SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
Commission File Number: 0-13086
FNB FINANCIAL SERVICES CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
North Carolina 56 - 1382275
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
202 South Main Street, Reidsville, North Carolina 27320
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(Address of principal executive offices) (Zip Code)
(336) 342-3346
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address, and former fiscal years,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities 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 [ ]
4,589,571 common shares were outstanding as of July 31, 2002, with a par value
per share of $1.00.
FNB FINANCIAL SERVICES CORPORATION
FORM 10-Q
INDEX
Page
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets
June 30, 2002 and December 31, 2001 1
Consolidated Statements of Income and Comprehensive Income Three
months and six months ended June 30, 2002 and 2001 2
Consolidated Statements of Cash Flows
Six months ended June 30, 2002 and 2001 3 - 4
Notes to Consolidated Financial Statements 5 - 9
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 10 - 15
Item 3 Quantitative and Qualitative Disclosures About Market Risk 16
PART II OTHER INFORMATION
Item 1 Legal Proceedings 17
Item 2 Changes in Securities and Use of Proceeds 17
Item 3 Defaults Upon Senior Securities 17
Item 4 Submission of Matters to a Vote of Security Holders 17
Item 5 Other Information 18
Item 6 Exhibits and Reports on Form 8 - K 18
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FNB Financial Services Corporation and Subsidiary
Consolidated Balance Sheets
(Dollars in thousands except par value)
June 30, December 31,
2002 2001
(Unaudited) (Audited)
-------- --------
ASSETS
Cash and due from banks $ 14,707 $ 23,673
Investment securities:
Securities available for sale 89,061 123,597
Federal Home Loan Bank and Federal Reserve Bank Stock 3,879 3,967
Loans, net of allowance for credit losses of $6,908 at
June 30, 2002 and $6,731 at December 31, 2001 536,582 528,614
Premises and equipment, net 10,960 11,381
Accrued income and other assets 16,150 13,593
-------- --------
Total assets $671,339 $704,825
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing $ 53,772 $ 58,831
Interest bearing 484,603 527,929
-------- --------
Total deposits 538,375 586,760
Federal funds purchased and retail repurchase agreements 18,898 19,677
Other borrowings 45,000 30,000
Accrued expenses and other liabilities 4,883 5,680
-------- --------
Total liabilities 607,156 642,117
-------- --------
Shareholders' Equity:
Preferred stock no par value; authorized 10,000,000 shares;
none issued -- --
Common stock, $1.00 par value; authorized 40,000,000 shares;
outstanding 4,617,878 at June 30, 2002 and
4,568,907 at December 31, 2001 4,618 4,569
Paid-in capital 26,390 26,465
Retained earnings 31,766 30,178
Accumulated other comprehensive income 1,409 1,496
-------- --------
Total shareholders' equity 64,183 62,708
-------- --------
Total liabilities and shareholders' equity $671,339 $704,825
======== ========
See notes to unaudited consolidated financial statements.
1
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Income and Comprehensive Income
(Unaudited; dollars in thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ -----------------------
2002 2001 2002 2001
---- ---- ---- ----
Interest income
Loans $ 9,218 $ 11,251 $ 18,242 $ 22,891
Federal funds sold and overnight deposits 23 82 43 169
Investment securities
Taxable 1,221 2,067 2,752 4,016
Tax exempt 96 193 193 386
Other 58 69 119 160
----------- ----------- ----------- ----------
Total interest income 10,616 13,662 21,349 27,622
----------- ----------- ----------- ----------
Interest expense
Deposits 4,243 7,573 9,141 15,134
Federal funds purchased and other borrowings 368 591 672 1,432
----------- ----------- ----------- ----------
Total interest expense 4,611 8,164 9,813 16,566
Net interest income 6,005 5,498 11,536 11,056
Provision for credit losses 680 260 965 483
----------- ----------- ----------- ----------
Net interest income after provision for credit losses 5,325 5,238 10,571 10,573
Other income
Service charges on deposit accounts 663 500 1,245 1,094
Net gain on sale of securities 318 158 318 159
Net gain on disposition of asset 94 -- 104 4
Income from investment services 77 37 146 74
Mortgage banking fees 282 48 442 48
Other income 114 91 223 151
----------- ----------- ----------- ----------
Total other income 1,548 834 2,478 1,530
Other expenses
Salaries and employee benefits 2,524 2,392 4,936 4,712
Occupancy expense 270 259 529 506
Furniture and equipment expense 482 492 979 969
Insurance expense, including FDIC assessment 52 43 97 85
Marketing expense 74 60 119 110
Printing and supply expense 94 109 229 173
Other expenses 1,081 590 2,019 1,306
----------- ----------- ----------- ----------
Total other expenses 4,577 3,945 8,908 7,861
Income before income taxes 2,296 2,127 4,141 4,242
Income tax expense 761 608 1,354 1,219
----------- ----------- ----------- ----------
Net income 1,535 1,519 2,787 3,023
Other comprehensive income (loss) 973 19 (87) 1,229
----------- ----------- ----------- ----------
Comprehensive income $ 2,508 $ 1,538 $ 2,700 $ 4,252
=========== =========== ============ ==========
Per share data
Net income, basic $ 0.33 $ 0.34 $ 0.60 0.67
Net income, diluted $ 0.32 $ 0.33 $ 0.59 $ 0.66
Cash dividends $ 0.13 $ 0.13 0.26 $ 0.25
Weighted average shares outstanding, basic 4,635,296 $ 4,511,576 4,605,891 4,501,958
Weighted average shares outstanding, diluted 4,739,204 $ 4,576,011 4,694,325 4,557,881
See notes to unaudited consolidated financial statements.
2
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited; dollars in thousands)
Six Months Ended
June 30,
2002 2001
-------- --------
Cash flows from operating activities:
Interest received $ 19,738 $ 35,906
Fees and commissions received 2,280 1,762
Interest paid (10,548) (17,763)
Noninterest expense paid (8,682) (6,616)
Income taxes paid (2,026) (1,232)
Funding of loans held for sale (12,232) (8,761)
Proceeds from sales of loans held for sale 12,514 8,026
-------- --------
Net cash provided by operating activities 1,044 11,322
-------- --------
Cash flows from investing activities:
Proceeds from sales or calls of securities available for sale 33,029 69,546
Proceeds from maturities of securities available for sale -- 1,500
Purchase of securities (220) (85,612)
Capital expenditures (218) (428)
(Increase) decrease in other real estate owned 823 75
(Increase) decrease in loans (8,033) (15,569)
-------- --------
Net cash provided (used) in investing activities 25,381 (30,488)
-------- --------
Cash flows from financing activities:
Increase (decrease) in demand, savings and interest
checking accounts (2,908) 2,846
Increase (decrease) in time deposits (45,477) 36,618
Increase (decrease) in federal funds purchased and
retail repurchase agreements (779) (2,069)
Increase (decrease) in other borrowings 15,000 (11,000)
Proceeds from issuance of common stock 1,072 81
Repurchase of common stock (1,100) --
Dividends paid (1,199) (1,142)
-------- --------
Net cash provided (used) by financing activities (35,391) 25,334
-------- --------
Net increase (decrease) in cash and cash equivalents (8,966) 6,168
Cash and cash equivalents, January 1 23,673 15,952
-------- --------
Cash and cash equivalents, June 30 $ 14,707 $ 22,120
======== ========
Supplemental disclosure of non-cash transactions:
Non-cash transfers from loans to other real estate $ 394 $ 189
======== ========
See notes to unaudited consolidated financial statements.
3
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited; dollars in thousands)
Reconciliation of net income to net cash provided by operating activities:
Six Months Ended
June 30,
----------------------------
2002 2001
-------- --------
Net income $ 2,787 $ 3,023
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for credit losses 965 483
Depreciation 684 744
Accretion and amortization 102 220
(Gain) loss on sale of securities available for sale (318) (159)
Funding of loans held for sale (12,232) (8,761)
Proceeds from sales of loans held for sale 12,514 8,026
(Gain) loss on other assets (104) (4)
(Increase) decrease in accrued income and other assets (2,557) 1,077
Increase (decrease) in accrued expenses and other liabilities (797) 6,673
-------- --------
Net cash provided by operating activities $ 1,044 $ 11,322
======== ========
See notes to unaudited consolidated financial statements.
4
FNB Financial Services Corporation and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles and
with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, these statements do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the six month period
ended June 30, 2002 are not necessarily indicative of the results that may
be expected for the year ending December 31, 2002.
2. Significant Activities
FNB Financial Services Corporation (the "Company") is a North Carolina
financial holding company. The Company's wholly owned subsidiary, FNB
Southeast (the "Bank"), is a North Carolina chartered commercial bank. FNB
Southeast operates two wholly owned subsidiaries, FNB Southeast Investment
Services, Inc. and FNB Southeast Mortgage Corporation.
As of June 30, 2002, FNB Southeast operated thirteen banking offices
in North Carolina and four banking offices in Virginia. The Company and the
Bank are headquartered in Reidsville, North Carolina.
3. Comprehensive Income
The Company's other comprehensive income for the three and six month
periods ended June 30, 2002 and 2001 consists of unrealized gains and
losses on available for sale securities, net of related income taxes, as
follows:
(Dollars in thousands) Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2002 2001 2002 2001
------- ------- ------- -------
Unrealized gains (losses) on
available for sale securities $ 1,913 $ 189 $ 176 $ 2,174
Reclassification of realized gains (318) (158) (318) (159)
Income tax effect (622) (12) 55 (786)
------- ------- ------- -------
$ 973 $ 19 $ (87) $ 1,229
======= ======= ======= =======
Other comprehensive income (loss)
5
4. Segment Information
The Company follows the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 131, "Disclosure about Segments of an
Enterprise and Related Information." SFAS 131 establishes standards for
determining an entity's operating segments and the type and level of
financial information to be disclosed in both annual and interim financial
statements. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers.
Operating segments are components of an enterprise with separate
financial information available for use by the chief operating decision
maker to allocate resources and to assess performance. The Company has
determined that it has one significant operating segment: the providing of
general financial services to the customers of its wholly owned subsidiary,
FNB Southeast. The various products offered by FNB Southeast are those
generally offered by community banks, and the allocation of resources is
based on the overall performance of the Company, rather than the individual
performance of banking offices or products.
5. Net Income Per Share
Basic and diluted earnings per share amounts have been computed based
upon net income as presented in the accompanying income statements divided
by the weighted average number of common shares outstanding or assumed to
be outstanding as summarized.
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Weighted average number of shares
used in basic EPS 4,635,296 4,511,576 4,605,891 4,501,958
Effect of dilutive stock options 103,908 64,435 88,434 55,923
--------- --------- --------- ---------
Weighted average number of common
shares and dilutive potential common
shares used in dilutive EPS 4,739,204 4,576,011 4,694,325 4,557,881
========= ========= ========= =========
As of June 30, 2002, there were 181,249 potentially dilutive share
options not included in the weighted average calculation since the option
exercise prices are greater than the fair market value of the common
shares.
6
6. Investment Securities Available for Sale
June 30, 2002 December 31, 2001
---------------------------- -----------------------------
(Dollars in thousands) Amortized Fair Amortized Fair
Cost Value Cost Value
-------- -------- -------- --------
U.S. Agency securities $ 75,043 $ 76,822 $104,039 $106,032
Mortgage backed securities 6,851 7,092 8,477 8,628
State and municipal obligations 4,551 4,833 8,325 8,628
Other 306 314 304 309
-------- -------- -------- --------
Total available for sale $ 86,751 $ 89,061 $121,145 $123,597
======== ======== ======== ========
7. Loans (net of unearned income)
(Dollars in thousands) June 30, December 31,
2002 2001
-------- --------
Loan Category:
Real estate - commercial $163,661 $168,419
Real estate - residential 123,863 129,212
Real estate - construction 75,234 55,861
Commercial, financial and agricultural 87,657 90,858
Consumer 92,305 89,943
-------- --------
Subtotal loans 542,720 534,293
Loans held for sale 770 1,052
-------- --------
Gross loans $543,490 $535,345
======== ========
7
Allowance for Credit Losses
June 30, 2002 December 31, 2001
--------------------------- ------------------------------
% of Loans % of Loans
(Dollars in thousands) in Each in Each
Category to Category to
Allowance Total Loans Allowance Total Loans
--------- ----------- --------- -----------
Balance at end of period
applicable to:
Real estate - construction 22 14 $ 18 10
Real estate - mortgage 185 53 104 56
Commercial 4,745 16 4,773 17
Consumer 1,956 17 1,836 17
--------- ----------- --------- -----------
Total $6,908 100% $ 6,731 100%
========= =========== ========= ===========
9. Analysis of Allowance for Credit Losses
Six Months Ended
June 30,
---------------------------
(Dollars in thousands) 2002 2001
------- -------
Balance, beginning of period $ 6,731 $ 6,311
Charge-offs 857 398
Recoveries (69) (101)
------- -------
Net charge-offs 788 297
------- -------
Allowance charged to operations 965 483
------- -------
Balance, end of period $ 6,908 $ 6,497
======= =======
Ratio of annualized net charge-offs during the
period to average loans outstanding
during the period 0.29% 0.12%
======= =======
Ratio of allowance for credit losses to
month end loans 1.27% 1.26%
======= =======
<
8
10. Nonperforming Assets
June 30, December 31,
(Dollars in thousands) 2002 2001
------ ------
Nonaccrual (1) $2,848 $2,260
Past due 90 days or more and still accruing interest 61 6
Other real estate 1,490 2,707
(1) Other than amounts listed above, there are no other loans which: (a)
represent or result from trends or uncertainties which management
reasonably expects will materially affect future operating results,
liquidity, or capital resources, or (b) represent material credits
about which management is aware of any information which causes
management to have serious doubts as to the ability of such borrowers
to comply with the loan repayment terms.
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Information set forth below contains various 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, which statements represent the Company's
judgment concerning the future and are subject to risks and uncertainties that
could cause the Company's actual operating results to differ materially. Such
forward-looking statements can be identified by the use of forward-looking
terminology, such as "may", "will", "expect", "anticipate", "estimate",
"believe", or "continue", or the negative thereof or other variations thereof or
comparable terminology. The Company cautions that such forward-looking
statements are further qualified by important factors that could cause the
Company's actual operating results to differ materially from those in the
forward-looking statements.
Summary
Assets at June 30, 2002 were $671.3 million, a decrease of $33.5 million
since December 31, 2001. The decrease in assets was primarily due to a decrease
in investment securities available for sale of $34.5 million over the first six
months of 2002. The decrease in the investment portfolio was due to continued
calls by issuers of various securities. The Company has elected to use these
proceeds to fund a managed decrease in relatively high cost deposits rather than
reinvesting in securities near the perceived bottom of the interest rate cycle.
Over the past six months, deposits have decreased $48.4 million.
Net income for the quarter ended June 30, 2002, of $1.5 million was $16,000
or 1.0% higher than the amount earned in the second quarter last year. Diluted
earnings per share for the current quarter were $0.32 per share compared to
$0.33 per share last year. For the six months to date, earnings of $2.8 million
were lower than the same period last year by $236,000 or 7.8%, and diluted
earnings per share totaled $0.59 compared to $0.66 in the same period last year.
Interest Income and Interest Expense
Second quarter total interest income was $10.6 million, a decrease of 22.3%
over the same quarter last year. Average earning assets for the quarter were
$642.4 million, compared to $683.3 million for the year ago period. Interest
income from loans was $9.2 million, down 18.1% from $11.3 million in the second
quarter of 2001. The decrease in interest income was driven primarily by a
dramatic decline in the prime lending rate. Average loans of $539.4 million were
5.1% higher than the $513.1 million last year. For the second quarter, the
average yield on loans was 6.85% in 2002 compared to 8.80% in 2001. For the six
months ended on June 30, 2002, total interest income was down 22.7% to $21.3
million from $27.6 million in the same period in 2001, on a 3.5% decrease in
average earning assets.
Interest income on investments totaled $1.4 million for the current
quarter, down 39.1% from $2.3 million for the year ago quarter. The change was
primarily attributable to a 40.1% decrease in the average balance of the
investment portfolio from $162.8 million in the second quarter of 2001 to $97.5
million in the second quarter of 2002. Due to call and sales of securities
within the portfolio over the last year, interest income on taxable investment
securities decreased $846,000, while interest income on tax exempt securities
decreased $97,000. Investment income for the six month period decreased from
$4.6 million in 2001 to $3.1 million in 2002 for the same reasons.
Second quarter total interest expense was $4.6 million compared to $8.2
million from the second quarter of last year, a 43.5% decrease. Average interest
bearing liabilities for the second quarter 2002 decreased 8.7% to $543.8 million
from $595.7 million for the second quarter of 2001. Overall cost of funds for
the second quarter was 3.40% and 5.50% in 2002 and 2001, respectively. Total
interest expense for the first six months of 2002 was $9.8 million, a 40.8%
decrease over the $16.6 million expense for the first six months of 2001.
10
Interest expense on deposits for the second quarter decreased 44.0% to $4.2
million as average interest bearing deposits for the quarter decreased 12.7% to
$478.8 million from $548.6 million in 2001. The Company elected to fund a
managed decrease in relatively high cost deposits rather with proceeds from
called or sold investment securities rather than reinvesting in securities near
the perceived bottom of the interest rate cycle. The average rate for the
quarter on interest bearing deposits decreased to 3.55% from 5.54% one year
earlier. Deposit interest expense for the six months ended June 30, 2002,
decreased from $15.1 million in 2001 to $9.1 million in 2002.
Interest expense on federal funds purchased and other borrowings was
$368,000 for the quarter ended June 30, 2002, down 37.7%, from $591,000 in the
second quarter of 2001. The decrease was primarily attributable to a decline in
average rate paid on purchased funds to 2.27% in the second quarter of 2002
compared to 5.03% in the second quarter of 2001. For the six months ended June
30, interest expense for this category decreased from $1.4 million in 2001 to
$672,000 in 2002.
Comparable net interest margins are as follows:
Time Period Asset Yield Rate Interest Rate Spread
----------------- ------------- ------------------------
Second Quarter, 2002 6.66% - 3.40% = 3.26%
Second Quarter, 2001 8.08% - 5.50% = 2.58%
Year-To-Date, 2002 6.65% - 3.57% = 3.08%
Year-To-Date, 2001 8.33% - 5.68% = 2.65%
Noninterest Income and Expense
Noninterest income in the second quarter of this year increased 85.4% to
$1.5 million from $834,000 in the same period last year. For the current
quarter, $318,000 of net gains from sales of investment securities were
recognized, an increase from $158,000 of net gains in the second quarter of last
year. Deposit service charges of $663,000 for the second quarter of 2002
increased 32.6% from the $500,000 in the second quarter of 2001. Noninterest
income in the second quarter of 2002 included $282,000 in mortgage banking fees
and $77,000 in investment service fees compared to revenues of $48,000 and
$37,000, respectively, for the previous year. The increase in mortgage banking
fees for the first half of 2002 was attributable to the operation of the
mortgage banking subsidiary established in June of 2001. During the second
quarter of 2002, the Company recognized a gain of $94,000 on the sale of
mortgage servicing rights. All of the underlying loans had been previously sold
in the secondary mortgage market. Mortgage servicing fees totaled $24,000 during
the first six months of 2002, but will be substantially reduced in the second
half of 2002. Total noninterest income for the first half of 2002 totaled $2.5
million, a 62.0% increase over the $1.5 million earned in the first half of
2001. Deposit service charges of $1.2 million for the six months were 13.8%
higher than the $1.1 million recorded in the same period last year.
Noninterest expense for the second quarter of 2002 was $4.6 million, a
16.0% increase over the $3.9 million expense in the second quarter of 2001.
Salaries and employee benefits increased $132,000 because of higher insurance
and retirement costs, occupancy expense increased $11,000, and furniture and
equipment expense decreased $10,000 compared to the year ago quarter. Other
expense for the 2002 second quarter totaled $1.1 million, compared to $590,000
for the year ago quarter. The Company incurred a $60,000 expense to buy-out a
third party service agreement and expense also recorded a writedown of $80,000
for the disposal of fixed assets. The Company intends to sell approximately 32
free standing ATMs during the third quarter of this year. A quarterly increase
of $108,000 was incurred in collection expenses, exams and audit expenses,
courier expense and communications expenses. Other expense in the first half of
2002 totaled $2.0 million, an increase of $713,000 from the first half of 2001.
11
This increase was largely attributable to a write-off of $138,000 in the first
quarter of 2002 of an uncollectable receivable from a U.S. government agency
that guaranteed a portion of a charge-off loan and the above mentioned items for
the second quarter. This year's six-month noninterest expense of $8.9 million
was 13.3% higher than the $7.9 million in the same period last year.
The provision for credit losses in the second quarter of 2002 was $680,000
compared to $260,000 in 2001. The allowance for credit losses as a percentage of
gross loans outstanding increased to 1.27% at June 30, 2002 from 1.26% at June
30, 2001. The increase in the provision for credit losses is attributable to
annualized net credit losses to average loans of 0.38% in the 2002 second
quarter compared to 0.22% in the 2001 second quarter. For the 2002 six months,
the provision totaled $965,000, compared to $483,000 for the same period in
2001.
The effective income tax rate of 32.7% for the first six months of 2002 was
higher than the 28.7% rate for the same quarter of 2001. Late in the second
quarter of 2002, the Company sold a portion of the tax-exempt investment
portfolio. This will have the general effect of increasing the effective tax
rate during the second half of 2002.
Financial Condition
The Company's total assets at June 30, 2002 and 2001 were $671.3 million
and $722.5 million, respectively. The $51.2 million decline represents a 7.1%
decrease over one year earlier. Since December 31, 2001, assets have decreased
$33.5 million. The decrease in assets was primarily due to a decrease in
investment securities available for sale of $34.5 million over the first six
months of 2002. Average earning assets for the 2002 second quarter were $642.4
million, or 6.0% lower than the $683.3 million average in the same quarter last
year.
Loans at June 30, 2002 totaled $543.5 million compared to $516.9 million
one year earlier, an increase of 5.1%. Loans have increased 1.5% from $535.3
million at December 31, 2001. Average loans for the second quarter of 2002 were
$539.4 million, or 5.1% higher than the $513.1 million average in this same
period one year ago.
Investment securities of $92.9 million at June 30, 2002 were 43.8% lower
than the $165.4 million recorded one year earlier. Average investment securities
were $97.5 million and $162.8 million for the second quarter of 2002 and 2001,
respectively. The decrease in the investment portfolio was due to continued
calls by issuers of various securities. The Company has elected to use these
proceeds to fund a managed decrease in relatively high cost deposits rather than
reinvesting in securities near the perceived bottom of the interest rate cycle.
Deposits totaled $538.4 million at June 30, 2002, an 11.6% decrease versus
$608.8 million one year ago, and an 8.3% decrease from the $586.8 million
recorded at December 31, 2001. At the end of the second quarter 2002,
noninterest bearing deposits were $53.8 million, or 10.0% of total deposits. The
decrease in deposits was the result of management's decision to use proceeds
from called investment securities for funding purposes, as discussed in the
previous paragraph.
At June 30, 2002, borrowings at the Federal Home Loan Bank of Atlanta
(FHLB) totaled $45.0 million, an increase of 50.0% compared to $30.0 million at
December 31, 2001. The increase in borrowings was due to favorable funding rates
available at the current time.
Shareholders' equity increased to $64.2 million at the end of the second
quarter 2002, compared to $62.7 million at December 31, 2001. The Company paid
dividends of $0.13 per share during the quarter ended June 30, 2002, the same
rate as the second quarter of 2001. Year to date dividends per share for 2002
were $0.26 compared to $0.25 in 2001. A stock repurchase program of up to 5% of
the outstanding common stock was announced during the second quarter of this
year. This program is intended to help the Company achieve its goal of building
shareholder value while maintaining appropriate capital levels. Through June 30,
2002, a total of 67,700 shares have been purchased. In accordance with state
law, repurchased shares are cancelled and are no longer considered issued.
12
Asset Quality
The credit loss allowance ratio at June 30, 2002 was 1.27% compared to
1.26% at December 31, 2001 and 1.26% at June 30, 2001. For the second quarter of
2002, provision charges against earnings totaled $680,000 compared to $260,000
in the second quarter one year earlier. Net charge-offs for the 2002 second
quarter totaled $514,000, or a 0.38% annualized loss ratio based on average
loans outstanding. This compares to net charge-offs of $286,000, or 0.22%
annualized loss ratio for the 2001 second quarter. Annualized net charge-offs
for the first six months of 2002 and 2001 were 0.29% and 0.12%, respectively,
based on average loans outstanding.
The Company's allowance for credit losses is analyzed quarterly by
management. This analysis includes a methodology that segments the loan
portfolio by selected types and considers the current status of the portfolio,
historical charge-off experience, current levels of delinquent, impaired and
non-performing loans, as well as economic and other risk factors. It is also
subject to regulatory examinations and determinations as to adequacy, which may
take into account such factors as the methodology employed and other analytical
measures in comparison to a group of peer banks. Management believes the
allowance for loan losses is sufficient to absorb known risk in the portfolio.
No assurances can be given that future economic conditions will not adversely
affect borrowers and result in increased losses.
Other real estate owned decreased to $1.5 million at June 30, 2002,
compared to $2.7 million at December 31, 2001. Approximately $394,000 has been
transferred from loans into other real estate and approximately $1.6 million of
such assets were disposed of during the first six months of 2002. A net loss of
$8,000 has been recorded on disposition of other real estate in the current
year.
Capital Resources
Banks and financial holding companies, as regulated institutions, must meet
required levels of capital. The Office of the Commissioner of Banks in North
Carolina and the Board of Governors of the Federal Reserve, which are the
primary regulatory agencies for FNB Southeast and the Company, respectively,
have adopted minimum capital regulations or guidelines that categorize
components and the level of risk associated with various types of assets.
Financial institutions are required to maintain a level of capital commensurate
with the risk profile assigned to their assets in accordance with the
guidelines.
As shown in the table below, the Company and its wholly-owned banking
subsidiary have capital levels exceeding the minimum levels for "well
capitalized" banks and financial holding companies as of June 30, 2002.
Regulatory Guidelines
-----------------------------------
Well Adequately FNB
Ratio Capitalized Capitalized Company Southeast
----- ---------------- --------------- ------------- -------------
Total Capital 10.0% 8.0% 13.1% 12.7%
Tier 1 Capital 6.0 4.0 11.8 11.5
Leverage Capital 5.0 4.0 9.3 9.0
New Accounting Pronouncements
The Financial Accounting Standards Board ("FASB") has issued Statement of
Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141 supersedes APB
Opinion No. 16, "Business Combinations", and FASB Statement No. 38, "Accounting
for Preacquisition Contingencies of Purchased Enterprises" and requires that all
business combinations be accounted for using the purchase method. This Statement
13
carries forward without reconsideration those portions of APB Opinion No. 16,
"Business Combinations", that provides guidance related to the application of
the purchase method. This Statement requires that intangible assets that meet
certain criteria be recognized as assets apart from goodwill. The provisions of
this Statement apply to all business combinations initiated after June 30, 2001.
This Statement also applies to all business combinations accounted for using the
purchase method for which the date of acquisition is July 1, 2001, or later.
SFAS 142 addresses financial accounting and reporting for acquired goodwill
and other intangible assets and supersedes APB Opinion No. 17, "Intangible
Assets." It addresses how intangible assets that are acquired individually or
with a group of other assets (but not those acquired in a business combination)
should be accounted for in financial statements upon their acquisition. This
Statement also addresses how goodwill and other intangible assets should be
accounted for after they have been initially recognized in the financial
statements. This Statement carries forward without reconsideration those
provisions of Opinion 17 related to the accounting for internally developed
intangible assets. The provisions of this Statement are required to be applied
starting with fiscal years beginning after December 15, 2001. Impairment losses
for goodwill and indefinite-lived intangible assets that arise due to the
initial application of this Statement (resulting from a transitional impairment
test) are to be reported as resulting from a change in accounting principle. The
provisions of both Statements have been adopted. The implementation did not have
a material effect on the Company's financial statements.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS 143 requires that obligations associated with the
retirement of a tangible long-lived asset to be recorded as a liability when
those obligations are incurred, with the amount of the liability initially
measured at fair value. SFAS 143 will be effective for financial statements
issued for fiscal years beginning after June 15, 2002 (early application is
encouraged). The provision of the Statement has been adopted. The implementation
did not have a material effect on the Company's financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS 144 supersedes SFAS 121 and
applies to all long-lived assets (including discontinued operations) and
consequently amends APB Opinion No. 30, "Reporting Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business." SFAS 144 requires
that long-lived assets that are to be disposed of by sale be measured at the
lower of book value or fair value less cost to sell. SFAS 144 is effective for
financial statements issued for fiscal years beginning after December 15, 2001
and, generally, its provisions are to be applied prospectively. The provision of
the Statement has been adopted. The implementation did not have a material
effect on the Company's financial statements.
In May 2002, the FASB issued SFAS No, 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections
as of April 2002." This Statement rescinds SFAS No. 4, "Reporting Gains and
Losses from Extinguishment of Debt", and an amendment of that Statement, No. 64,
"Extinguishments of Debt to Satisfy Sinking-Fund Requirements." This Statement
also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers"
and amends SFAS No. 13, "Accounting for Leases", to eliminate an inconsistency
between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions. This Statement also amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions.
Management does not anticipate implementation of this Statement will have a
material effect on the Company's financial statements.
14
Liquidity Management
Liquidity management refers to the ability to meet day-to-day cash flow
requirements based primarily on activity in loan and deposit accounts of the
Company's customers. Deposit withdrawals, loan funding and general corporate
activity create a need for liquidity for the Company. Liquidity is derived from
sources such as deposit growth; maturity, calls, or sales of investment
securities; principal and interest payments on loans; access to borrowed funds
or lines of credit; and profits.
During the first six months of 2002 the Company had net cash provided by
operating activities of $1.0 million. This was a reduction from $11.3 million of
net cash provided by operating activities in the first half of 2001. The
decrease is primarily attributable to the decline of $16.2 million in interest
received and an increase in noninterest expense paid of $2.1 million.
Net cash provided by investing activities in the first six months totaled
$25.4 million primarily based on the proceeds of $33.0 million from calls of
investment securities. Purchases of investment securities in the current year
totaled $220,000. This compares to the first half of 2001 when purchases of
$85.6 million in investment securities resulted in net cash used in investing
activities of $30.5 million. An increase in loans outstanding used $8.0 million
in cash during 2002, compared to an increase in outstanding loans in 2001 that
used $15.6 million of cash during the same period in 2001.
Financing activities in the 2002 first half used $35.4 million, based
primarily on $48.4 million outflow of deposits. These cash outflows were
partially offset by increased borrowings of $15.0 million during the first six
months. During the 2001 first half, financing activities provided $25.3 million.
Time deposits provided $36.6 million of cash, while repayment of other borrowing
used $11.0 million of cash and repayment of federal funds purchased and retail
repurchase agreements used $2.1 million during the first half of 2001.
Overall cash and cash equivalents totaled $14.7 million at June 30, 2002
compared to $23.7 million at December 31, 2001 and $22.1 million at June 30,
2001.
Liquidity is further enhanced by an approximately $115 million line of
credit with the FHLB collateralized by FHLB stock, investment securities and
qualifying 1 to 4 family residential mortgage loans, and qualifying commercial
real estate loans. The Company provides various reports to the FHLB on a regular
basis throughout the year to maintain the availability of the credit line. Each
borrowing request to the FHLB is initiated through an advance application that
is subject to approval by the FHLB before funds are advanced under the credit
agreement.
The Company also has unsecured overnight borrowing lines totaling $19
million available through four financial institutions. These lines are used to
manage the day to day, short-term liquidity needs of the Company. Each Federal
funds line has a requirement to repay the line in full on a frequent basis,
typically within five to ten business days.
Effects of Inflation
Inflation affects financial institutions in ways that are different from
most commercial and industrial companies, which have significant investments in
fixed assets and inventories. The effect of inflation on interest rates can
materially impact bank operations, which rely on net interest margins as a major
source of earnings. Non-interest expenses, such as salaries and wages, occupancy
and equipment cost are also negatively impacted by inflation.
15
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the possible chance of loss from unfavorable changes in
market prices and rates. These changes may result in a reduction of current and
future period net interest income, which is the favorable spread earned from the
excess of interest income on interest-earning assets, over interest expense on
interest-bearing liabilities.
The Company considers interest rate risk to be its most significant market
risk, which could potentially have the greatest impact on operating earnings.
The Company is asset sensitive, which means that falling interest rates could
result in a reduced amount of net interest income. The monitoring of interest
rate risk is part of the Company's overall asset/liability management process.
The primary oversight of asset/liability management rests with the Company's
Asset and Liability Committee. The Committee meets on a regular basis to review
asset/liability activities and to monitor compliance with established policies.
The Company has not experienced any substantive changes in portfolio risk
during the six months ended June 30, 2002.
16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders
On May 16, 2002, at the Annual Meeting of the Company's shareholders,
the following two proposals were voted on by shareholders.
Proposal One
------------
To elect five members of the Board of Directors as follows:
One Class II Director to fill the vacancy created by the retirement of
Dr. Clifton G. Payne as of December 31, 2001 and to serve the remainder
of a three year term ending in 2004. Votes for each nominee were as
follows:
Nominee For Withheld
------- --- --------
E. Reid Teague 3,442,512 35,168
Four Class III Directors to serve three-year terms ending in 2005.
Votes for each nominee were as follows:
Nominee For Withheld
------- --- --------
Gary G. Blosser 3,437,915 39,765
Joseph H. Kinnarney 3,436,328 41,352
Elton H. Trent, Jr. 3,437,867 39,813
Kenan C. Wright 3,437,900 39,780
The following directors remain in office: Barry Z. Dodson (Chairman),
Charles A. Britt (Vice Chairman), O. Eddie Green, and Ernest J. Sewell.
Proposal Two
To ratify the appointment of PricewaterhouseCoopers LLP as the
Company's independent accountants for the year ending December 31,
2002. The votes for this proposal were as follows:
For : 3,423,773
Against: 48,281
Abstain: 5,626
17
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
----------- ------------
3.01 Amended and Restated Articles of Incorporation.
3.02 Bylaws of Company, as amended.
4.01 Specimen Common Stock Certificate.
10.01 Stock Compensation Plan of the Registrant approved April
11, 1989, by the shareholders of the Registrant, with
forms of stock option and stock bonus agreements
attached.
10.02 Omnibus Equity Compensation Plan of the Registrant.
10.03 Severance Policy for Senior Officers of the Registrant
(employed for five years or more).
10.04 Revised Severance Plan for Senior Officers of the
Registrant (employed for five years or more).
10.05 Severance Policy for Senior Officers of the Registrant
(employed for less than five years).
10.07 Benefit Equivalency Plan of the Registrant effective
January 1, 1994. 10.08 Annual Management Incentive Plan
of the Registrant.
10.09 Long Term Incentive Plan of the Registrant.
10.10 Employment Agreement dated May 18, 1995, between the
Registrant, as employer, and Ernest J. Sewell, President
and Chief Executive Officer of the Registrant.
10.11 Split-Dollar Agreement dated January 27, 1995, between
the Registrant and Ernest J. Sewell.
10.13 Split-Dollar Agreement dated January 27, 1995, between
the Registrant and C. Melvin Gantt.
10.14 Split-Dollar Agreement dated December 8, 1995, between
the Registrant and Richard L. Powell.
10.15 Lease, dated January 31, 1997, between the Registrant
and Landmark Commercial, Inc., relating to the
Wilmington branch office.
10.16 Amendment to Benefit Equivalency Plan of the Registrant
effective January 1, 1998.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on May 17, 2002,
to announce plans to repurchase up to 5% of the Company's common
stock. Purchases may be made from time-to-time, in the open market or
in privately negotiated transactions, based on market conditions and
other factors. The repurchase program may be suspended at any time
without prior notice.
18
SIGNATURES
Pursuant to the requirements 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.
FNB FINANCIAL SERVICES CORPORATION
(Registrant)
August 12, 2002 /s/ Michael W. Shelton
-----------------------------------------
Michael W. Shelton
(Vice President, Secretary and Treasurer)
19