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UNITED STATES
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: 0-13086
FNB FINANCIAL SERVICES CORPORATION
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(Exact name of Registrant as specified in its Charter)
North Carolina 56-1382275
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(State of Incorporation) (I.R.S. Employer Identification No.)
1501 Highwoods Boulevard, Suite 400
Greensboro, North Carolina 27410
- ---------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(336) 369-0900
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(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [_]
At August 2, 2004, 5,502,511 shares of the registrant's common stock, $1.00
par value, were outstanding.
This Form 10-Q has 23 pages. The Exhibit Index begins on page 18.
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FNB FINANCIAL SERVICES CORPORATION
FORM 10-Q
INDEX
Page
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PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets 3
June 30, 2004 and December 31, 2003
Consolidated Statements of Income and Comprehensive Income 4
Three Months and Six Months Ended June 30, 2004 and 2003
Consolidated Statements of Cash Flows 5
Six months ended June 30, 2004 and 2003
Notes to Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition 10
and Results of Operations
Item 3 Quantitative and Qualitative Disclosures About Market Risk 16
Item 4 Controls and Procedures 16
PART II OTHER INFORMATION
Item 1 Legal Proceedings 17
Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of 17
Equity Securities
Item 3 Defaults Upon Senior Securities 17
Item 4 Submission of Matters to a Vote of Security Holders 17
Item 5 Other Information 18
Item 6 Exhibits and Reports on Form 8 - K 18
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FNB Financial Services Corporation And Subsidiary
Consolidated Balance Sheets
(Dollars in thousands except per share data)
June 30, December 31,
2004 2003 *
(Unaudited)
----------- ----------
ASSETS
Cash and due from banks $ 22,491 $ 29,319
Investment securities:
Securities available for sale 127,599 139,799
Federal Home Loan Bank and Federal Reserve Bank Stock 3,732 3,882
Loans, net of allowance for credit losses of $7,183 at
June 30, 2004 and $7,124 at December 31, 2003 593,343 574,260
Premises and equipment, net 13,743 13,031
Accrued income and other assets 25,475 20,635
--------- ---------
Total assets $ 786,383 $ 780,926
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing $ 77,621 $ 69,982
Interest bearing 561,015 571,925
--------- ---------
Total deposits 638,636 641,907
Federal funds purchased and retail repurchase agreements 20,301 15,363
Other borrowings 57,500 55,500
Accrued expenses and other liabilities 3,116 2,406
--------- ---------
Total liabilities 719,553 715,176
--------- ---------
Shareholders' Equity:
Preferred stock no par value; authorized 10,000,000 shares;
none issued -- --
Common stock, $1.00 par value; authorized 40,000,000 shares;
outstanding 5,496,791 at June 30, 2004 and
5,478,664 at December 31, 2003 5,497 5,479
Paid-in capital 21,703 22,025
Retained earnings 41,763 38,395
Accumulated other comprehensive loss (2,133) (149)
--------- ---------
Total shareholders' equity 66,830 65,750
--------- ---------
Total liabilities and shareholders' equity $ 786,383 $ 780,926
========= =========
See notes to unaudited consolidated financial statements.
*Derived fromaudited consolidated financial statements.
3
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Income and Comprehensive Income
(Unaudited; dollars in thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- --------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Interest income
Loans $ 9,311 $ 9,020 $ 18,498 $ 18,099
Federal funds sold and overnight deposits 29 28 46 41
Investment securities
Taxable 711 1,017 1,568 2,280
Tax exempt 342 272 671 419
Other 48 45 96 95
----------- ----------- ----------- ---------
Total interest income 10,441 10,382 20,879 20,934
----------- ----------- ----------- ---------
Interest expense
Deposits 2,967 3,979 6,135 8,096
Federal funds purchased and other borrowings 429 403 851 818
----------- ----------- ----------- ---------
Total interest expense 3,396 4,382 6,986 8,914
----------- ----------- ----------- ---------
Net interest income 7,045 6,000 13,893 12,020
Provision for credit losses 272 282 660 777
----------- ----------- ----------- ---------
Net interest income after provision for credit losses 6,773 5,718 13,233 11,243
Other income
Service charges on deposit accounts 960 871 1,972 1,631
Net gain on sale of securities -- 240 111 562
Income from investment services 180 102 313 243
Mortgage banking fees 553 482 887 946
Other income 912 72 1,163 180
----------- ----------- ----------- ---------
Total noninterest income 2,605 1,767 4,446 3,562
Other expenses
Salaries and employee benefits 2,984 2,580 5,782 5,127
Occupancy expense 311 275 636 557
Furniture and equipment expense 701 578 1,370 1,109
Insurance expense, including FDIC assessment 48 48 97 96
Marketing expense 215 85 367 182
Printing and supply expense 134 92 265 210
Other expenses 1,198 1,100 2,519 2,089
----------- ----------- ----------- ---------
Total noninterest expense 5,591 4,758 11,036 9,370
Income before income taxes 3,787 2,727 6,643 5,435
Income tax expense 1,274 953 2,235 1,911
----------- ----------- ----------- ---------
Net income 2,513 1,774 4,408 3,524
Other comprehensive income (loss) (3,070) 485 (1,984) 142
----------- ----------- ----------- ---------
Comprehensive income (loss) $ (557) $ 2,259 $ 2,424 $ 3,666
=========== =========== =========== ==========
Per share data
Net income, basic $ 0.45 $ 0.32 $ 0.80 $ 0.63
Net income, diluted $ 0.44 $ 0.31 $ 0.77 $ 0.61
Cash dividends $ 0.12 $ 0.11 $ 0.24 $ 0.22
Weighted average shares outstanding, basic 5,494,506 5,584,634 5,490,127 5,569,715
Weighted average shares outstanding, diluted 5,723,017 5,762,753 5,741,993 5,726,835
See notes to unaudited consolidated financial statements.
4
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited; dollars in thousands)
Six Months Ended
June 30,
-----------------------
2004 2003
-------- ----------
Cash flows from operating activities:
Net income $ 4,408 $ 3,524
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, accretion, and amortization 1,215 1,081
Provision for credit losses 660 777
Gain on sale of securities available for sale (111) (562)
Gain on disposal of premises and equipment (108) -
Net change in loans held for sale (1,982) 702
Changes in assets and liabilities:
Increase in other assets (1,599) (1,567)
Increase (decrease) in other liabilities 986 (1,488)
-------- ---------
Net cash provided by operating activities 3,467 2,467
-------- ---------
Cash flows from investing activities:
Proceeds from sales, maturities, or calls of securities
available for sale 18,362 78,082
Purchase of securities available for sale (9,564) (89,972)
Purchase of premises and equipment (1,688) (2,274)
Proceeds from disposal of premises and equipment 229 -
Increase in other real estate owned (40) (721)
Net increase in loans (19,642) (4,543)
-------- ----------
Net cash used in investing activities (12,343) (19,428)
-------- ----------
Cash flows from financing activities:
Net increase (decrease) in deposits (3,271) 56,402
Net increase (decrease) in other borrowings 2,000 (20,000)
Net increase (decrease) in federal funds purchased and
repurchase agreements 4,939 (1,542)
Repurchase of common stock (1,135) (1,636)
Proceeds from issuance of common stock 831 366
Cash dividends paid (1,316) (1,238)
-------- ----------
Net cash provided by financing activities 2,048 32,352
-------- ----------
Net increase (decrease) in cash and cash equivalents (6,828) 15,391
Cash and cash equivalents, January 1 29,319 24,524
-------- ----------
Cash and cash equivalents, June 30 $ 22,491 $ 39,915
======== ==========
See notes to unaudited consolidated financial statements.
5
FNB Financial Services Corporation and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America and with the instructions to Form 10-Q and Rule
10- 01 of Regulation S-X. Accordingly, these statements do not include all
of the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial
statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation
have been included. Operating results for the six-month period ended June
30, 2004 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2004. For further information refer to the
consolidated financial statements and footnotes thereto included in FNB
Financial Services Corporation's 2003 Annual Report on Form 10-K. Certain
reclassifications have been made to the prior period consolidated financial
statements to place them on a comparable basis with the current period
consolidated financial statements.
2. Per share data
Basic and diluted net income per share amounts have been computed based
upon net income as presented in the accompanying statements of income
divided by the weighted average number of common shares outstanding or
assumed to be outstanding as summarized.
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Weighted average number of shares
used in basic EPS 5,494,506 5,584,634 5,490,127 5,569,715
Effect of dilutive stock options 228,511 178,119 251,866 157,120
--------- --------- --------- ---------
Weighted average number of common
shares and dilutive potential common
shares used in dilutive EPS 5,723,017 5,762,753 5,741,993 5,726,835
========= ========= ========= =========
For the three months ended June 30, 2004, there were 272,375 potentially
dilutive share options not included in the weighted average calculation
since the option exercise prices are greater than the fair market value of
the common shares. For the six months ended June 30, 2004, there were
269,875 potentially dilutive share options not included in the weighted
average calculation.
3. Stock compensation plans
The proforma impact on net income and net income per share as if the fair
value of stock-based compensation plans had been recorded as a component of
compensation expense in the consolidated financial statements as of the
date of grant of awards related to such plans, pursuant to the provisions
of SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure," which amends SFAS No. 123, "Accounting for Stock Based
Compensation,", is disclosed in the accompanying table.
6
3. Stock compensation plans (cont.)
For the three months ended For the six months ended
-------------------------- ------------------------
June 30, June 30,
------------------- -------------------
(Dollars in thousands, except per share data) 2004 2003 2004 2003
- --------------------------------------------- ------- -------- -------- --------
Net income, as reported $ 2,513 $ 1,774 $ 4,408 $ 3,524
Less: Stock based compensation as
calculated per fair value method, net
of tax effect -- -- (361) (173)
------- ------- ------- -------
Proforma net income $ 2,513 $ 1,774 $ 4,049 $ 3,351
======= ======= ======= =======
Earnings per share:
Basic - as reported $ .45 $ .32 $ .80 $ .63
Basic - proforma $ .45 $ .32 $ .74 $ .60
Diluted - as reported $ .44 $ .31 $ .77 $ .61
Diluted - proforma $ .44 $ .31 $ .70 $ .58
4. Investment securities
June 30, 2004 December 31, 2003
--------------------- -------------------
(Dollars in thousands) Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ---------- --------- ---------
Available for sale:
U.S. Agency securities $ 79,844 $ 77,790 $ 88,534 $ 88,051
Mortgage backed securities 15,574 15,267 18,237 18,230
State and municipal obligations 34,474 33,352 32,617 32,850
Other 1,203 1,190 656 668
--------- --------- --------- ---------
Total available for sale 131,095 127,599 140,044 139,799
Federal Reserve Bank and Federal
Home Loan Bank stock 3,732 3,732 3,882 3,882
--------- --------- --------- ---------
Total investment securities $ 134,827 $ 131,331 $ 143,926 $ 143,681
5. Loans
Loan Category:
(Dollars in thousands) June 30, December 31,
2004 2003
---------- -------------
Real estate - commercial $ 147,036 $ 159,953
Real estate - residential 102,316 95,939
Real estate - construction 138,736 117,786
Commercial, financial and agricultural 89,600 90,224
Consumer 127,408 118,557
--------- ---------
Subtotal loans 605,096 582,459
Loans held for sale 4,570 1,075
--------- ---------
Gross loans $ 600,526 $ 581,384
========= =========
7
5. Loans (cont.)
Allowance for credit losses:
June 30, 2004 December 31, 2003
------------------------- ----------------------
% of Loans % of Loans
(Dollars in thousands) in Each in Each
Category to Category to
Allowance Total Loans Allowance Total Loans
---------- ----------- --------- ------------
Balance at end of period
applicable to:
Real estate - construction 1 23 $ 5 20
Real estate - mortgage 40 41 49 44
Commercial 5,406 15 5,116 16
Consumer 1,736 21 1,954 20
------- --- ------- ---
Total $ 7,183 100% $ 7,124 100%
======= === ======= ===
Rollforward - allowance for credit losses:
Six Months Ended
June 30,
-----------------------
(Dollars in thousands) 2004 2003
------- -------
Balance, beginning of period $ 7,124 $ 7,059
Charge-offs 634 906
Recoveries (33) (162)
------- -------
Net charge-offs 601 744
------- -------
Provision for credit losses 660 777
------- -------
Balance, end of period $ 7,183 $ 7,092
======= =======
Ratio of annualized net charge-offs during the
period to average loans outstanding
during the period 0.20% 0.26%
==== ====
Ratio of allowance for credit losses to
month end loans 1.20% 1.25%
==== ====
Nonperforming assets:
June 30, December 31,
(Dollars in thousands) 2004 2003
--------- -------------
Nonaccrual (1) $ 2,661 $ 5,174
Past due 90 days or more and still accruing interest 58 53
Other real estate 5,231 5,191
Renegotiated troubled debt -- --
(1) Other than amounts listed above, there are no other loans which: (a)
represent or result from trends or uncertainties which management
reasonably expects will materially affect future operating results,
liquidity, or capital resources, or (b) represent material credits about
which management is aware of any information which causes management to
have serious doubts as to the ability of such borrowers to comply with
the loan repayment terms.
8
6. Employee benefit plans
The accompanying table details the components of pension expense
recognized in the Company's Consolidated Statements of Income and
Comprehensive Income:
For the three months For the six months
--------------------- -------------------
ended June 30, ended June 30,
--------------- ---------------
(Dollars in thousands) 2004 2003 2004 2003
- ---------------------- ------ ------ ------ ------
Service cost $ 127 $ 93 $ 254 $ 186
Interest cost 90 75 180 150
Expected return on plan assets (121) (200) (242) (400)
Amortization of prior service cost 5 132 10 264
------ ------ ------ ------
Net periodic pension cost $ 101 $ 100 $ 202 $ 200
====== ====== ====== ======
For the 2004 Plan Year, no tax-deductible contributions are required or
allowed.
9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Information set forth below contains various forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934, which statements represent the Company's
judgment concerning the future and are subject to risks and uncertainties that
could cause the Company's actual operating results to differ materially. Such
forward-looking statements can be identified by the use of forward-looking
terminology, such as "may", "will", "expect", "anticipate", "estimate",
"believe", or "continue", or the negative thereof or other variations thereof
or comparable terminology. The Company cautions that such forward-looking
statements are further qualified by important factors that could cause the
Company's actual operating results to differ materially from those in the
forward-looking statements.
Application of Critical Accounting Policies
The Company's accounting policies are fundamental to understanding
management's discussion and analysis of results of operations and financial
condition. The Company's significant accounting policies are discussed in
detail in Note 1 of the consolidated financial statements included in the
Company's 2003 Annual Report on Form 10-K. The following is a summary of the
allowance for credit losses, one of the most complex and judgmental accounting
policies of the Company.
The allowance for credit losses, which is utilized to absorb actual
losses in the loan portfolio, is maintained at a level consistent with
management's best estimate of probable credit losses incurred as of the
balance sheet date. The Company's allowance for credit losses is also analyzed
quarterly by management. This analysis includes a methodology that separates
the total loan portfolio into homogeneous loan classifications for purposes of
evaluating risk, as well as analysis of certain individually identified loans.
The required allowance is calculated by applying a risk adjusted reserve
requirement to the dollar volume of loans within a homogenous group. Major
loan portfolio subgroups include: risk graded commercial loans, mortgage
loans, home equity loans, retail loans and retail credit lines. Management
also analyzes the loan portfolio on an ongoing basis to evaluate current risk
levels, and risk grades are adjusted accordingly. While management uses the
best information to make evaluations, future adjustments may be necessary, if
economic or other conditions differ substantially from the assumptions used.
Executive Summary
FNB Financial Services Corporation (the "Company") is a North Carolina
financial holding company. The Company's wholly owned subsidiary, FNB
Southeast (the "Bank"), is a North Carolina chartered commercial bank. As of
June 30, 2004, the Bank operated thirteen banking offices in North Carolina
and four banking offices in Virginia. The Bank has two wholly owned
subsidiaries; FNB Southeast Investment Services, Inc., which operated three
offices, and FNB Southeast Mortgage Corporation, which operated seven offices.
The Company relocated its headquarters from Reidsville, North Carolina to
Greensboro, North Carolina in April 2004.
Effective April 16, 2004, The Bank of Tazewell purchased loans and
assumed the deposits of the Bank's Richlands, Virginia branch. The Bank
transferred $15.0 million in deposit accounts and $7.3 million in loan
accounts in the transaction. The Company recognized $700,000 in net gain on
the sale. Also during April, an approximate $125,000 gain was realized from
the sale of the fixed assets associated with the Bank's Richlands, Virginia
branch.
Assets at June 30, 2004 were $786.4 million, an increase of $5.5
million since December 31, 2003. An increase in net loans of $19.1 million,
combined with a $12.2 million decrease in investment securities available for
sale, were the principal factors impacting this overall increase during the
first six months of 2004. Over the past six months, noninterest bearing
deposits increased $7.6 million, while interest bearing deposits declined
$10.9 million.
10
Net income of $2.5 million for the quarter ended June 30, 2004 was
$739,000, or 41.7%, higher than the amount earned in the second quarter last
year. Diluted earnings per share for the current quarter was $0.44 per share,
compared to $0.31 per share last year. For the first six months of 2004,
earnings of $4.4 million were $884,000, or 25.1%, higher than the same period
a year ago. Diluted earnings per share for the six months ended June 30, 2004
and 2003 were $0.77 and $0.61, respectively. Excluding a one-time after-tax
gain of $548,000 from the sale of a banking operation discussed earlier,
quarterly and year-to-date earnings increased 10.8% and 9.5%, respectively.
Financial Condition
Since December 31, 2003, the Company's assets have increased $5.5
million, rising from $780.9 million at yearend 2003 to $786.4 million at June
30, 2004. An increase in net loans of $19.1 million, offset by a $12.4 million
decrease in investment securities, were the principal factors impacting this
overall net increase.
Loans at June 30, 2004 totaled $600.5 million, compared to $581.4
million at yearend 2003, an increase of 3.3%. Investment securities of $131.3
million at June 30, 2004 were 8.6% lower than the $143.7 million balance at
December 31, 2003.
Deposits totaled $638.6 million at June 30, 2004, compared to $641.9
million at December 31, 2003. At the end of the second quarter 2004,
noninterest bearing deposits were $77.6 million, or 12.2% of total deposits.
At June 30, 2004, borrowings at the Federal Home Loan Bank of Atlanta (FHLB)
totaled $57.5 million, an increase of 3.6% compared to $55.5 million at
December 31, 2003. Federal funds purchased and retail repurchase agreements
totaled $20.3 million at June 30, 2004, an increase of $4.9 million from
December 31, 2003.
Our capital position remains strong, with all of our regulatory capital
ratios at levels that make the Company "well capitalized" under bank
regulatory capital guidelines. Shareholders' equity increased to $66.8 million
at the end of the second quarter 2004, compared to $65.8 million at December
31, 2003. The Company paid dividends of $0.12 per share during the quarter
ended June 30, 2004, a 9.1% increase over the $0.11 per share dividend rate
for the second quarter of 2003. Year to date dividends per share for 2004 were
$0.24, compared to $0.22 in 2003. The Company's Board of Directors approved a
stock repurchase program of the outstanding common stock during the fourth
quarter of 2002, authorizing the repurchase of up to 279,814 shares. This
program, continuing in 2004, is intended to help the Company achieve its goal
of building shareholder value while maintaining appropriate capital levels. A
total of 229,891 shares have been purchased through June 30, 2004 at an
average price of $16.087. In accordance with state law, repurchased shares
are cancelled and are no longer considered issued.
Asset Quality
The Company's allowance for credit losses is analyzed quarterly by
management. This analysis includes a methodology that segments the loan
portfolio by selected types and considers the current status of the portfolio,
historical charge-off experience, current levels of delinquent, impaired and
non-performing loans, as well as economic and other risk factors. It is also
subject to regulatory examinations and determinations as to adequacy, which
may take into account such factors as the methodology employed and other
analytical measures in comparison to a group of peer banks. Management
believes the allowance for loan losses is sufficient to absorb known risk in
the portfolio. No assurances can be given that future economic conditions will
not adversely affect borrowers and result in increased losses.
The credit loss allowance ratio was 1.20% at June 30, 2004, 1.23% at
December 31, 2003, and 1.25% at June 30, 2003. For the second quarter of 2004,
provision charges against earnings totaled $272,000, compared to $282,000 in
the second quarter of 2003. Net charge-offs for the second quarter of 2004
totaled $292,000, or a 0.20% annualized loss ratio based on average loans
outstanding. This is a decrease from the net charge-offs for the second
quarter of 2003 totaling $366,000, or 0.26% annualized loss ratio. Annualized
net charge-offs for the first six months of 2004 and 2003 were 0.20% and
0.26%, respectively, based on average loans outstanding.
11
Nonaccrual loans totaled $2.7 million at June 30, 2004, compared to $5.2
million at yearend 2003 and $9.0 million at June 30, 2003. Other real estate
owned was $5.2 million at June 30, 2004 and December 31, 2003, and $1.8
million at June 30, 2004. Approximately $1.8 million has been transferred from
loans into other real estate and approximately $1.7 million of such assets
were disposed of during the first six months of 2004. A net loss of $118,000
has been recorded on disposition of other real estate in the current year.
Total nonperforming assets (comprised of nonaccrual loans and other real
estate owned) decreased to $8.0 million, or 1.01% of total assets at June 30,
2004, from $10.4 million, or 1.33% of total assets at December 31, 2003 and
$10.8 million, or 1.39% of total assets a year ago. These changes indicate a
trend of improving asset quality.
Results of Operations for the Three Months Ended June 30, 2004 and 2003
Interest Income and Interest Expense
Total interest income was $10.4 million for the second quarter of 2004
and 2003. Average earning assets for the current quarter were $739.6 million,
an increase of 3.1% over the second quarter average of $717.5 million a year
ago. Interest income from loans was $9.3 million, up 3.2% from $9.0 million in
the second quarter of 2003. The increase in interest income was driven
primarily by an increase in average loans outstanding. Average loans of $598.3
million were 4.3% higher than the $573.5 million last year. Interest income on
investments totaled $1.1 million for the three months ended June 30, 2004,
compared to $1.3 million for the second quarter of 2003. The average balance
of the investment portfolio was $133.9 million for the quarter ended June 30,
2004, a 0.1% decline from the average balance of $134.0 million for the prior
year second quarter.
Second quarter total interest expense was $3.4 million, compared to $4.4
million from the second quarter of last year, a 22.5% decrease. Average
interest bearing liabilities for the second quarter 2004 increased 3.1%, to
$636.6 million from $617.3 million for the second quarter of 2003. Interest
expense on deposits for the second quarter decreased 25.4%, to $3.0 million
for 2004 from $4.0 million in 2003. Average interest bearing deposits
increased 0.3%, to $556.9 million, from $555.1 for the second quarter of 2003.
Interest expense on federal funds purchased and other borrowings was $429,000
for the quarter ended June 30, 2004, up 6.4%, from $404,000 in the second
quarter of 2003. The increase was attributable primarily to an increase in the
average balance of federal funds purchased and other borrowings from $62.2
million in 2003 to $79.7 million in 2004. The Company utilized these
borrowings as funding sources to support balance sheet growth.
Comparable net interest margins are as follows:
Three months ended June 30,
2004 2003
---- ----
Asset Yield 5.76% 5.88%
Liability Rate 2.14% 2.85%
---- ----
Interest Rate Spread 3.62% 3.03%
==== ====
Provision for Credit Losses
A provision for credit losses is charged against earnings in order to
maintain the allowance for credit losses at a level that reflects management's
evaluation of the incurred losses inherent in the portfolio. The amount of the
provision is based on continuing assessments of nonperforming and "watch list"
loans, analytical reviews of loan loss experience in relation to outstanding
loans, loan charge-offs, nonperforming asset trends and management's judgment
with respect to current and expected economic conditions and their impact on
the existing credit portfolio.
12
The provision for credit losses in the second quarter of 2004 was
$272,000 compared to $282,000 in 2003. The allowance for credit losses as a
percentage of gross loans outstanding was 1.20% at June 30, 2004, 1.23% at
December 31, 2003, and 1.25% at June 30, 2003. Annualized net credit losses,
as a percent of average loans, was 0.20% and 0.26% for the quarters ended June
30, 2004 and 2003, respectively.
Noninterest Income and Expense
Noninterest income in the second quarter of this year increased 47.4% to
$2.6 million from $1.8 million in the same period last year. Excluding a one-
time net gain of $825,000 from the sale of the Company's banking operation in
Richlands, Virginia, second quarter noninterest income was $1.8 million for
2004 and 2003. Deposit service charges of $960,000 for the second quarter of
2004 increased 10.2% from $871,000 in the second quarter of 2003. Growth in
deposits and enhancements to the deposit service charge pricing structure were
the principal factors contributing to this increase. There were no sales of
securities during the second quarter of 2004; however, there were $240,000 in
gains on the sale of securities available for sale during the same period in
2003. Noninterest income in the second quarter of 2003 included $553,000 in
mortgage banking fees and $180,000 in investment service fees compared to
revenues of $482,000 and $102,000, respectively, for the previous year. The
increase in mortgage banking fees for 2004 was attributable to the continuing
growth of the mortgage banking subsidiary.
Noninterest expense for the second quarter of 2004 was $5.6 million, a
17.5% increase over the $4.8 million expense in the second quarter of 2003.
Salaries and employee benefits increased $404,000 because of increased
staffing associated with the expansion of the mortgage banking operations and
the corporate headquarters relocation, combined with higher insurance and
retirement costs. Furniture and equipment expense rose $123,000, compared to
second quarter 2003. Other expense for the second quarters of 2004 and 2003
totaled $1.2 million and $1.1 million, respectively. Expense areas such as
occupancy, printing and supplies, and marketing were impacted by the corporate
headquarters relocation.
Provision for Income Taxes
The Company's provision for income taxes totaled $1.3 million for the
second quarter of 2004, an increase of $321,000, or 33.7%, compared to 2003.
The Company's effective tax rates for the three month periods ended June 30,
2004 and 2003 were 33.7% and 35.0%, respectively. The decline in the effective
rate from 2003 to 2004 reflects the implementation of investment strategies
that resulted in a reduction in the consolidated income tax provision. The
increase in the provision for 2004, compared to the prior year, results from
higher pretax income, offset in part by lower effective tax rate. Overall, the
effective tax rate is attributable to the current expense required to provide
an adequate provision for income taxes at June 30, 2004 and 2003.
Results of Operations for the Six Months Ended June 30, 2004 and 2003
Interest Income and Interest Expense
Total interest income was $20.9 million for the first six months of 2004
and 2003. Average earning assets for the six months ended June 30, 2004 were
$740.9 million, an increase of 3.9% over the average of $713.1 million a year
ago. Interest income from loans was $18.5 million, up 2.2% from $18.1 million
in 2003. The increase in interest income was driven primarily by a continuing
increase in average loans outstanding. Average loans of $594.2 million were
3.9% higher than the $571.9 million last year. Investment income for the six-
month period totaled $2.3 million in 2004 and $2.8 million in 2003. The $6.5
million, or 4.9%, increase in the average balance of the investment portfolio
was offset by a decline in the yield from 4.60% in 2003 to 3.84% in 2004.
13
Total interest expense for the first six months of 2004 was $7.0 million,
a 21.6% decrease from the $8.9 million expense for the first six months of
2003. Overall cost of funds for the six months ended June 30, 2004 and 2003
was 1.96% and 2.66%, respectively. Interest expense on deposits for the
six-month period decreased 24.2%, to $6.1 million for 2004 from $8.1 million
in 2003. The average rate for the six months on interest bearing deposits
decreased to 2.20% in 2004; from 2.97% one year earlier while average interest
bearing deposits increased 2.3%, to $561.9 million, from $549.4 for the first
six months of 2003. Interest expense on federal funds purchased and other
borrowings was $851,000 for the six months ended June 30, 2004, up 4.0%, from
$819,000 in 2003. The increase was attributable primarily to an increase in
the average balance of federal funds purchased and other borrowings from
$63.8 million in 2003 to $78.1 million in 2004. This increase was partially
offset by a decline in the average rate paid on purchased funds from 2.66% for
the first six months of 2003 to 1.96% for the same period in 2004. The
Company utilized these borrowings as funding sources to support balance sheet
growth.
Comparable net interest margins are as follows:
Six months ended June 30,
2004 2003
----- -----
Asset Yield 5.75% 5.98%
Liability Rate 2.19% 2.93%
---- ----
Interest Rate Spread 3.56% 3.05%
==== ====
Provision for Credit Losses
A provision for credit losses is charged against earnings in order to
maintain the allowance for credit losses at a level that reflects management's
evaluation of the incurred losses inherent in the portfolio. The amount of the
provision is based on continuing assessments of nonperforming and "watch list"
loans, analytical reviews of loan loss experience in relation to outstanding
loans, loan charge-offs, nonperforming asset trends and management's judgment
with respect to current and expected economic conditions and their impact on
the existing credit portfolio.
The provision for credit losses for the first six months of 2004 was
$660,000 compared to $777,000 in 2003. The allowance for credit losses as a
percentage of gross loans outstanding was 1.20% at June 30, 2004, 1.23% at
December 31, 2003, and 1.25% at June 30, 2003. Year to date annualized net
credit losses declined to 0.20% of average loans in 2004, compared to 0.26%
for the same period in 2003.
Noninterest Income and Expense
Noninterest income for the first six months of this year increased 24.8%
to $4.4 million from $3.6 million in the same period last year. Excluding a
one-time net gain of $825,000 from the sale of the Company's banking operation
in Richlands, Virginia, year-to-date noninterest income was $3.6 million in
2004 and 2003. For the six months, $111,000 of net gains from sales of
investment securities were recognized, a decrease from $562,000 of net gains
in the same period last year. Deposit service charges of $2.0 million for the
first half of 2004 increased 20.9% from the $1.6 million in 2003. Growth in
deposits and enhancements to the deposit service charge pricing structure were
the principal factors contributing to this increase. Mortgage banking fees
declined to $887,000 for the first six months of 2004, compared to $946,000
for the same period a year ago as refinancing activity began to slow down.
Investment service fees increased 28.8% for the first six months of 2004,
rising from $243,000 in the first half of 2003 to $313,000 in 2004.
14
Noninterest expense for the first half of 2004 was $11.0 million, a
17.8% increase over the $9.4 million expense in 2003. Salaries and employee
benefits increased $655,000 because of increased staffing associated with the
expansion of the mortgage banking operations and the corporate headquarters
relocation, combined with higher insurance and retirement costs. Furniture and
equipment expense rose $262,000, compared to same period in 2003. Other
expense for the first half of 2004 and 2003 totaled $2.5 million and $2.1
million, respectively. Expense areas such as occupancy, printing and supplies,
and marketing were impacted by the corporate headquarters relocation.
Provision for Income Taxes
The Company's provision for income taxes totaled $2.2 million for the
first six months of 2004, compared to $1.9 million for the first half of 2003.
The Company's effective tax rates for the six month periods ended June 30,
2004 and 2003 were 33.7% and 35.2%, respectively. The decline in the effective
rate from 2003 to 2004 reflects the implementation of investment strategies
that resulted in a reduction in the consolidated income tax provision. The
increase in the provision for 2004, compared to the prior year, results from
higher pretax income, offset in part by lower effective tax rate. Overall, the
effective tax rate is attributable to the current expense required to provide
an adequate provision for income taxes at June 30, 2004, and 2003.
Capital Resources
Banks and financial holding companies, as regulated institutions, must
meet required levels of capital. The Office of the Commissioner of Banks in
North Carolina and the Board of Governors of the Federal Reserve, which are
the primary regulatory agencies for FNB Southeast and the Company,
respectively, have adopted minimum capital regulations or guidelines that
categorize components and the level of risk associated with various types of
assets. Financial institutions are required to maintain a level of capital
commensurate with the risk profile assigned to their assets in accordance with
the guidelines.
As shown in the accompanying table, the Company and its wholly-owned
banking subsidiary have capital levels exceeding the minimum levels for "well
capitalized" banks and financial holding companies as of June 30, 2004.
Regulatory Guidelines
-----------------------------
Well Adequately FNB
Ratio Capitalized Capitalized Company Southeast
- ----- ----------- ----------- ------- ----------
Total Capital 10.0% 8.0% 12.0% 11.7%
Tier 1 Capital 6.0 4.0 10.9 10.6
Leverage Capital 5.0 4.0 8.6 8.4
Liquidity Management
Liquidity management refers to the ability to meet day-to-day cash flow
requirements based primarily on activity in loan and deposit accounts of the
Company's customers. Deposit withdrawals, loan funding and general corporate
activity create a need for liquidity for the Company. Liquidity is derived
from sources such as deposit growth; maturity, calls, or sales of investment
securities; principal and interest payments on loans; access to borrowed funds
or lines of credit; and profits.
During the first six months of 2004 the Company had net cash provided by
operating activities of $3.5 million. This was an increase of $1.0 million
from the $2.5 million of net cash provided by operating activities in the
first half of 2003. The increase is primarily attributable to the rise of
$884,000 in net income.
Net cash used in investing activities in the first six months of 2004
totaled $12.3 million. Purchases of investment securities in the current year
totaled $9.6 million and proceeds from sales, calls, or maturities of
securities were $18.4 million. This compares to the first half of 2003 when
proceeds from sales, calls, or maturities of securities totaled $78.1
million, leading to net cash used in investment activities of $19.4 million.
An increase in loans outstanding used $19.6 million in cash during 2004,
compared to an increase in outstanding loans in 2003 that used $4.5 million of
cash during the same period in 2003. Capital expenditures used $1.7 million in
2004, compared to $2.3 million in 2003.
15
During the 2004 first half, financing activities provided $2.0 million.
An outflow of $3.3 million in deposits was offset by an increase of $6.9
million in borrowings. Financing activities in the 2003 first half provided
$32.4 million, based primarily on $56.4 million rise in deposits. These cash
inflows were partially offset by a repayment of other borrowings of $21.5
million during the first six months.
Overall cash and cash equivalents totaled $22.5 million at June 30, 2004
compared to $29.3 million at December 31, 2003 and $39.9 million at June 30,
2003.
Liquidity is further enhanced by a line of credit with the FHLB
collateralized by FHLB stock, investment securities and qualifying 1-4 family
residential mortgage loans, and qualifying commercial real estate loans. The
Company provides various reports to the FHLB on a regular basis throughout the
year to maintain the availability of the credit line. Each borrowing request
to the FHLB is initiated through an advance application that is subject to
approval by the FHLB before funds are advanced under the credit agreement.
The Company also has unsecured overnight borrowing lines available
through four financial institutions. These lines are used to manage the day to
day, short-term liquidity needs of the Company. Each Federal funds line has a
requirement to repay the line in full on a frequent basis, typically within
five to ten business days. The Company has also established a $15 million
wholesale repurchase agreement with a regional brokerage firm. The Company can
access this additional source of liquidity by pledging investment securities
with the brokerage firm.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the possible chance of loss from unfavorable changes in
market prices and rates. These changes may result in a reduction of current
and future period net interest income, which is the favorable spread earned
from the excess of interest income on interest-earning assets, over interest
expense on interest-bearing liabilities.
The Company considers interest rate risk to be its most significant
market risk, which could potentially have the greatest impact on operating
earnings. The Company is asset sensitive, which means that falling interest
rates could result in a reduced amount of net interest income. The monitoring
of interest rate risk is part of the Company's overall asset/liability
management process. The primary oversight of asset/liability management rests
with the Company's Asset and Liability Committee. The Committee meets on a
regular basis to review asset/liability activities and to monitor compliance
with established policies.
The Company has not experienced any substantive changes in portfolio
risk during the six months ended June 30, 2004.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
The Company's management, under the supervision and with the
participation of the Chief Executive Officer and the Chief Financial Officer
of the Company (its principal executive officer and principal financial
officer, respectively), has concluded based on its evaluation as of the end of
the period covered by this Report, that the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed
by the Company in the reports filed or submitted by it under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in the applicable rules and forms,
and include controls and procedures designed to ensure that information
required to be disclosed by the Company in such reports is accumulated and
communicated to the Company's management, including the Chief Executive
Officer and the Chief Financial Officer of the Company, as appropriate to
allow timely decisions regarding required disclosure.
16
Changes in internal control over financial reporting
There have been no significant changes in internal control over
financial reporting during the period covered by this Report that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
The accompanying table details, by month, the information related to the
activity related to the share repurchase program approved by the Company's
Board of Directors in November 2002 and publicly announced that same month. A
total of 279,814 shares were approved for repurchase.
Stock Repurchase Program - Approved November 2002
------------------------------------------------------
(a) (b) (c) (d)
Total Number of Maximum Number
Shares Average Price Cumulative Number of of Shares that May Yet Be
Period Purchased Paid Per Share Shares of Purchased Purchased
- -------------- -------------- ------------- ------------------- --------------------------
April 1, 2004 to
April 30, 2004....... 5,400 $ 19.71 192,941 86,873
May 1, 2004 to May 31,
2004................. 23,700 $ 19.51 216,641 63,173
June 1, 2004 to
June 30, 2004........ 13,250 $ 18.56 229,891 49,923
Total.............. 42,350 $ 19.24
Item 3. Defaults Upon Senior Securities
Not Applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders
On May 20, 2004, at the Annual Meeting of the Company's
shareholders, the following proposal was voted on by shareholders:
Proposal
To elect two members of the Board of Directors as follows:
Two Directors to serve for a term of one year ending in 2005.
Votes for each nominee were as follows:
Nominee For Withheld
------- --- --------
O. Eddie Green 4,231,904 12,671
E. Reid Teague 4,232,904 11,671
The following directors remain in office: Gary G. Blosser, Joseph
H. Kinnarney, Kenan C. Wright, Ernest J. Sewell, Charles A. Britt,
and Barry Z. Dodson.
17
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
--------- -----------
3.01 (1) Amended and Restated Articles of Incorporation.
3.02 (1) Bylaws of Company, as amended.
4.01 (1) Specimen Common Stock Certificate.
10.01 (3) Stock Compensation Plan of the Registrant approved April 11, 1989, by the shareholders of the
Registrant, with forms of stock option and stock bonus agreements attached.
10.02 (4) Omnibus Equity Compensation Plan of the Registrant.
10.03 (5) Severance Policy for Senior Officers of the Registrant (employed for five years or more).
10.04 (6) Revised Severance Plan for Senior Officers of the Registrant (employed for five years or more).
10.05 (4) Severance Policy for Senior Officers of the Registrant (employed for less than five years).
10.06 (8) Benefit Equivalency Plan of the Registrant effective January 1, 1994.
10.07 (11) Annual Management Incentive Plan of the Registrant.
10.08 (8) Long Term Incentive Plan of the Registrant.
10.09 (10) Long Term Incentive Plan of the Registrant for certain senior management employees.
10.10 (8) Employment Agreement dated May 18, 1995, between the Registrant, as employer, and Ernest
J. Sewell, President and Chief Executive Officer of the Registrant.
10.11 (9) Split-Dollar Agreement dated January 27, 1995, between the Registrant and Ernest J. Sewell.
10.12 (9) Split-Dollar Agreement dated January 27, 1995, between the Registrant and C. Melvin Gantt.
10.13 (9) Split-Dollar Agreement dated December 8, 1995, between the Registrant and Richard L. Powell.
10.14 (2) Amendment to Benefit Equivalency Plan of the Registrant effective January 1, 1998.
10.15 (9) Split-Dollar Agreement dated March 20, 1998, between the Registrant and Ernest J. Sewell.
31.01 Certification of Ernest J. Sewell.
31.02 Certification of Michael W. Shelton.
32.01 Certification of Periodic Financial Report Pursuant to 18 U.S.C Section 1350.
Exhibit references:
(1) Incorporated herein by reference to the Registrant's Quarterly
Report on Form 10-Q for the fiscal quarter ended March 31,
1998, filed with the Securities and Exchange Commission.
(2) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
1998, filed with the Securities and Exchange Commission.
(3) Incorporated herein by reference to the Registrant's Statement
on Form S-8 (No. 33-33186), filed with the Securities and
Exchange Commission.
18
(4) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-KSB for the fiscal year ended December 31,
1996, filed with the Securities and Exchange Commission.
(5) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
1989, filed with the Securities and Exchange Commission.
(6) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-KSB for the fiscal year ended December 31,
1994, filed with the Securities and Exchange Commission.
(7) Incorporated herein by reference to the Registrant's Quarterly
Report, on Form 10-QSB for the fiscal quarter ended June 30,
1995, filed with the Securities and Exchange Commission.
(8) Incorporated herein by reference to the Registrant's Statement
on Form S-2 (File No. 333-47203) filed with the Securities
and Exchange Commission on March 3, 1998.
(9) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-KSB for the fiscal year ended December 31,
1997, filed with the Securities and Exchange Commission.
(10) Incorporated herin by reference to Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1999, filed with
the Securities and Exchange Commission.
(11) Incorporated herin by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2003, filed
with the Securities and Exchange Commission.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K, dated April 22,
2004, to report the results of operations for the first quarter of
2004.
The Company filed a Current Report on Form 8-K, dated May 24, 2004,
stating that on May 20, 2004 at its Annual Meeting of Shareholders,
the Board of Directors appointed Pressley A. Ridgill as President
and Chief Operating Officer of the Bank and appointed Ridgill to the
Bank's Board of Directors.
The Company filed a Current Report on Form 8-K, dated July 7, 2004,
stating that the Audit Committee of its Board of Directors had
dismissed PricewaterhouseCoopers LLP as its independent accountants
and appointed Dixon Hughes PLLC as its independent accountants.
The Company filed a Current Report on Form 8-K, dated July 21, 2004,
to report the results of operations for the second quarter of 2004.
The Company filed a Current Report on Form 8-K/A, dated July 23,
2004, to amend the Form 8-K filed on July 7, 2004 to include as
Exhibit 99.1 the letter from PricewaterhouseCoopers LLP confirming
that PwC had been terminated as the auditor of FNB Financial
Services Corporation's Employee's Savings Plus and Profit Sharing
Plan.
The Company filed a Current Report on Form 8-K, dated July 23,
2004, which contained a copy of the Company's news release
describing the continuation of the Company's share repurchase
program.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FNB FINANCIAL SERVICES CORPORATION
(Registrant)
August 9, 2004 /s/ Michael W. Shelton
----------------------
Michael W. Shelton
(Senior Vice President,
Chief Financial Officer,
Secretary, and Treasurer)
20