SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission file number 0-24159
MIDDLEBURG FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Virginia 54-1696103
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
111 West Washington Street
Middleburg, Virginia 20117
(Address of Principal Executive Offices) (Zip Code)
(703) 777-6327
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- -------------------
None n/a
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $5.00 per share
(Title of Class)
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 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 past 90 days. Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes ___ No _X__
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was last sold, or the average bid and asked price of such common
equity, as of the last business day of the registrant's most recently completed
second fiscal quarter. $61,170,310
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date. 1,852,682 shares of
Common Stock
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for the 2003 Annual Meeting of Shareholders - Part III
TABLE OF CONTENTS
PART I
------
Page
----
ITEM 1. BUSINESS.............................................................3
ITEM 2. PROPERTIES...........................................................7
ITEM 3. LEGAL PROCEEDINGS....................................................8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS...............................................9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS.......................................9
ITEM 6. SELECTED FINANCIAL DATA.............................................10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..............................11
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK......................................................36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.........................38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE...........................38
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS....................................38
ITEM 11. EXECUTIVE COMPENSATION..............................................38
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS..............................................38
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS......................39
ITEM 14. CONTROLS AND PROCEDURES.............................................39
PART IV
-------
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K..............................................40
-2-
PART I
------
ITEM 1. BUSINESS
General
Middleburg Financial Corporation ("MFC" or the "Company") is a bank
holding company that was incorporated under Virginia law in 1993. The Company
changed its name in May 2002 from Independent Community Bankshares, Inc. to
Middleburg Financial Corporation. The Company conducts its primary operations
through three wholly owned subsidiaries, Middleburg Bank (the "Bank"), Tredegar
Trust Company ("Tredegar") both of which are chartered under Virginia law, and
Gilkison Patterson Investment Advisors, Inc. ("GPIA"), which is an investment
advisor registered with the Securities and Exchange Commission.
The Bank has five full service branches and one limited service
facility. The Bank has its main office at 111 West Washington Street,
Middleburg, Virginia 20117, and has offices in Purcellville, Leesburg and
Ashburn, Virginia. The Bank opened for business on July 1, 1924.
Tredegar has its main office at 821 East Main Street, Richmond,
Virginia 23219, and a branch office in Middleburg, Virginia. Tredegar opened for
business in January 1994.
GPIA has its main office at 1901 North Beauregard Street, Alexandria,
Virginia 22311.
The Bank serves western Loudoun County. Loudoun County is in
northwestern Virginia and included in the Washington-Baltimore Metropolitan
statistical area. Loudoun County's population is approximately 170,000 with over
one-third of the population located in the Company's markets. The local economy
is driven by service industries requiring a high skill level, self-employed
individuals, the equine industry and the independently wealthy. Tredegar serves
primarily the greater Richmond area including the counties of Henrico,
Chesterfield, Hanover, Goochland and Powhatan, as well as Loudoun County.
However, Tredegar does have clients outside of its primary market. Richmond is
the state capital of Virginia, and the greater Richmond area has a population in
excess of 800,000 people. GPIA primarily serves the District of Columbia
metropolitan area including contingent markets in Virginia and Maryland but also
has clients in 25 other states.
The Company, through its subsidiaries, offers a wide range of banking,
fiduciary and investment management services available to both individuals and
small businesses. The banking services include various types of checking and
savings deposit accounts, and the making of business, real estate, development,
mortgage, home equity, automobile and other installment, demand and term loans.
Also, the Bank offers ATMs at all locations, internet banking, travelers'
checks, money orders, safe deposit rentals, collections, notary public, wire
services and other traditional bank services to its customers. Tredegar provides
a variety of investment management and fiduciary services including trust and
estate settlement. Tredegar can also serve as escrow agent, attorney-in-fact,
guardian of property or trustee of an IRA. GPIA provides fee based investment
management services for its clients.
The Bank has one wholly owned subsidiary, Middleburg Bank Service
Corporation. Middleburg Bank Service Corporation is a partner in a limited
liability company, Bankers Title Shenandoah, LLC, which sells title insurance to
its members. Middleburg Bank Service Corporation has also invested in another
limited liability company, Virginia Bankers Insurance Center, LLC, which acts as
a broker for insurance sales for its member banks. The Company has a fourth
wholly owned subsidiary, ICBI Capital Trust I, which is a Delaware Business
Trust that the Company formed in connection with the issuance of $10 million in
trust preferred debt in November 2001.
-3-
As of December 31, 2002, the Company had a total of 152 full time
equivalent employees. The Company considers relations with its employees to be
excellent. The Company's employees are not represented by a collective
bargaining unit.
Competition
The Company faces significant competition for both loans and deposits.
Competition for loans comes from commercial banks, savings and loan associations
and savings banks, mortgage banking subsidiaries of regional commercial banks,
subsidiaries of national mortgage bankers, insurance companies, and other
institutional lenders. Its most direct competition for deposits has historically
come from savings and loan associations and savings banks, commercial banks,
credit unions and other financial institutions. Based upon total deposits at
June 30, 2002 as reported to the FDIC, MFC has the largest share of deposits
among the banking organizations operating in Loudoun County, Virginia. MFC also
faces competition for deposits from short-term money market mutual funds and
other corporate and government securities funds.
Tredegar competes for clients and accounts with banks, other financial
institutions and money managers. Even though many of these institutions have
been engaged in the trust or investment management business for a considerably
longer period of time than Tredegar and have significantly greater resources,
Tredegar has grown through its commitment to quality trust services and a local
community approach to business.
GPIA competes for its clients and accounts with other money managers
and investment brokerage firms. Like the rest of the Company, GPIA is dedicated
to quality service and high investment performance for its clients. GPIA has
successfully operated in its markets for 21 years. For 19 years, GPIA operated
under the name of Kahn Brothers Investment Management Company ("KBIMC"). Upon
entering into a purchase option with MFC, KBIMC changed its name to "Gilkison
Patterson Investment Advisors, Inc."
Supervision and Regulation
General. As a bank holding company, the Company is subject to
regulation under the Bank Holding Company Act of 1956, as amended, (the "BHCA")
and the examination and reporting requirements of the Board of Governors of the
Federal Reserve System (the "Federal Reserve Board"). Under the BHCA, a bank
holding company may not directly or indirectly acquire ownership or control of
more than 5% of the voting shares or substantially all of the assets of any bank
or merge or consolidate with another bank holding company without the prior
approval of the Federal Reserve Board. The BHCA also generally limits the
activities of a bank holding company to that of banking, managing or controlling
banks, or any other activity that is determined to be so closely related to
banking or to managing or controlling banks that an exception is allowed for
those activities.
As a state-chartered commercial bank, the Bank is subject to
regulation, supervision and examination by the Virginia State Corporation
Commission's Bureau of Financial Institutions. It is also subject to regulation,
supervision and examination by the Federal Reserve Board. State and federal law
also governs the activities in which the Bank engages, the investments that it
makes and the aggregate amount of loans that may be granted to one borrower.
Various consumer and compliance laws and regulations also affect the Bank's
operations.
The earnings of the Company's subsidiaries, and therefore the earnings
of the Company, are affected by general economic conditions, management
policies, changes in state and federal legislation and actions of various
regulatory authorities, including those referred to above. The following
description
-4-
summarizes the significant federal and state laws to which the Company, the Bank
and Tredegar are subject. To the extent statutory or regulatory provisions or
proposals are described, the description is qualified in its entirety by
reference to the particular statutory or regulatory provisions or proposals.
Payment of Dividends. The Company is a legal entity separate and
distinct from its banking and other subsidiaries. The majority of the Company's
revenues are from dividends paid to the Company by the Bank. The Bank is subject
to laws and regulations that limit the amount of dividends it can pay. In
addition, both the Company and the Bank are subject to various regulatory
restrictions relating to the payment of dividends, including requirements to
maintain capital at or above regulatory minimums. Banking regulators have
indicated that banking organizations should generally pay dividends only if the
organization's net income available to common shareholders over the past year
has been sufficient to fully fund the dividends and the prospective rate of
earnings retention appears consistent with the organization's capital needs,
asset quality and overall financial condition. The Company does not expect that
any of these laws, regulations or policies will materially affect the ability of
the Bank to pay dividends. During the year ended December 31, 2002, the Bank
declared $2.1 million in dividends payable to the Company.
Capital. The Federal Reserve Board has issued risk-based and leverage
capital guidelines applicable to banking organizations that it supervises. Under
the risk-based capital requirements, the Company and the Bank are each generally
required to maintain a minimum ratio of total capital to risk-weighted assets
(including certain off-balance sheet activities, such as standby letters of
credit) of 8%. At least half of the total capital must be composed of common
equity, retained earnings and qualifying perpetual preferred stock, less certain
intangibles ("Tier 1 capital"). The remainder may consist of certain
subordinated debt, certain hybrid capital instruments, qualifying preferred
stock and a limited amount of the loan loss allowance ("Tier 2 capital," which,
together with Tier 1 capital, composes "total capital").
In addition, each of the federal banking regulatory agencies has
established minimum leverage capital requirements for banking organizations.
Pursuant to these requirements, banking organizations must maintain a minimum
ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%
subject to federal banking regulatory evaluation of an organization's overall
safety and soundness.
The risk-based capital or standards of the Federal Reserve Board
explicitly identify concentrations of credit risk and the risk arising from
non-traditional activities, as well as an institution's ability to manage these
risks, as important factors to be taken into account by the agency in assessing
an institution's overall capital adequacy. The capital guidelines also provide
that an institution's exposure to a decline in the economic value of its capital
due to changes in interest rates be considered by the agency as a factor in
evaluating a banking organization's capital adequacy.
Other Safety and Soundness Regulations. There are a number of
obligations and restrictions imposed on bank holding companies and their
depository institution subsidiaries by federal law and regulatory policy that
are designed to reduce potential loss exposure to the depositors of such
depository institutions and to the Federal Deposit Insurance Corporation
("FDIC") insurance funds in the event that the depository institution is
insolvent or is in danger of becoming insolvent. For example, under requirements
of the Federal Reserve Board with respect to bank holding company operations, a
bank holding company is required to serve as a source of financial strength to
its subsidiary depository institutions and to commit resources to support such
institutions in circumstances where it might not do so otherwise. In addition,
the "cross-guarantee" provisions of federal law require insured depository
institutions under common control to reimburse the FDIC for any loss suffered or
reasonably anticipated by the FDIC as a result of the insolvency of commonly
controlled insured depository institutions or for any assistance provided by the
FDIC to commonly controlled insured depository institutions in danger of
failure. The FDIC may decline to enforce the cross-guarantee provision if it
determines that a waiver is in
-5-
the best interests of the deposit insurance funds. The FDIC's claim for
reimbursement under the cross guarantee provisions is superior to claims of
shareholders of the insured depository institution or its holding company but is
subordinate to claims of depositors, secured creditors and nonaffiliated holders
of subordinated debt of the commonly controlled insured depository institutions.
The federal banking agencies also have broad powers under current
federal law to take prompt corrective action to resolve problems of insured
depository institutions. The extent of these powers depends upon whether the
institution in question is well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized or critically undercapitalized,
as defined by the law. As of December 31, 2002, the Company and the Bank were
classified as well capitalized.
State banking regulators also have broad enforcement powers over the
Bank, including the power to impose fines and other civil and criminal
penalties, and to appoint a conservator.
Interstate Banking and Branching. Current federal law authorizes
interstate acquisitions of banks and bank holding companies without geographic
limitation. Effective June 1, 1997, a bank headquartered in one state was
authorized to merge with a bank headquartered in another state, as long as
neither of the states had opted out of such interstate merger authority prior to
such date. After a bank has established branches in a state through an
interstate merger transaction, the bank may establish and acquire additional
branches at any location in the state where a bank headquartered in that state
could have established or acquired branches under applicable federal or state
law.
Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999 (the
"Act") was signed into law on November 12, 1999. The Act covers a broad range of
issues, including a repeal of most of the restrictions on affiliations among
depository institutions, securities firms and insurance companies. Most of the
Act's provisions require the federal banking regulatory agencies and other
regulatory bodies to adopt regulations to implement the Act, and for that reason
an assessment of the full impact on the Company of the Act must await completion
of that regulatory process.
The Act repeals sections 20 and 32 of the Glass-Stegall Act, thus
permitting unrestricted affiliations between banks and securities firms. The Act
also permits bank holding companies to elect to become financial holding
companies. A financial holding company may engage in or acquire companies that
engage in a broad range of financial services, including securities activities
such as underwriting, dealing, brokerage, investment and merchant banking,
insurance underwriting, sales and brokerage activities. In order to become a
financial holding company, the bank holding company and all of its affiliated
depository institutions must be well-capitalized, well-managed, and have at
least a satisfactory Community Reinvestment Act rating.
The Act provides that the states continue to have the authority to
regulate insurance activities but prohibits the states in most instances from
preventing or significantly interfering with the ability of a bank, directly or
through an affiliate, to engage in insurance sales, solicitations or
cross-marketing activities. Although the states generally must regulate bank
insurance activities in a nondiscriminatory manner, the states may continue to
adopt and enforce rules that specifically regulate bank insurance activities in
certain areas identified in the Act. The Act directs the federal banking
regulatory agencies to adopt insurance consumer protection regulations that
apply to sales practices, solicitations, advertising and disclosures.
The Act adopts a system of functional regulation under which the
Federal Reserve Board is confirmed as the umbrella regulator for financial
holding companies, but financial holding company affiliates are to be
principally regulated by functional regulators such as the FDIC for state
nonmember bank affiliates, the Securities and Exchange Commission for securities
affiliates and state insurance
-6-
regulators for insurance affiliates. The Act repeals the broad exemption of
banks from the definitions of "broker" and "dealer" for purposes of the
Securities Exchange Act of 1934, as amended, but identifies a set of specific
activities, including traditional bank trust and fiduciary activities, in which
a bank may engage without being deemed a "broker", and a set of activities in
which a bank may engage without being deemed a "dealer". The Act also makes
conforming changes in the definitions of "broker" and "dealer" for purposes of
the Investment Company Act of 1940, as amended, and the Investment Advisers Act
of 1940, as amended.
The Act contains extensive customer privacy protection provisions.
Under these provisions, a financial institution must provide to its customers,
at the inception of the customer relationship and annually thereafter, the
institution's policies and procedures regarding the handling of customers'
nonpublic personal financial information. The Act provides that, except for
certain limited exceptions, an institution may not provide such personal
information to unaffiliated third parties unless the institution discloses to
the customer that such information may be so provided and the customer is given
the opportunity to opt out of such disclosure. An institution may not disclose
to a non-affiliated third party, other than to a consumer reporting agency,
customer account numbers or other similar account identifiers for marketing
purposes. The Act also provides that the states may adopt customer privacy
protections that are more strict than those contained in the Act. The Act also
makes a criminal offense, except in limited circumstances, obtaining or
attempting to obtain customer information of a financial nature by fraudulent or
deceptive means.
Tredegar. Tredegar operates as a trust subsidiary of the Company. It is
subject to supervision and regulation by the Virginia State Corporation
Commission's Bureau of Financial Institutions and the Federal Reserve Board.
State and federal regulators have substantial discretion and latitude
in the exercise of their supervisory and regulatory authority over Tredegar,
including the statutory authority to promulgate regulations affecting the
conduct of business and the operations of Tredegar. They also have the ability
to exercise substantial remedial powers with respect to Tredegar in the event
that it determines that Tredegar is not in compliance with applicable laws,
orders or regulations governing its operations, is operating in an unsafe or
unsound manner, or is engaging in any irregular practices.
GPIA. GPIA operates as a non-banking subsidiary of the Company. It is
subject to supervision and regulation by the Securities and Exchange Commission
under the Investment Advisors Act of 1940, as amended.
ITEM 2. PROPERTIES
The headquarters building of the Company and the Bank, which also
serves as a branch office for Tredegar, was completed in 1981 and is a two-story
building of brick construction, with approximately 18,000 square feet of floor
space, located at 111 West Washington Street, Middleburg, Virginia 20117. The
office operates nine teller windows, including three drive-up facilities and one
stand-alone automatic teller machine. The Bank owns the headquarters building.
The Purcellville bank branch was purchased in 1994 and is a one-story
building with a basement of brick construction, with approximately 3,000 square
feet of floor space, located at 431 East Main Street, Purcellville, Virginia
20132. The office operates four teller windows, including three drive-up
facilities and one drive-up automatic teller machine. The Bank owns this branch
building.
-7-
The Catoctin Circle, Leesburg bank branch was completed in 1997 and is
a two-story building of brick construction, with approximately 6,000 square feet
of floor space, located at 102 Catoctin Circle, SE, Leesburg, Virginia 20175.
The office operates five teller windows, including three drive-up facilities and
one drive-up automatic teller machine. The Bank owns this branch building.
The Fort Evans Road, Leesburg bank branch was completed in July 2002
and is a one-story building of brick construction, with approximately 3,500
square feet of floor space, located at 211 Fort Evans Road, NE, Leesburg,
Virginia 20176. The office operates five teller windows, including three
drive-up facilities and one drive-up automatic teller machine. The Bank owns
this branch building.
The Leesburg limited service facility, located at 200 North King
Street, was leased beginning April 1999. The leased space consists of 200 square
feet with one teller window and a stand-alone automated teller machine.
Transactions in this branch are limited to paying and receiving teller
functions. The initial term of this lease is five years with two additional
renewal periods of five years each. The annual lease expense associated with
this location is $5,400.
The Ashburn bank branch, which is leased, opened in June 1999 and
consists of 3,400 rentable square feet at 20955 Professional Plaza, Suite 100,
Ashburn, Virginia 20147. The office is a full service branch with five teller
windows, three drive-up facilities and a drive-up automated teller machine. The
initial term of the lease is 15 years with two five-year renewal options. The
annual lease expense associated with this location is $68,000.
The Leesburg operations building was completed in June 2002. The
building is Class A office space and is home to the deposit and loan operations,
data processing, information technology, human resources, training and mortgage
banking departments. This building is a two story building with 18,000 square
feet of floor space, located at 106 Catoctin Circle, SE, Leesburg, Virginia
20175. The Bank owns this building.
Tredegar leases its main office at 821 East Main Street in Richmond,
Virginia. The lease, which was entered into in August 2001 when Tredegar moved
from its former location, is for a term of 15 years, with no renewal options.
The annual lease expense for the new location will be $165,000. Total lease
expense for 2001, including the new and previous office space, was $76,000.
Tredegar closed its branch office in Williamsburg, Virginia in April 2001. The
space included approximately 500 square feet used primarily for business
development and sales. The annual lease expense associated with this location
was $7,500.
GPIA leases its main office at 1901 North Beauregard Avenue,
Alexandria, Virginia, 22311. The lease, which was entered into in May 1999, is
for a term of five years, with no renewal options. The space includes
approximately 3,500 square feet of office space and 900 square feet of storage.
The annual lease expense associated with this location is $79,000. The lease is
currently in negotiations with no anticipated increase in expense.
All of the Company's properties are in good operating condition and are
adequate for the Company's present and anticipated future needs.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the company is
a party or of which the property of the Company is subject.
-8-
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders of the Company.
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since May 15, 2002, the Company's Common Stock has traded on the Nasdaq
SmallCap Market under the symbol "MBRG". From September 15, 2000 until May 14,
2002, the Company's Common Stock had traded on the Nasdaq SmallCap Market under
the symbol "ICBX".
Market Price and Dividends
Sales Price ($) Dividends ($)
--------------- -------------
High Low
---- ---
2001:
1st quarter............................ 33.00 21.00 .25
2nd quarter............................ 31.25 27.00 .25
3rd quarter............................ 36.00 29.00 .25
4th quarter............................ 35.90 32.50 .25
2002:
1st quarter............................ 45.58 35.11 .30
2nd quarter............................ 50.00 44.10 .30
3rd quarter............................ 48.75 44.00 .30
4th quarter............................ 48.25 45.25 .30
MFC historically has paid cash dividends on a quarterly basis. The
final determination of the timing, amount and payment of dividends on the Common
Stock is at the discretion of MFC's Board of Directors and will depend upon the
earnings of MFC and its subsidiaries, principally its subsidiary bank, the
financial condition of MFC and other factors, including general economic
conditions and applicable governmental regulations and policies. MFC or the Bank
has paid regular cash dividends for over 200 consecutive quarters.
As of March 4, 2003, MFC had approximately 1,350 shareholders of
record.
-9-
ITEM 6. SELECTED FINANCIAL DATA
The information set forth in the following table should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and Notes
thereto.
Years Ended December 31,
2002 2001 2000 1999 1998
(In thousands, except ratios and per share amounts)
Income Statement Data:
Interest income $23,758 $21,822 $19,209 $15,522 $13,785
Interest expense 6,524 7,814 7,041 5,345 5,313
Net interest income $17,234 $14,008 $12,168 $10,177 $8,472
Provision for loan losses 300 300 400 420 135
Net interest income after
provision for loan losses $16,934 $13,708 $11,768 $9,757 $8,337
Noninterest income 7,312 4,827 3,669 2,959 2,187
Securities gains (losses) (73) 384 (204) (13) (18)
Noninterest expense 15,526 11,947 9,555 8,040 6,674
Income before income taxes $8,647 $6,972 $5,678 $4,663 $3,832
Income taxes 2,335 1,755 1,450 1,097 857
Net income $6,312 $5,217 $4,228 $3,566 $2,975
Per Share Data:
Net Income, Basic $3.47 $2.99 $2.43 $2.00 $1.65
Net Income, Diluted 3.39 2.93 2.41 1.99 1.63
Cash Dividends 1.20 1.00 0.84 0.68 0.75
Book value at period end 22.35 17.31 15.68 12.97 12.85
Balance Sheet Data:
Assets $424,974 $354,101 $289,461 $243,925 $205,403
Loans, net of unearned income 212,107 196,400 177,598 143,235 121,323
Securities 163,673 124,351 81,577 67,739 57,786
Deposits 328,903 271,731 224,640 203,837 172,680
Shareholders' equity 41,410 30,338 27,271 23,075 22,863
Average shares outstanding, 1,821 1,746 1,741 1,779 1,803
Basic
Average shares outstanding, 1,863 1,783 1,752 1,795 1,821
Diluted
Performance Ratios:
Return on Average Assets 1.62% 1.67% 1.62% 1.60% 1.54%
Return on Average Equity 17.24% 17.55% 17.46% 15.48% 13.24%
Capital to Assets 9.74% 8.57% 9.42% 9.49% 11.13%
Dividend payout 35.04% 33.53% 34.57% 34.00% 45.45%
Efficiency (1) 60.93% 60.4% 57.4% 57.9% 58.5%
Capital and Liquidity Ratios:
Risk-based capital ratios:
Tier 1 capital 14.8% 16.4% 12.7% 14.0% 17.1%
Total capital 15.6% 17.3% 13.6% 14.8% 17.9%
Leverage 10.6% 12.5% 9.7% 10.8% 11.2%
- --------
(1) Computed by dividing noninterest expense by the sum of net interest income
on a tax equivalent basis and noninterest income, net of securities
gains or losses.
-10-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion provides information about the major
components of the results of operations and financial condition, liquidity, and
capital resources of MFC. This discussion and analysis should be read in
conjunction with the Company's Consolidated Financial Statements and Notes to
Consolidated Financial Statements.
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 the accounting policies of the Company. 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.
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 accounting
principles generally accepted in the United States of America; 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,
-11-
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.
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.
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.
Intangibles and Goodwill
The Company has approximately $6.9 million in intangible assets and
goodwill at December 31, 2002, an increase of $5.9 million since December 31,
2001. The increase is associated with the April 1, 2002 acquisition of Gilkison
Patterson Investment Advisors, Inc. ("GPIA"), a registered investment advisor.
In connection with this investment, a purchase price valuation (using FAS 141
and 142 as a guideline) was completed to determine the appropriate allocation to
identified intangibles. The valuation concluded that approximately 42% of the
purchase price was related to the acquisition of customer relationships with an
amortizable life of 15 years. Another 19% of the purchase price was allocated to
a non-compete agreement with an amortizable life of 7 years. The remainder of
the purchase price has been allocated to goodwill.
The purchase price allocation process requires management estimates and
judgment as to expectations for the life span of various customer relationships
as well as the value that key members of management add to the success of the
Company. For example, customer attrition rates were determined based upon
assumptions that the past five years may predict the future. If the actual
attrition rates, among other assumptions, differed from the estimates and
judgments used in the purchase price allocation, the amounts recorded in the
financial statements could result in a possible impairment of the intangible
assets and goodwill or require an acceleration in the amortization expense.
In addition, FAS 142 requires that goodwill be tested annually using a
two-step process. The first step is to identify a potential impairment. The
second step measures the amount of the impairment loss, if any. Processes and
procedures have been identified for the two-step process.
-12-
When the Company completes its ongoing review of the recoverability of
intangible assets and goodwill, factors that are considered important to
determining whether an impairment might exist include loss of customers acquired
or significant withdrawals of the assets currently under management and/or early
retirement or termination of key members of management. Any changes in the key
management estimates or judgments could result in an impairment charge, and such
a charge could have an adverse effect on the Company's financial condition and
results of operations.
Overview
MFC is headquartered in Middleburg, Virginia and conducts its primary
operations through three wholly owned subsidiaries, the Bank, Tredegar and GPIA.
The Bank is a community bank serving western Loudoun County, Virginia with five
full service branches and one limited service facility. Tredegar is a trust
company headquartered in Richmond, Virginia with a branch office in Middleburg,
Virginia. GPIA is a registered investment advisor headquartered in Alexandria,
Virginia serving clients in 26 states.
MFC exercised its option to buy GPIA in April 2002. The terms of the
transaction include a total purchase price of $6 million with 59,874 common
shares of MFC issued to the shareholders of GPIA. At the time of acquisition
GPIA had approximately $630 million of assets under management with clients in
30 states. Clients who are located in Washington, DC, Maryland and Virginia
account for approximately 68% of the assets under management. With the addition
of GPIA, assets under management by both Tredegar and GPIA exceeded $1 billion
at December 31, 2002.
In 2002, MFC continued to realize the benefit of high growth rates in
both assets and net earnings. Results for 2002 were also favorably affected by
the growth in revenues from the Bank's mortgage banking and investment sales
operations. By December 31, 2002, total assets were $425.0 million, an increase
of 20.0%. Total assets at December 31, 2001 were $354.1 million. Loans, net of
unearned income, grew 8.0% from $196.4 million at December 31, 2001 to $212.1
million at December 31, 2002. Total deposits increased $57.2 million from $271.7
million at December 31, 2001 to $328.9 million at December 31, 2002. MFC remains
well capitalized with risk-adjusted core capital and total capital ratios well
above the regulatory minimums. Asset quality measures also remained consistently
strong throughout the year.
MFC is not aware of any current recommendations by any regulatory
authorities that, if they were implemented, would have a material effect on the
registrant's liquidity, capital resources or results of operations.
-13-
Results of Operations
Net Income
Net income for 2002 was $6.3 million, an increase of 21.0% over 2001's
net income of $5.2 million. Net income for 2001increased 23.4% over 2000's net
income of $4.2 million. For 2002, earnings per diluted share were $3.39 compared
to $2.93 and $2.41 for 2001 and 2000, respectively.
Return on average assets ("ROA") measures how effectively MFC employs
its assets to produce net income. The ROA for MFC decreased slightly to 1.62%
for the year ended December 31, 2002 from 1.67% for the same period in 2001. The
decrease in the net interest margin and additional investments in fixed assets
during 2002 contributed to the five basis point decrease in the ROA. The ROA for
2000 was 1.62%. Return on average equity (ROE), another measure of earnings
performance, indicates the amount of net income earned in relation to the total
equity capital invested. ROE decreased to 17.24% for the year ended December 31,
2002. The additional capital issued in the acquisition of GPIA contributed the
decrease in ROE during 2002. ROE was 17.6% and 17.5% for the years ended
December 31, 2001 and 2000, respectively.
-14-
Average Balances, Income and Expenses, Yields and Rates
Years Ended December 31,
-------------------------------------------------------------------------------------------------
2002 2001 2000
-------------------------------------------------------------------------------------------------
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
-------------------------------------------------------------------------------------------------
(Dollars in thousands)
Assets :
Securities:
Taxable $ 101,725 $ 5,629 5.53% $ 52,040 $ 3,364 6.46% $ 46,838 $ 3,334 7.12%
Tax-exempt (1) (2) 36,471 2,757 7.56% 38,748 2,933 7.57% 30,963 2,392 7.73%
--------- --------- ---------- --------- ---------- ---------
Total securities $ 138,197 $ 8,386 6.07% $ 90,788 $ 6,297 6.94% $ 77,801 $ 5,726
Loans
Taxable $ 213,844 $ 16,137 7.55% $ 194,835 $ 16,297 8.36% $ 160,658 $ 14,049 8.74%
Tax-exempt 758 63 8.32% 520 46 8.85% 437 41 9.38%
--------- --------- ---------- --------- ---------- ---------
Total loans $ 214,602 $ 16,200 7.55% $ 195,355 $ 16,343 8.37% $ 161,095 $ 14,090 8.75%
Federal funds sold 5,396 82 1.52% 3,046 117 3.84% 2,800 170 6.07%
Interest on money market investments 2,194 39 1.77% 1,742 63 3.62% 512 40 7.81%
Interest bearing deposits in
other financial institutions 349 5 1.30% 250 9 3.60% 104 4 3.85%
--------- --------- ---------- --------- ---------- ---------
Total earning assets $ 360,738 $ 24,712 6.85% $ 291,181 $ 22,829 7.84% $ 242,312 $ 20,030 8.27%
Less: allowances for credit losses (2,187) (1,948) (1,595
Total nonearning assets 31,071 23,508 20,875
--------- --------- ----------
Total assets $ 389,621 $ 312,741 $ 261,592
========= ========= ==========
Liabilities:
Interest-bearing deposits:
Checking $ 39,430 $ 93 0.24% $ 33,978 $ 223 0.66% $ 32,461 $ 295 0.91%
Regular savings 19,813 183 0.92% 15,183 278 1.83% 13,148 263 2.00%
Money market savings 66,102 905 1.37% 46,616 1,166 2.50% 42,852 1,162 2.71%
Time deposits:
$100,000 and over 51,723 1,648 3.19% 39,154 2,086 5.33% 25,997 1,453 5.59%
Under $100,000 44,367 1,392 3.14% 46,409 2,088 4.50% 44,389 2,151 4.85%
--------- --------- ---------- --------- ---------- ---------
Total interest-bearing deposits $ 221,435 $ 4,221 1.91% $ 181,340 $ 5,841 3.22% $ 158,847 $ 5,324 3.35%
Federal Home Loan Bank Advances 3,126 115 3.68% 7,543 482 6.39% 9,186 584 6.36%
Securities sold under agreements
to repurchase 13,434 177 1.31% 13,292 399 3.00% 12,279 616 5.02%
Long-term debt 38,156 2,007 5.26% 19,332 1,076 5.57% 8,090 500 6.18%
Federal Funds Purchased 221 4 1.78% 371 16 4.31% 286 17 5.94%
--------- --------- ---------- --------- ---------- ---------
Total interest-bearing liabilities $ 276,373 $ 6,524 2.36% $ 221,878 $ 7,814 3.52% $ 188,688 $ 7,041 3.73%
Non-interest bearing liabilities
Demand Deposits 74,787 59,289 47,355
Other liabilities 1,860 1,854 1,329
--------- --------- ----------
Total liabilities $ 353,019 $ 283,021 $ 237,372
Shareholders' equity
36,602 29,720 24,220
--------- --------- ----------
Total liabilities and shareholders'
Equity $ 389,621 $ 312,741 $ 261,59
========= ========= ==========
--------- --------- ---------
Net interest income $ 18,188 $ 15,015 $ 12,989
========= ========= =========
Interest rate spread 4.49% 4.32% 4.54%
Interest expense as a percent of
average earning assets 1.81% 2.68% 2.91%
Net interest margin 5.04% 5.16% 5.36%
- ----------
(1) Income and yields are reported on tax equivalent basis assuming a
federal tax rate of 34%.
(2) Income and yields include dividends on preferred bonds that are 70%
excludable for tax purposes.
-15-
Net Interest Income
Net interest income represents the principal source of earnings of MFC.
Net interest income is the amount by which interest generated from earning
assets exceeds the expense of funding those assets. Changes in volume and mix of
interest earning assets and interest bearing liabilities, as well as their
respective yields and rates, have a significant impact on the level of net
interest income.
Net interest income on a fully tax-equivalent basis was $18.2 million
for the year ended December 31, 2002. This is an increase of 21.1% over the
$15.0 million reported for the same period in 2001. Net interest income for 2001
increased 15.6% over the $13.0 million reported for 2000.
The increase in net interest income in 2002 resulted from the 23.9%
growth in average earning assets. The 99 basis point decrease in earning assets
yield was offset by a 116 basis point decrease in the cost of funding, which
allowed the net interest margin to remain above 5% throughout 2002. The average
balance in the securities portfolio increased by $47.4 million while the
tax-equivalent yield decreased 87 basis points to 6.07%. Nevertheless, the
increase in the average balance of the securities portfolio was able to provide
$2.1 million in additional interest income on a tax-equivalent basis. The
average loan portfolio volume increased 9.9% during 2002. Conversely, the
average yield on the loan portfolio decreased 82 basis points. Loan demand was
strong throughout 2002; however, the loan portfolio experienced significant run
off due to borrower refinancings of residential real estate loans.
In 2002, MFC experienced significant growth in its interest bearing
checking, savings and money market accounts. Despite a 30.9% increase in the
average balances of these accounts, the decline in deposit rates during 2002
allowed MFC to experience a decrease in the respective interest expenses of
$486,000. The average balances in certificates of deposit increased 12.3%, while
the interest expense associated with these deposits decreased 27.2% or $1.1
million.
MFC's reliance on other funding sources, such as the Federal Home Loan
Bank overnight advances, decreased on average by $4.4 million with a related
decrease in interest expense of $367,000. During 2002, however, MFC increased on
average its long term borrowings from the Federal Home Loan Bank by $10.8
million. Total interest expense for 2002 was $6.5 million, a decrease of $1.3
million compared to the total interest expense for 2001.
The increase in net interest income in 2001 resulted from largely from
the continued growth in the average earning assets. Both the assets yields and
the cost of funding decreased at ratable amounts resulting in a decrease of 20
basis points in the net interest margin. The average balance in the securities
portfolio increased $13.0 million, while the tax-equivalent yield decreased 42
basis points to 6.94%, providing $571,000 in additional interest income on a
tax-equivalent basis. The asset/liability strategies employed by management
influenced the increase in the investment portfolio yield. The average loan
portfolio volume increased 21.3% during 2001, providing $2.8 million in interest
income, while the average yield on the loan portfolio decreased 38 basis points,
causing the interest income provided by the loan portfolio to decrease by
$579,000.
In 2001, MFC experienced respectable growth in its interest bearing
checking, savings and money market accounts. In spite of the 8.3% increase in
the average balances, the decline in deposit rates during 2001 allowed MFC to
experience a decrease in the respective interest expenses of $53,000. The
average balances in certificates of deposit increased 21.6%, while the interest
expense associated with these deposits increased 15.8% or $570,000. The decline
in the average rate paid on certificates of deposit produced a decrease in
interest expense of approximately $235,000, while the increased volume of
certificates of deposit increased interest expense by approximately $805,000.
-16-
MFC's reliance on other funding sources, such as the Federal Home Loan
Bank overnight advances, decreased on average by $1.6 million with a related
decrease in interest expense of $102,000. However, during 2001, MFC increased on
average its long term borrowings from the Federal Home Loan Bank by $9.5
million. During the fourth quarter of 2001, MFC issued $10 million in trust
preferred securities adding $1.7 million in average long term debt to the
balance sheet. The interest expense related to the trust preferred securities is
also included in long term debt interest expense and amounted to approximately
$59,000. Total interest expense for 2001 was $7.8 million, an increase of
$773,000 compared to 2000.
-17-
The following table analyzes changes in net interest income
attributable to changes in the volume of interest-bearing assets and liabilities
compared to changes in interest rates. The change in interest due to both volume
and rate has been allocated to volume and rate changes in proportion to the
relationship of the absolute dollar amounts of the change in each. Nonaccruing
loans are included in the average outstanding loans.
Volume and Rate Analysis
(Tax Equivalent Basis)
Years Ended December 31,
---------------------------------------------------------------
2002 vs 2001 2001 vs 2000
Increase (Decrease) Due Increase (Decrease) Due
to Changes in: to Changes in:
---------------------------------------------------------------
(In Thousands)
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
Earning Assets:
Securities:
Taxable $ 2,667 $ (402) $ 2,265 $ 181 $ (151) $ 30
Tax-exempt (172) (4) (176) 590 (49) 541
Loans:
Taxable 1,495 (1,655) (160) 2,825 (577) 2,248
Tax-exempt 20 (3) 17 7 (2) 5
Federal funds sold 126 (161) (35) 17 (70) (53)
Interest on money market investments 25 (49) (24) 30 (7) 23
Interest bearing deposits in other
financial institutions 7 (11) (4) 5 -- 5
------- ------- ------- ------- ------- -------
Total earning assets $ 4,168 $(2,285) $ 1,883 $ 3,655 $ (856) $ 2,799
------- ------- ------- ------- ------- -------
Interest-Bearing Liabilities:
Interest checking $ 44 $ (174) (130) $ 15 $ (87) (72)
Regular savings deposits 151 (246) (95) 33 (18) 15
Money market deposits 381 (642) (261) 34 (30) 4
Time deposits
$100,000 and over 550 (988 (438) 697 (64) 633
Under $100,000 (88) (608) (696) 108 (171) (63)
------- ------- ------- ------- ------- -------
Total interest bearing deposits $ 1,038 $(2,658) $(1,620) $ 887 $ (370) $ 517
------- ------- ------- ------- ------- -------
Federal Home Loan Bank
Advances $ (213) $ (154) $ (367) $ (105) $ 3 $ (102)
Securities sold under agree-
ment to repurchase 4 (226) (222) 56 (273) (217)
Long-term debt 987 (56) 931 620 (44) 576
Federal Funds Purchased (5) (7) (12) (13) 12 (1)
------- ------- ------- ------- ------- -------
Total interest bearing
liabilities $ 1,811 $(3,101) $(1,290) $ 1,445 $ (672) $ 773
------- ------- ------- ------- ------- -------
Change in net interest income $ 2,357 $ 816 $ 3,173 $ 2,210 $ (184) $ 2,026
======= ======= ======= ======= ======= =======
- ---------
(1) The change in interest, due to both rate and volume, has been allocated to
change due to volume and change due to rate in proportion to the
relationship of the absolute dollar amounts of the change in each.
-18-
Provision for Loan Losses
MFC's loan loss provision during 2002 and 2001 was $300,000. MFC is
committed to making loan loss provisions that maintain an allowance that
adequately reflects the risk inherent in the loan portfolio. This commitment is
more fully discussed in the "Asset Quality" section below.
Noninterest Income
Noninterest income has been and will continue to be an important factor
for increasing profitability. Management recognizes this and continues to review
and consider areas where non-interest income can be increased. Noninterest
income includes fees generated by the mortgage banking and investment sales
departments of the Bank as well as by Tredegar and GPIA. Trust fee income
decreased 7.7% during 2002 to $1.2 million. A significant portion of trust fees
are based upon a percentage of the market value of the assets under management,
so any decreases in market value of the assets under management result in a
similar decrease in fees. Tredegar's accounts are typically invested in equities
with a smaller allocation to fixed income securities. The continued decline in
equity market values have more than offset all of the growth in the fees as
result of new business. GPIA's investment advisory fees added $1.5 million to
noninterest income for the eight months that they have been a subsidiary of MFC.
Like Tredegar, their fees are based upon a percentage of the market value of the
assets under management; however, GPIA's clients have substantially more
invested in fixed income securities. The fixed income market typically has an
opposite reaction to the equity markets. Thus, about 5% of their fee increase
over 2001 is related to relative increases in market values of the portfolios
managed while the remaining 3% is related to new business growth. Due to
historic low mortgage rates and increased refinancings, the mortgage banking
department contributed an additional $452,000 of fees on loans held for sale
during 2002. During 2002, the Bank increased its transaction oriented deposit
accounts by 30.5% resulting in growth in service charges and fee income. The
service charges and fees associated with deposit accounts increased 35.0% during
2002. During 2002, MFC realized $73,000 in net losses as a result of
restructuring the investment portfolio in response to the change in the interest
rate environment in 2002. Total noninterest income for 2002 was $7.2 million,
compared to $5.2 million for 2001.
-19-
Noninterest income for 2001 increased 50.4% to $5.2 million from $3.5
million in 2000. The increase is due primarily to the increase on fees on loans
held for sale, investment sales fees and service charges on deposit accounts.
The mortgage banking department contributed an additional $840,000 of fees on
loans held for sale during 2001. The service charges and fees associated with
deposit accounts increased 23.1% during 2001. The increase in these fees was due
primarily to a 31.2% increase in transaction oriented deposit account growth.
Noninterest Income
Year Ended December 31,
----------------------------
2002 2001 2000
------- ------- -------
(In thousands)
Service charges, commissions and fees $ 1,960 $ 1,452 $ 1,180
Trust fee income 1,181 1,279 1,594
Investment advisory fee income 1,544 -- --
Fees on loans held for sale 1,935 1,483 643
Commission on investment sales 611 485 116
Other operating income 81 128 136
------- ------- -------
Noninterest income $ 7,312 $ 4,827 $ 3,669
Gains (losses) on securities available for
sale, net (73) 384 (204)
------- ------- -------
Total noninterest income $ 7,239 $ 5,211 $ 3,465
======= ======= =======
Noninterest Expenses
Improving operating efficiency is as important to management as
enhancing noninterest income. Total noninterest expenses increased 30.0% or $3.6
million to $15.5 million in 2002. The acquisition of GPIA on April 1, 2002
accounts for 32.3% or $1.1 million of the total increase in noninterest
expenses. Salaries and employee benefits increased $2.2 million or 30.7% due to
increased commission expense for fee-related business and enhancing the internal
infrastructure to support a growing organization. Approximately $673,000 of the
$2.2 million increase in salaries expense is related to the acquisition of GPIA.
Occupancy and equipment expense increased $605,000 or 48.6% to $1.9 million. The
costs to move the existing operations departments from the Company's main office
to the operations facility as well as readying the buildings for occupancy have
caused the increase in occupancy and equipment expense. Advertising expense
increased 29.4% in 2002. Two additional bank mergers within the market areas
presented opportunities for additional image advertising that resulted in
increased business. Computer operations expense increased 32.1% to $539,000
during 2002. The Company placed in service additional equipment to enhance the
security infrastructure of the internal network as well as upgraded the core
bank processing software. An increase in the usage of internet banking services
by accountholders also contributed to the increase in computer operations
expense. Other operating expenses increased $546,000 to $3.3 million for 2002
compared to $2.8 million for 2001. Expenses associated with servicing an
increased volume of accounts and transactions such as postage and printing have
also impacted other operating expenses in 2002.
-20-
Noninterest expenses increased 25.0% or $2.4 million to $11.9 million
in 2001. This increase resulted from both pressures to provide competitive
salary and benefit programs and occupancy and equipment investments to position
the Bank for future growth and productivity.
Noninterest Expenses
Years Ended December 31,
--------------------------------------
2002 2001 2000
-------- --------- ---------
(In thousands)
Salaries and employee benefits $ 9,383 $ 7,180 $ 5,600
Net occupancy and equipment expense 1,851 1,246 1,172
Advertising 414 320 347
Computer operations 539 408 298
Other operating expenses 3,339 2,793 2,138
-------- --------- ---------
Total $ 15,526 $ 11,947 $ 9,555
======== ========= =========
Income Taxes
Reported income tax expense was $2.3 million for 2002, an increase of
$580,000 compared to $1.8 million for 2001. The effective tax rate for 2002 was
27.0% compared to 25.2% in 2001 and 25.5% in 2000. The increase in the effective
tax rate for 2002 was influenced by the change in the mix of the investment
securities portfolio as well as the increase in non-interest income. Note 10 of
the Company's Consolidated Financial Statements provides a reconciliation
between the amount of income tax expense computed using the federal statutory
rate and MFC's actual income tax expense. Also included in Note 10 to the
Consolidated Financial Statements is information regarding the principal items
giving rise to deferred taxes for the two years ended December 31, 2002.
-21-
Summary of Financial Results by Quarter
2002 Quarter Ended
----------------------------------------------------------
(Dollars in thousands except per share) March 31 June 30 September 30 December 31
------------- ------------ ---------------- --------------
Net interest income $ 4,156 $ 4,290 $ 4,391 $ 4,397
Net interst income after provision
for loan losses 4,081 4,215 4,316 4,322
Non interest income 1,184 1,815 2,061 2,253
Net securities gains (losses) (80) 33 (31) 5
Non interest expense 3,128 3,711 4,058 4,630
Income before income taxes 2,057 2,352 2,288 1,950
Net income 1,514 1,686 1,642 1,470
Earnings per common share - assuming dilution $ 0.84 $ 0.90 $ 0.87 $ 0.78
Dividends per common share 0.30 0.30 0.30 0.30
2001 Quarter Ended
----------------------------------------------------------
(Dollars in thousands except per share) March 31 June 30 September 30 December 31
------------- ------------ ---------------- --------------
Net interest income $ 3,120 $ 3,422 $ 3,555 $ 3,911
Net interst income after provision
for loan losses 3,045 3,347 3,480 3,836
Non interest income 1,168 1,096 1,254 1,309
Net securities gains (losses) 252 (6) 66 72
Non interest expense 2,741 2,829 2,930 3,447
Income before income taxes 1,724 1,608 1,870 1,770
Net income 1,292 1,199 1,389 1,337
Earnings per common share - assuming dilution $ 0.73 $ 0.67 $ 0.77 $ 0.75
Dividends per common share 0.25 0.25 0.25 0.25
Financial Condition
MFC's total assets were $424.9 million as of December 31, 2002, up
$70.9 million or 20.0% from the $354.1 million level at December 31, 2001.
Securities increased $39.3 million or 31.6% from 2001 to 2002. Loans increased
by $15.7 million or 8.0% from 2001 to 2002, while deposits increased $57.2
million or 21.0% during the same period. Borrowings from the Federal Home Loan
Bank increased $4.0 million during 2002. It is anticipated that the borrowings
from the Federal Home Loan Bank will continue to rise should deposit growth not
match asset growth. Total shareholders' equity at year end 2002 and 2001 was
$41.4 million and $30.3 million, respectively.
Loans
MFC's loan portfolio is its largest and most profitable component of
earning assets, totaling 59.5% of average earning assets in 2002. MFC continues
to emphasize loan portfolio growth and diversification as a means of increasing
earnings while minimizing credit risk. Loans, net of unearned
-22-
income, were $212.1 million at December 31, 2002, an increase of 8.0% from
December 31, 2001's total of $196.4 million. Proactive sales efforts,
competitive pricing and the branch network supported the increase in loans
during 2002. Loans increased 10.6% from $177.6 million at December 31, 2000 to
$196.4 million at December 31, 2001. The loan to deposit ratio decreased to
64.5% at December 31, 2002 compared to 72.3% at December 31, 2001 and 79.1% at
December 31, 2000.
Loan Portfolio
December 31,
---------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(In thousands)
Commercial, financial and agricultural $ 20,323 $ 22,993 $ 22,555 $ 19,055 $ 18,880
Real estate construction 22,008 24,174 17,693 12,151 5,436
Real estate mortgage:
Residential (1-4 family) 74,298 80,824 81,545 61,062 55,595
Home equity lines 10,091 8,271 5,973 4,382 3,617
Non-farm, non-residential (1) 73,164 48,074 38,812 36,361 28,643
Agricultural 482 163 346 379 1,057
Consumer installment 11,741 11,901 10,674 9,845 8,095
-------- -------- -------- -------- ---------
Total loans $212,107 $196,400 $177,598 $143,235 $121,323
======== ======== ======== ======== ========
- ---------
(1) This category generally consists of commercial and industrial loans where
real estate constitutes a source of collateral.
At December 31, 2002, residential real estate (1-4 family) portfolio
loans constituted 35.0% of the total portfolio and decreased $6.5 million during
the year. The current historic low mortgage interest rates have caused many of
the Bank's clients to refinance to a long term fixed rate product. Real estate
construction loans consist primarily of pre-sold 1-4 family residential loans
along with a marginal amount of commercial construction loans. Real estate
construction loans increased to $22.0 million at December 31, 2002 and represent
10.4% of the total loan portfolio. MFC's one time closing construction/permanent
loan product competes successfully in a high growth market like Loudoun County
because MFC is local and can respond quickly to inspections and construction
draw requests. Non-farm, non-residential real estate loans are typically
owner-occupied commercial buildings. Non-farm, non-residential loans were 34.5%
of the total loan portfolio at December 31, 2002. The increase in the non-farm
non-residential real estate loans is the result of an increased focus on
diversifying the loan portfolio. The Bank has hired commercial business
development officers who have been successful in attracting new business to the
Bank. The branch network has also helped to support the loan portfolio
diversification, such as increased commercial real estate loans. Home equity
lines and agricultural real estate loans were 4.8% and 0.23% of total loans,
respectively, at December 31, 2002.
MFC's commercial, financial and agricultural loan portfolio consists of
secured and unsecured loans to small businesses. At December 31, 2002, these
loans comprised 9.6% of the loan portfolio. This portfolio decreased 11.6% in
2002 to $20.3 million. Generally business debt has declined nationwide as well
as locally thus causing a decrease in loan demand. Consumer installment loans
primarily consist of unsecured installment credit and account for 5.5% of the
loan portfolio.
Consistent with its focus on providing community-based financial
services, MFC generally does not extend loans outside its principal market area.
MFC's market area for its lending services encompasses Fauquier and Loudoun
Counties, where it operates full service branches.
-23-
MFC's unfunded loan commitments totaled $31.6 million at December 31,
2002 and $34.2 million at December 31, 2001. The decrease in the amount of
unfunded commitments is attributed in part to the increase in real estate
construction financing as well as customer demand for credit line products,
primarily home equity lines.
At December 31, 2002, MFC had no concentration of loans in any one
industry in excess of 10% of its total loan portfolio. However, because of the
nature of MFC's market, loan collateral is predominantly real estate.
The following table reflects the maturity distribution of selected loan
categories:
Remaining Maturities of Selected Loan Categories
December 31, 2002
Commercial, Real
Financial and Estate
Agricultural Construction
--------------- --------------
(Dollars in thousands)
Within 1 year $ 16,340 $ 10,762
--------------- --------------
Variable Rate:
1 to 5 years $ 1,600 $ 896
After 5 years - 631
--------------- --------------
Total $ 1,600 $ 1,527
--------------- --------------
Fixed Rate:
1 to 5 years $ 2,383 $ 8,790
After 5 years - 929
--------------- --------------
Total $ 2,383 $ 9,719
--------------- --------------
Total Maturities $ 20,323 $ 22,008
=============== ==============
Asset Quality
MFC has policies and procedures designed to control credit risk and to
maintain the quality of its loan portfolio. These include underwriting standards
for new originations and ongoing monitoring and reporting of asset quality and
adequacy of the allowance for loan losses. Total nonperforming assets, which
consist of nonaccrual loans, restructured loans and foreclosed property, were
$1.1 million at December 31, 2002. This is an increase of $984,000 from the
December 31, 2001 balance of $79,000. The increase is largely two residential
real estate loans both of which are well secured. Nonperforming assets at
December 31, 2001 decreased $26,000 from $105,000 at December 31, 2000.
Nonperforming Assets
Loans are placed on nonaccrual status when collection of principal and
interest is doubtful, generally when a loan becomes 90 days past due. There are
three negative implications for earnings when a loan is placed on nonaccrual
status. First, all interest accrued but unpaid at the date that the loan is
placed on nonaccrual status is either deducted from interest income or written
off as a loss. Second, accruals of interest are discontinued until it becomes
certain that both principal and interest can be repaid.
-24-
Finally, there may be actual losses that require additional provisions for loan
losses be charged against earnings. For real estate loans, upon foreclosure, the
balance of the loan is transferred to "Other Real Estate Owned" ("OREO") and
carried at the lower of the outstanding loan balance or the fair market value of
the property based on current appraisals and other current market trends. If a
write down of the OREO property is necessary at the time of foreclosure, the
amount is charged-off against the allowance for loan losses. A review of the
recorded property value is performed in conjunction with normal loan reviews,
and if market conditions indicate that the recorded value exceeds the fair
market value, additional write downs of the property value are charged directly
to operations.
Nonperforming Assets
December 31,
-------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- -------------- ------------ ------------- -------------
(In thousands)
Nonaccrual loans $ 1,063 $ 79 $ 105 $ 530 $ 409
Restructured loans - - - - -
Foreclosed property - - - - 200
-------- -------- -------- -------- --------
Total nonperforming assets $ 1,063 $ 79 $ 105 $ 530 $ 609
======== ======== ======== ======== ========
Allowance for loan losses
to nonperforming assets 217% 2608% 1718% 274% 175%
Nonperforming assets to
period end loans 0.50% 0.04% 0.06% 0.37% 0.50%
During 2002 and 2001, approximately $41,000 and $700, respectively, in
additional interest income would have been recorded if MFC's nonaccrual loans
had been current and in accordance with their original terms.
At December 31, 2002, the Company had no potential problem loans.
The allowance for loan losses was 217% of nonperforming loans at
December 31, 2002. At December 31, 2001 and 2000 the allowance for loan losses
was 2,608% and 1,718% of nonperforming loans. Management evaluates nonperforming
loans relative to their collateral value and makes appropriate reductions in the
carrying value of those loans based on that review.
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 accounting
principles generally accepted in the United States of America; 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.
-25-
The Company evaluates various loans individually for impairment as
required by 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 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.
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.
-26-
The following table depicts the transactions, in summary form, that
occurred to the allowance for loan losses in each year presented:
Allowance for Loan Losses
December 31,
--------------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
(In thousands)
Balance, beginning of period $2,060 $1,804 $1,453 $1,064 $ 974
Loans charged off:
Commercial, financial, and
agricultural - - 61 26 8
Real estate construction - - - - -
Real estate mortgage - 48 - 29 -
Consumer installment 74 35 35 96 77
------ ------ ------ ------ ------
Total loans charged off $ 74 $ 83 $ 96 $ 151 $ 85
------ ------ ------ ------ ------
Recoveries:
Commercial, financial, and
agricultural $ 2 $- $ 6 $ 7 $ 1
Real estate construction - - - - -
Real estate mortgage - - - 79 6
Consumer installment 19 39 41 34 33
------ ------ ------ ------ ------
Total recoveries $ 21 $ 39 $ 47 $ 120 $ 40
------ ------ ------ ------ ------
Net charge offs (recoveries) 53 44 49 31 45
Provision for loan losses 300 300 400 420 135
------ ------ ------ ------ ------
Balance, end of period $2,307 $2,060 $1,804 $1,453 $1,064
====== ====== ====== ====== ======
Ratio of allowance for loan
losses to loans outstanding
at end of period 1.09% 1.05% 1.02% 1.01% 0.88%
Ratio of net charge offs to
average loans outstanding
during period 0.03% 0.02% 0.03% 0.02% 0.04%
The allowance for loan losses was $2.3 million at December 31, 2002, an
increase of $247,000 from $2.1 million at December 31, 2001. The allowance was
$1.8 million at December 31, 2000. In 2002, MFC's net charge-offs increased
$9,000 from the previous year's net charge-offs of $44,000. Net charge-offs as a
percentage of average loans were 0.03% and 0.02% for 2002 and 2001 respectively.
The provision for loan losses was $300,000 for 2002 and 2001.
-27-
The following table shows the balance and percentage of the MFC's
allowance for loan losses allocated to each major category of loan:
Allocation of Allowance for Loan Losses
Commercial, Financial, Real Estate Real Estate
Agricultural Construction Mortgage Consumer
--------------------------- ----------------------- ------------------------ -----------------------
Allowance Percent of Allowance Percent of Allowance Percent of Allowance Percent of
for Loan in for Loan in for Loan in for Loan in
Loan Category to Loan Category to Loan Category to Loan Category to
Losses Total Loans Losses Total Loans Losses Total Loans Losses Total Loans
--------------------------- ----------------------- ------------------------ -----------------------
(In thousands)
December 31,
2002 $ 487 9.58% $ 624 10.38% $ 924 74.51% $ 272 5.54%
2001 $ 634 11.71% $ 750 12.31% $ 374 69.92% $ 302 6.06%
2000 $ 645 12.70% $ 500 9.96% $ 310 71.33% $ 349 6.01%
1999 $ 580 13.30% $ 350 8.48% $ 178 71.34% $ 345 6.82%
1998 $ 442 15.56% $ 100 4.48% $ 144 73.28% $ 378 6.43%
MFC has allocated the allowance according to the amount deemed
reasonably necessary to provide for the possibility of losses being incurred
within each of the above categories of loans. The allocation of the allowance as
shown in the table above should not be interpreted as an indication that loan
losses in future years will occur in the same proportions that they may have in
prior years or that the allocation indicates future loan loss trends.
Additionally, the proportion allocated to each loan category is not the total
amount that may be available for the future losses that could occur within such
categories since the total allowance is a general allowance applicable to the
total portfolio.
Securities
MFC manages its investment securities portfolio consistent with
established policies that include guidelines for earnings, rate sensitivity,
liquidity and pledging needs. MFC holds bonds issued from the Commonwealth of
Virginia and its political subdivisions with an aggregate book value and market
value of $2.7 million at December 31, 2002. The aggregate holdings of these
bonds approximate 6.6% of MFC's shareholders' equity.
MFC accounts for securities under Financial Accounting Standards Board
("FASB") Statement No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." This standard requires classification of investments into
three categories, "held to maturity" ("HTM"), "available for sale" ("AFS"), or
"trading," as further defined in Note 1 to the Company's Consolidated Financial
Statements. MFC's does not maintain a trading account and has classified no
securities in this category. HTM securities are required to be carried on the
financial statements at amortized cost. AFS securities are carried on the
financial statements at fair value. The unrealized gains or losses, net of
deferred income taxes, are reflected in shareholders' equity. The HTM
classification places restrictions on MFC's ability to sell securities or to
transfer securities into the AFS classification. Since MFC desires the
flexibility to respond to changing balance sheet needs through investment
portfolio management, it has chosen to classify only a small portion of its
portfolio in this category. At December 31, 2002, 2.8% of the portfolio was
classified as HTM.
-28-
MFC holds in its loan and securities portfolios investments that adjust
or float according to changes in "prime" lending rate. These holdings are not
considered speculative but instead necessary for good asset/liability
management.
The carrying value of the securities portfolio was $163.7 million at
December 31, 2002, an increase of $39.3 million or 31.6% from the carrying value
of $124.4 million at December 31, 2001. The market value of the AFS securities
at December 31, 2002 was $159.0 million. The unrealized loss on the AFS
securities was $409,000 that was more than offset by an unrealized gain of $5.4
million at December 31, 2002. The net market value gain at December 31, 2002 is
reflective of the recent decrease in market interest rates. The net unrealized
loss on the AFS securities was $376,000 at December 31, 2001.
Investment Securities Portfolio
The carrying value of securities held to maturity at the dates
indicated were as follows:
December 31,
------------------------------------------------------------
2002 2001 2000
------------------ --------------- --------------
(In thousands)
U.S. Government securities $ - $ - $ 250
State and political subdivision obligations 4,590 5,484 6,657
Mortgage-backed securities 53 61 93
------------------ --------------- --------------
$ 4,643 $ 5,545 $ 7,000
================== =============== ==============
The carrying value of securities available for sale at the dates
indicated were as follows:
December 31,
------------------------------------------------------------
2002 2001 2000
------------------ --------------- --------------
(In thousands)
U.S. Government securities $ 4,406 $ 267 $ 3,072
State and political subdivision obligations 32,639 33,220 27,961
Mortgage-backed securities 102,521 63,746 3,443
Other securities 19,464 21,573 9,501
------------------ --------------- --------------
$ 159,030 $ 118,806 $ 43,977
================== =============== ==============
-29-
The following table indicates the increased return experienced by MFC
by lengthening the maturity of the investment securities portfolio. Securities
with maturities greater than five years total $83.7 million and have an average
yield greater than 6.0%. The securities portfolio represents approximately 38.3%
of the earning assets of MFC. For that reason, it is managed primarily to
provide superior returns without sacrificing interest rate, market and credit
risk. Secondarily through the asset/liability process, MFC considers the
securities portfolio as a liquidity source in the event that funding is needed
quickly within a 30-day period of time.
Maturity Distribution and Yields of Investment Securities
December 31, 2002
Taxable-Equivalent Basis
Due in 1 year Due after 1 year Due after 5 years Due after 10 years
or less through 5 years through 10 years And Equities Total
------------------ ------------------ ----------------- ------------------ -----------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------------------ ------------------ ----------------- ------------------ -----------------
(In housands)
Securities held for investment:
Mortgage backed securities $ 2 4.63% $ 7 4.38% $ 12 4.42% $ 32 4.53% $ 53 4.48%
Tax-exempt securities (1) 376 7.39% 2,630 7.72% 1,584 7.85% - - 4,590 7.74%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total $ 378 7.37% $ 2,637 7.71% $ 1,596 7.83% $ 32 4.53% $ 4,643 7.70%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Securities available for sale:
U.S. Government securities $ 514 2.52% $ 3,615 3.03% $ 277 7.54% $ - - $ 4,406 3.25%
Mortgage backed securities 20,662 5.77% 40,676 5.54% 22,683 5.33% 18,500 5.39% 102,521 5.51%
Other 691 7.20% 6,511 4.76% 204 7.22% 7,980 3.77% 15,386 4.39%
Corporate preferred - - - - - - 2,283 7.23% 2,283 7.23%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total taxable $ 21,867 5.74% $ 50,802 5.26% $ 23,164 5.37% $ 28,763 5.09% $124,596 5.33%
Tax-exempt securities (1) 391 7.92% 1,602 7.98% 11,981 7.56% 18,136 7.71% 32,110 7.67%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total $ 22,258 5.78% $ 52,404 5.35% $ 35,145 6.12% $ 46,899 6.10% $156,706 5.81%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total securities $ 22,636 5.81% $ 55,041 5.46% $ 36,741 6.19% $ 46,931 6.10% $161,349 5.86%
======== ==== ======== ==== ======== ==== ======== ==== ======== ====
- ---------
(1) Yields on tax-exempt securities have been computed on a tax-equivalent
basis.
(2) Amounts exclude Federal Reserve Stock of $374,400 and Federal Home Loan
Bank Stock of $1,950,000.
Other Earning Assets
MFC's average investments in federal funds sold and money market
investments in 2002 were $5.4 million and $2.2 million, increases of $2.4
million and $452,000, respectively, over the 2001 amounts. Average investments
in federal funds sold and money market investments in 2001 were $3.0 million and
$1.7 million, respectively. Fluctuations in federal funds sold and money market
investments reflect excess deposit growth over loan growth as well as
management's goal to maximize asset yields while maintaining proper
asset/liability structure.
-30-
Deposits
Deposits continue to be an important funding source and primary supply
of MFC's growth. MFC's strategy has been to increase its core deposits at the
same time that it is controlling its cost of funds. The maturation of the branch
network, as well as increased advertising campaigns and bank mergers, have
contributed to the significant growth in deposits over the last several years.
By monitoring interest rates within the local market and that of alternative
funding sources, MFC is able to price the deposits effectively to develop a core
base of deposits in each branch.
The following table is a summary of average deposits and average rates
paid on those deposits:
Average Deposits and Rates Paid
December 31,
-----------------------------------------------------------------------------------
2002 2001 2000
--------------------------- --------------------------- --------------------------
Amount Rate Amount Rate Amount Rate
--------------------------- --------------------------- --------------------------
(Dollars in Thousands)
Noninterest-bearing deposits $ 74,787 - $ 59,289 - $ 47,355 -
Interest-bearing accounts:
Interest checking 39,430 0.24% 33,978 0.66% 32,461 0.91%
Regular savings 19,813 0.92% 15,183 1.83% 13,148 2.00%
Money market accounts 66,102 1.37% 46,616 2.50% 42,852 2.71%
Time deposits:
$ 100,000 and over 51,723 3.19% 39,154 5.33% 25,997 5.59%
Under $ 100,000 44,367 3.14% 46,409 4.50% 44,389 4.85%
----------- ----------- -----------
Total interest-bearing deposits $ 221,435 1.91% $ 181,340 3.22% $ 158,847 3.35%
---------- ----------- -----------
Total $ 296,222 $ 240,629 $ 206,202
========== =========== ===========
Average total deposits increased 23.1% during 2002, 16.7% during 2001
and 10.3% during 2000. During 2002, the average balance of non-interest bearing
deposits grew 26.1%. The average balance in interest checking and money market
accounts grew 16.0% and 41.8%, respectively, during 2002. Management believes
that some of the growth in the average balances of money market accounts is
associated with the movement of money from the equity markets to bank accounts,
a significant portion of the growth is also core growth. The total number of net
new deposit transactional (excluding time deposits) accounts have increased 30%
per year for the past two years.
MFC will continue to fund assets primarily with deposits and will focus
on core deposit growth as the primary source of liquidity and stability. MFC
offers individuals and small to medium-sized businesses a variety of deposit
accounts, including demand and interest checking, money market, savings and time
deposit accounts. MFC neither purchases brokered deposits nor solicits deposits
from sources outside its primary market area.
-31-
The following table is a summary of the maturity distribution of
certificates of deposit equal to or greater than $100,000 as of December 31,
2002:
Maturities of Certificates of Deposit of $100,000 and Greater
Within Three to Six to Over Percent
Three Six Twelve One of Total
Months Months Months Year Total Deposits
------------- ------------ ------------- ------------ ------------- ------------
(In thousands)
At December 31, 2002 $9,784 $12,653 $9,470 $24,729 $56,636 17.2%
Capital Resources and Dividends
MFC has an ongoing strategic objective of maintaining a capital base
that supports the pursuit of profitable business opportunities, provides
resources to absorb risks inherent in its activities and meets or exceeds all
regulatory requirements.
The Federal Reserve Board has established minimum regulatory capital
standards for bank holding companies and state member banks. The regulatory
capital standards categorize assets and off-balance sheet items into four
categories that weigh balance sheet assets according to risk, requiring more
capital for holding higher risk assets. The minimum ratio of qualifying total
capital to risk-weighted assets is 8.0%, of which at least 4.0% must be Tier 1
capital, composed of common equity and retained earnings. MFC had a ratio of
total capital to risk-weighted assets of 15.6% at December 31, 2002, compared to
17.3% at December 31, 2001. The ratio of Tier 1 capital to risk-weighted assets
was 14.8% and 16.4% at December 31, 2002 and 2001, respectively. Both ratios
exceed the minimum capital requirements adopted by the federal banking
regulatory agencies.
-32-
Analysis of Capital
December 31,
2002 2001
-------------- ---------------
(Dollars in thousands)
Tier 1 Capital:
Common stock $ 9,263 $ 8,761
Capital surplus 3,644 741
Retained earnings 25,184 21,084
Trust preferred debt 10,000 9,770
Goodwill (6,902) (1,272)
--------- ---------
Total Tier 1 capital $ 41,189 $ 39,084
--------- ---------
Tier 2 Capital:
Disallowed trust preferred $ - $ 230
Allowance for loan losses 2,307 2,060
--------- ---------
Total tier 2 capital $ 2,307 $ 2,290
--------- ---------
Total risk-based capital $ 43,496 $ 41,374
========= =========
Risk weighted assets $ 278,229 $ 238,605
CAPITAL RATIOS:
Tier 1 risk-based capital ratio 14.8% 16.4%
Total risk-based capital ratio 15.6% 17.3%
Tier 1 capital to average total
assets 10.6% 12.5%
MFC's core equity to asset ratio increased to 9.7% at December 31,
2002, compared to 8.6% at December 31, 2001. The issuance of additional shares
in the acquisition of GPIA as well as the exercise of 40,550 stock options have
contributed to the increase in capital and the equity to asset ratio in 2002.
The primary source of funds for dividends paid by MFC to its
shareholders is the dividends received from its subsidiaries. Federal regulatory
agencies impose certain restrictions on the payment of dividends and the
transfer of assets from the banking subsidiaries to the holding company.
Historically, these restrictions have not had an adverse impact on MFC's
dividend policy, and it is not anticipated that they will in the future.
Liquidity
Liquidity represents an institution's ability to meet present and
future financial obligations through either the sale or maturity of existing
assets or the acquisition of additional funds through liability management.
Liquid assets include cash, interest-bearing deposits with banks, federal funds
sold, short-term investments, securities classified as available for sale as
well as loans and securities maturing within one year. As a result of MFC's
management of liquid assets and the ability to generate liquidity through
liability funding, management believes MFC maintains overall liquidity
sufficient to satisfy its depositors' requirements and meet its customers'
credit needs.
MFC also maintains additional sources of liquidity through a variety of
borrowing arrangements. The Bank maintains federal funds lines with large
regional and money-center banking institutions. These available lines total in
excess of $5 million, of which none were outstanding at December 31, 2002.
Federal funds purchased during 2002 averaged $221,000 compared to an average of
$371,000 during
-33-
2001. At December 31, 2002 and 2001, the Bank had $8.9 million and $12.0
million, respectively, of outstanding borrowings pursuant to securities sold
under agreement to repurchase transactions (Repo Accounts), with maturities of
one day. The Repo Accounts are long-term commercial checking accounts with
average balances that typically exceed $100,000.
The Bank has a credit line in the amount of $56.5 million at the
Federal Home Loan Bank of Atlanta. This line may be utilized for short and/or
long-term borrowing. The Bank has utilized the credit line for overnight funding
throughout 2002 with an average balance of $3.1 million.
At December 31, 2002, cash, interest-bearing deposits with financial
institutions, federal funds sold, short-term investments, securities available
for sale, loans and securities maturing within one year were 51.3% of total
deposits and liabilities.
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.
Recent Accounting Pronouncements
In December, 2001, the American Institute of Certified Public
Accountants ("AICPA") issued Statement of Position 01-6, Accounting by Certain
Entities (Including Entities with Trade Receivables) That Lend to or Finance the
Activities of Others, to reconcile and conform the accounting and financial
reporting provisions established by various AICPA industry audit guides. This
Statement is effective for annual and interim financial statements issued for
fiscal years beginning after December 15, 2001, and did not have a material
impact on the Company's consolidated financial statements.
On March 13, 2002, the Financial Accounting Standard Board determined
that commitments for the origination of mortgage loans that will be held for
sale must be accounted for as derivatives instruments, effective for fiscal
quarters beginning after April 10, 2002. The Bank enters into commitments to
originate loans whereby the interest rate on the loan is determined prior to
funding. Such rate lock commitments on mortgage loans to be sold in the
secondary market are considered derivatives. Accordingly, these commitments
including any fees received from the potential borrower are recorded at fair
value in derivative assets or liabilities, with changes in fair value recorded
in the net gain or loss on sale of mortgage loans. Fair value is based on fees
currently charged to enter into similar agreements, and for fixed-rate
commitments also considers the difference between current levels of interest
rates and the committed rates. The cumulative effect of adopting Statement No.
133 for rate lock commitments as of December 31, 2002, was not material. The
Company originally adopted Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities on January 1, 2001.
-34-
In April 2002, the Financial Accounting Standards Board issued
Statement 145, Rescission of FASB No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections. The amendment to Statement 13 eliminates an
inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. This Statement also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. The provisions of this Statement related to the rescission of
Statement 4 shall be applied in fiscal years beginning after May 15, 2002. The
provisions of this Statement related to Statement 13 are effective for
transactions occurring after May 15, 2002, with early application encouraged.
In June 2002, the Financial Accounting Standards Board issued Statement
146, Accounting for Costs Associated with Exit or Disposal Activities. This
Statement requires recognition of a liability, when incurred, for costs
associated with an exit or disposal activity. The liability should be measured
at fair value. The provisions of the Statement are effective for exit or
disposal activities initiated after December 31, 2002.
Effective January 1, 2002, the Corporation adopted Financial Accounting
Standards Board Statement No. 142, Goodwill and Other Intangible Assets.
Accordingly, goodwill is no longer subject to amortization over its estimated
useful life, but is subject to at least an annual assessment for impairment by
applying a fair value based test. Additionally, Statement 142 requires that
acquired intangible assets (such as core deposit intangibles) be separately
recognized if the benefit of the asset can be sold, transferred, licensed,
rented, or exchanged, and amortized over their estimated useful life. Branch
acquisition transactions were outside the scope of the Statement and therefore
any intangible asset arising from such transactions remained subject to
amortization over their estimated useful life.
In October 2002, the Financial Accounting Standards Board issued
Statement No. 147, Acquisitions of Certain Financial Institutions. The Statement
amends previous interpretive guidance on the application of the purchase method
of accounting to acquisitions of financial institutions, and requires the
application of Statement No. 141, Business Combinations, and Statement No. 142
to branch acquisitions if such transactions meet the definition of a business
combination. The provisions of the Statement do not apply to transactions
between two or more mutual enterprises. In addition, the Statement amends
Statement No. 144, Accounting for the Impairment of Long-Lived Assets, to
include in its scope core deposit intangibles of financial institutions.
Accordingly, such intangibles are subject to a recoverability test based on
undiscounted cash flows, and to the impairment recognition and measurement
provisions required for other long-lived assets held and used.
The adoption of Statement Nos. 142, 145, 146 and 147 did not have a
material impact on the Company's consolidated financial statements.
The Financial Accounting Standards Board issued Statement No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure, an
amendment of Statement No. 123, in December 2002. The Statement amends Statement
No. 123 to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, the Statement amends the disclosure requirements of Statement 123
to require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. Finally, this Statement amends
APB Opinion No. 28, Interim Financial Reporting, to require disclosure about the
effects of stock options in interim financial information. The amendments to
Statement No. 123 are effective for financial statements for fiscal years ending
after December 15, 2002. The amendments to APB No. 28 are effective for
financial reports containing condensed financial statements for interim
-35-
periods beginning after December 15, 2002. Early application is encouraged for
both amendments. The Company continues to record stock options under APB Opinion
No. 25, Accounting for Stock Issued to Employees, and has not adopted the
alternative methods allowable under Statement No. 148.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET 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. MFC's primary
market risk exposure is interest rate risk, though it should be noted that the
assets under management by Tredegar are affected by equity price risk. The
ongoing monitoring and management of this risk is an important component of
MFC'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 Bank. In
this capacity, ALCO develops guidelines and strategies that govern MFC'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 MFC's financial instruments also change, affecting net
interest income, the primary component of MFC'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 MFC'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. Given
the current historic low in interest rates for the fiscal year 2002, the model
assumed only a 100 bp decrease in interest rates. The following reflects the
range of MFC's net interest income sensitivity analysis during the fiscal years
of 2002 and 2001 as compared to the 10% Board-approved policy limit.
2002
Rate Change Estimated Net Interest Income Sensitivity
----------- -----------------------------------------
High Low Average
+ 200 bp (2.51%) (1.00%) (1.75%)
- 100 bp 2.62% .63% 1.33%
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%
-36-
At the end of 2002, MFC's interest rate risk model indicated that in a
rising rate environment of 200 basis points over a 12 month period net interest
income could decrease by 1.75% on average. For the same time period the interest
rate risk model indicated that in a declining rate environment of 100 basis
points over a 12 month period net interest income could increase by 1.33% on
average. While these numbers are subjective based upon the parameters used
within the model, management believes the balance sheet is very balanced with
little risk to rising rates in the future.
During 2001, MFC 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, MFC has had minimal interest rate risks to either falling or rising
interest rates over the past two years. MFC 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, MFC could expect a positive impact to
net interest income of $386,000 over the next 12 months.
During May 2000, MFC 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.
MFC 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 December 31, 2001. The original term was 24
months and matured in May 2002. The weighted-average fixed payment rate was 7.0%
throughout the term. Variable interest payments received were based on
three-month LIBOR 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 $170,000 for
the year ended December 31, 2002.
The preceding sensitivity analysis does not represent an MFC 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 including 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, MFC 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.
-37-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are filed as a part of this report
following Item 15 below:
Independent Auditor's Report
Consolidated Balance Sheets as of December 31, 2002 and 2001
Consolidated Statements of Income for the Years Ended December 31,
2002, 2001, and 2000
Consolidated Statements of Changes in Shareholders' Equity for
the Years Ended December 31, 2002, 2001,and 2000
Consolidated Statements of Cash Flows for the Years Ended December 31,
2002, 2001, and 2000
Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on
accounting and financial disclosure during the last two fiscal years.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
Pursuant to General Instruction G(3) of Form 10-K, the information
contained under the headings "Nominees for Election for Terms Expiring in 2004,"
"Executive Officers Who Are Not Directors" and "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's Proxy Statement for the 2003
Annual Meeting of Shareholders is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Pursuant to General Instruction G(3) of Form 10-K, the information
contained under the headings "Director Compensation," "Compensation Committee
Interlocks and Insider Participation," "Executive Compensation," "Stock Options"
and "Employment Agreements" in the Company's Proxy Statement for the 2003 Annual
Meeting of Shareholders is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Security Ownership. Pursuant to General Instruction G(3) of Form 10-K,
the information contained under the headings "Security Ownership of Management"
and "Security Ownership of Certain Beneficial Owners" in the Company's Proxy
Statement for the 2003 Annual Meeting of Shareholders is incorporated herein by
reference.
-38-
Equity Compensation Plan Information. The following table sets forth
information as of December 31, 2002, with respect to compensation plans under
which shares of the Company's Common Stock are authorized for issuance.
Number of Securities
Number of Securities to Be Weighted Average Remaining Available
Issued upon Exercise of Exercise Price of for Future Issuance
Outstanding Options, Outstanding Options, Under Equity
Plan Category Warrants and Rights Warrants and Rights Compensation Plans (1)
------------------- ------------------- ----------------------
Equity Compensation Plans
Approved by Shareholders
1997 Incentive Stock 91,375 $29.80 35,633
Option Plan
Equity Compensation Plans Not
Approved by
Shareholders(2) -- -- --
Total 91,375 $29.80 35,633
- ---------
(1) Amounts exclude any securities to be issued upon exercise of outstanding
options, warrants and rights.
(2) The Company does not have any equity compensation plans that have not been
approved by shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to General Instruction G(3) of Form 10-K, the information
contained under the heading "Transactions with Management" in the Company's
Proxy Statement for the 2003 Annual Meeting of Shareholders is incorporated
herein by reference.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Rule 13a-14 under the
Securities Exchange Act of 1934, as amended. Based upon that evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective in timely alerting
them to material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's periodic filings with the
Securities and Exchange Commission. There have been no significant changes in
the Company's internal controls or in other factors that could significantly
affect internal controls subsequent to the date that the Company carried out its
evaluation.
In September 2002, the Company completed an upgrade conversion of its
core operating software that had commenced in early 2002. The core operating
software primarily provides customer accounting for deposit and loan
relationships. In addition, the system will serve as a record-keeping tool for
general ledger and accounts payable. The new system provides enhanced
capabilities for the management of the Company's customer relationships. As with
any system-related change, internal processes may need to change or adapt to
retain efficiency. As part of its evaluation of its disclosure controls and
procedures,
-39-
management continues to evaluate, document and monitor any changes to internal
controls as a result of the core operating software conversion.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) and (2). The response to this portion of Item 15 is submitted as
a separate section of
this report.
(3). Exhibits:
3.1 Articles of Incorporation of the Company (restated in electronic
format).
3.2 Bylaws of the Company, attached as Exhibit 3.2 to the
Registration Statement on Form S-4, Registration No. 333-24523,
filed with the Commission on April 4, 1997, incorporated herein
by reference.
10.1 Employment Agreement, dated as of January 1, 1998, between the
Company and Joseph L. Boling, attached as Exhibit 10.1 to the
Company's Annual Report on Form 10-KSB for the year ended
December 31, 1998, incorporated herein by reference.
10.2 Independent Community Bankshares, Inc. 1997 Stock Option Plan, as
amended, attached as Exhibit 4.3 to the Registration Statement on
Form S-8, Registration No. 333-93447, filed with the Commission
on December 22, 1999, incorporated herein by reference.
10.3 Agreement and Plan of Reorganization dated as of August 9, 1999,
between Gilkison Patterson Investment Advisors, Inc. ("GPIA"),
the Company and Tredegar, attached as Exhibit 10.1 to the
Company's Quarterly Report on Form 10-QSB for the period ended
September 30, 1999 (the "Form 10-QSB"), incorporated herein by
reference.
10.4 Shareholder Agreement dated as of August 9, 1999, between Robert
C. Gilkison, James H. Patterson, the Company and GPIA, attached
as Exhibit 10.2 to the Form 10-QSB, incorporated herein by
reference.
10.5 Stock Purchase Agreement dated as of August 9, 1999, between
Robert C. Gilkison, James H. Patterson and the Company, attached
as Exhibit 10.3 to the Form 10-QSB, incorporated herein by
reference.
10.6 Employment Agreement, dated as of August 9, 1999, between GPIA
and James H. Patterson.
21 Subsidiaries of the Company.
23.1 Consent of Yount, Hyde & Barbour, P.C.
-40-
99.1 Statement of Chief Executive Officer Pursuant to 18
U.S.C.ss.1350.
99.2 Statement of Chief Financial Officer Pursuant to 18
U.S.C.ss.1350.
(All exhibits not incorporated herein by reference are attached as
exhibits to the Company's Annual Report on Form 10-K for the year
ended December 31, 2002, as filed with the Securities and Exchange
Commission.)
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the last
quarter of the period covered by this report.
(c) Exhibits
The response to this portion of Item 15 as listed in Item 15(a)(3)
above is submitted as a separate section of this report.
(d) Financial Statement Schedules
The response to this portion of Item 15 is submitted as a separate
section of this report.
-41-
MIDDLEBURG FINANCIAL CORPORATION
Middleburg, Virginia
FINANCIAL REPORT
DECEMBER 31, 2002
C O N T E N T S
Page
INDEPENDENT AUDITOR'S REPORT ON THE
CONSOLIDATED FINANCIAL STATEMENTS 1
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated balance sheets 2
Consolidated statements of income 3
Consolidated statements of changes in shareholders' equity 4
Consolidated statements of cash flows 5 and 6
Notes to consolidated financial statements 7-31
[LETTERHEAD OF YOUNT, HYDE & BARBOUR, P.C.]
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Middleburg Financial Corporation
Middleburg, Virginia
We have audited the accompanying consolidated balance sheets of
Middleburg Financial Corporation and subsidiaries as of December 31, 2002 and
2001, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for the years ended December 31, 2002, 2001
and 2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Middleburg Financial Corporation and subsidiaries as of December 31, 2002 and
2001, and the results of their operations and their cash flows for the years
ended December 31, 2002, 2001 and 2000, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Yount, Hyde & Barbour, P.C.
Winchester, Virginia
January 17, 2003
1
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Balance Sheets
December 31, 2002 and 2001
(In Thousands, Except for Share Data)
Assets 2002 2001
--------- ---------
Cash and due from banks $ 8,338 $ 10,053
Interest-bearing deposits in banks 274 200
Temporary investments:
Federal funds sold - - 925
Other money market investments 911 1,797
Securities (fair value: 2002, $163,957; 2001, $124,522) 163,673 124,351
Loans held for sale 17,489 6,652
Loans, net of allowance for loan losses of $2,307 in 2002
and $2,060 in 2001 209,800 194,340
Bank premises and equipment, net 11,814 8,069
Accrued interest receivable and other assets 12,675 7,714
--------- ---------
Total assets $ 424,974 $ 354,101
========= =========
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Noninterest-bearing demand deposits $ 90,413 $ 68,771
Savings and interest-bearing demand deposits 138,661 111,148
Time deposits 99,829 91,812
--------- ---------
Total deposits $ 328,903 $ 271,731
Securities sold under agreements to repurchase 8,924 12,011
Federal Home Loan Bank advances - - 7,000
Long-term debt 31,545 20,805
Trust preferred capital notes 10,000 10,000
Accrued interest and other liabilities 4,192 2,216
Commitments and contingent liabilities - - - -
--------- ---------
Total liabilities $ 383,564 $ 323,763
--------- ---------
Shareholders' Equity
Common stock, par value $5 per share, authorized
10,000,000 shares; issued 2002, 1,852,682 shares;
issued 2001, 1,752,258 shares $ 9,263 $ 8,761
Capital surplus 3,644 741
Retained earnings 25,184 21,084
Accumulated other comprehensive income (loss) 3,319 (248)
--------- ---------
Total shareholders' equity $ 41,410 $ 30,338
--------- ---------
Total liabilities and shareholders' equity $ 424,974 $ 354,101
========= =========
See Notes to Consolidated Financial Statements.
2
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Income
Years Ended December 31, 2002, 2001 and 2000
(In Thousands, Except for Per Share Data)
2002 2001 2000
---- ---- ----
Interest and Dividend Income
Interest and fees on loans $ 16,178 $ 16,327 $ 14,076
Interest on investment securities:
Taxable interest income 3 19 25
Interest income exempt from federal income taxes 241 297 354
Interest and dividends on securities available for sale:
Taxable interest income 5,365 3,102 3,055
Interest income exempt from federal income taxes 1,568 1,607 1,167
Dividends 277 281 318
Interest on deposits in banks 5 9 4
Interest on federal funds sold 82 117 170
Interest on other money market investments 39 63 40
-------- -------- --------
Total interest and dividend income $ 23,758 $ 21,822 $ 19,209
-------- -------- --------
Interest Expense
Interest on deposits $ 4,221 $ 5,841 $ 5,324
Interest on securities sold under agreements to repurchase 181 415 633
Interest on Federal Home Loan Bank borrowings 115 482 584
Interest on long-term debt 2,007 1,076 500
-------- -------- --------
Total interest expense $ 6,524 $ 7,814 $ 7,041
-------- -------- --------
Net interest income $ 17,234 $ 14,008 $ 12,168
Provision for loan losses 300 300 400
-------- -------- --------
Net interest income after provision
for loan losses $ 16,934 $ 13,708 $ 11,768
-------- -------- --------
Noninterest Income
Service charges, commissions and fees $ 1,960 $ 1,452 $ 1,180
Trust and investment advisory fee income 2,725 1,279 1,594
Fees on loans held for sale 1,935 1,483 643
Gains (losses) on securities available for sale, net (73) 384 (204)
Commissions on investment sales 611 485 116
Other 81 128 136
-------- -------- --------
Total noninterest income $ 7,239 $ 5,211 $ 3,465
-------- -------- --------
Noninterest Expenses
Salaries and employees' benefits $ 9,383 $ 7,180 $ 5,600
Net occupancy and equipment expense 1,851 1,246 1,172
Advertising 414 320 347
Computer operations 539 408 298
Other operating expenses 3,339 2,793 2,138
-------- -------- --------
Total noninterest expenses $ 15,526 $ 11,947 $ 9,555
-------- -------- --------
Income before income taxes $ 8,647 $ 6,972 $ 5,678
Income tax expense 2,335 1,755 1,450
-------- -------- --------
Net income $ 6,312 $ 5,217 $ 4,228
======== ======== ========
Earnings per Share, basic $ 3.47 $ 2.99 $ 2.43
======== ======== ========
Earnings per Share, diluted $ 3.39 $ 2.93 $ 2.41
======== ======== ========
See Notes to Consolidated Financial Statements.
3
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Changes in Shareholders' Equity
Years Ended December 31, 2002, 2001 and 2000
(In Thousands, Except Share Data)
Accumulated
Other
Compre- Compre-
Common Capital Retained hensive hensive
Stock Surplus Earnings Income (Loss) Income Total
----- ------- -------- ------------- ------ -----
Balance, December 31, 1999 $ 8,895 $ 1,293 $ 14,852 $ (1,965) $ 23,075
Comprehensive income:
Net income - 2000 - - - - 4,228 - - $ 4,228 4,228
Other comprehensive income net of tax:
Unrealized holding gains arising during the
period (net of tax, $1,150) - - - - - - - - 2,233 - -
Reclassification adjustment (net of tax, $69) - - - - - - - - 135 - -
--------
Other comprehensive income (net of tax, $1,219) - - - - - - 2,368 $ 2,368 2,368
--------
Total comprehensive income - - - - - - - - $ 6,596 - -
========
Cash dividends - 2000 ($0.84 per share) - - - - (1,464) - - (1,464)
Purchase of common stock (57,785 shares) (289) (1,038) - - - - (1,327)
Issuance of common stock (18,038 shares) 90 301 - - - - 391
------- -------- -------- -------- -------- --------
Balance, December 31, 2000 $ 8,696 $ 556 $ 17,616 $ 403 $ 27,271
Comprehensive income:
Net income - 2001 - - - - 5,217 - - $ 5,217 5,217
Other comprehensive income net of tax:
Unrealized holding losses arising during the
period (net of tax, $204) - - - - - - - - (398) - -
Reclassification adjustment (net of tax, $131) - - - - - - - - (253) - -
--------
Other comprehensive income (net of tax, $335) - - - - - - (651) $ (651) (651)
--------
Total comprehensive income - - - - - - - - $ 4,566 - -
========
Cash dividends - 2001 ($1.00 per share) - - - - (1,749) - - (1,749)
Purchase of common stock (7,131 shares) (36) (178) - - - - (214)
Issuance of common stock (20,142 shares) 101 363 - - - - 464
--- ---- -------- -------- -------- -------- --------
Balance, December 31, 2001 $ 8,761 $ 741 $ 21,084 $ (248) $ 30,338
Comprehensive income:
Net income - 2002 - - - - 6,312 - - $ 6,312 6,312
Other comprehensive income net of tax:
Unrealized holding gains arising during the
period (net of tax, $1,813) - - - - - - - - 3,519 - -
Reclassification adjustment (net of tax, $25) - - - - - - - - 48 - -
--------
Other comprehensive income (net of tax, $1,704) - - - - - - 3,567 $ 3,567 3,567
--------
Total comprehensive income - - - - - - - - $ 9,879 - -
========
Cash dividends - 2002 ($1.20 per share) - - - - (2,212) - - (2,212)
Issuance of common stock (100,424 shares) 502 2,903 - - - - 3,405
-------- -------- -------- -------- --------
Balance, December 31, 2002 $ 9,263 $ 3,644 $ 25,184 $ 3,319 $ 41,410
======== ======== ======== ======== ========
See Notes to Consolidated Financial Statements.
4
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
Years Ended December 31, 2002, 2001 and 2000
(In Thousands)
2002 2001 2000
---------- --------- ---------
Cash Flows from Operating Activities
Net income $ 6,312 $ 5,217 $ 4,228
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation 953 692 645
Amortization 313 96 64
Provision for loan losses 300 300 400
Net (gain) loss on securities available for sale 73 (384) 204
Net (gain) loss on sale of assets (3) 2 (7)
Net loss on the sale of other real estate - - - - - -
Discount accretion and premium amortization
on securities, net (57) (110) (20)
Deferred income tax provision (benefit) 193 (95) (180)
Origination of loans held for sale (121,862) (93,229) (34,837)
Proceeds from sales of loans held for sale 111,025 88,708 33,938
Changes in assets and liabilities:
(Increase) in other assets (937) (917) (1,058)
Increase in other liabilities 235 211 846
---------- --------- ---------
Net cash provided by operating activities $ (3,455) $ 491 $ 4,223
---------- --------- ---------
Cash Flows from Investing Activities
Proceeds from maturity, principal paydowns
and calls of investment securities $ 897 $ 2,032 $ 772
Proceeds from maturity, principal paydowns
and calls of securities available for sale 24,839 9,070 4,527
Proceeds from sale of securities
available for sale 21,901 24,050 16,581
Purchase of securities available for sale (81,576) (78,415) (32,316)
Proceeds from sale of equipment 31 34 7
Purchases of bank premises and equipment (4,726) (2,448) (709)
Net (increase) in loans (16,760) (18,846) (34,412)
Purchase of subsidiary (1,240) - - - -
---------- --------- ---------
Net cash (used in) investing activities $ (56,634) $ (64,523) $ (45,550)
---------- ---------- ----------
See Notes to Consolidated Financial Statements.
5
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(Continued)
Years Ended December 31, 2002, 2001 and 2000
(In Thousands)
2002 2001 2000
---------- ---------- ----------
Cash Flows from Financing Activities
Net increase in noninterest-bearing and interest-
bearing demand deposits and savings accounts $ 49,155 $ 33,514 $ 11,147
Net increase in certificates of deposit 8,017 13,577 9,656
Increase (decrease) in securities sold under agreements
to repurchase (3,087) (2,310) 3,510
Proceeds from Federal Home Loan Bank advances 95,000 87,600 35,900
Proceeds from long-term debt 11,000 - - 1,300
Proceeds from trust preferred capital notes - - 10,000 - -
Payments on Federal Home Loan Bank advances (102,000) (80,600) - -
Payments on long-term debt (260) (495) (20,900)
Purchase of common stock - - (214) (1,327)
Net proceeds from issuance of common stock 906 464 34
Cash dividends paid (2,094) (1,676) (1,402)
---------- --------- ----------
Net cash provided by financing activities $ 56,637 $ 59,860 $ 37,918
---------- --------- ----------
(Decrease) in cash and and cash equivalents $ (3,452) $ (4,172) $ (3,409)
Cash and Cash Equivalents
Beginning 12,975 17,147 20,556
---------- --------- ----------
Ending $ 9,523 $ 12,975 $ 17,147
========== ========= ==========
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest paid to depositors $ 4,772 $ 6,294 $ 5,833
Interest paid on short-term obligations 118 479 445
Interest paid on long-term debt 1,978 1,073 500
---------- --------- ----------
$ 6,868 $ 7,846 $ 6,778
========== ========= ==========
Income taxes $ 2,158 $ 2,375 $ 1,557
========== ========= ==========
Supplemental Disclosure of Noncash Transactions
Issuance of common stock for contingent payment under
terms of acquisition of subsidiary $ 2,500 $ - - $ 357
========== ========= ==========
Unrealized (loss) gain on securities available for sale $ 5,405 $ (986) $ 3,587
========== ========= ==========
Note receivable forgiven in connection with purchase
of subsidiary $ 1,000 $ - - $ - -
========== ========= ==========
Exercise of option to purchase subsidiary $ 1,200 $ - - $ - -
========== ========= ==========
See Notes to Consolidated Financial Statements.
6
MIDDLEBURG FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
Note 1. Nature of Banking Activities and Significant Accounting Policies
Middleburg Financial Corporation's banking subsidiary, The
Middleburg Bank, grants commercial, financial, agricultural,
residential and consumer loans to customers principally in
Loudoun County and Fauquier County, Virginia. The loan portfolio
is well diversified and generally is collateralized by assets of
the customers. The loans are expected to be repaid from cash flow
or proceeds from the sale of selected assets of the borrowers.
The Tredegar Trust Company, a non-banking subsidiary, offers a
comprehensive range of fiduciary and investment management
services to individuals and businesses.
The accounting and reporting policies of the Company conform to
accounting principles generally accepted in the United States of
America and to accepted practice within the banking industry.
Principles of Consolidation
The consolidated financial statements of Middleburg
Financial Corporation (formerly Independent Community
Bankshares, Inc.) and its wholly-owned subsidiaries, The
Middleburg Bank, The Tredegar Trust Company, Gilkison
Patterson Investment Advisors, Inc., Middleburg Bank
Service Corporation and ICBI Capital Trust I, include the
accounts of all companies. All material intercompany
balances and transactions have been eliminated in
consolidation.
Securities
Investments are accounted for as follows:
a. Securities Held to Maturity
Securities classified as held to maturity are those
debt securities the Company has both the intent and
ability to hold to maturity regardless of changes in
market conditions, liquidity needs or changes in
general economic conditions. These securities are
carried at cost adjusted for amortization of premium
and accretion of discount, computed by the interest
method over their contractual lives.
b. Securities Available for Sale
Securities classified as available for sale are those
debt and equity securities that the Company intends
to hold for an indefinite period of time, but not
necessarily to maturity. Any decision to sell a
security classified as available for sale would be
based on various factors, including significant
movements in interest rates, changes in the maturity
mix of the Company's assets and liabilities,
liquidity needs, regulatory capital considerations,
and other similar factors. Securities available for
sale are carried at fair value. Unrealized gains or
losses are reported as increases or decreases in
shareholders' equity, net of the related deferred tax
effect. Realized gains or losses, determined on the
basis of the cost of specific securities sold, are
included in earnings.
7
Notes to Consolidated Financial Statements
Purchase premiums and discounts are recognized in
interest income using the interest method over the
terms of the securities. Declines in the fair value
of held to maturity and available for sale securities
below their cost that are deemed to be other than
temporary are reflected in earnings as realized
losses. Gains and losses on the sale of securities
are recorded on the trade date and are determined
using the specific identification method.
Loans Held for Sale
Mortgage loans originated and intended for sale in the
secondary market are carried at the lower of cost or
estimated market value in the aggregate. Substantially all
loans originated are held for sale to outside investors.
Loans
The Company's subsidiary bank grants mortgage, commercial
and consumer loans to customers. A substantial portion of
the loan portfolio is represented by mortgage loans
throughout Loudoun County and Fauquier County, Virginia.
The ability of the debtors to honor their contracts is
dependent upon the real estate and general economic
conditions in this area.
Loans that management has the intent and ability to hold
for the foreseeable future or until maturity or pay-off
generally are reported at their outstanding unpaid
principal balances less the allowance for loan losses.
Interest income is accrued on the unpaid principal
balance.
The accrual of interest on mortgage and commercial loans
is discontinued at the time the loan is 90 days delinquent
unless the credit is well-secured and in the process of
collection. Personal loans are typically charged off no
later than 180 days past due. In all cases, loans are
placed on nonaccrual or charged-off at an earlier date if
collection of principal or interest is considered
doubtful.
All interest accrued but not collected for loans that are
placed on nonaccrual or charged off is reversed against
interest income. The interest on these loans is accounted
for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans are returned to
accrual status when all the principal and interest amounts
contractually due are brought current and future payments
are reasonably assured.
Allowance for Loan Losses
The allowance for loan losses is established as losses are
estimated to have occurred through a provision for loan
losses charged to earnings. Loan losses are charged
against the allowance when management believes the
uncollectibility of a loan balance is confirmed.
Subsequent recoveries, if any, are credited to the
allowance.
8
Notes to Consolidated Financial Statements
The allowance for loan losses is evaluated on a regular
basis by management and is based upon management's
periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of
the loan portfolio, adverse situations that may affect the
borrower's ability to repay, estimated value of any
underlying collateral and prevailing economic conditions.
This evaluation is inherently subjective, as it requires
estimates that are susceptible to significant revision as
more information becomes available.
A loan is considered impaired when, based on current
information and events, it is probable that the Company's
subsidiary bank will be unable to collect the scheduled
payments of principal or interest when due according to
the contractual terms of the loan agreement. Factors
considered by management in determining impairment include
payment status, collateral value, and the probability of
collecting scheduled principal and interest payments when
due. Loans that experience insignificant payment delays
and payment shortfalls generally are not classified as
impaired. Management determines the significance of
payment delays and payment shortfalls on a case-by-case
basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the
length of the delay, the reasons for the delay, the
borrower's prior payment record, and the amount of the
shortfall in relation to the principal and interest owed.
Impairment is measured on a loan by loan basis for
commercial and construction loans by either the present
value of expected future cash flows discounted at the
loan's effective interest rate, the loan's obtainable
market price, or the fair value of the collateral if the
loan is collateral dependent.
Large groups of smaller balance homogeneous loans are
collectively evaluated for impairment. Accordingly, the
Company's subsidiary bank does not separately identify
individual consumer and residential loans for impairment
disclosures.
Loan Fees and Costs
Loan origination and commitment fees and direct loan costs
are being recognized as collected and incurred. The use of
this method of recognition does not produce results that
are materially different from results which would have
been produced if such costs and fees were deferred and
amortized as an adjustment of the loan yield over the life
of the related loan.
Bank Premises and Equipment
Bank premises and equipment are stated at cost less
accumulated depreciation. Depreciation of property and
equipment is computed principally on the straight-line
method over the following estimated useful lives:
Years
-------
Buildings and improvements 31.5-39
Furniture and equipment 3-10
9
Notes to Consolidated Financial Statements
Maintenance and repairs of property and equipment are
charged to operations and major improvements are
capitalized. Upon retirement, sale or other disposition of
property and equipment, the cost and accumulated
depreciation are eliminated from the accounts and gain or
loss is included in operations.
Other Real Estate
Real estate acquired by foreclosure is carried at the
lower of cost or fair market value less an allowance for
estimated selling expenses on the future disposition of
the property.
Goodwill
The Company adopted SFAS No. 142, Goodwill and Other
Identifiable Assets, effective January 1, 2002.
Accordingly, goodwill is no longer subject to amortization
over its estimated useful life, but is subject to at least
an annual assessment for impairment by applying a fair
value based test. Additionally, under SFAS 142, acquired
intangible assets (such as customer relationships and non
compete agreements) are separately recognized and
amortized over their useful life.
Income Taxes
Deferred income tax assets and liabilities are determined
using the balance sheet method. Under this method, the net
deferred tax asset or liability is determined based on the
tax effects of the temporary differences between the book
and tax bases of the various balance sheet assets and
liabilities and gives current recognition to changes in
tax rates and laws.
Earnings Per Share
Basic earnings per share represents income available to
common shareholders divided by the weighted-average number
of common shares outstanding during the period. Diluted
earnings per share reflects additional common shares that
would have been outstanding if dilutive potential common
shares had been issued, as well as any adjustment to
income that would result from the assumed issuance.
Potential common shares that may be issued by the Company
relate solely to outstanding stock options, and are
determined using the treasury stock method.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, amounts due from banks,
other temporary investments and federal funds sold.
Generally, federal funds are purchased and sold for
one-day periods.
10
Notes to Consolidated Financial Statements
Use of Estimates
The preparation of financial statements in conformity with
accounting principles generally accepted in the United
States of America requires management to make estimates
and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those
estimates. Material estimates that are particularly
susceptible to significant change in the near term relate
to the determination of the allowance for loan losses,
deferred taxes, goodwill and intangibles.
Advertising Costs
The Company follows the policy of charging the costs of
advertising to expense as incurred.
Comprehensive Income
Accounting principles generally require that recognized
revenue, expenses, gains and losses be included in net
income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on
available for sale securities, are reported as a separate
component of the equity section of the balance sheet, such
items, along with net income are components of
comprehensive income.
Derivative Financial Instruments
As part of the Company's asset/liability management, the
Company uses interest rate swaps to modify interest rate
characteristics of various balance sheet accounts.
Derivatives that are used as part of the asset/liability
management process are linked to specific assets or
liabilities and have high correlation between the contract
and the underlying item being hedged, both at inception
and throughout the hedge period. Swaps are accounted for
on the "accrual" method. Under that method, the interest
component associated with the contract is recognized over
the life of the contract in net interest income.
The Company enters into commitments to originate mortgage
loans whereby the interest rate on the loan is determined
prior to funding (rate lock commitments). Rate lock
commitments on mortgage loans that are intended to be sold
are considered to be derivatives. The period of time
between issuance of a loan commitment and closing and sale
of the loan generally ranges from 60 to 120 days. The
Company protects itself from changes in interest rates
through the use of best efforts forward delivery
commitments, whereby the Company commits to sell a loan at
the time the borrower commits to an interest rate with the
intent that the buyer has assumed interest rate risk on
the loan.
Stock-Based Employee Compensation Plan
At December 31, 2002, the Company had a stock-based
employee compensation plan which is described more fully
in Note 8. The Company accounts for the plan under the
recognition and measurement principles of APB opinion No.
25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based employee compensation cost
is reflected in net income, as all options granted under
those plans had an exercise
11
Notes to Consolidated Financial Statements
price equal to the market value of the underlying common
stock on the date of grant. The following table
illustrates the effect on net income and earnings per
share if the Company had applied the fair value
recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, to stock-based
employee compensation. In determining the pro forma
amounts below, the value of each grant is estimated at the
grant date using the Black-Scholes option-pricing model,
with the following weighted-average assumptions for grants
in 2002 and 2000;dividend rate of 0.22% and 0.20%;
risk-free interest rate of 5.51% and 5.35%; expected lives
of 10 years; and expected price volatility of 18.71% and
17.96%. No options were granted during 2001.
Year Ended December 31,
--------------------------------------
2002 2001 2000
--------- --------- ---------
Net income, as reported $ 6,312 $ 5,217 $ 4,228
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards (289) (223) (317)
--------- --------- ---------
Pro forma net income $ 6,023 $ 4,994 $ 3,911
========= ========= =========
Earnings per share:
Basic - as reported $ 3.47 $ 2.99 $ 2.43
Basic - pro forma 3.31 2.86 2.25
Diluted - as reported 3.39 2.93 2.41
Diluted - pro forma 3.23 2.80 2.23
Note 2. Securities
Amortized costs and fair values of securities being held to
maturity as of December 31, 2002 and 2001 are summarized as
follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
---------- ---------- ---------- ---------
2002
-----------------------------------------------------------
(In Thousands)
Obligations of states and
political subdivisions $ 4,590 $ 28 $ - - $ 4,874
Mortgage-backed securities 53 - - - - 53
---------- ---------- ---------- ---------
$ 4,643 $ 284 $ - - $ 4,927
========== ========== ========== =========
2001
-----------------------------------------------------------
(In Thousands)
Obligations of states and
political subdivisions $ 5,484 $ 17 $ - - $ 5,655
Mortgage-backed securities 61 - - - - 61
---------- ---------- ---------- ---------
$ 5,545 $ 171 $ - - $ 5,716
---------- ---------- ---------- ---------
12
Notes to Consolidated Financial Statements
The amortized cost and fair value of securities being held to
maturity as of December 31, 2002 by contractual maturity are
shown below. Maturities may differ from contractual maturities in
mortgage-backed securities because the mortgages underlying the
securities may be called or repaid without any penalties.
Therefore, these securities are not included in the maturity
categories in the following maturity summary.
Amortized Fair
Cost Value
-------- --------
(In Thousands)
Due in one year or less $ 376 $ 377
Due after one year through five years 2,630 2,780
Due after five years through 10 years 1,584 1,717
Mortgage-backed securities 53 53
-------- --------
$ 4,643 $ 4,927
======== ========
Amortized costs and fair values of securities available for sale
as of December 31, 2002 and 2001, are summarized as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
---------- ---------- ---------- ----------
2002
-------------------------------------------------------
(In Thousands)
U.S. Treasury securities and
obligations of U.S. Government
corporations and agencies $ 4,360 $ 46 $ - - $ 4,406
Obligations of states and
political subdivisions 31,195 1,444 - - 32,639
Mortgage-backed securities 98,877 3,651 (7) 102,521
Corporate preferred 2,221 93 (31) 2,283
Restricted stock 2,324 - - - - 2,324
Other 15,024 204 (371) 14,857
---------- ---------- ---------- ----------
$ 154,001 $ 5,438 $ (409) $ 159,030
========== ========== ========== ==========
13
Notes to Consolidated Financial Statements
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
---------- ---------- ---------- ----------
2001
----------------------------------------------------
(In Thousands)
U.S. Treasury securities and
obligations of U.S. Government
corporations and agencies $ 249 $ 18 $ - - $ 267
Obligations of states and
political subdivisions 33,338 381 (499) 33,220
Mortgage-backed securities 64,206 231 (691) 63,746
Corporate preferred 2,188 25 (28) 2,185
Restricted stock 2,134 - - - - 2,134
Other 17,067 265 (78) 17,254
---------- ---------- ---------- ----------
$ 119,182 $ 920 $ (1,296) $ 118,806
========== ========== ========== ==========
The amortized cost and fair value of securities available for
sale as of December 31, 2002, by contractual maturity are shown
below. Maturities may differ from contractual maturities in
corporate and mortgage-backed securities because the securities
and mortgages underlying the securities may be called or repaid
without any penalties. Therefore, these securities are not
included in the maturity categories in the following maturity
summary.
Amortized Fair
Cost Value
---------- ----------
(In Thousands)
Due in one year or less $ 1,378 $ 1,388
Due after one year through five years 5,416 5,568
Due after five years through 10 years 11,046 11,685
Due after 10 years 17,715 18,404
Mortgage-backed securities 98,877 102,521
Corporate preferred 2,221 2,283
Restricted stock 2,324 2,324
Other 15,024 14,857
---------- ----------
$ 154,001 $ 159,030
========== ==========
Proceeds from sales of securities available for sale during 2002,
2001 and 2000 were $21,900,811 , $24,050,000 and $16,581,000,
respectively. Gross gains of $ 80,419, $533,000 and $23,000 and
gross losses of $153,887, $149,000 and $227,000 were realized on
those sales, respectively.
The carrying value of securities pledged to qualify for fiduciary
powers, to secure public monies as required by law and for other
purposes amounted to $13,559,852 and $27,701,000 at December 31,
2002 and 2001, respectively.
14
Notes to Consolidated Financial Statements
Note 3. Loans, Net
December 31,
--------------------------------------
2002 2001
--------------- ---------------
(In Thousands)
Mortgage loans on real estate:
Construction $ 22,008 $ 24,174
Secured by farmland 482 163
Secured by 1-4 family residential 84,389 89,095
Other real estate loans 73,164 48,074
Loans to farmers (except secured by real estate) 686 632
Commercial loans 19,637 22,361
Loans to individuals for personal expenditures 11,550 11,735
All other loans 191 166
--------------- ---------------
Total loans $ 212,107 $ 196,400
Less: Allowance for loan losses 2,307 2,060
--------------- ---------------
Net loans $ 209,800 $ 194,340
=============== ===============
Note 4. Allowance for Loan Losses
2002 2001 2000
----------- ----------- -----------
(In Thousands)
Balance, beginning $ 2,060 $ 1,804 $ 1,453
Provision charged to operating expense 300 300 400
Recoveries 21 39 47
Loan losses charged to the allowance (74) (83) (96)
----------- ----------- -----------
$ 2,307 $ 2,060 $ 1,804
=========== =========== ===========
There were no loans recognized for impairment under SFAS No. 114
as of December 31, 2002 and 2001. The average recorded investment
in impaired loans during 2000 was $15,000. No interest income on
impaired loans was recognized in 2002, 2001 and 2000.
Nonaccrual loans excluded from impaired loan disclosure under
SFAS No. 114 amounted to $1,063,000 and $79,000 at December 31,
2002 and 2001, respectively. If interest on these loans had been
accrued, such income would have approximated $41,000 and $700 for
2002 and 2001, respectively.
15
Notes to Consolidated Financial Statements
Note 5. Bank Premises and Equipment, Net
Bank premises and equipment consists of the following:
2002 2001
------------ -------------
(In Thousands)
Land $ 2,262 $ 2,022
Banking facilities 7,621 3,907
Furniture, fixtures and equipment 7,279 5,400
Construction in progress and deposits
on equipment 210 1,406
------------ -------------
$ 17,372 $ 12,735
Less accumulated depreciation 5,558 4,666
------------ -------------
$ 11,814 $ 8,069
============ =============
Depreciation expense was $953,000, $692,000, and $645,000 for
the years ended December 31, 2002, 2001 and 2000, respectively.
Note 6. Deposits
The aggregate amount of jumbo time deposits, each with a minimum
denomination of $100,000, was approximately $ 56,636,000 and
$45,679,000 in 2002 and 2001, respectively.
At December 31, 2002, the scheduled maturities of time deposits
(in thousands) are as follows:
2003 57,578
2004 23,852
2005 7,215
2006 4,575
2007 6,418
Thereafter 191
------------
$ 99,829
------------
At December 31, 2002 and 2001, overdraft demand deposits
reclassified to loans totaled $191,000 and $166,000,
respectively.
Note 7. Borrowings
The Company has a $82,690,000 line of credit with the Federal
Home Loan Bank of Atlanta. Advances on the line are secured by
all of the Company's first lien loans on one-to-four unit
single-family dwellings. As of December 31, 2002, the book value
of these loans totaled approximately $67,000,000. The amount of
the available credit is limited to seventy-five percent of
qualifying collateral. Any borrowings in excess of the qualifying
collateral require pledging of additional assets.
16
Notes to Consolidated Financial Statements
The Company's fixed-rate long-term debt with the Federal Home
Loan Bank of $31,000,000 at December 31, 2002 matures through
2012. During 2002 and 2001, the interest rates ranged from 3.83
percent to 6.16 percent and from 4.73 percent to 6.16 percent,
respectively. At December 31, 2002 and 2001, the weighted average
interest rates were 5.13 percent and 5.73 percent, respectively.
At December 31, 2002, the Company had floating-rate long-term
debt with other institutions totaling $ 545,000 and maturing on
March 31, 2003. The floating rate is based on the 30-day LIBOR
plus 115 basis points. The interest rate ranged from 2.53 % to
3.03 % during 2002.
The contractual maturities of the Company's long-term debt are as
follows:
2002
-------------
(In Thousands)
Due in 2003 $ 545
Due in 2004 11,000
Due in 2005 15,000
Due in 2012 5,000
-------------
$ 31,545
The Company has an additional $5,300,000 in lines of credit
available from other institutions at December 31, 2002.
Note 8. Stock Option Plan
The Company sponsors a stock option plan, which provides for the
granting of both incentive and nonqualified stock options. Under
the plan, the Company may grant options to its officers and
employees for up to 190,000 shares of common stock. The exercise
price of each option equals the market price of the Company's
stock on the date of grant. The options vest over the three years
following the date of grant. All options expire ten years from
the grant date.
17
Notes to Consolidated Financial Statements
Options outstanding at December 31, 2002, 2001 and 2000 are
summarized as follows:
2002 2001 2000
------------------- -------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ --------- ------ --------
Outstanding at
beginning of year 104,425 $ 20.76 154,825 $ 21.15 123,825 $ 21.13
Granted 27,500 45.50 - - - - 31,000 21.66
Exercised (40,550) 17.10 (22,442) 20.29 - - - -
Forfeited - - - - (27,958) 23.28 - - - -
------- ------- -------
Outstanding at end
of year 91,375 $ 29.80 104,425 $ 20.76 154,825 $ 21.15
======= ======= =======
Options exercisable
at year end 69,600 $ 25.71 94,425 $ 20.62 116,749 $ 20.69
Weighted average
fair value of options
granted during the
year $ 12.04 $ - - $ 9.20
As of December 31, 2002, options outstanding and exercisable are
summarized as follows:
Weighted
Remaining
Exercise Options Contractual Options
Prices Outstanding Life Exercisable
------------ ----------- ----------- -----------
$ 17.00 2,000 4.9 2,000
23.50 18,000 6.0 18,000
24.50 3,875 6.7 3,875
24.75 20,000 7.0 20,000
21.25 20,000 8.0 17,640
45.50 27,500 9.3 8,085
Note 9. Employee Benefit Plans
The Company has a noncontributory, defined benefit pension plan
covering substantially all full-time employees. The Company funds
pension costs in accordance with the funding provisions of the
Employee Retirement Income Security Act. Information about the
plan follows:
18
Notes to Consolidated Financial Statements
2002 2001 2000
------- ------- -------
(In Thousands)
Change in Benefit Obligation
Benefit obligation, beginning of year $ 2,299 $ 1,862 $ 2,002
Service cost 155 274 215
Interest cost 172 140 150
Plan amendments - - - - (350)
Actuarial loss (gain) (181) 42 (33)
Benefits paid (329) (19) (122)
------- ------- -------
Benefit obligation, end of year $ 2,116 $ 2,299 $ 1,862
------- ------- -------
Change in Plan Assets
Fair value of plan assets, beginning of year $ 1,736 $ 1,894 $ 1,562
Actual return on plan assets (131) (289) 269
Employer contributions 705 151 185
Benefits paid (329) (20) (122)
------- ------- -------
Fair value of plan assets, ending $ 1,981 $ 1,736 $ 1,894
------- ------- -------
Funded status $ (135) $ (563) $ 32
Unrecognized net actuarial loss 1,034 956 463
Unrecognized net obligation at transition (24) (28) (32)
Unrecognized prior service cost (199) (199) (200)
------- ------- -------
Prepaid benefit cost included in other assets $ 676 $ 166 $ 263
======= ======= =======
Components of Net Periodic
Benefit Cost
Service cost $ 155 $ 274 $ 215
Interest cost 172 140 150
Expected return on plan assets (163) (174) (140)
Amortization of prior service cost (1) (1) 17
Amortization of net obligation
at transition (4) (4) (4)
Recognized net actuarial loss 35 14 22
------- ------- -------
Net periodic benefit cost $ 194 $ 249 $ 260
======= ======= =======
Weighted-Average Assumptions
as of December 31
Discount rate 7.25% 7.50% 7.50%
Expected return on plan assets 9.00% 9.00% 9.00%
Rate of compensation increase 5.00% 5.00% 5.00%
19
Notes to Consolidated Financial Statements
A deferred compensation plan was adopted for the President and
Chief Executive Officer. Benefits are to be paid in monthly
installments for 15 years following retirement or death. The
agreement provides that if employment is terminated for reasons
other than death or disability prior to age 65, the amount of
benefits would be reduced. The deferred compensation expense for
2002, 2001 and 2000, based on the present value of the retirement
benefits, was $23,320, $21,794, and $20,368. The plan is
unfunded. However, life insurance has been acquired on the life
of the employees in amounts sufficient to discharge the
obligations.
Note 10. Income Taxes
Net deferred tax assets (liabilities) consist of the following
components as of December 31, 2002 and 2001:
2002 2001
------- -------
(In Thousands)
Deferred tax assets:
Allowance for loan losses $ 670 $ 585
Deferred compensation 60 52
Other 25 13
Securities available for sale - - 128
------- -------
$ 755 $ 778
------- -------
Deferred tax liabilities:
Property and equipment $ 423 $ 243
Prepaid pension costs 244 126
Securities available for sale 1,712 - -
------- -------
$ 2,379 $ 369
------- -------
$(1,624 ) $ 409
======= =======
The provision for income taxes charged to operations for the
years ended December 31, 2002, 2001 and 2000 consists of the
following:
2002 2001 2000
---- ---- ----
(In Thousands)
Current tax expense $ 2,142 $ 1,850 $ 1,630
Deferred tax provision (benefit) 193 (95) (180)
------- ------- -------
$ 2,335 $ 1,755 $ 1,450
======= ======= =======
20
Notes to Consolidated Financial Statements
The income tax provision differs from the amount of income tax
determined by applying the U.S. federal income tax rate to pretax
income for the years ended December 31, 2002, 2001 and 2000, due
to the following:
2002 2001 2000
---- ---- ----
(In Thousands)
Computed "expected" tax expense $ 2,940 $ 2,370 $ 1,931
(Decrease) in income taxes
resulting from:
Tax-exempt interest income (594) (578) (466)
Other, net (11) (37) (15)
------- ------- -------
$ 2,335 $ 1,755 $ 1,450
======= ======= =======
Note 11. Related Party Transactions
The Company's subsidiary bank has had, and may be expected to
have in the future, banking transactions in the ordinary course
of business with directors, principal officers, their immediate
families and affiliated companies in which they are principal
stockholders (commonly referred to as related parties), on the
same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with others.
These persons and firms were indebted to the subsidiary bank for
loans totaling $4,211,000 and $2,550,000 at December 31, 2002 and
2001, respectively. During 2002, total principal additions were
$2,854,000 and total principal payments were $1,193,000.
Note 12. Contingent Liabilities and Commitments
In the normal course of business, there are outstanding various
commitments and contingent liabilities, which are not reflected
in the accompanying financial statements. The Company does not
anticipate any material loss as a result of these transactions.
See Note 15 with respect to financial instruments with
off-balance-sheet risk.
The Company must maintain a reserve against its deposits in
accordance with Regulation D of the Federal Reserve Act. For the
final weekly reporting period in the years ended December 31,
2002 and 2001, the aggregate amount of daily average required
reserves for each year was approximately $25,000.
21
Notes to Consolidated Financial Statements
Note 13. Earnings Per Share
The following shows the weighted average number of shares used in
computing earnings per share and the effect on weighted average
number of shares of diluted potential common stock. Potential
dilutive common stock had no effect on income available to common
stockholders.
2002 2001 2000
------------------------ ------------------------ ------------------------
Per Per Per
Share Share Share
Shares Amount Shares Amount Shares Amount
--------- ---------- --------- ---------- --------- ----------
Basic EPS 1,821,000 $ 3.47 1,746,000 $ 2.99 1,741,000 $ 2.43
========== ========== ==========
Effect of dilutive
securities:
Stock options 42,000 37,000 11,000
--------- ---------- ---------
Diluted EPS 1,863,000 $ 3.39 1,783,000 $ 2.93 1,752,000 $ 2.41
========= =========== ========== ========== ========= ==========
In 2002 and 2000, stock options representing 6,875 and 69,825
shares, respectively, were not included in the calculation of
earnings per share because they would have been antidilutive. No
options were excluded from the computation of diluted earnings
per share for the year ended December 31, 2001.
Note 14. Retained Earnings
Transfers of funds from the banking subsidiary to the Parent
Company in the form of loans, advances and cash dividends are
restricted by federal and state regulatory authorities. As of
December 31, 2002, the aggregate amount of unrestricted funds
which could be transferred from the Company's subsidiaries to the
Parent Company, without prior regulatory approval, totaled
$11,010,000 or 27.0 % of the total consolidated net assets.
Note 15. Financial Instruments With Off-Balance-Sheet Risk and Credit Risk
The Company is a party to financial instruments with
off-balance-sheet risk in the normal course of business to meet
the financing needs of its customers and to reduce its own
exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit, standby letters
of credit and interest rate swaps. Those instruments involve, to
varying degrees, elements of credit and interest rate risk in
excess of the amount recognized in the balance sheet. The
contract or notional amounts of those instruments reflect the
extent of involvement the Company has in particular classes of
financial instruments.
The Company's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for
commitments to extend credit and standby letters of credit is
represented by the contractual amount of those instruments. The
Company uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet
instruments.
22
Notes to Consolidated Financial Statements
A summary of the contract amount of the Company's exposure to
off-balance-sheet risk as of December 31, 2002 and 2001, is as
follows:
2002 2001
------------ ------------
(In Thousands)
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit $ 31,590 $ 34,244
Standby letters of credit 1,969 2,343
Commitments to extend credit are agreements to lend to a customer
as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates
or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each
customer's credit worthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation
of the counterparty. Collateral held varies but may include
accounts receivable, inventory, property and equipment, and
income-producing commercial properties.
Unfunded commitments under lines of credit are commitments for
possible future extensions of credit to existing customers. Those
lines of credit may not be drawn upon to the total extent to
which the Company is committed.
Standby letters of credit are conditional commitments issued by
the Company to guarantee the performance of a customer to a third
party. Those guarantees are primarily issued to support public
and private borrowing arrangements, including commercial paper,
bond financing, and similar transactions. The credit risk
involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. The
Company holds certificates of deposit, deposit accounts, and real
estate as collateral supporting those commitments for which
collateral is deemed necessary. The extent of collateral held for
those commitments at December 31, 2002 averages 66.0 percent.
The Company has utilized derivative instruments in the form of
interest rate swaps during the years 2002 and 2001. Interest rate
swaps are contracts in which a series of interest flows in a
single currency are exchanged over a prescribed period. These
transactions involve both credit and market risk. The notional
amounts are amounts on which calculations and payments are based.
The notional amounts are not exchanged and do not represent
direct credit exposure. Direct credit exposure is limited to the
net difference between the calculated amounts to be received and
paid, if any.
23
Notes to Consolidated Financial Statements
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 (interest rate swaps).
The notional principal amount of interest rate swaps outstanding
was $8,525,000 at December 31, 2001 and 2000. The original term
to maturity was 24 months. The weighted-average fixed payment
rate was 7.00% at December 31, 2002 and 2001. Variable interest
payments received are based on three-month LIBOR. At December 31,
2002 and 2001, the weighted average rate of variable
market-indexed interest payment obligations to the Company was
1.56 % and 1.67%, respectively. The effect of these agreements
was to transform fixed rate liabilities to variable rate
liabilities. The net income from these agreements was $ 169,774
and $250,848 for the twelve-month periods ended December 31, 2002
and 2001, which was charged to income as it accrued.
During 2002 and 2001, interest rate swaps used for
other-than-trading purposes modify the interest rate exposure in
the Company's interest-bearing deposits.
The Company has approximately $4,288,237 in deposits in financial
institutions in excess of amounts insured by the Federal Deposit
Insurance Corporation (FDIC) at December 31, 2002.
Note 16. Fair Value of Financial Instruments and Interest Rate Risk
The following methods and assumptions were used to estimate the
fair value of each class of financial instruments for which it is
practicable to estimate that value:
Cash and Short-Term Investments
For those short-term instruments, the carrying amount is a
reasonable estimate of fair value.
Securities
For securities held for investment purposes, fair values are
based on quoted market prices or dealer quotes.
Loans Held for Sale
Fair values of loans held for sale are based on commitments on
hand from investors or prevailing market prices.
Loans
For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on
carrying values. The fair values for other loans were
estimated using discounted cash flow analyses, using interest
rates currently being offered.
Accrued Interest
The carrying amounts of accrued interest approximate fair
values.
24
Notes to Consolidated Financial Statements
Deposits and Borrowings
The fair value of demand deposits, savings accounts, and
certain money market deposits is the amount payable on demand
at the reporting date. For all other deposits and borrowings,
the fair value is determined using the discounted cash flow
method. The discount rate was equal to the rate currently
offered on similar products.
Off-Balance-Sheet Financial Instruments
The fair value of commitments to extend credit is estimated
using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the
agreements and the present credit worthiness of the
counterparties. For fixed-rate loan commitments, fair value
also considers the difference between current levels of
interest rates and the committed rates. The fair value of
standby letters of credit is based on fees currently charged
for similar agreements or on the estimated cost to terminate
them or otherwise settle the obligations with the
counterparties at the reporting date. At December 31, 2002 and
2001, the carrying amounts of loan commitments and standby
letters of credit approximated fair values.
Fair values for off-balance-sheet derivative financial
instruments, for other-than-trading purposes, are based upon
quoted market prices.
The estimated fair values, and related carrying amounts, of
the Company's financial instruments are as follows:
2002 2001
---------------------- ----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
(In Thousands)
Financial assets:
Cash and short-term investments $ 9,523 $ 9,523 $ 12,975 $ 12,975
Securities 163,673 163,957 124,351 124,522
Loans held for sale 17,489 17,533 6,652 6,668
Loans 209,800 212,857 194,340 203,720
Accrued interest receivable 2,051 2,051 1,984 1,984
Financial liabilities:
Deposits $328,903 $330,768 $271,731 $272,864
Securities sold under agreements
to repurchase 8,924 8,924 12,011 12,011
Federal Home Loan Bank advances - - - - 7,000 7,000
Long-term debt 31,545 33,180 20,805 23,136
Trust preferred capital notes 10,000 10,000 10,000 10,000
Accrued interest payable 681 681 819 819
Off-balance-sheet derivative financial
instruments:
Other-than-trading assets:
Interest rate swaps $ - - $ - - $ - - $ 225
25
Notes to Consolidated Financial Statements
The Company assumes interest rate risk (the risk that general
interest rate levels will change) as a result of its normal
operations. As a result, the fair values of the Company's
financial instruments will change when interest rate levels
change and that change may be either favorable or unfavorable
to the Company. Management attempts to match maturities of
assets and liabilities to the extent believed necessary to
minimize interest rate risk. However, borrowers with fixed
rate obligations are less likely to prepay in a rising rate
environment and more likely to prepay in a falling rate
environment. Conversely, depositors who are receiving fixed
rates are more likely to withdraw funds before maturity in a
rising rate environment and less likely to do so in a falling
rate environment. Management monitors rates and maturities of
assets and liabilities and attempts to minimize interest rate
risk by adjusting terms of new loans and deposits and by
investing in securities with terms that mitigate the Company's
overall interest rate risk.
Note 17. Capital Requirements
The Company and the Bank are subject to various regulatory
capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can
initiate certain mandatory - possibly additional discretionary -
actions by regulators that, if undertaken, could have a direct
material effect on the Company's and Bank's financial statements.
Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Company and the Bank must meet
specific capital guidelines that involve quantitative measures of
the Company's and the Bank's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting
practices. The capital amounts and classification are also
subject to qualitative judgments by the regulators about
components, risk weightings, and other factors. Prompt corrective
action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum
amounts and ratios (set forth in the table below) of total and
Tier 1 capital to risk-weighted assets, and of Tier 1 capital to
average assets. Management believes, as of December 31, 2002 and
2001, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of December 31, 2002, the most recent notification from the
Federal Reserve Bank categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To
be categorized as well capitalized, an institution must maintain
minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the table. There are no conditions or
events since that notification that management believes have
changed the institution's category.
26
Notes to Consolidated Financial Statements
The Company's and the Bank's actual capital amounts and ratios
are also presented in the table.
Minimum
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirement Action Provisions
-------------------------- ------------------------- ------------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(In Thousands)
As of December 31, 2002:
Total Capital (to Risk
Weighted Assets):
Consolidated $ 43,496 15.6% $ 22,258 8.0% N/A
The Middleburg Bank $ 39,804 15.6% $ 20,396 8.0% $ 25,495 10.0%
Tier 1 Capital (to Risk
Weighted Assets):
Consolidated $ 41,189 14.8% $ 11,129 4.0% N/A
The Middleburg Bank $ 37,497 14.7% $ 10,198 4.0% $ 15,297 6.0%
Tier 1 Capital (to
Average Assets):
Consolidated $ 41,189 10.6% $ 15,597 4.0% N/A
The Middleburg Bank $ 37,497 9.9% $ 15,154 4.0% $ 18,943 5.0%
As of December 31, 2001:
Total Capital (to Risk
Weighted Assets):
Consolidated $ 41,374 17.3% $ 19,088 8.0% N/A
The Middleburg Bank $ 34,969 15.0% $ 18,675 8.0% $ 23,344 10.0%
Tier 1 Capital (to Risk
Weighted Assets):
Consolidated $ 39,084 16.4% $ 9,544 4.0% N/A
The Middleburg Bank $ 32,909 14.1% $ 9,338 4.0% $ 14,007 6.0%
Tier 1 Capital (to
Average Assets):
Consolidated $ 39,084 12.5% $ 12,542 4.0% N/A
The Middleburg Bank $ 32,909 10.8% $ 12,218 4.0% $ 15,273 5.0%
Note 18. Acquisition
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's 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 included a total purchase price of $6 million,
which included 59,874 shares ($2.5 million value) of the
Company's common stock issued to the shareholders of GPIA. Based
on a purchase price valuation, the Company allocated
approximately 61% of the purchase price to identified intangibles
with a weighted-average life of 12.5 years. The remaining 39% of
the purchase price has been treated as goodwill.
27
Notes to Consolidated Financial Statements
Note 19. Trust Preferred Capital Notes
On November 14, 2001, ICBI Capital Trust I, a wholly-owned
subsidiary of the Company, was formed for the purpose of issuing
redeemable Capital Securities. On November 28, 2001, $10 million
of trust preferred securities were issued through a pooled
underwriting totaling approximately $750 million. The securities
have a LIBOR-indexed floating rate of interest. During 2002, the
interest rates ranged from 5.17% to 5.85%. At December 31, 2002
the weighted-average interest rate was 5.79%. The securities
have a mandatory redemption date of December 8, 2031, and are
subject to varying call provisions beginning December 8, 2006.
The principal asset of the Trust is $10 million of the Company's
junior subordinated debt securities with the like maturities and
like interest rates to the Capital Securities.
The Trust Preferred Securities may be included in Tier 1 capital
for regulatory capital adequacy determination purposes up to 25%
of Tier 1 capital after its inclusion. The portion of the Trust
Preferred not considered as Tier 1 capital may be included in
Tier 2 capital.
The obligations of the Company with respect to the issuance of
the Capital Securities constitute a full and unconditional
guarantee by the Company of the Trust's obligations with respect
to the Capital Securities.
Subject to certain exceptions and limitations, the Company may
elect from time to time to defer interest payments on the junior
subordinated debt securities, which would result in a deferral
of distribution payments on the related Capital Securities.
28
Notes to Consolidated Financial Statements
Note 20. Condensed Financial Information - Parent Corporation Only
MIDDLEBURG FINANCIAL CORPORATION
(Parent Corporation Only)
Balance Sheets
December 31, 2002 and 2001
Assets 2002 2001
-------- --------
(In Thousands)
Cash on deposit with subsidiary bank $ 95 $ 35
Money market fund 556 1,409
Securities available for sale 2,292 2,273
Investment in subsidiaries, at cost, plus
equity in undistributed net income 42,228 33,881
Note receivable - - 1,000
Goodwill 3,422 1,272
Intangible assets 3,481 - -
Other assets 454 1,770
-------- --------
Total assets $ 52,528 $ 41,640
======== ========
Liabilities and Shareholders' Equity
Liabilities
Long-term debt $ 545 $ 805
Trust preferred capital notes 10,000 10,000
Other liabilities 573 497
-------- --------
Total liabilities $ 11,118 $ 11,302
-------- --------
Shareholders' Equity
Common stock $ 9,263 $ 8,761
Capital surplus 3,644 741
Retained earnings 25,184 21,084
Accumulated other comprehensive income (loss) 3,319 (248)
-------- --------
Total shareholders' equity $ 41,410 $ 30,338
-------- --------
Total liabilities and shareholders' equity $ 52,528 $ 41,640
======== ========
29
Notes to Consolidated Financial Statements
MIDDLEBURG FINANCIAL CORPORATION
(Parent Corporation Only)
Statements of Income
Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
------- ------- -------
(In Thousands)
Income
Dividends from subsidiaries $ 2,555 $ 1,795 $ 1,500
Interest and dividends from investments 158 169 224
Interest on money market 14 18 6
Interest from loan to GPIA 16 74 80
Management fees from GPIA 40 78 77
Gains (losses) on securities available
for sale, net (6) 119 (5)
------- ------- -------
Total income $ 2,777 $ 2,253 $ 1,882
------- ------- -------
Expenses
Salaries and employee benefits $ 2 $ 16 $ 123
Amortization 313 96 64
Legal and professional fees 73 63 65
Printing and supplies 51 1 9
Directors fees - - 50 34
Advertising 115 - - - -
Interest expense on loan from subsidiary - - 37 40
Interest expense other 584 114 76
Other 145 145 156
------- ------- -------
Total expenses $ 1,310 $ 66 $ 567
------- ------- -------
Income before allocated tax benefits and
undistributed income of subsidiaries $ 1,467 $ 1,586 $ 1,315
Income tax (benefit) (296) (49) (34)
------- ------- -------
Income before equity in undistributed
income of subsidiaries $ 1,763 $ 1,635 $ 1,349
Equity in undistributed income of subsidiaries 4,549 $ 3,582 $ 2,879
------- ------- -------
Net income $ 6,312 $ 5,217 $ 4,228
======= ======= =======
30
Notes to Consolidated Financial Statements
MIDDLEBURG FINANCIAL CORPORATION
(Parent Corporation Only)
Statements of Cash Flows
Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
------- ------- -------
(In Thousands)
Cash Flows from Operating Activities
Net income $ 6,312 $ 5,217 $ 4,228
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization 313 96 64
Undistributed earnings of subsidiaries (4,549) (3,582) (2,879)
(Gain) loss on sale of securities available for sale 6 (119) 5
(Increase) in other assets (190) (300) (19)
Increase (decrease) in other liabilities (42) (10) 92
------- ------- -------
Net cash provided by operating activities $ 1,850 $ 1,302 $ 1,491
------- ------- -------
Cash Flows from Investing Activities
Purchase of securities available for sale $ (156) $ (162) $- -
Proceeds from sale of securities available for sale 201 503 100
Investment in subsidiary bank - - (8,000) - -
Purchase of subsidiary (1,240) - - - -
------- ------- -------
Net cash provided by (used in) investing activities $(1,195) $(7,659) $ 100
------- ------- -------
Cash Flows from Financing Activities
Proceeds from issuance of trust preferred capital notes $ - - $ 10,000 $ - -
Proceeds from long-term debt - - - - 1,300
Payments on long-term debt (260) (495) - -
Payment of note payable to subsidiary - - (500) - -
Purchase of common stock - - (214) (1,327)
Net proceeds from issuance of common stock 906 464 34
Cash dividends paid (2,094) (1,676) (1,402)
------- ------- -------
Net cash provided by (used in) financing activities $(1,448) $ 7,579 $(1,395)
------- ------- -------
Increase (decrease) in cash and cash equivalents $ (793) $ 1,222 $ 196
Cash and Cash Equivalents
Beginning 1,444 $ 222 $ 26
------- ------- -------
Ending $ 65 $ 1,444 $ 222
======= ======= =======
Supplemental Disclosure of Noncash Transactions
Issuance of common stock for contingent payment
under terms of acquisition of subsidiary $ 2,500 $ - - $ 357
======= ======= =======
Note receivable forgiven in connection with
purchase of subsidiary $ 1,000 $ - - - -
======= ======= =======
Exercise of option to purchase subsidiary $ 1,200 $ - - - -
======= ======= =======
31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
MIDDLEBURG FINANCIAL CORPORATION
Date: March 28, 2003 By: /s/ Joseph L. Boling
--------------------------------------
Joseph L. Boling
Chairman of the Board, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Joseph L. Boling Chairman of the Board, President and Chief March 28, 2003
- ------------------------------------------- Executive Officer and Director
Joseph L. Boling (Principal Executive Officer)
/s/ Alice P. Frazier Executive Vice President and March 28, 2003
- ------------------------------------------- Chief Financial Officer
Alice P. Frazier (Principal Financial Officer)
/s/ Kathleen J. Chappell Senior Vice President and Controller March 28, 2003
- ------------------------------------------- (Principal Accounting Officer)
Kathleen J. Chappell
/s/ Howard M. Armfield Director March 28, 2003
- -------------------------------------------
Howard M. Armfield
/s/ Childs Frick Burden Director March 28, 2003
- -------------------------------------------
Childs Frick Burden
/s/ J. Lynn Cornwell, Jr. Director March 28, 2003
- -------------------------------------------
J. Lynn Cornwell, Jr.
/s/ William F. Curtis Director March 28, 2003
- -------------------------------------------
William F. Curtis
Director March 28, 2003
- -------------------------------------------
Robert C. Gilkison
Director March 28, 2003
- -------------------------------------------
C. Oliver Iselin, III
Director March 28, 2003
- -------------------------------------------
Gary D. LeClair
Director March 28, 2003
- -------------------------------------------
Thomas W. Nalls
/s/ John Sherman Director March 28, 2003
- -------------------------------------------
John Sherman
/s/ Millicent W. West Director March 28, 2003
- -------------------------------------------
Millicent W. West
/s/ Edward T. Wright Director March 28, 2003
- -------------------------------------------
Edward T. Wright
CERTIFICATION
I, Joseph L. Boling, Chairman of the Board, President and Chief Executive
Officer of Middleburg Financial Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Middleburg
Financial Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003 /s/ Joseph L. Boling
-----------------------------------
Joseph L. Boling
Chairman of the Board, President
and Chief Executive Officer
CERTIFICATION
I, Alice P. Frazier, Executive Vice President and Chief Financial Officer
of Middleburg Financial Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Middleburg
Financial Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003 /s/ Alice P. Frazier
--------------------------------------
Alice P. Frazier
Executive Vice President
and Chief Financial Officer
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3.1 Articles of Incorporation of the Company (restated in electronic
format).
3.2 Bylaws of the Company, attached as Exhibit 3.2 to the Registration
Statement on Form S-4, Registration No. 333-24523, filed with the
Commission on April 4, 1997, incorporated herein by reference.
10.1 Employment Agreement, dated as of January 1, 1998, between the Company
and Joseph L. Boling, attached as Exhibit 10.1 to the Company's Annual
Report on Form 10-KSB for the year ended December 31, 1998,
incorporated herein by reference.
10.2 Independent Community Bankshares, Inc. 1997 Stock Option Plan, as
amended, attached as Exhibit 4.3 to the Registration Statement on Form
S-8, Registration No. 333-93447, filed with the Commission on December
22, 1999, incorporated herein by reference.
10.3 Agreement and Plan of Reorganization dated as of August 9, 1999,
between Gilkison Patterson Investment Advisors, Inc. ("GPIA"), the
Company and Tredegar, attached as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-QSB for the period ended September 30, 1999
(the "Form 10-QSB"), incorporated herein by reference.
10.4 Shareholder Agreement dated as of August 9, 1999, between Robert C.
Gilkison, James H. Patterson, the Company and GPIA, attached as Exhibit
10.2 to the Form 10-QSB, incorporated herein by reference.
10.5 Stock Purchase Agreement dated as of August 9, 1999, between Robert C.
Gilkison, James H. Patterson and the Company, attached as Exhibit 10.3
to the Form 10-QSB, incorporated herein by reference.
10.6 Employment Agreement, dated as of August 9, 1999, between GPIA and
James H. Patterson.
21 Subsidiaries of the Company.
23.1 Consent of Yount, Hyde & Barbour, P.C.
99.1 Statement of Chief Executive Officer Pursuant to 18 U.S.C.ss.1350.
99.2 Statement of Chief Financial Officer Pursuant to 18 U.S.C.ss.1350.
(All exhibits not incorporated herein by reference are attached as
exhibits to the Company's Annual Report on Form 10-K for the year
ended December 31, 2002, as filed with the Securities and Exchange
Commission.)