FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended: March 31, 2003
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from:__________________ to __________________
Commission File Number: 0-19297
First Community Bancshares, Inc.
(Exact name of registrant as specified in its charter)
Nevada 55-0694814
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
One Community Place, Bluefield, Virginia 24605
(Address of principal executive offices) (Zip Code)
(276) 326-9000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No | |
Indicate by check mark whether Registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2).
Yes |X| No| |
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at April 30, 2003
Common Stock, $1 Par Value 9,831,092
------------
First Community Bancshares, Inc.
FORM 10-Q
For the quarter ended March 31, 2003
INDEX
PART I. FINANCIAL INFORMATION REFERENCE
---------
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2003 and
December 31, 2002 3
Consolidated Statements of Income for the Three
Month Periods Ended March 31, 2003 and 2002 4
Consolidated Statements of Cash Flows for the
Three Month Periods Ended March 31, 2003 and 2002 5
Consolidated Statements of Changes in Stockholders'
Equity for the Three Months Ended March 31,
2003 and 2002 6
Notes to Consolidated Financial Statements 7-13
Independent Accountants' Review Report 14
Item 2.Management's Discussion and Analysis of Financial
Condition and Results of Operations 15-25
Item 3.Quantitative and Qualitative Disclosures about 25
Market Risk
Item 4.Controls and Procedures 27
PART II. OTHER INFORMATION
Item 1.Legal Proceedings 27
Item 2.Changes in Securities and Use of Proceeds 27
Item 3.Defaults Upon Senior Securities 27
Item 4.Submission of Matters to a Vote of 27
Security Holders
Item 5.Other Information 27
Item 6.Exhibits and Reports on Form 8-K 27
SIGNATURES 30
Certifications 31
2
PART I. ITEM 1. FINANCIAL STATEMENTS
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31 December 31
2003 2002
ASSETS (UNAUDITED) (Note 1)
------------- -------------
CASH AND DUE FROM BANKS $ 36,979 $ 33,364
INTEREST-BEARING BALANCES WITH
BANKS 63,146 88,064
FEDERAL FUNDS SOLD 4 3,157
------------- -------------
TOTAL CASH AND CASH EQUIVALENTS 100,129 124,585
SECURITIES AVAILABLE FOR SALE (AMORTIZED COST OF $362,865 AT
MARCH 31, 2003; $289,616 AT DECEMBER 31, 2002) 372,926 300,885
SECURITIES HELD TO MATURITY (FAIR VALUE OF $42,410 AT
MARCH 31, 2003; $43,342 AT DECEMBER 31, 2002) 40,084 41,014
LOANS HELD FOR SALE 50,753 66,364
LOANS HELD FOR INVESTEMENT, NET OF UNEARNED INCOME 897,194 927,621
LESS ALLOWANCE FOR LOAN LOSSES 13,782 14,410
------------- -------------
NET LOANS HELD FOR INVESTMENT 883,412 913,211
PREMISES AND EQUIPMENT 25,417 25,078
OTHER REAL ESTATE OWNED 2,545 2,855
INTEREST RECEIVABLE 8,210 7,897
OTHER ASSETS 18,524 15,391
GOODWILL 26,038 25,758
OTHER INTANGIBLE ASSETS 1,072 1,325
------------- -------------
TOTAL ASSETS $ 1,529,110 $ 1,524,363
============= =============
LIABILITIES
DEPOSITS:
NONINTEREST-BEARING $ 162,998 $ 165,557
INTEREST-BEARING 990,704 974,170
------------- -------------
TOTAL DEPOSITS 1,153,702 1,139,727
INTEREST, TAXES AND OTHER
LIABILITIES 14,663 15,940
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE 95,621 91,877
FHLB BORROWINGS AND OTHER INDEBTEDNESS 110,429 124,357
------------- -------------
TOTAL LIABILITIES 1,374,415 1,371,901
------------- -------------
STOCKHOLDERS' EQUITY
PREFERRED STOCK, PAR VALUE UNDESIGNATED; 1,000,000 SHARES
AUTHORIZED;
NO SHARES ISSUED AND OUTSTANDING IN 2003 AND 2002 -- --
COMMON STOCK, $1 PAR VALUE; 15,000,000 SHARES AUTHORIZED;
9,965,123 AND 9,956,714 ISSUED IN 2003 AND 2002; AND 9,846,092
AND 9,988,482 OUTSTANDING IN 2003 AND 2002, RESPECTIVELY 9,965 9,957
ADDITIONAL PAID-IN CAPITAL 58,970 58,642
RETAINED EARNINGS 83,267 79,084
TREASURY STOCK, AT COST (3,543) (1,982)
ACCUMULATED OTHER COMPREHENSIVE INCOME 6,036 6,761
------------- -------------
TOTAL STOCKHOLDERS' EQUITY 154,695 152,462
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,529,110 $ 1,524,363
============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED)
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31 MARCH 31
2003 2002
------------ ------------
INTEREST INCOME:
INTEREST AND FEES ON LOANS HELD FOR
INVESTMENT $ 16,892 $ 18,036
INTEREST ON LOANS HELD FOR SALE 629 844
INTEREST ON SECURITIES-TAXABLE 3,145 3,378
INTEREST ON SECURITIES-NONTAXABLE 1,657 1,742
INTEREST ON FEDERAL FUNDS SOLD AND DEPOSITS IN BANKS 215 43
------------ ------------
TOTAL INTEREST INCOME 22,538 24,043
------------ ------------
INTEREST EXPENSE:
INTEREST ON DEPOSITS 5,317 6,993
INTEREST ON SHORT-TERM BORROWINGS 1,893 2,427
INTEREST ON OTHER DEBT 148 150
------------ ------------
TOTAL INTEREST EXPENSE 7,358 9,570
------------ ------------
NET INTEREST INCOME 15,180 14,473
PROVISION FOR LOAN LOSSES 589 937
------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 14,591 13,536
------------ ------------
NONINTEREST INCOME:
FIDUCIARY INCOME 416 343
SERVICE CHARGES ON DEPOSIT ACCOUNTS 1,821 1,463
OTHER SERVICE CHARGES, COMMISSIONS AND FEES 513 326
MORTGAGE BANKING INCOME 2,964 3,249
OTHER OPERATING INCOME 297 296
GAIN ON SECURITIES 20 177
------------ ------------
TOTAL NONINTEREST INCOME 6,031 5,854
------------ ------------
NONINTEREST EXPENSE:
SALARIES AND EMPLOYEE BENEFITS 6,333 5,803
OCCUPANCY EXPENSE OF BANK PREMISES 849 743
FURNITURE AND EQUIPMENT EXPENSE 530 503
CORE DEPOSIT AMORTIZATION 63 59
OTHER OPERATING EXPENSE 3,356 3,501
------------ ------------
TOTAL NONINTEREST EXPENSE 11,131 10,609
------------ ------------
INCOME BEFORE INCOME TAXES 9,491 8,781
INCOME TAX EXPENSE 2,743 2,464
------------ ------------
NET INCOME $ 6,748 $ 6,317
============ ============
BASIC AND DILUTED EARNINGS PER COMMON SHARE $ 0.68 $ 0.64
============ ============
WEIGHTED AVERAGE BASIC SHARES OUTSTANDING 9,870,279 9,933,222
============ ============
WEIGHTED AVERAGE DILUTED SHARES OUTSTANDING 9,921,346 9,977,531
============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS) (UNAUDITED)
THREE MONTHS ENDED
MARCH 31
2003 2002
--------- ---------
OPERATING ACTIVITIES:
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 6,748 $ 6,317
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
PROVISION FOR LOAN LOSSES 589 937
DEPRECIATION OF PREMISES AND EQUIPMENT 437 376
AMORTIZATION OF INTANGIBLE ASSETS 51 9
NET INVESTMENT AMORTIZATION AND ACCRETION 510 415
NET GAIN ON THE SALE OF ASSETS (60) (109)
NET GAIN ON SALE OF LOANS (4,753) (1,819)
MORTGAGE LOANS ORIGINATED FOR SALE (206,856) (148,816)
PROCEEDS FROM SALE OF MORTGAGE LOANS 226,599 168,074
INCREASE IN INTEREST RECEIVABLE (313) (374)
INCREASE IN OTHER ASSETS (2,448) (4,126)
(DECREASE) INCREASE IN OTHER LIABILITIES (505) 1,214
OTHER, NET 339 686
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 20,338 22,784
--------- ---------
INVESTING ACTIVITIES:
CASH FLOWS FROM INVESTING ACTIVITIES:
PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE 505 2,792
PROCEEDS FROM MATURITIES AND CALLS OF SECURITIES AVAILABLE
FOR SALE 27,074 12,297
PROCEEDS FROM MATURITIES AND CALLS OF SECURITIES HELD TO
MATURITY 928 445
PURCHASE OF SECURITIES AVAILABLE FOR SALE (101,316) (31,719)
NET DECREASE (INCREASE) IN LOANS MADE TO CUSTOMERS 30,148 (7,414)
PURCHASE OF PREMISES AND EQUIPMENT (948) (842)
SALE OF EQUIPMENT 58
NET CASH PROVIDED BY ACQUISITIONS 30
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (43,521) (24,441)
--------- ---------
FINANCING ACTIVITIES:
CASH FLOWS FROM FINANCING ACTIVITIES:
NET INCREASE IN DEMAND AND SAVINGS DEPOSITS 7,194 16,938
NET INCREASE (DECREASE) IN TIME DEPOSITS 6,844 (12,893)
NET DECREASE IN FHLB AND OTHER INDEBTEDNESS (10,179) (17,712)
REPAYMENT OF OTHER BORROWINGS (5) (105)
ACQUISITION OF TREASURY STOCK (2,562) (521)
DIVIDENDS PAID (2,565) (2,488)
--------- ---------
NET CASH USED IN FINANCING ACTIVITIES (1,273) (16,781)
--------- ---------
CASH AND CASH EQUIVALENTS
NET DECREASE IN CASH AND CASH EQUIVALENTS (24,456) (18,438)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 124,585 47,815
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 100,129 $ 29,377
========= =========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION) (UNAUDITED)
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED TREASURY COMPREHENSIVE
STOCK CAPITAL EARNINGS STOCK (LOSS) INCOME TOTAL
---------- ---------- ---------- ---------- ------------- ----------
BALANCE JANUARY 1, 2002 9,955 60,189 62,566 (424) 755 133,041
----------
COMPREHENSIVE INCOME:
NET INCOME -- -- 6,317 -- -- 6,317
OTHER COMPREHENSIVE INCOME, NET OF TAX:
NET UNREALIZED GAINS ON
SECURITIES AVAILABLE FOR SALE -- -- -- -- (1,124) (1,124)
---------- ---------- ----------
COMPREHENSIVE INCOME -- -- 6,317 -- (1,124) 5,193
---------- ---------- ----------
COMMON DIVIDENDS DECLARED
($.25 PER SHARE) -- -- (2,488) -- -- (2,488)
FRACTIONAL SHARE ADJUSTMENT FOR 10%
STOCK DIVIDEND 2 (1,729) 1,725 (14) (16)
PURCHASE 17,844 TREASURY SHARES AT
$29.19 PER SHARE -- -- -- (521) -- (521)
ISSUANCE OF TREASURY SHARES TO ESOP 140 792 932
---------- ---------- ---------- ---------- ---------- ----------
BALANCE MARCH 31, 2002 9,957 58,600 68,120 (167) (369) 136,141
========== ========== ========== ========== ========== ==========
BALANCE JANUARY 1, 2003 9,957 58,642 79,084 (1,982) 6,761 152,462
----------
COMPREHENSIVE INCOME:
NET INCOME -- -- 6,748 -- -- 6,748
---------- ---------- ---------- ---------- ---------- ----------
OTHER COMPREHENSIVE INCOME, NET OF TAX:
NET UNREALIZED GAINS ON
SECURITIES AVAILABLE FOR SALE -- -- -- -- (725) (725)
---------- ---------- ----------
COMPREHENSIVE INCOME -- -- 6,748 -- (725) 6,023
---------- ---------- ---------- ---------- ---------- ----------
COMMON DIVIDENDS DECLARED
($.26 PER SHARE) -- -- (2,565) -- -- (2,565)
PURCHASE 85,000 TREASURY SHARES AT
$30.15 PER SHARE -- -- -- (2,562) -- (2,562)
8,409 SHARES ISSUED IN STONE CAPITAL ACQUISITION
(SEE NOTE 3) 8 236 244
OPTION EXERCISE 11,100 SHARES AT $23.91 49 321 370
ISSUANCE OF TREASURY SHARES TO ESOP 43 680 723
---------- ---------- ---------- ---------- ---------- ----------
BALANCE MARCH 31, 2003 9,965 58,970 83,267 (3,543) 6,036 154,695
========== ========== ========== ========== ========== ==========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. UNAUDITED FINANCIAL STATEMENTS
The unaudited consolidated balance sheet as of March 31, 2003, the unaudited
consolidated statements of income for the three months ended March 31, 2003 and
2002 and the consolidated statements of cash flows and changes in stockholders'
equity for the three months ended March 31, 2003 and 2002 have been prepared by
the management of First Community Bancshares, Inc. ("FCBI" or the "Company".).
In the opinion of management, all adjustments (including normal recurring
accruals) necessary to present fairly the financial position of FCBI and
subsidiaries at March 31, 2003 and its results of operations, cash flows, and
changes in stockholders' equity for the three months ended March 31, 2003 and
2002 have been made. These results are not necessarily indicative of the results
of consolidated operations that might be expected for the full calendar year.
The consolidated balance sheet as of December 31, 2002 has been extracted from
the audited financial statements included in the Company's 2002 Annual Report to
Stockholders. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States have been omitted in accordance with standards for
the preparation of interim financial statements. These financial statements
should be read in conjunction with the financial statements and notes thereto
included in the 2002 Annual Report of FCBI.
A more complete and detailed description of FCBI's significant accounting
policies is included within Footnote 1 to the Company's Annual Report on Form
10-K for December 31, 2002. In addition, the Company's required disclosure of
the application of critical accounting policies is included within the
"Accounting Policies and Judgments" section of Part I, Item 2. "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included herein. The following is an update to reflect the requirements of
Financial Accounting Standards Board ("FASB") Statement 148.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICY UPDATE FOR CERTAIN REQUIRED DISCLOSURES
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 ("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. 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 dilutive effect
on earnings per share.
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.
7
Assuming use of the fair value method of accounting for stock options, pro forma
net income and earnings per share for the three month periods ended March 31,
2003 and 2002 would have been estimated as follows:
2003 2002
--------- ---------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income as reported $ 6,748 $ 6,317
Less: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (39) (82)
--------- ---------
$ 6,709 $ 6,235
========= =========
Earnings per share:
Basic as reported $ 0.68 $ 0.64
Basic pro forma $ 0.68 $ 0.63
Diluted as reported $ 0.68 $ 0.64
Diluted pro forma $ 0.68 $ 0.63
NOTE 2. RECLASSIFICATIONS
Certain amounts reflected in the December 31, 2002 balance sheet have been
reclassified to conform to the balance sheet presentation used in preparation of
the March 31, 2003 financial statements that are included in this periodic
report on Form 10-Q. In addition, the requirements of FASB 142 and 147 required
the retroactive discontinuance of goodwill amortization to all prior periods
presented; therefore, earnings, earnings per share, goodwill and stockholders
equity have been adjusted accordingly.
NOTE 3. MERGERS AND ACQUISITIONS
On November 30, 2002, the Company acquired Monroe Financial, Inc. ("Monroe") and
its banking subsidiary, Bank of Greenville ("Greenville"). 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 First Community Bank, N. A. (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
at December 31, 2002. The $931,000 excess of fair market value of the net assets
acquired over the purchase price was reallocated to the non-financial assets
acquired.
In January 2003, the Bank acquired Stone Capital Management, Inc. ("Stone
Capital"), with an office in Beckley, West Virginia. This acquisition expanded
the Bank's operations into wealth management, asset allocation, financial
planning and investment advice. At December 31, 2002, Stone Capital had total
assets under management of $94 million and operates under its name in
conjunction with First Community's Trust and Financial Services Division. Stone
Capital was acquired through the issuance of 8,409 shares of Company common
stock, upon consummation of the transaction, which represents 50% of the
total consideration. The balance of the consideration will be issued in
subsequent years according to the acquisition agreement.
On January 27, 2003, the Company signed a definitive merger agreement pursuant
to which the Company will acquire The CommonWealth Bank, a Virginia-chartered
commercial bank ("CommonWealth") through merger into the Bank. The total
consideration is estimated at approximately $25.0 million. The merger is
expected to close during the second quarter of 2003, pending the approval of
CommonWealth's shareholders. All regulatory approvals have been
received. At December 31, 2002, CommonWealth had total assets of $134.1 million,
net loans of $106.2 million and total deposits of $107.3 million. CommonWealth's
shareholder meeting to vote on the business combination will occur on May 21,
2003.
NOTE 4. BORROWINGS
Federal Home Loan Bank ("FHLB") borrowings and other indebtedness are comprised
of $100 million in convertible and callable advances and $10 million of
noncallable term advances from the FHLB of Atlanta.
8
The callable advances may be called (redeemed) in quarterly increments after
various lockout periods. These call options 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 following schedule details the outstanding advances, rates and corresponding
final maturities.
ADVANCE RATE MATURITY
(AMOUNTS IN THOUSANDS)
Callable advances: 25,000 5.71% 03/17/10
25,000 6.11% 05/05/10
25,000 6.02% 05/05/10
25,000 5.47% 10/04/10
--------
100,000
========
Noncallable advances: $ 8,000 5.95% 09/02/03
2,000 6.27% 09/02/08
--------
$ 10,000
========
NOTE 5. 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 United First Mortgage
("UFM"), a wholly-owned subsidiary of the Bank. 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, loans submitted
for repurchase have not been material. UFM, in turn, remarkets these loans to
alternate investors after repurchase and cure of the borrowers' defects.
Accordingly, loan repurchases have not had a material adverse effect on the
results of operations, financial position or liquidity 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 or potentially require the repurchase of the
underlying loan. To date, UFM has been required to execute only three such
indemnification agreements covering defaults which may occur on indemnified
loans over the five-year period following the indemnification. No losses have
occurred under such agreements. In addition, due to an apparent borrower
misrepresentation that disqualified a borrower from the program, UFM has been
required to repurchase one Virginia Housing and Development loan. This loan will
be remarketed to an alternate investor. Accordingly, loan indemnifications and
repurchases under the FHA and VA loan programs have not had a material adverse
effect on the financial position, results of operations or cash flows of UFM or
the Company.
As an alternative to repurchase, in certain circumstances, UFM may have the
option to pay an indemnification fee to the investor in lieu of repurchase and
allow the investor to seek resolution of any deficiency and/or liquidation of
the collateral.
The Bank 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
9
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
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.
Financial instruments whose contract amounts represent credit risk at March 31,
2003 are commitments to extend credit (including availability of lines of
credit) of $69.5 million and standby letters of credit and financial guarantees
written of $7.3 million. In addition, at March 31, 2003, UFM had commitments to
originate loans of $138.1 million.
NOTE 6. OTHER COMPREHENSIVE INCOME
The Company currently has one component of other comprehensive income, which
includes unrealized gains and losses on securities available for sale and is
detailed as follows:
THREE MONTHS ENDED
MARCH 31 MARCH 31
2003 2002
---------- ----------
(AMOUNTS IN THOUSANDS)
OTHER COMPREHENSIVE INCOME:
Unrealized losses arising during the period $ (1,198) $ (1,687)
Tax benefit 479 669
---------- ----------
Unrealized losses arising during the period, net of tax (719) (1,018)
Reclassification adjustment for gains realized in net
income (10) (177)
Tax expense of reclassification 4 71
---------- ----------
Other comprehensive loss (725) (1,124)
Beginning accumulated other comprehensive gain 6,761 755
---------- ----------
Ending accumulated other comprehensive income (loss) $ 6,036 $ (369)
========== ==========
NOTE 7. SEGMENT INFORMATION
The Company operates two business segments: community banking and mortgage
banking. These segments are primarily identified by their products and services
and the channels through which they are offered. The community banking segment
consists of the Company's full-service bank that 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 residential mortgage products into the secondary market.
Information for each of the segments is presented below.
10
THREE MONTHS ENDED MARCH 31, 2003
-------------------------------------------------------------------------------
(AMOUNTS IN THOUSANDS)
COMMUNITY MORTGAGE PARENT ELIMINATIONS TOTAL
BANKING BANKING
------------- ------------- ------------- ------------- -------------
NET INTEREST INCOME $ 15,011 $ 124 $ 55 $ (10) $ 15,180
PROVISION FOR LOAN LOSSES 589 -- -- -- 589
------------- ------------- ------------- ------------- -------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 14,422 124 55 (10) 14,591
OTHER INCOME 3,237 2,964 (4) (166) 6,031
OTHER EXPENSES 8,646 2,386 275 (176) 11,131
------------- ------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES 9,013 702 (224) -- 9,491
INCOME TAX EXPENSE (BENEFIT) 2,600 273 (130) -- 2,743
------------- ------------- ------------- ------------- -------------
NET INCOME (LOSS) $ 6,413 $ 429 $ (94) $ -- $ 6,748
============= ============= ============= ============= =============
AVERAGE ASSETS $ 1,510,362 $ 55,642 $ 154,576 $ (205,680) $ 1,514,900
============= ============= ============= ============= =============
TOTAL ASSETS $ 1,523,133 $ 57,392 $ 155,093 $ (206,508) $ 1,529,110
============= ============= ============= ============= =============
Three Months Ended March 31, 2002
-------------------------------------------------------------------------------
(Amounts in Thousands)
Community Mortgage Parent Eliminations Total
Banking Banking
------------- ------------- ------------- ------------- -------------
Net interest income $ 14,122 $ 289 $ 57 $ 5 $ 14,473
Provision for loan losses 937 -- -- -- 937
------------- ------------- ------------- ------------- -------------
Net interest income after provision
for loan losses 13,185 289 57 5 13,536
Other income 2,347 3,249 395 (137) 5,854
Other expenses 8,122 2,379 240 (132) 10,609
------------- ------------- ------------- ------------- -------------
Income before income taxes 7,410 1,159 212 -- 8,781
Income tax expense (benefit) 1,949 455 60 -- 2,464
------------- ------------- ------------- ------------- -------------
Net income $ 5,461 $ 704 $ 152 $ -- $ 6,317
============= ============= ============= ============= =============
Average assets $ 1,451,354 $ 54,087 $ 136,430 $ (185,008) $ 1,456,863
============= ============= ============= ============= =============
Total assets $ 1,457,953 $ 54,250 $ 136,501 $ (181,096) $ 1,467,608
============= ============= ============= ============= =============
NOTE 8. RECENT ACCOUNTING DEVELOPMENTS
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 impact of Statement 147 caused the Company to cease
amortization of this component of goodwill effective October 1, 2002,
retroactive to January 1, 2002 and accordingly, restate the presentation for the
first nine months of 2002 in its 2002 annual report to shareholders.
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
11
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
requirements of FIN 45 did not have a material adverse impact on results of
operations, financial position, or liquidity in the first quarter of 2003.
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. This interpretation applies immediately to variable
interest entities created after January 31, 2003, and to variable interest
entities in which a company obtains an interest after that date. It applies in
the first fiscal year or interim period beginning after June 15, 2003, to
variable interest entities in which a company holds a variable interest that it
acquired before February 1, 2003. The Company is currently evaluating the
potential impact of adopting this interpretation.
NOTE 9. EARNINGS PER SHARE
The following schedule details earnings and shares used in computing basic and
diluted earnings per share for the three months ended March 31, 2003 and 2002.
PERIOD ENDED
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
(AMOUNTS IN THOUSANDS, EXCEPT
SHARE AND PER SHARE DATA)
Basic:
Net income $ 6,748 $ 6,317
Weighted average shares outstanding 9,870,279 9,933,222
Earnings per share $ 0.68 $ 0.64
Diluted:
Net income $ 6,748 $ 6,317
Weighted average shares outstanding 9,870,279 9,933,222
Dilutive shares for stock options 46,978 44,309
Contingently issuable shares for acquisition 4,089 --
Weighted average dilutive shares outstanding 9,921,346 9,977,531
Earnings per share-dilutive $ 0.68 $ 0.64
NOTE 10. PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Company's lending strategy stresses quality growth diversified by product,
geography, and industry. All loans made by the Company are subject to common
credit standards and a uniform underwriting system. Loans are also subject to an
annual review process which varies based on the loan size and type. The Company
utilizes this ongoing review process to evaluate loans for changes in credit
risk. This process serves as the primary means by which the Company evaluates
the adequacy of the loan loss allowance. The total loan loss allowance is
divided into the following categories: i) specifically identified loan
relationships which are on non-accrual status, ninety days
12
past due or more and loans with elements of credit weakness, and ii) formula
allowances and special allocations addressing other qualitative factors
including industry concentrations, economic conditions, staffing and other
conditions.
Specific allowances are established to cover loan relationships, which are
identified as having significant cash flow weakness and for which a collateral
deficiency may be present. The allowances established under the specific
identification method are judged based upon the borrower's estimated cash flow
and projected liquidation value of related collateral.
Formula allowances, based on historical loss experience, are available to cover
homogeneous groups of loans not individually evaluated. The formula allowance is
developed and evaluated against loans in general by specific category
(commercial, mortgage, and consumer). The allowance is developed for each loan
category based upon a review of historical loss percentages for the Company and
other qualitative factors. The calculated percentage is considered in
determining the estimated allowance excluding any relationships specifically
identified and individually evaluated. While consideration is given to credit
weaknesses for specific loans and classifications within the various categories
of loans, the allowance is available for all loan losses.
In developing the allowance for loan losses, the Company also considers various
inherent risk factors, such as current economic conditions, the level of
delinquencies and nonaccrual 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. In addition,
management continually evaluates the adequacy of the allowance for loan losses
and makes specific adjustments to the allowance based on the results of risk
analysis in the credit review process, the recommendation of regulatory
agencies, and other factors, such as loan loss experience and prevailing
economic conditions.
13
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The Audit Committee of the Board of Directors
First Community Bancshares, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of First
Community Bancshares, Inc. and subsidiary (the Company) as of March 31, 2003,
and the related consolidated statements of income, cash flows and changes in
stockholders' equity for the three-month periods ended March 31, 2003 and 2002.
These financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements referred to above
for them to be in conformity with accounting principles generally accepted in
the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of the Company as
of December 31, 2002, and the related consolidated statements of income, cash
flows and changes in stockholders' equity for the year then ended (not presented
herein) and in our report dated January 27, 2003, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 2002, is fairly stated, in all material respects, in relation to
the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
May 6, 2003
14
FIRST COMMUNITY BANCSHARES, INC.
PART I. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis is provided to address information about
the Company's financial condition and results of operations. This discussion and
analysis should be read in conjunction with the 2002 Annual Report to
Shareholders and the other financial information included in this report.
The Company is a multi-state bank holding company headquartered in Bluefield,
Virginia with total assets of $1.53 billion at March 31, 2003. FCBI through its
community banking subsidiary, First Community Bank, N. A. ("the Bank"), provides
financial, mortgage brokerage and origination and trust and investment advisory
services to individuals and commercial customers through 41 full-service banking
locations in West Virginia, Virginia and North Carolina as well as 11 mortgage
brokerage facilities operated by United First Mortgage, Inc. ("UFM") 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.
FORWARD LOOKING STATEMENTS
The Company may from time to time make written or oral "forward-looking
statements", including statements contained in its filings with the Securities
and Exchange Commission (`SEC") (including this Quarterly Report on Form 10-Q
and the Exhibits hereto and thereto), in its reports to stockholders and in
other communications which are made in good faith by the Company pursuant to the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995.
These forward-looking statements include, among others, statements with respect
to the Company's beliefs, plans, objectives, goals, guidelines, expectations,
anticipations, estimates and intentions that are subject to significant risks
and uncertainties and are subject to change based on various factors (many of
which are beyond the Company's control). The words "may", "could", "should",
"would", "believe", "anticipate", "estimate", "expect", "intend", "plan" and
similar expressions are intended to identify forward-looking statements. The
following factors, among others, could cause the Company's financial performance
to differ materially from that expressed in such forward-looking statements; the
strength of the United States economy in general and the strength of the local
economies in which the Company conducts operations; the effects of, and changes
in, trade, monetary and fiscal policies and laws, including interest rate
policies of the Board of Governors of the Federal Reserve System; inflation,
interest rate, market and monetary fluctuations; the timely development of
competitive new products and services of the Company and the acceptance of these
products and services by new and existing customers; the willingness of
customers to substitute competitors' products and services for the Company's
products and services and vice versa; the impact of changes in financial
services' laws and regulations (including laws concerning taxes, banking,
securities and insurance); technological changes; the effect of acquisitions,
including, without limitation, the failure to achieve the expected revenue
growth and/or expense savings from such acquisitions; the growth and
profitability of the Company's noninterest or fee income being less than
expected; unanticipated regulatory or judicial proceedings; changes in consumer
spending and saving habits; and the success of the Company at managing the risks
involved in the foregoing.
The Company cautions that the foregoing list of important factors is not
exclusive. The Company does not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or on
behalf of the Company.
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
15
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.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is established and
maintained at levels 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.
As more fully described in Note 10 to the Notes 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 foregoing analysis is performed by the
Company's credit administration department to evaluate the portfolio and
calculate an estimated valuation allowance through a mathematical analysis that
applies risk factors to those identified loss risk areas.
This risk management evaluation is applied at both the portfolio level and the
individual loan level for commercial loans and credit relationships while the
level of consumer and residential mortgage loan allowance is determined
primarily on a total portfolio level based on a review of historical loss
percentages, and other qualitative factors including concentrations, industry
specific factors and economic conditions. The commercial and commercial real
estate portfolios require more specific analysis of individually significant
loans and the borrower's underlying cash flow, business conditions, capacity for
debt repayment and the valuation of secondary sources of payment (collateral).
This analysis may result in specifically identified weaknesses and corresponding
specific impairment allowances.
The use of various estimates and judgements in the Company's ongoing evaluation
of the required level of allowance can significantly impact the Company's
results of operations and financial condition and may result in either greater
provisions against earnings to increase the allowance or reduced provisions
based upon management's current view of portfolio and economic conditions and
the application of revised estimates and assumptions.
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. 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 established market
pricing indications. However, loans which have yet to be committed to an
individual investor ($3.05 million at March 31, 2003) are fair valued using
prevailing market rates and service premiums for loans of like term and
comparing with recorded cost. The estimated market value for these loans at
March 31, 2003 was $3.1 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
16
wholesale brokers for subsequent resale to these national investors as well. The
loans held for sale portfolio at March 31, 2003 was $50.8 million compared to
$66.4 million at December 31, 2002.
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 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 standards for derivative instruments and for hedging activities. UFM
uses forward mortgage contracts or 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 March 31, 2003, the Company's mortgage subsidiary held an investment in
forward mortgage contracts with a notional value of $80.0 million. These
contracts hedge interest rate risk associated with RLCs and closed loans not
allocated to a forward commitment of $90.6 million. At March 31, 2003, the fair
value of the forward contracts was a liability of $375,000, which represents a
$330,000 decline from the fair value at December 31, 2002. In addition, the fair
value of the RLCs at March 31, 2003 was an asset of $1.7 million, which
represents a $546,000 decline from the fair value at December 31, 2002. The
market valuation of RLCs at March 31, 2003 assumes 62% RLC pull through. If
actual pull through in succeeding months proves to be more or less than 62%, 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 experienced, as was the case
in 2002 as well as the first quarter of 2003, as a result of the continued
decline in mortgage rates. As a result, daily pull through varied significantly
over this time period. Customer behavior is difficult to model. However, the
mathematical tool utilized by UFM implies volatility gained from market data in
order to attempt to anticipate borrower reaction to market and rate movements.
For the quarter ended March 31, 2003, the Company incurred $2.5 million in the
cost of forward mortgage derivative contracts to originate and sell $223.2
million in loans in comparison to the first quarter of the prior year where
$166.4 million in loans were originated for sale with underlying forward
mortgage contracts that cost $30,000. The lower cost of forward mortgage
contracts in the prior year is reflective of the volatility of the pricing of
these types of contracts. Although the pricing of the contracts was favorable to
the Company in the prior year, UFM's pricing on loans sold was substantially
less as a result of the market pricing dynamics. The significant increase in
hedging cost demonstrates the potential volatility to earnings and the
sensitivity to pull through assumptions. The cost of these derivative contracts
along with RLC mark to market is netted within mortgage revenues in the
statements of income to arrive at the net revenues associated with the
origination, holding and sale of mortgage loans.
The Company also provides for "market losses" derived from early payoffs of sold
loans due to refinancing opportunities by mortgage customers. The current
environment for refinance presents substantial opportunity for such payoffs and
the Company has seen an increase in the cost of "rebate of service release
premiums" to investors as a result of early payoffs. As these losses accelerate
or subside the Company will provide for this impact by either recording higher
or lower investor premium rebate provision and charges against earnings.
Although the Company provides for such losses through monthly provisions, the
current environment could result in an increase in these provisions in future
periods.
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
17
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 $913,000 excess of the
fair market value of the net assets acquired over purchase price 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 agreement, as amended, which permits
CommonWealth shareholders to elect to have up to 50% of outstanding shares
converted into the right to receive cash. The merger is expected to close during
the second quarter of 2003, pending 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. This
acquisition expanded 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.
RESULTS OF OPERATIONS
GENERAL
Net income for the first three months of 2003 totaled $6.7 million, which is
$431,000, or 6.4% higher than net income of $6.3 million reported for the
corresponding period in 2002. Net income for the first three months of the
current year resulted in basic and diluted earnings per share of $0.68 versus
$0.64 basic and diluted earnings per share reported in the first quarter of
2002, a 6.3% increase. The most significant factors contributing to this
increase were a $707,000 increase in net interest income, an increase in
fiduciary and other service charge income of $618,000, and a $348,000 decrease
in the provision for loan losses. Partially offsetting these increases were a
$285,000 decrease in mortgage banking income during the first quarter of 2003
compared to the first quarter of last year, an increase of $530,000 in salaries
and benefits and an increase in tax expense of $279,000.
NET INTEREST INCOME
Net interest income (NII), the largest contributor to earnings, was $15.2
million for the three months ended March 31, 2003 compared with $14.5 million
for the corresponding period in 2002. For purposes of this discussion,
comparison of NII is done on a tax equivalent basis which provides a common
basis for comparing yields on earning assets exempt from federal income taxes to
those which are fully taxable. Table I displays taxable equivalent yields on
earning assets and taxable equivalent Net Interest Spread (NIS) and Net Interest
Margin (NIM). As indicated on Table I, tax equivalent net interest income
totaled $16.1 million for the three months ended March 31, 2003, an increase of
$657,000 from the $15.5 million reported in the first three months of 2002. This
$657,000 includes an $810,000 increase due to rate changes on the underlying
assets and liabilities as liabilities were aggressively priced downward and a
$153,000 decrease due to volume changes as net earning assets were added to the
portfolio at declining replacement rates. Average earning assets increased $57.2
million while interest-bearing liabilities increased $41.5 million. The yield on
earning assets decreased 75 basis points between 2002 and 2003 but was offset by
an 88 basis point decline in the cost of funds. The impact of these rate and
volume changes was an increase in the net interest rate spread from 4.12% to
4.24% for the three months ended March 31, 2003, a 12 basis point increase in
the spread between interest earning assets and interest bearing liabilities over
the three months ended March 31, 2002. However, the Company's tax equivalent net
interest margin of 4.64% for the three months ended March 31, 2003 remained
unchanged from that of the first three months of 2002.
As indicated in Table I, the overall tax equivalent yield on average earning
assets decreased 75 basis points from 7.51% to 6.76% for the three months ended
March 31, 2003, compared to March 31, 2002. The largest part of this decrease
was the decrease in the overall tax equivalent yield on loans held for
investment of 45 basis points from the prior year to 7.57% as loans repriced
downward in response to the current rate environment while the average balance
decreased $7.9 million. The decline in asset yield is attributable to the
current interest rate environment which creates refinancing or repricing
incentives for fixed rate borrowers to lower their current borrowing costs. In
addition, due to the volume of loans directly tied to prime and other indices
that are either adjustable incrementally
18
or are variable rate advances, asset yields have declined in response to rate
cuts and drops in the prime loan rate which began in 2001 and continue to remain
at lows not seen in over 40 years.
The average loans held for sale balance increased slightly, by $1.6 million
while the yield decreased 199 basis points to 5.15%.
During the three months ended March 31, 2003, the taxable equivalent yield on
securities available for sale decreased 59 basis points to 5.43% while the
average balance increased $14.1 million. Consistent with the current rate
environment, the Company and the securities industry as a whole have experienced
rapid turnover in securities as higher yielding securities are either called or
prepaid as the refinancing opportunity presents itself. Although the total
portfolio grew by $14.1 million in comparison to the prior year, the relative
rate on securities acquired since March 31, 2002 has declined substantially.
Both the average balance and tax equivalent yield on investment securities held
to maturity remained relatively stable with a decrease in yield of 17 basis
points to 8.05% and a $1.1 million decrease in average balance from the first
quarter of 2002. Compared to the first quarter of 2002, average interest-bearing
balances with banks increased $48.2 million while the yield decreased 23 basis
points. This average balance increase was largely the result of funds received
from new deposit growth in existing markets and deposits obtained in the
acquisition of Greenville in the fourth quarter of 2002.
The Company actively manages its product pricing by staying abreast of the
current economic climate and competitive forces in order to enhance repricing
opportunities available to the liability side of the balance sheet. In doing so,
the cost of interest-bearing liabilities decreased by 88 basis points from 3.39%
for the three months ended March 31, 2002 to 2.51% for the same period of 2003
while the average volume increased $41.5 million. Active deposit liability
pricing management is performed weekly through the Company's product committee
with input from numerous sources throughout the Company including individual
market statistics.
Average FHLB borrowings decreased by $35.0 million when comparing the three
months ended March 31, 2003 to the corresponding period of the prior year as a
result of maturities of $25 million in June 2002 and $10 million in December
2002 while the average rate paid remained relatively the same at 5.90% in 2003
versus 5.95% in 2002. The average balance and rate paid on other borrowings
remained virtually the same in 2003 compared to 2002.
In addition, the average balances of interest-bearing demand and savings
deposits increased $15.0 and $30.8 million, respectively, during the three
months ended March 31, 2003 while the corresponding average rate on both of
these deposits categories each declined 32 basis points. Average time deposits
increased $15.5 million while the average rate paid decreased 112 basis points
from 4.26% in 2002 to 3.14% in 2003. Likewise, average Fed Funds and repurchase
agreements increased $15.4 million while the average rate decreased 42 basis
points. The level of average noninterest-bearing demand deposits changed only
slightly, up $449,000 in 2003 from the prior year. Approximately $24.0 million
of the $61.2 million increase in average interest-bearing deposit growth was
acquired in the Greenville acquisition in the fourth quarter of 2002.
19
TABLE I AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2003 MARCH 31, 2002
AVERAGE INTEREST YIELD/RATE AVERAGE INTEREST YIELD/RATE
BALANCE (1)(2) (2) BALANCE (1)(2) (2)
----------- ---------- ------------ --------- ----------- ----------
Earning Assets:
Loans (3)
Loans Held for Sale $ 49,560 $ 629 5.15% $ 47,928 $ 844 7.14%
Loans Held for Investment:
Taxable 900,732 16,814 7.57% 908,406 $ 17,949 8.01%
Tax-Exempt 6,124 120 7.95% 6,343 133 8.50%
----------- -------- ---- ---------- -------- ----
Total 906,856 16,934 7.57% 914,749 18,082 8.02%
Reserve for Loan Losses (14,331) (14,426)
----------- -------- ---------- --------
Net Total 892,525 16,934 900,323 18,082
Securities Available For Sale:
Taxable 271,864 3,135 4.68% 254,141 3,339 5.33%
Tax-Exempt 93,464 1,753 7.61% 97,090 1,874 7.83%
----------- -------- ---- ---------- -------- ----
Total 365,328 4,888 5.43% 351,231 5,213 6.02%
Held to Maturity Securities:
Taxable 657 10 6.17% 2,054 39 7.70%
Tax-Exempt 39,959 797 8.09% 39,662 807 8.25%
----------- -------- ---- ---------- -------- ----
Total 40,616 807 8.05% 41,716 846 8.22%
Interest Bearing Deposits 58,627 209 1.45% 10,400 43 1.68%
Fed Funds Sold 2,093 6 1.16%
-------- ---- ---------- --------
Total Earning Assets 1,408,749 23,473 6.76% 1,351,598 25,028 7.51%
----------- -------- ---------- --------
Other Assets 106,151 105,265
----------- ----------
Total $ 1,514,900 $1,456,863
=========== ==========
Interest-Bearing Liabilities:
Demand Deposits $ 203,547 365 0.73% $ 188,542 490 1.05%
Savings Deposits 181,175 317 0.71% 150,377 381 1.03%
Time Deposits 598,520 4,634 3.14% 583,048 6,122 4.26%
----------- -------- ---- ---------- -------- ----
983,242 5,316 2.19% 921,967 6,993 3.08%
Fed Funds Purchased & Repurchase
Agreements 94,251 438 1.88% 78,887 448 2.30%
FHLB Convertible and Callable Advances 100,000 1,456 5.90% 135,000 1,979 5.95%
Other Borrowings 10,048 148 5.97% 10,158 150 5.99%
----------- -------- ---- ---------- -------- ----
Total Interest-bearing Liabilities 1,187,541 7,358 2.51% 1,146,012 9,570 3.39%
----------- -------- ---------- --------
Demand Deposits 157,504 157,055
Other Liabilities 14,633 16,612
Stockholders' Equity 155,222 137,184
----------- ----------
Total $ 1,514,900 $1,456,863
=========== ==========
Net Interest Income $ 16,115 $ 15,458
======== ========
Net Interest Rate Spread 4.24% 4.12%
==== ====
Net Interest Margin (4) 4.64% 4.64%
==== ====
(1) Interest amounts represent taxable equivalent results for the three months
ended March 31, 2003 and 2002.
(2) Fully Taxable Equivalent at the rate of 35%.
(3) Nonaccrual loans are included in average balances outstanding with no
related interest income during the period of nonaccrual.
(4) Represents tax equivalent net interest income divided by average interest
earning assets.
20
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses was $13.8 million on March 31, 2003, down slightly
from the $14.4 million at December 31, 2002 and the $14.3 million on March 31,
2002. The first quarter 2003 provision of $589,000 is down substantially
compared to the $937,000 for the corresponding period of 2002. 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 343% of non-performing loans at March 31, 2003 versus 455% and 295%
at December 31, 2002 and March 31, 2002, respectively. When other real estate is
combined with non-performing loans, the allowance equals 210% of non-performing
assets at March 31, 2003 versus 239% and 194% at December 31, 2002 and March 31,
2002, respectively.
FCBI's allowance for loan loss activity for the three month periods ended March
31, 2003 and 2002 is as follows:
FOR THE THREE MONTHS ENDED
MARCH 31
2003 2002
-------- --------
(DOLLARS IN THOUSANDS)
Beginning balance $ 14,410 $ 13,952
Provision 589 937
Charge-offs (1,668) (820)
Recoveries 451 202
-------- --------
Ending Balance $ 13,782 $ 14,271
======== ========
Based on the allowance for loan losses of approximately $13.8 million and $14.3
million at March 31, 2003 and 2002, respectively, the allowance to loans held
for investment ratios were 1.54% and 1.57% at the respective dates. The decline
in allowance as a percentage of nonperforming assets since year-end 2002 was
impacted by a combination of factors including the $1.06 million charge-off
mentioned in the following paragraph, a $31.0 million decline in the loans held
for investment portfolio and the fact that a large portion of the increase in
nonaccruing assets are represented by secured loans. Management considers the
allowance adequate based upon its analysis of the portfolio as of March 31,
2003.
Net charge-offs for the first three months of 2003 were $1.2 million compared
with $618,000 for the corresponding period of 2002. Expressed as a percentage of
average loans held for investment, net charge-offs were .13% for the three month
period of 2003, and 0.07% for the same period of 2002. The $599,000 increase in
net charge-offs between the three month periods ended March 31, 2002 and 2003
was largely due to a group of loans totaling $1.16 million related to a dairy
farm whose performance declined in conjunction with the 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 delinquent and $1.06 million
was charged off in the first quarter of 2003.
In addition to loans which are classified as non-performing and impaired, the
company closely monitors certain loans which could develop into problem loans.
These potential problem loans present characteristics of weakness or
concentrations of credit to one borrower. Among these loans at March 31, 2002
were two loans to separate borrowers which warrant close monitoring. The first
of these is a $12.7 million loan to a borrower within the hospitality industry.
The loan represents the retained portion of a $16 million total loan shared with
a participating
21
bank. As with other hospitality industry firms, the borrower has experienced
reduced cash flow associated with declines in the level of hotel occupancy. The
loan is secured by real estate improved with a national franchise hotel and
parking building in a major southeast city. The loan is further secured by the
guarantee of the principals of the borrowing entity. This loan, which was
originated in 1999, performed according to terms until it displayed delinquency
in February and March 2003 and was subsequently brought current. The loan
remains current as to principal and interest at the date of this report. The
loan has not been converted to non-accrual status based upon its secured
position, historical performance and strength of guarantors. This loan does,
however, represent one of the Company's largest credits and is within an
industry which has suffered from declining performance in 2001 and 2002.
The second loan of $2 million was for land development in eastern Virginia. The
borrower has been in the process of negotiating a sale of the raw land to other
developers. The company has renewed this loan as the borrower has been unable to
consummate a sale to date. The borrower has recently entered into a letter of
intent with a new prospective buyer and is continuing to pursue the sale;
however, this transaction may be delayed or may not be consummated. The borrower
is also indebted to the Company on another $6.0 million loan which is secured by
land improved with an 18-hole golf course and surrounding developable acreage in
northern Virginia. This loan continues to perform in accordance with loan terms.
There were no specific allocations of the allowance for loan losses for any of
the foregoing potential problem loans as of March 31, 2003.
NONINTEREST INCOME
Non-interest income consists of all revenues which are not included in interest
and fee income related to earning assets. Total non-interest income increased
approximately $177,000, or 3.02%, from $5.9 million for the three months ended
March 31, 2002 to $6.0 million for the corresponding period in 2003. The largest
portion of this increase is attributable to a $358,000, or a 24.47% increase in
service charges on deposit accounts (primarily the result of an overdraft
program that allows well-managed customer deposit accounts greater flexibility
in managing overdrafts to their accounts). In addition, other service charges,
commissions and fees were up $187,000 for the first quarter of 2003 compared to
that of 2002. Fiduciary earnings represent the asset management fees recorded
and were also up $73,000 for the first quarter of 2003 as a direct result of
estate and trust management activity, including the operations of Stone Capital
acquired in January 2003. The mortgage brokerage operations of UFM reflected a
$285,000 decrease in mortgage banking income for the three months ended March
31, 2003 versus the comparable three-month period in 2002. This decrease is
directly attributable to higher margins on the acquisition and sale of mortgage
loans in the first quarter of 2002 as well as favorable hedge experience during
the first quarter 2002 when the markets were less volatile for the mortgage
related assets and mortgage-backed security products used to hedge the
production pipeline. Mortgage banking income was also impacted by an increased
level of early payoffs on loans sold to investors due to the continued low rate
environment and refinancing opportunities presented to mortgage customers.
During the first quarter of 2003, the Company recorded approximately $99,000 in
service release premium rebates compared to $67,000 for the comparable period in
2002.
In addition, gain on securities was down $157,000 in the first quarter of 2003
compared to the respective period of 2002.
NONINTEREST EXPENSE
Non-interest expense totaled $11.1 million for the three months ended March 31,
2003, increasing $522,000 over the corresponding period in 2002. This increase
is primarily attributable to a $530,000 increase in salaries and benefits,
$116,000 of which was due to the acquisition of Greenville in the fourth quarter
of 2002 along with a $143,000 increase in salaries and commissions in the
mortgage operations of UFM (mostly due 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 the first three months of 2003, occupancy expense increased by $106,000 when
compared to the first three months of 2002. The general level of occupancy cost
grew primarily as a result of the harsher winter weather which drove up costs
for heating, snow removal and facilities maintenance in comparison to the prior
year along with increases in depreciation and insurance costs associated with
new branches.
The combined effect of all other operating expense accounts remained fairly
consistent for the first quarter of 2003 compared to the same period of 2002.
22
INCOME TAX
The effective income tax rate continues to benefit from the utilization of
tax-exempt municipal securities and the discontinuance of amortization of
goodwill that was not deductible for income tax purposes. Municipal securities,
which have offered an attractive tax equivalent yield, have assisted in
countering the effect of the declining interest rate environment. The Company's
effective tax rate was 28.1% for the three months ended March 31, 2002 and 28.9%
in the corresponding period of 2003.
FINANCIAL POSITION
SECURITIES
Investment securities, which are purchased with the intent to hold until
maturity, totaled $40.1 million at March 31, 2003, a decrease of $930,000 from
December 31, 2002. This 2.27% decrease is the result of maturities and calls
within the portfolio during the first three months of 2003. The market value of
investment securities held to maturity was 105.8% and 105.7% of book value at
March 31, 2003 and December 31, 2002, respectively. Recent trends in interest
rates have had little effect on the underlying market value since December 31,
2002.
Securities available for sale were $372.9 million at March 31, 2003 compared to
$300.9 million at December 31, 2002, an increase of $72.0 million. This change
reflects the purchase of $101.3 million in securities, $27.1 million in
maturities and calls, the sale of $0.5 million in securities, and the
continuation of larger pay-downs on mortgage-backed securities and CMO's
triggered by the lower interest rate environment. Securities available for sale
are recorded at their estimated fair market value. The unrealized gain or loss,
which is the difference between amortized cost and estimated market value, net
of related deferred taxes, is recognized in the Stockholders' Equity section of
the balance sheet as either accumulated other comprehensive income or loss. The
unrealized gains after taxes of $6.0 million at March 31, 2003, represent a
decrease of $0.8 million from the $6.8 million gain at December 31, 2002 due to
market value decreases in the first three months of 2003.
LOAN PORTFOLIO
LOANS HELD FOR SALE: The relative size of the portfolio of loans originated by
the Company's mortgage brokerage division, UFM, and held for sale, was impacted
significantly by the refinancing activity that occurred during 2002 and
continues into 2003. Loans held for sale fluctuate on a daily basis reflecting
retail originations, wholesale purchases and sales to investors. At March 31,
2003, loans held for sale were $50.8 million compared to $66.4 million at
December 31, 2002. Average loans held for sale (which is a better indicator of
volume maintained) remained relatively stable, increasing $1.6 million during
the first three months of 2003 compared to the first three months of 2002.
LOANS HELD FOR INVESTMENT: Total loans held for investment decreased $30.4
million from $927.6 million at December 31, 2002 to $897.2 million at March 31,
2003 due to several large commercial loan payoffs. Considering a $14 million
increase in deposits, the decrease in loans during the first quarter of 2003 has
lowered the loan to deposit ratio from its December 31, 2002 level. The loan to
deposit ratio, using only loans held for investment (excluding loans held for
sale), was 77.8% on March 31, 2003, 81.4% on December 31, 2002 and 83.9% on
March 31, 2002. Intense competition for loans in the face of low interest rates
and what appears to be slower loan demand have continued to reduce this measure
of loan production. Resulting liquidity has been reinvested in the available for
sale securities portfolio.
Average loans held for investment decreased $7.9 million when comparing the
first three months of 2003 to the same period of 2002. This decrease includes
approximately $17.1 million in average loans acquired in the Monroe acquisition
in the fourth quarter of 2002 net of the large commercial payoffs and regular
amortization in the first quarter 2003.
The held for investment loan portfolio continues to be diversified among loan
types and industry segments. The following tabular presentation of the loan
portfolio is presented as of March 31, 2003, December 31, 2002 and March 31,
2002 and provides an analytical overview of the portfolio from March 31, 2002
and the change in composition among the various categories.
23
LOAN PORTFOLIO OVERVIEW
(DOLLARS IN THOUSANDS)
MARCH 31, 2003 DECEMBER 31, 2002 MARCH 31, 2002
---------------------- ---------------------- ----------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
--------- --------- --------- --------- --------- ---------
LOANS HELD FOR INVESTMENT:
Commercial and Agricultural $ 59,724 6.66% $ 74,186 8.00% $ 89,248 9.79%
Commercial Real Estate 270,004 30.10% 285,847 30.83% 270,359 29.66%
Residential Real Estate 361,883 40.33% 364,065 39.25% 342,371 37.55%
Construction 78,576 8.76% 72,275 7.79% 78,178 8.57%
Consumer 126,241 14.07% 130,522 14.07% 130,717 14.34%
Other 766 0.09% 726 0.08% 873 0.10%
--------- --------- --------- --------- --------- ---------
Total $ 897,194 100.00% $ 927,621 100.00% $ 911,746 100.00%
========= ========= ========= ========= ========= =========
LOANS HELD FOR SALE $ 50,753 $ 66,364 $ 47,596
========= ========= =========
NON-PERFORMING ASSETS
Non-performing assets include loans on non-accrual status, loans contractually
past due 90 days or more and still accruing interest and other real estate owned
("OREO"). Non-performing assets were $6.6 million at March 31, 2003, $6.0
million at December 31, 2002 and $7.4 million at March 31, 2002, or 0.7%, 0.6%
and 0.8% of total loans and OREO, respectively. The following schedule details
non-performing assets by category at the close of each of the last five
quarters:
(IN THOUSANDS OF DOLLARS) MARCH 31 DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
2003 2002 2002 2002 2002
------------- ------------- ------------- ------------- -------------
Nonaccrual $ 3,997 $ 3,075 $ 4,987 $ 4,131 $ 4,644
Ninety Days Past Due 21 91 367 254 192
Other Real Estate Owned 2,544 2,855 2,668 2,452 2,538
------------- ------------- ------------- ------------- -------------
$ 6,562 $ 6,021 $ 8,022 $ 6,837 $ 7,374
============= ============= ============= ============= =============
Restructured loans
performing in accordance
with modified terms $ 341 $ 345 $ 347 $ 440 $ 523
============= ============= ============= ============= =============
At March 31, 2003, nonaccrual loans increased $922,000 from December 31, 2002,
while ninety day past due loans decreased $70,000. Ongoing activity within the
classification and categories of non-performing loans continues to include
collections on delinquencies, foreclosures and movements into or out of the
non-performing classification as a result of changing customer business
conditions. The $922,000 increase in nonaccrual loans in the first quarter of
2003 is largely due to an increase in the number of consumer and real estate
loans in default.
OREO decreased $311,000 during the first quarter of 2003 from December 31, 2002.
This decrease in OREO is due, in part, to the sale of properties. Other real
estate owned is carried at the lesser of estimated net realizable fair market
value or cost.
DEPOSITS AND OTHER BORROWINGS
Total deposits have grown $13.97 million or 1.23% since year-end 2002. In terms
of composition, noninterest-bearing deposits declined $2.56 million or 1.55%
while interest-bearing deposits grew $16.53 million or 1.70 % from December 31,
2002.
Overall, FCBI's total borrowed funds decreased $10.2 million since year-end
2002. The decrease in borrowed funds is primarily attributed to the repayment of
borrowings on a line of credit held by UFM with an outside party used to fund
mortgages. The Company's borrowings at March 31, 2003 consisted of $100 million
in convertible and callable
24
advances and $10 million of noncallable term advances from the FHLB of Atlanta.
For further discussion of FHLB borrowings, see Note 4 to the unaudited
consolidated financial statements included in this report.
STOCKHOLDERS' EQUITY
Total stockholders' equity reached $154.7 million at March 31, 2003, increasing
$2.2 million through earnings and comprehensive income (net of dividends of $2.6
million) over the $152.5 million, reported at December 31, 2002. The Federal
Reserve's risk based capital guidelines and leverage ratio measure capital
adequacy of banking institutions. Risk-based capital guidelines weight balance
sheet assets and off-balance sheet commitments based on inherent risks
associated with the respective asset types. At March 31, 2003, the Company's
total risk adjusted capital-to-asset ratio was 13.88% versus 13.33% in December
31, 2002. The Company's leverage ratio at March 31, 2003 was 8.21% compared with
8.10% at December 31, 2002. Both the risk adjusted capital-to-asset ratio and
the leverage ratio exceed the current well-capitalized levels prescribed for
banks of 10% and 5%, respectively.
RECENT LEGISLATIVE DEVELOPMENTS
Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into law the
Sarbanes-Oxley Act of 2002 (the "SOA".) The stated goals of the SOA are to
increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties of publicly traded companies and to
protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws. The SOA is the most far-reaching
U.S. securities legislation enacted in some time. The SOA 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 (the "SEC",) under
the Securities Exchange Act of 1934 (the "Exchange Act".)
The SOA 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 SOA 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.
The SOA addresses, among other matters: audit committees for all reporting
companies; certification of financial statements by the chief executive officer
and the chief financial officer; the forfeiture of bonuses or other
incentive-based compensation and profits from the sale of an issuer's securities
by directors and senior officers in the twelve month period following initial
publication of any financial statements that later require restatement; 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; expedited filing requirements for Form 4's; 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.
The SOA contains provisions which became effective upon enactment on July 30,
2002 and provisions which will become effective from within 30 days to one year
from enactment. The SEC has been delegated the task of enacting rules to
implement various provisions with respect to, among other matters, disclosure in
periodic filings pursuant to the Exchange Act.
PART I. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a significant level of liquidity in the form of cash and
cash equivalent balances ($100.1 million), investment securities available for
sale ($372.9 million) and Federal Home Loan Bank credit availability of
approximately $346.8 million. Cash and cash equivalents as well as advances from
the Federal Home Loan Bank are immediately available for satisfaction of deposit
withdrawals, customer credit needs and operations of the Company. Investment
securities available for sale represent a secondary level of liquidity available
for conversion to liquid funds in the event of extraordinary needs. The Company
also maintains approved lines of credit with correspondent banks as backup
liquidity sources.
25
At March 31, 2003, the Company had outstanding commitments to originate and/or
purchase mortgage and non-mortgage loans (including unused lines of credit) of
$207.6 million. The loan commitments of $207.6 million include commitments
extended by the Bank of $69.5 million and interest rate lock commitments of
$138.1 million originated by UFM. UFM's commitments are presented prior to any
assumed fallout; however, on an option adjusted basis after fallout, loans
anticipated to close are $85.5 million. Certificates of deposit which are
scheduled to mature within one year totaled $380.6 million at March 31, 2003,
and borrowings that are scheduled to mature within the same period amounted to
$8.3 million. The Company anticipates that it will have sufficient funds
available to meet its current loan commitments.
The Company maintains a liquidity policy as a means to enhance the liquidity
risk process. The policy includes a Liquidity Contingency Plan that is designed
as a tool for the Company to detect liquidity issues promptly in order to
protect depositors, creditors and shareholders. The Plan includes monitoring
various internal and external indicators such as changes in core deposits and
changes in market conditions. It provides for timely responses to a wide variety
of funding scenarios ranging from changes in loan demand to a decline in the
Company's quarterly earnings to a decline in the market price of the Company's
stock. The Plan calls for specific responses designed to meet a wide range of
liquidity needs based upon assessments on a recurring basis by management and
the Board of Directors.
INTEREST RATE RISK (IRR) AND ASSET/LIABILITY MANAGEMENT
While the Company continues to strive to decrease its dependence on net interest
income, the Bank's profitability is dependent to a large extent upon its ability
to manage its net interest margin. 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. Specific strategies for management of IRR have included
shortening the amortized maturity of fixed-rate loans and increasing the volume
of adjustable rate loans to reduce the average maturity of the Bank's
interest-earning assets.
The Bank seeks to control its 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, the Bank performs quarterly simulations using
financial models which project net interest income 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 and assumptions as to changes in the volume and mix of
interest-earning assets and interest-paying liabilities and management's
estimate of yields attainable in those future rate environments and rates which
will be paid on various deposit instruments and borrowings.
The Company's risk profile continues to reflect a slightly asset sensitive
position. The substantial level of prepayments and calls consistent with the
declining rate environment that occurred in the prior year, as well as the
success of deposit funding campaigns instituted in the prior year have led to an
increase in the banks overall liquidity position as reflected in the level of
cash reserves, due from balances and Fed Funds Sold of approximately $100.1
million. The Company continues to reinvest the funds generated from asset
paydowns and prepayments within a framework that attempts to maintain an
acceptable net interest margin in the current interest rate environment. In
addition, the mortgage operations of UFM use investments commonly referred to as
"forward" transactions or derivatives to balance the risk inherent in interest
rate lock commitments (also deemed to be derivatives) made to prospective
borrowers. The pipeline of loans is hedged to mitigate unusual fluctuations in
the 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 the Consolidated Balance Sheets and
the changes in fair value are reflected in the Consolidated Statements of
Income.
As discussed under "Derivative Instruments and Hedging Activities" under
Critical Accounting Policies, the Company's mortgage subsidiary held an
investment in the underlying notional value of investments in securities
("forward commitments") of $80 million versus option adjusted interest rate lock
commitments and closed loan inventory being hedged of $90.6 million. As of March
31, 2003, the change in the market value of investments in hedge securities
reflected a decline in estimated fair value of $330,000 compared to year-end
2002. In addition, interest rate lock commitments also reflected a decline in
value of $546,000 when compared to December 31, 2002. The value of interest rate
lock commitments at March 31, 2003 represent an asset of $1.7 million while the
securities used to hedge the underlying commitments represent a liability of
$375,000. This hedging strategy is managed through a series of mathematical
tools that are used to quantify the exposure to changes in interest rates.
The Company's earnings sensitivity measurements completed on a quarterly basis
indicate that the performance criteria, against which sensitivity is measured,
are currently within the Company's defined policy limits. A more complete
discussion of the overall interest rate risk is included in the Company's annual
report for December 31, 2002.
26
PART I. ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer along with the
Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to the
Securities Exchange Act of 1934 ("Exchange Act") Rule 13a-14. Based upon that
evaluation, the Company's Chief Executive Officer along with the Company's Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) required to be
included in the Company's periodic SEC filings. There have been no significant
changes in the Company's internal controls or in other factors which could
significantly affect these controls subsequent to the date the Company carried
out its evaluation.
Disclosure controls and procedures are Company controls and other procedures
that are designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by the Company in the reports that it files under the
Exchange Act is accumulated and communicated to the Company's management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is currently a defendant in various legal actions and asserted
claims involving lending and collection activities and other matters in the
normal course of business. 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.
On May 2, 2003, United First Mortgage ("UFM"), a wholly-owned mortgage banking
subsidiary of First Community Bank, the Company's wholly-owned banking
subsidiary, was joined as a party to a lawsuit in the U.S. District Court for
the Eastern District of Pennsylvania, styled John J. Lomanno v. Thomas Black,
et. al..., Civil Action Number 02-CV-8669. This suit had been filed by a former
UFM employee alleging, among other things, sexual discrimination in connection
with his dismissal. The Company believes that the lawsuit, which seeks damages
of $150,000 and punitive damages, is without merit, and intends to vigorously
defend this matter.
Item 2. Changes in Securities and Use of Proceeds
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27
EXHIBIT NO. EXHIBIT
----------- --------------------------------------------------------------
2.1 Agreement and Plan of Merger dated as of January 27, 2003, and
amended as of February 25, 2003, among First Community
Bancshares, Inc., First Community Bank, National Association,
and The CommonWealth Bank. (1)
3(i) Articles of Incorporation of First Community Bancshares, Inc.,
as amended. (2)
3(ii) Bylaws of First Community Bancshares, Inc., as amended. (2)
4.1 Specimen stock certificate of First Community Bancshares, Inc.
(7)
10.1 First Community Bancshares, Inc. 1999 Stock Option Plan.
(2)(3)
10.2 First Community Bancshares, Inc. 2001 Non-Qualified Directors
Stock Option Plan. (4)
10.3 Employment Agreement dated January 1, 2000 and amended October
17, 2000, between First Community Bancshares, Inc. and John M.
Mendez. (2)(5)
10.4 First Community Bancshares, Inc. 2000 Executive Retention
Plan. (3)
10.5 First Community Bancshares, Inc. Split Dollar Plan and
Agreement. (3)
10.6 First Community Bancshares, Inc. 2001 Directors Supplemental
Retirement Plan. (2)
10.7 First Community Bancshares, Inc. Wrap Plan. (7)
11.0 Statement regarding computation of earnings per share. (6)
15.0 Letter regarding unaudited interim financial information.
99.1 Certification of Chief Executive and Chief Financial Officer
Pursuant to 18 USC Section 1350
(1) Incorporated by reference to the corresponding exhibit previously filed as
an exhibit to the Form 8-K filed with the Commission on January 28, 2003
and February 26, 2003.
(2) Incorporated by reference from the Quarterly Report on Form 10-Q for the
period ended June 30, 2002 filed on August 14, 2002.
(3) Incorporated by reference from the Annual Report on Form 10-K for the
period ended December 31, 1999 filed on March 30, 2000 as amended April
13, 2000.
(4) The options agreements entered into pursuant to the 1999 Stock Option Plan
and the 2001 Non-Qualified Directors Stock Option Plan are incorporated by
reference from the Quarterly Report on Form 10-Q for the period ended June
30, 2002 filed on August 14, 2002.
(5) First Community Bancshares, Inc. has entered into substantially identical
agreements with Messrs. Buzzo and Lilly, with the only differences being
with respect to titles, salary and the use of a vehicle.
(6) Incorporated by reference from Footnote 9 of the Notes to Consolidated
Financial Statements included herein.
(7) Incorporated by reference from the Annual Report on Form 10-K for the
period ended December 31, 2002 filed on March 25, 2003 as amended on March
31, 2003.
(b) Reports on Form 8-K
A report on Form 8-K was filed on January 16, 2003 announcing the
Company's acquisition of Stone Capital Management.
A report on Form 8-K was filed on January 27, 2003 announcing the
Company's fourth quarter 2002 earnings, depicting certain financial
information as of December 31, 2002 and comparative income statements for
the three and twelve-month periods ended December 31, 2002 and 2001,
respectively.
A report on Form 8-K was filed on January 28, 2003 announcing the entry
into a merger agreement dated January 27, 2003 with The CommonWealth Bank.
28
A report on Form 8-K was filed on February 26, 2003 announcing an
amendment dated February 25, 2003 to the merger agreement with The
CommonWealth Bank.
A report on Form 8-K was filed on March 4, 2003 announcing an application
to list on the NASDAQ national market.
A report on Form 8-K was filed on March 28, 2003 announcing NASDAQ's
approval for listing on the NASDAQ National Market System.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
First Community Bancshares, Inc.
DATE: May 15, 2003
/s/ John M. Mendez
- ------------------------------
John M. Mendez
President & Chief Executive Officer
(Duly Authorized Officer)
DATE: May 15, 2003
/s/ Robert L. Schumacher
- ------------------------------
Robert L. Schumacher
Chief Financial Officer
(Principal Accounting Officer)
30
CERTIFICATIONS
I, John M. Mendez, certify that:
1. I have reviewed this quarterly report on Form 10-Q of First
Community Bancshares, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) Designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which the periodic
report is being prepared;
(b) Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this quarterly
report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and to the audit committee of the registrant's board of directors
(or persons performing the equivalent function):
(a) All significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ John M. Mendez
------------------------------------
John M. Mendez
President and Chief Executive Officer
31
I, Robert L. Schumacher, certify that:
1. I have reviewed this quarterly report on Form 10-Q of First
Community Bancshares, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) Designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which the periodic
report is being prepared;
(b) Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this quarterly
report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and to the audit committee of the registrant's board of directors
(or persons performing the equivalent function):
(a) All significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/Robert L. Schumacher
-------------------------------
Robert L. Schumacher
Chief Financial Officer
32
Index to Exhibits
Exhibit No.
15 Letter regarding unaudited interim financial information
99.1 Certification pursuant to section 906 of the Sarbanes-Oxley Act of 2002
33