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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________.
COMMISSION FILE NO. 333-59338
FIRST SECURITY GROUP, INC.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Tennessee 58-2461486
- --------------------------------------------------------------------------------
(State of Incorporation) I.R.S. Employer
Identification No.)
817 Broad Street, Chattanooga, TN 37402
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(423) 266-2000
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address, and former fiscal year,
if changed since last report)
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 and 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock, $.01 par value:
7,526,104 shares outstanding and issued (including subscriptions
for shares that have been accepted by the Company)
as of August 5, 2002.
First Security Group, Inc. and Subsidiaries
Form 10-Q
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheets -
June 30, 2002, December 31, 2001 and
June 30, 2001 3
Consolidated Statements of Operations -
Three months and six months ended
June 30, 2002 and 2001 4
Consolidated Statement of Stockholders' Equity -
Six months ended June 30, 2002 6
Consolidated Statements of Cash Flows -
Six months ended June 30, 2002 and 2001 7
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Part II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
2
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31, JUNE 30,
2002 2001 2001
(IN THOUSANDS) (UNAUDITED) (UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 20,203 $ 17,899 $ 12,913
Federal funds sold and securities purchased
under agreements to resell 18,740 - 2,490
----------------- ------------------------------------
Cash and cash equivalents 38,943 17,899 15,403
----------------- ------------------------------------
Securities available for sale 42,589 37,287 28,268
----------------- ------------------------------------
Loans 296,215 291,043 222,722
Less: Allowance for loan losses 3,944 3,825 2,752
----------------- ------------------------------------
292,271 287,218 219,970
----------------- ------------------------------------
Premises and equipment, net 10,000 9,829 8,165
----------------- ------------------------------------
Goodwill 6,193 6,193 6,434
----------------- ------------------------------------
Other assets 7,401 3,440 2,425
----------------- ------------------------------------
TOTAL ASSETS $ 397,397 $ 361,866 $ 280,665
================= ====================================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Noninterest bearing demand $ 54,792 $ 48,347 $ 36,342
Interest bearing demand 21,600 22,051 18,017
Savings 76,069 61,754 39,604
Certificates of deposit of $100 thousand or more 62,551 64,885 51,250
Certificates of deposit less than $100 thousand 98,210 96,840 88,922
----------------- ------------------------------------
Total deposits 313,222 293,877 234,135
Federal funds purchased and securities sold
under agreement to repurchase 11,767 21,528 10,584
Other borrowings 6,000 4,610 2,250
Other liabilities 3,203 2,586 2,343
----------------- ------------------------------------
Total liabilities 334,192 322,601 249,312
----------------- ------------------------------------
STOCKHOLDERS' EQUITY
Common stock - $.01 par value - 20,000 shares authorized;
7,229 issued as of June 30, 2002; 5,003 issued as of
December 31, 2001; 4,162 issued as of June 30, 2001 72 50 42
Paid-in surplus 62,220 40,054 32,108
Retained earnings (accumulated deficit) 522 (1,063) (1,039)
Accumulated other comprehensive income 391 224 242
----------------- ------------------------------------
Total stockholders' equity 63,205 39,265 31,353
----------------- ------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 397,397 $ 361,866 $ 280,665
================= ====================================
3
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- --------------------------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS) 2002 2001 2002 2001
- --------------------------------------------------------------------- ------------ ------------ -------------
INTEREST INCOME
Loans, including fees $ 5,455 $ 4,563 $10,784 $ 8,392
Debt securities - taxable 447 370 882 752
Debt securities - nontaxable 29 - 40 -
Other 93 40 105 205
------------ ------------ ------------ -------------
Total interest income 6,024 4,973 11,811 9,349
------------ ------------ ------------ -------------
INTEREST EXPENSE
Interest bearing demand deposits 64 80 113 160
Savings deposits 368 332 688 573
Certificates of deposit of $100 thousand or more 593 683 1,237 1,294
Certificates of deposit of less than $100 thousand 837 1,253 1,746 2,449
Other 108 112 238 167
------------ ------------ ------------ -------------
Total interest expense 1,970 2,460 4,022 4,643
------------ ------------ ------------ -------------
NET INTEREST INCOME 4,054 2,513 7,789 4,706
Provision for loan losses 139 703 249 981
------------ ------------ ------------ -------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,915 1,810 7,540 3,725
------------ ------------ ------------ -------------
NONINTEREST INCOME
Service charges on deposit accounts 472 334 887 607
Mortgage loan fee income 257 156 548 313
Gain on securities 52 - 75 -
Other noninterest income 122 80 240 149
------------ ------------ ------------ -------------
Total noninterest income 903 570 1,750 1,069
------------ ------------ ------------ -------------
NONINTEREST EXPENSE
Salaries and employee benefits 1,945 1,421 3,790 2,615
Net occupancy 254 213 503 413
Equipment expense 253 182 479 348
Data processing fees 174 144 335 275
Amortization expense - 120 - 240
Advertising expense 72 62 140 110
Supplies expense 90 79 155 143
Communications expense 63 47 137 86
Professional services 287 47 481 123
Postage expense 69 53 136 107
Other noninterest expense 358 91 578 255
------------ ------------ ------------ -------------
Total noninterest expense 3,565 2,459 6,734 4,715
------------ ------------ ------------ -------------
4
INCOME (LOSS) BEFORE INCOME TAX
PROVISION (BENEFIT) 1,253 (79) 2,556 79
Income tax provision (benefit) 474 (28) 971 37
----------------------------------------------
NET INCOME (LOSS) $ 779 $ (51) $ 1,585 $ 42
==============================================
NET INCOME (LOSS) PER SHARE
BASIC $ 0.13 $ (0.01) $ 0.29 $ 0.01
DILUTED $ 0.13 $ (0.01) $ 0.28 $ 0.01
WEIGHTED AVERAGE SHARES OUTSTANDING
BASIC 5,975 4,108 5,495 4,107
DILUTED 6,057 4,108 5,577 4,270
5
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
RETAINED ACCUMULATED
COMMON STOCK EARNINGS OTHER
---------------- PAID-IN (ACCUMULATED COMPREHENSIVE
(IN THOUSANDS) SHARES AMOUNT SURPLUS DEFICIT) INCOME TOTAL
- ---------------------------------------------------------- --------- ----------- --------------- ----------------- ------------
Balance - December 31, 2001 5,003 $ 50 $ 40,054 $ (1,063) $ 224 $ 39,265
Comprehensive income -
Net income (unaudited) 1,585 1,585
Change in net unrealized gain on securities
available for sale, net of tax (unaudited) 167 167
------------
Total comprehensive income (unaudited) 1,752
Common stock sold but not issued (unaudited) 2,226 22 22,234 22,256
Offering related expenses (unaudited) (68) (68)
--------- --------- ----------- --------------- ----------------- ------------
Balance - June 30, 2002 (unaudited) 7,229 $ 72 $ 62,220 $ 522 $ 391 $ 63,205
========= ========= =========== =============== ================= ============
6
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
---------------------------
(IN THOUSANDS) 2002 2001
- --------------------------------------------------------------------------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,585 $ 42
Provision for loan losses 249 981
Net amortization (accretion) of securities 15 (71)
Amortization of goodwill - 240
Depreciation 364 264
Gain on sale of available-for-sale securities (75) -
Changes in operating assets and liabilities -
Decrease (increase) in -
Interest receivable 45 (223)
Other assets (4,115) 230
Increase (decrease) in -
Interest payable 445 803
Other liabilities 172 (419)
----------------- --------------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (1,315) 1,847
----------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities -
Sales 6,045 -
Maturities, prepayments, and calls 5,053 4,891
Purchases (16,065) (12,653)
Loan originations and principal collections, net (5,301) (69,980)
Additions to premises and equipment (535) (1,407)
----------------- --------------
NET CASH USED BY INVESTING ACTIVITIES (10,803) (79,149)
----------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 19,345 71,621
Net increase (decrease) in federal funds purchased and
securities sold under agreements to repurchase (9,761) 5,996
Proceeds from issuance of long term debt 1,390 -
Proceeds from issuance of subordinated debt - 2,250
Proceeds from sale of common stock, net 22,188 563
----------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 33,162 80,430
----------------- --------------
NET DECREASE IN CASH AND CASH EQUIVALENTS 21,044 3,128
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 17,899 12,275
----------------- --------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 38,943 $ 15,403
================= ==============
7
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Unrealized appreciation of securities, net of deferred
taxes of $109 for 2002 and $103 for 2001 $ 167 $ 154
SUPPLEMENTAL SCHEDULE OF CASH FLOWS
Interest paid $ 4,467 $ 3,832
8
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments considered necessary for a fair statement of
financial condition and the results of operations have been included. All such
adjustments were of a normal recurring nature. Operating results for the
six-month period ended June 30, 2002, are not necessarily indicative of the
results that may be expected for the year ended December 31, 2002 or any other
period. The balance sheet as of December 31, 2001 has been derived from the
audited financial statements at that date, but does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's Annual Report on Form 10-K, for the year ended December 31, 2001.
NOTE B - COMPREHENSIVE INCOME
In accordance with Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standard No. 130, "Reporting Comprehensive Income," the
Company is required to report "comprehensive income," a measure of all changes
in equity, not only reflecting net income but certain other changes as well.
Comprehensive income for the three-month and six-month periods ended June 30,
2002 and 2001, respectively, was as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2001 2002 2001
-------------------------------------------------------------------------------------------------
Net income (loss) $ 779 $ (51) $ 1,585 $ 42
Unrealized gain (loss) - securities,
net of tax 229 (38) 167 154
-------------------------------------------
Comprehensive income (loss), net of tax $ 1,008 $ (89) $ 1,752 $ 196
===========================================
NOTE C - EARNINGS PER SHARE
On March 19, 2002, First Security's non-underwritten private placement of
up to $20 million in shares of First Security's common stock at a price of $10
per share became effective. Subsequently, the private placement was increased
from $20 million to $25 million. As of June 30, 2002, First Security had sold
2,225,620 shares in the offering.
Reference is made to Note 14, Long-Term Incentive Plan, in the Notes to
Consolidated Financial Statements in First Security's Form 10-K, which contains
descriptions of First Security's Stock Option Plan (the "Plan"). Shares under
option under the Plan had a dilutive impact of less than $.01 on net income per
share for the three months ended June 30, 2002 and a dilutive impact of $.01 on
net income per share for the six months ended June 30, 2002.
9
NOTE D - REGULATORY AND ACCOUNTING PRONOUNCEMENTS
First Security adopted the provisions of FASB Statement No. 142 (SFAS
142), "Goodwill and Other Intangible Assets" on January 1, 2002. A discussion of
the effect of adopting SFAS 142 is included in management's discussion and
analysis of noninterest expense.
In April 2002, FASB issued Statement No. 145, (SFAS 145), "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." SFAS 145 rescinds Statement 4, which required all gains
and losses from extinguishment of debt to be aggregated and, if material,
classified as an extraordinary item, net of related income tax effect. As a
result, the criteria in Opinion 30 will not be used to classify those gains and
losses. SFAS 145 also amends Statement 13 to require that certain lease
modifications that have economic effects similar to sale-leaseback transactions
be accounted for in the same manner as sale-leaseback transactions. This
statement also makes technical corrections to existing pronouncements. The
effect of adoption of SFAS 145 is not expected to have a material impact on the
Company's results of operations or its financial position.
In June 2002, FASB issued Statement of Financial Accounting Standards No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS
146). SFAS 146 addresses financial accounting and reporting for costs associated
with exit or disposal activities. SFAS 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized and measured
initially at fair value only when the liability is incurred. The accounting for
similar events and circumstances will be the same. This statement is effective
for exit or disposal activities that are initiated after December 31, 2002, with
early application encouraged. The effect of adoption of SFAS 146 is not expected
to have a material effect on First Security's results of operations or its
financial position.
Our Banks are members of the FDIC's Bank Insurance Fund ("BIF"), and
subject to FDIC deposit insurance assessments. FDIC annual deposit insurance
assessment rates currently range from 0 basis points on deposits for a financial
institution in the highest category to 27 basis points on deposits for an
institution in the lowest category, but may be as high as 31 basis points per
$100 of deposits. The FDIC also collects The Financing Corporation ("FICO")
deposit assessments on deposits, which for BIF members ranged from 1.84 to 1.96
basis points for BIF deposits. The Banks were not assessed any BIF premiums in
2001 or 2000. The Banks did pay $34 thousand in FICO assessments in 2001, and
$16 thousand in 2000. FICO assessments are 1.82 basis points, 1.76 basis points,
and 1.72 basis points, respectively for the first, second, and third quarters of
2002.
On October 26, 2001, a new anti-terrorism bill, The International Money
Laundering Abatement and Anti-Terrorism Funding Act of 2001, was signed into
law. This law restricts money laundering by terrorists in the United States and
abroad. This act specifies new "know your customer" requirements that will
obligate financial institutions to take actions to verify the identity of the
account holders in connection with opening an account at any U.S. financial
institution. Banking regulators will consider compliance with the act's money
laundering provisions in making decisions regarding approval of acquisitions and
mergers. In addition, sanctions for violations of the act can be imposed in an
amount equal to twice the sum involved in the violating transaction, up to $1
million.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In this Form 10-Q, "First Security," "FSG," "we," "us," and "our" refer to
First Security Group, Inc.
SECOND QUARTER 2002
The following discussion and analysis sets forth the major factors that
affected First Security's results of operations and financial condition
reflected in the unaudited financial statements for the three-month and
six-month periods ended June 30, 2002 and 2001. Such discussion and analysis
should be read in conjunction with the Company's Consolidated Financial
Statements and the notes attached thereto.
On March 13, 2002, we entered into an Agreement and Plan of Share
Exchange with First State Bank in Maynardville, Tennessee. Maynardville is
located in Union County, Tennessee, which is adjacent to the northern side of
Knox County, Tennessee. We completed the acquisition effective July 20, 2002.
First Security paid approximately $8.1 million for all of the outstanding common
stock of First State Bank. First State Bank now operates as a wholly-owned
subsidiary of FSG. As of December 31, 2001, First State Bank had consolidated
assets of approximately $43.1 million, consolidated deposits of approximately
$36.9 million, and consolidated shareholders' equity of approximately $5.8
million.
OVERVIEW
As of June 30, 2002, First Security had total consolidated assets of $397.4
million, total loans of $296.2 million, total deposits of $313.2 million and
stockholders' equity of $63.2 million. Our net income was $779 thousand and $1.6
million for the three and six months ended June 30, 2002.
RESULTS OF OPERATIONS
Net income for the three months ended June 30, 2002, was $779 thousand, or
$.13 per share (basic and diluted), compared to a net loss of $51 thousand, or
$.01 per share (basic and diluted), in the same period of 2001. Net income for
the six months ended June 30, 2002, was $1.6 million, or $.29 per basic share
and $.28 per diluted share, compared to net income of $42 thousand or $.01 per
share (basic and diluted) in the same period of 2001. As with the first quarter
of 2002, our second quarter, as well as the first six months ended June 30,
2002, resulted in significantly more net income than 2001 levels. The increases
are due to the growth rate of net interest income and noninterest income
outpacing the growth rate of noninterest expenses, as well as a decrease in
loan loss provision. Each of these categories is explained in detail in the
following narrative.
Return on average assets (annualized) for the three months ended June 30,
2002 and 2001 was 0.8% and -0.1%, respectively. For the six months ended June
30, 2002 and 2001, return on average assets (annualized) was 0.9% and 0.0%,
respectively. Return on average equity (annualized) for the three months ended
June 30, 2002 and 2001 was 6.4% and -0.7%, respectively; and, for the six months
ended June 30, 2002 and 2001, was 7.1% and 0.3%, respectively.
Net Interest Income
Net interest income increased by $1.5 million or 61% to $4.1 million for
the second quarter of 2002 compared to the same period a year ago. For the
six-month period ending June 30, 2002, net interest income increased by $3.1
million, or 66%, over the same period in the previous year. There are two
factors that influence net interest income: (1) volume of earning assets, and
(2) rate of net interest margin on those earning assets. Both factors caused an
increase in our net interest income from 2001 to 2002.
Quarter-to-date average earning assets increased by $123.1 million or 53%
to $354.7 million compared to average earning assets for the same period in
2001. On a year-to-date basis, average earning assets
11
increased by $129.1 million or 60% to $343.7 million versus the same period in
2001. Our average earning assets increased due to our branching activities and
increased loan demand, which is due, in part, to our management team's ties to
the local communities in which they work. As of June 30, 2002, our subsidiary
banks had 12 full service branches and one loan production office, compared to
nine full service branches and one loan production office as of June 30, 2001.
Through our branch network, our bankers were able to increase deposits and
deploy those funds into earning assets. This increase in earning assets has
enabled First Security to earn more net interest income. Subsequent to June 30,
2002, Frontier Bank opened a full service bank branch in Ooltewah, Tennessee,
and First Security completed its acquisition of First State Bank. We anticipate
that these efforts will increase our earning assets and thus enhance our net
interest income in the future.
The other factor influencing net interest income is net interest margin.
Positive changes in net interest margin did not influence net interest income as
significantly as the changes in earning assets. On a fully tax equivalent basis,
our net interest margin was 25 basis points higher in the second quarter of 2002
compared to the same period in 2001, and 15 basis points higher for the first
six months of 2002 versus the same period in 2001.
For the second quarter of 2002, 77% of average earning assets were funded
with interest bearing liabilities, compared to 81% for the same period in 2001.
This decrease in reliance on interest bearing funding contributed to improving
our net interest margin. A second contributing factor to our improved net
interest margin was that our weighted average rate on interest bearing
liabilities decreased at a faster pace than the weighted average yield on
interest earning assets. Interest rate decreases in 2001 resulted from the
Federal Reserve's initiative to stimulate economic growth in the weakening U.S.
economy. In 2001 the Federal Reserve cut interest rates 11 times for an
aggregate total of 4.75%. At the beginning of 2001, the federal funds rate and
the prime lending rate were 6.5% and 9.5%, respectively. By the end of 2001,
these rates had decreased to 1.75% and 4.75%. Since December 31, 2001 to the
date of this report, the Federal Reserve has not changed interest rates.
As a result of these rate decreases in 2001 and as assets and liabilities
continue to mature and reprice, we believe that the average rate earned on
assets and the average rate paid on liabilities may decrease slightly over the
next several months barring a Federal Reserve interest rate increase.
The interest rate earned on loans for the three months ended June 30, 2002
decreased 145 basis points compared to the same period in 2001. The decrease is
primarily attributable to the decreases in the prime lending rate during 2001,
which were effected by the Federal Reserve rate cut initiative. The yields on
investment securities and other earning assets also decreased over the same
periods. The overall yield on earning assets decreased 178 basis points in the
second quarter of 2002 compared to the same period in 2001. For the second
quarter of 2002, the cost of interest bearing liabilities decreased by 239 basis
points from the same period in 2001. As a result, net interest spread for the
first quarter of 2002 increased 60 basis points over the same period in the
prior year. Deposit and loan rates are adjusted as market conditions and the
Banks' needs allow. The following table summarizes net interest income and
average yields and rates paid for the quarters ended June 30, 2002 and 2001.
12
Average Consolidated Balance Sheets and Net Interest Analysis
For the three months ended June 30
Yield / Rates on Fully Tax-Equivalent Basis
(all dollar amounts in thousands)
-------------------------------- -----------------------------------
2002 2001
-------------------------------- -----------------------------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
-------------------------------- -----------------------------------
Assets
Earning assets:
Loans, net of unearned income $ 293,272 $ 5,455 7.46% $ 205,476 $ 4,563 8.91%
Investment securities 41,693 476 4.73% 23,055 370 6.44%
Other earning assets 19,769 93 1.89% 3,059 40 5.24%
-------------------------------- -----------------------------------
Total earning assets 354,734 6,024 6.83% 231,590 4,973 8.61%
Allowance for loan losses (3,912) (2,420)
Intangible asset 6,192 6,498
Cash & due from banks 12,747 9,270
Premises & equipment 9,885 7,768
Other assets 3,391 2,016
------------ --------------
TOTAL ASSETS $ 383,037 $ 254,722
============ ==============
Liabilities and Stockholders' Equity
Interest bearing liabilities:
NOW accounts $ 22,790 64 1.13% $ 16,380 80 1.96%
Money market accounts 62,243 335 2.16% 26,525 279 4.22%
Savings deposits 10,115 33 1.31% 7,138 53 2.98%
Time deposits < $100 96,758 837 3.47% 81,868 1,253 6.14%
Time deposits > $100 63,768 593 3.73% 44,628 683 6.14%
Federal funds purchased - - 0.00% 2,147 21 3.92%
Repurchase agreements 11,717 43 1.47% 6,409 63 3.94%
Other borrowings 6,000 65 4.35% 1,879 28 6.00%
-------------------------------- ------------------------ ------------
Total interest bearing liabilities 273,391 1,970 2.89% 186,974 2,460 5.28%
-------------------------- ---------------------------
Net interest spread $ 4,054 3.94% $ 2,513 3.33%
========== ===========
Noninterest bearing demand deposits
57,968 34,647
Accrued expenses and other liabilities 3,018 2,135
Stockholders' equity 48,424 30,754
Unrealized gain/loss on securities 236 212
TOTAL LIABILITIES AND
------------ --------------
STOCKHOLDERS' EQUITY $ 383,037 $ 254,722
============ ==============
Impact of noninterest bearing
sources and other changes in
balance sheet composition 0.66% 1.02%
------------ ------------
Net yield on earning assets 4.60% 4.35%
============ ============
13
The following table presents the dollar amount of changes in interest
income and interest expense from the 3-month period ended June 30, 2001 to the
3-month period ended June 30, 2002. The table distinguishes between the changes
related to average outstanding (volume) of earning assets and interest bearing
liabilities, as well as the changes related to average interest rates (rate) on
such assets and liabilities.
Change in Interest Income and Expense on a Tax Equivalent Basis
For the Three Months Ended June 30
(all dollar amounts in thousands)
2002 Compared to 2001
Increase (Decrease)
in Interest Income and Expense
Due to Changes in:
---------------------------------
Volume Rate Total
---------------------------------
Percent change net interest income
Loans, net of unearned income $ 1,633 $ (741) $ 892
Investment securities 223 (117) 106
Other earning assets 79 (26) 53
---------------------------------
Total earning assets 1,935 (884) 1,051
---------------------------------
Interest bearing liabilities:
NOW accounts 18 (34) (16)
Money market accounts 192 (136) 56
Savings deposits 10 (30) (20)
Time deposits < $100 129 (545) (416)
Time deposits > $100 178 (268) (90)
Federal funds purchased - (21) (21)
Repurchase agreements 19 (39) (20)
Other borrowings 45 (8) 37
-----------------------------
Total interest bearing liabilities
591 (1,081) (490)
---------------------------------
Increase in net interest income $ 1,344 $ 197 $ 1,541
=================================
Comparing the six months ended June 30, 2002 to the same period in 2001, the
interest rate earned on loans decreased 170 basis points because of the Federal
Reserve's rate cut initiative. We believe that the yield on the loan portfolio,
as well as the yield on earning assets and the cost of funding interest bearing
liabilities will most likely decrease because these assets and liabilities will
continue to reprice at lower rates. The yield on earning assets decreased by 184
basis points and the cost of interest bearing liabilities decreased 248 basis
points, which caused the net interest spread to increase by 64 basis points. The
following table summarizes net interest income and average yields and rates paid
for the six months ended June 30, 2002 and 2001.
14
Average Consolidated Balance Sheets and Net Interest Analysis
For the six months ended June 30
Yield / Rates on Fully Tax-Equivalent Basis
(all dollar amounts in thousands)
-------------------------------- -----------------------------------
2002 2001
-------------------------------- -----------------------------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
-------------------------------- -----------------------------------
Assets
Earning assets:
Loans, net of unearned income $ 292,276 $10,784 7.44% $ 185,078 $ 8,392 9.14%
Investment securities 39,583 922 4.80% 21,969 752 6.90%
Other earning assets 11,857 105 1.79% 7,574 205 5.46%
-------------------------------- -----------------------------------
Total earning assets 343,716 11,811 6.94% 214,621 9,349 8.78%
Allowance for loan losses (3,896) (2,220)
Intangible asset 6,192 6,558
Cash & due from banks 11,925 8,432
Premises & equipment 9,855 7,509
Other assets 3,331 1,760
------------ --------------
TOTAL ASSETS $ 371,123 $ 236,660
============ ==============
Liabilities and Stockholders' Equity
Interest bearing liabilities:
NOW accounts $ 23,029 113 0.99% $ 15,966 160 2.02%
Money market accounts 58,515 625 2.15% 22,215 473 4.29%
Savings deposits 9,739 63 1.30% 6,699 100 3.01%
Time deposits < $100 96,582 1,746 3.65% 77,940 2,449 6.34%
Time deposits > $100 63,600 1,237 3.92% 40,695 1,294 6.41%
Federal funds purchased 2,746 26 1.91% 1,075 21 3.94%
Repurchase agreements 11,085 89 1.62% 5,762 118 4.13%
Other borrowings 5,594 123 4.43% 945 28 6.00%
-------------------------------- -----------------------------------
Total interest bearing liabilities
270,890 4,022 2.99% 171,297 4,643 5.47%
-------------------------------- -----------------------------------
Net interest spread $ 7,789 3.95% $ 4,706 3.31%
========== ===========
Noninterest bearing demand deposits
52,951 32,555
Accrued expenses and other liabilities 2,900 1,916
Stockholders' equity 44,109 30,703
Unrealized gain/loss on securities 273 189
TOTAL LIABILITIES AND
------------ --------------
STOCKHOLDERS' EQUITY $ 371,123 $ 236,660
============ ==============
Impact of noninterest bearing
sources and other changes in
balance sheet composition 0.63% 1.12%
------------ ------------
Net yield on earning assets 4.58% 4.43%
============ ============
15
The following table presents the dollar amount of changes in interest
income and interest expense from the six months ended June 30, 2001 to the six
months ended June 30, 2002. The table distinguishes between the changes related
to average outstanding (volume) of earning assets and interest bearing
liabilities, as well as the changes related to average interest rates (rate) on
such assets and liabilities.
Change in Interest Income and Expense on a Tax Equivalent Basis
For the Six Months Ended June 30
(all dollar amounts in thousands)
2002 Compared to 2001
Increase (Decrease)
in Interest Income and Expense
Due to Changes in:
---------------------------------
Volume Rate Total
---------------------------------
Percent change net interest income
Loans, net of unearned income $ 3,955 $(1,563) $ 2,392
Investment securities 419 (249) 170
Other earning assets 38 (138) (100)
---------------------------------
Total earning assets 4,412 (1,950) 2,462
---------------------------------
Interest bearing liabilities:
NOW accounts 35 (82) (47)
Money market accounts 388 (236) 152
Savings deposits 20 (57) (37)
Time deposits < $100 337 (1,040) (703)
Time deposits > $100 445 (502) (57)
Federal funds purchased 16 (11) 5
Repurchase agreements 43 (72) (29)
Other borrowings 102 (7) 95
---------------------------------
Total interest bearing liabilities
1,386 (2,007) (621)
---------------------------------
Increase in net interest income $ 3,026 $ 57 $ 3,083
=================================
Provision for Loan Losses
The provision for loan losses charged to operations during the three months
ended June 30, 2002 was $139 thousand compared to $703 thousand in the same
period of 2001. Net charge-offs for the second quarter of 2002 were $132
thousand compared to net charge-offs of $167 thousand for the same period in
2001. The provision for the six months ended June 30, 2002 and 2001 was $249
thousand and $981 thousand, respectively. Net charge-offs for the six months
ended June 30, 2002 and 2001 were $130 thousand and $172 thousand, respectively.
The provision expense for 2002 decreased from the amount in 2001 due to our
analysis of inherent risks in the loan portfolio in relation to the portfolio's
growth and changes in past due loans. From December 31, 2001 to June 30, 2002,
the loan portfolio increased by $5.2 million, compared to an increase of $69.8
million for the six months ended June 30, 2001. Loans increased at a slower rate
this year due to our efforts to improve our liquidity position. See "Liquidity."
Assuming that the quality of our assets does not deteriorate, we anticipate
that during the remainder of 2002 our provision expense for loan losses will be
less than it was in 2001 because we do not anticipate that our loan portfolio
will grow at the pace that it grew in 2001. See "Nonperforming Assets."
16
The allowance for loan losses reflects management's assessment and estimate
of the risks associated with extending credit and its evaluation of the quality
of the loan portfolio. We periodically analyze our loan portfolio in an effort
to establish an allowance for loan losses that we believe will be adequate in
light of anticipated risks and loan losses. In assessing the adequacy of the
allowance, we review the size, quality and risk of loans in the portfolio. We
also consider such factors as:
o our banks' loan loss experience;
o the amount of past due and nonperforming loans;
o specific known risks;
o the status and amount of past due and nonperforming assets;
o underlying estimated values of collateral securing loans;
o current and anticipated economic conditions; and
o other factors which management believes affects the allowance for
potential credit losses.
An analysis of the credit quality of the loan portfolio and the adequacy of
the allowance for loan losses is prepared by our banks and presented to the
respective boards of directors on a regular basis. In addition, beginning in
2001, we engaged an outside loan review consultant to perform, on an annual
basis, an independent review of the quality of the loan portfolio and adequacy
of the allowance.
The banks' allowance for loan losses is also subject to regulatory
examinations and determinations as to adequacy, which may take into account such
factors as the methodology used to calculate the allowance for loan losses and
the size of the allowance for loan losses compared to a group of peer banks
identified by the regulators. During their routine examinations of banks, the
federal and/or state regulators may require a bank to make additional provisions
to its allowance for loan losses when, in the opinion of the regulators, their
credit evaluations and allowance for loan loss methodology differ materially
from ours.
While it is our policy to charge off in the current period loans for which a
loss is considered probable, there are additional risks of future losses which
cannot be quantified precisely or attributed to particular loans or classes of
loans. Because these risks include the state of the economy, management's
judgment as to the adequacy of the allowance is necessarily approximate and
imprecise.
As of June 30, 2002, Frontier Bank's allowance for loan losses was $2.2
million or 1.29% of its outstanding loans. The percentage of allowance to loans
increased during the first six months of 2002 by four basis points from the
December 31, 2001 level of 1.25%. The percentage increase occurred due to the
following reason. While Frontier Bank's loan portfolio grew in the first six
months of 2002 such growth was modest as we, subsequent to December 31, 2001,
determined to improve Frontier Bank's liquidity position (see "Liquidity").
However, as we did not adjust downward the projected and corresponding growth in
Frontier Bank's loan loss reserve to reflect the slower growth in its loan
portfolio, the percentage of allowance to loan losses increased. Frontier Bank's
peer group, as defined by the Federal Financial Institutions Examination
Council's March 31, 2002 Uniform Bank Performance Report, includes all insured
commercial banks between $100 million and $300 million average assets with 3 or
more banking offices located in a metropolitan area. This peer group, which
includes 831 banks, had a ratio of the allowance for loan losses divided by
total loans of 1.26% as of March 31, 2002, or three basis points less than
Frontier Bank. Upon attaining the charter for Frontier Bank in 2000, the
Tennessee Department of Financial Institutions imposed a three-year charter
condition that "at all times during the first three (3) years of operation, the
Bank shall maintain a minimum allowance for loan losses ratio of 1.25 percent of
total loans." We believe that this requirement has resulted in an allowance of
$224 thousand more as of June 30, 2002 than our methodology and assessments
would indicate. Using our methodology, which incorporates the aforementioned
consideration factors, we believe that as of June 30, 2002 an adequate allowance
for loan losses is approximately $2.0 million, or 1.16% of outstanding loans.
17
As of June 30, 2002, Dalton Whitfield Bank's allowance for loan losses was
$1.8 million, or 1.39% of its loans outstanding. Dalton Whitfield Bank's peer
group, as defined by the Federal Financial Institutions Examination Council's
March 31, 2002 Uniform Bank Performance Report, includes all insured commercial
banks between $100 million and $300 million average assets with 3 or more
banking offices located in a non-metropolitan area. This peer group, which
includes 891 banks, had a ratio of the allowance for loan losses divided by
total loans of 1.33% as of March 31, 2002, or six basis points less than Dalton
Whitfield Bank. Using our methodology, which incorporates the aforementioned
consideration factors, we believe that Dalton Whitfield Bank's allowance for
loan losses was adequate as of June 30, 2002.
Noninterest Income
Noninterest income totaled $903 thousand for the second quarter of this
year, an increase of $333 thousand, or 58%, from the same period in 2001.
Deposit related income, comprised primarily of account service charges and
non-sufficient fund charges, totaled $472 thousand for the second quarter of
2002, which was $138 thousand, or 41%, more than the corresponding quarter in
2001. Deposit related income increased as we have gained deposits, and we
believe that this source of income will continue to be boosted by further
deposit growth and our acquisition of First State Bank. Mortgage loan fees
increased by $101 thousand, or 65%, to $257 thousand for the second quarter of
2002 from the prior year. In 2001, rates for fixed rate residential 15- and
30-year loan products reached their lowest levels in the fourth quarter of the
year, and as a result, the mortgage refinancing activity peaked at that time.
Since the fourth quarter of 2001, the mortgage refinancing market has slowed;
however, we have enhanced our aggregate production, and thus mortgage loan fee
income, by opening a mortgage department at Dalton Whitfield Bank. That
department opened on August 1, 2001, and was in full production during the first
quarter of 2002. We believe that mortgage loan fees will remain near current
levels for the remainder of 2002.
For the first six months of this year, noninterest income was $1.8 million,
which is an increase of $681 thousand, or 64%, over the same period in 2001. For
the first six months of 2002, deposit related income totaled $887 thousand, an
increase of $280 thousand, or 46%, over the first six months of 2001. Mortgage
loan fees totaled $548 thousand for the six months ended June 30, 2002, which is
$235 thousand, or 75%, more than the same period in 2001.
Noninterest Expense
Noninterest expenses for the second quarter totaled $3.6 million, which was
an increase of $1.1 million, or 45% over the second quarter of 2001. First
Security's overhead ratio (noninterest expense, excluding amortization of
intangible assets, provision for loan losses, and income tax expenses, as a
percentage of net interest income and noninterest income) decreased from 76% in
the second quarter of 2001 to 72% for the same period in 2002. This is
reflective of our growth and the subsequent increase in earnings from the second
quarter of 2001 to the same period in 2002 as described in "Net Interest Income"
and "Noninterest Income."
Compared to the second quarter of 2001, salaries and benefits increased
$524 thousand or 37% to $1.9 million. The majority of the increase in salaries
and benefits is related to staff additions for our branch openings. As of June
30, 2001, we had nine full service branches and one loan production office open
and a total of 126 full time equivalent employees. As of June 30, 2002, we
employed 146 full time equivalent employees and operated 12 full service
branches and one loan production office. Salaries and benefits will increase for
the remainder of 2002 as a result of our acquisition of First State Bank.
The following expense categories are all higher in the second quarter 2002
versus the same period in the prior year as a result of the aforementioned
branching activities. Occupancy expenses increased $41 thousand, or 19%, to $254
thousand. Furniture, fixtures and equipment expenses increased $71 thousand, or
39%, to $253 thousand. Data processing costs increased $30 thousand, or 21%, to
$174 thousand. Advertising increased $10 thousand, or 16%, to $72 thousand.
Supplies, communications, and postage expenses increased in aggregate by $43
thousand, or 24%, to $222 thousand.
18
Professional fees increased $240 thousand or 511% to $287 thousand from
quarter to quarter. The increase was due to fees related to outsourcing of
internal audit, loan review, and compliance to Professional Bank Services, as
well as external audit and tax services and legal and accounting advice.
Additionally, we outsourced some of our information technology support
functions.
Goodwill amortization decreased from $120 thousand for the second quarter
of 2001 to $0 for the same period in 2002 as a result of FSG's adoption of SFAS
142, which eliminated the requirement that companies amortize goodwill; however,
goodwill must still be written down if the carrying value becomes impaired.
Noninterest expenses for the six-month period ending June 30, 2002 were $2.0
million, or 43%, higher and totaled $6.7 million compared to the same period in
2001. The changes are explained similarly to the quarterly data above and were
as follows. Salaries and benefits increased $1.2 million or 45%. Occupancy
expenses increased $90 thousand or 22%. Furniture, fixtures, and equipment
expenses increased $131 or 38%. Data processing costs increased $60 thousand or
22%. Advertising increased $30 thousand or 27%. Supplies, communications, and
postage expenses increased $92 thousand or 27%. Professional fees increased $358
thousand or 291%. Goodwill amortization decreased $240 thousand or 100%.
STATEMENT OF FINANCIAL CONDITION
First Security's total assets at June 30, 2002 and 2001, were $397.4
million and $280.7 million, respectively, and $361.9 million at December 31,
2001. Average earning assets for the second quarter of 2002 were $354.7 million
versus $231.6 million for the same period a year earlier, an increase of 53%.
With the completion of the acquisition of First State Bank, our total assets
will exceed $440 million.
First Security continues to actively pursue acquisitions and will continue
to seek means to enhance our market share through further branching.
Loans
Average loans of $293.3 million represented 83% of our average earning
assets during the second quarter of 2002. From December 31, 2001, gross loans
increased $5.2 million to $296.2 million at June 30, 2002; this modest increase
was due to our efforts to improve our liquidity. Comparing the second quarter
end of 2001 to 2002, gross loans increased $73.5 million, or 33%. The growth in
the loan portfolio is primarily attributable to our business strategy and the
ties of our bankers to the local communities in which they work. We believe that
general loan demand will remain strong, however, we do not anticipate growth at
the same level that we experienced during the past year. Funding of future loan
growth will be restricted by our ability to raise core deposits, although we
will use alternative funding sources if necessary and cost effective. Loan
growth will be further restricted by the necessity for us to maintain
appropriate capital levels, as well as adequate liquidity.
Asset Quality
The allowance for loan losses was $3.9 million or 1.33% of outstanding
loans at June 30, 2002 and $3.8 million or 1.31% of outstanding loans, at
December 31, 2001. The allowance for loan losses was 433% of nonperforming loans
at June 30, 2002 and 634% of nonperforming loans at December 31, 2001. For the
first six months of 2002, net charge-offs arising from loans secured by real
estate totaled $23 thousand, commercial loans totaled $12 thousand, and consumer
loans totaled $95 thousand. See "Provision for Loan Losses." We believe that our
reserve for inherent loan losses is adequate based on our assessment of the
information available. Our assessment involves uncertainty and judgment;
therefore, the adequacy of the allowance for loan losses cannot be determined
with precision and may be subject to change in future periods. In addition, bank
regulatory authorities, as part of their periodic examinations of our banks, may
require additional charges to the provision for loan losses in future periods if
the results of their reviews warrant.
19
The allocation of the allowance for loan losses by loan category at the
dates indicated is presented below.
As of June 30,
--------------
(in thousands)
2002 2001
---- ----
Percentage of loans Percentage of loans
in each category to in each category to
Amount total loans Amount total loans
----------------- --------------------- ----------------- ----------------------
Commercial $ 1,863 33.7% $ 897 36.6%
Real estate-construction 241 7.8% 78 4.0%
Real estate-mortgage 1,020 38.7% 851 39.7%
Consumer 555 19.8% 421 19.7%
Charter condition and
Unallocated 265 - 505 -
----------------- --------------------- ----------------- ----------------------
$ 3,944 100.0% $ 2,752 100.0%
================= ===================== ================= ======================
Nonperforming Assets
Nonaccrual loans were $758 thousand at June 30, 2002, $519 thousand at
December 31, 2001 and $440 thousand at June 30, 2001. The nonaccrual loans in
June 2002 included $109 thousand secured by real estate, $626 thousand of
commercial loans and $23 thousand of consumer loans. The ratio of nonaccrual
loans to total loans was 0.26% at June 30, 2002 and 0.18% at December 31, 2001.
At each date, we did not own any other real estate.
Loans past due 90 days and still accruing were $153 thousand at June 30,
2002, compared to $21 thousand at December 31, 2001. Of these past due loans at
June 30, 2002, $103 thousand were secured by real estate and $50 thousand were
consumer loans.
Investment Securities and Other Earning Assets
Securities totaled $42.6 million at June 30, 2002, $37.3 million at
December 31, 2001, and $28.3 million at June 30, 2001. The growth in the
securities portfolio has occurred as a result of our efforts to improve our
liquidity. At June 30, 2002, the securities portfolio had unrealized net gains
of approximately $652 thousand. In addition, all investment securities purchased
to date have been classified as available-for-sale. The following table provides
the carrying values of our federal agency and municipal securities by their
stated maturities (this maturity schedule excludes security prepayment and call
features), as well as the tax equivalent yields for each maturity range.
(in thousands) Less than One to Five to More than
one year five years ten years ten years
--------------------------------------------------------------------
Municipal $ - $ - $ 1,522 $ 1,959
Agency 1,048 17,528 10,144 9,736
--------------------------------------------------------------------
Total $ 1,048 $ 17,528 $ 11,666 $ 11,695
====================================================================
Tax Equivalent Yield 6.7% 4.6% 5.2% 6.6%
====================================================================
20
We currently have the ability and intent to hold our available-for-sale
investment securities to maturity. However, should conditions change, we may
sell unpledged securities. Our management considers the overall quality of the
securities portfolio to be high. All securities held are traded in liquid
markets. As of June 30, 2002, we owned securities from issuers in which the
aggregate book value from such issuers exceeded 10% of our stockholders equity.
As of the second quarter ended 2002, the book value and market value of the
securities from each issuer are as follows:
(in thousands) Book Value Market Value
FNMA* $ 11,740 $ 12,116
FHLMC** $ 12,546 $ 12,678
FHLB*** $ 9,404 $ 9,512
* Federal National Mortgage Association
** Federal Home Loan Mortgage Corporation
*** Federal Home Loan Bank
The following table presents the book values of the investments for the
dates presented in the consolidated balance sheets.
(in thousands) June 30, 2002 December 31, 2001 June 30, 2001
Federal agencies $ 38,455 $ 36,674 $ 27,865
Municipals 236
3,482 0
----------------- --------------------- ----------------
Total $ 41,937 $ 36,910 $ 27,865
================= ===================== ================
Federal funds sold increased to $18.7 million at June 30, 2002 from $0 at
December 31, 2001. The increase resulted from our efforts to increase our
liquidity (see "Liquidity"). We plan to invest a portion of these federal funds
into liquid investment securities to improve our yield on these earning assets;
however, we intend to transition the funds into the investment securities over
the course of several months in order to dollar-cost-average into the market.
Deposits and Other Borrowings
Total deposits increased 34% from June 30, 2001 to June 30, 2002, and 7%
from December 31, 2001 to June 30, 2002. Our deposit growth is primarily the
result of the branching activities. We anticipate our deposits to increase as a
result of future branching activities and the acquisition of First State Bank.
In January of this year, First Security borrowed $6 million in term notes
(see "Liquidity") from the Federal Home Loan Bank of Cincinnati. The following
table details the maturities and rates of the term debt.
21
Date Type Principal Term Rate Maturity
- ---------------------------------------------------------------------
1/8/2002 Fixed Rate Advance $500,000.00 24 mos. 3.73% 1/8/04
1/8/2002 Fixed Rate Advance 500,000.00 36 mos. 4.48% 1/8/05
1/8/2002 Fixed Rate Advance 500,000.00 48 mos. 5.04% 1/8/06
1/10/2002 Fixed Rate Advance 500,000.00 24 mos. 3.65% 1/10/04
1/10/2002 Fixed Rate Advance 500,000.00 36 mos. 4.45% 1/10/05
1/10/2002 Fixed Rate Advance 500,000.00 48 mos. 5.00% 1/10/06
1/15/2002 Fixed Rate Advance 500,000.00 24 mos. 3.50% 1/15/04
1/15/2002 Fixed Rate Advance 500,000.00 36 mos. 4.22% 1/15/05
1/15/2002 Fixed Rate Advance 500,000.00 48 mos. 4.77% 1/15/06
1/17/2002 Fixed Rate Advance 500,000.00 24 mos. 3.63% 1/17/04
1/17/2002 Fixed Rate Advance 500,000.00 36 mos. 4.35% 1/17/05
1/17/2002 Fixed Rate Advance 500,000.00 48 mos. 4.88% 1/17/06
- ---------------------------------------------------------------------
$6,000,000.00
===============
- -------------------------------------------
Composite rate 4.31%
Composite 2 yr. 3.63%
Composite 3 yr. 4.38%
Composite 4 yr. 4.92%
- -------------------------------------------
Liquidity
The liquidity position of the Banks is primarily dependent upon their need
to respond to withdrawals from deposit accounts and upon the liquidity of their
assets. Primary liquidity sources include cash and due from banks, federal funds
sold, short-term investment securities and loan repayments. At June 30, 2002,
our liquidity ratio was 21.8% (excluding anticipated loan repayments). Three
months and six months earlier on March 31st and December 31st, our liquidity was
16.8% and 12.7%, respectively. During the second quarter, the majority of our
liquidity improvement resulted from selling 2,225,620 shares of our common
stock. During the first quarter of this year, First Security improved its
liquidity ratio and reduced its dependency on overnight borrowings using two
methods: (i) the Federal Home Loan Bank and (ii) selling loan participations.
Frontier Bank is a member of the Federal Home Loan Bank of Cincinnati and, prior
to year-end, attained borrowing capability secured by a blanket lien on its 1-4
family residential mortgage loan portfolio. Subsequent to year-end, management
determined, because interest rates were at low levels, to convert the FHLB
overnight funding, as well as a portion of federal funds purchased, into $6
million of FHLB term borrowings. The terms on the borrowings are $2 million for
two years, $2 million for three years, and $2 million for four years. By using
term borrowings we locked in low cost funding and we improved our liquidity
ratio by decreasing our dependency on overnight liabilities. Frontier Bank also
used its borrowing capacity to purchase a letter of credit from FHLB that we
pledged to the State of Tennessee Public Collateral Pool. The letter of credit
allows us to release investment securities at the Collateral Pool and thus
improve our liquidity ratio. Additionally, Frontier Bank could increase its
borrowing capacity at FHLB, subject to more stringent collateral requirements,
by pledging loans other than 1-4 family residential mortgage loans. Dalton
Whitfield Bank is a member of the Federal Home Loan Bank of Atlanta; however,
Dalton Whitfield Bank does not presently have any FHLB borrowings but may in the
future. First Security has sold and may continue to sell loan participations as
a source of liquidity.
Management believes the liquidity sources are adequate to meet operating
needs. Management is not aware of any known trends, events or uncertainties that
will have or that are reasonably likely to have a material effect on our
liquidity, capital resources or operations.
22
Capital Resources
We continue to maintain capital ratios in excess of regulatory minimum
requirements. The current capital standards call for a minimum total capital of
10 percent of risk-adjusted assets, including 6 percent Tier I capital, and a
minimum leverage ratio of Tier I capital to total tangible assets of at least 5
percent. Each of our Banks has regulatory chartering conditions requiring
leverage ratios to not fall below 8 percent for the first three years of their
operations. First Security, Dalton Whitfield Bank, and Frontier Bank all
maintain capital levels exceeding the minimum levels required by the chartering
conditions, in addition to exceeding those capital requirements for well
capitalized banks and bank holding companies under applicable regulatory
guidelines.
June 30, 2002 Well Adequately First Dalton Frontier
Capitalized Capitalized Security Whitfield Bank
Bank
Tier I capital to risk adjusted assets 6.0% 4.0% 18.0% 10.6% 10.4%
Total capital to risk adjusted assets 10.0% 8.0% 19.2% 11.8% 11.7%
Leverage ratio 5.0% 4.0% 15.2% 8.8% 8.7%
Well Adequately First Dalton Frontier
December 31, 2001 Capitalized Capitalized Security Whitfield Bank
Bank
Tier I capital to risk adjusted assets 6.0% 4.0% 11.0% 10.6% 9.9%
Total capital to risk adjusted assets 10.0% 8.0% 12.2% 11.9% 11.1%
Leverage ratio 5.0% 4.0% 9.9% 9.1% 9.2%
Dalton
June 30, 2001 Well Adequately First Whitfield Frontier
Capitalized Capitalized Security Bank Bank
Tier I capital to risk adjusted assets 6.0% 4.0% 10.6% 10.4% 11.9%
Total capital to risk adjusted assets 10.0% 8.0% 11.8% 11.5% 13.1%
Leverage ratio 5.0% 4.0% 9.9% 9.7% 11.2%
We have never paid any cash dividends on our common stock, and we do not
anticipate paying any cash dividends in the foreseeable future. We currently
intend to retain future earnings, if any, to support the development and growth
of our business. Payment of future dividends, if any, will be at the discretion
of our board of directors and will depend upon our earnings, our financial
condition, the capital adequacy of First Security and our subsidiaries,
opportunities for growth and expansion, our subsidiaries' need for funds, and
other relevant factors, including applicable restrictions and governmental
policies and regulations.
EFFECTS OF INFLATION
Inflation generally increases the cost of funds and operating overhead,
and, to the extent loans and other assets bear variable rates, the yields on
such assets. Unlike most industrial companies, virtually all of our assets and
liabilities are monetary in nature. As a result, interest rates generally have a
more significant impact on our performance than the effects of general levels of
inflation have. Although interest rates do not necessarily move in the same
direction, or to the same extent, as the prices of goods and services, increases
in inflation generally have resulted in increased interest rates. In 1999, the
Federal Reserve increased the interest rate three times for a total of 75 basis
points in an attempt to control inflation. Again in 2000, the Federal Reserve
increased interest rates three times for a total of 100 basis points in an
attempt to control inflation. However, the Federal Reserve reduced interest
rates on 11 occasions for a total of 475 basis points in 2001 in an effort to
stimulate economic growth. Thus far in 2002, the Federal Reserve has not
increased or decreased interest rates.
In addition, inflation results in an increased cost of goods and services
purchased, cost of salaries and benefits, occupancy expense and similar items.
Inflation and related increases in interest rates generally decrease the market
value of investments and loans held and may adversely affect the liquidity and
earnings of our commercial banking and mortgage banking business, and our
shareholders' equity. With respect to our mortgage banking business, mortgage
originations and refinancings tend to slow as interest rates increase, and
increased interest rates would likely reduce our earnings from such activities
and the income from the sale of residential mortgage loans in the secondary
market.
23
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the statements made under the caption "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and elsewhere
throughout this Form 10-Q are forward-looking statements for purposes of the
Securities Act of 1933 and the Securities Exchange Act of 1934. Forward-looking
statements relate to future events or our future financial performance and may
involve known or unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of First Security to be
materially different from future results, performance, or achievements expressed
or implied by such forward-looking statements. Forward-looking statements
include statements using the words such as "may," "will," "anticipate,"
"should," "would," "believe," "contemplate," "expect," "estimate," "continue,"
"may," "intend," "seeks," or other similar words and expressions of the future.
These forward-looking statements involve risks and uncertainties, and may
not be realized due to a variety of factors, including, without limitation: the
effects of future economic conditions, governmental monetary and fiscal
policies, as well as legislative and regulatory changes; the risks of changes in
interest rates on the level and composition of deposits, loan demand, and the
values of loan collateral, securities, and interest sensitive assets and
liabilities; interest rate risks; the costs of evaluating possible acquisitions
and the risks inherent in integrating acquisitions; the effects of competition
from other commercial banks, thrifts, mortgage banking firms, consumer finance
companies, credit unions, securities brokerage firms, insurance companies, money
market and other mutual funds and other financial institutions operating in
First Security's market area and elsewhere, including institutions operating
regionally, nationally and internationally, together with such competitors
offering banking products and services by mail, telephone, computer and the
Internet; and the failure of assumptions underlying the establishment of
reserves for possible loan losses. All written or oral forward-looking
statements attributable to First Security are expressly qualified in their
entirety by this Special Note.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk, with respect to First Security, is the risk of loss arising
from adverse changes in interest rates and prices. The risk of loss can result
in either lower fair market values or reduced net interest income. Although we
manage other risk, such as credit and liquidity, management considers interest
rate risk to be the more significant market risk and it could potentially have
the largest material effect on our financial condition. Further, we believe the
potential reduction of net interest income to be more significant than the
effect of reduced fair market values. First Security does not maintain a trading
portfolio or deal in international instruments, and therefore First Security is
not exposed to risk inherent to trading activities and foreign currency.
First Security's interest rate risk management is the responsibility of the
Asset/Liability Management Committee ("ALCO"). ALCO has established policies and
limits to monitor, measure and coordinate First Security's sources, uses, and
pricing of funds.
Interest rate risk represents the sensitivity of earnings to changes in
interest rates. As interest rates change the interest income and expense
associated with First Security's interest sensitive assets and liabilities also
change, thereby impacting net interest income, the primary component of our
earnings. ALCO utilizes the results of both a static and dynamic Gap report to
quantify the estimated exposure of net interest income to a sustained change in
interest rates.
The Gap analysis projected net interest income based on both a rise and
fall in interest rates of 200 basis points (i.e. 2.00%) over a twelve-month
period. The model is based on actual repricing dates of interest sensitive
assets and interest sensitive liabilities. The model incorporates assumptions
regarding the impact of changing interest rates on the prepayment rates of
certain assets.
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First Security measures this exposure based on an immediate change in
interest rates of up or down 200 basis points. Given this scenario, First
Security had, at year-end, an exposure to falling rates and a benefit from
rising rates. More specifically, the model forecasts a decline in net interest
income of $701 thousand or 9%, as a result of a 200 basis point decline in
rates. The model also predicts a $551 thousand increase in net interest income,
or 7%, as a result of a 200 basis point increase in rates. The forecasted
results of the model are within the limits specified by ALCO. The following
chart reflects First Security's sensitivity to changes in interest rates as of
June 30, 2002. Numbers are based on a flat balance sheet and assumes paydowns
and maturities of both assets and liabilities are reinvested in like instruments
at current interest rates, rates down 200 basis points, and rates up 200 basis
points.
Interest Rate Risk
Income Sensitivity Summary
As of June 30, 2002
(in thousands)
DOWN UP
200 BP CURRENT 200 BP
----------------------------------------
Net interest income $ 7,088 $ 7,789 $ 8,340
Dollar change net interest income (701) - 551
Percent change net interest income -9.00% 0.00% 7.07%
The preceding sensitivity analysis is a modeling analysis, which changes
periodically and consists of hypothetical estimates based upon numerous
assumptions including interest rate levels, shape of the yield curve,
prepayments on loans and securities, rates on loans and deposits, reinvestments
of paydowns and maturities of loans, investments and deposits, and others. In
addition, there is no input for growth or a change in asset mix. While
assumptions are developed based on the current economic and market conditions,
management cannot make any assurances as to the predictive nature of these
assumptions including how customer preferences or competitor influences might
change.
As market conditions vary from those assumed in the sensitivity analysis,
actual results will differ. Also, the sensitivity analysis does not reflect
actions that ALCO might take in responding to or anticipating changes in
interest rates.
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PART II. OTHER INFORMATION
ITEM 2. Changes in Securities and Use of Proceeds
During the six months ended June 30, 2002, First Security sold
2,225,620 shares of its $.01 par value common stock at $10.00 per share to
accredited investors. We relied upon Rule 506 of regulation D of the Securities
Act of 1933 to exempt this transaction from registration under the federal
securities laws. No underwriters were involved in this transaction.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
EXHIBIT NUMBER DESCRIPTION
99.1 Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350
99.2 Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350
(b) Reports on Form 8-K:
The following reports on Form 8-K were filed during the quarter ended
June 30, 2002.
Current Report on Form 8-K dated April 30, 2002 and filed May 10, 2002,
Items 5 and 7.
Current Report on Form 8-K/A dated May 28, 2002 and filed May 28, 2002,
Items 2 and 7.
Current Report on Form 8-K/A dated June 6, 2002 and filed June 6, 2002,
Items 2 and 7.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be signed by the undersigned,
thereunto duly authorized.
FIRST SECURITY GROUP, INC.
(Registrant)
August 14, 2002 /s/ Rodger B. Holley
--------------------
Rodger B. Holley
Chairman, Chief Executive Officer & President
August 14, 2002 /s/ William L. Lusk, Jr.
------------------------
William L. Lusk, Jr.
Secretary, Chief Financial Officer &
Executive Vice President
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