EXHIBIT (13)
PEOPLES BANCORP OF NORTH CAROLINA, INC.
General Description of Business
Peoples Bancorp of North Carolina, Inc. (the "Company"), was formed in 1999
to serve as the holding company for Peoples Bank (the "Bank"). The Company is a
bank holding company registered with the Board of Governors of the Federal
Reserve System (the "Federal Reserve") under the Bank Holding Company Act of
1956, as amended (the "BHCA"). The Company's sole activity consists of owning
the Bank. The Company's principal source of income is any dividends which are
declared and paid by the Bank on its capital stock. The Company has no
operations and conducts no business of its own other than owning the Bank.
Accordingly, the discussion of the business which follows concerns the business
conducted by the Bank, unless otherwise indicated.
The Bank, founded in 1912, is a state-chartered commercial bank serving the
citizens and business interests of the Catawba Valley and surrounding
communities through 13 offices located in Lincolnton, Newton, Denver, Triangle,
Catawba, Conover, Maiden, Claremont, Hiddenite, and Hickory, North Carolina. At
December 31, 2001, the Company had total assets of $619.5 million, net loans of
$484.5 million, deposits of $490.2 million, investment securities of $84.3
million, and shareholders' equity of $45.4 million.
The Bank has a diversified loan portfolio, with no foreign loans and few
agricultural loans. Real estate loans are predominately variable rate commercial
property loans. Commercial loans are spread throughout a variety of industries
with no one particular industry or group of related industries accounting for a
significant portion of the commercial loan portfolio. The majority of the Bank's
deposit and loan customers are individuals and small to medium-sized businesses
located in the Bank's market area.
The operations of the Bank and depository institutions in general are
significantly influenced by general economic conditions and by related monetary
and fiscal policies of depository institution regulatory agencies, including the
Federal Reserve, the Federal Deposit Insurance Corporation (the "FDIC") and the
North Carolina Commissioner of Banks (the "Commissioner").
The Bank is a subsidiary of the Company. The Bank has two subsidiaries,
Peoples Investment Services, Inc. and Real Estate Advisory Services, Inc.
Through a relationship with Raymond James Financial Services, Inc., Peoples
Investment Services, Inc. provides the Bank's customers access to investment
counseling and non-deposit investment products such as stocks, bonds, mutual
funds, tax deferred annuities, and related brokerage services. Real Estate
Advisory Services, Inc., provides real estate appraisal and real estate
brokerage services.
In December, 2001 the Company formed a wholly owned Delaware statutory
trust, PEBK Capital Trust I ("PEBK Trust"), which issued $14 million of
guaranteed preferred beneficial interests in the Company's junior subordinated
deferrable interest debentures that qualify as Tier I capital under Federal
Reserve Board guidelines. All of the common securities of PEBK Trust are owned
by the Company.
This Annual Report contains forward-looking statements. These statements are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those anticipated in the forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
changes in interest rate environment, management's business strategy, national,
regional, and local market conditions and legislative and regulatory conditions.
Readers should not place undue reliance on forward-looking statements, which
reflect management's view only as of the date hereof. The Company undertakes no
obligation to publicly revise these forward-looking statements to reflect
subsequent events or circumstances. Readers should also carefully review the
risk factors described in other documents the Company files from time to time
with the Securities and Exchange Commission.
A-1
SELECTED
FINANCIAL DATA
Dollars in Thousands Except Per Share Amounts
2001 2000 1999 1998 1997
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
SUMMARY OF OPERATIONS
Interest income $ 41,898 40,859 32,302 29,215 23,783
Interest expense 23,027 19,432 14,790 14,540 11,179
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
Net interest income 18,871 21,427 17,512 14,675 12,604
Provision for loan losses 3,545 1,879 425 445 696
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
Net interest income after provision for loan losses 15,326 19,548 17,087 14,230 11,908
Non-interest income 8,263 3,915 3,380 3,646 2,060
Non-interest expense 16,752 15,509 13,832 12,020 10,413
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
Income before taxes 6,837 7,954 6,635 5,856 3,555
Income taxes 2,262 2,576 2,093 1,847 1,149
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
Net income $ 4,575 5,378 4,542 4,009 2,406
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
SELECTED YEAR-END BALANCES
Assets $ 619,505 519,002 432,435 402,273 326,853
Available for sale securities 84,286 71,565 62,498 63,228 53,307
Loans 489,856 407,790 336,959 306,748 238,449
Interest-earning assets 586,496 490,449 411,734 383,270 308,852
Deposits 490,223 450,073 376,634 350,067 275,393
Interest-bearing liabilities 515,989 420,594 339,243 315,387 258,685
Shareholders' equity $ 45,401 43,039 37,998 35,924 24,930
Shares outstanding* 3,218,714 3,218,714 3,218,950 3,219,150 2,808,300
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
SELECTED AVERAGE BALANCES
Assets $ 575,142 469,536 417,387 369,864 295,879
Available for sale securities 84,549 66,218 60,642 59,824 57,508
Loans 454,371 374,226 324,651 271,819 215,789
Interest-earning assets 545,945 447,645 396,606 351,730 281,215
Deposits 481,289 408,210 363,637 321,371 252,998
Interest-bearing liabilities 472,435 373,167 326,164 293,631 233,901
Shareholders' equity $ 47,432 42,852 39,348 33,303 24,117
Shares outstanding* 3,218,714 3,218,714 3,218,950 3,058,160 2,808,300
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
PROFITABILITY RATIOS
Return on average total assets 0.80% 1.15% 1.09% 1.08% 0.81%
Return on average shareholders' equity 9.65% 12.55% 11.54% 12.04% 9.98%
Dividend payout ratio 28.14% 23.39% 23.84% 22.61% 33.18%
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
LIQUIDITY AND CAPITAL RATIOS (AVERAGES)
Loan to deposit 94.41% 91.67% 89.28% 84.58% 85.29%
Shareholders' equity to total assets 8.25% 9.13% 9.43% 9.00% 8.15%
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
PER SHARE OF COMMON STOCK*
Net income $ 1.42 1.67 1.41 1.31 0.86
Cash dividends $ 0.40 0.39 0.34 0.28 0.28
Book value $ 14.11 13.37 11.81 11.16 8.88
- ---------------------------------------------------- --------------- ---------- ---------- ---------- ----------
* Shares outstanding and per share computations have been restated to reflect
a 10% stock dividend during second quarter 2000, the 3 for 2 stock split
during first quarter 1999 and the 10% stock dividend during second quarter
1997.
A-2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INTRODUCTION
Management's discussion and analysis of earnings and related data are
presented to assist in understanding the consolidated financial condition and
results of operations of Peoples Bancorp of North Carolina, Inc. (the
"Company"), for the years ended December 31, 2001, 2000 and 1999. The Company is
a registered bank holding company operating under the supervision of the Federal
Reserve Board and the parent company of Peoples Bank (the "Bank"). The Bank is a
North Carolina-chartered bank, with offices in Catawba, Lincoln and Alexander
Counties, operating under the banking laws of North Carolina and the Rules and
Regulations of the Federal Deposit Insurance Corporation (the "FDIC").
This discussion and related financial data should be read in conjunction
with the audited consolidated financial statements and related footnotes.
RESULTS OF OPERATIONS
SUMMARY
The Company reported earnings of $4.6 million in 2001, or $1.42 basic and
diluted net income per share, a 15% decrease as compared to $5.4 million, or
$1.67 basic and diluted net income per share, for 2000. Net income for 2000
represented an increase of 18% as compared to 1999 net income of $4.5 million.
The decline in net income in 2001 is attributable to a decrease in net interest
income, coupled with charge-offs of certain non-performing loans. The increase
in net income in 2000 compared to 1999 resulted from increased net interest
income combined with an increase in non-interest income and partially offset by
growth in non-interest expense.
Return on average assets in 2001 was 0.80%, compared to 1.15% in 2000 and
1.09% in 1999. Return on average shareholders' equity was 9.65% in 2001 compared
to 12.55% in 2000 and 11.54% in 1999.
NET INTEREST INCOME
Net interest income, the largest component of the Company's income, is the
amount by which interest and fees generated by earning assets exceed the total
cost of funds used to carry them. Net interest income is affected by changes in
the volume and mix of earning assets and interest-bearing liabilities, as well
as changes in the yields earned and rates paid. Net interest margin is
calculated by dividing tax-equivalent net interest income by average earning
assets, and represents the Company's net yield on its earning assets.
Net interest income on a tax-equivalent basis totaled $19.3 million in
2001, a decrease of 12% or $2.6 million from the comparable figure in 2000. The
increase in net interest income on a tax equivalent basis in 2000 over 1999 was
$3.9 million or 22%. The interest rate spread, which represents the rate earned
on interest earning assets less the rate paid on interest-bearing liabilities,
decreased to 2.89% in 2001 from 4.03% in 2000, following an increase from the
1999 net interest spread of 3.74%. The net yield on earning assets decreased to
3.54% in 2001 from 4.90% in 2000, following an increase from the 1999 net
interest margin of 4.54%.
A-3
Table 1 sets forth for each category of earning assets and interest-bearing
liabilities, the average amounts outstanding, the interest incurred on such
amounts and the average rate earned or incurred for the years ended December 31,
2001, 2000 and 1999. The table also sets forth the average rate earned on total
earning assets, the average rate paid on total interest-bearing liabilities, and
the net yield on average total earning assets for the same periods. Yield
information does not give effect to changes in fair value that are reflected as
a component of shareholders' equity. Nonaccrual loans and the interest income
that was recorded on these loans, if any, are included in the yield calculations
for loans in all periods reported.
TABLE 1- AVERAGE BALANCE TABLE
DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 1999
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(Dollars in Thousands) BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
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Earning Assets:
Loans: Net of unearned income $454,371 $ 36,512 8.04% $374,226 $ 36,424 9.73% $324,651 $ 28,375 8.74%
Investments - taxable 61,050 3,919 6.42% 44,320 2,994 6.76% 39,122 2,348 6.00%
Investments - nontaxable 20,080 1,381 6.88% 21,898 1,497 6.84% 21,520 1,475 6.86%
Federal funds sold 3,776 127 3.36% 4,593 282 6.14% 6,780 339 5.00%
Other 6,668 428 6.42% 2,608 171 6.56% 4,533 266 5.87%
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Total earning assets 545,945 42,367 7.76% 447,645 41,368 9.24% 396,606 32,803 8.27%
Cash and due from banks 12,273 11,538 10,667
Other assets 21,703 14,199 14,192
Allowance for loan losses (5,598) (4,281) (4,079)
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Total assets $574,323 $469,101 $417,386
==================================================================================================================================
Interest bearing liabilities:
Deposits:
NOW accounts $ 38,584 $ 413 1.07% $ 32,866 $ 456 1.39% $ 31,003 $ 429 1.38%
Regular savings accounts 22,670 178 0.78% 24,982 472 1.89% 26,258 490 1.87%
Insured money market accounts 65,846 2,373 3.60% 55,982 2,832 5.06% 54,757 2,435 4.45%
Certificates of deposit $100,000 or more 156,034 9,669 6.20% 108,130 6,729 6.22% 83,845 4,475 5.34%
Other time deposits 143,781 8,158 5.67% 133,419 7,838 5.87% 115,786 6,178 5.34%
FHLB borrowings 42,533 2,118 4.98% 15,806 974 6.16% 13,532 736 5.44%
Demand notes payable to U.S. Treasury 897 33 3.64% 852 55 6.46% 899 41 4.56%
Other 2,090 84 4.02% 1,130 76 6.73% 83 5 5.95%
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Total interest bearing liabilities 472,435 23,026 4.87% 373,167 19,432 5.21% 326,163 14,789 4.53%
Demand deposits 54,374 52,831 51,988
Other liabilities 3,486 3,268 2,166
Shareholders' equity 46,093 42,208 39,348
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Total liabilities and shareholder's equity $576,388 $471,474 $419,665
==================================================================================================================================
Net interest spread $ 19,341 2.89% $ 21,936 4.03% $ 18,014 3.74%
==================================================================================================================================
Net yield on earning assets 3.54% 4.90% 4.54%
==================================================================================================================================
Taxable equivalent adjustment
Investment securities 470 509 502
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Net interest income $ 18,871 $ 21,427 $ 17,512
==================================================================================================================================
A-4
Changes in interest income and interest expense can result from variances
in both volume and rates. Table 2 describes the impact on the Company's tax
equivalent net interest income resulting from changes in average balances and
average rates for the periods indicated. The changes in interest due to both
volume and rate have been allocated to volume and rate changes in proportion to
the relationship of the absolute dollar amounts of the changes in each.
TABLE 2 - RATE/VOLUME VARIANCE ANALYSIS
TAX EQUIVALENT BASIS
DECEMBER 31, 2001 DECEMBER 31, 2000
------------------------------------------- -----------------------------------------
CHANGES IN CHANGES IN TOTAL CHANGES IN CHANGES IN TOTAL
IN AVERAGE AVERAGE INCREASE IN AVERAGE AVERAGE INCREASE
(Dollars in Thousands) VOLUME RATES (DECREASE) VOLUME RATES (DECREASE)
- ------------------------------------------------------------------------------------ -----------------------------------------
Interest Income:
Loans: Net of unearned income $ 7,120 ($7,032) $ 88 $ 4,579 $ 3,470 $ 8,049
Investments - taxable 1,103 (178) 925 331 315 646
Investments - nontaxable (125) 9 (116) 26 (4) 22
Federal funds sold (39) (116) (155) (122) 65 (57)
Other 277 (20) 257 (108) 13 (95)
----------- ------------- --------------- ----------- -------------- ------------
Total interest income $ 8,336 ($7,337) $ 999 $ 4,706 $ 3,859 $ 8,565
Interest bearing liabilities:
Deposits:
NOW accounts 70 (113) (43) 26 1 27
Regular savings accounts (31) (263) (294) (24) 6 (18)
Insured money market accounts 427 (886) (459) 58 338 396
Certificates of deposit $100,000 or more 2,975 (35) 2,940 1,404 850 2,254
Other time deposits 598 (278) 320 988 672 1,660
FHLB Borrowings 1,489 (345) 1,144 132 106 238
Demand notes payable to U.S. Treasury 2 (25) (23) (3) 17 14
Other 54 (45) 9 66 6 72
----------- ------------- --------------- ----------- -------------- ------------
Total interest expense $ 5,584 ($1,990) $ 3,594 $ 2,647 $ 1,996 $ 4,642
----------- ------------- --------------- ----------- -------------- ------------
Net interest income $ 2,752 ($5,347) ($2,595) $ 2,059 $ 1,863 $ 3,923
The decrease in net interest income in 2001 was primarily attributable to
declining interest rates during 2001. The yield on earning assets decreased to
7.76% in 2001 from 9.24% in 2000. This decrease reflects a decrease in the
Company's average prime commercial lending rate in 2001, when compared to 2000.
The average balance of earning assets increased by $98.3 million, to $546.0
million in 2001 from $447.6 million in 2000. The increase in average loans
comprised $80.1 million of this increase. Average investments increased $14.9
million or 23% to $81.1 million in 2001 as compared to $66.2 million in 2000.
Average interest-bearing liabilities increased by $99.2 million, to $472.4
million in 2001 from $373.2 million in 2000. This growth in average
interest-bearing liabilities is a direct result of the increase in average
interest-bearing deposits, which increased by $71.5 million, to $426.9 million
in 2001 from $355.4 million in 2000 and an increase in Federal Home Loan Bank
(FHLB) borrowings of $26.7 million to $42.5 million in 2001 from $15.8 million
in 2000. The increase in average interest-bearing deposits was primarily
attributable to the growth in average time deposits, which increased $58.3
million to $299.8 million in 2001 from $241.5 million in 2000. The cost of funds
decreased to 4.87% in 2001 from 5.21% in 2000, mainly as a result of the
decrease in the cost of deposits. The decrease in net interest margin in 2001 is
primarily attributable to a large percentage of the Bank's loan portfolio being
tied to the prime commercial lending rate, which results in loans repricing more
quickly than fixed rate deposits in a falling interest rate environment.
A-5
Tax-equivalent interest income on loans in 2001 increased $88,000 from the
$36.4 million recorded for 2000, following an increase of $8.0 million or 28% in
2000 over 1999. The decrease in the net interest spread to 2.89% in 2001 from
4.03% in 2000 resulted from the decrease in the yield on earning assets to 7.76%
in 2001 from 9.24% in 2000, partially offset by a decrease in the cost of funds
to 4.87% in 2001 from 5.21% in 2000.
Interest expense on FHLB borrowings totaled $2.1 million during 2001 at an
average rate of 4.98% compared to $974,000 in 2000 at an average rate of 6.16%,
and $736,000 in 1999 at an average rate of 5.44%. Interest expense on federal
funds purchased, promissory notes and demand notes payable to the U.S. Treasury
totaled $117,000, $131,000 and $46,000 for 2001, 2000 and 1999, respectively.
PROVISION FOR LOAN LOSSES
Provisions for loan losses are charged to income in order to bring the
total allowance for loan losses to a level deemed appropriate by management of
the Company based on such factors as management's judgment as to losses within
the Company's loan portfolio, including the valuation of impaired loans in
accordance with Statement of Financial Accounting Standards (SFAS) no. 114 and
118, loan growth, net charge-offs, changes in the composition of the loan
portfolio, delinquencies and management's assessment of the quality of the loan
portfolio and general economic climate.
The provision for loan losses was $3.5 million, $1.9 million, and $425,000
for the years ended December 31, 2001, 2000 and 1999, respectively. The increase
in the provision for loan losses reflects management's decision to accelerate
the Bank's contribution to the allowance for loan losses due to declining
economic conditions, nationally and locally. Please see the section below
entitled "Allowance for Loan Losses." The ratio of net charge-offs to average
loans was 0.48% in 2001, 0.29% in 2000 and 0.20% in 1999. Net charge-offs for
2001 were $2.2 million. The ratio of non-performing loans to total loans was
0.90% at December 31, 2001, as compared to 1.45% and 1.03% at December 31, 2000
and 1999, respectively.
NON-INTEREST INCOME
Non-interest income for 2001 totaled $8.3 million, an increase of $4.4
million or 113% from non-interest income of $3.9 million for 2000. The increase
in non-interest income for 2001 resulted from fees arising from a new service
provided to retail checking customers, gains recorded on the sale of available
for sale securities, and a strong demand of mortgage loan services.
Non-interest income for 2000 increased $536,000 or 16% over non-interest income
of $3.4 million for 1999 primarily due to an increase in service charges, fees
and miscellaneous other income.
Service charge income increased $1.2 million, or 77% from 2000 to 2001, as
a result of growth in the deposit base coupled with fees arising from a new
product designed to automatically advance funds to assist in the event of
checking account overdrafts as well as an increase in account maintenance fees.
Increases in non-interest income for 2000 were attributable to an increase in
deposit volume and associated charges. Service charge income increased $262,000,
or 20% in 2000 compared to 1999.
The Company reported a net gain on sale of securities of $1.6 million in
2001, compared to a net loss on sale of securities of $483,000 during 2000 as
the Company sold $83.0 million of available for sale securities. During 1999 a
loss on sale of securities of approximately $35,000 was recognized.
Mortgage banking income increased to $1.0 million in 2001 from $241,000 in
2000 due to a strong demand for mortgage loan services. Mortgage banking income
decreased $499,000, or 67% in 2000 from the $740,000 reported in 1999. The
reduction in mortgage banking income for 2000 included a loss of $284,000
associated with the sale of jumbo mortgage loans.
NON-INTEREST EXPENSE
Total non-interest expense for 2001 amounted to $16.8 million. This was an
8% increase over the $15.5 million reported in 2000, and followed a 12% increase
in 2000 over the $13.8 million reported in 1999.
Salary and employee benefit expense was $9.1 million in 2001, compared to
$8.9 million during 2000, an increase of $216,000 or 2%, following a $1.2
million or 15% increase in salary and employee benefit expense in 2000 over
1999. The increase during 2001 resulted from merit increases. Increases during
2000 reflect merit increases, additional participation in management and
employee incentive plans, and increased staffing levels to support overall
Company growth.
The Company recorded occupancy expense of $3.0 million in 2001, compared to
$2.5 million during 2000, an increase of $474,000 or 20%, following an increase
of $279,000 or 13% in occupancy expenses in 2000 over 1999. The increase in 2001
reflects increased overhead expenses associated with new branches, existing
branch renovations and the Company's new corporate headquarters. Increases in
occupancy expense in 2000 over 1999 were due to the construction of two full
service branches and renovations associated with the Company's new corporate
headquarters.
A-6
The total of all other operating expenses increased $552,000 or 13% during
2001. Other operating expense increased $236,000 or 6% in 2000 over 1999.
INCOME TAXES
Total income tax expense was $2.3 million in 2001 compared with $2.6
million in 2000 and $2.1 million in 1999. The primary reason for the decrease
in taxes was the decrease in pretax income during 2001, following an increase in
taxes related to an increase in pretax income in 2000 over 1999. The Company's
effective tax rates were 33.08%, 32.39% and 31.55% in 2001, 2000 and 1999,
respectively.
LIQUIDITY
The Bank's liquidity position is generally determined by the need to
respond to short term demand for funds created by deposit withdrawals and the
need to provide resources to fund assets, typically in the form of loans. How
the Bank responds to these needs is affected by the Bank's ability to attract
deposits, the maturity of the loans and securities, the flexibility of assets
within the securities portfolio, the current earnings of the Bank, and the
ability to borrow funds from other sources. The Bank's primary sources of
liquidity are cash and cash equivalents, available-for-sale securities, deposit
growth, and the cash flows from principal and interest payments on loans and
other earning assets. In addition, the Bank is able, on a short-term basis, to
borrow funds from the Federal Reserve System, the Federal Home Loan Bank of
Atlanta and The Banker's Bank, and is also able to purchase federal funds from
other financial institutions. At December 31, 2001 the Bank had a line of
credit with the FHLB equal to 20% of the Bank's total assets, with an
outstanding balance of $68.2 million. The Bank also had the ability to borrow
up to $10 million through The Bankers Bank as of December 31, 2001. The
liquidity ratio for the Bank, which is defined as net cash, interest bearing
deposits with banks, Federal Funds sold, certain investment securities and
certain FHLB advances, as a percentage of net deposits (adjusted for deposit
runoff projections) and short-term liabilities was 20.62% at December 31, 2001,
27.03% at December 31, 2000, and 30.26% at December 31, 1999. The December 31,
1999 ratio has been restated to reflect increased borrowing capacity at the
FHLB, which the Bank recognizes as a factor of its liquidity.
As disclosed in the Company's Consolidated Statements of Cash Flows
included elsewhere herein, net cash provided by operating activities was
approximately $3.5 million during 2001. Net cash used in investing activities
of $104.6 million consisted primarily of a net change in loans of $82.1 million
and securities purchased of $118.4 million funded largely by sales, maturities
and paydowns of investment securities of $105.7 million. Net cash provided by
financing activities consisted of a $40.1 million net increase in deposits and a
$51.0 million net increase in FHLB borrowings. Additionally, the Company issued
$14.0 million in trust preferred securities in December 2001.
A-7
ASSET LIABILITY MANAGEMENT
The Company's asset liability management strategies are designed to
minimize interest rate risk between interest-earning assets and interest-bearing
liabilities at various maturities, while maintaining the objective of assuring
adequate liquidity and maximizing net interest income. Table 3 presents an
interest rate sensitivity analysis for the interest earning assets and
interest-bearing liabilities for the year ended December 31, 2001.
TABLE 3 - INTEREST SENSITIVITY ANALYSIS
OVER 5 YEARS
(DOLLARS IN THOUSANDS) IMMEDIATE 1-3 MONTHS 4-12 MONTHS 1 - 5 YEARS & NON-SENSITIVE TOTAL
- ----------------------------------------------------------------------------------------------------------------------------------
INTEREST EARNING ASSETS:
Loans $ 358,729 $ 7,726 $ 18,557 $ 68,372 $ 37,224 $490,608
Mortgage loans available for sale 5,339 0 0 0 0 5,339
Investment securities 4,000 1,638 2,357 4,776 71,515 84,286
Federal funds sold 2,261 0 0 0 0 2,261
Interest bearing deposit account-FHLB 214 0 0 0 0 214
Other earning assets 0 0 0 0 3,788 3,788
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Total interest earning assets $ 370,543 $ 9,364 $ 20,914 $ 73,148 $ 112,527 $586,496
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INTEREST BEARING LIABILITIES:
NOW, savings, and money market deposits $ 145,592 $ 0 $ 0 $ 0 $ 0 $145,592
Certificates of deposit of $100,000 or more 12,087 27,769 106,126 10,052 0 156,034
Other time deposits 18,231 27,913 67,355 18,271 1 131,771
Other short term borrowings 378 0 0 0 0 378
FHLB borrowings 0 5,000 11,000 5,214 47,000 68,214
Trust preferred securities 0 14,000 0 0 0 14,000
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Total interest bearing liabilities $ 176,288 $ 74,682 $ 184,481 $ 33,537 $ 47,001 $515,989
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Interest-sensitive gap 194,255 (65,318) (163,567) 39,611 65,526 70,507
Cumulative interest-sensitive gap 194,255 128,937 (34,630) 4,981 70,507
- ------------------------------------------------------------------------------------------------------------------------
Cumulative interest-sensitive gap
to total earning assets 33.12% 21.98% -5.90% 0.85% 12.02%
Management tries to minimize interest rate risk between interest earning
assets and interest bearing liabilities by attempting to minimize wide
fluctuations in net interest income due to interest rate movements. The ability
to control these fluctuations has a direct impact on the profitability of the
Company. Management monitors this activity on a regular basis through analysis
of its portfolios to determine the difference between rate sensitive assets and
rate sensitive liabilities.
The Company's rate sensitive assets are those earning interest at variable
rates and those maturing within one year. Rate sensitive assets therefore
include both loans and available-for-sale securities. Rate sensitive
liabilities include interest-bearing checking accounts, money market deposit
accounts, savings accounts, certificates of deposit and borrowed funds. At
December 31, 2001, 68% of the Company's interest earning assets, excluding
non-accrual loans could be repriced within one year, compared to 84% of
interest-bearing liabilities. Rate sensitive assets at December 31, 2001
totaled $586.5 million , exceeding rate sensitive liabilities of approximately
$516.0 million by $70.5 million.
An analysis of the Company's financial condition and growth can be made by
examining the changes and trends in interest-earning assets and interest-bearing
liabilities, and a discussion of these changes and trends follows.
A-8
ANALYSIS OF FINANCIAL CONDITION
INVESTMENT SECURITIES
All of the Company's investment securities are held in the
available-for-sale ("AFS") category. At December 31, 2001 the market value of
AFS securities totaled $84.3 million, compared to $71.6 million and $62.5
million at December 31, 2000 and 1999, respectively. Table 4 presents the
market value of the presently held AFS securities for the years ended December
31, 2001, 2000 and 1999.
TABLE 4 - SUMMARY OF INVESTMENT PORTFOLIO
YEAR ENDED YEAR ENDED YEAR ENDED
(DOLLARS IN THOUSANDS) DEC 31, 2001 DEC 31, 2000 DEC 31, 1999
- -------------------------------------------------------------------------------------------------------------
UNITED STATES TREASURY SECURITIES: $ - $ - $ 900
OBLIGATIONS OF UNITED STATES GOVERNMENT
AGENCIES AND CORPORATIONS: $ - $ 25,119 $ 23,374
OBLIGATIONS OF STATES AND POLITICAL SUBDIVISIONS: $ 16,404 $ 22,228 $ 22,012
MORTGAGE BACKED SECURITIES: $ 63,382 $ 24,218 $ 16,212
TRUST PREFERRED SECURITIES: $ 4,500 $ - $ -
TOTAL SECURITIES: $ 84,286 $ 71,565 $ 62,498
The composition of the investment securities portfolio reflects the
Company's investment strategy of maintaining an appropriate level of liquidity
while providing a relatively stable source of income. The investment portfolio
also provides a balance to interest rate risk and credit risk in other
categories of the balance sheet while providing a vehicle for the investment of
available funds, furnishing liquidity, and supplying securities to pledge as
required collateral for certain deposits.
The Company's investment portfolio consists of U.S. government agency
securities, municipal securities and U.S. government agency sponsored
mortgage-backed securities. AFS securities averaged $81.1 million in 2001,
$66.2 million in 2000 and $60.6 million in 1999. Table 5 presents the AFS
securities held by the Company by maturity category at December 31, 2001. Yield
information does not give effect to changes in fair value that are reflected as
a component of shareholders' equity and yields are calculated on a tax
equivalent basis.
TABLE 5 - MATURITY DISTRIBUTION AND WEIGHTED AVERAGE YIELD ON INVESTMENTS
ONE YEAR OR LESS AFTER ONE YEAR AFTER 5 YEARS AFTER 10 YEARS TOTALS
THROUGH 5 YEARS THROUGH 10 YEARS
(DOLLARS IN THOUSANDS) AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- -----------------------------------------------------------------------------------------------------------------------
BOOK VALUE:
States and political subdivisions $ 3,961 7.27% $ 4,624 7.01% $ 3,513 6.37% $ 4,336 7.11% $16,434 6.96%
Mortgage backed securities - - - - - - 64,862 6.35% 64,862 6.35%
Trust Preferred securities - - - - - - 4,500 7.07% 4,500 7.07%
=======================================================================================================================
Total securities $ 3,961 7.27% $ 4,624 7.01% $ 3,513 6.37% $73,698 6.44% $85,796 6.50%
A-9
LOANS
The loan portfolio is the largest category of the Company's earnings assets
and is comprised of commercial loans, real estate mortgage loans, real estate
construction loans and consumer loans. The Company restricts its primary lending
market to within the Catawba Valley region of North Carolina, which encompasses
Catawba, Alexander and Lincoln counties and portions of Iredell and Gaston
counties. The mix of the loan portfolio consists primarily of loans secured by
real estate and commercial loans. In management's opinion, there are no
significant concentrations of credit with particular borrowers engaged in
similar activities.
In the normal course of business, there are various commitments outstanding
to extend credit that are not reflected in the financial statements. At December
31, 2001, outstanding loan commitments totaled $91.8 million. 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 may expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements.
The composition of the Company's loan portfolio is presented in Table 6.
TABLE 6 - LOAN PORTFOLIO
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
(DOLLARS IN THOUSANDS) AMOUNT % OF LOANS AMOUNT % OF LOANS AMOUNT % OF LOANS AMOUNT % OF LOANS
- ---------------------------------------------------------------------------------------------------------------------------------
BREAKDOWN OF LOAN RECEIVABLES:
Commercial, financial & agricultural $102,409 20.87% $ 96,882 23.58% $ 83,644 24.66% $ 89,536 29.68%
Real Estate - Mortgage 277,737 56.61% 229,260 55.79% 190,921 56.29% 157,167 52.11%
Real Estate - Construction 82,791 16.88% 58,939 14.34% 39,340 11.60% 29,927 9.92%
Consumer 27,671 5.64% 25,858 6.29% 25,293 7.46% 24,995 8.29%
------------------------------------------------------------------------------------------
Total loans $490,608 100.00% $410,939 100.00% $339,198 100.00% $301,625 100.00%
Less: Allowance for Loan Losses 6,091 4,713 3,924 4,137
-------- -------- -------- --------
Net Loans $484,517 $406,226 $335,274 $297,488
======== ======== ======== ========
YEAR ENDED
DECEMBER 31, 1997
(DOLLARS IN THOUSANDS) AMOUNT % OF LOANS
- ------------------------------------------------------------
BREAKDOWN OF LOAN RECEIVABLES:
Commercial, financial & agricultural $ 80,230 33.42%
Real Estate - Mortgage 115,768 48.22%
Real Estate - Construction 24,291 10.12%
Consumer 19,793 8.24%
---------------------
Total loans $240,082 100.00%
Less: Allowance for Loan Losses 4,375
--------
Net Loans $235,707
========
As of December 31, 2001, gross loans outstanding were $490.6 million, an
increase of $79.7 million or 19% over the December 31, 2000 balance of $410.9
million. Most of this growth was attributable to growth in real estate loans.
Real estate mortgage loans grew $48.5 million in 2001, while real estate
construction loans grew $23.9 million in 2001. The Company experienced an
increase of $5.5 million in the commercial loan portfolio. As a percentage of
the Company's total loan portfolio, real estate mortgage loans represented
56.61% in 2001, 55.79% in 2000 and 56.29% in 1999. Over the same period
commercial loans represented 20.87%, 23.58% and 24.66% of the Company's total
loan portfolio, respectively. Real estate construction loans made up 16.88%,
14.34% and 11.60% of the Company's total loan portfolio at December 31, 2001,
2000 and 1999, respectively. Consumer loans represented 5.64%, 6.29% and 7.46%
of the Company's total loan portfolio at December 31, 2001, 2000 and 1999,
respectively.
Mortgage loans held for sale were $5.3 million at December 31, 2001, an
increase of $3.8 million over the December 31, 2000 balance of $1.6 million
which represented a decrease of $122,000 over the December 31, 1999 balance of
$1.7 million.
A-10
Table 7 identifies the maturities of all loans as of December 31, 2001 and
addresses the sensitivity of these loans to changes in interest rates.
TABLE 7 - MATURITY AND REPRICING DATA FOR LOANS
AFTER ONE
WITHIN ONE YEAR THROUGH AFTER FIVE
(DOLLARS IN THOUSANDS) YEAR OR LESS FIVE YEARS YEARS TOTAL LOANS
- ----------------------------------------------------------------------------------------------
Commercial, financial & agricultural $ 88,336 $ 11,244 $ 2,829 $ 102,409
Real Estate - Mortgage 201,461 35,520 40,756 277,737
Real Estate - Commercial 74,155 4,151 4,485 82,791
Consumer 10,032 14,024 3,615 27,671
- ----------------------------------------------------------------------------------------------
Total Loans $ 373,984 $ 64,939 $ 51,685 $ 490,608
==============================================================================================
Total fixed rate loans 12,745 64,301 51,685 128,731
Total floating rate loans 361,239 638 0 361,877
- ----------------------------------------------------------------------------------------------
Total loans $ 373,984 $ 64,939 $ 51,685 $ 490,608
==============================================================================================
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses reflects management's assessment and estimate
of the risks associated with extending credit and its evaluation of the quality
of the loan portfolio. The Bank periodically analyzes the loan portfolio in an
effort to review asset quality and to establish an allowance for loan losses
that management believes will be adequate in light of anticipated risks and loan
losses. In assessing the adequacy of the allowance, size, quality and risk of
loans in the portfolio are reviewed. Other factors considered are:
- the Bank's loan loss experience;
- the amount of past due and nonperforming loans;
- specific known risks;
- the status and amount of past due and nonperforming assets;
- underlying estimated values of collateral securing loans;
- current and anticipated economic conditions; and
- other factors which management believes affect the allowance for
potential credit losses.
An analysis of the credit quality of the loan portfolio and the adequacy of
the allowance for loan losses is prepared by the Bank's credit administration
area and presented to the Bank's Executive and Loan Committee on a regular
basis. In addition, the Bank has engaged an outside loan review consultant to
perform, and report on an annual basis, an independent review of the quality of
the loan portfolio relative to the accurateness of the Bank's loan grading
system. The allowance for loan losses is established through charges to expense
in the form of a provision for loan losses. Loan losses and recoveries are
charged and credited directly to the allowance.
An allowance for loan losses is also established, as necessary, for
individual loans considered to be impaired in accordance with SFAS No. 114. A
loan is considered impaired when, based on current information and events, it is
probable that all amounts due according to the contractual terms of the loan
will not be collected. Impaired loans are measured based on the present value
of expected future cash flows, discounted at the loan's effective interest rate,
or at the loan's observable market price, or the fair value of collateral if the
loan is collateral dependent. At December 31, 2001 and 2000, the recorded
investment in loans that were considered to be impaired under SFAS No. 114 was
approximately $4.4 million and $6.0 million, respectively, with related
allowance for loan losses of approximately $699,000 and $925,000, respectively.
The Bank's allowance for loan losses is also subject to regulatory
examinations and determinations as to adequacy, which may take into account such
factors as the methodology used to calculate the allowance for loan losses and
the size of the allowance for loan losses compared to a group of peer banks
identified by the regulators. During their routine examinations of banks, the
FDIC and the North Carolina Commissioner of Banks may require the Company to
recognize additions to the allowance based on their judgments about information
available to them at the time of their examination.
While it is the Bank's policy to charge off in the current period loans for
which a loss is considered probable, there are additional risks of future losses
which cannot be quantified precisely or attributed to particular loans or
classes of loans. Because these risks include the state of the economy,
management's judgment as to the adequacy of the allowance is necessarily
approximate and imprecise.
A-11
The Company grants loans and extensions of credit primarily within the
Catawba Valley region of North Carolina, which encompasses Catawba, Alexander,
Iredell and Lincoln counties. Although the Bank has a diversified loan
portfolio, a substantial portion of the loan portfolio is collateralized by real
estate, which is dependent upon the real estate market. Non-real estate
commercial loans also can be affected by local economic conditions. At
December 31, 2001, approximately 8% of the Company's portfolio was not secured
by any type of collateral. Unsecured loans generally involve higher credit
risk than secured loans and, in the event of customer default, the Company has a
higher exposure to potential loan losses.
Total non-performing loans were $4.4 million in 2001, $6.0 million in 2000
and $3.5 million in 1999. The ratio of net charge-offs to average total loans
was 0.48% in 2001, 0.29% in 2000 and 0.20% in 1999. The ratio of non-performing
loans to total loans was 0.90% at December 31, 2001, as compared to 1.45% and
1.04% at December 31, 2000 and 1999, respectively. The allowance for loan losses
totaled $6.1 million, representing 1.24% of total loans outstanding at December
31, 2001. For December 31, 2000 and 1999, the allowance for loan losses amounted
to $4.7 million, or 1.15% of total loans outstanding and $3.9 million, or 1.16%
of total loans outstanding, respectively.
Table 8 presents an analysis of the allowance for loan losses, including
charge-off activity.
TABLE 8 - ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
(DOLLARS IN THOUSANDS) 2001 2000 1999 1998 1997
============================================================================================================================
RESERVE FOR LOAN LOSSES AT BEGINNING $ 4,713 $ 3,924 $ 4,137 $ 4,375 $ 3,745
LOANS CHARGED OFF:
Commercial, financial, and agriculture 842 857 485 608 8
Real estate - mortgage 790 10 25 - -
Real estate - construction 51 36 - - -
Consumer 675 255 195 138 131
- ----------------------------------------------------------------------------------------------------------------------------
Total loans charged off $ 2,358 $ 1,158 $ 705 $ 746 $ 139
- ----------------------------------------------------------------------------------------------------------------------------
RECOVERIES OF LOSSES PREVIOUSLY CHARGED OFF:
Commercial, financial, and agriculture 84 20 24 39 60
Real estate - mortgage - - - - -
Real estate - construction 6 - - - -
Consumer 101 48 43 24 12
- ----------------------------------------------------------------------------------------------------------------------------
Total recoveries $ 191 $ 68 $ 67 $ 63 $ 72
- ----------------------------------------------------------------------------------------------------------------------------
Net loans charged off $ 2,167 $ 1,090 $ 638 $ 683 $ 67
Provision for loan losses 3,545 1,879 425 445 697
- ----------------------------------------------------------------------------------------------------------------------------
Reserve for loan losses at end of year $ 6,091 $ 4,713 $ 3,924 $ 4,137 $ 4,375
============================================================================================================================
Loans charged off net of recoveries, as
a percent of average loans outstanding 0.48% 0.29% 0.20% 0.25% 0.03%
NON-PERFORMING ASSETS
Non-performing assets, comprised of non-accrual loans, other real estate
owned and loans for which payments are more than 90 days past due totaled $4.7
million at December 31, 2001 compared to $6.1 million at December 31, 2000. This
decrease is a result of the resolution of two large problem credits included in
non-performing assets at December 31, 2000, which resulted in charge-offs of
$746,000 in 2001.
It is the general policy of the Company to stop accruing interest income
and place the recognition of interest on a cash basis when a loan is placed on
non-accrual status and any interest previously accrued but not collected is
reversed against current income.
A-12
A summary of non-performing assets at December 31 for each of the years
presented is shown in table 9.
TABLE 9 - NON-PERFORMING ASSETS
(DOLLARS IN THOUSANDS)
- -----------------------------------------------------------------------------------------------
YEAR 2001 2000 1999 1998 1997
- -----------------------------------------------------------------------------------------------
Nonaccrual loans $3,756 $5,421 $2,866 $3,292 $3,075
Loans 90 days or more past due and still accruing 655 545 645 328 586
Total non-performing loans 4,411 5,966 3,511 3,620 3,661
All other real estate owned 256 112 44 545 -
Total non-performing assets $4,667 $6,078 $3,555 $4,165 $3,661
AS A PERCENT OF TOTAL LOANS AT YEAR END
Non-accrual loans 0.77% 1.32% 0.84% 1.09% 1.28%
Loans 90 days or more past due and still accruing 0.13% 0.13% 0.19% 0.11% 0.24%
Total non-performing assets 0.95% 1.48% 1.05% 1.38% 1.52%
At December 31, 2001 the Company had non-performing loans, defined as
non-accrual and accruing loans past due more than 90 days, of $4.4 million or
0.90% of total loans. Non-performing loans for 2000 were $6.0 million, or 1.45%
of total loans and $3.5 million, or 1.03% of total loans for 1999. Interest that
would have been recorded on non-accrual loans for the years ended December 31,
2001, 2000 and 1999, had they performed in accordance with their original terms,
amounted to approximately $695,000, $508,000 and $333,000 respectively. Interest
income on non-accrual loans included in the results of operations for 2001,
2000, and 1999 amounted to approximately $22,000, $94,000 and $61,000,
respectively.
Management continually monitors the loan portfolio to ensure that all loans
potentially having a material adverse impact on future operating results,
liquidity or capital resources have been classified as non-performing. Should
economic conditions deteriorate, the inability of distressed customers to
service their existing debt could cause higher levels of non-performing loans.
DEPOSITS
The Company primarily uses deposits to fund its loan and investment
portfolios. The Company offers a variety of deposit accounts to individuals and
businesses. Deposit accounts include checking, savings, money market and
certificates of deposit. Certificates of deposit in amounts of $100,000 or more
totaled $156.0 million at December 31, 2001, $129.1 million and $89.3 million at
December 31, 2000 and 1999, respectively. The majority of these deposits are
from customers who reside or own businesses in the Bank's primary service area,
and therefore, are believed by the Bank to be stable, and for all practicable
purposes, no more rate sensitive than core deposits.
As of December 31, 2001, total deposits were $490.2 million, an increase of
$40.1 million or 9% increase over the December 31, 2000 balance of $450.1
million. The increase in deposits is primarily attributable to growth in time
deposits which resulted from deposit campaigns throughout 2001.
Table 10 is a summary of the maturity distribution of certificates of deposit in
amounts of $100,000 or more as of December 31, 2001.
TABLE 10 - MATURITIES OF TIME DEPOSITS OVER $100,000
(DOLLARS IN THOUSANDS)
================================================
MATURITY PERIOD AMOUNT
================================================
Three months or less $ 39,855
Over three months through six months 59,869
Over six months through twelve months 46,257
Over twelve months 10,053
--------
Total $156,034
========
A-13
BORROWED FUNDS
The Company has access to various short-term borrowings, including the
purchase of Federal Funds and borrowing arrangements from the FHLB and other
financial institutions. At December 31, 2001, FHLB borrowings totaled $68.2
million compared to $21.4 million at December 31, 2000 and $14.5 million at
December 31, 1999. Average FHLB borrowings for 2001 were $42.5 million, compared
to average balances of $15.8 million for 2000 and $13.5 million for 1999. The
maximum amount of outstanding FHLB borrowings was $68.2 million in 2001, and
$21.4 in 2000 and $14.5 in 1999. The FHLB advances outstanding at December 31,
2001 had both fixed and adjustable interest rates ranging from 1.83% to 6.16%.
Approximately $16.0 million of the FHLB advances outstanding mature prior to
December 31, 2002. Additional information regarding FHLB advances is provided
in note 7 to the consolidated financial statements.
Demand notes payable to the U. S. Treasury amounted to approximately
$118,000 at December 31, 2001 and $1.6 million at December 31, 2000 and 1999,
respectively.
TRUST PREFERRED SECURITIES
In December, 2001 the Company formed a wholly owned Delaware statutory
trust, PEBK Capital Trust I ("PEBK Trust"), which issued $14 million of
guaranteed preferred beneficial interests in the Company's junior subordinated
deferrable interest debentures that qualify as Tier I capital under Federal
Reserve Board guidelines. All of the common securities of PEBK Trust are owned
by the Company. The proceeds from the issuance of the common securities and the
trust preferred securities were used by PEBK Trust to purchase $14.4 million of
junior subordinated debentures of the Company, which pay interest at a floating
rate equal to prime plus 50 basis points. The proceeds received by the Company
from the sale of the junior subordinated debentures were used for general
purposes, primarily to provide capital to the Bank. The debentures represent
the sole asset of PEBK Trust. The debentures and related earnings statement
effects are eliminated in the Company's financial statements.
The Trust Preferred Securities accrue and pay quarterly distributions based
on the liquidation value of $50,000 per capital security at a floating rate of
prime plus 50 basis points. The Company has guaranteed distributions and other
payments due on the Trust Preferred Securities to the extent PEBK Trust has
funds with which to make the distributions and other payments. The net combined
effect of all the documents entered into in connection with the Trust Preferred
Securities is that the Company is liable to make the distributions and other
payments required on the Trust Preferred Securities.
The Trust Preferred Securities are mandatorily redeemable upon maturity of
the debentures on December 31, 2031, or upon earlier redemption as provided in
the indenture. The Company has the right to redeem the debentures purchased by
PEBK Trust, in whole or in part, on or after December 31, 2006. As specified in
the indenture, if the debentures are redeemed prior to maturity, the redemption
price will be the principal amount and any accrued but unpaid interest.
CAPITAL RESOURCES
Shareholders' equity at December 31, 2001 was $45.4 million compared to
$43.0 million and $38.0 million at December 31, 2000 and 1999, respectively. At
December 31, 2001, unrealized gains and losses net of tax in the
available-for-sale securities portfolio amounted to a loss of approximately
$922,000. For the years ended December 31, 2000 and 1999, unrealized gains and
losses net of tax in the available-for-sale securities portfolio amounted to a
gain of approximately $4,000 and a loss of approximately $920,000, respectively.
Average shareholders' equity as a percentage of total average assets is one
measure used to determine capital strength. Average shareholders' equity as a
percentage of total average assets was 8.25%, 9.13% and 9.43% for 2001, 2000 and
1999. The return on average shareholders' equity was 9.65% at December 31,
2001 as compared to 12.55% and 11.54% as of December 31, 2000 and December 31,
1999, respectively.
Under regulatory capital guidelines, financial institutions are currently
required to maintain a total risk-based capital ratio of 8.0% or greater, with a
Tier 1 risk-based capital ratio of 4.0% or greater. Tier 1 capital is generally
defined as shareholders' equity less all intangible assets and goodwill. Tier 1
capital at December 31, 2001 includes $14.0 million in trust preferred
securities. The Company's Tier I capital ratio was 11.14%, 10.11% and 10.99% at
December 31, 2001, 2000 and 1999, respectively. Total risk based capital is
defined as Tier 1 capital plus supplementary capital. Supplementary capital, or
Tier 2 capital, consists of the Company's allowance for loan losses, not
exceeding 1.25% of the Company's risk-weighted assets. Total risk-based capital
ratio is therefore defined as the ratio of total capital (Tier 1 capital and
Tier 2 capital) to risk-weighted assets. The Company's total risk based capital
ratio was 12.27%, 11.22% and 12.11% at December 31, 2001, 2000 and 1999,
respectively. In addition to the Tier I and total risk-based capital
requirements, financial institutions are also required by the FDIC to maintain a
leverage ratio of Tier 1 capital to total average assets of 4.0% or greater.
The Company's Tier I leverage capital ratio was 10.46%, 9.10% and 9.21% at
December 31, 2001, 2000 and 1999, respectively.
A Bank is considered to be "well capitalized" if it has a total risk-based
capital ratio of 10.0 % or greater, a Tier I risk-based capital ratio of 6.0% or
greater, and has a leverage ratio of 5.0% or greater. Based upon these
guidelines, the Bank was considered to be "well capitalized" at December 31,
2001, 2000 and 1999, respectively.
A-14
The Company's key equity ratios as of December 31, 2001, 2000 and 1999 are
presented in Table 11:
TABLE 11 - EQUITY RATIOS
YEARS ENDED DECEMBER 31,
2001 2000 1999
========================================================
Return on average assets 0.80% 1.15% 1.09%
Return on average equity 9.65% 12.55% 11.54%
Dividend payout ratio 28.14% 23.39% 23.84%
Average equity to average assets 8.25% 9.13% 9.43%
COMPANY REORGANIZATION
Effective August 31, 1999, the Bank completed the process of converting to
the holding company form of organization. The Bank is now a subsidiary of the
Company, a one-bank holding company, headquartered in Newton, North Carolina.
As a result of the reorganization, each share of the Bank's common stock
was automatically converted into one share of the Company's common stock. The
Company is now the sole shareholder of the Bank. The corporate reorganization
was accounted for in a manner similar to a pooling of interest.
QUARTERLY FINANCIAL DATA
The Company's consolidated quarterly operating results for the years ended
December 31, 2001 and 2000 are presented in table 12. The increase in provision
for loan losses in fourth quarter 2001 reflects the charge off of two large
loans during fourth quarter.
TABLE 12 - QUARTERLY FINANCIAL DATA
2001 2000
---------------------------------- ----------------------------------
(in thousands, except per share amounts)
First Second Third Fourth First Second Third Fourth
---------- ------ ------ ------ ---------- ------ ------ ------
Total interest income $ 10,935 10,849 10,568 9,546 $ 9,077 9,838 10,754 11,190
Total interest expense 5,905 5,998 5,952 5,172 4,015 4,428 5,176 5,814
---------------------------------- ----------------------------------
Net interest income 5,030 4,851 4,616 4,374 5,062 5,410 5,578 5,376
Provision for loan losses 429 453 760 1,903 256 523 640 460
Other income 1,602 1,990 2,110 2,561 863 1,141 868 1,044
Other expense 4,160 4,370 3,864 4,358 3,793 4,040 3,731 3,945
---------------------------------- ----------------------------------
Income before income taxes 2,043 2,018 2,102 674 1,876 1,988 2,075 2,015
Income taxes 672 668 716 206 606 646 689 635
---------------------------------- ----------------------------------
Net earnings $ 1,371 1,350 1,386 468 $ 1,270 1,342 1,386 1,380
================================== ==================================
Net earnings per share $ 0.42 0.42 0.43 0.15 $ 0.39 0.42 0.43 0.43
================================== ==================================
A-15
QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk reflects the risk of economic loss resulting from adverse
changes in market prices and interest rates. This risk of loss can be reflected
in either diminished current market values or reduced potential net interest
income in future periods.
The Company's market risk arises primarily from interest rate risk inherent
in its lending and deposit taking activities. The structure of the Company's
loan and deposit portfolios is such that a significant decline (increase) in
interest rates may adversely impact net market values and interest income.
Management seeks to manage the risk through the utilization of its investment
securities and off balance sheet derivative instruments. During the years ended
December 31, 2001, 2000 and 1999, the Company has used interest rate contracts
to manage market risk. During first quarter 2001, the Company entered into an
interest rate floor contract as a means of managing its interest rate risk.
Interest rate floors are used to protect certain designated variable rate
financial instruments from the downward effects of their repricing in the event
of a decreasing rate environment. The total cost of the interest rate floor was
$417,500 and it was not management's intention to use the floor as a fair value
or cash flow hedge, as defined in SFAS No. 133. The Company sold the interest
rate floor contract during the quarter ended June 30, 2001. For the years ended
December 31, 2001 the Company recognized no interest expense related to
derivative financial instruments. The Company expensed $3,200 and $22,944 for
the years ended December 31, 2000 and 1999, respectively, related to derivative
financial instruments. The Company had no off-balance sheet derivative
financial instruments at December 31, 2001.
Table 13 presents in tabular form the contractual balances and the
estimated fair value of the Company's on-balance sheet financial instruments and
the notional amount and estimated fair value of the Company's off-balance sheet
derivative instruments at their expected maturity dates for the period ended
December 31, 2001. The expected maturity categories take into consideration
historical prepayment experience as well as management's expectations based on
the interest rate environment at December 31, 2001. For core deposits without
contractual maturity (i.e. interest bearing checking, savings, and money market
accounts), the table presents principal cash flows based on management's
judgment concerning their most likely runoff or repricing behaviors.
TABLE 13- MARKET RISK TABLE
(IN THOUSANDS) PRINCIPAL/NOTIONAL AMOUNT MATURING IN:
YEAR ENDED DECEMBER YEAR ENDED DECEMBER YEAR ENDED DECEMBER
LOANS RECEIVABLE 31, 2002 31, 2003 31, 2004
==========================================================================================================
Fixed rate $ 17,544 $ 18,126 $ 18,736
Average interest rate 11.58% 8.48% 7.96%
Variable rate $ 129,765 $ 48,511 $ 35,072
Average interest rate 5.94% 5.35% 5.37%
INVESTMENT SECURITIES
==========================================================================================================
Interest bearing cash $ 214 $ - $ -
Average interest rate 1.83% - -
Federal funds sold $ 2,261 $ - $ -
Average interest rate 2.18% - -
Securities available for sale $ 3,070 $ 1,808 $ 4,307
Average interest rate 7.91% 4.89% 6.42%
Nonmarketable equity securities $ - $ - $ -
Average interest rate - - -
DEBT OBLIGATIONS
==========================================================================================================
Deposits $ 273,321 $ 24,328 $ 4,491
Average interest rate 4.77% 3.74% 3.83%
Advances from FHLB $ 16,000 $ 214 $ -
Average interest rate 1.88% 5.86% 0.00%
Demand Notes payable to U.S. Treasury $ 118 $ - $ -
Average interest rate 1.43% - -
YEARS ENDED
LOANS RECEIVABLE DECEMBER 31, 2005 & 2006 THEREAFTER TOTAL FAIR VALUE
======================================================================================================
Fixed rate $ 32,021 $ 45,417 $131,844 $ 135,532
Average interest rate 8.01% 8.65%
Variable rate $ 50,728 $ 94,688 $358,764 $ 364,170
Average interest rate 5.47% 5.54%
INVESTMENT SECURITIES
======================================================================================================
Interest bearing cash $ - $ - $ 214 $ 214
Average interest rate - -
Federal funds sold $ - $ - $ 2,261 $ 2,261
Average interest rate - -
Securities available for sale $ 2,934 $ 72,166 $ 84,286 $ 84,286
Average interest rate 6.02% 5.97%
Nonmarketable equity securities $ - $ 4,603 $ 4,603 $ 4,603
Average interest rate - -
DEBT OBLIGATIONS
======================================================================================================
Deposits $ 779 $ 187,305 $490,223 $ 493,303
Average interest rate 5.84% 0.76%
Advances from FHLB $ 5,000 $ 47,000 $ 68,214 $ 68,497
Average interest rate 0.00% 4.58%
Demand Notes payable to U.S. Treasury $ - $ - $ 118 $ 118
Average interest rate - -
A-16
MARKET FOR THE COMPANY'S COMMON EQUITY
AND RELATED SHAREHOLDER MATTERS
Peoples Bancorp common stock is traded on the over-the-counter (OTC) market
and quoted on the Nasdaq National Market, under the symbol "PEBK". Scott and
Stringfellow, Inc., Ryan, Beck & Co., and Trident Securities, Inc. are market
makers for the Company's shares.
Although the payment of dividends by the Company is subject to certain
requirements and limitations of North Carolina corporate law, neither the
Commissioner nor the FDIC have promulgated any regulations specifically limiting
the right of the Company to pay dividends and repurchase shares. However, the
ability of the Company to pay dividends and repurchase shares may be dependent
upon the Company's receipt of dividends from the Bank. The Bank's ability to
pay dividends is limited. North Carolina commercial banks, such as the Bank,
are subject to legal limitations on the amounts of dividends they are permitted
to pay. Dividends may be paid by the Bank from undivided profits, which are
determined by deducting and charging certain items against actual profits,
including any contributions to surplus required by North Carolina law. Also,
an insured depository institution, such as the Bank, is prohibited from making
capital distributions, including the payment of dividends, if, after making such
distribution, the institution would become "undercapitalized" (as such term is
defined in the applicable law and regulations). Based on its current financial
condition, the Bank does not expect that this provision will have any impact on
the Bank's ability to pay dividends.
As of March 1, 2002, the Company had 670 shareholders of record, not
including the number of persons or entities whose stock is held in nominee or
street name through various brokerage firms or banks. The market price for the
Company's common stock was $15.85 on March 1, 2002.
Following is certain market and dividend information for the last two
fiscal years. Information for quarters prior to the third quarter of 2000
relates to the Bank's common stock. Over-the-counter quotations reflect
inter-dealer prices, without retail mark-up, mark down or commission and may not
necessarily represent actual transactions.
MARKET AND DIVIDEND DATA
CASH DIVIDEND
2001 LOW BID HIGH BID PER SHARE
First Quarter $ 13.000 $ 16.000 $ 0.10
Second Quarter $ 16.050 $ 13.500 $ 0.10
Third Quarter $ 16.000 $ 20.000 $ 0.10
Fourth Quarter $ 14.100 $ 17.000 $ 0.10
CASH DIVIDEND
2000 LOW BID HIGH BID PER SHARE
First Quarter $ 11.591 $ 13.636 $ 0.09
Second Quarter $ 12.159 $ 16.250 $ 0.10
Third Quarter $ 12.000 $ 13.625 $ 0.10
Fourth Quarter $ 11.625 $ 13.500 $ 0.10
A-17
DIRECTORS AND OFFICERS OF THE COMPANY
DIRECTORS
- ---------
ROBERT C. ABERNETHY - CHAIRMAN
- ----------------------------------
Chairman of the Board, Peoples Bancorp of North Carolina, Inc. and Peoples Bank;
President, Secretary and Treasurer, Carolina Glove Company, Inc. (glove
manufacturer)
JAMES S. ABERNETHY
- --------------------
President and Assistant Secretary, Midstate Contractors, Inc. (paving company)
BRUCE R. ECKARD
- -----------------
President, Eckard Vending Company, Inc. (vending machine servicer)
JOHN H. ELMORE, JR.
- ----------------------
Chairman of the Board, Chief Executive Officer and Treasurer; Elmore
Construction Company, Inc.
GARY E. MATTHEWS
- ------------------
President and Director, Matthews Construction Company, Inc.
CHARLES F. MURRAY
- -------------------
President, Murray's Hatchery, Inc.
LARRY E. ROBINSON
- -------------------
President and Chief Executive Officer, Blue Ridge Distributing Co., Inc. (beer
and wine distributor) & President and Chief Executive Officer, Associated
Brands, Inc. (beer and wine distributor)
FRED L. SHERRILL, JR.
- ------------------------
Retired (furniture manufacturing executive)
DAN RAY TIMMERMAN, SR.
- -------------------------
President, Timmerman Manufacturing, Inc. (wrought iron furniture manufacturer)
BENJAMIN I. ZACHARY
- ---------------------
General Manager, Treasurer, Secretary and Member of the Board of Directors,
Alexander Railroad Company
OFFICERS
- --------
TONY W. WOLFE
- ---------------
President and Chief Executive Officer
JOSEPH F. BEAMAN, JR.
- ------------------------
Executive Vice President and Corporate Secretary
LANCE A. SELLERS
- ------------------
Executive Vice President and Assistant Corporate Secretary
WILLIAM D. CABLE
- ------------------
Executive Vice President and Assistant Corporate Treasurer
A. JOSEPH LAMPRON
- -------------------
Executive Vice President, Chief Financial Officer and Corporate Treasurer
A-18
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
Peoples Bancorp of North Carolina, Inc.
Newton, North Carolina:
We have audited the accompanying consolidated balance sheets of Peoples Bancorp
of North Carolina, Inc. as of December 31, 2001 and 2000, and the related
consolidated statements of earnings, comprehensive income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2001. 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 Peoples Bancorp of
North Carolina, Inc. as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States of America.
/s/ Porter Keadle Moore, LLP
Atlanta, Georgia
January 18, 2002
A-19
PEOPLES BANCORP OF NORTH CAROLINA, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
2001 2000
------------- -----------
Assets
------
Cash and due from banks, including reserve requirements
of $2,246,000 and $4,739,000 $ 13,042,320 13,619,197
Federal funds sold 2,261,000 5,020,000
------------- -----------
Cash and cash equivalents 15,303,320 18,639,197
Investment securities available for sale 84,286,037 71,564,844
Other investments 4,602,773 2,398,873
Mortgage loans held for sale 5,338,931 1,563,700
Loans, net 484,517,151 406,226,100
Premises and equipment, net 14,679,191 12,907,968
Cash surrender value of life insurance 4,583,000 -
Accrued interest receivable and other assets 6,194,301 5,701,105
------------- -----------
$619,504,704 519,001,787
============= ===========
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Noninterest-bearing $ 56,826,130 52,793,390
Interest-bearing 433,397,059 397,279,952
------------- -----------
Total deposits 490,223,189 450,073,342
Demand notes payable to U. S. Treasury 117,987 1,600,000
Accrued interest payable and other liabilities 1,548,139 2,932,284
Federal Home Loan Bank advances 68,214,286 21,357,142
Guaranteed preferred beneficial interests in Company's junior
subordinated debentures (Trust Preferred Securities) 14,000,000 -
------------- -----------
Total liabilities 574,103,601 475,962,768
------------- -----------
Commitments
Shareholders' equity:
Preferred stock, no par value; authorized 5,000,000 shares;
no shares issued and outstanding - -
Common stock, no par value; authorized 20,000,000 shares;
3,218,714 shares issued and outstanding 36,407,798 36,407,798
Retained earnings 9,915,399 6,627,533
Accumulated other comprehensive income (loss) (922,094) 3,688
------------- -----------
Total shareholders' equity 45,401,103 43,039,019
------------- -----------
$619,504,704 519,001,787
============= ===========
See accompanying notes to consolidated financial statements.
A-20
PEOPLES BANCORP OF NORTH CAROLINA, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
---------------- ----------- -----------
Interest income:
Interest and fees on loans $ 36,512,395 36,423,973 28,375,391
Interest on federal funds sold 126,791 281,659 338,941
Interest and dividends on securities:
U. S. Treasuries - 16,572 50,221
U. S. Government agencies 3,918,551 2,977,459 2,297,645
State and political subdivisions 911,707 988,020 973,744
Other 428,157 171,600 266,097
---------------- ----------- -----------
Total interest income 41,897,601 40,859,283 32,302,039
---------------- ----------- -----------
Interest expense:
Deposits 20,790,136 18,326,359 14,009,018
Federal Home Loan Bank advances 2,118,511 974,036 735,752
Other 117,849 131,705 45,501
---------------- ----------- -----------
Total interest expense 23,026,496 19,432,100 14,790,271
---------------- ----------- -----------
Net interest income 18,871,105 21,427,183 17,511,768
Provision for loan losses 3,545,322 1,879,100 425,000
---------------- ----------- -----------
Net interest income after provision for loan losses 15,325,783 19,548,083 17,086,768
---------------- ----------- -----------
Other income:
Service charges on deposit accounts 2,805,492 1,588,390 1,326,810
Other service charges and fees 471,998 367,352 298,454
Gain (loss) on sale of securities 1,613,992 (483,472) (34,824)
Mortgage banking income 1,014,043 241,007 740,031
Insurance and brokerage commissions 348,582 168,557 129,786
Miscellaneous 2,008,797 2,033,930 919,804
---------------- ----------- -----------
Total other income 8,262,904 3,915,764 3,380,061
---------------- ----------- -----------
Other expenses:
Salaries and employee benefits 9,115,496 8,899,285 7,737,404
Occupancy 2,984,100 2,509,720 2,230,448
Other operating 4,652,197 4,099,972 3,863,652
---------------- ----------- -----------
Total other expenses 16,751,793 15,508,977 13,831,504
---------------- ----------- -----------
Earnings before income taxes 6,836,894 7,954,870 6,635,325
Income tax expense 2,261,542 2,576,400 2,093,380
---------------- ----------- -----------
Net earnings $ 4,575,352 5,378,470 4,541,945
================ =========== ===========
Net earnings per share $ 1.42 1.67 1.41
================ =========== ===========
See accompanying notes to consolidated financial statements.
A-21
PEOPLES BANCORP OF NORTH CAROLINA, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
Accumulated
Common Stock Other
------------------------ Retained Comprehensive
Shares Amount Earnings Income (Loss) Total
---------- ------------ ----------- -------------- -----------
Balance, December 31, 1998 2,926,500 $31,730,372 3,735,171 458,592 35,924,135
Cash paid in lieu of fractional shares (182) (910) (4,961) - (5,871)
Cash dividends declared ($0.34 per share) - - (1,082,738) - (1,082,738)
Net earnings - - 4,541,945 - 4,541,945
Change in net unrealized gain (loss) on
investment securities available for
sale, net of tax - - - (1,378,992) (1,378,992)
---------- ------------ ----------- -------------- -----------
Balance, December 31, 1999 2,926,318 31,729,462 7,189,417 (920,400) 37,998,479
10% stock dividend 292,396 4,678,336 (4,678,336) - -
Cash paid in lieu of fractional shares - - (3,775) - (3,775)
Cash dividends declared ($0.39 per share) - - (1,258,243) - (1,258,243)
Net earnings - - 5,378,470 - 5,378,470
Change in net unrealized gain (loss) on
investment securities available for
sale, net of tax - - - 924,088 924,088
---------- ------------ ----------- -------------- -----------
Balance, December 31, 2000 3,218,714 36,407,798 6,627,533 3,688 43,039,019
Cash dividends declared ($0.40 per share) - - (1,287,486) - (1,287,486)
Net earnings - - 4,575,352 - 4,575,352
Change in net unrealized gain (loss) on
investment securities available for
sale, net of tax - - - (925,782) (925,782)
---------- ------------ ----------- -------------- -----------
Balance, December 31, 2001 3,218,714 $36,407,798 9,915,399 (922,094) 45,401,103
========== ============ =========== ============== ===========
See accompanying notes to consolidated financial statements.
A-22
PEOPLES BANCORP OF NORTH CAROLINA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
------------ --------- -----------
Net earnings $ 4,575,352 5,378,470 4,541,945
------------ --------- -----------
Other comprehensive income, net of tax:
Unrealized gains (losses) on investment
securities available for sale 97,560 1,030,186 (2,293,615)
Reclassification adjustment for (gains) losses on
sales of investment securities available for sale (1,613,992) 483,472 34,824
------------ --------- -----------
Total other comprehensive income (loss),
before income taxes (1,516,432) 1,513,658 (2,258,791)
------------ --------- -----------
Income tax expense (benefit) related to other comprehensive income:
Unrealized holding gains (losses) on investment
securities available for sale 38,000 401,258 (893,363)
Reclassification adjustment for (gains) losses on
sales of investment securities available for sale (628,650) 188,312 13,564
------------ --------- -----------
Total income tax expense (benefit) related to
other comprehensive income (590,650) 589,570 (879,799)
------------ --------- -----------
Total other comprehensive income (loss),
net of tax (925,782) 924,088 (1,378,992)
------------ --------- -----------
Total comprehensive income $ 3,649,570 6,302,558 3,162,953
============ ========= ===========
See accompanying notes to consolidated financial statements.
A-23
PEOPLES BANCORP OF NORTH CAROLINA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
-------------- ------------ ------------
Cash flows from operating activities:
Net earnings $ 4,575,352 5,378,470 4,541,945
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Depreciation, amortization and accretion 1,584,437 1,531,860 1,794,646
Provision for loan losses 3,545,322 1,879,100 425,000
Provision for deferred taxes (532,329) (246,511) 915,285
Loss (gain) on sale of investment securities (1,613,992) 483,472 34,824
Loss (gain) on sale of premises and equipment - (598,308) 12,925
Loss (gain) on sale of mortgage loans (37,152) 292,796 369,583
Loss (gain) on sale of other real estate 51,840 (9,226) 64,943
Change in:
Other assets 1,017,755 (1,090,782) (1,006,947)
Other liabilities (1,384,145) 1,230,278 (797,420)
Mortgage loans held for sale (3,738,079) (171,024) 7,204,762
-------------- ------------ ------------
Net cash provided by operating activities 3,469,009 8,680,125 13,559,546
-------------- ------------ ------------
Cash flows from investing activities:
Purchase of investment securities available for sale (118,372,897) (33,291,361) (23,737,969)
Proceeds from calls and maturities of investment securities
available for sale 22,714,408 7,139,920 15,076,886
Proceeds from sales of investment securities available
for sale 82,969,419 18,129,483 6,896,296
Change in other investments (2,203,900) (1,053,773) 150,200
Purchase of cash value life insurance (4,583,000) - -
Net change in loans (82,092,812) (72,926,623) (38,273,585)
Purchases of premises and equipment (3,652,961) (2,243,860) (1,857,657)
Proceeds from sale of premises and equipment 645,429 1,916,505 4,500
Construction in progress (100,633) (3,779,053) (870,284)
Improvements to other real estate - - (241,951)
Proceeds from sale of other real estate 60,310 36,426 740,962
-------------- ------------ ------------
Net cash used by investing activities (104,616,637) (86,072,336) (42,112,602)
-------------- ------------ ------------
Cash flows from financing activities:
Net change in deposits 40,149,847 73,438,973 26,566,991
Net change in demand notes payable to U. S. Treasury (1,482,013) - 1,460,765
Proceeds from FHLB borrowings 51,000,000 18,000,000 1,000,000
Payments of FHLB advances (4,142,856) (11,142,858) (142,857)
Proceeds from issuance of trust preferred securities 14,000,000 - -
Transaction costs associated with trust preferred securities (425,741) - -
Cash dividends (1,287,486) (1,258,243) (1,082,738)
Cash paid in lieu of fractional shares - (3,775) (5,871)
-------------- ------------ ------------
Net cash provided by financing activities 97,811,751 79,034,097 27,796,290
-------------- ------------ ------------
Net change in cash and cash equivalents (3,335,877) 1,641,886 (756,766)
Cash and cash equivalents at beginning of year 18,639,197 16,997,311 17,754,077
-------------- ------------ ------------
Cash and cash equivalents at end of year $ 15,303,320 18,639,197 16,997,311
============== ============ ============
See accompanying notes to consolidated financial statements.
A-24
PEOPLES BANCORP OF NORTH CAROLINA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
------------ ---------- -----------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $23,068,630 18,952,793 14,812,486
Income taxes $ 3,209,000 2,663,000 1,000,000
Noncash investing and financing activities:
Change in net unrealized gain(loss) on investment
securities available for sale, net of tax $ (925,782) 924,088 (1,378,992)
Transfer of loans to other real estate $ 256,439 95,000 123,451
Financed sales of other real estate $ - - 60,000
See accompanying notes to consolidated financial statements.
A-25
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
------------
Peoples Bancorp of North Carolina, Inc. (Bancorp) received regulatory
approval to operate as a bank holding company on July 22, 1999, and became
effective August 31, 1999. Bancorp is primarily regulated by the Federal
Reserve Bank, and serves as the one bank holding company for Peoples Bank.
Peoples Bank (the "Bank") commenced business in 1912 upon receipt of its
banking charter from the North Carolina State Banking Commission (the
"SBC"). The Bank is primarily regulated by the SBC and the Federal Deposit
Insurance Corporation and undergoes periodic examinations by these
regulatory agencies. The Bank, whose main office is in Newton, North
Carolina, provides a full range of commercial and consumer banking services
primarily in Catawba, Alexander, Lincoln and Iredell counties in North
Carolina.
Peoples Investment Services, Inc. is a wholly owned subsidiary of the Bank,
which began operations in 1996 to provide investment and trust services
through agreements with an outside party.
Real Estate Advisory Services, Inc. is a wholly owned subsidiary of the
Bank which began operations in 1997 to provide real estate appraisal and
property management services to individuals and commercial customers of the
Bank.
Principles of Consolidation
-----------------------------
The consolidated financial statements include the financial statements of
Peoples Bancorp of North Carolina, Inc. and its wholly owned subsidiaries,
PEBK Capital Trust I and Peoples Bank, along with its wholly owned
subsidiaries, Peoples Investment Services, Inc. and Real Estate Advisory
Services, Inc. (collectively called the "Company"). All significant
intercompany balances and transactions have been eliminated in
consolidation.
Basis of Presentation
-----------------------
The accounting principles followed by the Company, and the methods of
applying these principles, conform with accounting principles generally
accepted in the United States of America ("GAAP") and with general
practices in the banking industry. In preparing the financial statements in
conformity with GAAP, management is required to make estimates and
assumptions that affect the reported amounts in the financial statements.
Actual results could differ significantly from these estimates. Material
estimates common to the banking industry that are particularly susceptible
to significant change in the near term include, but are not limited to, the
determination of the allowance for loan losses and valuation of real estate
acquired in connection with or in lieu of foreclosure on loans.
Certain amounts in the 2000 and 1999 financial statements have been
reclassified to conform to the 2001 presentation. Such reclassifications
had no effect on net earnings or total assets.
Investment Securities
----------------------
The Company classifies its securities in one of three categories: trading,
available for sale, or held to maturity. Trading securities are bought and
held principally for sale in the near term. Held to maturity securities are
those securities for which the Company has the ability and intent to hold
the security until maturity. All other securities not included in trading
or held to maturity are classified as available for sale. At December 31,
2001 and 2000, the Company had classified all of its investment securities
as available for sale.
Available for sale securities are recorded at fair value. Unrealized
holding gains and losses, net of the related tax effect, on securities
available for sale are excluded from earnings and are reported as a
separate component of shareholders' equity until realized.
A decline in the market value of any available for sale investment below
cost that is deemed other than temporary is charged to earnings and
establishes a new cost basis for the security.
Premiums and discounts are amortized or accreted over the life of the
related security as an adjustment to the yield. Realized gains and losses
for securities classified as available for sale are included in earnings
and are derived using the specific identification method for determining
the cost of securities sold.
A-26
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
Other Investments
------------------
Other investments include equity securities with no readily determinable
fair value. These investments are carried at cost.
Mortgage Loans Held for Sale
--------------------------------
Mortgage loans held for sale are carried at the lower of aggregate cost or
market value. At December 31, 2001 and 2000, the cost of mortgage loans
held for sale approximates the market value.
Loans and Allowance for Loan Losses
-----------------------------------
Loans are stated at principal amount outstanding, net of the allowance for
loan losses. Interest on loans is calculated by using the simple interest
method on daily balances of the principal amount outstanding.
Impaired loans are measured based on the present value of expected future
cash flows, discounted at the loan's effective interest rate, or at the
loan's observable market price, or the fair value of the collateral if the
loan is collateral dependent. A loan is impaired when, based on current
information and events, it is probable that all amounts due according to
the contractual terms of the loan will not be collected.
Accrual of interest is discontinued on a loan when management believes,
after considering economic conditions and collection efforts, that the
borrower's financial condition is such that collection of interest is
doubtful. Interest previously accrued but not collected is reversed against
current period earnings when such loans are placed on nonaccrual status.
The allowance for loan losses is established through a provision for loan
losses charged to earnings. Loans are charged against the allowance for
loan losses when management believes that the collectibility of the
principal is unlikely. The allowance represents an amount, which, in
management's judgment, will be adequate to absorb probable losses on
existing loans that may become uncollectible.
Management's judgment in determining the adequacy of the allowance is based
on evaluations of the collectibility of loans. These evaluations take into
consideration such factors as changes in the nature and volume of the loan
portfolio, current economic conditions that may affect the borrower's
ability to pay, overall portfolio quality, and review of specific problem
loans. In determining the adequacy of the allowance for loan losses,
management uses a loan grading system that rates individual loans into nine
risk classifications. These risk categories are assigned allocations of
loss based on management's estimate of potential loss which is generally
based on an analysis of historical loss experience, current economic
conditions, performance trends, and discounted collateral deficiencies. The
combination of these results is compared monthly to the recorded allowance
for loan losses and material differences are adjusted by increasing or
decreasing the provision for loan losses. Management uses an independent
external loan reviewer to challenge and corroborate the loan grading system
and provide additional analysis in determining the adequacy of the
allowance for loan losses and the future provisions for estimated losses.
While management uses available information to recognize losses on loans,
future additions to the allowance may be necessary based on changes in
economic conditions. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Bank's
allowance for loan losses. Such agencies may require the Bank to recognize
additions to the allowance based on judgments different than those of
management.
Mortgage Banking Activities
-----------------------------
Mortgage banking income represents net gains from the sale of mortgage
loans and fees received from borrowers and loan investors related to the
Company's origination of single-family residential mortgage loans.
A-27
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
Mortgage Banking Activities, continued
-----------------------------
Mortgage servicing rights represent the unamortized cost of purchased and
originated contractual rights to service mortgages for others in exchange
for a servicing fee. Mortgage servicing rights are amortized over the
period of estimated net servicing income and are periodically adjusted for
actual prepayments of the underlying mortgage loans. The Company recognized
servicing assets of approximately $61,000, $172,000 and $610,000 during
2001, 2000 and 1999, respectively, and amortized approximately $196,000,
$220,000 and $212,000 during 2001, 2000 and 1999, respectively.
Mortgage loans serviced for others are not included in the accompanying
balance sheets. The unpaid principal balances of mortgage loans serviced
for others was approximately $79,128,000 and $97,899,000 at December 31,
2001 and 2000, respectively.
Premises and Equipment
------------------------
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed primarily using the straight-line method over the
estimated useful lives of the assets. When assets are retired or otherwise
disposed of, the cost and related accumulated depreciation are removed from
the accounts, and any gain or loss is reflected in earnings for the period.
The cost of maintenance and repairs which do not improve or extend the
useful life of the respective asset is charged to income as incurred,
whereas significant renewals and improvements are capitalized. The range of
estimated useful lives for premises and equipment are generally as follows:
Buildings and improvements 10 - 50 years
Furniture and equipment 3 - 10 years
Income Taxes
-------------
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases. Additionally, the recognition of future tax benefits, such as
net operating loss carryforwards, is required to the extent that
realization of such benefits is more likely than not. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which the assets and liabilities are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income tax expense in
the period that includes the enactment date.
In the event the future tax consequences of differences between the
financial reporting bases and the tax bases of the Company's assets and
liabilities results in deferred tax assets, an evaluation of the
probability of being able to realize the future benefits indicated by such
asset is required. A valuation allowance is provided for the portion of the
deferred tax asset when it is more likely than not that some portion or all
of the deferred tax asset will not be realized. In assessing the
realizability of the deferred tax assets, management considers the
scheduled reversals of deferred tax liabilities, projected future taxable
income, and tax planning strategies.
Intangible Assets
------------------
Deposit base premiums, representing the cost of acquiring deposits from
other financial institutions, are being amortized by charges to earnings
over seven years using the straight-line method. Amortization of deposit
base premiums was approximately $174,000 for 2001, 2000, and 1999.
Derivative Financial Instruments
----------------------------------
To manage interest rate risk, the Company uses purchased interest rate
floors and caps. Interest rate floors and caps are agreements whereby the
Bank obtains the right receive interest payments when an interest rate
moves above or below a specified floor or cap rate. The net interest
payable or receivable on floors and caps is accrued and recognized as an
adjustment to interest income or interest expense of the related asset or
liability. The derivative instrument is recorded at fair value and the
accounting for the changes in the fair value of the instrument depends upon
its intended use at inception. The change in fair value of instruments used
as fair value hedges is accounted for in the earnings of the period
simultaneous with accounting for the fair value change of the item being
hedged. The change in fair value of the effective portion of cash flow
hedges is accounted for as a component of comprehensive income rather than
earnings. The change in fair value of derivative instruments that are not
intended as a hedge is accounted for in the earnings of the period of the
change.
A-28
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
Net Earnings Per Share
-------------------------
Net earnings per share is based on the weighted average number of common
shares outstanding during the period while the effects of potential common
shares outstanding during the period are included in diluted earnings per
share. The average market price during the year is used to compute
equivalent shares. For the years ended December 31, 2001, 2000 and 1999,
net earnings per share equaled diluted earnings per share, as the potential
common shares outstanding during the period had no effect on the
computation. Net earnings per share for the years ended December 31, 2001,
2000 and 1999 are computed based on weighted average shares outstanding of
3,218,714.
During 1999, the Company declared a 3 for 2 stock split. Additionally, the
Company declared and distributed a 10% stock dividend to its shareholders
in April, 2000. All previously reported per share amounts have been
restated to reflect the stock split and stock dividend.
Recent Accounting Pronouncements
--------------------------------
Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities - a replacement of SFAS No. 125", was effective for transfers
and servicing of financial assets occurring after March 31, 2001 and was
effective for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. The
implementation of SFAS No. 140 did not have a material impact on the
Company's financial position, results of operations or liquidity.
On July 20, 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 141 is effective for business combinations
initiated after June 30, 2001 and requires all business combinations
completed after its adoption to be accounted for under the purchase method
of accounting and establishes specific criteria for the recognition of
intangible assets separately from goodwill. SFAS No. 142 will be effective
for the Company on January 1, 2002 and addresses the accounting for
goodwill and intangible assets subsequent to their initial recognition.
Upon adoption of SFAS No. 142, goodwill and some intangible assets will no
longer be amortized and will be tested for impairment at least annually.
The Company believes the adoption of SFAS No. 142 will not have a material
impact on its financial position, results of operations or liquidity.
(2) CORPORATE REORGANIZATION
Effective August 31, 1999, Peoples Bank completed the process of converting
to a holding company form of operation. Peoples Bancorp of North Carolina,
Inc. has become the parent of Peoples Bank. Bancorp is a North Carolina,
one-bank holding company, headquartered in Newton, North Carolina.
Peoples Bank's shareholders approved the holding company reorganization at
the Bank's annual meeting held in May, 1999. Regulatory approval was
received on July 22, 1999. The holding company conversion was completed
successfully on August 31, 1999. As a result of the conversion, each share
of Bank $5 par value common stock was converted into one share of Bancorp
no par value stock, and the Bank's common stock and additional paid-in
capital accounts were combined into Bancorp's common stock account. Certain
shareholders representing 182 shares were paid cash of $5,871 in lieu of
the issuance of fractional shares. Bancorp is now the sole shareholder of
the Bank.
(3) INVESTMENT SECURITIES
Investment securities available for sale at December 31, 2001 and 2000 are
as follows:
December 31, 2001
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- ----------
Mortgage-backed securities $64,862,499 99,308 1,579,620 63,382,187
State and political subdivisions 16,433,929 242,972 273,051 16,403,850
Trust preferred securities 4,500,000 - - 4,500,000
----------- ---------- ---------- ----------
Total $85,796,428 342,280 1,852,671 84,286,037
=========== ========== ========== ==========
A-29
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(3) INVESTMENT SECURITIES, CONTINUED
December 31, 2000
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- ----------
U.S. Government agencies $24,997,100 185,280 63,334 25,119,046
Mortgage-backed securities 24,396,834 141,760 320,829 24,217,765
State and political subdivisions 22,164,868 190,651 127,486 22,228,033
----------- ---------- ---------- ----------
Total $71,558,802 517,691 511,649 71,564,844
=========== ========== ========== ==========
The amortized cost and fair value of investment securities available for
sale at December 31, 2001, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because
borrowers have the right to call or prepay obligations with or without call
or prepayment penalties.
Amortized Estimated
Cost Fair Value
----------- ----------
Due within one year $ 3,960,963 3,995,251
Due from one to five years 4,624,279 4,775,590
Due from five to ten years 3,512,815 3,539,473
Due after ten years 8,835,872 8,593,536
Mortgage-backed securities 64,862,499 63,382,187
----------- ----------
$85,796,428 84,286,037
=========== ==========
Proceeds from sales of securities available for sale during 2001, 2000, and
1999 were $82,969,419, $18,129,483 and $6,896,296, respectively. Gross
gains of $1,626,583 and $39,788 for 2001 and 1999, respectively, along with
gross losses of $12,591, $483,472 and $74,612 for 2001, 2000 and 1999,
respectively, were realized on those sales.
Securities with a carrying value of approximately $27,210,000 and
$26,022,000 at December 31, 2001 and 2000, respectively, were pledged to
secure public deposits and for other purposes as required by law.
(4) LOANS
Major classifications of loans at December 31, 2001 and 2000 are summarized
as follows:
2001 2000
------------ -----------
Commercial $102,409,403 96,881,936
Real estate - mortgage 277,737,352 229,260,731
Real estate - construction 82,790,441 58,938,765
Consumer 27,670,525 25,857,895
------------ -----------
Total loans 490,607,721 410,939,327
Less allowance for loan losses 6,090,570 4,713,227
------------ -----------
Total net loans $484,517,151 406,226,100
============ ===========
The Company grants loans and extensions of credit primarily within the
Catawba Valley region of North Carolina which encompasses Catawba and
Alexander counties and portions of Iredell and Lincoln counties.
A-30
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(4) LOANS, CONTINUED
At December 31, 2001 and 2000, the Company had nonaccrual loans
approximating $3,756,000 and $5,421,000, respectively. In addition, the
Company had approximately $655,000 and $545,000 in loans past due more than
ninety days and still accruing interest at December 31, 2001 and 2000,
respectively. Interest income that would have been recorded on nonaccrual
loans for the years ended December 31, 2001, 2000, and 1999, had they
performed in accordance with their original terms, amounted to
approximately $695,000, $508,000 and $333,000, respectively. Interest
income on nonaccrual loans included in the results of operations for 2001,
2000 and 1999 amounted to approximately $22,000, $94,000 and $61,000,
respectively.
At December 31, 2001 and 2000, the recorded investment in loans that were
considered to be impaired under SFAS No. 114 was approximately $4,408,909
and $5,966,000, respectively, of which approximately $3,756,000 at December
31, 2001 and $5,421,000 at December 31, 2000 was on nonaccrual. The related
allowance for loan losses on these loans was approximately $699,000 and
$925,000 at December 31, 2001 and 2000, respectively. The average recorded
investment in impaired loans for the twelve months ended December 31, 2001
and 2000 was approximately $5,743,000 and $3,673,000, respectively. For the
years ended December 31, 2001, 2000, and 1999, the Company recognized
approximately $38,000, $94,000 and $61,000, respectively, of interest
income on impaired loans.
Changes in the allowance for loan losses were as follows:
2001 2000 1999
------------- ----------- ----------
Balance at beginning of year $ 4,713,227 3,924,348 4,136,690
Amounts charged off (2,358,320) (1,158,381) (705,277)
Recoveries on amounts previously charged off 190,341 68,160 67,935
Provision for loan losses 3,545,322 1,879,100 425,000
------------ ----------- ----------
Balance at end of year $ 6,090,570 4,713,227 3,924,348
============ =========== ==========
(5) PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as follows:
2001 2000
------------ ----------
Land $ 2,844,746 3,300,561
Buildings and improvements 9,847,402 3,990,234
Furniture and equipment 9,427,871 7,278,731
----------- ----------
22,120,019 14,569,526
Less accumulated depreciation 7,541,460 6,310,895
----------- ----------
14,578,559 8,258,631
Construction in progress 100,632 4,649,337
----------- ----------
$14,679,191 12,907,968
=========== ==========
Depreciation expense was approximately $1,337,000, $1,139,000 and
$1,175,000, for the years ended December 31, 2001, 2000, and 1999,
respectively.
A-31
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(6) TIME DEPOSITS
The aggregate amount of time deposit accounts with a minimum denomination
of $100,000 was $156,034,091 and $129,111,812 at December 31, 2001 and
2000, respectively.
At December 31, 2001, the scheduled maturities of time deposits are as
follows:
2002 $259,481,261
2003 23,053,831
2004 4,490,824
2005 554,826
2006 and thereafter 224,449
------------
$287,805,191
============
(7) FEDERAL HOME LOAN BANK ADVANCES
The Bank has advances from the Federal Home Loan Bank ("FHLB") with monthly
interest payments at various maturity dates and interest rates ranging from
1.83% to 6.16% at December 31, 2001. The FHLB advances are collateralized
by a blanket assignment on all residential first mortgage loans and
commercial real estate loans that the Bank owns.
Advances from the FHLB outstanding at December 31, 2001 mature as follows:
Year
----
2002 $16,000,000
2003 214,286
2005 5,000,000
2010 12,000,000
2011 35,000,000
-----------
$68,214,286
===========
These borrowings are extended to the Bank under an extension of credit
equal to 20% of the Bank's total assets. The Bank is required to purchase
and hold certain amounts of FHLB stock in order to obtain FHLB borrowings.
No ready market exists for the FHLB stock, and it has no quoted market
value. The stock is redeemable at $100 per share subject to certain
limitations set by the FHLB. At December 31, 2001 and 2000 the Bank owned
FHLB stock amounting to $3,410,800 and $1,206,900, respectively.
(8) TRUST PREFERRED SECURITIES
In December, 2001 the Company formed a wholly owned Delaware statutory
trust, PEBK Capital Trust I ("PEBK Trust"), which issued $14 million of
guaranteed preferred beneficial interests in the Company's junior
subordinated deferrable interest debentures that qualify as Tier I capital
under Federal Reserve Board guidelines. All of the common securities of
PEBK Trust are owned by the Company. The proceeds from the issuance of the
common securities and the trust preferred securities were used by PEBK
Trust to purchase $14.4 million of junior subordinated debentures of the
Company, which pay interest at a floating rate equal to prime plus 50 basis
points. The proceeds received by the Company from the sale of the junior
subordinated debentures were used for general purposes, primarily to
provide capital to the Bank. The debentures represent the sole asset of
PEBK Trust. The debentures and related earnings statement effects are
eliminated in the Company's financial statements.
The Trust Preferred Securities accrue and pay quarterly distributions based
on the liquidation value of $50,000 per capital security at a floating rate
of prime plus 50 basis points. The Company has guaranteed distributions and
other payments due on the Trust Preferred Securities to the extent PEBK
Trust has funds with which to make the distributions and other payments.
The net combined effect of all the documents entered into in connection
with the Trust Preferred Securities is that the Company is liable to make
the distributions and other payments required on the Trust Preferred
Securities.
A-32
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(8) TRUST PREFERRED SECURITIES, CONTINUED
The Trust Preferred Securities are mandatorily redeemable upon maturity of
the debentures on December 31, 2031, or upon earlier redemption as provided
in the indenture. The Company has the right to redeem the debentures
purchased by PEBK Trust, in whole or in part, on or after December 31,
2006. As specified in the indenture, if the debentures are redeemed prior
to maturity, the redemption price will be the principal amount and any
accrued but unpaid interest.
(9) INCOME TAXES
The provision for income taxes is summarized as follows:
2001 2000 1999
----------- ---------- ---------
Current $2,793,871 2,822,911 1,178,095
Deferred (532,329) (246,511) 915,285
----------- ---------- ---------
$2,261,542 2,576,400 2,093,380
=========== ========== =========
The differences between the provision for income taxes and the amount computed
by applying the statutory federal income tax rate to earnings before income
taxes are as follows:
2001 2000 1999
----------- ---------- ----------
Pre-tax income at statutory rates (34%) $2,324,544 2,704,656 2,256,010
Differences:
Tax exempt interest income (331,035) (354,948) (343,143)
Nondeductible interest and other expense 56,330 64,717 54,805
Other, net (16,444) (22,229) 30,642
State taxes, net of federal benefit 228,147 184,204 95,066
----------- ---------- ----------
$2,261,542 2,576,400 2,093,380
=========== ========== ==========
The following summarizes the tax effects of temporary differences that give rise
to significant portions of the deferred tax assets and deferred tax liabilities.
The net deferred tax asset is included as a component of other assets at
December 31, 2001 and 2000.
2001 2000
---------- ---------
Deferred tax assets:
Allowance for loan losses $1,938,983 1,341,505
Amortizable intangible assets 262,652 228,305
Accrued retirement expense 92,520 103,599
Accrued contingent liabilities 9,639 83,644
Foreclosed real estate 16,193 24,669
Income from non-accrual loans 254,247 250,330
Unrealized loss on available for sale securities 588,296 -
Other 24,520 9,076
---------- ---------
Total gross deferred tax assets 3,187,050 2,041,128
---------- ---------
Deferred tax liabilities:
Unrealized gain on available for sale securities - 2,354
Deferred loan fees 1,225,178 1,187,215
Premises and equipment 133,467 150,744
Deferred income from servicing rights 378,386 349,278
Other - 24,497
---------- ---------
Total gross deferred tax liabilities 1,737,031 1,714,088
---------- ---------
Net deferred tax asset $1,450,019 327,040
========== =========
A-33
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(10) RELATED PARTY TRANSACTIONS
The Company conducts transactions with its directors and executive
officers, including companies in which they have beneficial interests, in
the normal course of business. It is the policy of the Company that loan
transactions with directors and officers be made on substantially the same
terms as those prevailing at the time made for comparable loans to other
persons. The following is a summary of activity for related party loans for
2001:
Beginning balance $ 13,088,000
New loans 4,375,000
Repayments (3,681,000)
-----------
Ending balance $ 13,782,000
===========
At December 31, 2001 and 2000, the Company had deposit relationships with
related parties of approximately $11,955,000 and $8,800,000, respectively.
The Company also enters into contracts from time to time with certain
directors for the construction of bank facilities. At December 31, 2001,
the Company had outstanding construction contracts with these directors
amounting to approximately $1,100,000. During the year ended December 31,
2001, 2000 and 1999, total construction costs for bank facilities paid to
directors was approximately $1,435,000, $2,915,000 and $374,000,
respectively.
(11) COMMITMENTS
The Company leases various office space for banking and operational
facilities under operating lease arrangements. Future minimum lease
payments required for all operating leases having a remaining term in
excess of one year at December 31, 2001 are as follows:
Year Amount
---- ------
2002 $ 328,908
2003 330,908
2004 340,908
2005 340,908
2006 191,873
Thereafter 1,155,750
----------
Total minimum obligation $2,689,255
==========
Total rent expense was approximately $351,000, $361,000 and $262,000, for
2001, 2000, and 1999, respectively.
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. These financial instruments include commitments to extend
credit, standby letters of credit and financial guarantees. Those
instruments involve, to varying degrees, elements of credit risk in excess
of the amount recognized in the balance sheet. The contract amounts of
those instruments reflect the extent of involvement the Company has in
particular classes of financial instruments.
The 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 and financial guarantees written is represented
by the contractual amount of those instruments. The Company uses the same
credit policies in making commitments and conditional obligations as it
does for on-balance-sheet instruments.
A-34
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(11) COMMITMENTS, CONTINUED
In most cases, the Company does require collateral or other security to
support financial instruments with credit risk
Contractual Amount
------------------------
2001 2000
------------ ----------
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit $ 91,822,000 89,407,000
Standby letters of credit $ 1,667,000 2,208,000
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 may
expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each
customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Company, upon extension of
credit is based on management's credit evaluation. Collateral held varies
but may include unimproved and improved real estate, certificates of
deposit, or personal property.
Standby letters of credit and financial guarantees written are conditional
commitments issued by the Company to guarantee the performance of a
customer to a third party. Those guarantees are primarily issued to
businesses in the Company's delineated trade area. 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 real estate,
equipment, automobiles and customer deposits as collateral supporting those
commitments for which collateral is deemed necessary.
In the normal course of business, the Company is a party (both as plaintiff
and defendant) to a number of lawsuits. In the opinion of management and
counsel, none of these cases should have a material adverse effect on the
financial position of the Bank or the Company.
The Company has $16,500,000 available for the purchase of overnight federal
funds from three correspondent financial institutions.
(12) EMPLOYEE AND DIRECTOR BENEFIT PROGRAMS
The Company has a profit sharing and 401(k) plan for the benefit of
substantially all employees subject to certain minimum age and service
requirements. Under this plan, the Company matches employee contributions
to a maximum of five percent of annual compensation. The Company's
contribution pursuant to this formula was approximately $318,000, $249,000
and $163,000, for the years of 2001, 2000, and 1999, respectively. The
Board of Directors elected not to make a discretionary contribution in
2001, 2000, or 1999. Investments of the plan are determined by the
compensation committee consisting of selected outside directors and senior
executive officers. No investments in Company stock have been made by the
plan. The vesting schedule for the plan begins at 20 percent after three
years of employment and graduates 20 percent each year until reaching 100
percent after seven years of employment.
During December, 2001, the Company initiated a postretirement benefit plan
to provide retirement benefits to key officers and its Board of Directors
and to provide death benefits for their designated beneficiaries. Under the
plan, the Company purchased life insurance contracts on the lives of the
key officers and each director. The increase in cash surrender value of the
contracts, less the Company's cost of funds, constitutes the Company's
contribution to the plan each year. Plan participants are to be paid annual
benefits for a specified number of years commencing upon retirement. At
December 31, 2001, the cash surrender value of the insurance contracts was
approximately $4,583,000. The Company incurred no expense for benefits
relating to this plan during 2001.
A-35
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(12) EMPLOYEE AND DIRECTOR BENEFIT PROGRAMS, CONTINUED
The Company is currently paying medical benefits for certain retired
employees. Postretirement benefits, including amortization of the
transition obligation, were approximately $33,484, $30,680 and $28,830, for
the years ended December 31, 2001, 2000, and 1999, respectively. The
following table sets forth the accumulated postretirement benefit
obligation as of December 31, 2001 and 2000, which represents the liability
for accrued postretirement benefit costs:
2001 2000
--------- --------
Accumulated postretirement benefit obligation $213,536 194,598
Unrecognized transition obligation (17,407) (34,819)
Unrecognized gain (loss) (38,048) (16,024)
--------- --------
Net liability recognized $158,081 143,755
========= ========
Effective May 13, 1999, the Company adopted an Omnibus Stock Ownership and
Long Term Incentive Plan (the "Plan") whereby certain stock-based rights,
such as stock options, restricted stock, performance units, stock
appreciation rights, or book value shares, may be granted to eligible
directors and employees. A total of 321,860 shares were reserved for
possible issuance under this Plan. All rights must be granted or awarded
within ten years from the effective date.
Under the Plan, the Company awarded 5,365 book value shares to each of its
ten directors with vesting for nine of the directors over a five year
period, effective September 28, 1999, and immediate vesting for one
director. Any recipient of book value shares has no rights as a shareholder
with respect to the book value shares. The intitial value of the book value
shares awarded during 1999 was determined to be $11.45 per share. The
Company recorded an expense of approximately $43,000, $33,000 and $3,000
associated with the benefits of this plan in the years ended December 31,
2001, 2000 and 1999, respectively.
Also under the Plan, the Company granted incentive stock options to certain
eligible employees in order that they may purchase Company stock at a price
equal to the fair market value on the date of the grant. The options
granted in 1999 vest over a five year period. Options granted in 2001 and
2000 vest over a three year period. All options expire after ten years. A
summary of the activity in the Plan is presented below:
2001 2000 1999
---------------------- --------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Option Price Option Price Option Price
Shares Per Share Shares Per Share Shares Per Share
------- ------------- ------ ------------- ------ -------------
Outstanding, beginning of year 77,598 $ 14.00 27,657 $ 16.36 - $ -
Granted during the year 62,105 $ 15.86 49,941 $ 12.69 27,657 $ 16.36
------- ------------- ------ ------------- ------ -------------
Outstanding, end of year 139,703 $ 14.82 77,598 $ 14.00 27,657 $ 16.36
======= ============= ====== ============= ====== =============
Number of shares exercisable 27,709 5,530 -
======= ====== ======
The weighted average grant-date fair value of options granted in 2001, 2000
and 1999 was $10.40, $6.24, and $6.48, respectively. Options outstanding at
December 31, 2001 are exercisable at option prices ranging from $12.69 to
$16.36, as presented in the table above. Such options have a weighted
average remaining contractual life of approximately 9 years.
A-36
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(12) EMPLOYEE AND DIRECTOR BENEFIT PROGRAMS, CONTINUED
The Plan is accounted for under Accounting Principles Board Opinion No. 25
and related interpretations. No compensation expense has been recognized
related to the grant of the incentive stock options. Had compensation cost
been determined based upon the fair value of the options at the grant
dates, the Company's net earnings and net earnings per share would have
been reduced to the proforma amounts indicated below.
2001 2000 1999
----------- ---------- ---------
Net earnings As reported $4,575,352 5,378,470 4,541,945
Proforma $4,174,899 5,185,258 4,440,959
Net earnings per share As reported $ 1.42 1.67 1.55
Proforma $ 1.30 1.61 1.52
The fair value of each option is estimated on the date of grant using the
Black-Scholes options-pricing model with the following weighted average
assumptions used for grants in 2001, 2000 and 1999, respectively - dividend
yield of 2.8%, 2.9% and 2.5%, respectively; risk free interest rate of 5%,
5% and 7%, respectively; and an expected life of 10 years. For disclosure
purposes, the Company immediately recognized the expense associated with
the option grants assuming that all awards vest upon grant.
(13) REGULATORY MATTERS
The Company is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective
action, the Company must meet specific capital guidelines that involve
quantitative measures of the 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.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital to
average assets (as defined). Management believes, as of December 31, 2001,
that Bancorp and the Bank meet all capital adequacy requirements to which
they are subject.
As of December 31, 2001 the most recent notification from the FDIC
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Bank
must maintain minimum total risk-based, Tier 1 risk-based and Tier 1
leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the
institution's category.
A-37
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(13) REGULATORY MATTERS, CONTINUED
The Company's and the Bank's actual capital amounts and ratios are
presented below.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provision
----------------- ---------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
------- -------- ------- ------- ------- -------
AS OF DECEMBER 31, 2001:
Total Capital (to Risk Weighted Assets)
Consolidated $66,254 12.27% 43,208 8.00% N/A N/A
Bank $64,841 12.03% 43,105 8.00% 53,881 10.00%
Tier 1 Capital (to Risk Weighted Assets)
Consolidated $60,163 11.14% 21,604 4.00% N/A N/A
Bank $58,750 10.90% 21,552 4.00% 32,328 6.00%
Tier 1 Capital (to Average Assets)
Consolidated $60,163 10.46% 22,999 4.00% N/A N/A
Bank $58,750 10.24% 22,959 4.00% 28,699 5.00%
AS OF DECEMBER 31, 2000:
Total Capital (to Risk Weighted Assets)
Consolidated $47,412 11.22% 33,803 8.00% N/A N/A
Bank $46,464 11.02% 33,738 8.00% 42,172 10.00%
Tier 1 Capital (to Risk Weighted Assets)
Consolidated $42,699 10.11% 16,901 4.00% N/A N/A
Bank $41,751 9.90% 16,869 4.00% 25,303 6.00%
Tier 1 Capital (to Average Assets)
Consolidated $42,699 9.10% 18,768 4.00% N/A N/A
Bank $41,751 8.91% 18,751 4.00% 23,439 5.00%
(14) SHAREHOLDERS' EQUITY
In April, 2000, the Company declared and distributed a 10% stock dividend
to its shareholders. On the date of distribution, certain shareholders,
representing 236 shares, were paid cash of $3,775 in lieu of fractional
shares. On February 11, 1999, the Board of Directors of the Company
declared a 3 for 2 stock split to be effected in the form of a 50% stock
dividend. On the date of distribution, 182 shares, representing all
fractional shares, were paid cash of $5,871 representing the February 22,
1999 market price. All share and per share amounts have been changed to
reflect the stock split and stock dividend as if it had occurred on
December 31, 1998.
On June 27, 2000, the Board of Directors of the Company approved the
Peoples Bancorp of North Carolina, Inc. Dividend Reinvestment and Stock
Purchase Plan. The Plan provides for the full or partial reinvestment of
cash dividends and optional cash purchases of the Company's stock. A total
of 200,000 shares were reserved for possible issuance and sale under this
Plan.
The Board of Directors, at its discretion, can issue shares of preferred
stock up to a maximum of 5,000,000 shares. The Board is authorized to
determine the number of shares, voting powers, designations, preferences,
limitations and relative rights.
The Board of Directors of the Bank may declare a dividend of all of its
retained earnings as it may deem appropriate, subject to the requirements
of the General Statutes of North Carolina, without prior approval from the
requisite regulatory authorities. As of December 31, 2001, this amount was
approximately $13,710,000.
A-38
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(15) OTHER OPERATING EXPENSE
Other operating expense for the years ended December 31 included the
following items that exceeded one percent of total revenues:
2001 2000 1999
-------- ------- -------
Telephone $332,569 379,801 353,536
Education and Consulting $159,720 164,750 366,488
Merchant Processing $551,513 502,085 459,682
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company is required to disclose fair value information about financial
instruments, whether or not recognized on the face of the balance sheet,
for which it is practicable to estimate that value. The assumptions used in
the estimation of the fair value of the Company's financial instruments are
detailed below. Where quoted prices are not available, fair values are
based on estimates using discounted cash flows and other valuation
techniques. The use of discounted cash flows can be significantly affected
by the assumptions used, including the discount rate and estimates of
future cash flows. The following disclosures should not be considered a
surrogate of the liquidation value of the Company, but rather a good faith
estimate of the increase or decrease in value of financial instruments held
by the Company since purchase, origination, or issuance.
Cash and Cash Equivalents
----------------------------
For cash, due from banks and federal funds sold, the carrying amount
is a reasonable estimate of fair value.
Investment Securities Available for Sale
--------------------------------------------
Fair values for investment securities are based on quoted market
prices.
Other Investments
------------------
The carrying amount of other investments approximates fair value.
Loans and Mortgage Loans Held for Sale
--------------------------------------------
The fair value of fixed rate loans is estimated by discounting the
future cash flows using the current rates at which similar loans would
be made to borrowers with similar credit ratings. For variable rate
loans, the carrying amount is a reasonable estimate of fair value.
Mortgage loans held for sale are valued based on the current price at
which these loans could be sold into the secondary market.
Cash Surrender Value of Life Insurance
-------------------------------------------
Cash values of life insurance policies are carried at the value for
which such policies may be redeemed for cash.
Mortgage Servicing Rights
---------------------------
Fair value of mortgage servicing rights is determined by estimating
the present value of the future net servicing income, on a
disaggregated basis, using anticipated prepayment assumptions.
Deposits and Demand Notes Payable
---------------------------------
The fair value of demand deposits, interest-bearing demand deposits,
savings, and demand notes payable to U.S. Treasury is the amount
payable on demand at the reporting date. The fair value of fixed
maturity certificates of deposit is estimated by discounting the
future cash flows using the rates currently offered for deposits of
similar remaining maturities.
FHLB Borrowings
----------------
The fair value of FHLB borrowings is estimated based upon discounted
future cash flows using a discount rate comparable to the current
market rate for such borrowings.
Trust Preferred Securities
----------------------------
Because the Company's trust preferred securities were issued at a
floating rate, the carrying amount is a reasonable estimate of fair
value.
A-39
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED
Commitments to Extend Credit and Standby Letters of Credit
----------------------------------------------------------
Because commitments to extend credit and standby letters of credit are
made using variable rates, the contract value is a reasonable estimate
of fair value.
Limitations
-----------
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial
instrument. These estimates do not reflect any premium or discount
that could result from offering for sale at one time the Company's
entire holdings of a particular financial instrument. Because no
market exists for a significant portion of the Company's financial
instruments, fair value estimates are based on many judgments. These
estimates are subjective in nature and involve uncertainties and
matters of significant judgment and therefore cannot be determined
with precision. Changes in assumptions could significantly affect the
estimates.
Fair value estimates are based on existing on and off-balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities
that are not considered financial instruments. Significant assets and
liabilities that are not considered financial instruments include the
deferred income taxes and premises and equipment. In addition, the tax
ramifications related to the realization of the unrealized gains and
losses can have a significant effect on fair value estimates and have
not been considered in the estimates.
The carrying amount and estimated fair values of the Company's
financial instruments at December 31, 2001 and 2000 are as follows:
2001 2000
--------------------- --------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
--------- ---------- -------- ----------
(In thousands) (In thousands)
Assets:
Cash and cash equivalents $ 15,303 15,303 18,639 18,639
Investment securities available for sale $ 84,286 84,286 71,565 71,565
Other investments $ 4,603 4,603 2,399 2,399
Loans $ 484,517 493,611 406,226 402,239
Mortgage loans held for sale $ 5,339 5,339 1,564 1,564
Cash surrender value of life insurance $ 4,583 4,583 - -
Mortgage servicing rights $ 981 981 920 920
Liabilities:
Deposits and demand notes payable $ 490,341 493,421 451,673 467,512
FHLB advances $ 68,214 68,497 21,357 22,217
Trust preferred securities $ 14,000 14,000 - -
Unrecognized financial instruments:
Commitments to extend credit $ 91,822 91,822 89,407 89,407
Standby letters of credit $ 1,667 1,667 2,208 2,208
A-40
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(17) PEOPLES BANCORP OF NORTH CAROLINA, INC. (PARENT COMPANY ONLY) CONDENSED
FINANCIAL STATEMENTS
BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
Assets
------
2001 2000
----------- ----------
Cash $ 228,202 152,939
Investment in subsidiaries 58,421,072 42,091,437
Other investments 815,000 815,000
Other assets 472,872 19,056
----------- ----------
$59,937,146 43,078,432
=========== ==========
Liabilities and Shareholders' Equity
------------------------------------
Accrued expenses $ 103,043 39,413
Junior subordinated debentures 14,433,000 -
Shareholders' equity 45,401,103 43,039,019
----------- ----------
$59,937,146 43,078,432
=========== ==========
Statements of Earnings
For the Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999
---------- --------- ---------
Dividends from Bank $1,462,486 2,327,019 1,082,738
Expenses:
Interest 30,333 - -
Other operating expenses 311,117 191,519 -
---------- --------- ---------
Total expenses 341,450 191,519 -
---------- --------- ---------
Earnings before income tax benefit and equity in
undistributed earnings of subsidiaries 1,121,036 2,135,500 1,082,738
Income tax benefit 131,900 74,100 -
---------- --------- ---------
Earnings before equity in undistributed
earnings of subsidiaries 1,252,936 2,209,600 1,082,738
Equity in undistributed earnings of subsidiaries 3,322,416 3,168,870 3,459,207
---------- --------- ---------
Net earnings $4,575,352 5,378,470 4,541,945
========== ========= =========
A-41
PEOPLES BANCORP OF NORTH CAROLINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(17) Peoples Bancorp of North Carolina, Inc. (Parent Company Only) Condensed
Financial Statements, continued
Statements of Cash Flows
For the Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999
------------- ----------- -----------
Cash flows from operating activities:
Net earnings $ 4,575,352 5,378,470 4,541,945
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Equity in undistributed earnings of subsidiaries (3,322,416) (3,168,870) (3,459,207)
Provision for deferred taxes (28,076) (19,056) -
Change in:
Accrued expenses 63,630 39,413 5,871
------------- ----------- -----------
Net cash provided by operating activities 1,288,490 2,229,957 1,088,609
------------- ----------- -----------
Cash flows from investing activities:
Capital contributions to subsidiaries (13,933,000) - -
Purchase of other investments - (815,000) -
------------- ----------- -----------
Net cash used by investing activities (13,933,000) (815,000) -
------------- ----------- -----------
Cash flows from financing activities:
Proceeds from junior subordinated debentures 14,433,000 - -
Cash paid in lieu of fractional shares - (3,775) (5,871)
Dividends paid (1,287,486) (1,258,243) (1,082,738)
Transaction costs associated with trust preferred securities (425,741) - -
------------- ----------- -----------
Net cash provided (used) by financing activities 12,719,773 (1,262,018) (1,088,609)
------------- ----------- -----------
Net change in cash 75,263 152,939 -
Cash at beginning of year 152,939 - -
------------- ----------- -----------
Cash at end of year $ 228,202 152,939 -
============= =========== ===========
A-42