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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20552
--------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________to___________________
Securities Exchange Act Number 0-29040
FIDELITY BANKSHARES, INC.
-------------------------
(Exact name of registrant as specified in its charter)
Delaware 65-0717085
- ----------------------------- --------------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
205 Datura Street, West Palm Beach, Florida 33401
-------------------------------------------------
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (561) 803-9900
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report
Indicate by check |X| whether the Registrant has filed all reports required
to be filed by Sections 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 Securities Exchange Act of 1934. Yes |X| No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDING DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: There were 15,020,202 shares
of the Registrant's common stock par value $0.10 per share outstanding as of
November 1, 2003.
FIDELITY BANKSHARES, INC.
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Interim Financial Statements........................................1
Unaudited Consolidated Statements of Financial Condition as of
December 31, 2002 and September 30, 2003........................2
Unaudited Consolidated Statements of Operations for the three and the
nine months ended September 30, 2002 and 2003...................3
Unaudited Consolidated Statements of Comprehensive Operations for the
three and the nine months ended September 30, 2002 and 2003.....4
Unaudited Consolidated Statements of Cash Flows for the nine months
ended September 30, 2002 and 2003...............................5
Notes to Unaudited Consolidated Financial Statements................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................13
Item 3. Quantitative and Qualitative Disclosure About Market Risk..........18
Item 4. Controls and Procedures............................................21
PART II. OTHER INFORMATION...............................................22
PART I. FINANCIAL INFORMATION
Item I. Financial Statements
FIDELITY BANKSHARES, INC.
- ------------------------------------------------------------------------------------------------------------------------------------
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, September 30,
2002 2003
================= ======================
ASSETS (In thousands, except share and per share
data)
CASH AND CASH EQUIVALENTS:
Cash and amounts due from depository institutions........................ $ 66,178 $ 58,771
Interest-bearing deposits................................................ 63,488 109,042
----------- -----------
Total cash and cash equivalents...................................... 129,666 167,813
----------- -----------
ASSETS AVAILABLE FOR SALE (At Fair Value):
Municipal bonds and government and agency securities..................... 89,879 25,789
Mortgage-backed securities............................................... 109,755 465,660
Corporate debt securities................................................ 35,384 35,438
----------- -----------
Total assets available for sale...................................... 235,018 526,887
LOANS RECEIVABLE, Net......................................................... 1,936,370 2,083,513
OFFICE PROPERTIES AND EQUIPMENT, Net.......................................... 67,784 70,260
FEDERAL HOME LOAN BANK STOCK, At cost, which approximates market.............. 12,919 13,645
REAL ESTATE OWNED, Net........................................................ - 45
ACCRUED INTEREST RECEIVABLE................................................... 9,698 10,563
DEFERRED INCOME TAX ASSET..................................................... 6,785 6,764
OTHER ASSETS 41,157 49,898
----------- -----------
TOTAL ASSETS $ 2,439,397 $ 2,929,388
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
DEPOSITS ..................................................................... $ 1,898,341 $ 2,357,966
OTHER BORROWED FUNDS.......................................................... 44,416 28,725
ADVANCES FROM FEDERAL HOME LOAN BANK.......................................... 253,371 267,746
ADVANCES BY BORROWERS FOR TAXES AND INSURANCE................................. 3,185 21,210
DRAFTS PAYABLE................................................................ 6,181 2,063
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S
JUNIOR SUBORDINATED DEBENTURES........................................... 28,750 28,750
OTHER LIABILITIES............................................................. 36,066 43,084
----------- -----------
TOTAL LIABILITIES........................................................ 2,270,310 2,749,544
----------- -----------
STOCKHOLDERS' EQUITY:
PREFERRED STOCK, 2,000,000 shares authorized, none issued..................... - -
COMMON STOCK ($.10 par value) 30,000,000 authorized shares:
15,869,787 shares issued at December 31, 2002 and
15,020,202 shares issued at September 30, 2003......................... 1,587 1,502
ADDITIONAL PAID IN CAPITAL.................................................... 125,648 106,099
RETAINED EARNINGS - substantially restricted.................................. 77,687 87,763
TREASURY STOCK - at cost, 1,340,420 shares at December 31, 2002 and
310,906 shares at September 30, 2003..................................... (21,705) (1,688)
COMMON STOCK ALLOCATED TO:
Employee stock ownership plan............................................ (4,609) (4,344)
Recognition and retention plan........................................... (5,986) (4,788)
ACCUMULATED OTHER COMPREHENSIVE LOSS.......................................... (3,535) (4,700)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY............................................... 169,087 179,844
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................... $ 2,439,397 $ 2,929,388
============= ============
See Notes to Unaudited Consolidated Financial Statements.
2
FIDELITY BANKSHARES, INC.
- ------------------------------------------------------------------------------------------------------------------------------------
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
For the For the
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2003 2002 2003
==============================================================
(In Thousands, except per share data)
Interest income:
Loans......................................................... $31,441 $ 32,320 $ 91,293 $ 96,056
Investment securities......................................... 775 129 2,789 752
Other investments............................................. 782 419 2,357 1,410
Mortgage-backed and corporate debt securities................. 1,954 2,560 6,493 8,377
------ ----- ---------- ----------
Total interest income..................................... 34,952 35,428 102,932 106,595
------ ------ ---------- ----------
Interest expense:
Deposits...................................................... 10,157 9,728 30,964 29,153
Advances from Federal Home Loan Bank and other borrowings..... 5,470 4,643 16,312 13,914
------ ---------- ---------- ------
Total interest expense.................................... 15,627 14,371 47,276 43,067
------ ---------- ---------- ------
Net interest income................................................ 19,325 21,057 55,656 63,528
Provision for loan losses.......................................... 459 558 1,276 2,041
------ ---------- ---------- ----------
Net interest income after provision for loan losses................ 18,866 20,499 54,380 61,487
------ ---------- ---------- ----------
Other income:
Service charges on deposit accounts........................... 1,884 2,957 5,229 7,061
Fees for other banking services............................... 2,194 2,555 6,175 7,412
Net gain on sale of loans and mortgage-backed securities...... 88 118 131 3,731
Miscellaneous................................................. 271 239 777 696
------ ---------- ---------- ----------
Total other income........................................ 4,437 5,869 12,312 18,900
------ ---------- ---------- ----------
Operating expense:
Employee compensation and benefits............................ 9,875 11,235 27,483 33,635
Occupancy and equipment....................................... 2,954 3,703 8,500 10,534
(Gain)/loss on real estate owned.............................. 1 (7) (120) 27
Marketing..................................................... 531 482 1,420 1,482
Federal deposit insurance premium............................. 75 82 216 236
Miscellaneous................................................. 3,023 3,650 8,990 10,777
------ ---------- ---------- ----------
Total operating expense................................... 16,459 19,145 46,489 56,691
------ ---------- ---------- ----------
Income before provision for income taxes........................... 6,844 7,223 20,203 23,696
------ ---------- ---------- ----------
Provision for income taxes:
Current....................................................... 2,430 2,605 7,242 8,498
Deferred...................................................... 220 233 658 765
------ ---------- ---------- ----------
Total provision for income taxes.......................... 2,650 2,838 7,900 9,263
------ ---------- ---------- ----------
Net income........................................... $ 4,194 $ 4,385 $ 12,303 $ 14,433
======== ========== ========== ==========
Earnings per share:
Basic......................................................... $ 0.28 $ 0.30 $ 0.81 $ 1.00
======== ========== ========== ==========
Diluted....................................................... $ 0.28 $ 0.30 $ 0.81 $ 0.99
======== ========== ========== ==========
See Notes to Unaudited Consolidated Financial Statements.
3
FIDELITY BANKSHARES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
- ------------------------------------------------------------------------------------------------------------------------------------
For the For the
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2003 2002 2003
========================= ==============================
(In Thousands) (In Thousands)
Net Income............................................................$ 4,194 $ 4,385 $ 12,303 $ 14,433
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on assets available for sale:
Unrealized holding gains (losses) arising during (310) (1,063) 844 (1,165)
------------ ----------- ----------- ------------
period
Comprehensive income..................................................$ 3,884 $ 3,322 $ 13,147 $ 13,268
============ ========== =========== ===========
See Notes to Unaudited Consolidated Financial Statements.
4
FIDELITY BANKSHARES, INC.
- ------------------------------------------------------------------------------------------------------------------------------------
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended
September 30,
2002 2003
=========== ==============
(In Thousands)
CASH FLOWS FROM (FOR) OPERATING ACTIVITIES:
Net Income............................................................. $ 12,303 $ 14,433
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation........................................................ 2,715 3,060
ESOP and recognition and retention plan compensation expense........ 1,117 1,796
Accretion of discounts, amortization of premiums and other deferred (2,128) (497)
yield items........................................................
Provision for loan losses........................................... 1,276 2,041
Provisions for losses and net (gains) losses on sales of real estate (123) (29)
owned
Net (gain) loss on sale of:
Loans......................................................... (67) (3,731)
Mortgage-backed securities.................................... (64) -
Office properties and equipment............................... (1) 59
Decrease (increase) in accrued interest receivable.................. 745 (865)
Increase in other assets............................................ (3,643) (8,264)
Decrease in drafts payable.......................................... (6,484) (4,118)
Decrease in deferred income taxes................................... 262 766
Increase in other liabilities....................................... 7,844 6,998
-------- --------
Net cash provided by operating activities..................... 13,752 11,649
-------- --------
CASH FLOW FROM (FOR) INVESTING ACTIVITIES:
Loan originations and principal payments on loans...................... (234,247) (287,480)
Principal payments received on mortgage-backed securities.............. 86,167 223,586
Purchases of:
Loans............................................................... (35,202) (30,988)
Mortgage-backed securities.......................................... (16,952) (584,009)
Federal Home Loan Bank stock........................................ (1,186) (955)
Investment securities............................................... (195,000) (55,104)
Office properties and equipment..................................... (9,126) (6,505)
Proceeds from sales of:
Loans............................................................... 4,615 175,746
Federal Home Loan Bank stock........................................ - 229
Real estate acquired in settlement of loans......................... 991 840
Mortgage-backed securities available for sale....................... 4,456 -
Office properties and equipment..................................... - 550
Proceeds from maturities of municipal bonds and government and agency 169,445 119,000
securities
Purchase of insurance company assets................................... - (191)
Other.................................................................. 186 (518)
-------- ---------
Net cash used for investing activities........................ (225,853) (445,799)
-------- ---------
CASH FLOW FROM (FOR) FINANCING ACTIVITIES:
Proceeds from the sale of common stock and exercise of stock options, 100 308
net of issuance costs..................................................
Purchase of treasury stock............................................. (13,805) (10)
Cash dividends paid.................................................... (4,568) (4,335)
Net increase (decrease) in:
NOW accounts, demand deposits and savings accounts.................. 323,378 517,660
Certificates of deposit............................................. (49,282) (58,035)
Advances from Federal Home Loan Bank................................ 15,677 14,375
Other borrowed funds................................................ 4,618 (15,691)
Advances by borrowers for taxes and insurance....................... 17,243 18,025
-------- --------
Net cash provided by financing activities..................... 293,361 472,297
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS.............................. 81,260 38,147
CASH AND CASH EQUIVALENTS, Beginning of period......................... 96,290 129,666
-------- --------
CASH AND CASH EQUIVALENTS, End of period............................... $177,550 $167,813
======== ========
See Notes to Unaudited Consolidated Financial Statements.
5
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. GENERAL
The accounting and reporting policies of Fidelity Bankshares, Inc. (the
"Company") and its subsidiary Fidelity Federal Bank & Trust (the "Bank") conform
to accounting principles generally accepted in the United States of America and
to predominant practices within the thrift industry. The Company has not changed
its accounting and reporting policies from those disclosed in its 2002 Annual
Report on Form 10-K.
The Company conducts no significant business other than holding the common stock
of the Bank. Consequently, its net income is derived from the operations of the
Bank. In the opinion of the Company's management, all adjustments necessary to
fairly present the consolidated financial position of the Company at September
30, 2003 and the results of its consolidated operations and cash flows for the
period then ended, all of which are of a normal and recurring nature, have been
included.
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure, an amendment of FASB
Statement No. 123" to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
provisions of Statement 148 became effective for interim periods beginning after
December 15, 2002. See note 2 - Stock Options, in the unaudited consolidated
financial statements.
In November 2002, the FASB issued Interpretation ("FIN") No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". This interpretation requires elaborating
on the disclosures that must be made by a guarantor in its interim and annual
financial statements about its obligations under certain guarantees that it has
issued. It also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The disclosure requirements of this
Interpretation became effective for statements issued after December 15, 2002
and its recognition requirements are applicable for guarantees issued or
modified after December 31, 2002. The adoption of this statement did not have a
material impact on the Company's financial statements.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities." This Interpretation addresses consolidation by
business enterprises of variable interest entities (VIEs). A VIE is subject to
the consolidation provisions of FIN 46 if, by design, it cannot support its
financial activities without additional subordinated financial support from
other parties and does not have equity investors which as a group have the
ability to make decisions about its activities through voting rights. FIN 46
requires a VIE to be consolidated by its primary beneficiary. The primary
beneficiary is the party that holds variable interests that expose it to a
majority of the entity's expected losses and/or residual returns. The
application of this Interpretation was immediate for VIE's created after January
31, 2003. On October 9, 2003, the FASB deferred the implementation date of FIN
46 until the fourth quarter of 2003 for variable interest entities that existed
prior to February 1, 2003.
Along with other companies and the accounting industry, the Company is
evaluating and interpreting the potential impact of FIN 46 on the accounting for
its Guaranteed Preferred Beneficial Interests in Company Debentures as well as
the continued consolidation of the statutory business trust that issued these
secruities. The Preferred Securities were issued out of a grantor trust,
Fidelity Capital Trust I, a Delaware statutory trust, which was created by the
Company for the sole purpose of issuing the Preferred Securities and is 100%
owned by the Company. In July 2003, the Federal Reserve Board issued a
supervisory letter indicating that Trust-Preferred Securities currently will
continue to qualify as Tier 1 capital for regulatory purposes until further
notice. The Federal Reserve Board has also stated that it will continue to
review the regulatory implications of any accounting treatment changes and will
provide further guidance, if necessary. No other impact of significance on the
Company's results of operations or financial condition is expected from this
6
Interpretation. However, the FASB staff and the accounting industry continue to
address specific interpretative and implementation issues regarding this
Interpretation. The results of these actions could change the Company's
assessment of the impact of the Interpretation.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity". This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). This Statement is effective
for financial instruments entered into or modified after May 30, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The implementation of SFAS No. 150 has had no material
impact on our consolidated financial statements.
Certain amounts in the financial statements have been reclassified to conform
with the September 30, 2003 presentation.
2. STOCK OPTION PLANS
At September 30, 2003, the Company has three stock-based compensation plans. The
Company accounts for these plans using the intrinsic value method. Accordingly,
no stock option-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 based method to stock-based employee compensation.
For the For the
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2003 2002 2003
=========================== ============= ===============
(In Thousands) (In Thousands)
Net Income, as reported............................................... $ 4,194 $ 4,385 $ 12,303 $ 14,433
Add: Total stock-based employee compensation expense
included in reported net earnings, net of related tax effects..... 249 231 360 731
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects....................... (374) (376) (536) (1,126)
------- --------- -------- ---------
Pro forma net income.................................................. $ 4,069 $ 4,240 $ 12,127 $ 14,038
======= ========== =========== =========
Basic - as reported................................................ 0.28 0.30 0.81 1.00
Basic - pro forma.................................................. 0.27 0.29 0.80 0.97
Diluted - as reported.............................................. 0.28 0.30 0.81 0.99
Diluted - pro forma................................................ 0.27 0.29 0.80 0.96
The Company has reserved 550,237 shares of common stock under the 1994 Incentive
Stock Option Plan. The plan provides for the granting of options to key
employees until it expires on January 6, 2004. All options were granted at the
closing price on the date of grant and were exercisable at a rate of twenty
percent per year, not to exceed ten years. At September 30, 2002 and 2003 there
were 65,797 and 4,956 options outstanding and exercisable. Unexercised options
expire on January 6, 2004.
The Company has reserved 183,410 shares of common stock under the 1994 Stock
Option Plan for Outside Directors. The plan provides for the granting of options
to directors until it expires on January 6, 2004. All options were granted at
the closing price on the date of grant and are exercisable at any time up to ten
years. At September 30, 2002 and 2003 there were 91,837 and 29,332 options
outstanding and exercisable. Unexercised options expire on January 6, 2004.
7
On May 21, 2002, the Company adopted and stockholders approved the 2002
Incentive Stock Benefit Plan. Under the 2002 plan, the Company has reserved
869,594 shares of common stock, of which options to purchase 829,950 shares were
granted to key employees and outside directors on that day. Simultaneously with
the grant of any Stock Option to a participant, the plan allows for the Stock
Option committee to grant a Reload Option with respect to all or some of the
shares covered by such Stock Option. A Reload Option may be granted to a
participant who satisfies all or part of the exercise price of the stock option
with shares of common stock. The Reload Option represents an additional Stock
Option to acquire the same number of shares of Common Stock used by the
participant to pay for the original Stock Option. Any shares that are used for
payment of the exercise price of any stock option in connection with a Reload
Option will not be counted as issued under the plan and will be available for
future grants under the plan. Also, unvested Stock Options which are forfeited
due to termination of employment are also added to the outstanding Stock Options
available for future grants. The Stock Benefit Plan is effective for ten years
from the date of adoption. All Stock Options granted become fully vested over a
period not to exceed five years from the date of grant. At September 30, 2003,
41,444 options remained available for grant.
3. LOANS RECEIVABLE
Loans receivable at December 31, 2002 and September 30, 2003, consist of the
following:
December 31, September 30,
2002 2003
============== =============
(In Thousands)
One-to-four single family, residential real estate mortgages......... $1,062,956 $1,001,544
Commercial and multi-family real estate mortgages.................... 459,425 651,704
Real estate construction-primarily residential....................... 364,346 435,333
Land loans-primarily residential..................................... 29,181 32,088
---------- ----------
Total first mortgage loans........................................... 1,915,908 2,120,669
Consumer loans....................................................... 141,343 167,906
Commercial business loans............................................ 146,205 125,190
---------- ----------
Total gross loans.................................................... 2,203,456 2,413,765
Less:
Undisbursed portion of loans in process......................... 260,380 318,918
Unearned discounts, premiums and deferred loan fees (costs), net (1,612) 1,292
Allowance for loan losses....................................... 8,318 10,042
---------- ----------
Loans receivable-net................................................. $1,936,370 $2,083,513
========== ==========
During the quarter ended September 30, 2003, the Company sold $44.6 million in
loans, which resulted in net gains of approximately $118,000. The Company has
initiated a loan sales program to provide additional other income, reduce
interest rate risk and as a capital management tool. At September 30, 2003, the
Company held, at fair value, $9.8 million in loans available for sale.
8
4. ALLOWANCE FOR LOAN LOSSES
An analysis of the changes in the allowance for loan losses for the year ended
December 31, 2002 and the three and nine month periods ended September 30, 2002
and 2003, is as follows:
For the Year For the Three Months For the Nine Months
Ended Ended Ended
December 31, September 30, September 30,
2002 2002 2003 2002 2003
==================== =========================== ===========================
(In Thousands) (In Thousands) (In Thousands)
Balance at beginning of period...... $ 6,847 $ 7,441 $ 9,730 $ 6,848 $ 8,318
Current provision................... 1,986 459 558 1,276 2,041
Charge-offs......................... (575) (68) (246) (307) (317)
Recoveries.......................... 60 28 - 44 -
------------ ----------- ----------- ----------- ----------
Ending balance...................... $ 8,318 $ 7,860 $ 10,042 $ 7,860 $ $10,042
============ ============ =========== =========== ==========
An analysis of the recorded investment in impaired loans owned by the Company at
the end of each period and the related specific valuation allowance for those
loans is as follows:
December 31, 2002 September 30, 2003
=========================== ============================
Loan Related Loan Related
Balance Allowance Balance Allowance
------------- ------------- -------------- -------------
(In Thousands)
Impaired loan balances and related allowances:
Loans with related allowance for loan losses................ $ 1,145 $ 546 $ 1,394 $ 297
Loans without related allowance for loan losses............. 7,248 - 8,587 -
-------- -------- -------- --------
Total.............................................. $ 8,393 $ 546 $ 9,981 $ 297
======== ======== ======== ========
The Bank's policy for the accounting of interest income on impaired loans is to
reverse all accrued interest against interest income if a loan becomes more than
90 days delinquent and cease accruing interest thereafter. Such interest
ultimately collected is credited to income in the period of recovery.
5. DEPOSITS
The weighted-average interest rates on deposits at December 31, 2002 and
September 30, 2003 were 1.95% and 1.61%, respectively. Deposit accounts, by type
at December 31, 2002 and September 30, 2003 consist of the following:
December 31, September 30,
Account Type and Rate 2002 2003
========= ==============
(In Thousands)
Non-interest-bearing checking accounts..................... $209,695 $254,136
Interest-bearing checking and funds transfer accounts...... 388,179 513,570
Passbook and statement accounts............................ 340,709 593,214
Variable-rate money market accounts........................ 192,003 287,326
Certificates of deposit.................................... 767,755 709,720
---------- ----------
Total...................................................... $1,898,341 $2,357,966
========== ==========
9
6. REGULATORY CAPITAL
The Company's subsidiary, Fidelity Federal Bank & Trust, is a regulated
financial institution. Its regulatory capital amounts and ratios are presented
in the following table:
To be Considered
Minimum for Well Capitalized
Capital Adequacy for Prompt Corrective
Actual Purposes Action Provisions
------------ ------------ -------------- ------------- ------------- --------------
Ratio Amount Ratio Amount Ratio Amount
------------ ------------ -------------- ------------- ------------- --------------
(Dollars in Thousands)
As of December 31, 2002 Stockholders'
Equity and ratio to total assets 7.7% $187,501
========
Unrealized decrease in market value
of assets available for sale
(net of applicable income taxes) 2,084
Goodwill............................. (2,175)
Disallowed servicing assets.......... (8)
--------
Tangible capital and ratio to
adjusted total assets........... 7.7% $187,402 1.5% $ 38,613
======== ======== ====== =========
Tier I (core) capital and ratio to
adjusted total assets........... 7.7% $187,402 3.0% $ 73,227 5.0% $ 122,044
======== ======== ====== ========= ====== =========
Tier I (core) capital and ratio to
risk-weighted total assets...... 10.6% $187,402 4.0% $ 70,861 6.0% $ 106,291
======== ======== ====== ========= ====== =========
Allowable Tier 2 capital:
General loan valuation allowances ... 7,679
--------
Total risk-based capital and ratio to
risk-weighted total assets...... 11.0% $195,081 8.0% $ 141,721 10.0% $ 177,152
======== ======== ====== ========= ====== =========
Total assets......................... $2,439,654
==========
Adjusted total assets................ $2,440,887
==========
Risk-weighted assets................. $1,771,518
==========
As of September 30, 2003
Stockholders' Equity and ratio 6.8% $199,550
========
to total assets.................
Unrealized decrease in market value
of assets available for sale
(net of applicable income taxes) 3,248
Goodwill............................. (5,281)
Disallowed servicing assets.......... (108)
--------
Tangible capital and ratio to
adjusted total assets........... 6.7% $197,409 1.5% $ 43,915
======== ======== ====== =========
Tier I (core) capital and ratio to
adjusted total assets........... 6.7% $197,409 3.0% $ 87,829 5.0% $ 146,382
======== ======== ====== ========= ====== =========
Tier I (core) capital and ratio to
risk-weighted total assets...... 9.8% $197,409 4.0% $ 80,622 6.0% $ 120,934
======== ======== ====== ========= ====== =========
Allowable Tier 2 capital:
General loan valuation allowances ... 9,529
--------
Total risk-based capital and ratio to
risk-weighted total assets...... 10.3% $206,938 8.0% $ 161,245 10.0% $ 201,556
======== ======== ====== ========= ====== =========
Total assets......................... $2,927,711
==========
Adjusted total assets................ $2,927,647
==========
Risk-weighted assets................. $2,015,559
==========
10
7. EARNINGS PER SHARE
The weighted-average number of shares used to calculate basic and diluted
earning per share, including the adjustments for the stock options, for the
three and the nine month periods ended September 30, 2002 and 2003, are as
follows:
For the Three Months For the Three Months Ended
Ended September 30, 2003
September 30, 2002
----------------------------------- ---------------------------------------
Income Shares Per-Share Income Shares Per-Share
Numerator Denominator Amount Numerator Denominator Amount
===========================================================================
(Dollars In Thousands, except per share data)
Net income................. $ 4,194,000 $4,385,000
Basic EPS:
Mortgage loans.............
Income available to
common stockholders... $ 4,194,000 14,797,646 $ 0.28 $4,385,000 14,554,241 $ 0.30
======= ========
Effect of diluted shares:
Common stock options.. 142,198 244,060
----------- ------------
Diluted EPS:
Income available to
common stockholders... $ 4,194,000 14,939,844 $ 0.28 $4,385,000 14,798,301 $ 0.30
=========== ============ ======= ========== ============ ========
For the Nine Months Ended For the Nine Months Ended
September 30, 2002 September 30, 2003
---------------------------------------------------------------------------
Income Shares Per-Share Income Shares Per-Share
Numerator Denominator Amount Numerator Denominator Amount
============================================================================
(Dollars In Thousands, except per share data)
Net income................. $ 12,303,000 $14,433,000
Basic EPS:
Income available to
common stockholders... $ 12,303,000 15,111,972 $ 0.81 $14,433,000 14,474,561 $ 1.00
======= =========
Effect of diluted shares:
Common stock options.. 102,683 117,717
---------- ------------
Diluted EPS:
Income available to
common stockholders... $ 12,303,000 15,214,655 $ 0.81 $14,433,000 14,592,278 $ 0.99
============ ========== ======== =========== ============ =========
ESOP shares that have not been committed to be released are not considered to be
outstanding.
8. OTHER COMPREHENSIVE INCOME (LOSS)
An analysis of the changes in Accumulated Other Comprehensive Loss for the
periods ended September 30, 2002 and 2003, is as follows:
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
2002 2003 2002 2003
--------------------------- ---------------------------
Unrealized Unrealized
Losses Losses
On Securities On Securities
=========================== ============================
(In Thousands)
Beginning Balance............... $ (850) $ (3,637) $ (2,004) $ (3,535)
Current-period change........... (310) (1,063) 844 (1,165)
----------- --------- ---------- ----------
-------
Ending balance.................. $ (1,160) $ (4,700) $ (1,160) $ (4,700)
=========== ========== ============ ==========
11
An analysis of the related tax effects allocated to Other Comprehensive Income
(Loss) is as follows:
For the Three Months Ended For the Three Months Ended
September 30, 2002 September 30, 2003
------------------------------------ -----------------------------------
Tax Tax
Before-tax (Expense) Net-of-Tax Before-tax (Expense) Net-of-Tax
Amount Benefit Amount Amount Benefit Amount
=========== ============ =========== == =========== =========== ===========
(In Thousands)
Unrealized gains (losses) on assets available for sale:
Unrealized holding gains
(losses) arising during period $ (508) $ 198 $ (310) $(1,742) $ 679 $(1,063)
======== ======= ======== ======== ======= =======
For the Nine Months Ended For the Nine Months Ended
September 30, 2002 September 30, 2003
------------------------------------ -----------------------------------
Tax Tax
Before-tax (Expense) Net-of-Tax Before-tax (Expense) Net-of-Tax
Amount Benefit Amount Amount Benefit Amount
=========== ============ =========== == =========== =========== ===========
(In Thousands)
Unrealized gains (losses) on assets available for sale:
Unrealized holding gains
(losses) arising during period $ 1,384 $ (540) $ 844 $ (1,910) $ 745 $ (1,165)
======= ======== ======= =========== ======== ===========
9. CONTINGENCIES
On July 1, 2003, Fidelity Federal Bank & Trust was named as defendant in the
lawsuit, James Kehoe v. Fidelity Federal Bank & Trust, filed in the United
States District Court for the Southern District of Florida. In this action,
James Kehoe ("Kehoe"), on behalf of himself and other similarly situated
persons, has alleged that the Bank violated the Driver Privacy Protection Act by
obtaining driver registration information from the State of Florida for use in
its marketing efforts. Kehoe seeks as damages the statutory minimum of $2,500
per violation. As a result of Kehoe's suing on behalf of a class of plaintiffs,
the potential award, should Kehoe prevail, would be material. Kehoe alleges in
his motion for class certification that the class consists of over 500,000
individuals where personal information was obtained from the Florida Division of
Highway Safety & Motor Vehicles. On August 22, 2003, the Bank filed a motion to
dismiss or in the alternative a motion for summary judgment. On October 31,
2003, Kehoe filed its response in opposition to the motion and discovery has not
yet commenced. The Bank, in consultation with counsel, has concluded that the
lawsuit is without merit and the Bank intends to vigorously defend against
Kehoe's claim.
12
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General.
Fidelity Bankshares, Inc. (the "Company") is the parent company of Fidelity
Federal Bank & Trust ("Fidelity Federal" or the "Bank"). The Company conducts no
business other than holding the common stock of the Bank. Consequently, the
Company's net income is primarily derived from the Bank. The Bank's net income
is primarily dependent on its net interest income, which is the difference
between interest income earned on its investments in mortgage loans and
mortgage-backed securities, other investment securities and loans, and its cost
of funds consisting of interest paid on deposits and borrowings. The Bank's net
income also is affected by its provision for loan losses, as well as by the
amount of other income, including income from fees and service charges, net
gains and losses on sales of investments, and operating expense such as employee
compensation and benefits, deposit insurance premiums, occupancy and equipment
costs, and income taxes. Earnings of the Bank also are affected significantly by
general economic and competitive conditions, particularly changes in market
interest rates, government policies and actions of regulatory authorities, which
events are beyond the control of the Bank. In particular, the general level of
market interest rates tends to be highly cyclical.
Forward-Looking Statements.
When used in this report, the words or phrases "will likely result," "are
expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, including, among
other things, changes in economic conditions in the Company's market area,
changes in policies by regulatory agencies, fluctuations in interest rates,
demand for loans in the Company's market area and competition that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. The Company wishes to caution readers not to place
undue reliance on any such forward-looking statements, which speak only as of
the date made. The Company wishes to advise readers that the factors listed
above could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
Other Comprehensive Operations.
The Company's only component of Other Comprehensive Operations for the three and
the nine months ended September 30, 2003 and 2002 is the change in the
unrealized gain or loss on assets available for sale.
Other comprehensive loss for the nine months ended September 30, 2003 was $1.2
million compared to other comprehensive income of $844,000 for the nine months
ended September 30, 2002. During the nine months ended September 30, 2003, the
market value of the Company's assets available for sale decreased by $1.9
million, which net of income tax benefit of $745,000 resulted in other
comprehensive loss of $1.2 million. During the nine months ended September 30,
2002, the value of the Company's assets available for sale increased by $1.4
million, which net of $540,000 in income tax expense resulted in other
comprehensive income of $844,000.
Other comprehensive loss for the quarter ended September 30, 2003 was $1.1
million compared to other comprehensive loss of $310,000 for the quarter ended
September 30, 2002. During the quarter ended September 30, 2003, the market
value of the Company's assets available for sale decreased by $1.7 million,
which net of income tax benefit of $679,000 resulted in other comprehensive loss
of $1.1 million. During the quarter ended September 30, 2002, the value of the
Company's assets available for sale decreased by $508,000 which net of $198,000
in income tax benefit resulted in other comprehensive loss of $310,000.
13
Changes in Financial Condition.
The Company's assets increased by $490.0 million to $2.9 billion at September
30, 2003 from $2.4 billion at December 31, 2002. Net loans receivable increased
by $147.1 million, while cash and assets available for sale increased by $330.0
million. Through September 30, 2003, the Company's portfolio of commercial and
multi-family mortgage loans has increased by $192.3 million, while commercial
business loans and consumer loans have increased, in the aggregate, by $5.5
million. The residential mortgage loan portfolio has decreased by approximately
$12.5 million, largely due to the commencement of the Company's loan sales into
the secondary market during 2003, but also due to substantial prepayments of
loans in the Company's portfolio. As a result, the Company's loan portfolio has
grown only modestly. However, the Company's deposits have continued to grow
substantially. Accordingly, the Company increased its investment in assets
available for sale and interest earning cash balances. In addition, the Company
increased its investment in office properties and equipment, primarily for new
office sites, by $2.5 million, while all other assets increased by $10.4
million. Funds for the increase in assets were provided primarily as a result of
an increase in deposits of $459.6 million, together with increases in all other
liabilities in the amount of $19.6 million, of which advances from Federal Home
Loan Bank were $14.4 million. In addition to these increases in liabilities,
equity increased by $10.8 million to $179.8 million at September 30, 2003 from
$169.1 million at December 31, 2002 resulting mainly from net income for the
nine months of $14.4 million which was offset by dividends declared of $2.9
million.
Results of Operations.
Net income for the nine months ended September 30, 2003 was $14.4 million, a
$2.1 million increase compared to $12.3 million for the same 2002 period. This
increase was attributable to an increase in net interest income of $7.9 million
along with an increase in other income of $6.6 million. The increase in net
interest income resulted from an increase in interest income of $3.7 million
along with a decrease in interest expense of $4.2 million. The increase in other
income included a gain on the sale of loans of $3.7 million for the nine months
ended September 30, 2003. Offsetting these increases in income were increases in
loan loss provisions of $765,000, increases in operating expenses of $10.2
million and increases in the provision for income taxes of $1.4 million for the
nine months ended September 30, 2003 compared to the nine months ended September
30, 2002.
Net income for the quarter ended September 30, 2003 was $4.4 million, an
$191,000 increase compared to $4.2 million for the same 2002 quarter. This
increase was attributable to an increase of $1.7 million in net interest income
together with an increase in other income of $1.4 million. The increase in net
interest income resulted primarily from a decrease in interest expense of $1.3
million along with an increase in interest income of $476,000. Offsetting these
increases were an increase in operating expenses of $2.7 million and an increase
in the provision for income taxes of $188,000 for the quarter ended September
30, 2003 compared to the quarter ended September 30, 2002.
Interest Income.
Interest income for the nine months ended September 30, 2003, totaled $106.6
million, representing an increase of $3.7 million or 3.6% compared to the same
period in 2002. Interest income from loans increased by $4.8 million, primarily
as a result of a 17.9% increase in the average balance of loans to $2.0 billion
from $1.7 billion for the nine months ended September 30, 2003 and 2002,
respectively. This increase was substantially offset by a decline in the average
yield on loans. Interest income from mortgage-backed and corporate debt
securities increased to $8.4 million for the nine months ended September 30,
2003 from $6.5 million for the 2002 period. This increase was due to an increase
in the average balance of such securities of $167.0 million, partially offset by
a decrease in the average yield of these securities to 3.00% in 2003 from 4.22%
in 2002. There was a decline in interest income from investment securities of
$2.0 million resulting from a decrease in the average yield of these securities
to 2.24% from 3.45%, as well as a decrease in the average balance of such
securities to $44.6 million for the nine months ended September 30, 2003 from
$107.8 million for the nine months ended September 30, 2002. Interest income on
other investments also decreased by $946,000 due to a decrease in the average
balance on these investments to $130.9 million from $147.8 million and a decline
in the average yield to 1.44% from 2.13% for the periods ended September 30,
2003 and 2002, respectively.
14
Interest income for the quarter ended September 30, 2003, totaled $35.4 million,
representing an increase of $476,000 or 1.4% compared to the same quarter in
2002. Interest income from loans increased by $879,000, primarily as a result of
a 15.9% increase in the average balance of loans to $2.1 billion from $1.8
billion for the quarters ended September 30, 2003 and 2002, respectively. While
the average balances of loans increased, the benefits of this increase were
substantially offset by a decline in their yields. Interest income from
mortgage-backed and corporate debt securities increased to $2.6 million for the
quarter ended September 30, 2003 from $2.0 million for the 2002 quarter. This
increase resulted from a 163.0% increase in the average balance of such
securities to $482.7 million from $183.5 million, substantially offset by a
decrease in the average yield of these securities to 2.12% for the quarter ended
September 30, 2003 from 4.26% for the quarter ended September 30, 2002. A
substantial portion of the decline in average yield on the mortgage-backed
securities is attributable to accelerated amortization of premiums paid on these
securities as a result of prepayments of the underlying loans. There was a
decline in interest income from investment securities of $647,000 resulting from
a decrease in the average balance of such securities to $20.9 million from
$100.0 million, along with a decrease in the average yield of these securities
to 2.45% for the quarter ended September 30, 2003 from 3.10% for the quarter
ended September 30, 2002. Interest income on other investments also decreased by
$363,000 due partially to a decrease in the average balance on these investments
to $142.1 million from $147.8 million, but mainly from a decrease in yield to
1.18% from 2.12% for the quarters ended September 30, 2003 and 2002,
respectively.
Interest Expense.
Interest expense for the nine months ended September 30, 2003, totaled $43.1
million, a decrease of $4.2 million or 8.9% from the same period in 2002. The
principal cause for this decline was a decrease in interest expense on deposits
of $1.8 million. While the average balance of deposits increased to $2.2 billion
for the nine months ended September 30, 2003 compared to $1.7 billion for the
nine months ended September 30, 2002, the cost of those deposits declined to
1.79% compared to 2.40% for the comparative period. The decline in the cost of
deposits had two principal causes: (a) the Bank's core deposits, which consist
of lower costing interest-bearing and non interest-bearing transaction accounts,
money market accounts and passbook accounts increasing as a percentage of total
deposits to 69.9% at September 30, 2003 from 56.3% at September 30, 2002, and
(b) the majority of the Bank's maturing certificates of deposit repricing in a
lower rate environment. Interest expense on borrowed funds decreased by $2.4
million caused primarily due to a decrease in the average balance of such funds
to $335.6 million from $376.6 million and a decrease in the average cost of
borrowed funds to 5.53% for the nine months ended September 30, 2003 from 5.77%
for the comparable 2002 period.
Interest expense for the quarter ended September 30, 2003, totaled $14.4
million, a decrease of $1.3 million or 8.0% from the same quarter in 2002. The
principal cause for this decline was a decrease in interest expense on deposits
of $429,000. While the average balance of deposits increased to $2.3 billion for
the quarter ended September 30, 2003 compared to $1.8 billion for the quarter
ended September 30, 2002, the cost of those deposits declined to 1.67% compared
to 2.29% for the comparative quarter. The decline in the cost of deposits had
two principal causes as described in the preceding paragraph. Interest expense
on borrowed funds also decreased by $827,000 caused primarily by a decrease in
the average balance of such funds to $332.2 million from $376.9 million and a
decrease in the average cost of borrowed funds to 5.59% for the quarter ended
September 30, 2003 from 5.81% for the comparable 2002 quarter.
Net Interest Income.
During the nine months ended September 30, 2003, the Company's interest income
increased by $3.7 million compared to the same period in 2002, while interest
expense decreased by $4.2 million, resulting in net interest income of $63.5
million for the nine months ended September 30, 2003, a $7.9 million or, 14.1%
increase from the nine months ended September 30, 2002.
During the quarter ended September 30, 2003, the Company's interest income
increased by $476,000 compared to the same quarter in 2002, while interest
expense decreased by $1.3 million, resulting in net interest income of $21.1
million for the quarter ended September 30, 2003, a $1.7 million or, 9.0%
increase from the quarter ended September 30, 2002.
15
Provision for Loan Losses.
The provision for loan losses was $2.0 million for the nine months ended
September 30, 2003, compared to $1.3 million for the nine months ended September
30, 2002. The provision for the nine months ended September 30, 2003 is deemed
adequate by management in light of the risks known and inherent in the Bank's
loan portfolio.
The provision for loan losses was $558,000 for the quarter ended September 30,
2003, compared to $459,000 for the quarter ended September 30, 2002. The
provision for the quarter ended September 30, 2003 is deemed adequate by
management in light of the risks inherent in the Bank's loan portfolio.
Our financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America and, accordingly, allowances
for loan losses are based on management's estimate of the losses inherent in the
loan portfolio. We provide both general valuation allowances (for unspecified,
probable losses) and specific valuation allowances (for known losses) in our
loan portfolio. General valuation allowances are added to the Bank's capital for
purposes of computing the Bank's regulatory risk-based capital. We regularly
review our loan portfolio, including impaired loans, to determine whether any
loans require classification or the establishment of appropriate valuation
allowances. Since we are increasing our origination of commercial business loans
and commercial real estate mortgages and since such loans are deemed to have
more credit risk than residential mortgage loans, our provision for loan losses
is likely to increase in future periods.
Other Income.
Other income for the nine months ended September 30, 2003 was $18.9 million,
representing an increase of $6.6 million compared to the same period in 2002.
This increase is principally due to an increase in net gain on sale of loans of
$3.7 million, resulting directly from the sale of $172.0 million in loans in the
nine months ended September 30, 2003. These sales included a gain of $1.5
million on the sale of approximately $50.0 million of loans from the existing
portfolio, which occurred during the first quarter of 2003. The balance of loan
sales of $122.0 million generated $2.2 million in net gain, resulting from the
Company's commencement of loan sales into the secondary markets during 2003. The
Company has initiated the loan sales program to provide additional non interest
income, reduce interest rate risk and as a capital management tool. Also
contributing to the increase in other income were an increase in fees for other
banking services of $1.2 million to $7.4 million from $6.2 million and an
increase in service charges on deposit accounts of $1.8 million to $7.1 million
from $5.2 million for the nine months ended September 30, 2003 and 2002,
respectively.
Other income for the quarter ended September 30, 2003 was $5.9 million,
representing an increase of $1.4 million compared to the same quarter in 2002.
This increase is principally due to an increase in other income from fees for
other banking services of $361,000 to $2.6 million from $2.2 million and
increases in service charges on deposit accounts of $1.1 million to $3.0 million
from $1.9 million for the quarters ended September 30, 2003 and 2002,
respectively.
Operating Expense.
Operating expense increased by $10.2 million to $56.7 million for the nine
months ended September 30, 2003 when compared to the same nine month period in
2002. Of this increase, $6.2 million is attributable to employee compensation
and benefits expense. Increases in employee compensation and benefits expense
were primarily attributable to an $1.2 million increase in medical benefits
costs, a $841,000 increase in the Company's defined benefit retirement plan
costs, and a $678,000 increase in stockholder approved stock based compensation.
The remainder of the increase in compensation costs are principally due to
additional personnel to staff new offices, compensation for expansion of the
company's lending and other income production activities, increased incentive
compensation due to increased profitability, together with normal salary
increases. The increase of $2.0 million in occupancy and equipment costs
reflects the Company's continued expansion of offices and investment in
technology to better serve its customers. Miscellaneous operating costs
increased by $1.8 million due mainly to operating the new customer service
facilities.
16
Compared to the quarter ending September 30, 2002, operating expense for the
quarter ending September 30, 2003 increased by $2.7 million to $19.1 million. Of
this increase, $1.4 million is attributable to employee compensation and
benefits. Increases in employee compensation and benefits expense were primarily
attributable to an $331,000 increase in medical benefits costs and a $257,000
increase in the Company's defined benefit retirement plan costs. The remainder
of the increase in compensation costs is due to incentive compensation as a
result of increased profitability, additional personnel to serve deposit and
loan customers, as well as production of increased fee based income, together
with normal salary increases. Occupancy and equipment costs and miscellaneous
operating costs increased by $749,000 and $627,000, respectively reflecting the
operation of new customer service facilities.
Income Taxes.
The income tax provision was $9.3 million for the nine months ended September
30, 2003 compared to $7.9 million for the nine months ended September 30, 2002.
The provision reflects the current rates paid for Federal and State income taxes
applied to the Company's pre-tax income.
The income tax provision was $2.8 million for the quarter ended September 30,
2003 compared to $2.7 million for the quarter ended September 30, 2002. The
provision reflects the current rates paid for Federal and State income taxes
applied to the Company's pre-tax income.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Market Risk Analysis.
As a holding company for a financial institution, the Company's primary
component of Market Value market risk is interest rate of Portfolio volatility.
Fluctuations in Equity interest rates will ultimately impact both the level of
income and expense recorded on a large portion of the Bank's assets and
liabilities, and the market value of all interest-earning assets and
interest-bearing liabilities, other than those which possess a short term to
maturity. Since the majority of the Company's interest-bearing liabilities and
nearly all of the Company's interest-earning assets are held by the Bank,
virtually all of the Company's interest rate risk exposure lies at the Bank
level. As a result, all significant interest rate risk management procedures are
performed by management of the Bank. Based upon the nature of the Bank's
operations, the Bank is not subject to foreign currency exchange or commodity
price risk. The Bank's loan portfolio is concentrated primarily in Palm Beach,
Martin and Broward Counties in Florida and is therefore subject to risks
associated with the local economy. As of September 30, 2003, the Company does
not own any trading assets other than $1.2 million of assets held by the SMPIAP
Trust which can be actively traded by and are held for the benefit of senior
management. Income in these accounts accrues to and losses are solely absorbed
by senior management. At September 30, 2003, the Company does not have any
hedging transactions in place such as interest rate swaps and caps.
Asset and Liability Management-Interest Rate Sensitivity Analysis.
The majority of the Company's assets and liabilities are monetary in nature
which subjects the Company to significant interest rate risk. As stated above,
the majority of the Company's interest-earning assets and interest-bearing
liabilities are held by the Bank and therefore virtually all of the Company's
interest rate risk exposure lies at the Bank level.
The Bank monitors interest rate risk by various methods including analyzing
changes in its Market Value of Portfolio Equity ("MVPE"). MVPE is generally
defined as the difference between the market value of the Bank's assets and the
market value of the Bank's liabilities. The Bank uses an internal model that
generates estimates of the Bank's MVPE over a range of interest rate scenarios.
The model calculates MVPE essentially by discounting the cash flows from the
Bank's assets and liabilities to present value using current market rates and
adjusting those discount rates accordingly for various interest rate scenarios.
17
The following table sets forth the Bank's estimated internal calculations of
MVPE as of September 30, 2003.
Changes in Rates Market Value of Portfolio Equity
(Rate Shock) $ Amount $ Change % Change
============ ========== ============= =================
(Dollars in Thousands)
+200bp $ 298,836 $ (52,212) (14.9)%
+100bp 338,394 (12,654) ( 3.6)%
-0- 351,048 0 0.0%
-100bp 300,465 (50,583) (14.4)%
In preparing the MVPE table above, the Company makes various assumptions to
determine the net portfolio value at the assumed changes in interest rate. These
assumptions include loan prepayment rates, deposit decay rates and market values
of certain assets and liabilities under the various interest rate scenarios.
While management believes these assumptions to be reasonable there can be no
assurance that our assets and liabilities would be impacted as indicated in the
table above. Certain shortcomings are inherent in any methodology used in
interest rate risk measurements. Modeling changes in MVPE requires the making of
certain assumptions that may or may not reflect how actual yields and costs
respond to changes in market rates. For example, although certain assets and
liabilities may have similar maturities or periods to repricing, they may react
in different degrees to changes in market interest rates. Also, interest rates
on certain types of assets and liabilities may fluctuate in advance of or lag
behind changes in market interest rates. Additionally, certain assets, such as
ARM loans, have features that restrict changes in interest rates on a short-term
basis and over the life of the assets. Moreover, in the event of a change in
interest rates, prepayment and early withdrawal levels may possibly deviate
significantly from those assumed in calculating the above table. Management has
also made estimates of fair value discount rates that it believes to be
reasonable. However, due to the fact that there is no quoted market for many of
the assets and liabilities, management has no definitive basis to determine
whether the fair values presented would be indicative of the value negotiated in
an actual sale.
Accordingly, while the above table provides an estimate of the Bank's interest
rate risk exposure at a particular point in time, it is not intended to provide
a precise forecast of the effect of market changes on the Bank's MVPE and net
interest income, as actual results may vary.
Under OTS risk-based capital regulations, savings associations are required to
calculate the MVPE. These calculations are based upon data concerning
interest-earning assets, interest-bearing liabilities and other rate sensitive
assets and liabilities provided to the OTS on schedule CMR of the quarterly
Thrift Financial Report. Commencing September 30, 1994, for purposes of
measuring interest rate risk, the OTS began using the MVPE calculations which
essentially discount the cash flows from an institution's assets and liabilities
to present value, using current market rates. There are differences between the
Bank's internal assumptions used to calculate the previously presented MVPE and
those used by the OTS. For example, the Bank's internally calculated decay rates
for certain NOW, passbook and money market accounts produces an average expected
life for these instruments which is longer than the average expected life using
the OTS standard assumptions for these same instruments. Accordingly, the Bank's
previously presented MVPE calculations are not representative of those that
would be produced by the OTS.
The Bank's policy in recent years has been to reduce its exposure to interest
rate risk generally by better matching the maturities of its interest rate
sensitive assets and liabilities and by originating ARM loans and other
adjustable rate or short-term loans, as well as by purchasing short-term
investments. However, particularly in a low interest rate environment, borrowers
typically prefer fixed rate loans to ARM loans. The Bank does not solicit
high-rate jumbo certificates or brokered funds.
18
Liquidity and Capital Resources.
The Bank is required to maintain minimum levels of liquid assets as defined by
OTS regulations. This requirement, which varies from time to time depending upon
economic conditions and deposit flows, is based upon a percentage of deposits
and short-term borrowings. The Bank's liquidity ratio averaged 15.32% during the
month of September 2003. Liquidity ratios averaged 14.73% for the quarter ended
September 30, 2003. The Bank adjusts its liquidity levels in order to meet
funding needs of loan originations, deposit outflows, payment of real estate
taxes on mortgage loans, and repayment of borrowings and loan commitments. The
Bank also adjusts liquidity as appropriate to meet its asset and liability
management objectives.
The Bank's primary sources of funds are deposits, amortization and prepayment of
loans and mortgage-backed securities and other short-term investments, as well
as earnings and funds provided from operations. While scheduled principal
repayments on loans and mortgage-backed securities are a relatively predictable
source of funds, deposit flows and loan prepayments are greatly influenced by
general interest rates, economic conditions and competition. The Bank manages
the pricing of its deposits to maintain a desired deposit balance. In addition,
the Bank invests excess funds in short-term interest-earning and other assets,
which provide liquidity to meet lending requirements. Short-term
interest-bearing deposits with the FHLB of Atlanta amounted to $109.0 million at
September 30, 2003. Other assets qualifying for liquidity at September 30, 2003,
including unpledged mortgage-backed securities guaranteed by the Federal
National Mortgage Association and the Federal Home Loan Mortgage Corporation,
were $257.3 million. For additional information about cash flows from the
Company's operating, financing and investing activities, see Unaudited
Consolidated Statements of Cash Flows included in the Unaudited Consolidated
Financial Statements. The primary sources of cash are net income, principal
repayments on loans and mortgage-backed securities, increases in deposit
accounts and advances from the FHLB.
Liquidity management is both a daily and long-term function of business
management. If the Bank requires funds beyond its ability to generate them
internally, borrowing agreements exist with the FHLB which provide an additional
source of funds. At September 30, 2003, the Bank had $267.7 million in advances
from the FHLB. At September 30, 2003, the Bank had commitments outstanding to
originate or purchase loans of $226.8 million. This amount does not include the
unfunded portion of loans in process. Certificates of deposit scheduled to
mature in less than one year at September 30, 2003, totaled $499.5 million.
Based on prior experience, management believes that a significant portion of
such deposits will remain with the Bank.
New Accounting Pronouncements
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure, an amendment of FASB
Statement No. 123" to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
provisions of Statement 148 became effective for interim periods beginning after
December 15, 2002. See note 2 - Stock Options, in the unaudited consolidated
financial statements.
In November 2002, the FASB issued Interpretation ("FIN") No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". This interpretation requires elaborating
on the disclosures that must be made by a guarantor in its interim and annual
financial statements about its obligations under certain guarantees that it has
issued. It also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The disclosure requirements of this
Interpretation became effective for statements issued after December 15, 2002
and its recognition requirements are applicable for guarantees issued or
modified after December 31, 2002. The adoption of this statement did not have a
material impact on the Company's financial statements.
19
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities." This Interpretation addresses consolidation by
business enterprises of variable interest entities (VIEs). A VIE is subject to
the consolidation provisions of FIN 46 if, by design, it cannot support its
financial activities without additional subordinated financial support from
other parties and does not have equity investors which as a group have the
ability to make decisions about its activities through voting rights. FIN 46
requires a VIE to be consolidated by its primary beneficiary. The primary
beneficiary is the party that holds variable interests that expose it to a
majority of the entity's expected losses and/or residual returns. The
application of this Interpretation was immediate for VIE's created after January
31, 2003. On October 9, 2003, the FASB deferred the implementation date of FIN
46 until the fourth quarter of 2003 for variable interest entities that existed
prior to February 1, 2003.
Along with other companies and the accounting industry, the Company is
evaluating and interpreting the potential impact of FIN 46 on the accounting for
its Guaranteed Preferred Beneficial Interests in Company Debentures as well as
the continued consolidation of the statutory business trust that issued these
secruities. The Preferred Securities were issued out of a grantor trust,
Fidelity Capital Trust I, a Delaware statutory trust, which was created by the
Company for the sole purpose of issuing the Preferred Securities and is 100%
owned by the Company. In July 2003, the Federal Reserve Board issued a
supervisory letter indicating that Trust-Preferred Securities currently will
continue to qualify as Tier 1 capital for regulatory purposes until further
notice. The Federal Reserve Board has also stated that it will continue to
review the regulatory implications of any accounting treatment changes and will
provide further guidance, if necessary. No other impact of significance on the
Company's results of operations or financial condition is expected from this
Interpretation. However, the FASB staff and the accounting industry continue to
address specific interpretative and implementation issues regarding this
Interpretation. The results of these actions could change the Company's
assessment of the impact of the Interpretation.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity". This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). This Statement is effective
for financial instruments entered into or modified after May 30, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The implementation of SFAS No. 150 has had no material
impact on our consolidated financial statements.
Item 4. Controls and Procedures
Under the supervision and with the participation of the Company's management,
including the Chief Executive Officer and Chief Financial Officer, the Company
has evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as
of the end of the period covered by this quarterly report. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that, as of the end of the period covered by this quarterly report, the Companys
disclosure controls and procedures are effective to ensure that information
required to be disclosed in the reports that the Company files or submits under
the Securities Exchange Act 0f 1934 is recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms. There has been no change in the Company's internal
control over financial reporting during the most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Company's
internat control over financial reporting.
20
FIDELITY BANKSHARES, INC.
AND SUBSIDIARY
Part II - Other Information
Item 1 Legal Proceedings
The Company and its subsidiary are not involved in any
litigation, nor is the Company aware of any pending litigation,
other than legal proceedings incident to the business of the
Company, such as foreclosure actions filed on behalf of the
Company. Management, therefore, believes the results of any
current litigation, other than as described below, would be
immaterial to the consolidated financial condition or results of
operation of the Company.
On July 1, 2003, Fidelity Federal Bank & Trust was named as
defendant in the lawsuit, James Kehoe v. Fidelity Federal Bank &
Trust, filed in the United States District Court for the Southern
District of Florida. In this action, James Kehoe ("Kehoe"), on
behalf of himself and other similarly situated persons, has
alleged that the Bank violated the Driver Privacy Protection Act
by obtaining driver registration information from the State of
Florida for use in its marketing efforts. Kehoe seeks as damages
the statutory minimum of $2,500 per violation. As a result of
Kehoe's suing on behalf of a class of plaintiffs, the potential
award, should Kehoe prevail, would be material. Kehoe alleges in
his motion for class certification that the class consists of
over 500,000 individuals where personal information was obtained
from the Florida Division of Highway Safety & Motor Vehicles. On
August 22, 2003, the Bank filed a motion to dismiss or in the
alternative a motion for summary judgment. On October 31, 2003,
Kehoe filed its response in opposition to the motion and
discovery has not yet commenced. The Bank, in consultation with
counsel, has concluded that the lawsuit is without merit and the
Bank intends to vigorously defend against Kehoe's claim.
Item 2 Changes in Securities
None.
Item 3 Default Upon Senior Securities
Not applicable.
Item 4 Submission of Matters to a Vote of Security Holders
None
Item 5 Other Information
None.
21
Item 6 Exhibits 31.1, 31.2 and 32.1
Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
I, Vince A. Elhilow, President and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Fidelity Bankshares,
Inc;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e))for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this quarterly report based on
such evaluation; and
c) disclosed in this quarterly report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors:
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 13, 2003 /S/Vince A. Elhilow
-------------------------------------
Vince A. Elhilow, President and
Chief Executive Officer
23
Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
I, Richard D. Aldred, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Fidelity Bankshares,
Inc;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e))for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this quarterly report based on
such evaluation; and
c) disclosed in this quarterly report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors:
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 13, 2003 /s/Richard D. Aldred
--------------------------------------
Richard D. Aldred, Chief Financial Officer
24
Exhibit 32.1
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
Vince A. Elhilow, President and Chief Executive Officer, and Richard D. Aldred,
Executive Vice President and Chief Financial Officer of Fidelity Bankshares,
Inc. (the "Company"), each certify in his capacity as an officer of the Company
that he has reviewed the Quarterly Report of the Company on Form 10-Q for the
quarter ended September 30, 2003 and that to the best of his knowledge:
(1) the report fully complies with the requirements of Sections 13(a) of
the Securities Exchange Act of 1934; and
(2) the information contained in the report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
The purpose of this statement is solely to comply with Title 18, Chapter 63,
Section 1350 of the United States Code, as amended by Section 906 of the
Sarbanes-Oxley Act of 2002.
November 13, 2003 /s/Vince A. Elhilow
- ----------------- --------------------------
Date President and Chief Executive Officer
November 13, 2003 /s/Richard D. Aldred
- ----------------- --------------------------
Date Executive Vice President and
Chief Financial Officer
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
FIDELITY BANKSHARES, INC.
November 13, 2003 /s/Vince A. Elhilow
- ----------------- --------------------------
Date President and Chief Executive Officer
November 13, 2003 /s/Richard D. Aldred
- ----------------- --------------------------
Date Executive Vice President and
Chief Financial Officer