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FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended: September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from:__________________ to __________________
Commission File Number: 0-19297
First Community Bancshares, Inc.
(Exact name of registrant as specified in its charter)
Nevada 55-0694814
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
One Community Place, Bluefield, Virginia 24605
(Address of principal executive offices) (Zip Code)
(276) 326-9000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether Registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at October 31, 2003
Common Stock, $1 Par Value 11,247,910
First Community Bancshares, Inc.
FORM 10-Q
For the quarter ended September 30, 2003
INDEX
REFERENCE
---------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2003 and
December 31, 2002 3
Consolidated Statements of Income for the Three and Nine
Month Periods Ended September 30, 2003 and 2002 4
Consolidated Statements of Cash Flows for the
Nine Month Periods Ended September 30, 2003 and 2002 5
Consolidated Statements of Changes in Stockholders'
Equity for the Nine Months Ended September 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7-14
Independent Accountants' Review Report 15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16-29
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 29
Item 4. Controls and Procedures 30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 2. Changes in Securities and Use of Proceeds 31
Item 3. Defaults Upon Senior Securities 31
Item 4. Submission of Matters to a Vote of
Security Holders 31
Item 5. Other Information 31
Item 6. Exhibits and Reports on Form 8-K 31
SIGNATURES 34
2
PART I. ITEM 1. FINANCIAL STATEMENTS
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER December 31
2003 2002
(UNAUDITED) (Note 1)
-------------- -----------
ASSETS
CASH AND DUE FROM BANKS $ 32,889 $ 33,364
INTEREST-BEARING BALANCES WITH BANKS 76,309 88,064
FEDERAL FUNDS SOLD - 3,157
-------------- -----------
TOTAL CASH AND CASH EQUIVALENTS 109,198 124,585
SECURITIES AVAILABLE FOR SALE (AMORTIZED COST OF $388,283 AT
SEPTEMBER 30, 2003; $289,616 AT DECEMBER 31, 2002) 395,496 300,885
SECURITIES HELD TO MATURITY (FAIR VALUE OF $41,558 AT
SEPTEMBER 30, 2003; $43,342 AT DECEMBER 31, 2002) 39,433 41,014
LOANS HELD FOR SALE 16,689 66,364
LOANS HELD FOR INVESTEMENT, NET OF UNEARNED INCOME 1,028,189 927,621
LESS ALLOWANCE FOR LOAN LOSSES 15,680 14,410
-------------- -----------
NET LOANS HELD FOR INVESTMENT 1,012,509 913,211
PREMISES AND EQUIPMENT 29,661 25,078
OTHER REAL ESTATE OWNED 2,403 2,855
INTEREST RECEIVABLE 8,433 7,897
OTHER ASSETS 24,184 15,391
GOODWILL 39,903 25,758
OTHER INTANGIBLE ASSETS 1,427 1,325
-------------- -----------
TOTAL ASSETS $ 1,679,336 $ 1,524,363
============== ===========
LIABILITIES
DEPOSITS:
NONINTEREST-BEARING $ 194,060 $ 165,557
INTEREST-BEARING 1,038,438 974,170
-------------- -----------
TOTAL DEPOSITS 1,232,498 1,139,727
INTEREST, TAXES AND OTHER LIABILITIES 12,090 15,940
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE 102,449 91,877
FHLB BORROWINGS AND OTHER INDEBTEDNESS 159,815 124,357
-------------- -----------
TOTAL LIABILITIES 1,506,852 1,371,901
-------------- -----------
STOCKHOLDERS' EQUITY
PREFERRED STOCK, PAR VALUE UNDESIGNATED; 1,000,000 SHARES AUTHORIZED;
NO SHARES ISSUED AND OUTSTANDING IN 2003 AND 2002 - -
COMMON STOCK, $1 PAR VALUE; 15,000,000 SHARES AUTHORIZED;
11,432,815 AND 10,952,385 ISSUED IN 2003 AND 2002, AND
11,250,931 AND 10,877,330 OUTSTANDING IN 2003 AND 2002, 11,433 9,957
ADDITIONAL PAID-IN CAPITAL 108,078 58,642
RETAINED EARNINGS 54,407 79,084
TREASURY STOCK, AT COST (5,762) (1,982)
ACCUMULATED OTHER COMPREHENSIVE INCOME 4,328 6,761
-------------- -----------
TOTAL STOCKHOLDERS' EQUITY 172,484 152,462
-------------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,679,336 $ 1,524,363
============== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED)
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30 September 30 SEPTEMBER 30 September 30
2003 2002 2003 2002
------------- ------------- ------------ -------------
INTEREST INCOME:
INTEREST AND FEES ON LOANS HELD FOR INVESTMENT $ 52,465 $ 54,646 $ 18,591 $ 18,597
INTEREST ON LOANS HELD FOR SALE 2,084 2,521 800 851
INTEREST ON SECURITIES-TAXABLE 9,607 10,235 3,075 3,236
INTEREST ON SECURITIES-NONTAXABLE 4,851 5,101 1,552 1,679
INTEREST ON FEDERAL FUNDS SOLD AND DEPOSITS IN BANKS 490 170 128 88
------------- ------------- ------------- -------------
TOTAL INTEREST INCOME 69,497 72,673 24,146 24,451
------------- ------------- ------------- -------------
INTEREST EXPENSE:
INTEREST ON DEPOSITS 15,393 19,603 4,934 6,206
INTEREST ON SHORT-TERM BORROWINGS 5,856 6,963 2,029 2,083
INTEREST ON OTHER DEBT 449 451 151 151
------------- ------------- ------------- -------------
TOTAL INTEREST EXPENSE 21,698 27,017 7,114 8,440
------------- ------------- ------------- -------------
NET INTEREST INCOME 47,799 45,656 17,032 16,011
PROVISION FOR LOAN LOSSES 2,679 3,261 782 1,302
------------- ------------- ------------- -------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 45,120 42,395 16,250 14,709
------------- ------------- ------------- -------------
NONINTEREST INCOME:
FIDUCIARY INCOME 1,530 1,287 549 443
SERVICE CHARGES ON DEPOSIT ACCOUNTS 5,905 5,135 2,098 1,866
OTHER SERVICE CHARGES, COMMISSIONS AND FEES 1,622 1,009 553 328
MORTGAGE BANKING INCOME 6,921 7,594 507 2,238
OTHER OPERATING INCOME 881 582 340 100
GAIN ON SECURITIES 1,191 208 1,038 22
------------- ------------- ------------- -------------
TOTAL NONINTEREST INCOME 18,050 15,815 5,085 4,997
------------- ------------- ------------- -------------
NONINTEREST EXPENSE:
SALARIES AND EMPLOYEE BENEFITS 19,962 17,295 7,190 5,746
OCCUPANCY EXPENSE OF BANK PREMISES 2,533 2,160 861 738
FURNITURE AND EQUIPMENT EXPENSE 1,613 1,594 563 529
CORE DEPOSIT AMORTIZATION 178 180 64 61
OTHER OPERATING EXPENSE 10,833 10,077 3,896 3,177
------------- ------------- ------------- -------------
TOTAL NONINTEREST EXPENSE 35,119 31,306 12,574 10,251
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAXES 28,051 26,904 8,761 9,455
INCOME TAX EXPENSE 8,107 7,963 2,532 2,869
------------- ------------- ------------- -------------
NET INCOME $ 19,944 $ 18,941 $ 6,229 $ 6,586
============= ============= ============= =============
BASIC EARNINGS PER COMMON SHARE $ 1.81 $ 1.73 $ 0.55 $ 0.60
============= ============= ============= =============
DILUTED EARNINGS PER COMMON SHARE $ 1.79 $ 1.73 $ 0.55 $ 0.60
============= ============= ============= =============
WEIGHTED AVERAGE BASIC SHARES OUTSTANDING 11,047,199 10,929,010 11,262,180 10,920,876
============= ============= ============= =============
WEIGHTED AVERAGE DILUTED SHARES OUTSTANDING 11,143,175 10,980,872 11,383,941 10,975,950
============= ============= ============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30
2003 2002
------------ -----------
OPERATING ACTIVITIES:
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 19,944 $ 18,941
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING
ACTIVITIES:
PROVISION FOR LOAN LOSSES 2,679 3,261
DEPRECIATION OF PREMISES AND EQUIPMENT 1,418 1,215
CORE DEPOSIT AMORTIZATION 178 180
OTHER INTANGIBLE ACCRETION (157) (196)
NET INVESTMENT AMORTIZATION AND ACCRETION 2,181 1,116
NET (GAIN) LOSS ON THE SALE OF ASSETS (1,198) 161
NET GAIN ON SALE OF LOANS (6,256) (8,324)
MORTGAGE LOANS ORIGINATED FOR SALE (718,414) (495,097)
PROCEEDS FROM SALE OF MORTGAGE LOANS 774,345 500,164
(INCREASE) DECREASE IN INTEREST RECEIVABLE (115) 425
INCREASE IN OTHER ASSETS (2,822) (3,078)
DECREASE IN OTHER LIABILITIES (3,733) (993)
------------ -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 68,050 17,775
------------ -----------
INVESTING ACTIVITIES:
CASH FLOWS FROM INVESTING ACTIVITIES:
PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE 9,375 14,919
PROCEEDS FROM MATURITIES AND CALLS OF SECURITIES AVAILABLE FOR SALE 113,224 52,983
PROCEEDS FROM MATURITIES AND CALLS OF SECURITIES HELD TO MATURITY 1,653 1,662
PURCHASE OF INVESTMENT SECURITIES HELD TO MATURITY (75) -
PURCHASE OF SECURITIES AVAILABLE FOR SALE (220,859) (38,978)
NET DECREASE (INCREASE) IN LOANS MADE TO CUSTOMERS 18,841 (24,343)
PURCHASE OF PREMISES AND EQUIPMENT (5,367) (3,500)
SALE OF EQUIPMENT 60 -
NET CASH PROVIDED BY ACQUISITIONS 1,562 -
------------ -----------
NET CASH USED IN INVESTING ACTIVITIES (81,586) 2,743
------------ -----------
FINANCING ACTIVITIES:
CASH FLOWS FROM FINANCING ACTIVITIES:
NET (DECREASE) INCREASE IN DEMAND AND SAVINGS DEPOSITS (1,150) 39,133
NET DECREASE IN TIME DEPOSITS (11,154) (11,865)
NET INCREASE (DECREASE) IN FHLB AND OTHER INDEBTEDNESS 16,263 (35,953)
ISSUANCE OF TRUST PREFERRED SECURITIES 14,560 -
REPAYMENT OF OTHER BORROWINGS (8,013) (112)
ACQUISITION OF TREASURY STOCK (4,319) (1,607)
ISSUANCE OF TREASURY STOCK - 178
DIVIDENDS PAID (8,038) (7,455)
------------ -----------
NET CASH USED IN FINANCING ACTIVITIES (1,851) (17,681)
------------ -----------
CASH AND CASH EQUIVALENTS
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (15,387) 2,837
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 124,585 47,815
------------ -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 109,198 $ 50,652
============ ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION) (UNAUDITED)
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED TREASURY COMPREHENSIVE
STOCK CAPITAL EARNINGS STOCK (LOSS) INCOME TOTAL
--------- ----------- ----------- --------- ------------- ---------
BALANCE JANUARY 1, 2002 $ 9,955 $ 60,189 $ 62,566 $ (424) $ 755 $ 133,041
------------
COMPREHENSIVE INCOME:
NET INCOME - - 18,517 - - 18,517
OTHER COMPREHENSIVE INCOME, NET OF TAX:
NET UNREALIZED GAINS ON
SECURITIES AVAILABLE FOR SALE - - - - 6,127 6,127
----------- ------------ ---------
COMPREHENSIVE INCOME - - 18,517 - 6,127 24,644
----------- ------------ ---------
COMMON DIVIDENDS DECLARED
($.69 PER SHARE) - - (7,455) - - (7,455)
FRACTIONAL SHARE ADJUSTMENT FOR 10%
STOCK DIVIDEND 2 (1,729) 1,725 (14) (16)
PURCHASE 55,844 TREASURY SHARES AT
$28.74 PER SHARE - - - (1,607) - (1,607)
OPTION EXERCISE 5,500 SHARES @ $23.91 42 155 197
ISSUANCE OF TREASURY SHARES TO ESOP 140 792 932
--------- ----------- ----------- --------- ------------ ---------
BALANCE SEPTEMBER 30, 2002 $ 9,957 $ 58,642 $ 75,353 $ (1,098) $ 6,882 $ 149,736
========= =========== =========== ========= ============ =========
BALANCE JANUARY 1, 2003 $ 9,957 $ 58,642 $ 79,084 $ (1,982) $ 6,761 $ 152,462
------------
COMPREHENSIVE INCOME:
NET INCOME - - 19,944 - - 19,944
OTHER COMPREHENSIVE INCOME, NET OF TAX:
NET UNREALIZED GAINS ON
SECURITIES AVAILABLE FOR SALE - - - - (2,433) (2,433)
----------- ------------ ---------
COMPREHENSIVE INCOME - - 19,944 - (2,433) 17,511
--------- ----------- ----------- --------- ------------ ---------
COMMON DIVIDENDS DECLARED
($.73 PER SHARE) - - (8,038) - - (8,038)
PURCHASE 135,000 TREASURY SHARES AT
$31.99 PER SHARE - - - (4,319) - (4,319)
ACQUISITION OF STONE CAPITAL MANAGEMENT-
8,409 SHARES ISSUED (SEE NOTE 3) 8 236 244
OPTION EXERCISE 40,291 SHARES 40 259 335 634
ACQUISITION OF COMMONWEALTH BANK-
389,609 SHARES ISSUED 390 12,904 13,294
10% STOCK DIVIDEND & FRACTIONAL ADJUSTMENT 1,038 35,994 (36,583) (476) (27)
ISSUANCE OF TREASURY SHARES TO ESOP 43 680 723
--------- ----------- ----------- --------- ------------ ---------
BALANCE SEPTEMBER 30, 2003 $ 11,433 $ 108,078 $ 54,407 $ (5,762) $ 4,328 $ 172,484
========= =========== =========== ========= ============ =========
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. UNAUDITED FINANCIAL STATEMENTS
The unaudited consolidated balance sheet as of September 30, 2003, the unaudited
consolidated statements of income for the three and nine months ended September
30, 2003 and 2002 and the consolidated statements of cash flows and changes in
stockholders' equity for the nine months ended September 30, 2003 and 2002 have
been prepared by the management of First Community Bancshares, Inc. ("FCBI" or
the "Company"). In the opinion of management, all adjustments (including normal
recurring accruals) necessary to present fairly the financial position of FCBI
and subsidiaries at September 30, 2003 and its results of operations, cash
flows, and changes in stockholders' equity for the three and nine months ended
September 30, 2003 and 2002 have been made. These results are not necessarily
indicative of the results of consolidated operations that might be expected for
the full calendar year.
The consolidated balance sheet as of December 31, 2002 has been extracted from
the audited financial statements included in the Company's 2002 Annual Report to
Stockholders. Certain information and footnote disclosures normally included in
annual financial statements prepared in accordance with accounting principles
generally accepted in the United States have been omitted in accordance with
standards for the preparation of interim financial statements. These financial
statements should be read in conjunction with the financial statements and notes
thereto included in the 2002 Annual Report of FCBI.
A more complete and detailed description of FCBI's significant accounting
policies is included within Footnote 1 to the Company's Annual Report on Form
10-K for December 31, 2002. In addition, the Company's required disclosure of
the application of critical accounting policies is included within the
"Accounting Policies and Judgments" section of Part I, Item 2. "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included herein. The following is an update to reflect the requirements of
Financial Accounting Standards Board ("FASB") Statement 148.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICY UPDATE FOR CERTAIN REQUIRED DISCLOSURES
The Company has a stock option plan for certain executives and directors
accounted for under the intrinsic value method in accordance with Accounting
Principles Board ("APB") 25. Because the exercise price of the Company's
employee/director stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized. The effect of
option shares on earnings per share relates to the dilutive effect of the
underlying options outstanding. To the extent the granted exercise share price
is less than the current market price ("in the money") there is an economic
incentive for the shares to be exercised and an increase in the dilutive effect
on earnings per share results.
In December 2002, the FASB issued Financial Accounting Standards ("FAS") 148,
"Accounting for Stock-Based Compensation." This new standard provides
alternative methods of transition for a voluntary change to the fair value
method of accounting for stock-based compensation. In addition, the Statement
amends the disclosure requirements of FAS 123 to require prominent disclosure in
both annual and interim financial statements about the method of accounting for
stock-based compensation and the underlying effect of the method used on
reported results until exercised.
7
Assuming use of the fair value method of accounting for stock options, pro forma
net income and earnings per share for the three and nine month periods ended
September 30, 2003 and 2002 would have been estimated as follows:
NINE MONTHS NINE MONTHS THREE MONTHS THREE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30
2003 2002 2003 2002
------------ ------------ ------------ ------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income as reported....................... $ 19,944 $ 18,941 $ 6,229 $ 6,586
Less: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (157) (136) (39) (27)
----------- ----------- ----------- -----------
$ 19,787 $ 18,805 $ 6,190 $ 6,559
=========== =========== =========== ===========
Earnings per share:
Basic as reported............................ $ 1.81 $ 1.73 $ 0.55 $ 0.60
Basic pro forma.............................. $ 1.79 $ 1.71 $ 0.55 $ 0.60
Diluted as reported.......................... $ 1.79 $ 1.73 $ 0.55 $ 0.60
Diluted pro forma............................ $ 1.78 $ 1.71 $ 0.54 $ 0.60
NOTE 2. STOCK DIVIDEND
On June 17, 2003, the Company's Board of Directors declared a 10% stock dividend
to shareholders of record as of August 1, 2003, which was distributed on August
15, 2003. Average shares outstanding and per share amounts included in the
consolidated financial statements have been adjusted to reflect the impact of
the stock dividend.
NOTE 3. MERGERS AND ACQUISITIONS
On June 6, 2003, the Company acquired The CommonWealth Bank, a
Virginia-chartered commercial bank ("CommonWealth"). CommonWealth's four branch
facilities located in the Richmond, Virginia metro area were simultaneously
merged with and into the Bank. The completion of this transaction resulted in
the addition of $136.5 million in assets, including $120.0 million in loans and
added an additional $105.0 million in deposits to the Bank. As a result of a
preliminary allocation, $14.1 million excess of purchase price over the fair
market value of the net assets acquired and identified intangibles was recorded
as goodwill.
In January 2003, the Bank acquired Stone Capital Management, Inc. ("Stone
Capital"), with an office in Beckley, West Virginia. This acquisition expanded
the Bank's operations into wealth management, asset allocation, financial
planning and investment advice. At December 31, 2002, Stone Capital had total
assets under management of $94 million. Stone Capital was acquired through the
issuance of 8,409 shares of Company common stock, which represents 50% of the
total consideration. The balance of the consideration is payable over the next
three years in the form of Company common stock subject to revenue minimums
outlined in the acquisition agreement.
On November 30, 2002, the Company acquired Monroe Financial, Inc. ("Monroe") and
its banking subsidiary, Bank of Greenville ("Greenville"). Greenville's three
branch facilities, Greenville and Lindside in Monroe County, West Virginia and
Hinton in Summers County, West Virginia, were simultaneously merged with and
into First Community Bank, N. A. (the "Bank"). The completion of this
transaction resulted in the addition of $29.8 million in assets, including $17.4
million in loans and added an additional $28.0 million in deposits to the Bank
at December 31, 2002. The $931,000 excess of fair market value of the net assets
acquired over the purchase price was reallocated to the non-financial assets
acquired.
8
NOTE 4. BORROWINGS
Federal Home Loan Bank ("FHLB") borrowings and other indebtedness are comprised
of $136.3 million in convertible and callable advances and $8.3 million of
noncallable term advances from the FHLB of Atlanta. The callable advances may be
called (redeemed) at quarterly intervals after various lockout periods. These
call options may substantially shorten the lives of these instruments. If these
advances are called, the debt may be paid in full, converted to another FHLB
credit product, or converted to an adjustable rate advance.
The following schedule details the outstanding advances, rates and corresponding
final maturities at September 30, 2003.
NEXT CALL
ADVANCE RATE MATURITY DATE
-----------------------------------------
(AMOUNTS IN THOUSANDS)
Callable advances:
$ 5,000 1.10% 03/10/06 03/10/04
25,000 0.64% 06/30/06 06/30/04
1,250 4.14% 05/02/07 05/02/05
5,000 1.41% 09/27/07 12/29/03
25,000 5.71% 03/17/10 12/17/03
25,000 6.11% 05/05/10 11/05/03
25,000 6.02% 05/05/10 11/05/03
25,000 5.47% 10/04/10 01/05/04
----------
$ 136,250
==========
Noncallable advances: $ 900 4.55% 11/23/05 N/A
385 5.01% 12/11/06 N/A
5,000 1.30% 01/30/07 N/A
2,000 6.27% 09/02/08 N/A
----------
$ 8,285
==========
In addition to the amounts listed in the foregoing table, the Company issued
$15.0 million Trust Preferred Securities in September 2003 at a variable rate
indexed at the 3 Month LIBOR rate + 2.95%. The securities mature on October 8,
2033 and are continuously callable beginning October 8, 2008.
The Company's wholly owned mortgage subsidiary, United First Mortgage ("UFM"),
maintains a warehouse line of credit used to fund mortgage loan inventory with a
third party which was entered into in the third quarter of 2003. The maximum
line available under this credit facility is $15 million; however, no amounts
were outstanding at September 30, 2003. This line matures August 10, 2004 and
carries an interest rate of New York Prime, adjusting as the prime rate changes.
NOTE 5. COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is a defendant in various legal
actions and asserted claims, most of which involve lending, collection and
employment matters. While the Company and legal counsel are unable to assess the
ultimate outcome of each of these matters with certainty, they are of the belief
that the resolution of these actions, singly or in the aggregate, should not
have a material adverse affect on the financial condition, results of operations
or cash flows of the Company.
The Company conducts mortgage banking operations through UFM. The majority of
loans originated by UFM are sold to larger national investors on a service
released basis. Loans are sold under loan sales agreements which contain various
repurchase provisions. These repurchase provisions give rise to a contingent
liability for loans which could subsequently be submitted to UFM for repurchase.
The principal events which could result in a repurchase obligation are i.) the
discovery of fraud or material inaccuracies in a sold loan file and ii.) a
default on the first payment due after a loan is sold to the investor, coupled
with a ninety day delinquency in the first year of the life of the loan. Other
events and variations of these events could result in a loan repurchase under
terms of other loan sales agreements. The volume of contingent loan repurchases,
if any, is largely dependent on the quality of loan underwriting and systems
employed by UFM for quality control in the production of mortgage loans. UFM may
remarket these loans to alternate investors after repurchase and cure of the
borrowers' defects. To date, loans
9
submitted for repurchase have not been material and have not had a material
adverse effect on the results of operations, financial condition or liquidity of
UFM or the Company.
UFM also originates government guaranteed FHA and VA loans that are also sold to
third party investors. The Department of Housing and Urban Development ("HUD")
periodically audits loan files of government guaranteed loans and may require
UFM to execute indemnification agreements on loans which do not meet certain
predefined underwriting guidelines or may require the repurchase of the
underlying loan. To date, the number of required indemnification agreements, or
loan repurchases have not been material and no subsequent losses have been
incurred. Loan indemnifications and repurchases under the FHA and VA and VHDA
loan programs have not had a material adverse effect on the financial condition,
results of operations or cash flows of UFM or the Company.
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit, standby letters of
credit and financial guarantees. These instruments involve, to varying degrees,
elements of credit and interest rate risk beyond the amount recognized on the
balance sheet. The contractual amounts of those instruments reflect the extent
of involvement the Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of non-performance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit and financial guarantees written is represented by the
contractual amount of those instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is not a violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company, upon extension of credit is based on
management's credit evaluation of the counterparties. Collateral held varies but
may include accounts receivable, inventory, property, plant and equipment, and
income-producing commercial properties.
Standby letters of credit and written financial guarantees are conditional
commitments issued by the Company to guarantee the performance of a customer to
a third party. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
To the extent deemed necessary, collateral of varying types and amounts is held
to secure customer performance under certain of those letters of credit
outstanding.
Financial instruments whose contract amounts represent credit risk at September
30, 2003 are commitments to extend credit (including availability of lines of
credit) of $91.2 million and standby letters of credit and financial guarantees
written of $7.2 million. In addition, at September 30, 2003, UFM had commitments
to originate loans of $88.8 million. Of these commitments, the
fallout/pullthrough model employed by UFM identified $57.8 million that are
anticipated to close.
In September 2003, the Company issued, through FCBI Capital Trust, $15.0 million
of trust preferred securities in a private placement. In connection with the
issuance of the preferred securities, the Company has committed to irrevocably
and unconditionally guarantee the following payments or distributions with
respect to the preferred securities to the holders thereof to the extent that
FCBI Capital Trust has not made such payments or distributions and has the funds
therefore: (i) accrued and unpaid distributions, (ii) the redemption price, and
(iii) upon a dissolution or termination of the trust, the lesser of the
liquidation amount and all accrued and unpaid distributions and the amount of
assets of the trust remaining available for distribution.
10
NOTE 6. OTHER COMPREHENSIVE INCOME
The Company currently has one component of other comprehensive income, which is
comprised of unrealized gains and losses on securities available for sale,
detailed as follows:
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30
2003 2002 2003 2002
------------- ------------ ------------ ------------
(AMOUNTS IN THOUSANDS) (AMOUNTS IN THOUSANDS)
OTHER COMPREHENSIVE INCOME:
Unrealized (losses) gains arising during the period $ (2,876) $ 10,430 $ (5,935) $ 3,487
Related income tax benefit (expense) 1,151 (4,178) 2,374 (1,395)
----------- ----------- ----------- -----------
Unrealized (losses) gains arising during the period, net of tax (1,725) 6,252 (3,561) 2,092
Reclassification adjustment for gains realized in net
income (1,180) (208) (1,037) (22)
Tax expense of reclassification 472 83 415 9
----------- ----------- ----------- -----------
Other comprehensive (loss) gain (2,433) 6,127 (4,183) 2,079
Beginning accumulated other comprehensive gain 6,761 755 8,511 4,803
----------- ----------- ----------- -----------
Ending accumulated other comprehensive income $ 4,328 $ 6,882 $ 4,328 $ 6,882
=========== =========== =========== ===========
NOTE 7. SEGMENT INFORMATION
The Company operates two business segments: community banking and mortgage
banking. These segments are primarily identified by their products and services
and the channels through which they are offered. The community banking segment
consists of the Company's full-service bank that offers customers traditional
banking products and services through various delivery channels. The mortgage
banking segment consists of mortgage brokerage offices that originate, acquire,
and sell residential mortgage products into the secondary market through
national investors.
Information for each of the segments is presented below.
NINE MONTHS ENDED SEPTEMBER 30, 2003
------------------------------------------------------------------
(AMOUNTS IN THOUSANDS)
COMMUNITY MORTGAGE
BANKING BANKING PARENT ELIMINATIONS TOTAL
----------- --------- --------- ------------ -----------
NET INTEREST INCOME $ 47,239 $ 455 $ 156 $ (51) $ 47,799
PROVISION FOR LOAN LOSSES 2,679 - - - 2,679
----------- --------- --------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 44,560 455 156 (51) 45,120
OTHER INCOME 10,333 6,921 1,006 (210) 18,050
OTHER EXPENSES 27,454 7,440 486 (261) 35,119
----------- --------- --------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES 27,439 (64) 676 - 28,051
INCOME TAX EXPENSE (BENEFIT) 7,739 (26) 394 - 8,107
----------- --------- --------- ----------- -----------
NET INCOME (LOSS) $ 19,700 $ (38) $ 282 $ - $ 19,944
=========== ========= ========= =========== ===========
AVERAGE ASSETS $ 1,588,600 $ 58,223 $ 164,235 $ (216,858) $ 1,594,200
=========== ========= ========= =========== ===========
TOTAL ASSETS $ 1,672,505 $ 21,735 $ 190,047 $ (204,951) $ 1,679,336
=========== ========= ========= =========== ===========
11
Nine Months Ended September 30, 2002
-------------------------------------------------------------------
(Amounts in Thousands)
Community Mortgage
Banking Banking Parent Eliminations Total
----------- ----------- ----------- ------------ -----------
Net interest income $ 44,714 $ 685 $ 196 $ 61 $ 45,656
Provision for loan losses 3,261 - - - 3,261
----------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan losses 41,453 685 196 61 42,395
Other income 7,994 7,594 413 (186) 15,815
Other expenses 24,035 6,758 638 (125) 31,306
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 25,412 1,521 (29) - 26,904
Income tax expense (benefit) 7,384 591 (12) - 7,963
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 18,028 $ 930 $ (17) $ - $ 18,941
=========== =========== =========== =========== ===========
Average assets $ 1,459,414 $ 55,155 $ 141,203 $ (192,399) $ 1,463,373
=========== =========== =========== =========== ===========
Total assets $ 1,477,369 $ 73,957 $ 150,454 $ (217,873) $ 1,483,907
=========== =========== =========== =========== ===========
NOTE 8. RECENT ACCOUNTING DEVELOPMENTS
FINANCIAL ACCOUNTING STANDARDS BOARD ("FASB") STATEMENTS
FASB Statement No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity" was issued in May 2003. This
Statement requires certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity to be classified
as liabilities. Many of these instruments previously were classified as equity
or temporary equity and as such, Statement 150 represents a significant change
in practice in the accounting for a number of financial instruments, including
mandatorily redeemable equity instruments and certain equity derivatives that
frequently are used in connection with share repurchase programs.
The Statement is effective for public companies for all financial instruments
created or modified after May 31, 2003, and to other instruments at the
beginning of the first interim period beginning after June 15, 2003 (July 1,
2003 for calendar quarter companies). This statement did not have a material
impact on the Company's results of operations, financial condition, or
liquidity.
In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." Statement 149 amends Statement
133 as a result of:
- Decisions previously made as part of the Derivatives Implementation
Group ("DIG") process,
- Changes made in connection with other Board projects dealing with
financial instruments, and
- Deliberations in connection with issues raised in relation to the
application of the definition of a derivative.
The Statement is effective for contracts entered into or modified after June 30,
2003, and hedging relationships designated after June 30, 2003. However, the
provisions of Statement 149 that merely represent the codification of previous
DIG decisions, are already effective and will continue to be applied in
accordance with their prior respective effective dates. This Statement did not
have a material adverse impact on the Company's results of operations, financial
condition, or liquidity.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46")
"Consolidation of Variable Interest Entities", which addresses consolidation by
business enterprises of variable interest entities. FIN No. 46 clarifies the
application of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements", to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN No. 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. At its October 8, 2003 meeting, the FASB agreed to a broad-based deferral
of the effective date of FIN No. 46 for public companies until the end of
periods ending after December 15, 2003. Additionally, the Board agreed to
certain other modifications to the FIN No. 46 during the October 8 meeting. In
its current form, Fin 46 requires the Company to de-consolidate its investment
in
12
the trust preferred securities issued by FCBI Capital Trust in September 2003.
The de-consolidation of subsidiary trusts of bank holding companies formed in
connection with the issuance of trust preferred securities, such as FCBI Capital
Trust, appears to be an unintended consequence of FIN 46. It is currently
unknown if, or when, the FASB will address this issue. In July 2003, the Board
of Governors of the Federal Reserve System issued a supervisory letter
instructing bank holding companies to continue to include the trust preferred
securities in their Tier 1 capital for regulatory capital purposes until notice
is given to the contrary. The Federal Reserve intends to review the regulatory
implications of any accounting treatment changes and, if necessary or warranted,
provide further appropriate guidance. There can be no assurance that the Federal
Reserve will continue to allow institutions to include trust preferred
securities in Tier 1 capital for regulatory capital purposes.
As of September 30, 2003, $15 million in trust preferred securities issued by
FCBI Capital Trust were outstanding that are treated as Tier 1 capital for bank
regulatory purposes. If FCBI's outstanding trust preferred securities at
September 30, 2003 were not treated as Tier 1 capital at that date, FCBI's Tier
1 leverage capital ratio would have declined from 8.60% to 7.69%, its Tier 1
risk-based capital ratio would have declined from 13.06% to 11.68%, and its
total risk-based capital ratio would have declined from 14.34% to 12.96% as of
September 30, 2003. These reduced capital ratios would continue to meet the
applicable "well capitalized" Federal Reserve capital requirements.
With respect to interests subject to FIN 46, including low income housing
investments, the Company is in the process of determining if it is the primary
beneficiary of the variable interest entities. The Company's maximum estimated
exposure to these low income housing partnerships is approximately $4.3 million
(which reflects a combination of the unamortized basis in these entities, of
$1.8 million, combined with the maximum potential tax credit recapture from the
underlying partnerships of $2.5 million). In addition, the Company has no
obligation to advance any additional funds or to fund any loan commitment to
these partnerships.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." This interpretation expands the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees and requires the guarantor to recognize a
liability for the fair value of an obligation assumed under a guarantee. FIN 45
clarifies the requirements of FAS 5, "Accounting for Contingencies", relating to
guarantees. In general, FIN 45 applies to contracts or indemnification
agreements that contingently require the guarantor to make payments to the
guaranteed party based on changes in an underlying value that is related to an
asset, liability, or equity security of the guaranteed party. Certain guarantee
contracts are excluded from both the disclosure and recognition requirements of
this interpretation, including, among others, guarantees relating to employee
compensation, residual value guarantees under capital lease arrangements,
commercial letters of credit, loan commitments, subordinated interests in a
special purpose entity, and guarantees of a company's own future performance.
Other guarantees are subject to the disclosure requirements of FIN 45 but not to
the recognition provisions and include, among others, a guarantee accounted for
as a derivative instrument under FAS 133, a parent's guarantee of debt owed to a
third party by its subsidiary or vice versa, and a guarantee which is based on
performance rather than price. The disclosure requirements of FIN 45 were
effective for the Company as of December 31, 2002. The requirements of FIN 45
did not have a material impact on results of operations, financial condition, or
liquidity in the first nine months of 2003.
In October 2002, the FASB issued FAS No. 147, "Acquisitions of Certain Financial
Institutions." This Standard, which became effective upon issuance, provided
interpretive guidance on the application of the purchase method to acquisitions
of financial institutions, and required companies to cease amortization of
goodwill related to certain branch acquisitions. In addition, the Statement
amended FASB Statement No. 144 to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor and borrower relationship intangible assets and credit cardholder
intangible assets. Consequently, those intangible assets are subject to the same
undiscounted cash flow recoverability test and impairment loss recognition and
measurement provisions that Statement 144 requires for other long-lived assets
that are held and used. The impact of Statement 147 caused the Company to cease
amortization of this component of goodwill effective October 1, 2002,
retroactive to January 1, 2002 and accordingly, restate the presentation for the
first nine months of 2002 in its 2002 annual report to shareholders.
13
NOTE 9. EARNINGS PER SHARE
The following schedule details earnings and shares used in computing basic and
diluted earnings per share for the nine and three months ended September 30,
2003 and 2002.
FOR THE NINE MONTHS ENDED FOR THE THREE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30
2003 2002 2003 2002
------------- ------------- ------------- -------------
Basic:
Net income (in thousands) $ 19,944 $ 18,941 $ 6,229 $ 6,586
Weighted average shares outstanding 11,047,199 10,929,010 11,262,180 10,920,876
Earnings per share $ 1.81 $ 1.73 $ 0.55 $ 0.60
Diluted:
Net income (in thousands) $ 19,944 $ 18,941 $ 6,229 $ 6,586
Weighted average shares outstanding 11,047,199 10,929,010 11,262,180 10,920,876
Dilutive shares for stock options 91,479 51,862 117,264 55,074
Contingently issuable shares for acquisition 4,497 - 4,497 -
Weighted average dilutive shares outstanding 11,143,175 10,980,872 11,383,941 10,975,950
Earnings per share-dilutive $ 1.79 $ 1.73 $ 0.55 $ 0.60
NOTE 10. PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Company's lending strategy stresses quality growth diversified by product,
geography, and industry. All loans made by the Company are subject to common
credit standards and a uniform underwriting system. Loans are also subject to an
annual review process which varies based on the loan size and type. The Company
utilizes this ongoing review process to evaluate loans for changes in credit
risk. This process serves as the primary means by which the Company evaluates
the adequacy of the loan loss allowance. The total loan loss allowance is
divided into the following categories: i) specifically identified losses on loan
relationships which are on non-accrual status, ninety days past due or more and
loans with elements of credit weakness, and ii) formula allowances and special
allocations addressing other qualitative factors including industry
concentrations, economic conditions, staffing and other conditions.
Specific allowances are established to cover loan relationships, which are
identified as having significant cash flow weakness and for which a collateral
deficiency may be present. The allowances established under the specific
identification method are judged based upon the borrower's estimated cash flow
and projected liquidation value of related collateral.
Formula allowances, based on historical loss experience, are available to cover
homogeneous groups of loans not individually evaluated. The formula allowance is
developed and evaluated against loans in general by specific category
(commercial, mortgage, and consumer). The allowance is developed for each loan
category based upon a review of historical loss percentages for the Company and
other qualitative factors. The calculated percentage is considered in
determining the estimated allowance excluding any relationships specifically
identified and individually evaluated. While consideration is given to credit
weaknesses for specific loans and classifications within the various categories
of loans, the allowance is available for all loan losses.
In developing the allowance for loan losses, the Company also considers various
inherent risk factors, such as current economic conditions, the level of
delinquencies and non-accrual loans, trends in the volume and term of loans,
anticipated impact from changes in lending policies and procedures, and any
concentration of credits in certain industries or geographic areas. In addition,
management continually evaluates the adequacy of the allowance for loan losses
and makes specific adjustments to the allowance based on the results of risk
analysis in the credit review process, the recommendation of regulatory
agencies, and other factors, such as loan loss experience and prevailing
economic conditions.
14
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The Audit Committee of the Board of Directors
First Community Bancshares, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of First
Community Bancshares, Inc. and subsidiary (the Company) as of September 30,
2003, and the related consolidated statements of income for the three and nine
months ended September 30, 2003 and 2002 and the consolidated statements of cash
flows and changes in stockholders' equity for the nine-month periods ended
September 30, 2003 and 2002. These financial statements are the responsibility
of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements referred to above
for them to be in conformity with accounting principles generally accepted in
the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of the Company as
of December 31, 2002, and the related consolidated statements of income, cash
flows and changes in stockholders' equity for the year then ended (not presented
herein) and in our report dated January 27, 2003, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 2002, is fairly stated, in all material respects, in relation to
the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
October 22, 2003
15
FIRST COMMUNITY BANCSHARES, INC.
PART I. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis is provided to address information about
the Company's financial condition and results of operations. This discussion and
analysis should be read in conjunction with the 2002 Annual Report to
Shareholders and the other financial information included in this report.
The Company is a multi-state bank holding company headquartered in Bluefield,
Virginia with total assets of $1.7 billion at September 30, 2003. Through the
Bank, FCBI provides financial, mortgage brokerage and origination and trust and
investment advisory services to individuals and commercial customers through 47
full-service banking locations in West Virginia, Virginia and North Carolina as
well as 10 mortgage brokerage facilities operated by UFM, a wholly owned
subsidiary of the Bank. The Bank also operates Stone Capital, an investment
advisory firm with offices in Beckley, West Virginia.
FORWARD LOOKING STATEMENTS
The Company may from time to time make written or oral "forward-looking
statements", including statements contained in its filings with the Securities
and Exchange Commission ("SEC") (including this Quarterly Report on Form 10-Q
and the Exhibits hereto and thereto), in its reports to stockholders and in
other communications which are made in good faith by the Company pursuant to the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995.
These forward-looking statements include, among others, statements with respect
to the Company's beliefs, plans, objectives, goals, guidelines, expectations,
anticipations, estimates and intentions that are subject to significant risks
and uncertainties and are subject to change based on various factors (many of
which are beyond the Company's control). The words "may", "could", "should",
"would", "believe", "anticipate", "estimate", "expect", "intend", "plan" and
similar expressions are intended to identify forward-looking statements. The
following factors, among others, could cause the Company's financial performance
to differ materially from that expressed in such forward-looking statements; the
strength of the United States economy in general and the strength of the local
economies in which the Company conducts operations; the effects of, and changes
in, trade, monetary and fiscal policies and laws, including interest rate
policies of the Board of Governors of the Federal Reserve System; inflation,
interest rate, market and monetary fluctuations; the timely development of
competitive new products and services of the Company and the acceptance of these
products and services by new and existing customers; the willingness of
customers to substitute competitors' products and services for the Company's
products and services and vice versa; the impact of changes in financial
services' laws and regulations (including laws concerning taxes, banking,
securities and insurance); technological changes; the effect of acquisitions,
including, without limitation, the failure to achieve the expected revenue
growth and/or expense savings from such acquisitions; the growth and
profitability of the Company's non-interest or fee income being less than
expected; unanticipated regulatory or judicial proceedings; changes in consumer
spending and saving habits; and the success of the Company at managing the risks
involved in the foregoing.
The Company cautions that the foregoing list of important factors is not
exclusive. The Company does not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or on
behalf of the Company.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
First Community's consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States of America
and conform to general practices within the banking industry. First Community's
financial position and results of operations are affected by management's
application of accounting policies, including judgments made to arrive at the
carrying value of assets and liabilities and amounts reported for revenues,
expenses and related disclosures. Different assumptions in the application of
these policies could result in material changes in First Community's
consolidated financial position and/or consolidated results of operations.
Estimates, assumptions, and judgments are necessary principally when assets and
liabilities are required to be recorded at estimated fair value, when a decline
in the value of an asset carried on the financial statements at fair value
warrants an impairment write-down or valuation reserve to be established, or
when an asset or liability needs to be recorded based upon the probability of
occurrence of a future event. Carrying assets and liabilities at fair value
inherently results in more financial statement volatility. The fair values and
the information used to record valuation adjustments for certain assets and
liabilities are based either on quoted market prices or are provided by third
party
16
sources, when available. When third party information is not available,
valuation adjustments are estimated in good faith by management primarily
through the use of internal modeling techniques and/or appraisal estimates.
First Community's accounting policies are fundamental to understanding
Management's Discussion and Analysis of Financial Condition and Results of
Operations. The following is a summary of First Community's more subjective and
complex "critical accounting policies." In addition, the disclosures presented
in the Notes to the Consolidated Financial Statements and in management's
discussion and analysis, provide information on how significant assets and
liabilities are valued in the financial statements and how those values are
determined. Based on the valuation techniques used and the sensitivity of
financial statement amounts to the methods, assumptions, and estimates
underlying those amounts, management has identified the determination of the
allowance for loan losses, the valuation of loans held for sale and the
valuation of derivative instruments utilized in mortgage banking and hedging
activity to be the accounting areas that require the most subjective or complex
judgments.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is established and
maintained at levels management deems adequate to cover losses inherent in the
portfolio as of the balance sheet date and is based on management's evaluation
of the risks in the loan portfolio and changes in the nature and volume of loan
activity. Estimates for loan losses are determined by analyzing historical loan
losses, current trends in delinquencies and charge-offs, plans for problem loan
resolution, the opinions of FCBI's regulators, changes in the size and
composition of the loan portfolio and industry information. Also included in
management's estimates for loan losses are considerations with respect to the
impact of economic events, the outcome of which are uncertain. These events may
include, but are not limited to, a general slowdown in the economy, fluctuations
in overall lending rates, political conditions, legislation that may directly or
indirectly affect the banking industry and economic conditions affecting
specific geographic areas in which First Community conducts business.
As more fully described in Note 10 to the Notes to the Consolidated Financial
Statements and in the discussion included in the Allowance for Loan Losses
section of Management's Discussion and Analysis, the Company determines the
allowance for loan losses by making specific allocations to impaired loans and
loan pools that exhibit inherent weaknesses and various credit risk factors.
Allocations to loan pools are developed giving weight to risk ratings,
historical loss trends and management's judgment concerning those trends and
other relevant factors. These factors may include, among others, actual versus
estimated losses, regional and national economic conditions, business segment
and portfolio concentrations, industry competition and consolidation, and the
impact of government regulations. The foregoing analysis is performed by the
Company's credit administration department to evaluate the portfolio and
calculate an estimated valuation allowance through a quantitative and
qualitative analysis that applies risk factors to those identified risk areas.
This risk management evaluation is applied at both the portfolio level and the
individual loan level for commercial loans and credit relationships while the
level of consumer and residential mortgage loan allowance is determined
primarily on a total portfolio level based on a review of historical loss
percentages and other qualitative factors including concentrations, industry
specific factors and economic conditions. The commercial and commercial real
estate portfolios require more specific analysis of individually significant
loans and the borrower's underlying cash flow, business conditions, capacity for
debt repayment and the valuation of secondary sources of payment (collateral).
This analysis may result in specifically identified weaknesses and corresponding
specific impairment allowances.
The use of various estimates and judgments in the Company's ongoing evaluation
of the required level of allowance can significantly impact the Company's
results of operations and financial condition and may result in either greater
provisions against earnings to increase the allowance or reduced provisions
based upon management's current view of portfolio and economic conditions and
the application of revised estimates and assumptions.
LOANS HELD FOR SALE, DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: UFM provides
a distribution outlet for the sale of loans produced by UFM's wholesale and
retail operations. It originates residential mortgage loans through its
production offices located in Eastern Virginia and sells the majority of its
loans through pooled commitments to national investors on a servicing released
basis. In addition, UFM acquires loans from a network of wholesale brokers for
subsequent resale to these national investors. UFM originates all loans with the
positive intent to sell. Loans held for sale are stated at the lower of cost or
market ("LOCOM"). The LOCOM analysis on pools of homogeneous loans is applied on
a net aggregate basis. Interest income with respect to loans held for sale is
accrued on the principal amount outstanding. LOCOM valuation techniques
applicable to loans held for sale are based on estimated market price
indications for similar loans. Pricing estimates are established by
participating mortgage purchasers and prevailing economic conditions. The
majority of the loans held for sale have established market pricing indications.
The loans held for sale portfolio at September 30, 2003 was $16.7 million
compared to $66.4 million at December 31, 2002.
17
Risks associated with this lending function include interest rate risk, which is
mitigated through the utilization of financial instruments (commonly referred to
as derivatives) to assist in offsetting the effect of changing interest rates.
The Company accounts for these instruments in accordance with FASB Statement No.
133, as amended "Accounting for Derivative Instruments and Hedging Activity."
This Statement established accounting and reporting standards for derivative
instruments and for hedging activities. UFM uses forward mortgage contracts and
options (short position sales and options) to manage interest rate risk in the
pipeline of loans and interest rate lock commitments ("RLCs") from the point of
the loan commitment to the subsequent allocation and delivery to outside
investors. As a result of the timing from origination to sale, and the
likelihood of changing interest rates, forward commitments and options are
placed with counter-parties to attempt to counter the effect of changing
interest rates. The options and forward commitments to sell securities are
considered to be derivatives and, as such, are recorded on the consolidated
balance sheets at fair value and the changes in fair value are reflected in the
consolidated statements of income.
The fair value of the RLCs is based on prevailing interest rates, expected
servicing release premiums and the assumed probability of closing
(pull-through). The assumption of a given pull-through percentage also enters
into the determination of the volume of derivative contracts. Pull-through
assumptions are continually monitored for changes in the interest rate
environment and characteristics of the pool of RLCs. Differences between
pull-through assumptions and actual pull-through could result in a mismatch in
the volume of security contracts corresponding to RLCs and lead to volatility in
profit margins on the loan products ultimately delivered.
At September 30, 2003, UFM held an investment in forward mortgage contracts with
a notional value of $54.0 million and mortgage-backed security put options
totaling $8.0 million. These instruments are collectively referred to as hedging
instruments or securities. These contracts hedge interest rate risk associated
with RLCs and closed loans not allocated to a forward commitment of $57.8
million. At September 30, 2003, the fair value of the securities was a liability
of $588,000, which represents a $117,000 increase from the fair value at
December 31, 2002. In addition, the fair value of the RLCs at September 30, 2003
was $1.3 million, which represents a $927,000 decline from the fair value at
December 31, 2002. The market valuation of RLCs at September 30, 2003 assumes a
65.08% RLC pull- through. If actual pull-through in succeeding months proves to
be more or less than 65.08%, the full market value of RLCs may or may not be
realized and/or the valuation of RLCs may change. The valuation of RLCs is
considered critical because of the impact of borrower behavior and the impact
that this behavior pattern will have on the pull-through ratio during times of
significant rate volatility. Customer behavior is modeled by a mathematical tool
based upon historical pull-through experience; however, substantial volatility
can be experienced, as has been the case over the last eighteen months, as a
result of the general movement in mortgage rates. As a result daily pull-through
has varied significantly over this time period. Customer behavior is difficult
to model. However, the mathematical tool utilized by UFM incorporates volatility
derived from market data in an attempt to anticipate borrower reaction to market
rate movements.
For the nine months ended September 30, 2003, the Company incurred $1.2 million
in the cost of forward mortgage derivative contracts to originate and sell
$742.0 million in loans compared to the first nine months of the prior year in
which $494.1 million in loans were originated for sale with underlying forward
mortgage contracts that cost $4.6 million. The lower cost of forward mortgage
contracts between the two years is reflective of the volatility of the pricing
of these types of contracts during times of significant interest rate
volatility. Although the pricing of the contracts was favorable to the Company
in the current year, UFM's pricing and margin on loans sold was substantially
less favorable as a result of the market pricing dynamics and significant
competitive forces. The significant decrease in hedging cost as well as the
market price of loans sold, demonstrate the potential volatility to earnings and
the sensitivity to pull-through assumptions. The cost of these derivative
contracts are included as a component of mortgage banking income in the
consolidated statements of income, which represents the net revenues associated
with the origination, holding and sale of mortgage loans.
RECENT ACQUISITIONS AND BRANCHING ACTIVITY
In June 2003, the Company acquired CommonWealth , a Virginia-chartered
commercial bank for total consideration of approximately $23.2 million. The
merger was accomplished through the exchange of .9015 shares of the Company's
common stock valued at $30.50, cash, or a combination of the Company's stock and
cash equivalent to $30.50 for each share of CommonWealth common stock. At
acquisition, CommonWealth had total assets of $136.5 million, net loans of
$120.0 million and total deposits of $105.0 million.
In the second and third quarters of 2003, the Company opened two denovo branches
and has one under development in Winston-Salem, North Carolina. It is
anticipated that these branches will not be profitable until market development
has proven successful and adequate loan balances and corresponding loan revenue
are established to support the added facilities, infrastructure and other
operating costs of these branches.
18
RESULTS OF OPERATIONS
GENERAL
For the first nine months ("year-to-date") of 2003, net income totaled $19.9
million, which was $1.0 million, or 5.3% higher than net income of $18.9
reported for the corresponding period in 2002. The 2003 year-to-date net income
resulted in basic earnings per share of $1.81 versus $1.73 in 2002, a 4.6%
increase, and diluted earnings per share of $1.79 versus $1.73, in 2002, a 3.5%
increase. Year-to date net income in 2003 increased as a result of a $2.1
million increase in net interest income and a $2.2 million increase in other
operating income. Although the Company experienced gains in sources of operating
revenue of approximately $4.3 million, increases were also incurred in other
operating expense categories totaling $3.8 million as more fully discussed
below.
For the three months ended ("third quarter") September 30, 2003, net income
totaled $6.2 million, which was $357,000, or 5.4% lower than net income of $6.6
million reported for the corresponding period in 2002. Net income for the third
quarter of 2003 resulted in basic and diluted earnings per share of $0.55 versus
$0.60 basic and diluted earnings per share reported in the third quarter of
2002, an 8.3% decrease. The most significant changes in sources of income when
comparing the current and prior year quarters were a $1 million increase in net
interest income and $1 million in security gains. However, offsetting these
gains were a $1.7 million decrease in mortgage banking income and a $2.3 million
increase in other operating expenses.
NET INTEREST INCOME YEAR-TO-DATE COMPARISON (SEE TABLE I)
Net interest income, the largest contributor to earnings, was $47.8 million for
the nine months ended September 30, 2003 compared to $45.7 million for the
corresponding period in 2002. For purposes of the following discussion,
comparison of net interest income is done on a tax equivalent basis, which
provides a common basis for comparing yields on earning assets exempt from
federal income taxes to those which are fully taxable. As indicated in Table I,
tax equivalent net interest income totaled $50.5 million for the nine months
ended September 30, 2003, an increase of $2.0 million from the $48.5 million
reported in the first nine months of 2002. This $2.0 million increase was based
on a $3.1 million increase due to volume changes as earning assets were added to
the portfolio at declining replacement rates, which was partially offset by a
$1.1 million reduction due to rate changes on the underlying assets as asset
yields fell in the declining rate environment. Management was able to help
counter the effect of the declining asset yield through aggressive management of
deposit rates offered. Average earning assets increased $117.5 million while
interest-bearing liabilities increased $90.6 million. As indicated in Table I,
the yield on average earning assets decreased 89 basis points from 7.44% for the
nine months ended September 30, 2002 to 6.55% for the nine months ended
September 30, 2003. However, this decrease was largely offset by an 80 basis
point decline in the cost of funds during the same periods leaving the net
interest rate spread (the difference between interest income on earning assets
and expense on interest bearing liabilities) at September 30, 2003 slightly
lower at 4.21% compared to 4.30% the same period last year. The Company's tax
equivalent net interest margin of 4.58% for the nine months ended September 30,
2003 decreased 20 basis points from 4.78% in 2002.
The largest contributor to the decrease in the yield on average earning assets
in 2003, on a volume-weighted basis, was the decrease in the overall tax
equivalent yield on loans held for investment of 61 basis points from the prior
year to 7.35%, as loans repriced downward in response to the declining rate
environment while the average balance increased $36.5 million. The decline in
asset yield is attributable to the current interest rate environment which
creates refinancing or repricing incentives for fixed rate borrowers to lower
their current borrowing costs. In addition, due to the volume of loans directly
tied to prime and other indices that are either adjustable incrementally or are
variable rate advances, asset yields have declined in response to rate cuts and
drops in the prime loan rate which began in 2001, continued in 2002 and
continues to remain at lows not seen in over 40 years.
The balance of average loans held for sale increased by $2.2 million while the
yield decreased 141 basis points to 5.34%. The yield on loans held for sale is
much more sensitive to interest rate change since these loans are only held for
30 to 60 days and are replenished with new loan volume at the then prevailing
rates. The change in rate on this pool of loans is reflective of the volatility
experienced in mortgage rates and the underlying mortgage-backed securities into
which they are delivered. The average secondary market loan originated through
the Company's mortgage subsidiary varied in rate during the current year from a
high in January 2003 of 6.625% to 4.75% in June 2003.
During the nine months ended September 30, 2003, the taxable equivalent yield on
securities available for sale decreased 111 basis points to 4.90% while the
average balance increased by $53.2 million. Consistent with the
19
current rate environment, the Company and the securities industry as a whole
have experienced rapid turnover in securities as higher yielding securities are
either called or prepaid as the refinancing opportunity presents itself.
Although the total portfolio grew by $94.6 million from December 31, 2002, the
relative rate on securities acquired since December 31, 2002 has declined
substantially. The increasing average security balance is the result of
continued reinvestment of available funds largely created by higher average
deposit levels. Both the average balance and tax equivalent yield on investment
securities held to maturity remained relatively stable with a decrease in yield
of only 6 basis points to 8.10% and a $1.4 million decrease in average balance
from the first nine months of 2002.
Compared to the first nine months of 2002, average interest-bearing balances
with banks increased $26.3 million while the yield decreased 4 basis points.
This average balance increase was largely the result of funds received from new
deposit growth in existing markets and deposits obtained in the acquisition of
Greenville in the fourth quarter of 2002 as well as the continued cash flow
roll-off experience in the loan and investment portfolio.
The Company actively manages its product pricing by staying abreast of the
current economic climate and competitive forces in order to enhance repricing
opportunities available with respect to the liability side of its balance sheet.
In doing so, the cost of interest-bearing liabilities decreased by 80 basis
points from 3.14% for the nine months ended September 30, 2002 to 2.34% for the
same period of 2003 while the average volume increased $90.6 million. Active
deposit liability pricing management is performed weekly.
Average FHLB borrowings decreased by $8.2 million when comparing the nine months
ended September 30, 2003 to the corresponding period of the prior year as a
result of maturities which were partially offset by additional borrowings in
connection with the CommonWealth acquisition. The average rate paid on these
borrowings decreased 69 basis points to 5.20% in 2003 versus 5.89% in 2002.
In addition, the average balances of interest-bearing demand and savings
deposits increased $32.3 and $17.2 million, respectively, during the nine months
ended September 30, 2003 while the corresponding average rate paid on these
deposit categories declined 40 and 54 basis points, respectively. Average time
deposits increased $34.9 million while the average rate paid decreased 93 basis
points from 3.87% in 2002 to 2.94% in 2003. Likewise, average Fed Funds and
repurchase agreements increased $14.5 million while the average rate decreased
50 basis points. The level of average noninterest-bearing demand deposits
increased $17.9 million to $174.7 million at September 30, 2003 compared to the
corresponding period of the prior year. Approximately $24.6 million and $27.0
million of the $84.4 million increase in average interest-bearing deposit growth
is attributable to the acquisitions of Greenville in the fourth quarter of 2002
and CommonWealth in June 2003, respectively.
NET INTEREST INCOME - QUARTERLY COMPARISON (SEE TABLE II)
Net interest income for the quarter ended September 30, 2003 was $17.0 million
compared to $16.0 million for the same period in 2002, an increase of $1.0
million. Likewise, tax equivalent net interest income increased $936,000 from
$17.0 million for the quarter ended September 30, 2002, to $17.9 million for the
quarter ended September 30, 2003 (refer to Table II). A 77 basis point decrease
in the rate paid on interest-bearing liabilities partially offset a 103 basis
point decline in the average rate earned on interest-earning assets, resulting
in a decrease in the net interest margin of 38 basis points to 4.55% for the
quarter ended September 30, 2003. While the net interest margin decreased,
average earning assets increased $195.4 million in the third quarter of 2003
compared to the third quarter of 2002 resulting in the improvements in net
interest income. The largest increases in average earning assets included
increases in average loans held for investment of $101.4 and securities
available for sale of $81.3 million. The $936,000 increase in net interest
income was achieved through the combined effect of changes in volume and
corresponding rates on the underlying assets and liabilities. Earnings
attributable to the net volume increase in earning assets over paying
liabilities was approximately $6.9 million while the effect of declining rates
represented an offsetting net reduction of approximately $5.9 million for a
combined effect on net interest income of $936,000.
As previously mentioned, the impact of the declining interest rate environment
continued to reduce asset yields as assets repriced into lower interest rate
products and as securities were replaced with lower yielding instruments
reflecting the lower rate environment. This refinancing/repricing scenario is
reflected in all categories of interest earning assets. Management continues to
focus on margin enhancement by funding the balance sheet growth with lower
priced deposits and borrowings without significantly extending balance sheet
duration (the weighted average maturity) in anticipation of future rate
increases. In the third quarter of 2003, average interest-bearing deposits with
banks increased $8.5 million and Fed Funds Sold increased $113,000 and average
loans held for sale increased $7.0 million when compared to the third quarter of
the prior year. The increase in liquid assets is a direct result of higher asset
prepayment speeds noted in the loans and security portfolios as well as a
general increase in borrowings and the issuance of $15 million in
trust-preferred securities in September 2003.
20
Similar to the decline in asset yields created by the current interest rate
cycle, deposit and borrowing costs also have been adjusted where possible to
obtain this benefit on the liability side of the balance sheet. As previously
mentioned, management continues to strive for lower cost funding in light of
current asset yields. Management monitors the overall performance of assets and
interest-bearing liabilities through the Company's product management group.
Total interest-bearing liabilities increased $163.4 million with average
interest-bearing deposits increasing $109.8 million. The average rate paid on
paying liabilities and deposits dropped 77 and 76 basis points, respectively.
For the same periods, average Fed Funds purchased and repurchase agreements
increased $17.3 million while the average rate decreased 63 basis points.
Average short-term borrowings increased $36.1 million while the rate decreased
135 basis points.
21
TABLE I AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
AVERAGE INTEREST YIELD/RATE AVERAGE INTEREST YIELD/RATE
BALANCE (1) (1) BALANCE (1) (1)
-------------------------------------- --------------------------------------
Earning Assets:
Loans (2):
Held for Sale $ 52,134 $ 2,084 5.34% $ 49,906 $ 2,521 6.75%
Held for Investment:
Taxable 951,313 52,264 7.35% 913,785 54,385 7.96%
Tax-Exempt 5,530 311 7.51% 6,550 402 8.20%
----------- ----------- ----------- -----------
Total 956,843 52,575 7.35% 920,335 54,787 7.96%
Allowance for Loan Losses (14,717) (14,391)
----------- ----------- ----------- -----------
Net Total 942,126 52,575 905,944 54,787
Securities Available for Sale:
Taxable 306,905 9,573 4.17% 251,945 10,145 5.38%
Tax-Exempt 92,563 5,079 7.34% 94,338 5,421 7.68%
----------- ----------- ----------- -----------
Total 399,468 14,652 4.90% 346,283 15,566 6.01%
Securities Held to Maturity:
Taxable 602 33 7.33% 1,708 91 7.12%
Tax-Exempt 39,274 2,383 8.11% 39,531 2,427 8.21%
----------- ----------- ----------- -----------
Total 39,876 2,416 8.10% 41,239 2,518 8.16%
Interest Bearing Deposits 40,162 481 1.60% 13,844 170 1.64%
Fed Funds Sold 950 9 1.27% - - -
----------- ----------- ----------- -----------
Total Earning Assets 1,474,716 $ 72,217 6.55% 1,357,216 $ 75,562 7.44%
Other Assets 119,484 106,157
----------- -----------
Total $ 1,594,200 $ 1,463,373
=========== ===========
Interest-Bearing Liabilities:
Demand Deposits $ 219,463 1,088 0.66% $ 187,191 1,487 1.06%
Savings Deposits 183,859 891 0.65% 166,638 1,484 1.19%
Time Deposits 609,488 13,413 2.94% 574,624 16,631 3.87%
----------- ----------- ----------- -----------
Total Deposits 1,012,810 15,392 2.03% 928,453 19,602 2.82%
Fed Funds Purchased & Repurchase
Agreements 99,520 1,292 1.74% 85,059 1,427 2.24%
FHLB Convertible and Callable Advances 117,420 4,564 5.20% 125,659 5,537 5.89%
Other Borrowings 10,109 450 5.95% 10,091 451 5.98%
----------- ----------- ----------- -----------
Total Interest-bearing liabilities 1,239,859 21,698 2.34% 1,149,262 27,017 3.14%
Demand Deposits 174,680 156,814
Other Liabilities 15,337 15,348
Stockholders' Equity 164,324 141,949
----------- -----------
Total $ 1,594,200 $ 1,463,373
=========== ----------- =========== -----------
Net Interest Income, tax equivalent $ 50,519 $ 48,545
=========== ===========
Net Interest Rate Spread (3) 4.21% 4.30%
=========== ===========
Net Interest Margin (4) 4.58% 4.78%
=========== ===========
(1) Fully Taxable Equivalent at the rate of 35%.
(2) Non-accrual loans are included in average balances outstanding but with no
related interest income during the period of non-accrual.
(3) Represents the difference between the yield on earning assets and cost of
funds.
(4) Represents tax equivalent net interest income divided by average interest
earning assets.
22
TABLE II AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
AVERAGE INTEREST YIELD/RATE AVERAGE INTEREST YIELD/RATE
BALANCE (1) (1) BALANCE (1) (1)
-------------------------------------- --------------------------------------
Earning Assets:
Loans (2):
Held for Sale $ 58,750 $ 800 5.40% $ 51,779 $ 851 6.52%
Held for Investment:
Taxable 1,025,798 18,533 7.17% 922,752 18,510 7.96%
Tax-Exempt 5,077 91 7.13% 6,742 134 7.88%
------------ ----------- ----------- -----------
Total 1,030,875 18,624 7.17% 929,494 18,644 7.96%
Allowance for Loan Losses (15,807) (14,278)
----------- ----------- ----------- -----------
Net Total 1,015,068 18,624 915,216 18,644
Securities Available for Sale:
Taxable 327,397 3,073 3.72% 241,722 3,217 5.28%
Tax-Exempt 88,991 1,591 7.10% 93,353 1,767 7.51%
----------- ----------- ----------- -----------
Total 416,388 4,664 4.44% 335,075 4,984 5.90%
Securities Held to Maturity:
Taxable 553 8 5.74% 1,086 20 7.31%
Tax-Exempt 38,699 789 8.09% 39,531 816 8.19%
----------- ----------- ----------- -----------
Total 39,252 797 8.05% 40,617 836 8.16%
Interest Bearing Deposits 29,901 127 1.69% 21,358 88 1.63%
Fed Funds Sold 113 1 0.96% - - -
----------- ----------- ----------- -----------
Total Earning Assets 1,559,472 $ 25,013 6.36% 1,364,045 $ 25,403 7.39%
Other Assets 137,175 105,564
----------- -----------
Total $ 1,696,647 $ 1,469,609
=========== ===========
Interest-Bearing Liabilities:
Demand Deposits $ 237,931 356 0.59% $ 184,220 495 1.07%
Savings Deposits 186,503 280 0.60% 179,142 561 1.24%
Time Deposits 621,930 4,297 2.74% 573,216 5,149 3.56%
----------- ----------- ----------- -----------
Total Deposits 1,046,364 4,933 1.87% 936,578 6,205 2.63%
Fed Funds Purchased & Repurchase
Agreements 108,484 416 1.52% 91,199 494 2.15%
FHLB convertible and callable advance 146,117 1,613 4.38% 110,000 1,590 5.73%
Other Borrowings 10,235 152 5.89% 10,055 151 5.96%
----------- ----------- ----------- -----------
Total Interest-bearing liabilities 1,311,200 7,114 2.15% 1,147,832 8,440 2.92%
Demand Deposits 195,056 158,799
Other Liabilities 15,163 14,854
Stockholders' Equity 175,228 148,124
----------- -----------
Total $ 1,696,647 $ 1,469,609
=========== ----------- =========== -----------
Net Interest Income, tax equivalent $ 17,899 $ 16,963
=========== ===========
Net Interest Rate Spread (3) 4.21% 4.47%
=========== ===========
Net Interest Margin (4) 4.55% 4.93%
=========== ===========
(1) Fully Taxable Equivalent at the rate of 35%.
(2) Non-accrual loans are included in average balances outstanding but with no
related interest income during the period of non-accrual.
(3) Represents the difference between the yield on earning assets and cost of
funds.
(4) Represents tax equivalent net interest income divided by average interest
earning assets.
23
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level sufficient to absorb
probable loan losses inherent in the loan portfolio. The allowance is increased
by charges to earnings in the form of provisions for loan losses and recoveries
of prior loan charge-offs, and decreased by loans charged off. The provision for
loan losses is calculated to bring the allowance to a level, which, according to
a systematic process of measurement, reflects the amount needed to absorb
probable losses within the portfolio.
Management performs monthly assessments to determine the appropriate level of
allowance. Differences between actual loan loss experience and estimates are
reflected through adjustments that are made by either increasing or decreasing
the loss provision based upon current measurement criteria. Commercial, consumer
and mortgage loan portfolios are evaluated separately for purposes of
determining the allowance. The specific components of the allowance include
allocations to individual commercial credits and allocations to the remaining
non-homogeneous and homogeneous pools of loans. Management's allocations are
based on judgment of qualitative and quantitative factors about both macro and
micro economic conditions reflected within the portfolio of loans and the
economy as a whole. Factors considered in this evaluation include, but are not
necessarily limited to, probable losses from loan and other credit arrangements,
general economic conditions, changes in credit concentrations or pledged
collateral, historical loan loss experience, and trends in portfolio volume,
maturities, composition, delinquencies, and non-accruals. While management has
attributed the allowance for loan losses to various portfolio segments, the
allowance is available for the entire portfolio.
The allowance for loan losses was $15.7 million on September 30, 2003, compared
to $14.4 million at December 31, 2002 and $14.1 million on September 30, 2002.
The allowance for loan losses represents 653% of non-performing loans at
September 30, 2003, versus 455% and 263% at December 31, 2002 and September 30,
2002, respectively. When other real estate is combined with non-performing
loans, the allowance equals 326% of non-performing assets at September 30, 2003
versus 239% and 176% at December 31, 2002 and September 30, 2002, respectively.
The increase in the allowance since year-end 2002 is primarily attributable to
the acquisition of CommonWealth and the application of risk factors specific to
this portfolio. The allowance attributable to the CommonWealth portfolio at the
date of acquisition was $1.6 million.
FCBI's allowance for loan loss activity for the nine and three month periods
ended September 30, 2003 and 2002 are as follows:
FOR THE NINE MONTHS ENDED FOR THE THREE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
2003 2002 2003 2002
------------ ------------ ------------ ------------
(DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS)
Beginning balance $ 14,410 $ 13,952 $ 15,708 $ 14,194
Provision 2,679 3,261 782 1,302
Common Wealth balance acquired 1,584 - - -
Charge-offs (4,100) (3,654) (991) (1,591)
Recoveries 1,107 521 181 175
------------ ------------ ----------- ------------
Ending Balance $ 15,680 $ 14,080 $ 15,680 $ 14,080
============ ============ =========== =============
Based on the allowance for loan losses of approximately $15.7 million and $14.1
million at September 30, 2003 and 2002, respectively, the allowance to loans
held for investment ratio was 1.53 at September 30, 2003 vs. 1.52 for September
30, 2002. Management considers the allowance adequate based upon its analysis of
the portfolio as of September 30, 2003.
The provision for loan losses for the nine and three month periods ended
September 30, 2003 decreased $582,000 and $520,000, respectively, when compared
to the nine month and three month periods ending September 30, 2002. In both
instances, the decrease is largely attributable to improving asset quality and
loan loss history, changes in risk factors assigned and a decline in volume
within certain portfolio segments. Net charge-offs for the first nine months of
2003 and the corresponding period of 2002 were $3 million and $3.l million,
respectively. Expressed as a percentage of average loans held for investment,
net charge-offs decreased from 0.34% for the nine-month period of 2002, to 0.31%
for the same period of 2003 due to the increase in average loans of $36.5
million. Net charge-offs for the third quarter 2003 were $810,000 vs. $1.4
million for the third quarter 2002.
24
NON-INTEREST INCOME
Non-interest income consists of all revenues which are not included in interest
and fee income related to earning assets. Total non-interest income increased
approximately $2.2 million, or 14.19%, from $15.8 million for the nine months
ended September 30, 2002 to $18.0 million for the corresponding period in 2003.
Gains on the sale of securities of $983,000 were the largest contributor to this
increase, almost entirely due to the sale of certain short-term equity
investments in the third quarter of 2003 held by the parent company.
Along with the increase in deposits, service charges on deposit accounts
increased $770,000, or 15.0% primarily as the result of the Company's overdraft
program that allows well-managed customer deposit accounts flexibility in
managing overdrafts to their accounts. In addition, other service charges,
commissions and fees increased $613,000 for the first nine months of 2003
compared to that of 2002. Fiduciary earnings representing asset management fees
on trust and agency accounts also increased $243,000 for the first nine months
of 2003 as a direct result of estate and trust management activity, including
the operations of Stone Capital acquired in January 2003. Other operating income
increased $299,000. Mortgage banking income is discussed in more detail below.
Total non-interest income of $5.1 million for the third quarter of 2003
increased only $88,000 compared to the third quarter of 2002. Service charges on
deposit accounts and other service charges, commissions and fees increased
$457,000 in aggregate. As mentioned in the year-to-date discussion, gain on sale
of securities increased $1.0 million for the third quarter of 2003 compared to
that of 2002 due to the sale of certain short-term equity investments and
fiduciary earnings increased $106,000. Other miscellaneous income increased
$240,000. Increases were noted in all sources of non-interest income for the
quarter with the exception of mortgage banking income as described below.
Mortgage banking income was $507,000 in the third quarter of 2003 vs. $2.2
million for the third quarter of 2002, a decrease of approximately $1.7 million.
This decline during the third quarter of 2003 was primarily due to a decline in
the gain on sale of loans of $5.3 million, an increase in income recognized on
settlement of hedging securities of $4.9 million, and a decline in the fair
value of the derivative instruments of $1.4 million. The reduction in third
quarter 2003 earnings stems from reduced margins in the mortgage banking segment
as a result of volatility in mortgage interest rates, intensified market
competition for origination volume, reduced pricing from national investors and
consumer uncertainty which led to a significant decrease in loan application
volume within the quarter.
While no assurance can be given as to the future direction of interest rates and
its impact in the market place, over recent weeks, mortgage rates have
stabilized and application volume has increased.
This third quarter 2003 decrease resulted in a year to date reduction in
mortgage banking income of $673,000 to $6.9 million for the nine months ended
September 30, 2003 versus $7.6 million for the nine months ended September 30,
2002. This decline in mortgage banking income for the nine months ended
September 30, 2003 over the same period in 2002 was primarily due to a decline
in the gain on sale of loans of $2.3 million, an increase in income recognized
on settlement of hedging securities of $3.4 million, an increase in other
mortgage banking revenue of $400,000 and a decline in the fair value of the
derivative instruments of $900,000.
UFM recognized losses on the sale of loans for the third quarter of 2003 of $1.1
million and income on hedging securities of $2.1 million. This contrasts with
the gains on loans recognized in the comparable quarter of the prior year of
$4.2 million and expense of hedging instruments of $3.8 million. On a
year-to-date basis, gains on the sale of loans of $6 million were recorded in
2003 vs. $8.3 million reported for the nine months ended September 30, 2002
while the expense associated with hedging for the current and prior year-to-date
periods were $1.2 million and $4.6 million, respectively. The decline in the
gain on sale of loans and the resulting increase in income recognized on the
settlement of securities in the third quarter 2003 were impacted significantly
by extreme fluctuations in mortgage and mortgage-backed security interest rates.
These fluctuations, in turn, prompted investors to reduce service premiums paid
on loans due to the likelihood of borrower refinancing potential, thus reducing
the investment value of the loan.
In addition, the third quarter of 2003 was impacted by extreme fluctuations in
pull-through (which are loan commitments extended that turn into loans) or in
contrast fallout percentage (loans that "fall out" as the loan customer opts not
to close) as mortgage rates increased over 100 basis points from a low in June
2003 of almost 4.50% to an average rate in August of 5.75%. This increase in
rates created a greater incentive for borrowers to close loans previously locked
at lower rates and thus resulted in loan sold volume for the quarter of $273
million compared to $178 million reported in the third quarter 2002.
Extreme fluctuations in interest rates also impacted the securities market for
hedging instruments. This volatility negatively impacted the net yield of the
combined margin upon subsequent sale and delivery of the loans and securities to
investors.
25
As noted above, mortgage banking income was also significantly impacted by the
change in the fair value of the loan commitments and securities during the third
quarter of 2003 and the nine months ended September 30, 2003. The impact of
marking the loan commitments and securities to market resulted in a reduction in
mortgage banking earnings during the third quarter of 2003 of $1.4 million and a
reduction for the nine months, since December 2002, of $900,000. The
year-to-date reduction occurred as the net fair value declined from $1.7 million
at year-end 2002 to $800,000 at September 30, 2003. The fair value of the loan
commitments declined by $927,000 and $271,000 during the nine months ended
September 30, 2003 and the third quarter of 2003, respectively, due to a
significant change in the volume as loan commitments declined from $120 million
at December 31, 2002 and $180 million at June 30, 2003 to $88.8 million at
September 30, 2003. In addition, the fair value of the hedging securities
increased by $117,000 during the nine months ended September 30, 2003 but
declined $1.1 million during the third quarter of 2003 due to a significant
change in price of the securities and a significant decline in the volume of
securities. Securities outstanding declined from $75 million at December 31,
2002 and $129 million at June 30, 2003 to $62 million at September 30, 2003.
NON-INTEREST EXPENSE
Non-interest expense totaled $35.1 million for the nine months ended September
30, 2003, increasing $3.8 million, or 12.2% over the corresponding period in
2002. This increase is primarily attributable to a $2.7 million increase in
salaries and benefits as a result of variable costs of increased loan production
by UFM, the addition of Greenville in late 2002, the addition of CommonWealth in
June 2003 as well as a general increase in salaries and benefits as staffing
needs at several locations were satisfied in order to support added corporate
services and continued branch growth, including three newly established branches
in Winston-Salem, North Carolina.
In the first nine months of 2003, occupancy expense increased by $373,000 when
compared to the first nine months of 2002. The general level of occupancy cost
grew partially as a result of the Greenville and CommonWealth acquisitions as
well as increases in depreciation and insurance costs associated with new
branches.
All other operating expense accounts increased $756,000 for the first nine
months of 2003 compared to the same period of 2002. Again, this increase was
largely attributable to the Monroe and CommonWealth acquisitions along with the
three denovo branches opened and under development in the second and third
quarters of 2003, as well as higher operating costs associated with UFM's loan
production.
Non-interest expense for the three months ended September 30, 2003 totaled $12.6
million, a $2.4 million increase over the $10.2 million for the quarter ended
September 30, 2002. The majority of this increase was a $1.4 million increase in
salaries and employee benefits which is partially attributable to the Greenville
and CommonWealth acquisitions, increases due to higher loan origination activity
of UFM in 2003 and a general increase in salaries along with the addition of
personnel Company-wide to support the continued growth of the Bank.
Occupancy and other operating expenses increased $123,000 and $719,000,
respectively, for the quarter ended September 30, 2003 compared to September 30,
2002. These additional expenses were associated with the recent acquisitions,
and new branches.
INCOME TAX
The effective income tax rate continues to benefit from the utilization of
tax-exempt municipal securities. Municipal securities, which have offered an
attractive tax equivalent yield, have assisted in countering the effect of the
declining interest rate environment. The Company's effective tax rate was 28.90%
for both the three and nine months ended September 30, 2003, respectively, and
30.34% and 29.60% for the three and nine months ended September 30, 2002.
26
FINANCIAL POSITION
SECURITIES
Securities held to maturity totaled $39.4 million at September 30, 2003, a
decrease of $1.6 million from December 31, 2002. This 3.9% decrease is the
result of maturities and calls within the portfolio during the first nine months
of 2003. The market value of investment securities held to maturity was 105.4%
and 105.7% of book value at September 30, 2003 and December 31, 2002,
respectively. Recent trends in interest rates have had a slight negative effect
on the underlying market value since December 31, 2002. Although it is
impossible to predict future market directions, recent increases in yields in
the bond market have eroded a portion of the gains and may suggest a longer-term
trend of higher bond interest rates.
Securities available for sale were $395.5 million at September 30, 2003 compared
to $300.9 million at December 31, 2002, an increase of $94.6 million. This
change reflects the purchase of $220.9 million in securities, $113.1 million in
maturities and calls, the sale of $8.3 million in securities, along with the
continuation of larger pay-downs on mortgage-backed securities and
Collateralized Mortgage Obligations ("CMO's") triggered by the low interest rate
environment. Securities available for sale are recorded at their estimated fair
market value. The unrealized gain or loss, which is the difference between
amortized cost and estimated market value, net of related deferred taxes, is
recognized in the stockholders' equity section of the balance sheet as either
accumulated other comprehensive income or loss. The unrealized gains after taxes
of $4.3 million at September 30, 2003, represent a decrease of $2.5 million from
the $6.8 million gain at December 31, 2002 due to market value decreases in the
first nine months of 2003. Although it is impossible to predict future market
direction, recent trends in the bond market suggest the possibility of an
erosion of some or all of these market gains.
Although substantial investment has been made in the available for sale security
portfolio, the Company has attempted to maintain a shorter portfolio duration
(the cash-weighted term to maturity of the portfolio) to reduce the sensitivity
of the bonds price to changes in interest rates and lessen interest rate risk.
The longer the duration, the greater the impact of changing market rates for
similar instruments. At September 30, 2003, the average estimated duration of
the investment portfolio was 3.5 years (reflective of currently anticipated
prepayments). This compares to 2.78 years at September 30, 2002. The approximate
9 month increase in average duration reflects the substantial amount of
portfolio replacement over the last twelve months and investment in longer-term
municipal securities.
LOAN PORTFOLIO
LOANS HELD FOR SALE: The relative size of the portfolio of loans originated by
the Company's mortgage brokerage division, UFM, and held for sale, was impacted
significantly by the refinancing activity that occurred during 2002 and
continues into 2003 as a result of the low interest rate environment. Loans held
for sale fluctuate on a daily basis reflecting retail originations, wholesale
purchases and sales to investors. At September 30, 2003, loans held for sale
were $16.7 million compared to $66.4 million at December 31, 2002. Average loans
held for sale (which is a better indicator of volume maintained) remained
relatively stable, increasing $2.2 million during the first nine months of 2003
compared to the first nine months of 2002.
LOANS HELD FOR INVESTMENT: Total loans held for investment increased $100.6
million from $927.6 million at December 31, 2002 to $1.03 billion at September
30, 2003. The increase is attributable to the CommonWealth acquisition
(approximately $131.2 million at June 30, 2003) net of several large payoffs
during the first nine months of 2003. Considering a $92.8 million increase in
deposits and the increase in loans during the first nine months of 2003, the
loan to deposit ratio increased slightly at September 30, 2003 compared to the
December 31, 2002 level. The loan to deposit ratio, using only loans held for
investment (excluding loans held for sale), was 83.4% on September 30, 2003,
81.4% on December 31, 2002 and 83.82% on September 30, 2002. Intense competition
for loans in the face of low interest rates and what appears to be slower loan
demand continue to impact this measure of loan production. Resulting liquidity
during the period has been reinvested in the available for sale securities
portfolio.
Average loans held for investment increased $36.5 million when comparing the
first nine months of 2003 to the same period of 2002. This increase includes
approximately $15.9 million in average loans acquired in the Monroe acquisition
in the fourth quarter of 2002 and $54.0 million in average loans from the
CommonWealth acquisition on June 6, 2003 net of the large commercial payoffs
mentioned earlier and regular amortization in 2003.
27
The held for investment loan portfolio continues to be diversified among loan
types and industry segments. The following table presents the various loan
categories and changes in composition as of September 30, 2003, December 31,
2002 and September 30, 2002.
LOAN PORTFOLIO OVERVIEW
(DOLLARS IN THOUSANDS)
SEPTEMBER 30, 2003 DECEMBER 31, 2002 SEPTEMBER 30, 2002
------------------------ ----------------------- ------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
----------- ----------- ----------- ---------- ----------- -----------
LOANS HELD FOR INVESTMENT:
Commercial and Agricultural $ 68,268 6.64% $ 74,186 8.00% $ 84,462 9.12%
Commercial Real Estate 325,524 31.67% 285,847 30.83% 282,944 30.55%
Residential Real Estate 416,189 40.48% 364,065 39.25% 358,185 38.66%
Construction 93,711 9.11% 72,275 7.79% 68,228 7.36%
Consumer 123,625 12.02% 130,522 14.07% 131,959 14.24%
Other 872 0.08% 726 0.08% 622 0.07%
----------- ----------- ----------- ---------- ----------- -----------
Total $ 1,028,189 100.00% $ 927,621 100.00% $ 926,400 100.00%
=========== =========== =========== ========== =========== ===========
LOANS HELD FOR SALE $ 16,689 $ 66,364 $ 68,821
=========== =========== ===========
NON-PERFORMING ASSETS
Non-performing assets include loans on non-accrual status, loans contractually
past due 90 days or more and still accruing interest and other real estate owned
("OREO"). Non-performing assets were $4.8 million at September 30, 2003, $6.0
million at December 31, 2002 and $8.0 million at September 30, 2002, or 0.5%,
0.6% and 0.9% of total loans and OREO, respectively. The following schedule
details non-performing assets by category at the close of each of the last five
quarters:
SEPTEMBER 30 JUNE 30 MARCH 31 DECEMBER 31 SEPTEMBER 30
(IN THOUSANDS OF DOLLARS) 2003 2003 2003 2002 2002
------------ ------------ ------------ ------------ ------------
Nonaccrual $ 2,277 $ 2,547 $ 3,997 $ 3,075 $ 4,987
Ninety Days Past Due 124 86 21 91 367
Other Real Estate Owned 2,403 2,787 2,544 2,855 2,668
------------ ------------ ------------ ------------ ------------
$ 4,804 $ 5,420 $ 6,562 $ 6,021 $ 8,022
============ ============ ============ ============ ============
Restructured loans
performing in accordance
with modified terms $ 362 $ 368 $ 341 $ 345 $ 347
============ ============ ============ ============ ============
At September 30, 2003, non-accrual loans decreased $270,000 from June 30, 2003,
while ninety day past due loans increased only $38,000. Ongoing activity within
the classification and categories of non-performing loans continues to include
collections on delinquencies, foreclosures and movements into or out of the
non-performing classification as a result of changing customer business
conditions. The $270,000 decrease in non-accrual loans during the third quarter
of 2003 is largely the result of non-accrual loans being paid, moved to a
current status as a result of improved performance, or being liquidated through
foreclosure or repossession. OREO decreased $384,000 during the third quarter of
2003 from June 30, 2003 as a result of property sales of $419,000 and
write-downs of $79,000. Other real estate owned is carried at the lesser of
estimated net realizable fair market value or cost.
The Company continues to monitor certain potential problem loans identified in
the first quarter of 2003. These loans presented characteristics of weakness and
concentrations of credit to one borrower. These two loans or groups of loans, to
separate borrowers warranted closer monitoring but continue to perform and
remain current. The first loan is a $12.7 million loan to a borrower within the
hospitality industry. The loan represents the retained portion of a $16.0
million total loan shared with a participating bank.
The second group of loans made to one borrower consisted of a $2.0 million loan
for land development in Eastern Virginia and another loan of approximately $5.0
million which is secured by land improved with an 18-hole golf
28
course and surrounding developable acreage in Northern Virginia. The $2.0
million loan was paid in full on November 7, 2003. The $5.0 million loan
continues to perform according to terms and remains current. Earlier in the
third quarter, the borrower made unscheduled principal reductions of $762,000
and funded $100,000 of advance interest payments on the group of loans.
There were no specific allocations of the allowance for loan losses for any of
the foregoing potential problem loans as of September 30, 2003. These loans were
appropriately considered in evaluating the adequacy of the allowance for loan
losses.
DEPOSITS AND OTHER BORROWINGS
Total deposits have grown $92.8 million or 8.14% since year-end 2002 as a result
of the acquisition of CommonWealth. Deposits in the acquired CommonWealth
branches at September 30, 2003 totaled $95.0 million. In terms of composition,
non-interest-bearing deposits increased $28.5 million or 17.2% while
interest-bearing deposits grew $64.3 million or 6.6% from December 31, 2002. The
relatively larger increase in non-interest bearing deposits reflects
approximately $27.7 million in balances within an escrow product offering by
CommonWealth to title insurance companies, attorneys and closing agents.
FCBI acquired an additional $17.5 million in borrowed funds from the FHLB with
the acquisition of CommonWealth and borrowed an additional $25 million from the
FHLB in June 2003. These increases together with a decrease due to the repayment
of a line of credit used to fund mortgages held by UFM brought the Company's
borrowings at September 30, 2003 to $136.3 million in convertible and callable
advances and $8.3 million of noncallable term advances from the FHLB of Atlanta.
For further discussion of FHLB borrowings, see Note 4 to the unaudited
consolidated financial statements included in this report. In addition, FCBI
issued trust preferred securities in September 2003 of $15.0 million which is
also included in the total borrowings of the Company.
STOCKHOLDERS' EQUITY
Total stockholders' equity reached $172.5 million at September 30, 2003,
increasing $20.0 million from the $152.5 million reported at December 31, 2002
through earnings of $19.9 million less dividends paid of $8.0 million, a
decrease in other comprehensive income of $2.4 million, increases of $244,000
and $13.3 million for the purchases of Stone Capital and CommonWealth,
respectively, a $634,000 increase due to stock option exercises and a net
decrease due to treasury share transactions of $3.6 million.
The Federal Reserve's risk based capital guidelines and leverage ratio measure
capital adequacy of banking institutions. Risk-based capital guidelines weight
balance sheet assets and off-balance sheet commitments based on inherent risks
associated with the respective asset types. At September 30, 2003, the Company's
total risk adjusted capital-to-asset ratio was 14.34% versus 13.33% at December
31, 2002. The Company's leverage ratio at September 30, 2003 was 8.6% compared
with 8.10% at December 31, 2002. Both the risk adjusted capital-to-asset ratio
and the leverage ratio exceed the current well-capitalized levels prescribed for
banks of 10% and 5%, respectively.
PART I. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a significant level of liquidity in the form of cash and
cash equivalent balances ($109.2 million), investment securities available for
sale ($395.5 million) and Federal Home Loan Bank credit availability of
approximately $356.8 million. Cash and cash equivalents as well as advances from
the Federal Home Loan Bank are immediately available for satisfaction of deposit
withdrawals, customer credit needs and operations of the Company. Investment
securities available for sale represent a secondary level of liquidity available
for conversion to liquid funds in the event of extraordinary needs. The Company
also maintains approved lines of credit with correspondent banks as backup
liquidity sources.
The Company maintains a liquidity policy as a means to manage the liquidity risk
process and associated risk. The policy includes a Liquidity Contingency Plan
that is designed as a tool for the Company to detect liquidity issues promptly
in order to protect depositors, creditors and shareholders. The Plan includes
monitoring various internal and external indicators such as changes in core
deposits and changes in market conditions. It provides for timely
29
responses to a wide variety of funding scenarios ranging from changes in loan
demand to a decline in the Company's quarterly earnings to a decline in the
market price of the Company's stock. The Plan calls for specific responses
designed to meet a wide range of liquidity needs based upon assessments on a
recurring basis by management and the Board of Directors.
INTEREST RATE RISK (IRR) AND ASSET/LIABILITY MANAGEMENT
While the Company continues to strive to decrease its dependence on net interest
income, the Bank's profitability is dependent to a large extent upon its ability
to manage its net interest margin. The Bank, like other financial institutions,
is subject to interest rate risk to the degree that its interest-earning assets
reprice differently than its interest-bearing liabilities. The Bank manages its
mix of assets and liabilities with the goals of limiting its exposure to
interest rate risk, ensuring adequate liquidity, and coordinating its sources
and uses of funds. Specific strategies for management of IRR have included
shortening the amortized maturity of fixed-rate loans and increasing the volume
of adjustable rate loans to reduce the average maturity of the Bank's
interest-earning assets.
The Bank seeks to control its IRR exposure to insulate net interest income and
net earnings from fluctuations in the general level of interest rates. To
measure its exposure to IRR, the Bank performs quarterly simulations using
financial models which project net interest income through a range of possible
interest rate environments including rising, declining, most likely, and flat
rate scenarios. The results of these simulations indicate the existence and
severity of IRR in each of those rate environments based upon the current
balance sheet position and assumptions as to changes in the volume and mix of
interest-earning assets and interest-paying liabilities and management's
estimate of yields attainable in those future rate environments and rates which
will be paid on various deposit instruments and borrowings.
The Company's risk profile continues to reflect a position that is asset
sensitive. The substantial level of prepayments and calls on loans and
securities are consistent with the low rate environment that prevailed over the
past year, as well as the success of deposit funding campaigns instituted have
led to a strong liquidity position as reflected in the level of cash reserves,
due from balances and fed funds sold of approximately $109.2 million. The
Company continues to reinvest the funds generated from asset paydowns and
prepayments within a framework that attempts to maintain an acceptable net
interest margin in the current interest rate environment. In addition, the
mortgage operations of UFM use investments commonly referred to as "forward"
transactions and "options" or derivatives to balance the risk inherent in
interest rate lock commitments made to prospective borrowers. The pipeline of
loans is hedged to mitigate unusual fluctuations in the cash flows derived upon
settlement of the loans with secondary market purchasers and, consequently, to
achieve a desired margin upon delivery. The hedge transactions are used for risk
mitigation and are not for trading purposes. The derivative financial
instruments represented by these hedging transactions are recorded at fair value
in the Consolidated Balance Sheets and the changes in fair value are reflected
in the Consolidated Statements of Income.
In addition, UFM utilizes mortgage derivative contracts as an interest rate risk
management tool to hedge against exposure to changing interest rates as loan
commitments are originated. A more complete discussion of loans held for sale,
derivative instruments and hedging activities and the underlying impact is
included within the Application of Critical Accounting Policies section of the
Management's Discussion and Analysis included herein. The Company's earnings
sensitivity measurements completed on a quarterly basis indicate that the
performance criteria, against which sensitivity is measured, are currently
within the Company's defined policy limits. A more complete discussion of the
overall interest rate risk is included in the Company's annual report for
December 31, 2002.
PART I. ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer along with the
Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to the
Securities Exchange Act of 1934 ("Exchange Act") Rule 13a-15(b). Based upon that
evaluation, the Company's Chief Executive Officer along with the Company's Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) required to be
included in the Company's periodic SEC filings. There have been no changes in
the Company's internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect the Company's internal
controls over financial reporting.
30
Disclosure controls and procedures are Company controls and other procedures
that are designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by the Company in the reports that it files under the
Exchange Act is accumulated and communicated to the Company's management,
including the Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is currently a defendant in various legal actions and asserted
claims involving lending and collection activities and other matters in the
normal course of business. While the Company and legal counsel are unable to
assess the ultimate outcome of each of these matters with certainty, they are of
the belief that the resolution of these actions should not have a material
adverse affect on the financial position of the Company.
In May 2003, UFM was sued by a former UFM employee alleging, among other things,
gender discrimination in connection with his dismissal. The Company and counsel
believe that the lawsuit, which seeks damages of $150,000 and punitive damages,
is without merit, and intends to vigorously defend this matter.
Item 2. Changes in Securities and Use of Proceeds
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31
EXHIBIT NO. EXHIBIT
- -------------------------------------------------------------------------------
2.1 Agreement and Plan of Merger dated as of January 27, 2003, and
amended as of February 25, 2003, among First Community Bancshares,
Inc., First Community Bank, National Association, and The
CommonWealth Bank. (1)
3(i) Articles of Incorporation of First Community Bancshares, Inc., as
amended. (2)
3(ii) Bylaws of First Community Bancshares, Inc., as amended. (2)
4.1 Specimen stock certificate of First Community Bancshares, Inc. (7)
4.2* Indenture Agreement dated September 25, 2003.
4.3* Amended and Restated Declaration of Trust of FCBI Capital Trust
dated September 25, 2003.
4.4* Preferred Securities Guarantee Agreement dated September 25, 2003.
10.1 First Community Bancshares, Inc. 1999 Stock Option Plan. (2)(3)
10.2 First Community Bancshares, Inc. 2001 Non-Qualified Directors Stock
Option Plan. (4)
10.3 Employment Agreement dated January 1, 2000 and amended October 17,
2000, between First Community Bancshares, Inc. and John M. Mendez.
(2)(5)
10.4 First Community Bancshares, Inc. 2000 Executive Retention Plan. (3)
10.5 First Community Bancshares, Inc. Split Dollar Plan and Agreement.
(3)
10.6 First Community Bancshares, Inc. 2001 Directors Supplemental
Retirement Plan. (2)
10.7 First Community Bancshares, Inc. Wrap Plan. (7)
10.8 Employment Agreement between First Community Bancshares, Inc. and
J. E. Causey Davis. (8)
11.0 Statement regarding computation of earnings per share. (6)
15.0* Letter regarding unaudited interim financial information.
31.1* Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act
31.2* Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act
32* Certification of Chief Executive and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act
* Furnished herewith.
(1) Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Form 8-K filed with the Commission on January 28,
2003 and February 26, 2003.
(2) Incorporated by reference from the Quarterly Report on Form 10-Q for
the period ended June 30, 2002 filed on August 14, 2002.
(3) Incorporated by reference from the Annual Report on Form 10-K for the
period ended December 31, 1999 filed on March 30, 2000 as amended April
13, 2000.
(4) The options agreements entered into pursuant to the 1999 Stock Option
Plan and the 2001 Non-Qualified Directors Stock Option Plan are
incorporated by reference from the Quarterly Report on Form 10-Q for
the period ended June 30, 2002 filed on August 14, 2002.
(5) First Community Bancshares, Inc. has entered into substantially
identical agreements with Messrs. Buzzo and Lilly, with the only
differences being with respect to titles, salary and the use of a
vehicle.
(6) Incorporated by reference from Footnote 9 of the Notes to Consolidated
Financial Statements included herein.
(7) Incorporated by reference from the Annual Report on Form 10-K for the
period ended December 31, 2002 filed on March 25, 2003 as amended on
March 31, 2003.
32
(8) Incorporated by reference from S-4 Registration Statement filed on
March 28, 2003.
(b) Reports on Form 8-K
A report on Form 8-K was filed on July 24, 2003 announcing the
Company's second quarter 2003 earnings, depicting certain financial
information as of June 30, 2003 and comparative income statements for
the three and six months ended June 30, 2003 and 2002, respectively.
A report on Form 8-K was filed on September 5, 2003 announcing the
declaration of the Company's third quarter dividend of $0.25 per share
payable on or about September 30, 2003 to stockholders of record on
September 19, 2003.
A report on Form 8-K was filed on September 12, 2003 announcing the
Company's inclusion in the U. S. BANKER as a Top 100 Publicly Traded
Mid-Tier Bank.
A report on Form 8-K was filed on September 12, 2003 containing
Management's September 12, 2003 presentation to Trident Securities.
A report on Form 8-K was filed on September 25, 2003 containing
Management's announcement of the completion of a $15 million capital
trust offering.
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
First Community Bancshares, Inc.
DATE: November 10, 2003
/s/ John M. Mendez
- --------------------------------------
John M. Mendez
President & Chief Executive Officer
(Duly Authorized Officer)
DATE: November 10, 2003
/s/ Robert L. Schumacher
- --------------------------------------
Robert L. Schumacher
Chief Financial Officer
(Principal Accounting Officer)
34
Index to Exhibits
Exhibit No.
4.2 Indenture Agreement dated September 25, 2003.
4.3 Amended and Restated Declaration of Trust of FCBI Capital Trust dated
September 25, 2003.
4.4 Preferred Securities Guarantee Agreement dated September 25, 2003.
15 Letter regarding unaudited interim financial information
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act
32 Certification of Chief Executive and Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act
35