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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended:
December 31, 2003
Commission File Number: 1-13086
FNB FINANCIAL SERVICES CORPORATION
(Exact name of Registrant as specified in its Charter)
North Carolina 56-1382275
(State of Incorporation) (I.R.S. Employer Identification No.)
202 South Main Street
Reidsville, North Carolina 27320
(Address of principal executive offices) (Zip Code)
(336) 342-3346
(Registrant's telephone number, including area code)
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Securities Registered Pursuant to Section 12(g) of the Securities Exchange Act
of 1934:
Name of each exchange
Title of each class on which registered
------------------- -------------------
Common Stock, $1.00 par value Nasdaq Stock Market
Check if there is no disclosure of delinquent filers pursuant to Item 405
of Regulation S-K contained herein, and none will be contained, to the best of
Registrant's knowledge, in definitive proxy or information statements
incorporated by references in Part III of this Form 10-K or any amendment to
this Form 10-K. |_|
Check 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 whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES |X| NO |_|
The aggregate market value of the Registrant's Common Stock at March 25,
2004, held by non-affiliates of the Registrant, based on the average bid and
asked price of the Common Stock on that day, was approximately $105.5 million.
The number of shares of the Registrant's Common Stock outstanding on March 25,
2004, was 5,494,807.
Portions of the Proxy Statement of the Registrant for the Annual Meeting
of Shareholders to be held on May 20, 2004, are incorporated by reference in
Part III of this report.
The Exhibit Index begins on page 68.
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FNB Financial Services Corporation
Form 10-K
Table of Contents
Index Page
----
PART I
Item 1. Business................................................................. 1
Item 2. Properties............................................................... 16
Item 3. Legal Proceedings........................................................ 16
Item 4. Submission of Matters to a Vote of Security Holders...................... 16
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters....... 17
and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data.................................................. 17
Item 7 Management's Discussion and Analysis
of Financial Condition and Results of Operations.................... 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............... 27
Item 8. Financial Statements and Supplementary Data.............................. 41
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.............................. 66
Item 9A. Controls and Procedures.................................................. 66
PART III
Item 10. Directors and Executive Officers of the Registrant....................... 67
Item 11. Executive Compensation................................................... 67
Item 12. Security Ownership of Certain Beneficial Owners and Management......... 67
and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions........................... 67
Item 14. Controls and Procedures.................................................. 67
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......... 68
Signatures............................................................... 71
Statement Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains and incorporates by reference
statements relating to future results of FNB Financial Services Corporation (the
"Company") that are considered "forward-looking" within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21B of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). The forward-looking
statements are principally, but not exclusively, contained in Item 1: "Business"
and Item 7: "Management's Discussion and Analysis of Financial Condition and
Results of Operations." These statements relate to, among other things,
expectations concerning loan demand, growth and performance, simulated changes
in interest rates and the adequacy of our allowance for loan losses. These
statements involve known and unknown risks, uncertainties and other factors that
may cause our actual results, performance or achievements to be materially
different from any future results, performance or achievements expressed or
implied by the forward-looking statements. Actual results may differ materially
from those expressed or implied as a result of certain risks and uncertainties,
including, but not limited to, changes in political and economic conditions,
interest rate fluctuations, competitive product and pricing pressures within our
markets, equity and fixed income market fluctuations, personal and corporate
customers' bankruptcies, inflation, acquisitions and integrations of acquired
businesses, technological changes, changes in law and regulations, changes in
fiscal, monetary, regulatory and tax policies, monetary fluctuations, success in
gaining regulatory approvals when required, as well as, other risks and
uncertainties reported from time to time in our filings with the Securities and
Exchange Commission (the "SEC"). Forward-looking statements and factors that may
cause actual results to differ materially are also discussed at the beginning of
Item 7: "Management's Discussion and Analysis of Financial Condition and Results
of Operations." Broadly speaking, forward-looking statements include:
o projections of the Company's revenues, income, earnings per share,
capital expenditures, dividends, capital structure or other
financial items;
o descriptions of plans or objectives of the Company's management for
future operations, products or services;
o forecasts of the Company's future economic performance; and
o descriptions of assumptions underlying or relating to any of the
foregoing.
The Company may make forward-looking statements discussing management's
expectations about:
o future credit losses and non performing assets;
o the future value of mortgage servicing rights;
o the impact of new accounting standards;
o future short-term and long-term interest rate levels and their
impact on the Company's net interest margin, net income, liquidity
and capital; and
o future capital expenditures.
Forward-looking statements discuss matters that are not historical facts.
Because they discuss future events or conditions, forward-looking statements
often include words such as "anticipate," "might," "believe," "estimate,"
"expect," "plan," "could," "may," "should," "will," "would," or similar
expressions. Do not unduly rely on forward-looking statements. They detail
management's expectations about the future and are not guarantees.
Forward-looking statements speak only as of the date they are made, and
management may not update them to reflect changes that occur after the date the
statements are made.
PART I
Item 1. Business
General
FNB Financial Services Corporation (the "Company") is a North Carolina
("NC") financial holding company with consolidated assets of $780.9 million,
deposits of $641.9 million and shareholders' equity of $65.8 million, as of
December 31, 2003. The Company was organized in 1984 as a North Carolina bank
holding company, although its predecessor and wholly-owned subsidiary, FNB
Southeast (the "Bank"), opened as Rockingham Savings Bank and Trust in 1910, and
was then chartered as a national bank in 1918 under the name of First National
Bank of Reidsville. In May 1997, the Bank changed its name to First National
Bank Southeast to reflect its expansion into new markets. Effective March 15,
1999, the Bank changed its charter from a national bank to a North Carolina
state bank and changed its name to FNB Southeast. The Company filed an election
with the Federal Reserve Board to become a financial holding company on January
23, 2001, and became a financial holding company effective February 12, 2001,
under the Gramm-Leach-Bliley Act. A financial holding company is permitted to
engage in activities that are financial in nature or incidental to a financial
activity. The permitted activities of a financial holding company are broader
than for a bank holding company.
Historically, the Company has served the Rockingham County area of North
Carolina through three branches in Reidsville and two in Eden, North Carolina.
In 1995, the Company initiated a strategic growth plan beginning with the hiring
of a new chief executive officer. On August 31, 1999, the Company acquired Black
Diamond Savings Bank, FSB ("Black Diamond"), a federal savings bank
headquartered in Norton, Virginia. By the end of 2003, FNB Southeast had
increased its number of North Carolina branches from five to thirteen by closing
a branch in Eden and opening nine new branches in the Rockingham County towns of
Eden, Ruffin and Madison and in the new markets of Greensboro, Burgaw and
Wilmington. The acquisition of Black Diamond added branches in Norton,
Harrisonburg, Pennington Gap and Richlands, Virginia. The Company announced
plans to sell certain assets of the Richlands, Virginia branch to Bank of
Tazewell County. This transaction is expected to close in April 2004.
The Bank is community oriented and focuses primarily on offering
commercial, real estate and consumer loans, and deposit and other financial
services to individuals, small to medium-sized businesses and other
organizations in its market areas. It emphasizes individualized services and
community involvement, while at the same time providing its customers with the
financial sophistication and array of products typically offered by larger
banks. It competes successfully with larger banks located within and outside
North Carolina and Virginia by retaining its personalized approach and community
focus.
Under the leadership of Ernest J. Sewell, who became President and Chief
Executive Officer in 1995, the Company adopted the following three-part
strategy: (1) increase market share and geographic reach through opportunistic
acquisitions in markets where the mix of economic, operational, cultural and
other factors are favorable; (2) position the Company to manage its planned
growth by adding experienced personnel and upgrading its internal systems and
procedures; and (3) generate internal growth at its existing banking offices by
offering new and complementary services and products. To accomplish these
objectives, during the past eight years the Company has: (a) increased the
number of its North Carolina banking offices to thirteen; (b) expanded the
number of its full-time personnel by adding new employees, including several
senior executives; (c) completed the merger with Black Diamond to extend the
Company's reach into selected Virginia markets; (d) completed a systematic
review and revision of its loan administration, loan policy and credit
procedures; (e) enhanced its mix of products and services by forming investment
services and mortgage banking subsidiaries; and (f) announced the relocation of
its corporate headquarters to Greensboro, NC.
The Company plans to continue to pursue its strategy by strengthening its
presence in existing markets and opportunistically reaching into new markets in
North Carolina and Virginia. On January 24, 2003, the Bank completed the
acquisition of the Harrisonburg, Virginia branch of Guaranty Bank. The
Company continues to seek qualified personnel to help manage its planned growth
and to develop new products that are consistent with the Company's customer
service orientation. For example, the Company opened a wholesale mortgage
division in the fourth quarter of 2003 and staffed the division with a manager
and eleven employees. The Company also plans, where appropriate, to upgrade its
systems and procedures and refine its ability to offer customers sophisticated
services without sacrificing its personalized approach.
Strategy
Expand Banking Operations. Throughout most of its 94-year history, the
Company's banking activities were centered around Reidsville, located in
Rockingham County in the north central part of North Carolina. Beginning in
1995, however, the Company initiated a growth strategy to further penetrate
markets in which it had an existing market share and expand into and develop new
markets, such as Wilmington and Greensboro in North Carolina and into Virginia.
Management selects its target markets based on a number of factors, including
market size and growth potential, banking relationships developed by members of
management during their careers and the ability to integrate the targeted market
into the Company's community oriented culture.
The Company's expansion strategy, both within and outside of its existing
markets, involves three key elements: (i) ascertaining which markets may be
underserved by financial institutions whose primary focus is to cater to the
individualized needs of the customer; (ii) installing high-quality, well-trained
management to serve the market; and (iii) locating reasonably priced facilities.
Management believes that it has been successful in implementing these strategic
elements in its expansion program to date.
The Company first established a branch in Greensboro, NC during 1997 and
added two additional branches in 2000. The Guilford County deposit market is the
largest in the Company's market area and totaled $6.71 billion at June 30, 2003.
On December 2, 2003 the Company announced the relocation of the Company's
headquarters to 1501 Highwoods Boulevard, Suite 400, Greensboro. This move will
allow the Company more access to the financial markets and assist the Company in
reaching the larger customer base in Guilford County.
Seize Market Expansion Opportunities. The Company intends to continue to
capitalize on opportunities to enter new and contiguous markets which it
believes are underserved as a result of banking consolidation and in which the
Company's community oriented philosophy and culture might flourish. The Company
believes that there is value to be added by providing the opportunity for
greater personalized banking relationships that exist with larger commercial
banks in its markets, although the Company also recognizes the need to carefully
analyze markets that are already well served by numerous institutions. The
Company will continue to distinguish itself by emphasizing high quality,
sophisticated services in a hometown environment.
Establish a Platform for Future Growth. The Company seeks to position
itself to manage its expected growth in two fundamental ways: (1) attract,
retain and reward experienced personnel who are committed both to conducting
business in a friendly and personable manner and to serving the communities in
which they work and live; and (2) continue to upgrade, modify and expand its
internal systems, procedures, equipment and software to improve operating
efficiencies. The Company will continue to analyze technological developments in
the banking industry for opportunities to improve or augment its services and
products; however, management will continue to make every effort to maintain the
Company's personalized approach.
Maintain a Friendly Environment for Employees and Customers. The Company
has instituted various programs to instill high morale among its employees,
which the Company believes translate into exceptional customer service. The
Company holds weekly sales meetings to elicit ideas about featured products and
services and to develop and communicate ideas for expanding banking
relationships with
2
existing and potential customers. Management believes that the overall effect of
these type programs is to improve morale, customer service and financial
performance.
Market Areas
For operational purposes, the Company groups its markets into four
regions: the Triad and Wilmington regions of North Carolina, and the Norton and
Harrisonburg regions of Virginia. The Company's deposit market share in the
Rockingham County portion of the Triad Region as of June 30, 2003, the most
recent date for which data are available, was 29.4%, which ranked first among
banks and thrift institutions. The following table summarizes the banking
offices and deposit totals for the Company's offices, categorized by city.
Region and City Deposits at December 31,
------------------------------------------------------------
2003 2002 2001
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(In thousands)
Triad Region:
Reidsville (1) ............................. $ 196,292 $ 226,819 $ 198,885
Eden (2) ................................... 53,322 45,333 50,873
Madison .................................... 20,383 22,482 22,302
Ruffin ..................................... 10,710 10,872 11,152
Greensboro (1) ............................. 97,736 77,548 72,749
-------------- -------------- --------------
Subtotal ......................... 378,443 383,054 355,961
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Wilmington Region:
Wilmington (2) ............................. 83,668 55,259 52,489
Burgaw ..................................... 26,954 25,247 26,496
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Subtotal ......................... 110,622 80,506 78,985
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Norton Region:
Norton ..................................... 53,970 58,551 67,545
Pennington Gap ............................. 17,973 22,933 26,103
Richlands .................................. 18,641 22,174 26,203
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Subtotal ......................... 90,584 103,658 119,851
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Harrisonburg Region:
Harrisonburg (3) ........................... 62,258 37,787 31,963
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Total deposits ................... $ 641,907 $ 605,005 $ 586,760
============== ============== ==============
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(1) Includes three banking offices for all years.
(2) Includes two banking offices for all years.
(3) Includes two banking office for 2003, and one office for 2002 and 2001.
The following is a summary description of the Company's market areas.
Triad Region - Rockingham County. Rockingham County is located in the
north central area of North Carolina. It has a land area of 565 square miles and
a population of approximately 90,000. The Commonwealth of Virginia borders the
County on the north, while Guilford County is the neighboring county to the
south. Piedmont Triad International Airport is located twenty miles away, and
Norfolk Southern has two rail connection lines in the County. The area is served
by U.S. Highways 29, 158 and 220. The County, which consists of several
community oriented towns, provides a full range of municipal services and
extends financial support to certain boards, agencies, and commissions to assist
its effort to serve its citizens. The North Carolina Employment Security
Commission reported a December 2003 unemployment rate of 9.2% for Rockingham
County. Business and government leaders in the county have made progress in
diversifying the area's economy to make up for job losses in the textile and
tobacco industries.
3
Triad Region - Greensboro. Greensboro has a diverse economy attributable
to a blend of trade, manufacturing and service businesses. Local industry is
characterized by the production of a wide range of products, including textiles,
apparel, furniture, tobacco, machinery, pharmaceuticals, microchips, and
electronics equipment. Guilford County, with a population of 420,000, has access
to major domestic and international markets from Interstate Highways 40 and 85;
U.S. Highways 29, 70, 220 and 421; major rail connections; and the Piedmont
Triad International Airport. According to the North Carolina Employment Security
Commission, Guilford County reported an unemployment rate of 5.3% for December
2003, compared to a statewide unemployment rate of 5.8%.
Wilmington Region. Wilmington is the county seat and industrial center of
New Hanover County, located on the southeast coast of North Carolina. The total
population of the County is approximately 160,000. It is served by Interstate
Highway 40 and U.S. Highways 17 and 74, as well as major rail connections. This
area is serviced by national and regional airlines through facilities at the New
Hanover International Airport located near Wilmington. The New Hanover County
area has experienced extensive industrial development and service/trade sector
growth over the past twenty years. Industries in the Wilmington region produce
fiber optic cables for the communications industry, aircraft engine parts,
pharmaceuticals, nuclear fuel components and various textile products. The New
Hanover County area economy has become broadly diversified and has developed
into a major resort area, a busy sea port (one of North Carolina's two deep
water ports), a light manufacturing center, chemical manufacturing center and
the distribution hub of southeastern North Carolina. The North Carolina
Employment Security Commission reported a December 2003 unemployment rate of
4.4% for New Hanover County.
Norton Region. Norton is located in southwestern Virginia in the midst of
the Appalachian Mountains. The mining, retail and service industries of this
region operate from an abundant natural resource base that includes natural gas,
coal, timber and mineral deposits. The area is served by several U.S. Highways
and by major rail connections. The Bank operates branches in Norton (Wise
County), Pennington Gap (Lee County) and Richlands (Tazewell County). The
Company has announced plans to sell certain assets of the Richlands, Virginia
branch. For December 2003, the Virginia Employment Commission reported the
unemployment rate in Wise County was 4.7%.
Harrisonburg Region. Rockingham County is centrally located in the
Shenandoah Valley in west central Virginia. Harrisonburg, the county seat with a
population of 40,000, is an important educational, industrial, retail, tourism,
commercial, agricultural and governmental center. The area is served by
Interstate Highway 81, several primary U. S. highways, the Shenandoah Valley
Regional Airport and a major rail connection. The Bank operates two branches in
Harrisonburg, serving the counties of Rockingham and Augusta. According to the
Virginia Employment Commission, the December 2003 unemployment rate for
Rockingham County was 1.7% compared to a statewide unemployment rate of 3.3%.
Lending Activities
General. The Company offers a broad array of lending services, including
real estate, commercial and consumer loans, to individuals and small to
medium-sized business and other organizations that are located in or conduct a
substantial portion of their business in the Company's market areas. The Company
has also established niche markets such as residential construction lending in
local markets and airplane lending in markets throughout the southeastern United
States. The Company's total loans at December 31, 2003, were $581.4 million, or
74.5% of total assets. It also makes secured construction loans to homebuilders
and residential mortgages, which are often secured by first and second real
estate mortgages. At December 31, 2003, the Company had no large loan
concentrations (exceeding 10% of its portfolio) in any particular industry.
4
Loan Composition. The accompanying table summarizes, at the dates
indicated, the composition of the Company's loan portfolio and the related
percentage composition.
(In thousands) As of December 31,
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2003 2002 2001
------------------- ------------------- -------------------
Real estate:
Commercial $159,953 27.5% $170,657 30.3% $168,419 31.5%
Residential 94,864 16.3 119,316 21.2 130,264 24.4
Construction 117,786 20.3 87,696 15.6 55,861 10.4
-------- ----- -------- ----- -------- -----
Total real estate 372,603 64.1% 377,669 67.1% 354,544 66.3%
Commercial, financial and
agricultural 90,224 15.5% 87,458 15.5% 90,858 17.0%
-------- ----- -------- ----- -------- -----
Consumer:
Direct 39,276 6.8% 34,074 6.0% 37,112 6.9%
Home equity 65,563 11.2 54,073 9.6 46,169 8.6
Revolving 13,718 2.4 10,326 1.8 6,662 1.2
-------- ----- -------- ----- -------- -----
Total consumer 118,557 20.4% 98,473 17.4% 89,943 16.7%
-------- ----- -------- ----- -------- -----
Total loans $581,384 100.0% $563,600 100.0% $535,345 100.0%
======== ===== ======== ===== ======== =====
Real Estate Loans. Loans secured by real estate for a variety of purposes
constituted $372.6 million, or 64.1%, of the Company's total loans at December
31, 2003. At yearend, the Company held real estate loans of various sizes
ranging up to $6.8 million, secured by office buildings, retail establishments,
warehouses, motels, restaurants and other types of property. Loan terms are
typically limited to five years, with payments through the date of maturity
generally based on a 15-year amortization schedule. Interest rates may be fixed
or adjustable, based on market conditions, and the Company generally charges an
origination fee. Management has attempted to reduce credit risk in the real
estate portfolio by emphasizing loans on owner-occupied office and retail
buildings where the loan to value ratio, established by independent appraisals,
does not exceed 80%, and net projected cash flow available for debt service
amounts to at least 120% of the debt service requirement. The Company also often
requires personal guarantees of the principal owners of the property and obtains
personal financial statements of the principal owners in such cases. The Company
experienced no net charge-offs on commercial real estate loans in 2003, net
recoveries of $18,000 in 2002, and net charge-offs of $7,000 in 2001.
The Company originates residential loans for its portfolio on single and
multi-family properties, both owner-occupied and non owner-occupied, and at
December 31, 2003, it held $94.9 million of such loans. Loan terms are typically
limited to five years, with payments through the date of maturity generally
based on a 15 or 30 year amortization schedule. Rates may be fixed or variable,
and the Company typically charges an origination fee. The Company attempts to
minimize credit risk by requiring a loan to value ratio of 80% or less. The
Company experienced net charge-offs on residential real estate loans of $19,686
in 2003, $43,000 in 2002, and $36,000 in 2001.
The Company also originates residential loans for sale into the secondary
market. Through its mortgage banking activities, the Company originates both
fixed and variable rate residential mortgage loans for sale with servicing
released. The Company is able to generate loan origination fees, typically
ranging from 1.0% to 1.5% of the loan balance, which are recognized as income
when the loan is sold. During 2003, 2002, and 2001, the Company earned loan
origination fees from these types loans of $1,534,146, $746,000, and $376,000,
respectively. At December 31, 2003, the Company held $1.6 million of such loans
for sale, and during 2003 the Company sold an aggregate of $113.3 million of
such loans. The Company sells these loans on a non-recourse basis.
5
The Company's current lending strategy is for the majority of construction
and development loans on commercial and residential projects to be in the range
of $0.3 million to $4.0 million. At December 31, 2003, 2002, and 2001, the
Company held $117.8 million, $87.7 million, and $55.9 million, respectively, of
such loans. To reduce credit risk associated with such loans, the Company limits
its lending to projects involving small commercial centers that have strong
anchor tenants and are substantially pre-leased, or residential projects built
in strong, proven markets. The leases on commercial projects must generally
result in a loan to appraised value of 80% and a net cash flow to debt service
at no less than 120%. The Company historically has required a personal guarantee
from the developer or builder. Loan terms are typically twelve to fifteen
months, although the Company occasionally will make a "mini-permanent" loan for
purposes of construction and development of up to a five year term. Rates are
typically variable, and the Company typically charges an origination fee. The
Company experienced no net charge-offs from construction and development loans
during 2003, 2002, or 2001.
Commercial Loans. The Company makes loans for commercial purposes to
various types of businesses. At December 31, 2003, the Company held $90.2
million of commercial loans, or 15.5% of its total loan portfolio. Equipment
loans are typically made on terms up to five years at fixed or variable rates,
with the financed equipment pledged as collateral to the Company. The Company
attempts to reduce its credit risk on these loans by limiting the loan to value
ratio to 80%. Working capital loans are made on terms typically not exceeding
one year. These loans may be secured or unsecured, but the Company attempts to
limit its credit risk by requiring the borrower to demonstrate its capacity to
produce net cash flow available for debt service equal to 110% to 150% of its
debt service requirements. The Company experienced net charge-offs from
commercial loans of $1,035,949 in 2003, $803,000 in 2002, and $485,000 in 2001.
Consumer Loans. The Company makes a variety of loans to individuals for
personal and household purposes, including (i) secured and unsecured installment
and term loans originated directly by the Company; (ii) home equity revolving
lines of credit; and (iii) unsecured revolving lines of credit. The home equity
loans and certain of the direct loans are secured by the borrowers' residences.
At December 31, 2003, the Company held $118.6 million of consumer loans,
including home equity lines of credit. During 2003, 2002, and 2001,
respectively, the Company experienced net consumer charge-offs of $310,612,
$133,000, and $336,000.
Loan Approval and Review. The Company has adopted various levels of
officer lending authority in connection with its loan approval policies. When
the aggregate outstanding loans to a single borrower exceed that individual
officer's lending authority, the loan request must be considered and approved by
an officer with a higher lending limit. Branch loan officers typically have
retail lending limits ranging from $75,000 to $250,000. Community executives can
generally approve commercial relationships up to $750,000. If the lending
request exceeds the community executive's lending limit, the loan must be
submitted to and approved by the senior credit officer. The senior credit
officer has authority to approve commercial relationships up to $1,000,000.
Under joint approval, the senior credit officer and selected regional executives
may approve loans up to $1,750,000 million. All loans in excess of $1,750,000
must be approved by the President and Chief Executive Officer, who may approve
loans up to $2,500,000.
The Company has a loan review procedure involving multiple officers of the
Company that is designed to promote early identification of credit quality
problems through its credit management committee. All loan officers are charged
with the responsibility of reviewing on an annual basis all credit relationships
in excess of $250,000 in their respective portfolios. Loan officers also review
all criticized and classified assets in their portfolio quarterly with the
senior loan officer of the Company. The loan officers are responsible for
implementing, where appropriate, approved action plans with respect to such
criticized and classified assets which are designed to improve the Company's
credit position and lead to a favorable resolution of the problem loan. As part
of its overall strategy to improve policies and procedures, the Company also
periodically engages a third party consultant to review its loan portfolio. The
Company has used the findings of these examinations to further enhance credit
quality through improved credit administration policies and procedures.
6
The Company's credit review system supplements its loan rating system,
pursuant to which the Company may place a loan on its criticized asset list or
may classify a loan in one of various other classification categories. A
specified minimum percentage of loans in each adverse asset classification
category, based on the historical loss experience of the Company in each such
category, is used to determine the adequacy of the Company's allowance for
credit losses quarterly. These loans are also individually reviewed by the
senior credit officer of the Company to determine whether a greater allowance
allocation is justified due to the facts and circumstances of a particular
adversely classified loan.
See also Note 4 in the Notes to Consolidated Financial Statements on page
53 of this Annual Report on Form 10-K.
Investments
The Company seeks to maintain an investment portfolio consistent with its
overall financial needs. The following factors may be considered in the purchase
or sale of investment securities: liquidity, maturity, credit quality, income or
other factors. The portfolio consists of federal agency and municipal
securities, mortgage-backed securities and other investment securities.
See also Note 3 in the Notes to Consolidated Financial Statements on page
52 of this Annual Report on Form 10-K.
Deposits
The Company offers a variety of deposit products to individuals and to
small and medium-sized businesses and other organizations through the Bank at
interest rates generally competitive with local market conditions. The following
table sets forth the mix of depository accounts at the Company as a percentage
of total deposits at the dates indicated.
As of December 31,
-------------------------------
2003 2002 2001
----- ----- -----
Non-interest bearing demand ............. 10.9% 10.2% 10.0%
Savings, NOW, MMI ....................... 18.5 16.5 15.9
Certificates of deposit ................. 70.6 73.3 74.1
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
The Bank accepts deposits at its 18 banking offices, 16 of which have
automated teller machines ("ATMs"). Its memberships in the "STAR", "CIRRUS" and
"PLUS" networks allow customers access to their depository accounts from
regional ATM facilities. It charges competitive fees for the use of its ATM
facilities by those who are not depositors with the Bank. Deposit flows are
controlled primarily through the pricing of such deposits and, to a certain
extent, through promotional activities. Such promotional activities include the
Company's "Legacy Banking" and "Presidential Banking" accounts for deposit
relationships of $25,000 and $75,000, respectively, and the "FNB Club", which
extends special privileges and sponsors group excursions to sites and
performances of interest to account holders in certain markets over the age of
55. At December 31, 2003, the Bank had $194.8 million in certificates of deposit
of $100,000 or more. The Bank has joined an electronic network that allows it to
post interest rates and attract certificates of deposit nationally. The
investors are generally credit unions or commercial banks and amounts are
typically just under $100,000 to assure FDIC insurance coverage. It also
utilizes brokered deposits to supplement in-market deposit growth. The
accompanying table presents the scheduled maturities of time deposits of
$100,000 or more at December 31, 2003.
7
Scheduled maturity of time deposits of $100,000 or more
(In thousands)
Less than three months ................................ $ 64,654
Three through six months .............................. 30,913
Seven through twelve months ........................... 50,193
Over twelve months .................................... 49,042
--------
Total time deposits - $100,000 or more ........... $194,802
========
See also Note 7 in the Notes to Consolidated Financial Statements on page
54 of this Annual Report on Form 10-K.
Investment Services
In April 2000, the Company established FNB Southeast Investment Services,
Inc. as a wholly owned subsidiary of the Bank. FNB Southeast Investment
Services, Inc. employs three investment advisors who are based in the Company's
largest markets of Greensboro and Wilmington, North Carolina and Harrisonburg,
Virginia and allocate their time among the Company's branches and are available
to current and potential customers. The advisors offer a complete line of
investment products and services. The Company receives a commission based on the
advisors' sales. The Company benefits by earning additional fee income and by
attracting additional people to its branches that may become customers. The
investment services subsidiary generated revenues of $670,000 in 2003 and
$308,000 in 2002.
Mortgage Banking
In June 2001, the Company established FNB Southeast Mortgage Corporation
as a wholly owned subsidiary of the Bank. At inception, the new subsidiary
purchased selected assets of a successful mortgage brokerage company operating
three offices in the coastal area near Wilmington, North Carolina. The Company
formed a wholesale division of the mortgage subsidiary during the fourth quarter
of 2003 as part of a continuing strategy to promote the subsidiary's growth and
expand the variety of mortgage services offered. Fee income generated by the
mortgage banking subsidiary increased to $2,019,000 in 2003, compared to
$1,144,000 in 2002.
Marketing
The Company currently markets its services through advertising campaigns
and in printed material, such as newspapers, magazines and direct mailings, as
well as through promotional items, such as caps, pens, pencils and shirts. The
Company's officers are also heavily involved in local civic affairs and
philanthropic organizations in order to focus customers on products and services
at a personal level. The Company occasionally sponsors community events and
holds grand opening ceremonies for its new branches to which local dignitaries
are invited to speak and participate in the festivities. The Company engages a
marketing firm to assist with creative design, research, public relations, media
placement, etc., as well as assisting with promoting the overall image of the
Company to the general public and investment community.
o Value. Among other things, the Company offers attractive rates for
its financial products, including its certificates of deposit and
checking accounts. This pricing structure has been successful in
attracting depositors who are motivated by the Company's rates, as
well as by the variety of individualized services it promotes and
offers. During the first quarter of 2004, the Company will introduce
a new product line for retail and commercial banking customers. The
marketing firm assisted the Company in this effort through extensive
product analysis and market research.
8
o Convenience and Service. The Company's personnel focus upon serving
the individual needs of the Company's customers. For example, senior
personnel are accessible on very short notice, before, during, and
after normal banking hours, by way of mobile phones and other means.
Management intends to continue to market the Company's services through a
combination of advertising campaigns, public relations activities and local
affiliations. While the key messages of value, convenience, service and
reliability will continue to play a major role in the Company's marketing and
public relations efforts, management may also focus on targeted groups, such as
professionals, in addition to small to medium-sized local businesses.
A vital part of the Company's marketing plan is the execution of a public
relations strategy. Many traditional public relations methods are used in
promoting its services. Management pursues media coverage, including general
press, industry periodicals and other media covering banking and finance,
consumer issues and special interests. Press releases, quarterly shareholder
reports, media alerts and presentations are used to announce new banking
services as they are added.
Competition
Commercial banking in the southeastern United States is extremely
competitive, due in large part to interstate branching. Currently, many of the
Company's competitors are significantly larger and have greater resources. The
Company continues to encounter significant competition from a number of sources,
including bank holding companies, financial holding companies, commercial banks,
thrift institutions, credit unions, and other financial institutions and
financial intermediaries. The Company competes in its market areas with some of
the largest banking organizations in the Southeast, several of which have
numerous branches in North Carolina and Virginia. The Company's competition is
not limited to financial institutions based in North Carolina and Virginia. The
enactment of federal legislation authorizing nationwide interstate banking has
greatly increased the size and financial resources of some of the Company's
competitors. Consequently, many of its competitors have substantially higher
lending limits due to their greater total capitalization, and many perform
functions for their customers, such as trust services, that the Company
generally does not offer. The Company primarily relies on providing quality
products and services at a competitive price within the market area. As a result
of interstate banking legislation, the Company's market is open to future
penetration by banks located in other states provided that the other states
allow their domestic banking institutions to acquire North Carolina banking
institutions, thereby increasing competition.
In its Triad Region, as of June 2003, the Company competed with 19
commercial banks and three savings institutions, as well as numerous credit
unions. As of that date, the Company competed with 13 commercial banks, two
savings institution and several credit unions in its Wilmington Region. In its
Norton Region, as of June 2003, the Company competed with 18 commercial banks.
As of that date, the Company competed with 16 commercial banks in its
Harrisonburg Region.
Employees
On December 31, 2003, the Company had approximately 225 full-time and 12
part-time employees. None of the Company's employees are represented by a
collective bargaining unit. The Company considers its relations with its
employees to be good.
Available Information
The Company makes its Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K and amendments to those reports available
free of charge on its internet website www.fnbsoutheast.com, as soon as
reasonably practicable after the reports are electronically filed or furnished
to the SEC. Any materials that the Company files with the SEC may be read and/or
copied at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington,
DC 20549. Public information
9
may be obtained by calling the SEC at 1-800-SEC-0330. These filings are also
accessible on the SEC's website at www.sec.gov.
Additionally, the Company's corporate governance policies, including the
charters of the Audit, Compensation, and Nominating and Corporate Governance
committees; and the Code of Business Conduct and Ethics may also be found under
the "Investor Information" section of the Company's website. The Company elects
to disclose any amendments to or waivers of any Provisions of its Code of
Business Conduct and Ethics applicable to its principal executive officers and
senior financial officers on its website. A written copy of the foregoing
corporate governance policies is available upon written request to the Company.
Supervision and Regulation
Bank and financial holding companies and commercial banks are extensively
regulated under both federal and state law. The following is a brief summary of
certain statutes and rules and regulations that affect or will affect the
Company, the Bank, and the Bank's subsidiaries. This summary is qualified in its
entirety by reference to the particular statute and regulatory provisions
referred to below and is not intended to be an exhaustive description of the
statutes or regulations applicable to the business of the Company and the Bank.
Supervision, regulation and examination of the Company and the Bank by the
regulatory agencies are intended primarily for the protection of depositors
rather than shareholders of the Company. Statutes and regulations which contain
wide-ranging proposals for altering the structures, regulations and competitive
relationship of financial institutions are introduced regularly. The Company
cannot predict whether or in what form any proposed statute or regulation will
be adopted or the extent to which the business of the Company and the Bank may
be affected by such statute or regulation.
General. There are a number of obligations and restrictions imposed on
bank holding companies and their depository institution subsidiaries by law and
regulatory policy that are designed to minimize potential loss to the depositors
of such depository institutions and the FDIC insurance funds in the event the
depository institution becomes in danger of default or in default. For example,
to avoid receivership of an insured depository institution subsidiary, a holding
company is required to guarantee the compliance of any insured depository
institution subsidiary that may become "undercapitalized" with the terms of any
capital restoration plan filed by such subsidiary with its appropriate federal
banking agency up to the lesser of (i) an amount equal to 5% of the bank's total
assets at the time the bank became undercapitalized or (ii) the amount which is
necessary (or would have been necessary) to bring the bank into compliance with
all acceptable capital standards as of the time the bank fails to comply with
such capital restoration plan. The Company, as a registered financial holding
company, is subject to the regulation of the Federal Reserve. Under a policy of
the Federal Reserve with respect to holding company operations, a holding
company is required to serve as a source of financial strength to its subsidiary
depository institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such policy. The Federal Reserve
under the BHCA also has the authority to require a holding company to terminate
any activity or to relinquish control of a nonbank subsidiary (other than a
nonbank subsidiary of a bank) upon the Federal Reserve's determination that such
activity or control constitutes a serious risk to the financial soundness and
stability of any bank subsidiary of the holding company.
In addition, insured depository institutions under common control are
required to reimburse the FDIC for any loss suffered by its deposit insurance
funds as a result of the default of a commonly controlled insured depository
institution or for any assistance provided by the FDIC to a commonly controlled
insured depository institution in danger of default. The FDIC may decline to
enforce the cross-guarantee provisions if it determines that a waiver is in the
best interest of the deposit insurance funds. The FDIC's claim for damages is
superior to claims of stockholders of the insured depository institution or its
holding company but is subordinate to claims of depositors, secured creditors
and holders of subordinated debt (other than affiliates) of the commonly
controlled insured depository institutions.
10
As a result of the Company's ownership of the Bank, the Company is also
registered under the bank holding company laws of North Carolina. Accordingly,
the Company is also subject to regulation and supervision by the Commissioner.
Capital Adequacy Guidelines for Holding Companies. The Federal Reserve has
adopted capital adequacy guidelines for bank holding companies and banks that
are members of the Federal Reserve system and have consolidated assets of $150
million or more. Bank and financial holding companies subject to the Federal
Reserve's capital adequacy guidelines are required to comply with the Federal
Reserve's risk-based capital guidelines. Under these regulations, the minimum
ratio of total capital to risk-weighted assets is 8%. At least half of the total
capital is required to be "Tier I capital," principally consisting of common
stockholders' equity, noncumulative perpetual preferred stock, and a limited
amount of cumulative perpetual preferred stock, less certain goodwill items. The
remainder ("Tier II capital") may consist of a limited amount of subordinated
debt, certain hybrid capital instruments and other debt securities, perpetual
preferred stock, and a limited amount of the general loan loss allowance. In
addition to the risk-based capital guidelines, the Federal Reserve has adopted a
minimum Tier I capital (leverage) ratio, under which a holding company must
maintain a minimum level of Tier I capital to average total consolidated assets
of at least 3% in the case of a holding company which has the highest regulatory
examination rating and is not contemplating significant growth or expansion. All
other holding companies are expected to maintain a Tier I capital (leverage)
ratio of at least 1% to 2% above the stated minimum.
Capital Requirements for the Bank. The Bank, as a North Carolina
commercial bank, is required to maintain a surplus account equal to 50% or more
of its paid-in capital stock. As a North Carolina chartered, FDIC-insured
commercial bank that is a member of the Federal Reserve System, it is also
subject to capital requirements imposed by the Federal Reserve. Under Federal
Reserve regulations, member banks must maintain a minimum ratio of qualifying
capital to weighted risk assets equal to 8%. At least half of the total capital
is required to be Tier I Capital, with the remainder consisting of Tier II
Capital. In addition to the foregoing risk based capital guidelines, member
banks which receive the highest rating in the examination process and are not
anticipating or experiencing any significant growth, must maintain a minimum
level of Tier I Capital to total assets of 3%. Member banks, which do not fall
within the foregoing standards, are required to maintain higher capital ratios.
The Bank exceeded all applicable capital requirements as of December 31, 2003.
Dividend and Repurchase Limitations. The Company must obtain Federal
Reserve approval prior to repurchasing common stock for consideration in excess
of 10% of its net worth during any twelve-month period unless the Company (i)
both before and after the redemption satisfies capital requirements for "well
capitalized" state member banks; (ii) received a one or two rating in its last
examination; and (iii) is not the subject of any unresolved supervisory issues.
Although the payment of dividends and repurchase of stock by the Company
are subject to certain requirements and limitations of North Carolina corporate
law, except as set forth in this paragraph, neither the Commissioner nor the
FDIC have promulgated any regulations specifically limiting the right of the
Company to pay dividends and repurchase shares. However, the ability of the
Company to pay dividends or repurchase shares is dependent upon the Company's
receipt of dividends from the Bank.
North Carolina commercial banks, such as the Bank, are subject to legal
limitations on the amounts of dividends they are permitted to pay. Dividends may
be paid by the Bank from undivided profits, which are determined by deducting
and charging certain items against actual profits, including any contributions
to surplus required by North Carolina law. Also, an insured depository
institution, such as the Bank, is prohibited from making capital distributions,
including the payment of dividends, if, after making such distribution, the
institution would become "undercapitalized" (as such term is defined in the
applicable law and regulations).
Deposit Insurance Assessments. The Bank is subject to insurance
assessments imposed by the FDIC. Under current law, the insurance assessment to
be paid by members of the Bank Insurance Fund,
11
such as the Bank, shall be as specified in a schedule required to be issued by
the FDIC. FDIC assessments for deposit insurance range from 0 to 31 basis points
per $100 of insured deposits, depending on the institution's capital position
and other supervisory factors.
Federal Home Loan Bank System. The Federal Home Loan Bank ("FHLB") system
provides a central credit facility for member institutions. As a member of the
FHLB of Atlanta, the Bank is required to own capital stock in the FHLB of
Atlanta in an amount at least equal to the greater of 1% of the aggregate
principal amount of its unpaid residential mortgage loans, home purchase
contracts and similar obligations at the end of each calendar year, or 5% of its
outstanding advances (borrowings) from the FHLB of Atlanta. On December 31,
2003, the Bank was in compliance with this requirement.
Community Reinvestment. Under the Community Reinvestment Act ("CRA"), as
implemented by regulations of the FDIC, an insured institution has a continuing
and affirmative obligation consistent with its safe and sound operation to help
meet the credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions, nor does it limit an institution's
discretion to develop, consistent with the CRA, the types of products and
services that it believes are best suited to its particular community. The CRA
requires the federal banking regulators, in connection with their examinations
of insured institutions, to assess the institutions' records of meeting the
credit needs of their communities, using the ratings of "outstanding,"
"satisfactory," "needs to improve," or "substantial noncompliance," and to take
that record into account in its evaluation of certain applications by those
institutions. All institutions are required to make public disclosure of their
CRA performance ratings. The Bank received a "satisfactory" rating in its last
CRA examination, which was conducted during July 2002.
Prompt Corrective Action. The FDIC has broad powers to take corrective
action to resolve the problems of insured depository institutions. The extent of
these powers will depend upon whether the institution in question is "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," or "critically undercapitalized." Under the regulations, an
institution is considered "well capitalized" if it has (i) a total risk-based
capital ratio of 10% or greater, (ii) a Tier I risk-based capital ratio of 6% or
greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any
order or written directive to meet and maintain a specific capital level for any
capital measure. An "adequately capitalized" institution is defined as one that
has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier I
risk-based capital ratio of 4% or greater and (iii) a leverage ratio of 4% or
greater (or 3% or greater in the case of an institution with the highest
examination rating). An institution is considered (A) "undercapitalized" if it
has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier I
risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than
4% (or 3% in the case of an institution with the highest examination rating);
(B) "significantly undercapitalized" if the institution has (i) a total
risk-based capital ratio of less than 6%, or (ii) a Tier I risk-based capital
ratio of less than 3% or (iii) a leverage ratio of less than 3% and (c)
"critically undercapitalized" if the institution has a ratio of tangible equity
to total assets equal to or less than 2%. At December 31, 2003, the Bank had the
requisite capital levels to qualify as "well capitalized".
Changes in Control. The BHCA prohibits the Company from acquiring direct
or indirect control of more than 5% of the outstanding voting stock or
substantially all of the assets of any bank or savings bank or merging or
consolidating with another bank or financial holding company or savings bank
holding company without prior approval of the Federal Reserve. Similarly,
Federal Reserve approval (or, in certain cases, non-disapproval) must be
obtained prior to any person acquiring control of the Company. Control is
conclusively presumed to exist if, among other things, a person acquires more
than 25% of any class of voting stock of the Company or controls in any manner
the election of a majority of the directors of the Company. Control is presumed
to exist if a person acquires more than 10% of any class of voting stock and the
stock is registered under Section 12 of the Exchange Act or the acquiror will be
the largest shareholder after the acquisition.
Federal Securities Law. The Company has registered its common stock with
the SEC pursuant to Section 12(g) of the Exchange Act. As a result of such
registration, the proxy and tender offer rules,
12
insider trading reporting requirements, annual and periodic reporting and other
requirements of the Exchange Act are applicable to the Company.
Transactions with Affiliates. Under current federal law, depository
institutions are subject to the restrictions contained in Section 22(h) of the
Federal Reserve Act with respect to loans to directors, executive officers and
principal shareholders. Under Section 22(h), loans to directors, executive
officers and shareholders who own more than 10% of a depository institution (18%
in the case of institutions located in an area with less than 30,000 in
population), and certain affiliated entities of any of the foregoing, may not
exceed, together with all other outstanding loans to such person and affiliated
entities, the institution's loans-to-one-borrower limit (as discussed below).
Section 22(h) also prohibits loans above amounts prescribed by the appropriate
federal banking agency to directors, executive officers and shareholders who own
more than 10% of an institution, and their respective affiliates, unless such
loans are approved in advance by a majority of the board of directors of the
institution. Any "interested" director may not participate in the voting. The
FDIC has prescribed the loan amount (which includes all other outstanding loans
to such person), as to which such prior board of director approval is required,
as being the greater of $25,000 or 5% of capital and surplus (up to $500,000).
Further, pursuant to Section 22(h), the Federal Reserve requires that loans to
directors, executive officers, and principal shareholders be made on terms
substantially the same as offered in comparable transactions with non-executive
employees of the Bank. The FDIC has imposed additional limits on the amount a
bank can loan to an executive officer.
Loans to One Borrower. The Bank is subject to the loans to one borrower
limits imposed by the North Carolina Office of the Commissioner of Banks (the
"Commissioner"), which are substantially the same as those applicable to
national banks. Under these limits, no loans and extensions of credit to any
borrower outstanding at one time and not fully secured by readily marketable
collateral shall exceed 15% of the unimpaired capital and unimpaired surplus of
the bank. Loans and extensions of credit fully secured by readily marketable
collateral may comprise an additional 10% of unimpaired capital and unimpaired
surplus.
Gramm-Leach-Bliley Act. Federal legislation adopted by Congress during
1999, the Gramm-Leach-Bliley Act (the "GLB Act"), dramatically changed various
federal laws governing the banking, securities, and insurance industries. The
GLB Act expanded opportunities for banks and bank holding companies to provide
services and engage in other revenue-generating activities that previously were
prohibited to them.
In general, the GLB Act (i) expands opportunities to affiliate with
securities firms and insurance companies; (ii) overrides certain state laws that
would prohibit certain banking and insurance affiliations; (iii) expands the
activities in which banks and bank holding companies may participate; (iv)
requires that banks and bank holding companies engage in some activities only
through affiliates owned or managed in accordance with certain requirements; (v)
reorganizes responsibility among various federal regulators for oversight of
certain securities activities conducted by banks and bank holding companies; and
(vi) requires banks to adopt and implement policies and procedures for the
protection of the financial privacy of their customers, including procedures
that allow customers to elect that certain financial information not to be
disclosed to certain persons.
The GLB Act expanded opportunities for the Company to provide other
services and obtain revenues in the future but, at present, it has not had a
significant effect on the Company's operations as they are presently conducted.
However, this expanded authority also may present the Company with new
challenges as the Company competes with larger financial institutions that
expand their services and products into the same areas that are now feasible for
smaller, community-oriented financial institutions. The economic effects of the
GLB Act on the banking industry, and on competitive conditions in the financial
services industry generally, may be profound.
USA PATRIOT Act. In response to the events of September 11, 2001,
President George W. Bush signed into law the Uniting and Strengthening America
by Providing Appropriate Tools Required to
13
Intercept and Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, on October
26, 2001. The USA PATRIOT Act gives the federal government new powers to address
terrorist threats through many means, including broadened anti-money laundering
requirements. For example, by way of amendments to the Bank Secrecy Act, Title
III of the USA PATRIOT Act encourages information sharing among banks, bank
regulatory agencies, and law enforcement bodies to prevent money laundering.
Additionally, Title III of the USA PATRIOT Act imposes several affirmative
obligations on a broad range of financial institutions, including banks,
thrifts, brokers, dealers, credit unions, money transfer agents, and parties
registered under the Commodity Exchange Act.
Pursuant to Section 352 of the USA PATRIOT Act, all financial institutions
must establish anti-money laundering programs that include, at a minimum: (i)
internal policies, procedures, and controls, (ii) specific designation of an
anti-money laundering compliance officer, (iii) ongoing employee training
programs, and (iv) an independent audit function to test the anti-money
laundering program. Also, Section 326 of the Act requires certain minimum
standards with respect to customer identification and verification. Section 312
of the Act requires financial institutions that establish, maintain, administer,
or manage private banking accounts or correspondent accounts in the United
States for non-United States persons or their representatives (including foreign
individuals visiting the United States) to establish appropriate, specific, and,
where necessary, enhanced due diligence policies, procedures, and controls
designed to detect and report money laundering. Furthermore, effective December
25, 2001, financial institutions were prohibited from establishing, maintaining,
administering or managing correspondent accounts for foreign shell banks
(foreign banks that do not have a physical presence in any country), and are
subject to certain recordkeeping obligations with respect to correspondent
accounts of foreign banks. Bank regulators are directed to consider institutions
effectiveness in combating money laundering when ruling on Federal Reserve Act
and Bank Merger Act applications.
Sarbanes-Oxley Act of 2002. On July 30, 2002, the Sarbanes-Oxley Act of
2002 (the "Sarbanes-Oxley Act") was signed into law and became some of the most
sweeping federal legislation addressing accounting, corporate governance and
disclosure issues. The impact of the Sarbanes-Oxley Act is wide-ranging as it
applies to all public companies and imposes significant new requirements for
public company governance and disclosure requirements. Some of the provisions of
the Sarbanes-Oxley Act became effective immediately while others were
implemented over the 18 months following its passage.
In general, the Sarbanes-Oxley Act mandates important new corporate
governance and financial reporting requirements intended to enhance the accuracy
and transparency of public companies' reported financial results. It establishes
new responsibilities for corporate chief executive officers, chief financial
officers and audit committees in the financial reporting process and creates a
new regulatory body to oversee auditors of public companies. It backs these
requirements with new SEC enforcement tools, increases criminal penalties for
federal mail, wire and securities fraud, and creates new criminal penalties for
document and record destruction in connection with federal investigations. It
also increases the opportunity for more private litigation by lengthening the
statute of limitations for securities fraud claims and providing new federal
corporate whistleblower protection.
The economic and operational effects of this new legislation on public
companies, including the Company, will be significant in terms of the time,
resources, and costs associated with complying with the new law. Because the
Sarbanes-Oxley Act, for the most part, applies equally to public companies of
all sizes, the Company will be presented with additional challenges as a
smaller, community-oriented financial institution seeking to compete with larger
financial institutions in the Company's markets.
Other. Additional regulations require annual examinations of all insured
depository institutions by the appropriate federal banking agency, with some
exceptions for small, well-capitalized institutions and state chartered
institutions examined by state regulators, and establish operational and
managerial, asset quality, earnings and stock valuation standards for insured
depository institutions, as well as compensation standards.
14
The Bank is subject to examination by the Federal Reserve and the
Commissioner. In addition, it is subject to various other state and federal laws
and regulations, including state usury laws, laws relating to fiduciaries,
consumer credit and equal credit, fair credit reporting laws and laws relating
to branch banking. The Bank, as an insured North Carolina commercial bank, is
prohibited from engaging as a principal in activities that are not permitted for
national banks, unless (i) the FDIC or the Federal Reserve, as it is a member
bank, determines that the activity would pose no significant risk to the
appropriate deposit insurance fund and (ii) the Bank is, and continues to be, in
compliance with all applicable capital standards.
Limits on Rates Paid on Deposits and Brokered Deposits. Regulations
promulgated by the FDIC place limitations on the ability of insured depository
institutions to accept, renew or roll-over deposits by offering rates of
interest which are significantly higher than the prevailing rates of interest on
deposits offered by other insured depository institutions having the same type
of charter in such depository institution's normal market area. Under these
regulations, "well capitalized" depository institutions may accept, renew or
roll-over such deposits without restriction, "adequately capitalized" depository
institutions may accept, renew or roll-over such deposits with a waiver from the
FDIC (subject to certain restrictions on payments of rates) and
"undercapitalized" depository institutions may not accept, renew, or roll-over
such deposits. The regulations contemplate that the definitions of "well
capitalized," "adequately capitalized" and "undercapitalized" will be the same
as the definitions adopted by the FDIC to implement the corrective action
provisions discussed below.
Only a "well capitalized" (as defined in the statute as significantly
exceeding each relevant minimum capital level) depository institution may accept
brokered deposits without prior regulatory approval. "Adequately capitalized"
banks may accept brokered deposits with a waiver from the FDIC (subject to
certain restrictions on payment of rates), while "undercapitalized" banks may
not accept brokered deposits. The regulations contemplate that the definitions
of "well capitalized," "adequately capitalized" and "undercapitalized" are the
same as the definitions adopted by the agencies to implement the prompt
corrective action provisions discussed below.
The Company does not believe that these regulations have had or will have
a material adverse effect on the Bank's current operations.
Taxation. Federal Income Taxation. Financial institutions such as the Bank
are subject to the provisions of the Internal Revenue Code of 1986, as amended
(the "Code") in the same general manner as other corporations. However, banks
which meet certain definitional tests and other conditions prescribed by the
Code may benefit from certain favorable provisions regarding their deductions
from taxable income for annual additions to their bad debt reserve. The Bank may
compute its addition to the bad debt reserve under the specific charge-off
method or the reserve method. Under the reserve method, the addition to bad
debts from losses on loans is computed by use of the experience method. Use of
the experience method requires minimum additions to the reserve based on the
amount allowable under a six-year moving average. The Code also provides annual
limits on the amount the Bank can add to its reserves for loan losses.
State Taxation. Under North Carolina law, the Bank is subject to corporate
income taxes at a 6.90% rate and an annual franchise tax at a rate of 0.15%.
Future Requirements.
Statutes and regulations, which contain wide-ranging proposals for
altering the structures, regulations and competitive relationships of financial
institutions, are introduced regularly. Neither the Company nor the Bank can
predict whether or what form any proposed statute or regulation will be adopted
or the extent to which the business of the Company or the Bank may be affected
by such statute or regulation.
15
Item 2. Properties
The Company's executive offices, principal support and operational
functions are located at 202 South Main Street in Reidsville, North Carolina.
The corporate headquarters will be relocated to 1501 Highwoods Boulevard in
Greensboro, North Carolina during April 2004. The Company has 13 banking offices
located in North Carolina and five banking offices in Virginia. The location of
these banking offices, their form of occupancy and deposits as of December 31,
2003, information about drive-up ATM facilities, and the year each office was
opened is described in the accompanying table:
Location Owned or Leased Deposits ATM Year
-------- --------------- -------- --- ----
202 South Main Street, Reidsville, NC Owned $ 126,738 Yes 1910*
1501 Highwoods Boulevard, Greensboro, NC Leased -- -- 2004*
1646 Freeway Drive, Reidsville, NC Owned 35,481 Yes 1972
202 Turner Drive, Reidsville, NC Owned 34,073 Yes 1969
801 South Van Buren Road, Eden, NC Owned 37,341 Yes 1996
151 North Fieldcrest Road, Eden, NC Leased 15,981 No 1996
605 North Highway Street, Madison, NC Owned 20,383 Yes 1997
9570 US 29 Business, Ruffin, NC Leased 10,710 No 1997
2132 New Garden Road, Greensboro, NC Owned 56,636 Yes 1997
4638 Hicone Road, Greensboro, NC Owned 20,672 Yes 2000
3202 Randleman Road, Greensboro, NC Owned 20,428 Yes 2000
704 South College Road, Wilmington, NC Leased 80,010 Yes 1997
7210 Wrightsville Avenue, Wilmington, NC Leased 3,658 Yes 2000
301 East Fremont Street, Burgaw, NC Leased 26,954 Yes 1999
600 Trent Street, Norton, VA Owned 53,970 Yes 1973
2302 Second Street, Richlands, VA Owned 18,641 Yes 1977
700 East Morgan Avenue, Pennington Gap, VA Owned 17,973 Yes 1979
440 South Main Street, Harrisonburg, VA Owned 45,091 Yes 1988
Harrisonburg Mall, Harrisonburg, VA Owned 17,167 Yes 2003
----------
* Original office opened in different location in 1910. Current office
opened in 1980. Consists of 27,000 square feet in a two story building and
includes the Company's executive offices. The Company has announced plans
to relocate its corporate headquarters from Reidsville, NC to Greensboro,
NC in April 2004. The current headquarters building will undergo extensive
remodeling in 2004 and will serve as the Operations Center for the
Company.
Item 3. Legal Proceedings
In the ordinary course of operations, the Company and the Bank are party
to various legal proceedings. In the opinion of management, neither the Company
nor the Bank is involved in any pending legal proceedings other than routine,
non-material proceedings occurring in the ordinary course of business.
Item 4. Submission of Matters To a Vote of Security Holders
There were no matters submitted to a vote of the security holders of the
Company during the fourth quarter of the Company's fiscal year ended December
31, 2003.
16
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Market Prices and Dividend Policies
The Company's common stock is traded on The Nasdaq Stock Market National
Market System under the symbol "FNBF." The following table shows the high and
low sale price of the Company's common stock on The Nasdaq Stock Market National
Market System(1), based on published financial sources, for each of the last two
fiscal years. The table also reflects the per share amount of cash dividends
paid for each share during the fiscal quarter for each of the last two fiscal
years. Only one cash dividend was paid during each of the fiscal quarters
listed.(1)
Calendar Period High Low Dividends Paid
--------------- ---- --- --------------
Quarter ended March 31, 2002 $ 11.79 $ 10.47 $ 0.10
Quarter ended June 30, 2002 13.80 11.24 0.10
Quarter ended September 30, 2002 14.00 12.40 0.10
Quarter ended December 31, 2002 13.79 12.20 0.11
Quarter ended March 31, 2003 $ 14.88 $ 13.24 $ 0.11
Quarter ended June 30, 2003 16.32 14.10 0.11
Quarter ended September 30, 2003 17.78 14.57 0.11
Quarter ended December 31, 2003 20.90 17.01 0.12
----------
(1) For comparative purposes, the sale prices and dividends paid amounts
shown in the accompanying table have been restated to reflect the 5-for-4
stock split effected as a 25% stock dividend, effective December 29, 2003.
As of March 12, 2004, there were approximately 1,630 beneficial owners of
the Company's common stock, including 1,263 holders of record of the Company's
common stock. For a discussion as to any restrictions on the Company or the
Bank's ability to pay dividends, reference Item 1 - Supervision and Regulation
of the Company and the Bank.
See also Note 18 in the Notes to Consolidated Financial Statements on page
64 of this Annual Report on Form 10-K. See also "Supervision and Regulation -
Regulation of the Company, Dividend and Repurchase Limitations" and "Regulation
of the Bank - Dividends."
Recent Sales of Unregistered Securities
The Company did not sell any of its securities in the last three fiscal
years, which were not registered under the Securities Act of 1933, as amended,
except that it granted options to employees or directors to acquire an aggregate
of 218,125 shares of its common stock at a weighted average exercise price of
$13.44 per share pursuant to the Company's Omnibus Equity Compensation Plan.
Item 6. Selected Financial Data
The annual selected historical financial data presented in the
accompanying table are derived from the audited consolidated financial
statements for FNB Financial Services Corporation, FNB Southeast, FNB Southeast
Mortgage Corporation and FNB Southeast Investment Services, Inc. As this
information is only a summary, you should read it in conjunction with the
historical financial statements (and related notes) of the Company and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere herein.
17
Item 6. Selected Financial Data (cont.)
Table 1. Selected Financial Data
(In thousands, except per share, ratio and other data) At and For the Year Ended December 31,
------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Income Statement Data:
Net interest income $ 24,822 $ 23,753 $ 21,705 $ 22,659 $ 20,427
Provision for credit losses 1,431 1,300 1,278 2,525 1,401
Noninterest income 7,425 5,285 4,740 2,891 2,977
Noninterest expense 19,567 17,429 15,838 16,100 15,193
Net income 7,460 6,782 6,478 4,602 4,248
Balance Sheet Data:
Assets $ 780,926 $ 734,032 $ 704,825 $ 685,904 $ 588,419
Loans (1) 581,384 563,600 535,345 500,637 414,011
Allowance for credit losses 7,124 7,059 6,731 6,311 4,436
Deposits 641,907 605,005 586,760 569,451 484,242
Other borrowings 55,500 52,500 30,000 41,000 31,500
Shareholders' equity 65,750 64,333 62,708 56,392 50,730
Per Common Share Data(5):
Net income, basic 1.35 $ 1.19 $ 1.14 $ 0.83 $ 0.76
Net income, diluted (2) 1.30 1.17 1.13 0.82 0.75
Cash dividends declared 0.45 0.42 0.41 0.36 0.37
Book value 12.00 11.52 10.98 10.05 9.04
Tangible book value 11.82 11.48 10.92 9.98 8.96
Other Data:
Branch offices 18 17 17 18 15
Full-time employees 225 188 204 196 189
Performance Ratios:
Return on average assets 0.98% 0.97% 0.91% 0.72% 0.76%
Return on average equity 11.55 10.63 10.75 8.96 8.49
Net interest margin (tax equivalent) 3.53 3.57 3.25 3.83 3.88
Dividend payout 33.68 35.55 35.94 44.42 47.98
Efficiency (3) 59.65 59.71 59.05 62.20 64.50
Asset Quality Ratios:
Allowance for credit losses to period end loans 1.23% 1.25% 1.26% 1.26% 1.07%
Allowance for credit losses to period end
nonperforming loans (4) 136.30 191.87 297.04 195.87 338.00
Net charge-offs to average loans 0.24 0.18 0.17 0.14 0.11
Nonperforming assets to period end loans
and foreclosed property (4) 1.78 0.94 0.92 0.84 0.45
Capital and Liquidity Ratios:
Average equity to average assets 8.52% 9.09% 8.45% 8.07% 9.06%
Leverage capital 8.44 8.53 8.64 8.22 9.30
Tier 1 risk based capital 10.70 11.20 11.58 11.28 13.20
Total risk based capital 11.88 12.45 12.83 12.53 14.30
Average loans to average deposits 91.69 96.17 85.96 87.91 83.49
Average loans to average deposits
and borrowings 83.39 86.85 79.63 79.22 77.34
- ----------
(1) Loans net of unearned income, before allowance for losses.
(2) Assumes the exercise of outstanding options to acquire common stock. See
Note 14 to the Company's consolidated financial statements.
(3) Computed by dividing noninterest expense by the sum of taxable equivalent
net interest income and noninterest income.
(4) Nonperforming loans and nonperforming assets include loans past due 90
days or more that are still accruing interest.
(5) Per share data has been restated to reflect the 5-for-4 stock split,
effected as a 25% stock dividend, effective December 29, 2003.
18
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's Discussion and Analysis of Financial Condition and Results of
Operations of FNB Financial Services Corporation provides information about the
major components of the results of operations and financial condition, liquidity
and capital resources of the Company. This section should be read in conjuction
with the Company's consolidated financial statements and accompanying notes and
other detailed information.
Executive Overview
Significant Accomplishments. In the opinion of the management of FNB
Financial Services Corporation, the Corporation's most significant
accomplishments during 2003 were:
o Mortgage banking fee income increased 76.5%.
o Diluted net income per share increased 11.1%.
o We continued to execute upon the Corporation's strategic plan of
expanding our markets, products and services, including the formation
of a wholesale mortgage division.
o We determined to move the Corporation's headquarters to Greensboro,
North Carolina to enhance our ability to employ and retain personnel
with the skills and experience necessary to continue to execute our
strategic plan and to promote our penetration of this significant
urban market.
Challenges. The achievement of the Corporation's strategic initiatives and
long-term financial goals is subject to many uncertainties. The challenges,
which in the opinion of management, are most likely to have a near-term effect
on operations, are presented below:
o Building revenue momentum.
o Improving efficiency.
o The economical environment in our core markets.
o Costs associated with the current heightened regulatory environment.
o Expanding our core management team.
o Volatility in the mortgage banking business.
o Intense price competition.
General
The Company earned $7.46 million in 2003, a 10.0% increase over the $6.78
million earned in 2002. Diluted net income per share of $1.30 for 2003
represents a 11.1% increase over diluted net income per share of $1.17 in 2002.
Total assets at December 31, 2003 stood at $780.9 million compared to $734.0
million one year earlier. The increase in assets is primarily attributable to a
$17.8 million increase in gross loans and a $14.9 million increase in investment
securities. Gross loans at December 31, 2003 totaled $581.4 million, up from
$563.6 million at yearend 2002. Investment securities, which is the next largest
component of assets, totaled $143.7 million at December 31, 2003, an 11.6%
increase from the balance of $128.8 million a year ago.
19
During 2003, deposits increased 6.1% to $641.9 million at yearend.
Borrowings, comprised of federal funds purchased, retail repurchase agreements,
and FHLB advances, totaled $70.9 million at December 31, 2003, compared to $60.8
million at the prior yearend. Shareholders' equity increased 2.2% to $65.8
million at yearend 2003. Book value per share was $12.00 at December 31, 2003.
The Company's subsidiary bank, FNB Southeast, is a North Carolina
chartered commercial bank that, as of December 31, 2003, operated thirteen
banking offices in North Carolina and five banking offices in Virginia. The Bank
operates two wholly owned subsidiaries. FNB Southeast Investment Services, Inc.
was formed in 2000 to provide retail investment products and services. FNB
Southeast Mortgage Corporation was formed in 2001 to provide mortgage banking
services.
Results of Operations
Net interest income represents the gross profit from the lending and
investment activities of a banking organization and is the most significant
factor affecting the earnings of the Company. Net interest income is influenced
by changes in interest rates, volume and the mix of these various components.
Net interest income on a fully taxable equivalent basis for 2003 was $25.4
million, which represented a 6.2% increase from the previous year. In 2002,
taxable equivalent net interest income increased to $23.9 million from
approximately $22.1 million in 2001. Actual net interest income for 2003 was
$24.8 million, a 4.5% increase from $23.8 million recorded in 2002. The increase
in net interest income is primarily attributable to lower overall rates paid on
time deposits. The net effect was to increase the interest rate spread, which is
the average yield on earning assets minus the average rate paid on interest
bearing liabilities. While the average yield on earning assets declined in 2003,
that decline was more than offset by the reduction in average rates paid on
interest bearing liabilities. Average loans outstanding during the 2003 fiscal
year were $572.5 million compared to $547.8 million in 2002, an increase of
4.5%. In 2002, average loans outstanding were 6.3% higher than 2001. Average
investment securities during 2003 were $139.0 million compared to $110.3 million
in 2002 and $157.4 million in 2001.
Trends in interest rates remained downward for the year, as the Federal
Reserve decreased the federal funds rate by 25 basis points in July 2003, which
followed a 50 basis point interest rate reduction in November 2002. As a result,
the prime lending rate declined to 4.00% at December 31, 2003 from 4.25% at
December 31, 2002 and 4.75% at December 31, 2001. This had the effect of
decreasing both the earning asset yield and the interest bearing liability rate.
During 2003, the decline in the interest bearing liability rate outpaced the
decline in the earning asset yield. Additionally, the decline in interest rates
resulted in increases in the fair market value of the Company's investment
portfolio during 2003. The increased fair value resulted in increased liquidity,
due to securities being called and the sale of securities at a gain.
The weighted average yield on earning assets decreased 62 basis points to
5.86% for 2003 compared to 6.48% for 2002 and 7.75% for 2001. This decrease in
the asset yield in 2003 was primarily attributable to the decreased yield on
loans and, to a lesser degree, to a decreased yield on investment securities.
This was partially offset by an increase of $24.7 million in average loans
outstanding, combined with an increase of $20.6 million in tax-exempt
investments. During the current year, the yield on loans decreased 47 basis
points to 6.32% from 6.79% in 2002. This decline is due to variable rate loans
that repriced lower during the year in response to decreases in the underlying
index, and new fixed rate loans originated at lower rates.
The weighted average rate paid on interest bearing liabilities was 2.70%
in 2003, 3.41% in 2002 and 5.18% in 2001. Average interest bearing deposits for
2003 totaled $558.7 million, a 9.1% increase from $511.9 million in 2002. The
average balance in 2001 was $544.1 million. The overall rate for interest
bearing deposits declined 80 basis points to 2.72% in 2003, compared to 3.52% in
the prior year.
The overall rate on borrowings was 2.53% in 2003, compared to 2.51% a year
earlier. Average borrowings totaled $62.2 million in 2003 and $61.1 million in
2002, an increase of 1.8%.
20
Table 2 on page 29 summarizes net interest income and average yields
earned and rates paid for the years indicated, on a tax equivalent basis. Table
3 on page 30 presents the changes in interest income and interest expense
attributable to volume and rate changes between 2003 and 2002, and between 2002
and 2001.
Noninterest Income and Expense
Noninterest income of $7.4 million in 2003 was $2.1 million, or 40.5%,
more than the previous year amount of $5.3 million. In 2001, noninterest income
was $4.7 million. Gains on sale of securities for 2003 totaled $564,000,
compared to $318,000 in 2002 and $1.8 million in 2001. Service charges on
deposit accounts increased to $3.6 million from $2.8 million in 2002 and $2.2
million in 2001. The Company was able to capitalize on increased fees and
increased volume of demand deposits and other accounts with service charges.
Personnel expense of $10.5 million in 2003 exceeded the previous year
expense of $9.8 million by $725,000, or 7.4%. Personnel expense in 2001 was $9.3
million. At December 31, 2003, the Company had approximately 225 full-time and
12 part-time employees, compared with 188 full-time and 10 part-time employees
at December 31, 2002 and 204 full-time and 8 part-time employees at December 31,
2001. Occupancy expenses totaled $1.2 million for 2003, which was up 9.2% from
$1.1 million in 2002. Furniture and equipment expenses totaled $2.4 million in
the current year, a 24.8% increase from $1.9 million recorded in 2002. In 2001,
furniture and equipment expenses amounted to $1.8 million, and occupancy
expenses were $1.0 million. The efficiency ratio, which measures noninterest
expense as a percentage of net interest income plus noninterest income, was
59.7% in 2003 and 2002, and 59.1% in 2001. Other expenses were $4.2 million
compared to $3.7 million in 2002 and $2.8 in 2001.
Provision for Income Taxes
The Company's provision for income taxes totaled $3.8 million for 2003, an
increase of $262,000, or 7.4%, compared to 2002. The provision for income taxes
totaled $3.5 million in 2002 and $2.9 million in 2001. The Company's effective
tax rates for the years ended 2003, 2002, and 2001 were 33.7%, 34.2%, and 30.6%,
respectively. The decline in the effective rate from 2002 to 2003 reflects the
implementation of investment strategies that resulted in a reduction in the
consolidated income tax provision. The increase in the provision for 2003,
compared to the prior year results from higher pretax income, offset in part by
lower effective tax rate. Overall, the effective tax rate is attributable to the
current expense required to provide an adequate provision for income taxes at
the end of 2003, 2002, and 2001.
Financial Condition
The Company's consolidated assets of $780.9 million at yearend reflect an
increase of 6.4% over the previous year, following an increase of 4.1% in 2002.
Total average assets increased 8.1% to $758.1 million in 2003, compared to
$701.5 million in 2002. During 2003, the Company experienced a 7.2% increase in
average earning assets. Average earning assets totaled $718.9 million in 2003,
compared to $670.6 million in 2002. The increase in 2003 was primarily
attributable to a 26.1% growth in the average investment securities balance,
combined with an increase in average outstanding loans. The increase in the
average balance of securities was attributable to a combination of a slightly
weaker loan demand and a 9.6% rise in average deposits resulting from successful
deposit marketing campaigns during 2003.
During the fourth quarter of 2001 through the second quarter of 2002, the
Company implemented an asset liability strategy to reduce higher costing funding
sources with funds generated primarily from investment securities called by
issuers and the sales of other investment securities. Instead of reinvesting the
funds from investment calls and sales, the Company elected to reduce the higher
costing funding sources. This strategy resulted in a shrinking of the balance
sheet and increased interest rate margins, as planned, since the reductions
occurred in the least attractive rate structures. Starting in the third quarter
of
21
2002, the Company returned to a more traditional strategy of attracting new core
deposits (primarily certificates of deposit less than $100,000) and using the
proceeds to fund loan and investment growth.
Gross loan growth during 2003 was $17.8 million, with outstanding loans up
3.2% at year-end, which followed increases of 5.3% in 2002 and 6.9% in 2001.
Loans secured by real estate totaled $372.6 million in 2003 and represented
64.1% of total loans, compared with 67.1% at year end 2002. Within this
category, commercial real estate loans decreased 6.3% during fiscal 2003 to a
level of $160.0 million, while residential real estate loans decreased 20.5% to
$94.9 million and construction loans increased 34.3% to $117.8 million.
Commercial, financial and agricultural loans totaled $90.2 million and
represented 15.5% of total loans at the end of 2003 and 2002. Consumer loans
increased 20.4% during 2003, led by increased home equity loans. Management
believes the Company is not dependent on any single customer or group of
customers concentrated in a particular industry, the loss of whose deposits or
whose insolvency would have a material adverse effect on operations.
Investment securities (at amortized cost) of $143.9 million at yearend
2003 were up $17.5 million, or 13.9%, from $126.4 million at yearend 2002. U.S.
Government agency securities continue to represent the major share of the total
portfolio, and totaled $106.8 million, or 74.2% of the portfolio at yearend
2003, compared to $115.3 million, or 91.2% of the portfolio one year earlier.
Management believes that the additional risk of owning agency securities over
U.S. Treasury securities is negligible and has capitalized on the favorable
spreads available on the former. State and municipal obligations increased $25.6
million and amounted to at $32.6 million at yearend. The increase in municipal
securities in 2003 is attributable to the favorable tax effected yield, compared
to other available securities. The Company's investment strategy is to achieve
acceptable total returns, while investing in securities with relatively short
maturity dates as necessary to fund loan growth. To this end, the Company has
consistently categorized the entire portfolio as "Available for Sale," which it
believes offers the greatest amount of flexibility in managing a total return
concept. Table 4 on page 31 presents the composition of the securities portfolio
for the last three years, as well as information about cost, fair value and
weighted average yield.
Total deposits increased $36.9 million to $641.9 million at December 31,
2003, resulting in a 6.1% increase over $605.0 million in deposits one year
earlier. This increase was driven by an $8.3 million, or 13.5% increase in
demand deposits, a $9.7 million, or 2.2% increase in time deposits and an $18.8
million, or 18.8% increase in savings, NOW and MMI accounts.
The market for deposits remains fiercely competitive and the Company
relies on appropriate pricing and quality customer service to retain and
increase its retail deposit base. During the year, the Company had several
featured products to generate new deposits and increase the customer base. For
commercial customers, the Company is focused on building a total relationship,
which will foster growth in both loans and deposits. In addition to traditional
checking accounts, the Company offers a cash management sweep account, with
outstanding balances of $6.7 million at year end.
In order to attract additional deposits when necessary, the Company
maintains membership in an electronic network that allows it to post interest
rates and attract deposits nationally. As of December 31, 2003, FNB Southeast
had 10 of such certificates of deposit totaling $989,000, with an overall rate
of 3.60% for this portfolio. This certificate portfolio decreased by $10.5
million during 2003. The Company also held three brokered certificates of
deposit totaling $25.0 million at December 31, 2003, compared to $44.5 million
one year earlier. The brokered certificates have an original term of twelve to
twenty-four months with maturities of $25.0 million in 2004. The decrease in
bulletin board deposits and brokered deposits is attributable to the increase of
in market deposits generated in 2003. Management expects brokered deposits will
continue to decrease during 2004.
The Company also has a credit facility available with the FHLB of Atlanta.
Borrowing capacity is established at 17% of the Bank's total assets as submitted
on regulatory financial reports. The Company also utilized a portion of its
approximately $130 million line with the FHLB to fund earning assets. FHLB
borrowings totaled $55.5 million at yearend. Management continues to believe
this is a
22
cost effective and prudent alternative to deposit balances, since a particular
amount, term and structure may be selected to meet its current needs.
Asset Quality
Management places great emphasis on maintaining the Company's asset
quality. The allowance for credit losses, which is utilized to absorb actual
losses in the loan portfolio, is maintained at a level consistent with
management's best estimate of probable credit losses incurred as of the balance
sheet date.
The loan portfolio is analyzed on an ongoing basis to evaluate current
risk levels, and risk grades are adjusted accordingly. The Company's allowance
for credit losses is also analyzed quarterly by management. This analysis
includes a methodology that separates the total loan portfolio into homogeneous
loan classifications for purposes of evaluating risk. The required allowance is
calculated by applying a risk adjusted reserve requirement to the dollar volume
of loans within a homogenous group. Major loan portfolio subgroups include: risk
graded commercial loans, mortgage loans, home equity loans, retail loans and
retail credit lines. The provisions of Statement of Financial Accounting
Standard No. 114 ("SFAS No. 114"), Accounting by Creditors for Impairment of a
Loan, and related pronouncements are applied to individually significant loans.
Finally, individual reserves may be recorded based on a review of loans on the
"watch list."
Commercial loans. All commercial loans within the portfolio are risk
graded among nine risk grades based on management's evaluation of the overall
credit quality of the loan, including the payment history, the financial
position of the borrower, the underlying collateral value, an internal credit
risk assessment and examination results. There is an increased reserve
percentage for each successively higher risk grade. As a result, the allowance
is adjusted upon any migration of a loan to a higher risk grade within the
commercial loan portfolio. The accompanying table details the risk-graded
portfolio at December 31, 2003 and 2002.
Risk Percent of Commercial General
Grade Description Loans by Risk Grade Reserve Percentage
- ----- ----------- ---------------------- --------------------
2003 2002 2003 2002
---- ---- ---- ----
Risk 1 Low Risk 1.08% 0.22% 0.00% 0.00%
Lower Than
Risk 2 Average Risk 0.51 0.53 0.40 0.40
Risk 3 Average Risk 10.01 12.15 0.65 0.65
Moderately Higher
Risk 4 Than Average Risk 80.78 81.59 1.00 1.00
Higher Than
Risk 5 Average Risk 3.79 1.84 1.50 1.50
Risk 6 Special Mention 1.25 0.84 2.50 2.50
Risk 7 Substandard 2.53 2.83 15.00 15.00
Risk 8 Doubtful 0.00 0.00 50.00 50.00
Risk 9 Loss 0.05 0.00 100.00 100.00
The reserve percentages utilized have been determined by management to be
appropriate based on historical loan loss levels and the risk for each
corresponding risk grade. During 2002, the Company reviewed the reserve
percentages for commercial risk graded loans and made changes in the reserve
percentages in risk grade 2 through risk grade 5 to better reflect the
historical charge-off experience of the Company. Reserve percentages for risk
grade 6, risk grade 7, risk grade 8 and risk grade 9 remained
23
constant. The Company had 96.2% of total commercial loans in risk grade 1
through 5 in 2003, compared to 96.3% in 2002.
Mortgage, home equity, and credit lines. Reserves are calculated on
mortgage, home equity, and credit lines based on historical loss experience and
current economic conditions. The average rolling eight-quarter net loss
percentage is calculated for each of these loan categories. The reserve
requirement also includes a reserve percentage for current economic conditions.
The sum of these two components is applied to the dollar balance of loans in
each of these categories to determine the required reserve.
Retail loans. The retail loans are pooled together to determine the
reserve requirement. The average rolling eight-quarter net loss percentage is
calculated for this loan category. The reserve requirement also includes a
reserve percentage for current economic conditions. The sum of these two
components is applied to the dollar balance of retail loans to determine the
required reserve for current loans and loans past due less than 90 days. A
separate reserve is calculated for loans past due 90 days or more. A reserve
amount equal to 25.0% of all retail loans past due 90 days or more is added to
the above mentioned requirement to determine the total reserve requirement for
retail loans.
Specific impairment under SFAS No. 114. Management evaluates individually
significant loans in risk grade 7 and risk grade 8 on an individual basis for
impairment. The specific allowance is calculated based upon a review of these
loans and the estimated losses at the balance sheet date. At December 31, 2003
and 2002, the recorded investment in loans considered impaired was approximately
$10,615,000 and $10,567,000, respectively. Impaired loans at December 31, 2003
consisted of $1,398,000 of retail loans past due 90 days or more, and $9,041,000
of risk grade 7 commercial loans and $176,000 of risk grade 9 commercial loans.
Risk grade 9 loans are evaluated on an individual basis. Since these loans are
considered a loss, a reserve percentage of 100% of the outstanding balance is
required. Calculated reserves for impaired loans at December 31, 2003 totaled
$2,085,000, compared to $1,904,000 a year ago.
Watch list review. Specific allowances may be determined based on a review
of specific watch list loans. Specific losses are estimated at each measurement
date. The Company has established a monthly procedure to review all loans placed
on the watch list. The watch list primarily consist of loans classified as
special mention, substandard and doubtful. An estimated loss amount and action
plan is established for each watch list loan. By reviewing these watch list
loans, the Company is able to update original probable loss amounts in light of
developing conditions. This serves to reduce the differences between estimated
and actual observed losses.
The 2003 provision for credit losses of $1.4 million represented a 10.1%
increase from the level in 2002. As of December 31, 2003, nonperforming assets
totaled $10.4 million, primarily comprised of $5.2 million in nonaccrual loans
and $5.2 million in other real estate owned. Those figures compare to $3.6
million in nonaccrual loans and $1.7 million in other real estate owned at the
end of 2002, comprising $5.3 million in nonperforming assets. Net charge-offs
increased in 2003 to $1.4 million or 0.24% of average loans outstanding,
compared with $972,000 or 0.18% of average loans outstanding in the prior year.
At December 31, 2003 and 2002 the allowance for credit losses as a percentage of
year end loans was 1.23% and 1.25%, respectively.
During 2003 and at December 31, 2003, the commercial loan portfolio
experienced a migration to risk grades indicative of higher credit risk.
Specifically, as indicated in the table above, there was a migration from risk
grades 3 and 4 to risk grades 5 and 6. A similar migration occurred within the
retail portfolio as retail loans past due 90 days or more increased to $1.4
million at December 31, 2003, compared to $818,000 at the end of 2003. Risk
grade loans classified special mention, substandard, doubtful increased from
$12.6 million at yearend 2002 to $13.5 million at yearend 2003. The reserve
requirement for this category of loans totaled $1.7 million for 2003 and 2002.
Retail loans past due 90 days or more at December 31, 2003 were $1,398,000, with
a $350,000 reserve requirement. This compares to $818,000 in retail loans past
due 90 days or more and a reserve requirement of $323,000 at December 31, 2002.
24
The accompanying table summarizes the Company's allowance as a
percentage of total loans outstanding and net charge-off percentage for the past
five years.
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Allowance percentage 1.23% 1.25% 1.26% 1.26% 1.07%
Net charge-off percentage 0.24% 0.18% 0.17% 0.14% 0.11%
Nonperforming assets include nonaccrual loans, accruing loans
contractually past due ninety days or more, restructured loans, and other real
estate. Loans are placed on nonaccrual status when: (i) management has concerns
relating to the ability to collect the loan principal and interest and (ii)
generally when such loans are ninety days or more past due. No assurance can be
given, however, that economic conditions will not adversely affect borrowers and
result in increased credit losses.
Capital Resources
Banks, bank holding companies, and financial holding companies, as
regulated institutions, must meet required levels of capital. The Federal
Reserve has 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 its assets in accordance with the guidelines.
As shown in Table 10 on page 34, the Company and the Bank both maintained
capital levels exceeding the minimum levels to be "well capitalized" for the
three years presented. The Bank will continue to be required to meet certain
levels of capital.
Liquidity and Cash Flow
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. The investment portfolio at December 31, 2003,
held securities with call features, whereby the issuer of such a security has
the option to repay the purchaser of said instrument and cancels the instrument
before the contractual maturity date. Due to the interest rate on the original
instrument and current market rates on such instruments, the Company anticipates
that certain debt instruments in the portfolio may be called in the upcoming
year.
During 2003, the Company deployed cash flow from operating and financing
activities to fund increases in the loan portfolio. Overall, cash and cash
equivalents increased by $4.8 million, to $29.3 million at December 31, 2003.
As presented in the consolidated statement of cash flows, the Company
generated $7.5 million in operating cash flow during 2003, an increase of 35.6%
from $5.6 million in 2002. This increase was primarily attributable to a
decrease in interest paid, partly offset by an increase in noninterest expense
paid during 2003. In 2003, interest received in excess of interest paid was
$26.2 million, while in 2002, interest received in excess of interest paid was
$23.8 million. This change resulted from the growth in earning assets and
continued improvement in net interest margin in 2003.
In 2003, the Company had a net increase of $18.6 million in loans,
compared to $27.8 million in 2002. During 2003, the Company received $104.7
million from sales and calls of securities and $3.3 million from maturities,
while purchasing $130.6 million. The turnover in the security portfolio was
attributable to the continuing downward trend in interest rates during the year.
In 2002, the Company purchased $92.4 million of securities, while receiving
$92.3 million from sales and calls.
25
Increases in savings, NOW, and MMI deposits totaling $27.2 million, a $9.7
million increase in time deposits, and a $10.1 million combined increase in
other borrowings and federal funds purchased and retail repurchase agreements
comprised the Company's major financing sources during 2003, totaling $47.0
million versus a combined total of $40.7 million during 2002. In total, cash
flows from growth in deposits were $36.9 million in 2003, versus $18.2 million
in 2002. Partially offsetting these cash inflows was the repurchase of $2.3
million of the Company's outstanding common stock in 2003; and in 2002 a
decrease of $11.4 million in federal funds and repurchase agreements combined
with repurchases of $4.1 million of the Company's common stock.
Liquidity is further enhanced by an approximately $130 million line of
credit with the FHLB collateralized by FHLB stock, investment securities,
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 overnight
line has a requirement to repay the line in full on a frequent basis, typically
within five to ten business days. The Company also established a $15 million
wholesale repurchase agreement with a regional brokerage firm. The Company can
access this additional source of liquidity by pledging investment securities
with the brokerage firm.
The Company also projects future cash flow requirements based on scheduled
loan and deposit maturities, borrowing maturities, capital expenditures and
other factors. At December 31, 2003 and for the upcoming twelve month period,
the Company had scheduled loan maturities of $199.5 million, securities
maturities of $1.0 million and $347.9 million in maturing time deposits. The
Company also has $118.8 million in deposits with no contractual maturity, and
$70.0 million in demand deposit accounts that are subject to withdrawal during
2003. The Company has $30.5 million of borrowings that are scheduled for
repayment in 2004. Anticipated capital expenditures during 2004 are
approximately $1.7 million. Internal analysis indicated the Company is
positioned to meet expected liquidity requirements during the upcoming
twelve-month period.
Off-Balance Sheet Arrangements
The Company also has off-balance sheet arrangements with customers that
may impact the Company's overall liquidity needs. These commitments and
contingent liabilities are commitments to extend credit and commercial letters
of credit. The accompanying table presents commitments and contingent
liabilities at December 31, 2003.
One Year Over One
(Dollars in thousands) and Less Year Total
--------- --------- ---------
Commitments to extend credit $ 135,552 $ 8,040 $ 143,592
Commercial letters of credit 354 -- 354
--------- --------- ---------
Total commitments and contingent liabilities $ 135,906 $ 8,040 $ 143,946
========= ========= =========
A summary of the Company's known contractual obligations as of December
31, 2003 is contained in Table 11 on page 35. Payments for borrowings do not
include interest. Payments related to leases are based on actual payments
specified in the underlying contracts.
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.
26
For a complete discussion on market risk and how the Company addresses
this risk, see Item 7A on page 27 of this Annual Report on Form 10-K.
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. Noninterest expense, such as salaries and wages, occupancy
and equipment cost, are also negatively affected by inflation.
Application of Critical Accounting Policies
The Company's accounting policies are fundamental to understanding
management's discussion and analysis of results of operations and financial
condition. The Company's significant accounting policies are discussed in detail
in Note 1 of the consolidated financial statements of the Company's 2003 Annual
Report. The following is a summary of the allowance for credit losses, one of
the most complex and judgmental accounting policies of the Company.
The allowance for credit losses, which is utilized to absorb actual losses
in the loan portfolio, is maintained at a level consistent with management's
best estimate of probable credit losses incurred as of the balance sheet date.
The Company's allowance for credit losses is also analyzed quarterly by
management. This analysis includes a methodology that separates the total loan
portfolio into homogeneous loan classifications for purposes of evaluating risk.
The required allowance is calculated by applying a risk adjusted reserve
requirement to the dollar volume of loans within a homogenous group. Major loan
portfolio subgroups include: risk graded commercial loans, mortgage loans, home
equity loans, retail loans and retail credit lines. Management also analyzes the
loan portfolio on an ongoing basis to evaluate current risk levels, and risk
grades are adjusted accordingly. While management uses the best information to
make evaluations, future adjustments may be necessary, if economic or other
conditions differ substantially from the assumptions used.
Item 7A. 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.
Interest rate risk management is a 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, which is
comprised of senior management and members of the Company's Board of Directors.
The committee meets on a regular basis to review the asset/liability management
activities of the Company and monitor compliance with established policies. A
member of the Board of Directors chairs the committee and reports on its
activities to the full Board.
A primary objective of interest rate sensitivity management is to ensure
the stability and quality of the Company's primary earnings component, net
interest income. This process involves monitoring the Company's balance sheet in
order to determine the potential impact that changes in the interest rate
environment may have on net interest income. Rate sensitive assets and
liabilities have interest rates that are subject to change within a specific
time period, due to either maturity or to contractual agreements which allow the
instruments to reprice prior to maturity. Interest rate sensitivity management
seeks to ensure that both assets and liabilities react to changes in interest
rates within a similar time period, thereby minimizing the risk to net interest
income.
27
The measurement of the Company's interest rate sensitivity, or "gap", is a
technique traditionally used in asset/liability management. The interest
sensitivity gap is the difference between repricing assets and repricing
liabilities for a particular time period. Table 12 on page 37 indicates a ratio
of rate sensitive assets to rate sensitive liabilities within one year at
December 31, 2003, to be 0.80%. This ratio indicates that a larger balance of
liabilities compared to assets, could potentially reprice during the upcoming
twelve month period. Included in rate sensitive liabilities are certain deposit
accounts (NOW, MMI, and savings) that are subject to immediate withdrawal and
repricing, yet have no stated maturity. These balances are presented in the
category that management believes best identifies their actual repricing
patterns. This analysis assumes 60.0% of NOW and savings accounts, and 50.0% of
MMI accounts, reprice within one year, and the remaining balances reprice after
one year. The overall risk to net interest income is also influenced by the
Company's level of variable rate loans. These are loans with a contractual
interest rate tied to an index, such as the prime rate. A portion of these loans
may reprice on multiple occasions during a one-year period due to changes in the
underlying rate index. Approximately 42.4% of the total loan portfolio has a
variable rate and reprices in accordance with the underlying rate index subject
to terms of individual note agreements.
In addition to the traditional gap analysis, the Company also utilizes a
computer based interest rate risk simulation model. This comprehensive model
includes rate sensitivity gap analysis, rate shock net interest margin analysis,
and asset/liability term and rate analysis. The Company uses this model to
monitor interest rate risk on a quarterly basis and to detect trends that may
affect the overall net interest income for the Company. This simulation
incorporates the dynamics of balance sheet and interest rate changes and
calculates the related effect on net interest income. As a result, this analysis
more accurately projects the risk to net interest income over the upcoming
12-month period. The Company's asset/liability policy provides guidance for
levels of interest rate risk and potential remediations, if necessary, to
mitigate excessive levels of risk. The modeling results indicate the Company is
subject to an acceptable level of interest rate risk.
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 Company is not subject to
other types of market risk, such as foreign currency exchange rate risk,
commodity or equity price risk.
Table 13 on page 38 presents the Company's financial instruments that are
considered to be sensitive to changes in interest rates, categorized by
contractual maturities, average interest rates and estimated fair values as of
December 31, 2003.
28
Table 2
Average Balance Sheets and Net Interest Income Analysis
Fully Taxable Equivalent Basis
(Dollars in thousands)
Year Ended December 31,
-------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------- ----------------------------- -----------------------------
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
--------- -------- ------- --------- -------- ------- --------- -------- -------
Interest earning assets:
Loans, net(1) $ 572,472 $36,196 6.32% $ 547,816 $ 37,199 6.79% $ 515,287 $43,069 8.36%
Taxable investment securities 108,863 4,045 3.72 100,418 5,375 5.35 136,782 7,916 5.79
Tax-exempt investment securities(2) 26,389 1,652 6.26 5,766 452 7.84 15,083 1,114 7.39
Other securities 3,746 172 4.59 4,082 232 5.68 5,530 297 5.37
Overnight deposits 7,476 84 1.12 12,548 205 1.63 7,851 317 4.04
Federal funds sold -- -- -- -- -- 0.00 -- -- 0.00
--------- ------- --------- -------- --------- -------
Total earning assets 718,946 42,149 5.86 670,630 43,463 6.48 680,533 52,713 7.75
Non-earning assets:
Cash and due from banks 16,566 14,597 15,048
Premises and equipment 12,630 11,072 11,738
Other assets 17,028 12,159 12,673
Less: Allowance for credit loss (7,116) (6,928) (6,503)
--------- --------- ---------
Total assets $ 758,054 $ 701,530 $ 713,489
========= ========= =========
Interest bearing liabilities:
Savings and NOW $ 50,947 125 0.25 $ 45,172 231 0.51 $ 44,407 314 0.71
MMI 55,630 791 1.42 50,531 1,061 2.10 46,379 1,583 3.41
Time deposits 452,156 14,274 3.16 416,226 16,730 4.02 453,305 26,364 5.82
Federal funds purchased, borrowed
funds and securities sold under
agreements to repurchase 62,203 1,575 2.53 61,121 1,533 2.51 47,617 2,368 4.97
--------- ------- --------- -------- --------- -------
Total interest bearing liabilities 620,936 16,765 2.70 573,050 19,555 3.41 591,708 30,629 5.18
Other liabilities and shareholder's
equity
Demand deposits 65,592 57,708 55,358
Other liabilities 6,938 6,982 6,168
Shareholders' equity 64,588 63,790 60,255
--------- --------- ---------
Total liabilities and
shareholders' equity $ 758,054 $ 701,530 $ 713,489
========= ========= =========
Net interest income and net
yield on earning assets(3) $25,384 3.53% $ 23,908 3.57% $22,084 3.25%
======= ==== ======== ==== ======= ====
Interest rate spread(4) 3.16% 3.07% 2.57%
==== ==== ====
- ----------
(1) The average loan balances include nonaccruing loans and only interest
income actually collected and recognized.
(2) The fully taxable equivalent basis is computed using a federal tax rate of
34%.
(3) Net yield on earning assets is computed by dividing net interest income by
average earning assets.
(4) Earning asset yield minus interest bearing liabilities rate.
29
Table 3
Analysis of Interest Changes Due To Volume and Rates
Fully Taxable Equivalent Basis
(In thousands)
Year Ended December 31,
2003 compared with 2002 2002 compared with 2001
------------------------------------ ------------------------------------
Volume(2) Rate(2) Total Volume(2) Rate(2) Total
Variance Variance Variance Variance Variance Variance
-------- -------- -------- -------- -------- --------
Interest income:
Loans, net $ 1,674 $ (2,677) $ (1,003) $ 2,719 $ (8,589) $ (5,870)
Taxable investment securities 452 (1,782) (1,330) (2,104) (437) (2,541)
Tax-exempt investment securities(1) 1,617 (417) 1,200 (688) 26 (662)
Other securities (19) (41) (60) (78) 13 (65)
Deposits with FHLB (83) (38) (121) 190 (302) (112)
Federal funds sold and securities
purchased under the agreement to resale -- -- -- -- -- --
-------- -------- -------- -------- -------- --------
Total change 3,641 (4,955) (1,314) 22 (9,272) (9,250)
-------- -------- -------- -------- -------- --------
Interest expense:
Savings and NOW 30 (136) (106) 5 (88) (83)
MMI 107 (377) (270) 142 (664) (522)
Time deposits 1,444 (3,900) (2,456) (2,156) (7,478) (9,634)
Federal funds purchased, borrowed funds and
securities sold under agreements to repurchase 27 15 42 672 (1,507) (835)
-------- -------- -------- -------- -------- --------
Total change 1,609 (4,399) (2,790) (1,337) (9,737) (11,074)
-------- -------- -------- -------- -------- --------
Increase(decrease) in net interest income $ 2,032 $ (557) $ 1,476 $ 1,359 $ 465 $ 1,824
======== ======== ======== ======== ======== ========
- ----------
(1) Yields on nontaxable securities are stated on a fully taxable-equivalent
basis, assuming a 34% Federal tax rate. The adjustments made to convert to
a fully taxable equivalent basis were $562,000 for 2003, $155,000 for 2002
and $379,000 for 2001.
(2) Changes attributable to both volume and rate have been allocated
proportionately.
30
Table 4
Investment Securities
(Dollars in thousands)
As of December 31, 2003 As of December 31, 2002 As of December 31, 2001
------------------------------- ------------------------------ -----------------------------
Weighted Weighted Weighted
Amortized Fair Average Amortized Fair Average Amortized Fair Average
Cost Value Yield Cost Value Yield Cost Value Yield
---------- -------- -------- --------- -------- -------- --------- -------- --------
U.S. Treasury $ -- $ -- 0.00% $ -- $ -- 0.00% $ -- $ -- 0.00%
U.S. government agency 106,771 106,281 3.32 115,309 117,412 4.58 112,516 114,660 6.13
State and municipal obligations(1) 32,617 32,850 5.77 7,036 7,351 7.44 8,325 8,628 8.46
Other debt securities 95 109 7.00 306 321 6.83 304 309 6.83
Other equity 4,444 4,442 4.00 3,732 3,732 5.58 3,967 3,967 6.19
-------- -------- -------- -------- -------- --------
Total investment securities(1) $143,927 $143,682 3.90 $126,383 $128,816 4.58 $125,112 $127,564 6.32
======== ======== ======== ======== ======== ========
As of December 31, 2003
-----------------------------------------------------------------------------------------------
After One After Five
Within Year to Years to After
One Year Five Years Ten Years Ten Years Weighted
---------------- ----------------- ---------------- --------------- Average
Amount Yield Amount Yield Amount Yield Amount Yield Total Yield(1)
-------- ----- -------- ----- -------- ----- -------- ----- -------- --------
U.S. government agency $ 1,006 5.50% $ 67,233 2.85% $ 30,164 3.96% $ 8,368 4.32% $106,771 3.32%
State and municipal obligations(1) 0 0.00 1,027 7.10 4,533 6.03 27,057 5.68 32,617 5.77
Other debt securities -- 0.00 95 7.00 -- 0.00 -- 0.00 95 7.00
-------- -------- -------- -------- --------
Total debt securities(1) $ 1,006 5.50 $ 68,355 2.92 $ 34,697 4.24 $ 35,425 5.36 $139,483 3.90
======== ======== ======== ======== ========
- ----------
(1) Yields stated on a tax equivalent basis.
31
Table 5
Loan Portfolio Composition
(Dollars in thousands)
As of December 31,
---------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------------- ------------------ ---------------- ----------------- ----------------
Real Estate:
Commercial $159,953 27.5% $170,657 30.3% $168,419 31.5% $119,584 23.9% $115,434 27.9%
Residential 94,864 16.3 119,316 21.2 130,264 24.4 150,825 30.1 130,676 31.6
Construction 117,786 20.3 87,696 15.6 55,861 10.4 66,148 13.2 34,680 8.4
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total real estate 372,603 64.1 377,669 67.1 354,544 66.3 336,557 67.2 280,790 67.9
Commercial, financial and
Agricultural 90,224 15.5 87,458 15.5 90,858 17.0 74,981 15.0 58,002 14.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Consumer:
Direct 39,276 6.7 34,074 6.0 37,112 6.9 46,463 9.3 32,778 7.9
Home equity 65,563 11.3 54,073 9.6 46,169 8.6 39,204 7.8 32,836 7.9
Revolving 13,718 2.4 10,326 1.8 6,662 1.2 3,432 0.7 9,605 2.3
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total consumer 118,557 20.4 98,473 17.4 89,943 16.7 89,099 17.8 75,219 18.1
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total $581,384 100.0% $563,600 100.0% $535,345 100.0% $500,637 100.0% $414,011 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
Table 6
Loan Portfolio - Maturities and Interest Rate Sensitivities
(In thousands)
As of December 31, 2003
--------------------------------------------------------------------------------------
Rate Structure for Loans
Maturity Maturing Over One Year
----------------------------------------------------- -----------------------------
Over One Over Predetermined Floating or
One Year Year to Five Interest Adjustable
or Less Five Years Years Total Rate Rate
---------- ---------- ---------- ---------- -------------- -----------
Commercial, financial and agricultural $ 40,306 $ 36,912 $ 13,006 $ 90,224 $ 27,196 $ 22,722
Real estate - construction 83,261 31,031 3,494 117,786 17,443 17,082
Real estate - residential 17,009 46,263 31,592 94,864 57,089 20,766
Real estate - commercial 47,351 97,083 15,520 159,954 52,241 60,361
Consumer 11,622 36,938 69,996 118,556 51,056 55,878
---------- ---------- ---------- ---------- ---------- ----------
Total $ 199,549 $ 248,227 $ 133,607 $ 581,384 $ 205,025 $ 176,809
========== ========== ========== ========== ========== ==========
32
Table 7
Nonperforming Assets
(In thousands)
As of December 31,
------------------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
Nonperforming assets:
Nonaccrual loans $5,174 $3,614 $2,266 $3,222 $1,195
Loans past due 90 days or more and still accruing
interest 53 65 6 -- 117
Other real estate 5,191 1,662 2,707 1,007 534
Table 8
Summary of Allowance for Credit Losses
(Dollars in thousands)
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Balance, beginning of period $ 7,059 $ 6,731 $ 6,311 $ 4,436 $ 3,452
Charge-offs:
Commercial 890 1,017 510 65 --
Real estate-construction -- -- -- -- --
Real estate-mortgage 207 32 43 359 --
Consumer 450 220 448 380 512
-------- -------- -------- -------- --------
Total charge-offs 1,547 1,269 1,001 804 512
-------- -------- -------- -------- --------
Recoveries:
Commercial 7 188 25 -- 5
Real estate-construction -- -- -- -- --
Real estate-mortgage 16 7 -- -- --
Consumer 158 102 118 154 90
-------- -------- -------- -------- --------
Total recoveries 181 297 143 154 95
-------- -------- -------- -------- --------
Net charge-offs 1,366 972 858 650 417
Provision charged to operations 1,431 1,300 1,278 2,525 1,401
-------- -------- -------- -------- --------
Balance, end of period $ 7,124 $ 7,059 $ 6,731 $ 6,311 $ 4,436
======== ======== ======== ======== ========
Ratio of net charge-offs to average loans 0.24% 0.18% 0.17% 0.14% 0.11%
======== ======== ======== ======== ========
Ratio of allowance to year end loans 1.23% 1.25% 1.26% 1.26% 1.07%
======== ======== ======== ======== ========
33
Table 9
Allocation of the Allowance for Credit Losses
(Dollars in thousands)
2003 2002 2001 2000 1999
-------------- -------------- -------------- -------------- --------------
$ % (1) $ % (1) $ % (1) $ % (1) $ % (1)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Balance at end of period applicable to:
Commercial 5,116 16 5,201 16 4,773 17 4,523 15 2,242 14
Real estate-construction 5 20 7 16 18 10 28 13 50 8
Real estate-mortgage 49 44 180 51 104 56 125 54 868 60
Consumer 1,954 20 1,671 17 1,836 17 1,635 18 1,276 18
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total allocation 7,124 100 7,059 100 6,731 100 6,311 100 4,436 100
===== ===== ===== ===== ===== ===== ===== ===== ===== =====
- ----------
(1) Percent of loans in each category to total loans.
Table 10
Regulatory Capital
(Dollars in thousands)
As of / for year ended December 31,
-------------------------------------------------------------------------
2003 2002 2001
-------------------- ---------------------- -----------------
Total capital to risk weighted assets
Consolidated $ 72,055 11.9% $ 69,614 12.4% $ 67,468 12.8%
Subsidiary Bank 70,726 11.7 68,241 12.2 65,221 12.4
Tier 1 capital to risk weighted assets
Consolidated 64,931 10.7 62,622 11.2 60,888 11.6
Subsidiary Bank 63,602 10.5 61,253 11.0 58,658 11.2
Tier 1 capital to average assets
Consolidated 64,931 8.4 62,622 8.5 60,888 8.6
Subsidiary Bank 63,602 8.3 61,253 8.4 58,658 8.3
34
Table 11
Contractual Obligations
(In thousands)
Within One One Year to Three Years After Five
Year Three Years to Five Years Years Total
---------- ----------- ------------- ---------- ----------
Long-term debt obligations $ 30,500 $ -- $ 15,000 $ 10,000 $ 55,500
Capital lease obligations -- -- -- -- --
Operating lease obligations 601 1,247 1,109 940 3,897
Purchase obligations 2,034 1,846 13 4 3,897
Other long-term liabilities 26 572 520 660 1,778
---------- ---------- ---------- ---------- ----------
Total contractual obligations $ 33,161 $ 3,665 $ 16,642 $ 11,604 $ 65,072
========== ========== ========== ========== ==========
35
Table 12
Interest Sensitivity Analysis
(Dollars in thousands)
As of December 31, 2003
-------------------------------------------------------------------------------
Total Total
1 - 90 91 - 180 181 - 365 Sensitive Sensitive
Day Day Day Within Over
Sensitive Sensitive Sensitive One Year One Year Total
--------- --------- --------- --------- --------- ---------
Interest earning assets:
Loans, net of nonaccruals $ 299,012 $ 17,195 $ 45,854 $ 362,061 $ 214,096 $ 576,157
U. S. government agency -- -- 1,000 1,000 105,771 106,771
State and municipal obligations -- -- -- -- 32,617 32,617
Other investment securities 3,025 -- -- 3,025 952 3,977
Overnight deposits 2,436 -- -- 2,436 -- 2,436
--------- --------- --------- --------- --------- ---------
Total interest earning assets 304,473 17,195 46,854 368,522 353,436 721,958
--------- --------- --------- --------- --------- ---------
Interest bearing liabilities:
NOW 19,176 -- -- 19,176 12,784 31,960
MMI 33,459 -- -- 33,459 33,459 66,918
Savings 11,941 -- -- 11,941 7,961 19,902
Time deposits 188,316 78,144 81,534 347,994 105,152 453,146
Overnight borrowings 15,363 -- -- 15,363 -- 15,363
Other borrowings 23,000 -- 7,500 30,500 25,000 55,500
--------- --------- --------- --------- --------- ---------
Total interest bearing liabilities 291,255 78,144 89,034 458,433 184,356 642,789
--------- --------- --------- --------- --------- ---------
Interest sensitivity gap $ 13,218 $ (60,949) $ (42,180) $ (89,911) $ 169,080 $ 79,169
========= ========= ========= ========= ========= =========
Ratio of interest sensitive assets to liabilities 1.05 0.22 0.53 0.80 1.92 1.12
36
Table 13
Market Sensitive Financial Instruments Maturities
(Dollars in thousands)
Contractual Maturities as of December 31, 2003
------------------------------------------------------------------------------
After Average Estimated
2004 2005 2006 2007 2008 Five Years Total Rate Value
-------- -------- -------- -------- -------- -------- -------- ------- --------
Financial assets:
Debt securities $ 1,006 $ 6,002 $ 17,433 $ 24,855 $ 20,064 $ 70,123 $139,483 3.90% $139,240
Loans:
Fixed rate 123,489 30,028 36,353 43,825 35,333 62,655 335,101 6.86 331,683
Variable rate 76,060 27,224 32,959 23,533 18,973 66,973 246,283 4.58 245,722
-------- -------- -------- -------- -------- -------- -------- --------
Total financial assets $200,555 $ 63,254 $ 86,745 $ 92,213 $ 74,370 $199,751 $720,867 $716,645
======== ======== ======== ======== ======== ======== ======== ========
Financial liabilities:
NOW $ 31,960 $ -- $ -- $ -- $ -- $ -- $ 31,960 0.10% $ 28,479
MMI 66,917 -- -- -- -- -- 66,917 1.31 66,186
Savings 19,902 -- -- -- -- -- 19,902 0.19 17,787
Time deposits 347,887 63,761 13,147 16,842 10,486 1,024 453,147 2.67 460,435
Other borrowings 30,500 -- -- 15,000 -- 10,000 55,500 2.65 56,391
Federal funds purchased
and retail repurchase 15,363 -- -- -- -- -- 15,363 1.24 15,363
-------- -------- -------- -------- -------- -------- -------- --------
Total financial liabilities $512,528 $ 63,761 $ 13,147 $ 31,842 $ 10,486 $ 11,024 $642,789 $644,641
Contractual Maturities as of December 31, 2002
------------------------------------------------------------------------------ Average Estimated
Over Interest Fair
2003 2004 2005 2006 2007 Five Years Total Rate Value
-------- -------- -------- -------- -------- ---------- -------- -------- --------
Financial assets:
Debt securities $ 200 $ 1,215 $ 15,263 $ 17,217 $ 26,089 $ 62,667 $122,651 4.58% $125,084
Loans:
Fixed rate 72,691 28,855 49,131 26,596 23,351 91,140 291,764 7.64 292,298
Variable rate 90,066 22,728 38,699 30,714 26,718 62,911 271,836 4.74 271,602
-------- -------- -------- -------- -------- -------- -------- --------
Total financial assets $162,957 $ 52,798 $103,093 $ 74,527 $ 76,158 $216,718 $686,251 $688,984
======== ======== ======== ======== ======== ======== ======== ========
Financial liabilities:
NOW $ 30,461 $ -- $ -- $ -- $ -- $ -- $ 30,461 0.25% $ 27,499
MMI 51,465 -- -- -- -- -- 51,465 2.04 51,424
Savings 18,027 -- -- -- -- -- 18,027 0.50 16,410
Time deposits 345,638 52,736 27,737 4,687 11,975 628 443,401 3.57 450,581
Borrowings 20,000 7,500 -- -- 15,000 10,000 52,500 2.94 53,544
Federal funds purchased
and retail repurchase 8,258 -- -- -- -- -- 8,258 1.25 8,258
-------- -------- -------- -------- -------- -------- -------- --------
Total financial liabilities $473,849 $ 60,236 $ 27,737 $ 4,687 $ 26,975 $ 10,628 $604,112 $607,716
======== ======== ======== ======== ======== ======== ======== ========
37
Table 14
Quarterly Financial Data
(Dollars in thousands, except per share data)
2003 2002
--------------------------------------------- ---------------------------------------------
4th Qtr 3rd Qtr 2nd Qtr 1st Qtr 4th Qtr 3rd Qtr 2nd Qtr 1st Qtr
--------- --------- --------- ---------- ---------- --------- --------- --------
Interest income $ 10,330 $ 10,323 $ 10,382 $ 10,552 $ 11,093 $ 10,866 $ 10,616 $ 10,733
Interest expense 3,733 4,118 4,382 4,532 4,874 4,868 4,611 5,202
--------- --------- --------- ---------- ---------- --------- --------- --------
Net interest income 6,597 6,205 6,000 6,020 6,219 5,998 6,005 5,531
Provision for credit losses 351 303 282 495 85 250 680 285
--------- --------- --------- ---------- ---------- --------- --------- --------
Net interest income after provision
for credit losses 6,246 5,902 5,718 5,525 6,134 5,748 5,325 5,246
--------- --------- --------- ---------- ---------- --------- --------- --------
Noninterest income 1,853 2,011 1,767 1,794 1,555 1,252 1,548 930
Noninterest expense 5,185 5,012 4,758 4,612 4,484 4,037 4,577 4,331
--------- --------- --------- ---------- ---------- --------- --------- --------
Income before income taxes 2,914 2,901 2,727 2,707 3,205 2,963 2,296 1,845
Provision for income taxes 914 965 953 957 1,141 1,032 761 593
--------- --------- --------- ---------- ---------- --------- --------- --------
Net income $ 2,000 $ 1,936 $ 1,774 $ 1,750 $ 2,064 $ 1,931 $ 1,535 $ 1,252
========= ========= ========= ========== ========== ========= ========= ========
Earnings per share:
Basic $ 0.37 $ 0.35 $ 0.32 $ 0.31 $ 0.37 $ 0.34 $ 0.26 $ 0.22
Diluted $ 0.35 $ 0.34 $ 0.31 $ 0.30 $ 0.36 $ 0.33 $ 0.26 $ 0.22
38
THIS PAGE LEFT BLANK INTENTIONALLY
39
MANAGEMENT'S REPORT ON THE FINANCIAL STATEMENTS
AND THE INTERNAL CONTROL OVER FINANCIAL REPORTING
OF FNB FINANCIAL SERVICES CORPORATION
FNB Financial Services Corporation ("the Company") is responsible for
establishing and maintaining an adequate internal control structure and
procedures for financial reporting and over safeguarding of assets against
unauthorized acquisition, use or disposition, which are designed to provide
reasonable assurance to the Company's management and board of directors
regarding the preparation of reliable annual published financial statements and
such asset safeguarding. The Company's system of internal control structure and
procedures contains self-monitoring mechanism, and actions are taken to correct
deficiencies as they are identified. Even an effective internal control system,
no matter how well designed, has inherent limitations--including the possibility
of the circumvention or overriding of controls--and therefore can provide only
reasonable assurance with respect to financial statement preparation and such
asset safeguarding. Further, because of changes in conditions, internal control
system effectiveness may vary over time.
The Company assessed its internal control system as of December 31, 2003 in
relation to criteria for effective internal control over financial reporting
described in "Internal Control-Integrated Framework" issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on this assessment,
the Company believes that, as of December 31, 2003, its system of internal
control over financial reporting and over safeguarding of assets against
unauthorized acquisition, use or disposition met those criteria.
FNB Financial Services Corporation
March 1, 2004
/s/ ERNEST J. SEWELL
- ----------------------------
Ernest J. Sewell
President and Chief Executive Officer
/s/ PRESSLEY A. RIDGILL
- ----------------------------
Pressley A. Ridgill
Executive Vice President and Chief Operating Officer
/s/ MICHAEL W. SHELTON
- ----------------------------
Michael W. Shelton
Senior Vice President and Chief Financial Officer
40
Report of Independent Auditors
To the Board of Directors and Shareholders
of FNB Financial Services Corporation:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income and comprehensive income, of changes in
shareholders' equity, and of cash flows present fairly, in all material
respects, the financial position of FNB Financial Services Corporation and its
subsidiaries at December 31, 2003 and 2002, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2003 in conformity with accounting principles generally accepted in the
United States of America. 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 of these
statements in accordance with auditing standards generally accepted in the
United States of America, which 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina
March 1, 2004
41
FNB Financial Services Corporation and Subsidiary
Consolidated Balance Sheets
December 31, 2003 and 2002
(Dollars in thousands, except share data)
2003 2002
--------- ---------
ASSETS
Cash and due from banks ......................................................... $ 29,319 $ 24,524
Investment securities:
Available for sale ......................................................... 139,799 125,084
Federal Home Loan Bank and Federal Reserve Bank Stock ...................... 3,882 3,732
Loans, net of allowance for credit losses of $7,124 in 2003 and $7,059 in 2002 . 574,260 556,541
Premises and equipment, net ..................................................... 13,031 10,916
Accrued income and other assets ................................................. 20,635 13,235
--------- ---------
Total assets .......................................................... $ 780,926 $ 734,032
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing ........................................................ $ 69,982 $ 61,651
Interest-bearing ........................................................... 571,925 543,354
--------- ---------
Total deposits ........................................................ 641,907 605,005
Federal funds purchased and retail repurchase agreements ........................ 15,363 8,258
Other borrowings ................................................................ 55,500 52,500
Accrued expenses and other liabilities .......................................... 2,406 3,936
--------- ---------
Total liabilities ..................................................... 715,176 669,699
--------- ---------
Commitments and Contingent Liabilities: See Note 16
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 -
5,478,664 in 2003 and 4,467,239 in 2002 .................................... 5,479 4,467
Paid-in capital ................................................................. 22,025 23,833
Retained earnings ............................................................... 38,395 34,549
Accumulated other comprehensive income .......................................... (149) 1,484
--------- ---------
Total shareholders' equity ............................................ 65,750 64,333
--------- ---------
Total liabilities and shareholders' equity ............................ $ 780,926 $ 734,032
========= =========
See notes to consolidated financial statements
42
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Income and Comprehensive Income
Years ended December 31, 2003, 2002 and 2001
(Dollars in thousands, except per share data)
2003 2002 2001
---------- ---------- ----------
Interest income
Loans ................................................................. $ 36,196 $ 37,199 $ 43,069
Federal funds sold and overnight deposits ............................. 84 205 317
Investment securities
Taxable .......................................................... 4,059 5,375 7,916
Tax exempt ....................................................... 1,076 297 735
Other ................................................................. 172 232 297
---------- ---------- ----------
Total interest income ....................................... 41,587 43,308 52,334
---------- ---------- ----------
Interest expense
Deposits .............................................................. 15,190 18,022 28,261
Federal funds purchased and other borrowings .......................... 1,575 1,533 2,368
---------- ---------- ----------
Total interest expense ...................................... 16,765 19,555 30,629
---------- ---------- ----------
Net interest income ........................................................ 24,822 23,753 21,705
Provision for credit losses ................................................ 1,431 1,300 1,278
---------- ---------- ----------
Net interest income after provision for credit losses ...................... 23,391 22,453 20,427
---------- ---------- ----------
Noninterest income
Service charges on deposit accounts ................................... 3,585 2,819 2,180
Other service charges and fees ........................................ 587 696 460
Mortgage banking fees ................................................. 2,019 1,144 144
Investment services fees .............................................. 670 308 203
Net gain on securities available for sale ............................. 564 318 1,753
---------- ---------- ----------
Total noninterest income .................................... 7,425 5,285 4,740
---------- ---------- ----------
Noninterest expense
Salaries and employee benefits ........................................ 10,512 9,787 9,281
Occupancy expense ..................................................... 1,150 1,053 1,033
Furniture and equipment expense ....................................... 2,403 1,926 1,844
Insurance expense, including FDIC assessment .......................... 167 198 186
Marketing expense ..................................................... 682 289 241
Printing and supply expense ........................................... 427 443 376
Other noninterest expense ............................................. 4,226 3,733 2,877
---------- ---------- ----------
Total noninterest expenses .................................. 19,567 17,429 15,838
---------- ---------- ----------
Income before provision for income taxes ................................... 11,249 10,309 9,329
Provision for income taxes ................................................. 3,789 3,527 2,851
---------- ---------- ----------
Net income ................................................................. 7,460 6,782 6,478
Other comprehensive income (loss) .......................................... (1,633) (12) 1,343
---------- ---------- ----------
Comprehensive income ....................................................... $ 5,827 $ 6,770 $ 7,821
========== ========== ==========
Net income per share, basic ................................................ $ 1.35 $ 1.19 $ 1.14
========== ========== ==========
Net income per share, diluted .............................................. $ 1.30 $ 1.17 $ 1.13
========== ========== ==========
See notes to consolidated financial statements
43
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Changes in Shareholders' Equity
Years ended December 31, 2003, 2002 and 2001
(Dollars in thousands)
2003 2002 2001
---------- ---------- ----------
Common stock
Balance at beginning of period .......................................... $ 4,467 $ 4,569 $ 4,488
Stock repurchase ........................................................ (126) (246) --
Stock split effected in the form of a stock dividend .................... 1,097 -- --
Stock issuance .......................................................... -- -- --
Dividend reinvestment plan .............................................. -- -- 4
Exercise of stock options ............................................... 41 144 77
Employee 401(k) plan .................................................... -- -- --
---------- ---------- ----------
Balance at end of period ................................................ 5,479 4,467 4,569
---------- ---------- ----------
Paid-in capital
Balance at beginning of period .......................................... 23,833 26,465 25,723
Stock repurchase ........................................................ (2,204) (3,883) --
Stock issuance .......................................................... -- -- --
Dividend reinvestment plan .............................................. -- -- 34
Exercise of stock options ............................................... 392 1,249 708
Employee 401(k) plan .................................................... -- -- --
Employee stock awards ................................................... 4 2 --
---------- ---------- ----------
Balance at end of period ................................................ 22,025 23,833 26,465
---------- ---------- ----------
Retained earnings
Balance at beginning of period .......................................... 34,549 30,178 26,028
Net income .............................................................. 7,460 6,782 6,478
Cash dividends paid ..................................................... (2,512) (2,411) (2,328)
Cash paid for fractional shares ......................................... (5) -- --
Stock split effected in the form of a stock dividend .................... (1,097) -- --
---------- ---------- ----------
Balance at end of period ................................................ 38,395 34,549 30,178
---------- ---------- ----------
Accumulated other comprehensive income
Balance at beginning of period .......................................... 1,484 1,496 153
Other comprehensive income (loss) ....................................... (1,633) (12) 1,343
---------- ---------- ----------
Balance at end of period ................................................ (149) 1,484 1,496
---------- ---------- ----------
Total shareholders' equity .................................... $ 65,750 $ 64,333 $ 62,708
========== ========== ==========
See notes to consolidated financial statements
44
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Cash Flows
Years ended December 31, 2003, 2002 and 2001
(Dollars in thousands)
2003 2002 2001
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Interest received ............................................................... $ 43,742 $ 43,672 $ 52,467
Fees and commission received .................................................... 3,672 5,488 4,245
Interest paid ................................................................... (17,559) (19,915) (31,742)
Noninterest expense paid ........................................................ (18,130) (17,627) (15,029)
Income taxes paid ............................................................... (3,651) (3,854) (2,657)
Funding of loans held for sale .................................................. (113,807) (30,195) (18,766)
Proceeds from sales of loans held for sale ...................................... 113,250 28,005 18,426
--------- --------- ---------
Net cash provided by operating activities ............................. 7,517 5,574 6,944
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales and calls of securities available for sale .................. 104,715 92,311 154,383
Proceeds from maturities of securities available for sale ....................... 3,300 -- 20,625
Purchase of securities .......................................................... (130,562) (92,354) (149,402)
Capital expenditures ............................................................ (3,617) (599) (708)
Net proceeds (expenditures) for other real estate owned ......................... 561 (480) 1,154
Net increase in loans ........................................................... (19,708) (27,781) (37,219)
--------- --------- ---------
Net cash used in investing activities ................................. (45,311) (28,903) (11,167)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand, savings and interest checking accounts .................. 27,155 9,733 14,679
Net increase in time deposits ................................................... 9,743 8,511 2,630
Net increase (decrease) in other borrowings ..................................... 3,000 22,500 (11,000)
Net increase (decrease) in federal funds purchased and retail repurchase
agreements ...................................................................... 7,105 (11,419) 7,140
Repurchase of common stock ...................................................... (2,330) (4,129) --
Proceeds from issuance of common stock .......................................... 433 1,395 823
Cash dividends paid and cash paid in lieu of fractional shares .................. (2,517) (2,411) (2,328)
--------- --------- ---------
Net cash provided by financing activities ............................. 42,589 24,180 11,944
---------
--------- ---------
Net increase (decrease) in cash and cash equivalents ............................ 4,795 851 7,721
Cash and cash equivalents, beginning of year .................................... 24,524 23,673 15,952
--------- --------- ---------
Cash and cash equivalents, end of year .......................................... $ 29,319 $ 24,524 $ 23,673
========= ========= =========
Supplemental disclosure of non-cash transactions
Non-cash transfers from loans to other real estate .............................. $ 4,254 $ 1,526 $ 2,854
========= ========= =========
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net income ...................................................................... $ 7,460 $ 6,782 $ 6,478
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for credit losses ................................................ 1,431 1,300 1,278
Depreciation ............................................................... 1,551 1,287 1,388
Accretion and amortization ................................................. 850 203 455
Gain on sale of securities available for sale .............................. (564) (318) (1,753)
Gain on other assets ....................................................... (4) (104) --
Funding of loans held for sale ............................................. (113,807) (30,195) (18,766)
Proceeds from sales of loans held for sale ................................. 113,250 28,005 18,426
(Decrease) increase in accrued income and other assets ..................... (2,001) 358 282
Increase (decrease) in accrued expenses and other liabilities .............. (649) (1,744) (844)
--------- --------- ---------
Net cash provided by operating activities ............................. $ 7,517 $ 5,574 $ 6,944
========= ========= =========
See notes to consolidated financial statements
45
FNB Financial Services Corporation and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
Note 1 - Summary of significant accounting policies
Principles of consolidation
The accompanying consolidated financial statements include the
accounts of FNB Financial Services Corporation (the "Company") and its wholly
owned subsidiary FNB Southeast (the "Bank"). Also included are the accounts of
FNB Southeast Mortgage Corporation, and FNB Southeast Investment Services, Inc.,
both of which are wholly owned subsidiaries of FNB Southeast. All significant
intercompany balances and transactions have been eliminated in consolidation.
Nature of operations
FNB Southeast provides a variety of financial services to individual
and corporate customers in North Carolina through its thirteen full-service
branches in Reidsville, Madison, Eden, Ruffin, Greensboro, Burgaw, and
Wilmington, North Carolina. A majority of the Bank's North Carolina customers
are located in Rockingham, Guilford, and New Hanover Counties. The Bank also
provides a variety of financial services to customers in Virginia through its
five full-service branches in Norton, Harrisonburg, Richlands, and Pennington
Gap, Virginia. A majority of the Bank's Virginia customers are located in Wise,
Tazewell, Russell, Lee, Rockingham, and Augusta Counties. FNB Southeast's
primary deposit products are interest-bearing checking accounts, certificates of
deposit and individual retirement accounts. Its primary lending products are
commercial, real estate, and consumer loans.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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 their 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 relate to the determination of the allowance for credit losses on loans.
A majority of the Bank's loan portfolio consists of loans in the geographic
areas cited above. The local economies of these areas depend heavily on the
industrial, agricultural, and service sectors. Accordingly, the ultimate
collectibility of a large portion of the Bank's loan portfolio would be affected
by changes in local economic conditions.
Cash and cash equivalents
Cash and cash equivalents include cash and due from banks and
interest-bearing bank deposits. Cash and cash equivalents are defined as cash
and short-term investments with maturities of three months or less.
Investment securities
The Company classifies its investment securities at the time of
purchase into three categories as follows:
- Held to Maturity - reported at amortized cost,
- Trading - reported at fair value with unrealized gains and
losses included in earnings, or
46
- Available for Sale - reported at fair value with unrealized
gains and losses reported in other comprehensive income.
The Company is required to maintain certain levels of Federal
Reserve Bank ("FRB") and Federal Home Loan Bank of Atlanta ("FHLB") stock based
on various criteria established by the individual issuer. Gains and losses on
sales of securities are recognized when realized on a specific identification
basis. Premiums and discounts are amortized into interest income using the level
yield method.
Loans
Interest on loans is accrued and credited to income based on the
principal amount outstanding. The accrual of interest on impaired loans is
discontinued when, in management's opinion, the borrower may be unable to meet
payments as they become due. When interest accrual is discontinued, all unpaid
accrued interest is reversed. Loans are placed on nonaccrual status when: (i)
management has concerns relating to the ability to collect the loan principal
and interest and (ii) generally when such loans are ninety days or more past
due. Interest income is subsequently recognized only to the extent cash payments
are received. Mortgage loans held for sale are valued at the lower of cost or
market as determined by outstanding commitments from investors or current
investor yield requirements, calculated on the aggregate loan basis.
Loan origination fees and costs
Loan origination fees and certain direct origination costs are
capitalized and recognized as an adjustment of the yield on the related loan.
Allowance for credit losses
The Company's allowance for credit losses is based on management's
best estimate of probable loan losses incurred as of the balance sheet date.
Factors impacting estimated probable loan losses include credit quality trends,
past loan loss experience, current economic conditions, and loan volume among
loan categories.
While management uses the best available information to establish
the allowance for credit losses, future additions to the allowance may be
necessary based on the factors cited above. In addition, the allowance is
reviewed by regulatory agencies as an integral part of their examination
processes. Such agencies may require the Company to recognize changes to the
allowance based on their judgments about information available to them at the
time of their examination.
Other real estate
Other real estate, acquired through partial or total satisfaction of
loans, is carried at the lower of cost or fair market value, less estimated
costs to sell, which becomes the property's new basis. At the date of
acquisition, losses are charged to the allowance for credit losses. Subsequent
write-downs are charged to expense in the period they are incurred.
Premises and equipment
Premises and equipment are stated at cost less accumulated
depreciation and amortization. The provision for depreciation and amortization
is computed principally by the straight-line method over the estimated useful
lives of the assets. Useful lives are estimated at 20 to 40 years for buildings
and 3 to 10 years for equipment.
47
Expenditures for maintenance and repairs are charged to operations,
and the expenditures for major replacements and betterments are added to the
premises and equipment accounts. The cost and accumulated depreciation of the
premises and equipment retired or sold are eliminated from the appropriate asset
accounts at the time of retirement or sale and the resulting gain or loss is
reflected in current operations.
Income taxes
Provisions for income taxes are based on taxes payable or refundable
for the current year (after exclusion of non-taxable income such as interest on
state and municipal securities and non-deductible expenses) and deferred taxes
on temporary differences between the tax bases of assets and liabilities and
their reported amounts in the financial statements at currently enacted income
tax rates applicable to the period in which the deferred tax assets and
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
Common stock
A five-for-four stock split was effected in the form of a 25% stock
dividend, effective December 29, 2003, with the issuance of 1,096,890 shares of
stock and the transfer of $1,096,890 from retained earnings to the common stock
account. All per share amounts in the financial statements have been recomputed
to reflect this split.
Per share data
The Company follows Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings per Share". SFAS No. 128 requires disclosure of two
earnings per share amounts: basic net income per share of common stock and
diluted net income per share of common stock. Basic net income per share of
common stock is computed by dividing net income available to common shareholders
by the weighted average number of shares of common stock outstanding during each
year. Diluted net income per share of common stock is computed by dividing net
income plus any adjustments to net income related to the issuance of dilutive
potential common shares by the weighted average number of shares of common stock
outstanding during each year plus the number of potential dilutive common
shares.
Sales of loans
Gains and losses on the sale of loans are accounted for by imputing
gain or loss on those sales where a yield rate guaranteed to the buyer is more
or less than the contract interest rate being collected. Such gains or losses
are recognized in the financial statements during the year of sale. The Bank, or
a contracted third party, continues to service certain loans that have been
sold. Such loan balances are not included in the accompanying consolidated
balance sheets.
Off balance sheet financial instruments
In the ordinary course of business, the Bank enters into off balance
sheet financial instruments consisting of commitments to extend credit,
commitments under credit card arrangements, commercial letters of credit and
standby letters of credit. Such financial instruments are recorded in the
financial statements when they are funded or related fees are incurred or
received.
Segment information
The Company follows the provisions of SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." SFAS No. 131 requires
that public business enterprises report certain information about operating
segments in their annual financial statements and in condensed
48
financial statements for interim periods issued to stockholders. It also
requires that public business enterprises report related disclosures and
descriptive information about products and services provided by significant
segments, geographic areas, and major customers, differences between the
measurements used in reporting segment information and those used in the
enterprise's general-purpose financial statements, and changes in the
measurement of segment amounts from period to period.
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 commercial
financial services to customers located in Reidsville, Madison, Eden, Ruffin,
Greensboro, Burgaw, and Wilmington, North Carolina; Norton, Harrisonburg,
Richlands, and Pennington Gap, Virginia; and surrounding communities. The
various products 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 branches or products.
There are no differences between the measurements used in reporting
segment information and those used in the Company's general-purpose financial
statements.
Recent accounting pronouncements
During 2003, the Securities and Exchange Commission has promulgated
rules to implement several provisions of the Sarbanes-Oxley Act of 2002. These
rules included conditions for using financial measures that excluded information
that would be required under generally accepted accounting principles,
("non-GAAP financial measures"). Additionally, new rules expand the number of
events that require current reporting on Form 8-K. Furthermore, new rules have
been issued pertaining to an audit committee and its need for a financial expert
and code of ethics requirements for senior management. Also, new rules were
issued defining audit committee responsibility for external auditor retention
and determination of external auditor independence. Additional rules have been
promulgated to implement provisions requiring management to certify its
responsibilities for establishing, maintaining and monitoring internal reporting
and disclosure controls. Management anticipates additional costs to implement
the various provisions of this law; however, it is difficult to determine the
full impact of implementation until such time as all rules have been
promulgated.
In December 2002, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure," which amends SFAS No. 123, "Accounting for Stock Based
Compensation," to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. The provisions of SFAS No. 148 were effective December
31, 2002. Management currently intends to continue to account for stock-based
compensation under the intrinsic value method set forth in Accounting Principles
Board ("APB") Opinion 25 and related interpretations. For this reason, the
transition guidance of SFAS No. 148 does not have an impact on the Company's
consolidated balance sheet or consolidated statements of income and
comprehensive income. SFAS No. 148 does amend existing guidance with respect to
required disclosures, regardless of the method of accounting used. The revised
disclosure requirements are presented herein.
49
The proforma impact on net income and net income per share as if the
fair value of stock-based compensation plans had been recorded as a component of
compensation expense in the consolidated financial statements as of the date of
grant of awards related to such plans, pursuant to the provisions of SFAS No.
123 and SFAS No. 148, is disclosed as follows.
(Dollars in thousands, except per share data) 2003 2002 2001
---- ---- ----
Net income, as reported $ 7,460 $ 6,782 $ 6,478
Less: Stock based compensation as calculated
per fair value method, net of tax effect (254) (349) (522)
------- ------- -------
Proforma net income $ 7,206 $ 6,433 $ 5,956
Earnings per share:
Basic - as reported $ 1.35 $ 1.19 $ 1.14
Basic - proforma $ 1.30 $ 1.13 $ 1.06
Diluted - as reported $ 1.30 $ 1.17 $ 1.13
Diluted - proforma $ 1.26 $ 1.10 $ 1.04
The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following weighted
average assumptions used in 2003, 2002, and 2001: dividend yield of 2.75% for
2003, 3.30% for 2002, and 3.90% for 2001; expected volatility of 15.0% for 2003,
16.0% for 2002, and 42.0% for 2001; risk free interest rates of 3.75% for 2003,
3.47% for 2002, and 4.92% for 2001, and expected lives of seven years for all
years.
These plans provide that shares granted come from the Company's
authorized but unissued or reacquired common stock. The price of the options
granted pursuant to these plans will not be less than 100 percent of the fair
market value of the shares on the date of grant. The options granted in 1996 and
thereafter vest ratably over a four-year period. No option will be exercisable
after ten years from the date granted.
On November 25, 2002, the FASB issued FASB Interpretation ("FIN")
No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others (an interpretation of
SFAS No. 5, SFAS No. 57, and SFAS No. 107 and rescission of FIN No. 34)." FIN
No. 45 clarifies the requirements of SFAS No. 5, "Accounting for Contingencies,"
relating to a guarantor's accounting for, and disclosure of, the issuance of
certain types of guarantees. FIN No. 45 requires that, for guarantees that fall
within its scope, guarantors recognize a liability equal to the fair value of
the guarantee upon its issuance. The Company's primary guarantees included
within the scope of FIN No. 45 relate to financial standby letters of credit
issued to commercial customers. FIN No. 45 requires the liability recognized in
standalone arm's-length transactions to be the premium received or receivable by
the guarantor. Management does not anticipate the implementation of this
interpretation to have a material impact on the Company's financial statements.
In January 2003, the FASB issued FIN No. 46, "Consolidation of
Variable Interest Entities (an interpretation of Accounting Research Bulletin
No.51)." FIN No. 46 addresses the consolidation by business enterprises of
certain variable interest entities. Management does not anticipate the
implementation of this interpretation to have a material impact on the Company's
financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities." SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities" and SFAS No. 138, "Accounting
for Certain Derivative Instruments and Certain Hedging Activities," establish
accounting and reporting standards for derivative instruments including
derivatives embedded in other contracts (collectively referred to as
derivatives) and for hedging activities. SFAS No. 149 amends SFAS No. 133 for
certain decisions made by the Board as part of the Derivatives Implementation
Group ("DIG") process. SFAS No. 149 contains amendments relating to FASB
Concepts Statement No. 7, "Using Cash Flow Information and Present Value in
Accounting Measurements," and SFAS No. 65, "Accounting for Certain Mortgage
Banking Activities," SFAS No. 91 "Accounting for
50
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases," SFAS No. 95, "Statement of Cash Flows," and
SFAS No. 126, "Exemption from Certain Required Disclosures about Financial
Instruments for Certain Nonpublic Entities." The Company is presently evaluating
the effect of this pronouncement.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity". SFAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. Some of the provisions of SFAS No. 150 are
consistent with the current definition of liabilities in FASB Concepts Statement
No. 6, "Elements of Financial Statements." The remaining provisions of SFAS No.
150 are consistent with the Board's proposal to revise that definition to
encompass certain obligations that a reporting entity can or must settle by
issuing its own equity shares, depending on the nature of the relationship
established between the holder and the issuer. While the FASB still plans to
revise that definition through an amendment to FASB Concepts Statement 6, the
FASB decided to defer issuing that amendment until it has concluded its
deliberations on the next phase of this project. That next phase will deal with
certain compound financial instruments including puttable shares, convertible
bonds, and dual-indexed financial instruments. SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003, except for mandatorily redeemable financial instruments of nonpublic
entities. It is to be implemented by reporting the cumulative effect of a change
in an accounting principle for financial instruments created before the issuance
date of SFAS No. 150 and still existing at the beginning of the interim period
of adoption. Restatement is not permitted. Management does not anticipate the
implementation of SFAS No. 150 to have a material impact on the Company's
consolidated financial position or consolidated results of operations.
In December 2003, the FASB issued SFAS No. 132, "Employers
Disclosure about Pensions and Other Post Retirement Benefits (Revised 2003)," in
an effort to improve financial statement disclosures for defined benefit plans.
SFAS 132(Revised 2003) requires companies to provide additional details about
plan assets, benefit obligations, cash flows, benefit costs, and other relevant
information. Companies will also be required to report the various elements of
pension and other postretirement benefit costs on a quarterly basis in interim
financial statements. The new disclosure requirements are effective for fiscal
years ending after December 15, 2003, and for quarters beginning after December
15, 2003. The Company adopted the new disclosure requirements in connection with
the preparation of its consolidated financial statements for the year ended
December 31, 2003.
Based on the Company's operations as of December 31, 2003, none of
these standards are expected to have a material effect on the Company's
financial statements.
Reclassification
Certain items for 2001 and 2002 have been reclassified to conform to
the 2003 presentation. Such reclassifications had no effect on net income or
shareholders' equity as previously reported.
Note 2 - Restriction on cash and due from banks
The Subsidiary Bank maintains average required reserve balances with
the Federal Reserve. The average amounts of these reserve balances for the years
ended December 31, 2003 and 2002 were $1,943,000 and $1,188,000, respectively.
51
Note 3 - Investment securities
Investment securities at December 31 consist of the following:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In thousands)
2003:
Available for sale:
U.S. government agency securities ................ $ 88,534 $ 489 $ (972) $ 88,051
Mortgage backed securities ....................... 18,237 153 (160) 18,230
State and municipal obligations .................. 32,617 561 (328) 32,850
Other ............................................ 656 14 (2) 668
-------- -------- -------- --------
Total available for sale ......................... 140,044 1,217 (1,462) 139,799
Federal Home Loan Bank and Federal
Reserve Bank stock ............................... 3,882 -- -- 3,882
-------- -------- -------- --------
Total investment securities ................. $143,926 $ 1,217 $ (1,462) $143,681
======== ======== ======== ========
2002:
Available for sale:
U.S. government agency securities ................ $ 97,364 $ 1,660 $ -- $ 99,024
Mortgage backed securities ....................... 17,945 444 (1) 18,388
State and municipal obligations .................. 7,036 315 -- 7,351
Other ............................................ 306 15 -- 321
-------- -------- -------- --------
Total available for sale ......................... 122,651 2,434 (1) 125,084
Federal Home Loan Bank and Federal
Reserve Bank stock ............................... 3,732 -- -- 3,732
-------- -------- -------- --------
Total investment securities ................. $126,383 $ 2,434 $ (1) $128,816
======== ======== ======== ========
The amortized cost and estimated market value of debt securities at
December 31, 2003, by contractual maturities, are shown below. Expected
maturities may differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
Amortized Estimated
Cost Fair Value
--------- ----------
(In thousands)
Due in one year or less ................................................ $ 1,006 $ 1,041
Due after one through five years ....................................... 68,355 68,060
Due after five through ten years ....................................... 34,697 34,683
Due after ten years .................................................... 35,425 35,456
-------- --------
Total debt securities ............................................. $139,483 $139,240
======== ========
Proceeds from the sale of investment securities available for sale, gross
realized gains, and gross realized losses for the years ended December 31 were
as follows:
2003 2002 2001
-------- -------- --------
(In thousands)
Proceeds from sales .................................. $104,715 $ 3,913 $ 70,469
Gross realized gains ................................. 564 318 1,771
Gross realized losses ................................ -- -- 18
At December 31, 2003 and 2002, investment securities with a carrying value
of approximately $68,027,000 and $54,872,000, respectively, were pledged as
collateral to secure public deposits and for other purposes.
52
Note 4 - Loans
Major classifications of loans at December 31, are as follows:
2003 2002
-------- --------
(In thousands)
Commercial, financial and agricultural ....... $ 90,224 $ 87,458
Consumer ..................................... 118,557 98,473
Real estate:
Residential mortgage .................... 95,939 122,558
Commercial mortgage ..................... 159,953 170,657
Construction ............................ 117,786 87,696
-------- --------
Subtotal loans ............................... 582,459 566,842
Loans held for sale .......................... 1,075 3,242
-------- --------
Gross loans ................... $581,384 $563,600
======== ========
A loan is considered impaired, based on current information and events, if
it is probable that the Company will be unable to collect the scheduled payments
of principal or interest when due according to the contractual terms of the loan
agreement. Generally, a loan will be considered impaired if it exhibits the same
level of underlying weakness and probability of loss as loans classified
doubtful or loss.
The impairment evaluation compares the recorded book value of the loan, or
loan relationship, to the present value of the expected future principal,
interest and collateral value (if applicable) cash flows. The expected cash
flows are discounted at the contractual interest rate for the individual note. A
specific reserve is established if the present value of expected future cash
flows is less than the recorded book value of the loan.
At December 31, 2003 and 2002, the recorded investment in loans considered
impaired was approximately $10,615,000 and $10,567,000, respectively. The
related allowance for credit losses on these impaired loans was approximately
$2,085,000 and $1,904,000, respectively. The average recorded investment in
impaired loans for the years ended December 31, 2003, 2002 and 2001 was
approximately $12,437,000, $9,881,000, and $6,451,000 respectively.
Nonperforming loans include nonaccrual loans and loans past due 90 days or
more and still accruing interest. Nonperforming loans at December 31, 2003
consisted of $5,174,000 of nonaccrual loans and $53,000 of loans 90 days or more
past due still accruing interest. Nonperforming loans at December 31, 2002
consisted of $3,314,000 of nonaccrual loans and $65,000 of loans 90 days or more
past due still accruing interest. Nonperforming loans at December 31, 2001
consisted of $2,266,000 of non-accrual loans and $6,000 of loans 90 days or more
past due still accruing interest. The amount of interest income recorded on
nonperforming loans during 2003, 2002 and 2001 amounted to $142,000, $475,000
and $89,000, respectively. Interest income on nonperforming loans is recorded
when cash is actually received.
The amount of potential problem loans totaled $10,615,000 at December 31,
2003. These loans are considered impaired by the Company. There are no other
identified potential problem loans at December 31, 2003.
Certain 1 to 4 family residential mortgage loans are held as collateral
under a blanket floating lien to secure a portion of the Bank's borrowings (see
Note 9).
53
Note 5 - Allowance for credit losses
Changes in the allowance for credit losses for the years ended December 31
were as follows:
2003 2002 2001
------- ------- -------
(In thousands)
Balance at beginning of year ...................... $ 7,059 $ 6,731 $ 6,311
Provision for credit losses ....................... 1,431 1,300 1,278
Recoveries ........................................ 181 298 143
Losses charged off ................................ (1,547) (1,270) (1,001)
------- ------- -------
Balance at end of year ............................ $ 7,124 $ 7,059 $ 6,731
======= ======= =======
Note 6 - Premises and equipment
Premises and equipment at December 31 is summarized as follows:
2003 2002
------- -------
(In thousands)
Land ..................................................... $ 3,724 $ 2,868
Building and leasehold improvements ...................... 8,385 7,196
Equipment ................................................ 12,549 10,977
------- -------
Subtotal ................................................. 24,658 21,041
Less accumulated depreciation and amortization ........... 11,627 10,125
------- -------
Total premises and equipment, net ................... $13,031 $10,916
======= =======
Note 7 - Deposits
The aggregate amount of jumbo certificates of deposit, each with a minimum
denomination of $100,000, was approximately $194,802,000 and $257,397,000 in
2003 and 2002, respectively. The table below presents the scheduled maturities
of time deposits at December 31, 2003.
Year ending December 31, (In thousands)
------------------------ --------------
2004 ............................................ $347,886
2005 ............................................ 63,819
2006 ............................................ 13,147
2007 ............................................ 16,784
2008 ............................................ 10,486
Thereafter ...................................... 1,024
--------
Total time deposits ........................ $453,146
========
54
Note 8 - Federal funds purchased, retail repurchase agreements and other
borrowings
The following is a schedule of federal funds purchased, securities sold
under agreements to repurchase and FHLB borrowings:
Maximum
Balance Interest Rate Average Outstanding
as of as of Average Interest at Any
December 31 December 31 Balance Rate Month-end
----------- ----------- ------- ---- ---------
(Dollars in thousands)
2003
Federal funds purchased and securities
sold under agreements to
repurchase ........................... $15,363 1.24% $14,479 1.41% $18,131
FHLB borrowings ...................... 55,500 2.65% 47,724 2.28% 67,500
------- ------- -------
Total ...................... $70,863 $62,203 $85,631
======= ======= =======
2002
Federal funds purchased and securities
sold under agreements to
repurchase ........................... $ 8,258 1.25% $15,069 1.64% $25,739
FHLB borrowings ...................... 52,500 2.94% 46,052 2.79% 52,500
------- ------- -------
Total ...................... $60,758 $61,121 $78,239
======= ======= =======
At December 31, 2003, the Bank had an approximately $130 million line of
credit with the FHLB under which $55.5 million was outstanding. This line of
credit is secured with FHLB stock and a blanket floating lien on qualifying 1 to
4 family residential mortgage loans and qualifying commercial real estate. The
outstanding amounts consist of $30.5 million maturing in 2004, $15.0 million
maturing in 2007, and $10.0 million maturing in 2011. The borrowings maturing in
2007 and 2011 both have one time call features, and may be converted to a
floating rate based on the three month LIBOR rate at their respective call date.
Federal funds purchased represent unsecured overnight borrowings from
other financial institutions by the Bank. Securities sold under agreements to
repurchase represent short-term borrowings by the Bank, with overnight
maturities collateralized by securities of the United States government or its
agencies.
55
Note 9 - Income taxes
The components of income tax expense for the years ended December 31 are
as follows:
2003 2002 2001
--------- --------- ---------
(In thousands)
Current tax expense
Federal ...................................................... $ 3,721 $ 2,928 $ 3,373
State ........................................................ 397 275 96
--------- --------- ---------
Total current ...................................... 4,118 3,203 3,469
--------- --------- ---------
Deferred tax expense (benefit)
Federal ...................................................... (299) 282 (539)
State ........................................................ (30) 42 (79)
--------- --------- ---------
Total deferred ..................................... (329) 324 (618)
--------- --------- ---------
Total income tax expense ........................... $ 3,789 $ 3,527 $ 2,851
========= ========= =========
The significant components of deferred tax assets at December 31 are as
follows:
2003 2002
---------- ----------
(In thousands)
Deferred tax assets:
Allowance for credit losses ................................. $ 2,671 $ 2,676
Non-qualified deferred compensation plans ................... 285 390
Deferred loan fees .......................................... 272 --
Nonaccrual interest ......................................... 178 83
Net unrealized gain on securities available for sale ........ 96 --
Other ....................................................... 67 82
---------- ----------
Total .......................................... 3,569 3,231
Deferred tax liabilities:
Depreciable basis of property and equipment ................. 636 515
Net unrealized gain on securities available for sale ........ -- 949
Deferred loan fees .......................................... -- 208
Other ....................................................... -- --
---------- ----------
Total .......................................... 636 1,672
---------- ----------
Net deferred tax assets (liabilities) ......................... $ 2,933 $ 1,559
========== ==========
There is no valuation allowance for deferred tax assets as management
believes that realization of the deferred tax assets will more likely than not
be realized.
The provision for income taxes differs from that computed by applying the
federal statutory rate of 34% as indicated in the following analysis:
2003 2002 2001
---------- ---------- ----------
(In thousands)
Tax based on statutory rates ..................... $ 3,825 $ 3,505 $ 3,172
Increase (decrease) resulting from:
Effect of tax-exempt income ................. (326) (101) (228)
State income taxes, net of federal benefit .. 218 229 11
Other, net .................................. 72 (106) (104)
---------- ---------- ----------
Total provision for income taxes ............ $ 3,789 $ 3,527 $ 2,851
========== ========== ==========
56
Note 10 - Lease commitments
The minimum annual lease commitments under noncancelable operating leases
in effect at December 31, 2003, are as follows:
Year Ending December 31 (In thousands)
----------------------- --------------
2004 .................................................. $ 601
2005 .................................................. 628
2006 .................................................. 619
2007 .................................................. 626
2008 .................................................. 483
Thereafter ............................................ 940
-----------
Total lease commitments .......................... $ 3,897
===========
Rental expense was $458,000 in 2003, $429,000 in 2002, and $401,000 in
2001.
Note 11 - Related party transactions
The Bank had loans outstanding to principal officers and directors and
their affiliated companies during each of the past three years. Such loans were
made substantially on the same terms, including interest rates and collateral,
as those prevailing at the time for comparable transactions with other borrowers
and do not involve more than the normal risks of collectibility. The following
table summarizes the transactions for the past two years.
2003 2002
----------- -----------
Balance, beginning of year $ 4,936,000 $ 4,626,000
Advances during year 1,990,000 2,417,000
Repayments during year (2,231,000) (2,107,000)
----------- -----------
Balance, end of year $ 4,695,000 $ 4,936,000
=========== ===========
----------
NOTE: Unused credit available at December 31, 2003 totaled $4,165,000.
57
Note 12 - Stock based compensation
The Company may provide compensation to directors, employees and third
parties through stock grants or options. The Company did not issue stock grants
during 2003, 2002 or 2001.
The Company follows SFAS No. 123, "Accounting for Stock-Based
Compensation." Under SFAS No. 123, the Company has elected to continue using the
measurement prescribed in Accounting Principles Board ("APB") Opinion No. 25,
and accordingly, SFAS No. 123 had no effect on the Company's financial position
or results of operations. The Company has issued stock under both incentive and
non-qualified stock options. The following is a summary of stock option activity
and related information for the years ended December 31:
2003 2002 2001
-------------------------- --------------------------- ------------------------
Weighted Avg. Weighted Avg. Weighted Avg.
Options Exercise Price Options Exercise Price Options Exercise Price
------- -------------- ------- -------------- ------- --------------
Outstanding -
Beginning of year ... 787,014 $12.11 1,016,691 $11.57 997,605 $11.47
Granted ............. 218,125 13.44 6,250 13.38 157,500 10.24
Exercised ........... (54,812) 9.44 (180,479) 7.81 (105,665) 8.09
Forfeited ........... (48,918) 14.94 (55,448) 15.89 (32,749) 13.61
-------- ---------- ----------
Outstanding - End
of year ............. 901,409 $12.44 787,014 $12.11 1,016,691 $11.57
======== ========== ==========
Exercisable - End
of year ............. 630,167 $12.37 618,573 $12.57 704,691 $11.72
Weighted average fair
value of options granted
during the year $ 2.08 $ 1.83 $ 3.26
The following is a summary of information on outstanding and exercisable options
at December 31, 2003:
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------------- ------------------------
Weighted Average Weighted
Remaining Weighted Average
Range of Contractual Life Average Exercise
Exercise Prices Number (Years) Exercise Price Number Price
--------------- ------ ----------------- -------------- ------- --------
$ 5.76 - 9.65 202,986 5.30 $ 8.87 184,547 $ 8.81
$ 10.01 - 10.64 296,132 4.53 10.30 245,829 10.28
$ 13.44 - 14.00 258,750 8.36 13.53 56,250 13.88
$ 18.15 - 20.40 143,541 4.24 19.94 143,541 19.94
------- -------
901,409 5.76 $12.44 630,167 $12.37
======= =======
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used in 2003, 2002, and 2001: dividend yield of 2.75% for 2003,
3.30% for 2002, and 3.90% for 2001; expected volatility of 15.0% for 2003, 16.0%
for 2002, and 42.0% for 2001; risk free interest rates of 3.75% for 2003, 3.47%
for 2002, and 4.92% for 2001, and expected lives of seven years for all years.
These plans provide that shares granted come from the Company's authorized
but unissued or reacquired common stock. The price of the options granted
pursuant to these plans will not be less than 100 percent of the fair market
value of the shares on the date of grant. The options granted in 1996 and
thereafter vest ratably over a four year period. No option will be exercisable
after ten years from the date granted.
58
Note 13 - Other comprehensive income
The Company follows the provisions of SFAS No. 130, "Reporting
Comprehensive Income". SFAS No. 130 establishes requirements for the disclosure
of comprehensive income in the Company's consolidated financial statements.
Comprehensive income is defined as net income plus transactions and other
occurrences, which are the result of non-owner changes in equity. As required by
SFAS No. 130, prior period consolidated financial statements have been
reclassified to reflect application of the provisions of this statement.
Other comprehensive income is defined as comprehensive income exclusive of
net income. Unrealized gains (losses) on available for sale investment
securities represent the sole component of the Company's other comprehensive
income. Other comprehensive income (loss) at December 31 consists of the
following:
2003 2002 2001
------- ------- -------
(In thousands)
Unrealized holding gains (losses) arising during the year ................... $(3,242) $ 298 $ 3,954
Reclassification adjustment for gains included in net income ................ 564 318 1,753
------- ------- -------
Other comprehensive income (loss) before tax ................................ (2,678) (20) 2,201
Income tax expense (benefit) related to other comprehensive income .......... (1,045) (8) 858
------- ------- -------
Other comprehensive income (loss) ........................................... $(1,633) $ (12) $ 1,343
======= ======= =======
Note 14 - Net income per share
The following is a reconciliation of the numerator and denominator of
basic common stock and diluted net income per share of common stock as required
by SFAS No. 128:
For the year ended December 31, 2003
--------------------------------------
Weighted
Average
Income Common Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income per share of common stock:
Income available to common shareholders ............ $7,460,000 5,531,323 $ 1.35
======
Effect of dilutive securities:
Stock options ...................................... -- 193,289
---------- ---------
Net income per share of common stock - assuming
dilution:
Income available to common shareholders and
assumed conversion ............................ $7,460,000 5,724,612 $ 1.30
========== ========= ======
For the year ended December 31, 2002
--------------------------------------
Weighted
Average
Income Common Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income per share of common stock:
Income available to common shareholders ............ $6,782,000 5,700,693 $ 1.19
=====
Effect of dilutive securities:
Stock options ...................................... -- 120,504
---------- ---------
Net income per share of common stock - assuming dilution
Income available to common shareholders and
assumed conversion ....................... $6,782,000 5,821,197 $ 1.17
========== ========= ======
59
For the year ended December 31, 2001
--------------------------------------
Weighted
Average
Income Common Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income per share of common stock:
Income available to common shareholders ............. $6,478,000 5,659,779 $ 1.14
======
Effect of dilutive securities:
Stock options ....................................... -- 87,224
---------- ---------
Net income per share of common stock - assuming dilution:
Income available to common shareholders and
assumed conversion ........................ $6,478,000 5,747,003 $ 1.13
========== ========= ======
60
Note 15 - FNB Financial Services Corporation (Parent Company)
The parent company's principal asset is its investment in its subsidiary,
FNB Southeast. The principal source of income of the parent company is dividends
received from its subsidiary.
2003 2002 2001
-------- -------- --------
(In thousands)
Condensed balance sheets
Assets
Cash and due from banks ................................................. $ 132 $ 1,070 $ 818
Securities .............................................................. -- 11 11
Investment in wholly-owned subsidiary ................................... 64,421 62,964 60,478
Other assets ............................................................ 1,212 288 1,401
-------- -------- --------
Total assets ............................................................ $ 65,765 $ 64,333 $ 62,708
======== ======== ========
Shareholders' equity and other liabilities ................................... $ 65,765 $ 64,333 $ 62,708
======== ======== ========
Condensed statements of income
Dividends from subsidiary .................................................... $ 4,297 $ 4,421 $ 3,044
Management fees .............................................................. 300 300 240
Noninterest income ........................................................... 152 -- --
Noninterest expense .......................................................... (342) (437) (277)
-------- -------- --------
Income before tax benefit .................................................... 4,407 4,284 3,007
Income tax (provision) benefit ............................................... (37) -- 10
-------- -------- --------
Income before equity in undistributed net income of subsidiary ............... 4,370 4,284 3,017
Equity in undistributed net income of subsidiary ............................. 3,090 2,498 3,461
-------- -------- --------
Net income ................................................................... $ 7,460 $ 6,782 $ 6,478
======== ======== ========
Condensed statements of cash flows
Cash flows from operating activities
Dividends received from subsidiary ...................................... $ 4,297 $ 4,421 $ 3,044
Management fees received ................................................ 300 300 240
Cash paid for franchise tax, registration cost, acquisition cost
and other ............................................................... (212) (435) (267)
Decrease (increase) in other assets ..................................... (913) 1,113 (1,115)
-------- -------- --------
Net cash provided by operating activities .......................... 3,472 5,399 1,902
-------- -------- --------
Cash flows from investing activities
Investment in subsidiary ................................................ -- -- 11
-------- -------- --------
Net cash provided (used in) by investing activities ................ -- -- 11
-------- -------- --------
Cash flows from financing activities
Repurchase of common stock .............................................. (2,335) (4,129) --
Dividends paid, net of DRIP ............................................. (2,512) (2,411) (2,290)
Exercise of stock options ............................................... 437 1,393 785
-------- -------- --------
Net cash (used in) financing activities ............................ (4,410) (5,147) (1,505)
-------- -------- --------
Increase (decrease) in cash .................................................. (938) 252 408
Cash at beginning of year .................................................... 1,070 818 410
-------- -------- --------
Cash at end of year .......................................................... $ 132 $ 1,070 $ 818
======== ======== ========
Reconciliation of net income to cash provided by operating activities
Net income ................................................................... $ 7,460 $ 6,782 $ 6,478
Adjustments to reconcile net income to net cash provided
by operating activities:
Decrease (increase) in other assets and
liabilities .................................................................. (898) 1,111 (1,115)
Equity in undistributed net income of subsidiary ................... (3,090) (2,494) (3,461)
-------- -------- --------
Net cash provided by operating activities .................................... $ 3,472 $ 5,399 $ 1,902
======== ======== ========
61
Note 16 - Commitments and contingent liabilities
The Company's consolidated financial statements do not reflect various
commitments and contingent liabilities which arise in the normal course of
business and which involve elements of credit risk, interest rate risk and
liquidity risk. These commitments and contingent liabilities are commitments to
extend credit and standby letters of credit. A summary of the Bank's commitments
and contingent liabilities at December 31, are as follows:
Contract or
Notional Amount
--------------------
2003 2002
-------- --------
(In thousands)
Commitments to extend credit ....................... $135,552 $107,458
Commercial letters of credit ....................... 354 283
-------- --------
Total commitments and contingent liabilities .. $135,906 $107,741
======== ========
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend is represented
by the contractual notional amount of those instruments. The Bank uses the same
credit policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
Note 17 - Employee benefit plans
The Company's non-contributory defined benefit pension plan covers
substantially all of its employees. The plan calls for benefits to be paid to
eligible employees at retirement based primarily upon years of service with the
Company and a percentage of qualifying compensation during final years of
employment. Contributions to the plan are based upon the projected unit credited
actuarial funding method and comply with the funding requirements of the
Employee Retirement Income Security Act. Contributions are intended to provide
not only for benefits attributed to service to date but also for those expected
to be earned in the future. Plan assets consist primarily of cash and cash
equivalents, U.S. government securities, and common stocks. The following table
outlines the changes in the Company's pension obligations, assets and funded
status for the years ended December 31, 2003 and 2002, and the assumptions and
components of net periodic pension cost for the two years in the period ended
December 31, 2003.
2003 2002
------- -------
(Dollars in thousands)
Change in benefit obligation
Benefit obligation at beginning of year ............ $ 4,520 $ 4,573
Service cost ....................................... 371 383
Interest cost ...................................... 301 291
Amendments ......................................... -- 107
Actuarial gain (loss) .............................. 783 (605)
Benefits paid ...................................... (74) (229)
------- -------
Benefit obligation at end of year .................. 5,901 4,520
------- -------
Change in plan assets
Fair value of plan assets at beginning of year ..... 3,859 2,341
Actual return on plan assets ....................... 799 (362)
Employer contribution .............................. 874 2,109
Benefits paid ...................................... (74) (229)
------- -------
Fair value of plan assets at end of year ........... 5,458 3,859
------- -------
Plan assets less than projected benefit obligation . (443) (661)
Funded status
Unrecognized net actuarial (gain) loss ............. 1,777 1,502
Unrecognized prior service charge .................. 153 173
------- -------
Pension asset (liability) .......................... $ 1,488 $ 1,014
======= =======
62
2003 2002
------- -------
AMOUNTS RECOGNIZED IN THE STATEMENT OF FINANCIAL POSITION CONSISTS OF:
Prepaid benefit cost ................................................. $ 1,488 $ 1,014
Accrued benefit liability ............................................ -- --
Intangible asset ..................................................... N/A N/A
Accumulated comprehensive income ..................................... N/A N/A
------- -------
Net amount recognized ................................................ $ 1,488 $ 1,014
======= =======
COMPONENTS OF NET PERIODIC PENSION COST
Service cost ......................................................... $ 371 $ 384
Interest cost ........................................................ 301 291
Expected return on plan assets ....................................... (799) (255)
Amortization of prior service cost ................................... 528 55
------- -------
Net periodic pension cost ............................................ $ 401 $ 475
======= =======
WEIGHTED-AVERAGE ASSUMPTIONS
Discount rate ........................................................ 6.00% 7.25%
Expected return on plan assets ....................................... 9.00% 9.00%
Rate of compensation ................................................. 5.00% 5.00%
Market
WEIGHTED-AVERAGE ASSET ALLOCATIONS AT DECEMBER 31, 2003 Value Percent
------- -------
Debt securities:
Federated US Government Securities .................................. $ 925 17.0%
Pimco Total Return .................................................. 852 15.6
First Trust Institutional Money Market .............................. 91 1.7
First Trust Money Market Account .................................... 2 --
------- -------
1,870 34.3
------- -------
Equity securities:
American Funds Washington Mutual .................................... 2,052 37.6
American Growth Fund ................................................ 1,207 22.1
Fidelity Advisor MidCap ............................................. 328 6.0
------- -------
3,588 65.7
------- -------
Net assets .......................................................... $ 5,458 100.0%
======= =======
Target allocations are established based on periodic evaluation of
risk/reward under various economic scenarios and with varying asset class
allocations. The near-term and long-term impact on obligations and asset values
are projected and evaluated for funding and financial accounting implications.
Actual allocation and investment performance is reviewed quarterly. The current
target allocation ranges, along with the actual allocation as of December 31,
2003 is included in the accompanying table.
Actual
Long-Term Allocation at
Allocation December 31,
PLAN ASSETS Target 2003
---------- ------------
Equity securities ....................................... 49% - 71% 65.7%
Debt securities ........................................ 18% - 28% 34.3%
Real estate ............................................. 0% - 10% --
Other (primarily cash) .................................. 2% - 3% --
--------- --------
Total .............................................. 100% 100%
========= ========
The assumed expected return on assets considers the current level of
expected returns on risk-free investments (primarily government bonds), the
historical level of risk premium associated with the other
63
asset classes in the portfolio and the expectation for future returns of each
asset class. The expected return of each asset class is weighted based on the
target allocation to develop the expected long-term rate of return on assets.
This resulted in the selection of the 9.00% rate used in 2003 and to be used for
2004.
The Company has a Supplemental Executive Retirement Plan ("SERP") that
allows the Company to supplement the level of certain executives' retirement
income over the amount obtainable through the tax-qualified retirement plan.
Contributions to the SERP totaled $237,000 for 2003, $234,000 for 2002, and
$232,000 for 2001.
The Bank also has a separate contributory 401(k) savings plan covering
substantially all employees. The plan allows eligible employees to contribute up
to a fixed percentage of their compensation, with the Bank matching a portion of
each employee's contribution. The Bank's contributions were $122,000 for 2003,
$130,000 for 2002, and $130,000 for 2001.
A deferred compensation plan allows the directors and certain senior
officers of the Company and the Bank to defer the compensation they earn for
performance of their appointed duties for the Company and the Bank. Each plan
participant makes an annual election to either receive that year's compensation
currently or to defer receipt until their death, disability or retirement.
Effective November 1, 1999, the deferred compensation balances were transferred
to a Rabbi trust. No liability exists as of December 31, 2003 and 2002.
Note 18 - Regulatory matters
The primary source of funds for the dividends paid by the Company to its
shareholders is dividends received from the Bank. The Bank is restricted as to
dividend payout by state laws applicable to banks and may pay dividends only out
of undivided profits. Additionally, dividends paid by the Company may be limited
due to maintaining minimum capital requirements imposed by banking regulators.
Management does not expect any of these restrictions to materially limit its
ability to pay dividends comparable to those paid in the past. At December 31,
2003, the Bank had undivided profits of approximately $36.0 million.
The Bank is subject to various regulatory capital requirements
administered by federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possible additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital to average assets (as
defined). Management believes, as of December 31, 2003, that the Bank meets all
capital adequacy requirements to which they are subject.
The most recent notification from the North Carolina Commissioner of Banks
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table. Since that notification, the Bank has continued to
experience asset growth.
64
The actual capital amounts and ratios for the Company and the Bank are
presented in the accompanying table.
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
(In thousands, except percentages) Actual Purposes Action Provisions
------------------- ----------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
December 31, 2003
Total Capital (To Risk Weighted Assets)
Consolidated ........................ $72,055 11.9% $48,525 >/=8.0% $ N/A
Bank ................................ 70,726 11.7 48,428 >/=8.0 60,535 >/=10.0%
Tier 1 Capital (To Risk Weighted Assets)
Consolidated ........................ 64,931 10.7 24,262 >/=4.0 N/A
Bank ................................ 63,602 10.5 24,214 >/=4.0 36,321 >/=6.0
Tier 1 Capital (To Average Assets)
Consolidated ........................ 64,931 8.4 30,770 >/=4.0 N/A
Bank ................................ 63,602 8.3 30,727 >/=4.0 38,409 >/=5.0
December 31, 2002
Total Capital (To Risk Weighted Assets)
Consolidated ........................ $69,614 12.4% $44,742 >/=8.0% $ N/A
Bank ................................ 68,241 12.2 44,717 >/=8.0 55,897 >/=10.0%
Tier 1 Capital (To Risk Weighted Assets)
Consolidated ........................ 62,622 11.2 22,371 >/=4.0 N/A
Bank ................................ 61,253 11.0 22,359 >/=4.0 33,538 >/=6.0
Tier 1 Capital (To Average Assets)
Consolidated ........................ 62,622 8.5 29,351 >/=4.0 N/A
Bank ................................ 61,253 8.4 29,202 >/=4.0 36,502 >/=5.0
Note 19 - Fair value of financial instruments
The following methods and assumptions were used to estimate the fair value
for each class of the Company's financial instruments.
Cash and cash equivalents. For cash on hand and amounts due from banks the
carrying value is considered to be a reasonable estimate of fair value.
Investment securities. The fair value of investment securities is based on
quoted market prices, if available. If a quoted market price is not available,
fair value is estimated using quoted market prices for similar securities. The
fair value of equity investments in the restricted stock of the Federal Reserve
Bank and Federal Home Loan Bank equals the carrying value.
Loans. The fair value of fixed rate loans is estimated by discounting the
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining maturities.
Substantially all residential mortgage loans held for sale are pre-sold and
their carrying value approximates fair value. The fair value of variable rate
loans with frequent repricing and negligible credit risk approximates book
value.
Deposits. The fair value of noninterest-bearing demand deposits and NOW,
savings, and money market deposits is the amount payable on demand at the
reporting date. The fair value of time deposits is estimated using the rates
currently offered for deposits of similar remaining maturities.
Federal Funds Purchased and Retail Repurchase Agreements. The carrying
value of federal funds purchased and retail repurchase agreements is considered
to be a reasonable estimate of fair value.
65
Other borrowings. Other borrowings consist of FHLB borrowings with varying
maturities. The fair values of these liabilities are estimated using the
discounted values of the contractual cash flows. The discount rate is estimated
using the rates currently in effect for similar borrowings.
Commitments. The fair value of commitments to extend credit is considered
to approximate carrying value, since the large majority of these commitments
would result in loans that have variable rates and/or relatively short terms to
maturity. For other commitments, generally of a short-term nature, the carrying
value is considered to be a reasonable estimate of fair value. The various
commitment items were disclosed in Note 16.
The estimated fair values of financial instruments at December 31 are as
follows:
2003 2002
------------------------ ------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
-------- ----------- -------- ----------
(In thousands)
Financial assets:
Cash and cash equivalents ................................ $ 29,319 $ 29,319 $ 24,524 $ 24,524
Investment securities
Available for sale ................................... 139,799 139,799 125,084 125,084
Other equity securities .............................. 3,882 3,882 3,732 3,732
Loans held for sale ...................................... 1,075 1,075 3,242 3,242
Loans .................................................... 581,384 577,405 563,600 563,900
Financial liabilities:
Deposits ................................................. 641,907 642,869 605,005 607,565
Federal funds purchased and retail repurchase
agreements .......................................... 15,363 15,363 8,258 8,258
Other borrowings ......................................... 55,500 56,391 52,500 53,544
The fair value estimates are made at a specific point in time based on
relevant market and other information about the financial instruments. Because
no market exists for a significant portion of the Company's financial
instruments, fair value estimates are based on current economic conditions, risk
characteristics of various financial instruments, and such other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates. In addition, the tax
ramifications related to the realization of the unrealized gains and losses can
have a significant effect on fair value estimates and have not been considered
in the estimates.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of disclosure controls and procedures
The Company's management, under the supervision and with the participation
of the Chief Executive Officer and the Chief Financial Officer of the Company
(its principal executive officer and principal financial officer, respectively),
has concluded based on its evaluation as of the end of the period covered by
this Report, that the Company's disclosure controls and procedures are effective
to ensure that information required to be disclosed by the Company in the
reports filed or submitted by it under the Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported within the time periods
specified in the applicable rules and forms, and include controls and procedures
designed to ensure that information required to be disclosed by the Company in
such reports is accumulated and communicated to the Company 's management,
including the Chief Executive Officer and the Chief Financial Officer of the
Company, as appropriate to allow timely decisions regarding required disclosure.
Changes in internal control over financial reporting
There have been no significant changes in internal control over financial
reporting during the period covered by this Report that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
66
PART III
Item 10. Directors and Executive Officers of the Registrant.
(a) Directors and Executive Officers - The information required by this Item
regarding directors and executive officers of the Company, the Company's Audit
Committee and procedures for shareholder nominations is set forth under the
sections captioned "Election of Directors," "Executive Officers," "Report of
Audit Committee" and "Our Board of Directors and its Committees - How can a
shareholder nominate someone for election to the Board?" in the Company's
definitive proxy statement, to be filed with the Securities and Exchange
Commission with respect to the Annual Meeting of Shareholders to be held on May
20, 2004, which sections are incorporated by reference.
(b) Section 16(a) Compliance - The information required by this item regarding
compliance with Section 16(a) of the Securities Exchange Act of 1934 is set
forth under the section "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's definitive proxy statement, to be filed with the
Securities and Exchange Commission with respect to the Annual Meeting of
Shareholders to be held on May 20, 2004, which section is incorporated by
reference.
(c) Audit Committee Financial Expert - The Board of Directors of the Company has
determined that Barry Z. Dodson, a member of the Audit Committee, qualifies as
an "audit committee financial expert" and is "independent" as defined under
applicable SEC and NASD rules and regulations.
(d) Code of Ethics - The Company has adopted its "Code of Business Conduct and
Ethics", a code of ethics that applies to its directors, officers, and
employees. The Code of Business Conduct and Ethics is accessible on the
Company's website under the "Investor Information" section. The Company elects
to disclose any amendments to or waivers of any Provisions of its Code of
Business Conduct and Ethics applicable to its principal executive officers and
senior financial officers on its website.
Item 11. Executive Compensation
Director compensation, executive compensation and executive compensation
plan information are incorporated by reference to the sections captioned "Our
Board of Directors and its Committees - How are our directors compensated?" and
"Executive Compensation" in the Company's definitive proxy statement, to be
filed with the Securities and Exchange Commission with respect to the Annual
Meeting of Shareholders to be held on May 20, 2004.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Incorporated by reference to the sections captioned "Stock Ownership" and
"- Equity Compensation Plan Information" in the Company's definitive proxy
statement, to be filed with the Securities and Exchange Commission with respect
to the Annual Meeting of Shareholders to be held on May 20, 2004.
Item 13. Certain Relationships and Related Transactions
Incorporated by reference to the section captioned "Transactions with
Management" in the Company's definitive proxy statement, to be filed with the
Securities and Exchange Commission with respect to the Annual Meeting of
Shareholders to be held on May 20, 2004.
Item 14. Principal Accountant Fees and Services
Incorporated by reference to the section captioned "Information About Our
Independent Auditors in 2003" in the Company's definitive proxy statement, to be
filed with the Securities and Exchange Commission with respect to the Annual
Meeting of Shareholders to be held on May 20, 2004.
67
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Financial Statements. The following financial statements and
supplementary data are included in Item 8 of this report.
Financial Statements Form 10-K Page
-------------------- --------------
Report of Independent Auditors ..................................................... 41
Consolidated Balance Sheets as of December 31, 2003 and 2002 ....................... 42
Consolidated Statements of Income and Comprehensive Income for the years ended
December 31, 2003, 2002 and 2001 ................................................... 43
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2003, 2002 and 2001 ................................................... 44
Consolidated Statements of Cash Flows for the years ended December 31, 2003,
2002 and 2001 ...................................................................... 45
Notes to Consolidated Financial Statements ......................................... 46-66
(a)(2) Financial Statement Schedules. All applicable financial statement
schedules required under Regulation S-X have been included in the Notes to the
Consolidated Financial Statements.
(a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed
below.
Exhibit No. Description
- ----------- -----------
3.01(1) Amended and Restated Articles of Incorporation.
3.02(1) Bylaws of Company, as amended.
4.01(1) Specimen Common Stock Certificate.
10.01(3) 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(4) Omnibus Equity Compensation Plan of the Registrant.
10.03(5) Severance Policy for Senior Officers of the Registrant(employed
for five years or more).
10.04(6) Revised Severance Plan for Senior Officers of the
Registrant(employed for five years or more).
10.05(4) Severance Policy for Senior Officers of the Registrant(employed
for less than five years).
10.07(8) Benefit Equivalency Plan of the Registrant effective January 1,
1994.
10.08 Annual Management Incentive Plan of the Registrant.
10.09(8) Long Term Incentive Plan of the Registrant.
10.10(11) Long Term Incentive Plan of the Registrant for certain senior
management employees.
10.10(8) 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(9) Split-Dollar Agreement dated January 27, 1995, between the
Registrant and Ernest J. Sewell.
10.13(9) Split-Dollar Agreement dated January 27, 1995, between the
Registrant and C. Melvin Gantt.
10.14(9) Split-Dollar Agreement dated December 8, 1995, between the
Registrant and Richard L. Powell.
10.16(2) Amendment to Benefit Equivalency Plan of the Registrant effective
January 1, 1998.
21.01 Schedule of Subsidiaries.
23.01 Consent of PricewaterhouseCoopers LLP.
31.01 Certification of Ernest J. Sewell
31.02 Certification of Michael W. Shelton
32.01 Certification of Periodic Financial Report Pursuant to 18 USC
Section 1350.
Note: The exhibits listed above have been filed with the Securities and Exchange
Commission but are not included in this printed copy of the Company's Annual
Report on Form 10-K.
68
Exhibit references:
(1) Incorporated herein by reference to the Registrant's Quarterly
Report on Form 10-Q for the fiscal quarter ended March 31, 1998,
filed with the Securities and Exchange Commission.
(2) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1998, filed with
the Securities and Exchange Commission.
(3) Incorporated herein by reference to the Registrant's Statement on
Form S-8 (No. 33-33186), filed with the Securities and Exchange
Commission.
(4) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 1996, filed
with the Securities and Exchange Commission.
(5) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1989, filed with
the Securities and Exchange Commission.
(6) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 1994, filed
with the Securities and Exchange Commission.
(7) Incorporated herein by reference to the Registrant's Quarterly
Report, on Form 10-QSB for the fiscal quarter ended June 30, 1995,
filed with the Securities and Exchange Commission.
(8) Incorporated herein by reference to the Registrant's Statement on
Form S-2 (File No. 333-47203) filed with the Securities and Exchange
Commission on March 3, 1998.
(9) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 1997, filed
with the Securities and Exchange Commission.
(10) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2002, filed with
the Securities and Exchange Commission
(11) Incorporated herein by reference tp the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1999, filed with
the Securties and Exchange Commission.
(b) Reports on 8-K.
The Company filed a Current Report on Form 8-K, dated November 24, 2003,
announcing a five-for-four stock split, effected as a 25% stock dividend, and a
7.1% increase in the quarterly cash dividends.
The Company filed a Current Report on Form 8-K, dated December 3, 2003,
announcing plans to relocate its corporate headquarters from Reidsville, NC to
Greensboro, NC in 2004.
69
THIS PAGE LEFT BLANK INTENTIONALLY
70
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
FNB FINANCIAL SERVICES CORPORATION
Date: March 11, 2004 By: /s/ ERNEST J. SEWELL
-------------------------------------
Ernest J. Sewell,
President and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signature Capacity Date
--------- -------- ----
/s/ ERNEST J. SEWELL President, Chief Executive Officer and Director March 11, 2004
- -------------------------
Ernest J. Sewell (Principal Executive Officer)
/s/ MICHAEL W. SHELTON Vice President and Chief Financial Officer March 11, 2004
- -------------------------
Michael W. Shelton (Principal Financial and Accounting Officer)
/s/ BARRY Z. DODSON Chairman of the Board March 11, 2004
- -------------------------
Barry Z. Dodson
/s/ GARY G. BLOSSER Director March 11, 2004
- -------------------------
Gary G. Blosser
/s/ CHARLES A. BRITT Director March 11, 2004
- -------------------------
Charles A. Britt
/s/ O. EDDIE GREEN Director March 11, 2004
- -------------------------
O. Eddie Green
/s/ JOSEPH H. KINNARNEY Director March 11, 2004
- -------------------------
Joseph H. Kinnarney
/s/ E. REID TEAGUE Director March 11, 2004
- -------------------------
E. Reid Teague
/s/ KENAN C. WRIGHT Director March 11, 2004
- -------------------------
Kenan C. Wright
71