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EXHIBIT 13
(FIRST COMMUNITY BANCSHARES, INC. LOGO)
First Community Bancshares, Inc.
2002 Annual Report
(GRAPH)
<Table>
<Caption>
Diluted Earnings Per Share ($)
98 1.35
99 1.75
00 1.78
01 1.92
02 2.48
</Table>
<Table>
FINANCIAL HIGHLIGHTS CONTENTS
(Amounts in Thousands, Except Percent and Per Share Data) Message to Stockholders 1
Introduction 5
2002 ANNUAL REPORT
EARNINGS AND DIVIDENDS
2002 2001 2000 Management's Discussion and Analysis 6
Net income $24,719 $19,134 $17,063 Application of Critical Accounting Policies 7
Basic earnings per share 2.49 1.92 1.78 Recent and Pending Acquisitions 10
Diluted earnings per share 2.48 1.92 1.78 Summary Financial Results 12
Cash dividends per share 1.00 .089 .086 Five-Year Selected Financial Data 15
Return on average equity 17.16% 14.80% 15.70% Common Stock and Dividends 16
Return on average assets 1.68% 1.49% 1.51% Results of Operations 18
Balance Sheet Discussion 26
BALANCE SHEET DATA Liquidity 33
AT YEAR-END Interest Rate Sensitivity, Interest Rate Risk and
Asset/Liability Management 34
2002 2001 2000 Trust and Investment Management Services 37
Total Assets $1,524,363 $1,478,235 $1,218,017 Recent Legislation 37
Deposits 1,139,727 1,078,260 899,903 Consolidated Financial Statements 40
Securities sold under Report of Independent Auditors 74
agreements to repurchase 91,877 79,262 46,179 Report of Management Responsibilities 75
FHLB borrowings Board of Directors 76
and other indebtedness 124,357 145,320 138,015 Locations & Other Information 78
Stockholders' equity 152,462 133,041 120,682
</Table>
A MESSAGE TO OUR FRIENDS AND
STOCKHOLDERS
DEAR STOCKHOLDERS AND FRIENDS,
We, at First Community Bancshares, Inc., are very pleased to provide this annual
report on the operations of the Company for 2002. It has been an eventful year,
full of many new projects geared toward growth of the Company and the
establishment of First Community as a regional provider of financial services.
We consider ourselves very fortunate that we have been able to post another year
of record earnings while continuing to build and invest in resources for
development and growth. In the following summary, we will discuss our financial
performance for the year along with recent announcements and many of the
projects that are part of our strategic plan for growth and expansion of
services.
At the forefront of our recently completed year, were the strong operating
results. Earnings for 2002 not only set new records, but increased by more than
29% over the preceding year. Net income for 2002 was $24.7 million, an increase
of $5.6 million over the $19.1 million record posted in 2001. The $5.6 million
increase includes a $1.9 million (net of tax) reduction in goodwill amortization
as a result of the required adoption of Financial Accounting Standards 142 and
147. In addition, record results for 2002 were principally achieved through an
increase in net interest income of $10.8 million. The increase in net interest
income is the result of meticulous management of asset yields and cost of funds
throughout a year of historic lows in prevailing short-term interest rates and
prime loan rates. Interest rate forecasts early in 2002 indicated a possible 50
to 75 basis point increase in short-term interest rates by year-end 2002.
However, in response to continued weakness in the U.S. economy, the Federal
Reserve Open Market Committee continued an accommodative stance and further
lowered the federal funds rate by another 50 basis points in November 2002. The
continuation of lower
GROWTH
CONTINUING TO BUILD AND INVEST
IN RESOURCES FOR GROWTH AND DEVELOPMENT
interest rates constrained margins, to a degree, as deposit rates reached
historic lows and yields on loans continued to drop as a result of repricing of
adjustable rate loans and the attainment of lower yields on new loan production.
Despite this unforeseen interest rate environment, we were able to increase net
interest margin from 4.55% in 2001 to 4.76% for the full year 2002. Management
of rates offered through our product group and growth in average loans held for
investment and held for sale were important factors in the improvement in net
interest margin for the year.
(PHOTO)
JOHN M. MENDEZ
President and CEO
First Community Bancshares, Inc.
(GRAPH)
<Table>
<Caption>
Net Income ($)
(Amounts in millions)
98 13.1
99 16.9
00 17.1
01 19.1
02 24.7
</Table>
1
STOCKHOLDERS
MESSAGE (CONTINUED)
Non-interest income growth was concentrated in the $1.1 million increase in
deposit service charge revenue which stems from continued growth in deposits and
refinement in the Company's product set and service charge structure. Partially
offsetting this increase was a $500,000 drop in other operating revenues and a
$572,000 decrease in securities gains and losses. During 2002, the Company
recorded a $576,000 write-down on the impairment of a municipal bond issue which
led to this decrease in securities gains. Low interest rates on fifteen and
thirty-year mortgages, which were available throughout the year, resulted in
residential mortgage loan originations through the Company's mortgage subsidiary
of over $790.0 million in 2002, up from $621.0 million in 2001. Despite the
higher volume of loan originations, net income from mortgage banking fell short
of the preceding year as a result of higher hedge costs, primarily in the third
quarter. Overall, non-interest revenues were unchanged from the preceding year
at $20.3 million.
Basic and diluted earnings per share ("EPS") for 2002 reached $2.49 and $2.48,
respectively, and compared with $1.92 per share basic and diluted in 2001, an
increase of 29% year over year on a diluted basis. The adoption of the new
goodwill accounting standards in 2002 added $0.19 per share to diluted EPS.
Without the effect of the new standards, diluted EPS increased 18.0% in 2002
versus 2001. Return on equity in 2002 climbed to 17.16%, up from 14.80% in 2001.
The improvement in return on equity came as a result of improved leverage from
acquisitions in late 2001 as well as growth in net interest income and
operational improvements which impacted net income. Return on average assets
also improved significantly, increasing from 1.49% in 2001 to 1.68% for the
current year. Based on our year-end closing stock price of $30.76, 2002 earnings
per share produce a price/earnings multiple of 12.4X. Our common stock price
also experienced significant price appreciation during 2002, increasing from
$26.79 (year-end 2001 adjusted for the March 2002 10% stock dividend) to $30.76
at December 31, 2002. Total cash dividends paid in 2002 of $9.93 million also
resulted in a 3.7% cash return on the opening market value of First Community
common stock and combined with current year price appreciation, resulted in an
18.5% total return on investment for 2002.
In 2002, we opened five new full-service branches. In August, we opened our new
West Atlantic branch in Emporia, Virginia. This replaced our Halifax Street
location, which did not offer drive-up banking and had limited parking and other
facilities. In November, we opened our new Ridgeview branch in Bluefield,
Virginia. We believe that this new facility will significantly enhance our
service to both our Tazewell County, Virginia, and Mercer County, West Virginia,
customers. And on November 30, 2002, we completed the acquisition of Bank of
Greenville, which added three branches in Monroe and Summers Counties in West
Virginia.
(GRAPH)
<Table>
<Caption>
Total Assets ($)
(Amounts in millions)
98 1,054.0
99 1,088.2
00 1,218.0
01 1,478.2
02 1,524.4
</Table>
2
The branch additions are only part of your Company's plan to expand the scope of
its operations and provide a full array of financial services, in a community
bank setting, to a larger market which encompasses a large portion of the
Mid-Atlantic region. We plan to continue this expansion through the addition of
de novo branches, small bank affiliations and acquisition of financial service
providers. A major milestone in this strategy was achieved in January 2003 when
we announced the signing of a definitive agreement for the acquisition of The
CommonWealth Bank in Richmond, Virginia. CommonWealth is a $134 million bank
operating four branches within the Richmond metro market. This acquisition will
supplement our Southside, Virginia operations and establish a strong base of
operations in eastern Virginia. We are very excited about the addition of
CommonWealth and its fine staff of financial professionals. Subject to
regulatory approvals and the affirmative vote of CommonWealth stockholders, we
expect to close on this transaction in the second quarter of 2003.
On the North Carolina front, we are pleased to announce that we have completed
the acquisition of our first of two branch properties in Winston-Salem, North
Carolina with plans to open these new full service banking facilities in the
second quarter of 2003. This continues our expansion in North Carolina and
provides our first locations within the Piedmont/Triad area.
In the area of expanded financial services, we are pleased to announce our
recent acquisition of Stone Capital Management, Inc., a registered investment
advisory firm providing financial advisory and wealth management services to
individual investors. Stone Capital is based in Beckley, West Virginia with
current assets under management of over $94 million. Future plans include the
expansion of these services to other First Community markets under the Stone
Capital brand as well as the extension of asset management services, through
Stone Capital, to customers of the First Community Bank Trust and Financial
Services Division. The addition of Stone Capital is coupled with the recent
recruitment of our new Senior Vice President of Trust and Financial Services who
comes to us with superior qualifications and background. Mike Earle, who
received his MBA from George Washington University, is also an attorney and
Certified Financial Planner with over twenty years of experience in trust
management, equity investing and business valuation services. These new
resources significantly improve our financial advisory capabilities.
Great strides have been made in the past year in the area of asset quality with
significant reductions in ninety-day past due loans and non-accrual loans. These
two areas of non-performing assets have been reduced to very modest levels and
are well below our peer group averages, indicating a higher level of asset
quality when benchmarked against commercial banks of similar size. Total
non-performing assets to total assets were reduced to 0.41% at year-end 2002,
down from 0.58% at December 31, 2001. Asset quality is evident not only in
non-performing asset measures but also in loan delinquencies, which are at their
lowest level in the history of the Company. Loans past due thirty days or more
to total loans were 1.18% at year-end 2002, including ninety-day and non-accrual
loans. This compares favorably with 1.53% at year-end 2001. Each of these
measures ranks your Company very high among commercial banks in terms of asset
quality. In 2002 we recruited some very talented and experienced staff members
who have enhanced administrative controls over the credit portfolio and
sharpened policy and standards for the production and administration of both
commercial and consumer loans.
In July of last year Congress passed sweeping legislation known as the
Sarbanes-Oxley Act of 2002. This legislation is intended to improve the quality
of financial reporting, increase corporate accountability for financial
reporting, improve corporate governance and reform the accounting profession in
areas of attestation services, all with the objective of restoring investor
confidence in public company accounting and financial reporting. First Community
Bancshares has a strong record of producing quality financial reports and
integrity in corporate governance. Despite our Company's existing commitment to
excellence in these areas,
3
STOCKHOLDERS
MESSAGE (CONTINUED)
we have redoubled our efforts to ensure the continued confidence of you, our
stockholders, and the investing public at large. Since the passage of the act,
we have further formalized our financial reporting processes with the formation
of our Financial Reporting and Disclosure Committee, which is an integral part
of our financial report review process. This committee further enhances the
integrity of the financial reporting process through formalized assessment of
accounting policies and evaluation of financial disclosures. We have also formed
our Business Trends Committee, which meets monthly to consider and evaluate
trends and business conditions, and ensure important disclosures are
communicated through the organization and considered for disclosure where
appropriate. These new controls are in addition to the many existing controls
and processes already employed by our Company to ensure the accuracy and fair
presentation of financial information that we publish on a quarterly and annual
basis. Portions of this annual report are dedicated to these new processes, the
audit committee and the people who work very hard to ensure quality financial
reporting.
Once again, we thank you for your commitment to the success of our Company,
whether as a customer of First Community Bank, as one of our dedicated employees
or as an investor and shareholder. We are indeed grateful for the opportunity to
provide quality financial services and to serve as custodians of the many
resources of this growing company.
Sincerely,
/s/ JOHN M. MENDEZ
John M. Mendez
President and Chief Executive Officer
(GRAPH)
<Table>
<Caption>
Non-performing Assets ($)
(Amounts in millions)
98 11.687
99 11.098
00 9.011
01 8.013
02 6.021
</Table>
(PHOTO)
4
INTRODUCTION
The 2002 annual report reflects another record year in the history of First
Community Bancshares, Inc. As we grow and prosper, the basic tenets of our
philosophy remain the same. Our commitment to serve the financial needs of our
customers guides our path as we continue our efforts to be Your First Financial
Resource.
Our shareholders, customers and employees depend on us to be trustworthy. We
guard our corporate reputation and strive to earn and keep the trust of our
stakeholders. We believe that mutual trust results in strong and stable
relationships and creates satisfied shareholders, loyal customers and proud
employees.
Our commitment to the communities we serve remains strong. Good corporate
citizenship and corporate integrity go hand in hand with our efforts to continue
to build a financially strong company that provides service to our communities
and employment opportunities for our friends and neighbors. We strive to meet
the responsibility inherent in the name First Community Bank.
This report features the Board of Directors and the committees who provide the
oversight that ensures we are true to our values and honor our commitment to our
shareholders, customers and employees. These directors and officers provide the
guidance for ethical business practices so necessary to maintain our corporate
integrity. We trust that you will find it reassuring to learn about the people
who attest to the accuracy of the information you receive in this annual report.
(PHOTO)
ROBERT L. BUZZO
Vice President and Secretary
First Community Bancshares, Inc.
President
First Community Bank, N. A.
(PHOTO)
E. STEPHEN LILLY
Chief Operating Officer
First Community Bancshares, Inc.
Senior Vice President and COO
First Community Bank, N. A.
(PHOTO)
ROBERT L. SCHUMACHER
Chief Financial Officer
First Community Bancshares, Inc.
Senior Vice President-Finance
First Community Bank, N. A.
5
MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
(PHOTO)
This discussion should be read in conjunction with the consolidated financial
statements, notes and tables included throughout this report and the First
Community Bancshares, Inc., (the "Company" or "First Community") Annual Report
on Form 10-K. All statements other than statements of historical fact included
in this Annual Report, including statements in the Message to Stockholders and
in Management's Discussion and Analysis of Financial Condition and Results of
Operations are, or may be deemed to be, forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Exchange Act of 1934. Generally, the words "believe," "expect," "intend,"
"estimate," "anticipate," "project," "will" and similar expressions identify
forward-looking statements, which generally are not historical in nature. All
statements that address operating performance, events or developments that we
expect or anticipate will occur in the future -- including statements relating
to growth, share of revenues and earnings per share growth and statements
expressing general optimism about future operating results -- are
forward-looking statements. Forward-looking statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from our Company's historical experience and our present expectations or
projections. As and when made, management believes that these forward-looking
statements are reasonable. However, caution should be taken not to place undue
reliance on any such forward-looking statements since such statements speak only
as of the date when made.
Many factors could cause the Company's actual results to differ materially from
the results contemplated by the forward-looking statements. Some factors, which
could negatively affect the results, include: (1) general economic conditions,
either nationally or within the Company's markets, could be less favorable than
expected, (2) changes in market interest rates could affect interest margins and
profitability, (3) competitive pressures could be greater than anticipated, (4)
legal or accounting changes could affect the Company's results, (5) acquisition
cost savings may not be realized or the anticipated income may not be achieved,
and (6) adverse changes could occur in the securities and investments markets.
The foregoing list of important factors is not exclusive.
Forward-looking statements made herein reflect management's expectations as of
the date such statements are made. Such information is provided to assist
stockholders and potential investors in understanding current and anticipated
financial operations of the Company and are included pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. The Company
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
First Community is a multi-state holding company headquartered in Bluefield,
Virginia. With total assets of $1.52 billion at December 31, 2002, First
Community through its banking subsidiary, First Community Bank, N. A. ("FCBNA"
or "Bank"), provides financial, mortgage brokerage and origination and trust
services to individuals and commercial customers through 41 full-service banking
locations in West Virginia, Virginia and North Carolina as well as eleven
mortgage brokerage facilities operated by United First Mortgage, Inc. ("UFM".)
UFM is a wholly owned subsidiary of FCBNA. FCBNA also operates Stone Capital
Management, Inc. ("Stone Capital"), an investment advisory firm, with offices in
Beckley, West Virginia.
6
APPLICATION OF CRITICAL ACCOUNTING POLICIES
First Community's consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States of America
and conform to general practices within the banking industry. First Community's
financial position and results of operations are affected by management's
application of accounting policies, including judgments made to arrive at the
carrying value of assets and liabilities and amounts reported for revenues,
expenses and related disclosures. Different assumptions in the application of
these policies could result in material changes in First Community's
consolidated financial position and/or consolidated results of operations.
Estimates, assumptions and judgments are necessary principally when assets and
liabilities are required to be recorded at estimated fair value, when a decline
in the value of an asset carried on the financial statements at fair value
warrants an impairment write-down or valuation reserve to be established, or
when an asset or liability needs to be recorded based upon the probability of
occurrence of a future event. Carrying assets and liabilities at fair value
inherently results in more financial statement volatility. The fair values and
the information used to record valuation adjustments for certain assets and
liabilities are based either on quoted market prices or are provided by third
party sources, when available. When third party information is not available,
valuation adjustments are estimated in good faith by management primarily
through the use of internal modeling techniques and/or appraisal estimates.
First Community's accounting policies are fundamental to understanding
Management's Discussion and Analysis of Financial Condition and Results of
Operations. The following is a summary of First Community's more subjective and
complex "critical accounting policies." In addition, the disclosures presented
in the Notes to the Consolidated Financial Statements and in management's
discussion and analysis, provide information on how significant assets and
liabilities are valued in the financial statements and how those values are
determined. Based on the valuation techniques used and the sensitivity of
financial statement amounts to the methods, assumptions and estimates underlying
those amounts, management has identified the determination of the allowance for
loan losses, the valuation of loans held for sale and the valuation of
derivative instruments utilized in hedging activity to be the accounting areas
that require the most subjective or complex judgments.
(PHOTO)
7
STABILITY
THROUGH MANAGEMENT
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established and maintained at all levels that
management deems adequate to cover losses inherent in the portfolio as of the
balance sheet date and is based on management's evaluation of the risks in the
loan portfolio and changes in the nature and volume of loan activity. Estimates
for loan losses are determined by analyzing historical loan losses, current
trends in delinquencies and charge-offs, plans for problem loan resolution, the
opinions of our regulators, changes in the size and composition of the loan
portfolio and industry information. Also included in management's estimates for
loan losses are considerations with respect to the impact of economic events,
the outcome of which are uncertain. These events may include, but are not
limited to, a general slowdown in the economy, fluctuations in overall lending
rates, political conditions, legislation that may directly or indirectly affect
the banking industry and economic conditions affecting specific geographical
areas in which First Community conducts business. The loan portfolio also
represents the largest asset type on the consolidated balance sheet.
As more fully described in Notes 1 and 6 to the Consolidated Financial
Statements and in the discussion included in the Allowance for Loan Losses
section of management's discussion and analysis, the Company determines the
allowance for loan losses by making specific allocations to impaired loans and
loan pools that exhibit inherent weaknesses and various credit risk factors.
Allocations to loan pools are developed giving weight to risk ratings,
historical loss trends and management's judgment concerning those trends and
other relevant factors. These factors may include, among others, actual versus
estimated losses, regional and national economic conditions, business segment
and portfolio concentrations, industry competition and consolidation, and the
impact of government regulations. The level of consumer and residential mortgage
loan allowance is maintained at a total portfolio level based on a review of
historical loss percentages and other qualitative factors including
concentrations, industry specific factors and economic conditions.
LOANS HELD FOR SALE
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company's mortgage subsidiary, UFM, originates, acquires, and sells
residential mortgage products on a servicing released basis into the secondary
market. Currently, UFM originates all loans with the positive intent to sell.
Loans held for sale are stated at the lower of cost or market ("LOCOM"). The
LOCOM analysis on pools of homogeneous loans is applied on a net aggregate
basis. Interest income with respect to loans held for sale is accrued on the
principal amount outstanding. LOCOM valuation techniques applicable to loans
held for sale are based on estimated market price indications for similar loans.
Pricing estimates are established by participating mortgage purchasers and
prevailing economic conditions. The majority of the loans held for sale have
predetermined pricing indications. However, loans which have yet to be committed
to an individual investor ($6.7 million at December 31, 2002) are evaluated for
necessary write-downs. The applicable market for these loans at year-end was
$6.9 million and as such, no write-down was necessary.
UFM provides a distribution outlet for the sale of loans produced by UFM's
wholesale and retail operations. UFM originates residential mortgage loans
through its production offices located in eastern Virginia and sells the
majority of its loans through pooled commitments to national investors. In
addition, UFM acquires loans from a network of wholesale brokers for subsequent
resale to these national investors as well. The loans held for sale portfolio at
December 31, 2002, was $66.4 million compared to $65.5 million at December 31,
2001.
Risks associated with this lending function include interest rate risk, which is
mitigated through the utilization of financial instruments (commonly referred to
as derivatives) to assist in offsetting the effect of changing interest rates.
The Company accounts for these instruments in accordance with Financial
Accounting Standards Board ("FASB") Statement No. 133 "Accounting for Derivative
Instruments and Hedging Activity" as amended by Statements No. 137 and No. 138.
These Statements established accounting and reporting
8
standards for derivative instruments and for hedging activities. UFM uses
forward mortgage contracts (short position sales) to manage interest rate risk
in the pipeline of loans and interest rate lock commitments ("RLCs") from the
point of the loan commitment to the subsequent sale to outside investors. As a
result of the timing from origination to sale, and the likelihood of changing
interest rates, forward commitments are placed with counter-parties to
substantially lock the expected margin on the sale of the loan. The forward
commitment to sell the security is considered to be a derivative and, as such,
is recorded on the Consolidated Balance Sheets at fair value, and the changes in
fair value are reflected in the Consolidated Statements of Income.
The RLCs (representing forward commitments to fund loans which will be held for
sale) are also considered derivatives and are valued at estimated fair market
value based on prevailing interest rates, expected servicing release premiums
and the assumed probability of closing (pull-through). The assumption of a given
pull-through percentage also enters into the determination of the volume of
forward contracts. Pull-through assumptions are continually monitored for
changes in the interest rate environment and characteristics of the pool of
RLCs. Differences between pull-through assumptions and actual pull-through could
result in a mismatch in the volume of forward contracts corresponding to RLCs
and lead to volatility in margins on the loan products ultimately delivered.
At December 31, 2002, the Company's mortgage subsidiary held an investment in
forward mortgage contracts with a notional value of $75 million. These contracts
hedge interest rate risk associated with RLCs and closed loans not allocated to
a forward commitment. Adjustment of the forward mortgage contracts to fair value
resulted in a $700,000 write-down at December 31, 2002, while the adjustment to
market value on RLCs yielded a $1.8 million increase over the prior year. The
market valuation of RLCs at December 31, 2002 assumes 68.4% RLC pull-through. If
actual pull-through in succeeding months proves to be more or less than 68%, the
full market value of RLCs may or may not be realized and/or the valuation of
RLCs may change. The valuation of RLCs is considered critical because of the
impact of borrower behavior and the impact that this behavior pattern will have
on the pull-through ratio during times of significant rate volatility. Customer
behavior is modeled by a mathematical tool based upon historical pull-through
experience; however, substantial volatility can be and was experienced in 2002,
as a result of the continued decline in mortgage rates experienced in the latter
half of 2002 and, as a result, daily pull-through varied significantly over this
time period. For the year ending December 31, 2002, the Company incurred $8.1
million in the cost of forward mortgage derivative contracts to originate and
sell $791.8 million in loans in comparison to the prior year where $621.6
million in loans were sold with underlying forward mortgage contracts that cost
$1.6 million. The significant increase in hedging cost demonstrates the
potential volatility to earnings and the sensitivity to pull-through
assumptions.
(PHOTO)
Partnerships like this are built on trust, Kay Bayless
of Princeton, West Virginia, and John Bowling of FCB.
9
EXPANSION
RECENT AND PENDING ACQUISITIONS
On November 30, 2002, the Company acquired Monroe Financial, Inc. and its
banking subsidiary, Bank of Greenville, at a cost of $1.96 million. Bank of
Greenville's three branch facilities, Greenville and Lindside in Monroe County,
West Virginia, and Hinton in Summers County, West Virginia, were simultaneously
merged with and into the Bank. The completion of this transaction resulted in
the addition of $29.8 million in assets, including $17.4 million in loans and
added an additional $28.0 million in deposits to the Bank. The excess of the
fair market value of the net assets acquired over purchase price of $1.27
million was reallocated to the non-financial assets acquired.
On January 27, 2003, the Company announced the signing of a definitive merger
agreement pursuant to which the Bank will acquire The CommonWealth Bank, a
Virginia-chartered commercial bank ("CommonWealth Bank"), for total
consideration of approximately $25.0 million. Under the terms of the merger
agreement, each share of CommonWealth Bank common stock issued and outstanding
immediately prior to the merger shall become and be converted into the right to
receive either $30.50 in cash or a number of whole shares of the Company's
common stock as determined by dividing $30.50 by the average closing price of
the Company's common stock during a specified period preceding the merger
agreement, plus cash in lieu of any fractional share interest. The cash/stock
allocation is subject to procedures set forth in the merger, as amended, which
permits CommonWealth shareholders to elect to have up to 50% of their
outstanding shares converted into the right to receive cash. The merger is
expected to close during the second quarter of 2003, pending the receipt of all
requisite regulatory approvals and the approval of CommonWealth Bank's
shareholders. At December 31, 2002, CommonWealth Bank had total assets of $134.1
million, net loans of $106.2 million and total deposits of $107.3 million.
In January 2003, the Bank completed the acquisition of Stone Capital Management,
Inc. This acquisition will expand the Bank's operations to include a broader
range of financial services, including wealth management, asset allocation,
financial planning and investment advice. Stone Capital at December 31, 2002,
had total assets of $94 million under management. Stone Capital will continue to
operate under its name in conjunction with First Community's Trust and Financial
Services Division.
(PHOTO)
"We're broadening our base and geographic reach as
we take a stronger foothold in Virginia and North
Carolina," said President and CEO, John M. Mendez
pictured with Robert L. Buzzo,
Robert L. Schumacher and E. Stephen Lilly.
Monroe Financial, Inc. Bank of Greenville The CommonWealth Bank
Stone Capital Management
10
(MAP)
11
COMMITMENT TO
EXCELLENCE
SUMMARY FINANCIAL RESULTS
Net income for 2002 was $24.7 million, up $5.6 million from $19.1 million in
2001 and up $7.6 million from 2000 net income of $17.1 million. Basic and
diluted earnings per share for 2002 were $2.49 and $2.48, respectively, up from
basic and diluted earnings per share of $1.92 each and $1.78 each in 2001 and
2000, respectively. The change in basic earnings per share to $2.49 represents
an increase of 29.7% compared to $1.92 per share in 2001. Due to the adoption of
a new accounting standard on January 1, 2002, and the application of another new
accounting standard retroactively applied to January 1, 2002, the Company
discontinued the amortization of goodwill, subject to annual impairment testing.
On a comparative basis, without goodwill amortization, the prior year basic and
diluted earnings per share would have been $2.11. On a fully comparative basis
without goodwill amortization, the current year income increased 18% per
dilutive share. The most significant factors contributing to the increase in net
income were a $10.8 million increase in net interest income, a $926,000 decrease
in the provision for loan losses due to improvement in overall loan quality, and
a $2.15 million reduction in goodwill amortization due to the adoption of
Financial Accounting Standards Board ("FASB") Statements No. 142 and 147 in
2002. These factors were partially offset by an increase of approximately $3.4
million in salaries and benefits and a $2.3 million increase in other operating
expenses.
The improvement in net interest income was largely the result of an increase in
average earning assets of $180.3 million. The yield on these assets decreased 81
basis points between 2001 and 2002, but was offset by a 118 basis point decrease
in the cost of interest-bearing liabilities. The impact of these rate and volume
changes was an increase in the net interest rate spread from 3.91% to 4.29% for
the year 2002, a 38 basis point increase between 2001 and 2002. The Company's
tax equivalent net interest margin of 4.76% for 2002 reflects an increase of 21
basis points compared to 2001 when the tax equivalent yield was 4.55%. Interest
expense was managed through the use of a combination of retail deposits, Federal
Home Loan Bank borrowings, and active product pricing and marketing strategies
in the low rate environment.
The Company's key profitability ratios of Return on Average Assets (ROA) and
Return on Average Equity (ROE) compare favorably with the average of the
Company's national peer ratios of 1.19% and 13.74%, respectively, based on the
September 2002 Bank Holding Company Performance Report. ROA, which measures the
Company's stewardship of assets, was at 1.68%, compared to 1.49% in 2001 and
1.51% in 2000. ROE for the Company increased to 17.16% in 2002, compared to
14.80% in 2001 and 15.70% in 2000. ROE was impacted positively by increases in
the current year earnings and an increase in the Company's leverage position.
NEIGHBORHOOD
SERVICE IS OUR HIGHEST PRIORITY AT ALL LOCATIONS
12
(PHOTO)
Raymond Hall of FCB serves local companies like Artistic Woodworkers of
Bluewell, West Virginia.
With the adoption of FASB Statement No. 142, the Company ceased amortization of
certain goodwill beginning January 1, 2002, as required by the Statement, and
with the adoption of Statement 147 in October 2002, amortization of remaining
goodwill associated with branch acquisitions was discontinued. Cessation of such
amortization decreased goodwill expense in 2002 by $2.15 million compared to
2001. This resulted in an additional $1.9 million in after tax net income, or
$0.19 per share, in comparison to the prior year.
Non-interest income for 2002 which primarily consists of fiduciary earnings,
service charges on deposit accounts and mortgage banking income, remained fairly
consistent with the prior year as a result of continued strength in mortgage
banking and consistent earnings derived from deposit account charges. Service
charges on deposit accounts increased through growth in accounts and improved
usage of deposit programs. The level of total non-interest income in 2002 in
comparison to the prior year was maintained despite a securities write-down of
$576,000 as more fully described under "Results of Operations -- Non-interest
Income."
Operating expense for 2002, which included salaries and benefits, increased by
$4.3 million from $38.0 million reported for 2001 to $42.3 million in 2002. The
cost increases reflect the increased commission payments at UFM related to the
substantial increase in the volume of loans originated and sold, the full year
impact of four branches acquired in the fourth quarter of 2001, and additional
banking facilities opened in Athens, West Virginia, and Emporia and Bluefield,
Virginia.
13
RESULTS
SUMMARY FINANCIAL RESULTS CONTINUED
The increase in net income between 2000 and 2001 of $2.0 million or 12.1% was
driven by a $7.8 million increase in non-interest income and a $3.8 million
increase in net interest income. The improvement in net interest income was the
result of continued strong loan demand as indicated by the 7.4% increase in
loans outstanding, excluding loans acquired through branch acquisitions in
December 2001. In addition, increased mortgage banking activity stemming from
the lower interest rate environment during 2001 caused loans held for sale at
December 31, 2001 to, increase by 466.4%. As a result of the change in the
volume of loans, interest and fees on loans outpaced the preceding year,
increasing $7.1 million from $68.4 million in 2000 to $75.5 million in 2001.
In 2001, the Company's cost of funds experienced a $3.0 million dollar increase
over 2000, as the level of deposits and borrowings also increased. The rate paid
on interest-bearing liabilities declined by 22 basis points to 4.21% while the
yield on earning assets declined 58 basis points to 8.13%, resulting in a tax
equivalent net interest margin of 4.55% for the year compared to 4.86% in 2000.
Operating costs in 2001 included depreciation and certain expenses which
reflected a substantial investment in the future of the Company as over $3.0
million was invested in technology upgrades, image campaigns and marketing
programs. Operating expense for 2001 increased by $7.0 million from $31.0
million for 2000 to $38.0 million in 2001. This increase included the increased
operating costs at UFM related to the substantial increase in the volume of
loans originated and sold, the full year impact of Citizens Southern Bank which
was acquired in the fourth quarter of 2000, additional banking facilities
including the new Athens, West Virginia, branch and the four branches acquired
in December 2001.
(PHOTO)
Earning the respect from customers.
Glenn Hawkins, owner of Hawkins Supply and Fertilizer, of
Emporia, Virginia, and Cheryl Allen of FCB discuss business.
<Table>
<Caption>
Return on Average Equity (%)
98 13.02
99 16.23
00 15.70
01 14.80
02 17.16
</Table>
PERFORMANCE
RETURN ON AVERAGE EQUITY OF 17.16%
14
FIVE-YEAR SELECTED FINANCIAL DATA
(Amounts in Thousands, Except Percent and Per Share Data)
<Table>
<Caption>
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
BALANCE SHEET SUMMARY (at end of period):
Loans, net of unearned income $ 927,621 904,496 811,256 704,096 611,493
Loans held for sale 66,364 65,532 11,570 N/A N/A
Allowance for loan losses 14,410 13,952 12,303 11,900 11,404
Securities 341,899 395,891 283,298 290,873 277,210
Total assets 1,524,363 1,478,235 1,218,017 1,088,162 1,053,988
Deposits 1,139,727 1,078,260 899,903 833,258 875,996
Other indebtedness 124,357 145,320 138,015 10,218 18,176
Stockholders' equity 152,462 133,041 120,682 103,488 101,719
SUMMARY OF EARNINGS:
Total interest income $ 96,204 92,829 85,958 76,492 81,213
Total interest expense 35,008 42,409 39,379 32,250 38,128
Provision for loan losses 4,208 5,134 3,986 2,893 6,250
Non-interest income 20,049 20,275 12,492 10,732 11,182
Non-interest expense 42,269 38,025 30,968 27,457 28,752
Income tax expense 10,049 8,402 7,054 7,722 6,164
Net income 24,719 19,134 17,063 16,852 13,101
PER SHARE DATA:
Basic earnings per common share $ 2.49 1.92 1.78 1.75 1.35
Diluted earnings per common share 2.48 1.92 1.78 1.75 1.35
Cash dividends 1.00 0.89 0.86 0.80 0.76
Book value at year-end 15.42 13.39 12.14 10.78 10.55
SELECTED RATIOS:
Return on average assets % 1.68 1.49 1.51 1.62 1.24
Return on average equity 17.16 14.80 15.70 16.23 13.02
Dividend payout 40.16 46.35 48.31 45.71 56.30
Average equity to average assets 9.79 10.05 9.64 9.96 9.50
Risk-based capital to risk-adjusted assets 13.33 12.10 12.93 13.22 13.25
Leverage ratio 8.10 7.93 8.37 8.25 7.37
</Table>
15
SHAREHOLDER VALUE
COMMON STOCK AND DIVIDENDS
The Company's common stock trades on the NASDAQ Small-Cap Market under the
symbol FCBC. On December 31, 2002, First Community's year-end common stock price
was $30.76, a 14.8% increase over the $26.79 closing price on December 31, 2001.
Book value per common share was $15.42 at December 31, 2002, compared with
$13.39 at December 31, 2001, and $12.14 at the close of 2000. The year-end
market price for First Community common stock of $30.76 represents 199.5% of the
Company's book value as of the close of the year and reflects total market
capitalization of $304.2 million. Utilizing the year-end market price and 2002
diluted earnings per share, First Community common stock closed the year trading
at a price/earnings multiple of 12.4 times diluted earnings per share.
Cash dividends for 2002 totaled $1.00 per share, up $0.11 or 12.36% from the
$0.89 paid in 2001. The 2002 dividends resulted in a cash yield on the year-end
market value of 3.25%. Total dividends paid for the current and prior year
totaled $9.9 million and $8.9 million, respectively.
(GRAPH)
<Table>
<Caption>
Dividends Per Share ($)
98 0.76
99 0.80
00 0.86
01 0.89
02 1.00
</Table>
FIRST COMMUNITY BANK, N. A.
BOARD OF DIRECTORS
Front Row:
Sam Clark, I. Norris Kantor, W.W. Tinder, Jr.,
B.W. Harvey, Dale F. Woody and Juanita G. Bryan
Second Row:
Richard G. Rundle, Robert L. Buzzo, K.A. Ammar, Jr.,
John M. Mendez, William P. Stafford and Allen T. Hamner
Back:
James P. Bailey, A.A. Modena, Clyde B. Ratliff,
Robert E. Perkinson, Jr., D.L. Bowling, Jr. and
William P. Stafford, II
16
<Table>
<Caption>
Book
Bid Value Cash Dividend
High Low Per Share Per Share
-------- -------- --------- -------------
2002
First Quarter $ 30.75 $ 25.36 $ 13.67 $ 0.25
Second Quarter 33.00 28.00 14.50 0.25
Third Quarter 33.10 28.00 15.10 0.25
Fourth Quarter 33.33 29.17 15.42 0.25
--------
$ 1.00
========
2001
First Quarter $ 18.88 $ 17.13 $ 12.64 $ 0.21
Second Quarter 30.00 17.85 12.85 0.21
Third Quarter 33.80 29.75 13.33 0.21
Fourth Quarter 31.60 23.75 13.39 0.26
--------
$ 0.89
========
</Table>
(PHOTO)
17
RESULTS OF
OPERATIONS
NET INTEREST MARGIN
Net interest margin measures net interest income as a percentage of average
earning assets. In 2002, the net interest margin was 4.76% for the year, above
the 4.55% and slightly below the 4.86% levels attained in 2001 and 2000,
respectively. The current year's increase was due in large part to the combined
effect of a $180.3 million increase in average earning assets, and a general
decline in the cost of funds, which was partially offset by a decline in the
yield on earning assets. The associated reductions in loan and investment yields
were the result of the declining interest rate environment experienced beginning
in 2001 and continuing into 2002.
Average loans, which include loans held for sale, increased $89.0 million in
volume, which resulted in an increase of $400,000 in interest and fees on loans,
on a tax equivalent basis, despite the decline in the yield on total loans from
8.56% to 7.82%. Average investment securities available for sale increased $91.0
million over 2001, producing an additional $3.8 million in interest revenue
while the yield declined from 6.57% in 2001 to 5.92% by year-end 2002. The
slight increase in yield on investment securities held to maturity was offset by
a decrease in the average balance to $41.0 million in 2002 as compared to the
average balance of $42.2 million in 2001, resulting in a $70,000 decrease in
interest income on such investment securities. The increase in average loan and
security volume was partially offset by a reduction in yield on the underlying
assets. Total tax equivalent interest income increased $3.6 million. Despite
volume increases in average interest-bearing deposits of $131.3 million, the
Company experienced an overall decrease in interest on total deposits of $6.5
million due to the decline in the cost of funds. Short-term borrowings,
including retail repurchase agreements with existing bank customers and Federal
Home Loan Bank ("FHLB") advances increased $17.5 million and experienced an 85
basis point decline in the cost of these funding sources. In 2002, significant
increases in the loan portfolio were funded with a combination of increased
deposits and short-term borrowings.
(GRAPH)
<Table>
<Caption>
Net Interest Margin (%)
98 4.81
99 5.03
00 4.86
01 4.55
02 4.76
</Table>
18
NET INTEREST INCOME
The primary source of the Company's earnings is net interest income, the
difference between income on earning assets and the cost of funds supporting
those assets. Significant categories of earning assets are loans and securities
while deposits and short-term borrowings represent the major portion of
interest-bearing liabilities.
On a tax equivalent basis, net interest income increased $11.1 million, or 20.5%
in 2002 compared to an increase of $4.1 million, or 8.3% in 2001, in each case,
over the prior year. The increase in 2002 was the net result of an $8.7 million
increase due to the higher volume of interest-earning assets and
interest-bearing liabilities and a $2.4 million increase due to changes in rates
on these assets and liabilities. The increase in net interest income in 2002 was
primarily due to a $180.3 million or 15.2% increase in average earning assets
over 2001. The increase in 2002 average earning assets was the result of an
$89.0 million increase in average total loans, an $89.8 million increase in
average investment securities and a $3.2 million increase in other interest
yielding deposits. The cost of all interest bearing liabilities decreased to
3.03% in 2002, compared to 4.21% in 2001.
Average interest-bearing liabilities increased $148.7 million in 2002, which
included a $131.3 million increase in interest-bearing deposits, a $26.1
increase in fed funds purchased and repurchase agreements and an $8.7 million
decrease in short-term borrowings and other indebtedness. Additionally, there
was a $22.6 million increase in average non-interest bearing demand deposits
compared to the prior year. The acquisition of Bank of Greenville in the fourth
quarter of 2002 accounted for only $2.0 million of the average interest-bearing
deposit balance increase in 2002 while the branch acquisitions in the fourth
quarter of 2001 accounted for approximately $94.0 million.
The increase in net interest income in 2001 was primarily due to a $161.1
million or 15.7% increase in average earning assets over 2000. The 2001 increase
in average earning assets was the result of a $137.4 million increase in average
total loans, an $8.5 million increase in average investment securities and a
$15.8 million increase in average interest-bearing deposits. The net yield on
earning assets was 8.13% in 2001, compared to 8.71% in 2000, while the cost of
funds was 4.21% in 2001, compared to 4.43% in 2000.
Average interest-bearing liabilities increased $118.8 million in 2001, which is
largely attributable to increases in deposits of $76.4 million and a $42.3
million increase in short-term borrowings and other indebtedness. Additionally,
there was a $17.6 million increase in average non-interest bearing demand
deposits compared to the prior year.
(GRAPH)
<Table>
<Caption>
Tax Equivalent Net Interest Income ($)
(Amounts in thousands)
98 46,426
99 47,676
00 49,870
01 54,001
02 65,056
</Table>
19
OBJECTIVE
MEASUREMENTS
PROVISION FOR LOAN LOSSES
The provision for loan losses was $4.2 million in 2002, $5.1 million in 2001 and
$4.0 million in 2000. The provision and underlying allowance for loan losses is
quantified through a series of objective measurements, evaluation of economic
indications and estimation of levels of probable losses within the population of
loans that portray inherent weaknesses.
The current year provision of $4.2 million decreased by more than $900,000 from
2001 in response to continuing improvements in asset quality in the current year
and only modest growth in the loan portfolio year over year. The decline in the
provision is consistent with the noted improvements in all categories of
non-performing loans and other real estate owned. The 2001 provision of $5.1
million was elevated in comparison to 2000 in response to usual consumer
charge-offs in 2001 coupled with larger charge-offs of commercial credits as the
Company pursued workout and resolution of two commercial loans in non-accrual
status. See the further discussion under "Balance Sheet Discussion -- Allowance
for Loan Losses."
(PHOTO)
SAMUEL L. ELMORE
Senior Vice President
and Chief Credit Officer
First Community Bank, N. A.
NON-INTEREST INCOME
Non-interest income primarily consists of fiduciary income on trust services,
service charges on deposit accounts and income derived from the origination and
sale of mortgages. Non-interest income totaled $20.1 million in 2002, which is
substantially unchanged from the $20.3 million recognized in 2001 and a $7.60
million or 60.5% increase over the 2000 total of $12.5 million.
The current year reflects a net increase in the level of service charges on
deposit accounts of $1.1 million or an 18.3% increase. The prior year also
reflected increases over 2000 in this category of non-interest revenues of $2.0
million, or 48.9%. The increases in both 2002 and 2001 can be largely attributed
to a program developed for well managed demand deposit accounts,
OverdraftHonor(R), that allows the customer greater flexibility in managing
overdrafts to their accounts. As a result of this program, approximately $5.4
million in deposit account charges were recorded in 2002 in contrast to the $4.6
million recorded in 2001. The aforementioned deposit account program was
introduced in the latter part of 2000 and is the primary reason for the increase
to $7.1 million in service charges on deposit accounts recorded in 2002.
The Company's mortgage banking segment recognized $9.4 million in mortgage
banking income in 2002, which is primarily comprised of origination fees, gains
on loan sales, and hedging costs on mortgage derivative commitments. All loans
are sold servicing released. The level of mortgage banking income declined
slightly from the prior year level of $9.6 million. The decrease, despite
increased loan applications, is attributable to lower margins recognized on loan
sales in the third and fourth quarters of 2002. The reduction in margin is
attributable to lower than anticipated pull-through rates (closings versus
commitments) as mortgage rates fell to record lows and the earnings on a portion
of the loan commitments outstanding were not realized. Higher than anticipated
hedging cost reduced the margin on loan sales by approximately $1.1 million in
2002 due to the increased cost of mortgage derivative
20
commitments used to hedge the price volatility of loan commitments. The
inability of the mortgage company's hedge model to accurately predict loan
fallout percentages experienced in the third and early in the fourth quarter
2002 resulted in higher than predicted fallout. This fallout was due to loan
applicants who "opted out" of the mortgage company's process prior to closing
and, instead, reapplied elsewhere or simply waited on the sidelines for more
declines in mortgage rates, as they continued to decline to historically
unprecedented lows. The hedge model, which predicted the need to invest at a
specified level based upon historic information, failed to predict the sudden
increase in fallout, and in turn, hedge volume was elevated when measured
against the loan commitments which ultimately closed.
UFM originated and sold $791.8 million in loans during 2002 in comparison to the
prior year's volume of $621.6 million. The corresponding sale of loans resulted
in gross gains on sales during 2002 and 2001 of $12.9 million and $7.5 million,
respectively. Elevated hedge costs in 2002 and increased expense associated with
the higher volume of origination resulted in a drop in mortgage banking pre-tax
earnings from $2.0 million in 2001 to $798,000 in 2002. Pretax earnings for 2002
were further reduced by a $400,000 payment to a former mortgage company
executive to acquire a non-compete agreement on his termination of employment.
In the third quarter of 2002, management implemented various procedures to
better manage the mortgage division, loan pipeline and hedging process,
including the establishment of a committee to oversee risk management activities
of UFM. Committee members meet weekly to measure the ongoing effectiveness of
the mortgage delivery and hedging process. In addition, daily monitoring is
performed to determine that the adequate level of hedge is carried commensurate
with the volume of loans hedged and the implied volatility of the market for
mortgage securities.
FIDUCIARY INCOME
Fiduciary income continued at the $1.8 million level again in 2002 as it did in
2001 and 2000. The level of trust and estate revenues remained relatively
consistent in 2002 even though the total market value of the assets managed
declined during 2002. The volume of revenue generated from sources such as
trust, estate and asset management services is highly dependent upon the
corresponding assets under management and can be cyclical in nature. Trust
revenues, as described above, are comprised of fees for asset management and
estate settlement. Expenses associated with the operation of the Trust and
Financial Services Division are included in non-interest expense.
(continued on next page)
(GRAPH)
<Table>
<Caption>
Fiduciary Revenues ($)
(Amounts in thousands)
98 1,682
99 2,092
00 1,804
01 1,815
02 1,773
</Table>
21
TRUST
FIDUCIARY CONTINUED
Other service charges, commissions and fees of approximately $1.4 million also
remained relatively consistent in 2002, 2001 and 2000. These fees are dependent
upon customer behaviors and usage of the various products and services of the
Company and are transaction oriented revenues. Other service charges,
commissions and fees declined by $55,000 in 2002 compared to 2001 and increased
by $74,000 in 2001 versus 2000. Revenues in this category include, among others,
commissions on sales of credit life insurance, sales of checking supplies, ATM
surcharge revenues and safe deposit box rents.
During 2002, the Company experienced a net loss from available for sale
securities of approximately $390,000. The loss resulted from an
other-than-temporary write-down of a municipal issue within the portfolio of
$576,000 and losses from the sale of securities of $313,000. These losses were
partially offset by gains resulting from securities sold and called of $496,000.
During 2001, a net gain of $181,000 was realized as a result of the sale of
available for sale securities with gains of $209,000 and losses of $28,000.
The increase in total non-interest income in 2001 of $7.8 million in comparison
to 2000 was driven by the impact of loan origination income generated by UFM,
adding an additional $4.9 million in revenues in 2001 versus 2000, while the
OverdraftHonor(R) deposit account program generated an additional $2.0 million
in non-interest income in 2001.
NON-INTEREST EXPENSE
Non-interest expense consists of salaries and benefits, occupancy, equipment and
all other operating expense incurred by the Company. Non-interest expense
totaled $42.3 million in 2002, compared with $38.0 million and $31.0 million in
2001 and 2000, respectively. The increase in non-interest expense in 2002 of
$4.3 million is primarily attributable to a $3.4 million increase in salaries
and benefits, $1.0 million of which was due to the acquisition of the four
branches in the fourth quarter of 2001, along with a $700,000 increase in
salaries and commissions in the mortgage operations of UFM (primarily
attributable to increased loan production) and a general increase in salaries as
staffing needs at several locations were satisfied in order to support added
corporate services and continued branch growth. In addition, the combined impact
of increases in other non-interest expense categories of $800,000 is
attributable to increased operating expenses from the branch acquisitions
($380,000), increased operations of UFM ($820,000) and additional increases of
$1.6 million in other non-interest expense categories including costs associated
with occupancy and facilities maintenance, data communications and marketing
campaigns. These expenses were offset by the decline and goodwill amortization
of $2.0 million.
The $7.1 million increase in non-interest expense in 2001 relates largely to the
impact of the operation of UFM of $3.1 million over the prior year because of
substantial increases in loan production and the addition of new branches during
2001. Additional operating cost increases were experienced in 2001 due to the
full year's operations of Citizens Southern Bank, which was acquired in the
fourth quarter of 2000 and the new branch acquisitions in December 2001. Other
increases in 2001 included the cost of consolidating the Company's customer
databases and the undertaking of substantial marketing campaigns.
22
Occupancy expense increased $259,000 or 9.9% between 2001 and 2002, and $133,000
or 5.4% between 2000 and 2001. The current year's increase primarily consists of
$160,000 related to the full year's occupancy costs of the branch facilities
purchased in fourth quarter 2001, and additional costs of $70,000 associated
with UFM. The $133,000 increase between 2000 and 2001 was also largely due to a
full year's operations of branch facilities added through the Citizens Southern
acquisition as well as a general level of increased maintenance costs throughout
the Company.
With the adoption of FASB Statement No. 142, the Company ceased amortization of
certain goodwill beginning January 1, 2002, as required by the Statement and
with the adoption of Statement 147 in October 2002, amortization of remaining
goodwill associated with branch acquisitions was discontinued. Cessation of such
amortization decreased goodwill expense in 2002 by $2.15 million compared to
2001. This resulted in an additional $1.9 million in after tax net income in
comparison to the prior year.
Other operating expense also increased by $2.3 million in 2002 compared to 2001.
These accounts include increases in other operating costs associated with UFM of
$700,000 (tied to increased loan production and the payment of a $400,000
non-compete fee to the retiring president of UFM in connection with his
departure). Other increased expenses, largely due to the acquisition of the new
branches, included an increase in telephone and data communications expense of
$237,000, an increase in ATM service fees of $162,000 and an increase in courier
and travel expense of $214,000. Advertising expense was also up $114,000 in
comparison to last year due to ad campaigns for new products and branch
promotions. A litigation settlement led to reimbursement of legal costs which
reduced legal fees by $150,000 in 2001. The increase in other operating expense
in 2001 compared to 2000 of $2.9 million was largely impacted by the substantial
increase in loan volume and the corresponding cost associated with the
implementation of the wholesale loan origination program at UFM ($1.1 million)
and other increases in advertising, ATM fees, correspondent bank fees and data
processing costs relative to the increased infrastructure, size and needs of the
Company.
(PHOTO)
Financial collaboration with attorneys Meade Snyder
and Jim Snyder of Clifton Forge, Virginia
and R. Mason Cauthorn of FCB.
23
STEWARDSHIP
OVERHEAD AND EFFICIENCY RATIOS
The Company's net overhead ratio (non-interest expense less non-interest income
excluding security gains and non-recurring gains divided by average earning
assets) is a measure of its ability to manage and control costs. As this ratio
decreases, more of the net interest income earned is realized as net income. The
net overhead ratios for 2002, 2001 and 2000 were 1.48%, 1.39% and 1.64%,
respectively. Improvement in the 2001 ratio reflected substantial increases in
non-interest revenues associated with UFM and the Company's restructured product
set. The slight increase in the overhead ratio for 2002 reflects the relative
stability of non-interest income coupled with the increased salaries and
benefits associated with the first full year of operations of various branches,
the increased costs associated with commissions paid at UFM and a one-time
charge of $400,000 representing the cost of a non-compete agreement with UFM's
retiring president.
The Company's efficiency ratio also measures management's ability to control
costs and maximize net revenues. The efficiency ratio is computed by dividing
non-interest expense by the sum of net interest income plus non-interest income
(all non-recurring items and amortization of intangibles are excluded). The
efficiency ratios for 2002, 2001 and 2000 were 51.0%, 47.8% and 45.8%,
respectively. Increases in the current and prior year are reflective of the
higher operating costs incurred by UFM in the development of its wholesale
division which began production in the latter part of 2000 as well as the Bank's
addition of new branch facilities from the branch acquisitions completed in
December 2001, the fourth quarter 2001 branch facility constructed in Athens,
West Virginia, plus the addition of new Emporia and Bluefield, Virginia,
branches in 2002.
(GRAPH)
<Table>
<Caption>
Net Overhead Ratio (%)
98 2.06
99 1.96
00 1.64
01 1.39
02 1.48
</Table>
INTEGRITY
THROUGH SOLID BUSINESS PRACTICES
24
INCOME TAX EXPENSE
Income tax expense totaled $10.0 million in 2002, compared with $8.4 million in
2001 and $7.1 million in 2000. The $1.6 million increase in 2002 is reflective
of the higher level of pre-tax earnings in 2002 as is the $1.3 million increase
between 2000 and 2001. Pre-tax earnings increased $7.2 million between 2001 and
2002, including $6.8 million in tax-exempt earnings generated from state and
municipal bonds within the Company's investment portfolio and lower levels of
state income tax.
The major difference between the statutory tax rate and the effective tax rate
(income tax expense divided by pre-tax income) results from income not taxable
for federal income tax purposes. The primary category of non-taxable income is
that of state and municipal securities and industrial revenue bonds and tax-free
loans. The effective tax rate for 2002 was 28.9% compared with 30.5% for 2001
and 29.3% in 2000. The reduction in the Company's effective tax rate in 2002 was
partially attributable to the cessation of amortization of non-deductible
goodwill.
(PHOTO)
FIRST COMMUNITY
BANCSHARES, INC.
BOARD OF DIRECTORS
Front Row:
B.W. Harvey,
Sam Clark,
William P. Stafford,
W.W. Tinder, Jr.
and I. Norris Kantor
Second Row:
John M. Mendez,
Robert E. Perkinson, Jr.
and Allen T. Hamner
Third Row:
William P. Stafford, II
and A.A. Modena
25
BALANCE SHEET
DISCUSSION
SECURITIES HELD TO MATURITY
Investment securities held to maturity are comprised largely of U.S. Agency
obligations and state and municipal bonds. Obligations of States and Political
Subdivisions represent the largest portion of the held to maturity portfolio and
totaled $40.3 million at December 31, 2002. These are comprised of high-grade
municipal securities generally carrying AAA bond ratings, most of which also
carry credit enhancement insurance by major insurers of investment obligations.
The average final maturity of the investment portfolio decreased from 9.79 years
in 2001 to 9.06 years in 2002 with the tax equivalent yield increasing from
8.59% at year-end 2001 to 8.62% at the close of 2002. The average maturity of
the investment portfolio, based on market assumptions for prepayment, is reduced
to 3.3 years and 4.2 years at December 2002 and 2001, respectively. The average
maturity data differs from final maturity data because of the use of assumptions
as to anticipated prepayments.
SECURITIES AVAILABLE FOR SALE
At December 31, 2002, the Company had $300.9 million in securities available for
sale, compared with $354.0 million at year-end 2001, a decrease of $53.1 million
or 15.0%. During the year, $41.5 million in securities were purchased. However,
these increases were offset by maturities, calls, and mortgage-backed security
principal payments and prepayments of $94.8 million and sales of $15.9 million.
The fair value of securities available for sale exceeded book value at year-end
2002 by $11.3 million. The increase in the fair value of the securities
available for sale is a result of the decline in market rates for comparable
securities. When market rates decrease, as they did in 2002, the prices of the
securities in the Company's portfolio rise. The tax equivalent purchase yield on
securities available for sale was 6.32% in 2002 and 6.52% in 2001.
The average final maturity of the available for sale portfolio was 13.5 years
and 14.8 years at December 31, 2002, and 2001, respectively. The decrease in
average final maturity was the result of the $94.8 million in calls, principal
payments and prepayments that occurred as a result of the declining interest
rate environment. The average maturity of the portfolio, based on market
assumptions for prepayment, was 2.9 years and 5.4 years, respectively, at
December 31, 2002, and 2001, substantially shorter than the average final
maturity.
Securities available for sale are used as part of management's asset/liability
strategy. These securities may be sold in response to changes in interest rates,
changes in prepayment risk, for liquidity needs and other factors. These
securities are carried at market value.
(PHOTO)
26
LOAN PORTFOLIO
Loans Held for Sale: Loans held for sale were $66.4 million at December 31,
2002, compared with $65.5 million at December 31, 2001, an increase of just
under $1.0 million, or 1.4%. Secondary market loan demand remains strong as a
result of the favorable interest rate environment for borrowers. At December 31,
2002, refinance applications represented approximately 85% of the total volume
of loan commitments outstanding at year-end. Loans originated for sale and
funded during the current year were $791.8 million versus $621.6 million in
2001.
(PIE CHART)
<Table>
<Caption>
2002
Real Estate - Commercial 30.80%
Real Estate - Construction 7.80%
Real Estate - Residential 39.30%
Commercial, Financial & Agricultural 8.0%
Loans to Individuals 14.10%
</Table>
(PIE CHART)
<Table>
<Caption>
2001
Real Estate - Commercial 28.70%
Real Estate - Construction 8.60%
Real Estate - Residential 36.80%
Commercial, Financial & Agricultural 10.7%
Loans to Individuals 15.20%
</Table>
Loans Held for Investment: Loans held for investment net of unearned income,
were $927.6 million at December 31, 2002. The increase of $23.1 million
represents 2.6% growth from the $904.5 million level at December 31, 2001. The
fourth quarter acquisition of The Bank of Greenville accounted for $17.4 million
of this growth. The addition of these loans did not materially affect the
distribution of loan product types within the portfolio.
The held for investment loan portfolio is geographically diversified among loan
types and industry segments. Commercial and commercial real estate loans
represent 38.8% of the total portfolio. During 2002, commercial real estate
loans increased by $26.1 million to $285.8 million and comprised 30.8% of total
loans. Commercial loans decreased by $22.5 million to $74.2 million and
represented 8.00% of total loans. The decline in commercial loans was partially
the result of the payoff of several large commercial loans. The combined
commercial and commercial real estate sectors increased by only $3.7 million, or
1.03% in 2002. Real estate construction loans, which amounted to $72.3 million,
and comprised 7.8% of the portfolio, decreased by $5.1 million in 2002. This
category includes both residential and commercial construction with the decrease
attributable to completion of a number of development projects during 2002.
Additionally, consumer loans decreased by $6.6 million, or 4.8%, to $130.5
million at the close of 2002. Consumer loans represented 14.1% of the portfolio
at the close of 2002. Residential real estate loans amounted to $364.1 million,
an increase of $31.4 million, or 9.4% in 2002 and represented 39.3% of the total
portfolio at the end of 2002. This increase is the result of lower residential
mortgage rates during 2002 and the acquisition of Bank of Greenville.
27
STANDARDS
The total loans held for investment to deposit ratio, a measure of the volume of
loans supported by the customer deposit base, declined to 81.4% at December 31,
2002, from the prior year level of 83.9%. The decrease in the loan to deposit
ratio is reflective of the $23.1 million increase in the loan portfolio
(excluding loans held for sale) coupled with a larger and offsetting increase in
deposits of $61.5 million. As a result of the Greenville acquisition completed
in the fourth quarter of 2002, the Company also acquired $28.0 million in
deposits. The additional deposits and loans acquired in the acquisition
accounted for approximately 45.6% and 75.3%, respectively, of the total annual
increase in deposits and loans held for investment, respectively.
Slower growth in the loan portfolio in 2002 reflects the highly competitive
environment for both commercial and residential lending as customers continually
seek refinance opportunities. Slower economic conditions in some of the
Company's lending markets have also resulted in fewer requests for new credit
and greater competition from competing banks and non-bank lenders.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level sufficient to absorb
probable loan losses inherent in the loan portfolio. The allowance is increased
by charges to earnings in the form of provisions for loan losses and recoveries
of prior loan charge-offs, and decreased by loans charged off. The provision for
loan losses is calculated to bring the reserve to a level, which, according to a
systematic process of measurement, is reflective of the required amount needed
to absorb probable losses.
Management performs monthly assessments to determine the appropriate level of
allowance. Differences between actual loan loss experience and estimates are
reflected through adjustments that are made by either increasing or decreasing
the loss provision based upon current measurement criteria.
Commercial, consumer and mortgage loan portfolios are evaluated separately for
purposes of determining the allowance. The specific components of the allowance
include allocations to individual commercial credits and allocations to the
remaining non-homogeneous and homogeneous pools of loans. Management's
allocations are based on judgment of qualitative and quantitative factors about
both the macro and micro economic conditions reflected within the portfolio of
loans and the economy as a whole. Factors considered in this evaluation include,
but are not necessarily limited to, probable losses from loan and other credit
arrangements, general economic conditions, changes in credit concentrations or
pledged collateral, historical loan loss experience, and trends in portfolio
volume, maturity, composition, delinquencies, and non-accruals. While management
has attributed the allowance for loan losses to various portfolio segments, the
allowance is available for the entire portfolio. The allowance for loan losses
represents 455% of non-performing loans at year-end 2002 versus 280% and 186% at
December 31, 2001, and 2000, respectively. When other real estate is combined
with non-performing loans, the allowance equals 239% of non-performing assets at
the end of 2002 versus 174% and 137% at December 31, 2001, and 2000,
respectively.
Net loan charge-offs were $4.1 million in 2002, compared with $4.0 million in
2001 and $4.6 million in 2000, respectively. The level of charge-offs has
remained relatively constant over the three-year period, although two commercial
loan relationships resulted in spikes in charge-offs within the commercial loan
category. In 2000, the Company charged off $373,000 on a convenience store and
gasoline retailer along with a $586,000 charge-off on a golf course residential
development. These two relationships represented 20% of net charge-offs in 2000.
In 2001, the Company charged off an additional $1.2 million (30% of total
charge-offs) on the convenience store loans as it intensified its attempts to
market the underlying collateral. Excluding these larger commercial charge-offs,
a noticeable decrease in consumer charge-offs was realized in 2001 with a
reversal in 2002 as consumer charge-offs rose through the third quarter and then
moderated late in the year.
28
NON-PERFORMING ASSETS
Non-performing assets include loans on which interest accruals have ceased,
loans contractually past due 90 days or more and still accruing interest, and
other real estate owned (OREO) pursuant to foreclosure proceedings. The levels
of non-performing assets for the last five years are presented in the table on
page 30.
Total non-performing assets were $6.0 million at December 31, 2002, compared to
$8.0 million at December 31, 2001. Non-performing assets decreased $2.0 million
between 2001 and 2002. Every component of non-performing assets improved,led by
a $1.3 million or 93.3% decline in loans 90 days or more past due, which
are still accruing. In addition, other real estate owned decreased $174,000, or
5.7% and non-accrual loans decreased $558,000, or 15.4% compared to 2001. The
decrease in non-accrual loans resulted from the resolution of a number of loan
relationships through payment, repossession, or foreclosure and write-down of
the loan balances to reflect the net realizable value of the assets. The
decrease in loans 90 days or more past due is a result of movement of these
credits to non-accrual status and a more aggressive approach in collecting loans
90 days or more past due.
DEDICATED TO SERVICE
(PHOTO)
Helping others to help the community.
(Pictured from left to right) Sam Elmore,
Jim Shannon, President of the Beaver Volunteer
Fire Department, Hazel Burroughs, J.P. Morgan,
Brenda Troitino, Larry Raines and Susie Webb
29
EVALUATION
NON-PERFORMING ASSETS
<Table>
<Caption>
DECEMBER 31,
2002 2001 2000 1999 1998
(Amounts in Thousands)
Non-accrual Loans $ 3,075 3,633 5,397 7,889 7,763
Loans 90 Days or more Past Due 91 1,351 1,208 1,259 377
Other Real Estate Owned 2,855 3,029 2,406 1,950 3,547
$ 6,021 8,013 9,011 11,098 11,687
Nonperforming loans as a percentage of total loans % 0.3 0.6 0.8 1.3 1.3
Nonperforming assets as a percentage of total loans
and other real estate owned % 0.6 0.9 1.1 1.6 1.9
Allowance for loan losses as a percentage of nonperforming loans % 455.1 279.9 186.3 130.1 140.1
Allowance for loan losses as a percentage of nonperforming assets % 239.3 174.1 136.5 107.2 97.6
</Table>
Certain loans included in the non-accrual and 90 day past due categories have
been written down to the estimated realizable value or have been assigned
specific reserves within the allowance for loan losses based upon management's
estimate of loss upon ultimate resolution.
During 2002, 2001 and 2000, $2,168,000, $2,116,000 and $2,530,000 of assets were
acquired through foreclosure and transferred to other real estate owned.
In addition to non-performing loans reflected in the foregoing table, the
Company has identified certain performing loans as impaired based upon
management's evaluation of credit strength, projected ability to repay in
accordance with the contractual terms of the loans and varying degrees of
dependence on the sale of related collateral for liquidation of the loans. These
loans were current under loan terms and were classified as performing at
year-end 2002.
The following table presents the Company's investment in loans considered to be
impaired and related information on those impaired loans:
IMPAIRED LOANS
<Table>
<Caption>
2002 2001
(Amount in Thousands)
Recorded investment in loans considered to be impaired $ 8,980 5,129
Loans considered to be impaired that were on a non-accrual basis $ 1,238 1,229
Allowance for loan losses related to loans considered to be impaired 3,907 1,310
Average recorded investment in impaired loans 9,176 5,674
Total interest income recognized on impaired loans 512 255
</Table>
In the fourth quarter of 2002, the Company added two loan relationships to this
list of impaired loans. The first is a $5.0 million loan secured by a hotel
property which has suffered declines in levels of occupancy. The allowance for
loan losses related to this loan was $1.7 million at December 31, 2002. The
second relationship is a group of loans totaling $1.16 million related to a
dairy farm whose performance declined in conjunction with a drop in milk prices.
The allowance for loan losses related to this group of loans at year-end was
$1.06 million. This group of loans subsequently became uncollectable and
resulted in a $1.06 million charge off during the first quarter of 2003. As of
the date of this report, management continues its efforts to determine the level
of collateral available and priority of liens which will determine the
possibility of any recovery. Due to questions raised regarding the priority of
lien status and the rights to certain escrowed proceeds, no value was assigned
to certain collateral and escrowed funds in arriving at the related allowance
and charge off.
The Company has considered all impaired loans in the evaluation of the adequacy
of the allowance for loan losses at December 31, 2002.
30
DEPOSITS
Total deposits at December 31, 2002, increased $61.5 million or 5.7% when
compared to December 31, 2001. Approximately $28 million of the increase related
to deposits acquired through Bank of Greenville acquisition in November 2002.
Without considering the acquisition, deposits increased for the year by $33.5
million. The Company utilized short-term advances from the FHLB to supplement
the funding needs of the Company throughout 2001 and 2002. In 2002, the average
rate paid on interest bearing liabilities was 3.03%, down from the 4.21% in
2001.
Average deposits increased to $1.1 billion for 2002 versus $939.8 million in
2001, an increase of 16.4%, reflecting the effectiveness of new product
offerings and marketing campaigns introduced during the year as well as a full
year's impact of the deposits obtained in the December 2001 branch acquisitions.
Average savings deposits increased by $38.6 million while time deposits
increased by $48.6 million. Average interest-bearing demand and non-interest
bearing demand deposits increased by $44.1 million and $22.6 million,
respectively.
SHORT-TERM BORROWINGS
The Company's short-term borrowings consist primarily of overnight Federal Funds
purchased from the FHLB and securities sold under agreements to repurchase. This
category of funding is a source of moderately priced short-term funds.
Short-term borrowings increased on average approximately $17.5 million in
comparison to the prior year. The increase in average short-term borrowings in
2002, along with the increase in average deposits of $153.9 million, was
accompanied by an offsetting increase in total loans as these funds were used to
finance the average loans held for investment portfolio growth ($73.4 million)
and the average increase in available for sale securities ($91.0 million). The
price sensitivity of funding cost is managed by the Company's "Product Group",
which monitors product and pricing initiatives including, among other things,
the management of the overall cost of funds to assist in maintaining an
acceptable net interest margin, and to act as a resource in developing new
products and establishing pricing guidelines.
(PHOTO)
31
CAPITALIZATION
AND LEVERAGE
OTHER INDEBTEDNESS
FHLB borrowings and other indebtedness, which includes long-term advances from
the FHLB and structured term borrowings from the FHLB, decreased by $21.0
million in 2002 due primarily to a $25.0 million maturity in June 2002. Fixed
rate FHLB term advances and applicable interest rates were $8.0 million (5.95%)
and $2.0 million (6.27%), maturing in September 2003 and September 2008,
respectively. Additional borrowings of $100.0 million are comprised of
structured term convertible advances from the FHLB with final maturities in
2010. These convertible advances are callable by the FHLB based upon predefined
factors in quarterly increments after a lockout period that may substantially
shorten the lives of these instruments. The callability of these instruments is
controlled by and at the option of the FHLB. Additionally, UFM has entered into
a loan purchase agreement with Countrywide Credit ("Countrywide") whereby
Countrywide will pre-fund certain loans anticipated to be purchased by
Countrywide Home Loans, Inc. This borrowing arrangement by UFM with Countrywide
resulted in additional borrowings at December 31, 2002, of $14.3 million at a
floating rate of one month LIBOR plus 200 basis points, or approximately 3.42%
at December 31, 2002.
STOCKHOLDERS' EQUITY
Risk-based capital ratios are a measure of the Company's capital adequacy. At
December 31, 2002, the Company's Tier I capital ratio was 12.06% compared with
10.82% in 2001. Federal regulatory agencies use risk-based capital ratios and
the leverage ratio to measure the capital adequacy of banking institutions.
Risk-based capital guidelines, risk weight balance sheet assets, and off-balance
sheet commitments are used in determining capital adequacy. The Company's total
risk-based capital-to-asset ratio was 13.33% at the close of 2002 compared with
12.10% in 2001. Both of these ratios are well above the current minimum level of
8% prescribed for bank holding companies. The leverage ratio is the measurement
of total tangible equity to total assets. The Company's leverage ratio at
December 31, 2002, was 8.10% versus 7.93% at December 31, 2001, both of which
are well above the minimum levels prescribed by the Federal Reserve. (See Note
13 of the Notes to Consolidated Financial Statements.)
(GRAPH)
<Table>
<Caption>
Stockholders' Equity ($)
(Amounts in thousands)
98 101,719
99 103,488
00 120,682
01 133,041
02 152,462
</Table>
32
LIQUIDITY
Liquidity represents the Company's ability to respond to demands for funds and
is primarily derived from maturing investment securities, overnight investments,
periodic repayment of loan principal, and the Company's ability to generate new
deposits. The Company also has the ability to attract short-term sources of
funds and draw on credit lines that have been established at financial
institutions to meet cash needs.
Total liquidity of $619.2 million at December 31, 2002, is comprised of the
following: cash on hand and deposits with other financial institutions of $124.6
million; securities available for sale of $300.9 million; securities held to
maturity due within one year of $138,000; and Federal Home Loan Bank credit
availability of $193.6 million.
Liquidity management is both a daily and long-term function of business
management. Excess liquidity is generally used to pay down short-term
borrowings. On a longer-term basis, the Company maintains a strategy of
investing in various securities, mortgage-backed obligations and loans. The
Company uses sources of funds primarily to meet ongoing commitments, to pay
maturing savings certificates and savings withdrawals, fund loan commitments and
maintain a portfolio of securities. At December 31, 2002, approved loan
commitments outstanding amounted to $104.9 million. Certificates of deposit
scheduled to mature in one year or less totaled $392.8 million and FHLB
borrowings that are scheduled to mature within the same period amounted to $8.0
million. Management believes that the Company has adequate resources to fund
outstanding commitments and could either adjust rates on certificates of deposit
in order to retain or attract deposits in changing interest rate environments or
replace such deposits with advances from the FHLB or other funds providers if it
proved to be cost effective to do so.
(PHOTO)
The strength of customer service.
Ricky Hamm of Sparta, North Carolina
with Tom Gentry of FCB.
COMMUNITY
LENDING A HAND THROUGHOUT THE COMMUNITY
33
RISK ASSESSMENT
INTEREST RATE SENSITIVITY, INTEREST RATE RISK AND ASSET/LIABILITY MANAGEMENT
The Bank's profitability is dependent to a large extent upon its net interest
income (NII), which is the difference between its interest income on
interest-earning assets, such as loans and securities, and its interest expense
on interest-bearing liabilities, such as deposits and borrowings. The Bank, like
other financial institutions, is subject to interest rate risk to the degree
that its interest-earning assets reprice differently than its interest-bearing
liabilities. The Bank manages its mix of assets and liabilities with the goals
of limiting its exposure to interest rate risk, ensuring adequate liquidity, and
coordinating its sources and uses of funds while maintaining an acceptable level
of NII given the current interest rate environment.
The Company's primary component of operational revenue, NII, is subject to
variation as a result of changes in interest rate environments in conjunction
with unbalanced repricing opportunities on earning assets and interest-bearing
liabilities. Interest rate risk has four primary components including repricing
risk, basis risk, yield curve risk and option risk. Repricing risk occurs when
earning assets and paying liabilities reprice at differing times as interest
rates change. Basis risk occurs when the underlying rates on the assets and
liabilities the institution holds change at different levels or in varying
degrees. Yield curve risk is the risk of adverse consequences as a result of
unequal changes in the spread between two or more rates for different maturities
for the same instrument. Lastly, option risk is due to "embedded options" often
called put or call options given or sold to holders of financial instruments.
In order to mitigate the effect of changes in the general level of interest
rates, the Company manages repricing opportunities and thus, its interest rate
sensitivity. The Bank seeks to control its interest rate risk (IRR) exposure to
insulate net interest income and net earnings from fluctuations in the general
level of interest rates. To measure its exposure to IRR, quarterly simulations
of NII are performed using financial models that project NII through a range of
possible interest rate environments including rising, declining, most likely and
flat rate scenarios. The results of these simulations indicate the existence and
severity of IRR in each of those rate environments based upon the current
balance sheet position, assumptions as to changes in the volume and mix of
interest-earning assets and interest-paying liabilities and management's
estimate of yields to be attained in those future rate environments and rates
that will be paid on various deposit instruments and borrowings. Specific
strategies for management of IRR have included shortening the amortized maturity
of new fixed-rate loans, increasing the volume of adjustable rate loans to
reduce the average maturity of the Bank's interest-earning assets and monitoring
the term structure of liabilities to maintain a balanced mix of maturity and
repricing structures to mitigate the potential exposure. The simulation model
used by the Company captures all earning assets, interest bearing liabilities
and all off-balance sheet financial instruments and combines the various factors
affecting rate sensitivity into an earnings outlook. Based upon the latest
simulation, the Company believes that it is biased toward an asset sensitive
position. Absent adequate management, asset sensitive positions can negatively
impact net interest income in a falling rate environment or, alternatively,
positively impact net interest income in a rising rate environment.
The Company has established policy limits for tolerance of interest rate risk
that allow for no more than a 10% reduction in projected NII based on quarterly
income simulations. The most recent simulation indicates that current exposure
to interest rate risk is within the Company's defined policy limits.
34
The following table summarizes the impact on NII and the Market Value of Equity
(MVE) as of December 31, 2002, and 2001, respectively, of immediate and
sustained rate shocks in the interest rate environment of plus and minus 100 and
200 basis points from the flat rate simulation. The results of the rate shock
analysis depicted below differ from the results in quarterly simulations, in
that all changes are assumed to take effect immediately; whereas, in the
quarterly income simulations, changes in interest rates are assumed to take
place over a 24-month horizon simulating a more likely scenario for a changing
rate environment. This table, which illustrates the prospective effects of
hypothetical interest rate changes, is based upon numerous assumptions including
relative and estimated levels of key interest rates over a twelve-month time
period. This type of modeling technique, although useful, does not take into
account all strategies that management might undertake in response to a sudden
and sustained rate shock as depicted. Also, as market conditions vary from those
assumed in the sensitivity analysis, actual results will also differ due to:
prepayment/refinancing levels likely deviating from those assumed, the varying
impact of interest rate change caps or floors on adjustable rate assets, the
potential effect of changing debt service levels on customers with adjustable
rate loans, depositor early withdrawals and product preference changes, and
other internal/external variables.
<Table>
<Caption>
(Amount in Thousands)
2002
- -----------------------------------------------------------------------------------
Increase (Decrease) in
Interest Rates Net Interest % Market Value %
(Basis Points) Income Change of Equity Change
------------ ------ ------------ ------
200 $ 4,466 7.1 $ (8,709) (5.5)
100 2,387 3.8 (3,882) (2.5)
(100) (2,018) (3.2) 4,885 3.1
(200) (6,756) (10.8) 12,468 7.9
</Table>
<Table>
<Caption>
(Amount in Thousands)
2001
- -----------------------------------------------------------------------------------
Increase (Decrease) in
Interest Rates Net Interest % Market Value %
(Basis Points) Income Change of Equity Change
------------ ------ ------------ ------
200 $ 1,950 3.5 $ (4,674) (3.3)
100 1,059 1.9 (1,338) (1.0)
(100) (907) (1.6) 637 0.5
(200) (3,692) (6.6) 1,396 1.0
</Table>
35
When comparing the impact of the rate shock analysis between 2002 and 2001, the
2002 changes in NII reflect the impact of the change in the balance sheet
composition of assets and liabilities and as the profile moved toward greater
asset sensitivity. The change is the result of the heightened asset prepayment
levels experienced in light of the declining interest rate environment beginning
in 2001 and continuing with a 50 basis point decline in the targeted fed funds
rate in November 2002. Much of the change in balance sheet composition is
attributed to the declining interest rate environment and the level of asset
prepayments.
The asset sensitivity is reflected in the increased liquidity of $91.2 million
(Federal Funds sold and interest-bearing balances held with other banks). The
Company began to experience a shift in the balance sheet toward asset
sensitivity in 2000 which was attributed to the reduced lives of certain assets
and the control measures taken in prior years, and continuing throughout 2002,
to reduce deposit cost and identify opportunities for product and net interest
income enhancement. The following tables present contractual cash obligations
and commercial commitments as of December 31, 2002.
<Table>
<Caption>
PAYMENT DUE PERIOD
--------------------------------------------------------
LESS THAN TWO TO FOUR TO AFTER
TOTAL ONE YEAR THREE YEARS FIVE YEARS FIVE YEARS
----------- ----------- ----------- ----------- -----------
(Amount in Thousands)
Contractual cash obligations:
Certificates of deposit $ 593,088 $ 392,821 $ 145,472 $ 15,102 $ 39,693
FHLB advances 110,000 8,000 -- -- 102,000
Note Payable 14,357 14,322 35 -- --
----------- ----------- ----------- ----------- -----------
Total contractual cash
obligations $ 717,445 $ 415,143 $ 145,507 $ 15,102 $ 141,693
=========== =========== =========== =========== ===========
</Table>
<Table>
<Caption>
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
--------------------------------------------------------
LESS THAN TWO TO FOUR TO AFTER
TOTAL ONE YEAR THREE YEARS FIVE YEARS FIVE YEARS
----------- ----------- ----------- ----------- -----------
(Amount in Thousands)
Commitments:
Commercial lines of credit $ 39,645 $ 34,600 $ 3,508 $ 767 $ 770
Consumer lines of credit 24,547 10,435 926 1,274 11,912
Undispersed portion of loans in process 8,835 8,835 -- -- --
Letters of credit 6,023 4,277 1,652 20 74
----------- ----------- ----------- ----------- -----------
Total commitments $ 79,050 $ 58,147 $ 6,086 $ 2,061 $ 12,756
=========== =========== =========== =========== ===========
</Table>
Lines of credit with no stated maturity date are included in commitments for
less than one year.
36
TRUST
TRUST AND INVESTMENT MANAGEMENT SERVICES
As part of its banking services, the Company offers trust management and estate
administration services through its Trust and Financial Services Division (Trust
Division). The Trust Division reported market value of assets under management
of $433 million and $486 million at December 31, 2002, and 2001, respectively.
The Trust Division manages intervivos trusts and trusts under will, develops and
administers employee benefit plans and individual retirement plans and manages
and settles estates. Fiduciary fees for these services are charged on a schedule
related to the size, nature and complexity of the account.
The Trust Division employs 18 professionals and support staff with a wide
variety of estate and financial planning, investing and plan administration
skills. The Trust Division is located within the Company's banking offices in
Bluefield, West Virginia. Services and trust development activities to other
branch locations and primary markets are offered through the Bluefield-based
division.
RECENT LEGISLATION
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002
("Act"). The stated goals of the Act are to increase corporate responsibility,
to provide for enhanced penalties for accounting and auditing improprieties at
publicly traded companies, and to protect investors by improving the accuracy
and reliability of corporate disclosures pursuant to the securities laws. The
proposed changes are intended to allow stockholders to more easily and
efficiently monitor the performance of companies and directors.
The Act generally applies to all companies, both U.S. and non-U.S., that file or
are required to file periodic reports with the Securities and Exchange
Commission ("SEC") under the Securities Exchange Act of 1934 ("Exchange Act").
Given the extensive SEC role in implementing rules relating to many of the Act's
new requirements, the final scope of these requirements remains to be
determined.
The Act includes very specific additional disclosure requirements and new
corporate governance rules, requires the SEC and securities exchanges to adopt
extensive additional disclosure, corporate governance and other related rules
and mandates further studies of certain issues by the SEC and the Comptroller
General. The Act represents significant federal involvement in matters
traditionally left to state regulatory systems, such as the regulation of the
accounting profession, and to state corporate law, such as the relationship
between a board of directors and management and between a board of directors and
its committees.
This Act addresses, among other matters: audit committees; certification of
financial statements by the chief executive officer and the chief financial
officer; the forfeiture of bonuses and profits made by directors and senior
officers in the twelve-month period covered by restated financial statements; a
prohibition on insider trading during pension plan black-out periods; disclosure
of off-balance sheet transactions; a prohibition on personal loans to directors
and officers (excluding Federally insured financial institutions); expedited
filing requirements for stock transaction reports by officers and directors;
disclosure of a code of ethics and filing a Form 8-K for a change or waiver of
such code; "real time" filing of periodic reports; the formation of a public
accounting oversight board; auditor independence; and various increased criminal
penalties for violations of securities laws.
37
GOVERNANCE
RECENT LEGISLATION CONTINUED
At the September 2002 Board of Directors' meeting, within one month of the
passage of the Act, the Board of Directors of First Community approved a series
of actions to strengthen and improve its already strong corporate governance
practices. Included in those actions was the establishment of a new Financial
Reporting and Disclosure Committee (the "FRDC"), which was appointed to evaluate
and monitor the continued effectiveness of the design and operation of
disclosure controls in order to meet the objectives of adequate disclosure as it
impacts the full and fair presentation of the Company's financial statements.
The FRDC consists of key members of senior management as official and ex officio
members. SEC counsel participates in the committee on an advisory basis to
provide technical and legal guidance on matters of technical preparation, form
of periodic reporting and general advice on compliance with securities laws.
Independent accountants also attend FRDC meetings to provide technical
assistance and advice on matters of financial reporting and to assist in
interpretation and application of financial accounting standards. The committee
also includes the Chairman of the Audit Committee of the Board of Directors to
ensure independent thought and board perspective. The FRDC meets a minimum of
quarterly, but typically more frequently and its process culminates in the
pre-Audit Committee review of the interim (10-Q) and annual financial statements
(10-K).
The FRDC complements the Company's longstanding committee structure and process,
which has consistently proven an invaluable tool for communication of disclosure
information. Every key element of operation is subject to oversight by a
committee to ensure proper administration, risk management and an upstreaming of
critical management information and disclosures to finance and control,
executive management and the board of directors. The FRDC agenda is designed to
capture information from all segments of the business though reports from senior
managers and committee chairmen. In addition to the FRDC, the Company also
implemented the Business Trends and Current Events Committee (BTCE), which is
designed to draw out items of risk, exposure and possible disclosure which might
exist and be known at lower levels within the Company, but not necessarily be
known to executive management and those who prepare financial statements or make
significant decisions regarding disclosures within the financial statements. The
BTCE meets monthly and its membership covers all areas of the Company from both
an operational and geographic perspective. Although many of the items for
discussion at the FRDC and BTCE were already considered in the preparation of
financial statements and appropriately disclosed, these new processes are
considered valuable in further discussion of these items and should provide a
valuable forum for future evaluation of disclosure items and selection of
accounting policies.
It is believed that the addition of these new processes has brought with it a
broader and more in depth analysis to the Company's already effective and
detailed disclosure process. These more recent additions to the process are
expected to enhance the Company's overall disclosure control environment.
(PHOTO)
38
ASSURANCE
(PHOTO)
AUDIT COMMITTEE:
Allen T. Hamner, William P. Stafford,
Robert E. Perkinson, Jr. and B.W. Harvey.
(PHOTO)
FINANCIAL REPORTING AND
DISCLOSURE COMMITTEE:
Kenneth P. Mulkey,
E. Stephen Lilly,
Robert L. Schumacher,
Robert L. Buzzo,
John M. Mendez,
Timothy D. Velie,
and Allen T. Hamner.
39
CONSOLIDATED FINANCIAL STATEMENTS
<Table>
Consolidated Balance Sheets 41
Consolidated Statements of Income 42
Consolidated Statements of Cash Flow 43
Consolidated Statements of Changes in Stockholders' Equity 44
Notes to Consolidated Financial Statements 46
Report of Independent Auditors 74
Report of Management's Responsibilities 75
</Table>
40
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands, Except Share Data)
<Table>
<Caption>
DECEMBER 31,
2002 2001
------------ ------------
ASSETS
Cash and due from banks $ 33,364 $ 47,566
Interest-bearing deposits with banks 88,064 249
Federal funds sold 3,157 --
------------ ------------
Total cash and cash equivalents 124,585 47,815
Securities available for sale (amortized cost of $289,616, 2002; $352,759, 2001) 300,885 354,007
Securities held to maturity (fair value, $43,342, 2002; $43,393, 2001) 41,014 41,884
Loans held for sale 66,364 65,532
Loans held for investment, net of unearned income 927,621 904,496
Less allowance for loan losses 14,410 13,952
------------ ------------
Net loans held for investment 913,211 890,544
Premises and equipment 25,078 21,713
Other real estate owned 2,855 3,029
Interest receivable 7,897 8,765
Other assets 15,391 18,468
Goodwill 25,758 25,347
Other intangible assets 1,325 1,131
------------ ------------
TOTAL ASSETS $ 1,524,363 $ 1,478,235
============ ============
LIABILITIES
Deposits:
Non-interest-bearing $ 165,557 $ 161,346
Interest-bearing 974,170 916,914
------------ ------------
TOTAL DEPOSITS 1,139,727 1,078,260
Interest, taxes and other liabilities 15,940 15,852
Federal funds purchased -- 26,500
Securities sold under agreements to repurchase 91,877 79,262
FHLB borrowings and other indebtedness 124,357 145,320
------------ ------------
TOTAL LIABILITIES $ 1,371,901 $ 1,345,194
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value; 15,000,000 shares authorized in 2002
and 2001; 9,956,714 shares issued in 2002 and 9,955,425 in 2001;
9,888,482 and 9,936,442 shares outstanding in 2002 and 2001 9,957 9,955
Additional paid-in capital 58,642 60,189
Retained earnings 79,084 62,566
Treasury stock, at cost (1,982) (424)
Accumulated other comprehensive income 6,761 755
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 152,462 133,041
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,524,363 $ 1,478,235
============ ============
</Table>
See Notes to Consolidated Financial Statements
41
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in Thousands, Except Share and Per Share Data)
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
2002 2001 2000
------------ ------------ ------------
INTEREST INCOME
Interest and fees on loans held for investment $ 72,415 $ 72,582 $ 68,132
Interest on loans held for sale 3,584 2,956 281
Interest on securities-taxable 13,001 10,259 11,543
Interest on securities-nontaxable 6,819 6,190 5,575
Interest on federal funds sold and deposits in banks 385 842 427
------------ ------------ ------------
TOTAL INTEREST INCOME 96,204 92,829 85,958
------------ ------------ ------------
INTEREST EXPENSE
Interest on deposits 25,366 31,884 30,718
Interest on short-term borrowings 9,035 9,913 8,045
Interest on other indebtedness 607 612 616
------------ ------------ ------------
TOTAL INTEREST EXPENSE 35,008 42,409 39,379
------------ ------------ ------------
NET INTEREST INCOME 61,196 50,420 46,579
------------ ------------ ------------
Provision for loan losses 4,208 5,134 3,986
------------ ------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 56,988 45,286 42,593
------------ ------------ ------------
NON-INTEREST INCOME
Fiduciary income 1,773 1,815 1,804
Service charges on deposit accounts 7,056 5,966 4,007
Other service charges, commissions and fees 1,380 1,435 1,361
Mortgage banking income 9,435 9,582 4,651
Net securities (losses) gains (391) 181 1
Other operating income 796 1,296 668
------------ ------------ ------------
TOTAL NON-INTEREST INCOME 20,049 20,275 12,492
------------ ------------ ------------
NON-INTEREST EXPENSE
Salaries and employee benefits 23,267 19,830 16,046
Occupancy expense of bank premises 2,874 2,615 2,482
Furniture and equipment expense 2,082 1,814 1,698
Goodwill and core deposit amortization 245 2,285 2,154
Other operating expense 13,801 11,481 8,588
------------ ------------ ------------
TOTAL NON-INTEREST EXPENSE 42,269 38,025 30,968
------------ ------------ ------------
Income before income taxes 34,768 27,536 24,117
Income tax expense 10,049 8,402 7,054
------------ ------------ ------------
NET INCOME $ 24,719 $ 19,134 $ 17,063
============ ============ ============
WEIGHTED AVERAGE BASIC SHARES OUTSTANDING 9,924,636 9,944,310 9,607,217
------------ ------------ ------------
WEIGHTED AVERAGE DILUTED SHARES OUTSTANDING 9,973,129 9,980,919 9,607,217
============ ============ ============
BASIC EARNINGS PER COMMON SHARE $ 2.49 $ 1.92 $ 1.78
------------ ------------ ------------
DILUTED EARNINGS PER COMMON SHARE $ 2.48 $ 1.92 $ 1.78
============ ============ ============
</Table>
See Notes to Consolidated Financial Statements
42
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CASH FLOW
(Amounts in Thousands)
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
2002 2001 2000
------------ ------------ ------------
OPERATING ACTIVITIES
Cash flows from operating activities:
Net income $ 24,719 $ 19,134 $ 17,063
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Provision for loan losses 4,208 5,134 3,986
Depreciation of premises and equipment 1,630 1,490 1,396
Amortization of intangibles 32 2,119 2,156
Net investment amortization and accretion 1,467 485 233
Net gain on the sale of assets (11,669) (7,659) (2,517)
Mortgage loans originated for sale (737,101) (563,018) (106,169)
Proceeds from sale of mortgage loans 749,039 516,812 100,148
Decrease (increase) in interest receivable 1,082 874 (861)
(Increase) decrease in other assets (1,810) (175) 8,454
Increase in other liabilities 410 2,728 66
Other, net 163 (17) (296)
------------ ------------ ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 32,170 (22,093) 23,659
------------ ------------ ------------
INVESTING ACTIVITIES
Cash flows from investing activities:
Proceeds from sales of securities available for sale 15,871 18,907 2,163
Proceeds from maturities and calls of securities available for sale 94,815 102,458 17,849
Proceeds from maturities and calls of held to maturity securities 1,754 1,602 3,016
Purchase of securities available for sale (41,527) (232,056) (4,591)
Net increase in loans made to customers (9,300) (67,115) (66,918)
Purchase of bank-owned life insurance -- -- (4,100)
Cash provided by acquisitions, net 1,982 77,021 3,065
Purchase of premises and equipment (5,545) (3,462) (1,019)
Proceeds from sale of equipment -- 127 466
------------ ------------ ------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 58,050 (102,518) (50,069)
------------ ------------ ------------
FINANCING ACTIVITIES
Cash flows from financing activities:
Net increase (decrease) in demand and savings deposits 52,874 36,144 (7,755)
Net (decrease) increase in time deposits (19,059) 28,625 22,731
Net (decrease) increase in short-term debt (34,734) 66,902 35,126
Repayment of long-term debt (114) (14) (39)
Acquisition of treasury stock (2,491) (599) (2,869)
Dividends paid (9,926) (8,875) (8,338)
------------ ------------ ------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (13,450) 122,183 38,856
------------ ------------ ------------
CASH AND CASH EQUIVALENTS
Net increase (decrease) in cash and cash equivalents 76,770 (2,428) 12,446
Cash and cash equivalents at beginning of year 47,815 50,243 37,797
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 124,585 $ 47,815 $ 50,243
============ ============ ============
</Table>
See Notes to Consolidated Financial Statements
43
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Amounts in Thousands, Except Share and Per Share Information)
<Table>
<Caption>
ACCUMULATED
OTHER
COMPRE-
ADDITIONAL UNALLOCATED HENSIVE
COMMON PAID-IN RETAINED TREASURY ESOP INCOME
STOCK CAPITAL EARNINGS STOCK SHARES (LOSS) TOTAL
--------- ---------- --------- --------- ----------- ----------- ---------
BALANCE DECEMBER 31, 1999 $ 8,992 $ 34,264 $ 69,372 $ (2,945) $ (722) $ (5,473) $ 103,488
Comprehensive income:
Net income -- -- 17,063 -- -- -- 17,063
Other comprehensive income
Unrealized gains on securities
available for sale, net of tax -- -- -- -- -- 3,935 3,935
--------- --------- --------- --------- --------- --------- ---------
Comprehensive income -- -- 17,063 -- -- 3,935 20,998
Common dividends declared
($.86 per share) -- -- (8,338) -- -- -- (8,338)
Retirement of treasury shares (374) (5,238) -- 5,612 -- -- --
Issuance of common stock 434 6,343 -- -- -- -- 6,777
Purchase 145,682 treasury shares at
$19.70 per share -- -- -- (2,869) -- -- (2,869)
Allocation of ESOP shares -- (96) -- -- 722 -- 626
--------- --------- --------- --------- --------- --------- ---------
BALANCE DECEMBER 31, 2000 9,052 35,273 78,097 (202) -- (1,538) 120,682
--------- --------- --------- --------- --------- --------- ---------
Comprehensive income:
Net income -- -- 19,134 -- -- -- 19,134
Other comprehensive income
Unrealized gains on securities
available for sale, net of tax -- -- -- -- -- 2,402 2,402
Less reclassification adjustment
for gains realized in net income,
net of tax -- -- -- -- -- (109) (109)
--------- --------- --------- --------- --------- --------- ---------
Comprehensive income -- -- 19,134 -- -- 2,293 21,427
Common dividends declared
($.89 per share) -- -- (8,875) -- -- -- (8,875)
Purchase 27,036 treasury shares at
$22.17 per share -- -- -- (599) -- -- (599)
Issuance of ESOP shares -- 29 -- 377 -- -- 406
Effect of 10% stock dividend 903 24,887 (25,790) -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
BALANCE DECEMBER 31, 2001 9,955 60,189 62,566 (424) -- 755 133,041
--------- --------- --------- --------- --------- --------- ---------
Comprehensive income:
Net income -- -- 24,719 -- -- -- 24,719
Other comprehensive income
Unrealized gains on securities
available for sale, net of tax -- -- -- -- -- 5,770 5,770
Less reclassification adjustment
for gains realized in net income,
net of tax -- -- -- -- -- 236 236
--------- --------- --------- --------- --------- --------- ---------
Comprehensive income -- -- 24,719 -- -- 6,006 30,725
</Table>
(continued)
44
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued)
(Amounts in Thousands, Except Share and Per Share Information)
<Table>
<Caption>
ACCUMULATED
OTHER
COMPRE-
ADDITIONAL UNALLOCATED HENSIVE
COMMON PAID-IN RETAINED TREASURY ESOP INCOME
STOCK CAPITAL EARNINGS STOCK SHARES (LOSS) TOTAL
---------- ---------- ---------- ---------- ----------- ----------- ----------
Common dividends declared
($1.00 per share) -- -- (9,926) -- -- -- (9,926)
Purchase 85,844 treasury shares at
$29.00 per share -- -- -- (2,491) -- -- (2,491)
Issuance of 5,500 shares under
stock option plan -- 42 155 197
Issuance of ESOP shares -- 140 -- 792 -- -- 932
Fractional share adjustment for
10% dividend 2 (1,729) 1,725 (14) -- -- (16)
---------- ---------- ---------- ---------- ---------- ---------- ----------
BALANCE DECEMBER 31, 2002 $ 9,957 $ 58,642 $ 79,084 $ (1,982) $ -- $ 6,761 $ 152,462
========== ========== ========== ========== ========== ========== ==========
</Table>
See Notes to Consolidated Financial Statements
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accounting and reporting policies of First Community Bancshares, Inc.
("First Community" or the "Company") and subsidiary conform to accounting
principles generally accepted in the United States and to predominant practices
within the banking industry. In preparing financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the date of the balance sheet and revenues and
expenses for the period. Actual results could differ from those estimates.
Assets held in an agency or fiduciary capacity are not assets of the Company and
are not included in the accompanying consolidated balance sheets. Certain
amounts in the 2001 and 2000 financial statements have been reclassified to
conform to the 2002 presentation.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of First Community include the accounts of
all wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and due from banks, time deposits with
other banks, federal funds sold, and interest-bearing balances on deposit with
the Federal Home Loan Bank that are available for immediate withdrawal. Interest
and income taxes paid were as follows:
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
(Amounts in Thousands)
Interest $ 36,273 $ 42,968 $ 37,526
Income taxes 9,523 6,945 7,206
</Table>
Pursuant to agreements with the Federal Reserve Bank, the Company maintains a
cash balance of approximately $661,000 in lieu of charges for check clearing and
other services.
TRADING SECURITIES
At December 31, 2002 and 2001, no securities were held for trading purposes and
no trading account was maintained.
SECURITIES AVAILABLE FOR SALE
Securities to be held for indefinite periods of time including securities that
management intends to use as part of its asset/liability management strategy,
and that may be sold in response to changes in interest rates, changes in
prepayment risk, or other similar factors are classified as available for sale
and are recorded at estimated fair value. Unrealized appreciation or
depreciation in fair value above or below amortized cost is included in
stockholders' equity net of income taxes and is entitled "Other Comprehensive
Income." Premiums and discounts are amortized to expense or accreted to income
over the life of the security. Gain or loss on sale is based on the specific
identification method. Other than temporary losses on available for sale
securities are in net securities losses and gains.
SECURITIES HELD TO MATURITY
Investments in debt securities that management has the ability and intent to
hold to maturity are carried at cost. Premiums and discounts are amortized to
expense and accreted to income over the lives of the securities. Gain or loss on
the call or maturity of investment securities, if any, is recorded based on the
specific identification method.
LOANS HELD FOR SALE AND DERIVATIVE FINANCIAL INVESTMENTS
Loans held for sale primarily consist of one to four family residential loans
originated for sale in the secondary market and carried at the lower of cost or
fair value determined on an aggregate basis. Gains and losses on sales of loans
held for sale are included in mortgage banking income in the Consolidated
Statements of Income.
For loans to be sold, the Company enters into forward commitments or derivatives
to manage the risk inherent in interest rate lock
46
commitments made to potential borrowers. The inventory of loans and loan
commitments (both retail and wholesale) is hedged to protect the Company from
interest rate risk and any corresponding fluctuation in cash flows derived upon
settlement of the loans with secondary market purchasers, and consequently, to
achieve a desired margin upon delivery. The hedge transactions are used for risk
mitigation and are not for trading purposes. The derivative financial
instruments derived from these hedging transactions are recorded at fair value
in Other Assets and Liabilities on the Consolidated Balance Sheets and the
changes in fair value are reflected in Mortgage Banking Income on the
Consolidated Statements of Income. For the year ended December 31, 2002 the net
derivative expense reflected in the Consolidated Statements of Income, was $6.9
million which is comprised of a $700,000 decline in the fair value of the
forward mortgage contracts, an $8.1 million loss on the contract settlements,
and a gain of $1.9 million on rate lock commitments. Forward mortgage contracts
are settled at fair value upon expiration of the contract and result in either
the payment or receipt or funds. UFM's accumulated net derivative position was
$1.7 million and $480,000 as of December 31, 2002 and 2001, respectively.
Loans transferred to the held for sale classification are transferred at fair
value. Any write-down recorded at the point of transfer is charged to the
allowance for loan losses. Subsequent write-downs in fair value are recorded in
non-interest expense while further appreciation in fair value is not recorded.
During the fourth quarter of 2002, the Company transferred $6.0 million in loans
held for investment to loans held for sale and recognized a write-down through
the allowance for loan losses of $246,000.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level deemed adequate to absorb
probable losses inherent in the loan portfolio. The Company consistently applies
a monthly review process to continually evaluate loans for changes in credit
risk. This process serves as the primary means by which the Company evaluates
the adequacy of the allowance for loan losses. The allowance is maintained by
making specific allocations to impaired loans and loan pools that exhibit
inherent weaknesses and various credit risk factors. Allocations to loan pools
are developed giving weight to risk ratings, historical loss trends and
management's judgment concerning those trends and other relevant factors.
The allowance is allocated to specific loans to cover loan relationships
identified with significant cash flow weaknesses and for which a collateral
deficiency may be present. The allowance established under the specific reserve
method is based upon the borrower's estimated cash flow and projected
liquidation value of related collateral. The allowance is allocated to pools of
loans based on historical loss experience to cover the homogeneous and
nonhomogeneous loans not individually evaluated. Pools of loans are grouped by
specific category and risk characteristics. To determine the amount of allowance
needed for each loan category, an estimated loss percentage is developed based
upon historical loss experience. The historical loss experience is weighted for
various risk factors including macro and micro economic conditions, qualitative
assessments relative to the composition of the loan portfolio, the level of
delinquencies and non-accrual loans, trends in the volume and term of loans,
anticipated impact from changes in lending policies and procedures, and any
concentration of credits in certain industries or geographic areas. The
calculated percentage is used to determine the estimated allowance excluding any
relationships specifically identified and evaluated. While allocations are made
to specific loans and classifications within the various categories of loans,
the reserve is available for all loan losses.
The allowance for loan losses related to impaired loans is based upon the
discounted estimated cash flows or fair value of collateral when it is probable
that all amounts due pursuant to contractual terms of the loan will not be
collected and the recorded investment in the loan exceeds the fair value.
Certain smaller balance,
47
homogeneous loans, such as consumer installment loans and residential mortgage
loans, are evaluated for impairment on an aggregate basis in accordance with the
Company's policy.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed on the straight-line method over estimated useful
lives. Maintenance and repairs are charged to current operations while
improvements that extend the economic useful life of the underlying asset are
capitalized. Disposition gains and losses are reflected in current operations.
In addition, in accordance with Statement of Financial Accounting Standards
("FAS") No. 144, "Accounting for Long-Lived Assets and for Long-Lived Assets to
be Disposed of" requires that any material excess of the carrying value over the
fair value be recorded as an impairment loss.
LOAN INTEREST INCOME RECOGNITION
Accrual of interest on loans is based generally on the daily amount of principal
outstanding. It is the Company's policy to discontinue the accrual of interest
on loans based on the payment status and evaluation of the related collateral
and the financial strength of the borrower. The accrual of interest income is
normally discontinued when a loan becomes 90 days past due as to principal or
interest. Management may elect to continue the accrual of interest when the loan
is well secured and in process of collection. When interest accruals are
discontinued, interest accrued and not collected in the current year is reversed
and interest accrued and not collected from prior years is charged to the
reserve for possible loan losses.
LOAN FEE INCOME
Loan origination and underwriting fees are recorded as a reduction of direct
costs associated with loan processing, including salaries, review of legal
documents, obtainment of appraisals, and other direct costs. Fees in excess of
those related direct costs are deferred and amortized over the life of the
related loan. Loan commitment fees are deferred and amortized over the related
commitment period.
OTHER REAL ESTATE OWNED
Other real estate owned and acquired through foreclosure is stated at the lower
of cost or fair value less estimated costs to sell. Loan losses arising from the
acquisition of such properties are charged against the allowance for possible
loan losses. Expenses incurred in connection with operating the properties,
subsequent write-downs and gains or losses upon sale are included in other
non-interest income and expense.
STOCK OPTIONS
The Company has a stock option plan for certain executives and directors
accounted for under the intrinsic value method in accordance with Accounting
Principles Board Opinion ("APB") 25. Because the exercise price of the Company's
employee/director stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.
In December 2002, the FASB issued FAS 148, "Accounting for Stock-Based
Compensation." This new standard provides alternative methods of transition for
a voluntary change to the fair value method of accounting for stock-based
compensation. In addition, the Statement amends the disclosure requirements of
FAS 123 to require prominent disclosure in both annual and interim financial
statements about the method of accounting for stock-based compensation and the
underlying effect of the method used on reported results until exercised.
The effect of option shares on earnings per share relates to the dilutive effect
of the underlying options outstanding. To the extent the granted exercise share
price is less than the current market price, ("in the money"), there is an
economic incentive for the shares to be exercised and an increase in the
dilution effect on earnings per share.
48
Assuming use of the fair value method of accounting for stock options, pro forma
net income and earnings per share for the years ended December 31 would have
been estimated as follows:
<Table>
<Caption>
2002 2001 2000
---------- ---------- ----------
(Amounts in Thousands, Except Per Share Data)
Net income as reported $ 24,719 $ 19,134 $ 17,063
Less: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax effects (163) (310) (37)
---------- ---------- ----------
$ 24,556 $ 18,824 $ 17,026
========== ========== ==========
Earnings per share:
Basic as reported $ 2.49 $ 1.92 $ 1.78
Basic pro forma $ 2.47 $ 1.89 $ 1.77
Diluted as reported $ 2.48 $ 1.92 $ 1.78
Diluted pro forma $ 2.46 $ 1.89 $ 1.77
</Table>
The fair value of options was estimated at the date of grant using the
Black-Scholes option pricing model using the following assumptions: i) risk-free
interest rate of 5.15%, 5.12% and 6.00% for 2002, 2001 and 2000, respectively;
ii) a dividend yield of 3.20%, 3.40% and 5.21% for 2002, 2001 and 2000,
respectively; iii) volatility factors for the expected market price of the
Company's common stock of 24.5%, 31.2% and 26.1% for 2002, 2001 and 2000,
respectively; and iv) a weighted-average expected life of the option of 10.4,
12.2 and 13.7 years, for 2002, 2001 and 2000, respectively.
INTANGIBLE ASSETS
The excess of the cost of an acquisition over the fair value of the net assets
acquired is recorded as goodwill. The net carrying amount of goodwill was $25.8
million and $25.3 million at December 31, 2002 and 2001, respectively. The net
carrying amount of goodwill at December 31, 2002 and 2001 related to the
mortgage banking segment was $1.8 million and $1.0 million, respectively, while
the net carrying amount of goodwill related to the community banking segment at
December 31, 2002 and 2001 was $24.0 million and $24.3 million, respectively. A
portion of the purchase price in certain transactions has been allocated to
values associated with the future earnings potential of acquired deposits and is
being amortized over the estimated lives of the deposits, ranging from seven to
ten years while the weighted average remaining life of these core deposits is
approximately 3.8 years. As of December 31, 2002 and 2001, the balance of
acquired core deposits was $2.9 million and $2.6 million, respectively, while
the corresponding accumulated amortization was $1.2 million and $1.5 million,
respectively. The current year acquisition of Monroe added an additional
$441,000 in deposit intangible. The net unamortized balance of identified
intangibles associated with acquired deposits was $1.3 million and $1.1 million
at December 31, 2002 and 2001, respectively. Amortization expense of intangibles
for each of the next five years is approximately $200,000 annually.
49
On January 1, 2002, the Company adopted FAS 142 which required that goodwill
resulting from business acquisitions (as defined) no longer be amortized to
earnings, but instead be reviewed for impairment. Accordingly, the Company
ceased the amortization of goodwill on January 1, 2002. FASB Statement 142
required a transitional impairment test to be applied to all goodwill and other
indefinite-lived intangible assets within the first six months after adoption.
The impairment test involved identifying separate reporting units based on the
reporting structure of the Corporation, then assigning all assets and
liabilities, including goodwill, to these units. Goodwill is assigned based on
the reporting unit benefiting from the factors that gave rise to the goodwill.
Each reporting segment (community and mortgage banking) is then tested for
goodwill impairment by comparing the fair value of the unit with its book value,
including goodwill. If the fair value of the reporting unit is greater than its
book value, no goodwill impairment exists. However, if the book value of the
reporting unit is greater than its determined fair value, goodwill impairment
may exist and further testing is required to determine the amount, if any, of
the actual impairment loss. Through the results of impairment tests, management
has concluded that the current value placed on goodwill is not impaired and no
impairment losses were recorded for 2002 or prior years.
In October 2002, the FASB issued FAS No. 147, "Acquisitions of Certain Financial
Institutions." This new Standard which became effective upon issuance provides
interpretive guidance on the application of the purchase method to acquisitions
of financial institutions, and requires companies to cease amortization of
goodwill related to certain branch acquisitions. In addition, this Statement
amends FASB Statement No. 144 to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor- and borrower-relationship intangible assets and credit cardholder
intangible assets. Consequently, those intangible assets are subject to the same
undiscounted cash flow recoverability test and impairment loss recognition and
measurement provisions that Statement 144 requires for other long-lived assets
that are held and used.
The effect of the application of the non-amortization provisions of FAS
Statements 142 and 147 on net income and earnings per share is presented below.
<Table>
<Caption>
YEARS ENDED
DECEMBER 31, 2001 December 31, 2000
----------------- -----------------
(Amounts in Thousands, Except Per Share Data)
Reported net income $ 19,134 $ 17,063
Add back goodwill amortization, net of tax, subject to FAS 142 & 147 1,875 1,778
---------- ----------
Adjusted net income $ 21,009 $ 18,841
========== ==========
Basic and diluted earnings per share $ 1.92 $ 1.78
Add back goodwill amortization, net of tax, subject to FAS 142 & 147 0.19 0.19
---------- ----------
Adjusted basic and diluted earnings per share $ 2.11 $ 1.97
========== ==========
</Table>
50
RECENT ACCOUNTING DEVELOPMENTS
FAS 149, "Accounting for Certain Financial Instruments with Characteristics of
Liabilities and Equity," which is anticipated to be issued in March 2003,
establishes standards for issuers' classification as liabilities in the
Statement of Financial Position for certain equity linked contracts tied to the
issuers' shares. Implementation of FAS 149 is not anticipated to have a material
impact on the Company's financial position or results of operation. In January
2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation of Variable
Interest Entities". The objective of this interpretation is to provide guidance
on how to identify a variable interest entity (VIE) and determine when the
assets, liabilities, non-controlling interests, and results of operations of a
VIE need to be included in a company's consolidated financial statements. A
company that holds variable interests in an entity will need to consolidate the
entity if the company's interest in the VIE is such that the company will absorb
a majority of the VIE's expected losses and/or receive a majority of the
entity's expected residual returns, if they occur. FIN 46 also requires
additional disclosures by primary beneficiaries and other significant variable
interest holders. The provisions of this interpretation became effective upon
issuance. The Company does not anticipate the requirements of FIN 46 to have a
material impact on results of operations, financial position, or liquidity.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". This interpretation expands the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees and requires the guarantor to recognize a
liability for the fair value of an obligation assumed under a guarantee. FIN 45
clarifies the requirements of FAS 5, "Accounting for Contingencies", relating to
guarantees. In general, FIN 45 applies to contracts or indemnification
agreements that contingently require the guarantor to make payments to the
guaranteed party based on changes in an underlying value that is related to an
asset, liability, or equity security of the guaranteed party. Certain guarantee
contracts are excluded from both the disclosure and recognition requirements of
this interpretation, including, among others, guarantees relating to employee
compensation, residual value guarantees under capital lease arrangements,
commercial letters of credit, loan commitments, subordinated interests in a
special purpose entity, and guarantees of a company's own future performance.
Other guarantees are subject to the disclosure requirements of FIN 45 but not to
the recognition provisions and include, among others, a guarantee accounted for
as a derivative instrument under FAS 133, a parent's guarantee of debt owed to a
third party by its subsidiary or vice versa, and a guarantee which is based on
performance rather than price. The disclosure requirements of FIN 45 are
effective for the Company as of December 31, 2002, and require disclosure of the
nature of the guarantee, the maximum potential amount of future payments that
the guarantor could be required to make under the guarantee, and the current
amount of the liability, if any, for the guarantor's obligations under the
guarantee. The recognition requirements of FIN 45 are to be applied
prospectively to guarantees issued or modified after December 31, 2002. The
Company does not expect the requirements of FIN 45 to have a material impact on
results of operations, financial position, or liquidity.
In June 2002, the FASB issued FAS No 146, "Accounting for Costs Associated with
Exit or Disposal Activities." This pronouncement is effective for exit or
disposal activities initiated after December 31, 2002. This Statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EIFT) Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)."
Management is currently evaluating the impact of
51
this standard. However, it+is not anticipated to have a material impact on the
results of operations, financial position or liquidity. In April 2002, the FASB
issued FAS 145, which updates, clarifies, and simplifies certain existing
accounting pronouncements beginning at various dates in 2002 and 2003. The
statement rescinds FAS 4 and FAS 64, which required net gains or losses from the
extinguishment of debt to be classified as an extraordinary item in the income
statement. These gains and losses will now be classified as extraordinary only
if the item is material and both unusual and infrequent in nature. The changes
required by FAS 145 are not expected to have a material impact on results of
operations, financial position, or liquidity of the Company.
In August 2001, the FASB issued FAS 143, Accounting for Asset Retirement
Obligations. FAS 143 requires an entity to record a liability for an obligation
associated with the retirement of an asset at the time the liability is incurred
by capitalizing the cost as part of the carrying value of the related asset and
depreciating it over the remaining useful life of that asset. The standard is
effective for the Company beginning January 1, 2003, and its adoption is not
expected to have a material impact on results of operations, financial position,
or liquidity.
INCOME TAXES
The Company and its subsidiary file a consolidated federal income tax return.
The provision for income tax expense and the underlying effective rate is
determined based upon a combination of the enacted statutory federal and state
rates and reduced or increased by any corresponding nontaxable income or
nondeductible expenses, respectively.
Deferred income taxes, which are included in other assets, are recognized for
the tax consequences of "temporary differences" by applying enacted statutory
tax rates to the differences between the financial statement carrying amounts
and the tax bases of existing assets and liabilities. The book versus tax basis
difference is created by the timing of expense and/or income recognition
required for financial accounting reporting purposes as opposed to what is
required statutorily by enacted federal and state tax laws, as well as
differences assigned to the underlying asset and liability values at
acquisition. Deferred taxes are also applied to the unrealized appreciation or
depreciation on available for sale securities recorded in Other Comprehensive
Income in the Stockholders' Equity section of the Consolidated Balance Sheet.
EARNINGS PER SHARE
Basic earnings per share is determined by dividing net income by the weighted
average number of shares outstanding. Diluted earnings per share is determined
by dividing net income by the weighted average shares outstanding increased by
the dilutive effect of stock options. Basic and diluted net income per common
share calculations follow:
<Table>
<Caption>
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------ ------------ ------------
(Amounts in Thousands, Except Per Share Data)
Basic:
Net income $ 24,719 $ 19,134 $ 17,063
Weighted average shares outstanding 9,924,636 9,944,310 9,607,217
Earnings per share -- basic $ 2.49 $ 1.92 $ 1.78
Diluted:
Net income $ 24,719 $ 19,134 $ 17,063
Weighted average shares outstanding 9,924,636 9,944,310 9,607,217
Dilutive shares for stock options 48,493 36,609 --
Weighted average dilutive shares outstanding 9,973,129 9,980,919 9,607,217
Earnings per share -- dilutive $ 2.48 $ 1.92 $ 1.78
</Table>
52
NOTE 2. MERGER AND ACQUISITIONS
On November 30, 2002, the Company acquired Monroe Financial, Inc. ("Monroe"),
and its banking subsidiary, The Bank of Greenville ("Greenville") for $1.96
million cash. Greenville's three branch facilities in Greenville and Lindside in
Monroe County, West Virginia and Hinton in Summers County, West Virginia, were
simultaneously merged with and into First Community Bank, N. A. ("FCBNA" or the
"Bank"). The completion of this transaction resulted in the addition of $29.8
million in assets including $16.5 million to the loan portfolio, and an
additional $28.0 million in deposits to the Bank.
NOTE 3. SECURITIES AVAILABLE FOR SALE
As of December 31, the amortized cost and estimated fair value of securities
classified as available for sale are as follows:
<Table>
<Caption>
2002
--------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
(AMOUNTS IN THOUSANDS)
U.S. government agency securities $ 138,981 $ 5,006 $ -- $ 143,987
States and political subdivisions 93,587 2,739 (620) 95,706
Other securities 57,048 4,144 -- 61,192
---------- ---------- ---------- ----------
TOTAL $ 289,616 $ 11,889 $ (620) $ 300,885
========== ========== ========== ==========
</Table>
<Table>
<Caption>
2001
--------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
(Amounts in Thousands)
U.S. government agency securities $ 195,689 $ 981 $ (467) $ 196,203
States and political subdivisions 97,683 1,230 (1,464) 97,449
Other securities 59,387 1,022 (54) 60,355
---------- ---------- ---------- ----------
TOTAL $ 352,759 $ 3,233 $ (1,985) $ 354,007
========== ========== ========== ==========
</Table>
Securities available for sale with estimated fair values of $207,391,813 and
$180,086,000 at December 31, 2002 and 2001, respectively, were pledged to secure
public deposits, securities sold under agreements to repurchase and other
short-term borrowings and for other purposes.
As a condition to membership in the Federal Home Loan Bank ("FHLB") system,
FCBNA is required to subscribe to a minimum level of stock in the FHLB of
Atlanta. At December 31, 2002, FCBNA owned approximately $6.3 million in stock
which is classified as available for sale.
The amortized cost and estimated fair value of securities available for sale by
contractual maturity, at December 31, 2002, are shown below. Expected maturities
may differ from contractual maturities because issuers may have the right to
call or prepay obligations with or without call or prepayment penalties.
Included in the amounts below are securities that were acquired in the November
30, 2002 acquisition of The Bank of Greenville. The book and estimated market
value of these securities are $7.6 million and $7.7 million, respectively, at
December 31, 2002. During 2002, the Company experienced a net loss from
available for sale securities of $393,000. Gross losses resulted from an
other-than-temporary write-down of a municipal issue within the portfolio of
$576,000 and losses from the sale of securities of $313,000. These losses were
offset by gross gains resulting from securities sold and called of $496,000.
During 2001, a net gain of $181,000 was recognized as a result of the sale of
available for sale securities with gains of $209,000 and losses of $28,000.
53
<Table>
<Caption>
December 31, 2002
--------------------------------------------------------------------------
U.S. States Tax
Government and Equivalent
Agencies & Political Other Purchase
Corporations Subdivisions Securities Total Yield
------------ ------------ ------------ ------------ ----------
(Amounts in Thousands)
Amortized Cost
Maturity:
Within one year $ -- $ 500 $ -- $ 500 7.72%
After one year through five years 1,910 18,537 26,106 46,553 6.68%
After five years through ten years 37,669 14,247 20,295 72,211 6.17%
After ten years 99,402 60,303 10,647 170,352 6.28%
------------ ------------ ------------ ------------
Total amortized cost $ 138,981 $ 93,587 $ 57,048 $ 289,616
============ ============ ============ ============
Tax equivalent purchase yield 5.49% 8.02% 5.56% 6.32%
Average maturity (in years) 16.15 12.39 8.75 13.48
Fair Value
Maturity:
Within one year $ -- $ 504 $ -- $ 504
After one year through five years 1,944 18,983 28,046 48,973
After five years through ten years 39,020 14,653 22,142 75,815
After ten years 103,023 61,566 11,004 175,593
------------ ------------ ------------ ------------
TOTAL FAIR VALUE $ 143,987 $ 95,706 $ 61,192 $ 300,885
============ ============ ============ ============
</Table>
NOTE 4. SECURITIES HELD TO MATURITY
The following table presents amortized cost and approximate fair values of
investment securities held to maturity at December 31:
<Table>
<Caption>
2002
-------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
(AMOUNTS IN THOUSANDS)
U.S. government agency securities $ 336 $ 8 $ -- $ 344
States and political subdivisions 40,303 2,320 -- 42,623
Other securities 375 -- -- 375
---------- ---------- ---------- ----------
TOTAL $ 41,014 $ 2,328 $ -- $ 43,342
========== ========== ========== ==========
</Table>
<Table>
<Caption>
2001
-------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
(Amounts in Thousands)
U.S. government agency securities $ 743 $ 16 $ -- $ 759
States and political subdivisions 39,768 1,487 -- 41,255
Other securities 1,373 6 -- 1,379
---------- ---------- ---------- ----------
TOTAL $ 41,884 $ 1,509 $ -- $ 43,393
========== ========== ========== ==========
</Table>
54
<Table>
<Caption>
U.S. States Tax
Government and Equivalent
Agencies & Political Other Purchase
Corporations Subdivisions Securities Total Yield
------------ ------------ ------------ ------------ ----------
(Amounts in Thousands)
Amortized Cost
Maturity:
Within one year $ 63 $ -- $ 75 $ 138 5.78%
After one year through five years 98 4,594 -- 4,692 8.50%
After five years through ten years 175 15,663 300 16,138 8.58%
After ten years -- 20,046 -- 20,046 8.70%
------------ ------------ ------------ ------------
Total amortized cost $ 336 $ 40,303 $ 375 $ 41,014
============ ============ ============ ============
Tax equivalent purchase yield 5.08% 8.67% 6.60% 8.62%
Average maturity (in years) 4.43 9.14 4.79 9.06
Fair Value
Maturity:
Within one year $ 64 $ -- $ 75 $ 139
After one year through five years 99 4,935 -- 5,034
After five years through ten years 181 16,525 300 17,006
After ten years -- 21,163 -- 21,163
------------ ------------ ------------ ------------
Total fair value $ 344 $ 42,623 $ 375 $ 43,342
============ ============ ============ ============
</Table>
Various investment securities classified as held to maturity with an amortized
cost of approximately $4,454,299 and $4,439,000 were pledged at December 31,
2002 and 2001, respectively, to secure public deposits and for other purposes
required by law.
NOTE 5. LOANS
Loans consist of the following at December 31:
<Table>
<Caption>
2002 2001
-------- --------
(Amounts in Thousands)
Real estate-commercial $285,847 $259,717
Real estate-construction 72,275 77,402
Real estate-residential 364,065 332,671
Commercial, financial
and agricultural 74,186 96,641
Loans to individuals for household
and other consumer expenditures 130,522 137,104
All other loans 726 961
-------- --------
$927,621 $904,496
======== ========
</Table>
FCBNA is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit, standby letters of
credit and financial guarantees. These instruments involve, to varying degrees,
elements of credit and interest rate risk beyond the amount recognized on the
balance sheet. The contractual amounts of those instruments reflect the extent
of involvement the Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of non-performance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit and financial guarantees written is represented by the
contractual amount of those instruments. The Company uses the same credit
55
policies in making commitments and conditional obligations as it does for
on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is not a violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company, upon extension of credit is based on
management's credit evaluation of the counterparties. Collateral held varies but
may include accounts receivable, inventory, property, plant and equipment, and
income-producing commercial properties.
Standby letters of credit and financial guarantees written are conditional
commitments issued by the Company to guarantee the performance of a customer to
a third party. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
To the extent deemed necessary, collateral of varying types and amounts is held
to secure customer performance under certain of those letters of credit
outstanding at December 31, 2002.
Financial instruments whose contract amounts represent credit risk at December
31, 2002 are commitments to extend credit (including availability of lines of
credit) - $64.2 million, and standby letters of credit and financial guarantees
written - $6.0 million. At December 31, 2002, FCBNA's subsidiary, United First
Mortgage, Inc. (UFM), had commitments to originate loans of $120.2 million.
Loan commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral deemed
necessary by the Company is based on management's credit evaluation and
underwriting guidelines for the particular loan. The total commitments
outstanding at December 31, 2002 are summarized in the following table:
<Table>
<Caption>
2002
---------------------------
NOTIONAL
AMOUNT RATE
--------- -------------
(AMOUNTS IN THOUSANDS)
Real estate-commercial (fixed) $ 5,573 3.38 - 10.50%
Real estate-commercial (variable) 10,349 2.25 - 9.50%
Real estate-construction (fixed) 4,904 4.40 - 10.50%
Real estate-construction (variable) 8,349 4.25 - 9.00%
Real estate-residential (fixed) 4,211 5.75 - 18.00%
Real estate-residential (variable) 14,099 3.75 - 12.00%
Commercial, financial, agricultural (fixed) 1,689 4.00 - 18.00%
Commercial, financial, agricultural (variable) 14,739 2.25 - 10.50%
Loans to individuals for household and other consumer expenditures (fixed) 4,537 3.70 - 18.50%
Loans to individuals for household and other consumer expenditures (variable) 1,765 4.25 - 14.50%
---------
TOTAL $ 70,215
=========
</Table>
56
Management analyzes the loan portfolio regularly for concentrations of credit
risk, including concentrations in specific industries and geographic location.
At December 31, 2002, commercial real estate loans comprised 30.8% of the total
loan portfolio. Commercial loans include loans to small to mid-size industrial,
commercial and service companies that include but are not limited to coal mining
companies, manufacturers, automobile dealers, and retail and wholesale
merchants. Commercial real estate projects represent several different sectors
of the commercial real estate market, including residential land development,
apartment building operators, commercial real estate lessors, and hotel/motel
developers. Underwriting standards require comprehensive reviews and independent
evaluations be performed on credits exceeding predefined market limits on
commercial loans. Updates to these loan reviews are done periodically or on an
annual basis depending on the size of the loan relationship.
The majority of the loans in the current portfolio, other than commercial and
commercial real estate, were made and collateralized in West Virginia, Virginia,
North Carolina and the surrounding mid-Atlantic area. Although sections of the
West Virginia and Southwestern Virginia economies are closely related to natural
resource production, they are supplemented by service industries. The Company's
presence in three states, West Virginia, Virginia, and North Carolina, provides
additional diversification against geographic concentrations of credit risk.
In the normal course of business, FCBNA has made loans to directors and
executive officers of the Company and its subsidiary. All loans and commitments
made to such officers and directors and to companies in which they are officers,
or have significant ownership interest, have been made on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with other persons. The aggregate dollar amount of
such loans was $6.0 million and $7.8 million at December 31, 2002 and 2001,
respectively. Advances and repayments of these loans during 2002 were $1.9
million and $3.7 million, respectively.
NOTE 6. ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses was as follows:
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
(Amounts in Thousands)
Balance, January 1 $ 13,952 $ 12,303 $ 11,900
Provision for loan losses 4,208 5,134 3,986
Acquisition balance 395 484 1,051
Loans charged off (4,868) (4,880) (5,536)
Recoveries credited to reserve 723 911 902
-------- -------- --------
Net charge-offs (4,145) (3,969) (4,634)
-------- -------- --------
Balance, December 31 $ 14,410 $ 13,952 $ 12,303
======== ======== ========
</Table>
57
The following table presents the Company's investment in loans considered to be
impaired and related information on those impaired loans:
<Table>
<Caption>
2002 2001
-------- --------
(Amounts in Thousands)
Recorded investment in loans considered to be impaired $ 8,980 $ 5,129
Loans considered to be impaired that were on a non-accrual basis 1,238 1,229
Allowance for loan losses related to loans considered to be impaired 3,907 1,310
Average recorded investment in impaired loans 9,176 5,674
Total interest income recognized on impaired loans 512 255
</Table>
During 2002, 2001 and 2000, $2,168,000, $2,116,000, and $2,530,000 of assets
were acquired through foreclosure and transferred to other real estate owned.
NOTE 7. PREMISES AND EQUIPMENT
Premises and equipment are comprised of the following as of December 31:
<Table>
<Caption>
2002 2001
-------- --------
(Amounts in Thousands)
Land $ 7,648 $ 7,123
Bank premises 24,317 22,258
Equipment 16,832 15,831
-------- --------
48,797 45,212
Less: accumulated depreciation and amortization 23,719 23,499
-------- --------
TOTAL $ 25,078 $ 21,713
======== ========
</Table>
NOTE 8. OTHER INDEBTEDNESS
Other indebtedness includes structured term borrowings from the FHLB of $100
million and $125 million at December 31, 2002 and 2001, respectively, in the
form of convertible and callable advances. The callable advances may be called,
based on predefined factors, in quarterly increments that may substantially
shorten the lives of these instruments. If these advances are called, the debt
may be paid in full, converted to another FHLB credit product or converted to an
adjustable rate advance. The contractual maturity of these borrowings is 2010
and the weighted average rate is 5.83% at December 31, 2002. At December 31,
2001, the Company also held a non-callable term advance of $10.0 million which
matured in December 2002.
FCBNA is a member of the FHLB which provides credit in the form of short-term
and long-term advances collateralized by various mortgage assets. At December
31, 2002, credit availability with the FHLB totaled approximately $193.6
million. Advances from the FHLB are secured by stock in the FHLB of Atlanta,
qualifying first mortgage loans of $331.0 million, mortgage-backed securities,
and certain other investment securities. The FHLB advances are subject to
restrictions or penalties in the event of prepayment.
Other indebtedness also includes term borrowings with the FHLB of $10 million as
of December 31, 2002 and 2001. This debt has a weighted average interest rate of
6.01% and $8 million matures in 2003, while $2 million matures in 2008. Other
various debt obligations of the Company, excluding the borrowings of UFM
mentioned below, approximated $50,000 at December 31, 2002 and $320,000 at
December 31, 2001.
In late 2002, the Bank's mortgage subsidiary, UFM, entered into a loan purchase
agreement with Countrywide Warehouse Lending
58
("Countrywide") whereby Countrywide will pre-fund certain loans anticipated to
be purchased by Countrywide Home Loans, Inc.~This financing arrangement by UFM
with Countrywide resulted~in additional borrowings at December 31, 2002 of $14.3
million at~a floating rate of one month LIBOR plus 200 basis points or 3.42%~at
December 31, 2002. UFM's net worth of $4.2 million at~December 31, 2002 was
$300,000 deficient of Countrywide's minimum net worth requirement. Subsequent to
year-end, UFM received a letter of forbearance from Countrywide, cured the
deficiency, ceased continuance of this credit facility and ultimately requested
the return of all related collateral.
NOTE 9. DEPOSITS
At December 31, 2002, the scheduled maturities of certificates of deposit are as
follows:
<Table>
<Caption>
(Amounts in Thousands)
2003 $ 392,821
2004 97,079
2005 48,393
2006 15,102
2007 and thereafter 39,693
---------
$ 593,088
=========
</Table>
Time deposits, including certificates of deposit issued in denominations of
$100,000 or more, amounted to $176.8 million and $173.0 million at December 31,
2002 and 2001, respectively. Interest expense on these certificates was $6.1
million, $6.7 million, and $6.5 million for 2002, 2001, and 2000, respectively.
<Table>
<Caption>
(Amounts in Thousands)
Three Months or Less $ 39,653
Over Three to Six Months 37,998
Over Six to Twelve Months 45,048
Over Twelve Months 54,068
----------
TOTAL $ 176,767
==========
</Table>
NOTE 10. INCOME TAXES
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
2002 2001 2000
--------- -------- --------
(Amounts in Thousands)
INCOME TAXES ARE AS FOLLOWS:
Income exclusive of securities gains $ 10,205 $ 8,330 $ 7,053
Net securities (losses) gains (156) 72 1
--------- -------- --------
$ 10,049 $ 8,402 $ 7,054
========= ======== ========
</Table>
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
2002 2001 2000
--------- -------- --------
(Amounts in Thousands)
INCOME TAX PROVISIONS CONSISTS OF:
Current tax expense $ 9,056 $ 8,734 $ 7,150
Deferred tax expense (benefit) 993 (332) (96)
--------- -------- --------
$ 10,049 $ 8,402 $ 7,054
========= ======== ========
</Table>
59
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting versus
tax purposes. The tax effects of significant items comprising the Company's net
deferred tax assets as of December 31, 2002 and 2001 are as follows:
<Table>
<Caption>
2002 2001
-------- --------
(Amounts in Thousands)
DEFERRED TAX ASSETS:
Allowance for loan losses $ 5,644 $ 5,514
Unrealized losses on assets 214 203
Deferred compensation 979 916
Deferred insurance premiums 222 256
Other 739 148
-------- --------
Total deferred tax assets $ 7,798 $ 7,037
-------- --------
DEFERRED TAX LIABILITIES:
Intangible assets $ 1,537 $ 601
Fixed assets 701 267
Deferred loan fees 346 397
Unrealized gain on securities
available for sale 4,507 494
Other 1,636 1,145
-------- --------
Total deferred tax liabilities 8,727 2,904
-------- --------
Net deferred tax (liabilities) assets $ (929) $ 4,133
======== ========
</Table>
The reconciliation between the federal statutory tax rate and the effective
income tax rate is as follows:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
2002 2001 2000
-------- -------- --------
Tax at statutory rate 35.00% 35.00% 35.00%
(Reduction) increase resulting from:
Tax-exempt interest on investment securities
and loans (6.42)% (7.31)% (7.77)%
State income taxes, net of federal benefit 1.82% 2.55% 2.36%
Amortization of goodwill -% 1.57% 1.90%
Other, net (1.50)% (1.30)% (2.19)%
-------- -------- --------
Effective tax rate 28.90% 30.51% 29.30%
======== ======== ========
</Table>
60
NOTE 11. EMPLOYEE BENEFITS
EMPLOYEE STOCK OWNERSHIP AND SAVINGS PLAN
The Company maintains an Employee Stock Ownership and Savings Plan ("KSOP").
Coverage under the plan is provided to all employees meeting minimum eligibility
requirements.
EMPLOYER STOCK FUND:
Annual contributions to the stock portion of the plan are made at the discretion
of the Board of Directors, and are allocated to plan participants on the basis
of relative compensation. Substantially all plan assets are invested in common
stock of the Company. Total expense recognized by the Company related to the
Employer Stock Fund within the KSOP was $675,000, $948,000 and $992,000 in 2002,
2001 and 2000, respectively.
EMPLOYEE SAVINGS PLAN:
The Company provides a 401(k) Savings feature within the KSOP that is available
to substantially all employees meeting minimum eligibility requirements. The
cost of Company contributions under the Savings Plan component of the KSOP was
$563,000, $216,000, and $66,000 in 2002, 2001 and 2000, respectively. The
Company's matching contributions are at the discretion of the Board up to 100%
of elective deferrals of no more than 6% of compensation. The Company matching
rate was 100% for 2002, 50% for 2001, and 25% for 2000.
EMPLOYEE WELFARE PLAN
The Company provides various medical, dental, vision, life, accidental death and
dismemberment and long-term disability insurance benefits to all full-time
employees who elect coverage under this program (basic life, accidental death
and dismemberment, and long-term disability coverage are automatic). The health
plan is managed by a third party administrator ("TPA"). Monthly employer and
employee contributions are made to a tax-exempt employer benefits trust, against
which the TPA processes and pays claims. Stop loss insurance coverage limits the
Company's funding requirements and risk of loss to $50,000 and $1.95 million for
individual and aggregate claims, respectively. Total Company expenses under the
plan were $1.9 million, $1.4 million, and $1.4 million in 2002, 2001 and 2000,
respectively.
The Company has a post-retirement obligation for a group of retirees that
relates to benefits received prior to 1993. The obligation, which approximated
$122,000 and $135,000 at December 31, 2002 and 2001, respectively, is being
amortized over the average remaining life expectancy of the retirees.
Amortization expense approximated $(13,000), $26,000 and $45,000 in 2002, 2001
and 2000, respectively. The current year decline in amortization expense was the
result of the reduction in the number of participants involved in the remaining
pool of former employees and the corresponding reduction in the present value of
the benefit obligation.
DEFERRED COMPENSATION PLAN
FCBNA has deferred compensation agreements with certain current and former
officers providing for benefit payments over various periods commencing at
retirement or death. The liability at December 31, 2002 and 2001 was
approximately $700,000 and $750,000, respectively. The annual expenses
associated with this plan for 2002 and 2001 were $91,000 and $138,000 for 2000.
The obligation is based upon the present value of the expected payments and
estimated life expectancies.
The Company maintains life insurance contracts on the lives of certain of the
officers covered under this plan. Proceeds derived from death benefits are
intended to provide reimbursement of plan benefits paid over the post employment
lives of the participants. Premiums on the insurance contracts are currently
paid through policy dividends on the cash surrender values of $598,000 and
$594,000 at December 31, 2002 and 2001, respectively.
EXECUTIVE RETENTION PLAN
The Company maintains an Executive Retention Plan for key members of senior
management. This Plan provides for a benefit at normal retirement (age 62)
targeted at 35% of final compensation projected at an assumed 3% salary
progression rate. Benefits under the Plan become payable at age 62. Actual
benefits payable under the Retention Plan are dependent on an indexed retirement
benefit formula which accrues benefits equal to the aggregate after-tax
61
income of associated life insurance contracts less the Company's tax-effected
cost of funds for that plan year. Benefits under the Plan are dependent on the
performance of the insurance contracts and are not guaranteed by the Company.
Additionally, during 2001, the Company entered into a similar retirement plan
arrangement as described below with non-employee board members of the Company.
The Company funded the contracts through the purchase of bank-owned life
insurance, ("BOLI"), which is anticipated to fully fund the projected benefit
payout after retirement. The total amount invested in BOLI for the Executive
Retention Plan during 2000 and the corresponding cash surrender value at
December 31, 2002 was $4.1 million and $4.7 million, respectively. The
associated obligation expense incurred in connection with the Executive Plan was
$177,000, $156,000 and $193,000 for 2002, 2001 and 2000, respectively. The
income derived from policy appreciation was $157,000, $240,000 and $184,000 in
2002, 2001 and 2000, respectively. A portion of the pre-existing life insurance
contracts on non-vested terminating executives was reallocated and used to fund
the newly created Director Supplemental Retirement Plan referenced below.
In connection with the Executive Retention Plan, the Company has also entered
into Life Insurance Endorsement Method Split Dollar Agreements (the
"Agreements") with the individuals covered under the Plan. Under the Agreements,
the Company shares 80% of death benefits (after recovery of cash surrender
value) with the designated beneficiaries of the plan participants under life
insurance contracts referenced in the Plan. The Company as owner of the policies
retains a 20% interest in life proceeds and a 100% interest in the cash
surrender value of the policies.
The Plan also contains provisions for change of control, as defined, which allow
the participants to retain benefits, subject to certain conditions, under the
Plan in the event of a change in control.
Benefits under the Executive Plan vest 25% after five years, 50% after ten
years, 75% after 15 years and 5% per year thereafter, with vesting accelerated
to 100% upon attainment of age 62, irrespective of years of service under the
Plan.
DIRECTORS SUPPLEMENTAL RETIREMENT PLAN
In the fourth quarter of 2001, the Company established a Directors Supplemental
Retirement Plan for its non-employee Directors. This Plan provides for a benefit
upon retirement from service on the Board at specified ages depending upon
length of service or death. Benefits under the Plan become payable at age 70,
75, and 78 depending upon the individual director's age and original date of
election to the Board. Actual benefits payable under the Plan are dependent on
an indexed retirement benefit formula that accrues benefits equal to the
aggregate after-tax income associated life insurance contracts less the
Company's tax-effected cost of funds for that plan year. Benefits under the Plan
are dependent on the performance of the insurance contracts and are not
guaranteed by the Company.
In connection with the Directors Supplemental Retirement Plan, the Company has
also entered into Life Insurance Endorsement Method Split Dollar Agreements (the
"Agreements") with certain directors covered under the Plan. Under the
Agreements, the Company shares 80% of death benefits (after recovery of cash
surrender value) with the designated beneficiaries of the executives under life
insurance contracts referenced in the Retention Plan. The Company, as owner of
the policies, retains a 20% interest in life proceeds and a 100% interest in the
cash surrender value of the policies. Because the Plan was designed to retain
the future services of Board members, no benefits are payable under the Plan in
the event of involuntary or involuntary termination prior to retirement age as
defined in the Plan document.
The Plan also contains provisions for change of control, as defined, which allow
the Directors to retain benefits under the Plan in the event of a termination of
service, other than for cause, during the
62
12 months prior to a change in control or anytime thereafter, unless the
Director voluntarily terminates his service within 90 days following the change
in control.
The Plan expenses associated with the Directors Supplemental Retirement Plan for
2002 and 2001 were $217,000 and $32,000, respectively. The level of expense in
the prior year is reflective of the fourth quarter 2001 implementation of the
Plan.
STOCK OPTIONS
In 1999, the Company instituted a Stock Option Plan to encourage and facilitate
investment in the common stock of the Company by key executives and to assist in
the long-term retention of service by those executives. The Plan covers key
executives as determined by the Company's Board of Directors from time to time.
Options under the Plan were granted in the form of non-statutory stock options
with the aggregate number of shares of common stock available for grant under
the Plan set at 302,500 (adjusted for the 10% stock dividend paid in 2002 )
shares. The options granted under the Plan represent the rights to acquire the
option shares with deemed grant dates of January 1 for each year beginning with
the initial year granted and the following four anniversaries. All stock options
granted pursuant to the Plan vest ratably on the first through the seventh
anniversary dates of the deemed grant date. The option price of each stock
option is equal to the fair market value (as defined by the Plan) of the
Company's common stock on the date of each deemed grant during the five-year
grant period. Vested stock options granted pursuant to the Plan are exercisable
for a period of five years after the date of the grantee's retirement (provided
retirement occurs at or after age 62), and at disability, or death. If
employment is terminated other than by retirement, disability, or death, vested
options must be exercised within 90 days after the effective date of
termination. Any option not exercised within such period will be deemed
cancelled.
In the fourth quarter of 2001, the Company also granted stock options to
non-employee directors. The Director Option Plan was implemented to facilitate
and encourage investment in the common stock of the Company by non-employee
directors whose efforts, solely as directors, are expected to contribute to the
Company's future growth and continued success. The options granted pursuant to
the Plan expire at the earlier of 10 years from the date of grant or two years
after the optionee ceases to serve as a director of the Company. Options not
exercised within the appropriate time shall expire and be deemed cancelled. The
Plan covers non-employee directors as determined by the Company's Board of
Directors. Options under the Plan were granted in the form of non-statutory
stock options with the aggregate number of shares of common stock available for
grant under the Plan set at 99,000 (adjusted for the 10% stock dividend) shares.
A summary of the Company's stock option activity, and related information for
the years ended December 31 is as follows:
<Table>
<Caption>
2002 2001 2000
-------------------------- --------------------------- --------------------------
WEIGHTED- Weighted- Weighted-
OPTION AVERAGE Option Average Option Average
SHARES EXERCISE PRICE Shares Exercise Price Shares Exercise Price
-------- -------------- -------- -------------- ------- --------------
Outstanding, beginning of year 202,302 $ 18.65 84,451 $ 19.69 59,968 $ 21.78
Granted 68,351 27.12 120,601 17.90 59,968 17.60
Exercised 5,500 23.91 -- -- -- --
Forfeited -- -- 2,750 15.33 35,485 19.69
-------- -------------- --------- -------------- -------- --------------
Outstanding, end of year 265,153 $ 21.18 202,302 $ 18.65 84,451 $ 19.69
======== ============== ========= ============== ======== ==============
Exercisable at end of year 44,000 $ 23.91 49,500 $ 23.91 -- $ --
Weighted-average fair value of
options granted during the year $ 7.31 $ 5.28 $ 2.97
</Table>
63
For options with exercise prices ranging from $15.33 to $23.91 the number of
options outstanding is 196,802, the weighted-average exercise price and the
weighted-average remaining estimated life of the options outstanding are $19.12
and approximately 10 years, respectively , while the number and weighted-average
exercise price of options currently exercisable is 44,000 and $23.91.
For options with the exercise price of $27.12, the number and the remaining
estimated life were 68,351 and approximately 13 years, while none of the options
are currently exercisable.
NOTE 12. LITIGATION, COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is a defendant in various legal
actions and asserted claims most of which involve lending and collection
activities. While the Company and legal counsel are unable to assess the
ultimate outcome of each of these matters with certainty, they are of the belief
that the resolution of these actions should not have a material adverse affect
on the financial position of the Company.
The Company conducts mortgage banking operations through UFM, a wholly-owned
subsidiary of FCBNA. The majority of loans originated by UFM are sold to larger
national investors on a service released basis. Loans are sold under Loan Sales
Agreements which contain various repurchase provisions. These repurchase
provisions give rise to a contingent liability for loans which could
subsequently be submitted to UFM for repurchase. The principal events which
could result in a repurchase obligation are i.) the discovery of fraud or
material inaccuracies in a sold loan file, and ii.) a default on the first
payment due after a loan is sold to the investor, coupled with a ninety-day
delinquency in the first year of the life of the loan. Other events and
variations of these events could result in a loan repurchase under terms of
other Loan Sales Agreements. The volume of contingent loan repurchases is
dependent on the quality of loan underwriting and systems employed by UFM for
quality control in the production of mortgage loans. To date, only two such
loans totaling $250,000 have been considered for repurchase. Accordingly, loan
repurchases have not had a material adverse effect on the financial position,
results of operations or cash flows of UFM or the Company.
UFM also originates government guaranteed FHA and VA loans that are also sold to
third-party investors. The department of Housing and Urban Development ("HUD")
periodically audits loan files of government guaranteed loans and may require
UFM to execute indemnification agreements on loans which do not meet certain
predefined underwriting guidelines. To date, UFM has been required to execute
only three such indemnification agreements for defaults which may occur over the
five-year period following the indemnification and no losses have occurred under
such agreements. Accordingly, loan indemnifications have not had a material
adverse effect on the financial position, results of operations or cash flows of
UFM or the Company.
UFM is subject to net worth requirements issued by HUD. Failure to meet these
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions that, if undertaken, could have a direct
material effect on UFM's operations. UFM was in compliance with HUD's $1.0
million minimum net worth requirement at December 31, 2002 and 2001. UFM's
tangible net worth was $4.2 million at December 31, 2002, which exceeded the HUD
requirement.
NOTE 13. REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS
The primary source of funds for dividends paid by the Company is dividends
received from FCBNA. Dividends paid by FCBNA are subject to restrictions by
banking regulations. The most restrictive provision of the regulations requires
approval by the Office of the Comptroller of the Currency if dividends declared
in any year exceed the year's net income, as defined, plus retained net profit
of the two preceding years. During 2003, subsidiary accumulated earnings
available for distribution as dividends to the Company without prior
64
approval are $22.0 million plus net income for the interim period through the
date of dividend declaration.
The Company and FCBNA are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under the capital
adequacy guidelines and the regulatory framework for prompt corrective action,
which applies only to the Bank, the Bank must meet specific capital guidelines
that involve quantitative measures of the entity's assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The entity's capital amounts and classifications are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and FCBNA to maintain minimum amounts and ratios for total
and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier 1 capital (as defined) to average assets (as defined). As
of December 31, 2002, the Company and banking subsidiary met all capital
adequacy requirements to which they are subject.
As of December 31, 2002 and 2001, the most recent notifications from the Federal
Reserve Board categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized,
the Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1
leverage ratios as set forth in the table below. There are no conditions or
events since those notifications that management believes have changed the
institution's category.
<Table>
<Caption>
DECEMBER 31, 2002
-----------------------------------------------------------------------------
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
---------------------- --------------------- --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- ------- --------- ------- --------- -------
(AMOUNTS IN THOUSANDS)
TOTAL CAPITAL TO RISK-WEIGHTED ASSETS
First Community Bancshares, Inc. $ 131,097 13.33% $ 78,671 8.00% $ N/A N/A
First Community Bank, N. A. 119,434 12.20% 78,344 8.00% 97,930 10.00%
---------- ------- --------- ------- --------- -------
TIER 1 CAPITAL TO RISK-WEIGHTED ASSETS
First Community Bancshares, Inc. $ 118,618 12.06% $ 39,336 4.00% $ N/A N/A
First Community Bank, N. A. 107,164 10.94% 39,172 4.00% 58,758 6.00%
---------- ------- --------- ------- --------- -------
TIER 1 CAPITAL TO AVERAGE ASSETS (LEVERAGE)
First Community Bancshares, Inc. $ 118,618 8.10% $ 58,581 4.00% $ N/A N/A
First Community Bank, N. A. 107,164 7.35% 58,344 4.00% 72,930 5.00%
---------- ------- --------- ------- --------- -------
</Table>
65
<Table>
<Caption>
December 31, 2001
-----------------------------------------------------------------------------
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------- --------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ------- --------- ------- --------- -------
(Amounts in Thousands)
TOTAL CAPITAL TO RISK-WEIGHTED ASSETS
First Community Bancshares, Inc. $ 118,296 12.10% $ 78,234 8.00% $ N/A N/A
First Community Bank, N. A. 106,957 10.98% 77,933 8.00% 97,417 10.00%
---------- ------- --------- ------- --------- -------
TIER 1 CAPITAL TO RISK-WEIGHTED ASSETS
First Community Bancshares, Inc. $ 105,809 10.82% $ 39,117 4.00% $ N/A N/A
First Community Bank, N. A. 94,753 9.73% 38,967 4.00% 58,450 6.00%
---------- ------- --------- ------- --------- -------
TIER 1 CAPITAL TO AVERAGE ASSETS (LEVERAGE)
First Community Bancshares, Inc. $ 105,809 7.93% $ 53,398 4.00% $ N/A N/A
First Community Bank, N. A. 94,753 7.13% 53,170 4.00% 66,462 5.00%
---------- ------- --------- ------- --------- -------
</Table>
The tangible common equity ratio excludes goodwill and other intangible assets
from both the numerator and denominator.
Tier 1 capital consists of total equity plus qualifying capital securities and
minority interests, less unrealized gains and losses accumulated in other
comprehensive income, certain intangible assets, and adjustments related to the
valuation of mortgage servicing assets and certain equity investments in
non-financial companies (principal investments).
Total risk-based capital is comprised of Tier 1 capital plus qualifying
subordinated debt and allowance for loan losses and a portion of unrealized
gains on certain equity securities.
Both the Tier 1 and the total risk-based capital ratios are computed by dividing
the respective capital amounts by risk-weighted assets, as defined.
The leverage ratio reflects Tier 1 capital divided by average total assets for
the period. Average assets used in the calculation exclude certain intangible
and mortgage servicing assets.
NOTE 14. OTHER OPERATING EXPENSES
Included in other operating expenses are certain costs, the total of which
exceeds one percent of combined interest income and non-interest income.
Following are such costs for the years indicated:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
2002 2001 2000
-------- -------- --------
(Amounts in Thousands)
Advertising and public relations $ 1,347 $ 1,223 $ *
Other service fees $ 1,547 $ 1,261 $ *
Telephone and data communications $ 1,207 $ * $ *
</Table>
* Cost did not exceed the one percent requirement for the reported period.
66
NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value information about financial instruments, whether or not recognized in
the balance sheet, for which it is practical to estimate the value is based upon
the characteristics of the instruments and relevant market information.
Financial instruments include cash, evidence of ownership in an entity, or
contracts that convey or impose on an entity the contractual right or obligation
to either receive or deliver cash for another financial instrument. Fair value
is the amount at which a financial instrument could be exchanged in a current
transaction between willing parties, other than in a forced sale or liquidation,
and is best evidenced by a quoted market price if one exists.
The following summary presents the methodologies and assumptions used to
estimate the fair value of the Company's financial instruments presented below.
The information used to determine fair value is highly subjective and judgmental
in nature and, therefore, the results may not be precise. Subjective factors
include, among other things, estimates of cash flows, risk characteristics,
credit quality, and interest rates, all of which are subject to change. Since
the fair value is estimated as of the balance sheet date, the amounts that will
actually be realized or paid upon settlement or maturity on these various
instruments could be significantly different.
<Table>
<Caption>
2002 2001
-------------------------------------------------
CARRYING Carrying
AMOUNT FAIR VALUE Amount Fair Value
-------- ---------- -------- ----------
(Amounts in Thousands)
Assets:
Cash and cash equivalents $124,585 $ 124,585 $ 47,815 $ 47,815
Securities available for sale 300,885 300,885 354,007 354,007
Securities held to maturity 41,014 43,342 41,884 43,393
Derivative financial instruments 1,677 1,677 480 480
Loans held for sale 66,364 67,503 65,532 66,787
Loans held for investment 913,211 933,691 890,544 905,361
Interest receivable 7,897 7,897 8,765 8,765
Liabilities:
Demand deposits 165,557 165,557 161,346 161,346
Interest-bearing demand deposits 200,296 200,296 183,685 183,685
Savings deposits 180,786 180,786 142,839 142,839
Time deposits 593,088 604,313 590,390 593,548
Federal funds purchased -- -- 26,500 26,500
Securities sold under agreements to repurchase 91,877 92,112 79,262 79,524
Interest, taxes and other obligations 15,940 15,940 15,852 15,852
Other indebtedness 124,357 141,496 145,320 155,104
</Table>
67
FINANCIAL INSTRUMENTS WITH BOOK VALUE EQUAL TO FAIR VALUE
The book values of cash and due from banks, federal funds sold and purchased,
interest receivable, and interest, taxes and other liabilities are considered to
be equal to fair value as a result of the short-term nature of these items.
SECURITIES AVAILABLE FOR SALE
For securities available for sale, fair value is based on current market
quotations, where available. If quoted market prices are not available, fair
value has been based on the quoted price of similar instruments.
SECURITIES HELD TO MATURITY
For investment securities, fair value has been based on current
market quotations, where available. If quoted market prices are not available,
fair value has been based on the quoted price of similar instruments.
DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments are recorded at estimated fair value based upon
current market pricing for similar instruments.
LOANS
The estimated value of loans held for investment is measured based upon
discounted future cash flows and using the current rates for similar loans.
Loans held for sale are recorded at lower of cost or estimated fair value. The
fair value of loans held for sale is determined based upon the market sales
price of similar loans.
DEPOSITS AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Deposits without a stated maturity, including demand, interest-bearing demand,
and savings accounts, are reported at their carrying value in accordance with
FAS No. 107. No value has been assigned to the franchise value of these
deposits. For other types of deposits with fixed maturities, fair value has been
estimated by discounting future cash flows based on interest rates currently
being offered on deposits with similar characteristics and maturities.
OTHER INDEBTEDNESS
Fair value has been estimated based on interest rates currently available to the
Company for borrowings with similar characteristics and maturities.
COMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT, AND FINANCIAL
GUARANTEES
The amount of off-balance sheet commitments to extend credit, standby letters of
credit, and financial guarantees is considered equal to fair value. Because of
the uncertainty involved in attempting to assess the likelihood and timing of
commitments being drawn upon, coupled with the lack of an established market and
the wide diversity of fee structures, the Company does not believe it is
meaningful to provide an estimate of fair value that differs from the given
value of the commitment.
68
NOTE 16. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information related to First Community Bancshares, Inc. as
of December 31, 2002 and 2001, and for each of the years ended December 31,
2002, 2001 and 2000 is as follows:
CONDENSED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31
2002 2001
--------- ---------
(Amounts in Thousands)
ASSETS
Cash $ 6,129 $ 5,820
Investment in subsidiary 140,767 121,679
Other assets 6,220 6,056
--------- ---------
Total assets $ 153,116 $ 133,555
========= =========
LIABILITIES
Other liabilities $ 654 $ 514
STOCKHOLDERS' EQUITY
Common stock 9,957 9,955
Additional paid-in capital 58,642 60,189
Retained earnings 79,084 62,566
Treasury stock (1,982) (424)
Accumulated other comprehensive income 6,761 755
--------- ---------
Total stockholders' equity 152,462 133,041
--------- ---------
Total liabilities and stockholders' equity $ 153,116 $ 133,555
========= =========
</Table>
CONDENSED STATEMENTS OF INCOME
<Table>
<Caption>
DECEMBER 31,
2002 2001 2000
----------- ----------- ----------
(Amounts in Thousands, Except Per Share Data)
Cash dividends received from subsidiary bank $ 11,500 $ 8,500 $ 7,000
----------- ----------- ----------
Other income 650 331 339
Operating expense (759) (552) (278)
----------- ----------- ----------
11,391 8,279 7,061
Income tax benefit 311 72 (18)
Equity in undistributed earnings of subsidiary 13,017 10,783 10,020
----------- ----------- ----------
Net income $ 24,719 $ 19,134 $ 17,063
----------- ----------- ----------
Basic earnings per share $ 2.49 $ 1.92 $ 1.78
----------- ----------- ----------
Diluted earnings per share $ 2.48 $ 1.92 $ 1.78
=========== =========== ==========
</Table>
69
CONDENSED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEARS ENDING DECEMBER 31,
2002 2001 2000
------------ ------------ ------------
(Amounts in Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 24,719 $ 19,134 $ 17,063
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed earnings of subsidiary (13,017) (10,783) (10,020)
(Decrease) increase in other assets (138) 85 132
Gain on sale of assets (375) (9) --
Increase in other liabilities 1,169 621 138
Other, net 185 -- --
------------ ------------ ------------
Net cash provided by operating activities 12,543 9,048 7,313
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities available for sale (1,671) (2,855) (1,038)
Proceeds from sale of securities available for sale 1,954 586 26
------------ ------------ ------------
Net cash provided by(used in) investing activities 283 (2,269) (1,012)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt (100) -- --
Acquisition of treasury stock (2,491) (599) (2,869)
Dividends paid (9,926) (8,875) (8,338)
------------ ------------ ------------
Net cash used in financing activities (12,517) (9,474) (11,207)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 309 (2,695) (4,906)
Cash and cash equivalents at beginning of year 5,820 8,515 13,421
------------ ------------ ------------
Cash and cash equivalents at end of year $ 6,129 $ 5,820 $ 8,515
============ ============ ============
</Table>
NOTE 17. SEGMENT INFORMATION
The Company operates two business segments: community banking and mortgage
banking. These segments are primarily identified by the products or services
offered and the channels through which they are offered. The community banking
segment consists of the Company's full-service bank which offers customers
traditional banking products and services through various delivery channels. The
mortgage banking segment consists of mortgage brokerage facilities that
originate, acquire, and sell mortgage products. The accounting policies for each
of the business segments are the same as those of the Company described in Note
1.
70
Information for each of the segments is included below:
<Table>
<Caption>
DECEMBER 31, 2002
---------------------------------------------------------------------------
COMMUNITY MORTGAGE
BANKING BANKING PARENT ELIMINATIONS TOTAL
------------ ------------ ------------ ------------ ------------
(AMOUNTS IN THOUSANDS)
Net interest income $ 59,998 $ 915 $ 268 $ 15 $ 61,196
Provision for loan losses 4,208 -- -- -- 4,208
------------ ------------ ------------ ------------ ------------
Net interest income after provision for loan losses 55,790 915 268 15 56,988
Other income 10,075 9,435 382 157 20,049
Other expenses 31,786 9,552 759 172 42,269
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes 34,079 798 (109) -- 34,768
Income tax expense (benefit) 10,051 309 (311) -- 10,049
------------ ------------ ------------ ------------ ------------
Net income $ 24,028 $ 489 $ 202 $ -- $ 24,719
============ ============ ============ ============ ============
Average assets $ 1,467,969 $ 62,457 $ 143,356 $ (201,538) $ 1,472,244
============ ============ ============ ============ ============
</Table>
<Table>
<Caption>
December 31, 2001
---------------------------------------------------------------------------
Community Mortgage
Banking Banking Parent Eliminations Total
------------ ------------ ------------ ------------ ------------
(Amounts in Thousands)
Net interest income $ 49,379 $ 462 $ 315 $ 264 $ 50,420
Provision for loan losses 5,134 -- -- -- 5,134
------------ ------------ ------------ ------------ ------------
Net interest income after provision for loan losses 44,245 462 315 264 45,286
Other income 10,839 9,582 16 (162) 20,275
Other expenses 29,285 8,086 552 102 38,025
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes 25,799 1,958 (221) -- 27,536
Income tax expense (benefit) 7,805 669 (72) -- 8,402
------------ ------------ ------------ ------------ ------------
Net income $ 17,994 $ 1,289 $ (149) $ -- $ 19,134
============ ============ ============ ============ ============
Average assets $ 1,365,164 $ 45,271 $ 128,732 $ (252,853) $ 1,286,314
============ ============ ============ ============ ============
</Table>
<Table>
<Caption>
December 31, 2000
---------------------------------------------------------------------------
Community Mortgage
Banking Banking Parent Eliminations Total
------------ ------------ ------------ ------------ ------------
(Amounts in Thousands)
Net interest income $ 45,969 $ 65 $ 339 $ 206 $ 46,579
Provision for loan losses 3,986 -- -- -- 3,986
------------ ------------ ------------ ------------ ------------
Net interest income after provision for loan losses 41,983 65 339 206 42,593
Other income 7,911 4,651 -- (70) 12,492
Other expenses 25,560 4,994 278 136 30,968
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes 24,334 (278) 61 -- 24,117
Income tax expense (benefit) 7,122 (86) 18 -- 7,054
------------ ------------ ------------ ------------ ------------
Net income $ 17,212 $ (192) $ 43 $ -- $ 17,063
============ ============ ============ ============ ============
Average assets $ 1,124,304 $ 7,024 $ 108,133 $ (111,782) $ 1,127,679
============ ============ ============ ============ ============
</Table>
71
NOTE 18. SUPPLEMENTAL FINANCIAL DATA (UNAUDITED)
Quarterly earnings for the years ended December 31, 2002 and 2001 are as
follows:
<Table>
<Caption>
FIRST COMMUNITY BANCSHARES, INC.
QUARTERLY EARNINGS SUMMARY
2002
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
------------ ------------ ------------ -----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest income $ 24,043 $ 24,179 $ 24,451 $ 23,531
Interest expense 9,570 9,007 8,440 7,991
------------ ------------ ------------ -----------
Net interest income 14,473 15,172 16,011 15,540
Provision for loan losses 937 1,022 1,302 947
------------ ------------ ------------ -----------
Net interest income after provision for loan losses 13,536 14,150 14,709 14,593
Other income 5,677 4,955 4,975 4,833
Securities gains (losses) 177 9 22 (599)
Other expenses 10,609 10,446 10,251 10,963
------------ ------------ ------------ -----------
Income before income taxes 8,781 8,668 9,455 7,864
Income taxes 2,464 2,630 2,869 2,086
------------ ------------ ------------ -----------
Net income 6,317 6,038 6,586 $ 5,778
------------
FAS147 goodwill amortization 139 142 143 *
------------ ------------ ------------
Net income as previously reported $ 6,178 $ 5,896 $ 6,443 *
============ ============ ===========
Per share:
Basic earnings $ 0.64 $ 0.61 $ 0.66 $ 0.58
Diluted $ 0.64 $ 0.61 $ 0.66 $ 0.57
Earnings per share as previously reported $ 0.62 $ 0.59 $ 0.65 $ *
Dividends $ 0.25 $ 0.25 $ 0.25 $ 0.25
Weighted-average basic shares outstanding 9,933 9,945 9,928 9,893
============ ============ ============ ============
Weighted-average diluted shares outstanding 9,978 9,994 9,978 9,945
============ ============ ============ ============
</Table>
72
<Table>
<Caption>
FIRST COMMUNITY BANCSHARES, INC.
QUARTERLY EARNINGS SUMMARY
2001
March 31 June 30 Sept. 30 Dec. 31
---------- ---------- ---------- ----------
(Amounts in Thousands, Except Per Share Data)
Interest income $ 22,901 $ 23,135 $ 23,390 $ 23,403
Interest expense 10,986 10,882 10,580 9,961
---------- ---------- ---------- ----------
Net interest income 11,915 12,253 12,810 13,442
Provision for loan losses 747 985 1,282 2,120
---------- ---------- ---------- ----------
Net interest income after provision for loan losses 11,168 11,268 11,528 11,322
Other income 4,167 5,010 5,333 5,584
Securities gains (losses) 51 (7) 153 (16)
Other expenses 8,953 9,628 9,703 9,741
---------- ---------- ---------- ----------
Income before income taxes 6,433 6,643 7,311 7,149
Income taxes 1,977 2,034 2,311 2,080
---------- ---------- ---------- ----------
Net income as reported 4,456 4,609 5,000 5,069
FAS142 & 147 goodwill amortization 458 464 468 485
---------- ---------- ---------- ----------
Adjusted net income $ 4,914 $ 5,073 $ 5,468 $ 5,554
---------- ---------- ---------- ----------
Per share:
Basic earnings and diluted $ 0.45 $ 0.46 $ 0.50 $ 0.51
Basic & diluted earnings per share adjusted for FAS142 & 147 $ 0.49 $ 0.51 $ 0.55 $ 0.56
Dividends $ 0.21 $ 0.21 $ 0.21 $ 0.26
Weighted-average basic shares outstanding 9,945 9,948 9,944 9,940
========== ========== ========== ==========
Weighted-average diluted shares outstanding 9,952 9,967 10,003 9,992
========== ========== ========== ==========
</Table>
* Goodwill amortization on branch acquisitions ceased October 1, 2002 in
accordance with FAS147. Goodwill amortization on all other purchase business
combinations ceased on January 1, 2002.
73
REPORT OF INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS
OF FIRST COMMUNITY BANCSHARES, INC.
We have audited the accompanying consolidated balance sheets of First Community
Bancshares, Inc. and subsidiary as of December 31, 2002 and 2001, and the
related consolidated statements of income, cash flows and changes in
stockholders' equity for each of the three years in the period ended December
31, 2002. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of First Community
Bancshares, Inc. and subsidiary at December 31, 2002 and 2001, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, in 2002 the
Company changed its method of accounting for goodwill as required by Financial
Accounting Standards Board Statement No. 142, Goodwill and Other Intangible
Assets, and Statement No. 147, Acquisitions of Certain Financial Institutions.
/s/ ERNST & YOUNG LLP
Charleston, West Virginia
January 27, 2003
74
REPORT OF MANAGEMENT'S RESPONSIBILITIES
The management of First Community Bancshares, Inc. is responsible for the
integrity of its financial statements and their preparation in accordance with
accounting principles generally accepted in the United States. To fulfill this
responsibility requires the maintenance of a sound accounting system supported
by strong internal controls. The Company believes it has a high level of
internal control which is maintained by the recruitment and training of
qualified personnel, appropriate divisions of responsibility, the development
and communication of accounting and other procedures, and comprehensive internal
audits.
Our independent auditors, Ernst & Young LLP, are engaged to audit, and render an
opinion on, the fairness of our consolidated financial statements in conformity
with accounting principles generally accepted in the United States. Our
independent auditors obtain an understanding of our internal accounting control
systems, review selected transactions and carry out other auditing procedures
before expressing their opinion on our consolidated financial statements.
The Board of Directors has appointed an Audit Committee, composed of outside
directors, that periodically meets with the independent auditors, bank
examiners, management and internal auditors to review the work of each. The
independent auditors, bank examiners and the Company's internal auditors have
free access to meet with the Audit Committee without management's presence.
/s/ JOHN M. MENDEZ
John M. Mendez, President & Chief Executive Officer
/s/ KENNETH P. MULKEY
Kenneth P. Mulkey, Controller
/s/ ROBERT L. SCHUMACHER
Robert L. Schumacher, Chief Financial Officer
75
BOARD OF DIRECTORS OFFICERS
FIRST COMMUNITY BANCSHARES, INC. FIRST COMMUNITY BANCSHARES, INC.
SAM CLARK (Emeritus) John M. Mendez
Agent, State Farm Insurance President and Chief Executive Officer
Owner, Country Junction Company, Inc.
ROBERT L. SCHUMACHER
ALLEN T. HAMNER Chief Financial Officer
Professor of Chemistry, West Virginia
Wesleyan College; Member Executive
Committee and Chairman, Audit Committee ROBERT L. BUZZO
Vice President and Secretary
B. W. HARVEY
President, Highlands Real Estate E. STEPHEN LILLY
Management, Inc.; Member Executive Chief Operating Officer
Committee and Audit Committee
KENNETH P. MULKEY
I. NORRIS KANTOR Controller
Partner, Katz, Kantor & Perkins,
Attorneys-at-Law
JOHN M. MENDEZ
President and Chief Executive Officer,
First Community Bancshares, Inc.;
Executive Vice President, First Community
Bank, N. A.; Member Executive Committee
A. A. MODENA
Past Executive Vice President and Secretary,
First Community Bancshares, Inc.;
Past President & Chief Executive Officer,
The Flat Top National Bank of Bluefield;
Member Executive Committee
ROBERT E. PERKINSON, JR.
Past Vice President - Operations,
MAPCO Coal, Inc. - Virginia Region;
Vice Chairman, Audit Committee
WILLIAM P. STAFFORD
President, Princeton Machinery Service, Inc.;
Chairman, First Community Bancshares, Inc.;
Member Executive Committee and
Audit Committee
WILLIAM P. STAFFORD, II
Attorney-at-Law, Brewster, Morhous,
Cameron, Mullins, Caruth, Moore, Kersey &
Stafford, PLLC; Member Executive Committee
W. W. TINDER, JR.
Chairman of the Board and Chief Executive
Officer, Tinder Enterprises, Inc.;
CEO, Tinco Leasing Corporation (Real Estate
Holdings); Member Executive Committee
76
BOARD OF DIRECTORS
FIRST COMMUNITY BANK, N. A.
<Table>
K. A. AMMAR, JR. A. A. MODENA
President and Chief Executive Officer, Past Executive Vice President and Secretary,
Ammar's Inc. and Magic Mart First Community Bancshares, Inc.;
Past President and Chief Executive Officer,
The Flat Top National Bank of Bluefield
DR. JAMES P. BAILEY
Veterinarian, Veterinary Associates, Inc.
Chairman Emeritus, ROBERT E. PERKINSON, JR.
First Community Bank, N. A. Past Vice President - Operations,
MAPCO Coal, Inc. - Virginia Region
W. C. BLANKENSHIP, JR.
Agent, State Farm Insurance CLYDE B. RATLIFF
President, Gasco Drilling, Inc.
D. L. BOWLING, JR.
President, True Energy, Inc. RICHARD G. RUNDLE
Attorney-at-Law, Rundle and Rundle, LC
JUANITA G. BRYAN
Homemaker WILLIAM P. STAFFORD
President, Princeton Machinery Service, Inc.
ROBERT L. BUZZO
Vice President and Secretary, WILLIAM P. STAFFORD, II
First Community Bancshares, Inc. Attorney at Law, Brewster,
President, First Community Bank, N. A. Morhous, Cameron, Mullins, Caruth, Moore,
Kersey & Stafford, PLLC
SAM CLARK
Agent, State Farm Insurance W. W. TINDER, JR.
Owner, Country Junction Company, Inc. Chairman and Chief Executive Officer,
Tinder Enterprises, Inc.
C. WILLIAM DAVIS
Attorney-at-Law, Richardson & Davis DALE F. WOODY
President, Woody Lumber Company
ALLEN T. HAMNER, PH.D.
Professor of Chemistry,
West Virginia Wesleyan College
B. W. HARVEY
President, Highlands Real Estate
Management, Inc.; Chairman, First
Community Bank, N. A.
I. NORRIS KANTOR
Partner, Katz, Kantor & Perkins,
Attorneys-at-Law
JOHN M. MENDEZ
President and Chief Executive Officer, First
Community Bancshares, Inc.; Executive Vice
President, First Community Bank, N. A.
</Table>
77
LOCATIONS & Other Information
First Community Bank, N. A.
<Table>
1001 Mercer Street Main Street 302 Washington Square
Princeton, West Virginia Rowlesburg, West Virginia 26425 Richlands, Virginia 24641
24740-5939 (304) 454-2431 (276) 964-7454
(304) 487-9000 or (304) 327-5175
Pine Plaza Branch (304) 431-2225 16 West Main Street Chase Street & Alley 7
Richwood, West Virginia 26261 Clintwood, Virginia 24228
211 Federal Street (304) 846-2641 (276) 926-4671
Bluefield, West Virginia 24701-0950
(304) 325-7151 Railroad and White Avenue 747 Fort Chiswell Road
Mercer Mall Branch (304) 327-0431 Richwood, West Virginia 26261 Max Meadows, Virginia 24360
(304) 846-2641 (276) 637-3122
Blue Prince Road, Green Valley
Bluefield, West Virginia 24701-6160 874 Broad Street 8044 Main Street
(304) 325-3641 Summersville, West Virginia 26651 Pound, Virginia 24279
(304) 872-4402 (276) 796-5431
Highway 52
Bluefield, West Virginia 24701-3068 Route 20 & Williams River Road 910 East Main Street
(304) 589-3301 Cowen, West Virginia 26206 Wytheville, Virginia 24382
(304) 226-5924 (276) 228-1901
101 Vermillion Street
Athens, West Virginia 24712 Route 55, Red Oak Plaza 431 South Main Street
(304) 384-9010 Craigsville, West Virginia 26205 Emporia, Virginia 23847-2313
(304) 742-5101 (434) 634-8866
Corner of Bank & Cedar Streets
Pineville, West Virginia 24874-0249 111 Citizens Drive 4677 Main Street
(304) 732-7011 Beckley, West Virginia 25801-2970 Drakes Branch, Virginia 23937
East Pineville Branch (304) 252-9400 (434) 568-3301
(304) 732-7011
50 Brookshire Lane 125 West Atlantic Street
Mullens Shopping Plaza Beckley, West Virginia 25801-6765 Emporia, Virginia 23847
Route 54 (304) 254-9041 (434) 634-6555
Mullens, West Virginia 25882
(304) 294-0700 119 Main Street 511 Main Street
Greenville, West Virginia 24945 Clifton Forge, Virginia 24422
Route 10, Cook Parkway (304) 832-6265 (540) 862-4251
Oceana, West Virginia 24870-1680
(304) 682-8244 298 Stokes Drive 101 Brookfall Dairy Road
Hinton, West Virginia 25951 Elkin, North Carolina 28621
2 West Main Street (304) 466-5502 (336) 835-2265
Buckhannon, West Virginia 26201-0280
(304) 472-1112 U. S. 219 North 5519 Mountain View Road
Lindside, West Virginia 24951 Hays, North Carolina 28635
100 Market Street (304) 753-4311 (336) 696-2265
Man, West Virginia 25635
(304) 583-6525 101 Sanders Lane 57 N. Main Street
Bluefield, Virginia 24605 Sparta, North Carolina 28675
Corner of Main & Latrobe Streets (276) 322-5487 (336) 372-2265
Grafton, West Virginia 26354-0278
(304) 265-1111 643 E. Riverside Drive 150 N. Center Street
Tazewell, Virginia 24651 Taylorsville, North Carolina 28681
216 Lincoln Street (276) 988-5577 (828) 632-2265
Grafton, West Virginia 26354-1442
(304) 265-5111
</Table>
78
<Table>
<Caption>
Subsidiaries of First Community Bank, N. A. Financial Information
UNITED FIRST MORTGAGE, INC. CORPORATE HEADQUARTERS
(A WHOLLY OWNED SUBSIDIARY OF FIRST COMMUNITY BANK, N. A.) One Community Place
1503 Santa Rosa Road, Suite 109 P.O. Box 989
P. O. Box K-177 Bluefield, Virginia 24605-0989
Richmond, Virginia 23288 (276) 326-9000
(804) 282-5631 (276) 326-9010 Fax
STONE CAPITAL MANAGEMENT, INC.
(A WHOLLY OWNED SUBSIDIARY OF FIRST COMMUNITY BANK, N. A.) STOCK REGISTRAR AND TRANSFER AGENT
207 Brookshire Lane Registrar and Transfer Company
Beckley, West Virginia 25801 10 Commerce Drive
(304) 256-3982 Cranford, New Jersey 07016-3572
(800) 368-5948
FORM 10-K
The Annual Report on Form 10-K, filed with the Securities and
Exchange Commission, is available to shareholders upon request
to the Chief Financial Officer of First Community Bancshares, Inc.
or through the Company's website listed below.
FINANCIAL CONTACT
Robert L. Schumacher
Chief Financial Officer
First Community Bancshares, Inc.
P. O. Box 989
Bluefield, Virginia 24605-0989
Phone: (276) 326-9000
INTERNET ACCESS
Website: www.fcbinc.com
E-mail: ir@fcbinc.com
Website: www.fcbresource.com
E-mail: marketing@fcbinc.com
</Table>
NOTES
79
(FIRST COMMUNITY BANCSHARES, INC. LOGO)
First Community Bancshares, Inc.
One Community Place
Bluefield, VA 24605
276-326-9000
www.fcbinc.com