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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, 2003
[ ] 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)
(703) 777-6327
(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 or 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 the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes No X
-------- --------
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
1,897,266 shares of common stock, par value $5.00 per share,
outstanding as of August 8, 2003
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 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
Item 4. Controls and Procedures 20
Part II. Other Information
Item 1. Legal Proceedings 21
Item 2. Change in Securities and Use of Proceeds 21
Item 3. Defaults upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
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,
2003 2002
------------------- ------------------
Assets:
Cash and due from banks $ 15,929 $ 8,338
Interest-bearing balances in banks 324 274
Temporary investments:
Federal funds sold 6,050 --
Other money market investments 1,281 911
Securities (fair value: June 30, 2003,
$170,578, December 31, 2002, $163,957 ) 170,297 163,673
Loans held for sale 20,963 17,489
Loans, net of allowance for loan losses of $2,369 in 2003
and $2,307 in 2002 233,904 209,800
Bank premises and equipment, net 11,649 11,814
Other assets 21,236 12,675
------------------- ------------------
Total assets $481,633 $424,974
=================== ==================
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Non-interest bearing demand deposits $104,624 $ 90,413
Savings and interest-bearing demand deposits 152,004 138,661
Time deposits 108,539 99,829
------------------- ------------------
Total deposits $365,167 $328,903
Securities sold under agreements to
repurchase 10,827 8,924
Federal Home Loan Bank Advances 13,500 --
Long-term debt 31,420 31,545
Trust preferred capital notes 10,000 10,000
Other liabilities 3,944 4,192
------------------- ------------------
Total liabilities $434,858 $383,564
------------------- ------------------
Shareholders' Equity
Common stock par value $5.00 per
share, authorized 10,000,000 shares;
issued and outstanding at June 30, 2003 - 1,897,266
issued and outstanding at December 31, 2002 - 1,852,682 $ 9,486 $ 9,263
Capital surplus 5,427 3,644
Retained earnings 28,334 25,184
Accumulated other comprehensive income 3,528 3,319
------------------- ------------------
Total shareholders' equity $ 46,775 $ 41,410
------------------- ------------------
Total liabilities and shareholders' equity $481,633 $424,974
=================== ==================
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,
2003 2002 2003 2002
-------- -------- -------- --------
Interest Income
Interest and fees on loans $ 8,092 $ 8,022 $ 4,068 $ 4,043
Interest on investment securities
Taxable 1 2 1 1
Exempt from federal income taxes 103 125 50 59
Interest on securities available for sale
Taxable 3,041 2,608 1,531 1,374
Exempt from federal income taxes 776 792 387 393
Dividends 142 140 77 69
Interest on federal funds sold and other 28 47 18 24
-------- -------- -------- --------
Total interest income $ 12,183 $ 11,736 $ 6,132 $ 5,963
Interest expense
Interest on deposits $ 1,713 $ 2,169 $ 831 $ 1,069
Interest on long-term debt 854 980 546 544
Interest on short-term borrowings 310 141 47 60
-------- -------- -------- --------
Total interest expense $ 2,877 $ 3,290 $ 1,424 $ 1,673
-------- -------- -------- --------
Net interest income $ 9,306 $ 8,446 $ 4,708 $ 4,290
Provision for loan losses 300 150 225 75
-------- -------- -------- --------
Net interest income after provision
for loan losses $ 9,006 $ 8,296 $ 4,483 $ 4,215
-------- -------- -------- --------
Other Income
Trust and investment advisory fee income $ 1,688 $ 1,138 $ 842 $ 819
Service charges on deposit accounts 1,181 822 588 471
Net gains (losses) on securities
available for sale 441 (47) 146 33
Fees on loans held for resale 900 746 266 403
Commissions on investment sales 645 252 342 112
Equity in earnings of affiliate 764 -- 764 --
Other operating income 37 41 37 10
-------- -------- -------- --------
Total other income $ 5,656 $ 2,952 $ 2,985 $ 1,848
-------- -------- -------- --------
Other Expense
Salaries and employee benefits 5,126 4,131 2,486 2,188
Net occupancy expense of premises 1,125 750 546 404
Computer expense 300 230 161 125
Advertising 140 238 78 140
Other operating expenses 1,812 1,491 913 855
-------- -------- -------- --------
Total other expense $ 8,503 $ 6,840 $ 4,184 $ 3,712
-------- -------- -------- --------
Income before income taxes $ 6,159 $ 4,408 $ 3,284 $ 2,351
Income taxes 1,847 1,208 982 665
-------- -------- -------- --------
Net income $ 4,312 $ 3,200 $ 2,302 $ 1,686
======== ======== ======== ========
Net income per share, basic $ 2.30 $ 1.79 $ 1.22 $ 0.92
Net income per share, diluted $ 2.26 $ 1.74 $ 1.19 $ 0.90
Dividends per share $ 0.62 $ 0.60 $ 0.31 $ 0.30
See Accompanying Notes to Consolidated Financial Statements.
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Changes in Shareholders' Equity
For the Six Months Ended June 30, 2003 and 2002
(In Thousands)
(Unaudited)
Accumulated
Other
Common Capital Retained Comprehensive Comprehensive
Stock Surplus Earnings Income (Loss) Income Total
------------ ---------- ---------------- ----------------- ------------------ ----------
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 gains on available for sale
securities period (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
======== ======= ========= ======== =========
Balances - December 31, 2002 $ 9,263 $ 3,644 $ 25,184 $ 3,319 $ 41,410
Comprehensive Income
Net income 4,312 4,312 4,312
Issuance of common stock (44,584 shares) 223 1,783 2,006
Other comprehensive income
net of tax:
Unrealized holding gains arising during the
period (net of tax $258) 500
Reclassification adjustment for
gains realized in net income (net of tax $150) (291)
---------
Other comprehensive income (net of tax $108) 209 209 209
---------
Total comprehensive income $ 4,521
=========
Cash dividends declared (1,162) (1,162)
-------- ------- --------- -------- ---------
Balances - June 30, 2003 $ 9,486 $ 5,427 $ 28,334 $ 3,528 $ 46,775
======== ======= ========= ======== =========
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,
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,312 $ 3,200
Adjustments to reconcile net income to net cash provided by operating
activities
Provision for loan losses 300 150
Depreciation and amortization 786 512
Equity in earnings of affiliate (764) --
Net (gains) losses on securities available for sale (441) 47
Net (gains) on sales of equipment -- (3)
Discount (accretion) and premium amortization on securities, net (42) (46)
Originations of loans held for sale (86,145) (47,518)
Proceeds from sales of loans held for sale 82,671 47,217
Decrease (increase) in other assets 118 (1,616)
(Decrease) increase in other liabilities (386) 1,319
-------- --------
Net cash provided by operating activities $ 409 $ 3,262
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity, principal paydowns and calls on investment securities $ 814 $ 896
Proceeds from maturity, principal paydowns and
calls of securities available for sale 22,307 6,211
Proceeds from sale of securities available for sale 20,825 14,757
Purchase of securities available for sale (49,770) (36,612)
Investment in affiliate (6,116) (1,240)
Net (increase) in loans (24,404) (16,820)
Proceeds from sale of bank premises and equipment 18 20
Purchases of bank premises and equipment (440) (2,712)
-------- --------
Net cash (used in) investing activities $(36,766) $(35,500)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts, and savings accounts $ 27,554 $ 20,252
Net increase in certificates of deposits 8,710 2,668
Net increase in Fed Funds purchased -- 1,100
Proceeds from Federal Home Loan Bank advances 67,820 62,000
Payment on Federal Home Loan Bank advances (54,320) (66,000)
Proceeds from long-term debt -- 11,000
Payments on long-term debt (125) (130)
Cash dividends paid (1,130) (1,088)
Issuance of common stock 6 590
Increase in securities sold under agreements to repurchase 1,903 1,387
-------- --------
Net cash provided by financing activities $ 50,418 $ 31,779
-------- --------
Increase (decrease) in cash and cash equivalents $ 14,061 $ (459)
CASH AND CASH EQUIVALENTS
Beginning $ 9,523 $ 12,975
======== ========
Ending $ 23,584 $ 12,516
======== ========
6
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Cash Flows (continued)
(In Thousands)
(Unaudited)
For the Six Months Ended
----------------------------------
June 30, June 30,
2003 2002
-------------- -------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest $2,930 $2,604
Income taxes 842 1,207
SUPPLEMENTAL DISCLOSURES FOR NON-CASH
INVESTING AND FINANCING ACTIVITIES
Unrealized gain on securities available for sale 317 1,868
Stock issuance for purchase of affiliate 2,000 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.
7
MIDDLEBURG FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
For the Six Months Ended June 30, 2003 and 2002
(Unaudited)
Note 1. General
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, 2003
and the results of operations and changes in cash flows for the six months ended
June 30, 2003 and 2002. The statements should be read in conjunction with the
Notes to Consolidated Financial Statements included in the Annual Report on Form
10-K of Middleburg Financial Corporation (the "Company") for the year ended
December 31, 2002 (the "2002 Form 10-K"). The results of operations for the
three-month and six-month periods ended June 30, 2003 and 2002 are not
necessarily indicative of the results to be expected for the full year.
Note 2. Stock-Based Employee Compensation Plan
At June 30, 2003, the Company had a stock-based employee compensation
plan. The Company accounts for the plan under the recognition and measurement
principles of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and related Interpretations. No stock-based employee
compensation cost is reflected in net income, as all options granted under those
plans had an exercise price equal to the market value of the underlying common
stock on the date of grant. The following table illustrates the effect on net
income and earnings per share if the Company had applied the fair value
recognition provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
Six Months Ended Three Months Ended
June 30, March 31,
-------------------------- ------------------------
2003 2002 2003 2002
----------- -------------- ----------- ------------
(In Thousands) (In Thousands)
Net income, as reported $4,312 $ 1,514 $ 2,302 $ 1,686
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards (77) (31) (44) (56)
-------------------------- ------------------------
Pro forma net income $4,235 $ 1,483 $ 2,258 $ 1,630
========================== ========================
Earnings per share:
Basic - as reported $ 2.30 $ 1.79 $ 1.22 $ 0.92
Basic - pro forma 2.26 1.74 1.19 0.89
Diluted - as reported 2.26 1.74 1.19 0.90
Diluted - pro-forma 2.22 1.69 1.17 0.87
8
Note 3. Securities
Securities being held to maturity as of June 30, 2003 are summarized
as follows:
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains (Losses) Value
-----------------------------------------------------------
(In Thousands)
Obligations of states and
political subdivisions $ 3,787 $ 281 $ - $ 4,068
Mortgage backed securities 42 - - 42
---------------- ----------------------------- ------------
$ 3,829 $ 281 $ - $ 4,110
================ ============================= ============
Securities available for sale as of June 30, 2003 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 $ 6,838 $ 83 $ - $ 6,921
Corporate securities 3,947 237 (33) 4,151
Obligations of states and
political subdivisions 31,185 2,431 - 33,616
Mortgage backed securities 103,903 2,882 (103) 106,682
Other 15,254 213 (369) 15,098
------------------------------------------------------------
$ 161,127 $ 5,846 $ (505) $166,468
================ ================ ============= ============
Note 4. Loan Portfolio
The consolidated loan portfolio is composed of the following:
------------------------------------
June 30, December 31,
2003 2002
------------------------------------
(In Thousands)
Commercial, financial and agricultural $ 20,435 $ 20,323
Real estate construction 18,778 22,008
Real estate mortgage 184,943 158,035
Installment loans to individuals 12,117 11,741
------------------ -----------------
Total loans 236,273 212,107
Less: Allowance for loan losses 2,369 2,307
------------------ -----------------
Loans, net $ 233,904 $ 209,800
================== =================
The Company had $33,000 in non-performing assets at June 30, 2003.
9
Note 5. Allowance for Loan Losses
The following is a summary of transactions in the allowance for loan
losses:
---------------------------------
June 30, December 31,
2003 2002
---------------------------------
(In Thousands)
Balance at January 1 $ 2,307 $ 2,060
Provision charged to operating expense 300 300
Recoveries added to the allowance 9 21
Loan losses charged to the allowance (247) (74)
--------------- ----------------
Balance at the end of the period $ 2,369 $ 2,307
=============== ================
Note 6. 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.
Six Months Ended Three Months Ended
-------------------------------------------------- --------------------------------------------------
June 30, 2003 June 30, 2002 March 31, 2003 March 31, 2002
Per share Per share Per share Per share
Shares Amount Shares Amount Shares Amount Shares Amount
-------------------------------------------------- --------------------------------------------------
Basic EPS 1,871,526 $ 2.30 1,788,771 $ 1.79 1,890,371 $ 1.22 1,825,056 $ 0.92
=========== ========== ========= ========
Effect of dilutive
securities:
stock options 37,507 51,068 43,637 51,941
--------- --------- --------- --------
Diluted EPS 1,909,033 $ 2.26 1,839,839 $ 1.74 1,934,008 $ 1.19 1,876,997 $ 0.90
========= =========== ========= ========= ========= ======== ========= ========
Note 7. Investment in Affiliate
On April 15, 2003, the Middleburg Bank (the "Bank"), a wholly owned
subsidiary of the Company, acquired 40% of the issued and outstanding membership
interest units (the "Acquisition") of Southern Trust Mortgage, LLC ("Southern
Trust"). The Bank acquired the membership interest units in equal proportion
from the seven members of Southern Trust, all of whom own, in the aggregate, the
remaining issued and outstanding units of Southern Trust. Southern Trust is a
regional mortgage lender headquartered in Norfolk, Virginia and has offices in
Virginia, Maryland, North Carolina, South Carolina and Georgia. The purchase
price that the Company and the Bank paid in connection with the Acquisition
consisted of approximately $6.0 million in cash and 44,359 shares of the
Company's common stock ("Common Stock").
The Company is accounting for its investment in Southern Trust by the
equity method of accounting under which the Company's share of the net income of
the affiliate is recognized as income in the Company's income statement and
added to the investment account, and dividends received from the affiliate are
treated as a reduction of the investment account. The investment in affiliate
totaling $8.9 million at June 30, 2003 is included in other assets on the
consolidated balance sheet.
10
Note 8. Recent Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board issued
Statement No. 149, Amendment of Statement 133 on Derivative Instruments and
Hedging Activities. This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts(collectively referred to as derivatives) and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This Statement is effective for contracts
entered into or modified after June 30, 2003, and is not expected to have an
impact on the Company's consolidated financial statements.
In May 2003, the Financial Accounting Standards Board issued
Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. This Statement establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). Many of those instruments were
previously classified as equity. This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003, except for mandatory redeemable financial instruments of nonpublic
entities. Adoption of the Statement is not expected to have an impact on the
Company's consolidated financial statements.
11
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 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 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 in the 2002 Form 10-K.
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 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 the loan grading system.
The Company evaluates various loans individually for impairment as
required by 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, 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 No. 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, 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.
The amount of estimated impairment for individually evaluated loans and
groups of loans is added together for a total estimate of loans. This estimate
of losses is compared to the allowance for loan
12
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. As of June 30, 2003, the Company had no
derivative financial instruments outstanding.
Intangibles and Goodwill
The Company had approximately $6.7 million in intangible assets and
goodwill at June 30, 2003. On April 1, 2002, the Company acquired Gilkison
Patterson Investment Advisors, Inc. ("GPIA"), a registered investment advisor.
In connection with this investment, a purchase price valuation (using SFAS Nos.
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, SFAS No. 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.
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
13
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, 2003 increased 34.8% to
$4.3 million or $ 2.26 per diluted share compared to $3.2 million or $1.74 per
diluted share for the first six months of 2002. Annualized returns on average
assets and equity for the six months ended June 30, 2003 were 1.9 % and 19.0%,
respectively, compared to 1.7% and 19.1% for the same period in 2002.
Total assets for the Company increased to $481.6 million at June 30,
2003 compared to $425.0 million at December 31, 2002, representing an increase
of $56.7 million or 13.3%. Total loans at June 30, 2003 were $233.9 million, an
increase of $24.1 million from the December 31, 2002 balance of $209.8 million.
Net charge-offs were $238,000 for the six months ended June 30, 2003. Increased
net charge offs and the growth in the loan portfolio required an additional
$150,000 in provision during the first half of 2003. The allowance for loan
losses was $2.4 million or 1.0% of total loans outstanding at June 30, 2003. The
Company has developed a strong image advertising campaign that focuses on its
commercial lenders. This campaign has built additional awareness within the
market. Furthermore, the Company has hired two commercial lenders since January
2003 each of whom have significant experience within the Loudoun County market.
These factors have contributed to the strong loan growth during the first and
second quarter of 2003.
On April 15, 2003, the Bank acquired a 40% interest in Southern Trust.
Upon the acquisition of the 40% interest in Southern Trust, the Bank's existing
mortgage operation was assumed by Southern Trust. In connection with the
Southern Trust investment, the Company entered into two loan participation
agreements with Southern Trust. One arrangement is a tri-party agreement among
the Company, Southern Trust, and Colonial Bank, Southern Trust's warehouse line
lender. The agreement details the arrangements by which the Company purchases
99.0% of selected loans from Colonial Bank. The Company charges Southern Trust a
rate equal to the one month LIBOR rate at the time of purchase plus 175 basis
points. The rate has a floor of 1.95%. As noted in the tri-party agreement, the
Company does not intend to hold the purchased loans more than 30 days, Colonial
Bank maintains the note documentation on behalf of the Company, and the Company
will engage semi-annual testing to be conducted by third party to validate
Colonial Bank procedures. At June 30, 2003, the balance of the Company's
participated mortgages held for sale was $20.5 million. The tri-party agreement
is capped at $30.0 million.
The Company also entered into a construction loan participation
agreement with Southern Trust. According to this agreement, the Company can
purchase 93% of selected construction loans and draws, up to $20.0 million in
outstanding balances and $30.0 million in commitments. The Company will charge
Southern Trust an interest rate equal to the prime rate plus 75 basis points on
the outstanding participated loans held by the Company. Adjustments in rate
related to movements in the prime rate will be made monthly. There were no
construction participation loans at June 30, 2003.
The investment portfolio increased 4.0% to $170.3 million at June 30,
2003 compared to $163.7 million at December 31, 2002. Deposits increased $36.3
million to $365.2 million at June 30, 2003 from $328.9 million at December 31,
2002. Growth in demand deposits of $14.2 million accounts for the majority of
the increase during the first six months of 2003. While the Company has
experienced
14
significant growth in the balances within the low cost deposit categories,
management believes that a majority of the growth is related to an increase in
the number of accounts and relationships with new clients rather than an
existing client's decision to shift money from personal investments in stocks.
Time deposits decreased $8.7 million since December 31, 2002 to $108.5 million.
Securities sold under agreements to repurchase with commercial checking accounts
increased $1.9 million from $8.9 million at December 31, 2002 to $10.8 million
at June 30, 2003.
While the increase in deposits funded the majority of the Company's
asset growth for the six months ended June 30, 2003, a need for short term
funding materialized during the second quarter of 2003. This need resulted from
both an increased demand on the Company's loan portfolio and the implementation
of the mortgage loan participation agreement with Southern Trust. Federal Home
Loan Bank advances were $13.5 million at June 30, 2003, compared to $0 at
December 31, 2002.
Shareholders' equity was $46.8 million at June 30, 2003. This amount
represents an increase of 13.0% from the December 31, 2002 balance of $41.4
million. The issuance of 44,359 shares stock related to the investment in
Southern Trust accounts for much of the increase. The book value per common
share was $24.65 at June 30, 2003 and $22.35 at December 31, 2002.
Net Interest Income
Net interest income is one of the Company's primary sources 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 $9.3 million for the first six months
of 2003 compared to $8.4 million for the same period in 2002, an increase of
10.2%. Average earning assets increased $60.1 million from $346.2 million at
June 30, 2002 to $406.3 million at June 30, 2003. The Company continues to
obtain a majority of its funding from growth in the low cost deposit categories.
Average deposits increased $55.2 million from $283.3 million at June 30, 2002 to
$338.5 million at June 30, 2003. Total interest expense decreased to $2.9
million at June 30, 2003 from the $3.3 million balance at June 30, 2002,
representing a decrease of 12.6%. Both the strong growth in lower cost deposits
and the continued low interest rate environment have contributed to the
Company's decreased level in interest expense. The mix of low cost deposits
versus time deposits remains balanced at approximately 70% in low cost deposits
versus 30% in higher cost time deposits.
The net interest margin was 4.79 % for the six months ended June 30,
2003 compared to 5.15% for the same period in 2002. The decline stems from
significant prepayments in both the investment and loan portfolio over the past
year which have been reinvested in lower yielding assets.
Noninterest Income
Noninterest income increased 91.6% to $5.7 million for the first six
months of 2003 compared to $3.0 million for the same period in 2002. Noninterest
income (excluding net gains (losses) on securities available for sale) increased
73.9% to $5.2 million for the first six months of 2003 compared to $3.0 million
for the same period in 2002. Commissions and fees from trust and investment
advisory activities were $1.7 million for the six month period ended June 30,
2003 compared to $1.1 million for the same period in 2002. Equity in earnings of
affiliate, the line item representing the Company's earnings from its 40%
investment in Southern Trust, was $764,000 for the period ended June 30, 2003.
These earnings comprise 14.7% of total noninterest income at June 30, 2003, and
account for 34.5% of the $2.2 million increase in noninterest income. The equity
earnings in Southern Trust added $.26 per diluted share for the three months
ended June 30, 2003. Southern Trust closed $333 million in loans during the
second quarter with only 50% of its production attributable to refinancing
volume. Southern Trust also originated and closed $10 million in new
construction loans during that same period. As part of the investment in
Southern Trust, the Bank's mortgage banking department was transferred to
Southern Trust. After April 30, 2003, earnings of the
15
mortgage department will be reported within the equity in earnings from
affiliate. As agreed upon with the investment in Southern Trust, the Company
will receive 100% of the net income that had been budgeted for the mortgage
operation for the year 2003. For the amount that exceeds the 2003 budgeted net
income level, the Company will receive its 40% share. Earnings generated by the
Middleburg branch of Southern Trust in years subsequent to 2003 will be split
according to the Company's ownership percentage of Southern Trust. The Bank's
mortgage banking department contributed $.09 per diluted share towards the $.26
per diluted share attributed to Southern Trust above. For the six months ended
June 30, 2003, Southern Trust closed $550.4 million in loans. Despite the recent
increase in mortgage rates, Southern Trust is on track to produce over $800
million in loans for the third consecutive year. Southern Trust has 15 branch
offices in five states.
Investment advisory fees provided by GPIA a wholly owned subsidiary
acquired on April 1, 2002, totaled $1.0 million for the six months ended June
30, 2003. GPIA, a registered investment advisor, currently manages approximately
$600 million in assets. Fiduciary fees, provided by Tredegar Trust Company,
increased 1.9% from $637,000 at June 30, 2002 to $648,000 at June 30, 2003.
Fiduciary fees are based primarily upon the market value of the accounts under
administration.
Service charges on deposit accounts increased to $1.2 million at June
30, 2003. That represents an increase of 43.7% from the $822,000 June 30, 2002
balance. The Company continues to benefit from its three years of 20% growth in
transactional (checking and money market) accounts. The Company had implemented
a daily overdraft charge during the third quarter of 2002. Fees from this charge
account for 4.6% of the total service charges on deposit accounts for the six
months ended June 30, 2003. The Company also began accounting for the fee income
on ATM and VISA check card transactions in gross rather than net of expenses;
the result is an increase of $58,000 in service charge income. The related
expense is reflected in the noninterest expense section.
Investment sales fees increased from $252,000 at June 30, 2002, to
$645,000 at June 30, 2003. The addition of two financial consultants to the
Investment Sales department contributed to the 155.9% increase in investment
sales fees.
Fees on loans held for sale is derived from the sale of loans to the
secondary market. The Company does not retain servicing on these loans. Upon the
Company's investment in Southern Trust, it concluded its own mortgage
operations.
Noninterest Expense
Total noninterest expense includes employee-related costs, occupancy
and equipment expense and other overhead. Total noninterest expense increased
24.3% to $8.5 million for the first six months of 2003 compared to $6.8 million
for the same period in 2002. Salaries and employee benefits increased by 24.1%
when comparing June 30, 2003 to June 30, 2002. Additions to staff to support
business development, branching and the formation of a wealth management group
have contributed to the increase in salaries and employee benefits. Commissions
(included within the salaries and benefits expense) paid to employees for fee
related business, such as mortgage originations and investment sales have
increased by $266,000 to $668,000 as a result in the increase in sales volume.
Net occupancy expense of premises increased $375,000 from $750,000 for the six
months ended June 30, 2002 to $1.1
16
million for the six months ended June 30, 2003. The building expansion program
affected net occupancy and equipment expense year over year. An operations
center opened in late June 2002 and a second full service branch in Leesburg,
Virginia opened in July 2002.
There were no significant non-recurring expenses in the first half of
2003.
Allowance for Loan Losses
The allowance for loan losses at June 30, 2003 was $2.4 million
compared to $2.2 million at June 30, 2002. The allowance for loan losses was
1.0% of total loans outstanding at June 30, 2003 and 1.04% of total loans
outstanding at June 30, 2002. The provision for loan losses was increased to
$300,000 for the six months ended June 30, 2003. Increased net charge offs and
the growth in the loan portfolio during the first half of 2003 required an
additional $150,000 in provision. The provision was $150,000 for the six months
ended June 30, 2002. At June 30 , 2003, net loan charge offs totaled $238,000,
compared to $8,000 for the same date in 2002. Total loans past due 90 days or
more at June 30, 2003 were approximately $2,000. Non-performing loans were .01%
of total loans outstanding at June 30, 2003 compared to .06% at June 30, 2002.
Management believes that the allowance for loan losses is adequate to cover
credit losses inherent in the loan portfolio at June 30, 2003. 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.
Capital Resources
Shareholders' equity at June 30, 2003 and December 31, 2002 was $46.8
million and $41.4 million, respectively. Total common shares outstanding at June
30, 2003 were 1,897,266.
At June 30, 2003, the Company's tier 1 and total risk-based capital
ratios were 14.5% and 15.7%, respectively, compared to 14.8% and 15.6% at
December 31, 2002. The Company's leverage ratio was 9.7% at June 30, 2003
compared to 10.6% at December 31, 2002. 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.
Liquidity
Liquidity represents an institution's ability to meet present and
future financial obligations through either the sale or maturity of existing
assets or the acquisition of additional funds through liability management.
Liquid assets include cash, interest-bearing deposits with banks, federal funds
sold, short-term investments, securities classified as available for sale as
well as loans and securities maturing within one year. As a result of the
Company's management of liquid assets and the ability to generate liquidity
through liability funding, management believes that the Company maintains
overall liquidity sufficient to satisfy its depositors' requirements and meet
its customers' credit needs.
The Company also maintains additional sources of liquidity through a
variety of borrowing arrangements. The Bank maintains federal funds lines with
large regional and money-center banking institutions. These available lines
total in excess of $5 million, of which none were outstanding at June 30, 2003.
Federal funds purchased during the first half of 2003 averaged $460,000 compared
to an average of $563,000 during the same period in 2002. At June 30, 2003 and
December 31, 2002, the Bank had $10.8 million and $8.9 million, respectively, of
outstanding borrowings pursuant to securities sold under agreement to repurchase
transactions (Repo Accounts), with maturities of one day. The Repo
17
Accounts are long-term commercial checking accounts with average balances that
typically exceed $100,000.
The Bank has a credit line in the amount of $56.0 million at the
Federal Home Loan Bank of Atlanta. This line may be utilized for short and/or
long-term borrowing. The Bank has utilized the credit line for overnight funding
throughout the first half of 2003 with an average balance of $2.6 million.
At June 30, 2003, cash, interest-bearing deposits with financial
institutions, federal funds sold, short-term investments, loans held for sale
and securities available for sale were 58.8% of total deposits and liabilities.
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.
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 and investment management
subsidiaries for their clients are affected by equity and bond price risk and
are not considered in the asset/liability management process. 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
18
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 100 and 200 basis point (bp) downward shift in interest
rates and a 200 basis point upward shift. 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, 2003 as well as the fiscal year of 2002 compared to the 10%
Board-approved policy limit.
For the Six Months Ended June 30, 2003
Rate Change Estimated Net Interest Income Sensitivity
----------- -----------------------------------------
High Low Average
+ 200 bp 0.49% 0.34% 0.42%
- 100 bp (0.52)% (0.28)% (0.40)%
For the Year Ended December 31, 2002
Rate Change Estimated Net Interest Income Sensitivity
----------- -----------------------------------------
High Low Average
+ 200 bp (2.51%) (1.00%) (1.75%)
- 200 bp 2.62% .63% 1.33%
Since December 31, 2002, the company's balance sheet has grown by $56.7
million. Both deposit inflows and increased borrowings from the Federal Home
Loan Bank have 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 to the Company's
balance sheet of lesser rate sensitive deposits as well as low duration fixed
rate and adjustable rate mortgage backed securities to the investment portfolio
has mitigated the Company's liability sensitivity to rising rates. Based upon
the first six months of 2003's simulation, the Company could expect an average
positive impact to net interest income of $90,000 over the next 12 months if
rates rise 200 basis points. If rates were to decline 100 basis points, the
Company could expect an average negative impact to net interest income of
$94,000 over the next 12 months.
At the end of 2002, the Company's interest rate risk model indicated
that in a rising rate environment of 200 basis points over a 12 month period net
interest income could decrease by 1.75% on average. For the same time period the
interest rate risk model indicated that in a declining rate environment of 100
basis points over a 12 month period net interest income could increase by 1.33%
on average. While these numbers are subjective based upon the parameters used
within the model, management believes the balance sheet is very balanced with
little risk to rising rates in the future.
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,
19
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.
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 and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Rule 13a-15 under the
Securities Exchange Act of 1934, as amended. Based upon that evaluation, the
Company's Chief Executive Officer and 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 filings with the
Securities and Exchange Commission. There have been no significant changes in
the Company's internal controls or in other factors that could materially
affect, or are reasonably likely to materially affect, internal controls
subsequent to the date that the Company carried out its evaluation.
As disclosed above, on April 15, 2003, the Bank acquired a 40% interest
in Southern Trust. During the second quarter of 2003, the Company assisted
Southern Trust with an upgrade conversion of its accounting system. The Company
continues to monitor the implementation of this system by Southern Trust as part
of its evaluation of its disclosure controls and procedures under applicable
securities rules and regulations.
20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Change in Securities and Use of Proceeds
On April 15, 2003, the Bank acquired 40% of the issued and outstanding
membership interest units of Southern Trust. The purchase price that
the Company and the Bank paid in connection with the Acquisition
included, among other things, the issuance of 44,359 shares of Common
Stock, in the aggregate, to the seven members of Southern Trust. The
Company relied upon Section 4(2) of the Securities Act for the
exemption from registration for this issuance.
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
16, 2003 in Middleburg, Virginia. The shareholders were asked to vote
on the election of the directors of the Company.
At the Annual Meeting, the votes cast for or withheld for the election
of the directors were as follows:
NAME FOR WITHHELD
---- --- --------
Howard M. Armfield 1,130,018 100
Joseph L. Boling 1,130,018 100
Childs Frick Burden 1,130,018 100
J. Lynn Cornwell, Jr. 1,130,018 100
William F. Curtis 1,102,692 27,426
Robert C. Gilkison 1,130,018 100
C. Oliver Iselin, III 1,130,018 100
Gary D. LeClair 1,102,692 27,426
Thomas W. Nalls 1,130,018 100
John Sherman 1,129,114 1,004
Millicent W. West 1,130,018 100
Edward T. Wright 1,102,692 27,426
There were no other matters presented to the Company's shareholders
during the quarter ended June 30, 2003.
Item 5. Other Information
None
21
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Statement of Chief Executive Officer and Chief
Financial Officer Pursuant to 18 U.S.C. ss. 1350
(b) Reports on Form 8-K
On April 18, 2003, the Company filed a Current Report on Form
8-K dated April 16, 2003 to report, under Items 7 and 12
(under Item 9), and attach as an exhibit and incorporate by
reference, a press release that reported the Company's
financial results for the quarter ended March 31, 2003.
On April 30, 2003, the Company filed a Current Report on Form
8-K dated April 15, 2003 to disclose, under Item 2, the
Company's acquisition of an equity interest in Southern Trust.
22
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, 2003 /s/ Joseph L. Boling
------------------------------------------
Joseph L. Boling
Chairman of the Board & CEO
Date: August 14, 2003 /s/ Alice P. Frazier
------------------------------------------
Alice P. Frazier
Executive Vice President & CFO
Date: August 14, 2003 /s/ Kathleen J. Chappell
------------------------------------------
Kathleen J. Chappell
Senior Vice President & Controller
(Chief Accounting Officer)
23
EXHIBIT INDEX
Number Document
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Statement of Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. ss. 1350