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 September 30, 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 (I.R.S. Employer Identification No.)
of 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 25,487,110 shares
of the Registrant's common stock par value $.10 per share outstanding as of
October 31, 2006.
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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 September 30, 2006....................2
Unaudited Condensed Consolidated Statements of Operations for the
three and the nine months ended September 30, 2005 and 2006.......3
Unaudited Condensed Consolidated Statements of Comprehensive
Operations for the three and the nine months ended
September 30, 2005 and 2006......................................4
Unaudited Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 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....................................18
Item 3. Quantitative and Qualitative Disclosure About Market Risk.........25
Item 4. Controls and Procedures...........................................28
PART II. OTHER INFORMATION...............................................29
Item 1. Legal Proceedings.................................................29
Item 1A. Risk Factors......................................................30
Item 2. Changes in Securities and Stock Repurchases.......................30
Item 3. Default Upon Senior Securities....................................30
Item 4. Submission of Matters to a Vote of Security Holders...............30
Item 5. Other Information.................................................31
Item 6. Exhibits..........................................................31
EXHIBITS
Section 302 Certification
Section 906 Certification
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
1
FIDELITY BANKSHARES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
- --------------------------------------------------------------------------------
December 31, September 30,
2005 2006
==================== ===================
ASSETS (In thousands, except share data) CASH AND CASH EQUIVALENTS:
Cash and amounts due from depository institutions.............................. $ 150,657 $ 92,090
Interest-earning deposits...................................................... 39,283 26,658
----------- -----------
Total cash and cash equivalents............................................ 189,940 118,748
SECURITIES AVAILABLE FOR SALE....................................................... 410,473 342,425
SECURITIES HELD TO MATURITY ( fair value - $241,463 and $251,833 at December 31,
2005 and September 30, 2006, respectively)..................... 242,497 254,720
LOANS RECEIVABLE, net of allowance for loan losses - $16,171 and $17,390 at December
31, 2005 and September 30, 2006, respectively................................. 3,036,710 3,429,229
OFFICE PROPERTIES AND EQUIPMENT, net................................................ 91,164 94,294
FEDERAL HOME LOAN BANK STOCK, at cost............................................... 11,398 23,127
FORECLOSED ASSETS, net.............................................................. 1,793 14
ACCRUED INTEREST RECEIVABLE......................................................... 16,273 18,706
DEFERRED INCOME TAX ASSET........................................................... 11,933 14,218
GOODWILL .......................................................................... 14,256 14,256
CORE DEPOSIT INTANGIBLES............................................................ 6,528 5,957
OTHER ASSETS 49,646 65,855
----------- -----------
TOTAL ASSETS $ 4,082,611 $ 4,381,549
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
DEPOSITS:
Non-interest bearing........................................................... $ 485,425 $ 484,561
Interest bearing............................................................... 3,055,449 2,939,658
----------- -----------
Total deposits............................................................. 3,540,874 3,424,219
OTHER BORROWED FUNDS................................................................ 54,113 190,124
ADVANCES FROM FEDERAL HOME LOAN BANK................................................ 92,364 332,487
ADVANCES BY BORROWERS FOR TAXES AND INSURANCE....................................... 1,461 25,246
JUNIOR SUBORDINATED DEBENTURES...................................................... 53,608 53,608
OTHER LIABILITIES................................................................... 55,423 51,562
----------- ----------
TOTAL LIABILITIES.............................................................. 3,797,843 4,077,246
----------- ----------
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 25,384,215 at
September 30, 2006......................................................... 2,511 2,538
ADDITIONAL PAID IN CAPITAL.......................................................... 167,197 170,038
RETAINED EARNINGS - substantially restricted........................................ 129,842 146,081
TREASURY STOCK - at cost, 416,799 shares at December 31, 2005 and
397,023 shares at September 30, 2006........................................... (1,794) (1,751)
COMMON STOCK ALLOCATED TO:
Employee stock ownership plan.................................................. (3,561) (3,300)
Recognition and retention plan................................................. (1,785) (840)
ACCUMULATED OTHER COMPREHENSIVE LOSS................................................ (7,642) (8,463)
------------ -----------
TOTAL STOCKHOLDERS' EQUITY..................................................... 284,768 304,303
------------ -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.......................................... $ 4,082,611 $ 4,381,549
============ ===========
See Notes to Unaudited Condensed Consolidated Financial Statements.
2
FIDELITY BANKSHARES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
For the For the
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2006 2005 2006
==================================================
(In thousands, except per share data)
Interest income:
Loans............................................................. $ 44,920 $ 59,334 $ 123,109 $ 168,218
Securities ....................................................... 8,382 7,381 24,798 22,146
Other investments................................................. 681 752 1,477 3,388
--------- -------- ---------- ---------
Total interest income......................................... 53,983 67,467 149,384 193,752
--------- -------- ---------- ---------
Interest expense:
Deposits.......................................................... 17,513 26,594 41,889 75,383
Advances from Federal Home Loan Bank and other borrowings......... 3,049 7,563 11,017 14,914
--------- -------- ---------- ---------
Total interest expense........................................ 20,562 34,157 52,906 90,297
--------- -------- ---------- ---------
Net interest income.................................................... 33,421 33,310 96,478 103,455
Provision for loan losses.............................................. 304 694 1,298 1,320
-------- -------- --------- --------
Net interest income after provision for loan losses.................... 33,117 32,616 95,180 102,135
-------- -------- --------- --------
Other income:
Service charges on deposit accounts............................... 2,972 3,489 8,272 9,605
Fees for other banking services................................... 2,375 2,554 6,950 7,331
Net gain on sale of loans......................................... 170 41 643 265
Miscellaneous..................................................... 540 405 1,384 1,254
-------- -------- -------- --------
Total other income............................................ 6,057 6,489 17,249 18,455
-------- -------- -------- --------
Operating expense:
Employee compensation and benefits................................ 14,669 15,495 42,091 45,960
Occupancy and equipment........................................... 3,673 4,280 10,484 12,349
Data processing................................................... 1,811 1,916 4,818 5,487
Marketing......................................................... 715 940 2,230 2,657
Miscellaneous..................................................... 4,995 6,719 14,524 14,336
-------- -------- -------- --------
Total operating expense....................................... 25,863 29,350 74,147 84,075
-------- -------- -------- --------
Income before provision for income taxes............................... 13,311 9,755 38,282 36,515
Provision for income taxes............................................. 5,052 4,103 14,560 14,336
-------- -------- -------- ---------
Net income............................................... $ 8,259 $ 5,652 $ 23,722 $ 22,179
======== ======== ======== ========
Earnings per share: (Note 3)
Basic............................................................. $ 0.34 $ 0.23 $ 0.98 $ 0.90
======== ======== ======== ========
Diluted........................................................... $ 0.33 $ 0.22 $ 0.95 $ 0.87
======== ======== ======== ========
Dividends declared per share........................................... $ 0.08 $ 0.08 $ 0.24 $ 0.24
======== ======== ======== ========
See Notes to Unaudited Condensed Consolidated Financial Statements.
3
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FIDELITY BANKSHARES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
- --------------------------------------------------------------------------------
For the For the
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2006 2005 2006
===================================================
(In thousands)
Net Income........................................................ $ 8,259 $ 5,652 $ 23,722 $ 22,179
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on assets available for sale........ (2,179) 4,220 (4,355) (821)
-------- -------- -------- --------
Comprehensive income.............................................. $ 6,080 $ 9,872 $ 19,367 $ 21,358
======== ======== ======== ========
See Notes to Unaudited Condensed Consolidated Financial Statements.
4
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FIDELITY BANKSHARES, INC.
- --------------------------------------------------------------------------------
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended
September 30,
2005 2006
==========================
(In thousands)
CASH FLOWS FROM (FOR) OPERATING ACTIVITIES:
Net Income............................................................. $ 23,722 $22,179
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation........................................................ 5,246 5,504
Amortization of core deposit intangibles............................ 380 570
ESOP compensation expense........................................... 1,044 1,363
Stock based compensation expense....................................... 945 945
Accretion of discounts, amortization of premiums and intangible
assets, and other deferred yield items............................. (5,275) (4,672)
Provision for loan losses........................................... 1,298 1,320
Provision for losses and net (gains) losses on sales of real
estate owned....................................................... (130) (369)
Net (gain) loss on sale of:
Loans......................................................... (643) (265)
Office properties and equipment............................... 46 181
Excess tax benefits from share-based payment arrangements......... - (817)
Increase in accrued interest receivable............................. (1,977) (2,431)
Increase in other assets............................................ (2,651) (15,889)
Increase in deferred income tax asset............................ (1,741) (1,738)
Increase in drafts payable........................................ 1,314 675
Increase (decrease) in other liabilities............................ 2,493 (4,510)
-------- -------
Net cash provided by operating activities..................... 24,071 2,046
-------- -------
CASH FLOW FROM (FOR) INVESTING ACTIVITIES:
Loan originations and principal payments on loans...................... (450,854) (444,864)
Principal payments received on:
Securities available for sale...................................... 61,826 43,762
Securities held to maturity........................................ 34,297 26,899
Purchases of:
Loans............................................................... (29,809) -
Securities available for sale....................................... (6,947) (1,565)
Securities held to maturity......................................... - (4,388)
Federal Home Loan Bank stock........................................ (3,422) (25,696)
Office properties and equipment..................................... (9,202) (9,238)
Proceeds from sales of:
Loans............................................................... 35,907 20,684
Federal Home Loan Bank stock........................................ 8,695 13,966
Securities available for sale....................................... 24,667 -
Repossessed assets acquired in settlement of loans.................. 160 2,313
Office properties and equipment..................................... - 12
Mortgage backed securities.......................................... 8,246 -
Proceeds from maturities of securities available for sale.............. 5,050 25,000
Net cash received from acquisitions.................................... 6,577 -
Other.................................................................. (141) 166
-------- -------
Net cash used for investing activities........................ (314,950) (352,949)
-------- -------
CASH FLOW FROM (FOR) FINANCING ACTIVITIES:
Proceeds from the exercise of stock options............................ 212 1,544
Excess tax benefits from share-based payment arrangements.............. - 817
Cash dividends paid.................................................... (5,292) (5,914)
Net increase (decrease) in:
NOW accounts, demand deposits and savings accounts.................. 232,810 (105,742)
Certificates of deposit............................................. 132,781 (10,913)
Advances from Federal Home Loan Bank................................ (136,599) 240,123
Other borrowed funds................................................ 44,596 136,011
Advances by borrowers for taxes and insurance....................... 18,828 23,785
-------- --------
Net cash provided by financing activities..................... 287,336 279,711
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS.............................. (3,543) (71,192)
CASH AND CASH EQUIVALENTS, beginning of period......................... 149,409 189,940
-------- -------
CASH AND CASH EQUIVALENTS, end of period............................... $145,866 $118,748
======== =========
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 September 30, 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 September 30, 2006 presentation.
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 restricted 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.
6
The following is a summary of stock-based award activity during the nine months
ended September 30, 2006:
Weighted-Average Weighted-Average Aggregate
Number of Exercise Price Remaining Intrinsic Value
Shares Contractual Life (In Thousands)
----------- ---------------- ----------------- ----------------
Stock Options:
Outstanding as of December 31, 2005 1,188,877 $ 15.19
Granted - -
Exercised 111,895 13.79
Forfeited - -
--------- -------
Outstanding as of September 30, 2006 1,076,982 $ 15.34 5.8 $ 25,492
========= ======= ======= ========
Exercisable as of September 30, 2006 1,076,982 $ 15.34 5.8 $ 25,492
========= ======= ======= ========
Weighted-
Number of Average Weighted-Average
Restricted Grant-Date Remaining
Shares Fair Value Contractual Life
---------------------------------------
Restricted Stock:
Unvested as of December 31, 2005 186,570 $ 13.51
Awarded - -
Vested 93,375 13.51
Forfeited - -
------- -------
Unvested as of September 30, 2006 93,195 $ 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 $39.01 as of September 30, 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 nine months ended September 30, 2006, the total intrinsic
value of stock options exercised was $2.5 million. For the options exercised
during the nine months ended September 30, 2006, the Company received cash of
$1.5 million and realized a tax benefit from the exercise of stock option of
$817,000. The Company has a policy of issuing new shares to satisfy share option
exercises and shares which vest and are distributed under the RR Plan
7
<Page>
Additional information regarding options outstanding and exercisable as of
September 30, 2006, is as follows:
Weighted-Average Weighted-Average
Range of exercise prices Number of Shares Remaining Exercise Price
Contractual Life
- ---------------------------------------------------------------------------------------------------------
$13.51 919,097 5.6 $ 13.51
16.93 5,760 5.6 16.93
22.38 13,292 5.6 22.38
23.13 11,388 5.6 23.13
24.71 6,000 7.4 24.71
24.75 10,917 5.6 24.75
24.90 8,030 5.6 24.90
25.12 27,868 5.6 25.12
25.30 3,951 5.6 25.30
25.59 7,815 5.6 25.59
27.67 48,000 8.8 25.67
33.33 14,864 7.3 33.33
--------- ----------
1,076,982 5.8 $ 15.34
========= ======= ==========
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) allows 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 period,
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 and the nine months ended September 30,
2006, $195,000 and $584,000, respectively, 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 or restricted stock issued during the three months ended September
30, 2006 and September 30, 2005, respectively.
8
<page>
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 and nine month periods ended September 30, 2005 are presented
below (dollars in thousands, except per share amounts).
For the For the
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
==================== ====================
(In thousands, except per share amounts)
Net Income, as reported...................................................... $ 8,259 $ 23,722
Add: Total stock-based employee compensation expense included in
reported net earnings, net of related tax effects....................... 195 586
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax effects (334) (1,143)
--------- ----------
Pro forma net income......................................................... $ 8,120 $ 23,165
========= ==========
Basic - as reported....................................................... 0.34 0.98
Basic - pro forma......................................................... 0.33 0.95
Diluted - as reported..................................................... 0.33 0.95
Diluted - pro forma....................................................... 0.32 0.93
The assumptions used to determine the stock-based employee compensation expense
determined under the fair value based method for all awards for the nine months
ended September 30, 2005 include an expected volatility of 27.39%, a risk free
rate of return of 3.81%, an expected life of 5 years, and an expected dividend
yield of 1.16%.
As of September 30, 2006, there were no unvested stock options outstanding and,
accordingly, no related unrecognized compensation costs. As of September 30,
2006 the total unrecognized compensation cost related to restricted stock was
$840,000, which is expected to be recognized evenly through May 2007.
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 and nine months
ended September 30, 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
September 30,
-------------------------------------
2005 2006
Net income................................................... $ 8,259,000 $ 5,652,000
Weighted average common shares outstanding.................. 24,538,667 24,757,741
=========== ============
Basic earnings per share............. $ 0.34 $ 0.23
=========== ============
Weighted average common shares outstanding.................. 24,538,667 24,757,741
Additional dilutive shares related to stock options and
recognition and retention plan shares....................... 719,075 702,944
----------- ------------
Total weighted average common shares and equivalents outstanding
for diluted earnings per share computation................... 25,460,685 25,257,742
=========== ============
Diluted earnings per share............... $ 0.33 $ 0.22
=========== ============
For the Nine Months Ended
September 30,
-----------------------------------
2005 2006
Net income................................................... $ 23,722,000 $ 22,179,000
Weighted average common shares outstanding.................. 24,273,719 24,686,148
============= =============
Basic earnings per share............. $ 0.98 $ 0.90
============= =============
Weighted average common shares outstanding.................. 24,273,719 24,686,148
Additional dilutive shares related to stock options and
recognition and retention plan shares....................... 661,381 636,288
------------- -------------
Total weighted average common shares and equivalents outstanding
for diluted earnings per share computation................... 25,347,529 24,910,007
============= =============
Diluted earnings per share............... $ 0.95 $ 0.87
============= =============
10
<Page>
4. LOANS RECEIVABLE
Loans receivable at December 31, 2005 and at September 30, 2006, consist of the
following:
December 31, September 30,
2005 2006
===============================
(In thousands)
One- to four- family, residential real estate mortgages.............. $1,061,487 $1,224,553
Commercial and multi-family real estate mortgages.................... 1,082,719 1,236,161
Real estate construction-primarily residential....................... 390,751 458,157
Land loans-primarily residential..................................... 71,502 62,759
---------- ----------
Total first mortgage loans........................................... 2,606,459 2,981,630
Consumer loans....................................................... 295,622 314,561
Commercial business loans............................................ 153,916 153,304
---------- ----------
Total loans, net of loans in process................................. 3,055,997 3,449,495
Deduct:
Unearned discounts, premiums and deferred loan fees, (costs), net 3,116 2,876
Allowance for loan losses....................................... 16,171 17,390
---------- ----------
Loans receivable-net................................................. $3,036,710 $3,429,229
========== ==========
During the nine months ended September 30, 2006, the Company sold $20.8 million
in loans, which resulted in net gains of $265,000. During the nine months ended
September 30, 2005, the company sold $35.8 million in loans, which resulted in
net gains of $643,000. During the nine months ended September 30, 2006 and 2005,
the Company securitized $34.6 million and $202.6 million, respectively, in
one-to four-family mortgage loans where the Company retained the resulting
mortgage-backed securities.
During the quarter ended September 30, 2006, the Company sold $3.0 million in
loans, which resulted in net gains of $41,000. During the quarter ended
September 30, 2005, the Company sold $13.8 million in loans, which resulted in
net gains of approximately $170,000. No securitizations occurred during the
quarters ended September 30, 2006 and 2005.
At December 31, 2005, the Bank had $845,000 in loans held for sale or transfer.
No loans were held for sale at September 30, 2006.
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 and nine months ended September 30, 2005 and
2006, is as follows:
For the Year For the Three Months For the Nine Months
Ended Ended Ended
December 31, September 30, September 30,
2005 2005 2006 2005 2006
================= ==================== ====================
(In thousands) (In thousands) (In thousands)
Balance at beginning of period...... $ 13,628 $15,519 $16,703 $13,628 $16,171
Current provision................... 1,877 304 694 1,298 1,320
Effect of acquisition............... 995 - - 995 -
Charge-offs......................... (330) (168) (8) (266) (105)
Recoveries.......................... 1 - 1 - 4
-------- ------- ------- -------- -------
Ending balance...................... $ 16,171 $15,655 $17,390 $15,655 $17,390
======== ======= ======= ======== =======
11
<page>
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 September 30, 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 $ 1,277 $ 280
Loans without related allowance for loan losses............. 6,818 - 18,374 -
-------- -------- -------- --------
Total.............................................. $ 7,445 $ 334 $ 19,651 $ 280
======== ======== ======== ========
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.
6. DEPOSITS
The weighted-average interest rates on deposits at December 31, 2005 and
September 30, 2006 were 2.63% and 3.33%, respectively. Deposit accounts, by
type, at December 31, 2005 and September 30, 2006 consist of the following:
December 31, September 30,
Account Type 2005 2006
============= ==============
(In thousands)
Non-interest-bearing checking accounts..................... $ 485,425 $ 484,561
Interest-bearing checking and funds transfer accounts...... 820,588 755,415
Passbook and statement accounts............................ 825,117 624,569
Variable-rate money market accounts........................ 507,664 668,507
Certificates of deposit.................................... 902,080 891,167
----------- ----------
Total...................................................... $ 3,540,874 $3,424,219
=========== ==========
7. ADVANCES FROM FEDERAL HOME LOAN BANK
The Bank had outstanding advances from the FHLB of $92.4 million with a weighted
average interest rate of 4.89% and $332.5 million with a weighted average
interest rate of 5.33% at December 31, 2005 and September 30, 2006,
respectively. All of the advances shown had fixed interest rates and, depending
on market rates, may have substantial prepayment penalties. The advances are
repayable as follows:
At December 31, At September 30,
2005 2006
==========================================================
(In thousands)
Less than 1 year $ 13,572 $ 255,000
1-2 years 13,572 56,667
2-3 years 58,988 20,179
3-4 years 893 -
4-5 years - -
Thereafter 5,339 641
--------- ---------
Total $ 92,364 332,487
========= =========
12
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The Bank has a collateral agreement with the FHLB which includes a blanket
floating lien that requires the Bank to maintain qualifying first mortgage loans
as pledged collateral in an amount equal to the advances when discounted at 80%
of the unpaid principal balances of the qualifying first mortgage loans.
8. 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 For the
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2006 2005 2006
====================== ========================
(In Thousands) (In Thousands)
Service cost....................................... $ 596 $ 604 $ 1,788 $ 1,811
Interest cost...................................... 407 446 1,221 1,338
Expected return on assets.......................... (375) (475) (1,156) (1,425)
Net amortization .................................. 256 256 768 769
------- ------ -------- --------
Net periodic pension expense....................... $ 884 $ 831 $ 2,621 $ 2,493
======= ====== ======== ========
10,953
The Company contributed $4.8 million for the plan year 2005 in the third quarter
of 2006.
13
9. 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 September 30, 2006
Stockholders' Equity and ratio
to total assets................. 8.0% $ 351,019
========
Unrealized decrease in market value
of assets available for sale
(net of applicable income taxes) 6,606
Goodwill and other intangible assets. (20,737)
Disallowed servicing assets.......... (332)
----------
Tangible capital and ratio to
adjusted total assets........... 7.7% $ 336,556 1.5% $ 65,473
======== ========== ====== =========
Tier I (core) capital and ratio to
adjusted total assets........... 7.7% $ 336,556 3.0% $ 130,947 5.0% $ 218,245
======== ========== ====== ========= ====== =========
Tier I (core) capital and ratio to
risk-weighted total assets...... 10.6% $ 336,556 4.0% $ 126,421 6.0% $ 189,631
======== ---------- ====== ========= ====== =========
Allowable Tier 2 capital:
General loan valuation allowances ... 16,635
----------
Total risk-based capital and ratio to
risk-weighted total assets...... 11.2% $ 353,191 8.0% $ 252,841 10.0% $ 316,052
======== ========== ====== ========= ====== =========
Total assets......................... $4,379,355
==========
Adjusted total assets................ $4,364,892
==========
Risk-weighted assets................. $3,160,518
==========
14
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10. SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
For the Nine Months Ended
-----------------------------
September 30,
-----------------------------
2005 2006
=============================
(In Thousands)
Mortgage-backed securities retained from the
securitization of mortgage loans....................... $ 202,595 $ 34,369
========= =========
Common stock issued for acquisitions...................... $ 12,857 $ -
=========
11. 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.
Settlement Agreement With Respect to Class Action Litigation
On July 26, 2006, Fidelity Federal entered into a Settlement Agreement with the
Plaintiffs of two previously-disclosed class action lawsuits. These lawsuits,
James Kehoe v. Fidelity Federal Bank & Trust, and Timothy Neilsen and Timothy G.
Martin vs. Fidelity Federal Bank & Trust, each of which was filed in the United
States District Court for the Southern District of Florida, allege that Fidelity
Federal violated the Driver's Privacy Protection Act by obtaining driver
registration information from the State of Florida for use in Fidelity Federal's
marketing efforts.
Under the Settlement Agreement, and without admitting any liability or fault,
Fidelity Federal agreed to the certification of a conditional settlement class,
solely for settlement purposes, subject to preliminary and final court approval.
Under the terms of the Settlement Agreement, any class members who qualify and
timely submit a Claim Form will receive payment of an amount not to exceed $160
per person. Fidelity Federal has agreed to pay Plaintiffs' attorneys' fees in an
amount not to exceed $10,000,000 plus their reasonable expenses not to exceed
$120,000. Fidelity Federal will pay Class Representative James Kehoe not more
than $10,000, and Class Representatives Timothy Neilsen and Timothy G. Martin
not more than $3,000 each for their participation in this case on behalf of all
Class Members.
Additionally, Fidelity Federal has agreed to certain injunctive relief,
including certifying that Fidelity Federal did not keep or maintain any data
obtained from the State of Florida, providing that Fidelity Federal shall not
disclose or sell any such data, and agreeing to a privacy audit, the cost of
which shall not exceed $25,000. Under the terms of the settlement, Fidelity
Federal's total costs and expense, including the payments to Class Members,
cannot exceed $50 million.
In addition to final court approval, the Settlement Agreement is contingent upon
the consummation of the acquisition of Fidelity by National City, described in
Note 12.
15
<Page>
On July 31, 2006, the United States District Court for the Southern District of
Florida entered an Order Preliminarily Approving the Class Action Settlement.
The court established December 7, 2006 as the final hearing date to approve the
Settlement Agreement.
The foregoing description is qualified in its entirety by reference to the full
text of the Settlement Agreement, which was attached as an exhibit to the
Quarterly Report for the quarter ended June 30, 2006.
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
request for damages, other than the jurisdictional amount of in excess of
$15,000. The Plaintiffs allege they lost in excess of $18.0 million 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.
On April 8, 2005, Fidelity Federal Bank & Trust was named as defendant in a
lawsuit CORINTHIAN LLC vs. FIDELITY FEDERAL BANK & TRUST; SEWELL HARDWARE
COMPANY; BROWN/SEWELL PARTNERSHIP filed in the Fifteenth Judicial Circuit in and
for Palm Beach County, Florida. Fidelity is one of a number of defendants. The
plaintiffs in this case have alleged unspecified monetary damages for breach of
contract, specific performance, conversion and unjust enrichment in connection
with a contract for sale of Bank property where the Bank was forced to default
Plaintiff for failure to perform. Fidelity Federal in consultation with counsel
has concluded that the case is without merit, and intends to vigorously defend
the case. We have been notified of a companion lawsuit which has been filed in
the United States District Court for the Eastern District of Pennsylvania. We
intend to defend this lawsuit on the same basis we are defending this lawsuit in
Florida.
16
<Page>
12. AGREEMENT AND PLAN OF MERGER WITH NATIONAL CITY CORPORATION
Agreement and Plan of Merger
- ----------------------------
On July 26, 2006, Fidelity Bankshares, Inc. ("Fidelity"), the holding company of
Fidelity Federal Bank & Trust ("Fidelity Federal"), a federal savings bank
headquartered in West Palm Beach, Florida, and National City Corporation
("National City") entered into an Agreement and Plan of Merger (the "Merger
Agreement"). Pursuant to the Merger Agreement, and subject to the terms and
conditions set forth therein, Fidelity will merge with and into National City,
with National City being the surviving corporation of such merger. Under the
terms of the Merger Agreement, stockholders of Fidelity will be given the right
to elect the following consideration for each share of Fidelity common stock:
(i) 1.0977 shares of National City common stock; or (ii) $39.50 in cash, subject
to allocation procedures that are intended to ensure that in the aggregate, 50%
of the shares of Fidelity are converted into National City common stock and 50%
of Fidelity shares are converted into cash. Fidelity stock options will be
cashed out for the in-the-money value of such options. The transaction has a
total indicated value of approximately $1 billion.
Subject to Company stockholder approvals, the transaction is expected to close
in the first quarter of 2007. A special stockholders meeting to vote on the
transaction has been scheduled for November 20, 2006.
A copy of the Merger Agreement is filed as Exhibit 2 to the Company's Form 8-K
filed with the U.S. Securities and Exchange Commission on July 31, 2006. A copy
of the press release relating to the merger is filed as Exhibit 99 to the
Company's Form 8-K filed with the U.S. Securities and Exchange Commission on
July 31, 2006. The foregoing description is qualified in its entirety by
reference to the full text of such exhibits.
17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
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 loans and
securities, 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.
Recent Events.
Agreement and Plan of Merger
- ---------------------------
On July 26, 2006, the Company and National City Corporation ("National City")
entered into an Agreement and Plan of Merger (the "Merger Agreement"). Pursuant
to the Merger Agreement, and subject to the terms and conditions set forth
therein, the Company will merge with and into National City, with National City
being the surviving corporation of such merger. Under the terms of the Merger
Agreement, stockholders of the Company will be given the right to elect the
following consideration for each share of the Company common stock: (i) 1.0977
shares of National City common stock; or (ii) $39.50 in cash, subject to
18
<Page>
allocation procedures that are intended to ensure that in the aggregate, 50% of
the shares of the Company are converted into National City common stock and 50%
of the Company shares are converted into cash. The Company stock options will be
cashed out for the in-the-money value of such options. The transaction has a
total indicated value of approximately $1 billion.
Subject to Company stockholder approval, the transaction is expected to close in
the first quarter of 2007. A special stockholders' meeting to vote on the
transaction has been scheduled for November 20, 2006.
A copy of the Merger Agreement is filed as Exhibit 2 to the Company's Form 8-K
filed with the U.S. Securities and Exchange Commission on July 31, 2006. A copy
of the press release relating to the merger was filed as Exhibit 99 to the
Company's Form 8-K filed with the U.S. Securities and Exchange Commission on
July 31, 2006. The foregoing description is qualified in its entirety by
reference to the full text of such exhibits.
Settlement Agreement With Respect to Class Action Litigation
On July 26, 2006, Fidelity Federal entered into a Settlement Agreement with the
Plaintiffs of two previously-disclosed class action lawsuits. These lawsuits,
James Kehoe v. Fidelity Federal Bank & Trust, and Timothy Neilsen and Timothy G.
Martin vs. Fidelity Federal Bank & Trust, each of which was filed in the United
States District Court for the Southern District of Florida, allege that Fidelity
Federal violated the Driver's Privacy Protection Act by obtaining driver
registration information from the State of Florida for use in Fidelity Federal's
marketing efforts.
Under the Settlement Agreement, and without admitting any liability or fault,
Fidelity Federal agreed to the certification of a conditional settlement class,
solely for settlement purposes, subject to preliminary and final court approval.
Under the terms of the Settlement Agreement, any class members who qualify and
timely submit a Claim Form will receive payment of an amount not to exceed $160
per person. Fidelity Federal has agreed to pay Plaintiffs' attorneys' fees in an
amount not to exceed $10,000,000 plus their reasonable expenses not to exceed
$120,000. Fidelity Federal will pay Class Representative James Kehoe not more
than $10,000, and Class Representatives Timothy Neilsen and Timothy G. Martin
not more than $3,000 each for their participation in this case on behalf of all
Class Members.
Additionally, Fidelity Federal has agreed to certain injunctive relief,
including certifying that Fidelity Federal did not keep or maintain any data
obtained from the State of Florida, providing that Fidelity Federal shall not
disclose or sell any such data, and agreeing to a privacy audit, the cost of
which shall not exceed $25,000. Under the terms of the settlement, Fidelity
Federal's total costs and expense, including the payments to Class Members,
cannot exceed $50 million.
In addition to final court approval, the Settlement Agreement is contingent upon
the consummation of the acquisition of Fidelity by National City, described
above.
On July 31, 2006, the United States District Court for the Southern District of
Florida entered an Order Preliminarily Approving the Class Action Settlement.
The court established December 7, 2006 as the final hearing date to approve the
Settlement Agreement.
19
<Page>
The foregoing description is qualified in its entirety by reference to the full
text of the Settlement Agreement, which was attached as an exhibit to the
Quarterly Report for the quarter ended June 30, 2006.
Changes in Financial Condition.
Our assets increased by $298.9 million, from $4.1 billion at December 31, 2005
to $4.4 billion at September 30, 2006. Loans receivable increased by $392.5
million. Deposits decreased by $116.7 million, primarily due to the runoff of
short term certificates of deposit. In addition, cash and cash equivalents
decreased by $71.2 million, while securities held for sale decreased by $68.0
million. Funds for asset growth were provided by deposits and an increase of
$240.1 million in borrowings from the Federal Home Loan Bank. In addition, we
experienced an increase of $136.0 million in other borrowed funds which is
primarily a collateralized sweep account used by commercial depositors.
Results of Operations.
Net income for the nine months ended September 20, 2006 was $22.2 million
compared to $23.7 million for the same 2005 period. This decrease was
attributable to an increase in operating expense of $9.9 million which was
offset by an increase of $7.0 million in net interest income, together with an
increase in other income of $1.2 million. The increase in net interest income
resulted from an increase in interest income of $44.4 million which was
partially offset by an increase in interest expense of $37.4 million. As a
result of a decrease in income before provision for income taxes we had a
decrease in the provision for income taxes of $224,000 for the nine months ended
September 30, 2006 compared to the nine months ended September 30, 2005.
Net income for the quarter ended September 30, 2006 was $5.7 million compared to
$8.3 million for the same 2005 quarter. The decrease resulted from a decrease of
$111,000 in net interest income, together with an increase in the provision for
loan losses of $390,000, an increase in other income of $432,000, an increase in
operating expenses of $3.5 million, and a decrease in the provision for income
taxes of $949,000 for the quarter ended September 30, 2006 compared to the
quarter ended September 30, 2005. The decrease in net interest income resulted
from an increase in interest income of $13.5 million, which was offset by an
increase in interest expense of $13.6 million.
Interest Income.
Interest income for the nine months ended September 30, 2006, totaled $193.8
million, representing a 29.7% increase of $44.4 million, from $149.4 million for
the same period in 2005. Interest income from loans increased $45.1 million,
primarily as a result of a 22.5% increase in the average balance of loans to
$3.2 billion from $2.6 billion for the nine months ended September 30, 2006 and
2005, respectively, along with an increase in the average yield on loans to
6.93% for the nine months ended September 30, 2006 from 6.21% for the same
period ended September 30, 2005. Interest income from securities decreased to
$22.1 million for the nine months ended September 30, 2006 from $24.8 million
for the same period in 2005. The 10.7% decrease was attributable to a decrease
in the average balance of these securities to $624.4 million from $720.0
million, partially offset by an increase in the average yield of these
securities to 4.73% from 4.59%. We have been using proceeds from the repayment
of these securities to fund loan growth. Interest income on other investments
increased by $1.9 million due to an increase in the average yield of these
investments to 4.93% from 3.38% and an increase in the average balance of these
investments to $91.6 million from $58.3 million for the nine months ended
September 30, 2006 and 2005, respectively. Interest income for the quarter ended
September 30, 2006, totaled $67.5 million, representing an increase of $13.5
million or 25.0% from $54.0 million for the same quarter in 2005. Interest
income from loans increased $14.4 million, primarily as a result of a 19.5%
increase in the average balance of loans to $3.4 billion from $2.8 billion for
the quarters ended September 30, 2006 and 2005, respectively, along with an
increase in the average yield on loans to 7.08% for the quarter ended September
30, 2006 from 6.40% for the same period ended September 30, 2005. Interest
income from securities decreased to $7.4 million for the quarter ended September
30, 2006 from $8.4 million for the 2005 quarter. This 11.9% decrease was
attributable to a decrease in the average balance of these securities to $619.0
million from $718.6 million, partially offset by an increase in the average
yield of these securities to 4.77% from 4.67%. We have been using proceeds from
the repayment of these securities to fund loan growth. Interest income on other
investments increased by $71,000 due to an increase in the average yield of
these investments to 5.72% from 3.47% offset by a decrease in the average
balance of these investments to $52.6 million from $78.6 million for the
quarters ended September 30, 2006 and 2005, respectively.
20
<page>
Interest Expense.
Interest expense for the nine months ended September 30, 2006, totaled $90.3
million, an increase of $37.4 million, or 70.7%, from $52.9 million for the same
period in 2005. The increased interest expense reflects an increase in interest
expense on deposits of $33.5 million, or 80.0% and an increase in interest
expense on borrowings of $3.9 million. The average balance of interest bearing
deposits increased by $382.5 million, or 14.7% to $3.0 billion for the nine
months ended September 30, 2006 compared to $2.6 billion for the same period
ended September 30, 2005 and the average cost of those deposits also increased
to 3.36% compared to 2.14% for the comparative time period. The increase in the
cost of deposits in 2006, compared to 2005, is due to the higher interest rate
environment in 2006. The increase in interest expense on borrowings was caused
by an increase to $378.8 million from $298.9 million in the average balance of
these borrowings and an increase in the average cost of borrowed funds to 5.25%
for the nine months ended September 30, 2006 from 4.91% for the comparable 2005
period. The increase in borrowings was used to fund loan growth.
Interest expense for the quarter ended September 30, 2006, totaled $34.2
million, an increase of $13.6 million, or 66.1%, from $20.6 million for the same
quarter in 2005. The reason for this increase was an increase in interest
expense on deposits and borrowings of $9.1 million and $4.5 million,
respectively. The average balance of interest bearing deposits increased by
$72.8 million, or 2.6% to $2.9 billion for the quarter ended September 30, 2006
compared to $2.8 billion for the quarter ended September 30, 2005 and the
average cost of those deposits also increased to 3.71% compared to 2.51% for the
comparative quarter. The increase in interest expense on borrowings was caused
by an increase in the average balance of these borrowings to $573.5 million from
$257.1 million and an increase in the average cost of borrowed funds to 5.28%
for the quarter ended September 30, 2006 from 4.74% for the comparable 2005
quarter. Increases in the cost of deposits and borrowings in 2006, compared to
2005, reflects the higher short-term interest rate environment in 2006, and the
necessity to borrow additional funds for loan growth.
Net Interest Income.
During the nine months ended September 30, 2006, the Company's interest income
increased by $44.4 million compared to the same period in 2005, while interest
expense increased by $37.4 million, resulting in net interest income of $103.5
million for the nine months ended September 30, 2006, compared to $96.5 million
for the same period ended September 30, 2005.
21
<Page>
During the quarter ended September 30, 2006, the Company's interest income
increased by $13.5 million compared to the same quarter in 2005, while interest
expense increased by $13.6 million, resulting in net interest income of $33.3
million for the quarter ended September 30, 2006, a $111,000, or 0.3%, decrease
from the quarter ended September 30, 2005.
Provision for Loan Losses.
The provision for loan losses was $1.3 million for the nine months ended
September 30, 2006, compared to $1.3 million for the same period ended September
30, 2005. The provision for loan losses was $694,000 for the quarter ended
September 30, 2006, compared to $304,000 for the quarter ended September 30,
2005. The provision for the nine and three months ended September 30, 2006 is
deemed adequate by management, reflecting the risks inherent in the Bank's loan
portfolio.
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.
Other Income.
Other income for the nine months ended September 30, 2006 was $18.5 million,
representing an increase of $1.2 million compared to the same period in 2005.
The increase is primarily attributable to an increase in service charges on
deposit accounts of $1.3 million.
Other income for the quarter ended September 30, 2006 was $6.5 million,
representing an increase of $432,000 compared to the same quarter in 2005. The
increase is primarily attributable to an increase in service charges on deposit
accounts of $517,000.
Operating Expense.
Compared to the nine months ending September 30, 2005, operating expense for the
nine months ending September 30, 2006 increased by $9.9 million, or 13.4%, to
$84.1 million. Of this increase, $3.9 million is attributable to compensation
and benefits, which increased by 9.2%. Increases in compensation and benefits
expense were primarily attributable to operating 51 offices in the nine months
ended September 30, 2006 compared to 48 offices in the same period ended
September 30, 2005, as well as additional personnel to serve deposit and loan
customers, and normal salary increases. The increase in compensation and
benefits also reflects an increase of $644,000 in health care costs. Occupancy
and equipment costs and data processing costs increased by $2.5 million, which
reflects our continued investment in developing customer service facilities and
acquiring technology equipment. Miscellaneous operating costs also increased by
$3.1 million to $17.6 million for the nine months ended September 30, 2006
compared to the same period in 2005 primarily due to an increase of $783,000 in
auditing examination and consulting expenses, $190,000 increase in amortization
of core deposit intangibles from the April 2005 acquisition of First Community
Bancorp and $1.0 million in merger related expenses. The remaining increase in
expense largely reflects the costs of operating additional branch facilities.
22
<Page>
Compared to the quarter ending September 30, 2005, operating expense for the
quarter ending September 30, 2006 increased by $3.5 million, or 13.5%, to $29.4
million. Of this increase, $826,000, representing an increase of 5.6%, is
attributable to compensation and benefits. Increases in compensation and
benefits expense were primarily attributable to operating 51 offices in the
quarter ended September 30, 2006 compared to 48 offices in the quarter ended
September 30, 2005, as well as additional personnel to serve deposit and loan
customers, and normal salary increases. Occupancy and equipment costs and data
processing costs increased by $712,000, which reflects our continued investment
in developing customer service facilities and acquiring technology equipment.
Miscellaneous operating costs also increased by $1.7 million to $6.7 million for
the quarter ended September 30, 2006 compared to the same quarter in 2005
primarily due to an increase of $233,000 in accounting and consulting expenses
and $1.0 million in merger related expenses. The remaining increase in expense
largely reflects the costs of operating additional branch facilities.
Income Taxes.
The income tax provision was $14.3 million for the nine months ended September
30, 2006 compared to $14.6 million for the same period ended September 30, 2005.
The income tax provision was $4.1 million for the quarter ended September 30,
2006 compared to $5.1 million for the quarter ended September 30, 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 nine and
three months ended September 30, 2006 and 2005 is the change in the unrealized
gain or loss on securities available for sale.
Comprehensive income for the nine months ended September 30, 2006 was $21.4
million compared to comprehensive income of $19.4 million for the same period
ended September 30, 2005. During the nine months ended September 30, 2006, the
market value of the Company's assets available for sale decreased by $1.4
million which, net of income tax benefit of $547,000, resulted in other
comprehensive loss of $821,000. During the nine months ended September 30, 2005,
the market value of the Company's assets available for sale decreased by $7.1
million, which net of income tax benefit of $2.7 million resulted in other
comprehensive loss of $4.4 million.
Comprehensive income for the quarter ended September 30, 2006 was $9.9 million
compared to comprehensive income of $6.1 million for the quarter ended September
30, 2005. During the quarter ended September 30, 2006, the market value of the
Company's assets available for sale increased by $6.8 million which, net of
income tax of $2.6 million, resulted in other comprehensive income of $4.2
million. During the quarter ended September 30, 2005, the market value of the
Company's assets available for sale decreased by $3.5 million, which net of
income tax benefit of $1.3 million resulted in other comprehensive loss of $2.2
million.
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 3.18% during the
month of September 2006. Liquidity ratios averaged 3.16% for the quarter ended
23
<Page>
September 30, 2006. The Bank adjusts its liquidity levels in order to meet the
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 $659,000 at
September 30, 2006. Other assets qualifying for liquidity at September 30, 2006,
including unpledged mortgage-backed securities guaranteed by Fannie Mae and
Freddie Mac, were $121.3 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 September 30, 2006, the Bank had $332.5 million in advances
from the FHLB. At September 30, 2006, the Bank had commitments to extend credit
for or purchase loans of $253.7 million, in addition to undisbursed loan
proceeds on closed loans of $427.0 million and undisbursed revolving lines of
credit of $312.4 million. Certificates of deposit scheduled to mature in less
than one year at September 30, 2006 totaled $854.8 million. Based on prior
experience, management believes that a significant portion of such deposits will
remain with the Bank.
New Accounting Pronouncements
In September 2006, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 108 ("SAB 108"). Due to diversity in practice among
registrants, SAB 108 expresses SEC staff views regarding the process by which
misstatements in financial statements are evaluated for purposes of determining
whether financial statement restatement is necessary. SAB 108 is effective for
fiscal years ending after November 15, 2006, and early application is
encouraged. The effect of this recently-issued and not yet implemented
pronouncement is not yet known.
In July 2006, the FASB issued FASB Interpretation No. 48 ("FIN No. 48")
"Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement
No. 109." This interpretation clarifies the accounting for uncertainty in income
taxes recognized in an entity's financial statements in accordance with SFAS No.
109, "Accounting for Income Taxes." FIN No. 48 prescribes a recognition
threshold and measurement principles for financial statement disclosure of tax
positions taken or expected to be taken on a tax return. This interpretation is
effective for fiscal years beginning after December 15, 2006. The Company is
assessing the impact the adoption of FIN No. 48 will have on the Company's
consolidated financial position and results of operations.
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
24
<Page>
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.
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 September 30, 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 September 30, 2006, the Company does
not have any hedging transactions in place such as interest rate swaps and caps.
25
<page>>
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.
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, in a 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.
26
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
September 30, 2006 was a positive 15.50%.
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........................ $ 34,020 $ 94,074 $ 193,464 $ 133,196 $ 258,192
Adjustable rate................... 177,976 268,580 276,871 309,096 -
Commercial mortgage loans: (2)
Fixed rate........................ 18,364 33,401 52,500 33,837 52,440
Adjustable rate................... 472,302 562,120 10,895 302 -
Other loans (2)
Fixed rate.................... 15,615 27,372 36,693 16,956 7,097
Adjustable rate................... 360,188 3,944 - - -
Securities
Fixed rate........................ 27,587 74,556 182,897 101,996 159,386
Adjustable rate................... 61,420 - - - -
Other interest earning assets - adjustable 49,785 - - - -
----------- ----------- ---------- --------- -----------
Total $ 1,217,257 $ 1,064,047 $ 753,320 $ 595,383 $ 477,115
=========== =========== ========== ========= ===========
Interest-bearing liabilities
Deposits: (3)
Checking and funds transfer accounts $ 21,434 $ 64,301 $ 98,071 $ 73,167 $ 983,003
Passbook accounts................. 13,929 41,784 77,859 60,608 430,389
Money market accounts............. 23,343 70,030 107,974 67,089 400,071
Certificate accounts (4).......... 192,327 662,696 30,229 5,915 -
Borrowings: (4)..................... 502,081 10,250 63,246 642 -
----------- ----------- ---------- --------- -----------
Total $ 753,114 $ 849,061 $ 377,379 $ 207,421 $ 1,813,463
=========== =========== ========== ========= ===========
Excess (deficiency) of interest-earning
assets over interest-bearing
liabilities....................... $ 464,143 $ 214,986 $ 375,941 $ 387,962 $(1,336,348)
========== =========== ========== ========= ===========
Cumulative excess of interest-earning
assets over interest-bearing
liabilities......................... $ 464,143 $ 679,129 $1,055,070 $1,443,032 $ 106,684
========== ========== ========== ========== ===========
Cumulative excess of interest-earning
assets over interest-bearing liabilities
as a percent ot toal assets......... 10.59% 15.50% 24.08% 32.93% 2.43%
========== ========= ========== ========== ===========
- --------------------------------------------------------------------------------
(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.
27
<Page>
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
The Company, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, carried out an evaluation of the
effectiveness of the Company's disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered
by this report on Form 10-Q. Based on that evaluation, the Chief Executive
Officer and the Chief Financial Officer each concluded that the Company's
disclosure controls and procedures are effective in providing reasonable
assurance that information required to be disclosed by the Company in reports
that it files under the Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified by the
rules and forms of the Securities and Exchange Commission and that such
information is accumulated and communicated to the Company's management,
including its Chief Executive Officer and Chief Financial Officer, to allow
timely decisions regarding required disclosures.
(b) Changes in internal controls.
There were no changes in the Company's internal control over financial
reporting (as such term is defined in the Exchange Acts Rules 13a-15(f) and
15(d)-15(f)), that occurred during the quarter ended September 30, 2006 that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
See the Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
28
<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 26, 2006, Fidelity Federal entered into a Settlement Agreement with the
Plaintiffs of two previously-disclosed class action lawsuits. These lawsuits,
James Kehoe v. Fidelity Federal Bank & Trust, and Timothy Neilsen and Timothy G.
Martin vs. Fidelity Federal Bank & Trust, each of which was filed in the United
States District Court for the Southern District of Florida, allege that Fidelity
Federal violated the Driver's Privacy Protection Act by obtaining driver
registration information from the State of Florida for use in Fidelity Federal's
marketing efforts.
Under the Settlement Agreement, and without admitting any liability or fault,
Fidelity Federal agreed to the certification of a conditional settlement class,
solely for settlement purposes, subject to preliminary and final court approval.
Under the terms of the Settlement Agreement, any class members who qualify and
timely submit a Claim Form will receive payment of an amount not to exceed $160
per person. Fidelity Federal has agreed to pay Plaintiffs' attorneys' fees in an
amount not to exceed $10,000,000 plus their reasonable expenses not to exceed
$120,000. Fidelity Federal will pay Class Representative James Kehoe not more
than $10,000, and Class Representatives Timothy Neilsen and Timothy G. Martin
not more than $3,000 each for their participation in this case on behalf of all
Class Members.
Additionally, Fidelity Federal has agreed to certain injunctive relief,
including certifying that Fidelity Federal did not keep or maintain any data
obtained from the State of Florida, providing that Fidelity Federal shall not
disclose or sell any such data, and agreeing to a privacy audit, the cost of
which shall not exceed $25,000. Under the terms of the settlement, Fidelity
Federal's total costs and expense, including the payments to Class Members,
cannot exceed $50 million.
In addition to final court approval, the Settlement Agreement is contingent upon
the consummation of the acquisition of Fidelity by National City, described
above.
On July 31, 2006, the United States District Court for the Southern District of
Florida entered an Order Preliminarily Approving the Class Action Settlement.
The court established December 7, 2006 as the final hearing date to approve the
Settlement Agreement.
The foregoing description is qualified in its entirety by reference to the full
text of the Settlement Agreement, was filed as an exhibit to the Quarterly
Report for the quarter ended September 30, 2006.
On April 8, 2005, Fidelity Federal Bank & Trust was named as defendant in a
lawsuit CORINTHIAN LLC vs. FIDELITY FEDERAL BANK & TRUST; SEWELL HARDWARE
COMPANY; BROWN/SEWELL PARTNERSHIP filed in the Fifteenth Judicial Circuit in and
for Palm Beach County, Florida. Fidelity is one of a number of defendants. The
29
<Page>
plaintiffs in this case have alleged unspecified monetary damages for breach of
contract, specific performance, conversion and unjust enrichment in connection
with a contract for sale of Bank property where the Bank was forced to default
Plaintiff for failure to perform. Fidelity Federal in consultation with counsel
has concluded that the case is without merit, and intends to vigorously defend
the case. We have been notified of a companion lawsuit which has been filed in
the United States District Court for the Eastern District of Pennsylvania. We
intend to defend this lawsuit on the same basis we are defending this lawsuit in
Florida.
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
request for damages, other than the jurisdictional amount of in excess of
$15,000. The Plaintiffs allege they lost in excess of $18.0 million 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.
30
<Page>
Item 5 Other Information
None.
Item 6 Exhibits
31.1 302 Certification
31.2 302 Certification
32.1 906 Certification
31
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: November 6, 2006 By: /s/ Vince A. Elhilow
-------------------------------------
Vince A. Elhilow
President and Chief Executive Officer
Date: November 6, 2006 By: /s/ Richard D. Aldred
-----------------------------------
Richard D. Aldred
Executive Vice President
Chief Financial Officer
32
EXHIBITS
31.1 302 Certification
31.2 302 Certification
32.1 906 Certification
33
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;
November 6, 2006 /S/ Vince A. Elhilow
- ----------------------------- --------------------------
Date Vince A. Elhilow
President and Chief Executive Officer
34
<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;
November 6, 2006 /s/ Richard D. Aldred
- -------------------------- --------------------------
Date Richard D. Aldred
Executive Vice President,
Chief Financial Officer
35
EXHIBIT 32.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND
CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
36
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.
November 6, 2006 /s/ Vince A. Elhilow
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Date President and Chief Executive Officer
November 6, 2006 /s/ Richard D. Aldred
- ---------------- ------------------------------------
Date Executive Vice President,
Chief Financial Officer and Treasurer
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