Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2001 or

For the transition period from                to                

Commission file number 1-12991

BancorpSouth, Inc.

Registrant's telephone number, including area code        (662) 680-2000

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, $2.50 PAR VALUE
COMMON STOCK PURCHASE RIGHTS

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods 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 o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. o

(Cover Page Continued on Next Page)

Table of Contents

(Continued from Cover Page)

     The aggregate market value of the voting stock held by non-affiliates of the registrant as of January 31, 2002, was approximately $1,371,000,000 based on the closing sale price as reported on the New York Stock Exchange on such date.

     On January 31, 2002, the registrant had outstanding 81,132,989 shares of Common Stock, par value $2.50 per share.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the definitive Proxy Statement used in connection with Registrant’s Annual Meeting of Shareholders to be held April 23, 2002, are incorporated by reference into Part III of this Report.

2

Table of Contents

BANCORPSOUTH, INC.
FORM 10-K
For the Fiscal Year Ended December 31, 2001
CONTENTS

3

Table of Contents

PART I

Item 1. — Business

General

     BancorpSouth, Inc. (the “Company”) is a bank holding company, incorporated in 1982, with commercial banking and financial services operations in Mississippi, Tennessee, Alabama, Arkansas, Texas and Louisiana. Its principal subsidiary is BancorpSouth Bank (the “Bank”). At December 31, 2001, the Company and its subsidiaries had total assets of approximately $9.40 billion and total deposits of approximately $7.86 billion. The Company’s principal office is located at One Mississippi Plaza, Tupelo, Mississippi 38804 and its telephone number is (662) 680-2000.

Description of Business

     The Bank has its principal office in Tupelo, Lee County, Mississippi, and conducts a general commercial banking and trust business through 247 offices in 129 municipalities or communities in Mississippi, Tennessee, Alabama, Arkansas, Texas and Louisiana. The Bank has grown through the acquisition of other banks, the purchase of assets from federal regulators and through the opening of new branches and offices.

     The Bank and its subsidiaries provide a range of financial services to individuals and small-to-medium size businesses. The Bank operates investment services, consumer finance, credit life insurance and insurance agency subsidiaries which engage in investment brokerage services, consumer lending, credit life insurance sales and sales of other insurance products. The Bank’s trust department offers a variety of services including personal trust and estate services, certain employee benefit accounts and plans, including individual retirement accounts and limited corporate trust functions.

     At December 31, 2001, the Company and its subsidiaries had 3,920 full-time equivalent employees. The Company and its subsidiaries are not a party to any collective bargaining agreements and employee relations are considered to be good.

Competition

     Vigorous competition exists in all major areas where the Company is engaged in business. The Bank competes for available loans and depository accounts with state and national commercial banks as well as savings and loan associations, insurance companies, credit unions, money market mutual funds, automobile finance companies and financial services companies. None of these competitors is dominant in the entire area served by the Bank.

     The principal areas of competition in the banking industry center on a financial institution’s ability and willingness to provide credit on a timely and competitively priced basis, to offer a sufficient range of deposit and investment opportunities at a competitive price and maturity, and to offer personal and other services of sufficient quality and at competitive prices. The Company and its subsidiaries believe they can compete effectively in all these areas.

Regulation and Supervision

     The following is a brief summary of the regulatory environment in which the Company and its subsidiaries operate and is not designed to be a complete discussion of all statutes and regulations affecting such operations, including those statutes and regulations specifically mentioned herein.

     The Company is a bank holding company and is registered as such under the Bank Holding Company Act of 1956 (the “Bank Holding Company Act”) with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and is subject to regulation and supervision by the Federal Reserve. The Company is required to file with the Federal Reserve annual reports and such other information as it may require. The Federal Reserve may also conduct examinations of the Company.

     The Bank is incorporated under the banking laws of the State of Mississippi and is subject to the applicable provisions of Mississippi banking laws. The Bank is subject to the supervision of the Mississippi Department of Banking

4

Table of Contents

and Consumer Finance and to regular examinations by that department. Deposits in the Bank are insured by the Federal Deposit Insurance Corporation (the “FDIC”) and, therefore, the Bank is subject to the provisions of the Federal Deposit Insurance Act and to examination by the FDIC. The Bank is not a member of the Federal Reserve.

     The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) permits, among other things, the acquisition by bank holding companies of savings associations, irrespective of their financial condition, and increased the deposit insurance premiums for banks and savings associations. FIRREA also provides that commonly controlled federally insured financial institutions must reimburse the FDIC for losses incurred by the FDIC in connection with the default of another commonly controlled financial institution or in connection with the provision of FDIC assistance to such a commonly controlled financial institution in danger of default. Reimbursement liability under FIRREA is superior to any obligations to shareholders of such federally insured institutions (including a bank holding company such as the Company if it were to acquire another federally insured financial institution), arising as a result of their status as shareholders of a reimbursing financial institution.

     The Company and the Bank are subject to the provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”). This statute provides for increased funding for the FDIC’s deposit insurance fund and expands the regulatory powers of federal banking agencies to permit prompt corrective actions to resolve problems of insured depository institutions through the regulation of banks and their affiliates, including bank holding companies. The provisions are designed to minimize the potential loss to depositors and to FDIC insurance funds if financial institutions default on their obligations to depositors or become in danger of default. Among other things, FDICIA provides a framework for a system of supervisory actions based primarily on the capital levels of financial institutions. FDICIA also provides for a risk-based deposit insurance premium structure. The FDIC charges an annual assessment for the insurance of deposits based on the risk a particular institution poses to its deposit insurance fund. While most of the Company’s deposits are in the Bank Insurance Fund (BIF), certain other of the Company’s deposits which were acquired from thrifts over the years remain in the Savings Association Insurance Fund (SAIF).

     The Company is required to comply with the risk-based capital guidelines established by the Federal Reserve and with other tests relating to capital adequacy which the Federal Reserve adopts from time to time. See Note 18 to the Company’s Consolidated Financial Statements included in this Report.

     The Company is a legal entity which is separate and distinct from its subsidiaries. There are various legal limitations on the extent to which the Bank may extend credit, pay dividends or otherwise supply funds to the Company or its affiliates. In particular, the Bank is subject to certain restrictions imposed by federal law on any extensions of credit to the Company or, with certain exceptions, other affiliates.

     The primary source of funds for dividends paid to the Company’s shareholders is dividends paid to the Company by the Bank. Various federal and state laws limit the amount of dividends that the Bank may pay to the Company without regulatory approval. Under Mississippi law, the Bank must obtain written approval of the Commissioner of the Mississippi Department of Banking and Consumer Finance prior to paying any dividend on the Bank’s common stock. Under FDICIA, the Bank may not pay any dividends, if after paying the dividend, it would be undercapitalized under applicable capital requirements. The FDIC also has the authority to prohibit the Bank from engaging in business practices which the FDIC considers to be unsafe or unsound, which, depending on the financial condition of the Bank, could include the payment of dividends.

     In addition, the Federal Reserve has the authority to prohibit the payment of dividends by bank holding companies if their actions constitute unsafe or unsound practices. In 1985, the Federal Reserve issued a policy statement on the payment of cash dividends by bank holding companies, which outlined the Federal Reserve’s view that a bank holding company that is experiencing earnings weaknesses or other financial pressures should not pay cash dividends that exceed its net income, that are inconsistent with its capital position or that could only be funded in ways that weaken its financial health, such as by borrowing or selling assets. The Federal Reserve indicated that, in some instances, it may be appropriate for a bank holding company to eliminate its dividends

     In September 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“IBBEA”) was signed into law. IBBEA permits adequately capitalized and managed bank holding companies to acquire control of banks in states other than their home states, subject to federal regulatory approval, without regard to whether such a

5

Table of Contents

transaction is prohibited by the laws of any state. IBBEA permits states to continue to require that an acquired bank have been in existence for a certain minimum time period which may not exceed five years. A bank holding company may not, following an interstate acquisition, control more than 10% of the nation’s total amount of bank deposits or 30% of bank deposits in the relevant state (unless the state enacts legislation to raise the 30% limit). States retain the ability to adopt legislation to effectively lower the 30% limit. Federal banking regulators may approve merger transactions involving banks located in different states, without regard to laws of any state prohibiting such transactions; provided, however, that mergers may not be approved with respect to banks located in states that, prior to June 1, 1997, enacted legislation prohibiting mergers by banks located in such state with out-of-state institutions. Federal banking regulators may permit an out-of-state bank to open new branches in another state if such state has enacted legislation permitting interstate branching. Affiliated institutions are authorized to accept deposits for existing accounts, renew time deposits and close and service loans for affiliated institutions without being deemed an impermissible branch of the affiliate.

     The federal Gramm-Leach-Bliley Act of 1999 (the “GLBA”) was signed into law on November 12, 1999. Under the GLBA, banks are no longer prohibited by the Glass-Steagall Act from associating with a company engaged principally in securities activities. The GLBA also permits bank holding companies to elect to become a “financial holding company,” which would expand the powers of a bank holding company. Financial holding company powers relate to financial activities that are determined by the Federal Reserve to be financial in nature, incidental to an activity that is financial in nature or complementary to a financial activity (provided that the complementary activity does not pose a safety and soundness risk). The GLBA itself defines certain activities as financial in nature, including lending activities, underwriting and selling insurance, providing financial or investment advice, underwriting, dealing and making markets in securities and merchant banking. In order to qualify as a financial holding company, a bank holding company’s depository subsidiaries must be both well-capitalized and well-managed and must have at least a satisfactory rating under the Community Reinvestment Act. The bank holding company must also declare to the Federal Reserve its intention to become a financial holding company and certify that its depository subsidiaries meet the capitalization and management requirements. The repeal of the Glass-Steagall Act provisions and the availability of financial holding company powers became effective on March 11, 2000. The GLBA establishes the Federal Reserve as the umbrella regulator of financial holding companies, with subsidiaries of a financial holding company being more specifically regulated by other regulatory authorities, such as the Securities and Exchange Commission (“SEC”), the Commodity Futures Trading Commission and state securities and insurance regulators, based upon the subsidiaries’ particular activities. The GLBA also provides for minimum federal standards of privacy to protect the confidentiality of the personal financial information of customers and to regulate use of such information by financial institutions. A bank holding company that does not elect to become a financial holding company remains subject to the Bank Holding Company Act. Management believes that the Company currently meets the requirements to make an election to become a financial holding company under the GLBA.

     The Community Reinvestment Act of 1997 (“CRA”) and its implementing regulations are intended to encourage regulated financial institutions to meet the credit need of their local community or communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of such financial institutions. The regulations provide that the appropriate regulatory authority will assess CRA reports in connection with applications for establishment of domestic branches, acquisitions of banks or mergers involving bank holding companies. An unsatisfactory CRA rating may serve as a basis to deny an application to acquire or establish a new bank, to establish a new branch or to expand banking services. At December 31, 2001, the Company had a “satisfactory” CRA rating.

     On October 26, 2001, President Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”). Among its other provisions, the USA Patriot Act requires each financial institution: (i) to establish an anti-money laundering program; (ii) to establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks; (iii) to avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, foreign banks that do not have a physical presence in any country. The USA Patriot Act also requires the Secretary of the Treasury to prescribe, by regulations to be issued jointly with the federal banking regulators and certain other agencies, minimum standards that financial institutions must follow to verify the identity of customers, both foreign and domestic, when a customer opens an account. In addition, the USA Patriot Act contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities. At this

6

Table of Contents

time, the Company is unable to determine whether the provisions of the USA Patriot Act will have a material impact on the business of the Company and its subsidiaries.

     The Equal Credit Opportunity Act requires non-discrimination in the provision of banking services. The applicable federal enforcement agencies have recently cited institutions for red-lining (refusing to extend credit to residents of a specific geographic area known to be comprised predominantly of minorities) or reverse red-lining (extending credit to minority applicants on terms less favorable than those offered to non-minority applicants). Violations can result in the assessment of substantial civil penalties.

     The Bank’s insurance subsidiaries are regulated by the insurance regulatory authorities and applicable laws and regulations of the states in which they operate.

     The Bank’s investment services subsidiary is a registered adviser under the Investment Advisers Act of 1940 and is regulated by the SEC.

Lending Activities

     The Company’s lending activities include both commercial and consumer loans. Loan originations are derived from a number of sources including real estate broker referrals, mortgage loan companies, direct solicitation by the Company’s loan officers, existing depositors and borrowers, builders, attorneys, walk-in customers and, in some instances, other lenders. The Company has established systematic procedures for approving and monitoring loans that vary depending on the size and nature of the loan and applies these procedures in a disciplined manner.

Commercial Lending

     The Bank offers a variety of commercial loan services including term loans, lines of credit, equipment and receivable financing and agricultural loans. A broad range of short-to-medium term commercial loans, both secured and unsecured are made available to businesses for working capital (including inventory and receivables), business expansion (including acquisition and development of real estate and improvements), and the purchase of equipment and machinery. At times, the Company also makes construction loans to real estate developers for the acquisition, development and construction of residential subdivisions.

     Commercial loans are granted based on the borrower’s ability to generate cash flow to support its debt obligations and other cash related expenses. A borrower’s ability to repay commercial loans is substantially dependent on the success of the business itself and on the quality of its management. As a general practice, the Bank takes as collateral a security interest in any available real estate, equipment, inventory, receivables or other personal property, although such loans may also be made infrequently on an unsecured basis. Generally, the Bank requires personal guaranties of its commercial loans to offset the risks associated with such loans.

     The Bank has had very little exposure as an agricultural lender. Crop production loans have been either fully supported by the collateral and financial strength of the borrower, or else a 90% loan guaranty has been obtained through the Farmers Home Administration on such loans.

Residential Consumer Lending

     A portion of the Bank’s lending activities consists of the origination of fixed and adjustable rate residential mortgage loans secured by owner-occupied property located in the Bank’s primary market areas. Home mortgage lending is unique in that a broad geographic territory may be serviced by originators working from strategically placed offices either within the Bank’s traditional banking facilities or from affordable storefront locations in commercial buildings. In addition, the Bank offers construction loans, second mortgage home improvement loans and home equity lines of credit.

     The Bank finances the construction of individual, owner-occupied houses on the basis of written underwriting and construction loan management guidelines. First mortgage construction loans are made to solvent and competent contractors on both a pre-sold and a “speculation” basis. Such loans are also made to qualified individual borrowers and

7

Table of Contents

are generally supported by a take-out commitment from a permanent lender. The Bank makes residential construction loans to individuals who intend to erect owner occupied housing on a purchased parcel of real estate. The construction phase of these loans have certain risks, including the viability of the contractor, the contractor’s ability to complete the project and changes in interest rates.

     In most cases, the Bank will sell its mortgage loans with terms of 15 years or more in the secondary market. The sale to the secondary market allows the Bank to manage the interest rate risks related to such lending operations. This brokerage arrangement allows the Bank to accommodate its clients’ demands while eliminating the interest rate risk for the 15 to 30 year period generally associated with such loans. After the sale of a loan, the Bank’s only involvement is to act as a servicing agent.

     In most cases, the Bank requires title, fire, extended casualty insurance and, where required by applicable regulations, flood insurance to be obtained by the borrower. The Bank maintains its own errors and omissions insurance policy to protect against loss in the event of failure of a mortgagor to pay premiums on fire and other hazard insurance policies. Mortgage loans originated by the Bank customarily include a “due on sale” clause giving the Bank the right to declare a loan immediately due and payable in the event, among other matters, that the borrower sells or otherwise disposes of the real property subject to a mortgage. In general, the Bank enforces due on sales clauses. Borrowers are typically permitted to refinance or repay loans at their option without penalty.

Non-Residential Consumer Lending

     Non-residential consumer loans made by the Bank include loans for automobiles, recreation vehicles, boats, personal (secured and unsecured) and deposit account secured loans. In addition, the Bank provides federally insured or guaranteed student loans to students at universities and community colleges in the Bank’s market areas. The Bank also conducts various indirect lending activities through established retail companies in its market areas. Non-residential consumer loans are attractive to the Bank because they typically have a shorter term and carry higher interest rates than that charged on other types of loans. Non-residential consumer loans, however, do pose additional risks of collectability when compared to traditional types of loans granted by commercial banks such as residential mortgage loans.

     The Bank also issues credit cards solicited on the basis of applications received through referrals from the Bank’s branches. The Bank generally has a small portfolio of credit card receivables outstanding. Credit card lines are underwritten using conservative credit criteria, including past credit history and debt-to-income ratios, similar to the credit policies applicable to other personal consumer loans. Historically, the Bank believes that its credit card losses have been well below industry norms.

     Consumer loans are granted based on employment and financial information solicited from prospective borrowers as well as credit records collected from various reporting agencies. Stability of the borrower, willingness to pay and credit history are the primary factors to be considered. The availability of collateral is also a factor considered in making such a loan. The Bank seeks collateral that can be assigned and has good marketability with a clearly adequate margin of value. The geographic area of the borrower is another consideration, with preference given to borrowers in the Bank’s primary market areas.

Other Financial Services

     The Bank’s consumer finance subsidiary extends consumer loans to individuals and entities that may not satisfy the Bank’s lending standards and operates in 51 offices located in 51 communities in Mississippi and Tennessee.

     The Bank’s insurance service subsidiaries serve as agents in the sale of title insurance, commercial lines of insurance and a full line of property and casualty, life, health and employee benefits products and services and operates in Mississippi, Tennessee and Alabama.

     The Bank’s investment services subsidiary provides brokerage, investment advisory and asset management services and operates in certain communities in Mississippi, Tennessee, Alabama, Arkansas and Louisiana.

8

Table of Contents

     See Note 19 to the Company’s Consolidated Financial Statements included elsewhere in this Report for financial information about each segment of the Company, as defined by generally accepted accounting principles.

Asset Quality

     Management seeks to maintain a high quality of assets through conservative underwriting and sound lending practices. Management intends to follow this policy even though it may result in foregoing the funding of higher yielding loans. While there is no assurance that the Company will not suffer losses on its loans, management believes that the Company has in place adequate underwriting and loan administration policies and personnel to manage the associated risks prudently.

     In an effort to maintain the quality of the loan portfolio, management seeks to minimize higher risk types of lending. Undesirable loans include loans to provide initial equity and working capital to new businesses with no other capital strength, loans secured by unregistered stock, loans for speculative transactions in stock, land or commodity markets, loans to borrowers or the taking of collateral outside the Company’s primary market areas, loans dependent on secondary liens as primary collateral and non-recourse loans. To the extent risks are identified, additional precautions are taken in order to reduce the Company’s risk of loss. Commercial loans entail certain additional risks since they usually involve large loan balances to single borrowers or a related group of borrowers, resulting in a more concentrated loan portfolio. Further, since payment of these loans is usually dependent upon the successful operation of the commercial enterprise, the risk of loss with respect to these loans may increase in the event of adverse conditions in the economy.

     The Board of Directors of the Bank focuses much of its efforts and resources, and that of the Bank’s management and lending officials, on loan review and underwriting policies. Loan status and monitoring is handled through the Bank’s Loan Administration Department. Weak financial performance is identified and monitored using past due reporting, the internal loan rating system, loan review reports, the various loan committee functions, and periodic Asset Quality Rating Committee meetings. Senior loan officers have established a review process with the objective of quickly identifying, evaluating and initiating necessary corrective action for substandard loans. The results of loan reviews are reported to the Audit Committee of both the Company’s and the Bank’s Board of Directors. This process is an integral element of the Bank’s loan program. Nonetheless, management maintains a cautious outlook in anticipating the potential effects of uncertain economic conditions (both locally and nationally) and the possibility of more stringent regulatory standards.

Recent Acquisitions

     The Company completed no acquisitions during 2001.

Selected Statistical Information

     Set forth in this section is certain selected statistical information relating to the Company’s business.

Distribution of Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differentials

     See “Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Net Interest Revenue” included herein for information regarding the distribution of assets, liabilities and shareholders’ equity, and interest rates and interest differentials.

Analysis of Changes in Effective Interest Differential

     See “Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Net Interest Revenue” included herein for information regarding the analysis of changes in effective interest differential.

9

Table of Contents

Investment Portfolio

Held-to-Maturity Securities

     The following table shows the amortized cost of held-to-maturity securities at December 31, 2001, 2000 and 1999:

     The following table shows the maturities and weighted average yields as of the end of the latest period for the investment categories presented above:

     The yield on tax-exempt obligations of states and political subdivisions has been adjusted to a taxable equivalent basis using a 35% tax rate.

10

Table of Contents

Available-for-Sale Securities

     The following table shows the book value of available-for-sale securities at December 31, 2001, 2000 and 1999:

     The following table shows the maturities and weighted average yields as of the end of the latest period for the investment categories presented above:

     The yield on tax-exempt obligations of states and political subdivisions has been adjusted to a taxable equivalent basis using a 35% tax rate. See “Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Securities and Other Earning Assets.”

11

Table of Contents

Loan Portfolio

     The Company’s loans are widely diversified by borrower and industry. The following table shows the composition of loans by collateral type of the Company at December 31 for the years indicated. See “Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Loans.”

Maturity Distribution of Loans

     The maturity distribution of the Company’s loan portfolio is one factor in management’s evaluation of the risk characteristics of the loan portfolio. The following table shows the maturity distribution of loans net of unearned discount of the Company as of December 31, 2001:

12

Table of Contents

Sensitivity of Loans to Changes in Interest Rates

     The interest rate sensitivity of the Company’s loan portfolio is important in the management of effective interest differential. The Company attempts to manage the relationship between the interest rate sensitivity of its assets and liabilities to produce an effective interest differential that is not significantly impacted by the level of interest rates. The following table shows the interest rate sensitivity of the Company’s loans net of unearned discount as of December 31, 2001:

Non-Accrual, Past Due and Restructured Loans

     Non-performing loans consist of both non-accrual loans and loans which have been restructured (primarily in the form of reduced interest rates) because of the borrower’s weakened financial condition. The Company’s non-performing loans were as follows at the end of each period presented:

     The total amount of interest earned on non-performing loans was approximately $493,000, $263,000 and $212,000 in 2001, 2000 and 1999, respectively. The gross interest income that would have been recorded under the original terms of those loans amounted to $1,402,000, $878,000 and $626,000 in 2001, 2000 and 1999, respectively.

     Loans considered impaired under Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan — Income Recognition and Disclosure,” are loans for which, based on current information and events, it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company’s recorded investment in loans considered impaired at December 31, 2001, 2000 and 1999 was $17,578,000, $14,669,000 and $7,916,000 respectively, with a valuation allowance of $6,546,000, $5,639,000 and $2,074,000, respectively. The average recorded investment in impaired loans during 2001, 2000 and 1999 was $19,065,000, $21,796,000 and $17,620,000, respectively.

     The Company’s policy provides that loans, other than installment loans, are generally placed in non-accrual status if, in management’s opinion, payment in full of principal or interest is not expected or payment of principal or interest is more than 90 days past due, unless the loan is both well-secured and in the process of collection.

13

Table of Contents

     In the normal course of business, management becomes aware of possible credit problems in which borrowers exhibit potential for the inability to comply with the contractual terms of their loans, but which do not currently meet the criteria for disclosure as problem loans. Historically, some of these loans are ultimately restructured or placed in non-accrual status. At December 31, 2001, no loans were known to be potential problem loans.

     At December 31, 2001, the Company did not have any concentration of loans in excess of 10% of total loans outstanding. Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities, which would cause them to be similarly impacted by economic or other conditions. However, the Company does conduct business in a geographically concentrated area. The ability of the Company’s borrowers to repay loans is to some extent dependent upon the economic conditions prevailing in the Company’s market area.

Summary of Loan Loss Experience

     In the normal course of business, the Company assumes risks in extending credit. The Company manages these risks through its lending policies, loan review procedures and the diversification of its loan portfolio. Although it is not possible to predict loan losses with certainty, management continuously reviews the characteristics of the loan portfolio to determine its overall risk profile and quality.

     Attention is paid to the quality of the loan portfolio through a formal loan review process. The Board of Directors of the Bank has appointed a Loan Loss Reserve Valuation Committee (the “Loan Loss Committee”) that is responsible for ensuring that the allowance for credit losses provides coverage of both known and inherent losses. The Committee considers estimates of loss for individually analyzed credits as well as factors such as historical experience, changes in economic and business conditions and concentrations of risk in determining the level of the allowance for credit losses. The Committee meets at least quarterly to determine the amount of additions to the allowance for credit losses. The Committee is composed of senior management from the Bank’s Loan Administration, Lending and Finance departments. In each period, the Committee bases the allowance for credit losses on its loan classification system as well as an analysis of general economic and business trends in our region and nationally.

     A key input for determining the amount of the allowance for loan losses is the Company’s loan classification system. The Company has a systematic approach for assigning credit ratings and classifications to individual loans. Each loan is assigned a grade by the loan officer at origination that serves as a basis for the credit analysis of the entire portfolio. Periodically, loan officers review the status of each loan and update its grading. The grades assigned by the loan officer are reviewed by an independent Loan Review Department. The Loan Review Department is responsible for reviewing the credit rating and classification of individual loans. The Loan Review Department also assesses trends in the overall portfolio, adherence to internal credit policies and Loan Administration procedures and other factors that may affect the overall adequacy of the allowance for credit losses. Throughout this on-going process, management and the Loan Loss Committee are advised of the condition of individual loans and of the quality profile of the entire loan portfolio for consideration in establishing the allowance for credit losses.

     Any loan or portion thereof which is classified as “loss” by regulatory examiners or which is determined by management to be uncollectible because of such factors as the borrower’s failure to pay interest or principal, the borrower’s financial condition, economic conditions in the borrower’s industry or the inadequacy of underlying collateral, is charged off.

     The provision for credit losses charged to operating expense is an amount which, in the judgment of management, is necessary to maintain the allowance for credit losses at a level that is adequate to meet the risks of losses on the Company’s current portfolio of loans. Management’s judgment is based on a variety of factors which include the Company’s experience related to loan balances, charge-offs and recoveries, scrutiny of individual loans and risk factors, results of regulatory agency reviews of loans and economic conditions of the Company’s market area. Material estimates that are particularly susceptible to significant change in the near term are a necessary part of this process. Future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for credit losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

14

Table of Contents

     The breakdown of the allowance by loan category is based in part on evaluations of specific loans’ past history and on economic conditions within specific industries or geographical areas. Accordingly, since all of these conditions are subject to change, the allocation is not necessarily indicative of the breakdown of any losses.

     The following table presents (a) the breakdown of the allowance for credit losses by loan category and (b) the percentage of each category in the loan portfolio to total loans at December 31 for the years presented:

15

Table of Contents

     The following table sets forth certain information with respect to the Company’s loans (net of unearned discount) and the allowance for credit losses for the five years ended December 31, 2001. See “Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Provision for Credit Losses and Allowance for Credit Losses.”

Deposits

     Deposits represent the principal source of funds for the Company. The distribution and market share of deposits by type of deposit and by type of depositor are important considerations in the Company’s assessment of the stability of its funds sources and its access to additional funds. Furthermore, management shifts the mix and maturity of the deposits depending on economic conditions and loan and investment policies in an attempt, within set policies, to minimize cost and maximize effective interest differential. See “Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Deposits.”

16

Table of Contents

     The following table shows the classification of deposits on an average basis for the three years ended December 31, 2001: