SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to ________
Commission file number 0-7674
First Financial Bankshares, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Texas 75-0944023
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
400 Pine Street
Abilene, Texas 79601
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (325) 627-7155
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of Exchange on Which Registered
-------------- ------------------------------------
None N/A
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $10.00 per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
As of June 30, 2003, the last business day of the registrant's most
recently completed second fiscal quarter, the aggregate market value of voting
stock held by non-affiliates was $459,223,000.
As of March 1, 2004, there were 15,483,840 shares of Common Stock
outstanding.
Documents Incorporated by Reference
Certain information called for by Part III is incorporated by reference to
the Proxy Statement for the 2004 Annual Meeting of our shareholders, which will
be filed with the Securities and Exchange Commission not later than 120 days
after December 31, 2003.
TABLE OF CONTENTS
Page
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS....................1
PART I
ITEM 1. Business.................................................1
ITEM 2. Properties..............................................11
ITEM 3. Legal Proceedings.......................................12
ITEM 4. Submission of Matters to a Vote of Security Holders.....12
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................12
ITEM 6. Selected Financial Data.................................14
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................15
ITEM 7A. Quantitative and Qualitative Disclosures About
Market Risk........................................30
ITEM 8. Financial Statements and Supplementary Data.............31
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................32
ITEM 9A. Controls and Procedures.................................33
PART III
ITEM 10. Directors and Executive Officers of the Registrant......33
ITEM 11. Executive Compensation..................................33
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management ........................................33
ITEM 13. Certain Relationships and Related Transactions..........34
ITEM 14. Principal Accounting Fees and Services..................34
PART IV
ITEM 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K........................................34
SIGNATURES..................................................................35
EXHIBIT INDEX...............................................................37
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CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING STATEMENTS
This Form 10-K contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. When used in this Form 10-K, words such as
"anticipate," "believe," "estimate," "expect," "intend," "predict," "project,"
and similar expressions, as they relate to us or our management, identify
forward-looking statements. These forward-looking statements are based on
information currently available to our management. Actual results could differ
materially from those contemplated by the forward-looking statements as a result
of certain factors, including but not limited to:
o general economic conditions;
o legislative and regulatory actions and reforms;
o competition from other financial institutions and financial
holding companies;
o the effects of and changes in trade, monetary and fiscal policies
and laws, including interest rate policies of the Federal Reserve
Board;
o changes in the demand for loans;
o fluctuations in value of collateral and loan reserves;
o inflation, interest rate, market and monetary fluctuations;
o changes in consumer spending, borrowing and savings habits;
o our ability to attract deposits;
o consequences of continued bank mergers and acquisitions in our
market area, resulting in fewer but much larger and stronger
competitors;
o acquisitions and integration of acquired businesses; and
o other factors described in "PART II, Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of
Operations."
Such statements reflect the current views of our management with respect to
future events and are subject to these and other risks, uncertainties and
assumptions relating to our operations, results of operations, growth strategy
and liquidity. All subsequent written and oral forward-looking statements
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by this paragraph. We undertake no obligation to publicly update
or otherwise revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
PART I
ITEM 1. BUSINESS
General
First Financial Bankshares, Inc., a Texas corporation, is a financial
holding company registered under the Bank Holding Company Act of 1956, or BHCA.
As such, we are supervised by the Board of Governors of the Federal Reserve
System, or Federal Reserve Board, as well as several other state and federal
regulators. We were formed as a bank holding company in 1956 under the original
name F & M Operating Company, but our banking operations date back to 1890, when
Farmers and Merchants National Bank opened for business in Abilene, Texas. By
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virtue of a series of reorganizations, mergers, and acquisitions since 1956, we
now own, through our wholly-owned Delaware subsidiary, First Financial
Bankshares of Delaware, Inc., ten banks, a trust company and a technology
operating company, all organized and located in Texas. These subsidiaries are:
o First National Bank of Abilene, Abilene, Texas;
o First Technology Services, Inc., Abilene, Texas;
o First Financial Trust & Asset Management Company, National
Association, Abilene, Texas;
o Hereford State Bank, Hereford, Texas;
o First National Bank, Sweetwater, Texas;
o Eastland National Bank, Eastland, Texas;
o First Financial Bank, National Association, Cleburne, Texas;
o Stephenville Bank and Trust Co., Stephenville,Texas;
o San Angelo National Bank, San Angelo, Texas;
o Weatherford National Bank, Weatherford, Texas;
o First Financial Bank, National Association, Southlake, Texas; and
o City National Bank, Mineral Wells, Texas.
As described in more detail below, we elected to be treated as a financial
holding company in September 2001.
Our service centers are located primarily in North-Central and West Texas.
Considering the branches and locations of all our subsidiaries, as of December
31, 2003, we had 28 financial centers across Texas, with seven locations in
Abilene, two locations in Cleburne, two locations in Stephenville, two locations
in San Angelo, three locations in Weatherford, and one location each in Mineral
Wells, Hereford, Sweetwater, Eastland, Southlake, Aledo, Alvarado, Burleson,
Keller, Trophy Club, Roby, and Trent.
Information on our revenues, profits and losses and total assets appears in
the discussion of our Results of Operations contained in Item 7 hereof.
First Financial Bankshares, Inc.
We provide management and technical resources and policy direction to our
subsidiaries, which enables them to improve or expand their banking services
while continuing their local activity and identity. Each of our subsidiaries
operates under the day-to-day management of its own board of directors and
officers, with substantial authority in making decisions concerning their own
investments, loan policies, interest rates, and service charges. We provide
resources and policy direction in, among other things, the following areas:
o asset and liability management;
o accounting, budgeting, planning and insurance;
o capitalization; and
o regulatory compliance.
In particular, we assist our subsidiaries with, among other things,
decisions concerning major capital expenditures, employee fringe benefits,
including pension plans and group medical, dividend policies, and appointment of
officers and directors and their compensation. We also perform, through
corporate staff groups or by outsourcing to third parties, internal audits and
loan reviews of our subsidiaries. We provide advice and specialized services for
our banks related to lending, investing, purchasing, advertising, public
relations, and computer services.
We evaluate various potential financial institution acquisition
opportunities and evaluate potential locations for new branch offices. We
anticipate that funding for any acquisitions or expansions would be provided
from our existing cash balances, available dividends from subsidiary banks,
utilization of available lines of credit and future debt or equity offerings.
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Services Offered by Our Subsidiary Banks
Each of our subsidiary banks is a separate legal entity that operates under
the day-to-day management of its own board of directors and officers. Each of
our subsidiary banks provides general commercial banking services, which include
accepting and holding checking, savings and time deposits, making loans,
automated teller machines, drive-in and night deposit services, safe deposit
facilities, transmitting funds, and performing other customary commercial
banking services. Effective January 1, 2004, the activities of trust departments
of First National Bank of Abilene, First National Bank, Sweetwater, Stephenville
Bank and Trust Co., and San Angelo National Bank were transferred to our new
trust company, First Financial Trust & Asset Management Company, National
Association. Through this new company, we administer pension plans, profit
sharing plans and other employee benefit plans as well as administering estates,
testamentary trusts, various types of living trusts, and agency accounts. We
believe that the structure of our new trust company will result in a more
effectively managed trust department and provide trust services to customers of
our banks that do not currently have trust departments. In addition, First
National Bank of Abilene, First Financial Bank, National Association, Cleburne,
San Angelo National Bank and First Financial Bank, National Association,
Southlake, Texas provide securities brokerage services through arrangements with
various third parties.
Competition
Commercial banking in Texas is highly competitive, and because we hold less
than 1% of the state's deposits, we represent only a minor segment of the
industry. To succeed in this industry, our management believes that our banks
must have the capability to compete in the areas of (1) interest rates paid or
charged; (2) scope of services offered; and (3) prices charged for such
services. Our subsidiary banks compete in their respective service areas against
highly competitive banks, thrifts, savings and loan associations, small loan
companies, credit unions, mortgage companies, and brokerage firms, all of which
are engaged in providing financial products and services and some of which are
larger than our subsidiary banks in terms of capital, resources and personnel.
Our business does not depend on any single customer or any few customers,
the loss of any one of which would have a materially adverse effect upon our
business. Although we have a broad base of customers that are not related to us,
our customers also occasionally include our officers and directors, as well as
other entities with which we are affiliated. With our subsidiary banks we may
make loans to officers and directors, and entities with which we are affiliated,
in the ordinary course of business. We make these loans on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with other persons. Loans to directors,
officers and their affiliates are also subject to numerous restrictions under
federal and state banking laws which we describe in greater detail below.
Employees
With our subsidiary banks we employed approximately 780 full-time
equivalent employees at March 1, 2004. Our management believes that our employee
relations have been and will continue to be good.
Supervision and Regulation
Both federal and state laws extensively regulate bank holding companies,
financial holding companies and banks. These laws (and the regulations
promulgated thereunder) are primarily intended to protect depositors and the
deposit insurance fund of the Federal Deposit Insurance Corporation, or FDIC,
although shareholders may also benefit. The following information describes
particular laws and regulatory provisions relating to financial holding
companies and banks. This discussion is qualified in its entirety by reference
to the particular laws and regulatory provisions. A change in any of these laws
or regulations may have a material effect on our business and the business of
our subsidiary banks.
Bank Holding Companies and Financial Holding Companies
Traditionally, the activities of bank holding companies were limited to the
business of banking and activities closely related or incidental to banking.
Bank holding companies were generally prohibited from acquiring control of any
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company which was not a bank and from engaging in any business other than the
business of banking or managing and controlling banks. The Gramm-Leach-Bliley
Act, which took effect on March 12, 2000, dismantled many Depression-era
restrictions against affiliation between banking, securities and insurance firms
by permitting bank holding companies to engage in a broader range of financial
activities, so long as certain safeguards are observed. Specifically, bank
holding companies may elect to become "financial holding companies" that may
affiliate with securities firms and insurance companies and engage in other
activities that are financial in nature or incidental to a financial activity.
Thus, with the enactment of the Gramm-Leach-Bliley Act, banks, securities firms
and insurance companies find it easier to acquire or affiliate with each other
and cross-sell financial products. The act permits a single financial services
organization to offer a more complete array of financial products and services
than historically was permitted.
A financial holding company is essentially a bank holding company with
significantly expanded powers. Under the Gramm-Leach-Bliley Act, among the
activities that will be deemed "financial in nature" for financial holding
companies are, in addition to traditional lending activities, securities
underwriting, dealing in or making a market in securities, sponsoring mutual
funds and investment companies, insurance underwriting and agency activities,
activities which the Federal Reserve Board determines to be closely related to
banking, and certain merchant banking activities. The Federal Reserve Board has
proposed permitting a number of additional financial activities, but we cannot
predict whether any of these additional proposals will be adopted or the form
any final rule will take.
We elected to become a financial holding company in September 2001. As a
financial holding company, we have very broad discretion to affiliate with
securities firms and insurance companies, make merchant banking investments, and
engage in other activities that the Federal Reserve Board has deemed financial
in nature. In order to continue as a financial holding company, we must continue
to be well-capitalized, well-managed and maintain compliance with the Community
Reinvestment Act. Depending on the types of financial activities that we may
engage in in the future, under Gramm-Leach-Bliley's fractional regulation
principles, we may become subject to supervision by additional government
agencies. The election to be treated as a financial holding company increases
our ability to offer financial products and services that historically we were
either unable to provide or were only able to provide on a limited basis. As a
result, we will face increased competition in the markets for any new financial
products and services that we may offer. Likewise, an increased amount of
consolidation among banks and securities firms or banks and insurance firms
could result in a growing number of large financial institutions that could
compete aggressively with us.
Mergers and Acquisitions
We generally must obtain approval from the banking regulators before we can
acquire other financial institutions. We must not engage in certain acquisitions
if we are undercapitalized. Furthermore, the BHCA provides that the Federal
Reserve Board cannot approve any acquisition, merger or consolidation that may
substantially lessen competition in the banking industry, create a monopoly in
any section of the country, or be a restraint of trade. However, the Federal
Reserve Board may approve such a transaction if the convenience and needs of the
community clearly outweigh any anti-competitive effects. Specifically, the
Federal Reserve Board would consider, among other factors, the expected benefits
to the public (greater convenience, increased competition, greater efficiency,
etc.) against the risks of possible adverse effects (undue concentration of
resources, decreased or unfair competition, conflicts of interest, unsound
banking practices, etc.).
Banks
Federal and state laws and regulations that govern banks have the effect
of, among other things, regulating the scope of business, investments, cash
reserves, the purpose and nature of loans, the maximum interest rate chargeable
on loans, the amount of dividends declared, and required capitalization ratios.
National Banking Associations. Banks that are organized as national banking
associations under the National Bank Act are subject to regulation and
examination by the Office of the Comptroller of the Currency, or OCC. The OCC
supervises, regulates and regularly examines the First National Bank of Abilene,
First National Bank, Sweetwater, First Financial Bank, National Association,
Cleburne, Eastland National Bank, San Angelo National Bank, Weatherford National
Bank, First Financial Bank, National Association, Southlake and City National
Bank, Mineral Wells, as well as our new trust company, First Financial Trust &
4
Asset Management Company, National Association. The OCC's supervision and
regulation of banks is primarily intended to protect the interests of
depositors. The National Bank Act:
o requires each national banking association to maintain reserves
against deposits,
o restricts the nature and amount of loans that may be made and the
interest that may be charged, and
o restricts investments and other activities.
State Banks. Banks that are organized as state banks under Texas law are
subject to regulation and examination by the Banking Commissioner of the State
of Texas. The Commissioner regulates and supervises, and the Texas Banking
Department regularly examines, Hereford State Bank and Stephenville Bank and
Trust Co. The Commissioner's supervision and regulation of banks is primarily
designed to protect the interests of depositors. Texas law
o requires each state bank to maintain reserves against deposits,
o restricts the nature and amount of loans that may be made and the
interest that may be charged, and
o restricts investments and other activities.
Because our Texas-chartered banks are members of the FDIC, they are also
subject to regulation at the federal level by the FDIC, and are subject to most
of the federal laws described below.
Deposit Insurance
Each of our subsidiary banks is a member of the FDIC. The FDIC provides
deposit insurance protection that covers all deposit accounts in FDIC-insured
depository institutions and generally does not exceed $100,000 per depositor.
Our subsidiary banks must pay assessments to the FDIC under a risk-based
assessment system for federal deposit insurance protection. FDIC-insured
depository institutions that are members of the Bank Insurance Fund pay
insurance premiums at rates based on their risk classification. Institutions
assigned to higher risk classifications (i.e., institutions that pose a greater
risk of loss to their respective deposit insurance funds) pay assessments at
higher rates than institutions that pose a lower risk. An institution's risk
classification is assigned based on its capital levels and the level of
supervisory concern the institution poses to bank regulators. In addition, the
FDIC can impose special assessments to cover the costs of borrowings from the
U.S. Treasury, the Federal Financing Bank and the Bank Insurance Fund member
banks. As of December 31, 2003, the assessment rate for each of our subsidiary
banks is at the lowest level risk-based premium available.
Under the Financial Institutions Reform, Recovery, and Enforcement Act of
1989, or FIRREA, an FDIC-insured depository institution can be held liable for
any losses incurred by the FDIC in connection with (1) the "default" of one of
its FDIC-insured subsidiaries or (2) any assistance provided by the FDIC to one
of its FDIC-insured subsidiaries "in danger of default." "Default" is defined
generally as the appointment of a conservator or receiver, and "in danger of
default" is defined generally as the existence of certain conditions indicating
that a default is likely to occur in the absence of regulatory assistance.
The Federal Deposit Insurance Act, or FDIA requires that the FDIC review
(1) any merger or consolidation by or with an insured bank, or (2) any
establishment of branches by an insured bank. The FDIC is also empowered to
regulate interest rates paid by insured banks. Approval of the FDIC is also
required before an insured bank retires any part of its common or preferred
stock, or any capital notes or debentures. Insured banks that are also members
of the Federal Reserve System, however, are regulated with respect to the
foregoing matters by the Federal Reserve System.
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Payment of Dividends
We are a legal entity separate and distinct from our banking and other
subsidiaries. We receive most of our revenue from dividends paid to us by our
Delaware holding company subsidiary. Similarly, the Delaware holding company
subsidiary receives dividends from our bank subsidiaries. Described below are
some of the laws and regulations that apply when either we or our subsidiary
banks pay dividends.
Each state bank that is a member of the Federal Reserve System and each
national banking association is required by federal law to obtain the prior
approval of the Federal Reserve Board and the OCC, respectively, to declare and
pay dividends if the total of all dividends declared in any calendar year would
exceed the total of (1) such bank's net profits (as defined and interpreted by
regulation) for that year plus (2) its retained net profits (as defined and
interpreted by regulation) for the preceding two calendar years, less any
required transfers to surplus. In addition, these banks may only pay dividends
to the extent that retained net profits (including the portion transferred to
surplus) exceed bad debts (as defined by regulation).
Our subsidiary banks paid aggregate dividends of approximately $34.6
million in 2003 and approximately $26.6 million in 2002. Under the dividend
restrictions discussed above, as of December 31, 2003, our subsidiary banks,
without obtaining governmental approvals, could have declared in the aggregate
additional dividends of approximately $14.5 million from retained net profits.
To pay dividends, we and our subsidiary banks must maintain adequate
capital above regulatory guidelines. In addition, if the applicable regulatory
authority believes that a bank under its jurisdiction is engaged in or is about
to engage in an unsafe or unsound practice (which, depending on the financial
condition of the bank, could include the payment of dividends), the authority
may require, after notice and hearing, that such bank cease and desist from the
unsafe practice. The Federal Reserve Board and the OCC have each indicated that
paying dividends that deplete a bank's capital base to an inadequate level would
be an unsafe and unsound banking practice. The Federal Reserve Board, the OCC
and the FDIC have issued policy statements that recommend that bank holding
companies and insured banks should generally only pay dividends to the extent
that net income is sufficient to cover both cash dividends and rate of earnings
retention consistent with capital needs, asset quality and overall financial
condition. No undercapitalized institution may pay a dividend.
Affiliate Transactions
The Federal Reserve Act, the FDIA and the rules adopted under these
statutes restrict the extent to which we can borrow or otherwise obtain credit
from, or engage in certain other transactions with, our depository subsidiaries.
These laws regulate "covered transactions" between insured depository
institutions and their subsidiaries, on the one hand, and their nondepository
affiliates, on the other hand. "Covered transactions" include a loan or
extension of credit to a nondepository affiliate, a purchase of securities
issued by such an affiliate, a purchase of assets from such an affiliate (unless
otherwise exempted by the Federal Reserve Board), an acceptance of securities
issued by such an affiliate as collateral for a loan, and an issuance of a
guarantee, acceptance, or letter of credit for the benefit of such an affiliate.
The "covered transactions" that an insured depository institution and its
subsidiaries are permitted to engage in with their nondepository affiliates are
limited to the following amounts: (1) in the case of any one such affiliate, the
aggregate amount of "covered transactions" cannot exceed ten percent of the
capital stock and the surplus of the insured depository institution; and (2) in
the case of all affiliates, the aggregate amount of "covered transactions"
cannot exceed twenty percent of the capital stock and surplus of the insured
depository institution. In addition, extensions of credit that constitute
"covered transactions" must be collateralized in prescribed amounts. Further, a
bank holding company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with any extension of credit, lease or
sale of property or furnishing of services. Finally, when we and our subsidiary
banks conduct transactions internally among us, we are required to do so at
arm's length.
Loans to Directors, Executive Officers and Principal Shareholders
The authority of our subsidiary banks to extend credit to our directors,
executive officers and principal shareholders, including their immediate family
members and corporations and other entities that they control, is subject to
substantial restrictions and requirements under Sections 22(g) and 22(h) of the
Federal Reserve Act and Regulation O promulgated thereunder, as well as the
Sarbanes-Oxley Act of 2002. These statutes and regulations impose specific
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limits on the amount of loans our subsidiary banks may make to directors and
other insiders, and specified approval procedures must be followed in making
loans that exceed certain amounts. In addition, all loans our subsidiary banks
make to directors and other insiders must satisfy the following requirements:
o The loans must be made on substantially the same terms, including
interest rates and collateral, as prevailing at the time for
comparable transactions with persons not affiliated with us or the
subsidiary banks;
o The subsidiary banks must follow credit underwriting procedures at
least as stringent as those applicable to comparable transactions
with persons who are not affiliated with us or the subsidiary
banks; and
o The loans must not involve a greater than normal risk of repayment
or other unfavorable features.
Furthermore, each subsidiary bank must periodically report all loans made
to directors and other insiders to the bank regulators, and these loans are
closely scrutinized by the regulators for compliance with Sections 22(g) and
22(h) of the Federal Reserve Act and Regulation O.
Capital
Bank Holding Companies and Financial Holding Companies. The Federal Reserve
Board has adopted risk-based capital guidelines for bank holding companies and
financial holding companies. The ratio of total capital to risk weighted assets
(including certain off-balance-sheet activities, such as standby letters of
credit) must be a minimum of eight percent. At least half of the total capital
is to be composed of common shareholders' equity, minority interests in the
equity accounts of consolidated subsidiaries and a limited amount of perpetual
preferred stock, less goodwill, which is collectively referred to as Tier 1
Capital. The remainder of total capital may consist of subordinated debt, other
preferred stock and a limited amount of loan loss reserves.
In addition, the Federal Reserve Board has established minimum leverage
ratio guidelines for bank holding companies and financial holding companies.
Bank holding companies and financial holding companies that meet certain
specified criteria, including having the highest regulatory rating, must
maintain a minimum Tier 1 Capital leverage ratio (Tier 1 Capital to average
assets for the current quarter, less goodwill) of three percent. Bank holding
companies and financial holding companies that do not have the highest
regulatory rating will generally be required to maintain a higher Tier 1 Capital
leverage ratio of three percent plus an additional cushion of 100 to 200 basis
points. The Federal Reserve Board has not advised us of any specific minimum
leverage ratio applicable to us. The guidelines also provide that bank holding
companies and financial holding companies experiencing internal growth or making
acquisitions will be expected to maintain strong capital positions. Such strong
capital positions must be kept substantially above the minimum supervisory
levels without significant reliance on intangible assets (e.g., goodwill, core
deposit intangibles and purchased mortgage servicing rights). As of December 31,
2003, our capital ratios were as follows: (1) Tier 1 Capital to Risk-Weighted
Assets Ratio, 18.83%; (2) Total Capital to Risk-Weighted Assets Ratio, 19.83%;
and (3) Tier 1 Capital Leverage Ratio, 10.6%.
Banks. The Federal Deposit Insurance Corporation Improvement Act of 1991,
or FDICIA established five capital tiers with respect to depository
institutions: "well-capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized," and "critically undercapitalized." A
depository institution's capital tier will depend upon where its capital levels
are in relation to various relevant capital measures, including (1) risk-based
capital measures, (2) a leverage ratio capital measure and (3) certain other
factors. Regulations establishing the specific capital tiers provide that a
"well-capitalized" institution will have a total risk-based capital ratio of ten
percent or greater, a Tier 1 risk-based capital ratio of six percent or greater,
and a Tier 1 leverage ratio of five percent or greater, and not be subject to
any written regulatory enforcement agreement, order, capital directive or prompt
corrective action derivative. For an institution to be "adequately capitalized,"
it will have a total risk-based capital ratio of eight percent or greater, a
Tier 1 risk-based capital ratio of four percent or greater, and a Tier 1
leverage ratio of four percent or greater (in some cases three percent). For an
institution to be "undercapitalized," it will have a total risk-based capital
ratio that is less than eight percent, a Tier 1 risk-based capital ratio less
than four percent or a Tier 1 leverage ratio less than four percent (or a
leverage ratio less than three percent if the institution is rated composite 1
in its most recent report of examination, subject to appropriate federal banking
agency guidelines). For an institution to be "significantly undercapitalized,"
it will have a total risk-based capital ratio less than six percent, a Tier 1
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risk-based capital ratio less than three percent, or a Tier 1 leverage ratio
less than three percent. For an institution to be "critically undercapitalized,"
it will have a ratio of tangible equity to total assets equal to or less than
two percent. FDICIA requires federal banking agencies to take "prompt corrective
action" against depository institutions that do not meet minimum capital
requirements. Under current regulations, we were "well capitalized" as of
December 31, 2003.
FDICIA generally prohibits a depository institution from making any capital
distribution (including payment of a dividend) or paying any management fee to
its holding company if the depository institution would thereafter be
"undercapitalized." An "undercapitalized" institution must develop a capital
restoration plan and its parent holding company must guarantee that
institution's compliance with such plan. The liability of the parent holding
company under any such guarantee is limited to the lesser of five percent of the
institution's assets at the time it became "undercapitalized" or the amount
needed to bring the institution into compliance with all capital standards.
Furthermore, in the event of the bankruptcy of the parent holding company, such
guarantee would take priority over the parent's general unsecured creditors. If
a depository institution fails to submit an acceptable capital restoration plan,
it shall be treated as if it is "significantly undercapitalized." "Significantly
undercapitalized" depository institutions may be subject to a number of
requirements and restrictions, including orders to sell sufficient voting stock
to become "adequately capitalized," requirements to reduce total assets, and
cessation of receipt of deposits from correspondent banks. "Critically
undercapitalized" institutions are subject to the appointment of a receiver or
conservator. Finally, FDICIA requires the various regulatory agencies to set
forth certain standards that do not relate to capital. Such standards relate to
the safety and soundness of operations and management and to asset quality and
executive compensation, and permit regulatory action against a financial
institution that does not meet such standards.
If an insured bank fails to meet its capital guidelines, it may be subject
to a variety of other enforcement remedies, including a prohibition on the
taking of brokered deposits and the termination of deposit insurance by the
FDIC. Bank regulators continue to indicate their desire to raise capital
requirements beyond their current levels.
In addition to FDICIA capital standards, Texas-chartered banks must also
comply with the capital requirements imposed by the Texas Banking Department.
Neither the Texas Finance Code nor its regulations specify any minimum
capital-to-assets ratio that must be maintained by a Texas-chartered bank.
Instead, the Texas Banking Department determines the appropriate ratio on a bank
by bank basis, considering factors such as the nature of a bank's business, its
total revenue, and the bank's total assets. As of December 31, 2003, all of our
Texas-chartered banks exceeded the minimum ratios applied to them.
Our Support of Our Subsidiary Banks
Under Federal Reserve Board policy, we are expected to commit resources to
act as a source of strength to support each of our subsidiary banks. This
support may be required at times when, absent such Federal Reserve Board policy,
we would not otherwise be required to provide it. In addition, any loans we make
to our subsidiary banks would be subordinate in right of payment to deposits and
to other indebtedness of our banks. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to a federal bank
regulatory agency to maintain the capital of a subsidiary bank will be assumed
by the bankruptcy trustee and be subject to a priority of payment.
Under the National Bank Act, if the capital stock of a national bank is
impaired by losses or otherwise, the OCC is authorized to require the bank's
shareholders to pay the deficiency on a pro-rata basis. If any shareholder
refuses to pay the pro-rata assessment after three months notice, then the
bank's board of directors must sell an appropriate amount of the shareholder's
stock at a public auction to make up the deficiency. To the extent necessary, if
a deficiency in capital still exists and the bank refuses to go into
liquidation, then a receiver may be appointed to wind up the bank's affairs.
Additionally, under the Federal Deposit Insurance Act, in the event of a loss
suffered or anticipated by the FDIC (either as a result of the default of a
banking subsidiary or related to FDIC assistance provided to a subsidiary in
danger of default) our other banking subsidiaries may be assessed for the FDIC's
loss.
8
Interstate Banking and Branching Act
Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act
of 1994, or Riegle-Neal Act, a bank holding company or financial holding company
is able to acquire banks in states other than its home state. The Riegle-Neal
Act also authorized banks to merge across state lines, thereby creating
interstate branches, beginning June 1, 1997. Furthermore, under this act, a bank
is now able to open new branches in a state in which it does not already have
banking operations, if the laws of such state permit it to do so. Accordingly,
both the OCC and the Texas Banking Department accept applications for interstate
merger and branching transactions, subject to certain limitations on ages of the
banks to be acquired and the total amount of deposits within the state a bank or
financial holding company may control. Since our primary service area is Texas,
we do not expect that the ability to operate in other states will have any
material impact on our growth strategy. We may, however, face increased
competition from out-of-state banks that branch or make acquisitions in our
primary markets in Texas.
Community Reinvestment Act of 1977
The Community Reinvestment Act of 1977, or CRA subjects a bank to
regulatory assessment to determine if the institution meets the credit needs of
its entire community, including low- and moderate-income neighborhoods served by
the bank, and to take that determination into account in its evaluation of any
application made by such bank for, among other things, approval of the
acquisition or establishment of a branch or other deposit facility, an office
relocation, a merger, or the acquisition of shares of capital stock of another
financial institution. The regulatory authority prepares a written evaluation of
an institution's record of meeting the credit needs of its entire community and
assigns a rating. We believe our subsidiary banks have taken significant actions
to comply with the CRA, and each has received at least a "satisfactory"
commendation in its most recent review by federal regulators with respect to its
compliance with the CRA.
Monitoring and Reporting Suspicious Activity
Under the Bank Secrecy Act, IRS rules and other regulations, we are
required to monitor and report unusual or suspicious account activity as well as
transactions involving the transfer or withdrawal of amounts in excess of
prescribed limits. In the wake of the tragic events of September 11th, on
October 26, 2001, the President signed the Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and Obstruct Terrorism, or USA
PATRIOT Act, of 2001. Under the USA PATRIOT Act, financial institutions are
subject to prohibitions against specified financial transactions and account
relationships as well as enhanced due diligence and "know your customer"
standards in their dealings with foreign financial institutions and foreign
customers. For example, the enhanced due diligence policies, procedures, and
controls generally require financial institutions to take reasonable steps:
o to conduct enhanced scrutiny of account relationships to guard
against money laundering and report any suspicious transaction;
o to ascertain the identity of the nominal and beneficial owners of,
and the source of funds deposited into, each account as needed to
guard against money laundering and report any suspicious
transactions;
o to ascertain for any foreign bank, the shares of which are not
publicly traded, the identity of the owners of the foreign bank,
and the nature and extent of the ownership interest of each such
owner; and
o to ascertain whether any foreign bank provides correspondent
accounts to other foreign banks and, if so, the identity of those
foreign banks and related due diligence information.
Under the USA PATRIOT Act, financial institutions are also required to
establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum
standards for these programs, including:
9
o the development of internal policies, procedures, and controls;
o the designation of a compliance officer;
o an ongoing employee training program; and
o an independent audit function to test the programs.
In addition, the USA PATRIOT Act also requires the Secretary of the
Treasury to adopt rules addressing a number of related issues, including
increasing the cooperation and information sharing between financial
institutions, regulators, and law enforcement authorities regarding individuals,
entities and organizations engaged in, or reasonably suspected based on credible
evidence of engaging in, terrorist acts or money laundering activities. Any
financial institution complying with these rules will not be deemed to violate
the privacy provisions of the Gramm-Leach-Bliley Act that are discussed below.
Finally, under the regulations of the Office of Foreign Asset Control, we are
required to monitor and block transactions with certain "specially designated
nationals" who OFAC has determined pose a risk to U.S. national security.
Consumer Laws and Regulations
We are also subject to certain consumer laws and regulations that are
designed to protect consumers in transactions with banks. While the following
list is not exhaustive, these laws and regulations include the Truth in Lending
Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited
Funds Availability Act, the Equal Credit Opportunity Act, and the Fair Housing
Act, among others. These laws and regulations among other things prohibit
discrimination on the basis of race, gender or other designated characteristics
and mandate various disclosure requirements and regulate the manner in which
financial institutions must deal with customers when taking deposits or making
loans to such customers. These and other laws also limit finance charges or
other fees or charges earned in our activities. We must comply with the
applicable provisions of these consumer protection laws and regulations as part
of our ongoing customer relations.
Technology Risk Management and Consumer Privacy
State and federal banking regulators have issued various policy statements
emphasizing the importance of technology risk management and supervision in
evaluating the safety and soundness of depository institutions with respect to
banks that contract with outside vendors to provide data processing and core
banking functions. The use of technology-related products, services, delivery
channels and processes expose a bank to various risks, particularly operational,
privacy, security, strategic, reputation and compliance risk. Banks are
generally expected to prudently manage technology-related risks as part of their
comprehensive risk management policies by identifying, measuring, monitoring and
controlling risks associated with the use of technology.
Under Section 501 of the Gramm-Leach-Bliley Act, the federal banking
agencies have established appropriate standards for financial institutions
regarding the implementation of safeguards to ensure the security and
confidentiality of customer records and information, protection against any
anticipated threats or hazards to the security or integrity of such records and
protection against unauthorized access to or use of such records or information
in a way that could result in substantial harm or inconvenience to a customer.
Among other matters, the rules require each bank to implement a comprehensive
written information security program that includes administrative, technical and
physical safeguards relating to customer information.
Under the Gramm-Leach-Bliley Act, a financial institution must also provide
its customers with a notice of privacy policies and practices. Section 502
prohibits a financial institution from disclosing nonpublic personal information
about a consumer to nonaffiliated third parties unless the institution satisfies
various notice and opt-out requirements and the customer has not elected to opt
out of the disclosure. Under Section 504, the agencies are authorized to issue
regulations as necessary to implement notice requirements and restrictions on a
financial institution's ability to disclose nonpublic personal information about
consumers to nonaffiliated third parties. Under the final rule the regulators
adopted, all banks must develop initial and annual privacy notices which
describe in general terms the bank's information sharing practices. Banks that
share nonpublic personal information about customers with nonaffiliated third
10
parties must also provide customers with an opt-out notice and a reasonable
period of time for the customer to opt out of any such disclosure (with certain
exceptions). Limitations are placed on the extent to which a bank can disclose
an account number or access code for credit card, deposit, or transaction
accounts to any nonaffiliated third party for use in marketing.
Monetary Policy
Banks are affected by the credit policies of other monetary authorities,
including the Federal Reserve Board, that affect the national supply of credit.
The Federal Reserve Board regulates the supply of credit in order to influence
general economic conditions, primarily through open market operations in United
States government obligations, varying the discount rate on financial
institution borrowings, varying reserve requirements against financial
institution deposits, and restricting certain borrowings by financial
institutions and their subsidiaries. The monetary policies of the Federal
Reserve Board have had a significant effect on the operating results of banks in
the past and are expected to continue to do so in the future.
Pending and Proposed Legislation
New regulations and statutes are regularly proposed containing wide-ranging
proposals for altering the structures, regulations and competitive relationships
of financial institutions operating in the United States. We cannot predict
whether or in what form any proposed regulation or statute will be adopted or
the extent to which our business may be affected by any new regulation or
statute.
Enforcement Powers of Federal Banking Agencies
The Federal Reserve and other state and federal banking agencies and
regulators have broad enforcement powers, including the power to terminate
deposit insurance, issue cease-and-desist orders, impose substantial fees and
other civil and criminal penalties and appoint a conservator or receiver. Our
failure to comply with applicable laws, regulations and other regulatory
pronouncements could subject us, as well as our officers and directors, to
administrative sanctions and potentially substantial civil penalties.
Available Information
We file annual, quarterly and special reports, proxy statements and other
information with the Securities and Exchange Commission. You may read and copy
any document we file at the Securities and Exchange Commission's Public
Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call
the Securities and Exchange Commission at 1-800-SEC-0330 for further information
on the public reference room. Our SEC filings are also available to the public
at the Securities and Exchange Commission's web site at http://www.sec.gov. Our
web site is http://www.ffin.com. You may also obtain copies of our annual,
quarterly and special reports, proxy statements and certain other information
filed with the SEC, as well as amendments thereto, free of charge from our web
site. These documents are posted to our web site as soon as reasonably
practicable after we have filed them with the SEC. Our corporate governance
guidelines, including our code of conduct applicable to all our employees,
officers and directors, as well as the charters of our audit and nominating
committees, are available at www.ffin.com. The foregoing information is also
available in print to any shareholder who requests it. No information on any web
site is incorporated into this Form 10-K or our other securities filings and is
not a part of them.
ITEM 2. PROPERTIES
Our principal office is located in the First National Bank Building at 400
Pine Street in downtown Abilene, Texas. We lease two spaces in a building owned
by First National Bank of Abilene. The lease for approximately 3,300 square feet
of space expires December 31, 2010. The lease for approximately 1,100 square
feet of space expires May 31, 2006. Our subsidiary banks collectively own 22
banking facilities, some of which are detached drive-ins, and they also lease
five banking facilities and two ATM locations. Our management considers all of
our existing locations to be well-suited for conducting the business of banking.
We believe that our existing facilities are adequate to meet our requirements
and our subsidiary banks' requirements for the foreseeable future.
11
ITEM 3. LEGAL PROCEEDINGS
From time to time we and our subsidiary banks are parties to lawsuits
arising in the ordinary course of our banking business. However, there are no
material pending legal proceedings to which we, our subsidiary banks or our
other direct and indirect subsidiaries, or any of their properties, are
currently subject. Other than regular, routine examinations by state and federal
banking authorities, there are no proceedings pending or known to be
contemplated by any governmental authorities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the
fourth quarter of our fiscal year ended December 31, 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Our common stock, par value $10.00 per share, is traded on the Nasdaq Stock
Market under the trading symbol FFIN. See "Item 8--Financial Statements and
Supplementary Data--Quarterly Financial Data" for the high, low and closing
sales prices as reported by the Nasdaq National Market for our common stock for
the periods indicated.
Holders
As of February 1, 2004, we had approximately 1,600 shareholders of record.
Dividends
See "Item 8--Financial Statements and Supplementary Data--Quarterly Results
of Operations" for the frequency and amount of cash dividends paid by us. Also,
see "Item 1 - Business - Supervision and Regulation - Payment of Dividends" and
"Item 7 - Management's Discussion and Analysis of the Financial Condition and
Results of Operations - Liquidity - Dividends" for restrictions on our present
or future ability to pay dividends, particularly those restrictions arising
under federal and state banking laws.
12
Recent Sales of Unregistered Securities
During the year ended December 31, 2003, the following sales of
unregistered shares of common stock were made to employees in connection with
their exercise of stock options:
Number of Aggregate Sales
Date Common Shares Price Per Share Price
---- ------------- --------------- -----
02-11-03 551 $ 11.92 $ 6,571
03-05-03 250 11.92 2,980
03-05-03 125 11.92 1,490
03-06-03 94 16.64 1,560
03-07-03 3,018 11.92 35,969
04-03-03 187 16.64 3,120
04-03-03 1,609 11.92 19,176
04-21-03 94 16.64 1,560
04-29-03 137 23.42 3,220
04-29-03 1,250 11.92 14,900
04-29-03 1,688 11.92 20,115
04-29-03 250 11.92 2,980
04-29-03 94 16.64 1,560
05-02-03 125 11.92 1,490
05-07-03 1,071 18.15 19,468
05-07-03 313 11.92 3,725
05-08-03 94 11.92 1,118
05-08-03 250 11.92 2,980
05-14-03 1,072 18.15 19,468
05-14-03 278 23.42 6,498
05-14-03 250 16.64 4,160
05-14-03 464 11.92 5,528
05-14-03 257 23.42 6,029
06-06-03 801 11.92 9,548
06-06-03 500 11.92 5,960
06-10-03 103 23.42 2,412
06-13-03 2,012 11.92 23,983
07-08-03 549 23.42 12,858
07-21-03 2,165 16.30 35,283
07-29-03 300 23.42 7,026
07-29-03 824 23.42 19,298
09-18-03 500 23.42 11,710
11-07-03 808 11.92 9,631
11-07-03 150 23.42 3,513
12-02-03 500 11.92 5,960
12-08-03 800 18.15 14,520
12-09-03 686 23.42 16,066
12-09-03 412 23.42 9,649
12-10-03 756 23.42 17,705
12-11-03 600 11.92 7,152
12-18-03 200 11.92 2,384
------ ---------
Totals 26,187 $ 400,323
====== =========
Each of the foregoing sales were made in reliance upon the exemption
provided by Section 4(2)and Section 3(a)(10) of the Securities Act of 1933, as
amended.
13
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below as of and for the years ended
December 31, 2003, 2002, 2001, 2000, and 1999, have been derived from our
audited consolidated financial statements. The selected financial data should be
read in conjunction with "Item 7--Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our consolidated financial
statements. The results of operations presented below are not necessarily
indicative of the results of operations that may be achieved in the future. The
amounts related to shares of our common stock have been adjusted to give effect
to all stock dividends and stock splits. Management's Discussion and Analysis of
Financial Condition and Results of Operations incorporated information required
to be disclosed by the Securities and Exchange Commissions' Industry Guide 3,
"Statistical Disclosure by Bank Holding Companies."
Year Ended December 31,
---------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ---------- ---------- ---------- ----------
(dollars in thousands, except per share data)
Summary Income Statement Information:
Interest income $ 95,285 $ 104,286 $ 115,874 $ 117,951 $ 110,013
Interest expense 17,131 24,380 44,834 48,829 43,338
------------ ---------- ---------- ---------- ----------
Net interest income 78,154 79,906 71,040 69,122 66,675
Provision for loan losses 1,178 2,370 1,964 2,398 2,031
Noninterest income 34,109 30,129 28,177 25,947 24,484
Noninterest expense 61,154 59,082 55,071 51,692 51,934
------------ ---------- ---------- ---------- ----------
Earnings before income taxes 49,931 48,583 42,182 40,979 37,194
Income tax expense 14,626 14,630 12,827 12,663 11,504
------------ ---------- ---------- ---------- ----------
Net earnings $ 35,305 $ 33,953 $ 29,355 $ 28,316 $ 25,690
============ ========== ========== ========== ==========
Per Share Data:
Net earnings per share, basic $ 2.28 $ 2.20 $ 1.91 $ 1.82 $ 1.65
Net earnings per share, assuming dilution 2.27 2.19 1.90 1.82 1.64
Cash dividends declared 1.21 1.08 0.93 0.82 0.72
Book value at period-end 16.25 15.45 13.86 12.74 11.46
Earnings performance ratios:
Return on average assets 1.75% 1.78% 1.62% 1.67% 1.53%
Return on average equity 14.40 14.97 14.35 15.39 14.84
Summary Balance Sheet Data (Period-end):
Investment securities $ 910,302 $ 772,256 $ 721,694 $ 654,253 $ 656,218
Loans 987,523 964,040 940,131 859,271 797,275
Total assets 2,092,571 1,993,183 1,929,694 1,753,814 1,723,369
Deposits 1,796,271 1,711,562 1,685,163 1,519,874 1,524,704
Total liabilities 1,841,085 1,754,415 1,716,040 1,557,693 1,544,706
Total shareholders' equity 251,487 238,768 213,654 196,121 178,663
Asset quality ratios:
Allowance for loan losses/period-end loans 1.17% 1.16% 1.13% 1.15% 1.12%
Nonperforming assets/period-end loans plus
foreclosed assets 0.32 0.44 0.51 0.48 0.26
Net charge offs/average loans 0.09 0.19 0.18 0.18 0.27
Capital ratios:
Average shareholders' equity/average assets 12.13% 11.89% 11.29% 10.86% 10.30%
Leverage ratio (1) 10.60 10.51 9.92 10.40 9.62
Tier 1 risk-based capital (2) 18.83 18.42 17.10 17.75 17.19
Total risk-based capital (3) 19.83 19.47 18.08 18.74 18.13
Dividend payout ratio 53.10 49.13 48.94 45.23 43.64
- --------------------------------------------------------------------------------
(1) Calculated by dividing, at period-end, shareholders' equity (before
unrealized gain/loss on securities available-for-sale) less intangible
assets by fourth quarter average assets less intangible assets.
(2) Calculated by dividing, at period-end, shareholders' equity (before
unrealized gain/loss on securities available-for-sale) less intangible
assets by risk-adjusted assets.
(3) Calculated by dividing, at period-end, shareholders' equity (before
unrealized gain/loss on securities available for sale) less intangible
assets plus allowance for loan losses to the extent allowed under
regulatory guidelines by risk-adjusted assets.
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Introduction
As a multi-bank financial holding company, we generate most of our revenue
from interest on loans and investments, trust fees, and service charges. Our
primary source of funding for our loans are deposits we hold in our subsidiary
banks. Our largest expenses are interest on these deposits and salaries and
related employee benefits. We usually measure our performance by calculating our
return on average assets, return on average equity, our regulatory leverage and
risk based capital ratios, and our efficiency ratio, which is calculated by
dividing non interest expense by the sum of net interest income on a tax
equivalent basis and non interest income.
You should read the following discussion and analysis of the major elements
of our consolidated balance sheets as of December 31, 2003 and 2002, and
consolidated statements of earnings for the years 2001 through 2003 in
conjunction with our consolidated financial statements, accompanying notes, and
selected financial data presented elsewhere in this Form 10-K. All prices and
per share data related to our common stock have been adjusted to give effect to
all stock splits and stock dividends, including the five-for-four stock split in
the form of a 25% stock dividend effective June 2, 2003 for shareholders of
record on May 16, 2003.
Critical Accounting Policies
We prepare consolidated financial statements based on the selection of
certain accounting policies, generally accepted accounting principles and
customary practices in the banking industry. These policies, in certain areas,
require us to make significant estimates and assumptions.
We deem a policy critical if (1) the accounting estimate required us to
make assumptions about matters that are highly uncertain at the time we make the
accounting estimate; and (2) different estimates that reasonably could have been
used in the current period, or changes in the accounting estimate that are
reasonably likely to occur from period to period, would have a material impact
on the financial statements.
The following discussion addresses our allowance for loan loss and its
provision for loan losses, which we deem to be our most critical accounting
policy. We have other significant accounting policies and continue to evaluate
the materiality of their impact on our consolidated financial statements, but we
believe that these other policies either do not generally require us to make
estimates and judgments that are difficult or subjective, or it is less likely
that they would have a material impact on our reported results for a given
period.
The allowance for loan losses is an amount that we believe will be adequate
to absorb inherent estimated losses on existing loans in which full
collectibility is unlikely based upon our review and evaluation of the loan
portfolio, including letters of credit, lines of credit and unused commitments
to provide financing. The allowance for loan losses is increased by charges to
income and decreased by charge-offs (net of recoveries).
Our periodic evaluation of the adequacy of the allowance is based on
general economic conditions, the financial condition of the borrower, the value
and liquidity of collateral, delinquency, prior loan loss experience, and the
results of periodic reviews of the portfolio by our independent loan review
department and regulatory examiners. We have developed a consistent,
well-documented loan review methodology that includes allowances assigned to
specific loans and nonspecific allowances, which are based on the factors noted
in the prior sentence. While each subsidiary bank is responsible for the
adequacy of its allowance, our independent loan review department is responsible
for reviewing this evaluation for all of our subsidiary banks to ensure
consistent methodology and overall adequacy for us.
Although we believe that we use the best information available to make loan
loss allowance determinations, future adjustments could be necessary if
circumstances or economic conditions differ substantially from the assumptions
used in making our initial determinations. A downturn in the economy and
employment could result in increased levels of nonperforming assets and
charge-offs, increased loan loss provisions and reductions in income.
Additionally, as an integral part of their examination process, bank regulatory
15
agencies periodically review our allowance for loan losses. The bank regulatory
agencies could require the recognition of additions to the loan loss allowance
based on their judgment of information available to them at the time of their
examination.
Accrual of interest is discontinued on a loan when management believes,
after considering economic and business conditions and collection efforts, that
the borrower's financial condition is such that collection of interest is
doubtful.
Our policy requires measurement of the allowance for an impaired collateral
dependent loan based on the fair value of the collateral. Other loan impairments
are measured based on the present value of expected future cash flows or the
loan's observable market price.
Results of Operations
Performance Summary. Net earnings for 2003 were $35.3 million, an increase
of $1.4 million, or 3.98% over net earnings for 2002 of $34.0 million. Net
earnings for 2001 were $29.4 million. The increase in net earnings for 2003 over
2002 was primarily attributable to growth in noninterest income and a decline in
the provision for loan losses. The increase in net earnings for 2002 over 2001
was primarily attributable to an increase in net interest income resulting
primarily from the growth in average earning assets and an overall improved net
interest margin. The improvement in loan loss provision experienced in 2003 over
2002 was due to decreases in net charge-offs and nonperforming loans.
On a basic net earnings per share basis, net earnings were $2.28 for 2003
as compared to $2.20 for 2002 and $1.91 for 2001. Return on average assets was
1.75% for 2003 as compared to 1.78% for 2002 and 1.62% for 2001. Return on
average equity was 14.40% for 2003 as compared to 14.97% for 2002 and 14.35% for
2001.
The implementation of Statement of Financial Accounting Standards No. 141,
"Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142")
affect our 2003 and 2002 net earnings and basic and diluted earnings per share
as compared to 2001 amounts. SFAS No. 141 required that all business
combinations initiated after June 30, 2001 be accounted for under the purchase
method and addressed the initial recognition and measurement of goodwill and
other intangible assets acquired in a business combination. SFAS No. 142 also
addressed the accounting for goodwill and other intangible assets subsequent to
their acquisition. SFAS No. 142 provided that intangible assets with finite
useful lives continue to be amortized and that goodwill and intangible assets
with indefinite lives no longer be amortized, but rather be tested annually for
impairment. SFAS No. 142 was effective January 1, 2002; however, acquired
goodwill and intangible assets recorded in the acquisition of City Bancshares,
Inc. were subject immediately to its provisions.
On January 1, 2002, goodwill amounting to $23,765,896 was not subject to
further amortization as a result of SFAS No. 142. We conducted our required
goodwill impairment test in 2003 and 2002, with no reduction of recorded
goodwill resulting from the test. A reconciliation adjusting comparative net
earnings and earnings per share for the year ended December 31, 2001, to show
the effect of no longer amortizing our goodwill, follows:
16
Reported net earnings $ 29,354,505
Add back: goodwill amortization
Goodwill amortization, before income tax 1,641,367
Income tax benefit (420,000)
------------
Adjusted net earnings $ 30,575,872
============
Basic earnings per share:
Reported net earnings $ 1.91
Goodwill amortization, net of income tax benefit 0.08
------------
Adjusted net earnings $ 1.99
============
Earnings per share, assuming dilution:
Reported net earnings $ 1.90
Goodwill amortization, net of income tax benefit 0.08
------------
Adjusted net earnings $ 1.98
============
On July 3, 2001, we acquired City Bancshares, Inc. and its subsidiary City
National Bank, Mineral Wells, Texas for $16.5 million in cash. The results of
City National Bank are included in our consolidated financial statements
beginning July 1, 2001 and may to some extent affect the comparisons to the
prior period amounts and 2003 and 2002 operating results which include full
years of City National Bank's operations.
Net Interest Income. Net interest income is the difference between interest
income on earning assets and interest expense on liabilities incurred to fund
those assets. Our earning assets consist primarily of loans and investment
securities. Our liabilities to fund those assets consist primarily of
noninterest-bearing and interest-bearing deposits. Tax-equivalent net interest
income was $82.3 million in 2003 as compared to $83.6 million in 2002 and $74.2
million in 2001. The decrease in 2003 compared to 2002 was the result of
declining net interest spreads offset by increases in volume of earning assets.
In 2002, the increase over 2001 was primarily due to the growth in the volume of
earning assets and an improved net interest spread. Average earning assets were
$1.856 billion in 2003, as compared to $1.748 billion in 2002 and $1.653 billion
in 2001. The 2003 increase in average earning assets is attributable to a larger
volume of investment securities we held, which increased $118.1 million, and a
larger volume of loans we made, which increased $4.1 million. These increases
were partially offset by a $14.4 million decrease in the 2003 average of
short-term investments, which consist primarily of federal funds sold. The 2002
increase in average earning assets was attributable to higher average investment
securities we held, which increased $72.3 million, and higher average loans we
made, which increased $44.5 million. Table 1 allocates the change in
tax-equivalent net interest income between the amount of change attributable to
volume and rate.
Table 1 -- Changes in Interest Income and Interest Expense (in thousands):
2003 Compared to 2002 2002 Compared to 2001
------------------------------------ ------------------------------------
Change Attributable to Change Attributable to
--------------------- Total ----------------------- Total
Volume Rate Change Volume Rate Change
-------- -------- ---------- ----------- -------- --------
Short-term investments................. $ (239) $ (241) $ (480) $ (905) $ (1,359) $ (2,264)
Taxable investment securities.......... 4,907 (8,234) (3,327) 3,394 (3,094) 300
Tax-exempt investment securities (1)... 1,925 (325) 1,600 1,032 241 1,273
Loans (1).............................. 277 (6,599) (6,322) 3,690 (14,065) (10,375)
-------- -------- ---------- ----------- -------- --------
Interest income.................... 6,870 (15,399) (8,529) 7,211 (18,277) (11,066)
Interest-bearing deposits.............. 943 (8,063) (7,120) 1,169 (21,052) (19,883)
Short-term borrowings.................. (59) (70) (129) (26) (545) (571)
-------- -------- ---------- ----------- -------- --------
Interest expense................... 884 (8,133) (7,249) 1,143 (21,597) (20,454)
-------- -------- ---------- ----------- -------- --------
Net interest income (expense) $ 5,986 $ (7,266) $ (1,280) $ 6,068 $ 3,320 $ 9,388
======== ======== ========== =========== ======== ========
- ------------------
(1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
The net interest margin, which measures tax-equivalent net interest income
as a percentage of average earning assets, is illustrated in Table 2 for the
years 2001 through 2003. As the prime rate declined from 4.75% to 4.00% in 2003,
17
we repriced our earning assets correspondingly as the market required but were
unable to reduce interest bearing deposits by the same amounts as some deposits
had previously been reduced to the lowest rates we believed the market could
bear. This change resulted in a lower net interest margin. In 2002, we repriced
our interest bearing deposits more than our earning assets as we had repriced
earning assets in 2001 in advance of changes to rates of interest bearing
deposits. This repricing improved our net margin in 2002 over 2001.
Table 2 -- Average Balances and Average Yields and Rates (in thousands,
except percentages):
2003 2002 2001
------------------------- ------------------------- -------------------------
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
---------- -------- ---- ---------- -------- ---- ---------- -------- ----
Assets
Short-term investments..... $ 42,643 $ 467 1.10% $ 57,030 $ 947 1.66% $ 79,424 $ 3,211 4.04%
Taxable investment securities 688,178 29,143 4.23 597,830 32,470 5.43 540,771 32,170 5.95
Tax-exempt investment
securities (1)............ 178,541 12,075 6.76 150,824 10,475 6.95 135,620 9,202 6.79
Loans (1)(2)............... 946,173 57,768 6.11 942,101 64,090 6.80 897,616 74,465 8.30
---------- -------- ---------- -------- ---------- --------
Total earning assets...... 1,855,535 99,453 5.36 1,747,785 107,982 6.18 1,653,431 119,048 7.20
Cash and due from banks.... 88,518 81,016 80,032
Bank premises and equipment 41,866 41,195 40,903
Other assets............... 21,825 24,458 17,693
Goodwill, net.............. 23,866 24,644 29,178
Allowance for loan losses.. (11,425) (11,099) (10,107)
---------- ---------- ----------
Total assets.............. $2,020,185 $1,907,999 $1,811,130
========== ========== ==========
Liabilities and Shareholders'
Equity
Interest-bearing deposits.. $1,308,485 $ 16,968 1.30% $1,259,158 $ 24,088 1.91% $1,226,560 $ 43,971 3.58%
Short-term borrowings...... 19,615 163 0.83 24,628 292 1.19 25,392 863 3.40
---------- -------- ---------- -------- ---------- --------
Total interest-bearing
liabilities............... 1,328,100 17,131 1.29 1,283,786 24,380 1.90 1,251,952 44,834 3.58
-------- -------- --------
Noninterest-bearing deposits 430,747 385,012 339,800
Other liabilities.......... 16,210 12,433 14,861
---------- ---------- ----------
Total liabilities......... 1,775,057 1,681,231 1,606,613
Shareholders' equity......... 245,128 226,768 204,517
---------- ---------- ----------
Total liabilities and
shareholders' equity...... $2,020,185 $1,907,999 $1,811,130
========== ========== ==========
Net interest income.......... $ 82,322 $ 83,602 $ 74,214
======== ======== ========
Rate Analysis:
Interest income/earning
assets..................... 5.36% 6.18% 7.20%
Interest expense/earning
assets..................... 0.92 1.40 2.71
---- ---- ----
Net yield on earning assets 4.44% 4.78% 4.49%
==== ==== ====
- ---------------
(1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
(2) Nonaccrual loans are included in loans.
Noninterest Income. Noninterest income for 2003 was $34.1 million, an
increase of $4.0 million, or 13.2%, as compared to 2002. The increase resulted
primarily from (1) an increase in real estate mortgage fees of $1.1 million from
a continued high volume of mortgage originations and refinancing transactions
generated by low mortgage rates; (2) an increase in the gain from sale of
student loans of $1.1 million resulting from increased fees received from the
sale, (3) an increase in the gain on sale of other real estate of $736 thousand,
primarily from the sale of two properties, (4) an increase of $415 thousand in
ATM transaction fees which reflects our effort to increase the cardholder base
and the usage of check cards; and (5) an increase of $176 thousand in check
printing fees.
Noninterest income for 2002 was $30.1 million, an increase of $2.0 million,
or 6.9%, as compared to 2001. The increase resulted primarily from (1) an
increase in service fees on deposit accounts of $692 thousand which reflects
growth in number of accounts and transactions processed; (2) an increase in real
estate mortgage fees of $248 thousand which reflects a continued high volume of
mortgage originations and refinancing transactions generated by low mortgage
rates; (3) an increase of $429 thousand in ATM transaction fees which reflects
our effort to increase the cardholder base and the usage of check cards; and (4)
$735 thousand in check printing fees that, in periods prior to 2002, were
recorded as a reduction in printing and supplies expense. The change in
classification for check printing fees was made in response to a change in bank
regulatory financial reporting guidelines.
Table 3 provides comparisons for other categories of noninterest income.
18
Table 3 -- Noninterest Income (in thousands):
Increase Increase
2003 (Decrease) 2002 (Decrease) 2001
------- -------- -------- -------- --------
Trust department income ............. $ 6,018 $ 182 $ 5,836 $ (55) $ 5,891
Service fees on deposit accounts .... 15,747 312 15,435 692 14,743
Real estate mortgage fees ........... 2,923 1,065 1,858 248 1,610
Net gain on sale of student loans ... 1,896 1,113 783 185 598
Net gain on sale of other real estate 743 736 7 1 6
Net gain on securities transactions . 25 9 16 (52) 68
ATM fees ............................ 2,785 415 2,370 429 1,941
Other:
Mastercard fees ................... 751 (229) 980 26 954
Check printing fees ............... 911 176 735 735 -
Miscellaneous income .............. 871 376 495 (303) 798
Safe deposit rental fees .......... 396 (7) 403 9 394
Exchange fees ..................... 184 (12) 196 11 185
Credit life fees .................. 130 (70) 200 (16) 216
Data processing fees .............. 249 4 245 (16) 261
Brokerage commissions ............. 311 (29) 340 46 294
Interest on loan recoveries ....... 169 (61) 230 12 218
------- -------- -------- -------- --------
Total other .................... 3,972 148 3,824 504 3,320
------- -------- -------- -------- --------
Total Noninterest Income .......... $34,109 $ 3,980 $ 30,129 $ 1,952 $ 28,177
======= ======== ======== ======== ========
Noninterest Expense. Total noninterest expense for 2003 was $61.2 million,
an increase of $2.1 million, or 3.5%, as compared to 2002. Noninterest expense
for 2002 amounted to $59.1 million, an increase of $4.0 million or 7.3% as
compared to 2001. An important measure in determining whether a banking company
effectively managed noninterest expenses is the efficiency ratio, which is
calculated by dividing noninterest expense by the sum of net interest income on
a tax-equivalent basis and noninterest income. Our efficiency ratio for 2003 was
52.52% compared to 51.96% for 2002, and 53.82% for 2001.
Salaries and employee benefits for 2003 totaled $33.3 million, an increase
of $1.4 million, or 4.2%, as compared to 2002. Salaries for 2003 were up $1.5
million with the increase attributable to normal pay increases and a higher
number of full time equivalent employees. Medical and other benefits increased
$688 thousand in 2003 over 2002 due primarily to adverse claims experience in
the Company's self insured health plan. Profit sharing expense for 2003
decreased $1.2 million, as compared to the prior year due to the decreased
percentage increase in net income for 2003 over 2002. Pension expense for 2003
increased $196 thousand or 16.7% over 2002 due primarily from the increased
amortization of unrecognized net loss on return on plan assets. In 2002, we
lowered the expected long-term rate of return on pension plan assets from 8.5%
to 6.5%, but reinstated the long-term rate to 8.5% during 2003 to the level we
believe is representative of expected long-term rates for the assets in our
portfolio. Effective January 1, 2004, we froze our pension plan whereby no
additional service costs will accrue in the future (unless the pension plan is
reinstated). Under current generally accepted accounting principles and
utilizing current assumptions, we do not expect any significant pension costs in
2004 and beyond as a result of this action. We replaced the costs of our frozen
pension plan with a matching of employee salary deferrals into the 401(k) plan.
Effective January 1, 2004, we will match a maximum of 4% on employee deferrals
of 5% of their respective employee compensation.
Net occupancy expense and equipment expense for 2003 was virtually
unchanged from the prior year. Intangible asset amortization resulting from the
core deposit intangible from the Mineral Wells acquisition was the same for 2003
and 2002. Other professional and service fees increased by $340 thousand in 2003
as compared to 2002 primarily as a result of a consulting agreement with Mr. Ken
Murphy, the chairman of our board of directors and fees paid for information
technology consulting.
Salaries and employee benefits for 2002 totaled $32.0 million, an increase
of $3.3 million, or 11.5%, as compared to 2001. Salaries for 2002 were up $1.6
million with the increase attributable to normal pay increases, a higher number
of full time equivalent employees and higher performance incentive payments.
Profit sharing and pension expenses for 2002 increased $823 thousand and $549
thousand, respectively, as compared to the prior year. The higher profit sharing
19
expense related to our 2002 increase in net earnings. Net occupancy expense for
2002 was virtually unchanged from the prior year and equipment expense was up
$343 thousand over the 2001 amount. The higher equipment expense resulted
primarily from higher depreciation and higher repairs and maintenance expense as
compared to 2001. Intangible asset amortization for 2002 decreased $1.5 million
and resulted primarily from the change in accounting principle that became
effective January 1, 2002 and which eliminated the amortization of goodwill.
Printing, stationery and supplies expense for 2002 increased $391 thousand over
the prior year amount. The increase for 2002 was due to $735 thousand in check
printing fees being included in noninterest income for 2002 versus a reduction
in printing expense in prior years. ATM expense for 2002 was $266 thousand
higher than the 2001 amount and reflects increased customer usage in 2002.
Table 4 -- Noninterest Expense (in thousands):
Increase Increase
2003 (Decrease) 2002 (Decrease) 2001
------------ -------- ---------- ---------- ----------
Salaries..................................... $ 25,472 $ 1,488 $ 23,984 $ 1,604 $ 22,380
Medical and other benefits................... 2,985 688 2,297 180 2,117
Profit sharing............................... 1,473 (1,208) 2,681 823 1,858
Pension...................................... 1,369 196 1,173 549 624
Payroll taxes................................ 2,050 192 1,858 152 1,706
------------ -------- ---------- ---------- ----------
Total salaries and employee benefits....... 33,349 1,356 31,993 3,308 28,685
Net occupancy expense........................ 3,941 32 3,909 (87) 3,996
Equipment expense............................ 4,869 68 4,801 343 4,458
Intangible amortization...................... 135 - 135 (1,506) 1,641
Other:
Data processing and operation fees......... 1,040 (38) 1,078 (38) 1,116
Postage.................................... 1,118 24 1,094 (80) 1,174
Printing, stationery and supplies.......... 1,431 (44) 1,475 391 1,084
Advertising................................ 1,186 17 1,169 64 1,105
Correspondent bank service charges......... 1,501 10 1,491 162 1,329
ATM expense................................ 1,515 154 1,361 266 1,095
Credit card fees........................... 506 (190) 696 27 669
Telephone.................................. 883 13 870 (8) 878
Public relations and business development.. 792 34 758 43 715
Directors' fees............................ 596 80 516 30 486
Audit and accounting fees.................. 890 105 785 39 746
Legal fees................................. 426 43 383 50 333
Other professional and service fees........ 1,136 340 796 (37) 833
Regulatory exam fees....................... 535 9 526 83 443
Travel..................................... 298 (13) 311 7 304
Courier expense............................ 803 127 676 127 549
Operational and other losses............... 542 (201) 743 203 540
Other miscellaneous expense................ 3,662 146 3,516 623 2,893
------------ -------- ---------- ---------- ----------
Total other............................. 18,860 616 18,244 1,952 16,292
------------ -------- ---------- ---------- ----------
Total Noninterest Expense.................... $ 61,154 $ 2,072 $ 59,082 $ 4,010 $ 55,072
============ ======== ========== ========== ==========
Income Taxes. Income tax expense was $14.6 million for 2003 as compared to
$14.6 million for 2002 and $12.8 million for 2001. Our effective tax rates on
pretax income were 29.3%, 30.1% and 30.4%, respectively, for the years 2003,
2002 and 2001. The slight decrease in the effective rate in 2003 was due to
deductibility of dividends paid to our employee stock ownership plan that was
implemented effective July 1, 2003.
Balance Sheet Review
Loans. Our portfolio is comprised of loans made to businesses, individuals,
and farm and ranch operations located in the primary trade areas served by our
subsidiary banks. Real estate loans represent loans primarily for new home
construction and owner-occupied real estate. The structure of loans in the real
estate mortgage classification generally provides repricing intervals to
minimize the interest rate risk inherent in long-term fixed rate mortgage loans.
20
As of December 31, 2003, total loans were $987.5 million, an increase of $23.5
million, as compared to December 31, 2002. As compared to year-end 2002, real
estate loans increased $37.4 million and commercial, financial and agriculture
loans increased $22.1 million. Consumer loans as of year-end 2003 decreased
$36.0 million as compared to 2002 due primarily to increased competition from
zero/low interest rates on automobile loans. Loans averaged $946.2 million
during 2003, an increase of $4.1 million over the prior year average.
Table 5 -- Composition of Loans (in thousands):
December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- --------- --------- ---------
Commercial, financial and agricultural..... $ 333,840 $ 311,743 $ 312,053 $ 295,032 $ 297,966
Real estate-- construction................. 77,834 50,911 47,173 40,610 43,039
Real estate-- mortgage..................... 385,770 375,256 350,382 290,920 208,895
Consumer, net of unearned income........... 190,079 226,130 230,523 232,709 247,375
---------- ---------- --------- --------- ---------
$ 987,523 $ 964,040 $ 940,131 $ 859,271 $ 797,275
========== ========== ========= ========= =========
Table 6 -- Maturity Distribution and Interest Sensitivity of Loans at
December 31, 2003 (in thousands):
The following tables summarize maturity and yield information for the
commercial, financial, and agricultural and the real estate-construction portion
of our loan portfolio as of December 31, 2003:
After One
Year
One Year Through After Five
or less Five Years Years Total
------------- ------------- ----------- ---------
Commercial, financial, and agricultural $ 228,307 $ 84,600 $ 20,933 $ 333,840
Real estate-- construction........... 60,234 14,524 3,076 77,834
------------- ------------- ----------- ---------
$ 288,541 $ 99,124 $ 24,009 $ 411,674
============= ============= =========== =========
Maturities
After One Year
---------
Loans with fixed interest rates.................... $ 62,754
Loans with floating or adjustable interest rates...
60,379
---------
$ 123,133
Asset Quality. Loan portfolios of each of our subsidiary banks are subject
to periodic reviews by our centralized independent loan review group as well as
periodic examinations by state and federal bank regulatory agencies. Loans are
placed on nonaccrual status when, in the judgment of management, the
collectibility of principal or interest under the original terms becomes
doubtful. Nonperforming assets, which consist of nonperforming loans and
foreclosed assets, were $3.2 million at December 31, 2003, as compared to $4.3
million at December 31, 2002 and $4.8 million at December 31, 2001. As a percent
of loans and foreclosed assets, nonperforming assets were 0.32% at December 31,
2003, as compared to 0.44% at December 31, 2002 and 0.51% at December 31, 2001.
We consider the level of nonperforming assets to be manageable and are not aware
of any material classified credit not properly disclosed as nonperforming at
December 31, 2003.
21
Table 7 -- Nonperforming Assets (in thousands, except percentages):
At December 31,
--------------------------------------------------------------
2003 2002 2001 2000 1999
-------- ---------- ---------- ---------- ---------
Nonaccrual loans............................. $ 1,690 $ 3,716 $ 3,727 $ 3,512 $ 1,389
Loans still accruing and past due 90 days or
more......................................... 61 14 66 34 63
Restructured loans........................... - - - - -
-------- ---------- ---------- ---------- ---------
Nonperforming loans..................... 1,751 3,730 3,793 3,546 1,452
Foreclosed assets............................ 1,420 536 1,031 546 637
-------- ---------- ---------- ---------- ---------
Total nonperforming assets.............. $ 3,171 $ 4,266 $ 4,824 $ 4,092 $ 2,089
======== ========== ========== ========== =========
As a % of loans and foreclosed assets........ 0.32% 0.44% 0.51% 0.48% 0.26%
We record interest payments received on impaired loans as interest income
unless collections of the remaining recorded investment are doubtful, at which
time we record payments received as reductions of principal. We recognized
interest income on impaired loans of approximately $46,000, $111,000 and
$136,000 during the years ended December 31, 2003, 2002, and 2001, respectively,
of which approximately $4,000, $2,000 and $9,000 represented cash interest
payments received and recorded as interest income. If interest on impaired loans
had been recognized on a full accrual basis during the years ended December 31,
2003, 2002, and 2001, respectively, such income would have approximated
$207,000, $317,000 and $399,000.
Provision and Allowance for Loan Losses. The allowance for loan losses is
the amount we determine as of a specific date to be adequate to provide for
losses on loans that we deem are uncollectible. We determine the allowance and
the required provision expense by reviewing general loss experiences and the
performances of specific credits. The provision for loan losses was $1.2 million
for 2003 as compared to $2.4 million for 2002 and $2.0 million for 2001. As a
percent of average loans, net loan charge-offs were 0.09% during 2003, 0.19%
during 2002 and 0.18% during 2001. The allowance for loan losses as a percent of
loans was 1.17% as of December 31, 2003, as compared to 1.16% as of December 31,
2002. A key indicator of the adequacy of the allowance for loan losses is the
ratio of the allowance to nonperforming loans, which consist of nonaccrual
loans, loans past due 90 days, and restructured loans. This ratio for the past
five years is disclosed in Table 7. Table 9 provides an allocation of the
allowance for loan losses based on loan type and the percent of total loans that
each major loan type represents. Other than the loan types presented in Table 9,
we had no loan concentration at December 31, 2003 that represented more than 10%
of total loans.
Although we believe that we use the best information available to make loan
loss allowance determinations, future adjustments could be necessary if
circumstances or economic conditions differ substantially from the assumptions
used in making our initial determinations. A downturn in the economy and
employment could result in increased levels of nonperforming assets and
charge-offs, increased loan loss provisions and reductions in income.
Additionally, as an integral part of their examination process, bank regulatory
agencies periodically review our allowance for loan losses. The banking agencies
could require the recognition of additions to the loan loss allowance based on
their judgment of information available to them at the time of their
examination.
22
Table 8 -- Loan Loss Experience and Allowance for Loan Losses (in
thousands, except percentages):
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
Balance at January 1,.............................. $ 11,219 $ 10,602 $ 9,888 $ 8,938 $ 8,988
Allowance established from purchase acquisitions... - - 407 - -
--------- --------- --------- --------- ---------
11,219 10,602 10,295 8,938 8,988
Charge-offs:
Commercial, financial and agricultural........... 990 1,116 1,094 950 1,038
Consumer......................................... 1,186 1,471 1,498 1,998 2,747
All other........................................ 1 - 33 45 36
--------- --------- --------- --------- ---------
Total charge-offs.................................. 2,177 2,587 2,625 2,993 3,821
Recoveries:
Commercial, financial and agricultural........... 867 288 269 391 632
Consumer......................................... 482 535 688 855 936
All other........................................ 7 11 11 299 172
--------- --------- --------- --------- ---------
Total recoveries................................... 1,356 834 968 1,545 1,740
--------- --------- --------- --------- ---------
Net charge-offs.................................... 821 1,753 1,657 1,448 2,081
Provision for loan losses.......................... 1,178 2,370 1,964 2,398 2,031
--------- --------- --------- --------- ---------
Balance at December 31,............................ $ 11,576 $ 11,219 $ 10,602 $ 9,888 $ 8,938
========= ========= ========= ========= =========
Loans at year-end.................................. $ 987,523 $ 964,040 $ 940,131 $ 859,271 $ 797,275
Average loans...................................... 946,173 942,101 897,616 817,603 779,283
Net charge-offs/average loans...................... 0.09% 0.19% 0.18% 0.18% 0.27%
Allowance for loan losses/year-end loans........... 1.17 1.16 1.13 1.15 1.12
Allowance for loan losses/nonperforming loans...... 661.10 300.78 279.51 278.85 615.55
Table 9 -- Allocation of Allowance for Loan Losses (in thousands):
2003 2002 2001 2000 1999
----------- --------- --------- --------- ----------
Allocation Allocation Allocation Allocation Allocation
Amount Amount Amount Amount Amount
----------- --------- --------- --------- ----------
Commercial, financial and agricultural........ $ 5,293 $ 3,628 $ 4,966 $ 3,394 $ 3,340
Real estate-- construction.................... 669 592 415 468 483
Real estate-- mortgage........................ 3,754 4,368 2,710 3,348 2,342
Consumer...................................... 1,860 2,631 2,511 2,678 2,773
----------- --------- --------- --------- ----------
Total..................................... $ 11,576 $ 11,219 $ 10,602 $ 9,888 $ 8,938
=========== ========= ========= ========= ==========
Percent of Total Loans:
2003 2002 2001 2000 1999
----- ----- ----- ----- -----
Commercial, financial and agricultural................ 33.81% 32.34% 33.19% 34.33% 37.37%
Real estate-- construction............................ 7.88 5.28 5.02 4.73 5.40
Real estate-- mortgage................................ 39.06 38.93 37.27 33.86 26.20
Consumer, net of unearned income...................... 19.25 23.45 24.52 27.08 31.03
Certain loans classified for regulatory purposes as doubtful, substandard,
or special mention are included in the nonperforming asset table. Also included
in classified loans are certain other loans that are deemed to be potential
problems. Potential problem loans are those loans that are currently performing
but where known information about trends or uncertainties or possible credit
problems of the borrowers causes management to have serious doubts as to the
ability of such borrowers to comply with present repayment terms, possibly
resulting in the transfer of such loans to nonperforming status. These potential
problem loans totaled $1.7 million as of December 31, 2003.
Investment Securities. Investment securities totaled $910.3 million as of
December 31, 2003, as compared to $772.3 million at December 31, 2002 and $721.7
million at December 31, 2001. At December 31, 2003, securities with an amortized
cost of $131.3 million were classified as securities held-to-maturity and
securities with a market value of $779.0 million were classified as securities
available-for-sale. As compared to December 31, 2002, the overall portfolio at
23
December 31, 2003, reflected (1) an increase of $54.7 million in U.S. Treasury
securities and obligations of U.S. government sponsored-enterprises and
agencies; (2) an increase of $55.7 million in tax-exempt obligations of states
and political subdivisions; (3) a $12.7 million decrease in corporate bonds and
other securities; and (4) a $40.5 million increase in mortgage-backed
securities. As compared to December 31, 2001, the portfolio at December 31, 2002
reflected (1) an increase of $14.8 million in U.S. Treasury securities and
obligations of U.S. government sponsored-enterprises and agencies; (2) an
increase of $12.8 million in tax-exempt obligations of states and political
subdivisions; (3) a $4.2 million decrease in corporate bonds and other
securities; and (4) a $27.2 million increase in mortgage-backed securities. The
overall portfolio yield of 4.9% at the end of 2003 was down from the prior
year-end yield of 5.6% due to lower average interest rates. We did not hold any
high risk collateralized mortgage obligations or structured notes as of December
31, 2003. See Note 2 to the Consolidated Financial Statements for additional
disclosures relating to the maturities and fair values of the investment
portfolio at December 31, 2003 and 2002.
Table 10 -- Composition of Investment Securities (dollars in thousands):
At December 31,
-----------------------------------------------------------------------------------
2003 2002 2001
----------------------- ------------------------ ------------------------
Amortized Amortized Amortized
Held-to-Maturity: Cost Fair Value Cost Fair Value Cost Fair Value
---------------- -------- -------- --------- --------- --------- ---------
U.S. Treasury securities
and obligations of U.S.
government sponsored-
enterprises and agencies $ 78,224 $ 82,405 $ 110,939 $ 117,808 $ 172,880 $ 177,872
Obligations of states and
political subdivisions.. 43,325 45,885 60,836 64,050 75,959 77,495
Corporate bonds........... 503 545 499 540 498 512
Mortgage-backed securities 9,274 9,759 28,176 29,464 41,333 42,687
Other securities.......... - - - - 4 4
-------- -------- --------- --------- --------- ---------
$131,326 $138,594 $ 200,450 $ 211,862 $ 290,674 $ 298,570
At December 31,
-------------------------------------------------------------------------------------
2003 2002 2001
------------------------- ------------------------ ------------------------
Amortized Amortized Amortized
Available-for-Sale: Cost Fair Value Cost Fair Value Cost Fair Value
------------------ ---------- ---------- --------- --------- --------- ---------
U.S. Treasury securities
and obligations of U.S.
government sponsored-
enterprises and agencies $ 253,515 $ 259,000 $ 164,090 $ 171,619 $ 93,151 $ 94,919
Obligations of states and
political subdivisions. 178,287 183,904 104,800 110,741 82,546 82,851
Corporate bonds........... 36,103 37,798 49,234 51,812 56,553 58,522
Mortgage-backed securities 291,809 291,481 228,490 232,106 189,421 191,720
Other securities.......... 6,720 6,793 5,453 5,529 3,007 3,007
---------- ---------- --------- --------- --------- ---------
766,434 778,976 552,067 571,807 424,678 431,019
---------- ---------- --------- --------- --------- ---------
$ 897,760 $ 917,570 $ 752,517 $ 783,669 $ 715,352 $ 729,589
========== ========== ========= ========= ========= =========
24
Table 11 -- Maturities and Yields of Investment Securities Held at December
31, 2003 (in thousands, except percentages):
Maturing
------------------------------------------------------------------------------------
After One Year After Five Years
One Year Through Through After
or Less Five Years Ten Years Ten Years Total
-------------- -------------- -------------- ------------- --------------
Held-to-Maturity: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
- ---------------- ------- ---- ------- ---- ------- ---- ------ ---- -------- ----
U.S. Treasury obligations.. $ - -% $ - -% $ - -% $ - -% $ - -%
Obligations of U.S.
government
sponsored-enterprises and
agencies.............. 25,760 5.73 52,464 5.67 - - - - 78,224 5.69
Obligations of states and
political subdivisions.. 10,483 6.40 11,049 6.11 21,458 7.41 335 8.44 43,325 6.84
Corporate bonds and other
securities.............. - - 499 6.17 - - 4 - 503 6.12
Mortgage-backed securities. 999 5.69 7,054 6.36 1,221 5.38 - - 9,274 6.16
------- ---- ------- ---- ------- ---- ------ ---- -------- ----
Total................... $37,242 5.92% $71,066 5.81 $22,679 7.30% $ 339 8.44% $131,326 6.10%
======= ==== ======= ==== ======= ==== ====== ==== ======== ====
Maturing
------------------------------------------------------------------------------------
After One Year After Five Years
One Year Through Through After
or Less Five Years Ten Years Ten Years Total
-------------- -------------- -------------- -------------- --------------
Available-for-Sale: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
- ------------------ ------- ---- -------- ---- -------- ---- ------- ----- -------- ----
U.S. Treasury obligations.. $ 1,007 1.89% $ 100 1.62% $ - -% $ - -% $ 1,107 1.87%
Obligations of U.S.
government
sponsored-enterprises and
agencies.............. 24,095 4.52 233,798 3.70 - - - - 257,893 3.78
Obligations of states and
political subdivisions.. 3,123 6.42 34,847 6.64 88,675 6.89 57,259 5.70 183,904 6.46
Corporate bonds and other
securities.............. 14,669 6.23 25,353 5.65 - - 4,569 5.09 44,591 5.79
Mortgage-backed
securities............ 17,998 3.59 161,209 4.07 112,195 4.37 79 4.25 291,481 4.16
------- ---- -------- ---- -------- ---- ------- ---- -------- ----
Total................... $60,892 4.71% $455,307 4.17% $200,870 5.48% $61,907 5.65% $778,976 4.67%
======= ==== ======== ==== ======== ==== ======= ==== ======== ====
Maturing
------------------------------------------------------------------------------------
After One Year After Five Years
One Year Through Through After
or Less Five Years Ten Years Ten Years Total
-------------- -------------- -------------- ------------- --------------
Total Investment Securities: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
- --------------------------- ------- ---- -------- ---- -------- ---- ------ ---- -------- ----
U.S. Treasury obligations.. $ 1,007 1.89% $ 100 1.62% $ - -% $ - -% $ 1,107 1.87%
Obligations of U.S.
government
sponsored-enterprises and
agencies.............. 49,855 5.15 286,262 4.06 - - - - 336,117 4.22
Obligations of states and
political subdivisions.. 13,606 6.40 45,896 6.51 110,133 6.99 57,594 5.72 227,229 6.54
Corporate bonds and other
securities.. 14,669 6.23 25,852 5.66 - - 4,573 5.09 45,094 5.79
Mortgage-backed
securities............ 18,997 3.70 168,263 4.17 113,416 4.38 79 4.25 300,755 4.22
------- ---- -------- ---- -------- ---- ------- ---- -------- ----
Total................... $98,134 5.17% $526,373 4.39% $223,549 5.67% $62,246 5.67% $910,302 4.88%
======= ==== ======== ==== ======== ==== ======= ==== ======== ====
All yields are computed on a tax-equivalent basis assuming a marginal tax rate
of 35%. Maturities of mortgage-backed securities are based on contractual
maturities and could differ due to prepayments of underlying mortgages.
Table 12 -- Disclosure of Investment Securities with Continuous Unrealized Loss
The following table discloses, as of December 31, 2003, our investment
securities that have been in a continuous unrealized-loss position for less than
12 months and those that have been in a continuous unrealized-loss position for
12 or more months (in thousands):
Less than 12 Months 12 Months or Longer Total
--------------------- -------------------- -------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
--------- ------- -------- ------ -------- -------
U. S. Treasury securities
and obligations of U.S.
government sponsored-
enterprises and agencies $ 45,904 $ 640 $ - $ - $ 45,904 $ 640
Obligations of state and
political subdivisions 51,027 1,537 - - 51,027 1,537
Mortgage-backed securities 145,394 2,166 - - 145,394 2,166
25
We believe the investment securities in the table above are within ranges
customary for the banking industry. The number of investment positions in this
unrealized loss position totals 278. We do not believe these unrealized losses
are "other than temporary" as (1) the Company has the ability and intent to hold
the investments to maturity, or a period of time sufficient to allow for a
recovery in market value, (2) it is not probable that the Company will be unable
to collect the amounts contractually due and (3) no decision to dispose of the
investments were made prior to the balance sheet date. The unrealized losses
noted are interest rate related due to rising rates at December 31, 2003, in
relation to previous rates in mid-2003. The duration of these investments is
less than 5 years for all securities other than the municipal bonds, which is
less than 15 years. We have not identified any issues related to the ultimate
repayment of principal as a result of credit concerns on these securities.
Deposits. Deposits held by subsidiary banks represent our primary source of
funding. Total deposits were $1.796 billion as of December 31, 2003, as compared
to $1.712 billion as of December 31, 2002 and $1.685 billion as of December 31,
2001. Table 13 provides a breakdown of average deposits and rates paid over the
past three years and the remaining maturity of time deposits of $100,000 or
more.
Table 13 -- Composition of Average Deposits and Remaining Maturity of Time
Deposits of $100,000 or More (in thousands, except percentages):
2003 2002 2001
----------------------- ----------------------- ----------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
----------- ---- ---------- ---- ---------- ----
Noninterest-bearing deposits.... $ 430,747 - $ 385,012 - $ 339,800 -
Interest-bearing deposits
Interest-bearing checking.... 306,259 0.38 315,688 0.71% 279,585 1.43%
Savings and money market
accounts................... 434,574 0.79 389,337 1.18 366,412 2.58
Time deposits under $100,000. 340,384 2.20 371,970 3.11 384,576 5.30
Time deposits of $100,000 or
more....................... 227,268 2.15 182,163 3.13 195,987 5.19
----------- ---- ---------- ---- ---------- ----
Total interest-bearing deposits 1,308,485 1.30% 1,259,158 1.91% 1,226,560 3.58%
----------- ---------- ----------
Total average deposits.......... $ 1,739,232 $1,644,170 $1,566,360
=========== ========== ==========
December 31, 2003
-----------------
Three months or less............................... $ 83,583
Over three through six months...................... 57,033
Over six through twelve months..................... 53,328
Over twelve months................................. 26,123
-----------
Total time deposits of $100,000 or more.......... $ 220,067
===========
Capital Resources
We calculate capital resources by our ability to maintain adequate
regulatory capital ratios to do business in the banking industry. Issues related
to capital resources arise primarily when we are growing at an accelerated rate
but not retaining a significant amount of our profits or when we experience
significant asset quality deterioration.
By way of background, total shareholders' equity was $251.5 million, or
12.02% of total assets, at December 31, 2003, as compared to $238.8 million, or
11.98% of total assets, at December 31, 2002. During 2003, total shareholders'
equity averaged $245.1 million, or 12.13% of average assets, as compared to
$224.4 million, or 11.76% of average assets, during 2002.
Banking regulators measure capital adequacy by means of the risk-based
capital ratio and leverage ratio. The risk-based capital rules provide for the
weighting of assets and off-balance-sheet commitments and contingencies
according to prescribed risk categories ranging from 0% to 100%. Regulatory
capital is then divided by risk-weighted assets to determine the risk-adjusted
capital ratios. The leverage ratio is computed by dividing shareholders' equity
less intangible assets by quarter-to-date average assets less intangible assets.
Regulatory minimums for risk-based and leverage ratios are 8.00% and 3.00%,
respectively. As of December 31, 2003, our total risk-based and leverage ratios
were 19.83% and 10.60%, respectively, as compared to total risk-based and
26
leverage ratios of 19.47% and 10.51% as of December 31, 2002. We believe by all
measurements our capital ratios remain well above regulatory minimums.
Interest Rate Risk. Interest rate risk results when the maturity or
repricing intervals of interest-earning assets and interest-bearing liabilities
are different. Our exposure to interest rate risk is managed primarily through
our strategy of selecting the types and terms of interest-earning assets and
interest-bearing liabilities that generate favorable earnings while limiting the
potential negative effects of changes in market interest rates. We use no
off-balance-sheet financial instruments to manage interest rate risk.
Each of our subsidiary banks has an asset liability committee that monitors
interest rate risk and compliance with investment policies as well as a holding
company-wide committee that monitors the aggregate companies' interest rate risk
and compliance with investment policies. Each subsidiary bank tracks interest
rate risk by, among other things, interest-sensitivity gap and simulation
analysis. Table 14 sets forth the interest rate sensitivity of our consolidated
assets and liabilities as of December 31, 2003, and sets forth the repricing
dates of our consolidated interest-earning assets and interest-bearing
liabilities as of that date, as well as our projected consolidated interest rate
sensitivity gap percentages for the periods presented. The table is based upon
our estimates and assumptions as to when assets and liabilities will reprice in
a changing interest rate environment. Assets and liabilities indicated as
maturing or otherwise repricing within a stated period may, in fact, mature or
reprice at different times and at different volumes than those estimated. Also,
the renewal or repricing of certain assets and liabilities can be discretionary
and subject to competitive and other pressures. Therefore, the following table
does not and cannot necessarily indicate the actual future impact of general
interest rate movements on our consolidated net interest income.
Should we be unable to maintain a reasonable balance of maturities and
repricing of our interest-earning assets and our interest-bearing liabilities,
we could be required to dispose of our assets in an unfavorable manner or pay a
higher than market rate to fund our activities. Our asset liability committees
oversee and monitor this risk.
27
Table 14 -- Interest Sensitivity Analysis (in thousands, except percentages):
December 31,
2003
Estimated
2004 2005 2006 2007 2008 Beyond Total Fair Value
---------- -------- -------- -------- -------- -------- ---------- ---------
Loans:
Fixed rate loans...... $ 100,542 $ 58,555 $ 70,124 $ 73,124 $ 78,421 $ 65,756 $446,522 $453,513
Average interest rate 6.60% 7.87% 7.22% 6.89% 6.57% 7.33% 7.01%
Adjustable rate loans 505,511 4,095 9,473 9,308 11,653 961 541,001 541,001
Average interest rate 4.57 6.18 5.96 6.44 5.94 5.49 4.67
Investment securities:
Fixed rate securities 95,403 160,909 192,410 85,207 87,847 285,795 907,571 914,839
Average interest rate 5.24 4.68 4.52 3.84 4.10 5.63 4.87
Adjustable rate
securities............ 2,731 - - - - - 2,731 2,731
Average interest rate 2.68 - - - - - 2.68
Other earning assets:
Adjustable rate other 2,678 99 - - - - 2,777 2,777
Average interest rate 0.95 0.22 - - - - 0.92
---------- -------- -------- -------- -------- -------- ---------- ---------
Total interest sensitive
assets................ 706,865 223,658 272,007 167,639 177,921 352,512 1,900,602 1,914,861
Average interest rate 4.97% 5.54% 5.27% 5.32% 5.31% 5.95% 5.32%
Interest-bearing
Deposits:
Fixed rate deposits. 475,531 32,013 7,667 11,341 6,786 309 533,647 536,208
Average interest rate 1.71 3.18 3.14 4.23 3.25 2.66 1.89
Adjustable rate
deposits.............. 790,050 - - - - - 790,050 790,050
Average interest rate 0.58 - - - - - 0.59
Other interest-bearing
liabilities:
Adjustable rate other 28,975 - - - - - 28,975 28,975
Average interest rate 1.12 - - - - - 1.12
---------- -------- -------- -------- -------- -------- ---------- ---------
Total interest sensitive
liabilities......... 1,294,556 32,013 7,667 11,341 6,786 309 1,352,672 1,355,233
Average interest rate 1.01% 3.07% 3.14% 4.23% 3.25% 2.66% 1.11%
Interest sensitivity gap $(587,691) $191,645 $264,340 $156,298 $171,135 $352,203 $547,930 $559,628
Cumulative interest
sensitivity gap..... (587,691) (396,046) (131,706) 24,592 195,727 547,930
Ratio of interest
sensitive assets to
interest sensitive
liabilities......... 54.69%
Cumulative ratio of
interest sensitive
assets to interest
sensitive liabilities 54.69% 70.14% 90.11% 101.82% 114.46% 140.51%
Cumulative interest
sensitivity gap as a
percent of earning
assets.............. (30.81)% (20.84)% (6.94)% 1.29% 10.29% 28.83%
As of December 31, 2002, our 2003 interest-sensitivity gap was $(516.1)
million and our 2003 ratio of interest sensitive assets to interest sensitive
liabilities was 58.48%.
We estimate that, as of December 31, 2003, an upward shift of interest
rates by 150 basis points would result in a 1.8% increase in projected net
interest income over the next twelve months, and a downward shift of interest
rates by 100 basis points would result in a 3.7% reduction in projected net
interest income over the next twelve months. These are good faith estimates and
assume that the composition of our interest sensitive assets and liabilities
existing at each year-end will remain constant over the relevant twelve month
measurement period and that changes in market interest rates are instantaneous
and sustained across the yield curve regardless of duration of pricing
characteristics of specific assets or liabilities. Also, this analysis does not
contemplate any actions that we might undertake in response to changes in market
interest rates. We believe, these estimates are not necessarily indicative of
what actually could occur in the event of immediate interest rate increases or
decreases of this magnitude. We also believe that it is unlikely that such
changes would occur in a short time period. As interest-bearing assets and
liabilities reprice at different time frames and proportions to market interest
rate movements, various assumptions must be made based on historical
relationships of these variables in reaching any conclusion. Since these
correlations are based on competitive and market conditions we anticipate that
our future results will likely be different from the foregoing estimates, and
such differences could be material.
28
Liquidity
Liquidity is our ability to meet cash demands as they arise. Such needs can
develop from loan demand, deposit withdrawals or acquisition opportunities.
Potential obligations resulting from the issuance of standby letters of credit
and commitments to fund future borrowings to our loan customers are other
factors affecting our liquidity needs. Many of these obligations and commitments
are expected to expire without being drawn upon; therefore the total commitment
amounts do not necessarily represent future cash requirements affecting our
liquidity position. The potential need for liquidity arising from these types of
financial instruments is represented by the contractual notional amount of the
instrument, as detailed in Tables 15 and 16. Asset liquidity is provided by cash
and assets, which are readily marketable or which will mature in the near
future. Liquid assets include cash, federal funds sold, and short-term
investments in time deposits in banks. Liquidity is also provided by access to
funding sources, which include core depositors and correspondent banks that
maintain accounts with and sell federal funds to our subsidiary banks. Other
sources of funds include our ability to sell securities under agreement to
repurchase, which amounted to $29.0 million at December 31, 2003, and an
unfunded $20.0 million line of credit established with a nonaffiliated bank
which matures on June 30, 2004. We believe the line of credit will be renewed
upon maturity. Given the strong core deposit base and relatively low loan to
deposit ratios maintained at our subsidiary banks, we consider our current
liquidity position to be adequate to meet our short- and long-term liquidity
needs.
In addition, we anticipate that any future acquisition of financial
institutions and expansion of branch locations could also place a demand on our
cash resources. Available cash at our parent company which totaled $34.2 million
at December 31, 2003, available dividends from subsidiary banks which totaled
$14.5 million at December 31, 2003, utilization of available lines of credit,
and future debt or equity offerings are expected to be the source of funding for
these potential acquisitions or expansions.
Table 15-- Contractual Obligations As of December 31, 2003 (in thousands):
Payment Due by Period
--------------------------------------------------------------------
Less than 1 Over 5
Total Amounts year 1-3 years 4-5 years years
---------- ---------- ------- -------- ----------
Deposits.............................. $1,796,271 $1,735,953 $41,882 $ 18,127 $ 309
Capital Leases........................ - - - - -
Operating Leases...................... 1,499 468 821 207 3
Outsourcing Service Contracts......... 462 462 - - -
Long Term Debt........................ - - - - -
Contributions to Pension Plan......... 250 50 100 100 -
---------- ---------- ------- -------- ----------
Total Contractual Obligations..... $1,798,482 $1,736,933 $42,803 $ 18,434 $ 312
========== ========== ======= ======== ==========
Off-Balance Sheet Arrangements. We are a party to financial instruments
with off-balance-sheet risk in the normal course of business to meet the
financing needs of our customers. These financial instruments include unfunded
lines of credit commitments to extend credit and standby letters of credit.
Those instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in our consolidated balance sheets.
Our exposure to credit loss in the event of nonperformance by the
counterparty to the financial instrument for unfunded lines of credit,
commitments to extend credit and standby letters of credit is represented by the
contractual notional amount of these instruments. We generally use the same
credit policies in making commitments and conditional obligations as we do for
on-balance-sheet instruments.
Unfunded lines of credit and 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. These commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. We
evaluate each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, as we deem necessary upon extension of credit, is based on
our credit evaluation of the counterparty. Collateral held varies but may
include accounts receivable, inventory, property, plan, and equipment and
income-producing commercial properties.
29
Standby letters of credit are conditional commitments we issue to guarantee
the performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers. The average collateral value held on letters of
credit usually exceeds the contract amount.
Table 16 - Commitments As of December 31, 2003 (in thousands):
Total Notional
Amounts Less than 1 Over 5
Committed year 1-3 years 4-5 years years
-------- -------- ------- ------- -------
Unfunded lines of credit.............. $123,803 $120,445 $ 3,358 $ - $ -
Unfunded commitments to extend credit. 62,092 56,313 1,421 2,491 1,867
Standby letters of credit............. 6,068 5,252 807 9 -
-------- -------- ------- ------- -------
Total Commercial Commitments....... $191,963 $182,010 $ 5,586 $ 2,500 $ 1,867
======== ======== ======= ======= =======
We believe we have no other off-balance sheet arrangements or transactions
with unconsolidated, special purpose entities that would expose us to liability
that is not reflected on the face of the financial statements.
Parent Company Funding. Our ability to fund various operating expenses,
dividends, and cash acquisitions is generally dependent solely on our own
earnings (without giving effect to our subsidiaries), cash reserves and funds
derived from our subsidiary banks. These funds historically have been produced
by intercompany dividends and management fees that are limited to reimbursement
of actual expenses. We anticipate that our recurring cash sources will continue
to include dividends and management fees from our subsidiary banks. At December
31, 2003, approximately $14.5 million was available for the payment of
intercompany dividends by the subsidiary banks without the prior approval of
regulatory agencies. Our subsidiary banks paid aggregate dividends of $34.6
million in 2003 and $26.6 million in 2002. Also at December 31, 2003, we had
$20.0 million available under a line of credit with an unaffiliated financial
institution.
Dividends. Our long-term dividend policy is to pay cash dividends to our
shareholders of between 40% and 50% of net earnings while maintaining adequate
capital to support growth. The cash dividend payout ratios have amounted to
53.1%, 49.1% and 48.9% of net earnings, respectively, in 2003, 2002 and 2001.
Given our current strong capital position and projected earnings and asset
growth rates, we do not anticipate any significant change in our current
dividend policy.
Each state bank that is a member of the Federal Reserve System and each
national banking association is required by federal law to obtain the prior
approval of the Federal Reserve Board and the OCC, respectively, to declare and
pay dividends if the total of all dividends declared in any calendar year would
exceed the total of (1) such bank's net profits (as defined and interpreted by
regulation) for that year plus (2) its retained net profits (as defined and
interpreted by regulation) for the preceding two calendar years, less any
required transfers to surplus. In addition, these banks may only pay dividends
to the extent that retained net profits (including the portion transferred to
surplus) exceed bad debts (as defined by regulation).
To pay dividends, we and our subsidiary banks must maintain adequate
capital above regulatory guidelines. In addition, if the applicable regulatory
authority believes that a bank under its jurisdiction is engaged in or is about
to engage in an unsafe or unsound practice (which, depending on the financial
condition of the bank, could include the payment of dividends), the authority
may require, after notice and hearing, that such bank cease and desist from the
unsafe practice. The Federal Reserve Board and the OCC have each indicated that
paying dividends that deplete a bank's capital base to an inadequate level would
be an unsafe and unsound banking practice. The Federal Reserve Board, the OCC
and the FDIC have issued policy statements that recommend that bank holding
companies and insured banks should generally only pay dividends out of current
operating earnings.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our management considers interest rate risk to be a significant market risk
for us. See "Item 7--Management's Discussion and Analysis of Financial Condition
and Results of Operations--Balance Sheet Review--Interest Rate Risk" for
disclosure regarding this market risk.
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements begin on page F-1.
Quarterly Results of Operations (in thousands, except per share and common stock
data):
The following tables set forth certain unaudited historical quarterly
financial data for each of the eight consecutive quarters in fiscal 2003 and
2002. This information is derived from unaudited consolidated financial
statements that include, in our opinion, all adjustments (consisting of normal
recurring adjustments) necessary for a fair presentation when read in
conjunction with our consolidated financial statements and notes thereto
included elsewhere in this Form 10-K. All prices and per share data related to
our common stock have been adjusted to give effect to all stock splits and stock
dividends, including the five-for-four stock split in the form of a 25% stock
dividend effective June 2, 2003 for shareholders of record on May 16, 2003.
2003
----------------------------------------------------
4th 3rd 2nd 1st
---------- ---------- ---------- ----------
Summary Income Statement Information:
Interest income $ 23,730 $ 23,209 $ 23,990 $ 24,356
Interest expense 3,830 4,097 4,482 4,722
---------- ---------- ---------- ----------
Net interest income 19,900 19,112 19,508 19,634
Provision for loan losses 208 233 226 511
---------- ---------- ---------- ----------
Net interest income after provision for loan losses 19,692 18,879 19,282 19,123
Noninterest income 7,669 8,836 9,513 8,066
Net gain (loss) on securities transactions 9 20 (4) -
Noninterest expense 15,622 14,905 15,521 15,106
---------- ---------- ---------- ----------
Earnings before income taxes 11,748 12,830 13,270 12,083
Income tax expense 3,228 3,716 4,049 3,633
---------- ---------- ---------- ----------
Net earnings $ 8,520 $ 9,114 $ 9,221 $ 8,450
========== ========== ========== ==========
Per Share Data:
Net earnings per share, basic $ 0.55 $ 0.59 $ 0.60 $ 0.55
Net earnings per share, assuming dilution 0.55 0.59 0.59 0.54
Cash dividends declared 0.31 0.31 0.31 0.28
Book value at period-end 16.25 16.10 16.24 15.54
Common stock sales price: (1)
High $ 43.89 $ 41.02 $ 33.28 $ 32.34
Low 37.12 32.38 30.50 27.27
Close 41.12 36.96 33.46 28.40
31
2002
---------------------------------------------------
4th 3rd 2nd 1st
---------- --------- --------- ---------
Summary Income Statement Information:
Interest income $ 25,591 $ 26,052 $ 26,346 $ 26,445
Interest expense 5,244 5,818 6,246 7,072
---------- --------- ---------- ---------
Net interest income 20,347 20,234 20,100 19,373
Provision for loan losses 809 652 510 399
---------- --------- ---------- ---------
Net interest income after provision for loan losses 19,538 19,582 19,590 18,974
Noninterest income 7,954 7,792 7,245 6,975
Net gain (loss) on securities transactions - (3) 19 -
Noninterest expense 15,247 14,903 14,677 14,256
---------- --------- ---------- ---------
Earnings before income taxes 12,245 12,468 12,177 11,693
Income tax expense 3,694 3,768 3,655 3,513
---------- --------- ---------- ---------
Net earnings $ 8,551 $ 8,700 $ 8,522 $ 8,180
========== ========= ========== =========
Per Share Data:
Net earnings per share, basic $ 0.55 $ 0.56 $ 0.55 $ 0.53
Net earnings per share, assuming dilution 0.55 0.56 0.55 0.53
Cash dividends declared 0.28 0.28 0.28 0.24
Book value at period-end 15.45 15.40 14.75 14.08
Common stock sales price: (1)
High $ 33.60 $ 33.38 $ 34.40 $ 27.44
Low 27.72 27.88 26.40 23.44
Close 30.40 29.15 33.47 26.57
(1) These quotations reflect inter-dealer prices without retail mark-up,
mark-down or commission, and may not necessarily represent actual
transactions.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On March 25, 2002, we determined not to renew the engagement of our
independent accountants, Arthur Andersen LLP. Arthur Andersen had served as our
independent auditors since 1990. The decision not to renew the engagement of
Arthur Andersen was made by the executive committee of our board of directors
following the recommendation of our audit committee. Arthur Andersen's report on
our 2001 financial statements was filed with the Securities and Exchange
Commission on March 20, 2002 in conjunction with the filing of our Annual Report
on Form 10-K for the year ended December 31, 2001.
During the two fiscal years ended December 31, 2001, and through the
subsequent interim period through March 25, 2002, there were no disagreements
between Arthur Andersen and us on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreements if not resolved to Arthur Andersen's satisfaction would have
caused them to make reference to the subject matter of the disagreement in
connection with their reports.
None of the reportable events defined under Item 304(a)(1)(v) of Regulation
S-K occurred within our two fiscal years ended December 31, 2001 and through the
subsequent interim period through March 25, 2002. The audit reports of Arthur
Andersen on our consolidated financial statements as of and for the fiscal years
ended December 31, 2001 and 2000 did not contain any adverse opinion or
disclaimer of opinion, nor were they qualified or modified as to uncertainty,
audit scope, or accounting principles. We provided Arthur Andersen with a copy
of the foregoing disclosure, and a copy of its letter stating its agreement with
these statements was filed as an exhibit to our Form 8-K dated March 25, 2002.
The executive committee of our board of directors, upon the recommendation
of our audit committee, elected to appoint Ernst & Young LLP as our independent
auditors, effective May 16, 2002. Prior to engaging the new independent
auditors, we did not consult with Ernst & Young regarding any of the matters or
events set forth in Items 304(a)(2)(i) and (ii) of Regulation S-K.
32
ITEM 9A. CONTROLS AND PROCEDURES
As of December 31, 2003, we carried out an evaluation, under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Securities Exchange Act Rule 15d-15. Our management,
including the principal executive officer and principal financial officer, does
not expect that our disclosure controls and procedures will prevent all errors
and all fraud.
A control system, no matter how well conceived and operated, can provide
only reasonable not absolute, assurance that the objectives of the control
system are met. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, controls may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected. Our principal executive officer and principal financial officer
have concluded, based on our evaluation of our disclosure controls and
procedures, that our disclosure controls and procedures under Rule 13a-14 (c)
and Rule 15d-14 (c) of the Securities Exchange Act of 1934 are effective.
Subsequent to our evaluation, there were no significant changes in internal
controls or other factors that could significantly affect these internal
controls.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is hereby incorporated by reference
from our proxy statement for our 2004 annual meeting of shareholders.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is hereby incorporated by reference
from our 2004 proxy statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 related to security ownership of
certain beneficial owners and management is hereby incorporated by reference
from our 2004 proxy statement. The following chart gives aggregate information
under our equity compensation plans as of December 31, 2003.
33
Number of Securities
Remaining Available
For Future Issuance
Number of Securities Under Equity
To be Issued Upon Weighted Average Compensation Plans
Exercise of Exercise Price of (Excluding Securities
Outstanding Options, Outstanding Options, Reflected in
Warrants and Rights Warrants and Rights Far Left Column)
------- ------ -------
Equity compensation plans
approved by security holders 181,100 $23.43 553,687
Equity compensation plans not
approved by security holders - - -
------- -------
Total 181,100 $23.43 553,687
======= =======
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is hereby incorporated by reference
from our 2004 proxy statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is hereby incorporated by reference
from our 2004 proxy statement.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Financial Statements -
Report of Independent Auditors
Report of Independent Public Accountants
Management's Report on Responsibility for the Financial
Statements
Consolidated Balance Sheets as of December 31, 2003 and 2002
Consolidated Statements of Earnings for the years ended
December 31, 2003, 2002 and 2001
Consolidated Statements of Comprehensive Earnings for the
years ended December 31, 2003, 2002 and 2001
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001
Notes to the Consolidated Financial Statements
(2) Financial Statement Schedules -
These schedules have been omitted because they are not
required, are not applicable or have been included in our
consolidated financial statements.
(3) Exhibits -
The information required by this Item 15(a)(3) is set forth in
the Exhibit Index immediately following our signature pages.
The exhibits listed herein will be furnished upon written
request to J. Bruce Hildebrand, Executive Vice President,
First Financial Bankshares, Inc., 400 Pine Street, Abilene,
Texas 79601, and payment of a reasonable fee that will be
limited to our reasonable expense in furnishing such exhibits.
(b) Reports on Form 8-K.
On January 16, 2004, we furnished on Form 8-K our earnings release for the
quarter and year ended December 31, 2003.
34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST FINANCIAL BANKSHARES, INC.
Date: March 5, 2004 By: /s/ F. SCOTT DUESER
-----------------------------------------------
F. SCOTT DUESER
President, Chief Executive Officer and Director
The undersigned directors and officers of First Financial Bankshares, Inc.
hereby constitute and appoint J. Bruce Hildebrand, with full power to act and
with full power of substitution and resubstitution, our true and lawful
attorney-in-fact with full power to execute in our name and behalf in the
capacities indicated below any and all amendments to this report and to file the
same, with all exhibits thereto and other documents in connection therewith with
the Securities and Exchange Commission and hereby ratify and confirm all that
such attorney-in-fact or his substitute shall lawfully do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ KENNETH T. MURPHY Chairman of the Board and Director March 5, 2004
- -----------------------------------------------
Kenneth T. Murphy
/s/ F. SCOTT DUESER President, Chief Executive Officer March 5, 2004
- ----------------------------------------------- and Director
F. Scott Dueser (Principal Executive Officer)
/s/ J. BRUCE HILDEBRAND Executive Vice President and Chief March 5, 2004
- ----------------------------------------------- Financial Officer
J. Bruce Hildebrand (Principal Financial Officer and
Principal Accounting Officer)
/s/ JOSEPH E. CANON Director March 5, 2004
- -----------------------------------------------
Joseph E. Canon
/s/ MAC A. COALSON Director March 5, 2004
- -----------------------------------------------
Mac A. Coalson
/s/ DAVID COPELAND Director March 5, 2004
- -----------------------------------------------
David Copeland
35
Name Title Date
---- ----- ----
/s/ DERRELL E. JOHNSON Director March 5, 2004
- -----------------------------------------------
Derrell E. Johnson
/s/ KADE L. MATTHEWS Director March 5, 2004
- -----------------------------------------------
Kade L. Matthews
/s/ RAYMOND A. MCDANIEL, JR. Director March 5, 2004
- -----------------------------------------------
Raymond A. McDaniel, Jr.
/s/ BYNUM MIERS Director March 5, 2004
- -----------------------------------------------
Bynum Miers
/s/ JAMES M. PARKER Director March 5, 2004
- -----------------------------------------------
James M. Parker
/s/ JACK D. RAMSEY Director March 5, 2004
- -----------------------------------------------
Jack D. Ramsey
/s/ DIAN GRAVES STAI Director March 5, 2004
- -----------------------------------------------
Dian Graves Stai
/s/ F. L. STEPHENS Director March 5, 2004
- -----------------------------------------------
F. L. Stephens
/s/ JOHNNY TROTTER Director March 5, 2004
- -----------------------------------------------
Johnny Trotter
36
EXHIBIT INDEX
Item 601
Regulation S-K
Exhibit Reference
Number Exhibits
------ --------
3.1 -- Articles of Incorporation, and all amendments thereto, of the Registrant
(incorporated by reference from Exhibit 1 of the Registrant's Amendment No. 2 to
Form 8-A filed on Form 8-A/A No. 2 on November 21, 1995).
3.2 -- Amended and Restated Bylaws, and all amendments thereto, of the Registrant
(incorporated by reference from Exhibit 2 of the Registrant's Amendment No. 1 to
Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994).
4.1 -- Specimen certificate of First Financial Common Stock (incorporated by reference
from Exhibit 3 of the Registrant's Amendment No. 1 to Form 8-A filed on Form 8-A/A
No. 1 on January 7, 1994).
10.1 -- Deferred Compensation Agreement, dated October 28, 1992, between the Registrant and
Kenneth T. Murphy (incorporated by reference from Exhibit 10.1 of the Registrant's
Form 10-K Annual Report for the year ended December 31, 2002).
10.2 -- Revised Deferred Compensation Agreement, dated December 28, 1995, between the
Registrant and Kenneth T. Murphy (incorporated by reference from Exhbiit 10.2 of
the Registrant's Form 10-K Annual Report for the year ended December 31, 2002).
10.3 -- Executive Recognition Plan (incorporated by reference from Exhibit 10.3 of the
Registrant's Form 10-K Annual Report for year ended December 31, 2002).
10.4 -- Form of Executive Recognition Agreement (incorporated by reference from Exhbiit
10.4 of the Registrant's Form 10-K Annual Report for the year ended December 31,
2002).
10.5 -- 1992 Incentive Stock Option Plan (incorporated by reference from Exhibit 10.5 of
the Registrant's Form 10-K Annual Report for the fiscal year ended December 31,
1998).
10.6 -- 2002 Incentive Stock Option Plan (incorporated by reference from Appendix A of the
Registrant's Schedule 14a Definitive Proxy Statement for the 2002 Annual Meeting of
Shareholders)
*10.7 -- Revised Consulting Agreement dated January 1, 2004 between the Registrant and
Kenneth T. Murphy.
16.1 -- Letter regarding Change in Certifying Accountant (incorporated by reference from
Exhibit 16.1 of the Registrant's Form 8-K filed on March 25, 2002).
*21.1 -- Subsidiaries of the Registrant.
24.1 -- Power of Attorney (included on signature page of this Form 10-K).
*31.1 -- Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Executive Officer of First
Financial Bankshares, Inc.
*31.2 -- Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Financial Officer of First
Financial Bankshares, Inc.
*32.1 -- Section 1350 Certification of Chief Executive Officer of First Financial
Bankshares, Inc.
*32.2 -- Section 1350 Certification of Chief Financial Officer of First Financial
Bankshares, Inc.
- ---------------
*Filed herewith
37
Exhibit 10.7
------------
CONSULTING AGREEMENT
This Consulting Agreement (the "Agreement") is made and entered into as of
the 1st day of January, 2004 (the "Effective Date"), by and between FIRST
FINANCIAL BANKSHARES, INC. (the "Company"), and KENNETH T. MURPHY ("Murphy").
WITNESSETH:
WHEREAS, following December 31, 2002, Murphy retired as an officer of the
Company, and served in a Consulting capacity during the calendar year 2003; and
WHEREAS, the Company recognizes the experience, leadership, knowledge and
relationships of Murphy continue to be of great value to the Company and its
Shareholders; and
WHEREAS, the Company desires to retain Murphy's services as a consultant
to: (i) participate in the identification and evaluation of prospects for
acquisition or merger with the Company or a subsidiary of the Company; (ii)
negotiate with potential sellers and recommend terms and conditions of such
transaction(s); (iii) be accessible to the executive management of the Company
for advice as to opportunities for growth and expansion, to review planning
decisions, to build relationships and develop strategies which are intended to
enhance the business interests of the Company for the benefit of its
Shareholders (the "Services"); and
WHEREAS, Murphy is willing to provide the Services to the Company; and
WHEREAS, the parties desire to enter into this Agreement in a spirit of
mutual respect, congeniality, and a desire to work together in harmony for the
continued success of the Company;
NOW, THEREFORE, for and in consideration of the premises and of the mutual
representation, warranties, covenants and agreements contained herein, and of
other good and valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, and upon the terms and subject to the conditions
hereinafter set forth, the parties, intending to be legally bound, hereby agree
as follows:
1. Duties and Term of Consultancy. The Company hereby engages Murphy, and
Murphy hereby accepts engagement, as a consultant to provide the Services as
reasonably requested by the Company. The term of this Agreement shall commence
on the Effective Date and continue for a period of twelve (12) months ending on
December 31, 2004.
2. Commitment of Time. No specific time requirement shall be a part of this
Agreement. Rather, Murphy shall be reasonably available during the term of this
Agreement, whether it be in his office or by telephone conference, to provide
the Services as requested by the Company.
3. Means to Perform Services. Murphy shall be provided the necessary means
for the performance of the Services, including an office and secretarial
support, use of the Company's aircraft for travel related to the provision of
the Services, use of membership in Abilene Country Club, and membership(s) in
appropriate state and national banking organizations as determined by the
Company.
4. Compensation for Services. As compensation for the Services rendered
under this Agreement, the Company shall pay Murphy a fee of $8,333.33 per month,
shall reimburse Murphy for his reasonable business expenses incurred in the
provision of the Services, and shall convey the title of the 1998 Cadillac VIN
#1G6KD54Y6WU734561 to Murphy as of February 1, 2004.
5. Termination. Either party hereto may terminate this Agreement without
cause upon thirty (30) days written notice to the other party. In the event of
termination of this Agreement prior to December 31, 2004, the Company shall pay
Murphy the amount earned through the date of termination. This Agreement and the
obligations of the Company shall terminate in the event of the death of Murphy
as of the date of death.
IN WITNESS WHEREOF, the parties hereto have signed this Agreement to take
effect as of January 1, 2004.
FIRST FINANCIAL BANKSHARES, INC.
By: /s/ F. Scott Dueser
-------------------
Name: F. Scott Dueser
Title: President and Chief Executive Officer
"Company"
/s/ Kenneth T. Murphy
---------------------
KENNETH T. MURPHY
"Murphy"
Exhibit 21.1
------------
SUBSIDIARIES OF REGISTRANT
Percentage of Voting
Names of Subsidiary Place of Organization Securities Owned
------------------- --------------------- ----------------
First Financial Bankshares of Delaware, Inc. Delaware 100%
First Financial Investments, Inc. Texas 100%
First Technology Services, Inc. Texas 100%**
Abilene, Texas
First Financial Trust & Asset Management Texas 100%**
Company, National Association*
Abilene, Texas
First National Bank of Abilene* Texas 100%**
Abilene, Texas
Hereford State Bank Texas 100%**
Hereford, Texas
First National Bank, Sweetwater* Texas 100%**
Sweetwater, Texas
Eastland National Bank* Texas 100%**
Eastland, Texas
First Financial Bank, National Association* Texas 100%**
Cleburne, Texas
Stephenville Bank & Trust Co. Texas 100%**
Stephenville, Texas
San Angelo National Bank* Texas 100%**
San Angelo, Texas
Weatherford National Bank* Texas 100%**
Weatherford, Texas
First Financial Bank, National Association* Texas 100%**
Southlake, Texas
City National Bank* Texas 100%**
Mineral Wells, Texas
*Federal charter.
**By First Financial Bankshares of Delaware, Inc.
All subsidiaries (other than First Financial Investments, Inc. which, as of
December 31, 2003, had not yet begun operations) are included in the
consolidated financial statements.
Exhibit 31.1
------------
Certification of
Chief Executive Officer
of First Financial Bankshares, Inc.
I, F. Scott Dueser, President and Chief Executive Officer of First
Financial Bankshares, Inc., certify that:
1. I have reviewed this Form 10-K of First Financial Bankshares, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15 (e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the
registrant and have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b. [Intentionally omitted];
c. Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectives of the disclosure controls and procedures, as of the end of the
period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting; and
Date: March 5, 2004
By: /s/ F. SCOTT DUESER
--------------------------------------------
F. Scott Dueser
President and Chief Executive Officer
Exhibit 31.2
------------
Certification of
Chief Financial Officer
of First Financial Bankshares, Inc.
I, J. Bruce Hildebrand, Executive Vice President and Chief Financial
Officer of First Financial Bankshares, Inc., certify that:
1. I have reviewed this Form 10-K of First Financial Bankshares, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15 (e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the
registrant and have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b. [Intentionally omitted];
c. Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectives of the disclosure controls and procedures, as of the end of the
period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting; and
Date: March 5, 2004
By: /s/ J. Bruce Hildebrand
-----------------------------------
J. Bruce Hildebrand
Executive Vice President and Chief Financial Officer
Exhibit 32.1
------------
Certification of
Chief Executive Officer
of First Financial Bankshares, Inc.
This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United
States code) and accompanies the annual report on Form 10-K (the "Form 10-K")
for the year ended December 31, 2003 of First Financial Bankshares, Inc.
I, F. Scott Dueser, the President and Chief Executive Officer of the Issuer
certify that:
1. the Form 10-K fully complies with the requirements of section 13(a) or
section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or
78o(d)); and
2. the information contained in the Form 10-K fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Dated: March 5, 2004
By: /s/ F. SCOTT DUESER
---------------------------
F. Scott Dueser
Chief Executive Officer
Subscribed and sworn to before me this 5th of March 2004.
/s/ Gaila N. Kilpatrick
- -----------------------
Gaila N. Kilpatrick
Notary Public
My commission expires: April 15, 2005
Exhibit 32.2
------------
Certification of
Chief Financial Officer
of First Financial Bankshares, Inc.
This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United
States code) and accompanies the annual report on Form 10-K (the "Form 10-K")
for the year ended December 31, 2003 of First Financial Bankshares, Inc.
I, J. Bruce Hildebrand, the Executive Vice President and Chief Financial Officer
of the Issuer certify that:
1. the Form 10-K fully complies with the requirements of section 13(a) or
section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or
78o(d)); and
2. the information contained in the Form 10-K fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Dated: March 5, 2004
By: /s/ J. Bruce Hildebrand
---------------------------
J. Bruce Hildebrand
Chief Financial Officer
Subscribed and sworn to before me this 5th of March 2004.
/s/ Gaila N. Kilpatrick
- -----------------------
Gaila N. Kilpatrick
Notary Public
My commission expires: April 15, 2005
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
First Financial Bankshares, Inc.
We have audited the accompanying consolidated balance sheets of First Financial
Bankshares, Inc. (a Texas corporation) and subsidiaries as of December 31, 2003
and 2002, and the related consolidated statements of earnings, comprehensive
earnings, shareholders' equity, and cash flows for the years then ended. 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. The consolidated financial statements of First Financial Bankshares,
Inc. and subsidiaries for the year ended December 31, 2001, were audited by
other auditors who have ceased operations and whose report dated January 11,
2002, expressed an unqualified opinion on those statements.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 financial statements referred to above present fairly, in
all material respects, the financial position of First Financial Bankshares,
Inc. and subsidiaries at December 31, 2003 and 2002, and the consolidated
results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States.
As discussed above, the financial statements of First Financial Bankshares, Inc.
and subsidiaries for the year ended December 31, 2001 were audited by other
auditors who have ceased operations. As described in Note 1, these financial
statements have been revised to include the transitional disclosures required by
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, which was adopted by the Company as of January 1, 2002. Our
audit procedures with respect to the disclosures in Note 1 with respect to 2001
amounts included (a) agreeing the previously reported net income to the
previously issued financial statements and the proforma adjustments to reported
net income representing amortization expense including related tax effects
recognized in those periods related to goodwill to the Company's underlying
records obtained from management, and (b) testing the mathematical accuracy of
the reconciliation of proforma adjusted net income to reported net income, and
the related earnings per share amounts. In our opinion, the disclosures for 2001
are appropriate. However, we were not engaged to audit, review, or apply any
procedures to the 2001 financial statements of the Company other than with
respect to such disclosures and, accordingly, we do not express an opinion or
any other form of assurance on the 2001 financial statements taken as a whole.
Ernst & Young LLP
Dallas, Texas
January 16, 2004
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
First Financial Bankshares, Inc.
We have audited the accompanying consolidated balance sheets of First Financial
Bankshares, Inc. (a Texas corporation) and subsidiaries as of December 31, 2001
and 2000, and the related consolidated statements of earnings, comprehensive
earnings, 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. 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 financial statements referred to above present fairly, in
all material respects, the financial position of First Financial Bankshares,
Inc. and subsidiaries 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.
Arthur Andersen LLP
Dallas, Texas,
January 11, 2002
NOTE: THIS IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP,
WHICH CEASED OPERATIONS. THIS REPORT ADDRESSES CERTAIN FINANCIAL
STATEMENTS FOR PERIODS THAT ARE NOT OTHERWISE REQUIRED TO BE INCLUDED
IN THIS FORM 10-K.
F-2
MANAGEMENT'S REPORT ON RESPONSIBILITY FOR THE FINANCIAL STATEMENTS
The Management of First Financial Bankshares, Inc. and subsidiaries is
responsible for the preparation, integrity, and fair presentation of its annual
consolidated financial statements as of December 31, 2003 and 2002, and for each
of the three years in the period ended December 31, 2003. The financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States and, as such, include amounts based on judgments
and estimates made by Management. Management has also prepared the other
information included in this Annual Report and is responsible for its accuracy
and consistency with the consolidated financial statements.
The annual consolidated financial statements as of and for the years ended
December 31, 2003 and 2002 have been audited by Ernst & Young LLP, who have been
given unrestricted access to all financial records and related data, including
minutes of all meetings of shareholders and the Board of Directors. Management
believes that all representations made to Ernst & Young LLP during the audit
were valid and appropriate.
The annual consolidated financial statements for the year ended December 31,
2001, were audited by Arthur Andersen LLP, who were given unrestricted access to
all financial records and related data, including minutes of all meetings of
shareholders and the Board of Directors. Management believes that all
representations made to Arthur Andersen LLP during the audits were valid and
appropriate. Arthur Andersen LLP subsequently ceased operations.
F. Scott Dueser J. Bruce Hildebrand
President and Chief Executive Officer Executive Vice President
and Chief Financial Officer
F-3
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2003 and 2002
ASSETS 2003 2002
------ -------------- --------------
CASH AND DUE FROM BANKS $ 111,940,573 $ 108,436,645
FEDERAL FUNDS SOLD 1,900,000 70,000,000
-------------- --------------
Total cash and cash equivalents 113,840,573 178,436,645
INTEREST-BEARING DEPOSITS IN BANKS 876,839 2,324,425
INVESTMENT SECURITIES:
Securities held-to-maturity (fair value of $138,594,081 in
2003 and $211,862,151 in 2002) 131,326,111 200,449,784
Securities available-for-sale, at fair value 778,976,003 571,806,629
-------------- --------------
Total investment securities 910,302,114 772,256,413
LOANS 987,523,103 964,039,773
Less- allowance for loan losses 11,576,299 11,218,729
-------------- --------------
Net loans 975,946,804 952,821,044
BANK PREMISES AND EQUIPMENT, net 43,902,112 40,605,401
INTANGIBLE ASSETS 24,717,671 24,870,788
OTHER ASSETS 22,985,321 21,868,220
-------------- --------------
Total assets $2,092,571,434 $1,993,182,936
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
NONINTEREST-BEARING DEPOSITS $ 472,574,590 $ 425,473,353
INTEREST-BEARING DEPOSITS 1,323,696,580 1,286,088,863
-------------- --------------
Total deposits 1,796,271,170 1,711,562,216
DIVIDENDS PAYABLE 4,798,948 4,327,374
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE 28,975,167 26,708,994
OTHER LIABILITIES 11,039,392 11,816,707
-------------- --------------
Total liabilities 1,841,084,677 1,754,415,291
-------------- --------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock, $10 par value; authorized 20,000,000 shares;
15,480,679 and 12,364,201 issued and outstanding at
December 31, 2003 and 2002, respectively 154,806,790 123,642,010
Capital surplus 58,253,180 58,087,687
Retained earnings 31,276,464 45,647,522
Accumulated other comprehensive earnings 7,150,323 11,390,426
-------------- --------------
Total shareholders' equity 251,486,757 238,767,645
-------------- --------------
Total liabilities and shareholders' equity $2,092,571,434 $1,993,182,936
============== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
December 31, 2003, 2002 and 2001
2003 2002 2001
------------- ------------- ------------
INTEREST INCOME:
Interest and fees on loans $ 57,531,240 $ 63,826,534 $ 74,213,243
Interest on investment securities:
Taxable 29,142,980 32,469,972 32,169,874
Exempt from federal income tax 8,143,832 7,042,102 6,279,973
Interest on federal funds sold and interest-bearing
deposits in banks 466,615 946,861 3,211,316
------------- ------------- ------------
Total interest income 95,284,667 104,285,469 115,874,406
------------- ------------- ------------
INTEREST EXPENSE:
Interest on deposits 16,968,469 24,087,911 43,970,532
Other 162,402 291,793 863,480
------------- ------------- ------------
Total interest expense 17,130,871 24,379,704 44,834,012
------------- ------------- ------------
Net interest income 78,153,796 79,905,765 71,040,394
PROVISION FOR LOAN LOSSES 1,177,868 2,369,634 1,964,050
------------- ------------- ------------
Net interest income after provision for loan losses 76,975,928 77,536,131 69,076,344
------------- ------------- ------------
NONINTEREST INCOME:
Trust department income 6,017,962 5,835,909 5,890,600
Service fees on deposit accounts 15,747,288 15,435,137 14,743,217
ATM fees 2,784,537 2,370,313 1,941,508
Real estate mortgage fees 2,923,360 1,858,378 1,609,518
Net gain on securities transactions 24,984 16,373 67,789
Net gain on sale of student loans 1,895,977 782,655 598,439
Net gain on sale of other real estate 743,180 6,593 6,175
Other 3,971,333 3,823,564 3,319,683
------------- ------------- ------------
Total noninterest income 34,108,621 30,128,922 28,176,929
------------- ------------- ------------
NONINTEREST EXPENSE:
Salaries and employee benefits 33,349,068 31,992,733 28,685,294
Net occupancy expense 3,941,428 3,908,856 3,995,597
Equipment expense 4,868,583 4,800,768 4,457,909
Printing, stationary and supplies 1,431,031 1,474,683 1,084,134
Correspondent bank service charges 1,501,142 1,491,132 1,329,134
Amortization of intangible assets 135,156 135,156 1,641,367
Other expenses 15,927,292 15,278,722 13,878,262
------------- ------------- ------------
Total noninterest expense 61,153,700 59,082,050 55,071,697
------------- ------------- ------------
EARNINGS BEFORE INCOME TAXES 49,930,849 48,583,003 42,181,576
INCOME TAX EXPENSE 14,626,049 14,630,453 12,827,071
------------- ------------- ------------
NET EARNINGS $ 35,304,800 $ 33,952,550 $ 29,354,505
============= ============= ============
NET EARNINGS PER SHARE, BASIC $ 2.28 $ 2.20 $ 1.91
============= ============= ============
NET EARNINGS PER SHARE, ASSUMING DILUTION $ 2.27 $ 2.19 $ 1.90
============= ============= ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Earnings
December 31, 2003, 2002 and 2001
2003 2002 2001
------------- ------------ ------------
NET EARNINGS $ 35,304,800 $ 33,952,550 $ 29,354,505
OTHER ITEMS OF COMPREHENSIVE EARNINGS:
Change in unrealized gain on investment securities
available-for-sale, before income tax (7,172,878) 13,414,265 3,916,477
Reclassification adjustment for realized gains on investment
securities included in net earnings, before income tax (24,984) (16,373) (67,789)
Minimum liability pension adjustment, before income tax 674,626 (2,215,820) -
------------- ------------ ------------
Total other items of comprehensive earnings (6,523,236) 11,182,072 3,848,688
Income tax expense related to other items of
comprehensive earnings 2,283,133 (3,913,725) (1,347,041)
------------- ------------ ------------
COMPREHENSIVE EARNINGS $ 31,064,697 $ 41,220,897 $ 31,856,152
============= ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
December 31, 2003, 2002 and 2001
Accumulated
Other
Common Stock Treasury Comprehensive Total
----------------------- Capital Retained Stock, Earnings Shareholders'
Shares Amount Surplus Earnings at cost (Losses) Equity
---------- ------------ ----------- ----------- ----------- ----------- ------------
BALANCE, December 31, 2000 9,983,002 $99,830,020 $60,592,310 $38,003,195 $(3,925,069)$ 1,620,432 $196,120,888
Net earnings - - - 29,354,505 - - 29,354,505
Five for four stock split, effected
in the form of a 25% stock dividend 2,461,770 24,617,700 - (24,617,700) - - -
Cash dividends declared, $0.93 per share - - - (14,364,647) - - (14,364,647)
Acquisition of treasury stock - - - - (315,050) - (315,050)
Retirement of treasury stock (136,000) (1,360,000) (2,880,119) - 4,240,119 - -
Stock issuances 24,480 244,800 111,870 - - - 356,670
Change in unrealized gain on investment
in securities available-for-sale, net
of related income taxes - - - - - 2,501,647 2,501,647
---------- ------------ ----------- ----------- ----------- ----------- ------------
BALANCE, December 31, 2001 12,333,252 $123,332,520 $57,824,061 $28,375,353 $ - $ 4,122,079 $213,654,013
Net earnings - - - 33,952,550 - - 33,952,550
Cash dividends declared, $1.08 per share - - - (16,680,381) - - (16,680,381)
Stock issuances 30,949 309,490 263,626 - - - 573,116
Minimum liability pension adjustment, net
of related income taxes - - - - - (1,440,283) (1,440,283)
Change in unrealized gain on investment in
securities available-for-sale, net of
related income taxes - - - - - 8,708,630 8,708,630
---------- ------------ ----------- ----------- ----------- ----------- ------------
BALANCE, December 31, 2002 12,364,201 $123,642,010 $58,087,687 $45,647,522 $ - $11,390,426 $238,767,645
Net earnings - - - 35,304,800 - - 35,304,800
Five for four stock split, effected in the
form of a 25% stock dividend 3,092,995 30,929,950 - (30,929,950) - - -
Cash dividends declared, $1.21 per share - - - (18,745,908) - - (18,745,908)
Stock issuances 23,483 234,830 165,493 - - - 400,323
Minimum liability pension adjustment, net
of related income taxes - - - - - 438,507 438,507
Change in unrealized gain on investment in
securities available-for-sale, net of
related taxes - - - - - (4,678,610) (4,678,610)
---------- ------------ ----------- ----------- ----------- ----------- ------------
BALANCE, December 31, 2003 15,480,679 $154,806,790 $58,253,180 $31,276,464 $ - $7,150,323 $251,486,757
========== ============ =========== =========== =========== =========== ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
December 31, 2003, 2002 and 2001
2003 2002 2001
-------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 35,304,800 $ 33,952,550 $ 29,354,505
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 4,303,567 4,125,655 5,679,082
Provision for loan losses 1,177,868 2,369,634 1,964,050
Premium amortization, net of discount accretion 5,162,940 2,077,358 1,662,108
Gain on sale of assets (2,664,141) (739,765) (651,254)
Deferred federal income tax expense (benefit) (90,828) 350,415 (188,982)
(Increase) decrease in other assets (158,175) (1,508,089) 3,565,172
Increase (decrease) in other liabilities 2,289,231 2,695,532 (1,778,326)
-------------- ------------- -------------
Total adjustments 10,020,462 9,370,740 10,251,850
------------- ----------- -------------
Net cash provided by operating activities 45,325,262 43,323,290 39,606,355
-------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in interest-bearing deposits in banks 1,447,587 (950,140) (1,269,947)
Payment for stock of City Bancshares, Inc., net of cash acquired - - (6,848,231)
Activity in available-for-sale securities:
Sales 50,617,175 30,077,478 57,925,815
Maturities 875,368,243 814,880,024 660,484,725
Purchases (1,148,629,137) (972,026,050) (854,748,980)
Activity in held-to-maturity securities:
Maturities 74,627,202 90,203,464 176,972,321
Purchases (2,365,000) (2,360,727) (76,102,656)
Net increase in loans (23,046,251) (25,229,765) (31,041,094)
Purchases of bank premises and equipment (7,108,990) (2,913,886) (5,151,260)
Proceeds from sale of other assets 66,722 526,065 200,461
-------------- ------------- -------------
Net cash used in investing activities (179,022,449) (67,793,537) (79,578,846)
-------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in noninterest-bearing deposits 47,101,236 36,066,687 41,179,967
Net increase (decrease) in interest-bearing deposits 37,607,717 (9,667,069) 41,583,909
Net increase (decrease) in securities sold under
agreements to repurchase 2,266,173 6,861,927 (6,317,292)
Common stock transactions:
Acquisition of treasury stock - - (315,050)
Proceeds of stock issuances 400,323 573,116 356,670
Dividends paid (18,274,334) (16,052,983) (13,921,211)
-------------- ------------- -------------
Net cash provided by financing activities 69,101,115 17,781,678 62,566,993
-------------- ------------- -------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (64,596,072) (6,688,569) 22,594,502
CASH AND CASH EQUIVALENTS, beginning of year 178,436,645 185,125,214 162,530,712
-------------- ------------- -------------
CASH AND CASH EQUIVALENTS, end of year $ 113,840,573 $ 178,436,645 $ 185,125,214
============== ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
-------------------------------------------
Nature of Operations
- --------------------
First Financial Bankshares, Inc. (a Texas corporation) ("Bankshares") is a
financial holding company which owns (through its wholly-owned Delaware
subsidiary) all of the capital stock of ten banks located in Texas as of
December 31, 2003. Those subsidiary banks are First National Bank of Abilene;
Hereford State Bank; First National Bank, Sweetwater; Eastland National Bank;
First Financial Bank, National Association, Cleburne; Stephenville Bank & Trust
Co.; San Angelo National Bank; Weatherford National Bank; First Financial Bank,
National Association, Southlake and City National Bank, Mineral Wells. Each
subsidiary bank's primary source of revenue is providing loans and banking
services to consumers and commercial customers in the market area in which the
subsidiary is located. In addition, the Company owns First Financial Trust &
Asset Management Company, National Association and First Technology Services,
Inc., an information technology subsidiary.
A summary of significant accounting policies of Bankshares and subsidiaries
(collectively, the "Company") applied in the preparation of the accompanying
consolidated financial statements follows. The accounting principles followed by
the Company and the methods of applying them are in conformity with both
accounting principles generally accepted in the United States and prevailing
practices of the banking industry.
Stock Split
- -----------
All prices and per share data related to our common stock have been adjusted to
give effect to all stock splits and stock dividends, including the five-for-four
stock split in the form of a 25% stock dividend effective June 2, 2003 for
shareholders of record on May 16, 2003.
Use of Estimates in Preparation of Financial Statements
- -------------------------------------------------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates. Material estimates
that are particularly susceptible to significant change in the near term relate
to the determination of the allowance for loan losses, the valuations of
foreclosed real estate, deferred income tax assets, and the fair value of
financial instruments.
Consolidation
- -------------
The accompanying consolidated financial statements include the accounts of
Bankshares and its subsidiaries, all of which are wholly-owned. All significant
intercompany accounts and transactions have been eliminated.
Investment Securities
- ---------------------
Management classifies debt and equity securities as held-to-maturity,
available-for-sale, or trading based on its intent. Debt securities that
management has the positive intent and ability to hold to maturity are
classified as held-to-maturity and recorded at cost, adjusted for amortization
of premiums and accretion of discounts, which are recognized as adjustments to
interest income using the interest method. Securities not classified as
held-to-maturity or trading are classified as available-for-sale and recorded at
estimated fair value, with unrealized gains and losses, net of deferred income
taxes, excluded from earnings and reported in a separate component of
shareholders' equity. Securities classified as trading are recorded at estimated
fair value, with unrealized gains and losses included in earnings. The Company
had no trading securities at December 31, 2003, 2002, or 2001.
F-9
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
Loans and Allowance for Loan Losses
- -----------------------------------
Loans are stated at the amount of unpaid principal, reduced by unearned income
and an allowance for loan losses. Interest on loans is calculated by using the
simple interest method on daily balances of the principal amounts outstanding.
The Company expenses its net loan origination costs, a method which does not
materially differ from deferring and amortizing such amounts as an adjustment to
yield. The allowance for loan losses is established through a provision for loan
losses charged to expense. Loans are charged against the allowance for loan
losses when management believes the collectibility of the principal is unlikely.
The allowance is an amount that management believes will be adequate to absorb
estimated inherent losses on existing loans that are deemed uncollectible based
upon management's review and evaluation of the loan portfolio. The allowance is
comprised of specific reserves for impaired loans and an estimate of losses
inherent in the portfolio at the balance sheet date, but not yet identified with
specific loans. The allowance for loan losses is increased by charges to income
and decreased by charge-offs (net of recoveries). Management's periodic
evaluation of the adequacy of the allowance is based on general economic
conditions, the financial condition of the borrower, the value and liquidity of
collateral, delinquency, prior loan loss experience, and the results of periodic
reviews of the portfolio. For purposes of determining our general allocations,
all loans, other than consumer, are segregated by credit grades which are
assigned an allocation percentage. Our methodology is constructed so that
specific allocations are increased in accordance with deterioration in credit
quality and a corresponding increase in risk and loss. In addition, we adjust
our allowance for qualitative factors such as national, state and local economic
conditions, changes in trends in delinquencies or non-accruals, deterioration in
concentration of credit and results of independent and regulatory loan review.
This additional allocation based on qualitative factors serves to compensate for
additional areas of uncertainty inherent in our portfolio. Accrual of interest
is discontinued on a loan when management believes, after considering economic
and business conditions and collection efforts, that the borrower's financial
condition is such that collection of interest is doubtful. Generally all loans
past due greater than 90 days are placed on non-accrual.
The Company's policy requires measurement of the allowance for an impaired
collateral dependent loan based on the fair value of the collateral. Other loan
impairments are measured based on the present value of expected future cash
flows or the loan's observable market price. At December 31, 2003 and 2002, all
significant impaired loans have been determined to be collateral dependent and
the allowance for loss has been measured utilizing the estimated fair value of
the collateral.
Other Real Estate
- -----------------
Other real estate is foreclosed property held pending disposition and is valued
at the lower of its fair value, less estimated costs to sell or the recorded
investment in the related loan. At foreclosure, if the fair value, less
estimated costs to sell, of the real estate acquired is less than the Company's
recorded investment in the related loan, a write-down is recognized through a
charge to the allowance for loan losses. Any subsequent reduction in value is
recognized by a charge to income. Operating expenses of such properties, net of
related income, and gains and losses on their disposition are included in
noninterest expense.
Bank Premises and Equipment
- ---------------------------
Bank premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed principally on a
straight-line basis over the estimated useful lives of the related assets.
Leasehold improvements are amortized over the life of the respective lease or
the estimated useful lives of the improvements, whichever is shorter.
Business Combinations, Goodwill and Other Intangible Assets
- -----------------------------------------------------------
Goodwill, relating to acquisitions of certain subsidiary banks, was amortized by
the straight-line method over periods of 15 and 40 years during the year ended
December 31, 2001.
F-10
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
In June 2001, Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") were issued.
SFAS No. 141 required that all business combinations initiated after June 30,
2001 be accounted for under the purchase method and addressed the initial
recognition and measurement of goodwill and other intangible assets acquired in
a business combination. SFAS No. 142 also addressed the accounting for goodwill
and other intangible assets subsequent to their acquisition. SFAS No. 142
provided that intangible assets with finite useful lives continue to be
amortized and that goodwill and intangible assets with indefinite lives no
longer be amortized, but rather be tested annually for impairment. SFAS No. 142
was effective January 1, 2002; however, acquired goodwill or intangible assets
recorded in our acquisition of City Bancshares, Inc. were subject immediately to
its provisions.
On January 1, 2002, goodwill amounting to $23,765,896 was not subject to further
amortization as a result of SFAS No. 142. The Company conducted its required
goodwill impairment test in 2003 and 2002, with no reduction of recorded
goodwill resulting from the test. A reconciliation adjusting comparative net
earnings and earnings per share for the year ended December 31, 2001, to show
the effect of no longer amortizing the Company's goodwill, follows:
Reported net earnings $29,354,505
Add back: goodwill amortization
Goodwill amortization, before income tax 1,641,367
Income tax benefit (420,000)
-----------
Adjusted net earnings $30,575,872
===========
Basic earnings per share:
Reported net earnings $ 1.91
Goodwill amortization, net of income tax benefit 0.08
-----------
Adjusted net earnings $ 1.99
===========
Earnings per share, assuming dilution:
Reported net earnings $ 1.90
Goodwill amortization, net of income tax benefit 0.08
-----------
Adjusted net earnings $ 1.98
===========
Goodwill arising from acquisitions of assets and liabilities, rather than
acquisitions of stock, amounting to $13,000,000, is deductible for federal
income tax purposes.
Other identifiable intangible assets recorded by the Company represent the
future benefit associated with the acquisition of the core deposits of City
Bancshares, Inc. (Note 17) and is being amortized over seven years utilizing a
method that approximates the expected attrition of the deposits.
Securities Sold Under Agreements To Repurchase
- ----------------------------------------------
Securities sold under agreements to repurchase, which are classified as secured
borrowings, generally mature within one to four days from the transaction date.
Securities sold under agreements to repurchase are reflected at the amount of
the cash received in connection with the transaction. The Company may be
required to provide additional collateral based on the estimated fair value of
the underlying securities.
Segment Reporting
- -----------------
The Company has determined that it operates one line of business (community
banking) located in a single geographic area (Texas).
F-11
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
Statements of Cash Flows
- ------------------------
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks, and federal funds sold.
Accounting for Income Taxes
- ---------------------------
The Company's provision for income taxes is based on income before income taxes
adjusted for permanent differences between financial reporting and taxable
income. Deferred tax assets and liabilities are determined using the liability
(or balance sheet) method. Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the temporary differences
between the book and tax bases of the various balance sheet assets and
liabilities and gives current recognition to changes in tax rates and laws.
Stock Based Compensation
- ------------------------
The Company grants stock options for a fixed number of shares to employees with
an exercise price equal to the fair value of the shares at the date of grant.
The Company accounts for stock option grants using the intrinsic value method
prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). Under APB 25, because the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized. Had compensation cost for the plan
been determined consistent with Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation," the Company's net earnings and
earnings per share would have been reduced by insignificant amounts on a pro
forma basis for the years ended December 31, 2003, 2002 and 2001. Note 15
provides additional information on the Company's stock option plan.
Stock Repurchase
- ----------------
On July 25, 2000, the Company approved a stock repurchase plan, authorizing the
repurchase of shares of the Company's common stock. During the year ended
December 31, 2001, the Company repurchased 12,375 shares. The treasury shares
were purchased for $315,050, representing an average purchase price of $25.46
per share and were retired in 2001. The 2000 stock repurchase plan expired in
2002.
Additionally, on April 22, 2003, the Company's Board of Directors authorized the
repurchase of up to 500,000 shares of common stock over the next three years.
The plan authorizes management to repurchase the stock at such time as
repurchases are considered beneficial to stockholders. Any repurchases of the
stock will be through the open market or in privately negotiated transactions in
accordance with applicable laws and regulations. No stock has been repurchased
under this plan as of December 31, 2003.
Per Share Data
- --------------
Net earnings per share ("EPS") are computed by dividing net earnings by the
weighted average number of shares of common stock outstanding during the period.
The Company calculates dilutive EPS assuming all outstanding options to purchase
common stock have been exercised at the beginning of the year (or the time of
issuance, if later.) The dilutive effect of the outstanding options is reflected
by application of the treasury stock method, whereby the proceeds from the
exercised options are assumed to be used to purchase common stock at the average
market price during the period. The following table reconciles the computation
of basic EPS to dilutive EPS:
Weighted
Net Average Per Share
Earnings Shares Amount
----------- ---------- ---------
For the year ended December 31, 2003:
Net earnings per share, basic $35,304,800 15,468,752 $ 2.28
=========
Effect of stock options - 63,633
----------- ----------
Net earnings per share, assuming dilution $35,304,800 15,532,385 $ 2.27
=========== ========== =========
F-12
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
For the year ended December 31, 2002:
Net earnings per share, basic $33,952,550 15,439,205 $ 2.20
=========
Effect of stock options - 59,404
----------- ----------
Net earnings per share, assuming dilution $33,952,550 15,498,609 $ 2.19
=========== ========== =========
For the year ended December 31, 2001:
Net earnings per share, basic $29,354,505 15,397,933 $ 1.91
=========
Effect of stock options - 56,654
----------- ----------
Net earnings per share, assuming dilution $29,354,505 15,454,587 $ 1.90
=========== ========== =========
Reclassifications
- -----------------
Certain 2002 and 2001 amounts have been reclassified to conform to the 2003
presentation.
2. CASH AND INVESTMENT SECURITIES:
-------------------------------
The amortized cost, estimated fair values, and gross unrealized gains and losses
of the Company's investment securities as of December 31, 2003 and 2002, are as
follows:
December 31, 2003
------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Basis Holding Gains Holding Losses Fair Value
------------ ----------- ---------- ------------
Securities held-to-maturity:
U.S. Treasury securities and
obligations of U.S. government
sponsored-enterprises and
agencies $ 78,223,829 $ 4,181,765 $ - $ 82,405,594
Obligations of state and
political subdivisions 43,324,769 2,592,521 (32,564) 45,884,726
Corporate bonds and other 503,243 41,391 - 544,634
Mortgage-backed securities 9,274,270 485,902 (1,045) 9,759,127
------------ ----------- ---------- ------------
Total debt securities
held-to-maturity $131,326,111 $ 7,301,579 ($33,609) $138,594,081
============ =========== ========== ============
Securities available-for-sale:
U.S. Treasury securities and
obligations of U.S.
government
sponsored-enterprises and
agencies $253,515,211 $6,125,162 ($640,484) $258,999,889
Obligations of state and
political subdivisions 178,287,396 7,120,946 (1,504,035) 183,904,307
Corporate bonds and other 42,822,744 1,767,885 - 44,590,629
Mortgage-backed securities 291,808,871 1,836,831 (2,164,524) 291,481,178
------------ ----------- ---------- ------------
Total securities available-for-sale $766,434,222 $16,850,824 ($4,309,043) $778,976,003
============ =========== ========== ============
F-13
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
December 31, 2003
------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Basis Holding Gains Holding Losses Fair Value
------------ ----------- ---------- ------------
Securities held-to-maturity:
U.S. Treasury securities and
obligations of U.S. government
sponsored-enterprises and
agencies $110,939,173 $ 6,868,716 $ - $117,807,889
Obligations of state and
political subdivisions 60,835,676 3,214,571 - 64,050,247
Corporate bonds and other 498,936 41,064 - 540,000
Mortgage-backed securities 28,175,999 1,288,594 (578) 29,464,015
------------ ----------- ---------- ------------
Total debt securities
held-to-maturity $200,449,784 $11,412,945 $ (578) $211,862,151
============ =========== ========== ============
Securities available-for-sale:
U.S. Treasury securities and
obligations of U.S.
government
sponsored-enterprises and
agencies $164,090,045 $ 7,545,917 $ (16,670) $171,619,292
Obligations of state and
political subdivisions 104,800,319 5,952,505 (12,189) 110,740,635
Corporate bonds and other 54,687,216 2,653,387 - 57,340,603
Mortgage-backed securities 228,489,406 4,066,253 (449,560) 232,106,099
------------ ----------- ---------- ------------
Total securities available-for-sale $552,066,986 $20,218,062 $(478,419) $571,806,629
============ =========== ========== ============
The Company invests in mortgage-backed securities that have expected maturities
that differ from their contractual maturities. These differences arise because
borrowers may have the right to call or prepay obligations with or without a
prepayment penalty. These securities include collateralized mortgage obligations
(CMOs) and other asset backed securities. The expected maturities of these
securities at December 31, 2003 and 2002, were computed by using scheduled
amortization of balances and historical prepayment rates. At December 31, 2003
and 2002, the Company did not hold any CMOs that entail higher risks than
standard mortgage-backed securities.
F-14
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
The amortized cost and estimated fair value of debt securities at December 31,
2003, by contractual and expected maturity, are shown below.
Held-to-Maturity Available-for-Sale
---------------- ----------------------
Amortized Estimated Amortized Estimated
Cost Basis Fair Value Cost Basis Fair Value
------------ ------------ ------------ ------------
Due within one year $ 36,242,878 $ 37,083,292 $ 42,073,996 $ 42,894,034
Due after one year through five years 64,012,353 68,091,801 285,706,445 294,098,528
Due after five years through ten years 21,457,610 23,300,435 83,755,802 88,675,093
Due after ten years 339,000 359,426 63,089,108 61,827,170
------------ ------------ ------------ ------------
122,051,841 128,834,954 474,625,351 487,494,825
------------ ------------ ------------ ------------
Mortgage-back securities 9,274,270 9,759,127 291,808,871 291,481,178
------------ ------------ ------------ ------------
Total $131,326,111 $138,594,081 $766,434,222 $778,976,003
============ ============ ============ ============
The following table discloses, as of December 31, 2003, the Company's investment
securities that have been in a continuous unrealized-loss position for less than
12 months and those that have been in a continuous unrealized-loss position for
12 or more months (in thousands):
Less than 12 Months 12 Months or Longer Total
--------------------- ------------------- --------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
--------- ------- -------- -------- -------- ------
U. S. Treasury securities and
obligations of U.S. government
sponsored-enterprises
and agencies $ 45,904 $ 640 - - $ 45,904 $ 640
Obligations of state and
political subdivisions 51,027 1,537 - - 51,027 1,537
Mortgage-backed securities 145,394 2,166 - - 145,394 2,166
We believe the investment securities in the table above are within ranges
customary for the banking industry. The number of investment positions in this
unrealized loss position totals 278. We do not believe these unrealized losses
are "other than temporary" as (1) the Company has the ability and intent to hold
the investments to maturity, or a period of time sufficient to allow for a
recovery in market value, (2) it is not probable that the Company will be unable
to collect the amounts contractually due and (3) no decision to dispose of the
investment were made prior to the balance sheet date. The unrealized losses
noted are interest rate related due to rising rates at December 31, 2003, in
relation to previous rates in mid-2003. The duration of these investments is
less than 5 years for all securities other than the municipal bonds, which is
less than 15 years. We have not identified any issues related to the ultimate
repayment of principal as a result of credit concerns on these securities.
Securities, carried at approximately $275,342,000 and $239,971,000 at December
31, 2003 and 2002, respectively, were pledged as collateral for public or trust
fund deposits and for other purposes required or permitted by law.
During 2003, 2002, and 2001 sales of investment securities that were classified
as available-for-sale totaled approximately $50,617,000, $30,077,000, and
$57,926,000 respectively. Gross realized gains and losses from sales in 2003
were approximately $296,000 and $271,000, respectively. Gross realized gains and
losses from 2002 sales were approximately $24,000 and $7,000, respectively.
Gross realized gains and losses from 2001 sales were approximately $105,000 and
$37,000, respectively. The specific identification method was used to determine
cost in computing the realized gains and losses.
F-15
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
Certain subsidiary banks are required to maintain reserve balances with the
Federal Reserve Bank. During 2003 and 2002, such average balances totaled
approximately $15,727,000 and $12,776,000, respectively.
3. LOANS AND ALLOWANCE FOR LOAN LOSSES:
------------------------------------
Major classifications of loans are as follows:
December 31,
------------------------------
2003 2002
------------ ------------
Commercial, financial, and agricultural $333,840,269 $311,743,212
Real estate - construction 77,833,890 50,911,156
Real estate - mortgage 385,770,437 375,255,678
Consumer 190,081,323 226,140,626
------------ ------------
987,525,919 964,050,672
Unearned income (2,816) (10,899)
------------ ------------
Total loans $987,523,103 $964,039,773
============ ============
Included in real estate-mortgage and consumer loans above are $2.6 million and
$53.6 million in loans held for sale at December 31, 2003 in which the carrying
amount approximates market.
The Company's recorded investment in impaired loans and the related valuation
allowance are as follows:
December 31, 2003 December 31, 2002
-------------------------- -------------------------
Recorded Valuation Recorded Valuation
Investment Allowance Investment Allowance
---------- ---------- ---------- ----------
$1,741,278 $ 332,927 $3,734,261 $ 752,385
========== ========== ========== ==========
F-16
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
The average recorded investment in impaired loans for the years ended December
31, 2003 and 2002, was approximately $2,738,000 and $3,776,000, respectively.
The Company had approximately $3,171,000 and $4,266,000 in nonperforming assets
at December 31, 2003 and 2002, respectively. No additional funds are committed
to be advanced in connection with impaired loans.
Interest payments received on impaired loans are recorded as interest income
unless collections of the remaining recorded investment are doubtful, at which
time payments received are recorded as reductions of principal. The Company
recognized interest income on impaired loans of approximately $46,000, $111,000
and $136,000 during the years ended December 31, 2003, 2002, and 2001,
respectively, of which approximately $4,000, $2,000 and $9,000 represented cash
interest payments received and recorded as interest income. If interest on
impaired loans had been recognized on a full accrual basis during the years
ended December 31, 2003, 2002, and 2001, respectively, such income would have
approximated $207,000, $317,000 and $399,000.
The allowance for loan losses as of December 31, 2003 and 2002, is presented
below. Management has evaluated the adequacy of the allowance for loan losses by
estimating the losses in various categories of the loan portfolio which are
identified below:
2003 2002
----------- ------------
Allowance for loan losses provided for:
Loans specifically evaluated as impaired $ 332,927 $ 752,385
Remaining portfolio 11,243,372 10,466,344
----------- ------------
Total allowance for loan losses $11,576,299 $11,218,729
=========== ============
Changes in the allowance for loan losses are summarized as follows:
December 31,
-----------------------------------------------
2003 2002 2001
----------- ----------- -----------
Balance at beginning of year $11,218,729 $10,602,419 $ 9,887,646
Add:
Provision for loan losses 1,177,868 2,369,634 1,964,050
Loan recoveries 1,356,625 834,150 968,535
Allowance established at acquisition - - 407,129
Deduct:
Loan charge-offs (2,176,923) (2,587,474) (2,624,941)
----------- ----------- -----------
Balance at end of year $11,576,299 $11,218,729 $10,602,419
=========== =========== ===========
An analysis of the changes in loans to officers, directors, principal
shareholders, or associates of such persons for the years ended December 31,
2003 and 2002 (determined as of each respective year-end) follows:
Beginning Additional Ending
Balance Loans Payments Balance
----------- ----------- ----------- -----------
Year ended December 31, 2003 $27,731,290 $39,953,042 $22,917,464 $44,766,868
=========== =========== =========== ===========
Year ended December 31, 2002 $44,426,313 $27,349,995 $44,235,855 $27,540,453
=========== =========== =========== ===========
In the opinion of management, those loans are on substantially the same terms,
including interest rates and collateral requirements, as those prevailing at the
time for comparable transactions with unaffiliated persons.
F-17
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
4. BANK PREMISES AND EQUIPMENT:
----------------------------
The following is a summary of bank premises and equipment:
Useful Life December 31,
----------------------------------- -----------------------------
2003 2002
----------- -----------
Land - $ 8,620,686 $ 7,362,814
Buildings 20 to 40 years 53,526,533 50,560,723
Furniture and equipment 3 to 10 years 28,602,702 26,347,819
Leasehold improvements Lesser of lease term or 5 to 15 years 4,544,393 4,385,288
----------- -----------
95,294,314 88,656,644
Less- accumulated depreciation and amortization (51,392,202) (48,051,243)
----------- -----------
$43,902,112 $40,605,401
=========== ===========
Depreciation expense for the years ended December 31, 2003, 2002 and 2001
amounted to $4,168,411, $4,284,473, and $3,755,878, respectively and is included
in the captions net occupancy expense and equipment expense in the accompanying
consolidated statements of earnings.
The Company is lessor for portions of its banking premises. Total rental income
for all leases included in net occupancy expense is approximately $1,821,000,
$1,578,000 and $1,432,000, for the years ended December 31, 2003, 2002, and
2001, respectively.
5. TIME DEPOSITS
-------------
Time deposits of $100,000 or more totaled approximately $220,067,000 and
$195,754,000 at December 31, 2003 and 2002, respectively. Interest expense on
these deposits was approximately $4,885,000, $5,694,000, and $10,163,000 during
2003, 2002, and 2001, respectively.
At December 31, 2003, the scheduled maturities of time deposits (in thousands)
were, as follows:
Year ending December 31,
------------------------
2004 $475,531
2005 32,013
2006 7,667
2007 11,341
2008 6,786
Thereafter 309
--------
$533,647
========
6. LINE OF CREDIT
--------------
The Company has a line of credit with a nonaffiliated bank under which it could
borrow up to $20,000,000. The line of credit is unsecured and matures on June
30, 2004. The Company paid no fee to secure the unused line of credit and,
accordingly, did not estimate a fair value of the unused line of credit at
December 31, 2003 or 2002. The line of credit carries an interest rate of the
London Interbank Offering Rate plus 1.0%. There was no outstanding balance under
the line of credit as of December 31, 2003 or 2002.
F-18
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
7. INCOME TAXES:
-------------
The Company files a consolidated federal income tax return. Income tax expense
is comprised of the following:
Year Ended December 31,
-----------------------------------------------
2003 2002 2001
----------- ----------- -----------
Current federal income tax $14,716,877 $14,280,038 $13,016,053
Deferred federal income tax expense (benefit) (90,828) 350,415 (188,982)
----------- ----------- -----------
Income tax expense $14,626,049 $14,630,453 $12,827,071
=========== =========== ===========
Income tax expense, as a percentage of pretax earnings, differs from the
statutory federal income tax rate as follows:
As a Percent of Pretax Earnings
-------------------------------------------------
2003 2002 2001
--------------- -------------- --------------
Statutory federal income tax rate 35.0% 35.0 % 35.0 %
Reductions in tax rate resulting from
interest income exempt from
federal income tax (5.9)% (5.6)% (5.2)%
ESOP tax credit (0.2)% - -
Other 0.4 % 0.7 % 0.6 %
---- ---- ----
Effective income tax rate 29.3% 30.1 % 30.4 %
==== ==== ====
F-19
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
The approximate effects of each type of difference that gave rise to the
Company's deferred tax assets and liabilities at December 31, 2003 and 2002 are
as follows:
2003 2002
----------- -----------
Deferred tax assets-
Tax basis of loans in excess of financial statement basis $ 4,082,056 $ 3,940,576
Minimum liability in defined benefit plan 539,418 775,537
Recognized for financial reporting purposes but not
for tax purposes-
Deferred compensation 705,217 686,098
Write-downs and adjustments to other
real estate owned and repossessed assets 24,039 133,000
Other deferred tax assets 358,194 343,527
----------- -----------
Total deferred tax assets 5,708,924 5,878,738
----------- -----------
Deferred tax liabilities-
Financial statement basis of fixed assets in excess of
tax basis 1,567,661 1,442,962
Intangible asset amortization deductible for tax purposes,
but not for financial reporting purposes 831,314 832,527
Recognized for financial reporting purposes but not
for tax purposes:
Accretion on investment securities 481,930 437,660
Pension plan contributions 297,379 497,869
Net unrealized gain on investment securities
available-for-sale 4,389,625 6,908,875
Other deferred tax liabilities 79,545 71,334
----------- -----------
Total deferred tax liabilities 7,647,454 10,191,227
----------- -----------
Net deferred tax liability $(1,938,530) $(4,312,489)
=========== ===========
8. FAIR VALUE OF FINANCIAL INSTRUMENTS:
------------------------------------
The Company is required to disclose the estimated fair value of its financial
instrument assets and liabilities. For the Company, as for most financial
institutions, substantially all of its assets and liabilities are considered
financial instruments as defined. Many of the Company's financial instruments,
however, lack an available trading market as characterized by a willing buyer
and willing seller engaging in an exchange transaction.
Estimated fair values have been determined by the Company using the best
available data, as generally provided in the Company's regulatory reports, and
an estimation methodology suitable for each category of financial instruments.
For those loans and deposits with floating interest rates, it is presumed that
estimated fair values generally approximate the carrying value.
F-20
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
The estimated fair values, and carrying values at December 31, 2003 and 2002,
were as follows:
2003 2002
------------------------------ -------------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
------------- -------------- ------------- -------------
Cash and due from banks $111,940,573 $111,940,573 $108,436,645 $108,436,645
Federal funds sold 1,900,000 1,900,000 70,000,000 70,000,000
Interest-bearing deposits in banks 876,839 876,839 2,324,425 2,324,425
Investment securities 910,302,114 917,570,084 772,256,413 783,668,780
Net loans 975,946,804 982,937,785 952,821,044 964,782,729
Accrued interest receivable 14,901,681 14,901,681 15,360,833 15,360,833
Deposits with stated maturities 533,647,010 536,207,802 541,031,072 544,575,352
Deposits with no stated
maturities 1,262,624,160 1,262,624,160 1,170,531,144 1,170,531,144
Securities sold under agreements
to repurchase 28,975,167 28,975,167 26,708,994 26,708,994
Accrued interest payable 1,723,217 1,723,217 2,150,309 2,150,309
Financial instruments actively traded in a secondary market have been valued
using quoted available market prices. Financial instruments with stated
maturities have been valued using a present value discounted cash flow with a
discount rate approximating current market for similar assets and liabilities.
Financial instrument assets with variable rates and financial instrument
liabilities with no stated maturities have an estimated fair value equal to both
the amount payable on demand and the carrying value. Changes in assumptions or
estimation methodologies may have a material effect on these estimated fair
values.
The Company's remaining assets and liabilities, which are not considered
financial instruments, have not been valued differently than customary with
historical cost accounting.
There is no material difference between the carrying value and the estimated
fair value of the Company's contractual off-balance-sheet unfunded lines of
credit, loan commitments and letters of credit which are generally priced at
market at the time of funding.
Reasonable comparability between financial institutions may not be likely due to
the wide range of permitted valuation techniques and numerous estimates which
must be made given the absence of active secondary markets for many of the
financial instruments. This lack of uniform valuation methodologies also
introduces a greater degree of subjectivity to these estimated fair values.
9. COMMITMENTS AND CONTINGENCIES:
------------------------------
The Company is engaged in legal actions arising from the normal course of
business. In management's opinion, the Company has adequate legal defenses with
respect to these actions, and the resolution of these matters will have no
material adverse effects upon the results of operations or financial condition
of the Company.
The Company leases a portion of its bank premises and equipment under operating
leases. At December 31, 2003, future minimum lease commitments were: 2004 -
$468,000; 2005 - $437,000; 2006 - $384,000; 2007 - $189,000; 2008 - $18,000; and
thereafter - $3,000.
F-21
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK:
--------------------------------------------------
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include unfunded lines of credit, commitments to
extend credit and standby letters of credit. Those instruments involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the consolidated balance sheets.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for unfunded lines of credit,
commitments to extend credit and standby letters of credit is represented by the
contractual notional amount of these instruments. The Company generally uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance-sheet instruments.
Contract or
Notional Amount at
December 31, 2003
-----------------
Financial instruments whose contract amounts
represent credit risk:
Unfunded lines of credit $123,803,128
Unfunded commitments to extend credit 62,092,132
Standby letters of credit 6,067,787
Unfunded lines of credit and 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. These commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Company evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Company upon extension
of credit, is based on management's credit evaluation of the counterparty.
Collateral held varies but may include accounts receivable, inventory, property,
plant, and equipment, livestock, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. The average collateral value held on
letters of credit usually exceeds the contract amount.
The Company has no other off-balance sheet arrangements or transactions that
would expose the Company to liability that is not reflected on the face of the
financial statements.
11. CONCENTRATION OF CREDIT RISK:
-----------------------------
The Company grants commercial, retail, agriculture, and residential loans to
customers primarily in North Central and West Texas. Although the Company has a
diversified loan portfolio, a substantial portion of its debtors' ability to
honor their contracts is dependent upon this local economic sector.
12. PENSION AND PROFIT SHARING PLANS:
---------------------------------
The Company has a defined benefit pension plan covering substantially all of its
employees. The benefits are based on years of service and a percentage of the
employee's qualifying compensation during the final years of employment. The
Company's funding policy is to contribute annually the amount necessary to
satisfy the Internal Revenue Service's funding standards. Contributions to the
pension plan through December 31, 2003 were intended to provide not only for
benefits attributed to service to date but also for those expected to be earned
in the future. Effective January 1, 2004, the pension plan was frozen whereby no
additional years of service will accrue to
F-22
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
participants, unless the pension plan is reinstated. Under current generally
accepted accounting principles and utilizing current assumptions, we do not
expect any significant pension costs in 2004 and beyond as a result of this
action.
Using an actuarial measurement date of September 30, benefit obligation activity
and fair value of plan assets for the years ended December 31, 2003 and 2002,
and a statement of the funded status as of December 31, 2003 and 2002 are as
follows:
2003 2002
----------- ------------
Reconciliation of benefit obligations:
Benefit obligation at January 1 $15,540,397 $ 14,183,582
Service cost - benefits earned during the period 1,118,607 994,630
Interest cost on projected benefit obligation 1,078,485 983,977
Actuarial loss 1,027,430 45,731
Benefits paid (737,859) (667,523)
----------- ------------
Benefit obligation at December 31 18,027,060 15,540,397
----------- ------------
Reconciliation of fair value of plan assets:
Fair value of plan assets at January 1 11,659,711 12,631,250
Actual return on plan assets 1,535,499 (1,031,005)
Employer contributions 1,038,301 726,989
Benefits paid (737,859) (667,523)
----------- ------------
Fair value of plan assets at December 31 13,495,652 11,659,711
----------- ------------
Funded status $(4,531,408) $ (3,880,686)
=========== ============
Reconciliation of funded status to accrued pension liability:
Funded status at December 31 $(4,531,408) $ (3,880,686)
Unrecognized loss from past experience different than
that assumed and effects of changes in assumptions 5,447,571 5,109,193
Additional minimum liability recorded (1,717,208) (2,409,795)
Unrecognized prior-service cost 176,014 193,975
Other (66,509) (36,644)
----------- ------------
Accrued pension liability $ (691,540) $ (1,023,957)
=========== ============
The Company recorded an additional minimum liability in the year ended December
31, 2003 and 2002 to reflect the underfunded status of the plan. The accrued
pension liability at December 31, 2003 and 2002 represents the difference
between the fair value of plan assets and the accumulated benefit obligation.
The accumulated benefit obligation is the actuarial present value of benefits
attributed by the pension benefit formula to employee service rendered prior to
that date and based on current and past compensation levels. The accumulated
benefit obligation differs from the projected benefit obligation in that it
assumes no increase in future compensation. The following table details the
financial statement captions affected by recording the minimum liability:
F-23
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
2003 2002
----------- -----------
Prepaid pension asset before adjustment $ 1,025,668 $ 1,385,838
Intangible asset recorded (included in other assets) (176,014) (193,975)
Minimum liability adjustment (1,541,194) (2,215,820)
----------- -----------
Accrued pension liability $ (691,540) $(1,023,957)
=========== ===========
Net periodic pension cost for the years ended December 31, 2003, 2002, and 2001,
included:
Year Ended December 31,
----------------------------------------------
2003 2002 2001
---------- ---------- ----------
Service cost - benefits earned during the period $1,118,607 $ 994,630 $ 847,620
Interest cost on projected benefit obligation 1,078,485 983,977 970,710
Expected return on plan assets (1,072,853) (880,562) (1,153,733)
Amortization of unrecognized net loss 226,405 116,722 -
Amortization of prior-service cost 17,961 17,960 17,961
Other - (59,405) (58,954)
---------- ---------- ----------
Net periodic pension cost $1,368,605 $1,173,322 $ 623,604
========== ========== ==========
The following table sets forth the rates used in the actuarial calculations of
the present value of benefit obligations and net periodic pension cost and the
rate of return on plan assets:
2003 2002 2001
---- ---- ----
Weighted average discount rate 6.5% 6.9% 6.9%
Rate of increase in future compensation levels 4% 4% 4%
Expected long-term rate of return on assets 8.5% 6.5% 8.5%
The expected long-term rate of return on plan assets is based on historical
returns and expectations of future returns based on asset mix, after
consultation with our investment advisors and actuaries. In 2002, the expected
long-term rate of return was downwardly adjusted to 6.5% to reflect the
declining equity markets. In 2003, the expected long-term rate of return was
returned to 8.5% based on our estimate of changes to the markets in which our
investments reside after consultation with our investment advisors and
actuaries.
The major type of plan assets in the pension plan and the targeted allocation
percentage as of December 31, 2003 and 2002 is as follows:
December 31, 2003 December 31, 2002 Targeted
Allocation Allocation Allocation
---------- ---------- ----------
Equity securities 56% 57% 60%
Debt securities 35% 38% 40%
Other 9% 5% -
The range and weighted average maturities of debt securities held in the pension
plan as of December 31, 2003 are one to 15 years and approximately 6.4 years,
respectively.
The Trust Department of the First National Bank of Abilene, a wholly owned
subsidiary bank of the Company, manages the pension plan assets as well as the
profit sharing plan assets (see below). The investment strategy and targeted
allocations is based on similar strategies the Trust Department employs for most
of its managed accounts whereby appropriate diversification is achieved. The
Trust Department is prohibited from high risk investments including the use of
derivatives.
F-24
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
An estimate of the undiscounted projected future payments to eligible
participants for the next five years and the following five years in the
aggregate is as follows (dollars in thousands):
Year Ending December 31,
------------------------
2004 $ 831
2005 930
2006 1,019
2007 1,153
2008 1,248
2009-2013 8,371
The Company expects to make a contribution to the pension plan during 2004 in a
range of zero to $50,000 as required by the regulations. No discretionary or
non-cash contributions are expected.
As of December 31, 2003 and 2002, the fair value of the pension plan's assets
included Company common stock valued at approximately $634,000 and $468,000,
respectively.
The Company also provides a profit sharing plan, which covers substantially all
full-time employees. The profit sharing plan is a defined contribution plan and
allows employees to contribute up to 5% of their base annual salary. Employees
are fully vested to the extent of their contributions and become fully vested in
the Company's contributions over a seven-year vesting period. Costs related to
the Company's defined contribution plan totaled approximately $1,473,000,
$2,681,000 and $1,858,000 in 2003, 2002 and 2001, respectively, and are included
in salaries and employee benefits in the accompanying consolidated statements of
earnings. As of December 31, 2003 and 2002, the fair value of the profit sharing
plan's assets included Company common stock valued at approximately $18,348,000
and $14,323,000, respectively. We replaced the costs of our frozen pension plan
with a matching of employee salary deferrals into the 401(k) plan. Effective
January 1, 2004, we will match a maximum of 4% on employee deferrals of 5% of
their respective employee compensation.
13. DIVIDENDS FROM SUBSIDIARIES:
----------------------------
At December 31, 2003, approximately $14.5 million was available for the
declaration of dividends by the Company's subsidiary banks without the prior
approval of regulatory agencies.
14. 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, each of Bankshares'
subsidiaries must meet specific capital guidelines that involve quantitative
measures of the subsidiaries' assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The subsidiaries'
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 Bankshares and each of its subsidiaries to maintain minimum amounts and
ratios (set forth in the table below) of total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined), to average assets (as defined). Management believes as of December 31,
2003 and 2002, that Bankshares and each of its subsidiaries meet all capital
adequacy requirements to which they are subject.
F-25
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
As of December 31, 2003 and 2002, the most recent notification from each
respective subsidiaries' primary regulator categorized each of Bankshares'
subsidiaries as well-capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the subsidiaries must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
as set forth in the following table.
There are no conditions or events since that notification that management
believes have changed the institutions' categories. Bankshares' and its
significant subsidiaries' actual capital amounts and ratios are presented in the
table below:
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes: Action Provisions:
--------------------- ---------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------------- --- -------------- ----- -------------- ------
As of December 31, 2003:
- ------------------------
Total Capital (to Risk-Weighted
Assets):
Consolidated $ 230,226,000 20% =>$ 92,890,000 => 8% N/A N/A
First National Bank of Abilene $ 69,175,000 16% =>$ 34,109,000 => 8% =>$ 42,637,000 => 10%
San Angelo National Bank $ 30,793,000 20% =>$ 12,214,000 => 8% =>$ 15,267,000 => 10%
Weatherford National Bank $ 20,025,000 17% =>$ 9,462,000 => 8% =>$ 11,828,000 => 10%
Tier I Capital (to Risk-Weighted
Assets):
Consolidated $ 218,617,000 19% =>$ 46,445,000 => 4% N/A N/A
First National Bank of Abilene $ 65,436,000 15% =>$ 17,055,000 => 4% =>$ 25,582,000 => 6%
San Angelo National Bank $ 29,494,000 19% =>$ 6,107,000 => 4% =>$ 9,160,000 => 6%
Weatherford National Bank $ 18,890,000 16% =>$ 4,731,000 => 4% =>$ 7,097,000 => 6%
Tier I Capital (to Average
Assets):
Consolidated $ 218,617,000 11% =>$ 61,933,000 => 3% N/A N/A
First National Bank of Abilene $ 65,436,000 9% =>$ 22,244,000 => 3% =>$ 37,074,000 => 5%
San Angelo National Bank $ 29,494,000 10% =>$ 9,286,000 => 3% =>$ 15,476,000 => 5%
Weatherford National Bank $ 18,890,000 9% =>$ 6,216,000 => 3% =>$ 10,361,000 => 5%
F-26
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes: Action Provisions:
--------------------- ---------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------------- --- -------------- ----- -------------- ------
As of December 31, 2002:
- ------------------------
Total Capital (to Risk-Weighted
Assets):
Consolidated $ 213,725,000 20% =>$ 87,579,000 => 8% N/A N/A
First National Bank of Abilene $ 68,874,000 17% =>$ 32,153,000 => 8% =>$ 40,191,000 => 10%
San Angelo National Bank $ 30,716,000 22% =>$ 10,816,000 => 8% =>$ 13,520,000 => 10%
Weatherford National Bank $ 19,758,000 18% =>$ 8,802,000 => 8% =>$ 11,002,000 => 10%
Tier I Capital (to Risk-Weighted
Assets):
Consolidated $ 202,507,000 18% =>$ 43,790,000 => 4% N/A N/A
First National Bank of Abilene $ 64,971,000 16% =>$ 16,077,000 => 4% =>$ 24,115,000 => 6%
San Angelo National Bank $ 29,374,000 21% =>$ 5,408,000 => 4% =>$ 8,112,000 => 6%
Weatherford National Bank $ 18,757,000 17% =>$ 4,401,000 => 4% =>$ 6,601,000 => 6%
Tier I Capital (to Average
Assets):
Consolidated $ 202,507,000 11% =>$ 57,856,000 => 3% N/A N/A
First National Bank of Abilene $ 64,971,000 9% =>$ 20,626,000 => 3% =>$ 34,377,000 => 5%
San Angelo National Bank $ 29,374,000 10% =>$ 8,410,000 => 3% =>$ 14,016,000 => 5%
Weatherford National Bank $ 18,757,000 10% =>$ 5,884,000 => 3% =>$ 9,807,000 => 5%
15. STOCK OPTION PLAN:
------------------
The Company has an incentive stock plan to provide for the granting of options
to senior management of the Company at prices not less than market at the date
of grant. At December 31, 2003, the Company had allocated 734,787 shares of
stock for issuance under the plan. The plan provides that options granted are
exercisable after two years from date of grant at a rate of 20% each year
cumulatively during the 10-year term of the option. An analysis of stock option
activity for the years ended December 31, 2003, 2002, and 2001, is presented in
the table and narrative below:
2003 2002 2001
------------------- ------------------- -------------------
Wtd. Avg. Wtd. Avg. Wtd. Avg.
Shares Ex. Price Shares Ex. Price Shares Ex. Price
------- ------- ------- ------ ------- ------
Outstanding, beginning of year 142,850 $ 17.98 187,571 $17.28 218,699 $16.41
Granted 71,560 30.80 2,500 24.40 4,625 23.86
Exercised (26,187) 15.29 (38,686) 14.82 (30,600) 11.66
Canceled (7,123) 18.08 (8,535) 18.78 (5,153) 19.96
------- ------- -------
Outstanding, end of year 181,100 $ 23.43 142,850 $17.98 187,571 $17.28
======= ======= ======= ====== ======= ======
Exercisable at end of year 66,008 $ 18.52 72,281 $16.92 82,763 $15.15
======= ======= ======= ====== ======= ======
Weighted average fair value of
options granted at date of issue $6.54 $4.85 $4.90
===== ===== =====
F-27
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
The options outstanding at December 31, 2003, have exercise prices between
$11.92 and $30.80 with a weighted average remaining contractual life of 5.74
years. Stock options have been adjusted retroactively for the effects of stock
dividends and splits.
The Company accounts for this plan under APB 25 under which no compensation cost
has been recognized for options granted. The fair value of the options granted
in 2003, 2002 and 2001, was estimated using the Black-Scholes options pricing
model with the following weighted-average assumptions: risk-free interest rate
of 3.22%, 4.75% and 5.23% respectively; expected dividend yield of 3.94%, 4.43%
and 3.89% respectively; expected life of 6.0, 6.0 and 6.0 years, respectively;
and expected volatility of 28.18%, 26.9% and 26.5%, respectively.
F-28
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
16. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY:
-------------------------------------------------
Condensed Balance Sheets-December 31, 2003 and 2002
ASSETS 2003 2002
------ ------------ ------------
Cash in subsidiary bank $ 1,316,462 $ 903,319
Interest-bearing deposits in subsidiary banks 32,908,291 22,212,064
------------ ------------
Total cash and cash equivalents 34,224,753 23,115,383
Investment in and advances to subsidiaries, at equity 223,037,332 220,150,157
Intangible assets 899,390 917,350
Other assets 1,262,681 748,101
------------ ------------
Total assets $259,424,156 $244,930,991
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Total liabilities $ 7,937,399 $ 6,163,346
Shareholders' equity:
Common stock 154,806,790 123,642,010
Capital surplus 58,253,180 58,087,687
Retained earnings 31,276,464 45,647,522
Accumulated other comprehensive earnings 7,150,323 11,390,426
------------ ------------
Total shareholders' equity 251,486,757 238,767,645
------------ ------------
Total liabilities and shareholders' equity $259,424,156 $244,930,991
============ ============
Condensed Statements of Earnings-
For the Years Ended December 31, 2003, 2002, and 2001
-----------------------------------------------------
2003 2002 2001
----------- ----------- -----------
Income:
Cash dividends from subsidiary banks $34,625,000 $26,550,000 $25,500,000
Excess of earnings over dividends of
subsidiary banks 1,713,407 8,479,939 4,582,993
Other income 1,065,245 944,911 1,092,375
----------- ----------- -----------
37,403,652 35,974,850 31,175,368
----------- ----------- -----------
Expenses:
Salaries and employee benefits 1,191,453 1,451,136 1,160,903
Other operating expenses 1,602,354 1,142,832 1,015,184
----------- ----------- -----------
2,793,807 2,593,968 2,176,087
----------- ----------- -----------
Earnings before income taxes 34,609,845 33,380,882 28,999,281
Income tax benefit 694,955 571,668 355,224
----------- ----------- -----------
Net earnings $35,304,800 $33,952,550 $29,354,505
=========== =========== ===========
F-29
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
Condensed Statements of Cash Flows-
For the Years Ended December 31, 2003, 2002, and 2001
-----------------------------------------------------
2003 2002 2001
----------- ----------- -----------
Cash flows from operating activities:
Net earnings $35,304,800 $33,952,550 $29,354,505
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Excess of earnings over
dividends of subsidiary banks (1,713,407) (8,479,939) (4,582,993)
Depreciation 53,778 54,219 32,658
Discount accretion, net of premium amortization - - (4,667)
Amortization of excess of cost over fair value
of assets acquired - - 55,576
(Increase) decrease in other assets (491,762) (215,435) 559,515
(Decrease) increase in liabilities 1,758,948 (1,041,688) 186,391
----------- ----------- -----------
Net cash provided by operating activities 34,912,357 24,269,707 25,600,985
----------- ----------- -----------
Cash flows from investing activities:
Purchases of bank premises and equipment (76,598) (50,481) (157,291)
Maturities of available-for-sale securities - - 10,000,000
Cash payment for stock acquisition - - (16,500,000)
Investment in and advances to subsidiaries (5,852,378) - -
----------- ----------- -----------
Net cash used in investing activities (5,928,976) (50,481) (6,657,291)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds of stock issuances 400,323 573,116 356,670
Acquisition of treasury stock - - (315,050)
Cash dividends paid (18,274,334) (16,052,983) (13,921,211)
----------- ----------- -----------
Net cash used in financing activities (17,874,011) (15,479,867) (13,879,591)
----------- ----------- -----------
Net increase in cash and cash equivalents 11,109,370 8,739,359 5,064,103
Cash and cash equivalents, beginning of year 23,115,383 14,376,024 9,311,921
----------- ----------- -----------
Cash and cash equivalents, end of year $34,224,753 $23,115,383 $14,376,024
=========== =========== ===========
F-30
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
17. BUSINESS COMBINATION:
---------------------
In July 2001, the Company purchased all of the outstanding stock of City
Bancshares, Inc. ("City") and its subsidiary, City National Bank for $16,500,000
in cash. The total purchase price exceeded the estimated fair market value of
net assets acquired by approximately $7,800,000, of which approximately $950,000
was assigned to an identifiable intangible asset with the balance recorded by
the Company as goodwill. The identifiable intangible asset represents the future
benefit associated with the acquisition of the core deposits of City and is
being amortized over seven years utilizing a method that approximates the
expected attrition of the deposits.
The primary purpose of the acquisition was to expand the Company's market share
in areas with close proximity to Dallas/Ft. Worth, Texas. Factors that
contributed to a purchase price resulting in goodwill include City's
historically stable record of earnings, capable management and its geographic
location, which complements the Company's existing service locations. Subsequent
to the acquisition, the Company liquidated the stock of City and City National
Bank is operating as a subsidiary of the Company. The results of operations of
City National Bank are included in the consolidated earnings of the Company
commencing July 1, 2001.
The following is a condensed consolidated balance sheet disclosing the
preliminary estimated fair value amounts assigned to the major asset and
liability captions at the acquisition date.
ASSETS
Cash and cash equivalents $ 9,651,769
Investment securities 29,717,834
Loans, net 51,061,735
Goodwill 6,891,959
Identifiable intangible asset 946,073
Other assets 1,465,727
------------
Total assets $ 99,735,097
============
LIABILITIES AND SHAREHOLDER'S EQUITY
Noninterest-bearing deposits $ 11,949,766
Interest-bearing deposits 70,575,256
Other liabilities 710,075
Shareholders' equity 16,500,000
------------
Total liabilities and shareholder's equity $ 99,735,097
============
Goodwill recorded in the acquisition of City has been accounted for in
accordance with SFAS No. 142. Accordingly, goodwill has not been amortized,
rather it has been tested for impairment. The goodwill and identifiable
intangible asset recorded are not deductible for federal income tax purposes.
The proforma impact of City is insignificant to the Company's financial
statements.
Cash flow information relative to the acquisition of City is, as follows:
Fair value of assets acquired $ 99,735,097
Cash paid for the capital stock of City 16,500,000
------------
Liabilities assumed $ 83,235,097
============
F-31
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
18. CASH FLOW INFORMATION:
----------------------
Supplemental information on cash flows and noncash transactions is as follows:
Year Ended December 31,
---------------------------------------------
2003 2002 2001
----------- ----------- -----------
Supplemental cash flow information:
Interest paid $17,572,092 $25,704,950 $46,243,602
Federal income taxes paid 14,063,418 14,682,343 13,227,101
Schedule of noncash investing and financing activities:
Assets acquired through foreclosure 1,117,256 553,840 628,797
Loans to finance the sale of other real estate 19,400 - -
Retirement of treasury stock - - 4,240,119
F-32