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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
June 30, 2004
----------
Commission File Number 0-15572
FIRST BANCORP
(Exact Name of Registrant as Specified in its Charter)
North Carolina 56-1421916
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
341 North Main Street, Troy, North Carolina 27371-0508
(Address of Principal Executive Offices) (Zip Code)
(Registrant's telephone number, including area code) (910) 576-6171
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve 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.
|X| YES |_| NO
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.
|X| YES |_| NO
As of July 29, 2004, 9,422,402 shares of the registrant's Common Stock, no
par value, were outstanding. The registrant had no other classes of securities
outstanding.
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INDEX
FIRST BANCORP AND SUBSIDIARIES
Page
----
Part I. Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets -
June 30, 2004 and 2003
(With Comparative Amounts at December 31, 2003) 3
Consolidated Statements of Income -
For the Periods Ended June 30, 2004 and 2003 4
Consolidated Statements of Comprehensive Income -
For the Periods Ended June 30, 2004 and 2003 5
Consolidated Statements of Shareholders' Equity -
For the Periods Ended June 30, 2004 and 2003 6
Consolidated Statements of Cash Flows -
For the Periods Ended June 30, 2004 and 2003 7
Notes to Consolidated Financial Statements 8
Item 2 - Management's Discussion and Analysis of Consolidated
Results of Operations and Financial Condition 14
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 28
Item 4 - Controls and Procedures 29
Part II. Other Information
Item 2 - Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities 30
Item 4 - Submission of Matters to a Vote of Security Holders 30
Item 6 - Exhibits and Reports on Form 8-K 30
Signatures 33
Page 2
Part I. Financial Information
Item 1 - Financial Statements
First Bancorp and Subsidiaries
Consolidated Balance Sheets
June 30, December 31, June 30,
($ in thousands-unaudited) 2004 2003 (audited) 2003
- ---------------------------------------------------- ----------- -------------- ---------
ASSETS
Cash & due from banks, noninterest-bearing $ 22,614 36,315 25,795
Due from banks, interest-bearing 39,758 12,632 20,011
Federal funds sold 7,730 13,967 18,710
----------- --------- ---------
Total cash and cash equivalents 70,102 62,914 64,516
----------- --------- ---------
Securities available for sale (costs of $100,596,
$101,587, and $74,539) 100,009 103,455 76,564
Securities held to maturity (fair values of $13,392,
$14,906, and $16,255) 12,965 14,206 15,305
Presold mortgages in process of settlement 1,679 1,307 3,526
Loans 1,297,224 1,218,895 1,107,997
Less: Allowance for loan losses (14,313) (13,569) (12,243)
----------- --------- ---------
Net loans 1,282,911 1,205,326 1,095,754
----------- --------- ---------
Premises and equipment 25,256 25,356 22,709
Accrued interest receivable 6,190 6,087 5,753
Intangible assets 50,517 50,701 36,667
Other 8,622 6,417 5,009
----------- --------- ---------
Total assets $ 1,558,251 1,475,769 1,325,803
=========== ========= =========
LIABILITIES
Deposits: Demand - noninterest-bearing $ 157,820 146,499 135,288
Savings, NOW, and money market 466,711 462,876 404,479
Time deposits of $100,000 or more 269,284 238,535 236,580
Other time deposits 406,989 401,454 375,622
----------- --------- ---------
Total deposits 1,300,804 1,249,364 1,151,969
Borrowings 106,000 76,000 31,000
Accrued interest payable 2,292 2,138 2,383
Other liabilities 5,917 6,411 5,124
----------- --------- ---------
Total liabilities 1,415,013 1,333,913 1,190,476
----------- --------- ---------
SHAREHOLDERS' EQUITY
Common stock, No par value per share
Issued and outstanding: 9,424,884,
9,435,294, and 9,363,404 shares 53,226 55,392 54,162
Retained earnings 90,576 85,502 80,108
Accumulated other comprehensive income (loss) (564) 962 1,057
----------- --------- ---------
Total shareholders' equity 143,238 141,856 135,327
----------- --------- ---------
Total liabilities and shareholders' equity $ 1,558,251 1,475,769 1,325,803
=========== ========= =========
See notes to consolidated financial statements.
Page 3
First Bancorp and Subsidiaries
Consolidated Statements of Income
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ---------------------
($ in thousands, except share data-unaudited) 2004 2003 2004 2003
- ---------------------------------------------------------- ----------- --------- --------- ---------
INTEREST INCOME
Interest and fees on loans $ 18,192 17,249 36,195 34,258
Interest on investment securities:
Taxable interest income 1,129 911 2,284 1,851
Tax-exempt interest income 140 175 280 384
Other, principally overnight investments 104 222 190 528
----------- --------- --------- ---------
Total interest income 19,565 18,557 38,949 37,021
----------- --------- --------- ---------
INTEREST EXPENSE
Savings, NOW and money market 583 584 1,146 1,202
Time deposits of $100,000 or more 1,456 1,565 2,821 3,125
Other time deposits 2,006 2,318 4,031 4,785
Borrowings 661 416 1,319 893
----------- --------- --------- ---------
Total interest expense 4,706 4,883 9,317 10,005
----------- --------- --------- ---------
Net interest income 14,859 13,674 29,632 27,016
Provision for loan losses 740 540 1,310 1,060
----------- --------- --------- ---------
Net interest income after provision
for loan losses 14,119 13,134 28,322 25,956
----------- --------- --------- ---------
NONINTEREST INCOME
Service charges on deposit accounts 2,345 1,927 4,554 3,788
Other service charges, commissions and fees 794 633 1,690 1,409
Fees from presold mortgages 290 651 478 1,353
Commissions from sales of insurance and financial products 365 335 696 595
Data processing fees 104 79 200 152
Securities gains 96 -- 188 --
Other gains (losses) (82) (23) (82) 38
----------- --------- --------- ---------
Total noninterest income 3,912 3,602 7,724 7,335
----------- --------- --------- ---------
NONINTEREST EXPENSES
Salaries 4,921 4,312 9,844 8,591
Employee benefits 1,373 1,084 2,693 2,131
----------- --------- --------- ---------
Total personnel expense 6,294 5,396 12,537 10,722
Net occupancy expense 696 568 1,398 1,158
Equipment related expenses 712 637 1,466 1,269
Intangibles amortization 94 46 189 91
Other operating expenses 2,826 2,705 5,764 5,360
----------- --------- --------- ---------
Total noninterest expenses 10,622 9,352 21,354 18,600
----------- --------- --------- ---------
Income before income taxes 7,409 7,384 14,692 14,691
Income taxes 2,523 2,573 5,086 5,187
----------- --------- --------- ---------
NET INCOME $ 4,886 4,811 9,606 9,504
=========== ========= ========= =========
Earnings per share:
Basic $ 0.52 0.51 1.02 1.01
Diluted 0.51 0.50 1.00 0.99
Weighted average common shares outstanding:
Basic 9,450,723 9,390,186 9,459,047 9,375,439
Diluted 9,606,676 9,563,841 9,628,440 9,552,385
See notes to consolidated financial statements.
Page 4
First Bancorp and Subsidiaries
Consolidated Statements of Comprehensive Income
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
($ in thousands-unaudited) 2004 2003 2004 2003
- --------------------------------------------------- -------- ----- ------ -----
Net income $ 4,886 4,811 9,606 9,504
-------- ----- ------ -----
Other comprehensive income (loss):
Unrealized gains (losses) on securities
available for sale:
Unrealized holding gains (losses) arising
during the period, pretax (3,071) 839 (2,267) 626
Tax benefit (expense) 1,198 (327) 884 (244)
Reclassification to realized gains (96) -- (188) --
Tax expense 37 -- 73 --
Adjustment to minimum pension liability:
Additional pension charge related to unfunded
pension liability (46) -- (46) (127)
Tax benefit 18 -- 18 50
-------- ----- ------ -----
Other comprehensive income (loss) (1,960) 512 (1,526) 305
-------- ----- ------ -----
Comprehensive income $ 2,926 5,323 8,080 9,809
======== ===== ====== =====
See notes to consolidated financial statements.
Page 5
First Bancorp and Subsidiaries
Consolidated Statements of Shareholders' Equity
Accumulated
Common Stock Other
----------------- Retained Comprehensive Shareholders'
(In thousands, except per share - unaudited) Shares Amount Earnings Income (Loss) Equity
- -------------------------------------------- ------ -------- -------- ------------- -------------
Balances, January 1, 2003 9,122 $ 48,313 74,920 752 123,985
Net income 9,504 9,504
Cash dividends declared ($0.46 per share) (4,316) (4,316)
Common stock issued under
stock option plan 84 618 618
Common stock issued into
dividend reinvestment plan 25 620 620
Purchases and retirement of common
stock (201) (4,971) (4,971)
Common stock issued in acquisition 333 9,284 9,284
Tax benefit realized from exercise of
nonqualified stock options 298 298
Other comprehensive income 305 305
----- -------- ------ ------ -------
Balances, June 30, 2003 9,363 $ 54,162 80,108 1,057 135,327
===== ======== ====== ====== =======
Balances, January 1, 2004 9,435 $ 55,392 85,502 962 141,856
Net income 9,606 9,606
Cash dividends declared ($0.48 per share) (4,532) (4,532)
Common stock issued under
stock option plan 81 727 727
Common stock issued into
dividend reinvestment plan 23 783 783
Purchases and retirement of common
stock (114) (3,676) (3,676)
Other comprehensive loss (1,526) (1,526)
----- -------- ------ ------ -------
Balances, June 30, 2004 9,425 $ 53,226 90,576 (564) 143,238
===== ======== ====== ====== =======
See notes to consolidated financial statements.
Page 6
First Bancorp and Subsidiaries
Consolidated Statements of Cash Flows
Six Months Ended
June 30,
------------------
($ in thousands-unaudited) 2004 2003
- -------------------------------------------------------------------------- -------- -------
Cash Flows From Operating Activities
Net income $ 9,606 9,504
Reconciliation of net income to net cash provided by operating activities:
Provision for loan losses 1,310 1,060
Net security premium amortization 116 145
Loss (gain) on disposal of other real estate 4 (61)
Other losses 78 23
Gain on sale of securities available for sale (188) --
Increase (decrease) in loan fees and costs deferred (187) 10
Depreciation of premises and equipment 1,248 1,101
Tax benefit from exercise of nonqualified stock options -- 298
Amortization of intangible assets 189 91
Deferred income tax expense (benefit) (347) 668
Decrease (increase) in presold mortgages in process of settlement (372) 15,742
Decrease (increase) in accrued interest receivable (103) 125
Increase in other assets (50) (530)
Increase (decrease) in accrued interest payable 154 (300)
Decrease in other liabilities (528) (1,498)
-------- -------
Net cash provided by operating activities 10,930 26,378
-------- -------
Cash Flows From Investing Activities
Purchases of securities available for sale (13,449) (22,356)
Purchases of securities held to maturity (395) (235)
Proceeds from maturities/issuer calls of securities available for sale 10,357 22,380
Proceeds from maturities/issuer calls of securities held to maturity 1,551 2,686
Proceeds from sales of securities available for sale 4,161 --
Net increase in loans (79,559) (62,510)
Purchases of premises and equipment (1,148) (815)
Net cash paid in acquisitions -- (2,820)
-------- -------
Net cash used by investing activities (78,482) (63,670)
-------- -------
Cash Flows From Financing Activities
Net increase in deposits 51,440 37,151
Proceeds from (repayments of) borrowings, net 30,000 (1,000)
Cash dividends paid (4,534) (4,263)
Proceeds from issuance of common stock 1,510 1,238
Purchases and retirement of common stock (3,676) (4,971)
-------- -------
Net cash provided by financing activities 74,740 28,155
-------- -------
Increase (Decrease) in Cash and Cash Equivalents 7,188 (9,137)
Cash and Cash Equivalents, Beginning of Period 62,914 73,653
-------- -------
Cash and Cash Equivalents, End of Period $ 70,012 64,516
======== =======
Supplemental Disclosures Of Cash Flow Information:
Cash paid during the period for:
Interest $ 9,163 10,305
Income taxes 4,831 4,863
Non-cash transactions:
Unrealized gain (loss) on securities available for sale, net of taxes (1,498) 382
Foreclosed loans transferred to other real estate 851 291
Common stock issued in acquisition -- 9,284
See notes to consolidated financial statements.
Page 7
First Bancorp and Subsidiaries
Notes To Consolidated Financial Statements
(unaudited) For the Periods Ended June 30, 2004 and 2003
- --------------------------------------------------------------------------------
Note 1 - Basis of Presentation
In the opinion of the Company, the accompanying unaudited consolidated
financial statements contain all adjustments necessary to present fairly the
consolidated financial position of the Company as of June 30, 2004 and 2003 and
the consolidated results of operations and consolidated cash flows for the
periods ended June 30, 2004 and 2003. Reference is made to the 2003 Annual
Report on Form 10-K filed with the SEC for a discussion of accounting policies
and other relevant information with respect to the financial statements. The
results of operations for the periods ended June 30, 2004 and 2003 are not
necessarily indicative of the results to be expected for the full year.
Note 2 - Accounting Policies
Note 1 to the 2003 Annual Report on Form 10-K filed with the SEC contains
a description of the accounting policies followed by the Company and discussion
of recent accounting pronouncements. The following paragraphs update that
information as necessary.
In January 2003, the Financial Accounting Standards Board (FASB) issued
Financial Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest
Entities," which was subsequently revised (FIN 46R) in December 2003. FIN 46 and
FIN 46R address the consolidation and deconsolidation by business enterprises of
certain variable interest entities. The Company adopted FIN 46 as of December
31, 2003 and FIN 46R as of March 31, 2004. The adoption of FIN 46 and FIN 46R
did not have a material impact on the Company's financial position or results of
operations. Although the Company has no investments in variable interest
entities that required consolidation under FIN 46 or FIN 46R, the application of
certain provisions of FIN 46R as of March 31, 2004 resulted in the
de-consolidation of the trusts that have issued trust preferred capital
securities on behalf of the Company. The trust preferred capital securities have
been, and continue to be, classified as "borrowings" by the Company. The only
change caused by the adoption of FIN 46R was to change the description as to
whom the borrowings are owed. Prior to deconsolidation, the payable to the
trusts was eliminated in consolidation with the offsetting intercompany
receivable of the trusts. The amounts owed to the third-party purchasers of the
trust preferred securities were disclosed as being owed by the Company to those
third parties. Under de-consolidation accounting, only the amount owed by the
Company to the trusts is reported in the consolidated financial statements. The
receivables recorded by the trusts as being due from the Company and the amounts
payable by the trusts to the third-party purchasers of the trust preferred
securities remain on the trusts' books and are not included in the Company's
consolidated financial statements. The net effect is that the Company now
describes its borrowings as being due to the trusts instead of the third-party
purchasers of the trust preferred securities. There is no change to the terms of
the borrowings or the amounts owed.
In December 2003, the FASB issued Statement of Financial Accounting
Standards No. 132 (revised 2003) (Statement 132(R)), "Employers' Disclosures
about Pensions and Other Postretirement Benefits." Statement 132(R) revises
employers' disclosures about pension plans and other postretirement plans, but
does not change the measurement or recognition of those plans. Statement 132(R)
requires additional disclosures about the assets, obligations, cash flows, and
net periodic pension cost of defined benefit plans and other defined benefit
postretirement plans. Most of these disclosures are required only on an annual
basis and were included in Note 11 to the aforementioned 2003 consolidated
financial statements filed on Form 10-K with the SEC. Certain of the additional
disclosures are required to be included for interim periods, and the Company has
made those disclosures in Note 9 below.
Page 8
In March 2004, the SEC issued Staff Accounting Bulletin Number 105 (SAB
105), "Application of Accounting Principles to Loan Commitments." SAB 105
summarizes the views of the SEC staff regarding the application of generally
accepted accounting principles to loan commitments accounted for as derivatives,
and its provisions were required for such loan commitments entered into
subsequent to March 31, 2004. The adoption of SAB 105 did not have a material
impact on the Company's consolidated financial statements.
Note 3 - Reclassifications
Certain amounts reported in the period ended June 30, 2003 have been
reclassified to conform with the presentation for June 30, 2004. These
reclassifications had no effect on net income or shareholders' equity for the
periods presented, nor did they materially impact trends in financial
information.
Note 4 - Stock Option Plans
At June 30, 2004, the Company had six stock-based employee compensation
plans, five of which were assumed in acquisitions. The Company accounts for each
plan under the recognition and measurement principles of Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under those plans had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per share if
the Company had applied the fair value recognition provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation.
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
(In thousands except per share data) 2004 2003 2004 2003
-------- ----- ------ -----
Net income, as reported $ 4,886 4,811 9,606 9,504
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (1,134) (159) (1,186) (210)
-------- ----- ------ -----
Pro forma net income $ 3,752 4,652 8,420 9,294
======== ===== ====== =====
Earnings per share: Basic - As reported $ 0.52 0.51 1.02 1.01
Basic - Pro forma 0.40 0.50 0.89 0.99
Diluted - As reported 0.51 0.50 1.00 0.99
Diluted - Pro forma 0.39 0.49 0.87 0.97
Note 5 - Earnings Per Share
Basic earnings per share were computed by dividing net income by the
weighted average common shares outstanding. Diluted earnings per share includes
the potentially dilutive effects of the Company's stock option plan. The
following is a reconciliation of the numerators and denominators used in
computing basic and diluted earnings per share:
Page 9
For the Three Months Ended June 30,
---------------------------------------------------------------------------------
2004 2003
-------------------------------------- ----------------------------------------
($ in thousands except per Income Shares Per Share Income Shares Per Share
share amounts) (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
- ----------------------------- ----------- ------------- --------- ----------- ------------- ---------
Basic EPS
Net income $ 4,886 9,450,723 $ 0.52 $ 4,811 9,390,186 $ 0.51
====== ======
Effect of Dilutive Securities -- 155,953 -- 173,655
------- --------- ------- ---------
Diluted EPS $ 4,886 9,606,676 $ 0.51 $ 4,811 9,563,841 $ 0.50
======= ========= ====== ======= ========= ======
For the Six Months Ended June 30,
---------------------------------------------------------------------------------
2004 2003
-------------------------------------- ----------------------------------------
($ in thousands except per Income Shares Per Share Income Shares Per Share
share amounts) (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
- ----------------------------- ----------- ------------- --------- ----------- ------------- ---------
Basic EPS
Net income $ 9,606 9,459,047 $ 1.02 $ 9,504 9,375,439 $ 1.01
====== ======
Effect of Dilutive Securities -- 169,393 -- 176,946
------- --------- ------- ---------
Diluted EPS $ 9,606 9,628,440 $ 1.00 $ 9,504 9,552,385 $ 0.99
======= ========= ====== ======= ========= ======
For the three months ended June 30, 2004 and 2003, there were options of
95,006, and 21,000, respectively, that were antidilutive because the exercise
price exceeded the average market price for the period. Those same amount of
options were antidilutive for the six months ended June 30, 2004 and 2003.
Antidilutive options have been omitted from the calculation of diluted earnings
per share for the respective periods.
Page 10
Note 6 - Asset Quality Information
Nonperforming assets are defined as nonaccrual loans, loans past due 90 or
more days and still accruing interest, restructured loans and other real estate.
Nonperforming assets are summarized as follows:
June 30, December 31, June 30,
($ in thousands) 2004 2003 2003
---------------------------------------- -------- ------------ --------
Nonperforming loans:
Nonaccrual loans $ 3,320 4,274 3,741
Restructured loans 18 21 22
Accruing loans > 90 days past due -- -- --
------- ----- -----
Total nonperforming loans 3,338 4,295 3,763
Other real estate 1,857 1,398 1,174
------- ----- -----
Total nonperforming assets $ 5,195 5,693 4,937
======= ===== =====
Nonperforming loans to total loans 0.26% 0.35% 0.34%
Nonperforming assets as a percentage of loans
and other real estate 0.40% 0.47% 0.45%
Nonperforming assets to total assets 0.33% 0.39% 0.37%
Allowance for loan losses to total loans 1.10% 1.11% 1.10%
Note 7 - Deferred Loan Fees
Loans are shown on the Consolidated Balance Sheets net of net deferred
loan fees of approximately $417,000, $603,000, and $712,000 at June 30, 2004,
December 31, 2003, and June 30, 2003, respectively.
Note 8 - Goodwill and Other Intangible Assets
The following is a summary of the gross carrying amount and accumulated
amortization of amortizable intangible assets as of June 30, 2004, December 31,
2003, and June 30, 2003 and the carrying amount of unamortized intangible assets
as of those same dates.
June 30, 2004 December 31, 2003 June 30, 2003
----------------------------- ----------------------------- -----------------------------
Gross Carrying Accumulated Gross Carrying Accumulated Gross Carrying Accumulated
($ in thousands) Amount Amortization Amount Amortization Amount Amortization
- ------------------------ -------------- ------------ -------------- ------------ -------------- ------------
Amortizable intangible
assets:
Customer lists $ 394 69 394 54 394 39
Noncompete agreements 50 38 50 25 50 12
Core deposit premiums 2,441 590 2,441 429 1,106 324
-------- --- ------ --- ------- ---
Total $ 2,885 697 2,885 508 1,550 375
======== === ====== === ======= ===
Unamortizable intangible
assets:
Goodwill $ 48,246 48,231 35,399
======== ====== =======
Pension $ 83 93 93
======== ====== =======
Amortization expense totaled $94,000 and $46,000 for the three months
ended June 30, 2004 and 2003, respectively. Amortization expense totaled
$189,000 and $91,000 for the six months ended June 30, 2004 and 2003,
respectively.
Page 11
The following table presents the estimated amortization expense for each
of the five calendar years ending December 31, 2008 and the estimated amount
amortizable thereafter. These estimates are subject to change in future periods
to the extent management determines it is necessary to make adjustments to the
carrying value or estimated useful lives of amortized intangible assets.
Estimated Amortization
(Dollars in thousands) Expense
---------------------- ----------------------
2004 $ 379
2005 290
2006 242
2007 220
2008 219
Thereafter 1,027
-------
Total $ 2,377
=======
Note 9 - Pension Plans
The Company sponsors two defined benefit pension plans - a qualified
retirement plan (the "Pension Plan") which is generally available to all
employees, and a Supplemental Executive Retirement Plan (the "SERP Plan"), which
is for the benefit of certain senior management executives of the Company.
The Company incurred pension expense totaling $433,000 and $311,000 for
the three months ended June 30, 2004 and 2003, respectively, related to the
Pension Plan and the SERP Plan. The following table contains the components of
the pension expense.
For the Three Months Ended June 30,
-----------------------------------------------------------------------------
2004 2003 2004 2003 2004 Total 2003 Total
(in thousands) Pension Plan Pension Plan SERP Plan SERP Plan Both Plans Both Plans
- --------------------------------------------- ------------ ------------ --------- --------- ---------- ----------
Service cost - benefits earned during the
period $ 233 173 82 26 315 199
Interest cost on projected benefit obligation 149 131 35 22 184 153
Expected return on plan assets (179) (126) -- -- (179) (126)
Net amortization and deferral 85 74 28 11 113 85
------ ---- --- -- ---- ----
Net periodic pension cost $ 288 252 145 59 433 311
====== ==== === == ==== ====
The Company recorded pension expense totaling $798,000 and $624,000 for
the six months ended June 30, 2004 and 2003, respectively, related to the
Pension Plan and the SERP Plan.
For the Six Months Ended June 30,
-----------------------------------------------------------------------------
2004 2003 2004 2003 2004 Total 2003 Total
(in thousands) Pension Plan Pension Plan SERP Plan SERP Plan Both Plans Both Plans
- --------------------------------------------- ------------ ------------ --------- --------- ---------- ----------
Service cost - benefits earned during the
period $ 478 345 121 52 599 397
Interest cost on projected benefit obligation 321 263 64 44 385 307
Expected return on plan assets (379) (253) -- -- (379) (253)
Net amortization and deferral 153 150 40 23 193 173
------ ---- --- --- ---- ----
Net periodic pension cost $ 573 505 225 119 798 624
====== ==== === === ==== ====
The Company's contributions to the Pension Plan are based on computations
by independent actuarial consultants and are intended to provide the Company
with the maximum deduction for income tax purposes. The contributions are
invested to provide for benefits under the Pension Plan. Because of the
significant employer contribution made to the Pension Plan during 2003 and the
high return on assets experienced, no contributions are required by funding
regulations in 2004. However, the Company expects to make a discretionary
contribution of approximately $650,000 in the second half of 2004.
Page 12
The Company's funding policy with respect to the SERP Plan is to fund the
related benefits through investments in life insurance policies, which are not
considered plan assets for the purpose of determining the SERP Plan's funded
status. The cash surrender values of the life insurance policies are included in
the line item "other assets." The Company does not expect that any payment will
be due to participants of the SERP Plan in 2004.
Page 13
Item 2 - Management's Discussion and Analysis of Consolidated Results of
Operations and Financial Condition
CRITICAL ACCOUNTING POLICIES
The accounting principles followed by the Company and the methods of
applying these principles conform with accounting principles generally accepted
in the United States of America and with general practices followed by the
banking industry. Certain of these principles involve a significant amount of
judgment and/or use of estimates based on the Company's best assumptions at the
time of the estimation. The Company has identified two policies as being more
sensitive in terms of judgments and estimates, taking into account their overall
potential impact to the Company's consolidated financial statements - 1) the
allowance for loan losses, and 2) intangible assets.
Allowance for Loan Losses
Due to the estimation process and the potential materiality of the amounts
involved, the Company has identified the accounting for the allowance for loan
losses and the related provision for loan losses as an accounting policy
critical to the Company's consolidated financial statements. The provision for
loan losses charged to operations is an amount sufficient to bring the allowance
for loan losses to an estimated balance considered adequate to absorb losses
inherent in the portfolio.
Management's determination of the adequacy of the allowance is based
primarily on a mathematical model that estimates the appropriate allowance for
loan losses. This model has two components. The first component involves the
estimation of losses on loans defined as "impaired loans." A loan is considered
to be impaired when, based on current information and events, it is probable the
Company will be unable to collect all amounts due according to the contractual
terms of the loan agreement. The estimated valuation allowance is the
difference, if any, between the loan balance outstanding and the value of the
impaired loan as determined by either 1) an estimate of the cash flows that the
Company expects to receive from the borrower discounted at the loan's effective
rate, or 2) in the case of a collateral-dependent loan, the fair value of the
collateral.
The second component of the allowance model is to estimate losses for all
loans not considered to be impaired loans. First, loans that have been risk
graded by the Company as having more than "standard" risk but are not considered
to be impaired are assigned estimated loss percentages generally accepted in the
banking industry. Loans that are classified by the Company as having normal
credit risk are segregated by loan type, and estimated loss percentages are
assigned to each loan type, based on the historical losses, current economic
conditions, and operational conditions specific to each loan type.
The reserve estimated for impaired loans is then added to the reserve
estimated for all other loans. This becomes the Company's "allocated allowance."
In addition to the allocated allowance derived from the model, management also
evaluates other data such as the ratio of the allowance for loan losses to total
loans, net loan growth information, nonperforming asset levels and trends in
such data. Based on this additional analysis, the Company may determine that an
additional amount of allowance for loan losses is necessary to reserve for
probable losses. This additional amount, if any, is the Company's "unallocated
allowance." The sum of the allocated allowance and the unallocated allowance is
compared to the actual allowance for loan losses recorded on the books of the
Company and any adjustment necessary for the recorded allowance to equal the
computed allowance is recorded as a provision for loan losses. The provision for
loan losses is a direct charge to earnings in the period recorded.
Although management uses the best information available to make
evaluations, future adjustments may be necessary if economic, operational, or
other conditions change. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Company's
allowance for loan losses. Such agencies may require the Company to recognize
additions to the allowance based on the examiners' judgment about information
available to them at the time of their examinations.
For further discussion, see "Nonperforming Assets" and "Summary of Loan
Loss Experience" below.
Page 14
Intangible Assets
Due to the estimation process and the potential materiality of the amounts
involved, the Company has also identified the accounting for intangible assets
as an accounting policy critical to the Company's consolidated financial
statements.
When the Company completes an acquisition transaction, the excess of the
purchase price over the amount by which the fair market value of assets acquired
exceeds the fair market value of liabilities assumed represents an intangible
asset. The Company must then determine the identifiable portions of the
intangible asset, with any remaining amount classified as goodwill. Identifiable
intangible assets associated with these acquisitions are generally amortized
over the estimated life of the related asset, whereas goodwill is tested
annually for impairment, but not systematically amortized.
For the Company, the only identifiable intangible asset typically recorded
in connection with a whole-bank or bank branch acquisition is the value of the
core deposit intangible, whereas when the Company acquires an insurance agency,
the primary identifiable intangible asset is the value of the acquired customer
list. Determining the amount of identifiable intangible assets and their average
lives involves multiple assumptions and estimates and is typically determined by
performing a discounted cash flow analysis, which involves a combination of any
or all of the following assumptions: customer attrition/runoff, alternative
funding costs, deposit servicing costs, and discount rates. The Company
typically engages a third-party consultant to assist in each analysis. For the
whole-bank and bank branch transactions recorded to date, the core deposit
intangible in each case has been estimated to have a ten year life, with an
accelerated rate of amortization. For the 2003 insurance agency acquisition, the
identifiable intangible asset related to the customer list was determined to
have a ten year life, with amortization occurring on a straight-line basis.
Subsequent to the initial recording of the identifiable intangible assets
and goodwill, the Company amortizes the identifiable intangible assets over
their estimated average lives, as discussed above. In addition, on an at least
an annual basis, goodwill is evaluated for impairment by comparing the fair
value of the Company's reporting units to their related carrying value,
including goodwill (the Company's community banking operations is its only
material reporting unit). At its last evaluation, the fair value of the
Company's community banking operations exceeded its carrying value, including
goodwill. If the carrying value of a reporting unit were ever to exceed its fair
value, the Company would determine whether the implied fair value of the
goodwill, using a discounted cash flow analysis, exceeded the carrying value of
the goodwill. If the carrying value of the goodwill exceeded the implied fair
value of the goodwill, an impairment loss would be recorded in an amount equal
to that excess. Performing such a discounted cash flow analysis would involve
the significant use of estimates and assumptions.
The Company reviews identifiable intangible assets for impairment whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. The Company's policy is that an impairment loss is recognized,
equal to the difference between the asset's carrying amount and its fair value,
if the sum of the expected undiscounted future cash flows is less than the
carrying amount of the asset. Estimating future cash flows involves the use of
multiple estimates and assumptions, such as those listed above.
Current Accounting Matters
See Note 2 to the Consolidated Financial Statements above as it relates to
accounting standards that have been recently adopted by the Company. The
following accounting standards/proposals will be adopted or may impact the
Company subsequent to June 30, 2004.
In December 2003, the American Institute of Certified Public Accountants
issued Statement of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or
Debt Securities Acquired in a Transfer." SOP 03-3 provides guidance on the
accounting for differences between contractual and expected cash flows from the
purchaser's initial investment in loans or debt securities acquired in a
transfer, if those differences are attributable, at least in
Page 15
part, to credit quality. The scope of SOP 03-3 includes loans that have shown
evidence of deterioration of credit quality since origination, and includes
loans acquired individually, in pools or as part of a business combination.
Among other things, SOP 03-3: (1) prohibits the recognition of the excess of
contractual cash flows over expected cash flows as an adjustment of yield, loss
accrual or valuation allowance at the time of purchase; (2) requires that
subsequent increases in expected cash flows be recognized prospectively through
an adjustment of yield; and (3) requires that subsequent decreases in expected
cash flows be recognized as impairment. In addition, SOP 03-3 prohibits the
creation or carrying over of a valuation allowance in the initial accounting of
all loans within the scope that are acquired in a transfer. Under SOP 03-3, the
difference between expected cash flows and the purchase price is accreted as an
adjustment to yield over the life of the loans. For loans acquired in a business
combination that have shown deterioration of credit quality since origination,
SOP 03-3 represents a significant change from the current purchase accounting
practice whereby the acquiree's allowance for loan losses is typically added to
the acquirer's allowance for loan losses. SOP 03-3 becomes effective for loans
or debt securities acquired in fiscal years beginning after December 15, 2004.
The Company does not expect the adoption of this statement to have a material
impact on the Company's financial statements.
In May 2004, the Federal Reserve Board (FRB) issued a proposal concerning
the regulatory capital treatment of Trust Preferred Securities (TPS) by Bank
Holding Companies (BHCs). The proposed rule would retain TPS in the Tier 1
capital of BHCs, but with stricter quantitative limits and clearer qualitative
standards. The proposal would continue to count TPS as Tier 1 capital by BHCs up
to 25% of core capital elements. After a 3-year transition period and beginning
March 31, 2007, institutions would still be able include 25% of TPS in Tier 1
capital elements, but goodwill would be deducted from the Tier I capital
elements. If adopted as a final rule, the Company does not expect that it would
materially impact the Company's capital ratios.
RESULTS OF OPERATIONS
Overview
Net income for the three months ended June 30, 2004 was $4,886,000, or
$0.51 per diluted share, a 2.0% increase in diluted earnings per share over the
net income of $4,811,000, or $0.50 per diluted share, recorded in the second
quarter of 2003. Net income for the six months ended June 30, 2004 amounted to
$9,606,000, or $1.00 per diluted share, a 1.0% increase in diluted earnings per
share over the net income of $9,504,000, or $0.99 per diluted share, reported
for the six months ended June 30, 2003.
The increase in the Company's earnings in 2004 compared to 2003 was
primarily due to the Company's overall growth, which resulted in increases in
net interest income and noninterest income, the positive benefits of which were
partially offset by higher provisions for loan losses and higher operating
expenses.
An increase in loans and deposits over the past twelve months resulted in
an increase in the Company's net interest income when comparing the three and
six month periods in 2004 to the comparable periods in 2003. Net interest income
for the second quarter of 2004 amounted to $14.9 million, an 8.7% increase over
the $13.7 million recorded in the second quarter of 2003. Net interest income
for the six months ended June 30, 2004 amounted to $29.6 million, a 9.7%
increase over the $27.0 million recorded in the same six month period in 2003.
The positive impact on net interest income from the increases in loans and
deposits more than offset lower net interest margins realized in 2004 compared
to 2003. The Company's net interest margin (tax-equivalent net interest income
divided by average earning assets) for the second quarter of 2004 was 4.26%
compared to 4.53% for the second quarter of 2003. The Company's net interest
margin for the six months ended June 30, 2004 was 4.31% versus 4.56% for the
comparable period in 2003. The Company's net interest margin has been negatively
impacted by the thirteen interest rate cuts initiated by the Federal Reserve
from 2001 to 2003 and the Company's shift towards originating more adjustable
rate loans compared to fixed rate loans to protect the Company from anticipated
increases in interest rates. The Federal Reserve increased interest rates by 25
basis points on June 30,
Page 16
2004, which the Company expects to have a slightly positive impact on net
interest margin beginning in the third quarter of 2004.
Partially offsetting the increases in net interest income realized in the
three and six months ended June 30, 2004 compared to 2003 were higher amounts of
provisions for loan losses recorded by the Company. The provision for loan
losses in the second quarter of 2004 was $740,000 compared to $540,000 in the
second quarter of 2003, and the provision for loan losses for the first six
months of 2004 was $1,310,000 compared to $1,060,000 recorded in the same period
of 2003. The higher provisions for loan losses were a result of 1) higher credit
risk associated with higher loan growth, and 2) minor shifts of loans among the
internally classified risk categories within the Company's allowance for loan
loss model. Net internal loan growth for the second quarter of 2004 was $45
million compared to $37 million for the second quarter of 2003. Net internal
loan growth for the first six months of 2004 was $78 million compared to $62
million for the same six months of 2003.
Except for fees from presold mortgages, most components of noninterest
income and noninterest expense increased in 2004 as a result of the Company's
overall growth. Fees from presold mortgages have decreased in 2004 as a result
of a decline in mortgage refinancing activity caused by higher mortgage interest
rates. The Company realized securities gains of $96,000 and $188,000 for the
three and six months ended June 30, 2004, respectively, whereas no securities
gains were realized during the first half of 2003.
The Company's asset quality ratios have remained sound in 2004. For the
three and six months ended June 30, 2004, net charge-offs as a percentage of
average loans amounted to 11 basis points (annualized) and 9 basis points,
respectively, compared to 7 basis points (annualized) and 9 basis points for
each of the comparable periods in 2003. The Company's nonperforming assets to
total assets ratio of 0.33% at June 30, 2004 is slightly more favorable than the
same ratio of 0.37% a year earlier and is more favorable than a March 31, 2004
North Carolina state bank average of 0.52%.
The Company's annualized return on average assets for the second quarter
of 2004 was 1.29% compared to 1.47% for the second quarter of 2003. The
Company's annualized return on average assets for the six months ended June 30,
2004 was 1.28% compared to 1.48% for the first half of 2003.
The Company's annualized return on average equity for the second quarter
of 2004 was 13.48% compared to 14.15% for the second quarter of 2003. The
Company's annualized return on average equity for the six months ended June 30,
2004 was 13.29% compared to 14.20% for the first half of 2003.
Components of Earnings
Net interest income is the largest component of earnings, representing the
difference between interest and fees generated from earning assets and the
interest costs of deposits and other funds needed to support those assets. Net
interest income for the three month period ended June 30, 2004 amounted to
$14,859,000, an increase of $1,185,000, or 8.7% from the $13,674,000 recorded in
the second quarter of 2003. Net interest income for the six months ended June
30, 2004 amounted to $29,632,000, an increase of $2,616,000, or 9.7% from the
$27,016,000 recorded in the first six months of 2003.
There are two primary factors that cause changes in the amount of net
interest income recorded by the Company - 1) growth in loans and deposits, and
2) the Company's net interest margin (tax-equivalent net interest income divided
by average interest-earning assets). For the three and six month periods ended
June 30, 2004, growth in loans and deposits increased net interest income, the
positive effects of which were partially offset by a decrease in the Company's
net interest margin.
Page 17
For internal purposes and in the discussion that follows, the Company
evaluates its net interest income on a tax-equivalent basis by adding the tax
benefit realized from tax-exempt securities to reported interest income. The
following tables present net interest income analysis on a taxable-equivalent
basis.
For the Three Months Ended June 30,
-------------------------------------------------------------------
2004 2003
-------------------------------- --------------------------------
Interest Interest
Average Average Earned Average Average Earned
($ in thousands) Volume Rate or Paid Volume Rate or Paid
----------- ------- -------- ----------- ------- --------
Assets
Loans (1) $ 1,273,672 5.74% $ 18,192 $ 1,087,932 6.36% $ 17,249
Taxable securities 100,776 4.51% 1,129 74,961 4.87% 911
Non-taxable securities (2) 12,597 8.27% 259 15,085 8.19% 308
Short-term investments 27,050 1.55% 104 44,470 2.00% 222
----------- -------- ----------- --------
Total interest-earning assets 1,414,095 5.60% 19,684 1,222,448 6.13% 18,690
-------- --------
Liabilities
Savings, NOW and money market deposits $ 472,520 0.50% $ 583 $ 403,078 0.58% $ 584
Time deposits >$100,000 260,976 2.24% 1,456 234,219 2.68% 1,565
Other time deposits 406,872 1.98% 2,006 377,595 2.46% 2,318
----------- -------- ----------- --------
Total interest-bearing deposits 1,140,368 1.43% 4,045 1,014,892 1.77% 4,467
Borrowings 70,946 3.75% 661 32,874 5.08% 416
----------- -------- ----------- --------
Total interest-bearing liabilities 1,211,314 1.56% 4,706 1,047,766 1.87% 4,883
-------- --------
Non-interest-bearing deposits 159,895 125,418
Net yield on interest-earning
assets and net interest income 4.26% $ 14,978 4.53% $ 13,807
======== ========
Interest rate spread 4.04% 4.26%
Average prime rate 4.00% 4.23%
(1) Average loans include nonaccruing loans, the effect of which is to lower
the average rate shown.
(2) Includes tax-equivalent adjustments of $119,000 and $133,000 in 2004 and
2003, respectively, to reflect the tax benefit that the Company receives
related to its tax-exempt securities, which carry interest rates lower
than similar taxable investments due to their tax exempt status. This
amount has been computed assuming a 35% tax rate and is reduced by the
related nondeductible portion of interest expense.
Page 18
For the Six Months Ended June 30,
-------------------------------------------------------------------
2004 2003
-------------------------------- --------------------------------
Interest Interest
Average Average Earned Average Average Earned
($ in thousands) Volume Rate or Paid Volume Rate or Paid
----------- ------- -------- ----------- ------- --------
Assets
Loans (1) $ 1,254,874 5.80% $ 36,195 $ 1,068,857 6.46% $ 34,258
Taxable securities 100,438 4.57% 2,284 74,434 5.01% 1,851
Non-taxable securities (2) 12,756 8.23% 522 15,412 8.61% 658
Short-term investments 25,034 1.53% 190 48,740 2.18% 528
----------- -------- ----------- --------
Total interest-earning assets 1,393,102 5.66% 39,191 1,207,443 6.23% 37,295
-------- --------
Liabilities
Savings, NOW and money market deposits $ 467,820 0.49% $ 1,146 $ 399,625 0.61% $ 1,202
Time deposits >$100,000 253,548 2.24% 2,821 226,198 2.79% 3,125
Other time deposits 404,456 2.00% 4,031 376,310 2.56% 4,785
----------- -------- ----------- --------
Total interest-bearing deposits 1,125,824 1.43% 7,998 1,002,133 1.83% 9,112
Borrowings 71,275 3.72% 1,319 32,692 5.51% 893
----------- -------- ----------- --------
Total interest-bearing liabilities 1,197,099 1.57% 9,317 1,034,825 1.95% 10,005
-------- --------
Non-interest-bearing deposits 154,354 120,688
Net yield on interest-earning
assets and net interest income 4.31% $ 29,874 4.56% $ 27,290
======== ========
Interest rate spread 4.09% 4.28%
Average prime rate 4.00% 4.25%
(1) Average loans include nonaccruing loans, the effect of which is to lower
the average rate shown.
(2) Includes tax-equivalent adjustments of $242,000 and $274,000 in 2004 and
2003, respectively, to reflect the tax benefit that the Company receives
related to its tax-exempt securities, which carry interest rates lower
than similar taxable investments due to their tax exempt status. This
amount has been computed assuming a 35% tax rate and is reduced by the
related nondeductible portion of interest expense.
Average loans outstanding for the second quarter of 2004 were $1.274
billion, which was 17.1% higher than the average loans outstanding for the
second quarter of 2003 ($1.088 billion). Average loans outstanding for the six
months ended June 30, 2004 were $1.255 billion, which was 17.4% higher than the
average loans outstanding for the six months ended June 30, 2003 ($1.069
billion).
Average deposits outstanding for the second quarter of 2004 were $1.300
billion, which was 14.0% higher than the average deposits outstanding for the
second quarter of 2003 ($1.140 billion). Average deposits outstanding for the
six months ended June 30, 2004 were $1.280 billion, which was 14.0% higher than
the average deposits outstanding for the six months ended June 30, 2003 ($1.123
billion). Generally, the Company can reinvest funds from deposits at higher
yields than the interest rate being paid on those deposits, and therefore
increases in deposits typically result in higher amounts of net interest income
for the Company.
See additional discussion regarding the nature of the growth in loans and
deposits in the section entitled "Financial Condition" below. The effect of the
higher amounts of average loans and deposits was to increase net interest income
in 2004.
In the tables above, there was a decrease in the yields on interest
earning assets and liabilities for the periods in 2004 compared to 2003, which
were caused by the declining interest rate environment in effect during the past
several years. The decrease in the weighted average cost of the Company's
borrowings was also affected by the Company having a higher percentage of
low-cost overnight borrowings outstanding during 2004 compared to 2003, which
had the effect of decreasing the weighted average rate of all borrowings. The
Company had virtually no low-cost overnight borrowing outstanding during the
three and six month periods ended June 30, 2003, whereas for both the three and
six month periods ended June 30, 2004, the Company had an average of
approximately $20
Page 19
million in low-cost overnight borrowing outstanding. As discussed more below,
over the past several years the yields on the Company's interest-earning assets
have generally decreased by more than the rates paid on the Company's
interest-bearing liabilities, which has resulted in a decrease in the Company's
net interest margin.
The Company's net interest margin has been negatively impacted by the
interest rate environment and a shift towards originating more adjustable rate
loans compared to fixed rate loans to protect the Company from an expected rise
in interest rates. The mostly declining interest rate environment in effect from
2001 until June 30, 2004, and the level to which it dropped, resulted in the
Company being unable to reset deposit rates by an amount (because of their
already near-zero rates) that would offset the negative impact of the lower
yields earned on the Company's interest earning assets. The shift in the
Company's loan mix from fixed rate loans to adjustable rate loans has occurred
primarily over the past 2.5 years. At December 31, 2001, the Company's loan
portfolio was comprised of 57% fixed rate loans and 43% adjustable rate loans.
Since that time, the ratio has gradually shifted towards adjustable rate loans
as the Company has originated more adjustable rate loans than fixed rate loans.
At June 30, 2004, the Company's loan portfolio was comprised of 59% adjustable
rate loans and 41% fixed rate loans. The primary reason for this shift has been
that with interest rates at a historically low level, the Company has more
attractively priced adjustable rate loans in order to avoid locking in fixed
rate loans at a time when most economists believe that rates will rise. Although
the Company believes that this strategy is prudent given the historically low
interest rate environment, it has had a negative effect on the Company's
recently realized net interest margins because in this rate environment
adjustable rate loans generally carry lower initial rates than fixed rate loans
of similar maturities. Additionally, the generally declining rate environment
experienced since 2001 has resulted in the Company's adjustable rate loans
repricing to lower levels following each rate cut. The Federal Reserve increased
interest rates by 25 basis points on June 30, 2004, which the Company expects to
have a slightly positive impact on net interest margin beginning in the third
quarter of 2004. See additional information regarding net interest income in the
section entitled "Interest Rate Risk."
Partially offsetting the increases in net interest income realized in the
three and six months ended June 30, 2004 compared to 2003 were higher amounts of
provisions for loan losses recorded by the Company. The provision for loan
losses in the second quarter of 2004 was $740,000 compared to $540,000 in the
second quarter of 2003, and the provision for loan losses for the first six
months of 2004 was $1,310,000 compared to $1,060,000 recorded in the same period
of 2003. The higher provisions for loan losses were a result of 1) higher credit
risk associated with higher loan growth, and 2) minor shifts of loans among the
internally classified risk categories within the Company's allowance for loan
loss model. Net internal loan growth for the second quarter of 2004 was $45
million compared to $37 million for the second quarter of 2003. Net internal
loan growth for the first six months of 2004 was $78 million compared to $62
million for the same six months of 2003.
Noninterest income for the second quarter of 2004 amounted to $3,912,000,
an 8.6% increase over the $3,602,000 recorded in the second quarter of 2003.
Noninterest income for the first half of 2004 amounted to $7,724,000, a 5.3%
increase over the $7,335,000 recorded in the comparable period of 2003. Except
for fees from presold mortgages and other gains/losses, each component of
noninterest income increased, primarily as a result of the Company's growth -
internal growth, as well as external growth from the acquisition of four
branches from RBC Centura Bank in October 2003 that had $25 million in loans and
$102 million in deposits. Fees from presold mortgages have decreased
significantly in 2004 primarily because of a decrease in mortgage refinancing
activity as a result of rising mortgage interest rates. Fees from presold
mortgages amounted to $290,000 in the second quarter of 2004, a decrease of
$361,000 from the $651,000 recorded in the second quarter of 2003. Fees from
presold mortgages amounted to $478,000 for the six months ended June 30, 2004, a
decrease of $875,000 from the $1,353,000 realized in the first six months of
2003.
Also contributing to the increases in noninterest income in 2004 were
higher amounts of commissions from sales of insurance and financial products.
This line item includes commissions the Company receives from three sources - 1)
sales of credit insurance associated with new loans, 2) commissions from the
sales of investment, annuity, and long-term care insurance products, and 3)
commissions from the sale of property and casualty insurance. The following
table presents these components for the three and six month periods ended June
30, 2004 compared to the same periods in 2003:
Page 20
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ ------------------------------
($ in thousands) $ % $ %
2004 2003 Change Change 2004 2003 Change Change
----- ---- ------ ------ ----- ---- ------ ------
Commissions earned from:
Sales of credit insurance $ 89 70 19 27.1% $ 148 148 -- 0.0%
Sales of investments, annuities,
and long term care insurance 103 100 3 3.0% 157 122 35 28.7%
Sales of property and casualty
insurance 173 165 8 4.8% 391 325 66 20.3%
----- --- -- ---- ----- --- --- ----
Total $ 365 335 30 9.0% $ 696 595 101 17.0%
===== === == ==== ===== === === ====
Also within noninterest income in 2004, the Company realized security
gains of $96,000 and $188,000 for the three and six months ended June 30, 2004,
respectively, whereas there were no securities gains in the comparable periods
of 2003. The 2004 securities sales were transacted primarily in order to realize
current income.
The Company recorded "Other Losses" of $82,000 for the three and six
months ended June 30, 2004 primarily related to the write-down of a low-income
tax credit investment that funds affordable housing for those in need and also
provides federal tax benefits for the Company. However, the impact on net income
of this investment was insignificant because the Company also recorded a tax
credit of $98,000 during the second quarter of 2004, which reduced income tax
expense. In the second quarter of 2003, a similar write-down of the same
investment of $43,000 was largely offset by miscellaneous other gains. The
amount of the tax credit recorded in the second quarter of 2003 was $20,000.
There were no further adjustments related to this investment in the second half
of 2003 and no further adjustments are expected in the second half of 2004.
Noninterest expenses for the three and six months ended June 30, 2004
amounted to $10,622,000 and $21,354,000, respectively, increases of 13.6% and
14.8% from the amounts recorded in the same three and six month periods in 2003.
The increase in noninterest expenses occurred in all categories and is
associated with the overall growth of the Company in terms of branch network,
employees and customer base. The Company has opened three de novo branches and
acquired four branches since June 30, 2003. The acquisition of the four RBC
Centura branches in October 2003 has resulted in incremental noninterest
expense, including an increase in intangibles amortization, of approximately
$450,000 per quarter.
The provision for income taxes was $2,523,000 in the second quarter of
2004 compared to $2,573,000 in the second quarter of 2003, a decline of 1.9%.
The provision for income taxes for the six months ended June 30, 2004 amounted
to $5,086,000 compared to $5,187,000 for the first half of 2003. Although the
effective tax rates did not vary significantly among the periods presented,
amounting to 34%-35% in each period, the effective tax rate for each of the
periods in 2004 was approximately 0.7% lower than the comparable periods in 2003
due largely to the higher tax credit realized in 2004 compared to 2003 related
to the low income tax credit investment discussed above. In the normal course of
business, the Company carries out various tax planning initiatives in order to
manage its effective tax rate.
The Consolidated Statements of Comprehensive Income reflect "Other
Comprehensive Loss" of $1,960,000 and $1,526,000 for the three and six months
ended June 30, 2004, respectively, compared to "Other Comprehensive Income" of
$512,000 and $305,000 for the comparable periods of 2003. The significant
decreases in other comprehensive income/loss in 2004 are primarily attributable
to a decrease in the value of the Company's available-for-sale securities
portfolio as a result of rising fixed income security yields in the marketplace.
The Company's available-for-sale securities portfolio is predominantly comprised
of fixed income securities that decline in value when market yields for fixed
income securities increase. During the second quarter of 2004, the market yields
on fixed income securities increased significantly. Because the Company expects
to receive full repayment, at maturity, of all of its securities with unrealized
losses, all of the unrealized losses are considered to be "temporary" unrealized
losses.
Page 21
Note 4 to the consolidated financial statements contains pro forma net
income and earnings per share information as if the Company applied the fair
value recognition provisions of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" (Statement 123). The note
reflects that if the Company had applied Statement 123, net income would have
been reduced by $1,134,000 and $159,000 for the three month periods ended June
30, 2004 and 2003, respectively, and that net income for the six month periods
ended June 30, 2004 and 2003 would have been reduced by $1,186,000 and $210,000,
respectively. The higher amount of pro forma option expense in 2004 is primarily
due to the Company granting 95,006 employee options in April 2004 with immediate
vesting (under Statement 123, expense related to the fair market value of
options is recognized when the options vest). Prior to that grant, all previous
employee option grants had five year vesting periods (20% vesting each year),
and thus the amount of expense related to options was generally spread over the
five year vesting period. The Company expects that future employee stock option
grants will revert to having five year vesting periods.
FINANCIAL CONDITION
Total assets at June 30, 2004 amounted to $1.56 billion, 17.5% higher than
a year earlier. Total loans at June 30, 2004 amounted to $1.30 billion, a 17.1%
increase from a year earlier, and total deposits amounted to $1.30 billion at
June 30, 2004, a 12.9% increase from a year earlier. The Company's acquisition
of four RBC Centura Bank branches on October 27, 2003 contributed to the
year-over-year increases. As of the acquisition date, the four RBC Centura Bank
branches had $25 million in loans and $102 million in deposits.
The following tables present information regarding the nature of the
Company's growth since June 30, 2003.
Balance at Balance at Total Percentage growth,
July 1, 2003 to beginning of Internal Growth from end of percentage excluding
June 30, 2004 period Growth Acquisitions period growth acquisitions
- ------------------------------ ------------ -------- ------------ ---------- ---------- ------------------
($ in thousands)
Loans $ 1,107,997 164,416 24,811 1,297,224 17.1% 14.8%
=========== ======= ======= ========= ==== ====
Deposits - Noninterest bearing $ 135,288 (6,524) 29,056 157,820 16.7% -4.8%
Deposits - Savings, NOW, and
Money Market 404,479 26,565 35,667 466,711 15.4% 6.6%
Deposits - Time>$100,000 236,580 28,054 4,650 269,284 13.8% 11.9%
Deposits - Time<$100,000 375,622 (1,226) 32,593 406,989 8.4% -0.3%
----------- ------- ------- --------- ---- ----
Total deposits $ 1,151,969 46,869 101,966 1,300,804 12.9% 4.1%
=========== ======= ======= ========= ==== ====
January 1, 2004 to
June 30, 2004
- ------------------------------
Loans $ 1,218,895 78,329 -- 1,297,224 6.4% 6.4%
=========== ======= ======= ========= ==== ====
Deposits - Noninterest bearing $ 146,499 11,321 -- 157,820 7.7% 7.7%
Deposits - Savings, NOW, and
Money Market 462,876 3,835 -- 466,711 0.8% 0.8%
Deposits - Time>$100,000 238,535 30,749 -- 269,284 12.9% 12.9%
Deposits - Time<$100,000 401,454 5,535 -- 406,989 1.4% 1.4%
----------- ------- ------- --------- ---- ----
Total deposits $ 1,249,364 51,440 -- 1,300,804 4.1% 4.1%
=========== ======= ======= ========= ==== ====
As can be seen in the first table, over the past twelve months the
Company's internal growth rates for loans and deposits were 14.8% and 4.1%
respectively, with the growth assumed in acquisitions increasing the overall
growth
Page 22
in loans to 17.1% and deposits to 12.9%. All of the growth in 2004 has
been internally generated, as the Company has not completed any acquisitions in
2004. The Company opened two de novo branches in the fourth quarter of 2003 and
one de novo branch in January 2004, which contributed to the internal growth. In
2004, the Company has attractively priced time deposits >$100,000 in order to
fund loan growth, which has resulted in its high growth rate.
Nonperforming Assets
Nonperforming assets are defined as nonaccrual loans, loans past due 90 or
more days and still accruing interest, restructured loans and other real estate.
Nonperforming assets are summarized as follows:
June 30, December 31, June 30,
($ in thousands) 2004 2003 2003
---------------------------------------- -------- ------------ --------
Nonperforming loans:
Nonaccrual loans $ 3,320 4,274 3,741
Restructured loans 18 21 22
Accruing loans > 90 days past due -- -- --
------- ----- -----
Total nonperforming loans 3,338 4,295 3,763
Other real estate 1,857 1,398 1,174
------- ----- -----
Total nonperforming assets $ 5,195 5,693 4,937
======= ===== =====
Nonperforming loans to total loans 0.26% 0.35% 0.34%
Nonperforming assets as a percentage of
loans and other real estate 0.40% 0.47% 0.45%
Nonperforming assets to total assets 0.33% 0.39% 0.37%
Allowance for loan losses to total loans 1.10% 1.11% 1.10%
Management has reviewed the collateral for the nonperforming assets,
including nonaccrual loans, and has included this review among the factors
considered in the evaluation of the allowance for loan losses discussed below.
Nonperforming loans (which includes nonaccrual loans and restructured
loans) as of June 30, 2004, December 31, 2003, and June 30, 2003 totaled
$3,338,000, $4,295,000, and $3,763,000, respectively. Nonperforming loans as a
percentage of total loans amounted to 0.26%, 0.35%, and 0.34%, at June 30, 2004,
December 31, 2003, and June 30, 2003, respectively. The variances in
nonperforming loans among the periods have been primarily due to changes in
nonaccrual loans, as restructured loans have not changed significantly. The
increase in nonaccrual loans from June 30, 2003 to December 31, 2003 related
primarily to the Company placing five loans totaling $1.3 million on nonaccrual
basis during the second half of the year. Each of these unrelated loans had an
outstanding loan balance of between $225,000 and $325,000, and each loan was
secured by real estate. Three of the five loans were liquidated during the first
half of 2004 with no material loss to the Company, while two of the loans were
foreclosed upon and the real estate collateral recorded as other real estate.
The removal of these five loans from nonaccrual loan status resulted in the
decrease in nonaccrual loans from December 31, 2003 to June 30, 2004.
The Company continues to have one large credit that was on nonaccrual
basis as of each of the three dates presented. The nonaccrual balance of this
credit amounted to $640,000, $663,000, and $750,000 as of June 30, 2004,
December 31, 2003, and June 30, 2003, respectively. This relationship, secured
primarily by real estate, was placed on nonaccrual status in 2001 due to
liquidity problems experienced by the borrower and had a $1.9 million balance at
that time. The borrower has been actively working to sell real estate to pay
down the balance. In 2002, the Company accepted a nonbinding proposal from a
third party that would have resulted in the receipt of approximately $750,000
of the remaining $1.0 million balance outstanding at the time. Accordingly, in
the fourth quarter of 2002, the Company established a specific impaired loan
valuation allowance of $250,000 for this relationship. During the first quarter
of 2003, because the Company believed that there was a high likelihood that the
terms of the nonbinding proposal would occur, the Company charged-off the
$250,000 specific reserve that had
Page 23
been established. However in the ensuing months, numerous delays occurred
relating to the pay-off proposal, and management of the Company now believes
that the proposal will not occur. The Company continues to actively seek
collection of the loan and has received payments from collateral sales that have
reduced the loan balance to its current amount. The Company has assigned a
specific impaired loan valuation allowance of $330,000 to the remaining balance
at June 30, 2004.
At June 30, 2004, December 31, 2003, and June 30, 2003, the recorded
investment in loans considered to be impaired was $1,215,000, $1,449,000, and
$1,718,000, respectively, all of which were on nonaccrual status. A significant
portion of the impaired loans for each of the three periods presented is the
same credit noted above that is on nonaccrual status. At June 30, 2004, December
31, 2003, and June 30, 2003, the related allowance for loan losses for all
impaired loans was $480,000 (all three impaired loans at June 30, 2004 had an
assigned valuation allowance), $341,000 (related to five of the seven impaired
loans with a total balance of $1,207,000), and $289,000 (seven of the nine
impaired loans totaling $962,000 at June 30, 2003 had an assigned valuation
allowance), respectively. The average recorded investments in impaired loans
during the six month period ended June 30, 2004, the year ended December 31,
2003, and the six months ended June 30, 2003 were approximately $1,313,000,
$1,590,000, and $1,643,000, respectively. For the same periods, the Company
recognized no interest income on those impaired loans during the period that
they were considered to be impaired.
The Company's other real estate owned amounted to $1,857,000, $1,398,000,
and $1,174,000 at June 30, 2004, December 31, 2003 and June 30, 2003,
respectively. The increase in other real estate from December 31, 2003 to June
30, 2004 is primarily attributable to the foreclosure of two loans that were on
nonaccrual basis at December 31, 2003 with real estate collateral totaling
$552,000. The Company's management has reviewed recent appraisals of its owned
real estate and believes that their fair values, less estimated costs to sell,
equal or exceed their respective carrying values at the dates presented.
Summary of Loan Loss Experience
The allowance for loan losses is created by direct charges to operations.
Losses on loans are charged against the allowance in the period in which such
loans, in management's opinion, become uncollectible. The recoveries realized
during the period are credited to this allowance.
The Company has no foreign loans, few agricultural loans and does not
engage in significant lease financing or highly leveraged transactions.
Commercial loans are diversified among a variety of industries. The majority of
the Company's real estate loans are primarily various personal and commercial
loans where real estate provides additional security for the loan. Collateral
for virtually all of these loans is located within the Company's principal
market area.
The provision for loan losses in the second quarter of 2004 was $740,000
compared to $540,000 in the second quarter of 2003, and the provision for loan
losses for the first six months of 2004 was $1,310,000 compared to $1,060,000
recorded in the same period of 2003. The higher provisions for loan losses were
a result of 1) higher credit risk associated with higher loan growth, and 2)
minor shifts of loans among the internally classified risk categories within the
Company's allowance for loan loss model. Net internal loan growth for the second
quarter of 2004 was $45 million compared to $37 million for the second quarter
of 2003. Net internal loan growth for the first six months of 2004 was $78
million compared to $62 million for the same six months of 2003.
At June 30, 2004, the allowance for loan losses amounted to $14,313,000,
compared to $13,569,000 at December 31, 2003 and $12,243,000 at June 30, 2003.
The allowance for loan losses was between 1.10% and 1.11% of total loans as of
each of those same dates.
Management believes the Company's reserve levels are adequate to cover
probable loan losses on the loans outstanding as of each reporting date. It must
be emphasized, however, that the determination of the reserve using the
Company's procedures and methods rests upon various judgments and assumptions
about economic conditions and other factors affecting loans. No assurance can be
given that the Company will not in any particular period
Page 24
sustain loan losses that are sizable in relation to the amounts reserved or that
subsequent evaluations of the loan portfolio, in light of conditions and factors
then prevailing, will not require significant changes in the allowance for loan
losses or future charges to earnings.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan losses
and value of other real estate. Such agencies may require the Company to
recognize adjustments to the allowance or the carrying value of other real
estate based on their judgments about information available at the time of their
examinations.
For the periods indicated, the following table summarizes the Company's
balances of loans outstanding, average loans outstanding, changes in the
allowance for loan losses arising from charge-offs and recoveries, and additions
to the allowance for loan losses that have been charged to expense and additions
that were recorded related to acquisitions.
Six Months Twelve Months Six Months
Ended Ended Ended
June 30, December 31, June 30,
($ in thousands) 2004 2003 2003
----------- ------------- -----------
Loans outstanding at end of period $ 1,297,224 1,218,895 $ 1,107,997
=========== ========= ===========
Average amount of loans outstanding $ 1,254,874 1,113,426 $ 1,068,857
=========== ========= ===========
Allowance for loan losses,
at beginning of period $ 13,569 10,907 $ 10,907
Total charge-offs (650) (1,341) (630)
Total recoveries 84 240 155
----------- --------- -----------
Net charge-offs (566) (1,101) (475)
----------- --------- -----------
Additions to the allowance charged to expense 1,310 2,680 1,060
----------- --------- -----------
Addition related to loans assumed in corporate
acquisitions -- 1,083 751
----------- --------- -----------
Allowance for loan losses, at end of period $ 14,313 13,569 $ 12,243
=========== ========= ===========
Ratios:
Net charge-offs (annualized) as a percent of average loans 0.09% 0.10% 0.09%
Allowance for loan losses as a percent of
loans at end of period 1.10% 1.11% 1.10%
Based on the results of the Company's loan analysis and grading program
and management's evaluation of the allowance for loan losses at June 30, 2004,
there have been no material changes to the allocation of the allowance for loan
losses among the various categories of loans since December 31, 2003.
Liquidity, Commitments, and Contingencies
The Company's liquidity is determined by its ability to convert assets to
cash or acquire alternative sources of funds to meet the needs of its customers
who are withdrawing or borrowing funds, and to maintain required reserve levels,
pay expenses and operate the Company on an ongoing basis. The Company's primary
liquidity sources are net income from operations, cash and due from banks,
federal funds sold and other short-term investments. The Company's securities
portfolio is comprised almost entirely of readily marketable securities, which
could also be sold to provide cash.
In addition to internally generated liquidity sources, the Company has the
ability to obtain borrowings from the following three sources - 1) an
approximately $270 million line of credit with the Federal Home Loan Bank (of
which $66 million was outstanding at June 30, 2004), 2) a $50 million overnight
federal funds line of credit with a
Page 25
correspondent bank (none of which was outstanding at June 30, 2004), and 3) an
approximately $57 million line of credit through the Federal Reserve Bank of
Richmond's discount window (none of which was outstanding at June 30, 2004).
The Company's liquidity declined slightly from December 31, 2003 to June
30, 2004, as a result of loan growth ($78 million) that exceeded deposit growth
($52 million). The Company's loan to deposit ratio increased to 99.7% at June
30, 2004 compared to 97.6% at December 31, 2003. As a result of the higher loan
growth compared to deposit growth, the Company increased its borrowings from the
$76 million outstanding at December 31, 2003 to $106 million at June 30, 2004 in
order to maintain the Company's internally targeted liquidity levels.
The amount and timing of the Company's contractual obligations and
commercial commitments has not changed materially since December 31, 2003,
detail of which is presented in Table 18 on page 52 of the Company's 2003 Form
10-K.
The Company is not involved in any legal proceedings that, in management's
opinion, could have a material effect on the consolidated financial position of
the Company.
The Company's management believes its liquidity sources, including unused
lines of credit, are at an acceptable level and remain adequate to meet its
operating needs in the foreseeable future. The Company will continue to monitor
its liquidity position carefully and will explore and implement strategies to
increase liquidity if deemed appropriate.
Off-Balance Sheet Arrangements and Derivative Financial Instruments
Off-balance sheet arrangements include transactions, agreements, or other
contractual arrangements in which the Company has obligations or provides
guarantees on behalf of an unconsolidated entity. The Company has no off-balance
sheet arrangements of this kind other than repayment guarantees associated with
its previously discussed trust preferred securities - see Note 2 to the
consolidated financial statements for additional discussion.
Derivative financial instruments include futures, forwards, interest rate
swaps, options contracts, and other financial instruments with similar
characteristics. The Company has not engaged in derivative activities through
June 30, 2004, and has no current plans to do so.
Capital Resources
The Company is regulated by the Board of Governors of the Federal Reserve
Board (FED) and is subject to securities registration and public reporting
regulations of the Securities and Exchange Commission. The Company's banking
subsidiary is regulated by the Federal Deposit Insurance Corporation (FDIC) and
the North Carolina Office of the Commissioner of Banks. The Company is not aware
of any recommendations of regulatory authorities or otherwise which, if they
were to be implemented, would have a material effect on its liquidity, capital
resources, or operations.
The Company must comply with regulatory capital requirements established
by the FED and FDIC. Failure to meet minimum capital requirements can initiate
certain mandatory, and possibly additional discretionary, actions by regulators
that, if undertaken, could have a direct material effect on the Company's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company must meet specific capital
guidelines that involve quantitative measures of the Company's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Company's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. These capital standards require the Company to
maintain minimum ratios of "Tier 1" capital to total risk-weighted assets and
total capital to risk-weighted assets of 4.00% and 8.00%, respectively. Tier 1
capital is comprised of total shareholders' equity calculated in accordance with
generally accepted accounting principles, excluding accumulated other
comprehensive income (loss), less intangible assets, and total capital is
comprised of Tier 1 capital plus certain adjustments, the largest of which for
the Company is the allowance for loan losses. Risk-
Page 26
weighted assets refer to the on- and off-balance sheet exposures of the Company,
adjusted for their related risk levels using formulas set forth in FED and FDIC
regulations.
In addition to the risk-based capital requirements described above, the
Company is subject to a leverage capital requirement, which calls for a minimum
ratio of Tier 1 capital (as defined above) to quarterly average total assets of
3.00% to 5.00%, depending upon the institution's composite ratings as determined
by its regulators. The FED has not advised the Company of any requirement
specifically applicable to it.
At June 30, 2004, the Company's capital ratios exceeded the regulatory
minimum ratios discussed above. The following table presents the Company's
capital ratios and the regulatory minimums discussed above for the periods
indicated.
June 30, December 31, June 30,
2004 2003 2003
-------- ------------ --------
Risk-based capital ratios:
Tier I capital to Tier I risk adjusted assets 10.79% 11.09% 11.47%
Minimum required Tier I capital 4.00% 4.00% 4.00%
Total risk-based capital to
Tier II risk-adjusted assets 12.17% 12.56% 12.51%
Minimum required total risk-based capital 8.00% 8.00% 8.00%
Leverage capital ratios:
Tier I leverage capital to adjusted most
recent quarter average assets 8.77% 9.09% 9.20%
Minimum required Tier I leverage capital 4.00% 4.00% 4.00%
The Company's capital ratios have not changed significantly among the
periods presented. From June 30, 2003 to December 31, 2003, two of the Company's
three capital ratios decreased primarily as a result of the acquisition of the
four branches from RBC Centura Bank on October 24, 2003, the impact of which was
partially offset by the Company's issuance of $20 million in trust preferred
securities during December 2003. The Company's capital ratios have decreased
slightly in 2004 as a result of the Company's growth and the effect of stock
repurchases that have been made to manage the Company's number of outstanding
shares of common stock.
As discussed in more detail in "Current Accounting Matters" above, in May
2004, the Federal Reserve Board issued a proposal concerning the regulatory
capital treatment of trust preferred securities by bank holding companies. Under
the terms of the proposal, trust preferred securities would continue to be
includable as Tier I capital, but with slightly more restrictive limits. If
adopted as a final rule, the Company does not expect that it will have a
material impact on the Company's regulatory capital ratios.
The Company's bank subsidiary is also subject to similar capital
requirements as those discussed above. The bank subsidiary's capital ratios do
not vary materially from the Company's capital ratios presented above. At June
30, 2004, the Company's bank subsidiary exceeded the minimum ratios established
by the FED and FDIC.
SHARE REPURCHASES
The Company routinely issues new shares of common stock into the Company's
dividend reinvestment plan and to satisfy stock option exercises. In order to
manage the number of common shares outstanding, the Company frequently
repurchases shares of its common stock. During the first six months of 2004, the
Company issued a total of 104,000 common shares (into the dividend reinvestment
plan and to satisfy stock option exercises), while approximately 114,000 shares
were repurchased. Additional information regarding those repurchases is provided
in the following paragraph and is also presented in Part II, Item 2 "Changes in
Securities, Use of Proceeds and Issuer Purchases of Equity Securities."
Page 27
During the second quarter of 2004, the Company repurchased 64,300 shares
of its common stock at an average price of $31.24 per share. For the six months
ended June 30, 2004, the Company repurchased 114,242 shares of its common stock
at an average price of $32.18 per share. At June 30, 2004, the Company had
approximately 46,000 shares available for repurchase under existing authority
from its board of directors. In July 2004, the Company announced that its board
of directors had authorized the repurchase of an additional 250,000 shares of
common stock. The Company plans to repurchase these shares in open market and
privately negotiated transactions, as market conditions and the Company's
liquidity warrant, subject to compliance with applicable regulations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK (INCLUDING QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK)
Net interest income is the Company's most significant component of
earnings. Notwithstanding changes in volumes of loans and deposits, the
Company's level of net interest income is continually at risk due to the effect
that changes in general market interest rate trends have on interest yields
earned and paid with respect to the various categories of earning assets and
interest-bearing liabilities. It is the Company's policy to maintain portfolios
of earning assets and interest-bearing liabilities with maturities and repricing
opportunities that will afford protection, to the extent practical, against wide
interest rate fluctuations. The Company's exposure to interest rate risk is
analyzed on a regular basis by management using standard GAP reports, maturity
reports, and an asset/liability software model that simulates future levels of
interest income and expense based on current interest rates, expected future
interest rates, and various intervals of "shock" interest rates. Over the years,
the Company has been able to maintain a fairly consistent yield on average
earning assets (net interest margin). Over the past five calendar years the
Company's net interest margin has ranged from a low of 4.23% (realized in 2001)
to a high of 4.58% (realized in 2002). During that five year period the prime
rate of interest has ranged from a low of 4.00% to a high of 9.50%.
Using stated maturities for all instruments except mortgage-backed
securities (which are allocated in the periods of their expected payback) and
securities and borrowings with call features that are expected to be called
(which are included in the period of their expected call), at June 30, 2004 the
Company had $328 million more in interest-bearing liabilities that are subject
to interest rate changes within one year than earning assets. This generally
would indicate that net interest income would experience downward pressure in a
rising interest rate environment and would benefit from a declining interest
rate environment. However, this method of analyzing interest sensitivity only
measures the magnitude of the timing differences and does not address earnings,
market value, or management actions. Also, interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. In addition to the effects of "when" various rate-sensitive products
reprice, market rate changes may not result in uniform changes in rates among
all products. For example, included in interest-bearing liabilities at June 30,
2004 subject to interest rate changes within one year are deposits totaling $467
million comprised of NOW, savings, and certain types of money market deposits
with interest rates set by management. These types of deposits historically have
not repriced coincidentally with or in the same proportion as general market
indicators.
Thus, the Company believes that in the near term (twelve months), net
interest income would not likely experience significant downward pressure from
rising interest rates. Similarly, management would not expect a significant
increase in near term net interest income from falling interest rates (In fact,
it has been the Company's experience that each interest rate cut occurring
during the past three years has negatively impacted (at least temporarily) the
Company's net interest margin). Generally, when rates change, the Company's
interest-sensitive assets that are subject to adjustment reprice immediately at
the full amount of the change, while the Company's interest-sensitive
liabilities that are subject to adjustment reprice at a lag to the rate change
and typically not to the full extent of the rate change. The net effect is that
in the twelve month horizon, as rates change, the impact of having a higher
level of interest-sensitive liabilities is substantially negated by the later
and typically lower
Page 28
proportionate change these liabilities experience compared to interest sensitive
assets. However, recent rate cuts, particularly the two rate cuts totaling 75
basis points that occurred in November 2002 and June 2003, have had a more
pronounced and a longer lasting negative impact on the Company's net interest
margin than previous rate cuts because of the inability of the Company to reset
deposit rates by an amount (because of their already near-zero rates) that would
offset the negative impact of the rate cut on the yields earned on the Company's
interest earning assets. Additionally, as previously discussed, over the past
two years, the Company has originated significantly more adjustable rate loans
compared to fixed rate loans. In the prevailing interest rate environment,
adjustable rate loans generally carry lower initial interest rates than fixed
rate loans. For these reasons, the second quarter of 2004 marked the fifth
consecutive quarter of declining net interest margins. The Federal Reserve
increased interest rates by 25 basis points on June 30, 2004, which the Company
expects to have a slightly positive impact on net interest margin beginning in
the third quarter of 2004.
The Company has no market risk sensitive instruments held for trading
purposes, nor does it maintain any foreign currency positions.
See additional discussion of the Company's net interest margin in the
"Components of Earnings" section above.
Item 4. Controls and Procedures
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our chief
executive officer and chief financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on the
evaluation, our chief executive officer and chief financial officer concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information required to be included in our periodic reports
with the Securities and Exchange Commission. It should be noted that the design
of any system of controls is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions,
regardless of how remote. In addition, no change in our internal control over
financial reporting has occurred during, or subsequent to, the period covered by
this report that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
FORWARD-LOOKING STATEMENTS
Part I of this report contains statements that could be deemed
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934 and the Private Securities Litigation Reform Act, which
statements are inherently subject to risks and uncertainties. Forward-looking
statements are statements that include projections, predictions, expectations or
beliefs about future events or results or otherwise are not statements of
historical fact. Such statements are often characterized by the use of
qualifying words (and their derivatives) such as "expect," "believe,"
"estimate," "plan," "project," or other statements concerning opinions or
judgment of the Company and its management about future events. Factors that
could influence the accuracy of such forward-looking statements include, but are
not limited to, the financial success or changing strategies of the Company's
customers, the Company's level of success in integrating acquisitions, actions
of government regulators, the level of market interest rates, and general
economic conditions.
Page 29
Part II. Other Information
Item 2 - Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
Issuer Purchases of Equity Securities
- ---------------------------------------------------------------------------------------------------------------------------------
Total Number of Shares Maximum Number of
Purchased as Part of Shares that May Yet Be
Total Number of Average Price Paid per Publicly Announced Purchased Under the
Period Shares Purchased (2) Share Plans or Programs (1) Plans or Programs (3)
- ------------------------------- -------------------- ---------------------- ---------------------- ----------------------
January 1, 2004 to January 31,
2004 -- $ -- -- 160,554
February 1, 2004 to February
29, 2004 28,000 33.56 28,000 132,554
March 1, 2004 to March 31, 2004 21,942 33.15 21,942 110,612
------- ------- ------- -------
Total - January 1, 2004 to
March 31, 2004 49,942 33.38 49,942 110,612
------- ------- ------- -------
April 1, 2004 to April 30, 2004 2,000 32.06 2,000 108,612
May 1, 2004 to May 31, 2004 25,000 30.03 25,000 83,612
June 1, 2004 to June 30, 2004 37,300 31.98 37,300 46,312
------- ------- ------- -------
Total - April 1, 2004 to June
30, 2004 64,300 31.24 64,300 46,312
------- ------- ------- -------
Total - January 1, 2004 to June
30, 2004 114,242 $ 32.18 114,242 46,312
======= ======= ======= =======
Footnotes to the Above Table
(1) All shares were purchased pursuant to the share repurchase authorization
announced on April 23, 2003. A total of 200,000 shares were authorized for
repurchase. The repurchase authorization does not have an expiration date.
There were no plans or programs that expired during the period covered by
the table. There are no plans or programs the issuer has determined to
terminate prior to expiration, or under which the issuer does not intend
to make further purchases.
(2) The shares included in the table above do not include shares that were
used by option holders to satisfy the exercise price of the Company's call
options issued by the Company to its employees and directors pursuant to
the 1994 First Bancorp Stock Option Plan. In January 2004, 2,913 shares of
the Company's common stock, with a weighted average market price of
$33.37, were used to satisfy such exercises. In February 2004, 2,812
shares of the Company's common stock, with a weighted average market price
of $33.78, were used to satisfy such exercises. There were no such
exercises from March 1, 2004 through June 30, 2004.
(3) In July 2004, the Company announced that its board of directors had
authorized the repurchase of an additional 250,000 shares of common stock.
Item 4 - Submission of Matters to a Vote of Shareholders
The following proposals were considered and acted upon at the annual
meeting of shareholders of the Company held on April 29, 2004:
Proposal 1
A proposal to elect eighteen (18) directors to serve until the next
annual meeting of shareholders and until their successors are
elected and qualified.
Page 30
Voted Withheld
Nominee For Authority
---------------------- --------- ---------
Jack D. Briggs 8,116,345 41,766
H. David Bruton, M.D. 8,116,108 42,004
R. Walton Brown 8,119,509 38,603
David L. Burns 8,117,498 40,613
John F. Burns 8,038,194 119,918
Jesse S. Capel 8,117,203 40,909
Goldie Wallace-Gainey 8,115,945 42,166
James H. Garner 8,118,809 39,302
James G. Hudson, Jr. 8,117,444 40,668
George R. Perkins, Jr. 8,081,507 76,604
Thomas F. Philips 8,041,248 116,863
William E. Samuels 8,036,019 122,093
Edward T. Taws 8,116,435 41,677
Frederick H. Taylor 8,116,125 41,986
Virginia C. Thomasson 8,104,975 53,137
A. Jordan Washburn 8,117,015 41,097
Dennis A. Wicker 8,111,875 46,236
John C. Willis 8,112,745 45,366
Proposal 2
A proposal to ratify the appointment of KPMG LLP as the independent
auditors of the Company for the current fiscal year.
For 8,024,674 Against 113,882 Abstain 19,555
Proposal 3
A proposal to adopt a new stock option plan, entitled the "First
Bancorp 2004 Stock Option Plan."
For 5,741,324 Against 383,707 Abstain 177,516 Broker Non-Votes 1,855,563
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
The following exhibits are filed with this report or, as noted, are
incorporated by reference. Management contracts, compensatory plans and
arrangements are marked with an asterisk (*).
3.a Copy of Articles of Incorporation of the Company and amendments thereto
were filed as Exhibits 3.a.i through 3.a.v to the Company's Quarterly
Report on Form 10-Q for the period ended June 30, 2002, and are
incorporated herein by reference.
3.b Copy of the Amended and Restated Bylaws of the Company was filed as
Exhibit 3.b to the Company's Annual Report on Form 10-K for the year ended
December 31, 2003, and is incorporated herein by reference.
Page 31
31.1 Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) There were two reports on Form 8-K filed during the quarter ended June 30,
2004.
On April 22, 2004, the Company filed a report on Form 8-K regarding its
April 21, 2004 news release in which it announced its earnings for the
three month period ended March 31, 2004. The full text of the news release
dated April 21, 2004 was attached as Exhibit 99(a) to this Form 8-K
filing.
On April 30, 2004, the Company filed a report on Form 8-K regarding its
April 29, 2004 news release in which it announced the results of the
annual shareholders' meeting held on April 29, 2004. The full text of the
news release dated April 29, 2004 was attached as Exhibit 99(a) to this
Form 8-K filing.
Copies of exhibits are available upon written request to: First Bancorp, Anna G.
Hollers, Executive Vice President, P.O. Box 508, Troy, NC 27371
Page 32
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST BANCORP
August 6, 2004 BY: James H. Garner
--------------------------
James H. Garner
President
(Principal Executive Officer),
Treasurer and Director
August 6, 2004 BY: Anna G. Hollers
--------------------------
Anna G. Hollers
Executive Vice President
and Secretary
August 6, 2004 BY: Eric P. Credle
---------------------------
Eric P. Credle
Senior Vice President
and Chief Financial Officer
Page 33