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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2004
[ ] Transition Report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ____________ to _____________
Commission file number: 0-24159
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:
3,803,402 shares of common stock, par value $2.50 per share,
outstanding as of May 7, 2004
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 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
Item 4. Controls and Procedures 23
Part II. Other Information
Item 1. Legal Proceedings 24
Item 2. Change in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities 24
Item 3. Defaults upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
2
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Balance Sheets
(In Thousands, Except Share Data)
(Unaudited)
March 31, December 31,
2004 2003
------------ ------------
Assets:
Cash and due from banks $ 12,489 $ 10,668
Interest-bearing balances in banks 1,434 423
Temporary investments,
Money market investments -- 740
Securities (fair value: March 31, 2004,
$191,241, December 31, 2003, $194,793) 191,042 194,581
Loans held for sale 28,213 11,192
Loans, net of allowance for loan losses of $2,732 in 2004
and $2,605 in 2003 267,737 258,112
Bank premises and equipment, net 11,120 11,261
Other assets 21,950 21,962
-------- --------
Total assets $533,985 $508,939
======== ========
Liabilities and Shareholders' Equity:
Liabilities:
Deposits:
Non-interest bearing demand deposits $106,191 $103,845
Savings and interest-bearing demand deposits 179,691 161,963
Time deposits 102,835 104,178
-------- --------
Total deposits $388,717 $369,986
Federal funds purchased 700 1,500
Securities sold under agreements to
repurchase 27,338 13,535
Federal Home Loan Bank advances -- 27,250
Long-term debt 48,500 31,000
Trust preferred capital notes 15,000 15,000
Other liabilities 4,228 3,341
-------- --------
Total liabilities $484,483 $461,612
-------- --------
Shareholders' Equity:
Common stock, par value $2.50 per
share, authorized 20,000,000 shares;
issued and outstanding at March 31, 2004 - 3,803,402
issued and outstanding at December 31, 2003 - 3,803,102 $ 9,509 $ 9,508
Capital surplus 5,544 5,541
Retained earnings 32,023 30,798
Accumulated other comprehensive income, net 2,426 1,480
-------- --------
Total shareholders' equity $ 49,502 $ 47,327
-------- --------
Total liabilities and shareholders' equity $533,985 $508,939
======== ========
See Accompanying Notes to Consolidated Financial Statements
3
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Income
(In Thousands, Except Per Share Data)
Unaudited
------------------------------
For the Three Months
Ended March 31,
2004 2003
------------------------------
Interest and Dividend Income
Interest and fees on loans $4,193 $4,024
Interest on investment securities
Exempt from federal income taxes 48 53
Interest on securities available for sale
Taxable 1,631 1,510
Exempt from federal income taxes 393 389
Dividends 53 65
Interest on federal funds sold and other 4 10
------ ------
Total interest income $6,322 $6,051
------ ------
Interest Expense
Interest on deposits $ 702 $ 882
Interest on long-term debt 631 493
Interest on short-term borrowings 113 78
------ ------
Total interest expense $1,446 $1,453
------ ------
Net interest income $4,876 $4,598
Provision for loan losses 109 75
------ ------
Net interest income after provision
for loan losses $4,767 $4,523
------ ------
Other Income
Trust and investment advisory fee income $ 939 $ 846
Service charges 350 593
Net gains on securities
available for sale 181 295
Fees on loans held for resale -- 634
Commissions on investment sales 175 303
Equity in earnings of affiliate 461 --
Other service charges, commissions and fees 89 --
Other operating income 29 --
------ ------
Total other income $2,224 $2,671
------ ------
Other Expense
Salaries and employee benefits $2,579 $2,640
Net occupancy expense of premises 576 579
Advertising 79 62
Computer operations 170 152
Other operating expenses 857 886
------ ------
Total other expense $4,261 $4,319
------ ------
Income before income taxes $2,730 $2,875
Income taxes 782 865
------ ------
Net income $1,948 $2,010
====== ======
Net income per share, basic $ 0.51 $ 0.55
Net income per share, diluted $ 0.50 $ 0.53
Dividends per share $ 0.19 $ 0.16
See Accompanying Notes to Consolidated Financial Statements.
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Changes in Shareholders' Equity
For the Three Months Ended March 31, 2004 and 2003
(In Thousands)
(Unaudited)
Accumulated
Other
Common Capital Retained Comprehensive Comprehensive
Stock Surplus Earnings Income Income Total
-------- -------- -------- ------------- ------------- --------
Balances - December 31, 2002 $ 9,263 $ 3,644 $ 25,184 $ 3,319 $ 41,410
-------- -------- -------- -------- --------
Comprehensive Income
Net income 2,010 $ 2,010 2,010
Other comprehensive income
net of tax:
Unrealized holding losses arising during the
period (net of tax $424) (826)
Reclassification adjustment for
gains realized in net income (net of tax $100) (195)
--------
Other comprehensive income (net of tax $524) (1,021) $ (1,021) (1,021)
--------
Total comprehensive income $ 989
========
Cash dividends declared (574) (574)
-------- -------- -------- -------- --------
Balances - March 31, 2003 $ 9,263 $ 3,644 $ 26,620 $ 2,298 $ 41,825
======== ======== ======== ======== ========
Balances - December 31, 2003 $ 9,508 $ 5,541 $ 30,798 $ 1,480 $ 47,327
Comprehensive Income
Net income 1,948 1,948 1,948
Other comprehensive income
net of tax:
Unrealized holding gains arising during the
period (net of tax $549) 1,065
Reclassification adjustment for
gains realized in net income (net of tax $62) (119)
--------
Other comprehensive income (net of tax $487) 946 $ 946 946
--------
Total comprehensive income $ 2,894
========
Cash dividends declared (723) (723)
Issuance of common stock 1 3 4
-------- -------- -------- -------- --------
Balances - March 31, 2004 $ 9,509 $ 5,544 $ 2,023 $ 2,426 $ 49,502
======== ======== ======== ======== ========
See Accompanying Notes to Consolidated Financial Statements.
5
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
Unaudited
For the Three Months Ended
--------------------------
March 31, March 31,
2004 2003
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,948 $ 2,010
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Provision for loan losses 109 75
Depreciation and amortization 398 387
Equity in undistributed earnings of affiliate (185) --
Net (gains) on securities available for sale (181) (295)
Discount (accretion) and premium amortization on securities, net (10) 21
Originations of loans held for sale (76,072) (37,592)
Proceeds from sales of loans held for sale 59,051 38,782
Decrease in other assets 92 486
Increase (decrease) in other liabilities 401 (85)
-------- --------
Net cash provided (used in) by operating activities $(14,449) $ 3,789
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity, principal paydowns and calls on investment securities $ 261 $ 524
Proceeds from maturity, principal paydowns and
calls of securities available for sale 10,844 9,571
Proceeds from sale of securities available for sale 6,883 12,287
Purchase of securities available for sale (12,825) (26,504)
Net (increase) in loans (9,734) (10,598)
Purchases of premises and equipment (153) (376)
-------- --------
Net cash (used in) investing activities $ (4,724) $(15,096)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts, and savings accounts $ 20,074 $ 10,206
Net (decrease) in certificates of deposits (1,343) (1,729)
Net (decrease) in federal funds purchased (800) --
Proceeds from Federal Home Loan Bank advances 44,500 23,000
Payment on Federal Home Loan Bank advances (54,250) (12,000)
Payments on long-term debt -- (65)
Cash dividends paid (723) (556)
Issuance of common stock 4 --
Increase (decrease) in securities sold under agreements to repurchase 13,803 (2,303)
-------- --------
Net cash provided by financing activities $ 21,265 $ 16,553
-------- --------
Increase in cash and cash equivalents $ 2,092 $ 5,246
CASH AND CASH EQUIVALENTS
Beginning $ 11,831 $ 9,523
======== ========
Ending $ 13,923 $ 14,769
======== ========
6
MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Cash Flows (continued)
(In Thousands)
(Unaudited)
For the Three Months Ended
------------------------------
March 31, March 31,
2004 2003
-------------- --------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest 1,106 1,447
Income taxes - -
SUPPLEMENTAL DISCLOSURES FOR NON-CASH
INVESTING AND FINANCING ACTIVITIES
Unrealized gain (loss) on securities available for sale 1,433 (1,545)
See Accompanying Notes to Consolidated Financial Statements.
7
MIDDLEBURG FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
For the Three Months Ended March 31, 2004 and 2003
(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 at March 31, 2004
and the results of operations and changes in cash flows for the three months
ended March 31, 2004 and 2003. 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, 2003 (the "2003 Form 10-K"). The results of operations for the
three month periods ended March 31, 2004 and 2003 are not necessarily indicative
of the results to be expected for the full year.
On September 11, 2003, the Board of Directors of the Company approved a
2-for-1 stock split (the "Stock Split") of the Company's common stock ("Common
Stock"). The distribution of the additional shares of Common Stock was made on
October 17, 2003 to shareholders of record as of October 2, 2003. All per share
information for all periods presented in this report has been retroactively
restated to reflect the Stock Split.
Note 2. Stock -Based Employee Compensation Plan
At March 31, 2004, 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.
Three Months Ended
March 31,
------------------------------
2004 2003
------------------------------
(In Thousands)
Net income, as reported $ 1,948 $ 2,010
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards (44) (33)
------------------------------
Pro forma net income $ 1,904 $ 1,977
==============================
Earnings per share:
Basic - as reported $ 0.51 $ 0.55
Basic - pro forma 0.50 0.53
Diluted - as reported 0.50 0.53
Diluted - pro-forma 0.49 0.52
8
Note 3. Securities
Securities being held to maturity at March 31, 2004 are summarized as
follows:
--------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains (Losses) Value
--------------------------------------------------------------
(In Thousands)
Obligations of states and
political subdivisions $ 3,427 $ 199 $ - $ 3,626
Mortgage backed securities 38 - - 38
----------------- --------------- ------------- -------------
$ 3,465 $ 199 $ - $ 3,664
================= =============== ============= =============
Securities available for sale at March 31, 2004 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 $ 1,784 $ 28 $ (3) $ 11,809
Corporate securities 3,377 171 (24) 3,524
Obligations of states and
political subdivisions 30,881 2,408 (6) 33,283
Mortgage backed securities 119,630 1,876 (490) 121,016
Other 18,228 105 (388) 17,945
---------
$ 183,900 $ 4,588 $ (911) $ 187,577
========= ========= ========= =========
Note 4. Loan Portfolio
The consolidated loan portfolio is composed of the following:
------------------------------------
March 31, December 31,
2004 2003
------------------------------------
(In Thousands)
Commercial, financial and agricultural $ 19,696 $ 20,360
Real estate construction 34,544 30,239
Real estate mortgage 203,829 198,290
Installment loans to individuals 12,400 11,828
----------------- -----------------
Total loans 270,469 260,717
Less: Allowance for loan losses 2,732 2,605
------------------ -----------------
Loans, net $ 267,737 $ 258,112
================== =================
The Company had $838,000 in non-performing assets at March 31, 2004.
9
Note 5. Allowance for Loan Losses
The following is a summary of transactions in the allowance for loan
losses:
-----------------------------------
March 31, December 31,
2004 2003
-----------------------------------
(In Thousands)
Balance at January 1 $ 2,605 $ 2,307
Provision charged to operating expense 109 575
Recoveries added to the allowance 82 27
Loan losses charged to the allowance (64) (304)
------------------ ----------------
Balance at the end of the period $ 2,732 $2,605
================== ================
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. All amounts have been
retroactively restated to reflect the Stock Split.
Three Months Ended
---------------------------------------------
March 31, 2004 March 31, 2003
Per share Per share
Shares Amount Shares Amount
---------------------------------------------
Basic EPS 3,803,148 $ 0.51 3,705,364 $ 0.55
======== ========
Effect of dilutive
securities:
stock options 118,876 62,754
--------- ---------
Diluted EPS 3,922,024 $ 0.50 3,768,118 $ 0.53
=============================================
Note 7. Segment Reporting
The Company operates in a decentralized fashion in two principal
business activities: banking and trust and investment advisory services. Revenue
from banking activities consists primarily of interest earned on loans and
investment securities and service charges on deposit accounts through Middleburg
Bank (the "Bank"). Through the Bank's 40% investment in Southern Trust Mortgage
Company ("Southern Trust"), the Company also recognizes its share of the net
income from the Southern Trust investment in the other income section of the
Bank's income statement.
Revenues from the trust and investment advisory activities are
comprised mostly of fiduciary fees. The trust and investment advisory services
are conducted by two subsidiaries of the Company, the Tredegar Trust Company
("Tredegar") and Gilkison Patterson Investment Advisors, Inc. ("GPIA"). The
fiduciary fees are based primarily upon the market value of the accounts under
administration.
10
The following tables present segment information for the three months
ended March 31, 2004 and March 31, 2003.
Three Months Ended
March 31, 2004
Trust and
Investment
Banking Advisory Eliminations Consolidated
------- -------- ------------ ------------
(In Thousands)
Revenues:
Interest income $ 6,314 $ 10 $ (2) $ 6,322
Trust and investment advisory
fee income -- 960 (21) 939
Other income 1,295 -- (10) 1,285
-------- -------- -------- --------
Total operating income 7,609 970 (33) 8,546
-------- -------- -------- --------
Expenses:
Interest expense 1,448 -- (2) 1,446
Salaries and employee benefits 2,048 531 -- 2,579
Provision for loan losses 109 -- -- 109
Other 1,420 293 (31) 1,682
-------- -------- -------- --------
Total operating expenses 5,025 824 (33) 5,816
-------- -------- -------- --------
Income before income taxes 2,584 146 -- 2,730
Provision for income taxes 704 78 -- 782
-------- -------- -------- --------
Net income $ 1,880 $ 68 $ -- $ 1,948
-------- -------- -------- --------
Total assets $534,254 $ 7,889 $ (8,158) $533,985
Capital expenditures $ 153 $ -- $ -- $ 153
11
Three Months Ended
March 31, 2003
Trust and
Investment
Banking Advisory Eliminations Consolidated
------- -------- ------------ ------------
(In Thousands)
Revenues:
Interest income $ 6,042 $ 11 $ (2) $ 6,051
Trust and investment advisory
fee income -- 864 (18) 846
Other income 1,835 -- (10) 1,825
-------- -------- -------- --------
Total operating income 7,877 875 (30) 8,722
-------- -------- -------- --------
Expenses:
Interest expense 1,455 -- (2) 1,453
Salaries and employee benefits 2,189 451 -- 2,640
Provision for loan losses 75 -- -- 75
Other 1,403 304 (28) 1,679
-------- -------- -------- --------
Total operating expenses 5,122 755 (30) 5,847
-------- -------- -------- --------
Income before income taxes 2,755 120 -- 2,875
Provision for income taxes 796 69 -- 865
-------- -------- -------- --------
Net income $ 1,959 $ 51 $- $ 2,010
-------- -------- -------- --------
Total assets $442,769 $ 8,548 $ (8,886) $442,431
Capital expenditures $ 343 $ 28 $ -- $ 376
The banking segment has assets in custody with Tredegar and accordingly
pays Tredegar a monthly fee. The banking segment also pays interest to both
Tredegar and GPIA on deposit accounts each has at the Bank. GPIA pays the
Company a management fee each month for accounting and other services provided.
Transactions related to these relationships are eliminated to reach consolidated
totals.
12
Note 8. Defined Benefit Pension Plan
The table below reflects the components of the Net Periodic Benefit
Cost.
Pension Benefits
---------------------------
2004 2003
---------------------------
Three Months Ended March 31, (In Thousands)
Service cost $ 101 $ 78
Interest cost 45 36
Expected return on plan assets (51) (37)
Amortization of net obligation
at transition (1) (1)
Amortization of net (gain) loss 8 9
---------------------------
Net periodic benefit cost $ 102 $ 85
===========================
The Company previously disclosed in the 2003 Form 10-K that it expected
to contribute $307,000 to its pension plan in 2004. As of March 31, 2004, no
contributions have been made.
13
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Critical Accounting Policies
General
The financial condition and results of operations presented in the
Consolidated Financial Statements, the accompanying Notes to Consolidated
Financial Statements and this section 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 ("Critical Accounting Policies") to
the portrayal and understanding of the Company's financial condition and results
of operations. The 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.
Allowance for Loan Losses
The Bank monitors and maintains an allowance for loan losses to absorb
an estimate of probable losses inherent in the loan and lease portfolio. The
Bank 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 Bank 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 ("SFAS 5"), with a group of loans that have similar
characteristics.
For loans without individual measures of impairment, the Bank 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.
The amounts of estimated impairment for individually evaluated loans
and groups of loans are added together for a total estimate of loans and lease
losses. This estimate of losses is compared to the
14
allowance for loan and lease losses of the Bank 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 Bank
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.
Intangibles and Goodwill
The Company has approximately $6.5 million in intangible assets and
goodwill at March 31, 2004, a decrease of $100,000 since December 31, 2003. On
April 1, 2002, the Bank acquired GPIA, a registered investment advisor, for $6.0
million. Approximately $5.9 million of the purchase price was allocated to
intangible assets and goodwill. In connection with this investment, a purchase
price valuation (using Financial Accounting Standard (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 GPIA's 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
Consolidated 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. The Company
engages an independent third party to conduct the two-step process as required
by FAS 142. On January 27, 2004, the third party had issued an opinion that
stated the amount of goodwill carried on the Company's balance sheet at December
31, 2003 was not impaired.
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.
15
Financial Summary
Net income for the three months ended March 31, 2004 decreased slightly
to $1.9 million from the $2.0 million reported for the first three months of
2003. Most of this decrease results from fewer gains realized on sales of
investment securities during the first quarter of 2004. Total average assets
increased 21.1% from the March 31, 2003 amount of $431 million to $522 million
at March 31, 2004. Average shareholders' equity increased 17.1% or $7.2 million
during that same period. Annualized returns on average assets and equity for the
three months ended March 31, 2004 were 1.5% and 15.9%, respectively, compared to
1.7% and 17.8% for the same period in 2003.
Total assets for the Company increased to $534.0 million at March 31,
2004, compared to $508.9 million at December 31, 2003, representing an increase
of $25.0 million or 4.9%. Total loans at March 31, 2004 were $267.7 million, an
increase of $9.6 million from the December 31, 2003 balance of $258.1 million.
Additional staff, a solid local economy and the relationship with Southern Trust
have contributed to the strong loan growth experienced thus far in 2004. Net
recoveries were $18,000 for the three months ended March 31, 2004. Because the
Company has experienced both fewer net charge offs and continued low levels of
past due loans during 2004, the Company currently expects the provision made to
the allowance for loan losses to be lower in 2004 than the amount recorded
during 2003. The provision for the three months ended March 31, 2004 was
$109,000. The allowance for loan losses was $2.7 million or 1.0% of total loans
outstanding at March 31, 2004.
On April 15, 2003, the Bank acquired a 40% interest in Southern Trust.
In connection with the Bank's investment in Southern Trust, the Bank's existing
mortgage operation was assumed by Southern Trust and 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.
Initially, the Company charged Southern Trust a rate equal to the one month
LIBOR rate at the time of purchase plus 175 basis points. The LIBOR rate had a
floor of 1.95%, which was removed on October 1, 2003. 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 a third party
to validate Colonial Bank's procedures. At March 31, 2004, the balance of the
Company's participated mortgages held for sale was $28.2 million. The tri-party
agreement is capped at $30.0 million.
The Company also entered into a construction loan participation
agreement with Southern Trust. Under 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 charges 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 $5.9 million in outstanding
balances of these construction loans at March 31, 2004.
The investment portfolio decreased 1.8% to $191.0 million at March 31,
2004 compared to $194.6 million at December 31, 2003. Deposits increased $18.7
million to $388.7 million at March 31, 2004 from $370.0 million at December 31,
2003. The Bank has developed an interest bearing product that integrates the use
of the cash within client accounts at Tredegar for overnight funding at the
Bank. The overall balance of this product was $21.5 million at March 31, 2004
and is reflected in both the interest bearing deposit and securities sold under
agreement to repurchase amounts on the balance sheet. Absent the increase from
the new deposit product for Tredegar clients, growth in both interest and non
interest bearing demand deposits of $12.5 million comprises the majority of the
increase in deposits during the first three months of 2004. Time deposits
decreased $1.3 million since December 31, 2003 to $102.8
16
million. One of the Bank's largest depositors had approximately $3.0 million in
Certificates of Deposits mature during the first quarter of 2004. Securities
sold under agreements to repurchase (Repo Accounts) increased $13.8 million from
$13.5 million at December 31, 2003 to $27.3 million at March 31, 2004. The Repo
Accounts are long-term commercial checking accounts with average balances that
typically exceed $100,000. Nearly all of this increase is from the new deposit
product developed for Tredegar Trust.
The increase in deposits funded the Company's asset growth experienced
during the three months ended March 31, 2004, and allowed for the curtailment of
some of the outstanding funds borrowed on an overnight basis. Federal Home Loan
Bank overnight advances were $0 at March 31, 2004 compared to the $27.3 million
balance at December 31, 2003. Federal Home Loan Bank long term advances
increased to $48.5 million at March 31, 2004, from the December 31, 2003 balance
of $31.0 million. Most of the overnight advances were paid with the funds
deposited into the new Tredegar Trust deposit account; however, the Company
decided to also obtain a termed advance with favorable pricing and reduce its
overnight outstandings.
Shareholders' equity was $49.5 million at March 31, 2004. This amount
represents an increase of 4.6% from the December 31, 2003 balance of $47.3
million. The book value per common share was $13.02 at March 31, 2004 and $12.44
at December 31, 2003.
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 $4.9 million for the first three months
of 2004 compared to $4.6 million for the same period in 2003, an increase of
6.0%. Average earning assets increased $75.7 million from $396.8 million at
March 31, 2003 to $472.5 million at March 31, 2004. The Company continues to
obtain a majority of its funding from growth in the low cost deposit categories.
Average deposits increased $38.0 million from $331.6 million at March 31, 2003
to $369.6 million at March 31, 2004. Total interest expense remained stable at
approximately $1.4 million for the three months ended March 31, 2004 and 2003.
Both the strong growth in lower cost deposits and the continued low interest
rate environment have contributed to the Company's stable level in interest
expense. The mix of low cost deposits versus time deposits remains unchanged at
approximately 70% in low cost deposits versus 30% in higher cost time deposits.
The net interest margin, on a tax equivalent basis, was 4.31% for the
three months ended March 31, 2004 compared to 4.83% for the same period in 2003.
The decline in net interest margin stems from significant prepayments in both
the investment and loan portfolio over the past year which have been reinvested
in lower yielding assets and has been offset partially by growth in earning
assets.
Noninterest Income
Noninterest income decreased 16.7% to $2.2 million for the first three
months of 2004 compared to $2.7 million for the same period in 2003. Commissions
and fees from trust and investment advisory activities were $939,000 for the
three month period ended March 31, 2004 compared to $846,000 for the same period
in 2003. Equity in earnings of affiliate, the line item representing the
Company's earnings from the Bank's 40% investment in Southern Trust, was
$461,000 for the period ended March 31, 2004. These earnings comprise 20.7% of
total noninterest income at March 31, 2004. The equity earnings in Southern
Trust added $.08 to net income per diluted share for the three months ended
March 31, 2004. Southern Trust closed $195.4 million in loans during the first
quarter of 2004 with only 40.0% of its production attributable to refinancing
volume. This production decrease, and any decreases associated
17
with the seasonality of second quarter home sales, is expected to be offset
slightly by an increase in purchase money financings and new construction loans.
Southern Trust began measures in August 2003 to cut expenses in efforts to
maintain efficiencies.
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 mortgage department were reported within the equity in earnings
from affiliate. As agreed upon with the investment in Southern Trust, the
Company received 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 received 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.
Investment advisory fees provided by GPIA totaled $545,000 for the
three months ended March 31, 2004. As of March 31, 2004, GPIA, a registered
investment advisor, manages approximately $594 million in assets. Fiduciary
fees, provided by Tredegar, increased 23.6% to $393,000 at March 31, 2004.
Fiduciary fees are based primarily upon the market value of the accounts under
administration.
Service charges, which include both deposit fees and certain loan fees,
decreased 25.8% to $439,000 at March 31, 2004, compared to $593,000 for the same
period in 2003. Approximately $78,000 of the decrease results from the Bank no
longer recognizing certain loan fees related to the sale of mortgages since its
investment in Southern Trust. Upon the Bank's investment in Southern Trust, it
ended its own mortgage operations.
Investment sales fees decreased 42.2% to $175,000 for the quarter ended
March 31, 2004, compared to $303,000 for the quarter ended March 31, 2003. A
strategic decision was made late in the third quarter of 2003 to change the
broker dealer clearing provider in the investment services department. This
resulted in a short-term decline in revenues for that period. It is anticipated
that the new clearing relationship will provide better client service,
heightened regulatory control, additional growth opportunities, and improved
financial contribution to the Company. Since the system conversion, the
investment services department has added two new financial consultants. These
additions provide the department with four full time financial consultants.
Noninterest Expense
Total noninterest expense includes employee-related costs, occupancy
and equipment expense and other overhead. Total noninterest expense remained
relatively stable, decreasing only $58,000 from March 31, 2003 to March 31,
2004. Salaries and employee benefits decreased 2.3% when comparing March 31,
2004 to March 31, 2003. Commissions (included within the salaries and benefits
expense) paid on investment sales fees and mortgage banking decreased 77.9% to
$85,000 for the quarter ended March 31, 2004 from $384,000 for the same period
in 2003. For the three months ended March 31, 2003, sales commissions included
mortgage banking which accounted for $225,000 of the total. Mortgage banking
sales commissions are now reported within equity in earnings from affiliate.
18
Allowance for Loan Losses
The allowance for loan losses at March 31, 2004 was $2.7 million
compared to $2.4 million at March 31, 2003. The allowance for loan losses was
1.0% of total loans outstanding at March 31, 2004 and 1.1% of total loans
outstanding at March 31, 2003. The provision for loan losses was $109,000 for
the three months ended March 31, 2004. Although net charge offs have decreased
during 2004, the provision added to the allowance for loan losses at March 31,
2004, increased over the same period in 2003 to accommodate the growth in the
loan portfolio during the first three months of 2004. The provision was $75,000
for the three months ended March 31, 2003. At March 31, 2004, net loan
recoveries totaled $18,000, compared to net charge offs of $25,000 for the same
date in 2003. Total loans past due 90 days or more at March 31, 2004 were
approximately $8,000. Non-performing loans were .31% of total loans outstanding
at March 31, 2004 compared to .11% at March 31, 2003. Management believes that
the allowance for loan losses is adequate to cover credit losses inherent in the
loan portfolio at March 31, 2004. 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 March 31, 2004 and December 31, 2003 was $49.5
million and $47.3 million, respectively. Total common shares outstanding at
March 31, 2004 were 3,803,402.
At March 31, 2004 the Company's tier 1 and total risk-based capital
ratios were 13.8% and 15.0%, respectively, compared to 14.4% and 15.6% at
December 31, 2003. The Company's leverage ratio was 10.1% at March 31, 2004
compared to 11.3% at December 31, 2003. 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 Company maintains federal funds lines
with large regional and money-center banking institutions. These available lines
total approximately $8 million, of which $700,000 was outstanding at March 31,
2004. Federal funds purchased during the first three months of 2004 averaged
$1.4 million compared to an average of $540,000 during the same period in 2003.
At March 31, 2004 and December 31, 2003, the Company had $27.3 million and $13.5
million, respectively, of outstanding borrowings pursuant to securities sold
under agreement to repurchase transactions (Repo Accounts), with maturities of
one day. The Repo Accounts are long-term commercial checking accounts with
average balances that typically exceed $100,000.
The Company has a credit line in the amount of $87.1 million at the
Federal Home Loan Bank of Atlanta. This line may be utilized for short and/or
long-term borrowing. The Company has utilized the credit
19
line for both overnight and long-term funding throughout the first three months
of 2004. Overnight and long-term advances averaged $19.6 million and $38.4
million, respectively, at March 31, 2004.
At March 31, 2004, cash, interest-bearing deposits with financial
institutions, federal funds sold, short-term investments, loans held for sale
and securities available for sale were 47.4% of total deposits and liabilities.
Caution About 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, the following factors:
* the ability to successfully manage the Company's growth or
implement its growth strategies if it is unable to identify
attractive markets, locations or opportunities to expand in
the future;
* the ability to continue to attract low cost core deposits to
fund asset growth
* maintaining capital levels adequate to support the Company's
growth;
* maintaining cost controls and asset qualities as the Company
opens or acquires new branches;
* reliance on the Company's management team, including its
ability to attract and retain key personnel;
* the successful management of interest rate risk;
* changes in general economic and business conditions in the
Company's market area;
* changes in interest rates and interest rate policies;
* risks inherent in making loans such as repayment risks and
fluctuating collateral values;
* competition with other banks and financial institutions, and
companies outside of the banking industry, including those
companies that have substantially greater access to capital
and other resources;
* demand, development and acceptance of new products and
services;
* problems with technology utilized by the Company;
* changing trends in customer profiles and behavior; and
* changes in banking and other laws and regulations applicable
to the Company.
20
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 interest rate 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 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 a 100 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 three months ended March 31,
2004 as well as the fiscal year of 2003 compared to the 10% Board-approved
policy limit.
21
For the Three Months Ended March 31, 2004
Rate Change Estimated Net Interest Income Sensitivity
----------- -----------------------------------------
High Low Average
---- --- -------
+ 200 bp (1.45%) (1.45%) (1.45%)
- 100 bp (1.16%) (1.16%) (1.16%)
For the Year Ended December 31, 2003
Rate Change Estimated Net Interest Income Sensitivity
----------- -----------------------------------------
High Low Average
---- --- -------
+ 200 bp (2.11%) .34% (1.23%)
- 100 bp .60% (.28%) .44%
Since December 31, 2003, the Company's balance sheet has grown by $25.0
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. The Company's interest rate profile of the balance sheet has a
slightly liability sensitive bias in the near short term and then shifts toward
intermediate and long term asset sensitivity. The Company expects, based on
projections from internal interest rate risk models and the assumption of a
sustained rising rate environment, net interest income to initially trend
downward slightly throughout the first year as mortgage related assets extend
and funding costs rise quickly. That decrease to net interest income could be
expected to be approximately 1.45% or $283,000 in the first year should rates
rise 200 basis points. During the second year, as funding costs stabilize and
the asset base continues to reprice or replace, a widening of the balance sheet
spread is predicted, thus causing a benefit to net interest income.
If interest rates should decline 100 basis points, the expected impact
to the Company's net interest income over the next twelve months would be a
decline of approximately $227,000.
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.
22
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.
The Company's management is also responsible for establishing and
maintaining adequate internal control over financial reporting. There were no
changes in the Company's internal control over financial reporting identified in
connection with the evaluation of it that occurred during the Company's last
fiscal quarter that materially affected, or are reasonably likely to materially
affect, internal control over financial reporting.
As disclosed above, on April 15, 2003, the Bank acquired a 40% interest
in Southern Trust. During 2003, the Bank assisted Southern Trust with an upgrade
conversion of its accounting system. The Bank 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.
23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Change in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
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 February 4, 2004, the Company furnished a Current Report on
Form 8-K dated January 30, 2004 to report, under Item 12, and
attach as an exhibit and incorporate by reference, a press
release that reported the Company's financial results for the
year ended December 31, 2003.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
MIDDLEBURG FINANCIAL CORPORATION
(Registrant)
Date: May 14, 2004 /s/ Joseph L. Boling
-----------------------------------------
Joseph L. Boling
Chairman of the Board & CEO
Date: May 14, 2004 /s/ Alice P. Frazier
-----------------------------------------
Alice P. Frazier
Executive Vice President & COO
(Chief Financial Officer)
Date: May 14, 2004 /s/ Kathleen J. Chappell
-----------------------------------------
Kathleen J. Chappell
Senior Vice President & Controller
(Chief Accounting Officer)
25
EXHIBIT INDEX
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