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FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended: June 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 __________________
Commission File Number: 0-19297
First Community Bancshares, Inc.
(Exact name of registrant as specified in its charter)
Nevada 55-0694814
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Community Place, Bluefield, Virginia 24605
(Address of principal executive offices) (Zip Code)
(276) 326-9000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 of 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 Registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2).
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at July 31, 2003
----- ---------------------------
Common Stock, $1 Par Value 11,287,938
First Community Bancshares, Inc.
FORM 10-Q
For the quarter ended June 30, 2003
INDEX
PART I. FINANCIAL INFORMATION REFERENCE
---------
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2003 and
December 31, 2002 3
Consolidated Statements of Income for the Three and Six
Month Periods Ended June 30, 2003 and 2002 4
Consolidated Statements of Cash Flows for the
Six Month Periods Ended June 30, 2003 and 2002 5
Consolidated Statements of Changes in Stockholders'
Equity for the Six Months Ended June 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7-14
Independent Accountants' Review Report 15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16-27
Item 3. Quantitative and Qualitative Disclosures about 27
Market Risk
Item 4. Controls and Procedures 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2. Changes in Securities and Use of Proceeds 29
Item 3. Defaults Upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 30
Item 6. Exhibits and Reports on Form 8-K 30
SIGNATURES 33
2
PART I. ITEM 1. FINANCIAL STATEMENTS
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
- --------------------------------------------------------------------------------
JUNE 30 December 31
2003 2002
ASSETS (UNAUDITED) (Note 1)
----------- -----------
CASH AND DUE FROM BANKS $ 43,551 $ 33,364
INTEREST-BEARING BALANCES WITH BANKS 25,795 88,064
FEDERAL FUNDS SOLD 7,353 3,157
----------- -----------
TOTAL CASH AND CASH EQUIVALENTS 76,699 124,585
SECURITIES AVAILABLE FOR SALE (AMORTIZED COST OF $405,630 AT
JUNE 30, 2003; $289,616 AT DECEMBER 31, 2002) 419,815 300,885
SECURITIES HELD TO MATURITY (FAIR VALUE OF $42,604 AT
JUNE 30, 2003; $43,342 AT DECEMBER 31, 2002) 39,745 41,014
LOANS HELD FOR SALE 46,743 66,364
LOANS HELD FOR INVESTEMENT, NET OF UNEARNED INCOME 1,026,643 927,621
LESS ALLOWANCE FOR LOAN LOSSES 15,707 14,410
----------- -----------
NET LOANS HELD FOR INVESTMENT 1,010,936 913,211
PREMISES AND EQUIPMENT 29,449 25,078
OTHER REAL ESTATE OWNED 2,787 2,855
INTEREST RECEIVABLE 8,381 7,897
OTHER ASSETS 22,966 15,391
GOODWILL 41,300 25,758
OTHER INTANGIBLE ASSETS 1,491 1,325
----------- -----------
TOTAL ASSETS $ 1,700,312 $ 1,524,363
=========== ===========
LIABILITIES
DEPOSITS:
NONINTEREST-BEARING $ 210,347 $ 165,557
INTEREST-BEARING 1,046,374 974,170
----------- -----------
TOTAL DEPOSITS 1,256,721 1,139,727
INTEREST, TAXES AND OTHER LIABILITIES 21,686 15,940
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE 93,742 91,877
FHLB BORROWINGS AND OTHER INDEBTEDNESS 152,855 124,357
----------- -----------
TOTAL LIABILITIES 1,525,004 1,371,901
----------- -----------
STOCKHOLDERS' EQUITY
PREFERRED STOCK, PAR VALUE UNDESIGNATED; 1,000,000 SHARES AUTHORIZED;
NO SHARES ISSUED AND OUTSTANDING IN 2003 AND 2002 -- --
COMMON STOCK, $1 PAR VALUE; 15,000,000 SHARES AUTHORIZED ;
11,390,205 AND 10,952,385 ISSUED IN 2003 AND 2002, RESPECTIVELY; AND
11,256,674 AND 10,877,330 OUTSTANDING IN 2003 AND 2002, RESPECTIVELY 11,390 9,957
ADDITIONAL PAID-IN CAPITAL 108,286 58,642
RETAINED EARNINGS 51,149 79,084
TREASURY STOCK, AT COST (4,028) (1,982)
ACCUMULATED OTHER COMPREHENSIVE INCOME 8,511 6,761
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 175,308 152,462
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,700,312 $ 1,524,363
=========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED)
- --------------------------------------------------------------------------------
SIX MONTHS ENDED THREE MONTHS ENDED
------------------------- -------------------------
JUNE 30 June 30 JUNE 30 June 30
2003 2002 2003 2002
----------- ----------- ----------- -----------
INTEREST INCOME:
INTEREST AND FEES ON LOANS HELD FOR INVESTMENT $ 33,874 $ 36,049 $ 16,982 $ 18,013
INTEREST ON LOANS HELD FOR SALE 1,284 1,670 655 826
INTEREST ON SECURITIES-TAXABLE 6,532 6,999 3,387 3,621
INTEREST ON SECURITIES-NONTAXABLE 3,299 3,422 1,642 1,680
INTEREST ON FEDERAL FUNDS SOLD AND DEPOSITS IN BANKS 362 82 147 39
----------- ----------- ----------- -----------
TOTAL INTEREST INCOME 45,351 48,222 22,813 24,179
----------- ----------- ----------- -----------
INTEREST EXPENSE:
INTEREST ON DEPOSITS 10,459 13,397 5,142 6,404
INTEREST ON SHORT-TERM BORROWINGS 3,827 4,880 1,934 2,451
INTEREST ON OTHER DEBT 298 300 150 152
----------- ----------- ----------- -----------
TOTAL INTEREST EXPENSE 14,584 18,577 7,226 9,007
----------- ----------- ----------- -----------
NET INTEREST INCOME 30,767 29,645 15,587 15,172
PROVISION FOR LOAN LOSSES 1,897 1,959 1,308 1,022
----------- ----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN
LOSSES 28,870 27,686 14,279 14,150
----------- ----------- ----------- -----------
NONINTEREST INCOME:
FIDUCIARY INCOME 981 844 565 501
SERVICE CHARGES ON DEPOSIT ACCOUNTS 3,807 3,269 1,986 1,806
OTHER SERVICE CHARGES, COMMISSIONS AND FEES 1,069 681 556 355
MORTGAGE BANKING INCOME 6,414 5,356 3,450 2,107
OTHER OPERATING INCOME 541 482 244 186
GAIN ON SECURITIES 153 186 133 9
----------- ----------- ----------- -----------
TOTAL NONINTEREST INCOME 12,965 10,818 6,934 4,964
----------- ----------- ----------- -----------
NONINTEREST EXPENSE:
SALARIES AND EMPLOYEE BENEFITS 12,772 11,549 6,439 5,746
OCCUPANCY EXPENSE OF BANK PREMISES 1,672 1,422 823 679
FURNITURE AND EQUIPMENT EXPENSE 1,050 1,065 520 562
CORE DEPOSIT AMORTIZATION 114 119 51 60
OTHER OPERATING EXPENSE 6,937 6,900 3,581 3,399
----------- ----------- ----------- -----------
TOTAL NONINTEREST EXPENSE 22,545 21,055 11,414 10,446
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 19,290 17,449 9,799 8,668
INCOME TAX EXPENSE 5,575 5,094 2,832 2,630
----------- ----------- ----------- -----------
NET INCOME $ 13,715 $ 12,355 $ 6,967 $ 6,038
=========== =========== =========== ===========
BASIC AND DILUTED EARNINGS PER COMMON SHARE $ 1.25 $ 1.14 $ 0.63 $ 0.55
=========== =========== =========== ===========
WEIGHTED AVERAGE BASIC SHARES OUTSTANDING 10,937,927 10,933,145 10,969,748 10,939,674
=========== =========== =========== ===========
WEIGHTED AVERAGE DILUTED SHARES OUTSTANDING 11,021,010 10,984,274 11,084,847 10,993,193
=========== =========== =========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS) (UNAUDITED)
- --------------------------------------------------------------------------------
SIX MONTHS ENDED
JUNE 30
----------------------
2003 2002
--------- ---------
OPERATING ACTIVITIES:
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 13,715 $ 12,355
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
PROVISION FOR LOAN LOSSES 1,897 1,959
DEPRECIATION OF PREMISES AND EQUIPMENT 897 785
CORE DEPOSIT AMORTIZATION 114 119
OTHER INTANGIBLE ACCRETION (49) (126)
NET INVESTMENT AMORTIZATION AND ACCRETION 1,199 764
NET (GAIN) LOSS ON THE SALE OF ASSETS (157) 33
NET GAIN ON SALE OF LOANS (7,206) (4,127)
MORTGAGE LOANS ORIGINATED FOR SALE (448,982) (301,189)
PROCEEDS FROM SALE OF MORTGAGE LOANS 475,925 319,274
(INCREASE) DECREASE IN INTEREST RECEIVABLE (484) 435
INCREASE IN OTHER ASSETS (5,035) (1,856)
INCREASE IN OTHER LIABILITIES 6,139 2,993
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 37,973 31,419
--------- ---------
INVESTING ACTIVITIES:
CASH FLOWS FROM INVESTING ACTIVITIES:
PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE 3,601 13,956
PROCEEDS FROM MATURITIES AND CALLS OF SECURITIES AVAILABLE FOR SALE 64,623 40,171
PROCEEDS FROM MATURITIES AND CALLS OF SECURITIES HELD TO MATURITY 1,265 568
PURCHASE OF SECURITIES AVAILABLE FOR SALE (183,887) (32,523)
NET DECREASE (INCREASE) IN LOANS MADE TO CUSTOMERS 20,712 (26,207)
PURCHASE OF PREMISES AND EQUIPMENT (4,579) (1,694)
SALE OF EQUIPMENT 58 --
NET CASH PROVIDED BY ACQUISITIONS 1,339 --
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (96,868) (5,729)
--------- ---------
FINANCING ACTIVITIES:
CASH FLOWS FROM FINANCING ACTIVITIES:
NET INCREASE IN DEMAND AND SAVINGS DEPOSITS 12,188 24,966
NET DECREASE IN TIME DEPOSITS (444) (21,512)
NET INCREASE (DECREASE) IN FHLB AND OTHER INDEBTEDNESS 7,559 (38,952)
REPAYMENT OF OTHER BORROWINGS (9) (109)
ACQUISITION OF TREASURY STOCK (3,062) (1,224)
DIVIDENDS PAID (5,223) (4,971)
--------- ---------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 11,009 (41,802)
--------- ---------
CASH AND CASH EQUIVALENTS
NET DECREASE IN CASH AND CASH EQUIVALENTS (47,886) (16,112)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 124,585 47,815
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 76,699 $ 31,703
========= =========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION) (UNAUDITED)
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED TREASURY COMPREHENSIVE
STOCK CAPITAL EARNINGS STOCK (LOSS) INCOME TOTAL
------- ---------- ---------- --------- ------------- ---------
BALANCE JANUARY 1, 2002 9,955 60,189 62,566 (424) 755 133,041
--------
COMPREHENSIVE INCOME:
NET INCOME -- -- 12,355 -- -- 12,355
OTHER COMPREHENSIVE INCOME, NET OF TAX:
NET UNREALIZED GAINS ON SECURITIES
AVAILABLE FOR SALE -- -- -- -- 4,048 4,048
-------- -------- --------
COMPREHENSIVE INCOME -- -- 12,355 -- 4,048 16,403
-------- -------- --------
COMMON DIVIDENDS DECLARED
($.45 PER SHARE) -- -- (4,971) -- -- (4,971)
FRACTIONAL SHARE ADJUSTMENT FOR 10%
STOCK DIVIDEND 2 (1,729) 1,725 (14) (16)
PURCHASE 42,844 TREASURY SHARES AT
$28.52 PER SHARE -- -- -- (1,224) -- (1,224)
ISSUANCE OF TREASURY SHARES TO ESOP 140 792 932
-------- -------- -------- -------- -------- --------
BALANCE JUNE 30, 2002 9,957 58,600 71,675 (870) 4,803 144,165
======== ======== ======== ======== ======== ========
BALANCE JANUARY 1, 2003 9,957 58,642 79,084 (1,982) 6,761 152,462
--------
COMPREHENSIVE INCOME:
NET INCOME -- -- 13,715 -- -- 13,715
OTHER COMPREHENSIVE INCOME, NET OF TAX:
NET UNREALIZED GAINS ON SECURITIES
AVAILABLE FOR SALE -- -- -- -- 1,750 1,750
-------- -------- --------
COMPREHENSIVE INCOME -- -- 13,715 -- 1,750 15,465
-------- -------- -------- -------- -------- --------
COMMON DIVIDENDS DECLARED
($.47 PER SHARE) -- -- (5,223) -- -- (5,223)
PURCHASE 100,000 TREASURY SHARES AT
$30.62 PER SHARE -- -- -- (3,062) -- (3,062)
ACQUISITION OF STONE CAPITAL MANAGEMENT-
8,409 SHARES ISSUED (SEE NOTE 3) 8 236 244
OPTION EXERCISE 11,600 SHARES AT $28.92 (58) 336 278
ACQUISITION OF COMMONWEALTH BANK-
389,609 SHARES ISSUED 390 14,031 14,421
EFFECT OF 10% STOCK DIVIDEND 1,035 35,392 (36,427) --
ISSUANCE OF TREASURY SHARES TO ESOP 43 680 723
-------- -------- -------- -------- -------- --------
BALANCE JUNE 30, 2003 11,390 108,286 51,149 (4,028) 8,511 175,308
======== ======== ======== ======== ======== ========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. UNAUDITED FINANCIAL STATEMENTS
The unaudited consolidated balance sheet as of June 30, 2003, the unaudited
consolidated statements of income for the three and six months ended June 30,
2003 and 2002 and the consolidated statements of cash flows and changes in
stockholders' equity for the six months ended June 30, 2003 and 2002 have been
prepared by the management of First Community Bancshares, Inc. ("FCBI" or the
"Company"). In the opinion of management, all adjustments (including normal
recurring accruals) necessary to present fairly the financial position of FCBI
and subsidiaries at June 30, 2003 and its results of operations, cash flows, and
changes in stockholders' equity for the three and six months ended June 30, 2003
and 2002 have been made. These results are not necessarily indicative of the
results of consolidated operations that might be expected for the full calendar
year.
The consolidated balance sheet as of December 31, 2002 has been extracted from
the audited financial statements included in the Company's 2002 Annual Report to
Stockholders. Certain information and footnote disclosures normally included in
annual financial statements prepared in accordance with accounting principles
generally accepted in the United States have been omitted in accordance with
standards for the preparation of interim financial statements. These financial
statements should be read in conjunction with the financial statements and notes
thereto included in the 2002 Annual Report of FCBI.
A more complete and detailed description of FCBI's significant accounting
policies is included within Footnote 1 to the Company's Annual Report on Form
10-K for December 31, 2002. In addition, the Company's required disclosure of
the application of critical accounting policies is included within the
"Accounting Policies and Judgments" section of Part I, Item 2. "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included herein. The following is an update to reflect the requirements of
Financial Accounting Standards Board ("FASB") Statement 148.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICY UPDATE FOR CERTAIN REQUIRED DISCLOSURES
The Company has a stock option plan for certain executives and directors
accounted for under the intrinsic value method in accordance with Accounting
Principles Board ("APB") 25. Because the exercise price of the Company's
employee/director stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized. The effect of
option shares on earnings per share relates to the dilutive effect of the
underlying options outstanding. To the extent the granted exercise share price
is less than the current market price, ("in the money"), there is an economic
incentive for the shares to be exercised and an increase in the dilutive effect
on earnings per share results.
In December 2002, the FASB issued Financial Accounting Standards ("FAS") 148,
"Accounting for Stock-Based Compensation." This new standard provides
alternative methods of transition for a voluntary change to the fair value
method of accounting for stock-based compensation. In addition, the Statement
amends the disclosure requirements of FAS 123 to require prominent disclosure in
both annual and interim financial statements about the method of accounting for
stock-based compensation and the underlying effect of the method used on
reported results until exercised.
7
Assuming use of the fair value method of accounting for stock options, pro forma
net income and earnings per share for the three and six month periods ended June
30, 2003 and 2002 would have been estimated as follows:
SIX MONTHS SIX MONTHS THREE MONTHS THREE MONTHS
ENDED ENDED ENDED ENDED
JUNE 30 JUNE 30 JUNE 30 JUNE 30
2003 2002 2003 2002
------------ ------------ ------------ ------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income as reported $ 13,715 $ 12,355 $ 6,967 $ 6,038
Less: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (78) (109) (39) (27)
---------- ---------- --------- ---------
$ 13,637 $ 12,246 $ 6,928 $ 6,011
========== ========== ========= =========
Earnings per share:
Basic as reported $ 1.25 $ 1.14 $ 0.63 $ 0.55
Basic pro forma $ 1.24 $ 1.12 $ 0.62 $ 0.54
Diluted as reported $ 1.25 $ 1.14 $ 0.63 $ 0.55
Diluted pro forma $ 1.24 $ 1.12 $ 0.62 $ 0.54
NOTE 2. RECLASSIFICATIONS
Certain amounts reflected in the December 31, 2002 balance sheet have been
reclassified to conform to the balance sheet presentation used in preparation of
the June 30, 2003 financial statements that are included in this periodic report
on Form 10-Q.
NOTE 3. STOCK DIVIDEND
On June 17, 2003, the Company's Board of Directors declared a 10% stock dividend
to shareholders of record August 1, 2003, to be distributed on or about August
15, 2003. Average shares outstanding and per share amounts included in the
consolidated financial statements have been adjusted to reflect the impact of
the stock dividend. Fractional share adjustments will be reflected in the third
quarter of 2003 subsequent to the final share distribution.
NOTE 4. MERGERS AND ACQUISITIONS
On November 30, 2002, the Company acquired Monroe Financial, Inc. ("Monroe") and
its banking subsidiary, Bank of Greenville ("Greenville"). Bank of Greenville's
three branch facilities, Greenville and Lindside in Monroe County, West Virginia
and Hinton in Summers County, West Virginia, were simultaneously merged with and
into First Community Bank, N. A. (the "Bank"). The completion of this
transaction resulted in the addition of $29.8 million in assets, including $17.4
million in loans and added an additional $28.0 million in deposits to the Bank
at December 31, 2002. The $931,000 excess of fair market value of the net assets
acquired over the purchase price was reallocated to the non-financial assets
acquired.
In January 2003, the Bank acquired Stone Capital Management, Inc. ("Stone
Capital"), with an office in Beckley, West Virginia. This acquisition expanded
the Bank's operations into wealth management, asset allocation, financial
planning and investment advice. At December 31, 2002, Stone Capital had total
assets under management of $94 million and operates under its name in
conjunction with First Community's Trust and Financial Services Division. Stone
Capital was acquired through the issuance of 8,409 shares of Company common
stock which represents 50% of the total consideration. The balance of the
consideration is payable in the form of Company stock subject to revenue
minimums outlined in the acquisition agreement.
On June 6, 2003, the Company acquired The CommonWealth Bank, a
Virginia-chartered commercial bank ("CommonWealth"). CommonWealth's four branch
facilities located in the Richmond, Virginia metro area were simultaneously
merged with and into the Bank.
8
The completion of this transaction resulted in the addition of $136.5 million in
assets, including $120.0 million in loans and added an additional $105.0 million
in deposits to the Bank. As a result of a preliminary allocation, $15.2 million
excess of purchase price over the fair market value of the net assets acquired
and identified intangibles was recorded as goodwill.
NOTE 5. BORROWINGS
Federal Home Loan Bank ("FHLB") borrowings and other indebtedness are comprised
of $136.3 million in convertible and callable advances and $16.3 million of
noncallable term advances from the FHLB of Atlanta.
The callable advances may be called (redeemed) at quarterly intervals after
various lockout periods. These call options may substantially shorten the lives
of these instruments. If these advances are called, the debt may be paid in
full, converted to another FHLB credit product, or converted to an adjustable
rate advance.
The following schedule details the outstanding advances, rates and corresponding
final maturities at June 30, 2003.
NEXT CALL
ADVANCE RATE MATURITY DATE
---------------- --------- -------- ---------
(AMOUNTS IN THOUSANDS)
Callable advances:
$5,000 1.10% 03/10/06 03/10/04
25,000 0.61% 06/30/06 06/30/04
1,250 4.14% 05/02/07 05/02/05
5,000 1.41% 09/27/07 09/29/03
25,000 5.71% 03/17/10 09/17/03
25,000 6.11% 05/05/10 08/05/03
25,000 6.02% 05/05/10 08/05/03
25,000 5.47% 10/04/10 10/06/03
-----------------
$136,250
=================
Noncallable advances: $8,000 5.95% 09/02/03 N/A
900 4.55% 11/23/05 N/A
385 5.01% 12/11/06 N/A
5,000 1.30% 01/30/07 N/A
2,000 6.27% 09/02/08 N/A
-----------------
$16,285
=================
NOTE 6. COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is a defendant in various legal
actions and asserted claims, most of which involve lending and collection
activities. While the Company and legal counsel are unable to assess the
ultimate outcome of each of these matters with certainty, they are of the belief
that the resolution of these actions, singly or in the aggregate, should not
have a material adverse affect on the financial position of the Company.
The Company conducts mortgage banking operations through United First Mortgage
("UFM"), a wholly-owned subsidiary of the Bank. The majority of loans originated
by UFM are sold to larger national investors on a service released basis. Loans
are sold under loan sales agreements which contain various repurchase
provisions. These repurchase provisions give rise to a contingent liability for
loans which could subsequently be submitted to UFM for repurchase. The principal
events which could result in a repurchase obligation are i.) the discovery of
fraud or material inaccuracies in a sold loan file and ii.) a default on the
first payment due after a loan is sold to the investor, coupled with a ninety
day delinquency in the first year of the life of the loan. Other events and
variations of these events could result in a loan repurchase under terms of
other loan sales agreements. The volume of contingent loan repurchases, if any,
is dependent on the quality of loan underwriting and systems employed by UFM for
quality control in the production of mortgage loans. UFM may remarket these
loans to alternate investors after repurchase and cure of the borrowers'
defects. To date, loans submitted for repurchase have not been material and have
not had a material adverse effect on the results of operations, financial
position or liquidity of UFM or the Company.
UFM also originates government guaranteed FHA and VA loans that are also sold to
third party investors. The Department of Housing and Urban Development ("HUD")
periodically audits loan files of government guaranteed loans and may require
UFM to execute indemnification agreements on loans which do not meet certain
predefined underwriting guidelines or may require the repurchase of the
underlying loan. To date, the number of required indemnification agreements, or
loan repurchases have not been
9
material and no subsequent losses have been incurred. UFM has been required to
execute only three such indemnification agreements covering defaults which may
occur on indemnified loans over the five-year period following the
indemnification. No losses have occurred under such agreements. As a result of
an apparent borrower misrepresentation that disqualified a borrower from the
program, UFM was required to repurchase one Virginia Housing Development loan.
This loan was remarketed to an alternate investor. Loan indemnifications and
repurchases under the FHA and VA and VHDA loan programs have not had a material
adverse effect on the financial position, results of operations or cash flows of
UFM or the Company.
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit, standby letters of
credit and financial guarantees. These instruments involve, to varying degrees,
elements of credit and interest rate risk beyond the amount recognized on the
balance sheet. The contractual amounts of those instruments reflect the extent
of involvement the Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of non-performance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit and financial guarantees written is represented by the
contractual amount of those instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is not a violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company, upon extension of credit is based on
management's credit evaluation of the counterparties. Collateral held varies but
may include accounts receivable, inventory, property, plant and equipment, and
income-producing commercial properties.
Standby letters of credit and written financial guarantees are conditional
commitments issued by the Company to guarantee the performance of a customer to
a third party. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
To the extent deemed necessary, collateral of varying types and amounts is held
to secure customer performance under certain of those letters of credit
outstanding.
Financial instruments whose contract amounts represent credit risk at June 30,
2003 are commitments to extend credit (including availability of lines of
credit) of $91.4 million and standby letters of credit and financial guarantees
written of $8.2 million. In addition, at June 30, 2003, UFM had commitments to
originate loans of $179.9 million.
On May 2, 2003, United First Mortgage ("UFM"), a wholly-owned mortgage banking
subsidiary of First Community Bank, the Company's wholly-owned banking
subsidiary, was joined as a party to a lawsuit in the U.S. District Court for
the Eastern District of Pennsylvania, styled John J. Lomanno v Thomas Black, et.
al., Civil Action Number 02-CV-8669. This suit had been filed by a former UFM
employee alleging, among other things, sexual discrimination in connection with
his dismissal. The Company and counsel believe that the lawsuit, which seeks
damages of $150,000 and punitive damages, is without merit, and intends to
vigorously defend this matter.
NOTE 7. OTHER COMPREHENSIVE INCOME
The Company currently has one component of other comprehensive income, which is
comprised of unrealized gains and losses on securities available for sale
detailed as follows:
10
SIX MONTHS ENDED THREE MONTHS ENDED
---------------------- ----------------------
JUNE 30 JUNE 30 JUNE 30 JUNE 30
2003 2002 2003 2002
------- -------- ------- --------
(AMOUNTS IN THOUSANDS) (AMOUNTS IN THOUSANDS)
OTHER COMPREHENSIVE INCOME:
Unrealized gains arising during the period $ 3,059 $ 6,943 $ 4,257 $ 8,630
Related taxes (1,224) (2,783) (1,702) (3,452)
------- ------- ------- -------
Unrealized gains arising during the period,
net of tax 1,835 4,160 2,555 5,178
Reclassification adjustment for gains realized
in net income (143) (186) (133) (9)
Tax expense of reclassification 58 74 53 3
------- ------- ------- -------
Other comprehensive gain 1,750 4,048 2,475 5,172
Beginning accumulated other comprehensive
gain (loss) 6,761 755 6,036 (369)
------- ------- ------- -------
Ending accumulated other comprehensive income $ 8,511 $ 4,803 $ 8,511 $ 4,803
======= ======= ======= =======
NOTE 8. SEGMENT INFORMATION
The Company operates two business segments: community banking and mortgage
banking. These segments are primarily identified by their products and services
and the channels through which they are offered. The community banking segment
consists of the Company's full-service bank that offers customers traditional
banking products and services through various delivery channels. The mortgage
banking segment consists of mortgage brokerage offices that originate, acquire,
and sell residential mortgage products into the secondary market through
national investors.
Information for each of the segments is presented below.
SIX MONTHS ENDED JUNE 30, 2003
----------------------------------------------------------------------------
(AMOUNTS IN THOUSANDS)
COMMUNITY MORTGAGE
BANKING BANKING PARENT ELIMINATIONS TOTAL
---------- ---------- ---------- ------------ ----------
NET INTEREST INCOME $ 30,487 $ 191 $ 112 $ (23) $ 30,767
PROVISION FOR LOAN LOSSES 1,897 -- -- -- 1,897
---------- ---------- ---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 28,590 191 112 (23) 28,870
OTHER INCOME 6,743 6,414 (4) (188) 12,965
OTHER EXPENSES 17,408 5,047 301 (211) 22,545
---------- ---------- ---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES 17,925 1,558 (193) -- 19,290
INCOME TAX EXPENSE (BENEFIT) 5,134 606 (165) -- 5,575
---------- ---------- ---------- ---------- ----------
NET INCOME (LOSS) $ 12,791 $ 952 $ (28) $ -- $ 13,715
========== ========== ========== ========== ==========
AVERAGE ASSETS $1,687,141 $ 54,844 $ 157,766 $ (357,622) $1,542,129
========== ========== ========== ========== ==========
TOTAL ASSETS $1,695,614 $ 52,438 $ 176,031 $ (223,771) $1,700,312
========== ========== ========== ========== ==========
11
Six Months Ended June 30, 2002
----------------------------------------------------------------------------
(Amounts in Thousands)
Community Mortgage
Banking Banking Parent Eliminations Total
---------- ---------- ---------- ------------ ----------
Net interest income $ 28,980 $ 500 $ 125 $ 40 $ 29,645
Provision for loan losses 1,959 -- -- -- 1,959
---------- ---------- ---------- ---------- ----------
Net interest income after provision
for loan losses 27,021 500 125 40 27,686
Other income 5,237 5,353 391 (163) 10,818
Other expenses 16,223 4,551 404 (123) 21,055
---------- ---------- ---------- ---------- ----------
Income before income taxes 16,035 1,302 112 -- 17,449
Income tax expense (benefit) 4,654 506 (66) -- 5,094
---------- ---------- ---------- ---------- ----------
Net income $ 11,381 $ 796 $ 178 $ -- $ 12,355
========== ========== ========== ========== ==========
Average assets $1,456,184 $ 54,375 $ 138,003 $ (188,370) $1,460,192
========== ========== ========== ========== ==========
Total assets $1,447,883 $ 56,334 $ 144,863 $ (193,746) $1,455,334
========== ========== ========== ========== ==========
NOTE 9. RECENT ACCOUNTING DEVELOPMENTS
FINANCIAL ACCOUNTING STANDARDS BOARD ("FASB") STATEMENTS
FASB Statement No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity" was issued in May 2003. This
Statement requires certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity to be classified
as liabilities. Many of these instruments previously were classified as equity
or temporary equity and as such, Statement 150 represents a significant change
in practice in the accounting for a number of financial instruments, including
mandatorily redeemable equity instruments and certain equity derivatives that
frequently are used in connection with share repurchase programs.
The Statement is effective for public companies for all financial instruments
created or modified after May 31, 2003, and to other instruments at the
beginning of the first interim period beginning after June 15, 2003 (July 1,
2003 for calendar quarter companies). Management does not expect this Statement
to have a material impact on the Company's results of operations, financial
position, or liquidity.
In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." Statement 149 amends Statement
133 as a result of:
o Decisions previously made as part of the Derivatives Implementation
Group (DIG) process,
o Changes made in connection with other Board projects dealing with
financial instruments, and
o Deliberations in connection with issues raised in relation to the
application of the definition of a derivative.
The Statement is effective for contracts entered into or modified after June 30,
2003, and hedging relationships designated after June 30, 2003. However, the
provisions of Statement 149 that merely represent the codification of previous
Derivatives Implementation Group decisions, are already effective and should
continue to be applied in accordance with their prior respective effective
dates. Management does not expect this Statement to have a material adverse
impact on the Company's results of operations, financial position, or liquidity.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities." The objective of this interpretation is to
provide guidance on how to identify a variable interest entity (VIE) and
determine when the assets, liabilities, non-controlling interests, and results
of operations of a VIE need to be included in a company's consolidated financial
statements. A company that holds variable interests in an entity will need to
consolidate the entity if the company's interest in the VIE is such that the
company will absorb a majority of the VIE's expected economic losses and/or
receive a majority of the entity's expected residual returns, if they occur. FIN
46 also requires additional disclosures by primary beneficiaries and other
significant variable interest holders. The provisions of this interpretation
became effective upon issuance for variable interest entities created after
January 31, 2003, and to variable interest entities in which a company obtained
an interest after that date. It applies in the first fiscal year or interim
period beginning after June 15, 2003, to variable interest entities in which a
12
company holds a variable interest that it acquired before February 1, 2003.
With respect to interests held by the Company that may be subject to FIN 46,
including low income housing investments, the Company is in the process of
determining if it is the primary beneficiary of the variable interest entities.
The Company's maximum estimated exposure to these low income housing
partnerships is approximately $4.1 million or a combination of the unamortized
basis in these entities, or $1.9 million, combined with the maximum potential
tax credit recapture from the underlying partnerships of $2.2 million. In
addition, the Company does not have any obligation to advance any additional
funds or to fund any loan commitment to these partnerships.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." This interpretation expands the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees and requires the guarantor to recognize a
liability for the fair value of an obligation assumed under a guarantee. FIN 45
clarifies the requirements of FAS 5, "Accounting for Contingencies", relating to
guarantees. In general, FIN 45 applies to contracts or indemnification
agreements that contingently require the guarantor to make payments to the
guaranteed party based on changes in an underlying value that is related to an
asset, liability, or equity security of the guaranteed party. Certain guarantee
contracts are excluded from both the disclosure and recognition requirements of
this interpretation, including, among others, guarantees relating to employee
compensation, residual value guarantees under capital lease arrangements,
commercial letters of credit, loan commitments, subordinated interests in a
special purpose entity, and guarantees of a company's own future performance.
Other guarantees are subject to the disclosure requirements of FIN 45 but not to
the recognition provisions and include, among others, a guarantee accounted for
as a derivative instrument under FAS 133, a parent's guarantee of debt owed to a
third party by its subsidiary or vice versa, and a guarantee which is based on
performance rather than price. The disclosure requirements of FIN 45 were
effective for the Company as of December 31, 2002, and require disclosure of the
nature of the guarantee, the maximum potential amount of future payments that
the guarantor could be required to make under the guarantee, and the current
amount of the liability, if any, for the guarantor's obligations under the
guarantee. The recognition requirements of FIN 45 are to be applied
prospectively to guarantees issued or modified after December 31, 2002. The
requirements of FIN 45 did not have a material impact on results of operations,
financial position, or liquidity in the first six months of 2003.
In October 2002, the FASB issued FAS No. 147, "Acquisitions of Certain Financial
Institutions." This Standard, which became effective upon issuance, provided
interpretive guidance on the application of the purchase method to acquisitions
of financial institutions, and required companies to cease amortization of
goodwill related to certain branch acquisitions. In addition, the Statement
amended FASB Statement No. 144 to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor and borrower relationship intangible assets and credit cardholder
intangible assets. Consequently, those intangible assets are subject to the same
undiscounted cash flow recoverability test and impairment loss recognition and
measurement provisions that Statement 144 requires for other long-lived assets
that are held and used. The impact of Statement 147 caused the Company to cease
amortization of this component of goodwill effective October 1, 2002,
retroactive to January 1, 2002 and accordingly, restate the presentation for the
first nine months of 2002 in its 2002 annual report to shareholders.
13
NOTE 10. EARNINGS PER SHARE
The following schedule details earnings and shares used in computing basic and
diluted earnings per share for the six and three months ended June 30, 2003 and
2002.
FOR THE SIX MONTHS ENDED FOR THE THREE MONTHS ENDED
------------------------------ ------------------------------
JUNE 30, 2003 JUNE 30, 2002 JUNE 30, 2003 JUNE 30, 2002
------------- ------------- ------------- -------------
Basic:
Net income (in thousands) $ 13,715 $ 12,355 $ 6,967 $ 6,038
Weighted average shares outstanding 10,937,927 10,933,145 10,969,748 10,939,674
Earnings per share $ 1.25 $ 1.14 $ 0.63 $ 0.55
Diluted:
Net income (in thousands) $ 13,715 $ 12,355 $ 6,967 $ 6,038
Weighted average shares outstanding 10,937,927 10,933,145 10,969,748 10,939,674
Dilutive shares for stock options 78,959 51,129 110,602 53,519
Contingently issuable shares for acquisition 4,124 -- 4,497 --
Weighted average dilutive shares outstanding 11,021,010 10,984,274 11,084,847 10,993,193
Earnings per share-dilutive $ 1.25 $ 1.14 $ 0.63 $ 0.55
NOTE 11. PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Company's lending strategy stresses quality growth diversified by product,
geography, and industry. All loans made by the Company are subject to common
credit standards and a uniform underwriting system. Loans are also subject to an
annual review process which varies based on the loan size and type. The Company
utilizes this ongoing review process to evaluate loans for changes in credit
risk. This process serves as the primary means by which the Company evaluates
the adequacy of the loan loss allowance. The total loan loss allowance is
divided into the following categories: i) specifically identified losses on loan
relationships which are on non-accrual status, ninety days past due or more and
loans with elements of credit weakness, and ii) formula allowances and special
allocations addressing other qualitative factors including industry
concentrations, economic conditions, staffing and other conditions.
Specific allowances are established to cover loan relationships, which are
identified as having significant cash flow weakness and for which a collateral
deficiency may be present. The allowances established under the specific
identification method are judged based upon the borrower's estimated cash flow
and projected liquidation value of related collateral.
Formula allowances, based on historical loss experience, are available to cover
homogeneous groups of loans not individually evaluated. The formula allowance is
developed and evaluated against loans in general by specific category
(commercial, mortgage, and consumer). The allowance is developed for each loan
category based upon a review of historical loss percentages for the Company and
other qualitative factors. The calculated percentage is considered in
determining the estimated allowance excluding any relationships specifically
identified and individually evaluated. While consideration is given to credit
weaknesses for specific loans and classifications within the various categories
of loans, the allowance is available for all loan losses.
In developing the allowance for loan losses, the Company also considers various
inherent risk factors, such as current economic conditions, the level of
delinquencies and nonaccrual loans, trends in the volume and term of loans,
anticipated impact from changes in lending policies and procedures, and any
concentration of credits in certain industries or geographic areas. In addition,
management continually evaluates the adequacy of the allowance for loan losses
and makes specific adjustments to the allowance based on the results of risk
analysis in the credit review process, the recommendation of regulatory
agencies, and other factors, such as loan loss experience and prevailing
economic conditions.
14
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The Audit Committee of the Board of Directors
First Community Bancshares, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of First
Community Bancshares, Inc. and subsidiary (the Company) as of June 30, 2003, and
the related consolidated statements of income for the three and six months ended
June 30, 2003 and 2002 and the consolidated statements of cash flows and changes
in stockholders' equity for the six-month periods ended June 30, 2003 and 2002.
These financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements referred to above
for them to be in conformity with accounting principles generally accepted in
the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of the Company as
of December 31, 2002, and the related consolidated statements of income, cash
flows and changes in stockholders' equity for the year then ended (not presented
herein) and in our report dated January 27, 2003, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 2002, is fairly stated, in all material respects, in relation to
the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
August 6, 2003
15
FIRST COMMUNITY BANCSHARES, INC.
PART I. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis is provided to address information about
the Company's financial condition and results of operations. This discussion and
analysis should be read in conjunction with the 2002 Annual Report to
Shareholders and the other financial information included in this report.
The Company is a multi-state bank holding company headquartered in Bluefield,
Virginia with total assets of $1.7 billion at June 30, 2003. FCBI through the
Bank provides financial, mortgage brokerage and origination and trust and
investment advisory services to individuals and commercial customers through 47
full-service banking locations in West Virginia, Virginia and North Carolina as
well as 11 mortgage brokerage facilities operated by UFM, a wholly owned
subsidiary of the Bank. The Bank also operates Stone Capital, an investment
advisory firm with offices in Beckley, West Virginia.
FORWARD LOOKING STATEMENTS
The Company may from time to time make written or oral "forward-looking
statements", including statements contained in its filings with the Securities
and Exchange Commission ("SEC") (including this Quarterly Report on Form 10-Q
and the Exhibits hereto and thereto), in its reports to stockholders and in
other communications which are made in good faith by the Company pursuant to the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995.
These forward-looking statements include, among others, statements with respect
to the Company's beliefs, plans, objectives, goals, guidelines, expectations,
anticipations, estimates and intentions that are subject to significant risks
and uncertainties and are subject to change based on various factors (many of
which are beyond the Company's control). The words "may", "could", "should",
"would", "believe", "anticipate", "estimate", "expect", "intend", "plan" and
similar expressions are intended to identify forward-looking statements. The
following factors, among others, could cause the Company's financial performance
to differ materially from that expressed in such forward-looking statements; the
strength of the United States economy in general and the strength of the local
economies in which the Company conducts operations; the effects of, and changes
in, trade, monetary and fiscal policies and laws, including interest rate
policies of the Board of Governors of the Federal Reserve System; inflation,
interest rate, market and monetary fluctuations; the timely development of
competitive new products and services of the Company and the acceptance of these
products and services by new and existing customers; the willingness of
customers to substitute competitors' products and services for the Company's
products and services and vice versa; the impact of changes in financial
services' laws and regulations (including laws concerning taxes, banking,
securities and insurance); technological changes; the effect of acquisitions,
including, without limitation, the failure to achieve the expected revenue
growth and/or expense savings from such acquisitions; the growth and
profitability of the Company's noninterest or fee income being less than
expected; unanticipated regulatory or judicial proceedings; changes in consumer
spending and saving habits; and the success of the Company at managing the risks
involved in the foregoing.
The Company cautions that the foregoing list of important factors is not
exclusive. The Company does not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or on
behalf of the Company.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
First Community's consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States of America
and conform to general practices within the banking industry. First Community's
financial position and results of operations are affected by management's
application of accounting policies, including judgments made to arrive at the
carrying value of assets and liabilities and amounts reported for revenues,
expenses and related disclosures. Different assumptions in the application of
these policies could result in material changes in First Community's
consolidated financial position and/or consolidated results of operations.
Estimates, assumptions, and judgments are necessary principally when assets and
liabilities are required to be recorded at estimated fair value, when a decline
in the value of an asset carried on the financial statements at fair value
warrants an impairment write-down or valuation reserve to be established, or
when an asset or liability needs to be recorded based upon the probability of
occurrence of a future event. Carrying assets and liabilities at fair value
inherently results in more financial statement volatility. The fair values and
the information used to record valuation adjustments for certain assets and
liabilities are based either on quoted market prices or are provided by third
party
16
sources, when available. When third party information is not available,
valuation adjustments are estimated in good faith by management primarily
through the use of internal modeling techniques and/or appraisal estimates.
First Community's accounting policies are fundamental to understanding
Management's Discussion and Analysis of Financial Condition and Results of
Operations. The following is a summary of First Community's more subjective and
complex "critical accounting policies." In addition, the disclosures presented
in the Notes to the Consolidated Financial Statements and in management's
discussion and analysis, provide information on how significant assets and
liabilities are valued in the financial statements and how those values are
determined. Based on the valuation techniques used and the sensitivity of
financial statement amounts to the methods, assumptions, and estimates
underlying those amounts, management has identified the determination of the
allowance for loan losses, the valuation of loans held for sale and the
valuation of derivative instruments utilized in mortgage banking and hedging
activity to be the accounting areas that require the most subjective or complex
judgments.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is established and
maintained at levels management deems adequate to cover losses inherent in the
portfolio as of the balance sheet date and is based on management's evaluation
of the risks in the loan portfolio and changes in the nature and volume of loan
activity. Estimates for loan losses are determined by analyzing historical loan
losses, current trends in delinquencies and charge-offs, plans for problem loan
resolution, the opinions of our regulators, changes in the size and composition
of the loan portfolio and industry information. Also included in management's
estimates for loan losses are considerations with respect to the impact of
economic events, the outcome of which are uncertain. These events may include,
but are not limited to, a general slowdown in the economy, fluctuations in
overall lending rates, political conditions, legislation that may directly or
indirectly affect the banking industry and economic conditions affecting
specific geographic areas in which First Community conducts business.
As more fully described in Note 10 to the Notes to the Consolidated Financial
Statements and in the discussion included in the Allowance for Loan Losses
section of Management's Discussion and Analysis, the Company determines the
allowance for loan losses by making specific allocations to impaired loans and
loan pools that exhibit inherent weaknesses and various credit risk factors.
Allocations to loan pools are developed giving weight to risk ratings,
historical loss trends and management's judgment concerning those trends and
other relevant factors. These factors may include, among others, actual versus
estimated losses, regional and national economic conditions, business segment
and portfolio concentrations, industry competition and consolidation, and the
impact of government regulations. The foregoing analysis is performed by the
Company's credit administration department to evaluate the portfolio and
calculate an estimated valuation allowance through a quantitative and
qualitative analysis that applies risk factors to those identified risk areas.
This risk management evaluation is applied at both the portfolio level and the
individual loan level for commercial loans and credit relationships while the
level of consumer and residential mortgage loan allowance is determined
primarily on a total portfolio level based on a review of historical loss
percentages and other qualitative factors including concentrations, industry
specific factors and economic conditions. The commercial and commercial real
estate portfolios require more specific analysis of individually significant
loans and the borrower's underlying cash flow, business conditions, capacity for
debt repayment and the valuation of secondary sources of payment (collateral).
This analysis may result in specifically identified weaknesses and corresponding
specific impairment allowances.
The use of various estimates and judgments in the Company's ongoing evaluation
of the required level of allowance can significantly impact the Company's
results of operations and financial condition and may result in either greater
provisions against earnings to increase the allowance or reduced provisions
based upon management's current view of portfolio and economic conditions and
the application of revised estimates and assumptions.
LOANS HELD FOR SALE, DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: UFM provides
a distribution outlet for the sale of loans produced by UFM's wholesale and
retail operations. It originates residential mortgage loans through its
production offices located in Eastern Virginia and sells the majority of its
loans through pooled commitments to national investors on a servicing released
basis. In addition, UFM acquires loans from a network of wholesale brokers for
subsequent resale to these national investors as well. UFM originates all loans
with the positive intent to sell. Loans held for sale are stated at the lower of
cost or market ("LOCOM"). The LOCOM analysis on pools of homogeneous loans is
applied on a net aggregate basis. Interest income with respect to loans held for
sale is accrued on the principal amount outstanding. LOCOM valuation techniques
applicable to loans held for sale are based on estimated market price
indications for similar loans. Pricing estimates are established by
participating mortgage purchasers and prevailing economic conditions. The
majority of the loans held for sale have established market pricing indications.
The loans held for sale portfolio at June 30, 2003 was $46.7 million compared to
$66.4 million at December 31, 2002.
17
Risks associated with this lending function include interest rate risk, which is
mitigated through the utilization of financial instruments (commonly referred to
as derivatives) to assist in offsetting the effect of changing interest rates.
The Company accounts for these instruments in accordance with FASB Statement No.
133, as amended "Accounting for Derivative Instruments and Hedging Activity."
This Statement established accounting and reporting standards for derivative
instruments and for hedging activities. UFM uses forward mortgage contracts
(short position sales and options) to manage interest rate risk in the pipeline
of loans and interest rate lock commitments ("RLCs") from the point of the loan
commitment to the subsequent delivery to outside investors. As a result of the
timing from origination to sale, and the likelihood of changing interest rates,
forward commitments and options are placed with counter-parties to substantially
lock the expected margin on the sale of the loan. The options and forward
commitments to sell securities are considered to be derivatives and, as such,
are recorded on the Consolidated Balance Sheets at fair value and the changes in
fair value are reflected in the Consolidated Statements of Income.
The RLCs (representing forward commitments to fund loans which will be held for
sale) are also considered derivatives and are valued at estimated fair market
value based on prevailing interest rates, expected servicing release premiums
and the assumed probability of closing (pull-through). The assumption of a given
pull-through percentage also enters into the determination of the volume of
derivative contracts. Pull-through assumptions are continually monitored for
changes in the interest rate environment and characteristics of the pool of
RLCs. Differences between pull-through assumptions and actual pull-through could
result in a mismatch in the volume of security contracts corresponding to RLCs
and lead to volatility in margins on the loan products ultimately delivered.
At June 30, 2003, the Company's mortgage subsidiary held an investment in
forward mortgage contracts with a notional value of $106.0 million and
mortgage-backed security put options totaling $23.0 million. These instruments
are collectively referred to as hedging instruments or securities. These
contracts hedge interest rate risk associated with RLCs and closed loans not
allocated to a forward commitment of $110.9 million. At June 30, 2003, the fair
value of the securities was an asset of $529,000, which represents a $1.2
million increase from the fair value at December 31, 2002. In addition, the fair
value of the RLCs at June 30, 2003 was an asset of $1.6 million, which
represents a $655,000 decline from the fair value at December 31, 2002. The
market valuation of RLCs at June 30, 2003 assumes 61.3% RLC pull- through. If
actual pull-through in succeeding months proves to be more or less than 61.3%,
the full market value of RLCs may or may not be realized and/or the valuation of
RLCs may change. The valuation of RLCs is considered critical because of the
impact of borrower behavior and the impact that this behavior pattern will have
on the pull- through ratio during times of significant rate volatility. Customer
behavior is modeled by a mathematical tool based upon historical pull-through
experience; however, substantial volatility can be experienced, as has been the
case over the last eighteen months, as a result of the general movement in
mortgage rates. As a result daily pull-through varied significantly over this
time period. Customer behavior is difficult to model. However, the mathematical
tool utilized by UFM implies volatility gained from market data in order to
attempt to anticipate borrower reaction to market and rate movements.
For the six months ended June 30, 2003, the Company incurred $3.3 million in the
cost of forward mortgage derivative contracts to originate and sell $469.0
million in loans compared to the first six months of the prior year in which
$316.3 million in loans were originated for sale with underlying forward
mortgage contracts that cost $831,000. The lower cost of forward mortgage
contracts in the prior year is reflective of the volatility of the pricing of
these types of contracts during times of significant interest rate volatility.
Although the pricing of the contracts was favorable to the Company in the prior
year, UFM's pricing on loans sold was substantially less as a result of the
market pricing dynamics. The significant increase in hedging cost demonstrates
the potential volatility to earnings and the sensitivity to pull-through
assumptions. The cost of these derivative contracts along with RLC mark to
market is netted within mortgage revenues in the consolidated statements of
income to arrive at the net revenues associated with the origination, holding
and sale of mortgage loans.
RECENT ACQUISITIONS AND BRANCHING ACTIVITY
On June 6, 2003, the Company acquired The CommonWealth Bank, a
Virginia-chartered commercial bank ("CommonWealth Bank") for total consideration
of approximately $23.2 million. The merger was accomplished through the exchange
of .9015 shares of First Community Bancshares' common stock valued at $30.50,
cash, or a combination of First Community stock and cash equivalent to $30.50
for each share of CommonWealth Bank common stock issued and outstanding
immediately prior to the merger, plus cash in lieu of any fractional share
interest, subject to the election and allocation procedures set forth in the
merger agreement intended to ensure that not more than 60% of the value of
consideration would be in the form of Company common stock with the remainder in
the form of cash. At acquisition, CommonWealth Bank had total assets of $136.5
million, net loans of $120.0 million and total deposits of $105.0 million.
18
In the second quarter of 2003, the Company opened two DeNovo branches in
Winston-Salem, North Carolina. In addition, a third DeNovo facility will be
opened in the third quarter of 2003. It is anticipated that these branches will
not be profitable until market development has proven successful and adequate
loan balances and corresponding loan revenue are established to support the
added facilities, infrastructure and other operating costs of these branches.
RESULTS OF OPERATIONS
GENERAL
For the first six months ("year-to-date") of 2003, net income totaled $13.7
million, which was $1.3 million, or 11.01% higher than net income of $12.4
reported for the corresponding period in 2002. The 2003 year to date net income
resulted in basic and diluted earnings per share of $1.25 versus $1.14 in 2002,
a 9.65% increase. Year-to-date increases of $1.1 million in both net interest
income and mortgage banking income were largely responsible for the 2003
increase in net income; however, these increases were partially offset by a
year-to-date $1.2 million increase in salaries and benefits when compared to the
same period of 2002.
For the three months ended ("second quarter") June 30, 2003, net income totaled
$7.0 million, which was $929,000, or 15.4% higher than net income of $6.0
million reported for the corresponding period in 2002. Net income for the second
quarter of 2003 resulted in basic and diluted earnings per share of $0.63 versus
$0.55 basic and diluted earnings per share reported in the second quarter of
2002, a 14.6% increase. As mentioned in the year-to-date discussion, the most
significant factors contributing to this increase were a $415,000 increase in
net interest income and a $1.3 million increase in mortgage banking income.
Partially offsetting these increases were current increases of $286,000 in the
provision for loan losses and $693,000 in salaries and benefits.
NET INTEREST INCOME YEAR-TO-DATE COMPARISON (SEE TABLE I)
Net interest income, the largest contributor to earnings, was $30.8 million for
the six months ended June 30, 2003 compared to $29.6 million for the
corresponding period in 2002. For purposes of this discussion, comparison of net
interest income is done on a tax equivalent basis which provides a common basis
for comparing yields on earning assets exempt from federal income taxes to those
which are fully taxable. As indicated in Table I, tax equivalent net interest
income totaled $32.6 million for the six months ended June 30, 2003, an increase
of $1.0 million from the $31.6 million reported in the first six months of 2002.
This $1.0 million increase was based on a $1.4 million increase due to volume
changes as earning assets were added to the portfolio at declining replacement
rates, which was partially offset by a $340,000 reduction due to rate changes on
the underlying assets as asset yields fell in the declining rate environment.
Management was able to help counter the effect of the declining asset yield
through aggressive management of deposit rates offered. Average earning assets
increased $77.9 million while interest-bearing liabilities increased $53.6
million. The yield on earning assets decreased 82 basis points between 2002 and
2003, but was offset by an 82 basis point decline in the cost of funds leaving
the net interest rate spread (the spread between interest earning assets and
interest bearing liabilities) at June 30, 2003 unchanged at 4.21% from the
comparable period last year. However, the Company's tax equivalent net interest
margin of 4.59% for the six months ended June 30, 2003 decreased 11 basis points
from 4.70% in 2002.
As indicated in Table I, the overall tax equivalent yield on average earning
assets decreased 82 basis points from 7.47% at June 30, 2002 to 6.65% for the
six months ended June 30, 2003. The largest contributor to this decrease, on a
volume-weighted basis, was the decrease in the overall tax equivalent yield on
loans held for investment of 51 basis points from the prior year to 7.45%, as
loans repriced downward in response to the declining rate environment while the
average balance increased $3.6 million. The decline in asset yield is
attributable to the current interest rate environment which creates refinancing
or repricing incentives for fixed rate borrowers to lower their current
borrowing costs. In addition, due to the volume of loans directly tied to prime
and other indices that are either adjustable incrementally or are variable rate
advances, asset yields have declined in response to rate cuts and drops in the
prime loan rate which began in 2001, continued in 2002 and remain at lows not
seen in over 40 years.
The balance of average loans held for sale decreased only slightly, by $170,000
while the yield decreased 157 basis points to 5.31%. The yield on loans held for
sale is much more sensitive to interest rate change since these loans are only
held for 30 to 60 days and are replenished with new loan volume at the then
prevailing rates.
During the six months ended June 30, 2003, the taxable equivalent yield on
securities available for sale decreased 90 basis points to 5.16% while the
average balance increased by $38.9 million. Consistent with the current rate
environment, the Company and the securities industry as a whole have experienced
rapid turnover in securities as higher yielding securities are either called or
prepaid as the refinancing opportunity presents itself. Although the
19
total portfolio grew by $118.9 million in comparison to the prior year, the
relative rate on securities acquired since June 30, 2002 has declined
substantially. Both the average balance and tax equivalent yield on investment
securities held to maturity remained relatively stable with a decrease in yield
of only 7 basis points to 8.09% and a $70,000 decrease in average balance from
the first six months of 2002.
Compared to the first six months of 2002, average interest-bearing balances with
banks increased $35.4 million while the yield decreased 8 basis points. This
average balance increase was largely the result of funds received from new
deposit growth in existing markets and deposits obtained in the acquisition of
Greenville in the fourth quarter of 2002.
The Company actively manages its product pricing by staying abreast of the
current economic climate and competitive forces in order to enhance repricing
opportunities available with respect to the liability side of its balance sheet.
In doing so, the cost of interest-bearing liabilities decreased by 82 basis
points from 3.26% for the six months ended June 30, 2002 to 2.44% for the same
period of 2003 while the average volume increased $53.6 million. Active deposit
liability pricing management is performed weekly.
Average FHLB borrowings decreased by $30.8 million when comparing the six months
ended June 30, 2003 to the corresponding period of the prior year as a result of
maturities of $25 million in June 2002 and $10 million in December 2002 while
the average rate paid decreased 17 basis points to 5.79% in 2003 versus 5.96% in
2002. The average balance and rate paid on other borrowings remained virtually
the same in 2003 compared to 2002.
In addition, the average balances of interest-bearing demand and savings
deposits increased $21.4 and $22.2 million, respectively, during the six months
ended June 30, 2003 while the corresponding average rate paid on these deposit
categories declined 36 and 48 basis points, respectively. Average time deposits
increased $27.8 million while the average rate paid decreased 97 basis points
from 4.02% in 2002 to 3.05% in 2003. Likewise, average Fed Funds and repurchase
agreements increased $13.0 million while the average rate decreased 43 basis
points. The level of average noninterest-bearing demand deposits increased $8.5
million to $164.3 million at June 30, 2003 compared to the corresponding period
of the prior year. Approximately $24.4 million and $8.8 million of the $71.4
million increase in average interest-bearing deposit growth is attributable to
the acquisitions of Greenville in the fourth quarter of 2002 and CommonWealth in
June 2003, respectively.
NET INTEREST INCOME -QUARTERLY COMPARISON (SEE TABLE II)
Net interest income for the quarter ended June 30, 2003 was $15.6 million
compared to $15.2 million for the same period in 2002, an increase of $415,000.
Likewise, tax equivalent net interest income increased $381,000 from $16.1
million at June 30, 2002, to $16.5 million at June 30, 2003 (refer to Table II).
A 76 basis point decrease in rate paid on interest-bearing liabilities largely
offset an 88 basis point decline in the average rate earned on interest-earning
assets, leaving a decrease in the net interest margin of 22 basis points to
4.55% for the quarter ended June 30, 2003. While the net interest margin
decreased, average earning assets increased $98.5 million in the second quarter
of 2003 compared to the second quarter of 2002 resulting in the improvements in
net interest income. Increases in average earning assets included increases in
average securities available for sale of $63.4 million and average loans held
for investment of $14.2 million.
As previously mentioned, the impact of the declining interest rate environment
continued to reduce asset yields as assets repriced into lower interest rate
products and as securities were replaced with lower yielding instruments
reflecting the lower rate environment. This refinancing/repricing scenario is
reflected in all categories of interest earning assets. Management continues to
focus on margin enhancement by funding the balance sheet growth with lower
priced deposits and borrowings without significantly extending balance sheet
duration (the weighted average maturity) in anticipation of future rate
increases. In the second quarter of 2003, average interest-bearing deposits with
banks increased $22.6 million and Fed Funds Sold increased $666,000, while
average loans held for sale decreased $1.2 million when compared to the second
quarter of the prior year.
Similar to the decline in asset yields created by the current interest rate
cycle, deposit and borrowing costs also have been adjusted where possible to
obtain this benefit on the liability side of the balance sheet. As previously
mentioned, management continues to strive for lower cost funding in light of
current asset yields. Management meets weekly to monitor the overall performance
of assets and interest-bearing liabilities through the Company's product
management group. Total interest-bearing liabilities increased $69.1 million
with average interest-bearing deposits increasing $81.5 million. The average
rate paid on paying liabilities and deposits dropped 76 and 72 basis points,
respectively. For the same periods, average Fed Funds purchased and repurchase
agreements increased $14.2 million with the average rate decreasing 51 basis
points.
20
TABLE I AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
(DOLLARS IN THOUSANDS)
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2003 JUNE 30, 2002
------------------------------------------- --------------------------------------
AVERAGE INTEREST YIELD/RATE AVERAGE INTEREST YIELD/RATE
BALANCE (1) (1) BALANCE (1) (1)
------------ ----------- ----------- ----------- ----------- ----------
Earning Assets:
Loans (2):
Held for Sale $ 48,771 $ 1,284 5.31% $ 48,941 $ 1,670 6.88%
Held for Investment:
Taxable 913,480 33,731 7.45% 909,227 35,875 7.96%
Tax-Exempt 5,759 219 7.68% 6,452 268 8.38%
----------- ----------- ----------- -----------
Total 919,239 33,950 7.45% 915,679 36,143 7.96%
Allowance for Loan Losses (14,163) (14,448)
----------- ----------- ----------- -----------
Net Total 905,076 33,950 901,231 36,143
Securities Available for Sale:
Taxable 296,387 6,514 4.43% 257,761 6,928 5.42%
Tax-Exempt 94,480 3,482 7.43% 94,219 3,654 7.82%
----------- ----------- ----------- -----------
Total 390,867 9,996 5.16% 351,980 10,582 6.06%
Securities Held to Maturity:
Taxable 626 18 5.80% 1,992 71 7.19%
Tax-Exempt 39,567 1,594 8.12% 39,563 1,611 8.21%
----------- ----------- ----------- -----------
Total 40,193 1,612 8.09% 41,555 1,682 8.16%
Interest Bearing Deposits 45,377 354 1.57% 10,025 82 1.65%
Fed Funds Sold 1,376 8 1.17% -- -- --
----------- ----------- ----------- -----------
Total Earning Assets 1,431,660 $ 47,204 6.65% 1,353,732 $ 50,159 7.47%
Other Assets 110,469 106,460
----------- -----------
Total $ 1,542,129 $ 1,460,192
=========== ===========
Interest-Bearing Liabilities:
Demand Deposits $ 210,077 732 0.70% $ 188,700 992 1.06%
Savings Deposits 182,515 611 0.68% 160,282 923 1.16%
Time Deposits 603,163 9,116 3.05% 575,339 11,482 4.02%
----------- ----------- ----------- -----------
Total Deposits 995,755 10,459 2.12% 924,321 13,397 2.92%
Fed Funds Purchased & Repurchase
Agreements 94,964 876 1.86% 81,939 929 2.29%
FHLB Convertible and Callable Advances 102,834 2,951 5.79% 133,619 3,949 5.96%
Other Borrowings 10,045 298 5.98% 10,108 300 5.99%
----------- ----------- ----------- -----------
Total Interest-bearing liabilities 1,203,598 14,584 2.44% 1,149,987 18,575 3.26%
Demand Deposits 164,323 155,810
Other Liabilities 15,821 15,592
Stockholders' Equity 158,387 138,803
----------- -----------
Total $ 1,542,129 $ 1,460,192
=========== ----------- =========== -----------
Net Interest Income $ 32,620 $ 31,584
=========== ===========
Net Interest Rate Spread (3) 4.21% 4.21%
=========== =========
Net Interest Margin (4) 4.59% 4.70%
=========== =========
(1) Fully Taxable Equivalent at the rate of 35%.
(2) Non-accrual loans are included in average balances outstanding but with no
related interest income during the period of non-accrual.
(3) Represents the difference between the yield on earning assets and cost of
funds.
(4) Represents tax equivalent net interest income divided by average interest
earning assets.
21
TABLE II AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED THREE MONTHS ENDED
JUNE 30, 2003 JUNE 30, 2002
-------------------------------------------- ---------------------------------------
AVERAGE INTEREST YIELD/RATE AVERAGE INTEREST YIELD/RATE
BALANCE (1) (1) BALANCE (1) (1)
----------- ----------- ------------ ----------- ----------- ----------
Earning Assets:
Loans (2):
Held for Sale $ 47,990 $ 655 5.47% $ 49,222 826 6.73%
Held for Investment:
Taxable 926,089 16,917 7.33% 910,759 17,925 7.89%
Tax-Exempt 5,399 99 7.39% 6,560 136 8.32%
----------- ----------- ----------- ----------
Total 931,488 17,016 7.33% 917,319 18,061 7.90%
Allowance for Loan Losses (13,998) (14,470)
----------- ----------- ----------- ---------
Net Total 917,490 17,016 902,849 18,061
Securities Available for Sale:
Taxable 320,641 3,381 4.23% 260,109 3,588 5.53%
Tax-Exempt 95,485 1,729 7.26% 92,612 1,780 7.71%
----------- ----------- ----------- -----------
Total 416,126 5,110 4.93% 352,721 5,368 6.10%
Securities Held to Maturity:
Taxable 595 6 4.04% 1,930 33 6.86%
Tax-Exempt 39,180 797 8.16% 39,464 804 8.17%
----------- ----------- ----------- ----------
Total 39,775 803 8.10% 41,394 837 8.11%
Interest Bearing Deposits 32,272 145 1.80% 9,655 39 1.62%
Fed Funds Sold 666 2 1.20% -- -- --
----------- ----------- ----------- -----------
Total Earning Assets 1,454,319 $ 23,731 6.55% 1,355,841 $ 25,131 7.43%
Other Assets 114,983 107,732
----------- -----------
Total $ 1,569,302 $ 1,463,573
=========== ===========
Interest-Bearing Liabilities:
Demand Deposits $ 216,535 367 0.68% $ 188,857 502 1.07%
Savings Deposits 183,840 294 0.64% 170,077 542 1.28%
Time Deposits 607,755 4,483 2.96% 567,715 5,361 3.79%
----------- ----------- ----------- ----------
Total Deposits 1,008,130 5,144 2.05% 926,649 6,405 2.77%
Fed Funds Purchased & Repurchase
Agreements 99,182 438 1.77% 84,958 482 2.28%
FHLB Convertible and Callable Advances 105,637 1,495 5.68% 132,253 1,971 5.98%
Other Borrowings 10,044 150 5.99% 10,058 150 5.98%
----------- ----------- ----------- ----------
Total Interest-bearing liabilities 1,222,993 7,227 2.37% 1,153,918 9,008 3.13%
Demand Deposits 167,488 154,667
Other Liabilities 17,199 14,580
Stockholders' Equity 161,622 140,408
----------- -----------
Total $ 1,569,302 $ 1,463,573
=========== ----------- =========== ----------
Net Interest Income $ 16,504 $ 16,123
=========== ==========
Net Interest Rate Spread (3) 4.18% 4.30%
=========== =========
Net Interest Margin (4) 4.55% 4.77%
=========== =========
(1) Fully Taxable Equivalent at the rate of 35%.
(2) Non-accrual loans are included in average balances outstanding but with no
related interest income during the period of non-accrual.
(3) Represents the difference between the yield on earning assets and cost of
funds.
(4) Represents tax equivalent net interest income divided by average interest
earning assets.
22
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level sufficient to absorb
probable loan losses inherent in the loan portfolio. The allowance is increased
by charges to earnings in the form of provisions for loan losses and recoveries
of prior loan charge-offs, and decreased by loans charged off. The provision for
loan losses is calculated to bring the allowance to a level, which, according to
a systematic process of measurement, reflects the amount needed to absorb
probable losses within the portfolio.
Management performs monthly assessments to determine the appropriate level of
allowance. Differences between actual loan loss experience and estimates are
reflected through adjustments that are made by either increasing or decreasing
the loss provision based upon current measurement criteria. Commercial, consumer
and mortgage loan portfolios are evaluated separately for purposes of
determining the allowance. The specific components of the allowance include
allocations to individual commercial credits and allocations to the remaining
non-homogeneous and homogeneous pools of loans. Management's allocations are
based on judgment of qualitative and quantitative factors about both macro and
micro economic conditions reflected within the portfolio of loans and the
economy as a whole. Factors considered in this evaluation include, but are not
necessarily limited to, probable losses from loan and other credit arrangements,
general economic conditions, changes in credit concentrations or pledged
collateral, historical loan loss experience, and trends in portfolio volume,
maturities, composition, delinquencies, and non-accruals. While management has
attributed the allowance for loan losses to various portfolio segments, the
allowance is available for the entire portfolio.
The allowance for loan losses was $15.7 million on June 30, 2003, compared to
$14.4 million at December 31, 2002 and $14.2 million on June 30, 2002. The
allowance for loan losses represents 597% of non-performing loans at June 30,
2003, versus 455% and 324% at December 31, 2002 and June 30, 2002, respectively.
When other real estate is combined with non-performing loans, the allowance
equals 290% of non-performing assets at June 30, 2003 versus 239% and 208% at
December 31, 2002 and June 30, 2002, respectively. The increase in the allowance
since year-end 2002 is primarily attributable to the acquisition of CommonWealth
Bank. The allowance attributable to the CommonWealth portfolio at the date of
acquisition was $1.6 million. This increase in the allowance, coupled with a
decline in non-performing loans, resulted in an increase in the allowance as a
percentage of nonperforming assets since year-end 2002. The Company also made
additional provisions of $0.5 million in the second quarter of 2003 based upon
an internal downgrade of a loan officer's portfolio. Management determined that
an aggregate $2.8 million in loans, part of a $12.2 million portfolio originated
by the loan officer, was substandard. During the second quarter of 2003,
following the discovery of the officer's deficiencies in the application of loan
policies and procedures associated with these loans, management implemented an
ongoing comprehensive risk review of the officer's portfolio and incorporated
specific credit allocations in its analysis for loan losses at June 30, 2003.
Based upon this analysis, management believes that the resulting increase in the
provision and allowance under the circumstances is appropriate. Management has
terminated the loan officer in question and has made associated changes in
regional management.
FCBI's allowance for loan loss activity for the six and three month periods
ended June 30, 2003 and 2002 are as follows:
FOR THE SIX MONTHS ENDED FOR THE THREE MONTHS ENDED
JUNE 30 JUNE 30
------------------------ --------------------------
2003 2002 2003 2002
-------- -------- -------- --------
(DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS)
Beginning balance $ 14,410 $ 13,952 $ 13,782 $ 14,271
Provision 1,897 1,959 1,308 1,022
Balance acquired in CommonWealth acquisiton 1,583 -- 1,583 --
Charge-offs (3,109) (2,061) (1,441) (1,243)
Recoveries 926 344 475 144
-------- -------- -------- --------
Ending Balance $ 15,707 $ 14,194 $ 15,707 $ 14,194
======== ======== ======== ========
Based on the allowance for loan losses of approximately $15.7 million and $14.2
million at June 30, 2003 and 2002, respectively, the allowance to loans held for
investment ratio was 1.53% for both periods. Management considers the allowance
adequate based upon its analysis of the portfolio as of June 30, 2003.
The provision for loan losses for the six months ended June 30, 2003 decreased
by $62,000 versus the prior comparable period, but increased by $1.3 million in
the second quarter to $1.9 million versus $589,000 for the quarter ended March
31, 2003. The increase during the quarter is largely attributable to loans
determined to be
23
substandard subsequent to an evaluation conducted in the second quarter
regarding the aforementioned loan officer's portfolio. Net charge-offs for the
first six months of 2003 were $2.2 million compared with $1.7 million for the
corresponding period of 2002. Expressed as a percentage of average loans held
for investment, net charge-offs increased slightly from 0.19% for the six month
period of 2002, to 0.24% for the same period of 2003.
NON-INTEREST INCOME
Non-interest income consists of all revenues which are not included in interest
and fee income related to earning assets. Total non-interest income increased
approximately $2.2 million, or 19.9%, from $10.8 million for the six months
ended June 30, 2002 to $13.0 million for the corresponding period in 2003. The
largest portion of this increase is attributable to the mortgage brokerage
operations of UFM, which reflected a $1.1 million increase in mortgage banking
income for the six months ended June 30, 2003 over the comparable six-month
period in 2002. This increase is directly attributable to increased volume from
the sale of mortgage loans in the six months ended June 30, 2003 due to the
continued and increased refinance activity in the favorable rate environment for
mortgage loans.
Mortgage banking income is comprised of the changes in the fair value of forward
mortgage contracts and interest rate lock commitments, the costs associated with
the settlement of forward mortgage contracts, gains and losses on the sale of
mortgage loans and other income recognized upon the sale of the mortgage loans.
As previously discussed under the Application of Critical Accounting Policies
section of this Management's Discussion and Analysis, the fair value of forward
mortgage contracts increased by $1.2 million, while the fair value of the
interest rate lock commitments declined by $655,000 during the six months ended
June 30, 2003. This compares to an increase in the fair value of forward
mortgage contracts of $835,000 and a decrease in the fair value of interest rate
lock commitments of $494,000 for the six months ended June 30, 2002. During the
six months ended June 30, 2003, the Company incurred costs of $3.3 million on
the settlement of forward mortgage contracts compared to costs of $831,000
incurred during the six months ended June 30, 2002.
In addition, gain on sale of loans increased approximately $3.1 million, or 76%
from $4.1 million for the six months ended June 30, 2002 to $7.2 million for the
corresponding period in 2003. Other mortgage banking fee income of $2.0 million,
primarily origination and document preparation fees, remained relatively
consistent with the amount recorded for the six months ended June 30, 2002.
Along with the increase in deposits, service charges on deposit accounts
increased $538,000, or 16.5% primarily as the result of the Company's overdraft
program that allows well-managed customer deposit accounts flexibility in
managing overdrafts to their accounts. In addition, other service charges,
commissions and fees were up $388,000 for the first six months of 2003 compared
to that of 2002. Fiduciary earnings representing asset management fees on trust
and agency accounts and were also up $137,000 for the first six months of 2003
as a direct result of estate and trust management activity, including the
operations of Stone Capital acquired in January 2003. In addition, gain on
securities was $153,000 in the six months ended June 30, 2003, down slightly
compared to the comparable period in 2002.
Total non-interest income of $6.9 million for the second quarter of 2003
increased $2.0 million compared to the second quarter of 2002, the majority of
which was attributable to an increase of $1.3 million in mortgage banking
income, while service charges on deposit accounts and other service charges,
commissions and fees increased $380,000 in aggregate. In addition, gain on sale
of securities increased $124,000 for the second quarter of 2003 compared to that
of 2002.
NON-INTEREST EXPENSE
Non-interest expense totaled $22.5 million for the six months ended June 30,
2003, increasing $1.5 million, or 7.1% over the corresponding period in 2002.
This increase is primarily attributable to a $1.2 million increase in salaries
and benefits as a result of increased loan production by UFM, the addition of
Bank of Greenville in late 2002, the addition of The CommonWealth Bank in June
2003 as well as a general increase in salaries and benefits as staffing needs at
several locations were satisfied in order to support added corporate services
and continued branch growth including newly established branches in
Winston-Salem, North Carolina.
In the first six months of 2003, occupancy expense increased by $250,000 when
compared to the first six months of 2002. The general level of occupancy cost
grew partially as a result of the Greenville and CommonWealth acquisitions as
well as increases in depreciation and insurance costs associated with new
branches.
24
The combined effect of all other operating expense accounts remained fairly
consistent for the first six months of 2003 compared to the same period of 2002.
Non-interest expense for the three months ended June 30, 2003 totaled $11.4
million, a $968,000 increase over the $10.4 million for the quarter ended June
30, 2002. The majority of this increase was a $693,000 increase in salaries and
employee benefits which is partially attributable to the Greenville and
CommonWealth acquisitions, increases due to higher loan origination activity of
UFM in 2003 and a general increase in salaries along with the addition of
personnel Company-wide to support the continued growth of the Bank.
Occupancy and other operating expenses increased $144,000 and $182,000,
respectively, for the quarter ended June 30, 2003 compared to June 30, 2002. As
discussed earlier, this additional expense was associated with the recent
acquisitions, new branches and expanded infrastructure.
INCOME TAX
The effective income tax rate continues to benefit from the utilization of
tax-exempt municipal securities. Municipal securities, which have offered an
attractive tax equivalent yield, have assisted in countering the effect of the
declining interest rate environment. The Company's effective tax rate was 30.34%
and 29.19% for the three and six months ended June 30, 2002, respectively, and
28.9% for both the three and six months ended June 30, 2003.
FINANCIAL POSITION
SECURITIES
Investment securities, which are purchased with the intent to hold until
maturity, totaled $39.7 million at June 30, 2003, a decrease of $1.3 million
from December 31, 2002. This 3.1% decrease is the result of maturities and calls
within the portfolio during the first six months of 2003. The market value of
investment securities held to maturity was 107.2% and 105.7% of book value at
June 30, 2003 and December 31, 2002, respectively. Recent trends in interest
rates have had a positive effect on the underlying market value since December
31, 2002. However, recent increases in yields in the bond market in July and
August 2003 have eroded a portion of the gains and may suggest a longer-term
trend of higher bond interest rates.
Securities available for sale were $419.8 million at June 30, 2003 compared to
$300.9 million at December 31, 2002, an increase of $118.9 million. This change
reflects the purchase of $183.9 million in securities, $64.6 million in
maturities and calls, the sale of $3.5 million in securities, and the
continuation of larger pay-downs on mortgage-backed securities and
Collateralized Mortgage Obligations ("CMO's") triggered by the lower interest
rate environment. Securities available for sale are recorded at their estimated
fair market value. The unrealized gain or loss, which is the difference between
amortized cost and estimated market value, net of related deferred taxes, is
recognized in the Stockholders' Equity section of the balance sheet as either
accumulated other comprehensive income or loss. The unrealized gains after taxes
of $8.5 million at June 30, 2003, represent an increase of $1.7 million from the
$6.8 million gain at December 31, 2002 due to market value increases in the
first six months of 2003. Again, although it is impossible to predict future
market direction, recent trends in the bond market suggest the possibility of an
erosion of some or all of these market gains.
LOAN PORTFOLIO
LOANS HELD FOR SALE: The relative size of the portfolio of loans originated by
the Company's mortgage brokerage division, UFM, and held for sale, was impacted
significantly by the refinancing activity that occurred during 2002 and
continues into 2003. Loans held for sale fluctuate on a daily basis reflecting
retail originations, wholesale purchases and sales to investors. At June 30,
2003, loans held for sale were $46.7 million compared to $66.4 million at
December 31, 2002. Average loans held for sale (which is a better indicator of
volume maintained) remained relatively stable, decreasing only $170,000 during
the first six months of 2003 compared to the first six months of 2002.
LOANS HELD FOR INVESTMENT: Total loans held for investment increased $99.0
million from $927.6 million at December 31, 2002 to $1.0 billion at June 30,
2003. The increase is attributable to the CommonWealth acquisition
(approximately $131.2 million at June 30, 2003) net of several large payoffs
during the first six months of 2003. Considering a $117 million increase in
deposits and the increase in loans during the first six months of 2003, the loan
to deposit ratio remained stable compared to the December 31, 2002 level. The
loan to deposit ratio, using only loans held for investment (excluding loans
held for sale), was 81.7% on June 30, 2003, 81.4% on December 31,
25
2002 and 90.67% on June 30, 2002. Intense competition for loans in the face of
low interest rates and what appears to be slower loan demand continue to impact
this measure of loan production. Resulting liquidity during the period has been
reinvested in the available for sale securities portfolio.
Average loans held for investment remain stable increasing only $3.6 million
when comparing the first six months of 2003 to the same period of 2002. This
increase includes approximately $16.5 million in average loans acquired in the
Monroe acquisition in the fourth quarter of 2002 and $16.8 million in average
loans from CommonWealth (a slight impact since acquisition on June 6, 2003) net
of the large commercial payoffs and regular amortization in the second quarter
2003.
The held for investment loan portfolio continues to be diversified among loan
types and industry segments. The following tabular presentation of the loan
portfolio is presented as of June 30, 2003, December 31, 2002 and June 30, 2002
and provides an analytical overview of the portfolio from June 30, 2002 and the
change in composition among the various categories.
LOAN PORTFOLIO OVERVIEW
(DOLLARS IN THOUSANDS)
JUNE 30, 2003 DECEMBER 31, 2002 JUNE 30, 2002
--------------------------- ------------------------ ------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
--------------- --------- ------------ --------- ------------ --------
LOANS HELD FOR INVESTMENT:
Commercial and Agricultural $ 58,501 5.70% $ 74,186 8.00% $ 84,700 9.12%
Commercial Real Estate 346,892 33.80% 285,847 30.83% 275,155 29.64%
Residential Real Estate 418,312 40.75% 364,065 39.25% 354,962 38.23%
Construction 73,314 7.14% 72,275 7.79% 80,661 8.69%
Consumer 128,833 12.55% 130,522 14.07% 131,879 14.20%
Other 791 0.08% 726 0.08% 1,184 0.13%
--------------- ------ ------------ ------ ------------ ------
Total $ 1,026,643 100.00% $ 927,621 100.00% $ 928,541 100.00%
=============== ====== ============ ====== ============ ======
LOANS HELD FOR SALE $ 46,743 $ 66,364 $ 52,095
=============== ============ ============
NON-PERFORMING ASSETS
Non-performing assets include loans on non-accrual status, loans contractually
past due 90 days or more and still accruing interest and other real estate owned
("OREO"). Non-performing assets were $5.4 million at June 30, 2003, $6.0 million
at December 31, 2002 and $6.8 million at June 30, 2002, or 0.5%, 0.6% and 0.7%
of total loans and OREO, respectively. The following schedule details
non-performing assets by category at the close of each of the last five
quarters:
(IN THOUSANDS OF DOLLARS) JUNE 30 MARCH 31 DECEMBER 31 SEPTEMBER 30 JUNE 30
2003 2003 2002 2002 2002
------- -------- ----------- ------------ -------
Nonaccrual $2,547 $3,997 $3,075 $4,987 $4,131
Ninety Days Past Due 86 21 91 367 254
Other Real Estate Owned 2,787 2,544 2,855 2,668 2,452
------ ------ ------ ------ ------
$5,420 $6,562 $6,021 $8,022 $6,837
====== ====== ====== ====== ======
Restructured loans
performing in accordance
with modified terms $ 368 $ 341 $ 345 $ 347 $ 440
====== ====== ====== ====== ======
At June 30, 2003, non-accrual loans decreased $1.5 million from March 31, 2003,
while ninety day past due loans increased only $65,000. Ongoing activity within
the classification and categories of non-performing loans continues to include
collections on delinquencies, foreclosures and movements into or out of the
non-performing classification as a result of changing customer business
conditions. The $1.5 decrease in non-accrual loans during the second quarter of
2003 is largely due to the receipt of a partial payoff from the sale and
subsequent charge-off of a commercial real estate loan in the amount of
$707,000. The remainder of the decrease is a result of non-accrual loans being
paid, moved to a current status as a result of improved performance, or being
liquidated through
26
foreclosure or repossession. OREO increased $243,000 during the second quarter
of 2003 from March 31, 2003. Other real estate owned is carried at the lesser of
estimated net realizable fair market value or cost.
During the first quarter 2003, the Company identified certain potential problem
loans. These loans present characteristics of weakness and concentrations of
credit to one borrower. These two loans or groups of loans, to separate
borrowers warrant close monitoring but continue to perform. The first loan is a
$12.7 million loan to a borrower within the hospitality industry. The loan
represents the retained portion of a $16 million total loan shared with a
participating bank. The loan continues to perform according to terms and remains
current.
The second group of loans made to one borrower consists of a $2 million loan for
land development in Eastern Virginia and another loan of approximately $5.0
million which is secured by land improved with an 18-hole golf course and
surrounding developable acreage in Northern Virginia. The loans continue to
perform according to terms and remain current. Subsequent to June 30, 2003, the
borrower received zoning approval on land securing the $2.0 loan which enhances
the marketability of the collateral. The Company has also received a payoff on a
smaller $500,000 loan associated with the $5.0 million golf course land loan and
a principal curtailment in the amount of $288,000 was applied to the $5.0
million loan. As a result of these events, prospects for normal amortization,
liquidation and continued performance in accordance with loan terms have
improved.
There were no specific allocations of the allowance for loan losses for any of
the foregoing potential problem loans as of June 30, 2003.
DEPOSITS AND OTHER BORROWINGS
Total deposits have grown $117 million or 10.27% since year-end 2002, $109,000
of which was acquired with CommonWealth. In terms of composition,
non-interest-bearing deposits increased $44.8 million or 27.05% while
interest-bearing deposits grew $72.2 million or 7.41 % from December 31, 2002.
The relatively larger increase in non-interest bearing deposits reflects
approximately $25.0 million in balances within an escrow product offering by
CommonWealth to title insurance companies, attorneys and clearing agents.
FCBI acquired an additional $17.5 million in borrowed funds from the FHLB with
the acquisition of CommonWealth and borrowed an additional $25 million from the
FHLB in June 2003. These increases together with a decrease due to the repayment
of a line of credit used to fund mortgages held by UFM with an outside party
brought the Company's borrowings at June 30, 2003 to $136.3 million in
convertible and callable advances and $16.3 million of noncallable term advances
from the FHLB of Atlanta. For further discussion of FHLB borrowings, see Note 5
to the unaudited consolidated financial statements included in this report.
STOCKHOLDERS' EQUITY
Total stockholders' equity reached $175.3 million at June 30, 2003, increasing
$22.8 million from the $152.5 million reported at December 31, 2002 through
earnings of $13.7 million less dividends paid of $5.2 million, an increase in
other comprehensive income of $1.8 million, increases of $244,000 and $14.4
million for the purchases of Stone Capital and CommonWealth, respectively, and a
net decrease due to treasury share transactions of $2.1 million.
The Federal Reserve's risk based capital guidelines and leverage ratio measure
capital adequacy of banking institutions. Risk-based capital guidelines weight
balance sheet assets and off-balance sheet commitments based on inherent risks
associated with the respective asset types. At June 30, 2003, the Company's
total risk adjusted capital-to-asset ratio was 12.64% versus 13.33% at December
31, 2002. The Company's leverage ratio at June 30, 2003 was 8.17% compared with
8.10% at December 31, 2002. Both the risk adjusted capital-to-asset ratio and
the leverage ratio exceed the current well-capitalized levels prescribed for
banks of 10% and 5%, respectively.
PART I. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a significant level of liquidity in the form of cash and
cash equivalent balances ($76.7 million), investment securities available for
sale ($419.8 million) and Federal Home Loan Bank credit availability of
approximately $355.4 million. Cash and cash equivalents as well as advances from
the Federal Home Loan Bank are immediately available for satisfaction of deposit
withdrawals, customer credit needs and operations of the
27
Company. Investment securities available for sale represent a secondary level of
liquidity available for conversion to liquid funds in the event of extraordinary
needs. The Company also maintains approved lines of credit with correspondent
banks as backup liquidity sources.
At June 30, 2003, the Company had outstanding commitments to originate and/or
purchase mortgage and non-mortgage loans (including unused lines of credit) of
$271.3 million. The loan commitments of $271.3 million include commitments
extended by the Bank of $91.4 million and interest rate lock commitments of
$179.9 million issued by UFM. UFM's rate lock commitments are presented prior to
any assumed fallout; however, on an option adjusted basis after fallout, loans
anticipated to close are $110.9 million. Certificates of deposit which are
scheduled to mature within one year totaled $404.2 million at June 30, 2003, and
borrowings that are scheduled to mature within the same period amounted to $8.0
million. The Company anticipates that it will have sufficient funds available to
meet its current loan commitments and normal depositor withdrawals.
The Company maintains a liquidity policy as a means to enhance the liquidity
risk process. The policy includes a Liquidity Contingency Plan that is designed
as a tool for the Company to detect liquidity issues promptly in order to
protect depositors, creditors and shareholders. The Plan includes monitoring
various internal and external indicators such as changes in core deposits and
changes in market conditions. It provides for timely responses to a wide variety
of funding scenarios ranging from changes in loan demand to a decline in the
Company's quarterly earnings to a decline in the market price of the Company's
stock. The Plan calls for specific responses designed to meet a wide range of
liquidity needs based upon assessments on a recurring basis by management and
the Board of Directors.
INTEREST RATE RISK (IRR) AND ASSET/LIABILITY MANAGEMENT
While the Company continues to strive to decrease its dependence on net interest
income, the Bank's profitability is dependent to a large extent upon its ability
to manage its net interest margin. The Bank, like other financial institutions,
is subject to interest rate risk to the degree that its interest-earning assets
reprice differently than its interest-bearing liabilities. The Bank manages its
mix of assets and liabilities with the goals of limiting its exposure to
interest rate risk, ensuring adequate liquidity, and coordinating its sources
and uses of funds. Specific strategies for management of IRR have included
shortening the amortized maturity of fixed-rate loans and increasing the volume
of adjustable rate loans to reduce the average maturity of the Bank's
interest-earning assets.
The Bank seeks to control its IRR exposure to insulate net interest income and
net earnings from fluctuations in the general level of interest rates. To
measure its exposure to IRR, the Bank performs quarterly simulations using
financial models which project net interest income through a range of possible
interest rate environments including rising, declining, most likely, and flat
rate scenarios. The results of these simulations indicate the existence and
severity of IRR in each of those rate environments based upon the current
balance sheet position and assumptions as to changes in the volume and mix of
interest-earning assets and interest-paying liabilities and management's
estimate of yields attainable in those future rate environments and rates which
will be paid on various deposit instruments and borrowings.
The Company's risk profile continues to reflect a position that is largely asset
sensitive. The substantial level of prepayments and calls consistent with the
declining rate environment that occurred in the prior year, as well as the
success of deposit funding campaigns instituted have led to a strong liquidity
position as reflected in the level of cash reserves, due from balances and Fed
Funds Sold of approximately $76.7 million. The Company continues to reinvest the
funds generated from asset paydowns and prepayments within a framework that
attempts to maintain an acceptable net interest margin in the current interest
rate environment. In addition, the mortgage operations of UFM use investments
commonly referred to as "forward" transactions "options" or derivatives to
balance the risk inherent in interest rate lock commitments (also deemed to be
derivatives) made to prospective borrowers. The pipeline of loans is hedged to
mitigate unusual fluctuations in the cash flows derived upon settlement of the
loans with secondary market purchasers and, consequently, to achieve a desired
margin upon delivery. The hedge transactions are used for risk mitigation and
are not for trading purposes. The derivative financial instruments derived from
these hedging transactions are recorded at fair value in the Consolidated
Balance Sheets and the changes in fair value are reflected in the Consolidated
Statements of Income.
As discussed under "Derivative Instruments and Hedging Activities" under
Critical Accounting Policies, the Company's mortgage subsidiary held an
investment in the underlying notional value of investments in securities
("forward commitments" and "options") of $129 million versus option adjusted
interest rate lock commitments being hedged of $110.9 million. As of June 30,
2003, the change in the market value of investments in hedge securities
reflected a increase in estimated fair value of $1.2 million compared to
year-end 2002. In addition, interest rate lock commitments reflected a decline
in value of $655,000 when compared to December 31, 2002. The value of interest
rate lock commitments at June 30, 2003 represents an asset of $1.6 million while
the securities used
28
to hedge the underlying commitments represent an asset of $529,000. This hedging
strategy is managed through a series of mathematical tools that are used to
quantify the exposure to changes in interest rates.
The Company's earnings sensitivity measurements completed on a quarterly basis
indicate that the performance criteria, against which sensitivity is measured,
are currently within the Company's defined policy limits. A more complete
discussion of the overall interest rate risk is included in the Company's annual
report for December 31, 2002.
PART I. ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer along with the
Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to the
Securities Exchange Act of 1934 ("Exchange Act") Rule 13a-14. Based upon that
evaluation, the Company's Chief Executive Officer along with the Company's Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) required to be
included in the Company's periodic SEC filings. There have been no significant
changes in the Company's internal controls or in other factors which could
significantly affect these controls subsequent to the date the Company carried
out its evaluation.
Disclosure controls and procedures are Company controls and other procedures
that are designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by the Company in the reports that it files under the
Exchange Act is accumulated and communicated to the Company's management,
including the Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is currently a defendant in various legal actions and asserted
claims involving lending and collection activities and other matters in the
normal course of business. While the Company and legal counsel are unable to
assess the ultimate outcome of each of these matters with certainty, they are of
the belief that the resolution of these actions should not have a material
adverse affect on the financial position of the Company.
On May 2, 2003, United First Mortgage ("UFM"), a wholly-owned mortgage banking
subsidiary of First Community Bank, the Company's wholly-owned banking
subsidiary, was joined as a party to a lawsuit in the U.S. District Court for
the Eastern District of Pennsylvania, styled John J. Lomanno v Thomas Black, et.
al., Civil Action Number 02-CV-8669. This suit had been filed by a former UFM
employee alleging, among other things, sexual discrimination in connection with
his dismissal. The Company and counsel believe that the lawsuit, which seeks
damages of $150,000 and punitive damages, is without merit, and intends to
vigorously defend this matter.
Item 2. Changes in Securities and Use of Proceeds
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Stockholders was held on April 22, 2003.
(b) The following directors were elected to serve a three-year term through
the date of the 2006 Annual Meeting of Stockholders:
29
I. Norris Kantor, A. A. Modena, and William P. Stafford, II
(c) Two proposals were voted upon at the annual meeting, which included: 1)
the election of the aforementioned directors as Class of 2006; and 2)
ratification of the selection of Ernst & Young, Charleston, West
Virginia, as independent auditors for the year ending December 31,
2003. The results of the proposals and voting are as follows:
Proposal 1. Election of Directors:
Votes For Votes Withheld
-------------- ------------------
I. Norris Kantor 7,373,662 1,027,057
A. A. Modena 7,134,584 1,266,135
William P. Stafford, II 7,436,291 964,428
Proposal 2. Ratification of the selection of Ernst & Young LLP as independent
auditors:
Votes For 7,422,988
Votes Against 71,377
Votes Abstained 906,354
(d) N/A
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
30
EXHIBIT NO. EXHIBIT
- -------------------- ------------------------------------------------------------------------------------------------
2.1 Agreement and Plan of Merger dated as of January 27, 2003, and amended as of February 25,
2003, among First Community Bancshares, Inc., First Community Bank, National Association, and
The CommonWealth Bank. (1)
3(i) Articles of Incorporation of First Community Bancshares, Inc., as amended. (2)
3(ii) Bylaws of First Community Bancshares, Inc., as amended. (2)
4.1 Specimen stock certificate of First Community Bancshares, Inc. (7)
10.1 First Community Bancshares, Inc. 1999 Stock Option Plan. (2)(3)
10.2 First Community Bancshares, Inc. 2001 Non-Qualified Directors Stock Option Plan. (4)
10.3 Employment Agreement dated January 1, 2000 and amended October 17, 2000, between First
Community Bancshares, Inc. and John M. Mendez. (2)(5)
10.4 First Community Bancshares, Inc. 2000 Executive Retention Plan. (3)
10.5 First Community Bancshares, Inc. Split Dollar Plan and Agreement. (3)
10.6 First Community Bancshares, Inc. 2001 Directors Supplemental Retirement Plan. (2)
10.7 First Community Bancshares, Inc. Wrap Plan. (7)
10.8 Employment Agreement between First Community Bancshares, Inc. and J. E. Causey Davis. (8)
11.0 Statement regarding computation of earnings per share. (6)
15.0 Letter regarding unaudited interim financial information.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
32 * Certification of Chief Executive and Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act
* Furnished herewith.
(1) Incorporated by reference to the corresponding exhibit previously filed as
an exhibit to the Form 8-K filed with the Commission on January 28, 2003
and February 26, 2003.
(2) Incorporated by reference from the Quarterly Report on Form 10-Q for the
period ended June 30, 2002 filed on August 14, 2002.
(3) Incorporated by reference from the Annual Report on Form 10-K for the
period ended December 31, 1999 filed on March 30, 2000 as amended April 13,
2000.
(4) The options agreements entered into pursuant to the 1999 Stock Option Plan
and the 2001 Non-Qualified Directors Stock Option Plan are incorporated by
reference from the Quarterly Report on Form 10-Q for the period ended June
30, 2002 filed on August 14, 2002.
(5) First Community Bancshares, Inc. has entered into substantially identical
agreements with Messrs. Buzzo and Lilly, with the only differences being
with respect to titles, salary and the use of a vehicle.
(6) Incorporated by reference from Footnote 10 of the Notes to Consolidated
Financial Statements included herein.
(7) Incorporated by reference from the Annual Report on Form 10-K for the
period ended December 31, 2002 filed on March 25, 2003 as amended on March
31, 2003.
(8) Incorporated by reference from S-4 Registration Statement filed on March
28, 2003.
31
(b) Reports on Form 8-K
A report on Form 8-K was filed on April 22, 2003 announcing the
Company's first quarter 2003 earnings, depicting certain financial
information as of March 31, 2003 and comparative income statements for
the three months ended March 31, 2003 and 2002, respectively.
A report on Form 8-K was filed on April 22 2003 containing the
President's comments and presentation at the Annual Stockholders'
Meeting dated April 22, 2003.
A report on Form 8-K was filed on May 22, 2003 announcing CommonWealth
shareholder approval of the merger and acquisition of CommonWealth
Bank.
A report on Form 8-K was filed on June 5, 2003 announcing the
declaration of the Company's second quarter dividend of $0.26 per share
payable on or about June 30, 2003 to stockholders of record on June 18,
2003.
A report on Form 8-K was filed on June 9, 2003 announcing the Company's
completion of the merger and acquisition of Commonwealth Bank.
A report on Form 8-K was filed on June 18, 2003 announcing the
Company's declaration of a 10% stock dividend to be distributed August
15, 2003 to stockholders of record August 1, 2003.
32
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.
First Community Bancshares, Inc.
DATE: August 14, 2003
/s/ John M. Mendez
- ------------------------------
John M. Mendez
President & Chief Executive Officer
(Duly Authorized Officer)
DATE: August 14, 2003
/s/ Robert L. Schumacher
- ------------------------------
Robert L. Schumacher
Chief Financial Officer
(Principal Accounting Officer)
33
Index to Exhibits
Exhibit No.
15 Letter regarding unaudited interim financial information
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act
32* Certification of Chief Executive and Chief Financial Officer pursuant to
Seciton 906 of the Sarbanes-Oxley Act
* Furnished herewith.
34