U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2002
[ ] Transition Report under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ____________ to _____________
Commission file number: 0-24159
MIDDLEBURG FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Virginia 54-1696103
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
111 West Washington Street
Middleburg, Virginia 20117
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (703) 777-6327
INDEPENDENT COMMUNITY BANKSHARES, INC.
Former Name, 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 Exchange Act 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:
1,812,432 shares of common stock, par value $5.00 per share,
outstanding as of May 6, 2002
MIDDLEBURG FINANCIAL CORPORATION
INDEX
Part I. Financial Information Page No.
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Changes in Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
Part II. Other Information
Item 1. Legal Proceedings 17
Item 2. Change in Securities 17
Item 3. Defaults upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
2
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Balance Sheets
(In Thousands, Except Share Data)
(Unaudited)
March 31, December 31,
2002 2001
----------- ------------
Assets:
Cash and due from banks $ 9,732 $ 10,053
Interest-bearing balances in banks 36 200
Temporary investments:
Federal funds sold 1,000 925
Other money market investments 949 1,797
Securities (fair value: March 31, 2002,
$125,821 , December 31, 2001, $124,522) 125,642 124,351
Loans held for sale 5,148 6,652
Loans, net 202,396 194,340
Bank premises and equipment, net 8,417 8,069
Other assets 7,720 7,714
--------- ---------
Total assets $ 361,040 $ 354,101
========= =========
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Non-interest bearing demand deposits $ 68,487 $ 68,771
Savings and interest-bearing demand deposits 117,973 111,148
Time deposits 94,640 91,812
--------- ---------
Total deposits $ 281,100 $ 271,731
Securities sold under agreements to
repurchase $ 13,542 $ 12,011
Federal Home Loan Bank Advances 2,000 7,000
Long-term debt 20,740 20,805
Trust preferred debt 10,000 10,000
Other liabilities 2,751 2,216
--------- ---------
Total liabilities $ 330,133 $ 323,763
--------- ---------
Shareholders' Equity:
Common stock par value $5.00 per
share, authorized 10,000,000 shares;
issued and outstanding at March 31, 2002 - 1,752,558
issued and outstanding at December 31, 2001 - 1,752,258 $ 8,763 $ 8,761
Capital surplus 747 741
Retained earnings 22,053 21,084
Accumulated other comprehensive (loss) (656) (248)
--------- ---------
Total shareholders' equity $ 30,907 $ 30,338
--------- ---------
Total liabilities and shareholders' equity $ 361,040 $ 354,101
========= =========
See Accompanying Notes to Consolidated Financial Statements.
3
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Income
(In Thousands, Except Per Share Data)
Unaudited
--------------------------
For the Three Months
Ended March 31,
2002 2001
--------------------------
Interest Income
Interest and fees on loans $ 3,979 $ 3,976
Interest on investment securities
Taxable 1 6
Exempt from federal income taxes 66 80
Interest on securities available for sale
Taxable 1,234 688
Exempt from federal income taxes 399 381
Dividends 71 71
Interest on federal funds sold and other 23 47
------- -------
Total interest income $ 5,773 $ 5,249
Interest expense
Interest on deposits $ 1,100 $ 1,521
Interest on long-term debt 436 244
Interest on short-term borrowings 81 364
------- -------
Total interest expense $ 1,617 $ 2,129
------- -------
Net interest income $ 4,156 $ 3,120
Provision for loan losses 75 75
------- -------
Net interest income after provision
for loan losses $ 4,081 $ 3,045
Other Income
Trust fee income $ 319 $ 358
Service charges on deposit accounts 351 312
Net gains (losses) on securities
available for sale (80) 252
Fees on loans held for resale 343 299
Other operating income 171 199
------- -------
Total other income $ 1,104 $ 1,420
------- -------
Other Expense
Advertising $ 98 $ 69
Salaries and employee benefits 1,943 1,740
Net occupancy expense of premises 346 273
Other operating expenses 741 659
------- -------
Total other expense $ 3,128 $ 2,741
------- -------
Income before income taxes $ 2,057 $ 1,724
Income taxes 543 432
------- -------
Net income $ 1,514 $ 1,292
======= =======
Earnings per weighted average share:
Net income per share, basic $ 0.86 $ 0.74
Net income per share, diluted $ 0.84 $ 0.73
Dividends per share $ 0.30 $ 0.25
See Accompanying Notes to Consolidated Financial Statements.
4
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statement of Changes in Shareholders' Equity
For the Three Months ended March 31, 2002 and 2001
(In Thousands)
(Unaudited)
Accumulated
Other
Common Capital Retained Comprehensive Comprehensive
Stock Surplus Earnings Income (Loss) Income Total
----- ------- -------- ------------- ------ -----
Balances - December 31, 2000 $ 8,696 $ 556 $ 17,616 $ 403 $ - $27,271
Comprehensive Income
Net income 1,292 1,292 1,292
Other comprehensive income
net of tax:
Unrealized gain on available for
sale securities (net of tax $356) 688
Reclassification adjustment for
gains realized in net income (net of tax $86) (166)
---------
Other comprehensive income (net of tax $270) 522 522 522
---------
Total comprehensive income $1,814
=========
Cash dividends declared (435) (435)
-------- ------ --------- ------ -------
Balances - March 31, 2001 $ 8,696 $ 556 $ 18,473 $ 925 $28,650
======== ====== ========= ====== =======
Balances - December 31, 2001 $ 8,761 $ 741 $ 21,084 ($248) $30,338
Comprehensive Income
Net income 1,514 1,514 1,514
Issuance of common shares in stock
option plan (300 shares) 2 6 8
Other comprehensive income net of tax:
Unrealized holding losses arising during the
period (net of tax $236) (461)
Reclassification adjustment for
losses realized in net income (net of tax $27) 53
---------
Other comprehensive income (net of tax $209) (408) (408) (408)
---------
Total comprehensive income $1,106
=========
Cash dividends declared (545) (545)
-------- ------ --------- ------ -------
Balances - March 31, 2002 $ 8,763 $ 747 $ 22,053 (656) $30,907
======== ====== ========= ====== =======
See Accompanying Notes to Consolidated Financial Statements.
5
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(In Thousands)
Unaudited
For the Three Months Ended
March 31, March 31,
2002 2001
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,514 $ 1,292
Adjustments to reconcile net income to net cash provided by (used in) operating activities
Provision for loan losses 75 75
Depreciation and amortization 222 183
Net (gains) losses on securities available for sale 80 (252)
Net (gains) losses on sales of equipment (15) -
Discount accretion and premium amortization on securities, net (25) (30)
Originations of loans held for sale (22,513) (16,343)
Proceeds from sales of loans held for sale 24,017 9,944
Decrease (increase) in other assets 188 (1,360)
Increase in other liabilities 428 293
-------- --------
Net cash provided by (used in) operating activities $ 3,971 $ (6,198)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity, principal paydowns and calls on investment securities $ 591 $ 687
Proceeds from maturity, principal paydowns and
calls of securities available for sale 3,262 2,297
Proceeds from sale of securities available for sale 9,328 12,654
Purchase of securities available for sale (15,144) (14,249)
Net (increase) in loans (8,131) (912)
Proceeds from sale of bank premises and equipment 20 16
Purchases of bank premises and equipment (560) (372)
-------- --------
Net cash provided by (used in) investing activities $(10,634) $ 121
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts, and savings accounts $ 6,541 $ 5,209
Net increase in certificates of deposits 2,828 2,800
Proceeds from Federal Home Loan Bank advances 27,000 15,600
Payment on Federal Home Loan Bank advances (32,000) (15,600)
Payments on long-term debt (65) (300)
Cash dividends paid (438) (365)
Issuance of common stock 8 -
Increase (decrease) in securities sold under agreement to repurchase 1,531 (1,364)
-------- --------
Net cash provided by financing activities $ 5,405 $ 5,980
-------- --------
Decrease in cash and cash equivalents $ (1,258) $ (97)
CASH AND CASH EQUIVALENTS
Beginning $ 12,975 $ 17,147
======== ========
Ending $ 11,717 $ 17,050
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest paid to depositors 1,343 1,652
Income taxes - 85
SUPPLEMENTAL DISCLOSURES FOR NON-CASH
INVESTING AND FINANCING ACTIVITIES
Unrealized gain on securities available for sale 617 792
See Accompanying Notes to Consolidated Financial Statements.
6
MIDDLEBURG FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
For the Three Months Ended March 31, 2002 and 2001
(Unaudited)
Note 1.
In the opinion of management, the accompanying unaudited financial
statements contain all adjustments (consisting of only normal recurring
accruals) necessary to present fairly the financial position as of March 31,
2002 and the results of operations and changes in cash flows for the three
months ended March 31, 2002 and 2001. The statements should be read in
conjunction with the Notes to Consolidated Financial Statements included in the
Company's Annual Report on Form 10-KSB for the year ended December 31, 2001. The
results of operations for the three-month periods ended March 31, 2002 and 2001
are not necessarily indicative of the results to be expected for the full year.
Note 2. Securities
Securities being held to maturity as of March 31, 2002 are summarized
as follows:
------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains (Losses) Value
------------------------------------------------------------
(In Thousands)
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ - $ - $ - $ -
Obligations of states and
political subdivisions 4,743 179 - 4,922
Mortgaged backed securities 60 - - 60
----------------- --------------- ------------ -------------
$ 4,803 $ 179 $ - $ 4,982
================= =============== ============ =============
7
Securities available for sale as of March 31, 2002 are summarized
below:
-----------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains (Losses) Value
-----------------------------------------------------------------
(In Thousands)
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ 249 14 $ - $ 263
Corporate securities 2,082 45 (66) 2,061
Obligations of states and
political subdivisions 32,199 438 (374) 32,263
Mortgaged backed securities 74,133 275 (1,093) 73,315
Other 13,167 120 (350) 12,937
--------- --------- --------- ---------
$ 121,830 $ 892 $ (1,883) $ 120,839
========= ========= ========= =========
Note 3.
The consolidated loan portfolio is composed of the following:
-----------------------------
March 31, December 31,
2002 2001
-----------------------------
(In Thousands)
Commercial, financial and agricultural $ 23,276 $ 22,993
Real estate construction 26,239 24,174
Real estate mortgage 26,239 24,174
Installment loans to individuals 12,127 11,901
-------- --------
Total loans 204,525 196,400
Less: Allowance for loan losses 2,129 2,060
-------- --------
Loans, net $202,396 $194,340
======== ========
The Company had $185,535 in non-performing assets at March 31, 2002.
8
Note 4. Reserve for Loan Losses
The following is a summary of transactions in the reserve for loan
losses:
---------------------------------
March 31, December 31,
2002 2001
---------------------------------
(In Thousands)
Balance at January 1 $ 2,060 $ 1,804
Provision charged to operating expense 75 300
Recoveries added to the reserve 4 39
Loan losses charged to the reserve (10) (83)
---------------- ----------------
Balance at the end of the period $ 2,129 $ 2,060
================ ================
Note 5. Earnings Per Share
The following table shows the weighted average number of shares used in
computing earnings per share and the effect on the weighted average number of
shares of potential dilutive common stock. Potential dilutive common stock has
no effect on income available to common shareholders. There were no
anti-dilutive effects from options at March 31, 2002.
March 31, 2002 March 31, 2001
Per share Per share
Shares Amount Shares Amount
----------- ----------- ----------- ------------
Basic EPS 1,752,486 $ 0.86 1,739,247 $ 0.74
=========== ============
Effect of dilutive
securities:
stock options 50,195 28,744
----------- -----------
Diluted EPS 1,802,681 $ 0.84 1,767,991 $ 0.73
=========== =========== =========== ============
Note 6. Derivative Financial Instruments
Interest rate swap agreements:
During May 2000, the Company entered into two agreements to assume
variable market-indexed interest payments in exchange for fixed-rate interest
payments (interest rate swaps). The notional principal amount of interest rate
swaps outstanding was $8,525,000 at March 31, 2002. The original term to
maturity was 24 months. The weighted-average fixed payment rate was 7.0% at
March 31, 2002. Variable interest payments received are based on three-month
LIBOR. At March 31, 2002, the weighted average rate of variable market-indexed
interest payment obligations to the Company was 1.56%. The effect of these
agreements was to transform fixed rate liabilities to variable rate liabilities.
The net income from these agreements was $112,779 for the three month period
ended March 31, 2002, which is charged to income as it accrues.
9
The Company's current credit exposure on swaps is limited to the value
of interest rate swaps that have become assets to the Company. At March 31,
2002, the fair value of interest rate swaps in an asset position was $112,437.
Note 7. Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued two
statements - Statement 141, Business Combinations, and Statement 142, Goodwill
and Other Intangible Assets - that will potentially impact the accounting for
goodwill and other intangible assets. Statement 141 eliminates the pooling
method of accounting for business combinations and requires that intangible
assets that meet certain criteria be reported separately from goodwill. The
Statement also requires negative goodwill arising from a business combination to
be recorded as an extraordinary gain. Statement 142 eliminates the amortization
of goodwill and other intangibles that are determined to have an indefinite
life. The Statement requires, at a minimum, annual impairment tests for goodwill
and other intangible assets that are determined to have an indefinite life.
Upon adoption of these Statements, an organization is required to
re-evaluate goodwill and other intangible assets that arose from business
combinations entered into before July 1, 2001. If the recorded other intangible
assets do not meet the criteria for recognition, they should be classified as
goodwill. Similarly, if there are other intangible assets that meet criteria for
recognition but were not separately recorded from goodwill, they should be
reclassified from goodwill. An organization also must reassess the useful lives
of intangible assets and adjust the remaining amortization periods accordingly.
Any negative goodwill must be written-off.
The standards generally are required to be implemented by the Company
in its 2002 financial statements. The adoption of these standards will not have
a material impact on the financial statements.
Note 8. Subsequent Event
On August 9, 1999, the Company purchased one percent of the issued and
outstanding capital stock of Gilkison Patterson Investment Advisors, Inc.
("GPIA"), an investment advisory firm based in Alexandria, Virginia. The Company
also acquired the right to purchase all of the remaining authorized, issued and
outstanding shares of GPIA capital stock on or after July 1, 2001. This option
was extended through June 30, 2002. On April 1, 2002, the Company completed the
acquisition of GPIA. The terms of the transaction include a total purchase price
of $6 million with 59,874 shares of the Company's common stock issued to the
shareholders of GPIA. The Company expects that nearly all of the purchase price
will be booked as goodwill or other intangibles. The Company has not determined
how much of the purchase price will be classified as goodwill or other
identifiable intangibles.
10
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Critical Accounting Policies
The financial condition and results of operations presented in the
Consolidated Financial Statements, accompanying Notes to the Consolidated
Financial Statements and management's discussion and analysis are, to a large
degree, dependent upon Middleburg Financial Corporation (the "Company")
accounting policies. The selection and application of these accounting policies
involve judgments, estimates, and uncertainties that are susceptible to change.
Presented below is discussion of those accounting policies that
management believes are the most important (Critical Accounting Policies) to the
portrayal and understanding of the Company's financial condition and results of
operations. These Critical Accounting Policies require management's most
difficult, subjective and complex judgments about matters that are inherently
uncertain. In the event that different assumptions or conditions were to
prevail, and depending upon the severity of such changes, the possibility of
materially different financial condition or results of operations is a
reasonable likelihood. See also Note 1 of the Notes to Consolidated Financial
Statements.
Allowance for Loan Losses
The Company monitors and maintains an allowance for loan losses to
absorb an estimate of probable losses inherent in the loan and lease portfolio.
The Company maintains policies and procedures that address the systems of
controls over the following areas of maintenance of the allowance: the
systematic methodology used to determine the appropriate level of the allowance
to provide assurance they are maintained in accordance with GAAP; the accounting
policies for loan charge-offs and recoveries; the assessment and measurement of
impairment in the loan and lease portfolio; and the loan grading system.
The Company evaluates various loans individually for impairment as
required by Statement of Financial Accounting Standard (SFAS) No. 114,
Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting
by Creditors for Impairment of a Loan - Income Recognition and Disclosures.
Loans evaluated individually for impairment include non-performing loans, such
as loans on non-accrual, loans past due by 90 days or more, restructured loans
and other loans selected by management. The evaluations are based upon
discounted expected cash flows or collateral valuations. If the evaluation shows
that a loan is individually impaired, then a specific reserve is established for
the amount of impairment. If a loan evaluated individually is not impaired, then
the loan is assessed for impairment under SFAS No. 5, Accounting for
Contingencies (SFAS 5), with a group of loans that have similar characteristics.
For loans without individual measures of impairment, the Company makes
estimates of losses for groups of loans as required by SFAS 5. Loans are grouped
by similar characteristics, including the type of loan, the assigned loan grade
and the general collateral type. A loss rate reflecting the expected loss
inherent in a group of loans is derived based upon estimates of default rates
for a given loan grade, the predominant collateral type for the group and the
terms of the loan. The resulting estimate of losses for groups of loans are
adjusted for relevant environmental factors and other conditions of the
portfolio of loans and leases, including: borrower and industry concentrations;
levels and trends in delinquencies, charge-offs and recoveries; changes in
underwriting standards and risk selection; level of experience, ability and
depth of lending management; and national and local economic conditions.
11
The amount of estimated impairment for individually evaluated loans and
groups of loans is added together for a total estimate of loans and lease
losses. This estimate of losses is compared to the allowance for loan and lease
losses of the Company as of the evaluation date and, if the estimate of losses
is greater than the allowance, an additional provision to the allowance would be
made. If the estimate of losses is less than the allowance, the degree to which
the allowance exceeds the estimate is evaluated to determine whether the
allowance falls outside a range of estimates. If the estimate of losses is below
the range of reasonable estimates, the allowance would be reduced by way of a
credit to the provision for loan losses. The Company recognizes the inherent
imprecision in estimates of losses due to various uncertainties and variability
related to the factors used, and therefore a reasonable range around the
estimate of losses is derived and used to ascertain whether the allowance is too
high. If different assumptions or conditions were to prevail and it is
determined that the allowance is not adequate to absorb the new estimate of
probable losses, an additional provision for loan losses would be made, which
amount may be material to the Consolidated Financial Statements.
Valuation of Derivatives
The Company maintains an overall interest rate risk management strategy
that incorporates the use of derivative financial instruments. The Company has
used derivative financial instruments only for asset/liability management
through the hedging of a specific transaction or position, and not for trading
or speculative purposes. The Company's derivative financial instruments are
classified as fair value hedges or cash flow hedges. Fair value hedges recognize
currently in earnings both the impact of change in the fair value of the
derivative financial instrument and the offsetting impact of the change in fair
value of the hedged asset or liability. The change in fair value of cash flow
hedges is recognized in other comprehensive income.
Management believes that the risk associated with using derivative
financial instruments to mitigate interest rate risk sensitivity is minimal and
should not have any material unintended impact on the Company's financial
condition or results of operations. See further information regarding
derivatives in Note 6 (page 9) of the Notes to Consolidated Financial
Statements.
Financial Summary
Net income for the three months ended March 31, 2002 increased 17.2% to
$1.5 million or $.84 per diluted share compared to $1.3 million or $.73 per
diluted share for the first three months of 2001. Annualized returns on average
assets and equity for the three months ended March 31, 2002 were 1.7% and 19.3%,
respectively, compared to 1.7% and 17.1% for the same period in 2001.
Total assets for the Company increased to $361.0 million at March 31,
2002 compared to $354.1 million at December 31, 2001, representing an increase
of $6.9 million or 2.0%. Total loans at March 31, 2002 were $202.4 million, an
increase of $8.1 million from the December 31, 2001 balance of $194.3 million.
The Company is located in one of the fastest growing counties and metropolitan
areas in the United States. In addition, the Company has increased its customer
base as a result of increased advertising and consolidation in the banking
industry within its local market. These factors have contributed to the solid
loan and deposit growth experienced over the past year. Due to the upward swing
in the interest rate environment, mortgage refinancings and purchases have
declined slightly in the local market and, as a result, loans held for sale
decreased to $5.1 million at March 31, 2002 from $6.7 million at December 31,
2001. The investment portfolio increased 1.0% to $125.6 million at March 31,
2002 compared to $124.4 million at December 31, 2001. Deposits increased $9.4
million to $281.1 million at
12
March 31, 2002 from $271.7 million at December 31, 2001. Growth in the
transactional accounts and time deposits accounts for $6.5 million and $2.8
million, respectively, of the increase during the first three months of 2002.
Securities sold under agreements to repurchase with commercial checking accounts
increased $1.5 million from $12.0 million at December 31, 2001 to $13.5 million
at March 31, 2002.
Shareholders' equity was $30.9 million at March 31, 2002. This amount
represents an increase of 1.9% from the December 31, 2001 balance of $30.3
million. The book value per common share was $17.64 at March 31, 2002 and $17.31
at December 31, 2001.
Net Interest Income
Net interest income is the Company's primary source of earnings and
represents the difference between interest and fees earned on earning assets and
the interest expense paid on deposits and other interest bearing liabilities.
Net interest income totaled $4.1 million for the first three months of 2002
compared to $3.0 million for the same period in 2001. The increase is attributed
to both the significant growth in average earning assets as well as the effect
that the lower interest rate environment had on the amount of interest expense
paid on deposits. Average earning assets increased $66.7 million from $268.8
million at March 31, 2001 to $335.6 million at March 31, 2002. The average cost
of interest bearing deposits was 2.10% for the three months ended March 31,
2002, a decrease of 155 basis points from the average cost of interest bearing
deposits for the three months ended March 31, 2001. The total cost of funds
decreased 133 basis points from 3.24% to 1.91% for the three months ended March
31, 2001 and 2002, respectively. The interest expense related to the trust
preferred securities is also included in long-term debt interest expense and
amounted to approximately $144,000 at March 31, 2002.
Noninterest Income
Noninterest income consisting of fees from deposit accounts, fiduciary
activities and mortgage banking decreased 22.3% to $1.1 million for the first
three months of 2002 compared to $1.4 million for the same period in 2001. Most
of the decline is attributed to the lack of obtainable gains from sales of
securities available for sale. The Company realized $80,000 in net losses on the
investment portfolio for the three months ended March 31, 2002. However, despite
the recent upward swing in the interest rate environment, mortgage refinancings
and purchases have remained strong in the local market and have provided
significant volume increases in mortgage fees on loans held for sale. Service
charges on deposit accounts for the first three months of 2002 totaled $351,000
compared to $312,000 for the same period in 2001, an increase of 12.5%.
Commissions and fees from fiduciary activities were $319,000 for the three-month
period ended March 31, 2001 compared to $358,000 for the same period in 2001.
Fees on loans held for sale increased $44,000 or 14.7% to $343,000 at March 31,
2002 from the March 31, 2001 balance of $299,000. Other operating income
decreased $28,000 to $171,000 for the three months ended March 31, 2002 compared
to $199,000 for the same period in 2001.
Noninterest Expense
Total noninterest expense includes employee-related costs, occupancy
and equipment expense and other overhead. Total noninterest expense was $3.1
million for the first three months of 2002 compared to $2.7 million for the same
period in 2001. This is a 14.2% increase from the three months ended March 31,
2001 to the three months ended March 31, 2002. Salary and benefit expense
increased 11.7% from $1.7 million for the three months ended March 31, 2001 to
$1.9 million for the three months ended March 31, 2002. The Company has
increased its staffing in both the business development and operations areas to
support the significant asset growth over the past three years. Commissions paid
to employees for fee related business, such as mortgage originations and
investment sales have increased by $18,000 to $198,000 as a result in the
increase in sales volume. Net occupancy expense of premises increased $73,000
14
from $273,000 for the three months ended March 31, 2001 to $346,000 for the
three months ended March 31, 2002.
Allowance for Loan Losses
The allowance for loan losses at March 31, 2002 was $2.1 million
compared to $1.9 million at March 31, 2001. The provision for loan losses was
unchanged at $75,000 for the three months ended March 31, 2002, and March 31,
2001. The allowance for loan losses was 1.04% of total loans outstanding at
March 31, 2002 and 1.04% of total loans outstanding at March 31, 2001. At March
31, 2002, net loan charge offs totaled $6,000. Total loans past due 90 days or
more at March 31, 2002 were approximately $117,000. Non-performing loans
increased to .09% of total loans outstanding at March 31, 2002 compared to .05%
at March 31, 2001. Management believes that the allowance for loan losses is
adequate to cover credit losses inherent in the loan portfolio at March 31,
2002. Loans classified as loss, doubtful, substandard or special mention are
adequately reserved for and are not expected to have a material impact beyond
what has been reserved.
Capital Resources
Shareholders' equity at March 31, 2002 and March 31, 2001 was $30.9
million and $28.7 million, respectively. Total common shares outstanding at
March 31, 2002 were 1,752,558.
At March 31, 2002 the Company's tier 1 and total risk-based capital
ratios were 16.4% and 17.3%, respectively, compared to 16.4% and 17.3% at
December 31, 2001. The Company's leverage ratio was 12.9% at March 31, 2002
compared to 12.5% at December 31, 2001. The Company's capital structure places
it above the regulatory guidelines, which affords the Company the opportunity to
take advantage of business opportunities while ensuring that it has the
resources to protect against risk inherent in its business.
Forward-Looking Statements
Certain information contained in this discussion may include
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements are generally identified by phrases
such as "the Company expects," "the Company believes" or words of similar
import. Such forward-looking statements involve known and unknown risks
including, but not limited to, changes in general economic and business
conditions, interest rate fluctuations, competition within and from outside the
banking industry, new products and services in the banking industry, risk
inherent in making loans such as repayment risks and fluctuating collateral
values, problems with technology utilized by the Company, changing trends in
customer profiles and changes in laws and regulations applicable to the Company.
Although the Company believes that its expectations with respect to the
forward-looking statements are based upon reliable assumptions within the bounds
of its knowledge of its business and operations, there can be no assurance that
actual results, performance or achievements of the Company will not differ
materially from any future results, performance or achievements expressed or
implied by such forward-looking statements.
14
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Market and Interest Rate Risk
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market rates or prices such as interest rates, foreign
currency exchange rates, commodity prices and equity prices. The Company's
primary market risk exposure is interest rate risk, though it should be noted
that the assets under management by its trust subsidiary, Tredegar Trust
Company, are affected by equity price risk. The ongoing monitoring and
management of this risk is an important component of the Company's
asset/liability management process, which is governed by policies established by
its Board of Directors that are reviewed and approved annually. The Board of
Directors delegates responsibility for carrying out asset/liability management
policies to the Asset/Liability Committee (ALCO) of the Company's banking
subsidiary, Middleburg Bank. In this capacity, ALCO develops guidelines and
strategies that govern the Company's asset/liability management related
activities, based upon estimated market risk sensitivity, policy limits and
overall market interest rate levels and trends.
Interest rate risk represents the sensitivity of earnings to changes in
market interest rates. As interest rates change, the interest income and expense
streams associated with the Company's financial instruments also change,
affecting net interest income, the primary component of the Company's earnings.
ALCO uses the results of a detailed and dynamic simulation model to quantify the
estimated exposure of net interest income to sustained interest rate changes.
While ALCO routinely monitors simulated net interest income sensitivity over a
rolling two-year horizon, it also employs additional tools to monitor potential
longer-term interest rate risk.
The simulation model captures the impact of changing interest rates on
the interest income received and interest expense paid on all assets and
liabilities reflected on the Company's balance sheet. The simulation model is
prepared and updated four times during each year. This sensitivity analysis is
compared to ALCO policy limits, which specify a maximum tolerance level for net
interest income exposure over a one-year horizon, assuming no balance sheet
growth, given both a 200 basis point (bp) upward and downward shift in interest
rates. A parallel and pro rata shift in rates over a 12-month period is assumed.
The following reflects the range of the Company's net interest income
sensitivity analysis during the quarter ended March 31, 2002 and the fiscal year
of 2001 compared to the 10% Board-approved policy limit.
For the quarter Ended March 31, 2002
Rate Change Estimated Net Interest Income Sensitivity
----------- -----------------------------------------
High Low Average
---- --- -------
+ 200 bp (2.51%) (2.51%) (2.51%)
- 200 bp 2.62% 2.62% 2.62%
For the year ended December 31, 2001
Rate Change Estimated Net Interest Income Sensitivity
----------- -----------------------------------------
High Low Average
---- --- -------
+ 200 bp (2.21%) (.32%) (1.32%)
- 200 bp 3.24% 1.57% 2.44%
Since December 31, 2001, the company's balance sheet has grown by
nearly $7.0 million. Deposit inflows and the reduction in loans held for sale
provided the funding for the growth in the loan
15
and securities portfolios. Overall, the Company continues to have minimal
interest rate risks to either falling or rising interest rates. The additions of
fixed rate assets during the first quarter of 2002 have made the Company
somewhat more liability sensitive in the short term, reducing its exposure to
falling rates but slightly increasing the potential exposure to rising rates.
Based upon first quarter 2002's simulation, the Company could expect a negative
impact to net interest income of $421,000 over the next 12 months if rates rise
200 basis points. If rates decline 200 basis points, the Company could expect a
positive impact to net interest income of $440,000 over the next 12 months.
During 2001, the Company was able to test the parameters and
assumptions of its simulation model in light of the 4.75% decrease in short term
rates over 11 months. The simulation model proved to be accurate in its
presentation of a company that benefits from falling interest rates. As
presented in the table above, the Company has had minimal interest rate risks to
either falling or rising interest rates over the past 15 months. The Company
could expect a negative impact to net interest income of $364,000 if rates rise
200 basis points over the next 12 months. If rates decline 200 basis points, the
Company could expect a positive impact to net interest income of $386,000 over
the next 12 months.
During May 2000, the Company entered into two interest rate swap
agreements to assume variable market-indexed interest payments in exchange for
fixed-rate interest payments. The interest rate swap was used to offset the cost
of offering a premium market rate on a promotional retail certificate of
deposit. The Company raised $8.5 million in new deposits during this three-day
promotion. The terms of the certificate of deposit and the fixed portion of the
interest rate swap are identical. The notional principal amount of interest rate
swaps outstanding was $8.5 million at March 31, 2002. The original term was 24
months. The weighted-average fixed payment rate was 7.0% at March 31, 2002.
Variable interest payments received are based on three-month LIBOR. At March 31,
2002, the weighted average rate of variable market-indexed interest payment
obligation to the Company was 1.56%. The effect of these agreements was to
transform the certificates of deposit (fixed rate liabilities) to variable rate
certificates of deposit (liabilities). The net income from these agreements was
$112,779 for the three months ended March 31, 2002.
The preceding sensitivity analysis does not represent a forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions, including the
nature and timing of interest rate levels such as yield curve shape, prepayments
on loans and securities, deposit decay rates, pricing decisions on loans and
deposits, reinvestment or replacement of asset and liability cashflows. While
assumptions are developed based upon current economic and local market
conditions, the Company cannot make any assurances about the predictive nature
of these assumptions, including how customer preferences or competitor
influences might change.
Also, as market conditions vary from those assumed in the sensitivity
analysis, actual results will also differ due to factors such as prepayment and
refinancing levels likely deviating from those assumed, the varying impact of
interest rate change, caps or floors on adjustable rate assets, the potential
effect of changing debt service levels on customers with adjustable rate loans,
depositor early withdrawals and product preference changes, and other internal
and external variables. Furthermore, the sensitivity analysis does not reflect
actions that ALCO might take in response to or anticipation of changes in
interest rates.
16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Change in Securities.
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information.
None
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits - None
b) Reports on Form 8-K - None
17
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, as amended, the registrant caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
MIDDLEBURG FINANCIAL CORPORATION
(Registrant)
Date: May 15, 2002 /s/ Joseph L. Boling
------------------------------------------------
Joseph L. Boling
Chairman of the Board & CEO
Date: May 15, 2002 /s/ Alice P. Frazier
------------------------------------------------
Alice P. Frazier
Executive Vice President & CFO
(Chief Accounting Officer)
18