UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________.
COMMISSION FILE NO. 333-59338
FIRST SECURITY GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
Tennessee 58-2461486
(State of Incorporation) (I.R.S. Employer Identification No.)
817 Broad Street, Chattanooga, TN 37402
(Address of principal executive offices) (Zip Code)
(423) 308-2000
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address, and former fiscal year,
if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock, $.01 par value:
5,002,644 shares outstanding and issued (including subscriptions
for shares that have been accepted by the Company)
as of November 9, 2001.
1
First Security Group, Inc. and Subsidiaries
Form 10-Q
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 2001, December 31, 2000 and
September 30, 2000 3
Consolidated Statements of Operations -
Three months and nine months ended
September 30, 2001 and 2000 4
Consolidated Statement of Stockholders' Equity -
Nine months ended September 30, 2001 5
Consolidated Statements of Cash Flows -
Nine months ended September 30, 2001 and 2000 6
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
Part II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURES 25
2
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
2001 2000 2000
(IN THOUSANDS) (UNAUDITED) (UNAUDITED)
--------- --------- ---------
ASSETS
Cash and due from banks $ 10,696 $ 7,905 $ 5,596
Federal funds sold and securities purchased
under agreements to resell -- 4,370 3,520
--------- --------- ---------
Cash and cash equivalents 10,696 12,275 9,116
--------- --------- ---------
Securities available for sale 30,426 20,178 17,192
--------- --------- ---------
Loans 267,494 152,913 127,959
Less: Allowance for loan losses 3,600 1,942 1,669
--------- --------- ---------
263,894 150,971 126,290
Premises and equipment, net 9,271 7,022 6,897
--------- --------- ---------
Goodwill 6,313 6,674 6,795
--------- --------- ---------
Other assets 3,168 2,432 1,566
--------- --------- ---------
TOTAL ASSETS $ 323,768 $ 199,552 $ 167,856
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits -
Noninterest bearing demand $ 45,471 $ 28,171 $ 23,454
Interest bearing demand 18,884 16,352 12,541
Savings 46,505 19,510 18,127
Certificates of deposit of $100 thousand or more 63,164 32,211 28,666
Certificates of deposit less than $100 thousand 96,395 66,270 50,941
--------- --------- ---------
Total deposits 270,419 162,514 133,729
--------- --------- ---------
Federal funds purchased and securities sold
under agreements to repurchase 14,361 4,588 2,687
Other liabilities 4,433 1,856 896
--------- --------- ---------
Total liabilities 289,213 168,958 137,312
--------- --------- ---------
STOCKHOLDERS' EQUITY
Common stock - $.01 par value - 20,000 shares
authorized; 4,475 shares issued 45 41 41
Paid-in surplus 35,230 31,546 31,546
Accumulated deficit (1,154) (1,081) (1,030)
Accumulated other comprehensive income (loss) .. 434 88 (13)
--------- --------- ---------
Total stockholders' equity 34,555 30,594 30,544
--------- --------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 323,768 $ 199,552 $ 167,856
========= ========= =========
3
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS) 2001 2000 2001 2000
-------- -------- -------- --------
INTEREST INCOME
Loans, including fees $ 5,164 $ 2,848 $ 13,556 $ 6,768
Debt securities - taxable 439 284 1,191 801
Other 46 89 251 398
-------- -------- -------- --------
Total interest income 5,649 3,221 14,998 7,967
-------- -------- -------- --------
INTEREST EXPENSE
Interest bearing demand deposits 87 57 247 162
Savings deposits 389 145 962 369
Certificates of deposit of $100 thousand or more 787 428 2,081 951
Certificates of deposit of less than $100 thousand 1,308 816 3,757 1,979
Other 132 29 299 167
-------- -------- -------- --------
Total interest expense 2,703 1,475 7,346 3,628
-------- -------- -------- --------
NET INTEREST INCOME 2,946 1,746 7,652 4,339
Provision for loan losses 843 413 1,824 532
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 2,103 1,333 5,828 3,807
-------- -------- -------- --------
NONINTEREST INCOME
Service charges on deposit accounts 351 190 958 494
Mortgage loan fee income 217 35 531 56
Other noninterest income 108 53 256 127
-------- -------- -------- --------
Total noninterest income 676 278 1,745 677
-------- -------- -------- --------
NONINTEREST EXPENSE
Salaries and employee benefits 1,617 1,051 4,232 2,842
Net occupancy 236 153 649 363
Equipment expense 209 151 558 338
Data processing fees 157 86 433 210
Amortization expense 120 120 362 323
Advertising expense 95 48 204 103
Loss on securities -- 3 -- 5
Other noninterest expense 523 406 1,234 1,131
-------- -------- -------- --------
Total noninterest expense 2,957 2,018 7,672 5,315
-------- -------- -------- --------
LOSS BEFORE INCOME TAX BENEFIT (178) (407) (99) (831)
Income tax benefit (63) (154) (26) (316)
-------- -------- -------- --------
NET LOSS $ (115) $ (253) $ (73) $ (515)
======== ======== ======== ========
NET LOSS PER SHARE
BASIC AND DILUTED $ (0.03) $ (0.06) $ (0.02) $ (0.13)
WEIGHTED AVERAGE SHARES OUTSTANDING
BASIC 4,289 4,106 4,168 4,106
DILUTED 4,601 4,106 4,382 4,106
4
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
ACCUMULATED
OTHER
COMMON STOCK PAID-IN ACCUMULATED COMPREHENSIVE
(IN THOUSANDS) SHARES AMOUNT SURPLUS DEFICIT INCOME TOTAL
----- ------- ------- ------- ------- -------
Balance - December 31, 2000 4,106 $ 41 $31,546 $(1,081) $ 88 $30,594
Common stock sold (unaudited) 369 4 3,684 3,688
Comprehensive income -
Net loss (unaudited) (73)
Change in net unrealized gain on securities
available-for-sale, net of tax (unaudited) 346
Total comprehensive income (unaudited) 273
----- ------- ------- ------- ------- -------
Balance - September 30, 2001 (unaudited) 4,475 $ 45 $35,230 $(1,154) $ 434 $34,555
===== ======= ======= ======= ======= =======
5
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
(IN THOUSANDS) 2001 2000
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (73) $ (515)
Provision for loan losses 1,824 532
Net accretion of securities (87) (59)
Amortization of goodwill 362 323
Depreciation 423 242
Loss on sale of available-for-sale securities -- 5
Changes in operating assets and liabilities -
Decrease (increase) in -
Interest receivable (628) (319)
Other assets (108) (133)
Increase (decrease) in -
Interest payable 720 424
Other liabilities (624) (697)
--------- ---------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES 1,809 (197)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities -
Sales -- 1,192
Maturities, prepayments, and calls 6,021 2,030
Purchases (15,605) (4,019)
Loan originations and principal collections, net (114,747) (57,622)
Additions to premises and equipment (2,673) (1,475)
Net cash paid in transaction accounted for
under the purchase method of accounting -- (815)
--------- ---------
NET CASH USED BY INVESTING ACTIVITIES (127,004) (60,709)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 107,905 57,677
Net increase (decrease) in federal funds purchased and securities
sold under agreements to repurchase 9,773 (789)
Proceeds from issuance of subordinated debt 2,250 --
Proceeds from sale of common stock 3,688 --
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 123,616 56,888
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,579) (4,018)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 12,275 13,134
--------- ---------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 10,696 $ 9,116
========= =========
6
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Unrealized appreciation of securities,
net of deferred taxes of $231 for 2001 and $29 for 2000 $ 346 $ 43
SUPPLEMENTAL SCHEDULE OF CASH FLOWS
Interest paid $ 6,626 $ 3,204
ACQUISITION OF BANK/BRANCH
Loans $ -- $ 533
Premises and equipment -- 777
Interest receivable -- 2
Other assets -- 3
Goodwill -- 973
Deposit liabilities -- (1,167)
Interest payable -- (3)
Other liabilities -- (3)
Deposit paid in prior year -- (300)
----- -------
Net cash paid $ -- $ 815
===== =======
7
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with U.S. generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by U.S. generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
considered necessary for a fair statement of financial condition and the results
of operations have been included. All such adjustments were of a normal
recurring nature. Operating results for the nine-month period ended September
30, 2001, are not necessarily indicative of the results that may be expected for
the year ended December 31, 2001 or any other period. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's Form S-1, as filed effective June 14, 2001.
NOTE B - COMPREHENSIVE INCOME
Under FASB Statement of Financial Accounting Standard's No. 130, "Reporting
Comprehensive Income," the Company is required to report "comprehensive
income," a measure of all changes in equity, not only reflecting net income but
certain other changes as well. Comprehensive income for the three month and
nine month periods ended September 30, 2001 and 2000, respectively, was as
follows:
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------
(DOLLARS IN THOUSANDS) 2001 2000
----- -----
Net loss $(115) $(253)
Unrealized gains - securities, net of tax 192 73
----- -----
Comprehensive income (loss), net of tax $ 77 $(180)
===== =====
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
(DOLLARS IN THOUSANDS) 2001 2000
----- -----
Net loss $ (73) $(515)
Unrealized gains - securities, net of tax 346 43
----- -----
Comprehensive income (loss), net of tax $ 273 $(472)
===== =====
NOTE C - EARNINGS PER SHARE
On June 14, 2001, First Security's non-underwritten public offering of up
to $30 million in shares of First Security's common stock at a price of $10 per
share became effective. As of September 30, 2001, First Security had sold
368,804 shares in the offering.
Reference is made to Note 17, Subsequent Events, in the Notes to
Consolidated Financial Statements in First Security's Form S-1, which contains
descriptions of First Security's Stock Option Plan (the "Plan") and Subordinated
Mandatory Convertible Notes (the "Notes"). Shares under option under the Plan
and shares into which the Notes can be converted had an anti-dilutive impact on
net loss per share for the three months and nine months ended September 30,
2001.
8
NOTE D - ACCOUNTING PRONOUNCEMENTS
The FASB has issued Statements of Financial Accounting Standards No. 141
(FAS 141), "Business Combinations," and No. 142 (FAS 142), "Goodwill and Other
Intangible Assets."
FAS 141 supersedes APB Opinion No. 16, "Business Combinations," and
Statement of Financial Accounting Standards No. 38, "Accounting for
Preacquisition Contingencies of Purchased Enterprises," and requires that all
business combinations be accounted for using the purchase method. FAS 141
carries forward without reconsideration those portions of APB Opinion No. 16,
"Business Combinations," which provides guidance related to the application of
the purchase method. FAS 141 requires that intangible assets that meet certain
criteria be recognized as assets apart from goodwill.
The provisions of FAS 141 apply to all business combinations initiated
after June 30, 2001, as well as to all business combinations accounted for using
the purchase method for which the date of acquisition is July 1, 2001, or later.
FAS 142 addresses financial accounting and reporting for acquired goodwill
and other intangible assets and supersedes APB Opinion No. 17, "Intangible
Assets." FAS 142 addresses how intangible assets that are acquired individually
or with a group of other assets (but not those acquired in a business
combination) should be accounted for in financial statements upon their
acquisition. FAS 142 also addresses how goodwill and other intangible assets
should be accounted for after they have been initially recognized in the
financial statements. FAS 142 carries forward without reconsideration those
provisions of APB Opinion No. 17 related to the accounting for internally
developed intangible assets. The provisions of FAS 142 are required to be
applied with fiscal years beginning after December 15, 2001, and early
application is permitted for entities with fiscal years beginning after March
15, 2001, under certain conditions. Impairment losses for goodwill and
indefinite-lived intangible assets that arise due to the initial application of
FAS 142 (resulting from a transitional impairment test) are to be reported as
resulting from a change in accounting principle. We believe FAS 141 may limit
our ability to acquire businesses using our stock without recognizing goodwill,
which does not count as capital for regulatory purposes. The elimination of
amortization of goodwill and other intangibles pursuant to FAS 142 is expected
to improve our earnings in 2002 and allow us to make acquisitions at a premium
without adversely affecting net income due to goodwill and intangible
amortization. We cannot fully determine the effects of these changes at this
time, however.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, "Accounting for Asset Retirement
Obligations." This statement addresses financial and reporting obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. It applies to legal obligations associated with the
retirement of long-lived assets that result from acquisition, construction,
development and/or the normal operation of a long-lived asset, except for
certain obligations of lessees. This statement is effective for financial
statements issued for fiscal years beginning after June 15, 2002. We are
currently evaluating the effect of adoption of FAS 143 on our financial position
and results of operations, but at this time, we do not expect this will have a
material effect.
In August 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("FAS 144"). This statement supersedes FAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and Accounting Principles Board Opinion No. 30, "Reporting
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." This statement retains the fundamental provisions of FAS 121 for
recognition and measurement of impairment, but amends the accounting and
reporting standards for segments of a business to be disposed of. The provisions
of this statement are required to be adopted no later than fiscal years
beginning after December 31, 2001, with early adoption encouraged. The Company
is currently evaluating the impact of the adoption of FAS 144, but at this time,
we do not expect this to have a material effect.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In this form 10-Q, "First Security," "FSG," "we," "us," and "our" refer to
First Security Group, Inc.
THIRD QUARTER 2001
The following discussion and analysis sets forth the major factors that
affected First Security's results of operations and financial condition
reflected in the unaudited financial statements for the three-month and
nine-month periods ended September 30, 2000 and 2001. Such discussion and
analysis should be read in conjunction with the Company's Consolidated Financial
Statements and the notes attached thereto.
OVERVIEW
As of September 30, 2001, First Security had total consolidated assets of
$323.8 million, total loans of $267.5 million, total deposits of $270.4 million
and stockholders' equity of $34.6 million. We incurred a net loss of $115
thousand for the three months ended September 30, 2001.
On a going forward basis, we are uncertain how the terrorist attacks of
September 11, 2001, and the United States' Response to these attacks, may
affect our business. These attacks have resulted in a general economic slowdown
that may adversely affect both our commercial banking and mortgage banking
business. Additionally, under the Soldiers' and Sailors' Civil Relief Act of
1940, a borrower who enters military service is afforded various types of
relief under their loans and other obligations, including a maximum annual
interest rate of 6% during the period of the borrower's active duty. We cannot
predict the effect that the Relief Act will have on our loan portfolio.
RESULTS OF OPERATIONS
Net loss for the quarter ended September 30, 2001, was $115 thousand, or
- -$.03 per share (basic and diluted), compared to net loss of $51 thousand or
$.01 per share (basic and diluted) in the second quarter of 2001 and a net loss
of $253 thousand or -$.06 per share (basic and diluted) for the third quarter of
2000. Net loss for the nine-months ended September 30, 2001, was $73 thousand,
or -$.02 per share (basic and diluted), compared to net loss of $515 thousand or
- -$.13 per share (basic and diluted) for the same period in 2000. As a result of
the adoption of FAS 142, the goodwill amortization expense will no longer be
incurred after 2001; however, the goodwill would be written down should the
carrying value become impaired. Net loss per share (basic and diluted), without
amortization of goodwill (net of tax benefit), for the three months ended
September 30, 2001 would have been $.01 and $.04 for the three months ended
September 30, 2000.
Net Interest Income
Net interest income (fully taxable equivalent) increased by $1.2 million or
69 percent to $2.9 million for the third quarter of 2001 compared to the same
period a year ago, and was $433 thousand more than the second quarter of 2001.
For the nine-month period ending September 30, 2001, net interest income (on a
tax equivalent basis) increased by $3.3 million, or 76 percent, over the same
period in the previous year. The two factors that primarily influence net
interest income are: (1) volume of earning assets, and (2) rate of net interest
margin on those earning assets. Of these two, the quarterly and year-to-date
increases in net interest income resulted from the growth in earning assets.
Quarter-to-date average earning assets increased by $139.0 million or 102
percent to $275.3 million at the end of September 2001 compared to the
quarter-to-date average for the same period in 2000, and was $43.7 million, or
19 percent, greater than the 2001 second quarter average. From 2000 to 2001, the
year-to-date average earning assets increased $116.0 million, or 97 percent, to
$235.1 million. Our earning assets increased primarily due to the branching and
deposit gathering activities of Frontier Bank in Tennessee. Frontier Bank opened
for business on June 26, 2000. As of September 30, 2001, Frontier Bank had seven
full service branches and two loan production offices. Subsequent to the end of
the third quarter of 2001, Frontier Bank converted one of the loan production
offices into a full service branch in Lenoir City, Tennessee and opened an
additional full service branch in Chattanooga, Tennessee. The deposits raised
through these branches have been deployed into earning assets. These earning
assets have enabled First Security to earn more net interest income.
10
The other factor influencing net interest income is net interest margin.
Negative changes in net interest margin did not influence net interest income as
significantly as the changes in earning assets. Net interest margin was 83 basis
points lower in the third quarter of 2001 compared to the same period in 2000,
and 52 basis points lower for the nine-month period ending September 30, 2001
versus the same period in 2000.
For the third quarter, as well as the first nine months of 2001, one reason
for the decrease in net interest margin is that interest bearing sources of
funding comprise a larger percentage of the overall funding in 2001 from 2000.
For the third quarter, 82 percent of average earning assets were funded with
interest bearing liabilities, compared to 77 percent for the same period in 2000
and 81 percent in the second quarter of 2001. For the first nine months of 2001,
81 percent of average earning assets were funded with interest bearing
liabilities, compared to 75 percent for the same period of 2000.
Another factor influencing the net interest margin is rate changes by the
Federal Reserve. On December 19, 2000, the Federal Reserve indicated that the
U.S. economy was showing signs of weakness. Soon thereafter, the Federal Reserve
began an initiative to stimulate economic growth through rate cuts. The table
below indicates the rate changes imposed by the Federal Reserve, as well as the
simultaneous decreases in the prime lending rate. On August 21, 2001, the
Federal Reserve cut rates by 25 basis points as indicated on the table. At that
time, the federal funds futures market expected the Federal Reserve to decrease
interest rates by one additional 25 basis points cut before the end of 2001 and,
thus, stave off a recession. The terrorist attacks of September 11, 2001 on New
York City and Washington, D.C. forced the Federal Reserve to take more drastic
measures. After the attack, the stock markets in the United States closed until
Monday, September 17, 2001, on which date the Federal Reserve instituted an
inter-meeting 50 basis point interest rate cut. Then again at its next two
regularly scheduled meetings, the Federal Reserve cut interest rates an
additional 50 basis points at each meeting (i.e. a total of 100 basis points or
1%), and at the time of this filing, the federal funds futures market
anticipates an additional 25 basis point cut in interest rates by the Federal
Reserve by the end of 2001.
As a result of these rate decreases, we anticipate that the average rate
earned on loans and the average rate paid on deposits will decrease during the
remainder of the year. Each decrease in the prime lending rate initially
decreases our net interest income since a large number of loans are tied to the
prime lending rate and are directly and immediately affected. However, with the
passage of time, interest sensitive liabilities will decrease and our interest
margins should stabilize.
Historical Change in Monetary Policy and Yield Curve Reaction
FOMC
Announcement Federal Funds Prime Lending
Date Rate Rate
---------------------------------------------------
Start of 2000 5.50% 8.50%
02/02/00 5.75% 8.75%
03/21/00 6.00% 9.00%
05/16/00 6.50% 9.50%
01/03/01 6.00% 9.00%
01/31/01 5.50% 8.50%
03/20/01 5.00% 8.00%
04/18/01 4.50% 7.50%
05/15/01 4.00% 7.00%
06/27/01 3.75% 6.75%
08/21/01 3.50% 6.50%
09/17/01 3.00% 6.00%
10/02/01 2.50% 5.50%
11/05/01 2.00% 5.00%
11
The interest rate earned on loans for the three months ended September 30,
2001 decreased 134 basis points compared to the same period in 2000, and
decreased 39 basis points compared to the second quarter of 2001. The decrease
is primarily attributable to the decreases in the prime lending rate during
2001, which were effected by the Federal Reserve rate cut initiative. The yields
on investment securities and other earning assets also decreased over the same
periods. The overall yield on earning assets decreased 124 basis points in the
third quarter of 2001 compared to the third quarter of 2000, and decreased by 47
basis points from the second to third quarters of 2001. For the third quarter of
2001, the cost of interest bearing liabilities decreased by 85 basis points from
the same period in 2000 and 55 basis points from the second quarter period of
2001. As a result, net interest spread for the third quarter of 2001 decreased
39 basis points over the same period in the prior year, and increased 8 basis
points over the second quarter of 2001. Deposit and loan rates are adjusted as
market conditions and the Banks' needs allow. The following table summarizes net
interest income and average yields and rates paid for the quarters ended
September 30, 2001 and 2000.
Average Consolidated Balance Sheets and Net Interest Analysis
For the three months ended September 30, 2001
Fully Tax-Equivalent Basis
(all dollar amounts in thousands)
-------------------------------- ------------------------------
2001 2000
-------------------------------- ------------------------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
--------- --------- ---- --------- --------- ----
Assets
Earning assets:
Loans, net of unearned income $ 240,431 $ 5,164 8.52% $ 114,581 $ 2,848 9.86%
Investment securities 29,652 439 5.87% 15,892 284 7.09%
Other earning assets 5,184 46 3.52% 5,825 89 6.06%
--------- --------- ---- --------- --------- ----
Total earning assets 275,267 5,649 8.14% 136,298 3,221 9.38%
Allowance for loan losses (3,015) (1,419)
Intangible asset 6,378 6,816
Cash & due from banks 13,688 6,163
Premises & equipment 8,770 6,918
Other assets 2,278 1,200
--------- ---------
TOTAL ASSETS $ 303,366 $ 155,976
========= =========
12
Liabilities and Stockholders' Equity
Interest bearing liabilities:
NOW accounts $ 18,136 87 1.90% $ 12,076 57 1.87%
Money market accounts 36,443 337 3.67% 10,807 110 4.04%
Savings deposits 7,975 52 2.59% 4,534 35 3.06%
Time deposits < $100 92,658 1,308 5.60% 49,693 816 6.51%
Time deposits > $100 57,727 787 5.41% 25,222 428 6.73%
Federal funds purchased 3,544 29 3.25% 190 3 6.26%
Repurchase agreements 8,152 69 3.36% 2,351 26 4.39%
Other borrowings 2,250 34 6.00% -- -- 0.00%
-----------------------------------------------------------------------------------------
Total interest bearing 226,885 2,703 4.73% 104,873 1,475 5.58%
Net interest spread $ 2,946 3.41% $ 1,746 3.80%
Noninterest bearing demand deposits 41,603 19,376
Accrued expenses and other
liabilities 2,317 1,047
Stockholders' equity 32,304 30,755
Unrealized gain/loss on 257 (75)
securities
TOTAL LIABILITIES AND -------- --------
STOCKHOLDERS' EQUITY $303,366 $155,976
======== ========
Impact of noninterest bearing
Sources and other changes in
Balance sheet composition 0.84% 1.28%
---- ----
Net yield on earning assets 4.25% 5.08%
==== ====
13
The following table presents the dollar amount of changes in interest
income and interest expense from the 3-month period ended September 30, 2000 to
the 3-month period ended September 30, 2001. The table distinguishes between the
changes related to average outstanding (volume) of earning assets and interest
bearing liabilities, as well as the changes related to average interest rates
(rate) on such assets and liabilities.
Change in Interest Income and Expense on a Tax Equivalent Basis
For the Three Months Ended September 30
(all dollar amounts in thousands)
2001 Compared to 2000
Increase (Decrease)
in Interest Income and Expense
Due to Changes in:
-----------------------------------------------
Volume Rate Total
------- ------- -------
Interest earning assets:
Loans, net of unearned income $ 2,703 $ (387) $ 2,316
Investment securities 204 (49) 155
Other earning assets (6) (37) (43)
------- ------- -------
Total earning assets 2,901 (473) 2,428
------- ------- -------
Interest bearing liabilities:
NOW accounts 29 1 30
Money market accounts 237 (10) 227
Savings deposits 22 (5) 17
Time deposits < $100 607 (115) 492
Time deposits > $100 443 (84) 359
Federal funds purchased 27 (1) 26
Repurchase agreements 49 (6) 43
Other borrowings 34 -- 34
------- ------- -------
Total interest bearing liabilities 1,448 (220) 1,228
------- ------- -------
Increase (decrease) in net interest income $ 1,453 $ (253) $ 1,200
======= ======= =======
Comparing the nine months ended September 30, 2001 to the same period in
2000, the interest rate earned on loans decreased 57 basis points because of the
Federal Reserve's rate cut initiative. We believe that the yield on the loan
portfolio, as well as the yield on earning assets and the cost of funding
interest bearing liabilities will most likely decrease because these assets and
liabilities will continue to reprice at lower rates. The yield on earning assets
decreased by 41 basis points and the cost of interest bearing liabilities
decreased 23 basis points, which caused the net interest spread to decrease by
18 basis points. The following table summarizes net interest income and average
yields and rates paid for the nine months ended September 30, 2001 and 2000.
14
Average Consolidated Balance Sheets and Net Interest Analysis
For the nine months ended September 30
Fully Tax-Equivalent Basis
(all dollar amounts in thousands)
2001 2000
---------------------------------- -------------------------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
--------- --------- ---- --------- --------- ----
Assets
Earning assets:
Loans, net of unearned income $ 203,730 $ 13,556 8.90% $ 95,493 $ 6,768 9.47%
Investment securities 24,558 1,191 6.48% 15,392 801 6.95%
Other earning assets 6,768 251 4.96% 8,138 398 6.53%
-----------------------------------------------------------------------
Total earning assets 235,056 14,998 8.53% 119,023 7,967 8.94%
Allowance for loan losses (2,488) (1,176)
Intangible asset 6,497 6,206
Cash & due from banks 10,203 4,871
Premises & equipment 7,933 6,137
Other assets 1,939 1,311
--------- ---------
TOTAL ASSETS $ 259,140 $ 136,372
========= =========
Liabilities and Stockholders' Equity
Interest bearing liabilities:
NOW accounts $ 16,697 247 1.98% $ 11,432 162 1.89%
Money market accounts 27,010 810 4.01% 7,582 248 4.37%
Savings deposits 7,129 152 2.85% 4,821 121 3.35%
Time deposits < $100 82,900 3,757 6.06% 42,255 1,979 6.26%
Time deposits > $100 46,434 2,081 5.99% 19,473 951 6.52%
Federal funds purchased 1,907 49 3.44% 1,718 79 6.14%
Repurchase agreements 6,567 188 3.83% 2,181 74 4.53%
Other borrowings 1,385 62 5.99% 259 14 7.22%
-----------------------------------------------------------------------
Total interest bearing liabilities $ 190,029 7,346 5.17% 89,721 3,628 5.40%
-------------------- ------------------
Net interest spread $ 7,652 3.36% $ 4,339 3.54%
========= =========
Noninterest bearing demand deposits 35,604 14,804
Accrued expenses and other liabilities 2,053 1,047
Stockholders' equity 31,242 30,900
Unrealized gain/loss on securities 212 (100)
TOTAL LIABILITIES AND
--------- ---------
STOCKHOLDERS' EQUITY $ 259,140 $ 136,372
========= =========
Impact of noninterest bearing
Sources and other changes in
Balance sheet composition 0.99% 1.33%
--------- ---------
Net yield on earning assets 4.35% 4.87%
========= =========
15
The following table presents the dollar amount of changes in interest
income and interest expense from the nine months ended September 30, 2000 to the
nine months ended September 30, 2001. The table distinguishes between the
changes related to average outstanding (volume) of earning assets and interest
bearing liabilities, as well as the changes related to average interest rates
(rate) on such assets and liabilities.
Change in Interest Income and Expense on a Tax Equivalent Basis
For the Nine Months Ended September 30
(all dollar amounts in thousands)
2001 Compared to 2000
Increase (Decrease)
in Interest Income and Expense
Due to Changes in:
-------------------------------------------------------
Volume Rate Adjustments* Total
------- ------- ------- -------
Interest earning assets:
Loans, net of unearned income $ 7,202 $ (408) $ (6) $ 6,788
Investment securities 445 (54) (1) 390
Other earning assets (51) (96) (147)
------- ------- ------- -------
Total earning assets 7,596 (558) (7) 7,031
------- ------- ------- -------
Interest bearing liabilities:
NOW accounts 78 7 85
Money market accounts 582 (20) 562
Savings deposits 49 (18) 31
Time deposits < $100 1,842 (62) (2) 1,778
Time deposits > $100 1,208 (77) (1) 1,130
Federal funds purchased 5 (35) (30)
Repurchase agreements 125 (11) 114
Other borrowings 50 (2) 48
------- ------- ------- -------
Total interest bearing liabilities 3,939 (218) (3) 3,718
------- ------- ------- -------
Increase (decrease) in net interest income $ 3,657 $ (340) $ (4) $ 3,313
======= ======= ======= =======
*Adjustments due to 2000 having one additional day due to leap year.
Provision for Loan Losses
The provision for loan losses charged to operations during the three months
ended September 30, 2001 was $843 thousand compared to $413 thousand in the same
period of 2000 and $703 thousand in the second quarter of 2001. The provision
for loan losses charged for the nine month periods ended September 30, 2001 and
2000 were $1.8 million and $532 thousand, respectively. Net charge-offs for the
first nine months increased from $14 thousand in 2000 to $166 thousand in 2001.
Net charge-offs annualized as a percentage of average loans totaled 0.11 percent
for the first nine months of 2001 and 0.02 percent for the same period in 2000.
The 2001 provisions were more than the 2000 provisions due to our analysis
of inherent risks in the loan portfolio in relation to the portfolio's growth,
the increase in past due loans, as well as general economic conditions. The loan
portfolio increased by $114.6 million from December 31, 2000 to September 30,
2001, compared to an increase of $58.2 million from December 31, 1999 to
September 30, 2000. See "Nonperforming Assets."
The allowance for loan losses reflects management's assessment and estimate
of the risks associated with extending credit and its evaluation of the quality
of the loan portfolio. We periodically analyze our commercial loan portfolio in
an effort to establish an allowance for loan losses that we believe will be
16
adequate in light of anticipated risks and loan losses. In assessing the
adequacy of the allowance, we review the size, quality and risk of loans in the
portfolio. We also consider such factors as:
- Our banks' loan loss experience;
- the amount of past due and nonperforming loans;
- specific known risks;
- the status and amount of past due and nonperforming assets;
- underlying estimated values of collateral securing loans;
- current and anticipated economic conditions; and
- other factors which management believes affects the allowance for
potential credit losses.
An analysis of the credit quality of the loan portfolio and the adequacy of
the allowance for loan losses is prepared by our banks and presented to the
respective boards of directors on a regular basis. In addition, we engaged an
outside loan review consultant to perform, on an annual basis, an independent
review of the quality of the loan portfolio and adequacy of the allowance.
The banks' allowance for loan losses is also subject to regulatory
examinations and determinations as to adequacy, which may take into account
such factors as the methodology used to calculate the allowance for loan losses
and the size of the allowance for loan losses compared to a group of peer banks
identified by the regulators. During their routine examinations of banks, the
federal and/or state regulators may require a bank to make additional
provisions to its allowance for loan losses when, in the opinion of the
regulators, their credit evaluations and allowance for loan loss methodology
differ materially from ours.
While it is our policy to charge off in the current period loans for which
a loss is considered probable, there are additional risks of future losses
which cannot be quantified precisely or attributed to particular loans or
classes of loans. Because these risks include the state of the economy,
management's judgment as to the adequacy of the allowance is necessarily
approximate and imprecise.
Noninterest Income
Noninterest income totaled $676 thousand for the third quarter of this
year, an increase of $398 thousand, or 143 percent, from the same period in
2000, and an increase of $106 thousand, or 19 percent, over the second quarter
of 2001.
Deposit related income, comprised primarily of account service charges and
non-sufficient fund charges totaled $351 thousand for the third quarter of 2001
which was $161 thousand, or 85 percent, more than the corresponding quarter in
2000, and was an increase of $17 thousand, or 5 percent, from the second quarter
to the third quarter of 2001. Deposit related income increased as we have gained
deposits, and we believe that this source of income will continue to be boosted
by further deposit growth. Mortgage loan fees increased by $182 thousand, or 520
percent, to $217 thousand for the third quarter of 2001 from the prior year.
Lower rates for fixed rate residential 15- and 30-year loan products during 2001
have contributed to the growth in mortgage loan fee income as home refinancing
activities have increased. Assuming 15- and 30-year mortgage interest rates
remain stable, we anticipate that mortgage loan fees will also remain near their
current levels or increase slightly as Dalton Whitfield Bank's new (opened
August 1, 2001) mortgage loan operation reaches full capacity.
Noninterest income totaled $1.7 million for the nine-month period ending
September 30, 2001, an increase of $1.1 million, or 158 percent, from the same
period last year. As in the quarterly comparison, two significant increases
occurred. The first increase was an additional $464 thousand, or a 94 percent
increase in deposit related income. The second was a $475 thousand, or 848
percent increase in mortgage related fee income.
Noninterest Expense
Noninterest expenses for the third quarter totaled $3.0 million, which was
an increase of $939 thousand or 47 percent over the third quarter of 2000.
Compared to the second quarter of this year, noninterest expense increased by
$498 thousand or 20 percent for the third quarter. First Security's overhead
ratio (excluding amortization of intangible assets) decreased from 94 percent in
the third quarter of 2000 to 78 percent this year for the third quarter. This is
reflective of our opening Frontier Bank and the subsequent enhancement of
earnings as described in "Net Interest Income" and "Noninterest Income."
17
Compared to the third quarter of 2000, salaries and benefits increased $566
thousand or 54 percent to $1.6 million. Most of the increase in salaries and
benefits is related to staff additions for our branch openings. As of September
30, 2000, we had six full service branches open with a total of 98 full time
equivalent employees. As of September 30, 2001, we employed 138 full time
equivalent employees and operated ten full service branches and two loan
production offices.
The following expense categories are all higher in the third quarter 2001
versus the same period in the prior year as a result of the aforementioned
branching activities. Occupancy expenses increased $83 thousand or 54 percent to
$236 thousand. Furniture, fixtures and equipment expenses increased $58 thousand
or 38 percent to $209 thousand. Data processing costs increased $71 thousand or
83 percent to $157 thousand. Advertising increased $47 thousand or 98 percent to
$95 thousand. Supplies, communications, and postage expenses increased in
aggregate by $18 thousand or 10 percent to $204 thousand.
Professional fees increased $28 thousand or 35 percent to $109 thousand
from quarter to quarter. The primary reason for the increase was our outsourcing
of internal audit, loan review, and compliance to Professional Bank Services.
Noninterest expenses for the nine-month period ending September 30, 2001
were $2.4 million or 44 percent higher and totaled $7.7 million compared to the
same period in 2000. The changes are explained similarly to the quarterly data
above and were as follows. Salaries and benefits increased $1.4 million or 49
percent. Occupancy expenses increased $286 thousand or 79 percent. Furniture,
fixtures, and equipment expenses increased $220 or 65 percent. Data processing
costs increased $223 thousand or 106 percent. Advertising increased $101
thousand or 98 percent. Goodwill amortization increased $39 thousand or 12
percent due to the goodwill created by the acquisition of First Central Bank of
Monroe County in Sweetwater, Tennessee. Goodwill associated with this
acquisition was $973 thousand. Supplies, communications, and postage expenses
increased $122 or 29 percent. And, professional fees decreased $113 thousand or
32 percent. The higher professional fees in 2000 primarily included legal and
accounting services necessary for the opening of Frontier Bank.
STATEMENT OF FINANCIAL CONDITION
First Security's total assets at September 30, 2001 and 2000, were $323.8
million and $167.9 million, respectively, and $199.6 million at December 31,
2000. Average earning assets for the third quarter of 2001 were $275.3 million
versus $136.3 million for the same period a year earlier, an increase of 102
percent. As in the second quarter of this year, our year-to-year corporate
growth is largely due to the growth of Frontier Bank, which was enhanced by our
branching activities. From third quarter end 2000 to the filing of this report,
we opened the following locations:
835 South Congress Parkway
Athens, Tennessee
Full Service Branch of Frontier Bank
Opened November 6, 2000
702 Grove Street, Suite 100
Loudon, Tennessee
Loan Production Office of Frontier Bank
Opened February 5, 2001
4535 Highway 58
Chattanooga, Tennessee
Full Service Branch of Frontier Bank
Opened May 7, 2001
820 Ridgeway Avenue
Signal Mountain, Tennessee
Full Service Branch of Frontier Bank
18
Opened May 29, 2001
2709 Chattanooga Road, Suite 5
Rocky Face, Georgia
Full Service Branch of Dalton Whitfield Bank
Opened June 4, 2001
119 Broadway West
Lenoir City, Tennessee
Full Service Branch of Frontier Bank
Opened July 2, 2001 as a Loan Production Office
Converted to Full Service Branch on October 15, 2001
1409 Cowart Street
Chattanooga, Tennessee
Full Service Branch of Frontier Bank
Opened October 22, 2001
First Security continues to actively pursue acquisitions and will continue
to seek means to enhance our market share through further branching.
Loans
Average loans of $240.4 million represented 87 percent of our average
earning assets during the third quarter of 2001. Gross loans increased to $267.5
million at September 30, 2001, a 75 percent increase over loans at December 31,
2000, and a 109 percent increase over loans at September 30, 2000. The growth in
the loan portfolio is primarily attributable to activity at Frontier Bank. We
believe that general loan growth will remain strong, however, not at the same
level that we experienced during the past year. Funding of future loan growth
will be restricted by our ability to raise core deposits, although we will use
alternative funding sources if necessary and cost effective. Loan growth will be
further restricted by the necessity for us to maintain appropriate capital
levels, as well as adequate liquidity.
Asset Quality
The allowance for loan losses was $3.6 million or 1.35 percent of
outstanding loans at September 30, 2001 and $1.9 million or 1.27 percent of
outstanding loans, at December 31, 2000. The allowance for loan losses was 128
percent of nonperforming loans at September 30, 2001 and 1,764 percent of
nonperforming loans at December 31, 2000. For the first nine months of 2001, net
losses arising from loans secured by real estate for construction and land
development totaled $51 thousand; net losses from commercial loans totaled $24
thousand; and, net losses from consumer loans totaled $91 thousand. See
"Provision for Loan Losses." We believe that our reserve for inherent loan
losses is adequate based on our assessment of the information available. Our
assessment involves uncertainty and judgment; therefore, the adequacy of the
allowance for loan losses cannot be determined with precision and may be subject
to change in future periods. In addition, bank regulatory authorities, as part
of their periodic examinations of our banks, may require additional charges to
the provision for loan losses in future periods if the results of their reviews
warrant.
19
The allocation of the allowance for loan losses by loan category at the
dates indicated is presented below.
Nine Months Ended September 30,
-------------------------------
(in thousands)
--------------
2001 2000
---- ----
Percentage of loans Percentage of loans
in each category to in each category to
Amount total loans Amount total loans
------ ----------- ------ -----------
Commercial $1,485 33.8% $ 685 37.1%
Real estate-construction 197 6.2% 54 3.5%
Real estate-mortgage 1,199 40.2% 589 41.0%
Consumer 587 19.6% 283 18.2%
Unallocated 132 0.2% 58 0.2%
------ ------ ------ ------
$3,600 100.0% $1,669 100.0%
====== ====== ====== ======
Nonperforming Assets
Nonaccrual loans were $961 thousand at September 30, 2001, and $63 thousand
at December 31, 2000. The nonaccrual loans in September 2001 included $930
thousand of commercial loans and $31 thousand of consumer loans. The ratio of
nonaccrual loans to total loans was 0.36 percent at September 30, 2001 and 0.04
percent at December 31, 2000. At each date, we did not own any other real
estate.
Loans past due 90 days and still accruing were $1.8 million at September
30, 2001, compared to $47 thousand at December 31, 2000. Of the past due loans
at September 2001, $317 thousand were secured by real estate and $1.5 million
were consumer loans. We believe that the rise in loans past due is primarily
related to the decline of the general economy.
Investment Securities
Securities totaled $30.4 million at September 30, 2001 versus $20.1 million
at December 31, 2000. The growth in the securities portfolio has occurred for
two reasons: (1) to provide adequate liquidity, and (2) to pledge as collateral
against public deposits and repurchase agreements. At September 30, 2001, the
securities portfolio had unrealized net gains of approximately $723 thousand. In
addition, all investment securities purchased to date have been classified as
available-for-sale. As of September 30, 2001, securities with a carrying value
of $6.1 million were scheduled to mature within the next five years. Of this
amount, no securities are scheduled to mature within one year (excluding
prepayment and call features). We currently have the ability and intent to hold
our available-for-sale investment securities to maturity. However, should
conditions change, we may sell unpledged securities. Our management considers
the overall quality of the securities portfolio to be high. All securities held
are traded in liquid markets.
Deposits and Other Borrowings
Total deposits increased 102 percent from September 30, 2000 to September
30, 2001, and 66 percent from December 31, 2000 to September 30, 2001. Our
deposit growth is primarily the result of the branching and market acceptance of
Frontier Bank.
On April 15, 2001, we issued subordinated mandatory convertible notes for
$2.25 million. The principal and interest (6 percent) on these notes mandatorily
converted into our common stock on October 15, 2001. The proceeds from the
issuance of these notes have been invested in Dalton Whitfield Bank and will be
used to support growth opportunities for that bank.
20
Liquidity
The liquidity position of the Banks is primarily dependent upon their need
to respond to withdrawals from deposit accounts and upon the liquidity of their
assets. Primary liquidity sources include cash and due from banks, federal funds
sold, short-term investment securities and loan repayments. At September 30,
2001, our liquidity ratio was 9.5 percent (excluding anticipated loan
repayments). Management believes the liquidity sources are adequate to meet
operating needs; however, we currently have an initiative to increase our
liquidity ratio to 15 percent. There are no known trends, events or
uncertainties that will have or that are reasonably likely to have a material
effect on our liquidity, capital resources or operations.
Capital Resources
We continue to maintain capital ratios in excess of regulatory minimum
requirements. The current capital standards call for a minimum total capital of
10 percent of risk-adjusted assets, including 6 percent Tier I capital, and a
minimum leverage ratio of Tier I capital to total tangible assets of at least 5
percent. Each of our Banks has regulatory chartering conditions requiring
leverage ratios to not fall below 8 percent for the first three years of their
operations.
Dalton
September 30, 2001 Well Adequately First Whitfield Frontier
Capitalized Capitalized Security Bank Bank
Tier I capital to risk adjusted assets 6.00% 4.00% 9.95% 9.18% 9.90%
Total capital to risk adjusted assets 10.00% 8.00% 11.20% 10.37% 11.15%
Leverage ratio 5.00% 4.00% 9.21% 8.45% 8.83%
On October 22, 2001, First Security's recent stock offering terminated
upon reaching its maturity date. The offering became effective with the SEC on
June 14, 2001 and was open for 100 days plus one 30-day extension. Through the
offering we were authorized to sell to the general public up to 3 million shares
of our common stock at a price of $10.00 per share. The purpose of this offering
was to raise funds for future growth. We sold 664,550 shares of our common stock
for $6,645,000. We believe that this capital campaign was hampered by the
terrorist attacks on September 11, 2001 and their effects on the capital
markets. On October 15, 2001 we also issued 231,750 shares of our common stock
upon conversion of $2,250,000 in subordinated mandatory convertible notes we
issued on April 15, 2001. In order to continue our growth we will have a
continuing need for capital.
EFFECTS OF INFLATION
Inflation generally increases the cost of funds and operating overhead, and
to the extent loans and other assets bear variable rates, the yields on such
assets. Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates generally have a more significant impact on the performance of a
financial institution than the effects of general levels of inflation. Although
interest rates do not necessarily move in the same direction or to the same
extent as the prices of goods and services, increases in inflation generally
have resulted in increased interest rates. In addition, inflation results in
financial institutions' increased cost of goods and services purchased, the cost
of salaries and benefits, occupancy expense, and similar items. Inflation and
related increases in interest rates generally decrease the market value of
investments and loans held and may adversely affect liquidity, earnings, and
shareholders' equity. Mortgage originations and refinancings tend to slow as
interest rates increase, and likely will reduce First Security's earnings from
such activities and the income from the sale of residential mortgage loans in
the secondary market; conversely, as interest rates decline mortgage
originations tend to accelerate.
21
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the statements made under the caption "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and elsewhere
throughout this Form 10-Q are forward-looking statements for purposes of the
Securities Act and the Exchange Act. Forward-looking statements relate to future
events or our future financial performance and may involve known or unknown
risks, uncertainties and other factors which may cause the actual results,
performance or achievements of First Security to be materially different from
future results, performance, or achievements expressed or implied by such
forward-looking statements. Forward-looking statements include statements using
the words such as "may," "will," "anticipate," "should," "would," "believe,"
"contemplate," "expect," "estimate," "continue," "may," "intend," "seeks," or
other similar words and expressions of the future.
These forward-looking statements involve risks and uncertainties, and may
not be realized due to a variety of factors, including, without limitation: the
effects of future economic conditions, governmental monetary and fiscal
policies, as well as legislative and regulatory changes; the risks of changes
in interest rates on the level and composition of deposits, loan demand, and
the values of loan collateral, securities, and interest sensitive assets and
liabilities; interest rate risks; the costs of evaluating possible acquisitions
and the risks inherent in integrating acquisitions; the effects of competition
from other commercial banks, thrifts, mortgage banking firms, consumer finance
companies, credit unions, securities brokerage firms, insurance companies,
money market and other mutual funds and other financial institutions operating
in First Security's market area and elsewhere, including institutions operating
regionally, nationally and internationally, together with such competitors
offering banking products and services by mail, telephone, computer and the
Internet; and the failure of assumptions underlying the establishment of
reserves for possible loan losses. All written or oral forward-looking
statements attributable to First Security are expressly qualified in their
entirety by this Cautionary Notice.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Although First Security's exposure to market risk is comprised of many
variables including credit and liquidity risk, management considers interest
rate risk to be the most significant. This risk can result in either lower fair
market values or reduced net interest income. Management believes the effects on
net interest income to be more significant than reduced fair market values.
First Security does not maintain a trading portfolio or deal in international
instruments, and therefore First Security is not exposed to risks involved with
trading activities and foreign currency.
First Security's interest rate risk management is the responsibility of our
Asset/Liability Management Committee (ALCO), which has established policies and
limits to monitor, measure, and coordinate First Security's sources, uses, and
pricing of funds. The Asset/Liability Management Committee utilizes the results
of simple and dynamic gap analysis, as well as Plansmith's quarterly
RiskAnalyzer report, to measure the estimated exposure of net interest income to
a sustained change in interest rates.
The gap analysis projects net interest income based on an immediate change
in interest rates of up or down 200 basis points. First Security had an exposure
to falling rates and a benefit from rising rates at September 30, 2001. More
specifically, the model forecasts a decline in net interest income of $950
thousand, or 9.29% on an annualized basis, as a result of a 200 basis point
decline in interest rates. The model also predicts a $634 thousand or a 6.20%
increase in net interest income on an annualized basis as a result of a 200
basis point increase in rates. These results are within the limits specified by
the Asset/Liability Management Committee, and they are summarized in the
following chart:
22
Interest Rate Risk
Income Sensitivity Summary
As of September 30, 2001
(in thousands)
DOWN UP
200 BP CURRENT 200 BP
------ ------- ------
Net interest income $ 6,702 $ 7,652 $ 8,286
Dollar change net interest income (950) -- 634
Percent change net interest income -9.29% 0.00% 6.20%
The model is based on actual repricing dates of interest sensitive assets and
interest sensitive liabilities, and it incorporates assumptions regarding the
impact of changing interest rates on the prepayment rates of certain assets.
These assumptions include interest rate levels, shape of the yield curve,
prepayments on loans and securities, rates on loans and deposits, reinvestments
of paydowns and maturities of loans, investments and deposits, and others.
Numbers are based on a flat balance sheet and it is assumed that paydowns and
maturities of assets and liabilities are reinvested in like instruments at: (1)
current interest rates, (2) rates of 200 basis points less, and (3) rates of
200 basis points more. In addition, there is no input for growth or a change in
asset mix. These assumptions are developed based on the current economic and
market conditions, but management cannot make any assurances as to the
predictive nature of these assumptions, including how customer preferences or
competitor influences might change. As market conditions vary from those assumed
in the sensitivity analysis, actual results will differ. Also, this sensitivity
analysis does not reflect actions that our Asset/Liability Management Committee
might take in responding to or anticipating changes in interest rates.
PART II. OTHER INFORMATION
ITEM 2. Changes in Securities and Use of Proceeds
On April 15, 2001, we issued subordinated mandatory convertible notes
for $2.25 million. The principal and interest on these notes mandatorily
converted into 231,750 shares of our common stock on October 15, 2001. The
proceeds from the issuance of these notes have been invested in Dalton Whitfield
Bank and will be used to support growth opportunities for that Bank.
Our offering to the public of up to 3 million shares of our common
stock at $10.00 per share commenced on June 14, 2001 and terminated on October
22, 2001. We sold 664,550 of the 3 million registered shares for gross proceeds
of $6,645,000. No underwriters were involved in this offering. Total actual
expenses for this offering were $420 thousand. No direct or indirect payments
of expenses were made to any of our directors, officers, to any of our
affiliates, or persons owning 10 percent or more of any of our securities.
The net proceeds from this offering will be used for general corporate
purposes and working capital including, but not limited to, capital
contributions to our banks to support growth and for working capital, and
possible acquisitions of financial services businesses.
ITEM 4. Submission of Matters to a Vote of Security Holders
We held our Annual Meeting of Shareholders on July 31, 2001 where the
following seven directors were elected: Rodger B. Holley, Larry R. Belk, Clayton
Causby, Kenneth C. Dyer, III, Douglas F. Heuer, III, Ralph L. Kendall, and D.
Ray Marler. These are all of our directors. The directors were voted on as a
slate and the slate received 2,449,162 votes for and 6,500 votes were withheld.
23
The only other matter put to a vote at the Annual Meeting was a
ratification of the appointment of Joseph Decosimo and Company, LLP, as
independent auditors for First Security for the fiscal year ending December 31,
2001. The number of votes cast for this proposal was 2,442,662, the number of
votes against was zero, and the number of abstentions was 13,000.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
None.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarter ended September
30, 2001.
24
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be signed by the undersigned,
thereunto duly authorized.
FIRST SECURITY GROUP, INC.
(Registrant)
November 14, 2001 /s/ Rodger B. Holley
----------------------------------------
Rodger B. Holley
Chairman, Chief Executive Officer &
President
November 14, 2001 /s/ William L. Lusk, Jr.
----------------------------------------
William L. Lusk, Jr.
Secretary, Chief Financial Officer &
Executive Vice President
25