceeds the amount of
interest-bearing liabilities maturing or repricing within a specified period of
time. An interest rate sensitive gap is considered negative when the amount of
interest-bearing liabilities exceeds the amount of interest-earning assets
maturing or repricing within a specified period of time. Companies with a
positive gap can expect net interest income to increase during periods of rising
interest rates and decline in periods of falling interest rates.
In preparing the gap analysis table below, the Company makes various assumptions
including loan prepayment rates and deposit decay rates. While management
believes these assumptions to be reasonable there can be no assurance that our
assets and liabilities would be impacted as indicated in the table. Certain
shortcomings are inherent in any methodology used in interest rate risk
measurements. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. Therefore, in the event of a change in
interest rates, prepayment and early withdrawal levels may possibly deviate
significantly from those assumed in calculating the above table.
22
<Page>
Accordingly, while the table provides an estimate of the Bank's interest rate
risk exposure at a particular point in time, it is not intended to provide a
precise forecast of the effect of market changes on the Bank's net interest
income, as actual results may vary.
The Bank's policy in recent years has been to reduce its exposure to interest
rate risk generally by better matching the maturities of its interest rate
sensitive assets and liabilities and by originating ARM loans and other
adjustable rate or short-term loans, as well as by purchasing short-term
investments. However, particularly in the current low interest rate environment,
borrowers typically prefer fixed rate loans to ARM loans. The Bank does not
solicit high-rate jumbo certificates or brokered funds.
23
The table below provides information about the Company's financial instruments
that are sensitive to changes in interest rates. As shown in the following
table, the Company's cumulative one-year interest rate sensitivity gap at March
31, 2006 was a positive 26.87%.
Time to Maturity
--------------------------------------------------------------------------
Within Three Four to More Than More Than Over Five
Months Twelve One Year to Three Years Years
Months Three to Five
Years Years
(Dollars in Thousands)
Interest-earning assets (1):
Residential mortgage loans: (2)
Fixed rate........................ $ 31,361 $ 85,959 $ 178,991 $ 122,032 $ 232,283
Adjustable rate................... 162,547 263,817 230,148 308,649 -
Commercial mortgage loans: (2)
Fixed rate........................ 12,740 30,774 45,764 29,391 45,644
Adjustable rate................... 409,740 563,568 7,152 940 -
Other loans (2)
Fixed rate.................... 13,633 27,447 35,524 15,720 5,598
Adjustable rate................... 356,910 6,154 - - -
Mortgage-backed securities
Fixed rate........................ 37,418 74,756 153,280 133,050 161,998
Adjustable rate................... 67,845 - - - -
Other interest earning assets - adjustable 116,549 - - - -
---------- ---------- --------- --------- --------
Total $1,208,743 $1,052,475 $ 650,859 $ 609,782 $445,523
========== ========== ========= ========= ========
Interest-bearing liabilities
Deposits: (3)
Checking and funds transfer accounts $ 25,097 $ 75,291 $ 114,680 $ 85,415 $ 1,155,470
Passbook accounts................. 18,655 55,964 104,283 81,177 576,452
Money market accounts............. 18,865 56,594 83,984 53,662 340,859
Certificate accounts (4).......... 369,424 358,042 87,167 6,415 -
Borrowings: (4)..................... 133,941 9,909 70,483 247 -
-------- --------- --------- --------- ----------
Total $565,982 $ 555,800 $ 460,597 $ 226,916 $2,072,781
======== ========= ========= ========= ==========
Excess (deficiency) of interest-earning
assets $642,761 $ 496,675 $ 190,262 $ 382,866 $(1,627,258)
======== ========= ========= ========= ===========
Cumulative excess of interest-earning
assets over interest-bearing
liabilities........................ $642,761 $1,139,436 $1,329,698 $1,712,564 $ 85,306
======== ========== ========== ========== ===========
Cumulative excess of interest-earning
assets over interest-bearing liabilities
as a percent of total assets....... 15.16% 26.87% 31.36% 40.39% 2.01%
======== ========== ========== ========== ===========
(1) Adjustable and floating rate assets are included in the period in which
interest rates are next scheduled to adjust rather than in the period in
which they are due. Fixed rate assets are included in the periods in which
they are scheduled to be repaid based on scheduled amortization. In both
cases, amounts are adjusted to reflect estimated prepayments. For this
table, all loans and mortgage-backed securities were assigned a 15%
prepayment rate.
(2) Balances are shown net of loans in process and are not adjusted for
premiums, discounts, reserves and unearned fees.
(3) All of the Company's non-certificate deposits are generally subject to
immediate withdrawal. However, in preparation of this table the Company has
used national decay rates calculated by a leading Bank consulting firm.
These national decay rates consider a significant portion of these accounts
to be core deposits having longer effective maturities based on the firm's
calculations of national average deposit runoff. These decay rates may be
different than the actual decay rates experienced by the Company.
(4) Certificate accounts and Borrowings are assumed to have no prepayments and
are shown in the period in which they contractually mature.
24
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Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we evaluated
the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act)
as of March 31, 2006. Based upon that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that as of the Evaluation Date, our
disclosure controls and procedures were effective in timely alerting them to the
material information relating to us (or our consolidated subsidiaries) required
to be included in our periodic SEC filings.
(b) Changes in internal controls.
There were no material changes made in our internal controls during the
period covered by this report or, to our knowledge, in other factors that has
materially affected or is reasonably likely to materially affect these internal
controls over financial reporting.
See the Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
25
<Page>
FIDELITY BANKSHARES, INC.
AND SUBSIDIARY
PART II - OTHER INFORMATION
Item 1 Legal Proceedings
The Company is subject to various claims, legal actions and complaints arising
in the ordinary course of business. In the Company's opinion, the disposition of
these matters will not have a material adverse effect on our consolidated
financial condition, results of operations or cash flows.
On July 1, 2003, Fidelity Federal Bank & Trust was named as the sole defendant
in the lawsuit, James Kehoe v. Fidelity Federal Bank & Trust, filed in the
United States District Court for the Southern District of Florida. In this
action, James Kehoe ("Kehoe"), on behalf of himself and other similarly situated
persons, alleged that Fidelity Federal violated the Driver Privacy Protection
Act by obtaining driver registration information from the State of Florida for
use in Fidelity Federal's marketing efforts. Kehoe seeks as damages the
statutory minimum of $2,500 per class member. Kehoe has alleged that the class
numbers over 560,000 individuals. On June 14, 2004, the Court granted Fidelity
Federal's Motion for Summary Judgment and entered a Final Judgment in favor of
Fidelity Federal against Kehoe ruling that there could be no statutory minimum
damages award unless there were actual damages. This issue was one of several
issued raised by Fidelity Federal. The Court did not rule on the other issues.
Kehoe appealed the ruling to the 11th Circuit Court of Appeals, and on August
26, 2005, the Circuit Court reversed the Trial Court's Order of Summary Judgment
and remanded the case back to the Trial Court for further proceedings, stating
that actual damages need not be proved before an award of the statutory minimum
damages of $2,500 per individual could be made. Consequently, the potential
damages that could be awarded would be the result of multiplying the statutory
minimum of $2,500 per class member by the total class of defendants. However,
the Circuit Court also stated that the Trial Court "in its discretion, may
fashion what it deems to be an appropriate award." The Circuit Court also stated
that, "the use of the word `may' suggests that the award of any damages is
permissive and discretionary." Fidelity Federal's Motion for Summary Judgment on
one of the issues was heard by the Trial Court on April 27, 2006 but has not yet
been ruled on by the court. Additionally, the briefings in opposition to Kehoe's
Motion for Class Certification are almost complete. Fidelity Federal in
consultation with counsel, has concluded that the likelihood of the class being
certified is remote, and the damages if awarded, would be minimal. Therefore,
Fidelity Federal intends to vigorously defend the case.
On February 18, 2004, Fidelity Federal Bank & Trust was named as defendant in a
lawsuit William Adams et al., vs. Thomson Financial, Inc., Fidelity Federal Bank
& Trust, N.A., Fidelity Investments Services, L.L.C., d/b/a Fidelity
Investments, National Financial Services, L.L.C., f/k/a National Financial
Services Corporation, Zoe Marrero, filed in the Fifteenth Judicial Circuit in
and for Palm Beach County, Florida. The plaintiffs in this case have alleged
various causes of action against numerous defendants which arise from
plaintiffs' investments in various entities controlled and operated by Thomas
Abrams, who was convicted of running a Ponzi Scheme. Fidelity Federal is a named
defendant in one count of the complaint alleging aiding and abetting breaches of
fiduciary duty. The allegations are based upon Fidelity Federal allowing Abrams
to set up accounts with Fidelity Federal, deposit monies in them, issue bank
checks based upon the deposits and instructions from authorized signatories on
the accounts and generally offer banking services to the Abrams entities.
Plaintiffs make additional allegations that Fidelity Federal solicited clients
for the Abrams entities and pressured clients to place deposits with the Abrams
entities and Fidelity Federal, which are without basis. There is no specific
26
<Page>
request for damages, other than the jurisdictional amount of in excess of
$15,000. The Plaintiffs allege they lost in excess of $18,000,000 investing with
Abrams. The actual amount of losses incurred by the plaintiffs are as of yet
undetermined. On May 20, 2005, the Court entered an Order granting in part
Fidelity Federal's Motion to Dismiss the Second Amended Complaint. The Court
struck all of Plaintiff's claims for non-economic damages (e.g., custodial
damages), and dismissed the aiding and abetting breach of fiduciary duty claim,
with leave to amend, based on each Plaintiff's failure to allege specific
ultimate facts that the bank's alleged actions were the proximate cause of
plaintiff's losses. A Fourth Amended Complaint was filed on January 27, 2006. We
intend to vigorously defend our position on the basis that we acted solely as a
depository bank in the transactions and allegations of improper conduct by the
bank are factually inaccurate.
Item 1A. Risk Factors
There are no changes from the risk factors set forth in the
Company's Annual Report on Form 10-K.
Item 2 Changes in Securities and Stock Repurchases
None.
Item 3 Default Upon Senior Securities
Not applicable.
Item 4 Submission of Matters to a Vote of Security Holders
None.
Item 5 Other Information
None.
Item 6 Exhibits
31.1 302 Certification
31.2 302 Certification
32.1 906 Certification
27
Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
I, Vince A. Elhilow, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Fidelity Bankshares,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting;
May 9, 2006 /S/ Vince A. Elhilow
- --------------- -------------------------------------
Date Vince A. Elhilow
President and Chief Executive Officer
28
<Page>
Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
I, Richard D. Aldred, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Fidelity Bankshares,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting;
May 9, 2006 /s/ Richard D. Aldred
- --------------- ------------------------
Date Richard D. Aldred
Executive Vice President,
Chief Financial Officer
29
EXHIBIT 32.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND
CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
Exhibit 32.1
Certification pursuant to
18 U.S.C. Section 1350,
as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Vince A. Elhilow, President and Chief Executive Officer and Richard D. Aldred,
Executive Vice President, Chief Financial Officer and Treasurer of Fidelity
Bankshares, Inc. (the "Company") each certify in his capacity as an officer of
the Company that he has reviewed the quarterly report of the Company on Form
10-Q and that to the best of his knowledge:
(1) the report fully complies with the requirements of Sections 13(a) of the
Securities Exchange Act of 1934; and
(2) the information contained in the report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
The purpose of this statement is solely to comply with Title 18, Chapter 63,
Section 1350 of the United States Code, as amended by Section 906 of the
Sarbanes-Oxley Act of 2002.
May 9, 2006 /s/ Vince A. Elhilow
- --------------- -------------------------------------
Date President and Chief Executive Officer
May 9, 2006 /s/ Richard D. Aldred
- --------------- ------------------------------------
Date Executive Vice President,
Chief Financial Officer and Treasurer
<Page>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
FIDELITY BANKSHARES, INC.
Date: May 9, 2006 By: /s/ Vince A. Elhilow
------------------------------------
Vince A. Elhilow
President and Chief Executive Officer
Date: May 9, 2006 By: /s/ Richard D. Aldred
------------------------------------
Richard D. Aldred
Executive Vice President
Chief Financial Officer