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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2002
[ ] Transition Report under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ____________ to _____________
Commission file number: 0-24159
MIDDLEBURG FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Virginia 54-1696103
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
111 West Washington Street
Middleburg, Virginia 20117
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (703) 777-6327
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Exchange Act during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------- -------
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
1,852,682 shares of common stock, par value $5.00 per share,
outstanding as of August 14, 2002
MIDDLEBURG FINANCIAL CORPORATION
INDEX
Part I. Financial Information Page No.
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Changes in Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
Part II. Other Information
Item 1. Legal Proceedings 18
Item 2. Change in Securities and Use of Proceeds 18
Item 3. Defaults upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
2
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Balance Sheets
(In Thousands, Except Share Data)
(Unaudited)
June 30, December 31,
2002 2001
--------------- ------------------
Assets:
Cash and due from banks $10,456 10,053
Interest-bearing balances in banks 258 200
Temporary investments:
Federal funds sold - 925
Other money market investments 1,802 1,797
Securities (fair value: June 30, 2002,
$141,208 , December 31, 2001, $124,522 ) 140,966 124,351
Loans held for sale 6,953 6,652
Loans, net of allowances for loan losses of
$2,202 in 2002 and $2,060 in 2001 210,010 194,340
Bank premises and equipment, net 10,357 8,069
Other assets 13,288 7,714
----------- -----------
Total assets $ 394,090 $ 354,101
=========== ===========
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Non-interest bearing demand deposits $ 75,603 $ 68,771
Savings and interest-bearing demand deposits 124,568 111,148
Time deposits 94,480 91,812
---------- -----------
Total deposits $ 294,651 $ 271,731
Securities sold under agreements to
repurchase $ 13,398 $ 12,011
Federal funds purchased 1,100 -
Federal Home Loan Bank Advances 3,000 7,000
Long-term debt 31,675 20,805
Trust preferred debt 10,000 10,000
Other liabilities 3,492 2,216
---------- ----------
Total liabilities $ 357,316 $ 323,763
---------- ----------
Shareholders' Equity
Common stock par value $5.00 per
share, authorized 10,000,000 shares;
issued and outstanding at June 30, 2002 -
1,846,607
issued and outstanding at December 31, 2001 -
$1,752,258 $ 9,233 $ 8,761
Capital surplus 3,359 741
Retained earnings 23,196 21,084
Accumulated other comprehensive income (loss) 986 (248)
---------- ---------
Total shareholders' equity $ 36,774 $ 30,338
---------- ---------
Total liabilities and shareholders' equity $ 394,090 $ 354,101
========== =========
See Accompanying Notes to Consolidated Financial Statements.
3
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Income
(In Thousands, Except Per Share Data)
Unaudited Unaudited
-------------------------------------------
For the Six Months For the Quarter
Ended June 30, Ended June 30,
2002 2001 2002 2001
-------------------------------------------
Interest Income
Interest and fees on loans $ 8,022 $ 8,048 $ 4,043 $ 4,072
Interest on investment securities
Taxable 2 12 1 6
Exempt from federal income taxes 125 154 59 74
Interest on securities available for
sale
Taxable 2,608 1,373 1,374 685
Exempt from federal income taxes 792 792 393 411
Dividends 140 143 69 72
Interest on federal funds sold and
other 47 132 24 85
--------------------- --------------------
Total interest income $11,736 $10,654 $ 5,963 $ 5,405
--------------------- --------------------
Interest expense
Interest on deposits 2,169 3,040 1,069 1,519
Interest on long-term debt 980 465 544 221
Interest on short-term borrowings 141 606 60 242
--------------------- --------------------
Total interest expense $ 3,290 $ 4,111 $ 1,673 $ 1,982
--------------------- --------------------
Net interest income $ 8,446 $ 6,543 $ 4,290 $ 3,423
Provision for loan losses 150 150 75 75
--------------------- --------------------
Net interest income after
provision for loan losses $ 8,296 $ 6,393 $ 4,215 $ 3,348
--------------------- --------------------
Other Income
Trust fee income $ 1,138 $ 657 $ 819 $ 299
Service charges on deposit accounts 822 711 471 399
Net gains (losses) on securities
available for sale (47) 246 33 (6)
Fees on loans held for resale 746 574 403 275
Other operating income 293 322 122 123
--------------------- --------------------
Total other income $ 2,952 $ 2,510 $ 1,848 $ 1,090
--------------------- --------------------
Other Expense
Advertising $ 238 $ 170 $ 140 $ 101
Salaries and employee benefits 4,131 3,428 2,188 1,688
Net occupancy expense of premises 750 581 404 308
Other operating expenses 1,721 1,392 980 733
--------------------- --------------------
Total other expense $ 6,840 $ 5,571 $ 3,712 $ 2,830
--------------------- --------------------
Income before income taxes $ 4,408 $ 3,332 $ 2,351 $ 1,608
Income taxes 1,208 841 665 409
--------------------- --------------------
Net income 3,200 2,491 1,686 1,199
===================== ====================
Earnings per share, basic $ 1.79 $ 1.43 $ 0.92 $ 0.69
Earnings per share, diluted $ 1.74 $ 1.40 $ 0.90 $ 0.67
Dividends per share $ 0.60 $ 0.50 $ 0.30 $ 0.25
See Accompanying Notes to Consolidated Financial Statements.
4
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statement of Changes in Shareholders' Equity
For the Six Months ended June 30, 2002 and 2001
(In Thousands)
(Unaudited)
Accumulated
Other
Common Capital Retained Comprehensive Comprehensive
Stock Surplus Earnings Income (Loss) Income Total
------------ --------------------------- ----------------------------------- -----------
Balances - December 31, 2000 $ 8,696 $ 556 $ 17,616 $ 403 $ - $ 27,271
Comprehensive Income
Net income 2,491 - 2,491 2,491
Issuance of common stock (13,011 shares) 65 185 250
Other comprehensive income
net of tax:
Unrealized gain on available for
sale securities (net of tax $36) 69
Reclassification adjustment for
gains realized in net income (net of tax $84) (162)
-------------
Other comprehensive income (net of tax $48) (93) (93) (93)
-------------
Total comprehensive income $ 2,398
=============
Cash dividends declared (873) (873)
---------- ----------- ----------- -------------- -----------
Balances - June 30, 2001 $ 8,761 $ 741 $ 19,234 $ 310 $ 29,046
========== =========== =========== ============== ===========
Balances - December 31, 2001 $ 8,761 $ 741 $ 21,084 $ (248) $ 30,338
Comprehensive Income
Net income 3,200 3,200 3,200
Issuance of common stock (94,349 shares) 472 2,618 3,090
Other comprehensive income net of tax:
Unrealized gain on available for sale
securities (net of tax $620) 1,203
Reclassification adjustment for
losses realized in net income (net of
tax $16) 31
------------
Other comprehensive income (net of tax
$636) 1,234 1,234 1,234
------------
Total comprehensive income $ 4,434
============
Cash dividends declared (1,088) (1,088)
---------- ----------- ----------- -------------- -----------
Balances -June 30, 2002 $ 9,233 $ 3,359 $ 23,196 $ 986 $ 36,774
============ =========================== ================== ===========
See Accompanying Notes to Consolidated Financial Statements.
5
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(In Thousands)
Unaudited
For the Six Months Ended
------------------------------------
June 30, June 30,
2002 2001
-------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 3,200 $ 2,491
Adjustments to reconcile net income to net cash provided by (used in)
operating activities
Provision for loan losses 150 150
Depreciation and amortization 512 368
Net (gains) losses on securities available for sale 47 (246)
Net (gains) losses on sales of equipment (3) 3
Discount accretion and premium amortization on securities, net (46) (51)
Originations of loans held for sale (47,518) (36,819)
Proceeds from sales of loans held for sale 47,217 30,282
Decrease (increase) in other assets (1,616) (1,216)
Increase in other liabilities 1,319 586
-------------- ---------------
Net cash provided by (used in) operating activities $ 3,262 $ (4,452)
-------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity, principal paydowns and calls on investment securities $ 896 $ 797
Proceeds from maturity, principal paydowns and
calls of securities available for sale 6,211 3,614
Proceeds from sale of securities available for sale 14,757 16,383
Purchase of securities available for sale (36,612) (29,048)
Purchase of subsidiary (1,240) -
Net (increase) in loans (16,820) (10,586)
Proceeds from sale of bank premises and equipment 20 31
Purchases of bank premises and equipment (2,712) (690)
-------------- ---------------
Net cash (used in) investing activities $ (35,500) $ (19,499)
-------------- ---------------
CASH FLOWS FROM FINANCING ACTIVTIES
Net increase in demand deposits, NOW accounts, and savings accounts $ 20,252 $ 9,333
Net increase in certificates of deposits 2,668 4,042
Net increase in Fed Funds purchased 1,100 -
Proceeds from Federal Home Loan Bank advances 62,000 26,600
Payment on Federal Home Loan Bank advances (66,000) (22,600)
Proceeds from long term debt 11,000 -
Payments on long-term debt (130) (365)
Cash dividends paid (1,088) (800)
Issuance of common stock 590 250
Increase (decrease) in securities sold under agreement to repurchase 1,387 (1,201)
-------------- ---------------
Net cash provided by financing activities $ 31,779 $ 15,259
-------------- ---------------
Decrease in cash and cash equivalents $ (459) $ (8,692)
CASH AND CASH EQUIVALENTS
Beginning $ 12,975 $ 17,147
============== ===============
Ending $ 12,516 8,455
============== ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest paid to depositors 2,604 3,073
Income taxes 1,207 1,069
SUPPLEMENTAL DISCLOSURES FOR NON-CASH
INVESTING AND FINANCING ACTIVITIES
Unrealized gain (losses) on securities available for sale 1,868 (141)
Stock issuance for purchase of subsidiary 2,500 -
Note receivable forgiven in connection with purchase of subsidiary 1,000 -
Exercise of option to purchase subsidiary 1,200
See Accompanying Notes to Consolidated Financial Statements.
6
MIDDLEBURG FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
For the Six Months Ended June 30, 2002 and 2001
(Unaudited)
Note 1.
In the opinion of management, the accompanying unaudited financial
statements contain all adjustments (consisting of only normal recurring
accruals) necessary to present fairly the financial position as of June 30, 2002
and the results of operations and changes in cash flows for the six months ended
June 30, 2002 and 2001. The statements should be read in conjunction with the
Notes to Consolidated Financial Statements included in the Company's Annual
Report on Form 10-KSB for the year ended December 31, 2001. The results of
operations for the six-month periods ended June 30, 2002 and 2001 are not
necessarily indicative of the results to be expected for the full year.
Note 2. Securities
Securities being held to maturity as of June 30, 2002 are summarized as
follows:
------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains (Losses) Value
------------------------------------------------------------
(In Thousands)
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ - $ - $ - $ -
Obligations of states and
political subdivisions 4,592 242 - 4,834
Mortgaged backed securities 55 - - 55
----------------- --------------- ------------- -----------
$ 4,647 $ 242 $ - $ 55
================= =============== ============= ===========
7
Securities available for sale as of June 30, 2002 are summarized below:
------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains (Losses) Value
------------------------------------------------------------
(In Thousands)
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ 249 $ 21 $ - $ 270
Corporate securities 2,131 84 (35) 2,180
Obligations of states and
political subdivisions 31,495 885 (52) 32,328
Mortgaged backed securities 87,435 947 (161) 88,221
Other 13,508 162 (350) 13,320
-------------- ---------------- ------------- -----------
$134,818 $ 2,099 $ (598) $ 136,319
============== ================ ============= ============
Note 3.
The consolidated loan portfolio is composed of the following:
------------------------------------
June 30, December 31,
2002 2001
------------------------------------
(In Thousands)
Commercial, financial and agricultural $ 22,839 $ 22,993
Real estate construction 25,850 24,174
Real estate mortgage 151,050 137,332
Installment loans to individuals 12,473 11,901
------------------ -----------------
Total loans $ 212,212 $ 196,400
Less: Allowance for loan losses 2,202 2,060
------------------ -----------------
Loans, net $ 210,010 $ 194,340
================== =================
The Company had $137,051 in non-performing assets at June 30, 2002.
8
Note 4. Allowance for Loan Losses
The following is a summary of transactions in the allowance for loan
losses:
---------------------------------
June 30, December 31,
2002 2001
---------------------------------
---------------------------------
(In Thousands)
Balance at January 1 $ 2,060 $ 1,804
Provision charged to operating expense 150 300
Recoveries 6 39
Loan losses (14) (83)
---------------- ----------------
Balance at the end of the period $ 2,202 $ 2,060
================ ================
Note 5. Earnings Per Share
The following table shows the weighted average number of shares used in
computing earnings per share and the effect on the weighted average number of
shares of potential dilutive common stock. Potential dilutive common stock has
no effect on income available to common shareholders. There were no
anti-dilutive effects from options at June 30, 2002.
June 30, 2002 June 30, 2001
Per share Per share
Shares Amount Shares Amount
------------------------------------------------------
Basic EPS $ 1,788,771 $ 1.79 $ 1,739,890 $ 1.43
============= ============
Effect of dilutive
securities:
stock options 51,068 34,023
------------- -------------
Diluted EPS $ 1,839,839 $ 1.74 $1,773,914 $ 1.40
============= ============= ============= ============
Note 6. Derivative Financial Instruments
Interest rate swap agreements:
During May 2000, the Company entered into two agreements to assume
variable market-indexed interest payments in exchange for fixed-rate interest
payments (interest rate swaps). The agreements matured on May 15, 2002. The
notional principal amount of interest rate swaps outstanding during the contract
period was $8,525,000. The original term to maturity was 24 months. The
weighted-average fixed payment rate was 7.0% during the life of the agreement
period. Variable interest payments received are based on three-month LIBOR. At
May 15, 2002, the weighted average rate of variable market-indexed interest
payment obligations to the Company was 1.56%. The effect of these agreements was
to transform fixed rate liabilities to variable rate liabilities. The net income
from these agreements was $169,774 for the six month period ended June 30, 2002,
which was charged to income as it accrued.
9
Note 7. Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued two
statements - Statement 141, Business Combinations, and Statement 142, Goodwill
and Other Intangible Assets - that will potentially impact the accounting for
goodwill and other intangible assets. Statement 141 eliminates the pooling
method of accounting for business combinations and requires that intangible
assets that meet certain criteria be reported separately from goodwill. The
Statement also requires negative goodwill arising from a business combination to
be recorded as an extraordinary gain. Statement 142 eliminates the amortization
of goodwill and other intangibles that are determined to have an indefinite
life. The Statement requires, at a minimum, annual impairment tests for goodwill
and other intangible assets that are determined to have an indefinite life.
Upon adoption of these Statements, an organization is required to
re-evaluate goodwill and other intangible assets that arose from business
combinations entered into before July 1, 2001. If the recorded other intangible
assets do not meet the criteria for recognition, they should be classified as
goodwill. Similarly, if there are other intangible assets that meet criteria for
recognition but were not separately recorded from goodwill, they should be
reclassified from goodwill. An organization also must reassess the useful lives
of intangible assets and adjust the remaining amortization periods accordingly.
Any negative goodwill must be written-off.
The standards generally are required to be implemented by the Company
in its 2002 financial statements. The adoption of these standards will not have
a material impact on the financial statements.
Note 8. Acquisition of Subsidiary
On August 9, 1999, the Company purchased one percent of the issued and
outstanding capital stock of Gilkison Patterson Investment Advisors, Inc.
("GPIA"), an investment advisory firm based in Alexandria, Virginia. The Company
also acquired the right to purchase all of the remaining authorized, issued and
outstanding shares of GPIA capital stock on or after July 1, 2001. This option
was extended through June 30, 2002. On April 1, 2002, the Company completed the
acquisition of GPIA. The terms of the transaction include a total purchase price
of $6 million, which included 59,874 shares ($2.5 million value) of the
Company's common stock issued to the shareholders of GPIA. Based on a purchase
price valuation, the Company allocated approximately 60% of the purchase price
to identified intangibles with a weighted-average life of 12.5 years. The
remaining 40% of the purchase price has been treated as goodwill.
10
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Critical Accounting Policies
The financial condition and results of operations presented in the
Consolidated Financial Statements, accompanying Notes to the Consolidated
Financial Statements and management's discussion and analysis are, to a large
degree, dependent upon the accounting policies of Middleburg Financial
Corporation (the "Company"). The selection and application of these accounting
policies involve judgments, estimates, and uncertainties that are susceptible to
change.
Presented below is discussion of those accounting policies that
management believes are the most important (Critical Accounting Policies) to the
portrayal and understanding of the Company's financial condition and results of
operations. These Critical Accounting Policies require management's most
difficult, subjective and complex judgments about matters that are inherently
uncertain. In the event that different assumptions or conditions were to
prevail, and depending upon the severity of such changes, the possibility of
materially different financial condition or results of operations is a
reasonable likelihood. See also Note 1 of the Notes to Consolidated Financial
Statements.
Allowance for Loan Losses
The Company monitors and maintains an allowance for loan losses to
absorb an estimate of probable losses inherent in the loan and lease portfolio.
The Company maintains policies and procedures that address the systems of
controls over the following areas of maintenance of the allowance: the
systematic methodology used to determine the appropriate level of the allowance
to provide assurance they are maintained in accordance with accounting
principles generally accepted in the United States of America; the accounting
policies for loan charge-offs and recoveries; the assessment and measurement of
impairment in the loan and lease portfolio; and the loan grading system.
The Company evaluates various loans individually for impairment as
required by Statement of Financial Accounting Standard (SFAS) No. 114,
Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting
by Creditors for Impairment of a Loan - Income Recognition and Disclosures.
Loans evaluated individually for impairment include non-performing loans, such
as loans on non-accrual, loans past due by 90 days or more, restructured loans
and other loans selected by management. The evaluations are based upon
discounted expected cash flows or collateral valuations. If the evaluation shows
that a loan is individually impaired, then a specific reserve is established for
the amount of impairment. If a loan evaluated individually is not impaired, then
the loan is assessed for impairment under SFAS No. 5, Accounting for
Contingencies (SFAS 5), with a group of loans that have similar characteristics.
For loans without individual measures of impairment, the Company makes
estimates of losses for groups of loans as required by SFAS 5. Loans are grouped
by similar characteristics, including the type of loan, the assigned loan grade
and the general collateral type. A loss rate reflecting the expected loss
inherent in a group of loans is derived based upon estimates of default rates
for a given loan grade, the predominant collateral type for the group and the
terms of the loan. The resulting estimate of losses for groups of loans are
adjusted for relevant environmental factors and other conditions of the
portfolio of loans and leases, including: borrower and industry concentrations;
levels and trends in delinquencies, charge-offs and recoveries; changes in
underwriting standards and risk selection; level of experience, ability and
depth of lending management; and national and local economic conditions.
11
The amount of estimated impairment for individually evaluated loans and
groups of loans is added together for a total estimate of loans and lease
losses. This estimate of losses is compared to the allowance for loan and lease
losses of the Company as of the evaluation date and, if the estimate of losses
is greater than the allowance, an additional provision to the allowance would be
made. If the estimate of losses is less than the allowance, the degree to which
the allowance exceeds the estimate is evaluated to determine whether the
allowance falls outside a range of estimates. If the estimate of losses is below
the range of reasonable estimates, the allowance would be reduced by way of a
credit to the provision for loan losses. The Company recognizes the inherent
imprecision in estimates of losses due to various uncertainties and variability
related to the factors used, and therefore a reasonable range around the
estimate of losses is derived and used to ascertain whether the allowance is too
high. If different assumptions or conditions were to prevail and it is
determined that the allowance is not adequate to absorb the new estimate of
probable losses, an additional provision for loan losses would be made, which
amount may be material to the Consolidated Financial Statements.
Valuation of Derivatives
The Company maintains an overall interest rate risk management strategy
that incorporates the use of derivative financial instruments. The Company has
used derivative financial instruments only for asset/liability management
through the hedging of a specific transaction or position, and not for trading
or speculative purposes.
Management believes that the risk associated with using derivative
financial instruments to mitigate interest rate risk sensitivity is minimal and
should not have any material unintended impact on the Company's financial
condition or results of operations. See further information regarding
derivatives in Note 6 (page 9) of the Notes to Consolidated Financial
Statements.
Intangibles and Goodwill
The Company has approximately $7.1 million in intangible assets and
goodwill at June 30, 2002, an increase of $6.1 million since December 31, 2001.
The increase is associated with the April 1, 2002 acquisition of Gilkison
Patterson Investment Advisors, Inc. ("GPIA"), a registered investment advisor.
In connection with this investment, a purchase price valuation (using FAS 141
and 142 as a guideline) was completed to determine the appropriate allocation to
identified intangibles. The valuation concluded that approximately 42% of the
purchase price was related to the acquisition of customer relationships with an
amortizable life of 15 years. Another 19% of the purchase price was allocated to
a non-compete agreement with an amortizable life of 7 years. The remainder of
the purchase price has been allocated to goodwill.
The purchase price allocation process requires management estimates and
judgment as to expectations for the life span of various customer relationships
as well as the value that key members of management add to the success of the
Company. For example, customer attrition rates were determined based upon
assumptions that the past five years may predict the future. If the actual
attrition rates, among other assumptions, differed from the estimates and
judgments used in the purchase price allocation, the amounts recorded in the
financial statements could result in a possible impairment of the intangible
assets and goodwill or require an acceleration in the amortization expense.
In addition, FAS 142 requires that goodwill be tested annually using a
two-step process. The first step is to identify a potential impairment. The
second step measures the amount of the impairment loss, if any. Processes and
procedures have been identified for the two-step process.
12
When the Company completes its ongoing review of the recoverability of
intangible assets and goodwill, factors that are considered important to
determining whether an impairment might exist include loss of customers acquired
or significant withdrawals of the assets currently under management and/or early
retirement or termination of key members of management. Any changes in the key
management estimates or judgments could result in an impairment charge, and such
a charge could have an adverse effect on the Company's financial condition and
results of operations.
Financial Summary
Net income for the six months ended June 30, 2002 increased 28.5% to
$3.2 million or $1.74 per diluted share compared to $2.5 million or $1.40 per
diluted share for the first six months of 2001. Annualized returns on average
assets and equity for the six months ended June 30, 2002 were 1.7% and 19.1%,
respectively, compared to 1.6% and 17.1% for the same period in 2001.
Total assets for the Company increased to $394.1 million at June 30,
2002 compared to $354.1 million at December 31, 2001, representing an increase
of $40.0 million or 11.3%. Total loans at June 30, 2002 were $210.0 million, an
increase of $15.7 million from the December 31, 2001 balance of $194.3 million.
The Company is located in one of the fastest growing counties and metropolitan
areas in the United States. In addition, the Company has increased its customer
base as a result of increased advertising and consolidation in the banking
industry within its local market. These factors have contributed to the solid
loan and deposit growth experienced over the past year.
To better accommodate the Company's expanding employee base, a two
story, 19,000 square foot operations center was constructed and was placed in
service during June 2002. Nearly half of the Company's employees are now working
in the operations center. In addition to the operations and administrative
staff, the center also houses the Company's mortgage banking operations. The
facility is adjacent to the Company's Leesburg, Virginia branch. Approximately
$2.5 million was spent on the land and construction of the operations center.
The investment portfolio increased 13.4% to $141.0 million at June 30,
2002 compared to $124.4 million at December 31, 2001. Deposits increased $22.9
million to $294.7 million at June 30, 2002 from $271.7 million at December 31,
2001. Growth in the transactional accounts and time deposits accounts for $20.3
million and $2.6 million, respectively, of the increase during the first six
months of 2002. Securities sold under agreements to repurchase with commercial
checking accounts increased $1.4 million from $12.0 million at December 31, 2001
to $13.4 million at June 30, 2002.
Shareholders' equity was $36.8 million at June 30, 2002. This amount
represents an increase of 21.2% from the December 31, 2001 balance of $30.3
million. The majority of the increase resulted from the shares of common stock
issued by the Company for the acquisition of GPIA on April 1, 2002. The company
issued 59,874 shares of common stock for the acquisition. The book value per
common share was $19.91 at June 30, 2002 and $17.31 at December 31, 2001.
Net Interest Income
Net interest income is the Company's primary source of earnings and
represents the difference between interest and fees earned on earning assets and
the interest expense paid on deposits and other interest bearing liabilities.
Net interest income totaled $8.4 million for the first six months of 2002
compared to $6.5 million for the same period in 2001. The increase is attributed
to both the significant growth in average earning assets as well as the effect
that the lower interest rate environment had on the amount of interest expense
paid on deposits. Average earning assets increased $69.2 million from $277.0
million at June 30, 2001 to $346.2 million at June 30, 2002. Accordingly,
interest income increased
13
10.2% compared to the six month period ended June 30 , 2001. The Company
continues to experience growth in its lower-cost deposit products. Average
deposits increased $54.3 from $229.0 million at June 30, 2001. Increases in
lower cost deposit products combined with the lower interest rate environment
resulted in a 20.0% decrease in interest expense for the six months ended June
30, 2002 compared to the same period in 2001.
Noninterest Income
Noninterest income consisting of fees from deposit accounts, fiduciary
activities and mortgage banking increased 17.6% to $3.0 million for the first
six months of 2002 compared to $2.5 million for the same period in 2001. The
Company realized $47,000 in net losses on the investment portfolio for the six
months ended June 30, 2002. Mortgage refinancings and purchases have remained
strong in the local market and have provided significant volume increases in
mortgage fees on loans held for sale. Fees on loans held for resale increased
30.0% to $746,000 at June 30, 2002 from the $574,000 balance at June 30, 2001.
Service charges on deposit accounts for the first six months of 2002 totaled
$822,000 compared to $711,000 for the same period in 2001, an increase of 15.6%.
Commissions and fees from fiduciary activities were $1.1 million for the
six-month period ended June 30, 2002 compared to $657,000 for the same period in
2001. GPIA, the Company's newest subsidiary, contributed nearly $502,000 in
gross fees to the commission and fees from fiduciary activities total. Other
operating income decreased $29,000 to $293,000 for the six months ended June 30,
2002 compared to $322,000 for the same period in 2001.
Noninterest Expense
Total noninterest expense includes employee-related costs, occupancy
and equipment expense and other overhead. Total noninterest expense was $6.8
million for the first six months of 2002 compared to $5.6 million for the same
period in 2001. This is a 22.8% increase from the six months ended June 30, 2001
to the six months ended June 30, 2002. Salary and benefit expense increased
20.5% from $3.4 million for the six months ended June 30, 2001 to $4.1 million
for the six months ended June 30, 2002. The Company has increased its staffing
in both the business development and operations areas to support the significant
asset growth over the past three years. Commissions paid to employees for fee
related business, such as mortgage originations and investment sales have
increased by $65,000 to $402,000 as a result in the increase in sales volume.
Net occupancy expense of premises increased $169,000 from $581,000 for the six
months ended June 30, 2001 to $750,000 for the six months ended June 30, 2002.
Allowance for Loan Losses
The allowance for loan losses at June 30, 2002 was $2.2 million
compared to $1.9 million at June 30, 2001. The provision for loan losses was
unchanged at $150,000 for the six months ended June 30, 2002, and June 30, 2001.
The allowance for loan losses was 1.04% of total loans outstanding at June 30,
2002 and 1.03% of total loans outstanding at June 30, 2001. At June 30, 2002,
net loan charge offs totaled $8,000. Total loans past due 90 days or more at
June 30, 2002 were approximately $92,000. Non-performing loans decreased to .07%
of total loans outstanding at June 30, 2002 compared to .08% at June 30, 2001.
Management believes that the allowance for loan losses is adequate to cover
credit losses inherent in the loan portfolio at June 30, 2002. Loans classified
as loss, doubtful, substandard or special mention are adequately reserved for
and are not expected to have a material impact beyond what has been reserved.
14
Capital Resources
Shareholders' equity at June 30, 2002 and June 30, 2001 was $36.8
million and $29.0 million, respectively. Total common shares outstanding at June
30, 2002 were 1,846,607.
At June 30, 2002 the Company's tier 1 and total risk-based capital
ratios were 15.8% and 14.9%, respectively, compared to 16.4% and 17.3% at
December 31, 2001. The Company's leverage ratio was 10.0% at June 30, 2002
compared to 12.5% at December 31, 2001. The Company's capital structure places
it above the regulatory guidelines, which affords the Company the opportunity to
take advantage of business opportunities while ensuring that it has the
resources to protect against risk inherent in its business.
Forward-Looking Statements
Certain information contained in this discussion may include
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements are generally identified by phrases
such as "the Company expects," "the Company believes" or words of similar
import. Such forward-looking statements involve known and unknown risks
including, but not limited to, changes in general economic and business
conditions, interest rate fluctuations, competition within and from outside the
banking industry, new products and services in the banking industry, risk
inherent in making loans such as repayment risks and fluctuating collateral
values, problems with technology utilized by the Company, changing trends in
customer profiles and changes in laws and regulations applicable to the Company.
Although the Company believes that its expectations with respect to the
forward-looking statements are based upon reliable assumptions within the bounds
of its knowledge of its business and operations, there can be no assurance that
actual results, performance or achievements of the Company will not differ
materially from any future results, performance or achievements expressed or
implied by such forward-looking statements.
15
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Market and Interest Rate Risk
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market rates or prices such as interest rates, foreign
currency exchange rates, commodity prices and equity prices. The Company's
primary market risk exposure is interest rate risk, though it should be noted
that the assets under management by its trust subsidiary, Tredegar Trust
Company, are affected by equity price risk. The ongoing monitoring and
management of this risk is an important component of the Company's
asset/liability management process, which is governed by policies established by
its Board of Directors that are reviewed and approved annually. The Board of
Directors delegates responsibility for carrying out asset/liability management
policies to the Asset/Liability Committee (ALCO) of the Company's banking
subsidiary, Middleburg Bank. In this capacity, ALCO develops guidelines and
strategies that govern the Company's asset/liability management related
activities, based upon estimated market risk sensitivity, policy limits and
overall market interest rate levels and trends.
Interest rate risk represents the sensitivity of earnings to changes in
market interest rates. As interest rates change, the interest income and expense
streams associated with the Company's financial instruments also change,
affecting net interest income, the primary component of the Company's earnings.
ALCO uses the results of a detailed and dynamic simulation model to quantify the
estimated exposure of net interest income to sustained interest rate changes.
While ALCO routinely monitors simulated net interest income sensitivity over a
rolling two-year horizon, it also employs additional tools to monitor potential
longer-term interest rate risk.
The simulation model captures the impact of changing interest rates on
the interest income received and interest expense paid on all assets and
liabilities reflected on the Company's balance sheet. The simulation model is
prepared and updated four times during each year. This sensitivity analysis is
compared to ALCO policy limits, which specify a maximum tolerance level for net
interest income exposure over a one-year horizon, assuming no balance sheet
growth, given both a 200 basis point (bp) upward and downward shift in interest
rates. A parallel and pro rata shift in rates over a 12-month period is assumed.
The following reflects the range of the Company's net interest income
sensitivity analysis during the six months ended June 30, 2002 as well as the
fiscal year of 2001 compared to the 10% Board-approved policy limit.
For the Six Months Ended June 30, 2002
Rate Change Estimated Net Interest Income Sensitivity
----------- -----------------------------------------
High Low Average
+ 200 bp (2.51%) (2.18%) (2.35%)
- 200 bp 2.62% 1.24% 1.93%
For the Year Ended December 31, 2001
Rate Change Estimated Net Interest Income Sensitivity
----------- -----------------------------------------
High Low Average
+ 200 bp (2.21%) (.32%) (1.32%)
- 200 bp 3.24% 1.57% 2.44%
16
Since December 31, 2001, the company's balance sheet has grown by
nearly $40.0 million. Deposit inflows provided the funding for the growth in the
loan and securities portfolios. Overall, the Company continues to have minimal
interest rate risks to either falling or rising interest rates. The addition of
fixed rate assets during the first six months of 2002 has made the Company
somewhat more liability sensitive in the short term, reducing its exposure to
falling rates but slightly increasing the potential exposure to rising rates.
Based upon first six months of 2002's simulation, the Company could expect an
average negative impact to net interest income of $405,000 over the next 12
months if rates rise 200 basis points. If rates decline 200 basis points, the
Company could expect a positive impact to net interest income of $330,000 over
the next 12 months.
During 2001, the Company was able to test the parameters and
assumptions of its simulation model in light of the 4.75% decrease in short term
rates over 11 months. The simulation model proved to be accurate in its
presentation of a company that benefits from falling interest rates. As
presented in the table above, the Company has had minimal interest rate risks to
either falling or rising interest rates over the past 15 months. The Company
could expect a negative impact to net interest income of $364,000 if rates rise
200 basis points over the next 12 months. If rates decline 200 basis points, the
Company could expect a positive impact to net interest income of $386,000 over
the next 12 months.
The preceding sensitivity analysis does not represent a forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions, including the
nature and timing of interest rate levels such as yield curve shape, prepayments
on loans and securities, deposit decay rates, pricing decisions on loans and
deposits, reinvestment or replacement of asset and liability cashflows. While
assumptions are developed based upon current economic and local market
conditions, the Company cannot make any assurances about the predictive nature
of these assumptions, including how customer preferences or competitor
influences might change.
Also, as market conditions vary from those assumed in the sensitivity
analysis, actual results will also differ due to factors such as prepayment and
refinancing levels likely deviating from those assumed, the varying impact of
interest rate change, caps or floors on adjustable rate assets, the potential
effect of changing debt service levels on customers with adjustable rate loans,
depositor early withdrawals and product preference changes, and other internal
and external variables. Furthermore, the sensitivity analysis does not reflect
actions that ALCO might take in response to or anticipation of changes in
interest rates.
17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Change in Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Shareholders on Wednesday, April
17, 2002 in Middleburg, Virginia. The shareholders were asked to vote
on the election of the directors of the Company and to change the name
of the Company from "Independent Community Bankshares, Inc." to
"Middleburg Financial Corporation".
The votes cast for or withheld for the election of the directors were
as follows:
NAME FOR WITHHELD
---- --- --------
Howard M. Armfield 1,255,645 32,105
Joseph L. Boling 1,250,666 37,084
Childs Frick Burden 1,255,658 32,092
J. Lynn Cornwell, Jr. 1,255,545 32,205
William F. Curtis 1,287,150 600
Robert C. Gilkison 1,287,237 513
C. Oliver Iselin, III 1,255,558 32,192
Gary D. LeClair 1,255,658 32,092
Thomas W. Nalls 1,255,658 32,092
John Sherman 1,255,658 32,092
Millicent W. West 1,255,545 32,205
Edward T. Wright 1,287,250 500
The votes cast for, against or abstain to approve an amendment to the
Company's Articles of Incorporation to change the name of the Company
to "Middleburg Financial Corporation" were as follows:
FOR AGAINST ABSTAIN
--- ------- -------
Name Change to Middleburg Financial
Corporation 1,232,581 35,849 19,315
Item 5. Other Information
None
18
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
99.1 Statement of Chief Executive Officer and Chief
Financial Officer Pursuant to 18 U.S.C.ss.1350
b) Reports on Form 8-K
On May 15, 2002, the Company filed a Current Report on Form
8-K dated May 15, 2002 to disclose, under Item 5, the
announcement of the change in the name of the Company to
"Middleburg Financial Corporation."
19
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, as amended, the registrant caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
MIDDLEBURG FINANCIAL CORPORATION
(Registrant)
Date: August 14, 2002 /s/Joseph L. Boling
------------------------------------
Joseph L. Boling
Chairman of the Board & CEO
Date: August 14, 2002 /s/Alice P. Frazier
------------------------------------
Alice P. Frazier
Executive Vice President & CFO
(Chief Accounting Officer)
20